Section 7201 provides in pertinent part that "Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall * * * be guilty of a felony". Section 7201 encompasses two closely related but distinct crimes: (1) An attempt to evade or defeat any tax (evasion of assessment),and (2) an attempt to evade or defeat the payment of any tax (evasion of payment). See Sansone v. United States, 380 U.S. 343, 354 (1965) (citing Lawn v. United States, 355 U.S. 339 (1958)).


Letantia Bussell and Estate of John Bussell, Deceased, Letantia Bussell, Surviving Spouse v. Commissioner.

Dkt. No. 5766-04L , 130 TC --, No. 13, May 29, 2008.

[

[Code Secs. 6330, 6331, 7201 and 7429]

Collection Due Process: Jeopardy Levy: Notice requirements: Tax Evasion: Conviction: Collateral Estoppel. --

The IRS did not abuse its discretion by determining that a married couple's unpaid tax liabilities were excepted from bankruptcy discharge because the wife had been convicted of attempted tax evasion and bankruptcy fraud. In addition, the IRS properly proceeded with collection of the unpaid taxes by serving jeopardy levies. The taxpayer was collaterally estopped from arguing that her tax liabilities (and interest and penalties thereon) were discharged by bankruptcy in a petition against a jeopardy levy because she had been properly convicted of attempted tax evasion under Code Sec. 7201. The IRS did not violate any notice requirement of Code Sec. 6331 or Code Sec. 7429 when it issued the jeopardy levy. --CCH.





Letantia Bussell, pro se; Ronald S. Chun, for respondent.



R assessed income tax deficiencies, additions to tax, penalties, and interest against PW and her husband (H) for 1983, 1984, 1986, and 1987 (Ps' unpaid tax liabilities). In 1994 R filed notices of Federal tax lien in California and Utah with regard to Ps' unpaid tax liabilities. In early 1995 PW and H filed a bankruptcy petition under ch. 7 of the Bankruptcy Code. The bankruptcy court issued a discharge order in the bankruptcy case later that year.



In 2000 PW and H were indicted and charged with various violations associated with bankruptcy fraud. In February 2002 H died, and no verdict was returned as to him. PW was convicted of, among other crimes, attempted evasion of payment of Ps' unpaid tax liabilities in violation of sec. 7201, I.R.C.



In April 2002 R determined that (1) Ps' unpaid tax liabilities were excepted from discharge in bankruptcy because PW was convicted of attempted evasion of payment of Ps' unpaid tax liabilities, and (2) collection of Ps' unpaid tax liabilities would be jeopardized by delay. R served jeopardy levies and collected amounts that were applied to Ps' unpaid tax liabilities. R subsequently issued to Ps a notice of the jeopardy levies pursuant to secs. 6330 and 7429, I.R.C. Ps requested and received an Appeals Office hearing under sec. 6330, I.R.C. In March 2004 R sent Ps a notice of determination upholding the decision to proceed with the jeopardy levies. Ps timely petitioned this Court to review R's determination.



Held: R did not abuse his discretion in determining that (1) Ps' unpaid tax liabilities were excepted from discharge in bankruptcy by reason of PW's conviction for attempted evasion of payment of Ps' unpaid tax liabilities and that (2) it was appropriate to proceed with collection by serving the jeopardy levies in dispute.



Held, further, although Ps received a discharge and were relieved of personal (in personam) liability for the penalties and related interest that R assessed for the years in issue, the liens that R filed before Ps filed for bankruptcy attached to certain of Ps' assets, survived the bankruptcy proceeding, and enabled R to collect the penalties and interest by an action against Ps in rem.



Held, further, R complied with sec. 6331(a), I.R.C., by providing Ps with notice and demand for payment of their unpaid tax liabilities for the years in issue before proceeding with collection by serving the jeopardy levies in dispute.



MARVEL, Judge: Petitioners1 invoked the Court's jurisdiction pursuant to section 6330(d)2 to review respondent's determination that it was appropriate to collect petitioners' unpaid tax liabilities for 1983, 1984, 1986, and 1987 (sometimes referred to as the years in issue) by serving jeopardy levies. As explained in detail below, we shall sustain respondent's determination.





FINDINGS OF FACT



Some of the facts have been stipulated. We incorporate the stipulated facts into our findings by this reference. Petitioner Letantia Bussell (petitioner) resided in California when the petition was filed.



Petitioner was married to John Bussell (Mr. Bussell) (collectively the Bussells) from 1972 until his death in 2002.



Petitioner is a licensed physician with a specialty in dermatology. Since 1979 she has maintained a dermatology practice in Beverly Hills, California. From 1981 through approximately 1995 petitioner conducted her medical practice through various corporations including Letantia Bussell MD Inc. Mr. Bussell was a licensed physician specializing in anesthesiology until he became disabled in September 1992.




I. Assessments for 1983, 1984, 1986, and 1987


The Bussells filed joint Forms 1040, U.S. Individual Income Tax Return, for 1983, 1984, 1986, and 1987. Respondent subsequently examined those tax returns and, pursuant to deficiency procedures and other means, entered substantial assessments of Federal income tax, additions to tax, penalties, and interest for each year. The validity of these assessments is not in issue.3




II. Notices of Balance Due and Notices of Intent To Levy


Between November 1992 and October 1993 respondent sent the Bussells multiple notices of balance due for each of the years in issue to correspond with the assessments mentioned above.



Between May and November 1993 respondent sent the Bussells a separate notice of intent to levy for each of the years in issue.




III. Balances Due for the Years in Issue


Petitioners failed to pay their taxes for the years in issue. Respondent's records, as of May 29, 2002, reflected that petitioners' unpaid balances for 1983, 1984, 1986, and 1987 totaled $44,556.55, $61,422.27, $600,789.65, and $309,085.73, respectively. These amounts do not include substantial amounts of accrued but unassessed interest for the years in issue inasmuch as respondent's Forms 4340, Certificate of Assessments, Payments, and Other Specified Matters, indicate that respondent last assessed interest for the taxable years 1983, 1984, 1986, and 1987 between June and September 1993.




IV. Notices of Federal Tax Lien for 1983, 1984, 1986, and 1987


On March 10, 1994, respondent filed a notice of Federal tax lien with the Los Angeles County Recorder's Office with respect to petitioners' unpaid tax liabilities for the years in issue. On September 6, 1994, respondent filed a notice of Federal tax lien in Coalville, Utah, with respect to petitioners' unpaid tax liabilities for the years in issue.




V. The Bussells' Bankruptcy Proceeding


On March 7, 1995, the Bussells filed a petition under chapter 7 of the Bankruptcy Code with the U.S. Bankruptcy Court for the Central District of California. The Bussells also filed with the bankruptcy court a list of assets which included a condominium unit in Utah and separate term life insurance policies issued by Connecticut Mutual Life Insurance Co. (Connecticut Mutual)4 and John Hancock Mutual Life Insurance Co. (John Hancock). The Connecticut Mutual and John Hancock life insurance policies were issued to Mr. Bussell as the insured in September 1987 and April 1990, respectively, and petitioner was named as the beneficiary under the Connecticut Mutual policy.5 Neither life insurance policy had a cash surrender value on the date the Bussells' bankruptcy petition was filed. However, under the terms of each policy, Mr. Bussell had a right to renew the policy without evidence of insurability.



The Bussells also disclosed in their list of assets that (1) Mr. Bussell was receiving monthly disability payments totaling $45,650 on four different disability insurance policies, and (2) Mr. Bussell had a pending lawsuit for a claim for unpaid disability benefits against a fifth insurance company.



The Bussells failed to include various assets in the list of assets they submitted to the bankruptcy court. One such asset was a pension plan account that petitioner maintained at Washington Mutual Bank under the name L.B. Bussell Medical Corp. As of December 31, 1994, shortly before the Bussells filed their bankruptcy petition, there was a balance of $284,040 in the pension plan account.



On April 14, 1995, the bankruptcy trustee filed a so-called no asset report with the bankruptcy court. On August 22, 1995, the bankruptcy court entered an order of discharge in the Bussells' bankruptcy case which stated in pertinent part: "The above-named debtor is released from all dischargeable debts".




VI. Criminal Proceedings


On July 5, 2000, the Federal grand jury for the Central District of California returned a 17-count indictment against the Bussells and one of their attorneys. United States v. Bussell, case No. SA CR 01-56(A)-AHS. On January 31, 2002, a superseding indictment was filed against the Bussells and their attorney.



On February 6, 2002, at the close of the criminal trial, Mr. Bussell died. Although no verdict was returned as to Mr. Bussell, petitioner was convicted of one count of violating 18 U.S.C. section 371 (conspiracy to commit an offense against or defraud the United States), two counts of violating 18 U.S.C. section 152(1) (concealment of assets in bankruptcy), two counts of violating 18 U.S.C. section 152(3) (false declaration and statement in bankruptcy), and one count of violating section 7201 (attempted evasion of payment of tax). With regard to this last count, the superseding indictment stated that beginning in June 1992 and continuing until at least August 1995 the Bussells willfully attempted to evade and defeat the payment of a total of $353,394 of the income tax they owed for 1983, 1984, 1986, and 1987 by fraudulently causing the bankruptcy court to discharge their tax debts.



Petitioner was sentenced to a term of incarceration and was initially ordered to pay restitution to various creditors, exclusive of special assessments and interest, totaling $2,393,527. Pursuant to this order, petitioner was directed to pay $1,067,621.90 to the Internal Revenue Service (IRS). Petitioner was further ordered to pay the costs of prosecution totaling $62,214.37, pursuant to section 7201.



Petitioner appealed to the Court of Appeals for the Ninth Circuit, which issued an opinion affirming petitioner's convictions and remanding the case for further proceedings. See United States v. Bussell, 414 F.3d 1048 (9th Cir. 2005). Following the remand, the Court of Appeals issued a second opinion affirming both petitioner's sentence and an order directing petitioner to pay restitution of $2,284,172.87 and prosecution costs of $55,626.09. See United States v. Bussell, 504 F.3d 956, 963-968 (9th Cir. 2007).




VII. Jeopardy Levies


On or about April 30, 2002, respondent's area director for Los Angeles, California, made a determination that collection of petitioners' unpaid income tax liabilities for 1983, 1984, 1986, and 1987 would be jeopardized by delay. On or about April 30, 2002, respondent's area director also entered a jeopardy assessment under section 6861(a) of approximately $1.25 million in respect of petitioners' tax liability for 1996.6



Revenue Officer Farrell Stevens (Revenue Officer Stevens) was assigned to collect petitioners' unpaid tax liabilities for 1983, 1984, 1986, 1987, and 1996. On April 30, 2002, Revenue Officer Stevens hand delivered three notices of levy to Washington Mutual Bank. Two of the levy notices pertained to collection of $2,128,931.70 identified as petitioners' unpaid tax liabilities for 1983, 1984, 1986, and 1987. The third levy notice was delivered with respect to collection of petitioners' unpaid tax liability for 1996. In response to the levies, Washington Mutual Bank delivered to respondent a single check for $713,496.28. Of that amount, approximately $150,000 came from three of petitioners' checking accounts, and $563,000 came from a pension plan account petitioners maintained at the bank.



Respondent subsequently served levies for 1983, 1984, 1986, 1987, and 1996 on Connecticut Mutual and John Hancock in respect of the benefits payable to petitioner on term life insurance policies issued to Mr. Bussell. Connecticut Mutual and John Hancock responded to the levies by transferring to respondent $1,043,525.66 and $1 million respectively.




VIII. Administrative and Judicial Proceedings Related to the Jeopardy Levies


On May 2, 2002, 3 days after delivering the above-described levy notices to Washington Mutual Bank, Revenue Officer Stevens mailed to petitioners by certified mail a Notice of Jeopardy evyRight of Appeal for 1983, 1984, 1986, and 1987. The notice stated that petitioners were entitled to (1) request an administrative review of the jeopardy levy determination pursuant to section 7429 and (2) request an Appeals Office hearing regarding the jeopardy levy determination pursuant to section 6330.



A. Petitioners' Request for an Appeals Office Hearing Under Section 6330



On May 13, 2002, petitioners filed with respondent pursuant to section 6330 a handwritten Form 12153, Request for a Collection Due Process Hearing, listing the years in dispute as 1983, 1984, 1986, 1987, and 1996. On or about May 30, 2002, petitioners' representative filed with respondent a second (typed) request for an administrative hearing. In both requests petitioners asserted that (1) their underlying tax liabilities were not subject to collection because they were discharged in bankruptcy and (2) petitioner was eligible for relief under section 6015.



B. Petitioners' Civil Complaint Filed Pursuant to Section 7429



On August 23, 2002, petitioners filed a complaint in the U.S. District Court for the Central District of California, Bussell v. Commissioner, case No. CV-02-6629 SVW, seeking review pursuant to section 7429(b) of the jeopardy levies (described above) and the jeopardy assessment for 1996. Shortly after the complaint was filed, the parties filed cross-motions for summary judgment. Petitioners argued that they were unable to hide or dissipate assets because of court supervision, that the Government was able to acquire petitioners' assets by other means, that other assets were available to satisfy the tax liabilities, and that all tax penalties were discharged in bankruptcy.



On or about December 11, 2002, the District Court entered an order granting the Commissioner's motion for summary judgment and denying petitioners' motion for summary judgment. The District Court held that the Commissioner had satisfied his burden of proof, i.e., that his jeopardy determination was reasonable, inasmuch as petitioner's criminal history demonstrated that petitioner failed to report income and engaged in a scheme to hide assets from the Commissioner in an attempt to defeat collection of unpaid taxes. The District Court also held that petitioners failed to satisfy their burden of showing that the jeopardy assessment for 1996 pursuant to section 6861(a) was not appropriate under the circumstances.7



C. Petitioner's Payment



On or about May 19, 2003, petitioner remitted to respondent a cashier's check in the amount of $680,000. Petitioner included the following notation on the back of the check: "This check is being tendered for full payment of claimed alleged taxes, interest, and penalties by the IRS against Letantia Bussell. It is tendered with full reservation of rights and under protest." By letter to petitioner dated May 19, 2003, Revenue Officer Stevens acknowledged receipt of the check and indicated that petitioners' tax liability for 1996 was paid in full and that the IRS would release any outstanding liens and levies for 1983, 1984, 1986, 1987, and 1996. However, by letter dated September 10, 2003, Revenue Officer Stevens informed petitioners' counsel that, taking into account additional interest assessments, petitioner still owed $541,372.24 for 1983, 1984, and 1986 and that amount might be abated for lack of additional prepetition assets to provide a source for collection, but that the matter ultimately would be decided by respondent's counsel.



D. Petitioner's Refund Claim



In 2003 petitioner submitted to respondent a Form 843, Claim for Refund and Request for Abatement, for 1986 and 1987. Petitioner alleged in her petition that she did not receive a response to her claim.



E. Appeals Office Proceedings and Notice of Determination



On December 1, 2003, Appeals Officer Charlotte Edginton met with petitioner to conduct an administrative hearing pursuant to section 6330. On March 3, 2004, respondent issued to petitioners a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330 (notice of determination) with respect to the collection of their tax liabilities for 1983, 1984, 1986, and 1987. The notice of determination includes the following determinations:8 (1) All legal and procedural requirements were met; (2) petitioners were sent multiple notices and demand for payment of the tax liabilities in question; (3) petitioners had ample opportunity to resolve their tax matters with the Commissioner; (4) petitioners failed to submit financial statements as required for consideration of alternative payment methods; (5) petitioners were precluded from challenging their 1983, 1984, 1986, and 1987 tax liabilities because respondent issued notices of deficiency for those years; (6) petitioners' tax liabilities for the years in issue were not discharged in bankruptcy because petitioner was convicted of attempted evasion of payment of those taxes under section 7201, among other crimes; (7) Federal tax liens attached to the Bussells' assets and survived any bankruptcy discharge; (8) petitioner was precluded from asserting a claim for relief under section 6015 because her application for section 6015 relief was unprocessable; and (9) petitioners failed to submit any evidence to establish that the jeopardy levies did not balance the need for efficient collection of taxes with the legitimate concern that any collection action be no more intrusive than necessary. The notice of determination also stated that the Appeals Office declined to consider the taxable year 1996 because petitioners were engaged in a separate collection review proceeding regarding a lien that respondent had filed for 1996.



Petitioners filed with the Court a timely petition and an amendment to petition, challenging respondent's notice of determination. Petitioners contend that (1) their tax liabilities for 1983, 1984, 1986, and 1987, and interest thereon, were discharged in bankruptcy, (2) all penalties assessed for the years in issue, and interest thereon, were discharged in bankruptcy, (3) the liens that respondent filed before petitioners filed for bankruptcy did not attach to any of the assets that respondent levied on during 2002, (4) respondent failed to provide petitioners with notice and demand for payment in advance of the jeopardy levies, and (5) respondent waived the right to challenge issues (1) and (3) above.





OPINION



Our review of respondent's determination to proceed with collection requires an understanding of the interplay between laws governing collection of Federal income taxes and laws extending protections to debtors who file for bankruptcy. Consequently, we shall preface our analysis with a brief overview of (1) the Secretary's authority to collect Federal income taxes, (2) the protections extended to taxpayers in collection matters pursuant to sections 6320 and 6330, and (3) protections afforded taxpayers under the Federal bankruptcy laws.




I. The Secretary's Authority To Assess and Collect Income Taxes


The Secretary is required to make inquiries, determinations, and assessments of all taxes imposed under the Internal Revenue Code. Sec. 6201(a). An assessment is made when the liability of the taxpayer is recorded in the Office of the Secretary. Sec. 6203.



Section 6301 authorizes the Secretary to collect taxes imposed by the internal revenue laws. As a general rule, the Secretary is obliged, within 60 days after making an assessment of tax under section 6203, to give notice to each person liable for such tax stating the amount due and demanding payment thereof. Sec. 6303(a). Such notice may be left at the person's dwelling or usual place of business or shall be sent by mail to the person's last known address. Sec. 6303(a).



A. Liens



Section 6321 provides that if any person liable to pay any tax neglects or refuses to pay the same after demand, the tax and any interest, additional amount, addition to tax, or assessable penalty shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person. The lien imposed under section 6321 generally arises at the time the assessment is made and continues until the tax liability is satisfied or becomes unenforceable by reason of lapse of time. Sec. 6322. However, the lien imposed under section 6321 is not valid against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor until the Secretary files notice of the lien with the proper State or Federal authorities. Sec. 6323(a), (f).



B. Levies



Section 6331(a) provides that, if any person liable to pay any tax neglects or refuses to pay the tax within 10 days after notice and demand, the Secretary is authorized to collect such tax by levy upon all property and rights to property belonging to such person or on which there is a lien for the payment of such tax. The final sentence of section 6331(a) provides:



If the Secretary makes a finding that the collection of such tax is in jeopardy, notice and demand for immediate payment of such tax may be made by the Secretary and, upon failure or refusal to pay such tax, collection thereof by levy shall be lawful without regard to the 10-day period provided in this section.



In connection with the foregoing, section 6331(d)(1) and (2) sets forth the general rule that the Secretary must provide a taxpayer with 30 days' advance notice before proceeding with collection by levy. Nevertheless, section 6331(d)(3) provides that paragraph (1) shall not apply to a levy if the Secretary determines that collection of the tax is in jeopardy under the final sentence of section 6331(a).




II. Collection Review Proceedings Under Sections 6320 and 6330


Section 6330(a) provides the general rule that no levy may be made on any property or right to property of any taxpayer unless the Secretary has provided 30 days' advance notice to the taxpayer of the right to an administrative hearing before the levy is carried out. Section 6330(f) provides, however, that if the Secretary finds that the collection of the tax is in jeopardy, the taxpayer shall be given the opportunity for a section 6330 hearing within a reasonable time after the levy.



If the taxpayer makes a timely request for an administrative hearing, the hearing shall be conducted by the IRS Office of Appeals (Appeals Office) before an impartial officer. Sec. 6330(b)(1), (3). The parameters for the hearing are set forth in section 6330(c). First, the Appeals officer must obtain verification from the Secretary that the requirements of any applicable law or administrative procedure have been met. Sec. 6330(c)(1). Second, the taxpayer may raise at the hearing any issue relevant to the collection action, including spousal defenses, challenges to the appropriateness of the collection action, and offers of collection alternatives. Sec. 6330(c)(2)(A). Additionally, the taxpayer may contest the existence and amount of the underlying tax liability, but only if he or she did not receive a notice of deficiency or otherwise have an opportunity to dispute the tax liability. Sec. 6330(c)(2)(B). The Appeals officer must make a determination after reviewing the matters prescribed in section 6330(c)(1) and (2) and considering whether the proposed collection action balances the need for efficient collection of taxes with the legitimate concern of the taxpayer that the collection should be no more intrusive than necessary. Sec. 6330(c)(3).



After the Appeals Office makes a determination under section 6330(c), the taxpayer may petition the Tax Court for judicial review. Sec. 6330(d). If the taxpayer's underlying tax liability is properly at issue, the Court reviews any determination regarding the underlying tax liability de novo. Sego v. Commissioner, 114 T.C. 604, 610 (2000). The Court reviews any other administrative determinations regarding the proposed collection action for abuse of discretion. Id.




III. Protections Afforded Taxpayers Under the Bankruptcy Code


A debtor who files a bankruptcy petition under chapter 7 of the Bankruptcy Code shall be granted a discharge unless one of the grounds for denial of discharge enumerated in that chapter exists. 11 U.S.C. sec. 727(a). Title 11 U.S.C. section 727(b) provides in relevant part that, except as provided in 11 U.S.C. section 523, a discharge under subsection (a) of 11 U.S.C. section 727 discharges a debtor from personal liability for all debts incurred before the bankruptcy petition was filed. See United States v. Hatton, 220 F.3d 1057, 1059-1060 (9th Cir. 2000).



Title 11 U.S.C. section 523(a) sets forth several exceptions to discharge under 11 U.S.C. section 727 and provides in pertinent part:



§ 523. Exceptions to discharge



(a) A discharge under section 727 * * * of this title does not discharge an individual debtor from any debt --



(1) for a tax or a customs duty --



(A) of the kind and for the periods specified in section 507(a)(2) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed;



(B) with respect to which a return, if required --



(i) was not filed; or



(ii) was filed after the date on which such return was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition; or



(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax * * *



Title 11 U.S.C. section 507(a)(8) refers to certain income taxes due for specified periods before the bankruptcy petition was filed. See Washington v. Commissioner, 120 T.C. 114, 121-122 (2003). Thus, 11 U.S.C. section 523(a)(1)(C) provides that a discharge under 11 U.S.C. section 727 does not discharge an individual debtor with regard to certain Federal income taxes if the debtor willfully attempted in any manner to evade or defeat such taxes.



A discharge under 11 U.S.C. section 727 relieves the debtor of personal (or in personam) liability. See, e.g., Schott v. WyHy Fed. Credit Union, 282 Bankr. 1, 5 (B.A.P. 10th Cir. 2002). Such a discharge, however, does not protect the debtor's assets if those assets were subject to a Federal tax lien that was properly filed pursuant to section 6323 before the bankruptcy petition was filed. See 11 U.S.C. sec. 522(c)(2)(B). As the Supreme Court explained in Johnson v. Home State Bank, 501 U.S. 78, 84 (1991), a discharge of personal liability in bankruptcy "extinguishes only one mode of enforcing a claim --namely, an action against the debtor in personam --while leaving intact another --namely, an action against the debtor in rem." See Connor v. United States, 27 F.3d 365, 366 (9th Cir. 1994); Iannone v. Commissioner, 122 T.C. 287, 292-293 (2004); Woods v. Commissioner, T.C. Memo. 2006-38.




IV. Analysis


A. Jurisdiction



In the light of the relatively novel set of circumstances that preceded the filing of the petition, we feel compelled to briefly outline the scope of the Court's jurisdiction in this case. We first note that this case comes before the Court after respondent collected substantial amounts from petitioners for the years 1983, 1984, 1986, and 1987 by issuing jeopardy levies.9 There is no dispute that the Court's jurisdiction to review collection actions under section 6330(d) vests the Court with authority to review the Commissioner's determination to issue a jeopardy levy. See Dorn v. Commissioner, 119 T.C. 356, 359 (2002); see also sec. 301.6330-1(a)(2)(ii), Proced. & Admin. Regs.



We also observe that although petitioners do not dispute the specific amounts of their underlying tax liabilities for any of the years in issue,10 they do assert that some or all of their tax liabilities for the years in issue were discharged in bankruptcy. The Court's jurisdiction to review a collection action under section 6320 and/or 6330 includes the authority to determine whether a taxpayer's unpaid tax liabilities were discharged in a bankruptcy proceeding. See Swanson v. Commissioner, 121 T.C. 111, 118-119 (2003); Washington v. Commissioner, supra at 120-121. A taxpayer's assertion that his or her tax liabilities were discharged in bankruptcy amounts to a challenge to the appropriateness of the collection action under section 6330(c)(2)(A). Swanson v. Commissioner, supra at 119. Accordingly, we have jurisdiction to review respondent's determination that petitioners' tax liabilities were excepted from discharge in the bankruptcy proceeding. See Kendricks v. Commissioner, 124 T.C. 69, 75 (2005); Swanson v. Commissioner, supra at 119.



Finally, the notice of determination includes a statement that any question regarding the appropriateness of the disputed jeopardy levies is moot inasmuch as petitioners' tax liabilities for the years in issue were fully paid by application of the amounts collected through the jeopardy levies and petitioner's payment in May 2003.11 We conclude that this matter is not moot.



When the Commissioner determines that collection of tax is in jeopardy, the taxpayer is not afforded a prior opportunity for a hearing under section 6330 to challenge the appropriateness of the levy before it is issued. See sec. 6330(f)(1). In recognition of this reality, section 6330(f) provides that the taxpayer against whom a jeopardy levy is issued "shall be given the opportunity for the hearing described in [section 6330] within a reasonable time after the levy." The right to a hearing conferred by section 6330(f) is not limited to situations where some portion of the taxpayer's tax liability remains unpaid. In sum, subsections (d) and (f) of section 6330 confer upon a taxpayer against whom a jeopardy levy has been issued an unqualified right to a postlevy hearing (if timely requested) and judicial review by this Court, regardless of whether the jeopardy levy resulted in the seizure of assets sufficient to fully pay the disputed tax liabilities. See Dorn v. Commissioner, supra.



Consistent with the foregoing, the issues we are called upon to decide are (1) whether the requirements of all applicable laws and administrative procedures were met in respect of the disputed jeopardy levies, and (2) the related questions whether petitioners' tax liabilities were discharged in bankruptcy and whether respondent improperly levied on certain of petitioners' assets.12



B. Dischargeability of Unpaid Taxes



The notice of determination states the Appeals officer concluded petitioners' tax liabilities for the years in issue were excepted from discharge in bankruptcy under 11 U.S.C. section 523(a)(1)(C) and therefore respondent was free to proceed with collection. Petitioners contend that the Appeals officer erred in this determination.



Title 11 U.S.C. section 523(a)(1)(C) excepts from discharge a debtor's liability for taxes if the debtor "willfully attempted in any manner to evade or defeat such tax". Although bankruptcy courts normally make determinations regarding the dischargeability of specific debts, nonbankruptcy courts may exercise jurisdiction to determine the applicability of the exceptions to discharge enumerated in 11 U.S.C. section 523(a) (other than the exceptions contained in subsection (a)(2), (4), and (6)). See 4 Collier on Bankruptcy, par. 523.03, at 523-19 to 523-21 (March 2006). As we explained in Swanson v. Commissioner, supra, the question whether a taxpayer's debts are excepted from discharge may have a direct bearing on whether the Commissioner's determination in a collection action should be sustained.



Neither the Bankruptcy Code nor the Federal Rules of Bankruptcy Procedure impose a time limit or deadline in respect of a determination of the applicability of an exception to discharge under 11 U.S.C. section 523(a)(1)(C). See Fed. R. Bankr. P. 4007(b) (a complaint that a debt is excepted from discharge may be filed anytime during a bankruptcy case, and if the case is closed, the case may be reopened for the purpose of filing such a complaint); see also 4 Collier on Bankruptcy, par. 523.04, at 523-23 (September 2005) ("If the dischargeability issue is not raised during the bankruptcy case, it may be determined potentially in the state court or other nonbankruptcy court in an action initiated by the debtor or as an affirmative defense in an action initiated by the creditor.").13



The exception to discharge under 11 U.S.C. section 523(a)(1)(C) is applicable if the following elements are present: (1) The debtor engaged in an affirmative act or omission to evade or defeat the payment or collection of tax, and (2) the debtor acted willfully. See United States v. Jacobs, 490 F.3d 913, 921 (11th Cir. 2007) (and cases cited therein); United States v. Fegeley, 118 F.3d 979, 983-984 (3d Cir. 1997). A debtor acts willfully under 11 U.S.C. section 523(a)(1)(C) by voluntarily and intentionally violating a known legal duty. Griffith v. United States, 206 F.3d 1389, 1396 (11th Cir. 2000).



Respondent avers that petitioner is collaterally estopped from denying that her tax liabilities for the years in issue were excepted from discharge under 11 U.S.C. section 523(a)(1)(C) because petitioner was convicted of willfully attempting to evade the payment of her tax liabilities for 1983, 1984, 1986, and 1987 under section 7201.14



As explained by the Supreme Court in Montana v. United States, 440 U.S. 147, 153 (1979), the doctrine of issue preclusion, or collateral estoppel, provides that, once an issue of fact or law is "actually and necessarily determined by a court of competent jurisdiction, that determination is conclusive in subsequent suits based on a different cause of action involving a party to the prior litigation." See Parklane Hosiery Co. v. Shore, 439 U.S. 322, 329 (1979). Collateral estoppel is a judicially created equitable principle the purposes of which are to protect parties from unnecessary and redundant litigation, to conserve judicial resources, and to foster certainty in and reliance on judicial action. Montana v. United States, supra at 153-154; United States v. ITT Rayonier, Inc., 627 F.2d 996, 1000 (9th Cir. 1980).



It is well settled that bankruptcy courts may apply the doctrine of collateral estoppel in making dischargeability determinations. See Grogan v. Garner, 498 U.S. 279, 285 n.11 (1991); Simone v. United States, 252 Bankr. 302, 306-307 (Bankr. E.D. Pa. 2000). Inasmuch as this Court has undertaken to determine in the disposition of this collection review proceeding whether petitioners' tax liabilities were excepted from discharge, and with a view to furthering the policies underlying the doctrine of collateral estoppel, we conclude that the doctrine may be asserted and considered by the Court in this collection review proceeding under section 6330.



In Peck v. Commissioner, 90 T.C. 162, 166-167 (1988), affd. 904 F.2d 525 (9th Cir. 1990), the Court identified the following five conditions that must be satisfied before collateral estoppel may be applied in the context of a factual dispute: (1) The issue in the second suit must be identical in all respects with the issue decided in the first suit, (2) the issue in the first suit must have been the subject of a final judgment entered by a court of competent jurisdiction, (3) the person against whom collateral estoppel is asserted must have been a party or in privity with a party in the first suit, (4) the parties must actually have litigated the issue in the first suit and resolution of the issue must have been essential to the prior decision, and (5) the controlling facts and applicable legal principles must remain unchanged from those in the first suit. See United States IRS v. Palmer, 207 F.3d 566, 568 (9th Cir. 2000) (citing Pena v. Gardner, 976 F.2d 469, 472 (9th Cir. 1992)). We shall examine each of these conditions in turn.



Section 7201 provides in pertinent part that "Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall * * * be guilty of a felony". We note that section 7201 encompasses two closely related but distinct crimes: (1) An attempt to evade or defeat any tax (evasion of assessment),15 and (2) an attempt to evade or defeat the payment of any tax (evasion of payment). See Sansone v. United States, 380 U.S. 343, 354 (1965) (citing Lawn v. United States, 355 U.S. 339 (1958)). Petitioner was convicted of attempting to evade the payment of her taxes for the years in issue.



To prove that a taxpayer attempted to evade payment of tax, the Government must establish that the taxpayer failed to pay a tax imposed under the Internal Revenue Code,16 the taxpayer engaged in an affirmative act to evade payment, and the taxpayer acted willfully. See United States v. Schoppert, 362 F.3d 451, 454-456 (8th Cir. 2004). Like the willfulness element under 11 U.S.C. section 523(a)(1)(C), willfulness for purposes of section 7201 requires proof that the taxpayer voluntarily and intentionally violated a known legal duty. Cheek v. United States, 498 U.S. 192, 201 (1991); United States v. Pomponio, 429 U.S. 10, 12 (1976). Because the elements necessary for a conviction under section 7201 overlap with the elements necessary to establish the applicability of the exception to discharge under 11 U.S.C. section 523(a)(1)(C), we conclude the first condition for collateral estoppel is present.



Petitioner was charged in a single count of the superseding indictment with violating section 7201 by willfully attempting to evade and defeat the payment of income taxes she owed for 1983, 1984, 1986, and 1987. The superseding indictment alleged that petitioner fraudulently caused the bankruptcy court to discharge her tax debts for the years in issue. When an act of evasion of payment of taxes involves transfers of funds or concealing assets that cannot logically be assigned to a particular taxable year, section 7201 permits a unit of prosecution charging an evasion of payment of taxes owed for a group of tax years. See United States v. Pollen, 978 F.2d 78, 85-87 (3d Cir. 1992). In United States v. Shorter, 809 F.2d 54, 56-58 (D.C. Cir. 1987), the court explained that tax evasion covering several taxable years may be charged in a single count where the defendant has allegedly engaged in a course of conduct directed at evading payment of those taxes.



After a hard-fought and lengthy trial, petitioner was convicted of several crimes, including a violation of section 7201, as outlined above, and each such conviction was upheld on appeal. See United States v. Bussell, 414 F.3d at 1052. Consequently, we conclude that the second, third, and fourth conditions for the application of collateral estoppel are present. Specifically, petitioner was the defendant in the earlier criminal proceeding, the parties litigated the charge that petitioner violated section 7201, and petitioner's conviction under section 7201 was affirmed by a final judgment entered by the Court of Appeals for the Ninth Circuit.



Finally, there is no dispute that the controlling facts and legal principles remain unchanged from the time of the criminal proceeding to the present. Consistent with the foregoing, we hold that petitioner is collaterally estopped from contesting respondent's determination that her tax liabilities for the years in issue were excepted from discharge under 11 U.S.C. section 523(a)(1)(C).17 See Grothues v. IRS, 226 F.3d 334, 339 (5th Cir. 2000) (taxpayer estopped from challenging 11 U.S.C. section 523(a)(1)(C) discharge exception because taxpayer pleaded guilty to evading the payment of excise taxes under section 7201); Simone v. United States, 252 Bankr. 302 (Bankr. E.D. Pa. 2000).



Petitioner seeks to avoid the application of collateral estoppel by arguing that it is possible the jury decided that she was guilty of violating section 7201 because she attempted to evade the payment of tax for one or more (but not all) of the years in issue. To the contrary, the Government charged petitioner with a single count of violating section 7201 by engaging in a course of conduct intended to evade the payment of taxes for each of the years in issue. As previously mentioned, section 7201 permits a unit of prosecution (a single count) charging evasion of payment of taxes owed for a group of tax years in a case (such as the present case) where it is not practicable to assign to a particular taxable year the value of assets a taxpayer attempted to hide from the Commissioner. See United States v. Pollen, supra at 85-87. Moreover, the record clearly shows that, before filing for bankruptcy, petitioners failed to pay substantial amounts of their tax liabilities for each of the years in issue. There is no indication that petitioners attempted to contest that fact in the criminal case, and it is evident that any attempt to do so would have been futile. Finally, what the Government alleged and proved to the satisfaction of the jury in petitioner's criminal case was that petitioners failed to disclose all of their assets in the bankruptcy proceeding in a willful attempt to use the bankruptcy proceeding as a means to evade the payment of their tax liabilities for the years in issue. Petitioner simply cannot relitigate these facts.



Petitioner also asserts that the exception to discharge under 11 U.S.C. section 523(a)(1)(C), which uses the past tense in referring to a debtor who "willfully attempted" to evade or defeat a tax, is applicable only if the debtor attempted to defeat or evade taxes before filing for bankruptcy; i.e., prepetition. Petitioner reasons that, because the superseding indictment stated that petitioner violated section 7201 by acts committed both prepetition and postpetition,18 the possibility exists that the jury based its guilty verdict solely on petitioner's postpetition activities.



Petitioner does not cite any case in which 11 U.S.C. section 523(a)(1)(C) has been interpreted in this fashion, and we are not aware of such a case. In any event, petitioner's argument is strained and unconvincing --we see no justification for limiting the scope of the exception to discharge set forth in 11 U.S.C. section 523(a)(1)(C) to a taxpayer's prepetition activities when opportunities to deceive the Commissioner and the bankruptcy court are available throughout a bankruptcy proceeding. In sum, we reject petitioner's argument and conclude that the plain language of 11 U.S.C. section 523(a)(1)(C) is properly read as excepting from discharge any tax that petitioner attempted to defeat or evade either before or during the bankruptcy proceeding.



C. Dischargeability of Interest



Petitioners contend that the bankruptcy court's discharge order relieved them of liability for interest accrued on their unpaid tax liabilities. However, interest accrued on a tax liability excepted from discharge is also nondischargeable. See Bruning v. United States, 376 U.S. 358, 360 (1964); Ward v. Board of Equalization (In re Artisan Woodworkers), 204 F.3d 888, 891 (9th Cir. 2000). Because petitioners' 1983, 1984, 1986, and 1987 tax liabilities are excepted from discharge, they remain liable for the interest that accrued on those liabilities.



D. Dischargeability of Penalties



The parties agree that the penalties respondent assessed against petitioners for the years in issue were discharged under 11 U.S.C. section 523(a)(7)(B), which provides for the discharge of any tax penalty "imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition".19 Respondent apparently does not dispute that there is no exception to discharge for these penalties because 11 U.S.C. section 523(a)(1)(A), which refers to 11 U.S.C. section 507(a), excepts from discharge only priority tax penalties, a term defined in 11 U.S.C. section 507(a)(8)(G) as penalties "in compensation for actual pecuniary loss." Respondent acknowledges that the penalties assessed against petitioners were not "pecuniary loss" penalties. Respondent argues, however, that he was free to collect the penalties in question because the notice of Federal tax lien filed with the Los Angeles County Recorder's Office in March 1994 attached to certain of the Bussells' assets before they filed their bankruptcy petition.



A Federal tax lien that is properly filed before a debtor files for bankruptcy attaches to the debtor's property and is not extinguished by a subsequent bankruptcy discharge. See 11 U.S.C. sec. 522(c)(2)(B); Johnson v. Home State Bank, 501 U.S. at 84; Connor v. United States, 27 F.3d at 366; Iannone v. Commissioner, 122 T.C. at 292-293. On the other hand, a prepetition lien does not attach to property acquired by the debtor after a bankruptcy petition is filed. See, e.g., United States v. McGugin (In re Braund), 423 F.2d 718, 718-719 (9th Cir. 1970).



Respondent contends that the notice of Federal tax lien filed with the Los Angeles County Recorder's Office attached to the pension plan account that petitioners maintained at Washington Mutual Bank and to the Connecticut Mutual and John Hancock term life insurance policies and therefore respondent was justified in levying upon and applying the proceeds from those assets to satisfy the penalties in question.20



Petitioners do not challenge the validity of respondent's lien, nor do they dispute that the Bussells owned the pension plan account and the life insurance policies when they filed their bankruptcy petition. Petitioners argue instead that respondent failed to prove that those assets had sufficient value as of the date of the bankruptcy filing to offset all of the penalties in question. As petitioners see it, respondent must have improperly collected petitioners' postpetition assets and applied the proceeds against petitioners' penalties. Petitioners contend that they are entitled to a refund of any amounts that respondent collected in violation of the bankruptcy discharge as it pertains to tax penalties.



This is not a case in which the levies in question were preceded by an invalid assessment, see Chocallo v. Commissioner, T.C. Memo. 2004-152, nor (as discussed below) did respondent fail to adhere to any of the statutory provisions governing jeopardy levies, see Zapara v. Commissioner, 124 T.C. 223 (2005), as supplemented 126 T.C. 215 (2006). Respondent was entitled, pursuant to the notice of Federal tax lien filed in March 1994, to levy upon prepetition assets to satisfy petitioners' tax liabilities, including the discharged penalties. Because respondent had the right to proceed in rem against petitioners' prepetition assets, respondent's decision to pursue a jeopardy levy was appropriate and was not an abuse of discretion.



Because respondent had the right to proceed in rem against prepetition assets to satisfy the discharged penalties, petitioners' contention that they are entitled to a refund to the extent respondent may have improperly applied proceeds of postpetition assets in partial satisfaction of the discharged penalties is not relevant to the issue before us --whether respondent's use of a jeopardy levy was appropriate. Petitioners' contention may be relevant in an action seeking refund of an overpayment. See sec. 6342(b). However, any ruling by this Court on that subject would amount to an advisory opinion. See, e.g., Greene-Thapedi v. Commissioner, 126 T.C. 1, 13 (2006).



For the reasons already described, we do not have to decide the value of the pension plan account21 or the value of the life insurance policies22 on the date the Bussells filed their bankruptcy petition in order to decide whether the jeopardy levy was appropriate. We conclude only that respondent was entitled to levy on all of these assets and apply the proceeds against petitioners' unpaid tax liabilities, interest thereon, and the penalties in question.



E. Satisfaction of Notice Requirements for Collection



Petitioners contend that the Appeals officer erroneously concluded that petitioners received proper notice before the jeopardy levies were served on Washington Mutual Bank. Specifically, petitioners contend that respondent failed to provide them with notice and demand for immediate payment and, as a result, they were denied the opportunity to fail or refuse to pay their tax liabilities before respondent served the jeopardy levies. As explained below, petitioners simply misconstrue the applicable statutory provisions.



The first sentence of section 6331(a) provides that, if any person liable to pay any tax neglects or refuses to pay the tax within 10 days after notice and demand, the Secretary is authorized to collect such tax by levy upon all property and rights to property belonging to such person or on which there is a lien for the payment of such tax. The final sentence of section 6331(a) provides that if the collection of tax is in jeopardy and the Commissioner finds it necessary to expedite collection, the normal 10 days' advance notice requirement may be set aside and the Commissioner may instead serve the taxpayer with a notice and demand for immediate payment. Petitioners assert that respondent was obliged under the last sentence of section 6331(a) to provide them with notice and demand for immediate payment before proceeding with the jeopardy levies in dispute. We disagree.



The record shows that respondent complied with the first sentence of section 6331(a) by sending the Bussells multiple notices of balance due with regard to their unpaid taxes for the years in issue during 1992 and 1993. In addition, respondent sent them notices of intent to levy for each of the years in issue during 1993, and respondent filed Federal tax liens for the years in issue during 1994. All of these collection notices were issued well in advance of the jeopardy levies which were served in 2002. It is well settled that a notice of balance due constitutes a notice and demand for payment within the meaning of section 6303(a). See Hughes v. United States, 953 F.2d 531, 536 (9th Cir. 1992); see also Hansen v. United States, 7 F.3d 137, 138 (9th Cir. 1993); Craig v. Commissioner, 119 T.C. 252, 262-263 (2002).



Considering that respondent fully complied with the first sentence of section 6331(a) and petitioners repeatedly failed to pay their taxes for the years in issue, respondent was under no obligation to provide petitioners with any additional notice and demand for payment before serving the jeopardy levies in question. Requiring a notice and demand for immediate payment in all jeopardy situations, as petitioners suggest, is inconsistent with both section 6331(d)(3), which provides that the Commissioner is not required to give a taxpayer any notice of his intent to levy if collection is in jeopardy, and section 7429(a)(1)(B), which provides that the Commissioner has 5 days from the date of a jeopardy levy to give the taxpayer written notice of the information upon which he relied in determining that collection was in jeopardy. Simply put, by the time respondent determined that collection of petitioners' tax liabilities was in jeopardy, he had already complied with the 30 days' advance notice requirement, and therefore he was free to serve the jeopardy levies in dispute.23



Petitioners received each collection notice that they were entitled to under the law. In addition to providing petitioners with notice and demand for payment, respondent complied with sections 6330(f) and 7429(a)(1)(B) by providing petitioners with notice of the jeopardy levies and of their rights to administrative and judicial review of the levies 3 days after the levies were served. Petitioners took full advantage of both avenues of review.




V. Conclusion


We conclude that respondent did not abuse his discretion in determining that it was appropriate to proceed with collection by jeopardy levy. The Appeals officer determined that all procedural requirements were met, addressed petitioners' arguments raised at the Appeals Office hearing, and balanced the need for efficient collection of taxes against petitioners' concern that the collection method was overly intrusive. Petitioners' unpaid tax liabilities and the interest accrued thereon were not discharged in bankruptcy, and respondent held a lien on petitioners' property that survived bankruptcy and provided an avenue for respondent to collect some, if not all, of the penalties petitioners owed.



We have considered the remaining arguments of both parties for results contrary to those discussed herein, and to the extent not discussed above, conclude those arguments are irrelevant, moot, or without merit.



To reflect the foregoing,



Decision will be entered for respondent.


1 References to petitioners are to Letantia Bussell and the Estate of John Bussell.

2 Unless indicated otherwise, all section references are to the Internal Revenue Code in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure. References to sections and chapters of the Bankruptcy Code are to tit. 11 of the United States Code after the effective date of amendments made thereto by the Bankruptcy Reform Act of 1994, Pub. L. 103-394, 108 Stat. 4106, that were effective for bankruptcies filed on and after Oct. 22, 1994. Id. sec. 702, 108 Stat. 4150.

3 Although the validity of the assessments is not in issue, the Court has discovered an anomaly with regard to certain assessments for 1986 and 1987. In particular, the Bussells filed a petition with the Court at docket No. 6156-92 contesting a notice of deficiency for 1986 and 1987. On June 25, 1993, the Court entered an agreed decision at docket No. 6156-92 in which the parties agreed in pertinent part that the Bussells were liable for income tax deficiencies of $186,679 and $97,071.15 for 1986 and 1987, respectively. The agreed decision included a stipulation below the signature of the Judge who entered the decision that respondent claimed increased deficiencies of $12,973 and $12,360.15 for 1986 and 1987, respectively. An examination of the notice of deficiency for 1986 and 1987 suggests that these increased deficiencies were reflected in the $186,679 and $97,071.15 deficiency amounts listed in the Court's decision. However, in September 1993 respondent entered assessments for additional tax for 1986 and 1987 of $199,652 and $109,431.30, respectively. Assuming the increased deficiencies were already reflected in the deficiency amounts listed in the Court's decision, the $199,652 amount assessed for 1986 is inflated by $12,973, and the $109,431.30 amount assessed for 1987 is inflated by $12,360.15.

4 Connecticut Mutual Life Insurance Co. is now known as Massachusetts Mutual Life Insurance Co., but we shall refer to the company as Connecticut Mutual.

5 We assume, as petitioner asserts, that she was also the beneficiary under the John Hancock policy, but the record does not clearly establish this.

6 After entering the jeopardy assessment for 1996, respondent issued a notice of deficiency to petitioners for 1996. Sec. 6861(b). Petitioner filed a petition with the Court at docket No. 15462-02 for redetermination of the deficiency.

Respondent also issued a notice of Federal tax lien dated May 3, 2003, with regard to petitioners' unpaid tax liability for 1996. Petitioners requested and received an administrative hearing with regard to the lien pursuant to sec. 6320. On Mar. 3, 2004, respondent issued to petitioners a notice of determination sustaining the filing of the lien for 1996 but noting that the lien had been released because petitioners had fully paid their tax liability for 1996. Petitioners did not file a petition with the Court challenging the notice of determination for 1996.

In Bussell v. Commissioner, T.C. Memo. 2005-77, affd. without published opinion 101 AFTR 2d 2008-313, 2008-1 USTC par. 50,107 (9th Cir. 2007), the Court sustained respondent's determination that petitioner was liable for a substantial deficiency for 1996, as well as a fraud penalty under sec. 6663(a). The Court also denied petitioner's claim for relief under sec. 6015.

7 The District Court declined to address petitioners' assertion that penalties assessed for 1983, 1984, 1986, and 1987 were discharged in bankruptcy. The District Court noted that the penalties had been assessed years earlier and were not the subject of the disputed jeopardy assessment for 1996. See Bussell v. Commissioner, case No. CV-02-6629 SVW (C.D. Cal. 2002). The District Court suggested that the question whether the penalties were discharged in bankruptcy could be raised in the Tax Court or in a refund action.

8 The notice of determination admitted as Exhibit 22-J is not a complete copy of the notice of determination issued for 1983, 1984, 1986, 1987. A copy of the notice of determination, however, was attached to petitioner's petition, and we rely on it for these findings.

9 Although the parties stipulated that respondent issued jeopardy levies with regard to petitioners' unpaid taxes for 1983, 1984, 1986, 1987, and 1996, and respondent applied amounts that he collected to each of those years, petitioners did not challenge the notice of determination for 1996 that respondent issued to them on Mar. 3, 2004, nor did they attempt to place the taxable year 1996 at issue. Thus, our review is limited to respondent's determination to proceed with collection for 1983, 1984, 1986, and 1987.

10 Petitioner likewise did not challenge the statement in the notice of determination that her claim for relief under sec. 6015 was "unprocessable" and not part of the administrative hearing. Under the circumstances, petitioner is deemed to have conceded this issue. See Rule 331(b)(4).

11 Respondent did not assert that this matter is moot in his pleadings or at trial. Respondent made a passing reference to mootness in a footnote in his opening brief, but he did not offer any meaningful discussion with regard to the issue.

12 In connection with the argument that some or all of their taxes for the years in issue were discharged in bankruptcy, petitioners erroneously maintain that (1) they are entitled to a determination that they overpaid their taxes, and (2) the Court has the authority under sec. 6512(b) to order respondent to process a refund. To the contrary, we recently held in Greene-Thapedi v. Commissioner, 126 T.C. 1, 8-13 (2006), that sec. 6330 does not provide this Court with jurisdiction to determine an overpayment or to order a refund or credit of taxes paid. On the other hand, we also noted in Greene-Thapedi v. Commissioner, supra at 9 n.13, that the Court has inherent equitable powers to order the Commissioner to return to a taxpayer property that was improperly levied upon.

13 We reject petitioners' contention that respondent was obliged to bring an action in the bankruptcy court to revoke petitioners' discharge under 11 U.S.C. sec. 727(d) and (e) (revocation of discharge obtained through debtor's fraud). An action under 11 U.S.C. sec. 727(e)(1) to revoke a discharge extends to all of the debtor's debts and constitutes an action that is distinct from the two-party dispute contemplated in an action to determine whether a particular tax debt is excepted from discharge under 11 U.S.C. sec. 523(a). See Menk v. Lapaglia, 241 Bankr. 896, 906-907, 911 (B.A.P. 9th Cir. 1999) (recognizing the distinctions between the two actions); see also 6 Collier on Bankruptcy, par. 727.01[1], at 727-8 (June 2006) ("The concept of nondischargeability of a particular debt under section 523 is not to be confused with denial of discharge for all debts under section 727.").

14 Petitioners contend that respondent did not properly plead collateral estoppel in his answer. We disagree. The notice of determination includes a statement that petitioner's tax liabilities were not dischargeable, as a result of petitioner's criminal conviction under sec. 7201, and petitioners specifically challenged this point in their petition. Moreover, respondent addressed the matter in his answer by admitting that collateral estoppel would not be applicable if petitioner's convictions were overturned on appeal. In short, both parties understood that application of the doctrine of collateral estoppel was a disputed issue.

15 To prove that a taxpayer attempted to evade assessment of tax, the Government normally must establish three elements: willfulness, the existence of a tax deficiency, and an affirmative act constituting an evasion or attempted evasion of tax. See Sansone v. United States, 380 U.S. 343, 351 (1965); United States v. Wilkins, 385 F.2d 465, 472 (4th Cir. 1967).

16 In an evasion of payment case, the Government normally is not required to show that a tax deficiency exists because the underlying tax liability has been assessed but remains unpaid. See United States v. Conley, 826 F.2d 551, 557 (7th Cir. 1987) (taxpayer filed timely and accurate returns reporting tax due but concealed his assets to evade payment); United States v. Hook, 781 F.2d 1166, 1168-1169 (6th Cir. 1986) (same).

17 Petitioners make the point that Mr. Bussell was not convicted of tax evasion or any other crime, and therefore, the doctrine of collateral estoppel does not apply to the Estate of John Bussell. As discussed in detail in this Opinion, however, we conclude that petitioner is collaterally estopped from contesting respondent's determination that her tax liabilities for the years in issue were excepted from discharge under 11 U.S.C. sec. 523(a)(1)(C). Further, we observe that petitioner resides in California, a community property State, and there has been no showing that respondent levied upon anything other than the Bussells' "community property" under California law. See, e.g., Ordlock v. Commissioner, 126 T.C. 47, 58 (2006) (citing McIntyre v. United States, 222 F.3d 655 (9th Cir. 2000), for the proposition that under California law the Commissioner may collect one spouse's separate tax liability out of community assets). Consequently, absent any indication that respondent levied on separate property of the Estate of John Bussell, the nonapplicability of collateral estoppel as to the Estate of John Bussell is simply irrelevant to the question concerning the appropriateness of the disputed collection action.

18 The superseding indictment referred to petitioner's course of conduct between June 1992 through at least Aug. 22, 1995 --the latter being the date the bankruptcy court issued its discharge order.

19 The Bussells filed their bankruptcy petition on Mar. 7, 1995, and their unpaid income tax liabilities for 1983, 1984, 1986, and 1987 arose more than 3 years before that date.

20 We reject petitioners' assertion that respondent "waived" the right to make this argument. To the contrary, although the issue was discussed in the notice of determination, petitioners did not address it in their petition. Nevertheless, because the parties stipulated matters related to this issue and developed the issue through testimony at trial, we conclude the issue was tried by consent of the parties and is properly before the Court. See Rule 41(b).

21 The record shows that the Bussells' pension plan account had substantial value on the date the bankruptcy petition was filed. Revenue Officer Stevens testified that the prepetition value of the pension plan was $284,040 and that he determined the value from account statements and other documents sent to him by the plan administrator and by petitioners' representative at that time.

22 A term life insurance policy may have value to the extent (1) the insured has the right to renew the policy at the end of the term regardless of his or her medical condition, and (2) the beneficiary of the policy has the right to receive death benefits if the insured dies during the period the policy is in effect. See Minnesota Mut. Life Ins. Co. v. Ensley, 174 F.3d 977, 984 n.3 (9th Cir. 1999); Elfmont v. Elfmont, 891 P.2d 136, 141-142 (Cal. 1995) (citing Pritchard v. Logan (Estate of Logan), 236 Cal. Rptr. 368, 371 (Ct. App. 1987)).

23 We also note that the last sentence of sec. 6331(a) is permissive in that it states that the Secretary may issue a notice and demand for immediate payment. Compare sec. 6861(a), which provides that in a case of jeopardy the Secretary shall immediately assess such deficiency and notice and demand shall be made for the payment.

IRS Levy - section 6331(a)- Upon service of a notice of levy, the Service steps into the shoes of the taxpayer and acquires whatever rights to the property the taxpayer had possessed prior to the notice of levy. Nat'l Bank of Commerce, 472 U.S. at 725. However, the levy only reaches the taxpayer's rights "as it finds them." United States v. Sullivan, 333 F.2d 100, 110 (3 rd Cir. 1964) [ 64-1 USTC ¶9392].

Symbol: CC:PA:BR:3-GL-147605-07


Uniform Issue List No. 6331.00-00

[ Code Sec. 6331]






Levy and distraint.



DATE: January 9, 2008



TO: Associate Area Counsel (Indianapolis) (Small Business/Self-Employed)



FROM: Mitchel S. Hyman, Senior Technician Reviewer (Procedure & Administration)



SUBJECT: Levy on State Retirement Fund



This Chief Counsel Advice responds to your request for assistance. In accordance with I.R.C. § 6110(k)(3), this Chief Counsel Advice should not be cited as precedent.





ISSUE



After serving a notice oflevy on a state retirement fund, can the Service exercise the taxpayer's right to suspend membership in the fund in order to obtain an immediate distribution of the taxpayer's assets in the fund when the taxpayer has not yet reached retirement age?





CONCLUSION



No, the Service may not exercise the taxpayer's right to suspend membership in the fund in order to obtain an immediate distribution of the taxpayer's assets in the fund when the taxpayer has not yet reached retirement age. The Service may levy upon a retirement plan even if a participant has no immediate right to receive benefits. However, the fund is not obligated to turn over any assets pursuant to the Service's levy until the taxpayer reaches the age in which she is eligible for retirement benefits under the plan or the taxpayer voluntarily suspends her membership in the plan.





FACTS



Married taxpayers have an unpaid joint income tax liability. One spouse has an account with a state retirement fund. She is fifty years old and not currently receiving benefits from the fund. Although the taxpayer no longer works for the state, she has obtained other employment and is not retired. According to the terms of the retirement fund the taxpayer may elect to suspend membership in the fund and receive a distribution of all assets in her account. If she does not make such an election, when the taxpayer reaches retirement age, she will be eligible to receive her retirement benefits from the account.



The Service served a notice of levy on the state retirement fund in order to collect the taxpayer's assets in the fund. The fund will not distribute the assets unless the taxpayer elects to suspend membership in the fund. The revenue officer asks whether the Service can "elect" to suspend membership in the fund on the taxpayer's behalf.





LAW AND ANALYSIS



For the reasons stated below, the Service cannot elect the suspension of membership in the state retirement fund on behalf of the taxpayer.



Pursuant to I.R.C. § 6321, a lien arises upon "all property or rights to property" of the taxpayer. Additionally, I.R.C. § 6331(a) authorizes the Service to levy upon "all property and rights to property" of a taxpayer or on which there is a federal tax lien in order to collect delinquent taxes. Congress broadly defined "property" in section 6331(a) to reach every interest a taxpayer might have in property. See United States v. Nat'l Bank of Commerce, 472 U.S. 713, 719-720 (1985) [ 85-2 USTC ¶9482]. Only property that is specifically enumerated in I.R.C. 6334(a) is exempt from levy. Because the Code does not specifically exempt funds in a state retirement fund from levy, the Service's levy attaches to the taxpayers' interest in the state retirement fund. See Shanbaum v. United States , 32 F.3d 180 (5 th Cir. 1994) [ 94-2 USTC ¶50,512].



Generally, a levy extends only to property rights and obligations that exist at the time of the levy. Treas. Reg. § 301.6331-1(a). Obligations exist for purposes of a levy when the liability of the obligor is fixed and determinable, although the right to receive payment is deferred until a later date. Id. See also Tull v. United States, 69 F.3d 394 (9 th Cir. 1995) [ 95-2 USTC ¶50,602]. Accordingly, even if the taxpayer is not currently receiving benefits from the retirement fund, if a present right to a future payment exists, the levy reaches that present right. See Rev. Rul. 55-210, 1955-1 C.B. 544 (lien attaches to entire unqualified right to receive future benefits; only one notice of levy needs to be served to effectively reach benefits subsequently payable.)



Upon service of a notice of levy, the Service steps into the shoes of the taxpayer and acquires whatever rights to the property the taxpayer had possessed prior to the notice of levy. Nat'l Bank of Commerce, 472 U.S. at 725. However, the levy only reaches the taxpayer's rights "as it finds them." United States v. Sullivan, 333 F.2d 100, 110 (3 rd Cir. 1964) [ 64-1 USTC ¶9392]. Accordingly, the levy only reaches property rights that exist at the time of the levy. Thus, for example, in Sullivan, the Service levied on the taxpayer's insurance policy. The insurance policy had a cash surrender value. The court held that the Service's levy did not require the insurance company to turn over the cash surrender value of the policy. The court reasoned that the levy reached only the taxpayer's basic right under the policy to receive benefits upon the policy's maturation. The Service had no authority, through its levy, to exercise the taxpayer's right to cancel the policy. Id. at 108-119. 1



In this case, we similarly conclude that although the Service's levy reaches the taxpayer's future right to retirement benefits when the taxpayer reaches retirement age 2 , it does not entitle the Service to compel suspension of the taxpayer's membership in the fund. Accordingly, the Service is not entitled to a distribution of the assets in the account before the taxpayer is eligible to receive benefits.



However, the Service may bring a lien foreclosure suit pursuant to I.R.C. § 7403. A lien foreclosure suit is appropriate here because the administrative levy in this situation will not immediately entitle the Service to any assets.



This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views.



Please call ***** if you have any further questions.



By: Mitchel S. Hyman, Senior Technician Reviewer (Procedure & Administration).


1 Congress subsequently enacted I.R.C. §6332(b) which created a special procedure by which the Service can levy upon the cash surrender value of an insurance policy.

2 Levying on the present right to future payment would not require immediate distribution by the retirement fund. Honoring the levy would only be required when the benefits become payable to the taxpayer under the terms of the retirement fund. See IRM 5.11.6.1(3).

Innocent Spouse - IRS abused its discretition - section 6015

The IRS abused its discretion in denying a request for equitable innocent spouse relief under Code Sec. 6015(f). The requesting spouse was not employed when the tax liability arose and relied totally upon the income of her husband, an attorney who was abusing drugs. The Tax Court had jurisdiction to review the denial of innocent spouse relief under Code Sec. 6015(e)(1) and could use evidence outside of the administrative record in determining whether the IRS abused its discretion. With regard to the factors set out in Rev. Proc. 2000-15, 2000-1 CB 448, the IRS abused its discretion in failing to consider whether the couple was still married, whether there was abuse or if a finding of liability would impose economic hardship on the wife. Although the couple was not divorced at the time of the request and they were living in the same home, they were using separate bedrooms, so the marital status factor was deemed to favor the wife. Evidence of abuse and economic hardship was present, but the IRS failed to follow up on the evidence. Relief was proper because the only factor that ultimately weighed against the wife was her knowledge of the underpayment.


Chrystina Nihiser v. Commissioner.

Dkt. No. 19315-04 , TC Memo. 2008-135, May 20, 2008.








MEMORANDUM FINDINGS OF FACT AND OPINION



HOLMES, Judge: Chrystina Nihiser was a stay-at-home mom. With only a small income from her own part-time work, she relied on her husband's law practice to support their family. But his practice was only intermittently successful and, when financial troubles arrived, he stopped paying the taxes they owed.



She applied for innocent-spouse relief at a time when her life was becoming increasingly worse. Her husband, it turned out, was using drugs and stealing from his clients --eventually leading to his arrest and imprisonment. She now seeks relief from joint liability for a 1996-2001 tax debt of nearly a quarter-million dollars. Her case raises tricky questions of what evidence we can consider and how we should weigh it.





FINDINGS OF FACT



Nihiser married Kevin Connolly in 1980. Connolly was a plaintiff's lawyer with a small practice, and Nihiser was a schoolteacher until 1988, when she gave birth to their daughter. During their marriage, Connolly controlled the family finances. He kept most of his income hidden from Nihiser by using a checking account in his law practice's name, and paid most of the family's expenses from this account. When Nihiser needed money, Connolly would give her a check from his account and she would deposit it in their joint checking account. Connolly himself never deposited money directly into the joint account.



He also kept Nihiser away from their tax returns, letting her see them only when he presented them to her for her signature. This was Nihiser's one chance each year to learn about Connolly's income. But Connolly lowered the odds of her noticing anything by showing them to her only on their due date. (The one return not signed on its due date was signed on April 14.) Connolly's accountants likewise signed the returns on or just days before their due date.



In 1993, Connolly began filing returns without paying the amounts due. Nihiser would see that they owed taxes, and she did ask Connolly how he planned on paying them. But Connolly would complain that his law practice's expenses were just too great, and promised her that one of his cases would settle, or a new business venture would pay off, and provide the needed funds. Nihiser believed him, but was naturally left uneasy by his answers. When she followed up, Connolly would berate her. And he never did pay the taxes due.



In 1997, Connolly tried to solve their financial difficulties by filing for bankruptcy. It was the couple's second trip to the bankruptcy courthouse. Their first --in 1993 --had already cost them their house. The 1997 bankruptcy discharged their 1993-95 tax liabilities, but the strains on their marriage only grew worse.



The problem was drugs. Nihiser had suspected that Connolly was using from about the time she gave birth to their daughter, and claimed --credibly, but without corroborating evidence --that the family doctor finally confirmed her suspicions when he told her that Connolly's blood tested positive for cocaine. Connolly finally admitted to drug use, during counseling as their marriage careened to its end. But he refused help and became enraged when she brought it up.



In 1998 Connolly and Nihiser filed their 1997 tax return, but Connolly again failed to pay the taxes shown as due. Nihiser intensified her efforts to get Connolly to satisfy their tax liability, but Connolly kept making the same empty promises. He also told her that she should continue to sign the returns because California's being a community-property state meant there was no way she could get out of being liable for half of the taxes anyway. Nothing changed with their 1998 tax return, and their unpaid tax liability continued to grow.



In July 1999, part of the routine did change: Connolly filled out divorce papers and gave them to her. Although he never filed the papers with a court, Nihiser thought (and we specifically find her testimony credible on this point) that they were legally separated. Only they did not literally separate. For the next five years, Connolly and Nihiser lived in separate rooms of the same apartment. During this time, Connolly continued to control their finances and pay the rent. The new living arrangement did not change their tax habits. In 1999 and 2000, Connolly and Nihiser again filed joint tax returns showing taxes owed.



In July 2001, Connolly felt that filing for bankruptcy a third time was the answer and convinced Nihiser to sign the petition. Then, in October 2002, Nihiser signed their 2001 tax return. It was to be their last return filed jointly. Nihiser learned that Connolly had let their health insurance lapse, and for her this was the last straw. The next month she began looking for her own answer to their tax problems and learned about innocent-spouse relief. She filed a Form 8857, Request for Innocent Spouse Relief, and Form 12510, Questionnaire for Requesting Spouse, with the Commissioner to be relieved of liability for the unpaid taxes from 1996-2001.1 She included with the two forms a letter describing her situation. Unbeknownst to Nihiser, Connolly had about this same time attracted the attention of the California State Bar, which began disciplinary proceedings against him for stealing money from his clients.



While the bar probe got under way, the Commissioner's Centralized Cincinnati Innocent Spouse Operations (CCISO) was reviewing Nihiser's claim for relief. In a March 2003 letter, CCISO denied her relief because she did not have reason to believe that Connolly would ever pay their taxes, given the years of unpaid balances --balances that kept on growing --and the couple's return trips to bankruptcy court. The letter also explained that the verbal abuse she suffered was not enough "of a factor to overcome continuing to file joint returns with balances due without taking corrective action." The CCISO workpapers, which were introduced at trial, gave more insight into the Commissioner's reasoning. They listed the various factors considered, but not always consistently. Few of the factors listed in those workpapers were even mentioned in the form letter that Nihiser received.



Nihiser then sent a "statement of disagreement" to the IRS's Appeals Office. She explained that Connolly had assured her that he would pay the taxes and that she had taken him on his word since he denied her access to their financial records. She also explained that, though she had returned to full-time teaching in January 2003, raising a child on her salary would be a hardship if she also had to pay the now very substantial back taxes. Near the end of her statement, Nihiser informed the Commissioner that when the IRS contacted Connolly about her request he got "extremely angry" and threatened to tell them that she had spent all their money.



Connolly may well have been upset for another reason --in November 2003, the ongoing state investigation triggered his resignation from the bar. He again kept Nihiser in the dark. In any event, she pressed forward by meeting that same month with the Appeals officer who was assigned to her case. He told her that IRS policy required him to contact Connolly about her request. He also asked her to supply more complete information about the couple's income and expenses. Nihiser credibly testified at trial that she did not provide the Appeals officer with more information because she was afraid to ask Connolly about his finances.



In July 2004, the Appeals officer sent Nihiser a notice of determination denying her request for relief. The denial was based largely on his conclusion that she should have known when she signed returns the taxes were not going to be paid when she signed the returns. He found her stated belief that Connolly would pay the taxes unreasonable because of the couple's history of not paying taxes, the size of the underpayment, and their serial bankruptcies. (He also seemed to find that Nihiser failed to fulfill her duty to inquire about the amount of the couple's tax liability. This is odd, given that she always claimed that she knew the amount of the liabilities when she signed the returns and reported the exact amounts for each liability in her request for relief.)



The Appeals officer also found that paying the tax would not cause her economic hardship because she was still living with Connolly, commingling income and sharing expenses. He supported his conclusion by writing that when he asked Nihiser to provide more financial information, she decided to drop the issue. He recognized that the income on which the taxes were due was overwhelmingly Connolly's, but did not make any findings on any of the other factors the IRS routinely weighs in innocent-spouse cases. Nihiser, then as now a resident of California, responded by filing a petition with our Court. By the time of trial, state police had arrested Connolly. He was later convicted of grand theft, and remains imprisoned. We held a trial, though the Commissioner objected to the introduction of all evidence not contained in the administrative record.2





OPINION



Section 6013(a)3 lets married couples file their federal tax return jointly but, if they do, both spouses are then responsible for the return's accuracy and both are generally liable for the entire tax due. Sec. 6013(d)(3); Butler v. Commissioner [Dec. 53,869] 114 T.C. 276, 282 (2000). In some cases, however, section 6015 can relieve a spouse from this joint liability. Relief comes in three varieties: Relief under section 6015(b) or (c) requires either an "understatement" or a "deficiency;" whereas relief under section 6015(f) requires only that the requesting spouse be "liable for any unpaid tax or any deficiency." Therefore, if the liability is neither an "understatement" nor a "deficiency", the only possible relief is under subsection (f). See Hopkins v. Commissioner [Dec. 55,243] 121 T.C. 73, 87-88 (2003).



The Commissioner never asserted a deficiency against Nihiser, so hers is a case where relief is possible only under section 6015(f). This turns out to be important in considering three preliminary questions:



! jurisdiction;



! standard of review; and



! scope of review.




I. Jurisdiction to Hear Cases Under Section 6015(f)


Our jurisdiction in this case is affected by its being not only a nondeficiency case, but a stand-alone nondeficiency case. A "stand-alone" case is one where the requesting spouse's claim for innocent-spouse relief was made under section 6015 on her own initiative, and not as part of a deficiency action or in response to the Commissioner instituting a lien or levy to try and collect the tax debt. This distinction made Nihiser's one of a large number of cases affected first by the Ninth Circuit's opinion in Commissioner v. Ewing [2006-1 USTC ¶50,191] 439 F.3d 1009 (9th Cir. 2006), revg. [Dec. 54,766] 118 T.C. 494 (2002), and vacating [Dec. 55,519] 122 T.C. 32 (2004), and then by this Court's opinion in Billings v. Commissioner [Dec. 56,572] 127 T.C. 7 (2006). Both these cases held that the Tax Court has no jurisdiction to review the Commissioner's determinations in stand-alone nondeficiency cases. It seemed reasonably likely that Congress would treat Ewing and Billings as having identified a glitch in the Code and would respond by amending section 6015, so we did not dismiss this case after deciding Billings, but waited to see what would happen. Congress did respond by amending section 6015(e), giving us jurisdiction to review innocent-spouse determinations in either "the case of an individual against whom a deficiency has been asserted * * *, or in the case of an individual who requests equitable relief under subsection (f)." Tax Relief and Health Care Act of 2006, Pub. L. 109-432, div. C, sec. 408(a), 120 Stat. 3061. This amendment was effective for liabilities remaining unpaid on December 20, 2006. Id. sec. 408(c), 120 Stat. 3062. After it became law, the parties stipulated that Nihiser's tax liability for the years in question remained unpaid on December 20, 2006. We therefore have jurisdiction to review the Commissioner's determination.




II. Standard of Review


That Nihiser's is a stand-alone nondeficiency case is also important in deciding what standard of review to use. We review section 6015(b) and (c) stand-alone cases under a de novo standard, since in those cases we are determining the existence or amount of a tax liability. See Haltom v. Commissioner [Dec. 56,133(M)] T.C. Memo. 2005-209; McClelland v. Commissioner [Dec. 56,036(M)] T.C. Memo. 2005-121.



In contrast, our standard of review in section 6015(f)

stand-alone cases is for abuse of discretion, e.g., Cheshire v. Commissioner [Dec. 54,028] 115 T.C. 183, 198 (2000), affd. [2002-1 USTC ¶50,222] 282 F.3d 326 (5th Cir. 2002), and it's Nihiser's burden to prove that the Commissioner committed one, see Alt v. Commissioner [Dec. 54,961] 119 T.C. 306, 311 (2002), affd. [2004-1 USTC ¶50,279] 101 Fed. Appx. 34 (6th Cir. 2004).4


Courts generally hold that a decisionmaker abuses his discretion when it "`makes an error of law * * * or rests its determination on a clearly erroneous finding of fact * * * [or] applies the correct law to facts which are not clearly erroneous but rules in an irrational manner.'" Indus. Investors v. Commissioner [Dec. 56,904(M)] T.C. Memo. 2007-93 (quoting United States v. Sherburne, 249 F.3d 1121, 1125-26 (9th Cir. 2001)); see also Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 402-03 (1990) (same).




III. Scope of Review


Our scope of review --i.e., what evidence we look at to decide whether the Commissioner abused his discretion --is likewise affected by this being a 6015(f) case. The Commissioner argues that we should look only at the administrative record compiled when Nihiser applied for relief from the IRS, met with IRS employees, and filled out (or didn't fill out) the relevant IRS forms. For reasons discussed below, we need not further address the Commissioner's point.5



The scope of review is an even bigger problem in innocent-spouse cases when we find that the Commissioner abused his discretion. Although rarely employed by district courts in reviewing administrative agency action, a trial de novo typically consists of independent factfinding and legal analysis unmarked by deference to the original factfinder. See, e.g., Morris v. Rumsfeld, 420 F.3d 287, 292, 294 (3d Cir. 2005) (defining "trial de novo" as involving judicial review "without deferring to any prior administrative adjudication" and "entirely independent of the administrative proceedings"); Timmons v. White, 314 F.3d 1229, 1233-34 (10th Cir. 2003) (same); see also Wright & Koch, 33 Federal Practice and Procedure: Judicial Review of Administrative Action, sec. 8332, at 161-62 (2006). In section 6015(f) innocent-spouse cases, however, precedent constrains us to combine the independent factfinding of a trial de novo with an abuse-of-discretion standard of review.



Another difference between our practice and district court review of administrative-agency action for abuse of discretion is that district courts generally are able to remand a case to the agency for reconsideration if the court holds that the agency's factfinding or legal analysis went awry. Fla. Power Light Co. v. Lorion, 470 U.S. 729, 744 (1985) ("If the record before the agency does not support the agency action, if the agency has not considered all relevant factors, or if the reviewing court simply cannot evaluate the challenged agency action on the basis of the record before it, the proper course, except in rare circumstances, is to remand to the agency for additional investigation or explanation."); Virk v. INS, 295 F.3d 1055, 1060-61 (9th Cir. 2002) (remanding a denial by the INS of a motion to reopen proceedings where the INS failed to consider all relevant factors); see also Yale-New Haven Hosp. v. Leavitt, 470 F.3d 71, 87 (2d Cir. 2006) (remanding an administrative decision to the Department of Health and Human Services after finding it was adopted in an arbitrary and capricious manner); Stuttering Found. of Am. v. Springer, 498 F.Supp.2d 203, 213-14 (D.D.C. 2007) (finding the Office of Personnel Management misapplied Federal tax law when classifying a charitable organization and remanding the issue to the agency for a new factual determination under correct standards). When this happens, the agency is able to compile a new (or at least supplemental) administrative record, and judicial review on remand can be done using an abuse-of-discretion standard applied against that record.6



Remand is not an option in innocent-spouse cases under current law. In Friday v. Commissioner [Dec. 56,019] 124 T.C. 220, 222 (2005), we held that "whether relief is appropriate under section 6015 is generally not a `review' of the Commissioner's determination in a hearing but is instead an action begun in this Court." Friday is a division opinion. We must follow it. See Sec. State Bank v. Commissioner [Dec. 52,859] 111 T.C. 210, 213 (1998), affd. [2000-2 USTC ¶50,549] 214 F.3d 1254 (10th Cir. 2000); Hesselink v. Commissioner [Dec. 47,499] 97 T.C. 94, 99-100 (1991).




IV. Equitable Relief Under Section 6015(f)


Having unpacked this preliminary baggage, we turn to the case before us. Section 6015(f) allows relief to a requesting spouse "if taking into account all the facts and circumstances, it is inequitable to hold the individual liable." The Commissioner exercises his discretion using Revenue Procedure 2000-15, 2000-1 C.B. at 447, a framework guiding the exercise of his discretion when determining whether or not to grant equitable relief. We also follow that revenue procedure in reviewing his determination and deciding what relief is appropriate.7 See, e.g., Washington v. Commissioner [Dec. 55,120] 120 T.C. 137, 147-52 (2003); Jonson v. Commissioner [Dec. 54,641] 118 T.C. 106, 125-26 (2002), affd. [2004-1 USTC ¶50,122] 353 F.3d 1181 (10th Cir. 2003).



Rev. Proc. 2000-15, sec. 4.01, 2000-1 C.B. at 448, has seven general requirements that all requesting spouses must meet for relief under section 6015(f). The Commissioner concedes that Nihiser meets all seven conditions.



The procedure also has a safe harbor. This safe harbor grants relief to a requesting spouse if she meets three conditions. Rev. Proc. 2000-15, sec. 4.02, 2000-1 C.B. at 448. The first requires that:



At the time relief is requested, the requesting spouse is no longer married to, or is legally separated from, the nonrequesting spouse, or has not been a member of the same household as the nonrequesting spouse at any time during the 12-month period ending on the date relief was requested;



id. sec. 4.02(1)(a). The parties agree that Nihiser was married when she requested relief, but she argues that her de facto separation qualifies as a legal separation. Nihiser offers no authority for her position, however. We don't need to consider this condition because Nihiser fails the second condition in this safe harbor test. As discussed below in section IV.D., Nihiser knew at the time she signed them, the tax shown on the joint returns would not be paid. So Nihiser does not qualify for the safe harbor.



This leaves an eight-factor balancing test to consider before deciding if relief would be "equitable." Rev. Proc. 2000-15, sec. 4.03, 2000-1 C.B. 448-49. The Commissioner may consider other factors, but this is where he starts. Ewing, 122 T.C. at 47-48; Rev. Proc. 2000-15, sec. 4.03. We can summarize the eight factors in a table (those factors not in dispute are in italics):





________________________________________________________________________
Weighs for Relief Neutral Weighs against Relief

________________________________________________________________________
Separated or divorced Still married N/A

________________________________________________________________________
Abuse present No abuse present N/A

________________________________________________________________________
Significant benefit No significant N/A
benefit

________________________________________________________________________
N/A Later compliance with Lack of later
Federal tax laws compliance with Federal
tax laws

________________________________________________________________________
No knowledge or N/A No economic hardship
reason to know

________________________________________________________________________
Tax liability N/A Liability
attributable to attributable to
non-requesting spouse petitioner

________________________________________________________________________
Non-requesting spouse No divorce decree Petitioner
responsible for paying responsible for paying
tax under divorce tax under divorce
decree decree

________________________________________________________________________




The Commissioner conceded that the attribution factor weighs in Nihiser's favor, and that the significant-benefit, noncompliance-with-tax-laws, and nonrequesting-spouse's-legal obligation-to-pay-the-tax factors are neutral. We treat the parties' agreement that Nihiser received no significant benefit from the underpayment as weighing in her favor.8 That leaves Nihiser disputing only the Commissioner's determination concerning the marital-status, knowledge, abuse, and hardship factors.



And here we meet the Commissioner's first abuse of discretion in this case --he simply failed to consider all the factors listed in Revenue Procedure 2000-15 when making his determination. See Walter Trans. Inc. v. United States, 432 F. Supp. 2d 955, 959 (W.D. Mo. 2006) (citing Sukhov v. Gonzales, 403 F.3d 568, 570 (8th Cir. 2005) (stating that an abuse of discretion may be found where the Appeals officer fails to consider all factors presented); Gall v. United States, 552 U.S. ___, 128 S. Ct. 586, 607 (2007) (Alito, J., dissenting) (citing cases analyzing several areas of law that require consideration of all factors to avoid an abuse of discretion). The Appeals officer made no findings on either the marital-status or abuse factors, and both these factors are at issue. As we also find below, the Commissioner's determination on the economic-hardship factor was erroneous in failing to consider reasonably all the facts in the administrative record. We therefore find that the Commissioner has abused his discretion, and examine the disputed factors with an eye to determining the appropriate relief available to Nihiser under section 6015.



This course of action follows from our holding in Friday. If we find an abuse of discretion, it is up to us --in the words of section 6015(e) --"to determine the appropriate relief available to the individual under this section" rather than remand the case to the IRS for a reopening of the administrative record and a consideration for the first time of evidence we received during the trial. And so we next ask not just whether the Commissioner abused his discretion in denying Nihiser relief, but, if he did, what is "the appropriate relief available?"



A. Marital Status



The IRS's finding on the marital status factor is confusing. The CCISO's workpapers show that the initial IRS reviewer regarded Nihiser's situation as weighing in favor of relief, though leaving it unmentioned in the March 2003 letter to her. The subsequent notice of determination doesn't mention the factor at all, except summarily as one of "several factors * * * considered," so we have no idea how it was weighed in the end.



The revenue procedure itself is not a model of clarity on how the IRS should go about analyzing this factor. In the section discussing qualification for the safe harbor, marital status is important, and we're told when to look and what to look for. See supra p. 16.



But we have to look at the description of this factor in a different part of the Procedure, section 4.03(1)(a)'s description of when the marital-status factor weighs in favor of granting relief when applying the eight-factor balancing test. This description is different --it says that marital status weighs in favor of relief when the "requesting spouse is separated (whether legally separated or living apart) or divorced from the nonrequesting spouse." Rev. Proc. 2000-15, sec. 4.03(1)(a), (emphasis added). We infer from the absence of any reference to separate "households" in this description of the marital-status factor (in contrast to the safe harbor condition discussed supra) that spouses can be "living apart" even in the same household.



This is actually a good description of how Nihiser and Connolly were living when she requested relief in late 2002. Nihiser's intent, buttressed by her actions, shows that her relationship with Connolly was drastically changed on July 9, 1999, when he flourished divorce papers at her. From then on, they no longer shared a bedroom, and she reasonably thought that her husband had filed for legal separation --even reporting that day as the start of their legal separation on her forms requesting innocent-spouse relief. She explained on these forms that they remained under the same roof only because of their financial situation. We believe her, and find that she was "living apart" from her husband both when she requested relief and when the Commissioner made his determination. We thus agree with the apparent conclusion reached by the CCISO in its initial consideration of her request that this factor weighs in favor of relief. The Appeals officer making the Commissioner's final determination abused his discretion by not discussing and weighing this factor.



We are not certain that this is where our analysis of this factor should end. As is often the case in the sort of troubled marriages that spawn requests for innocent-spouse relief, alienation became separation and finally divorce. By the time of trial, Nihiser had without any doubt been living in a separate household --remember that by then her husband was an inmate --and filed for divorce as well. So, if we are to follow Friday's command that we judge the merits of a request for innocent-spouse relief without remanding for additional factfinding, we would find on the basis of the trial record as well as the administrative record that this factor weighs in Nihiser's favor.9



B. Abuse



The next contested factor is spousal abuse. The revenue procedure doesn't actually define "abuse,"10 but does say that proof that the "requesting spouse was abused by the nonrequesting spouse, but such abuse did not amount to duress," weighs in favor of relief. Rev. Proc. 2000-15, sec. 4.03(1)(c), 2000-1 C.B. at 449. And this obviously lets us infer that "abuse" is at least sometimes somehow lesser than "duress."



Duress is a concept we've had a lot to say about. Courts have long considered duress to be a reason to relieve a taxpayer from joint liability where her spouse coerces her to sign a tax return. See Furnish v. Commissioner [59-1 USTC ¶9189] 262 F.2d 727, 733 (9th Cir. 1958); affg. in part and remanding in part Funk v. Commissioner [Dec. 22,664] 29 T.C. 279 (1957); Stanley v. Commissioner [Dec. 40,487] 81 T.C. 634 (1983); Brown v. Commissioner [Dec. 29,199] 51 T.C. 116, 119-120 (1968); Stanley v. Commissioner [Dec. 27,878] 45 T.C. 555, 565 (1966). Duress is a subjective analysis, where the "focus is on the mind of the individual at the relevant time in question, rather than on the means by which the given state of mind was induced." In re Hinkley, 256 B.R. 814, 825 (Bankr. M.D. Fla. 2000); see also Stanley, 45 T.C. at 561. An extreme case is "Sign the return or I pull the trigger." But in tax law duress means any constraint of will so strong that it makes a person reasonably unable to resist demands to sign a return. When that happens, innocent-spouse relief is unavailable even if she applies for it, because duress means the return isn't treated as joint. See Raymond v. Commissioner [Dec. 54,915] 119 T.C. 191, 195-96 (2002); Brown, 51 T.C. at 120-21.



And there are also a good number of cases analyzing abuse-not-amounting-to-duress in considering whether one spouse knew or should have known about the other's wrongdoing. E.g., Kistner v. Commissioner [94-1 USTC ¶50,059] 18 F.3d 1521, 1526 (11th Cir. 1994), revg. T.C. Memo. [Dec. 47,633(M)] 1991-463; Estate of Brown v. Commissioner [Dec. 44,882(M)] T.C. Memo. 1988-297. A classic instance is when abuse helps explain a spouse's failure to inquire about noncompliance with tax law. E.g., Aude v. Commissioner [Dec. 52,315(M)] T.C. Memo. 1997-478 (finding that threats and intimidation explained why a requesting spouse didn't review or inquire about the joint returns); Makalintal v. Commissioner [Dec. 51,111(M)] T.C. Memo. 1996-9 (determining that, "in light of the frequent physical abuse" by the nonrequesting spouse and his "general refusal to discuss his business and financial affairs with petitioner, * * * petitioner's inquiry was reasonable and sufficient to satisfy her duty of inquiry").11



But it's abuse as a factor by itself, not just as a relevant bit of evidence about one spouse's state of knowledge, that we're looking for in this case. This is an important point because it liberates us from focusing on the moment the return is signed --the relevant abuse precedes that moment, but there's no suggestion in the Procedure or any other source of relevant law that limits our consideration of whether a spouse was abused only to abuse that causes a particular instance of noncompliance with the tax law.



This leads to the heart of our inquiry: What is abuse for purposes of innocent-spouse relief? Verifiable physical harm is likely sufficient. See, e.g., McKnight v. Commissioner [Dec. 56,576(M)] T.C. Memo. 2006-155 (finding abuse where alcoholic nonrequesting spouse physically shoved, hit, cut, and beat the requesting spouse on multiple occasions, one of which left her on crutches). But can psychological mistreatment in the absence of physical harm be "abuse"? We think the answer to that question is "yes". Being a xanthippe is not by itself enough, but we have recognized that a nonrequesting spouse can engage in mental, emotional, and verbal abuse sufficiently severe to incapacitate a requesting spouse in the same manner as a physically abusive spouse. Compare Grubich v. Commissioner [Dec. 49,020(M)] T.C. Memo. 1993-194 (abuse found in extreme belittling and constant disparaging of the requesting spouse's contribution to the family business).



We are aware of the danger that requesting spouses, in trying to escape financial liability, may easily exaggerate the level of nonphysical abuse. Innocent-spouse cases often spring from the dissolution of troubled marriages, and there is an obvious incentive to vilify the nonrequesting spouse. Our cases therefore require substantiation, or at least specificity, in allegations of abuse. See, e.g., Fox v. Commissioner [Dec. 56,428(M)] T.C. Memo. 2006-22 (weighing abuse as a positive factor where a police report corroborated the requesting spouse's claim of assault); Knorr v. Commissioner [Dec. 55,752(M)] T.C. Memo. 2004-212 (finding no abuse where requesting spouse provided only generalized claims of physical and emotional abuse); Collier v. Commissioner [Dec. 54,776(M)] T.C. Memo. 2002-144 (finding no abuse in absence of specific details).



We have also hesitated to find abuse when marital conflict is understandably distressing but doesn't significantly alter a requesting spouse's behavior. See, e.g., Krasner v. Commissioner [Dec. 56,437(M)] T.C. Memo. 2006-31 (spouse didn't hesitate to leave her children with nonrequesting spouse, and police reports reflected little evidence of unwanted physical contact or mental abuse); Ogonoski v. Commissioner [Dec. 55,561(M)] T.C. Memo. 2004-52 (lack of abuse in the anxiety caused by uncertainty as to whether nonrequesting spouse would pay taxes); Ewell v. Commissioner [Dec. 44,844(M)] T.C. Memo. 1988-265 (no abuse where there was domineering but no physical abuse or mental intimidation).



This is not a terribly well-developed corner of tax law, and it is not one in which we can really get much help by looking at detailed regulations or the ordinary canons of construction. So we think it at least helpful to look at those factors widely recognized as psychologically abusive where law has confronted domestic violence. Scholars have identified a number of factors that are common features of domestic abuse in domestic-relations law and the subfield of criminal law arising from domestic violence. In these fields, a psychologically abusive spouse is one who may: (1) isolate the victim; (2) encourage exhaustion by, for example, intentionally limiting food or interrupting sleep; (3) behave in an obsessive or possessive manner; (4) threaten to commit suicide, to murder the requesting spouse, or to cause the death of family or friends; (5) use degrading language including humiliation, denial of victim's talents and abilities, and name calling; (6) abuse drugs or alcohol, including administering substances to the victim; (7) undermine the victim's ability to reason independently; or (8) occasionally indulge in positive behavior in order to keep hope alive that the abuse will cease.12



Although we're certainly not prepared to make these factors an exclusive list of what to look for --human perversity being unimaginably creative --they at least give us some objective indications that abuse, and not just a deviation from the ideal of marital harmony, is what we're seeing. We think these factors indicate a relationship in which there is enough abuse to make it reasonable to conclude that the spouse seeking relief was less likely to do what the Tax Code requires --making it more equitable to relieve her from joint liability. We again stress, though, that our consideration in such an underdeveloped area has to be case by case. See, e.g., Sjodin v. Commissioner [Dec. 55,743(M)] T.C. Memo. 2004-205, vacated and remanded on another issue [2006-1 USTC ¶50,357] 174 Fed. Appx. 359 (8th Cir. 2006) (finding no mental abuse where nonrequesting spouse was merely controlling and secretive).



In this case, the administrative record provides the following account of psychological abuse: On the Form 8857, Nihiser checked the box indicating that she had "been a victim of domestic abuse and [feared] that filing a claim for innocent-spouse relief [would] result in retaliation." She repeated her claim that she was the victim of abuse on her questionnaire and in her letter, writing that her husband verbally abused her. She also stated that he had a drug problem and she offered to provide copies of positive urine test results from his counselor. She also said that she filed a police report after he told her he had a gun and made a suicide threat. Neither CCISO nor the Appeals officer asked Nihiser for any such specific allegations --she supplied them sua sponte. The administrative record tells us that Nihiser feared her husband, and she stated in her paperwork that she blamed his abusive behavior on cocaine. On her request for relief, she offered to provide the Commissioner with a statement from her neighbor attesting to the abuse, but neither CCISO nor the Appeals officer followed up. She claimed that he threatened to leave her and stick her with their tax bill. CCISO agreed that Nihiser suffered verbal abuse, but conclusorily dismissed it as not "enough of a factor to overcome continuing to file joint returns with a balance due without taking corrective action." And, as with the marital-status factor, the Appeals officer who actually issued the notice of determination didn't discuss the factor at all.



The trial record reinforced the abuse allegations Nihiser made during the administrative process. She credibly testified to her husband's hot temper, describing a situation in which he used foul language while upbraiding Nihiser in front of their daughter. She said she was intimidated by his controlling behavior to the point that she was in fear of her safety and the wellbeing of their daughter. Considering the factors suggestive of psychological abuse that we listed above --the threat of suicide, the reasonable fear in someone economically dependent on her spouse of being left without support, and the always lurking explosive potential of someone abusing illegal drugs --we find that Nihiser has shown, both in the administrative record and the record assembled at trial, that the abuse factor should weigh in her favor.



C. Economic Hardship



The next contested factor is whether forcing Nihiser to pay the tax debt would cause her economic hardship. This factor weighs in a requesting spouse's favor when satisfaction of the tax liability will cause her to be unable to pay her "reasonable basic living expenses." Sec. 301.6343-1(b)(4), Proced. & Admin. Regs.13 In determining a reasonable amount for basic living expenses, the Commissioner looks at any information provided by the requesting spouse. See sec. 301.6343-1(b)(4)(ii), Proced. & Admin. Regs.



And Nihiser did at least partially fill out the relevant section of the form. When CCISO looked at it, an IRS employee tapped into IRS records and confirmed the bankruptcy filings and absence of income reported from third parties. In considering the safe-harbor factors, this seems to have been enough to cause CCISO to conclude that "the requesting spouse will suffer economic hardship." But then, on the same page of the workpaper, the employee listed lack of economic hardship as a factor weighing against relief:



she is saying yes but her statement shows no income at all, she has been separated from him since 1999 and still is paying 2,000 per month for rent or mortgage, her expenses are very high like $200 month for clothings.



How this weighed in the IRS's first round of consideration is unclear, since economic hardship isn't even mentioned in the March 2003 letter. The IRS's decision at the Appeals level is easier to understand. The Appeals officer determined that Nihiser would not suffer economic hardship because her and her husband's combined salaries were greater than their reasonable basic living expenses. This was almost certainly due to Nihiser's having left part of the "average monthly household income and expenses" section of the questionnaire blank because she didn't know of Connolly's income.14 Nihiser told him that she was scared to press Connolly on the question, and so would drop the issue.



Here we again run into the problem of what time we should be looking at to judge which way this factor weighs. When she applied for relief, Nihiser's own income was a meager couple thousand dollars a year from part-time teaching. By the time that the Appeals officer met with her in November 2003, she'd returned to full-time teaching at a salary of about $68,000 and she remained employed full time at the time of trial. However, by the time of trial her wages were being garnished to pay a substantial state-tax debt left over from her marriage.



