Xlan, Inc. v. United States

Citations: 397 F. Supp. 2d 1111; 96 A.F.T.R.2d (RIA) 5217; 2005 U.S. Dist. LEXIS 18730Docket: No. M-04-83

Court: District Court, S.D. Iowa; February 6, 2005; Federal District Court

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The Court has reviewed and adopted the December 23, 2004 Report and Recommendation by Chief U.S. Magistrate Judge Ross A. Walters concerning a petition to quash an IRS administrative summons. The summons, issued on June 1, 2004, required AmerUs Life Insurance Company to produce documents related to the xélan 419 Welfare Benefit Plan and the identities of its participants, as part of a tax shelter investigation under IRC Sections 6700 and 7408. The petitioners, including xélan, incorporated and its founder Dr. L. Donald Guess, sought to quash the summons. AmerUs, as an intervenor, also requested the quashing of the summons. The Court denied the petitioners' request to quash and granted the government's motion for summary enforcement of the summons. Furthermore, the Court directed the government and AmerUs to confer to address and potentially resolve AmerUs's objections, with a report on their status due by February 28, 2005. The investigation, led by IRS Agent Jay Higgins, is focused on xélan's financial management services marketed to doctors and dentists, which suggest tax avoidance strategies.

Each xélan participant begins with the calculation of their "critical capital mass" (CCM), which is the financial amount necessary for the participant and their spouse, if applicable, to sustain their lifestyle over their expected lifetime. A financial consultant from xélan then develops a plan for the participant to accumulate the CCM through xélan’s deductible savings plans, allowing the participant to use pretax dollars to enhance their net worth until they reach their CCM.

The 419 Program operates under I.R.C. 162, allowing Subchapter C corporations to deduct the full annual costs of life and severance insurance provided through a compliant welfare benefit trust, specifically under I.R.C. 419A(f)(6). These compliant plans are known as "10-or-more-employer" plans, offering substantial tax benefits to participating corporations and their employees. However, if a plan fails to meet the qualifying criteria, those tax benefits are forfeited. Benefits from the 419 Program are funded through life insurance policies from AmerUs.

Higgins is conducting an investigation into xélan, Inc. to determine if it made fraudulent statements regarding the tax benefits of the 419 Program and other xélan offerings, and whether such actions warrant an injunction against xélan. The investigation also seeks to ascertain if the xélan programs qualify as tax shelters under the registration and disclosure requirements of I.R.C. 6111 and 6112, which impose penalties for noncompliance as outlined in I.R.C. 6707 and 6708. 

Higgins has issued an administrative summons to AmerUs for detailed information about the 419 Program and its participants to facilitate the investigation. The IRS can issue such summonses to third-party record keepers to verify tax return accuracy or investigate tax-related offenses, as per I.R.C. 7602. A party notified of a summons can challenge it, prompting the government to demonstrate a prima facie case by establishing a legitimate investigation purpose, relevance of the information sought, absence of existing information, and adherence to proper administrative procedures. If the government meets this burden, the responsibility shifts to the challenging party to contest any element of the prima facie case or argue that enforcing the summons would abuse the court’s process, with the burden of rebuttal being substantial.

Agent Higgins' declaration is presented as the government's prima facie case in a tax shelter compliance investigation of xélan, focusing on whether it is liable for a 6700 penalty and related injunctive relief. The investigation involves the 419 Program and other identified xélan programs under the Internal Revenue Code's registration, disclosure, and reporting requirements. The summons seeks disclosure of all life insurance products issued to xélan members under the 419 Program, related communications between AmerUs and xélan, agreements regarding life insurance products for the program, and documents reflecting the relationship between AmerUs and xélan entities concerning the 419 Program. The IRS only needs to demonstrate that the documents "may be relevant" to its investigation, with the understanding that such information could illuminate aspects of the tax return.

Higgins argues that the life insurance products and associated documents are pertinent to the investigation, as they may reveal information about the 419 Program participants and xélan's promotional conduct regarding tax benefits. Concerns about disclosing participant identities are addressed by explaining that this information is crucial for the IRS to question participants about their interactions with xélan. Additionally, the 419 Program is classified as a "reportable transaction," necessitating a list of all investors. Furthermore, xélan, Inc. and related entities filed for Chapter 11 bankruptcy, and the summons could assist the IRS in pursuing tax and penalty claims within that context.

Higgins confirms that the documents requested are not already in the IRS's possession and that all necessary administrative procedures for the summons have been properly followed, leading the court to conclude that the government has established a prima facie case for enforcing the summons. Xélan does not contest the validity of the investigation but challenges the request for participant identities, which is related to its argument of bad faith. There is no dispute regarding the legality of issuing a third-party summons under I.R.C. 7602(a) and 7609(a) to aid such an investigation.

Xélan does not dispute the relevance of the documents requested by the IRS summons, merely claiming that revealing participants' identities would render the documents irrelevant to the tax shelter investigation. In opposing the motion for summary enforcement, xélan challenges the government's prima facie case, arguing that the IRS has not demonstrated that it lacks the documents in question and that proper administrative procedures were not followed, particularly concerning notice to third parties mentioned in the summons. Xélan asserts that it and its program participants have provided thousands of documents to the IRS, including insurance policies, but this claim does not sufficiently counter the need for further documents sought from AmerUs. The summons requests more than just insurance policies; it seeks comprehensive business records related to AmerUs' dealings with xélan, which xélan contends may not be fully produced by them.

