Opinion
1246-16W
11-01-2024
ESTATE OF DONALD M. ARNDT, DECEASED, KATHY R. ARNDT, PERSONAL REPRESENTATIVE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Albert G. Lauber Judge
This is a whistleblower award case brought pursuant to section 7623(b)(4).By Order served May 10, 2024, we directed the parties to file the entire administrative record stipulated as to its genuineness and completeness. If the parties were unable to stipulate the administrative record, we directed respondent to file what he contended to be the entire administrative record, certified as to its genuineness and completeness. We likewise directed petitioner-if she asserted that the administrative record submitted by respondent was not complete-to file a motion to supplement it.
Unless otherwise indicated, statutory references are to the Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times, and Rule references are to the Tax Court Rules of Practice and Procedure.
On June 18, 2024, respondent filed what he contends to be the entire administrative record, consisting of documents stamped Bates No. R-0001 through R-2135. Respondent concurrently filed a privilege log covering a limited amount of redacted information. On August 15, 2024, petitioner filed a Motion to Complete or Supplement the Administrative Record, urging that the administrative record filed by respondent is deficient, and respondent replied on October 15, 2024. Having carefully considered the parties' arguments, we will deny petitioner's Motion.
Background
On August 16, 2010, the IRS Whistleblower Office (WBO) received from Mr. Arndt (now deceased) a Form 211, Application for Award for Original Information. He alleged that the target taxpayer (Target), a bank, had avoided tax in 2009 by engaging in "distressed asset trust" (DAT) transaction. By engaging in this DAT transaction, Mr. Arndt alleged, Target had improperly shifted a built-in loss from a tax indifferent party to itself.
Mr. Arndt alleged that the DAT transaction "consisted of integrated steps"- including the creation of trusts, LLCs, special purpose entities, section 351 transactions, and mergers-all of which had allegedly occurred during 2009. Citing the doctrines of "substance over form" and "step transaction," he contended that Target during 2009 had engaged in a "predetermined, single transaction consisting of multiple, interwoven steps" that allegedly constituted a "listed transaction" under IRS Notice 2008-34, 2008-12 I.R.B. 645 (effective March 24, 2008).
The WBO forwarded Mr. Arndt's information to the exam team handling the audit of Target's 2008-2009 returns. In July 2012 Mr. Arndt sent the exam team a follow-up letter that referenced post-2009 collateral effects allegedly stemming from the "abusive DATT in the first quarter of 2009." That letter also suggested "additional grounds for invalidating [Target's] DATT."
On the basis of Mr. Arndt's information, the exam team issued Information Document Requests and developed a draft notice of proposed adjustment (NOPA). On July 27, 2012, the draft NOPA was forwarded to the IRS National Office for review. After reviewing the draft NOPA, the National Office in September 2012 advised the exam team that it would not support the proposed adjustment based on Mr. Arndt's DAT theory. The 2008/2009 examination was therefore closed with no adjustment. No proceeds were collected as a result of Mr. Arndt's information.
A member of the exam team prepared a Form 11369, Confidential Evaluation Report on Claim for Award, recommending that Mr. Arndt's claim be denied. See Internal Revenue Manual 24.2.1.5.5 (May 28, 2020). The attached narrative explained: "The taxpayer was already under continuous audit when the team received the claim. The team examined the issue and sent a draft NOPA with three alternative theories to local counsel for review. Local counsel forwarded the NOPA to National Office (NO) for input and approval and NO did not support the proposed adjustment. The issue was then closed with no adjustment proposed."
The Form 11369 was forwarded to the WBO together with relevant documents from the 2008/2009 exam files. On December 17, 2015, the WBO issued petitioner a Final Determination denying his claim. In support of its decision the WBO explained:
The claim has been recommended for denial because the information you provided did not result in additional tax [or other amount] related to the issues you raised regarding the listed, distressed asset trust transaction that improperly shifts a built-in loss from a tax indifferent party to the taxpayer. The IRS reviewed the information you provided as part of an ongoing examination of the taxpayer. However, that review did not result in the assessment of additional tax [or other amount] with respect to the listed, distressed asset trust issues you raised.
