Sugarloaf Funding, LLC v. U.S. Dept. of Treasury

• Decision Date: 07 October 2009
• Docket Number: No. 08-2515.,08-2515.
• Citation: 584 F.3d 340
• Parties: SUGARLOAF FUNDING, LLC; Derringer Trading, LLC; Knight Trading, LLC; Portfolio Properties, Inc.; Warwick Trading, LLC; John E. Rogers, Petitioners, Appellants, v. U.S. DEPARTMENT OF THE TREASURY, Respondent, Appellee.
• Court: U.S. Court of Appeals — First Circuit

584 F.3d 340

SUGARLOAF FUNDING, LLC; Derringer Trading, LLC; Knight Trading, LLC; Portfolio Properties, Inc.; Warwick Trading, LLC; John E. Rogers, Petitioners, Appellants, v. U.S. DEPARTMENT OF THE TREASURY, Respondent, Appellee.

No. 08-2515.

United States Court of Appeals, First Circuit.

Heard June 5, 2009.

Decided October 7, 2009.

Jerome R. Weitzel, with whom Paul J. Kozacky, Kozacky & Weitzel, P.C., Richard E. Quinby, Lauren J. Coppola and Craig & MaCauley, were on brief, for appellants.

Rachel I. Wollitzer, Attorney, Tax Division, Department of Justice, with whom Michael J. Sullivan, United States Attorney, John A. DiCicco, Acting Assistant Attorney General, Gilbert S. Rothenberg, Acting Deputy Assistant Attorney General and Robert W. Metzler, Attorney, Tax Division, Department of Justice, were on brief, for appellee.

Before TORRUELLA, LIPEZ and HOWARD, Circuit Judges.

HOWARD, Circuit Judge.

This case is one of more than a dozen in federal courts across the country related to an Internal Revenue Service ("IRS") investigation into possible improper tax shelters.¹ As in the other cases, the targets of the investigation petitioned the district court to quash administrative summonses issued by the IRS. Approving a magistrate judge's report and recommendation, the district court denied the motions to quash and ordered the summonses enforced. The petitioners timely appealed. Consistent with every other court to address this issue, we affirm the district court.²

I. Background

The IRS investigation is focused on transactions that generated losses claimed from writing down the value of "distressed debt" consisting of consumer accounts receivable obtained from one or more Brazilian retail stores. According to an IRS Coordinated Issue Paper ("CIP")³ issued in April 2007, such "distressed asset and debt" transactions (known as "DAD tax shelters") generate tax losses that are not allowable as deductions. In a DAD shelter, a foreign entity that does not pay United States taxes sells purportedly high-basis, low-value debt (the "distressed debt") to a United States entity taxed as a partnership in exchange for a payment that is a very small percentage of the face value of the debt. The United States entity then contributes the distressed debt to other entities taxed as partnerships — partnerships in which interests are sold to tax shelter participants. The shelter participants then claim some or all of the face value of the distressed debt as a loss to offset other earned income. The IRS contends that U.S. taxpayers participating in the Brazilian debt DAD shelters claimed losses of approximately $39 million in 2003 and $119 million in 2004. The IRS is investigating the veracity of these claimed losses by examining the returns filed by the entities that pass on the losses to U.S. taxpayers and those filed by the individual taxpayers.

II. The parties

The appellants are engaged in the business of consumer receivables management and collection. They partner with creditors for the servicing and collecting of consumer receivables in a global industry fueled by increasing levels of consumer debt, increasing defaults of the receivables, and utilization of third-party providers to collect such receivables.

Appellant John E. Rogers, an attorney with an MBA in international finance, was the driving force behind the appellants' involvement in the Brazilian debt market. Jetstream Business, Ltd.⁴ ("Jetstream") was Rogers's platform for international investment opportunities. Jetstream is the Tax Matters Partner of appellants Derringer Trading, LLC ("Derringer") and Knight Trading, LLC ("Knight"). Rogers, in turn, is the sole shareholder of appellant Portfolio Properties, Inc. ("Portfolio"), an Illinois corporation that is the sole shareholder of Jetstream. Appellant Warwick Trading, LLC ("Warwick"), was formed by Jetstream as a possible vehicle through which to invest. In 2006, Derringer and Knight were transferred to appellant Sugarloaf Fund, LLC ("Sugarloaf"), a Delaware company. Rogers is the general manager of Sugarloaf.

