Quatloos! > Tax > Tax
Investigation > Xelan
Under Investigation
IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
DAVID A. COHEN et al.
v.
UNITED STATES OF AMERICA
CIVIL ACTION
NO. 03-3234
________________________________________
MEMORANDUM
February 10, 2004
Dalzell, J.
Xélan, The Economic Association of Health Care Professionals, is a
California-based organization that has marketed "tax reduction plans" and
other services to tens of thousands of physicians under the leadership of dentist-cum-financial
guru L. Donald Guess.1 Pursuant to an investigation into the tax liability
of two xélan members, Doctors David and Margaret Cohen, the Internal
Revenue Service has issued summonses directing SEI Private Trust Company of
Oaks, Pennsylvania, to produce documents relating to a disability trust program
with more than $400 million in assets that it administered on xélan's
behalf until September of 2003.2
The Cohens and xélan have filed petitions to quash the summonses, and
the Government has filed an omnibus motion for summary enforcement. For the
reasons provided below, we dismiss the petitions to quash and grant the Government's
motion for enforcement.
Factual and Procedural Background
Petitioner Dr. David A. Cohen is a Florida orthodontist and the sole full-time
employee and shareholder of David Andrew Cohen, DMD, MS, PA. His wife, petitioner
Dr. Margaret Cohen, is a pathologist and employee of Ameripath, Inc. In May
of 1997, xélan prepared a "Tax Reduction Plan" for David Cohen
that promised to lower his federal income taxes from $143,040 to $49,880 per
annum and enable him to achieve a "Critical Capital Mass" of $3,000,000
by diverting as much of his practice's net income as possible into purportedly
tax-free and tax-deferred programs. See Marien Decl. Ex. 1.
Around the time that her husband received his Tax Reduction Plan, Margaret
Cohen successfully lobbied Ameripath for leave to participate in xélan.
According to a document the IRS obtained, she sent Vice President of Human
Resources Stephen Fuller a xélan videotape along with a letter containing
the friendly warning that if the company wanted to attract good pathologists, "strategies
must be developed to lower their tax liability" because "[h]igh income
employees ... will not tolerate the current structure of withholding from their
salary for long." Marien Decl. Ex. 7.
Between January of 1998 and June of 2002, the Cohens accumulated over a million
dollars in xélan-sponsored programs, thereby claiming hundreds of thousands
of dollars in tax savings. David Cohen's professional corporation remitted
about $393,500 in purported premiums to the xélan disability insurance
trust. Cohen did not report these premiums as income, and the corporation fully
deducted them as the qualified cost of purchasing disability insurance for
its employee. Ameripath similarly withheld, pre-tax, some $504,852 from Margaret
Cohen's salary and remitted it to the disability insurance trust. Finally,
David Cohen has claimed charitable deductions for contributions of approximately
$200,000 to the xélan Foundation, which administers "personal public
charity foundations" from which "[d]octors and family members of
doctors may be compensated ... for their own teaching, research, and other
pro-bono work on charitable projects important to them that are approved for
funding by the Board of Directors...." Marien Decl. Ex. 1, at 19.
The Internal Revenue Service is now examining the tax liabilities of the Cohens
and David Cohen's professional corporation for the years 1998 to 2001. Pursuant
to its investigation, the Service has issued summonses directing SEI Private
Trust Company to produce all documents in its possession relating not only
to the Cohens but also to all other participants in the disability trust. The
Cohens and xélan have filed petitions to quash these summonses, arguing
that the IRS is seeking information from SEI in bad faith and that its purpose
is to uncover the identities of other xélan participants without complying
with the procedural requirements for a "John Doe" summons under I.R.C. §7609(f).3
Discussion
The Internal Revenue Code grants the IRS authority to issue administrative
summonses for the production of "books, papers, records, or other data" to
determine the correctness of any return or the tax liability of any person.
I.R.C. §7602(a)(1). The Supreme Court has underscored the breadth of this
power by analogizing it to that of a grand jury, "which does not depend
on a case or controversy for power to get evidence but can investigate merely
on suspicion that the law is being violated, or even just because it wants
assurance that it is not." United States v. Powell, 379 U.S. 48, 57 (1964).
This Court has jurisdiction under I.R.C. §§7402(b) and 7604(a) to
enforce IRS summonses. Our Court of Appeals has observed that "[s]ummons
enforcement proceedings are designed to be summary in nature, and their sole
purpose is to ensure that the IRS has issued the summons for a proper purpose
and in good faith." United States v. Rockwell Int'l, 897 F.2d 1255, 1261
(3d Cir. 1990). In determining whether the summonses are enforceable, we apply
Powell's burden-shifting regime. First, the Government must make a prima facie
showing that (1) the investigation will be conducted pursuant to a legitimate
purpose, (2) the inquiry may be relevant to that purpose, (3) the information
sought is not already within the Commissioner's possession, and (4) the administrative
steps that the Code requires have been followed. Powell, 379 U.S. at 57-58.
