Menu
Tax Notes logo

Individual Claims Entitlement to Judicial Review of Penalty Assessment

SEP. 5, 2017

John M. Larson v. United States

DATED SEP. 5, 2017
DOCUMENT ATTRIBUTES
  • Case Name
    John M. Larson v. United States
  • Court
    United States Court of Appeals for the Second Circuit
  • Docket
    No. 17-503
  • Institutional Authors
    Kostelanetz & Fink LLP
    Nelson, Mullins, Riley & Scarborough LLP
  • Cross-Reference

    Appealing Larson v. United States, No. 1:16-cv-00245 (S.D.N.Y. 2016).

  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Tax Analysts Document Number
    2018-1992
  • Tax Analysts Electronic Citation
    2018 TNT 10-48

John M. Larson v. United States

[Editor's Note:

The addendum can be viewed in the PDF version of the document.

]

JOHN M. LARSON,
Plaintiff-Appellant,
v.

UNITED STATES OF AMERICA,
Defendant-Appellee.

IN THE
United States Court of Appeals
FOR THE SECOND CIRCUIT

ON APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF NEW YORK

REPLY BRIEF FOR PLAINTIFF-APPELLANT

MEGAN L. BRACKNEY
KOSTELANETZ & FINK, LLP
7 World Trade Center
New York, New York 10007
(212) 808-8100

REED J. HOLLANDER
NELSON MULLINS RILEY & SCARBOROUGH, LLP
4140 Parklake Avenue, Suite 200
Raleigh, North Carolina 27612
(919) 329-3800

C. WELLS HALL, III
NELSON MULLINS RILEY & SCARBOROUGH, LLP
100 North Tryon Street, 42nd Floor
Charlotte, North Carolina 28202
(704) 417-3000

Attorneys for Plaintiff-Appellant


Table of Contents

INTRODUCTION

POINT I — THE FLORA FULL PAYMENT RULE DOES NOT APPLY TO APPELLANT'S REFUND SUIT

A. Contrary to the Government's Stinting Reading, Flora Repeatedly Presumed the Existence of a Deficiency Allowing Tax Court Review

B. The Government's Attempts to Distinguish Laing and Irving Contradict Its Own Arguments in Laing

C. The Second Circuit Cases Cited by the Government are Not On Point

D. The Statutory Exceptions to the Full Payment Rule Support Appellant's Position

POINT II — DUE PROCESS REQUIRES THAT APPELLANT HAVE ACCESS TO JUDICIAL REVIEW OF THE ASSESSMENT OF PENALTIES AGAINST HIM

A. It is Not Constitutionally Adequate to Demand Payment in Full of an IRS Penalty Originally Exceeding $160 Million Before Access to Any Judicial Review

B. IRS Appeals Review Alone Does Not Provide Due Process for Appellant

POINT III — THE COURT SHOULD EXERCISE JURISDICTION OVER APPELLANT'S APA CLAIM SO THAT HE IS NOT DEPRIVED OF JUDICIAL REVIEW OF THE PENALTY IMPROPERLY ASSESSED AGAINST HIM

POINT IV  THE COURT SHOULD ALLOW APPELLANT'S EIGHTH AMENDMENT CLAIM TO GO FORWARD

CONCLUSION

TABLE OF AUTHORITIES

CASES

Ardalan v. United States, 748 F.2d 1411 (10th Cir. 1984)

Ashcroft v. Iqbal, 556 U.S. 662 (2009)

Austin v. United States, 509 U.S. 602 (1993)

Baker v. Comm'r, 787 F.2d 637 (D.C. Cir 1986)

Bob Jones Univ. v. Simon, 416 U.S. 725 (1974)

Bowen v. Mich. Academy of Family Physicians, 476 U.S. 667 (1986)

Cafeteria Workers v. McElroy, 367 U. S. 886 (1961)

Cassuto v. Comm'r, 93 T.C. 256 (1989), aff'd in part, rev'd on other grounds, 936 F2.d 736 (2d Cir. 1991)

Cataldo v. Comm'r, 60 T.C. 522 (1973)

Chapman v. Comm'r, T.C. Summ. Op. 2009-155

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

Curry v. United States, 774 F.2d 852 (7th Cir. 1985)

Diversified Group, Inc. v. United States, 123 Fed. Cl. 442 (2015)

Donelan Phelps & Co v. United States, 681 F. Supp. 615 (E.D. Mo. 1987)

Estate of Baird v. Comm'r, 416 F'3d 442 (5th Cir. 2005)

Estate of Landers v. Leavitt, 545 F.3d 98 (2d Cir. 2008)

Estate of Michael ex. Rel. Michael v. Lullo, 173 F.3d 502 (4th Cir. 1999)

Fitzgerald v. United States, 789 F. Supp. 177 (E.D. Pa. 1992)

Flora v. United States, 357 U.S. 63 (1958), aff'd on reh'g, 362 U.S. 145 (1960)

Forma v. United States, 42 F.3d 753 (2d Cir. 1994)

Hall v. United States, 493 F.2d 1211 (6th Cir. 1974)

Hanson v. Comm'r, 975 F.2d 1150 (5th Cir. 1992)

Holmes v Director, Dep't of Revenue, 937 F.2d 481 (9th Cir. 1991)

Hubbard v. Comm'r, 89 T.C. 792 (1987)

Iames v. Comm'r, 850 F.3d 160 (4th Cir. 2017)

In re American Bicycle Ass'n, 895 F.2d 1277 (9th Cir. 1990)

Irving v. Gray, 479 F.2d 20 (2d Cir. 1973)

Judicial Watch, Inc. v. Rossotti, 317 F.3d 401 (4th Cir. 2003)

Kahn v. United States, 753 F.2d 1208 (3d Cir. 1985)

