Tax Litigation Update: Second Circuit Tweaks its Standard of Review in Tax Cases Involving Mixed Questions of Law and Fact; Decides Complex Tax Controversy Involving “Midco” Transaction

On November 14, 2013, the United States Court of Appeals for the Second Circuit clarified the standard of review for mixed questions of law and fact in a case on review from the Tax Court. The case, Diebold Foundation, Inc. v. Commissioner of Internal Revenue, involved a group of shareholders who wished to dispose of the stock they owned in a corporation which in turned owned appreciated property. Further, the Second Circuit joined the First and Fourth Circuits in concluding that the two prongs of §6901, dealing with transferred assets, are independent, and that the Tax Court did not err by only addressing the second prong of that section. A copy of the decision can be found here.

BACKGROUND

Upon the disposition of appreciated property, taxpayers, including corporate entities, generally owe tax on the property’s built-in gain””that is, the difference between the amount realized from the disposition of the property and its adjusted basis. 26 U.S.C. §§ 1(h), 1001, 1221, 1222. When shareholders who own stock in a C Corp that in turn holds appreciated property wish to dispose of the C Corp, they can do so through one of two transactions: an asset sale or a stock sale. If the shareholders sell the assets, the company is liable for tax on the built-in gain of appreciated property and therefore, there is less money to distribute to the shareholders. If the shareholders sell the stock, they must sell it at a lesser value so that the buyer will be insulated from the property’s built-in gains which will trigger a tax liability when sold. For shareholders to get the benefit of selling stock at a good price and buyers to get the benefit of buying assets without built-in gains, parties engage in “Midco transactions.”

“Midco transactions” or “intermediary transactions” are structured to allow the parties to have it both ways: letting the seller engage in a stock sale and the buyer engage in an asset purchase. In such a transaction, the selling shareholders sell their C Corp stock to an intermediary entity (or “Midco”) at a purchase price that does not discount for the built-in gain tax liability, as a stock sale to the ultimate purchaser would. The Midco then sells the assets of the C Corp to the buyer, who gets a purchase price basis in the assets, as opposed to the lower basis the corporate entity formerly had. The Midco keeps the difference between the asset sale price and the stock purchase price as its fee. The Midco’s willingness to allow both buyer and seller to avoid the tax consequences inherent in holding appreciated assets in a C Corp is based on a claimed tax-exempt status or supposed tax attributes, such as losses, which allow it to absorb the built-in gain tax liability. See I.R.S. Notice 2001-16, 2001-1 C.B. 730. It is important to note that if these tax attributes of the Midco prove to be artificial, then the tax liability created by the built-in gain on the sold assets still needs to be paid. In many instances, the Midco is a newly formed entity created for the sole purpose of facilitating such a transaction, without other income or assets and thus likely judgment-proof. The IRS must then seek payment from the other parties involved in the transaction in order to satisfy the tax liability the transaction was created to avoid.

FACTS

Double D Ranch, Inc., a personal holding company taxed as a C Corp., owned assets worth approximately $319 million, all of which had substantial built-in gain, such that the sale of the assets would have triggered a tax liability of approximately $81 million. The shareholders, Dorothy R. Diebold Marital Trust and Diebold Foundation, Inc., wanted to get rid of the assets of the corporation without triggering this tax liability but also without having to sell their shares at a substantial discount. Therefore, they decided to engage in a Midco transaction.

The parties to this Midco transaction all filed tax returns. On its tax return, the Midco claimed sufficient losses to offset the gain from the sale of assets, resulting in no net tax liability. The IRS issued a notice of deficiency against Double D Ranch, determining a deficiency of income tax, penalties, and interest of approximately $100 million. The deficiency resulted from the IRS’s determination that the Shareholders sale of Double D Ranch stock was, in substance, actually an asset sale followed by a liquidating distribution to the Shareholders. Double D Ranch did not contest this assessment, but the IRS was unable to find any Double D Ranch assets from which to collect the liability, as they had all been sold as part of the “Midco” transaction.

Deciding that any additional efforts to collect from Double D Ranch would be futile, the Commissioner attempted to collect from the Shareholders as transferees of Double D Ranch. Section 6901 of the Internal Revenue Code authorizes the assessment of liability against both (a) transferees of a taxpayer who owes income tax and (b) transferees of transferees. 26 U.S.C. § 6901(a)(1)(A)(I), (c)(2). The IRS issued a notice of transferee liability against Mrs. Diebold, trustee of the Marital Trust and director of Diebold Foundation, as a transferee of Double D Ranch. The Tax Court determined that she was not liable because the Marital Trust was the actual Double D Ranch shareholder, and the court saw no reason to ignore its separate existence. The Tax Court’s decision is available here.

SECOND CIRCUIT OPINION

  1. Standard of Review

The Second Circuit started its discussion by setting forth that its previous standard of review for mixed questions of law and fact was clear error. See Wright v. Comm’r, 571 F.3d 215, 219 (2d Cir. 2009). However, the Court noted that, according to statutory mandate, all Courts of Appeals are to “review the decisions of the Tax Court ”¦ in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury.” 26 U.S.C. §7482(a)(1). That is, all Courts of Appeal are to review decisions of the Tax Court de novo to the extent that the alleged error is in the misunderstanding of a legal standard and for clear error to the extent the alleged error is in a factual determination. Consequently, the Second Circuit acknowledged that its case law enunciating the standard of review for mixed questions of law and fact in an appeal from the Tax Court was in direct tension with this statutory mandate. Thus, because all Article III courts, with the exception of the Supreme Court, are solely creatures of statute, see U.S. Const. art. III; 28 U.S.C. §§ 1-463, the Second Circuit found that the statute must be determinative. Moreover, the Second Circuit Court held that there is no reason to review the Tax Court under a different standard than a district court, as “its relationship to us [is] that of a district court to a court of appeals.” Scheidelman v. Comm’r, 682 F.3d 189, 193 (2d Cir. 2012) (internal quotation marks omitted). Therefore, the Court held that “the Tax Court’s findings of fact are reviewed for clear error, but that mixed questions of law and fact are reviewed de novo, to the extent that the alleged error is in the misunderstanding of a legal standard.” See 26 U.S.C. § 7482(a)(1).

  1. The Merits of the Tax Controversy

In its discussion of the merits of the case, the Second Circuit Court studied IRC Section 6901, which provides that the IRS may assess tax against the transferee of assets of a taxpayer who owes income tax. The section provides that the tax liability will “be assessed, paid, and collected in the same manner and subject to the same provisions and limitations as in the case of the taxes with respect to which the liabilities were incurred” and allows for the collection of “[t]he liability, at law or in equity, of a transferee of property…of a taxpayer.” A “transferee” includes a “donee, heir, legatee, devisee, [or] distributee.”

Furthermore, the Second Circuit stated that although the provision with respect to transferees is not expansive in its terms, the IRS may assess transferee liability under § 6901 against a party if two distinct prongs are met: (1) the party must be a transferee under § 6901; and (2) the party must be subject to liability at law or in equity. Rowen v. Comm’r, 215 F.2d 641, 643 (2d Cir. 1954) (discussing predecessor statute, 26 U.S.C. § 311). Under the first prong of § 6901, courts look to federal tax law to determine whether the party in question is a transferee. The second prong, whether the party is liable at law or in equity, is determined by the applicable state law, in this case, the New York Uniform Fraudulent Conveyance Act (“NYUFCA”), N.Y. Debt. & Cred. Law §§ 270-281.

The Second Circuit joined the First and Fourth Circuits in concluding that the two prongs of § 6901 are independent and that the Tax Court did not err by only addressing the liability prong. See Frank Sawyer Trust of May 1992 v. Comm’r, 712 F.3d 597, 605 (1st Cir. 2013);Starnes v. Comm’r, 680 F.3d 417, 428 (4th Cir. 2012). The Court cited Commissioner v. Stern, 357 U.S. 39 (1958) where the Supreme Court recognized that the predecessor statute to § 6901 “neither creates nor defines a substantive liability but provides merely a new procedure by which the Government may collect taxes.” The statute was enacted in order to do away with the procedural differences between collecting taxes from one who was originally liable and from someone who received property from the original tax owner.

As for the second prong, the Second Circuit Court stated that the NYUFCA defines a “conveyance” as “every payment of money, assignment, release, transfer, lease, mortgage or pledge of tangible or intangible property, and also the creation of any lien or encumbrance.” N.Y. Debt. & Cred. Law § 270. Further, the NYUFCA establishes liability for a transferee if the transferor, without regard to his actual intent, (1) makes a conveyance, (2) without fair consideration, (3) that renders the transferor insolvent. See N.Y. Debt. & Cred. Law § 273; McCombs, 30 F.3d at 323. If Double D had sold its assets and liquidated the proceeds to its shareholders without retaining sufficient funds to pay the tax liability on the assets’ built-in gains, this would be a clear case of a fraudulent conveyance under § 273. However, due to the Midco form of this transaction, Double D did not actually make a conveyance to the Shareholders. If the form of the transaction is respected, § 273 is inapplicable.