The petitioner must then prove either that the Government has not satisfied
one of the elements of its prima facie case or that enforcement of the summons
would be an abuse of the court's process. Id. Although the petitioner need
not conclusively disprove the prima facie case, he must point to serious weaknesses
in the Government's proffer or create a "substantial question in the court's
mind" concerning the Government's purpose. United States v. Gertner, 65
F.3d 963, 967 (1st Cir. 1995).
A. The Government's Prima Facie Case
In support of its prima facie case, the Government has offered the declarations
of Internal Revenue Agent Catherine Johns, who is conducting the Cohen audit,
and Agent John L. Marien, an IRS Technical Advisor who specializes in the improper
uses of employee welfare benefit funds and is assisting Agent Johns in her
investigation. Upon scrutiny of these detailed affidavits, we conclude that
the Government has established a prima facie case for the enforcement of these
summonses.
First, Agents Marien and Johns have declared that the Service is seeking information
from SEI for the legitimate purpose of determining the Cohens' tax liability
and that it can properly proceed under §7602 because there has been no
Justice Department referral. Johns Decl. ¶¶ 3, 9-10; Marien Decl. ¶¶ 37-38.
It is well-settled that an affidavit of the investigating officer is sufficient
to make a prima facie case, and we therefore find that the Government has established
the first prong of its prima facie case under Powell. Gertner, 65 F.3d at 966.
Somewhat more controversially, we find that the IRS has made a prima facie
showing that the examination of SEI's records may be relevant to the Cohen
audit, even though it will reveal the identities of other insureds and the
details of their participation in the trust. Agent Marien's declaration offers
two justifications for such an expansive investigation. In the first place,
he asserts that an examination of all the records in SEI's possession may enable
the IRS to confirm whether the trust is, in fact, a program of insurance. Second,
he declares that even if the Service concludes that the trust indeed qualifies
as insurance, the investigation may assist the IRS in determining whether David
Cohen's corporation was entitled to deduct the full amount of the premiums
it paid on his behalf and whether both Cohens could exclude remittances to
the trust from their taxable incomes.
To grasp both the Government's position and our reasons for concluding that
it has met its burden under the second prong of the Powell test, it is helpful
to begin with a summary of the IRS's current understanding of the disability
trust's structure and operation. According to Agent Marien, xélan touts
the disability trust as a "new approach to disability coverage 'that combines
savings along with the disability coverage component.'" Marien Decl. ¶ 18
(quoting audiotape presentation of Donald Guess). Doctors can contribute any
amount from $4,000 per annum up to their practices' entire net income to the
program, which is administered in the British Virgin Islands by Euro American
Trust and Management Services, Ltd. ("Euro American"). The Service
believes that in the years at issue here, about ninety-six percent of premiums
went into what Dr. Guess has termed "segregated accounts" at SEI,
and much like a 401(k) plan, these funds were placed in a variety of investment
vehicles of the participants' choosing.4 Under the terms of the program, a
vested participant who does not become disabled is eventually entitled to a
refund of premiums, along with the earnings on those premiums that have accrued
on a purportedly tax-deferred basis.
The Service is concerned that the trust may not, in fact, qualify as an insurance
scheme entitling its participants to the tax benefits that the Cohens have
so aggressively claimed. The United States Supreme Court long ago held that
for an arrangement to constitute insurance for federal income tax purposes,
it must shift to the insurance plan the risk that a participant will experience
a loss and distribute each participant's risk of loss among all the participants.
Helvering v. Le Gierse, 312 U.S. 531, 539 (1941).
As Agent Marien has explained, the structure of the trust as well as xélan's
own reports to the Cohens lead the Service to suspect that the trust does not
bear the hallmarks of risk shifting and distribution. The use of "segregated
accounts,'' the ability of participants to direct the investment of their funds,
and xélan's provision of monthly account statements suggest that the
trust is more akin to a savings plan than to a scheme of insurance. See, e.g.,
Marien Decl. Ex. 2 (account statement providing "market value'' of segregated
account as of January 31, 1998). Moreover, xélan's marketing materials
and the individualized reports it has provided the Cohens describe trust funds
as an asset that they can draw on in the future, with nary a reference to the
possibility that xélan may use these funds to pay other participants'
claims. See Marien Decl. ¶ 18 (noting that, in an audiotape presentation,
Dr. Guess describes the refund provision of the trust as an "equity feature");
Marien Decl. Exs. 4 & 5 ("annual updates" for David Cohen describing
funds in disability trust as "qualified plan asset," confirming that
all such assets "are available eventually to satisfy your lifestyle needs," and
advising Cohen to place all surplus income in "various Xélan [sic]
pre-tax savings plans, i.e. ... Disability Equity Trust Plans, Malpractice
Equity Trust Plans, Long Term Care Equity Trust Plans and Family Public Charity/xélan
Foundation Plans").
In addition, the IRS argues that even if the disability trust is actually
providing insurance, its investigation of the SEI records may help it calculate
the limits, if any, on the deductibility and excludability of the hundreds
of thousands of dollars in premiums that the Cohens' employers have paid into
the trust. An employer can deduct contributions to a trust providing employee
welfare benefits under I.R.C. §162, but I.R.C. §419 limits the employer's
deduction to the "qualified cost" of the insurance coverage that
the trust actually purchases on the employee's behalf. In view of the eyebrow-raising
amounts that the Cohens have arranged for their employers to remit to the trust,
it is entirely possible that these premiums are disproportionate to the value
of any insurance benefits the Cohens are deriving from the scheme.
