IRS Sanctioned by Court for ‘Bad Faith’ on Backdated Document

The IRS will have to pay sanctions because its attorneys acted in bad faith by failing to come clean about the date that a $15.2 million conservation easement penalty was approved, the US Tax Court ruled Tuesday.

The court said Internal Revenue Service counsel “knew or should have known” the approval date they supplied to the court was wrong by Nov. 2, 2022, because that’s when the supervisor in charge of approving the penalty told agency counsel she wasn’t sure the date given to the court in August 2022 documents was accurate. However, the agency didn’t come forward to the court at that point to correct the misstatements.

“Furthermore, no other remedial action was taken with the Court to correct the error until April 10, 2023,” wrote Judge Christian N. Weiler. That was after Weiler issued a March order finding the agency had obtained approval in time to assess the penalty based on the incorrect approval date.

The court tossed out that March ruling, which it said “was predicated on facts that were not true.” Based on what has come to light, there are still material facts to be sorted out about whether the IRS complied with the approval requirement, it said.

The IRS attorney misconduct shouldn’t be attributed directly to the IRS, according to the court. It said agency counsel who appeared later in the case worked “to provide clarity and correction to the erroneous factual representations made by original counsel.”

The dispute concerns a requirement under tax code Section 6751(b) for an immediate IRS supervisor to approve the initial determination to assess various penalties. The agency initially said a penalty approval form that included the $15.2 million penalty was signed by the supervisor on July 16, 2016, but it has since conceded that the signature was placed on that form on Feb. 10, 2017.

The dispute over penalty approval backdating has taken place against the backdrop of the IRS’s campaign to fight what it says are improper tax deductions tied to conservation easement donations. Such donations involve promoting conservation by giving away property development rights.

‘Bad Faith’

The court rejected the agency’s argument that, while its actions fell short “of the level of excellence and professionalism that the Court has a right to expect,” they didn’t “rise to the level of fraud or bad faith.”

IRS counsel acted “in bad faith” and “multiplied the proceedings in this case unreasonably and vexatiously” by failing to timely advise the court of the erroneous statement on the penalty approval, Weiler said.

The court noted that its own rules require attorneys before it to abide by the American Bar Association Model Rules of Professional Conduct, which prohibit lawyers from knowingly making a false factual statement or failing to correct a materially false factual statement to the court.

The amount of the monetary sanctions still needs to be determined based on what fees and expenses LakePoint incurred as a result of the IRS attorney misconduct, Weiler said.

In addition to getting a reimbursement of costs, LakePoint asked for a sanction against the IRS in the form of a ruling that it didn’t have to pay the penalty. However, the court said such a sanction would be inappropriate.

“On the other hand, a government attorney who unreasonably and vexatiously multiplies Tax Court proceedings brings down upon the United States, subjects the United States to, and makes the United States vulnerable to liability for the costs, expenses, and fees attributable to the services of the taxpayer’s attorney’s professional services that are required as an appropriate response to the misconduct,” Weiler said.

Weiler cited the court’s authority under tax code Section 6673 to award “excess costs, expenses, and attorneys’ fees reasonably incurred because of” conduct that “unreasonably and vexatiously” multiples proceedings.

In a separate case, the court on Monday said the IRS fell “woefully short” of the court’s expectations when agency counsel failed to inform the court of their attempt to reconstruct a tax bill to attach to a court filing when they couldn’t access the case’s physical administrative file due to pandemic-related constraints.

LakePoint is represented in the Tax Court case by Skadden, Arps, Slate, Meagher & Flom LLP; Chamberlain, Hrdlicka, White, Williams & Aughtry; and Todd Welty PC.

Former deputy US Attorney General Rod Rosenstein, who is now a partner at King & Spalding LLP, is representing LakePoint in a separate lawsuit at a federal district court seeking IRS records on the penalty approval backdating under the Freedom of Information Act.

The case is Lakepoint Land II, LLC v. Commissioner, T.C., No. 13925-17, 8/29/23.