The Appeals officer quite understandably didn't spend too much time pondering such subtleties. And a refusal to supply information is ordinarily, of course, more than enough reason for the IRS to consider an issue conceded. See McCoy Enters, Inc. v. Commissioner [95-2 USTC ¶50,332] 58 F.3d 557, 563 (10th Cir. 1995) (can't exercise discretion if there is no information about a factor), affg. [Dec. 48,672(M)] T.C. Memo. 1992-693; Chimblo v. Commissioner [Dec. 52,379(M)] T.C. Memo. 1997-535 (same), affd. [99-1 USTC ¶50,540] 177 F.3d 119 (2d Cir. 1999). But Nihiser credibly testified that when she met with the Appeals officer to further explain her situation, she was deterred from presenting more complete financial information by the Appeals officer's statement that he would need to contact her husband again, and that she would need to ask him about his finances. We find these statements are highly likely to have kept some of this information off the record. In a case like this, where a petitioner credibly cites fear as a reason for not seeking relevant information, we find that the Appeals officer abused his discretion by not probing further. The regulation does, after all, tell him to consider all available information when making economic hardship determinations. See sec. 301.6343-1(b)(4), Proced. & Admin. Regs.



We need not consider evidence outside the administrative record to conclude that the Appeals officer clearly erred in finding that Nihiser wouldn't suffer economic hardship. She was, when the case was before him, a schoolteacher in her mid-50s living in Orange County with no asset other than an 18-year-old car. She was also supporting a teenage daughter. The CCISO had checked the IRS's own records and found the history of bankruptcy filings and lack of any third-party payments to Nihiser and Connolly. It thus should have been screamingly obvious that she would not be able to meet her basic living expenses if she had to pay a tax liability of more than $200,000. We also do not need the evidence presented at trial to determine that Connolly's financial contributions would soon end. The two had serious marital problems, he had a substance-abuse problem, and they had declared bankruptcy three times.



There is yet another possibly difficult question hidden here: When do we take the snapshot of a spouse's finances to decide if paying the overdue taxes would wreak a financial hardship? The Appeals officer was understandably looking at her situation at the time of his conference with her. But under Ewing and Friday, we do not have to confine ourselves to the administrative record. We think this means that, in gauging how to weigh the economic-hardship factor, we should (at least once we've found there to have been an abuse of discretion, and so have to determine what relief should be available under section 6015) look at the evidence presented at trial, and the state of her finances at that time. These only support her request --by the time of trial, Connolly was in prison and thus was in no position to contribute to her support. She had resumed teaching, but her salary was about $5700 a month. On her request for relief, she reported $3415 in basic living expenses. These are reasonable expenses for a mother and daughter living in Orange County, California. At trial she also credibly testified that she has two additional reasonable monthly expenses: $480 tuition for her daughter and $500 to pay the Franchise Tax Board for her and her husband's California tax debt. After subtracting state taxes, federal income taxes, and Social Security and Medicare taxes, we find that Nihiser's current expenses use up most of her income. But we must also consider Nihiser's future ability to earn her current salary and pay her basic living expenses. She restarted her career late in life, and does not have a home or other assets to rely on after she retires. We find that if she is required to pay over $200,000 in taxes she will not be able to pay her basic living expenses. We find that the economic-hardship factor weighs in favor of relief.



D. Knowledge



The last contested factor is Nihiser's knowledge of the underpayment. This factor weighs against relief if she "knew or had reason to know * * * the reported liability would be unpaid at the time the return was signed." Rev. Proc. 2000-15, sec. 4.03(2)(b), 2001-1 C.B. at 449. We agree with the Commissioner that this factor does weigh against Nihiser. At the time she signed the returns she did have reason to know the taxes would not be paid. She and Connolly had filed for bankruptcy once when she signed the 1996 return, twice when she signed the 1997-2000 returns, and three times when she signed the 2001 return, and they had not made any other effort to pay their taxes. She also suspected that her husband's continuing drug habit was contributing to their financial problems. We find no error in the Commissioner's finding on this point, and so find that he did not abuse his discretion in concluding that this factor weighs against relief. We find likewise on the basis of the trial record. The knowledge factor therefore weighs against granting relief.





Conclusion



After analyzing these contested factors, whether looking only at the administrative record by itself or as supplemented by the trial record, we find that the table should now look like this:





________________________________________________________________________
Weighs for Relief Neutral Weighs against Relief

________________________________________________________________________
Marital Status

________________________________________________________________________
Abuse

________________________________________________________________________
No significant
benefit

________________________________________________________________________
Later compliance with
Federal tax laws

________________________________________________________________________
Knowledge

________________________________________________________________________
Economic hardship

________________________________________________________________________
Attribution

________________________________________________________________________
No divorce decree

________________________________________________________________________




Thus, Nihiser has five factors weighing in favor of relief and only one weighing against. But the factor weighing against relief is knowledge, and the revenue procedure tells us that knowledge is an "extremely strong factor weighing against relief." Rev. Proc. 2000-15, sec. 4.03(2)(b), 2000-1 C.B. 449.



The Commissioner's own procedure nevertheless anticipates at least some cases where knowledge or reason to know will not be enough to deny relief: "Nonetheless, when the factors in favor of equitable relief are unusually strong, it may be appropriate to grant relief under § 6015(f) in limited situations where a requesting spouse knew or had reason to know that the liability would not be paid." Id. A case like this one, where the only factor weighing against relief is knowledge of underpayment and all the other factors are neutral or in her favor, is logically the most likely to be one of these "limited situations" where relief is appropriate.



As in any multifactor balancing test, we must have something in mind as the appropriate fulcrum when there are factors weighing down both sides of the lever. And here we think that an appropriate fulcrum is the extent to which the economic unity of the household filing a joint return has been broken down by the actions of the nonrequesting spouse in a way that didn't allow the requesting spouse a reasonable exit. As the Third Circuit once wrote, the innocence we look for "within the meaning of this statute is innocent vis-a-vis a guilty spouse whose income is concealed from the innocent and spent outside the family." Bliss v. Commissioner [95-2 USTC ¶50,370] 59 F.3d 374, 380 n.3 (2d Cir. 1995) (discussing former section 6013), affg. [Dec. 49,242(M)] T.C. Memo. 1993-390. The knowledge factor's unique importance is, seen in this way, entirely appropriate because in the ordinary course of events knowing her husband is mishandling their joint return would allow a wife to begin to pull away from the entanglement of joint liability. We therefore find on the peculiar facts of this case that Nihiser's knowledge of her husband's underpayment of their taxes is outweighed by the abuse she suffered and her utter lack of any benefit from the money. He kept her from seeing the broader state of the family's finances and spent the money on himself. And since she began filing on her own, she has consistently followed the tax law and paid her current taxes as they became due. Her ability to act in response to her knowledge as her marriage was dissolving was thus so reduced as to make relieving her from the joint tax liability for the years in question the appropriate relief under section 6015.



Decision will be entered for petitioner.


1 Her application included taxes for 1993 through 1995, but she evidently didn't realize that these had already been discharged in bankruptcy.

2 The Commissioner continued his objection to the admission of nonrecord evidence in his post-trial brief. The findings of fact in this background section reflect our consideration of evidence presented at trial, and are not limited to the stipulation and administrative record. In the later sections of this opinion, which analyze the individual factors considered in deciding whether to grant relief, we will make separate findings based on the administrative record and the record at trial.

3 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue.

4 At least when, as here, the IRS has considered a request and rejected it. We leave to another day the question of whether the amendment to section 6015(e) will cause a different standard of review to apply to stand-alone nondeficiency petitions filed with us after six months of IRS inaction. See sec. 6015(e)(1)(A)(i)(II).

5 In the somewhat similar context of reviewing of notices of determination that the Commissioner issues in collection due process (CDP) cases under sections 6320 and 6330, we also engage in de novo review for abuse of discretion. Robinette v. Commissioner [Dec. 55,698] 123 T.C. 85 (2004), revd. [2006-1 USTC ¶50,213] 439 F.3d 455 (8th Cir. 2006). As a reviewed opinion, it remains good law for our Court unless a case is to be appealed to the Eighth Circuit. We have, however, since deciding Murphy v. Commissioner [Dec. 56,232] 125 T.C. 301 (2005), affd. [2007-1 USTC ¶50,115] 469 F.3d 27 (1st Cir. 2006), declined to consider evidence that a taxpayer might have presented (but chose not to) at a CDP hearing because "an appeals officer does not abuse her discretion when she fails to take into account information that she requested and that was not provided in a reasonable time." Id. at 315. Similarly, in Giamelli v. Commissioner [Dec. 57,155] 129 T.C. 107, 113 (2007), we found that "if an issue is never raised at [a hearing with the Appeals officer], it cannot be part of the Appeals officer's determination."

6 As is always the case in administrative law, general principles yield to any specific governing statute. See, e.g. Nguyen v. Shalala, 43 F.3d 1400, 1403 (10th Cir. 1994) (outlining specific statutory remedies available to a court reviewing denial of Social Security disability claims).

7 Nihiser filed Form 8857 in November 2002, and received a preliminary determination letter in March 2003. The procedure in effect when she filed her request for relief was Revenue Procedure 2000-15, 2000-1 C.B. at 447. It has been superseded by Revenue Procedure 2003-61, 2003-2 C.B. at 296, but the new revenue procedure applies only to requests for relief filed on or after November 1, 2003, or those pending on November 1, 2003, for which no preliminary determination letter has been issued as of that date. Id., sec. 7, 2003-2 C.B. at 299. We therefore apply Revenue Procedure 2000-15 to this case.

8 Rev. Proc. 2000-15, sec. 4.03, does not state that the absence of a significant benefit will weigh in a petitioner's favor, but only that receiving a significant benefit will weigh against her. Nonetheless, we decided in Ferrarese v. Commissioner [Dec. 54,894(M)] T.C. Memo. 2002-249 (and other cases cited), that the absence of a significant benefit should be a positive factor for petitioners.

9 Compare this analysis to the law governing judicial review in Social Security benefit cases cited supra note 6. In those kind of cases, a court may remand a case to the Social Security Administration when new evidence arises that is material and where there is good cause for the late submission. 42 U.S.C. sec. 405(g) (2006). There is no requirement that the new evidence existed when the agency first made its decision, though the new evidence must relate to the petitioner's condition on or before the date of that decision. See Williams v. Barnhart, 178 Fed. Appx. 785, 792 (10th Cir. 2006).

10 Black's Law Dictionary defines abuse as "physical or mental maltreatment, often resulting in mental, emotional, sexual, or physical injury." Black's Law Dictionary 10 (8th ed. 2004).

11 Rev. Proc. 2003-61, sec. 4.03(2)(b)(i), 2003-2 C.B. at 299, although not the revenue procedure that applies here, likewise states that a history of abuse by the nonrequesting spouse may mitigate a requesting spouse's knowledge or reason to know.

12 See Mary Ann Douglas (Dutton), "The Battered Woman Syndrome," in Domestic Violence on Trial: Psychological and Legal Dimensions of Family Violence 39 (Daniel Jay Sonkin ed., 1987) (citing L. Walker, The Battered Woman Syndrome (1984)).

13 In order to determine whether a requesting spouse will suffer economic hardship, the revenue procedure directs us to the test in section 301.6343-1(b)(4), Proced. & Admin. Regs. See Rev. Proc. 2000-15, secs. 4.02(1)(c), 4.03(1)(b), (2)(d), 2000-1 C.B at 448-49.

14 Nihiser listed her monthly expenses as:



Rent $2,000
Food 500
Utilities 300
Telephone 65
Auto insurance 100
Auto - gas and repairs 250
Clothing 200
Total living expenses $3,415

Section 2511 Gift: buy-sell agreements serve a legitimate purpose in maintaining control of a closely held business. E.g., Estate of Bischoff v. Commissioner, supra; Estate of Reynolds v. Commissioner, 55 T.C. 172 (1970); Estate of Fiorito v. Commissioner, 33 T.C. 440 (1959).8

Husband and wife taxpayers' transfers of limited partnership (LP) units to a trust and a custodianship were not indirect gifts for purposes of Code Sec. 2511.

[Code Secs . 2512 and 2703]



Thomas H. Holman, Jr. and Kim D. L. Holman, Petitioners v. Commissioner.

Dkt. No. 7581-04 , 130 TC --, No. 12, May 27, 2008. Opinion by Halpern.



[Code Sec. 2511]







Ps transferred D stock of substantial value to a newly formed family limited partnership and then made gifts of limited partnership units (LP units) to a custodian for one of their children and in trust for the benefit of all of their children. Ps made a large gift in 1999 and smaller gifts in 2000 and 2001. In valuing the gifts for Federal gift tax purposes, they applied substantial discounts for minority interest status and lack of marketability. With respect to the 1999 gift, R argues that the gift should be treated as an indirect gift of D shares and not as a direct gift of LP units. For all of the gifts treated as gifts of LP units, R argues that the restrictions in the partnership agreement on a limited partner's right to transfer her interest should be disregarded pursuant to I.R.C. sec. 2703(a)(2). R also disagrees with Ps' application of discounts.



1. Held: The limited partnership was formed and the shares of D stock were transferred to it almost 1 week in advance of the 1999 gift, so that, on the facts before us, the transfer cannot be viewed as an indirect gift of the shares to the donees under sec. 25.2511-1(a) and (h)(1), Gift Tax Regs.



2. Held, further, the 1999 gift may not be viewed as an indirect gift of the shares to the donees under the step transaction doctrine.



3. Held, further, in valuing the gifts, the transfer restrictions are disregarded pursuant to I.R.C. sec. 2703(a)(2).



4. Held, further, values of the gifts determined.



HALPERN, Judge: By separate notices of deficiency (the notices), respondent determined deficiencies in each petitioner's Federal gift tax of $205,473, $8,793, and $16,009 for 1999, 2000, and 2001, respectively. In response to the notices, petitioners jointly filed a single petition. Respondent answered, and, by amendment to answer, he increased by $2,304 and $13, the deficiencies he had determined for each petitioner for 1999 and 2001, respectively.



Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.



After concessions, the principal issues for decision are (1) whether petitioners' transfer of assets to a family limited partnership constitute an indirect gift to another member of the partnership; (2) if not, whether, in valuing the gifts of limited partner interests that are the subject of this litigation, we must disregard certain restrictions on the donees' rights to sell those interests; and (3) assuming that we must value those interests, those values.





FINDINGS OF FACT






OPINION I.




I. Introduction


Petitioners transferred Dell stock of substantial value to a newly formed family limited partnership and then made gifts of limited partnership units in the partnership (LP units) to a custodian for one of their children and in trust for the benefit of all of their children. Petitioners made a large gift in 1999 and smaller gifts in 2000 and 2001 (collectively, the gifts; individually, the 1999, 2000, or 2001 gift, respectively). In valuing the gifts for Federal gift tax purposes, they applied substantial discounts for minority interest status and lack of marketability. With respect to the 1999 gift, respondent argues that the gift should be treated as an indirect gift of Dell shares and not as a direct gift of LP units. For all of the gifts treated as gifts of LP units, respondent argues that the restrictions contained in the partnership agreement on a limited partner's right to transfer her interests in the partnership should be disregarded pursuant to section 2703(a)(2). Respondent also disagrees with petitioners' application of discounts. Respondent has abandoned his reliance on section 2704(b) ("Certain restrictions on liquidation disregarded."), and he no longer argues that the partnership should be treated as if it were a trust. We shall address respondent's remaining arguments in turn.




II. Indirect Gifts


A. Law



Section 2501(a) imposes a tax on the transfer of property by gift during the year. The tax is imposed on the values of the gifts made during the year. See sec. 2502(a). The amount of a gift of property is the value thereof on the date of transfer. See sec. 2512(a). That value of a gift of property is determined by the value of the property passing from the donor and not necessarily by the measure of enrichment resulting to the donee from the transfer. Sec. 25.2511-2(a), Gift Tax Regs. Where property is transferred for less than adequate and full consideration in money or money's worth (hereafter, simply, adequate consideration), then the excess of the value of the property transferred over the consideration received is generally deemed a gift. See sec. 2512(b). The gift tax applies whether the gift is direct or indirect. Sec. 2511(a). Section 25.2511-1(h)(1), Gift Tax Regs., illustrates an indirect gift made by a shareholder of a corporation to the other shareholders of the corporation. The shareholder transfers property to the corporation for less than adequate consideration. The regulation concludes that, generally, such a transfer represents gifts by the shareholder to the other individual shareholders to the extent of their proportionate interests in the corporation. Similarly, if a partner transfers property to a partnership for less than adequate consideration, the transfer generally will be treated as an indirect gift by the transferor to the other partners. See, e.g., Shepherd v. Commissioner, 115 T.C. 376, 389 (2000), affd. 283 F.3d 1258 (11th Cir. 2002). Indeed, in affirming the Tax Court, the Court of Appeals said: "[G]ifts to a partnership, like gifts to a corporation, are deemed to be indirect gifts to the stakeholders 'to the extent of their proportionate interests' in the entity. See * * * [sec. 25.2511-1(h)(1), Gift Tax Regs.]." Shepherd v. Commissioner, 283 F.3d at 1261.



B. Parties' Arguments



1. Respondent's Indirect Gift Arguments



Respondent's arguments are simple and straightforward:



The gift tax is imposed on the donor, and is based on the value of the transferred property on the date of the gift. * * * Here, the property that passed from the donors is Dell stock, not the * * * LP units. Therefore, Tom and Kim's transfers of Dell stock, not the * * * LP units, as of November 8, 1999, are taxed under the terms of § 2501(a)(1).



Alternatively, the formation, funding, and gifts of * * * LP units dated as of November 8, 1999 are steps of an integrated donative transaction. Once the intermediate steps are collapsed, Tom and Kim's gifts are gifts of Dell stock in the form of * * * LP units. * * *



2. Petitioners' Responses



Petitioners' responses are equally simple and straightforward:



First, no donative transfer occurred on formation of the Partnership because each partner contributed Dell stock to the Partnership, and each received interests in the Partnership precisely in proportion to the assets contributed by each. Further, because the Partnership was clearly and properly established under Minnesota law on November 3, 1999, Petitioners' gifts of Partnership interests on November 8, 1999, to the Trust and to the Minnesota UTMA Account cannot constitute indirect gifts of the Dell stock owned by the Partnership on that date.



C. Discussion



1. A Gift to the Partners on Account of a Transfer to the Partnership



Respondent's first alternative indirect gift argument invokes the illustration in section 25.2511-1(h)(1), Gift Tax Regs., of an indirect gift made by a shareholder of a corporation to the other shareholders of the corporation. The regulation concludes that, generally, where a shareholder transfers property to a corporation for less than adequate consideration, the transfer represents gifts by the shareholder to the other shareholders to the extent of their proportionate interests in the corporation. Respondent asks us to compare the facts at hand to the facts in Shepherd and in Senda v. Commissioner, T.C. Memo. 2004-160, affd. 433 F.3d 1044 (8th Cir. 2006), in both of which we concluded that transfers by a partner to a partnership were indirect transfers to the other partners.



In Shepherd v. Commissioner, 115 T.C. at 380-381, the taxpayer transferred real property and shares of stock to a newly formed family partnership in which he was a 50-percent owner and his two sons were each 25-percent owners. Rather than allocating contributions to the capital account of the contributing partner, the partnership agreement provided that any contributions would be allocated pro rata to the capital accounts of each partner according to ownership. Id. at 380. Because the contributions were reflected partially in the capital accounts of the noncontributing partners, the values of the noncontributing partners' interests were enhanced by the contributions of the taxpayer. Accordingly, we held that the transfers to the partnership were indirect gifts by the taxpayer to his sons of undivided 25-percent interests in the real property and shares of stock. Id. at 389.



In Senda v. Commissioner, supra, the Commissioner contended that the taxpayers' transfers of shares of stock to two family limited partnerships, coupled with their transfers of limited partner interests to their children, were indirect gifts of the shares to those children. In both instances, the stock transfers and the transfers of the partnership interests occurred on the same day. We said that the taxpayers' transfers of shares were similar to the transfer of property in the Shepherd case: "In both cases, the value of the children's partnership interests was enhanced by their parents' contributions to the partnership." We rejected the taxpayers' attempt to distinguish the Shepherd case on the ground that they first funded the partnership and then transferred the partnership interests to their children. We found: "At best, the transactions were integrated (as asserted by respondent) and, in effect, simultaneous." We held that the taxpayers' transfers of the shares of stock to the two partnerships were indirect gifts of the shares to their children.



The facts in the instant case are distinguishable from those of both the Shepherd and Senda cases. On November 3, 1999, the partnership was formed, petitioners transferred 70,000 Dell shares to the partnership, and Janelle, as trustee, transferred 100 Dell shares to the partnership. On account of those transfers, petitioners and Janelle received partnership interests proportional to the number of shares each transferred to the partnership. It was not until November 8, 1999, that petitioners are deemed to have made (and, on that date, they did make)5 a gift of LP units to Janelle, both as custodian for I. under the Minnesota UTMA and as trustee. Petitioners did not first transfer LP units to Janelle and then transfer Dell shares to the partnership, nor did they simultaneously transfer Dell shares to the partnership and LP units to Janelle. The facts of the Shepherd and Senda cases are materially different from those of the instant case, and we cannot rely on those cases to find that petitioners made an indirect gift of Dell shares to Janelle, either as custodian for I. under the Minnesota UTMA or as trustee. We shall proceed to respondent's alternative argument.



2. Indirect Gift Under the Step Transaction Doctrine



Alternatively, respondent argues that petitioners made an indirect gift under the step transaction doctrine. As we recently summarized that doctrine in Santa Monica Pictures, L.L.C. v. Commissioner, T.C. Memo. 2005-104:



The step transaction doctrine embodies substance over form principles; it treats a series of formally separate steps as a single transaction if the steps are in substance integrated, interdependent, and focused toward a particular result. Penrod v. Commissioner, 88 T.C. 1415, 1428 (1987). "Where an interrelated series of steps are taken pursuant to a plan to achieve an intended result, the tax consequences are to be determined not by viewing each step in isolation, but by considering all of them as an integrated whole." Packard v. Commissioner, 85 T.C. 397, 420 (1985).



There is no universally accepted test as to when and how the step transaction doctrine should be applied to a given set of facts; however, courts have applied three alternative tests in deciding whether to invoke the step transaction doctrine in a particular situation: the "binding commitment," the "interdependence," and the "end result" tests. Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. 181, 198-199 (1989); Penrod v. Commissioner, supra at 1429-1430. * * *



We have considered the step transaction doctrine in transfer (gift and estate) tax cases. See, e.g., Daniels v. Commissioner, T.C. Memo. 1994-591.



Respondent does not explicitly state which of the above three tests he is relying on, although it appears he is arguing that the ';interdependence' test is applicable. In Santa Monica Pictures, we described the interdependence test as follows:



Under the "interdependence" test, the step transaction doctrine will be invoked where the steps in a series of transactions are so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series. * * We must determine whether the individual steps had independent significance or whether they had significance only as part of a larger transaction. * * * [Citations omitted.]



In his brief, respondent argues:



If none of the individual events occurring between the contribution of the property to the partnership and the gifts of partnership interests had any significance independent of its status as an intermediate step in the donors' plan to transfer their assets to their donees in partnership form, the formation, funding, and transfer of partnership units pursuant to an integrated plan is treated as a gift of the assets to a partnership of which the donees are the other partners. Treas. Reg. § 25.2511-1(h)(1).



The nub of respondent's argument is that petitioners' formation and funding of the partnership should be treated as occurring simultaneously with their 1999 gift of LP units since the events were interdependent and the separation in time between the first two steps (formation and funding) and the third (the gift) served no purpose other than to avoid making an indirect gift under section 25.2511-1(h), Gift Tax Regs. While we have no doubt that petitioners' purposes in forming the partnership included making gifts of LP units indirectly to the children, we cannot say that the legal relations created by the partnership agreement would have been fruitless had petitioners not also made the 1999 gift. Indeed, respondent does not ask that we consider either the 2000 gift (made approximately 2 months after formation of the partnership) or the 2001 gift (made approximately 15 months after formation of the partnership) to be indirect gifts of Dell shares. We must determine whether the fact that less than 1 week passed between petitioners' formation and funding of the partnership and the 1999 gift requires a different result.



Respondent relies heavily on the opinion of the Court of Appeals for the Eighth Circuit in Senda v. Commissioner, 433 F.3d 1044 (8th Cir. 2006).6 In affirming our decision in the Senda case, the Court of Appeals concluded that we did not clearly err in finding that the taxpayers' transfers of shares of stock to two family limited partnerships, coupled with their transfers on the same days of limited partner interests to their children, were in each case integrated steps in a single transaction. Id., at 1049. The taxpayers argued that the order of transfers did not matter since, pursuant to the partnership agreements in question, their contributions of the shares of stock were credited to their partnership capital accounts before being credited to the children's accounts. Id. at 1047. Invoking the step transaction doctrine, the Court of Appeals rejected that step-dependent argument. Id. at 1048. It said: "In some situations, formally distinct steps are considered as an integrated whole, rather than in isolation, so federal tax liability is based on a realistic view of the entire transaction." Id.



This case is distinguishable from Senda because petitioners did not contribute the Dell shares to the partnership on the same day they made the 1999 gift; indeed, almost 1 week passed between petitioners' formation and funding of the partnership and the 1999 gift. Nevertheless, the Court of Appeals in Senda did not say that, under the step transaction doctrine, no indirect gift to a partner can occur unless, on the day property is transferred to the partnership, the partner is (or becomes) a member of the partnership. As respondent's failure to argue indirect gifts on account of the 2000 and 2001 gifts suggests, however, the passage of time may be indicative of a change in circumstances that gives independent significance to a partner's transfer of property to a partnership and the subsequent gift of an interest in that partnership to another.



Here the value of an LP unit changed over time. The parties have stipulated the high, low, average, and closing prices of a share of Dell stock on November 2, 1999, the date petitioners initially transferred Dell shares to the partnership's account, and the subsequent dates of the gifts, and we have found accordingly. See supra table 7. Beginning on November 2, 1999, and ending on the dates of the gifts, the percentage changes in the average price of a share of Dell stock were as follow:



Table 9

Percentage Changes in the Average Price of a Share of Dell Stock




Date Percentage

11/2/1999
to
1/8/1999 -1.316

11/2/1999
to
1/4/2000 +17.745

11/2/1999
to
2/2/2001 -35.748





The value of an LP unit, based on its proportional share of the average value of the Dell shares held by the partnership, fell or rose between the dates indicated by the percentage indicated. Respondent has proposed as a finding of fact, and we have found, that, at the time Tom decided to create the partnership, he had plans to make the 1999, 2000, and 2001 gifts. Petitioners bore the risk that the value of an LP unit could change between the time they formed and funded the partnership and the times they chose to transfer LP units to Janelle. Indeed, the absolute value of the rate of change in the value of an LP unit was greater from November 2 to November 8, 1999, than it was from November 2, 1999, to February 2, 2001. Morever, the partnership held only shares of Dell stock on both November 8, 1999 (the date of the 1999 gift), and January 4, 2000 (the date of the 2000 gift), and the partnership agreement was not changed in the interim. Respondent apparently concedes that a 2-month separation is sufficient to give independent significance to the funding of the partnership and a subsequent gift of LP units. We assume that concession to be on account of respondent's recognition of the economic risk of a change in value of the partnership that petitioners bore by delaying the 2000 gift for 2 months. We draw no bright lines. Given, however, that petitioners bore a real economic risk of a change in value of the partnership for the 6 days that separated the transfer of Dell shares to the partnership's account and the date of the 1999 gift, we shall treat the 1999 gift the same way respondent concedes the 2000 and 2001 gifts are to be treated; i.e., we shall not disregard the passage of time and treat the formation and funding of the partnership and the subsequent gifts as occurring simultaneously under the step transaction doctrine.7



D. Conclusion



The 1999 gift is properly treated as a direct gift of LP units and not as an indirect gift of Dell shares.




III. Section 2703


A. Introduction



In pertinent part, section 2703(a) provides that, for purposes of the gift tax, the value of any property transferred by gift is determined without regard to any right or restriction (without distinction, restriction) relating to the property. Paragraphs 9.1, 9.2, and 9.3 of the partnership agreement (paragraphs 9.1, 9.2, and 9.3, respectively), set forth supra, govern the assignment of LP units, and the parties agree that those paragraphs contain restrictions on the right of a limited partner in the partnership (a limited partner) to sell or assign her partnership interest. Section 2703(b) provides that section 2703(a) does not apply to disregard a restriction if the restriction meets each of the following three requirements:



(1) It is a bona fide business arrangement.



(2) It is not a device to transfer such property to members of the decedent's family for less than full and adequate consideration in money or money's worth.



(3) Its terms are comparable to similar arrangements entered into by persons in an arm's length transaction.



Because we find that paragraph 9.3 fails at least the first and second restrictions, we shall disregard it in determining the values of the LP units transferred.



B. Bona Fide Business Arrangement



1. Parties' Arguments



Respondent argues that paragraph 9.3 is not part of a bona fide business arrangement since "[c]arrying on a business requires more than holding securities and keeping records." As authority for that proposition, respondent cites an income tax case, Higgins v. Commissioner, 312 U.S. 212 (1941) (taxpayer's managerial activities in connection with collecting interest and dividends on securities held for investment did not amount to carrying on a business for purposes of deducting associated expenses). Besides, respondent adds, Tom's primary purpose in forming the partnership were to preserve his Dell wealth and "disincentivize" the children from spending it, while Kim's primary purpose in forming it was to educate the children about family wealth. Those, respondent argues, "are personal, not business [,] goals. Personal goals, with nothing more, do not create a business arrangement."



Petitioners argue:



The restrictions on transferability, the right of first refusal, and the payout mechanism in paragraphs 9.1, 9.2, and 9.3 of the Partnership Agreement serve a bona fide business purpose * * * by preventing interests in the Partnership from passing to non-family members. * * * The creation of a mechanism to ensure family ownership and control of a family enterprise has long been held by this Court to constitute a bona fide and valid business purpose. See Estate of Stone v. Comm'r, 86 T.C.M. (CCH) 551 (2003); Estate of Bischoff v. Comm'r, 69 T.C. 32, 39-41 (1977); Estate of Reynolds v. Comm'r, 55 T.C. 172, 194 (1970), acq., 1971-2 C.B. 1; Estate of Littick v. Comm'r, 31 T.C. 181, 187 (1958), acq., 1984-2 C.B. 1; Estate of Harrison v. Comm'r, 52 T.C.M. (CCH) 1306, 1309 (1987) (holding that "[w]ith respect to business purpose, petitioner presented convincing proof that the partnership was created as a means of providing necessary and proper management of decedent's properties and that the partnership was advantageous to and in the best interests of decedent").



2. Discussion



Section 2703 contains no definition of the phrase "bona fide business arrangement". Nevertheless, we have held that the subject of the restrictive agreement need not directly involve an actively managed business. See, e.g., Estate of Amlie v. Commissioner, T.C. Memo. 2006-76 (citing Estate of Bischoff v. Commissioner, 69 T.C. 32, 40-41 (1977), a pre-section 2073 case in which we found it irrelevant that the restrictive agreements necessary to maintain continuity of management in, and control over, corporations carrying on active businesses were agreements with respect to the ownership of a holding company not actively conducting a trade or business and requiring no management). In Estate of Amlie, the asset in question was the decedent's minority interest in a bank. Before her death the decedent voluntarily became the ward of a conservator appointed to oversee her affairs. The conservator entered into a series of agreements that, among other things, fixed the value of the decedent's bank shares for purposes of satisfying the decedent's obligations to transfer those shares to a prospective heir both in satisfaction of promised bequests and by sale upon her death. The fixed value was lower than the price obtained by the heir on his resale of the shares a month after the decedent's death. The Commissioner sought to disregard the value-fixing agreements entered into by the conservator. We found that, in securing the agreements, the conservator "was seeking to exercise prudent management of decedent's assets by mitigating the very salient risks of holding a minority interest in a closely held bank, consistent with the conservator's fiduciary obligations to decedent." We held:



[A]n agreement that represents a fiduciary's efforts to hedge the risk of the ward's holdings may serve a business purpose within the meaning of section 2703(b)(1). In addition, planning for future liquidity needs of decedent's estate, which was also one of the objectives underlying * * * [one of the relevant agreements], constitutes a business purpose under section 2703(b)(1). * * *



In reaching that conclusion, we referred to the legislative history of section 2703, which includes an informal report of the Senate Committee on Finance, Informal Senate Report on S. 3209, 101st Cong., 2d Sess. (1990), 136 Cong. Rec. 30,488, 30,539 (1990) (the Committee on Finance report). The Committee on Finance report observes that buy-sell agreements



are common business planning arrangements * * * that * * * generally are entered into for legitimate business reasons * * * . Buy-sell agreements are commonly used to control the transfer of ownership in a closely held business, to avoid expensive appraisals in determining purchase price, to prevent the transfer to an unrelated party, to provide a market for the equity interest, and to allow owners to plan for future liquidity needs in advance. * * *



Indeed, we have held that buy-sell agreements serve a legitimate purpose in maintaining control of a closely held business. E.g., Estate of Bischoff v. Commissioner, supra; Estate of Reynolds v. Commissioner, 55 T.C. 172 (1970); Estate of Fiorito v. Commissioner, 33 T.C. 440 (1959).8



Here, however, we do not have a closely held business. From its formation through the date of the 2001 gift, the partnership carried on little activity other than holding shares of Dell stock. Dell was not a closely held business either before or after petitioners contributed their Dell shares to the partnership. While we grant that paragraphs 9.1 through 9.3 (and paragraph 9.3 in particular) aid in control of the transfer of LP units, the stated purposes of the partnership, viewed in the light of petitioners' testimony as to their reasons for forming the partnership and including paragraphs 9.1 through 9.3 in the partnership agreement, lead us to conclude that those paragraphs do not serve bona fide business purposes. Paragraph 3.1 of the partnership agreement includes among the stated purposes of the partnership: "to * * * provide a means for the Family to gain knowledge of, manage, and preserve Family Assets." Tom testified at some length as to his understanding of the term "preservation" and his reasons for making asset preservation a purpose of the partnership. On the basis of that testimony, we find that his reason for making asset preservation a purpose of the partnership was to protect family assets from dissipation by the children. Tom also testified that paragraph 9.1 "lays out pretty strong limitations on what the limited partners can do in assigning or giving away their interests to other people." He viewed the buy-in provisions of paragraph 9.3 as a "safety net" if an impermissible person obtained an assignment of a limited partner interest from one of the girls. He considered the provisions of paragraphs 9.1, 9.2, and 9.3, together, as important in accomplishing his goal of keeping the partnership a closely held partnership of family members: "If there are ways for the family [the children] to wiggle out of that and bring other people in, then it will prevent us from accomplishing our goals, so we wanted a couple of levels here of restriction that would prevent that from happening." Kim testified that the purpose of organizing the partnership was to establish a tool for Tom and her "to be able to teach * * * [the] children about wealth and the responsibility of that wealth."



We believe that paragraphs 9.1 through 9.3 were designed principally to discourage dissipation by the children of the wealth that Tom and Kim had transferred to them by way of the gifts. The meaning of the term "bona fide business arrangement" in section 2703(b)(1) is not self apparent. As discussed supra, in Estate of Amlie v. Commissioner, T.C. Memo. 2006-76, we interpreted the term "bona fide business arrangement" to encompass value-fixing arrangements made by a conservator seeking to exercise prudent management of his ward's minority stock investment in a bank consistent with his fiduciary obligations to the ward and to provide for the expected liquidity needs of her estate. Those are not the purposes of paragraphs 9.1 through 9.3. There was no closely held business here to protect, nor are the reasons set forth in the Committee on Finance report as justifying buy-sell agreements consistent with petitioners' goals of educating their children as to wealth management and "disincentivizing" them from getting rid of Dell shares, spending the wealth represented by the Dell shares, or feeling entitled to the Dell shares.



3. Conclusion



We find that paragraphs 9.1 through 9.3 do not serve bona fide business purposes. Those paragraphs do not constitute a bona fide business arrangement within the meaning of section 2703(b)(1).



C. Device Test



The second requirement of section 2703(b) is that the restriction not be a device to transfer the encumbered property to members of the decedent's family for less than full and adequate consideration in money or money's worth (hereafter, simply adequate consideration). Sec. 2703(b)(2). The Secretary's regulations interpreting section 2703 substitute the term "the natural objects of the transferor's bounty" for the term "members of the decedent's family", apparently because he interprets section 2703 to apply to both transfers at death and inter vivos transfers. Sec. 25.2703-1(b)(1)(ii), Gift Tax Regs.9 Clearly, the gifts of the LP units were both (1) to natural objects of petitioners' bounty and (2) for less than adequate consideration. They were not, however, a "device" to transfer the LP units to the children for less than adequate consideration. The question we must answer is whether paragraphs 9.1 through 9.3, which restrict the children's rights to enjoy the LP units, constitute such a device. We believe that they do. Those paragraphs serve the purposes of Tom and Kim to discourage the children from dissipating the wealth that Tom and Kim had transferred to them by way of the gifts. They discourage dissipation by depriving a child desirous of making an impermissible transfer of the ability to realize the difference in value between the fair market value of his LP units and the units' proportionate share of the partnership's NAV. If a child persists in making an impermissible transfer, paragraph 9.3 allows the general partners (currently Tom and Kim) to redistribute that difference among the remaining partners. Thus, if the provisions of paragraph 9.3 are triggered and the partnership redeems the interest of an impermissible transferee for less than the share of the partnership's net asset value proportionate to the impermissible transferee's interest in the partnership (which is likely, given the agreement of the parties' valuation experts as to how the valuation discounts appropriate to an LP unit are applied; see infra section IV.A. of this report), the values of the remaining partners' interests in the partnership will increase on account of that redemption. See infra note 17 and the accompanying paragraph. The partners benefiting from the redemption could (indeed, almost certainly, would) include one or more of the children, natural objects of petitioners' bounty.



Tom participated in the drafting of the partnership agreement to ensure, in part, that "asset preservation" as he understood that term (i.e., to discourage the children from dissipating their wealth) was addressed. Tom impressed us with his intelligence and understanding of the partnership agreement, and we have no doubt that he understood the redistributive nature of paragraph 9.3. and his and Kim's authority as general partners to redistribute wealth from a child pursuing an impermissible transfer to his other children. We assume, and find, that he intended paragraph 9.3 to operate in that manner, and this intention leads us to conclude, and find, that paragraph 9.3 is a device to transfer LP units to the natural objects of petitioners' bounty for less than adequate consideration.



D. Comparable Terms



The third requirement of section 2703(b) is that the terms of the restriction be comparable to similar arrangements entered into by persons in an arm's-length transaction. Comparability is determined at the time the restriction is created. Sec. 25.2703-1(b)(1)(iii), Gift Tax Regs. The parties rely on expert testimony to show that the elements of section 2703(b)(3) have or have not been satisfied.



Respondent called Daniel S. Kleinberger, professor of law at William Mitchell College of Law, St. Paul, Minnesota. Professor Kleinberger was accepted as an expert on arm's-length limited partnerships. In his direct testimony, he expressed the opinion that the overall circumstances of the partnership arrangement made it unlikely that a person in an arm's-length arrangement with the general partners would accept any of the "salient" restrictions on sale or use contained in the partnership agreement. He explained:



In virtually every material respect, the * * * [partnership] agreement blocks for 50 years the limited partners' ability to sell or use their respective limited partner interests. In an arm's length transaction, a reasonable investor faced with such a prospect would ask, "What is so special about this opportunity, what do I get out of this arrangement that justified so restricting and enfeebling my rights?" The answer, in an arm's length context, is nothing.



On cross-examination, he agreed with counsel for petitioners that transfer restrictions similar to those found in paragraphs 9.1 through 9.3 are common in agreements entered into at arm's length. That, however, he concluded, was beside the point since "The owners of a closely held business at arm's length would never get into this deal with the Holmans, period, so the issue [transfer restrictions] wouldn't come up." In response to petitioner's counsel's expression of doubt as to what he meant, he answered:



What I mean is that when you look at the overall context, when you look at the nature of the assets, when you look at the expertise or non-expertise of the general partner, when you look at the 50-year term, when you look at the inability to get out, when you look at the susceptibility of this single asset, * * * the issue [transfer restrictions] wouldn't arise, because nobody at arm's length would get into this deal."



Using a colorful expression, he summed up his view as follows:



[B]ased on my experience and based on conversations with more than a dozen practitioners who do this stuff, I couldn't find anybody would do this deal, who would let their client into a deal like this as a limited partner without writing a very large CYA memo, saying: "We advise against this."



Petitioners called William D. Klein (Mr. Klein), a shareholder in the Minnesota law firm of Gray, Plant, Mooty, Mooty & Bennett, P.A. Mr. Klein has "practiced, written, and lectured about" partnership taxation and law for more than 20 years. He has participated in the drafting of, or reviewed drafts of, more than 300 limited partnership agreements. He was accepted as an expert with respect to the comparability of the provisions of the partnership agreement to provisions in other partnership agreements entered into by parties at arm's length. He was asked by petitioners to express his opinion as to whether various provisions of the partnership agreement are "'comparable to similar arrangements entered into by persons in an arm's length transaction'". With respect to paragraphs 9.1 and 9.2, Mr. Klein is of the opinion that the paragraphs "are comparable to provisions one most often finds in limited partnership agreements among unrelated partners." As to paragraph 9.3, he is of the opinion that the paragraph "is not out of the mainstream of what one typically finds in arm's length limited partnership agreements."



Petitioners must show that paragraph 9.3 is "comparable to similar arrangements entered into by persons in an arm's length transaction." See sec. 2703(b)(3). The experts agree that transfer restrictions comparable to those found in paragraphs 9.1 through 9.3 are common in agreements entered into at arm's length. That would seem to be all that petitioners need to show to satisfy section 2703(b)(3). Nevertheless, respondent relies on one of his expert's, Professor Kleinberger's, testimony "that the overall circumstances of the * * * [partnership] arrangement make it unlikely that arm's length third parties would agree to any one of its restrictions on sale or use." Even were we to find that paragraph 9.3 is comparable to similar arrangements entered into by persons in arm's-length transactions (thus satisfying section 2703(b)(3)), we would still disregard it because it fails to constitute a bona fide business arrangement, as required by section 2703(b)(1), and is a prohibited device within the meaning of section 2703(b)(2). Therefore, we need not (and do not) decide today whether respondent is correct in applying the arm's-length standard found in section 2703(b)(3) to the transaction as a whole.




IV. Valuation


A. Introduction



We must determine the values of the gifts. Although the gifts were of LP units, the parties agree that the starting point for determining those values is the net asset value (NAV) of the partnership. Since, on the dates of the gifts, the partnership held only shares of Dell stock and had no liabilities, the parties agree that the NAV on each of those dates equals the value of the Dell shares then held. The parties also agree that, in valuing the gifts of LP units, we are to look to the pro rata portion of the NAV of the partnership allocable to the LP units transferred but are to make negative adjustments to the values so determined to reflect the lack of control and lack of marketability inherent in the transferred interests. The parties disagree on the magnitude of those discounts. They also disagree on the effect of disregarding paragraph 9.3. We have set forth as appendixes A through D hereto comparisons based on materials prepared by respondent of the parties' valuation positions for each of the gifts. There appear to be no discrepancies between the information in those appendixes and petitioners' computations of like amounts.



B. Law



Pertinent to our determination of the values of the gifts is section 25.2512-1, Gift Tax Regs., which provides that the value of property for Federal gift tax purposes is "the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts." The willing buyer and willing seller are hypothetical persons, rather than specific individuals or entities, and their characteristics are not necessarily the same as those of the donor and the donee. See, e.g., Estate of Davis v. Commissioner, 110 T.C. 530, 535 (1998). The hypothetical willing buyer and the hypothetical willing seller are presumed to be dedicated to achieving the maximum economic advantage. E.g., id.



C. Expert Opinions



1. Introduction



The parties rely exclusively on expert testimony to establish the appropriate discounts to be applied in determining the fair market values of the gifts of LP units. Of course, we are not bound by the opinion of any expert witness, and we may accept or reject expert testimony in the exercise of our sound judgment. Helvering v. Natl. Grocery Co., 304 U.S. 282, 295 (1938); Estate of Newhouse v. Commissioner, 94 T.C. 193, 217 (1990). Because valuation necessarily involves an approximation, the figure at which we arrive need not be directly traceable to specific testimony if it is within the range of values that may be properly derived from consideration of all the evidence. E.g., Peracchio v. Commissioner, T.C. Memo. 2003-280.



2. Petitioners' Expert



Petitioners called Troy D. Ingham (Mr. Ingham) as an expert witness to testify concerning the values of the gifts. Mr. Ingham is a vice president and director with Management Planning, Inc., a business valuation firm. He has been performing valuation services since 1996. He is a candidate for the American Society of Appraisers. The Court accepted Mr. Ingham as an expert on business valuation and limited partnership valuation, and we received into evidence as his direct testimony four reports he had participated in preparing. Three of those reports express his opinions as to the fair market value of an LP unit on November 8, 1999, January 4, 2000, and February 2, 2001, respectively (the dates of the 1999, 2000, and 2001 gifts, respectively). In each report, Mr. Ingham gives his opinion alternatively regarding and disregarding the effect of paragraph 9.3. Mr. Ingham's opinions are summarized in appendixes A through D. Petitioners offered Mr. Ingham's fourth report in rebuttal to respondent's valuation expert witness's testimony, and that report expresses Mr. Ingham's opinion that some of respondent's valuation expert witness's conclusions are flawed.



3. Respondent's Expert



Respondent called Francis X. Burns (Mr. Burns) as an expert witness to testify concerning the values of the gifts. Mr. Burns is a vice president of CRA International, Inc., an international consulting firm that provides business valuation services. He is an accredited senior appraiser in business valuation within the American Society of Appraisers and a member of the Institute of Business Appraisers. He has been performing valuation services for more than 18 years, and he has testified as an expert in several valuation cases. The Court accepted Mr. Burns as an expert in the valuation of business entities and partnerships, and we received into evidence as his direct testimony the report he had prepared. In that report, he expresses his conclusions as to the fair market values of the gifts, alternatively regarding and disregarding the effect of paragraph 9.3. His opinions are summarized in appendixes A through D.



D. Discussion



1. Net Asset Value of Partnership



The parties agree on the numbers of Dell shares the partnership held on the dates of the gifts. They further agree that the value of those shares establishes the NAV of the partnership on each of those dates. They agree that the partnership's NAV was $2,812,763 (rounded) on the date of the 1999 gift. They disagree as to the partnership's NAV on each of the dates of the 2000 and 2001 gifts. Relying on Mr. Ingham's calculation of the closing values of a share of Dell stock on the dates of those gifts, petitioners argue that the partnership's NAVs on those dates were $4,672,758 and $2,798,331, respectively. Relying on Mr. Burns's calculations of the averages of the high and low prices of a share of Dell stock on those dates, respondent argues that the partnership's NAVs on those dates were $4,798,033 and $2,902,488, respectively. Section 25.2512-2, Gift Tax Regs., deals with the valuation of stocks and bonds for purposes of the gift tax. See sec. 25.2512-2(a), Gift Tax Regs. In pertinent part, section 25.2512-2(b)(1), Gift Tax Regs., provides: "In general, if there is a market for stocks * * *, on a stock exchange, in an over-the-counter market or otherwise, the mean between the highest and lowest quoted selling prices on the date of the gift is the fair market value per share". Petitioners argue that, because the gifts here being valued are gifts of partnership interests that do not trade in a public market, the regulation is inapplicable. Moreover, argue petitioners, in determining his discount for lack of control, Mr. Ingham relied on data showing that shares of publicly held investment companies generally trade at a discount from NAV, determined by comparing the price of the company to its end-of-day NAV.



We cannot dismiss the regulation, as petitioners would have us do. The starting point for valuing the gifts is determining the NAV of the partnership, which is defined exclusively by the value of shares of Dell stock, which Mr. Ingham opines are "traded over-the-counter". The rules for valuing marketable shares of stock found in section 25.2512-2(b)(1), Gift Tax Regs., are not gift-specific rules whose application makes no sense if it is only the value of the shares, indirectly, that is at issue, and petitioners provide no authority for disregarding the rules. To the contrary, petitioners cite a case that supports a contrary view: Estate of Cook v. Commissioner, T.C. Memo. 2001-170 (annuity tables appropriate to value installment payoff of lottery ticket held by partnership notwithstanding marketability discount that might apply to valuation of partnership interest), affd. 349 F.3d 850 (5th Cir. 2003).



Petitioners' argument with respect to Mr. Ingham's methodology for determining a lack of control discount is equally unpersuasive. Data from the universe of trades of publicly held investment companies may well show that shares of those companies generally trade at a discount from NAV determined at the end of the day, but petitioners have failed to show that any statistical inference to be drawn from that data would be any different if an average of the highs and lows of the component securities were used to determine NAV.



We shall rely on Mr. Burns's computations of $4,798,033 and $2,902,488 as the partnership's NAVs on the dates of the 2000 and 2001 gifts, respectively.



2. Minority Interest (Lack of Control) Discount



a. Introduction



Pursuant to the partnership agreement, a hypothetical buyer of an LP unit would have limited control of his investment. For instance, such a buyer (1) would have no say in the partnership's investment strategy, and (2) could not unilaterally recoup his investment by forcing the partnership either to redeem his unit or to undergo a complete liquidation. The parties agree that the hypothetical "willing buyer" of an LP unit would account for such lack of control by demanding a reduced price; i.e., a price that is less than the unit's pro rata share of the partnership's NAV.



b. Comparison to Closed-End Investment Funds



Both Messrs. Ingham and Burns apply minority interest discounts in valuing the gifts by reference to the prices of shares of publicly traded, closed-end investment funds, which typically trade at a discount relative to their share of fund NAV by definition.10 The idea is that since, by definition, such shares enjoy a high degree of marketability, those discounts must be attributable, at least to some extent, to a minority shareholder's lack of control over the investment fund. The minority interest discounts applied by Messrs. Ingham and Burns in valuing the gifts are as follows:



Table 10





Valuation
expert 1999 gift 2000 gift 2001 gift

Mr. Ingham Mr. 14.4% 16.3% 10%

Burns 11.2 13.4 5





In determining those discounts, both experts rely on samples of closed-end investment funds with investment portfolios comprising predominantly domestic equity securities; viz, shares of common stock. Each expert relies on three samples, one for the date of each gift (the valuation dates). Mr. Ingham's sample sizes are 28, 28, and 27, and Mr. Burns's are 28, 27, and 25. For the first two valuation dates, 20 of the closed-end investment funds in each of the four sets of samples are the same. For the third date, 18 are the same. Mr. Burns relies solely on general equity funds, which contain a diversified portfolio of stocks across industries. Mr. Ingham includes in his samples seven specialized equity funds with investments in the healthcare, petroleum and resources, and banking industries. Mr. Ingham computes (and relies on) only the median discount for each of his samples. Mr. Burns computes not only the median discount for each of his samples but also the mean and interquartile mean discounts for each.11 The following table shows the results of each expert's computations.



Table 11





Valuation
expert's
computation 1999 gift 2000 gift 2001 gift

Mr. Ingham:
Median 13.1% 14.8% 9.1%

Mr. Burns: Mean 10.8 11.7 3.4

Mr. Burns:
Median 12.1 14.8 3.8

Mr. Burns:
Interquartile
mean 11.2 13.4 5.0





Mr. Ingham considers adjustments to his median discount figures to reflect what he describes as quantitative factors (i.e., aggregate size of the partnership's NAV, relative volatility of the partnership's portfolio, measures of return and yield) but determines that those factors had an insignificant influence. He considers qualitative factors (i.e., the lack of diversification of the partnership's portfolio, the depth and quality of the partnership's management, the partnership's income tax status), and he determines that, "[b]ased on all relevant factors, including the fact that * * * [the partnership's] portfolio is neither well diversified nor professionally managed on a daily basis", an investor or willing buyer of an LP unit would require a discount 10 percent greater than the median discount he had determined. Table 10 reflects his final determination that the appropriate minority interest discounts are 110 percent of the median discounts he determined. Mr. Burns relies on the interquartile mean discount. Although he considers a downward adjustment to reflect the large size of the limited partner interest held by Janelle as trustee (and the influence that would give her over the general partners), he rejects any adjustment "as a point of conservatism".



We must determine (1) the composition of the appropriate samples of closed-end investment funds (i.e., whether Mr. Ingham appropriately includes specialized funds); (2) the appropriate descriptive statistic to measure the central tendency of the samples; and (3) whether Mr. Ingham's adjustments to his sample medians are justified.



c. Discussion



On cross-examination, Mr. Ingham agreed with counsel for respondent that the seven specialized equity funds that he had included in his samples of closed-end equity funds resembled the partnership only in that they were specialized in their investments. Indeed, that was his reason for including them, although he agreed that he could find no correlation between quantitative factors particular to the funds in his samples and the discounts at which those funds traded. He further agreed that he had included no explanation in his report as to why he had included the specialized funds in his samples. We have examined the data Mr. Ingham presented with respect to discounts from NAV for the seven specialized funds for the first valuation date (November 8, 1999) and have determined that the discounts for that subset of his sample range from a minimum of 9.8 percent to a maximum of 24.9 percent, with mean and median discounts of 17.1 and 17.8 percent, respectively, as compared to the range of discounts for the full sample, 1 to 24.9 percent, with mean and median discounts of 12 and 13 percent, respectively. Both experts agree that general equity funds are sufficiently comparable to the partnership so that useful information as to an appropriate minority discount can be drawn from a sample of those funds. They disagree as to whether useful information can be obtained by considering funds specializing in industries different from Dell's computer business. Mr. Burns believes that it cannot. Given that disagreement and the significant differences we found in comparing the range, mean, and median of the subset and the sample, we are content to rely on the area of the experts' agreement; i.e., that a sample of general equity funds is reliable for purposes of determining an appropriate minority discount. We shall construct samples for each valuation date from the intersection of the experts' data sets for that date (i.e., the 20 funds selected for both the first and second valuation dates and the 18 funds selected for the third valuation date).



Mr. Ingham dealt with his concern for outliers12 by relying on the median of each sample. He is of the opinion that the median does not put any weight on outliers as the mean would. In response to the Court's question as to whether he relied on the median because outliers caused a significant difference between the means and the medians in his samples, he answered that he did not know since he had not computed the mean. Mr. Burns computed the mean, the median, and the interquartile mean for each of his samples. His approach to the problem of outliers appears to have been more thoughtful than Mr. Ingham's, and we shall follow his lead and deal with the problem of outliers by relying on the interquartile mean of each sample we construct.



We shall also follow Mr. Burns's lead and make no adjustments to the averages so obtained. Simply put, Mr. Ingham has failed to convince us that lack of portfolio diversity and professional management justify an increased adjustment on account of lack of control of 10 percent (or, indeed, any adjustment at all). In his report, Mr. Ingham concedes: "the Partnership's relatively simple investment portfolio negates [lack of professional management]". Nor can we see how lack of diversity could exacerbate lack of control since the partnership was, on the valuation dates, transparently, the vehicle for holding shares of stock of a single, well-known corporation. Mr. Ingham's 10-percent adjustment, based on "all relevant factors", is without sufficient analytical support to convince us that any adjustment should be made to the sample averages we obtain. See Casey v. Commissioner, 38 T.C. 357, 381 (1962) ("An expert's opinion is entitled to substantial weight only if it is supported by the facts.").



Conclusion



We determine minority interest discounts to be applied in valuing the gifts as follows:



Table 12





1999
gift 2000 gift 2001 gift

11.32% 14.34% 4.63%





3. Marketability Discount



a. Introduction



The parties agree that, to reflect the lack of a ready market for LP units (or, more pertinently, assignee interests in the partnership), an additional discount (after applying the minority interest discounts) should be applied to the partnership's NAV to determine the fair market values of the gifts. Such a discount is commonly referred to as marketability discount. The experts differ sharply on two points: (1) The existence of a market for LP units, and (2) the weight that should be given various qualitative factors.



b. Mr. Ingham's Opinion



To determine an appropriate marketability discount, Mr. Ingham looks at his and others' studies of restricted stock transactions, which compare the private-market price of restricted shares of public companies (i.e., shares that, because they have not been registered with the Securities and Exchange Commission (SEC), generally cannot be sold in the public market for a 2-year period)13 with their coeval public market price. Mr. Ingham combines data from the restricted stock approach with his analysis of the "investment quality" of the LP units to support a marketability discount of 35 percent.



c. Mr. Burns's Opinion



Mr. Burns's approach requires more explanation. He also considers various studies of marketability discounts with respect to restricted stock sales. He looks at studies of the mean discount (in two cases, the median discount) on sales of restricted stock during three periods: (1) before 1990; (2) from 1990 to 1997; and (3) during 1997 and 1998. In 1972, the SEC adopted rule 144, 17 C.F.R. sec. 230.144 (1972), imposing a 2-year holding period on the resale of restricted stock. In 1990, the SEC adopted rule 144A, 17 C.F.R. sec. 230.144A (1990), allowing institutional buyers to buy and sell restricted stock. In 1997, the SEC amended rule 144, 17 C.F.R. sec. 230.144 (1997), reducing the required holding period to 1 year. For the first period (pre-1990), which Mr. Burns characterizes as "lack[ing] * * * a resale market", the average of the discounts for the studies he considered is 34 percent. For the second period (1990 to 1997), the similar average is 22 percent, and, for the third period (1997 and 1998), it is 13 percent. He concludes:



Based on the evolution of restricted stock discounts, there appear to be at least two factors that influence investors: 1) the limited access to a liquid market and 2) the required holding period before the restricted stock can be freely traded. These factors suggest an explanation as to why average marketability discounts have decreased since the implementation of Rule 144A and the Amendment to Rule 144A [sic., Rule 144]. Rule 144A allowed for institutional trading of restricted stocks. The difference between average marketability discounts before and after Rule 144A would appear to reflect the discount investors required for having virtually no secondary market. In contrast, the difference between average discounts found prior to and after 1997 is a logical result of the reduction in holding period from two years to one year.



Mr. Burns recognizes that the partnership is very different from the operating companies that are the subject of the restricted stock studies he examined. Nevertheless, he thinks that the changes in restricted stock discounts over time evidenced by those studies are instructive with respect to the pricing decisions of investors holding securities that cannot readily be resold. He starts with the premise that, before SEC rule 144A, holders of restricted stock had virtually no access to any secondary (resale) market and, therefore, demanded a discount (34 percent being the average of the studies he examined) to account for that lack of market access. The promulgation of SEC rule 144A, he argues, opened a resale market (albeit a limited one), and the average discount of the studies he examined for the period from 1990 to 1997 is, at 22 percent, 12 percentage points lower than the average discount he observed for the prior period, before the promulgation of rule 144A. He concludes that the difference is due to the availability of a resale market after 1990. Put another way, Mr. Burns believes that 12 percent is indicative of the charge that the buyer imposed on the seller of restricted stock before 1990 to account for the buyer's lack of access to a ready resale market. Mr. Burns concludes that the remaining 22 percentage points of the average pre-1990 discount of 34 percent are attributable to holding period restrictions and factors unrelated to marketability. He explains the effect of holding period restrictions as follows: "Legally mandated holding periods can be particularly onerous for investors when the restricted shares are subject to extreme price volatility, as is the case with many financially distressed companies." He concludes:



For investment holding companies such as the Partnership --those not hindered by legal holding periods, nor subject to the operating and financial risks of typical restricted shares --the measure of discount based on restricted stock research suggests a lack of marketability adjustment closer to 12 percent.



That, he explains "is the incremental level of discounts that investors demanded before 1990, when the trading market became more liquid."



Mr. Burns next turns his attention to the circumstances of the partnership. He believes that there are factors particular to the partnership that must be considered in determining an appropriate marketability discount. Mr. Burns lists the following factors: the failure to make distributions, a nondiversified portfolio, the restrictions on transferring LP units, the dissolution provisions of the partnership agreement, and the liquidity of Dell shares. He considers the last two factors as increasing marketability. He believes that the provisions of the partnership agreement providing for the voluntary dissolution of the partnership (and distribution of its assets on a pro rata basis to its partners) would benefit a limited partner wishing to sell her interest. He believes that a voluntary dissolution of the partnership would be of little detriment to the remaining partners, who could reconstitute the partnership less the withdrawing partner (who might agree to pay the costs attendant to dissolution and reconstitution), and the dissolution would significantly benefit the withdrawing partner, who would save the large discount to her proportional share of the partnership's NAV attendant to any assignment of her interest. He notes that, on each valuation date, the partnership's portfolio consisted of only highly liquid, marketable securities; viz, Dell shares: "These assets have an easily discernible value and can be sold quickly and easily."14 Mr. Burns concludes that a reasonable negotiation between a buyer and seller over the price of a limited partner interest in the partnership would result in a price concession for lack of marketability in the range of 10 to 15 percent. He starts with the notion that traditional studies of unregistered shares of public companies suggest a price concession of 12 percent due to the lack of a ready market. Because of his belief that, unlike restricted stock, a limited partner interest in the partnership is not burdened by prescribed holding period limitations on resale, nor does it carry the business or financial risk associated with the typical issuer of private placement shares, he adds little for those factors. He settles on a marketability discount of 12.5 percent.



d. Discussion



(1) Introduction



The experts agree on the usefulness of restricted stock studies in determining appropriate marketability discount for the gifts. They further agree that (1) no secondary market exists for LP units; (2) an LP unit cannot be marketed to the public or sold on a public exchange; and (3) an LP unit can be sold only in a private transaction. They disagree principally on the likelihood of a private market among the partners for LP units.



(2) Mr. Ingham's Opinion



Mr. Ingham's approach is relatively straightforward. He believes that "restricted shares [of publicly held companies] sell at a price below their publicly traded (unrestricted) counterparts because of the lack of access to a ready market due to SEC Rule 144." He has sampled private transactions in the common stocks of actively traded companies. His sample shows median and mean discounts of 24.8 and 27.4 percent, respectively, "for equities with access to public stock market liquidity in about two years." He believes that "these private placement transactions * * * are an appropriate starting point from which to measure the diminution in valuing arising from lack of marketability." He adds: "The * * * [marketability] discounts demanded by potential investors in privately held business interests with potentially very long holding periods should be much larger [than for restricted shares with access to a ready market in 2 years]." In particular, with respect to the partnership, he concludes that (1) the willing buyer of a limited partner interest "has no real prospects of being able to sell the interest in the public market at the full, freely traded value at any time," and (2) "there is virtually no ready market for * * * [interests in the partnership]". He appears to dismiss altogether the possibility of a private sale of LP units:



Further, there is no market for a limited partnership unit in * * * [the partnership]. There have never been any purchases or sales of * * * [partnership] limited partnership units. Sales of partnership units are restricted by the Agreement. A buyer has no assurance, as well, of being admitted as a substitute partner, as such admission requires the consent of all the partners.



He concludes: "Considering all relevant factors, * * * [I] believe that the discount for lack of marketability should be at least 35%." (Emphasis added.) He settles for a 35-percent discount for lack of marketability in determining the value of an LP unit.



Respondent observes about Mr. Ingham's analysis: If Mr. Ingham's assumptions about the absence of a market for LP units are accepted, "then the conclusion is unavoidable that the value of limited partnership interests in the * * * [partnership] is virtually zero, or that they cannot be valued at all." Respondent criticizes Mr. Ingham for being arbitrary in stopping at 35 percent when his analysis would seem to lead to the conclusion that, since he believes that an LP unit cannot be sold, the appropriate discount for lack of marketability should be 100 percent. Respondent has a point. Mr. Ingham's analysis is predicated on the assumption that he can extrapolate the marketability discount appropriate to an LP unit from the typical discount found by him with respect to a sample of sales of restricted stock barred from resale in a ready market for 2 years. The obstacle he must overcome is his belief that there is not now, nor will there ever be, a ready market (indeed, any market) for LP units. If we are to assume (as he would have us do) that the size of the marketability discount is a function of the length of time that a holder of an interest in a business is barred access to a ready market, then Mr. Ingham has not persuaded us that his stopping point, 35 percent, is anything but a guess. He does not build from his observed sample median and mean discounts of 24.8 and 27.4 percent, respectively, to his 35 percent conclusion by quantitative means. He considers the "investment quality" of the LP units, concluding that the lack of public information about the partnership is a detriment that is mitigated "somewhat" by the transparency of the partnership (since its only assets are shares of Dell stock). He takes into account that there is no market for LP units, and an investor wishing to acquire Dell shares could do so outside of the partnership without encountering the various restrictions attaching to a partnership interest. Without any further analysis, he concludes, as stated supra: "Considering all relevant factors, * * * the discount for lack of marketability should be at least 35 percent."15 Given his assumptions that (1) there is virtually no ready market for LP units, and (2) the size of any marketability discount is a function of the length of time that a holder of an interest in a business is barred access to a ready market, it would seem that he could only draw the conclusion that an LP interest is simply not salable, which is not the conclusion that he draws. We do not reject per se Mr. Ingham's reliance on restricted stock studies. We simply lack confidence in the result he reaches given the assumptions he makes. We need not rely on the unsupported opinion of an expert witness. See Casey v. Commissioner, 38 T.C. at 381.



(3) Mr. Burns's Opinion



Mr. Burns looks at the marketability discount as comprising principally two components: a market access (liquidity) component and a holding period component. We assume that petitioner's expert, Mr. Ingham, accepts that division since, in his rebuttal report, he states: "[Mr. Burns] concluded, correctly, that private placement discounts have declined because of relaxations for institutional trading and reductions in required holding periods under Rule 144." (Emphasis added.) Mr. Burns pegs at 12 percent the difference in private placement discounts between a period in which holders of restricted stock had no access to a ready market and could only dispose of their restricted stock in private transactions and a period in which certain holders of restricted stock were allowed limited access to a ready market.16 He concludes: "[That] difference * * * would appear to reflect the discount investors required for having virtually no secondary market." That difference suggests to Mr. Burns the market access component of the marketability discount appropriate to an LP unit; i.e., the price concession that a buyer of an LP unit would demand to reflect that the unit could only be liquidated in a private transaction.



Mr. Burns recognizes that factors particular to the partnership (such as the restrictions on transferring LP units) might elicit an additional discount, and, on the basis of those factors and the discounts suggested by his empirical research studies, he settles on a marketability discount of 12.5 percent. He makes little, if any, adjustment on account of holding period restrictions. He notes that the partners can agree to dissolve the partnership; and, although he did not determine the likelihood of a dissolution, he testified that, so long as the artnership continued to hold only shares of Dell stock (which he characterizes as having "an easily discernible value"), "[he could not] envision an economic reason why * * * [the partnership] would not be willing to let somebody be bought out, because * * * [the remaining partners would] be holding the same proportion of assets, the same type of assets, after * * * [the buyout]." Indeed, given the significant minority interest and marketability discounts from an LP unit's proportional share of the partnership's NAV that each expert would apply in valuing the gifts, it would appear to be in the economic interest of both any limited partner not under the economic necessity to do so but wishing to make an impermissible assignment of LP units and the remaining partners to strike a deal at some price between the discounted value of the units and the dollar value of the units' proportional share of the partnership's NAV. The wishing-to-assign partner would get more than she would get in the admittedly "thin" market for private transactions, and the dollar value of each remaining partner's share of the partnership's NAV would increase.17 So long as the partnership's assets remain highly liquid (as they were on each of the valuation dates), the remaining partners would appear to bear little or no economic risk in agreeing to a redemption or similar transaction to accommodate a wishing-to-assign partner.



A transaction of the type described would (if petitioners' proposed discounts are to be credited) increase the wealth of the family members post hoc. While such a transaction is perhaps inconsistent with the stated purpose of the partnership to "preserve Family assets", the provision in the partnership agreement allowing for the consensual dissolution of the partnership convinces us that preservation of family assets is not an unyielding purpose. We think that Mr. Burns was correct to take into account the prospect of such a dissolution of the partnership as a significant factor in the private market for LP units, and we think that the economic self-interest of the partnership (more precisely, any remaining partners) must be considered in determining any marketability discount. We agree with Mr. Burns that the holding period component of the marketability discount is of little, if any, influence here.18



(4) Conclusion



Mr. Burns has persuaded us that a hypothetical purchaser of an LP unit would demand and get a price concession to reflect the market access component of the marketability discount but would get little if any price concession to reflect the holding period component of that discount. On the record before us, and considering the expert testimony presented, we cannot determine any better estimate of an appropriate marketability discount than Mr. Burns's estimate, 12.5 percent, and we find accordingly.



(5) Paragraph 9.3



Since we have determined to disregard paragraph 9.3 in determining the values of the gifts, we need not address the parties' differences with respect to its effects on those values.19




V. Conclusion


On the premises stated, we calculate the fair market values of the gifts as follows:



Table 13

Date of gift




2/2/2001
11/8/1999 11/8/1999in 1/4/2000in in
f/b/o I. trust trust trust

Net asset
value $2,812,763 $2,812,763 $4,798,033 $2,902,488

Gift
interest 14.265% 70.054% 3.285% 5.431%

Pro rata
portion of
net asset
value 401,241 1,970,453 157,615 157,634

Discount
for lack of
control
(11.32,
11.32, 14.34,
and 4.63%
respectively) (45,420) (223,055) (22,602) (7,298)

355,820 1,747,398 135,013 150,336

Discount
for lack of
marketability
(12.5%) (44,478) (218,425) (16,877) (18,792)

Fair market
value 311,343 1,528,973 118,137 131,544





We find accordingly, except that, on the basis of respondent's position on brief that the amount of the 2001 gift is $131,033, we find that the total amount of that gift is that amount.



Decision will be entered under Rule 155.

Section 6654 - Taxpayer did not meet the requirements of any exceptions to section 6654. See sec. 6654(e). Taxpayers was titled to a credit for the Federal income tax withheld from his wages under 6664(g). See Bagby v. Commissioner, 102 T.C. 596, 613 (1994).


Michael Cabirac v. Commissioner.


FOLEY, Judge: The issues for decision are whether petitioner is liable for income tax deficiencies attributable to unreported income, for sections 6651(a)(1)1 and (2) and 6654(a) additions to tax, for a section 6662(a) penalty, and for a section 72(t) additional tax.





FINDINGS OF FACT



Beginning in 2001, petitioner worked for United States Liability Insurance Co. (USLIC) as an insurance underwriter. In 2002 and 2003, USLIC paid petitioner $68,115 and $77,546, respectively, and issued Forms W-2, Wage and Tax Statement, reflecting those amounts. In 2002, petitioner also received from National Financial Services, L.L.C. retirement distributions totaling $5,500.



Petitioner did not file an income tax return relating to 2001. In 2003, respondent prepared a substitute for return (SFR) relating to petitioner's 2001 taxable year. On September 14, 2004, petitioner submitted Forms 1040, U.S. Individual Income Tax Return, relating to 2002 and 2003. On the 2002 Form 1040, petitioner reported zero income and zero tax liability, and requested an $8,610 refund. Respondent did not accept the 2002 Form 1040 as a valid return, and prepared an SFR which set forth a tax liability of $15,758. On the 2003 Form 1040, petitioner reported zero income and zero tax liability and requested a refund of $10,010. Respondent processed the 2003 Form 1040.



On August 23, 2006, respondent issued petitioner notices of deficiency relating to 2002 and 2003 determining income tax deficiencies of $15,758 and $14,613, respectively. Respondent also determined that petitioner was liable for a section 6651(a)(1) addition to tax for failure to timely file tax returns relating to 2002 and 2003, a section 6651(a)(2) addition to tax for failure to pay relating to 2002 and 2003, a section 6654(a) addition to tax for failure to pay estimated tax relating to 2002, a section 6662(a) accuracy-related penalty for underpayment of tax relating to 2003, and a section 72(t) additional tax for retirement plan distributions relating to 2002.



On November 24, 2006, petitioner, while residing in Pennsylvania, filed his petition.





OPINION



Petitioner concedes that in 2002 and 2003, respectively, he received $68,115 and $77,546 from USLIC, and in 2002 received distributions totaling $5,500 from National Financial Services, L.L.C. Petitioner raised numerous meritless contentions and failed to present any credible evidence.2 Accordingly, petitioner is liable for the deficiencies.



A taxpayer shall be liable for additions to tax for failure to timely file a return unless such failure was due to reasonable cause and not willful neglect. Sec. 6651(a)(1). Petitioner submitted both his 2002 and 2003 Forms 1040 on September 14, 2004. Pursuant to section 7491(c), respondent bears and has met his burden of production relating to section 6651(a), and petitioner's failure to timely file returns was a result of willful neglect and not reasonable cause. Accordingly, petitioner is liable for the section 6651(a)(1) additions to tax.



The section 6651(a)(2) addition to tax for failure to pay is applicable only when an amount of tax is shown on a return. Cabirac v. Commissioner, 120 T.C. 163, 170 (2003). On the 2002 SFR, which was prepared in conformity with the requirements of section 6020(b), respondent calculated and reported a tax liability of $15,758. On his 2003 Form 1040, petitioner reported a zero tax liability. Pursuant to section 7491(c), respondent bears and has met the burden of production relating to section 6651(a)(2) relating to 2002. With respect to 2002, petitioner is liable for the section 6651(a)(2) addition to tax based on the amount of tax shown on the 2002 SFR. With respect to 2003, however, we reject respondent's determination because there is no tax liability reported on petitioner's Form 1040, which respondent accepted as a valid return.



Unless one of the section 6654(e) exceptions applies, a section 6654(a) addition to tax is imposed when estimated tax payments do not equal the percentage of total liability required to be paid. Niedringhaus v. Commissioner, 99 T.C. 202, 222 (1992). In order to satisfy his burden of production, respondent, at a minimum, must establish that petitioner was required to make an annual payment. Secs. 7491(c), 6654(d)(1)(B); Wheeler v. Commissioner, 127 T.C. 200, 211 (2006), affd. 521 F.3d 1289 (10th Cir. 2008). The required annual payment is generally equal to the lesser of 90 percent of the tax shown for the subject taxable year (or, if no return is filed, 90 percent of the tax for such year) or 100 percent of the tax shown on the taxpayer's return for the preceding year. Sec. 6654(d)(1)(B)(i) and (ii).



Pursuant to the SFRs prepared by respondent, petitioner was required to make an annual payment relating to 2002. Petitioner does not meet the requirements of any exceptions to section 6654. See sec. 6654(e). Accordingly, we sustain the addition to tax relating to 2002. Pursuant to section 6654(g), petitioner is, however, entitled to a credit for the Federal income tax withheld from his wages. See Bagby v. Commissioner, 102 T.C. 596, 613 (1994).



Respondent determined that petitioner is liable for a section 6662(a) accuracy-related penalty for the underpayment of tax relating to 2003. Petitioner earned $77,546 in 2003, yet reported zero income and zero tax liability. In short, he made no attempt to comply with the Internal Revenue Code. Accordingly, petitioner is liable for the section 6662 penalty.



In 2002, petitioner received distributions from a retirement plan. Pursuant to section 72(t), a 10-percent additional tax is imposed upon such distributions unless the distributions meet the requirements of one of the exceptions enumerated in section 72(t)(2). Sec. 72(t)(1) and (2); see also Dwyer v. Commissioner, 106 T.C. 337 (1996). The distributions do not meet any of those exceptions. Accordingly, petitioner is liable for the additional tax.



Contentions we have not addressed are irrelevant, moot, or meritless.



To reflect the foregoing,



Decision will be entered under Rule 155.


1 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.

2 Sec. 7491(a) is inapplicable because petitioner failed to introduce credible evidence within the meaning of sec. 7491(a)(1).

Section 6321 imposes a lien in favor of the United States on all property and rights to property of a person liable for tax and any additions to tax, penalties, interest, and costs that may accrue in addition thereto if there has been a demand for payment and the person has failed to pay. Iannone v. Commissioner, 122 T.C. 287, 293 (2004). This lien arises at the date of the assessment. Sec. 6322. So that the Federal tax lien will take precedence over other liens or security interest, the IRS must file a notice of Federal tax lien. Sec. 6323(a); Behling v. Commissioner, 118 T.C. 572, 575 (2002).

Tax lien withdrawal request:


Section 6323(j) provides in pertinent part:



SEC. 6323(j). Withdrawal of Notice in Certain Circumstances. --



(1) In general. --The Secretary may withdraw a notice of lien filed under this section * * * if the Secretary determines that --



(A) the filing of such notice was premature or otherwise not in accordance with administrative procedures of the Secretary,



(B) the taxpayer has entered into an agreement under section 6159 to satisfy the tax liability for which the lien was imposed by means of installment payments, unless such agreement provides otherwise,



(C) the withdrawal of such notice will facilitate the collection of the tax liability, or



(D) with the consent of the taxpayer or the National Taxpayer Advocate, the withdrawal of such notice would be in the best interests of the taxpayer (as determined by the National Taxpayer Advocate) and the United States.





Marko Filipovich v. Commissioner.

Docket No. 13302-06S . Filed May 21, 2008.

[Code Secs. 6323 and 6330]

Notice of tax lien. --

The IRS did not abuse its discretion when it sustained the filing of a lien for an individual's unpaid taxes. There was no support for the taxpayer's contention that the IRS's filing of the lien after rejecting his first offer-in-compromise (OIC) was an act of retaliation or that the IRS abused its discretion in rejecting his second OIC. The individual also did not offer any evidence to show how withdrawal of the lien would facilitate the collection of taxes or would be in the best interests of the taxpayer and the United States.



PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b), THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.









GOLDBERG, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code.



Petitioner filed a petition with this Court in response to a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330 (notice of determination) for 2002 and 2003. Pursuant to section 6330(d), petitioner seeks review of respondent's determination. The issue for decision is whether respondent abused his discretion by sustaining the filing of a Federal tax lien.





Background



Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits received into evidence are incorporated herein by reference. At the time the petition was filed, petitioner resided in Illinois.



Petitioner has a longstanding history of not paying his Federal income taxes. Specifically, petitioner failed to pay his Federal income taxes due for taxable years 1993 through 2003.



Petitioner filed his Forms 1040, U.S. Individual Income Tax Return, for 2002 and 2003 on August 11, 2003, and December 14, 2004, respectively, and the amounts reported due for those years, $4,991 and $11,337, respectively, were assessed.



A notice and demand for payment was mailed to petitioner within 60 days of each assessment as required under section 6303. In response, petitioner submitted an offer-in-compromise (OIC) on June 6, 2005. In his OIC petitioner offered $750 to settle in full his unpaid taxes for the years 1993 through 2003. On August 19, 2005, the Internal Revenue Service (IRS) rejected petitioner's OIC, and petitioner protested by letter received by the IRS on September 22, 2005. On November 10, 2005, respondent notified petitioner that his protest was untimely and that his file was being returned to the offer unit.



On August 19, 2005, Letter 3172, Notice of Federal Tax Lien Intent to Levy and Your Right to a Hearing under Section 6320 (notice of Federal tax lien), was mailed to petitioner with respect to the years at issue. The notice of Federal tax lien indicated that a Federal tax lien could be filed at any time. A notice of Federal tax lien was filed against petitioner on August 30, 2005, at the office of the Recorder of Deeds for DuPage County, Illinois.



On September 9, 2005, petitioner submitted Form 12153, Request for a Collection Due Process Hearing, in which he claimed that the notice of Federal tax lien was filed as an act of retaliation by the same Appeals officer who, he claimed, denied his OIC. Petitioner also claimed that sustaining the notice of Federal tax lien would "not be in the best interest of the government" and that it would impair his ability to find a job.



On October 7, 2005, petitioner filed a bankruptcy petition under chapter 7 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Illinois. On January 30, 2006, the bankruptcy court granted a discharge of petitioner's Federal tax liabilities for taxable years 1993 through 2001.



On March 7, 2006, the collection due process hearing was held between petitioner and Appeals Officer Karin Banks (Ms. Banks), who had earlier mailed to petitioner a letter that listed the statutory requirements to obtain a withdrawal of a notice of Federal tax lien pursuant to section 6323(j). During the hearing petitioner presented an account of his financial situation and reiterated his interest in making an OIC. On the basis of her review of the financial information provided by petitioner, Ms. Banks did not extend an offer to settle the tax liabilities owed.



Petitioner did not offer any arguments as to why the notice of Federal tax lien should be withdrawn pursuant to section 6323(j). Petitioner only reiterated his position that the Appeals officer who denied his $750 OIC filed the notice of Federal tax lien in retaliation.



On June 6, 2006, the Appeals Office in Chicago issued petitioner a notice of determination sustaining the filing of the notice of Federal tax lien and finding that none of the statutory requirements for withdrawal pursuant to section 6323(j) had been met. In response to the notice of determination, petitioner timely filed his petition with this Court on July 11, 2006.





Discussion



As this case does not concern petitioner's underlying Federal income tax liabilities, the Court's review falls under the abuse of discretion inquiry of section 6330. See Sego v. Commissioner, 114 T.C. 604, 610 (2000); Goza v. Commissioner, 114 T.C. 176, 182 (2000). This standard requires the Court to decide whether respondent's rejection of petitioner's request to have the Federal tax lien withdrawn was arbitrary, capricious, or without sound basis in fact or law. See Woodral v. Commissioner, 112 T.C. 19, 23 (1999); Keller v. Commissioner, T.C. Memo. 2006-166; Fowler v. Commissioner, T.C. Memo. 2004-163.


Section 6321 imposes a lien in favor of the United States on all property and rights to property of a person liable for tax and any additions to tax, penalties, interest, and costs that may accrue in addition thereto if there has been a demand for payment and the person has failed to pay. Iannone v. Commissioner, 122 T.C. 287, 293 (2004). This lien arises at the date of the assessment. Sec. 6322. So that the Federal tax lien will take precedence over other liens or security interest, the IRS must file a notice of Federal tax lien. Sec. 6323(a); Behling v. Commissioner, 118 T.C. 572, 575 (2002).




Petitioner contends, for the following reasons, that Ms. Banks abused her discretion by failing to withdraw the notice of Federal tax lien: (1) Under section 6323(j)(1)(C) --because the withdrawal of the notice would help facilitate the collection of tax; and (2) under section 6323(j)(1)(D) --because it serves no purpose other than to retaliate against petitioner and prevent him from securing a job. For the reasons discussed infra, we disagree with petitioner.

Section 6323(j) provides in pertinent part:



SEC. 6323(j). Withdrawal of Notice in Certain Circumstances. --



(1) In general. --The Secretary may withdraw a notice of lien filed under this section * * * if the Secretary determines that --



(A) the filing of such notice was premature or otherwise not in accordance with administrative procedures of the Secretary,



(B) the taxpayer has entered into an agreement under section 6159 to satisfy the tax liability for which the lien was imposed by means of installment payments, unless such agreement provides otherwise,



(C) the withdrawal of such notice will facilitate the collection of the tax liability, or



(D) with the consent of the taxpayer or the National Taxpayer Advocate, the withdrawal of such notice would be in the best interests of the taxpayer (as determined by the National Taxpayer Advocate) and the United States.





At the outset, we note that although petitioner has not challenged the administrative procedures followed in the filing of the notice of Federal tax lien, we find that the notice of Federal tax lien was not filed prematurely. The filing of the Federal tax lien took place after assessment and notice and demand, and at each step petitioner was properly notified.



Petitioner offered not one scintilla of evidence to show how the withdrawal of the notice of Federal tax lien would facilitate the collection of the liabilities owed. In fact, looking at the long history of petitioner's failure to pay Federal income taxes, coupled with his filing a petition for bankruptcy under chapter 7, it is obvious to the Court that the IRS would have no easier time collecting the liabilities without the filing of a notice of Federal tax lien than with it being filed. It is our opinion that the Appeals officer correctly determined that a withdrawal of the notice of Federal tax lien would not be in the best interests of the Government given petitioner's history of nonpayment and his financial status. Moreover, by sustaining the notice of Federal tax lien, respondent properly protected the Government's interests in petitioner's assets.



Petitioner also contends that an abuse of discretion occurred when Ms. Banks refused to accept a second OIC at the hearing. He claims that Ms. Banks's rejection of that OIC, based on her knowledge of his failure to pay past and current taxes, constituted an abuse of discretion. We disagree. In Giamelli v. Commissioner, 129 T.C. 107, 111-112 (2007), we held that a "Reliance on a failure to pay current taxes in rejecting a collection alternative does not constitute an abuse of discretion." Moreover, during the hearing petitioner was never clear as to what amount he would be willing to pay to settle his outstanding liabilities. We view his demeanor at that hearing to be nothing more than uncooperative so as to prolong this matter and, accordingly, the time at which he would be finally required to pay the amounts owed.



As to petitioner's argument that the filing and sustaining of the notice of Federal tax lien was an act of retaliation by Ms. Banks, petitioner provided no specific evidence in support of this accusation. Moreover, we are not convinced that Ms. Banks was even the Appeals officer responsible for rejecting petitioner's original OIC. Even if she was, there is no evidence to support petitioner's contention that the notice of Federal tax lien filed against him was the result of a personal vendetta on the part of Ms. Banks. In short, we find petitioner's assertion that the notice of Federal tax lien was filed as a retaliatory act to be both inflammatory and without merit.



Petitioner did not offer any evidence pursuant to section 6323(j)(1)(D) to support his contention that the National Taxpayer Advocate determined that a withdrawal of the notice of Federal tax lien would be in the best interests of petitioner and the United States. The record contains a letter dated December 16, 2004, from the National Taxpayer Service in Chicago, Illinois. This letter does not contain any determination on the part of the National Taxpayer Advocate. To wit, the letter was sent to petitioner long before the notice of Federal tax lien was filed. The letter only relates information regarding what publications petitioner should refer to for an explanation of the collections process.



Finally, petitioner did not offer any evidence to support his contention that the withdrawal would allow him to secure a job. This assertion is purely conjecture.



On our review of the record, we conclude that respondent's Appeals officer did not abuse her discretion in sustaining the notice of Federal tax lien.



To reflect the foregoing,



Decision will be entered for respondent.

6015 – Innocent Spours – IRS abused its discretion
The IRS abused its discretion in denying a request for equitable innocent spouse relief under Code Sec. 6015(f). The requesting spouse was not employed when the tax liability arose and relied totally upon the income of her husband, an attorney who was abusing drugs. The Tax Court had jurisdiction to review the denial of innocent spouse relief under Code Sec. 6015(e)(1) and could use evidence outside of the administrative record in determining whether the IRS abused its discretion. With regard to the factors set out in Rev. Proc. 2000-15, 2000-1 CB 448, the IRS abused its discretion in failing to consider whether the couple was still married, whether there was abuse or if a finding of liability would impose economic hardship on the wife. Although the couple was not divorced at the time of the request and they were living in the same home, they were using separate bedrooms, so the marital status factor was deemed to favor the wife. Evidence of abuse and economic hardship was present, but the IRS failed to follow up on the evidence. Relief was proper because the only factor that ultimately weighed against the wife was her knowledge of the underpayment.


Chrystina Nihiser v. Commissioner.

Dkt. No. 19315-04 , TC Memo. 2008-135, May 20, 2008.



Collection: Innocent spouse relief: Equitable relief: Abuse of discretion: Tax Court jurisdiction. --




MEMORANDUM FINDINGS OF FACT AND OPINION

HOLMES, Judge: Chrystina Nihiser was a stay-at-home mom. With only a small income from her own part-time work, she relied on her husband's law practice to support their family. But his practice was only intermittently successful and, when financial troubles arrived, he stopped paying the taxes they owed.

She applied for innocent-spouse relief at a time when her life was becoming increasingly worse. Her husband, it turned out, was using drugs and stealing from his clients --eventually leading to his arrest and imprisonment. She now seeks relief from joint liability for a 1996-2001 tax debt of nearly a quarter-million dollars. Her case raises tricky questions of what evidence we can consider and how we should weigh it.


FINDINGS OF FACT

Nihiser married Kevin Connolly in 1980. Connolly was a plaintiff's lawyer with a small practice, and Nihiser was a schoolteacher until 1988, when she gave birth to their daughter. During their marriage, Connolly controlled the family finances. He kept most of his income hidden from Nihiser by using a checking account in his law practice's name, and paid most of the family's expenses from this account. When Nihiser needed money, Connolly would give her a check from his account and she would deposit it in their joint checking account. Connolly himself never deposited money directly into the joint account.

He also kept Nihiser away from their tax returns, letting her see them only when he presented them to her for her signature. This was Nihiser's one chance each year to learn about Connolly's income. But Connolly lowered the odds of her noticing anything by showing them to her only on their due date. (The one return not signed on its due date was signed on April 14.) Connolly's accountants likewise signed the returns on or just days before their due date.

In 1993, Connolly began filing returns without paying the amounts due. Nihiser would see that they owed taxes, and she did ask Connolly how he planned on paying them. But Connolly would complain that his law practice's expenses were just too great, and promised her that one of his cases would settle, or a new business venture would pay off, and provide the needed funds. Nihiser believed him, but was naturally left uneasy by his answers. When she followed up, Connolly would berate her. And he never did pay the taxes due.

In 1997, Connolly tried to solve their financial difficulties by filing for bankruptcy. It was the couple's second trip to the bankruptcy courthouse. Their first --in 1993 --had already cost them their house. The 1997 bankruptcy discharged their 1993-95 tax liabilities, but the strains on their marriage only grew worse.

The problem was drugs. Nihiser had suspected that Connolly was using from about the time she gave birth to their daughter, and claimed --credibly, but without corroborating evidence --that the family doctor finally confirmed her suspicions when he told her that Connolly's blood tested positive for cocaine. Connolly finally admitted to drug use, during counseling as their marriage careened to its end. But he refused help and became enraged when she brought it up.

In 1998 Connolly and Nihiser filed their 1997 tax return, but Connolly again failed to pay the taxes shown as due. Nihiser intensified her efforts to get Connolly to satisfy their tax liability, but Connolly kept making the same empty promises. He also told her that she should continue to sign the returns because California's being a community-property state meant there was no way she could get out of being liable for half of the taxes anyway. Nothing changed with their 1998 tax return, and their unpaid tax liability continued to grow.

In July 1999, part of the routine did change: Connolly filled out divorce papers and gave them to her. Although he never filed the papers with a court, Nihiser thought (and we specifically find her testimony credible on this point) that they were legally separated. Only they did not literally separate. For the next five years, Connolly and Nihiser lived in separate rooms of the same apartment. During this time, Connolly continued to control their finances and pay the rent. The new living arrangement did not change their tax habits. In 1999 and 2000, Connolly and Nihiser again filed joint tax returns showing taxes owed.

In July 2001, Connolly felt that filing for bankruptcy a third time was the answer and convinced Nihiser to sign the petition. Then, in October 2002, Nihiser signed their 2001 tax return. It was to be their last return filed jointly. Nihiser learned that Connolly had let their health insurance lapse, and for her this was the last straw. The next month she began looking for her own answer to their tax problems and learned about innocent-spouse relief. She filed a Form 8857, Request for Innocent Spouse Relief, and Form 12510, Questionnaire for Requesting Spouse, with the Commissioner to be relieved of liability for the unpaid taxes from 1996-2001.1 She included with the two forms a letter describing her situation. Unbeknownst to Nihiser, Connolly had about this same time attracted the attention of the California State Bar, which began disciplinary proceedings against him for stealing money from his clients.

While the bar probe got under way, the Commissioner's Centralized Cincinnati Innocent Spouse Operations (CCISO) was reviewing Nihiser's claim for relief. In a March 2003 letter, CCISO denied her relief because she did not have reason to believe that Connolly would ever pay their taxes, given the years of unpaid balances --balances that kept on growing --and the couple's return trips to bankruptcy court. The letter also explained that the verbal abuse she suffered was not enough "of a factor to overcome continuing to file joint returns with balances due without taking corrective action." The CCISO workpapers, which were introduced at trial, gave more insight into the Commissioner's reasoning. They listed the various factors considered, but not always consistently. Few of the factors listed in those workpapers were even mentioned in the form letter that Nihiser received.

Nihiser then sent a "statement of disagreement" to the IRS's Appeals Office. She explained that Connolly had assured her that he would pay the taxes and that she had taken him on his word since he denied her access to their financial records. She also explained that, though she had returned to full-time teaching in January 2003, raising a child on her salary would be a hardship if she also had to pay the now very substantial back taxes. Near the end of her statement, Nihiser informed the Commissioner that when the IRS contacted Connolly about her request he got "extremely angry" and threatened to tell them that she had spent all their money.

Connolly may well have been upset for another reason --in November 2003, the ongoing state investigation triggered his resignation from the bar. He again kept Nihiser in the dark. In any event, she pressed forward by meeting that same month with the Appeals officer who was assigned to her case. He told her that IRS policy required him to contact Connolly about her request. He also asked her to supply more complete information about the couple's income and expenses. Nihiser credibly testified at trial that she did not provide the Appeals officer with more information because she was afraid to ask Connolly about his finances.

In July 2004, the Appeals officer sent Nihiser a notice of determination denying her request for relief. The denial was based largely on his conclusion that she should have known when she signed returns the taxes were not going to be paid when she signed the returns. He found her stated belief that Connolly would pay the taxes unreasonable because of the couple's history of not paying taxes, the size of the underpayment, and their serial bankruptcies. (He also seemed to find that Nihiser failed to fulfill her duty to inquire about the amount of the couple's tax liability. This is odd, given that she always claimed that she knew the amount of the liabilities when she signed the returns and reported the exact amounts for each liability in her request for relief.)

The Appeals officer also found that paying the tax would not cause her economic hardship because she was still living with Connolly, commingling income and sharing expenses. He supported his conclusion by writing that when he asked Nihiser to provide more financial information, she decided to drop the issue. He recognized that the income on which the taxes were due was overwhelmingly Connolly's, but did not make any findings on any of the other factors the IRS routinely weighs in innocent-spouse cases. Nihiser, then as now a resident of California, responded by filing a petition with our Court. By the time of trial, state police had arrested Connolly. He was later convicted of grand theft, and remains imprisoned. We held a trial, though the Commissioner objected to the introduction of all evidence not contained in the administrative record.2


OPINION

Section 6013(a)3 lets married couples file their federal tax return jointly but, if they do, both spouses are then responsible for the return's accuracy and both are generally liable for the entire tax due. Sec. 6013(d)(3); Butler v. Commissioner, 114 T.C. 276, 282 (2000). In some cases, however, section 6015 can relieve a spouse from this joint liability. Relief comes in three varieties: Relief under section 6015(b) or (c) requires either an "understatement" or a "deficiency;" whereas relief under section 6015(f) requires only that the requesting spouse be "liable for any unpaid tax or any deficiency." Therefore, if the liability is neither an "understatement" nor a "deficiency", the only possible relief is under subsection (f). See Hopkins v. Commissioner, 121 T.C. 73, 87-88 (2003).

