RESPONSE TO COMMISSIONER'S ARGUMENT
A. The Appeals Officers Abused Their Discretion in Rejecting Petitioners' Offers in Compromise, as the Offers Fostered Effective Tax Administration Without the Risk of Undermining Voluntary Compliance.
1. Taxpayers Should be Able to Rely on the IRS Given their Far Superior Knowledge of the Facts.
Admittedly taxes are the life-blood of the government and taxpayers playa vital role to the health of the U.S. Treasury. See Commissioner's Answering Brief ("Com.Br.") 26. During consideration of the Internal Revenue Service Restructuring and Reform Act of 1998 (the "RRA 1998"), Senator Baucus quoted Oliver Wendell Holmes and said, "Taxes are what we pay for a civilized society." Senator Baucus then went on to say, "[h]owever, Justice Holmes did not consider additional burdens imposed on taxpayers -added costs and delays that result from inefficiencies and inconsistencies in the administration of the tax law." 142 Congo Rec. S7753 (daily ed. July 11, 1996)(statement of Sen. Baucus).
Commissioner's theory in this case is that Petitioners were either dishonest, or not acting in good faith to disclose information. The facts show that the opposite is true. Petitioners were unsophisticated individuals who genuinely believed they were entitled to the write-offs claimed on their returns. If Hoyt's promises about the cattle were true, then the deductions would have been allowable. Bales v. Commissioner, T.C. Memo. 1989-568).
By continuing to follow a retribution based approach, Commissioner keeps the focus on the Petitioners and treats their investment like "abusive tax shelters."} Com.Br. 27-28. At no time does Commissioner admit that the delay facts of this case are rare, relevant, unique, or unlikely to occur again in the future. There is also no admission in regards to significant IRS errors that were made during a span of over 20 years (1978 to 1998). Under Commissioner's theory the IRS will be the one to gain (through accrual of interest) from its errors and mistakes. Consequently, there will be no motivation for the IRS to shut down future tax schemes quickly, or to share knowledge of facts with taxpayers.
Commissioner's concern that abating interest and penalties in the Hoyt cases will lure other taxpayers to claim risky tax benefits is actually humorous. It is extremely doubtful that taxpayers will want to pay a crook (who will steal their money) substantially more money than they receive in tax benefits and then repay those tax benefits plus interest for 10 years. What a sales pitch!
2. Petitioners' "Standard" Offers In Compromise Conform To The Will Of Congress And The Treasury Regulations.
1Interestingly, Commissioner also states that after Bales "the IRS felt constrained to work with Hoyt and to treat his organization as a legitimate business ...." Com.Br.55.
a. It Was an Abuse of Discretion for the Settlement Officers to Base Their Decision on the Internal Revenue Manual Instead of the "Controlling" Treasury Regulations.
Petitioners did not argue in their opening brief that the relevant Treasury Regulations are invalid, or that they are procedurally defective, arbitrary, capricious, or manifestly contrary to the statute. See Com.Br. 30 (citing United States v. Mead Corp., 533 U.S. 218, 227 (2001)). Instead, it was the fact that Settlement Officer ("SO") Linda Cochran admittedly refused to deviate from the Internal Revenue Manual ("I.R.M."), while other Settlement Officers felt constrained by the I.R.M. See, e.g., ER-2 111-112,229,237; ER-3 80-83, 179, 187; ER-12 45-46, 200-201, 209; See also ER-14 90-91 (SO Vander Linden); ER15 63-64 (SO Owens). Thus, the Settlement Officers treated the I.R.M. as if it were the Treasury Regulations. Instead, as the I.R.M. is "directory rather than mandatory, are not codified regulations, and clearly do not have the force and effect of law." Fargo v. Commissioner, 447 F.3d 706, 713 (9th Cir. 2006).
In an attempt to resuscitate the I.R.M. provisions relied on by the Settlement Officers, Commissioner takes the approach that the I.R.M. is consistent with the legislative history of26 U.S.C. § 7122. See Com.Br. 36. However, there is nothing in either the Code provision or the Treasury Regulations that is similar to I.R.M. § 5.8.11.2.2(3), which was used as a primary basis to deny the Petitioners' offers.
See Com.Br. 35-36. Had the Settlement Officers reviewed the law and regulations, they would have realized they must consider "all the facts and circumstances" even if acceptance is not warranted "under the Secretary's policies and procedures." Treas. Reg. § 301.7122-1(b)(3)(ii). The failure to look beyond the I.R.M. gave the Settlement Officers an "erroneous view of law," which constitutes an abuse of discretion.
b. The IRS Can, and Should Compromise with Petitioners.
Commissioner argues (Com.Br. 37-38) that settlement decisions are completely discretionary, and that while Congress may have wanted the IRS to utilize its authority to resolve longstanding cases it is not required to do so. Just because the IRS is not required to compromise longstanding cases does not mean it can ignore relevant facts and given determinative weight to the I.R.M. Proper review still requires the correct application of law to the relevant facts. By failing to apply the law the Settlement Officers have failed to implement Congressional intent to be "flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations and remain in the tax system." H.R. Conf. Rep. No. 105-599, at 289 (1998).
Commissioner cannot just ignore legislative history, but needs to provide explanation why it is not appropriate in any case -because that is what he is stating, i.e., that interest and penalties should not be abated in longstanding cases. Commissioner must take that position in the current case because there does not appear to be a dispute in regards to this being a longstanding case. See Com.Br. 37-40.
1. Legal and Factual Sufficiency.
The Treasury Regulations provide that "the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability." Treas. Reg. § 301.7122-I(b)(3)(ii) (emphasis added). "Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner." ld. "No compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by taxpayers with the tax laws." ld. § 301.7122-1(b)(3)(iii). Lastly, the background information to finalized Treasury Regulation § 301.7122-I(b), states that: cases in which a taxpayer believes the liability was caused, in whole or in part, by delay on the part of the IRS or by the actions of third parties may be appropriate for compromise under the public policy and equity standard. Such cases, however, are expected to be rare, as the taxpayer must identify compelling public policy or equity concerns that satisfy the standard set forth above. Compromise of Tax Liabilities, 67 Fed. Reg. 48,025,48,027 (July 23,2002) (codified at 26 C.F.R. pt. 301); see also Fargo, 447 F.3d at 714.
Given the above, it is Petitioners' burden to show that their concerns are (1) exceptional or unique enough that the public will perceive the failure to settle for less than full collection potential as inequitable, and (2) taxpayers will continue to comply with the Tax Code if compromise occurs. See also Fargo, 447 F.3d at 713. Interestingly, Commissioner never acknowledges that IRS delay can be a compelling reason for abatement.
There is no question that with all the exceptional facts of this case there is certainly enough reason for the public to perceive a failure to settle as inequitable. Unlike Fargo, delay in this case was not based solely on the operation of law (i.e., TEFRA). The delay was based on a host of facts that were outlined in the opening brief, including (but not limited to2):
2 Since the Treasury Inspector General for Tax Administration ("TIGTA") report pertaining to Hoyt was not made available to Petitioners during the Tax Court trials more IRS delay facts could be present.
