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Couple Seeks Reversal of Decision on Valuation Misstatement Penalties

NOV. 15, 2018

John L. Roth et ux. v. Commissioner

DATED NOV. 15, 2018
DOCUMENT ATTRIBUTES

John L. Roth et ux. v. Commissioner

JOHN L. & DEANNE M. ROTH,
Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.

IN THE UNITED STATES COURT OF APPEALS
FOR THE TENTH CIRCUIT

ON APPEAL FROM THE UNITED STATES TAX COURT
THE HONORABLE L. PAIGE MARVEL,
CHIEF JUDGE, UNITED STATES TAX COURT
DOCKET NO. 5544-12

REPLY BRIEF FOR THE APPELLANTS

James R. Walker, Esq.
LEWIS ROCA ROTHGERBER CHRISTIE LLP
1200 17th Street, Suite 3000
Denver, CO 80202
Tel:(303) 623-9000
Fax:(303) 623-9222
Email:jwalker@lrrc.com
Attorneys for Appellants


TABLE OF CONTENTS

INTRODUCTION

I. The Government's Clerical Error Assertion and Admission That the Penalties Will Be Imposed Since the Roths Refused to Settle Before the Notice of Deficiency Was Issued

II. Government Distorts Second Circuit Chai Holding and Ignores Its Factual Underpinnings

III. A Section 6751(b) Initial Determination Cannot Be Made by an IRS Examiner

IV. Government Flouts the Supreme Court, This Court's Decision in Fisher and Plain Terms of the Administrative Procedure Act

A. The APA Is Clear and Unambiguous

B. The Government's Contrary Position Distorts and Ignores the APA's Text

CONCLUSION

TABLE OF AUTHORITIES

CASES

Ax v. Commissioner, 146 T.C. 153 (2016)

Brown v. Williamson, 529 U.S. 120 (2000)

Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017)

Cohen v. United States, 650 F.3d 717 (D.C. Cir. 2011)

Dickinson v. Zurko, 527 U.S. 150 (1999)

Ewing v. Commissioner, 122 T.C. 32 (2004)

FCC v. Fox Television Stations, Inc., 556 U.S. 502 (2009)

Fisher v. Commissioner, 45 F.3d 396 (10th Cir. 1995)

Graev v. Commissioner, 149 T.C. No. 23 (2017)

Graham County Soil & Water Conservation Dist. v. United States ex. Rel. Wilson, 559 U.S. 280 (2010)

King v. Burwell, 576 U.S. ___ (2015) 

Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44 (2011)

Ramaprakash v. FAA, 346 F.3d 1121 (D.C. Cir. 2003)

Skinner v. Mid-America Pipeline Co., 490 U.S. 212 (1989)

STATUTES, REGULATIONS AND RULES

5 U.S.C. § 551

5 U.S.C. § 556

5 U.S.C. § 559

5 U.S.C. § 706

I.R.C. § 6213

I.R.C. § 6214

I.R.C. § 6751

I.R.C. § 7522

Tax Court Rule 142

Tax Court Rule 41

Treas. Reg. § 601.103

OTHER AUTHORITIES

143 Cong. Rec. H10001 (daily ed. Nov. 5, 1997 (Statement of Rep. Dreier)

143 Cong. Rec. H10029 (daily ed. Nov. 5, 1997 (Statement of Rep. Paul)

IRS Reform Act § 3306

Stephanie Hoffer & Christopher J. Walker, The Death of Tax Court Exceptionalism, 99 Minn. L. Rev. 221 (2014)


 

INTRODUCTION

This case presents important questions of taxpayers' rights and federal administrative law. In 1997, Congress conducted three days of hearings on IRS conduct and actions. During these hearings, IRS agents confessed to an established policy of intimidating weak and poor taxpayers in order to make examples of them. See 143 Cong. Rec. H10029 (daily ed. Nov. 5, 1997 (Statement of Rep. Paul)).

Following the hearings, Congress enacted the Internal Revenue Service Restructuring and Reform Act of 1998. Pub L. No. 15-206, 112 Stat. 685 (July 22, 1998). This legislation was intended to comprehensively reform the Internal Revenue Service making the Agency more user-friendly and more accountable to taxpayers. See 143 Cong. Rec. H10001 (daily ed. Nov. 5, 1997 (Statement of Rep. Dreier)).

