In re Tax Refund Litigation
| Decision Date | 24 May 1991 |
| Docket Number | No. MDL 87-731 (TCP).,MDL 87-731 (TCP). |
| Citation | 766 F. Supp. 1248 |
| Parties | In re TAX REFUND LITIGATION. |
| Court | U.S. District Court — Eastern District of New York |
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Silverstein & Osach by Nathan Silverstein, New Haven, Conn., for plaintiffs Bellof, Gold, Barrister Associates and Chadwick Investor Services, Inc.
Kostelanetz, Ritholz, Tigue & Fink by Jules Ritholz, New York City, for plaintiffs Townsend and Universal.
U.S. Dept. of Justice, Tax Div. by Harold Sklar, Washington, D.C., for defendant.
By jury verdict rendered July 11, 1990, the seven plaintiffs were found to have promoted an abusive tax shelter and thus to be liable for the penalty prescribed by I.R.C. § 6700 (1982). By agreement of the parties, this Court will now determine the correct amount of the penalty owed by each of the plaintiffs.
The tax shelter promoted by the plaintiffs centered around the purchase and subsequent leasing of what the parties have referred to as "book properties." In broad brush, it was structured in the following manner. Plaintiff Geoffrey Townsend Ltd. ("Townsend") purchased certain book properties, that is, the plates, films, computer discs and other equipment which are used in the printing of hard and soft cover books, from various book publishers in 1982. It paid for the properties with small cash down payments and larger recourse notes at a rate of 9% per annum. At trial, it was established that the purchase price vastly exceeded the fair market value of the book properties.
Later in 1982, Townsend leased its book properties to 35 limited partnerships. The individual limited partnerships oversaw the production and distribution of the books produced using the book properties. For their investment, the limited partners were promised certain tax advantages: a deduction for the lease payments, and a proportionate share of the investment tax credit, based upon the inflated purchase price, which Townsend elected to pass through to its lessees.
In 1983, plaintiff Universal Publishing Resources, Inc. ("Universal") essentially repeated the actions of Townsend in the previous year. It purchased book properties on the same terms as Townsend, then leased them to 65 limited partnerships and elected to pass through the investment tax credit.
Plaintiff Barrister Associates ("Barrister"), a New York general partnership, was the general partner in all of the limited partnerships which leased book properties from Universal and Townsend. For its services, it collected substantial general partner fees. Plaintiffs Paul Belloff and Robert Gold are the sole general partners of Barrister Associates. Plaintiff Chadwick Investor Services, Inc. (a/k/a Chadwick Securities Corp.) ("Chadwick") is a company which the limited partnerships employed as an agent in selling limited partnership interests. Plaintiff Madison Library, Inc. provided administrative and clerical services to Universal and Townsend.
In 1986, the IRS determined that this series of transactions constituted the promotion of abusive tax shelters and assessed the following penalties against each of the plaintiffs:
Townsend ............... $2,739,013
Universal .............. $5,399,811
Madison Library ........ $ 400,000
Barrister .............. $5,306,000
Belloff ................ $5,306,000
Gold ................... $5,306,000
Chadwick ............... $5,211,000
The penalties against Universal and Townsend were computed as a percentage of the gross income each entity derived from its promotions. The penalties against Barrister, Belloff, Gold and Chadwick were computed based upon the theory that each act of organizing a limited partnership and each sale of a limited partnership interest constituted a separate violation of the statute justifying the imposition of a separate $1000 penalty.
In February 1987, pursuant to I.R.C. § 6703 (1982), the plaintiffs paid 15% of these assessments and filed this refund action. The Government brought a counterclaim seeking payment of the remaining 85% of the assessed penalty. By Memorandum and Order dated November 2, 1988, this Court rejected the government's theory regarding the imposition of multiple $1000 penalties and directed that the penalties be reassessed. See In re Tax Refund Litigation, 698 F.Supp. 439, 443-44 (E.D. N.Y.1988). On July 24, 1989, the IRS assessed the following penalties against each of the plaintiffs:
Townsend ............... $4,395,925
Universal .............. $8,994,367
Madison Library ........ $ 400,000
Barrister .............. $ 534,693
Belloff ................ $ 124,672
Gold ................... $ 124,672
Chadwick ............... $1,446,713
The increase in the penalties assessed against Universal and Townsend resulted from a change in the theory upon which the Government computed their gross income. The penalties assessed against the remaining plaintiffs were now computed as a percentage of the gross income each derived from the promotions.