Keller Tank Serv. Inc. v. Comm'r, 854 F.3d 1178 (10th Cir. 2017)

Laing v. United States, 423 U.S. 161 (1976)

Magnone v. United States, 902 F.2d 192 (2d Cir. 1990)

Mathews v. Eldridge, 424 U.S. 319 (1976)

Matter of La Salle Rolling Mills, Inc., 832 F.2d 390 (7th Cir. 1987)

Minahan v. Comm'r, 88 T.C. 492 (1987)

Moore v. United States, No. C13-2063 RAJ, 2015 WL 1510007 (W.D. Wash. Apr. 1, 2015)

Morrissey v. Brewer, 408 U. S. 471 (1972)

Nat. Rest. Ass'n v. Simon, 411 F. Supp. 993 (D. D.C. 1976)

Newnham v. United States, 813 F.2d 1384 (9th Cir. 1987)

Our Country Home Enterprises, Inc., v. Comm'r, 855 F.3d 773 (7th Cir. 2017)

Owens v. Comm'r, T.C. Memo. 2002-253

Petito v. Comm'r, T.C. Memo 2002-271

Phillips v. Comm'r, 283 U.S. 589 (1931)

Prudential-Bache Sec. v. Tranakos, 593 F. Supp. 783 (N.D. Ga 1984)

Rocovich v. United States, 933 F.2d 991 (Fed. Cir. 1991)

Sharkey v. Quarantillo, 541 F.3d 75 (2d Cir. 2008)

South Carolina v. Regan, 465 U.S. 367, 378 (1984)

Thompson v. United States, 523 F. Supp. 2d 1291 (N.D. Ala. 2007)

United States v. Bajakajian, 524 U.S. 321 (1988)

United States v. Clintwood Elkhorn Min. Co., 553 U.S. 1 (2008)

United States v. Morgan, 313 U.S. 409 (1941)

United States v. Sam Ellis Stores, Inc., 768 F. Supp. 286 (S.D. Cal. 1991)

Withrow v. Larkin, 421 U.S. 35 (1975)

STATUTES

5 U.S.C. § 702

5 U.S.C. § 704

26 U.S.C. § 6330

26 U.S.C. § 6672

26 U.S.C. § 6694

26 U.S.C. § 6700

26 U.S.C. § 6703

26 U.S.C. § 6707

26 U.S.C. § 7430

28 U.S.C. § 1346

28 U.S.C. § 2201

OTHER AUTHORITIES

Internal Revenue Manual, 8.1.1.2.1 (Feb. 10, 2012)

Transcript of January 21, 1975 Oral Argument in Laing v. United States, 423 U.S. 161 (1976)


INTRODUCTION

The government's brief stretches Flora v. United States, 357 U.S. 63 (1958) (Flora I), aff'd on reh'g, 362 U.S. 145 (1960) (Flora II), well beyond its actual holding. In so doing, the government is advocating for non-reviewability (in any practical sense) of the gargantuan penalty assessed against John Larson (“Appellant”), while not acknowledging the due process concerns with its position. The government's position contradicts the arguments that it made to the Supreme Court in Laing v. United States, 423 U.S. 161 (1976), and this Court's opinion in Irving v. Gray, 479 F.2d 20 (2d Cir. 1973), which correctly recognized the limited scope of Flora.

Denial of refund jurisdiction would not only be an incorrect application of the full payment rule, but would also violate Appellant's right to procedural due process under the Fifth Amendment. If the Court finds that the full payment rule applies, which it should not, to avoid a due process violation the Court should allow for judicial review under the Administrative Procedure Act (“the APA”), and should allow all of Appellant's claims to go forward, including the claim that the $160 million penalty violates the excessive fines clause of the Eighth Amendment.

POINT I

THE FLORA FULL PAYMENT RULE DOES NOT APPLY TO APPELLANT'S REFUND SUIT

A. Contrary to the Government's Stinting Reading, Flora Repeatedly Presumed the Existence of a Deficiency Allowing Tax Court Review

The government contends that Appellant's argument that the full-payment rule should not apply to cases where the IRS has not issued a notice of deficiency “depends on reading a single word from Flora II out of context . . . ” (Brief for Defendant-Appellee (“Gov. Br.”) at 22). This is simply incorrect. The concept of a deficiency, enabling a taxpayer access to the Tax Court, is at the core of both of the Supreme Court's opinions in Flora.

Chief Justice Warren's first sentence of Flora I puts it plainly: “The issue in this case is whether a taxpayer must pay the full amount of an income tax deficiency before he may challenge its correctness by a suit for refund.” Flora I, 357 U.S. at 63. The Court notes that “[a] deficiency assessment was levied . . .” against the taxpayer, the Board of Tax Appeals was created to alleviate the "hardship of prelitigation payment," and that a taxpayer could “contest a deficiency assessment by a petition in the Tax Court” as an alternative to payment and suit for refund. Id. at 74-75. The Court further stated that a taxpayer too poor to pay the assessed tax in full “is free to litigate in the Tax Court without any advance payment” — which, of course, can only occur if a notice of deficiency has been issued. Id. at 75. The presumption that the IRS had issued a notice of deficiency underlies the entire Flora I opinion, and the government's claim that Appellant has read “deficiency” out of context is a substantial mischaracterization.

The government's attempt to minimize Flora's holding that full payment is required in cases in which the IRS has issued a notice of deficiency fares even worse when lined up against Flora II. As described in Appellant's Brief, the Flora II court expressed its frustration with the “inconclusive” statutory language and “irrelevant” legislative history. (Brief for Plaintiff-Appellant (“App. Br.”) at 13) (citing Flora II, 362 U.S. at 152). It was only after the Court delved into the history and purpose of the Board of Tax Appeals, later the U.S. Tax Court, did a five-member majority determine that Congress's intent in 28 U.S.C. § 1346 was to prevent taxpayers who had the option of Tax Court review from instead making partial payments and suing for a refund in federal district court. (App. Br. at 14-15). As the Court explained, “a decision in petitioner's favor could be expected to throw a great portion of Tax Court litigation into the District Courts.” Flora II at 176. Of course, this concern does not exist for cases such as the one at bar: the federal district court is the only judicial forum available to Appellant.

