Indiana Law Review


Are There Procedural Deficiencies in Tax
Fraud Cases?: A Reply to
Professor Schoenfeld

Leandra Lederman*

Introduction

Since the Senate hearings on alleged abuses by the Internal Revenue Service

(IRS)J and the resulting IRS Reform Act, enacted in 1998,^ scholarly attention
to perceived inequities in the resolution oftax controversies has mushroomed.^

For example. Professor Eric Posner has argued that the fact the IRS reform was
widely supported despite the impediments it imposes to audits suggests that, in

the absence of trust in the IRS, the public may not voluntarily comply with
federal tax laws/

Last year, the Indiana Law Review published an article entitled A Critique
ofthe Internal Revenue Service 's Refusal to Disclose How It "Determined" a
Tax Deficiency, and of the Tax Court 's Acquiescence with This View by
Professor Marcus Schoenfeld (the "article")-^ The article argued that current law
unfairly advantages the IRS in civil tax cases, particularly tax fraud cases. It

reflects a particular concern that "the [IRS] combines with the Tax Court to keep
the taxpayer from obtaining information about how the Service made its

* Associate Professor of Law, George Mason University School of Law. A.B., 1987,
Bryn Mawr College; J.D., 1990, New York University School of Law; LL.M., 1993, New York
University School ofLaw. I would like to thank Terry Chorvat, David Hyman, and Stephen Mazza

for valuable comments on prior drafts ofthis article; Mark Newton for helpful conversations about

the article; and George Mason University School ofLaw and its Law and Economics Center for
financial support.

1

.

During three days ofhearings before the Senate Finance Committee, taxpayers and IRS

agents told "horror stories" about IRS treatment oftaxpayers. See Wm. Brian Henning, Reforming
the IRS: The Effectiveness ofthe Internal Revenue Service Restructuring andReform Act of1998,

82 Marq. L. Rev. 405, 405 (1999). The hearings were broadcast on television. See Ryan J.

Donmoyer, Three Days ofHearings Paint Picture of Troubled IRS, 76 TAX NOTES 1655, 1655

(1997).

2. Internal Revenue Service Restructuring and Reform Act of 1998, 105 Pub. L. 206; 1 12

Stat. 685 §1203 (1998).

3. See, e.g.. Heather B. Conoboy, A Wrong Step in the Right Direction: The National

Taxpayer Advocate and the 1998 IRS Restructuring and Reform Act, 41 WM. & MARY L. Rev.
1401 (2000); Henning, supra note 1, at 405; Steve R. Johnson, The Dangers of Symbolic

Legislation: Perceptions and Realities ofthe New Burden-of-ProofRules, 84 lOWA L. REV. 413

( 1 999); Eric A. Posner, Law andSocial Norms: The Case ofTax Compliance, 86 Va. L. Rev. 1 78

1

(2000); Amy S. Wei, Can Mediation Be the Answer to Taxpayers ' Woes?: An Examination ofthe
Internal Revenue Service 's Mediation Program, 15 OHIO ST. J. ON DiSP. ResOL. 549 (2000).

4. See Posner, supra note 3, at 1812.

5

.

Marcus Schoenfeld,A Critique ofthe Internal Revenue Service 's Refusal to Disclose How
It "Determined" a Tax Deficiency, and ofthe Tax Court's Acquiescence with This View, 33 IND.

L. Rev. 517(2000).



144 INDIANA LAW REVIEW [Vol. 35: 143

determination of the taxpayer's deficiency."^

Professor Schoenfeld's article provides a helpful overview of tax cases

involving civil fraud, and discusses a wide array of procedural issues that arise
in many of those cases. There is all too little scholarship on tax procedure/ so
it is particularly rewarding to discover an additional contribution. Although I
agree with Professor Schoenfeld's concern that there should be appropriate

controls on the power ofthe IRS,* I disagree both with his suggestions for change
and with some of the premises underlying those suggestions.

Professor Schoenfeld's argument, briefly stated, is that a combination of

factors conspire to hinder taxpayers' defense ofcivil tax cases, particularly cases

involving allegations offraud.^ The factors he points to span a variety ofaspects
oftax procedure. First, a "presumption ofcorrectness" '° attaches to the statutory

notice of deficiency, •' the letter from the IRS that legally asserts an
underpayment in tax and is required for the United States Tax Court ("Tax
Court") to take jurisdiction over a resulting lawsuit.'^ Second, notices of

deficiency do not always adequately explain the reasons for the asserted

deficiency.'^ Third, the Tax Court generally will not "look behind"'"* a notice of
deficiency to see what underlies it.'^ Fourth, techniques allowed by the Tax
Court to reconstruct unreported illegal income may "yield harsh results,"'^
particularly with respect to co-conspirators only marginally involved in a

criminal conspiracy.'^ Fifth, the IRS may assert "that all of its documents are
privileged,"'* and therefore not available in discovery.'^ Sixth, the Tax Court
position that IRS errors will be remedied at trial ignores the substantive

importance of the notice of deficiency.^° Finally, collateral estoppel generally

precludes a taxpayer criminally convicted from denying facts found in the

criminal trial but does not preclude a civil tax trial of a taxpayer who was
acquitted criminally.^' In making these points, the article also discusses related

issues such as the procedures for declaring notices of deficiency involving

6. Id. at 569.

7. Steve Johnson, A Residual Damages Right Against the IRS: A Cure Worse than the

Disease, 88 Tax NOTES 395, 395 (2000).

8. See Schoenfeld, supra note 5, at 568.

9. Id 3A5\7.

10. Id

11. Id

12. See I.R.C. §§ 6212(a), 6213(a) (Supp. 1999).

13. Schoenfeld, supra note 5, at 517.

14. Id at 524.

15. Id at 524-25.

16. Mat 518.
17. Id

18. Id

19. Id

20. Id

21. Id at 549.



2001] A REPLY TO PROFESSOR SCHOENFELD 145

unreported income "arbitrary and erroneous.
"^^

Tax controversy procedure, like civil litigation procedure generally, reflects
a balancing of interests of plaintiff and defendant. In tax controversies, the

parties are the IRS and the taxpayer. In general, the procedural rules seek to
provide a level playing field, place the burden of producing information on the

party in possession of that information, and encourage settlement. Professor

Schoenfeld's criticism ofthe IRS and the Tax Court should be considered in that
context. That is, to what extent are the burdens he discusses unfairly targeted at

taxpayers, and to what extent do they reflect only one side of an even-handed

balancing act?

Professor Schoenfeld's concerns, listed above, logically fall into two general
categories: taxpayer access to IRS information and IRS techniques for proving

tax fraud. Accordingly, this reply has two principal parts. Part I disputes

Professor Schoenfeld's contentions that the IRS's approach, coupled with the

Tax Court's rules, hampers taxpayers' abilities to obtain appropriate information
to defend tax deficiency and tax fraud suits. Section A briefly outlines basic tax
controversy procedure. Section B focuses on notices of deficiency. It discusses
their importance and the multiple roles they play in tax controversies, and it

specifically considers the "presumption ofcorrectness" as well as uninformative,

inaccurate, and arbitrary notices. Section C of Part I explores procedures for
obtaining the report of the IRS revenue agent.

Part II ofthis reply analyzes the IRS's methods ofproving tax fraud, focusing

on the areas Professor Schoenfeld finds particularly objectionable: collateral

estoppel, the use of badges of fraud, and IRS-protective positions. Section A of
this Part analyzes the use ofcollateral estoppel and badges offraud in the context

of the IRS's burden of proving fraud by clear and convincing evidence. This

section argues that these methods are appropriate means for the IRS to use to try
to meet that burden. Section B of Part II focuses on IRS-protective positions,
which address a materially different aspect ofany fraud case: the amount ofthe
deficiency. Once fraud is proven by the IRS, it is the taxpayer who bears the
burden of proving the amount of the deficiency that is not attributable to fraud.
Section B focuses on the problems that this procedural posture causes while
refuting some of Professor Schoenfeld's objections to IRS-protective positions.

I. Obtaining Information from the IRS in Civil Tax Controversies

A. Basic Tax Controversy Procedure

As Professor Schoenfeld explains, civil tax cases generally begin with a
disagreement between the taxpayer and the IRS over the tax owed by the
taxpayer.^^ Ifthe disagreement began with a refund claim filed by the taxpayer,
the IRS manifests its disagreement with a "notice of disallowance." In other
cases, an unresolved dispute generally results in IRS issuance of a "notice of

22. ^-ee /^. at 539-40.

23. /^. at 520.



146 INDIANA LAW REVIEW [Vol. 35: 143

deficiency," the letter mentioned previously that alerts the taxpayer to the amount
of the alleged deficiency (underpayment of tax). The notice may also contain
additions to tax for such things as late filing ofthe return, negligence, or fraud.
It generally also provides an explanation of the deficiency and additions to tax.

Except where collection of the tax is in jeopardy,^'* the IRS generally is
required by statute to mail the taxpayer a notice of deficiency prior to
assessment.^^ "Assessmenf is formal recording by the IRS ofthe taxpayer's tax
liability.^^ Assessment is a legal prerequisite to the IRS's administrative

collection procedures. The notice of deficiency therefore is central to tax
controversies.

The notice of deficiency also provides the taxpayer with a "ticket to the Tax
Court"; Tax Court subject-matterjurisdiction over tax deficiency cases requires
both a notice of deficiency and a timely responsive petition (generally one that

is filed within ninety days ofthe date the notice ofdeficiency was mailed).^^ The
IRS is required to file an answer.^* Those documents form the pleadings in Tax
Court litigation; additional pleadings may be made in the form of amendments
and a reply when required.^^ In civil fraud cases, the IRS bears the burden of
persuasion by "clear and convincing evidence."^^

B. The Notice ofDeficiency

Exchange of information between the IRS and the taxpayer typically begins
with the audit. In most tax controversies, after the audit, the IRS will send the
taxpayer a preliminary notice of deficiency, commonly known as a thirty-day
letter. The thirty-day letter is the cover letter accompanying the IRS revenue
agent's report. It provides an opportunity for the taxpayer to obtain an

administrative appeal by responding within thirty days.^* Informal

communications, the revenue agent's report, the appeals conference, and other

settlement efforts are all sources of information about the IRS's case.

Ifa tax controversy remains unresolved when the statute of limitations nears

24. I.R.C.§ 6861(a) (1994).

25. Id. § 6212(a) (Supp. V 1999) ("If the Secretary [of the Treasury] determines that there
is a deficiency in respect of any tax imposed by [certain subtitles and chapters of the Code] he is

authorized to send notice of such deficiency to the taxpayer by certified mail or registered mail.").

The authorization language apparently refers to the method of delivery; the notice itself is not

optional. See id. § 62 1 3(a) (subject to certain exceptions, "no assessment ofa deficiency in respect

of any tax imposed by [certain subtitles and chapters] and no levy or proceeding in court for its

collection shall be made, begun, or prosecuted until such notice has been mailed to the taxpayer").

26. See LEANDRA LEDERMAN& STEPHEN W. W<2Zk, TAX CONTROVERSIES: PRACTICEAND
Procedure 8 (2000).

27. I.R.C.§ 6213(a) (1994).

28. Tax Ct. R. Prac. & P. 30; see also id at 36.
29. 5ee/^. at 30, 37,41.

30. Id at 142(b); see also I.R.C. § 7454(a) (1994).

31. 5ee Lederman & Mazza, 5«/7ra note 26, at 9.



