Monday, August 23, 2004
Monday, August 23, 2004
David Cay Johnston has a fascinating article in the New York Times about 2 former IRS attorneys who have been disbarred by their respective state jurisdictions (Oregon and Arkansas) following the 9th Circuit's ruling in Dixon v. Commissioner, 316 F3d 1041 (9th Cir. 2003), that they defrauded the Tax Court by making a corrupt deal with a few tax shelter investors in exchange for their testimony, which was to be used against other tax shelter investors. The case sparked a spirited discussion on the TaxProf E-mail Discussion Group, and Leandra Lederman (George Mason) has given me permission to share her thoughts with the broader tax community:
The case involved more than just bargained-for testimony; it involved what the Ninth Circuit found amounted to a fraud on the Tax Court by the two IRS attorneys discussed in the Johnston article, McWade and Sims. The Ninth Circuit case is Dixon v. Commissioner, which reversed T.C. Memo. 1999-101. (These are two decisions of many in a group of consolidated cases.) The cases relate to a tax shelter promoted by Henry Kersting in the 1970s and 80s. About 1,300 taxpayers who made Kersting investments and received notices of deficiency agreed to a test case approach whereby they entered "piggyback" agreements, agreeing to be bound by the decision of the court with respect to a representative group of eight taxpayers.
According to the 9th Circuit, the two attorneys, one of which was trying the case and the other of which was a supervising attorney, entered into secret settlement agreements with two of the test case petitioners. The settlement required the two taxpayers to remain test case petitioners until after trial. The IRS attorney litigating the case also apparently convinced one of those taxpayers to proceed pro se and agreed to reduce the deficiency of the other taxpayer (Thompson) by the amount of his attorneys' fees (over $60,000). The taxpayers' testimony apparently mattered in part because one of the issues was whether the taxpayers had a profit motive in making the Kersting investments.
Based on facts found by the Tax Court, the Ninth Circuit found that the IRS attorney litigating the case, McWade, misled the Tax Court by failing to disclose the settlement at various points, e.g., when moving to set aside the piggyback agreement of one of the 2 taxpayers, in order for that taxpayer to be a test case petitioner, and when, at trial, the taxpayer started to testify about the settlement and the IRS attorney shifted the line of questioning. The Tax Court also found that a Counsel Settlement Memorandum the IRS attorneys filed with respect to a third taxpayer contained two false statements. The Tax Court found for the IRS in the test cases and entered judgment against the taxpayers under the piggyback agreements. The IRS attorneys then moved to set aside the judgments relating to the two taxpayers with whom they had settled, so it could honor the settlements. IRS officials who were asked to approve the motions to set aside the judgment first learned of the settlements at that point, informed the Tax Court of the settlements, and asked for an evidentiary hearing to determine whether the settlements had affected the Tax Court trial or opinion.
With respect to the IRS attorneys' conduct and IRS sanctions, the Tax Court stated:Mr. Sanchez [Regional Counsel for the Western Region of the IRS] sent Notices of Proposed Disciplinary Action to Messrs. Sims and McWade. The notices asserted that Messrs. Sims and McWade had violated: (1) Department of the Treasury Minimum Standards of Conduct, section 0.735-30(a)(2) (an employee shall avoid any action which might result in or create the appearance of giving preferential treatment to any person); (2) Department of the Treasury Minimum Standards of Conduct, section 0.735-30(a)(6) (an employee shall avoid any action that might adversely affect the confidence of the public in the integrity of the Government); and (3) Internal Revenue Service Rule of Conduct 214.5 (an employee will not intentionally make false or misleading verbal or written statements in matters of official interest). The notices proposed to suspend both Messrs. Sims and McWade for 14 calendar days without pay.Mr. Sanchez' Notices of Proposed Disciplinary Action to Messrs. Sims and McWade listed the following reasons for the proposed disciplinary actions: (1) Negotiating an unauthorized settlement agreement with the Thompsons; (2) basing the Thompson settlement on unaudited and insufficiently documented losses from an unrelated shelter; (3) allowing the Thompsons a settlement that provided them more favorable treatment than other taxpayers; (4) compensating the Thompsons for their attorney's fees; and (5) not informing the Tax Court of the Thompson settlement arrangements.Dixon v. Commissioner, T.C. Memo. 1999-101. With respect to sanctions, the 9th Cir. stated:McWade and Sims were both suspended for two weeks without pay and transferred out of the Honolulu division. Sims accepted this censure and was transferred to the San Francisco Regional Counsel Office, where he was assigned nonsupervisory duties. McWade retired from the IRS, choosing not to accept the terms of the proposed disciplinary action but keeping the $1,000 bonus earlier paid him for his performance in the original Tax Court proceedings. We note that counsel for the Hongsermeier test case petitioners recently filed a grievance against McWade and Sims with the attorneys' respective Bars.Dixon v. Commissioner, 316 F.3d 1041, 1047 n.10 (9th Cir. 2003).
In terms of the outcome of the case, the Tax Court denied the IRS' request for an evidentiary hearing and enforced the terms of the secret settlements. The other test case petitioners appealed, arguing that the trial of the test cases had been tainted by the secret settlement agreements. The 9th Circuit remanded and ordered the Tax Court to conduct a hearing. The Tax Court found that the IRS attorneys' misconduct did not constitute a structural defect in the trial and that it constituted harmless error rather than reversible error. The Tax Court also held that the taxpayers' claims of fraud on the court did not warrant renunciation of its deficiency determinations. It therefore reinstated most of its original decision. On appeal, the Ninth Circuit reversed, finding that the two IRS attorneys perpetrated a fraud on the taxpayers and the Tax Court. It chose to order the Tax Court to enter judgment in favor of the taxpayers on terms equivalent to those of the settlement agreement with Thompson.