Judicial review is only available to Appellant, in any real and practical sense, if the “full payment rule” is confined to the class of tax cases addressed in Flora — where a deficiency permits Tax Court review. Notably, this is precisely what the government argued to the Supreme Court in Laing.

B. The Government's Attempts to Distinguish Laing and Irving Contradict Its Own Arguments in Laing

Laing and Irving concerned whether the IRS was required to issue a notice of deficiency when it makes a jeopardy assessment upon early termination of a tax year. That is not a concern in the present case. However, the parties argued, and those courts considered, if the IRS was not required to issue a deficiency after early termination (and thus no Tax Court jurisdiction existed), whether full payment was a precondition to district court jurisdiction.

The Laing majority did not address this issue, as it found that the IRS must issue a notice of deficiency. Laing, 423 U.S. at 184. The dissent disagreed that a notice of deficiency was required, but explained why the lack of a deficiency notice would not leave the taxpayer without a review remedy. Id. at 208-209. The dissent stated,

Where, as here, in these terminated period situations, there is no deficiency and no consequent right of access to the Tax Court, there is and can be no requirement of full payment in order to institute a refund suit. The taxpayer may sue for his refund even if he is unable to pay the full amount demanded upon the termination of his taxable period.

Id. at 208-09 (citing Irving, 479 F.2d, at 24-25, n. 6). The dissent's discussion of the limits of Flora's scope is squarely on point here. In Irving, this Court also stated that the taxpayers would have a review remedy, since Flora would not apply where no deficiency had been determined. 479 F.2d at 24-25, n. 6.

The dissent in Laing addressed Flora because it agreed with the government's position that the IRS need not issue a notice of deficiency for a jeopardy assessment. 423 U.S. at 208-10. Since the lack of a notice of deficiency would prevent review in Tax Court (as in the present case), the taxpayers expressed concern that they would be barred from district court review under Flora unless they paid in full. Id. At oral argument, the government made two points quite clearly: first, the government explained why Flora's holding was limited to tax matters for which Tax Court review was available; and second, that failure to allow district court review in a partial-payment case where no Tax Court review was available would raise significant constitutional concerns.1

During oral argument, government's counsel, Stuart A. Smith, was asked whether the Tax Court was the only forum available for someone who could not pay the full amount of a tax assessment. The government's response was completely in agreement with Appellant's current position:

Q: But a good argument can be made, certainly, [the Tax Court is] the only forum for someone who can't pay all the amount of the assessment under the Flora case.

Mr. Smith: There is an argument that the Flora case would bar litigation in the district court, at least types of cases with respect to someone in Mrs. Hall's position.2 We think that argument misreads this Court in Flora's opinion.

What this Court held in Flora was that under general circumstances a taxpayer cannot bring a refund suit until he has paid the full amount of the assessment. In reaching that decision, the Court painstakingly went through the legislative history in connection with the creation of the Board of Tax Appeals, and there were indications going both ways as to what Congress really intended. But I think that the really operative portion of the Chief Justice'[s] opinion in Flora was the fact that there the taxpayer had another remedy. He could have gone to the Tax Court, and that made all the difference in Flora because essentially you had a situation where if you were subjected to an assessment of $100 and you want to pay $2 and go to the district court, well, then this Court said in Flora you can't do that, you have to pay the whole $100.” And the reason the Court said that in Flora was because, as the Chief Justice said, he could have gone to the Tax Court without paying a single cent. And the fact of the existence of that Tax Court review convinced the Court that if they had held to the contrary in Flora, they would have infringed upon the pre-payment jurisdiction of the Tax Court because essentially you have a situation where you could split the course of action, you could in effect litigate the refund suit for $2 and perhaps litigate the $98 case in the Tax Court. This Court held that Congress didn't want to split those causes of action and cause these two different systems, that is refund review and Tax Court review, to infringe upon each other.

Here that rationale has no application because we say that Congress has made a conscious decision not to give the Tax Court jurisdiction over these termination cases. Once that is accepted, as we think the statutory history demonstrates, then Flora is no bar to the bringing of these kinds of suits, whether the whole amount is seized or not, in the district court.

Addendum at 14-16.

Later, the Court homed in on two essential questions: first, whether a taxpayer without recourse to the Tax Court would have to pay in full prior to filing a refund suit, or if she could instead pay in part and sue for refund; and second, whether answering that question was necessary to the Court's decision or only advisory. The colloquy between the government and the Court is illuminating:

Q: Is it really realistic to suggest that a taxpayer like Mrs. Hall has a remedy which is based on her paying the deficiency, in this case $52,000, when the Government has made a levy on all of her known assets. . . .?

Mr. Smith:. . . . But the point is that she has brought this suit, Mr. Justice Powell, to enjoin the Commissioner's action. I suppose that she has expended funds in connection with this suit, and we would think that if she had channeled her litigation energies toward the right remedy, she would be well on her way to a disposition in this.

Q: She really didn't have to pay $52,000 to get into court, though.

Mr. Smith: Exactly. She doesn't have to pay $52,000 to get into court. In my colloquy with Mr. Justice Rehnquist, I think it was pointed out in our brief, we don't think that the Flora case bars.

. . .

Q: Was that the declaratory judgment in this context, or was that an essential holding?

Mr. Smith: I think, without attempting to classify it, I think that it would be both essential from the Commissioner's point of view and the Tax Court's.