2001] A REPLY TO PROFESSOR SCHOENFELD 147

expiration, the IRS will send the taxpayer a notice of deficiency. The notice of
deficiency is the first official, required notice to the taxpayer of the IRS's

assertion ofa tax underpayment. As discussed above, the taxpayer may be well-
versed in the IRS's case at the point he receives a notice of deficiency.

Nonetheless, the notice of deficiency provides official notice of the deficiency

amount and the IRS's reason for the adjustment.
Mailing of a notice of deficiency has multiple, important consequences.

First, the notice of deficiency provides notice to the taxpayer of the asserted

deficiency and of the IRS's intent to assess if the taxpayer does not respond by

filing a timely Tax Court petition (a notification function). Second, the notice
provides the taxpayer with the jurisdictional "ticket to the Tax Court," as
discussed above. Third, assessment of tax is prohibited during the ninety-day

period within which the taxpayer may petition the Tax Court, and ifa Tax Court
petition is filed, until the Tax Court decision is final. Fourth, as a corollary, the
notice tolls the statute of limitations on assessment for the length of the

prohibited period plus sixty days, providing the IRS with time to assess tax

should the taxpayer lose the Tax Court case or fail to petition the Tax Court.
Fifth, if the taxpayer does petition the Tax Court, the notice of deficiency

becomes part of the pleadings, in effect forming the first statement of the IRS's
case, analogous to a complaint. Finally, in Tax Court, the notice of deficiency
plays an important role in allocating the burden of proof

^^

A notice ofdeficiency that is defective such that it is invalid is void ab initio
so that, generally speaking, it plays none of these functions." The immediate
effect of a Tax Court determination that a notice is invalid is that the Tax Court
will dismiss the case for lack of subject-matter jurisdiction. A key collateral
consequence is that an invalid notice does not toll the statute of limitations on

assessment, so the period for assessment ordinarily will have expired.^'*

Expiration ofthe statute oflimitations precludes assessment and collection oftax

by the IRS.
Professor Schoenfeld accurately points out that, in considering arguably

defective notices of deficiency, the Tax Court has overemphasized the
jurisdictional function ofthe notice ofdeficiency .^^ I have previously argued that

not all defects in notices of deficiency are grounds for invalidation and

32. The notice of deficiency therefore has three main functions and several lesser functions.

The three main functions are the notice function, the pleading function in a Tax Court case, and the

jurisdictional function in Tax Court. Confusing these functions may result in inappropriate

remedies for defective notices, particularly inappropriate dismissals for lack ofTax Court subject-

matter jurisdiction. See generally Leandra Lederman, "Civil "izing Tax Procedure: Applying

General Federal Learning to Statutory Notices ofDeficiency, 30 U.C. DAVIS L. REV. 1 83 (1 996).

33. Cf Roszkos v. Comm'r, 850 F.2d 514, 517 (9th Cir. 1988) (stating that notices of

deficiency sent to incorrect addresses were "null eind void").

34. See, e.g., Reddock v. Comm'r, 72 T.C. 21, 26 (1979); Atlas Oil & Ref Corp. v. Comm'r,
22 T.C. 552, 558-59 (1954), overruled on other grounds by Woods v. Comm'r, 92 T.C. 776, 778

(1989).

35. See Schoenfeld, supra note 5, at 534.



148 INDIANA LAW REVIEW [Vol. 35:143

concomitant dismissal of the Tax Court case.^^ Instead, the Tax Court should
consider whether a defect affects the notification or pleading function or is truly
jurisdictional?^ In fact, a notice ofdeficiency needs far fewer elements to allow

the Tax Court to take jurisdiction over the case than it does to notify a taxpayer
in enough detail to enable the taxpayer to rebut IRS allegations in his principal
Tax Court pleading, the petition.^*

1. The ''Presumption ofCorrectness.
"—As Professor Schoenfeld points out,

a "presumption of correctness" is afforded the notice of deficiency .^^ This term

is somewhat misleading. Professor Schoenfeld argues that "the Notice [of
deficiency] . . . carries substantive weight because it is presumed to be correct.'"*^
However, the presumption of correctness is not a true presumption; it carries no
more evidentiary weight than does the "presumption of innocence" ofa criminal
defendant. The presumption of correctness merely serves to assign the burden
ofgoing forward."*' That is, by affording the notice ofdeficiency initial credence,
the taxpayer must come forward in any Tax Court case with evidence to counter
it, rather than the IRS first submitting additional documents."*^

There are two main rationales for the presumption ofcorrectness. First, it is
the taxpayer who has the evidence supporting the entries on his tax return."*^
Second, in the usual case, the IRS follows a businesslike routine that will be

effective in the vast majority of cases. In fact, many audits end at the
administrative level before a notice ofdeficiency is ever prepared. Ifthe IRS has

concluded its administrative process through issuance of the notice, the

presumption of administrative regularity justifies placing the initial burden in

litigation on the taxpayer."*"*

There are two important exceptions to the usual case in which the notice of

deficiency provides a basis for placing the burden of going forward on the

taxpayer, one of which, "arbitrary and erroneous" notices, was discussed by

36. See Lederman, supra note 32, at 238.

37. See id.

38. Learned Hand famously stated that "the notice is only to advise the person who is to pay

the deficiency that the Commissioner means to assess him; anything that does this unequivocally

is good enough." Olsen v. Helvering, 88 F.2d 650, 651 (2d Cir. 1937).

39. Schoenfeld, supra note 5, at 5 1 7.

40. Id. at 5 1 8 (emphasis added).

41. See, e.g., United States v.Janis, 428 U.S. 433, 441 (1976);Portinov.Comm'r,932F.2d

1128, 1133 (5th Cir. 1991); Anastasato v.Comm'r, 794F.2d884, 886(3dCir. 1 986); c/ DiMauro

V. United States, 706 F.2d 882, 884 (8th Cir. 1983) (in wagering excise tax case, government must

come forward with evidence connecting taxpayer to wagering before presumption applies).

42. See Anastasato, 794 F.2d at 887. "The presumption of correctness establishes di prima

facie case, but it arises only ifsupported by foundational evidence connecting the taxpayer with the

tax-generating activity." Id. (emphasis added).

43

.

Sean M. Moran, The Presumption ofCorrectness: Should the Commissioner Be Required

to Carry the Initial Burden ofProduction, 55 FORDHAM L. REV. 1087, 1 100 (1987).

44. See Lederman, supra note 32, at 201 n.97.



200 1 ] A REPLY TO PROFESSOR SCHOENFELD 1 49

Professor Schoenfeld. In Janis v. United States*^ the United States Supreme

Court termed an arbitrary assessment a '"naked' assessment without any

foundation whatsoever.'"*^ The line of cases addressing arbitrary and erroneous
notices reflects the understanding that, in cases involving unreported income, the

rationale that the taxpayer possesses the evidence breaks down. As many courts
have noted, it is difficult, if not impossible, to prove a negative (that is,

nonreceipt of income). Thus, in unreported income cases, particularly those

involving income allegedly received from illegal or illicit sources,"*^ ifa taxpayer

alleges that the notice was arbitrary and erroneous, the burden of going forward
shifts back to the IRS to support the notice.'**

In Ryan v. Commissioner,'^^ a case that influenced Professor Schoenfeld 's
article,^^ the Tax Court stated it this way:

As we review each of [the IRS's] assertions concerning each respective
search [by the police officer petitioners], we consider whether
respondent has presented predicate evidence linking the specific

petitioner to the tax-generating activity from which respondent asserts

income has arisen for such petitioner. Where there is no such predicate
evidence, we attribute no income to that petitioner.^'

When the IRS is able to tie the taxpayer to the illegal or illicit income-generating
activity, the IRS has met its burden, and the burden then shifts back to the

taxpayer. Faced with the allegation of a source of the income, the taxpayer is

then empowered to provide some defense to the allegation.
In several cases, taxpayers have been successful in shifting the burden to the

IRS based on an allegation that the notice of deficiency was arbitrary and
erroneous. Some ofthose cases were won on motion by the taxpayer because the
IRS could not come up with evidence supporting the notice .^^ Admittedly, those
cases suggest administrative failure that burdened the taxpayer. However,

prevailing taxpayers are entitled to sue for administrative costs and litigation

45. 428 U.S. 433(1976).

46. /flf. at441.

47. "Most of the cases stating that the Commissioner is not entitled to the presumption [of

correctness] based on a naked assessment without factual foundation have involved illegal income."

AnastasatOy 794 F.2d at 887. Anastasato involved the receipt of illicit "override" commissions by

a travel agent. See id. at 885. It is particularly hard to disprove the receipt of income that a

recipient would generally have received secretly.

48. Cf. Gerardo v. Comm'r, 552 F.2d 549, 554 (3d Cir. 1977) (stating that in case of

unreported illegal income, the IRS must present "some predicate evidence connecting the taxpayer

to the charged activity.").

49. 75 T.C.M.(CCH) 1778 (1998).

50. See Schoenfeld, supra note 5, at 5 1 7 n.* . ("The opinions ofthe author are largely based

[sic] and are augmented by . . . Ryan.'").

51. /?ya/t, 75 T.CM.(CCH) at 1777-78.

52. See, e.g., Portillo v. Comm'r, 932 F.2d 1128, 1 130 (5th Cir. 1991).



150 INDIANA LAW REVIEW [Vol. 35:143

fees.^^ Those costs and fees may be awarded if the IRS pursued a frivolous
position, the taxpayer exhausted any administrative remedies afforded by the
IRS, and the taxpayer meets a net worth requirement.^"*

An exception to the usual burden ofproofprocedure was statutorily created
in 1998. Code section 7491 provides the taxpayer with the opportunity to shift
the burden of proof to the IRS, if he meets several requirements. Because, in
order to do so, the taxpayer is required to make an initial presentation of
"credible evidence" with respect to the factual issue," it is most accurate to say
that section 7491 places the burden of going forward on the taxpayer, though it
allows a shift in the burden of persuasion. As noted by numerous
commentators,^^ section 7491 is likely to be of little practical use. In addition,

the IRS already bears the burden of proving fi-aud. However, it is important to
note that the content ofsection 7491 , with its "credible evidence" requirement,^^

suggests continuing cognizance ofthe practical reality that the taxpayer is the one
with evidence supporting the entries on the tax return, just as the presumption of

correctness does.

Thus, the so-called presumption of correctness, though unfortunately

implying a degree of deference to the IRS, in fact serves the salutary purpose of

allocating the burden ofgoing forward to the party in possession ofthe evidence

relating to the controversy. Even the workings of section 7491 reflect this
notion. Where the presumption would allocate the burden of going forward to
a party without evidence, because it alleges receipt of illicit income, case law

53. 5eeI.R.C. §7430(1994).