5. The IRS failed to convict Hoyt of any tax crimes during its four criminal investigations. It was not until recently in the RCR#1litigation that previously requested information was given to the partnerships to support a claim of IRS delay. See River City Ranches #1 v. Commissioner, T.C. Memo. 2003-150, 85 T.C.M. (CCH) 1365, ajf'd in part, rev'd in part, vacated in part, & remanded, 401 F.3d 1136 (9th Cir. 2005), opinion on remand T.C. Memo. 2007-171, 94 T.C.M. (CCH) 1, appeal pnd'g, 9th Cir. No. 07-74301 ("RCR #1). Commissioner opines (Com.Br. 9-11, 19,44,59) that it would be unfair to settle with Petitioners, as some Hoyt partners took the IRS settlement offer. This argument is specious. Partners that settle take the risk that other partners will obtain a better result from the Courts. Kercheval v. United States (DC 1997) 97-2 USTC P 50960, 80 AFTR 2d 8256, ajJ'd without op., 172 F.3d 863 (4th Cir. 1999); See also Bankers' Reserve Life Co. v. United States 42 F.2d 313 (1930), cert den, 282 U.S. 871 (l930)(Law later determined unconstitutional, agreement still valid); Dubinsky v. Becker, 64 F.2d 601 (8th Cir. 1933)(Law later repealed, agreement still valid). Furthermore, the Hoyt partners who settled were not aware of IRS failures, or the significant record that was developed in this case.
Additionally, if Commissioner refuses to settle for less than full collection potential, public confidence in the tax system could be eroded as Commissioner is refusing to admit his part in the delay. See Treas. Reg. § 301.7122-1(b)(3)(ii). The Taxpayer Advocate in a fairly recent report to Congress expressed the following concern:
In addition, the IRS is, perhaps understandably, reluctant to consider ETA relief for taxpayers who have invested in a tax shelter or have any history of non-compliance. However, in some cases these investors thought they were investing in legitimate tax planning investment opportunities because the shelter promoter actively deceived them. It appears that these ETA offers are being rejected, regardless of any other facts that would suggest that a non-hardship ETA compromise might be appropriate.
The National Taxpayer Advocate's Fiscal Year 2005 Objectives Report to Congress, 2004 Tax Notes Today 128-21 (June 30, 2004) (citations omitted). As a representative of the public, the Taxpayer Advocate's views shed light on public perception. Surely public confidence is undermined if victims of fraud are not given relief. This is especially true here, as Commissioner continued to let Jay Hoyt practice before the IRS as an Enrolled Agent until approximately 1998, despite actual evidence of wrongdoings dating back to 1982. ER-2 188,287-295, ER-4 126 ~ 9, RCR #1, T.C. Memo 2003-150 (Slip Op. at 13). Commissioner cited no authority outside of the I.R.M. for his belief that public confidence would be undermined if relief was given in this case. Perhaps the most notable evidence to the contrary is Judge Jones' statement. Judge Jones was the District Court Judge on Hoyt's criminal case and a person who is both neutral and informed. Judge Jones informed Commissioner that he believed the Hoyt investors were victims of Hoyt's fraud and requested that Commissioner consider abating interest and penalties. Mekulsia v. Commissioner, 389F.3d 601,602 (6th Cir. 2004).3
Moreover, Petitioners do not have a history of noncompliance, have not taken deliberate actions to avoid the payment of taxes, and there is no evidence suggesting Petitioners encouraged others to refuse to comply with the tax law. See Treas. Reg. § 301.7122-1(c)(3)(ii).
In regards to the second test, taxpayers in general will continue to comply with the Tax Code if a compromise occurs. It is impossible to fathom that another investment could mirror the facts of the Hoyt cases. Taxpayers are not going to jump into abusive tax shelters and tax avoidance schemes in the hopes that they will become victims of fraud, or in the hopes the IRS will continue to negotiate with a dishonest promoter.
3 See also Darryll K. Jones, The 'Hoyt Fiasco~ 2006 Tax Notes Today 128-12 (June 16,2006); Let's Make a Deal, Forbes, Apr. 14,2003; Mark Larabee, Paper Cowboy' Sentenced, Oregonian, June 20,2001; NBC Evening News, The Fleecing of America (Modern Cattle Rustling) (NBC television broadcast, May 30,2001); John Bankston, Herds of Investors Roped into Scheme, The Augusta Cbron. Mar. 11,2001, at Bus. Sec.
Future taxpayers can also take notice that Petitioners who based their offer on public policy sought compromise by paying all of the underlying tax liability plus regular interest to April 15, 1993. Commissioner claimed that this type of offer would place Petitioners "in a better position than if [they] had timely and fully met [their] obligations." Com.Br. 34 (citing I.R.M. § 5.8.11.2.2(11)). Unsurprisingly, Commissioner did not present any mathematical support for his conclusion -because it is not correct. Hoyt took at least 75% of the generated refunds until 1992. See, e.g., ER-2 556-560, ER-6 49-50, ER-12 83-84, ER-13 4142, ER-14 29-30, ER-15 116. After 1992, the Hoyt partners no longer received refunds, but continued paying on their promissory notes. ER-2 730, 748-749, 760,
789. In addition, Hoyt made assessment calls for feed and legal costs.
Consequently, Petitioner Gordon Freeman (for example) sought compromise by offering $346,258 ($202,861 are taxes and the remainder interest) to pay an estimated $750,740 liability. ER-l 476,480, ER-I0 135-136, 178-182 (Transcripts show no refunds). Mr. Freeman paid Hoyt approximately $190,000. ER-I0 42-43. In other words, by paying $346,258 Mr. Freeman is in a much worse position than he would have been in had he filed his returns without any Hoyt items. Because Hoyt stole all the money, Mr. Freeman is paying the tax liability twice (once to Hoyt and again to Commissioner) AND paying interest on that money for 10 years.
(a) Section 6404(e) does not foreclose relief
The Settlement Officers abused their discretion by concluding that interest abatement relief was unavailable, as it was not available under the interest abatement provisions contained in 26 U.S.C. § 6404(e). ER-2 229, 237, ER-6 130. And not only was it their belief, Commissioner trains them on that position. ER-2 1083 (stating that an ETA offer "cannot be used for"..."P&I Abatement"). ER-4 107-108.
Commissioner misleads this Court when he recognizes that there can be interest abatement in cases that do not qualify for abatement under section 6404(e). Com.Br. 41-42. This was misleading because it does not matter if Commissioner's counsel recognizes the possibility, what matters is that Commissioner's employees applied an incorrect legal standard. It is an abuse of discretion} for Commissioner to train his employees contrary to legislative history and the Regulations.
And, there is no question that that the standard for interest abatement in ETA cases was not the same as the standard as in section 6404(e). Petitioners (as Amici) 4 Calculations of other Hoyt partner out-of-pocket payments are similar -not just for Petitioners. Counsel's client has this evidence in his files and Counsel is inputed that knowledge. Furthermore, Counsel has seen some of this evidence already in the record of another case filed with this Court. Counsel of record was also Commissioner's counsel in Hansen and Petitioners' brief in that case stated that the Hansens' net investment, after the tax benefit was deduction, was $79,786.
raised this issue in Fargo and this Court specifically determined that the basis for interest abatement in an ETA offer can differ from that available under section 6404(e). Fargo, 447 F.3d at 714; Compromise of Tax Liabilities, 67 Fed. Reg. 48,025,48,027 (July 23,2002) (codified at 26 C.F.R. pt. 301).
