Burke v. Commissioner , 105 T.C. 41 ( 1995 )

OPINION

HALPERN, Judge:

This matter is before the Court on the parties’ motions for summary judgment (respondent’s motion and petitioners’ motion, respectively). Both petitioners and respondent have moved for summary adjudication with regard to a question of res judicata. The question is whether the rule of res judicata precludes respondent from litigating an additional deficiency in tax (and additions to tax) on account of petitioners’ alleged fraud. In part because of an agreement between the parties, our granting of either respondent’s or petitioners’ motion will resolve all issues in this case.

Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.

Background

Respondent has set forth certain facts in support of her motion that are undisputed by petitioners. Certain aver-ments in the pleadings also are undisputed. We will accept those undisputed facts and averments as true for purposes of disposing of respondent’s and petitioners’ motions.

General

Petitioners are calendar year taxpayers, who made a joint return of Federal income tax for 1987, the taxable year here in question. Petitioners resided in Brooklyn, New York, at the time the petition was filed.

The First Proceeding

On December 13, 1989, respondent mailed to petitioners a statutory notice of deficiency for 1987 (the first notice of deficiency), in which respondent determined that petitioners had underreported their taxable income by $1,015 and had claimed an erroneous deduction of $20. On March 19, 1990, petitioners timely filed a petition with this Court, contesting the adjustments set forth in the first notice of deficiency (the first proceeding).¹

In a letter to petitioners’ counsel dated September 10, 1990, respondent offered to concede all of the adjustments determined in the first notice of deficiency. Respondent enclosed with that letter a copy of a proposed decision document, which reflected no deficiency in petitioners’ 1987 income tax or additions to tax (the proposed decision document). Respondent requested that the proposed decision document be signed by petitioners’ counsel and returned to respondent for filing with the Court.

In a letter dated November 1, 1990, respondent’s counsel again sent a copy of the proposed decision document to petitioners’ counsel and requested that it be signed and returned to respondent.

In a letter to respondent’s counsel dated November 5, 1990, petitioners’ counsel responded to the “recent correspondence” regarding the proposed decision document. Petitioners’ counsel stated that petitioners understood that a criminal tax fraud referral report (fraud referral report) had been made by one of respondent’s revenue agents and that facts underlying the fraud referral report led the revenue agent to conclude that adjustments should be made to petitioners’ 1987 return. Petitioners’ counsel concluded the letter by stating: “In view of the pending criminal referral, if you still wish to stipulate that these taxpayers owe no additional tax or penalty for 1987 please advise my office.”

In a letter to petitioners’ counsel dated November 15, 1990, respondent’s counsel responded as follows:

In response to your letter of November 5, 1990, please be advised that this office has no knowledge of a fraud referral report being issued for the 1987 tax year of Eugene and Kathleen Burke.

We would ask that you execute the decision document previously sent to you to bring the proceedings in this docketed case to a close.

Petitioners’ counsel did not sign the proposed decision document. Rather, petitioners’ counsel moved for an evi-dentiary hearing. Petitioners’ counsel also caused a subpoena duces tecum (subpoena) to be issued to the revenue agent who was responsible for the alleged fraud referral report. The subpoena was returnable at the proposed evidentiary hearing, which was to take place during a trial session of this Court on February 11, 1991, in Newark, New Jersey. Petitioners’ counsel .asked for the evidentiary hearing in order to establish a record in the first proceeding regarding the existence and status of the alleged fraud investigation of petitioners for 1987. In particular, petitioners’ counsel wanted to preserve evidence that might be used in a later proceeding in the event that respondent issued a second notice of deficiency based on fraud for 1987. Petitioners’ counsel’s request was based upon his understanding of this Court’s opinion in Zackim v. Commissioner, 91 T.C. 1001 (1988), revd. 887 F.2d 455 (3d Cir. 1989).

On February 11, 1991, a hearing (the February 11 hearing) was held on petitioners’ motion for an evidentiary hearing. At the February 11 hearing, respondent both opposed petitioners’ request for the evidentiary hearing and filed a motion to quash the subpoena on the grounds that petitioners’ liability for civil fraud for 1987 was not raised in the first notice of deficiency or in respondent’s answer. Therefore, respondent argued, petitioners’ liability for civil tax fraud was not before the Court. Respondent also requested that the Court enter a final decision document reflecting respondent’s concession of the two adjustments set forth in the first notice of deficiency.

