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Designated Orders for the Week of October 23-27

Posted on Nov. 6, 2017

Professor Samantha Galvin of University of Denver Sturm College of Law brings us this week’s edition of Designated Orders. This week she looks at an order involving a motion for reconsideration. Those types of requests are always an uphill battle for the requestor and not to spoil her post but this one proves no different. She also discusses a designated order involving the capacity of the petitioner to be the petitioner and one involving subpoenas. Keith

There were several designated orders this week. Three are discussed below, but those not discussed are orders: 1) denying a motion to dismiss on a timely mailed petition (here), 2) granting partial summary judgment in connect with estate related transfers (here), 3) requesting supplemental briefs on a notice of final partnership administrative adjustment (here), 4) addressing an improper motion for nonconsensual depositions of party witnesses (here), 5) addressing how to treat a non-participating party in TEFRA litigation (here), 6) denying a motion for partial summary judgment in case involving gift tax (here), and 7) granting a motion for summary judgment for a case involving alternative minimum tax (here).

No Reason to Reconsider

Docket #: 13243-15, Zane W. Penley and Monika J. Penley v. C.I.R. (Order Here)

In this first designated order Judge Wherry addresses a motion for reconsideration filed by petitioners, a husband and wife. The motion came after the Court issued an opinion finding for respondent, because petitioners had not adequately substantiated their argument. The Court also imposed an accuracy-related penalty.

Under Rule 161, a motion for reconsideration is an option available within 30 days after an opinion has been served, however, whether to grant the motion is within the Court’s discretion. A party may move for reconsideration to correct substantial errors of fact or law or to introduce new evidence that could not have been introduced by exercising due diligence in the first proceeding. A motion for reconsideration should not be used to revisit rejected arguments or present new legal theories.

The petitioners appear to believe that they are introducing new evidence, but the Court disagrees.

The issue in the case was whether husband petitioner, Mr. Penley, was a real estate professional entitled to take ordinary losses or an investor subject to passive activity loss rules. To be a real estate professional, section 469(c)(7)(b) requires a taxpayer to spend more than half of his or her working time on real estate activities and that the time spent working on real estate activities exceeds 750 hours in the taxable year at issue.

The “new” evidence petitioners present consists of a self-invented calculation method used to estimate of the amount of time Mr. Penley spent on real estate activities. A calendar, that had been introduced in the prior proceeding, is used as part of this calculation along with national median pay data for different occupations, a ratio of labor to renovation material purchase costs, phone records, an article about the need to work over 100 hours a week to survive on minimum wage and an article about a corporate CEO who worked 130 hours per week. As a result of this self-invented calculation, petitioners allege that Mr. Penley worked 2,520 hours on real estate activities in the year at issue.

The Court mentions that this evidence could have been raised before the Court’s decision was issued, but even so, goes on to address the key points raised by petitioners. The Court finds that the evidence is still too vague, untrustworthy, exaggerated and doesn’t prove that Mr. Penley actually worked more than 100 hours per week.

The Court goes on to say that even if the evidence was credible, petitioners still would have to prove that Mr. Penley was a real estate professional performing personal services in connection with a trade or business rather than an investor.

Regarding the accuracy-related penalty, although the petitioners had hired an enrolled agent to prepare their return, the Court found that no reasonable cause had been shown because petitioners did not accurately provide the preparer with all of the relevant facts.

Judge Wherry denies their motion for reconsideration, since petitioners did not show unusual circumstances, a substantial error of fact or law, or any other reason justifying relief.

LLC Lacks Legal Capacity

Docket #: 26053-15R, MD Facs Trust LLC v. C.I.R. (Order Here)

This designated order involves respondent moving to dismiss for lack of jurisdiction arguing (after supplementing its motion) that petitioner, a limited liability company (“LLC”), lacked legal capacity at the time it filed its Tax Court petition. The LLC petitioned the Tax Court after it allegedly sought review of a retirement plan and the IRS allegedly failed to provide a determination.

