The IRS Reform Act vs. Professor Tony Lovullo

September 1998

The courtroom was filled to capacity with all the regulars from the Title 26 Inn. They were amazed that the parties were able to bring the case to trial in the short time that had passed since Professor Tony Lovullo had verbally attacked "The Internal Revenue Service Restructuring and Reform Act of 1998" during "Guest Speaker" night at the Inn.

Most of the spectators in the courtroom had also been at the Inn that night to hear a presentation by the Reform Act about its numerous provisions. At the end of the presentation Professor Lovullo raced to the podium and told the audience that they had just heard a crock of political hyperbole.

When challenged by the Act to support his characterization with a more specific example, the Professor replied, "I'll give you three. First, the new burden of proof provision is a farce. Second, the so-called accountant-client privilege is a trap for the uninformed. Third, the new summons provision falls critically short of the proclamations that followed its enactment."

The Professor finished his diatribe by equating the process by which the Act had come into fruition with the plot of The Music Man. He said that Congress had used last year's IRS abuse hearings and the Act to take the pressure off Congress to clean up and simplify the incredibly complex tax statute enacted by Congress in past years. He ridiculed the Act with a ditty: "I'm Professor Harold Hill, and I'm here to sell you a new IRS reform Bill.....'cause we got trouble, oh we got trouble.....right here in IRS city... ."

The Act sued the Professor for slander. No one seriously expected anything more than nominal damages to be awarded. But the Act wanted its day in court.

Professor Lovullo welcomed the opportunity to prove that the Act was no more than a ruse to deflect attention from the complexity that infected the Internal Revenue Code.

Judge Phylis Hiatt seemed amused by the idea of a tax Act commencing an action against a law professor. Nevertheless, she had put a lot of effort into the pre-trial proceedings to parse the case down to its essentials. The trial was reduced to the issue of whether the Professor had made slanderous remarks about the provisions dealing with the burden of proof, the accountant-client privilege, and the changes to procedures for administrative summonses issued by the IRS.

The opening statements had been brief. The plaintiff's attorney, Edward Diaz, said that the plaintiff's witnesses would show that the provisions of the act were a great leap forward in protecting taxpayers from abuse by the IRS. The Professor's attorney, Jack Manto, replied that the Defendant would show that his statements were not slanderous because they were a true and accurate depiction of the Act.

Section 1 of the Act was the lead witness for the plaintiff. Edward Diaz intended to use Section 1 to draw a road map of the Act for the Court. Although the spectators were eager to have the trial start, the majority of them expected to hear a tough cross-examination by Jack Manto with respect to the three sections of the act at issue.

After the oath was administered to Section 1, Edward Diaz swiftly completed his objectives with the first witness.

MR. DIAZ: What is your function as part of the Act?

SECTION 1: Well, I contain the short title for the Act, the table of contents, and a provision that eliminates any penalty for under payment of estimated taxes that might arise from the other provisions of the Act.

MR. DIAZ: How is the Act organized?

SECTION 1: There are nine titles in the Act. Title I deals with the reorganization and restructuring of the IRS. Title II addresses electronic filing of tax returns and the use of electronic means by the IRS to disseminate information. Title III contains taxpayer protections and rights. In fact, Title III is also known as the Taxpayer Bill of Rights 3. That Title contains the provisions the Professor defamed.

MR. MANTO: Objection. The witness's last statement was beyond the bounds of the question.

JUDGE HIATT: Sustained. Please try to limit your response to the question asked. You may continue your direct exam, Counselor.

MR. DIAZ: What else is in the Act?

SECTION 1: Title IV contains provisions concerning the role of Congress and the IRS. Title V contains two substantive tax law amendments. The first reduces the holding period for special capital gains rates from 18 months to one year, and the second liberalizes the exclusion and deduction rules for the cost of meals provided to employees for an employers' convenience. Title VI contains a number of technical corrections to some of the previous tax acts. Title VII has a few revenue raising provisions; Title VIII identifies the provisions of the Act that have limited tax benefits and are, therefore, subject to the line item veto act; and Title IX deals with amendments to the Transportation Equity Act for the 21st Century.