We readily conclude that information in SEI's possession concerning the general
administration of the trust and the Cohens, experience as participants are
subjects relevant to their audit. The more difficult question is whether the
IRS has made a prima facie showing that the wholesale disclosure of other participants,
identities and financial information is relevant here. The Service has offered
two major justifications for this aspect of the investigation contemplated
in the summonses. In the first place, the inquiry will enable the Service to
develop a more complete understanding of how xélan and the other participants
treated their contributions and earnings as well as whether account activity
provides evidence of risk shifting and distribution.5 According to the IRS,
its need to gather more complete information on the trust is particularly pressing
because xélan officials have been less than forthcoming about the operation
of the trust and because the Insurance Company and Euro American are offshore
entities beyond even the long arm of the IRS.6 Second, the IRS asserts that
it may need to contact other participants to verify their age, health, occupation,
and other risk factors in order to determine the qualified cost of the Cohens,
disability insurance. In other words, access to the other participants, identities
and whereabouts would allow the IRS to reconstruct the actuarial underpinnings
of the disability program, an admittedly Herculean step but one that is well
within the IRS's broad investigatory powers.
As our discussion should make apparent, Agent Marien has offered a highly
particularized articulation of the Service's reasons for pursuing the SEI investigation
and how the information it hopes to uncover will shed light on the Cohens'
tax liability. We therefore conclude that the IRS has made a prima facie showing
of relevance. We now turn to consider whether the Service has satisfied the
third and fourth prongs of the Powell test.
Under the third prong, the Service must show that the information sought is
not already within its possession. The IRS satisfies this requirement because
Agents Marien and Johns have declared that the documents and testimony the
IRS seeks from SEI in these summons are not already in the Service's possession.
Johns Decl. ¶ 7; Marien Decl. ¶ 39. Moreover, Agent Marien has amply
substantiated this assertion by detailing the IRS's difficulty in obtaining
information from xélan about the operation of the trust. Id. ¶ 35.
Finally, xélan has impliedly conceded that the IRS lacks complete information
relating to other participants by entering an appearance in these proceedings
and contesting its disclosure.
Fourth, and finally, the IRS must show that it has followed all administrative
steps required under the Internal Revenue Code for the issuance of the summonses.
Agent Johns has so declared, and she has thus established this element of the
Service's prima facie case. Johns Decl. ¶ 8.
B. The Petitioners, Response to the Service's Prima Facie Case
Because the IRS has established a prima facie case for the enforcement of
these summonses, the burden shifts to xélan and the Cohens to prove
either that the Service has not satisfied one of the elements of its prima
facie case or that enforcement of the summons would be an abuse of the court's
process. The petitioners advance a number of arguments against enforcement,
each of which we examine in turn.
First, the petitioners argue that the IRS has failed to show that the identities
of other trust participants are relevant to the Cohen audit because the trust
does not, in fact, employ "segregated accounts", whose fluctuating
value could confirm whether or not the disability plan is a program of insurance
Instead, xélan reports to us, the trust uses employer contributions
to pay premiums on a group insurance policy issued by Doctors Benefit Insurance
Company, participants have no ownership interest in the invested reserves,
and the monthly statements from SEI merely show each participants, pro rata
share of the trust's reserves, which may or may not be refundable depending
on the claims experience of the entire pool of insureds.7 Buck Decl.8 ¶¶ 11-13;
Dunn Decl. ¶¶ 7-10.
This argument fails to address the Service's showing that the disclosure of
other participants' identities may help resolve the qualified cost issue. In
addition, Buck's and Dunn's descriptions of how the trust operates vary so
greatly from the representations in xélan's own reports to the Cohens
that the divergence itself substantiates the IRS's case. As we note above,
both the monthly statements and xélan's annual updates create the impression
that the Cohens' premium contributions are still their assets. While some day
it may turn out that xélan's assurances to this Court concerning the
trust are true, the disjuncture between these representations and the documents
now in the Service's possession underscores both the IRS's interest in developing
a complete understanding of the trust's operation and the relevancy of this
inquiry to the Cohen audit.
Second, the petitioners make the related argument that the SEI summonses are,
in essence, nullities because they call for the production of documents relating
to the Cohens' and other participants' "investments" with SEI, whereas
all the xélan-related funds at SEI were held for and owned by Doctors
Benefit Insurance Company. This argument is too clever by half. The summonses
themselves define the term "investment" as "any funds held by
or for SEI for the benefit of employers or their respective employees as a
result of their relationship with xélan" and related entities.
See, e.g., Johns Decl. Ex. 1 ¶ 14. Such a definition encompasses the funds
that SEI formerly held. Even on the petitioners' version of how the trust operates,
plan participants have a beneficial interest in trust assets, as evidenced
by the refund provision that is such a prominent feature of the disability
program and SEI's production of monthly account statements.
