United States v. Titan International, Incorpor

In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 14-3789
UNITED STATES OF AMERICA,
Plaintiff-Appellee,
v.
TITAN INTERNATIONAL, INC.,
Defendant-Appellant.
____________________
Appeal from the United States District Court
for the Central District of Illinois.
No. 14-C-3263 — Richard Mills, Judge.
____________________
ARGUED SEPTEMBER 21, 2015 — DECIDED FEBRUARY 1, 2016
____________________
Before POSNER, WILLIAMS, and SYKES, Circuit Judges.
SYKES, Circuit Judge. In February of 2014, the Internal
Revenue Service issued an administrative summons to Titan
International, Inc., to inspect its 2009 books and records in
connection with an audit of the company’s 2010 tax return.
Titan had taken an operating-loss carryforward in the 2010
tax year for a loss that occurred in 2009. Titan had claimed
this same loss in 2009, and the IRS had already audited the
company’s return for that tax year.
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Titan refused to comply with the 2014 summons because
the IRS had inspected the same records during its audit of
the company’s 2009 return. Titan’s refusal was based on
26 U.S.C. § 7605(b), which provides that “only one inspec-
tion of a taxpayer’s books of account shall be made for each
taxable year unless … the [Treasury] Secretary … notifies the
taxpayer in writing that an additional inspection is neces-
sary.” Because the Secretary had not issued this notice, Titan
asserted that the reinspection of its 2009 records was not
permitted. The district court disagreed and ordered Titan to
comply with the summons.
We affirm. Section 7605(b) applies if the IRS seeks to in-
spect a taxpayer’s records when auditing a tax liability for a
given year when the agency has already inspected the
records in auditing the taxpayer’s liability for that same tax
year. It does not apply when the IRS seeks already-inspected
records for an audit of a different tax year. Because the IRS
summoned the 2009 records in connection with an audit of
Titan’s 2010 return—not its 2009 return—§ 7605(b) imposes
no barrier here.
I. Background
Titan is an Illinois manufacturer of parts for off-road
equipment. In 2010 the IRS audited Titan’s 2009 tax return.
During the course of that audit, the agency summoned
Titan’s 2009 general ledger, its 2009 airplane flight logs, and
other 2009 business travel documents. Titan complied with
that summons, and the audit concluded with a reduction of
No. 14-3789 3
Titan’s claimed net operating loss for that year. 1 Titan ac-
cepted this adjustment to its 2009 tax liability and the audit
was closed.
In 2014 the IRS opened an audit of Titan’s 2010 tax return
and again summoned Titan’s 2009 general ledger, flight logs,
and travel records. This inquiry related to an operating-loss
carryforward Titan had claimed on its 2010 return. Citing
§ 7605(b), Titan refused to comply, asserting that the statute
blocks inspection of already-inspected records unless the
Treasury Secretary makes a finding of necessity and notifies
the taxpayer in writing of that finding. No such notice was
sent before the IRS summoned Titan’s 2009 records for the
2010 audit.
The United States, on behalf of the IRS, filed a petition in
the district court to enforce the summons. The court rejected
Titan’s interpretation of § 7605(b) and ordered it to comply.
II. Discussion
Titan’s appeal raises only a legal question about the
meaning of § 7605(b). Questions of statutory interpretation
are subject to de novo review. Breneisen v. Motorola, Inc.,
656 F.3d 701, 704 (7th Cir. 2011). We begin with the relevant
text of the statute:
1 A net operating loss is a deduction valued as the excess of a business’s
deductions over the business’s income for a given year. A net-operating-
loss deduction earned in one year can be applied to reduce the business’s
tax liability of a later year (i.e., a year in which the business’s income was
greater than its deductions). This is called a net-operating-loss carryfor-
ward.
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No taxpayer shall be subjected to unnecessary
examination or investigations, and only one in-
spection of a taxpayer’s books of account shall be
made for each taxable year unless … the Secre-
tary … notifies the taxpayer in writing that an
additional inspection is necessary.
§ 7605(b) (emphasis added).
