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Accuracy Penalties IRS Penalties Tax Procedure

Substantial Authority, When the Authority is Not Clear


What if you have a tax question and find a court case that:

(1) has the same facts as your case,

(2) addresses the same tax item as in your case (such as a tax deduction, credit, etc.), and

(3) the court case is decided in the taxpayer’s favor,

but the court case does not address one or more legal issues the IRS may raise in your case? The IRS failed to raise the legal issues in the prior court case.

The outcome is favorable to your position and the facts are the same. Can you rely on the outcome of the case? Can this case be “substantial authority” to avoid penalties if you are wrong?

The recent United States v. Gwendolyn Berry et vir, No. 19-20050 (5th Cir. 2020) case provides an opportunity to consider these questions.

Facts & Procedural History

The Defendants are husband and wife. The wife was convicted of various crimes, including falsifying tax returns. The wife was ordered to pay $2 million in restitution to the government.

The couple had five IRA accounts. Of these accounts, several were in the wife’s name and several were in both spouses names.

The wife agreed to pay over the IRA accounts in her name, but not those in both spouses names.

The government applied for a writ of garnishment for 50% of the funds in the joint IRAs.

The district court granted the writ, which led to this appeal.

Prior Case Law

On appeal, the appeals court cites United States v. Loftis, 607 F.3d 173 (5th Cir. 2010):

The Mandatory Victims Restitution Act makes a restitution order enforceable to the same extent as a tax lien. 18 U.S.C. § 3613(c). Consequently, the district court also correctly held that the government could garnish Todd’s [the defendant’s] one-half interest in any community property solely managed by Lisa, including her retirement savings account. Id. at 179 n.7 (citation omitted).

Thus, the court in Loftis affirmed the restitution order in a case with the same fact pattern as the fact pattern in the present case. The governing laws had not been changed by Congress since the Loftis case was decided.

But the defendant in the present case raised arguments not raised in Loftis. The defendants in the present case argued that the husband’s IRA is Federal property and that the Federal rules preempt the wife’s state law community property rights. They also argued that the an anti-alienation provision for IRAs prevents the wife from gaining access to the husband’s IRAs.

The Orderliness Rule

The appeals court dismissed the defendant’s new arguments. It cited the orderliness rule.

The orderliness rule says that a court may not overturn a controlling precedent absent an intervening change in law, such as by a statutory amendment, or the Supreme Court, or our en banc court.

Accordingly, the appeals court stated:

Under our rule of orderliness, though, an earlier panel decision binds even if that panel’s opinion does not explicitly address arguments presented to the later panel. See Legendre v. Huntington Ingalls, Inc., 885 F.3d 398, 403 (5th Cir. 2018). 

Because the court had previously held that the government could reach the 50% interest in IRAs owned by a spouse to satisfy the other spouse’s tax restitution, it concluded that it was bound by its prior decision.

Stare Decisis

The rule of orderliness is based in the concept of stare decisis. Stare decisis is the concept that a court should stand by its prior decisions.

The courts use this to provide certainty to those who rely on their court decisions. Stare decisis is often cited by a trial court that applies an appellate court case as precedent. The trial court in essence adopts the reasoning of the higher appellate court. This is vertical stare decisis.

Stare decisis also applies to one court following its own guidance. This is referred to as horizontal stare decisis.

The rule of orderliness is narrower than stare decisis, in that it addresses a decision by the same appeals court.

Applying the Stare Decisis & the Orderliness Rule

This brings us back to the question at the top of this post. Assume that you have an appellate level court case where a similarly situated taxpayer prevailed. The prior appellate court case is in the same judicial circuit that your case would be heard in. The law has not been changed by Congress since the court case was decided.

The IRS raises new issues in your case. Maybe this is done on audit, in appeals, or with the IRS attorney working the case. These new issues are ones that the IRS could have raised in the prior court case, but the IRS failed to raise the issues in the prior case.

To take it a step further, assume that you believe the IRS is correct in its new arguments in your case. Assume that the new arguments suggest that you should lose your case.

Can you rely on the prior court case in filing a tax return or on audit or appeal before the IRS?

The prior appellate case is binding precedence for your case. Thus, the IRS should apply the case based on stare decisis. At trial, the trial court should apply the holding of the prior appellate court case (this is vertical stare decisis). If the trial court reaches a different decision, on appeal, stare decisis should also dictate that the court follow the prior case.

The appeals court would then either cite the orderliness rule or hear the appeal en banc and reverse its prior opinion. En banc means all of the appeals court judges would have to hear the case. Presumably this is what should happen in your case. But it has not yet happened.

Substantial Authority

Tax attorneys will often look to the definition of “substantial authority” for the Sec. 6662 penalty to determine whether a court case can be relied upon. Section 6662 sets out the accuracy-related penalty that would typically apply if there was an understatement of tax.

Substantial authority is a higher standard than the “reasonable basis” standard needed to avoid tax preparer penalties, but lower than the “more likely than not” standard that applies to tax shelters. These are the standards tax attorneys consider in providing tax advice.

Tax advisors can penalties if they can show that there was “substantial authority” for the tax treatment of an item shown on their tax return. The regulations for the Section 6662 penalty clarify when there is substantial authority.

Generally, there is substantial authority for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment.

It is often said that an authority that merely states a conclusion ordinarily is less persuasive than one that reaches its conclusion by cogently relating the applicable law to pertinent facts. It is also said that the weight accorded an authority depends on its relevance and persuasiveness.

But in our example, there is no guidance other than our favorable appellate decision. The favorable appellate decision is did not consider the IRS’s new arguments, but and we are assuming that the new arguments would lead the court to overturn its prior appellate decision.

But the court has not yet done so. The appellate decision is the most persuasive guidance on point at the time. Is this substantial authority and can it be used to avoid penalties?

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