Sterling Trading, LLC v. U.S.

• Decision Date: 14 February 2008
• Docket Number: No. SACV 07-915 JVS (ANx).,SACV 07-915 JVS (ANx).
• Citation: 553 F.Supp.2d 1152
• Parties: STERLING TRADING, LLC v. UNITED STATES of America, et al.
• Court: U.S. District Court — Central District of California

553 F.Supp.2d 1152

STERLING TRADING, LLC v. UNITED STATES of America, et al.

No. SACV 07-915 JVS (ANx).

United States District Court, CD. California.

February 14, 2008.

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George M. Jones, Weiss and Jones, Long Beach, CA, John M. Sheldon, Paul J. Kozacky, Kozacky and Weitzel P.C., Chicago, IL, for Sterling Trading LLC.

Assistant U.S. Attorney SA-CV, Office of U.S. Attorney, Santa Ana, CA, for United States of America and Department of the Treasury.

Order Denying Petition to Quash and Granting Cross-Petition to Enforce IRS Summonses

JAMES V. SELNA, District Judge.

Petitioner, Sterling Trading, LLC ("Sterling Trading") petitions this Court to quash the third-party summons served on Jimmy B. Summitt ("Summitt") by Respondent, United States of America, Department of the Treasury, Internal Revenue Service ("IRS"). The IRS counterpetitions to enforce the summons.

I. Background

On July 20, 2007, the IRS served Summitt with a summons to appear for examination on September 7, 2007 and to produce documents as indicated in the rider. (Petition ¶¶ 4, 6, Ex. A.) Summitt indirectly owns 73.5% of Sterling Trading. (Weinger Decl. ¶ 16.) Sterling Trading received notice of the third-party summons by service on July 23, 2007. (Weinger Decl. Ex. 1, "Summons.") It filed this petition to quash on August 8, 2007.

The summons was issued in connection with an IRS investigation into Distressed Asset and Debt transactions, which resulted in taxpayer claimed losses of $39 million in 2003 and $119 million in 2004, and which the IRS characterizes as abusive tax shelters. (Weinger Decl. ¶¶ 2-3.) The Court notes that there are evidently more than a dozen other petitions to quash similar summons in other district courts around the country. (Response to Counter-petition p. 4.) The Judicial Panel on Multi-District Litigation denied petitioners' request to consolidate and transfer the litigation. (Docket No. 27.) Accordingly, the Court now decides the petition and cross-petition before it.

II. Legal Standard

The IRS has "expansive information-gathering authority" to determine tax liability under the Internal Revenue Code, including by issuance of summonses to taxpayers and third-party record holders. United States v. Arthur Young & Co., 465 U.S. 805, 816, 104 S.Ct. 1495, 79 L.Ed.2d 826 (1984); I.R.C. § 7602. Taxpayers may petition to quash such summonses and the IRS may petition to enforce them. I.R.C. §§ 7604, 7609. In either type of action, the IRS must make a prima facie showing "[1] that the investigation will be conducted pursuant to a legitimate purpose, [2] that the inquiry may be relevant to the purpose, [3] that the information sought is not already within the Commissioner's possession, and [4] that the administrative steps required by the Code have been followed." United States v. Powell, 379 U.S. 48, 57-58, 85 S.Ct. 248, 13 L.Ed.2d 112 (1964). The IRS need only make a "minimal" showing, and "assertions by affidavit of the investigating agent that the requirements are satisfied are sufficient to make the prima facie case." Liberty Financial Services v. United States, 778 F.2d 1390, 1392 (9th Cir.1985).

Once the IRS has made this showing, the burden shifts to the taxpayer to disprove one or more of the Powell requirements, or show that enforcement would be "an abuse of process, e.g., that the summons was issued in bad faith for an improper purpose." Liberty Financial Services, 778 F.2d at 1392; United States v. Jose, 131 F.3d 1325, 1328 (9th Cir.1997). The taxpayer's burden is heavy, and he "must allege specific facts and evidence to support his allegations." Liberty Financial Services, 778 F.2d at 1392.

III. Discussion

A. IRS's Prima Facie Showing

The IRS has submitted a Declaration by Agent Larry Weinger ("Weinger") that addresses each of the four Powell requirements. (Counter-Petition p. 2; Weinger Decl. passim.)

i. Legitimate Purpose

The IRS is authorized to issue summonses "in good faith pursuit of the congressionally authorized purposes of § 7602." United States v. La Salle Nat'l Bank, 437 U.S. 298, 318, 98 S.Ct. 2357, 57 L.Ed.2d 221 (1978). These purposes include: "[1] ascertaining the correctness of any return, [2] making a return where none has been made, [3] determining the liability of any person for any internal revenue tax...." I.R.C. § 7602(a).

