Ninth Circuit Sides with Government’s Interpretation of QAR Regulations in Bergmann

That didn’t take long.  Less than two weeks after learning that the parties would not be mediating their dispute (see our previous report here), the Ninth Circuit issued a brief five-page unpublished opinion affirming the Bergmann case in favor of the government.  The court held that the time for filing a qualified amended return for an undisclosed listed transaction terminates when the promoter (here, KPMG) is first contacted by the IRS about examining the transaction, not when the IRS later determines the transaction is a tax shelter.

To recap the issue (see our original report here), under Treas. Reg. § 1.6664-2(c)(3)(ii), as in effect when the Bergmanns filed their amended return, the time to file a qualified amended return terminates when the IRS first contacts a “person” concerning liability under 26 U.S.C. § 6700 (a promoter investigation) for an activity with respect to which the taxpayer claimed a tax benefit.  The Bergmanns claimed tax benefits from a Short Option Strategy promoted by KPMG on their 2001 tax return.  The IRS served summonses on KPMG in March 2002 for its role in promoting the Short Option Strategy transactions.  The Bergmanns did not file their qualified amended return until March 2004, shortly after KPMG identified the Bergmanns as among those taxpayers who participated in the transaction.  The Bergmanns argued that “person” as used in the regulation meant only those persons liable for a promoter penalty under 26 U.S.C. § 6700.

The Ninth Circuit quickly dispatched the taxpayers’ argument, characterizing their interpretation of the regulation as “impermissibly rendering its text and purpose nonsensical.”  Under the express language of the regulation, it applies when the promoter is “first contacted,” not found liable.  The court of appeals concluded by observing that the purpose of qualified amended returns is to encourage and reward taxpayers who “voluntarily disclose abusive tax practices, thereby saving IRS resources.”  Here, the taxpayers did not amend their return until after KPMG gave their names to the IRS.

Bergmann – Ninth Circuit Opinion

 

Ninth Circuit Refers Bergmann Case to Mediation After Oral Argument

In a somewhat unusual move, the Ninth Circuit issued an order last week suggesting that the parties pursue mediation in the Bergmann case.  The order came two days after the court heard oral argument.  The order states that “the court believes this case may be appropriate for mediation” and therefore it is being referred to the Ninth Circuit’s Mediation Office.  A mediator will then contact the parties to determine their interest, but the parties are not required to elect mediation.  The Circuit Mediator is directed to report back to the panel by January 4.  In the meantime, the court will not act on the appeal.

The oral argument in this case was held on December 3 before Ninth Circuit Judges Gould, Paez, and District Court Judge Marilyn Huff, sitting by designation.  As we have previously reported, the issue in this case is whether the taxpayer was insulated from penalties for participating in a tax shelter because he filed a qualified amended return.  The outcome turns on the applicability of Treasury regulations that delineate when it is, in effect, too late for a taxpayer to save himself by filing an amended return because it is understood that he is doing so only because IRS actions have tipped him off that the shelter is being audited.  As the parties framed the issue at oral argument, the dispute boils down to whether the current Treasury regulation (which describes what IRS actions are to be understood as tipping off the taxpayer) was merely a clarification of the previous regulation that was in effect at the time that the taxpayer filed his amended return.  The taxpayer’s counsel conceded that applying the terms of the current regulation would have terminated the right to avoid penalties by filing an amended return; government counsel conceded that it is the older regulation, not the current one, that applies.

A couple of questions were asked at oral argument of each side, but nothing unexpected arose that obviously should have prompted the panel to suggest mediation.  Towards the end of the argument, however, after the panel had established that few, if any, taxpayers remain governed by the terms of the older regulation, District Judge Huff asked government counsel whether the parties had considered mediation (noting that she did not even know if the Ninth Circuit had a mediation program).  Not surprisingly, both government counsel and later taxpayer counsel said that they would not rule anything out and would be willing to entertain mediation.

The Ninth Circuit, of course, has an established mediation program — to which this case is now being referred — but that program ordinarily kicks in at the outset of the appeal, not after briefing and oral argument.  In fact, in this case the parties participated in the first stage of that process, a telephone settlement assessment conference, back in March 2012.  Thereafter, on March 15, 2012, the Court issued an order stating that the case was not selected for the mediation program, and it then proceeded to briefing.

The panel is now suggesting that the parties take a fresh look and decide whether they can reach a middle ground.  There is no middle ground if the appeal proceeds to a decision:  either the qualified amended return was timely and effective to protect against penalties or the taxpayer’s ability to achieve that protection was terminated before he filed the amended return.  The panel perhaps decided that a fairer result lies somewhere in the middle — given that the text of the older regulation appears to lean towards the taxpayer but resolving the case on that basis might be regarded as allowing the taxpayer to benefit from a poorly drafted regulation when it should have been too late, as a policy matter, to avoid penalties by filing an amended return.  Whatever the court was thinking, the oral argument and this order have given each side reason for concern that it might lose if the appeal proceeds to judgment.  On the one hand, the judges did not question the government’s assertions that its interpretation of the regulation was entitled to deference and that it would be a bad policy result to allow the taxpayer to escape penalties here.  On the other hand, the court — particularly Judge Gould who questioned government counsel on this point — did not appear entirely convinced that the current regulation can be viewed as a “clarification” because the text of the older regulation is not easily read to support the government’s position.  It is entirely possible that both sides will seize this opportunity to split the baby and will reach a settlement through the mediation process.

