Tax Court May Not Disregard Findings of a Special Trial Judge

By James Beavers, J.D., LL.M., CPA

The Fifth Circuit held that the Tax Court did not give due regard to the findings of its special trial judge and ordered the Tax Court to issue a final order adopting the findings in that judge's report.

Background

The IRS assessed deficiencies against Robert Lisle, Claude Ballard, and Burton Kanter for the years 1987, 1988, and 1989 for unreported income the IRS alleged the men had received through an elaborate kickback scheme related to Lisle's and Ballard's employment in the residential real estate department at Prudential Life Insurance Co. of America. The three men challenged the IRS's assessments against them in the Tax Court in a consolidated case. Tax Court Chief Judge Mary Ann Cohen appointed Judge D. Irwin Couvillion as the special trial judge (STJ) for the case.

Judge Couvillion conducted the trial in the summer of 1994 and submitted his report on the trial to Chief Judge Cohen in 1998. His original report exonerated all three defendants; it found that they had not engaged in any kickback schemes, none of the payments in question were unreported income to them, and they were not liable for the tax and penalties assessed against them.

Chief Judge Cohen assigned the case to Tax Court Judge H. A. Dawson Jr. After reviewing Couvillion's report, Judge Dawson and Chief Judge Cohen determined that Judge Couvillion's findings were in error. After conferring with the chief judge and Judge Dawson, Judge Couvillion withdrew his original report. The chief judge instructed Dawson and Couvillion to write a collaborative report to replace the original report. The collaborative report, unlike the original report, concluded that Lisle, Ballard, and Kanter were liable for the tax deficiencies assessed against them and for fraud penalties. Judge Dawson filed the collaborative report as the decision of the Tax Court (Investment Research Assocs. Ltd., T.C. Memo. 1999-407).

Lisle, Ballard, and Kanter suspected that the report filed as the Tax Court's opinion was not Judge Couvillion's original report and filed motions to have access to his original report, which the Tax Court denied. The defendants separately appealed their cases to the appropriate appeals circuits (the Fifth for Lisle, the Seventh for Kanter, and the Eleventh for Ballard) (Estate of Lisle, 341 F.3d 364 (5th Cir. 2003); Estate of Kanter, 337 F.3d 833 (7th Cir. 2003); Ballard, 321 F.3d 1037 (11th Cir. 2003)).

In Kanter and Ballard's cases, the appeals courts affirmed the assessment of the fraud penalty in addition to the tax and other penalties; in Lisle's case, the court only affirmed the assessment of tax and the penalties other than the fraud penalty, and it remanded the case to the Tax Court to recalculate the amount due. Kanter and Ballard immediately appealed their cases to the Supreme Court, asking it to decide whether the Tax Court could exclude an STJ's report from the record on appeal.

Supreme Court Holding

The Supreme Court granted certiorari and held that Tax Court Rule 183, which sets out the rules of practice and procedure for cases assigned to an STJ, did not allow a collaborative effort with regard to an STJ's report and that the Tax Court was not authorized to exclude an STJ's report from the record on appeal. The Court further held that pursuant to Rule 183, an STJ's findings of fact should be presumed correct and that the Tax Court must give due regard to the fact that the STJ had the opportunity to evaluate the credibility of the witnesses at the trial. Therefore, because the Tax Court had failed to give proper deference to Judge Couvillion's original report, the Court reversed the appeals court's judgments affirming the Tax Court's judgments against Ballard and Kanter and remanded the cases for further proceedings (Ballard, 544 U.S. 40 (2005)).

Second Tax Court Decision

Based on the Supreme Court's decision in Ballard, the Fifth Circuit remanded Lisle's case to the Tax Court with instructions to assign a new judge to the case, to disregard the collaborative opinion, and to give due regard to Judge Couvillion's original report and findings (presuming them to be correct unless manifestly unreasonable). On remand, the Tax Court again found Lisle liable for tax deficiencies but not for fraud penalties (Estate of Kanter, T.C. Memo. 2007-21). In making its decision, the Tax Court adopted some of Judge Couvillion's findings, rejected others as unreasonable, and supplemented others that it found incomplete.

Lisle again appealed the Tax Court's decision, arguing that it had failed to give appropriate deference to Judge Couvillion's original findings. Lisle further argued that in making its decision, the Fifth Circuit should focus on whether the record supported Judge Couvillion's findings.

Fifth Circuit's Decision

The Fifth Circuit agreed with Lisle and held that the Tax Court had not given appropriate deference to Judge Couvillion's findings and had erred in issuing an opinion contrary to those findings. Therefore, it remanded the case back to the Tax Court with instructions for the Tax Court to enter a final order adopting Judge Couvillion's original trial report.

The Fifth Circuit, adopting the same position as the Eleventh Circuit had in the appeal of Lisle's co-defendant Ballard (Ballard, 522 F.3d 1229 (11th Cir. 2008)), found that a Tax Court STJ's findings could be disregarded only if they were clearly erroneous. It also agreed with Lisle that in determining whether the findings were clearly erroneous, it should focus on whether the record supported the findings. According to the court, as it had held in Lisle's first appeal, this meant it could "disturb the Special Trial judge's findings of fact and credibility determinations only if they are ‘manifestly unreasonable.'" Looking at the record, and taking into account that Judge Couvillion had the opportunity to personally judge the creditability of the witnesses at the trial, the Fifth Circuit held that his findings were supported by the record and should have been adopted by the Tax Court.

Reflections

While regular Tax Court judges more often than not serve as the trial judges in Tax Court cases, when a case is tried by an STJ, the regular Tax Court judge serves the same function as an appellate judge and, like any appellate judge, generally is not entitled to overturn the trial judge's factual findings in the absence of clear error. In this case, the regular Tax Court judge and the chief judge tried to eliminate the distinction between the STJ and the regular Tax Court judge in order to reach what they believed was the correct result. While the STJ's factual findings may have been questionable, it was his role in the process to make those findings, and disregarding them was patently unfair to Lisle and the other defendants.

Estate of Lisle, No. 07-60862 (5th Cir. 8/25/08)

The reports of cases, rulings, etc., herein, except for the Reflections, are edited versions of the relevant court opinion, published ruling, etc.

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