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A Burden of Proof Primer and Two Trips into the TEFRA Thicket – Designated Orders: February 4 – 8, 2018

Posted on Mar. 18, 2019

The Tax Court designated nine orders this week; we’ll discuss three here. The others included two fairly routine orders granting motions for summary judgment in CDP cases; another reminder that parties can’t use Rule 155 computations to alter substantive litigated issues; a cryptic order from Judge Carluzzo in a case we previously covered, which seems to suggest that these pro se petitioners disagreed with Judge Carluzzo’s denial of their motion to dismiss for lack of jurisdiction; and a pair of orders from Judge Leyden, one of which warns of a section 6673 penalty.

Docket Nos. 15265-17S, 25142-17S, Pagano v. C.I.R. (Order Here)

Judge Carluzzo issued a bench opinion in Pagano, upholding Respondent’s changes to Petitioner’s 2014 and 2015 income taxes in a Notice of Deficiency, along with an increased deficiency that Respondent desired after the NOD was issued. Petitioners made this all the easier on Respondent when they failed to appear for trial.

While the opinion is run-of-the-mill, it provides a useful distinction between the various burden of proof rules that can apply in Tax Court. Usually, Petitioner bears the burden of proof—including the burden of producing evidence and the ultimate burden of persuasion—in any Tax Court case. The Notice of Deficiency is “imbued with a presumption of correctness”; in other words, if Petitioner puts on no evidence, then Respondent’s changes in the NOD are upheld.

This dynamic shifts, however, where (1) Respondent raises a “new matter” that is outside the scope of the Notice of Deficiency, or (2) the NOD provides for an adjustment based on unreported income. In the former case, because the new matter was not contemplated at the administrative level, Respondent must both raise the issue and provide foundational evidence to support such an adjustment. For unreported income, the Tax Court has repeatedly held (as Caleb Smith discussed previously) that Respondent cannot rely on a “naked assessment” regarding unreported income. Otherwise, taxpayers are forced to prove a negative. Instead, Respondent must first link the taxpayer to an income producing activity.

In Pagano, the substantive issues included overstated Schedule C deductions for 2014 and 2015, and understated Schedule C income for 2015.

The Petitioners lose on the deductions for both years under the general principle that the petitioner carries the burden of proof. Missing trial is a good way to fail to carry that burden.

In contrast, Respondent had some work to do on its adjustment for understated Schedule C income—not much work, but Respondent needed to do more than simply showing up to trial, sitting on its hands, and saying “we win.” Nevertheless, Respondent still wins. Because Respondent introduced evidence to connect Petitioners to an income producing activity—namely, Petitioner’s tax preparation business—its adjustments regarding unreported income were likewise upheld. It helped that Respondent also seems to have provided evidence to justify the underlying adjustments, but I’m not sure that would have been necessary with absent petitioners.

Finally, Respondent seems to have concluded that the Service’s earlier bank deposit analysis on unreported income was somewhat off. Therefore, Respondent sought an increased deficiency from that reported in the NOD. Here too, Judge Carluzzo finds that Respondent satisfied its independent burden in raising this new matter, through the bank deposit analysis that Respondent entered into evidence, along with a revenue agent’s testimony.

Docket No. 23017-11, Hurford Investments No. 2, Ltd. v. C.I.R. (Order Here)

This order from Judge Holmes comes on a motion for extension of time to file a motion to reconsider Judge Holmes’ prior order denying Petitioner’s motion for reasonable litigation and administrative costs under Rule 231. That order, which Judge Holmes issued on December 21, 2018 and did not designate, disagreed with the Court of Federal Claims’ decision in BASR Partnership v. United States, 130 Fed. Cl. 286 (2017), that partnerships could submit Qualified Offers under section 7430(c)(4)(E)(i). In this order, Judge Holmes explains his disagreement with the Court of Federal Claims in detail.

Hold on a second. Did an undesignated order just create a split of authority between the Tax Court and the Court of Federal Claims?

Well, not necessarily. Orders are, under Tax Court Rule 50(f), non-precedential. Other judges in the Tax Court might reach a different result. Of course, a partnership shouldn’t expect to return to Judge Holmes with an identical argument and hope to win; he’s likely to apply the same logic as in Hurford Investments.

After losing their motion for fees and costs, Petitioners planned to move for reconsideration. But their counsel knew that the decision in BASR Partnerships—which the Service appealed to the Federal Circuit—would soon be forthcoming. Indeed, the Federal Circuit issued their opinion on February 8, as we covered here. So, Petitioners moved on January 17 for an extension of time to file their motion for reconsideration, such that the Tax Court could consider any subsequent opinion from the appellate court.

Judge Holmes denied the motion for an extension of time, noting that there were alternative grounds for decision, which the Federal Circuit was unlikely to reach. I initially had some trouble seeing that argument. The grounds for decision were (1) that Hurford wasn’t a prevailing party in the traditional sense because Respondent’s litigating position was substantially justified, and (2) that Hurford couldn’t make a Qualified Offer as a matter of law. Presuming the first point is correct (a fair assumption, given the novelty of the underlying case), the Court must still find that Petitioner was prevented from submitting a qualified offer. Let’s take a look at the statute and Judge Holmes’ analysis.