MR. DIAZ: Thank you Section 1. I have no further questions for this witness, Your Honor.

JUDGE HIATT: Do you wish to cross examine the witness, Counselor Manto?

MR. MANTO: Yes, indeed I do, Your Honor.

Jack Manto wasn't the type of lawyer who wasted precious court time on useless cross-examination. He knew how to make his points with the smallest possible number if questions, especially in a case being tried before a judge rather than a jury. This witness offered little opportunity to benefit the Professor's defense, so the spectators were perplexed when Manto rose to cross examine Section 1. But Jack had a few points he wanted to make.

MR. MANTO: Didn't you testify that Title IX dealt with the Transportation Equity Act for the 21st Century?

SECTION 1: Yes.

MR. MANTO: Isn't that just a lot of pork barrel legislation for expenditure of highway funds?

SECTION 1: Well, I wouldn't describe it that way.

MR. MANTO: But don't you agree that it has nothing to do with restructuring or reorganizing the IRS or with taxes?

SECTION 1: Yes.

MR. MANTO: Please tell the court the full official title of the Act.

SECTION 1: The official title of the Act is "The Internal Revenue Service Restructuring and Reform Act of 1998."

MR. MANTO: Didn't you also testify that you contain a short title for the Act?

SECTION 1: Yes.

MR. MANTO: Now please tell the court the short title for the Act.

SECTION 1: Well....it's...it's the same as the full official name for the Act...it's "The Internal Revenue Service Restructuring and Reform Act of 1998."

MR. MANTO: So if I want to refer to "The Internal Revenue Service Restructuring and Reform Act of 1998" by its short title I'll still have to say "The Internal Revenue Service Restructuring and Reform Act of 1998."

SECTION 1: Yes, but most people just call it the Reform Act of 1998.

MR. MANTO: But that isn't the official name or the official short name, is it?

SECTION 1: No.

MR. MANTO: Were you there when my client allegedly slandered the plaintiff?

SECTION 1: Of course I was there, I'm part of the Act.

MR. MANTO: Well, was my client talking about what most people might think the Act says or was he talking about the actual provisions of the Act?

MR. DIAZ: Objection. Calls for speculation and seems to be argumentative.

JUDGE HIATT: Yes, I think so, too. Sustained. But you've made your point, Counselor. Do you have any other questions for this witness?

Jack Manto knew how to take a hint from the court. He ended his cross exam of Section 1. Edward Diaz proceeded directly to the plaintiff's next witness, Section 3001 of the Act.

JUDGE HIATT: Please identify yourself for the record.

SEC. 3001: I'm Section 3001 of the Internal Revenue Service Restructuring and Reform Act of 1998. I reside in Title III of the Act, which is also known as "The Taxpayer Bill of Rights 3."

JUDGE HIATT: You may start your direct examination, Mr. Diaz.

MR. DIAZ: What is your main function with respect to the Plaintiff?

SEC. 3001: I contain provisions that shift the burden of proof from the taxpayer to the IRS.

MR. DIAZ: What was the law with respect to the burden of proof before your enactment?

SEC. 3001: Except where the Code specifically provided otherwise, there was a rebuttable presumption that the IRS's determination of tax liability was correct.

MR. DIAZ: What was the source of that presumption?

SEC. 3001: The presumption was judicially created, although there is evidence that the presumption has been repeatedly considered and approved by Congress. The Internal Revenue Code contains a number of civil provisions that explicitly place the burden of proof on the Commissioner in certain circumstances, the most common of which is the assertion of the civil fraud penalty.

MR. DIAZ: What was the nature of that common-law presumption?

SEC. 3001: The presumption placed both the burden of production and the burden of persuasion on the taxpayer. As a procedural device the presumption required that the taxpayer go forward with prima facie evidence to support a finding contrary to the IRS's determination. Even after the procedural burden was satisfied, the taxpayer still had to carry the ultimate burden of proof or persuasion on the merits. Thus, the taxpayer not only had the burden of proof of establishing that the Commissioner's determination was incorrect, but also of establishing the merit of its claims by a preponderance of the evidence, as exemplified in Danville Plywood Corp. v. U.S., 63 AFTR 2d 89-1036, 1043 (U.S. Cl. Ct., 1989).

