Arthur H. Shealy
Attorney at Law
325 Georgia Avenue
North Augusta, SC 29841
February 1, 1999
HON. SENATOR ABCDEF
c/o MR. GHIJKL
RUSSELL SENATE OFFICE BUILDING
WASHINGTON, D.C. 20510
RE: PARTNERS IN HOYT CATTLE RAISING TAX SHELTER
Thank you very much for your December 7, 1998, letter that
transmits the Internal Revenue Service's response to my clients' concerns. I do appreciate
your assistance in extracting a response from the IRS. My letter today is to address
certain points in the IRS response and to further request your help in persuading the IRS
to undertake an independent review of the Hoyt Tax Shelter Project, removing it from the
jurisdiction of the Sacramento Appeals Office. One of the reasons for this mountainous
problem is mishandling by the Sacramento Office management.
Ex Parte Contacts Between Exam and Appeals
Specifically management assigned at least one IRS
employee, R. M. Spooner, Associate Chief of the Sacramento Appeals Office to negotiate and
sign the May 20, 1993 Memorandum of Understanding that gave rise to the taxpayers'
liabilities for the years before 1987. He and the Sacramento appeals office is now
assigned the task of reviewing appeals regarding this Memorandum of Understanding.(1) Because of
similar conduct, Congress recognized the importance of ensuring an independent Appeals
Office and enacted a restriction against this practice in The IRS Restructuring and Reform
Act of 1998. Specifically, the Act included a provision that provides:
(a) IN GENERAL. - The Commissioner of Internal Revenue shall
develop and implement a plan to reorganize the Internal Revenue Service. The plan shall -
(4) ensure an independent appeals function within the Internal
Revenue Service, including the prohibition in the plan of ex parte communication between
appeals officers and other Internal Revenue Service employees to the extent that such
communications appear to compromise the independence of the appeals officers.
H.R. 2676, Internal Revenue Service Restructuring and Reform Act
of 1998, Pub. L. 105-206, § 1001 (a)
My clients and I believe that over the years the
Sacramento Appeals Office has effectively become part of the examination team and that it
is impossible for the individual investors to receive an impartial review from that
office. We request that jurisdiction of the matter be handled in the National Office by
individuals capable of negotiating a global settlement, at least somewhere besides
IRS Knowledge of Tax Matters Partner
Conflict of Interest
As mentioned, my clients' tax bills for the 1981 through
1986 years stem from a Memorandum of Understanding ("MOU") between Jay Hoyt and
the IRS, signed on May 20, 1993. Jay Hoyt personally negotiated this settlement and was
not represented by counsel during the negotiations. The Sacramento Appeals Office actively
participated in the negotiation of this MOU.
While the IRS negotiated this MOU, it was investigating
Jay Hoyt for criminal violation of US income tax laws and knew he had a conflict interest
with the other partners. Hoyt's concessions in the MOU resulted in huge tax liabilities
for the individual partners; but, absolved Jay Hoyt and his family, including Jay Hoyt's
wife, from large tax liabilities. By Jay Hoyt's actions, the investor partnerships
conceded huge interest payments made to an entity owned by the Hoyt family, Hoyt &
Sons Ranches ("Ranches"). These interest payments apparently had not been
included in Ranches' income. Thus, while the MOU created huge tax liabilities for the
individual partners, the Hoyt family's tax liability was actually significantly reduced.
At the time Jay Hoyt signed the MOU, he was under
investigation for tax return preparer penalties. He had also been under criminal
investigation between the periods 1983 through 1987 and again from October/November 1989
to November 1991. There is also evidence that the Criminal Investigation Division was
