Opinion
1:20-cv-11307
11-01-2024
MANN CONSTRUCTION, INC.; BROOK WOOD; KIMBERLY WOOD; LEE COUGHLIN; DEBBIE COUGHLIN; Plaintiffs, v. UNITED STATES OF AMERICA, Defendant.
District Judge Thomas L. Ludington
REPORT AND RECOMMENDATION ON PLAINTIFFS' MOTION FOR ATTORNEY FEES (ECF No. 52)
PATRICIA T. MORRIS, UNITED STATES MAGISTRATE JUDGE
I. RECOMMENDATION
For the following reasons, I RECOMMEND that the Court DENY Plaintiffs' motion for attorney fees (ECF No. 52).
II. REPORT
A. Introduction
This is a refund suit brought by a construction company and its shareholders to recover penalties they paid to the IRS. Plaintiffs succeeded on the merits of their case and regained the funds paid to the IRS. Now, they move to recover the expenses they incurred in pursuit of their refund under 26 U.S.C. § 7430. For the reasons set forth below, I suggest that Plaintiffs cannot recover their expenses and their motion should be denied.
B. Background
The Sixth Circuit Court of Appeals concisely summarized the facts of this case:
In collecting federal taxes, the Internal Revenue Service uses a “system of self-reporting.” United States v. Bisceglia, 420 U.S. 141, 145 (1975). Much as there may not be “a patriotic duty to increase one's taxes” under that system, Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), there is a duty to report all of the financial information that Congress requires.
Congress delegated power to the Secretary of the Treasury, who, through the IRS, requires taxpayers to submit information needed to assess and collect taxes. See 26 U.S.C. § 6011; see also id. § 7701(a)(11)(B). This information-gathering imperative allows the government to ensure compliance with tax provisions and ferret out improper tax avoidance.
In 2004, Congress added 26 U.S.C. § 6707A to the IRS's arsenal of tools for identifying tax avoidance schemes. Designed to shed light on potentially illegal tax shelters, § 6707A permits the IRS to penalize the failure to provide information concerning “reportable” and “listed” transactions.
A “reportable transaction” is one that has the “potential for [illegal] tax avoidance or evasion.” Id. § 6707A(c)(1). A “listed transaction” is one that “is the same as, or substantially similar to, a transaction” that the IRS has identified as a “tax avoidance transaction.” Id. § 6707A(c)(2). The statute authorizes monetary penalties and criminal sanctions for noncompliance with these reporting requirements. Id. §§ 6707A(b), 7203.
Today's dispute centers on a listed transaction. In 2007, the IRS issued Notice 2007-83, entitled “Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits.” 2007-2 C.B. 960. The Notice designates certain employee-
benefit plans featuring cash-value life insurance policies as listed transactions. A cash-value life insurance policy combines life insurance coverage with a cash-value investment account. As the IRS saw it, these transactions run the risk of allowing small business owners to receive cash and other property from the business “on a tax-favored basis.” Id.
Brook Wood and Lee Coughlin collectively own Mann Construction, which is based in Michigan. The company provides general contracting, construction management, and similar services.
From 2013 to 2017, Mann Construction established an employee-benefit trust that paid the premiums on a cash-value life insurance policy benefitting Wood and Coughlin. The company deducted these expenses, while Wood and Coughlin reported as income part of the insurance policy's value. Neither the individuals nor the company reported this arrangement to the IRS as a listed transaction.
In 2019, the IRS concluded that this structure fit the description identified in Notice 2007-83. The agency imposed penalties on the company ($10,000) and both of its shareholders ($8,642 and $7,794) for failing to disclose their participation in the trust. All three paid the penalties for the 2013 tax year and sought administrative refunds, claiming the IRS lacked authority to penalize them. When the administrative process for challenging the penalties left the taxpayers empty-handed, they turned to federal court.Mann Constr. v. United States, 27 F.4th 1138, 1141-42 (6th Cir. 2022).
Their complaint alleged four counts challenging the validity of their penalties: “(1) the Notice failed to comply with the notice-and-comment requirements of the Administrative Procedure Act; (2) it constituted unauthorized agency action; (3) it was arbitrary and capricious; and (4) even if the Notice was valid, the arrangement at issue did not fall within its scope.” Id. at 1142. Plaintiffs sought refunds for tax year 2013 and declaratory relief for tax years 2014 through 2017, for which they had not yet paid any penalties. (ECF No. 1, PageID.29; see also id. at PageID.25-26, 28).