Q: I meant advisory rather than declaratory.

Mr. Smith: If the Court held here as we urge that the Tax Court has no jurisdiction in these cases, I think it would concomitantly have to reach the question as to the bar of Flora, because the bar of Flora is a significant bar. If you can't get to the district court with respect to if you don't pay the whole thing, then I think that the taxpayers here have a significant problem, because in effect it bars for quite a long time.

Q: It's more than a problem here; it's a significant constitutional question.

Mr. Smith: Indeed. And I don't think that the Code — I think since we are right on the statutory question and the interpretation of Flora, I think the constitutional question vanishes.

Addendum at 31-33. The majority did not reach the Flora bar issue because it decided that the IRS should have issued a notice of deficiency. The dissent contended that a notice of deficiency was not required, and then explained  consistent with the government's argument  why the taxpayer still had the opportunity for judicial review because Flora did not require full payment unless there was a notice of deficiency. 423 U.S. at 208-09.

C. The Second Circuit Cases Cited by the Government Are Not On Point

The government cites to the decisions in Forma v. United States, 42 F.3d

753 (2d Cir. 1994), and Magnone v. United States, 902 F.2d 192 (2d Cir. 1990) (per curiam), to support its contention that this Court has not suggested that Flora is limited to situations where Tax Court review is available. (Gov. Br. at 26). However, Forma and Magnone involved standard income tax deficiencies that could have been contested in Tax Court. Forma, 42 F.3d at 761 (Appellants “had failed to pay certain income taxes . . . Accordingly, the IRS made four assessments against [them]. [Appellants] neither contested the assessments in the Tax Court, nor did they opt to pay the assessed taxes in full and then file an administrative refund claim with the IRS or an independent refund suit in the District Court.”); Magnone, 902 F.2d at 193 (describing plaintiffs' claims as “suits for abatement of interest on tax deficiency assessments.”) These cases fall squarely in line with Flora, and there was no reason for the Court to have considered whether, if those litigants had no right of Tax Court review, Flora would apply.

D. The Statutory Exceptions to the Full Payment Rule Support Appellant's Position

The government argues that express statutory exceptions to the full payment rule, such as in §§ 6694, 6700, and 6703,3 show that Congress did not intend for refund jurisdiction based on partial payment of § 6707 penalties. (Gov. Br. at 27). This is where the legislative history, described in Appellant's opening brief, is especially important. (App. Br. at 33-40). When Congress enacted the version of § 6707 at issue, it had no understanding that the IRS would it interpret it in such a way as to result in the massive penalties that we see in this case. We submit that if Congress had known, it would have provided clearer instructions on computing the penalty, or it would have made the penalty divisible.

POINT II

DUE PROCESS REQUIRES THAT APPELLANT HAVE ACCESS TO JUDICIAL REVIEW OF THE ASSESSMENT OF PENALTIES AGAINST HIM

A. It is Not Constitutionally Adequate to Demand Payment in Full of an IRS Penalty Originally Exceeding $160 Million Before Access to Any Judicial Review

Fifth Amendment due process jurisprudence requires that the core requirement is meaningful review — both in time and in manner. “'Due process,' unlike some legal rules, is not a technical conception with a fixed content unrelated to time, place and circumstances.” Cafeteria Workers v. McElroy, 367 U. S. 886, 895 (1961). “[D]ue process is flexible and calls for such procedural protections as the particular situation demands.” Mathews v. Eldridge, 424 U.S. 319, 334 (1976) (citing Morrissey v. Brewer, 408 U. S. 471, 481 (1972)). The Fifth Amendment calls for “procedural protection as dictated by the particular circumstance.” Kahn v. United States, 753 F.2d 1208, 1218 (3d Cir. 1985). As explained in Phillips v. Comm'r, 283 U.S. 589, 595 (1931), while the government may engage in summary proceedings to obtain taxes, the taxpayer must have an “adequate opportunity” for “later judicial determination.”

The government and Appellant disagree as to whether Appellant has a constitutionally adequate opportunity to obtain judicial review. This unusual case presents a situation unlike any of the due process cases cited by the government:

1. Appellant cannot obtain judicial review of this penalty in the Tax Court, unlike the cases in which Flora's full payment rule has been invoked, such as Ardalan v. United States, 748 F.2d 1411 (10th Cir. 1984), which involved a challenge to a deficiency assessment that could have been brought in Tax Court.

2. This is not a self-reported liability, such as in Curry v. United States, 774 F.2d 852 (7th Cir. 1985), and Rocovich v. United States, 933 F.2d 991 (Fed. Cir. 1991). The rationale in those cases does not apply to a multi-million dollar penalty imposed by the IRS.

3. Appellant has expressly alleged in his Complaint (taken as true for purposes of the motion to dismiss), that he is unable to pay in full the $60+ million remaining of the $160+ million penalty. (Joint Appendix (“JA”) 15, ¶ 28). Thus, if the government prevails, Appellant can never obtain any judicial review of this penalty. This is unlike the cases cited by the government, such as Curry, where the taxpayer claimed it would be a “hardship” to pay the tax in full, not that it would be impossible. Notably, the Flora Court recognized that the full-payment rule would cause some taxpayers “great hardship” but also stated that the hardship argument “seems to ignore entirely the right of the taxpayer to appeal the deficiency to the Tax Court without paying a cent.” Flora II, 362 U.S. at 175 (emphasis added). Since no such “right” exists in this case, the “great hardship” analysis is different in Appellant's case than that in Flora and the vast majority of cases applying Flora.

4. There is no underlying tax amount owed – only penalties. District court jurisdiction to review the penalty assessment on Appellant's refund request would not jeopardize the governmental interest in the smooth and uninterrupted functioning of the tax collection process.