The Commissioner never asserted a deficiency against Nihiser, so hers is a case where relief is possible only under section 6015(f). This turns out to be important in considering three preliminary questions:

! jurisdiction;

! standard of review; and

! scope of review.



I. Jurisdiction to Hear Cases Under Section 6015(f)
Our jurisdiction in this case is affected by its being not only a nondeficiency case, but a stand-alone nondeficiency case. A "stand-alone" case is one where the requesting spouse's claim for innocent-spouse relief was made under section 6015 on her own initiative, and not as part of a deficiency action or in response to the Commissioner instituting a lien or levy to try and collect the tax debt. This distinction made Nihiser's one of a large number of cases affected first by the Ninth Circuit's opinion in Commissioner v. Ewing, 439 F.3d 1009 (9th Cir. 2006), revg. 118 T.C. 494 (2002), and vacating 122 T.C. 32 (2004), and then by this Court's opinion in Billings v. Commissioner, 127 T.C. 7 (2006). Both these cases held that the Tax Court has no jurisdiction to review the Commissioner's determinations in stand-alone nondeficiency cases. It seemed reasonably likely that Congress would treat Ewing and Billings as having identified a glitch in the Code and would respond by amending section 6015, so we did not dismiss this case after deciding Billings, but waited to see what would happen. Congress did respond by amending section 6015(e), giving us jurisdiction to review innocent-spouse determinations in either "the case of an individual against whom a deficiency has been asserted * * *, or in the case of an individual who requests equitable relief under subsection (f)." Tax Relief and Health Care Act of 2006, Pub. L. 109-432, div. C, sec. 408(a), 120 Stat. 3061. This amendment was effective for liabilities remaining unpaid on December 20, 2006. Id. sec. 408(c), 120 Stat. 3062. After it became law, the parties stipulated that Nihiser's tax liability for the years in question remained unpaid on December 20, 2006. We therefore have jurisdiction to review the Commissioner's determination.



II. Standard of Review
That Nihiser's is a stand-alone nondeficiency case is also important in deciding what standard of review to use. We review section 6015(b) and (c) stand-alone cases under a de novo standard, since in those cases we are determining the existence or amount of a tax liability. See Haltom v. Commissioner, T.C. Memo. 2005-209; McClelland v. Commissioner, T.C. Memo. 2005-121.

In contrast, our standard of review in section 6015(f)
stand-alone cases is for abuse of discretion, e.g., Cheshire v. Commissioner, 115 T.C. 183, 198 (2000), affd. 282 F.3d 326 (5th Cir. 2002), and it's Nihiser's burden to prove that the Commissioner committed one, see Alt v. Commissioner, 119 T.C. 306, 311 (2002), affd. 101 Fed. Appx. 34 (6th Cir. 2004).4
Courts generally hold that a decisionmaker abuses his discretion when it "`makes an error of law * * * or rests its determination on a clearly erroneous finding of fact * * * [or] applies the correct law to facts which are not clearly erroneous but rules in an irrational manner.'" Indus. Investors v. Commissioner, T.C. Memo. 2007-93 (quoting United States v. Sherburne, 249 F.3d 1121, 1125-26 (9th Cir. 2001)); see also Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 402-03 (1990) (same).



III. Scope of Review
Our scope of review --i.e., what evidence we look at to decide whether the Commissioner abused his discretion --is likewise affected by this being a 6015(f) case. The Commissioner argues that we should look only at the administrative record compiled when Nihiser applied for relief from the IRS, met with IRS employees, and filled out (or didn't fill out) the relevant IRS forms. For reasons discussed below, we need not further address the Commissioner's point.5

The scope of review is an even bigger problem in innocent-spouse cases when we find that the Commissioner abused his discretion. Although rarely employed by district courts in reviewing administrative agency action, a trial de novo typically consists of independent factfinding and legal analysis unmarked by deference to the original factfinder. See, e.g., Morris v. Rumsfeld, 420 F.3d 287, 292, 294 (3d Cir. 2005) (defining "trial de novo" as involving judicial review "without deferring to any prior administrative adjudication" and "entirely independent of the administrative proceedings"); Timmons v. White, 314 F.3d 1229, 1233-34 (10th Cir. 2003) (same); see also Wright & Koch, 33 Federal Practice and Procedure: Judicial Review of Administrative Action, sec. 8332, at 161-62 (2006). In section 6015(f) innocent-spouse cases, however, precedent constrains us to combine the independent factfinding of a trial de novo with an abuse-of-discretion standard of review.

Another difference between our practice and district court review of administrative-agency action for abuse of discretion is that district courts generally are able to remand a case to the agency for reconsideration if the court holds that the agency's factfinding or legal analysis went awry. Fla. Power Light Co. v. Lorion, 470 U.S. 729, 744 (1985) ("If the record before the agency does not support the agency action, if the agency has not considered all relevant factors, or if the reviewing court simply cannot evaluate the challenged agency action on the basis of the record before it, the proper course, except in rare circumstances, is to remand to the agency for additional investigation or explanation."); Virk v. INS, 295 F.3d 1055, 1060-61 (9th Cir. 2002) (remanding a denial by the INS of a motion to reopen proceedings where the INS failed to consider all relevant factors); see also Yale-New Haven Hosp. v. Leavitt, 470 F.3d 71, 87 (2d Cir. 2006) (remanding an administrative decision to the Department of Health and Human Services after finding it was adopted in an arbitrary and capricious manner); Stuttering Found. of Am. v. Springer, 498 F.Supp.2d 203, 213-14 (D.D.C. 2007) (finding the Office of Personnel Management misapplied Federal tax law when classifying a charitable organization and remanding the issue to the agency for a new factual determination under correct standards). When this happens, the agency is able to compile a new (or at least supplemental) administrative record, and judicial review on remand can be done using an abuse-of-discretion standard applied against that record.6

Remand is not an option in innocent-spouse cases under current law. In Friday v. Commissioner, 124 T.C. 220, 222 (2005), we held that "whether relief is appropriate under section 6015 is generally not a `review' of the Commissioner's determination in a hearing but is instead an action begun in this Court." Friday is a division opinion. We must follow it. See Sec. State Bank v. Commissioner, 111 T.C. 210, 213 (1998), affd. 214 F.3d 1254 (10th Cir. 2000); Hesselink v. Commissioner, 97 T.C. 94, 99-100 (1991).



IV. Equitable Relief Under Section 6015(f)
Having unpacked this preliminary baggage, we turn to the case before us. Section 6015(f) allows relief to a requesting spouse "if taking into account all the facts and circumstances, it is inequitable to hold the individual liable." The Commissioner exercises his discretion using Revenue Procedure 2000-15, 2000-1 C.B. at 447, a framework guiding the exercise of his discretion when determining whether or not to grant equitable relief. We also follow that revenue procedure in reviewing his determination and deciding what relief is appropriate.7 See, e.g., Washington v. Commissioner, 120 T.C. 137, 147-52 (2003); Jonson v. Commissioner, 118 T.C. 106, 125-26 (2002), affd. 353 F.3d 1181 (10th Cir. 2003).

Rev. Proc. 2000-15, sec. 4.01, 2000-1 C.B. at 448, has seven general requirements that all requesting spouses must meet for relief under section 6015(f). The Commissioner concedes that Nihiser meets all seven conditions.

The procedure also has a safe harbor. This safe harbor grants relief to a requesting spouse if she meets three conditions. Rev. Proc. 2000-15, sec. 4.02, 2000-1 C.B. at 448. The first requires that:

At the time relief is requested, the requesting spouse is no longer married to, or is legally separated from, the nonrequesting spouse, or has not been a member of the same household as the nonrequesting spouse at any time during the 12-month period ending on the date relief was requested;

id. sec. 4.02(1)(a). The parties agree that Nihiser was married when she requested relief, but she argues that her de facto separation qualifies as a legal separation. Nihiser offers no authority for her position, however. We don't need to consider this condition because Nihiser fails the second condition in this safe harbor test. As discussed below in section IV.D., Nihiser knew at the time she signed them, the tax shown on the joint returns would not be paid. So Nihiser does not qualify for the safe harbor.

This leaves an eight-factor balancing test to consider before deciding if relief would be "equitable." Rev. Proc. 2000-15, sec. 4.03, 2000-1 C.B. 448-49. The Commissioner may consider other factors, but this is where he starts. Ewing, 122 T.C. at 47-48; Rev. Proc. 2000-15, sec. 4.03. We can summarize the eight factors in a table (those factors not in dispute are in italics):



________________________________________________________________________
Weighs for Relief Neutral Weighs against Relief

________________________________________________________________________
Separated or divorced Still married N/A

________________________________________________________________________
Abuse present No abuse present N/A

________________________________________________________________________
Significant benefit No significant N/A
benefit

________________________________________________________________________
N/A Later compliance with Lack of later
Federal tax laws compliance with Federal
tax laws

________________________________________________________________________
No knowledge or N/A No economic hardship
reason to know

________________________________________________________________________
Tax liability N/A Liability
attributable to attributable to
non-requesting spouse petitioner

________________________________________________________________________
Non-requesting spouse No divorce decree Petitioner
responsible for paying responsible for paying
tax under divorce tax under divorce
decree decree

________________________________________________________________________

The Commissioner conceded that the attribution factor weighs in Nihiser's favor, and that the significant-benefit, noncompliance-with-tax-laws, and nonrequesting-spouse's-legal obligation-to-pay-the-tax factors are neutral. We treat the parties' agreement that Nihiser received no significant benefit from the underpayment as weighing in her favor.8 That leaves Nihiser disputing only the Commissioner's determination concerning the marital-status, knowledge, abuse, and hardship factors.

And here we meet the Commissioner's first abuse of discretion in this case --he simply failed to consider all the factors listed in Revenue Procedure 2000-15 when making his determination. See Walter Trans. Inc. v. United States, 432 F. Supp. 2d 955, 959 (W.D. Mo. 2006) (citing Sukhov v. Gonzales, 403 F.3d 568, 570 (8th Cir. 2005) (stating that an abuse of discretion may be found where the Appeals officer fails to consider all factors presented); Gall v. United States, 552 U.S. ___, 128 S. Ct. 586, 607 (2007) (Alito, J., dissenting) (citing cases analyzing several areas of law that require consideration of all factors to avoid an abuse of discretion). The Appeals officer made no findings on either the marital-status or abuse factors, and both these factors are at issue. As we also find below, the Commissioner's determination on the economic-hardship factor was erroneous in failing to consider reasonably all the facts in the administrative record. We therefore find that the Commissioner has abused his discretion, and examine the disputed factors with an eye to determining the appropriate relief available to Nihiser under section 6015.

This course of action follows from our holding in Friday. If we find an abuse of discretion, it is up to us --in the words of section 6015(e) --"to determine the appropriate relief available to the individual under this section" rather than remand the case to the IRS for a reopening of the administrative record and a consideration for the first time of evidence we received during the trial. And so we next ask not just whether the Commissioner abused his discretion in denying Nihiser relief, but, if he did, what is "the appropriate relief available?"

A. Marital Status

The IRS's finding on the marital status factor is confusing. The CCISO's workpapers show that the initial IRS reviewer regarded Nihiser's situation as weighing in favor of relief, though leaving it unmentioned in the March 2003 letter to her. The subsequent notice of determination doesn't mention the factor at all, except summarily as one of "several factors * * * considered," so we have no idea how it was weighed in the end.

The revenue procedure itself is not a model of clarity on how the IRS should go about analyzing this factor. In the section discussing qualification for the safe harbor, marital status is important, and we're told when to look and what to look for. See supra p. 16.

But we have to look at the description of this factor in a different part of the Procedure, section 4.03(1)(a)'s description of when the marital-status factor weighs in favor of granting relief when applying the eight-factor balancing test. This description is different --it says that marital status weighs in favor of relief when the "requesting spouse is separated (whether legally separated or living apart) or divorced from the nonrequesting spouse." Rev. Proc. 2000-15, sec. 4.03(1)(a), (emphasis added). We infer from the absence of any reference to separate "households" in this description of the marital-status factor (in contrast to the safe harbor condition discussed supra) that spouses can be "living apart" even in the same household.

This is actually a good description of how Nihiser and Connolly were living when she requested relief in late 2002. Nihiser's intent, buttressed by her actions, shows that her relationship with Connolly was drastically changed on July 9, 1999, when he flourished divorce papers at her. From then on, they no longer shared a bedroom, and she reasonably thought that her husband had filed for legal separation --even reporting that day as the start of their legal separation on her forms requesting innocent-spouse relief. She explained on these forms that they remained under the same roof only because of their financial situation. We believe her, and find that she was "living apart" from her husband both when she requested relief and when the Commissioner made his determination. We thus agree with the apparent conclusion reached by the CCISO in its initial consideration of her request that this factor weighs in favor of relief. The Appeals officer making the Commissioner's final determination abused his discretion by not discussing and weighing this factor.

We are not certain that this is where our analysis of this factor should end. As is often the case in the sort of troubled marriages that spawn requests for innocent-spouse relief, alienation became separation and finally divorce. By the time of trial, Nihiser had without any doubt been living in a separate household --remember that by then her husband was an inmate --and filed for divorce as well. So, if we are to follow Friday's command that we judge the merits of a request for innocent-spouse relief without remanding for additional factfinding, we would find on the basis of the trial record as well as the administrative record that this factor weighs in Nihiser's favor.9

B. Abuse

The next contested factor is spousal abuse. The revenue procedure doesn't actually define "abuse,"10 but does say that proof that the "requesting spouse was abused by the nonrequesting spouse, but such abuse did not amount to duress," weighs in favor of relief. Rev. Proc. 2000-15, sec. 4.03(1)(c), 2000-1 C.B. at 449. And this obviously lets us infer that "abuse" is at least sometimes somehow lesser than "duress."

Duress is a concept we've had a lot to say about. Courts have long considered duress to be a reason to relieve a taxpayer from joint liability where her spouse coerces her to sign a tax return. See Furnish v. Commissioner, 262 F.2d 727, 733 (9th Cir. 1958); affg. in part and remanding in part Funk v. Commissioner, 29 T.C. 279 (1957); Stanley v. Commissioner, 81 T.C. 634 (1983); Brown v. Commissioner, 51 T.C. 116, 119-120 (1968); Stanley v. Commissioner, 45 T.C. 555, 565 (1966). Duress is a subjective analysis, where the "focus is on the mind of the individual at the relevant time in question, rather than on the means by which the given state of mind was induced." In re Hinkley, 256 B.R. 814, 825 (Bankr. M.D. Fla. 2000); see also Stanley, 45 T.C. at 561. An extreme case is "Sign the return or I pull the trigger." But in tax law duress means any constraint of will so strong that it makes a person reasonably unable to resist demands to sign a return. When that happens, innocent-spouse relief is unavailable even if she applies for it, because duress means the return isn't treated as joint. See Raymond v. Commissioner, 119 T.C. 191, 195-96 (2002); Brown, 51 T.C. at 120-21.

And there are also a good number of cases analyzing abuse-not-amounting-to-duress in considering whether one spouse knew or should have known about the other's wrongdoing. E.g., Kistner v. Commissioner, 18 F.3d 1521, 1526 (11th Cir. 1994), revg. T.C. Memo. 1991-463; Estate of Brown v. Commissioner, T.C. Memo. 1988-297. A classic instance is when abuse helps explain a spouse's failure to inquire about noncompliance with tax law. E.g., Aude v. Commissioner, T.C. Memo. 1997-478 (finding that threats and intimidation explained why a requesting spouse didn't review or inquire about the joint returns); Makalintal v. Commissioner, T.C. Memo. 1996-9 (determining that, "in light of the frequent physical abuse" by the nonrequesting spouse and his "general refusal to discuss his business and financial affairs with petitioner, * * * petitioner's inquiry was reasonable and sufficient to satisfy her duty of inquiry").11

But it's abuse as a factor by itself, not just as a relevant bit of evidence about one spouse's state of knowledge, that we're looking for in this case. This is an important point because it liberates us from focusing on the moment the return is signed --the relevant abuse precedes that moment, but there's no suggestion in the Procedure or any other source of relevant law that limits our consideration of whether a spouse was abused only to abuse that causes a particular instance of noncompliance with the tax law.

This leads to the heart of our inquiry: What is abuse for purposes of innocent-spouse relief? Verifiable physical harm is likely sufficient. See, e.g., McKnight v. Commissioner, T.C. Memo. 2006-155 (finding abuse where alcoholic nonrequesting spouse physically shoved, hit, cut, and beat the requesting spouse on multiple occasions, one of which left her on crutches). But can psychological mistreatment in the absence of physical harm be "abuse"? We think the answer to that question is "yes". Being a xanthippe is not by itself enough, but we have recognized that a nonrequesting spouse can engage in mental, emotional, and verbal abuse sufficiently severe to incapacitate a requesting spouse in the same manner as a physically abusive spouse. Compare Grubich v. Commissioner, T.C. Memo. 1993-194 (abuse found in extreme belittling and constant disparaging of the requesting spouse's contribution to the family business).

We are aware of the danger that requesting spouses, in trying to escape financial liability, may easily exaggerate the level of nonphysical abuse. Innocent-spouse cases often spring from the dissolution of troubled marriages, and there is an obvious incentive to vilify the nonrequesting spouse. Our cases therefore require substantiation, or at least specificity, in allegations of abuse. See, e.g., Fox v. Commissioner, T.C. Memo. 2006-22 (weighing abuse as a positive factor where a police report corroborated the requesting spouse's claim of assault); Knorr v. Commissioner, T.C. Memo. 2004-212 (finding no abuse where requesting spouse provided only generalized claims of physical and emotional abuse); Collier v. Commissioner, T.C. Memo. 2002-144 (finding no abuse in absence of specific details).

We have also hesitated to find abuse when marital conflict is understandably distressing but doesn't significantly alter a requesting spouse's behavior. See, e.g., Krasner v. Commissioner, T.C. Memo. 2006-31 (spouse didn't hesitate to leave her children with nonrequesting spouse, and police reports reflected little evidence of unwanted physical contact or mental abuse); Ogonoski v. Commissioner, T.C. Memo. 2004-52 (lack of abuse in the anxiety caused by uncertainty as to whether nonrequesting spouse would pay taxes); Ewell v. Commissioner, T.C. Memo. 1988-265 (no abuse where there was domineering but no physical abuse or mental intimidation).

This is not a terribly well-developed corner of tax law, and it is not one in which we can really get much help by looking at detailed regulations or the ordinary canons of construction. So we think it at least helpful to look at those factors widely recognized as psychologically abusive where law has confronted domestic violence. Scholars have identified a number of factors that are common features of domestic abuse in domestic-relations law and the subfield of criminal law arising from domestic violence. In these fields, a psychologically abusive spouse is one who may: (1) isolate the victim; (2) encourage exhaustion by, for example, intentionally limiting food or interrupting sleep; (3) behave in an obsessive or possessive manner; (4) threaten to commit suicide, to murder the requesting spouse, or to cause the death of family or friends; (5) use degrading language including humiliation, denial of victim's talents and abilities, and name calling; (6) abuse drugs or alcohol, including administering substances to the victim; (7) undermine the victim's ability to reason independently; or (8) occasionally indulge in positive behavior in order to keep hope alive that the abuse will cease.12

Although we're certainly not prepared to make these factors an exclusive list of what to look for --human perversity being unimaginably creative --they at least give us some objective indications that abuse, and not just a deviation from the ideal of marital harmony, is what we're seeing. We think these factors indicate a relationship in which there is enough abuse to make it reasonable to conclude that the spouse seeking relief was less likely to do what the Tax Code requires --making it more equitable to relieve her from joint liability. We again stress, though, that our consideration in such an underdeveloped area has to be case by case. See, e.g., Sjodin v. Commissioner, T.C. Memo. 2004-205, vacated and remanded on another issue 174 Fed. Appx. 359 (8th Cir. 2006) (finding no mental abuse where nonrequesting spouse was merely controlling and secretive).

In this case, the administrative record provides the following account of psychological abuse: On the Form 8857, Nihiser checked the box indicating that she had "been a victim of domestic abuse and [feared] that filing a claim for innocent-spouse relief [would] result in retaliation." She repeated her claim that she was the victim of abuse on her questionnaire and in her letter, writing that her husband verbally abused her. She also stated that he had a drug problem and she offered to provide copies of positive urine test results from his counselor. She also said that she filed a police report after he told her he had a gun and made a suicide threat. Neither CCISO nor the Appeals officer asked Nihiser for any such specific allegations --she supplied them sua sponte. The administrative record tells us that Nihiser feared her husband, and she stated in her paperwork that she blamed his abusive behavior on cocaine. On her request for relief, she offered to provide the Commissioner with a statement from her neighbor attesting to the abuse, but neither CCISO nor the Appeals officer followed up. She claimed that he threatened to leave her and stick her with their tax bill. CCISO agreed that Nihiser suffered verbal abuse, but conclusorily dismissed it as not "enough of a factor to overcome continuing to file joint returns with a balance due without taking corrective action." And, as with the marital-status factor, the Appeals officer who actually issued the notice of determination didn't discuss the factor at all.

The trial record reinforced the abuse allegations Nihiser made during the administrative process. She credibly testified to her husband's hot temper, describing a situation in which he used foul language while upbraiding Nihiser in front of their daughter. She said she was intimidated by his controlling behavior to the point that she was in fear of her safety and the wellbeing of their daughter. Considering the factors suggestive of psychological abuse that we listed above --the threat of suicide, the reasonable fear in someone economically dependent on her spouse of being left without support, and the always lurking explosive potential of someone abusing illegal drugs --we find that Nihiser has shown, both in the administrative record and the record assembled at trial, that the abuse factor should weigh in her favor.

C. Economic Hardship

The next contested factor is whether forcing Nihiser to pay the tax debt would cause her economic hardship. This factor weighs in a requesting spouse's favor when satisfaction of the tax liability will cause her to be unable to pay her "reasonable basic living expenses." Sec. 301.6343-1(b)(4), Proced. & Admin. Regs.13 In determining a reasonable amount for basic living expenses, the Commissioner looks at any information provided by the requesting spouse. See sec. 301.6343-1(b)(4)(ii), Proced. & Admin. Regs.

And Nihiser did at least partially fill out the relevant section of the form. When CCISO looked at it, an IRS employee tapped into IRS records and confirmed the bankruptcy filings and absence of income reported from third parties. In considering the safe-harbor factors, this seems to have been enough to cause CCISO to conclude that "the requesting spouse will suffer economic hardship." But then, on the same page of the workpaper, the employee listed lack of economic hardship as a factor weighing against relief:

she is saying yes but her statement shows no income at all, she has been separated from him since 1999 and still is paying 2,000 per month for rent or mortgage, her expenses are very high like $200 month for clothings.

How this weighed in the IRS's first round of consideration is unclear, since economic hardship isn't even mentioned in the March 2003 letter. The IRS's decision at the Appeals level is easier to understand. The Appeals officer determined that Nihiser would not suffer economic hardship because her and her husband's combined salaries were greater than their reasonable basic living expenses. This was almost certainly due to Nihiser's having left part of the "average monthly household income and expenses" section of the questionnaire blank because she didn't know of Connolly's income.14 Nihiser told him that she was scared to press Connolly on the question, and so would drop the issue.

Here we again run into the problem of what time we should be looking at to judge which way this factor weighs. When she applied for relief, Nihiser's own income was a meager couple thousand dollars a year from part-time teaching. By the time that the Appeals officer met with her in November 2003, she'd returned to full-time teaching at a salary of about $68,000 and she remained employed full time at the time of trial. However, by the time of trial her wages were being garnished to pay a substantial state-tax debt left over from her marriage.

The Appeals officer quite understandably didn't spend too much time pondering such subtleties. And a refusal to supply information is ordinarily, of course, more than enough reason for the IRS to consider an issue conceded. See McCoy Enters, Inc. v. Commissioner, 58 F.3d 557, 563 (10th Cir. 1995) (can't exercise discretion if there is no information about a factor), affg. T.C. Memo. 1992-693; Chimblo v. Commissioner, T.C. Memo. 1997-535 (same), affd. 177 F.3d 119 (2d Cir. 1999). But Nihiser credibly testified that when she met with the Appeals officer to further explain her situation, she was deterred from presenting more complete financial information by the Appeals officer's statement that he would need to contact her husband again, and that she would need to ask him about his finances. We find these statements are highly likely to have kept some of this information off the record. In a case like this, where a petitioner credibly cites fear as a reason for not seeking relevant information, we find that the Appeals officer abused his discretion by not probing further. The regulation does, after all, tell him to consider all available information when making economic hardship determinations. See sec. 301.6343-1(b)(4), Proced. & Admin. Regs.

We need not consider evidence outside the administrative record to conclude that the Appeals officer clearly erred in finding that Nihiser wouldn't suffer economic hardship. She was, when the case was before him, a schoolteacher in her mid-50s living in Orange County with no asset other than an 18-year-old car. She was also supporting a teenage daughter. The CCISO had checked the IRS's own records and found the history of bankruptcy filings and lack of any third-party payments to Nihiser and Connolly. It thus should have been screamingly obvious that she would not be able to meet her basic living expenses if she had to pay a tax liability of more than $200,000. We also do not need the evidence presented at trial to determine that Connolly's financial contributions would soon end. The two had serious marital problems, he had a substance-abuse problem, and they had declared bankruptcy three times.

There is yet another possibly difficult question hidden here: When do we take the snapshot of a spouse's finances to decide if paying the overdue taxes would wreak a financial hardship? The Appeals officer was understandably looking at her situation at the time of his conference with her. But under Ewing and Friday, we do not have to confine ourselves to the administrative record. We think this means that, in gauging how to weigh the economic-hardship factor, we should (at least once we've found there to have been an abuse of discretion, and so have to determine what relief should be available under section 6015) look at the evidence presented at trial, and the state of her finances at that time. These only support her request --by the time of trial, Connolly was in prison and thus was in no position to contribute to her support. She had resumed teaching, but her salary was about $5700 a month. On her request for relief, she reported $3415 in basic living expenses. These are reasonable expenses for a mother and daughter living in Orange County, California. At trial she also credibly testified that she has two additional reasonable monthly expenses: $480 tuition for her daughter and $500 to pay the Franchise Tax Board for her and her husband's California tax debt. After subtracting state taxes, federal income taxes, and Social Security and Medicare taxes, we find that Nihiser's current expenses use up most of her income. But we must also consider Nihiser's future ability to earn her current salary and pay her basic living expenses. She restarted her career late in life, and does not have a home or other assets to rely on after she retires. We find that if she is required to pay over $200,000 in taxes she will not be able to pay her basic living expenses. We find that the economic-hardship factor weighs in favor of relief.

D. Knowledge

The last contested factor is Nihiser's knowledge of the underpayment. This factor weighs against relief if she "knew or had reason to know * * * the reported liability would be unpaid at the time the return was signed." Rev. Proc. 2000-15, sec. 4.03(2)(b), 2001-1 C.B. at 449. We agree with the Commissioner that this factor does weigh against Nihiser. At the time she signed the returns she did have reason to know the taxes would not be paid. She and Connolly had filed for bankruptcy once when she signed the 1996 return, twice when she signed the 1997-2000 returns, and three times when she signed the 2001 return, and they had not made any other effort to pay their taxes. She also suspected that her husband's continuing drug habit was contributing to their financial problems. We find no error in the Commissioner's finding on this point, and so find that he did not abuse his discretion in concluding that this factor weighs against relief. We find likewise on the basis of the trial record. The knowledge factor therefore weighs against granting relief.


Conclusion

After analyzing these contested factors, whether looking only at the administrative record by itself or as supplemented by the trial record, we find that the table should now look like this:



________________________________________________________________________
Weighs for Relief Neutral Weighs against Relief

________________________________________________________________________
Marital Status

________________________________________________________________________
Abuse

________________________________________________________________________
No significant
benefit

________________________________________________________________________
Later compliance with
Federal tax laws

________________________________________________________________________
Knowledge

________________________________________________________________________
Economic hardship

________________________________________________________________________
Attribution

________________________________________________________________________
No divorce decree

________________________________________________________________________

Thus, Nihiser has five factors weighing in favor of relief and only one weighing against. But the factor weighing against relief is knowledge, and the revenue procedure tells us that knowledge is an "extremely strong factor weighing against relief." Rev. Proc. 2000-15, sec. 4.03(2)(b), 2000-1 C.B. 449.

The Commissioner's own procedure nevertheless anticipates at least some cases where knowledge or reason to know will not be enough to deny relief: "Nonetheless, when the factors in favor of equitable relief are unusually strong, it may be appropriate to grant relief under § 6015(f) in limited situations where a requesting spouse knew or had reason to know that the liability would not be paid." Id. A case like this one, where the only factor weighing against relief is knowledge of underpayment and all the other factors are neutral or in her favor, is logically the most likely to be one of these "limited situations" where relief is appropriate.

As in any multifactor balancing test, we must have something in mind as the appropriate fulcrum when there are factors weighing down both sides of the lever. And here we think that an appropriate fulcrum is the extent to which the economic unity of the household filing a joint return has been broken down by the actions of the nonrequesting spouse in a way that didn't allow the requesting spouse a reasonable exit. As the Third Circuit once wrote, the innocence we look for "within the meaning of this statute is innocent vis-a-vis a guilty spouse whose income is concealed from the innocent and spent outside the family." Bliss v. Commissioner, 59 F.3d 374, 380 n.3 (2d Cir. 1995) (discussing former section 6013), affg. T.C. Memo. 1993-390. The knowledge factor's unique importance is, seen in this way, entirely appropriate because in the ordinary course of events knowing her husband is mishandling their joint return would allow a wife to begin to pull away from the entanglement of joint liability. We therefore find on the peculiar facts of this case that Nihiser's knowledge of her husband's underpayment of their taxes is outweighed by the abuse she suffered and her utter lack of any benefit from the money. He kept her from seeing the broader state of the family's finances and spent the money on himself. And since she began filing on her own, she has consistently followed the tax law and paid her current taxes as they became due. Her ability to act in response to her knowledge as her marriage was dissolving was thus so reduced as to make relieving her from the joint tax liability for the years in question the appropriate relief under section 6015.

Decision will be entered for petitioner.

1 Her application included taxes for 1993 through 1995, but she evidently didn't realize that these had already been discharged in bankruptcy.

2 The Commissioner continued his objection to the admission of nonrecord evidence in his post-trial brief. The findings of fact in this background section reflect our consideration of evidence presented at trial, and are not limited to the stipulation and administrative record. In the later sections of this opinion, which analyze the individual factors considered in deciding whether to grant relief, we will make separate findings based on the administrative record and the record at trial.

3 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue.

4 At least when, as here, the IRS has considered a request and rejected it. We leave to another day the question of whether the amendment to section 6015(e) will cause a different standard of review to apply to stand-alone nondeficiency petitions filed with us after six months of IRS inaction. See sec. 6015(e)(1)(A)(i)(II).

5 In the somewhat similar context of reviewing of notices of determination that the Commissioner issues in collection due process (CDP) cases under sections 6320 and 6330, we also engage in de novo review for abuse of discretion. Robinette v. Commissioner, 123 T.C. 85 (2004), revd. 439 F.3d 455 (8th Cir. 2006). As a reviewed opinion, it remains good law for our Court unless a case is to be appealed to the Eighth Circuit. We have, however, since deciding Murphy v. Commissioner, 125 T.C. 301 (2005), affd. 469 F.3d 27 (1st Cir. 2006), declined to consider evidence that a taxpayer might have presented (but chose not to) at a CDP hearing because "an appeals officer does not abuse her discretion when she fails to take into account information that she requested and that was not provided in a reasonable time." Id. at 315. Similarly, in Giamelli v. Commissioner, 129 T.C. 107, 113 (2007), we found that "if an issue is never raised at [a hearing with the Appeals officer], it cannot be part of the Appeals officer's determination."

6 As is always the case in administrative law, general principles yield to any specific governing statute. See, e.g. Nguyen v. Shalala, 43 F.3d 1400, 1403 (10th Cir. 1994) (outlining specific statutory remedies available to a court reviewing denial of Social Security disability claims).

7 Nihiser filed Form 8857 in November 2002, and received a preliminary determination letter in March 2003. The procedure in effect when she filed her request for relief was Revenue Procedure 2000-15, 2000-1 C.B. at 447. It has been superseded by Revenue Procedure 2003-61, 2003-2 C.B. at 296, but the new revenue procedure applies only to requests for relief filed on or after November 1, 2003, or those pending on November 1, 2003, for which no preliminary determination letter has been issued as of that date. Id., sec. 7, 2003-2 C.B. at 299. We therefore apply Revenue Procedure 2000-15 to this case.

8 Rev. Proc. 2000-15, sec. 4.03, does not state that the absence of a significant benefit will weigh in a petitioner's favor, but only that receiving a significant benefit will weigh against her. Nonetheless, we decided in Ferrarese v. Commissioner, T.C. Memo. 2002-249 (and other cases cited), that the absence of a significant benefit should be a positive factor for petitioners.

9 Compare this analysis to the law governing judicial review in Social Security benefit cases cited supra note 6. In those kind of cases, a court may remand a case to the Social Security Administration when new evidence arises that is material and where there is good cause for the late submission. 42 U.S.C. sec. 405(g) (2006). There is no requirement that the new evidence existed when the agency first made its decision, though the new evidence must relate to the petitioner's condition on or before the date of that decision. See Williams v. Barnhart, 178 Fed. Appx. 785, 792 (10th Cir. 2006).

10 Black's Law Dictionary defines abuse as "physical or mental maltreatment, often resulting in mental, emotional, sexual, or physical injury." Black's Law Dictionary 10 (8th ed. 2004).

11 Rev. Proc. 2003-61, sec. 4.03(2)(b)(i), 2003-2 C.B. at 299, although not the revenue procedure that applies here, likewise states that a history of abuse by the nonrequesting spouse may mitigate a requesting spouse's knowledge or reason to know.

12 See Mary Ann Douglas (Dutton), "The Battered Woman Syndrome," in Domestic Violence on Trial: Psychological and Legal Dimensions of Family Violence 39 (Daniel Jay Sonkin ed., 1987) (citing L. Walker, The Battered Woman Syndrome (1984)).

13 In order to determine whether a requesting spouse will suffer economic hardship, the revenue procedure directs us to the test in section 301.6343-1(b)(4), Proced. & Admin. Regs. See Rev. Proc. 2000-15, secs. 4.02(1)(c), 4.03(1)(b), (2)(d), 2000-1 C.B at 448-49.

14 Nihiser listed her monthly expenses as:

Rent $2,000
Food 500
Utilities 300
Telephone 65
Auto insurance 100
Auto - gas and repairs 250
Clothing 200
Total living expenses $3,415

A preliminary injunction under section 7426 to stop an IRS levy may only issue when the moving party establishes that: (1) there is a substantial likelihood that he will ultimately prevail on the merits of the claim; (2) he will suffer irreparable injury unless the injunction issues; (3) the threatened injury to the movant outweighs whatever damage the proposed injunction may cause the opposing party; and (4) the public interest will not be harmed if the injunction should issue. Schiavo ex rel. Schindler v. Schiavo, 403 F.3d 1223, 1225-26 (11th Cir. 2005); Ferrero v. Assoc. Materials Inc., 923 F.2d 1441, 1448 (11th Cir. 1991). The judgment of this court was wrong. There was no discussion of the alter ego issue, and there was a levy on accounts receivable (i.e., gross income). The facts showed irreparable hardship.

Viking Security Services, Inc., Plaintiff v. United States of America, Defendant.

U.S. District Court, Mid. Dist. Fla., Orlando Div.; 6:08-cv-720-Orl-19KRS , May 2, 2008.

-
A company's request for a temporary restraining order to enjoin an IRS levy while the court determined whether the company was an alter-ego of another entity was denied because the levy did not constitute irreparable harm. Relief was available only if the IRS levy would have irreparably injured the company's rights in the levied property. Here, even if the levy would prevent the company from timely paying its employees and conducting its daily business operations, monetary harm is not irreparable damage; thus, relief was not available.




ORDER


FAWSETT, CHIEF JUDGE UNITED STATES DISTRICT COURT: This case comes before the Court on the Verified Emergency Motion of Plaintiff Viking Security Services, Inc. for Temporary Injunction. (Doc. No. 1, filed May 2, 2008.)


Background


Plaintiff Viking Security Services, Inc. ("Viking Security") has moved the Court under 28 U.S.C. §7426(b)(1) to enjoin the Internal Revenue Service ("IRS") from levying on the company's bank accounts, accounts receivable, and assets. ( Id. at 1.) Viking Security alleges that the IRS levied on its property on April 18, 2008 upon the erroneous belief that Viking Security is an alter ego of Viking Protective Group, Inc. ("Viking Protective"), a company which Viking Security purchased in August of 2007. ( Id. at 2.) Viking Security claims that the IRS attached its property because Viking Protective has been delinquent in paying its own taxes. ( Id.) As result of the levy, Viking Security claims that "by the time [the appeal with the IRS on the levy is heard], Viking Security will, by virtue of the Levies having frozen it's [sic] assets and having made it impossible for it to conduct its daily operations and pay its regular bills, have suffered irreparable damage to its business and its business reputation." ( Id. at 2.) In addition, Viking Security explains that "[i]f the levies are not released, the Plaintiff will not be able to make its payroll on Friday, May 2, 2008; will not be able to pay the bills it must pay in order to keep its business operating in the normal course; and will incur irreparable damage to its relationships with its customers." ( Id. at 3.)


Standard of Review


As a general matter, federal law strongly disfavors actions enjoining the collection of taxes. See 26 U.S.C. §7421 (2006); Cool Fuel, Inc. v. Connett, 685 F.2d 309, 313 (9th Cir. 1982). Such suits are governed by the "Tax Anti-Injunction Act" which provides that "no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person..." 26 U.S.C. §7421(a). However, the Act contains several statutory exceptions to its prohibition, including section 7426 upon which Viking Security bases its claim. (Doc. No. 1 at 1 (citing 26 U.S.C. §7426(b)).) Under section 7426, a party other than the delinquent tax payer may seek injunctive relief to remedy a wrongful levy. 28 U.S.C. §7426(a)(1), (b); see also Sharp Mgmt., L.L.C. v. United States, No. C07-402JLR, 2007 WL 1367698, at *2 (W.D. Wash. May 8, 2007) (citing Shannon v. United States, 521 F.2d 56, 60 n. 10 (9th Cir. 1975)). The injunctive relief provision provides:
Injunction.-If a levy or sale would irreparably injure rights in property which the court determines to be superior to rights of the United States in such property, the court may grant an injunction to prohibit the enforcement of such levy or to prohibit such sale.

26 U.S.C. §7426(b)(1).

In addition, a request for a temporary restraining order is always subject to the general requirements for obtaining injunctive relief. See, e.g., Sharp Mgmt., 2007 WL 1367698, at *2. In the Eleventh Circuit, a preliminary injunction may only issue when the moving party establishes that: (1) there is a substantial likelihood that he will ultimately prevail on the merits of the claim; (2) he will suffer irreparable injury unless the injunction issues; (3) the threatened injury to the movant outweighs whatever damage the proposed injunction may cause the opposing party; and (4) the public interest will not be harmed if the injunction should issue. Schiavo ex rel. Schindler v. Schiavo, 403 F.3d 1223, 1225-26 (11th Cir. 2005); Ferrero v. Assoc. Materials Inc., 923 F.2d 1441, 1448 (11th Cir. 1991).

The requirement of irreparable harm or injury is the "sine qua non of injunctive relief." Siegel v. LePore, 234 F.3d 1163, 1176 (11th Cir. 2000). "An injury is irreparable only if it cannot be undone through monetary remedies." Cunningham v. Adams, 808 F.2d 815, 821 (11th Cir.1987) (lost business is not an irreparable harm because it can be compensated through monetary damages). "The possibility that adequate compensatory or other corrective relief will be available at a later date, in the ordinary course of litigation, weighs heavily against a claim of irreparable harm." Sampson v. Murray, 415 U.S. 61, 90 (1974).

Finally, requests for a temporary restraining order ("TRO") are subject to an additional requirement. Under Federal Rule of Civil Procedure 65, a TRO may only be issued if:
(A) specific facts in an affidavit or a verified complaint clearly show that immediate and irreparable injury, loss, or damage will result to the movant before the adverse party can be heard in opposition; and (B) the movant's attorney certifies in writing any efforts made to give notice and the reasons why it should not be required.

Fed. R. Civ. P. 65(b)(1).


Analysis


Viking Security's request for a TRO is facially deficient because the company fails to explain whether its "attorney certifie[d] in writing any efforts made to give notice and the reasons why it should not be required." Id. Furthermore, it is not apparent from the Verified Motion why Viking Security was forced to move for a TRO, as opposed to requesting a preliminary injunction and giving the IRS notice of the proceedings. According to the Verified Motion and the attached exhibits, the IRS levied on Viking Security's property on April 18, 2008. (Doc. No. 1 at 1; Doc. No. 1-2 at 1-28.) Viking Security then waited two weeks until the day it was required to pay its employees to bring this action for injunctive relief. The company has not explained why this predicament was unexpected in light of the April 18th levies.

In addition, Viking Security's request for a TRO fails to identify an irreparable harm. Turning to the requirements of section 7426(b)(1), Viking Security does not allege that the IRS's levy will "irreparably injure rights" in the levied property. Instead, Viking Security alleges that the levy will prevent it from paying its employees and otherwise function as a business. Thus, section 7426(b)(1) does not provide relief in this case. Midwest Fin., Inc. v. United States, 991 F.2d 801, 1993 WL 106885, at *1 (8th Cir. Apr. 13, 1993) (unpublished table decision) ("Based on the unambiguous language of section 7426(b)(1)...and legislative history...we conclude that irreparable injury to `rights in property,' as used in section 7426(b)(1), refers only to the particular property levied upon."); Sharp Mgmt., 2007 WL 1367698 at *4 ("A temporary loss of funds and consequential financial difficulties does not constitute irreparable harm sufficient to justify an injunction against enforcement of tax liabilities."); Jarro v. United States, 835 F. Supp. 625, 630 (S.D. Fla. 1992). C.f. O'Hagan v. United States, 86 F.3d 776, 783 (8th Cir. 1996) (irreparable harm shown through sale of real property in which the claimant had an interest). 1

Based on the facts presented in the Verified Motion, Viking Security has also failed to meet the Eleventh Circuit's general requirements for the issuance of injunctive relief. Viking Security has not shown "irreparable harm" because "[a]n injury is irreparable only if it cannot be undone through monetary remedies." Cunningham, 808 F.2d at 821. Much like the plaintiff in Cunningham, Viking Security attempts to demonstrate irreparable harm by claiming financial ruin and harm to its business. (Doc. No. 1 at 2-3.) The Eleventh Circuit has been unequivocal that monetary harm, no matter how ruinous, cannot constitute an irreparable harm because the harm may be remedied through adequate compensation at a later date. Id. ("The key word in this consideration is irreparable. Mere injuries, however substantial, in terms of money, time and energy necessarily expended in the absence of a stay are not enough.").

Accordingly, Viking Security has not demonstrated that it is entitled to a temporary restraining order.


Conclusion


Based on the foregoing the Verified Emergency Motion of Plaintiff Viking Security Services, Inc. for Temporary Injunction (Doc. No. 1) is DENIED .

DONE and ORDERED in Chambers in Orlando, Florida on May 2, 2008.

1 Viking Security's failure to demonstrate an irreparable harm under section 7426(b)(1) may deprive this Court of subject matter jurisdiction to hear its claim. Jarro, 835 F. Supp. at 630. However, due to the preliminary nature of the proceedings, the Court will refrain from deciding whether to dismiss this action until the record is further developed. See id. (noting the lack of subject matter jurisdiction to hear the plaintiff's claim but nevertheless refraining from sua sponte dismissal and placing the case on an expedited schedule). However, Viking Security should be on notice of this apparent jurisdictional defect.

Burdon of Proof

In general, the Government is awarded an initial presumption of correctness for its assessment, placing the burden of disproving such assessments on the taxpayer. United States v. Besase, 623 F.2d 463, 465 (6th Cir. 1980). The Government, however, can never rest its case on an assessment that lacks a minimal evidentiary foundation. Where a taxpayer must make a "negative assertion," i.e., a showing that the taxpayer did not in fact earn income that the IRS claims he earned, "[r]easonable denials of the assessment's validity have sufficed in such cases to shift the burden back to the government." Besase, 623 F.2d at 465.
The government was not entitled to a presumption of accuracy pertaining to tax assessments that it sought to reduce to judgment against an individual. The burden of proving the accuracy of the assessments shifted to the government because it lost the records upon which its assessments were based and the individual's testimony regarding the probable inaccuracy of the government's calculations was reasonable. Further, the individual was not judicially estopped from denying the accuracy of tax assessments against him. He had never asserted that the government's assessed amount was accurate, and his admission of guilt in criminal proceedings did not preclude him from disputing the amount of the assessment. Furthermore, the government did not show that the accuracy of the IRS assessment had been addressed or accepted by the sentencing court.




United States of America, Plaintiff-Appellant v. David L. Hammon, Sr., Respondent-Appellee.

U.S. Court of Appeals, 6th Circuit; 06-4607, May 6, 2008.





I. Background


From September 1984 to November 1988, Hammon was engaged in an illegal gambling business. The FBI seized written records of Hammon's business on November 20, 1988. 1 In 1990, Hammon pled guilty to the information the Government filed charging him with engaging in an illegal gambling business from 1984 to 1988. In 1995, the IRS made assessments against Hammon for unpaid wagering excise taxes, penalties, and interest for the periods ending January 31, 1986, through November 30, 1988. The assessments totaled $2,398,519.20, and were based on records seized by the FBI and I.R.C. §4401, which imposes a two percent excise tax on the gross amount of illegal wagers accepted by a person "who is engaged in the business of accepting wagers." Since then, the Government lost the seized records and therefore was unable to present them to substantiate the accuracy of its assessments.

Hammon entered another plea agreement in 2005, pleading guilty to: (1) possession of cocaine with the intent to distribute; (2) conducting an illegal gambling business during 2003 and 2004; (3) tax evasion with respect to the Government's 1995 wagering excise tax assessment; and (4) money laundering. Following the guilty plea, the district court sentenced Hammon to concurrent sentences of 87 months and 60 months, and ordered Hammon to pay $2.39 million in restitution.

The Government filed a civil complaint against Hammon later that year to recover taxes owed. In the civil case, the district court denied both parties' cross-motions for summary judgment on the accuracy of the Government's tax assessments, as well as the Government's motion to reconsider. After trial, the jury found in favor of the Government in the amount of $450,869.00. The district court denied the Government's motion for judgment as a matter of law as to the amount of taxes owed. Subsequently, the Government filed a motion to modify and clarify judgment in order to specify that the jury award did not include statutory interest, which the district court then denied. The Government now appeals. At issue in the present case is whether this Court should overturn the $450,869.00 jury verdict and judgment for taxes owed in Hammon's civil case.


II. Summary Judgment


The Government claims that the district court erred as a matter of law in denying its motion for summary judgment in its civil case by: (1) shifting the burden of proof for the accuracy of the tax assessment back to the Government and (2) refusing to find that Hammon was judicially estopped from denying the correctness of the assessments.


A. Standard of Review


The denial of summary judgment is reviewable after a trial on the merits where the question is purely a question of law. Paschal v. Flagstar Bank, 295 F.3d 565, 572 (6th Cir. 2002); McPherson v. Kelsey, 125 F.3d 989, 995 (6th Cir. 1997). Where the denial of summary judgment is based on a question of law, this Court reviews the decision de novo. McMullen v. Meijer, Inc., 355 F.3d 485, 489 (6th Cir. 2004).

The allocation of the burden of proof is generally a question of law. Fuji Kogyo Co. v. Pacific Bay Int'l, 461 F.3d 675, 681 (6th Cir. 2005) (quoting First Tenn. Bank Nat. Ass'n v. Barreto, 268 F.3d 319, 326 (6th Cir. 2001)). When the question is whether a presumption has been rebutted, factual issues are reviewed for clear error. United States v. Walton, 909 F.2d 915, 919 (6th Cir. 1990). Mere general denials, however, are considered questions of law and therefore reviewed de novo. Williams v. United States, 46 F.3d 1132, 1995 WL 21431, *4 (6th Cir. Jan. 19, 1995) (unpublished) ("Where a mere general denial of correctness is offered, without supporting documentary evidence, the finding of failure to rebut is one made as a matter of law, and thus, can be reviewed de novo.").

A district court's application of judicial estoppel is reviewed de novo. Browning v. Levy, 283 F.3d 761, 775 (6th Cir. 2002). Because "`[p]lea agreements are contractual in nature' " and the interpretation of contracts are questions of law, "a district court's construction of a plea agreement presents a question of law which this [C]ourt reviews de novo." United States v. Fitch, 282 F.3d 364, 366 (6th Cir. 2002) (quoting United States v. Robison, 924 F.2d 612, 613 (6th Cir. 1991)).


B. Burden of Proof


The Government contests the district court's determination that the Government bore the burden of proving the accuracy of its tax assessment against Hammon. In general, the Government is awarded an initial presumption of correctness for its assessment, placing the burden of disproving such assessments on the taxpayer. United States v. Besase, 623 F.2d 463, 465 (6th Cir. 1980). The Government, however, "can never rest its case on an assessment that lacks a minimal evidentiary foundation." Walton, 909 F.2d at 919. Where a taxpayer must make a "negative assertion," i.e., a showing that the taxpayer did not in fact earn income that the IRS claims he earned, "[r]easonable denials of the assessment's validity have sufficed in such cases to shift the burden back to the government." Besase, 623 F.2d at 465; accord Walton, 909 F.2d at 918. This Circuit's `reasonable denial' rule was created to avoid infringing upon a taxpayer's Fifth Amendment privilege against self-incrimination. Besase, 623 F.2d at 466.

Thus, where a taxpayer is faced with the "impracticality and inequity" of proving a negative assertion, the burden placed on the taxpayer is considerably lessened. Id. at 465; accord Walton, 909 F.2d at 918-19. Vague and general denials of the accuracy of the Government's assessment, however, are insufficient to constitute a reasonable denial. Walton, 909 F.2d at 922 (a "vague denial, which was modified moments later when [the taxpayer] acknowledged that BIRA did owe him $24,000, was certainly not sufficient to meet the defendant's burden of production"); Williams, 1995 WL 21431, at *4 (the taxpayer's "general denial of the accuracy of the assessment is insufficient to rebut the presumption of correctness as a matter of law.").

Here, the Government contends that Hammon's testimony was too vague and conclusory to constitute a reasonable denial and justify shifting the burden of proof back onto the Government. Hammon argued, during the district court hearing, that he would have needed to have earned $1.6 million per month in order to merit the $2.39 million in taxes assessed by the Government, which was calculated as two percent of Hammon's monthly salary. As to the actual amount earned in January 1986, Hammon testified:
Q. In January of 1986, did you accept during the month of January, 1986, $1 million or $2 million in bets?

A. No. No, sir, I did not.

Q. How much did you accept?

A. I can't really tell you legitimately.

Q. Why can't you really tell me legitimately? I want you to be legitimate.

A. It's 20 years ago, Number 1. And how could I possibly remember what I did 20 years ago? And the numbers are outrageous.

Q. Why are the numbers outrageous? Why would you say that?

A. Because it's a million dollars, million plus in one month, that's $250,000 a week. That's a lot of money. No, I never did that kind of - in that -

...

Q. Did you ever again see the records that were seized?

A. No, sir.

...

Q. Did you ever ask in this lawsuit to see the records that were seized?

A. Yes, sir - yes.

...

Q. After that, did you ever see the records that were seized?

A. No, sir.

...

Q. Well, Mr. Hammon, let me ask you this. What kind of bets did you accept during, let's say, January of 1986?

A. It was a long time to go back and really - not enough to be confused.

Q. Well -

A. In 1986, I - I took some bets, a thousand or two a game.

...

A. I have a lot of guys that bet $50 a game.

From this testimony, the district court concluded that because Hammon "faces special problems challenging the accuracy of the assessments as the United States lost or refuses to deliver the seized records used to calculate the amount of the assessment," Hammon's testimony met the reasonable denial requirement. United States v. Hammon, No. 1:05-CV-2282, 2006 WL 2468357, at *3 (N.D. Ohio Aug. 25, 2006) (unpublished).

Whether Hammon met the standard for a reasonable denial is a question of fact, and the district court did not clearly err in finding that Hammon had succeeded in shifting the burden of proof back to the Government. Although reasonable minds could differ, Hammon's testimony was not vague or conclusory; Hammon's denial was based on his perception of the probable inaccuracy of a calculation of what the Government claimed he had been making as a bookmaker seventeen years earlier. Since the Government had lost all records upon which its assessment was based, it was impractical and inequitable to require Hammon to produce documents or other evidence to prove his negative assertion. Moreover, "[b]ecause of its unique opportunity to judge the demeanor of witnesses, we accord particular deference to the district court's findings based on assessments of credibility." Walton, 909 F.2d at 919 (relying on the district court's finding of fact that the taxpayer had failed to meet his burden regarding the accuracy of the tax assessments at issue).

The Government further contends that the district court erred in finding that Hammon's testimony constituted a reasonable denial because, according to the Government, his testimony was contradicted by (1) admissions in his 2005 plea agreement and (2) the 2005 restitution order. As stated above, such findings of fact are reviewed for clear error. "A factual finding will only be clearly erroneous when, although there may be evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed." United States v. Oliver, 397 F.3d 369, 374 (6th Cir. 2005) (quoting United States v. Navarro-Camacho, 186 F.3d 701, 705 (6th Cir. 1999)). "Where there are two permissible views of the evidence, the factfinder's choice between them cannot be clearly erroneous." Anderson v. City of Bessemer, 470 U.S. 564, 574, 105 S. Ct. 1504, 84 L. Ed. 2d 518 (1985).

The evidence highlighted by the Government is insufficient to merit reversal for clear error. First, the Government claims that the district court erred in finding that Hammon made a reasonable denial of accuracy of the Government's tax assessment because Hammon's 2005 plea agreement directly contradicted his later testimony. His 2005 plea agreement, however, only stipulated that he willfully attempted to evade and defeat the excise tax due, not that the $2.39 million figure was accurate. The applicable section of the plea agreement states:
On September 29, 1995, HAMMON was assessed by the Internal Revenue Service approximately $2.39 million in wagering excise taxes as a consequence of failing to register his gambling enterprise with the IRS, and failing to obtain the $500 occupational wagering stamp and failing to pay monthly excise taxes of two percent of gross wagers accepted by his illegal gambling business from on or about January 1, 2986 through on or about November 30, 1988.

On July 8, 1996, the IRS filed federal tax liens totaling approximately $2.39 million.

From November 1988 through September 26, 2004, HAMMON, willfully attempted to evade and defeat the payment of a large part of the excise tax due and owing by him to the United States of America for the calendar years 1986 through 1988 in the amount of approximately $2.39 million by transferring title to real estate he owned into the name of a nominee, by attempting to purchase a condominium in such a manner that his name would not be revealed on the public record, by cashing checks at a bar rather than at a bank, and by transacting business in cash rather then [sic] by using bank accounts.

As the district court concluded, this plea agreement included only an admission that Hammon willfully avoided taxes assessed against him, not that the $2.39 million was an accurate figure. United States v. Hammon, No. 1:05-CV-2282, 2006 WL 2587534, at *3-4 (N.D. Ohio Sept. 5, 2006) (unpublished). At most, the plea agreement is ambiguous as to whether Hammon admitted that the $2.39 million assessment was accurate. Given the general presumption that "[a]mbiguities in a plea agreement must be construed against the government," the district court did not err in finding that Hammon made a reasonable denial despite his 2005 plea agreement. Fitch, 282 F.3d at 367 (quoting United States v. Randolph, 230 F.3d 243, 248 (6th Cir. 2000)); accord United States v. Debreczeny, 69 F. App'x 702, 708 (6th Cir. 2003) (unpublished) ("The government is held to a higher standard because of its role as the drafter of the plea agreement and because it is seen as possessing the upper hand and expertise in the bargaining process.").

The Government also alleges that the district court clearly erred in finding that Hammon had made a "reasonable denial" because the 2005 restitution order in his criminal case mandated that Hammon "pay the total criminal monetary penalties," including $2.39 million in restitution. However, the restitution order does not clearly state that the $2.39 million penalty was for taxes owed. Moreover, even if the restitution order were for taxes owed, the sentencing court did not base the figure on anything other than the Government's unlitigated assertion that $2.39 million was the correct amount. Restitution orders in criminal proceedings for tax evasion do not preclude future suits over the accuracy of such assessments. Hickman v. C.I.R., 183 F.3d 535, 538 (6th Cir. 1999) (stating that "although the district court may have based its order of restitution upon a government witness'[s] estimate of the taxes due from [the taxpayer], the order did not purport to be an exact and comprehensive determination of what [the taxpayer] owed the IRS."). Thus, the district court did not clearly err in according less weight to the 2005 restitution order and finding that Hammon made a reasonable denial of the Government's tax assessment.

We, therefore, AFFIRM the district court's denial of summary judgment because the district court did not erroneously accord the burden of proof to the Government.


C. Judicial Estoppel


The Government argues that the district court erred in finding that Hammon was not judicially estopped from denying the accuracy of the Government's assessments. Judicial estoppel is an equitable doctrine that "is utilized in order to preserve `the integrity of the courts by preventing a party from abusing the judicial process through cynical gamesmanship.' " Browning v. Levy, 283 F.3d 761, 776 (6th Cir. 2002) (quoting Teledyne Indus., Inc. v. NLRB, 911 F.2d 1214, 1218 (6th Cir. 1990)). Although there is "no set formula for assessing when judicial estoppel should apply," courts consider whether: (1) a party's later position is clearly inconsistent with its earlier position; (2) the party has succeeded in persuading a court to accept that party's earlier position; and (3) the party advancing an inconsistent position would gain an unfair advantage if allowed to proceed with the argument. In re Commonwealth Institutional Sec., 394 F.3d 401, 406 (6th Cir. 2005).

We have noted, however, that judicial estoppel must be "applied with caution to avoid impinging on the truth-seeking function of the court because the doctrine precludes a contradictory position without examining the truth of either statement." Teledyne, 911 F.2d at 1218; see also Patriot Cinemas, Inc. v. Gen. Cinemas Corp., 834 F.2d 208, 212 (1st Cir. 1987) (noting that the specific requirements of judicial estoppel "are rather vague and vary from state to state and from circuit to circuit," and that "some circuits and jurisdictions have never recognized the doctrine") (citations and internal quotation marks omitted). To limit the doctrine's application, we have held that judicial estoppel applies only when a party attempts to take "a position inconsistent with one successfully and unequivocally asserted by that same party in an earlier proceeding." Warda v. Comm'r, 15 F.3d 533, 538 (6th Cir. 1994). Judicial estoppel is therefore generally limited to circumstances where a party asserts a position in litigation that is adopted by the court, gains an advantage through that assertion, and then attempts to assert a clearly opposite position in a later proceeding.

In Warda, this Court applied judicial estoppel because Warda first persuaded a state probate court that title to her father's land was rightfully hers, and then in a later federal case attempted to persuade the tax court that title to the same land was vested in her son. Id. at 539. We concluded that judicial estoppel was appropriate because Warda had gained an advantage by achieving success with a position that necessarily precluded the truth of her later inconsistent position. See id.

In the present case, however, Hammon did not "successfully and unequivocally" assert that the $2.39 million assessment was accurate in the criminal proceeding, nor did his admission of guilt for tax evasion necessarily preclude him from later disputing the amount of the Government's assessment. The exact dollar amount of tax owed was not an element of the offense that Hammon was charged with in the criminal proceeding, and the language of the plea agreement failed to make clear that Hammon was conceding agreement with the accuracy of the IRS's assessment.

Furthermore, because the Government drafted the plea agreement, it could have made clear that Hammon was stipulating to the numerical accuracy of the tax assessment. It nonetheless failed to do so. The language of the plea agreement states that Hammon pled guilty to avoiding taxes "assessed by the government in the amount of approximately $2.39 million." This language confirms only the fact of the Government's assessment, not its accuracy.

The Government next argues Hammon should not have been allowed to contest the accuracy of the assessment because he stipulated to a base offense level of 22. For a base offense level of 22 to apply, the offense at issue must have resulted in a tax loss of between $1 and $2.5 million. Hammon's stipulation to the offense level, however, was not necessarily inconsistent with his position that the $2.39 million tax assessment was inaccurate, and his agreement to a range of loss between $1 and $2.5 million hardly evinces an unambiguous intent to concede the accuracy of the Government's assessment. Rather, his agreement simply evinces a settlement of the criminal charges against him based upon offense level 22.

The Government also failed to demonstrate that the sentencing court accepted the accuracy of the IRS assessment --the second prong of the judicial estoppel test. Although an admission in a guilty plea might satisfy the judicial acceptance factor of the judicial estoppel test, see Lowery v. Stovall, 92 F.3d 219, 224-25 (4th Cir. 1996), the sentencing court in the present case did not address, much less accept, the accuracy of the IRS's tax assessment. We therefore cannot conclude that the sentencing court "accepted" Hammon's "earlier position."

Finally, it is not clear from the record that Hammon gained any unfair advantage by being allowed to contest the accuracy of the Government's assessment in the civil proceeding. Although the court in the criminal proceeding noted that Hammon had taken responsibility for his crime, the Government has failed to point to any evidence in the record showing that Hammon received any advantage on that basis. The court did not grant Hammon a downward departure for acceptance of responsibility, nor did it suggest that it was giving Hammon any credit because he had conceded that the dollar amount of the assessment was accurate. And there is no question that, in the civil proceeding before us, the Government was allowed to fully litigate the issue of the amount of the assessment and present any and all evidence to the jury as to both the plea agreement and the accuracy of the earlier assessment. The district court therefore did not err in finding that Hammon was not judicially estopped from denying the accuracy of the Government's assessments.


III. Jury Instructions


Additionally, the Government claims that the district court erred (1) by instructing the jury that the Government bore the burden of proving the accuracy of its assessments, and (2) by failing to instruct the jury that it was required to find that Hammon's liability to the United States was no less than $1 million.


A. Standard of Review


Disputes regarding jury instructions are questions of law that are reviewed de novo. William ex rel. Hart v. Paint Valley Local Sch. Dist., 400 F.3d 360, 365 (6th Cir. 2005). The refusal to give a requested instruction is reviewed for abuse of discretion. Id.


B. Burden of Proof


The Government's argument that the jury instructions erroneously placed the burden of proof on the Government is essentially the same as its earlier claim that the district court erred in finding the Government bore the burden of proving the accuracy of its assessments. As explained above, the district court did not err in that determination. Therefore, the district court's jury instruction on the burden of proof was not in error.


C. Liability of At Least $1 Million


As stated above, the district court's failure to give a jury instruction and special interrogatories that the jury was required to find that Hammon's tax liabilities were no less than $1 million is reviewed for abuse of discretion. "A trial court has broad discretion in drafting jury instructions and does not abuse its discretion unless the jury charge `fails to accurately reflect the law.' " United States v. Beaty, 245 F.3d 617, 621 (6th Cir. 2001) (quoting United States v. Layne, 192 F.3d 556, 574 (6th Cir. 1999)). Indeed, a judgment will only be reversed if "the instructions, viewed as a whole, were confusing, misleading, or prejudicial." Id. at 622 (quoting United States v. Harrod, 168 F.3d 887, 892 (6th Cir. 1999)).

The Government contends that the district court erred by according no preclusive effect to the 2005 plea agreement which resulted in sentencing Hammon based on an assumed tax loss of at least $1 million. In essence, the Government argues that Hammon should have been collaterally estopped from presenting evidence that he owed less than $1 million in taxes. Collateral estoppel is applicable to issues litigated in criminal cases, even if by virtue of a guilty plea. Gray v. Comm'r, 708 F.2d 243, 246 (6th Cir. 1983). "The doctrine of collateral estoppel operates when three requirements are met: (1) the issue in the current action and the prior action are identical; (2) the issue was actually litigated; and (3) the issue was necessary and essential to the judgment on the merits." Beaty, 245 F.3d at 624.

Here, collateral estoppel is inapplicable because the issue in the criminal action differed from the issue in the current suit. In Hammon's criminal case, the question was whether Hammon avoided taxes due. The accuracy of the IRS's assessments was not necessary and essential to the criminal case. 2 In contrast, the civil case centers on the accuracy of the Government's tax assessment, a question that was neither closely nor clearly evaluated during Hammon's criminal proceedings. The district court's refusal to instruct the jury that they must find Hammon's tax liability to be at least $1 million, therefore, did not inaccurately reflect the law. Moreover, it is not evident that the Government was substantially prejudiced by the refusal to give the requested instruction, as the Government was still allowed to present evidence of Hammon's plea agreement, along with any other evidentiary support for the accuracy of its assessment. The district court thus did not abuse its discretion in refusing to issue the Government's proposed jury instructions on Hammon's minimum liability.


IV. Motion for Judgment as a Matter of Law


The Government also contests the district court's denial of its motion for judgment as a matter of law.


A. Standard of Review


The denial of a motion for judgment as a matter of law ("JMOL") or a renewed motion for judgment as a matter of law is reviewed de novo. H.C. Smith Invs., L.L.C. v. Outboard Marine Co., 377 F.3d 645, 650 (6th Cir. 2004). A JMOL may be granted where "the court finds that a reasonable jury would not have a legally sufficient evidentiary basis to find for the [non-moving] party." Fed. R. Civ. P. 50(a)(1). There is no legally sufficient evidentiary basis for a particular finding if "the facts are sufficiently clear that the law requires a particular result," Weisgram v. Marley, 528 U.S. 440, 448, 120 S. Ct. 1011, 145 L. Ed. 2d 958 (2000) (quoting 9A C. Wright & A. Miller, Federal Practice & Procedure §2521, 240 (2d ed. 1995)), or "if in viewing the evidence in the light most favorable to the non-moving party, there is no genuine issue of material fact for the jury, and reasonable minds could come to but one conclusion, in favor of the moving party." Gray v. Toshiba Am. Consumer Prods., Inc., 263 F.3d 595, 598 (6th Cir. 2001).


B. Discussion


The Government contends it is entitled to judgment as a matter of law on Hammon's tax assessment because (1) Hammon failed to present sufficient evidence to constitute a "reasonable denial" of the Government's tax assessments and (2) the district court erred in not finding that Hammon was judicially estopped from denying the accuracy of the Government's tax assessments. Both of the Government's concerns as to the sufficiency of Hammon's denial and the district court's refusal to apply the doctrine of judicial estoppel were discussed above. Because Hammon presented sufficient evidence under the circumstances to constitute a reasonable denial and the district court did not err in refusing to apply judicial estoppel, the district court did not err in refusing to grant JMOL to the Government after the jury found Hammon liable for taxes in the amount of $450,369.00.


V. Statutory Interest


Finally, the Government claims that it is entitled to statutory interest on the jury award pursuant to 26 U.S.C. §6601.


A. Standard of Review


Questions of statutory interpretation are reviewed de novo. Cmtys. for Equity v. Mich. High Sch. Athletic Ass'n, 459 F.3d 676, 680 (6th Cir. 2006), cert. denied, 127 S. Ct. 1912 (2007). Likewise, the award of interest on a judgment is reviewed de novo if that determination is based on statutory interpretation or legal analysis. Bangert Bros. Constr. Co., Inc. v. Kiewit W. Co., 310 F.3d 1278, 1297 (10th Cir. 2002).


B. Discussion


Section 6601(a) of the Internal Revenue Code requires that "[i]f any amount of tax imposed [by the Internal Revenue Code] is not paid on or before the last date prescribed for payment, interest on such amount...shall be paid for the period from such last date to the date paid." That interest accrues from the date of assessment to the date of payment. United States v. Sarubin, 507 F.3d 811, 814-15 (4th Cir. 2007). Because the amount of interest is a matter of law, not of evidence, the Government does not have to assert or prove the amount of interest at trial. Id. at 815; United States v. Schroeder, 900 F.2d 1144, 1150 n.5 (7th Cir. 1990); Ghandour v. United States, 37 Fed. Cl. 121, 124 n.11 (1997).

The jury verdict form read: "We, the Jury...find the issues in this case in favor of the plaintiff, the United States of America, and against defendant, David L. Hammon, Sr., and award taxes, penalties and interest to the plaintiff in the amount of:...." The district court determined that because "the jury verdict explicitly contemplated penalties and interest in addition to [Hammon's] tax liability," there was no need to modify the jury award to include interest. However, the district court confused the issue of fact determined by the jury with the issue of law to be determined by the court. The issue of fact was the accuracy and actual amount of Hammon's assessed tax liability, which included the interest from each of the 35 months for which an assessment was made against Hammon. In contrast, the Government is statutorily entitled to a different type of interest, unassessed interest, which accrued from the September 29, 1995, assessment date until the assessments are paid. 26 U.S.C. §6601; Sarubin, 507 F.3d at 815 (interest pursuant to §6601 may be collected in addition to the amount awarded in a common law action to collect taxes owed). Thus, the district court's interpretation of the jury verdict and refusal to award interest was incorrect as a matter of law. We therefore AFFIRM the jury verdict, but we REVERSE as to the award of interest pursuant to 26 U.S.C. §6601 and REMAND for the entry of judgment to include such interest.

1 I.R.C. §4403 requires bookmakers to keep daily records showing the gross amount of all wagers for which they are liable. Hammon did not maintain such records, throwing out his records every thirty days "[b]ecause it became clutter."

2 The 2005 plea agreement stipulated that Hammon would "not request a sentence lower than the advisory Sentencing Guidelines range." The base offense level awarded was 22, which corresponds to a tax loss of more than $1,000,000. U.S.S.G. §2T4.1. Although this is evidence that Hammon may have owed the Government more than $1,000,000 in unpaid taxes, this issue was not fully litigated, and the plea agreement does not evince a clear intent on the part of Hammon to settle the question of the accuracy of the tax assessment.

Section 6015(f) claim for relief

The 6015(f) calim arises in deficiency actions, as an affirmative defense. If the taxpayer prevails on his or her claim for section 6015(f) relief, this Court will enter a decision reflecting a reduced deficiency due after application of section 6015(f). Notably, section 6015(f) claims in such cases will not necessarily arise as challenges to administrative determinations made before the commencement of the Tax Court litigation. Section 6015(f) contains no requirement of an Appeals Office hearing. Nor does it fix a specific point from which to measure the Commissioner's determination. Consequently, while the Commissioner's determination can be made in response to a Form 8857, Request for Innocent Spouse Relief, it can also be made by way of an answer to a petition in this Court which might raise entitlement to relief under section 6015(f) for the first time as an affirmative defense. See, e.g., Cheshire v. Commissioner, 115 T.C. 183 (2000) (the taxpayer's claim for equitable relief was initiated in her petition, the Commissioner conceded partial relief before trial, and this Court held that the taxpayer was entitled to additional relief under section 6015(f)), affd. 282 F.3d 326 (5th Cir. 2002); Rowe v. Commissioner, T.C. Memo. 2001-325 (the taxpayer raised section 6015 claims in an amended petition, the Commissioner granted partial relief in his amended answer and subsequently conceded section 6015 relief for other items, and this Court held that the taxpayer was entitled to additional relief under section 6015(f)).



Suzanne L. Porter, a.k.a. Suzanne L. Holman v. Commissioner.

Dkt. No. 13558-06 , 130 TC --, No. 10, May 16, 2008.



[Code Sec. 6015]

Innocent spouse relief: Equitable relief: New evidence on review: Scope of review. --

An individual seeking review of the IRS's denial of equitable relief from tax liability as an innocent spouse is entitled to present evidence that was not presented to the IRS; the court is not restricted to considering only the administrative record. The IRS's motion in limine, based on a claim that the provisions of the Administrative Procedure Act should trump the provisions of the Internal Revenue Code with regard to the scope of the Tax's Court's review, was rejected.





Suzanne L. Porter, a.k.a. Suzanne L. Holman, pro se; Kelly R. Morrison-Lee and Ann M. Welhaf, for respondent.



R denied P's application for relief from joint income tax liability under sec. 6015, I.R.C. P petitioned this Court to seek our determination whether she is entitled to relief under sec. 6015(f), I.R.C. R filed a motion in limine to preclude P from introducing at trial any evidence, documentary or testimonial, which was not available to R during the administrative process. R urges us to reconsider our holding in Ewing v. Commissioner, 122 T.C. 32 (2004), vacated on unrelated jurisdictional grounds 439 F.3d 1009 (9th Cir. 2006).



Held: We will continue to follow our holding in Ewing v. Commissioner, 122 T.C. 32 (2004). Therefore, our determination whether P is entitled to relief under sec. 6015(f), I.R.C., is made in a trial de novo and we may consider evidence introduced at trial which was not included in the administrative record.



Held, further: R's motion in limine will be denied.



HAINES, Judge: The issue for decision is whether in determining petitioner's eligibility for relief under section 6015(f) we may consider evidence introduced at trial which was not included in the administrative record.1





FINDINGS OF FACT



Some of the facts have been stipulated and are so found. The stipulation of facts, the exhibits attached thereto, and the stipulation of settled issues are incorporated herein by this reference. At the time she filed her petition, petitioner resided in Silver Spring, Maryland.



Petitioner and her husband (Mr. Porter) filed a joint Form 1040, U.S. Individual Income Tax Return, for 2003 (2003 return). Mr. Porter prepared the 2003 return. On April 21, 2004, 6 days after petitioner signed the 2003 return, she and Mr. Porter legally separated.2



On June 20, 2005, respondent issued petitioner and Mr. Porter a statutory notice of deficiency for 2003. Neither petitioner nor Mr. Porter petitioned this Court for redetermination of the deficiency.



On December 1, 2005, petitioner submitted a Form 8857, Request for Innocent Spouse Relief. In a June 14, 2006, final determination, respondent's Appeals officer determined that pursuant to section 6015(c) petitioner was entitled to relief from joint and several liability with respect to the income tax on $12,765 of unreported employee compensation Mr. Porter received in 2003, but denied relief under section 6015(b), (c), and (f) from the 10-percent additional tax of $1,070 imposed by section 72(t) on an IRA distribution of $10,700 reported on the 2003 return. The parties stipulated that petitioner does not qualify for relief from joint and several liability on the 10-percent additional tax under section 6015(b) or (c).



Respondent filed a motion in limine to preclude petitioner from introducing any evidence, documentary or testimonial, which was not available to respondent during the administrative process. The Court took the motion under advisement and permitted petitioner to testify and introduce evidence subject to its ruling on the motion in limine.





OPINION




A. Respondent's Position and Background


Respondent contends that, pursuant to the Administrative Procedure Act (APA), 5 U.S.C. secs. 551-559, 701-706 (2000), and cases decided thereunder, this Court may consider only the administrative record (the record rule) in making our determination in this case. See Camp v. Pitts, 411 U.S. 138, 142 (1973); United States v. Carlo Bianchi & Co., 373 U.S. 709, 715 (1963). We first stated our position on that issue in Ewing v. Commissioner, 122 T.C. 32 (2004). Respondent urges us to reconsider our position since the U.S. Court of Appeals for the Ninth Circuit vacated our decision in Ewing on jurisdictional grounds. See Commissioner v. Ewing, 439 F.3d 1009 (9th Cir. 2006), revg. 118 T.C. 494 (2002), vacating 122 T.C. 32 (2004). However, Congress subsequently confirmed our jurisdiction to determine the appropriate relief available to a taxpayer under section 6015(f) with respect to tax liability remaining unpaid on or after December 20, 2006. Sec. 6015(e)(1)(A); Tax Relief and Healthcare Act of 2006, Pub. L. 109-432, div. C, sec. 408, 120 Stat. 3061.



In Ewing v. Commissioner, 122 T.C. at 44, we held that our determination of whether a taxpayer is entitled to relief under section 6015(f) "is made in a trial de novo and is not limited to matter contained in respondent's administrative record". Respondent raises many of the same arguments we considered in Ewing . Consequently, our discussion of this issue draws heavily on the reasoning of the majority opinion in Ewing as well as the reasoning of Judge Thornton's concurrence. See id. at 50. For the reasons stated more fully herein, we hold that in determining whether a taxpayer is eligible for relief under section 6015(f) we may consider evidence introduced at trial which was not included in the administrative record.




B. The Applicability of the APA Judicial Review Provisions to Tax Court Proceedings Under Section 6015


Since its enactment in 1946 the APA has generally not governed proceedings in this Court (or in its predecessor, the Board of Tax Appeals). See Ewing v. Commissioner, 122 T.C. at 50 (Thornton, J., concurring). The U.S. Court of Appeals for the Fourth Circuit, the Court to which an appeal in this case would lie, has held that "The Tax Court * * * is a court in which the facts are triable de novo" and "the Tax Court is not subject to the Administrative Procedure Act." O'Dwyer v. Commissioner, 266 F.2d 575, 580 (4th Cir. 1959), affg. 28 T.C. 698 (1957). This long-established practice comports with the provisions of the APA and its history. Ewing v. Commissioner, 122 T.C. at 50 (Thornton, J., concurring).



As a statute of general application, the APA does not supersede specific statutory provisions for judicial review. Id. "When Congress enacted the APA to provide a general authorization for review of agency action in the district courts, it did not intend that general grant of jurisdiction to duplicate the previously established special statutory procedures relating to specific agencies."3 Bowen v. Massachusetts, 487 U.S. 879, 903 (1988).



The Code has long provided a specific statutory framework for reviewing deficiency determinations of the Internal Revenue Service. Secs. 6213 and 6214; Ewing v. Commissioner, 122 T.C. at 52 (Thornton, J., concurring). Section 6015 is part and parcel of the same statutory framework. Our de novo review procedures emanate from that statutory framework.



Our jurisdiction under section 6015 is couched in language similar to that of our deficiency jurisdiction under sections 6213 and 6214. Section 6015(e)(1)(A) authorizes this Court to "determine" the appropriate relief available under section 6015. Section 6213(a) provides that taxpayers who receive a notice of deficiency may petition this Court for a "redetermination" of the deficiency. Section 6214(a) provides this Court jurisdiction to "redetermine" the amount of the deficiency.



Congress first granted the Board of Tax Appeals (the predecessor to the Tax Court) jurisdiction to "redetermine" deficiencies and additions to tax in 1924. Ewing v. Commissioner, 122 T.C. at 38. Since 1926 we have also had jurisdiction to "determine" overpayments. Id. These determinations and redeterminations have always been made de novo. O'Dwyer v. Commissioner, supra at 580; Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324, 327-328 (1974); see Clapp v. Commissioner, 875 F.2d 1396, 1403 (9th Cir. 1989); Raheja v. Commissioner, 725 F.2d 64, 66 (7th Cir. 1984), affg. T.C. Memo. 1981-690; Jones v. Commissioner, 97 T.C. 7, 18 (1991). Congress has defined the jurisdiction of this Court using the words "determine" and "redetermination".4 Ewing v. Commissioner, 122 T.C. at 38. We see no material difference between "determine" in section 6015(e), "determine" in section 6512(b), and "redetermination" in section 6213(a) for purposes of this discussion. Id.



We can presume that in 1998 when Congress chose to use the word "determine" in section 6015, it did so in full awareness of our long history of de novo review.5 If Congress includes language from a prior statute in a new statute, courts can presume that Congress intended the longstanding legal interpretation of that language to be applied to the new statute. Commissioner v. Estate of Noel, 380 U.S. 678, 680-681 (1965); United States v. 101.80 Acres, 716 F.2d 714, 721 (9th Cir. 1983). The use of the word "determine" in section 6015(e)(1)(A) suggests that Congress intended that we conduct trials de novo in making our determinations under section 6015(f).




C. The Eighth Circuit Decision in Robinette v. Commissioner Does Not Govern the Decision in This Case


Respondent argues that pursuant to the Court of Appeals for the Eighth Circuit's decision in Robinette v. Commissioner, 439 F.3d 455 (8th Cir. 2006), revg. 123 T.C. 85 (2004), our review is limited to the administrative record. We disagree.



Robinette involved a claim under section 6330, not section 6015(f). We held that the APA was not applicable to our review of the Commissioner's determinations under section 6330. The Court of Appeals reversed. The Court of Appeals' opinion in Robinette, a case brought under section 6330, is distinguishable from the current case brought under section 6015.6 Whereas section 6015 provides that we "determine" whether the taxpayer is entitled to relief, section 6330(d) provides for judicial review of the Commissioner's determination by allowing the taxpayer to "appeal such determination to the Tax Court" and vesting the Tax Court with "jurisdiction with respect to such matter". As discussed above, the use of the word "determine" suggests that we conduct a trial de novo. That Congress chose not to use the word "determine" or some derivation thereof in section 6330(d) distinguishes Robinette v. Commissioner, 439 F.3d 455 (8th Cir. 2006), from cases arising under section 6015.




D. The Scope of Review in Other Areas of Our Jurisdiction


We have jurisdiction to issue declaratory judgments relating to the status, qualification, valuation, or classification of certain section 501(c)(3) organizations, retirement plans, gifts, governmental obligations, and installment payments under section 6166. Secs. 7428, 7476, 7477, 7478, 7479. In contrast to section 6015, none of those sections authorizes us to make a determination; instead, those sections authorize this Court, after the Commissioner has made a determination, to make a declaration with respect to the matter. Our Rules regarding declaratory judgments generally require these actions to be disposed of on the basis of the administrative record.7 See Rule 217(a). The reason for this limited review lies in Congress's legislative directive that "The court is to base its determination upon the reasons provided by the Internal Revenue Service in its notice to the party making the request for a determination, or based upon any new matter which the Service may wish to introduce at the time of trial." H. Rept. 93-807, at 108(1974), 1974-3 C.B. (Supp.) 236, 343; see Rule 217(a), Explanatory Note, 68 T.C. 1048.



Congress, in full awareness of our history of de novo review, did not impose a similarly restrictive standard on our review of the Commissioner's determinations under section 6015. Ewing v. Commissioner, 122 T.C. at 55 (Thornton, J., concurring). Unlike the statutes providing our jurisdiction to issue declaratory judgments, nothing in section 6015 or its legislative history indicates that the APA is to apply to section 6015 cases or that we are to restrict our review to the administrative record. Id. Section 6015 expanded the Court's jurisdiction to review all denials of relief from joint and several liability. Id. As described in the conference report, the House bill "specifically provides that the Tax Court has jurisdiction to review any denial of innocent spouse relief." H. Conf. Rept. 105-599, at 250 (1998), 1998-3 C.B. 747, 1004. Similarly, under the Senate amendment, "The Tax Court has jurisdiction of disputes arising from the separate liability election." Id. at 251, 1998-3 C.B. at 1005. The conference agreement "follows the House bill and the Senate amendment in establishing jurisdiction in the Tax Court over disputes arising in this area." Id.



That section 6015 postdates the APA does not render the APA judicial review procedures applicable here. Ewing v. Commissioner, 122 T.C. at 52 (Thornton, J., concurring). APA section 559 provides that the APA does "not limit or repeal additional requirements imposed by statute or otherwise recognized by law." 5 U.S.C. sec. 559 (2000). When the APA was enacted in 1946, this Court's de novo procedures for reviewing IRS functions were well established and "recognized by law" within the meaning of APA section 559.8 See Ewing v. Commissioner, 122 T.C. at 38. These de novo trial procedures, which have remained essentially unchanged since the APA's enactment, provide a stricter scope of review of the Commissioner's determinations than would obtain under APA review procedures. Ewing v. Commissioner, 122 T.C. at 52-53 (Thornton, J., concurring). Consequently, pursuant to APA section 559, the APA does not limit or repeal our de novo review procedures.9 Id. at 53 (Thornton, J., concurring).




E. Abuse of Discretion and De Novo Review


We have reviewed the Commissioner's denial of relief in cases arising under section 6015(f) for abuse of discretion.10 Jonson v. Commissioner, 118 T.C. 106, 125 (2002), affd. 353 F.3d 1181 (10th Cir. 2003); Van Arsdalen v. Commissioner, T.C. Memo. 2007-48. Review for abuse of discretion does not trigger application of the APA record rule or preclude us from conducting a de novo trial. Ewing v. Commissioner, 122 T.C. at 40. Our longstanding practice has been to hold trials de novo in many situations where an abuse of discretion standard applies. In those cases, our practice has not been to limit taxpayers to evidence contained in the administrative record or arguments made by the taxpayer at the administrative level.



Examples of actions in which we conduct a trial de novo include those where we must decide whether it was an abuse of discretion for the Commissioner to (1) determine that a taxpayer's method of accounting did not clearly reflect income under section 446, e.g., Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 533 (1979) (Supreme Court used Tax Court findings in making its determination); Mulholland v. United States, 25 Cl. Ct. 748 (1992); (2) reallocate income or deductions under section 482, e.g., Bausch & Lomb, Inc. v. Commissioner, 933 F.2d 1084, 1088 (2d Cir. 1991) (U.S. Court of Appeals for the Second Circuit implicitly approved our de novo consideration of section 482 reallocations), affg. 92 T.C. 525 (1989); (3) fail to waive penalties and additions to tax, e.g., Krause v. Commissioner, 99 T.C. 132, 179 (1992) (based in part on the Commissioner's expert's testimony that taxpayers were influenced by energy crisis to invest in energy partnerships, failure to waive the addition to tax for underpayment attributable to valuation overstatement under section 6659(e) was an abuse of discretion), affd. sub nom. Hildebrand v. Commissioner, 28 F.3d 1024 (10th Cir. 1994); (4) refuse to abate interest under section 6404, e.g., Goettee v. Commissioner, T.C. Memo. 2003-43, affd. 192 Fed. Appx. 212 (4th Cir. 2006); Jean v. Commissioner, T.C. Memo. 2002-256; Jacobs v. Commissioner, T.C. Memo. 2000-123; (5) refuse to grant the taxpayer's request for an extension of time to file, e.g., Estate of Proios v. Commissioner, T.C. Memo. 1994-442 (taxpayer's failure to call witnesses held against the taxpayer); and (6) disallow a bad debt reserve deduction, e.g., Newlin Mach. Corp. v. Commissioner, 28 T.C. 837, 845 (1957) (testimony and evidence considered). We are aware of no reason to depart from this longstanding practice in making our determination under section 6015(f).11




F. Neither Magana v. Commissioner nor Giamelli v. Commissioner Governs This Case


Respondent contends that under Magana v. Commissioner, 118 T.C. 488 (2002), we may not consider facts or issues that were not previously raised by the taxpayer during the Commissioner's consideration of the taxpayer's request for relief under section 6015(f). In Magana v. Commissioner, supra at 493, a case in which we reviewed the Commissioner's determination under section 6330(d)(1) that tax lien filings were appropriate, we held that, absent special circumstances, the taxpayer could not raise before this Court an issue he had not raised in a hearing conducted by the Commissioner's Appeals Officer under section 6330(b). See also Giamelli v. Commissioner, 129 T.C. 107 (2007).



Neither Magana nor Giamelli applies here. See Ewing v. Commissioner, 122 T.C. at 41. First, in Magana v. Commissioner, supra at 494 n.3, we said we were not deciding whether our holding therein applies to claims for relief from joint liability under section 6015 raised in a collection proceeding under section 6330. In Giamelli , we did not extend our holding to claims under section 6015. Second, we did not say in Magana or Giamelli that the taxpayer would be limited to the administrative record or that the taxpayer may not offer evidence in the proceeding in this Court. Third, in neither Magana nor Giamelli did we discuss the APA or the record rule. Thus, Magana and Giamelli do not govern here.




G. Our Adoption of Respondent's Position Would Lead to Inconsistent Procedures in Similar Cases


Adoption of respondent's position would lead to the anomaly of proceedings in some section 6015(f) cases on the basis of the Commissioner's administrative record and in other such cases on the basis of trials de novo. See Ewing v. Commissioner, 122 T.C. at 42. Consider two examples.



First, we have jurisdiction to make a determination if a taxpayer petitions this Court 6 months after filing an election for section 6015 relief and the Commissioner has made no determination granting or denying relief. Sec. 6015(e)(1)(A)(i)(II); Ewing v. Commissioner, 122 T.C. at 42. A trial de novo would be necessary and is clearly authorized in this situation; there may be only a skeletal administrative record. Second, in a deficiency case we hold a trial de novo relating to a taxpayer's affirmative defense that he or she is entitled to innocent spouse relief under section 6015(f). Adoption of respondent's position would cause us to apply different procedures in our determinations in cases under section 6015. See Ewing v. Commissioner, 122 T.C. at 42. We believe that cases in which the taxpayer seeks relief under section 6015(f) should receive similar treatment and, thus, the same scope of review.



The nonrequesting spouse may intervene in the proceeding in which we determine whether the requesting spouse qualifies for relief under section 6015(f). Sec. 6015(e)(4). Intervention by the nonrequesting spouse is available both in deficiency cases in which section 6015 relief is requested and in stand-alone case such as this case. Rule 325; Ewing v. Commissioner, 122 T.C. at 43; King v. Commissioner, 115 T.C. 118, 122-123 (2000); Corson v. Commissioner, 114 T.C. 354, 365 (2000). That Congress provided for intervention by nonrequesting spouses suggests Congress intended that we conduct trials de novo under section 6015(f) to permit the intervenor an opportunity to offer evidence relating to the requesting spouse's entitlement to relief. See Ewing v. Commissioner, 122 T.C. at 43.




H. Conclusion


We read section 6015(e) and (f) to give effect to both. Ewing v. Commissioner, 122 T.C. at 43. Our de novo review of the Commissioner's determinations under section 6015(f) gives effect to the congressional mandate that we determine whether a taxpayer is entitled to relief under section 6015. The measure of deference provided by the abuse of discretion standard is a proper response to the fact that section 6015(f) authorizes the Secretary to provide procedures under which, on the basis of all the facts and circumstances, the Secretary may relieve a taxpayer from joint liability. That approach (de novo review, applying an abuse of discretion standard) properly implements the statutory provisions at issue here and has a long history in numerous other areas of Tax Court jurisprudence.



To reflect the foregoing, An order will be issued denying respondent's motion in limine.



Reviewed by the Court.



COLVIN, COHEN, SWIFT, WELLS, FOLEY, VASQUEZ, GALE, THORNTON, MARVEL, GOEKE, and WHERRY, JJ., agree with this majority opinion.



VASQUEZ, J., concurring: I agree with the majority opinion and write separately to clarify the confusion that exists between the terms "scope of review" and "standard of review".



It is important to distinguish between two separate concepts: scope of review and standard of review. The scope of judicial review refers merely to the evidence the reviewing court will examine in reviewing an agency decision; the standard of judicial review refers to how the reviewing court will examine that evidence. See Franklin Sav. Association v. Dir., Office of Thrift Supervision, 934 F.2d 1127, 1136 (10th Cir. 1991).



In Robinette v. Commissioner, 439 F.3d 455, 460 (8th Cir. 2006), revg. 123 T.C. 85 (2004), the U.S. Court of Appeals for the Eighth Circuit stated: "The agreed-upon standard of review [abuse of discretion] itself implies that review is limited to the administrative record". To support this conclusion, the Court of Appeals relied on Living Care Alt. of Utica, Inc. v. United States, 411 F.3d 621 (6th Cir. 2005). See Robinette v. Commissioner, supra at 458-459. Living Care, however, dealt with the standard of review (abuse of discretion) and not the scope of review (de novo or the administrative record).



With all due respect to the Court of Appeals for the Eighth Circuit, I believe it is incorrect to conclude when the standard of review is "abuse of discretion" that a fortiori our scope of review is limited to the administrative record. See majority op. pp. 13-14 (listing numerous instances where the standard of review the Court applies is "abuse of discretion" but where the scope of our review is not limited to the administrative record --i.e., we conduct trials de novo and receive evidence in accordance with Rule 143 and section 7453).



SWIFT and WELLS, JJ., agree with this concurring opinion.



THORNTON, J., concurring: I agree with the majority opinion and write separately to offer additional historical perspective.




A. Status of the Tax Court Under the APA


When the APA was enacted in 1946, the Tax Court of the United States was an agency of the executive branch. In substance, however, it functioned as a court. Consequently, for over two decades after the APA's enactment, there was uncertainty as to whether or how the APA should apply to the Tax Court.1 Partly to resolve that question, in 1969 the United States Tax Court, as it was newly renamed, was formally incorporated into the judiciary as an Article I court. Tax Reform Act of 1969, Pub. L. 91-172, secs. 951-962, 83 Stat. 730. Since then, it has been clear that this Court is not subject to the APA rules that govern agency adjudications.



Similarly, the APA has never affected this Court's long-established practice of conducting trials de novo in deficiency actions and most other actions, including those involving claims for relief from joint and several liability. The explanation for this well-established practice lies largely in the history of the Tax Court and of the APA.




B. Historical Roots of De Novo Review in the Tax Court


The precursor of the Tax Court, the Committee on Appeals and Review (the Committee), was part of the Bureau of Internal Revenue. Dubroff, The United States Tax Court: An Historical Analysis 39 (1979). This Committee was not a fact finder; instead, it operated under its own version of a record rule. "The taxpayer was generally permitted to introduce evidence to the Committee only in affidavit or documentary form and could not adduce evidence that had not been considered by the Income Tax Unit." Id. at 42.



Pressures to replace the Committee resulted largely from two factors: (1) The Committee was not independent of the Bureau of Internal Revenue; and (2) the proceedings in the Committee were not adversary, were not public, and did not permit the introduction of new evidence. Id. at 44. To address these concerns, the Revenue Act of 1924, ch. 234, 43 Stat. 253, replaced the Committee with the Board of Tax Appeals (the Board). Originally, the Administration had proposed that the Board be created as an informal hearing body within Treasury. Dubroff, supra at 111. Under the original Administration proposal, the Board was to consider its cases "on the basis of Bureau files. Since under the proposal the Board was to be a part of Treasury, there was no impediment to access by the Board to Bureau files." Id. at 91.



