2121 Arlington Heights Corp. v. I.R.S.

Citation109 F.3d 1221
Decision Date31 March 1997
Docket NumberNo. 96-2888,96-2888
Parties-1793, 97-1 USTC P 50,351 2121 ARLINGTON HEIGHTS CORP., Plaintiff-Appellant, v. INTERNAL REVENUE SERVICE, Robert E. Rubin, Secretary of the Treasury, Margaret M. Richardson, Commissioner of Internal Revenue, and Victoria Fedele, Internal Revenue Agent, Defendants-Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (7th Circuit)

Robert P. Sheridan (argued), Chicago, IL, for Plaintiff-Appellant.

Charles E. Brookhart, Annette M. Wietecha, Pamela C. Berry (argued), Department of Justice, Tax Division, Appellate Section, Jennifer M. Blunt, Department of Justice, Tax Division, Washington, DC, Thomas P. Walsh, Office of the United States Attorney, Civil Division, Chicago, IL, for I.R.S.

Charles E. Brookhart, Pamela C. Berry, Department of Justice, Tax Division, Appellate Section, Thomas P. Walsh, Office of the United States Attorney, Civil Division, Chicago, IL, for Robert E. Rubin, Margaret M. Richardson, Victoria Fedele.

Before POSNER, Chief Judge, and ROVNER and EVANS, Circuit Judges.

TERENCE T. EVANS, Circuit Judge.

The Wellington, a popular restaurant in suburban Chicago owned by the 2121 Arlington Heights Corporation, currently finds itself under the microscope of an Internal Revenue Service audit of its 1992 and 1993 tax returns. During the course of the audit the IRS issued an administrative summons to the local phone company, Ameritech, requesting a list of the restaurant's outgoing phone calls from May 1994 through October 1995. The Wellington asked the district court to quash the summons. The government countered with a motion for enforcement. The district court thought the government had the better argument and enforced the summons. The Wellington, unhappy with this decision, appeals.

In 1995 the IRS decided to take a look at the Wellington's tax returns. Based on its projections, the IRS estimated that the Wellington underreported its income by $500,000 to $1.5 million in 1992 and 1993. As a result, the IRS dispatched revenue agent Victoria Fedele to the scene. Agent Fedele quickly learned that the audit would not be a walk in the park. The Wellington did not bother to retain its cash register tapes or guest checks, but instead merely summarized its cash intake on daily reports. The Wellington's attorney also let Agent Fedele know that any accounts receivable records retained by the restaurant would not be turned over without a fight.

Agent Fedele concluded that because the Wellington had not retained sufficient source records to substantiate the figures listed on its tax return, she would need to reconstruct the restaurant's income. She first attempted to accomplish that feat by tallying up the quantity of meat purchased during the audit period, converting that amount into a projected number of entrees, and in turn, calculating the income those entrees would have brought in for the Wellington. Using that approach, Agent Fedele figured the Wellington had hidden $1.6 million from Uncle Sam in 1992 alone. Although the Wellington apparently has a beef with the formula Agent Fedele used to convert meat purchases into an estimated number of entrees, that issue is not before us. 1 Rather, this case deals only with Agent Fedele's second attempt to reconstruct the restaurant's income.

According to Agent Fedele, the Wellington's accountant let slip that a substantial share of the restaurant's business came from banquets set up by repeat customers. As a result, she decided to reconstruct income by tracking down the Wellington's cash-paying banquet customers. The restaurant disputed the characterization of their banquet business as "substantial." Instead, the Wellington preferred the term "moderate." As evidence of the "moderate" nature of that aspect of its business, the Wellington gave Agent Fedele a list purportedly naming all 21 of the restaurant's repeat banquet customers. Because the restaurant did not retain any banquet contracts, appointment books, or cash receipts, however, Agent Fedele thought better of taking the Wellington's word for its banquet clientele. Instead, she decided to flush out that group of customers by examining the restaurant's outgoing phone calls.

Agent Fedele's plan ran into a little snag. Because Ameritech only retains "mudd sheets"--lists of all outgoing calls made on a given phone line--for 18 months, the Wellington's phone records from 1992 and 1993 had already been destroyed. Rather than giving up on her quest to track down the Wellington's banquet income, Agent Fedele figured that the Wellington's mudd sheets, however recent, might shed some light on repeat customers who had held banquets at the restaurant during the audit period. Agent Fedele reasoned that calling repeat customers might help her locate cash payments, if any, which didn't find their way into the Wellington's books. As a result, on November 2, 1995, Agent Fedele requested that an administrative summons be issued under I.R.C. § 7602 ordering Ameritech to provide a list of the Wellington's outgoing phone calls from May 1994 through October 1995. Catherine Vaughn, Agent Fedele's group manager, signed off on the request a week later.