Section 7430 authorizes reasonable litigation costs where the taxpayer is the “prevailing party,” which means (1) that the taxpayer won a litigated case, and (2) that the IRS litigating position was not “substantially justified.” See I.R.C. § 7430(c)(4)(B). However, a taxpayer can avoid the “substantially justified” provision if the taxpayer submits a “qualified offer”, as defined in the statute, and if “the liability of the taxpayer pursuant to the judgment in the proceeding . . . is equal to or less than the liability of the taxpayer which would have been so determined if the United States had accepted a qualified offer . . . .” I.R.C. § 7430(c)(4)(E)(i).

In turn under section 7430(g), a “Qualified Offer” is:

  • A written offer;
  • Made by the taxpayer to the United States;
  • During the qualified offer period;
    1. Beginning on the date the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review is sent
    2. Ending on the date which is 30 days before the date the case is first set for trial;
  • Specifies the offered amount of the taxpayer’s liability;
  • Is designated at the time it is made as a qualified offer for purposes of section 7430; and
  • Remains open during the period beginning on the date it is made and ending on the earliest of the date the offer is rejected, the date the trial begins, or the 90th day after the date the offer is made.

However, section 7430(c)(4)(E)(ii) provides that a qualified offer isn’t available in “any proceeding in which the amount of tax liability is not in issue….” Judge Holmes previously found that this was such a case. The ultimate tax liability is not calculated at the partner level in a TEFRA proceeding; instead, the tax liability of the partners is separately calculated, and can depend upon individual circumstances independent of those addressed in the TEFRA proceeding.

Further, Judge Holmes found that Hurford Investments wasn’t even a “taxpayer” under section 7430, because it has no ultimate tax liability that is calculated, and so couldn’t even make an offer as required under 7430(g)(2).

Similarly, Judge Holmes suggests Petitioner didn’t comply with section 7430(g)(4), which requires taxpayers to specify the amount of the taxpayer’s liability.  Hurford Investments couldn’t have done so, Judge Holmes suggests, because they had no liability as a partnership.

Finally, the regulation interpreting this section requires the taxpayer to “clearly” make their qualified offer, and also requires that it be “with respect to all of the adjustments at issue” and “only those adjustments.” 26 C.F.R. § 301.7430-7(c)(3). Judge Holmes seems to state that because offered the adjustments at the partnership level flow through to the partners—i.e., that Hurford Investments’ proposal wasn’t limited to only its tax liability, but extended to their partners—this wasn’t a proper “qualified offer” under the regulation.

This latter point must be the “alternative grounds” upon which Judge Holmes denied the motion for an extension of time. All other grounds that Judge Holmes rejected stem from the premise that Hurford Investment didn’t have a tax “liability” and, relatedly, that the tax liability cannot be at issue in a TEFRA proceeding.

As it happens, the Federal Circuit issued their opinion shortly after this order, after which Petitioner filed a motion for reconsideration. We’ll continue to wait and watch this not-yet-ripe split of authority develop.

Docket No. 10201-08, BCP Trading and Investments v. C.I.R. (Order Here)

Finally, this order provides an example of the Court addressing a gap in the rules in an interesting context. Judge Holmes decided this TEFRA case in 2017 (T.C. Memo. 2017-151). Turns out, an indirect partner didn’t participate in that litigation. When parties to a partnership action settle, Rule 248(b)(4) requires Respondent to move for entry of decision; the Court then must wait 60 days to see if any nonparticipating party objects to the settlement. The Rule exists to provide the nonparticipating, though very affected, party one last shot to participate in final disposition of the case.

There’s no similar rule, however, where the case is litigated. Indeed, the equity interests are somewhat different here, since the Court is ultimately calling the shots. In this case, the participating parties did agree on the “language of the decisions”—which I take to mean the decision documents that will ultimately resolve this docket after Judge Holmes decided the substantive issues in 2017.

So, it appears, the parties and Judge Holmes felt that this nonparticipating party needed a chance to voice its opinion on this final decision. As such, the Court served the proposed decision on the partner (an estate), and issued an order to show cause why the Court shouldn’t enter that decision. They used the procedures in Rule 248(b)(4), and so provided the estate with 60 days to respond.

The estate responded and filed a motion for leave to intervene. Petitioner consented to the motion, but Respondent objected, arguing that the motion was untimely and otherwise inappropriate on the merits.

Judge Holmes finds that the motion to intervene was timely; it was timely made in response to the bespoke procedure that the parties created in this case to provide the estate with notice and an opportunity to respond. Even though the motion would be untimely under Rule 245 (which generally governs motions to intervene in TEFRA cases), Respondent had already agreed to these new procedures in this case.

On Respondent’s second argument, however, the estate loses. The estate sought to raise the very same argument that the Court had rejected when the participating parties brought it: that the statute of limitations on assessment barred any additional liability. Thus, Judge Holmes found that the estate didn’t qualify for mandatory intervention, as the participating partners had adequately represented the partners’ collective interests. Permissive intervention was, accordingly, also inappropriate, where relitigating that sole issue would “only further delay its conclusion.”

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