Buried in this 1998 comprehensive legislative reform effort was a statutory provision placing new procedural requirements upon the IRS. IRS Reform Act § 3306, I.R.C. § 6751. Although enacted 20 years ago, Section 6751 long suffered from neglect. It has, however, found new vitality.

Just last year, the Second Circuit addressed a taxpayer challenge under Section 6751. Chai v. Commissioner, 851 F.3d 190, 215-223 (2d Cir. 2017). Armed with this new appellate guidance, the United States Tax Court then took a deeper review into a taxpayer's Section 6751(b) challenge, reversing its earlier ruling and issuing a new opinion . . . “in the interest of repose and uniformity on an issue that touches many cases before us.” Graev v. Commissioner, 149 T.C. No. 23 (2017).1

The Administrative Proceeding

In the instant case, the Roths participated in an IRS administrative audit proceeding that concluded on January 28, 2011, when the IRS Examiner released proposed adjustments. The proposed adjustments included a total disallowance of the Roths' charitable contributions deduction associated with their perpetual easement donation. Appx. 10. On February 11, 2011, through counsel, the Roths submitted a written protest of proposed IRS audit adjustments and requested a conference with IRS Appeals. App. 154-158. In submitting this written protest, the Roths followed longstanding federal administrative tax procedure regulations. Treas. Reg. § 601.103(c)(1).

Following receipt of their written protest, the IRS granted the Roths a conference with the IRS Appeals Office. Id. The conference did not result in any resolution of the Roths' tax dispute. Following the conference, the Appeals Officer prepared an “Appeals Case Memo” summarizing the Agency's position. Appx. 14-16.

On December 2, 2011, the Internal Revenue Service Appeals Office issued a Notice of Deficiency (“Notice”). This Notice represented the IRS' determination of the Roths' tax liability and penalties.

A notice of deficiency represents the Agency's final determination of a taxpayers' tax liability and, if not challenged in court, enables the IRS to demand payment from the taxpayer in the amount assessed. I.R.C. § 6213(c). Longstanding Treasury regulations provide that such a notice of deficiency is considered final insofar as the taxpayer's appeal rights within the Service is concerned. Treas. Reg. § 601.103(b).

The Notice issued to the Roths did not contain any determination that the Roths owed a gross valuation misstatement penalty. On April 24, 2012, after the Roths filed their Petition in the United States Tax Court and, later, during the Tax Court judicial proceeding, attorneys with the Office of Chief Counsel filed an answer asserting the prior IRS determination could be amended with the addition of new valuation misstatement penalties. App. 83-86.

Notwithstanding the Roths' assertion that this belated action violated the protections embedded in I.R.C. § 6751(b), the United States Tax Court sustained valuation penalties contending that

no matter which of these three instances was the initial determination of the 40% penalty, Section 6751(b) was satisfied because each instance was approved in writing by an immediate supervisor.

App. 195.

The Roths commenced this appeal, asserting that the IRS Notice contained the IRS's initial determination (as such term is set forth in Section 6751(b)). Since the Notice failed to include valuation penalties, the Roths contend Section 6751(b) prohibits the IRS from later attempting to “amend” the initial determination expressed in the Notice to add penalties during the Tax Court judicial proceeding.

The Government counters asserting (Br. 12) that Chai fashioned a “workable” interpretation of Section 6751(b). The Government also contends (Br. 12) that Chai established a separate analysis and alternative statutory approach for penalties that are not included in a Notice of Deficiency. As described in their opening brief and below, the Roths disagree.

I. The Government's Clerical Error Assertion and Admission That the Penalties Will Be Imposed Since the Roths Refused to Settle Before the Notice of Deficiency Was Issued

The Government asserts (Br. 33) that the IRS Office of Appeals apparently made a clerical error in preparing the Notice. Notwithstanding the purported blunder, the Government forges ahead asserting (Br. 33) that this is not a case where “an unapproved initial determination of the penalty” was allowed “to proceed through administrative proceedings, settlement negotiations, and potential Tax Court proceedings, only to be approved sometime prior to assessment” (a state of affairs the Second Circuit stated “would do nothing to stem the abuses § 6751(b)(1) was meant to prevent”), Chai, 851 F.3d at 219. The Government also adds (Br. 33-34) that nothing about these facts suggest that, in this case, any “IRS agents” were “threatening unjustified penalties to encourage taxpayers to settle.” Id.

