Tax News

CCH (cch.taxgroup.com) reports:

  In an action based on taxpayers' and the IRS's motions for reconsideration of the taxpayers' prior consolidated cases arising out of the Kersting project tax shelter litigation ( L.L. Hartman , Dec. 57,431(M), TC Memo. 2008-124 (Hartman I)), the Tax Court denied the IRS's motion to reverse all factual findings that were based on an item in the IRS's privilege log that included three drafts of a proposed post-trial settlement offer and that concerned formulation and communication of that settlement offer. The three drafts were documents in the IRS's records subject to discovery that were properly includible in the record in the taxpayers's consolidated cases in Hartman I.

  In addition, the mitigating effect of the post-trial settlement offer could not be properly evaluated without consideration of the three drafts and all of the documents included in the same privilege log item were relevant to the issues in the motions to vacate in Hartman I. Because the drafts spoke for themselves, the court ordered them received into evidence as the court's exhibits rather than setting the matter for a hearing and commencing discovery procedures, which the IRS opposed.

  Background. In Hartman I, the court granted the taxpayers' motions to vacate the decisions entered in their three consolidated cases arising out of the Kersting project tax shelter litigation, which involved fraud on the court by an IRS attorney and supervisor in the process of resolving the cases. The taxpayers, who entered into a settlement after the fraud was discovered, but on terms less favorable terms than the outcome in a later Ninth Circuit appeal, were entitled to have their settlements vacated and their cases resolved on terms identical to those ordered by the appellate court.

  Generally, in order to resolve deficiencies and additions to tax assessed against hundreds of tax shelter participants, the taxpayers and other participants agreed to be bound by the outcome of selected test cases. In order to encourage the participants in one particular test case not to withdraw, IRS attorneys entered into a secret settlement (known as the "T settlement" or the "Thompson settlement") that ensured a refund sufficient to cover their attorney's fees. The Ninth Circuit eventually ruled that the IRS attorneys had committed fraud on the court by failing to disclose the "T settlement" offer to their superiors, the attorneys for other participants, and the court. As a consequence, it held that terms equivalent to the secret settlement agreement had to be extended to all test case petitioners and all others properly before the court ( J.A. Dixon, CA-9, 2003-1 USTC ¶50,194 (Dixon V)).

  This did not, however, alter the outcome for those, like the taxpayers in Hartman I, who entered into stipulated settlements after the fraud was discovered but prior to the Dixon V decision. The court in Hartman I also held that the sanction mandated by the Ninth Circuit in Dixon V should be imposed in the cases of all Kersting project petitioners in which stipulated decisions were entered on or after the commencement date of implementing the test case procedure. The court further held that, once the Hartman I decision became final, an implementation order would be issued requiring that all remaining Kersting project taxpayers against whom stipulated decisions had been entered have their accounts adjusted administratively in accordance with the Thompson settlement.

  The IRS's motion to reconsider Hartman I to strike from it findings of continuing fraud on the court beyond the original misconduct of the IRS's attorneys in the test case proceedings was determined to be moot because the court did not find such a continuing fraud beyond that committed by the IRS's trial counsel during the test case proceedings and there were no findings to strike.

  In response to the IRS's requests to delay entry of decisions in the taxpayers' cases and the implementation of any sanction in the closed cases until after the Ninth Circuit has issued its mandate in the current appeal of certain test and nontest cases, the court concluded that the decisions in those cases should not be postponed. The court, however, ruled that the implementation of the sanction in closed cases other than the cases at hand should not commence until the later of: (1) the last date a decision in any of these cases become final, (2) the date the Ninth Circuit renders its mandate in any of these cases, if and when the decisions are appealed, and (3) the date of the mandate in the test case appeal. The court also issued an order to facilitate the implementation of the sanction and ruled that, in each case in which the taxpayers have requested that the sanction be applied in their affected closed cases, the IRS will file a motion to vacate the decision.

  The court denied the taxpayers' motion to extend the sanction to participants in the Kersting tax shelters who never filed a petition in the Tax Court to contest the deficiencies determined against them or who filed a petition but settled their cases before the test case proceedings began. The fraud committed on the court did not extend the time for filing a petition after a notice of deficiency had been issued and the court never acquired jurisdiction over those taxpayers or their deficiencies. Also, a taxpayer who did not file a petition in the Tax Court did not have a case in this court to which the fraud committed by the IRS's attorneys in the test case proceeding could have attached.

  Further, the court invoked its inherent power to impose the sanction against the IRS for the harm done to the test case proceedings, which did not involve taxpayers who were not part of those proceedings. Finally, the court's inherent power is limited to imposing the sanction in those cases in which a fraud was committed and does not extend to cases where no fraud was committed (such as cases that settled before the test case proceedings began) or where no case was filed.

L.L. Hartman, TC Memo. 2009-124, Dec. 57,840(M)

Other References:

 
Tax Court Rule 161

  CCH Reference - 2009FED ¶42,321.74

  CCH Reference - 2009FED ¶42,321.76

  Tax Research Consultant

  CCH Reference - TRC LITIG: 6,592