The Second Circuit Court relied on HBE Leasing Corp. v. Frank, 48 F.3d 623, 635 (2d Cir. 1995), where it had previously stated: “[i]t is well established that multilateral transactions may under appropriate circumstances be ”˜collapsed’ and treated as phases of a single transaction for analysis under the UFCA.” HBE Leasing described a “paradigmatic scheme” under this collapsing doctrine as one in which one transferee gives fair value to the debtor in exchange for the debtor’s property, and the debtor then gratuitously transfers the proceeds of the first exchange to a second transferee. The first transferee thereby receives the debtor’s property, and the second transferee receives the consideration, while the debtor retains nothing. Such a transaction can be collapsed if two elements are met. “First, in accordance with the foregoing paradigm, the consideration received from the first transferee must be reconveyed by the [party owing the liability] for less than fair consideration or with an actual intent to defraud creditors ”¦ Second, . . . the transferee in the leg of the transaction sought to be voided must have actual or constructive knowledge of the entire scheme that renders her exchange with the debtor fraudulent.”

The Second Circuit stated that in this case, it was clear that the first element was met. Although the transaction had an additional wrinkle””namely, an additional party serving as the conduit for the transfers””it is still the case that one transferee received Double D’s property, another transferee (the Shareholders) received the consideration for these assets, and Double D was left with neither its assets nor the value of them. Therefore, in order for there to be liability against the selling Shareholders (and their successor entities), the Shareholders “must have actual or constructive knowledge of the entire scheme that renders [the] exchange with [Double D] fraudulent.”

When applying § 273 to a single transaction, the intent of the parties is typically irrelevant; the knowledge and intent of the parties becomes relevant when, as here, a court is urged to treat multiple business deals as a single transaction. Therefore, the Court proceeded to assess whether the Shareholders had actual or constructive knowledge of the entire scheme. The facts in this case demonstrated both a failure of ordinary diligence and active avoidance of the truth. Specifically the Court noted that the Shareholders recognized the “problem” of the tax liability arising from the built-in gains on the assets held by Double D, and sought out parties to help them avoid the tax liability inherent in a C Corp holding appreciated assets. They viewed slideshow and other presentations from three different firms that purported to deal with such problems.

The Court also noted that the Shareholder representatives had a sophisticated understanding of the structure of the entire transaction, a fact that courts frequently consider when determining whether to collapse a transaction and impose liability on an entity. See HBE Leasing, 48 F.3d at 635- 36 (“The case law has been aptly summarized in the following terms: “In deciding whether to collapse the transaction and impose liability on particular defendants, the courts have looked frequently to the knowledge of the defendants of the structure of the entire transaction and to whether its components were part of a single scheme.”) quoting In re Best Products Co., 168 B.R. 35, 57-58 (Bankr. S.D.N.Y. 1994 (emphasis added).

The fact that there had been a delay of the original closing date by one day, and the Shareholders’ representatives’ corresponding intervention between Shap Acquisition Corporation II (“Shap II”), an entity created specifically to carry out the transaction  and Morgan Stanley, the ultimate buyer of Double D securities, made the conclusion of their “active avoidance of the truth” inescapable. By asking Morgan Stanley to “back off” and give Shap II extra time to provide the Double D securities so that the transactions would not be upended, the Shareholders demonstrated not only their knowledge of the structure of the entire transaction, but their understanding that Shap II did not have the assets to meet its obligation to buy equivalent shares on the open market for delivery to Morgan Stanley or pay Morgan Stanley an equivalent sum in cash. This understanding, combined with the Shareholders’ knowledge that Shap II had just come into existence for the purposes of the transaction, was more than sufficient to demonstrate an awareness that Shap II was a shell that did not have legitimate offsetting losses or deductions to cancel out the huge built-in gain it would incur upon the sale of the Double D securities.

The Second Circuit Court concluded that the Shareholders’ conduct evinced constructive knowledge, and therefore collapsed the series of transactions and found that there was a conveyance under the NYUFCA. In collapsing the transactions, the Court stated that, in substance, Double D sold its assets and made a liquidating distribution to its Shareholders, which left Double D insolvent””that is, “the present fair salable value of [its] assets [wa]s less than the amount . . . required to pay [its] probable liability on [its] existing debts as they bec[a]me absolute and matured.” N.Y. Debt. & Cred. Law § 271. With the liquidating distribution, Double D did not receive anything from the Shareholders in exchange, and thus Double D certainly did not receive fair consideration. Consequently, all three prongs of § 273 were met: Double D (1) made a conveyance, (2) without fair consideration, (3) that rendered Double D insolvent. See N.Y. Debt. & Cred. Law § 273; McCombs, 30 F.3d at 323. Because the Court determined that there was state law liability, an issue arose regarding whether Diebold New York was a transferee under I.R.C. § 6901, and subsequently, whether Diebold was a transferee of a transferee under the same statute. To answer these questions, the Second Circuit Court remanded the case to the Tax Court.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of tax litigation. They will continue to monitor developments in this and similar cases. If you have any questions, an attorney can be reached by emailing us atcontact@fidjlaw.com or by calling 305.350.5690.

 

Tax Litigation Update: The D.C. Circuit is the Proper Venue for Many Appeals of Tax Court Cases

Last month, we wrote about the uncertainty in choosing the proper appeals court in certain Tax Court cases, and described the rift between the First, Eighth and Ninth Circuits on the one hand and the D.C. Circuit on the other. More specifically, we described that the First, Eighth and Ninth Circuits had previously held that they themselves were the proper forums for appeals based solely on the residence of the taxpayer, but that the Tax Court had written that in many cases the D.C. Circuit was the proper forum, regardless of the residence of the taxpayer. As of last month, the D.C. Circuit had not opined.

On January 17, 2014, the United States Court of Appeals for the D.C. Circuit issued its opinion in Byers v. Commissioner of Internal Revenue, available
here. In Byers, as the DC Circuit described, “Appellant does not seek review of the amount of the taxes he owes. Rather, he raises a number of procedural and substantive challenges emanating from an IRS Office of Appeals Collection Due Process (“CDP”) hearing which resulted in the contested levy.” The Department of Justice, litigating on behalf of the IRS, moved the DC Circuit to transfer the case to the U.S. Court of Appeals for the Eighth Circuit, which would have been the proper forum if the case involvedthe more typical petition for a re-determination of an income tax deficiency (commonly referred to as a “Ninety Day Letter” or“Stat.Notice”).

In opposing the Government’s Motion to Transfer, the Appellant argued that because he was “not seeking a redetermination of the amount of his taxes,” venue was proper in the D.C. Circuit. As the DC Circuit described:

Appellant points the court to an illuminating article, James Bamberg, A Different Point of Venue: The Plainer Meaning of Section 7482(b)(1), 61 TAX LAW. 445 (2008), in which the author contends that [a] plain meaning reading of the [statute] instructs that the D.C. Circuit Court is the appropriate venue, the default even, for all tax cases on appeal from the Tax Court that are not expressly brought up in section 7482(b)(1). Thus, it would appear that cases dealing with  . . ”˜collection due process’ hearings . . . should all be appealed to the D.C. Circuit Court. Id. at 456-57. We agree and therefore deny the Commissioner’s motion to transfer this case to the Eighth Circuit.

Slip op. at 2; (emphasis added).

Later in its Opinion, the Court reviewed the types of tax litigation in the district courts (refund litigation), the Claims Court (refund litigation), the Tax Court (re-determination litigation and Collection Due Process litigation) and compared and contrasted the different types of tax litigation and the appropriate forum for each. The DC Circuit then delved into the history of the Tax Court and the D.C. Circuit’s default status for appeals arising from Tax Court cases.  The D.C. Circuit observed that for many years it was the “default” court for tax appeals, but in 1966 the venue provision was amended by Congress giving rise to the statutory scheme in place today:

For both corporations and individuals, the statute stated that the proper venue for appeals involving redeterminations of liability was the federal court of appeals for the circuit in which the taxpayer’s residence was located. However, for the appeal of any case not enumerated in subsection (A) and (B), it assigned venue to the D.C. Circuit. Id. In other words, in 1966, Congress deliberately made the D.C. Circuit the default venue for tax cases.

Slip op., at 6.

The Court also noted:

Between 1966 and 1997, as Congress continued to expand the jurisdiction of the Tax Court, it also amended § 7482(b)(1) to add four more subsections, § 7482(b)(1)(C)-(F), that established venue based on a taxpayer’s residency”¦After these various revisions, the D.C. Circuit remained the default venue if “for any reason no subparagraph [assigning venue to a regional circuit] applies.” 26 U.S.C. § 7482(b)(1). Unlike its approach when expanding Tax Court jurisdiction to other areas, Congress did not alter the venue provision when it created the CDP framework in 1998.

Id.; (internal citations omitted).

In rejecting the Government’s position that the case should be transferred, the D.C. Circuit stated: “The Internal Revenue Manual clearly states that ”˜none of subparagraphs (A)-(F) [in 26 U.S.C. § 7482(b)(1)] expressly mentions a decision in a CDP case.’ IRM 36.2.5.8(1).  We agree with this characterization of the statute, which makes the Commissioner’s motion to transfer all the more puzzling.”  Slip op. at 11.