In the 1924 legislation, Congress changed this plan to make the Board an independent agency in the executive branch; it was generally required to follow formal judicial procedures. Id. at 111. Moreover, the Board's record had to be independently compiled. Id. at 95. "Thus, the Board stressed that '[w]hat has been submitted to or considered by the Bureau of Internal Revenue is beyond the ken of this Board . . . . [E]vidence that has been presented before any other department of the Government must be reintroduced before this Board before we can consider it.'" Id. (quoting Lyon v. Commissioner, 1 B.T.A. 378, 379 (1925)).



The Revenue Act of 1924 left the resolution of most procedural and evidentiary issues to the discretion of the Board. Dubroff, supra at 151. In adopting judicial standards for the receipt of evidence, the Board chose to follow the liberal rules of evidence applicable in equity proceedings in the District of Columbia, where most of its cases were tried. Id. at 153-154. In 1926 this evidentiary rule was codified. Revenue Act of 1926, ch. 27, sec. 1000, 44 Stat. 105. Essentially the same provision survives today in section 7453.



In 1942 the Board of Tax Appeals was renamed the Tax Court of the United States. This name change did not significantly affect the jurisdiction, powers, or duties that previously had belonged to the Board. Dubroff, supra at 182.



In sum, when the APA was enacted in 1946, de novo trials in the deficiency actions and various other matters within the Tax Court's jurisdiction were well-established practice and fundamental to this Court's reason for existence. Similarly, it was well-established practice in Federal District Courts to conduct trials de novo in tax refund cases. See, e.g., Lewis v. Reynolds, 284 U.S. 281, 283 (1932).




C. Legislative History of the APA


In enacting the APA Congress expressly recognized that tax matters were the subject of de novo proceedings in the courts. APA section 554, which defines the procedures that generally govern agency adjudications, applies only in the case of an "adjudication required by statute to be determined on the record after opportunity for an agency hearing"; it excepts all matters that are "subject to a subsequent trial of the law and of the facts de novo in a court". The associated legislative history states: "The exception of matters subject to a subsequent trial of the law and the facts de novo in any court exempts such matters as the tax functions of the Bureau of Internal Revenue (which are triable de novo in the Tax Court)". S. Comm. on the Judiciary, 79th Cong., 1st Sess., Administrative Procedure Act (Comm. Print 1945), reprinted in Administrative Procedure Act Legislative History, 1944-1946, at 22 (1946).2



As a corollary to these APA provisions regarding agency adjudications, APA section 706 expressly contemplates that certain types of agency actions will be subject to de novo judicial review. In particular, APA section 706(2)(F) provides that the "reviewing court" shall "hold unlawful and set aside agency action, findings, and conclusions found to be * * * unwarranted by the facts to the extent that the facts are subject to trial de novo by the reviewing court." Although the statute does not otherwise specify the types of cases in which the facts are to be "subject to trial de novo", the legislative history illuminates this matter. The Senate and House reports state identically: "Thus, where adjudications such as tax assessments are not made upon an administrative hearing and record, contests may involve a trial of the facts in the Tax Court or the United States District Courts." S. Rept. 752, 79th Cong., 1st Sess. (1945), reprinted in Administrative Procedure Act Legislative History, 1944-1946, at 214 (1946); H. Rept. 1980, 79th Cong., 2d Sess. (1946), reprinted in Administrative Procedure Act Legislative History, 1944-1946, at 279 (1946).




D. De Novo Review in Deficiency Actions


Consistent with this legislative history, the courts have uniformly held that deficiency proceedings in the Tax Court are de novo and not governed by the APA. In O'Dwyer v. Commissioner, 266 F.2d 575, 580 (4th Cir. 1959), affg. 28 T.C. 698 (1957), the Court of Appeals for the Fourth Circuit stated:



The Tax Court is given jurisdiction to redetermine the deficiency asserted by the Commissioner, and in doing so it is empowered to prescribe rules of practice and procedure and is required to apply the rules of evidence applicable to nonjury trials in the United States Court of the District of Columbia and make findings of fact upon such evidence. Secs. 6213, 7453 and 7459, Internal Revenue Code of 1954 * * * . The Tax Court thus renders its decision only upon the evidence produced before it. * * *



The Tax Court, rather than being a "reviewing court", within the meaning of Sec. 10(e) [the APA provision governing scope of judicial review] reviewing the "record", is a court in which the facts are triable de novo * * *. We agree that the Tax Court is not subject to the Administrative Procedure Act.



In a more recent unpublished opinion, the Court of Appeals for the Ninth Circuit reached the same conclusion. Sharon v. Commissioner, 1991 U.S. App. LEXIS 31395, 1992 WL 8190 (9th Cir. 1992), affg. without published opinion T.C. Memo. 1990-604. The Court of Appeals cited Clapp v. Commissioner, 875 F.2d 1396, 1403 (9th Cir. 1989), which states:



The Tax Court has as its purpose the redetermination of deficiencies, through a trial on the merits, following a taxpayer petition. It exercises de novo review. * * *



*******



The courts carefully review administrative action for arbitrariness when an agency exercises final, statutory decisionmaking authority, such as an agency rulemaking. In tax cases such as this, the Tax Court or United States District Court review the Commissioner's decision on the merits de novo. Too detailed a substantive review of the Commissioner's threshold "determination", undertaken solely for purposes of exercising subject matter jurisdiction would be duplicative and burdensome on the courts and the Commissioner.



Similarly, in an unpublished opinion involving the validity of the Commissioner's issuance of a notice of deficiency, the Court of Appeals for the Seventh Circuit concluded: "The APA is irrelevant, however, because the IRS's issuance of a notice of tax deficiency and the Tax Court's review of it are governed by the Internal Revenue Code and the rules and procedures of the Tax Court * * * and not by the APA." Bratcher v. Commissioner, 116 F.3d 1482 (7th Cir. 1997), affg. without published opinion T.C. Memo. 1996-252.



Although some have criticized the rationale of these decisions, even among these critics there appears to be no dispute that the APA does not affect the Tax Court's long-established practice of conducting trials de novo in deficiency actions.3




E. De Novo Review in Actions Involving Claims for Relief From Joint and Several Liability


The original statutory provision for relief from joint and several liability, as contained in former section 6013(e), was enacted in 1971. Although this relief provision postdated enactment of the APA, actions involving claims for relief under former section 6013(e) were subject to de novo review in both the Tax Court and the Federal District Courts, in the same manner as deficiency actions and tax refund actions always had been. See, e.g., Terzian v. Commissioner, 72 T.C. 1164 (1979); Sanders v. United States, 369 F. Supp. 160 (N.D. Ala. 1973), affd. 509 F.2d 162 (5th Cir. 1975). Similarly, claims arising pursuant to the more recently enacted provisions of section 6015(b) and (c) are subject to de novo review. See, e.g., Alt v. Commissioner, 119 T.C. 306 (2002), affd. 101 Fed. Appx. 34 (6th Cir. 2004). Hence, although an action for relief under former section 6013(e) or under section 6015(b) or (c) technically may not constitute a deficiency action, there appears to be no question that such actions are appropriately subject to trial de novo.




F. Section 6015(f) Claims for Relief


1. Abuse of Discretion Standard Does Not Preclude De Novo Review.



Similarly, a claim for relief from joint and several liability that arises under section 6015(f) is appropriately subject to de novo judicial review. This is true even if the standard of review is for abuse of discretion. As the majority opinion discusses at page 13, this Court has long conducted trials de novo in numerous types of actions in which the pertinent question was whether the Commissioner had abused his or her discretion, for example, in determining that a taxpayer's method of accounting did not clearly reflect income under section 446 or in reallocating income or deductions under section 482.



Some have suggested that actions involving section 6015(f) claims for relief demand different treatment, reasoning that although de novo review of the Commissioner's exercise of discretion is appropriate with respect to deficiency actions, it is inappropriate with respect to other actions, such as actions involving claims for relief from joint and several liability. Ewing v. Commissioner, 122 T.C. 32, 66 (2004) (Halpern and Holmes, JJ., dissenting), vacated 439 F.3d 1009 (9th Cir. 2006). The premise seems to be that APA section 706(2)(F) contemplates "trials de novo" in income tax deficiency actions but seemingly in no other type of tax proceeding, including actions involving claims for relief from joint and several liability. See id. at 60. No authority has been cited, and none has been discovered, in support of this restrictive view as to the types of tax matters subject to "trials de novo" under APA section 706(2)(F). As shown by the previous discussion, this restrictive view is not supported by the text or legislative history of the APA and is contradicted by the well-established practice of the courts (both the Tax Court and the District Courts) to review de novo claims for relief from joint and several liability.



2. Section 6015(f) Claims Arising in Deficiency Actions



In any event, section 6015(f) claims for relief can, and do, arise in deficiency actions, as affirmative defenses. If the taxpayer prevails on his or her claim for section 6015(f) relief, this Court will enter a decision reflecting a reduced deficiency due after application of section 6015(f). Notably, section 6015(f) claims in such cases will not necessarily arise as challenges to administrative determinations made before the commencement of the Tax Court litigation. Section 6015(f) contains no requirement of an Appeals Office hearing. Nor does it fix a specific point from which to measure the Commissioner's determination. Consequently, while the Commissioner's determination can be made in response to a Form 8857, Request for Innocent Spouse Relief, it can also be made by way of an answer to a petition in this Court which might raise entitlement to relief under section 6015(f) for the first time as an affirmative defense. See, e.g., Cheshire v. Commissioner, 115 T.C. 183 (2000) (the taxpayer's claim for equitable relief was initiated in her petition, the Commissioner conceded partial relief before trial, and this Court held that the taxpayer was entitled to additional relief under section 6015(f)), affd. 282 F.3d 326 (5th Cir. 2002); Rowe v. Commissioner, T.C. Memo. 2001-325 (the taxpayer raised section 6015 claims in an amended petition, the Commissioner granted partial relief in his amended answer and subsequently conceded section 6015 relief for other items, and this Court held that the taxpayer was entitled to additional relief under section 6015(f)).



3. Section 6015 Claims Based on Administrative Inaction



In other cases, section 6015(f) claims might come before this Court on a stand-alone basis. The statute expressly contemplates that the petition might be filed in the Tax Court before there has been any administrative action; it provides that if the Internal Revenue Service has failed to act on the individual's request for relief within 6 months, the individual may petition the Tax Court for relief. Sec. 6015(e)(1)(A)(i)(II).



Consequently, in a variety of circumstances section 6015(f) claims for relief may be raised in the Tax Court even in the absence of prior administrative action. In such circumstances limiting judicial review to the administrative record would be meaningless.



4. Statutorily Mandated Standards and Procedures



Statutorily mandated standards and procedures contemplate that the Tax Court will generally conduct trials de novo in its proceedings, including actions involving claims for relief from joint and several liability. Section 7453 provides that, with limited exceptions not relevant here, "the proceedings of the Tax Court * * * shall be conducted in accordance with such rules of practice and procedure (other than rules of evidence) as the Tax Court may prescribe and in accordance with the rules of evidence applicable in trials without a jury in the United States District Court of the District of Columbia." As previously discussed, this is substantially the same requirement that has been in effect since the inception of the Board of Tax Appeals in 1924; the requirement was in direct response to the legislative imperative that the Board independently compile the record upon which it decided cases. Moreover, section 7459 requires the Tax Court to make findings of fact in each report upon "any proceeding" instituted before the Tax Court.



5. Jurisdictional Grant Under Section 6015(e) Contemplates Trials De Novo



Section 6015(e)(1)(A) grants the Tax Court jurisdiction to "determine the appropriate relief available to the individual" who requests equitable relief under subsection (f). Particularly in the light of this Court's inability to remand section 6015(f) cases for further administrative consideration, see Friday v. Commissioner, 124 T.C. 220 (2005), a trial de novo is appropriate and often necessary to enable the Court to determine the appropriate relief. In determining the appropriate relief, it is not necessarily sufficient to decide whether the Commissioner abused his or her discretion. For instance, the Court might conclude that the Commissioner had abused his or her discretion in the methodology or procedures employed in denying section 6015(f) relief but still decide after a de novo trial that no relief was appropriate. Or the Court might conclude that the Commissioner had abused his or her discretion and decide on the basis of evidence presented at trial that the taxpayer was entitled to either partial or full relief.



As the majority opinion notes, the jurisdictional grant in section 6015(e)(1)(A) for the Tax Court to "determine the appropriate relief available to the individual" differs significantly from its jurisdictional grant in section 6330(d)(1) "with respect to such matter" as may involve an Appeals office determination in a collection proceeding. Moreover, section 6015, unlike section 6330, contains no statutory requirement of an Appeals Office hearing, and there is no assurance of any meaningful record to review with respect to a section 6015(f) request for relief. The jurisdictional grant pursuant to section 6015(e)(1)(A) lies entirely with the Tax Court, so there is no risk of "disparate forms of judicial review depending on which court was reviewing" the claim for relief, as seemed to concern the Court of Appeals in Robinette v. Commissioner, 439 F.3d 455, 461 (8th Cir. 2006), revg. 123 T.C. 85 (2004), with respect to judicial review of collection determinations pursuant to section 6330.4



COLVIN, SWIFT, WELLS, GALE, and MARVEL, JJ., agree with this concurring opinion.



GOEKE, J., concurring: I agree with the conclusion of the majority opinion but write separately for two reasons: (1) Applying the record rule to section 6015(f) cases would be contrary to Congress's mandate that the Commissioner use the Appeals process for administrative hearings in section 6015(f) cases, and (2) an abuse of discretion standard is not the appropriate standard of review in section 6015(f) cases.




The Record Rule Is Not Appropriate in Section 6015(f) Cases


In addition to the reasons provided by the statutory analysis in the majority opinion, I believe that the Court's review of section 6015(f) decisions should not be limited to the administrative record because the informal Appeals process by which the Commissioner makes decisions under section 6015(f) is incompatible with a rule that limits the Court's review to a well-defined administrative record. Any attempt to limit the Court's review to such a record would be problematic in the vast majority of section 6015(f) cases.



The Office of Chief Counsel attempted to define the "administrative record" in section 6015(f) cases in Chief Counsel Notice CC-2004-026 (July 12, 2004):



The administrative record is that part of the petitioner's administrative file that the Service considered, or the petitioner or nonrequesting spouse submitted to the Service for consideration, with respect to petitioner's claim for relief. This includes, but is not limited to, Form 8857, Request for Innocent Spouse Relief; Form 12507, Innocent Spouse Statement; Form 12508, Questionnaire for Nonrequesting Spouse; Form 12510, Questionnaire for Requesting Spouse; all written correspondence between the petitioner and the Service; all written correspondence between the nonrequesting spouse and the Service; any documents presented to the examiner or Appeals officer; the preliminary notice of determination; the final notice of determination; any written analysis by the examiner or Appeals officer; and the Appeals Case Memorandum.



Notably, this explanation does not include a record of any hearings or other oral communications between the taxpayer and the settlement officer. In addition, what is characterized as the "administrative record" in fact ranges widely from case to case. In some cases the stipulated administrative record includes draft reports and miscellaneous documents from the Internal Revenue Service's (IRS) Cincinnati Service Center. In others, the administrative record consists of correspondence sent to the taxpayer and abbreviated notes from telephone conversations with the taxpayer.



Another practical problem with the record rule is that the administrative record, however defined, is frequently incomplete. Many taxpayers assume that the settlement officers will request more information if they do not have enough evidence to grant relief, and the taxpayers therefore do not produce all relevant evidence they have because they are not specifically asked for it. In some of these situations, consideration of additional evidence establishes that relief is appropriate even though the settlement officer initially denied relief. See, e.g., Washington v. Commissioner, 120 T.C. 137 (2003). In other cases the financial situations of the taxpayers may deteriorate after the settlement officer denies relief, making it more likely that the taxpayers are eligible for relief on the basis of their economic hardship. While the Court should not relieve taxpayers of their burden of proving that relief is appropriate and coming forward with relevant evidence, it would be inconsistent with the focus of section 6015(f) on equitable relief for the Court to turn a blind eye to any relevant information that the taxpayer can provide unless the taxpayer withholds or conceals the information at the administrative level or otherwise fails to cooperate with the settlement officer.



Although the Court has long accepted telephone hearings in both section 6015 and 6330 cases, see, e.g., Greene-Thapedi v. Commissioner, 126 T.C. 1 (2006); Katz v. Commissioner, 115 T.C. 329, 337 (2000); Magee v. Commissioner, T.C. Memo. 2005-263; Hendricks v. Commissioner, T.C. Memo. 2005-72; Pahamotang v. Commissioner, T.C. Memo. 2003-177, the trend toward expediency has made it increasingly difficult to determine the accuracy of representations made about conversations between the taxpayer and the settlement officer. The Court is often left with only the often-cryptic notes of the settlement officer as evidence of those conversations.



This is not a criticism of the Commissioner's administrative practices. The Appeals process is and has been an expedited and efficient means to resolve tax disputes. The Appeals process has never been conducted to create a reviewable administrative record and is ineffective for that purpose.



Congress enacted section 6015 as part of the Internal Revenue Service Restructuring and Reform Act (RRA) of 1998, Pub. L. 105-206, sec. 3201, 112 Stat. 734, replacing section 6013(e). In RRA Congress also mandated a reorganization of IRS, particularly the Appeals process:



[The reorganization plan shall] ensure an independent appeals function within the Internal Revenue Service, including the prohibition in the plan of ex parte communications between appeals officers and other Internal Revenue Service employees to the extent that such communications appear to compromise the independence of the appeals officers.



RRA sec. 1001(a)(4), 112 Stat. 689. Furthering this mandate, Senator Roth, Chairman of the Senate Finance Committee, explained in his statement introducing RRA for Senate debate:



One of the major concerns we heard throughout our oversight initiative was that the taxpayers who get caught in the IRS hall of mirrors have no place to turn that is truly independent and structured to represent their concerns. This legislation requires the agency to establish an independent Office of Appeals --one that may not be influenced by tax collection employees or auditors. Appeals officers will be made available in every state, and they will be better able to work with taxpayers who proceed through the appeals process.



144 Cong. Rec. 14689 (1998) (Statement of Senator Roth). As the Court discussed in Lewis v. Commissioner, 128 T.C. 48, 59-60 (2007), Congress saw the informal Appeals process as serving an important function in resolving tax disputes while giving taxpayers a meaningful opportunity to voice their concerns. But because the Appeals conferences in section 6015(f) cases have always been informal, the information that settlement officers receive from taxpayers to determine whether relief is appropriate is not always well documented. A problem arises when the Commissioner attempts to limit the Court's review to the evidence contained in the administrative record, but because of the informality of the proceedings, the administrative record does not include a complete and accurate account of the taxpayer's situation. Applying the Administrative Procedure Act (APA), 5 U.S.C. secs. 551-559, 701-706 (2000), to the administrative procedures under section 6015(f) might be effective if the Commissioner adopted formal procedures to review requests for relief under section 6015(f), but this would be contrary to the congressionally mandated use of the traditional Appeals function, which has never included transcripts of the hearings or records of the proceedings.



In Volentine & Littleton v. United States, 136 Ct. Cl. 638, 145 F. Supp. 952 (1956) (arising under the Wunderlich Act, which was the subject of United States v. Carlo Bianchi & Co., 373 U.S. 709 (1963), upon which the Court of Appeals for the Eighth Circuit in Robinette v. Commissioner, 439 F.3d 455 (8th Cir. 2006), revg. 123 T.C. 5 (2004), and the dissent in Ewing v. Commissioner, 122 T.C. 32 (2004), vacated 439 F.3d 1009 (9th Cir. 2006), relied heavily), the Court of Claims considered the Government's argument that where a department's decision must be upheld unless it is "fraudulent or capricious or arbitrary or so grossly erroneous as necessarily to imply bad faith, or is not supported by substantial evidence", the court's review of the department's decision is limited to the administrative record. The court explained the flaw in the Government's argument as follows:



There is logic in the Government's position. But we do not adopt it. It would require two trials in many cases involving this question. The first trial would include the presentation of the "administrative record" and its study to determine whether, on the basis of what was in it, the administrative decision was tolerable. But the so-called "administrative record" is in many cases a mythical entity. There is no statutory provision for these administrative decisions or for any procedure in making them. * * * Whoever makes it has no power to put witnesses under oath or to compel the attendance of witnesses or the production of documents. There may or may not be a transcript of the oral testimony. The deciding officer may, and even in the departments maintaining the most formal procedures, does, search out and consult other documents which, it occurs to him, would be enlightening, and without regard to the presence or absence of the claimant.



Volentine & Littleton v. United States, 136 Ct. Cl. at 641-642.



Although Volentine & Littleton arose under a different statute, the logic used therein is compelling in the context of section 6015(f) cases. Even after United States v. Carlo Bianchi & Co., supra, the Court of Claims adhered to the idea that the Supreme Court did not create a rule of general application in that case. Brown v. United States, 184 Ct. Cl. 501, 396 F.2d 989 (1968). The Court of Claims adopted the rule that whether to apply the record rule is a matter that should be determined after considering the relationship between the judicial function and the role of the agency, as well as the adequacy of the administrative record. Id. at 506-517, 396 F.2d at 993-999. In cases such as the one before the Court, where the Court is well equipped to apply section 6015(f) to individual taxpayers and the settlement officer has frequently failed to create an administrative record adequate for the Court's review, a de novo review of the facts is appropriate.



In many of the cases where courts have found it appropriate to limit their review to the administrative record, the administrative record was clearly defined and extensive and, if there was an administrative hearing, closely resembled the record that would be created in one of our own cases. For example, in United States v. Carlo Bianchi & Co., supra at 711, the Board of Claims and Appeals of the Corps of Engineers created a substantial record by holding an adversarial hearing, allowing the parties to offer evidence, and allowing each side the opportunity for cross-examination. In United States v. Iron Mountain Mines, Inc., 987 F. Supp. 1250, 1253-1254 (E.D. Cal. 1997), the smaller of the two administrative records at issue contained 359 documents, including reports from a 2-year investigation, comments and proposals submitted by interested parties, and the agency's responses to those comments and proposals. The larger of the administrative records contained 2,648 of the same types of documents. Id. at 1254; see also NVE, Inc. v. HHS, 436 F.3d 182 (3d Cir. 2006).



The APA itself suggests that hearings conducted under its rules will be well documented. APA section 556, 5 U.S.C. sec. 556, which provides the rules for hearings conducted under APA sections 553 and 554, explains the contents of the record as follows:



(e) The transcript of testimony and exhibits, together with all papers and requests filed in the proceeding, constitutes the exclusive record for decision in accordance with section 557 of this title and, on payment of lawfully prescribed costs, shall be made available to the parties. When an agency decision rests on official notice of a material fact not appearing in the evidence in the record, a party is entitled, on timely request, to an opportunity to show the contrary.



By contrast, the administrative record in section 6015(f) cases does not include testimony or a transcript of the conference. Furthermore, the administrative record is rarely, if ever, given to the taxpayer in full to allow the taxpayer to present before the Court a case based on the administrative record. Finally, because settlement officers unilaterally decide what information is shared with the taxpayer and generally control what is included in the administrative record, the safeguard available to parties to APA hearings under APA section 556 --to ask for the opportunity to contradict agency findings based on material facts not in the record --would offer little protection to taxpayers in section 6015 cases.



While courts have applied the record rule in cases where the procedures are less formal than section 6015(f) conferences, the record rule was generally more appropriate in those cases because the agencies' decisions did not depend as heavily on informal communication with individuals. See, e.g., Camp v. Pitts, 411 U.S. 138, 140-141 (1973); Holy Land Found. For Relief and Dev. v. Ashcroft, 333 F.3d 156, 163 (D.C. Cir. 2003); Beno v. Shalala, 30 F.3d 1057, 1073-1074 (9th Cir. 1994). In those cases, resolution of the dispute depended largely on written information available to the agency even without substantial evidentiary submissions by the other party, making a clearly defined administrative record unnecessary.



By contrast, equitable relief under section 6015(f) depends largely upon statements and evidence provided by the requesting spouse, and the requesting spouse generally has few resources available to ensure that the statements and evidence produced are completely and adequately represented in the record. The Court often receives an incomplete administrative record where the truth of the parties' claims is difficult to determine. As the majority opinion points out, the Court holds trials de novo under section 6015(e)(1)(A)(i)(II) where a taxpayer petitions the Court 6 months after filing an election for section 6015 relief and has not received a determination, and in such cases the administrative record is generally deficient. The Court also allows intervention by the nonrequesting spouse in both deficiency cases and stand-alone cases, and allows the nonrequesting spouse to present evidence that is not part of the administrative record.1 In the administrative process, the Commissioner recognizes that intervenors have the right to participate; but because intervenors have even less of an opportunity to create a complete and accurate administrative record than requesting spouses, the Court allows intervenors to supplement the record at trial. See King v. Commissioner, 115 T.C. 118, 124-125 (2000). In deficiency cases, the Court accepts evidence outside of the administrative record where taxpayers may raise section 6015(f) as an affirmative defense. The fact that section 6015(e) commits review of innocent spouse cases to the Tax Court confirms that Congress believes that the Court is well equipped to address questions under section 6015(f).



Rejecting the record rule does not mean that taxpayers will be free to withhold information at the administrative level and then introduce it at trial. Where the settlement officer has requested relevant facts or documents from the taxpayer and the taxpayer has not cooperated, the Court may exclude evidence that is not part of the administrative record. However, the Court should not assume that because certain facts or evidence are not in the administrative record it necessarily follows that the taxpayer had an adequate opportunity to present them.



My concern is that lost in the statutory debate both in our Court and in the Courts of Appeals is the impracticality of the Commissioner's narrow position and the inconsistency of the Commissioner's position with decades of administrative practice in the Appeals process.




The Standard of Review


I agree with Judge Wherry's concurring opinion that the Court should not apply an abuse of discretion standard of review in section 6015(f) cases. I write separately to explain in greater detail why the Court's current reliance on Butler v. Commissioner, 114 T.C. 276 (2000), and its progeny as the source of the Court's standard of review in section 6015(f) cases, is misplaced in the light of the amendment to section 6015(e)(1) by the Tax Relief and Health Care Act of 2006, Pub. L. 109-432, div. C, sec. 408(a), 120 Stat. 3061.



After Congress enacted section 6015 in RRA sec. 3201, Butler v. Commissioner, supra, was the first Tax Court case to consider the Court's jurisdiction to review the Commissioner's denial of relief under section 6015(f).2 In Butler v. Commissioner, supra at 289, the Court faced the issue of whether the Commissioner's decision to deny relief under section 6015(f) was subject to judicial review at all or was committed to agency discretion. The Court then concluded that it had jurisdiction to review the Commissioner's denial of relief under section 6015(f) and stated without discussion that the standard of review was abuse of discretion.3 Id. at 292.



Section 6015(f) provides that the Commissioner "may" grant relief under certain circumstances, indicating that the Commissioner's decision is discretionary. Before 2006 Congress had not specified whether the Court had jurisdiction to review the Commissioner's decision whether to grant relief under section6015(f) or, if it did, what standard of review the Court should use. Although section 6015(e) gave the Court jurisdiction to determine appropriate relief under section 6015(b) and (c), it was silent as to section 6015(f). In the absence of any clear guidance from Congress, it was logical for the Court in Butler v. Commissioner, supra, to hold that it did have jurisdiction to review the Commissioner's decisions but to find that the standard of review was abuse of discretion because of the discretionary language in section 6015(f).



After the Court's Opinion in Billings v. Commissioner, 127 T.C. 7 (2006), Congress amended section 6015(e)(1) to make it clear that the Court has jurisdiction to review taxpayers' requests for equitable relief under section 6015(f). However, section 6015(e)(1) does not provide the Court with jurisdiction to review the Commissioner's decision but "to determine the appropriate relief available to the individual under this section". (Emphasis added.)



After section 6015(e)(1) was amended, the Court continued to review the Commissioner's denial of relief under section 6015(f) using an abuse of discretion standard, relying on Jonson v. Commissioner, 118 T.C. 106, 125 (2002), affd. 353 F.3d 1181 (10th Cir. 2003), and Butler v. Commissioner, supra. Banderas v. Commissioner, T.C. Memo. 2007-129; Ware v. Commissioner, T.C. Memo. 2007-112; Farmer v. Commissioner, T.C. Memo. 2007-74; Van Arsdalen v. Commissioner, T.C. Memo. 2007-48. The Court in Jonson v. Commissioner, supra at 125, stated that the Court reviews the Commissioner's denial of relief under section 6015(f) for an abuse of discretion, citing Butler v. Commissioner, supra at 292, as the source of the Court's jurisdiction.



While it was logical for the Court in Butler and other pre-Billings cases to review the Commissioner's denial of relief under section 6015(f) for an abuse of discretion using the reasoning of Mailman and Gardner, given the ambiguity in section 6015(e)(1) at the time, the amendment to section 6015(e)(1) warrants a reconsideration of our standard of review in section 6015(f) cases. This explicit grant of authority to make determinations under section 6015(f) in section 6015(e)(1) should now be the source of the Court's standard of review.



COLVIN, SWIFT, FOLEY, MARVEL, WHERRY, and KROUPA, JJ., agree with this concurring opinion.



WHERRY, J., concurring in the result: I agree with the majority's designated scope of review but write separately to urge the adoption of a matching standard of review when the merits of this case are decided.1 The majority concludes that the Administrative Procedure Act, 5 U.S.C. secs. 551-559, 701-706 (2000), does not control and that our scope of review in this case allows us to look beyond the administrative record. The majority then correctly notes that the Court has historically applied an abuse of discretion standard of review in determining whether relief is warranted. See Butler v. Commissioner, 114 T.C. 276, 291-292 (2000); see also Fernandez v. Commissioner, 114 T.C. 324, 332 (2000). However, notwithstanding the caselaw cited by the majority regarding the standard of review, section 6015(e) itself provides no basis for the imposition of that deferential standard of review in any section 6015 case.2



Given that the recent amendment to section 6015(e), Tax Relief and Health Care Act of 2006, Pub. L. 109-432, div. C, sec. 408(a), (c), 120 Stat. 3061, 3062, resolves any lingering doubts regarding our jurisdiction over section 6015(f) cases, it is appropriate to revisit the issues of the scope and standard of review to be used in determining whether such relief is warranted. Moreover, because section 6015(e) grants us the authority to determine whether relief is warranted under section 6015(b), (c), and (f), we look to subsection (e), rather than to subsection (f), in order to determine the appropriate scope and standard of review in section 6015 cases. Section 6015(e) provides in relevant part as follows:



SEC. 6015(e). Petition for Review by Tax Court. --



(1) In general. --In the case of an individual against whom a deficiency has been asserted and who elects to have subsection (b) or (c) apply, or in the case of an individual who requests equitable relief under subsection (f) --



(A) In general. --In addition to any other remedy provided by law, the individual may petition the Tax Court (and the Tax Court shall have jurisdiction) to determine the appropriate relief available to the individual under this section if such petition is filed * * *. [Emphasis added.]



I agree with the majority that the use of the word "determine" suggests that Congress intended for us to use a de novo scope of review in determining the appropriateness of relief under section 6015(f). In other instances where the word "determine" or "redetermine" is used, such as in sections 6213 and 6512(b), the Court applies a de novo scope of review and standard of review. If, as the majority notes, the use of the word "determine" in section 6015(e) suggests a de novo scope of review, why does it not also suggest a de novo standard of review?



Importantly, nothing in section 6015(e) suggests that Congress intended for us to use an abuse of discretion standard of review, despite the fact that, in similar circumstances, Congress has shown that it knows how to limit our standard of review when it wants to. See sec. 6404(h) (providing the Court with jurisdiction "to determine whether the Secretary's failure to abate interest * * * was an abuse of discretion" (emphasis added)).3 In amending section 6015(e), Congress gave us jurisdiction over section 6015(f) cases without any such limitation.4



An abuse of discretion standard of review is also at odds with our decision to decline to remand section 6015(f) cases to the Secretary for reconsideration. Friday v. Commissioner, 124 T.C. 220, 222 (2005). Section 6330 is analogous to section 6015(f) insofar as both sections consider economic hardship as a factor in determining whether relief is appropriate. In section 6330(d)(2), Congress provided that the Internal Revenue Service Office of Appeals would retain jurisdiction over collection cases to allow it to consider changes in the taxpayers' circumstances. The fact that Congress did not include a similar provision in section 6015 is consistent with the recent amendment to section 6015(e)(1) that allows the Court to determine whether relief for taxpayers under section 6015(f) is appropriate. See Friday v. Commissioner, supra at 222 ("There is in section 6015 no analog to section 6330 granting the Court jurisdiction after a hearing at the Commissioner's Appeals Office.").



Finally, it is noteworthy that section 6015(e)(1), which addresses our jurisdiction over requests for innocent spouse relief, applies to subsections (b), (c), and (f). The Court applies a de novo scope and standard of review in determining whether relief is warranted under subsections (b) and (c). See, e.g., Alt v. Commissioner, 119 T.C. 306, 313-316 (2002) (applying the abuse of discretion standard of review only to section 6015(f), not subsection (b) or (c)), affd. 101 Fed. Appx. 34 (6th Cir. 2004). Because subsection (e) grants us jurisdiction to "determine the appropriate relief available" under subsections (b), (c), and (f), our scope and standard of review should be the same in all cases under section 6015. There is no reason to single out taxpayers seeking relief under subsection (f) for disparate treatment. Yet, that is the consequence of a nonuniform standard of review in innocent spouse cases.



COLVIN, SWIFT, FOLEY, GALE, MARVEL, GOEKE, and KROUPA, JJ., agree with this concurring opinion.



HALPERN and HOLMES, JJ., dissenting: Respectfully, we dissent. The majority repeats what we considered to be the error of its analysis in Ewing v. Commissioner, 122 T.C. 32, 56, 57-67 (2004) (Halpern and Holmes dissenting with respect to the scope of review appropriate to the Commissioner's determination), vacated 439 F.3d 1009 (9th Cir. 2006). We see no need to repeat, or elaborate on, what we said in Ewing .


1 Unless otherwise indicated, section references are to the Internal Revenue Code, as amended. Rule references are to the Tax Court Rules of Practice and Procedure. Amounts are rounded to the nearest dollar.

2 A Judgment of Absolute Divorce was entered on May 16, 2006.

3 Applying these principles, the U.S. Court of Appeals for the Fifth Circuit has indicated that the APA is not an appropriate vehicle for challenging the Commissioner's denial of a request to abate interest under sec. 6404. See Beall v. United States, 336 F.3d 419, 427 n.9 (5th Cir. 2003) ("review under the APA is accordingly available only where 'there is no other adequate remedy in a court.'" (quoting 5 U.S.C. sec. 704)). Similarly, in an unpublished opinion involving the validity of the Commissioner's issuance of a notice of deficiency, the U.S. Court of Appeals for the Seventh Circuit concluded: "The APA is irrelevant, however, because the IRS's issuance of a notice of tax deficiency and the Tax Court's review of it are governed by the Internal Revenue Code and the rules and procedures of the Tax Court * * * and not by the APA." Bratcher v. Commissioner, 116 F.3d 1482 (7th Cir. 1997), affg. without published opinion T.C. Memo. 1996-252; see also Poirier v. Commissioner, 299 F. Supp. 465, 466 (E.D. La. 1969) (rejecting taxpayer's claim that review to restrain enforcement of IRS summons is governed by APA secs. 703 and 704 because secs. 7602 and 7604 and Reisman v. Caplin, 375 U.S. 440, 443 (1964), "[provide] an adequate remedy").

4 As another example, sec. 6404 authorizes this Court to "determine" whether the Secretary's refusal to abate interest was an abuse of discretion. Our practice has been to make our determination after providing an opportunity for a trial de novo. See, e.g., Goettee v. Commissioner, T.C. Memo. 2003-43, affd. 192 Fed. Appx. 212 (4th Cir. 2006); Jean v. Commissioner, T.C. Memo. 2002-256; Jacobs v. Commissioner, T.C. Memo. 2000-123.

5 There are other situations besides the redetermination of deficiencies in which we make determinations de novo. For example, sec. 7436(a) provides that the Tax Court may "determine" whether the Commissioner's determination regarding an individual's employment status is correct. The legislative history shows that Congress intended for us to conduct a trial de novo with respect to our determinations regarding employment status. See H. Rept. 105-148, at 639 (1997), 1997-4 C.B. (Vol. 1) 319, 961; S. Rept. 105-33, at 304 (1997), 1997-4 C.B. (Vol. 2) 1067, 1384; H. Conf. Rept. 105-220, at 734 (1997), 1997-4 C.B. (Vol. 2) 1457, 2204.

6 No inference should be drawn that, by distinguishing Robinette v. Commissioner, 439 F.3d 455 (8th Cir. 2006), we are changing our position in lien and levy cases as expressed in 123 T.C. 85 (2004).

7 Our Rules relating to declaratory judgment cases provide for consideration under various circumstances of evidence not in the administrative record. See Ewing v. Commissioner, 122 T.C. at 39 n.7.

8 When the APA was enacted, this Court had jurisdiction not only to redetermine deficiencies, but also to determine certain overpayments, to redetermine excessive profits on defense contracts as previously determined by the Secretary, and to hear claims for refunds of processing taxes; all these matters were reviewed de novo. See Revenue Act of 1943, ch. 63, sec. 701(e), 58 Stat. 86 (excessive profits); Revenue Act of 1942, ch. 619, secs. 504, 510(b), 56 Stat. 957, 967 (refunds of processing taxes); Revenue Act of 1926, ch. 27, sec. 284(e), 44 Stat. (Part 2) 67 (overpayments); Revenue Act of 1924, ch. 234, sec. 274, 43 Stat. 297 (deficiencies).

9 The legislative history of the APA confirms this understanding. See S. Comm. on the Judiciary, 79th Cong., 1st Sess., Administrative Procedure Act (Comm. Print 1945), reprinted in Administrative Procedure Act Legislative History, 1944-46, at 22 (1946) (stating that there are exempted from APA formal adjudication requirements matters that are subject to de novo review of facts and law such "as the tax functions of the Bureau of Internal Revenue (which are triable de novo in The Tax Court)"); S. Rept. 752, 79th Cong., 1st Sess. (1945), reprinted in Administrative Procedure Act Legislative History, 1944-46, at 214 (1946) (explaining that pursuant to APA provisions governing the scope of judicial review, courts establish facts de novo where the agency adjudication is not subject to APA formal adjudication provisions "such as tax assessments * * * not made upon an administrative hearing and record, [where] contests may involve a trial of the facts in the Tax Court"); H. Rept. 1980, 79th Cong., 2d Sess. (1946), reprinted in Administrative Procedure Act Legislative History, 1944-46, at 279 (1946) (same).

10 In deciding petitioner's motion in limine relating to our scope of review, we need not decide any issue relating to the standard of review. Our determination of the proper scope of review does not depend on the standard of review applied.

11 This is not to say, however, that we could not or should not, in appropriate circumstances, borrow principles of judicial review embodied in the APA. See Dittler Bros., Inc. v. Commissioner, 72 T.C. 896, 909 (1979) (this Court looked to APA caselaw in adopting a "substantial evidence" rule as the appropriate measure for reviewing the reasonableness of the Commissioner's determination as to tax avoidance in a declaratory judgment action arising under former sec. 7477), affd. without published opinion 642 F.2d 1211 (5th Cir. 1981).

1 During consideration of the APA, at the request of the Chairman of the Senate Judiciary Committee, the Attorney General commented on various aspects of the legislation. In his statement, which was later appended to the Senate report, the Attorney General opined that for purposes of the APA the term "Courts" included the Tax Court and that consequently the APA did not apply to its procedures. S. Rept. 752, 79th Cong., 1st Sess. (1945), reprinted in Administrative Procedure Act Legislative History, 1944-1946, at 224. Notwithstanding this authority, contemporary commentators disagreed over whether the APA applied to the Tax Court. Compare Note, "Effect of the Administrative Procedure Act on Decisions of the Tax Court", 2 Tax L. Rev. 103 (1946) (concluding that the APA applied to the Tax Court), with Gordon, "Reviewability of Tax Court Decisions", 2 Tax L. Rev. 171 (1947) (concluding that the APA did not apply to the Tax Court). There developed a split in the circuits as to whether the Tax Court was to be considered an agency so as to be subject to the provisions of the APA governing agency adjudications. Compare Kennedy Name Plate Co. v. Commissioner, 170 F.2d 196 (9th Cir. 1948), affg. a Memorandum Opinion of this Court, and Anderson v. Commissioner, 164 F.2d 870 (7th Cir. 1947), affg. 5 T.C. 443 (1945) (both holding that the APA provisions did not apply to the Tax Court), with Lincoln Elec. Co. v. Commissioner, 162 F.2d 379, 382 (6th Cir. 1947) (holding that review of Tax Court decisions was governed by the APA), revg. 6 T.C. 37 (1946).

2 The Senate and House reports explain this provision in identical terms, noting that it is one of several exceptions affecting "even adjudications otherwise required by statute to be made after hearing. The first [exception], where the adjudication is subject to a judicial trial de novo, is included because whatever judgment the agency makes is effective only in a prima facie sense at most and the party aggrieved is entitled to complete judicial retrial and decision." S. Rept. 752, 79th Cong., 1st Sess. (1945), reprinted in Administrative Procedure Act Legislative History, 1944-1946, at 202 (1946); H. Rept. 1980, 79th Cong., 2d Sess. (1946), reprinted in Administrative Procedure Act Legislative History, 1944-1946, at 260 (1946).

3 The decision in O'Dwyer v. Commissioner, 266 F.2d 575 (4th Cir. 1959), affg. 28 T.C. 698 (1957), has been criticized as being "premised on a now-outmoded understanding that informal agency action cannot be reviewed based on an administrative record." Robinette v. Commissioner, 439 F.3d 455, 461 (8th Cir. 2006), revg. 123 T.C. 85 (2004); see also Ewing v. Commissioner, 122 T.C. 32, 61 (2004) (Halpern and Holmes, JJ., dissenting) (characterizing O'Dwyer as being of "dubious" continuing relevance), vacated 439 F.3d 1009 (9th Cir. 2006). Even these critics of O'Dwyer , however, do not appear to disagree with its holding that deficiency actions in the Tax Court are properly conducted de novo; but apparently they arrive at that conclusion by a different route, construing APA sec. 706(2)(F) narrowly as contemplating "trials de novo" in income tax deficiency proceedings seemingly to the exclusion of all other types of tax proceedings. See Ewing v. Commissioner, supra at 61 (Halpern and Holmes, JJ., dissenting). As discussed infra, this narrow interpretation of APA sec. 706(2)(F) is contrary to the legislative history of the APA and the well-established practice of the Tax Court and the District Courts.

4 In any event, the Court of Appeals' concern in this particular regard was addressed by Congress in the Pension Protection Act of 2006, Pub. L. 109-280, sec. 855, 120 Stat. 1019, which gave the Tax Court exclusive jurisdiction in collection matters to hear appeals from notices of determination issued after Oct. 16, 2006.

1 While Rev. Proc. 2003-19, 2003-1 C.B. 371, gives the nonrequesting spouse the right to participate at the administrative level, in practice, the nonrequesting spouse frequently suffers from the same problems as the requesting spouse in building a complete administrative record and does not have a statutory right to an in-person or telephone hearing.

2 Mira v. United States, 245 Bankr. 788 (Bankr. M.D. Pa. 1999), was the first case to address this issue. The court concluded that because of the word "may" in sec. 6015(f), the Commissioner's determinations were committed to agency discretion by law and therefore were not reviewable by any court. Id. at 792.

3 In Butler v. Commissioner, 114 T.C. 276, 291 (2000), the Court found that there was an ascertainable standard upon which to review the Commissioner's discretionary denial of relief pursuant to sec. 6015(f), pointing out that the Court had applied a facts and circumstances analysis in considering the application of former sec. 6013(e)(1)(D), which uses substantially the same language as the current sec. 6015(f). The Court supported this argument by citing cases such as Terzian v. Commissioner, 72 T.C. 1164 (1979), and Kistner v. Commissioner, T.C. Memo. 1995-66, where the Court made de novo determinations of whether the taxpayers satisfied former sec. 6013(e)(1)(D). However, the Court declined to apply the same standard of review to sec. 6015(f) as it had applied to former sec. 6013(e)(1)(D).

1 The majority denies respondent's motion in limine to limit our review to the administrative record. The Court has not yet applied a standard of review because it has yet to address the merits of petitioner's case.

In addition, although the terms "scope of review" and "standard of review" are sometimes used interchangeably, there is undoubtedly a difference between them. Our "scope of review" relates to what we will consider in determining whether the Commissioner committed an error. Our "standard of review" relates to how much, if any, deference to afford the Commissioner in determining whether an error was made.

2 It is unclear to me why the Court has adopted a deferential standard of review when addressing sec. 6015(f) even in the context of a petition for redetermination of a deficiency, a context in which our standard of review is normally unrestricted. See Butler v. Commissioner, 114 T.C. 276, 291-292 (2000).

That the Court has conducted de novo trials using an abuse of discretion standard of review under other circumstances sheds no light whatsoever on whether it should do so in this particular context. In addition, considering evidence that was not part of the administrative record while at the same time analyzing the agency's decision for an abuse of discretion presents difficult conceptual problems.

3 Sec. 6404 was amended in a historical context similar to that in which Congress recently amended sec. 6015(e). Before statutory amendments in 1996, this Court lacked jurisdiction to determine whether interest abatement was warranted; whether a taxpayer warranted such relief was entirely within the discretion of the Secretary. See Beall v. United States, 336 F.3d 419, 425 (5th Cir. 2003). In 1996, Congress amended sec. 6404 to give us jurisdiction to determine whether interest abatement is warranted under an abuse of discretion standard of review. In amending sec. 6015(e) to provide unequivocally that we possess jurisdiction over sec. 6015(f) cases, Congress imposed no such limitation upon our standard of review.

4 See Franklin Natl. Bank v. New York, 347 U.S. 373, 378 (1954) ("We find no indication that Congress intended to make this phase of national banking subject to local restrictions, as it has done by express language in several other instances.").

A defendant may be convicted under §7206 even if his involvement in the preparation of certain returns was minimal. See United States v. Searan, 259 F.3d 434 (6th Cir. 2001).

States of America, Plaintiff-Appellee v. Gregory D. Goosby, Defendant-Appellant.

U.S. Court of Appeals, 6th Circuit; 07-5229, April 24, 2008.Affirming an unreported DC Tenn., decision.

[ Code Sec. 7206]

Tax crimes: Preparation of false or fraudulent returns: Willfulness: Jury instructions: Conviction and sentencing. --

A tax preparer was properly convicted and sentenced for willfully preparing false or fraudulent income tax returns. The evidence at trial clearly established that the individual willfully prepared returns containing materially false statements. Further, the court's instruction to the jury was not in error and did not affect the jury's verdict. The instruction allowed the jury to consider IRS publications when deciding whether the individual committed the offense charged; however, it also emphasized that a violation of IRS rules and regulations alone was not criminal. Finally, the sentence imposed on the individual was reasonable. The court did not err by applying an enhancement for obstruction of justice or when calculating the tax loss based on IRS interviews with the individual's customers. The court also considered the individual's history and imposed a sentence within the Sentencing Guidelines range.





OPINION


SILER, Circuit Judge. Defendant Gregory Goosby appeals his jury conviction and sentence on thirty counts of willfully aiding or assisting in the preparation and presentation of false or fraudulent income tax returns under 26 U.S.C. §7206(2). He challenges (1) the sufficiency of the evidence, (2) the district court's evidentiary ruling on a motion in limine, (3) the jury charge regarding IRS publications, and (4) the reasonableness of his sentence. We AFFIRM.




BACKGROUND


Goosby operated a tax preparation business or, as he would characterize it, an electronic taxfiling center from his home. Goosby's business prepared 558 returns in 1999, 877 returns in 2000, and 1,435 returns in 2001. In 2006, Goosby was indicted on thirty-three counts of violating 26 U.S.C. §7206. The government dismissed three counts, and Goosby was found guilty on the remaining thirty counts. He was sentenced to a 46-month term of imprisonment.

The witnesses at trial included IRS employees, numerous taxpayers, and several of Goosby's former employees. The trial began with testimony to explain the background of the IRS investigation. Investigative Analyst Carl Gibeault explained that he received a list of tax return preparers for the region that included Goosby's business. Gibeault used a computer program that allows him to review all the returns by a given tax preparer and rank the returns by amount of refund. He then compared the ratio of adjusted gross income to the amount of deductions; a high ratio is an indicator of potential fraud. Gibeault found a high ratio for returns prepared by Goosby's business and referred the case for further investigation.

The taxpayer witnesses testified to similar experiences in their dealings with Goosby's tax preparation business. The greatest areas of commonality concerned how the taxpayers came to employ Goosby's business, what they experienced while meeting with Goosby or his employees, their reliance on Goosby's business to properly prepare their returns and determine their entitlement to deductions, and the type and number of deductions on their returns. Eighteen of the taxpayers testified that they relied on Goosby to properly prepare their tax returns. At least ten of these taxpayers met or talked with Goosby in person and provided him with documents and/or answered questions asked by Goosby. The remaining taxpayer witnesses met with Goosby's employees and provided them with documents and/or answered questions asked by the employees. Most of the taxpayers testified that neither Goosby nor his employees reviewed the completed tax returns with them, and most did not receive a copy of their return from Goosby or his employees as IRS regulations require.

During the trial, the taxpayers were shown copies of their returns, and all identified deductions for which they had provided no information or deductions that were based on answers given to Goosby or his employees in response to questions. They identified numerous false or inflated deductions of which they were unaware. Nearly all of the taxpayers identified false deductions for personal property taxes and/or false charitable contribution deductions. Most also identified false or inflated reporting of un-reimbursed employee expenses --generally, some combination of deductions for cell phones, computers, internet access, extra phone lines, uniforms, dry cleaning, laundry expenses, work boots, mileage, meals, entertainment, and travel. Instead of providing the information needed to properly determine whether they were eligible for specific deductions, most of the taxpayers testified that they were simply asked questions about how far they drove to work and how much they paid for items such as cell phones and computers. Their tax returns then claimed deductions for the full cost of these items. As a result of the false deductions, most of the taxpayers were audited or voluntarily filed amended tax returns, and most paid thousands of dollars in additional taxes.

One of the taxpayers, Idella Branch, filed a tax return that contained only one deduction, for gambling losses. In 2001, she won two jackpots totaling approximately $163,000 and took home around $104,000 after taxes. Branch testified that she loaned approximately $55,000 to family members and spent or gambled away the rest. Her tax return, prepared by Goosby, reported $162,886 of gambling losses, thereby entitling her to a refund of the previously withheld taxes. Branch testified that it was impossible for her to have lost that amount and that she never told Goosby she had lost that amount.

The employee witnesses all testified that they were data entry personnel. Their job was to enter data into a computer program that filled out the customers' tax returns. They had no training in tax preparation. Several employees testified that they relied on Goosby to determine whether particular items were deductible; others testified that the returns were reviewed, presumably by Goosby, before being submitted to the IRS. Some of the employees testified that they asked customers questions about mileage and how much they paid for items such as uniforms, cell phones, and computers; these amounts were either recorded and passed on to someone else or entered directly into the computer program.

Goosby testified at the trial and denied any wrongdoing. He denied that he was a tax preparer and admitted to preparing only one tax return, a 1999 amended return. He essentially accused the taxpayer witnesses of lying.




DISCUSSION





A. Sufficiency of the Evidence


When a defendant claims there is insufficient evidence to support a conviction, we must decide "whether, after viewing the evidence in a light most favorable to the government, any rational trier of fact could have found the essential elements of the crime beyond a reasonable doubt." United States v. Gardner, 488 F.3d 700, 710 (6th Cir. 2007). A conviction will be reversed based on insufficient evidence only if it is "not supported by substantial and competent evidence upon the record as a whole." United States v. Barnett, 398 F.3d 516, 522 (6th Cir. 2005). Furthermore, "[c]ircumstantial evidence alone, if substantial and competent, may support a verdict and need not remove every reasonable hypothesis except that of guilt." United States v. Tarwater, 308 F.3d 494, 504 (6th Cir. 2002) (quoting United States v. Humphrey, 279 F.3d 372, 378 (6th Cir. 2002)).

Goosby was convicted of thirty violations of 26 U.S.C. §7206(2). An offense under §7206(2) has three essential elements:

(1) that defendant aided, assisted, procured, counseled, advised or caused the preparation and presentation of a return;

(2) that the return was fraudulent or false as to a material matter; and

(3) that the act of the defendant was willful.

United States v. Sassak, 881 F.2d 276, 278 (6th Cir. 1989) (quoting United States v. Hooks, 848 F.2d 785, 788-89 (7th Cir. 1988)). Goosby argues that the evidence is insufficient with respect to the second and third elements --materiality and willfulness.




1. Willfulness


The element of willfulness requires the government to prove an "intentional violation of a known legal duty." Sassak, 881 F.2d at 280 (citing United States v. Pomponio, 429 U.S. 10, 12-23 (1976) (per curiam)). Goosby claims that the government failed to prove he intentionally violated the law. However, viewing the evidence in the light most favorable to the government, it is sufficient to permit a finding that Goosby intentionally assisted in the filing of false or fraudulent tax returns. The taxpayer witnesses came to Goosby, or to his business, to have their taxes prepared. They were assisted by either Goosby or one of his employees. The taxpayers relied on Goosby to determine what deductions were legal and proper, and some of the employees explicitly testified that they also relied on Goosby to determine the propriety of deductions and to review the returns before they were submitted. All of the employees testified that they were data entry personnel and did not have the knowledge or training to determine whether deductions were proper. Further, Goosby's claim that he did not prepare returns, aside from the one he admits to, is contradicted repeatedly by the taxpayers' testimony.

A defendant may be convicted under §7206 even if his involvement in the preparation of certain returns was minimal. See United States v. Searan, 259 F.3d 434 (6th Cir. 2001). In Searan, a mother and son operated a tax preparation business. Id. at 438. The son was convicted under §7206 and argued there was insufficient evidence to support the conviction. Id. at 443. Although the evidence showed that his mother had prepared and signed most of the returns and sometimes even spoke with taxpayers outside his presence, we upheld the son's conviction because "he actively participated...by assuring victims of his and his mother's competency to file tax returns, particularly returns containing allegedly legitimate `deductions' known to few other people." Id. at 445.

In this case, the similarity in the type of false deductions claimed on most of the tax returns is strong circumstantial evidence that the defendant willfully submitted tax returns containing false statements. Viewing the evidence in the light most favorable to the government, the jury could find beyond a reasonable doubt that Goosby was responsible for submitting the tax returns with numerous false deductions and that his actions were willful.




2. Materiality


Goosby's second contention involves the requirement that the return be "fraudulent or false as to a material matter." Sassak, 881 F.2d at 278. He argues that the government failed to prove the returns were materially false and that it was error for the district court to submit the issue of materiality to the jury. "When materiality is an element of the offense, it must be submitted to the jury." United States v. Kone, 307 F.3d 430, 436 (6th Cir. 2002). Therefore, the district court did not err in submitting the question of materiality to the jury.

Goosby acknowledges that the government presented evidence of materiality at the sentencing hearing, but he argues there was no such proof at trial. However, the evidence at trial established that most of the taxpayers had been audited or filed amended returns, and they paid or owed additional money to the IRS as a result of the false statements. Further, some of the false deductions were so large or inflated, e.g., the approximately $162,000 of gambling losses, that they were obviously material. Therefore, sufficient evidence was presented at trial to prove that the tax returns contained materially false statements.




B. Evidentiary Ruling on Gibeault's Testimony


Goosby filed a pre-trial motion in limine that sought to prohibit the testimony of Investigative Analyst Gibeault. The district court allowed Gibeault's testimony. Goosby argues that the testimony was inadmissible hearsay and that it was in violation of the Sixth Amendment Confrontation Clause, FRE 404(b), and FRE 403. We review the evidentiary rulings of the district court for abuse of discretion. United States v. Lloyd, 462 F.3d 510, 516 (6th Cir. 2006).

We have allowed similar background testimony in other contexts. In United States v. Aguwa, DEA agents were permitted to testify about information they received from an informant, which precipitated a controlled purchase of heroin from the defendant. 123 F.3d 418, 421 (6th Cir. 1997) ("The statements were not offered `for the truth of the matter asserted,' see Fed. R. Evid. 801(c), but only to provide background information and to explain how and why the agents even came to be involved with this particular defendant."). As in Aguwa, the testimony here was limited to "constructing the sequence of events" in the investigation and did not directly implicate the defendant in criminal activity. Id. (brackets omitted). Likewise, the purpose of Gibeault's testimony was to provide background information about the investigation, not to discuss the character or prior bad acts of the defendant; thus, FRE 404(b) is not implicated. There is also no Confrontation Clause violation because Gibeault did not make statements that would be characterized as testimonial hearsay. See Davis v. Washington, 126 S. Ct. 2266, 2273-74 (2006).

Goosby's final evidentiary argument is that Gibeault's testimony violates FRE 403 because its prejudicial effect outweighs its probative value. The only statement by Gibeault that approaches having an unduly prejudicial effect is that he was able to find fifteen returns with a suspicious ratio "very quickly." However, that statement was not before the district court when it ruled on the motion in limine and cannot be considered in determining whether the district court abused its discretion in denying the motion. 1




C. Jury Instruction on IRS Publications


At trial, IRS Agent Janet Cunningham testified about how a taxpayer can properly claim the deductions seen repeatedly on the returns involved in the indictment. The government also introduced various IRS publications into evidence. During Cunningham's testimony, the court gave a limiting instruction to make it clear that a violation of IRS rules or regulations "is insufficient to establish criminal conduct." At the conclusion of the trial, Goosby requested the following jury instruction regarding the evidence on IRS rules, regulations, and publications:


The violations by the defendant, Gregory D. Goosby, of the rules, regulations, or directives set out in the publications of the Internal Revenue Service are not evidence or proof that the defendant committed the criminal acts alleged in the indictment. The defendant is not on trial for any acts or crimes not alleged in the indictment.


However, the district court agreed with the government that the IRS publications could be considered as "some evidence" that the defendant violated §7206. The court ultimately gave an instruction similar to the one requested by Goosby, except it included the following sentence: "You may consider them in deciding whether or not the crimes were committed, but violation of the IRS rules and regulations alone is insufficient." (emphasis added).

Goosby asserts that the instruction given by the district court was an incorrect statement of the law. Because Goosby did not object to the instruction, we review the refusal to give his requested instruction for plain error. United States v. Blood, 435 F.3d 612, 625 (6th Cir. 2006). Even if an error occurred here, there is no basis to find that its "adverse impact seriously affected the fairness, integrity or public reputation of the judicial proceedings," United States v. Koeberlein, 161 F.3d 946, 949 (6th Cir. 1998), particularly where the district court's instruction emphasized that a violation of the IRS rules and regulations would not establish a criminal violation. Therefore, the district court did not commit plain error.




D. Sentencing


We review the district court's sentencing decision for reasonableness. United States v. Liou, 491 F.3d 334, 337 (6th Cir. 2007). Goosby appeals his sentence on both procedural and substantive grounds. Procedurally, he challenges the district court's determination of sentence enhancements. Findings under the Sentencing Guidelines that increase a defendant's sentence must be based on reliable information and supported by a preponderance of the evidence. See United States v. Yagar, 404 F.3d 967, 972 (6th Cir. 2005). The district court's factual findings regarding the amount of tax loss and obstruction of justice enhancement are reviewed for clear error. See United States v. Burke, 345 F.3d 416, 428 (6th Cir. 2003).

Goosby contends that it was improper to calculate the tax loss based on Agent McElroy's interviews with taxpayers who were not cross-examined and whose reliability was not investigated. However, we have previously upheld a calculation of tax loss based on IRS interviews with taxpayers. See United States v. Redmond, 188 F. App'x 377, 382 (6th Cir. 2006) (unpublished opinion). Goosby also appeals the district court's decision to apply an enhancement for obstruction of justice under USSG §3C1.1. Conduct that gives rise to the obstruction of justice enhancement includes committing perjury. USSG §3C1.1 cmt. n.4. In light of Goosby's testimony, which was contradicted in material respects by the taxpayer witnesses and Agent McElroy, the district court did not clearly err in determining that the obstruction of justice enhancement should apply. See Redmond, 188 F. App'x at 381 (quoting Regalado v. United States, 334 F.3d 520, 524 (6th Cir. 2003)) ("Where there are two permissible views of the evidence, the factfinder's choice between them cannot be clearly erroneous.").

Finally, Goosby argues that the sentence imposed is substantively unreasonable under 18 U.S.C. §3553(a). Because of his stable home life, prior military service, and lack of a criminal record, Goosby contends that he should have been sentenced to a term of probation. However, the district court's imposition of a 46-month term of imprisonment is within the properly calculated Guidelines range of 41 to 51 months. This court has applied a "`rebuttable presumption of reasonableness' to sentences falling within the applicable Guidelines range." Liou, 491 F.3d at 337. In this case, the district court clearly considered Goosby's history and explained its decision to impose a sentence within the Guidelines range. That sentence was reasonable.

AFFIRMED.

1 Goosby did not raise or renew his FRE 403 objection when Gibeault testified at trial regarding how quickly he found the sample of fifteen suspicious returns.

26 U.S.C. §6323 extensively sets forth means for assessing the priority of the Government's lien as against others' interests in certain types of property.

Tax liens reduced to judgment.
United States of America, Plaintiff v. Dennis Wagner, Carol Wagner, Key Bank, Defendants.

U.S. District Court, Dist. Colo.; Civil Action No. 07-cv-00978-MSK-KMT, April 28, 2008.

Related decision at 2008-1 USTC ¶50,214.

[ Code Sec. 7403]

Tax liens: Reduced to judgment: Foreclosure and sale: Evidence: Third-party interest. --
Federal tax liens against an individual's real property were reduced to judgment. The government established that the individual was liable for unpaid taxes, interest and penalties, that he held title to the property as a joint tenant and that the liens had been recorded against his interest in that property. However, foreclosure was not ordered because issues relating to the scope of other parties' interests in the property, the priority of the liens and whether the other parties' interests could be adequately protected remained unresolved. Back references: ¶41,653.12 and ¶41,653.40.







OPINION AND ORDER GRANTING, IN PART, MOTION FOR SUMMARY JUDGMENT


KRIEGER, United States District Judge: THIS MATTER comes before the Court pursuant to the Government's Motion for Summary Judgment (# 35) , to which no responsive papers have been filed..

According to the Complaint (# 1) , Defendant Dennis Wagner has been assessed with unpaid income taxes, penalties, and interest for the tax years of 1995-2002, totaling $383,094.33 as of March 1, 2007. Dennis Wagner is an owner of real property located in Fort Collins, Colorado. (The other Defendants in this action possess some interest in the property that would be impaired by the relief requested by the Government.) As a result of the unpaid taxes, the Government has recorded liens on Dennis Wagner's interest in the property pursuant to 26 U.S.C. §6321. The Government now seeks to reduce the outstanding tax liability to judgment, to foreclose upon the liens, and, eventually, to foreclose the liens by the sale of the property pursuant to 26 U.S.C. §7403 and 28 U.S.C. §2001.

The Government has moved for summary judgment (# 35) on its claim. It has come forward with competent evidence that Dennis Wagner received income from various sources in each of the tax years at issue, and that he has not paid taxes on this income. The record indicates that the amount of unpaid taxes, interest, and penalties is $412,649.06 as of February 28, 2008, with additional interest and penalties accruing from that date. The Government has produced evidence showing that Dennis Wagner holds title, as a joint tenant with Defendant Carol Wagner, in a parcel of real property located at 4820 Crest Road in Fort Collins, Colorado ("the Crest property"). The Wagners' interest in the Crest property is encumbered by a lien held by Defendant Key Bank. In 2004 and 2005, the Government recorded tax liens against Dennis Wagner's interest in the property, pursuant to 26 U.S.C. §6321.

The Government's motion requests the following relief: (i) a judgment against Dennis Wagner in the amount of $412,649.06, plus interest and penalties accruing after February 28, 2008; (ii) a declaration that "the United States has valid and subsisting federal tax liens...on all property and rights to property of Mr. Wagner..."; and (iii) "that the United States' tax liens encumbering the Crest property be foreclosed." However, at this time, the Government does not request an order directing the sale of the property. In a footnote to its motion, the Government states that it anticipates filing a future motion seeking "an order for the sale of the Crest property and a distribution of the proceeds in accordance with this Court's findings regarding the priority of the claimants' interests." The Court notes that nothing in the Government's instant motion requests any findings as to the scope or priority of any of the Defendants' interests in the Crest property.

No Defendant has responded to the Government's motion, and thus, the Court treats all of the facts therein as being undisputed.

Rule 56 of the Federal Rules of Civil Procedure facilitates the entry of a judgment only if no trial is necessary. See White v. York Intern. Corp., 45 F.3d 357, 360 (10th Cir. 1995). Summary adjudication is authorized when there is no genuine dispute as to any material fact and a party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c). Substantive law governs what facts are material and what issues must be determined. It also specifies the elements that must be proved for a given claim or defense, sets the standard of proof and identifies the party with the burden of proof. See Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986); Kaiser-Francis Oil Co. v. Producer's Gas Co., 870 F.2d 563, 565 (10th Cir. 1989). A factual dispute is "genuine" and summary judgment is precluded if the evidence presented in support of and opposition to the motion is so contradictory that, if presented at trial, a judgment could enter for either party. See Anderson, 477 U.S. at 248. When considering a summary judgment motion, a court views all evidence in the light most favorable to the non-moving party, thereby favoring the right to a trial. See Garrett v. Hewlett Packard Co., 305 F.3d 1210, 1213 (10th Cir. 2002).

If the movant has the burden of proof on a claim or defense, the movant must establish every element of its claim or defense by sufficient, competent evidence. See Fed. R. Civ. P. 56(e). Once the moving party has met its burden, to avoid summary judgment the responding party must present sufficient, competent, contradictory evidence to establish a genuine factual dispute. See Bacchus Indus., Inc. v. Arvin Indus., Inc., 939 F.2d 887, 891 (10th Cir. 1991); Perry v. Woodward, 199 F.3d 1126, 1131 (10th Cir. 1999). If there is a genuine dispute as to a material fact, a trial is required. If there is no genuine dispute as to any material fact, no trial is required. The court then applies the law to the undisputed facts and enters judgment.

26 U.S.C. §7403(a) states that:


In any case where there has been a refusal or neglect to pay any tax, or to discharge any liability in respect thereof, [the Government] may direct a civil action to be filed in a district court of the United States to enforce the lien of the United States under this title with respect to such tax or liability or to subject any property, of whatever nature, of the delinquent, or in which he has any right, title, or interest, to the payment of such tax or liability.


26 U.S.C. §7403(a). Upon proper notice to and joinder of any person claiming a lien or interest in the property at issue, 26 U.S.C. §7403(b), the Court is required to "adjudicate all matters involved therein and finally determine the merits of all claims to and liens upon the property." 26 U.S.C. §7403(c). The Court "may decree a sale of such property," and distribute the proceeds "according to the findings of the court in respect to the relative interests of the parties 1 and of the United States." Id.

To establish the necessary predicates for relief under §7403, the Government must show: (i) that Dennis Wagner is liable for unpaid taxes; (ii) that Dennis Wagner possesses an interest in certain property; (iii) the Government has effectuated a lien on Dennis Wagner's interest in that property as a result of such unpaid taxes; and (iv) that the interests of any other person holding an interest in the property can be adequately protected. See generally U.S. v. Pottof, 881 F.Supp. 482, 487 (D. Kan. 1995).

Turning first to the question of whether the Government has come forward with adequate evidence to demonstrate that Dennis Wagner has liability to the Government for unpaid taxes, the Court finds that the Government has done so. The Government has supplied the Court with copious records, including records evidencing amounts paid as income to Dennis Wagner in each of the tax years at issue, and an affidavit by Maureen Neal that Dennis Wagner has not filed a tax return nor made any payments for any of the tax years in question. Ms. Neal states, supported by evidence in the record, that Dennis Wagner has unpaid tax liability, including accrued interest and penalties, of $412,649.06 as of February 28, 2008. The Defendants have come forward with no contradictory evidence on any of these points, and thus, the Court finds that the Government has established that Dennis Wagner has unpaid tax liability in that amount. See generally U.S. v. Byock, 130 Fed.Appx. 594, 595 (3d Cir. 2005) (unpublished).

Next, the Government has come forward with evidence that Dennis Wagner presently holds title to the Crest property, as a joint tenant with Defendant Carol Wagner. The Government has also come forward with evidence that Defendant Key Bank is the beneficiary of a Deed of Trust recorded against the property, securing a Promissory Note in the amount of $156,000, and that former Defendant First Community Bank is the beneficiary of a Deed of Trust against the property, securing a Promissory Note in the amount of 35,700. 2 As above, these facts are not disputed, and thus, the Court deems the Government to have established these facts.

The record further reflects that the Government recorded liens with the Larimer County Clerk and Recorder, against Dennis Wagner's interest in the subject property on March 12, 2004 (as to tax years 1995-2001), and January 12, 2005 (as to tax year 2002).

Accordingly, the Court finds that the Government has carried its burden of establishing all of the necessary elements to determine the liability of Dennis Wagner for unpaid income taxes and the existence of liens recorded against the Crest property. As to those issues, the Government is entitled to summary judgment on its claim.

However, as stated previously, the Government's motion requests three forms of relief. First, the Government seeks a judgment against Dennis Wagner in the amount of $412,649.06, plus interest and penalties accruing after February 28, 2008. Although 26 U.S.C. §7403 does not expressly identify an in personam judgment as an item of available relief, courts typically characterize the statutory action as being one to "reduce to judgment" an assessment of unpaid taxes. See generally U.S. v. Dawes, 161 Fed.Appx. 742, 744 (10th Cir. 2005) (unpublished); U.S. v. Gosnell, 961 F.2d 1518, 1519 (10th Cir. 1992). 26 U.S.C. §7403(a) does appear to contemplate relief running in personam against the taxpayer, stating that a tax lien can be enforced against "any property, of whatever nature, of the [taxpayer], or in which he has any right, title, or interest." 26 U.S.C. §7403(a). The Court sees no impediment to entering an in personam judgment in favor of the Government and against Dennis Wagner, and thus, this item of relief is granted. Within 15 days of the date of this Order, the Government shall submit a current statement of the outstanding liability of Dennis Wagner, including all interest and penalties accrued up to May 15, 2008. Upon such a filing, the Court will enter judgment in that amount.

Next, the Government requests a declaration "that the United States has valid and subsisting federal tax liens, by virtue of the assessments," against all of Dennis Weaver's property. It is unclear what authority provides for such a declaration, and in any event, it is unclear why such relief is necessary. Pursuant to 26 U.S.C. §6321, a lien "automatically arises upon assessment of a tax and continues until the taxpayer's liability is satisfied"; in other words, no judicial action is necessary to create or sustain such a lien. See Kyler v. Everson, 442 F.3d 1251, 1252 (10th Cir. 2006). Nevertheless, insofar as no Defendant has opposed the Government's motion, the Court will so declare.

Finally, the Government requests "that the United States' tax liens encumbering the Crest property be foreclosed." This relief cannot be granted at this time, in light of the outstanding issues relating to the scope of the various Defendants' interests in the Crest property and the relative priority of the liens against Dennis Wagner's title. Based on the record before the Court, the Court cannot ensure that all of the interests of all of those holding interest in the property can be adequately protected in the event of a foreclosure sale. Therefore, relief in the form of foreclosure and sale is not awarded at this time.

Accordingly, the Government's Motion for Summary Judgment (# 35) is GRANTED IN PART and DENIED IN PART . Within 15 days of the date of this Order, the Government shall file an updated statement of the outstanding taxes, penalties, and accrued interest owed by Dennis Wagner as of May 15, 2008., and the Court will then enter judgment in favor of the Government and against Dennis Wagner. Within 60 days of this Order, the Government shall file papers sufficient to address the remaining issues in this matter, failing which the case will be closed, subject to reopening by any party upon an appropriately-supported request.

Dated this 28th day of April, 2008

1 26 U.S.C. §6323 extensively sets forth means for assessing the priority of the Government's lien as against others' interests in certain types of property.

2 The Government represents that it reached a stipulation with former Defendant First Community Bank regarding their respective interests in this matter.

Section 7122 - The IRS has supplemented and clarified the procedures identified in Reg. §301.7122-1 for submitting and processing offers to compromise a tax liability under Code Sec. 7122.

Revenue Procedure 2003-71, I.R.B. 2003-36, September 8, 2003.


Estate, gift, generation-skipping transfer and income taxes: Returns and procedure: Offers to compromise: Guidelines. --


An offer to compromise, which must be submitted in writing on Form 656, Offer in Compromise, should include the legal grounds for compromise, as well as the amount the taxpayer proposes to pay and the payment terms. An offer becomes processable when the IRS determines that it meets the following minimum requirements: (1) the offer is submitted on the proper version of Form 656 and Form 433-A or B, as appropriate; (2) the taxpayer is not in bankruptcy; (3) the taxpayer has complied with all filing and payment requirements listed in the Form 656 instructions; (4) the taxpayer has enclosed the application fee, if required; and (5) the offer meets any other minimum requirements established by the IRS. The decision as to whether to accept an offer to compromise is within the discretion of the IRS and an offer will only be accepted if it is determined to be in the best interest of both the taxpayer and the IRS. A taxpayer may withdraw an offer to compromise anytime prior to acceptance of the offer. An offer to compromise is not considered accepted until the IRS issues written notification of acceptance to the taxpayer. This procedure is effective August 21, 2003, but provisions relating to the offer in compromise application fee are not effective for offers submitted before November 1, 2003. Rev. Proc. 96-38, 1996-2 CB 300, is obsoleted. Back references: ¶15,897.03 and ¶15,897.151.






SECTION 1. PURPOSE

The purpose of this revenue procedure is to explain the procedures applicable to the submission and processing of offers to compromise a tax liability under section 7122 of the Internal Revenue Code. These procedures reflect changes to the law made by the Internal Revenue Service Restructuring and Reform Act of 1998, Public Law 105-206 (112 Stat. 685, 764).



SECTION 2. BACKGROUND

.01 Section 7122 permits the Secretary of the Treasury or his delegate to compromise any civil or criminal liability arising under the internal revenue laws before the case is referred to the Department of Justice for prosecution or defense.

.02 The Secretary has developed guidelines and procedures for the submission and evaluation of offers to compromise under section 7122. These guidelines can be found in § 301.7122-1 of the Regulations on Procedure and Administration, the Internal Revenue Manual, and various forms and publications issued by the Internal Revenue Service (Service). This revenue procedure supplements and clarifies the procedures identified in § 301.7122-1.

.03 This revenue procedure includes provisions relating to the offer in compromise application fee, required under § 300.3 of the Regulations on User Fees and effective November 1, 2003.



SECTION 3. SCOPE

This revenue procedure applies to all offers to compromise a civil or criminal liability under section 7122 submitted to the Service, except for those offers submitted directly to the Office of Appeals. This revenue procedure does not apply to offers to compromise a tax liability after a case involving a civil or criminal liability has been referred to the Department of Justice for prosecution or defense.



SECTION 4. SUBMITTING AN OFFER TO COMPROMISE

.01 An offer to compromise a tax liability must be submitted in writing on the Service's Form 656, Offer in Compromise. None of the standard terms may be stricken or altered, and the form must be signed under penalty of perjury. The offer should include all liabilities to be covered by the compromise, the legal grounds for compromise, the amount the taxpayer proposes to pay, and the payment terms. Payment terms include the amounts and due dates of the payments. The offer should also contain any other information required by Form 656. The Service occasionally revises Form 656 and may require offers to be submitted on the most recent version of the form. The most recent version of the form and instructions are available on the Service's website at www.irs.gov.

.02 An offer to compromise a tax liability should set forth the legal grounds for compromise and should provide enough information for the Service to determine whether the offer fits within its acceptance policies.

(1) Doubt as to liability. Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence of the liability.

An offer to compromise based on doubt as to liability generally will be considered acceptable if it reasonably reflects the amount the Service would expect to collect through litigation. This analysis includes consideration of the hazards of litigation that would be involved if the liability were litigated. The evaluation of the hazards of litigation is not an exact science and is within the discretion of the Service.

(2) Doubt as to collectibility. Doubt as to collectibility exists in any case where the taxpayer's assets and income cannot satisfy the full amount of the liability.

An offer to compromise based on doubt as to collectibility generally will be considered acceptable if it is unlikely that the tax can be collected in full and the offer reasonably reflects the amount the Service could collect through other means, including administrative and judicial collection remedies. See Policy Statement P-5-100. This amount is the reasonable collection potential of a case. In determining the reasonable collection potential of a case, the Service will take into account the taxpayer's reasonable basic living expenses. In some cases, the Service may accept an offer of less than the total reasonable collection potential of a case if there are special circumstances.

(3) Promotion of effective tax administration.


(a) The Service may compromise to promote effective tax administration where it determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship. Economic hardship is defined as the inability to pay reasonable basic living expenses. See § 301.6343-1(d). No compromise may be entered into on this basis if compromise of the liability would undermine compliance by taxpayers with the tax laws.





An offer to compromise based on economic hardship generally will be considered acceptable when, even though the tax could be collected in full, the amount offered reflects the amount the Service can collect without causing the taxpayer economic hardship. The determination to accept a particular amount will be based on the taxpayer's individual facts and circumstances.



(b) If there are no other grounds for compromise, the Service may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. The taxpayer will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full. No compromise may be entered into on this basis if compromise of the liability would undermine compliance by taxpayers with the tax laws.





An offer to compromise based on compelling public policy or equity considerations generally will be considered acceptable if it reflects what is fair and equitable under the particular facts and circumstances of the case.


.03 The offer should include all information necessary to verify the grounds for compromise. Except for offers to compromise based solely on doubt as to liability, this includes financial information provided in a manner approved by the Service. Individual or self-employed taxpayers must submit a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, together with any attachments or other documentation required by the Service. Corporate or other business taxpayers must submit a Form 433-B, Collection Information Statement for Businesses, together with any attachments or other documentation required by the Service. The Service may require the corporate officers or individual partners of a business taxpayer to complete a Form 433-A.

.04 An offer to compromise a tax liability should be mailed to the appropriate address listed on Form 656. The Service may, in its discretion, receive offers to compromise in other manners. Simply because the Service has received an offer does not mean that it has accepted the offer for processing such that the offer is considered pending within the meaning of section 6331(k)(1). Accepting an offer for processing is addressed in Section 5.01 of this revenue procedure.

.05 If a deposit is submitted with the offer to compromise and the taxpayer authorizes application of a deposit to tax liabilities, it will be credited to the taxpayer's account as of the day the deposit is first received.



SECTION 5. WHEN AN OFFER BECOMES PENDING AND RETURN OF OFFERS

.01 Section 6331(k)(1) generally prohibits the Service from making a levy on a taxpayer's property or rights to property while an offer to compromise a liability is pending with the Service, for 30 days after the rejection of an offer to compromise, or while an appeal of a rejection is pending. The statute of limitations on collection is suspended while levy is prohibited. An offer to compromise becomes pending when it is accepted for processing. The Service accepts an offer to compromise for processing when it determines that: the offer is submitted on the proper version of Form 656 and Form 433-A or B, as appropriate; the taxpayer is not in bankruptcy; the taxpayer has complied with all filing and payment requirements listed in the instructions to Form 656; the taxpayer has enclosed the application fee, if required; and the offer meets any other minimum requirements established by the Service. A determination that the offer meets these minimum requirements means that the offer is processable.

.02 A determination is made to accept an offer to compromise for processing when a Service official with delegated authority to accept an offer for processing signs the Form 656. The date the Service official signs the Form 656 is recorded on the Service's computers. As of this date, levy is prohibited unless the Service determines that collection of the liability is in jeopardy.

.03 If the Service determines that an offer to compromise a liability does not meet the minimum requirements the Service has established for a processable offer, the offer to compromise is not processable and may be returned to the taxpayer. Because the offer to compromise was never accepted for processing, it was never pending and levy was never prohibited.

.04 If an offer to compromise accepted for processing does not contain sufficient information to permit the Service to evaluate whether the offer should be accepted, the Service will request that the taxpayer provide the needed additional information. These requests for information are described in Section 6 below. If the taxpayer does not submit the additional information that the Service has requested within a reasonable time period after such a request, the Service may return the offer to the taxpayer. The Service also may return the offer after it has been accepted for processing if:

(1) The Service determines that the offer was submitted solely to delay collection;

(2) The taxpayer fails to file a return or pay a liability;

(3) The taxpayer files for bankruptcy;

(4) The offer is no longer processable; or

(5) The offer was accepted for processing in error.

When an offer is returned under this Section 5.04, the Service will not refund the application fee submitted with the offer unless the offer was accepted for processing in error.

.05 If a determination is made to return the offer to compromise as described in Sections 5.03 and 5.04, the return of the offer does not constitute a rejection. The taxpayer is not entitled to appeal the matter to Appeals under the provisions of § 301.7122-1(f)(5). If the Service initiates collection action following a return of an offer to compromise, the taxpayer may be able to appeal the collection action under section 6320, section 6330, or under the Collection Appeals Program.

.06 An offer to compromise is considered to be returned on the day the Service mails, or personally delivers, a written letter to the taxpayer informing the taxpayer of the decision to return the offer. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the offer is returned. The Service may levy to collect the liability that was the subject of the offer anytime after it returns the offer to the taxpayer.



SECTION 6. CASE BUILDING, INVESTIGATION, AND EVALUATION

.01 Once the Service accepts an offer to compromise for processing, it begins to gather the basic information necessary to begin evaluating the offer. During this initial processing, the Service may contact the taxpayer to secure information or documentation that was incorrect or omitted from the offer documents.

.02 After all of the basic information has been obtained from the taxpayer, the Service evaluates the information and determines whether the taxpayer's offer is acceptable. In the course of evaluating the offer to compromise, the Service may request additional information or documentation from the taxpayer.

.03 The decision whether and when to accept an offer to compromise a liability is within the discretion of the Service. In keeping with Policy Statement P-5-100, an offer will only be accepted if it is determined to be in the best interest of both the taxpayer and the Service. In addition to the criteria discussed in Section 4.02, the Service may take into account public policy and tax administration concerns in determining whether an offer to compromise is acceptable.

.04 For all offers to compromise, except for those based solely on doubt as to liability, the Service verifies the taxpayer's income and assets according to the Service's policies and procedures. Verification allows the Service to determine whether or not the taxpayer can fully pay the liability and, if not, to determine the reasonable collection potential of the liability.

(1) The Service uses a variety of sources to verify the taxpayer's valuation of the taxpayer's property. The Service relies on internal sources, such as its computer databases or other records, public and electronic sources, such as state motor vehicle records and credit bureau reports, and taxpayer supplied documentation.

(2) Section 7122 requires the Service to prescribe and publish guidelines to ensure that taxpayers entering into a compromise have an adequate means to provide for basic living expenses. The amount of basic living expenses will be determined based on an evaluation of the individual facts and circumstances presented by the taxpayer's case. The Service maintains a schedule of national and local allowances to account for the basic living expenses of taxpayers seeking to compromise. To determine whether an offer is adequate, the Service uses these schedules to analyze the income and expenses of the taxpayer to determine the monthly income available to pay the liability. These schedules are available in the Financial Analysis Handbook, IRM 5.15, and on the Service's website at www.irs.gov. The schedules are not applied when doing so would leave the taxpayer without adequate means to provide for basic living expenses.

(3) For purposes of evaluating an offer to compromise, the Service allows expenses only to the extent it determines they are necessary for the health and welfare of the taxpayer or the taxpayer's family or are necessary for the production of income.



SECTION 7. WITHDRAWING AN OFFER TO COMPROMISE

.01 The taxpayer may withdraw an offer to compromise a liability anytime prior to acceptance of the offer. An offer that has been withdrawn is no longer pending and the Service may levy to collect the liability that was the subject of the offer. When an offer is withdrawn the Service will not refund the application fee submitted with the offer.

.02 The taxpayer may withdraw an offer to compromise by delivery of written notification of the withdrawal in person, by mail, or by fax. An offer assigned to Centralized Offer in Compromise Units, however, may not be withdrawn by personal delivery, because documents cannot be personally delivered to these units. A taxpayer may also request withdrawal of an offer telephonically. A notice of intent to withdraw an offer should be directed to the Service office assigned to the case.

(1) If the taxpayer withdraws an offer to compromise by personal delivery, the offer will be considered withdrawn when written notification of the withdrawal is received by the Service.

(2) If the taxpayer withdraws an offer to compromise by mailing written notification of the withdrawal via U.S. certified mail, the offer will be considered withdrawn on the date the Service receives the certified mail.

(3) In all other cases, including withdrawal by non-certified mail, fax, or phone, the offer will be considered withdrawn on the date the Service mails, or personally delivers, a written letter to the taxpayer acknowledging the withdrawal.



SECTION 8. ACCEPTING AN OFFER TO COMPROMISE

.01 An offer to compromise has not been accepted until the Service issues written notification of acceptance to the taxpayer. Acceptance is effective as of the date on the acceptance letter.

.02 Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one taxpayer does not extinguish the liability of any person not named in the offer who is also liable for the tax to which the offer relates. The Service may take action to collect from any person not named in the offer.



SECTION 9. REJECTING AN OFFER TO COMPROMISE

.01 An offer to compromise has not been rejected until the Service issues written notification of rejection to the taxpayer. Section 7122(d) requires the Service to conduct an independent administrative review before the rejection of an offer to compromise is communicated to the taxpayer. The Service reviews each case to determine if the proposed rejection is reasonable based on the facts and circumstances of the case. Rejection is effective as of the date on the rejection letter. When an offer is rejected the Service will not refund the application fee submitted with the offer.

.02 The taxpayer may appeal the rejection of an offer to compromise to Appeals. The taxpayer must timely file the appeal with the Service office that rejected the offer. An appeal is timely filed if it is delivered to the Service or postmarked within thirty days from the date of the letter of rejection.

.03 Pursuant to section 6331, the Service may not make a levy on the taxpayer's property or rights to property for thirty days following the rejection of an offer to compromise or while an appeal of a rejection is pending.



SECTION 10. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 96-38 is obsoleted.



SECTION 11. EFFECTIVE DATE

This revenue procedure is effective August 21, 2003, the date this revenue procedure was announced by news release, except that the provisions relating to the offer in compromise application fee are not effective for offers submitted prior to November 1, 2003.



SECTION 12. DRAFTING INFORMATION

The principal author of this revenue procedure is Sheara L. Krvaric of the Office of the Associate Chief Counsel (Procedure and Administration), Collection, Bankruptcy & Summonses Division. For further information regarding this revenue procedure contact Branch 2 of Collection, Bankruptcy & Summonses on (202) 622-3620 (not a toll free call).

Section 7122 Offer in Compromise Regulations
Table of contents. --This section lists the major captions that appear in the regulations under §301.7122-1.

§301.7122-1. Compromises.

(a) In general.

(b) Grounds for compromise.

(c) Special rules for the evaluation of offers to compromise.

(d) Procedures for submission and consideration of offers.

(e) Acceptance of an offer to compromise a tax liability.

(f) Rejection of an offer to compromise.

(g) Effect of offer to compromise on collection activity

(h) Deposits.

(i) Statute of limitations.

(j) Inspection with respect to accepted offers to compromise.

(k) Effective date.

[Reg. §301.7122-0.]

.01 Historical Comment: Adopted 7/18/2002 by T.D. 9007.

Compromises
In general

(1) If the Secretary determines that there are grounds for compromise under this section, the Secretary may, at the Secretary's discretion, compromise any civil or criminal liability arising under the internal revenue laws prior to reference of a case involving such a liability to the Department of Justice for prosecution or defense.

(2) An agreement to compromise may relate to a civil or criminal liability for taxes, interest, or penalties. Unless the terms of the offer and acceptance expressly provide otherwise, acceptance of an offer to compromise a civil liability does not remit a criminal liability, nor does acceptance of an offer to compromise a criminal liability remit a civil liability.
(b) Grounds for compromise

(1) Doubt as to liability. --Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability. See paragraph (f)(4) of this section for special rules applicable to rejection of offers in cases where the Internal Revenue Service (IRS) is unable to locate the taxpayer's return or return information to verify the liability.

(2) Doubt as to collectibility. --Doubt as to collectibility exists in any case where the taxpayer's assets and income are less than the full amount of the liability. (3) Promote effective tax administration

(i) A compromise may be entered into to promote effective tax administration when the Secretary determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship within the meaning of §301.6343-1.

(ii) If there are no grounds for compromise under paragraphs (b)(1), (2), or (3)(i) of this section, the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. A taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full.

(iii) No compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by taxpayers with the tax laws.
(c) Special rules for evaluating offers to compromise

(1) In general. --Once a basis for compromise under paragraph (b) of this section has been identified, the decision to accept or reject an offer to compromise, as well as the terms and conditions agreed to, is left to the discretion of the Secretary. The determination whether to accept or reject an offer to compromise will be based upon consideration of all the facts and circumstances, including whether the circumstances of a particular case warrant acceptance of an amount that might not otherwise be acceptable under the Secretary's policies and procedures.

(2) Doubt as to collectibility

(i) Allowable Expenses. --A determination of doubt as to collectibility will include a determination of ability to pay. In determining ability to pay, the Secretary will permit taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the taxpayer's case. To guide this determination, guidelines published by the Secretary on national and local living expense standards will be taken into account.

(ii) Nonliable spouses

(A) In general. --Where a taxpayer is offering to compromise a liability for which the taxpayer's spouse has no liability, the assets and income of the nonliable spouse will not be considered in determining the amount of an adequate offer. The assets and income of a nonliable spouse may be considered, however, to the extent property has been transferred by the taxpayer to the nonliable spouse under circumstances that would permit the IRS to effect collection of the taxpayer's liability from such property (e.g., property that was conveyed in fraud of creditors), property has been transferred by the taxpayer to the nonliable spouse for the purpose of removing the property from consideration by the IRS in evaluating the compromise, or as provided in paragraph (c)(2)(ii)(B) of this section. The IRS also may request information regarding the assets and income of the nonliable spouse for the purpose of verifying the amount of and responsibility for expenses claimed by the taxpayer.

(B) Exception. --Where collection of the taxpayer's liability from the assets and income of the nonliable spouse is permitted by applicable state law (e.g., under state community property laws), the assets and income of the nonliable spouse will be considered in determining the amount of an adequate offer except to the extent that the taxpayer and the nonliable spouse demonstrate that collection of such assets and income would have a material and adverse impact on the standard of living of the taxpayer, the nonliable spouse, and their dependents.

(3) Compromises to promote effective tax administration

(i) Factors supporting (but not conclusive of) a determination that collection would cause economic hardship within the meaning of paragraph (b)(3)(i) of this section include, but are not limited to --

(A) Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer's financial resources will be exhausted providing for care and support during the course of the condition;

(B) Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and

(C) Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.

(ii) Factors supporting (but not conclusive of) a determination that compromise would undermine compliance within the meaning of paragraph (b)(3)(iii) of this section include, but are not limited to --

(A) Taxpayer has a history of noncompliance with the filing and payment requirements of the Internal Revenue Code;

(B) Taxpayer has taken deliberate actions to avoid the payment of taxes; and

(C) Taxpayer has encouraged others to refuse to comply with the tax laws.

(iii) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary's discretion, under the economic hardship provisions of paragraph (b)(3)(i) of this section:

Example 1. The taxpayer has assets sufficient to satisfy the tax liability. The taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the taxpayer will need to use the equity in his assets to provide for adequate basic living expenses and medical care for his child. The taxpayer's overall compliance history does not weigh against compromise.

Example 2. The taxpayer is retired and his only income is from a pension. The taxpayer's only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave the taxpayer without an adequate means to provide for basic living expenses. The taxpayer's overall compliance history does not weigh against compromise.

Example 3. The taxpayer is disabled and lives on a fixed income that will not, after allowance of basic living expenses, permit full payment of his liability under an installment agreement. The taxpayer also owns a modest house that has been specially equipped to accommodate his disability. The taxpayer's equity in the house is sufficient to permit payment of the liability he owes. However, because of his disability and limited earning potential, the taxpayer is unable to obtain a mortgage or otherwise borrow against this equity. In addition, because the taxpayer's home has been specially equipped to accommodate his disability, forced sale of the taxpayer's residence would create severe adverse consequences for the taxpayer. The taxpayer's overall compliance history does not weigh against compromise.

(iv) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary's discretion, under the public policy and equity provisions of paragraph (b)(3)(ii) of this section:

Example 1. In October of 1986, the taxpayer developed a serious illness that resulted in almost continuous hospitalizations for a number of years. The taxpayer's medical condition was such that during this period the taxpayer was unable to manage any of his financial affairs. The taxpayer has not filed tax returns since that time. The taxpayer's health has now improved and he has promptly begun to attend to his tax affairs. He discovers that the IRS prepared a substitute for return for the 1986 tax year on the basis of information returns it had received and had assessed a tax deficiency. When the taxpayer discovered the liability, with penalties and interest, the tax bill is more than three times the original tax liability. The taxpayer's overall compliance history does not weigh against compromise.

Example 2. The taxpayer is a salaried sales manager at a department store who has been able to place $2,000 in a tax-deductible IRA account for each of the last two years. The taxpayer learns that he can earn a higher rate of interest on his IRA savings by moving those savings from a money management account to a certificate of deposit at a different financial institution. Prior to transferring his savings, the taxpayer submits an e-mail inquiry to the IRS at its Web Page, requesting information about the steps he must take to preserve the tax benefits he has enjoyed and to avoid penalties. The IRS responds in an answering e-mail that the taxpayer may withdraw his IRA savings from his neighborhood bank, but he must redeposit those savings in a new IRA account within 90 days. The taxpayer withdraws the funds and redeposits them in a new IRA account 63 days later. Upon audit, the taxpayer learns that he has been misinformed about the required rollover period and that he is liable for additional taxes, penalties and additions to tax for not having redeposited the amount within 60 days. Had it not been for the erroneous advice that is reflected in the taxpayer's retained copy of the IRS e-mail response to his inquiry, the taxpayer would have redeposited the amount within the required 60-day period. The taxpayer's overall compliance history does not weigh against compromise.

