In re Mitchell
| Decision Date | 10 August 1989 |
| Docket Number | Bankruptcy No. 87-01176,Adv. No. A87-06771. |
| Citation | 109 BR 434 |
| Parties | In re James E. MITCHELL and Diane C. Mitchell, Debtors. James E. MITCHELL and Diane C. Mitchell, Plaintiffs, v. UNITED STATES of America, Defendant. |
| Court | U.S. Bankruptcy Court — Western District of Washington |
Charles S. Kennedy, III, Trial Atty., Office of Special Litigation, U.S. Dept. of Justice, Tax Div., Washington, D.C., for defendant.
Ernest A. Bentley, Sherwood, Bentley & Anderson, Bellingham, Wash., for plaintiffs.
This matter came before the Court for trial on May 1, 1989. Pursuant to stipulation between the parties, as reflected in the Pre-Trial Order, the issues associated with dischargeability of various tax claims have been resolved. The remaining issues before the Court involve a determination of tax liability under Section 505 of the Bankruptcy Code, 11 U.S.C. § 505, and Sections 6701 and 6707 of the Internal Revenue Code, 26 U.S.C. §§ 6701, 6707.
This Court has jurisdiction pursuant to 28 U.S.C. § 157 and 11 U.S.C. § 505. This matter is a core proceeding under 28 U.S.C. § 157(b)(2)(B), (O).
The plaintiff/debtor, Mitchell, commenced this action to avoid penalties assessed against him by the Internal Revenue Service.
Mitchell has a background of tax preparation and of giving financial advice. He began selling tax shelters in 1982. In 1983 or 1984 Mitchell organized his own tax shelter which was a limited partnership known as Cascade Hydro. Mitchell was the general partner. The investors were the limited partners. The purpose of Cascade Hydro was to own, construct and operate two small hydro-electric plants in Whatcom County, Washington, one on Spring Creek and the other on Sygitowicz Creek. The objective was to have Spring Creek in operation in 1984, producing an average of 34 KW per month; and to have Sygitowicz Creek in operation by 1985, producing an average of 150 KW per month.
In December of 1984, Spring Creek was in operation, producing about 10 KW per month. However, it was not connected to public power. Some time in late 1984 or early 1985, Cascade Hydro abandoned Spring Creek and shifted all of its efforts and resources to Sygitowicz Creek. Sygitowicz Creek became operational on December 30, 1986, when it was connected to the public power supply.
In 1985, Cascade Hydro incorporated as a Subchapter S corporation.
Cascade Hydro took deductions and tax credits for 1984, based on Spring Creek, and passed the credits through to thirty two partners. In 1985, Cascade Hydro took deductions and tax credits based on the completion of both plants. As in 1984, the deductions and credits were passed through to the then thirty four shareholders. As to both years, Mitchell, as the principal party involved, reviewed and signed the Cascade Hydro tax returns and the K-1 forms for the limited partners and/or shareholders which showed their purported shares of the deductions and credits.
Cascade Hydro was never registered as a tax shelter.
The defendant/IRS assessed civil penalties against Mitchell under Sections of the Internal Revenue Code pertaining to individuals who aid and abet the understatement of tax liability (26 U.S.C. § 6701), and who fail to furnish information regarding tax shelters (26 U.S.C. § 6707).
Standard of Proof:
Sections 6700, 6701, 6702 and 6703 were enacted in the Tax Equity and Fiscal Responsibility Act of 1982, Pub.L. No. 97-248, § 324(a), 96 Stat. 324, 611-615. These various provisions of the Internal Revenue Code establish civil penalties to be assessed against persons who promote and sell abusive tax shelters (26 U.S.C. § 6700); who aid and abet the understatement of tax liability (26 U.S.C. § 6701); and who file frivolous income tax returns (26 U.S.C. § 6702).
Section 6703 of the Internal Revenue Code (26 U.S.C. § 6703), places the burden of proof upon the United States on the issue of whether or not a person is liable for the penalties involved in sections 6700, 6701 and 6702. However, the parties disagree as to which standard of proof applies. The defendant maintains that the "preponderance" standard is applicable, while Mitchell argues that the Government must meet the "clear and convincing" standard. Cases have been cited in support of both positions.