5. The IRS calculated the penalties as a percentage of the “aggregate amount invested” in the transactions at issue, and not based on any percentage of Appellant's income or assets. Thus, the penalties bear no relationship to Appellant's ability to pay, unlike most penalties that are computed on a percentage of the underlying tax owed.

6. One of Appellant's core contentions is that the IRS has vastly inflated the “aggregate amount invested” in the transaction, and thus the resulting penalty amount. As explained in Appellant's principal brief (App. Br. at 4-5), the IRS disregarded as fictitious and fraudulent the loans and loan premiums when it determined they were part of a tax shelter scheme, and even refers to them as “purportedly borrowed money” (Gov. Br. at 5-6). Yet, the IRS included those loans and loan premiums in its calculation of the “aggregate amount invested” for the 1% penalty, which caused the penalty to increase twenty times the amount it would be if those amounts were not included. Even in the face of what may be a grossly overinflated penalty calculation, the IRS insists that no court can review its penalty calculation, even for purposes of jurisdictional analysis to determine whether Appellant has already paid in full the correct amount of the penalty, without him first paying over $60 million.

In these unusual circumstances, due process will not be satisfied if the Court applies the full payment rule to bar Appellant's refund suit.

[I]dentification of the specific dictates of due process generally requires consideration of three distinct factors: First, the private interest that will be affected by the official action; second, the risk of an erroneous deprivation of such interest through the procedures used, and the probable value, if any, of additional or substitute procedural safeguards; and, finally, the government's interest, including the function involved and the fiscal and administrative burdens that the additional or substitute procedural requirement would entail.

Mathews, 424 U.S. at 335.

The private interest affected is that Appellant is faced with a massive penalty that he is, and likely forever will be, unable to pay, and which bears no relationship to money ever earned by him. The risk of erroneous deprivation is enormous, since the IRS unilaterally imposed the penalty. Finally, while undoubtedly the government has an essential interest in collecting tax revenues, this is a penalty designed to motivate compliance with tax shelter reporting, not a revenue-driven tax. The government cannot credibly claim that all judicial review must be barred until it obtains payment in full of a penalty designed to deter non-compliance, on the grounds that collection of the penalty somehow is essential to the public fisc.

The government's discussion of Bob Jones Univ. v. Simon, 416 U.S. 725 (1974), omits key language that sheds a different light on the Supreme Court's due process requirements. In that case, the taxpayer contended that it was a violation of due process for the trial court to dismiss its complaint seeking an injunction preventing the IRS from revoking plaintiff's tax-exempt status. Explaining why the due process argument lacked merit, the Court opened with a clear statement: “This is not a case in which an aggrieved party has no access at all to judicial review. Were that true, our conclusion might well be different.” Id. at 746.

The Court went on to explain that if the taxpayer had taxable income as a result of the revocation of its tax-exempt status, “it may in accordance with prescribed procedures petition the Tax Court . . . Alternatively, petitioner may pay income taxes . . . exhaust the Service's internal review procedures, and then bring suit for a refund. These review procedures offer petitioner a full, albeit delayed, opportunity to litigate the legality of the Service's revocation of tax-exempt status . . .” Id. The Court's statement that “the problems presented do not rise to the level of constitutional infirmities” was made after recognizing that both Tax Court review and a practical opportunity to litigate in district court were available to the plaintiff, but that a lack of access to judicial review “might well” lead to a due process clause challenge. Id.

Consider the practical reality that Appellant faces: if no court can review this penalty until he pays it in full, he will almost certainly never have access to judicial review. The IRS would be permitted to regularly seize from him, with its various powers of collection, all of his assets for as long as the law permits. At no point would he be allowed to challenge the penalty, since the government would insist that he had not yet “paid in full.” Simply put, this penalty would financially destroy Appellant for the remainder of his life, with no prospect for judicial review. This cannot reasonably pass the procedural due process test stated in Mathews v. Eldridge.

B. IRS Appeals Review Alone Does Not Provide Due Process for Appellant

The government seems to be arguing that the Appeals review was sufficient to satisfy due process and that judicial review is not required. (Gov. Br. at 31-32). For support, the government cites the recent line of cases of Our Country Home Enterprises, Inc., v. Comm'r, 855 F.3d 773 (7th Cir. 2017); Keller Tank Serv. Inc. v. Comm'r, 854 F.3d 1178 (10th Cir. 2017); and Iames v. Comm'r, 850 F.3d 160 (4th Cir. 2017).

These cases address the issue of whether taxpayers can raise arguments concerning their tax liability during collection due process (“CDP”) hearings under § 6330. None of these cases considered procedural due process, but focused only on the statutory language of § 6330(c)(2)(B), which allows taxpayers a limited opportunity to raise arguments as to the tax liability during CDP if they had no prior “opportunity to dispute” the liability. These cases address the specific meaning of the phrase “an opportunity to dispute” in § 6330(c)(2)(B), and have no broader application. See Our Country Home, 855 F.3d at 784-790; Keller Tank, 854 F.3d at 1196-1201; Iames, 850 F.3d at 165-66.

Moreover, as is explained in the brief submitted by amicus curiae, The Legal Services Center of Harvard Law School Federal Tax Clinic (“Amicus Br.”), these CDP cases highlight the importance of access to refund jurisdiction for taxpayers like Appellant who have no opportunity for prepayment judicial review through the CDP process. (Amicus Br. at 13).

In any event, whether Appeals review is constitutionally adequate in a particular case depends on the facts and circumstances of that case, and here, the record is not sufficiently developed as to the adequacy of the Appeals review for the Court to make a finding that Appellant is not entitled to judicial review.

