Lately I’ve been obsessing over how to remedy “bad answers” from the IRS). In my last post, I detailed how IRS counsel’s failure to “reasonably inquire” under Rule 33 before filing a “bad answer” may make them more susceptible to awards of litigation costs under IRC § 7430. Of course, litigation costs come at the end of the ligation process, so that might not seem like a useful remedy for more quickly resolving a case when the IRS files a “bad answer.”
Fortunately, the consequences for failing to reasonably inquire before filing an answer include more than just the heightened possibility of litigation costs. Indeed, far more immediate consequences may ensue. Read on for two more examples, from two more Tax Court orders.
Remedies for Bad Answers: Motion for More Definite Statement
There are a great many lessons that can be gleaned from the case of Patrick McCabe and Zine Magubane v. C.I.R. (Dkt. # 23862-05). I sincerely hope that the Tax Court considers returning to the practice of issuing “designated orders” at some time in the future. I have no idea if the order I am about to cover in detail was “designated” by Judge Panuthos when he issued it in 2006… but it is exactly the sort of order that practitioners would benefit from reading.
For everyone else, the Readers Digest version is as follows:
Petitioners were audited for Schedule C income and deduction issues. The petitioners engaged in the audit process, providing (they allege) adequate substantiation for each issue that ended up on the Notice of Deficiency. Importantly, they alleged that they had adequately substantiated everything and complied with the audit as part of their petition to the Tax Court. Keep my earlier discourse on the limits of burden shifting under IRC § 7491 in the back of your mind…
IRS Counsel asked for more time to file its answer because they didn’t have the administrative file. No one objected, and more time was granted.
Days passed. Again, the IRS can’t find a way to get the administrative file to IRS Counsel. At this point the facts are fairly similar to Vermouth v. C.I.R., 88 T.C. 1488 (1987).
Only now the parties diverge. Rather than file another motion asking for additional time to answer, IRS Counsel decides they’ll just file a “bad answer” instead. In response to all the facts alleged by petitioner, IRS Counsel “denies for lack of sufficient information or knowledge.”
Judge Panuthos and the petitioner are not impressed. Everything from my prior two posts now comes full circle… The interplay of Vermouth and responsive pleadings under Rule 36, as well as the post on reasonable inquiry requirements under Rule 33(b). What a payoff!
Petitioners file a “Motion for More Definite Statement” under Tax Court Rule 51. In that motion, they argue that the IRS’s answer is too vague to allow a reply and that the burden of proof should shift under IRC § 7491.
Note that this burden shift is critical to the Rule 51 motion. You really can’t argue “I need more clarity in order to reply!” (i.e., Rule 51) if a reply doesn’t make sense in the first place, because the burden is on you to prove something you affirmatively alleged. That is your prototypical deficiency case: petitioner alleges facts needed to show no deficiency, etc. When IRS Counsel denies those facts, you do not have to (indeed, shouldn’t) file a “reply.” If there was something more at play than IRS Counsel just saying, “we deny those facts, please uphold the deficiency,” however, Rule 51 might come in handy. From my look over the Tax Court orders, this most often arises with the assertion of fraud, but it could be any number of things (see, e.g., Rule 39). Here, it appears that the only way petitioners can get to Rule 51 is if there is a burden shift for the deficiency.
Whether or not a Rule 51 motion is appropriate in the McCabe/Magubane case isn’t really touched on – though Judge Panuthos seems to think Rule 51 isn’t the way to go in a footnote (that is, no “reply” is needed in this case). In any event, Judge Panuthos is willing to entertain the general notion that the IRS’s answer is deficient. And IRS Counsel’s argument for why the answer is fine is… not impressive.
In a nutshell, IRS Counsel thinks they should be able to deny everything for lack of sufficient information because they still can’t find the administrative file. Not their fault that someone else at the IRS isn’t doing their job. And this mistake from some other person at the IRS is the reason they (truthfully) don’t have “sufficient information or knowledge.” Things should just be left at that.
But Judge Panuthos doesn’t leave things at that. Instead, he (literally) underscores the requirement of Rule 33(b) that provides the signer’s knowledge or belief should be “formed after a reasonable inquiry.”
And here things go an important step further. It isn’t enough to just say “I don’t have the file, and it’s not my fault it can’t be found.” Judge Panuthos writes:
“The Commissioner’s knowledge includes that of the revenue agent and other IRS personnel involved in the examination in this case. Thus, although the absences of the administrative file may be a direct impediment to the filing of a proper answer, counsel for respondent must avail himself of the other sources of information that would allow him to prepare a proper responsive pleading.”
This is, I think, a fair position to take. Note that it isn’t quite “imputing” full knowledge from one disparate wing of the IRS to another. Rather, it is something of a middle road: if you know that some other wing of the IRS has information/knowledge of the issues at hand, you have to reasonably inquire of those sources.
Similarly, I’d say Judge Panuthos’s ultimate ruling on the motion is also a fair position. He grants the motion, but with (for the time being at least) a less severe remedy than what was asked for by petitioner: the burden doesn’t shift, but the IRS has to file an amended (better) answer in less than a month.
Note that Judge Panuthos’s analysis was squarely on Rule 33, the violation of which allows for a range of sanctions. In other words, you need not go the route of “Motion for More Definite Statement” if the IRS answer has the type of shortfalls outlined above. More thoughts on other options at the conclusion of this post.
So How Far Does an Inquiry Need to Be for it to be Reasonable?