The IRS examined Target's returns for 2010 and 2011, and petitioner alleges that the IRS may have made adjustments to one or both of those returns. But the WBO did not send petitioner's information to the exam team which conducted that examination. Nor did the 2010/2011 exam team forward to the WBO any documents from the 2010/2011 exam files. Thus, no WBO administrative claim file was constructed for that audit cycle.
Mr. Arndt timely petitioned this Court for review of the WBO's decision. He agreed that the IRS had made no adjustment and had recovered no proceeds by use of his information during the 2008-2009 audit cycle. But he shifted his focus away from the DAT transaction-described in his claim as having occurred in 2009-and contended that "[t]he Transaction comprised an integrated series of steps occurring over the course of four tax years," ending only in 2012 when the parties allegedly "completed all of the prearranged steps." In other words, he now asserted that the DAT transaction was just the first step in a multi-year transaction; that the IRS, while not adjusting Target's income for 2009, did adjust it for 2010 and/or 2011 by challenging subsequent steps of the transaction; and that the IRS would not have made these adjustments but for the information he supplied.
After the case was docketed in this Court the parties filed, and in May 2016 we granted, a Joint Motion for Protective Order under Rule 103. The stated purpose for this protective order was to enable respondent to disclose to petitioner, on a confidential basis, documents from IRS files that constituted "returns" and "return information" of Target. The parties then commenced informal discovery
On December 4, 2018, Mr. Arndt issued a request for production of documents requesting the IRS's complete examination files of Target for 2010 and 2011. In response the IRS supplied some documents from those examination files (Bates No. R-2136 through R-2283) but withheld others. On August 14, 2019, Mr. Arndt filed a Motion to Compel Production of Documents requesting that respondent be directed to produce the withheld documents, which he asserted were relevant to his "step transaction" theory of the case.
By Order served December 11, 2019, we granted the Motion to Compel in part. Noting that respondent had already produced through discovery some 2010/2011 examination file documents, we concluded that production of additional documents was appropriate, expressing hope that the parties "will be able to agree to a properly limited scope of production for 2010 and 2011." At the time we issued that Order, the prevailing standard for discovery in whistleblower cases was the same relevancy standard under Rule 70 that applies in Tax Court cases generally. Cf. Whistleblower One 10683-13W v. Commissioner, 145 T.C. 204, 206-07 (2015) (applying relevancy standard in granting whistleblower's motion to compel). Accordingly, we reasoned that limited discovery of examination file documents from Target's 2010/2011 audit cycle was appropriate because the requested documents were "relevant to petitioner's theory of the case."
Following the issuance of our Order, Mr. Arndt asked respondent to produce numerous documents from Target's 2010/2011 examination files, including Information Document Requests (and IRS responses thereto), correspondence among members of the 2010/2011 examination team, and other information that Mr. Arndt believed might support his four-year step-transaction theory. Respondent produced in compliance with our Order another 4,000 pages of documents (Bates No. R-2284 through R-6305). Dissatisfied with that production, Mr. Arndt filed a second Motion to Compel Production of Documents.
Proceedings in this case were then held in abeyance, first on account of Mr. Arndt's death, and then to await the resolution of appeals bearing on this Court's jurisdiction in whistleblower award cases. See, e.g., Lissack v. Commissioner, 68 F.4th 1312 (D.C. Cir. 2023), aff'g 157 T.C. 63 (2021). During this interim period, the Court issued precedential opinions that clarified the exceptions to section 6103 and the discovery standard applicable to whistleblower award cases in the Tax Court. See Whistleblower 972-17W v. Commissioner, 159 T.C. 1 (2022); Berenblatt v. Commissioner, 160 T.C. 534 (2023). In light of these developments, we directed the parties to file (and they did file) supplemental memoranda expressing their views as to the application of Berenblatt in the instant case.
