Lesson From The Tax Court: The Perils of Stipulations

Tax Court procedure marches to a different beat from other federal courts.  For example, when a taxpayer files a Petition contesting a Notice of Deficiency (NOD) the taxpayer cannot voluntarily dismiss the case the way litigants can do in federal district court.  See Lesson From The Tax Court: The Hotel California Rule, TaxProf Blog (Nov. 12, 2018).  And it is not just pro se litigants who get tripped up, which is to be expected despite the heroic guidance given by the Tax Court on its webpage.  Experienced practitioners sometimes goof this up as well.

The recent case of Donald Bailey and Sandra M. Bailey v. Commissioner, T.C. Memo. 2021-55 (May 10, 2021) (Judge Pugh), teaches an important lesson about the crucial role of stipulations in the Tax Court’s decisional process: litigants must have a firm grasp of their case very early, or risk stipulating themselves into defeat as the taxpayers did in this case.  Details below the fold.

The Role of Stipulations In Tax Court Discovery Process
The U.S. judicial system is renowned (and sometimes vilified) for its very liberal approach to pre-trial discovery.  See generally, Stephen N. Subrin, Discovery In Global Perspective: Are We Nuts?, 52 DePaul L. Rev. 299 (2002).  The system gives parties the right to “obtain discovery regarding any nonprivileged matter that is relevant to any party's claim or defense and proportional to the needs of the case...”  Federal Rule of Civil Procedure (“FRCP”) 26(b)(1).  Basically, that means one party can force opposing parties to disclose information under threat of court-imposed sanctions.  FRCP 37.  Failure to cooperate in discovery subjects a party to a wide range of sanctions up to and including “rendering a default judgment against the disobedient party.”  FRCP 37(b)(2)(A)(vi).  This liberal approach has received both praise and criticism, and constant calls for reform and re-thinking.  For a particularly intriguing idea, see Diego A. Zambrano, Discovery as Regulation, 119 Mich. L. Rev. 71 (2020).

The Tax Court takes a different approach.  Here, as in many other areas, the Tax Court is not like the federal district courts (neither is the Court of Federal Claims, but that’s beyond today’s topic).  The Tax Court’s approach to discovery differs in two important respects.  Let’s take a look.

1. Discovery Is Informal

First, Tax Court discovery relies heavily on informal information exchange.  Tax Court Rule 70 permits parties to use the usual discovery tools, but warns that “the Court expects the parties to attempt to attain the objectives of discovery through informal consultation or communication before utilizing the discovery procedures provided in these Rules.”  This informality is in one sense even more liberal than federal district courts because it permits a potentially wider scope of information exchange.

The Tax Court emphasized this informal information sharing regime in the classic case of Branerton Corp. v. Commissioner, 61 T.C. 691 (1974), a case that arose shortly after the Tax Court had issued the new Rule 70.  There, an enthusiastic young attorney, one Steven L. Packard (still in practice!) was engaged to represent a closely held corporation and its members.  Mr. Packard related to me that this case was one of his first cases after he opened his own practice.  Noticing that the Tax Court had seemingly just adopted the FRCP rules for discovery, effective January 1 of 1974, the zealous attorney followed the standard discovery practice of sending a ream of interrogatories to the government.  He sent them out January 2nd.  The IRS responded by asking for a protective order because Mr. Packard had not attempted informal exchange of information first.

The Tax Court, in an opinion by Judge Dawson—yes, the judge whose name now graces the Tax Court’s case management system—found that this premature use of discovery tools  “sharply conflicts with the intent and purpose of Rule 70(a)(1) and constitutes an abuse of the Court's procedures.” 61 T.C. 691 at 692.  Judge Dawson issued a protective order providing that the IRS need not answer the interrogatories and directing the parties “to have informal conferences during the next 90 days for the purpose of making good faith efforts to exchange facts, documents, and other information.”  For more on Branerton and Mr. Packard, go read the Codas at the end of this post.

The Tax Court’s Branerton decision has been operationalized in the “Branerton Letter.” See IRM 35.4.3.2 (08-11-2004) (Informal Requests).  The IRM instructs Chief Counsel to send not one, but two Branerton letters to the taxpayer: the first is a request for a meeting and information.  If the first letter produces no cooperation the second one is a shot across the bow, warning of more formal discovery process if the taxpayer does not participate informally.  Id.  Nothing prevents taxpayers from sending their own Branerton letters to the IRS.  Over time, especially in complex cases, the amount of information sought this way may make a Branerton letter look a lot like a request for production of documents.

But it is still informal.  In federal district court if a party does not adequately respond to a document request, the other party can go to directly to court to enforce.  In Tax Court, if a party does not give sufficient response to a Branerton letter, the next step is to start the formal discovery process.  That creates an additional step and additional time.  But so long as the informal process works, it's a lot cheaper and quicker than the formal process used in federal district courts.