III. The summonses and prior proceedings

In June 2007, the IRS issued a set of administrative summonses to Massachusetts resident Michael Hartigan ("Hartigan"), an attorney, directing him to appear before IRS Revenue Agent Larry Weinger to testify and produce for examination documents and information relating to Derringer, Knight, Portfolio, Sugarloaf and Warwick. A few days later, Hartigan received a second summons from the IRS, directing him to appear before IRS Agent Kimberlee Loren to testify and produce documents regarding Rogers. The first set was served on Hartigan because he claimed losses on his joint income tax return based on his wife's interest in Derringer and Knight.⁵ The second was based on his relationship with Rogers, as the IRS believed that Hartigan, in addition to receiving fees from participants, also assisted Rogers in organizing, managing and selling interests in the various entities.⁶

The petitioners timely filed a motion to quash the summonses, claiming that the IRS was engaging in a nationwide pattern of harassment.⁷ The government moved to deny the motion to quash and for enforcement of the summonses. After a hearing on the petitioners' motion for an evidentiary hearing, the magistrate judge denied both the motion for a hearing and the motion to quash, while simultaneously recommending the enforcement of the summonses. The district court adopted the report and recommendation. This appeal followed.

IV. Discussion

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); 26 U.S.C. § 7602. Taxpayers may petition to quash such summonses and the IRS may petition to enforce them. 26 U.S.C. §§ 7604, 7609. Enforcement proceedings are designed to be summary in nature. Donaldson v. United States, 400 U.S. 517, 529, 91 S.Ct. 534, 27 L.Ed.2d 580 (1971). "The court's role is to ensure that the IRS is using its broad authority in good faith and in compliance with the law." United States v. Gertner, 65 F.3d 963, 966 (1st Cir.1995).

Regardless of who initiates the action, the court follows a familiar structured analysis in a summons enforcement proceeding. Gertner, 65 F.3d at 966. The IRS must first 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. See Gertner, 65 F.3d at 966 ("This burden is not taxing, so to speak."). An affidavit of the investigating agent that the Powell requirements are satisfied is sufficient to make the prima facie case. Id.; see also United States v. Dynavac, Inc., 6 F.3d 1407, 1414 (9th Cir. 1993); Alphin v. United States, 809 F.2d 236, 238 (4th Cir.1987); In re Newton, 718 F.2d 1015, 1019 (11th Cir.1983); United States v. Will, 671 F.2d 963, 966 (6th Cir. 1982); United States v. Kis, 658 F.2d 526, 538 (7th Cir.1981); United States v. Garden State Nat'l Bank, 607 F.2d 61, 68 (3d Cir.1979); Howa Trading, 2008 WL 2323872 at *4; Thomas v. United States, 254 F.Supp.2d 174, 180 (D.Me.2003).

Once the IRS has made this showing, the burden shifts to the taxpayer to disprove one or more of the Powell requirements, or to show that enforcement would be "an abuse of process, e.g., that the summons was issued in bad faith for an improper purpose." Sterling Trading, 553 F.Supp.2d at 1155-56 (C.D.Cal.2008) (citing Liberty Fin. Serv. v. United States, 778 F.2d 1390, 1392 (9th Cir.1985)). The taxpayer's burden is heavy, and he "must allege specific facts and evidence to support his allegations." Id. at 1156. The district court found that the appellants failed to meet their ultimate burden. After reviewing the ruling on the motions to quash for abuse of discretion, Bogosian v. Woloohojian Realty Corp., 323 F.3d 55, 66 (1st Cir.2003), we affirm.

A. The prima facie case

The appellants first argue that the district court erred when it concluded that the sworn declarations from Weinger and Loren were sufficient to establish the IRS's prima facie case under Powell.

Weinger's declaration stated that the summonses were issued for the purpose of investigating the appellants' returns because they may be involved in potentially abusive DAD tax shelters. More specifically, Weinger stated that the IRS examinations concerned the correctness of partnership returns filed by Sugarloaf, Warwick, Derringer and Knight for various tax years between January 1, 2003 and December 31, 2005. The examination also implicated returns filed by individual participants who claimed losses through their interests in these entities.

Weinger further stated that Portfolio's S-corporation return for tax years 2003-2005 was a subject of his examination, as was Rogers, indirectly, because he was Portfolio's sole shareholder, and Portfolio's losses flowed directly through to his individual returns.

Regarding the summonses at issue, Weinger stated that after following all IRS procedural requirements, the summonses were issued to Hartigan because he, through his wife (with whom he files a joint tax return) purchased tax shelters involving several tiers of LLCs receiving and contributing distressed debt to other LLCs, transactions appearing similar to the DAD shelters described in the CIP. Hartigan also promoted the sale of interests in similar LLCs to others. According to Weinger, Hartigan's wife indirectly owned between 96 and 98 percent of Derringer, and over 96 percent of Knight,...