So, what does this mean for taxpayers?  In collection due process cases, and other cases not falling expressly within subparagraphs (A)-(F) of 26 U.S.C. 7482, the appropriate Court of Appeals is the D.C. Circuit.  Moreover, and perhaps more importantly, the D.C. Circuit’s jurisprudence now controls the Tax Court’s analysis.  This, in essence, means that in collection due process cases, there will only be one Court of Appeals (absent a stipulation between the parties to the contrary) that is the appropriate appellate forum, and as such, the “baby Supreme Court” just became even more important.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience in tax litigation and working with taxpayers facing tax deficiencies and IRS collection efforts.  We have litigated numerous cases before the United States Tax Court, the district courts, and the various Circuit Courts of Appeal including the DC Circuit. You can reach an attorney by calling us at 305-350-5690 or emailing us at contact@fidjlaw.com.

Tax Litigation Update: Determination Of Proper Appellate Court For Review Of Certain Tax Court Cases In Flux

INTRODUCTION AND BACKGROUND

It is a bedrock principle of tax litigation that the US Tax Court is bound to following the precedent of the Circuit Court of Appeals to which its decisions are subject to appeal.  See Golsen v. Comm’r, 54 T.C. 742 (1970).  Generally, this determination is based on the residence of the taxpayer at the time the Tax Court petition is filed.  For instance, if a taxpayer residing in Miami petitions the Tax Court for review of a Statutory Notice of Deficiency, appeal of the Tax Court’s decision will be to the 11th Circuit Court of Appeals, which covers Alabama, Florida, and Georgia.  Logically, and more importantly, in adjudicating the taxpayer’s case, the Tax Court is bound by the precedents of the 11th Circuit.

However, in recent years the jurisdiction of the Tax Court has expanded from its traditional role of serving as a prepayment forum in tax deficiency cases.  For example, the Tax Court has recently been granted jurisdiction over requests for innocent spouse relief, collection due process appeals, review of IRS denials of interest abatement requests, and the review of IRS whistleblower awards, among other varieties of actions.

With the expansion of the Tax Court’s jurisdiction, an exception to the “geographic” determination of the applicable Circuit Court of Appeals precedent appears to have developed.  The source of this exception is Internal Revenue Code (hereinafter “IRC”) § 7482(b)(1).  That statute sets forth six types of Tax Court cases that are subject to the general rule, outlined above, that the taxpayer’s residence (or principal place of business for taxpayer entities) will determine which Court of Appeals is the appropriate forum for review of the Tax Court’s decision.  The cases subject to this general rule include review of determinations by the IRS of tax deficiencies alleged to be owed by individuals or entities, certain declaratory judgment actions, and partnership cases implicating TEFRA.

However, when expanding the Tax Court’s jurisdiction by statute (for example, by extending the Tax Court’s jurisdiction to collection due process appeals) Congress has not correspondingly amended IRC § 7482(b)(1) to include each new type of case the Tax Court can hear.  In other words, while the variety of cases the Tax Court has power to decide has expanded, the six varieties of cases subject to the general geographic-determinative rule of IRC § 7482(b)(1) has remained the same.

This lack of correlation appears to implicate the catchall of IRC § 7482(b)(1), which states: “If for any reason no subparagraph (listing the six type of cases subject to the general, geographic-determinative venue provision) of the preceding sentence applies, then such decisions may be reviewed by the Court of Appeals for the District of Columbia.”

A plain reading of the appellate venue statute leads to the conclusion that regardless of the taxpayer’s residence at the time the Tax Court petition is filed, if the action is of a type not expressly set forth in IRC § 7482(b)(1), the D.C. Circuit Court of Appeals is the appropriate appellate venue.  Consequently, under the Golsen rule, the D.C. Circuit’s precedents will govern these actions at the Tax Court level.

Recently, this interpretation of § 7482(b)(1) has been gaining more traction.  For instance, in Whistleblower 14106-10W v. Comm’r, 137 T.C. 183 (2011), the Tax Court indicated that an appeal of that whistleblower action would lie with the D.C. Circuit under the § 7482(b)(1) catchall.  Further, in Cohen v. Comm’r, 139 T.C. No. 12 (2012), another whistleblower case, the government sought to transfer appellate venue from the Third Circuit to the D.C. Circuit using the § 7482(b)(1) catchall (the motion was unopposed and the case is currently pending before the D.C. Circuit).  Finally, in a case pending before the D.C. Circuit, Byers v. Comm’r, the taxpayer has argued that appeal of his collection due process case should lie in the D.C. Circuit, rather than the Eighth Circuit, which would be the geographically applicable Circuit Court of Appeal, based on the § 7482(b)(1) catchall provision.

THE EFFECT OF D.C. CIRCUIT APPELLATE REVIEW OF COLLECTION DUE PROCESS CASES

The impact of this interpretation of the statute could be wide-ranging.  First, it is important to note that the under IRC § 7482(b)(2), the parties (i.e. the taxpayer and the IRS) can stipulate to review by a Circuit Court of Appeals of their choosing.  However, in situations where the parties do not stipulate, review by the D.C. Circuit could be advantageous to a taxpayer.

A primary example of when review in the D.C. Circuit can be advantageous is a collection due process case.  In a collection due process case, the IRS serves a notice of intent to begin collection activity or to lien or levy against the taxpayer’s property.  Upon receipt of that notice, the taxpayer may invoke the review of the IRS Office of Appeals to determine whether the IRS’s proposed collection action is proper in light of the taxpayer’s financial circumstances.  The taxpayer may also request a collection alternative (such as an offer in compromise or a payment plan) and assert other rights.

If the Appeals Office upholds the IRS’s proposed collection action, the taxpayer has the right to seek review of the Appeals Office’s determination in the Tax Court.  In reviewing the determination, an issue arises as to the scope of the Tax Court’s review.  The Tax Court has held that its review of the evidence presented at trial is de novo, which means it can accept new evidence not presented at the Appeals Office level.  See Robinette v. Comm’r, 123 T.C. 85 (2004).  However, three Circuit Courts of Appeal have  held that the Tax Court is limited to review of the administrative record (so that if the taxpayer fails to present evidence at the Appeals Office level, the taxpayer will be precluded from introducing the evidence at the Tax Court level).

The D.C. Circuit Court of Appeals has not proscribed the scope of Tax Court review of a collection due process case (the three Circuit Courts that have done so are the First, Eighth, and Ninth).  For that reason, a taxpayer residing in the First, Eighth, or Ninth Circuits seeking de novo review of the evidence in a collection due process case would be wise to assert and attempt to establish appeals venue in the D.C. Circuit under the IRC § 7482(b)(1) catchall (thereby establishing de novo review of evidence at the Tax Court level under Golsen), rather than the geographically applicable Circuit Court.

However, this is a two way street and can be disadvantageous to the taxpayer.  If the DC Circuit establishes precedent that is contrary to the taxpayer’s interests, the government would be in position to ensure that the case is appealed to the D.C. Circuit, under the IRC § 7482(b)(1) catchall, thereby ensuring application of the negative precedent at the Tax Court level.

IMPLICATIONS FOR TAX COURT LITIGATION STRATEGY

The combination of the Golsen rule and the flexible nature of appeals court venue for Tax Court cases raises another interesting issue bearing on litigation strategy: at what point does a party (and the Tax Court) become bound by a particular Circuit Court’s jurisprudence?  As stated above, the parties in a Tax Court case can stipulate to appeals venue in a particular Circuit Court of Appeals of their choosing.  By so doing, the parties presumably bind themselves to the precedents of that Circuit Court under the Golsen rule.  This indicates that the Appeals Court venue provision is not jurisdictional in nature, and the right to assert a particular appeals venue can be waived.  That, in turn, raises the issue of whether a party can bind another party to a particular Circuit Court at the pleadings stage or some other stage of the litigation.  Doing so would have the effect of cutting off the right to subsequently file a motion to transfer appeals venue.

Under Tax Court Rule 36(c), if a material allegation set forth in a petition is not expressly admitted or denied in the Respondent’s answer, the allegation is deemed admitted.  Further, Tax Court precedent generally indicates that failure by a party in Tax Court litigation to respond to an argument on a specific point results in concession of that point.  See Straight v. Comm’r,1999 WL 33587419 (U.S. Tax Court May 6, 1999).

This authority indicates that it may be beneficial in some circumstances for a litigant to assert its position regarding the proper appeals venue early in the case.  Failure by other party to directly address the issue may result in waiver of the right to assert venue in an alternative appeals court.  At the very least, raising the appeals venue issue early forces the parties to commit to a position and clarifies which Circuit’s law will govern the proceedings.