The Wellington filed a petition to quash the summons under I.R.C. § 7609(b)(2). First, the Wellington alleged the summons would impermissibly allow the IRS to stick its nose into the private lives of the restaurant's employees. That is, the restaurant explained, because its employees-over 100 of them--were not allowed to leave the premises during their shifts, they were granted the privilege of using the restaurant's phone to make personal calls. Second, despite its claim that it made "no calls on the telephones in question, but rather all such [calls] were made by the employees," the Wellington argued that calling the numbers listed on the mudd sheets would ruin its business. It alleged that diners, fearing they would become entangled in an IRS investigation, would shy away from the restaurant. Third, the Wellington alleged that the information targeted by the summons was irrelevant. The restaurant stressed that most banquets would be arranged through incoming--not outgoing--calls and that the mudd sheets targeted by the summons did not cover the tax years under audit. Finally, the Wellington claimed Agent Fedele requested the summons as a sinister attempt to ruin the restaurant's business and pressure it into settling its alleged tax liability. In support, the Wellington pointed to the affidavit of its accountant, which stated I requested a meeting with [Agent Fedele's] group manager, to discuss the pending audit and how it might be resolved. Agent Fedele responded that there would be no such meeting, and that the only way to resolve the matter was by the payment of additional tax as assessed by her, and that if the tax was not paid she would ruin their business by contacting their suppliers, customers and by standing at the very door of the premises as need be. "I can make their life miserable," she told me. At another point, she told me that if my client didn't sign a document to extend the statute of limitations, she "wouldn't be talking to anybody."

As is customary when a taxpayer asks the district court to put the kibosh on an IRS summons, the government countered with an application for enforcement under I.R.C. § 7604. On July 29, 1996, after denying the Wellington's request for an evidentiary hearing, the district court sided with the government. The court first noted because the restaurant had not saved sufficient source records, the IRS was entitled to reconstruct its income using any reasonable means. Next, the court found that the mudd sheets may be relevant to the audit and dismissed the Wellington's allegations as "self-serving, inconsistent and exaggerated." Finally, the court concluded that although Agent Fedele had used "tough language," the Wellington had not shown that the IRS had acted in bad faith.

The Wellington first argues the district court should have quashed, rather than enforced, the summons. While the Wellington's motion to quash the summons and the IRS's application for enforcement were based on different provisions of the tax code, the parties' burdens and the process used to resolve both claims are the same. First, the government must make a prima facie case that the IRS issued the summons in good faith. United States v. Kis, 658 F.2d 526, 536 (7th Cir.1981), cert. denied, 455 U.S. 1018, 102 S.Ct. 1712, 72 L.Ed.2d 135 (1982); United States v. Gertner, 65 F.3d 963, 966 (1st Cir.1995). That isn't much of a hurdle. The government must only show: the investigation underlying the summons has a legitimate purpose; the information sought may be relevant to that purpose; the information is not already in the IRS's hands; and the IRS has followed the statutory steps for issuing a summons. United States v. Powell, 379 U.S. 48, 57-58, 85 S.Ct. 248, 254-55, 13 L.Ed.2d 112 (1964). The government typically makes that showing through the affidavit of the revenue agent conducting the audit. Kis, 658 F.2d at 536. This case is no exception. In her affidavit Agent Fedele declared that the IRS was auditing the Wellington; the mudd sheets might help her reconstruct the Wellington's income by exposing repeat banquet customers and tracing their payments for banquets held in 1992 and 1993; the IRS didn't already have the information; and the IRS complied with the tax code when it issued the summons. That declaration touches all the bases covered by Powell.

Because the government met its burden, the ball falls in the Wellington's court to show that enforcement of the summons would constitute an abuse of process. It can do that either by disproving the existence of one of the Powell factors or pointing to specific facts suggesting that the IRS issued the summons in bad faith. See United States v. Stuart, 489 U.S. 353, 360, 109 S.Ct. 1183, 1188, 103 L.Ed.2d 388 (1989...

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