CAM FERENBACH, United States Magistrate Judge.
This matter is before the court in Case No. 2:10-cv-00495-GMN-VCF on defendant/counterclaimant United States of America's Motion For Protective Order. (# 30). Plaintiff Texture Source, Inc. filed an Opposition (# 31), and the government filed a Reply (# 32). This matter is also before the court in Case No. 2:10-cv-00497-LRH-VCF on defendant/counterclaimant USA's Motion For Protective Order. (# 29). Plaintiff Hutchins Drywall, Inc. filed an Opposition (# 30), and the government filed a Reply (# 31).
In two similar actions in this District (Case No. 2:10-cv-00490-KJD-GWF and Case No. 2:10-cv-00498-LRH-GWF)(hereinafter the "Judge Foley Actions"), the government filed motions for protective orders seeking to protect the same information related to the motions before this court. A combined hearing was held on the motions in the Judge Foley Actions on October 24, 2011. As counsel is the same for all plaintiffs, the legal arguments and discovery sought in the actions before this court and the Judge Foley Actions are identical. The underlying facts in all of the aforementioned actions are substantially similar, and the names, specific monetary amounts, and dates are the only factual differences for purposes of these instant motions.
In the interest of consistent rulings, this court reviewed Judge Foley's orders in preparing this order. Since the parties are familiar with the underlying facts of the actions, the court will not restate them here.
On April 20, 2011, plaintiffs served their first set of requests for production of documents and first interrogatories upon the government. (# 30 and # 29). The discovery requests seek documents and information regarding the Internal Revenue Service's (hereinafter "IRS") purported prior examinations of Centennial Drywall Systems, Inc (hereinafter "Centennial" or "CDSI")(the company that provided drywall workers to plaintiffs for construction projects in Nevada), "including documents prepared, or relied upon, by the [IRS] in connection with one of several, specific purported examinations of Centennial, as well as the [IRS]'s purported efforts to collect taxes from Centennial." Id.
In plaintiffs' first supplemental Rule 26(a)(1) disclosures, plaintiffs identified numerous
The government asserts that a protective order is appropriate because "neither the [IRS]'s analysis of the tax liabilities at issue in [these suits], nor the [IRS]'s purported prior examinations of Centennial, are relevant to any party's claim or defense in [these actions]." Id. The government also asserts that the protective order is necessary because "details of the [IRS]'s purported prior examinations of Centennial, if any, are protected from disclosure pursuant to 26 U.S.C. § 6103." Id. The parties attempted to resolve this issue without the court's involvement pursuant to Local Rule 26-7(b), but were unable to resolve the matter. Id.
In support of the motions for protective orders (# 30 and # 29), the government relies on R.E. Dietz Corp. v. United States, 939 F.2d 1, 4 (2nd Cir.1991) and other cases regarding the standard which governs the district court's determination in a tax refund action.
Dietz states in this regard:
Based on this de novo review standard, trial courts have prohibited or restricted discovery regarding the IRS's administrative determinations of the tax liability on the grounds that it is irrelevant, except in those cases in which the IRS Commissioner is vested with some discretion in the imposition of a tax. See Vons Companies, Inc. v. United States, 51 Fed.Cl. 1, 6 (2001); McLeod v. United States, 2000 WL 1902257 *2 (D.Nev.2000) and Xcel Energy, Inc. v. United States, 237 F.R.D. 416 (D.Minn.2006).
