On May 19, 2020, the Tax Court issued a Memorandum Opinion in the case of Frantz v. Commissioner (T.C. Memo. 2020-64). The issue before the court in Frantz was whether the IRS Whistleblower Office abused its discretion to investigate a claim against the trustee of the petitioner’s chapter 7 bankruptcy estate, who the petitioner claimed significantly understated the estate’s tax liability.
The petitioner was a potato farmer, or at least he lived in Idaho, so there’s a fair to middlin’ chance that he was. Petitioner was down on his luck and filed (with his wife, Mrs. Potato Farmer) for chapter 7 bankruptcy protection. Petitioner alleges that the trustee of the bankruptcy estate understated the petitioner’s joint (Federal and potato) income tax liability from 2014-2017 by $2.3m. This number was calculated by a CPA hired by the petitioner to sniff out the trustee’s malfeasance based on documentation submitted to the CPA from the petitioner, himself. The petitioner included a letter from the CPA and a draft amended 2017 tax return prepared by the CPA “based on the information the petitioner provided” to the CPA.
The WBO reviewed the claims as to the trustee and as to the estate/petitioner’s individual (joint) returns. Finding that the trustee claim lacked merit on its face, the WBO summarily rejected the claim. Conversely, the WBO performed a cursory investigation into the estate/individual claim, but ultimately denied it. (More on the difference between rejection and denial in a moment.)
As to both claims, the WBO did not forward the claims to the IRS for further examination. The WBO notified the petitioner of the decision, and shocked and appalled, many times over, the petitioner petitioned the Tax Court for review. (Note – Although the claim was submitted by the petitioner and his wife, only the husband had the stomach for Tax Court.)
Interesting Summary Judgment Issue
It’s well established that when the IRS moves for summary judgment, the Tax Court must construe factual materials and inferences drawn from them in the light most favorable to the non-moving party, the petitioner. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994). In Frantz, however, the petitioner filed a cross-motion for summary judgment.
The Tax Court ruled that because it intended to grant the IRS’s motion, it would draw factual inferences in favor of the petitioner. See Palmolive Bldg. Inv’rs, LLC v. Commissioner, 152 T.C. 75, 82 (2019). How this works mechanically, is not clear. Did the Tax Court try the case twice in its head, once with the facts favorable to the petitioner and once with the facts favorable to the IRS and then decide that because the petitioner lost either way to use the prior approach?
Standard and Scope of Review
The Tax Court reviews the WBO’s determinations regarding an award for abuse of discretion. See Kasper v. Commissioner, 150 T.C. 8, 22-23 (2018). Abuse of discretion exists when a determination is arbitrary, capricious, or without sound basis in fact or law. See Murphy v. Commissioner, 125 T.C. 301, 320 (2005), aff’d, 469 F.3d 27 (1st Cir. 2006). In ascertaining whether the WBO abused its discretion, the TC generally confines its review to the administrative record. See Kasper, 150 T.C. at 20.
Whistleblower Review in a Nutshell
Before a whistleblower award may be paid, IRC § 7623(b)(1) requires the IRS to first proceed with an “administrative or judicial action” and collect proceeds from the target taxpayer. See Cohen v. Commissioner, 139 T.C. 299, 302 (2012), aff’d, 550 F. App’x 10 (D.C. Cir. 2014); Perales v. Commissioner, T.C. Memo. 2018-177, at *6. Thus, no collection means no award.
The Tax Court’s jurisdiction to review any determination regarding such an award, including rejections and denials arises out of IRC § 7623(b)(4). See Lacey v. Commissioner, 153 T.C. 146, 169 (2019); see also Cooper v. Commissioner, 135 T.C. 70, 75-76 (2010). The Tax Court does not, however, have authority to compel the IRS to commence an administrative or judicial action, nor does the Tax Court have the authority (or, frankly, the time or desire) to review the IRS’ determination of the alleged tax liability to which a whistleblower’s claim pertains. See Lacey, 153 T.C. at 166; Cohen, 139 T.C. at 302; Cooper, 136 T.C. at 600.
Thumbs Down – True Distinction between WBO Rejection and Denial?
The WBO may “reject” or “deny” a claim. Although the Tax Court attempts to distinguish the two, and they are factually distinguishable, because of the high abuse of discretion threshold and the fact that the Tax Court will not “look behind” the WBO’s decision, in practice, whether the WBO summarily “rejects” a claim or performs a cursory review of a claim and ultimately denies it, the Tax Court arrives at the same result – sustaining the WBO’s decision. This might be cynical, and there may yet prove to be a case that turns on the distinction, but I have not seen one yet where it makes a bit of practical difference.
Rejection and denial both begin with an initial evaluation before any referral to an IRS operating division for the decision whether to investigate the target taxpayer. See Lacey, 153 T.C. at 162-63; see also Alber v. Commissioner, T.C. Memo. 2020-20, at *7. The WBO may reject a claim outright in its initial evaluation if it determines that the claim does not meet the criteria set forth in Treas. Reg. § 301.7623-1(c)(4) and Treas. Reg. § 301.7623-3(b)(3). See also Lacey, 153 T.C. at 161. A rejection, therefore, is a determination made from the information on the face of the claim without further review. Treas. Reg. § 301.7623-3(c)(7).
On the other hand, a denial of a claim occurs when the WBO does not reject the claim outright from the face of the claim itself but nonetheless determines not to grant an award. See Treas. Reg. § 301.7623-3(c)(8); see also Lacey, 153 T.C. at 161-62. A denial is a determination based on taxpayer information and is made after the WBO has engaged in some substantive consideration of the claim. Id.
The WBO rejected the trustee claim, because on its face, the claim lacked credible information regarding underpayments or violations of the internal revenue laws, and the information that it did provide was speculative in nature. Though the claim provided an “estimated” 2017 return, it was prepared at the petitioner’s behest with his own information.
This was not good enough for the WBO, and the Tax Court found that decision sound and not an abuse of discretion. In denying the individual/estate claim, the WBO evaluated the individual/estate for collection potential, ultimately deciding that pursuing the information provided by the petitioner and his wife would not have resulted in the collection of any proceeds. The Tax Court found that this ground alone was sufficient justification to deny the claims. See Kasper, 150 T.C. at 27-28.Add to favorites