Hongsermeier v. Comm'r Of Internal Revenue

Citation621 F.3d 890
Decision Date01 September 2010
Docket NumberNos. 07-72828, 07-73718, 07-73719, 07-73818, 07-73822, 07-73823, 07-73825.,s. 07-72828, 07-73718, 07-73719, 07-73818, 07-73822, 07-73823, 07-73825.
PartiesRichard HONGSERMEIER; Fiorella Hongsermeier, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Richard B. Rogers; Donna G. Rogers, Petitioners-Appellants, v. Commissioner of Internal Revenue, Respondent-Appellee. John L. Huber; Terry E. Huber, Petitioners, v. Commissioner of Internal Revenue, Respondent. Stanley C. Titcomb; Sharon A. Titcomb, Petitioners-Appellants, v. Commissioner of Internal Revenue, Respondent-Appellee. Norman W. Adair; Barbara L. Adair, Petitioners-Appellants, v. Commissioner of Internal Revenue, Respondent-Appellee. Gloria K. Owens; Terry D. Owens, Petitioners, v. Commissioner of Internal Revenue, Respondent. Hoyt W. Young; Barbara D. Young, Petitioners-Appellants, v. Commissioner of Internal Revenue, Respondent-Appellee.
CourtU.S. Court of Appeals — Ninth Circuit

OPINION TEXT STARTS HERE

Michael Louis Minns, Houston, TX, for petitioners Richard and Fiorella Hongsermeier.

Joe Alfred Izen, Jr., Bellaire, TX, for petitioners Norman W. and Barbara L. Adair, Terry D. and Gloria K. Owens, and Hoyt W. and Barbara D. Young.

Robert Patrick Sticht, Los Angeles, CA, for petitioners Richard B. and Donna G. Rogers, John L. and Terry E. Huber, and Stanley C. and Sharon A. Titcomb.

Nathan J. Hochman, Richard Farber, and John A. Dudeck, Jr. (argued), U.S. Department of Justice, Washington, D.C., for the respondent.

Appeal from a Decision of the Tax Court. Tax Ct. Nos. 29643-86, 17993-95, 20119-84, 17992-95, 17642-83, 38965-84, 35608-86, 479-89, 8070-90, 40159-84, 4201-84, 22783-85, 30010-85.

Before: FERDINAND F. FERNANDEZ, ANDREW J. KLEINFELD and RICHARD R. CLIFTON, Circuit Judges.

OPINION

CLIFTON, Circuit Judge:

Petitioners are representatives of a group of taxpayers who have previously been before our court. The taxpayers participated in a tax shelter that was challenged by the government and became the subject of litigation before the Tax Court. Misconduct by government attorneys tainted that litigation. Specifically, a case was tried before the Tax Court involving “test case” taxpayers selected by the larger group of taxpayers and by the government. It was discovered after the Tax Court announced its decision from the test case that government attorneys had previously reached a settlement with one taxpayer but withheld that information from the court and from the other taxpayers so that evidence advantageous to the government could be elicited from the taxpayer during the Tax Court trial. This Court held in Dixon v. CIR, 316 F.3d 1041, 1047-48 (9th Cir.2003), that the misconduct constituted fraud on the court, and we remanded the cases to the Tax Court for entry of judgment on terms equivalent to those provided to the taxpayer who was party to the secret settlement. We left it to that court to determine what the precise terms should be. The Tax Court rendered its decision, Dixon v. CIR, 91 T.C.M. (CCH) 1086, 2006 WL 1157520, and it was again appealed by the taxpayers. That is the appeal now before us. We affirm the Tax Court's determination of petitioners' remaining federal income tax deficiencies and liability for underpayment of interest.

I. Background A. Prior Factual and Procedural History 1

During the 1970s and 1980s, a group of individual taxpayers participated in an investment program and tax shelter designed and administered by Honolulu businessman Henry Kersting (“Kersting”). The investments, which came to bear Kersting's name, consisted of a somewhat complicated program in which participants purchased stock with loans from Kersting-controlled entities financed by two layers of promissory notes. 2 Kersting marketed the product as a legitimate investment which would enable participants to claim interest deductions on their individual tax returns. When Kersting participants claimed those deductions, 3 the IRS issued notices of deficiency, disallowing all interest deductions taken, and reasoning that the underlying transactions were shams, the interest was not “paid or properly accrued,” and the notes did not constitute a bona fide indebtedness.