Third, xélan and the Cohens argue that in compelling the production
of documents relating to trust participants other than the Cohens, the IRS
has circumvented the "John Doe" summons procedures of I.R.C. §7609(f)
and is acting in bad faith for the sole purpose of identifying xélan
participants and subjecting them to audits.9 Section 7609(f) requires the IRS
to obtain judicial approval before issuing a summons seeking information relevant
to the tax liability of an unnamed party. However, the Supreme Court has held
that the Service need not comply with §7609(f) where it serves a summons
with the dual purpose of investigating both known and unknown taxpayers, so
long as the information sought may be relevant to a legitimate investigation
of the named parties. Tiffany Fine Arts, Inc. v. United States, 469 U.S. 310,
323-24 (1985).
The petitioners seek to escape the implications of Tiffany Fine Arts by invoking
a line of cases in which courts have refused to enforce IRS summonses that
would have required the disclosure of third parties' identities. In United
States v. Gertner, supra, for example, two lawyers reported to the IRS that
their firm had received sizeable cash payments from a client, but they declined
to disclose the client's name on attorney-client confidentiality grounds. The
IRS then opened an investigation into the law firm's tax liability and issued
summonses for certain records that would have revealed the client's identity.
The district court concluded that the audit of the firm was a pretext for the
anticipated investigation of the client, and it refused to enforce the summonses.
Gertner, 65 F.3d at 965. The Court of Appeals for the First Circuit upheld
the district court, reasoning that the case was distinguishable from Tiffany
Fine Arts because "the IRS did not have an actual interest in the investigation
of the taxpayer (the respondents' law firm), but only in learning more about
John Doe." Id. at 971 (emphasis in original); see also David S. Tedder & Assoc.,
Inc. v. United States, 77 F.3d 1166, 1170 (9th Cir. 1996) (upholding district
court determination, after in camera review of lawyer's bank records that were
subject of summonses, that clients' names were not, per se, relevant to lawyer's
audit).
The difficulty with the petitioners' argument is that in both Gertner and
Tedder the courts found that the clients' identities were not relevant to the
tax liability of their attorneys. Here, by contrast, we have already concluded
that the identities of the Cohens' fellow xélots (to coin a phrase)
are relevant to the IRS's examination of the Cohens, and thus Tiffany Fine
Arts squarely governs this case.10
Fourth, the petitioners claim that the Government has failed to show that
the information sought through these summonses is not already in its possession
because xélan has already provided the IRS with thousands of pages of
documents, including account statements for three hundred other trust participants
and independent (but xélan-commissioned) actuarial studies of the disability
program. However, the fact that the IRS may have already obtained copies of
documents does not prevent it from seeking the originals, and it would defeat
the Service's broad investigative powers were it required to rely on a pot-pourri
of xélan-produced documents to answer the questions that the Cohen audit
has prompted.11 See United States v. Darer, 543 F.2d 996, 1000 (2d Cir. 1976)
("The Service should not be required to rely on the taxpayer's affidavit
that a print-out accurately reproduces all information [requested on tapes
as s]uch a holding would run contrary to the investigatorial purpose of the
audit."); United States v. Administration Co., 1994 WL 240518, at *3 (N.D.
Ill. May 31, 1994) ("That the IRS may have already obtained copies of
documents it seeks from other sources in the tax court case does not prevent
its seeking original documents from the respondents. The IRS is entitled, and
it is a legitimate purpose to summon, original documents so as to check their
consistency and completeness with those obtained elsewhere.").
Fifth, the petitioners claim that the Government has failed to show the relevance
of SEI documents from 2002, a year not under examination in the Cohen audit.
The IRS may use its summons power to seek information regarding a period outside
the scope of an investigation provided it satisfies the relevancy requirement
we have already applied here. Barguero v. United States, 18 F.3d 1311, 1318
(5th Cir. 1994). Here, Agent Marien's declaration establishes that information
from 2002 may help the IRS answer its questions about the operation of the
trust. The Cohens were still participating in the disability program in 2002,
and the petitioners have not even attempted to show that the disability trust
in 2002 underwent a change so radical that documents from that year could not
shed light on its operation in the period under investigation.
Sixth, in a last-ditch effort to stave off the disclosure of other participants'
identities, xélan has stipulated that the SEI account statements will
not evidence risk shifting and distribution. However, this stratagem fails
because, as we have already noted, the other participants' identities are relevant
to the Service's inquiry into the qualified cost issue. Moreover, as the Government
has forcefully argued, there is no authority for the proposition that a taxpayer
(or interested third party such as xélan) can by making such a stipulation
hobble the power of the IRS to draw its own conclusions on a subject relevant
to a taxpayer's liability. The IRS, in short, always has the right to cut the
taxpayer's cards.
Finally, we address the petitioners' request for an evidentiary hearing. Our
Court of Appeals has directed that a hearing is warranted where the taxpayer
has factually refuted material Government allegations or has factually supported
an affirmative defense. United States v. Garden State Nat'l Bank, 607 F.2d
61, 71 (3d Cir. 1979). A review of the petitioners' efforts to show the existence
of disputed factual issues shows that they have not satisfied this standard.
In the first place, they have produced a sizeable body of evidence in support
of their contention that the disability trust program is actuarially sound
and satisfies the definition of insurance. While this evidence is certainly
relevant to the petitioners' underlying dispute with the Service, it does not
call into question the Service's purpose in seeking additional information
or verifying xélan's representations concerning the trust.