(d) Procedures for submission and consideration of offers

(1) In general. --An offer to compromise a tax liability pursuant to section 7122 must be submitted according to the procedures, and in the form and manner, prescribed by the Secretary. An offer to compromise a tax liability must be made in writing, must be signed by the taxpayer under penalty of perjury, and must contain all of the information prescribed or requested by the Secretary. However, taxpayers submitting offers to compromise liabilities solely on the basis of doubt as to liability will not be required to provide financial statements.
(2) When offers become pending and return of offers. --An offer to compromise becomes pending when it is accepted for processing. The IRS may not accept for processing any offer to compromise a liability following reference of a case involving such liability to the Attorney General for prosecution or defense. If an offer accepted for processing does not contain sufficient information to permit the IRS to evaluate whether the offer should be accepted, the IRS will request that the taxpayer provide the needed additional information. If the taxpayer does not submit the additional information that the IRS has requested within a reasonable time period after such a request, the IRS may return the offer to the taxpayer. The IRS may also return an offer to compromise a tax liability if it determines that the offer was submitted solely to delay collection or was otherwise nonprocessable. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the IRS returns the offer to the taxpayer. See paragraphs (f)(5)(ii) and (g)(4) of this section for rules regarding the effect of such returns of offers.
(3) Withdrawal. --An offer to compromise a tax liability may be withdrawn by the taxpayer or the taxpayer's representative at any time prior to the IRS' acceptance of the offer to compromise. An offer will be considered withdrawn upon the IRS' receipt of written notification of the withdrawal of the offer either by personal delivery or certified mail, or upon issuance of a letter by the IRS confirming the taxpayer's intent to withdraw the offer.

(e) Acceptance of an offer to compromise a tax liability

(1) An offer to compromise has not been accepted until the IRS issues a written notification of acceptance to the taxpayer or the taxpayer's representative.

(2) As additional consideration for the acceptance of an offer to compromise, the IRS may request that taxpayer enter into any collateral agreement or post any security which is deemed necessary for the protection of the interests of the United States.

(3) Offers may be accepted when they provide for payment of compromised amounts in one or more equal or unequal installments.

(4) If the final payment on an accepted offer to compromise is contingent upon the immediate and simultaneous release of a tax lien in whole or in part, such payment must be made in accordance with the forms, instructions, or procedures prescribed by the Secretary.

(5) Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one taxpayer does not extinguish the liability of, nor prevent the IRS from taking action to collect from, any person not named in the offer who is also liable for the tax to which the compromise relates. Neither the taxpayer nor the Government will, following acceptance of an offer to compromise, be permitted to reopen the case except in instances where --

(i) False information or documents are supplied in conjunction with the offer;

(ii) The ability to pay or the assets of the taxpayer are concealed; or

(iii) A mutual mistake of material fact sufficient to cause the offer agreement to be reformed or set aside is discovered.
(6) Opinion of Chief Counsel. --Except as otherwise provided in this paragraph (e)(6), if an offer to compromise is accepted, there will be placed on file the opinion of the Chief Counsel for the IRS with respect to such compromise, along with the reasons therefor. However, no such opinion will be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. Also placed on file will be a statement of --

(i) The amount of tax assessed;

(ii) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed; and

(iii) The amount actually paid in accordance with the terms of the compromise.
(f) Rejection of an offer to compromise

(1) An offer to compromise has not been rejected until the IRS issues a written notice to the taxpayer or his representative, advising of the rejection, the reason(s) for rejection, and the right to an appeal.

(2) The IRS may not notify a taxpayer or taxpayer's representative of the rejection of an offer to compromise until an independent administrative review of the proposed rejection is completed.

(3) No offer to compromise may be rejected solely on the basis of the amount of the offer without evaluating that offer under the provisions of this section and the Secretary's policies and procedures regarding the compromise of cases.

(4) Offers based upon doubt as to liability. --Offers submitted on the basis of doubt as to liability cannot be rejected solely because the IRS is unable to locate the taxpayer's return or return information for verification of the liability.
(5) Appeal of rejection of an offer to compromise

(i) In general. --The taxpayer may administratively appeal a rejection of an offer to compromise to the IRS Office of Appeals (Appeals) if, within the 30-day period commencing the day after the date on the letter of rejection, the taxpayer requests such an administrative review in the manner provided by the Secretary.

(ii) Offer to compromise returned following a determination that the offer was nonprocessable, a failure by the taxpayer to provide requested information, or a determination that the offer was submitted for purposes of delay. --Where a determination is made to return offer documents because the offer to compromise was nonprocessable, because the taxpayer failed to provide requested information, or because the IRS determined that the offer to compromise was submitted solely for purposes of delay under paragraph (d)(2) of this section, the return of the offer does not constitute a rejection of the offer for purposes of this provision and does not entitle the taxpayer to appeal the matter to Appeals under the provisions of this paragraph (f)(5). However, if the offer is returned because the taxpayer failed to provide requested financial information, the offer will not be returned until a managerial review of the proposed return is completed.

(g) Effect of offer to compromise on collection activity
(1) In general. --The IRS will not levy against the property or rights to property of a taxpayer who submits an offer to compromise, to collect the liability that is the subject of the offer, during the period the offer is pending, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals.
(2) Revised offers submitted following rejection. --If, following the rejection of an offer to compromise, the taxpayer makes a good faith revision of that offer and submits the revised offer within 30 days after the date of rejection, the IRS will not levy to collect from the taxpayer the liability that is the subject of the revised offer to compromise while that revised offer is pending.
(3) Jeopardy. --The IRS may levy to collect the liability that is the subject of an offer to compromise during the period the IRS is evaluating whether that offer will be accepted if it determines that collection of the liability is in jeopardy.

(4) Offers to compromise determined by IRS to be nonprocessable or submitted solely for purposes of delay. --If the IRS determines, under paragraph (d)(2) of this section, that a pending offer did not contain sufficient information to permit evaluation of whether the offer should be accepted, that the offer was submitted solely to delay collection, or that the offer was otherwise nonprocessable, then the IRS may levy to collect the liability that is the subject of that offer at any time after it returns the offer to the taxpayer.

(5) Offsets under section 6402. --Notwithstanding the evaluation and processing of an offer to compromise, the IRS may, in accordance with section 6402, credit any overpayments made by the taxpayer against a liability that is the subject of an offer to compromise and may offset such overpayments against other liabilities owed by the taxpayer to the extent authorized by section 6402.

(6) Proceedings in court. --Except as otherwise provided in this paragraph (g)(6), the IRS will not refer a case to the Department of Justice for the commencement of a proceeding in court, against a person named in a pending offer to compromise, if levy to collect the liability is prohibited by paragraph (g)(1) of this section. Without regard to whether a person is named in a pending offer to compromise, however, the IRS may authorize the Department of Justice to file a counterclaim or third-party complaint in a refund action or to join that person in any other proceeding in which liability for the tax that is the subject of the pending offer to compromise may be established or disputed, including a suit against the United States under 28 U.S.C. 2410. In addition, the United States may file a claim in any bankruptcy proceeding or insolvency action brought by or against such person.

(h) Deposits. --Sums submitted with an offer to compromise a liability or during the pendency of an offer to compromise are considered deposits and will not be applied to the liability until the offer is accepted unless the taxpayer provides written authorization for application of the payments. If an offer to compromise is withdrawn, is determined to be nonprocessable, or is submitted solely for purposes of delay and returned to the taxpayer, any amount tendered with the offer, including all installments paid on the offer, will be refunded without interest. If an offer is rejected, any amount tendered with the offer, including all installments paid on the offer, will be refunded, without interest, after the conclusion of any review sought by the taxpayer with Appeals. Refund will not be required if the taxpayer has agreed in writing that amounts tendered pursuant to the offer may be applied to the liability for which the offer was submitted.

(i) Statute of limitations

(1) Suspension of the statute of limitations on collection. --The statute of limitations on collection will be suspended while (2) Extension of the statute of limitations on assessment. --For any offer to compromise, the IRS may require, where appropriate, the extension of the statute of limitations on assessment. However, in any case where waiver of the running of the statutory period of limitations on assessment is sought, the taxpayer must be notified of the right to refuse to extend the period of limitations or to limit the extension to particular issues or particular periods of time.
(j) Inspection with respect to accepted offers to compromise. --For provisions relating to the inspection of returns and accepted offers to compromise, see section 6103(k)(1).

(k) Effective date. --This section applies to offers to compromise pending on or submitted on or after July 18, 2002. [Reg. §301.7122-1.]

.01 Historical Comment: Adopted 7/18/2002 by T.D. 9007. [Reg. §301.7122-1 does not reflect P.L. 109-222 (2006).

Offer to compromise fee
(a) Applicability. --This section applies to the processing of offers to compromise tax liabilities pursuant to §301.7122-1 of this chapter. Except as provided in this section, this fee applies to all offers to compromise accepted for processing.

(b) Fee

(1) The fee for processing an offer to compromise is $150.00, except that no fee will be charged if an offer is --

(i) Based solely on doubt as to liability as defined in §301.7122-1(b)(1) of this chapter; or

(ii) Made by a low income taxpayer, that is, an individual who falls at or below the dollar criteria established by the poverty guidelines updated annually in the Federal Register by the U.S. Department of Health and Human Services under authority of section 673(2) of the Omnibus Budget Reconciliation Act of 1981 (95 Stat. 357, 511) or such other measure that is adopted by the Secretary.

(2) The fee will be applied against the amount of the offer, unless the taxpayer requests that it be refunded, if the offer is --

(i) Accepted to promote effective tax administration pursuant to §301.7122-1(b)(3) of this chapter; or

(ii) Accepted based on doubt as to collectibility and a determination that collection of an amount greater than the amount offered would create economic hardship within the meaning of §301.6343-1 of this chapter.

(3) Except as otherwise provided in this paragraph (b), the fee will not be refunded to the taxpayer if the offer is accepted, rejected, withdrawn, or returned as nonprocessable after acceptance for processing.

(4) No additional fee will be charged if a taxpayer resubmits an offer the Secretary determines to have been rejected in error or returned in error after acceptance for processing.

(c) Person liable for the fee. --The person liable for the processing fee is the taxpayer whose tax liabilities are the subject of the offer. [Reg. §300.3.]

.01 Historical Comment: Proposed 11/6/2002. Adopted 8/14/2003 by T.D. 9086. [Reg. §300.3 does not reflect P.L. 109-222 (2006).

.D. 9007 T.D. 9007

I.R.B. 2002-33, 349 (August 19, 2002)


[Code Sec. 7122]

Tax liabilities: Compromise: Offer-in-compromise: Statute of limitations: Economic hardship.




[4830-01-p]

DEPARTMENT OF THE TREASURY

Internal Revenue Service
26 CFR Part 301
[TD 9007]
RIN 1545-AW87
Compromise of Tax Liabilities
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations and removal of temporary regulations.
SUMMARY: This document contains final regulations relating to the compromise of internal revenue taxes. The regulations adopt the rules of the temporary regulations and reflect changes to the law made by the Internal Revenue Service Restructuring and Reform Act of 1998 and the Taxpayer Bill of Rights 2.
EFFECTIVE DATE: These regulations are effective July 18, 2002.
FOR FURTHER INFORMATION CONTACT: Frederick W. Schindler, (202) 622-3620 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains final regulations amending the Procedure and Administration Regulations (26 CFR part 301) under section 7122 of the Internal Revenue Code (Code). The regulations reflect the amendment of section 7122 by section 3462 of the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA 1998), Public Law 105-206 (112 Stat. 685, 764) and by section 503 of the Taxpayer Bill of Rights II, Public Law 104-168 (110 Stat. 1452, 1461).

As amended by RRA 1998, section 7122 provides that the Secretary will develop guidelines to determine when an offer to compromise is adequate and should be accepted to resolve a dispute. The legislative history accompanying RRA 1998 explains that Congress intended that, in certain circumstances, factors such as equity, hardship, and public policy be taken into account by the IRS in evaluating whether the compromise of individual tax liabilities would promote effective tax administration. H. Conf. Rep. 599, 105th Cong., 2d Sess. 289 (1998). On July 21, 1999, temporary regulations (TD 8829; 64 FR 39020) and a notice of proposed rulemaking (REG-116991-98; 64 FR 39106) reflecting these changes were published in the Federal Register. Four written comments on the temporary and proposed regulations were received. A public hearing on the regulations was requested but that request was later withdrawn. No public hearing was scheduled or held. The final regulations adopt the rules of the temporary regulations with minor changes.


Explanation of Provisions

A compromise is an agreement between a taxpayer and the Government that settles a tax liability for payment of less that the total amount determined and assessed. Consistent with its mission of applying the tax laws with integrity and fairness to all, the IRS generally expects that all taxpayers will pay the total amount due, regardless of amount. See Policy Statement P-5-2, Collecting Principles (Approved February 17, 2000), reprinted at IRM 1.2.1.5.2. When attempting to resolve a tax delinquency, the IRS will work with taxpayers to achieve full payment of all tax, penalties, and interest imposed by Congress. Where payment in full cannot immediately be achieved, the IRS may, at its discretion, allow taxpayers to pay over time through installment agreements.

The IRS recognizes that it is both sound business practice and good tax policy to settle some cases for less than the total amount due. Prior to issuance of the temporary regulations, the IRS had a longstanding practice of compromising where there was doubt as to the existence or amount of the tax liability or doubt that the total amount due could be collected. The final regulations continue these traditional grounds for compromise. In addition, to reflect the changes made by RRA 1998, the final regulations allow compromise where there is no doubt as to liability or as to collectibility, but where compromise would promote effective tax administration because either (1) collection of the liability would create economic hardship, or (2) compelling public policy or equity considerations provide a sufficient basis for compromising the liability. Compromise based on these hardship and public policy/equity bases, however, may not be authorized if compromise would undermine compliance with the tax laws.


Effective Tax Administration--Economic Hardship

The final regulations retain the reference in the temporary regulations to the economic hardship standard of §301.6343-1, which defines economic hardship as the inability to pay reasonable basic living expenses. In determining reasonable basic living expenses, §301.6343-1 directs the IRS to consider relevant information such as the taxpayer's age, employment status and history, number of dependents, and other "unique circumstances." The final regulations supplement this standard by providing a non-exclusive list of factors which support a finding of economic hardship, and by providing examples to illustrate application of the standard.

The fourth example of economic hardship in the temporary regulations, involving a business taxpayer, has been removed in order to eliminate an inconsistency. The economic hardship standard of §301.6343-1 specifically applies only to individuals. The fourth example was included in the temporary regulations in the event that a standard for evaluating economic hardship with respect to non-individuals could be developed. After evaluating this issue further, the IRS and Treasury Department have concluded that an economic hardship standard for non-individuals does not necessarily promote effective tax administration. Permitting compromise in non-individual cases where there is no doubt as to collectibility, for instance, would raise the issue of whether the Government should be foregoing the collection of taxes to support a nonviable business.

Although economic hardship therefore is not a basis for compromise for non-individuals under the final regulations, IRS experience has shown that the doubt as to collectibility standard often may permit the resolution of cases involving businesses and other non-individual taxpayers. In addition, even if a business or other non-individual is unable to compromise on liability or collectibility grounds, compelling public policy or equity considerations (discussed below) may provide sufficient grounds to compromise the case.

A commenting party suggested that the economic hardship standard and examples were not inclusive enough, specifically stating that the first two examples of economic hardship in the temporary regulations were drawn too narrowly. The first example illustrating economic hardship described a taxpayer whose assets and income are likely to be exhausted caring for a dependent child. The commenting party believed that the regulations would better promote effective tax administration if the example were expanded to include care of a dependent parent or other family member. The second example described a retired taxpayer whose only income is from a pension and whose only asset is a retirement account. The taxpayer could pay the tax liability in full by liquidating his retirement account, but doing so would leave the taxpayer without adequate means of support. The commenting party suggested that the example should specifically state that the age of the taxpayer should be taken into account. Otherwise, a taxpayer close to retirement age may feel compelled to retire so as to eliminate other sources of income and qualify under this example since retirement funds would then be the only source of income. A second commenting party also suggested that the moral or legal obligation to support others be listed as a factor supporting a finding of economic hardship.

The final regulations adopt these suggestions, in part, by stating that one factor supporting a finding of economic hardship might be that all available funds are used for the care of a dependent. Although the final regulations include examples to illustrate the application of the economic hardship standard, the central inquiry is whether full collection of the liability would render the taxpayer unable to provide for reasonable basic living expenses. Facts such as the number of dependents and the age and health of taxpayers and their dependents are factors which §301.6343-1 provides should be considered when making that economic hardship determination. Furthermore, the examples in the final regulations are not intended to be exclusive and should not be read to suggest that all of the facts discussed in a given example must be present in a case in order for compromise to be authorized.


Effective Tax Administration--Public Policy and Equity

The temporary regulations provided that the IRS may compromise a liability to promote effective tax administration even if no other basis for compromise is available. (As discussed above, compromise on the basis of economic hardship is not available to non-individuals under the final regulations.) The temporary regulations provided that the IRS may compromise under the non-hardship effective tax administration standard to promote effective tax administration when, "[r]egardless of the taxpayer's financial circumstances, exceptional circumstances exist such that collection of the full liability will be detrimental to voluntary compliance by taxpayers."

The "detrimental to voluntary compliance" standard in the temporary regulations was intended to indicate that the IRS may compromise in those rare cases where collection of the full liability would adversely affect the overall tax system. Based on public comments and on IRS experience in implementing the temporary regulations, this standard has been restated in the final regulations to clarify the types of cases that may qualify for compromise on these grounds. Compromise under the non-hardship effective tax administration standard in the final regulations, however, still is expected to be appropriate only in those rare cases where collection would adversely affect the overall tax system.

Under the final regulations, a taxpayer seeking to compromise a liability on this basis must identify compelling public policy or equity considerations providing a sufficient basis for compromising the liability. The circumstances must be such that compromise is justified even though a similarly situated taxpayer may have paid his liability in full. Before accepting an offer based on equity and public policy considerations, the IRS must conclude that collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner.

The clarification to the non-hardship effective tax administration standard in the final regulations recognizes that compromise on these grounds raises the issue of disparate treatment of taxpayers who are able to pay the full amount of their liabilities without economic hardship. Some taxpayers will pay less than the full amount owed, while others must pay in full. (Some taxpayers who pay in full also may be in situations similar to that of the taxpayer requesting compromise.) Accordingly, the final regulations specify that a taxpayer must demonstrate that the circumstances of the taxpayer's liability implicate public policy or equity concerns compelling enough to justify compromise notwithstanding this inherent inequity. As noted earlier, the cases satisfying the equity and public policy standard are expected to be rare. In applying this standard, the IRS will presume that the correct application of the tax laws produces a fair and equitable result, absent exceptional circumstances.

The notice of proposed rulemaking specifically encouraged the public to make comments or provide examples regarding the particular types of cases or situations in which the Secretary's authority to compromise should be used because: (1) collection of the full amount of tax liability would be detrimental to voluntary compliance (i.e., may be appropriate for compromise under the non-hardship effective tax administration standard) or (2) IRS delay in determining the tax liability has resulted in the accumulation of significant interest and penalties. Parties providing comments regarding delay in interest and penalty cases were asked to consider the possible interplay between cases compromised under this provision and the relief accorded taxpayers under section 6404(e).

Two parties submitted comments in response to this request. Both suggested that the regulations be expanded to authorize compromise in situations where delay in determining the taxpayer's liability caused substantial interest and penalties to accrue. The first suggested that compromise on the basis that collection in full would be detrimental to voluntary compliance was warranted when any undue delay by the IRS resulted in the accumulation of penalties and interest. The commenting party suggested that the regulations include delay by the IRS in determining the taxpayer's liability, issuing a revenue agent's report or notice of deficiency, or litigating the issues as factors and examples supporting compromise on these grounds. The commenting party did not suggest a standard for determining "undue delay" and did not discuss whether this kind of expansion of the compromise regulations would undermine the interest abatement provisions of section 6404(e).

The second party to comment on this provision in the regulations suggested compromise should be authorized where a liability results from factors beyond the taxpayer's control and the accumulation of interest and penalties is disproportionately large compared to the initial liability. The specific example suggested by the commenting party was one in which the Tax Matters Partner (TMP) in a partnership subject to the unified audit procedures of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) fraudulently sells shares in a sham business to other partners and those partners incur substantial interest and penalties attributable to partnership items. According to the commenting party, the failure of the IRS to remove a TMP being investigated for fraud relating to the partnership, and to allow the TMP to continue to represent the partnership during the audit, creates "exceptional circumstances" warranting compromise with other partners. The commenting party acknowledged that section 6404(e) would not usually authorize the abatement of interest under such circumstances because the interest does not result from an unreasonable error or delay by an IRS official in performing a ministerial or managerial act. The commenting party also acknowledged that it would be unwise to craft a rule that would make the Government an insurer of individual taxpayer liabilities attributable to the misdeeds of a tax shelter promoter. However, the commenting party believed that where the IRS's failure to remove the TMP contributed to the problem, compromise is warranted.

The IRS and Treasury Department do not believe that it would promote effective tax administration to authorize compromise solely on the basis of an asserted delay by the IRS, particularly delay that does not support relief under section 6404(e) with respect to accrued interest, or on the basis that a third party, such as the taxpayer's partner, is claimed to have defrauded or otherwise caused financial harm to the taxpayer. Nevertheless, cases in which a taxpayer believes the liability was caused, in whole or in part, by delay on the part of the IRS or by the actions of third parties may be appropriate for compromise under the public policy and equity standard. Such cases, however, are expected to be rare, as the taxpayer must identify compelling public policy or equity concerns that satisfy the standard set forth above.

The IRS and Treasury Department are mindful that the Congressional Conference Committee, in adding section 7122(c) as part of RRA 1998, anticipated that the IRS may use the authority provided in section 7122(c) to resolve longstanding cases by foregoing penalties and interest resulting from delays in determining a taxpayer's liability. See H. Conf. Rep. 599, 105th Cong., 2d Sess. 289 (1998). The IRS' experience in applying the temporary regulations is that these regulations have given effect to the intent of Congress, as expressed in the Conference Report, since cases involving substantial interest and penalties often can be compromised under the standards of doubt as to collectibility and economic hardship. Similarly, although a taxpayer is in the best position to anticipate, and protect himself or herself from, the risks of business associations and transactions, the misdeeds of third parties that may have contributed to a tax liability may be taken into account when determining whether to accept a compromise based on doubt as to collectibility or on a finding that collection would cause economic hardship.


Amount of Compromise if Basis for Compromise Exists

The final regulations set forth the permissible bases for compromise, one of which must be established in order to accept an offer to compromise liabilities arising under the internal revenue laws. They do not, however, prescribe the amount which must be offered in order for an offer to be acceptable. The amount to be paid, future compliance, or other conditions precedent to satisfaction of a liability for less than the full amount due are matters left to the discretion of the Secretary. For the sake of clarity, the final regulations now expressly state this principle, which was stated only in the preamble to the temporary regulations.

As required by section 7122(c)(2)(A) and (B), added by RRA 1998, the final regulations provide for the development and publication of national and local living allowances that permit taxpayers entering into offers to compromise to have an adequate means to provide for their basic living expenses. The determination of whether the published standards should be applied in any particular case must be based upon an evaluation of the individual facts and circumstances presented. The Secretary will continue to determine the appropriate means to publish these national and local living allowances.

A commenting party suggested that the national and local living allowance standards be eliminated in favor of a rule requiring all offer specialists to look only to an individual taxpayer's actual facts and circumstances to determine the amount necessary to provide for reasonable basic living expenses. According to the commenting party, IRS employees rarely depart from the national and local standards, which, in practice, serve as a "cap" on expenses, rather than as a general guide to be applied based on the specific facts of a case.

Because publication of the national and local standards is required by section 7122(c)(2)(A), the suggestion that the standards be eliminated has not been adopted. In accordance with section 7122(c)(2)(B), the final regulations require that the IRS consider the facts and circumstances of the case when determining basic living expenses. Consistent with this requirement in the statute and regulations, the IRS has issued internal guidance requiring that the particular facts and circumstance of a taxpayer's case be considered whenever the expenses standards are applied, and that expense allowances beyond the standards be used whenever use of the standards would result in a taxpayer not having adequate means to provide for basic living expenses.


Other Provisions

Section 7122(c)(3)(A) prohibits the rejection of an offer to compromise by a low income taxpayer based solely on the amount of the offer. The final regulations expand this rule to apply to all taxpayers regardless of income level. The final regulations state that no offer may be rejected based solely on the amount of the offer. Offers will only be rejected when the IRS determines that no basis for compromise under this section is present or that the offer is unacceptable under the Secretary's policies and procedures.

In accordance with section 7122(d)(1), the final regulations provide that all proposed rejections of offers to compromise will receive independent administrative review prior to final rejection. Section 7122(d)(2) requires and the regulations also provide that the taxpayer may appeal any rejection of an offer to compromise to the IRS Office of Appeals. The final regulations provide, however, that when the IRS returns an offer to compromise because the offer was submitted solely to delay collection, or because the taxpayer failed to provide requested information required by the IRS to evaluate or process the offer under IRS procedures, the return of the offer does not constitute a rejection and, thus, is not subject to appeal. In the event that the IRS institutes collection action following the return of an offer to compromise, the taxpayer may have the right to consideration of the whole of his collection case under other provisions of the Code.

Although not required by any provision of the Code, the temporary regulations provided that an offer could not be returned to a taxpayer for failure to submit requested financial information until an independent administrative review of the proposed return was completed. The requirement of an independent administrative review of proposed returns was the source of significant delays and was redundant because an IRS manager must review and approve all returns of offers for failure to submit requested financial information. The final regulations therefore require review only by an IRS manager in these cases.

Pursuant to section 6331(k), the final regulations also provide that the IRS may not levy to collect a liability while an offer to compromise is pending, or for the 30 days following any rejection of an offer to compromise, or during any period that an appeal of any rejection is being considered, when such appeal is instituted within the 30 days following rejection. Levy will not, however, be precluded in any case where collection is in jeopardy or the offer to compromise was submitted solely to delay collection. The regulations also correct for an omission in the temporary regulations by providing that the IRS may not refer a case to the Department of Justice to collect an unpaid tax through a judicial proceeding while an offer to compromise that tax is pending or while a rejection of such an offer is being considered by the IRS Office of Appeals. The IRS may, however, authorize the Department of Justice to file a counterclaim in any refund proceeding commenced by a taxpayer, participate in bankruptcy or insolvency cases commenced by or against the taxpayer, or join a taxpayer in any other proceeding in which liability for the tax at issue may be established or disputed.

The final regulations also implement section 503(a) of the Taxpayer Bill of Rights II by specifying that Chief Counsel review of an accepted offer to compromise is required only for offers in compromise involving $50,000 or more in unpaid liabilities.


Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because these regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the preceding temporary regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.


Drafting Information

The principal author of these regulations is Frederick W. Schindler of the Office of Associate Chief Counsel (Procedure and Administration), Collection, Bankruptcy & Summonses Division.


List of Subjects in 26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.


Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 301 is amended as follows:


PART 301--PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805***

Par. 2. Sections 301.7122-0 and 301.7122-1 are added to read as follows:


§301.7122-0 Table of contents.

This section lists the major captions that appear in the regulations under §301.7122-1.


§301.7122-1 Compromises.
(a) In general.
(b) Grounds for compromise.
(c) Special rules for the evaluation of offers to compromise.
(d) Procedures for submission and consideration of offers.
(e) Acceptance of an offer to compromise a tax liability.
(f) Rejection of an offer to compromise.
(g) Effect of offer to compromise on collection activity
(h) Deposits.
(i) Statute of limitations.
(j) Inspection with respect to accepted offers to compromise.
(k) Effective date.

§301.7122-1 Compromises.

(a) In general--(1) If the Secretary determines that there are grounds for compromise under this section, the Secretary may, at the Secretary's discretion, compromise any civil or criminal liability arising under the internal revenue laws prior to reference of a case involving such a liability to the Department of Justice for prosecution or defense.

(2) An agreement to compromise may relate to a civil or criminal liability for taxes, interest, or penalties. Unless the terms of the offer and acceptance expressly provide otherwise, acceptance of an offer to compromise a civil liability does not remit a criminal liability, nor does acceptance of an offer to compromise a criminal liability remit a civil liability.

(b) Grounds for compromise--(1) Doubt as to liability. Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability. See paragraph (f)(4) of this section for special rules applicable to rejection of offers in cases where the Internal Revenue Service (IRS) is unable to locate the taxpayer's return or return information to verify the liability.

(2) Doubt as to collectibility. Doubt as to collectibility exists in any case where the taxpayer's assets and income are less than the full amount of the liability.

(3) Promote effective tax administration. (i) A compromise may be entered into to promote effective tax administration when the Secretary determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship within the meaning of §301.6343-1.

(ii) If there are no grounds for compromise under paragraphs (b)(1), (2), or (3)(i) of this section, the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. A taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full.

(iii) No compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by taxpayers with the tax laws.

(c) Special rules for evaluating offers to compromise--(1) In general. Once a basis for compromise under paragraph (b) of this section has been identified, the decision to accept or reject an offer to compromise, as well as the terms and conditions agreed to, is left to the discretion of the Secretary. The determination whether to accept or reject an offer to compromise will be based upon consideration of all the facts and circumstances, including whether the circumstances of a particular case warrant acceptance of an amount that might not otherwise be acceptable under the Secretary's policies and procedures.

(2) Doubt as to collectibility--(i) Allowable Expenses. A determination of doubt as to collectibility will include a determination of ability to pay. In determining ability to pay, the Secretary will permit taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the taxpayer's case. To guide this determination, guidelines published by the Secretary on national and local living expense standards will be taken into account.

(ii) Nonliable spouses--(A) In general. Where a taxpayer is offering to compromise a liability for which the taxpayer's spouse has no liability, the assets and income of the nonliable spouse will not be considered in determining the amount of an adequate offer. The assets and income of a nonliable spouse may be considered, however, to the extent property has been transferred by the taxpayer to the nonliable spouse under circumstances that would permit the IRS to effect collection of the taxpayer's liability from such property (e.g., property that was conveyed in fraud of creditors), property has been transferred by the taxpayer to the nonliable spouse for the purpose of removing the property from consideration by the IRS in evaluating the compromise, or as provided in paragraph (c)(2)(ii)(B) of this section. The IRS also may request information regarding the assets and income of the nonliable spouse for the purpose of verifying the amount of and responsibility for expenses claimed by the taxpayer.

(B) Exception. Where collection of the taxpayer's liability from the assets and income of the nonliable spouse is permitted by applicable state law (e.g., under state community property laws), the assets and income of the nonliable spouse will be considered in determining the amount of an adequate offer except to the extent that the taxpayer and the nonliable spouse demonstrate that collection of such assets and income would have a material and adverse impact on the standard of living of the taxpayer, the nonliable spouse, and their dependents.

(3) Compromises to promote effective tax administration--(i) Factors supporting (but not conclusive of) a determination that collection would cause economic hardship within the meaning of paragraph (b)(3)(i) of this section include, but are not limited to--

(A) Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer's financial resources will be exhausted providing for care and support during the course of the condition;

(B) Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and

(C) Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.

(ii) Factors supporting (but not conclusive of) a determination that compromise would undermine compliance within the meaning of paragraph (b)(3)(iii) of this section include, but are not limited to--

(A) Taxpayer has a history of noncompliance with the filing and payment requirements of the Internal Revenue Code;

(B) Taxpayer has taken deliberate actions to avoid the payment of taxes; and

(C) Taxpayer has encouraged others to refuse to comply with the tax laws.

(iii) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary's discretion, under the economic hardship provisions of paragraph (b)(3)(i) of this section:

Example 1. The taxpayer has assets sufficient to satisfy the tax liability. The taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the taxpayer will need to use the equity in his assets to provide for adequate basic living expenses and medical care for his child. The taxpayer's overall compliance history does not weigh against compromise.

Example 2. The taxpayer is retired and his only income is from a pension. The taxpayer's only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave the taxpayer without an adequate means to provide for basic living expenses. The taxpayer's overall compliance history does not weigh against compromise.

Example 3. The taxpayer is disabled and lives on a fixed income that will not, after allowance of basic living expenses, permit full payment of his liability under an installment agreement. The taxpayer also owns a modest house that has been specially equipped to accommodate his disability. The taxpayer's equity in the house is sufficient to permit payment of the liability he owes. However, because of his disability and limited earning potential, the taxpayer is unable to obtain a mortgage or otherwise borrow against this equity. In addition, because the taxpayer's home has been specially equipped to accommodate his disability, forced sale of the taxpayer's residence would create severe adverse consequences for the taxpayer. The taxpayer's overall compliance history does not weigh against compromise.

(iv) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary's discretion, under the public policy and equity provisions of paragraph (b)(3)(ii) of this section:

Example 1. In October of 1986, the taxpayer developed a serious illness that resulted in almost continuous hospitalizations for a number of years. The taxpayer's medical condition was such that during this period the taxpayer was unable to manage any of his financial affairs. The taxpayer has not filed tax returns since that time. The taxpayer's health has now improved and he has promptly begun to attend to his tax affairs. He discovers that the IRS prepared a substitute for return for the 1986 tax year on the basis of information returns it had received and had assessed a tax deficiency. When the taxpayer discovered the liability, with penalties and interest, the tax bill is more than three times the original tax liability. The taxpayer's overall compliance history does not weigh against compromise.

Example 2. The taxpayer is a salaried sales manager at a department store who has been able to place $2,000 in a tax-deductible IRA account for each of the last two years. The taxpayer learns that he can earn a higher rate of interest on his IRA savings by moving those savings from a money management account to a certificate of deposit at a different financial institution. Prior to transferring his savings, the taxpayer submits an e-mail inquiry to the IRS at its Web Page, requesting information about the steps he must take to preserve the tax benefits he has enjoyed and to avoid penalties. The IRS responds in an answering e-mail that the taxpayer may withdraw his IRA savings from his neighborhood bank, but he must redeposit those savings in a new IRA account within 90 days. The taxpayer withdraws the funds and redeposits them in a new IRA account 63 days later. Upon audit, the taxpayer learns that he has been misinformed about the required rollover period and that he is liable for additional taxes, penalties and additions to tax for not having redeposited the amount within 60 days. Had it not been for the erroneous advice that is reflected in the taxpayer's retained copy of the IRS e-mail response to his inquiry, the taxpayer would have redeposited the amount within the required 60-day period. The taxpayer's overall compliance history does not weigh against compromise.

(d) Procedures for submission and consideration of offers--(1) In general. An offer to compromise a tax liability pursuant to section 7122 must be submitted according to the procedures, and in the form and manner, prescribed by the Secretary. An offer to compromise a tax liability must be made in writing, must be signed by the taxpayer under penalty of perjury, and must contain all of the information prescribed or requested by the Secretary. However, taxpayers submitting offers to compromise liabilities solely on the basis of doubt as to liability will not be required to provide financial statements.

(2) When offers become pending and return of offers. An offer to compromise becomes pending when it is accepted for processing. The IRS may not accept for processing any offer to compromise a liability following reference of a case involving such liability to the Attorney General for prosecution or defense. If an offer accepted for processing does not contain sufficient information to permit the IRS to evaluate whether the offer should be accepted, the IRS will request that the taxpayer provide the needed additional information. If the taxpayer does not submit the additional information that the IRS has requested within a reasonable time period after such a request, the IRS may return the offer to the taxpayer. The IRS may also return an offer to compromise a tax liability if it determines that the offer was submitted solely to delay collection or was otherwise nonprocessable. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the IRS returns the offer to the taxpayer. See paragraphs (f)(5)(ii) and (g)(4) of this section for rules regarding the effect of such returns of offers.

(3) Withdrawal. An offer to compromise a tax liability may be withdrawn by the taxpayer or the taxpayer's representative at any time prior to the IRS' acceptance of the offer to compromise. An offer will be considered withdrawn upon the IRS' receipt of written notification of the withdrawal of the offer either by personal delivery or certified mail, or upon issuance of a letter by the IRS confirming the taxpayer's intent to withdraw the offer.

(e) Acceptance of an offer to compromise a tax liability. (1) An offer to compromise has not been accepted until the IRS issues a written notification of acceptance to the taxpayer or the taxpayer's representative.

(2) As additional consideration for the acceptance of an offer to compromise, the IRS may request that taxpayer enter into any collateral agreement or post any security which is deemed necessary for the protection of the interests of the United States.

(3) Offers may be accepted when they provide for payment of compromised amounts in one or more equal or unequal installments.

(4) If the final payment on an accepted offer to compromise is contingent upon the immediate and simultaneous release of a tax lien in whole or in part, such payment must be made in accordance with the forms, instructions, or procedures prescribed by the Secretary.

(5) Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one taxpayer does not extinguish the liability of, nor prevent the IRS from taking action to collect from, any person not named in the offer who is also liable for the tax to which the compromise relates. Neither the taxpayer nor the Government will, following acceptance of an offer to compromise, be permitted to reopen the case except in instances where--

(i) False information or documents are supplied in conjunction with the offer;

(ii) The ability to pay or the assets of the taxpayer are concealed; or

(iii) A mutual mistake of material fact sufficient to cause the offer agreement to be reformed or set aside is discovered.

(6) Opinion of Chief Counsel. Except as otherwise provided in this paragraph (e)(6), if an offer to compromise is accepted, there will be placed on file the opinion of the Chief Counsel for the IRS with respect to such compromise, along with the reasons therefor. However, no such opinion will be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. Also placed on file will be a statement of--

(i) The amount of tax assessed;

(ii) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed; and

(iii) The amount actually paid in accordance with the terms of the compromise.

(f) Rejection of an offer to compromise. (1) An offer to compromise has not been rejected until the IRS issues a written notice to the taxpayer or his representative, advising of the rejection, the reason(s) for rejection, and the right to an appeal.

(2) The IRS may not notify a taxpayer or taxpayer's representative of the rejection of an offer to compromise until an independent administrative review of the proposed rejection is completed.

(3) No offer to compromise may be rejected solely on the basis of the amount of the offer without evaluating that offer under the provisions of this section and the Secretary's policies and procedures regarding the compromise of cases.

(4) Offers based upon doubt as to liability. Offers submitted on the basis of doubt as to liability cannot be rejected solely because the IRS is unable to locate the taxpayer's return or return information for verification of the liability.

(5) Appeal of rejection of an offer to compromise--(i) In general. The taxpayer may administratively appeal a rejection of an offer to compromise to the IRS Office of Appeals (Appeals) if, within the 30-day period commencing the day after the date on the letter of rejection, the taxpayer requests such an administrative review in the manner provided by the Secretary.

(ii) Offer to compromise returned following a determination that the offer was nonprocessable, a failure by the taxpayer to provide requested information, or a determination that the offer was submitted for purposes of delay. Where a determination is made to return offer documents because the offer to compromise was nonprocessable, because the taxpayer failed to provide requested information, or because the IRS determined that the offer to compromise was submitted solely for purposes of delay under paragraph (d)(2) of this section, the return of the offer does not constitute a rejection of the offer for purposes of this provision and does not entitle the taxpayer to appeal the matter to Appeals under the provisions of this paragraph (f)(5). However, if the offer is returned because the taxpayer failed to provide requested financial information, the offer will not be returned until a managerial review of the proposed return is completed.

(g) Effect of offer to compromise on collection activity--(1) In general. The IRS will not levy against the property or rights to property of a taxpayer who submits an offer to compromise, to collect the liability that is the subject of the offer, during the period the offer is pending, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals.

(2) Revised offers submitted following rejection. If, following the rejection of an offer to compromise, the taxpayer makes a good faith revision of that offer and submits the revised offer within 30 days after the date of rejection, the IRS will not levy to collect from the taxpayer the liability that is the subject of the revised offer to compromise while that revised offer is pending.

(3) Jeopardy. The IRS may levy to collect the liability that is the subject of an offer to compromise during the period the IRS is evaluating whether that offer will be accepted if it determines that collection of the liability is in jeopardy.

(4) Offers to compromise determined by IRS to be nonprocessable or submitted solely for purposes of delay. If the IRS determines, under paragraph (d)(2) of this section, that a pending offer did not contain sufficient information to permit evaluation of whether the offer should be accepted, that the offer was submitted solely to delay collection, or that the offer was otherwise nonprocessable, then the IRS may levy to collect the liability that is the subject of that offer at any time after it returns the offer to the taxpayer.

(5) Offsets under section 6402. Notwithstanding the evaluation and processing of an offer to compromise, the IRS may, in accordance with section 6402, credit any overpayments made by the taxpayer against a liability that is the subject of an offer to compromise and may offset such overpayments against other liabilities owed by the taxpayer to the extent authorized by section 6402.

(6) Proceedings in court. Except as otherwise provided in this paragraph (g)(6), the IRS will not refer a case to the Department of Justice for the commencement of a proceeding in court, against a person named in a pending offer to compromise, if levy to collect the liability is prohibited by paragraph (g)(1) of this section. Without regard to whether a person is named in a pending offer to compromise, however, the IRS may authorize the Department of Justice to file a counterclaim or third-party complaint in a refund action or to join that person in any other proceeding in which liability for the tax that is the subject of the pending offer to compromise may be established or disputed, including a suit against the United States under 28 U.S.C. 2410. In addition, the United States may file a claim in any bankruptcy proceeding or insolvency action brought by or against such person.

(h) Deposits. Sums submitted with an offer to compromise a liability or during the pendency of an offer to compromise are considered deposits and will not be applied to the liability until the offer is accepted unless the taxpayer provides written authorization for application of the payments. If an offer to compromise is withdrawn, is determined to be nonprocessable, or is submitted solely for purposes of delay and returned to the taxpayer, any amount tendered with the offer, including all installments paid on the offer, will be refunded without interest. If an offer is rejected, any amount tendered with the offer, including all installments paid on the offer, will be refunded, without interest, after the conclusion of any review sought by the taxpayer with Appeals. Refund will not be required if the taxpayer has agreed in writing that amounts tendered pursuant to the offer may be applied to the liability for which the offer was submitted.

(i) Statute of limitations--(1) Suspension of the statute of limitations on collection. The statute of limitations on collection will be suspended while levy is prohibited under paragraph (g)(1) of this section.

(2) Extension of the statute of limitations on assessment. For any offer to compromise, the IRS may require, where appropriate, the extension of the statute of limitations on assessment. However, in any case where waiver of the running of the statutory period of limitations on assessment is sought, the taxpayer must be notified of the right to refuse to extend the period of limitations or to limit the extension to particular issues or particular periods of time.

(j) Inspection with respect to accepted offers to compromise. For provisions relating to the inspection of returns and accepted offers to compromise, see section 6103(k)(1).

(k) Effective date. This section applies to offers to compromise pending on or submitted on or after July 18, 2002.

Par. 3. Sections 301.7122-0T and 301.7122-1T are removed.


§301.7122-1T [Removed]
Commissioner of Internal Revenue
Charles O. Rossotti
Approved: July 15, 2002
Acting Assistant Secretary of the Treasury (Tax Policy)
Pamela F. Olson
Dale D. Goode
CERTIFIED COPY

Section 7122 - Offer in Compromise Statute


SEC. 7122. COMPROMISES.


7122(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.



7122(b) RECORD. --Whenever a compromise is made by the Secretary in any case, there shall be placed on file in the office of the Secretary the opinion of the General Counsel for the Department of the Treasury or his delegate, with his reasons therefor, with a statement of --



7122(b)(1) The amount of tax assessed,



7122(b)(2) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed, and



7122(b)(3) The amount actually paid in accordance with the terms of the compromise.



Notwithstanding the foregoing provisions of this subsection, no such opinion shall be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. However, such compromise shall be subject to continuing quality review by the Secretary.



7122(c) RULES FOR SUBMISSION OF OFFERS-IN-COMPROMISE. --



7122(c)(1) PARTIAL PAYMENT REQUIRED WITH SUBMISSION. --



7122(c)(1)(A) LUMP-SUM OFFERS. --



7122(c)(1)(A)(i) IN GENERAL. --The submission of any lump-sum offer-in-compromise shall be accompanied by the payment of 20 percent of the amount of such offer.



7122(c)(1)(A)(ii) LUMP-SUM OFFER-IN-COMPROMISE. --For purposes of this section, the term "lump-sum offer-in-compromise" means any offer of payments made in 5 or fewer installments.



7122(c)(1)(B) PERIODIC PAYMENT OFFERS. --



7122(c)(1)(B)(i) IN GENERAL. --The submission of any periodic payment offer-in-compromise shall be accompanied by the payment of the amount of the first proposed installment.



7122(c)(1)(B)(ii) FAILURE TO MAKE INSTALLMENT DURING PENDENCY OF OFFER. --Any failure to make an installment (other than the first installment) due under such offer-in-compromise during the period such offer is being evaluated by the Secretary may be treated by the Secretary as a withdrawal of such offer-in-compromise.



7122(c)(2) RULES OF APPLICATION. --



7122(c)(2)(A) USE OF PAYMENT. --The application of any payment made under this subsection to the assessed tax or other amounts imposed under this title with respect to such tax may be specified by the taxpayer.



7122(c)(2)(B) APPLICATION OF USER FEE. --In the case of any assessed tax or other amounts imposed under this title with respect to such tax which is the subject of an offer-in-compromise to which this subsection applies, such tax or other amounts shall be reduced by any user fee imposed under this title with respect to such offer-in-compromise.



7122(c)(2)(C) WAIVER AUTHORITY. --The Secretary may issue regulations waiving any payment required under paragraph (1) in a manner consistent with the practices established in accordance with the requirements under subsection (d)(3).



7122(d) STANDARDS FOR EVALUATION OF OFFERS. --



7122(d)(1) IN GENERAL. --The Secretary shall prescribe guidelines for officers and employees of the Internal Revenue Service to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute.



7122(d)(2) ALLOWANCES FOR BASIC LIVING EXPENSES. --



7122(d)(2)(A) IN GENERAL. --In prescribing guidelines under paragraph (1), the Secretary shall develop and publish schedules of national and local allowances designed to provide that taxpayers entering into a compromise have an adequate means to provide for basic living expenses.



7122(d)(2)(B) USE OF SCHEDULES. --The guidelines shall provide that officers and employees of the Internal Revenue Service shall determine, on the basis of the facts and circumstances of each taxpayer, whether the use of the schedules published under subparagraph (A) is appropriate and shall not use the schedules to the extent such use would result in the taxpayer not having adequate means to provide for basic living expenses.



7122(d)(3) SPECIAL RULES RELATING TO TREATMENT OF OFFERS. --The guidelines under paragraph (1) shall provide that --



7122(d)(3)(A) an officer or employee of the Internal Revenue Service shall not reject an offer-in-compromise from a low-income taxpayer solely on the basis of the amount of the offer,



7122(d)(3)(B) in the case of an offer-in-compromise which relates only to issues of liability of the taxpayer --



7122(d)(3)(B)(i) such offer shall not be rejected solely because the Secretary is unable to locate the taxpayer's return or return information for verification of such liability; and



7122(d)(3)(B)(ii) the taxpayer shall not be required to provide a financial statement, and



7122(d)(3)(C) any offer-in-compromise which does not meet the requirements of subparagraph (A)(i) or (B)(i), as the case may be, of subsection (c)(1) may be returned to the taxpayer as unprocessable.



7122(e) ADMINISTRATIVE REVIEW. --The Secretary shall establish procedures --



7122(e)(1) for an independent administrative review of any rejection of a proposed offer-in-compromise or installment agreement made by a taxpayer under this section or section 6159 before such rejection is communicated to the taxpayer; and



7122(e)(2) which allow a taxpayer to appeal any rejection of such offer or agreement to the Internal Revenue Service Office of Appeals.



7122(f) DEEMED ACCEPTANCE OF OFFER NOT REJECTED WITHIN CERTAIN PERIOD. --Any offer-in-compromise submitted under this section shall be deemed to be accepted by the Secretary if such offer is not rejected by the Secretary before the date which is 24 months after the date of the submission of such offer. For purposes of the preceding sentence, any period during which any tax liability which is the subject of such offer-in-compromise is in dispute in any judicial proceeding shall not be taken into account in determining the expiration of the 24-month period.



Code Sec. 7122(f)[(g)]), below, as added by P.L. 109-432, §407(d), applies to submissions made and issues raised after the date on which the Secretary first prescribes a list under Code Sec. 6702(c), as amended by P.L. 109-432, §407(a).

7122(f)[(g)] FRIVOLOUS SUBMISSIONS, ETC. --Notwithstanding any other provision of this section, if the Secretary determines that any portion of an application for an offer-in-compromise or installment agreement submitted under this section or section 6159 meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A), then the Secretary may treat such portion as if it were never submitted and such portion shall not be subject to any further administrative or judicial review.



Committee Reports on P.L. 105-206 (IRS Restructuring and Reform Act of 1998)


[This committee report does not reflect changes made by Senate Floor Amendment No. 2380. Selected portions of the Senate Floor Debate are reproduced below. --CCH.]

.17 Offers-in-compromise. --Rights of taxpayers entering into offers-in-compromise. --The provision requires the IRS to develop and publish schedules of national and local allowances that will provide taxpayers entering into an offer-in-compromise with adequate means to provide for basic living expenses. The IRS also will be required to consider the facts and circumstances of a particular taxpayer's case in determining whether the national and local schedules are adequate for that particular taxpayer. If the facts indicate that use of scheduled allowances would be inadequate under the circumstances, the taxpayer would not be limited by the national or local allowances.

The provision prohibits the IRS from rejecting an offer-in-compromise from a low --income taxpayer solely on the basis of the amount of the offer.36 The provision provides that, in the case of an offer-in-compromise submitted solely on the basis of doubt as to liability, the IRS may not reject the offer merely because the IRS cannot locate the taxpayer's file. The provision prohibits the IRS from requesting a financial statement if the taxpayer makes an offer-in-compromise based solely on doubt as to liability.

Suspend collection by levy while offer-in-compromise is pending. --The provision prohibits the IRS from collecting a tax liability by levy (1) during any period that a taxpayer's offer-in-compromise for that liability is being processed, (2) during the 30 days following rejection of an offer, and (3) during any period in which an appeal of the rejection of an offer is being considered. Taxpayers whose offers are rejected and who made good faith revisions of their offers and resubmitted them within 30 days of the rejection or return would be eligible for a continuous period of relief from collection by levy. This prohibition on collection by levy would not apply if the IRS determines that collection is in jeopardy or that the offer was submitted solely to delay collection. The provision provides that the statute of limitations on collection would be tolled for the period during which collection by levy is barred.

Procedures for reviews of rejections of offers-in-compromise and installment agreements. --The provision requires that the IRS implement procedures to review all proposed IRS rejections of taxpayer offers-in-compromise and requests for installment agreements prior to the rejection being communicated to the taxpayer. The provision requires the IRS to allow the taxpayer to appeal any rejection of such offer or agreement to the IRS Office of Appeals. The IRS must notify taxpayers of their right to have an appeals officer review a rejected offer-in-compromise on the application form for an offer-in-compromise.

Publication of taxpayer's rights with respect to offers-in-compromise. --The provision requires the IRS to publish guidance on the rights and obligations of taxpayers and the IRS relating to offers in compromise, including a compliant spouse's right to apply to reinstate an agreement that would otherwise be revoked due to the nonfiling or nonpayment of the other spouse, providing all payments required under the compromise agreement are current.

Liberal acceptance policy. --It is anticipated that the IRS will adopt a liberal acceptance policy for offers-in-compromise to provide an incentive for taxpayers to continue to file tax returns and continue to pay their taxes.

Effective Date. --The provision is generally effective for offers-in-compromise submitted after the date of enactment. The provision suspending levy is effective with respect to offers-in-compromise pending on or made after the 60th day after the date of enactment. --Senate Committee Report (S. REP. NO. 105-174).

Senate Floor Debate. --Mr. MOYNIHAN. --* * * Mr. President, it was with these challenges in mind that Senator Kerrey and I offered this amendment to briefly delay some of the effective dates in the Finance Committee's IRS Restructuring legislation in order to allow time for the Y2K conversion to be completed. This amendment has been drafted based on Commissioner Rossotti's recommendations, and has been modified after consultations with the Majority.

The amendment would delay the effective date on a list of provisions from date of enactment until after the century date change. --Senate Floor Debate for Amendment No. 2380 (144 CONG. REC. 56, S4510).

Conference Agreement. --The conference agreement follows the Senate amendment, with the following additions. First, the provision suspending collection by levy while an offer-in-compromise is pending is also expanded to apply while an installment agreement is pending.

Second, the provision authorizes the Secretary to prescribe guidelines for the IRS to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute. Accordingly, the conferees expect that the present regulations will be expanded so as to permit the IRS, in certain circumstances, to consider additional factors (i.e., factors other than doubt as to liability or collectibility) in determining whether to compromise the income tax liabilities of individual taxpayers. For example, the conferees anticipate that the IRS will take into account factors such as equity, hardship, and public policy where a compromise of an individual taxpayer's income tax liability would promote effective tax administration. The conferees anticipate that, among other situations, the IRS may utilize this new authority to resolve longstanding cases by forgoing penalties and interest which have accumulated as a result of delay in determining the taxpayer's liability. The conferees believe that the ability to compromise tax liability and to make payments of tax liability by installment enhances taxpayer compliance. In addition, the conferees believe that the IRS should be flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations and remain in the tax system. Accordingly, the conferees believe that the IRS should make it easier for taxpayers to enter into offer-in-compromise agreements, and should do more to educate the taxpaying public about the availability of such agreements. --Conference Committee Report (H.R. CONF. REP. NO. 105-599).

36 This provision does not affect the ability of the IRS to reject an offer in compromise made by a taxpayer (other than a low-income taxpayer) because the amount offered is too low.


Joint Committee Summary of P.L. 109-432 (Tax Relief and Health Care Act of 2006)


.14 Frivolous tax submissions. --The provision modifies the IRS-imposed penalty by increasing the amount of the penalty to up to $5,000 and by applying it to all taxpayers and to all types of Federal taxes.

The provision also modifies present law with respect to certain submissions that raise frivolous arguments or that are intended to delay or impede tax administration. The submissions to which the provision applies are requests for a collection due process hearing, installment agreements, and offers-in-compromise. First, the provision permits the IRS to disregard such requests. Second, the provision permits the IRS to impose a penalty of up to $5,000 for such requests, unless the taxpayer withdraws the request after being given an opportunity to do so.

The provision requires the IRS to publish a list of positions, arguments, requests, and submissions determined to be frivolous for purposes of these provisions.


Effective Date


The provision applies to submissions made and issues raised after the date on which the Secretary first prescribes the required list of frivolous positions. --Joint Committee on Taxation, Technical Explanation of the Tax Relief and Health Care Act of 2006, December 20, 2006 (JCX-50-06).

Section 6694 Penalty

FAQs Related to Tax Return Preparer Penalty Notices

Internal Revenue Code Section 6694 imposes penalties on tax return preparers who prepare returns taking positions that may not be fully supported by current law. Congress amended this section last May by extending the application of the income tax return preparer penalties to all tax return preparers and by raising the standard that preparers must meet to avoid the section 6694(a) preparer penalty. The Department of Treasury and IRS recently issued Notice 2008-13 in order to provide interim guidance regarding implementation of the tax return preparer penalty provisions until final regulations are published. In addition to Notice 2008-13, additional guidance has been provided in Notice 2008-12 with respect to the implementation of the tax return preparer signature requirement under Section 6695(b), and in Notice 2008-11, which clarifies the transition relief provided in Notice 2007-54, issued earlier this year. The following questions and answers highlight many of the issues addressed by these notices.

Why is the IRS issuing this notice?
The revised standards for return preparers were effective for returns prepared after May 25, 2007. Transitional relief for the rest of the 2007 year was provided in Notice 2007-54 and clarified in Notice 2008-11. The regulations will be significantly revised in the upcoming year to update the regulatory scheme governing tax return preparer penalties that has remained substantially unchanged since the late 1970’s. Until then, this notice provides interim guidance on the application of the tax return preparer penalties as amended by the Act for this filing season.

What is the effective date of this notice?
This notice is effective as of: (1) January 1, 2008, for all tax returns, amended tax returns, and claims for refund (other than 2007 employment and excise tax returns) filed on or after that date and with respect to advice provided on or after that date; and (2) February 1, 2008, for all 2007 employment and excise tax returns filed on or after that date and with respect to advice provided on or after that date.

Who is a tax return preparer subject to this notice?
A tax return preparer is any person who prepares for compensation, or who employs one or more persons to prepare for compensation, all or a substantial portion of a tax return or claim for refund of tax imposed by the Internal Revenue Code. Only one individual associated with a firm is a preparer with respect to the same tax return or refund claim. A person who prepares a return or claim for refund for a taxpayer with no explicit or implicit agreement for compensation is not a preparer, even though the person receives a gift or return service or favor. A person who prepares a return or claim for refund of an employer by whom the person is regularly and continuously employed is also not a preparer. If an attorney or CPA hires someone else to prepare one’s own personal return, the attorney or CPA is the taxpayer and not a preparer for purposes of that return.

What forms prepared by a tax return preparer are subject to the Section 6694 penalty?
Exhibit 1 in the notice provides a list of tax returns and claims for refund that report tax liability that will subject a tax return preparer to a Section 6694 penalty. Exhibit 2 in the notice provides a list of information returns that report information that is or may be reported on another tax return that may subject a tax return preparer to the Section 6694(a) penalty if the information reported constitutes a substantial portion of the other tax return. Exhibit 3 lists forms that would not subject a tax return preparer to the section 6694(a) penalty unless prepared willfully in any manner to understate the liability of tax on a return or claim for refund or in a reckless or intentional disregard of rules or regulations.

Is the list of forms in the Exhibits intended to be all inclusive? If so, are there any other tax returns that need to be included in any of the Exhibits?
Yes. The notice, however, states that we may choose to add or remove documents from any of the categories or exhibits to this notice in future guidance as we gain experience in implementing the provisions of the Act and receive public comments.

Will a person who prepares all or a substantial portion of a form or document listed in Exhibit 3 be penalized under Section 6694(a) or 6694(b)?
If the form or document in Exhibit 3 was prepared willfully in any manner to understate the liability of tax on a tax return or claim for refund or in reckless or intentional disregard of rules or regulations, the preparer may be subject to a penalty under either Section 6694(a) or 6694(b).

Is the current de minimis safe harbor in Treasury Regulation section 301.7701-15(b)(2) is still in effect?
Yes. A tax return preparer will not be considered to have prepared a “substantial portion” of a return or claim for refund if the schedule, entry, or other portion of a return or claim for refund involves amounts of gross income, amounts of deductions, or amounts on the basis of which credits are determined which are (i) less than $2,000; or (ii) less than $100,000, and also less than 20 percent on the gross income (or adjusted gross income if the taxpayer is an individual) as shown on the return or claim for refund. We are considering whether revisions to these current de minimis rules are necessary in any future regulations.

If a taxpayer brings a tax organizer to an appointment with a tax return preparer and the organizer reflects that the taxpayer made certain dollar amount of charitable contributions, does a preparer need to see documentation of the payments?
A preparer may rely in good faith without verification upon information furnished by the taxpayer if it does not appear to be incorrect or incomplete, but may not ignore the implications of information furnished to the tax return preparer or actually known to the tax return preparer. The preparer, however, needs to inquire about the existence of documentation in accordance with the appropriate reporting and substantiation requirements. See Example 8 in the Notice.

What if there is no substantial authority for a position but there is a reasonable basis?
The preparer must provide the taxpayer a prepared tax return with a complete Form 8275 or 8275-R disclosure statement, or disclose the position on the return in accordance with the annual revenue procedure.

If a position is a tax shelter as described in Section 6662(d)(2)(C), how must a preparer advise the taxpayer of the different penalty standards between that section and Section 6694?
The preparer must advise clients that, for tax shelter positions, there needs to be at a minimum substantial authority and a reasonable belief that the tax treatment was more likely that not the proper treatment in order for the taxpayer to avoid a penalty, that disclosure will not protect the taxpayer from penalty, and any differences with the preparer’s own standards under Section 6694.

Is there any general pro forma language that preparers can use in complying with the interim transition rules? If so, are preparers able to use this general pro forma language in every case or does the language need to be specific to the positions taken on the particular return? Does the advice to the client regarding the different penalty standards have to be spoken advice or does a memo included with the return suffice? Will one contemporaneous document cover the entire return or would one document be required for every undisclosed item?
There is no general pro forma language that a preparer may use to comply with the interim transitional rules. There is also no special format required under the Notice to satisfy the interim guidance and documentation requirements of the notice. The important point is that each item subject to the notice must be specifically addressed by the preparer with the taxpayer in a meaningful fashion and the contemporaneous documentation must in turn memorialize the discussion regarding each item. The language of the interim compliance rules also clearly contemplates that the advice and documentation are two separate events. A preparer runs a serious risk of not complying with the interim guidance standards if the only thing the preparer does is include a memo with the return. A preparer may choose to comply with the documentation requirement in one document covering all items, or in multiple documents each covering one item. Note that taxpayers are already permitted to disclose multiple items on a single Form 8275 for purposes of satisfying the penalty disclosure provisions of the Code.

What is “the gross income derived” for purposes of calculating the amount of the Section 6694 penalty and may a preparer limit the potential penalty amount with respect to a given client by intentionally bifurcating billing into various different engagements?
Notice 2008-13 addresses the interim standards applicable to tax return preparers under Section 6694(a), and was not intended to address other aspects of the return preparer penalty. Final guidance under Section 6694, when issued, will address the standards applicable to tax return preparers under Section 6694, as well as all of the other elements of the return preparer penalty under Section 6694, including the penalty amounts and related calculations. Nevertheless, tax return preparers and their clients should understand that the IRS has significant experience in looking through the form of transactions in determining their true substance, and should expect that all billing arrangements between tax return preparers and their clients will be scrutinized to ascertain the actual substance of those arrangements.

Do the rules in the notice apply to returns or claims prepared in other countries?
Yes. Under existing regulations, there are no geographical limitations regarding who may be considered a tax return preparer.

How does a preparer disclose a position in the case of items attributable to a pass-through entity?
Disclosure in the case of items attributable to a pass-through entity (pass-through items) is generally made with respect to the return of the entity. Thus, disclosure in the case of pass-through items must be made on the entity’s prepared tax return with a complete Form 8275 or 8275-R disclosure statement, or on the entity's return in accordance with the annual revenue procedure, if applicable.

Will the IRS automatically assess a Section 6694 penalty if it determines that a non-disclosed position taken on a return is incorrect?
No. This determination will be made on a case-by-case basis and the penalty will only be determined in appropriate cases. Similarly, the IRS will not choose what tax returns to examine based upon the existence or absence of a disclosure.
Notice 2008-12.

Under Notice 2008-12, are preparers allowed to continue to sign returns in accordance with the rules prescribed in ?
Yes. Notice 2004-54 provides that paid preparers will be permitted to sign original returns, amended returns, or requests for filing extensions by rubber stamp, mechanical device (such as signature pen), or computer software program. The interim rules provided in Notice 2008-12 do not affect the ability of preparers to continue to sign returns as previously authorized.

*Exhibits applicable to Section 6694 of the Internal Revenue Code are contained within Notice 2008-13.

IRS Tax Attorney - www.irstaxattorney.com 888.712.7690 Alvin Brown & Associates

IRS Tax Attorney - www.irstaxattorney.com 888.712.7690 Alvin Brown & Associates

Internal Revenue Bulletin: 2007-27
July 2, 2007

Notice 2007-54
Preparer Penalty Provisions Under the Small Business and Work Opportunity Act of 2007

--------------------------------------------------------------------------------

Table of Contents


SCOPE
BACKGROUND
PENALTY UNDER SECTION 6694
TRANSITIONAL RELIEF
EFFECTIVE DATE
CONTACT INFORMATION
This notice provides guidance and transitional relief for the return preparer penalty provisions under section 6694 of the Internal Revenue Code, as amended by the Small Business and Work Opportunity Act of 2007.

SCOPE
The transitional relief provided by this notice will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.

BACKGROUND
The Small Business and Work Opportunity Act of 2007, Pub. L. No. 110-28, 121 Stat. , (the Act) was enacted into law on May 25, 2007. Section 8246 of the Act amends several provisions of the Code to extend the application of the income tax return preparer penalties to all tax return preparers, alter the standards of conduct that must be met to avoid imposition of the penalties for preparing a return which reflects an understatement of liability, and increase applicable penalties. The amendments are effective for tax returns prepared after the date of the enactment, May 25, 2007.

The amendments made by the Act raise questions regarding activities representing preparation of a tax return, who is a return preparer within the meaning of section 7701(a)(36) (as amended), and how the statute applies to signing and non-signing preparers. In order to address these questions, the Internal Revenue Service and the Treasury Department are considering whether regulations or other published guidance are needed, including but not limited to, amendments to Treas. Reg. sections 301.7701-15 and 1.6694-0 through 1.6694-4. Because the Act extends the types of returns subject to the new provisions, changes are also required to the relevant forms and publications. The Service must also alter existing procedures in order to process disclosures with certain forms and in electronic formats. Because the amendments to section 6694 are effective immediately for returns prepared after May 25, 2007, the Service and the Treasury Department believe that effective tax administration requires transitional relief with respect to the new standards of conduct under section 6694(a).

PENALTY UNDER SECTION 6694
Prior to amendment by the Act, the penalty under section 6694(a) applied if:

(1) any part of an understatement of liability with respect to any return or claim for refund is due to a position for which there was not a realistic possibility of being sustained on its merits,

(2) any person who is an income tax return preparer with respect to such return or claim knew (or reasonably should have known) of such position, and,

(3) such position was not disclosed as provided in section 6662(d)(2)(B)(ii) or was frivolous.

Prior to amendment by the Act, the penalty under section 6694(b) applied if any part of an understatement was due to:

(1) a willful attempt in any manner by an income tax return preparer to understate the liability for tax; or

(2) to any reckless or intentional disregard of rules or regulations by an income tax return preparer.

Section 8246 of the Act amended several provisions of the Code to extend the scope of the income tax return preparer penalties to preparers of all tax returns, amended returns and claims for refund, including estate and gift tax returns, generation-skipping transfer tax returns, employment tax returns, and excise tax returns. The Act amended section 6694(a) to provide that the penalty would apply if:

(A) the tax return preparer knew (or reasonably should have known) of the position,

(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and

(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or

(ii) there was no reasonable basis for the position.

Although the Act did not alter the standard of conduct under section 6694(b), it increased the amount of the penalty and made the penalty applicable to all tax return preparers.

Section 8246 of the Act amends the standards of conduct under section 6694(a) in two ways. First, for undisclosed positions, the Act replaces the realistic possibility standard with a requirement that there be a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits. Second, for disclosed positions, the Act replaces the not-frivolous standard with the requirement that there be a reasonable basis for the tax treatment of the position.

The Act also increased the first-tier section 6694(a) penalty for understatements from $250 to the greater of $1000 or 50% of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty was imposed. The Act increased the second-tier section 6694(b) penalty for willful or reckless conduct from $1000 to the greater of $5,000 or 50% of the income derived (or to be derived) by the tax return preparer.

Under both the prior and current law, disclosure under section 6694(a) is adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2). In addition, under both the prior and current law, the penalty under section 6694(a) would not be imposed if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.

TRANSITIONAL RELIEF
In order to provide sufficient time to address issues pertaining to the implementation of the Act, the Service is providing the following transitional relief: For income tax returns, amended returns, and refund claims, the standards set forth under the previous law and current regulations under section 6694 will be applied in determining whether the Service will impose a penalty under section 6694(a). Generally, in applying transitional relief for income tax returns, amended returns or refund claims, disclosure would be adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2).

For all other returns, amended returns, and claims for refund, including estate, gift, and generation-skipping transfer tax returns, employment tax returns, and excise tax returns, the reasonable basis standard set forth in the regulations issued under section 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the Service will impose a penalty under section 6694(a).

This transitional relief will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.

No transitional relief is available under section 6694(b) as transitional relief is not appropriate for return preparers who exhibit willful or reckless conduct, regardless of the type of return prepared.

EFFECTIVE DATE
This notice is effective as of May 25, 2007.

CONTACT INFORMATION
The principal author of this notice is Michael E. Hara of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this notice, contact Mr. Hara at (202) 622-4910 (not a toll-free call).

section 6330 - CDP Appeal - An IRS Appeals officer properly sustained a proposed levy to collect a corporation's unpaid employment taxes. His rejection of the proposed installment agreement was reasonable because it was based on the corporation's failure to provide requested financial information, its history of nonpayment and its failure to timely file all tax returns and make tax deposits. The corporation's argument that financial information should have been requested from a former officer who was a responsible person was rejected. Although the current president was not involved with the corporation at the time it accrued the tax liability, the financial information requested from him was necessary to understand the corporation's ability to remain current on its tax obligations.



Kieft Bros. West, Inc., a Colorado corporation, Plaintiff v. Commissioner of the Internal Revenue Service, Defendant.

U.S. District Court, Dist. Colo.; Civil Action No. 06-cv-00691-WYD-BNB, April 21, 2008.

[ Code Sec. 6330]






ORDER




I. INTRODUCTION

DANIEL, U. S. District Judge: THIS MATTER is before the Court on this case which seeks appellate review of a Notice of Determination Concerning Collective Action(s) under Section 6230 and/or 6330 issued by the United States Appeals Office of the Internal Revenue Service on March 13, 2006. Plaintiff Kieft Bros. West, Inc. ["Kieft Bros."] filed an Opening Brief on November 27, 2006. Defendant Commissioner of the Internal Revenue Service ["Commissioner"] filed a Response Brief on January 11, 2007. No reply brief was filed. For the reasons stated below, the Notice of Determination Concerning Collective Action(s) is sustained and the appeal is dismissed.



II. FACTUAL BACKGROUND

Robert Kieft and Diedre Kieft owned all of the issued and outstanding shares of Kieft Bros. until April 13, 2005. Diedre Kieft owned a majority of the stock and served as President of the company. On or about April 13, 2005, Richard M. Lewis purchased 80% of the issued and outstanding stock of Kieft Bros. by contributing certain capital to the corporation. Mr. Lewis is the current president and majority stockholder of Kieft Bros. Robert Kieft owns approximately 20% of Plaintiff's stock. Diedre Kieft no longer owns stock in the company.

Kieft Bros. became delinquent in paying its employment taxes in the last two quarters of 2004 and the first quarter of 2005. The Internal Revenue Service ["IRS"] sent notices of delinquency to Kieft Bros. on March 13, 2005, June 6, 2005, and August 8, 2005, involving its alleged failure to file and/or pay quarterly tax returns for the periods ending September 30, 2004, December 31, 2004, and March 31, 2005. The Certificates of Assessments and Payments for the periods at issue reflect that Kieft Bros. owed approximately $99,700.00 in taxes.

On October 30, 2005, the IRS issued its thirty-day notice of levy letter as required by 26 U.S.C. § 6331(d). Kieft Bros. timely requested a Collection Due Process ["CDP"] hearing pursuant to 26 U.S.C. § 6330.

The CDP hearing was held on December 5, 2005. Mr. Lewis and Mr. Kieft were present at the hearing. Kieft Bros. did not contest the validity of the underlying tax liability. Instead, Kieft Bros., through its principal officer Richard Lewis, proposed that it be permitted to enter into an installment agreement whereby it would make payments of between $2,000 and $5,000.00 per month on the delinquency. Mr. Lewis explained at the hearing that Kieft Bros. was a distressed company when he acquired it in April 2005, and that his primary concern for the company was to stabilize the business into a productive enterprise. The Appeals Settlement Officer Michael R. Jeka ["the appeals officer"] requested that Mr. Lewis, personally, and Kieft Bros. provide certain financial information. Financial information was then provided to the appeals officer in an attempt to verify Mr. Lewis's representations regarding Kieft Bros.' financial information.

By the time of the hearing, Kieft Bros. had become further delinquent in the payment of its employment taxes as it had failed to make sufficient deposits for the second and third quarters of 2005, creating additional liabilities of $81,000.00 for these quarters. At the hearing, the appeals officer advised Mr. Lewis and Mr. Kieft that the Form 941 for the third quarter of 2005 was late and that Kieft Bros. would incur a failure to file penalty.

On March 13, 2006, a Notice of Determination was issued. The decision sustained the IRS's determination to proceed with the collection action because 1) the taxpayer and Mr. Lewis had not submitted certain requested financial information data (and the financial information provided by Mr. Lewis was deficient) and 2) the taxpayer had become delinquent in its federal tax obligations for subsequent quarters. Kieft Bros. challenges the Notice of Determination asserting that the appeals officer abused his discretion in recommending that the proposed collection action be sustained.



III. ANALYSIS

After receiving a notice of proposed collection action a taxpayer may request a hearing before the IRS Office of Appeals "with respect to the taxable period to which the unpaid tax [listed in the notice] relates." 26 U.S.C. § 6330(b)(2). The statute provides that the person may raise at the hearing any relevant issue relating to the unpaid tax or the proposed levy, including "appropriate spousal defenses", "challenges to the appropriateness of collection actions"; and "offers of collection alternatives, which may include the posting of a bond, the substitution of other assets, an installment agreement, or an offer-in-compromise." Id., § 6330(c)(2)(A). The person may also raise at the hearing challenges to the existence or amount of the underlying tax liability. Id, § 6330(c)(2)(B). There is also a requirement of investigation. Specifically, "[t]he appeals officer shall at the hearing obtain verification from the Secretary that the requirements of any applicable law or administrative procedure have been met." Id., § 6330(c)(1).

Following the CDP hearing, the IRS Office of Appeals issues a Notice of Determination to the taxpayer. 26 C.F.R. § 301.6330-1(f). In making a CDP determination, the appeals officer must: 1) verify that the requirements of applicable law and administrative procedures have been met; 2) consider issues raised by the taxpayer; and 3) consider whether any proposed collection action balances the legitimate concern of the taxpayer that any collection action be no more intrusive than necessary. Id., § 6330(c)(2)(3).

Following the hearing, the determination may be appealed to the Tax Court if that Court has jurisdiction over the underlying tax liability, or to the United States District Court. 26 U.S.C. § 6330(d). Any levy action is suspended during the period of the hearing and appeal. Id. at § 6330(e). Where the validity of the underlying tax liability is not at issue, the administrative determination must be reviewed for an abuse of discretion. Goza v. Commissioner, 114 T.C. 176, 181 (2000); see also Mesa Oil, Inc. v. United States of America, No. 00-B-851, 2000 WL 1745280, at *2 (D. Colo. 2000). The standard for determining whether an abuse of discretion has occurred is whether the exercise of discretion is arbitrary or capricious or without sound basis in law or fact. Freije v. Commissioner, 125 T.C. 14, 23 (2005); Roman v. Commissioner, T.C. Memo 2004-20, 2004 WL 157817, at *4 (2004).

Kieft Bros. argues that the appeals officer failed to properly balance the need of the efficient collection of taxes with the legitimate concern of Kieft Bros., an ongoing business, that the collection action be no more intrusive than necessary. Instead, it is argued that the determination was unnecessarily intrusive upon the collection process. It is also argued that the appeals officer improperly rejected the installment agreement proposed by Kieft Bros.

I find that Kieft Bros. has failed to show an abuse of discretion. First, I agree with the Commissioner that the failure of Kieft Bros. to remain current with payment obligations is a valid reason to decline a proposed installment agreement. In USA Financial Services v. United States, 459 F. Supp. 2d 440 (E.D. Va. 2006), the court upheld a Notice of Determination where the IRS declined to accept an installment agreement due to the taxpayer's history of not paying its federal tax liabilities on time, noting that the IRS is not required to accept an installment agreement "where there was evidence that the installment payment agreement would be futile." Id. at 447 (citations omitted). I find that opinion persuasive.

As the Commissioner notes, the futility of accepting an installment agreement in the instant case is evidenced by the following delinquencies in addition to those at issue at the CDP hearing: 1) $51,000.00 in employment taxes for the second quarter of 2005; 2) $30,000 in employment taxes for the third quarter of 2005; 3) delinquent tax deposits for the fourth quarter of 2005; 4) delinquent tax deposits for January 2006; and 5) delinquent unemployment tax deposits for 2006. See Pl.'s Ex. 1 at 2, 4 and 5. I find that it would be futile for the IRS to accept an installment agreement for past due obligations where a taxpayer such as Kieft Bros. has demonstrated an inability to remain current with its ongoing obligations.

While it is argued that the appeals officer abused his discretion in failing to assess Kieft Bros.' financial condition and whether the collection action would be unnecessarily intrusive, I find no abuse of discretion in this regard. First, the Notice of Determination was in part based on the failure of the corporation to provide complete financial information. The rejection of an installment agreement is not an abuse of discretion where a taxpayer has failed to provide complete financial information. See Roman, 2004 WL 157817, at *5-6. Here, Kieft Bros. failed to provide adequate information concerning its income and expenses. See Pl.'s Ex. 1 at 5. Such information is relevant to whether the taxpayer's finances could support an installment agreement, or alternatively, whether the taxpayer had the ability to make a lump sum payment of the liabilities at issue. While it is argued that the appeal officers openly derided the financial information that was provided, it is undisputed that all the requested information was not given. I also note that Kieft Bros. fails to specify exactly what investigation should have occurred concerning the corporation which was not conducted.

Kieft Bros. relies on Mesa Oil, Inc. v. United States, 2000 WL 1745280 (D. Colo. 2000), a case where the court determined that the IRS failed to properly balance the need of the efficient collection of taxes with the legitimate concern of the plaintiff, an ongoing business, that the collection action would put it out of business. I find that case distinguishable. As noted previously, the determination in this case turned on the fact that Kieft Bros. had not provided all the financial information requested of the officer and was currently not in compliance with employment taxes. Those were not at issue in Mesa Oil. Instead, in that case "the sparse Determination gives every indication that the 'proposed collection action [was] approved solely because the IRS show[ed] that it ha[d] followed appropriate procedures.'" Id.

As noted above, the grounds stated by the appeals officer were a proper basis to deny the request for an installation agreement. Further, while the Notice of Determination did not specifically address the level of intrusiveness on Kieft Bros.' financial condition, it is clear that he did consider the financial condition of the company in making his determination. See Pl.'s Ex. 1 at 2-3.

Plaintiff also argues that the appeals officer improperly issued his determination without giving Mr. Lewis time to complete the process of providing information requested by the appeals officer or to explore collection options. However, the CDP hearing was held on December 5, 2005, and the Notice of Determination was not issued until March 13, 2006, more than three months later. Further, the Notice of Determination noted that the appeals officer told Mr. Lewis initially that he must provide the information by January 31, 2006. Pl.'s Ex. 1 at 4. The Notice of Determination also stated that the appeals officer advised Mr. Lewis on February 21, 2006 (more than three weeks before the decision was issued) that he was surprised by the lack of information provided. Id. See Roman, 2004 WL 157817, at *6 (determination was not unreasonable even though the officer issued a determination before all information was received and without giving notice of a deadline when the determination was made more than two months after the request for information and six weeks after the date by which the taxpayer initially stated he supply the materials).

I also note that the appeals officer advised Mr. Lewis in his conversation on February 21, 2006, that an installment agreement would not be provided if Kieft Bros. was not in compliance with required federal tax deposits ["FTDs"]. It is undisputed that Kieft Bros. continued to accrue delinquencies between December 5, 2005 and March 13, 2006, and did not get in compliance in connection with its FTDs. Under those circumstances, I find it was not an abuse of discretion to decline to accept an installment agreement while the corporation continued its pattern of failure to make timely tax deposits.

Kieft Bros. also argues that the financial information requested of Mr. Lewis was not necessary for the consideration of an installment agreement, as the liability was solely that of Kieft Bros. Further, the appeals officer failed to request financial records from Deirdre Kieft, a former officer facing potential liability as a responsible officer. The appeal officer also identified Robert Kieft as the primary officer of Kieft Bros., but did not request that Mr. Kieft provide any financial information. I do not find any abuse of discretion as to these issues.

First, I find that the financial information for the majority stockholder and president of a closely held corporation is or arguably could be relevant to determining whether a proposed installment agreement is a realistic mechanism for collecting delinquent taxes, even if he was not involved with the corporation at the time it accrued the tax liability at issue. As the Commissioner notes, in evaluating an installment agreement it is essential to determine the necessary expenditures of a corporation such as salaries. The financial information of an owner/officer would show the amount of salary, if any, paid by the corporation to that owner. Salary payments to Mr. Lewis may be a necessary expense of the corporation depending on whether Mr. Lewis needed income from the corporation to meet his living expenses. Additionally, the requested financial information would reveal any amounts borrowed by Mr. Lewis from the corporation or lent by Mr. Lewis to the corporation. If Mr. Lewis had lent significant amounts to the corporation, and the corporation was still unable to meet is ongoing obligations, it is doubtful it could ever become current through an installment agreement through its ongoing operations.

As the appeals officer properly demanded information from the principal officer, I do not find it an abuse of discretion of the officer not to also request information from Robert Kieft or former officer Diedre Kieft. Kieft Bros. has not cited any authority that such financial information should have been obtained or that this was an abuse of discretion.

It is also argued that the appeals officer improperly relied on the statement by Mr. Lewis that payment of the tax liability was not his priority and took the statement out of context. I do not find this argument persuasive. While the appeals officer did note this in the determination (Pl.'s Ex. 1 at 3, 4, 6), the determination was ultimately based on the fact that the requested financial information was not provided and that Kieft Bros. continued to fail to timely make federal tax deposits, despite being advised that it must get current as to same. The intentions or priorities of Mr. Lewis, good or bad, do not alter these findings or the reasonableness of the conclusion of the appeals officer that an installment agreement was not a viable collection alternative in the instant case.

In conclusion, I find that Kieft Bros.' arguments do support a finding of an abuse of discretion. Accordingly, it is

ORDERED that the Notice of Determination is SUSTAINED, and Plaintiff's appeal of the Determination is DENIED. It is

FURTHER ORDERED that the Clerk of Court shall enter judgment in favor of Defendant and against Plaintiff.

Section 6015 – Innocent Spouse relief denied because wife meaningly participtated in her husbamds business and therefore is barred under section 6015(g)(2)

Khen T. Huynh, Petitioner-Appellant v. Commissioner of Internal Revenue, Respondent-Appellee.

U.S. Court of Appeals, 9th Circuit; 06-75806, May 1, 2008.

Unpublished opinion affirming the Tax Court, Dec. 56,603(M); 92 TCM 184; TC Memo. 2006-180.

[ Code Sec. 6015]

Innocent spouse relief: Prior proceedings: Meaningful participation. --
An individual was not entitled to innocent spouse relief from joint liability for tax deficiencies that were sustained in prior proceedings in which she meaningfully participated. The taxpayer had prepared the joint federal income tax returns for the years at issue, signed documents, participated in pretrial preparations and settlement negotiations and testified at trial during the prior litigation.



Before: Graber, Fisher and Berzon, Circuit Judges.



MEMORANDUM * . Appeal from a Decision of the United States Tax Court. Submitted April 22, 2008 ** .

Khen T. Huynh appeals pro se from the Tax Court's decision upholding the denial of relief under 26 U.S.C. § 6015 from joint liability with her husband for tax deficiencies in 1996 and 1997. We have jurisdiction pursuant to 26 U.S.C. § 7482(a)(1). We review for clear error the Tax Court's factual findings, including the determination that Huynh is not entitled to innocent spouse relief under § 6015. See Guth v. Comm'r, 897 F.2d 441, 443 (9th Cir. 1990) (reviewing claim for relief under predecessor statute). We affirm.

The Tax Court did not clearly err in finding that Huynh meaningfully participated in prior proceedings concerning her tax liability for 1996 and 1997 given that she prepared the tax returns, signed documents, participated in pretrial preparations and settlement negotiations, and testified on the substance of the tax matters at the prior trial. See 26 U.S.C. § 6015(g)(2).

AFFIRMED.

* This disposition is not appropriate for publication and is not precedent except as provided by 9th Cir. R. 36-3.

** The panel unanimously finds this case suitable for decision without oral argument. See Fed. R. App. P. 34(a)(2).


Khen T. Huynh v. Commissioner.

Dkt. No. 24719-04 , TC Memo. 2006-180, August 29, 2006.

[Appealable, barring stipulation to the contrary, to CA-9. --CCH.]

[Code Sec. 6015]
Innocent spouse relief: Equitable relief: Res judicata. --
An individual was barred by res judicata from obtaining innocent spouse relief from joint liability for tax deficiencies that were sustained in prior litigation in which she meaningfully participated. The taxpayer failed to carry her burden of establishing that she did not meaningfully participate in the prior litigation concerning the tax liability at issue. The taxpayer argued that she had only minimal knowledge of the underlying basis for the tax deficiencies and that she signed various administrative and Tax Court documents merely under her husband's direction. However, the taxpayer read and understood English and had prepared their joint federal income tax returns for the years at issue. During the prior litigation, the taxpayer signed all documents, participated in pretrial preparations and settlement negotiations, and testified at trial. Therefore, the taxpayer was barred under Code Sec. 6015(g)(2) from obtaining any relief from the joint liability.


Khen T. Huynh, pro se; Michael S. Hensley, for respondent.


MEMORANDUM FINDINGS OF FACT AND OPINION

SWIFT, Judge: Petitioner seeks review of respondent's notices of determination denying petitioner relief under section 6015 from joint liability for tax deficiencies for 1996 and 1997 of $1,552 and $1,515, respectively. Respondent's determinations as to the deficiencies were sustained in a final decision in Huynh v. Commissioner, T.C. Summary Opinion 2001-131.

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue.

The issue for decision is whether petitioner under section 6015(g)(2) is barred from obtaining relief from joint liability for the tax deficiencies which were sustained in Huynh v. Commissioner, supra.


FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

At the time the petition was filed, petitioner resided in San Diego, California.

From 1979 through 1997, petitioner worked for the County of San Diego Department of Social Services as an eligibility technician, reviewing the eligibility of those seeking social service benefits. Petitioner speaks and reads English.

In May of 1996, petitioner's husband (Hong), who apparently possesses numerous college and graduate degrees, including a law degree, was laid off from his job. Hong had purchased insurance coverage which provided, among other things, that in the event Hong became unemployed the insurers would make payments on some portion of the outstanding balance due on his 11 credit cards.

When Hong became unemployed, the insurers began making monthly payments on his credit cards. At the end of 1996, Hong's credit cards reflected a total outstanding balance of $91,333.

In 1996 and 1997, the insurers paid $9,719 and $9,631, respectively, to the credit card companies on Hong's behalf.

For 1996 and 1997, petitioner prepared her and Hong's joint Federal income tax returns. On their tax returns, petitioner and Hong, apparently under the impression that these amounts did not constitute taxable income, did not report the above insurance payments that had been made on Hong's behalf.

Upon audit for 1996 and 1997, respondent determined that the insurance payments constituted taxable income. In connection with respondent's audit, Hong explained to petitioner that respondent's adjustments were related to the taxability of the insurance payments made on his behalf.

On December 15, 1998, and October 13, 1999, respectively, respondent's notices of deficiency relating to petitioner and Hong's 1996 and 1997 joint Federal income tax returns were mailed to petitioner and Hong.

With regard to the notice of deficiency for each year, petitioner and Hong jointly filed petitions with the Tax Court to redetermine the deficiencies, and petitioner read and signed both petitions. The two cases were consolidated for trial.

Prior to the trial, petitioner and Hong attended meetings with respondent's Appeals Office and meetings with counsel for respondent. Petitioner spoke and participated in these meetings, and petitioner signed various documents including a stipulation of settled issues, a power of attorney, and stipulations of facts.

At the trial in Huynh v. Commissioner, supra, petitioner testified and stated that she knew that Hong had credit card insurance to cover a portion of his credit card debt if he should become unemployed and that in 1996 and 1997 she knew Hong was unemployed. Petitioner also signed a trial brief, a reply brief, and a motion for leave to file a reply brief.

On August 30, 2001, the Tax Court filed its opinion in Huynh, sustaining respondent's tax deficiencies against petitioner and Hong.

In March and April of 2002, petitioner requested section 6015 relief from joint liability for 1996 and 1997 with regard to the above tax deficiencies that had been sustained by the Court. Respondent denied petitioner's claims for section 6015 relief, and petitioner filed the instant action.


OPINION

Spouses filing joint Federal income tax returns generally are jointly liable for all taxes due. Sec. 6013(d)(3). However, under certain circumstances, a spouse may be relieved of liability on a joint return. Sec. 6015.

Even after a final opinion has been filed by a court in litigation involving joint filers' Federal income tax liability, the opinion may not be conclusive with respect to a requesting spouse where section 6015 relief was not an issue in the court litigation. Sec. 6015(g)(2). The requesting spouse shall be barred from obtaining section 6015 relief, however, if the court determines that he or she participated meaningfully in the prior litigation. Id.; see Thurner v. Commissioner [Dec. 55,223], 121 T.C. 43, 51-52 (2003); Vetrano v. Commissioner [Dec. 54,319], 116 T.C. 272, 278 (2001); sec. 1.6015-1(e), Income Tax Regs.

Under section 6015(g)(2), the requesting spouse bears the burden of proof to show, by a preponderance of the evidence, that he or she did not meaningfully participate in the prior litigation. Monsour v. Commissioner [Dec. 55,726(M)], T.C. Memo. 2004-190.

Generally, where a court of competent jurisdiction enters a final judgment on the merits of a cause of action, the parties in the prior litigation are bound by every matter that was or that could have been offered and received to sustain or defeat the claim. Commissioner v. Sunnen [48-1 USTC ¶9230], 333 U.S. 591, 597 (1948). Section 6015(g)(2), however, modifies this common law doctrine of res judicata with regard to claims under section 6015 for relief from joint liability.

Court cases have not yet clearly defined "meaningful participation" in all respects, although we have indicated that "merely [complying]" with a spouse's instructions to sign various pleadings and other documents filed in prior litigation is not conclusive of meaningful participation, Thurner v. Commissioner, supra at 53, but signing court documents and participating in settlement negotiations are indicators of meaningful participation; id.; Monsour v. Commissioner, supra.

In Trent v. Commissioner [Dec. 54,938(M)], T.C. Memo. 2002-285, we suggested that a taxpayer who participated in meetings with an Appeals officer and who voluntarily signed a decision document generally would be regarded as having participated meaningfully, regardless of whether the taxpayer was represented by counsel.1

The legislative history of section 6015 does not provide any significant guidance as to the definition of "meaningful participation."

Petitioner argues that she did not meaningfully participate in Huynh v. Commissioner, T.C. Summary Opinion 2001-131. She claims that during the litigation in Huynh she had only minimal knowledge of the underlying basis for the tax deficiencies, that she signed various administrative and Court documents merely under Hong's direction, and that her testimony therein consisted solely of "nervous" responses to the Court's "leading questions".

Respondent counters that petitioner could have raised the instant issue of relief from joint liability in Huynh and that petitioner's ability to read and understand the documents she signed, her participation in the pretrial meetings, and her testimony at trial all indicate that petitioner participated meaningfully.

We agree with respondent. In Huynh, petitioner signed all documents, participated in pretrial preparations and settlement negotiations, and testified at trial.

Petitioner may have signed some documents under the direction of Hong. Petitioner, however, reads English. She prepared her and Hong's joint Federal income tax returns. She was present at meetings with respondent's Appeals Office, as well as at pretrial meetings with respondent's counsel, and at trial.

In Huynh, petitioner was not formally represented by counsel. Hong, however, has a law degree, and petitioner has introduced no evidence that Hong did not allow her the opportunity to raise therein her innocent spouse claim.

We conclude that petitioner meaningfully participated in Huynh and that petitioner therefore is barred under section 6015(g)(2) from obtaining any relief from joint liability for 1996 and 1997.

For the reasons stated, we shall sustain respondent's determination to deny relief from joint liability.

To reflect the foregoing,

Decision will be entered for respondent.

1 It may be noted that the effective date of sec. 6015 is not a mitigating factor in the present case, as it was in Trent v. Commissioner [Dec. 54,938(M)], T.C. Memo. 2002-285.

IRS Audit Statistics - Treasury Inspector General for Tax Administration (TIGTA) Report: Trends in Compliance Activities Through Fiscal Year 2007 (Reference Number: 2008-30-095). During FY 2007, the overall percentage of tax returns examined increased by almost 9 percent, even though the number of field Examination function personnel decreased by just over 4 percent. In addition, the overall percentage of tax returns examined was 2 percent higher than in FY 1998.

May 1, 2008


TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION


Trends in Compliance Activities

Through Fiscal Year 2007

April 18, 2008

Reference Number: 2008-30-095

This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined to be restricted from public release has been redacted from this document.

Phone Number | 202-622-6500

Email Address | inquiries@tigta.treas.gov

Web Site | http://www.tigta.gov




DEPARTMENT OF THE TREASURY


WASHINGTON, D.C. 20220

TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION

April 18, 2008

MEMORANDUM FOR DEPUTY COMMISSIONER FOR SERVICES AND ENFORCEMENT

FROM: Michael R. Phillips
Deputy Inspector General for Audit

SUBJECT: Final Audit Report - Trends in Compliance Activities Through
Fiscal Year 2007 (Audit # 200830016)

This report presents the results of our review of statistical information reflecting collection and examination activities within the Internal Revenue Service (IRS). The overall objective of this review was to provide statistical information and trend analyses of the data, as requested by the IRS Oversight Board.1



Impact on the Taxpayer

This report is a compilation of statistical information reported by the IRS. We did not verify or validate the authenticity or reliability of the data and, therefore, did not identify any specific impact on the taxpayer. However, continued effort to improve compliance is important to reducing the tax gap and maintaining the integrity of the voluntary tax compliance system.



Synopsis

Since Fiscal Year (FY) 2000, the IRS has reversed many of the downward trends in compliance activities that had occurred in prior years. In FY 2007, many of these activities continued to increase, even though Collection and Examination function field staffing decreased slightly. Both the Collection and Examination functions plan to hire enforcement personnel during FY 2008.




Trends in Compliance Activities Through Fiscal Year 2007


Some of the positive changes noted in this report might be attributable to management emphasis on the Collection and Examination functions' programs. Over the last few years, the Small Business/Self-Employed Division has implemented reengineering and organizational changes that could have had a positive impact on enforcement efforts. In addition, both functions continue to study ways to improve workload selection.