On the Government's motion, the District Court dismissed most of Plaintiffs' complaint. To start, the Parties concurred in dismissal of Plaintiffs' claims for declaratory relief from liability for tax years 2014 through 2017 and the Court agreed to dismissal, ostensibly recognizing that it lacked subject matter jurisdiction over these claims. (ECF No. 22, PageID.243 (citing (ECF No. 15, PageID.72)). See generally 26 U.S.C. § 1346(a)(1); 28 U.S.C. § 1346(a)(1). As for tax year 2013, the Court dismissed each count except for Plaintiffs' notice-and-comment theory. (ECF No. 22, PageID.265).
The United States later moved for summary judgment on this final issue and the District Court granted their motion, agreeing that Notice 2007-83 did not violate the notice-and-comment requirements of the Administrative Procedure Act (“APA”). (ECF No. 45). The Sixth Circuit reversed, entering judgment in favor of Plaintiffs, and the government later refunded their penalties. (ECF Nos. 49, 67). Plaintiffs now move to recover their litigation expenses, totaling $220,482.50. (ECF No. 52).
C. Analysis
At their discretion, district courts may order the United States to reimburse a taxpayer for any reasonable expenses incurred during an action to recover “taxes, penalties, or interest” unlawfully collected by the government. 26 U.S.C. § 7430(a). To be eligible, a taxpayer must have been a “prevailing party”-that is, the Taxpayer must “substantially” prevail on either “the amount in controversy” or “the most significant issue . . . presented.” Id. § 7430(a), (c)(4). But that general rule comes with a hefty caveat. Even successful taxpayers cannot be treated as “prevailing parties” eligible to recover litigation expenses if the government's opposition was “substantially justified.” Id. § 7430(c)(4)(B). If the government pursued a “substantially justified” position, then taxpayers can recover their fees in just one circumstance. They must show that the government rejected a valid settlement offer (referred to in the statute as a “qualified offer”), and that the taxpayer's liability “pursuant to the judgment” is “equal to or less than the” taxpayer's offer. Id. at § 7430(c)(4)(E), (g). In this situation, the taxpayer may recover all reasonable expenses from the time of the offer. Id. at § 7430(c)(4)(E)(iii).
All parties agree that Plaintiffs substantially prevailed on both the amount in controversy and the most significant set of issues. (See ECF Nos. 52, 55). Yet the government's position in this matter was substantially justified and Plaintiffs did not tender a valid qualified offer. Thus, despite succeeding on the merits, Plaintiffs cannot be treated as prevailing parties, and the Court has no discretion to award fees and costs.
1. Whether the United States' Position Was Substantially Justified
Even if a taxpayer succeeds on the merits of its refund suit, the taxpayer cannot be treated as a prevailing party eligible to recover fees and costs if the government's opposition to the taxpayer's refund “was substantially justified.” 26 U.S.C. § 7430(c)(4)(E). The government's position need not be successful or even correct to be “substantially justified.” See Ekman v. Comm'r of Internal Revenue, 184 F.3d 522, 526-27 (6th Cir. 1999); Estate of Lute v. United States, 19 F.Supp.2d 1047, 1061 (D. Neb. Mar. 11, 1998). Rather, the government's position is substantially justified if it “has a reasonable basis in law or fact.” William L. Comer Family Equity Pure Trust v. Comm'r of Internal Revenue, 958 F.2d 136, 139-40 (6th Cir. 1992) (internal quotation marks omitted) (quoting Pierce v. Underwood, 487 U.S. 552, 563-65 (1988). Put differently, its position must have been “justified to a degree that could satisfy a reasonable person.” Pierce, 487 U.S. at 563-65. The government bears the burden of proving that it pursued a substantially justified position. 26 U.S.C. §7430 (c)(4)(B)(i); see United States v. True, 250 F.3d 410, 419 n.7 (6th Cir. 2001).
When Plaintiffs initially filed this action, they argued that the IRS's penalties were unlawful on four distinct grounds. (ECF No. 1, PageID.23-29). Yet now, they only assert that one of these positions was so incontrovertible that the government was not substantially justified in pursuing the penalties. Specifically, they argue that no reasonable person could accept the government's position that Notice 2007-83 was not subject to the APA's notice and comment procedures. (ECF No. 52, PageID.648-53).
For a “legislative”rule, like Notice 2007-83, to have the force and effect of law, the agency must first “publish a notice about the proposed rule, allow the public to comment on the rule, and, after considering the comments, make appropriate changes and include in the final rule a ‘concise general statement of' its contents.” Mann Constr., 27 F.4th at 1142 (quoting 5 U.S.C. § 553). All agree that the IRS did not follow this notice and comment procedure before issuing notice 2007-83. Nonetheless, the Government argues that it need not have done so because Congress exempted it from complying with this provision of the APA.