MR. DIAZ: How do your provisions change all that?

SEC. 3001: Well, for income, estate, gift, and generation-skipping transfer taxes the burden of proof will be on the IRS, except to the extent provided otherwise by legislation.

MR. DIAZ: Thank you Section 3001. I have no further questions, Your Honor.

JUDGE HIATT: I assume you want to cross exam the witness, Mr. Manto?

MR. MANTO: Yes, Your Honor. Isn't it true that new §7491 does not eliminate the common-law presumption of correctness but merely shifts the burden of proof to the IRS under a few circumstances?

SEC. 3001: Well, yes I guess that's an accurate summary of my effect.

MR. MANTO: O.K. then, let me get a little more specific about your limitations. Isn't it true that IRC §7491 applies only to factual issues, and has no application to legal issues?

SEC. 3001: That's correct.

MR. MANTO: It only applies if the taxpayer has complied with the requirements under the Code for substantiation of any items, and only applies if the taxpayer has also maintained all records required under the Code?

SEC. 3001: Yes.

MR. MANTO: And the taxpayer must have cooperated with reasonable requests by the IRS for witnesses, information, documents, meetings, and interviews before the burden will shift?

SEC. 3001: Yes.

MR. MANTO: Does the burden of proof shift for corporations, trusts, and partnerships whose net worth exceeds $7 million?

SEC. 3001: No.

MR. MANTO: And most importantly, doesn't the taxpayer have the burden of proving that the taxpayer meets all of the criteria needed to shift the burden of proof?

SEC. 3001: Yes, that's true.

MR. MANTO: And even if the taxpayer meets all of the criteria we just explored, the burden of proof will not shift unless and until the taxpayer introduces credible evidence with respect to the factual issues relevant to ascertaining the liability of the taxpayer?

SEC. 3001: That's correct.

MR. MANTO: And isn't it true that credible evidence is the quality of evidence which, after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted?

SEC. 3001: Yes.

MR. MANTO: In other words, if the court doesn't believe the taxpayer's evidence, then the burden will not shift and the IRS will not need to submit any evidence to sustain the proposed deficiency?

SEC. 3001: Yes, the court will still follow the rule of law set forth in Quock Ting v. United States, 140 U.S. 417 (1891).

MR. MANTO: Thank you Section 3001. I have no further questions, Your Honor.

JUDGE HIATT: Mr. Diaz - any redirect?

MR. DIAZ: Yes, Your Honor, just a few questions. Are there any exceptions to all of the criteria that Mr. Manto just took you through?

SEC. 3001: Yes. The new burden of proof rule does not apply to any issue if any other provision of the Code provides for a specific burden of proof with respect to such issue. For example, the IRS will continue to have the burden of production and the burden of persuasion with regard to imposition of the fraud penalty.

MR. DIAZ: Any others?

SEC. 3001: Well, for individual taxpayers, the IRS will have the burden of production and the burden of persuasion in any court proceeding with respect to any item of income which was reconstructed by the IRS solely through the use of statistical information on unrelated taxpayers.

MR. DIAZ: Anything else?

SEC. 3001: One last item - the IRS will have the burden of production in any court proceeding with respect to the liability of any individual for any penalty, addition to tax, or additional amount imposed by the Code.

MR. DIAZ: Thank you. Nothing further for plaintiff with this witness, Your Honor.

JUDGE HIATT: Mr. Manto - any re-cross?

MR. MANTO: Just two questions, Your Honor.

MR. MANTO: Do the new burden of proof rules apply to pending cases?

MR. DIAZ: Objection, outside of the scope of direct and re-direct examination.

JUDGE HIATT: I tend to agree with you, Counselor, but I'd like to know when this provision is effective, and I suppose I could ask the witness myself, or require the defendant to call Section 3001 as his witness. But to speed things up, why don't we just let Mr. Manto ask those questions? I'll give you a chance to re-re-direct if you feel the need.