Xélan also claims that the IRS failed to notify all relevant parties mentioned in the summons, as required by I.R.C. 7609(a)(1). However, Agent Higgins states that notice was properly given to those identified by name. Xélan contends that the notice should extend to all participants in the 419 Program, but the Court determined that the IRS's notice to identified individuals sufficed, incorporating this conclusion as part of the report and recommendation.

Additionally, xélan raises issues suggesting bad faith or improper purpose behind the summons: (1) the IRS has presented conflicting justifications for the summons, (2) the true intent is to uncover the identities of other participants rather than assess xélan’s liability for penalties under I.R.C. 6700, (3) a criminal referral exists that might invalidate the summons under I.R.C. 7602(d), and (4) improper actions by IRS Agent John Wong in Florida raise concerns about the IRS's motives.

The IRS is critical of the 419 Program, as evidenced by the Cohen summons issued to AmerUs, aimed at assessing the tax liabilities of a program participant. This current summons is broader and seeks similar documents required in the Cohen case. The 419 Program must comply with I.R.C. 419A(f)(6) for "10-or-more employer" plans to be eligible for tax benefits. However, tax court precedent indicates that plans with experience-relating arrangements differ significantly from those compliant with this provision. The IRS argues that the 419 Program may not meet these requirements, as demonstrated by its previous notices (Notice 95-34 and Notice 2000-15) classifying such arrangements as tax shelters subject to specific tax code requirements. Xélan challenges the IRS's inconsistent stance: whether it is still investigating the program's merits or has already concluded that it is an unacceptable tax shelter. The IRS's conflicting claims reflect a complex stance rather than a straightforward determination.

The IRS is authorized to conduct simultaneous investigations into the legitimacy of the 419 Program as a welfare benefit plan and the conduct related to its sale that may incur penalties under I.R.C. 6700 and 7408. The request for documents from AmerUs does not imply bad faith or improper purpose, even if the investigations are related. Xélan argues that the summons aims to identify other 419 Program participants for tax return examinations, a claim previously made in case No. M-03-83. Although the Court acknowledges that identifying other taxpayers is a motive for the summons, the relevance of the information to Xélan's compliance investigation outweighs this concern. If the summons were solely for identifying participants, it would be irrelevant to the investigation focused on Xélan's marketing practices and statutory compliance. The Court notes that a "John Doe" summons under I.R.C. 7609(f) would be necessary for such an inquiry, but Xélan has not provided evidence to suggest the IRS is circumventing this requirement. Since the information sought is relevant to the legitimate investigation of Xélan, the additional goal of identifying other taxpayers does not invalidate the summons. The Court concludes that Xélan has been notified and has the standing to contest the summons, but cannot object based on the IRS’s dual purpose.

An administrative summons cannot be issued or enforced if there is an active Justice Department referral concerning a person, per I.R.C. 7602(d)(1). Such a referral exists if the IRS has recommended a grand jury investigation or criminal prosecution for tax offenses, or if the Justice Department has requested return information under I.R.C. 6103(h)(3)(B). Agent Higgins declared that there is no Justice Department referral related to xélan, Inc., nor any request for disclosure. Xélan disputes this, referencing a July 2004 grand jury subpoena issued to Vanguard Group, Inc., which sought records pertaining to individuals and entities associated with xélan. Xélan posits that this subpoena indicates an ongoing criminal investigation. However, the IRS maintains that it cannot issue summons if a person is under grand jury investigation for tax crimes, but the existence of the grand jury subpoena does not confirm that xélan, Inc. is targeted or that the investigation concerns tax offenses. Xélan has not received notification of being a target from the U.S. Attorney, and the Court finds that the grand jury subpoena does not contradict Higgins’ declaration, allowing the IRS to issue the summons.

Regarding allegations against Agent Wong for improperly acquiring a donor list, the Court concludes that these allegations do not affect the legitimacy of the summons. Xélan requests an evidentiary hearing if the motion for summary enforcement is not denied, but fails to specify disputed factual issues warranting such a hearing. According to the Eighth Circuit, an evidentiary hearing is only necessary when substantial deficiencies in the summons proceedings are demonstrated. Xélan has not shown such deficiencies, as the issues raised primarily involve legal points that can be resolved with existing facts. The objections from intervener AmerUs remain to be addressed, and if the current recommendations are approved, the government and AmerUs will be instructed to work together to narrow these objections and report back to the Court within 20 days.

Petitioner's request to quash the administrative summons is recommended for denial, while the respondent's motion for summary enforcement of the summons is recommended for approval. Parties have until January 12, 2005, to submit written objections to this recommendation, which must specify the contested portions of the report and provide a basis for the objections; failing to do so may waive the right to appeal factual questions. The case is considered referred for report and recommendation under the implied referral rule due to prior related cases. The parties involved are collectively referred to as "xélan." The court acknowledges ongoing IRS investigations into xélan, noting that any enforcement of a third-party summons may be excepted from automatic bankruptcy stay provisions, as outlined in 11 U.S.C. 362(b)(9)(A). Despite xélan’s late opposition filing, it does not argue the bankruptcy stay's relevance. The petition claims the summons lacks reasonable specificity regarding the required documents and information, a point not addressed in the briefs; however, the court finds the summons adequately specific.