FUTURE CONGRESSIONAL ACTION

The issue of Appeals Court venue in collection due process cases is currently included in potential tax reforms being considered by Congress, a good compilation of which can be found here.  Current draft legislation would apply the general geography-based appeals venue provision to both innocent spouse cases and collection due process cases.  This legislation could have the effect of applying, on a nationwide basis, the more restrictive scope of Tax Court review currently in place in the First, Eighth, and Ninth Circuits.  This important issue will undoubtedly continue to develop, both in Congress and with the resolution of the Byers case, over the next year.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience in tax litigation and working with taxpayers facing tax deficiencies and IRS collection efforts.  We will continue to monitor the development of these issues, and we will update this blog with relevant information as often as possible. You can reach an attorney by calling us at 305-350-5690 or emailing us at contact@fidjlaw.com.

Raminfard Guilty Plea Highlights Complexity Of International Tax Compliance, Seriousness Of Violations, Importance Of Irs Offshore Voluntary Disclosure Program

Los Angeles Businessman, David Raminfard, pleaded guilty on November 4th, 2013 in the Federal District Court in Los Angeles to conspiring to defraud the United States, the Justice Department and Internal Revenue Service-Criminal Investigation (IRS-CI) announced.

Raminfard, a U.S. citizen, maintained undeclared bank accounts at an international bank headquartered in Tel Aviv, Israel, identified in court documents only as Bank A.  The accounts were held in the names of nominees in order to keep them secret from the U.S. government.  One of the accounts was held in the name of Westrose Limited, a nominee entity formed in the Turks and Caicos Islands.  To further ensure that his undeclared accounts remained secret, Raminfard placed a mail hold on his accounts.  Rather than having his account statements mailed directly to him, Raminfard would receive them from an international accounts manager with Bank A in Israel, who brought them to Los Angeles to review them with Raminfard during meetings at a hotel.

In 2000, Raminfard began secretly using the funds in his undeclared accounts as collateral for back-to-back loans obtained from the Los Angeles branch of Bank A.  A “back-to-back” loan is a two party arrangement in which a bank advances a loan on the basis of a loan advanced by another bank in another country. In this particular case, the “back-to-back loan” was taken out at Bank A’s Los Angeles Branch secured by funds in an account located at Bank A’s Israel Branch (the “pledged account”). The pledged account in Israel was held in a certificate of deposit, and there was usually a 1% to 2% spread between the interest earned on the certificate of deposit and the interest charged on the back-to-back loan.

Raminfard used the loan money to purchase commercial real estate in Los Angeles.  By using back-to-back loans, Raminfard was able to access his funds in Israel without the U.S. Government learning about his undeclared accounts.  These loans also enabled Raminfard to claim the interest paid on the loans as a business expense on his companies’ business tax returns, while not reporting the interest earned in Israel as income on his individual income tax returns filed with the IRS.  For tax years 2005 through 2010, Raminfard failed to report approximately $521,000 in income.  The highest balance in Raminfard’s undeclared accounts was approximately $3 million.

As we have previously explained , and , federal law requires all United States persons with a financial interest in or signature authority over at least one financial account located outside of the United States, the aggregate value of which exceeded $10,000 at any time during the calendar year, to be reported to the U.S. Treasury by filing an FBAR. Failure to disclose these accounts can result in both civil and criminal liabilities. As we have further explained, the IRS has established a voluntary disclosure initiative for taxpayers who want to disclose previously undisclosed accounts and avoid being criminally prosecuted.

Consequently, using the money in an undeclared bank account exposes a person to various forms of liability, and it therefore becomes highly difficult for the U.S. person to access it from within the United States.  Back-to-back loans, then, come into the picture as a vehicle to allow the account holder in the U.S. to access the account without the federal government discovering it. However, as the Raminfard case makes clear, the United States perceives this as tax evasion and will prosecute it as such.

Raminfard is the latest in a series of defendants charged in the U.S. District Court for the Central District of California with conspiring to defraud the United States in connection with using undeclared bank accounts in Israel to obtain back-to-back loans in the United States. He faces a potential maximum prison term of five years and a maximum fine of $250,000.  In addition, he has agreed to pay a civil penalty to the IRS in the amount of 50 percent of the high balance of his undeclared accounts for failing to file FBARs.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of international tax compliance and tax litigation.  They will continue to monitor developments in this and similar cases. If you have any questions, an attorney can be reached by emailing us at contact@fidjlaw.comor by calling 305.350.5690.

Florida Business Litigation Update: The Carmack Amendment Preempts Virtually Everything

The Carmack Amendment to the Interstate Commerce Act established a uniform national policy for interstate carriers’ liability for property loss. 49 U.S.C. § 14706. Under Carmack, while a carrier is generally liable for the actual loss or injury to the property, the carrier may limit its liability to an agreed value established by a written shipper’s declaration or agreement between the carrier and shipper. In practice, virtually all goods shipped through common carrier are typically expressly valued at a price substantially less than the real fair market value of the goods shipped.

Carmack preempts otherwise available state and common law.  Like any preemption statute, the scope of what is preempted has been the subject of a great deal of litigation since Carmack’s enactment in 1906.  Early Supreme Court precedent found that Carmack’s “preemptive scope supersedes all the regulations and policies of a particular state upon the same subject … [and its] preemption embraces all losses resulting from any failure to discharge a carrier’s duty as to any part of the agreed transportation.”  Conversely, the 11th Circuit holds that claims that are “based on conduct separate and distinct from the delivery, loss of, or damage to goods escape preemption.”

Yet, consider the following scenario:  Shipper is an internationally renowned artist.  Shipper ships several original works of art, each appraised at tens of thousands of dollars, through Carrier, who declares the total shipment to be valued at $100.00.  Shipper does not receive goods. Carrier responds that the shipment was lost, and compensates Shipper for $100.00.  Carrier then internally declares the works of art to be “lost goods,” and sells the goods to a third party, who then sells the works of art to the public for its appraised value.  Shipper sues Carrier for conversion, deceptive and unfair trade practices, civil theft, and misappropriation of Shipper’s name and likeness.  Carrier argues that the lawsuit is preempted by Carmack’ limitations of liability provisions.  The question is whether Carrier’s conduct is legally “separate and distinct” from the losses to the goods covered by Carmack.

This is the fact pattern faced by Florida’s Fourth District Court of Appeals in Mlinar v. United Parcel Service, Inc., 38 Fla. L. Weekly D2542 (Fla. 4th DCA Dec. 4, 2013), a copy of which is available here. The Mlinar court analyzed a survey of Carmack cases across the federal circuits, and held that the test for determining whether the conduct is legally “separate and distinct” is “whether the claims are based on conduct separate and distinct from the delivery, loss of, or damage to goods. In other words, separate and distinct conduct rather than injury must exist for a claim to fall outside the preemptive scope of the Carmack Amendment.” Id. (emphasis in original).  The court determined that the conduct of “non-delivery of the goods,” regardless of whether that non-delivery arose from an intentional act of theft or simple negligence, is inseparable, and thus Carmack preempted the claims sounding in conversion and civil theft.  Likewise, the court found that the claim of misappropriation of Shipper’s name and likeness was preempted, because the injury, or damages, arose from the non-delivery of the goods, and thus the conduct again fell within the purview of Carmack.  Finally, the court found that the allegations of deceptive and unfair trade practices, were too “closely related to the performance of the contract,” and thus found those claims were also preempted.  The Mlinar court notes that it was compelled to find preemption because, “To hold otherwise would undermine the Carmack Amendment’s goal of creating a uniform national policy on a carrier’s liability for property loss.”

At first glance, it may appear that Carmack creates an unbalanced and unfair transactional environment between the carrier and the shipper.  However, Carmack enables the shipping industry to offer competitive pricing to enable the free-flow of interstate commerce, without fear of budgeting for unknown litigation risks typically associated with the shipment of goods.  Conversely, armed with the knowledge and predictability that the carrier has an explicit limitation of liability, the shipper may duly protect its interest by purchasing shipper’s insurance for the true value of the goods.  This essentially allows a risk-adverse shipper to pay a different, itemized price for shipping its goods. It provides for a more robust, competitive market.

It should be noted that the Mlinar court did certify a potential conflict with another decision, Braid Sales & Mktg., Inc. v. R & L Carriers, Inc., 838 So. 2d 590, 593 (Fla. 5th DCA 2003), which found that a claim of an alleged oral contract between the parties for payment of repairs, entered into after the shipment was completed, constituted a separate harm which was legally “separate and distinct” from the loss or damage to goods, and thus not preempted.  However, whether the Florida Supreme Court will accept the certification, or find that there is any conflict, is far from certain.  Still, regardless of whether the case is eventually reversed, the lessons to be gleaned from Mlinar are clear.  A shipper needs to appreciate that absent insurance, its goods are only nominally protected against a carrier’s duty to deliver the goods.  Shipper’s insurance should be carefully considered and analyzed before placing the goods in the care of a carrier.  Indeed, the added expense, which may be passed on to the end consumer, may prove to be the difference between a recoverable loss and a catastrophic loss.

For more information, please contact us at contact@fidjlaw.com or call us directly at 305-350-5690.

Litigation Update – The Electronic Loss of Privilege

The art of communication has changed considerably over the past few years.  Rather than in-person or telephonic, the majority of communications in today’s business world are electronically transmitted.  Likewise, professional advice, such as legal or accountant-related services, is often sought and rendered electronically.