Given all of the foregoing a compromise would "alleviate potential present nonpayment while discouraging future nonpayment by others." See Fargo, 447 F.3d at 713. Consequently, Petitioners are entitled to ETA relief based on public policy.
11. Petitioners Have Shown Exceptional Circumstances That Warrant Acceptance of Their "Standard Offer."
The last paragraph of the Fargo opinion may or may not be a "definitive" test (Com.Br. 47), but it does provide this Court's framework for the evaluation of an ETA OIC in light of the Treasury Regulations and the legislative history.
First, the fact that Petitioners invested in a tax shelter does not mean they are not entitled to relief, as Commissioner suggests (Com.Br. 48). In fact, the Taxpayer Advocate describes a scenario remarkably similar to the Hoyt investments as one where relief should be granted. National Taxpayer Advocate's 2005 Report, supra. Tax professionals, including Commissioner, often mention that one of the world's greatest tax shelters is a home! In a letter to Hoyt partners,
Commissioner stated: First, a "tax shelter" is not necessarily synonymous with a "sham" investment. Low income housing credits, your personal residences, and real estate rentals are examples of tax shelters. It is an oversimplification to state tax-shelters are never recognized for Federal income tax purposes. Hansen, T.C. Memo. 2004-269, (Slip Op. at 17).
Bales proves either that the investment was potentially legitimate or that Hoyt's fraud was so detailed that the investment appeared to be legitimate (with legitimate tax benefits). Bales, 58 T.C.M. (CCH) at 449 (1989). Commissioner implies that Petitioners "got what they bought" -an abusive tax shelter. However, that is directly contrary to Hoyt's conviction for defrauding Petitioners. ER2-181182, 688-704. Petitioners believed they purchased a legitimate investment and continued to pay even after refunds were frozen in the early 1990s. ER-l 187. The Tax Court even ruled that Mr. and Mrs. Hansen invested to provide for their retirement. Hansen, T.C. Memo. 2004-269 (Slip Op. 24). As shown in Petitioners' Opening Brief ("Op.Br." 54-56), this was certainly not a "purely' tax-motivated transaction.
Second, just because Hoyt's fraud was not enough to preclude finding Hoyt partners liable for the accuracy related penalty (Com.Br. 48-49), it does not mean fraud is irrelevant in this preceding. See Hansen v. Commissioner, T.C. Memo.
2004-269, aff'd, 471 F.3d 1021, 1033 (9th Cir. 2006). Legislative history refers to "foregoing" penalties, which (almost by definition) means that penalties have will or legally could be assessed. H.R. Conf. Rep. No. 105-599, at 289 (1998).
Thus, the opposite from what Commissioner claims is true. That is, even though certain taxpayers might be legally liable for penalties, equity might demand that those penalties be abated and an example of where that is appropriate is when the taxpayers were clearly defrauded -as is true in this case.
It should also be noted that some of the years at issue in this proceeding are much older than the Hansen case, i.e., 1991. See id. In fact, the Memorandum of Understanding ("MOU") between Hoyt and the IRS for tax years 1980 through 1986 did not address penalties, and none of the Petitioners in this proceeding were assessed with negligence or valuation penalties for the 1980 through 1986 taxable years. See ER-2 206-214.
Third, Petitioners' arguments about delay (Op.Br. 61-64) were not tied to TEFRA, as Commissioner suggests (Com.Br. 49-53). Fargo did not have:
5 The Tax Court recently found that Commissioner "knew or had reason to know that Hoyt's interest in extending the period within which respondent could issue the FPAAs was in conflict with the investor-partners' interest in not delaying
See also Fargo, 447 F.3d at 708, 713.
Commissioner had sufficient tools at his disposal to shut Hoyt down and did not. Petitioners have not requested relief due to the inequities of the TEFRA process, but are requesting relief due to Commissioner's inept handling of the case which caused substantial delays.
As this Court noted in RCR #1, it was to Hoyt's benefit to delay the proceedings and Commissioner's actions concerning the statute extensions allowed this delay to continue. RCR #1,401 F.3d at 143. This is not a complaint about TEFRA procedures, but focuses on Commissioner's actions and delays in this case -as required by the legislative history the issuance of the FPAAs." RCR #1, T.C. Memo. 2007-171, 2007 Tax Ct. Memo LEXIS 175, *37-40, appeal pending docket no. 07-74301 (9th Cir.).
Fourth, as always, Commissioner only points out certain portions of the 1,000 lb. Tax Shelter (Com.Br. 53-58). There are both positive (such as potential for profit and the payment of tax) and negative statements in the Hoyt promotional materials, as you will find in most business offerings. See, ER-2 326 (thirty-five years in cattle business), 348 (USDA carcass program used), 349 (performance pedigree testing), 352 (profit potential and capital gains), 357 (payment of all debt to partnership over life cycle), 361 (paying taxes). However, the promotional material did not warn that Hoyt was lying about the number and quality of the cattle, which was the ultimate reason for the understatements in tax.
It is ironic that Commissioner states that the taxpayers are the first line of defense in abusive tax shelters. Com.Br.53. The first line of defense in this case was the early investors. Commissioner was already auditing Hoyt in 1978, which is two years prior to when any of Petitioners became involved (i.e., 1980 to 1986).
Furthermore, just because Petitioners read the 1,000 lb. Tax Shelter does not mean they did not perform an adequate investigation or stay in touch with the Hoyt organization (i.e., the TMP). Op.Br.22-25. Many Hoyt partners, including some Petitioners, did contact independent third party advisors, including a tax preparer, an attorney, an accounting firm, and a business consultant. ER-2 16-19, ER-6 2021, 86, 104, ER-8 116-117, ER-I0 17; Op.Br. 57-58. Other Petitioners saw cattle and large trucks, and sometimes worked at the ranches. ER-7 95-97, ER-8 117, ER-l1 63, ER-13 21, 23-25,30-31, ER-16 13. While other Petitioners received further assurances when an independent auditor conducted a livestock count. ER 1428-29; ER-15 103-104, 110; ER-2 436-437.
Commissioner points to the Sixth Circuit's opinion in Mortensen (a Hoyt accuracy related penalty case) for the proposition that Petitioner's '"acte[ed] like a prairie rabbit in a hailstorm and just hunker[ed] down until it pass[ed].'" Com.Br. 57 (citing Mortensen v. Commissioner, 440 F.3d 375,389 (6th Cir. 2006)). However, IRS delay and the fraudulent activity of a promoter have less relevance in a penalty case, where Congress intended IRS delay to be a reason to abate penalties and interest.
Also, Petitioners did not just hunker down due to the storm, as they believed fellow "prairie dogs" were getting shot off the mound. Hoyt's collection techniques made the investors believe they could not get out of the partnership. These collection techniques included collection letters (ER-2 425-433), the repossession of cows (ER-2 454, 786), threats of a large tax liability due to the relief of debt (ER-2 718), and threatened litigation (ER-2 718). See also ER-2 551. Additionally, when the Settlement Committee (through the help of an attorney) tried to make a deal with the IRS that would have put Hoyt out of business they were not successful. Op.Br. 64. It is unsurprising that an unsophisticated investor would feel trapped.6
6 Petitioners addressed the four factors in detail in the opening brief.
In the end, Petitioners have shown that compromise of their debts -in accordance with the laws enacted by Congress and the Treasury Regulations -will 'not be detrimental to taxpayer compliance. It is also the right thing-to do in such a unique longstanding case.