Only “legislative” rules that create “new duties on rights” have the “force and effect of law” and are subject to the APA's notice-and-comment procedure. Mann Constr., 27 F.4th at 1143 (internal quotation marks omitted) (quoting Perez v. Mortgage Bankers Ass'n, 575 U.S. 92, 96-97 (2015)). Rules that merely interpret existing law carry no binding weight and need not be promulgated through notice-and-comment. Id. As explained by the Sixth Circuit, Notice 2007-83 is a legislative rule. Id. at 1143-44.
Later statutes may only modify or supersede the APA's notice comment procedures if they do so “expressly.” 5 U.S.C. § 559. Yet Courts have not read this language literally. While § 559 would appear to “forbid[] amendment of the APA by implication,” courts have long recognized that Congress need not “employ magical passwords in order to effectuate an exemption from the” APA. Marcello v. Bonds, 349 U.S. 302, 310 (1955); Lane v. U.S. Dep't of Agric., 120 F.3d 106, 110 (8th Cir. 1997). A subsequent statute abrogates the APA's notice-and-comment requirement if it expresses Congress's intent to do so in a “‘clear' or ‘plain' way”- exemptions from the APA should not be “lightly . . . presumed.” Marcello, 349 U.S. at 310; Mann Constr., 27 F.4th at 1145 (quoting Lockhart v. United States, 546 U.S. 142, 145-46 (2005)). Or, as put by the D.C. Circuit, the question is “whether Congress has established procedures so clearly different from those required by the APA that it must have intended to displace the norm.” Asiana Airlines v. FAA, 134 F.3d 393, 397 (D.C. Cir. 1998).
So when is an exemption from the APA sufficiently clear? To start with an obvious example, Congress's express statement that the APA “shall not apply” to a particular statute constitutes a valid exemption. Reich v. Youghiogheny & Ohio Coal Co., 66 F.3d 111, 114 n.2 (6th Cir. 1995). But Congress may also exempt an agency from the APA without saying so outright. For example, the Supreme Court held that the Immigration and Nationality Act implicitly superseded the APA because Congress “laborious[ly] adaptat[ed]” the APA and deviated from its baseline procedure at “specific points.” Marcello, 349 U.S. at 310. Likewise, the D.C. Circuit held that the Federal Aviation Reauthorization Act implicitly superseded the APA by creating “specific procedures” that differed “from those of the APA.” Asiana Airlines, 134 F.3d at 398.
By contrast, courts have held that minor deviations from the APA do not clearly supersede the Act if they remain compatible with the APA's procedures. Lake Carriers' Ass'n v. EPA, 652 F.3d 1, 6 (D.C. Cir. 2011); Citizens for Resp. & Ethics in Wash. v. FEC, 993 F.3d 880, 890-92 (D.C. Cir. 2021); Lane v. U.S. Dep't of Agric., 120 F.3d 106, 109-10 (8th Cir. 1997).
The government, and the District Judge, believed that Congress expressed an exemption that fell on the “sufficiently clear” side of the fence. The District Court reasoned that § 6707A defined listed transactions as “reportable transaction[s] which [are] the same as, or substantially similar to, [transactions] specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011.” Mann Constr. v. United States, 539 F.Supp.3d 745, 757-58, 760-61 (E.D. Mich. 2021). And a reportable transaction, in turn, is any transaction “the Secretary determines as having a potential for tax avoidance” as “determined under the regulations prescribed under § 6011.” Id. The Court observed that at the time Congress passed § 6707A, a regulation passed under § 6011 had already defined reportable transactions to include listed transactions identified by the Secretary “by notice, regulation, or other form of published guidance.” Id. That “reference [was] significant,” according to the Court, because “revenue notices . . . are normally issued without the notice and comment required by the APA.” Id.
Under well-established precedent, “Congress is presumed to be aware of an administrative . . . interpretation of a statute ....” Lorillard v. Pons, 434 U.S. 575, 580 (1978). If that precedent was to be taken seriously, then Congress, when it instructed that § 16011-4 would define reportable (and listed) transactions, presumably knew that the regulation permitted the IRS to identify listed transactions by notice. See id. Thus, Congress adopted § 1.6011-4's procedural rules by crossreferencing the regulation without any qualifications. Mann Constr., 539 F.Supp. at 760. That alone was enough for the District Court to find that Congress clearly exempted § 6707A from the APA's notice-and-comment procedure. Id. at 760-61. But to alleviate any doubt, the Court went on to note that Congress passed up on three opportunities to amend § 6707A since it passed since it passed the statute, even though the IRS had identified thirty-four listed transactions by revenue notice in the years since § 6707A came into effect. Id. at 761-62.
