Our tax laws seem to evolve (devolve?) over time. This evolution seems to follow a pretty predictable pattern. I will use Action on Decision 2005-001, which is an interesting decision in and of itself, to describe this process.
In this AOD the IRS announces that it will not follow the Ninth Circuit Court of Appeal decision in Estate of Paul Mitchell v. Commissioner. The Mitchell case is yet another stock valuation case. In this case the taxpayer estate reported a stock valuation of $28.5 million and the IRS issued a notice of deficiency based on a $105 million value for estate tax purposes. At trial the IRS valuation expert placed the value at $81 million, $34 million less than the IRS’ original claim. There was evidence that the IRS valuation expert had originally appraised the value at $85 million as a minority interest, but then increased the value to $105 million at the request of the IRS. The tax court set the value at $41 million after considering the evidence.
On appeal the Ninth Circuit rejected the method that the tax court used to reach the $41 million value, noting that the discount factor used was not within the range of figures provided by the evidence (contrary to the express statement made by the tax court). The valuation issue is interesting; however, that is not the issue that the IRS chose to dispute in its AOD.
The IRS AOD contests the Ninth Circuit holding that the burden of proof at trial remains with the IRS when there is evidence that the IRS determination is invalid. For the non-lawyers, the burden of proof is the procedural rule that slants tax cases in favor of the government and often results in taxpayers having no chance of winning tax disputes. In general the government starts out with the burden of proof. The court presumes that that burden is met if the government produces a notice of deficiency (which is simply an entry in the IRS records showing that the taxpayer owes a tax). However, if there is evidence that the IRS deficiency is invalid then the burden remains with the government. In that case the government must prove that there were additional taxes owed, not the taxpayer proving that no additional taxes were owed. This may sound like mere semantics, but it is really important in determining which party will prevail in many cases.
In Mitchell there was evidence that the value used in the notice of deficiency was changed by the valuation expert at the IRS request and the IRS even asserted in court that the stock value was much less than what the value asserted in the notice of deficiency. In its AOD the IRS takes the position that this evidence should be ignored. I do not think I need to address this argument because readers will understand that it is without merit.
The IRS also takes the position that the cases that support shifting the burden of proof are not applicable because they involved cases of unreported income, not stock valuation cases. The IRS position tries to distinguish unreported income and stock valuation; however, both concepts are essentially the same for tax purposes. The reason why stock valuation is important is because, as the IRS asserted in the Mitchell case, low valuations result in additional taxes being owed. Similarly, the reason why unreported income is important is because it results in additional taxes being owed.
Furthermore, the burden shifting process employed at trial is a matter that is in the courts discretion. The court, with guidance by Constitutional principles, has the authority to say when and how the burden of proof shifts. The courts do not answer to the IRS and the IRS does not have the authority to establish our rules of judicial procedure. So the IRS decision seems to be saying to the Ninth Circuit and the Tax Court that if those courts choose to spell out how trials are to be conducted, the IRS is going to: To what? To pout? To sulk? To huff and puff and blow the house down? To nothing?
So why would the IRS issue such an AOD? The short answer is that this is the process by which our tax law evolves (or devolves). This process starts with a pro-taxpayer ruling. The IRS then begins to respond to that ruling by issuing decisions and rulings that downplay or reject the pro-taxpayer ruling. A mountain of paperwork rejecting the pro-taxpayer ruling starts to build up.
Once the mountain is large enough the IRS begins looking for taxpayers who face the same situation, but where the facts are slightly more favorable for the government (i.e., in this case the IRS’ valuation discrepancy will only be a few million dollars off of what was in the notice of deficiency and what was asserted in court). The IRS will also look for taxpayers who do not reside in the circuit that issued the pro-taxpayer ruling (in this case, the Ninth Circuit). More precisely, the IRS will shop for a circuit court that they feel will reject the other circuit courts pro-taxpayer ruling and they will seek out a taxpayer in that circuit.
Once the unsuspecting taxpayer comes along the IRS will spring its trap. The IRS will give the taxpayer no recourse but to litigate his or her case. The IRS will either win or lose. If the IRS wins it will reset its trap, which is now baited with the lower courts pro-government ruling. Eventually an unsuspecting taxpayer will take the bait and the IRS will lose in the lower courts. At that point the IRS will get what it wanted: the ability to contest the pro-taxpayer law in a particular circuit court.
By citing the new mountain of paperwork as precedent the IRS will probably be successful in convincing the circuit court to reject the other circuit court’s pro-taxpayer ruling. If the IRS loses then it faces the decision of whether to appeal the decision to the Supreme Court. Whether the IRS pursues the Supreme Court option will depend on the language used by the circuit court in its judicial opinion. If it is favorable then the IRS might go for it; if not, then the IRS will probably reset its trap and wait for another unsuspecting taxpayer in another circuit.
Over time this process results in our tax laws being slanted against taxpayers and in favor of the government. The IRS sets its trap, it bides its time, and it slowly chips away at pro-taxpayer rulings. Eventually the law gains such an anti-taxpayer bias that either the courts or the Congress step in to reset the law to more of a middle position and the process begins anew.
This process plays out year after year, case after case, and IRS decision after IRS decision. Is this is the best way to establish our tax law? Can we not come up with a system that is fairer to taxpayers? Can we not come up with a system that is less wasteful of our limited resources? Somehow it just seems like we are missing the big picture here.