The rise of technological advances has caused a clash with foundational legal cornerstones that have been established through decades of jurisprudence.  Amongst those principles is the inviolate protection of the confidentiality between the attorney and client.  Generally speaking, as long as a client reasonably expects that the communication with his/her lawyer is made in confidence, meaning that it will not be shared with third parties, for the purposes of receiving legal advice, the communication is privileged.

With the advent of electronic communications, the question arises as to whether the client should reasonably expect that an electronic communication be free from peering third party eyes.  The question is compounded when the electronic communication is sent from a device owned or controlled by a third party, such as an employer, with no password protections or which may otherwise be monitored by a third party.  Further complicating matters is a situation where an employee communicates with his/her private counsel, on a company computer, for matters pertaining to a dispute with the company.  The courts are routinely tasked with  deciding the expectation of confidentiality in these complex cases.

This is the situation addressed by the Delaware Court in In re Info. Mgmt. Services, Inc. Derivative Litig., 2013 WL 5426157 (Del. Ch. 2013).  Drawing on the Supreme Court’s test of an employee’s expectation of privacy, the court found:

[A]n employee can have reasonable expectation of privacy in areas such as the employee’s office, desk, and files, but that the “employee’s expectation of privacy … may be reduced by virtue of actual office practices and procedures, or by legitimate regulation. … Although e-mail communication, like any other form of communication, carries the risk of unauthorized disclosure, the prevailing view is that lawyers and clients may communicate confidential information through unencrypted e-mail with a reasonable expectation of confidentiality.” [internal citations omitted].

The question thus turns to whether the client has “a reasonable expectation” to confidentiality. The court adopted the four factor test promulgated in the oft-cited In Re Asia Global Crossing, Ltd., 322 B.R. 247, 259 (S.D.N.Y.2005) decision, The Southern District of Florida has applied this test.  See Leor Exploration & Prod. LLC v. Aguiar, 2009 WL 3097207 (S.D. Fla. 2009).

to determine whether there is an expectation of confidentiality:

(1) does the corporation maintain a policy banning personal or other objectionable use, (2) does the company monitor the use of the employee’s computer or e-mail, (3) do third parties have a right of access to the computer or e-mails, and (4) did the corporation notify the employee, or was the employee aware, of the use and monitoring policies?

While no one factor is dispositive, “The question of privilege comes down to whether the [employee’s] intent to communicate in confidence was objectively reasonable.”

Courts throughout the country have applied this test, or a derivation thereof, but generally center the analysis on the company’s explicit policies on electronic communications (or lack thereof), the manner in which this policy is communicated to the employees, and enforcement of such policies.  Put simply, when the courts find an absence of corporate policies (or an absence of explicit communication of such policies), the courts will infer an expectation of confidentiality.  However, where there is an explicit corporate policy duly communicated to the employee that provides that all emails (or other electronic data) used on company computers or stored on company servers may be monitored by the corporation, there can be no reasonable expectation of privacy.

In our ever-changing world, it is critical that every corporation ensure that it has a sound and clear policy on the rights to electronic information stored or transmitted on company computers and servers.  The clarity of such a policy, duly communicated to the employees, may very well have far-reaching implications, from serving as the key to discovering, or concealing, the “smoking gun” in litigation, or perhaps uncovering, and preventing, an employee’s plan to misappropriate proprietary data to be used as a means of future competition.  Regardless, corporate policies are becoming increasingly critical to ensure compliance with corporate goals and functions.

For more information, please contact us at contact@fidjlaw.com or call us directly at 305-350-5690.

False Claims Act Litigation Update: Florida Federal Court Finds Hospital Violated Stark Law Via Oncologist Bonus Compensation System

On November 13, 2013, the United States District Court for the Middle District of Florida granted partial summary judgment in favor of the United States inUnited States ex rel. Baklid-Kunz v. Halifax Hospital Med. Ctr., et al. In its order, the Court provided clarification on the extent to which bonus compensation for referrals qualifies under the “bona fide employment relationships” exception to the Stark Law. A copy of the decision can be read here.

  1. Factual Background

This case centers around how Halifax Hospital Medical Center (“Halifax”) compensated certain doctors within its hospital. Halifax, though its staffing instrumentality Halifax Staffing, entered into employment agreements with six oncologists. The employment agreements provided that the oncologists would receive both a salary and a bonus. The bonus for each oncologist was a percentage of a bonus pool which consisted of revenue from services directly performed by each oncologist and profits earned by the oncology department for fees and services not personally performed by each physician.

Halifax paid the bonus to its oncologists from 2005 through 2008. During this time, Halifax submitted thousands of claims forms to Medicare in which one or more of the oncologists were identified as an attending or operating physician. On June 16, 2009, the Relator, Halifax’s compliance officer, filed the qui tam action against Halifax alleging it violated the Stark Law by billing Medicare for items provided as a result of referrals from physicians with whom it had an improper financial relationship. On October 4, 2011, the Government elected to intervene in the Relator’s Stark lawsuit. The Court’s November 13, 2013 decision granted summary judgment for the Government and the Relator on the issue of whether the Stark Law was provided.

  1. Stark Law Basics
  1. Prohibited Referrals and Potential Liability

Generally speaking, the Stark Law, which was passed in two parts, “Stark I” and “Start II”, prohibits physicians from referring their Medicare and Medicaid patients to business entities in which the physicians or their immediate family members have a financial interest. 42 U.S.C §1395nn.

More specifically, Stark prohibits physicians from making referrals to an entity for clinical lab services if the physician had a prohibited financial relationship with the entity. In addition, Stark prohibits physicians from referring Medicare patients for the “designated health services” to an entity with which the physician (or immediate family member) has a financial relationship, unless an exception applies. Designated health services include:

(A)     Clinical laboratory services;

(B)      Physical therapy service;

(C)      Occupational therapy services;

(D)      Radiology services;

(E)      Radiation therapy services and supplies;

(F)      Durable medical equipment and supplies;

(G)      Parental and enteral nutrients, equipment, and supplies;

(H)      Prosthetics, orthotics, and prosthetic devices and supplies;

(I)      Home health services;

(J)      Outpatient prescription drugs;

(K)      Inpatient and outpatient hospital services;

(L)      Outpatient speech-language pathology services.

42 U.S.C. § 1395nn(h)(6).

The Stark Law provides:

(a) Prohibition of certain referrals

(1) In general

Except as provided in subsection (b) of this section, if a physician (or an immediate family member of such physician) has a financial relationship with an entity specified in paragraph (2), then,

(A) The physician may not make a referral to the entity for the furnishing of designated health services for which payment otherwise may be made under this subchapter, and

(B) the entity may not present or cause to be presented a claim under this subchapter or bill to any individual, third party payor, or other entity for designated health services furnished pursuant to a referral prohibited under subparagraph (A).

42 U.S.C. § 1395nn(a)(1)(emphasis added).

In order to understand Stark’s reach, it is important to understand how Stark defines a “financial relationship” and a “referral.” As explained by the Court:

The Stark Law broadly defines “financial relationships” to include an ownership or investment interest in an entity or a “compensation arrangement.” 42 U.S.C. § 1395nn(a). “Compensation arrangement,” in turn, is defined as “any arrangement involving any remuneration between a physician (or an immediate family member of such physician) and an entity.” 42 U.S.C.§ 1395nn(h)(1)(A). “Remuneration,” with certain exceptions not applicable to the instant case, includes, “any remuneration, directly or indirectly, overly or covertly, in cash or in kind.” 42 U.S.C. § 1395nn(h)(1)(B).

“Referral,” for purposes of the Stark Law, is defined as “the request or establishment of a plan of care by a physician which includes the provision of designated health services.” 42 U.S.C. § 1395nn(h)(5)(A).The regulations interpreting the statute also broadly define “referral” as, among other things, “a request by a physician that includes the provision of any designated health service for which payment may be made under Medicare, the establishment of a plan of care by a physician that includes the provision of such a designated health service, or the certifying  or recertifying of the need for such a designated health service.” 42 C.F.R. § 411.351. A referring physician is defined in the same regulation as “a physician who makes a referral as defined in this section or who directs another person or entity to make a referral or who controls referrals made to another person or entity.” Id. (emphasis added).

The Stark Law further provides that should any amounts be billed in violation of the act, the biller shall be liable for the overpayment and must refund that amount to the Government. 42 U.S.C. § 1395nn(g)(2). Violators of the Stark Law are subject to potential civil monetary penalties for each service billed.

In addition, violators also face potential False Claims Act (“FCA”), 31 U.S.C. § 3729 et seq., liability for knowingly submitting prohibited claims. Although a detailed analysis of the FCA is beyond the scope of this article, generally speaking, the FCA empowers private persons, known as relators, to file civil actions known as qui tamlawsuits and recover damages on behalf of the United States from any person who: 1) knowingly presents, or causes to be presented, a false or fraudulent claim for payment; or 2) knowingly makes uses, or causes to be made or used, a false record or statement to get a false or fraudulent claim paid or approved by the Government. As it relates to this case, “[f]alsely certifying compliance with the Stark Law in connection with a claim submitted to a federally funded insurance program is actionable under [the FCA].”