Here, Weinger states that "the examinations concern the correctness of the returns, Form 1065 Return of Partnership Income, for taxable periods January 1, 2003 through December 31, 2004 filed by Sterling Trading, LLC." (Weinger Decl. ¶ 4.) He also states that the summons has the additional legitimate purpose of ascertaining "the correctness of returns filed by, and the correct tax liabilities of the participants [i.e. Summitt] who claimed losses through their interest in one or more of Petitioner [i.e. Sterling Trading]." (Id.)

The IRS has indicated that it issued the summons on Summitt for purposes authorized under § 7602 and therefore satisfies the first Powell requirement.

ii. Relevance

The IRS is authorized to inquire as to all items that may be of "potential relevance to its investigation." United States v. Arthur Young & Co., 465 U.S. 805, 814, 104 S.Ct. 1495, 79 L.Ed.2d 826 (1984). Materials requested by summons are potentially relevant to an IRS investigation when they "might throw light upon the correctness of the return." David H. Tedder & Assocs. v. United States, 77 F.3d 1166, 1169 (9th Cir.1996) (quoting United States v. Goldman, 637 F.2d 664, 667-(9th Cir.1980)). In other words, materials summoned are relevant if the IRS has "a realistic expectation rather than an idle hope that something may be discovered." Id. (citing Arthur Young & Co., 465 U.S. at 813-14, n. 11, 104 S.Ct. 1495.)

In this case, Weinger outlines the way in which each of the categories of requested documents is relevant to the IRS's investigation into the correctness of Sterling Trading's partnership return and Summitt's returns. The first category requests "[a]ll documents regarding legal advice or tax advice in connection with your participation in Sterling Trading." (Summons Rider p. 2.) Weinger states that documents responsive to this request are relevant to whether Summitt conducted due diligence and sought the opinions of advisors. (Weinger Decl. ¶ 22.) Since Summitt has a 73.5% interest in Sterling Trading, the due diligence he undertook in connection with the transactions here is directly relevant to whether penalties may be imposed on him as well as whether they can be imposed on Sterling Trading. (Reply Br. p. 7.)

The second category requests "[a]ll documents discussing or purporting to describe the anticipated tax benefits, or lack thereof, of Sterling Trading." (Summons Rider p. 2.) Documents responsive to this request are relevant to whether Summitt's investment in Sterling Trading was motivated by tax reasons in part or in full or for other economic reasons. (Weinger Decl. ¶ 19; Counter-petition p. 8; Gov't Reply Br. p. 6.)

The third, fourth and sixth categories request "[a]ll engagement letters ... and correspondence relating to legal ... or tax advice relating to Sterling Trading," "[a]ll documents ... related to any fees for legal ... and tax advice ... incurred., in connection with Sterling Trading," and "[a]ll documents showing payment of funds ... in connection with Sterling Trading." (Summons Rider p. 2.) Weinger states that all of these categories relate to the "income and expenses" of Sterling Trading. (Weinger Decl. ¶ 20.) Sterling Trading's income and expenses are obviously related to its tax liability.

The fifth category requests "[a]ll minutes, notes ... and other recordings relating to ... meetings ... in which Sterling Trading ... was discussed." (Summons Rider p. 2.) Weinger states that any responsive documents would be relevant in as far as they "reflect on the facts and circumstances of the transactions." (Weinger Decl. ¶ 22.) These documents might also throw light on Summitt's economic or tax-related motives for participating in the transactions, which would be relevant to both Sterling Trading's as well as Summitt's returns.

The Court is satisfied that for each of the categories of documents requested, the IRS has a realistic expectation that it might discover information pertaining to the correctness of Sterling Trading's and Summitt's returns.

iii. Documents not in IRS's possession

Weinger clearly states that "[t]he IRS is not in possession of the summoned information." (Weinger Decl. ¶ 10.) He notes that "[w]hile the IRS has obtained information from some taxpayers and third parties, Petitioner has not provided the records sought by the summons." (Id.) The IRS has therefore established the third element of its prima facie showing.

iv. Administrative Steps

When the IRS serves a summons on a third-party recordkeeper, it must give notice to the person identified in the summons "within 3 days of the day on which such service is made." I.R.C. § 7609(a)(1). Since Summitt was served with the summons on July 20, 2007, and Sterling Trading was served with notice on July 23, 2007, the IRS is in compliance with the notice requirement. (Summons p. 2.) Moreover, Weinger states that the IRS followed all procedures required by the Internal Revenue Code. (Weinger Decl. ¶ 9.)

Accordingly, the Court finds that the IRS has made an adequate prima facie showing of good faith under Powell

B. Sterling Trading's Rebuttal

Given that the IRS has made a prima facie showing that the summons were issued in good faith and should be enforced, Sterling Trading must disprove one or more of the Powell factors or show that the IRS was, in fact, acting in bad faith.

i. Legitimate Purpose

To meet its burden, Sterling Trading must show not merely that the IRS issued the summons for some improper purpose, but rather that there is no legitimate purpose for which it was issued. Thus, "[e]ven the co-existence of an...