Source: https://procedurallytaxing.com/category/penalty-application/page/2/
Timestamp: 2019-04-19 08:45:24+00:00

Document:
The case of Whitaker v. Commissioner, T.C. Memo. 2017-192 provides another example of a taxpayer who works hard to make sure that the IRS penalizes him. In the process, he drains resources at the IRS and the Tax Court. I have no great sympathy for the behavior, but it is a generally sad process to watch. In this case, it is especially sad because it appears that if the Whitakers had filed a proper return claiming the retirement distribution, they would have received back all of the withholding. They do not appear to have enough income to be taxed since their standard deduction and personal exemptions exceeded the amount of the pension. Unless there was other taxable income not reflected in the report of the case, they traded a $3,600 refund for a $10,000 penalty.
The opinion involves the imposition of the frivolous tax return penalty of IRC 6702(a). This is one of over 50 assessable penalties found in Chapter 68, Subchapter B of the Internal Revenue Code. Section 6702 entered the Code in 1982. Taxpayers making frivolous tax returns or frivolous submissions get hit with a $5,000 penalty. I have written about this penalty before here, here, here and here. What interests me about this case, and what has interested me before because it is hard to tell, is why Mr. Whitaker was permitted to litigate the merits of his 6702 penalty in a Collection Due Process (CDP) case. I believe taxpayers should have the right to litigate the merits of assessable penalties in CDP cases because they do not have the right to a prepayment forum; however, the IRS generally objects and the Tax Court sustains the objection based on the IRS regulations. I will discuss the issue further below, but I cannot tell why the IRS did not object to the litigation in this case. As an outside observer without all of the information driving the decision not to object, it is unclear to me why the IRS objects in some cases and not in others.
Additionally, the IRS can reject frivolous arguments in CDP cases; however, it can only reject cases based on frivolous submissions and not frivolous returns. Because Mr. Whitaker’s case involves a frivolous return described in 6702(a) rather than a frivolous submission described in 6702(b), the bar to making an argument in a CDP case does not preclude him from making his type of frivolous argument in this CDP case.
The Court explains why Mr. Whitaker’s, and the actions of his deceased wife, meet the criteria of the statute. Basically, they kept submitting documents purporting to be returns that showed zero income and zero tax, but withholding which they wanted to use as a basis for obtaining a refund (a refund it looks like they were entitled to, had they properly listed their income.) The IRS conceded the penalty for one of the returns during the Tax Court case which may have influenced the Tax Court not to impose the 6673 penalty, which it had done in a prior case involving frivolous submission penalty, but the imposition of the penalty itself breaks no new ground. The Tax Court may have been influenced not to impose a 6673 penalty because of the apparent lack of a tax liability on the return had it been correctly filed and the sadness of the case.
We have written extensively on the efforts to litigate the merits of a tax liability before the Tax Court of individuals faced with large assessable penalties who have no easy, and sometimes no realistic, way to pay the penalty and bring a refund suit. The Whitaker case contains no explanation of why the taxpayer did or did not have an opportunity to bring the merits of the assessed penalty to Appeals at the time of the assessment and why that opportunity did not foreclose the opportunity to raise the merits of the penalty at the CDP stage of the case. Did the IRS fail to offer an Appeals hearing at the time it imposed this penalty? Did the IRS simply fail to object to raising the merits during the CDP process and allow a tax protestor to go forward with the merits litigation in Tax Court, tying up the resources of the Court and three Chief Counsel attorneys on what seems like a fairly wasteful case (though the concession of one of the three penalties suggests the existence of a partially meritorious suit)? Does the fact that the IRS allowed Mr. Whitaker to bring a merits case on his assessable penalty mean that other taxpayers should at least try to bring merits litigation in the CDP context hoping that they will be allowed to do so? I would like to know why the merits litigation was allowed here, and in other cases I occasionally see where I would have expected the taxpayer to have the opportunity to go to Appeals at the time of the imposition of an assessable penalty, when most taxpayers get turned away. The answer may lie in a simple failure to offer a conference with Appeals at the time of assessment, but it is unclear.
As mentioned above, another interesting feature of this case is that the IRS could have turned this case away from CDP consideration under the provision of IRC 6330((c)(4)(B) if his frivolous position were a “submission” rather than a “return.” This section precludes the taxpayer from raising an issue at a CDP hearing if the issue meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A). The bar to raising frivolous positions in CDP cases is intended to keep persons from using the CDP process to promote such positions. This case shows how the CDP process can still be used to promote a frivolous position as long as the taxpayer takes the position on a tax return, as Mr. Whitaker did, rather than on another type of document such as a CDP request. The case also points out the terrible result that can happen when tax protestor arguments are pursued.