The Sixth Circuit, on the other hand, felt the District Judge's rationale took too “winding and elaborate” of a “route” to show a “clear” displacement of the APA's notice-and-comment procedure. Mann Constr., 27 F.4th at 1147. To start, the Court found it notable that Congress did not abrogate the APA's notice-and-comment procedure in text of § 6707A itself. Id. at 1145-46. And as for § 6707A's cross-reference to § 16011-4, the Court conceded that the cross reference was “probative of whether Congress was aware of the IRS's transaction-listing procedures” but it believed the cross reference was not quite enough “to show an express exemption from the APA procedures.” Id. at 1146-47. The Court also remarked that § 9707A's “key feature” was to list the “‘type[s]' of ‘transactions'” subject to penalties and that Congress listed the cross-reference in the definitions portion of the statute. Id. at 1146 (quoting 26 U.S.C. § 6707A(c)(1)). In the Sixth Circuit's view, this indicated that Congress meant to authorize the IRS to determine the types of transactions that were reportable-not the process for making that determination. Id.
Both the Sixth Circuit and this Court reached reasonable conclusions. Neither Court found any cases, let alone binding precedent, specifically addressing whether § 6707A abrogated the APA. Id. at 1144-48; Mann Constr., 539 F.Supp.3d at 75663. Nor did they find any examples where a court considered whether Congress clearly abrogated the APA's notice-and-comment procedures by giving its blessing to an existing regulation that departed from the notice-and-comment procedure. Id. In the absence of any analogous precedent, both Courts solved this novel issue resorting to first principles. But those principles, directing the Court to consider whether Congress expressed a clear intent to abrogate the APA, were too broad and abstract to provide any useful guidance. See Nalle v. Comm'r of Internal Revenue, 55 F.3d 189, 192 (5th Cir. 1995); George v. United States, 666 F.Supp. 962, 965 (E.D. Mich. 1987). At bottom, the District Court and the Sixth Circuit were tasked with answering a nebulous question that required both Courts to make a judgment call. The District Judge felt that § 6707A was clear enough; the Sixth Circuit believed the statute fell short of that standard. See Christiansburg Garment Co. v. EEOC, 434 U.S. 412, 421-22 (1978); Marre v. United States, 117 F.3d 297, 301 (5th Cir. 1997).
That should be enough to establish that the Government was substantially justified in penalizing Plaintiffs, but Plaintiffs attempt to save their argument by lobbing one final Hail Mary. According to Plaintiffs, the Court should find the government's position to not be substantially justified as, essentially, punishment for various misdeeds of an IRS attorney involved in the imposition of their penalties. (ECF No. 52, PageID.649-50, 653-56). Plaintiffs explain that this attorney, Brian Derdowski, was involved at the administrative level and currently represents the United States in two parallel proceedings pending before the Tax Court. (Id.) Although there are apparently others, Plaintiffs share just three of these wrongdoings with the Court. First, they accuse Derdowski of directing “the IRS Independent Office of Appeals” not to inform Plaintiffs of “the basis for their penalties.” (Id. at PageID.653-54). Second, they accuse Derdowski of incorrectly arguing to the Tax Court that the District Court dismissed part of their complaint “on the merits.” (Id. at pageID.654-55). And third, they accuse Derdowski of misrepresenting various aspects of the Benefits Trust “in all assessments” he “authored.” (Id. at PageID.655-56).
None of these actions are relevant to determining whether the government's position is substantially justified. Under § 7430, the government's position is its position on the ultimate issue in the matter-whether the taxpayer is liable for taxes or penalties in a given year. Indeed, the statute instructs to consider not whether “a” position of the United States was substantially justified, or whether the “position[s]” of the United States were justified: it asks whether “the position of the United States was substantially justified.” 26 U.S.C. § 7430(c)(4)(B)(i)-(iii), (c)(A)-(B) (emphasis added). The statute, therefore, does not direct courts to scrutinize every argument or assertion advanced by the government throughout litigation. See Id. Instead, it narrowly directs the Court to conduct an “objective[]” inquiry into whether the government was substantially justified in pursuing penalties or owed taxes. See Beaty v. United States, 937 F.2d 288, 292-93 (6th Cir. 1991). If so, then the government's position is substantially justified, irrespective of whatever blunders, failed arguments, or misrepresentations the government may have made in its pursuit of an otherwise reasonable goal. See Estate of Lute, 19 F.Supp.2d at 1061 (quoting H.R. Rep. No. 1418 (1980), reprinted in 1980 U.S.C.C.A.N. 4984, 4993).