B. PETITIONERS' SPECIAL CIRCUMSTANCES WARRANT ACCEPTANCES OF THEIR OFFERS IN COMPROMISE.
1. Legal Principals.
Commissioner correctly argues that the IRS should reject a hardship offer if the amount offered is less than what can be collected without causing economic hardship, as defined by the Regulations. (Com.Br. 60). However, Commissioner then imputes a limitation not found in the Regulations, i.e., that it has to be a "current" hardship limited to the next four years.
The Regulations state that economic hardship occurs when a taxpayer is unable to pay "reasonable basic living expenses" considering "the unique circumstances of the individual taxpayer." Treas. Reg. § 301.6343-(I)(b)(4)(i). In each case, Commissioner failed to even acknowledge the "unique circumstances", i.e., age and health, made no difference to Commissioner's calculation. See infra atB.2.
Factors to be considered include, but are not limited to, the taxpayers' age, employment status and history, and ability to earn. See id. § 301.6343 (1)(B)(4)(ii)(A)-(F). However, the Regulations also provide that a finding of economic hardship is supported when:7
(A) Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer's financial resources will be exhausted providing for care and support during the course of the condition;
***
(C) Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.
Treas. Reg. § 301.7122-1(c)(3)(i)(emphasis added). Moreover, the examples provide that economic hardship can be found when:
Example 2. The taxpayer is retired and his only income is from a pension. The taxpayer's only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave the taxpayer without an adequate means to provide for basic living expenses.
See also Example 3, which describes a disabled taxpayer with a specially equipped home with equity that is sufficient to pay off the liability, but the taxpayer is unable to obtain a mortgage and the forced sale of the residence would create severe adverse consequences for the taxpayer. Treas. Reg. § 301.7122-1(c)(3)(iii).
7 Both Commissioner and the Tax Court interpret the hardship Regulations to apply to circumstances when a taxpayer does not have enough money to pay the full liability. See Andrews, ER-l 52-53 (describing offers based on doubt as to collectability with special circumstances and effective tax administration.)
It is clear from a review of the Regulations that a hardship evaluation is not whether Petitioners "will suffer current hardship", as Commissioner suggests. (Com.Br. 60). In fact, this makes no sense and is what is considered in a regular doubt as to collectability offer. Reasonably foreseeable forecasts in regards to future income and expenses are allowed in a Special Circumstance offer. See Treas. Reg. § 301.7122-1(c)(3)(i)(A). As such, ifit is reasonably foreseeable that the taxpayers will have a shortfall in income, sufficient assets should be retained in order to cover the shortfall. Commissioner's calculations fail to acknowledge this point.
Petitioners provided medical records, as well as detailed statements pertaining to age and disabilities as a means to forecast future expenses. The future does not come with a guarantee, but it is reasonably foreseeable that an individual with serious health problems will not only continue to have problems in the future, but will face complications. It is also reasonably foreseeable that an elderly taxpayer will need to retain sufficient assets to cover age related expenses, such as when they are no longer able to mow the lawn.
As proof of the age-related expenses, Petitioner provided retirement projections based on government publications that took into account factors such as life expectancy, inflation, transportation, and extraordinary expenses. ER-3 128. While the government's own records were used to prove that these expenses occur, Petitioners never assumed or estimated that each Petitioner would incur all these expenses -or even 50% of them. Furthermore, Commissioner failed to provide any guidance in his manual and regulations or contact Petitioners to let them know he wanted more substantiation. It is easy to claim that future expenses are speculative, however, it is unreasonable to do so and not provide any guidance on what Commissioner expects as substantiation,
Contrary to the Regulations, Commissioner's "current hardship" view does not extend beyond the term of the offer (i.e., 48 months for a cash offer). See Com.Br. 64 n.17. Ironically, under this analysis it will be the public who will end up covering the expenses of those who have the anticipated shortfall.
2. The Petitioners Demonstrated Adequate Special Circumstances.
The Andrewses' compromise was based on the fact that Mrs. Andrews was retired, had suffered two heart attacks, underwent several angioplasties, had diabetes, high blood pressure, high cholesterol, acid reflux disease, and depression.
Mr. Andrews suffered from severe depression and skin cancer. ER-148-49, ER-2 123-124.
According to the Andrewses' first retirement projection, a shortfall in income would have occurred in 2012 if assets were retained, and an immediate shortfall was expected if the full amount of the 401(k) was used as Commissioner suggest. ER 3-128, 130-152. Using Commissioner's actuarial tables, Mr. Andrews had a life expectancy of22.5 years and Mrs. Andrews 26.8 years. ER-3
128. In reality, these estimates were conservative. When Mrs. Andrews died, the additional medical expenses far exceeded the estimates -not to mention there was a decrease in social security income. See Op.Br. 27-28, 66-67. By failing to consider the reasonably foreseeable expenses (Com.Br. 63), SO Cochran had an erroneous view of the law.
The Barneses' were retired with very limited retirement assets ($3,438 IRA, $22,771 life insurance, and $106,500 in real estate equity), increasing medical premiums, and medical concerns such as high blood pressure and gall bladder problems. ER-4 78, 88-92. In performing her analysis SO Cochran not only failed to determine reasonably foreseeable expenses, but she failed to determine how additional mortgage or rent payments could be made. See Op.Br. 28-29, 67-69.
Commissioner argues (Com.Br. 64) that SO Cochran acted reasonably by including $500 in undocumented other expenses, but is also evident from this consolidated appeal that this amount represents attorney fees. 8 ER-4 112 ("There remains the possibility, however, that this expense represents such allowable expenses as attorney's fees."); see also ER-1 724, ER-12 154 (line 44),206. Commissioner's calculation only works if you only look at expenses for the next 4 years. Why are estimates for the next 4 years reasonable and estimates using Commissioner's own life expectancy tables are not?
And, unlike the Andrews, we do not know what happened in the intervening years between the hearing and the trial as Judge Laro prohibited the Barnes from testifying.
Mr. Carter has arthritis, in both knees, a bad right hip, and degenerative arthritis of the lower spine. Mrs. Carter was suffering from colitis, reduced kidney function, a defective aortic heart valve, hypertension, and high cholesterol. ER-6 200-201,214,257. Mrs. Carter's condition required constant monitoring and her kidney was starting to show reduced function. ER-6 201, 214, 257.
Given the severity of Mrs. Carter's conditions, it was reasonably foreseeable that her ability to work long-term was impaired. Nonetheless, SO Cochran 8 SO Cochran could have resolved this issue by providing her income/expense tables, or by making a simple phone call. ER-4 118 (showing no phone calls after February 15,2005 submission).
determined she could continue working for 41-months at $916 per month. ER-l 278; ER-6 155,284-285. Approximately two months after the CDP hearing, Mrs. Carter was hospitalized due to heart problems, and she never returned to work. ER 680. When the $916 is deducted over 39-months, the Carter's collection potential is reduced to $108,882 (144,606 -35,724) -a number extremely close to the offer of$99,851. See Com.Br. 65. However, similar to Barnes, the Carters would also have a large shortfall in income during their life expectancies. See ER-6 255.
