Opinion
7196-19
06-29-2022
JO ANN SHARP & RANDALL W. SHARP, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Elizabeth A. Copeland, Judge
In an order dated September 17, 2020, we requested briefing from the parties as to the issue of costs of goods sold as it relates to protections afforded to Petitioners, Jo Ann Sharp and Randall W. Sharp (the Sharps), under the U.S. Constitution; and the effects of such protections, if any, on the Sharps' burden of proof. (Docket Index No. 17.) We received three briefs as a result of that order: (1) Petitioners' Seriatim Opening Brief, filed on October 16, 2020; (2) Respondent's Seriatim Answering Brief, filed on December 28, 2020; and (3) Petitioners' Seriatim Reply Brief, filed on February 11, 2021. (Docket Index Nos. 20, 24, and 26, respectively.) We deem Petitioners' Seriatim Opening Brief to also be their motion to shift the burden of proof.
On March 2, 2022, the Sharps filed with the Court Petitioners' Motion for Judgment on the Pleadings Pursuant to Rule 120 (Motion for Judgment on the Pleadings). (Docket Index No. 35.) In this Order, we decide the Sharps' motion to shift the burden of proof. We will also order Respondent to respond to the Motion for Judgment on the Pleadings.
Background
We derived the following background from the pleadings, the parties' briefs, and the supporting exhibits attached thereto. We note that the background is stated solely for purposes of ruling on the Sharps' motion to shift the burden of proof and is not a finding of facts. The Sharps resided in Colorado when they petitioned this Court.
During tax year 2014, Mrs. Sharp was a limited partner at High Mountain Medz LLC (HMM), a partnership licensed by the State of Colorado to operate a marijuana dispensary. HMM timely filed Form 1065, U.S. Return of Partnership Income, wherein it reported its gross receipts for tax year 2014, claimed an exclusion for costs of goods sold (COGS), and deducted various business expenses. The Internal Revenue Service (IRS) audited HMM's 2014 tax return. During the course of that audit, the IRS requested from HMM records that: (1) showed it reported the correct amount of gross receipts for tax year 2014; (2) substantiated the exclusion it claimed for COGS; and (3) substantiated its claimed deductions for various business expenses. HMM either declined to provide the requested records or provided redacted copies.
The IRS examiner who presided over the examination prepared a set of lead sheets, which lead sheets the Sharps attached to their seriatim opening brief. These lead sheets note that the redacted copies HMM provided were "redacted to the extent that the examiner" could not verify the veracity of the COGS exclusion or business deductions claimed.
The IRS, based on the records HMM submitted, determined that: (1) HMM reported the correct amount of gross receipts for tax year 2014; (2) HMM failed to substantiate its COGS exclusion; and (3) HMM failed to substantiate its claimed deductions for various business expenses. The IRS adjusted HMM's 2014 tax return to reflect its determinations. Due to the passthrough nature of partnerships, the IRS' adjustments to HMM's return caused corresponding adjustments to the individual income tax returns of HMM's partners, including Mrs. Sharp. Consequently, the IRS mailed the Sharps a notice of deficiency reflecting its adjustments to Mrs. Sharp's distributive share of HMM's tax attributes. The Sharps petitioned this Court in response to that notice of deficiency; and the deemed motion to shift the burden of proof followed in due course.
Discussion
I. Burden of Proof
Generally, Respondent's determinations in a notice of deficiency are presumed correct, and the Sharps bear the burden of proving those determinations incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). However, in certain circumstances, the burden of proof can shift to Respondent. See Higbee v. Commissioner, 116 T.C. 438, 440-41 (2001). As relevant here, the burden of proof will shift to Respondent if the taxpayer proves that Respondent's determinations are arbitrary, capricious, or unreasonable. City Line Candy & Tobacco Corp. v. Commissioner, 141 T.C. 414, 420 (2013) (citing Paccar, Inc. v. Commissioner, 85 T.C. 754, 787 (1985)), aff'd, 624 Fed.Appx. 784 (2d Cir. 2015).