POINT III

THE COURT SHOULD EXERCISE JURISDICTION OVER APPELLANT'S APA CLAIM SO THAT HE IS NOT DEPRIVED OF JUDICIAL REVIEW OF THE PENALTY IMPROPERLY ASSESSED AGAINST HIM

Appellant alternatively seeks review under the APA if the Court determines that a refund suit is not available to him. The APA establishes a broad presumption of judicial review of final agency action. 5 U.S.C. § 702. In determining whether a suit can be brought under the APA, “[w]e begin with the strong presumption that Congress intends judicial review of administrative action.” Bowen v. Mich. Academy of Family Physicians, 476 U.S. 667, 670 (1986).

As is explained in his opening brief (App. Br. at 32-40), Appellant has satisfied the three preliminary requirements for APA review: (1) there is a final agency action; (2) such action is not committed to agency discretion; and (3) Congress did not intend to preclude judicial review. Sharkey v. Quarantillo, 541 F.3d 75, 87 (2d Cir. 2008).

The government does not dispute that Appellant has established these requirements for APA review. Regarding the third requirement, that Congress did not preclude judicial review, the government contends that there is no evidence of Congress' intent to allow review without full payment. (Gov. Br. at 40). As discussed in his opening brief (App. Br. at 33-29), the legislative history instead shows that Congress did not intend for the penalties to be imposed at the astronomically high levels that they are here so as to have effectively precluded judicial review.

In addition, Appellant has shown that “no other adequate remedy” exists to provide him with judicial review. See id.; 5 U.S.C. § 704. Because of the IRS's actions in assessing an unreasonable and impossibly high penalty resulting from its incorrect interpretation of the meaning of “aggregate amount invested” in § 6707, Appellant cannot pay in full before bringing suit. Even though the tax refund suit procedure exists, in the abstract, it is not an adequate remedy for Appellant. Appellant cannot meet the threshold requirement of full payment because the IRS has misinterpreted the law to create an insurmountable barrier.

The government's primary argument — in connection with the applicability of the APA as well as the Anti-Injunction Act (“AIA”), 28 U.S.C. § 2201(a)  is that APA review is not available because Appellant could file a tax refund suit. (Gov. Br. at 33-41). The Supreme Court's decision in South Carolina v. Regan, 465 U.S. 367, 378 (1984), carves out an exception to the AIA for “actions brought by aggrieved parties for whom it has not provided an alternative remedy.” This exception applies here, as the tax refund suit does not provide an adequate remedy to Appellant. (See App. Br. at 41-48).

A decision not to allow APA review (while also finding that the full payment rule applies), would not merely bar Appellant from judicial review, but would impact other taxpayers. Appellant and amicus curiae raised hypotheticals highlighting the need for the Court to maintain flexibility with the APA (or the full payment rule) so that the IRS cannot foreclose taxpayers' right to judicial review in assessable penalty cases. (App. Br. at 46-47; Amicus Br. at 8-10). The government did not even attempt to respond to amicus curiae, and tried to avoid responding to Appellant. In Appellant's first hypothetical, the IRS miscalculated a penalty for failure to report a gift from a foreign relative, assessing a $30 million, instead of $30,000, penalty. Appellant's second hypothetical involved a tax protestor against whom the IRS improperly assessed a frivolous tax return penalty under § 6707(a) well beyond the statutory limit, and the Appeals Officer does not grant relief. Under the government's logic, these taxpayers who cannot pay the improperly assessed penalties because they are beyond their means have no right of judicial review.

The government tried to dodge these hypotheticals by arguing that the court should not presume that “the Appeals Office is not sufficiently effective to catch and correct obvious mistakes or misconduct.” (Gov. Br. at 38-39).4 This transparent attempt to avoid answering these hypotheticals should be rejected. Indeed, Congress has recognized the IRS's penchant for error by allowing taxpayers to collect attorney fees when the IRS's position is not substantially justified. § 7430. In addition to countless cases in which courts have not sustained the IRS's actions, there are a legion of reported decisions in which the IRS was not even substantially justified in its position, such as when it has unreasonably interpreted the Code,5 ignored case law or Treasury regulations supporting the taxpayer's position,6 issued a notice of deficiency for a year which was clearly time-barred,7 asserted a penalty with no factual basis,8 failed to consider information in its possession,9 and treated one taxpayer more harshly than similarly-situated taxpayers.10 The government's argument that judicial review is not necessary because the IRS does not make mistakes cannot be taken seriously. As with any agency action, there is a potential for error, which is why judicial review is crucial, particularly in a case like this, in which the IRS is applying a novel interpretation of a statute that has never been judicially tested, in such a way as to financially devastate Appellant.11

Returning to the hypotheticals: Would these taxpayers, like Appellant, be deprived of judicial review and subject to a lifetime of enforced collection and/or forced into bankruptcy? The answer that the government is afraid to give is “yes,” unless the Court finds that either the full payment rule does not apply or that Appellant is entitled to APA review.

In the opening brief, Appellant references three cases in which courts have permitted alternative remedies in tax cases: Nat. Rest. Ass'n v. Simon, 411 F. Supp. 993 (D. D.C. 1976); Estate of Michael ex. Rel. Michael v. Lullo, 173 F.3d 502 (4th Cir. 1999); and Cohen v. United States, 650 F.3d 717 (D.C. Cir. 2011). (App. Br. at 41-43). The government criticizes these citations as not being factually analogous. (Gov. Br. at 37). This is because there is no precedent for Appellant's specific situation. But, the lack of precedent does not mean that the Court should deny Appellant's request relief. Given what is at stake — Appellant's only chance for judicial review of the IRS's imposition of permanently devastating penalties based on the IRS's aggressive and never before reviewed interpretation of a statute  the Court should permit APA review to go forward.