The Catlows' were both retired and living on a fixed pension of$4,551 per month. ER-7 10,85, 105, 118 119. In order to save on living expenses, the Catlows live in a 1973 mobile home with an assessed value of $8,950 on land worth $36,000. ER-7 85-86. As such, the Catlows' housing and utility expenses were only $682 per month. ER-7 105. SO Cochran determined the land should be liquidated, but she neglected to increase the housing and utilities expenses to the local standard amount of$912 per month to compensate for the new mortgage. ER-7 86, 118. Additionally, medical expenses were reduced by $803 per month, despite the fact that Mr. Catlow needed for expensive dental work. ER-7 85, 119.
The Claytons were 69 and 72 years old at the time of their hearing, retired, and living off monthly withdrawals from retirement accounts in order to cover their shortfall. ER-8 101, 105-110 (projections), 125. SO Cochran considered the retirement account fully collectible, which would have created an immediate monthly shortfall of$2,913 according to the financial statement, and $689 pursuant to SO Cochran's numbers. ER-8 125, 137-139. She also punished the Claytons by declaring that voluntary payments to the IRS in the amount of $57,432 were a dissipation of assets. ER-8 4-9, 139. This was clearly an abuse of discretion.
Mr. Ertz was retired, had suffered four strokes, and had a hard time walking. Mrs. Ertz was also retired and had osteoporosis. ER-9 123, 132, 156. At the time of the offer, Mr. and Mrs. Ertz had a shortfall in income of$227, but they had a retirement account to cover the shortfall. ER-9 153. As part of the offer calculation, Ertz determined that he could fund the offer with $203,211 of the retirement account, which left $51,765 ($44,000 after taxes) for future housing and car ownership expenses (Ertz owned a 1990 Toyota with 195,000 miles on it). ER9, 122-123, 148, 153 (projection), 172.
Contrary to the Regulations, SO Cochran determined that both the retirement account and the home were fully collectible. Treas. Reg. § 301.71221(c)(3)(i)(example 2); ER-9 172-173. Commissioner (Com.Br. 66-67) argues that collection potential is $242,467 (a lower amount than Cochran), but like Cochran's adjustments, there is still no adjustment for the increased monthly payments on a mortgage or rent. With no retirement account to make up the shortfall, this creates an immediate and significant economic hardship for the remainder of the Ertzes' life expectancy.9
Mrs. Hubbart was retired, and suffering from ulcerative colitis. Mr. Hubbart was retired with heart problems, recent heart surgeries, and the potential for heart by-pass surgery. ER-12 63-65, 95, 123, 161-162. It was learned at trial that Mrs. Hubbart developed osteoarthritis, which limited her mobility and required her to walk with a cane. ER-12 96-97.
Commissioner (Com.Br. 68) argues that the specially equipped home was not given consideration by SO Cochran, as she was not aware of the modifications. However, given the Hubbarts' medical conditions it was reasonably foreseeable that home modifications would be needed in the future. Commissioner incorrectly suggests that another CDP hearing is available -at least as to the issues raised in this hearing. 26 U.S.C. § 6330(c)(4)( issue preclusion).
The Johnsons were 74 and 69 years old at the time of their offer, retired, suffering from medical problems (Op.Br. 36), and living off monthly withdrawals from retirement accounts in order to cover their shortfall. ER-13 140-141, 148-154 (doctor), 155-158 (projections), 168, 173. SO Cochran considered the retirement account and the home fully collectible, which increased in their monthly shortfall. ER-13186. Commissioner (Com.Br. 68) labels the Johnson's statement concerning future medical problems as speculative. ER-13 140. However, after submission of the offer Mrs. Johnson was hospitalized for gall bladder surgery, which caused complications with her digestive system. ER-13 46-47. Given the Johnsons' advanced age, it was certainly reasonably foreseeable that problems like this could occur.
9 The IRS local housing standards for the Ertzes allow $1,628 per month for housing and utilities. See Internal Revenue Service, California -Local Standards: Housing and Utilities (Sept. 23, 2008), available at http://www.irs.gov/businesses/small/article/0..id=104701.00.html.This is at least a $601 shortfall per month ($227 shortfall is increased by the difference between the amount claimed ($1,254 -ER-9 153) and the recent guidelines ($1,628)).
The Lindleys' compromise was initially based on the fact that Mr. Lindley had diabetes, hypertension, and high cholesterol, while Mrs. Lindley had inflammation of the arteries and significant hypertension. ER-15 128-129, 171,
175. However, during the negotiation process a pure doubt as to collectability (without special circumstances) offer was discussed. There was a dispute at the Tax Court level in regards to whether the waiver of the special circumstances was "contingent" on acceptance of a $150,000 offer. ER-1 719. Nevertheless, abuse of discretion occurred even if the special circumstances are considered waived.
The Tax Court's $175,535 reasonable collection potential is much more precise than SO Owen's calculations. Indeed, Settlement Officer Owens ("SO Owens") was off by $250,904, while the Lindleys' were off by only $25,535.
Moreover, the Tax Court relied on an I.R.M. provision to disallow the $309 in monthly education expenses for the Lindleys' middle school child, and attorney fees were kept at $400 per month, despite the fact they increased from $400 to $500 per month. ER-l 723-724 (citing I.R.M. 5.8.5.5.3(6)); ER-15 201-202. When these calculations are taken into account the Lindleys are off by only $5,903 ($409 x 48 = $19,632). Had SO Owen's performed more precise calculations, the parties could have reasonably come to terms on any remaining issues. SO Owen's hyper-inflated calculations were an abuse of discretion.
Gary McDonough has pain from work-related injuries and in physical therapy weekly, which is likely to result in disability and reduced earning power in the future. ER 16 129, 145-146 (doctor letters about potential future disability). Nonetheless, SO Cochran determined that Mr. McDonough could work for another 10-years, as she believed an actual disability was needed, instead of a foreseeable disability. ER-1696-97, 99, 222. As Cochran's income projections were not supported by doctor letters, her projections were speculative.
Mr. Smith was retired, and had suffered from diabetes, high cholesterol, heart disease, knee arthritis, glaucoma, and varicose views. Mrs. Smith was also retired and suffered from hypertension and osteoarthritis, and a failing bladder. ER-17 36, 73-77 (doctors statements). The Smiths reported a current shortfall in income of$819 per month. The retirement accounts were needed to cover the shortfall for the reminder of the Smiths' life expectancy. ER-17 52, 79-81 (projections). Commissioner (Com.Br. 71) points out that a retirement account with a value of$38,823 was missing from the financial statement, as well as $1,500 in real property. However, at the time the offer was submitted Mr. Smith was in intensive care, and since he usually handled the finances, it is reasonable that Mrs. Smith missed the oversight. ER-17 92-93. Regardless, Settlement Officer Driver determined the Smiths "did not establish any special circumstances." ER-17 101. It was reasonably foreseeable that the Smiths' medical problems and their shortfall in income would cause economic hardship.
a. Abuse of Discretion.
Commissioner's pattern of looking at economic hardship prior to the offer is an abuse of discretion. It is also a clearly erroneous interpretation of the Regulations that requires Commissioner to evaluate the impact of liquidation of assets. Treas. Reg. § 301.7122-1(c)(3)(iii). It is extremely misleading to provide calculations, but fail to note that the taxpayers will have an immediate economic hardship under any definition if the assets are liquidated to pay the taxes.