It’s easy to feel sorry for the people who invested in Son of Boss tax shelters. They really wanted to pay the right amount of taxes but were hoodwinked into investing into tax shelters that did not turn out like they hoped causing them to have significant problems with the IRS that they never intended.
If that’s your take on Son of Boss investors, you will love a case that came out earlier this summer. If that’s not your take, you might still find the situation amusing. I think the IRS found the situation just slightly less amusing than paying out attorney’s fees to tax shelter promoter BASR. In Ervin v. United States, the district court found that investors in a Son of Boss shelter were entitled to a refund of penalties paid to the IRS even though they recovered the penalties from their tax advisors who brought them into the tax shelter in the first place. How did we get there?
The investors brought a suit against the IRS to obtain a refund of the valuation misstatement penalty and penalty interest payments. They convinced a jury of their peers that they had reasonable cause for the tax positions they took. Now, they want the IRS to give them a refund of the penalties they paid.
In the meantime, the investors sued some of their tax advisors – BDO Seidman and Curtis Mallet – to recover the penalties asserted against them for investing in the Son of Boss shelter and they won that suit also. It came out in the tax refund suit that they had won the suit against their advisors and recovered a substantial amount of money. The IRS argued that it should not have to refund the penalties and interest to them because the recovery that the investors received from their advisors was intended to pay for the penalty. If the investors got to keep the recovery and did not have to pay the penalty, the investors would receive a windfall. The IRS argued that it should keep the money the investors paid to it because they were already made whole and the payments by the advisors represented the true payments of the penalties. The investors argued that they should receive the entire refund despite the private settlement. They also argued that the IRS does not have a claim of right with respect to the penalty payments.
The Court rejected the argument made by the IRS and rejected it without giving the IRS any further discovery. It finds that the investors did not fail to disclose a matter “bearing on the nature and extent of injuries suffered.” The suit was about their liability for penalties and the private suit against their advisors really had nothing to do with it. The Court said that it could not find a single instance in which a court has excused the IRS from its obligation to repay the improperly assessed and collected tax in a refund suit and ordered the IRS to pay here.
This case brings up an issue that Steve and I have debated before and he has written about. When a taxpayer argues reasonable cause based on the advice of tax advisor, the case is in many ways the malpractice case involving the advisor. If the taxpayer succeeds in fending off the penalty, maybe the taxpayer does not pursue the advisor. So, a victory for the taxpayer may be an economic victory for the party who caused the problem just as much for the taxpayer.
If taxpayers are going to defend against the IRS and sue their advisor in situations in which they can win both cases because they were reasonable in relying on the advisor and the advisor did give bad advice, maybe this feels bad to the IRS but it puts the economic loss in the right place, or maybe it misallocates the placement of the economic loss which is why the IRS was complaining.
The advisor who gives the bad advice should be liable and pay for the damages caused by the bad advice. The bad advice has really harmed both the IRS and the taxpayer. If the taxpayer pays the right amount of tax after the audit, the IRS is whole from the perspective of collecting the correct amount of tax but has still had to expend effort to collect that tax instead of having the self-reporting system work as it should. If the taxpayer pays the correct amount of tax in the end, should the taxpayer be freed from paying the advisor who caused the taxpayer to incur the problem in the first place? The taxpayer may have had to pay more money to fight with the IRS about the correct amount of tax and certainly did not get the value bargained for.
In cases where the taxpayer avoids an otherwise appropriate penalty because the taxpayer reasonably relied upon the advisor, should the system penalize the advisor so that the IRS recovers something akin to the appropriate penalty and so that the advisor feels the pain of causing the problem while also allowing the taxpayer to recover from the advisor at least the cost of the original bad advice plus perhaps the cost of the advice to fix the problem created? The IRS is right to complain here, in the sense that some penalty payment seems appropriate. It also seems right to allow the taxpayer to avoid paying the penalty to the IRS where the taxpayer reasonably relied on the advice of a professional and to allow the taxpayer to recover the cost the taxpayer paid for the bad advice. Maybe we should look at recasting the penalty scheme to bring all of the players to the table. Where I am particularly bothered, the advisor is continuing to represent the taxpayer in the reasonable cause litigation and I felt that the advisor was using the taxpayer’s more sympathetic case as a shield for the advisors’ less sympathetic one.
A number of IRC 6751 cases have been bottled up waiting for this opinion. Look for a number of cases to now come out on this issue and look also for some of these petitioners to take the issue to the next level.
Because I had an extensive email exchange with Carl Smith about this case, I have placed his comments at the end of the post for those interested in a more in depth review of the issues presented.
