IRS to Examine Its Ways After Investors Group Wins Settlement
A group of tax shelter investors who claim that the Internal Revenue Service harassed them through a series of administrative errors is claiming a potentially important victory over the agency.
Newport Beach tax attorney James T. Burnes said the precedent-setting agreement could result in a housecleaning of the agency’s collection procedures.
Burnes is representing 70 investors in a defunct tax shelter program promoted in 1980-83 by Southwest Solar Products, an Irvine firm that later closed and filed for protection from creditors under Chapter 11 of the federal bankruptcy code.
The investors came under IRS scrutiny as part of the agency’s longstanding war on tax shelter abuses.
The investors are still awaiting a decision on their suit to void the IRS claims against them. Even so, the procedural agreement could have a significant impact on how the agency conducts itself in the future.
The 70 are part of a larger group of 2,100 Southwest Solar investors who are suing the IRS to invalidate claims for nearly $30 million in back taxes and penalties.
Apparent Breakdown of Safeguards
Burnes said his clients were hit with erroneous tax collection notices, default notices and, in at least one case, a lien against wages because IRS internal procedures designed to safeguard taxpayers against such mistakes apparently broke down.
Now, based on the settlement in November of a test case filed by Burnes, the IRS has agreed to establish a task force at its regional headquarters in Laguna Niguel to examine collection problems in the Southwest Solar case and, if necessary, to change internal procedures so other taxpayers aren’t subjected to the same treatment.
One of those changes was revealed by IRS District Director Michael Quinn last week in a speech to a tax accountants group, Burnes said.
In his speech, Quinn said the agency plans to end its practice of assigning separate agents to audit each year of an individual taxpayer’s returns. Instead, it will assign one agent to one taxpayer, regardless of how many years of returns are being scrutinized.
Burnes said many of the problems encountered by Southwest Solar investors occurred because there was no coordination among various agents auditing individual returns.
Differences in Viewpoint
“A client would work out the problems on his 1981 return with one agent, only to find that a different agent was disallowing the same things on his 1982 return, and the whole process would have to start over again,” he said.
In the November settlement, the agency also agreed to pay some attorney costs for many of the individuals in the group who received erroneous tax deficiency notices and had to file petitions in tax court.
While the dollar amounts are relatively small ($300 per case for less than two dozen individuals), Burnes said it is the first time a single test case has led to payment of attorney fees for members of a larger group.
IRS officials downplayed the significance of the settlement, which involves just a few thousand dollars in attorney costs.
But several tax attorneys and tax accountants not involved in the case said they had never heard of a group settlement by the IRS in a claim for repayment of attorney fees.
Generally, taxpayers have pressed such claims individually, often running up sizable legal bills in the process.
Burnes said the settlement--hashed out before there was a ruling on the test case, but after the judge warned the IRS it would probably lose--is important for two reasons:
“This could prompt more group cases, which are much less expensive for the individual taxpayer, and it provides incentives for the IRS to process tax shelter cases more carefully than it has in the past.”
Alleged Violations of Procedures
Basically, the Southwest Solar cases involve alleged IRS violations of internal procedures and policies that resulted in collection notices being sent to people whose cases were still pending in tax court; delinquency notices being filed against people who had already settled their cases and, in at least one instance, garnishing of the wages of a Los Angeles woman who had settled her case weeks earlier.
The clients affected by the attorney fee settlement are part of the larger group of 2,100 investors suing the IRS over its holding that they are not entitled to the $15 million or more in business deductions and solar investment tax credits that they claimed on their tax returns.
With penalties and interest, the IRS is seeking $27 million from members of the investors group, National Solar Equipment Owners Assn. Also, $43 million in claims have been filed against 4,000 Southwest Solar investors who do not belong to the association.
The main tax case has been argued by both sides, but a ruling from the tax court is not expected for several months, said David A. Weinfeld, the Costa Mesa attorney who is general counsel for the investor association.
The IRS has claimed that the investors knowingly paid inflated prices for the residential solar water heating systems they acquired. The agency alleged that they made the investments not to turn a profit but solely to claim tax benefits.
To claim the business and solar energy investment credits legitimately. the IRS maintained, the taxpayers had to have made their investments with the expectation of making a legitimate business profit.
The National Solar association has denied the IRS allegations.
Victory Called Significant
Burnes’ victory in the action for IRS payment of attorney fees is significant “because it shows that the more people band together to face up to ‘em (the IRS), the more they will have to do it right,” Weinfeld said.
“The IRS has loose discipline because of its size,” Weinfeld said, “but there is no reason to take it out on the taxpayer.”
Judith Goulding, a spokeswoman for the IRS in Laguna Niguel, said creating a task force to examine procedural problems in the Southwest Solar case “is not too unusual. . . . We are continually monitoring our procedures.”
She said most of the problems cited by Burnes and his clients were “processing errors,” many of them caused when only the first name on a list of Southwest Solar investors who had filed petitions in tax court was entered into the IRS computer.
All of those on the list whose names weren’t entered, she said, received notices that they owned the IRS money, even thought the filing of a petition suspends the agency’s claim until the case is heard.
Burnes, while generally supportive of IRS efforts to reach accord with his clients, nonetheless has little good to say about the agency’s internal workings in tax shelter audits.