Unless otherwise indicated, all statutory references are to the Internal Revenue Code, Title 26 U.S.C. (I.R.C.), in effect at all relevant times, all regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Deductions are a matter of legislative grace, and the Sharps bear the burden of proving that they are entitled to the deductions claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Higbee, 116 T.C. at 440; see Rule 142(a)(1). COGS exclusions from gross income, however, are not a matter of legislative grace. The Sixteenth Amendment grants Congress the power "to lay and collect taxes on incomes, from whatever source derived …." U.S. Const. amend. XVI (emphasis added). To "ensure taxation of income rather than sales, the 'costs of goods sold' is a mandatory exclusion from the calculation of a taxpayer's gross income." Alpenglow Botanicals, LLC v. United States, 894 F.3d 1187, 1199 (10th Cir. 2018) (emphasis in original) (citing Max Sobel Wholesale Liquors v. Commissioner, 630 F.2d 670, 671 (9th Cir. 1980)); see also N. Cal. Small Bus. Assistants v. Commissioner, 153 T.C. 65, 68 (2019); Newman v. Commissioner, T.C. Memo. 2000-345, 2000 WL 1675519, at *2. Nevertheless, taxpayers are required to maintain records that are sufficient to enable Respondent to determine their correct tax liability. See I.R.C. § 6001; Treas. Reg. § 1.6001-1(a). Whether a particular expense is a deduction subject to legislative grace or a mandatory exclusion under the Sixteenth Amendment does not excuse taxpayers from keeping and producing records under section 6001 and the regulations thereunder. See Newman, 2000 WL 1675519, at *2; Treas. Reg. § 1.6001-1(a) ("[A]ny person subject to tax under Subtitle A of the Code … or any person required to file a return of information with respect to income, shall keep such permanent books of account or records … as are sufficient to establish the amount of gross income … shown by such person in any return of such tax or information.").
The Sharps move this Court to place the burden of proof as to COGS on Respondent. They advance four arguments in support of their motion, which we consider below.
II. Petitioners' Arguments
A. First Argument: The "Unconstitutional Conditions" Doctrine
The Sharps first contend that for them to bear the burden of proof would mean that Mrs. Sharp would have to relinquish her Fifth Amendment privilege against compelled self-incrimination in exchange for her Sixteenth Amendment right to a COGS exclusion. They assert that such a result would run afoul of the "unconstitutional conditions" doctrine. They conclude that Respondent must bear the burden of proof because it would be unconstitutional for them to bear it. This argument has no merit.
The unconstitutional conditions doctrine stems from an amalgam of Supreme Court decisions holding that the government cannot condition the receipt of a benefit on the waiver of a constitutional right. See Koontz v. St. Johns River Water Mgmt. Dist., 570 U.S. 595, 604 (2013). The purpose of this doctrine is to protect "the Constitution's enumerated rights by preventing the government from coercing people into giving them up." Id. Importantly, for there to be an unconstitutional condition, the claimant must be able to feasibly assert the constitutional right that they claim the government is coercing them to waive. Cf. Ohio Adult Parole Auth. v. Woodard, 523 U.S. 272, 285-88 (1998) (finding it "unnecessary to address" the unconstitutional conditions doctrine because the Fifth Amendment was not violated "under any view.").
Ordinarily, we would proceed by evaluating whether Mrs. Sharp can feasibly assert the Fifth Amendment privilege, but this case does not arise from the ordinary posture. That is, the notice of deficiency did not arise from an audit of the Sharps' joint individual income tax return. Rather, the IRS audited HMM and adjusted its tax return, which in turn, caused the IRS to adjust the Sharps' joint individual income tax return and mail them a notice of deficiency reflecting those adjustments. Although HMM is not the petitioner here, its close interplay with Mrs. Sharp (and thus, the Sharps) in this case requires us to evaluate whether Mrs. Sharp can feasibly assert the Fifth Amendment privilege from two perspectives: as an individual and as a limited partner of HMM.
Viewing Mrs. Sharp as an individual, the Fifth Amendment protects only against compelled self-incrimination. See id. at 286; Baxter v. Palmigiano, 425 U.S. 308, 316-18 (1976). The privilege against self-incrimination has never been thought to be in itself a substitute for evidence that would assist a party in meeting their burden. See United States v. Rylander, 460 U.S. 752, 758 (1983). Thus, where a party is required to maintain adequate records to establish the correct amount of taxable income, using the privilege to escape that requirement would impermissibly convert the privilege "from the shield against compulsory self-incrimination which it was intended to be into a sword whereby a claimant asserting the privilege would be freed from adducing proof in support of a burden which would otherwise have been his." Id. Rylander teaches that the Sharps' "possible failure of proof on an issue on which they bear the burden is not 'compulsion' for purposes of the Fifth Amendment." Feinberg v. Commissioner, 916 F.3d 1330, 1337 (10th Cir. 2019) (citing United States v. Goodman, 527 Fed.Appx. 697, 700 (10th Cir. 2013)), aff'g on other grounds T.C. Memo. 2017-211. Mrs. Sharp is not under a compulsion to produce records related to HMM's COGS exclusion. She was required to maintain those records in the ordinary course of her business under section 6001 and Treas. Reg. § 1.6001-1. She is free to choose whether she wants to produce those records to substantiate HMM's COGS exclusion and she bears the consequences of her choice, including the possibility that the Sharps will not have met their burden of proving that Respondent erred in disallowing HMM's COGS exclusion from gross income. See id. As such, from an individual perspective, the Fifth Amendment accords Mrs. Sharp no protection since there is no compulsion.