54. See id.

55. I.R.C. § 7491(a)(1) (Supp. V 1999).
56. See, e.g., Johnson, supra note 3, at 413 (Code section 7491 "is a pernicious exercise in

symbolic legislation."); Anthony F. Newton, The 'Stat' Notice in the New Millennium: Shouldn 't

the Notice Be User Friendly?, 91 TAX NOTES 1 139, 1 157 (2001) ("Congress did make a feeble

attempt to level the playing field with the addition of section 7491 . However, its effect has not yet

been realized and, due to its limitations, more likely than not, it never will be.'*); see also Higbee

V. Comm'r, 116 T.C. 438 (2001).

Because [the taxpayers] have failed to provide credible evidence ofa casualty loss, the

burden of proof as to this issue is not placed on [the IRS]. Further, for similar reasons

regarding our discussion of [the taxpayers'] evidence for purposes ofsection 7491, we

conclude that [the taxpayers] have not met their burden of proof

Id. at 443; cf. Nathan E. Clukey, Examining the Limited Benefits ofShifting the Burden ofProof

to the IRS, 82 TAX NOTES 683 ( 1 999).

This article . . . posits that ... an expansive reading of credible evidence must be

rejected, and that once that is done, the statute will have a noticeable effect in regard to

evidence not governed by heightened substantiation requirements—by giving the
taxpayer a strategic advantage compared to prior law. However, it acknowledges that

where the heightened substantiation requirements are applicable, this strategic

advantage will be eviscerated.

/^. at 685.

57. IdsLteSS.



200 1 ] A REPLY TO PROFESSOR SCHOENFELD 1 5

1

provides a mechanism for shifting that burden to the IRS.

2. Inaccurate, Arbitrary, and Uninformative Notices ofDeficiency.—One
of Professor Schoenfeld's major complaints is the rule of Greenberg's Express,

Inc. V. Commissioner.^^ In Greenberg's Express, the Tax Court held that it
would not "look behind a deficiency notice to examine the evidence used or the
propriety of [the IRS's] motives or of the administrative policy or procedure

involved in making [the] determinations."^^ The court reasoned that the Tax
Court trial is a de novo proceeding in which the administrative record is

irrelevant.^° In effect, the court seemed to be stating that it would not invalidate

the notice because ofthe process that generated it, even ifthat process might be

defective. Professor Schoenfeld makes the excellent point that the facts of
Greenberg 's Express involved the issue ofwhether the IRS had chosen to audit
certain taxpayers for an impermissible reason, not if the audit process itselfwas
careless or otherwise defective. He argues that ''Greenberg 's Express is of little
pertinence to an inquiry into how (not why) a revenue agent may have committed
errors in preparing his determination of the assertions set out in the Statutory

Notice."'^

Although this analysis might imply that the holding ofGreenberg 's Express

should be limited to cases involving IRS selection ofwhich returns to audit, there
is still value in treating the notice of deficiency as a pleading that the Tax Court
does not look behind. Essentially, the notice makes allegations of fact that the

taxpayer has the option to dispute in court.^^ If there are mistakes in the notice

of deficiency, the taxpayer should have the evidence necessary to correct them
unless they arrive out ofan arbitrary and erroneous notice, which the taxpayer is

empowered to counter procedurally, as discussed above. Analyzing the process
used to generate the notice would distract from analysis ofthe substantive issues
in the case.

Professor Schoenfeld posits that "[a]pplying Greenberg's Express as the

Service argues would shield almost all information that might tend to show that
an employee of the Service acted improperly or carelessly."^^ However, the

Greenberg's Express court did state that it would shift the burden of going

58. 62 TC. 324(1974).

59. Id at 327.

60. /J. at 328.

61. Schoenfeld, supra note 5, at 528 (emphasis in original).

62. If the taxpayer never receives the notice or fails to petition the Tax Court in a timely

manner, he will still have an opportunity to litigate, post-assessment. Two fora will be available

to the taxpayer: the United States District Courts and the United States Court of Federal Claims.

See 28 U.S.C. §§ 1346(a)(1), 1491(a)(1) (1994). Following assessment, the taxpayer will be

required to pay the tax. Following payment, a taxpayer who wishes to contest the tax liability must

file a refund claim as a prerequisite to suit. I.R.C. § 7422(a) (1994). Upon disallowance of the

claim, waiver of disallowance by the taxpayer, or passage of six months, the taxpayer may file suit

in either of the refund fora listed above. See id § 6532(a)(1). Unfortunately, the "full payment"

rule does provide a barrier to accessing those fora. See Flora v. United States, 362 U.S. 1 45 ( 1 960).

63. Schoenfeld, supra note 5, at 529.



152 INDIANA LAW REVIEW [Vol. 35:143

forward to the IRS if a taxpayer presented substantial evidence of
unconstitutional conduct by the IRS.^ Professor Schoenfeld makes this point
quite clearly: "[T]he Tax Court did not say that it would never look behind the
Statutory Notice. On the contrary, the court said it would do so, particularly
when there was substantial evidence of unconstitutional behavior on the part of
the Service's employees in preparing the Statutory Notice."^^ He points out that,
in that instance, "the Statutory Notice would no longer carry the presumption of
correctness that is normally conferred upon it."^^ In other words, the Tax Court
would shift the burden of going forward to the IRS.

a. Inaccurate notices.—^Professor Schoenfeld used Scar v. Commissioner^^ as
"[a]n extreme example of the Tax Court's persistent refusal to look behind a
Statutory Notice."^* Scar is extreme; its facts are highly unusual and

unrepresentative of the overwhelming majority of statutory notices. However,

Scar has little relevance to Tax Court reluctance to examine the pre-notice of
deficiency administrative process at the IRS. Instead, Scar is a case about the

proper remedy for an inaccurate notice of deficiency.
As Professor Schoenfeld relates in his article, the notice ofdeficiency in Scar

asserted a deficiency of $96,600 based on the disallowance of deductions

attributable to the "Nevada Mining Project,"^^ a tax shelter in which the Scars
had never invested. The notice calculated the deficiency by applying the
maximum marginal rate ofseventy percent to $ 1 3 8,000 ofdisallowed deductions.
An attachment explained, "In order to protect the government's interest and since
your original income tax return is unavailable at this time, the income tax is being

assessed at the maximum tax rate of 70%."^°

The Scars' Tax Court petition denied that they had ever had any interest in
the Nevada Mining Project. The IRS's answer denied the allegations of the
petition in full. The Scars moved to dismiss for lack ofjurisdiction. In response,
the IRS conceded that the Scars had never had any interest in Nevada Mining,
and moved for leave to amend its answer, to state a decreased deficiency
attributable to Executive Productions, Inc., a videotape tax shelter.^'

In court, the IRS explained that the error in the notice had occurred because

one of its agents had transposed numbers when entering the code assigned to the
videotape tax shelter.^^ The Scar case reflects a degree ofsloppiness rarely seen.

As is evident from the case, the tax shelter era of the 1980s produced a

64. 62T.C. at328.

65. Schoenfeld, supra note 5, at 527-28 (emphasis in original) (footnotes omitted).

66. Mat 528.
67. 81 T.C 855 (1983), rev'd, 814 F.2d 1363 (9th Cir. 1987).

68. Schoenfeld, 5M/?ra note 5, at 531.

69. Scar v. Comm'r, 814 F.2d 1363, 1365 (9th Cir. 1987), rev'g 81 T.C. 855 (1983).

70. Id. This aspect ofthe case is discussed below. See infra notes 8 1 -83 and accompanying

text.

71. 814 F.2d at 1365-66.

72. Id at 1365.



200 1
]

A REPLY TO PROFESSOR SCHOENFELD 1 53

voluminous caseload for the IRS/^

The main issue decided in Scar, which went up to the Court of Appeals for

the Ninth Circuit, was whether the faulty notice ofdeficiency was "invalid" and
therefore required dismissal for lack of Tax Court subject-matter jurisdiction.^"*

The Ninth Circuit reversed the Tax Court's ruling that the notice was valid,
holding that the notice had failed to make the "determination" required by section
6212(a).^^ Professor Schoenfeld praises the outcome in Scar, stating:

The view of the Ninth Circuit in Scar seems correct. There really

should be a "determination" as prescribed in the statute and the Service's

published internal procedures, and then those determinations offact and

law should be spelled out in the Notice. This is necessary to permit

fairness in litigation. The Statutory Notice not only confers jurisdiction

on the Tax Court, in practical effect it is really also the initial pleading
in the case.^^

Although Professor Schoenfeld is correct that the notice ofdeficiency serves

a pleading function once a taxpayer invokes the Tax Court'sjurisdiction by filing

a petition, and although notices ofdeficiency should specify their determinations,

as the Code requires,^^ that does not mean Scar was correctly decided. In fact,
what Scar did was turn a defect in a pleading function (framing the litigation)
into 2ljurisdictional objection. As discussed previously, much less is required
to get a case before a court than to make one's case to the court. In Scar, the
notice of deficiency met minimum jurisdictional standards: it contained the
Scars' names and address, the correct tax year, a deficiency amount, and a

statement explaining how the deficiency was calculated.^^

73

.

That volume is evidenced in part by the inventory ofthe Tax Court. IRS data reflects that

in 1 98 1 , the Tax Court had about 38,000 docketed cases, with about seventeen percent ofthose tax

shelter cases, while in 1984, the Tax Court had about 43,000 docketed cases, thirty-three percent

ofwhich were tax shelter cases. See U.S. Tax Court Judicial Conference, Chief Counsel for

THE Internal Revenue Service, October 1 986, at 1 . According to the Tax Court, in fiscal year

1984, 42,024 cases were filed and 63,598 were pending. See UNITED States Tax Court, 1990

Fiscal Year Statistical Information (1991). By contrast, in fiscal year 2000, only 16,572

cases were pending in the Tax Court, and fewer than eleven percent ofthose were tax shelter cases.

See Office of Chief Counsel, Internal Revenue Service, American Bar Association Tax

Section Court Procedure Committee 1 1 (200 1 ). Scar was decided in 1 983, during a spurt in

tax shelter litigation.

74. 814F.2datl365.

75. 5eezV/. atl370.

76. Schoenfeld, supra note 5, at 534.

77. See I.R.C. § 7522 (1 994). Section 7522 is discussed in more detail later. See infra text

accompanying notes 100-11.

78. Cf. Scar, 814 F.2d at 1370 n.1 1 ("In the case before us the Commissioner argues that,

because the notice contained the Taxpayers' names, social security number, the tax year in question,

and 'the' amount of deficiency, it was 'clearly sufficient.'"); Olsen v. Helvering, 88 F.2d 650, 651

(2d Cir. 1937) (holding that anything that communicates IRS's intent to assess suffices); Donohue



154 INDIANA LAW REVIEW [Vol. 35:143

The Scar notice nevertheless is highly problematic. Judge Hall, the former
Tax Court judge who dissented in Scar, stated that a notice of deficiency is
"nothing more than 'a jurisdictional prerequisite to a taxpayer's suit seeking the
Tax Court's redetermination of [the IRS's] determination ofthe tax liability. '"^^

That is an overstatement; it does not account for the pleading function of the

notice. As I have previously argued, "The egregious content errors in the Scars'
statutory notice are troublesome but are notjurisdictional. The content errors in
the Scar notice should instead have been corrected during the litigation."^° Once
the Scar answ^er was amended, it would have asserted "new matter" not raised in
the notice of deficiency, which would place the burden of proof on those issues
on the IRS.*' In fact, even if the IRS had not moved to amend its answer, the
Scars could have moved to have the burden shifted to the IRS under Tax Court
Rule 142(a) on the issues relating to the videotape tax shelter.