Yet Plaintiffs do not explain how Derdowski's actions rendered the government's ultimate position unreasonable. True, Plaintiffs note that Derdowski allegedly misrepresented several facts about the trust, and they accurately recite that a substantially justified position must have “a reasonable basis in . . . fact.” (ECF No. 52, PageID.648, 653-56). But for the government's position to not have had a reasonable basis in fact, it must have relied on Derdowski's misrepresentations. See Pierce, 487 U.S. at 563-65. The Government's entire position does not lose a reasonable basis in fact just because it may have misstated some immaterial facts. See id. Yet Plaintiffs do not explain why these misrepresentations mattered. And based on the District Judge's discussion of whether the Trust constituted a listed transaction in his order in Defendants' motion to dismiss, it is difficult to see how these facts were relevant. (See ECF No. 22, PageID.255-63). At bottom, § 7430 is not the proper tool for the Plaintiffs to hold “Derdowski and the IRS . . . to account for their conduct.” (ECF No. 52, PageID.656).
That is assuming these statements truly were misrepresentations. Counsel provides no citations or exhibits to support his argument. (Id.)
Plaintiffs' arguments that Derdowski was not “substantially justified” in misrepresenting facts to the Tax Court fails for another fundamental reason. Section 7430 only permits taxpayers to recover fees “in connection with” the proceeding in which it prevails. 26 U.S.C. § 7430(a), (c)(1)(B)(i)-(ii). Likewise, the substantial justification exception evaluates the government's position “in the proceeding.” Id. § 7430(c)(4)(B)(i). But Brook Wood and Lee Coughlin's actions in the Tax Court are separate proceedings.
Once a taxpayer exhausts its administrative remedies, it generally has three options for appeal: the Tax Court, the Court of Claims, or the District Courts. Martin v. Comm'r of Internal Revenue, 753 F.2d 1358, 1360 (6th Cir. 1985). The decision of each Court can be appealed to the applicable Circuit Court. See Jianglin Zhou v. United States, 727 Fed.Appx. 651, 654 (Fed. Cir. 2018) (citing 28 U.S.C. § 1295(a)(3)); Cooper v. Comm'r of Internal Revenue, 502 Fed.Appx. 472, 476 (6th Cir. 2012) (citing 26 U.S.C. § 7482(a)(1)). Thus, the District Court and the Tax Court are alternative trial courts for Taxpayers-they function independently with neither Court having appellate jurisdiction over the other. See Davis v. IRS, No. 6:18-cv-2052, 2019 WL 11502083, at *4 (M.D. Fla. Oct. 30, 2019) (citing U.S. v. Lezdey, 448 Fed.Appx. 893, 895 (11th Cir. 2011)).
Plaintiffs provide little detail about their Tax Court cases except to state that they also “involve the APA issue challenging the Notice.” (ECF No. 57, PageID.808 n.6). Presumably, Plaintiffs filed their suits in the Tax Court after the District Court dismissed their claims for declaratory relief from liability for the 2014 through 2017 tax years for lack of jurisdiction. (See ECF No. 22, PageID.243 (citing ECF No. 15, PageID.72)). Indeed, the district courts only have jurisdiction over refund suits; the Tax Court is the only venue in which taxpayers can sue the government without first paying their deficiency. Govig & Assocs., Inc. v. United States, No. CV-22-00579, 2023 WL 2614910, at *2 (D. Ariz. Mar. 23, 2023).
However, it is not Plaintiffs' challenge of Notice 2007-83 under the APA, but their ultimate tax liability for each given year that constitutes a distinct cause of action. Finely v. United States, 612 F.2d 166, 170 (5th Cir. 1980). So to the extent Plaintiffs are pursuing declaratory relief in the Tax Court for Tax Years 2014 through 2017, these are separate causes of action before an independent trial court-even if they involve the same IRS Notice and turn on similar facts. See id.; Davis, 2019 WL 11502803, at *4. Thus, they are distinct “proceeding[s].” See 26 U.S.C. § 7430(a). And if Plaintiffs also filed suit in the Tax Court to obtain a refund for the 2013 Tax Year, then that action would have deprived this court of jurisdiction at the moment it was filed. Statland v. United States, 178 F.3d 465, 471-72 (7th Cir. 1999) (citing 26 U.S.C. § 7422(e)). In any event, Coughlin and Lee's actions before the Tax Court are separate proceedings, and it is for the Tax Court, not the District Court, to determine whether the government's position in those proceedings is substantially justified.
For these reasons, I suggest that the Government's position was substantially justified, and Plaintiffs are not entitled to fees and costs unless they made a valid qualified offer.