We refer the Court to the prior discussion of these three cases, but respond to a few of the government's comments. First, regarding Nat. Rest. Ass'n, the court crafted an alternative remedy to avoid forcing the taxpayer to violate the law (and be assessed penalties for which it could pay and sue for a refund), before being able to challenge the law. The government uses this as an opportunity to bring up Appellant's criminal conviction, stating that he “already is a 'lawbreaker.'” (Gov. Br. at 37). Appellant's conviction is not relevant here, as the IRS's penalty determination rests on legal and factual issues not decided in the criminal case. The government knows this, but is merely referring to his conviction in an improper attempt to prejudice Appellant.

Second, the government pulls from the Cohen decision the language that “[i]n the tax context, the only APA suits subject to review would be those cases pertaining to final agency action unrelated to tax assessment and collection.” 650 F.3d at 733. The government fails to explain the context in which the Court made this statement. The discussion relates to the administrative exhaustion requirement for refund jurisdiction.12 In any event, the government ignores the Cohen court's admonition that whether there is jurisdiction under the APA “requires a careful inquiry into the remedy sought, the statutory basis for that remedy, and any implication the remedy may have on assessment and collection.” Id. at 726. Moreover, the court rejected the IRS's view, similar to that expressed in this case, of “a world in which no challenge to its actions is ever outside the closed loop of its taxing authority.” Id.

Next, regarding Estate of Lullo, the government contends that the case should be distinguished because the taxpayer had certainty of success on the merits, but in Appellant's case, “any prospect of success on the merits has yet to be demonstrated.” (Gov. Br. at 37). Of course, at this stage in the proceeding, Appellant has not had an opportunity to present his arguments on the merits. If the Court accepts the government's invitation to consider whether Appellant has a prospect of success, we refer the Court to the prior discussion of the legislative history of § 6707. (App. Br. at 33-39). This history shows that the IRS has incorrectly interpreted “aggregate amount invested” to inflate the penalty from approximately $7 million to approximately $160 million. There has been no judicial review of the IRS's interpretation of § 6707 to date, and unless this Court permits Appellant to have his day in court, the IRS will be free to continue to apply its mistaken interpretation creating devastating results for Appellant and other taxpayers.

The government also cites several cases that do not support its opposition to relief under the APA and do not address the issue in this case: whether refund jurisdiction is an adequate remedy where Tax Court review is not available and the IRS has improperly computed the penalty assessment to make full payment impossible. First, the government cites to Bob Jones University, 416 U.S. at 747, for its position that a tax refund suit is an adequate remedy here. (Gov. Br. at 35). The Supreme Court, however, distinguished the situation “in which an aggrieved party has no access at all to judicial review.” Here, due to the IRS's misinterpretation of § 6707, Appellant effectively has no access to judicial review, and thus should be permitted to proceed under the APA.

The government's citation to United States v. Clintwood Elkhorn Min. Co., 553 U.S. 1, 4 (2008), (Gov. Br. at 34), also is unhelpful. In that case, the Supreme Court held that taxpayers must comply with the administrative exhaustion and timeliness requirements for refund suits. These requirements are of a different character than the full payment rule in Appellant's case because they were fully under the control of the taxpayers, who could have complied with them in order to establish refund jurisdiction. In contrast, through no fault of his own, but due to the IRS's action in improperly assessing the penalty at a level that made it impossible to ever pay, Appellant cannot make full payment.

The government also cites to Judicial Watch, Inc. v. Rossotti, 317 F.3d 401, 408 (4th Cir. 2003), in which an entity sought to enjoin the IRS from initiating an audit after revoking its tax exempt status. The Court found that that the AIA barred the suit because organizations whose exempt status had been denied or revoked can seek declaratory relief, an adequate method of judicial review. Id. Here, in contrast, Appellant does not otherwise have access to judicial review.

Last, Matter of La Salle Rolling Mills, Inc., 832 F.2d 390 (7th Cir. 1987), and In re American Bicycle Ass'n, 895 F.2d 1277, 1279 (9th Cir. 1990), held that the AIA prevents a bankruptcy court from enjoining the collection of trust fund recovery penalties assessed under § 6672 against the responsible officer of a debtor corporation. Part of the basis of the courts' decisions was that the officer could challenge the penalty by paying and suing for a refund. American Bicycle, 895 F.2d at 1279; La Salle, 832 F.2d at 393. Notably, the trust fund recovery penalty is divisible, and thus the officer would only have had to pay a nominal amount — the employment tax liability for one employee for one quarter  to satisfy the full payment rule. La Salle, 832 F.2d at 393, n.8; see also American Bicycle, 895 F.2d 1281, n. 4.

If the Court does not rule in Appellant's favor on the full payment rule, it should grant Appellant's alternative request for review under the APA. Otherwise, the IRS will have unilateral and unreviewable power to determine the size and applicability of any assessable penalty.

POINT IV

THE COURT SHOULD ALLOW APPELLANT'S EIGHTH AMENDMENT CLAIM TO GO FORWARD

The Complaint alleged a violation of the Eighth Amendment of the United States Constitution. Specifically, the § 6707 penalty of $160,232,026 is an excessive fine because it is grossly disproportionate to the gravity of the offense. See Austin v. United States, 509 U.S. 602, 622-23 (1993); United States v. Bajakajian, 524 U.S. 321, 334 (1988).

The government first argues that to the extent that Appellant's claim is for money damages, it should be dismissed. (Gov. Br. at 43). Appellant, however, has not brought a claim for money damages (App. Br. at 48-50), but is seeking a determination that the penalty was improperly assessed and a refund of the portion of the penalty that he has paid to the government, which the Court can hear under the APA. See Moore v. United States, No. C13-2063 RAJ, 2015 WL 1510007 (W.D. Wash. Apr. 1, 2015) (exercising jurisdiction over Eighth Amendment claim in APA action).

Moreover, the Complaint does contain sufficient allegations to “state a claim to relief that is plausible on its face.” See Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). “A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id. at 556. The Complaint, read as a whole, adequately pleaded a violation of the Eighth Amendment. (App. Br. at 52-54).

