Opinion
Case No. 01-MISC-50
February 13, 2002
DECISION AND ORDER
This matter comes before the Court on the Frederic Kohler Estate's ("the Estate") petition to quash two Internal Revenue Service ("IRS") summonses issued on August 22, 2001. The respondent has filed a motion to dismiss the petition, and for the reasons stated below, the motion is granted and the petition to quash is denied.
I.
Frederic C. Kohler died on March 4, 1998. The decedent owned stock in the Kohler Company, a close corporation. Pursuant to an audit, the IRS is in the process of determining the value of this stock for estate tax purposes. In connection with its investigation, the IRS has issued two summonses. One seeks documents from Nan G. Todd, Clerk of Court for the Sheboygan County Circuit Courthouse. The other seeks documents from the Kohler Company itself. Many of the documents sought were generated in connection with a lawsuit filed in Sheboygan County, Kohler Company v. SoGen International Fund, et al., Case No. 98-CV-0437. The focus of this lawsuit was to determine the fair value of Kohler Company stock pursuant to Wisconsin's dissenter's rights procedure, Wis. Stat. § 180.1330 et seq..
Many are under seal, but as will become apparent, this is irrelevant to the Court's analysis.
II.
The IRS has broad authority to issue summonses in connection with an investigation:
(a) Authority to summon, etc. — For the purpose of ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax or the liability at law or in equity of any transferee or fiduciary of any person in respect of any internal revenue tax, or collecting any such liability, the Secretary is authorized —
(1) To examine any books, papers, records, or other data which may be relevant or material to such inquiry.26 U.S.C. § 7602 (a)(1) (emphasis added). "The information-gathering authority granted to the IRS under § 7602 is quite broad. Indeed, the Supreme Court has described § 7602 as the `centerpiece' of a much larger congressional design to endow the IRS with expansive authority to conduct effective tax investigations. Holifield v. United States, 909 F.2d 201, 205 (7th Cir. 1990) (citing United States v. Arthur Young Co., 465 U.S. 805, 814 (1984)). The Estate has standing to challenge the summonses even though they have been served on third parties. See generally § 7609.
When, as here, the summonses are served on third-parties, § 7609 outlines specific procedures and safeguards. The IRS has complied with all of these procedures.
When a party does not comply with a summons (or, as here, when a petition to quash is filed), the IRS must rely on the district courts for enforcement. § 7402(b). As an initial matter, the IRS must establish that the summons was issued in good faith. This is accomplished with a prima facie showing of the following elements: (1) the investigation underlying the summons has a legitimate purpose; (2) the information sought may be relevant to that purpose; (3) the information is not already in the IRS's hands; and (4) the IRS has followed the statutory steps for issuing a summons. See 2121 Adington Heights Corp. v. Internal Revenue Service, 109 F.3d 1221, 1224 (7th Cir. 1997) (citing United States v. Powell, 379 U.S. 48, 57-58 (1964)). "That isn't much of a hurdle. . . . The government typically makes that showing through the affidavit of the revenue agent conducting the audit," and this case is no exception. 2121 Arlington Heights at 1224 (citing United States v. Kis, 658 F.2d 526, 536 (7th Cir. 1981), cert. denied, 455 U.S. 1018 (1982)).
The declaration of IRS Estate Tax Attorney Norman D. Wheeler ("Wheeler"), the investigating officer in this case, meets all of these requirements.
Finally, a portion of the Seventh Circuit's opinion in United States v. Kis adequately summarizes the nature of the proceedings before this Court:
In discussing the relative burdens of the parties in summons enforcement actions, we cannot stress too emphatically that these proceedings are intended to be summary in nature. They occur, after all, at only the investigative stage of any action against a taxpayer, and no guilt or liability on the part of the taxpayer is established. The sole reason for the proceedings and for permitting the taxpayer to intervene . . . is to ensure that the IRS has issued the summons for proper investigatory purposes under section 7602 and not for some illegitimate purpose (such as, for example, using a civil summons to gather evidence to be used solely in a criminal prosecution).
For these reasons, the burden on the taxpayer to prove Government wrongdoing is significantly greater than that on the Government to show its legitimate purpose. The action should be concluded quickly, so that the investigation may advance toward the ultimate determination of civil or criminal liability, if any.Kis at 536.
III.
Because the government has met its burden, the Estate must "show that enforcement of the summons would constitute an abuse of process. [The Estate] can do that either by disproving the existence of one of the [above-listed] factors or pointing to specific facts suggesting that the IRS issued the summons in bad faith." 2121 Arlington Heights at 1224. There are seven categories of documents the IRS is seeking to obtain, and the Estate is essentially objecting that the documents and information sought are not relevant to the investigation. The Estate has no objection to the first two categories of documents, so the Court will only examine the remaining five categories.
The Estate characterizes Category One as including "Documents Containing Financial Information or other information prior to January 1, 1999, no matter when the document was created." Category Two includes "Appraisals and Related Documents Commissioned by Kohler Co. in connection with the state or federal litigation with a valuation date in May 1998."
A. Category Three: Financial documents containing financial information about the financial status of the Kohler Co. on or after January 1, 1999
The Estate argues that any information regarding the financial status of the Kohler Company after September 4, 1998, the elected date of stock valuation, is not relevant for the purpose of ascertaining the correctness of its tax return. The Estate cites Rev. Rul. 59-60, 1959-1 C.B. 237 which outlines the approach to be used in valuing shares of capital stock of closely held corporations for estate and gift tax purposes. According to this ruling, valuation is "a prophesy as to the future and must be based on facts available at the required date of appraisal." Emphasis added. The Estate therefore argues that the summonses must be quashed to the extent they seek information about the financial status of the Kohler Company on or after January 1, 1999.