The Roths believe the record contains uncontroverted direct evidence that the Internal Revenue Service intended to impose valuation misstatement penalties because a settlement with IRS Appeals could not be achieved. App. 16. IRS Appeals Officer Kawakami (i.e. the individual primarily responsible for preparing the Notice of Deficiency) explained his reasoning and intent that valuation penalties should be imposed as retaliatory action. In his Appeals Case Memo, Appeals Officer Kawakami warned that:

The proposed penalties are fully sustained for the government. It has been determined that since the rep will not consider any settlement until the outcome of the Temple/Escobar cases currently being heard in TC, that all related cases should be processed as SND and all issues including penalties should be fully sustained for the government.

App. 16 (emphasis added).

Although entirely ignored by the United States Tax Court, Mr. Kawakami's factual settlements are competent, relevant direct evidence. The statements constitute an admission and clear evidence of the Agency's wrongful intent. Section 6751(b) was enacted to prevent just this circumstance.

II. Government Distorts Second Circuit Chai Holding and Ignores Its Factual Underpinnings

At the heart of its defense, the Government asserts Chai pioneered a new “bifurcated approach” to Section 6751(b)'s procedural requirements. (Br. 12.) The Government distorts Chai's holding and overlooks its underlying facts.

Contrary to position asserted by the Government, Chai directs that:

It is not enough that approval be given before the Tax Court proceeding ends, however, for the supervisor's discretion to be given force the approval must be issued before the Tax Court proceeding is even initiated. Section 6751 requires supervisory approval of the “initial determination of such assessment.”

851 F.3d at 220 (emphasis added).

Chai supports the Roths' assertion that the initial penalty determination must be made in the Notice. Unlike in this case, the Chai notice of deficiency did contain the required penalty determination:

The Notice of Deficiency the Commissioner issued Chai in May 2009 indicates that the determinations were made by Deborah Bennett, Technical Services Territory manager for the IRS, or a revenue agent working under her authority. See App'x 30. Form 886-A, which was included with the Notice of Deficiency, details why the IRS determined to assess the penalty, including that the IRS employee determined that Chai lacked reasonable cause for the underpayment. See App'x 40-41.

851 F.3d at 217.

With the penalty asserted in the original notice of deficiency and a “reasoned explanation” documented and disclosed to the taxpayer, Chai presented a fundamentally different case. The Second Circuit opinion lacks any discussion of a “bifurcated approach.” In Chai, the Internal Revenue Service lawyers did file an “answer” asserting income tax and penalty adjustments. 851 F.3d at 201. But unlike the penalties asserted in this case, the Chai penalties adjustments were “corresponding” and computational to the notice of defiency. The answer merely adjusted the previously determined penalty amounts based upon income tax revisions that were made to tax determinations set forth in the notice of deficiency. No new penalties were asserted in the Chai answer.

The Second Circuit opinion contains a footnote reference to penalties asserted in an “answer or amended answer.” 851 F.3d at 221, n. 24. The opinion's footnote reference is only in passing and provides no description or discussion of a purported bifurcated analysis applying to new post-notice of deficiency penalty determinations. The Government's reading of Chai is unsupported.

III. A Section 6751(b) Initial Determination Cannot Be Made by an IRS Examiner

Following the Tax Court's lead, the Government asserts (Br. 34) that the IRS examiner can make the “initial determination” of such assessment. This assertion is legally wrong; it is fundamentally at odds with the Internal Revenue Code and Treasury regulations.

Under the general rule of I.R.C. § 6213(a), in order for the Internal Revenue Service to make an assessment, the Internal Revenue Service must issue a notice of deficiency. See Section 6213(a) (. . . no assessment of a deficiency . . . shall be made, begun or prosecuted until such notice has been mailed . . . ).

Section 6213(a) ties the Internal Revenue Service's ability to record an “assessment” directly to a notice of deficiency. Section 6213(a) bars the IRS from assessing tax or penalties based solely upon an examiner's findings. The IRS examiner's conclusions are preliminary and merely proposed. Such findings do not constitute a notice of deficiency. As such, the only way for an assessment to occur is for the IRS to insert tax or penalty determinations into a notice of deficiency.