As our report points out, the IRS has reversed many of the enforcement declines in both the Collection and Examination functions. Although the IRS has taken significant actions to improve its enforcement efforts, the Government Accountability Office continued to include enforcement of tax laws (collection of unpaid taxes and Earned Income Tax Credit noncompliance) as one of the high-risk areas in the Federal Government in its most recent (January 2007) update.2

In FY 2007, the level of compliance activities and the results obtained in many Collection function areas showed a continued increase. The uses of liens and levies (collection enforcement tools) continued to increase and reached the 10-year highs. The use of seizures also increased but is unlikely to return to pre-1998 levels in the foreseeable future. Enforcement revenue collected also continued to increase (to $59.2 billion), but the total dollar amount of uncollected liabilities increased to the 10-year high of $290 billion. In addition, the gap between new delinquent account receipts and closures had widened by almost 63 percent by the end of FY 2007.

The Collection function collected almost 3 percent more than in FY 2006, but the number of taxpayers (866,777) and the amount owed ($34.9 billion) on accounts in the Queue were each at a 10-year high. One reason for the increase in the Queue this year is a rise in the number of compliance assessments. While the Queue is a source of work for Collection function employees, a significant number of accounts in the Queue might never be worked. In addition, in FYs 2001 through 2007, the IRS removed almost 7.6 million accounts with balance-due amounts totaling almost $31.2 billion from Collection function inventory. These accounts might never be worked.

In September 2006, the IRS started assigning balance-due cases that otherwise would not have been worked to private collection agencies. Through FY 2007, the IRS had received a total of $26.6 million after expected commissions on cases assigned to the collection agencies, and program costs totaled $69.8 million. More than 96 percent of the total revenue collected by the agencies was received during FY 2007 alone. The program netted $11.3 million after subtraction of expected commissions and program costs for the year. However, continued use of private collection agencies is uncertain because some members of Congress want the IRS to discontinue their use.

During FY 2007, the overall percentage of tax returns examined increased by almost 9 percent, even though the number of field Examination function personnel decreased by just over 4 percent. In addition, the overall percentage of tax returns examined was 2 percent higher than in FY 1998.

Overall, the number of individual tax returns examined increased during FY 2007.3 Correspondence examinations accounted for 83 percent of the examinations of individuals.4 Because correspondence examinations are usually not as comprehensive as face-to-face examinations, the impact on compliance might be limited. In addition, the dollar yield per hour increased for individual income tax return examinations conducted by revenue agents and tax compliance officers.

In FY 2007, the number of corporate tax returns examined increased by just over 4 percent, after decreasing 1 percent in FY 2006. However, the number of corporate returns examined has decreased almost 45 percent since FY 1998. The total number examined decreased from 1 of 48 returns filed in FY 1998 to 1 of 75 returns filed in FY 2007. The number of tax returns examined for small corporations (those with assets of less than $10 million) increased by slightly more than 12 percent, while the number of returns examined for large corporations (those with assets of $10 million and greater) decreased by almost 9 percent. The dollar yield per hour decreased by 36 percent in FY 2007.

Continued effort to improve compliance is important to reducing the tax gap and maintaining the integrity of the voluntary tax compliance system. According to a tax gap strategy document dated September 2006, the tax gap for Tax Year 2001 was $345 billion.5 The strategy document provides a broad base on which to build future efforts to address the tax gap but depends on future budgets to provide detailed strategy elements. In August 2007, the IRS released a report that builds on the strategy by providing details about actions planned to reduce the tax gap.6 However, many of the actions will require the assistance of Congress.



Recommendation

We made no recommendations in this report. However, key IRS management officials reviewed the report prior to issuance and agreed with the facts and conclusions.

Copies of this report are also being sent to the IRS managers affected by the report information. Please contact me at (202) 622-6510 if you have questions or Margaret E. Begg, Acting Assistant Inspector General for Audit (Small Business and Corporate Programs), at (202) 622-8510.




Table of Contents


Background

Results of Review


Overall, Compliance Activities Increased and Results Improved



Collection Function Compliance Activities Increased and Results Improved



Examination Function Compliance Activities Increased and Results Improved


Appendices


Appendix I - Detailed Objective, Scope, and Methodology



Appendix II - Major Contributors to This Report



Appendix III - Report Distribution List



Appendix IV - Glossary of Terms



Appendix V - Detailed Charts of Statistical Information



Appendix VI - Prior Treasury Inspector General for Tax Administration Compliance Trends Reports



Abbreviations





ACS Automated Collection System




CFf Collection Field function




FY Fiscal Year




IRS Internal Revenue Service




SCCB Service Center Collection Branch




TDA Taxpayer Delinquent Account




TDI Taxpayer Delinquency Investigation




TIGTA Treasury Inspector General for Tax Administration







Background


We initiated this review of nationwide compliance statistics for examination and collection activities due to an ongoing request of the Internal Revenue Service (IRS) Oversight Board. Our data analyses were performed in the Treasury Inspector General for Tax Administration (TIGTA) Chicago, Illinois, office during the period January through March 2008. We used nationwide data from IRS management information system reports during our review. Due to time and resource constraints, we did not audit IRS systems to validate the accuracy and reliability of their information. Also, we did not assess internal controls because doing so was not applicable within the context of our objective. Our analyses were limited to identifying changes and trends in data prepared and reported by the IRS.

Detailed information on our objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II. A Glossary of Terms is included in Appendix IV. Detailed charts and tables referred to in the body of this report are included in Appendix V. We eliminated some charts for examinations of individual taxpayers this year because the IRS Examination function changed the way in which it categorizes individual tax returns. We added charts showing statistics for efforts to secure delinquent tax returns from taxpayers.

Most of the calculations throughout the report and Appendix V are affected by rounding. All initial calculations were performed using the actual numbers rather than the rounded numbers that appear in the report. Much of the data included in this report update prior TIGTA reports on compliance trends. Appendix VI presents a list of those reports.




Results of Review


Overall, many compliance activities increased and results improved during Fiscal Year (FY) 2007. Since FY 2000, the IRS has reversed numerous downward trends in compliance activities that occurred in prior years. In FY 2007, many of these activities continued to increase, while others fell slightly from the prior year.

Although the IRS has reversed many of the downward trends in compliance activities, the enforcement staff levels in the Collection and Examination functions are not significantly higher than the 10-year lows experienced in FY 2003. The combined number of Collection function and Examination function enforcement personnel1 declined by 23 percent, from approximately 19,500 at the beginning of FY 1998 to 15,000 at the end of FY 2007. After increasing by 8 percent during FY 2006, staffing decreased by 4 percent this year. The Small Business/Self-Employed Division FY 2008 Hiring Plan includes authorized hiring of nearly 1,000 revenue agents, tax compliance officers, and revenue officers. The Collection and Examination Enforcement budget was flat for FYs 2006 through 2008. However, the President's Budget Proposal for FY 2009 includes an 8 percent increase for that budget account.



Overall, Compliance Activities Increased and Results Improved

For some time, the total number of tax returns filed and the total dollars the IRS received (gross collections) have increased. In the past 10 years, the total number of tax returns filed grew by almost 12 percent, from about 161 million in Calendar Year 1997 to more than 179 million in Calendar Year 2006. IRS gross collections grew from $1.77 trillion in FY 1998 to $2.13 trillion in FY 2001, then fell a total of slightly more than 8 percent during FYs 2002 and 2003 to $1.95 trillion. These were the first decreases in total revenue since FY 1983. However, since FY 2003, gross collections have increased by almost 38 percent and reached a new record high of $2.69 trillion in FY 2007.2

After remaining relatively constant for FYs 1999 through 2002, the amount of enforcement revenue collected increased by almost 74 percent in the last 5 years. During FY 2007, enforcement revenue collected increased by 22 percent to $59.2 billion.3 This amount (not adjusted for inflation) is 68 percent higher than the FY 1998 amount.4

As our report points out, the IRS has reversed many of the enforcement declines in both the Collection and Examination functions. However, despite work the IRS is doing to improve its enforcement efforts, the Government Accountability Office continued to include enforcement of tax laws (collection of unpaid taxes and Earned Income Tax Credit noncompliance) as 1 of the 26 high-risk areas in the Federal Government in its most recent (January 2007) update.5 The Government Accountability Office states that improvements in compliance with tax laws will require efforts by the IRS and Congress.

Continued effort to improve compliance is important to reducing the tax gap and maintaining the integrity of the voluntary tax compliance system. According to a tax gap strategy document dated September 2006, the tax gap for Tax Year 2001 was $345 billion, representing a compliance rate of about 84 percent.6 The purpose of the strategy document was to provide a broad base on which to build future efforts to address the tax gap. In August 2007, the IRS released a report that builds on the strategy by providing details about actions planned to reduce the tax gap.7

The IRS' current strategy for reducing the tax gap is largely dependent on receipt of funding for additional compliance resources and legislative changes. Therefore, long-term success will in large part be dependent on reducing risk factors, some of which are beyond the control of the IRS. One proposal-to add information reporting requirements-is a proven method for increasing compliance. However, outside stakeholder groups have expressed concern about the increased burden of additional information reporting requirements. However, 61 percent of taxpayers surveyed cited information reporting as a factor for reporting and paying taxes honestly.8



Collection Function Compliance Activities Increased and Results Improved

The number of Collection Field function (CFf) revenue officer personnel working assigned delinquent cases decreased 4 percent (to 3,724) by the end of FY 2007.9 However, since the start of FY 1998, revenue officer staffing has decreased by almost 32 percent.

Although revenue officer staffing is down, many compliance activities continued to increase and results improved during FY 2007. Some of the improvements in Collection function activities that have occurred over the last few years could be the result of an FY 2005 organizational change in the Small Business/Self-Employed Division and efforts to improve business processes. However, the results of some activities were not positive.



Many Collection function operations showed improvement

The following activities showed positive results for the Collection function during FY 2007:


Ÿ Dollars collected on Taxpayer Delinquent Accounts (TDA) by Automated Collection System (ACS) and CFf employees totaled just over $6.3 billion, an increase of almost 3 percent from FY 2006.10 This year's amount is almost 76 percent greater than the 10-year low that occurred in FY 2000.



Ÿ The average amount collected per CFf staff year on TDAs increased by just over 2 percent from FY 2006. The amount increased by just over 109 percent (to $567,733) from a low of $271,110 in FY 1999.11 However, the average amount collected is about 2 percent less than that in FY 2005, the 10-year high.



Ÿ The number of TDAs closed (excluding shelved accounts) and the number closed by full payment increased by almost 7 percent and by almost 6 percent, respectively, from FY 2006.12 This year's volumes are the 10-year highs.



Ÿ The number of taxpayers with Taxpayer Delinquency Investigations (TDI) closed by the ACS and the CFf because delinquent tax returns were received by the IRS increased by almost 2 percent from FY 2006. This was due to the large increase in closures by the CFf; ACS closures decreased by almost 6 percent during the year. Overall, there has been a 74 percent increase since the 10-year low that occurred in FY 2002.



Ÿ As shown in Figure 1, the use of liens (a collection enforcement tool) has increased by 307 percent since the low experienced in FY 1999. During FY 2007, the number of liens issued by the CFf increased by almost 17 percent, while liens issued by the ACS decreased by almost 2 percent.13 The CFf and total volumes represented 10-year highs. As mentioned in last year's report, part of the increase in the number of liens filed on accounts with large balance-due amounts might be attributable to procedural changes made by the Collection function.14





As also shown in Figure 1, the uses of levies and seizures (additional collection enforcement tools) increased substantially from lows experienced in FY 2000. Levies increased by 1,610 percent, and seizures increased by 814 percent.15 While use of levies has surpassed the FY 1998 level, the current seizure level represents only a small fraction of the FY 1998 level. The use of seizures is unlikely to return to a pre-1998 level in the foreseeable future.




Figure 1: Use of Collection Enforcement Tools Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Some Collection function operations showed mixed results

Some indicators were not positive for Collection function compliance activity during FY 2007.


Ÿ The amount of gross accounts receivable increased by almost 7 percent (to $290 billion) after increasing almost 5 percent during FY 2006.16 The FY 2007 amount represents the 10-year high. The increase in gross accounts receivable occurred even though there were increases in gross collections and enforcement revenue collected.



Ÿ More TDAs were received than closed, and the gap between TDA receipts and TDA closures had widened by almost 63 percent (to 1,914,508 accounts) as of the end of the fiscal year.17 This is the largest year-end gap in the 10-year period.


An inventory of unassigned collection cases is maintained in the Queue. The number of taxpayers with TDAs in the Queue and the amount owed on these accounts increased to 10-year highs during FY 2007.18 The number of taxpayer accounts increased by just over 11 percent to 866,777. At the same time, the amount owed increased by just over 28 percent to $34.9 billion. One reason for the increase in the Queue is a rise in the number of compliance assessments.19 In addition, the number of taxpayers with TDIs increased by just over 21 percent to 998,287, even though there was a just over 173 percent increase in the number of these accounts that were shelved or surveyed (removed from inventory) during the year.20 Although many of the cases in the Queue might be assigned to be worked, a significant number might never be worked.

As noted above, the Queue inventory increased during FY 2007. However, those inventory figures do not include the millions of TDA and TDI tax periods shelved or surveyed (removed) from Collection function inventory during the last few years. In FYs 2001 through 2007, the IRS removed almost 7.6 million TDAs21 (with balance-due amounts totaling almost $31.2 billion) and 18.1 million TDI tax periods from Collection function inventory. These cases were removed because they were potentially less productive than other available inventory and might never be worked.

The Collection function is unable to work all of the existing accounts in the Queue with current staffing, and the number of TDA receipts is outpacing closures. If changes do not occur, a significant number of cases will continue to not be worked. This reinforces the need for additional resources to work the cases. As previously noted, the number of revenue officers decreased during FY 2007, but there are plans to hire for this position during FY 2008. In addition, in September 2006, the IRS started assigning balance-due cases that otherwise would not have been worked to private collection agencies. Through FY 2007, the IRS had received a total of $26.6 million after expected commissions on cases assigned to the collection agencies, and program costs totaled $69.8 million. More than 96 percent of the total revenue collected by the agencies was received in FY 2007 alone. The program netted $11.3 million after subtraction of expected commissions and program costs for the year. However, continued use of private collection agencies is uncertain because some members of Congress want the IRS to discontinue their use.



Examination Function Compliance Activities Increased and Results Improved

Overall, the number of field Examination function personnel that conduct examinations of tax returns decreased by just over 4 percent between FYs 2006 and 2007. The number of revenue agents decreased to 10,121, while the number of tax compliance officers decreased to 1,060 as of the end of the fiscal year.22 The number of examiners in field offices23 has decreased by almost 20 percent since the start of FY 1998.

Despite the decrease in the number of examiners during FY 2007, Examination function compliance activities increased in some areas, as noted below. Some of this increase could have been the result of changes implemented by the Small Business/Self-Employed Division, which over the last few years has implemented reengineering and organizational changes that could have had a positive impact on compliance activities within the Examination function. In addition, the Examination function continues to study methods that will result in identifying for examination those tax returns that contain greater potential for noncompliance.

Compared to FY 2006, the percentage of tax returns examined increased for most types of returns during FY 2007. At the same time, the dollar yield per hour on examinations increased for individual tax returns, but revenue agent results decreased for corporate and other types of tax returns.24



The number of tax returns examined increased, but many examinations were conducted via correspondence

When analyzing examination coverage rates, one must recognize differences in the types of contacts that are counted in Examination function statistics. Examinations range from issuance of an IRS notice asking for clarification of a single tax return item that appears to be incorrect (correspondence examination) to a full, face-to-face interview and review of the taxpayer's records. Face-to-face examinations are generally more comprehensive and time consuming for the IRS and the taxpayers, and they typically result in higher dollar adjustments to the tax amounts. Thus, caution should be used when combining statistics from the various Examination function programs into overall examination rates. During FY 2007, slightly more than 71 percent of all examinations were conducted via correspondence.

In addition, the IRS uses several computer-matching and automated error-checking routines in the Computing Centers to check the accuracy of tax returns. These routines often identify adjustments to tax liabilities. However, these adjustments are not included in the traditional "audit rates" and are not generally reported separately as enforcement efforts.

The overall percentage of tax returns examined (including face-to-face and correspondence examinations) increased by almost 9 percent25 from FY 2006 and has doubled since FY 2000. In addition, the overall percentage of tax returns examined was almost 2 percent higher than in FY 1998. The largest increase in the examination rate from FY 2000 was due to examinations of individual, employment, and excise tax returns. Examinations of other types of tax returns did not increase as significantly or decreased.



Figure 2: Percentage Change in the Number of Field Examiners and Examinations Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image



Figure 2 compares the change in field Examination function staffing to the change in the number of examinations by field employees, for all types of tax returns, from the beginning of FY 1998 through FY 2007. The chart line for the number of field examiners does not start at zero because the number of examiners conducting examinations during FY 1998 decreased by almost 3 percent during the year. While Examination function staffing decreased during FY 2007, the IRS plans to hire additional examiners in FY 2008.

A continued effort to increase examination coverage is important to maintaining the effectiveness of the voluntary tax compliance system. The study of taxpayer attitudes about the acceptability of cheating on taxes showed a decline in each of the last 2 years, after showing improvements each year since 2003. In 2007, 13 percent of taxpayers believed it was acceptable to cheat on their tax returns. This is up from 10 percent in 2005. Fear of examination as a major factor influencing taxpayers to report taxes honestly also decreased in the last 2 years. In 2007, 54 percent of taxpayers surveyed cited fear of examination as a factor that influenced their voluntary compliance. This is down from 62 percent in 2005.

The following paragraphs summarize examination coverage for various types of tax returns:


Ÿ Individual Income Tax Examinations - Overall, the number of individual income tax returns examined decreased from FY 1998 through FY 2000. During FY 2000, only 617,765 (1 of every 202) individual income tax returns were examined. Since then, the number examined has continuously increased: 1,384,563 (1 of every 97) returns were examined in FY 2007.26 Almost 83 percent of the examinations of individuals were done by correspondence during FY 2007.27 Only 1 of every 561 individual income tax returns filed received a face-to-face examination, while 1 of every 118 received a correspondence examination.



Ÿ Corporate Income Tax Examinations - The number of corporate income tax returns examined (excluding returns for foreign corporations and S Corporations) increased by just over 4 percent in FY 2007, after decreasing by 1 percent in FY 2006. However, the number of examinations has decreased by almost 45 percent since FY 1998. In FYs 1998 to 2007, the total number of corporate tax returns examined decreased from 53,648 (1 of every 48 returns filed) to 29,664 (1 of every 75 returns filed).28 The number of corporate income tax returns filed decreased by 13 percent during the 10-year period. The decrease in the number of returns filed reduced the impact on the examination coverage rate.





The number of corporate tax returns examined with assets of less than $10 million increased by slightly over 12 percent in FY 2007. During the same period, the number of corporate tax returns examined with assets of $10 million and greater decreased by almost 9 percent, and examinations of those with assets of $250 million and greater decreased by almost 20 percent. However, a much higher percentage of the large corporations than those with assets of less than $10 million is examined.



Ÿ S Corporation Return Examinations - After declining by 75 percent from FYs 1998 to 2004, the number of S Corporation tax returns examined increased by almost 176 percent from FYs 2004 to 2007. The increase in FY 2007 alone was slightly over 26 percent. Since FY 2004, the number of S Corporation returns filed has increased by 16 percent. During that period, the number of tax returns examined increased from 1 of every 526 returns filed to 1 of every 221 returns filed.29 The increase in examination coverage can be partly attributed to the IRS research project studying the compliance of S Corporation entities. However, almost all of these examinations are completed, which could result in a decrease in the number of examinations in future years. The results of this project could lead to future changes in the examination selection methodology for this type of tax return.



Ÿ Partnership Return Examinations - The number of partnership returns examined increased by 25 percent in FY 2007 and has increased by almost 141 percent since the 10-year low experienced in FY 2001. The number of returns filed increased by about 42 percent between FYs 2001 and 2007.30 About 1 of every 408 returns filed was examined in FY 2001. This increased to 1 of every 241 for this year.



Ÿ Other Tax Types Examinations (Fiduciary, Employment, Excise, Estate, and Gift Taxes) - The overall number of examinations in these 5 classes increased by just over 49 percent during FY 2007 and was up just over 156 percent from the 10-year low experienced in FY 2003. A major portion of this year's increase was due to rises in the number of examinations of employment and excise tax returns. The number of fiduciary returns examined increased slightly, but the number of estate and gift tax returns examined decreased.31




Examination function dollar yield per hour has mixed results

Figure 3 shows the dollar yield per hour for FYs 1998 through 2007 for revenue agents and tax compliance officers. The dollar yield per hour improved for examinations of individual tax returns during FY 2007-by almost 3 percent for tax compliance officers and by just over 15 percent for revenue agents. However, the yield decreased by almost 36 percent for revenue agent examinations of corporate tax returns during FY 2007.



Figure 3: Examination Function Dollar Yield per Hour Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image



The Examination function dollar yield per hour for individual income tax return examinations was lower in FY 2004 than in FY 1998.32 Since FY 2004, the yield has increased each year for tax compliance officers. The dollar yield per hour increased significantly for revenue agents during FY 2005, decreased slightly during FY 2006, then increased slightly during FY 2007. The dollar yield per hour for revenue agents is above the FY 1998 level, but the yield for tax compliance officers is not. The dollar results per individual income tax return examined fluctuated during the 10-year period, especially for revenue agents. The number of hours used to examine each tax return increased substantially through FY 2004, then decreased through FY 2007 except for a small increase during FY 2007 for tax compliance officers.

The dollar yield per hour spent examining corporate tax returns increased by 239 percent from FYs 2003 to 2006 and then decreased almost $1,000 per hour (36 percent) in FY 2007.33 During the same time period, the average hours spent examining each tax return and the average dollar amounts assessed per return fluctuated significantly. The net effect was an increase in the dollar yield per hour for FYs 2003 through 2006 and a decrease in FY 2007.



Conclusion

Since FY 2000, the IRS has reversed numerous downward trends in compliance activities that occurred in both the Collection and Examination functions. The IRS should continue its efforts to improve the business processes and workload selection methods because they appear to be having a positive impact on compliance efforts. In addition, the hiring and training of new enforcement personnel should continue to be a top priority because many experienced employees in those positions are already eligible for retirement or will become eligible in the next few years.



Appendix I




Detailed Objective, Scope, and Methodology


The overall objective of this review was to provide statistical information and trend analyses of examination and collection activities, as requested by the IRS Oversight Board.1

To accomplish our objective, we analyzed information obtained from IRS management information system reports to determine trends and changes in the major areas of compliance. Due to time and resource constraints, we did not audit IRS systems to validate the accuracy and reliability of their information. Also, we did not assess internal controls because doing so was not applicable within the context of our objective. The major issues we focused on included:


Ÿ Enforcement revenue and gross accounts receivable.



Ÿ Collection and Examination function staffing.



Ÿ Collection and Examination function direct time.



Ÿ Collection function delinquent account inventories and unfiled return investigations.



Ÿ Collection function enforcement actions (liens, levies, and seizures).



Ÿ Examination function coverage of individual and business tax returns compared to the number of returns filed in each category.



Ÿ Examination function productivity results for individual and business tax returns.



Ÿ Other activities resulting in improvements in the accuracy of filed tax returns and the filing of delinquent returns.




Appendix II




Major Contributors to This Report


Margaret E. Begg, Acting Assistant Inspector General for Audit (Small Business and Corporate Programs)

Carl L. Aley, Director

Amy L. Coleman, Audit Manager

Joseph P. Snyder, Lead Auditor

Janice A. Murphy, Senior Auditor



Appendix III




Report Distribution List


Commissioner C

Office of the Commissioner - Attn: Acting Chief of Staff C

Commissioner, Large and Mid-Size Business Division SE:LM

Commissioner, Small Business/Self-Employed Division SE:S

Commissioner, Wage and Investment Division SE:W

Deputy Commissioner, Large and Mid-Size Business Division SE:LM

Deputy Commissioner, Small Business/Self-Employed Division SE:S

Deputy Commissioner, Wage and Investment Division SE:W

Director, Office of Research, Analysis, and Statistics RAS

Chief Counsel CC

National Taxpayer Advocate TA

Director, Office of Legislative Affairs CL:LA

Director, Office of Program Evaluation and Risk Analysis RAS:O

Office of Internal Control OS:CFO:CPIC:IC

Audit Liaisons:


Commissioner, Large and Mid-Size Business Division SE:LM



Commissioner, Small Business/Self-Employed Division SE:S



Commissioner, Wage and Investment Division SE:W




Appendix IV




Glossary of Terms


6020(b) Program - A provision of the Internal Revenue Code that allows the IRS to prepare returns for businesses when they appear to be liable for a return, have not filed the return, and attempts to secure the return have failed.

Automated Collection System - A telephone contact system through which telephone assistors collect unpaid taxes and secure tax returns from delinquent taxpayers who have not complied with previous notices.

Automated Substitute for Return system - A system designed to assess taxes on wage earners who fail to file tax returns. It analyzes information submitted to the IRS and historical tax return information.

Balance Sheet - A statement of the financial assets and liabilities of a business at a given date filed with a corporate income tax return. It is used by the IRS to group businesses by the size of their assets.

Campus - The data processing arm of the IRS. The campuses process paper and electronic submissions, correct errors, and forward data to the Computing Centers for analysis and posting to taxpayer accounts.

Collection Field function - The unit in the field offices consisting of revenue officers who handle personal contacts with taxpayers to collect delinquent accounts or secure unfiled tax returns.

Compliance Assessments - Those assessments generated by the Examination function, the Underreporter Program, the Automated Substitute for Return Program, and the 6020(b) Program.

Computing Centers - IRS facilities that support tax processing and information management through a data processing and telecommunications infrastructure.

Corporate Income Tax Return - U.S. Corporation Income Tax Return (Form 1120). It is used by corporations to report the corporate income tax.

Dollar Yield Per Hour - The amount of tax adjustments on tax returns divided by the number of hours spent examining those returns.

Earned Income Tax Credit - A tax credit for certain people who work and have income under established limits.

Employment Tax Returns - Various Form 940 return series (primarily Employer's Annual Federal Unemployment (FUTA) Tax Return (Form 940) and Employer's QUARTERLY Federal Tax Return (Form 941)) filed by businesses to report things such as employer's Federal unemployment taxes and Federal taxes withheld.

Enforcement Revenue - Any tax, penalty, or interest received from a taxpayer as a result of an IRS enforcement action (usually an examination or a collection action).

Estate Tax Return - United States Estate (and Generation-Skipping Transfer) Tax Return (Form 706). It is filed for estates of certain deceased persons.

Examination (Face-to-Face) - A field examination of an individual, a partnership, or a corporation that occurs either at the taxpayer's place of business or through an interview(s) at an IRS office.

Excise Tax Return - Quarterly Federal Excise Tax Return (Form 720). It is used to report and pay certain taxes, such as those on transportation and fuel.

Fiduciary Income Tax Returns - Income tax returns filed for estates and trusts.

Gift Tax Return - United States Gift (and Generation-Skipping Transfer) Tax Return (Form 709). It is used to report transfers subject to the Federal gift taxes and to calculate the taxes due on those transfers.

Gross Accounts Receivable - Includes all unpaid tax, with accrued penalties and interest, on taxpayers' delinquent accounts.

Individual Income Tax Returns - U.S. Individual Income Tax Returns (Form 1040 series). They are annual income tax returns filed by citizens or residents of the United States.

IRS Data Book - An IRS annual report providing information on returns filed and taxes collected, enforcement, taxpayer assistance, the IRS budget and workforce, and other selected activities for the fiscal year.

IRS Oversight Board - An independent body charged with overseeing the IRS in its administration, management, conduct, direction, and supervision of the execution and application of the internal revenue laws.

Levy - A method used by the IRS to collect outstanding taxes from sources such as bank accounts and wages.

Lien - An encumbrance on property or rights to property as security for outstanding taxes.

Math Error Program - A process in which the IRS contacts taxpayers through the mail or by telephone when it identifies mathematical errors or mismatches of taxpayer information that would result in tax changes.

National Research Project - Research conducted by the IRS to determine filing, payment, and reporting compliance by taxpayers for different types of taxes.

Overhead Staff - Support staff performing indirect duties within the function such as automation support, technical support, and quality review.

Partnership Return - U.S. Return of Partnership Income (Form 1065). It is used to report the income and expenses of domestic partnerships and the share distributed to each partner.

Queue - An automated holding file for unassigned inventory of delinquent cases for which the Collection function does not have enough resources to immediately assign for contact.

Revenue Agent - An employee in the Examination function who conducts face-to-face examinations of more complex tax returns such as businesses, partnerships, corporations, and specialty taxes (e.g., excise tax returns).

Revenue Officer - An employee in the CFf who attempts to contact taxpayers and resolve collection matters that have not been resolved through notices sent by the IRS campuses (formerly known as service centers) or the ACS.

Revenue Officer Examiner - A revenue officer who has been trained to conduct examinations of employment tax returns.

S Corporation Tax Return - U.S. Income Tax Return for an S Corporation (Form 1120S). It is filed by qualifying small business corporations and includes amounts distributed to shareholders.

Seizure - The taking of a taxpayer's property to satisfy his or her outstanding tax liability.

Service Center Collection Branch - An IRS function that mails the balance-due and return-delinquency notices to taxpayers and analyzes and responds to taxpayer correspondence.

Shelved or Surveyed Cases - Delinquent unpaid accounts or investigations of unfiled tax returns that have been taken out of the Collection function inventory because they are of lower priority than other available inventory.

Tax Compliance Officer/Tax Auditor - An employee in the Examination function that primarily conducts examinations of individual taxpayers through interviews at IRS field offices. The position title was changed in 2002 from tax auditor to tax compliance officer.

Tax Examiner - In the context of this report, an employee located in a field office who conducts examinations through correspondence. However, the tax examiner position is also used for many other types of positions located in various IRS offices.

Taxpayer Delinquent Account - A balance-due account of a taxpayer. A separate TDA exists for each delinquent tax period.

Taxpayer Delinquency Investigation - An unfiled tax return(s) for a taxpayer. One TDI exists for all delinquent tax periods for a taxpayer.

Tax Gap - The difference between what taxpayers should have paid and what they actually paid on time.

Tax Period - Refers to each tax return filed by the taxpayer for a specific period (year or quarter) during a calendar year for each type of tax.

Underreporter Program - A process where items reported on an individual's income tax return are matched to information supplied to the IRS from outside sources (such as employers, banks, and credit unions) to determine if the taxpayer's tax return reflected the correct amounts and if the tax amount is correct.



Appendix V




Detailed Charts of Statistical Information


Note : We eliminated some charts for examinations of individual taxpayers this year because the IRS Examination function changed the way in which it categorizes individual tax returns. We added charts showing statistics for efforts to secure delinquent tax returns from taxpayers.

Figure 1 - Gross Collections by Type of Tax Since FY 1998

Figure 2 - Changes in Enforcement Revenue and Gross Accounts Receivable - Percentage Change From FY 1998

Figure 3 - Amounts of Enforcement Revenue Collected Compared to Growth in Gross Accounts Receivable

Figure 4 - Examination Function Staffing at the End of Each Fiscal Year

Figure 5 - CFf Staffing at the End of Each Fiscal Year

Figure 6 - Staff Years Detailed to Assist Walk-In Taxpayers

Figure 7 - Changes in Direct Time Percentages

Figure 8 - Average Dollars Collected per Staff Year on TDAs by the CFf

Figure 9 - Total Dollars Collected on TDAs by the CFf and ACS

Figure 10 - TDAs and TDIs in the Queue

Figure 11 - TDA and TDI Tax Periods Shelved or Surveyed Each Year

Figure 12 - Gap Between TDI Tax Period Receipts and Closures

Figure 13 - Number of TDI Tax Periods Closed, Excluding Shelved Accounts

Figure 14 - Number of TDI Tax Periods Closed With Receipt of a Delinquent Tax Return

Figure 15 - Gap Between TDA Receipts and Closures

Figure 16 - Number of Taxpayers and Amount Owed in the Queue

Figure 17 - Number of TDAs Closed, Excluding Shelved Accounts

Figure 18 - Number of TDAs Closed by Full Payment

Figure 19 - Liens Filed by the CFf and ACS

Figure 20 - Levies Issued by the CFf and ACS

Figure 21 - Number of Seizures Made Each Fiscal Year

Figure 22 - Examination Coverage of All Tax Returns - Percentage Change From FY 1998

Figure 23 - Revenue Agent Results on U.S. Individual Income Tax Returns (Form 1040), Excluding Training Returns - Percentage Change From FY 1998

Figure 24 - Revenue Agent Results on Corporate Income Tax Returns, Excluding Training Returns - Percentage Change From FY 1998

Figure 25 - Revenue Agent Results on Other Types of Tax Returns, Excluding Training Returns - Percentage Change From FY 1998

Figure 26 - Tax Compliance Officer Results on Forms 1040, Excluding Training Returns - Percentage Change From FY 1998

Figure 27 - Number of Forms 1040 Examined Face-to-Face or Through Correspondence

Figure 28 - Percentage of Forms 1040 Examined Face-to-Face or Through Correspondence

Figure 29 - Examination Coverage of Forms 1040

Figure 30 - Examination Coverage of Forms 1040 - Percentage Change From FY 1998

Figure 31 - Examination Coverage of Corporate Income Tax Returns - Percentage Change From FY 1998

Figure 32 - Percentage of Corporate Income Tax Returns Examined - Corporations With Assets of Less Than $10 Million

Figure 33 - Percentage of Corporate Income Tax Returns Examined - Corporations With Assets of $10 Million and Greater

Figure 34 - Examination Coverage of Corporations With Assets of Less Than $10 Million

Figure 35 - Examination Coverage of Corporations With Assets of $10 Million and Greater

Figure 36 - Examination Coverage of Forms 1120S - Percentage Change From FY 1998

Figure 37 - Examination Coverage of Forms 1120S

Figure 38 - Examination Coverage of Partnership Income Tax Returns

Figure 39 - Examination Coverage of Fiduciary Income Tax Returns

Figure 40 - Examination Coverage of Employment Tax Returns

Figure 41 - Examination Coverage of Excise Tax Returns

Figure 42 - Examination Coverage of Estate Tax Returns

Figure 43 - Examination Coverage of Gift Tax Returns

Figure 44 - Other Compliance Contacts on Forms 1040

Figure 45 - Other Compliance Contacts - Percentage of Form 1040 Coverage

Figure 46 - Numbers and Percentages of Individual and Business Tax Returns Examined



Figure 1. Gross Collections by Type of Tax Since FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 2. Changes in Enforcement Revenue and Gross Accounts Receivable - Percentage Change From FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 3. Amounts of Enforcement Revenue Collected Compared to Growth in Gross Accounts Receivable Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 4. Examination Function Staffing at the End of Each Fiscal Year Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 5. CFf Staffing at the End of Each Fiscal Year Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 6. Staff Years Detailed to Assist Walk-In Taxpayers Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 7. Changes in Direct Time Percentages Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 8. Average Dollars Collected per Staff Year on TDAs by the CFf Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 9. Total Dollars Collected on TDAs by the CFf and ACS Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 10. TDAs and TDIs in the Queue Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 11. TDA and TDI Tax Periods Shelved or Surveyed Each Year Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 12. Gap Between TDI Tax Period Receipts and Closures Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 13. Number of TDI Tax Periods Closed, Excluding Shelved Accounts Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 14. Number of TDI Tax Periods Closed With Receipt of a Delinquent Tax Return Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 15. Gap Between TDA Receipts and Closures Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 16. Number of Taxpayers and Amount Owed in the Queue Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 17. Number of TDAs Closed, Excluding Shelved Accounts Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 18. Number of TDAs Closed by Full Payment Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 19. Liens Filed by the CFf and ACS Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 20. Levies Issued by the CFf and ACS Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 21. Number of Seizures Made Each Fiscal Year Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 22. Examination Coverage of All Tax Returns - Percentage Change From FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 23. Revenue Agent Results on U.S. Individual Income Tax Returns (Form 1040), Excluding Training Returns - Percentage Change From FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 24. Revenue Agent Results on Corporate Income Tax Returns, Excluding Training Returns - Percentage Change From FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 25. Revenue Agent Results on Other Types of Tax Returns, Excluding Training Returns - Percentage Change From FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 26. Tax Compliance Officer Results on Forms 1040, Excluding Training Returns - Percentage Change From FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 27. Number of Forms 1040 Examined Face-to-Face or Through Correspondence Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 28. Percentage of Forms 1040 Examined Face-to-Face or Through Correspondence Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 29. Examination Coverage of Forms 1040 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 30. Examination Coverage of Forms 1040 - Percentage Change From FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 31. Examination Coverage of Corporate Income Tax Returns - Percentage Change From FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 32. Percentage of Corporate Income Tax Returns Examined - Corporations With Assets of Less Than $10 Million Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 33. Percentage of Corporate Income Tax Returns Examined - Corporations With Assets of $10 Million and Greater Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 34. Examination Coverage of Corporations With Assets of Less Than $10 Million Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 35. Examination Coverage of Corporations With Assets of $10 Million and Greater Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 36. Examination Coverage of Forms 1120S - Percentage Change From FY 1998 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 37. Examination Coverage of Forms 1120S Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 38. Examination Coverage of Partnership Income Tax Returns Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 39. Examination Coverage of Fiduciary Income Tax Returns Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 40. Examination Coverage of Employment Tax Returns Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 41. Examination Coverage of Excise Tax Returns Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 42. Examination Coverage of Estate Tax Returns Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 43. Examination Coverage of Gift Tax Returns Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 44. Other Compliance Contacts on Forms 1040 Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 45. Other Compliance Contacts - Percentage of Form 1040 Coverage Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Figure 46. Numbers and Percentages of Individual and Business Tax Returns Examined Inline TIFF Image Download TIFF Image Full-sized PNG Image Screen-Width PNG Image





Appendix VI




Prior Treasury Inspector General for Tax Administration Compliance Trends Reports


Management Advisory Report: Evaluation of Reduction in the Internal Revenue Service's Compliance Activities (Reference Number 2000-30-075, dated May 2000).

Management Advisory Report: Tax Return Filing and Examination Statistics (Reference Number 2001-30-175, dated September 2001).

Management Advisory Report: Analysis of Trends in Compliance Activities Through Fiscal Year 2001 (Reference Number 2002-30-184, dated September 2002).

Trends in Compliance Activities Through Fiscal Year 2002 (Reference Number 2003-30-078, dated March 2003).

Trends in Compliance Activities Through Fiscal Year 2003 (Reference Number 2004-30-083, dated April 2004).

Trends in Compliance Activities Through Fiscal Year 2004 (Reference Number 2005-30-055, dated March 2005).

Trends in Compliance Activities Through Fiscal Year 2005 (Reference Number 2006-30-055, dated March 2006).

Trends in Compliance Activities Through Fiscal Year 2006 (Reference Number 2007-30-056, dated March 27, 2007).

1 See Appendix IV for a glossary of terms used in this report.

2 HIGH-RISK SERIES - An Update (GAO-07-310, dated January 2007).

3 This includes examinations conducted by employees located in field offices and campuses.

4 We computed this percentage using the audit technique to identify whether there was actual face-to-face contact during the examination. This number differs from publicized reports that rely solely on the organizational code.

5 A Comprehensive Strategy for Reducing the Tax Gap (Department of the Treasury, Office of Tax Policy, dated September 26, 2006).

6 Reducing the Federal Tax Gap - A Report on Improving Voluntary Compliance (IRS, dated August 2, 2007).

1 Collection function and Examination function staff located in field offices, excluding management and overhead staff.

2 See Appendix V, Figure 1.

3 See Appendix V, Figure 3.

4 See Appendix V, Figure 2.

5 HIGH-RISK SERIES - An Update (GAO-07-310, dated January 2007).

6 A Comprehensive Strategy for Reducing the Tax Gap (Department of the Treasury, Office of Tax Policy, dated September 26, 2006).

7 Reducing the Federal Tax Gap - A Report on Improving Voluntary Compliance (IRS, dated August 2, 2007).

8 IRS Oversight Board 2007 Taxpayer Attitude Survey (dated February 2008).

9 See Appendix V, Figure 5.

10 See Appendix V, Figure 9.

11 See Appendix V, Figure 8.

12 See Appendix V, Figures 17 and 18.

13 See Appendix V, Figure 19.

14 High-Risk Work Is Selected From the Unassigned Delinquent Account Inventory, but Some Unassigned Accounts Need Management's Attention (Reference Number 2006-30-030, dated February 2006).

15 See Appendix V, Figures 20 and 21.

16 See Appendix V, Figure 3.

17 See Appendix V, Figure 15.

18 See Appendix V, Figure 16.

19 See Appendix V, Figures 22, 24, and 45.

20 See Appendix V, Figures 10 and 11.

21 See Appendix V, Figure 11.

22 See Appendix V, Figure 4.

23 Examiners in field offices include revenue agents, tax compliance officers, tax examiners, and revenue officer examiners.

24 See Appendix V, Figures 23 through 26.

25 The IRS has traditionally calculated the percentage of examination coverage by dividing the number of returns examined in the current fiscal year by the number of returns filed in the preceding calendar year.

26 This includes examinations conducted by employees located in field offices and campuses. See Appendix V, Figure 29.

27 We computed this percentage using the audit technique to identify whether there was actual face-to-face contact during the examination. This number differs from publicized reports that rely solely on the organizational code.

28 See Appendix V, Figures 34, 35, and 46 for coverage by size of corporation.

29 See Appendix V, Figures 37 and 46.

30 See Appendix V, Figures 38 and 46.

31 See Appendix V, Figures 39 through 43 and 46.

32 See Appendix V, Figures 23 and 26.

33 See Appendix V, Figure 24.

1 See Appendix IV for a glossary of terms used in this report.


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Section 368 - step transaction doctrine issue

Rev. Rul. 2008-25 , I.R.B. 2008-21, May 8, 2008.


A merger of a controlling corporation's newly-formed subsidiary into a target corporation, followed by the liquidation of the target, did not constitute a reverse subsidiary reorganization. Instead, the transaction was a qualified purchase by the controlling corporation of the target's stock followed by a Code Sec. 332 liquidation. Although the IRS found that the merger and liquidation were part of a series of interrelated steps which prevented them from qualifying as a reorganization, the IRS concluded that the acquisition of the target's stock was a qualified stock purchase, as defined in Code Sec. 338(d)(3) followed by a separate Code Sec. 332 liquidation. This resulted in the acquiring corporation receiving the target's assets in liquidation with a carryover basis.



[ Code Sec. 368]


Reverse subsidiary mergers: Step transaction doctrine. --
A merger of a controlling corporation's newly-formed subsidiary into a target corporation, followed by the target's liquidation, did not constitute a reverse subsidiary reorganization. Instead, the transaction was a qualified purchase by the controlling corporation of the target's stock followed by a Code Sec. 332 liquidation. Applying the step transaction doctrine, the IRS concluded that the liquidation of the target into the controlling corporation meant that the target did not hold substantially all of its properties and the properties of the merged subsidiary, as required in a Code Sec. 368(a)(2)(E) reverse subsidiary merger.





ISSUE

What is the proper Federal income tax treatment of the transaction described below?



FACTS

T is a corporation all of the stock of which is owned by individual A. T has 150x dollars worth of assets and 50x dollars of liabilities. P is a corporation that is unrelated to A and T. The value of P's assets, net of liabilities, is 410x dollars. P forms corporation X, a wholly owned subsidiary, for the sole purpose of acquiring all of the stock of T by causing X to merge into T in a statutory merger (the "Acquisition Merger"). In the Acquisition Merger, P acquires all of the stock of T, and A exchanges the T stock for 10x dollars in cash and P voting stock worth 90x dollars. Following the Acquisition Merger and as part of an integrated plan that included the Acquisition Merger, T completely liquidates into P (the "Liquidation"). In the Liquidation, T transfers all of its assets to P and P assumes all of T's liabilities. The Liquidation is not accomplished through a statutory merger. After the Liquidation, P continues to conduct the business previously conducted by T.



LAW

Section 368(a)(1)(A) of the Internal Revenue Code provides that the term "reorganization" means a statutory merger or consolidation. Section 368(a)(2)(E) provides that a transaction otherwise qualifying under §368(a)(1)(A) shall not be disqualified by reason of the fact that stock of a corporation in control of the merged corporation is used in the transaction, if (i) after the transaction, the corporation surviving the merger holds substantially all of its properties and of the properties of the merged corporation (other than stock of the controlling corporation distributed in the transaction), and (ii) in the transaction, former shareholders of the surviving corporation exchanged, for an amount of voting stock of the controlling corporation, an amount of stock in the surviving corporation which constitutes control of the surviving corporation. Further, §1.368-2(j)(3)(iii) of the Income Tax Regulations provides that "[i]n applying the `substantially all' test to the merged corporation, assets transferred from the controlling corporation to the merged corporation in pursuance of the plan of reorganization are not taken into account."

Section 368(a)(1)(C) provides in part that a reorganization is the acquisition by one corporation, in exchange solely for all or part of its voting stock, of substantially all of the properties of another corporation, but in determining whether the exchange is solely for stock, the assumption by the acquiring corporation of a liability of the other shall be disregarded. Section 368(a)(2)(B) provides that if one corporation acquires substantially all of the properties of another corporation, the acquisition would qualify under §368(a)(1)(C) but for the fact that the acquiring corporation exchanges money or other property in addition to voting stock, and the acquiring corporation acquires, solely for voting stock described in §368(a)(1)(C), property of the other corporation having a fair market value which is at least 80 percent of the fair market value of all of the property of the other corporation, then such acquisition shall (subject to §368(a)(2)(A)) be treated as qualifying under §368(a)(1)(C). Section 368(a)(2)(B) further provides that solely for purposes of determining whether its requirements are satisfied, the amount of any liabilities assumed by the acquiring corporation shall be treated as money paid for the property.

Section 1.368-1(a) generally provides that in determining whether a transaction qualifies as a reorganization under §368(a), the transaction must be evaluated under relevant provisions of law, including the step transaction doctrine.

Section 1.368-2(k) provides, in part, that a transaction otherwise qualifying as a reorganization under §368(a) shall not be disqualified or recharacterized as a result of one or more distributions to shareholders (including distribution(s) that involve the assumption of liabilities) if the requirements of §1.368-1(d) are satisfied, the property distributed consists of assets of the surviving corporation, and the aggregate of such distributions does not consist of an amount of assets of the surviving corporation (disregarding assets of the merged corporation) that would result in a liquidation of such corporation for Federal income tax purposes.

Rev. Rul. 67-274, 1967-2 C.B. 141, holds that an acquiring corporation's acquisition of all of the stock of a target corporation solely in exchange for voting stock of the acquiring corporation, followed by the liquidation of the target corporation as part of the same plan, will be treated as an acquisition by the acquiring corporation of substantially all of the target corporation's assets in a reorganization described in §368(a)(1)(C). The ruling explains that, under these circumstances, the stock acquisition and the liquidation are part of the overall plan of reorganization and the two steps may not be considered independently of each other for Federal income tax purposes. See also, Rev. Rul. 72-405, 1972-2 C.B. 217.

Rev. Rul. 2001-46, 2001-2 C.B. 321, holds that, where a newly formed wholly owned subsidiary of an acquiring corporation merged into a target corporation, followed by the merger of the target corporation into the acquiring corporation, the step transaction doctrine is applied to integrate the steps and treat the transaction as a single statutory merger of the target corporation into the acquiring corporation. Noting that the rejection of step integration in Rev. Rul. 90-95, 1990-2 C.B. 67, and §1.338-3(d) is based on Congressional intent that §338 replace any nonstatutory treatment of a stock purchase as an asset purchase under the Kimbell-Diamond doctrine, the Service found that the policy underlying §338 is not violated by treating the steps as a single statutory merger of the target into the acquiring corporation because such treatment results in a transaction that qualifies as a reorganization in which the acquiring corporation acquires the assets of the target corporation with a carryover basis under §362, rather than receiving a cost basis in those assets under §1012. (In Kimbell-Diamond Milling Co. v. Commissioner, 14 T.C. 74, aff'd per curiam, 187 F.2d 718 (1951), cert. denied, 342 U.S. 827 (1951), the court held that the purchase of the stock of a target corporation for the purpose of obtaining its assets through a prompt liquidation should be treated by the purchaser as a purchase of the target corporation's assets with the purchaser receiving a cost basis in the assets.)

Section 338(a) provides that if a corporation makes a qualified stock purchase and makes an election under that section, then the target corporation (i) shall be treated as having sold all of its assets at the close of the acquisition date at fair market value and (ii) shall be treated as a new corporation which purchased all of its assets as of the beginning of the day after the acquisition date. Section 338(d)(3) defines a qualified stock purchase as any transaction or series of transactions in which stock (meeting the requirements of §1504(a)(2)) of one corporation is acquired by another corporation by purchase during a 12-month acquisition period. Section 338(h)(3) defines a purchase generally as any acquisition of stock, but excludes acquisitions of stock in exchanges to which §351, §354, §355, or §356 applies.

Section 338 was enacted in 1982 and was "intended to replace any nonstatutory treatment of a stock purchase as an asset purchase under the Kimbell-Diamond doctrine." H.R. Conf. Rep. No. 760, 97th Cong, 2d Sess. 536 (1982), 1982-2 C.B. 600, 632. Stock purchase or asset purchase treatment generally turns on whether the purchasing corporation makes or is deemed to make a §338 election. If the election is made or deemed made, asset purchase treatment results and the basis of the target assets is adjusted to reflect the stock purchase price and other relevant items. If an election is not made or deemed made, the stock purchase treatment generally results. In such a case, the basis of the target assets is not adjusted to reflect the stock purchase price and other relevant items.

Rev. Rul. 90-95 (Situation 2), holds that the merger of a newly formed wholly owned domestic subsidiary into a target corporation with the target corporation shareholders receiving solely cash in exchange for their stock, immediately followed by the merger of the target corporation into the domestic parent of the merged subsidiary, will be treated as a qualified stock purchase of the target corporation followed by a §332 liquidation of the target corporation. As a result, the parent's basis in the target corporation's assets will be the same as the basis of the assets in the target corporation's hands. The ruling explains that even though "the step-transaction doctrine is properly applied to disregard the existence of the [merged subsidiary]," so that the first step is treated as a stock purchase, the acquisition of the target corporation's stock is accorded independent significance from the subsequent liquidation of the target corporation and, therefore, is treated as a qualified stock purchase regardless of whether a §338 election is made. Thus, in that case, the step transaction doctrine was not applied to treat the transaction as a direct acquisition by the domestic parent of the assets of the target corporation because such an application would have resulted in treating a stock purchase as an asset purchase, which would be inconsistent with the repeal of the Kimbell-Diamond doctrine and §338.

Section 1.338-3(d) incorporates the approach of Rev. Rul. 90-95 into the regulations by requiring the purchasing corporation (or a member of its affiliated group) to treat certain asset transfers following a qualified stock purchase (where no §338 election is made) independently of the qualified stock purchase. In the example in §1.338-3(d)(5), the purchase for cash of 85 percent of the stock of a target corporation, followed by the merger of the target corporation into a wholly owned subsidiary of the purchasing corporation, is treated (other than by certain minority shareholders) as a qualified stock purchase of the stock of the target corporation followed by a §368 reorganization of the target corporation into the subsidiary. As a result, the subsidiary's basis in the target corporation's assets is the same as the basis of the assets in the target corporation's hands.



ANALYSIS

If the Acquisition Merger and the Liquidation were treated as separate from each other, the Acquisition Merger would be treated as a stock acquisition that qualifies as a reorganization under §368(a)(1)(A) by reason of §368(a)(2)(E), and the Liquidation would qualify under §332. However, as provided in §1.368-1(a), in determining whether a transaction qualifies as a reorganization under §368(a), the transaction must be evaluated under relevant provisions of law, including the step transaction doctrine. In this case, because T was completely liquidated, the §1.368-2(k) safe harbor exception from the application of the step transaction doctrine does not apply. Accordingly, the Acquisition Merger and the Liquidation may not be considered independently of each other for purposes of determining whether the transaction satisfies the statutory requirements of a reorganization described in §368(a)(1)(A) by reason of §368(a)(2)(E). As such, this transaction does not qualify as a reorganization described in §368(a)(1)(A) by reason of §368(a)(2)(E) because, after the transaction, T does not hold substantially all of its properties and the properties of the merged corporation.

In determining whether the transaction is a reorganization, the approach reflected in Rev. Rul. 67-274 and Rev. Rul. 2001-46 is applied to ignore P's acquisition of the T stock in the Acquisition Merger and to treat the transaction as a direct acquisition by P of T's assets in exchange for 10x dollars in cash, 90x dollars worth of P voting stock, and the assumption of T's liabilities.

However, unlike the transactions considered in Revenue Rulings 67-274, 72-405 and 2001-46, a direct acquisition by P of T's assets in this case does not qualify as a reorganization under §368(a). P's acquisition of T's assets is not a reorganization described in §368(a)(1)(C) because the consideration exchanged is not solely P voting stock and the requirements of §368(a)(2)(B) are not satisfied. Section 368(a)(2)(B) would treat P as acquiring 40 percent of T's assets for consideration other than P voting stock (liabilities assumed of 50x dollars, plus 10x dollars cash). See Rev. Rul. 73-102, 1973-1 C.B. 186 (analyzing the application of §368(a)(2)(B)). P's acquisition of T's assets is not a reorganization described in §368(a)(1)(D) because neither T nor A (nor a combination thereof) was in control of P (within the meaning of §368(a)(2)(H)(i)) immediately after the transfer. Additionally, the transaction is not a reorganization under §368(a)(1)(A) because T did not merge into P. Accordingly, the overall transaction is not a reorganization under §368(a).

Additionally, P's acquisition of the T stock in the Acquisition Merger is not a transaction to which §351 applies because A does not control P (within the meaning of §368(c)) immediately after the exchange.

Rev. Rul. 90-95 and §1.338-3(d) reject the step integration approach reflected in Rev. Rul. 67-274 where the application of that approach would treat the purchase of a target corporation's stock without a §338 election followed by the liquidation or merger of the target corporation as the purchase of the target corporation's assets resulting in a cost basis in the assets under §1012. Rev. Rul. 90-95 and §1.338-3(d) treat the acquisition of the stock of the target corporation as a qualified stock purchase followed by a separate carryover basis transaction in order to preclude any nonstatutory treatment of the steps as an integrated asset purchase.

In this case, further application of the approach reflected in Rev. Rul. 67-274, integrating the acquisition of T stock with the liquidation of T, would result in treating the acquisition of T stock as a taxable purchase of T's assets. Such treatment would violate the policy underlying §338 that a cost basis in acquired assets should not be obtained through the purchase of stock where no §338 election is made. Accordingly, consistent with the analysis set forth in Rev. Rul. 90-95, the acquisition of the stock of T is treated as a qualified stock purchase by P followed by the liquidation of T into P under §332.



HOLDING

The transaction is not a reorganization under §368(a). The Acquisition Merger is a qualified stock purchase by P of the stock of T under §338(d)(3). The Liquidation is a complete liquidation of a controlled subsidiary under §332.



PROSPECTIVE APPLICATION

The Service will consider the application of §7805(b) on a case-by-case basis.



DRAFTING INFORMATION

The principal author of this revenue ruling is Mary W. Lyons of the Office of Associate Chief Counsel (Corporate). For further information regarding this revenue ruling, contact Ms. Lyons at (703) 622-7930 (not a toll-free call).

IRS Fraud on the Court

Larry L. Hartman, et al. v. Commissioner.

Dkt. Nos. 1371-85 , 48690-86 , 4116-87 , 15673-87 , 16761-87 , 18551-88 , 29429-88 , TC Memo. 2008-124, May 1, 2008.

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Tax Court Rules: Kersting tax shelter litigation: Stipulated settlement: Order to vacate. --
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LARRY L. HARTMAN, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent*



MEMORANDUM OPINION


Introduction

Petitioners' motions arise from the misconduct of respondent's attorneys in implementing the Court's test case procedure used by the Court in the Kersting tax shelter project to try and decide Dixon v. Commissioner [Dec. 47,801(M)] T.C. Memo. 1991-614 (Dixon II), vacated and remanded sub nom. DuFresne v. Commissioner [94-1 USTC ¶50,286] 26 F.3d 105 (9th Cir. 1994), on remand Dixon v. Commissioner [Dec. 53,314(M)] T.C. Memo. 1999-101 (Dixon III), supplemented by [Dec. 53,832(M)] T.C. Memo. 2000-116 (Dixon IV), revd. and remanded [2003-1 USTC ¶50,194] 316 F.3d 1041 (9th Cir. 2003) (Dixon V), culminating with our disposition of the second remand in Dixon v. Commissioner [Dec. 56,502(M)] T.C. Memo. 2006-90 (Dixon VI), supplemented by [Dec. 56,615(M)] T.C. Memo. 2006-190 (Dixon VIII).3 We have entered decisions in the 27 docketed cases that participated in the second remand; 13 of those cases are on appeal to the Court of Appeals for the Ninth Circuit,4 where, we assume, they will be considered by the panel that decided Dixon V.5

In Dixon V, the Court of Appeals held that the misconduct of respondent's trial attorney and his supervisor was a fraud on the Court that violated the rights of all Kersting project petitioners who had agreed to be bound by the outcome of the Tax Court proceeding. The Court of Appeals ordered this Court to sanction respondent by entering decisions in the cases of the remaining test case petitioners and other Kersting project petitioners before the Court of Appeals on terms equivalent to those provided in the secret Thompson settlement.





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II. Analysis

A. The Fraud on the Court Committed by Respondent's Attorneys, the Harm Done Thereby, and the Sanction Mandated by the Court of Appeals

In Dixon V at 1045, the Court of Appeals for the Ninth Circuit held that the misconduct of McWade and Sims during the test case proceedings, including its persistence and concealment, was a fraud on the Tax Court. "Fraud on the court occurs when the misconduct harms the integrity of the judicial process, regardless of whether the opposing party is prejudiced." Id. at 1046 (citing Alexander v. Robertson, 882 F.2d at 424).

McWade and Sims perpetrated a fraud on the Court that harmed the integrity of the judicial process. That judicial process was the test case procedure that the parties, with the Tax Court's participation and encouragement, invoked in their efforts to resolve the more than 1,800 cases arising from respondent's disallowance of deductions claimed by participants in the Kersting programs.

When the Court, taxpayers, and the IRS agree to employ the test case procedure, the taxpayers whose cases are bound (whether by piggyback agreement or the Court's order to show cause procedure) by the outcome of the test cases expect (and have a right to do so) that the test cases will be well and fairly tried. The fraud on the Court committed by McWade and Sims in the Kersting project test cases violated the rights of all Kersting project petitioners who were bound by the outcome of the test case proceedings and betrayed the confidence of all future litigants in the test case procedure. Id. at 1047. The test case procedure is a valuable judicial procedure, and, as the Court of Appeals recognized, the continued viability of that procedure requires the confidence of all future litigants.

The fraud on the Court committed by respondent's attorneys in the Kersting project test cases violated the rights of not only the test case petitioners but every petitioner whose case was bound by the outcome of the test cases. The fraud committed by McWade and Sims was a fraud on the Court in every one of those cases.

The appropriate sanction against respondent for the fraud committed on the Court by McWade and Sims should remedy the harm done to the judicial process, restore public confidence in the test case proceedings, rectify the violation of the rights of the Kersting project petitioners whose cases were bound by the outcome of the test cases, and deter future violations by the offending party. After expressing indignation at the odiousness of the Government attorneys' misconduct and the Tax Court's repeated failures to "get it right", the Court of Appeals formulated and mandated an intermediate sanction that provides both an appropriate remedy for the violation of the rights of Kersting project petitioners and an effective deterrent to further misconduct by Government attorneys. Holding the limited sanctions we initially imposed in Dixon III and IV to be grossly inadequate, but recognizing that the power to sanction is to be "'exercised with restraint and discretion'", Dixon V at 1047 (quoting Roadway Express, Inc. v. Piper, 447 U.S. 752, 764 (1980)), the Court of Appeals held that it would be inappropriate to force the taxpayers to endure a remand for a trial on the merits,41 but also declined to enter judgment eradicating all tax liability of the Kersting project petitioners --"Such an extreme sanction, while within the court's power, is not warranted under these facts." Id. at 1047 (citing Chambers v. NASCO, Inc., 501 U.S. 32, 45 (1991)).

The Court of Appeals recognized that the fraud on the court committed by respondent's attorneys in the Kersting project test cases was a fraud on the court in every case bound by the outcome of the test cases and sanctioned respondent in each of those cases before the Court of Appeals. The Court of Appeals held that the appropriate remedy to be applied to all Kersting project petitioners who were bound by the test cases (test case and nontest case petitioners alike) properly before it was to enter decisions that put them, as nearly as possible, in the same position as provided for in the Thompson settlement. Id. at 1047 n.11. Putting every Kersting project petitioner (test case and nontest case petitioners alike) whose cases were part of the test case proceedings in the same position as provided for in the Thompson settlement is the appropriate remedy for the violation of their rights and the sanction that should have the necessary deterrent effect.

We have granted petitioners leave to file and petitioners have filed motions to vacate the stipulated decisions entered in their cases. In effect, they have asked the Court to impose on respondent in their cases the sanction mandated by the Court of Appeals in Dixon V. Motions in this Court to vacate or revise a decision are covered by Rule 162, which provides: "Any motion to vacate or revise a decision, with or without a new or further trial, shall be filed within 30 days after the decision has been entered, unless the Court shall otherwise permit." Rule 162 provides no guidance as to when this Court will grant leave to file a motion to vacate more than 30 days after a decision is entered or, more importantly, when this Court will grant a motion to vacate.

A stipulated decision falls within the purview of Rule 91(a), which requires parties to stipulate "all matters not privileged which are relevant to the pending case, regardless of whether such matters involve fact or opinion or the application of law to fact." The stipulation process has broad scope and is not confined to the stipulation of facts or evidence. Willamette Indus., Inc. v. Commissioner [Dec. 50,570(M)] T.C. Memo. 1995-150 (citing Explanatory Note to Rule 91(a), 60 T.C. 1118). "The Court will not permit a party to a stipulation to qualify, change, or contradict a stipulation in whole or in part, except that it may do so where justice requires." Rule 91(e) (emphasis added). Where Rule 91(e) applies, the Tax Court must proceed in accordance with the provisions of that Rule. Farrell v. Commissioner [98-1 USTC ¶50,194] 136 F.3d 889, 893-897 (2d Cir. 1998), revg. and vacating Spears v. Commissioner [Dec. 51,468(M)] T.C. Memo. 1996-341. The Court is reluctant to set aside a stipulated decision in absence of fraud, mutual mistake of fact, or other like cause. MacElvain v. Commissioner [Dec. 44,073(M)] T.C. Memo. 1987-366 (citing Saigh v. Commissioner [Dec. 21,694] 26 T.C. 171, 176 (1956), and Estate of Jones v. Commissioner [Dec. 40,973(M)] T.C. Memo. 1984-53, affd. [86-2 USTC ¶13,675] 795 F.2d 566 (6th Cir. 1986)).

When a taxpayer files a motion to vacate a decision after it has become final, our authority to vacate the decision, though limited, may be exercised in situations where the taxpayers establish the existence of a fraud on the Court. Cinema '84 v. Commissioner [Dec. 55,593] 122 T.C. 264, 270 (2004). Fraud on the Court is a fraud that harms the integrity of the judicial process. Standard Oil Co. of Cal. v. United States, 429 U.S. 17 (1976); Hazel-Atlas Glass Co. v. Hartford-Empire Co., 322 U.S. 238, 245 (1944). Fraud on the court includes any unconscionable plan or scheme that is designed to improperly influence the court in its decision. Abatti v. Commissioner [88-2 USTC ¶9548] 859 F.2d 115, 118-119 (9th Cir. 1988), affg. [Dec. 43,138] 86 T.C. 1319 (1986). The limited definition of fraud on the Court reflects the policy of putting an end to litigation and serves the important legal and social interest in preserving the finality of judgments. Toscano v. Commissioner, 441 F.2d at 934.

Recognizing that the fraud on the Court committed by respondent's trial attorneys (1) was a fraud on the Court in every Kersting project case that was bound by the test case cases and (2) violated the rights of all Kersting project petitioners in those cases, we are convinced that justice will best be served by vacating the stipulated decisions and imposing on respondent the sanction mandated by the Court of Appeals in Dixon V.

Respondent's position in these cases is that Kersting project petitioners are not entitled to the benefit of the final Thompson settlement unless they can directly connect conduct amounting to fraud on the Court to the decisions entered in their cases. Respondent does not object to vacating the decisions in nontest cases that were entered after December 11, 1991, the date the Court filed its Dixon II opinion, and before June 9, 1992, the date respondent disclosed the misconduct of McWade and Sims to the Court in the motions to vacate the decisions in the Thompson, Cravens, and Rina test cases. Respondent concedes that decisions in Kersting project cases that were entered during that "gap period" (see supra note 39 and accompanying text) were obtained by fraud on the Court and that decisions in those cases should be vacated. Respondent agrees that taxpayers who agreed to stipulated decisions "in possible reliance on Dixon II and in apparent ignorance of the misconduct in the test cases" are entitled to have their decisions vacated because of the fraud on the Court.

Respondent objects to vacating stipulated decisions in these and other Kersting project cases that were entered before the publication of Dixon II (such as the Hartman cases) or after the discovery and disclosure to the Court of the misconduct of respondent's attorneys (such as the Lewis and the Liu cases). Respondent objects to vacating decisions entered in these and other similar cases on the ground that the misconduct of McWade and Sims had no influence on those petitioners' decisions to settle their cases.

Respondent contends that before Dixon II was issued no one knew with absolute certainty how the Court would rule on the merits of the Kersting programs and that implicit in prior decisions to settle was petitioners' belief that "they would lose under a fairly tried case". In our view, petitioners, irrespective of whether they had concluded that their position on the merits was well-nigh hopeless or had some chance of success, were entitled to assume that the test cases whose outcome would determine the tax effects of the Kersting programs would be well and fairly tried. That assumption was defeated by McWade's and Sims's intervening misconduct.




C. Subsequent Voluntary Disclosure of the Fraud on the Court Does Not Purge the Fraud

Although respondent reported the secret settlements to the Court and counsel for the remaining test case petitioners promptly after discovering McWade's and Sims's misconduct, those disclosures did not purge any of the Kersting project cases of the fraud committed on the Court. Once a fraud is committed, subsequent voluntary disclosure of the fraud does not purge the fraud. Badaracco v. Commissioner [84-1 USTC ¶9150] 464 U.S. 386, 394 (1984). A taxpayer who files a fraudulent return, regardless of the taxpayer's subsequent voluntary disclosure, remains subject to criminal prosecution and the civil fraud penalty. Id. The fraud is committed and the offense completed when the original fraudulent return is prepared and filed. Id. Where a taxpayer files a false or fraudulent return but later files a nonfraudulent amended return, section 6501(c)(1) applies and a tax may be assessed "at any time", regardless of whether more than 3 years have expired since the filing of the amended return. Id. (citing United States v. Habig [68-1 USTC ¶9243] 390 U.S. 222 (1968), and Plunkett v. Commissioner [72-2 USTC ¶9541] 465 F.2d 299, 302-303 (7th Cir. 1972), affg. [Dec. 30,349(M)] T.C. Memo. 1970-274); see also George M. Still, Inc. v. Commissioner [Dec. 19,511] 19 T.C. 1072, 1077 (1953), affd. [55-1 USTC ¶9172] 218 F.2d 639 (2d Cir. 1955).


A party cannot avoid sanctions for committing a fraud on the court by settlement or withdrawal from the case. See, e.g., Bader v. Itel Corp. (In re Itel Secs. Litig.), 791 F.2d 672 (9th Cir. 1986). It is well settled that an agreement between private parties cannot deprive the Court of its power to investigate, to render rulings, or to impose sanctions for an alleged fraud upon the court. Chambers v. NASCO, Inc., 501 at 44 (citing Universal Oil Prods. Co. v. Root Ref. Co., 328 U.S. 575, 580 (1946)); see also Hazel-Atlas Glass Co. v. Hartford-Empire Co., 322 U.S. 238 (1944); Bush Ranch, Inc. v. E.I. du Pont de Nemours & Co., 918 F. Supp. 1524 (M.D. Ga. 1995), revd. and remanded on other grounds 99 F.3d 363 (11th Cir. 1996). "Of particular relevance here, the inherent power also allows a federal court to vacate its own judgment upon proof that a fraud has been perpetrated upon the court." Chambers v. NASCO, Inc., supra at 44 (citing Hazel-Atlas Glass Co. v. Hartford-Empire Co., supra, and Universal Oil Prods. Co. v. Root Ref. Co., supra at 580); see also Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 396 (1990) ("A court may make an adjudication of contempt and impose a contempt sanction even after the action in which the contempt arose has been terminated."); Bush Ranch, Inc. v. E.I. DuPont De Nemours & Co., 99 F.3d at 367-368 (District Court had power to investigate an alleged fraud upon the court and impose civil sanctions for the fraud in a case where the plaintiffs had voluntarily moved for dismissal of their claims with prejudice 2 years earlier).

Further, we agree with petitioners that their acceptance of the posttrial settlement offer did not release respondent from the consequences of the fraud on the Court. In Lewis v. Commissioner [Dec. 56,128(M)] T.C. Memo. 2005-205, we stated that the Lewises settled their cases with the understanding, set forth explicitly in respondent's posttrial settlement offer, that accepting the offer would "'preclude any further challenge or appeal with respect to the Kersting programs or the merits of the Dixon opinion'." On reconsideration, we now conclude that petitioners' requests that sanctions be imposed on respondent for the fraud committed in their cases is not a challenge to the Kersting programs or to the merits of the Dixon II opinion within the meaning of respondent's posttrial settlement offer.

A settlement "is a contract and thus is a proper subject of judicial interpretation as to its meaning, in light of the language used and the circumstances surrounding its execution." Robbins Tire & Rubber Co. v. Commissioner [Dec. 29,612] 52 T.C. 420, 435-436 (1969); see also Brink v. Commissioner [Dec. 25,815] 39 T.C. 602, 606 (1962), affd. [64-1 USTC ¶9257] 328 F.2d 622 (6th Cir. 1964); Saigh v. Commissioner, 26 T.C. at 177; Davis v. Commissioner [Dec. 12,461] 46 B.T.A. 663, 671 (1942); Himmelwright v. Commissioner [Dec. 44,644(M)] T.C. Memo. 1988-114. The circumstances in the Kersting test case proceedings and the terms of the posttrial settlement offer show that petitioners did not release respondent from claims arising from or related to McWade's and Sims's misconduct during the Kersting test case proceedings.

cases remains unchanged" was misleading, because it conveyed the impression that Dixon II and the Court's rulings were the last word on the subject. It failed to disclose that the other test cases were on appeal and that appellants were asserting fraud on the court as a ground for vacating the decisions in the other test cases.

The failure of the offer to disclose and identify the test case petitioners who had received a very different settlement, giving them much more favorable treatment, and that giving preferential treatment violated IRS policy and the Department of the Treasury Minimum Standards of Conduct renders disingenuous the statement in the posttrial settlement offer "we have concluded that in fairness all petitioners be afforded an opportunity to settle their cases".








Conclusion

We hold that neither the posttrial settlement offer nor the stipulated decisions thereby generated bar the Court from considering the fraud on the Court as it affected all cases pending at the time the offer was made or imposing sanctions to remedy the harm caused by the fraud on the Court. We also hold that all Kersting project petitioners whose cases were bound by the results in the Kersting project test cases are entitled to the benefit of the Thompson settlement regardless of when they settled their cases. All taxpayers whose cases are part of a test case procedure should be assured that the test cases will be well and fairly tried, regardless of whether or when they settle their cases. The misconduct that was a fraud on the Court began long before the trial of the test cases that resulted in Dixon II. The Kersting project test case proceedings began June 10, 1985, the first day of the June 1985 session during which the Court agreed with Seery and McWade to use the test case proceeding to resolve all Kersting project cases. We do not think that justice would be served if we were to require another trial in each previously settled case to determine whether sanctions should be imposed for the fraud committed on the Court during the Kersting test case proceedings. As expressed by the Court of Appeals in Dixon V at 1047:

Here, it plainly would be unjust to remand for a new, third trial. The IRS had an opportunity to present its case fairly and properly. Instead its lawyers intentionally defrauded the Tax Court. The Tax Court had two opportunities to equitably resolve this situation and failed. Enormous amounts of time and judicial resources have been wasted. * * *

In Hazel-Atlas Glass Co. v. Hartford Empire Co., 322 U.S. 238 (1944), the Supreme Court explained that the inquiry into whether a judgment should be set aside for fraud on the court focuses not so much on whether the alleged fraud prejudiced the opposing party but on whether the alleged fraud harms the integrity of the judicial process. The misconduct of McWade and Sims was a fraud on the Court because it harmed the integrity of the judicial process. The judicial process that was harmed by the misconduct was more than just the trial of the test cases; the judicial process that was implicated is the test case procedure that encompassed the cases of all taxpayers before this Court that were bound by the results in the test cases. The judicial process referred to by the Court of Appeals also encompasses all future cases employing test case procedures. Taxpayers' confidence in future test case proceedings was undermined by the misconduct. Dixon V at 1046-1047. In deciding the proper sanction to impose for the fraud on the Court, we must "carefully balance the policy favoring adjudication on the merits with * * * the need to maintain institutional integrity and the desirability of deterring future misconduct." Aoude v. Mobil Oil Corp., 892 F.2d 1115, 1118 (1st Cir. 1989) (finding that the District Court considered the relevant factors and in dismissing the action acted well within its discretion).

Respondent's attorneys committed a fraud on the Tax Court during the Kersting test case proceedings that was a fraud on the Court in every case bound by the results of the test cases. Extending to every petitioner whose case was bound by the results of the Kersting project test cases, by piggyback agreement or the Court's order to show cause procedure, the benefit of the Thompson settlement strikes us as an appropriate accommodation of the competing considerations; it is a sanction for the misconduct that is consistent with Dixon V and is "no more than necessary" to maintain public trust in the judicial process that employs test case procedures. See, e.g., Gomez v. Vernon, 255 F.3d 1118, 1135 (9th Cir. 2001). We have considered the relevant factors with the standard set by the Court of Appeals in Dixon V. We are protective of the integrity of our judicial process and concerned about deterrence. We are "entitled to send a message, loud and clear." Aoude v. Mobil Oil Corp., supra at 1122. We hold that sanctions should be imposed in the cases of all Kersting project petitioners in which stipulated decisions were entered on or after June 10, 1985, the date the Kersting project test case proceedings began.

Our holding is limited to the unique and narrow circumstances of these cases --where we are imposing sanctions for a fraud committed on the Court in a test case proceeding that bound more than a thousand cases. Compare Dixon V with Abatti v. Commissioner, 859 F.2d at 117.

Having reconsidered Lewis v. Commissioner [Dec. 56,128(M)] T.C. Memo. 2005-205, and addressed the merits of petitioners' arguments and respondent's objections, we shall grant petitioners' motions to vacate the stipulated decisions entered in the cases at hand and enter new decisions in accordance with Dixon VI and Dixon VIII, giving effect to the opinion of the Court of Appeals for the Ninth Circuit in Dixon V.


Implementation of Sanction

Recognizing that "Enormous amounts of time and judicial resources have been wasted", the Court wishes to relieve other Kersting project nontest case petitioners who had stipulated decisions entered in their cases on or after June 10, 1985, of the burden of filing motions for leave to file motions to vacate decisions. We believe that the most expeditious and efficient means of implementing the sanction is to allow respondent to adjust administratively the accounts of all Kersting project petitioners, other than Hartman, the Lewises, and the Lius, without requiring further action from the Kersting project petitioners.47 Administrative adjustments would eliminate the need for other Kersting project petitioners to file motions for leave to file motions to vacate the decisions in their cases and the attorney's fees that otherwise might be incurred and claimed for the preparation and filing of such motions.

To facilitate the implementation of this sanction, we shall issue an order (the implementation order) directing respondent to send a copy of this opinion and the implementation order to all taxpayers who filed petitions in this Court contesting the adjustments at issue in Dixon II who had stipulated decisions entered in their cases (closed cases) on or after June 10, 1985. That notification action by respondent is to be completed within 60 days after the decisions entered in these cases become final; i.e., after the Court of Appeals for the Ninth Circuit renders its decision, if and when the decisions herein should be appealed. See Bush Ranch, Inc. v. E.I. du Pont de Nemours & Co., 918 F. Supp. at 1556.

Respondent shall have 9 months after the date the decisions in these cases becomes final (the implementation period) to adjust administratively the accounts of all Kersting project petitioners who had stipulated decisions entered in their cases on or after June 10, 1985. The implementation order will require respondent to provide the following additional information to the Kersting project petitioners:

1.The name of IRS contact personnel who can answer any questions Kersting project petitioners may have concerning the adjustments of their accounts;

2.the date the decisions in these cases became final; and

3.the expiration date of the implementation period.

The implementation order will require respondent, on or before the expiration of the implementation period, to file a status report with the Court, listing the cases of all Kersting project petitioners to whom respondent sent copies of this opinion and the implementation order and identifying any petitioner whose account has not been adjusted administratively.

During the implementation period, the Court will not grant leave to file motion to vacate decision in any case where motions for leave have been filed. If respondent adjusts administratively the accounts of those Kersting project petitioners who have filed motions for leave and the parties notify the Court of the adjustment, the Court will deny as moot the motions for leave. Additionally, the Court will not accept for filing any motions for leave to file motions to vacate the decisions in the cases of any other Kersting project petitioner unless and until respondent fails to adjust administratively the account of the Kersting project petitioner before the expiration of the implementation period. If respondent does not timely adjust administratively the account of any Kersting project petitioner, the Court will accept for filing a motion for leave to file motion to vacate decision, will grant leave to file such a motion, and will order respondent to show cause why the Court should not grant the motion to vacate decision and enter a new decision in accordance with this opinion.

To reflect the foregoing, Appropriate orders will be issued, and decisions will be entered under Rule 155.

FOIA case as it pertains to section 6103

The IRS was required to respond to a discovery request and to prepare a Vaughn index in order to determine whether it was justified in withholding from disclosure certain documents requested under the Freedom of Information Act (FOIA). The IRS agent's declaration supporting the Service's refusal to disclose responsive documents contained only a generalized, blanket statement that the documents sought were exempt from disclosure under FOIA exemptions (b)(3) and (b)(5). The index was necessary because it would assist the requestor and the court in determining whether the documents were appropriately withheld or could be produced in redacted form. Finally, because the IRS made a less-than-diligent effort to conduct a search for responsive documents, it was required to answer interrogatories to the extent that they concerned the adequacy of its search.



Kozacky & Weitzel, P.C., Plaintiff v. United States of America, Department of the Treasury, Internal Revenue Service, Defendant.

U.S. District Court, No. Dist. Ill., East. Div.; 1:07-cv-02246, April 10, 2008.

[ Code Sec. 6103]

Freedom of Information Act: Exemptions:








MEMORANDUM OPINION AND ORDER


KENNELLY, District Judge: Kozacky & Weitzel, P.C. (K&W) has sued the Internal Revenue Service (IRS) under the Freedom of Information Act (FOIA), 5 U.S.C. §552, seeking an order enjoining the agency from withholding records and directing the production of any records improperly withheld. The IRS has moved for summary judgment, asserting that it has produced to K&W all non-exempt documents responsive to K&W's FOIA request. K&W thereafter moved for an extension of time to respond to the IRS's motion for summary judgment so that it may engage in discovery, and it moved to compel the IRS to respond to K&W's discovery requests and produce of a Vaughn index. For the following reasons, the Court grants K & W's motion for a Vaughn index and grants in part its motion to compel discovery.




Facts


On November 3, 2006, the IRS issued letters to Rodney R. Kirby and Heidi M. Kirby informing them that their 2003 and 2004 tax returns had been selected for audit. On December 28, 2006, K&W, on behalf of the Kirbys, submitted a FOIA request to the IRS, requesting "[a]ll documents prepared and/or considered by the Department of the Treasury that led to the November 3, 2006 letters to Rodney R. and Heidi M Kirby...alleging they participated in a `tax shelter transaction' and/or an `abusive transaction.' " Compl. ¶8. On January 30, 2007, the IRS responded by producing a copy of the Kirbys' files for tax years 2003 and 2004. On February 7, 2007, K&W made a second FOIA request to the IRS for documents "that may indicate reasons why Rodney R. and Heidi M Kirby were accused of such transactions, including but not limited to documents signed by the IRS officials concerning generally the subject of the aforestated `tax shelter transactions' and or `abusive transactions.' " Id. ¶13. On March 9, 2007, the IRS informed K&W that it would be unable to respond during the statutory period of time for FOIA requests and extended its response time to March 28, 2007.

K&W filed this suit on April 24, 2007. On August 20, 2007, Gerald Role, an attorney in the Department of Justice's Tax Division, sent a letter to K&W stating that an additional ninety-five pages of documents had been located. The letter explained that the IRS was releasing ten redacted pages and two unredacted pages and was withholding the remaining pages under certain FOIA exemptions. On October 15, 2007, the IRS moved for summary judgment, attaching declarations from Margaret Keller, an IRS employee who processes FOIA requests, Melissa C. Quale, an IRS attorney who handles FOIA lawsuits, and Role. The three declarations explained the processing of K&W's FOIA request. Additionally, Quale stated in her declaration that the withheld documents fell under certain FOIA exemptions. In response to the IRS's summary judgment motion, K&W filed the present motion for extension of time and to compel production of a Vaughn index and discovery.




Discussion




1. Vaughn Index

Under FOIA, the Court is authorized to "enjoin [an] agency from withholding agency records and to order the production of any agency records improperly withheld from the complainant." 5 U.S.C. §552(a)(4)(B). FOIA reflects "a general philosophy of full agency disclosure unless information is exempted under clearly delineated statutory language." Dep't of Air Force v. Rose, 425 U.S. 352, 360-61 (1976).

The exemptions provided in FOIA are construed narrowly, to provide as much access to documents as is feasible and safe for the government to do. Id. at 823. "When the Government declines to disclose a document the burden is upon the agency to prove de novo in trial court that the information sought fits under one of the exemptions to the FOIA." Vaughn v. Rosen, 484 F.2d 820, 823 (D.C. Cir. 1973). In determining whether the agency has met its burden, the court must decide whether its declarations provide the court with "an adequate factual basis" for determining whether the documents withheld truly fall within one of FOIA's exemptions. Patterson v. IRS, 56 F.3d 832, 836 (7th Cir. 1995). Affidavits that do nothing more than categorically describe withheld information as falling into a particular exemption category are inadequate. Id.

In seeking summary judgment, the IRS argues - relying on Quale's declaration --that the withheld documents fell under certain FOIA exemptions. K&W argues that Quale's declaration does not adequately explain her conclusions that the documents are exempt from disclosure and is therefore insufficient to permit the Court to make an informed ruling regarding the applicability of the claimed exemptions. K & W argues that the Court should require the IRS to produce a so-called Vaughn index to facilitate determination of the applicability of the claimed FOIA exemptions.

The term "Vaughn index" derives from the D.C. Circuit's decision in the Vaughn case. In Vaughn, the court expressed its concern that under then-prevailing procedures in FOIA cases, a party seeking disclosure was effectively helpless to controvert the government's assertion that information was exempt from disclosure, because it was forced to argue in the blind, often in response to conclusory governmental claims of exemption from disclosure. This, in turn, left it to the reviewing court to conduct its own investigation, a questionable procedure in a system accustomed to adversary presentations. Vaughn, 484 F.2d at 823-26.

As a result, the court developed what is now known as the Vaughn index, an itemizing and indexing system that correlates each portion of any document withheld with the government's reason for withholding it. "In preparing a Vaughn Index, an agency must list the title of the document or category of documents, the date of the document, the author and recipient(s), a detailed factual description of the document, and the statutory exemption the agency is claiming to support nondisclosure." Becker v. IRS, 34 F.3d 398, 401 n.9 (7th Cir. 1994). The Vaughn index is used with or in lieu of government affidavits supporting a claim of exemption when the affidavits lack specificity sufficient to allow the Court to determine whether withheld documents are exempt from disclosure. See Vaughn, 484 F.2d at 826-27.

There is no per se rule requiring the filing of a Vaughn index in FOIA cases; determination of whether to compel a Vaughn index requires a case-by-case analysis of the information produced by the agency in response to a FOIA request. Becker, 34 F.3d at 402. When the government's affidavits provide sufficient information for the court to evaluate the exemption claims, a Vaughn index is not required. Wright v. OSHA, 822 F.2d 642, 646-48 (7th Cir. 1987). "The agency need only provide sufficient information to allow a court to review the agency's claimed exemption." Id. at 646.

To support the withholding of parts or all of particular documents, the IRS relies on the declaration of IRS attorney Melissa Quale. Quale states that the documents numbered 578 through 683 were withheld based on FOIA exemption (b)(3), exemption (b)(5), or both. Quale Decl. ¶ ¶9-20.

a. Documents Withheld under Exemption (b)(3)

The IRS has withheld certain documents under FOIA exemption (b)(3) in conjunction with 26 U.S.C. §6103(a), a provision of the Internal Revenue Code that shields from disclosure certain information regarding third-party taxpayers. Exemption (b)(3) states that disclosure is not required of information


specifically exempted from disclosure by statute (other than section 552(b) of this title), provided that such statute (A) requires that the matters be withheld from the public in such a manner as to leave no discretion on the issue, or (B) establishes particular criteria for withholding or refers to particular types of matters to be withheld.


5 U.S.C. §552(b)(3). It has long been held that section 6103(a) qualifies as an exempting statute under exemption (b)(3). See King v. IRS, 688 F.2d 488, 496 (7th Cir. 1982); see also, Church of Scientology v. IRS, 484 U.S. 9, 11 (1987).

Under section 6103(a), "[r]eturns and return information shall be confidential." 26 U.S.C. §6103(a). A "return" is any tax or informational return or other similar document filed with the IRS. Id. §6103(b)(1). "Return information" is defined as:


a taxpayer's identity, the nature, source, or amount of his income, payments, receipts, deductions, credits, assets, liabilities, net worth, tax liability, tax withheld, deficiencies, overassessments, or tax payments, whether the taxpayer's return was, is being, or will be examined or subject to other investigation or processing, or any other data, received by, recorded by, prepared by, furnished to, or collected by the Secretary with respect to a return or with respect to the determination of the existence, or possible existence, of liability (or the amount thereof) of any person under this title for any tax, penalty, interest, fine, forfeiture, or other imposition or offense....


Id. §6103(b)(2)(A).

Quale states that "the [IRS] withholds [documents] 000578-000585, 000595, 000607, and 000616-000619 in full and [documents] 000586-000594, 000596-000606, and 000645-000683 in part pursuant to FOIA exemption (b)(3) in conjunction with [26 U.S.C. §] 6103(a) because the information is the return information of taxpayers other than the plaintiff (third-party taxpayers)." Quale Decl. ¶9. Quale does not get a great deal more specific than that in her description of the documents withheld. Rather, she describes the documents only in general terms, stating as follows:


- document 578-579 is a "flowchart showing relationships between third-party promoters and investors";



- document 580-585 is an "(2) email from a third-party taxpayer representative with attachments pertaining to protective lists as provided by Treas. Reg. §301.6112-1(e)(3)(i), for distressed asset/debt transactions,"



- document 586-594 is an "attachment to email from third-party taxpayer representative containing protective list of investors in distressed assets/debt transaction [sic]";



- document number 595 is another third-party taxpayer representative email "discussing protective list for an additional transaction"



- document 596-604 is a "protective list and privilege statement submitted by third-party taxpayer representative for distressed asset/debt transaction"



- document 605-606 is an "internal memorandum discussing team assigned to distressed asset/debt transactions containing names of several third-party taxpayer promoters";



- document 607 is a "letter from IRS to third-party taxpayer requesting production of protective list";



- document 616 is an "internal email requesting information about a third-party taxpayer promoter and its distressed asset/debt transactions";



- and document 617-618 is an "email exchange between IRS employees discussing possible distressed asset/debt case and its promoter."


Quale Decl. ¶10.

These explanations are too curt to permit the court to determine whether the documents are fully exempt or could appropriately be produced in redacted form, that is, after redacting any return information protected under 26 U.S.C. §6103(a). In addition, , no explanation is provided for why the identity of a "promoter" - who would seem not to be a taxpayer as such - constitutes "return information" (the Court notes that this likewise is not explained in the IRS's summary judgment motion).

Under FOIA, "`any reasonable segregable portion of the record' must be disclosed." Patterson, 56 F.3d at 840 (quoting 5 U.S.C. §552(b); citing PHE, Inc. v. Dep't of Justice, 983 F.2d 248, 252 (D.C. Cir. 1993) ("non-exempt portions of a document must be disclosed unless they are inextricably intertwined with exempt portions")). In her declaration, Quale makes one generalized blanket statement concerning segregability, concerning all documents the IRS has withheld in their entirety: "I conclude that the Service has withheld in their entirety only those documents that fall within a FOIA exemption, or those documents wherein the portions exempt from disclosure under FOIA are so inextricably intertwined with nonexempt material as to be non-segregable." Quale Decl. ¶3. This "type of `general conclusion' about the segregability of the exempt information [is] inadequate." Patterson, 56 F.3d at 840 (citing Church of Scientology Int'l v. U.S. Dep't of Justice, 30 F.3d 224, 231 (1st Cir. 1994) (focusing on whether the declarations demonstrate careful scrutiny of each document by the government)). To put it another way, a categorical description of this type is insufficient to enable the requesting party to address, and the Court to determine, whether any or all of the withheld documents can and should be produced in redacted form. Id. at 836. A Vaughn index is needed to aid the court in determining whether the documents truly fall, in their entirety, within the cited exemption.

b. Documents Withheld under Exemption (b)(5)

The IRS claims documents numbered 620-644 are exempt from disclosure under FOIA exemption (b)(5), which provides that disclosure is not required of "inter-agency or intra-agency memorandums or letters which would not be available by law to a party other than an agency in litigation with the agency." 5 U.S.C. §552(b)(5). The purpose of exemption (b)(5) is to insure that frank and open discussions of legal and policy matters are not inhibited by a fear of those deliberations being made public, which could, in turn, negatively affect the quality of those decisions. See NLRB v. Sears, Roebuck & Co., 421 U.S. 132, 150 (1975). The exemption covers "all papers which reflect the agency's group thinking in the process of working out its policy and determining what its law shall be," such as advisory opinions and recommendations. Id. at 153.

Exemption (b)(5) exempts from disclosure documents that are protected from civil discovery under, among other things, the deliberative process privilege. See King v. IRS, 684 F.2d 517, 519 (7th Cir. 1982) (citing EPA v. Mink, 410 U.S. 73 (1973). The exemption is narrowly construed; "for this privilege to apply, the document must be `predecisional' and `deliberative.' " Becker, 34 F.3d at 403. The government bears the burden of proving the deliberative process that was involved and the role the document played in that process. Id.

In a single sentence of her declaration, Quale states that these twenty-five pages are an "unreviewed draft outline of points for consideration used internally by IRS employees working on distressed asset/debt transactions." Quale Decl. ¶19. The Court cannot determine, based on this statement, that these pages are both "predecisional" and "deliberative" or, as discussed in the previous section, whether there are segregable parts of the document that could be disclosed. As a result, there is a need for further explanation so K&W can address the government's claim and the Court can make an informed decision.

c. Other Withheld Documents

The IRS argues that the documents numbered 608-615 are appropriately withheld in full because they fall under both exemptions (b)(3) and (b)(5). Quale describes these documents as "email exchanges between numerous employees discussing the treatment of several distressed asset/debt cases where the promoters, third-party taxpayers, are under examination." Quale Decl. ¶14. For the same reasons described earlier, this description is insufficient to permit the court to make an informed decision as to whether these documents, in their entirety, actually fall within the claimed exemptions.

Quale also states that document 605-606 is exempt under 26 U.S.C. §6103(a), describing these document as an "internal memorandum discussing team assigned to distressed asset/debt transactions containing names of several third-party taxpayer promoters." Quale Decl. ¶10. Because the document was actually produced, in its entirety, as an attachment to Tax Division attorney Gerald Role's August 20, 2007 letter, the Court is able to review the validity of the IRS's claim of exemption. S ee Pl. Ex. B at 11-12. Based on the Court's review, only small portions of the document even arguably contain third-party information, and (as noted earlier) it is unclear whether these few words - which appear to identify alleged tax shelter promoters, not taxpayers as such -constitute appropriately-withheld "return information" within the meaning of §6103(b)(2)(A). This document should not have been withheld in its entirety. The fact that the IRS withheld it from production gives rise to a legitimate question regarding whether the IRS has, with regard to the other documents involved in this case, done what FOIA requires.

Finally, document 619 does not appear to be described anywhere in Quale's declaration, which prevents the Court from determining whether it properly falls under any FOIA exemption.

In sum, due to the inadequacy of the affidavits submitted by the IRS, a Vaughn index is required to enable K&W to argue the case adequately and to permit the Court to determine (either with or without in camera inspection) whether the documents are appropriately withheld under the claimed exemptions. Vaughn & ldquo;requires the government to list the title of the document or category of documents, the date of the document, the author and recipient, a detailed factual description of the document, and the statutory exemption claimed by the agency to support nondisclosure." Patterson, 56 F.3d at 839 n.11. The government should also address the issues of segregability and redaction, and it should be prepared to produce the documents in question for in camera inspection by the Court.



2. Discovery

K&W contends discovery is warranted "to determine whether an adequate initial search was conducted, whether adequate subsequent searches were conducted, whether the withheld documents are truly exempt from disclosure, and whether declarations submitted by the IRS in support of its motion for summary judgment are sufficient." Pl. Mot. at 9. K&W requests that the IRS be compelled to answer the interrogatories that K&W served on July 13, 2007.

The IRS argues that discovery is generally inappropriate in FOIA cases and is impermissible in this case because the Court has not determined the sufficiency of the IRS's declarations. The IRS argues that K&W's discovery requests are aimed at finding the reasons its clients were audited, which the IRS contends is impermissible in a FOIA action.

To decide whether further discovery is warranted, the Court must determine whether the IRS conducted a reasonable search for documents in response to K & W's FOIA request. Patterson, 56 F.3d at 841. As the Seventh Circuit has stated,


[t]he issue is not whether other documents may exist, but rather whether the search for undisclosed documents was adequate....The adequacy of the document search is judged under a reasonableness standard. The agency may rely on reasonably detailed nonconclusory affidavits submitted in good faith to support their claims of compliance.