The importance of the informal information exchange is also reflected in the Tax Court’s unique approach to deposition discovery.  Depositions are notoriously expensive and subject to abuse.  To deal with that in federal district courts, FRCP 30 permits each party up to 10 non-consensual depositions without leave of court.  But still it's up to each party.  That is, if a party wants to take a deposition, they can compel the other party, or any third party, to be deposed.  FRCP 45 permits any party to obtain a summons to any person to compel attendance for such deposition.  Again, this is automatic and does not involve asking the court for permission.  FRCP 45(a)(3).

Tax Court is different.  Tax Court rules put no limit on the number of depositions but for each deposition the Court requires the parties to either file a stipulated agreement for the deposition or, if there is no agreement, file a motion asking the Court to rule on whether to order a deposition.  Getting the Tax Court to approve depositions is an uphill battle.  Rule 74(c)(1)(B) explicitly provides that court-ordered depositions “may be used only where...such testimony, documents, electronically stored information, or things practicably cannot be obtained through informal consultation or communication.”  You don’t find that language in the Federal Rules of Civil Procedure!

2. Stipulations Are Mandatory

The reason for the emphasis on informal information exchange—and the discouragement of depositions—is a second big difference in pre-trial procedure as between Tax Court and federal district courts.  The parties are expected to use their information exchange to agree to facts, issues, and even applicable law.  Tax Court Rule 91(a) says that parties “are required to stipulate, to the fullest extent to which complete or qualified agreement can or fairly should be reached, all matters not privileged which are relevant to the pending case, regardless of whether such matters involve fact or opinion or the application of law to fact.”  (Emphasis supplied). Wow.  Again, you also won’t find that language in the FRCP.

In federal court the purpose of discovery is to prepare for trial.  Certainly, discovery helps parties settle cases.  For example, depositions are generally reserved until the end of the discovery process and often serve as a means of testing out and refining theories of the case, as well as road-testing potential witnesses.  Often cases will settle after depositions because parties get a much more accurate read on the various hazards of trial.

In Tax Court, however, the purpose of discovery is not so much to settle the case—although that is often a happy effect.  The purpose of the informal information exchange is to create a series of stipulations that will vastly reduce the need for trial time and save the Tax Court a ton of work it would otherwise have to do: sifting through testimony and documents and ruling on witness credibility.  As Judge Dawson wrote in Branerton: “For many years the bedrock of Tax Court practice has been the stipulation process, now embodied in Rule 91. Essential to that process is the voluntary exchange of necessary facts, documents, and other data between the parties as an aid to the more expeditious trial of cases as well as for settlement purposes.” 61 T.C. at 692 (emphasis supplied).

Just as stipulations were the bedrock of Tax Court procedure in 1974, they still are.  Arriving at a set of stipulated issues and facts is still the essential purpose of the informal information sharing regime.  As one leading treatise puts it: “the informal discovery practices of the Tax Court remain a central feature that distinguishes litigation in the Tax Court from other courts.” Sean M. Atkins, Kandyce Korotky & David Sams, Chapter 7 “Litigating A Case In The Tax Court,” in Effectively Representing Your Client Before the IRS (8th ed.), Christine Speidel and Patrick Thomas (eds), at p. 7-65, note 331.

Tax Court Rule 91(a)(1) not only requires parties to stipulate, it also makes it difficult for a party to refuse to stipulate.  For example, if a party wants to object on the basis of materiality or relevance, the party must still stipulate, and then record those kind of objections as part of the stipulation.  That way, the Tax Court can rule on them if it becomes necessary.  It’s rarely necessary.  See e.g. Sundstrand Corp. v. Commissioner, 89 T.C. 810 (1987) (sustaining taxpayer’s objection to stipulations related solely to years not before the Court).

Once a stipulation is made, it is binding.  Tax Court Rule 91(e) says that a stipulated fact is a “conclusive admission” by the parties.  See e.g. Ball v. Commissioner, T.C. Memo. 1984-218 (taxpayer deemed to stipulated gross receipt figures).  A party can, however, be relieved of a stipulation if the “interests of justice” so require.  See Corson v. Commissioner, 114 T.C. 354, 363, note 2 (2000) (“All concessions, including stipulated settlement agreements, are subject to the Court's discretionary review and may be rejected in the interests of justice.”)

Let’s see what that means for the taxpayer in today’s case.

Facts
Mr. Bailey was a CPA for almost 30 years before losing his license.  He then became an unenrolled tax return preparer and was in that business during the tax years at issue: 2008-2012.  It was not a high-volume business.  He apparently prepared about 100 returns each year.