MR. MANTO: Thank you, Your Honor. I'd like the court reporter to re-read the last question.

COURT REPORTER: The last question was "Do the new burden of proof rules apply to pending cases?"

SEC. 3001: No, the new rules only apply to court proceedings arising in connection with examinations that began after the date of enactment, that is July 22, 1998. If a case gets to trial without a prior examination by the IRS then the new rules apply only to the proceedings insofar as it concerns taxable periods or events beginning or occurring after the date of enactment.

MR. MANTO: I have no more questions, Your Honor.

MR. DIAZ: Nor I, Your Honor.

JUDGE HIATT: Then please call your next witness.

SEC. 3411: I'm Section 3411 of the Internal Revenue Service Restructuring and Reform Act of 1998.

MR. DIAZ: What is your relationship to the new tax Act?

SEC. 3411: I add a new section to the IRC, §7525, entitled the Uniform Application of Confidentiality Privilege to Taxpayer Communications with Federally Authorized Practitioners.

MR. DIAZ: What does that section do?

SEC. 3411: In a nutshell, IRC §7525 applies the common-law attorney-client privilege of confidentiality to tax advice that is furnished to a client-taxpayer (or potential client-taxpayer) by any individual who is authorized under Federal law to practice before the IRS if such practice is subject to regulation under section 330 of Title 31, United States Code.

MR. DIAZ: Who are the individuals authorized to practice before the IRS and subject to regulation under Title 31?

SEC. 3411: Attorneys, certified public accountants, enrolled agents and enrolled actuaries.

MR. DIAZ: What effect will this have on the average taxpayer?

SEC. 3411: Taxpayers can now communicate with their representatives in a confidential atmosphere. Taxpayer representatives will no longer need to warn their clients that anything they tell them might be discovered by the IRS.

MR. DIAZ: And what is the effective date of this new section?

SEC. 3411: It applies to communications made on or after the date of the enactment of the Act, which was July 22, 1998.

MR. DIAZ: Thank you. I have no other questions, Your Honor.

JUDGE HIATT: Your turn, Mr. Manto.

MR. MANTO: Does the privilege apply to all communication between the taxpayer and the representative?

SEC. 3411: No. It only applies to "tax advice" which is defined as advice given by an individual with respect to a matter which is within the scope of the individual's authority to practice before the IRS.

MR. MANTO: Does the privilege apply to information disclosed for purposes of preparing a tax return?

SEC. 3411: No, because information given to a representative to prepare a tax return is information that the taxpayer intends to be disclosed to the IRS, so the taxpayer would not have an expectation of confidentiality of such information with respect to the IRS.

MR. MANTO: Can the privilege be asserted in any criminal tax proceedings before the IRS?

SEC. 3411: No.

MR. MANTO: Can the privilege be asserted in the Federal courts with regard to a criminal tax proceeding where the United States is a party?

SEC. 3411: No.

MR. MANTO: Can the privilege be asserted to protect the disclosure of information to any regulatory body other than the IRS?

SEC. 3411: No.

MR. MANTO: So is it possible for the IRS to force disclosure of privileged communications made during the course of a civil proceeding if the IRS turns the civil investigation into a criminal investigation?

SEC. 3411: Yes, but there are arguments that might sustain the position that a privileged communication should not lose its confidential status simply because the IRS has started a criminal investigation.

MR. MANTO: But those arguments have not been tested yet, have they?

SEC. 3411: No.

MR. MANTO: And there isn't anything in the legislative history that directly supports those arguments, is there?

SEC. 3411: No.

MR. MANTO: And isn't it true that the privilege doesn't apply to any written communication between a federally authorized tax practitioner and a director, shareholder, officer, or employee, agent, or representative of a corporation in connection with the promotion of the direct or indirect participation of such corporation in any tax shelter as defined in IRC §6662(d)(2)(C)(iii)?

SEC. 3411: That's true.