  1. Stark’s Exceptions for Certain Compensation Arrangements

The Stark Law also provides for several exceptions to the broad general prohibition on compensation arrangements between health care entities and referring physicians. If a hospital’s financial relationship with a physician comes under one of the exceptions, then it is not prohibited under the Stark Law. The complete list of compensation arrangements exceptions are found at 42 U.S.C. § 13955nn(e).

In this case, the issue centered around whether the hospital’s financial relationship with its doctors qualified under the “bona fide employment relationships” exceptions under Stark. Under the bona fide employment relationship exception, amounts paid to a physician by an employer will not be considered a compensation arrangement under Stark if:

(A) The employment is for identifiable services;

(B) The amount of remuneration under the employment –

(i) is consistent with the fair market value of the services, and

(ii) is not determined in a manner that takes into account (directly or indirectly) the volume or value of any referrals by the referring physician;

(C) The remuneration is provided pursuant to an agreement which would be commercially reasonable even if no referrals were made to the employer, and

(D) The employment meets such other requirements as the Secretary may impose by regulation as needed to protect against program or patient abuse.

42 U.S.C. § 1395nn(e)(2).

  1. Analysis

In concluding that Halifax’s bonus scheme violated Stark and did not qualify as a bona fide employment relationship, the District Court focused its analysis on whether Halifax’s bonus compensation program “takes into account (directly or indirectly) the volume or value of any referrals by the referring physician.” 42 U.S.C. 1395nn(e)(2). In finding that the bonus compensation varied with the volume of referrals, the Court reasoned that because “[t]he bonus itself was based on factors in addition to personally performed services – including revenue from referrals made by the Medical Oncologists for [designated health services]. . . .the size of the pool (and thus the size of each oncologist’s bonus) could be increased by making more referrals.” Thus, the bonus compensation plan did not satisfy the requirements of the bona fide employment exception and therefore the oncologists were prohibited from making referrals to Halifax for designated health services and Halifax was prohibited from submitting Medicare claims for services furnished pursuant to such services.

However, in order to establish that a violation of Stark occurred, the Government was also required to establish that the physicians who were part of the bonus compensation plan provided referrals for designated health services for which Halifax submitted Medicare claims. In finding that this did in fact occur, the Court studied the listing of physician’s on Halifax’s Medicare claims forms  (Claims Form UB-04) either as the “attending physician” or “operating physician” and held that the claims forms were relevant evidence which, if not rebutted, established that a particular physician made a referral under Stark.

In addition, because Stark is a strict liability offense, the qui tamrelator need not prove that anyone at Halifax acted in knowing violation of the law in order to establish that a violation occurred. Thus, although Halifax presented evidence that it received a legal opinion letter which found that its compensation program was compliant with the bona fide employment exception, it could not rely upon this letter as a defense to a Stark violation. However, it must be noted that the Court did not grant summary judgment as to damages under the FCA. As explained above, although Stark is a strict liability offense, the False Claims Act requires that a party commit a knowing violation in order to establish liability. Thus, the Court found, at least partially based on the existence of the legal opinion, that a genuine issue of material fact still exists as to liability under the FCA.

  1. Conclusion

The Court’s decision provides clarification on the breadth of the bona fide employment relationship exception of the Stark Law. The decision makes clear that a bonus structure which merely divides up bonus compensation based on the services personally performed by an employer’s physicians will not fall within the exception if the bonus formula is not based solely on the services personally performed by each physician. If the bonus is based on factors in addition to personally performed services which can result in greater compensation based on increased referrals, then regardless of whether an employer divides the bonus based on volume of services personally performed, the bonus plan will violate the Stark law.

The Court’s decision also makes clear that health care facilities cannot shield themselves completely from Stark liability merely by having a legal opinion on file which states that the facility’s compensation relationship satisfies a recognized Stark exception. This is different than liability under the False Claims Act or the Anti-Kickback Law, 42 U.S.C § 1320a-7b(b), both of which require knowing violations to establish liability and where legal opinion letters may arguably be used as a defense to prosecution.

The health law attorneys of Fuerst Ittleman David & Joseph have extensive experience handling the various regulatory and compliance issues surrounding the provision of Medicare and Medicaid services, including False Claims Act (qui tam cases) as well as violations of the Anti-Kickback and Stark self-referral laws, among others. Furthermore, when necessary, we can provide aggressive, experienced litigation services in civil and criminal actions related to all of these areas. FIDJ also handles provider acquisitions and provides strategic tax planning advice to health care providers and suppliers.

Fuerst Ittleman David & Joseph’s Health Care Practice Group combines experienced lawyers and consultants from several practice areas to provide comprehensive representation in all aspects of health care law.  Let FIDJ show you how we can help today.

For more information, please contact us at contact@fidjlaw.com or call us directly at 305-350-5690.

IRS Makes Significant Changes to Innocent Spouse Relief

Under Internal Revenue Code (hereinafter “IRC” or “Code”) § 6013(d)(3), spouses who file joint tax returns are jointly and severally liable for all tax due and owing for the tax year, as well as any penalties or interest that accrue on the tax liability.  Because the debt is joint and several, the IRS can choose to collect the outstanding tax in its entirety from a single spouse.  Further, a divorce settlement or other state court document directing a spouse to pay the tax liability is not binding on the IRS.

In certain circumstances, imposing joint and several liability on both spouses can create inequitable results.  For instance, a spouse that is completely unaware of an item of income attributable to the other spouse, and did not benefit from the income, is still held liable for payment of tax on the income under the provisions of § 6013(d)(3).  Recognizing the potential for inequity, Congress added provisions to the Internal Revenue Code which set forth grounds upon which so-called “innocent spouses” can obtain relief from the general imposition of joint and several liability.

Recently, changes have been made to the innocent spouse provisions that make their scope and applicability more available for taxpayers.  This blog entry will first provide a general overview of the Internal Revenue Code’s innocent spouse provisions, and will then highlight the key recent modifications to those provisions.

Overview of Innocent Spouse Provisions

Innocent spouse relief is set forth in § 6015 of the Code.  Generally, three types of relief are potentially available, depending on the individual spouse’s circumstances.  Each of the three bases for relief has unique characteristics, but there are some universal conditions which must be met before any of the three types of relief can be utilized.  First, there must a valid joint return (i.e. the taxpayers’ marriage must be valid, the signature of a spouse cannot be forged or coerced).  Without a valid joint return, there is no joint and several liability.  Second, the request for relief, form 8857, must be timely filed.  In most circumstances, the deadline to file is two years from when the IRS first begins collection action.  However, as explained below, the time limit may be different depending on which basis for relief the spouse invokes in his or her request.  Third, the liability must arise out of income taxes.  Most taxes required to be included on a joint return are income taxes, so this requirement is usually not a significant obstacle.  One example of a tax that is required to be reported on a joint return but is not considered income tax is the tax imposed on domestic employment service (i.e. working in the employer’s private home) by § 3510 of the Code.  Fourth, a court cannot have rendered a judgment as to the liability of the spouse requesting relief (hereinafter “requesting spouse”).  If the requesting spouse participated in a proceeding regarding the liability and had a chance to request relief but failed to do so, relief is also precluded. 

Once these threshold requirements are met, it is necessary to determine which specific type of relief under IRC § 6015 is potentially available to the requesting spouse.

        i. Innocent Spouse Relief: IRC § 6015(b)

The first type of relief, set forth under IRC § 6015(b), is called “Innocent Spouse Relief.”  This relief is potentially available to all joint filers.  To qualify for this relief, in addition to the universal requirements set forth above, the following requirements must be met:

  1. There must be an understatement of tax, i.e. the amount stated on the return is less than the amount actually due.  This is distinguished from anunderpayment of tax, where the correct amount is stated on the return, but not enough money was paid toward the liability;
  1. The understatement must be based on an erroneous item (either unreported income or an incorrect deduction, credit, or determination of basis) attributable to the other spouse;
  1. The requesting spouse must be without knowledge of the understatement, and without a reason to know of its existence;
  1. Taking into account all facts and circumstances it would be unfair to hold the innocent spouse liable for the tax.

A determination of whether a spouse had reason to know of the understated tax, thus precluding that spouse from taking advantage of § 6015’s equitable relief, is based on factors such as the educational background of the requesting spouse, the business experience of the requesting spouse, and whether the erroneous item represents a departure from a recurring pattern in previous tax years.  This is not an all or nothing proposition””a spouse can be aware of some erroneous items (and thus remain jointly and severally liable for those items) but still gain equitable relief for other items of which he or she was not aware.

In determining whether it is unfair to hold a spouse jointly and severally liable, the IRS will look to several factors, including whether the claiming spouse benefitted from the understated tax (for instance, by living a lavish lifestyle while tax liabilities went unpaid), whether the parties were divorced, and whether one spouse deserted the other. 