Titan argues that the statute limits the IRS to a single in-
spection of a “taxpayer’s books of account” created for a
particular taxable year, unless the Secretary finds a second
inspection “necessary” and sends written notice to that
effect. In other words, Titan reads “for each taxable year” as
modifying “taxpayer’s books of account.” On this interpreta-
tion, Titan’s 2009 records—already inspected during the
audit of its return for tax year 2009—cannot be inspected
again in connection with the audit of its 2010 tax return (or
any subsequent tax-year audit, for that matter) unless the
Secretary first sends written notice of necessity.
Titan’s interpretation is disjointed and curiously omits
some of the language of the statute. The key statutory phrase
is this: “[O]nly one inspection of a taxpayer’s books of
account shall be made for each taxable year.” The more
natural reading of this language limits the IRS to one inspec-
tion of a taxpayer’s books per audit of a given year’s tax
return (subject, of course, to notice and a finding by the
Secretary that a second inspection is necessary). Read in this
more natural way, § 7605(b) does not bar the summons of
Titan’s 2009 records for the purpose of auditing its 2010 tax
return.
No. 14-3789 5
Two cases, one from this court and one from the tax
court, confirm this interpretation of the statute. In Reineman
v. United States, the taxpayers purchased six horses in 1954
for their horse-breeding business. 301 F.2d 267, 268 (7th Cir.
1962). They then deducted the entire cost of the horses on
their 1954 tax return. Id. In 1956 the IRS audited the 1954 tax
return and adjusted that deduction. Id. at 269. Later the IRS
audited the taxpayers’ 1955 tax return; in the process the
agency reopened the 1954 audit (without written notice from
the Secretary) and again adjusted the deduction for the six
horses. Id. at 269–71. The 1954 records inspected by the IRS
to adjust the deduction for the second time were wholly
irrelevant to the 1955 audit. Id. at 271. We concluded that the
second inspection of those records violated § 7605(b) because
it was an “additional inspection” of the taxpayers’ books for
the purpose of reopening the 1954 tax return. Id. at 272.
The second relevant case is Digby v. Commissioner,
103 T.C. 441 (1994). There the IRS audited a married couple’s
1987 tax return and allowed them to claim a pass-through
loss for that year from their S corporation. Id. at 443. In the
course of that audit, the IRS inspected records showing the
couple’s basis in its S corporation stock. See id. at 444. The
IRS later audited their 1988 tax return, a year in which the
couple claimed another pass-through loss from the same
S corporation. Id. To complete this audit, the IRS necessarily
summoned the same basis records it inspected for the 1987
audit; as the tax court explained, the agency was “in posses-
sion of the information necessary to make a [basis] determi-
nation for 1988 and/or 1987.” Id. at 448. Based on these
summoned records, the IRS determined that the couple’s
basis was inadequate to support the pass-through loss for
1988 and 1987, despite its prior 1987 audit. Id. at 445–46. The
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IRS therefore disallowed the pass-through loss for both
years. Id. at 446.
The tax court concluded that the second inspection of the
records was not a violation of § 7605(b) because that inspec-
tion was undertaken for the purpose of examining the 1988
tax return, and—unlike Reineman—those records were
necessary to complete that audit. Id. at 448–49. The court
ruled that an additional adjustment of the tax return for an
earlier taxable year is not a violation of § 7605(b) so long as it
was not coupled with an additional inspection of the taxpay-
er’s books for the purpose of adjusting that year’s tax liabil-
ity. Id.
This case is more like Digby than Reineman. The IRS first
inspected Titan’s 2009 records to verify its net operating loss
in connection with an audit of its 2009 tax return. The IRS
now seeks to inspect those same records for the purpose of
auditing Titan’s 2010 tax return in order to determine the
validity of its 2010 net-operating-loss carryforward. Much
like the pass-through loss at issue in Digby (and unlike the
deduction at issue in Reineman), the net-operating-loss
carryforward on the 2010 tax return cannot be verified
unless the IRS inspects the 2009 records. Accordingly, the
summons for inspection of Titan’s 2009 books and records
for the purpose of auditing its 2010 tax return does not
require written notice and a finding of necessity by the
Secretary under § 7605(b).
AFFIRMED.