MR. MANTO: So is it fair to say that a tax practitioner should advise his or her client that although the Internal Revenue Code recognizes a privilege for communications between them, the privilege: (1) only applies to tax advice; (2) does not apply to information disclosed for purposes of preparing a tax return; (3) cannot be asserted if the matter turns into a criminal investigation by the IRS or a criminal proceeding before a federal court; (4) will not protect the information from any other federal agency other than the IRS; and, (5) will not apply to corporate taxpayers with regard to written information involving a statutorily defined tax shelter?

SEC. 3411: Yes, I'd say that such a disclosure would be needed to fully inform the client of the nature and limitations of the privilege.

MR. MANTO: Before this statute was enacted, wasn't there already a simple method by which communication between a non-lawyer tax practitioner and the client could be protected without worry about all those exceptions in new IRC §7525?

SEC. 3411: Yes, under the doctrine of U.S. v. Kovel, 296 F.2d 918 (2d Cir. 1961), if the non-attorney tax practitioner was hired by either the client or the attorney to aid the attorney in giving legal advice to the client, then communication with the non-lawyer tax practitioner fell within the protection of the attorney-client privilege. However, the Kovel doctrine has its limitations, as exemplified by the case of U.S. v. Adelman, 68 F.3d 1495 (2d Cir. 1995).

MR. MANTO: Is the Kovel doctrine still applicable?

SEC. 3411: The legislative history doesn't mention Kovel, so I would assume it is still valid, although I can imagine the IRS trying to argue that §7525 is the exclusive means under which communication between a taxpayer and a federally licensed tax practitioner would be privileged.

MR. MANTO: So it is possible that this new section might actually reduce the rights of taxpayers rather than expand them?

MR. DIAZ: Objection. Calls for speculation.

JUDGE HIATT: Sustained.

MR. MANTO: No further questions, Your Honor.

MR. DIAZ.: No re-direct, Your Honor. The plaintiff's last witness will be Section 3415.

Section 3411 refused to take an oath and was instead administered an affirmation. He was arrogant and seemed perturbed at having to stand witness in the trial. Edward Diaz knew this witness would be difficult, but he had to put him on the stand to prove that the defendant's remarks were incorrect.

JUDGE HIATT: Please identify yourself for the court.

SEC. 3415: I'm Section 3415 of the Internal Revenue Service Restructuring and Reform Act of 1998.

MR. DIAZ: What is your relationship to the new Tax Act?

SEC. 3415: I make several modifications to §7609 of the Internal Revenue Code, which deals with required notices to the taxpayer when certain summonses are issued by the IRS to third parties.

MR. DIAZ: What was the status of the law before you were enacted?

SEC. 3415: Before I was enacted, if the IRS issued a summons to a "third-party recordkeeper'" that required production of records relating to the taxpayer, then notice of the summons had to be given to the taxpayer within three days by certified or registered mail.

MR. DIAZ: What was the purpose of the notice to the taxpayer?

SEC. 3415: The taxpayer had up to 23 days to begin a court proceeding to quash the summons. If the taxpayer did so, then the third-party recordkeeper was prohibited from complying with the summons until the court ruled on the taxpayer's petition or motion to quash. Of course, the statute of limitations for assessment and collection with respect to the taxpayer was stayed during the pendency of such a proceeding.

MR. DIAZ: What was a "third-party recordkeeper?"

SEC. 3415: A third-party recordkeeper was generally any person who held financial information about the taxpayer; such as banks, brokers, attorneys, and accountants.

MR. DIAZ: What has been changed by the new law?

SEC. 3415: The new law expands the application of the old "third-party recordkeeper" procedures to summonses issued to persons other than the taxpayer. Thus, the taxpayer whose liability is being investigated will receive notice of a summons to any person, not only to "third-party recordkeepers." And the taxpayer is entitled to bring an action in the appropriate U.S. District Court to quash the summons.

MR. DIAZ: Does the new law expand the rights of taxpayers in any other matter?

SEC. 3415: Yes. The old law only applied to a summons for the production of records. The new law also applies to a summons for testimony.