In his August 31, 2023, supplemental memorandum, respondent modified his earlier position regarding the application of section 6103. He acknowledged that the IRS may disclose the "de-redacted" versions of documents previously produced to petitioner, to the extent authorized by our Court's holding in Whistleblower 972-17W v. Commissioner. By Order served May 10, 2024, we denied petitioner's second Motion to Compel Production of Documents insofar as it concerned the application of 6103 and insofar as it concerned petitioner's requests for further discovery. But we did so without prejudice to petitioner's ability to move for supplementation of the administrative record.
On June 18, 2024, respondent filed what he contends to be the entire administrative record (appropriately certified as to its genuineness and completeness). In respondent's view, the documents properly includable in the administrative record consist of Bates No. R-0001 through R-2135, and thus exclude the material from Target's 2010/2011 examination files that Mr. Arndt obtained in discovery. Respondent concurrently filed a privilege log explaining his redactions to the administrative record. Those redactions are based on the attorney-client privilege or section 6103 (to protect information relating to taxpayers other than Target).
On August 15, 2024, petitioner filed a Motion to Complete or Supplement the Administrative Record. She contends that the administrative record filed by respondent is deficient because it redacts certain information and excludes material obtained in discovery from Target's 2010/2011 examination files.
Discussion
I. Petitioner's Request for Supplementation of the Record
The standard of our review of whistleblower award determinations is abuse of discretion, and the scope of our review is limited to the administrative record (the record rule). See Berenblatt v. Commissioner, 160 T.C. at 545-46. Ordinarily, the record before this Court (designated record) consists of those documents that were before the WBO and were considered by the WBO in making its award determination.
In Van Bemmelen v. Commissioner, 155 T.C. 64, 76-77 (2020), we explained that in exceptional circumstances we may supplement the designated record with evidence that the WBO did not consider. The D.C. Circuit has "recognized a small class of cases where the district courts [or, as here, our Court] may consult extra-record evidence when 'the procedural validity of the [agency's action] . . . remains in serious question.'" Hill Dermaceuticals, Inc. v. FDA, 709 F.3d 44, 47 (D.C. Cir. 2013). Our consideration of extra-record evidence "is the exception, not the rule." Van Bem-melen, 155 T.C. at 76 (quoting Theodore Roosevelt Conservation P'ship v. Salazar, 616 F.3d 497, 514 (D.C. Cir. 2010)). The D.C. Circuit and our Court have held that extra-record evidence may be consulted in three "unusual circumstances":
(1) if the agency "deliberately or negligently excluded documents that may have been adverse to its decision," (2) if background information was needed "to determine whether the agency considered all the relevant factors," or (3) if the "agency failed to explain administrative action so as to frustrate judicial review."Van Bemmelen, 155 T.C. at 76-77 (quoting City of Dania Beach, 628 F.3d at 590).
Petitioner contends that the designated record should be supplemented to include the material from Target's 2010/2011 audit files that the IRS produced in discovery, i.e., documents stamped Bates No. R-2136 through R-6305. Respondent urges that the administrative record should exclude these documents because they were not considered by the WBO in denying petitioner's claim. And respondent contends that petitioner has not shown any "unusual circumstances" that would justify inclusion of such extra-record evidence under Van Bemmelen.
We agree with respondent. Petitioner does not contend that the WBO "deliberately or negligently excluded [from the record] documents that may have been adverse to its decision." Van Bemmelen, 155 T.C. at 76-77. And petitioner has not shown that the WBO "failed to explain [the] administrative action so as to frustrate judicial review." Ibid. Mr. Arndt alleged in his Form 211 that Target derived improper tax benefits by engaging in a DAT transaction in 2009. The IRS National Office ultimately rejected his DAT theory, and the 2008/2009 examination was accordingly closed with no adjustment. The WBO properly explained this "administrative action" when denying his claim.