Thus, Scar involved an erroneous notice of deficiency. The Ninth Circuit's
decision to invalidate the notice did not require "looking behind" it to evidence

regarding the IRS's administrative process. Instead the court found that

information on the face of the notice warranted the court's concern.

Unfortunately, the court chose the wrong remedy: it simply should have shifted
the burden of going forward to the IRS, rather than invalidating the notice and

therefore dismissing the case.

b. Arbitrary notices.—One issue in Scar was the apparent arbitrariness of
the IRS's "determination," because the Scars' original return was unavailable.
At first blush, it may appear impossible for the IRS to make a determination of
tax liability without the taxpayer's return. However, the IRS codes data from

each tax return.*^ The IRS's position, supported by case law,*^ is that the IRS

V. Comm'r, 37 T.C.M. (CCH) 954, 954-56 (1 978) (holding that mutilated notice containing no date,

address, year or deficiency amount was sufficient for Tax Court subject-matter jurisdiction).

79. 814 F.2d at 1372 (Hall, J., dissenting) (quoting Stamm Int'l Corp. v. Comm'r, 84 T.C.

248, 252 (1985)). Subsequent decisions, even in the Ninth Circuit, have limited Scar to its facts.

See, e.g., Clapp v. Comm'r, 875 F.2d 1396, 1402 (9th Cir. 1989) ("Only where the notice of

deficiency reveals on its face that the Commissioner failed to make a determination is the

Commissioner required to prove that he did in fact make a determination."); Campbell v. Comm'r,

90 T.C. 110(1988).

Where the alleged notice of deficiency reveals on its face that [the IRS] failed to make

a determination, then the Ninth Circuit would require respondent to prove that he did

m2ike a determination. Here the 9-page document does not reveal on its face that [the

IRS] failed to make a determination.

Mat 114.
80. Lederman, supra note 32, at 238.

81. See Tax Ct. R. Prac. & P. 1 42(a).
82. See Scar, 814 F.2d at 1374 n.4, stating:

Although the "unavailability" of the Scars' return may indicate that the Scars' original

paper return was not before the Commissioner, it does not show that specific data on that

return or relation to the video-tape tax shelter was not considered. Due to the

computerization of the IRS, the Commissioner no longer operates from original paper



2001] A REPLY TO PROFESSOR SCHOENFELD 155

"may rely on taxpayer return information duly recorded in the Service's official
records and data bases"*"* because a requirement that the IRS rely only on the
original paper return would inhibit the IRS's efforts to computerize.*^

Computerization generally makes the IRS's processes both quicker and less

costly.*^

Another concern expressed in Scar is the hypothetical of an IRS run amok,

sending out notices ofdeficiency willy-nilly. The Ninth Circuit reproduced from
Judge Sterrett's dissent in the Tax Court an invented, tongue-in-cheek notice that
reflects this fear. In part, it states:

Dear Taxpayer: There is a rumor afoot that you were a participant in the
Amalgamated Hairpin Partnership during the year 1980. Due to the
press of work we have been unable to investigate the accuracy of the
rumor or to determine whether you filed a tax return for that year.*^

It seems unlikely that the IRS would send out notices based on mere rumor
or worse, invidious discrimination against certain taxpayers.** In fact.

returns.

Id. (Hall, J., dissenting); Whittington v. Comm'r, 78 T.C.M. (CCH) 339 (1999) (IRS used Returns

Transaction Data System (RTVUE), a line-by-line transcript oftaxpayer's return, in arriving at its

deficiency determination).

83. See, e.g., Griner v. Comm'r, 1991 U.S. App. LEXIS 30021 (9th Cir. 1991) ("Griner's

argument that the determination was invalid because the Commissioner may not have used the

original papers filed by the Griners is without merit. Whether the Commissioner used the originals,

copies, or computer reports of the returns is not important."); Whittington v. Comm'r, 78 T.C.M.

(CCH) 339 (1999) (upholding IRS use of RTVUE transcript of taxpayer's return to arrive at
deficiency determination).

84. IRS FSA 200004017, 1999 FSA LEXIS 291, *9.

85. Id. However, in a Tax Court case, appealable to the Ninth Circuit, in which the IRS did

not actually use the transcript ofthe return that was in its files, and simply computed the tax at the

top marginal rate, the IRS found the notice of deficiency invalid under the reasoning ofScar. See

Kong v. Comm'r, 60 T.C.M. (CCH) 696 (1990); see also Toll v. Comm'r, 1991 U.S. App. LEXIS

17529 (9th Cir. 1991) (similar holding by the Ninth Circuit, on similar facts); Camahan v. Comm'r,

61 T.C.M. (CCH) 2406, 2407-08 (1991) (prior docket in the case was dismissed because it was

based on notice of deficiency that stated "[i]n order to protect the government's interest and since

your original income tax return is unavailable at this time, the income tax is being assessed at the

maximum tax rate of 70%.").

86. For example, in 1993, the IRS estimated that its use of the RTVUE system would save
$1.2 million dollars, and would enable the IRS to provide taxpayers with transcripts of their

accounts within twenty-four to forty-eight hours of a request, as opposed to the six to eight weeks

required to obtain a copy of a tax return. See Fact Sheet FS-93-3, 1 993 IRB LEXIS 394.

87. Scar, 814 F.2d 1363, 1370 n.l2 (9th Cir. 1987) (quoting Scar v. Comm'r, 81 T.C. 855,

869 (1983) (Sterrett, J., dissenting)).

88. In a Litigation Guideline Memorandum issued by the IRS to its personnel shortly after

Scar was decided, and released in 2000 under the Freedom of Information Act, the IRS stated, in

part:



156 INDIANA LAW REVIEW [Vol. 35:143

investigation of the "abuses" alleged at the IRS hearings—^most of which were
concentrated in the collections area^'—suggests that many of them were
unfounded.^° In addition, the Code provides criminal penalties for unauthorized
inspection ofreturn information by IRS employees.^' Furthermore, the Internal
Revenue Service Restructuring and Reform Act of 1998 included a provision
known as the "Ten Deadly Sins," commission of which requires termination of
the IRS employee.'^ The "sins" include "violations ofthe Internal Revenue Code
of 1 986, Department ofTreasury regulations, or policies ofthe Internal Revenue
Service (including the Internal Revenue Manual) for the purpose of retaliating
against, or harassing, a taxpayer, [or] taxpayer representative,"^^ as well as

"threatening to audit a taxpayer for the purpose of extracting personal gain or

benefit."''

Taxpayers also have tools to contest arbitrary or unfounded notices of

deficiency. First, the Tax Court provides a forum for taxpayers to contest notices
of deficiency without first paying the deficiency asserted. In addition, an

undocumented notice alleging unreported income would be arbitrary and
erroneous, which, on the taxpayer's motion, would result in a shift to the IRS of
the burden of going forward, unless the IRS were able to tie the taxpayer to the
tax-generating activity. In the case of an arbitrary notice denying a deduction,

credit, or exclusion, the taxpayer should have the evidence to rebut the IRS's

contention. Furthermore, as discussed above. Code section 7430 allows a court
to award a prevailing taxpayer reasonable litigation and administrative costs if
the IRS's position was not substantiallyjustified and the taxpayer "has exhausted
the administrative remedies available"'^ to him within the IRS.'^

Section 7430, which requires that the taxpayer substantially prevail, will not

protect a taxpayer who loses on the merits after a successful "fishing expedition"

Notwithstanding our legal view that the Ninth Circuit panel majority was incorrect in

its legal analysis ofthe jurisdiction ofthe Tax Court and our commitment to defend the

jurisdiction as noted above, the process the Service used in Scar is rightly condemned.

The Office of Chief Counsel has expressed to the Examination Division its strong

objections to the procedure of issuing inadequate notices to "protect the government's

interest." Steps are being taken to prevent a repeat ofthe situation exemplified by Scar.

All attorneys in the Office ofChiefCounsel should be aware of this and take necessary

steps to forestall further Scar situations.

LGM TL-3 (Jan. 15, 1988), 2000 TNT 121-89.
89. See George Guttman, Public Relations: The IRS CouldDo a Lot More to Help Its Image,

87 Tax Notes 479, 480 (2000).
90. Ryan J. Donmoyer, Horror Story Heard by Senate Panel Was Half-Told Tale, 79 TAX

Notes 518, 520 (1998).

91. 5eeI.R.C. §7213A(Supp. V1999).

92. H.R.2676, 105th Cong. § 1203(1998).

93. /^. at§1203(b)(6)-(10).

94. Id

95. I.R.C.§ 7430(b)(1) (1994).

96. Id § 7430.



200 1 ] A REPLY TO PROFESSOR SCHOENFELD 157

by the IRS. However, Tax Court rules require parties or their attorneys to sign
their pleadings,^' and they contain sanctions similar to Rule 1 1 of the Federal

Rules of Civil Procedure for pleadings filed for improper purposes:

The signature ofcounsel or a party constitutes a certificate by the signer
that ... to the best of the signer's knowledge, information, and belief

formed after reasonable inquiry, it is well grounded in fact and is

warranted by existing law or a good faith argument for the extension,

modification, or reversal ofexisting law, and that it is not interposedfor
any improperpurpose, such as to harass or to cause unnecessary delay
or needless increase in the cost oflitigation. ... If a pleading is signed

in violation of this Rule, the Court, upon motion or upon its own
initiative, may impose upon the person who signed it, a represented
party, or both, an appropriate sanction, which may include an order to
pay to the other party or parties the amount of the reasonable expenses

incurred because of the filing of the pleading, including reasonable

counsel's fees.^^

This provision provides a sanction for the hypothetical circumstance in which

IRS pleadings were made in order to perpetuate a case premised on harassing the
taxpayer.

c. Uninformative notices.—Professor Schoenfeld also expresses concern
about specificity in notices of deficiency, arguing that

[a]pplying Greenberg's Express as the Service argues would shield

almost all information that might tend to show that an employee of the
Service acted improperly or carelessly. Except for the most blatant and

erroneous situations, such as an obvious and substantial mathematical

error on the face ofthe Statutory Notice, or a Notice which clearly does

not refer to the petitioner's income or deductions, a petitioner must know
how the specific dollar assertions in the Statutory Notice were computed
in order to begin to bear his burden of refuting the assertions.^^

It is certainly true that the taxpayer must know how the dollar amounts in the
notice were determined in order to produce appropriate evidence to contradict the

determination. However, Greenberg's Express does not prevent specificity in

notices of deficiency. On the contrary. Code section 7522, enacted subsequent
to the decision in Greenberg's Express, requires specificity in IRS notices,
including notices of deficiency. In part, it provides: "Any notice to which this
section applies shall describe the basis for, and identify the amounts (if any) of.

97. See TAX Ct. R. Prac. & P. 23(a)(3) ("The original signature, either of the party or the
party's counsel, shall be subscribed in writing to the original ofevery paper filed by or for that party

with the Court, except as otherwise provided by these Rules."); id. at 33(b) ("If a pleading is not

signed, it shall be stricken, unless it is signed promptly after the omission is called to the attention

of the pleader.").