“There is no single problem we are dealing with,” he said. “It is just negligence by the IRS. Not willful, not malicious, but negligence just the same. There has developed a mentality that sending a wrong collection notice is no big deal because it can be corrected. So they don’t worry about sending them out in error.
“But a collection notice is a big deal to the person who gets one. The language in these notices is very strict, and it is emotionally upsetting to get one and especially anguishing to get several.”
He said the problem results partly from the sheer size of the IRS and partly from the high turnover rate in the agency’s lower echelons, where much of the auditing and processing are handled.
Look for ‘Patterns of Error’
But Goulding said the IRS “can’t do anything about turnover and the size of the organization, but we continually look at these (tax shelter) cases, and if we see patterns of error and can develop a process to cure it, we do.”
The IRS, she said, expects to process 110 million tax returns this year, “and we have to expect errors.” She said the agency boasts “a 5% error rate, and that’s not bad for any business.”
Unless, perhaps, one is the subject of such an error.
Jim Clark, a Seal Beach resident and employee of McDonnell Douglas Astronautics in Huntington Beach, invested $17,500 with Southwest Solar in 1981--$5,500 cash and a $12,000 note.
Following approved federal deduction and tax credit guidelines for solar investment, he obtained almost $5,000 in tax refunds that year, related strictly to the Southwest Solar investment.
In 1984, the IRS told him that his deductions and credits for the Southwest Solar equipment were being disallowed. He subsequently joined the investors association and, through Burnes, filed a petition in tax court opposing the IRS ruling.
Over the next few years, while his case was pending, Clark said, he received a preliminary collection notice telling him that the IRS wanted $16,000 in taxes, interest and penalties for the $5,000 solar-related refund he received in 1981.
He also received a second notice, a third notice and a fourth notice, he said, the last one telling him that if his payment wasn’t forthcoming, his wages could be garnished, his real estate attached and his bank accounts and automobile seized to satisfy the claim.
“I had 85 or 90 written and verbal communications with the IRS during that time,” Clark said, “trying to tell them that I didn’t owe them anything yet because my case was still pending.”
Finally, Clark agreed to a settlement, paying less than the IRS initially claimed.
It has been an experience, he said, “that has not been fun. It has affected me and my family.
“If it wasn’t for the (investors) association and the ability to fight this as part of a group, I would have had to have paid the entire $16,000 because there was no way I could have afforded to fight as an individual.”
TEN STEPS IN AN IRS AUDIT 1. Taxpayer receives a notice that the IRS questions certain claims or deductions and intends to audit.
2. Taxpayer meets IRS audit agent to review issues.
3. Subsequent meeting is held to try negotiating a settlement.
4. If settlement is not reached, IRS mails letter giving taxpayer 30 days to file protest with IRS Appeals Office.
5. After protest is filed, appeals hearing is ordered. Because of backlog, it generally takes at least 180 days and sometimes more than a year to schedule hearing.
6. If hearing does not result in a settlement, IRS issues notice of deficiency, also called a “90-day notice.” Taxpayer has 90 days to pay or file formal appeal petition with U.S. Tax Court.
7. Meeting held with appeals officer or with IRS district counsel to attempt settlement again, normally about 90 days after formal appeal petition received (can take more than a year).
8. If still no settlement, a tax court trial is scheduled. Cases take one to two years to go to trial.
9. Either side can appeal findings of tax court to U.S. Circuit Court of Appeals.
10. Few cases go beyond that level, but loser in appeals court can ask U.S. Supreme Court to hear the case.
CHRONOLOGY OF A TAX SHELTER CASE 1980 Southwest Solar Products founded in Irvine. Begins selling residential solar water-heating systems to investors, who lease them to home and apartment owners.
1983
IRS flags Southwest Solar as a potential abusive tax shelter and begins sending audit notices to investors.
August to December, 1984 IRS obtains court order barring Southwest Solar from selling equipment. Southwest pays $395,000 penalty without admitting guilt.
Southwest Solar closes and files for bankruptcy protection.
Several Southwest Solar investors hire Costa Mesa attorney David A. Weinfeld to represent them.
Weinfeld files a tax court appeals petition on behalf of several clients chosen to serve as test cases for the entire group.
Investors organize a formal group, National Solar Investors Assn., with headquarters in Santa Barbara. Ultimately, 2,100 investors join the association.
April, 1985, to May, 1986 Tax court hears the lead cases in four sessions, two in San Diego and two in Utah.
July, 1986 Newport Beach tax attorney James T. Burnes files a motion to recover attorney fees for a group of 70 National Solar members he claims were victims of collection actions that violated IRS policies.
September to December, 1987 Several settlement conferences are held.
November, 1987 Before the tax court judge hears Burnes’ motion, the IRS agrees to a settlement. Agreement calls for payments of $300 by IRS for each of several dozen instances of wrongful tax deficiency. IRS additionally offers to establish a task force to review its actions in the Southwest Solar case.
Task force formed at IRS regional headquarters in Laguna Niguel.
1988 IRS task force continues working.
Final decision in investors’ suit against IRS expected by midyear.
THE ESCALATING WAR ON TAX SHELTERS Total tax returns involving tax shelter deductions pulled by IRS for audit:
1973 400
1981 246,000
1982 284,000
1983 311,000
1984 338,000
1985 377,000
1986* 425,000
* estimated
Source: Internal Revenue Service