Finally, petitioner has not shown that extra-record evidence from Target's 2010/2011 examination files is needed "to determine whether the [WBO] considered all the relevant factors." Van Bemmelen, 155 T.C. at 76-77. Petitioner in her Motion does not address this (or any other aspect) of our Court's analysis in Van Bemmelen. Indeed, petitioner does not even cite Van Bemmelen-the controlling precedent in our Court-when mounting her argument that supplementation of the record is needed.
Petitioner cites Van Bemmelen only once in her Motion, for the proposition that a case can be remanded to the WBO if the record is found insufficient.
Rather, petitioner simply asserts, in conclusory fashion, that "[t]he administrative record must be supplemented with the documents produced in discovery regarding the 2010 and 2011 tax years, since those documents establish the collection of proceeds arising from the step transaction." But despite having access to 4,000+ pages of such documents, petitioner does not cite a single page that supports this assertion. And the "step transaction" petitioner now alleges is entirely different from the step transaction alleged in the Form 211.
In the Form 211 Mr. Arndt alleged that Target during 2009 had engaged in a "predetermined, single transaction consisting of multiple, interwoven steps" that collectively constituted a DAT transaction. According to petitioner, all steps of this alleged "step transaction" occurred in 2009. After the IRS rejected that theory and made no adjustment for 2009, petitioner shifted ground and hypothesized that Target actually engaged in a four-year step transaction ending in 2012. But petitioner has offered nothing but speculation and conjecture to support that hypothesis.
In July 2012 Mr. Arndt sent the exam team a letter that referenced post-2009 collateral effects allegedly stemming from the "abusive DATT in the first quarter of 2009." This submission simply elaborated on the alleged out-year tax consequences of accepting his 2009 DAT transaction theory-a theory the IRS rejected. At no point has petitioner cited any evidence to show how the IRS could have recovered any proceeds based on his four-year step-transaction theory unless it accepted his premise that a DAT transaction had occurred in 2009. The IRS National Office declined to accept that premise.
In sum, petitioner has failed to show that this case presents any of the "unusual circumstances" that would justify supplementation of the administrative record under Van Bemmelen. We will accordingly deny petitioner's request to expand the designated record to include extra-record material from Target's 2010/2011 examination files.
Petitioner contends that the WBO improperly denied her claim as to years 2010 and 2011 in the absence of a Form 11369 explaining the denial. But the WBO made no reference to any "claim" for 2010-2011; it denied her claim for 2009, the year of the alleged DAT transaction that Mr. Arndt described in the Form 211. And the team that conducted the 2010/2011 examination did not receive petitioner's Form 211 or any of the information it contained. That exam team thus had no occasion to address in a Form 11369 the merits of any award claim.
II. Respondent's Redactions to the Administrative File
Respondent has made limited redactions to 34 documents within the designated record, which consists of 375 documents totaling 2,135 pages. He contends that the redacted material constitutes confidential attorney-client communications and confidential taxpayer return information that is not disclosable under section 6103.
Proceedings in the Tax Court are conducted in accordance with the Federal Rules of Evidence (FRE). See § 7453; Rule 143. The FRE incorporate the common law rules of privilege, including the attorney-client privilege. See AD Inv. 2000 Fund LLC v. Commissioner, 142 T.C. 248, 254 (2014); Fed R. Evid. 501, 1101(c). The attorney-client privilege applies to communications made in confidence (1) by a client to an attorney for the purpose of obtaining legal advice and (2) by an attorney to a client, where the communication contains legal advice or reveals confidential information relating to such advice. Upjohn Co. v. United States, 449 U.S. 383, 390 (1981)); Bernardo v. Commissioner, 104 T.C. 677, 682 (1995). Communications between IRS Chief Counsel lawyers and members of an IRS exam team are generally covered by the attorney-client privilege. See United States v. Jicarilla Apache Nation, 564 U.S. 162, 169-70 (2011); Solers, Inc. v. IRS, 827 F.3d 323, 332 (4th Cir. 2016) (holding that the IRS properly redacted communications between a revenue agent and IRS Chief Counsel).