The Estate has elected September 4, 1998 as an "alternate valuation date" for its Kohler stock. 26 U.S.C. § 2032. § 2032 permits an estate to elect a valuation date six months after the date of death, provided the value of the estate has declined.
Information about financial status on or before December 31, 1998 is not at issue because they are part of Category One. As noted above, the Estate does not object to the production of "Category One" documents.
However, the standard is not this exacting. A summons should be enforced if the information sought "may be relevant or material to the inquiry." § 7602(a). The Supreme Court has noted that, in drafting this language, the "purpose of Congress is obvious: the Service can hardly be expected to know whether such data will in fact be relevant until it is procured and scrutinized." Arthur Young at 814. The Court is therefore hesitant to conclude, as a matter of law, that this information could not possibly be relevant or material to the inquiry. Wheeler avers that he is seeking management projections for 1998 through 2000 to aid in determining "the validity of the two sets of Kohler Company projections of future business results made before the valuation date and used in appraisals for the Estate submitted with its return." Wheeler Aff., ¶ 6. Wheeler also seeks drafts of Kohler Company's board of directors' plans and monthly financial plans for periods after December 31, 1998 to facilitate a comparison of Kohler's projections after the valuation date with the actual results. Id., ¶ 7. This could show whether "the projections used in the appraisals submitted with the Estate tax return were unduly pessimistic thus resulting in a lower stock valuation as of March 4 and September 4, 1998." Id., ¶ 6. This is sufficient to show that the material sought could be relevant to determining the correctness of the Estate's return. As such, the petition to quash the summonses with respect to documents in Category Three is denied.
Wheeler further avers: "I routinely request and use information about appraisals and sales within three years of the valuation date when determining the value of closely held stock on estate tax returns. By within 3 years, I mean 3 years before the valuation date and three years after the valuation date." Wheeler Aff., ¶ 9 (emphasis added).
B. Category Four: Appraisals and related documents not commissioned by Kohler Co., but by third parties
The IRS seeks "documents and information identified by an expert the government is considering hiring, Valuemetrics, as those it needs in order to appraise the Kohler Company." Motion to Dismiss, p. 13. These documents were used by Valuemetrics to value the Kohler Company stocks for some of the dissenting shareholders in the state court litigation cited above. The Estate objects to producing these documents because the purpose of the underlying litigation was to determine the "fair value" of the stock under Wisconsin law, not to determine the "fair market value" as that term is defined in the federal tax code. Further, the Estate objects because the stock was valued as of May 11, 1998, as opposed to September 4, 1998, the Estate's elected valuation date for federal estate tax purposes. The focus of the state litigation certainly differed from the focus of the IRS's present inquiry. However, the underlying documents could be relevant for more than one purpose. In other words, simply because the focus of the state litigation differed from the IRS's estate tax inquiry does not necessarily imply that the underlying documents would be irrelevant to ascertaining the correct value of the shares for estate tax purposes. Despite the differing standards and valuation dates, at a minimum, the information could be relevant to ascertaining the correctness of the Estate's return. Accordingly, the petition to quash the summonses with respect to documents in Category Four is denied.
Valuemetrics was required to destroy these documents after the litigation eventually settled. Wheeler Aff., ¶ 5.
Pursuant to a settlement agreement, the "fair value" of the stock under Wisconsin law was determined to be $135,000 per share. Phillip H. Martin Aff., Ex. 1.
The Estate also objects to the production of these third-party valuations because, as Donald M. Nicholson ("Nicholson") avers, "[t]he dissenting shareholders' appraisals represent opinions as to value offered by parties which have interests adverse to Kohler and which were never subjected to the court's scrutiny or cross examination. As such they are untried, unproven and possibly highly biased. I would not find the value conclusions offered in such appraisals as useful, objective or relevant to performing an appraisal of Kohler in the Estate matter." Nicholson Aff., ¶ 8. However, even information which is "untried, unproven and possibly highly biased" could be relevant to the IRS's inquiry. § 7602's standard of relevance is not to be equated with the term as it is used in the Federal Rules of Evidence.
C. Category Five: To the extent the IRS now identifies documents which have not been summonsed, the Petition to Quash should be granted
The Estate seeks to quash the petition to the extent the IRS seeks documents referred to in their motion to dismiss but not included in their summons to the Kohler Company. However, the documents the Estate identifies were properly summonsed. The summons identifies ranges of document numbers, and all of these documents were included in those ranges. Accordingly, the petition to quash the summons with respect to documents in Category Five is denied.
For example, the summons requests Sheboygan County Court Foley Respondents Exhibits K23937-38-K1508-10. Apparently, the Estate read this as referring to two documents (K23937-38 and K 1508-10), but the dash between the two was meant to include all document numbers between them.
D. Category Six: Documents which appear in the attachment to the Kohler summons, but the IRS has not even attempted to make a showing that the documents are relevant to its inquiry
The Estate lists a number of documents for which, it argues, the IRS has failed to make the required showing of relevancy. All but one of the document numbers are included in the ranges listed on the summonses, but the numbers do not have any corresponding documents. The IRS cannot summons documents which do not exist.
The IRS has made the required relevancy showing for this document. See Respondents' Exhibit J, p. 12, Foley Respondents' Exhibit List, #K23937-38.
E. Category Seven: The documents under seal with the Sheboygan Clerk of Courts sought by the IRS are objected to only to the extent that the documents would fall into category numbers 3-6 above
Because the petition to quash documents in categories 3-6 has been denied, there is no need to discuss the documents identified in Category Seven.
NOW, THEREFORE, BASED ON THE FOREGOING, IT IS HEREBY ORDERED THAT:
1. The Respondents' motion to dismiss is GRANTED, such that the Estate's petition to quash is in all respects DENIED.