Tax Court Ruling Makes Going to Trial Under ‘Jarkesy’ Complex

Taxpayers that believe they can get a jury trial under Jarkesy v. SEC to fight tax fraud penalties may want to think twice before pursuing that option, due to a subsequent US Tax Court decision that narrows the opportunities for such a trial.

In Jarkesy, the US Supreme Court held that when the Securities and Exchange Commission seeks civil penalties against a party for securities fraud, that party is entitled to a jury trial before an Article III Judge under the Seventh Amendment. The SEC may not pursue the penalty administratively or before a non-Article III judge.

The Supreme Court noted in Jarkesy that, while George Jarkesy, Jr. was entitled to a jury trial, the right to a jury trial doesn’t extend to lawsuits in matters involving “public rights.” While acknowledging its failure to definitively explain the distinction between public and private rights, the justices said that the “public rights” exception includes the government’s collection of revenue.

Per Jarkesy, the presumption is in favor of a jury trial in an Article III court, even for matters that arguably fall within the scope of the “public rights” doctrine. But Jarkesy didn’t address the question of whether the “public rights” exception extends to collection of tax-related penalties in addition to collection of taxes themselves.

Based on Jarkesy, some taxpayers feel entitled to a jury trial on whether they’re liable for tax-related penalties, and that administrative assessment and collection of tax-related penalties violates their Seventh Amendment right to a jury trial.

However, the Tax Court, in Silver Moss Properties, LLC v. Commissioner, unanimously held that taxpayers aren’t entitled to an Article III court jury trial on whether they’re liable for fraud penalties asserted under IRC Section 6663.

Sovereign immunity bars such claims for jury trials, because the taxpayer is suing the government, rather than the other way around, the court held. It also held that the “public rights” exception extends to both tax-related penalties and taxes.

Going forward, taxpayers litigating in Tax Court that want a jury trial on the factual issues relating to tax penalties must appeal the Seventh Amendment issue to the Court of Appeals and, until the Supreme Court rules on this issue, face the possibility of Supreme Court review of their case.

Most taxpayers will be reluctant to pursue such appeals, given what awaits them. If they prevail on the Seventh Amendment issue, they will face the prospect of the government suing them in US District Court for the tax-related penalties after losing on the merits of the tax liability in Tax Court.

What could possibly be more fun than paying for two separate trials—one for taxes and another for penalties—in two separate courts, involving a common set of facts?

Taxpayers and their counsel contemplating this course of action should consider both the time and cost involved and, more importantly, whether the taxpayer is likely to fare materially better by having a jury decide factual issues relating to tax penalties.

Taxpayers that want to raise the Seventh Amendment issue because they can’t (or don’t) go to Tax Court to challenge tax-related penalty assessments are in a different position. They should be able to raise the Seventh Amendment issue in a collection due process appeal under Section 6330(c)(1) as an alleged failure to follow applicable procedure, without having to litigate the merits of a tax liability first.

For Seventh Amendment purposes, standalone civil tax penalties, such as penalties for a failure to timely file accurate Forms 3520, may differ from civil tax penalties that are owed only if the taxpayer has an understatement (or underpayment) of taxes.

Standalone tax penalties are typically based on failure to provide information and thus can be imposed without regard to whether the taxpayer understated their taxes. Thus, they more resemble penalties imposed for failing to timely file accurate reports of foreign bank and financial accounts, or FBARs, than they resemble civil fraud penalties or accuracy-related penalties.

Notably, the government has yet to argue in a pending case, United States v. Sagoo, that the “public rights” exception applies to litigation involving FBAR-related penalties.

I question the Tax Court’s holding that sovereign immunity is relevant to resolving the Seventh Amendment issue merely because taxpayers are suing the government in Tax Court and not vice versa.

That holding ignores the fact that a Tax Court petition is a response to an administrative assertion of civil tax penalties by the IRS in a notice of deficiency. The notice of deficiency can be compared to the SEC’s administrative assertion of civil penalties that was found to violate the Seventh Amendment in Jarkesy.

The Tax Court’s holdings that tax-related penalties—such as the fraud penalty and the accuracy-related penalty—fall within the scope of the “public rights” exception are more understandable, even if you believe (as I do) that the historical analysis offered by the amicus brief in Silver Moss is correct.

Courts will be reluctant to reach a conclusion that will prevent unrepresented taxpayers from resolving their IRS disputes with “one-stop shopping” in the Tax Court, particularly given that a constitutional amendment is the only “fix” to such a disruption to the existing process.

Standalone tax penalties that aren’t tethered to an underlying tax liability, however, bear a stronger resemblance to the penalties asserted by the SEC in Jarkesy. Whether such a resemblance will be enough for the Supreme Court to require jury trials for standalone tax penalties remains unclear.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

A. Lavar Taylor is the founder and managing partner of Taylor Nelson Amitrano in Irvine, Calif.

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