Becker, 34 F.3d at 405-06 (emphasis in original) (internal quotation marks omitted).

The history of the case suggests that the IRS may have made a less-thandiligent effort to respond to K&W's FOIA requests. In response to K&W's first FOIA request, the IRS's search "was limited to the information contained in the Kirby's individual files." Keller Decl. ¶7. Only upon further inquiry by K&W did the IRS advise K&W that "requests seeking information not contained within the Kirby's individual files, but about a national tax shelter initiative should be directed to the Baltimore, Maryland Disclosure Officer (Baltimore Office)." Id. Then, in response to K&W's second FOIA request, the IRS determined that the request was too vague and that the request "should be closed as imperfect," at which point the IRS requested more detailed information from K&W. Id. ¶ ¶12-14. Finally, after K & W filed this suit, the IRS received information about the names of people who "may have information responsive to the Second FOIA Request." Id. ¶16.

One might reasonably infer from this sequence of events that continuous prodding was required to get the IRS to conduct a search for responsive documents. One might also reasonably question whether the search that was done after the filing of this case was reasonable or half-hearted and done only so the IRS could appear responsive. For these reasons, the Court will require the IRS to answer those interrogatories that are directed to the adequacy of its search, as answers may help illuminate whether the IRS has done what FOIA requires.

That said, most of K&W's interrogatories go beyond the scope of what is appropriate in discovery in a FOIA suit. Interrogatories 2 through 4 and 8 through 13 concern the appropriateness of deductions claimed by the Kirbys and are thus inappropriate because "[the plaintiff] cannot use FOIA discovery to conduct an investigation into the IRS' rationale for [an] audit." Flowers v. IRS, 307 F. Supp. 2d 60, 72 (D.D.C. 2004). Interrogatories 16 and 19 likewise appear, as best as the Court can determine, to concern statements in the IRS's answer to allegations in the complaint involving matters of underlying tax policy that are not, in the Court's view, pertinent to the FOIA disclosure and exemption issues involved in this case. Interrogatories 5 through 7 concern the IRS's contention that the Kirbys are not eligible for attorney's fees and costs should they prevail; the Court will not require an answer to these interrogatories because they involve a matter more appropriately taken up if and when the Kirbys prevail in the case. Interrogatories 14 and 18 seek clarification of the IRS's responses to particular paragraphs of the complaint, responses that are, in the Court's view, clear enough that further elaboration is not required. Finally, interrogatory 20 seeks clarification of the IRS's lack-of-information denial of a rather argumentative allegation in K&W's complaint in this case regarding alleged "harassment" of taxpayers; in the Court's view, further clarification of the IRS's statement that it lacks sufficient information to respond to certain parts of this paragraph is either unnecessary, or inappropriate as part of a FOIA case, or both.

The remaining interrogatories - 15, 17, 21, and 22 - each concern the nature and adequacy of the IRS's search(es) for documents following K&W's FOIA requests. The Court directs the IRS to answer these interrogatories, as an answer may help illuminate whether the IRS has done what FOIA requires.




Conclusion


For the reasons stated above, the Court grants plaintiff's motion to compel production of Vaughn index and grants in part its motion to compel discovery [docket nos. 18 & 20]. The Court directs defendant to answer plaintiff's interrogatories 15, 17, 21, and 22, and to produce a Vaughn index, by May 15, 2008. Defendant's motion for summary judgment is terminated without prejudice [docket no. 15], as it is clear that the basis for any such motion will be altered by the disclosures the Court has ordered. The case is set for a status hearing on May 22, 2008 at 9:30 a.m.

Jurisdiction of Tax Court in section 6330 cases.T

The Tax Court is a court of limited jurisdiction, and may exercise judgment only to the extent authorized by Congress. Naftel v. Commissioner, 85 T.C. 527, 529 (1985). Before the enactment of the Pension Protection Act of 2006 (PPA), Pub. L. 190-280, 120 Stat. 780, the Tax Court had jurisdiction to review an Appeals officer's determinations only in those cases where the Tax Court had jurisdiction over the underlying tax liability. Callahan v. Commissioner, 130 T.C.____, ____ (2008) (slip. op. at 2-3); Zapara v. Commissioner, 126 T.C. 215, 227 (2006); Katz v. Commissioner, 115 T.C. 329, 338-339 (2000). The Tax Court lacks jurisdiction over trust fund recovery penalties in deficiency cases. Moore v. Commissioner, 114 T.C. 171, 175 (2000); Medeiros v. Commissioner, 77 T.C. 1255 (1991). The Tax Court can not review the Commissioner's determinations to collect this type of tax until the PPA became effective for determinations made after October 16, 2006. PPA sec. 855, 120 Stat. 1019; see Rustam v. Commissioner, T.C. Memo. 2005-42.





Morton L. Ginsberg v. Commissioner.

Dkt. No. 11585-07L , 130 TC --, No. 7, April 28, 2008.



[Code Sec. 6330]

IRS determinations: Judicial review: Tax Court jurisdiction. --

The Tax Court lacked jurisdiction to review the IRS's determinations set forth in a supplemental determination notice regarding collection of a trust fund recovery penalty because the court did not have jurisdiction to review the determinations in the original determination notice. The supplemental determination notice was issued after the Tax Court was given jurisdiction over Code Sec. 6330 determinations, but also after the individual had filed a complaint with the federal District Court at a time when only the District Court had subject matter jurisdiction over trust fund liability issues. The supplemental determination was made after the amendment's effective date of October 16, 2006, and merely supplemented the original determination notice. It was not a new determination and did not provide the taxpayer any additional appeal rights. Therefore, the supplemental notice related back to the original notice



P filed a complaint with District Court seeking review of R's determination to proceed with collection of a trust fund recovery penalty. The District Court remanded the case to R's Appeals Office, which issued a supplemental determination notice. The Pension Protection Act of 2006, amending sec. 6330(d), I.R.C. to expand this Court's jurisdiction over sec. 6330, I.R.C. determinations, became effective with respect to determinations made after a date that fell between the dates of the original determination notice and the supplemental determination notice. P filed a petition with this Court in response to the supplemental determination notice.



Held: We lack jurisdiction to review R's determinations in the supplemental determination notice. The supplemental notice relates back to the original notice and is not a new determination for purposes of the effective date of amended sec. 6330(d), I.R.C.





OPINION



KROUPA, Judge: This case is before the Court on respondent's Motion to Dismiss for Lack of Jurisdiction, filed October 5, 2007. Petitioner filed a petition to review respondent's determinations in a supplemental determination notice that petitioner is liable for the trust fund recovery penalty for the periods ending June 30, 1991, December 31, 1991, September 30, 1992, March 31, 1994, and September 30, 1994 (the relevant periods). This issue arises because the supplemental determination notice was issued after the effective date of the amendment to section 6330(d)(1) 1 and after petitioner had originally filed a complaint with Federal District Court at a time when only the District Court had subject matter jurisdiction over the trust fund liabilities. We conclude that we lack jurisdiction to review respondent's determinations set forth in the supplemental determination notice because we did not have jurisdiction to review the determinations in the original determination notice. We shall therefore grant respondent's motion to dismiss for lack of jurisdiction.





Background



Petitioner is a real estate investor who controlled real estate holdings through many partnerships and corporations. At least five of the entities petitioner controlled accrued payroll tax liabilities. Petitioner had a chief financial officer to handle various financial matters such as tax liabilities. The chief financial officer failed to carry out his duties and embezzled funds from petitioner. Petitioner asserts that part of the embezzled funds included the unpaid payroll taxes.



Respondent sent petitioner a Final Notice of Intent to Levy on March 25, 1999, to collect trust fund recovery penalties under section 6672 for the relevant periods. Petitioner requested a hearing. After the hearing, respondent issued a determination notice (the original determination notice) on June 20, 2003, in which respondent sustained the proposed levy action for petitioner's liabilities for the trust fund recovery penalty, among other things.



Petitioner disputed the original determination notice by filing a complaint with the United States District Court for the District of New Jersey (District Court). Petitioner could file a complaint only with the District Court because the Tax Court lacked jurisdiction over trust fund liabilities. The District Court remanded the matter to respondent's Appeals Office and dismissed the case in a consent order on October 5, 2005. The District Court directed that upon remand, the Appeals Office should consider petitioner's challenges to the existence or amount of the underlying liability. The consent order further provided that petitioner's rights under section 6330 would be impaired in no way.



Respondent's Appeals Office held a supplemental hearing with petitioner. The Appeals Office issued petitioner a supplemental determination notice on April 26, 2007, in which respondent sustained the proposed levy action for petitioner's liabilities for the trust fund recovery penalty with certain adjustments. Petitioner filed a petition with this Court contesting the determinations in the supplemental determination notice on May 23, 2007. Petitioner resided in Florida at the time he filed the petition. Petitioner also filed another complaint with the District Court contesting the determinations in the supplemental determination notice.



Respondent filed a motion to dismiss this case for lack of jurisdiction. Respondent asserts that the supplemental determination notice is not a new determination and that jurisdiction remains with the District Court. Respondent argues that the District Court has jurisdiction notwithstanding the amendment to section 6330(d) giving the Tax Court exclusive jurisdiction over all section 6330 determinations made after October 16, 2006.



Petitioner states in his response to respondent's motion that he filed simultaneous suits in this Court and with the District Court because he was uncertain about which court had jurisdiction after the amendment to section 6330(d).





Discussion



We now consider whether we have jurisdiction to review respondent's determination in the supplemental determination notice. This is the first time we have been asked to consider whether we have jurisdiction to review a supplemental determination notice where the amendments to section 6330(d) giving us exclusive jurisdiction became effective between the issuance of the original determination notice and the issuance of the supplemental determination notice. We begin by explaining the scope of our jurisdiction under section 6330 and Congress' recent expansion of that jurisdiction.



A taxpayer must receive written notice of the right to request a hearing before the Commissioner may levy upon any property or property right of the taxpayer. Sec. 6330(a). If the taxpayer requests a hearing, an Appeals officer holds the hearing and then makes a determination. Sec. 6330(b)(1), (c)(3). The taxpayer may seek judicial review of the Appeals officer's determination within 30 days of its issuance. Sec. 6330(d)(1).




Tax Court Jurisdiction On or Before October 16, 2006


This Court is a court of limited jurisdiction, and we may exercise judgment only to the extent authorized by Congress. Naftel v. Commissioner, 85 T.C. 527, 529 (1985). Before the enactment of the Pension Protection Act of 2006 (PPA), Pub. L. 190-280, 120 Stat. 780, the Tax Court had jurisdiction to review an Appeals officer's determinations only in those cases where the Tax Court had jurisdiction over the underlying tax liability. Callahan v. Commissioner, 130 T.C.____, ____ (2008) (slip. op. at 2-3); Zapara v. Commissioner, 126 T.C. 215, 227 (2006); Katz v. Commissioner, 115 T.C. 329, 338-339 (2000). The Tax Court lacks jurisdiction over trust fund recovery penalties in deficiency cases. Moore v. Commissioner, 114 T.C. 171, 175 (2000); Medeiros v. Commissioner, 77 T.C. 1255 (1991). Accordingly, we could not review the Commissioner's determinations to collect this type of tax until the PPA became effective for determinations made after October 16, 2006. PPA sec. 855, 120 Stat. 1019; see Rustam v. Commissioner, T.C. Memo. 2005-42.




Tax Court Jurisdiction After October 16, 2006


The PPA expanded our jurisdiction to include review of the Commissioner's collection activity, regardless of the type of underlying tax involved, for determinations made after October 16, 2006. PPA sec. 855; Perkins v. Commissioner, 129 T.C. 58, 63 n.7 (2007). Accordingly, we now have jurisdiction to review all appeals of collection determinations made after October 16, 2006. Callahan v. Commissioner, supra.




Determination Notices and Supplemental Determination Notices


The supplemental determination in this case was made after the effective date of October 16, 2006, but the original determination was made before the effective date. Petitioner appealed the original determination to the District Court, and the District Court remanded the case to the Appeals Office. This case presents the unique situation where the effective date of the PPA falls between an original determination notice appealable to District Court and a supplemental determination notice.



A taxpayer is entitled to only one notice of intent to levy and only one hearing per taxable period. Sec. 6330(a)(1), (b)(2); see also Drake v. Commissioner, T.C. Memo. 2006-151, affd. 511 F.3d 65 (1st Cir. 2007). A hearing under section 6330 may consist of one or more written or oral communications between an Appeals officer and the taxpayer. Sec. 301.6330-1, Proced. & Admin. Regs. Taxpayers do not have a right to any further or additional hearing. H. Conf. Rept. 105-599, at 266 (1998), 1998-3 C.B. 747, 1020. Any further hearing that a taxpayer has is a supplement to the initial hearing, and the two hearings together constitute the hearing under section 6330(d). Drake v. Commissioner, supra (citing Parker v. Commissioner, T.C. Memo. 2004-226).



It follows that this hearing, which may actually consist of several meetings or other written or oral communications, yields only one determination. See sec. 6330(c)(3), (d)(1). This determination may be supplemented by a supplemental determination notice, if the matter is remanded to Appeals after the initial determination. The supplemental determination notice is merely a supplement to the original determination notice and relates back to the original determination notice.2 It is not a new determination and does not provide the taxpayer any additional appeal rights.3



We conclude that the supplemental determination notice relates back to the original determination notice dated June 30, 2003. As the original determination notice was issued before October 16, 2006, we do not have jurisdiction to review respondent's determination because we lack jurisdiction to review the underlying tax liability. See Moore v. Commissioner, 114 T.C. 171, 175 (2000). We shall therefore grant respondent's motion to dismiss for lack of jurisdiction.



To reflect the foregoing, An appropriate order of dismissal for lack of jurisdiction will be entered.


1 All section references are to the Internal Revenue Code, unless otherwise indicated.

2 The Office of Chief Counsel at the Internal Revenue Service (IRS) has issued a Notice providing guidance to IRS personnel in situations like this one. Chief Counsel Notice CC-2007-001 (Oct. 13, 2006). The Notice states that the District Court has jurisdiction because the supplemental determination notice supplements the original determination notice.

3 We also decide today Kelby v. Commissioner, 130 T.C. ___ (2008), holding that the determination we review is the original determination notice as supplemented by all subsequent determination notices, and that the original determination notice is rendered moot to the extent supplanted by the subsequent determination notices. If we do not have jurisdiction to review the original determination notice, however, the issuance of a supplemental determination notice does not give us jurisdiction.

section 6015 innocent spouse relief

The IRS did not abuse its discretion by denying an individual's request under Code Sec. 6015(f) for innocent spouse relief from joint income tax liability. The taxpayer failed to qualify for relief under Rev. Proc. 2003-61, 2003-2 CB 296, since it was not inequitable to hold her liable for the deficiency. Part of the unpaid liability stemmed from her sale of stock of a corporation that had been her employer for 20 years. She was still married to the nonrequesting spouse, economic hardship was not shown, she had actual knowledge of the item giving rise to the deficiency, and she offered no evidence that she suffered any abuse at the hands of her husband. -



Andrea C. Casula v. Commissioner.

Docket No. 3385-05S . Filed May 5, 2008.

[Code Sec. 6015]


GOLDBERG, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

This cases arises from petitioner's request for relief from joint income tax liability for the taxable year 2000. A notice of deficiency was not issued. Petitioner filed Form 8857, Request for Innocent Spouse Relief (And Separation of Liability and Equitable Relief), seeking relief under section 6015(f). Respondent denied petitioner's request, and the sole issue for decision is whether respondent abused his discretion.


Background

Discussion

Except as otherwise provided under section 6015, petitioner bears the burden of proof with respect to her entitlement to relief under section 6015. See Rule 142(a); Alt v. Commissioner, 119 T.C. 306, 311 (2002), affd. 101 Fed. Appx. 34 (6th Cir. 2004).

Section 6013(d)(3) provides that if a joint return is filed, the tax is computed on the taxpayer's aggregate income, and liability for the resulting tax is joint and several. See also sec. 1.6013-4(b), Income Tax Regs. Relief may be granted under section 6015 under limited circumstances.

Generally, in order to obtain relief from joint and several liability a spouse must qualify under section 6015(b) or, if eligible, allocate liability under section 6015(c). The parties agree that petitioner is not entitled to seek relief under section 6015(b) or (c). If relief is not available under section 6015(b) or (c), a spouse may seek equitable relief under section 6015(f). Fernandez v. Commissioner, 114 T.C. 324, 329-331 (2000); Butler v. Commissioner, 114 T.C. 276, 287-292 (2000).

The Internal Revenue Service (IRS) may relieve an individual from joint and several liability under section 6015(f) if, taking into account all the facts and circumstances, it is inequitable to hold the taxpayer liable for any unpaid tax or deficiency and she or he does not qualify for relief under section 6015(b) or (c).

As directed by section 6015(f), the Commissioner has prescribed guidelines in Rev. Proc. 2003-61, 2003-2 C.B. 296, modifying Rev. Proc. 2000-15, 2000-1 C.B. 447, that are to be used in determining whether it is inequitable to hold a requesting spouse liable for all or part of the deficiency.1 Rev. Proc. 2003-61, sec. 4.01, 2003-2 C.B. at 297, provides the following seven threshold conditions that must be satisfied before a request for relief will be considered: (1) The requesting spouse filed a joint return for the year for which relief is sought; (2) relief is not available under section 6015(b) or (c); (3) the application for relief is made no later than 2 years after the date of the Commissioner's first collection activity; (4) no assets were transferred between spouses as part of a fraudulent scheme; (5) the nonrequesting spouse did not transfer disqualifying assets to the requesting spouse; (6) the requesting spouse did not file or fail to file the return with fraudulent intent; and (7) absent enumerated exceptions, the liability from which relief is sought is attributable to an item of the nonrequesting spouse. Respondent argues that because part of the unpaid liability stems from petitioner's sale of her Marsh & McLennan stock, this last threshold requirement has not been met. We agree. Where as here the requesting spouse might fail to qualify for relief under Rev. Proc. 2003-61, sec. 4.01, the Court, for the sake of completeness, will nevertheless examine whether we may grant relief under Rev. Proc. 2003-61, sec. 4.03, 2003-2 C.B. at 298.

Rev. Proc. 2003-61, sec. 4.03(2), 2003-2 C.B. at 298, lists the eight nonexclusive factors that the Commissioner will consider in determining whether, taking into account all the facts and circumstances, it is inequitable to hold the requesting spouse liable for all or part of the deficiency, and full or partial equitable relief under section 6015(f) should be granted. These nonexclusive factors include whether: (1) The requesting spouse is separated or divorced from the nonrequesting spouse; (2) the requesting spouse will suffer economic hardship without relief; (3) the requesting spouse did not know or have reason to know of the item giving rise to the deficiency; (4) the nonrequesting spouse had a legal obligation to pay the outstanding liability; (5) the requesting spouse received a significant benefit from the item giving rise to the deficiency; (6) the requesting spouse has made a good faith effort to comply with income tax laws in subsequent years; (7) the requesting spouse was abused by the nonrequesting spouse; and (8) the requesting spouse was in poor mental or physical health when signing the return or requesting relief. Rev. Proc. 2003-61, supra, further provides that no single factor will be determinative, but that all relevant factors will be considered. We will now consider petitioner's request in the light of these relief factors.

The Casulas are still married, and therefore petitioner fails to meet the first factor.

With respect to the second factor, petitioner must show that she would be unable to pay basic reasonable living expenses if relief were not granted. See Monsour v. Commissioner, T.C. Memo. 2004-190. Being unable to pay basic reasonable living expenses would amount to economic hardship. Sec. 301.6343-1(b)(4)(i), Proced. & Admin. Regs. Petitioner was silent as to how respondent's denial of her request for relief would result in economic hardship. She is gainfully employed as an executive with Marsh & McLennan. The Court fails to see, and petitioner has neither raised as an issue nor established, that she would suffer economic hardship if her request for relief from joint liability were denied.

As to the third factor, as discussed earlier petitioner sold her Marsh & McLennan stock in 2000. Petitioner sold the stock at the request of her husband, and therefore she had knowledge of the sale as well as the distribution taken from her husband's section 401(k) account. She also testified that she had actual knowledge of all of the items reported on the Casulas' 2000 tax return. Rev. Proc. 2003-61, sec. 4.03, specifically states that actual knowledge by the requesting spouse of the item giving rise to the deficiency is a strong factor weighing against relief. This strong factor may be overcome only if the factors in favor of equitable relief are particularly compelling. We conclude that they are not.

As the Casulas are still married, the fourth factor is inapplicable.

As to the fifth factor, we have insufficient evidence to determine whether petitioner received a substantial benefit when her husband purportedly used the proceeds of the sale of her Marsh & McLennan stock or his IRA distribution to help keep his business afloat. We are convinced that petitioner did not have access to Mr. Casula's business funds, although she did have access to the couple's personal checking account and there is evidence that both of these funds --the proceeds from the stock sale and the IRA distribution --were distributed to Mr. Casula's business through the couple's personal account. We also recognize that by using these funds to keep his business afloat Mr. Casula prevented the couple from losing their home or other personal assets. The Court is therefore convinced that the substantial benefit factor weighs against granting relief.

The sixth factor concerns compliance with income tax laws and, particularly, the good faith efforts of the requesting spouse in subsequent years. Rev. Proc. 2003-61, sec. 4.03(2)(a)(vi), 2003-2 C.B. at 299. With respect to this inquiry, there is no evidence outside of the year at issue. Accordingly, we find this factor neutral.

As to the seventh factor, abuse, petitioner has offered no evidence that she suffered any abuse at the hands of her husband. Likewise, and as to the final factor, whether the requesting spouse seeking relief was in poor mental or physical health when signing the return, there is nothing in the record to show that petitioner suffered from any ailment that would have affected her ability to pay her Federal income tax obligation for the year in issue. As these last two factors weigh only in favor of, and not against, relief, they are neutral. Id. sec. 4.03(2)(b)(ii), 2003-2 C.B. at 299.

Accordingly, since none of the relevant factors identified in the pertinent revenue procedure weigh in favor of granting relief, the Court holds that there was no abuse of discretion by respondent in denying relief to petitioner under section 6015(f).

Decision will be entered for respondent.

1 Rev. Proc. 2000-15, 2000-1 C.B. 447, was superseded by Rev. Proc. 2003-61, 2003-2 C.B. 296, which is effective as to requests for relief filed on or after Nov. 1, 2003, and for requests for relief pending on Nov. 1, 2003, as to which no preliminary determination letter had been issued as of that date. Although petitioner's application for relief was filed on Sept. 12, 2003, it was still pending on Nov. 1, 2003. The preliminary determination letter was issued on Nov. 17, 2004.

Notice 2008-46 , I.R.B. 2008-18, April 16, 2008.[ Code Sec. 6694]


Penalties, civil: Tax return preparers: Supplemental guidance. --
The IRS has issued additional guidance regarding implementation of the tax return preparer penalty provisions of Code Sec. 6694, as amended by the Small Business and Work Opportunity Tax Act of 2007 ( P.L. 110-28). Certain returns and other documents to which preparer penalties may apply have been added to those listed in Exhibits 1, 2 and 3 of Notice 2008-13. Notice 2008-13, I.R.B. 2008-3, 282, is supplemented.




This notice provides guidance regarding implementation of the tax return preparer penalty provisions under section 6694 of the Internal Revenue Code, as amended by the Small Business and Work Opportunity Tax Act of 2007, Pub. L. No. 110-28, 121 Stat. 190, by adding certain returns and documents supplementing Exhibits1, 2, and 3 of Notice 2008-13, 2008-3 I.R.B. 282.



A. Returns and Claims for Refund Subject to 6694 Penalty

Notice 2008-13 describes categories of returns and other documents to which section 6694 could apply. Notice 2008-13 provides that, solely for purposes of section 6694, a return or claim for refund includes the tax returns listed in Exhibit 1 or a claim for refund with respect to any such return. The Notice further provides that a person who for compensation prepares all or a substantial portion of any of the tax returns listed on Exhibit 1 is a tax return preparer who is subject to section 6694.

Notice 2008-13 also provides that solely for purposes of section 6694, an information return or document listed on Exhibit 2 that includes information that is or may be reported on a taxpayer's tax return or claim for refund is a return to which section 6694 could apply if the information reported constitutes a substantial portion of that taxpayer's tax return or claim for refund. A person who for compensation prepares any of the information returns or documents listed on Exhibit 2, which return or document does not report a tax liability but affects an entry or entries on a tax return and constitutes a substantial portion of the tax return or claim for refund that does report a tax liability, is a tax return preparer who is subject to section 6694.

Notice 2008-13 also provides that solely for purposes of section 6694, a document listed on Exhibit 3 that includes information that is or may be reported on a taxpayer's tax return or claim for refund (and that constitutes a substantial portion of such tax return or claim for refund) will not subject the preparer to a penalty under section 6694(a). A document listed on Exhibit 3, however, may subject the preparer to a willful or reckless conduct penalty under section 6694(b) if the information reported on the document constitutes a substantial portion of the tax return or claim for refund and is prepared willfully in any manner to understate the liability of tax on a tax return or claim for refund, or in reckless or intentional disregard of rules or regulations. A person who for compensation prepares all or a substantial portion of any of the documents listed on Exhibit 3 is not a tax return preparer subject to section 6694(a) unless the document was prepared willfully in any manner to understate the liability of tax on a tax return or claim for refund or in reckless or intentional disregard of rules or regulations.

Notice 2008-13 also provides that the Treasury Department and the Internal Revenue Service may add or remove forms or documents from any of the categories or exhibits to Notice 2008-13 in future guidance. Accordingly, the following returns and documents are added to Exhibits 1, 2, and 3 of Notice 2008-13:



Exhibit 1 - Tax Returns Reporting Tax Liability

(1) Form 1040-C, U.S. Departing Alien Income Tax Return;

(2) Form 1040NR, U.S. Nonresident Alien Income Tax Return;

(3) Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents;

(4) Form 1041-N, U.S. Income Tax Return for Electing Alaska Native Settlement Trusts;

(5) Form 1041-QFT, U.S. Income Tax Return for Qualified Funeral Trusts;

(6) Form 1120-FSC, U.S. Income Tax Return of a Foreign Sales Corporation;

(7) Form 1120-H, U.S. Income Tax Return for Homeowners Associations;

(8) Form 1120-L, U.S. Life Insurance Company Income Tax Return;

(9) Form 1120-ND, Return for Nuclear Decommissioning Funds and Certain Related Persons;

(10) Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return;

(11) Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations;

(12) Form 1120-REIT, U.S. Income Tax Return for Real Estate Investment Trusts;

(13) Form 1120-RIC, U.S. Income Tax Return for Regulated Investment Companies;

(14) Form 1120-SF, U.S. Income Tax Return for Settlement Funds (Under Section 468B);

(15) Form 1040-SS, U.S. Self-Employment Tax Return;

(16) Form 2438, Undistributed Capital Gains Tax Return;

(17) Form 8288, U.S. Withholding Tax Return for Disposition by Foreign Persons of U.S. Real Property Interests;

(18) Form 8752, Required Payment or Refund under Section 7519; and

(19) Form 8804, Annual Return for Partnership Withholding Tax ( Section 1446).

Exhibit 2 - Information Returns That Report Information That is or May be Reported on Another Tax Return That May Subject a Tax Return Preparer to the Section 6694(a) Penalty if the Information Reported Constitutes a Substantial Portion of the Other Tax Return

(1) Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts;

(2) Form 3520-A, Annual Return of Foreign Trust With a U.S. Owner;

(3) Form 5471, Report by Shareholders of a Foreign Corporation;

(4) Form 5472, Information Return of a 25% Foreign Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business;

(5) Form 8805, Foreign Partner's Information Statement of §1446 Withholding Tax;

(6) Form 8858, Information Return of US Person with Respect to Disregarded Entities; and

(7) Form 8865 - Return of U.S. Persons with Respect to Certain Foreign Partnerships.

Exhibit 3 - Forms That Would Not Subject a Tax Return Preparer to the Section 6694(a) Penalty Unless Prepared Willfully in any Manner to Understate the Liability of Tax on a Return or Claim for Refund or in Reckless or Intentional Disregard of Rules or Regulations

(1) Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests; and

(2) Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests.



EFFECTIVE DATE

This notice is effective as of April 16, 2008.





EFFECT ON OTHER DOCUMENTS

Notice 2008-13, 2008-3 I.R.B. 282, is supplemented.



CONTACT INFORMATION

The principal authors of this notice are Matthew S. Cooper and Michael E. Hara of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this notice, contact Mr. Cooper at (202) 622-4940 or Mr. Hara at (202) 622-4910 (not toll-free calls).

Jade Trading, LLC, by and through, Robert W. Ervin and Laura Kavanaugh Ervin on behalf of Ervin Capital, LLC, Partners Other Than the Tax Matters Partner, Plaintiffs

U.S. Court Federal Claims; 03-2164T, December 21, 2007, 80 FedCl 11.


[ Code Sec. 723]

Tax shelters: Partnerships: Contingent liabilities: Basis in partnership interests: Economic substance doctrine. --
Transactions involving the simultaneous purchase and sale of offsetting foreign exchange options that were subsequently transferred to a partnership lacked economic substance. The losses claimed by the partners from such offsetting option transactions did not represent bona fide losses reflecting actual economic consequences. The structure of the spread transaction and the high fees required for participation ensured that there was no reasonable profit potential. The inability to realize a profit, lack of investment character, meaningless inclusion in a partnership, and disproportionate tax advantage compared to the amount invested and potential return, made it evident that the spread transaction objectively lacked economic substance.


.

[ Code Sec. 6662]

Penalties, civil: Accuracy-related penalties: Reasonable cause. --
A partnership was subject to accuracy-related penalties for gross valuation misstatement, negligence, and substantial understatement. The partnership had no purpose except to generate the inflated basis in its assets to secure the necessary tax benefits. Since the partners' claimed adjusted basis in their partnership interests exceeded their correct adjusted basis by more than 400 percent the gross valuation misstatement penalty applied. Further, there was no substantial authority for the position that the partnership took regarding the tax treatment of the spread transaction and it did not reasonably rely on professional tax advice. Therefore, the penalties for substantial understatement of income tax and negligence were also applicable.

OPINION





Introduction


WILLIAMS, Judge: This tax refund case presents the issue of whether investments of $450,000 which generated over $40 million in tax losses possessed economic substance. In 1999, the Ervin brothers sold their cable business, netting over $40 million in profit. That same year, each of the three Ervin brothers, through his limited liability corporation (LLC), simultaneously purchased a euro option from AIG for a premium of $15,000,020 and sold a euro option to AIG for a premium of $14,850,018 but only paid AIG the difference --a net premium of $150,002. Each LLC contributed the option spread to Jade Trading, LLC (Jade), and upon exiting the partnership, claimed a basis of over $15 million in its Jade interest by including only the premium for the purchased call option and ignoring the premium for the sold call option. The artificially high basis generated a loss of almost $15 million when each LLC redeemed its partnership interest at its fair market value.

At issue in this case is whether the spread transactions contributed to Jade lacked economic substance such that they must be disregarded for tax purposes. This issue is complicated by the reality that precedent at the time of these transactions permitted each LLC to ignore the sold call option in computing its basis in its Jade interest because that option was a contingent obligation, not a liability, under section 752 of the Internal Revenue Code. 1 Poignantly at play here is the tension between technical compliance with the Internal Revenue Code and the longstanding common-law economic substance doctrine which compels courts to disregard transactions which lack economic substance despite their literal compliance with the Code. Plaintiffs characterize the tension differently, arguing that the economic substance doctrine cannot ignore "deliberately adopted rules of law," in particular, the holding in Helmer v. Commissioner [ CCH Dec. 33,225(M)], 34 T.C.M. (CCH) 727 (1975), that contingent obligations do not constitute section 752 liabilities for purposes of calculating a partner's basis. According to Plaintiffs, Helmer and its progeny construed section 752 to permit taxpayers to exclude contingent obligations like the sold option in calculating basis under the theory that the sold option did not create a fixed liability because it was uncertain when, at what price, or if AIG would ever exercise the option.

Plaintiffs' theory cannot prevail in light of the Federal Circuit's decision in Coltec Industries, Inc. v. United States [ 2006-2 USTC ¶50,389], 454 F.3d 1340, 1352-54 (Fed. Cir. 2006), reaffirming the vitality of the economic substance doctrine. Coltec teaches that the legitimacy of a transaction for tax purposes is not guaranteed merely because a technical interpretation of the Code would support the tax treatment. Id. at 1354. Rather, Coltec mandates additional scrutiny of the bona fides of a transaction, requiring independently that the transaction pass muster under the objective economic substance test. Id. at 1355. Further, the Coltec Court clarified the parameters for applying that test holding that the taxpayer has the burden of proving that the transaction which gave rise to the tax benefit objectively had economic substance, i.e., was a real transaction structured in a particular way to provide a tax benefit as opposed to a transaction created for tax avoidance purposes. Id.

Here, several factors compel a conclusion that Plaintiffs have not met their burden of demonstrating that the spread transactions contributed to Jade objectively had economic substance. First, their claimed losses were purely fictional --each of the Ervins did not invest $15 million in the spread and did not lose $15 million when exiting Jade without exercising either option. 2 Second, although Plaintiffs contend that the spread transaction had the potential to earn a profit, that contention is belied by two factors --the structure of the transaction itself and the large and unusual fees the LLCs were forced to pay to do the transaction. The structure of this transaction delimited the maximum net profit to some $140,000 per LLC, no matter how high the euro climbed. The fees also undercut profit potential. Each LLC paid fees of $934,100 on an investment of $150,002. 3

Third, the spread transaction was developed as a tax avoidance mechanism and not an investment strategy. The transaction was devised and marketed by a tax accounting group, BDO Seidman's "Tax $ells" Division, as a tax product, not by an investment advisor as a vehicle to earn profit. The spread transaction was included in the chapter of BDO Seidman's Tax Product Manual entitled "Capital Gain or Ordinary Income Eliminators" and was described as being structured around "anomalies in the tax law to allow for the creation of stepped-up basis that can be used to shelter gains." Def.'s Ex. DX (DX) 665 at 019776.

Fourth, the requirement that the spread transaction be purchased outside the partnership and contributed to it had no effect whatsoever on the investment's value, quality, or profitability, except to add cost and burden. However, packaging the investment in the partnership vehicle was an absolute necessity for securing the tax benefits.

A final indicium of the lack of economic substance here, while not dispositive in and of itself, is the highly disproportionate tax advantage to the underlying monetary outlay --the tax loss per brother, $14.9 million, was roughly 65 times greater than each LLC's $225,002 financial commitment to Jade, almost 100 times each LLC's $150,002 investment in the spread transaction which generated the loss, and approximately 100 times the $140,000 potential net profit each LLC could have earned.

In sum, this transaction's fictional loss, inability to realize a profit, lack of investment character, meaningless inclusion in a partnership, and disproportionate tax advantage as compared to the amount invested and potential return, compel a conclusion that the spread transaction objectively lacked economic substance.

The determination that the transaction lacked economic substance and the conclusion that each LLC's basis in its partnership interests must be substantially reduced requires this Court to conclude that the IRS's 40-percent penalty is applicable at this juncture. Section 6662(h). Under the Code, the 40-percent gross valuation misstatement penalty applies as a matter of computation if the misstated basis was 400 percent higher than the corrected adjusted basis. Here, each LLC's adjusted basis must be reduced from some $15 million to $225,002, --meaning each LLC's basis was misstated by well over 400 percent. The alternative 20-percent penalties for substantial understatement of income tax and negligence are also applicable. Because only partnership items are before the Court in this proceeding, the Court lacks jurisdiction to consider the individual partners' defenses to the penalties, but these defenses may be entertained subsequently in individual partner-level proceedings.




Findings of Fact 4




The Ervins

In 1980, Gary Ervin applied for a cable franchise, and Ervin Cable Construction was awarded a cable franchise in the Ervins' home town of Sturgis, Kentucky. Tr. 292-96, 322 (G. Ervin). 5 Gary Ervin and his two brothers, Robert and Tim, were equal partners in the cable business. Gary Ervin ran the office, handled the finances for the brothers, and had primary responsibility for dealing with investment advisors, bankers, lawyers, and accountants. Tr. 166-67 (Maidman); Tr. 259-60 (Pace); Tr. 304-08 (G. Ervin); Tr. 403-06 (R. Ervin); Tr. 437-38 (T. Ervin). Tim and Robert Ervin relied on Gary to make all financial decisions for the family businesses and provided Gary with general powers of attorney in 1998 which authorized Gary to manage their financial, business, and tax affairs. Pls.' Ex. (PX) 203-04; Tr. 309 (G. Ervin); Tr. 405 (R. Ervin); Tr. 440, 444, 446 (T. Ervin).



Selling the Cable Businesses in March 1999

In 1986 or 1987, the Ervins split their cable business into cable franchise and cable construction businesses, and in 1997 or 1998, split their businesses again, creating Apex Digital TV, Inc. (Apex). Tr. 298-99 (G. Ervin). In 1998 or 1999, the Ervins decided to sell these businesses --Ervin Cable Construction (ECC), Apex, and Communications Systems Development (CSD). Tr. 315-18, 320-21 (G. Ervin). The Apex acquisition was structured as a reverse triangular merger, and the Ervins sold Ervin Cable Construction to Dycom in exchange for cash and Dycom stock. 6 Joint Stipulation of Facts (Stip.) ¶ 3, 4; Tr. 317-18, 439-40 (G. Ervin). In March 1999, the Ervins realized a total gain of approximately $40,248,733 on the sale, approximately $13,500,000 per brother. Joint Ex. (JX) 96 at 89, JX 97 at 59, JX 98 at 57.

Because Dycom was a publicly traded company, Dycom disclosed the acquisition of the Ervin companies to the SEC. After that disclosure, Gary was inundated with calls from investment brokers who wanted to "help" the Ervins reinvest their capital. Tr. 318-23 (G. Ervin). John Eckstrom, a former competitor in the cable industry, recommended that Gary talk to Cheyne Pace of Goldman Sachs for advice on investing the proceeds of the sale of these businesses. Tr. 324 (G. Ervin).



The Goldman Sachs Presentation: February 1999

In February 1999, Gary Ervin met with Cheyne Pace of Goldman Sachs in Sturgis, Kentucky. Tr. 209-10 (Pace); Tr. 324-26, 341 (G. Ervin). Pace recommended that the Ervins consider taxadvantaged investments such as oil and gas master limited partnerships (MLPs), and tax-exempt bonds. Tr. 219-20 (Pace); Tr. 327-29 (G. Ervin). Pace also recommended that the Ervins enter into "costless collars" to protect their position in Dycom stock. JX 2; Tr. 211-12 (Pace); Tr. 330-31 (G. Ervin). 7 Gary opened accounts for himself and his brothers with Goldman Sachs after his first meeting with Pace but did not execute the collars at that time because of the black-out period imposed by SEC Rule 144. Tr. 214-17 (Pace); Tr. 345-46 (G. Ervin). 8



The Ervins' Referral to BDO Seidman

Pace recommended that Gary talk with an accountant, Philip Chandler, who in turn referred the Ervins to BDO Seidman, a tax and consulting firm, for a finder's fee of $180,000. Tr. 221 (Pace); Tr. 336-37 (G. Ervin); see DX 523; see also Tr. 1503-04 (DiMuzio). 9

In March 1999, Gary spoke with John Pridnia of BDO Seidman about BDO's proposal for tax-advantaged investments. Tr. 340-42 (G. Ervin). Pridnia and David DiMuzio, another BDO Seidman employee, knew that the Ervins had reaped a large capital gain from the sale of their business in 1999. Tr. 1557-58, 1579-80 (DiMuzio). DiMuzio believed that BDO could provide a "value-added service" to the Ervins if they could find a way to make the tax liability associated with the brothers' gain "disappear or be reduced." Tr. 1579-80 (DiMuzio). Pridnia recommended that Gary talk with Jenkens & Gilchrist, a large law firm, to discuss tax-advantaged investments. Tr. 282, 340-44, 627-28 (G. Ervin).



The Jenkens & Gilchrist Proposal: March 1999

On or about March 25, 1999, a telephonic conference was held among Gary, David DiMuzio and John Pridnia of BDO Seidman, Martin McElroy, the Ervins' long-time accountant, Vickie Davis, the Ervins' general counsel, and lawyers from Jenkens & Gilchrist. Stip. ¶ 8; JX 3; Tr. 279-81, 342- 43 (G. Ervin). 10 BDO and Jenkens & Gilchrist presented a tax-advantaged investment based upon "a case the IRS had won," by conference call. Tr. 345, 365-66, 628, 630 (G. Ervin). The tax strategy consisted of contributing foreign currency options to an S corporation in order to create a high-basis, low-value asset, the sale of which could result in a capital loss in excess of the cash that was contributed. Tr. 1506-07 (DiMuzio). Gary Ervin was troubled by the fact that there was no investment advisor to advise him on what trades he ought to pursue and there was almost no consideration given to the economics. As far as Gary Ervin could see, the tax-advantaged "investment" presented by BDO Seidman and Jenkens & Gilchrist had no investment component at all because the "primary thrust of the call with Jenkens & Gilchrist... [was] [t]o discuss ... the tax aspect of it." Tr. 282, 345 (G. Ervin); Tr. 1404 (McElroy). Gary testified: "there was no investment to it, or none that I saw." Tr. 345 (G. Ervin); Tr. 1404 (McElroy).

Gary Ervin concluded, on behalf of his brothers, that it did not make sense to rely on a law firm to handle an investment. Tr. 1404 (McElroy). Consequently, the proposal was never brought up again. Tr. 285, 345 (G. Ervin); Tr. 1404 (McElroy). However, DiMuzio continued to contact Gary Ervin over the next few months in the hope of acquiring Gary as a client for BDO Seidman. Tr. 1510-11, 1513 (DiMuzio).



Dagny Maidman and the Costless Collar and STARS Transactions: April - June 1999

On April 20, 1999, Gary opened accounts with Montgomery Securities in San Francisco in order to execute "costless collar" options. PX 202; Tr. 354-57 (G. Ervin); Tr. 128 (Maidman); JX 4. 11 On June 9, 1999, each of the Ervins, through a family LLC, entered into a set of "costless collar" options contracts with Dagny Maidman. JX 14-16; Tr. 129-33, 167 (Maidman); DX 667. These transactions had the net effect of guaranteeing the Ervins a minimum price for their Dycom stock --thus limiting potential losses while capping their potential profit. Tr. 178-82 (Maidman). As of July 31, 1999, each brother had approximately $3.6 million dollars in Dycom stock in the costless collars. See PX 223-225. 12



The Creation of the Spread Transaction: BDO Seidman, Curtis Mallet, Sentinel and AIG

BDO Seidman is a national accounting and tax consulting firm. Tr. 2759 (Field). BDO's tax practice division used the logo, "TAX $ELLS!" See DX 578; see also Tr. 2880 (Field). The function of the TAX $ELLS! division of BDO was to sell tax products such as "Capital Gain Eliminators," "Ordinary Income Eliminators," and "NOL [Net Operating Loss]/Capital Loss Refresher." DX 578, 593, 668; Tr. 2778 (Field). BDO priced these tax products based on the "value," or dollar amount of taxes that the product could save its purchaser. See DX 578, 665, 668; Tr. 2876 (Field). BDO Seidman likewise calculated employee bonuses on the amount of tax savings claimed or achieved by selling a given tax product. See DX 523, 668; see also Tr. 2847-48 (Field).

The tax practice team at BDO Seidman was known internally as the "Wolf Pack." DX 578; see also Tr. 2880 (Field). According to Denis Field, then the managing partner of BDO's tax practice, the "Wolf Pack" represented "cooperation, collaboration, communication, and concentration," an attempt to make BDO's tax practice more competitive and profitable. Tr. 2780, 2742-43, 2880 (Field); DX 578; Tr. 1596 (DiMuzio). As the leader of the tax practice, Denis Field described himself as the "alpha wolf." Tr. 2742-43, 2880 (Field). As the "alpha wolf," Field cultivated the TAX $ELLS! division and wolf pack ideas throughout BDO's tax practice. Tr. 2878- 79 (Field).

BDO compiled and updated a "Tax Product Sales Manual" that was used for the marketing and sale of BDO's tax products. See DX 593, 665, 668; see also Tr. 2758-59, 2777-79 (Field); see also DX 600. 13



Sentinel Advisors

Sentinel Advisors, LLC (Sentinel), the tax matters partner and managing member of Jade, was a hedge fund manager in New York. JX 19. Sentinel was formed in 1997, by Ari Bergmann 14 and Abraham Pfeiffer. 15 See JX 19; Tr. 806 (Pfeiffer). In 1999, Sentinel's Chief Financial Officer (CFO) was Smita Conjeevaram, a certified public accountant (CPA) and former tax manager. 16 See JX 19; Tr. 2594-96 (Conjeevaram). In 1999 and 2000, Sentinel controlled a subsidiary, New Vista, LLC, which was owned 75 percent by Sentinel and 25 percent by Michael Powlen, a Californiabased tax attorney. See JX 18 at 14; see also Tr. 1238 (Bergmann); Tr. 2609-11 (Conjeevaram). The bulk of Sentinel's profits in 1999 arose from investments it executed for BDO. Tr. 1342 (Bergmann).



The Genesis of the Spread Transaction

Between January and March of 1999, Ari Bergman from Sentinel Advisors approached Charles Bee, a senior partner at BDO Seidman responsible for developing its Tax Solutions Group's business line, with the idea for the spread transaction. Tr. 2905-07 (Bee); Tr. 1234-37 (Bergman). 17

Bee testified:


Q. The spread transaction I'm referring to is described as involving the purchase and sale of foreign currency options creating a spread position, which is contributed to a partnership. When the investor exits the partnership, a marketable asset is received which has a high basis and a low value, the sale of which generates a loss. Now, my understanding is that the idea for the spread transaction or the concept of the spread transaction was brought to you by Ari Bergmann. Is that right?



A. Brought to BDO?



Q. Brought to BDO by Ari Bergmann.



A. By Ari Bergmann. That's correct.



Q. Could you just describe to the Judge how it is that that idea or that concept was brought to BDO Seidman in the initial development or the early stages of it, the birth as it were of the spread transaction?



A. Well, Ari Bergmann was introduced to us, and I'm not exactly sure by whom. He either came to our offices or we had a meeting at his offices, and I don't recall which. There were a few of us at the meeting, and he described an investment which we called a spread option, ... . We had not heard --I hadn't heard, and I don't think anyone else at that meeting had ever heard --of the concept of a spread option or any tax benefits or other aspects of spread options at that time.



Q. And just to clarify, the time is when? Early 1999? Is that right?



A. It must have been sometime between January and March of 1999.


Tr. 2905-07 (Bee).

Bergmann testified as follows regarding the origin of the spread transaction:


A. We came to them [BDO Seidman]. They were our accountants. We had big problems with phantom income the year before in 1998 that we had very, very detrimental tax treatment on the derivatives. We went to BDO Seidman, and we asked them in every derivative product that we did what was the tax treatment. We heard that the tax treatment of short options was favorable...



Q. Okay. And there was a transaction that was described to you in your discussions with BDO involving spread options?



A. To the best of my recollection it was not a transaction described. We asked them. Short options. What is the tax treatment like we asked everything else of them what was the tax treatment. That was what we asked.



Q. Did you learn of an economic mismatch that could take place between the economic results of a spread transaction and the tax results of a spread transaction in your conversations with BDO?



A. We learned of a different tax treatment. That is correct. A tax treatment.



Q. Okay. And that produced a mismatch between the economic results and the taxable income resulting from the transaction?



A. Yes.



Q. And that involved a short position that is then contributed to a partnership or trading fund?



A. We didn't learn that it then contributed. We learned --that was not the gist of the conversation. The gist of the conversation was short positions. What is the value? We know the short position is a short. It has a negative value. If it's contributed to a fund, what does it do to the basis? We had heard that it does not because it is so contingent. It doesn't reach to the level of a liability. That's what we asked them.



Q. Where had you heard this?



A. On the street. I don't even know who.


Tr. 1234-36 (Bergmann). Bee acknowledged that Bergmann had discussed tax ramifications of the spread:


Q. But Mr. Bergmann indicated that there were tax ramifications to the spread transaction, didn't he?



A. Yes, he did.



... .



Q. When Mr. Bergmann brought this spread transaction concept to BDO with the tax ramifications, tax benefits, what did BDO Seidman do?



A. We examined it. The first thing that struck me is that I called up a law firm that I had personally dealt with, the firm had dealt with for many years, and we had the utmost confidence in as an independent advisor and as extremely fine tax attorneys, and that is William Bricker and Curtis Mallet. Bill is an international tax specialist, and we were talking about foreign currency options and for a whole host of reasons.


Tr. 2908, 2911-12 (Bee).



BDO Seidman's Tax Product Sales Manual's "Spread Transaction"

Under Field's leadership, BDO's tax practice group updated the Tax Product Sales Manual. See DX 665. In August 1999, Section 250, Capital Gain Eliminators, and Section 300, Ordinary Income Eliminators, of the Tax Product Sales Manual were revised to include a tax product known as the "Spread Transaction." DX 665; Tr. 2878 (Field). 18

According to BDO's Tax Product Sales Manual, the spread transaction was a tax product that BDO claimed could create "stepped-up basis ... to shelter gains." DX 665. The spread transaction was priced as a percentage of the gain to be sheltered. DX 665. Section 250 of the Tax Products Sales Manual stated that "[t]he fee for the Spread Transaction [would] typically be 8% of the gain." DX 665 at 019777.

BDO's Tax Products Sales Manual described the Spread Transaction as follows:


There are several different transactions which might deal with capital gains. Although each is structured around different statutory provisions, and have various structural differences, they each rely on anomalies in the tax law to allow for the creation of stepped-up basis that can be used to shelter gains.



Spread Transaction: This transaction requires a minimum gain of $15 million, and a taxpayer who meets certain minimum assets requirements that generally require gross assets of at least $10 million. A tax opinion is provided by a law firm on this transaction, which can be used for gains already recognized in 1999.



... .



The Spread Transaction involves the purchase and sale of foreign currency options, creating a spread position, 19 which is contributed to a partnership. When the investor exits the partnership, a marketable asset is received which has a high-basis and low value, the sale of which generates a loss.



... .



These transactions are structured around anomalies in the tax law that allow for the creation of stepped-up basis that results in an ordinary loss that can be used to shelter ordinary income ...



... .



... including previously generated income in the same year.


DX 665 at 019776, 019778; see also Tr. 2869-72 (Field). 20



Curtis Mallet

BDO Seidman's Bee had met William Bricker, a partner at the law firm of Curtis Mallet in New York, at a lecture. Tr. 912-13 (Bricker). Over a period of several months including April, 1999, Bee and Bricker had ongoing discussions about a potential foreign-currency-options transaction that would involve Sentinel Advisors, a hedge fund manager, doing the trading because BDO was not licensed to sell securities. Tr. 915, 985-87 (Bricker); Tr. 2905-06, 2911-13, 2922-24 (Bee); JX 19. 21 Bricker and Curtis Mallet would provide tax opinion letters to investors concerning the transactions. Tr. 2941 (Bee).

BDO became a client of Curtis Mallet, and Bricker and his partner Eduardo Cukier, spoke with Ari Bergmann, Abraham Pfeiffer, and other members of Sentinel about the mechanics of the spread transaction. Tr. 913-14 (Bricker); Tr. 2709, 2713-14 (Cukier). In investigating the details of the spread transaction, Bricker spoke with employees of AIG, an investment firm, about AIG's account opening forms and fees. Tr. 920-21 (Bricker). At some point during this process, the BDO Tax Group determined that it would refer clients to Sentinel to purchase the spread transaction and to Curtis Mallet for tax opinion letters. Tr. 1562-63 (DiMuzio); Tr. 2922-25 (Bee).

Throughout the first half of 1999, Bricker and Cukier reviewed and commented on draft documents from BDO, AIG, and other law firms regarding foreign currency option exchanges for the future execution of the Spread Transaction, including transaction documents relating to currency trading, a subscription agreement, a partnership agreement, an offering memo, an agreement with New Vista to provide services, and a withdrawal/redemption letter. Tr. 921-23, 987-89 (Bricker); see also DX 559, 598. After reviewing these documents, Bricker concluded that the spread transaction would "more likely than not" create a step-up in basis of the asset and allow for reportable losses under Federal tax law and issued an opinion to that effect to clients of BDO. JX90; Tr. 943-44 (Bricker).

Bricker's opinion stated that the "transfer to the Partnership of the [option spread] should [be] viewed as a contribution of the Purchased Call Option ... to the Partnership and the Partnership's assumption of the Sold Call Option. Thus, ... the Partnership interest equal[s] the basis of the Purchased Call Option ... ." JX 90 at 15-16. Interpreting Internal Revenue Code section 752, Bricker opined that the obligations created by the sold options assumed by the partnership were "contingent," because they were not exercised and therefore not a liability for purposes of lowering the basis under section 752(b). JX 90, Tr. 943, 1015-16 (Bricker).



AIG: May - June 1999

In April or May of 1999, Bergmann met Ann Reed, the treasurer of AIG's Trading Group, and Sheldon Pang, a salesperson on the foreign exchange desk at AIG. Tr. 1670-72 (Reed). At that meeting, Bergmann proposed transactions in which Sentinel clients would buy option spreads, and AIG would be paid account opening and transaction fees. JX 112 (Pang Dep. at 139); Tr. 1177-78 (Bergmann). 22 Pang was AIG's principal contact with Sentinel on the "sales side," where he was in charge of setting up accounts for Sentinel. Tr. 1672-74 (Reed). Reed was also an AIG contact for opening and setting up accounts with Sentinel, and she met with Sentinel to establish a working relationship. Tr. 1674-75 (Reed).

Before AIG would being trading with Sentinel clients executing the Spread Transaction, a series of required steps had to be established --these steps were recorded in a document entitled "Procedures for Transactions with AIG, Meeting at Sentinel with AIG on May 17, 1999 at 3 pm" that was prepared in conjunction with a meeting between AIG and Sentinel that day. DX 555; Tr. 1675-76 (Reed); Tr. 2631-48 (Conjeevaram). 23 These May 17, 1999 procedures set forth four primary steps required to complete each transaction and assigned responsibility for each step of the spread transaction. See DX 555; see also Tr. 2631-48 (Conjeevaram). The four steps were:


1. Trade To Be Done



2. Trade is Executed



3. Contributions into the Partnership



4. Redemption from Partnership.


DX 555. Under each of these four steps, administrative tasks were listed. Under "Contributions into the Partnership," the following steps were listed:


a. Assignment & Assumption agreement to be signed by Sentinel and Investor and sent to AIG for signature



b. Noreen to follow up with investor and AIG for signed and completed Assignment & Assumption Agreement



c. After Assignment & Assumption is signed by all parties, Sentinel to determine the date of the revaluation of the spread and the date for the Assignment & Assumption Agreement.



d. Contribution / Revaluation date and the date of the Assignment & Assumption should be the same



e. Udai / Jeremy should inform AIG the revaluation date



f. Revaluation reviewed and checked



g. Noreen to send investor a copy of the revaluation and the signed Assignment & Assumption agreement


Id.

The following tasks were listed under step four, "Redemption from Partnership":


a. Letter from Investor



b. E-mail redemption date to Eli / Udai and Jeremy



c. E-mail assets to be redeemed to Udai / Jeremy



d. Reply to investor re. date of redemption



e. AIG to value the partnership's assets - turn-around time is approximately 2 days after request



f. Untracht & Assoc. to review investor capital account



g. Determine the assets to be redeemed



h. Letter to AIG to transfer requisite amount of currency


Id. 24



The Master Trading Agreements: September 15, 1999

On September 15, 1999, the Ervin LLCs entered into a letter agreement with AIG authorizing Sentinel to act on their behalf in trading with AIG. See JX 34, JX 35, JX 36; see also Tr. 1695-96 (Reed). That same day, each Ervin LLC entered into a separate Master Trading Agreement with AIG, and Reed signed the agreements on behalf of AIG. Tr. 1679 (Reed); JX 31, JX 32, JX 33. 25 These Master Trading Agreements were developed internally at AIG, and were specific to foreign exchange trading. Tr. 1679-80 (Reed).

Provision 11.1 of each Master Trading Agreement stated in part:


This Agreement may not be assigned by either party in whole or in part without the prior written consent of the other party. Transactions may be assigned to a new counterparty solely upon credit and legal approval of the new counterparty by AIG, such approval to occur in writing prior to any such assignment.


JX 31, JX 32, JX 33. According to Reed, this provision was intended to protect AIG's interests by prohibiting either party from randomly assigning its position to anyone else. Tr. 1681-82 (Reed).

Schedule E of the Master Trading Agreements established original margin requirements for options sold to AIG by the Ervin LLCs as follows:


(a) For each Currency Contract, 5% of the Contract Value of that Transaction where the underlying currency pairs consist of Group A Currencies, as defined herein, and otherwise, between 10% and 20% of the Contract Value of that Transaction, as determined by AIG in its sole discretion. Except as otherwise agreed by the parties, "Group A Currencies" shall include the ...Euro and the US Dollar.



... .



(c) For each Currency Option under which AIG is the Holder, the product of (i) 5% of the Contract Value of that Transaction where the underlying currency pairs consist of Group A Currencies, and otherwise, between 10% and 20% of the Contract Value of that Transaction, as determined by AIG in its sole discretion, and (ii) the delta for that Transaction (as determined by AIG in any commercially reasonable manner).


JX 31-33. 26 Ann Reed testified that the purpose of Schedule E of the Master Trading Agreements was to clarify "how original margin would be held for an option which was sold to AIG." Tr. 1682-83 (Reed).

Paragraph 11.6 of the Master Trading Agreement provided: "Unless otherwise agreed, Counterpart shall, from time to time and as requested by AIG, pay to AIG a fee equal to 0.0275% multiplied by the notional amount of any Call spread or Put spread Option Transaction." JX 31, JX 32, JX 33. Bergmann testified as follows regarding the fee provision in Section 11.6:


Now, we did with AIG something which was called either an account open fee or a facility fee because we knew that we were planning to trade these things in and out all the time, and if you would have to pay a bid offer every single time it would be very costly and onerous. 27 We had a gentlemen's agreement, an understanding with the traders, that we will pay a fee, a specific fee up front, which would be called either a facility fee or an account opening fee, whatever the terminology is, to allow us to trade reasonably a few times without having to pay additional bid offers to the tightest bid offer, which is like one-hundredth. That would allow us to trade and to make money without having to pay out every time.



Q. To pay out what every time?



A. A bid offer. The regular bid offers.


Tr. 1177-78. 28 Bergmann could not recall the name of the person at AIG with whom he reached the referenced "gentlemen's agreement." Tr. 1316 (Bergmann). He testified that provision 11.6 of the Master Trading Agreement was intended to reflect this agreement, but that the language is unclear. Tr. 1374-75, 3458-61 (Bergmann).

AIG did not normally require counterparties to pay an up-front fee prior to engaging in foreign exchange option trading. Tr. 1694-95 (Reed). Ann Reed, the Treasurer of AIG's Trading Group and the primary contact with Sentinel for drafting the Master Trading Agreement testified as follows:


Q. Now, what is that fee for?



A. I don't know.



Q. Is it a standard term in AIG's multi agreement?



A. It was not in the basic multi agreement as developed, no.



Q. Do you know why it was included in this agreement?



A. I do not.



Q. Was it included in the master trading agreements for other Sentinel clients?



A. Yes. Now, I can't say that they all have this, but I know that some of them did.



Q. Was it included in master trading agreements other than for Sentinel's clients?



A. I've never seen this provision that I recall outside of Sentinel's clients.



Q. Was there a negotiation between AIG and Sentinel about the fees that were to be paid by Sentinel's clients?



A. I don't know.



Q. Do you know if AIG agreed to forego bid offers in favor of up front fees?



A. I do not.



Q. So you're not familiar with an informal agreement to that effect?



A. I am not.


Tr. 1686-87 (Reed).

Reed sent a draft of the Master Trading Agreement to Conjeevaram by fax on July 13, 1999, that did not contain provision 11.6. DX 564; Tr. 1689-90 (Reed). Reed acknowledged that the final version of the Master Trading Agreement used for Sentinel clients did contain this provision, but did not know when it was added. Tr. 1690-92 (Reed). Neither Conjeevaram nor Pang knew how or when provision 11.6 became part of the Master Trading Agreement. Tr. 2598 (Conjeevaram). JX 112 (Pang Dep. 73-74).

Dr. David DeRosa, Defendant's expert in options and foreign exchange trading, testified that the $84,100 fee arrangement in the Master Agreement was unusual. Dr. DeRosa stated: "I've never paid such a fee, and none of the investment partnership hedge funds I've ever been associated with who I've ever heard of ever paid a fee like that." Tr. 3184 (De Rosa). He opined that the reason he never had to pay such a fee was because "[his investments] were real opportunities for the investment bank." Id. When asked why he believed the Ervin LLCs were asked to pay such a fee he stated:


I think the answer is because the business isn't worth very much to AIG, and they had to make some money on it. But it's certainly not a normal relationship, and I --you know, I've seen a lot of circumstances in this big world of foreign exchange, but I never saw anybody pay to play... .There is no way I would do this... . I've never heard of this. Honestly, I have never heard of this, an account opening fee before.


Tr. 3185-86 (DeRosa).

Neither Reed nor any other AIG employee assessed the creditworthiness of Sentinel's clients individually, even though AIG had an established process for making such an assessment that would not have "taken very long." Tr. 1685 (Reed). Instead, AIG relied on Sentinel's assurance that each of its clients had net assets in excess of $10 million. Tr. 3454-55, 3462 (Bergmann). 29 AIG began trading with Sentinel in June of 1999. Tr. 1675 (Reed). According to Reed, AIG provided services to more than 50 Sentinel clients in 1999. Tr. 1677 (Reed). 30



BDO Seidman's Tax Opinion Letter

In May 1999, BDO Seidman prepared a 37-page tax opinion for potential investors in the spread transaction. The opinion briefly described the investment aspects of the spread transaction, --the type of options to be purchased and sold, the strike price for each option, the dollar and euro value of each option, the expiration dates of the options, and profit potential of the transaction. JX 23 at 2. 31 The opinion went into great detail about the tax consequences of the transaction. The opinion began:


THIS OPINION CONSIDERS CERTAIN FEDERAL INCOME TAX CONSEQUENCES OF A PROPOSED INVESTMENT TRANSACTION AND IS BASED ON A HYPOTHETICAL FACT PATTERN.


JX 23 at 1. The opinion outlined four steps of the investment strategy, which were: 1) Investment in Foreign Currency, 2) Contribution to a Partnership, 3) Partnership Investments, 4) Termination of Partnership Interests. JX 23 at 2-3. The opinion explained that the investor would first "purchase a European-style call option" and at "the same time ... sell a European-style call option." JX 23 at 2. The investor would then contribute the purchased and sold call options to a partnership that had been previously formed under Delaware law. JX 23 at 2-3. "Sentinel Advisors [would be] the investment advisor to the Partnership, and [would] charge the Partnership an investment advisory fee." JX 23 at 2. In return for the options contribution the investor would receive a "less than 50% interest in the partnership." JX 23 at 3.

In the fourth step of the BDO Spread Transaction, "Termination of Partnership Interests," the purchaser of the spread would exit the partnership, receive an asset with a claimed high-basis and low-value, and then sell that asset in order to generate a tax loss. JX 23 at 3; DX 665. The partnership would continue to exist and invest. See JX 23 at 3, §4, ¶2. BDO recommended to its customers that the amount of time between the second step (entering the partnership) and the fourth step (exiting the partnership) be no less than 60 days. Tr. 2969-70 (Bee). BDO recommended this 60 day minimum for tax reasons --to establish that purchasers of the spread transaction were "partners" for purposes of substantive tax law. Tr. 2969-71 (Bee).

The opinion summarized the federal income tax consequences of the spread transaction stating "it is more likely than not that:"


1. You should recognize gain on the transfer of the Purchased Call Option to the Partnership. You will not recognize any loss on the contribution of the Purchased Call Option to the Partnership.



2. Your basis for the Partnership interest should be equal to your basis in the Purchased Call Option, reduced by the amount of liabilities assumed by the Partnership. The sold call option should not be considered a liability for purposes of section 752.



3. Your share of any loss incurred by the Partnership should be deductible by you, and should not be subject to the passive activity loss rules.



4. You should not recognize gain or loss on the receipt of foreign currency from the Partnership in exchange for your Partnership interest.



5. The basis of the foreign currency received in liquidation of your Partnership interest should equal your basis for the Partnership interest.



6. The gain or loss recognized on your sale of the foreign currency should be treated as ordinary income or loss.


JX 23 at 4. The opinion provided a detailed analysis of Helmer, and concluded that a "Sold Call Option contract creates no obligation to return the premium to the purchaser. Indeed, the premium represents deferred income to the seller and is not a liability." JX 23 at 13-14.



Dimuzio Introduces the Spread Transaction to the Ervins

On August 23, 1999, DiMuzio mailed BDO's May 1999 draft model tax opinion to Martin McElroy. Tr. 1512, 1517 (DiMuzio); JX 22, 23. McElroy reviewed this opinion and was "impressed" with it. Tr. 1626 (Mountjoy). McElroy was impressed overall with Sentinel, BDO Seidman, Curtis Mallet, and the opinions and guidance they provided on the proposed transaction. Tr. 337-38 (G. Ervin); Tr. 1409, 1411-12 (McElroy); Tr. 1626 (Mountjoy). Jesse Mountjoy also reviewed the BDO Seidman model opinion at the request of Gary Ervin and found the model opinion to be thorough, well researched, and "balanced from the standpoint of presenting both sides of legal interpretation." Tr. 1614 (Mountjoy).



Gary Ervin's Failure to Restrike the Dycom Options: August 26, 1999

In late August 1999, Maidman called Gary and told him that the Dycom stock price had dropped dramatically, from $48.56 per share on June 1, to $37.50 per share on August 26, 1999. Tr. 136 (Maidman); Tr. 357-58 (G. Ervin); JX 1. The Ervins' put option gave them the right to sell the Dycom Stock at $42.2859 per share and realize a gain of $4.7859 per share. JX 1 at 5; JX 14 at 2, JX 15 at 2, JX 16 at 2. Maidman explained that the Ervins could restrike the appreciated put option in each collar, leave the call option unaltered, and reap an aggregate profit that exceeded $1.5 million. 32 Tr. 136-37 (Maidman); Tr. 358 (G. Ervin). On the advice of Cheyne Pace, Gary did not restrike any of the options at this time. Tr. 359-60, 362-63 (G. Ervin); Tr. 222-23 (Pace). After the Dycom stock quickly recovered, Gary regretted that decision. Tr. 362-63 (G. Ervin). On behalf of himself and his brothers, he restruck the purchased option the next time the opportunity arose. Tr. 484 (T. Ervin); JX 1 (Nov. 1, 1999 Entry.) 33



The September 2, 1999 Meeting Between BDO Seidman and Gary Ervin

On September 2, 1999, DiMuzio met with Gary Ervin, Mountjoy, and McElroy at McElroy's office in Henderson, Kentucky. Tr. 519, 522, 525, 634 (G. Ervin); Tr. 1513, 1574 (DiMuzio); see also PX 244. 34 At the meeting DiMuzio explained the substance and tax benefits of the Spread Transaction described in the model opinion letter. Tr. 1514 (DiMuzio); Tr. 520 (G. Ervin). No representative of Sentinel was present. Tr. 634 (G. Ervin); Tr. 1499, 1513, 1542 (DiMuzio). DiMuzio, McElroy, Mountjoy, and Gary Ervin discussed the model opinion letter in "pretty good detail." Tr. 1407, 1438 (McElroy). 35 Specifically, DiMuzio recommended that Gary talk to Sentinel about trading euro options as Sentinel had a group of "very successful" and "very experienced" traders, and because the "tax advantage portion" of the Spread Transaction "was very similar to [BDO's] earlier presentation." Tr. 364-65, 369-70, 372-73 (G. Ervin); Tr. 1405 (McElroy).

Gary Ervin enlisted his long-time tax attorney, Jesse Mountjoy, a former IRS attorney, to attend this meeting with BDO Seidman. Tr. 518-20 (G. Ervin). After Gary Ervin had described the Jenkens & Gilchrist deal to Mountjoy, he was skeptical, and Gary wanted him involved in the debate "to play devil's advocate." Tr. 518 (G. Ervin). Initially, Mountjoy, who is blunt, was skeptical, but by the end of the meeting Mounjoy became "convinced otherwise," and told Gary Ervin so. Tr. 520 (G. Ervin). Had Mountjoy not been convinced, Gary Ervin would not have done the spread transaction. Tr. 519 (G. Ervin). Jesse Mountjoy had represented the Ervin family since the late 1980s, and Gary Ervin had uniformly followed his advice. Tr. 517 (G. Ervin); Tr. 1637 (Mountjoy).

DiMuzio told Gary Ervin to call Bricker of Curtis Mallet for tax advice in the form of an opinion letter. Tr. 699-700 (G. Ervin); Tr. 1518-19 (DiMuzio).



Gary Ervin's Discussion With Bricker: Late August or Early September 1999

Following DiMuzio's suggestion, Gary Ervin contacted Bricker to discuss the spread transaction in late August or early September of 1999. Tr. 583, 699, 718 (G. Ervin); Tr. 923-24 (Bricker); Tr. 1518-19 (DiMuzio). The Ervins did not engage Mr. Bricker at that time, because they understood that they did not need to engage the law firm until they planned to exit the partnership, and they intended to retain Bricker when they left the partnership. Tr. 583, 738 (G. Ervin); Tr. 923-24 (Bricker). 36 During that initial conversation, Gary asked Bricker questions about options and commodity trading and questioned him extensively about his educational background and professional experience with options and commodity trading. Tr. 924-27 (Bricker). In Bricker's view, Gary Ervin was "conducting some sort of review or due diligence" on him and Curtis Mallet, and Bricker explained to Gary that he had 30 years of legal experience focusing on the tax consequences of commodity transactions and other issues. Bricker also gave Gary Ervin the background of Curtis Mallet, explaining that the firm "had been around a long time" and did "a lot of international work." Tr. 926 (Bricker).



DiMuzio's September 8, 1999 Letter to Gary Ervin: Information on Sentinel and its Fee, and BDO's Preparation of the Ervins' 1999 Personal Tax Returns

In a letter dated September 8, 1999, DiMuzio informed Gary Ervin that Sentinel Advisors had agreed to a five-percent fee as long as the Ervins' transaction was at least $40 million in total. JX 24. The letter stated:


To confirm my voice mail message, Sentinel Advisors agreed to the 5% fee, assuming a transaction of at least $40 million in total. All other fees and costs would remain the same as discussed in our meeting last Thursday.



Enclosed is information on Sentinel Advisors including biographies of the partners, a list of references and an Investment Advisor Registration statement, which, by SEC regulation, is provided to prospective investors. Also enclosed is a private placement memorandum for New Wave I LLC. This will not be your investment vehicle; I simply included it to give you a sense of Sentinel's other activities.



With respect to fees for preparing your personal tax returns, as I indicated, it is difficult to quote a fee without analyzing your prior year returns and knowing more about your current situation. Because time is short, we may not be able to get enough information to make a fully informed estimate. However, to resolve this issue in order to keep the transaction moving, BDO Seidman, LLP will agree to prepare tax returns for you and your brothers at a fee commensurate with your prior year returns. In other words, if your 1999 federal income tax return is substantially similar to your 1998 return except for the sale of the businesses and the proposed transaction, our fee will be no higher than what you paid last year. State returns will be prepared on the same basis.



I look forward to working with you, your brothers, Martin and Jesse in completing this engagement.


JX 24.

DiMuzio vaguely testified that the "proposed transaction" mentioned in his September 8 letter referred to an "investment with a Sentinel hedge fund:"


Q. What was the transaction though? I want --you used the word.



A. The investment.



Q. Would you please specify that?



A. If I'm being evasive, Your Honor, I don't want to be. The Sentinel investment, the decision to invest in a Sentinel hedge fund partnership.



Q. Okay, that's an investment. This is a transaction. You used the word twice. You said let's keep the transaction moving, and then you said --



A. Yes, yes, I did.



Q. --later in the letter, "In other words, if your 1999 federal income tax return is substantially similar to your '98 return except for the sale of the businesses and the proposed transaction."



A. That would be --I think I was referring to the Sentinel investment in both of those cases. That's what I meant by transaction, yes.



Q. Okay. And what Sentinel Investment? Specify the transaction.



A: An investment with a Sentinel hedge fund, an investment with a Sentinel hedge fund. I think that's what I was referring to encompassing transaction.



Q. Had you been privy to the proposed transaction that the Ervins were contemplating at that time, the specific transaction, not just a general investment? I'm trying to get specifics here.



A. Oh, I was --I attended the meeting when Smita made a presentation about --a detailed presentation about the options, about the trading of the options inside of the partnership, about knock-out options, about the leveraging that was allowed or that was available there, about the potential returns. So that's what I was thinking about in connection with that.


Tr. 1567-69 (DiMuzio). In early September 1999, the Ervins became clients of BDO Seidman. Tr. 519-25, 634 (G. Ervin); Tr. 1512-13, (Di Muzio).



BDO Seidman Introduces the Ervins to Sentinel: Late August or September 1999

In late August or early September of 1999, DiMuzio gave Gary Ervin's contact information to Bergmann. Tr. 369, 3627-28 (Gary Ervin). Bergmann contacted Gary Ervin via telephone in August or September of 1999, and spoke to him for "a few hours" about possible investments and the services that Sentinel could provide. Tr. 367-69, 3627-28 (G. Ervin); Tr. 1069-72 (Bergmann). During the call Bergmann informed Gary Ervin of his professional experience in accounting and trading, provided professional background information on key personnel at Sentinel, and introduced Gary to several of the Sentinel partners. Tr. 367-69 (G. Ervin). Bergmann considered the Ervins to be "overly positioned" in Dycom stock and told Gary Ervin they needed to diversify their investments. Tr. 375 (G. Ervin). Bergmann recommended that Gary Ervin and his brothers diversify by investing in euro currency options where they could potentially make "10, 15, 20 times" their investment. Tr. 1072 (Bergmann); Tr. 375 (G. Ervin).

During Bergmann's initial phone conversation with Gary Ervin, Bergmann informed him that a unique opportunity existed to make large investment returns from the euro and that derivatives were the ideal instrument to take advantage of the euro. Tr. 381 (G. Ervin); Tr. 1071 (Bergmann). Specifically, Bergmann testified that he told Gary: "1999 was a critical year, was the year of the introduction of the euro, and you have to realize that the euro ... was an event that seldomly happens in the lifetime, and in the lifetime of an investor the opportunities that you have to catch." Tr. 1070 (Bergmann).

During the first telephone conference, in August or September 1999, and during telephone conferences over the next 30 days, Bergmann recommended engaging in heavy trading on euro options. Tr. 381-82 (G. Ervin); Tr. 1070-71 (Bergmann). Gary Ervin recalled approximately eight different phone conversations with Bergmann during the August and September 1999 time frame. Tr. 3631-3632 (G. Ervin).

Bergmann recommended that the Ervins combine "two regular options in [their] trade called an option spread." Tr. 1080 (Bergmann). Bergmann also recommended acquiring "reverse knockout options." Tr. 1077-79 (Bergmann); Tr. 382 (G. Ervin). Options like knockout options are often described as exotic strategies. Tr. 2509 (Shoji); See Tr. 3118 (DeRosa). One type of exotic option is a "barrier" option, which has a "price barrier" which, if hit, causes the option to expire immediately. Tr. 3118 (DeRosa). A knockout option has a barrier set below the strike price; if the currency ever trades at or below the barrier, the option immediately expires worthless. See DX 501 at 7-8; Tr. 3119-20 (DeRosa); DX 768 at 39. 37

Bergmann testified about how he described the reverse knockout to Gary Ervin during their initial phone conversation:


The reverse knock-out allows you to have a multiple up to 38 to 1 if you are right, and if worse comes to worse you could lose your premium. You could lose your premium if the euro goes lower, or you can lose your premium if the euro goes too high. We thought it was an ideal instrument to present, and that's what I told Gary.



... .



And we told him, listen, if you want to do now an investment to get you a return, which is also levered [sic], not as levered [sic] and as tailored as a reverse knock-out, but also has a very good characteristic, is combining two regular options in your trade called an option spread.



... .



He will basically double his money, not exactly, but around doubling his money.


Tr. 1079-80 (Bergmann); see Tr. 385 (G. Ervin). Bergmann also told Gary Ervin that, based on a Swiss Franc study, the Ervins stood a one in five chance to reap an average return of 14:1 with the reverse knockout options. Tr. 385 (G. Ervin); Tr. 1367-68 (Bergmann).

Sentinel sent the Ervins copies of a Sentinel brochure, a Sentinel reference list (which listed clients such as Merrill Lynch, Morgan Stanley, PricewaterhouseCoopers, Dewey Balantine, and BDO Seidman), examples of restriking pairs of options at a profit, a euro knock-out explanation, the Confidential Offering Memorandum of Jade Trading, LLC, and the book Understanding Options by Dr. Robert W. Kolb. Tr. 578-79 (G. Ervin); Tr. 1141 (Bergmann); JX 21. The Sentinel brochure outlined the trading background of Sentinel's principals and traders. JX 19; PX 227; Tr. 578-79 (G. Ervin). The other materials explained how option trading works, and more specifically, how the foreign currency investments that the Ervins were contemplating would work. Tr. 572-79 (G. Ervin); Tr. 1140-41 (Bergmann). The Sentinel marketing materials included the monthly historic returns for Sentinel's Citadel fund from August 1997 to July 1999, and examples of how spreads could be restricken and profits could be earned on knockout options. JX 20, PX 232, 228; Tr. 667-68 (G. Ervin). 38

After speaking with Bergmann and reviewing the materials he was provided by BDO and Sentinel, Gary Ervin concluded that Bergmann was more knowledgeable and experienced in this area than Maidman and Pace. Gary Ervin was impressed with Bergmann and his group at Sentinel. Tr. 372-74, 563-64 (G. Ervin).



Gary Ervin's Inquiries About Sentinel

Gary Ervin asked both Pace and Maidman about Sentinel and its recommendations on the euro. Tr. 137-40 (Maidman); Tr. 225-26 (Pace); Tr. 491-93 (G. Ervin). Maidman also asked the "appropriate people around [her] department in New York," about Sentinel but did not do a detailed background check. Tr. 199 (Maidman). Maidman told Gary that she knew of nothing negative about Sentinel, and said that her bank's position on the euro was positive. Tr. 139-40, 203 (Maidman); Tr. 492-94 (G. Ervin). 39

Gary Ervin also asked Pace about his view on Sentinel, and Pace told Gary that the Sentinel principals had "distinguished backgrounds" and there was nothing negative to report. Tr. 224-25 (Pace); Tr. 515-16 (G. Ervin); JX 19. Pace informed Gary that he was positive on the euro. Tr. 226- 27 (Pace); Tr. 516 (G. Ervin).



The Formation of the Ervin Single-Member LLCs: September 17, 1999

Gary, Robert, and Tim Ervin formed Ervin Holdings, LLC, Ervin Capital, LLC , and Ervin Investments, LLC, respectively, on September 17, 1999, as single-member limited liability companies under Delaware law. JX 28-30; DX 769; Tr. 3632-33 (G. Ervin). According to Gary Ervin, the Ervins formed the LLCs to execute the spread transaction based on the advice of William Bricker in order to limit their personal liability if the spread options were ever "split apart." Tr. 552- 53 (G. Ervin). Gary believed that if they did not form LLCs and the spread options were separated in a manner beyond the Ervins' control, he and his brothers would lose their $15 million premiums in the purchased call options and would also be personally liable for the $300 million "total premium amount" of the sold call options. Tr. 553 (G. Ervin).

By fax dated September 21, 1999, Conjeevaram advised Gary Ervin:


Enclosed for your information is a copy of the business card for the attorney's [sic] that are working on the documentation for the three single-member LLCs that [were] formed for the transactions. The names used for the three are Ervin Capital, LLC, Ervin Investments, LLC and Ervin Holdings, LLC. We should have the LLC operating agreements from the attorneys later this morning.



... .



If you are happy with the names of the LLC's I will have AIG work on revising the Master Trading Agreement. Please let me know.



I will call you later this morning to confirm our meeting on Thursday in Evansville. Either my partner, Ari Bergmann or I will meet with you.


JX 25.



Gary Ervin's September 23, 1999 Meeting with Sentinel's CFO

Gary Ervin recalled meeting with Conjeevaram, Sentinel's CFO, twice before investing with Sentinel, but Conjeevaram only recalled one meeting. Tr. 638 (G. Ervin); Tr. 2608-09; 2669-71 (Conjeevaram). Neither Bergmann nor Pfeiffer ever met with Gary in person prior to the Ervins' investment in Jade --their contact was strictly on the phone. See Tr. 638-39 (G. Ervin); Tr. 1301 (Bergmann). Conjeevaram never worked as a foreign currency trader, and had a heavy tax and accounting background. Tr. 2590-94 (Conjeevaram). 40

On September 23, 1999, Gary Ervin and Martin McElroy met with Conjeevaram at the airport in Evansville, Illinois. JX 26; Tr. 638, 3636 (G. Ervin); Tr. 1408 (McElroy). McElroy testified that the meeting was primarily a presentation of Sentinel "investments and the opportunities in the euros and their strategies on options," and also included information regarding "big multiples on some other strategies that they were recommending." Tr. 1408 (McElroy).



The Formation of Jade: September 23, 1999

Jade was formed by Sentinel and Banque Safra on September 23, 1999. JX 47, 84; Tr. 1092- 93, 1223-24 (Bergmann). At some point during September 1999, Sentinel gave the Ervins copies of a "Confidential Private Offering Memorandum of Jade Trading, LLC," which stated:


The investment objective of the Company is to realize short- and medium-term capital appreciation from the application of derivative trading strategies to a variety of investments in the foreign exchange and general fixed income global markets. The Company will seek to provide returns which are not correlated to the general fixed income and equity markets. Current income is not a primary objective.


JX 47 at 1; Tr. 572-73, 579 (G. Ervin); Tr. 1156-57 (Bergmann); Stip. ¶ 28.

Jade's Limited Liability Company Agreement described Jade's purposes as follows:


Sec. 1.06 Purposes of the Company. The Company is organized for the purposes of investing substantially all of its assets in Securities ... and engaging in all activities and transactions as the Managing Member may deem necessary or advisable in connection therewith, including, without limitation:



(a) to invest, on margin or otherwise, in securities and other financial instruments of U.S. and foreign entities, including, without limitation: capital stock; shares of beneficial interest; partnership interests and similar financial instruments ... .


JX 60 - 62; Tr. 1186-88 (Bergmann). This agreement was drafted by Sentinel. JX 60-62; JX 47 at 1; Tr. 572-73 (G. Ervin); Tr. 1156-57; 1186-87 (Bergmann). According to the BDO opinion letter provided by DiMuzio to the Ervins, Jade was formed for the "purpose of acquiring financial investments, buying and selling call options on foreign currency, and conducting other investment activities." JX 23 at 2.

Sentinel, the managing member and tax matters partner of Jade, held a profit interest, management fee, and incentive allocation that grew with the appreciation of Jade's capital. Tr. 1221-23 (Bergmann). At the end of each accounting period, any net capital appreciation or depreciation of Jade would be allocated to Sentinel and the other members of Jade in proportion to each member's capital account at the beginning of the accounting period. JX 47 at 000080. The management fee paid to Sentinel by the non-managing members, was an annualized two percent of the value of each non-managing member's capital account balance on the first day of each quarter, or 0.5% each quarter. JX 47 at 000065. In addition, "[o]n June 30th and December 31st of each year ... an amount equal to 20% of any net capital appreciation allocated to the capital account of each Non-Managing Member ... [was to be] debited ... [as an] 'Incentive Allocation.'" JX 47 at 000063. Further, a partner "would be subject to a withdrawal fee equal to five percent of the value of the partner's capital account on the date of withdrawal" for withdrawing prior to 12 months from entering the partnership. JX 89 at 7; see DX 665.



The Ervins' Spread Transaction: September 29, 1999

One day after Gary Ervin's meeting with Conjeeveram and the formation of Jade, September 24, 1999, the Ervin LLCs attempted to enter into the first set of euro options Sentinel was recommending. Tr. 561 (G. Ervin); 1145 (Bergmann). Their efforts were thwarted because the funds were not transferred, due to problems with the Ervins' funds being wired to Sentinel --they sat in an AIG account for a few days before Sentinel actually received them. Tr. 560-61 (G. Ervin). Gary Ervin said there was a "misfiring" of the wiring process. Id.

On September 29, 1999, the Ervin LLCs each established a spread option position on the euro with AIG. See JX 38 - 43. 41 The Ervins purchased the option spread on the advice of Sentinel/New Vista, although they did not yet have any consulting agreement with either entity. Tr. 1146 (Bergmann); compare JX 38-43 with JX 48-50.

The terms of the option spreads purchased by each Ervin LLC were identical except for a 10-pip 42 difference in the strike price:




Face amount Strike price

___________________________________________________________________________________
Purchased Option €290,540,000 1.084

Sold Option €290,540,000 1.085




Tr. 1173-75 (Bergmann); JX 38-43. The premium to be paid by each Ervin LLC on the option purchased from AIG was $15,000,020. See JX 38-40. The premium to be received by each Ervin LLC on the option sold to AIG was $14,850,018. See JX 41-43. These premiums were netted, and each Ervin LLC actually paid AIG $150,002 --not $15,000,020. JX 44-46. The expiration date of all six options was September 29, 2000, at 10:00 a.m. New York time. See JX 38-43. The options purchased by the Ervin LLCs were European options that typically can only be exercised at the expiration date. Tr. 1101, 1163 (Bergmann); Tr. 2486 (Shoji). 43

AIG did not require margin from the Ervin LLCs because the most the Ervin LLCs could lose was their initial purchase price, $150,002, the approximate difference in price between the two options in the spread. Tr. 2535-39 (Shoji); see also Tr. 3135 (DeRosa); Tr. 1701-02 (Reed). 44 From AIG's perspective, the spread transaction was free of credit risk because under no circumstances would the Ervin LLCs owe AIG any money on the options. DX 501 at 11. However, AIG's credit protection would disappear if the option components were separated or assigned to other parties. Id. Although the Ervin LLCs were prohibited from assigning their option strategies by paragraph 11.1 of the Master Trading Agreements, if the options were somehow split or assigned, AIG would have required the Ervin LLCs to post original margin. Tr. 1702-03 (Reed). Dr. DeRosa, Dr. Kolbe, and Dr. Kolb calculated that the original margin on the call options sold by the Ervin LLCs to AIG would have been approximately $8.4 million. DX 501 at 13-14; Tr. 3146 (DeRosa); Tr. 2367 (Kolbe); Tr. 3506 (Kolb). If the Ervin LLCs had separated the spread or assigned their obligations on the sold call options, AIG would have required the LLCs to pay the $15,000,020 premium for each call option purchased by the LLCs from AIG, plus the $8.4 million original margin for each call option sold by the LLCs to AIG. DX 501 at 13-14; Tr. 1702-03 (Reed); Tr. 2367-72 (Kolbe); Tr. 3506 (Kolb).

The Ervin LLCs each paid AIG $84,110 pursuant to provision 11.6 of the Master Trading Agreements in connection with their acquisition of the option spreads. Stip. ¶26.



The New Vista Consulting Agreement: October 3, 1999

Each Ervin LLC entered into a consulting agreement with New Vista on October 2, 1999. JX 48-50. The consulting agreements obligated New Vista to


advise the [Ervin LLCs] with respect to Risk Management, including, without limitation, in connection with the sale, pledge, loan, conveyance, assignment, transfer or other disposition of any instrument or investments, and the creation of hedging positions to preserve or limit the loss of value of any positions or otherwise through the use of one or more interest rate, currency, or other derivative products, including, without limitation: (i) swaps, options, warrants, caps, collars, floors and forward rate agreements; (ii) spot and forward currency transactions; and (iii) agreements relating to or securing such transactions. The Consultant will also (i) give advice regarding macroeconomic issues in structuring transactions and (ii) provide derivatives expertise training to the Client and/or any of the Client's employees.


JX 48 at 1-2; 49 at 1-2; 50 at 1-2.

Gary understood that if the Ervins did not pay the New Vista fee they would not be admitted as partners in Jade. Tr. 567, 569-70 (G. Ervin). Although the Ervins were required to pay the New Vista fee as a prerequisite for entering Jade, Sentinel did not pay a fee. Tr. 1315 (Bergmann).



Legal and Consulting Fees

Each Ervin LLC paid the following fees in addition to the $150,002 premium paid to AIG:




Fee Amount

$750,000 45 45
40 percent of
the $750,000
--or $300,000
--was remitted
by New Vista to
BDO Seidman for
a "tax planning
fee," pursuant
to BDO's
agreement with
Sentinel and New
Vista. Tr.
1090-91, 1371
(Bergmann); Tr.
1584-85
New Vista consulting fee (Dimuzio).

AIG account opening fee $84,100

Curtis Mallet legal fees $100,000

Total $934,100




JX 26, 37, 48-50, 85-87; Tr. 928 (Bricker); Tr. 1650-51 (Mountjoy). In addition to the fees listed above, the Ervins were also required to pay Sentinel a two-percent management fee of the net asset value of their contribution in Jade Trading ($225,002 per brother) and 20 percent of any profits earned by Jade. Tr. 1314-15 (Bergmann); see JX 57-59.

It is unclear what value the Ervins received for the $750,000 consulting fee. New Vista provided the Ervin LLCs with reports on foreign exchange and other financial markets as well as investment periodicals reporting on different European investments. These brief reports covered the current market conditions in the foreign exchange market. Tr. 3193-96 (DeRosa); JX 69. DeRosa testified as follows regarding the New Vista fee and services provided to the Ervin LLCs:


I cannot for the life of me understand why any fees would go to New Vista at all. It doesn't make any sense to me whatsoever. Those are big numbers. Three-quarters of a million times three? And the purported thing is buying research --well, research is free... . there are any number of foreign exchange dealers that supply research continuously to market participants. I haven't traded in a long time. I still get fully covered by research from the major houses. I get inundated with it.


Tr. 3191-92 (DeRosa).

Dr. DeRosa opined:


It is not clear to me, however, that New Vista provided any meaningful or useful consulting to the Ervin LLCs. For example, New Vista was not even retained at the time the Ervin LLCs did their only significant foreign exchange transaction, when they entered into the spread strategies. New Vista was not on board when the Ervin LLCs theoretically ought to have needed its assistance the most. The documents I have reviewed (that New Vista supplied to the Ervin LLCs) and the comments made by Mr. Bergmann in his deposition lead me to believe that New Vista's services were of practically no use to the Ervin LLCs. Furthermore, after the Ervin LLCs contributed their spread strategies to Jade, the only trading that they did was to liquidate the final distribution from Jade. Thus whatever advice New Vista had to offer would have been wasted on the Ervin LLCs in this regard.


DX 501 at 21-22.

The $84,100 paid to AIG covered the costs associated with opening a new account. JX 26, 37. Ari Bergmann testified that he negotiated this fee with AIG as a "gentlemen's agreement" in lieu of having to pay "bid offers" every time Sentinel clients did a trade with AIG. Tr. 1177 (Bergmann). However, this gentlemen's agreement was wholly uncorroborated.

Reed was unaware of who at AIG negotiated the fee arrangement with Sentinel, although she presumed it might have been Pang. Pang likewise professed ignorance regarding the origin of the $84,100 fee, testifying that fees were "not [his] area," and that he thought the fee arrangement was "odd." JX 112 (Pang Dep. 73-74). Pang testified that AIG published research reports on foreign exchange trading "daily," sent them to customers to generate business, and "typically" did not charge customers for those reports. JX 112 (Pang Dep. 81).

Each Ervin LLC paid $100,000 to Curtis Mallet for a tax opinion letter. The opinion letter was requested to cover "certain aspects of United States Federal income tax in connection with (i) investments in foreign currency that [the Ervins had] made and (ii) transactions in which [they] engaged with a partnership that ... trades in foreign currency ... ." JX 89 at 1. The $100,000 fee was a one-time fee for each LLC. Gary Ervin believed the fee of $100,000 per LLC was excessive since the opinion was going to be essentially the same opinion for each LLC, but he was unsuccessful in negotiating a lower fee with Bricker. See Tr. 584-86 (G. Ervin), 928-29 (Bricker), 1651-53 (Mountjoy).

The Ervins also incurred fees from their long-time accountant McElroy and outside attorney Mountjoy for services rendered regarding the spread transaction, although the amount of fees paid to these advisors is not in the record. Tr. 432-33 (T. Ervin); Tr. 517-18 (G. Ervin).



The Ervins' Entry Into Jade: October 6, 1999

On October 6, 1999, the three Ervin LLCs entered Jade. In total there were five partners in Jade --the Ervin LLCs, Sentinel Advisors, and Banque Safra. 46 Tr. (G. Ervin) 286-87; JX 57-59, 84. Gary testified that the Ervin LLCs entered Jade Trading because Bergmann had told him that he planned to actively trade on behalf of the Ervin LLCs and if the LLCs were members of the partnership, Bergmann had the ability to get better terms on behalf of the LLCs. Tr. 566-68 (G. Ervin). Specifically, Gary testified:


Q. Please, can you explain what you were told?



A. There were I guess volume. [Bergmann] could trade for all the partners instead of doing it individually in different accounts. It was the trading, you know. He was going to do the knock-outs and the more aggressive type of trading. It was going to be, you know, I understood be very actively traded. I guess his ability to have discretion and to trade actively into that partnership. That was my understanding.


Tr. 567-68 (G. Ervin).

Bergmann testified that by entering Jade, the Ervin LLCs were able to pool assets and make larger more diverse trades than they would be able to execute on their own, and they were also able to obtain lower "institutional pricing" on trades executed by the partnership. Tr. 1151-54 (Bergmann). Specifically, Bergmann testified as follows:


Q. Excuse me. Are you saying getting into the partnership you get superior pricing?



A. Yes, you get what's called the institutional pricing.



... .



A. Second thing is when a partnership, because there are more assets an investor is able to achieve diversification.


Tr. 1151, 1153 (Bergmann).

