Think you can count on the IRS to be "fair" when it comes to determining your tax liability? Think again.
In an extraordinary decision, the U.S. Tax Court recently ordered the IRS to pay back approximately US$30 million collected in a tax shelter case dating back to the 1980s.
In doing so, the court declared that the IRS had committed "fraud on the court." The lawyer representing 100 of the 500 taxpayers affected by the ruling called the decision "137 pages of utter scandal."
That's a pretty accurate depiction, considering the facts.
In the early 1980s, the IRS ruled that an arrangement dubbed the "Kersting tax shelter" was illegal. It then began making assessments against nearly 2,000 taxpayers.
In proceedings of this type, it's common for the IRS and attorneys representing the taxpayers to agree to present a test case or cases before the Tax Court. In the Kersting litigation, the IRS and the taxpayers agreed to be bound by the outcome of the cases.
However, two IRS attorneys then did something highly unethical. They decided to stack the deck in favor of the IRS. They did so by entering into a secret settlement—not disclosed to the court—with one of the participants in the test cases. The settlement gave the taxpayer a refund large enough to cover his attorney fees. Not surprisingly, the taxpayer accepted it with open arms.
The test cases then proceeded to trial, with results much less favorable to the taxpayers. However, since no one knew of the secret settlement, most of the taxpayers dutifully settled with the IRS.
Shortly thereafter, the scheme began to unravel. The Tax Court tried to enforce its "official" ruling against the taxpayer involved in the secret settlement. The taxpayer then testified as to existence of the secret settlement.
In 2003, a federal appeals court ruled that the IRS attorneys had committed fraud on the court because they neglected to disclose the secret settlement offer to IRS management, opposing counsel, and the court itself. It declared that everyone who had agreed to be bound by the test cases should instead be provided the same settlement given secretly to one of the participants.
In the meantime, however, more than 500 taxpayers who settled with the IRS and paid their tax assessments in full before the 2003 ruling. In 2005, the Tax Court refused to revisit one of those settlements.
On May 1, however, the Tax Court reversed itself. It declared that these 500 taxpayers should also receive the benefit of the secret settlement.
There's a lesson here, but it’s not the one you learn in civics class. The IRS—and indeed, all branches of the U.S. government—fight dirty. The objective is to win at all costs.
But, once in a while, justice prevails, even if it takes more than 20 years. Such was the case here. It's about time.
Copyright © 2008 by Mark Nestmann
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