Commissioner also abused his discretion by setting up short deadlines and not providing Petitioners with a chance to respond to his determination before finalizing it. Er-2 99, ER-3 69, ER-6 162. This Court stated: More disturbing, however, is that Asarco was never given an opportunity to respond to the findings reached by Steiner. The report furnished the principal basis for the agency's action and it was a prejudicial violation of agency law principles not to allow Asarco an opportunity to challenge its accuracy. See e. g., Bowman Transportation v. Arkansas-Best Freight System, Inc., 419 U.S. 281, 288 n. 4, 95 S. Ct. 438, 443, 42 L. Ed. 2d 447 (1974); Marathon Oil Co. v. EPA, 564 F.2d 1253, 1271 (9th Cir. 1977). Asarco, 616 F.2d at 1162.
Petitioners are not alleging that Commissioner should have made a counteroffer, instead the issue is whether Commissioner denied Petitioners due process when he substantially limited the time Petitioners had to gather the information, did not issue adequate guidelines for Special Circumstances, did not let Petitioners know that he thought more information was necessary, then issued the Determination without any additional contact. Commissioner abused his discretion by setting up a procedure that guaranteed that Petitioners would not be able to meet the detailed substantiation that Commissioner apparently requires for Special Circumstance offers in compromise.
C. The Tax Court Had Jurisdiction to Determine that Petitioner Ertz and the Other Hoyt Partners Are Not Liable for Tax-Motivated Interest.
1. The Tax Court's Jurisdiction and the Scope of Review.
Contrary to the lower court's determination, the parties both agree that Tax Court had jurisdiction to determine if Commissioner correctly asserted Tax-Motivated Transaction ("TMT") interest in the computational adjustments. However, as stated in Petitioners' opening brief, the Tax Court's jurisdiction is limited to the record in the partnership proceeding. Op.Br. 79-81. Commissioner is incorrect when he asserts that alleged "subsidiary" documents (that were not part of the record at the partnership-level proceeding) can be considered (i.e., Tax Court ER-9 218, SER 27-31 (Exhibit 442-J).
The determination of whether alleged subsidiary documents can be considered is vital, as the Tax Court determined that "[t]he opinion and the orders and decisions cannot fairly be interpreted as making findings or determinations regarding whether [the partnerships] transactions were tax motivated." ER-l 459. As described below, if review is limited to Durham Genetic Engineering 1985-5's ("DGE85-5") partnership record, then Petitioners are not liable for TMT interest.
2. Ertz and the Other Hoyt Partners Are Not Liable for TMT Interest Based on a Valuation Issues.
Hoyt (as TMP) and the IRS entered into a Memorandum of Understanding ("MOD") concerning the 1980 through 1986 years, which is the basis for the 1982 through 1988 deficiencies in Ertz.lO ER-2206-214. The settlement between the parties agreed that a reduced number of cattle existed and allowed reduced losses to the partnerships and thereby to Hoyt partners. ER-2208-210. The Tax Court . interpreted the MOD and stated: Pursuant to the settlement agreement (the agreement), the numbers of cattle deemed to be held by the partnerships were reduced. Accordingly, the amount of principal on each of the notes payable to Ranches was treated as reduced. Shorthorn Genetic Engineering 1982-2 v. Commissioner, T.C. Memo. 1996-515, 1996 Tax Ct. Memo. LEXIS, at *6-8.
Here, the MO sets forth a basis for settlement, reasoning that fewer cattle were in service in all of the Hoyt investor partnerships than were claimed on the tax returns. ER-2 208; Com.Br. 80. However, the MOD does not state how many cattle were claimed as the basis for depreciation deductions in DGE85-5, or the aggregate number of cattle listed in the depreciation schedules of all the investor partnerships. ER-2 206-214. Moreover, the Tax Court's order and decision documents in the partnership-level proceeding does not state those numbers either.
10 Petitioner Ertz initially claimed both a partnership loss and an investment tax credit in 1985. ER-1422-423. The investment tax credit was partially used in 1985 and carried back to 1982, 1983, and 1984, and carried forward to 1987, and 1988. ER-l 423. Additionally, in 1986 Petitioner claimed a partnership loss. ER1422 ER-2 208, 212; ER9 235-236, 251-254. These numbers cannot be found anywhere in the DGE85-5 partnership record. See ER-2 208, 212; ER9 235-236, 251-254; SER46, 48-50,52-54,68-73, 75-77.
Now, in this later partner-level proceeding, Commissioner points to a schedule his agents prepared to show how many cattle were in service at the time the tax returns were prepared. Com.Br. 81; SER 27-31. This schedule is not evidence of Hoyt's claimed number of cattle. Further, there is no evidence in the partnership record that Hoyt stipulated to the usage of this schedule or that the schedule reflects the actual number of cattle that were the basis of the deductions. 11 in an attempt to bolster his schedule, Commissioner makes reference to the partnership-level decision documents, and calls the issue one that can be resolved through "simple arithmetic". Com.Br. 81-82. However, the fact that the TMP agreed to specific dollar adjustments does not support a finding that DGE85-5 claimed 520 cattle, or that the aggregate amount of all the cattle claimed in all Hoyt investor partnerships was 17,425. See SER 29, 31. To do his "simple arithmetic", Commissioner has to rely on his schedule that is not part of the partnership record. The only thing that can be determined from the partnership record is that Commissioner and the TMP stipulated that 120 cattle were placed in service in 1985.12 See also Com.Br. 81.
11 Petitioner Ertz also did not stipulate that the TMP and Commissioner agreed to the usage of the schedule during the partnership-level proceeding. ER-9 218, ~ 12.
The cattle number is important. The overvaluation penalty would not apply unless Hoyt valued each animal at $6,000.00 or more at the time he prepared the tax returns.13 As the tax returns only report the cost basis, this number must be elsewhere in the partnership record to determine the claimed value per animal. See SER 10, 13,23. For example, if DGE85-5's records showed DGE85-5 claimed 784 cattle, the average value of each animal would be less than $6,000 ahead14 and there would be no valuation overstatement.
a. A Valuation Overstatement Cannot Be Imposed for Cattle That Do Not Exist. Furthermore, as argued extensively on brief by the petitioners in Keller v. Commissioner (9th Cir. -No. 06-75411) and McDonough v. Commissioner (9th Cir. -No. 07-73610) a valuation overstatement cannot be imposed for cattle that did not exist. Gainer v. Commissioner, 893 F.2d 225,228 (9th Cir. 1990); See also Heasley v. Commissioner, 902 F.2d 380,383 (5th Cir. 1990); Todd v. Commissioner, 862 F.2d 540,543 (5th Cir. 1988). In Gainer this Court stated:
12 The stipulated $480,000 cost of qualified investment property divided by the stipulated cost per head of$4,000 equals 120 cows. SER 48-49 (paragraphs 2 and 5),68, 76. 13 $6,000 is 150% of the agreed upon $4,000 fair market value for adult cattle. ER 2208. 14 $4,701,120 basis / $6,000 = 783.52 cows (see SER 13 depreciation schedule) I $4,701,120 basis / 784 cows = $5,996 per cow.
...Gainer's overvaluation becomes irrelevant to the determination of any tax due. The parties stipulated that the container had not been placed in service in 1981 and the Tax Court therefore found no deductions or credits could have been taken in that year. Even if Gainer had correctly valued the container, the underpayment of tax would be the same because the container was not placed in service. Thus, Gainer's actual tax liability, after adjusting for failure to place the container in service, was no different from his liability after adjusting for any overvaluation. See Todd, 862 F.2d at 543. This formula has been adopted by the Tax Court and the Fifth Circuit. See Gainer v. Commissioner, 1988 Tax Ct. Memo LEXIS 449,56 T.C.M. (CCH) 39, 40-41 (1988); Todd v. Commissioner, 89 T.C. 912 (1987) affd, 862 F.2d 540 (5th Cir. 1988). Gainer, 893 F.2d at 228.