In Xcel Energy, Inc. v. United States, the government disallowed certain corporate interest deductions on life insurance policies that the plaintiff had purchased on behalf of its employees. The plaintiff requested production of documents relating to the government's decision to disallow the deduction. The government produced most of the requested documents, but redacted
The plaintiff in Xcel Energy argued, however, that the internal memoranda of the IRS agents were relevant because the Internal Revenue Code provides an exception to the imposition of penalties if there is "substantial authority" for the taxpayer's position. Id., 237 F.R.D. at 419, citing 26 U.S.C. § 6662(d)(2)(B)(I) and Treasury Regulation § 1.6620-4(d)(2). In rejecting the argument that the memoranda were relevant on this basis, the court stated that it had "found no authority for the proposition that the internal ruminations of IRS agents, during an administrative consideration of the taxpayer's tax liability, could serve, however slightly, as the "substantial authority" required by Section 6662(d)(2)(B)(I), and Xcel has drawn none to our attention." Id.
There are, however, contexts in which such information may be relevant and discoverable. In United States v. Cathcart, 2009 WL 482220, *3-4 (N.D.Cal.2009), the government sought the imposition of a penalty against the defendant based on the allegation that he participated in a "90% stock loan program" which constituted an abusive tax shelter or tax fraud scheme. The government was required to prove that defendant knew or should have known that the program was fraudulent. The defendant sought to discover whether the IRS had concluded, in prior audits of other taxpayers, that the same loan program was not an abusive tax shelter. In holding that defendant was entitled to some discovery on this issue, the court stated: "If the IRS concluded that the program was legitimate when it, audited borrowers, that may tend to show that a reasonable person in defendant's position would believe that the program was not an abusive tax shelter." Id. at *5.
As a general rule, a taxpayer's reliance on an erroneous IRS administrative ruling is no defense to the payment of a lawful tax. See Vons Companies, Inc. v. United States, 51 Fed.Cl. 1, 6-7 (2001), citing Dixon v. United States, 381 U.S. 68, 72-73, 85 S.Ct. 1301, 14 L.Ed.2d 223 (1965). The "safe haven" provision of § 530 of the Revenue Act of 1978, however, provides an exception to this rule as it relates to the employment status of individuals for whom employment taxes may be owed.
Section 530(a)(1) states as follows:
Section 530(a)(2) sets forth statutory standards "providing one method of satisfying the requirements of paragraph (1)." It states:
Section 530 "was designed to relieve employers of the burden of surprise or uncertain imposition of retroactive tax liability resulting from an increase in IRS employment-status audits." General Investment Corp. v. United States, 823 F.2d 337, 339 (9th Cir.1987).
In support of the relevancy of their discovery requests, plaintiffs state that "to demonstrate, in part, [their] entitlement to relief under Section 530 [plaintiffs] will present evidence that there was a recognized
Subsection 530(a)(2)(c) requires the taxpayer to prove two elements. First, the taxpayer must prove that there was, in fact, a long-standing recognized practice in a significant segment of the industry. Second, the taxpayer must prove that he relied on this practice in the tax treatment of his or her workers. The court in General Investment Corp. held that the plaintiff satisfied its burden by presenting testimony by its principal officer and another mine operator that mining companies in the county treated their mine workers as independent contractors. 823 F.2d at 340-41. In Springfield, the plaintiff met his burden by presenting undisputed testimony by himself and by salesmen that independent used car dealers in the county treated their salesmen as independent contractors. 88 F.3d at 753-54. See also 303 West 42nd St. Enterprises, Inc. v. Internal Revenue Service, 181 F.3d 272, 277 (2nd Cir.1999) (holding that taxpayer's survey of its particular industry regarding the tax treatment of the same type of worker may be sufficient to establish the practice of a significant segment of the industry). Statements made by IRS officers or employees to business operators/taxpayers recognizing the existence of the practice in the industry are also relevant and may be admissible to prove the existence of the practice. The Government is therefore not entitled to a protective order in regard to discovery of any such statements.
The taxpayer can also establish reasonable reliance based on judicial precedent, published rulings, technical advice with respect to the taxpayer, a letter ruling to the taxpayer or a past IRS audit that resulted in a finding or inference that similarly situated workers were not employees for tax purposes. § 530(a)(2)(A) and (B).