The United States has cited two cases from district courts in this circuit. These cases involved penalties assessed under § 6700 and § 6702. In Franklet v. United States, 578 F.Supp 1552 (D.N.D. Cal.1984), aff'd, 761 F.2d 529 (9th Cir.1985), the district court held the I.R.S. bore the burden of proving by a preponderance of the evidence all factual matters for imposition of a § 6702 penalty for the filing of a frivolous return. In United States v. H & L Schwartz, Inc., et al., 60 AFTR.2d 87-6031 (D.C.Cal.1987), aff'd sub nom., Bond v. U.S., 872 F.2d 898 (9th Cir.1989), the district court held the "preponderance" standard was the proper standard to apply in § 6700 and § 6702 penalty cases.
The plaintiff/debtor argues that the more stringent "clear and convincing" burden of proof should be applied. In support of his position, the debtor cites Warner v. U.S., 700 F.Supp. 532 (D.S.D.Fla.1988). That case discussed the standard of proof for assessment of penalties under § 6701, the same section applicable in the present case. In Warner, supra, the district court, ruling upon a Motion in Limine, held that § 6701 imposes the most severe civil penalties which may be imposed against a tax preparer. For that reason, the court ruled that the United States was required to carry its burden of proof by clear and convincing evidence.
This Court adopts the reasoning and conclusions of Franklet v. United States, supra, and United States v. H.L. Schwartz, Inc., et al., supra. Both cases held that the "preponderance" standard is the proper standard to apply in § 6700 and § 6702 penalty cases. Since § 6701 is governed by the same provisions of § 6703 as §§ 6700 and 6702, and since district and appellate courts in this circuit have determined that the preponderance standard is applicable to cases under § 6700 and § 6702, then the logical analysis is that the preponderance standard should apply to cases under § 6701.
Knowledge Element of § 6701:
Section 6701 (26 U.S.C. § 6701(a)), provides:
The parties agree that Mitchell aided or assisted in the preparation and/or presentation of the Cascade Hydro returns for the years 1984 and 1985, and that he knew that the returns would be used in connection with material matters arising under the internal revenue laws. However, the parties disagree as to whether Mitchell "knew" that the returns would result in an understatement of tax liability.
The Government argues that "knowledge" includes not only positive knowledge, but also includes deliberate ignorance, citing United States v. Jewell, 532 F.2d 697 (9th Cir.1976), cert. denied, 426 U.S. 951, 96 S.Ct. 3173, 49 L.Ed.2d 1188 (1976), and Wyle v. R.J. Reynolds Industries, Inc., 709 F.2d 585 (9th Cir.1983). However, neither case interpreted the "knowledge" element of § 6701. Mitchell contends that "knowledge" means either the intentional preparation of tax returns with the intent to defraud the United States, or with no regard to the truth or accuracy of the information, citing Sansom v. U.S., 703 F.Supp. 1505 (D.N.D.Fla.1988), 62 AFTR 2d 88-5304, which held that the United States must prove that the taxpayer had actual knowledge of the understatement of tax liability.
The language of § 6701 differs from other statutes which impose penalties on tax preparers. Section 6694(b) imposes a civil penalty for the willful attempt to understate tax liability. Section 7206(2) imposes criminal penalties for the willful preparation or presentation of fraudulent tax documents. Section 6701, however, does not include the willful language. Rather Section 6701 requires that the tax preparer "know" that the tax is understated.
The legislative history establishes that Congress intentionally drafted different statutory language. The Senate reports establishes that the tax preparer must have "direct involvement" in the preparation of a false or fraudulent document. S.Rep. No. 494, 97th Cong., 2d Sess., 1982 U.S. Code Cong. & Ad.News 1190, 1348. Mertens Law of Fed Income Tax § 56.26 at 107-108 (1988). Sansom v. U.S., 703 F.Supp. 1505, 1511 (D.N.D.Fla.1988). Further, the legislative history of Section 6701 indicated that it is not to apply in cases of negligence or intentional disregard. S.Rep. No. 494, 97th Cong.,2d Sess., 1982 U.S. Code Cong. & Ad.News 1190, 1348; H.Conf.Rep. No. 760, 97th Cong.2d Sess., 1982 U.S.Code Cong. & Ad.News 1190, 1348; Sansom, supra, at 1511.
Accordingly, this Court concludes that the Section 6701 penalties are applicable in this case only if Mitchell knew or had actual knowledge of the understatement of tax liability.
Placed in Service:
The extent of Mitchell's knowledge is dependent to a great extent on the definition of "placed in service" set forth in Treasury Regulation 1.46-3(d) which provides:
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