It is also important to note that relief under § 6015(b) does not provide relief for underpayments of tax.  For example, if the return states a tax due of $5,000.00 and only $3,000.00 is paid, § 6015(b) would be unavailable to a spouse seeking relief from the balance of $2,000.00, regardless of any of the innocent spouse factors.

        ii. Separation of Liability Relief: IRC § 6015(c)

A distinct form of equitable relief is available to innocent spouses under IRC § 6015(c) if the spouses are divorced, legally separated or living apart.  The understated tax can be allocated based on amounts for which each spouse is responsible.  In addition to meeting the universal requirements set forth above, there are a few key points regarding relief under § 6015(c) that should be highlighted.

  1. For § 6015(c) to apply, the spouses must be divorced, legally separated, or living apart.  While the status of being divorced or legally separated is clear, “living apart” is less clear.  Based on guidance published by the IRS, spouses are living apart if they are not members of the same household during the 12-month period ending on the day innocent spouse relief is requested.  Even if spouses are separated, if the home is maintained in anticipation of the spouse’s return (for example, if one spouse is in prison or away on military service), then the spouses are not considered to be living apart.
  1. Equitable relief is not available under § 6015(c) to the extent that the requesting spouse had actual knowledge of the understatement.  This is a different standard than that set forth under 6015(b); simply having reason to know of the erroneous item is not a basis upon which a court can draw the inference that the spouse had actual knowledge of the understatement.  However, a spouse that deliberately avoids learning about the erroneous item, or if the erroneous item is the result of property that the spouses jointly owned, then a determination of actual knowledge is more likely.
  1. Equitable relief is precluded in its entirety if the IRS can prove that the spouses transferred assets to each other as part of a fraudulent scheme.  Additionally, if property is transferred to the requesting spouse in an effort to avoid the incurrence or payment of a tax liability, then the understatement of tax attributable to the requesting spouse is increased by the value of the property transferred to the requesting spouse.  If a transfer of property is made to the requesting spouse within one year before the IRS sends its first notice of the proposed deficiency, then a presumption arises that the transfer was made to avoid the incurrence or payment of tax.
  1. Like § 6015(b), this section only applies to understatements of tax.  No relief is provided under this section for underpayments of tax.
  1. In allocating liability, the requesting spouse does not have to establish his or her innocence regarding the deficiency.  If the requesting spouse proves that any part of the understatement is not attributable to him or her, relief must be granted unless the IRS can prove a condition defeating relief exists.

        iii. Equitable Relief: IRC § 6015(f)

In the event a spouse does not qualify for relief under IRC §§ 6015(b) or (c), the spouse may still pursue relief under the catchall of IRC § 6015(f), generally described as “equitable relief.” 

Equitable relief under this provision is unique in that it can provide relief from both an understatement of tax and an underpayment of tax.

In addition to meeting the universal requirements set forth above, several other conditions must be met before a spouse is eligible for relief under § 6015(f):

  1. Relief under either IRC § 6015(b) or (c) cannot be available to the requesting spouse;
  1. Assets cannot have been transferred between the spouses as part of a fraudulent scheme or in an effort to avoid tax;
  1. The requesting spouse cannot have knowingly participated in the filing of a fraudulent return;
  1. The liability at issue must be attributable to the non-requesting spouse (this requirement can be disregarded in in certain circumstances, such as when the non-requesting spouse engages in fraud, or the requesting spouse is the victim of domestic violence);
  1. The non-requesting spouse cannot have transferred “disqualified assets” to the requesting spouse.  A “disqualified asset” is one that was transferred to the non-requesting spouse with the principal purpose of the avoidance of tax or payment of tax.  A presumption arises that an asset is disqualified if it is transferred within a year of the IRS contacting the taxpayers about a proposed deficiency.    

Once the threshold requirements for relief under § 6015(f) are met, the next determination the IRS will make is whether the case is “streamlined” or not.  Under newly issued IRS guidelines, set forth in Rev. Proc. 2013-34, equitable relief cases under IRC § 6015(f) are divided into streamlined and non-streamlined categories.  If a case is streamlined, relief is generally granted.  A case is considered streamlined if all of the following conditions are met:

  1. The spouses are either divorced, legally separated, have not been members of the same household for a year or more, or one of the spouses is deceased;
  1. The requesting spouse will suffer economic hardship if the IRS does not grant the requested relief;
  1. The requesting spouse did not:
  1. Know of or have reason to know of the deficiency, or
  2. Know of or have reason to know that the non-requesting spouse would not or could not pay the underpayment

If streamlined treatment is not available, then the IRS will weigh the particular facts and circumstances applicable to the requesting spouse to determine whether it would be inequitable to hold the requesting spouse partially or wholly responsible for the at-issue liability.  The factors the IRS looks to in making this determination include:

  1. Whether the spouses are separated or divorced;
  1. Whether the requesting spouse would suffer significant economic hardship if relief is not granted;
  1. Whether one or both of the spouses has a legal obligation under a divorce decree to pay the tax;
  1. Whether the requesting spouse received a significant benefit (beyond normal support) from the underpaid tax or the item giving rise to the understatement of tax;
  1. Whether the requesting spouse has made a good faith effort to comply with the tax laws; and
  1. Whether the requesting spouse knew or had reason to know about the item that caused the understatement or that the tax would not be paid.

Recent Modifications to Equitable Relief under § 6015(f)

The determination of whether a spouse is entitled to equitable relief under IRC § 6015(f) has recently undergone significant modification.  Specifically, in Rev. Proc. 2013-34, a link to which is provided above, the IRS superseded its previous guidance (Rev. Proc. 2003-61) and modified, in a manner favorable to taxpayers, certain substantive considerations in determining whether a spouse is entitled to equitable relief.

        i. Substantive Modifications of Rev. Proc. 2013-34

Rev. Proc. 2013-34 primarily altered the substantive analysis the IRS will undertake when determining whether a requesting spouse is entitled to equitable relief.  Keep in mind that the changes set forth in Rev. Proc. 2013-34 are most relevant when a case is not “streamlined” and the IRS is therefore required to engage in a balancing test to determine whether holding the requesting spouse liable would be inequitable. 

The changes set forth in Rev. Proc. 2013-24 are almost uniformly taxpayer-friendly.  More than anything, these changes represent awareness on the IRS’s part of the severe hardship spouses in abusive or domineering relationships face.  Below is a brief summary of the significant changes:

  1. Rev. Proc. 2013-34 directs the IRS to place greater emphasis on, and grant more deference to, the issue of whether the spouse suffered from domestic abuse.  The weight given to the existence of domestic abuse is significant enough that it will negate other factors that might have weighed against a finding of entitlement to equitable relief.
  1. The determination of whether economic hardship would result if equitable relief were denied was modified to be based on minimum standards of income, expenses, and assets.  Further, a finding that economic hardship will not result from a denial of the requested relief does not, in and of itself, weigh against a granting equitable relief as it previously did. Instead, it is now treated as neutral factor. 
  1. A finding that the requesting spouse had actual knowledge of the item causing the understatement is not weighed more heavily than other factors, as it was previously.  Additionally, if the requesting spouse did not challenge the non-requesting spouse’s treatment of any tax items out of fear of retaliation, then even actual knowledge of improper treatment of an item will not preclude equitable relief. 
  1. Similarly, abused spouses, or those spouses with no control over financial decisions, will not suffer from having the “significant benefit” factor weigh against them in the determination of equitable relief.
  1. A spouse’s subsequent compliance with the tax laws will weigh in favor of a request for equitable relief.  Prior to Rev. Proc. 2013-34 it was merely a neutral factor.
  1. Whereas previously the liability from which the requesting spouse sought relief had to be attributable to the non-requesting spouse, relief under § 6015(f) is available even if the item is attributable to the requesting spouse if the tax deficiency is the result of the non-requesting spouse’s fraud.
  1. A legal obligation of the requesting spouse to pay the liability is taken into consideration.  Previously, only whether the non-requesting spouse had a legal obligation to pay the liability was taken into account.     

ii. Procedural Modifications

Additionally, recent changes to the application of IRC 6015(f) have eased time constraints on filing relief requests.  Whereas previously claims for equitable relief had to be filed within two years of the IRS’s first attempt to collect the liability (as is still the case under IRC §§ 6015(b) and (c)), in IRS Notice 2011-70, the time period was extended to match the IRS’s general collection deadline of 10 years after the assessment of the liability.  This provision was recently adopted as part of a proposed treasury regulation, and is likely to become final regulation.  We previously blogged about this change here and here. 

Conclusion

The modifications to equitable relief set forth in Rev. Proc. 2013-34 are a clear sign that the IRS is beginning to recognize the reality that its previous standards in evaluating equitable relief claims were too stringent.  Abused spouses, or those spouses who have no control over the household’s finances and fear retaliation from their spouse if any attempt to assert control is made, should not be forced to incur joint and several liability based on the actions of their spouse.  Further, the two-year deadline on filing equitable relief claims was too strict.  Given the turmoil that divorced or separated spouses often face, resolving past tax liability may, initially, be a low priority.  The extended time limit allows spouses to focus on more immediately pressing concerns before addressing their tax debt.