2. Whether Plaintiffs Made a Qualified Offer
Even if the Government's position was substantially justified, Plaintiffs argue that they should nonetheless be treated as prevailing parties because they tendered a “qualified offer” to the government. Under § 7430(c)(4)(E), a taxpayer “shall be treated” as a prevailing party from the moment it tenders a settlement offer (referred to in the statute as a “qualified offer”) to the government if the government rejects that offer and “the liability of the taxpayer” ends up being “equal to or less than the liability of the taxpayer which would have been so determined if the United States had accepted” the offer. 26 U.S.C. § 7430(c)(4)(E)(i), (g). A taxpayer may tender a qualified offer as soon as it receives a “letter of proposed deficiency” allowing the taxpayer to pursue administrative review. Id. § 7430(g)(2)(A).
The parties agree that Plaintiffs tendered a settlement offer that meets the basic requirements of a “qualified offer.” (ECF No. 52, PageID.657-58; see ECF No. 55, PageID.789-92). Indeed, Plaintiffs ultimately owed less money that they offered to pay in their qualified offer, they tendered their qualified offer during the correct timeframe, and they met all the statute's other procedural requirements. (Id.)
Still, the government argues that Plaintiffs did not make a valid qualified offer. It explains that Plaintiffs offered to settle their claims for only one dollar. (ECF No. 55, PageID.790-92). That de minimis offer, according to the Government, was not made in good faith to elicit a settlement. (Id.) Instead, Plaintiffs intended to fully litigate their claims, and they only made the offer so they could recover their attorney fees if they won, regardless of whether the Government's position was substantially justified. (Id.)In response, Plaintiffs do not suggest that they would have expected a reasonable government officer to have accepted their one dollar offer. (ECF No. 57, PageID.809-13). Rather, Plaintiffs maintain that they sincerely believed their position was correct and they offered one dollar to “stand[] by their convictions” rather than reach a compromise. (Id. at PagelD.812-13). Plaintiffs justify their choice by arguing that a one dollar offer is acceptable under the statute which does not require a qualified offer to be made in “good faith or with a reasonable relationship to the amount in controversy.” (Id. at PageID.811-12 & n.7).
The Government raises one other issue with the offer, but its argument can be disposed of rather quickly. Under 26 U.S.C. § 7430(c)(4)(E)(ii)(II), the qualified offer rule does not apply to “any proceeding in which the amount of tax liability is not in issue, including any declaratory judgment proceeding ....” According to the government, Plaintiffs seek both declaratory and monetary relief; thus, their suit is one for declaratory relief and the qualified offer rules do not apply. (ECF No. 55, 783-84). But § 7430(c)(4)(E)(ii)(II) applies only where “the amount of tax liability is not at issue”; a “declaratory judgment proceeding,” therefore, is a proceeding exclusively for declaratory relief. 26 U.S.C. § 7430(c)(4)(E)(ii)(II) (emphasis added). Thus, even if the government is correct that Plaintiffs seek declaratory relief alongside their refund, § 7430(c)(4)(E)(ii)(II) still would not apply.
At first blush, the plain language of the statute supports Plaintiffs' position. The statute does not impose any minimum amount on a taxpayer's qualified offer, except to say that it must be “equal to” or greater than the taxpayer's ultimate liability. 26 U.S.C. § 7430(c)(4)(E), (g). Nor does it explicitly require the qualified offer to be “reasonable” or made in “good faith” to procure a settlement. BASR P'ship v. United States, 130 Fed.Cl. 286, 305-06 (2017).
But this Court does not write on a clean slate. Congress modeled § 7430(c)(4)(E) after Federal Rule of Civil Procedure 68, and in that context, the Supreme Court has expressed skepticism that parties can make de minimis, “sham,” settlement offers to circumvent general limitations on their right to recover costs. Delta Air Lines, Inc. v. August, 450 U.S. 346, 353 (1981). Like § 7430's qualified offer rule, Rule 68 incentivizes certain parties to make settlement offers by relaxing the general rules limiting that party's right to recover fees and costs. Id. at 352. Specifically, while district courts should generally award fees and costs in favor of the prevailing party in a civil action, Federal Rule of Civil Procedure 54(d) gives courts discretion to award or deny costs as they see appropriate. But Rule 68 removes the court's discretion where a “party defending against a claim” that is rejected by the offeree and the offeree later “obtains” a judgment that “is not more favorable than the unaccepted offer.” Fed.R.Civ.P. 68(a). In this situation, the offeree “must” pay all fees and costs “incurred after the offer was made.” Fed.R.Civ.P. 68(d).
Knudsen v. Comm'r of Internal Revenue, No. 18048-09, 2013 WL 1294773, at *4 n.7 (T.C. Apr. 1, 2013); Estate of Lippitz v. Comm r of Internal Rev., Nos. 35775-84, 360-87, 32365-88, 45694-85, 37518-87, 27448-89, 2007 WL 2780496, at *6 n.9, *8 (T.C. Sept. 25, 2007); Johnston v. Comm'r of Internal Revenue, 122 T.C. 124, 129 (2004) (citing Gladden v. Comm'r of Internal Revenue, 120 T.C. 446, 450 (2003)).