working with the Postal Inspector when it "raided" the Hoyt business offices in
1995. It is unclear if the IRS ever stopped its criminal investigation of Jay Hoyt.
He was never notified that the criminal investigation had been terminated. In spite of
these severe conflict of interests, the IRS, including the Sacramento Appeals Office,
continued to negotiate with Mr. Hoyt, as the representative of the partnerships. This is
true even though the IRS had the ability and the duty to remove Jay Hoyt, due to the
criminal investigation, pursuant to Treas. Reg. § 301.6231(c)-5T.(2)
This issue is the crux of the problem. Hornbook agency and
partnership law have long held that when a third party knows that a partner has a conflict
of interest with the partnership in a matter, that third party cannot rely on the words,
actions, or signature of the conflicted partner to bind the partnership to any agreement
regarding that matter. The Second Circuit Court of appeals applied this basic rule of
agency and partnership law in TRANSPAC DRILLING
VENTURE 1982-12, et al., v. COMMISSIONER OF INTERNAL REVENUE, 98 TNT 130-6, 82 AFTR2d
Par. 98-5016 (2nd Cir. 1998). The Transpac Court refused to allow a partner
under criminal investigation to bind the other partners to concessions to the IRS. The IRS
could have easily prevented years of litigation, astronomical amounts of penalties and
interest, and the swindling of hundreds of innocent investors(3)
merely by recognizing this basic rule to remove Jay Hoyt as Tax Matters Partner.
IRS Bad Faith
In approximately 1992, interested partners organized a
group ("Settlement Committee") to participate in settlement negotiations. Prior
to the 1993 settlement between Jay Hoyt and the IRS, the Settlement Committee attempted to
negotiate a settlement with the IRS. During these negotiations with the Settlement
Committee, the IRS, through Appeals Officer William E. McDevitt, improperly required that
Jay Hoyt make personal concessions before the IRS would make "greater
concessions" to the individual partners. These concessions included Jay Hoyt
conceding the tax return preparer penalty, a penalty that reflected Jay Hoyt's personal
actions and was not related to the substantive tax liabilities of the individual partners.
On July 24, 1992, the Settlement Committee obtained a
Letter of Intent from Jay Hoyt wherein Hoyt agreed to sign any settlement reached between
the IRS and the Settlement Committee. Specifically, the Letter of Intent from Jay Hoyt
stated that he agreed to the IRS conditions.
The Settlement Committee met numerous times with the IRS
and believed it had reached a tentative basis for settlement with the IRS. This tentative
basis for settlement was a global settlement and would have ended the Hoyt litigation for
all matters. When the Settlement Committee arrived at what they believed to be the
decisive meeting concerning this global settlement, the members found out that the chief
IRS negotiator was retiring that day. No meeting took place.
The Settlement Committee met at least one more time with
the IRS and that was with Mr. Cantalupo, the then head of Appeals for the Western Region.
At that meeting, the Settlement Committee presented Mr. Cantalupo with the Letter of
Intent. While the IRS professed interest in continuing negotiations with the Settlement
Committee, the Committee received no significant communications from the IRS concerning
settlement after the Cantalupo meeting. The Committee also never received any statement
from the IRS rejecting the proposed global settlement. Inconceivably, the Sacramento
Appeals Office instead entered into the MOU with Jay Hoyt.
November 28, 1998 Cover Letter
In this letter Mr. Wilson states that although the IRS is
mandated by Congress to take appropriate action against the promoters of abusive tax
shelters, section 6103 of the internal revenue code protects the results of such actions
from disclosure. This statement is irrelevant and misleading in this case. The IRS never
took any action to stop Jay Hoyt as a promoter of an abusive tax shelter. In fact, its
concerns regarding disclosure never stopped the IRS from disclosing to the negotiating
investor groups precisely what concessions the IRS would require from Jay Hoyt. No
disclosure limitation, all of which the IRS ignored, prevented the IRS from undertaking
action to stop Jay Hoyt as a promoter of an abusive tax shelter. The IRS's citation of
these disclosure limitations is merely an attempt to absolve itself of its own mishandling
of this matter.
General Information Regarding Hoyt
First, the IRS response provided contains misleading or
inaccurate information prepared by the Sacramento Office as follows:
1. IRS Information: "They have also
used this ruling as an approval of the shelter for investment purposes. The Bales ruling
related specifically to investments prior to 1980. In this case, one of the issues before
the court was whether the activity was engaged in for profit. Because the Tax Court found
the partnership to be a bonafide business, the investors claimed they had won the Case.