As it existed at the time the events in question occurred, section 6700 required promoters of abusive tax shelters to "pay a penalty equal to the greater of $1,000 or 10% of the gross income derived or to be derived by such person from such activity." I.R.C. § 6700(a) (1982).1 Because the Government has now chosen to calculate all of the penalties as a percentage of the gross income each plaintiff derived, in their post-trial memoranda the parties dispute whether certain items were properly included in the government's calculation of that gross income.
Before considering each plaintiff's specific objections to the IRS' computation of its gross income derived from the tax shelters, we first must confront two general arguments presented by the Government which are applicable to all plaintiffs. First, the Government seeks to erect the so-called variance doctrine as a bar to certain arguments made by the plaintiffs with regard to the calculation of their gross incomes. In brief, the variance doctrine prevents a taxpayer from raising issues or claims in a refund action before the district court, if it has not previously raised them in its administrative claim filed with the IRS. Real Estate-Land Title & Trust Co. v. United States, 309 U.S. 13, 17-18, 60 S.Ct. 371, 373, 84 L.Ed. 542 (1940); United States v. Felt & Tarrant Mfg. Co., 283 U.S. 269, 272, 51 S.Ct. 376, 377, 75 L.Ed. 1025 (1931).2 The doctrine is designed to promote thorough administrative investigation of claims by ensuring that the IRS gets a sufficiently detailed claim. United States v. Memphis Cotton Oil Co., 288 U.S. 62, 70-72, 53 S.Ct. 278, 281-282, 77 L.Ed. 619 (1933). It also provides the IRS with notice of all claims and thus prevents factual surprise at trial. Mayer v. United States, 285 F.2d 683, 685-86 (9th Cir.1960).
Two factors present in this case render application of the variance doctrine inappropriate. First, it was not until well after the plaintiffs first filed their refund claims that the IRS adopted its present, modified calculation of the penalty owed by each. Moreover, the IRS not only altered its calculation of the penalties but it did so based upon a modification in the theory upon which the penalties were calculated. Given the IRS' change of position, this Court may not seriously entertain the argument that it should bar plaintiffs from advancing new arguments to address the IRS' changed computation and theory because those arguments were not contained in a claim filed with the IRS before the Government reversed its field. Furthermore, there is no chance of the sort of factual surprise or surprise at trial which the variance doctrine was intended to avoid. Trial has concluded and the facts are firmly established. This Court will therefore entertain all arguments made by the plaintiffs regarding the computation of their gross income.
Second, the government contends that the plaintiffs must bear the burden of proof with regard to any reduction in the IRS' penalty assessment. It arrives at this conclusion by arguing that IRS assessments are presumptively correct and can be rebutted only through the introduction of competent and relevant evidence to the contrary. Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9, 78 L.Ed. 212 (1933); Valley Title Co. v. Commissioner, 559 F.2d 1139, 1141 (9th Cir.1977). In a penalty assessment, it argues, this presumption extends to two issues: 1) whether the person against whom the penalty is assessed is liable for the penalty and 2) the amount of the penalty assessed. In the case of section 6700 penalties, the government concedes that this allocation of burdens is partially modified. Section 6703 prescribes the procedures to be followed in the assessment of section 6700 penalties and specifically states that "in any proceeding involving the issue of whether or not any person is liable for a penalty under section 6700 ... the burden of proof with respect to that issue shall be on the Secretary." I.R.C. § 6703(a) (1988) (emphasis added). Because section 6703(a) explicitly assigns the burden of proof to the Government only on this issue, the Government concludes that the plaintiffs retain the burden of proof with respect to the amount of the penalty.
The plaintiffs respond that the presumption relied upon by the government applies only in cases where the IRS has assessed a tax deficiency and may not be applicable here. Not only does this case not involve a tax deficiency, they argue, but section 6703(b) specifically states that deficiency procedures do not apply to the assessment of section 6700 penalties. Id. § 6703(b). Further, they point out that one district court has held that the Government bears the burden of establishing the plaintiff's gross income. See Weir v. United States, 716 F.Supp. 574, 580-81 (N.D.Ala.1989).3
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