This issue first came to my attention through Frank Agostino and fittingly, Frank represents the petitioners in this case. As we have mentioned in prior posts, this issue essentially went unnoticed for almost 15 years after the passage of RRA 98. After a TIGTA report highlighted that the IRS had failed to notice and follow this requirement, Frank picked up on the issue and began asserting that the IRS failed to follow the provision. In Graev he made the argument but with somewhat unusual facts. I will briefly discuss the facts before getting to the three different views on the issue expressed by the members of the Court followed by views on the opinions by Carl Smith and me.
Petitioners claimed a charitable contribution for a façade conservation easement on a home they purchased in a historic preservation district in New York City. The easement was donated to the National Architectural Trust (NAT). In a previous opinion, Graev v. Commissioner, 140 T.C. 377 (2013), the Tax Court held that petitioners could not claim a charitable contribution deduction for the donation of the easement because NAT gave them a side letter guaranteeing that it would return the contribution if the IRS disallowed the charitable contribution.
At the time of the contribution, some concern existed about the ability to claim a deduction for a contribution of the façade easement because of a Notice the IRS had issued on a different type of conservation easement but one with enough overlap to suggest that the IRS might not allow a charitable contribution deduction for the type of easement being contributed by the Graevs. The opinion details the letters sent by NAT before and after the donation regarding pronunciations by the IRS and Congress on the donation of easements. It also recounts the actions, or inaction, of the Graevs in the face of the correspondence.
The IRS did audit the return filed by Graevs claiming the contribution of the easement. The agent not only proposed disallowing the contribution but also recommended the imposition of the 40% gross valuation misstatement penalty of section 6662(h). The agent prepared the penalty approval form – a form the IRS devised specifically to meet the requirements of section 6751 – and his manager signed the form. Because the agent could not reach an agreement with the taxpayers, he prepared a statutory notice of deficiency, which, due to the issue, required Chief Counsel review. The reviewing attorney agreed with the notice; however, he recommended that the IRS add to it, as an alternative position, the imposition of the 20% penalty under 6662(a) and (b)(1) for negligence or substantial understatement. The manager in Chief Counsel’s Office agreed with this recommendation.
The IRS added the alternate penalty to the notice of deficiency but the agent did not go back to his manager for approval of the alternate penalty. In the first Tax Court case the Court determined that petitioners were not entitled to the charitable contribution deduction because the side letter created a subsequent event that was not “so remote as to be negligible.” Because of the basis for the decision, the IRS conceded that the 40% penalty did not apply and argued that the 20% penalty did.
In defense to the application of the 20% penalty, the Graevs argued that the IRS did not comply with section 6751 because the agent’s manager did not approve the 20% penalty.
This is a 106 page opinion. The majority (and the dissent) goes into many aspects of the statute in reaching its conclusion. The majority also spends time explaining why the dissent is incorrect. We may come back with subsequent posts about the opinion but at its core is the view that the language of the statute requires approval before assessment and the Tax Court is a pre-assessment forum. This facially logical view of the statute leads to trouble in the ability of a taxpayer to challenge the application of section 6751 and raises questions about the Tax Court’s role as a pre-assessment forum. Of course the drafters of the statute might have thought a little more about that before writing it.
The concurring judges looked to the purpose for the statute which is to prevent the use of penalties as bargain chips. Here, these judges found that even if the IRS did not strictly comply with the requirements of section 6751(b) the failure to do so did not prejudice petitioners. These judges would defer the detailed analysis of the statute until presented with a case where the facts did raise the possibility of prejudice.
The dissent would require that the IRS obtain managerial approval prior to issuing the notice of deficiency. Because the IRS issued the notice prior to obtaining approval of the alternative position, it would not sustain the penalty. The dissent discusses the role of the Tax Court in the assessment process and concludes that to properly fulfill that role it should address the penalty issue as presented in the notice of deficiency.
The majority opinion suggests a taxpayer should never raise IRC 6751 in Tax Court, or anywhere, until liability is assessed and raise it instead in the Collection Due Process (CDP) context after assessment. This seems contrary to the purpose of Tax Court and puts taxpayers in an awkward position. By allowing assessment to occur, the panoply of IRS collection options becomes available. The Tax Court may anticipate that CDP is a process available to everyone for reentry into the Court for a determination but for low income taxpayers and taxpayers with relatively low liabilities, the IRS may collect via offset and fully satisfy the liability without the need to send a CDP notice. Of course, the taxpayer whose liability is fully satisfied can sue for a refund but if the penalty is $1,200 on a liability of $6000 for wrongfully claiming the EITC, how practical is it to file an expensive suit in district court to contest this issue?
The case is before the Tax Court because the penalty, at least the penalty at issue in this case and in many cases, is a part of the notice of deficiency. For the reasons stated by the dissent, the Tax Court has jurisdiction to decide the issue. This should not be a post-assessment question. After all, to borrow from Judge Gustafson, section 6501 also precludes an assessment being made after the SOL has expired, but the Tax Court has a long history of considering compliance with section 6501’s requirements during the deficiency case – i.e. pre-assessment.
