Today we welcome guest blogger, Scott Schumacher. Scott directs the tax clinic and the graduate tax program at the University of Washington. His clinic won an interesting case late last year which had both procedural and substantive issues present. Scott accepted our invitation to blog on the case but wisely waited for the appeal period to run before submitting the post. The primary issue discussed here involves the age old question of conflicting testimony. Reading the opinion and Scott’s description below, it is easy to see the importance of properly developing and presenting the facts. Legal arguments do not mean much until the necessary facts lay the foundation. Keith
I like to tell my students that tax touches everything. From marriage to divorce, birth to death, nearly every life or financial event has tax consequences. It is not surprising, therefore, that the outcome of many tax cases turns on differing recollections of facts between parties, including between former spouses. Is a payment to a former spouse alimony or child support? Did one spouse in an innocent spouse case know or have reason to know of an understatement? The United States Tax Court routinely wrestles with these thorny questions, and lawyers representing one of the parties must determine how to prove that their client is telling the truth. A recent case decided by the Tax Court, Roberts v. Commissioner, dealt with just such a situation. Issued as a T.C. opinion because it resolved a novel legal issue on who should be taxed on an IRA distribution, Roberts also involved several procedural issues that I hope will be of interest to the readers of Procedurallytaxing.com.
The facts and the issue in the Roberts case were pretty straightforward. Roberts owned several IRA accounts, and during the year at issue, someone withdrew substantial amounts from those accounts. Roberts said his now ex-wife forged his signature and took the money, while the ex-wife said that she had nothing to do with it. The IRS took the position that even if she took the money, Roberts as the owner of the retirement accounts, was still taxable on the withdrawals. There was some case law that seemed to suggest that, but the cases were far from definitive. See Bunney v. Commissioner (generally the payee or distributee of an IRA is the participant or beneficiary who is eligible to receive funds from the IRA.)
We therefore had to prove that Roberts did not request or receive the IRA withdrawals, and even if we proved he didn’t, that he was nevertheless not the “distributee,” despite the fact that he was the person who was the participant in the IRA and was eligible to receive distributions.
Proving who signed a document can be challenging, particularly without expert testimony. However, we noticed some obvious discrepancies between Roberts’ normal signature and the signatures on the IRA withdrawal requests. While Roberts is known by friends and family as “Andy Roberts,” he signs every document with his full formal name, “Andrew W. Roberts.” In addition, as a former member of the military, he dates every document he signs with the date first, then the month, and finally the year. We had numerous documents showing how he signs and dates documents. A notable exception were the IRA withdrawal requests. Those were signed “Andy Roberts,” and they were dated with the month first and then the date.
Based on these discrepancies, along with significant other evidence, including the fact that the IRA withdrawal requests were faxed from Roberts’ wife place of employment, Judge Marvel found that Roberts’ wife had in fact withdrawn the funds from his IRA accounts. The Court went on to hold that because Roberts did not request, receive, or benefit from the IRA distributions, he was not a payee or distributee within the meaning of section 408(d)(1). While this legal question is obviously the most important aspect of the Court’s decision, this holding would not have been possible had we not been able to prove Roberts did not request or receive the IRA distributions.
The final legal and procedural wrinkle in the case involved the penalties. The IRS had asserted the substantial understatement penalty against Roberts. However, the Service did not assert, until its reply brief, the negligence penalties, and the Tax Court will not consider arguments raised for the first time in a reply brief. (As an aside, I am continually surprised that the IRS does not, as a matter of course, assert both the negligence and substantial understatement penalties in a Notice of Deficiency). A defense to both penalties is that the taxpayer acted with reasonable cause and in good faith. The substantial understatement penalty has the additional defense of “substantial authority.” Significantly, while there is no threshold for the application of the negligence penalty, the substantial understatement penalty requires that the understatement of tax exceed the greater of 10 percent of the tax required to be shown on the return or $5,000.
We did not have a great reasonable cause defense. Roberts relied on his wife to file his return, even though they were separated at the time the return was filed. He did not ask to see the return before it was filed, nor did he file an amended return after he learned that the original return was incorrect. There was also no benefit in having the Court focus on what the taxpayer should have done, but did not. Finally, we knew that if we won the primary issue, the understatement of tax would not be large enough for the substantial understatement to apply. Thus, we did not put on any evidence regarding the penalties. Fortunately, we prevailed on the underlying tax issue, and the substantial understatement penalty was therefore not applicable.
As result, not only did Robert not get hit with a penalty, he received a refund. While lengthy trials are not the norm in Tax Court, and many cases turn solely on legal issues, winning the factual battle can help you win the war.