Longstanding treasury regulations confirm this established characterization of an examiner's audit results.  Treas. Reg. §601.103(b) (describing IRS examiner's adjustments as “proposed” and, after issued, provide taxpayers with appeal rights). The Government's contention (and Tax Court's holding) wrongfully overlook the preliminary nature of an IRS examiner's work product. Such proposed audit adjustments cannot constitute an “initial determination of such assessment” as those terms are expressed in I.R.C. § 6751(b).

As reviewed above, Congress enacted I.R.C. § 6751(b) to address IRS audit tactics and “sharp dealings” that abuse a taxpayer's decision to participate in the administrative process. As Chai declares, I.R.C. §6751(b) contains a temporal element aiming its requirements at IRS penalty determinations that are found in a notice of deficiency. ([Section 6751(b)] was meant to prevent IRS agents from threatening unjustified penalties to encourage taxpayers to settle), Chai, 851 F.3d at 219.

The Government argues (Br. 47) that the Roths “have not been wronged, either procedurally or substantively, by the Commissioner's decision to raise the penalty in his Answer.” The Government's argument is false.

Following the alleged clerical blunder, IRS attorneys represented (App. 86) to the United States Tax Court that they held the legal authority to “amend” previous IRS determinations as set forth in a Notice. The Roths can find no authority for amending initial determinations. The Government fails to cite any such authority.

By its terms, the IRS's answer (and specifically its prayer clause statement) acknowledges that the IRS's initial penalty determinations were contained in the Notice. The IRS prayer clause then wrongfully asserts that the Commissioner's earlier penalty determination could be “amended” with the addition of a new penalty. Such a contention undermines Congress' attempt to end abusive audit tactics and safeguard taxpayer's rights.

The Government suggests (Br. 38-41) that United States Tax Court jurisdictional authority under I.R.C. § 6214(a) allows the Tax Court to make an “initial determination of such assessment” under I.R.C. § 6751(b). This suggestion lacks merit.

The United States Tax Court's jurisdictional authority awarded under Section 6214(a) and its jurisdiction to impose penalties are outside of Section 6751(b). As described in the Government's brief, Section 6751(b) addresses IRS conduct during the audit. Nowhere in the legislative history of this provision is there any hint that Congress intended to modify the jurisdictional award set forth in Section 6214(a).

Notwithstanding its attempted reliance on Section 6214(a), the Government curiously contends (Br. 45-47) that neither Section 6751(a) nor Section 7522 have any applicability in this case. Both provisions, however, plainly express Congress' intent and desire that notices of deficiency contain penalty details and computations.

These statutory provisions support the Roths' analysis. They must be considered. The United States Supreme Court supports the careful evaluation of additional Internal Revenue Code provisions. See King v. Burwell, 576 U.S. ___ (2015) (Slip at 9) (. . . often times the “meaning — or ambiguity — of certain words or phrases may only become evident when placed in context.” Brown v. Williamson, 529 U.S. 120, 132 (2000). So when deciding whether the language is plain, we must read the words “in their context and with a view to their place in the overall statutory scheme.” Id., at 133 (internal quotation marks omitted). Our duty, after all, is “to construe statutes, not isolated provisions.” Graham County Soil & Water Conservation Dist. v. United States ex. Rel. Wilson, 559 U.S. 280, 290 (2010) (internal quotation remarks omitted). See also King v. Burnell, 576 U.S. ___ (2015) (slip at 21) (“. . . in every case we must respect the role of the legislature, and take care not to undo what it has done. A fair reading of legislative demands a full understanding of the legislative plan.”

Contrary to the Government's bald assertions, the IRS' conduct, its admission by the Appeals Officer, and IRS counsel's retaliatory action constitute the precise abuses that Congress meant to prevent. Chai, 851 F.3d at 219. Following the Supreme Court's directives, this Court should reverse the Tax Court and issue a ruling that carries out Congress' 1998 legislative plan.

In addition to asserting that Section 6214(a) supports the IRS actions taken in this case, the Government (Br. 20-21) contends that the Tax Court Rules (i.e. Rules 142(a)(1) and 41(b)(1)) support the IRS' conduct and actions.