If the opinion of the majority stands up on appeal, taxpayers who know or think that the IRS did not obtain the appropriate approval prior to issuing the notice of deficiency should consider making no mention of 6751 during the Tax Court case for fear of alerting the IRS to the defect prior to the making of the assessment and allowing it to cure that defect. Here, I assume that the IRS will obtain managerial approval before it makes the assessment. One possible outcome of the case if it comes back to the Tax Court in the CDP context is that the post-decision, pre-assessment managerial approval will satisfy the language of the statute in the eyes of the judges in majority, and perhaps concurring, opinion.
In footnote 22 on page 40, the court fairly acknowledges that it is likely just kicking the issue of compliance with section 6751(b) (whatever it means) down the road until a post-assessment Collection Due Process proceeding. Doubtless, the 6751(b) issues that the court avoids today will have to be addressed in a Tax Court CDP opinion — perhaps even one that the Graevs bring after the penalties are formally assessed and a notice of intention to levy or a notice of federal tax lien (i.e., a ticket to a CDP hearings) is issued. Query, though, whether challenging an assessed penalty under section 6751(b) in a CDP hearing is prohibited by the language of section 6330(c)(2)(B), which prohibits CDP challenges to underlying liability where a taxpayer has received a notice of deficiency — as the Graevs did? Or is a section 6751(b) challenge one going to the procedural correctness of the assessment under section 6330(c)(1), not a prohibited underlying liability challenge?
If one can’t challenge non-compliance with section 6751(b) through CDP, then Judge Gustafson points out a statute that might also preclude a later refund lawsuit over the penalty. See his quote and brief discussion of section 6512(a) on page 78. n. 5.
If neither CDP nor a refund suit is the way to challenge non-compliance with section 6751(b), then taxpayers would be left without a remedy. The anti-injunction act of section 7421(a) has an exception if no adequate remedy exists; however, probably the exception would not apply, and the act would likely preclude a suit to restrain assessment or collection of the penalty. And section 7433, which provides a suit for damages from wrongful collection actions would not apply, since the issue being challenged here is an assessment issue, not a collection issue.
This opinion has been a long time in coming. The case was originally with Judge Gustafson. And he foreshadowed his dissent in a brief order he issued more than two years ago on July 16, 2014. Clearly, he wrote a proposed opinion along the lines of his dissent, but then at court conference, his opinion did not prevail and Judge Thornton got the assignment to write the majority opinion. On the day the opinion was issued, an order reassigning the case from Judge Gustafson to Judge Thornton was also entered in the case.
There is an interesting new entry on the Tax Court docket sheet accompanying this opinion that I have never seen before when an opinion is issued. It reads: “Internet Sources Cited in Opinion”. The problem of URL links to court opinions disappearing over time has been a large one for all courts. Perhaps this is a warning to the Tax Court about what it must think about doing when the government printing office formally prints the opinion in a T.C. volume. Will the Tax Court later be revising its opinions in the same way that Supreme Court judges currently do? It is my understanding that the Supreme Court recently has changed its practices of modifying opinions that have already been published. Now, the court will let the public know of the post-issuance changes to the opinions. Will the Tax Court do the same? Perhaps it is worth asking the clerk’s office what the purpose of this new entry on the docket sheet implies.
Finally, Judge Gustafson decides a lot of the questions under section 6751(b) on which the majority postpones ruling. Judge Gustafson’s opinion is joined by four other judges. Readers of the opinion should not jump to the conclusion that any of the judges in the majority would disagree with those rulings of Judge Gustafson on the issues on which the majority deferred ruling if the arguments are again presented in a case (presumably a CDP case) where those arguments are ripe. Thus, this victory for the IRS in allowing a deficiency including penalties to be incorporated into the Tax Court decision may turn into no penalties ever being collected by the IRS if a court, in a future case, decides the deferred issues adversely to the IRS.
My worry about whether compliance with 6751(b) is merely a procedural compliance issue in a CDP case is based in part on the way that the Tax Court has treated compliance with 6501. The Tax Court has refused to consider 6501 arguments in a CDP case if a taxpayer previously received a notice of deficiency. But, I am pretty sure the Tax Court judges are going to treat 6571(b) compliance as a CDP procedural issue, since to treat it as an issue barred by 6330(c)(2)(B) would be to deprive a taxpayer of any possibility of judicial review of compliance with 6751(b).