As such, Commissioner effectively concedes that a portion of the cattle cannot be overvalued as they did not exist.
b. A Valuation Overstatement Cannot Be Imposed on Interest and Other Expenses.
Petitioners agree with Commissioner's concession (Com.Br. 83 n.20) that a portion of the claimed income and deductions had nothing to do with valuation, and therefore should only be subject to regular interest. Indeed, the partnership returns and the decision documents show that more was at issue than a cattle count in the partnership-level proceedings. ER-9 236, 251; SER 1, 8, 14, 17. For example in 1986, DGE85-5 claimed a $1,503,411 loss, out of which only $982,534 was claimed depreciation. ER-9 251; SER 15, 17. The remainder was for feed, trucking, gas, insurance, interest, pasture rent, repairs, supplies, taxes, utilities, vet fees, and other miscellaneous expenses. SER 17. The same was true in 1985.
Since some of these expenses are not related to "property," they cannot be overvalued within the meaning of section 6659(c). When these adjustments are made in connection with the adjustment for cattle not in existence, Respondent's TMT interest calculation will be much smaller.
3. This Was Not a Sham or a Fraudulent Transaction.
a. Commissioner Fails to Point to Anything in the Partnership level Proceeding Indicating DGE85-5 was Engaged in a Sham Transaction.
The TMT interest penalty cannot be imposed on the nonexistent cattle based on a "sham" transaction theory (see Com.Br. 82-84), as the MOD, the stipulations, and the decision documents clearly reflect that cattle existed. Moreover, Commissioner admits that the MOD was to reduce deduction to "demonstrable economic reality." ER-2 208-209, Com.Br. 80. The Tax Court's finding that "[t]he opinion and the orders and decisions cannot fairly be interpreted as making findings or determinations regarding whether [the partnerships] transactions were tax motivated" is supportive of this view. ER-1459.
The Commissioner tries to negate this fact by focusing on what happened in court cases that were not part of the MOD, instead of pointing to the partnership-level facts during the relevant years. See Com.Br. 83-84 (citing RCR#l, T.C.
Memo. 2007-171 and Durham Farms #1, T.C. Memo. 2000-159. 15 Yet, there are no facts to support Commissioner's theory in the partnership record. See Com.Br. 78 (citing Botany Worsted Mills v. United States, 278 U.S. 282, 290 (1929)). Consequently, Petitioner Ertz should not be held liable for TMT interest under a sham transaction theory.
b. Commissioner Fails to Point to Anything Outside of the Partnership-level Proceeding Indicating DGE85-5 was Engaged in a Sham Transaction.
As stated above, review should be limited to the partnership record. Nonetheless, if this Court determines that facts outside of the partnership record can be considered, then Mr. Ertz still prevails. In determining whether a sham exists, this Court focuses on whether there was "1) a non-tax business purpose (a subjective analysis), and 2) that the transaction had 'economic substance' beyond the generation of tax benefits (an objective analysis)." Sochin v. Commissioner, 843 F.2d 351,354 (9th Cir. 1988)(citing Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543, 1549 (9th Cir.. 1987)). This is not a "rigid two-step analysis." Id.; Sacks v. Commissioner, 69 FJd 982,988 (9th Cir. 1995). Given the above, even if facts outside of the partnership-level proceeding are relevant, an analysis of the relevant facts proves that the Hoyt partnerships were not a sham 15 The years at issue in RCR #1 were 1986 to 1996 and Durham Farms #1 were 1987 to 1992. from 1980 through 1986 (i.e., the MOD years). See ER-2 206.
First, this was a well-run ranch that did more than generate tax benefits. See Bales, 58 T.C.M. (CCH) at 449-50 ("There is no doubt that tax savings play an important role in these investments. Yet there are profits to be made independent of tax savings."). Second, the record does not establish that the transactions were not at arms-length, and the SGE 1982-2 Court specifically found the partners debt to be recourse. SGE 1982-2, 1996 Tax Ct. Memo. LEXIS 531, at *7. Indeed, the Tax Court has previously found that Hoyt made "not-so-thinly-veiled threats" to enforce collection. Hansen, T.C. Memo. 2004-269 (Slip Op. at 37). Third, the contractual terms were not illusory, otherwise Petitioners would not have been entitled to depreciation deductions. This argument also ignores the fact that Hoyt enforced the provisions of the contracts. Finally, the expert opinions in the Bales case established that it was not uncommon for a Hoyt single breeding heifer to bring $10,000 to $20,000 in 1985. Bales, 58 T.C.M (CCH) at 441-42,446. As such, there is no objective proof that DGE85-5's cattle were outside the reasonable range of value.
In Weiner v. United States, 389 F.3d 152 (5th Cir. 2004), the taxpayers conceded the disallowances without litigation, and the Fifth Circuit refused to uphold the assertion of TMT interest. Id. at 162-63. In doing so, the Court held:
[section 6621(c)] was one of the provisions enacted by Congress "to deal with the Tax Court backlog." Yet, fifteen years after the statute's repeal, imposing the penalty in situations such as this does nothing to relieve the Tax Court's backlog, when the taxpayers have in fact settled with the IRS. Because, under the circumstances of these cases, the taxpayers' underpayments are not "attributable to" a tax motivated transaction as a matter of law, the IRS may not assess the additional interest against them.
ld. (citation omitted). Similar to Weiner, upholding the assessment of TMT interest in this case fails as a matter of law, as well as from a policy standpoint.
4. Alternatively, Petitioner Ertz Relied in Good Faith on Hoyt's Stated Values of the Cattle. If Commissioner is successful with his position that facts outside of the partnership record can be admitted, then Petitioner Ertz asserts that such value was claimed in good faith. See 26 U.S.C. §§ 6621(c)(3)(A)(i) (valuation overstatement defined by former 26 U.S.C. § 6659(c)); 6659(e)(waiver of addition to tax for reasonable basis or good faith). As the section 6659 penalty was not found at the partnership-level, only Petitioner's good faith is at issue (and not the partnership's) concerning the imposition of section 6621(c). Likewise, a "non-tax business purpose (a subjective analysis)" is relevant in determining whether a sham exists. Sochin, 843 F.2d at 354 (citing Bail Bonds, 820 F.2d at 1549). Petitioner clearly acted in good faith when he claimed the Hoyt losses on his income tax returns. All available evidence seemed to support Hoyt's assertions. And, Petitioner Ertz made a concerted effort to investigate the Hoyt operation both prior to and after his decision to invest.16 This included consultations with approximately twelve to fifteen co-workers who were Hoyt investors, as well as his immediate supervisor. ER-921-22. As fellow co-workers, Petitioner respected these opinions. ER-921.
