[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FILED
FOR THE ELEVENTH CIRCUIT U.S. COURT OF APPEALS
________________________ ELEVENTH CIRCUIT
JUNE 10, 2009
No. 08-12053 THOMAS K. KAHN
________________________ CLERK
D. C. Docket No. 07-01816-CV-TWT-1
NERO TRADING, LLC,
SADDLEBROOK TRADING, LLC,
SEVERUS FUND, LLC,
BUTLER FUND, LLC,
Plaintiffs-Appellants,
versus
UNITED STATES OF AMERICA, DEPARTMENT
OF THE TREASURY, Internal Revenue Service,
Defendant-Appellee.
______________________
No. 08-12879
______________________
D. C. Docket No. 07-00059-MC-T-30-MSS
IRONWOOD TRADING, LLC,
LONSWAY TRADING, LLC,
BARTON 2005 TRUST,
LANCER A. BARTON,
Plaintiffs-Appellants,
versus
INTERNAL REVENUE SERVICE,
Defendant-Appellee.
________________________
Appeals from the United States District Court
for the Northern District of Georgia
and the Middle District of Florida
________________________
(June 10, 2009)
Before BIRCH and BARKETT, Circuit Judges, and KORMAN,* District Judge.
PER CURIAM:
This consolidated appeal centers on the Internal Revenue Service (“the
Service”) and the appropriate limits of its summons power. Nero Trading, LLC, et
al., (“Nero Trading”) and Ironwood Trading, LLC, et al., (“Ironwood Trading”)
(collectively, “Appellants”) appeal the orders of the United States District Court
for the Northern District of Georgia (re Nero Trading) and the United States
District Court for the Middle District of Florida (re Ironwood Trading). Nero
*
Honorable Edward Korman, United States District Judge for the Eastern District of
New York, sitting by designation.
Trading appeals the district court’s denial of its petition to quash administrative
summonses issued by the Service and Ironwood Trading appeals the district court’s
denial of its like motion to quash and the court’s grant of the government’s motion
to enforce the summonses. The Appellants argue that the district courts erred in
finding that the government made a prima facie showing that the summonses
should be enforced under United States v. Powell, 379 U.S. 48, 85 S. Ct. 248
(1964) and contend that enforcement of the summonses constituted an abuse of the
courts’ processes. Because the district court did not explain its decision to not hold
an evidentiary hearing in the Nero Trading case and did not sufficiently explain its
rationale for denying Nero Trading’s motion to quash the summonses, we cannot
adequately review the district court’s decision in that case. As regards the
Ironwood Trading case, we find that the district court did not abuse its discretion in
denying Ironwood’s motion to quash and granting the government’s motion to
enforce the summonses. Accordingly, because we conclude that Nero Trading has
been deprived of a fair opportunity to substantiate its claims, we REVERSE and
REMAND to the United States District Court for the Northern District of Georgia
for proceedings consistent with this opinion. We AFFIRM the judgment of the
United States District Court for the Middle District of Florida.
I. BACKGROUND
3
Given the complex nature of the cases before us, we begin with a look at the
transactions giving rise to the summonses in question. We then trace the
procedural history of each case in order to better acquaint ourselves with the
blizzard of underlying facts. Once in command of the facts, we turn to the
Appellants’ arguments.
A. Tax Shelters
Both Nero Trading and Ironwood Trading received administrative
summonses from the Service. In general, the summonses requested information
regarding legal and tax advice obtained by the Appellants in relation to distressed
asset and debt (“DAD”) transactions. In particular, the summonses requested
testimony and documents pertaining to (1) the anticipated tax benefits of the DAD
transactions; (2) engagement letters, invoices, and billing records for legal,
management, or tax advice; (3) correspondence and notes of discussions with the
entity at issue in each summons; and (4) any legal or tax advice with respect to the
DAD transactions.