They failed to recognize that the Tax Court decision also found that deductions and
investment credits were overstated."
Taxpayer Response: These statements are
misleading. In Bales v. Commissioner, T.C. Memo. 1989-568, the Tax Court found:
1. The stated sales price for the cattle was reasonable;
- The financing had economic substance;
- The "benefits and burdens" of ownership passed to
the individual partners;
- The transactions had economic substance;
- The activity was entered into for a profit;
- The debt was bona fide;
- The expenses incurred were ordinary and necessary (i.e.,
- That the investment tax credit was allowed; and
- That I.R.C.§ 6621(c) (tax motivated interest assessment)
was not applicable.
Specifically, the Tax Court did not find that the
deductions and investment tax credits were overstated. The taxpayers won on every
substantive issue in front of the Tax Court. However; after trial, but prior to opinion,
and without the participation, consent, or knowledge of the other individual
investor-partners, Jay Hoyt conceded to the IRS that the individual partners were not
"at risk" on the promissory notes. This concession, not the Tax Court, is what
limited the expenses and deductions that the individual partners could take on their
individual returns. While the Tax Court did not specifically rule on the "at
risk" issue, it did find that these same promissory notes had economic
substance and that the benefits and burdens of ownership passed to the investors. Nothing
in the Tax Court opinion indicates that the IRS would have won the "at risk"
issue, if it had been presented to the Court.
The individual partners rightly perceived that the Bales
Court's opinion was a total victory. The impact of Jay Hoyt's concessions on the Bales
partners' individual returns was absent from the Bales opinion. Most partners did
not know and were not told by Jay Hoyt, that he made any concessions after trial. (Note:
The opinion reflects the judge's analysis of the substantive legal issues and does not
reflect the final adjustments made to the taxpayers account.) However, notwithstanding the
Bales opinion, the IRS continued to treat the Hoyt partners as participants in an
"abusive tax shelter" and offered them a traditional "abusive tax
shelter" settlement. A settlement that would have forced the majority of the partners
into bankruptcy, if they accepted it.
Rather than relying on my evaluation of the case, I
request that you review the actual opinion and then determine whose analysis of the case
is more accurate.
2. IRS Information: "After receipt
of the Pre-filing Notices, some of the partners filed new Forms W-4, Employee's
Withholding Allowance Certificate, which included excessive allowances based on the
partnership deductions and/or credits. These Forms W-4 were filed to purposefully
circumvent the effect of the previously issued Pre-Filing Notices. Therefore, it was
determined that they did not meet the requirements of the Internal Revenue Code (the Code)
Section 3402 and related Employment Tax Regulations. Thus, their employers were directed
to disregard the subsequently filed Forms W-4 and to withhold at the Single rate with
"Although there were no formal or administrative
procedures for appealing the IRS's decision concerning the withholding allowances, the
taxpayers were able to request a redetermination. Upon the taxpayer's request, they were
allowed a reasonable amount of allowances, once proper substantiation was provided."
Response: On the advice of Jay Hoyt, Hoyt
partners did make changes to their Forms W-4. However, the method described and used by
the IRS to correct any allegedly improper W-4s was not in accord with its own IRS Manual
provisions. The Internal Revenue Service Manual §4299 describes the procedures used
concerning "questionable" Forms W-4. The Manual states that a form letter will
be sent to the taxpayer informing the taxpayer that his or her Form W-4 has been selected
for review. The IRS employee reviewing the Form W-4 must contact the taxpayer, interview
the taxpayer, and document the final conclusion using "all the facts and
circumstances that lead up to [the conclusion]."
Instead of following this procedure, the IRS changed the
Hoyt partner Forms W-4, without prior notification to the partners and, apparently,
without even reviewing the taxpayer's income tax returns to determine marital status. The
IRS uniformly changed all the challenged Form W-4s to Single and Zero.