At the February 11 hearing, the presiding Judge informed the parties as follows: (1) Respondent’s motion to quash the subpoena would be granted; (2) petitioners’ motion for an evi-dentiary hearing as to the status of any criminal tax fraud investigation of petitioners would be denied; and (3) a decision reflecting respondent’s concession of the two tax adjustments and reflecting no deficiency or additions to tax due from petitioners for 1987 would be entered.

On May 8, 1991, respondent filed a motion for leave to file an amendment to answer out of time (motion to amend answer). The proposed amendment to answer sought, among other things, to increase the deficiency determined against petitioners for 1987 and to impose certain additions to tax for fraud on virtually all of the increased deficiency. In the proposed amendment, respondent averred that petitioners had failed to report income of $942,189 from Natal Contracting & Building Corp. (Natal).

On May 15, 1991, petitioners filed an objection to respondent’s motion to amend answer.

On May 17, 1991, the Court entered a final order and decision. In that decision the Court denied respondent’s motion to amend answer. The decision was not appealed by either party.

The Second Proceeding

On May 20, 1992, respondent mailed to petitioners a notice of deficiency (second notice of deficiency), in which respondent determined that petitioners did not report on their 1987 joint Federal income tax return $942,189 of income received from Natal and that petitioners’ failure to report that income was attributable to fraud under section 6653(b).

On July 14, 1992, petitioners filed a petition, which is the basis for this case, contesting respondent’s determination as set forth in the second notice of deficiency (the second proceeding). In that petition, petitioners set forth res judicata as an affirmative defense. On February 18, 1994, respondent filed respondent’s motion. On March 22, 1994, petitioners filed petitioners’ motion.

Discussion

I. Summary Judgment

There is no genuine issue as to any material fact. That being the case, the issue presented is purely a matter of law. Accordingly, the issue is ripe for summary adjudication. Rule 121(b).

II. Issue

Under the rule of res judicata, as it applies in the Federal income tax law, a Tax Court decision generally precludes the Commissioner from litigating an additional deficiency of income tax for the same tax year. See Commissioner v. Sunnen, 333 U.S. 591, 598 (1948). The question is whether that aspect of the rule of res judicata, i.e., claim preclusion, applies in this case. The relevant statutory provision is section 6212(c)(1), which, in pertinent part, provides as follows:

General Rule. — If the Secretary has mailed to the taxpayer a notice of deficiency as provided in subsection (a), and the taxpayer files a petition with the Tax Court within the time prescribed in section 6213(a), the Secretary shall have no right to determine any additional deficiency of income tax for the same taxable year, * * * except in the case of fraud, * * *.

Thus, generally, the Commissioner may not issue a second notice of income tax deficiency for the same taxable year; an exception to that rule is provided in the case of fraud. In Zackim v. Commissioner, 91 T.C. 1001 (1988), we held that the fraud exception to the general rule of section 6212(c)(1) does not absolutely bar a defense based on the rule of res judicata. In Zackim, we found that, although the Commissioner had ample opportunity to raise the issue of fraud in the first proceeding, she had not. Id. at 1007. We examined the legislative history of section 6212(c) and concluded that, in that case, the rule of res judicata precluded the Commissioner from litigating, assessing, and collecting an increased deficiency and an addition to tax for fraud. Id. at 1010. The Court of Appeals for the Third Circuit disagreed and reversed our decision. Zackim v. Commissioner, 887 F.2d 455 (3d Cir. 1989).

III. Arguments of the Parties

A. Petitioners’ Arguments

Petitioners’ primary argument is that, regardless of the scope of respondent’s authority under section 6212(c)(1), respondent is barred from issuing the second notice of deficiency here because respondent failed to appeal the denial of the motion to amend answer in the first proceeding. Alternatively, petitioners, citing this Court’s opinion in Zackim v. Commissioner, supra, contend that a second notice of deficiency that is based on fraud-related deficiencies and fraud additions to tax cannot be issued when the deficiency and fraud are discovered before the final decision of the Tax Court involving the same petitioners and same taxable year.