In accordance with a publicly released Coordinated Issue Paper (“CIP”)
dated 18 April 2007, the Service has determined that certain DAD transactions
constitute tax shelters that generate tax “losses” that are not allowable. Nero, R1-
15, Exh. 2 at 1. These transactions generally involve the use of distressed assets to
4
shift economic losses from a tax indifferent party to a United States taxpayer. In
this case, the tax indifferent parties are Brazilian retail stores carrying distressed
debt in the form of consumer accounts receivable. According to the Service, “the
effect [of these transactions] is that the U.S. taxpayer is benefiting [sic] from the
built-in economic losses in the [Brazilian] party’s distressed asset when the U.S.
taxpayer did not incur the economic costs of that asset.” Nero, R1-15, Exh. 2 at 1.
The Appellants contend that their bad-business debt deductions, taken pursuant to
26 U.S.C. § 166, do not fall under the scheme described by the Service in its CIP.
The Appellants argue that they acquired the distressed debt from the Brazilian
retail stores in order to collect upon it, not to dispose of it. Because the CIP would
disallow a United States taxpayer from benefitting from a built-in loss upon
disposition of the distressed asset, the Appellants assert that their deductions are
readily distinguishable from those described in the CIP.
B. Nero Trading
According to the Service, Nero Trading, LLC and Saddlebrook Trading,
LLC are entities that filed tax returns claiming losses from DAD transactions
substantially similar to those described in the CIP. Alexander J. Gallo, Jr.
(“Gallo”) indirectly owns 99.6% of both Nero Trading, LLC and Saddlebrook,
5
LLC. Nero Trading, LLC and Saddlebrook Trading, LLC are limited liability
companies that are treated as partnerships for tax purposes. As such, both function
as pass-through entities with no entity-level income tax liability. Each passes its
respective income, deductions, gains and losses on to its partners. Because Gallo
indirectly owns most of Nero Trading, LLC and Saddlebrook Trading, LLC, on 25
June 2007, the Service issued summonses (for Nero Trading, LLC and
Saddlebrook Trading, LLC) to Gallo to give testimony and produce the materials
as described in the summonses. The summonses concerned the taxable period 1
January 2003 through 31 December 2004 for Nero Trading, LLC and 1 January
2004 through 31 December 2004 for Saddlebrook Trading, LLC.
The issuing revenue agent for the summonses was Piotr Kleszcz and the
approving agent was Larry Weinger. The summonses listed the date for
appearance as 25 July 2007. On 13 July 2007, Nero Trading filed a petition to
quash the summonses with the United States District Court for the Northern
District of Georgia. Before the district court entertained the petition, the Service
issued a Notice of Final Partnership Administrative Adjustment (“FPAA”) to Nero
Trading, LLC on 18 July 2007.1 The Service has described FPAA as “the ticket to
the Tax Court in the case of a partnership” or “the equivalent of the notice of
1
Saddlebrook Trading, LLC did not receive a FPAA.
6
deficiency issued in the case of an individual taxpayer.” Supp. Materials, Service
Memo (12 January 09) at 4-5 n.3 (quotation marks and citation omitted).
According to Weinger, “the IRS issued the FPAA because the statute of limitations
in which to do so was soon to expire” and the tax matters partner for both Nero
Trading, LLC and Saddlebrook Trading, LLC refused to extend it in order for the
Service to complete its examination.2 Nero, R1-15, Weinger Dec. at 3. On 28
September 2007, the Service filed its motion to deny the petition to quash and for
enforcement of the summonses. The district court ultimately denied the Service’s
motion to enforce the summonses and denied Nero Trading’s petition to quash.
Nero Trading filed a motion to vacate or reconsider which the district court denied
on 19 February 2008.
C. Ironwood Trading
Ironwood Trading’s background roughly parallels that of Nero Trading.
According to the Service, Ironwood Trading, LLC and Lonsway Trading, LLC are
entities that filed returns claiming losses from DAD transactions substantially
2
Weinger also indicated that Nero Trading, LLC subsequently petitioned the United
States Tax Court challenging the Service’s determinations in the FPAA. [Nero, R1-15, Weinger
Dec. at 3].
