Federal Taxation - Timothy J. Peaden

• Publication year: 1995

Federal Taxationby Timothy J. Peaden^*

Procedural issues once again dominated the federal tax cases decided by the Eleventh Circuit. During 1994, the court considered cases involving the assessment procedure, jurisdiction issues, transferee liability, priority of liens, and other procedural issues.

I. Income Taxes

A. Tax Assessments

The issue in Hempel v. United States¹ was whether the taxpayers had waived their right to a notice of deficiency.² The tangled facts of this case required the Eleventh Circuit to consider a number of the procedural provisions in the Internal Revenue Code ("IRC"). Seeking to tie the results of their case to another case being tried in the United States Tax Court, the taxpayers first executed a series of consents to waive the statute of limitations³ and then a closing agreement in which they agreed to be bound by the results of the other case.⁴ The closing agreement provided:

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The amount of any federal income tax that becomes due from the taxpayers under the terms of this agreement may be assessed by the Commissioner of Internal Revenue on or before the expiration of the one year (365 days) period following the date on which the decision in the controlling cases become [sic] final, notwithstanding the expiration of any period of limitation on assessment and collection otherwise prescribed by the Internal Revenue Code section 6501. This assessment shall be made without the issuance of the notice of deficiency authorized by . . . section 6212 and without regard to the restrictions otherwise imposed by . . . section 6213.⁵

Two years after Sutton was decided, the taxpayers terminated their consent to the extension of the statute of limitations.⁶ The IRS assessed the taxes due under the closing agreement and did not send a notice of deficiency.⁷ The taxpayers then brought this action to enjoin the collection of taxes.⁸

The Eleventh Circuit upheld the district court's dismissal of the case, albeit for different reasons.⁹ The issue was whether, as contended by the taxpayers, the closing agreement required the IRS to issue a notice of deficiency unless the taxes were assessed within one year of the decision in the Sutton litigation.¹⁰ The Eleventh Circuit held that the taxpayer's interpretation was inconsistent with the plain language of the closing agreement and that it was illogical in view of the circumstances surrounding the agreement.¹¹

In Feldman v. Commissioner,¹² the Eleventh Circuit considered the validity of consents to waive the statute of limitations.¹³ It was uncontroverted that the taxpayers had entered into the consents and had not terminated their consents by filing a Form 872-T for the years at issue.¹⁴ After the IRS issued a notice of deficiency, the taxpayers filed a petition in the Tax Court challenging the deficiency.¹⁵ The Tax Court rejected the taxpayers' argument that the consents were invalid and, after a trial, upheld the deficiencies.¹⁶

The Eleventh Circuit rejected the taxpayers' argument that the consents were invalid due to fraud and misrepresentation.¹⁷ Relying on a Seventh Circuit decision in Borg-Warner Corp. v. Commissioner,¹⁸ the taxpayers argued they signed the consents based upon the understanding that "meaningful" settlement negotiations would ensue.¹⁹ The court found first that there were settlement negotiations and second that Borg-Warner was inapposite.²⁰ In particular, the issue in Borg-Warner was whether the IRS terminated the consent by mailing a letter stating that no mutually satisfactory basis for settling the matter was reached and that a notice of deficiency would be sent.²¹ In Feldman it was clear that the consent was not terminated until the taxpayers filed Form 872- fp 22

B. "Innocent Spouse" Defense

Although frequently claimed, courts rarely allow the "innocent spouse" defense to a taxpayer.²³ In Kistner v. Commissioner,²⁴ the Eleventh

Circuit reversed the Tax Court and found the defense to be applicable.²⁵ Lucille Kistner and George W. Weasel, Jr. were married for twenty-four years, divorced for a two-year period, remarried for four more years, and then divorced again.²⁶ Throughout these years the taxpayers enjoyed an affluent lifestyle.²⁷ The Commissioner determined that for years 1979 and 1980, during the second marriage, the couple received additional income of $1,142,681 and $1,386,134 relating to personal expenses paid by their corporation.²⁸ The Tax Court rejected Kistner's "innocent spouse" claim, finding that while she may have been unaware of the "precise tax implications of the payments . . . she was or should have been aware of the payments, and she had a duty to make further inquiry as to the proper tax treatment thereof."²⁹

