The Tax Court upheld the IRS's imposition of penalties against a couple for marketing and promoting tax shelters based on the use of a corporation sole.
Fredric Gardner, an accountant, and his wife, Elizabeth, a paralegal, each hold a theology degree. After their Christian bookstore business failed, they were inspired to use the name of the Lord in another effort to put bread on the table.
To that end, they formed Bethel Aram Ministries in Nevada as a corporation sole. Historically, a corporation sole is a succession of persons holding an ecclesiastical or monarchical office. Corporations sole are authorized under the laws of some states to enable religious leaders to hold property and conduct business for the benefit of the religious entity, as opposed to the benefit of the officeholder himself or herself.
The intended purpose of a corporation sole is to ensure continuity of ownership of property dedicated to the benefit of a religious organization. However, the Gardners' more immediate purpose for forming Bethel Aram Ministries was to use it as a vehicle for selling a tax plan to other individuals that involved the use of a corporation sole. By using this plan, the Gardners claimed that an individual would gain a number of benefits that would save the individual a considerable amount of tax. In marketing the plan, the Gardners stated that "God has provided a way for you to be unencumbered in his church today and not at odds with the government, whatsoever!"
The IRS eventually caught wind of what the Gardners were doing and started an investigation into their corporation sole plan. Rather than finding that the plan was a God-given way to legally reduce taxes, the IRS concluded it was an abusive tax shelter. Therefore, it brought an action in district court against the Gardners, seeking a judicial decree enjoining them from promoting the corporation sole plan. The district court obliged and, in March 2008, entered an order permanently enjoining the couple from promoting the plan.
After the district court issued the injunction, the IRS opened an examination of the Gardners' 2002, 2003, and 2004 income tax returns and a Sec. 6700 penalty investigation of their promotion of the corporation sole plan for the same years. Under Sec. 6700, the IRS can impose a penalty against any person who organizes or sells an abusive tax shelter. The penalty is the lesser of $1,000 or 100% of the gross income derived (or to be derived) by the person for each shelter sold. The IRS agent conducting the investigation identified 200 purchasers of the Gardners' plan and, after further investigation and analysis of returns filed by these purchasers, identified 47 returns that had potential issues related to the use of the plan.
As a result of these findings, the IRS issued $47,000 in Sec. 6700 penalty assessments against the Gardners in September 2011. Although not all the assessments were related to plans the Gardners sold or set up in 2003, the IRS designated all of them as for the year 2003 because that was the year the investigation commenced.
The Gardners did not pay the penalties assessed against them, and the IRS began collection activities, eventually sending each of them a notice of intent to levy. They each subsequently requested and received collection due process hearings, in which the settlement officers held that the IRS could proceed with its collection actions. The IRS afterward issued separate notices of determination to both taxpayers. The Gardners, in response, separately petitioned the Tax Court, and the Tax Court consolidated their cases. In the case, to determine whether the Gardners were liable for the penalties, the Tax Court found that the IRS was required to prove that the Gardners were liable for the penalties and the amount of the penalties.
The Tax Court's Decision
The Tax Court held that the Gardners were liable for the Sec. 6700 penalties. The court found that the Gardners' liability for the penalties was established under the judicial doctrine of collateral estoppel and that the IRS had proved the amount of the penalties through the testimony of its agent about his investigation into the Gardners' plans. In addition, it found no fault with the IRS's designation of all of the assessments as for 2003.
Collateral estoppel: The Tax Court, citing Peck, 90 T.C. 162 (1988), aff'd, 904 F.2d 525 (9th Cir. 1990), stated that collateral estoppel applies in a factual dispute if the following conditions are satisfied: (1) The issue in the second suit is identical in all respects with the one decided in the first action; (2) there is a final judgment rendered by a court of competent jurisdiction; (3) the party against which collateral estoppel is asserted is either a party to the prior judgment or the privy of a party to the prior judgment; (4) the parties actually litigated the issues, and the resolution of these issues was essential to the prior decision; and (5) the controlling facts and applicable legal rules remain unchanged from those in the prior litigation.
The court found that all five Peck factors had been met through the adjudication of the Gardners' earlier district court case and the court's decision in the case. With respect to the first factor, the court explained that it enjoined the Gardners from promoting their corporation sole plan per Sec. 7408(a), which empowers a court to enjoin any person from further engaging in "specified conduct." Specified conduct is defined in Sec. 7408(c) and includes any action or failure to take action that is subject to penalty under Sec. 6700. The Tax Court stated, "To enjoin the Gardners from engaging in promoting and selling of an abusive tax shelter plan or arrangement, the District Court necessarily determined that they engaged in conduct subject to the section 6700 penalty."
Besides finding that the Peck factors were satisfied, the court noted that the Gardners were simply making the same arguments in the present case regarding their liability for the penalty that they made in district court. According to the court, the Gardners were doing exactly what "the doctrine of collateral estoppel was intended to avoid: relitigating closed questions." Thus, the court found that the doctrine applied and the IRS had established that the Gardners were liable for the penalties.
Amount of liability: As to the amount of the liability, the Tax Court found that the IRS was required to show that the Gardners had committed 47 acts that made them liable for the Sec. 6700 penalty. The court concluded that the IRS had done so through the IRS investigator's detailed explanation of the examination procedures he and his colleagues performed to identify the 47 corporations sole on which the penalties assessed were based. The Gardners countered that this testimony did not establish the amount of the penalties because it did not show that any of the individuals who purchased the corporation sole plan used the plan to avoid tax. The court rejected this argument because it found that, based on the legislative history of Sec. 6700, the focus of Sec. 6700 is on the promoter of the abusive tax shelter in question, not on the purchaser of the shelter. Even if the purchaser does not use the shelter and does not underreport his or her tax, the promoter is still liable for the penalty.
Year of penalty assessment: Finally, the Tax Court addressed whether the IRS notice of assessment, which designated that all of the penalty assessments were for 2003, was valid despite the fact that some of the corporation sole plans that were the subject of penalties were sold in 2002 and 2004. The court concluded that a notice of assessment for a Sec. 6700 penalty requires only a statement of the amount of the penalty and a demand for payment, and that the notices issued to the Gardners clearly contained both these elements.
The court also determined that a notice must meet the "fairness" requirement of due process, which meant that if the notice contained a technical defect, it nonetheless was valid if the taxpayer was not prejudiced or misled by the error and was afforded a meaningful opportunity to litigate his or her claims. The court said the IRS provided a cogent administrative reason for using 2003 to designate all of the assessments in the notices of determination provided to the Gardners, and the couple had knowledge of all the relevant facts and arguments of the IRS and had a full opportunity to contest the penalties assessed. Therefore, the court found that the notices of determination were adequate.
A corporation sole is not a commonly encountered entity, but when it is used for the purposes it actually is intended for, it is a perfectly valid and useful structure. However, its proper use is very narrow, and practitioners should be wary if they come across a corporation sole that a taxpayer is using for anything that is not clearly a bona fide church or religious organization.
Gardner, 145 T.C. No. 6 (2015)