In Uncategorized on 04/07/2011 at 13:01

Tax Court Tells IRS

That’s the takeaway from Agripina D. Smith and James F. Smith, Jr., 2011 T.C. Memo. 82, filed 4/6/11. Agripina was a member of the Tribal Council of the Nooksack Indian Tribe of Washington State during the years in question, a paid position.

Most of Judge Morrison’s decision deals with what portion of Agripina’s pay as Councilmember is exempt pursuant to Section 7873. That section exempts income derived from fishing-rights related activities by Indians.

Judge Morrison finds Agripina provided insufficient substantiation of what activities she (and her fellow Councilmembers whose petitions are consolidated for trial) performed, and no evidence specifically distinguishing between fishing and non-fishing activities. In a typographical error in her petition, Agripina claimed all her activities were fishy (see T.C. Mem. 2011-82, footnote 7 at pp.13- 14; Judge Morrison kindly corrects the error).

In Judge Morrison’s words: “The exact nature of the work of the Nooksack tribal council on salmon fishing issues is unclear in the record, as is the magnitude of the work in  comparison to the council’s other activities. The trial record does not even contain the minutes of the meetings of the council. The only concrete piece of relevant evidence is that the tribe spent 11.9 percent, 10.9 percent, and 9.7 percent of its budget on fishing expenses….”

IRS allocated the Tribe’s percentages to Councilmembers’  exempt income, and issued a deficiency as to the balance. This Tax Court sustains.

That’s all very well, and no doubt interesting to specialists in “Indians not taxed” taxation.

Now for the rest of us. IRS claimed the Councilmembers were liable for self-employment tax on the non-exempt Tribal Council compensation. The Councilmembers never reported the income, so a fortiori they never filed 1040-SEs or paid SE tax.

But IRS never claimed that Agripina owed SE tax in the deficiency notice, nor yet in the answer to the petition. IRS first raised the issue in IRS’ pretrial memorandum.

No fair.

Judge Morrison thus rebukes IRS:  “The belatedness with which the IRS raised the issue of self-employment liability for the tribal-council compensation is a violation of Rule 31(a), which provides that the answer and other pleadings should give the other party fair notice of the matters in controversy. In Stewart v. Commissioner, 714 F.2d 977, 986 (9th Cir. 1983), affg. T.C. Memo. 1982-209, the Court of Appeals for the Ninth Circuit explained that the most appropriate times for the IRS to raise the legal theories on which it intends to rely are in the deficiency notice and in the answer. The failure of the IRS to raise a legal theory at these times does not cause the IRS to forfeit its right to rely on the theory if the taxpayer is not surprised and disadvantaged by the delay in raising the theory. Id. at 986-987. The petitioners would suffer prejudice from the belated raising of the issue of self-employment tax liability stemming from the tribal-council compensation. The issue does not hinge on the same factual questions as does petitioners’ liability for income taxes stemming from the tribal-council compensation. Therefore the IRS is barred from raising the issue.” T.C. Mem. 2011-82, at pp.20-21.

So, IRS, when you go on the warpath, don’t ambush the taxpayer–whether or not the taxpayer is an Indian.

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