The petitioners also point to what they characterize as the IRS's pattern
of "subterfuge, deception and harassment" in its dealings with xélan
to support their request for an evidentiary hearing, as well as restate their
overarching claim that bad faith taints these summonses. Petitioners' Mem.
at 6. According to the petitioners, IRS Agent John Wong stole a list of contributors
to the xélan Foundation during a 2001 examination into the Foundation's
tax-exempt status. The list found its way to IRS agents in Florida, and a number
of xélan participants received notices of examination suspiciously soon
thereafter. The (alleged) treachery of Agent Wong is the subject of a lawsuit
in California and has prompted an internal IRS investigation. Jacquot Decl. ¶ 7-24;
Suverkrubbe Decl., at 4 (noting that the IRS Inspector General for Tax Administration
has commenced an investigation of Agent Wong and that he is currently on administrative
leave).
To substantiate their claim that the Service's conduct demonstrates bad faith
such that enforcement of the summonses would amount to an abuse of process,
the petitioners must show that the IRS, as an institution, issued the summonses
with some illegitimate intent or that particular agents' motives "infected
the institutional posture of the IRS." 2121 Arlington Heights Corp. v.
I.R.S., 109 F.3d 1221, 1226 (7th Cir. 1997), citing United States v. LaSalle
Nat'l Bank, 437 U.S. 298, 316 (1978).
Measured against this exacting standard, the petitioners' allegations regarding
Agent Wong and his colleagues are not grounds for conducting an evidentiary
hearing, much less quashing the summonses at issue here. Even if we assume
that the alleged subterfuge of Wong and the other agents stemmed from their
desire to harass xélan and its members, the fact that the IRS is conducting
its own investigation of this incident belies any claim that these agents'
motive has infected the institutional posture of the Cohen audit.
For all the reasons provided above, we conclude that the petitioners have
not created a substantial question as to the validity of the Government's purpose
in investigating SEI's xélan-related records pursuant to its examination
of the Cohens's tax liability. We will therefore deny the request for an evidentiary
hearing, deny the petitions to quash, and grant the Government's motion for
summary enforcement.12
ORDER
AND NOW, this 10th day of February, 2004, upon consideration of petitioners'
petitions to quash summonses and the Government's omnibus response thereto,
the Government's omnibus motion for summary enforcement and the petitioners'
response thereto, and the parties' supplemental briefs, and in accordance
with the accompanying memorandum, it is hereby ORDERED that:
1. The petitions to quash summonses originally docketed under Civil Action
Nos. 03-3238 and 03-3239 are DENIED;
2. The petition to quash summonses originally docketed under Civil Action
No. 03-3234 is DENIED AS MOOT;
3. The Government's motion for summary enforcement is GRANTED;
4. The Government's request for attorneys' fees is DENIED;
5. SEI Private Trust Company shall COMPLY with the summonses whose enforcement
was challenged in the petitions originally docketed under Civil Action Nos.
03-3238 and 03-3239; and
6. The Clerk of Court shall CLOSE this action statistically.
BY THE COURT:
/s/ Stewart Dalzell, J.
ATTORNEYS
E. David Chanin, 10th Floor, 1515 Market St., Phila,. PA 19102
For Plaintiff
ATTORNEYS
Stuart D. Gibson, U.S. Dept. of Justice, Box 227
Ben Franklin Station, Washington, D.C 20044
For Defendant
________________________________________
1 We note that xélan, which like "e.e. cummings" eschews capitalization,
is a veritable family of corporations and affiliated financial advisors, the
following of which are petitioners in this action: xélan, Inc; xélan
Administrative Services, Inc.; xélan Investment Services, Inc.; xélan
Foundation, Inc.; xélan Annuity Co., Ltd.; xélan, The Economic
Association of Health Professionals, Inc.; Pyramidal Funding Systems, Inc.,
d/b/a xélan Insurance Services; and Jaye and Junck Consulting, Inc.
We can only speculate on the origins of xélan's name, though the presence
of the acute accent reminds one of the word meaning "[a]rdor, impetuousness,
vivacity." See élan def. b, V The Oxford English Dictionary 107
col. 2 (2d ed. 1989). Xélan's website, which is largely "Doctors
Only," sheds no light on this point. See http://www.xélan.com.
2 According to a declaration of Paul Dunn, the President of xélan Investment
Services, Inc., xélan has transferred the accounts whose records are
at issue here to the Vanguard Group. Dunn Decl. ¶ 13.
3 The Cohens and xélan filed three petitions, which were docketed under
Civil Action Nos. 03-3234, 03-3238, and 03-3239. We consolidated them under
Civil Action No. 03-3234. The IRS subsequently withdrew the two summonses that
were the original subject-matter of Civil Action No. 03-3234.
4 Xélan apparently uses the remaining four percent of premiums for
claims and other expenses. Insurance benefits are provided by Doctors Benefit
Insurance Company, Ltd., formerly known as the xélan Disability Insurnace
Company, which the IRS believes is a Barbadian corporation. It is noteworthy
that at the time it briefed this case, the IRS was apparently unaware that
the insurance company had changed its name. See Marien underscore how little
the IRS actually knows about the workings of the xélan disability insurance
program, an issue we address below at greater length.