B. Respondent’s Arguments

Respondent’s motion is based on two arguments. First, respondent asks that the Court reconsider its opinion in Zackim v. Commissioner, supra, in light of the Court of Appeals for the Third Circuit’s reversal of the decision in that case. Respondent urges that we overrule our decision in Zackim and hold that claim preclusion does not apply in the case of fraud. Alternatively, respondent argues that, even if the Court does not overrule Zackim, respondent’s motion should be granted because respondent complied with the Zackim opinion by attempting to amend her answer in the first proceeding.

IV. Analysis

A. Failure To Appeal in First Proceeding Does Not Bar Respondent

Respondent did not appeal the denial of the motion to amend answer. That resulted in a final decision. Sec. 7481(a)(1). Thus, petitioners contend that, even if we were to overrule our prior opinion in Zackim v. Commissioner, supra (as respondent has requested), the issues raised in the second notice of deficiency are barred under the rule of res judicata because they were raised and settled in the denial of the motion to amend answer. We think that petitioners misunderstand the role that section 6212(c) plays in determining whether a claim in a second notice of deficiency is barred under the rule of res judicata.

Any claim of res judicata must begin with a determination of the things that were settled and the claims that should have been made in the earlier proceeding. For a discussion of res judicata as it encompasses both issue (collateral estop-pel) and claim preclusion, see 18 Wright et al., Federal Practice and Procedure, sec. 4402 (1981 & Supp. 1988). For a more particularized discussion of claim preclusion, see 18 Wright et al., supra sec. 4407. To determine whether claim preclusion applies, Federal courts in other types of cases will often analyze, for example, whether the allegedly barred claim arose from a “common nucleus of operative facts” that were the basis for the claims asserted in the earlier proceeding. Poe v. John Deere Co., 695 F.2d 1103, 1106 (8th Cir. 1982). To support their first argument, petitioners cite cases in which courts utilize common law principles (such as the “common nucleus of operative facts” test) when determining the claim-preclusive effect of earlier judgments or decisions. See, e.g., Marin v. HEW, Health Care Financing Agency, 769 F.2d 590 (9th Cir. 1985) (same); Poe v. John Deere Co., supra (same); Macris v. Sociedad Maritima San Nicholas, S.A., 271 F.2d 956, 957-958 (2d Cir. 1959) (employing a common law claim preclusion analysis). We have recognized, however, that “In our view * * * [section 6212(c)(1)] authorizes a determination of a deficiency and addition to tax which, except for [that provision], respondent might be barred from asserting under the doctrine of [claim preclusion]”. Breman v. Commissioner, 66 T.C. 61, 70 (1976). In other words, the doctrine of claim preclusion, as it applies to matters which require the issuance of notices of deficiency, has been modified by section 6212(c).² Thus, we must determine the claim-preclusive effect of any decision in an earlier proceeding by reference to section 6212(c). If we conclude that the additional deficiency determined in the second notice of deficiency falls within the fraud exception to claim preclusion that is found in section 6212(c), then the finality of the Court’s decision to deny respondent’s motion to amend the answer does not bar respondent from going forward in this proceeding. Indeed, we implicitly reached the same conclusion in Arthur A. Everts Co. v. Commissioner, a Memorandum Opinion and order of this Court dated August 12, 1949, 8 T.C.M. 707, PH Memo T.C. par. 49,189 (Arthur A. Evers Co.) (1949), when we stated in dictum: “It is true, of course, that if we should deny respondent’s motion to amend his answer and raise the new issues contained in his affirmative allegations, including fraud, he could issue a new deficiency notice as provided under [the predecessor section to section 6212(c)(1)]”. Thus, we turn to the parties’ arguments with respect to the scope of respondent’s authority under section 6212(c)(1).

B. Petitioners’ Reliance on Zackim

Petitioners’ alternative argument is that a failure to grant their motion would constitute an “unwarranted” departure from our holding in Zackim v. Commissioner, 91 T.C. 1001 (1988). Petitioner also asserts that, as to relevant matters, the “present case is factually indistinguishable from Zackim.” As our discussion of respondent’s arguments below will make clear, we disagree with petitioners. We conclude that the circumstances of this case fall within the scope of the fraud exception to section 6212(c)(1). Our holding in Zackim does not bar respondent from pursuing the instant action.