7
similar to those described in the CIP. In this case, Lancer Barton (“Barton”)
indirectly owns 96.04% of Ironwood Trading, LLC and Lonsway Trading, LLC.
Ironwood Trading, LLC and Lonsway Trading, LLC are also limited liability
companies that are treated as partnerships for tax purposes. Similar to Nero
Trading, the Service summoned Barton to testify and produce documents relevant
to returns filed by Ironwood Trading, LLC, Lonsway Trading, LLC, Barton Trust
2005, and by Barton individually. The summonses concerned the taxable year
2004 for Ironwood Trading, LLC, the years 2003 and 2004 for Lonsway Trading,
LLC, and the year 2005 for both Barton 2005 Trust and Barton individually. In
this case, Weinger was the issuing revenue agent and the return date listed for the
summonses was 21 August 2007.
On 20 July 2007, Ironwood Trading filed a petition to quash the summonses
in the United States District Court for the Middle District of Florida. Five days
later, the Service issued a FPAA to Lonsway Trading, LLC. As in Nero Trading,
the Service claimed that it issued the FPAA because the statute of limitations in
which to do so was soon to expire and the tax matters partner for Lonsway
Trading, LLC refused to extend it in order for the Service to complete its
examination. According to Weinger, Lonsway Trading, LLC also subsequently
petitioned the United States Tax Court challenging the Service’s determinations in
8
the FPAA.
On 3 October 2007, the Service filed a motion to deny the petition to quash
and to enforce the summonses. In response, Ironwood Trading requested
discovery and an evidentiary hearing. Before the district court ruled on the
discovery request, Ironwood Trading served the government with a request for
admissions, interrogatories, and a request for production of documents. The
government responded with a motion to quash the discovery request and for a
protective order against further discovery requests pending a decision by the
district court on the government’s motion to deny the petition to quash and for
enforcement of the summonses.
The district court ultimately conducted a limited evidentiary hearing.
Ironwood Trading subpoenaed five Service employees to produce documents and
testify at the hearing. The Service moved to quash all of the subpoenas except for
the one for testimony by Weinger. After Weinger testified at the hearing,
Ironwood’s attorney advised the district court that he had taken “too much time” in
his examination of Agent Weinger, and that “in light of [the] agent’s candid
testimony about speaking with district counsel, Letkewicz, about these ongoing
audits, the Petitioners rest [without calling any additional witnesses].” Ironwood,
R2-50-51.
9
Appellants now appeal the district courts’ orders to us.
II. DISCUSSION
The Appellants present a host of arguments directed to the merits of the
orders enforcing the IRS subpoenas, the lion’s share of which we do not discuss.
Instead, we focus principally on the propriety of a meaningful adversarial hearing
in the context of a motion to quash summonses issued by the Service.
We have held that “[a]n order enforcing an IRS summons will not be
reversed unless clearly erroneous.” United States v. Morse, 532 F.3d 1130, 1131
(11th Cir. 2008) (per curiam). In addition, we review a district court’s denial of
discovery and an evidentiary hearing for abuse of discretion. United States v.
Harris, 628 F.2d 875, 884 (5th Cir. 1980).
At the outset, we recognize the Service’s obligation to administer and
enforce Congress’ power to lay and collect taxes. See Morse, 535 F.3d at 1131;
see also U.S. Const. amend. XVI. Towards that end, 26 U.S.C. § 7602 vests the
Service with the authority to issue a summons “[f]or the purpose of ascertaining
the correctness of any return, making a return where none has been made,
determining the liability of any person for any internal revenue tax . . ., or
collecting any such liability.” Id. § 7602(a). Although its “power to investigate
. . . has been described as broad and expansive,” see La Mura v. United States, 765
10
F.2d 974, 979 (11th Cir. 1985) (quotation marks and citation omitted), the
Service’s authority is not without limits and “[n]o summons may be issued . . .
with respect to any person if a Justice Department referral is in effect with respect
to such person.” Id. § 7602(d)(1).
