Opinion
24786-18 24788-18
03-29-2024
KALEB J. PIERCE, ET AL., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Travis A. Greaves, Judge
These cases are set for trial at the Court's Salt Lake City, Utah Special Session scheduled to commence on April 1, 2024. On March 7, 2024, respondent filed a Motion in Limine to admit into evidence the Mothers Lounge, LLC Financial Analysis and Projections Detail in Preparation for Valuation as of June 4, 2014 (2017 Lone Peak Report) prepared by Lone Peak Valuation Group at the request of petitioners. Petitioners object to the admission of the 2017 Lone Peak Report on the basis that it is a statement made during compromise negotiations with the Internal Revenue Service (IRS) Independent Office of Appeals (Appeals Office) that is protected by Rule 408. For the reasons set forth below, we grant respondent's motion only insofar as it seeks a determination that the 2017 Lone Peak Report is not protected by Rule 408.
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 Federal Rules of Evidence.
Background
The following facts are derived from the pleadings, the parties' motion papers, and the exhibits and declarations attached thereto. They are stated solely for purposes of deciding this motion and not as findings of fact in these cases. See Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). Petitioners, a formerly married couple, lived in Utah when they timely filed their petitions in these cases. The primary issue in these cases is the valuation of interests in Mothers Lounge, LLC (Mothers Lounge).
Mothers Lounge was established in 2005 as an e-commerce business focused on baby and maternity products. On June 4, 2014, petitioners each made a gift of a 29.4% interest in Mothers Lounge to irrevocable trusts. On the same day, petitioners also each sold a 20.6% interest in Mothers Lounge to Giving Stream, LLC in exchange for a $3,419,600 promissory note. Petitioners timely filed Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Returns. Each petitioner reported the value of the 29.4% interest as $4,880,400 and the 20.6% interest as $3,419,600. Petitioners derived this valuation based on a valuation report prepared by David Posey, a certified public accountant at Pinnock, Robbins, Posey & Richins, PC (Posey Report).
On March 30, 2016, the IRS selected petitioners' 2014 gift tax returns for examination, and these cases were assigned to Estate and Gift Tax Attorney Patricia Siler. On January 12, 2017, petitioners hired law firm Holland & Hart, including attorney Carol Warnick, to represent them before the IRS. After petitioners executed powers of attorney, Ms. Warnick scheduled a conference call with Ms. Siler. On January 25, 2017, prior to the conference call, the IRS issued 30-day letters to petitioners. The 30-day letters informed petitioners of their right to file protests with the Appeals Office and provided a deadline of March 2, 2017, to file the protests. On February 1, 2017, the parties spoke during the prescheduled conference call, and Ms. Warnick requested an extension of the 30-day deadline to file the protests to allow a new valuation report to be completed. Ms. Siler denied this request in a letter, stating that a new valuation report would not change the examination determinations.
On March 2, 2017, petitioners filed written protests with the Appeals Office. The protests disputed the valuation of the interests in Mothers Lounge but did not assert alternative values. Rather, petitioners abandoned the Posey Report and explained that a new valuation report was close to completion. The IRS Examination Division closed the case and transferred it to the Appeals Office. On May 8, 2017, the case was assigned to Appeals Officer (AO) Peter Palka. On May 16, 2017, Ms. Warnick and AO Palka spoke on the phone. Ms. Warnick informed AO Palka that the updated valuation report was close to completion. Other than the pending valuation report, the parties discussed the Taxpayer Bill of Rights.
On May 31, 2017, petitioners filed supplemental protests, attaching the 2017 Lone Peak Report and a valuation report from Stout Risius Ross, Inc. (SRR Report). Based on the 2017 Lone Peak Report, the SSR Report concluded that the value of the interests in Mothers Lounge was lower than reported on petitioners' gift tax returns. Petitioners asserted this lower value was the proper valuation for Mothers Lounge. In asserting the new lower valuation, the protests criticized the IRS's valuation and the Posey Report. Petitioners did not make an express settlement offer nor did the supplemental protests discuss the hazards of litigation standard. After reviewing the supplemental protests, AO Palka determined they contained new facts, which the IRS Examination Division needed to review. AO Palka informed petitioners of this transfer and released jurisdiction back to the IRS Examination Division.