On that same date, each Ervin LLC transferred its spread to Jade executing an "Assignment and Assumption Agreement." 47 JX 54-59.

Dr. DeRosa testified that it was "highly unusual" for the Ervin LLCs to purchase the spread options and later contribute them to Jade. Tr. 3385-86 (DeRosa). DeRosa testified that it was common practice in the business world for investors to invest cash in a fund or a partnership, but not a "pair of unusual options." Tr. 3386 (DeRosa). Specifically, Dr. DeRosa testified:


I don't understand what the advantage to them is. I assume when people do --you know, it's a complex transaction involving three LLCs, and then a partnership. I don't understand why they would buy them on their own and then contribute them to Jade, to a partnership. So I'm just a little bit mystified. If somebody wanted to trade, they would just keep trading in the LLCs. But I don't see any advantage to them of taking these options that they bought, the three LLCs have bought, and then going to the whole trouble of getting permission and all that, assigning them and then dumping them into the partnership.


Tr. 3410-11 (DeRosa).

Each Ervin LLC also contributed $75,000 cash to Jade. See JX 51-53. 48



Trading Activities While In Jade

Jade engaged in a number of foreign currency trades from October 6, 1999, when the Ervins entered Jade, until December 2, 1999, when the last Ervin LLC provided notice that it intended to withdraw from Jade. See JX 67. However, only the October 13, 1999 reverse knockout transaction was of any significance, and the majority of the trades executed by Jade during that two-month period were short-term trades and not profit generators. See JX 67, 68; PX 281 at 21; Tr. 1833 (Kolb); Tr. 3189-90 (DeRosa).

The reverse knockout option invested in by Jade had the following features:




Strike price: 1.0770

Barrier price: 1.1309

Expiration date: November 3, 2000

Number of euros: 62,140,483.00

Number of dollars: 66,925,300.19

Purchase Price: $103, 015




JX 68. The October 13, 1999 knockout option had a maximum payoff potential of $3,343,158, resulting in a best-case scenario profit potential of $3,240,143 after the option premium was paid. See DX 501 at 8; PX 281 at 17. The likelihood of hitting this maximum payoff, however, was very small. In fact, it was highly unlikely that the knockout would yield any net profit at all. DX 501. Dr. Kolbe explained that the knockout option transaction engaged in by Jade only "paid off if (1) the exchange rate did not reach $1.1309 per euro ..., and (2) the exchange rate was ... above the $1.077 per euro exercise price at option expiration." DX 505 at 16 (emphasis in original). Dr. Kolbe opined that the "odds of getting any positive payout" from the knockout option were "small." Id. (emphasis in original).



Movement of The Euro in October - November 1999

The euro began a sharp decline in value on October 18, 1999, and in late October 1999, Sentinel and Bergmann changed their positions on the euro. Tr. 575-77 (G. Ervin). In trader parlance, the euro failed. JX 111; Tr. 1203-04 (Bergmann). Through November, the euro continued to decline, nearing what is called "parity" by the end of the month. Parity is a currency trading term that refers to a 1:1 ratio between the euro and the U.S. dollar. Tr. 1211 (Bergmann). The euro had not previously dropped that low, and in the downward trend, the euro threatened to run below parity. Parity is a significant benchmark that threatened to trigger a "sell-off" of the euro, compounding its decline. Tr. 1210-11 (Bergmann).

After losing one-half of the initial investment, Gary Ervin lost faith in Sentinel, New Vista, and the euro. Tr. 555, 577 (G. Ervin). Gary testified that he decided that he and his brothers should cut their losses and salvage any available tax benefits. As Robert specifically recalls, Gary told him they needed to get out of Jade because "it's going south, ... and we need to get out." 408 (R. Ervin). Robert and Tim followed their brother's advice. Tr. 408 (R. Ervin); 577 (G. Ervin); 1410-11 (McElroy).



Exiting Jade: November 30, 1999

As of November 10, 1999, BDO Seidman was instructing members of the Tax Solutions Group, including DiMuzio, to ensure that "everyone who has entered into partnerships managed by Sentinel understands that they need to give notice soon if they want to withdraw this year." JX 517; Tr. 1524-27 (DiMuzio). By November 18, 1999, 43 days after the Ervins had entered Jade, DiMuzio was working with Gary Ervin and McElroy to calculate the amount of the Ervins' capital and ordinary losses. JX 57-59; DX 519; Tr. 693-94 (G. Ervin); Tr. 1529-30, 1570-71 (DiMuzio); Tr. 1410-11, 1416 (McElroy).

Each Ervin brother sent a nearly identical letter to Sentinel's Conjeevaram formally requesting withdrawal from Jade effective December 15, 1999, approximately 60 days after the Ervin LLCs purchased the three option spreads and transferred them to Jade. See JX 72-74. On November 30, Gary formally requested redemption, and on December 2, 1999, Robert and Tim Ervin formally requested redemption. 49

On December 17, 1999, Sentinel sent each Ervin brother a letter stating that the Ervins' withdrawal proceeds would be sent to them in a combination of "currency and equity securities." See JX 78-80. On December 21, 1999, Sentinel sent each Ervin brother a letter valuing his interest in the partnership at approximately $126,122. JX 81-83. The letter also indicated that, in redemption of each brother's interest, Sentinel had sent each brother a combination of euros and Xerox stock with a total market value of approximately $126,122. See JX 81-83; see also DX 503 at 13.

The Ervin brothers sold a substantial portion of the Xerox stock before December 31, 1999. Tr. 696 (G. Ervin).



Curtis Mallet Opinion Letters to the Ervins: July 7, 2000

Prior to July 7, 2000, Bricker sent the Ervins a draft opinion letter asking them to confirm the factual representations in the letter. Tr. 953 (Bricker). After discussing this draft opinion letter with Davis, McElroy, and Mountjoy, the Ervins did not suggest any changes, and Bricker assumed the facts were correct. Tr. 588-90, 706 (G. Ervin); Tr. 954-55 (Bricker).

On July 7, 2000, Curtis Mallet issued identical opinion letters to each Ervin brother regarding the substantive tax treatment of the Spread Transaction, accompanied by three identical 124-page memoranda of law. See JX 89, 90. 50 The Curtis Mallet opinion letters stated that the Ervins decided to invest in Jade after determining that their "profit potential from [their] investment in the Partnership was in excess of all fees, transaction costs and expenses associated with or attributable to such investments in the Partnership (including any advisory fees under the [New Vista] Consulting Agreement which may be attributable to the investment in the Partnership)." See JX 89 at 7. The opinion stated:


Your trading strategy in establishing the European Call Options was to earn a profit on the expected appreciation of the Euro via-a-vis the U.S. dollar while limiting your economic risk to your actual investment. To this end, your currency positions were heavily leveraged (which was intended to increase the potential return on investment). You reasonably anticipated that the European Call Options would provide the opportunity to earn a profit in the range of 50% to 100% of the actual investment, which returns would be in excess of all fees and costs incurred by you in connection with the European Call Options.


JX 89 at 3.

In addressing the profit potential of the Ervins' transactions in the opinion letters, Bricker stated that he considered: (1) the AIG account opening fees and other "related fees" AIG may have charged; (2) the Sentinel two-percent management and 20-percent performance fees; and (3) the legal fees for the opinion letters. Tr. 934-35 (Bricker). Bricker did not consider all of the New Vista fees in evaluating profit potential, and he could not say what portion of the fees, if any, he did consider. 51 Tr. 935-38; 940 (Bricker). The tax benefits offered by the spread transaction were available only if the spread was purchased outside the partnership and then contributed to it. See JX 23; JX 90 at 2-5; Tr. 851-52 (Pfeiffer).

Bricker concluded in the opinion letters that it was more likely than not that no penalties would apply due to the Ervins' reporting losses relating to the "currency option program," stating:


1. You did not recognize gain on the transfer of the Purchased Call Option by the [Ervin Family] LLC to [Jade] and you did not recognize any loss on the assumption of the Sold Call Option by [Jade];



2. Your basis for the [Jade] Partnership interest that the [Ervin Family] LLC acquired in the Partnership exchange for the transfer of the Purchased Call Option equaled the basis in the Purchased Call Option transferred by the [Ervin Family] LLC to the Partnership ($15,000,020.00) plus the amount of cash contributed to the Partnership, reduced by the amount of liabilities assumed by the Partnership, and that a Sold Call Option would not be considered a liability for purposes of Section 752;



3. All income or loss recognized by you, the [Ervin Family] LLC or the Partnership on foreign currency contracts was ordinary income or loss (as opposed to capital gain or loss);



4. Your distributive share of any loss incurred by the Partnership was deductible, and should not have been subject to the passive activity loss rules;



5. Upon the [Ervin Family] LLC's withdrawal from the Partnership, you did not recognize gain or loss on the receipt of foreign currency and publicly traded stock that the Partnership transferred to the [Ervin Family] LLC in exchange (redemption) of its Partnership interest. It is more likely than not that your combined interest in the foreign currency and publicly traded stock received in liquidation of the [Ervin Family] LLC's Partnership interest equaled your basis in such Partnership interest. It is more likely than not that any income or loss that you recognized on the sale of such foreign currency was treated as ordinary gain or loss. It is more likely than not that any income or loss that you recognized on the sale of such publicly traded stock was treated as capital gain or loss;



6. The case law doctrines known as the Step Transaction Doctrine and the Sham Transaction Doctrine that the Internal Revenue Service (the "IRS") and courts have used to deny certain tax outcomes did not apply to the transactions; and



7. The Anti-Abuse Regulations under Treas. Reg. §1.701-2 did not apply to the transaction.


JX 89 at 11-13, see JX 91; see also Tr. 943-44 (Bricker).

The Curtis Mallet opinion extensively reviewed case law on the economic substance doctrine and concluded:


You engaged in these transactions with the expectation that fluctuations in the market value of the foreign currencies would provide you with the opportunity to earn a reasonable profit. Based on this profit motive, it is more likely than not that your transactions described above will not be treated as sham transactions.



... .



... [Y]ou determined that the investments in foreign currencies, including the European Call Options, had a reasonable possibility of returning significant profits (independent of any tax benefits) to you in excess of all fees and costs incurred by you in connection with each respective investment, including the investment in the Partnership, even if fees related to the investments (including the fees under the Consulting Agreement even if such fees are attributable to your Partnership interest) were taken into account. Accordingly, it is more likely than not that the transactions had "economic substance ... .



... .



You determined that its investments in foreign currency, foreign currency options, and the Partnership had a reasonable possibility for profit after expenses and fees ... Therefore, it is more likely than not that the transactions had a subjective business purpose. Because your transactions had objective economic substance and you had a non-tax business purpose in entering the transactions, it is more likely than not that the transactions would not be recharacterized ... .


JX 90 at 87, 91-92.



The Experts' Views on the Profitability of the Spread Transaction

The experts for Plaintiffs and the Government agreed that the profit potential of the Spread Transaction was limited. Plaintiffs' expert in trading foreign exchange options, Mr. Shoji, testified that the Ervins could have profited from the spread transaction on any appreciation of the euro above 1.0840, but only up to a rate of 1.0850 --the Ervins would not have profited from any increases above 1.0850. Tr. 2462-63, 2473, 2534-39; (Shoji); PX 283 at 7. 52 Mr. Shoji explained that the maximum net profit potential of the Spread Transaction under all circumstances was $140,538, and the maximum loss was the net premium amount, $150,002 --if the euro did not rise above 1.0840. Tr. 2534-39 (Shoji); PX 283 at 7.

Similarly, Defendant's expert in economics and finance and foreign exchange options Dr. DeRosa, calculated that the maximum profit from the spread would have been $140,538 if the euro was trading at 1.0850 at the option's expiration date. DX 501; Tr. 3058 (DeRosa). 53 This profit figure does not take into account the fees paid by each Ervin LLC. Dr. DeRosa concluded that when including the fees paid by each Ervin LLC, it was unlikely that the Ervins would have made any profit at all. DX 501. Specifically, Dr. DeRosa testified: "The money that these people [the Ervins] have invested in this, the fees they've paid, dwarf any of these trading profits, these phantom trading profits that they never tried to do anyway." Tr. 3252 (DeRosa).

Dr. Kolbe, Defendant's expert in the areas of financial economics, risk return, valuation, investment and leverage, and capital market principles, opined that the expected rate of return of the Spread Transaction executed by each Ervin LLC was "a negative $929,000," or a "negative 80.2 percent rate of return" based on total outlays. Tr. 2319 (Kolbe). 54

Dr. Kolbe concluded that each Ervin LLC's total cost to execute the Jade Spread Transaction was approximately $1.17 million counting the cost of the spread option and the $75,000 contributed to Jade and $940,000 in required fees. DX 505 at 3 (Kolbe). He explained:


To break even on these outlays absent the claimed tax deduction, [each Ervin LLC] needed a rate of return on their Jade contributions ... of ... 420 percent ... . It is wholly unrealistic to expect such a rate of return on the contribution to Jade.


Id. 55



Jade's Partnership Return

Jade filed its 1999 Form 1065 Partnership Income Return on March 23, 2000. See JX 84. Jade's partnership return for tax year 1999 was prepared by Untracht & Associates (Untracht), Sentinel's accounting firm. JX 84; Tr. 2632 (Conjeevaram). The return was signed by Untracht & Associates. JX 84 at 000009. The return treated the Ervin LLCs as partners in Jade and reflected that each Ervin brother contributed capital of approximately $236,918, received assets worth approximately $132,760 in redemption, and lost approximately $104,158 in their participation in Jade. See JX 84 at 000028 (Ervin Holdings, LLC ); JX 84 at 000032 (Ervin Investments, LLC); JX 84 at 000040 (Ervin Capital, LLC).



The Ervins' Individual Returns

Although McElroy prepared the Ervins' individual and business tax returns every year from the mid to late 1980s forward, BDO Seidman prepared their 1999 and 2000 individual returns. Tr. 1436-37 (McElroy). Gary Ervin testified that he wanted the reputation of BDO to "stand behind the advice that they had given" with respect to tax planning for the spread transaction. Tr. 738 (G. Ervin). When Dimuzio was asked why he prepared and signed the 1999 returns, he responded:


Initially we talked about the complexity of the transactions that they had undertaken in 1999, the sale of the business, the collaring of the stock, all of the rest of it, and whether or not Martin McElroy may have been overwhelmed and whether or not they wanted BDO Seidman ... a larger organization, a national organization, to take over the preparation of the return. That was the basis of the discussion. It turned out ultimately that Martin [McElroy] really carried the laboring oar there ultimately.


Tr. 1565-66 (DiMuzio). DiMuzio's testimony on this is inconsistent with McElroy's. McElroy testified that his role with respect to the Ervins' 1999 tax returns was limited to gathering the necessary information and providing it to DiMuzio so that he could prepare the returns. Tr. 1413-15 (McElroy). 56

The Ervins filed their individual 1999 tax returns on August 15, 2000. Tr. 1436 (McElroy); see JX 96-98. Schedule D of Gary Ervin's 1999 Form 1040 reflects a short-term capital loss of $10,447,107 described as "Salomon Smith Barney" with an acquired date of "VARIOUS," a sold date of December 23, 1999, a price of $90,043, and a cost of $10,537,150. JX 96 at 147. 57 Schedule D of Robert Ervin's 1999 Form 1040 reflects a short term capital loss $10,447,107 described as "[Salomon] Smith Barney" with an acquired date of September 29, 1999, a sold date of December 29, 1999, a price of $90,043, and a cost of $10,537,150. JX 97 at 114. Schedule D of Tim Ervin's 1999 Form 1040 reflects a short term capital loss of $10,447,107 described as "S[a]lomon Smith Barney" with an acquired date of "VARIOUS," a sold date of December 23, 1999, a price of $90,043, and a cost of $10,537,150. JX 98 at 115. Gary and Robert Ervin listed a long-term capital gain on their 1999 Form 1040s of $8,727,759 under the description of "Ervin Cable Const Inc. (KY)." Tim Ervin listed a long-term capital gain of $8,727,760 under the same description. JX 96 at 149; JX 97 at 115; JX 98 at 117. Form 4797 of Gary's, Robert's, and Tim's 1999 Form 1040 reflect ordinary losses of $776,746 for "foreign currency trades." JX 96 at 155, JX 97 at 86, JX 98 at 85. Schedule D of Gary's, Robert's, and Tim's 2000 Form 1040 reflects a long-term capital loss described as "Salomon Smith Barney" of $3,717,779, $3,717,779, and $3,717,778, respectively. PX 260 at 77, 259 at 203, 261 at 62. 58 In total, each Ervin brother claimed approximately $14,941,632 in losses and expenses from the execution of the spread transaction and involvement in Jade.



IRS Notice 2000-44

IRS Notice 2000-44 was issued on August 11, 2000, and published in the Internal Revenue Bulletin on September 5, 2000. JX 95; Notice 2000-44, 2000-36 I.R.B. 255. The Notice warned taxpayers of transactions calling for the simultaneous purchase and sale of offsetting options which were then transferred to a partnership. Under the position advanced by the promoters of the arrangement, once the partnership held the offsetting options the taxpayer claimed that the basis in his partnership interest increased by the cost of the purchased option, but was not reduced under section 752 by the partnership's assumption of the sold option. The Notice determined that the purported losses from such offsetting option transactions did not represent bona fide losses reflecting actual economic consequences, and that the purported losses were not allowable for federal tax purposes. The Notice also warned taxpayers that penalties might be imposed on the participants and promoters of such transactions, including accuracy-related penalties under section 6662.

Notice 2000-44 was issued several days prior to August 14 and 15, 2000, the dates the Ervins and their spouses signed and filed their 1999 federal tax returns. Stip. ¶ 56; see JX 96-98. DiMuzio called McElroy several weeks after the Ervins filed their tax returns and informed him of the Notice. Tr. 1428 (McElroy). On August 16, 2000, Curtis Mallet issued a memorandum to clients potentially engaged in activities covered by the Notice summarizing the Notice and stating that the firm was analyzing its ramifications. JX 99. Once made aware of Notice 2000-44, Gary Ervin spoke with McElroy, Mountjoy, Davis, and BDO Seidman regarding its ramifications. Tr. 593-94 (G. Ervin). Gary also re-engaged Curtis Mallet and requested that counsel review their previous opinion letters of July 2000. Tr. 593 (G. Ervin); see JX 89-91. Curtis Mallet provided a supplemental memorandum dated October 11, 2000, addressing Notice 2000-44, stating that the Ervins' spread transaction investments were "possibly" distinguishable from Notice 2000-44 and that it was more likely than not the Notice did not change the substantive law regarding the Ervins' spread transaction or impact conclusions set forth in Curtis Mallet's previous opinion letters. JX 102-104. McElroy and Mountjoy concurred with the conclusions in Curtis Mallet's supplemental memorandum. Tr. 594-95 (G. Ervin). As a result, the Ervins did not amend their 1999 tax returns in light of the Notice.

Tr. 710-11 (G. Ervin).



The Audit

In June 2002, the IRS initiated an audit of the Ervins' 1999 individual returns. Tr. 1934-35 (Hogue). On December 16, 2002, the IRS initiated a partnership-level audit of Jade's 1999 return. Tr. 1935 (Hogue); JX 105-108. Revenue Agent Jim Hogue handled both audits. Tr. 1934 (Hogue). As part of the audit, Hogue interviewed the Ervins on April 9, 2003, at the IRS office in Owensboro, Kentucky. Tr. 3001-02 (Hogue). The Ervins, their representatives, and Revenue Agent Janice Ambrose of the IRS's Owensboro office attended the interview. Tr. 3001-02 (Hogue).



The FPAA

On April 15, 2003, the IRS issued a Final Partnership Administrative Adjustment (FPAA) to Jade Trading with respect to Jade's partnership items for the 1999 tax year. JX 109; Stip. ¶62. The FPAA disallowed the deductions claimed for losses purportedly incurred from the spread transaction. Specifically, the FPAA made the following determinations regarding Jade:


1. It is determined that Jade Trading, LLC, is a sham and, under [Treasury Regulation] §1.701-2, was formed or availed of in connection with a transaction or transactions in taxable year 1999, a principal purpose of which was to reduce substantially the present value of the partners' aggregate federal tax liability in a manner that is inconsistent with the intent of Subchapter K of the Internal Revenue Code. It is consequently determined that the partnership is disregarded and that all transactions engaged by Jade Trading, LLC, are treated as engaged in directly by the purported partners. This includes the determination that the euros and Xerox stock purportedly acquired by the partnership were acquired directly by purported partners Ervin Holdings, LLC, Ervin Capital, LLC, and Ervin Investments, LLC.



2. It is determined that, under §1.701-2 of the Treasury Regulations, euro currency options, purportedly contributed to or assumed by the partnership, are treated as never having been contributed to or assumed by the partnership and any gains or losses purportedly realized by the partnership on the options are treated as having been realized by the purported partners Ervin Holdings, LLC, Ervin Capital, LLC, and Ervin Investments, LLC.



3. It is further determined that, under §1.701-2 of the Treasury Regulations, Ervin Holdings, LLC, Ervin Capital, LLC, and Ervin Investments, LLC, should be treated as not being partners in the partnership.



4. It is further determined that, under §1.701-2 of the Treasury Regulations, contributions to the partnership will be adjusted to reflect clearly the partnership's or partners' income.



5. Even if euro currency options were to be treated as contributed to the partnership, the bases of the options are reduced, both in the hands of the contributing partners and the partnership, by any amount received by the contributing partner from the contemporaneous sale of a substantially similar option to the same counter-party. Thus, any amount treated as an increase in outside basis from the contribution of euro currency options is disallowed.


JX 109.



Discussion



Jurisdiction

This Court has "jurisdiction to hear and to render judgment upon any petition under section 6226 ... of the Internal Revenue Code ... ." 28 U.S.C. §1508. Section 6226(f) gives this Court


jurisdiction to determine all partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates, the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item.


26 U.S.C. §6226(f). 59

Invoking section 6226, Plaintiffs bring this partnership tax refund action seeking judicial review of the FPAA issued to Jade which adjusted partnership items relating to the spread transaction. JX 109. 60 The Court's jurisdiction over partnership items is explained by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), which added sections 6221- 6231 to the Internal Revenue Code. 61

TEFRA was enacted "to provide a method of uniformly adjusting items of partnership income, loss, deduction, or credit that affect each partner." Roberts v. Comm'r [ CCH Dec. 46,638(M)], 94 T.C. 853, 859 (1990). Prior to TEFRA's passage, tax liability adjustments of individual partners based on the operations of the partnership were rendered at the partner-level, often resulting in duplication of administrative and judicial resources and inconsistent results among audited partners. Callaway v. Comm'r [ 2000-2 USTC ¶50,744], 231 F.3d 106, 107 (2d Cir. 2000).

With the enactment of TEFRA came a "single unified procedure for determining the tax treatment of all partnership items at the partnership-level, rather than separately at the partnerlevel." AD Global Fund, LLC v. United States, 67 Fed.Cl. 657, 660 (2005), aff'd [ 2007-1 USTC ¶50,312], 481 F.3d 1351 (Fed. Cir. 2007) (quoting Callaway [ 2000-2 USTC ¶50,744], 231 F.3d at 108). TEFRA's process allows for one proceeding to determine all "partnership items," and the result of this proceeding then applies to each individual partner's tax returns. AD Global, 67 Fed.Cl. at 660; Roberts [ CCH Dec. 46,638(M)], 94 T.C. at 859-60. 62

A "partnership item" is defined by statute as "any item required to be taken into account for the partnership's taxable year under any provision of subtitle A to the extent ... such item is more appropriately determined at the partnership-level than at the partner-level." Section 6231(a)(3). More commonly, partnership items are "items of income[,] gain, loss, deduction, or credit of the partnership." AD Global, 67 Fed.Cl. at 661 n.2 (quoting Callaway [ 2000-2 USTC ¶50,744], 231 F.3d at 108). In essence, partnership items are those items a partnership is required to determine for purposes of its books and records or for purposes of furnishing information to a partner.

Further guidance on what constitutes a partnership item can be gleaned from Treasury Regulation §301.6231(a)(3)-1(a), which defines the following items as partnership items:


(1) The partnership aggregate and each partner's share of each of the following:



(i) Items of income, gain, loss, deduction, or credit of the partnership;



... .



(v) Partnership liabilities (including determinations with respect to the amount of the liabilities, whether the liabilities are nonrecourse, and changes from the preceding taxable year) ...



... .



(4) Items relating to the following transactions, to the extent that a determination of such items can be made from determinations that the partnership is required to make with respect to an amount, the character of an amount, or the percentage interest of a partner in the partnership, for purposes of the partnership books and records or for purposes of furnishing information to a partner:



(i) Contributions to the partnership;



(ii) Distributions from the partnership ...


Treas. Reg. §301.6231(a)(3)-1(a). The regulation further provides that the term partnership item includes "the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc." Treas. Reg. §301.6231(a)(3)-1(b).

The regulation goes on to state that with respect to contributions, the partnership needs to determine "[t]he character of the amount received from a partner" and "[t]he basis to the partnership of contributed property (including necessary preliminary determinations, such as the partners' basis in the contributed property)." Treas. Reg. §301.6231(a)(3)-1(c)(2). Similarly, with respect to distributions, the regulation specifies that the partnership needs to determine "the adjusted basis to the partnership of distributed property" and "the character of partnership property." Treas. Reg. §301.6231(a)3-1(c)(3).

In Nussdorf v. Commissioner, 129 T.C. 30, 44 (2007), an action also involving the contribution of offsetting options to a purported partnership, the Tax Court held that the character of the property the partnership received from each member "such as whether any such property received from each member was a contribution ... and whether any such property should be aggregated with other property received from each such member, and the basis to [the partnership] of any property contributed to it by each member, including necessary preliminary determinations, such as the basis of each such member in such property" were partnership items. The Tax Court reasoned that the partnership there, Evergreen Trading, was required to make determinations regarding these matters for purposes of its books or records or furnishing information to partners. Id. at 43. The Nussdorf Court further recognized that whether the property received from each member was a contribution or a liability --was also a partnership item. Id. at 44 n.16. The Tax Court stated:


determining whether any property that Evergreen Trading received from each member was a contribution or a liability, Evergreen Trading was required to determine whether the so-called obligation leg ( i.e., the short position) of the Euro options in question was a liability that Evergreen assumed.


Id. Similarly here, because Jade had to make the underlying determinations regarding the Ervin LLCs' contributions to Jade and the distributions to them for purposes of its books and records and furnishing information to its partners, these are partnership items.

In sum, the matters addressed in the FPAA here are partnership items and must be determined at the partnership-level. As such, this Court's jurisdiction extends to determining the tax treatment of those items. 26 U.S.C. §§6221, 6226; see AD Global, 481 F.3d at 1354-1355; Conway v. United States [ 2003-1 USTC ¶50,412], 326 F.3d 1268, 1271 (Fed. Cir. 2003); Transpac Drilling Venture v. United States [ 96-1 USTC ¶50,271], 83 F.3d 1410, 1412 (Fed. Cir. 1996); Santa Monica Pictures, L.L.C. v. Comm'r [ CCH Dec. 56,016(M)], 89 T.C.M. (CCH) 1157, 1224 (2005); Long Term Capital Holdings v. United States [ 2004-2 USTC ¶50,351], 330 F.Supp.2d 122, 166 (D. Conn. 2004), aff'd [ 2005-2 USTC ¶50,575], 150 Fed.Appx. 40 (2d Cir. 2005).



Standard of Review

This Court makes a de novo determination regarding the partnership items of Jade that were adjusted by the FPAA. Atlantic Richfield Co. v. Dept. of the Treasury [ 97-1 USTC ¶50,170], No. 96-2867 1996 U.S. Dist. LEXIS 19891 at 3 (D. D.C. 1996) ("A court hearing plaintiff's [FPAA] readjustment petition would have jurisdiction to determine de novo [a partnership's] taxable income, deductions, and credits ...").



Although the Spread Transactions Contributed to Jade Literally Complied With the Code They Lacked Economic Substance



Literal Compliance With the Code

In 1999, the Ervins realized a gain of approximately $40 million on the sale of their cable companies --approximately $13.5 million per brother. After consulting with BDO Seidman, Sentinel, and Curtis Mallet and their personal attorneys and accountant, Plaintiffs simultaneously bought and sold offsetting pairs of euro options, creating a spread position. The premium paid by each Ervin LLC on the options purchased from AIG was $15,000,020 and on the options sold to AIG was $14,850,018. These premium amounts were netted, and each Ervin LLC actually paid AIG $150,002 --not $15,000,020. Each LLC then transferred the option spread to Jade and contributed $75,000 cash to the partnership. Some 60 days after entering Jade, the LLCs exited the partnership and received euros and Xerox stock in exchange for their partnership interests.

Plaintiffs claim that their bases in their Jade partnership interests increased by the value of the purchased option but did not decrease by the value of the sold option assumed by the partnership. 63 Section 722 addresses partnership basis, stating:


The basis of an interest in a partnership acquired by a contribution of property, including money, to the partnership shall be the amount of such money and the adjusted basis of such property to the contributing partner at the time of the contribution ... .


At issue here is whether each Ervin LLC was required to reduce its basis in its partnership interest by the sold option assumed by Jade, or whether this type of "liability" was too uncertain to fit within the parameters of a "liability" within the meaning of section 752. The statute itself does not define liability or address this issue in haec verba. Section 752(b) states:


Any decrease in a partner's share of the liabilities of a partnership, or any decrease in a partner's individual liabilities by reason of the assumption by the partnership of such individual liabilities, shall be considered as a distribution of money to the partner by the partnership.


Plaintiffs argue that the sold options assumed by Jade were contingent obligations, not liabilities for purposes of lowering the basis in the Ervin LLCs' partnership interests under section 752(b). In so arguing, Plaintiffs seize upon the construction of section 752 by the Tax Court in Helmer v. Commissioner [ CCH Dec. 33,225(M)], 34 T.C.M. (CCH) 727 (1975), which at the time of their transactions was good law. 64

In Helmer, the Tax Court held that a contingent obligation such as an option was not a liability under section 752 because a partnership's obligation under the option does not become fixed until the option is exercised. Helmer's reasoning that contingent obligations are not liabilities was applied in subsequent cases. Salina P'ship L.P. v. Comm'r [ CCH Dec. 54,122(M)], 80 T.C.M. (CCH) 686, 697 (2000). (recognizing Helmer stands for the general proposition that amounts owed or paid to a partnership in an open transaction for tax purposes do not generate adjustments to the partners' bases in their partnership interests until the transaction is closed and the tax characteristics of the transaction can be determined.); see also LaRue v. Comm'r [ CCH Dec. 44,652(M)], 90 T.C. 465, 479-80 (1988) (non-fixed obligations of a partnership could not be used to adjust the partners' bases under section 752); Long v. Comm'r [ CCH Dec. 35,449(M)], 71 T.C. 1 (1978) (stating that contested or contingent liabilities such as claims were not liabilities within the meaning of section 752); see generally CEMCO Investors, LLC v. United States [ 2007-1 USTC ¶50,385], No. 04-8211 2007 U.S. Dist. LEXIS 22246 (N.D. Ill. Mar. 27, 2007), appeal docketed, No. 07-2220 (7th Cir. May 25, 2007) (recognizing that Helmer was good law prior to Notice 2000-44, permitting a taxpayer to ignore a short option as a liability under section 752). 65

Thus, under Helmer and its progeny, the sold call option contributed to Jade would not be considered a liability for purposes of section 752 and the inflated bases resulting from the Ervin LLCs' contribution of the spread transaction to Jade complied with section 752.

Nonetheless, under Coltec, such compliance with the Code is insufficient in and of itself for Jade to reap the tax benefits claimed here. Coltec [ 2006-2 USTC ¶50,389], 454 F.3d at 1355. Rather, the transaction must also meet the objective economic substance test.



The Economic Substance Doctrine In the Federal Circuit

The Federal Circuit in Coltec put to rest any question about the continued vitality of the economic substance doctrine. The Coltec Court disregarded a transaction for tax purposes despite its literal compliance with the Code on the ground it lacked economic substance. The Federal Circuit described the economic substance doctrine as "a judicial effort to enforce the statutory purpose of the tax code" stating:


From its inception, the economic substance doctrine has been used to prevent taxpayers from subverting the legislative purpose of the tax code by engaging in transactions that are fictitious or lack economic reality simply to reap a tax benefit.


Coltec [ 2006-2 USTC ¶50,389], 454 F.3d at 1353-54. 66 Transactions are considered to have economic substance when "imbued with tax-independent considerations, and ... not shaped solely by tax-avoidance features ... ." Frank Lyon Co. v. United States [ 78-1 USTC ¶9370], 435 U.S. 561, 584 (1978).

In unequivocally confirming the viability of the economic substance doctrine, the Federal Circuit articulated five general principles espoused by the doctrine:


Ÿ First, the law does not permit the taxpayer to reap tax benefits from a transaction that lacks economic reality.



Ÿ Second, it is the taxpayer who bears the burden of proving that the transaction has economic substance.



Ÿ Third, the economic substance of a transaction must be viewed objectively.



Ÿ Fourth, the only transaction to be analyzed is the one that gave rise to the alleged tax benefit.



Ÿ Finally, arrangements with subsidiaries that do not affect the economic interests of independent third parties deserve particularly close scrutiny.


Coltec [ 2006-2 USTC ¶50,389], 454 F.3d at 1355-57. This Court applies each of these principles in turn.



1. Did the Spread Transaction Lack Economic Reality?

As articulated by the Federal Circuit, the economic substance doctrine subsumes an overarching principle --although a taxpayer has an unquestioned right to decrease or avoid his taxes by means which the law permits, the law does not permit a taxpayer to reap tax benefits from a transaction that lacks economic reality. The Ervins' spread transaction clearly fits within the scope of this prohibition.

Although the Ervins purchased a euro option from AIG for a premium of $15,000,020 and sold a euro option to AIG for a premium of $14,850,018, they only paid AIG the difference --a net premium of $150,002. They contributed the spread to Jade, and upon exiting the partnership, claimed a basis of over $15 million in their Jade interests by including only the premium for the purchased call option, and ignoring the premium for the sold call option, viewing it as a contingent obligation, not a liability. The artificially high basis generated a $14.9 million tax loss, but the loss was purely fictional. Each Ervin LLC did not invest $15 million in the spread transaction contributed to Jade and did not lose almost $15 million upon exiting Jade without exercising either option. As the District Court for the Northern District of Illinois recognized in characterizing a similar transaction in CEMCO, "it is important to highlight one point upon which [the parties] agree: the loss of $3,563,211.71 claimed on CEMCO's ... return was fictional." CEMCO [ 2007-1 USTC ¶50,385], 2007 U.S. Dist. LEXIS 22246 at 9.

Further, the formation of the Jade partnership as the vehicle through which to make investments had no real economic purpose. Funneling the trades through the partnership did nothing to enhance the investment potential of the spread transaction or the other trades Jade did, but it was crucial for tax purposes to have the individual partners contribute the spreads to Jade and redeem the unexercised spreads from Jade in order to generate the inflated bases. Absent the partnership, the spreads would have had no meaningful economic consequences --other than the cost of playing. As Dr. DeRosa recognized, there was no economic reason for the Ervin LLCs of going to the trouble of structuring these transactions as they did. He testified: "If somebody wanted to trade they would just keep trading in the LLCs. But I don't see any advantage to them of taking these options that they bought ... and then going to the whole trouble of getting permission and all that, assigning them and then dumping them into the partnership." Tr. 3410-11 (DeRosa).



2. The Taxpayer Has the Burden to Prove Economic Substance

The Coltec Court held that the taxpayer has the burden of proving that a transaction has economic substance, dispelling any notion that the Government is required to demonstrate a transaction's lack of economic substance. Coltec [ 2006-2 USTC ¶50,389], 454 F.3d at 1355. 67 In explaining the nature of this burden, the Federal Circuit harked backed to Rothschild v. United States [ 69-1 USTC ¶9224], 407 F.2d 404 (Ct.Cl. 1969), a decision of its predecessor, the Court of Claims, and quoted that decision's fundamental recognition:


Gregory v. Helvering requires that a taxpayer carry an unusually heavy burden when he attempts to demonstrate that Congress intended to give favorable tax treatment to the kind of transaction that would never occur absent the motive of tax avoidance (citation omitted).


[ 69-1 USTC ¶9224], 407 F.2d at 411. 68

Plaintiffs have attempted to shift this burden to Defendant to prove that their transaction lacked economic substance under section 7491. Pls.' Post-Trial Br. at 7-8; Pls.' Reply to Def.'s Post-Trial Br. at 27. Under section 7491, the burden of proof will shift to the Government with respect to any factual issue relevant to ascertaining the liability of the taxpayer if: (1) the taxpayer introduces credible evidence with respect to such issue; (2) the taxpayer has complied with all applicable substantiation requirements; (3) the taxpayer has maintained all records otherwise required by the Internal Revenue Code; (4) the taxpayer has cooperated with reasonable requests by the Service for meetings, interviews, witnesses, information and documents; and (5) the taxpayer, if not an individual, satisfies the net worth requirements described in section 7430(c)(4)(A)(ii). Section 7491(a)(1)-(2). The taxpayer has the burden of establishing that the requirements of section 7491 have been met. Long Term Capital Holdings [ 2004-2 USTC ¶50,351], 330 F.Supp.2d at 166.

Plaintiffs seek to shift the burden of proof to the Government with respect to four issues:


1. Whether Jade was formed and operated as a partnership entity;



2. Whether the investors contributed and assigned separately purchased and sold call options and cash to Jade;



3. Whether the partners' transfer of such options to Jade had economic substance; and



4. Whether Jade and its partners had the potential to earn pre-tax profits.


Pls.' Post-Trial Br. at 12-19; Pls.' Reply to Def.'s Post-Trial Br. at 25-28.

Because these are legal, not factual issues, the Court does not shift the burden of proof. First, whether Jade Trading was formed and operated as a partnership entity is an ultimate legal issue. Second, whether the offsetting options contributed to Jade by its members were, for federal tax purposes, separately purchased and sold call options, or are a single position also implicates a question of law. What transpired as a matter of fact with regard to the purchase and sale of offsetting options is not disputed --it is the legal import of those transactions --their characterization and treatment for tax purposes which is at issue --a legal question. See Frank Lyon [ 78-1 USTC ¶9370], 435 U.S. at 581 n.16 ("The general characterization of a transaction for tax purposes is a question of law... ."). Third, whether the partners' transfer of such options to Jade had economic substance is a component of the ultimate issue before the Court --it addresses one step in the challenged transaction. The fourth issue on which Plaintiffs seek to shift the burden does have some factual elements --the potential of Jade and its partners to earn pre-tax profits. However, that issue is no longer a relevant inquiry in light of Coltec. It matters not whether Jade and its partners had the potential to earn pre-tax profits in all of their endeavors. What matters is whether the single transaction which gave rise to the tax benefits --here the spread transaction contributed to Jade --had the ability to earn pre-tax profits. Coltec [ 2006-2 USTC ¶50,389], 454 F.3d at 1356 (stating "the transaction to be analyzed is the one that gave rise to the alleged tax benefit."). In sum, the burden of proof clearly remains on Plaintiffs to establish the economic substance of the spread transaction contributed to Jade.



3. The Economic Substance of a Transaction Must Be Viewed Objectively Rather Than Subjectively

The Federal Circuit has clarified that in applying the economic substance doctrine, the "objective economic reality of the transaction" is paramount. The Court explained:


The Supreme Court cases and our predecessor court's cases have repeatedly looked to the objective economic reality of the transaction in applying the economic substance doctrine. Gregory, 293 U.S. at 469-70, 55 S.Ct. 266; Frank Lyon Co. [ 78-1 USTC ¶9370], 435 U.S. at 584... . While the taxpayer's subjective motivation may be pertinent to the existence of a tax avoidance purpose, all courts have looked to the objective reality of the transaction is assessing its economic substance. See, e.g., Black & Decker [ 2006-1 USTC ¶50,142], 436 F.3d at 441-42 (noting that economic substance inquiry requires an "objective determination of whether a reasonable possibility of profit from the transaction existed") ...; Dow Chem. Co., 435 F.3d at 599; In re CM Holdings, Inc., 301 F.3d at 103 (stating that the objective economic substance inquiry is "whether the transaction affected the taxpayer's financial position in any way"); United Parcel Serv. of Am., Inc., 254 F.3d at 1018; Rice's Toyota World, Inc. v. Comm'r of Internal Revenue [ 85-1 USTC ¶9123], 752 F.2d 89, 94 (4th Cir. 1985).


Coltec [ 2006-2 USTC ¶50,389], 454 F.3d at 1356 n.16 (citations omitted in part). Thus, a determination of the objective reality of contributing the spread transaction to Jade requires assessing the transaction itself --its reasonable possibility of profit and its effect on the Ervins' financial positions. The inquiry is not whether the Ervins believed the Jade transaction was a real investment capable of making a profit, but whether the Jade transaction in fact objectively was a real investment capable of making a profit and altering their financial positions. 69



4. The Only Transaction to Be Analyzed for Economic Substance Is the One That Gave Rise to the Tax Benefit

Plaintiffs characterize the Ervins' investment in Jade as a bet that the euro would rise. This is an inaccurate picture of what Jade did. While there was extensive testimony regarding the Ervins' decision to invest in the euro, including the persuasive sales pitch from Sentinel about the unique opportunity for investing in a newly offered foreign currency and "exotic options" like the reverse knockout options with potential returns of 38-to-1, this hype was a red herring since the investment in offsetting options was a hedge --the Ervins were protected and their gains and losses limited no matter how the euro performed. Under Coltec, the spread transaction which gave rise to the inflated basis and the large tax benefit is the only transaction to be scrutinized. As such, Plaintiffs' claims that they could have increased profitability by executing the reverse knockout option and other trades in Jade cannot be considered because these transactions did not give rise to the tax benefit. 70 Here, both the structure of the spread transaction and the unusually high fees required for participation ensured that no matter what the euro did, the spread transaction did not have a reasonable profit potential.

The objective economic substance test requires that a taxpayer prove that a transaction had a "realistic financial benefit" beyond tax avoidance. Coltec [ 2006-2 USTC ¶50,389], 454 F.3d at 1356 n.16 (quoting Rothschild [ 69-1 USTC ¶9224], 407 F.2d at 411); see also ACM P'ship v. Comm'r [ 98-2 USTC ¶50,790], 157 F.3d 231, 251 (3d Cir. 1998). More precisely, the economic substance inquiry requires an objective determination of whether a reasonable possibility of profit from the transaction existed, exclusive of tax benefits. Coltec [ 2006-2 USTC ¶50,389, 454 F.3d at 1356 (citing Black & Decker Corp. v. United States[ 2006-1 USTC ¶50,142], 436 F.3d 431, 441-442 (4th Cir. 2006)); see also Gilman v. Comm'r [ 91-1 USTC ¶50,245], 933 F.2d 143, 146 (2d Cir. 1991); Lerman v. Comm'r [ 91-2 USTC ¶50,480], 939 F.2d 44, 49 (3d Cir. 1991); Rice's Toyota World, Inc. v. Comm'r [ 85-1 USTC ¶9123], 752 F.2d 89, 91 (4th Cir. 1985); IES Indus. v. United States [ 2001-2 USTC ¶50,471], 253 F.3d 350, 353 (8th Cir. 2001).

Several courts have analyzed economic substance objectively by viewing an investment transaction through the eyes of a "prudent investor" at the time of the transaction --asking whether a prudent investor would engage in the transaction with a belief that profits could be earned. See Gilman [ 91-1 USTC ¶50,245], 933 F.2d at 146-47 (requiring the plaintiff to demonstrate that a prudent investor could have concluded that there was a realistic opportunity for a profit); Estate of Strober v. Comm'r [ CCH Dec. 48,295(M)], 63 T.C.M. (CCH) 3158, 3160 (1992) ("We conclude that ...a prudent investor, relying upon independently obtained appraisals and research, would not have concluded that [the] transaction offered a reasonable opportunity for economic gain exclusive of tax benefits."); Long Term Capital Holdings [ 2004-2 USTC ¶50,351], 330 F.Supp.2d at 172 (finding that the transaction lacked economic substance because, "at the time the transaction was entered into, a prudent investor would have concluded that there was no chance to earn a non-tax based profit return in excess of the costs of the transaction.").

Plaintiffs' and Defendant's experts, Mr. Shoji and Dr. DeRosa, agreed the maximum profit potential on the spread at expiration, on its face, was roughly $140,000, no matter how high the euro climbed. See JX 38-43; Tr. 2536-2539 (Shoji); Tr. 3129 (DeRosa); DX 501 at 27. Dr. DeRosa testified:


The only thing that can happen is you come up to the counter. You plop down $150,000. If you're lucky, you're going to win net $140,000. You're never going to get more than that. You could get less than that because if it's in between the strikes the payoff won't be the whole $140,000, but if it's at 1.0840 or less say goodbye to your $150,000. It's gone. It looks enormous, but net it's trivially small.


Tr. 3130-31 (DeRosa). Further, according to Mr. Shoji, based on how the spread transaction was structured, AIG would never have exercised the sold call option and the Ervins would never have owed any additional funds to AIG. Tr. 2538 (Shoji). The exercise of any option would have required "a delivery of euro 290,540,000, an underlying value or notional amount about 20 times larger than the value of the option itself." PX 281 at 18; Tr. 2538 (Shoji).

Moreover, the unusual fees paid by the Ervins which far exceeded the potential return on the investments, virtually ensured that the transaction could not be profitable. Each Ervin brother "invested" $225,002 in Jade --$150,002 as a payment for the spread, and an additional $75,000 in cash, but also paid the following fees in order to do the spread transaction:




Fee Amount

New Vista consulting fee $750,000

AIG account opening fee $84,100

Curtis Mallet fee $100,000

Total $934,100




JX 26, 37, 48-50, 85-87; Tr. 928 (Bricker); Tr. 1650-51 (Mountjoy). The New Vista fee covered amorphous investment advice and training, but it was unclear that the Ervins received any value for the New Vista fee. New Vista is largely owned by Sentinel --the tax matters and managing partner of Jade, and payment of the New Vista fee was a sine qua non of the deal. The AIG fee was highly unusual, only charged to Sentinel clients, and there was no cogent explanation as to why this fee was required. Finally, Curtis Mallet charged each brother $100,000 for an identical legal opinion and refused to discount its fee.

The $934,100 does not include fees paid for forming the Ervin LLCs, fees paid to Ervin advisors Martin McElroy and Jesse Mountjoy, Sentinel's two-percent management fee or its 20 percent incentive fee, or the five-percent penalty for early withdrawal from Jade. 71 In addition, the Ervins incurred unnecessary costs by structuring their investment in Jade as they did. They contributed options instead of cash to Jade, subjecting their investments to Sentinel's incentive fee of 20 percent, and took their distribution from Jade in Xerox stock and euros, incurring additional transaction costs to sell this stock. Tr. 2321-22 (Kolbe); See DX 505 at 19-20; DX 767 at 15. Moreover, just breaking even on this investment, that is, exiting Jade with the $225,002 invested and enough to cover the over $934,100 in fees, would have required at least an annualized 420 percent rate of return on that $225,002 investment. DX 505 at 3, 7; see Tr. 2302-03 (Kolbe); DX 767 at 7. 72

The fact that the Ervins had to spend over $934,000 to obtain an investment return of $140,000, establishes that no reasonable investor would engage in such a transaction to earn a profit. As Dr. Kolbe testified, the Ervins' investment "was not even equivalent to buying a lottery ticket or placing a wager in a casino. Absent the tax motivation, there was no economically rational reason to undertake these transactions, and no economically rational investor would have done so." DX 505 at 20. To quote the Court in Long Term Capital Holdings [ 2004-2 USTC ¶50,351], 330 F.Supp.2d at 172, "at the time the transaction was entered into, a prudent investor would have concluded that there was no chance to earn a non-tax based profit return in excess of the costs of the transaction."

In addition to its inherent lack of potential profitability, the spread transaction was developed as a tax avoidance mechanism and not an investment strategy. The transaction was devised and marketed by a tax accounting group, BDO Seidman's "Tax $ells" Division, a/k/a the Wolf Pack. Although BDO Seidman witnesses claim that Bergmann brought them the idea for the spread transaction, these witnesses acknowledged that BDO Seidman investigated the tax ramifications of the spread transaction, added the spread transaction to its Tax Product Sales Manual, prepared a marketing letter describing the tax benefits of the spread transaction, joined forces with Curtis Mallet and sold the spread transaction concept to clients as a tax product, while leaving the execution of the transactions to Sentinel.

Plaintiffs make much of the fact that Gary Ervin "rejected the Jenkens & Gilchrist proposal for want of an investment purpose." Pls.' Br. Regarding Application of Coltec at 7. However, according to DiMuzio, the Jenkens & Gilchrist proposal was remarkably similar to the spread transaction --it involved the contribution of foreign currency options to an S corporation in order to create a high-basis, low-value asset, the sale of which would result in a capital loss in excess of the amount contributed. Tr. 1506-07 (DiMuzio). The tax strategy which Gary Ervin rejected for wholly lacking an investment component based upon his reaction to Jenkins & Gilchrist was objectively no different from the deal the Ervins ultimately signed onto, after hearing Bergmann's telephonic promotion.

Plaintiffs further argue that the spread transaction had economic substance because the euro option purchased from AIG and the euro option sold to AIG represented two distinct legal entitlements which should not be recast as one. Pls.' Post-Trial Br. at 2, 6, 41. In Plaintiffs' view, the sold euro option should be deemed a contingent obligation, not a liability, which would not affect partnership basis and permit the basis in the purchased call option to be inflated, yielding a large tax loss. Pls.' Post-Trial Br. at 50-51. However, the economic realities of the spread transaction contributed to Jade made it impossible to delink the option pairs.

If the Ervin LLCs had wished to hold only the long position --that is, the option they purchased from AIG --they would have faced the prospect of theoretically unlimited gain. They would have benefitted from any rise of the euro above 1.084, not capped in any way. Tr. 2545-46 (Shoji). To obtain that position, the Ervin LLCs would have been required to pay AIG the full face amount of the premium, about $15 million each, to purchase the options. Tr. 2545-46 (Shoji); Tr. 3144 (DeRosa). Neither the Ervin LLCs nor Jade ever had sufficient funds to make such a payment. See PX 292, 293, 294. Moreover, under this scenario, the entire amount would have been at risk; had the euro not risen to 1.084, each Ervin LLC would have lost the entire $15 million premium it paid to AIG. Tr. 2545-46 (Shoji).

Had the Ervin LLCs wished to hold only the short option sold to AIG they would have faced the prospect of theoretically unlimited loss, as AIG would have benefitted in any rise of the euro above 1.085, not capped in any way. Tr. 2546 (Shoji). Because such a transaction would be uncovered, AIG would have had extensive credit concerns. Tr. 1702-03 (Reed); Tr. 2366-67 (Kolbe); DX 767 at 29-30; Tr. 3147 (DeRosa). The Ervin LLCs would not have received the premiums to which they would be theoretically entitled, because AIG would have retained those premium payments as margin because AIG would not have had the spread's protection from loss. Tr. 3303 (DeRosa); Tr. 3508 (Kolb). AIG would have required that the Ervins post margin in the amount of at least $8 million each. 73 In sum, under the agreement with AIG, the Ervins could not separate the components of the spread without AIG's permission which would not likely have been forthcoming without the required margin. See JX 31-33; see also DX 501 at 13-15; DX 767 at 29- 30; Tr. 3144-47 (DeRosa); Tr. 3504-06 (Kolb); Tr. 2367 (Kolbe).

Plaintiffs contend that longstanding precedent has rejected creative attempts by the IRS to collapse "roughly counterbalancing positions" such as vertical spread options, silver straddles, soybean straddles, mortgage swaps, sale/leasebacks, and other offsetting transactions. In so arguing Plaintiffs rely on six decisions in which courts refused to collapse such dual transactions, Cottage Savings Association v. Commissioner [ 91-1 USTC ¶50,187], 499 U.S. 554 (1991), Frank Lyon Co. v. United States [ 78-1 USTC ¶9370], 435 U.S. 561 (1978), Valley Waste Mills v. Page [ 40-2 USTC ¶9746], 115 F.2d 466 (5th Cir. 1940), Laureys v. Commissioner [ CCH Dec. 45,446(M)], 92 T.C. 101 (1989), Smith v. Commissioner [ CCH Dec. 38,835(M)], 78 T.C. 350 (1982), Maloney v. Commissioner [ Dec. CCH Dec. 21,618(M)], 25 T.C. 1219 (1956). However, these decisions are distinguishable from the instant case because the so-called counterbalancing positions were legally distinct and clearly not inextricably linked as are the options comprising the spread transaction here. 74 In contrast to the transactions in the Cottage Savings line of cases where transactions could not be collapsed because they were independent, the transactions here cannot be separated because they were totally dependent on one another from an economic and pragmatic standpoint. 75



5. Arrangements That Do Not Affect the Economic Interests of Independent Third Parties Deserve Particularly Close Scrutiny

In Coltec, the Federal Circuit directed that arrangements with subsidiaries that do not affect economic interests of independent third parties deserve particularly close scrutiny. Although Jade does not involve an inter-company transfer among affiliated entities, the Coltec Court's directive regarding independent third parties also pertains here. The Jade partners decided to contribute and redeem the spread transaction "for [their] own separate purposes" and not as genuine multi-party transactions. See Coltec [ 2006-2 USTC ¶50,389], 454 F.3d at 1357. As these transactions were structured, AIG had nothing to gain or lose beyond its fee. Further, in the context of analyzing whether the transaction affected third-party interests, the Coltec Court looked to whether the transaction was the "consummation of a preconceived plan" as in Gregory or a "foregone conclusion." Id. The spread transaction as depicted in BDO Seidman's marketing letter and Tax $ells Manual, Curtis Mallet's opinion letter, and the AIG procedures for executing Sentinel transactions, was a preordained plan. Just as in Gregory, the Ervins' transfer of the spread transaction to Jade and their exit from Jade some 60 days later lacked economic substance because this machination was "the consummation of a preconceived plan," not to earn profits speculating on a new currency, but to enter and exit the partnership, using one leg of the spread to generate grossly inflated basis. 293 U.S. at 469. In sum, under the economic substance doctrine as applied in the Federal Circuit, the Jade spread transaction lacked economic reality and must be disregarded.



Penalties Imposed by the FPAA

The FPAA issued to Jade imposed four penalties:


1. A 40-percent gross valuation misstatement penalty;



2. Alternatively, a 20-percent negligence penalty;



3. Alternatively, a 20-percent substantial understatement of income tax penalty;



4. Alternatively, a 20-percent "substantial understatement of income tax [penalty] because the transaction is a tax shelter, no substantial authority has been established for the position taken, and there was no reasonable belief upon the filing of the return that the position taken was more likely than not the correct treatment of the transaction."


JX 109.



Jurisdiction Over Penalties

Section 6221 establishes that the applicability of penalties arising out of a partnership return is properly determined at the partnership-level in a TEFRA partnership proceeding. Section 6226(f) confers jurisdiction on this Court to determine the "applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item." Section 6226(f). Further, because any penalty imposed in the FPAA is premised upon the conduct of the partnership, courts may determine, at the partnership-level, "all the legal and factual determinations that underlie the determination of any penalty ..." Treas. Reg. §301.6221-1T(c) (1999); see also Long Term Capital Holdings, 330 F.Supp 2d at 199-204; Santa Monica Pictures [ CCH Dec. 56,016(M)], 89 T.C.M. (CCH) at 1225.



Gross Valuation Misstatement Penalty

The FPAA imposed a 40-percent penalty on the underpayment of income tax due to the gross valuation misstatement of the Ervin LLCs' adjusted bases in their partnership interests in Jade, and in their consequent bases in the Xerox stock and euros received upon withdrawing from Jade. Section 6662 contains two distinct penalties for the underpayment of tax due to a valuation misstatement --a 20-percent "substantial valuation misstatement" and a 40-percent "gross valuation misstatement." Section 6662(e),(h). A substantial valuation misstatement occurs when the adjusted basis of any property claimed on any tax return is 200 percent or more of the amount determined to be the correct adjusted basis, and a gross valuation misstatement occurs when the adjusted basis is 400 percent or more of the amount determined to be correct. Section 6662(e)(1)(A), (h)(1)-(2).

Section 6662(h) makes the application of the 40-percent penalty mandatory, stating: "[t]o the extent that a portion of the underpayment to which this section applies is attributable to one or more gross valuation misstatements, [a valuation misstatement penalty] shall be applied with respect to such portion [of underpayment of tax] ...'" Section 6662(h)(1) (emphasis added); Long Term Capital Holdings [ 2004-2 USTC ¶50,351], 330 F.Supp.2d at 204 ("penalties, such as valuation misstatement, are intended to apply in mechanical fashion, inquiring only as to the magnitude of error in the taxpayer's claimed value or adjusted basis... ."); see Gilman [ 91-1 USTC ¶50,245], 933 F.2d at 149 ("The amount of the [valuation misstatement] penalty is a percentage of the underpayment; the applicable percentage is based on the degree of overvaluation.").

Although each Ervin LLC treated its partnership interest in Jade as having a basis of approximately $15 million, this Court determined that each Ervin LLC's basis in its partnership interest should have been $225,002. 76 Since the Ervin LLCs' claimed adjusted bases in their Jade partnership interests for the 1999 tax year exceeded their adjusted bases in their Jade partnership interests by more than 400 percent, the 40-percent gross valuation misstatement penalty must be applied.

Plaintiffs raise several challenges to the imposition of the gross valuation misstatement penalty. First, Plaintiffs argue that the gross valuation penalty only applies to property expressly enumerated in Treasury Regulation §1.6662-5(e)(3) --which does not include a partner's basis in a partnership interest or in stock or currency received from the partnership. Treasury Regulation §1.6662-5(e)(3) defines property for the purposes of a valuation misstatement penalty as "both tangible and intangible property." The regulation continues:


Tangible property includes property such as land, buildings, fixtures and inventory. Intangible property includes property such as goodwill, covenants not to compete, leaseholds, patents, contract rights, debts and choses in action.


Treas. Reg. §1.6662-5(e)(3).

Thus, the regulation does not purport to contain an exhaustive litany of the type of property to which the penalty may be applied. More importantly, the Code itself, section 6662(e)(1)(A), expressly provides that a valuation misstatement includes a misstatement of "the adjusted basis of any property claimed on any return of tax imposed by chapter 1." 77 See also CEMCO [ 2007-1 USTC ¶50,385], 2007 U.S. Dist. LEXIS 22246 at 29 ("the clear statutory language of section 6662 ... states that valuation misstatements include highly inflated adjusted bases. I.R.C. § 6662(e)(1)(A)."); Santa Monica Pictures [ CCH Dec. 56,016(M)], 89 T.C.M. (CCH) at 1226 ("Congress did not limit the definition of a "'valuation misstatement'" to instances involving inflated valuations [of property] but included within that definition instances involving inflated adjusted bases."); Treas. Reg. §1.6662-5(e)(2) (defining a gross valuation misstatement as a claimed adjusted basis of any property on a tax return which is "400 percent or more of the correct amount."). 78

Secondly, Plaintiffs contend that as a matter of law, no gross valuation misstatement penalty applies where the underlying transaction is disregarded for lack of economic substance. Plaintiffs rely primarily on Klamath Strategic Investment Fund, LLC v. United States [ 2007-1 USTC ¶50,223], 472 F.Supp.2d 885 (E.D. Tex. 2007), reconsid. denied, 2007 U.S. Dist. LEXIS 24806 (E.D. Tex. Apr. 3, 2007) for this proposition. In Klamath, a partnership-level action, members of the partnership challenged both the Commissioner's determination that several loan transactions lacked economic substance and the imposition of accuracy-related penalties. The Court agreed that the transactions lacked economic substance, but determined that the gross valuation misstatement did not apply. The Klamath Court recognized that under section 6662(h), the 40-percent penalty applies if the underpayment of tax is "attributable to" a gross valuation misstatement. The Klamath Court interpreted the "attributable to" language as follows: "if [a] court disregards [a transaction] because the transaction lacks economic substance, then the underpayment of tax is not 'attributable to' any gross valuation misstatement. Instead, the underpayment would be attributable to the disregard of the transaction." Klamath [ 2007-1 USTC ¶50,223], 472 F.Supp.2d at 900. This Court does not interpret the statute in that fashion in this context. Here, the underpayment of tax directly and exclusively was "attributable to" the overstatement of each Ervin LLC's basis --it was not "attributable to" the subsequent independent action of the court disregarding the transaction. 79

Third, Plaintiffs argue that the penalty "by definition, can only apply to those situations where a taxpayer intentionally overvalues property to generate larger tax deductions, not situations such as this involving a reasonable interpretation of the law." Pls.' Post-Trial Br. at 67-70; Pls.' Reply to Def.'s Post-Trial Br. at 102-04. Plaintiffs contend that there was no intentional overvaluation of property in the Ervin LLCs' partnership interests in Jade, "only a legal debate as to whether the sold call option constitutes a contingent liability under Helmer, et al." Pls.' Post-Trial Br. at 68. The Court is not persuaded by this argument. Once a gross valuation misstatement has occurred, the penalty applies mechanically, regardless of the intent of the taxpayers in executing the transaction or their reliance on legal authority. See Merino v. Comm'r[ 99-2 USTC ¶50,940], 196 F.3d 147 (3d Cir. 1999); Zfass v. Comm'r [ 97-2 USTC ¶50,503], 118 F.3d 184 (4th Cir. 1997); Illes v. Comm'r[ 93-2 USTC ¶50,525] , 982 F.2d 163 (6th Cir. 1992); Massengill v. Comm'r [ 89-1 USTC ¶9337], 876 F.2d 616 (8th Cir. 1989); Gilman v. Comm'r [ 91-1 USTC ¶50,245], 933 F.2d 143 (2d Cir. 1991); Long Term Capital Holdings [ 2004-2 USTC ¶50,351], 330 F.Supp.2d at 199; Santa Monica Pictures [ CCH Dec. 56,016(M)], 89 T.C.M. (CCH) at 1225-26.



Negligence

Alternatively, the FPAA imposed a 20-percent penalty under section 6662(b)(1) for any portion of the underpayment of income tax for the taxable year of 1999 due to "negligence or a disregard of rules and regulations." JX 109. Negligence is defined by section 6662(c) as "any failure to make a reasonable attempt to comply with the provisions of [the Internal Revenue Code]." 80 Treasury Regulation §1.6662-3(b)(1)(ii) explains a taxpayer is negligent if he fails to make a reasonable attempt to ascertain the correctness of a deduction, credit, or exclusion on a return that would seem "too good to be true" under the circumstances to a reasonable and prudent person. The negligence standard is an objective one, requiring a finding of "the lack of due care or the failure to do what a reasonable and prudent person would do under similar circumstances" Goldman v. Comm'r [ 94-2 USTC ¶50,577], 39 F.3d 402, 407 (2d Cir. 1994) (quoting Allen v. Comm'r [ 91-1 USTC ¶50,080], 925 F.2d 348, 353 (9th Cir. 1991); accord Pasternak [ 93-1 USTC ¶50,226], 990 F.2d 893, 902 (6th Cir. 1993); Marcello v. Comm'r [ 67-2 USTC ¶9516], 380 F.2d 499, 506 (5th Cir. 1967); Neely v. Comm'r [ CCH Dec. 42,540(M)], 85 T.C. 934, 947 (1985).

In Neonatology Associates, P.A. v. Commissioner [ 2002-2 USTC ¶50,550], 299 F.3d 221, 234 (3d Cir. 2002), the Third Circuit found that when "a taxpayer is presented with what would appear to be a fabulous opportunity to avoid tax obligations, he should recognize that he proceeds at his own peril." See also Van Scoten v. Comm'r, 439 F.3d 1243, 1260 (10th Cir. 2006) (upholding negligence-related penalties where the plaintiffs' actions in relation to their investment and the tax claims were objectively unreasonable); Pasternak [ 93-1 USTC ¶50,226], 990 F.2d at 902 ("petitioners were aware that they were buying a program that consisted primarily of 'window dressings' for tax benefits and either negligently or intentionally disregarded the law.").

The applicability of the negligence penalty in this TEFRA proceeding depends upon the conduct of Jade, its managing member and tax matters partner, Sentinel, as well as the parties here --the Ervins. Sentinel's principal, Ari Bergmann, stands in a different posture than the Ervins both with respect to his sophistication in the realm of tax matters and his role in the spread transaction. Given Bergmann's status as the managing member and tax matters partner of Jade, it is appropriate for the Court to assess the reasonableness of his conduct in considering the applicability of the negligence penalty. Santa Monica Pictures[ CCH Dec. 56,016(M)], 89 T.C.M. (CCH) at 1228. In Santa Monica Pictures, the Tax Court found the negligence penalty applicable at the partnership-level, examining the sophistication and conduct of the tax matters partner, a tax attorney who engineered the transaction found to be lacking in economic substance. The Tax Court stated:


Mr. Lerner is a highly educated, sophisticated tax attorney. He worked for many years at O'Melveny & Myers; at one point, he established and ran the firm's London office. Mr. Lerner also worked as a clerk/attorney-advisor with the U.S. Tax Court and as an attorney advisor for the U.S. Treasury Department.



Mr. Lerner personally engineered a plan to transfer the built-in losses in the defunct MGM Group Holdings from Generale Bank and CLIS to the Ackerman group. This transaction had no economic substance for Federal tax purposes... . Under the circumstances, we believe that a reasonable and prudent person would recognize that these tax losses were "'too good to be true,'" ...



Petitioner seeks to hide behind formal compliance with the partnership tax rules. As an experienced tax attorney, Mr. Lerner should have known that mere formal compliance with statutory provisions would not sustain transactions that have no economic substance and that are mere contrivances designed solely to exploit tax benefits. Under the circumstances, we conclude that reasonably prudent persons with Mr. Lerner's tax experience would not have conducted themselves as he did in reporting the bases in the ... receivables and the substantial losses from the transactions ...


Id.

Similarly, in the instant case, Sentinel's principal, Bergmann, while not an attorney, was a CPA with tax experience, having headed the Transaction Development Group at Bankers Trust which, inter alia, advised clients on tax transactions and hedge fund structures. Bergmann was instrumental in developing the spread transaction with BDO Seidmann and paramount in marketing the transaction to the Ervins. It was Bergmann's pitch, along with BDO Seidman's and Curtis Mallet's recommendations, which persuaded the Ervins to do the deal. Further, while Sentinel and Bergmann were to do the trading, that was not their only role --Sentinel's CFO, Conjeeveram, prepared the paperwork for the Ervin LLCs and worked with AIG devising the procedures to be followed --using Sentinel personnel and its accounting firm, Untracht. Sentinel was involved not only in executing the spread transaction but also in facilitating contributions to and redemptions from the partnership, including valuing the partnership assets and determining the assets to be redeemed. 81 Finally, Sentinel's accounting firm, Untracht, prepared and signed Jade's 1999 tax return.

The spread transaction contributed to Jade was structured to yield and did yield tax benefits which Bergmann should have recognized as being "too good to be true." The Ervin LLCs only had to "invest" $150,002 to purchase the spread options but in return received approximately $15 million each in taxable losses. The Ervin LLCs were protected from realizing any significant financial losses as they could lose no more than their initial investment in Jade. The transaction which Bergmann brought to BDO Seidman from the street was an elaborate fictional construct with no economic consequences other than tax benefits. A reasonably prudent investor with Bergmann's hedge fund and market experience would have known there was no investment and no potential for profit in the spread transaction. A reasonably prudent person with Bergmann's CPA background and tax experience would not have conducted himself as Bergmann did here in reporting such substantial tax losses from a fictional transaction.

Nor does Sentinel's reliance on Curtis Mallet and BDO Seidman defeat the partnership's negligence penalty here. "While it is true that actual reliance on the tax advice of an independent, competent professional may negate a finding of negligence ... the reliance itself must be objectively reasonable in the sense that the taxpayer supplied the professional with all the necessary information to assess the tax matter and that the professional himself does not suffer from a conflict of interest or lack of expertise that the taxpayer knew of or should have known about." Neonatology Assoc's [ 2002-2 USTC ¶50,550], 299 F.3d at 234. Both BDO Seidman's model opinion and Curtis Mallet's opinion were premised on the fallacy that the spread transaction could generate a profit. Moreover, Jade itself did not obtain an opinion from Curtis Mallet, only the Ervins did. 82 Nor does Sentinel's and the Ervins' reliance on BDO Seidman advance their cause. "It is well established that taxpayers generally cannot reasonably rely on the professional advice of a tax shelter promoter." Edwards v. Comm'r [ CCH Dec. 54,807(M)], T.C. Memo 2002-169 (2002); see also Goldman [ 94-2 USTC ¶50,577], 39 F.3d at 408 ("Appellants cannot reasonably rely for professional advice on someone they know to be burdened with an inherent conflict of interest."); Neonatology Assoc's, P. A. v. Comm'r [ CCH Dec. 53,970(M)], 115 T.C. 43, 98 (2000) ("Reliance may be unreasonable when it is placed upon insiders, promoters, or their offering materials, or when the person relied upon has an inherent conflict of interest that the taxpayer knew or should have known about."). As such, the alternative 20-percent negligence penalty is applicable.



Substantial Understatement

The FPAA imposed alternative 20-percent penalties under section 6662(b)(2) for the underpayment of tax for 1999 due to a "substantial understatement of income tax" and for a "substantial understatement of income tax because the transaction is a tax shelter, no substantial authority has been established for the position taken, and there was no reasonable belief upon the filing of the return that the position taken was more likely than not the correct treatment of the transaction." JX 109.

An understatement exists if the correct tax exceeds the reported tax, section 6662(d)(2)(A), and an understatement is substantial if it exceeds the greater of $5,000 or 10% of the tax required to be shown on the return. Section 6222(d)(1)(A). A taxpayer may obtain relief from the penalty if it makes the showing in section 6662(d)(2)(B), that there was "substantial authority" for its position. That relief is limited, however, where the understatement is "attributable to a tax shelter." Section 6662(d)(2)(C). Section 6662(d)(2)(C)(iii) defines a tax shelter as "a partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, if a significant purpose" of such an entity "is the avoidance or evasion of Federal income tax." If the understatement is attributable to a tax shelter, the taxpayer, in addition to demonstrating substantial authority for its position, must also prove that it "reasonably believed that [its position] was more likely than not the proper treatment." Section 6662(d)(2)(C)(i)(II).

As explained above, an objective scrutiny of the spread transaction contributed to Jade leads ineluctably to the conclusion that the spread transaction wholly lacked economic reality and concomitantly that tax avoidance was a significant purpose of this transaction. 83 As such, the transaction meets the definition of a tax shelter, and Plaintiffs may avoid imposition of the substantial understatement penalty only if they show both that their reporting position was supported by "substantial authority" and that they "reasonably believed that the tax treatment of such item ... was more likely than not the proper treatment." Section 6662(d)(2)(C)(i)(II); see Long Term Capital Holdings [ 2004-2 USTC ¶50,351], 330 F.Supp.2d at 200 ("the reduction rules are modified 'in the case of any item of a taxpayer other than a corporation which is attributable to a tax shelter' ... no reduction is available for adequate disclosure and, to be entitled to a reduction on grounds of substantial authority for any item, the taxpayer must also have 'reasonably believed that the tax treatment of such item by the taxpayer was more likely than not the proper treatment.'") (quoting Section 6662(d)(2)(C)(I)-(II); In re CM Holdings, Inc. [ 2000-2 USTC ¶50,791], 254 B.R. 578, 649 (D. Del. 2000) ("If [plaintiff's] loan interest deductions are tax shelter items, in order for this exception to apply, the taxpayer must, at a minimum, satisfy an 'authority requirement' and a 'belief requirement.'").

The taxpayer bears the burden of proving substantial authority. Norgaard v. Comm'r [ 91-2 USTC ¶50,378], 939 F.2d 874, 877-78 (9th Cir. 1999). Substantial authority for tax treatment exists "only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment." Treas. Reg. §1.6662-4(d)(3)(i). Substantial authority is an "objective standard involving an analysis of the law and application of the law to relevant facts." Treas. Reg. §1.6662-4(d)(2). "[T]he taxpayer's belief that there is substantial authority for the tax treatment of an item is not relevant in determining whether there is substantial authority for that treatment." Treas. Reg. §1.6662-4(d)(3)(i) (1998). Pertinent authorities for a substantial authority analysis include the Internal Revenue Code, other statutory provisions, regulations, revenue rulings, and court decisions, but not opinions rendered by tax professionals. Treas. Reg. §1.6662- 4(d)(3)(iii).

Plaintiffs argue that substantial authority existed for the tax treatment of the spread transaction based on Helmer. Plaintiffs are correct that at the time the spread transaction was executed, Helmer supported the premise that a sold call option would not constitute a liability under section 752 for purposes of calculating a partner's basis in its partnership interest. Indeed, recently in CEMCO the District Court for the Northern District of Illinois recognized that Helmer was good law prior to Notice 2000-44, stating:


In Helmer v. Commissioner [ CCH Dec. 33,225(M)], T.C. Memo 1975-160, 34 T.C.M. (CCH) 727 (1975), the Tax Court held that a contingent obligation, such as a short or sold option, is not a liability under section 752 because a partnership's obligation under the option does not become fixed until the option is exercised. This principle was affirmed in multiple subsequent cases under section 752. See, e.g., Long v. Comm'r [ CCH Dec. 35,449(M)], 71 T.C. 1, 6-7 (1978), aff'd in part [ 81-2 USTC ¶9668], 660 F.2d 416 (10th Cir. 1981) (holding that contingent obligations are not liabilities for purposes of increasing partnership basis until they become fixed or liquidated); La Rue v. Comm'r [ CCH Dec. 44,652(M)], 90 T.C. 465, 478 (1988) (obligations that are fixed but remain contingent are not liabilities under section 752); Gibson Prods. Co. v. United States [ 81-1 USTC ¶9213], 637 F.2d 1041, 1049 (5th Cir. 1981) (contingent nature of a partnership obligation precludes treatment as a liability for tax purposes). For many years, the Helmer rule served as the definition of liability under section 752. See Assumption of Partnership Liabilities, 68 Fed. Reg. 37434 (June 24, 2003) ("There is no statutory or regulatory definition of liabilities for purposes of section 752."). Thus, under Helmer and its progeny, it would have been proper for CIP to ignore the short, or sold, option as a liability under section 752.


CEMCO [ 2007-1 USTC ¶50,385], 2007 U.S. Dist. LEXIS 22246 at 10-11.

The question of whether there was "substantial authority" for the positions taken by Jade here requires an examination of several legal theories. There was clearly authority under Helmer and its progeny for the proposition that contingent obligations were not liabilities within the meaning of section 752 of the Code. There was also some authority that the two legs of the spread transaction could be viewed separately, but the weight of both factual and legal authorities demonstrate that the options here could not be separated. More importantly, there is an overarching legal doctrine --the economic substance doctrine --which must be considered in evaluating whether Helmer was substantial authority for Jade's position. As the Federal Circuit in Coltec recognized, "[o]ver the last seventy years, the economic substance doctrine has required disregarding for tax purposes, transactions that comply with the literal terms of the tax code, but lack economic reality." [ 2006-2 USTC ¶50,389], 454 F.3d at 1352. The Federal Circuit traced the roots of this doctrine to Supreme Court cases and noted that the Federal Circuit's predecessor had repeatedly applied the doctrine over the years and that "various tax treatises also recognize the doctrine's continued viability." Id. At bottom, the fictional nature of the transaction and its lack of economic reality outweigh Helmer in the substantial authority assessment.

Because this Court finds that, on balance, substantial authority did not exist for the tax treatment of the spread transaction in Jade, it is not necessary to analyze whether the taxpayers reasonably believed at the time the return was filed that the tax treatment of the spread transaction was "more likely than not the proper treatment." See Treas. Reg. §1.6662-4(g)(1)(i)(B). As such, the alternative 20-percent substantial understatement penalties of section 6662(b)(2) were properly imposed by the Commissioner. 84



Reasonable Cause Exception

The reasonable cause exception codified in section 6664(c) states "[n]o penalty shall be imposed under section 6662 ... with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion." See also Treas. Reg. §1.6664-4(a). Plaintiffs argue that Defendant may not impose any penalties against them under section 6662 as they proceeded in "good faith based on reasonable cause" within the meaning of section 6664. Pls.' Post-Trial Br. at 11-12, 57-72.

As stated above, this is a partnership-level action under TEFRA. Partner-level defenses to any penalty that relates to the adjustment of a partnership item in a partnership-level proceeding cannot be litigated in this proceeding. Treasury Regulation §301.6221-1T(d) (1999) states:


Partner-level defenses to any penalty ... that relates to an adjustment to a partnership item may not be asserted in the partnership-level proceeding, but may be asserted through separate refund actions following assessment and payment... . Partner-level defenses are limited to those that are personal to the partner or are dependent upon the partner's separate return, and cannot be determined at the partnership-level... . Examples of these determinations are ... . section 6664(c)(1) (reasonable cause exception)... . 85


Because the regulation expressly cites the reasonable cause exception as an example of a partner-level defense, the Ervin LLCs are barred from raising the reasonable cause defense in this partnership-level action and may only raise such defense in a subsequent refund action at the partnerlevel. See also Fears v. Comm'r [ CCH Dec. 57,029(M)], 129 T.C. No. 2 (2007).

Plaintiffs agree that Treasury Regulation §301.6221-1T(d) (1999), on its face, bars individual partners from raising the reasonable cause defense in a partnership action, but contend that the regulation itself is invalid. Plaintiffs claim this regulation violates both the section 6444 prohibition against imposing penalties where reasonable cause exists and the section 6221 mandate that the "applicability of penalties" relating to "partnership items" shall be determined at the partnership-level. Pls.' Reply to Def.'s Post-Trial Br. at 100-01.

Section 6444 does prohibit imposing penalties if "it is shown that there was reasonable cause" for the underpayment of tax. The regulation prevents the Ervins from attempting to show their reasonable cause here, while the statute nonetheless requires the Court to determine the "applicability" of the penalty at the partnership-level. The upshot is that the Ervins must pay the penalty and file individual refund actions in order to litigate reasonable cause. Section 6230(c)(4). While this is burdensome on the taxpayer, it is not reason to invalidate the regulation. The regulation does not deprive a taxpayer from ever being able to show reasonable cause --it merely delays the adjudication of that defense until the partner-level proceeding, recognizing that the reasonable cause defense may differ from partner to partner depending upon individual circumstances. The individual partners may still avail themselves of section 6664's protection and defeat the penalties if they can show the requisite reasonable cause and good faith. This is consistent with TEFRA's purpose of litigating all common partnership items at the partnership-level and deferring the unique individual defenses to the partner-level proceeding. As such, the regulation implements the Code in a reasonable manner and is valid and controlling. See Rowan Cos. v. United States [ 81-1 USTC ¶9479], 452 U.S. 247, 252 (1981); United States v. Correll [ 68-1 USTC ¶9101], 389 U.S. 299, 307 (U.S. 1967); Nat'l Muffler Dealers Ass'n. v. United States [ 79-1 USTC ¶9264], 440 U.S. 472, 477 (1979).

Plaintiffs also rely on Klamath for the proposition that partners may raise a partner-level reasonable cause defense at a partnership-level proceeding. Pls.' Memo on Application of Klamath at 16. The Klamath Court held that the partner-level reasonable cause defense could be raised in a partnership-level action because it involved actions by the managing member and the IRS had delved into the potential defenses of the partners during the administrative process. Klamath [ 2007-1 USTC ¶50,223], 472 F.Supp.2d at 904. However, none of the Ervin LLCs was the managing member, and they did not prepare Jade's tax returns --Sentinel's accounting firm did.

In Long Term Capital Holdings [ 2004-2 USTC ¶50,351], 330 F Supp.2d at 205, the Court considered the reasonable cause defense at the entity-level, examining whether the entity, Long Term, had reasonable cause in claiming large losses. So too, in Santa Monica Pictures, the Tax Court considered the reasonable cause defense at the entity-level, considering advisory opinions on which the managing member partner relied in preparing the partnerships tax returns.[ CCH Dec. 56,016(M)], 89 T.C.M. (CCH) at 1229-30. Plaintiffs here do not ask this Court to apply the reasonable cause defense to the actions of Jade, but instead to those of the Ervin LLCs as partners in Jade. Pls.' Post-Trial Br. at 11-12, 57-72. Because the reasonable cause defenses are unique to the individual Ervin LLCs, these defenses must be litigated in partnerlevel proceedings.




Conclusion


Plaintiffs' petition for readjustment of the partnership items of Jade is DENIED. This Court lacks jurisdiction to consider partner-level reasonable cause defenses in this proceeding. The Commissioner's application of penalties at the partnership-level is affirmed without consideration of the reasonable cause defenses, which may be raised in any partner-level proceedings.

1 Under section 752(b), a partnership's assumption of a partner's liability decreases the partner's basis in the partnership interest. Because the sold call options assumed by Jade were contingent obligations, not liabilities for the purpose of section 752(b), they did not lower the Ervin LLCs' basis in Jade.

2 Rather, each LLC paid a net premium of $150,002 for the spread and contributed the offsetting options and $75,000 cash to Jade. Upon exiting Jade, each LLC received euros and Xerox stock valued at $126,122 in exchange for its partnership interest.

3 An up-front consulting fee of $750,000 had to be paid to New Vista as a sine qua non of participation. New Vista was an entity largely owned by Jade's managing and tax matters partner, Sentinel, which did the foreign currency trading. What real value, if any, the Ervins received for this fee was never persuasively demonstrated. Rather, the $750,000 New Vista fee covered amorphous advice and training. There was another unusual fee of $84,100, --an "account opening fee" paid to AIG which AIG did not charge any of its clients except Sentinel clients, and the value each LLC received for this fee was similarly uncertain. Finally, each LLC paid a fee of $100,000 to the law firm of Curtis Mallet, for a tax opinion blessing the tax losses generated by the spread transaction. This $934,100 tally of the fees per LLC does not take into account Sentinel's fees or any fees of the Ervins' personal accountant, Martin McElroy, or attorney, Jessie Mountjoy.

4 These findings are based upon the evidentiary record developed during a fourteen-day trial --nine days in Atlanta, Georgia, and five days in Washington, DC. This matter was stayed on April 27, 2006, pending the Federal Circuit's resolution of Coltec Industries, Inc. v. United States [ 2006-2 USTC ¶50,389], 454 F.3d 1340 (Fed. Cir. 2006). The stay was lifted July 19, 2006, and the parties filed supplemental briefing on the application of the Federal Circuit's decision in Coltec to the economic substance issues in this case. The parties also sought leave of the Court to file supplemental briefing on the application of Klamath Strategic Investment Fund, LLC v. United States [ 2007-1 USTC ¶50,223], 472 F.Supp.2d 885 (E.D. Tex. 2007), reconsid. denied [ 2007-1 USTC ¶50,410], 2007 U.S. Dist. LEXIS 24806 (E.D. Tex. Apr. 3, 2007). Plaintiffs filed their brief on March 8, 2007, and Defendant filed its response March 23, 2007. Defendant filed a Notice of Supplemental Authority on August 22, 2007, informing the Court of the Tax Court's decision in Nussdorf v. Commissioner , 129 T. C. 30 (2007).

5 Gary Ervin saw an ad in the newspaper for a cable franchise while he was home from college and decided to apply. Although the Ervins attended college on athletic scholarships, none of the brothers obtained a college degree. Gary Ervin was a semester short of completing his degree, Robert Ervin was two classes short, and Tim Ervin was one class short. Tr. 291 (G. Ervin); Tr. 392 (R. Ervin); Tr. 434 (T. Ervin). Prior to entering the cable industry, Gary and Tim Ervin worked in coal mines. Tr. 290 (G. Ervin). Robert Ervin was too young to work in the mines, and by the time he reached an appropriate age for that type of work, his brothers' business had become established, and he joined their venture. Id. at 290-91.

6 The reverse triangular merger involved the Ervins swapping their Apex stock for stock in the acquiring company, Dycom. Stip. ¶¶ 3, 4. Under Securities and Exchange Commission (SEC) Rule 144, the Ervins were prohibited from selling the Dycom stock for one year, i.e., until March 2000. 17 C.F.R. §230.144 (1998).

7 In a collar, a put option is purchased, and a call option sold, by the investor to a bank. Tr. 131 (Maidman). In a "costless collar," the premium received on the sold option is equal to the premium due on the purchased option, and the proceeds from selling the call option are used to purchase the put option. Tr. 133-35 (Maidman); Tr. 212-13 (Pace).

8 As of 1999, the Ervins each had approximately $10-12 million under the management of Cheyne Pace. DX 534 - 42. Pace characterized the bulk of the assets he managed for the Ervins --roughly 65% --as "very low risk." Tr. 247-48 (Pace).

9 The date of this referral is not in the record. BDO Seidman paid the finders fee to Chandler. Tr. 1503-04 (DiMuzio). Gary had never dealt with BDO Seidman before. Tr. 337 (G. Ervin).

10 Jesse Mountjoy, the Ervins' personal tax attorney, was not involved in any discussions with Jenkens & Gilchrist. Tr. 1661 (Mountjoy). Mountjoy received information regarding the proposal Jenkens & Gilchrist made to the Ervins "third-hand" from Martin McElroy. Id. DiMuzio does not recall this phone conference. Tr. 1505-06 (DiMuzio).

11 In April 1999, Dycom was pursuing a second offering and informed Gary Ervin that the offering of new stock would significantly extend the black-out period. Tr. 349-51 (G. Ervin). Upon urging from Gary Ervin, Dycom agreed to allow the Ervins to go forward with the costless collar options provided that the Ervins did so with Bank of America, an affiliate of Dycom's bank. Tr. 351-53 (G. Ervin). Because of this agreement, Gary began working with Dagny Maidman at Montgomery Securities in San Francisco, a Bank of America affiliate. Tr. 126-27 (Maidman); Tr. 353 (G. Ervin).

12 On June 10, 1999, the Ervins had entered into a prepaid variable forward sale, known as STARS. See JX 12-13; see also Tr. 185-86 (Maidman). STARS involved agreeing to sell stock at a set price in the future in return for a loan against that future sale price. See JX 4; see also Tr. 185- 86 (Maidman). Approximately $13 million of the Ervins' stock (collectively) was involved in this transaction. See JX 12, 13; see also Tr. 3613 (G. Ervin). The Ervins also had approximately $6-7 million dollars of Dycom stock (collectively) in an escrow account related to the sale of Apex; the escrow was to be released in October, 2000. Tr. 529, 3608-10 (G. Ervin).

13 As of February 5, 1999, BDO's National Tax Sales Executive Group (NTSEG) was responsible for selling BDO's tax products. On October 13, 1999, the NTSEG and another BDO component, the National Tax Consulting Group, combined and were renamed the Tax Solutions Group. See DX 600; see also Tr. 2758 (Field). Like the NTSEG, the Tax Solutions Group was responsible for selling BDO's tax products. See DX 600; see also Tr. 2758-59 (Field). Denis Field, Charles Bee, and Adrian Dicker were in charge of the Tax Solutions Group, and they had overall responsibility for development of the Tax Solutions Group's business line. See DX 600; see also Tr. 2753-54 (Field); Tr. 1502 (DiMuzio). DiMuzio was also a member of the Tax Solutions Group during 1999 and 2000. Tr. 1499-1500 (DiMuzio).

14 Ari Bergmann received a Bachelor of Arts degree from Ner Israel Rabbinical College in 1981, and he is a certified public accountant. JX 19. He worked as a staff accountant at Price Waterhouse in New York from 1986-87. He then worked as an Assistant Vice President at Drexel Burnham Lambert Trading dealing in precious metal transactions, commodity trading, and derivative arbitrage. Bergmann began work at Bankers Trust in 1989 at the U.S. Interest Rate Derivatives trading desk and managed this unit in 1992 and 1993. During this time he was active in arbitrage and in the development of structured notes, index-amortizing swaps, times swaps, binary options and other derivative products. From 1993 to 1997, he headed the Transaction Development Group, a unit that he founded. The group was active in the application of derivative techniques in the privatization of a number of European state-owned companies. The group also advised clients on mergers and acquisitions, tax transactions and hedge fund structures. Bergmann formed Sentinel in 1997, after leaving his position as Senior Managing Director at Bankers Trust Company. Id.

15 Abraham Pfeiffer received a Bachelor of Science degree in Computer and Information Science from Brooklyn College in 1989. Pfeiffer worked for Goldman Sachs from 1989 until 1996 as a team leader for its Global Portfolio Management system and as the head of its prime brokerage support team. While at Goldman Sachs, Pfeiffer specialized in foreign trade security transaction processing, corporate action and reorganization processing, and performance measurement. JX 19; Tr. 804-07 (Pfeiffer).

16 Smita Conjeevaram received a Bachelor of Arts in Economics from Ethiraj College, Madras, India, and a Bachelor of Science in Accounting from Butler University, Indiana. Conjeevaram served as a Tax Manager at Price Waterhouse from 1987 until 1994, concentrating on international tax issues, advising offshore investment advisors and hedge funds on tax-driven structural and financial issues. Conjeevaram then worked for Long-Term Capital Management from 1994 until 1999, as a Tax Manager in the portfolio tax group where she was responsible for monitoring compliance, initiating timely planning, and analyzing derivative products, their structure, and their taxation in the United States and Europe. Conjeevaram joined Sentinel as a principal in April 1999, serving as CFO. JX 19; Tr. 2594 (Conjeevaram).

17 Charles Bee received a degree in Economics with a minor in Accounting from Central Michigan University in 1972. He became a certified public accountant in 1974-1975 and worked for Arthur Andersen from 1973 to 1979, and for Deloitte & Touche from 1980 to 1982. Bee joined BDO Seidman in 1982 as a senior tax manager. Over the years he became a member of BDO Seidman's Tax Opinion Committee, Chairman of the BDO International Tax Committee, Head of the International Tax Specialty Group, Head of International Taxes for BDO and BDO Worldwide, and Vice Chairman of the Board of Directors. Tr. 2900-04 (Bee).

18 The Tax Product Sales Manual was updated on or about August 3, 1999, specifically to include the spread transaction. See DX 665 at 019775. The August 3, 1999 forwarding letter transmitted internally at BDO Seidman, stated: "Enclosed are Sections 250 and 300 of the Tax Sales Manual, which have been revised to include the Spread Transaction." Id.

19 A "spread" connotes a position held on a foreign currency through the simultaneous purchase and/or sale of more than one option to create a net position. Tr. 1791-92 (Kolb); Tr. 2496 (Shoji); Tr. 3122-24 (DeRosa).

20 BDO Seidman claims to have disavowed its manual several months prior to October 1999, but is unclear when this disavowal occurred. Tr. 2935, 2947, 2957 (Bee).

21 Bricker testified that he and Bee discussed the spread transaction "for many months, and I believe it included April of 1999." Tr. 985-86 (Bricker).

22 The de bene esse Pang deposition and the video tape of that deposition were admitted into evidence as JX 112 and JX 113, respectively. Tr. 3637-40. Pang testified that his impression was that Bergmann's clients were "some speculative funds or high net worth individuals" and that these clients "would be net buying options." JX 112 (Pang Dep. 22-25).

23 Plaintiffs objected to this exhibit arguing that it was not clear that this was one complete document or a series of documents. Tr. 2646. Given the testimony of Conjeevaram, the Court admitted the exhibit for the purpose of demonstrating that the document reflected the procedures used for transactions between Sentinel and AIG and accurately reflected the duties of Conjeevaram's assistants at Sentinel in processing such transactions. Tr. 2648.

24 The first names referenced in the document --Noreen, Udai, Eli and Jeremy --refer to Sentinel employees. Tr. 2631-32 (Conjeevaram).

25 The Ervin LLCs were created on September 17, 1999, two days after the Master Trading Agreements were executed. See DX 769.

26 Dr. Kolbe, an expert for the Government in financial economics, investment, leverage, and capital market principles defined margin as the "security necessary to post on the sold call to make sure you can honor your obligation." Tr. 2367-68 (Kolbe). The amount of margin is generally calculated by reference to a percentage of the total amount at risk in a trade. See DX 501 at 13-15; DX 768 at 32-33; Tr. 3144-47 (DeRosa); Tr. 3504-06 (Kolb).

27 Mr. Shoji defined a bid/offer spread as follows: "In the financial markets there's typically a price at which a trader or market maker would buy a particular asset and a different price, a higher price, which I will sell that asset. Tr. 2493 (Shoji). Financial institutions' profits generally arise from earning small percentages on the bid-ask spread on many transactions, so dealers for those institutions look for a counterparty who will trade in sufficient volume to generate revenue. See DX 768 at 11-14; see also Tr. 3083-91 (DeRosa).

28 See Tr. 1370 (Bergmann) ( "[The facility fee] gave you the right to instead of paying a bid offer every time you restrike it you paid a fee, and you got an agreement that you would restrike the options for a minimal, if any, bid offer.").

29 Sentinel did not give AIG any documentation in support of its assurance that each client had the necessary assets. Tr. 1685 (Reed).

30 According to Pang, AIG provided foreign exchange trading services to more than ten Sentinel clients. JX 112 (Pang Dep. at 80).

31 With respect to profit potential the opinion stated: "[t]he options are structured to provide you with the opportunity to earn a profit equal to 135% of your actual investment, and to limit your losses to your actual investment." JX 23 at 2. However, the opinion did not provide any further explanation of the profit potential or loss limitation. See JX 23.

32 According to Dr. Kolbe, "[a]ll restriking does is pay a fee in exchange for taking some cash out now, and in the process losing some insurance ... . So it's not a money-maker. It's a liquidity-maker." Tr. 2356 (Kolbe).

33 The Ervins entered into another put option agreement on or about November 1, 1999, so that they would have the protection of the "costless collar" once again. Tr. 136-37 (Maidman); Tr. 358, 505-08, 619 (G. Ervin); Tr. 835-37 (Pfeiffer); Tr. 2356 (Kolbe).

34 PX 244 is Gary Ervin's personal calendar from December 1998 to January 2000. The calendar entry for September 2, 1999, states "David Demesio - BDO 10:00, Martin McElroy." PX 244.

35 Tim and Robert Ervin testified that McElroy later explained the tax benefits of the spread transaction to them in the context of options on corn and soybeans. Tr. 1488-89 (McElroy);