98. Id. (emphasis added).

99. Schoenfeld, supra note 5, at 529 (footnote omitted).



158 INDIANA LAW REVIEW [Vol. 35: 143

the tax due, interest, additional amounts, additions to the tax, and assessable

penalties included in such notice."'°^

Enforcement ofsection 7522 should address Professor Schoenfeld's concerns

about unspecific and uninformative notices. Unfortunately, Tax Court
jurisprudence interpreting this provision has not been ideal. Section 7522 also

provides that "[a]n inadequate description . . . shall not invalidate [the] notice."'^'

That has the positive effect of avoiding a taxpayer win based on ajurisdictional
ruling when the nature of the error actually affects the pleading function of the
notice. However, the quoted sentence has the unfortunate effect of precluding

one remedy without specifying another.

Over time, the Tax Court has developed the remedy ofshifting the burden of
proof to the IRS as a remedy for violation of section 7522.'^^ This remedy in
effect requires the IRS to come up with the explanation it did not afford in the
notice ofdeficiency. It relieves the taxpayer from having to counter an unknown
allegation. It is an excellent remedy for a vague notice. Unfortunately, in Shea
V. Commissioner, ^^^ the Tax Court applied the same standard as it does to
determine ifthe IRS has raised "new matter," which requires shifting the burden
of proof to the IRS.'^ The "new matter" jurisprudence encourages the IRS to
draft broadly worded notices ofdeficiency so that little raised subsequently will

be found inconsistent with the determination in the notice of deficiency. '^^ That

test for new matter is not appropriate for determining whether the notice is
adequately specific and descriptive.

^°^

100. I.R.C.§ 7522(a) (1994). The section applies to notices of deficiency. Seeid. § 7522(b).

101. /^.§ 7522(a).

102. See Shea v. Comm'r, 112 T.C. 183 (1999).

We, therefore, hold that where a notice ofdeficiency fails to describe the basis on which

the Commissioner relies to support a deficiency determination and that basis requires

the presentation of evidence that is different than that which would be necessary to

resolve the determinations that were described in the notice of deficiency, the

Commissioner will bear the burden ofproofregarding the new basis. To hold otherwise

would ignore the mandate of section 7522 and Rule 142(a).

Id. at 197; Straight v. Comm'r, 74 T.C.M. (CCH) 1457 (1997) (IRS conceded that shifting the

burden of proof would be appropriate remedy for section 7522 violation); Ludwig v. Comm'r, 68

T.C.M. (CCH) 961, 963 (1994) ("What then remains of the responsibility of the IRS when the

Commissioner fails to obey the command of section 7522(a)? Perhaps this Court could fashion

some sort of remedy for the taxpayer, such as imposing the burden of proof, or at least the burden

of going forward, on the Government.").

103. 112 T.C. 183(1999).

104. Seeid. at 193-94; TAX CT.R.PRAC.& P. 142(a); ^eea/^o Elliott v. Comm'r, 82 TC.M.

(CCH) 13, *21 (2001) ("In a recent case, we considered whether the Commissioner's position was

new matter in the context of section 7522." Citing Shea v. Comm'r, 1 12 T.C. 183 (1999)).

1 05. See Leandra Lederman Gassenheimer, The Dilemma ofDeficient Deficiency Notices, 73

Taxes 83 (1995) (containing a detailed discussion).

1 06. See Leandra Lederman, Deficient Statutory Notices and the Burden ofProof: A Reply to



200 1
]

A REPLY TO PROFESSOR SCHOENFELD 1 59

For example, in Sellers v. Commissioner, ^^^ the notice of deficiency stated

that the IRS had disallowed the taxpayers' bad debt deduction "because it has not
been established that any amount of bad debts existed in fact and in law."'^^

Similarly, the IRS stated that it disallowed a net operating loss carryover
"because it has been determined that a net operating loss did not exist in the year

that caused the carryforward."'°^ The Tax Court stated, with respect to section
7522, "At trial, [the IRS] has taken no position that would require [the taxpayers]

to present evidence different from that necessary to resolve the determinations

that were described in the notice ofdeficiency, so as tojustify placing the burden

of proof on [the IRS].""° In fact, the broader the statement in the notice of

deficiency, the less likely different evidence would be needed to prove post-
notice positions adopted by the IRS. Fortunately, the Tax Court does recognize
the purpose of section 7522."' Additional reform in this area would solve the

problem; Greenberg's Express need not be overruled.

C. Obtaining the Revenue Agent's Report

Professor Schoenfeld argues that, because of Greenberg's Express and

assertions of privilege, the IRS "consistently argues that all documents

supporting its computations of a deficiency are . . . not discoverable.""^ He
focuses on the revenue agent's report."^ Yet, many, if not most, taxpayers

receive the revenue agent's report before ever receiving a notice of deficiency;

it generally arrives with the thirty-day letter. In fact, in order to demonstrate the

function of the revenue agent's report, Professor Schoenfeld quotes Block-

Southland Sportswear Co. V. United States^^^ as saying, "The purpose of such

letter and report is to inform the taxpayer ofthe results ofan income tax audit for

a particular year and to extend to him an opportunity to request a conference for
a further discussion of a proposed adjustment in his tax liability.""^ The prior
sentence of that opinion states, "On June 23, 1971, under Section 6532(a)(1) of
the Internal Revenue Code of 1954, the District Director of Internal Revenue of
the State of North Carolina issued to plaintiff \i\s Form LI 91 (Rev. 3-69)
commonly known as a 'thirty-day letter' to which was attached a Revenue

Mr. Newton, 92 TAX NOTES 1 17, 122-23 (2001) (criticizing Shea's approach to § 7522).

107. 80 T.C.M. (CCH) 135 (2000).

108. /^. at 138.

109. Id.

110. /i/. at 139 (citation omitted).

111. See Elliott v. Comm'r, 82 T.C.M. (CCH) 13, *22 (2001) ("[The Shea] holding was

predicated on our understanding that the purpose of section 7522 is to give taxpayers notice ofthe

basis for a deficiency determination.").

1 12. Schoenfeld, supra note 5, at 536.

113. See id. at 536-37.

1 14. 73-1 USTC ^ 9230, aff'd, 480 F.2d 921 (4th Cir. 1973).
1 1 5. Schoenfeld, supra note 5, at 537 n. 122 (quoting Block-Southland Sportswear Co. , 73-1

USTC 1 9230).



160 INDIANA LAW REVIEW [Vol. 35:143

Agent's Reportr^^^

Ifthe taxpayer does not receive a copy ofthe revenue agent's report with the
thirty-day letter, many practitioners request it (and in fact, often request the entire
administrative file) as soon as the notice of deficiency arrives."^ If an informal

request is unsuccessful, a Freedom of Information Act request is in order. That
may or may not result in obtaining the file in time for use in Tax Court litigation.
If it does not, use of the Tax Court's discovery procedures is the remaining
option.

Professor Schoenfeld states that,

[i]n effect, the Service is asserting that everything its employees do at
any time is potentially part of some future litigation and, thus, not
discoverable. This position reinforces the Service's position in

Greenberg '5 Express, sharply decreasing the likelihood that a petitioner

will find a basis for any error in a Statutory Notice."^

Yet, Peterson v. United States,
^^^

the case that Professor Schoenfeld discusses

immediately following the quoted language, contradicts the assertion that the

taxpayer will be hampered. In that case, although the government argued that

documents were privileged as prepared in anticipation oflitigation or for trial, the
court did not so find:

The only indication before the court that the documents were so
prepared are conclusory statements by counsel for the Government. The
Government has neither shown nor offered to show that such documents
are trial preparation material. Generally, it is this court 's beliefthat IRS
appellate conferee reports andIRSfield agent reports are notprepared
in anticipation oflitigation orfor trial. Presumably they are prepared

in the assessment and review process and, if they be held to be in

anticipation of litigation, it is hard to see what would not be. Litigation

cannot be anticipated in every such case when relatively few result in
litigation. Since no showing to the contrary has been made or offered,
it is this court's finding that the contents of the documents sought to be

discovered by the plaintiffs through Interrogatories Nos. 6 and 8 are not

trial preparation material and are not protected from discovery by rule

26(b)(3).'2'

Peterson was not the only case in which the taxpayer was able to obtain

116. Block-Southland Sportswear Co. ,73-1 USTC
If
9230.

117. Cf. Swanson v. Comm'r, 1 06 T.C. 76, 8 1 ( 1 996) ("Because the notice ofdeficiency failed

to adequately explain respondent's bases for determining deficiencies and additions to tax with

respect to the years at issue, petitioners requested and received the revenue agent's report in their

case.").

1 18. Schoenfeld, supra note 5, at 537 (emphasis in original).

119. 52F.R.D.317(S.D. III. 1971).

120. M at 320-21 (emphasis added).



200 1 ] A REPLY TO PROFESSOR SCHOENFELD 1 6

1

revenue agent reports. In Hernley v. United States,^^^ a case in which the

taxpayer sought disclosure of grand jury materials, the Court ofAppeals for the

Seventh Circuit stated: "In support of their claim of right to depose Agent
Johnson, the Hernly defendants asserted that in discovery they had obtained a
copy ofAgent Johnson 's Revenue Agent '5 Report.

""^^^ The court also described

contents of that report, including contents relating to civil fraud.
*^^

Professor Schoenfeld's concern may be that Peterson and other favorable
cases were not decided by the Tax Court. He states:

[T]he [Internal Revenue] Service . . . often refuses to disclose exactly

how it calculated the dollar amounts of the taxpayer's asserted tax
deficiencies, based upon its overly broad interpretation ofcase law. This
refusal to disclose details seems to be contrary to the discovery rules of

the Tax Court; however, the court usually agrees with the Service's
position because it does not wish to look into the inner administrative

workings of the agency.
^^^

Tax Court discovery rules seem to allow taxpayers to obtain revenue agents'
reports. Tax Court Rule 70(b)(1) states in part, "The information or response
sought through discovery may concern any matter not privileged and which is
relevant to the subject matter involved in the pending case."'^^ In Haag v.
Commissioner, ^^^ the Tax Court admitted a thirty-day letter and revenue agent's
report into evidence "for the limited purpose of showing the basis for the

deficiency determination, and not as proofofthe facts contained therein."'^^ The
Tax Court does not always admit revenue agents' reports into evidence, but
inadmissibility ofevidence does not preclude its availability through discovery.

"It is not ground for objection [to discovery] that the information or response

sought will be inadmissible at the trial, if that information or response appears

reasonably calculated to lead to discovery of admissible evidence, regardless of

the burden of proof involved."'^*

In Rountree Cotton Co. v. Commissioner,
^^"^

a case submitted to the court

fully stipulated, the Tax Court refused to admit into evidence a revenue agent's
report that the taxpayer had received "before issuance of the notice of

deficiency."'^^ The court sustained the IRS's relevance objection, finding that
the IRS's pre-notice administrative record was irrelevant given the absence of

121. 832 F.2d 980 (7th Cir. 1 987).

122. M at 982 (emphasis added).
123. ^ee /flf. at 982-83.

1 24. Schoenfeld, supra note 5, at 5 1 8.