In August v. Delta Airlines, Inc., the Supreme Court held that the drafters of Rule 68 did not intend to allow prevailing defendants to benefit from de minimis offers, in part because those offers functioned as “shams” that rendered Rule 45(g) inoperative by usurping courts of their general discretion to deny costs on behalf of a prevailing defendant. 450 U.S. at 353. August was a Title VII discrimination action brought by an airline employee against her employer in which the employee sought reinstatement and $20,000 in damages. Id. at 348. Only “[a] few months” after the employee filed her complaint, the employer offered to settle the case for $450. Id. The employee refused the offer but eventually lost at trial; however, the district court directed both parties to bear their own coats. Id. at 348-49. The employer objected, reasoning that Rule 68 required the plaintiff to pay the employer's fees and costs. Id.
The district court denied the employer's motion and the Seventh Circuit affirmed. Id. According to the Seventh Circuit, a Rule 68 offer must be sufficient “to justify serious consideration by the” offeree. August v. Delta Airlines, Inc., 600 F.2d 699, 701 (7th Cir. 1979). If the rule were otherwise, the court reasoned, all defendants who intended to fully litigate their claims would make a nominal settlement offer to secure their right to recover costs if they won. Id. That would defeat Rule 68's purpose of encouraging settlements and avoiding “protracted litigation.” Id.
The Supreme Court agreed that all well-advised litigants who did not intend to settle would make “nominal” offers to secure their right to recover fees, but the Court added an important insight. August, 450 U.S. at 353. Rule 54(d) expressed the drafters' clear, “specific intent,” that district courts should generally have discretion to deny an award of fees and costs on behalf of a prevailing defendant. Id. Allowing a prevailing defendant to circumvent this general rule through a “token” offer would strip Rule 54(d) of all meaning. Id. To hold that the drafters meant to grant district courts discretion in awarding costs under Rule 54(d) while simultaneously allowing defendants to usurp that discretion through a “meaningless act” would be to “attribute a schizophrenic intent to the drafters.” Id.
For those reasons, the Court did not believe that the drafters could have intended to allow defendants to thwart trial courts' Rule 54(d) discretion by making nominal settlement offers. Id. But that did not necessarily mean that the Rule required defendants to make offers adequate “to justify serious consideration by the” offeree. Rather, the Court observed that Rule 68 applied only where the plaintiff, not the defendant, “obtained” a judgment, and the Court held that this language should be read literally to apply only where the plaintiff prevails on its claims so that sham offers “would serve no purpose.” Id. at 351-52, 355-56. Thus, while the Court did not believe that the drafters intended to allow defendants to make sham offers, it was “unnecessary” for the Court “to read a reasonableness requirement into the Rule.” Id. at 355-56. Importantly, the Court did not criticize the Seventh Circuit's attempt to resolve the conflict between Rule 68 and Rule 54(d) by reading a reasonableness requirement into the Rule, and the Court did not state that it would not have taken the same approach if the plain language of Rule 68 indicated that it also applied where a defendant prevailed in an action. Id.
De minimis settlement offers pose a similar problem under § 7430's qualified offer rule. Under § 7430(c)(4)(B), a taxpayer who obtains a favorable judgment generally cannot recover its fees or costs if the United States took a “substantially justified,” albeit unsuccessful, position against the taxpayer. 26 U.S.C. § 7430(c)(4)(B). But taxpayers need not worry about this strict rule if they can make nominal settlement offers early on in litigation. If allowed, it would be in the best interest of every taxpayer to immediately make a qualified offer for an insignificant sum of money-say one dollar or one penny-as soon as it receives the IRS's letter of deficiency. The taxpayer may later settle its case if it wishes to do so. But if not, the taxpayer can rest assured that it will recoup its expenses if it prevails, regardless of whether the IRS was substantially justified. Cf. August, 450 U.S. at 353. No rational taxpayer would allow the IRS to protect itself by arguing that its position was substantially justified. As in August, reading § 7430(c)(4)(E) to include de minimis, “sham” offers made by a prevailing taxpayer would allow the exception to swallow the rule. Cf. August, 450 U.S. at 353; August, 600 F.2d at 701.