The case of Kimdun, Inc. v. United States provides yet another example of the havoc wrecked by payroll provider companies. Over the last 15 years, a fair number of payroll providers have run off with the money leaving their clients in hot water with the IRS. The IRS standard approach to these cases involved telling the cheated taxpayers that they owed their taxes, penalties, and interest. The cheated taxpayer received little compassion from the IRS as they tried to sort through the financial wreckage caused by the payroll provider. The traditional IRS view on this issue sees the payroll provider as an agent of the taxpayer and any problems created by the payroll provider as problems the taxpayer must fix. That approach has a sound legal basis but does not always make good policy because some of the payroll provider cases invoke a lot of sympathy.
I thought the IRS position concerning payroll providers had softened. Several pronunciations seemed to suggest a kinder, gentler approach by the IRS on these cases. I quote from the relatively new IRM on ETA offers at the end of the post and cite there to other relevant IRM provisions that a taxpayer facing this problem should explore.
Kimdun definitely did not meet the kinder side of the IRS. This case does not involve Kimdun’s liability for the stolen taxes themselves but rather picks up at the penalty phase. This case involves delinquency penalties for failure to pay and failure to deposit. Kimdun loses the argument in a preemptory fashion. The five McDonalds franchise locations will need to flip a lot of burgers to pay off the penalty for hiring a company that cheated on it and caused it not to pay its taxes on time.
Kimdun paid the taxes and penalties assessed by the IRS in addition to making payments of the taxes to its payroll provider who ran off with the payments. This case involves a refund suit for return of the money paid for the penalties. Kimdun and the affiliated corporations that made up the franchise group owned by Kim Dobbins have operated in the Los Angeles area for about 30 years. The opinion states that for that entire time or almost that entire time, the companies hired Copac Payroll Service and its clearinghouse bank, Cachet Banz, Inc. to process its payroll, make the necessary deposits, fill out the payroll returns, etc. The payroll company and the bank would electronically sweep the money to pay the payroll and the taxing authorities from the bank accounts of the franchisees. The companies could see (I assume they were looking) that the money was coming out of their bank accounts. They knew their employees received payment because the employees would have quickly sounded an alarm if they had not received payment, and the company assumed that the payroll provider sent the appropriate amounts to the state and federal taxing authorities. Unfortunately the companies apparently did not check up on the timely filing and payment of the taxes.
Some question exists whether the companies had notice of failures before the firing of the payroll company, but eventually the failure became clear. and they fired the payroll provider, The companies also learned that the payroll provider was the subject of a federal grand jury investigation, and the companies received bills from the IRS and California for the unpaid taxes.
Kimdun and the affiliated companies apparently paid over the taxes without a fuss. Having worked on payroll provider cases when I worked in Chief Counsel’s office, I can say that not every taxpayer who gets cheated like this can stroke a check and do that. Many taxpayers who find themselves in this situation face quite a struggle to come up with the taxes for a second time. The ability of Kimdun to pay the IRS the taxes and the penalties attests to the strength of the business and demonstrates that the business stepped up when it learned of the problem and did not shirk from the problem. Hopefully, it also received a theft loss deduction to soften the blow somewhat.
Nonetheless, the IRS stuck to its guns on the penalty. Kimdun argued that the failure to pay the taxes on time and to make the required deposits resulted from reasonable cause and not willful neglect. The court cited United States v. Boyle, 469 U.S. 241 (1985). When a court in this situation cites to Boyle, it is generally a bad sign for the taxpayer and that held true in this case. In Boyle, the Supreme Court set a high bar for taxpayer seeking penalty relief based on the failure of someone on whom the taxpayer relied. The district court here characterized the Supreme Court’s view of the misplaced reliance as providing little relief from penalty where the task involved something the taxpayer could check without expertise such as the timely filing of a return or the timely payment of a debt contrasted with reliance where the expertise of the person on whom the taxpayer relied would reasonably occur such as the taking of a legal position on a return.
The district court here cited to an earlier 9th Circuit case, Conklin Bros. v. United States, 986 F.2d 315 (9th Cir. 1993), involving embezzlement by an in-house bookkeeper rather than a payroll provider. In Conklin, the 9th Circuit, the circuit to which the appeal in this case would lie and the circuit providing controlling precedent to this district court, held that Congress had “charged Conklin with an unambiguous duty to file, pay, and deposit employment taxes and Conklin cannot avoid responsibility by simply relying on its agent to comply with the statutes.” The district court here applied the same logic in holding Kimdun and its affiliates liable for the delinquency penalties.
This is a tough outcome. If you represent a company whose payroll provider steals its money, look hard at the IRS pronunciations on the relief it may provide to taxpayers in this circumstance. Even if the IRS can win in court decisions that sustain the application of the delinquency, it may not always press for such penalties. It appears there was a little evidence that Kimdun might have had some information to support firing the payroll provider earlier. The case also did not contain information about the IRS failing to follow its own procedures and sometimes you will find that in these cases. Before giving up, seek penalty relief (and in the right circumstances, relief from some of the taxes themselves) but be aware of the precedent and the uphill battle your client will face, because the payroll provider was their agent and ultimately the IRS can place the burden of the loss on the taxpayer.