The Eleventh Circuit disagreed that the taxpayer had "reason to know" of the tax deficiency.³⁰ Relying on Stevens v. Commissioner,³¹ the Eleventh Circuit enumerated a four-part test to determine whether a taxpayer had a "reason to know": (1) the taxpayer's level of education; (2) the taxpayer's involvement in the family's business and financial affairs; (3) lavish or unusual expenditures as compared with the past; and (4) the culpable spouse's evasiveness and deceit regarding the couple's finances.³² In this case, the Tax Court found that the taxpayer was not a high school graduate and was not significantly involved in the financial affairs of the couple, thus satisfying the first two criteria.³³ While the Tax Court found that the third criterion was unsatisfied, it "seemed to determine lavishness based on the dollar value of the expenditure rather than evaluating the rarity of the expense."³⁴ Noting that "one person's luxury may be another's necessity," the Eleventh Circuit stated that the "lavishness of any expense must be measured from each family's relative level of ordinary support."³⁵ In this case, the expenditures in question were no more lavish than those to which the taxpayer was accustomed.³⁶

By contrast, the Eleventh Circuit in Feldman v. Commissioner,³⁷ rejected the taxpayers' "innocent spouse" defense.³⁸ As noted previously, each of the requirements of section 6013(e) must be met in order for the defense to be applicable, and the issue in this case was whether the deductions claimed were "grossly erroneous."³⁹ Although the Tax Court had denied the deductions in question, it further held that the deductions were not "grossly erroneous."⁴⁰ The Eleventh Circuit agreed.⁴¹

II. Estate and Gift Taxes

In Baptiste v. Commissioner,⁴² the Eleventh Circuit upheld the Tax Court's grant of summary judgment to the government.⁴³ The taxpayer was the beneficiary of an estate which was previously found to owe a tax deficiency.⁴⁴ The Commissioner asserted transferee liability against the taxpayer, relying on section 6324(a)(2) of the Internal Revenue Code.⁴⁵ Given the specific statutory provision imposing transferee liability, the Eleventh Circuit first rejected the taxpayer's argument that transferee status should be based on state law.⁴⁶ Next, the court found that the amount of the tax liability had been properly determined in the prior proceeding, and the taxpayer's attempt to recompute the amount was barred by res judicata.⁴⁷ Finally, the court found the taxpayer was liable for interest on the tax deficiency, and that the limitation on transferee liability found in section 6324(a)(2) is inapplicable to the interest obligation.⁴⁸

III. Other Procedural Issues

A. Tax Court Jurisdiction

In McMullen v. Commissioner,⁴⁹ the Eleventh Circuit affirmed the Tax Court's denial of a motion for redetermination of interest following a stipulated decision as to the amount of the tax deficiency.⁵⁰ Following decisions in other circuits, the court determined that the taxpayer must pay the interest before the Tax Court has jurisdiction to decide the dispute.⁵¹

B. Litigation Fees

In re Rasbury⁵² was a case of first impression. After Chapter 11 debtors successfully defeated a claim for withholding taxes, they requested attorney fees pursuant to 26 U.S.C. Sec. 7430.⁵³ The Eleventh Circuit, faced with the question for the first time,⁵⁴ held that abuse of discretion was the standard of review for the denial of attorney fees.⁵⁵ The court found unpersuasive the debtors' argument that a different rule should apply because the district court reviewed the bankruptcy court's determination de novo.⁵⁶

C. Tax Liens

Another case arising in a bankruptcy context, In re Haas,⁵⁷ considered the priority of a federal tax lien filed after a mortgagee's erroneous release of mortgage, but before it was reinstated.⁵⁸ The bankruptcy court and the district court, relying on Alabama law, held that the reinstated mortgage had priority.⁵⁹ The Eleventh Circuit reversed.⁶⁰ After determining that a judgment creditor without notice of an erroneously released lien would have priority under Alabama law,⁶¹ the Eleventh Circuit adopted the reasoning of the Seventh Circuit in...