According to respondent, petitioner lacks legal capacity because the LLC was not in good standing with the State of Maryland when the petition was filed. A taxpayer must have capacity, under Rule 60(c), to engage in litigation but the rule does not specifically address how the capacity of an LLC is determined. Respondent argues that capacity should be determined by Maryland law because that is where the petitioner is organized. Petitioner does not challenge that approach.

Under Maryland law, if an LLC is no longer in good standing it is barred from initiating a lawsuit. In this case, the LLC was not in good standing because it was forfeited by the Department of Assessments and Taxation three years before it petitioned the Tax Court. As a result, the Court finds petitioner lacked capacity to commence the case so dismissing the case for lack of jurisdiction is warranted.

Legal capacity aside, section 7476 gives Court jurisdiction to make a declaratory judgment regarding the tax-qualified status of a retirement plan, but before it can do so it must determine that the taxpayer has exhausted administrative remedies. The Court goes on to find that even if petitioner had legal capacity, it did not exhaust administrative remedies because its application was not procedurally complete. An application for tax-qualified status of a retirement plan is procedurally complete when it includes the appropriate forms, payment of the user fee, and a copy of the retirement plan and trust document among other things.

The petitioner alleges that it submitted the appropriate forms and presents copies of forms signed and dated in July 2014 to respondent and the Court. The version of one of the forms presented was published in August so it was not yet available in July, which suggests that the petitioner did not actually file the forms as he alleges. Additionally, the IRS had no record of forms being submitted nor record of the user fee being paid. Petitioner also did not submit a copy of the retirement plan nor trust agreement, which made a review by the IRS impossible.

In addition to lacking legal capacity to institute the Tax Court proceeding, the Court finds petitioner did not prove that it exhausted administrative remedies so the motion to dismiss for lack of jurisdiction is granted.

Mind the Scope of Subpoenas

Docket #: 13370-13, Estate of Marion Levine, Deceased, Robert L. Larson, Personal Representative and Trustee, Robert H. Levine, Trustee and Nancy S. Saliterman, Trustee v. C.I.R., (Order Here)

In this order, petitioners move for a protective order to limit the scope of a subpoena that respondent served on one of petitioner’s attorneys and the attorney’s firm. Petitioner, an estate represented by its personal representative and trustees, argues the scope of the subpoena is overly broad as respondent sought all documents that petitioner’s attorney or his firm had in their files for Marion Levine and her estate for a period of more than 10 years, between January 2007 until July 2017. The petitioner argues anything after April 2013, when the notice of deficiency was issued, is work-product and likely undiscoverable.

Petitioner had also subpoenaed the attorney and his firm for the firm’s files for the period between beginning in January 2007 until the estate return was filed in April 2010. The reason petitioner subpoenaed this information was to prepare a reasonable cause defense to penalties.

Respondent agrees that documents prepared after the notice of deficiency was issued are work-product, but argues that by attempting to raise the reasonable cause defense petitioners waive any work-product privilege.

The work-product privilege specifically limits discovery of documents prepared in anticipation of litigation and not merely assembled in the ordinary course of business. In the tax realm, even audit documents could be prepared in anticipation of litigation.

Respondent refers to a case and an order in which the Court held that raising a good-faith defense could waive attorney-client privilege, but in the case and order the documents and notes were written before the transaction at issue and respondent was not seeking anything from a period after the taxpayer filed returns.

The Court agrees that good faith and reasonable cause can waive work-product protection for certain documents made before a return is filed, but Respondent does not cite any authority supporting the argument that the protection is waived for documents made after litigation begins.

Even so, a party can obtain work-product if there is a substantial need. Respondent says it has a genuine need for the information to rebut petitioner’s reasonable cause defense, but gives no reason for needing any of the information that was produced after the return was filed. The Court says subpoenas in the form of a “large scale drift netting” are generally not okay and grants petitioner’s protective order limiting the scope of the information available to respondent.

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