Compromise may promote ETA and allow for relief if the taxpayer demonstrates that the criminal or fraudulent act of a third party is directly responsible for the tax liability.
In any case involving a fraudulent act of a third party, the taxpayer should be able to provide supporting documentation that the act occurred and was the direct cause of the delinquency. The taxpayer should also be able to show that the nature of the crime was such that despite prudent and responsible business actions the taxpayer was misled to believe the tax obligations were properly addressed. There should be evidence that the funds required for the payment of the taxes were segregated or otherwise identified and were available to pay the taxes in a timely manner. Compromise would promote ETA in such situations only where the failure to comply is directly attributable to intervention by a third party and where the taxpayer has made reasonable efforts to comply and taken reasonable precautions to prevent the criminal or fraudulent acts at issue. If appropriate, the taxpayer’s efforts to mitigate the damages by pursuing collection from the third party should also be considered. Compromise for this reason would only promote ETA where there is a very close nexus between the actions at issue and the failure to comply.
In situations where the actions of a payroll service provider (PSP) contributed to the delinquency, once the offer specialist (OS) has determined sufficient supporting information or documents are available to verify the PSP was the cause of the delinquency and the taxpayer acted in a reasonable manner, the OS may proceed with minimal additional documentation, refer to IRM 5.8.11.5.
Other IRM provisions worth looking at include IRM 5.1.24.4 (08-15-2012) Types of Third-Party Payer Arrangements; IRM 5.1.24.4.2 (08-15-2012) Payroll Service Provider; IRM 5.1.24.5 (08-15-2012) Collection Actions in Cases Involving Third-Party Payers; IRM 5.1.24.5.1 (11-06-2015)Assignment of Third-Party Payer Client Cases; IRM 5.1.24.5.3 (08-15-2012) Use of Electronic Federal Tax Payment System (EFTPS) for Payment Verification; and 5.1.24.5.8 (08-15-2012)Trust Fund Recovery Penalty (TFRP) Investigations.
Victims of payroll tax providers should take a hard look at the ETA offer provisions because they do provide a way out of the problem caused by paying over the taxes twice. Of course, the IRS does not want to serve as a taxpayer’s insurer; however, this relatively new section of the IRM suggests that in the right circumstances, the IRS will take the hit for the taxpayer because that provides the most effective manner to administer the tax laws.
Hopefully, readers of PT will never have to consider this issue, but what is the proper venue on appeal from sanctions imposed by the Tax Court on attorneys under IRC sec. 6673(a)(2)? The answer is not clear. But recent appeals of the rulings in Best v. Commissioner, T.C. Memo. 2014-72 and T.C. Memo. 2016-32, and May v. Commissioner, T.C. Memo. 2014-194 and T.C. Memo. 2016-43, will try to dodge the issue, since both the taxpayers and the same counsel in each case (all of whom were sanctioned) have protectively appealed to the Ninth Circuit (Docket Nos. 16-71777(Best) and 16-71795(May)) and the D.C. Circuit (Docket Nos. 16-1188(Best) and [not yet assigned](May)).
But, that legislation, sadly, did not resolve the issue of the proper venue on appeal from Tax Court attorney sanctions under section 6673(a)(2).
The taxpayers in Best and May all lived in the Ninth Circuit when they filed their Tax Court petitions in 2010 and 2012, respectively. In neither case were the taxpayers contesting the amount of underlying liability. In both cases, the taxpayers were represented by a Phoenix attorney named Donald MacPherson. In the Tax Court, MacPherson’s arguments were only  that (1) the Appeals Settlement Officer abused her discretion in relying only on computer transcripts to verify that the taxpayers’ unpaid tax had been properly assessed and (2) collection could not proceed because the IRS had failed to furnish the taxpayers with Form 23C or RACS 006 (including the name and signature of the assessment officer and the date of the assessment), rather than the Form 4340 transcripts that the IRS had furnished the taxpayers.
The judges in the Best and May cases (Halpern and Lauber, respectively) rejected these arguments as so frivolous at this point that the judges considered the cases to have been filed by the taxpayers primarily for delay. Section 6673(a)(1) allows the court to sanction taxpayers who bring or maintain suits primarily for delay or who maintain frivolous or groundless positions in their cases. In their initial opinions in the cases, the judges both held that collection could proceed and the taxpayers were subject to penalties under section 6673(a)(1) of $5,000 and $500, respectively.
In follow-up opinions in both cases issued earlier this year, the judges decided to impose penalties on MacPherson under section 6673(a)(2) of $19,837.50 and $7,188, respectively. That section provides that “[w]henever it appears to the Tax Court that any attorney . . . has multiplied the proceedings in any case unreasonably and vexatiously,” the court may require that the attorney “pay personally the excess costs, expenses, and attorneys’ fees reasonably incurred because of such conduct.” The judges computed the excess costs using a well-settled “lodestar” amount for the work of IRS attorneys and law clerks.