125. Tax Ct. R. Prac. & P. 70(b)(1).
126. 88 T.C. 604 (1987), ajfcl, 855 F.2d 855 (8th Cir. 1988).

127. Id. at622n.l4.

128. TaxCt. R. Prac. & P. 70(b)(1).
129. 113 T.C. 422 (1999), ajpd, 2001 U.S. App. Lexis 5258 (10th Cir. 2001).

130. Mat 426.



1 62 INDIANA LAW REVIEW [Vol . 3 5 : 1 43

allegations ofunconstitutional IRS conductJ^^ However, Professor Schoenfeld's

objection seems to be that the revenue agent's report may be unavailable to the
taxpayer, not that it will be inadmissible as evidence supporting the taxpayer. In

Rountree Cotton, as in most other cases, the taxpayer will already have obtained
the report.

'^^

II. Proof IN Tax Fraud Cases

Although Professor Schoenfeld's primary concern seems to be with obtaining

information from the IRS, he also expresses concern about the IRS's methods for

proving tax fraud, particularly the use ofcollateral estoppel, badges offraud, and

allocation of the proceeds of a criminal conspiracy. Each of these is discussed
below.

Code section 6663(a) contains the fraud penalty. It provides: "Ifany part of
any underpayment oftax required to be shown on a return is due to fraud, there
shall be added to the tax an amount equal to 75 percent of the portion of the
underpayment which is attributable to fraud.'"" Therefore, a civil fraud case

requires proof of both underpayment of tax and fraud. The IRS has the burden
of proving fraud, and it must do so by clear and convincing evidence.*^"* In fact,

the IRS must establish each element offraud with that level of proof. Collateral

estoppel and so-called "badges offraud" are techniques the IRS uses to meet its
burden of proving the fraud element. The underpayment element generally

requires additional evidence.

An underpayment of tax in a fraud case generally stems either from
disallowed deductions or unreported income. Professor Schoenfeld's article

focuses on cases involving unreported income, particularly cases involving

illegal income. Because ofthe difficulties ofproving the negative ofnonreceipt,

an IRS determination ofreceipt ofprofits from an illegal enterprise requires some
predicate evidence connecting the taxpayer to the activity. ^^^ The importance of
this element of the proof is discussed below.

A. Methods ofProving Fraud

1. Collateral Estoppel.—Professor Schoenfeld states that "[cjollateral
estoppel is ... a no-win situation for the taxpayer: heads the Service wins, tails

the taxpayer loses."'^^ He is referring to the reality that in addition to the fact
that a conviction ofcriminal tax evasion '^^ estops the taxpayer from denying the

131. Id.

1 32. See supra notes 1 1 3-28 and accompanying text.

133. I.R.C.§ 6663(a) (1994).

134. See id § 7454(a); TAX Ct. R. Prac. & P. 142(b).
135. Anastasato v. Comm'r, 794 F.2d 884, 887 (3d Cir. 1986); Gerardo v. Comm'r, 552 F.2d

554, 556 (3d Cir. 1977).

1 36. Schoenfeld, supra note 5, at 549 n. 1 89.

137. For purposes of applying collateral estoppel, a plea of guilty is treated the same as a

conviction. See, e.g., McCulley v. Comm'r, 73 T.C.M. (CCH) 3163, 3165 n.5 (1997); see also



2001] A REPLY TO PROFESSOR SCHOENFELD 163

elements of the crime, acquittal of a tax crime does not preclude a subsequent

civil trial because the burden of proof is lower in a civil fraud trial ("clear and

convincing evidence," as opposed to "beyond a reasonable doubt"). This is not

unique to tax cases; it is well known that when O.J. Simpson was acquitted ofthe
murders of Nicole Brown and Ronald Goldman,'^* collateral estoppel did not
preclude successful wrongful death suits by the families ofthe victims. '^^ In fact,

it is logical that although conviction under a higher standard of proof precludes

contesting the predicate findings under a lower standard ofproof, acquittal under

a higher standard of proof does not preclude a subsequent suit under a lower

standard of proof

The doctrine of collateral estoppel allows a court to preclude relitigation of
an issue that was decided in a previous case that involved the party against whom
estoppel is sought. "Collateral estoppel, like the related doctrine ofres judicata,

has the dual purpose of protecting litigants from the burden of relitigating an

identical issue with the same party or his privy and of promoting judicial
economy by preventing needless litigation." "*° The issue with respect to which
estoppel is sought must have been necessary in reaching the original decision,

'^^

as well as part of a "valid and final judgment."''*^ In addition, courts consider

whether the party sought to be estopped had a "full and fair opportunity to

litigate"'"*^ the issue in the first suit.'"*^

As previously indicated, burden of proof is also considered when a party
seeks estoppel. Acquittal ofa criminal charge is "an adjudication that the proof

was not sufficient to overcome all reasonable doubt of the guilt of the
accused."'"*^ Accordingly, acquittal does not preclude a subsequent civil trial on

the same issues; '"^^ the standard of proof is lower in a civil proceeding."*^ In

Johnson v. Sawyer, 47 F,3d 7 1 6, 722 n. 1 3 (5th Cir. 1 995). However, there are good arguments that

a plea should be analyzed differently. See Kathleen H. Musslewhite, The Application ofCollateral

Estoppel in the Tax Fraud Context: Does It Meet the Requirement ofFairness andEquity?, 33 AM.

U.L. REV. 643(1984).

138. See Julian A. Cook, Jr. & Mark S. Kende, Color-blindness in the Rehnquist Court:
Comparing the Court 's Treatment ofDiscrimination Claims by a Black Death Row Inmate and

White Voting Rights Plaintiffs, 13T.M.CooleyL.REV.815, 852n. 193 (1996) (referring to State

of California v. Orenthal James Simpson, B.A. 09721 1 (Cal. Super. Ct., Oct. 1, 1995)).

139. See Complaint for Damages for Wrongful Death Goldman v. Simpson, No. SC03640

(Cal. Super. Ct., L.A. County May 4, 1 995), http://www.courttv.com/casefiles/simpson/documents/

goldcomp.html; Complaint for Damages—Survival Action Brown v. Simpson, No. SC036876 (Cal.
Super. Ct., L.A. County June 12, 1995), http://www.courttv.com/casefiIes/simpson/documents/

browncomp.html.

140. Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326 (1979) (footnote omitted).

141. Mat326n.5.

142. Ashev.Swenson, 397 U.S. 436,443(1970).

143. Montana v. United States, 440 U.S. 147, 154 (1979).

144. See, e.g., id.

145. Lewis v. Frick, 233 U.S. 291, 302 (1914) (emphasis added).

146. E.g, Helvering v. Mitchell, 303 U.S. 391, 397 (1938) ("That acquittal on a criminal



164 INDIANA LAW REVIEW [Vol. 35:143

addition, criminal conviction precludes relitigation in a civil case ofthe elements

of the offense:

Because of the higher standard of proof and the numerous safeguards
surrounding a criminal trial, a conviction in a criminal action is

conclusive in a subsequent civil litigation between the same parties as to
issues that were actually litigated and adjudicated in the prior criminal
proceeding.

'"^^

The rationale behind applying collateral estoppel makes as much sense in tax
cases as it does in other cases. Tax fraud cases are no exception. Thus, as
Professor Schoenfeld notes, a taxpayer convicted of criminal tax fraud under

Code section 720 1 will likely be estopped from denying tax fraud in a subsequent
civil suit.'"*^

Under section 720 1 , the government must prove, beyond a reasonable doubt,
that the taxpayer "willfully attempt[ed] in any manner to evade or defeat any tax
. . .

."^^^ In Amos v. Commissioner, ^^^ the Tax Court held that the willfulness
element of section 7201 encompasses all of the elements of the fraud provision

that is now Code section 6663.'^^ Given the identity of issue combined with the

charge is not a bar to a civil action by the Government, remedial in its nature, arising out of the

same facts on which the criminal proceeding was based has long been settled.").

147. See Commander Roger D. Scott, Kimmel, Short, Mcvay: Case Studies in Executive

Authority, Law and the Individual Rights ofMilitary Commanders, 1 56 MIL. L. REV. 52, 1 09 n.2 1

2

(1998) ("The same evidence that might not meet the higher standard of proof applicable in a

criminal context ('beyond a reasonable doubt') might satisfy the standard of proof for liability in

a civil context ('a preponderance of evidence')."). Civil fraud proceedings have an intermediate

standard of proof, "clear and convincing evidence." E.g., Considine v. United States, 683 F.2d

1285, 1286 n.l (9th Cir. 1982); Powell v. Granquist, 252 F.2d 56, 61 (9th Cir. 1958).

148. Sec. & Exch. Comm'n v. Everest Mgmt. Corp., 466 F. Supp. 167, 172 (S.D.N.Y. 1979)
(footnote omitted); see also Emich Motors Corp. v. Gen. Motors Corp., 340 U.S. 558, 568 (1951)

(stating that "[i]t is well established that a prior criminal conviction may work an estoppel in favor

of the Government in a subsequent civil proceeding.").

149. See Schoenfeld, supra note 5, at 547.

150. I.R.C. § 7201 (1994). The section provides, in full:

Any person who willfully attempts in any manner to evade or defeat any tax imposed
by this title or the payment thereof shall, in addition to other penalties provided by law,

be guilty of a felony and, upon conviction thereof, shall be fined not more than

$ 1 00,000 ($500,000 in the case ofa corporation), or imprisoned not more than 5 years,

or both, together with the costs of prosecution.

Id

151. 43 T.C. 50 (1964), ajf'd, 360 F.2d 358 (4th Cir. 1965), overruled in part on other

grounds by Meier v. Comm'r, 91 T.C. 273 (1988).

152. Id at 55; see also I.R.C. § 6663(a) (1994) ('if any part of any underpayment of tax

required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to

75 percent ofthe portion ofthe underpayment which is attributable to fraud."). Amos was applying

the fraud provision that used to be contained in Code section 6653(b). See Amos, 43 T.C. at 52.



200 1
]

A REPLY TO PROFESSOR SCHOENFELD 1 65

higher burden of proof required in the criminal case, estoppel can apply to

preclude the taxpayer to deny tax fraud if he was convicted of a willful attempt
to evade or defeat tax.'^^

In addition, there is an array oftax crimes that do not estop the taxpayer from

denying civil tax fraud. '^"^ Many ofthese other crimes are more easily proven by
the IRS because they do not require proof of a tax deficiency, and Code section
7201 does.'^^ Thus, not every taxpayer convicted of a tax crime will face
collateral estoppel in a subsequent civil case. ^

2. Badges of Fraud.—Commission of fraud requires scienter. That is,
negligent or even grossly negligent activity does not constitute fraud because

fraud has an intent element. It is rarely possible for the IRS to prove to a court
the taxpayer's intent to violate the law through direct evidence (such as a

confession). Accordingly, the IRS uses circumstantial evidence known as
"badges offraud" to try to meet its burden. Professor Schoenfeld lists ten ofthe
badges fraud frequently used in civil tax cases:

A. A Pattern of Understatement.
B

.

Concealment of Assets or Sources of Income.