Ultimately, and perhaps unhelpfully, the “test” of reasonable inquiry is one of facts and circumstances. The Supreme Court has said as much with regards to FRCP 11, which is very similar to TC Rule 33. (For the Supreme Court take on Rule 11, see Business Guides, Inc. v. Chromatic Communications Enterprises, Inc., 498 U.S. 533 (1991).
At one extreme, IRS counsel failing to do much of any inquiry after failing to timely receive the administrative file is not good enough. To see something of the opposite extreme, it may be instructive to review the case of Wilmington Partners, L.P., v. C.I.R., Dkt. # 15098-06.
Wilmington was a TEFRA case involving a 65-page petition and 48-page IRS answer. The attorneys in Wilmington didn’t much appreciate that the IRS frequently denied portions of their meticulously laid-out petition for “lack of sufficient information or knowledge.” In particular, they were of the opinion that many of the facts were known to the Commissioner in some capacity or another, over the lifespan of the many exams and hours spent on the myriad partners comprising the case. Since IRS Counsel would have known these facts if they “reasonably inquired,” their denials (“lack of sufficient information”) should be stricken… or perhaps less dramatically, IRS Counsel should have to provide a more definite response.
To this, Judge Carluzzo said “no.” IRS Counsel contended that it reviewed literally thousands of pages contained in the administrative file before filing its 48-page answer. This might be enough to be considered a “reasonable inquiry,” but Judge Carluzzo doesn’t want to go too far down the road of defining that term (and resolves the matter without doing so).
Nonetheless, wading through over a thousand pages of administrative file is likely to be a reasonable inquiry – or at least enough to keep the Tax Court from imposing tough sanctions like striking an allegation. But simply throwing up your hands when the administrative file doesn’t come your way is not.
Moving Forward: Lessons Learned
I hope you’ve enjoyed these last few posts at least as much as I’ve enjoyed writing them during my spring break… We’ve covered a lot of ground, to the extent that I think some recap is in order. For me, the lessons I’ve pulled and plan on incorporating in my practice are as follows:
First and foremost, engage with the IRS during the administrative phase (i.e., exam), even if you are not sanguine on your prospects for success at that level. You cannot expect IRS Counsel to have knowledge of information you allege in your (eventual) petition if you haven’t sent it to the IRS exam or Appeals previously. You also can’t possibly expect to either burden shift or get attorney’s fees if you come late to the game.
Second, and relatedly, think strategically in crafting the facts portion of your petition. Can you allege facts that the IRS should be well aware of from information previously provided? Can you make a case for a burden shift? Can you phrase things in a way that would make it awkward for the IRS to “deny for lack of sufficient information?”
In deficiency cases, there are times where I allege and reference facts that should clearly be in the administrative file (e.g., “Taxpayer responded to the IRS CP2000 Notice on [x] date by sending a letter.”) But these are generally relevant to penalty issues only. (In the above example, it is relevant under IRC § 6751 and Walquist’s take on IRC § 6662 as being “automated” which I take issue with.) I have yet to argue for a burden shift in the petition, though that may change someday soon.
Third, emphasize when the administrative file is directly relevant (perhaps dispositive) to the issue at play in the petition. This is very easily done in most collection cases. Frankly, in my opinion the IRS shouldn’t file an answer to an “abuse of discretion” collection issue before at least reviewing the administrative file. I am almost certain to push back on any answer that denies for “lack of sufficient information” facts that are (1) directly relevant to the merits of the case and (2) necessarily found in the administrative file. The IRS has (indeed, created and maintains) the administrative file that is directly on point for those issues. It really just delays dispositive motion practice to answer a petition before reviewing that file.
Fourth, and finally, genuinely try to work with IRS Counsel before filing some sort of motion in response to a “bad answer.” It is important to keep things collegial before burning bridges, and moving for sanctions is a great way to poison the well (please hold all your “mixed metaphor” comments until the end). Respecting the things that are truly beyond IRS Counsel’s control means suggesting (and freely agreeing to) motions for additional time to file an answer. And although the Tax Court frowns on submitting “exhibits in the nature of evidence” with a petition, there is no reason why you cannot send documents directly to IRS Counsel supporting your petition after you’ve filed and they’ve been served. This isn’t to say that area Counsel will accept those documents… but it can’t hurt.
There are ways to be pro-active, and ways to have a “bad-answer” haunt the IRS. The increased chance of an attorney’s fees award is certainly one negative incentive for the IRS to do better. But another thought is to speed up the discovery process. Petitioners can be the ones to send (and initiate) the Branerton conference. Informally asking IRS Counsel to admit to the obvious facts previously listed on the petition can put them in an awkward space: do they deny and then deal with more formal admissions requests thereafter? Or do they admit to the facts alleged in the petition, thereby essentially conceding that they should have never denied in their answer to begin with? (Note that this would not come after the IRS had received additional information not already available to them at the answer stage.)
The point of all of this isn’t to catch IRS Counsel on a technicality or punish them for other branches of the IRS failing to send them the administrative file. The point is to make litigation more efficient. The pleading stage should narrow down issues and agree on facts to the greatest extent possible. Presently, at least in low-income cases, it is little more than a perfunctory “I Allege” and “We Deny” dance.
While many low-income cases involve thorny questions of fact, just as often they resolve on documentary evidence that both parties would agree to, if only they looked it over. I have had precious few cases where I’ve ultimately relied on the finder of fact (i.e., Tax Court judge) to make a determination based on testimony. I dream of a day that one of my deficiency cases may be ripe for summary judgment because both parties properly engaged before the case was set for trial…