Petitioner Ertz even visited the Hoyt operation on at least two occasions prior to investing, as well as visiting the Hoyt ranch in Burns, Oregon after investing. ER-9 22,25. This was not the first time Petitioner experienced the cattle business, as he milked cattle during his childhood, and he helped his uncle raise approximately fifty head. ER-9 20-21. After conducting his investigation, Petitioner Ertz believed cows existed, and he did not invest for tax benefits. ER-9 24-25. Indeed, he believed he was buying cattle, that the cattle would grow, and that he would sell the cattle to supplement his retirement. ER-9 25. Mr. Ertz' testimony is supported by Appeals Officer McDevitt's memorandum, where he indicated that "after speaking with scores of investors, it [was] difficult for [him] to allege that their principal motivation in investing with Hoyt was tax avoidance." ER-2279. Appeals Officer McDevitt also mentioned that Hoyt was open about the "tax advantages" and that Hoyt convinced investors that the program was only designed to "defer" the ultimate tax liability. ER-2279.
16 Petitioner has suffered four strokes, and he had memory difficulties during his trial. ER-9 22, 29-31, 123, 13 139 (footnote 1). Nonetheless, it is reasonable to assume that he reviewed and relied on Hoyt promotional material, as he remembered attending partnership meetings. ER-925.
Thus Petitioner Ertz cannot be held liable for TMT interest due to overvaluation as he claimed the values in good faith.
Thus it is necessary to remand this case to the District Court for plenary review of the Secretary's decision. That review is to be based on the full administrative record that was before the Secretary at the time he made his decision. But since the bare record may not disclose the factors that were considered or the Secretary's construction of the evidence it may be necessary for the District Court to require some explanation in order to determine if the Secretary acted within the scope of his authority and if the Secretary's action was justifiable under the applicable standard.
The court may require the administrative officials who participated in the decision to give testimony explaining their action.
Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U.S. 402, 420 (1971)(emphasis added.)
This Court agreed and explained the need further: The Supreme Court recognized in Overton Park, however, that even where the agency has employed adequate fact-finding procedures, the courts may find it necessary to go outside the agency record to evaluate agency action properly. The Court contemplated that any additional material should be explanatory in nature, such as requiring the involved administrative officials to demonstrate the basis for their action. A satisfactory explanation of agency action is essential for adequate judicial review, because the focus of judicial review is not on the wisdom of the agency's decision, but on whether the process employed by the agency to reach its decision took into consideration all the relevant factors.
Asarco, Inc. v. EPA, 616 F.2d 1153, 1159 (9th Cir. 1980).
The court cannot adequately discharge its duty to engage in a "substantial inquiry" if it is required to take the agency's word that it considered all relevant matters. We think these conflicting considerations can be satisfactorily reconciled. If the reviewing court finds it necessary to go outside the administrative record, it should consider evidence relevant to the substantive merits of the agency action only for background information, as in Bunker Hill, or for the limited purposes of ascertaining whether the agency considered all the relevant factors or fully explicated its course of conduct or grounds of decision.
Id. at 1160.
1. Oral Testimony. Commissioner dismisses Petitioners' attempts to estimate future expenses as speculative. Unfortunately, whether estimating expenses in year 4 (which is apparently acceptable to Commissioner) or year 8, there is an element of speculation because the future is uncertain. Petitioners' testimony provides a method for the Court to double check if Commissioner's easy dismissal of future expenses is supported.
Rather than showing Petitioners had exaggerated their future needs, Mr. Andrews' testimony revealed that Mrs. Andrews had not lived out her life expectancy (using the IRS life expectancy table) but her illness caused significantly more medical costs than were estimated. The same is true for the Carters. Disregarding Mrs. Carter's precarious health, Commissioner speculated that she would continue to work for the next 4-years. In fact, Mrs. Carter was only able to work for two months after the hearing. In the Hubbart case, Mrs. Hubbart developed an additional illness.
It is clear from Overton Park and Asarco, that the Settlement Officers' testimony is particularly necessary. Without the SO Linda Cochran's testimony we would not know that she did not "agree or disagree" with Petitioners' facts (ER-6 147-148) and that Revenue Officers were not appraisers (even though SO Cochran's background was as a Revenue Officer). ER-6 123, 150, ER-9 68,89. This was extremely relevant as Cochran disputed Petitioners' home values in both the Carter and Ertz cases and applied a new value -and yet she was not an appraiser.
The fact that SO Cochran neither agreed or disagreed with Petitioners' facts reveals the total lack of fact-finding done by Commissioner in these cases. ER-6 149. This was an abuse of discretion but could not have been revealed without the ability to examine SO Cochran at trial.
Finally, both Petitioners' and Settlement Officers' testimony were particularly needed in the Judge Laro cases as he only allowed briefs in two of the six cases tried before him. How can the Petitioners prove an abuse of discretion without neither testimony nor briefs?
2. Background Documents.
To be clear, Petitioners' position is that the additional records are either (1) already part of the administrative file but Commissioner failed to associate the documents (or stipulate to the facts), (2) background and/or explanatory documents, or (3) Commissioner abused his discretion by effectively isolating the partnership records from the CDP case.
Commissioner attempts to isolate the CDP cases as if the Hoyt partnership cases were not related and therefore not "part" of the administrative file. When it became clear that Commissioner failed to associate relevant information from the partnership files, Petitioners attempted to offer the missing portions at trial as background for facts referenced in their letters. See (for example) ER-2 177-198, ER-982.
Commissioner's argument ignores the underlying requirement that the agency must engage in adequate fact-finding. Asarco, 616 F.2d at 1159. Even though Petitioners described the facts in great detail, the Settlement Officer made no attempt to review Commissioner's own files to determine if those facts were . accurate. See ER-6 149, ER-16 82, ER-13 71-72. The documents and testimony Petitioner is offering into evidence is the background information concerning the TEFRA audit, the criminal investigation of Jay Hoyt, and the promoter penalty investigations of Jay Hoyt.
Thus, testimony about the Settlement Officers' failure to confirm Petitioners' factual claims by reviewing relevant portions of the Hoyt partnership audit file is relevant as to whether Commissioner engaged in adequate fact-finding in these cases. Such a failure is an abuse of discretion.
3. RCR #1 Documents.
Commissioner repeatedly states that Petitioners are not entitled to relief solely due to the TEFRA procedures or their TMP's actions. Each time Commissioner correctly states the law, he then ignores that Petitioners are not "complaining" about the law. As argued in Petitioners' Opening Brief, Petitioners are requesting relief because of Commissioner's actions and delays. Op.Br.87-90.
Commissioner is incorrect in his belief that the RCR #1 documents are not relevant. For example, Commissioner complains about Petitioners' "10-year" rule. At the time of the hearings, Petitioners best evidence was that the Hoyt audits started in approximately 1982. ER-10 135. However, Commissioner's internal memoranda reveal that the audits started in approximately 1978. ER-5 197. In the CDP hearings, Petitioners alleged that the multiple criminal investigations must have delayed the civil audit. However, Petitioners did not have specific proof of that fact. RCR #1 provides that proof. Op.Br. 87-90, ER5 211-213.
Without discussing any of the RCR #1 documents, Commissioner claims they are not relevant. It was an abuse of discretion that these cases were not remanded so that a neutral Appeals Officer could determine if the RCR #1 documents are sufficient to prove that the IRS delays require that some amount of interest and penalties should be abated.
The RCR #1 documents show that the agency's internal documents are needed to reveal whether the agency committed error or delay.
Petitioners request that this Court reverse the Tax Court concerning the issues stated above and remand those factual issues that remain undeveloped.
Respectfully submitted,
Dated: NOV 10 2008