Tax Court Must Heed Special Trial Judge’s Report

In the long-running case of three taxpayers at the center of an alleged kickback and tax avoidance scheme, the Seventh Circuit held that the Tax Court did not give proper deference to the findings of its special trial judge (STJ) 12 years ago. In so finding, the court remanded to the Tax Court the case with respect to one of the men, the late well-known tax lawyer and businessman Burton W. Kanter. The case, which has taken what the Seventh Circuit called a “yoyo path,” involves tax years as far back as 1978 and has survived both Kanter, who died in 2001, and his wife, who was a joint taxpayer on some returns at issue (their estates and son/executor are now styled as plaintiffs). It has been appealed previously as far as the Supreme Court. Two other circuit courts have held similarly to the Seventh Circuit’s latest opinion with respect to the two other taxpayers (or their estates), Claude Ballard and Robert Lisle.

Under IRC § 7443A and Tax Court rules 180 through 183, the Tax Court’s chief judge may appoint an STJ to conduct hearings, trials or other matters before the court. For cases other than “small tax cases,” the STJ then reports to the Tax Court his or her findings of fact and conclusions of law and, in some cases, recommendations.

In 1986, Kanter filed a petition seeking review of the IRS’ determination that he had not paid all his taxes for various tax years between 1978 and 1986; the case was later expanded to include the 1987–1989 tax years. The IRS also assessed deficiencies against Lisle and Ballard, alleging that the three orchestrated an elaborate kickback scheme and concealed the resulting income by diverting it to entities under Kanter’s control. The STJ, Irvin D. Couvillion, conducted a five-week trial in 1994 and submitted his report to Chief Tax Court Judge Mary Ann Cohen in 1998, finding that the taxpayers had not engaged in kickback schemes, that none of the payments in question were unreported income to them, and that they were not liable for the tax and penalties assessed against them.

Cohen and Tax Court Judge Howard A. Dawson Jr. reviewed Couvillion’s report. After conferring with Cohen and Dawson, Couvillion withdrew his original report, which was replaced by a collaborative report written by Dawson and Couvillion. The collaborative report found, and Dawson ruled in 1999, that Lisle, Ballard and Kanter were liable for tax deficiencies assessed against them and for fraud penalties. In his opinion, Dawson claimed to have adopted the opinion of the STJ. Ballard and Kanter appealed to the Supreme Court (via the Eleventh Circuit), objecting to the absence of the STJ’s original report from the record and winning a favorable decision in 2005 (Ballard v. Commissioner, 544 U.S. 40). In response, the Tax Court amended Rule 183 to provide a procedure for service to the parties of the STJ’s findings, opportunity for the parties to file objections, and review by a regular Tax Court judge of the findings and objections. The regular judge may change or reject any or all of the STJ’s findings, but must note such action in the record. However, the STJ’s findings of fact “shall be presumed to be correct” and “due regard” given to his or her “opportunity to evaluate the credibility of witnesses” (Rule 183(d)).

On that remand, the Tax Court held (TC Memo 2007-21) that this review did not preclude determinations that the STJ made “manifestly unreasonable” findings of fact, in which case the court could make countervailing or additional findings of fact if they were directly supported by the case record. Couvillion did make such manifestly unreasonable findings with respect to the credibility of witnesses and resulting legal conclusions, the court held. Kanter appealed to the Seventh Circuit, which found that the plain language of Rule 183 mandates deference to the STJ and that nothing in that rule suggests that the presumption evaporates after the Tax Court has acted and the case has been appealed. Couvillion’s original findings were not clearly erroneous, the Seventh Circuit said, and therefore were to be accorded deference. The Seventh Circuit thus joined the Fifth and Eleventh circuits in again remanding the case to the Tax Court with instructions that it adopt the original STJ report as its opinion and enter a judgment consistent with that report.

By Alice A. Upshaw, CPA, MPA, instructor of accounting, and Darlene Pulliam, CPA, Ph.D., McCray Professor of Accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.