Ninth Circuit to Rule on Timing for Filing a Qualified Amended Return for an Undisclosed Listed Transaction

The taxpayers in Bergmann v. Commissioner are appealing an adverse Tax Court decision, 137 T.C. No. 10, holding that they failed to timely file a qualified amended return for 2001 and thus are liable for the 20-percent accuracy related penalty.   The taxpayers participated in a listed transaction promoted by KPMG, known as the Short Option Strategy.  In 2004, two years after the IRS issued a summons to KPMG specifically identifying the Short Option Strategy transaction, the Bergmanns filed an amended return disclaiming the tax benefits of the transaction.  The case concerns the interpretation of Treas. Reg. § 1.6664-2(c)(3)(ii) (2004), which establishes rules on the timing of filing a qualified amended return for undisclosed listed transactions.  If an amended return is filed before certain terminating events, additional tax reported on the amended return will be treated as if it were reported on the original return.  Under the “promoter provision,” the amended return must be filed before the IRS first contacts a person concerning liability under section 6700 (a promoter investigation).   The Tax Court rejected the taxpayers’ argument that the IRS must establish that the target of the promoter investigation is in fact liable for a promoter penalty.  The Tax Court also held that, in investigating the promoter, the IRS need only identify the “type” of transaction in which the taxpayer engaged, not the specific transaction or the identity of the taxpayer.

In 2000-2001, taxpayer Jeffrey Bergmann was a tax partner in KPMG’s Stratecon Group, which the Tax Court characterizes as “focused on designing, promoting and implementing aggressive tax planning strategies for high-net-worth individuals.”  In tax years 2000 and 2001, Bergmann entered into a “Short Option Strategy” transaction promoted by fellow KPMG partner Jeffrey Greenberg.  This transaction was identified by the IRS as an abusive tax shelter in Notice 2000-44, 2000-2 C.B. 255 (transactions generating losses by artificially inflating basis).  The taxpayers (Bergmann and his wife) claimed losses for the 2000 and 2001 Short Option Strategy transactions on their 2001 return, but filed an amended return in March 2004 removing the losses attributable to the transactions and paying approximately $200,000 in additional tax.  The IRS treated the qualified amended return as untimely and assessed accuracy-related penalties.

Under Treas. Reg. § 1.6664-2(c)(3)(ii), as in effect when the Bermanns filed their amended return, the time to file a qualified amended return terminates when the IRS first contacts a person “concerning” liability under section 6700 (a promoter investigation) for an “activity” with respect to which the taxpayer claimed a tax benefit.  The IRS served KPMG with two summonses in March 2002, one of which was specifically targeted at KPMG’s involvement in promoting transactions covered by Notice 2000-44.  Attempting to disassociate their transaction from those that were the subject of the KPMG investigation, the taxpayers argued that Greenberg acted in his individual capacity in advising them, not as an agent of KPMG.  The Tax Court rejected this argument, concluding that the transactions in which the taxpayers engaged were within the scope of Greenberg’s responsibilities as a KPMG partner and also concluding that KPMG had not limited Greenberg’s authority to engage in Notice 2000-44 transactions with other KPMG partners, including Bergmann.   The Tax Court also rejected the taxpayers’ argument that the promoter investigation must specifically identify the “activity” that gave rise to the tax benefit.  The Tax Court held that the summons need only refer to the “type” of transaction in which the taxpayer participated.  The court found that the March 2002 summons met this requirement because it specifically identified the transaction as the same or substantially similar to the transaction identified in Notice 2000-44.

The Tax Court noted that disclosure of the transaction after the Notice 2000-44 summons was served on KPMG would not have been voluntary.  The Tax Court explained that the purpose of the promoter provision is to encourage taxpayers to voluntarily disclose abusive tax shelters.  That purpose is effectuated by terminating the period to file a qualified amended return when disclosure would no longer be voluntary.

The Tax Court addressed a second issue as well.  At first glance, the taxpayers appeared to be subject to the 40% gross overvaluation penalty because the scheme depended on what was found to be an artificially inflated based.  They argued, however, that the tax underpayment was not “attributable to” the overvaluation because the Commissioner contended (and the taxpayers eventually conceded) that the entire transaction should be disallowed for lack of economic substance, thereby making the valuation irrelevant.  The Tax Court noted that this type of bootstrapping argument has been rejected by several circuits, which have held that the 40% penalty applies when overvaluation is intertwined with a tax avoidance scheme, but that Ninth Circuit precedent has accepted the argument.  Keller v. Commissioner, 556 F.3d 1056.  Accordingly, the Tax Court rejected the IRS’s attempt to impose a 40% penalty, and the taxpayers were assessed only the standard 20% accuracy-related penalty.  The IRS has not appealed this issue.

The taxpayers’ opening brief is due on May 16.  The case is docketed in the Ninth Circuit as No. 12-70259.

Tax Court Opinion