Under section 6103, IRS offices and employees are barred from disclosing confidential taxpayer information unless an exception applies. One such exception authorizes the IRS to disclose return information in a Federal judicial proceeding pertaining to tax administration if "the proceeding arose out of, or in connection with, determining the taxpayer's . . . liability." § 6013(h)(4)(A); see Whistleblower 972-17W v. Commissioner, 151 T.C. 1 (2022). Respondent now agrees that section 6013(h)(4)(A) authorizes disclosure to petitioner of Target's taxpayer information. But he has redacted information in the designated record that relates to other taxpayers.
Respondent has the burden of showing that the documents sought by petitioner are privileged. Bernardo, 104 T.C. at 682. In practice, this Court has generally required the party asserting privilege to submit a privilege log. See Bernardo, 104 T.C. at 683-84. At a minimum the privilege log must include the subject matter of the documents and the facts establishing each element of the privilege claim. See Pac. Mgmt. Group v. Commissioner, T.C. Memo. 2015-97, 109 T.C.M. (CCH) 1505, 1506. However, the "privilege log must balance the need to show that specific communications are privileged against the risk of inadvertently waiving the attorney-client privilege by disclosing too much information." Ibid.
Respondent asserts the attorney-client privilege with respect to 31 documents in the designated record. The privilege log describes these documents as communications between IRS Chief Counsel attorneys and members of Target's examination team. The privilege log provides a brief description of each document's subject matter. Petitioner makes the high-level assertion that respondent should not "be permitted to use . . . the attorney-client privilege as an excuse to shield potentially unfavorable portions of the administrative record from the Court." But petitioner does not contend that respondent's privilege log is inadequate to support his claims of privilege.
Respondent asserts section 6103 as the basis for redacting three documents in their entirety. Respondent made these redactions to protect taxpayers who are not identified in petitioner's claim for award. Petitioner asserts that "[t]here is no justification for redacting the administrative record, since the redacted documents are essential to any proper judicial review of Respondent's determination." But petitioner wholly fails to address the specific redactions respondent has made and respondent's justification for making them. Petitioner has offered no plausible argument-indeed, she makes no argument at all-that section 6013(h)(4)(A) authorizes disclosure of the information redacted from the three documents in question.
In sum, we find that respondent's privilege log and the documents themselves "set forth facts that establish, as to each document, each element of the claimed privilege," including "the identification of the authors, dates of preparation, and subject matter of the documents." Pac. Mgmt. Group, T.C. Memo. 2015-97, 109 T.C.M. (CCH) at 1506. The privilege log thus justifies the redactions respondent has made to the designated record.
III Petitioner's Request for Remand
Petitioner alternatively requests an order remanding this case to the WBO for further consideration of her award claim. Our review of WBO determinations is generally limited to the designated record. Berenblatt, 160 T.C. at 545-46. However, if the record before the agency does not support the agency action, if the agency has not considered all relevant factors, or if the reviewing court simply cannot evaluate the challenged agency action on the basis of the record before it, the proper course is generally to remand to the agency for additional investigation or explanation. See Whistleblower 769-16W v. Commissioner, 152 T.C. 172, 178 (quoting Fla. Power & Light Co. v. Lorion, 470 U.S. 728, 744 (1985)).
Respondent contends that remand is unnecessary because the designated record supports the WBO's determination to deny petitioner's award claim. Respondent represents that he will file a motion for summary judgment that will further support this point. We will deny petitioner's request for a remand at this time, but she may renew that request in connection with her response to the forthcoming motion.
Upon due consideration, it is
ORDERED that petitioner's Motion to Complete and Supplement the Administrative Record, filed August 15, 2024, is denied.