C. Reconsideration of Zackim Is Unnecessary

Respondent has asked us to reconsider our opinion in Zackim v. Commissioner, supra, in light of the Court of Appeals’ reversal of our decision in that case. In particular, respondent “respectfully requests that the Tax Court reconsider its prior opinion and adopt the reasoning of the Third Circuit, i.e., that I.R.C. sec. 6212(c) authorizes respondent to issue an additional notice of deficiency in the case of fraud, regardless of when the fraud is discovered.” In support of that argument, respondent contends that the plain language and the legislative history of section 6212(c) show that respondent has authority to issue and litigate the second notice of deficiency, that the doctrine of claim preclusion is not applicable in this case, and that this Court’s Zackim ruling poses certain practical problems for respondent in terms of compliance.

The nub of our holding in Zackim is that the fraud exception in section 6212(c) is not absolute. 91 T.C. at 1006-1007. The facts before us today are distinguishable from those in Zackim. For that reason, we can decide this case without overruling Zackim.

D. Zackim Is Distinguishable

The circumstances of this case are distinguishable from those present in Zackim v. Commissioner, 91 T.C. 1001 (1988). Simply put, in the first proceeding, by the motion to amend answer, respondent did try to determine an additional deficiency. By denying that motion, we precluded respondent from determining that additional deficiency. In contrast, in Zackim, we said:

Respondent had ample opportunity to raise the [fraud] issue in the prior litigation. The Government did not lack knowledge and had no ground for failing to appreciate the consequences of choosing not to amend respondent’s answer in the earlier litigation. Respondent’s counsel in the prior proceeding was fully aware of respondent’s criminal tax fraud investigation of petitioner for 1978, 1979, and 1980, and of the referral for prosecution to the Department of Justice well before she agreed to settle the Tax Court case for 1979. Respondent could have requested leave to amend his answer to place the additional deficiency and addition to tax for fraud for 1979 in issue. As he typically does, respondent could have requested the Court to stay the civil proceeding pending completion of the criminal investigation and possible trial. Indeed, these are the normal courses of action for respondent in hundreds of Tax Court cases. Instead, respondent chose to ignore the criminal fraud investigation. [Id. at 1007-1008; emphasis added; fn. ref. omitted.]

In support of respondent’s motion, respondent states that the motion to amend answer was an attempt to comply with our decision in Zackim. Petitioners objected to respondent’s motion to amend answer. We will not prohibit respondent from litigating the fraud-related issues raised in the second notice of deficiency, when her attempt to raise those issues in the first proceeding was both objected to by petitioners and denied by the Court.

Based on the foregoing, we agree with respondent that our decision in Zackim v. Commissioner, supra, does not bar respondent from issuing the second notice of deficiency or from litigating, assessing, and collecting the fraud-related deficiency and fraud additions to tax raised in the second notice of deficiency. Zackim is distinguishable.

V. Conclusion

Notwithstanding her previous determination of a deficiency in income tax for a taxable year, section 6212(c)(1) permits respondent to determine an additional deficiency in income tax for the year in the case of fraud. The rule of res judicata does not here bar respondent’s determination of an additional deficiency (and additions to tax) based on fraud in the second notice of deficiency.

For the reasons stated, we will grant respondent’s motion for summary judgment and deny petitioners’ motion for summary judgment.

An appropriate order will be issued.

Reviewed by the Court.

Hamblen, Chabot, Cohen, Ruwe, Whalen, Colvin, and Beghe, JJ., agree with this majority opinion. Jacobs and Chiechi, JJ., concur in the result only.

1 Docket No. 4930-90.

2 Of course, even in cases where common law claim preclusion has not been modified by statute, “Limitations on the jurisdiction or the nature of the [first] proceedings * * * may justify relaxation of the general requirement that all parts of a single claim or cause of action be advanced.” 18 Wright et al., Federal Practice and Procedure, sec. 4412, at 93 (1981).