But the United States Tax Court rules cannot modify the provisions of the Internal Revenue Code. Just two years ago, the Tax Court instructed that “. . . Congress has the power to override the Tax Court rules and to provide, however radically, that 'new matter' could not be litigated in a deficiency case.” Ax v. Commissioner, 146 T.C. 153, 164 (2016).

By enacting Section 6751(b), Congress did just that — it declared that penalties cannot be imposed — except following an “initial determination of such assessment.” Section 6751(b)'s protections are not limited by the rules of practice and procedure promulgated by the United States Tax Court.

IV. Government Flouts the Supreme Court, This Court's Decision in Fisher and Plain Terms of the Administrative Procedure Act.

Flouting the United States Supreme Court's Mayo Foundation decision, this Court's holding in Fisher and the plain terms of the federal administrative procedure act, the Government asserts (Br. 20) that Congress established a unique system of judicial review for tax cases incompatible with the Administrative Procedure Act (“APA”).

In making this bold declaration, the Government interjects (Br. 14) the discredited theory of tax exceptionalism.2 The United States Supreme Court rejected this concept in 2011 and 16 years earlier, this Court rejected the theory. Fisher v. Commissioner, 45 F.3d 396 (10th Cir. 1995). **

Seven years ago, the United States Supreme Court issued its opinion in Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44 (2011). Squarely rejecting the position the Government now continues to advocate, the Court announced:

. . . we are not inclined to carve out an approach to administrative review good for tax law only. To the contrary, we have expressly “[r]ecognize[ed] the importance of maintaining a uniform approach to judicial review of administrative action.” Dickinson v. Zurko, 527 U.S. 150, 154 (1999). See, e.g., Skinner v. Mid-America Pipeline Co., 490 U.S. 212, 222-223 (1989) (declining to apply “a different and stricter nondelegation doctrine in cases where Congress delegates discretionary authority to the Executive under its taxing power”).

562 U.S. at 55.

Sixteen years before Mayo Foundation, this Court issued its decision in Fisher. In Fisher, this Court applied generally applicable administrative law principles — and more particularly, the requirement that an agency provide a reasoned explanation for its actions — to the notice of deficiency. 45 F.3d at 396-97.

Because the IRS had offered no “reasoned explanation” for its penalty determination in the Notice of Deficiency, this Court struck down the penalty assessment. Id. at 397. This Court instructed that “The IRS cannot make taxpayersv haul it into Tax Court . . . to discover what the rationale for its decision is.” Id.

In reaching these directives, Fisher supports a critical review of the Notice and the determinations contained therein. Taxpayer rights and decisions flow from this Agency action. “Defective” notices cannot be allowed to serve as an inducement to experience a freewheeling government trampling upon a taxpayer's rights.

Contrary to this appellate guidance, the Tax Court's has declared “well established”3 the proposition “that the APA does not apply to deficiency cases in [the Tax] Court; that is, cases arising under sections 6213 or 6214 in which we may redetermine the taxpayer's tax liability.” Ewing v. Commissioner, 122 T.C. 32, 37 (2004).

Not all Tax Court Judges agree. See, e.g., id. at 61 (Halpern & Holmes, JJ., dissenting) (“[T]he majority's premise that the judicial review provisions of the APA do not apply to deficiency cases in [the Tax Court cannot stand.”).

The Court of Appeals for the D.C. Circuit has addressed this fundamental issue of administrative law. “[T]he IRS is not special in this regard; no exception exists shielding it — unlike the rest of the Federal Government — from suit under the APA.” Cohen v. United States, 650 F.3d 717, 723 (D.C. Cir. 2011) (en banc). Even if there are “good policy reasons to exempt IRS action from judicial review,” the en banc D.C. Circuit explained, “Congress has not made that call” and the courts “are in no position to usurp [its] choice.” Id. at 736. See also Mayo, 562 U.S. at 55 (“. . . there is simply no statutory basis for “carv[ing] out an approach to administrative review good for tax law only.”)