The Sharps contend that "[f]orced waiver of Fifth Amendment privilege in order to obtain constitutionally protect[ed] costs of goods sold distinguishes this case from Rylander." We disagree. As we have explained, for there to be an unconstitutional condition of the type the Sharps advance, Mrs. Sharp must be able to feasibly assert the Fifth Amendment privilege against compelled self-incrimination. Rylander is applicable because it explains the privilege's limitations.
Viewing Mrs. Sharp as one of HMM's limited partners, the Fifth Amendment does not protect entities like HMM from compelled self-incrimination. Braswell v. United States, 487 U.S. 99, 102-03 (1988). And an individual cannot assert the Fifth Amendment "to avoid producing the records of a collective entity which are in … [the individual's] possession in a representative capacity, even if those records might incriminate … [that individual] personally." Bellis v. United States, 417 U.S. 85, 87-88 (1974). Since the Fifth Amendment does not afford HMM any protection, HMM's records-including those records that would substantiate its claimed COGS exclusion-are likewise not accorded Fifth Amendment protection. As such, from a limited partner perspective, the Fifth Amendment accords Mrs. Sharp no protection because it is inapplicable to HMM.
In total, Mrs. Sharp cannot feasibly assert the Fifth Amendment privilege to shift the burden of proof or protect HMM and its records. Her inability to do so undermines the Sharps' contention that an unconstitutional condition is present here.
B. Second Argument: Due Process Clause
The Sharps secondly contend that for Mrs. Sharp to bear the burden of proof would mean she would have to prove criminal conduct in order to obtain her Sixteenth Amendment right to a COGS exclusion. They assert that such a result would "violate the Due Process Clause of the Constitution." In support of that argument, they rely on Hebert v. Louisiana, 272 U.S. 312 (1926), Justice Marshall's dissent in United States v. Raddatz, 447 U.S. 667, 699-700 (1980) (Marshall, J., dissenting), and Speiser v. Randall, 357 U.S. 513 (1958).
Hebert and Speiser are inapposite because those cases involve the due process clause under the Fourteenth Amendment. The Fourteenth Amendment is inapplicable to the Federal government. See District of Columbia v. Carter, 409 U.S. 418, 423-24 (1973). It also does "not operate as a limitation on the taxing power of the Federal Government." Hamilton v. Commissioner, 68 T.C. 603, 606 (1977). Thus, Sharps' reliance on Hebert and Speiser is misplaced.
The Sharps cite to a passage in Justice Marshall's dissent in Raddatz, which passage quotes the three-factor procedural due process test established in Mathews v. Eldridge, 424 U.S. 319, 335 (1976). See Raddatz, 447 U.S. at 699-700 (Marshall, J., dissenting). After citing to that dissent, they conclude "[i]n using the above criteria, it is clear that placing the burden on the taxpayer to prove the nature and extent of his/her crime does not comport with the fundamental principles of liberty and justice."
In Mathews, the Supreme Court propounded a three-factor balancing test for determining whether a person was accorded appropriate due process in instances where government action deprives (or threatens to deprive) their liberty or property interests. See Mathews, 424 U.S. at 335. We balance: (1) the interest that will be affected by government action; (2) the adequacy of current procedures safeguarding that interest and the value of any additional or substitute safeguards; and (3) the government's interest, including the "function involved and the fiscal and administrative burdens that" any additional or substitute safeguards would entail. See id.
That argument has two fatal errors. First, the Sharps do not explain-and we cannot discern-the logical connection between Justice Marshall's dissent in Raddatz and the aforementioned conclusion. Second, if we assume arguendo that in citing to Raddatz, the Sharps are implicitly advancing a procedural due process claim, that claims fails because they do not analyze the three-factor Mathews test and apply it to their circumstances. Their argument is nothing more than a citation with a conclusion. It is not enough merely to mention a possible argument in the most skeletal way, leaving us to do counsel's work, create the ossature for the argument, and put flesh on its bones; we are not expected to be mindreaders; the Sharps have an obligation to spell out their arguments squarely and distinctly. See United States v. Zannino, 895 F.2d 1, 17 (1st Cir. 1990).