MR. DIAZ: Thank you, Section 3415. I have no more questions for this witness, Your Honor.

JUDGE HIATT: Before you begin your cross examination, Mr. Manto, I want to ask the witness a question about the effective date to avoid an objection from Mr. Diaz when you ask about it.

MR. MANTO: I wasn't going to ask that question of this witness, Your Honor.

JUDGE HIATT: Well, I'm going to ask it anyway. When is the new notice of summons law effective?

SEC. 3415: The new law applies to summonses served after the date of enactment, which was July 22, 1998.

JUDGE HIATT: Now you can start your cross-examination.

Professor Lovullo tugged at Jack Manto's coat sleeve and told Jack to ask the judge if there were any other questions the judge wanted to ask the witness that the defense was not going to ask the witness. Manto knew that such a question might be viewed as contempt. He waved the Professor off and proceeded with his cross examination of Section 3415.

MR. MANTO: Under the old law, did the IRS have to give notice to the taxpayer of a summons served on a third-party recordkeeper by a criminal investigator of the IRS?

SEC. 3415: Yes.

MR. MANTO: Under the new law, does the IRS have to give notice to the taxpayer of a summons served by a criminal investigator of the IRS?

SEC. 3415: No, unless it is served on a third-party recordkeeper.

MR. MANTO: So the alleged expansion of the third-party summons rule was not expanded for criminal investigations?

SEC. 3415: That's correct.

MR. MANTO: And therefore, in the most serious of matters to a taxpayer a criminal investigation the new law makes no changes that favor the taxpayer?

SEC. 3415: I object to the question, Your Honor.

JUDGE HIATT: Witnesses can't object. Please answer the question. And don't bother getting up, Mr. Diaz because I'm not going to sustain an objection from you, either.

MR. MANTO: I'll re-ask the question. Does the new law make any changes for purposes of a criminal investigation that favors taxpayers?

SEC. 3415: No.

MR. MANTO: So, it's business as usual with respect to IRS criminal investigations? Taxpayers are presumed to be guilty until they prove their innocence?

Edward Diaz had jumped to his feet. Jack Manto had already turned his back to the witness and was headed back to the defendant's table. Diaz exclaimed "Objection!" Judge Hiatt followed quickly with "Sustained" and without hesitation Manto replied "No more questions, Your Honor."

JUDGE HIATT: Any re-direct, Mr. Diaz?

MR. DIAZ: No, Your Honor. And no other witnesses for the plaintiff.

JUDGE HIATT: Mr. Manto, will the defense be calling any of the witnesses on the witness list?

MR. DIAZ: No, Your Honor. I think we have made our point sufficiently with the cross examination of the plaintiff's witnesses. The defendant is ready to proceed to closing arguments.

JUDGE HIATT: Mr. Diaz, are you ready to present your closing argument?

MR. DIAZ: Yes, Your Honor. My client, the Internal Revenue Service Restructuring and Reform Act of 1998, is the most far-reaching legislation of the last four decades with regard to reforming the way the tax collector does business. The provisions that are at issue in this case, the burden of proof, the extension of the attorney-client privilege to tax practitioners, and the notice of summons provisions, represent important safeguards for the protection of taxpayers from abuse by the IRS. The defendant's unjustified depiction of those provisions as a farce cannot be allowed to stand without detriment to him. Thank you judge.

JUDGE HIATT: You may proceed with your closing argument, Mr. Manto.

MR. MANTO: Your Honor, the press releases put out by congress about "The Internal Revenue Service Restructuring and Reform Act of 1998" were like the curtain that hid the Wizard of Oz. Today we have had a chance to peek behind the curtain and see the real wizard. What we found was a tax statute stuffed with straw but no brains. In an attempt to stop the misleading information being disseminated by the Act, all my client did was speak the truth about those provisions. In essence, my client drew back the wizard's curtain and then got sued by the wizard for exposing the reality behind the curtain to the public. He didn't slander the Act. He performed a public service. Thank you.

JUDGE HIATT: Thank you, gentlemen. I'll let you know my decision in a few days.