C. Dealings in Cash.

D. Failure to Maintain Books and Records.

E. Engaging in Illegal Activities.

F. Attempting to Conceal Illegal Activities.

G. Failure to Cooperate with Tax Authorities.
H. Showing a Willingness to Defraud Business Associates or Others.
I. Taxpayer's Sophistication, Education, and Knowledge of Duty to

Report Income.

J. Giving Implausible Explanations.
^^^

Most ofthe items on the above list—other than item I., which is not focused
on acts—comport with intuition about the likely behavior of an individual
engaged in tax fraud. With respect to the first item on his list, a pattern of
understatement. Professor Schoenfeld states:

In any year for which the taxpayer has been convicted of filing a
false return, under I.R.C. § 7206(1) (1999) [sic], the Service will treat

that year as part of a pattern of understatement, thereby helping prove

the intent to evade. However, this reasoning is circular and illogical. In
Wright, the Tax Court decided that a conviction for filing a false return

153. See, e.g., Blohm v. Comm'r, 994 F.2d 1542, 1554 (1 1th Cir. 1993); Klein v. Comm'r,

880 F.2d 260, 262 (10th Cir. 1989); Gray v. Comm'r, 708 F.2d 243 (6th Cir. 1983), cert, denied,

466 U.S. 927 (1984); Fontneau v. United States, 654 F.2d 8, 10 (1st Cir. 1981) (per curiam); Amos
V. Comm'r, 43 T.C. 50, 56 (1964), affd, 360 F.2d 358 (4th Cir. 1965).

154. See, e.g., I.R.C. §§ 7203, 7206, 7207 (1994 & Supp. V 1999).
155. See Sansone v. United States, 380 U.S. 343, 351 (1965); Lawn v. United States, 355 U.S.

339,361(1958).

1 56. Schoenfeld, supra note 5, at 556.



166 INDIANA LAW REVIEW [Vol. 35:143

under I.R.C. § 7206( 1 ) ( 1 999) does not equal fraud, because the required
intent to evade tax is not an element of I.R.C. § 7206(1) (1999). It is

quite illogical to say that § 7206( 1 ) requires an additional factor to show
fraud, and then attempt to prove that additional factor by invoking §
7206(1) itself

^'^

Certainly conviction of a section 7206(1) offense does not in and of itself
establish fraud. If it did, it could be used to estop the taxpayer from rebutting a
civil fraud claim for the same year.'^^ That is, unlike Code section 7201, section
7206(1)'^^ does not contain an element of intent to evade taxes,'^^ nor does it

require proofofan understatement oftax. The civil fraud penalty requires proof
of both.^^^ Nonetheless, conviction of a section 7206(1) violation is highly

relevant. It demonstrates intent to file a false return, an illegal activity. If the

return in fact understated tax, that is an instance of understatement of tax. ^^^ If
there are other such instances, they may form a pattern. A pattern of
understatement is an indicium of fraudulent intent.'"

In Investment Research Associates v. Commissioner^^^^ a fairly recent tax

fraud case, the Tax Court compiled a longer list of indicia of fraud that included
the following:

1

)

failure to produce records during discovery;

2) destruction of records;

3) misleading statements or actions;

4) commingling of personal assets with those of the taxpayer's

corporation in an attempt to avoid tax;

5) diversion of income to third parties;

1 57. Id. at 557-58 (footnotes omitted).

158. 5*66 .SM/7ra notes 153-55 and accompanying text.

1 59. Code section 7206 provides, in relevant part:

Any person who

—

(1 ) . . . Willfully makes and subscribes any return, statement, or other document,

which contains or is verified by a written declaration that it is made under the penalties

of perjury, and which he does not believe to be true and correct as to every material

matter . . . shall be guilty of a felony and, upon conviction thereof, shall be fined not

more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more

than 3 years, or both, together with the costs of prosecution.

I.R.C. §7206(1994).

160. See United States v. Bishop, 412 U.S. 346, 359-60 & n.8 (1973).
161. 5ee I.R.C. § 6663(a) (1994).

162. See, e.g., Considine v. United States, 645 F.2d 925, 928-31 (Ct. 01. 1981) (holding that

prior conviction under section 7206(1) estopped taxpayer from contesting that the return was

willfully false and resulted in an underpayment of tax, as indictment had charged that return was

false because items of income were omitted).

163. "The existence of several indicia is persuasive circumstantial evidence of fraud." Inv.

Research Assocs. v. Comm'r, 78 T.C.M. (CCH) 951, 1081 (1999) (emphasis added).

164. Id.



200 1 ] A REPLY TO PROFESSOR SCHOENFELD 1 67

6) reporting income from property beneficially owned by the taxpayer
on the returns of family members;

7) structuring of a business and use of cash management techniques
which made difficult the tracing of income;

8) banking devices used to conceal earnings;

9) concealing income under the names of other persons who reported
such income;

10) omission of income from the taxpayer's property, title to which was
held in names of others who reported the income therefrom. '^^

Of course, as Professor Schoenfeld states, a taxpayer could have reasons
other than tax evasion for engaging in any ofthese acts.'^^ Thus, these items are

merely indicia of fraud, not proof of fraud. Professor Schoenfeld expresses

concern that "[t]he Service can assert, as an indicia [sic] of fraud, every badge

of fraud against a taxpayer that could possibly be true. Of course, the Service
will not assert any countervailing factors."'^^ He is probably right. However, in
an adversary system, assertion of countervailing factors and evidence is the job

ofthe taxpayer and his counsel, not ofthe IRS. In addition, the question offraud

is a factual one that courts resolve by considering the entire record.
'^^

B. Reconstruction ofIncome

Professor Schoenfeld understandably expresses great concern with respect

to proper allocation of gross income in a tax fraud case involving co-

conspirators.^^^ There are inherent difficulties in reconstructing unreported

income, and those difficulties are compounded if proceeds from an enterprise
were divided among the participants. That is, conspiracy fraud cases may raise
more risk of an excessive deficiency determination with respect to a particular
taxpayer than do fraud cases involving a single individual.

^^°

The IRS makes the initial determination of the amount of gross income

1 65. Id. (citations omitted). Investment Research Associates cites the following cases: United

States V. Walton, 909 F.2d 915 (6th Cir 1990); Scallen v. Commissioner, Sll F.2d 1364, 1370-71

(8th Cir. 1 989); Furnish v. Commissioner, 262 F.2d 727 (9th Cir. 1 958); Maddas v. Commissioner,

1 14 F.2d 548 (3d Cir. 1940); Lewis v. Commissioner, 46 T.C.M. (CCH) 1311 (1983), aff'd, 762

F.2d 1009 (6th Cir. 1985); McManus v. Commissioner, 31 T.C.M. (CCH) 999 (1972), afd, 486

F.2d 1399 (4th Cir. 1973); Estate of Beck v. Commissioner, 56 T.C. 297 (1971); Lang v.

Commissioner, 20 T.C.M. (CCH) 666 (1961); Hecht v. Commissioner, 16 T.C. 981 (1951).

166. Schoenfeld, 5M/7ra note 5, at 567.

167. Id

168. See, e.g., Gajewski v. Comm'r, 67 T.C. 181, 199 (1976), aff'd, 578 F.2d 1383 (8th Cir.

1978).

1 69. See Schoenfeld, supra note 5, at 541

.

170. See, e.g., Jones v. Comm'r, 903 F.2d 1301, 1302-03 (10th Cir. 1990) (upholding

deficiency based on $33 million of unreported income from drug sales in a particular location,

where taxpayer denied involvement but did not explain who might be receiving the drug proceeds

instead).



168 INDIANA LAW REVIEW [Vol. 35:143

allocable to a taxpayer. Its determination is reflected in the notice ofdeficiency.

As discussed previously, even in civil cases not involving fraud, a determination
of unreported income must have some support if the taxpayer denies receipt of
income.*^' A determination without foundation is "arbitrary and erroneous."'^^
If the taxpayer alleges such a "naked assessment," the burden of going forward

shifts to the IRS. If the IRS cannot support its determination, generally by
linking the taxpayer to an illegal tax-generating activity, the IRS loses.

'^^

In civil cases involving an allegation of unreported income, if the taxpayer

denies receiving the income, the IRS may use a variety of techniques to
"reconstruct" that income. Court-approved techniques include the net-worth

method, which "is particularly well-suited to ferreting out hidden income,
especially income from illegal sources;"^^"* the cash transaction method; the bank
deposits method; the specific items method; the source and application offunds

method; and the T-account method. ^^^ Each one seeks to establish the amount of
income earned by the taxpayer and to compare it to the taxpayer's return to
determine the amount of unreported income, if any.

In a case involving a fraud penalty, the IRS bears the burden ofproving both
fraud and an underpayment of tax by clear and convincing evidence. Use of
these methods ofreconstructing income assists the IRS in proving that there was
an underpayment of tax; absent an underpayment, the fraud penalty does not

apply. '^^ However, once the IRS proves fraud, the burden shifts to the taxpayer

to establish the amount ofthe deficiency not attributable to fraud. '^^ A denial of
the underlying activities will not help the taxpayer at this stage, because the court

will not reach this stage unless it is convinced that the taxpayer committed

fraud.
''*

171. See supra text accompanying notes 3 5-42.

172. Id.

173. Id.

174. Linda S. Eads, From Capone to Boesky: Tax Evasion, Insider Trading, and Problems

ofProof, 79 Cal. L. Rev. 1421, 1426 (1991). In Holland v. United States, 348 U.S. 121 (1954),

the United States Supreme Court approved the use of the "net worth" method but required proof

of a "likely source" of the unreported income. Id. at 132, 137-38.

1 75. See Lederman & MazZA, supra note 26, at 80.
176. 5eeI.R.C.§ 6663(a) (1994).

177. See id ^ 6663(h).

178. Cf Jones v. Comm'r, 903 F.2d 1301, 1303 (10th Cir. 1990) (upholding IRS assertion of

$33 million of unreported income). The court stated:

Jones offered almost no real evidence to prove that the Commissioner's assessment was

erroneous except his weak attempts to distance himself from all drug sales. He made

no attempt to suggest a more appropriate or more accurate estimate of his drug related

income, nor did he suggest who, ifnot he, was receiving the majority of income arising

from drug trafficking at Hanover Place in 1985.

Id at 373. See alsoMand'ma. v. Comm'r, 43 T.C.M. (CCH) 359 (1982), ajfd, 758 F.2d 1 399 (1 1 th

Cir. 1 984 (per curiam), and aff'das modified sub nom. Schaffer v. Comm'r, 779 F.2d 849 (2d Cir.

1985). In Mandina, the court stated:



200 1 ] A REPLY TO PROFESSOR SCHOENFELD 1 69

In conspiracy cases, the IRS faces another level of complication in
determining the taxpayer's deficiency, and the taxpayer faces a corresponding

complication in rebutting that determination. Once the IRS has reconstructed
income from the conspiracy, it must allocate the income among the participants.
Professor Schoenfeld refers to allocation of aggregate conspiracy profits as the

"slice of the pie" approach. '^^ The IRS may alternatively use what Professor
Schoenfeld terms the "act-by-act approach,"'^^ under which the IRS allocates
among co-conspirators profits from each of the conspiracy's acts rather than on
an aggregate basis. '^' Under either method of allocation, the IRS may
protectively redundantly allocate the total amount (of the pie or of profits from
each act).'^^

Professor Schoenfeld expresses concern about the IRS's protective allocation

of the same dollar amounts to multiple co-conspirators. ^^^ This is an important
issue because of the taxpayer's burden of proving the amount of the deficiency
that is not attributable to fraud.