At any rate, it is difficult to see how the Sharps are not being accorded ample due process here. As we have laid out in the previous section, HMM had an obligation to maintain business records supporting any exclusions from gross income, including COGS. This case is a de novo proceeding, meaning that the Sharps can still produce records substantiating COGS and receive judicial review of their deficiency before the IRS can make an assessment.
C. Third Argument: Section 280E is a Penalty
The Sharps thirdly contend that section 280E, in operation, acts as a penalty. As such, Respondent should bear the burden of proof. We have previously held, in a precedential opinion reviewed by the Court pursuant to section 7460(b), that "section 280E is not a penalty provision." N. Cal. Small Bus. Assistants, 153 T.C. at 72. The Court of Appeals for the Tenth Circuit has also held that section 280E is not a penalty. See Alpenglow Botanicals, 894 F.3d at 1202.
We note that this contention is incorrect at the outset. When Respondent proposes to impose a penalty, section 7491(c) imposes upon him the burden of production. The burden of production is not the same as the burden of proof. See Higbee, 116 T.C. at 446-47 ("Congress' use of the phrase 'burden of production' and not the more general phrase 'burden of proof' … indicates to us that Congress did not desire that the burden of proof be placed on the Commissioner with regard to penalties.").
This Division of the Court partially dissented in N. Cal. Small Bus. Assistants, 153 T.C. at 90-94 (Copeland, J., concurring in part and dissenting in part). In that side opinion, this Division of the Court observed that "even if section 280E was not written as a penalty provision, it operates as such." Id. at 93. The Sharps are seemingly advancing that observation as their argument. But we will not depart from the majority's precedential holding that section 280E is not a penalty, id. at 72, in this case. We also note that Judge Urda was recused and did not participate in consideration of the N. Cal. Small Bus. Assistants case.
The Sharps point out, in an attempt to distinguish this case from Alpenglow Botanicals and N. Cal. Small Bus. Assistants, that "the Tenth Circuit in Alpenglow Botanicals and this Court in [N. Cal. Small Bus. Assistants] stated that § 280E, as written, is not a penalty. The focus [of this argument] is that § 280E in operation acts as a penalty - a different question than what was answered previously."
The Sharps' interpretation of Alpenglow Botanicals and N. Cal. Small Bus. Assistants is incorrect. Both opinions clearly hold that section 280E is not a penalty. Alpenglow Botanicals, 894 F.3d at 1202 ("We remain convinced that § 280E is not a penalty."); N. Cal. Small Bus. Assistants, 153 T.C. at 72 ("[W]e hold that section 280E is not a penalty provision."). Nothing in either opinion supports the Sharps' interpretation or distinction.
The Sharps' argument that laws written by Congress need to be separately evaluated based on their operable effect lacks merit. Both Alpenglow Botanicals and N. Cal. Small Bus. Assistants evaluated section 280E and determined that Congress did not intend it to be a penalty, which forecloses the Sharps' argument that section 280E, in operation, is a penalty.
D. Fourth Argument: The Commissioner's Determination Was Arbitrary, Capricious, or Unreasonable
The Sharps finally contend that the records HMM provided to the IRS were sufficient to substantiate COGS. As such, Respondent's disallowance of HMM's COGS exclusion was arbitrary, capricious, or unreasonable. Thus, Respondent should bear the burden of proof as to COGS. See City Line Candy & Tobacco, 141 T.C. at 420.
We disagree. The lead sheets the Sharps attached to their seriatim opening brief belie their contention. The lead sheets that concern COGS all state that HMM did not provide sufficient documentation to support its claimed COGS exclusion. The Sharps have presented no evidence showing that the statements in those lead sheets are incorrect. Therefore, we cannot conclude that the burden of proof as to COGS shifts to Respondent because the record before us at this juncture does not show any impropriety.
III. Conclusion
In conclusion, for the reasons stated above, we reject all four of the Sharps' arguments. We will therefore deny their motion to shift the burden of proof. In reaching our holding, we have considered all arguments made and, to the extent not mentioned above, we conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing, it is
ORDERED that Petitioners' Seriatim Opening Brief, filed on October 16, 2020, at Docket Index No. 20, is retitled as Petitioners' Motion to Shift the Burden of Proof and Seriatim Opening Brief. It is further
ORDERED that Petitioners' motion to shift the burden of proof as outlined above, is denied. It is further
ORDERED that Respondent shall, on or before August 26, 2022, file a response to Petitioners' Motion for Judgment on the Pleadings, filed on March 2, 2022, at Docket Index No. 35.