Because a summons issued by the Service is not self-executing, the Service
must apply to the appropriate district court for enforcement. See id. § 7604(b).
The Service must make a four-step prima facie showing to have a summons
enforced. The Service must show: (1) “that the investigation will be conducted
pursuant to a legitimate purpose,”(2) “that the inquiry may be relevant to the
purpose,” (3) “that the information sought is not already within the
Commissioner’s possession,” and (4) “that the administrative steps required by the
Code have been followed.” United States v. Powell, 379 U.S. 48, 57-58, 85 S. Ct.
248, 255 (1964). We have held that the Service “may satisfy its minimal burden
by presenting the sworn affidavit of the agent who issued the summons attesting to
these facts.” Morse, 532 F.3d at 1132 (citation omitted).
Once the Service has made its prima facie showing, “the burden shifts to the
party contesting the summons to disprove one of the four elements of the
government’s prima facie showing or convince the court that enforcement of the
summons would constitute an abuse of the court’s process.” Id. (citation omitted).
11
How a taxpayer might meet that burden is pivotal in the cases before us.
We have held that a taxpayer is entitled to a limited adversarial hearing in
order to ascertain whether the Service issued a given summons for an improper
purpose. United States v. Southeast First Nat’l Bank, 655 F.2d 661, 668 (5th Cir.
Sept. 1981). Moreover, we have held that “an allegation of improper purpose is
sufficient to trigger a limited adversary hearing where the taxpayer may question
IRS officials concerning the Service’s reasons for issuing the summons.” Id. at
667. By our lights, Southeast First National Bank is the legitimate offspring of the
Supreme Court’s seminal decision in Powell. Powell reminds us that “the
adversarial hearing to which the taxpayer is entitled before enforcement is ordered”
is not “meaningless,” and that “[a]t the hearing he may challenge the summons on
any appropriate ground.” Powell, 379 U.S. at 58, 85 S. Ct. at 255 (quotation marks
and citation omitted). That said, we also recognize the limits of any such
adversarial hearing and agree with our brethren in the Fifth Circuit that
“[d]epositions, interrogatories, and the rest of the panoply of expensive and time-
consuming pretrial discovery devices may not be resorted to as a matter of course
and on a mere allegation of improper purpose.” In re E.E.O.C., 709 F.2d 392, 397-
98 (5th Cir. 1983) (quotation marks and citation omitted).
Generally, the scope of any adversarial hearing in this area is left to the
12
discretion of the district court.3 Although our standard as articulated in Southeast
First National Bank is permissive, it does not categorically strip district courts of
their discretionary power to determine whether an adversarial hearing is
appropriate. See Southeast First Nat’l Bank, 655 F.2d at 668 (“We therefore hold
that although the district court may in [its] discretion restrict or deny prehearing
discovery, [it] may not refuse a limited enforcement hearing when to do so would
deny taxpayer his sole means of demonstrating the truth (or falsity) of his
allegations.”) (citation omitted and emphasis added). We note, however, the
danger of circumscribing such a hearing to the extent that its utility is altogether
frustrated.
We are mindful that our precedent in this area is not in accord with that of a
number of our sister circuits. See, e.g., United States v. Tiffany Fine Arts, Inc.,
718 F.2d 7, 14 (2d Cir. 1983), aff’d, 469 U.S. 310, 105 S. Ct. 725; United States v.
Kis, 658 F.2d 526, 539-540 (7th Cir. 1981) (requiring the taxpayer to develop facts
3
We recognize that the Supreme Court has indicated as much in Tiffany Fine Arts, Inc.
v. United States, 469 U.S. 310, 324 n.7, 105 S. Ct. 725, 732 (1985). We note that we have never
held that a taxpayer’s right to a limited adversarial hearing is absolute. However, we view our
precedent in this area as in line with the Supreme Court’s language in Donaldson and Powell.