The Appeals Office has the authority to settle cases based on the hazards of litigation, which includes uncertainty about the court's interpretation of facts and law. Internal Revenue Manual 4.46.5.3 (Sept. 16, 2021).
The IRS Examination Division reviewed the new information, and the parties were unable to reach a resolution. Petitioners again exercised their appeals rights to the Appeals Office. The Appeals Office considered the valuations and the hazards of litigation. Settlement attempts were unsuccessful. On September 19, 2018, respondent issued a notice of deficiency to each petitioner asserting gift tax deficiencies and accuracy-related penalties. Petitioners timely filed petitions with this Court for redetermination of the deficiencies, and the two cases were consolidated.
On February 5, 2024, the parties filed expert reports with the Court. Respondent's expert relied on the projections contained in the 2017 Lone Peak Report in determining the valuation of Mothers Lounge. On March 7, 2024, respondent filed the current motion to admit into evidence the 2017 Lone Peak Report. Petitioners objected to this motion on the ground that the report is protected settlement communication under Rule 408.
Discussion
This Court applies the Federal Rules of Evidence when deciding evidentiary issues. § 7453. Rule 408 provides that "a statement made during compromise negotiations" is not admissible "either to prove or disprove the validity or amount of a disputed claim or to impeach by a prior inconsistent statement or a contradiction." Absent stipulation to the contrary, this case is appealable to the U.S. Court of Appeals for the Tenth Circuit. § 7482(b)(1)(A). The Tenth Circuit has held that "compromise negotiations" have not commenced until discussions have "crystallized to the point of threatened litigation." See Big O Tire Dealers, Inc. v. Goodyear Tire & Rubber Co., 561 F.2d 1365, 1373 (10th Circuit 1977) (determining whether statements were normal business communications or compromise negotiations).
Petitioners urge this Court to disregard the binding Tenth Circuit precedent in favor of adopting a broad rule that all documents submitted to the Appeals Office are settlement communications under the protection of Rule 408. Petitioners base this argument on the role the Appeals Office plays in tax administration and the ability to negotiate and settle cases based on the hazards of litigation. Precedent does not support this brightline rule. EEOC v. Gear Petroleum, Inc., 948 F.2d 1542, 1545 (10th Cir. 1991) (refusing to determine whether a statement was made during a compromise negotiation based solely on whether it was made during the investigation phase or the conciliation phase of an Equal Employment Opportunity Commission investigation). Instead, we must make a fact intensive inquiry into whether compromise negotiations had begun when petitioners filed the supplemental protests and appended the 2017 Lone Peak Report. See id.
There is no evidence that discussions between petitioners and the IRS had "crystallized to the point of threatened litigation" at the time the supplemental protests were filed. After failing to reach an agreement with the IRS Examination Division, petitioners exercised their rights to file an administrative appeal with the Appeals Office. There is no evidence that either side threatened litigation at this point. Cf. Big O Tire Dealers, Inc., 561 F.2d at 1369 (determining the threat of litigation crystallized after a phone call in which one party threatened to protract litigation). In fact, as petitioners stated in their objection, most deficiency cases are resolved in the Appeals Office without the need for litigation. Petitioners' limited communication with AO Palka did not threaten litigation. Petitioners explained that the new valuation report was close to completion and AO Palka merely explained petitioners' rights. Neither party has represented that express settlement negotiations occurred during this time nor that the parties discussed the hazards of litigation.
In addition to the context, the supplemental protests at issue do not appear to warrant Rule 408 protection. The purpose of the supplemental protests was to "provide additional factual support and arguments regarding the valuation." The supplemental protests contained no settlement offer nor any language that could be construed as settlement negotiations. The supplemental protests did not discuss the hazards of litigation, which is a possible basis for settlement with the Appeals Office. Rather, petitioners were offering new facts to support their claimed valuation. These protests did not crystallize the discussions to the point of threatened litigation.
Petitioners filed the supplemental protests and 2017 Lone Peak Report prior to discussions having "crystallized to the point of threatened litigation." Therefore, they are not statements made during compromise negotiations protected by Rule 408. Therefore, we grant respondent's motion as it relates to whether the 2017 Lone Peak Report is barred by Rule 408. Respondent retains the burden at trial to show that the report is otherwise admissible.
Upon due consideration, it is
ORDERED that respondent's Motion in Limine is granted in part to the extent stated herein. It is further
ORDERED that respondent's Motion in Limine is denied in all other respects.