Only when an aggrieved partner contacted the IRS, did the
IRS did redetermine the appropriate allowances, often increasing the allowances. However,
the IRS information implies that the IRS only changed the Forms W-4 once; i.e. - after the
taxpayer had filed a new Form W-4 requesting "excessive allowances." However,
the IRS made many changes to an individual Hoyt partner's Form W-4 and often not in
response to a change made by the Hoyt Partner. For example, the IRS changed exemptions
that it had previously determined to be correct in its "redetermination"
process. The following is an actual example of changes made by the IRS to one couple's
allowances. Documents are available to substantiate this conduct.
The justification provided by the IRS does not explain all
of the above changes to this couple's Forms W-4. It certainly does not explain changing
the wife's W-4 from a very reasonable Married with 1 exemption to single with zero
exemptions. Further, the partners who contacted the IRS about changing their W-4s were
directed to speak with the IRS Sacramento District, where the case was managed by the IRS
and Chief Counsel. These Hoyt partners would then be asked to settle their individual tax
liability. This settlement contact is an inappropriate use of the W-4 program.
3. IRS Information: "Many of the
partners have expressed their anger and frustrations over the continuation of the
partnerships. Although the IRS is mandated by congress to take appropriate action against
the promoters of abusive tax shelters, IRC section 6103 protects the results of such
actions from being disclosed."
Response: The IRS failed to take any
effective action as "mandated by congress." I.R.C. §6103 did not prohibit the
IRS from removing Jay Hoyt as the Tax Matters Partner while he was under criminal
investigation for violating the Internal Revenue laws of the United States. In fact, the
IRS is required to remove Tax Matters Partners that are under criminal
investigation because the "criminal investigation for the violation of the internal
revenue laws relating to income tax will interfere with the effective and efficient
enforcement of the internal revenue laws." Temp. Reg. § 301.6231(c)-5T. Jay Hoyt's
removal would have effectively alerted the partners to many of the problems. It is
unlikely that Jay Hoyt could have continued to sell partnerships interests, if he was
removed as the Tax Matters Partner when the IRS commenced its criminal investigation of
him. A partner, without Jay Hoyt's conflicts, could have easily replaced Jay Hoyt as Tax
matters partner and dealt with the IRS. The partners would have at least had the
opportunity to discover Jay Hoyt's deceptive practices in a timely manner.
I.R.C. § 6103 also did not prohibit the IRS from
enjoining Jay Hoyt from promoting "abusive tax shelters" under I.R.C. § 7408.
The IRS determined that the Hoyt partnerships were "abusive tax shelters" and
used this determination as justification for many of its actions against the individuals.
However, the IRS never attempted to enjoin Jay Hoyt for conduct concerning promoting
abusive tax shelters or for aiding and abetting the understatement of tax as permitted
under I.R.C. 7408 since 1982. An injunction also would have effectively alerted the
individual partners to Jay Hoyt's fraudulent and deceptive activities. At a minimum, it
would have stopped the sale of additional partnerships. The IRS began auditing the Hoyt
partnerships in 1977 (or earlier). However, Jay Hoyt was allowed to continue organizing
and selling partnership from 1977 to 1997. The majority of the individual tax liabilities
would not have even existed, if the IRS had acted as permitted by law.
I urge you to review this matter and to require the IRS
National Taxpayers Advocate Office or the General Accounting Office to investigate the
IRS's conduct. I do appreciate any attention you can devote to my clients. If you have any
questions or if I can assist you in any way, please contact me at the above address or
phone number. Thank you again for your consideration.
ARTHUR H. SHEALY
1. At page eight of this Memorandum of Understanding, Mr. Spooner
blithely recognizes that the partners have potentially suffered a theft loss as a result
of Jay Hoyt's actions; yet, he allows Jay Hoyt to bind all these partners to an agreement
which bankrupts most of them.
2. The IRS is required to remove
Tax Matters Partners that are under criminal investigation because the "criminal
investigation for the violation of the internal revenue laws relating to income tax will
interfere with the effective and efficient enforcement of the internal revenue
laws." Temp. Reg. § 301.6231(c)-5T.
3. Jay Hoyt is currently under
indictment for wire fraud.