A. The APA Is Clear and Unambiguous

Section 706(2)(A) of the APA — the provision from which the reasoned-explanation requirement comes, FCC v. Fox Television Stations, Inc., 556 U.S. 502, 513-14 (2009) — applies whenever a “reviewing court” is asked to “set aside agency action” as “arbitrary” or “capricious.” 5 U.S.C. § 706(2)(A); see Dickinson v. Zurko, 527 U.S. 150, 154 (1999) (where “agency action” is challenged before a “reviewing court,” the “reviewing court must apply the APA's court/agency review standards in the absence of an exception” (emphasis added)).

As a matter of plain text, Section 706(2)(A) thus applies to United States Tax Court review of Notices of Deficiency:

  • The IRS is an “agency.” See 5 U.S.C. § 551(1).

  • A Notice of Deficiency is “agency action.” See 5 U.S.C. § 551(6).

  • And the Tax Court is a “reviewing court.” 5 U.S.C. § 706.

At its core, the Government's tax exceptionalism assertion invites a question of whether the IRS is bound by elemental APA requirements or whether it is somehow exempt in a way that other federal agencies are not.

Nothing in the APA suggests, much less explicitly states, that the IRS is different or exempt. Certainly the APA contains no exception for the IRS (or, for that matter a notice of deficiency). This Court should uphold that no such exemption exists.

B. The Government's Contrary Position Distorts and Ignores the APA's Text

Section 556(b) of the APA states that “[t]his subchapter does not supersede the conduct of specified classes of proceedings. . . .” 5 U.S.C. §556(b) (emphasis added). Section 556(b) appears in the APA subchapter devoted to “Administrative Procedure” before agencies themselves — subchapter II of Chapter 5. The APA's provisions for judicial review, meanwhile, appear in Chapter 7.

Section 559 provides that “chapter 7 do[es] not limit or repeal additional requirements imposed by statute or otherwise recognized by law.” 5 U.S.C. § 559 (emphasis added). That qualifier is crucial: it means that preexisting requirements apply in addition to the APA's uniform requirements, not in place of them. See Dickinson, 527 U.S. at 155 (“The APA was meant to bring uniformity to a field full of variation and diversity.”).

Of course, in theory, Congress could choose to exempt the IRS, or Notices of Deficiency, from the APA — but it hasn't. Certainly Congress has not expressly exempted the IRS from any provision of the APA. That is the end of the ballgame. Section 559 of the APA specifies that agency-specific exceptions cannot be inferred, but can only be made “expressly.” 5 U.S.C. § 559.

The government fails to identify any statute that “expressly” exempts the IRS from the APA's standards of judicial review or any other APA requirement. As this Court held 23 years ago, there is no such exemption. Fisher, 45 F.3d at 397.

CONCLUSION

The Internal Revenue Service's conduct in this case falls squarely within the types of audit action that Congress sought to prevent. Two decades after Section 6751(b)'s enactment, the Government's penalty tactics continue unabated. This Court should reverse the Tax Court's ruling and carry out Congress' legislative plan to protect taxpayer's rights and enter judgment in favor of the Taxpayers.

James R. Walker
LEWIS ROCA ROTHGERBER CHRISTIE LLP
1200 17th Street, Suite 3000
Denver, CO 80202
Tel:(303) 623-9000
Fax:(303) 623-9222
Email:jwalker@lrrc.com
Attorneys for Appellants

FOOTNOTES

1The Tax Court's 2017 Graev opinion exposed sharp differences among the United States Tax Court judges. The opinion is 81 pages long with six judges dissenting in part from the majority's conclusions and approach. Judge Buch's separate opinion specifically addressed the role and limited authority of IRS counsel.

2“Tax jurisprudence and scholarship have suffered” for “decades . . . from what has been labeled 'tax exceptionalism' — the perception that tax law is so different from the rest of the regulatory state that general administrative law doctrines and principles do not apply.” Stephanie Hoffer & Christopher J. Walker, The Death of Tax Court Exceptionalism, 99 Minn. L. Rev. 221, 222 (2014).

3Cf. Ramaprakash v. FAA, 346 F.3d 1121, 1122 (D.C. Cir. 2003) (“Learned Hand once remarked that agencies tend to 'fall into grooves, . . . and when they get into grooves, then God save you to get them out.'” (alteration in original) (citation omitted)).

END FOOTNOTES

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