5 For example, the inquiry may enable the IRS to determine whether xélan
has ever dipped into a participant's "segregated account" to pay
another participant's claim.
6 According to Agent Marien, the IRS deposed Dr. Guess in January of 2003.
At that time, he could not or would not identify the parties who own or control
the xélan Disability Insurance Company, explain the meaning of the term "segregated
accounts," or explain how xélan calculates the purported insurance
premiums. Dr. Guess referred the IRS to one Leslie S. Buck for more information
but said he was unable to provide Buck's address or phone number. Marien Decl. ¶ 33.J.
7 The petitioners have also brought to our attention a 1983 Revenue Ruling
in which the Service concluded that reserve premiums subject to a retrospective
rate refund clause under the malpractice liability policy described in the
Ruling were deductible as business expenses in the year paid. See Rev. Rul.
83-66, 1983-1 C.B. 43. The applicability of this Ruling to the xélan
disability trust is wholly outside the scope of these proceedings.
8 In support of these claims, xélan offers the declaration of none
other than Leslie S. Buck. As we observe above in note 6, the Government has
represented that Dr. Guess was unable to shed any light on Buck's whereabouts
at his deposition in January of 2003, despite the fact that Buck was a high-ranking
officer in several xélan entities from 1987 until his resignation (prompted
by a "routine SEC audit") in April of 2001. Buck Decl. ¶ 7.
We surmise that xélan tracked down its elusive former executive in the
course of responding to the motion for summary enforcement.
9 The petitioners also bolster their bad faith argument by pointing to what
they regard as the perfidy of one Agent John Wong, who allegedly stole materials
from xélan that brought the Cohens within the IRS's cross hairs. We
examine this claim in more detail below.
10 It is appropriate to note here that xélan has offered to bear the
cost of redacting the SEI account statements of other disability trust participants,
and the parties have spilled some ink over whether a district court has the
power to order such redaction in summons enforcement proceedings. Regardless
of the answer to this question, there is no justification for redaction here
because the IRS has shown the relevance of the other participants' identities--or
to be more precise, their actuarial profiles, which the IRS can only conclusively
confirm by contacting these participants in person.
11 Indeed, as we have already noted, the wide-ranging investigation into the
disability program is manifestly relevant to the Cohen audit given the divergences
between xélan's representations to this Court and its own members regarding
the operation of the trust.
12 The Service has sought attorneys' fees from the Cohens and xélan.
As the detail and length of our analysis here has evidenced, we found their
positions to be much more than frivolous taxpayer intransigence. Under the
circumstances, we conclude that fee-shifting is unwarranted.
Financial
Firm Files Chap. 11 Bankruptcy
Xelan's tax shelter draws IRS attention (July 15, 2004)
Judge Backs I.R.S. Effort to Get Tax Shelter Files
NY
Times Article
________________________________
NY Times
Correction: Feb. 14, 2004, Saturday
An article in Business Day yesterday about an effort by the Internal Revenue
Service to obtain the names of buyers of tax shelters referred incorrectly
to a judge's ruling and an I.R.S. summons concerning an investment program
offered by xélan, the Economic Association of Health Professionals Inc.
While both the ruling and the summons questioned the tax benefits of the program,
neither called it fraudulent or illegal.
________________________________
IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
XÉLAN, INC. et al.
v.
UNITED STATES OF AMERICA
CIVIL ACTION
NO. 03-6433
________________________________________
MEMORANDUM
Dalzell, J. May 6, 2004
Petitioner xélan, The Economic Association of Health Care Professionals,
offers physicians the opportunity to make purportedly tax-deductible contributions
to a trust that purchases supplemental malpractice insurance for its participants
from the xélan Insurance Company, which is domiciled in the British
Virgin Islands.
Between 1999 and 2001, petitioners Ronald and Patricia Baughman claimed tax
deductions totalling $290,000 for their contributions to the trust. These deductions
attracted the attention of the Internal Revenue Service, which opened an investigation
into the Baughmans' tax liability for those years. Pursuant to the investigation,
the Service has issued two summonses directing SEI Private Trust Company of
Oaks, Pennsylvania, to produce all documents in its possession concerning the
trust, including records relating to other participants. Xélan and the
Baughmans have filed petitions to quash the summonses, and the Government has
filed a motion for summary enforcement.
This action came to us because it is factually related to Cohen v. United
States, 306 F. Supp.2d 495 (E.D. Pa. 2004), a case involving summonses that
the Service issued to SEI in connection with another xé1an insurance
trust program. In Cohen, we denied the petitions to quash and granted the Government's
motion for summary enforcement.1 After independent review of the record in
this case, and for the reasons set forth at greater length in Cohen, we will
also dismiss the petitions now before us and grant the Government's motion
for summary enforcement.
Discussion
The Internal Revenue Code grants the Service broad authority to issue administrative
summonses for the production of "books, papers, records, or other data" to
determine the correctness of any return or the tax liability of any person.