See Donaldson v. United States, 400 U.S. 517, 529, 91 S. Ct. 534, 541 (1971) (stating that a
summary proceeding may be used in a summons enforcement case “so long as the rights of the
party summoned are protected and an adversary hearing, if requested, is made available”);
United States v. Powell, 379 U.S. 48, 58, 85 S. Ct. 248, 255 (1964) (reminding us that “the
adversarial hearing to which the taxpayer is entitled before enforcement is ordered” is not
“meaningless,” and that “[a]t the hearing he may challenge the summons on any appropriate
ground”).
13
sufficient to allow court to draw inference of wrongful conduct by government
before adversarial hearing can be granted); United States v. Nat’l Bank of South
Dakota, 622 F.2d 365, 367 (8th Cir. 1980) (per curiam). However, we are
convinced that Southeast First National Bank’s considered review of our earlier
line of cases in this area strikes the appropriate balance between honoring the
intended summary nature of the summons proceeding and protecting the interests
of the taxpayer.4 Our rationale in Southeast First National Bank bears repeating.
Without a right to either pretrial discovery, a right severely curtailed in
Harris, or an adversary hearing before the district judge, a taxpayer
threatened with judicial enforcement of an IRS summons will have no
meaningful opportunity to determine whether the IRS issued the
summons for a proper purpose. Instead, the taxpayer, who normally has
no knowledge of the facts necessary to establish institutional purpose,
will be forced to accept on blind faith the IRS’ protestations that it had
a civil motive for issuing the summons. Given these circumstances, we
simply refuse to create a rule that would require taxpayer to allege a
factual background before he is entitled to the initial, basic discovery
provided by an adversary hearing. To accept this view would impose an
unreasonable circular burden on the taxpayer: the facts that he must
show to obtain discovery are only available through discovery. We will
not saddle the taxpayer with this Catch 22.
Id. (quotation marks and citation omitted).
4
We find the notion that passage of I.R.C. § 7602(b) and (c) created a bright-line rule
precluding a determination of improper motive in the absence of a Justice Department referral
unpersuasive. See generally In re E.E.O.C., 709 F.2d at 398-99 (discussing legislative
modification of pre-summons enforcement discovery standards). First, we are aware of no
Eleventh Circuit precedent recognizing such a rule. Second, such a rule implies that improper
motive or purpose can only mean the issuance of a summons in order to conduct a criminal
investigation. Our reading of improper motive or purpose is not so narrowly circumscribed.
14
In Nero Trading’s case, the district court’s failure to articulate its reasons for
forgoing an evidentiary hearing and denying Nero Trading’s motion to quash leads
us to conclude that Nero Trading was not afforded a meaningful opportunity to
question the Service concerning its reasons for issuing the summonses. The
district court refused a limited adversarial hearing and issued a perfunctory order
with only passing reference to any legal standard and no reference at all to either
the merits of the Service’s prima facie case or Nero Trading’s claims in rebuttal.
As regards Ironwood Trading’s case, because the district court at least allowed a
limited adversarial hearing, albeit a truncated one, we cannot find that the district
court abused its discretion.
III. CONCLUSION
Nero Trading appeals the district court’s denial of its petition to quash
administrative summonses issued by the Service and Ironwood Trading appeals the
district court’s denial of its like motion to quash and the court’s grant of the
government’s motion to enforce the summonses. Because the district court did not
explain its decision to not hold an evidentiary hearing in Nero Trading’s case and
did not sufficiently explain its rationale for denying Nero Trading’s motion to
quash the summonses, we cannot adequately review the district court’s decision in
that case. As regards Ironwood Trading’s case, we find that the district court did
15
not abuse its discretion in denying Ironwood’s motion to quash and granting the
government’s motion to enforce the summonses for substantially the same reasons
stated in the district court memorandum and order. See Ironwood Trading, LLC v.
United States, 2008 WL 817066 (M.D. Fl. March 25, 2008). Accordingly, we
REVERSE and REMAND to the United State District Court for the Northern
District of Georgia for proceedings consistent with this opinion and AFFIRM the
judgment of the United States District Court for the Middle District of Florida.
REVERSED and REMANDED, in part, and AFFIRMED, in part.
16