Moreover, appellate venue regarding section 6673(a)(2) is uncertain. Venue for appeal of Tax Court decisions is governed by section 7482(b). The venue for appeal is likely either the Court of Appeals for the Ninth Circuit (because of the legal residence of petitioners), see sec. 7482(b)(1)(A), or the Court of Appeals for the District of Columbia Circuit, see sec. 7482(b)(1) (flush language). . . . Because we are unsure of appellate venue, and because we find that Mr. MacPherson’s conduct would constitute bad faith under the Court of Appeals for the Ninth Circuit’s test for bad faith, we will for purposes of this case (and without deciding the standard in this Court), adopt that standard.
T.C. Memo. 2016-32, slip op. at *11- *12.
We find that Mr. MacPherson knowingly or recklessly advanced arguments that he knew were frivolous and lacking in any legal basis. Because his actions thus manifested subjective bad faith, they are deserving of sanction under section 6673(a)(2). See Moore v. Keegan Mgmt. Co. (In re Keegan Mgmt. Co., Sec. Litig.), 78 F.3d 431, 436 (9th Cir. 1996); Reliance Ins. Co. v. Sweeney Corp., 792 F.2d 1137, 1138 (D.C. Cir. 1986); Takaba v. Commissioner, 119 T.C. 285, 296-297 (2002).
T.C. Memo. 2016-43, slip op. at *15 (footnote omitted).
In early June, notices of appeal were filed in both cases in the Ninth and D.C. Circuits. All four of the notices attach the rulings of the Tax Court in the opinions that sanctioned MacPherson, but not the earlier opinions concerning the taxpayers. All notices of appeal nominally are in the names of the taxpayers, but are signed only by MacPherson. While the notices of appeal are a bit confusing (and may not be jurisdictionally-sufficient for all of the parties desiring to appeal), it appears that the appeals are intended to be both on behalf of the taxpayers and MacPherson, even though MacPherson has not put his name in the captions of the appeals as an appellant.
In the notices of appeal to the D.C. Circuit, MacPherson explains (without citing Byers) that venue on appeal of CDP cases such as Best and May is unclear, and so the filings in the D.C. Circuit are essentially protective. He states that the appellants prefer that the appeals be heard by the Ninth Circuit and that he has asked counsel for the government to stipulate to the Ninth Circuit as the proper venue.
I expect that the government will agree to the requested stipulation – both for the taxpayers and MacPherson’s penalty appeals.
When evaluating appellate venue after a taxpayer files a notice of appeal, if the taxpayer appeals a non-liability case to the D.C. Circuit, and the case is not enumerated in section 7482(b), Chief Counsel attorneys should not recommend objecting to venue since Byers is controlling in the D.C. Circuit. If a taxpayer appeals a non-liability case to the proper regional circuit, Chief Counsel attorneys should likewise not object to venue as the taxpayer’s choice of venue is consistent with our position.
(Emphasis added.) It is thus the IRS preference to litigate CDP cases in the regional Circuits of the taxpayers’ residence.
Second, I don’t expect the IRS to object to venue of MacPherson’s penalty appeals in the Ninth Circuit, either, since judicial economy (and government briefing expenses) would be served by hearing the taxpayers’ and their lawyer’s appeals together.
But, I do want to discuss the open question as to the proper venue for an attorney who is appealing penalties imposed by the Tax Court under section 6673(a)(2).
Recall that section 7482(b)(1)’s flush language provides a general rule that appeals from the Tax Court go to the D.C. Circuit, unless one of a series of lettered subparagraphs applies. Subparagraph (A) directs appeals by individuals from rulings involving petitions seeking redetermination of tax liability to the Circuit of the individual’s residence. Just as in Byers, where the D.C. Circuit held CDP petitions not to fall within subparagraph (A), in Dornbusch v. Commissioner, 860 F.2d 611 (5th Cir. 1988), the Fifth Circuit held that an appeal from a Tax Court criminal contempt order against a third-party witness could not be heard by the Circuit of the petitioner’s residence but had to be heard by the D.C. Circuit under the flush language of section 7482(b)(1). In that case, the Fifth Circuit transferred the criminal contempt appeal to the D.C. Circuit.