^^'^
It may be difficult for the taxpayer to prove

that too much ofthe conspiracy's income was assigned to him rather than to co-
conspirators, particularly in the likely absence of books and records. Yet, as

Professor Schoenfeld notes, if the IRS does not take a protective position, it
increases its risk of whipsaw.'^^

Professor Schoenfeld also points out that some co-conspirators may not have
received notices of deficiency, perhaps because they were not convicted of

Since we have concluded that respondent has shown with respect to each petitioner an

underpayment oftax in the year 1969, a part ofwhich was due to fraud, it is incumbent

on petitioners to show that the amounts ofthe deficiencies as determined by respondent

are in error. Because of the position taken by each petitioner, that he had received no

unreported income, it is very difficult to determine exactly how much of the money

extracted from DMI by the four petitioners was taken by each.
Id. (citation omitted).

1 79. Schoenfeld, supra note 5, at 544.

180. Id.

181. Id.

182. See id. at 543-44. The IRS does not always use redundant allocation. See, e.g.. Barber

V. Comm'r, 39 T.C.M. (CCH) 1026, 1029 (1980) (upholding IRS determination that one-seventh

ofbank robbery proceeds would be allocated to taxpayer, one ofseven participants), aff'd, 679 F.2d

896 (9th Cir. 1982).

183. See Schoenfeld, supra note 5, at 544-47.

184. 5'eeI.R.C.§ 6663(b) (1994).

1 85. Schoenfeld, supra note 5, at 543.

A whipsaw situation occurs in the tax field when two taxpayers take positions with
respect to a particular transaction which are so inconsistent with each other that only

one should logically succeed—and yet, because ofjurisdictional or procedural reasons,
first one and then the other prevails against the government.

Remarks by Phillip R. Miller at Court of Claims Judicial Conference, October 14, 1971, on

Whipsaw Problems in Tax Cases, 25 TAX LAWYER 193 (1972).



170 INDIANA LAW REVIEW [Vol. 35:143

underlying crimes *^^ (and thus fraud would be harder to prove). If one taxpayer
successfully argues that part of his "share" was actually received by others, the
IRS would be faced with either increasing the deficiency of the others
(procedurally disadvantageous), or being whipsawed if those others were either
not before the court or had already successfully argued that those amounts were
not received by them. Thus, he agrees that "the protective position makes
sense"'^^ under a "slice of the pie" approach. '^^ He nonetheless questions the
"logic behind the protective position ... in act-by-act cases[,] [b]ecause there is

no 'pie.'"''"

Actually, the difference between slice-of-the-pie and act-by-act case is the

number of pies and size of those pies. That is, a particular case analyzed as a
slice-of-the-pie case would have one large pie for allocation, while that case
analyzed on an act-by-act basis would have multiple, smaller pies to allocate.
Mandina v. Commissioner, ^^^ quoted below, illustrates this principle.'^'

Redundant allocation of slices of the pie or pies involved protects the IRS,
but at the expense of taxpayer difficulties of proof. As Professor Schoenfeld
points out, the taxpayer may not know until after trial how much the IRS really
plans to attribute to him, hampering his defense. '^^ Yet all is not lost. "The
Commissioner has the right to make inconsistent determinations to protect the
public fisc, as long as none of the deficiencies has been collected and the
Commissioner acknowledges only one tax liability is due''^^^ That is, the IRS

may collect only one tax on any given deficiency.'^"* In fact, the IRS generally
will drop its protective position before entry ofdecision. For example, '^^ in Ryan
V. Commissioner, an act-by-act case'^^ that is an important focus of Professor

1 86. Schoenfeld, supra note 5, at 543.

187. IddX544.

188. Id.

189. /^. at 545.

190. 43 T.C.M. (CCH) 359 (1982), aff'd, 758 F.2d 1399 (1 1th Cir. 1984) (per curiam), and

offdas modified sub nom. Schaffer v. Comm'r, 779 F.2d 849 (2d Cir. 1985).

191. See infra text accompanying note 200.

192. See Schoenfeld, supra note 5, at 546-47.

193. Ryan v. Comm'r, 75 T.C.M. (CCH) 1778, 1787 (1998) (emphasis added).

194. See. e.g., Schaffer, 779 F.2d at 852; Gerardo v. Comm'r, 552 F.2d 549, 556 (3d Cir.

1977).

195. Another example used by Professor Schoenfeld is Arouth v. Commissioner, 64 T.C.M.

(CCH) 1390 (1992). See Schoenfeld, supra note 5, at 543 n.l62. In that case, "[t]he court

permitted the protective position until further information was uncovered; when no records or

reliable testimony were uncovered regarding the conspirators' division of income, the court

determined that it was 'appropriate to approximate the respective percentages ofthe sales proceeds

that each petitioner received.'" Id. {quoting Arouth, 64 T.C.M. at 1395). In other cases, the IRS

abandoned its protective position on brief, arguing instead for pro rata allocations. See, e.^., Puppe

v. Comm'r, 55 T.C.M. (CCH) 1297, 1300 (1998).

1 96. Schoenfeld, supra note 5, at 544 n. 1 67.



200 1 ] A REPLY TO PROFESSOR SCHOENFELD 1 7

1

Schoenfeld's article,^^^ the court noted, "At trial, [IRS's] counsel stated [IRS's]

intention to ask the Court to decide the amounts of income each petitioner

received individually. Accordingly, on brief [the IRS] no longer attributes the

same dollar of income to more than one [taxpayer]. . . ."'^^

In addition, from the perspective ofa particular co-conspirator, consolidating

the cases of all parties to the conspiracy may be best because the Tax Court
generally will avoid redundant deficiency determinations.'^^ For example, in one
case, the Tax Court stated:

Because of the lack of evidence and our beliefthat it would be totally
unfair to tax the same amount to each of these petitioners merely
because oftheirfailure toprove the division ofthe amount^ we conclude
that one-third ofthe $300,000 obtained from the June 20, 1969, check is

taxable to each of petitioners Mandina, O'Nan and Schaffer, and none
of this amount is taxable to petitioner Mitchell. Because of this same
lack ofevidence, we conclude that one-fourth of [the amounts from each
of five transactions] is taxable to each of the four petitioners.^^^

Given this approach, consolidating the cases ofall parties to the conspiracy may
be better for taxpayers in multi-party fraud cases.^^'

Finally, on an act-by-act approach to the conspiracy, if the IRS does not

connect a particular taxpayer with a tax-generating act, the court probably will

not assign any income to the taxpayer from that act. In Ryan, the court stated:

1 97. See, e.g., id. 2X5X1 n.* ("The opinions ofthe author are largely based and are augmented

by . . . Ryan.'')', id. at 535-36 (describing facts surrounding testimony of revenue agent in Ryan);

id. at 545-46 (describing complication in Ryan that arose from IRS use ofprotective positions); id.

at 553-54 (using Ryan as an example of a case in v^^hich an element missing after application of

partial collateral estoppel may be proven by other means).

198. Ryan, 15 T.C.M. at \n7.

199. See. e.g.. Ash v. Comm'r, 33 T.C.M. (CCH) 974, 976-77 (1974) ("Respondent admits

an inconsistent position and acts as a stakeholder. It would, therefore, seem inappropriate to tax

both Ash and Cannon on the entire $64,680. Accordingly we hold that Ash and Cannon each

earned one-half of the total sent from Hodges to Ash, or $32,340."), ciffd sub nom. Cannon v.

Comm'r, 533 F.2d 959 (5th Cir. 1976).

200. Mandina v. Comm'r, 43 TC.M. (CCH) 359, 373 (1982), affd, 758 F.2d 1399 (1 1th Cir.

1984) (per curiam), and affd as modified sub nom. Schaffer v. Comm'r, 779 F.2d 849 (2d Cir.

1985) (emphasis added).

On appeal, the Court of Appeals for the Second Circuit held that Schaffer should not have
been attributed any income from certain transactions. Schaffer, 779 F.2d at 860. The Court of

Appeals for the Eleventh Circuit affirmed the Tax Court's holding with respect to Mandina. Thus,

in this case, appeals to different circuits resulted in a partial whipsaw for the IRS.

201. In a sense, once the aggregate deficiency is determined in a multi-party case, the case

reflects a sort of reverse interpleader situation, with the IRS as a stakeholder. That is, interpleader

serves to determine how to allocate a sum of money among multiple claimants, while in a multi-

party tax fraud case, the issue is how to allocate the obligation to pay a sum of money. Cf Ash, 33

T.C.M. (CCH) at 976 ("Respondent admits an inconsistent position and acts as a stakeholder,").



172 INDIANA LAW REVIEW [Vol. 35:143

As we review each of respondent's assertions concerning each
respective search, we consider whether respondent has presented
predicate evidence linking the specific petitioner to the tax-generating

activity from which respondent asserts income has arisen for such
petitioner. Where there is no such predicate evidence, we attribute no
income to that petitioner.^^^

Conclusion

Those accused of civil tax fraud, particularly following a related criminal
conviction, will likely face a tough fight with the IRS. Is that fair? It is

important to note that the IRS will encounter major obstacles, as well. The
taxpayer generally benefits from his superior information about his activities. In

addition, in attempting to reconstruct a taxpayer's transactions, the IRS will
inevitably face difficulties resulting from the likelihood that a guilty taxpayer

will have taken steps to conceal his activities.

Contrary to the impression given by Professor Schoenfeld's article, the

taxpayer will not be precluded from receiving information about the IRS's case.

Nonetheless, a taxpayer who denies any and all participation in the underlying
activity is unlikely to win a tax fraud case if there is proofofhis involvement in

that activity. The taxpayer will not be able to rebut the amount of conspiracy
profits allocated to him if he simply denies any participation in the conspiracy.

A complete denial therefore may not be the best strategy, particularly in a case
involving a related criminal conviction or substantial evidence ofthe taxpayer's

participation in the conspiracy. Instead, the taxpayer may be able to present
evidence indicating that someone else actually received amounts attributed to
him.

A taxpayer facing the IRS in a civil fraud case also benefits from certain
procedural protections. First, it is the IRS that bears the burden ofproving both

an underpayment of tax and the element of fraud. Second, its proofmust rise to

the level ofclear and convincing evidence. A criminal conviction ofthe taxpayer
will help the IRS meet that burden. That may seem unfair, but a criminal
conviction means that the taxpayer, most likely represented by counsel, was
found guilty ofa crime beyond a reasonable doubt. Ourjustice system generally

allows both a civil suit following a criminal conviction and use of collateral

estoppel in the subsequent civil suit, if its elements are met.

In sum. Professor Schoenfeld's article is a valuable contribution to the

limited literature on federal tax controversies. His article reflects serious

concerns about the checks on the power of the IRS. This reply has indicated

areas in which existing checks are sufficient, as well as areas in which

improvements would make the tax controversy process more balanced and
procedurally fair.

202. Ryan, 75 T.C.M. (CCH) at 1787-88.