The IRS apparently did not issue any technical advice memoranda or private letter rulings to plaintiffs stating that it was proper for them to treat the drywall workers as independent contractors. Nor did the IRS conduct any prior audits of plaintiffs relating to the tax treatment of such workers. Plaintiffs allege, however, that they relied on representations made to them by CDSI that the IRS had approved CDSI's treatment of the drywall workers as independent contractors and that it was proper for the plaintiffs to also treat such workers as independent contractors so long as the same conditions relating to control over the workers were present. In support of this argument, plaintiffs cite a September 6, 1989 letter that an IRS officer sent to the president of CDSI, which stated as follows:
Plaintiffs also cited a purported January 4, 2007 letter from an IRS Revenue Office Examiner.
Plaintiffs argue that this document confirms that as recently as the end of 2006, the IRS recognized CDSI's right, pursuant to § 530, to treat the drywall workers as independent contractors.
Section 530(a)(2) does not provide any express authority for a taxpayer to rely on IRS technical memoranda or private letter rulings issued to other taxpayers. In these actions, however, the plaintiffs contracted with CDSI to provide drywall workers for their construction projects and allegedly relied on its representations that the IRS had approved or confirmed the independent contractor status of the workers. The Court could therefore find, pursuant to § 530, that it was reasonable for plaintiffs to rely on CDSI's representations so long as CDSI had a reasonable basis for making such representations. Technical advice memoranda or private letter rulings issued to CDSI which approved or confirmed the independent contractor status of the workers would provide evidence supporting the reasonableness of CDSI's belief and representations. Likewise, prior IRS audits of CDSI which resulted in no assessments being made based on a finding that the workers were employees could also support the reasonableness of CDSI's belief and representations. Discovery regarding such matters is therefore relevant. On the other hand, the internal memoranda of IRS agents containing their analysis regarding the employment status of the drywall workers is irrelevant so long as the memoranda and/or their contents were not disclosed to CDSI or plaintiffs. If the memoranda discuss communications between the IRS and CDSI (or plaintiffs) regarding the employment status of the workers, however, information regarding such communications are relevant and discoverable.
The Government also argues that pursuant to 26 U.S.C. § 6103(a) it is prohibited from disclosing any return or return information concerning a non-party taxpayer, in these actions CDSI. (# 30 and # 29). As the Government notes, however, § 6103 contains several exceptions, including an exception which permits disclosure to a person authorized by the taxpayer to receive such information. CDSI is a defunct corporation. Plaintiffs have attached to their response an authorization by CDSI's former president, Edwin Braithwaite, authorizing the release of return information to plaintiffs for purposes of this lawsuit. The Government appears to accept, or at least does not strenuously dispute, the validity of this authorization pursuant to 26 U.S.C.
Based on the foregoing, the Court concludes that discovery into the internal analysis, impressions or conclusions of IRS employees or officers relating to plaintiffs' or CDSI's potential liability for the employment taxes at issue is irrelevant. The Government is therefore entitled to a protective order against plaintiffs' efforts to discover such information, whether it be through depositions of IRS personnel, interrogatories or requests for production. Plaintiffs are not precluded, however, from discovering statements made by the IRS to CDSI and/or plaintiffs regarding the employment status of the drywall workers, regardless of whether such statements were made in the form of technical advice memoranda, private letter rulings or other forms of communication. Plaintiffs are also not precluded from discovering relevant information regarding prior IRS audits of CDSI which resulted in determinations relevant to the drywall workers' status as independent contractors or employees, and upon which CDSI may have relied in allegedly representing to plaintiffs that the workers were independent contractors.
Accordingly, and for good cause shown,
IT IS ORDERED that Defendant/Counterclaimant United States' Motion for Protective Order (# 30) in Case No. 2:10-cv-00495-GMN-VCF and Motion for Protective Order (# 29) in Case No. 2:10-cv-00497-LRH-VCF are GRANTED in accordance with and subject to the limitations set forth in this order.
