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Bodensee Fund, LLC v. U.S. Dep't of the Treasury

September 30, 2008


The opinion of the court was delivered by: Bongiovanni, Magistrate Judge



Petitioners, Bodensee Fund, LLC ("Bodensee") and Queen Trading, LLC ("Queen"), filed a petition with this Court on July 11, 2007 to quash third-party summonses that Respondent, the United States of America, Department of the Treasury, Internal Revenue Service ("IRS"), issued to Frank Koretsky ("Koretsky"). In response, on February 21, 2008, the IRS opposed Petitioners' petition to quash and moved for summary enforcement of its summonses. After considering each party's arguments, the Court finds that Petitioners' request should be denied, and that the IRS's Motion to Enforce its summonses should be granted.

I. Background

Bodensee and Queen are limited liability companies that are registered in Illinois but conduct their consumer debt collection business primarily in Brazil. Both companies elected partnership status with the IRS for tax-filing purposes, and file income and expense information on IRS Form 1065. As a result, each company's income or loss flows to its partners as a percentage of each partner's ownership. The income or loss is factored into the partner's taxable liability. Koretsky indirectly owns 48.51% of Bodensee, and 48.01% of Queen.

The IRS, under the supervision of Agent Larry Weinger ("Agent Weinger"), has been investigating the tax-return filings by Bodensee for the year ending December 31, 2004, and tax filings by Queen for the years ending December 31, 2003 and December 31, 2004. The IRS has also been investigating the tax return filings of Koretsky because the correctness of Petitioners' tax returns affects the correctness of Koretsky's returns.

Specifically, the IRS investigations focused on financial transactions by Petitioners characterized as Distressed Asset and Debt ("DAD") tax shelters. Under a DAD tax shelter, U.S. companies doing business in foreign countries purchase high-basis, low-value consumer debt from foreign entities for a small percentage of the debt's face value. The U.S. companies -- either directly or through various intermediary entities -- "write-down" the debt by using the high-basis rather than electing to adjust the actual value pursuant to 26 U.S.C. §754. With a high-cost basis and low-value, the transaction provides the partnership with a steep loss that reduces each partner's federal income tax liability. The IRS estimates that U.S. taxpayers used DAD tax shelters to claim losses of $39,000,000 in 2003 and $119,000,000 in 2004. The current action before the Court represents one of more than a dozen similar petitions to quash IRS-issued summonses in connection with DAD shelters.

The IRS published a Coordinated Issue Paper ("CIP") on April 18, 2007 discussing DAD tax shelters and the IRS's authority to disallow certain losses that taxpayers claim from DAD transactions. Several grounds for disallowance addressed in the CIP that Agent Weinger referred to in his January 16, 2008 deposition include failure to comply with, or abuse of, certain portions of the Internal Revenue Code ("IRC"), and incompatibility with judicial doctrines like step-transaction, lack of economic substance, substance over form, and lack of profit motive.

On June 21, 2007, Agent Weinger and his team issued two summonses to Koretsky to give testimony and produce documents related to his investment in Bodensee and Queen. Agent Weinger testified that he believed Koretsky possessed the summoned information given Koretsky's investment in Bodensee and Queen.

II. Discussion

In order to enforce its summonses, the IRS has the initial burden to demonstrate that the summonses were issued in good faith by making a prima facie showing: (1) that the investigation will be conducted pursuant to a legitimate purpose; (2) that the inquiry may be relevant to the purpose; (3) that the information sought is not already within its possession; and (4) that the administrative steps required by the Internal Revenue Code have been followed. United States v. Powell, 379 U.S. 48, 57-58 (1964). The IRS's burden is slight, it only needs to make a minimal showing to establish its prima facie case. Liberty Fin. Services v. United States, 778 F.2d 1390, 1392 (9th Cir. 1985). Generally, the IRS makes this showing through the deposition testimony of its agent who issued the summonses. United States v. Garden State Nat'l Bank, 607 F.2d 61, 68 (3d Cir. 1979). Here, the IRS relies on Agent Weinger's deposition.

Once the IRS makes its prima facie case, the burden shifts to Petitioners to demonstrate that the IRS did not issue the summonses in question in good faith and that enforcement would constitute an abuse of process by the Court. Powell, 379 U.S. at 58. Despite Petitioners claims to the contrary, Petitioners, in order to overcome the IRS' prima facie case, are not simply required to make "a short and plain statement" showing that they are "entitled to relief" pursuant to FED.R.CIV.P. 8(a)(2). Petitioners' reliance on Rule 8 is misplaced because it ignores the fact that Rule 8 does not govern this matter; instead, Powell and the progeny of cases that follow do. Consequently, Petitioners, unlike the IRS, bear a heavy burden in establishing that the IRS summonses were not issued in good faith. See Liberty Financial, 778 F.2d at1392. For the reasons explained below, Petitioners fail to carry their heavy burden. Petitioners, similarly fail to establish that the summonses at issue are unconstitutional.

A. Legitimate Purpose

The IRS is authorized to issue summonses to verify the accuracy of any tax return, and the taxable liability of any taxpayer. 26 U.S.C. §7602(a). Agent Weinger testified that the purpose of the summonses issued to Koretsky was to examine the correctness of tax returns filed by Bodensee, Queen, and Koretsky, as well as their involvement in DAD tax shelters. Agent Weinger's testimony establishes a legitimate purpose for the IRS's investigation. Thus, the IRS has carried its burden with respect to the first element of the Powell test.

Petitioners attempt to rebut the IRS's argument and claim that the IRS's investigation was not conducted in accordance with a legitimate purpose, and that the IRS knew Petitioners' DAD transactions were not "abusive tax shelters." Specifically, Petitioners argue that the IRS's purpose in issuing the summonses was to harass Petitioners, to use the summonses as a pre-litigation discovery tool, and to extend the statute of limitations. Each of these arguments is addressed in turn.


In order to succeed on their argument that the IRS' purpose in issuing the summonses at issue was to harass, Petitioners must demonstrate that the IRS maintained an institutional posture of harassment towards them. Arlington Heights v. I.R.S., 109 F.3d 1221, 1226 (7th Cir. 1997). The conduct of individual agents is controlling insofar as it establishes an institutional posture of harassment. Id. at 1226.

Petitioners first argue that the IRS harassed them by offering to settle with individual investors, then threatening penalties in the event that the individuals refused. Agent Weinger acknowledged that the IRS extended such settlement proposals to investors. Petitioners, however, provide no evidence that the IRS, in fact, made any threats upon any who refused to settle. Furthermore, Petitioners fail to establish standing on matters that involve potential settlements with third-parties.

Next, Petitioners claim that IRS Agent Ray Tabor ("Agent Tabor") threatened Petitioners' attorney, Sweta Shah ("Shah"), with disciplinary action for failing to timely comply with the IRS's Information Document Requests during a November 2006 telephone discussion. Petitioners argue that Agent Weinger admitted in his deposition that the IRS made the aforementioned threat to Shah. In fact, Agent Weinger testified that the IRS made no threat. Instead, Agent Weinger explained that the IRS audit team told Shah that her repeated failure to comply with the IRS's ...

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