I.R.C. §7602(a)(1). This Court has jurisdiction under I.R.C. §§7402(b)
and 7604(a) to enforce summonses, and in making this determination, we apply
the burden-shifting regime set forth in United States v. Powell, 379 U.S. 48
(1964).
The Government must first make a prima facie showing that (1) the investigation
will be conducted pursuant to a legitimate purpose, (2) the inquiry may be
relevant to that purpose, (3) the information sought is not already within
the Commissioner's possession, and (4) the administrative steps that the Code
requires have been followed. The petitioner must then prove either that the
Government has not satisfied the elements of its prima facie case or that enforcement
of the summons would be an abuse of the court's process. Id. at 57-58. Although
the petitioner need not conclusively disprove the prima facie case, he must
point to serious weaknesses in the Government's proffer or create a "substantial
question in the court's mind" concerning the Government's purpose. United
States v. Gertner, 65 F.3d 963, 967 (1st Cir. 1995).
A. The Government's Prima Facie Case
In support of its prima facie case, the Government has offered the declarations
of Internal Revenue Agent Catherine Johns, who is conducting the Baughman audit,
and Agent John L. Marien, an IRS Technical Advisor who specializes in the improper
use of employee welfare benefit funds and is assisting Agent Johns.
First, Agent Johns has declared that the Service is seeking information from
SEI for the legitimate purpose of determining the Baughmans' tax liability
and that it can properly proceed under §7602 because there has been no
Justice Department referral. Johns Decl. ¶¶ 3, 10. Agent Johns's
declaration satisfies the first prong of the Government's prima facie case.
See Gertner, 65 F.3d at 966 (an affidavit of the investigating officer suffices
to establish the Service's prima facie case).
We also find that the Service has made a prima facie showing that the examination
of SEI's records may be relevant to the Baughman audit. Agent Marien's declaration
offers two reasons for the sweeping investigation these summonses contemplate.
First, an examination of all the records in SEI's possession may enable the
Service to confirm whether the trust is actually a program of insurance. Second,
even if the Service concludes that the trust qualifies as insurance, the investigation
may assist it in determining whether the Baughmans were entitled to a tax deduction
for the full amount of their contributions.
We begin with the Service's concern that the trust may not qualify as insurance.
For tax purposes, a plan qualifies as insurance if it shifts to itself the
risk that a participant will experience a loss and distributes each participant's
risk of loss among all the participants. In the absence of both of these features,
the plan is merely a savings arrangement whose participants are not entitled
to the Code's generous treatment of insurance premiums. See Helvering v. Le
Gierse, 312 U.S. 531, 539-40 (1941).
As Agent Marien explains, the structure of the malpractice insurance trust
has prompted the Service's suspicion that it does not employ risk shift and
distribution. Xélan allows physicians to pay into the trust "premiums" of
up to forty percent of their net practice income. See Policy, ¶ 16 (Pets.'
Resp. Ex. A). Moreover, the trust will invest up to ninety-four percent of
a participant's contributions in a "segregated account" where, according
to xélan, they can grow on a tax-deferred basis because "they represent
assets inside of an insurance policy and also the reserves necessary to pay
certain claims in the event of your being threatened or sued for malpractice." "Key
Questions and Answers Relating to the xélan Malpractice Equity Trust",
at 3 (Marien Decl. Ex. A). If, in fact, the funds in the Baughmans' "segregated
account" are not available to pay other participants' claims--which is
certainly a fair reading of the above-quoted pamphlet language--then it is
possible that the disability trust is not so much an insurance plan as it is
an IRA-like tax-deferred savings scheme with an extremely generous upper limit
on annual contributions.
Second, Agent Marien has explained that the investigation into SEI's records
may help it calculate the qualified cost of any insurance the trust has actually
provided the Baughmans, which will then enable it to determine whether the
Baughmans were entitled to the deductions they claimed from 1999 to 2001. Marien
Decl. ¶ 8.b; Cohen, 306 F. Supp.2d at 501.
Both of these inquiries are relevant to the Baughman audit and justify a root-and-branch
investigation of the workings of the trust. The more interesting question--and
the question that has prompted xélan to oppose these summonses so strenuously--is
whether the Service has made a prima facie showing that it is entitled to the
disclosure of other trust participants' identities and financial information.
As we explained in Cohen, such information is indeed relevant to the Service's
inquiry. With access to the financial records of other participants, the Service
can develop a complete understanding of how xélan and the other participants
treat their contributions and earnings, determine whether trust accounts provide
evidence of risk shifting and distribution, and calculate the limits (if any)
on the deductibility of contributions to the trust. See id. at 501-02.
Here, as in Cohen, we reject the petitioners' efforts to foreclose this aspect
of the investigation by "conceding" that other participants' account
information will not demonstrate risk shifting and distribution. See Suverkrubbe
Admission and Concession (Pets.' Resp. to Govt.'s Mot. Summary Enforcement).