In a Tax Court action brought by Kersting on their behalf, program participants sought a redetermination of the deficiencies. Recognizing that the sheer number of affected taxpayers (approximately 1,800) made it impractical to try each case individually, the parties agreed to employ a “test case” approach to determine liability. To facilitate this process, the bulk of affected taxpayers signed stipulations (“piggyback agreements”) agreeing to be bound by the decision of a test case trial involving representative taxpayers. The agreed-upon process provided that two representatives would be chosen by the taxpayers' attorneys and five by IRS attorneys. Approximately 1,300 taxpayers, some 500 already having settled, signed on to the piggyback agreements.

The test cases proceeded to a consolidated one-month trial before the Tax Court sitting in Honolulu. The Tax Court ultimately concluded that the taxpayers were liable for all assessed deficiencies and would be required to pay additional negligence and tax-motivated transaction penalties. Crucial to this determination was the testimony of John R. Thompson (“Thompson”), the only taxpayer who testified that he believed the instruments creating the claimed interest would not be enforced.

As it turns out, that which the Tax Court and other participants believed to be a legitimate, representative proceeding, binding on the test case petitioners and all those waiting in the wings, was anything but. Some time prior to the test case trial, Kenneth W. McWade (“McWade”), the IRS attorney trying the case, and William A. Sims (“Sims”), the IRS attorney with supervisory authority over it, had entered into secret settlement agreements with Thompson and another test case petitioner, John R. Cravens (“Cravens”). Cravens was one of the taxpayer-selected test case representatives, chosen by taxpayer counsel because his payment of capital gains taxes upon exiting the Kersting investment program made him a particularly good representative.

A condition of their settlements required Thompson and Cravens to remain test case petitioners. McWade also convinced Cravens, who mistakenly believed his liability was finalized by the settlement, to proceed pro se. With respect to Thompson, 4 McWade agreed to have Thompson's tax deficiencies reduced in proportion to his attorney's fees, which exceeded $60,000. At no point did McWade or Sims reveal to the Tax Court or to any other taxpayer representative that two of the test case petitioners' cases had been settled, much less reveal the conditions imposed on them.

The deception continued with a cover-up, which was carefully designed to prevent the Tax Court and other taxpayers from learning of the secret settlement agreements. At Kersting's deposition, which McWade attended, Kersting's lawyer objected to the presence of Thompson's attorney because of rumors that Thompson was attempting to settle. Knowing that Thompson had, in fact, already settled, McWade remained silent. McWade then misled the Tax Court by failing to disclose the settlement when he moved to set aside the Thompson piggy-back agreement, a pre-trial motion necessary to ensure Thompson's status as a test case petitioner. Deceptive silence matured into overt misconduct when, during the course of the test case trial, it became apparent that Thompson was going to testify about his settlement. McWade quickly shifted his questions to unrelated matters. 5

McWade and Sims also secured an agreement with taxpayer Dennis Alexander 6 (“Alexander”) whereby the IRS would reduce Alexander's tax deficiencies in exchange for testimony and trial preparation assistance. In accordance with this agreement, the IRS paid for Alexander's expenses in Hawaii for the length of the trial. McWade then filed a memorandum regarding the basis for the settlement of Alexander's tax liabilities which the Tax Court later found to be false. During the test case trial, McWade also sat silently through testimony by Alexander that he knew to be false. 7

The Tax Court's test case determination left the remaining taxpayers-those who had signed on to the piggyback agreements-subject to judgment on the same adverse terms. This is when the McWade-Sims house of cards began to collapse. Thompson and Cravens, who had sat silent while the Tax Court entered judgment against them, pressured McWade and Sims to live up to the terms of their secret settlement agreements. It was now clear that the IRS would have to move to set aside the Thompson and Cravens judgments; McWade and Sims were forced to reveal the secret settlements necessitating the Tax Court's entry of “revised” judgments in favor of Thompson and Cravens.

After being asked to approve the set aside motions, senior IRS officials determined that McWade and Sims had engaged in active misconduct and informed the Tax Court of the secret settlements, 8 asking for an evidentiary hearing to determine the extent of the damage. The Tax Court refused to hold an evidentiary hearing and proceeded to enforce the terms of the Thompson and Cravens settlements. The taxpayers appealed the refusal to this Court, which remanded with instructions to hold an evidentiary hearing. DuFresne v. CIR, 26 F.3d 105 (9th Cir.1994).

On remand, the Tax Court conducted the mandated evidentiary hearing. Incredibly, McWade's pattern of deception continued with his persistent denial that the Thompson settlement was a vehicle for paying Thompson's attorneys' fees and his testimony that the Thompson settlement was attributable to a separate transaction. After making extensive findings concerning the government's misconduct, the Tax Court surprisingly concluded that what had occurred was harmless error. While the bulk of the decision from the original test case proceeding was reinstated, the Tax Court did relieve...

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