Innocent spouse relief under IRC § 6015 is a crucial lifeline to many taxpayers facing severe, unexpected tax burdens due to the actions of their spouse.  Reforms liberalizing the application of section 6015, like Rev. Proc. 2013-34, should be both welcomed and taken advantage of by taxpayers.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers facing tax deficiencies and IRS collection efforts.  We will continue to monitor the development of innocent spouse relief under the Internal Revenue Code, and we will update this blog with relevant information as often as possible. You can reach an attorney by calling us at 305-350-5690 or emailing us at contact@fidjlaw.com.

Criminal FBAR Prosecutions Underscore Importance of IRS Offshore Voluntary Disclosure Program

According to statistics compiled by Jack A. Townsend, author of the Federal Tax Crimes Blog, nearly 130 individuals have been charged with maintaining and failing to report offshore bank accounts, or enabling those who do.  Specifically, 94 taxpayers and 35 enablers have been charged with various crimes arising out of the failure to report offshore accounts, including the criminal Foreign Bank Account Report (FBAR) statute (31 U.S.C. § 5322), the tax perjury statute (I.R.C. § 7206(1)), and conspiracy (18 U.S.C § 371).

These charges have in turn led to 72 guilty pleas and 12 guilty verdicts after a trial.  Only one individual has been acquitted of the charged crimes.  Of those charged, 53 individuals have been sentenced, with 28 receiving prison time as part of their sentence.  Of those individuals receiving prison time as part of their sentence, the average period of incarceration has been over 13 months, though incarceration periods have reached as high as 10 years.

These statistics underscore the aggressiveness with which the United States is pursuing individuals who fail to properly report offshore bank accounts and offshore income.  The statistics also underscore the value of the Offshore Voluntary Disclosure Program (OVDP), which permits delinquent taxpayers to disclose their offshore financial accounts and unreported income, in exchange for a generally lower monetary penalty and a promise from the IRS to not recommend the taxpayer’s case for criminal prosecution.

As we have previously addressed, the OVDP is not available to taxpayers whose non-compliance is discovered by the Government through the Government’s independent investigation efforts.  For that reason, and given the unrelenting efforts by the United States to root out non-compliant taxpayers with offshore assets and the potentially severe penalties they face, those considering applying to the OVDP should act sooner rather than later.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers who have undisclosed foreign bank accounts and who are seeking to avail themselves of the OVDP.  We will continue to monitor the development of these issues, and we will update this blog with relevant information as often as possible. You can reach an attorney by calling us at 305-350-5690 or emailing us at  contact@fidjlaw.com.

FDA Regulatory Update: FDA to Recommend Reclassifying Hydrocodone Combination Drugs; Issue Highlights Cooperative Relationship Between FDA, DEA

On October 24, 2013, Janet Woodcock, the U.S. Food and Drug Administration’s (“FDA”) Director for the Center for Drug Evaluation and Research (“CDER”),issued a statement explaining that the FDA will recommend that the U.S. Drug Enforcement Administration (“DEA”) reclassify hydrocodone combination products from Schedule III to Schedule II under the Controlled Substances Act (“CSA”). This statement comes ten years after the DEA first approached the U.S. Department of Health and Human Services (“HHS”) for a recommendation. The reclassification, however, will not go into effect unless the proposed change is approved and accepted by the DEA.

Regulatory Framework for Controlled Substances

Pursuant to the CSA, the DEA has regulatory authority over controlled substances, which are certain drugs that have potential for abuse and dependence. (For more information on the regulation of controlled substances, please read 21 U.S.C. § 801  et seq.  and the DEA’s Office of Diversion Control Controlled Substance Schedule, which can be accessed here.) Controlled substances are classified into five distinct categories, or schedules, depending on the drug’s acceptable medical use and potential for abuse or dependency.

Schedule I consists of the drugs with the highest potential for abuse and Schedule V represents the class of drugs with the lowest potential for abuse. Specifically, Schedule I drugs are defined as having “no currently accepted medical use,” lacking accepted safety for use under medical supervision, and carrying a high potential for abuse. Examples of Schedule I drugs are heroin, ecstasy, peyote, and marijuana. (To read our previous posts regarding the federal regulation of marijuana as a controlled substance, please click here, here, here and here.) Schedule II drugs are also considered dangerous but have a lower abuse potential than Schedule I drugs, with use potentially leading to severe psychological or physical abuse. Examples of current Schedule II drugs are methamphetamines and oxycodone. Schedule III drugs are defined as having a “moderate to low potential for physical and psychological dependence” and pose a higher abuse potential than Schedule IV drugs, which are defined as having a “low potential for abuse and low risk of dependence.” Carrying the lowest risk of drug abuse potential are Schedule V drugs, which usually consist of preparations containing limited quantities of certain narcotics, such as those used for antidiarrheal, antitussive, and analgesic purposes. (For more information about the scheduling of controlled substances, please visit the DEA’s website here.)

Proceedings to control, remove from control, or re-schedule a drug or substance may be initiated by the DEA, HHS, or by petition from any interested party, such as a drug manufacturer, medical society, public interest group, state agency, or individual. When a petition is received by the DEA, the agency begins its own investigation of the drug. Once the DEA has collected the necessary data, the DEA Administrator, by authority of the Attorney General, requests from HHS a thorough scientific and medical evaluation and recommendation “as to whether such drug or other substance should be so controlled or removed as a controlled substance.” See 21 U.S.C. § 811(b). Then, HHS solicits information from the FDA, the National Institute on Drug Abuse, and if it so chooses, the scientific and medical community. The scientific and medical matters contained in the recommendation “shall be binding on the Attorney General.” Id. Once the DEA has received the scientific and medical evaluation from HHS, the DEA will evaluate all available data and make a final decision. Section 811(c) of the Controlled Substances Act directs the DEA to consider the following factors:

  1. Its actual or relative potential for abuse;
  2. Scientific evidence of its pharmacologic effect, if known;
  3. The state of current scientific knowledge regarding the drug or other substance;
  4. Its history and current pattern of abuse;
  5. The scope, duration and significance of abuse;
  6. What, if any, risk there is to public health;
  7. Its psychic or physiological dependence liability; and
  8. Whether the substance is an immediate precursor of a substance already controlled under this subchapter.

Although the DEA works hand-in-hand with HHS with respect to controlled substances, the DEA has the ultimate decision-making authority to take

DEA Seeks Recommendation Regarding the Reclassification of Hydrocodone Combination Products

        FDA’s recent statement that it intends to formally recommend the reclassification of hydrocodone combination products comes after nearly ten years of debate. Back in 2004, the DEA asked the FDA to investigate and recommend whether to reclassify hydrocodone combination products from Schedule III to Schedule II. In response, the FDA concluded that hydrocodone combination products should remain a Schedule III drug because “hydrocodone combination products have a less potential for abuse than the drugs or other substances in Schedule II.” (For more information regarding the FDA’s scientific and medical investigation of hydrocodone, please click here.)

        As a result of continued pressure from the public and industry organizations, the DEA collected and re-analyzed new data regarding the abuse of hydrocodone combination products in 2008. The following year, DEA submitted another request to FDA to reconsider moving all hydrocodone combination products to Schedule II. On January 24 – 25, 2013, the FDA’s Drug Safety and Risk Management Advisory Committee convened to discuss the public health benefits and risks of drugs containing hydrocodone, as well as the potential for abuse or dependency. (For a comprehensive review of the FDA’s recommendation, please read the FDA Briefing Document, Drug Safety and Risk Management Advisory Committee (DSaRM) Meeting 1 here and here.) At the culmination of this meeting, the FDA Advisory Committee voted 19 to 10 in favor of rescheduling hydrocodone combination products from Schedule III to Schedule II. (To read FDA’s Memorandum summarizing the events of this meeting, please click here.) Nine months later, the FDA announced its intention to formally recommend reclassifying hydrocodone combination products to Schedule II.

In light of the Advisory Committee’s decision in January 2013, the FDA’s statement that it intends “to recommend to HHS that hydrocodone combination products should be reclassified to a different and more restrictive schedule” comes as no surprise. (To read the FDA’s statement, please click here. For additional news coverage, please click here, here, here, and here.) The FDA’s recommendation to reclassify hydrocodone combination products could have a significant impact on how physicians prescribe these products. For instance, Schedule II drugs require patients to present a written prescription to the pharmacy, as physicians cannot call in a prescription for Schedule II drugs. Most notably, if the DEA accepts the FDA’s recommendation, hydrocodone combination products will be subject to stricter security controls, including a restriction on the amount of medication that a patient can be prescribed. If reclassified as Schedule II drugs, a physician would only be permitted to prescribe refills of hydrocodone combination products for up to three months, which is half the amount allowed for Schedule III drugs.

The FDA has not submitted a final recommendation package to HHS, but expects to do so by early December 2013. If this recommendation is accepted by the DEA, new regulations could go into effect as early as 2014. (For more information, please read the New York Times’s coverage here.)

Fuerst Ittleman David & Joseph, PL will continue to monitor the developments in the classification of hydrocodone combination products. For more information, please feel free to contact us by email at contact@fidjlaw.com or by phone at (305) 350-5690.