Unlike Rule 68, however, the qualified offer rule provides no off-ramp for the Court to avoid reading a reasonableness requirement into the statute. Indeed, § 7430(c)(4)(E) is not triggered by the judgment “obtained” by the government; it is simply triggered by “the judgment in the proceeding,” and only where the taxpayer-the party making the offer-“prevail[s] with respect to the most significant issue.” See August, 450 U.S. at 351-52; compare Fed.R.Civ.P. 68(d), with 26 U.S.C. § 7430(c)(4)(E). So the court must confront the issue of whether to read in a “reasonableness” requirement head on.
I suggest that the Court must read a reasonableness requirement into the statute. “[O]ne of the most” fundamental “interpretive canons” instructs that a “statute should be construed so that effect is given to all its provisions, so that no part will be inoperative or superfluous, void or insignificant.” Rubin v. Islamic Republic of Iran, 138 S.Ct. 816, 824-25 (2018) (internal quotation marks omitted) (quoting Corley v. United States, 556 U.S. 303, 314 (2009)). That principle is one reason why the August Court found that Rule 68 could not have been intended to encompass de minimis offers made by a prevailing defendant. 450 U.S. at 353. And that principle is also why § 7430's qualified offer rule cannot encompass de minimis offers made by a prevailing taxpayer that were not reasonably calculated to procure a settlement. It is incongruous for the statute to excuse the government from paying fees if its position is substantially justified, but to also enable taxpayers to dodge that limitation through a token act. Cf. id.; see Knudsen, 2013 WL 1294773, at *4 n.7 (recognizing that August's discussion of Rule 68 is instructive when interpreting § 7430); Estate of Lippitz, 2007 WL 2780496, at *6 n.9 (same). To hold that taxpayers can sidestep the substantial justification rule by making sham offers would be to strip the rule of all effect, rendering it “inoperative” and “insignificant.” Rubin, 138 S.Ct. at 824-25.
Accordingly, a qualified offer under § 7430(c)(4)(E), must be reasonably calculated “to justify serious consideration by the” IRS. August, 600 F.2d at 701. But here, Plaintiffs' position was not so strong that it should have expected reasonable counsel for the IRS to seriously consider their one dollar offer. Over $26,000 dollars were at issue in this matter,the bulk of Plaintiffs' arguments did not survive the pleading stage, and Plaintiffs only prevailed on their Notice-and-Comment theory after appealing to the Sixth Circuit. (ECF Nos. 22, 73; see ECF No. 45, PageID.603-04). Plaintiffs' token offer could not have warranted “serious consideration” by the IRS. For that reason, I suggest Plaintiffs did not make a qualified offer, so because the government's position was substantially justified,
As mentioned above, the Court dismissed Plaintiffs' claims concerning tax years 2014 through 2017 for lack of jurisdiction.
Plaintiffs cannot be treated as a prevailing party and they cannot be awarded fees and costs.
Because the statute itself implicitly defines a qualified offer to mean an offer that is reasonably calculated to induce a settlement, the Court need not resort to its discretionary powers to save the statute as the Government suggest it should. (ECF No. 55, PageID.792).
D. Conclusion
For these reasons, I RECOMMEND that the Court DENY Plaintiffs' motion for attorney fees (ECF No. 52).
III. REVIEW
Pursuant to Rule 72(b)(2) of the Federal Rules of Civil Procedure, “[w]ithin 14 days after being served with a copy of the recommended disposition, a party may serve and file specific written objections to the proposed findings and recommendations. A party may respond to another party's objections within 14 days after being served with a copy.” Fed.R.Civ.P. 72(b)(2); see also 28 U.S.C. § 636(b)(1). Failure to file specific objections constitutes a waiver of any further right of appeal. Thomas v. Arn, 474 U.S. 140 (1985); Howard v. Sec'y of Health & Human Servs., 932 F.2d 505 (6th Cir. 1991); United States v. Walters, 638 F.2d 947 (6th Cir. 1981). The parties are advised that making some objections, but failing to raise others, will not preserve all the objections a party may have to this R&R. Willis v. Sec'y of Health & Human Servs., 931 F.2d 390, 401 (6th Cir. 1991); Dakroub v. Detroit Fed'n of Teachers Local 231, 829 F.2d 1370, 1373 (6th Cir. 1987). Pursuant to E.D. Mich. LR 72.1(d)(2), a copy of any objections is to be served upon this magistrate judge.
Any objections must be labeled as “Objection No. 1,” “Objection No. 2,” etc. Any objection must recite precisely the provision of this R&R to which it pertains. Not later than 14 days after service of an objection, the opposing party may file a concise response proportionate to the objections in length and complexity. Fed.R.Civ.P. 72(b)(2); E.D. Mich. LR 72.1(d). The response must specifically address each issue raised in the objections, in the same order, and labeled as “Response to Objection No. 1,” “Response to Objection No. 2,” etc. If the Court determines that any objections are without merit, it may rule without awaiting the response.