The government also argues that Appellant failed to allege how the § 6707 penalty compares to penalties imposed in other cases. (Gov. Br. at 47). This would be an unfair bar to relief, given there have been very few § 6707 cases at all, and none on the merits. The only case that the government cites is Diversified Group, Inc. v. United States, 123 Fed. Cl. 442, 445 (2015), which was dismissed without any review of the penalty assessment.

As with other aspects of this case, there is no precedent that readily resolves the issues. Given the extremely high penalties, which Appellant has adequately alleged violate the Eighth Amendment, the Court should allow Appellant's case, including his Eighth Amendment claim, to be heard.

CONCLUSION

The decision of the district court dismissing the Complaint should be reversed, and the case remanded for further proceedings.

Dated: September 5, 2017
New York, New York

By: Megan L. Brackney
Kostelanetz & Fink, LLP
7 World Trade Center
New York, New York 10007
Telephone: (212) 808-8100
Fax: (212) 808-8108
mbrackney@kflaw.com

NELSON MULLINS
RILEY & SCARBOROUGH LLP
By: Reed J. Hollander
C. Wells Hall, III
301 S. College Street, 23rd Floor
Charlotte, NC 28202
Telephone: (704) 417-3206
Fax: (704) 377-4814
wells.hall@nelsonmullins.com

Reed J. Hollander
4140 Parklake Avenue, Suite 200
Raleigh, NC 27612
Telephone: (919) 877-3816
Fax: (919) 877-3799
reed.hollander@nelsonmullins.com

Attorneys for Plaintiff-Appellant

FOOTNOTES

1On September 5, 2017, Appellant filed a motion requesting that the Court take judicial notice of the transcript of the January 21, 1975 argument in Laing. A copy of the transcript is contained in the attached Addendum.

2The companion case of Hall v. United States was consolidated with Laing for oral argument.

3Unless otherwise, stated, all references to sections herein are to the Internal Revenue Code of 1986 (as amended), in effect during 1997-2000.

4The cases that the government cites for this point all relate to claims that an agency official's public statements on policy issues do not create a presumption of bias. See Withrow v. Larkin, 421 U.S. 35, 47 (1975); United States v. Morgan, 313 U.S. 409 (1941); Estate of Landers v. Leavitt, 545. F.3d 98, 113 (2d Cir. 2008). These cases are not relevant to Appellant's situation or of the taxpayers in the hypotheticals who would be foreclosed from review if the IRS's erroneous action had the effect of cutting off their ability to seek review through a refund suit.

5Newnham v. United States, 813 F.2d 1384, 1387 (9th Cir. 1987); Thompson v. United States, 523 F. Supp. 2d 1291 (N.D. Ala. 2007).

6Estate of Baird v. Comm'r, 416 F'3d 442 (5th Cir. 2005); Holmes v. Director, Dep't of Revenue, 937 F.2d 481, 485 (9th Cir. 1991); Minahan v. Comm'r, 88 T.C. 492 (1987).

7Hanson v. Comm'r, 975 F.2d 1150 (5th Cir. 1992); Cassuto v. Comm'r, 93 T.C. 256, 262–65 (1989), aff'd in part, rev'd in part on other grounds, 936 F.2d 736 (2d Cir. 1991).

8Fitzgerald v. United States, 789 F. Supp. 177, 178–79 (E.D. Pa. 1992); United States v. Sam Ellis Stores, Inc., 768 F. Supp. 286, 289 (S.D. Cal. 1991); Donelan Phelps & Co v. United States, 681. F. Supp. 615, 621 (E.D. Mo. 1987); Owens v. Comm'r, T.C. Memo. 2002-253.

9Fitzgerald v. United States, 789 F. Supp. 177, 178–79 (E.D. Pa. 1992); Prudential-Bache Sec. v. Tranakos, 593 F. Supp. 783, 786–87 (N.D. Ga 1984); Chapman v. Comm'r, T.C. Summ. Op. 2009-155; Petito v. Comm'r, T.C. Memo 2002-271.

10Baker v. Comm'r, 787 F.2d 637, 643–44 (D.C. Cir 1986); Hubbard v. Comm'r, 89 T.C. 792, 803. (1987).

11The government also argues that Appeals review itself is an adequate remedy, and that further judicial review is not warranted for Appellant or any other taxpayer. Gov. Br. at 38. In the present case, there is no indication that the Appeals Officer considered the merits of Appellant's arguments. (See JA 4-6). In any event, the government should be aware that with respect to other taxpayers who may be affected by the Court's ruling in this case, Appeals review is not a right, Cataldo v. Comm'r, 60 T.C. 522, 523 (1973), and a taxpayer may not have a chance for Appeals review for a number of different reasons, including that the IRS decides to coordinate its position on a particular issue and not allow any Appeals review at all, see Internal Revenue Manual, 8.1.1.2.1 (Feb. 10, 2012) (some exceptions to Appeals authority).

12The sentence preceding that cited by the government is: “Allowing Appellants to proceed without first filing a refund claim will not open the courthouse door to those wishing to avoid administrative exhaustion procedures in other cases.” 650 F.3d at 733.

END FOOTNOTES

DOCUMENT ATTRIBUTES
  • Case Name
    John M. Larson v. United States
  • Court
    United States Court of Appeals for the Second Circuit
  • Docket
    No. 17-503
  • Institutional Authors
    Kostelanetz & Fink LLP
    Nelson, Mullins, Riley & Scarborough LLP
  • Cross-Reference

    Appealing Larson v. United States, No. 1:16-cv-00245 (S.D.N.Y. 2016).

  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Tax Analysts Document Number
    2018-1992
  • Tax Analysts Electronic Citation
    2018 TNT 10-48
Copy RID