Tuesday, January 21, 2003
IRS Committed Fraud on Tax Court in Investment Case, Court Rules
By a MetNews Staff Writer
Lawyers for the Internal Revenue Service defrauded the U.S. Tax Court by staging a sham trial of taxpayers with whom they already secretly settled, in order to obtain a favorable precedent, the Ninth U.S. Circuit Court of Appeals ruled Friday.
In a blistering opinion by Judge Michael Daly Hawkins, the court threw out the Tax Court ruling that found the IRS’ actions harmless and ordered that about 1,300 airline pilots who invested in a creative but questionable investment program get the benefit of deals the IRS brokered with the two pilots who cooperated in the deception.
Hawkins blasted IRS lawyers Kenneth W. McWade and William A. Sims, assigned to the Honolulu office, for deceiving the Tax Court about their settlement scheme. At one point in the month-long trial over tax liability on the shelter, McWade abruptly cut off one of the taxpayers just as he apparently was about to reveal the settlement to the court.
“Here, the factual findings of the Tax Court support the conclusion that a fraud, plainly designed to corrupt the legitimacy of the truth-seeking process, was perpetrated on the trial court by McWade and Sims,” Hawkins wrote.
The IRS punished the two lawyers for deceiving the court, but Hawkins was unimpressed, saying the government agency did little to dissuade similar acts in the future and that the IRS itself should be sanctioned.
McWade and Sims both were suspended for two weeks without pay. Sims, the supervisor, then was transferred out of Hawaii and into the IRS’ San Francisco office. The IRS rewarded McWade, the trial lawyer, with a $1,000 bonus for his performance at trial and did not revoke it after his role in the deception became clear. McWade retired rather than accept discipline.
At issue in the Tax Court was whether a shelter designed and run by now-deceased Honolulu businessman Henry Kersting was legitimate.
The program allowed the pilots to purchase stock with loans from Kersting-controlled entities that were financed with promissory notes. Participants could claim interest deductions on their individual tax returns, according to the court.
The IRS discovered the scheme in 1981 and disallowed the deductions. The agency billed the pilots for additional taxes and penalties amounting to more than $1 billion.
Kersting took the case to Tax Court to obtain a redetermination of the deficiencies. Instead of trying each case individually, the parties agreed to use a “test case,” and most of the taxpayers signed a stipulation agreeing to be bound by the decision as it was applied to representatives of the group.
The IRS selected taxpayer John R. Thompson as one of the representatives, and the taxpayers’ counsel picked John R. Cravens.
The IRS entered into a deal with both. Cravens believed, incorrectly, that his settlement erased his tax liability. Thompson’s deal lowered his tax liability in direct proportion to his attorney fees.
As a condition of the pact, Cravens and Thompson had to agree to stay in the test case.
“At no point did McWade or Sims reveal to the Tax Court or to any other taxpayer representative that two of the test case petitioners’ cases had been settled, much less reveal the conditions imposed upon them,” Hawkins said.
At a deposition, Kersting’s lawyer objected to the presence of Thompson’s lawyer because of rumors Thompson was attempting to settle. McWade did not mention that in fact Thompson already had settled.
“McWade then misled the Tax Court by failing to disclose the settlement when he moved to set aside the Thompson piggyback agreement, a pre-trial motion necessary to ensure Thompson’s status as a test case petitioner,” Hawkins said. “Deceptive silence turned into overt misconduct when, during the course of the test case trial, it became apparent that Thompson was going to testify about his settlement. McWade quickly shifted his questions to unrelated matters.”
The IRS also reached a deal with taxpayer Dennis Alexander, reducing his tax deficiencies—and covering his Hawaii expenses for the month-long trial—in exchange for false testimony. McWade’s memorandum regarding the basis of his settlement of Alexander’s tax liabilities also was false.
The Tax Court entered judgment against all of the taxpayers, including Thompson and Cravens, based on its decision in the test case. The “McWade-Sims house of cards,” in Hawkins’ words, collapsed when Thompson and Cravens pressured the IRS to live up to its settlement terms, and the IRS had to reveal the agreements when it went into court to get the judgment set aside against the two.
Hawkins called the proceeding a “charade fraught with concealed motives, hidden agendas and false testimony, that was “clearly designed to defile the court.”
“Such fraud corrupts the adversarial nature of the proceeding, the integrity of the witnesses and the ability of the trial court to judge impartially,” Hawkins said. “This harm is noteworthy not only because it defiled the sanctity of the court and the confidence of all future litigants, but also because it violated the rights of the test case petitioners and the more than 1,300 taxpayers who agreed to be bound by the outcome of the tax court proceeding.”
But Hawkins said that although the IRS should be punished, it would go too far to wipe out the tax liability of all of the hundreds of taxpayers involved. Instead, he said, all of them should get the same deal the IRS reached with Thompson and McWade.
The case is Dixon v. Commissioner of Internal Revenue, 00-70858.
Copyright 2003, Metropolitan News Company