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Practitioners have been grumbling for some time about the often quirky way in which the IRS administers its determination letter program, but it's not often that the IRS gets called to the carpet by a federal district court judge for “extortionary, deplorable, and wrong” behavior. A clearly incensed Judge Rodney S. Webb of Arkansas railed against the IRS and two of its agents in the recent case of Jewell v. U.S., 2007-2 USTC. ¶50,838 (E.D. Ark 2007), setting aside a closing agreement and ordering the government to refund a penalty of nearly $9,000 that the plaintiff Barry J. Jewell had paid.

Most of the underlying facts in the case are unremarkable. Jewell's former law firm served as a plan sponsor of four prototype plan documents, which it provided to its clients. Following the series of legislative amendments to the tax code known colloquially as the GUST amendments, Jewell began the process of amending the prototype plans and adoption agreements. Updated plans were filed for approval by the IRS within the remedial amendment period, but the IRS later found errors and asked Jewell to make corrections. Jewell made corrections and re-filed the plan document.

Perhaps betraying his concern about the timeliness of the prototype plan amendments, Jewell took the step of filing for an individual determination letter for each of his firm's clients, which the IRS granted. Rather than leaving well enough alone, after receiving the favorable individual determination letters, the law firm updated the prototype plan accordingly and resubmitted an adoption agreement for approval. The resubmission apparently piqued the curiosity of the two IRS agents, who began reviewing each of the individually filed plans.

Although Jewell resisted the agents' assertion that the resubmission of the prototype plan “proves” that the earlier filed plans were late amenders, he consented to negotiating an umbrella closing agreement. The negotiation was complicated by the simultaneous dissolution of Jewell's law firm, and the subsequent revocation of Jewell's authority to negotiate with the IRS. Instead, Jewell's former partners finalized a closing agreement which required Jewell to pay the nearly $9,000 penalty.

Here is where the agents overstepped. In order to coerce him to sign on to the agreement and pay his share of the penalty, Jewell alleged that the IRS agents threatened to walk away from the closing agreement, exposing Jewell to law suits from his former partners and making Jewell's clients targets of individual investigations. These threats--which the agents delivered to Jewell in writing--amounted to a Hobson's choice, the court said: either he would have to accept the closing agreement and pay a penalty or subject his clients to the “harsh consequences of disqualification, penalty, or both.” As an attorney, Jewell “had an ethical obligation to …accept the closing agreement and pay a penalty, whether rightfully deserved or not. The lack of any true options took away any negotiation position Jewell and [his law firm] may have had. This conduct is extortionary, deplorable, and wrong,” the court said.

Jewell's victory against the IRS must have been a bright spot in an otherwise stormy year in which he was the target of a criminal investigation that led to his indictment by a federal grand jury for unrelated charges of conspiracy to defraud the U.S., three counts of money laundering, and one count of income tax evasion. Jewell and his former law firm partner Bobby Keith Moser were also at the time being sued by a former client for legal malpractice.

For more information, in the Tax Management Portfolios, see Ireland, 360 T.M., Qualified Plans -- IRS Determination Letter Procedures, and in Tax Practice Series, see ¶5540, Obtaining IRS Approval for Qualified Plans.