More recently and to the point, the Tax Court has speculated that appeals of its section 6673(a)(2) penalties on attorneys also probably don’t fall within subparagraph (A) of section 7482(b)(1) or any other subparagraph, so, absent stipulation otherwise, should go only to the D.C. Circuit. Takaba v. Commissioner, 119 T.C. 285, 297 (2002); Edwards v. Commissioner, T.C. Memo. 2003-149, aff’d, 119 Fed. Appx. 293 (D.C. Cir. 2005) (D.C. Cir. opinion lacks any discussion of venue); Davis v. Commissioner, T.C. Memo. 2007-201, taxpayer’s appeal only aff’d, 301 Fed. Appx. 389 (6th Cir. 2008) (attorney’s appeal dismissed because notice of appeal did not make clear that attorney was appealing).
The issue of venue for appeals of section 6673(a)(2) penalties once came up in a D.C. Circuit opinion. The taxpayer had appealed his case, Powell v. Commissioner, T.C. Memo. 2009-174, to the Sixth Circuit, where the appeal was pending when the taxpayer’s attorney appealed his section 6673(a)(2) sanctions in the case to the D.C. Circuit. The DOJ apparently moved to transfer the attorney’s appeal to the Sixth Circuit, but the D.C. Circuit directed briefing on the entire case (including the transfer issue), and when the D.C. Circuit issued its opinion in Barringer v. U.S. Tax Court, 408 Fed. Appx. 381 (D.C Cir. 2010)[free copy unavailable], it affirmed the Tax Court without transferring the case, writing: “Because the appeal has been fully briefed and argued, the judicial economy rationale of the Tax Court’s suggestion this appeal be transferred to the Sixth Circuit where the taxpayer’s appeal is pending, no longer exists.” Thus, the Barringer opinion also does not decide the normally-correct venue on appeal for a section 6673(a)(2) penalty case.
In hunting around for other venue rulings on section 6673(a)(2) penalties, I found one opinion from a regional Circuit, Johnson v. Commissioner, 289 F.3d 452 (7th Cir. 2002). In the Tax Court case related thereto, the taxpayer, Johnson, lived in Indiana (within the Seventh Circuit). Johnson v. Commissioner, 116 T.C. 111, 112 (2001). After ruling against the taxpayer, the Tax Court also sanctioned her attorney, Joe Izen, under section 6673(a)(2). Izen was from Texas. Apparently, only Izen appealed the case to the Seventh Circuit to contest his penalties. The Seventh Circuit held that the penalties were warranted, but did not discuss the venue on appeal – leading me to assume the DOJ did not raise the issue of possible improper venue.
In sum, there are no appellate court opinions – precedential or otherwise – on the correct venue on appeal from attorney penalties imposed by the Tax Court under section 6673(a)(2), just Tax Court speculation that proper appellate venue, absent stipulation otherwise, probably is only the D.C. Circuit.
May readers never have to be involved in a case where this issue has to be resolved.
Two quick items here. First, the IRS in late April 2016 has issued final regs under Section 6708 regarding the penalty for material advisors for failure to make available lists with respect to reportable transactions. General write up can be found on the TaxAdvisor webpage here. Some changes have been viewed positively, as easing slightly the penalties on advisors.
More interesting to me, but somewhat substantive, is an update to the Cosentino case we covered in SumOp back in 2014, which can be found here. In Cosentino, the Tax Court held that malpractice proceeds received by a taxpayer against his accountant were not taxable income. The accountant had advised the taxpayers to enter into a transaction that was later determined to be a tax shelter. The shelter was used to artificially inflate the basis in real estate, which didn’t work (very oversimplified, and you can find more on the specifics from Roberts and Holland here). The taxpayers claimed they would not have entered into the transaction had they known it was bunk, and, as such, should be entitled to the tax back from the accountant. They ended up getting $375,000.
The taxpayer’s argued that this was a replacement of capital, and, to the extent the replacement of capital didn’t exceed basis, was not taxable. The Service disagreed, stating the correct amount of tax on the sale of the property was sold (which it believed removed the case from a set of precedent that held if more than the proper amount of tax was paid, the recovery of the excess was not taxable). The Court held that the taxpayers would have sold the property, but used Section 1031 to defer the tax, had they known the accountant was providing shady shelter advice, and then got a step up in basis at death—a bit speculative. The Court holding essentially gave them the step up during lifetime, without possibly passing through the estate tax system. An interesting result, but this is a difficult situation to put the parties back into their prior positions.
The Service did not appeal the case. Apparently it didn’t view this as the winning case to take on appeal, didn’t like the venue, or wasn’t ready to keep arguing this point. In April, however, the Service let us all know that it intends to continue litigating this issue in other cases. See AOD 2016-001. We do not see many IRS actions on decisions anymore these days, so this is pretty exciting.
There has been lots of other great coverage on this case. We haven’t linked Ed Zollar’s writing enough here on SumOp, but we check his blog pretty frequently. He wrote about the AOD here. The always entertaining Tony Nitti also wrote about the case back in 2014 for Forbes. You can find more background in that article, which is found here.

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