Mr. Bailey was also a shareholder in a small closely-held corporation called Interradiology, Inc., which properly elected to be taxed under Subchapter S such that the income or losses of the corporation would pass through, and be taxed to, its shareholders.  In 2008 Mr. Bailey owned 10% of the shares and for the other years he owned 20% of the shares.  He prepared Interradiology’s tax returns for all the years at issue.

On the married filing jointly returns for the years at issue Mr. Bailey reported income from wages, Schedule C business income, capital gains, taxable Social Security benefits, and distribution of profits from Interradiology.  On audit, the IRS determined he had underreported his distributions from Interradiology.  By a lot.

After filing the Tax Court petition for himself and Ms. Bailey, Mr. Bailey engaged in the informal information sharing.  The couple was asked to stipulate to various facts and issues.  At the same time, they submitted at least four sets of amended returns, some signed, some not, and provided the same to the Chief Counsel attorney.

Eventually, Mr. Bailey and the IRS agreed on what issues would be settled and what issues needed to be litigated.  In November 2019 they filed these stipulations of settled issues with the Court.  Paragraph 6 of these stipulations said that “[t]he following table shows the amount of income from Interradiology, Inc., as reported by Petitioners on Schedule E, the correct amount that should have been reported, and the correct adjustments to Petitioners’ Schedule E income for the tax years at issue.”  Here’s the table that Mr. Bailey stipulated to, using rounded numbers:

Year	As Reported	As Corrected	Resulting Adjustment
2008	$0	$25,000	$25,000
2009	($83,000)	$64,000	$147,000
2010	($68,000)	$67,000	$135,000
2011	$0	$77,000	$77,000
2012	($33,000)	$76,000	$109,000

At trial, on December 16, 2019, Mr. Bailey and IRS also submitted stipulations of facts.  Paragraph 88 of the stipulation of facts was a copy of paragraph 6 of the previously filed stipulation of issues.

During trial, however, Mr. Bailey objected to the stipulations he had agreed to in paragraph 6 of the stipulation of settled issues, and repeated in paragraph 88 of the stipulations of fact.  He argued that the numbers were wrong and the correct numbers were those contained in one or more of the four amended returns he had previously given to Chief Counsel during the pre-trial process.

That objection did not go well.

Lesson: Think Before You Stipulate
Judge Pugh pointed out repeatedly the importance of stipulations.  She noted that in addition to Tax Court Rule 91, the stipulation documents themselves recite that the stipulations were to be “accepted as facts.”  She noted a party could avoid the binding effect of a stipulation only when justice so required, such as if the party showed the stipulation was obtained by fraud or deceit or mutual mistake, or gave some other really, really, solid reason for relief from the effect of stipulations.

Here, Mr. Bailey gave no good reasons for relief.  He had formally agreed to the stipulations by signing and submitting them to the Court.  His argument was only that the numbers were wrong because...he said so!  He had "exchanged" information during discovery by sending his amended returns.  And he was now willing to so testify to the truth of those documents.  But he gave no evidence, offered no proof, other than the mere amended return forms.  Judge Pugh patiently re-explained (she had apparently told him this at trial as well), that “the amended returns were merely statements of petitioners’ position and not evidence of the contents.”  Op. at 14.

Bottom line: once the Baileys stipulated to the omitted income, they were bound by that stipulation.  They could not later change their mind.  They needed to have fully thought it through before signing and submitting.

Coda 1:  The rest of the story of Branerton is interesting.  The oft-cited opinion was just the first of three opinions issued in the case.  About a year after first decision, Mr. Packard asked the Tax Court to order the IRS to turn over various Revenue Agent reports (RARs), district conferee reports, appellate conferee reports, and two internal conference memoranda,  Judge Dawson granted the motion for the RARs but denied the rest on what we now call the deliberative process privilege.  That opinion is actually much more in-depth than the oft-cited opinion because Judge Dawson also considers (and rejects) the government's claims of work-product privilege and attorney-client privilege.  See Branerton Corp. v. Commissioner, 64 T.C. 191 (1975).  Eventually, the parties narrowed the issue for trial with the biggest being a cancellation of debt issue.  You can find the outcome in Branerton Corp. v. Commissioner, T.C. Memo. 1976-365 (sorry but I cannot find a free link to it).

Coda 2:  I had a delightful conversation with Mr. Packard.  He continues to practice law as he celebrates his 82nd year on the planet.  We should all be so lucky.  He still represents taxpayers before the Tax Court, having recently filed a Petition for a client.  He uses DAWSON, but does not like it (sorry, Judge Buch!).  He told me that he often will send out what he calls a “reverse Branerton” letter when litigating.  You can find a good explanation of concept in the Effectively Representing treatise, supra.  Finally, I am pretty sure he agrees with today's lesson: practitioners need to be wary of the Tax Court pre-trial process and understand how different it is from other federal courts. 

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return to TaxProf Blog each Monday for a new Lesson From The Tax Court.