As we noted in Cohen, not only is x41an's concession unresponsive to the qualified
cost issue, but there is no authority for the proposition that a taxpayer or
other interested party can stipulate to certain facts and thereby preclude
the Service from examining documents and drawing its own conclusions in an
investigation. Id. at 505. Finally, as in Cohen, we cannot endorse the petitioners'
assertion that Agent Marien's declaration is insufficient to support the Service's
assertions concerning the relevance of the investigation. See Cohen v. United
States, No. 03-3234, 2004 WL 792373, at *1 (E.D. Pa. Apr. 9, 2004) (Dalzell,
J.) (on motion to stay, holding that Court may consider Government's arguments
justifying investigation that are reasonable glosses on agent's declaration).
Turning to the third and fourth prongs of the Powell test, we conclude that
the Government has discharged its burden. Agent Johns has declared that the
information the Service seeks from SEI is not already in its possession, and
she has also declared that the Service has followed all administrative steps
required under the Code for the issuance of the summonses. Johns Decl. ¶¶ 6-8.
B. The Petitioners' Response to the Service's Prima Facie Case
Because the Service has established a prima facie case for the enforcement
of these summonses, the burden shifts to xélan and the Baughmans to
prove either that the Service has not satisfied one of the elements of its
prima facie case or that enforcement of the summonses would be an abuse of
the court's process.2
The petitioners first reiterate the argument xélan made in Cohen that
the Service is acting in bad faith for the purpose of obtaining the other participants'
identities and that it should have complied with the "John Doe" summons
procedures of I.R.C. §7609(f). These claims are without merit. Even if
the Service does intend to use the SEI records to investigate the tax liability
of other participants, it is entitled to act for the dual purpose of investigating
both known and unknown taxpayers where, as here, the information it seeks is
relevant to a legitimate investigation of the known parties. Moreover, the
Service is not required to comply with §7609(f) when it serves a summons
with such a dual purpose. Tiffany Fine Arts, Inc. v. United States, 469 U.S.
310, 323-24 (1985).
The petitioners also assert that these summonses must be quashed because the
Service failed to comply with §7609(a)(1), which requires it to give notice
to "any person (other than the person summoned) who is identified in the
summons...." They argue that because the summonses seek information related
to other malpractice trust participants, any participants who are already known
to the Service were entitled to notice.
Even if we assume that the petitioners have standing to assert this argument
and that it is correct as a matter of statutory interpretation, the Service's
lack of compliance with §7609(a)(1) would not be a basis for quashing
the summonses. Where a taxpayer has received every benefit of an administrative
procedure required under the Code, "a failure by the IRS to meet the technical
niceties of the statute will not bar enforcement of the summons." United
States v. Texas Heart Institute, 755 F.2d 469, 478 (5th Cir. 1985), overruled
in part on other grounds by United States v. Barrett, 837 F.2d 1341 (5th Cir.
1988); see also Cook v. United States, 104 F.3d 886, 890 (6th Cir. 1997) ("[T]he
district courts possess discretionary authority to excuse the Service's technical
notice errors where the party in interest suffered no actual prejudice.");
Sylvestre v. United States, 978 F.2d 25, 27 (1st Cir. 1992).
Xélan has vigorously defended the interests of its members in Cohen
and this action, it has filed an appeal in Cohen, and it will surely do so
in this case as well. Under the circumstances, we cannot conclude that any
identified-but-not-notified trust participants could have suffered any prejudice
from the lack of notice, assuming they were entitled to it in the first place.
Conclusion
The Government has established its prima facie case, and the petitioners have
failed to show that enforcement of the summonses would be an abuse of process.
Moreover, for all the reasons provided above, the petitioners have failed to
support their request for an evidentiary hearing by factually refuting material
Government allegations or factually supporting an affirmative defense. United
States v. Garden State Nat'l Bank, 607 F.2d 61, 71, (3d Cir. 1979). We therefore
deny the request for an evidentiary hearing, deny the petitions to quash, and
grant the Government's motion for summary enforcement.
An appropriate Order follows.
ORDER
AND NOW, this 6th day of May, 2004, upon consideration of petitioners' petitions
to quash summonses and the Government's response thereto, the Government's
motion for summary enforcement (docket entry # 4) and the petitioners' response
thereto, and in accordance with the accompanying Memorandum, it is hereby
ORDERED that:
1. The petitions to quash summonses originally docketed under Miscellaneous
Action Nos. 03-216 and 03-217 are DENIED;
2. The Government's motion for summary enforcement is GRANTED;
3. The Government's request for attorneys' fees is DENIED;1
4. SEI Private Trust Company shall COMPLY with the summonses whose enforcement
was challenged in the petitions originally docketed under Miscellaneous Action
Nos. 03-216 and 03-217; and
5. The Clerk of Court shall CLOSE this action statistically.
BY THE COURT:
/s/ Stewart Dalzell, J.
- - - - - - - - - - - - -
1 Our decision in Cohen is now on appeal.
2 We have already discussed the petitioners' arguments that the Government
has failed to establish the relevancy of this investigation and that Agent
Marien's declaration is insufficient to sustain the Government's burden on
this issue.
3 As we explained in United States v. Cohen, 306 F. Supp.2d 495, 506 n.12
(E.D. Pa. 2004), fee-shifting is unwarranted in the xélan litigation
because the petitioners' positions are "much more than frivolous taxpayer
intransigence."
________________________________
Related Documents: