here - Fuerst Ittleman David & Joseph, PL

Case: 11-1612 Document: 003110561288 Page: 1 Date Filed: 06/13/2011
No. 11-1612
In the United States Court of Appeals
for the Third Circuit
FRANK GANGI,
vs.
UNITED STATES OF AMERICA,
Appellant,
Appellee.
APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE
DISTRICT OF NEW JERSEY, No. 3:10-mc-24-GEB-DEA
HON. G. E. BROWN, JR., PRESIDING
_______________________________________________
BRIEF FOR APPELLANT FRANK GANGI
WITH JOINT APPENDIX VOL. I
_______________________________________________
Joseph A. DiRuzzo, III, Esq., CPA
FUERST ITTLEMAN, PL
1001 Brickell Bay Drive, 32 nd Floor
Miami, FL 33131
305.350.5690 (o)
305.371.8989 (f)
jdiruzzo@fuerstlaw.com
Counsel for Appellant, Frank Gangi
FUERST ITTLEMAN, PL
1001 BRICKELL BAY DRIVE, 32 ND
FLOOR, MIAMI, FL 33131 • T: 305.350.5690 • F: 305.371.8989 • WWW.FUERSTLAW.COM

Case: 11-1612 Document: 003110561288 Page: 2 Date Filed: 06/13/2011
1001 BRICKELL BAY DRIVE, 32 ND
TABLE OF CONTENTS
FUERST ITTLEMAN, PL
PAGE
TABLE OF CONTENTS……………………………………………………….….i
TABLE OF CASES AND AUTHORITIES……………………………………….ii
STATEMENT OF SUBJECT MATTER AND APPELLATE JURISDICTION….1
STATEMENT OF ISSUES PRESENTED FOR REVIEW………………………..2
INTRODUCTION AND STATEMENT OF THE CASE...……………………….2
STATEMENT OF THE FACTS…………………………………………………...5
A. TAX TREATMENT OF USVI RESIDENTS………………………...…6
B. IRS SUMMONSES……………………………………………………....9
C. PROCEEDINGS BELOW……………………………………………...12
STATEMENT OF RELATED CASES AND PROCEEDINGS…………………14
STATEMENT OF THE STANDARD AND SCOPE OF REVIEW……………..16
STATEMENT REGARDING ORAL ARGUMENT…………………………….16
SUMMARY OF ARGUMENT…………………………………………………...16
ARGUMENT
POINT I
THE DISTRICT COURT ERRED IN CONCLUDING THAT THE
ENFORCEMENT OF THE IRS SUMMONSES WOULD NOT RESULT IN AN
ABUSE OF ITS PROCESS….……………………………………………………17
A. UNCONSTITUTIONAL CONDUCT……………………………………..19
B. INSTITUTIONAL BAD FAITH…………………………………………..25
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CONCLUSION…………………………………………………………………...33
CERTIFICATE OF BAR MEMBERSHIP……………………………………….34
CERTIFICATE OF COMPLIANCE RE: WORD COUNT……………………...34
CERTIFICATE OF COMPLIANCE RE: E-BRIEF ……………………………...34
CERTIFICATE OF COMPLIANCE RE: VIRUS CHECK.……………………...34
CERTIFICATE OF SERVICE……………………………………………………35
CASES
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1001 BRICKELL BAY DRIVE, 32 ND
TABLE OF CASES AND AUTHORITIES
FUERST ITTLEMAN, PL
PAGE
Abramson Enters., Inc. v. Gov’t of the V.I., 994 F.2d 140 (3d Cir. 1993)………….8
Appleton v. Comm’r, 3d. Cir. case # 10-4522……………………………..…2-3, 14
Appleton, v. Comm’r, No. 7717-10 (T.C.)...………………………………………15
A. Brooker v. Comm’r, No. 18182-09 (T.C.)……………………………………...16
L. Brooker v. Comm’r, No. 18164-09 (T.C.)……………………………………...16
B. Cooper v. Comm’r, No. 11810-10 (T.C.)……………………………………....15
S. Cooper v. Comm’r, No. 11811-10 (T.C.)…………………………………...….15
Birdman, et al. v Office of the Governor, No. 10-4189 (3d Cir.)…………………14
Birdman, et al. v. Comm’r, et al., No. 3:10-cv-140 (D.V.I.)……………………...15
D. Birdman v. Comm’r, No. 5816-10 (T.C).………………………………...……16
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H. Birdman v. Comm’r, No. 5817-10 (T.C.)……………………………………...16
Harvey & Diane Birdman v. Comm’r, No. 28897-10 (T.C.)…………………......16
Bolling v. Sharpe, 347 U.S. 497 (1954)…………………………………………...22
Brown v. Board of Education, 347 U.S. 483 (1954)……………………………...22
Buckley v. Valeo, 424 U.S. 1 (1976), aff’g 401 F.Supp. 1235 (D.D.C. 1975), aff’g
in part, rev’g in part 519 F.2d 821 (D.C. Cir. 1975)……………………………...22
Chase Manhattan Bank, N.A. v. Gov’t of the Virgin Islands, 300 F.3d 320 (3d Cir.
2002), overruling 173 F.Supp.2d 386 (D.V.I. 2001)………………………………6
Chicago Bridge & Iron Co. v. Wheatley, 430 F.2d 973 (3d Cir. 1970), rev’g 295
F.Supp. 240 (D.V.I. 1969), cert. denied 91 S.Ct. 873 (1971)…………………7, 19
James Coffey v. Comm’r, No. 4949-10 (T.C.)………………………………...…..15
Judith Coffey v. Comm’r, No. 4720-10 (T.C.)…………………………………….15
Cooper v. Comm’r, No. 11-10617 (11th Cir.)…………………………………….14
Cooper, et al. v. Comm’r, et al., No. 1:10-cv-40 (D.V.I.)………………………...15
Day et al v. United States, No. 10-cv-1949 (D. Colo.)…………………………....15
Dorr v. United States, 195 U.S. 138 (1904)………………………………………23
Duncan v. Louisiana, 391 U.S. 145 (1958)……………………………………….23
Gangi, et al v. United States, No. 10-mc-10088 (D. Mass.)………………………15
Gangi, et al v. United States, No. 10-mc-10148 (D. Mass.) ...……………………15
Gangi, et al v. United States, No. 10-mc-10160 (D. Mass.)………………………15
Gangi, et al v. United States, No. 10-mc-10178 (D. Mass.) ...……………………15
1001 BRICKELL BAY DRIVE, 32 ND
FUERST ITTLEMAN, PL
FLOOR, MIAMI, FL 33131 • T: 305.350.5690 • F: 305.371.8989 • WWW.FUERSTLAW.COM
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Case: 11-1612 Document: 003110561288 Page: 5 Date Filed: 06/13/2011
Gov’t of the Virgin Islands v. Boynes, slip op., Crim. No. F426-2002, 2003 Lexis 5
(Terr. Ct. V.I. April 9, 2003)……………………………………………………...23
B. Hirsch v. Comm’r, No. 5819-10 (T.C.)…………………………………...……16
H. Hirsch v. Comm’r, No. 5821-10 (T.C.)……………………………………......16
Herbert & Bonita Hirsch v. Comm’r, No. 6034-11 (T.C.)………………………..16
HMW Indus., Inc. v. Wheatley, 504 F.2d 146 (3d Cir. 1974), aff’g 368 F.Supp. 915
(D.V.I. 1973)……………………………………………………………………….6
Huff v. Comm’r, et al., No. 1:10-cv-26 (D.V.I.)…………………………………..15
Huff v. Comm’r, No. No. 11-10608 (11th Cir.)…………………………………..14
In re Grand Jury Proceedings, 486 F.2d 85 (3d Cir. 1973)………………………27
In re: United States, 273 F.3d 380 (3d Cir. 2001)…………………………32, ft. 12
Japan Whaling Ass'n v. American Cetacean Society, 478 U.S. 221, 106 S. Ct.
2860, 92 L. Ed. 2d 166 (1986)……………………………………………..32, ft. 13
Iris Khoury v. Comm’r, No. 9739-09 (T.C.)………………………………………16
Issam Khoury v. Comm’r, No. 10291-09 (T.C.)…………………………………..15
McGrogan v. Comm’r, et al., No. 3:09-cv-167 (D.V.I)…………………………..15
McGrogan v. Comm’r, No. 11-10618 (11th Cir.)………………………………...14
McGrogan v. Comm’r, No. 456-10 (T.C.)…………………………………...…....15
McHenry v. Comm’r, et al., No. 1:10-cv-21 (D.V.I.)……………………………..15
McHenry v. Comm’r, No. 11-1239 (4th Cir.)……………………………………..14
1001 BRICKELL BAY DRIVE, 32 ND
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McHenry v. Comm’r, No. 7568-10 (T.C.)………………………………...………15
Pickel v. United States, 746 F.2d 176 (3d Cir. 1984)…………………………18, 28
SEC v. Wheeling-Pittsburgh Steel Corp., 648 F.2d 118 (3d Cir. 1981) (en banc)..27
Soto v. United States 273 F. 628 (3d Cir. 1921)…………………………………..23
Teffeau, et al. v. Comm’r, et al., No. 3:10-cv-123 (D.V.I.)……………………….15
Lewis Teffeau v. Comm’r, No. 27904-10 (T.C.)…………………………………..16
Linda Teffeau v. Comm’r, No. 27905-10 (T.C.)…………………………………..16
United States v. LaSalle National Bank, 437 U.S. 298 (1978)……………………18
United States v. McCarthy, 514 F.2d 368 (3d Cir. 1975)…………………………27
United States v. Powell, 379 U.S. 48 (1964)………………………………....passim
United States v. Rockwell, 897 F.2d 1255 (3d Cir. 1990)…………………17-18, 28
Village of Willowbrook v. Grace, 528 U.S. 562 (2000), aff’g 160 F.3d 386 (7th Cir.
1998)……………………………………………………………………………....22
Weinberger v. Wiesenfeld, 420 U.S. 636 (1975), aff’g 367 F.Supp. 981 (D.N.J.
1973)………………………………………………………………………………23
AMENDMENTS TO THE UNITED STATES CONSITUTION
5 th Amendment…………………………………………………………...21, 22, 30
14 th Amendment…………………………………………………………..21, 22, 30
FEDERAL STATUTES
26 U.S.C. (IRC) § 932…………………………………………………………...…8
26 U.S.C. (IRC) § 934…………………………………………………………...…7
1001 BRICKELL BAY DRIVE, 32 ND
FUERST ITTLEMAN, PL
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26 U.S.C. (IRC) § 6501………………………………………………………passim
48 U.S.C. § 1397………………………………………………………………...6, 7
TREASURY REGULATIONS
Treas. Reg. § 1.932-1(c)(2)(ii)…………………………………………………….25
USVI STATUTES
29 V.I.C. § 701 et seq…………………………………………………………….…7
29 V.I.C. § 704 et seq…………………………………………………………….…7
RULES
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Federal Rule of Appellate Procedure 42…………………………………………..14
Federal Rule of Civil Procedure 72……………………………………………….12
Federal Rule of Evidence 801…………………………………………………….27
IRS GUIDANCE
FSA 199906031; 1998 FSA LEXIS 18………………………………………..19-20
Notice 2007-31; 2007-1 C.B. 971; 2007-16 I.R.B. 971……………………...passim
Notice 2007-19; 2007-1 C.B. 689; 2007-11 I.R.B. 689……………………...passim
Tax Guide for Individuals With Income From U.S. Possessions (2001 and
2002)........................................................................................................................10
OTHER
Convention between the United States and Denmark, 39 Stat. 1706, proclaimed
January 25, 1917……………………………………………………………..6, fn. 7
Katcher, Stark, & Schantz, Signed, Sealed, Delivered – USVI Returns and Section
6501, 2009 TNT 161-8 (Aug. 24, 2009)……………………………………………3
Naval Service Appropriation Act of July 12, 1921……………………………...…7
1001 BRICKELL BAY DRIVE, 32 ND
FUERST ITTLEMAN, PL
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S. Rep. 99-313……………………………………………………………………...9
Tax Implementation Agreement Between the United States of America and the
Virgin Islands, Feb. 24, 1987, 1989-1 C.B. 347……………………………………9
Taxpayer Advocate Service, 2009 Annual Report to Congress, Vol. I, Legislative
Recommendation No. 10………………………………………………….25, 26, 27
1001 BRICKELL BAY DRIVE, 32 ND
FUERST ITTLEMAN, PL
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Case: 11-1612 Document: 003110561288 Page: 9 Date Filed: 06/13/2011
STATEMENT OF SUBJECT MATTER AND APPELLATE
JURISDICTION
The Third Circuit Court of Appeals has jurisdiction over this matter pursuant
to 28 U.S.C. § 1291.
Appellant appeals from the Order of the United States District Court for the
District of New Jersey entered on January 7, 2011, adopting, with modifications,
the United States Magistrate Judge‘s Report and Recommendations granting the
United States‘ Motion to Enforce. Frank Gangi, et al. v. United States of America,
Case No. 3:10-mc-24-GEB-DEA. Doc. # 26; 1 A-000007. 2 The District Court had
jurisdiction pursuant to 26 U.S.C. (the ―Internal Revenue Code‖ or ―IRC‖) §§
7402(b), 7609(h) and 28 U.S.C. § 1340.
On March 7, 2011, Appellant filed a Notice of Cross Appeal of the District
Court‘s January 7, 2011, Order. Doc. # 29; A-000001. Also on March 7, 2011,
Appellant filed an Amended Notice of Cross Appeal 3 of the District Court‘s
January 7, 2011, Order. Doc. # 30; A-000004. This appeal follows.
1 The District Court Docket Entries are referred to herein as ―Doc. # _.‖
2 Numbers shall refer to pages of Joint Appendix which appear in the lower right
hand corner of each page of the Appendix as follows: A-000001, A-000002, etc.
3 The Amended Notice of Cross Appeal gave notice that the following business
entities would not be joining the cross-appeal, to wit: Ferrous Miner Holdings,
Ltd.; BABP VI, LLC; and Global NAPS, Inc.
FUERST ITTLEMAN, PL
1001 BRICKELL BAY DRIVE, 32 ND FLOOR, MIAMI, FL 33131 • T: 305.350.5690 • F: 305.371.8989 • WWW.FUERSTLAW.COM
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STATEMENT OF ISSUES PRESENTED FOR REVIEW
The Instant case presents one main issue: whether the District Court erred in
concluding that enforcing the IRS summonses would not result in an abuse of its
process? In addressing this issue this Court will have to examine the
constitutionality of the IRS‘ position that the statute of limitations provision
contained in IRC § 6501 only applies (for the years at issue) to those United States
Citizens residing in the United States Virgin Islands (―USVI‖) who had income
less than $75,000. The Court will also have to examine whether the District Court
erred in concluding that Appellant failed to demonstrate institutional bad faith on
the part of the IRS.
INTRODUCTION AND STATEMENT OF THE CASE
To quote the Government of the Virgin Islands:
This case is one small but important battle in a long-running war
being waged by the Internal Revenue Service (―IRS‖) on an important
economic development program of the Government of the U.S. Virgin
Islands (―Government‖). Although Congress has repeatedly endorsed
the program - which relies upon tax incentives that Congress created
specifically to promote the program‘s success and thus reduce the
need for federal subsidies to the Virgin Islands - the IRS has long
been hostile. In an apparent effort to chill interest in those tax
incentives, the IRS has launched protracted audits of hundreds of
program participants—and in so doing has deterred participation by
many existing and potential participants, including many who could
legitimately claim the program‘s tax benefits (emphasis added).
FUERST ITTLEMAN, PL
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Appleton v. Comm’r, 3d. Cir. case # 10-4522, United States Virgin Islands
(―USVI‖) Brief (January 14, 2011) at page 8 of 57.
Sometime in late 2003 or early 2004 the IRS began to audit United States
citizens who resided in the USVI and filed income tax returns with the USVI
Bureau of Internal Revenue (―BIR‖) to determine if they were bona fide USVI
residents, whether the taxpayers had properly claimed an Economic Development
Program (―EDP‖) tax credit, and whether the taxpayers‘ income was sourced in or
effectively connected with a USVI trade or business. See generally Katcher, Stark,
& Schantz, Signed, Sealed, Delivered – USVI Returns and Section 6501, 2009
TNT 161-8 (Aug. 24, 2009) (noting that in a 2007 report to Congress the IRS
disclosed that 279 United States citizens were under audit, and that 90 percent of
the 279 cases were for 2003 and earlier tax years). This IRS audit program is
referred to, at least within the IRS, as the ―Virgin Islands project.‖ 4 Mr. Gangi is
one taxpayer in the hundreds of program participants that has been, and is being,
subject to the IRS‘ never-ending audits.
At first the IRS asked taxpayers, such as Mr. Gangi, who were under audit to
execute Form 872. Form 872 is the internal form the IRS uses to ―extend‖ the
normal statute of limitations period under IRC § 6501(a). By executing Form 872
taxpayers agree to extend the statute of limitations on assessment for a set amount
4 The undersigned has personally been told this by numerous IRS Revenue Agents.
FUERST ITTLEMAN, PL
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of time; however taxpayers are under no obligation to execute Form 872 and the
IRS cannot force taxpayers to execute same. The majority of the taxpayers that
were (and still are) under audit did not execute Form 872. 5 As a result of the
taxpayers‘ failure to extend the statute of limitations, and undeterred by the clear
provisions of the Internal Revenue Code, the IRS unilaterally changed the rules
regarding the statue of limitations, 6 which has resulted in the instant case.
Indeed, the weapon of choice of the IRS in its battle against taxpayers such
as Mr. Gangi has been an unconstitutional construction of the applicable three year
statute of limitations under IRC § 6501(a). On March 12, 2007, the IRS with
apparent disregard for the United States Constitution issued Notice 2007-19; 2007-
1 C.B. 689; 2007-11 I.R.B. 689 (―Statute of Limitations on Assessment
Concerning Certain Individuals Filing Income Tax Returns With the U.S. Virgin
Islands‖). Notice 2007-19 stated that:
an income tax return filed with the U.S. Virgin Islands by a U.S.
citizen or resident alien (USVI Form 1040) will be deemed to be a
U.S. income tax return of that individual for purposes of section
6501(a), provided that the individual is a covered person. The term
―covered person‖ means a U.S. citizen or resident alien who takes the
position that he or she is a bona fide resident of the U.S. Virgin
Islands, files USVI Form 1040 with the U.S. Virgin Islands, and has
less than $75,000 of gross income for the taxable year.
5
The undersigned represents numerous taxpayers that are under audit, many of
whom did not execute Form 872.
6
See Notice 2007-19 and discussion infra.
FUERST ITTLEMAN, PL
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Notice 2007-19 at § 2.
However, as discussed in more detail below, the term ―covered person‖
never appears in the Internal Revenue Code, nor does the applicability of the
statute of limitations section of the Internal Revenue Code turn on income level or
place of residence.
With this newfound weapon in the IRS‘ arsenal, the IRS issued numerous
third-party summonses in respect to those taxpayers that claimed USVI EDP tax
credits. When the IRS issued third-party summonses in respect to Mr. Gangi‘s tax
liability Mr. Gangi timely petitioned the United States District Court for the
District of New Jersey to quash the summonses.
The present appeal requires this Court to decide whether an IRS third-party
summons that is predicated upon an unconstitutional construction of the Internal
Revenue Code is an abuse of the District Court‘s process, and whether there is
institutional bad faith on part of the IRS is respect to the third-party summonses
issued in furtherance of the IRS‘ USVI audit program.
STATEMENT OF THE FACTS
To understand the errors made by the District Court a brief description of the
interrelationship between unique taxation system of the USVI, the IRS summonses
FUERST ITTLEMAN, PL
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issued in respect to Mr. Gangi, and the proceedings below is required. Each will
be address in turn.
A. TAX TREATMENT OF USVI RESIDENTS
The USVI is a territory of the United States which was acquired from
Denmark in 1917. 7 In 1921, Congress created the so-called ―mirror system‖ of
taxation, under which United States income tax laws constitute the income tax laws
of the USVI, with the only difference being that USVI residents pay tax to the
USVI rather than to the United States. See Naval Service Appropriation Act of
July 12, 1921, 48 U.S.C. § 1397; see also Chase Manhattan Bank, N.A. v. Gov’t of
the Virgin Islands, 300 F.3d 320, 322-23 (3d Cir. 2002), overruling 173 F.Supp.2d
386 (D.V.I. 2001).
The purpose of the ―mirror system‖ was ―to impose upon the inhabitants of
the Virgin Islands . . . a territorial income tax, payable directly into the Virgin
Islands treasury, to assist the Islands in becoming self-supporting.‖ HMW Indus.,
Inc. v. Wheatley, 504 F.2d 146, 150 (3d Cir. 1974), aff’g 368 F.Supp. 915 (D.V.I.
1973). Pursuant to the mirror system the words ―Virgin Islands‖ are substituted for
the words ―United States‖ wherever they appear in the Internal Revenue Code. 48
7 Convention between the United States and Denmark, 39 Stat. 1706, proclaimed
January 25, 1917.
FUERST ITTLEMAN, PL
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U.S.C. § 1397. Income taxes imposed under this system are payable to the BIR
rather than to the IRS.
Under the mirror system ―any changes to, interpretations of, regulations and
revenue rulings on and court interpretations of the substantive tax provisions of the
Internal Revenue Code are applicable to Virgin Islands tax cases as long as the
particular provision at issue is not manifestly inapplicable or incompatible with a
separate territorial income tax . . . .‖ Chicago Bridge & Iron Co. v. Wheatley, 430
F.2d 973, 976 (3d Cir. 1970), rev’g 295 F.Supp. 240 (D.V.I. 1969), cert. denied 91
S.Ct. 873 (1971).
Five decades ago the U.S. Congress and the USVI government created the
EDP to attract business people to establish new businesses in the USVI. See
generally 29 V.I.C. § 701 et seq. The Economic Development Commission
(―EDC‖) was created by the USVI government to oversee the EDP. See generally
29 V.I.C. § 704 et seq. The EDP offers the opportunity for those approved
beneficiaries to receive an income tax credit, pursuant to IRC § 934. Despite the
creation of the EDP, and the best efforts of the U.S. Congress and the USVI
government, economic growth in the USVI has been, and continues to be, arrested
as evidenced by both the number and percentage of the population living below the
FUERST ITTLEMAN, PL
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poverty line and the per capital income in the Territory that ranks behind all 50
States and the District of Columbia. 8
In 1986, Congress enacted Section 932 of the Internal Revenue Code, which
draws a clear distinction between individuals who are bona fide USVI residents
and those who are not. A United States resident who derives income from the
USVI, but who is not a bona fide USVI resident, must file two tax returns, one
with the IRS and the other with the USVI. IRC § 932(a). Such individuals pay tax
on USVI source income to the BIR, and tax on non-USVI source income to the
IRS. IRC § 932(b). In contrast, a bona fide resident of the USVI must file a return
only with the BIR, and pays tax on all income, regardless of its source, to the
USVI. IRC § 932(c). By paying the BIR the correct amount of tax on all
worldwide income, a bona fide USVI resident is relieved of any income tax
liability to the United States, even on non-USVI source income. Id.; see also
Abramson Enters., Inc. v. Gov’t of the V.I., 994 F.2d 140 (3d Cir. 1993).
In enacting IRC § 932, Congress contemplated that the USVI BIR would
provide the IRS with information regarding Virgin Islands residents that report
non-Virgin Islands income:
[a] Virgin Islands resident deriving gross income from sources
outside the Virgin Islands will report all items of such income on
8 Available at http://www.statemaster.com/graph/eco_gdp_percap-product-currentdollars-per-capita,
last Accessed June 12, 2011.
FUERST ITTLEMAN, PL
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his or her Virgin Islands return. Information contained on these
returns will be compiled by the Virgin Islands Bureau of Internal
Revenue and transmitted to the Internal Revenue Service to
facilitate enforcement assistance.
S. Rep. 99-313, at 482.
Consistent with this understanding, the United States and the USVI entered
into an agreement ―for the exchange of information and mutual assistance with
respect to taxes in order to prevent the evasion or avoidance of United States or
Virgin Islands taxes.‖ Tax Implementation Agreement Between the United States
of America and the Virgin Islands, p. 1 Feb. 24, 1987, 1989-1 C.B. 347. 9 Doc. #
6-1; A-000229. Among other things, the Virgin Islands agreed to ―routinely
supply‖ the United States with ―information about any taxpayer subject to Virgin
Islands tax with non-Virgin Islands source income who files an income tax return
with the Virgin Islands claiming for the first time to be a Virgin Islands resident.‖
Id., Art. 4, § 2(b)(iii).
B. IRS SUMMONSES
It is against this backdrop that Mr. Gangi filed his personal income tax
returns and paid tax for 2000 through 2004 (including the years subject to the
summonses in question) with the BIR. Mr. Gangi timely filed with the BIR a tax
return for 2000 through 2004, properly using the same Form 1040 that United
9 This is not a typographical error. The Agreement was first published by the
Service in the 1989 Cumulative Bulletin, two years after it was signed.
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States residents file with the IRS, reporting both Virgin Islands and non-Virgin
Islands source income, and paying all tax to the BIR. Mr. Gangi did so pursuant to
IRC § 932(c), and also in accordance with contemporaneous IRS guidance, which
provided, ―If you are a bona fide resident of the Virgin Islands on the last day of
the tax year, you must file your tax return on Form 1040 with the Government of
the Virgin Islands and pay the entire tax due to the Virgin Islands.‖ Tax Guide for
Individuals With Income From U.S. Possessions, at 7 (2001 and 2002). Doc. # 6-2;
A-000250.
In December 2004, the IRS opened an audit on Mr. Gangi for the purpose of
determining whether Mr. Gangi was a USVI bona fide resident for 2000, 2001,
2002, and 2003 tax years. The IRS‘ claims that ―[t]he legitimacy of Mr. Gangi‘s [
] USVI residency for tax purposes us relevant to [its] investigation because, if he
was not a USVI bona fide resident for tax purposes . . . he was required to file
income tax returns with the [IRS], and report all of his income on such U.S. tax
returns.‖ Doc. # 4; A-000099.
The IRS conducted a de facto deposition of Mr. Gangi on October 19, 2006,
as to his purported tax liability to the United States. Approximately six years after
the IRS audit was first opened and three and a half years after interviewing Mr.
Gangi, on February 2, 2010, Internal Revenue Agent Jackie Moss (―Agent Moss‖)
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issued an administrative summons to CitiBank (the ―CitiBank summons‖) under
the authority of IRC § 7602. Doc. # 1-2; A-000042. On the same day, the IRS
commenced an audit of Mr. Gangi‘s business entity BABP VI, LLC (Doc. # 1-4;
A-000076) and on the next day, the IRS commenced the audit of another one of
Mr. Gangi‘s business entities, Ferrous Miner Holdings, Ltd. (Doc. # 1-5; A-
000081). Subsequently, on May 10, 2010, Agent Moss issued another
administrative summons, this time to Sovereign Bank (the ―Sovereign Bank
summons‖), also under the authority of IRC § 7602. Doc. # 5-3; A-000144.
Both administrative summonses issued by the IRS direct third-parties
CitiBank and Sovereign Bank to produce all ―DOCUMENTS‖ and records in their
possession or under their control relating to Petitioners‘ accounts for the period
―from December 31, 1999 through December 31, 2004 10 or the date the accounts
were opened, whichever is later‖ including, but not limited to copies of all
signature cards; account applications; correspondence between the banks and the
account holders; account statements; debit/credit advances; payment checks
deposited; authorizations; notifications; wire transfers etc.
To date, more than six and one-half years after the IRS opened its audit of
Mr. Gangi; the IRS audit remains ongoing without any end in sight.
10 Paragraph 1 of the Sovereign Bank Summons is for ―the period December 1,
1999 through January 31, 2005.‖
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C. PROCEEDINGS BELOW
On February 24, 2010, Mr. Gangi and his related entities petitioned the
District Court for the District of New Jersey to quash the respective IRS summons.
Doc. # 1; A-000032. The basis for the Appellant‘s Petition to Quash was that the
IRS summonses failed to comply with the Supreme Court‘s decision in United
States v. Powell, 379 U.S. 48 (1964).
On April 16, 2010, the IRS filed its Opposition to the Petition. Doc. # 4; A-
000096. As stated above, one week later, undaunted and unperturbed by the
pending Petition before the District Court, the IRS issued yet another
administrative summons, (Doc. # 5-3; A-000144), this time to third party
Sovereign Bank , thus necessitating the filing of a second, separate Petition to
Quash on May 3, 2010. Doc. # 5; A-000133.
On July 26, 2010, oral argument was held before the United States
Magistrate assigned to the case below. On August 26, 2010, the Magistrate issued
a dispositive Order (Doc. # 12; A-000347) and Opinion (Doc. # 11; A-000338)
purporting to enforce the respective summonses issued by the IRS. On September
3, 2010, the District Court entered an Order re-characterizing the dispositive Order
as a Report and Recommendation. Doc. # 14; A-000348. On September 22, 2010,
Mr. Gangi, pursuant to Federal Rule of Civil Procedure 72, timely filed his
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Objections to the Magistrate‘s Report and Recommendation. Included in the
Appellant‘s Objections was a request for discovery and an adversarial hearing.
Doc. # 17; A-000349.
On October 5, 2010, the District Court entered an Order requiring the parties
below to provide supplementary material in respect to the IRS‘ compliance with
IRC § 7602(c). Doc. # 18; A-000366. Mr. Gangi filed his supplemental pleading
on October 15, 2010, (Doc. # 20; A-000368) and the United States filed its
supplemental pleading on October 18, 2010 (Doc. # 21; A-000392). On October
28, 2010, the District Court entered an Order permitting Mr. Gangi to provide
additional briefing. Doc. # 23; A-000400. Mr. Gangi provided additional briefing
on November 5, 2010. Doc. # 24; A-000401.
On January 7, 2011, the District Court entered an Order, inter alia, adopting
with modifications the Magistrate‘s August 25, 2010, Report and
Recommendation; and further ordered that the United States‘ Motion to Enforce
was granted in part; and further ordered that the Petitions to Quash were granted in
part (in respect that the IRS summonses issued to CitiBank and Sovereign Bank
may not be enforced against Ferrous Miner and BABP VI, LLC). Doc. # 26; A-
000007. The Order was accompanied with a contemporaneous Memorandum
Opinion. Doc. # 25; A-000009.
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On March 7, 2011, Appellant filed an Amended Notice of Cross Appeal of
the District Court‘s January 7, 2011, Order. Doc. # 30; A-000004. The instant
appeal follows.
STATEMENT OF RELATED CASES AND PROCEEDINGS
Initially the United States appealed the decision of the District Court which
was docket at case number 11-01611, however the United States dismissed said
case and an order was entered pursuant to Fed. R. App. 42(b) on April 28, 2011.
However, there are numerous cases pending before the Circuit Courts, the District
Courts, and the Tax Court that involved the IRS audits of United States citizens
who resided in the USVI and claimed an EDP tax credit. The cases (to the best of
the undersigned‘s knowledge) are as follows.
Circuit Courts: Appleton v. Comm’r, No. 10-4522 (3d. Cir.) (USVI
intervention); In re: Birdman, et al. No. 11-1462 (3d Cir.) (Petition for Writ of
Mandamus); Birdman, et al. v Office of the Governor, No. 10-4189 (3d Cir.)
(Injunction against BIR); Huff v. Comm’r, No. No. 11-10608 (11 th Cir.) (USVI
intervention); Cooper v. Comm’r, No. 11-10617 (11 th Cir.) (USVI intervention);
McGrogan v. Comm’r, No. 11-10618 (11 th Cir.) (USVI intervention); McHenry v.
Comm’r, No. 11-1239 (4 th Cir.) (USVI intervention).
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District Courts: Gangi, et al v. United States, No. 10-mc-10088 (D. Mass.)
(Petition to Quash); Gangi, et al v. United States, No. 10-mc-10148 (D. Mass.)
(Petition to Quash); Gangi, et al v. United States, No. 10-mc-10160 (D. Mass.)
(Petition to Quash); Gangi, et al v. United States, No. 10-mc-10178 (D. Mass.)
(Petition to Quash); Day et al v. United States, No. 10-cv-1949 (D. Colo.) (Petition
to Quash); McGrogan v. Comm’r, et al., No. 3:09-cv-167 (D.V.I) (Petition for
Redetermination and Refund Suit); McHenry v. Comm’r, et al., No. 1:10-cv-21
(D.V.I.) (Petition for Redetermination and Refund Suit); Huff v. Comm’r, et al.,
No. 1:10-cv-26 (D.V.I.) (Petition for Redetermination and Refund Suit); Cooper, et
al. v. Comm’r, et al., No. 1:10-cv-40 (D.V.I.) (Petition for Redetermination and
Refund Suit); Teffeau, et al. v. Comm’r, et al., No. 3:10-cv-123 (D.V.I.) (Petition
for Redetermination and Refund Suit); Birdman, et al. v. Comm’r, et al., No. 3:10-
cv-140 (D.V.I.) (Petition for Redetermination, Refund Suit, 42 U.S.C. § 1983, 5 th
Amendment Takings, Bivens).
Tax Court: Appleton, v. Comm’r, No. 7717-10 (T.C.); Judith Coffey v.
Comm’r, No. 4720-10 (T.C.); James Coffey v. Comm’r, No. 4949-10 (T.C.); B.
Cooper v. Comm’r, No. 11810-10 (T.C.); S. Cooper v. Comm’r, No. 11811-10
(T.C.); McGrogan v. Comm’r, No. 456-10 (T.C.); McHenry v. Comm’r, No. 7568-
10 (T.C); Issam Khoury v. Comm’r, No. 10291-09 (T.C.); Iris Khoury v. Comm’r,
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No. 9739-09 (T.C.); Lewis Teffeau v. Comm’r, No. 27904-10 (T.C.); Linda Teffeau
v. Comm’r, No. 27905-10 (T.C.); H. Birdman v. Comm’r, No. 5817-10 (T.C.); D.
Birdman v. Comm’r, No. 5816-10 (T.C.); Harvey & Diane Birdman v. Comm’r,
No. 28897-10 (T.C.); H. Hirsch v. Comm’r, No. 5821-10 (T.C.); B. Hirsch v.
Comm’r, No. 5819-10 (T.C.); Herbert & Bonita Hirsch v. Comm’r, No. 6034-11
(T.C.); L. Brooker v. Comm’r, No. 18164-09 (T.C.); A. Brooker v. Comm’r, No.
18182-09 (T.C.) (All of the Tax Court cases are Petitions for Redetermination).
STATEMENT OF THE STANDARD AND SCOPE OF REVIEW
The standard of review for the issues raised in Point I is de novo.
STATEMENT REGARDING ORAL ARGUMENT
Appellant respectfully requests Oral Argument of this case as such would be
beneficial to the Court‘s review of the matters contained in this appeal.
SUMMARY OF ARGUMENT
The District Court erred in its application of the Supreme Court‘s seminal
case of Powell, supra, and its progeny, including cases from this Circuit. The
District Court‘s conclusion that the enforcement of the respective IRS summonses
would not result in an abuse of the District Court‘s process was in error as
Appellant had demonstrated valid other grounds besides the four explicit Powell
factors. Appellant had demonstrated that the IRS audit of Mr. Gangi was
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predicated upon an unconstitutional construction of the applicability of the statute
of limitations provision of the Internal Revenue Code.
The District Court also erred in finding that Appellant had failed to show
institutional bad faith on the part of the IRS in respect to the IRS‘ never-ending
audits, including that of the Appellant. Consequently the District Court erred in
enforcing the IRS third-party summonses. Moreover, the District Court erred in
concluding that Appellant‘s arguments below regarding the constitutionality, or
lack thereof, were premature and could not be brought at the first instance for
redress before the District Court. The District Court‘s misinterpretation of Powell
was legal error, subject to de novo review.
ARGUMENT
POINT I
THE DISTRICT COURT ERRED IN
CONCLUDING THAT THE ENFORCEMENT OF
THE IRS SUMMONSES WOULD NOT RESULT IN
AN ABUSE OF ITS PROCESS.
The District Court in its memorandum opinion cited to the correct law in this
Circuit, but when it applied the facts to the applicable law reached the wrong
conclusion. As the District Court aptly noted:
The Third Circuit has recognized that, under the Powell test, ―[t]he
taxpayer retains the right to challenge the summons on any
appropriate ground. The teaching of . . . decisions [since Powell] is
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that an ‗appropriate ground‘ for challenging the summons exists
when the taxpayer disproves one of the four elements of the
government‘s Powell showing, or otherwise demonstrates that
enforcement of the summons will result in an abuse of the court‘s
process.‖ [United States v.] Rockwell, 897 F.2d [1255] at 1262 [3d
Cir. 1990] (citations omitted).
(emphasis added). Mem. Op. at 3-4; Doc. # 25; A-000011-12.
Examples of an abuse of the court's process include, but the Appellant
submits are not limited to, when IRS third-party summons are issued ―such as to
harass the taxpayer or to put pressure on him to settle a collateral dispute, or for
any other purpose reflecting on the good faith of the particular investigation
(emphasis added).‖ Pickel v. United States, 746 F.2d 176, 184 fn. 11 (3d Cir. 1984)
citing to Powell, supra at 58. In order to succeed on an abuse of process claim, a
taxpayer must show bad faith by the IRS as an institution, not just an individual
agent. United States v. LaSalle National Bank, 437 U.S. 298, 316 (1978).
In what appears to be a matter of first impression is the question of whether
unconstitutional conduct on the part of the IRS, when demonstrated by a taxpayer,
qualifies as demonstrating that the enforcement of an IRS summons would be an
abuse of the District Court‘s process. Appellant submits that it would be, and the
District Court erred in enforcing the subject IRS summonses. Appellant also
submits that institutional bad faith exists in the instant case, and it was error for the
District Court to refuse to quash said IRS summonses.
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A. UNCONSTITUTIONAL CONDUCT
Unconstitutional conduct exists on the part of the IRS as evidenced by the
IRS‘ position that the statute of limitations does not exist for those United States
citizens residing in the USVI, unless they earn less than $75,000 per year. IRC §
6501(a) provides that the normal statute of limitations for assessment is three years
from the later of the date the return was due or filed. Under the mirror code (48
U.S.C. § 1397) ―any changes to, interpretations of, regulations and revenue rulings
on and court interpretations of the substantive tax provisions of the Internal
Revenue Code are applicable to Virgin Islands tax cases as long as the particular
provision at issue is not manifestly inapplicable or incompatible with a separate
territorial income tax . . . .‖ Chicago Bridge & Iron Co., supra at 976.
Consequently, the normal statute of limitations provision in IRC § 6501(a) (i.e.,
three years) is applicable in the USVI.
In 1999, a Field Service Advice (―FSA‖) was issued by the IRS addressing
the statute of limitations for a taxpayer who filed with the BIR. The 1999 FSA
specifically provided that:
[IRC] section 932(c)(2) requires bona fide USVI residents to file an
annual return with the USVI. Since A filed a USVI tax return for Year
B, he met the requirements of [IRC] section 932(c)(2). However, on
account of his failure to report dividend income from a domestic
corporation, A did not satisfy [IRC] section 932(c)(4)(B), which
required that he report on his USVI return income from all sources
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and to identify the source of each item shown on such return, nor
[IRC] section 932(c)(4)(C), which required that he pay income tax to
the USVI on his worldwide income. [IRC] section 6501(a) gives the
IRS a period of up to three years from the date of the filing of a return
to assess taxes due by the taxpayer. Since more than three years have
passed since the taxpayer filed the tax return required by [IRC]
section 932(c)(2), the IRS may not assess and collect additional tax
unless other exceptions apply. [IRC] section 6501(a).
FSA 199906031; 1998 FSA LEXIS 18 (December 18, 1998). 11
At the time the IRS focused its attention on the USVI, it was clear that the
statute of limitations had run, or was about to run, on most of the taxpayers the IRS
intended to audit. To avoid this fact, the IRS unilaterally changed the statute of
limitations provisions under IRC § 6501 (this was necessary otherwise the ―Virgin
Islands project‖ would have been for naught).
Specifically, in Notice 2007-19, the IRS, without appropriate legislative
process or delegated executive authority, took the unconstitutional position that the
three year statute of limitations period for tax years ending before December 31,
2006, only applies to those individuals who filed with the BIR and who had less
than $75,000 of gross income for the taxable year. Notice 2007-19.
Subsequently, the IRS issued Notice 2007-31, which amended Notice 2007-
19. Notice 2007-31 states: ―[t]his notice announces that for taxable years ending
on or after December 31, 2006, the U.S. federal statute of limitations for all U.S.
11 This is not an error; the Field Service Advice was dated December 18, 1998, but
not published until 1999, hence the discrepancy in the dates.
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citizens and residents claiming to be bona fide residents of the U.S. Virgin
Islands generally will commence upon the filing of an income tax return with the
U.S. Virgin Islands (emphasis added).‖ Notice 2007-31; 2007-1 C.B. 971; 2007-
16 I.R.B. 971 at § 3 (April 16, 2007). This distinction should not go unnoticed.
Notice 2007-31 marks a change in the IRS‘ position in that under Notice 2007-31
any person ―claiming‖ to be bona fide USVI resident is able to obtain the benefit of
the three year statute of limitations period that Congress intended under IRC §
6501(a). This position is in stark contrast to Notice 2007-19 which applies the
three statute of limitations period to only those that meet the definition of ―covered
persons.‖ Notice 2007-19 at § 2.
The District Court erred in its determination that the IRS‘ protracted audits
of U.S. citizens who were residents of the USVI, that is predicated on violations of
equal protection prohibited by the 14 th Amendment, and due process guaranteed in
the 5 th Amendment, did not constitute an abuse of the District Court‘s process.
The evidence of unconstitutional conduct can be found in the
aforementioned two IRS pronouncements: Notice 2007-19 and Notice 2007-31.
Notice 2007-19 and Notice 2007-31 demonstrate violations of the Equal Protection
Clause of the 14 th Amendment and Due Process Clause of the 5 th Amendment.
Normally, the legal lens in which one views disparate treatment under the law is
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the equal protection clause of the Fourteenth Amendment. See Village of
Willowbrook v. Grace, 528 U.S. 562 (2000), aff’g 160 F.3d 386 (7 th Cir. 1998).
However the Supreme Court in Bolling v. Sharpe, 347 U.S. 497, 499–500 (1954), a
companion case to the landmark Brown v. Board of Education, 347 U.S. 483
(1954), held that segregation of students in the public schools of the District of
Columbia violated the Due Process clause of the Fifth Amendment and not the
Equal Protection Clause of the Fourteenth Amendment. The Fifth Amendment of
the U.S. Constitution, which is applicable in the District of Columbia, notably does
not contain an equal protection clause which applies only to the Several States.
The Supreme Court noted that the concepts of equal protection and due
process, both stemming from the universal ideal of fairness under the law, are not
mutually exclusive and are coextensive. The Equal Protection Clause is more of a
safeguard to prohibit unfairness than the Due Process Clause, and as such the two
clauses are not always interchangeable. But discrimination may be so unjustifiable
as to be violative of the Due Process Clause of the Fifth Amendment. Bolling,
supra. ―Equal protection analysis in the Fifth Amendment area,‖ the Supreme
Court has said, ―is the same as that under the Fourteenth Amendment.‖ Buckley v.
Valeo, 424 U.S. 1, 93 (1976), aff’g 401 F.Supp. 1235 (D.D.C. 1975), aff’g in part,
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rev’g in part 519 F.2d 821 (D.C. Cir. 1975); Weinberger v. Wiesenfeld, 420 U.S.
636, 638 n.2 (1975), aff’g 367 F.Supp. 981 (D.N.J. 1973).
As the USVI is an unincorporated territory of the United States, not all of the
provisions of the U.S. Constitution automatically apply in the USVI. Dorr v.
United States, 195 U.S. 138, 148 (1904). Only ―fundamental‖ constitutional rights
automatically apply in the USVI, while ―remedial‖ rights apply only by legislative
grace. Compare Duncan v. Louisiana, 391 U.S. 145, 149 (1958) (right to jury trial
is fundamental) with Gov’t of the Virgin Islands v. Boynes, slip op., Crim. No.
F426-2002, 2003 Lexis 5 (Terr. Ct. V.I. April 9, 2003) (because the USVI is an
unincorporated territory, the right to a jury trial is a remedial right which can be
enacted and repealed by Congress).
This Court in Soto v. United States 273 F. 628 (3d Cir. 1921), explained that
the USVI is an unincorporated territory which is subject to the fundamental
right/remedial right distinction. However, this Court held that the Due Process
Clause of the Fifth Amendment is a fundamental right that automatically applies to
unincorporated territories. Id. at 633.
United States citizens who resided in the USVI are being deprived of their
statutory rights and discriminated against solely based on where they resided (the
USVI versus the 50 States) and discriminated against based on an arbitrary income
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level (those that made less than $75,000 and resided and filed in the USVI have the
benefit of the statute of limitations versus that that made more than $75,000 who
do not). What is important to note, is that neither place of residence nor income
level has ever been a reason to provide that the statute of limitations applies, or
does not apply, to a particular taxpayer. There is nothing in the Internal Revenue
Code, the Treasury Regulations thereunder, or the Congressional Record that
advances such a theory.
Additionally, the term ―covered person‖ is never mentioned in the Internal
Revenue Code. The term ―covered person‖ was created without any grant of
authority by the IRS, and without any notice to the public or comment period.
Further the monetary level, i.e., the $75,000, appears to be an arbitrary number
used to target those individuals with sufficient wherewithal to make an IRS audit
economically feasible. In other words, as the majority of the USVI population
lives at or below the poverty line, by setting the bar well above the poverty line
those poorly-healed residents will be given the statutory right of having the statute
of limitations period under IRC § 6501 apply to them. On the other hand, those
well-healed residents, many of which participated in the EDP, would not be
afforded the protections of IRC § 6501. Although not explicitly named, Mr. Gangi
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has in fact been singled out as a discrete subset of taxpayers for improper treatment
by the IRS.
Further, the fact that the IRS and the USVI had subsequently entered into an
exchange of information agreement, and the fact that the IRS finally issued
Treasury Regulations, e.g. Treas. Reg. § 1.932-1(c)(2)(ii) (see also Notice 2007-31
(discussing working arrangement between the IRS and the BIR)), is of no moment.
For taxpayers such as Mr. Gangi, the failure of the BIR and/or the IRS to properly
exchange information is of no fault of his making. Indeed if there is any blame to
be had it falls on the shoulders of the respective governments. Mr. Gangi should
not have to bear the burdens of the governments‘ shortcomings, and moreover, the
respective governments‘ shortcoming cannot be used to excuse unconstitutional
conduct. Accordingly, the District Court erred in concluding that there was no
abuse of the District Court‘s process and erred in enforcing the IRS summonses.
B. INSTITUTIONAL BAD FAITH
The District Court also erred in its determination that there was no
institutional bad faith on the part of the IRS. Institutional bad faith is evidenced in
Ms. Nina Olsen‘s (the IRS Taxpayer Advocate) 2009 annual report to Congress.
Taxpayer Advocate Service, 2009 Annual Report to Congress, Vol. I, Legislative
Recommendation No. 10. Doc. # 1-6; A-000084. The 2009 report to Congress
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states that: ―the IRS has singled out a small group of USVI taxpayers for
special treatment – the very types of high income taxpayers that federal tax
incentives are seeking to attract to the USVI – by effectively eliminating the
[statute of limitations] applicable to them but not the [statute of limitation]
applicable to other similarly situated taxpayers (emphasis added).‖ Id. at 391-
92; Doc. # 1-6; A-000085-86.
Ms. Olsen goes on to note that: ―the IRS has, without legislation, upset
longstanding expectations by singling out for special treatment those taxpayers
with gross incomes of more than $75,000 who are claiming USVI residency. For
many taxpayers the [statute of limitations] will not begin (or end) for tax years
ending before December 31, 2006, even if they have properly filed nonfraudulent
returns and have not claimed [USVI tax] benefits.‖ Id. at 397; Doc. # 1-6; A-
000091.
Moreover, both the District Court and this Court stand as bulwarks to protect
taxpayers‘ rights from IRS over-reaching. Again, the Taxpayer Advocate notes:
For a year and a half, the National Taxpayer Advocate
has been requesting specific data regarding USVI cases.
Only after it became evident that she would publicly
discuss this lack of transparency did the IRS provide any
USVI data to [the Taxpayer Advocate]. The IRS’s
repeated failure to provide such information to [the
Taxpayer Advocate], an entity designed by Congress
to protect taxpayer rights, is cause for concern.
FUERST ITTLEMAN, PL
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Without transparency of statutory limits on the IRS‘s
exercise of discretion in conducting audits of a certain
group of USVI residents for an unlimited period of time,
taxpayer rights are at risk.
(emphasis added). Id. at 398-99; Doc. # 1-6; A-000092-93. All of Ms. Olsen‘s
statement should be taken as an admission of a party opponent under Fed.R.Ev.
801(d)(2), and should be taken as definitive evidence of institutional bad faith, and
was argued as such in the proceeding below. As Ms. Olsen‘s statement
demonstrates, this Court should construe her statement as an admission that the
IRS as an institution has not acted in good faith.
This Court should not allow the IRS to trample over the rights of taxpayers,
ignore its obligations under the law, and defy the intent of Congress:
―[u]nquestionably the broad investigatory powers of IRS agents will occasionally
be subject to abuses. The courts should be attentive to circumstances where such
abuses are likely to have taken place.‖ United States v. McCarthy, 514 F.2d 368,
375 (3d Cir. 1975). Moreover, ―federal courts have never lent their enforcement
machinery to an executive branch investigative body in the manner of a rubber
stamp.‖ SEC v. Wheeling-Pittsburgh Steel Corp., 648 F.2d 118, 124 (3d Cir. 1981)
(en banc) (quoting In re Grand Jury Proceedings, 486 F.2d 85, 90 (3d Cir. 1973)).
Indeed, the District Court properly noted that ―the requirement of legitimate
purpose means nothing more than that the government‘s summons must be issued
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in good faith pursuant to one of the powers granted under 26 U.S.C. § 7602.‖
Memo. Op. at 9 (Doc. # 25; A-000017) quoting United States v. Rockwell Int'l, 897
F.2d 1255, 1262 (3d Cir. 1990).
However, the District Court erred in concluding that there is no evidence of
institutional bad faith when it misinterpreted this Court‘s holding in Pickel, supra.
As the District Court stated:
In considering bad faith under Powell, the Third Circuit has instructed
that ‗where the taxpayer can prove that the summons is issued solely
to harass him, or to force him to settle a collateral dispute, or that the
IRS is acting solely as an information-gathering agency for other
departments, such as the Department of Justice, or the FBI, the
summons will be unenforceable because of the IRS‘s bad faith.‘
Memo. Op. at 8-9, (Doc. # 25; A-000016-17) quoting Pickel, supra.
While this quote is not incorrect, it is incomplete. The full quote from this
Court‘s decision in Pickel is:
We do not doubt that portions of the Powell and LaSalle discussions
of bad faith retain vitality and that where the taxpayer can prove that
the summons is issued solely to harass him, or to force him to settle a
collateral dispute, Powell, 379 U.S. at 58, or that the IRS is acting
solely as an information-gathering agency for other departments, such
as the Department of Justice, LaSalle, 437 U.S. at 317, or the FBI, the
summons will be unenforceable because of the IRS's bad faith.
Pickel, supra at 185.
The District Court‘s memorandum opinion fails to include the citation to
both Powell and LaSalle. By reading the passage from the Pickel decision without
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looking at the underlying Supreme Court cases, the District Court‘s reading of
Pickel reads out a very important term in Powell, i.e., ―such as.‖ Powell, supra at
58. To the extent that there is a conflict between Powell and Pickel, Powell must
control. The teaching of Powell is that the District Court can quash an IRS
summons when its process has been, or would be abused. The Powel factors are
illustrative but not exhaustive, and as the District Court relied on a hyper-
restrictive view of the holding in Powell, its determination that there was not an
abuse of the District Court‘s process was in error and this Court must reverse the
District Court‘s order.
The District Court also reasoned that ―[s]hould the IRS ultimately seek to
assess tax penalties in the future, [Mr. Gangi] will then have the opportunity to
assert these constitutional and statutory defenses, and the court will then have the
opportunity to determine whether the IRS‘s conduct deprived [Mr. Gangi] of [his]
constitutional and statutory rights.‖ Memo. Op. at 10 (Doc. # 25; A-000018). The
District Court further reasoned that Appellant‘s ―institutional bad faith arguments
are premature.‖ Id. at 9-10 (Doc. # 25; A-000017-18).
However this reasoning is problematic. In essence, the District Court ruled
that violations of the United States Constitution cannot qualify as an abuse of the
District Court‘s process or as evidence of institutional bad faith, and cannot be
FUERST ITTLEMAN, PL
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raised at the first opportunity. Appellant submits that violations of the United
States Constitution are so important as to require that the District Courts and the
Circuit Courts examine them at the first opportunity (in this case in the context of
summons enforcement/petitions to quash summons). What could be more an abuse
of the Court‘s process than unconstitutional conduct?
The best way to illustrate the fallacy of the District Court‘s reasoning is by
way of hypothetical. If the IRS had an audit plan named ―the New Jersey Project‖
and issued IRS summonses in respect to those taxpayers residing in New Jersey for
tax years long since closed, but only for those individuals who are members of a
discrete racial group, should not the target of such an IRS audit be permitted at the
first opportunity to seek redress for such unconstitutional conduct? Appellant
submits one should as equal protection under the law mandates such a conclusion.
The fact that the violation of equal protection raised in the instant case is based on
income level instead of race should not be outcome determinative; rather the
determination should be made on a clear violation of the Equal Protection Clause
of the 14 th Amendment and/or the Due Process Clause of the Fifth Amendment.
Accordingly, the District Court‘s conclusion that Mr. Gangi‘s institutional bad
faith arguments are premature was in error, rather they were ripe for the District
Court‘s consideration.
FUERST ITTLEMAN, PL
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Finally, the District Court erred in concluding that the Taxpayer Advocate‘s
Report was only a proper policy position properly directed at the political branches
of government. Mem. Op. at 10 (Doc. # 25; A-000018). The District Court
concluded that by allowing a taxpayer such as Mr. Gangi to contest the
enforcement of an IRS summons, notwithstanding the fact that the taxpayer had
raised a facial challenge to IRS investigatory policies at this preliminary stage,
would, inter alia, ―open the door to judicial management of IRS investigations,
whenever a taxpayer objects to the IRS‘s ‗institutional‘ bad faith.‖ Id. at 9-10
(Doc. # 25; A-000017-18). While the District Court may have concern for the
parade of horribles that would be unleashed if the District Court would have to
examine institutional bad faith, such concern is unfounded
The reason that the District Court‘s concern is unfounded is that in the
instant case, unlike nearly all summons enforcement proceedings, the IRS
Taxpayer Advocate has stated in public documents that the IRS is targeting of a
select group of taxpayers for select treatment. This uncontroverted evidence
together with the unconstitutional concept of a ―covered person‖ makes this case
so unlike any other case before it, and presumably unlike any other case that will
follow. Accordingly, The District Court‘s conclusion that it would be imposing
limitations that would hinder legitimate functions of the IRS pursuant to IRC §
FUERST ITTLEMAN, PL
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7602 was in error as the broad investigatory powers given to the IRS are not
without limits. Indeed, as this Court noted in another context, ―rarely if ever does
not mean never.‖ 12 This is one of the rare cases where there is institutional bad
faith which requires quashing of the subject summonses. 13
Accordingly, Mr. Gangi demonstrated through the aforementioned public
documents that the IRS is unconstitutionally, and in bad faith, singling out
taxpayers such as himself, and the enforcement of the subject summons was in fact
an abuse of the District Court‘s process. Consequently the District Court‘s
decision that the subject summonses should be enforced (and conversely the
denial, in part, of Mr. Gangi‘s Petition to Quash) was in error, and as such this
12
In re: United States, 273 F.3d 380, 385 (3d Cir. 2001) (addressing issuance of
writ of mandamus).
13 The District Court also appears to be implying that this is a political question that
should be addressed by the political branches of government. To the extent that
the District Court concluded that the IRS‘ never-ending audits of select USVI
taxpayers is a political question best left for Congress, the District Court erred.
Undoubtedly, "[t]he political question doctrine excludes from judicial review those
controversies which revolve around policy choices and value determinations
constitutionally committed for resolution to the halls of Congress or the confines of
the Executive Branch. . . . But under the Constitution, one of the judiciary's
characteristic roles is to interpret statutes, and [the courts] cannot shirk this
responsibility merely because [the] decision may have significant political
overtones." Japan Whaling Ass'n v. American Cetacean Society, 478 U.S. 221,
229-230, 106 S. Ct. 2860, 2866, 92 L. Ed. 2d 166 (1986). In the instant case we do
not have a pure political question; instead we have questions of institutional bad
faith and constitutional violations which require judicial intervention.
FUERST ITTLEMAN, PL
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Court should reverse the January 7, 2011, Order entered by the District Court and
direct to the District Court to quash the issuance of the subject summonses.
CONCLUSION
For the reasons contained in Points I at Sub-Point A and B, this Court must
vacate the decision of the District Court granting the IRS motion to enforce
compliance with the IRS third-party summonses issued to CitiBank and Sovereign
Bank and must enter an order directing the District Court to quash said third-party
summonses in their entirety.
Respectfully Submitted,
_________________________
Joseph A. DiRuzzo, III, Esq., CPA
USVI Bar # 1114; NJ Bar # 1912-2005
FUERST ITTLEMAN, PL
1001 Brickell Bay Drive, 32 nd Floor
Miami, FL 33131
305.350.5690 (o)
305.371.8989 (f)
jdiruzzo@fuerstlaw.com
FUERST ITTLEMAN, PL
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CERTIFICATE OF BAR MEMBERSHIP
The undersigned counsel hereby certifies that he is a member of the bar of
the United States Courts of Appeals for the Third Circuit.
_________________________
Joseph A. DiRuzzo, III, Esq., CPA
CERTIFICATE OF COMPLIANCE RE: WORD COUNT
Pursuant to Fed.R.App.P. 32(a)(7)(C)(i) counsel certifies that this brief is in
compliance with the 14,000 typed- volume limitation of Rule 32(a)(7)(B)(i). The
instant brief is 8,075 words in length.
_________________________
Joseph A. DiRuzzo, III, Esq., CPA
CERTIFICATE OF COMPLIANCE RE: E-BRIEF
Counsel hereby certifies that the text of the E-Brief and the text of the hardcopy
briefs are identical.
_________________________
Joseph A. DiRuzzo, III, Esq., CPA
CERTIFICATE OF COMPLIANCE RE: VIRUS CHECK
Counsel also certifies that he has performed a virus scan on the E-Brief
using Symantec Anti-virus software.
_________________________
Joseph A. DiRuzzo, III, Esq., CPA
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CERTIFICATE OF SERVICE
I hereby certify that on the 13th day of June, 2011, I caused:
1. Pursuant to L.A.R. Misc. 113.14, an electronic original copy of the brief and
appendix (volumes I and II) to be filed via ECF.
2. Ten paper copies of the brief and volume I of the appendix and four paper
copies of the volume II of the appendix will be sent via Federal Express to the
Clerk, United States Court of Appeals for the Third Circuit, 601 Market Street,
Philadelphia, PA, 19106 within five days pursuant to L.A.R. 31.1 and
L.A.R.Misc. 113.1(b).
3. An electronic copy to John Schumann, Esq., U.S. Dept. of Justice, Tax
Division, Appellate Section, pursuant to Fed. R. App. P. 25(c)(1)(D), Local
Appellate Rule 25.1(b), and L.A.R. Miscellaneous Rules 113.2(c) and 113.4(a).
A courtesy paper copy of the brief and both volumes of the appendix will be
mailed to the above address.
_________________________
Joseph A. DiRuzzo, III, Esq., CPA
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Case: 11-1612 Document: 003110561288 Page: 44 Date Filed: 06/13/2011
No. 11-1612
In the United States Court of Appeals
for the Third Circuit
FRANK GANGI,
vs.
UNITED STATES OF AMERICA,
Appellant,
Appellee.
ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE
DISTRICT OF NEW JERSEY, Case No. 3:10-mc-24-GEB-DEA
HON. G. E. BROWN, JR., PRESIDING
_______________________________________________
JOINT APPENDIX VOLUME I
PAGE NUMBERS A-000001 THROUGH A-000025
_______________________________________________
Joseph A. DiRuzzo, III, Esq., CPA
FUERST ITTLEMAN, PL
1001 Brickell Bay Drive, 32 nd Floor
Miami, FL 33131
305.350.5690 (o)
305.371.8989 (f)
jdiruzzo@fuerstlaw.com
Counsel for Appellant, Frank Gangi
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Case: 11-1612 Document: 003110561288 Page: 45 Date Filed: 06/13/2011
APPENDIX VOLUME I
TABLE OF CONTENTS
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PAGE
NOTICE OF CROSS APPEAL…………………………………………..A-000001
AMENDED NOTICE OF CROSS APPEAL…………………………….A-000004
ORDER…………………………………………………………………...A-000007
MEMORANDUM OPINION ADOPTING REPORT & RECOMMENDATION
WITH MODIFICATIONS………………………………………………..A-000009

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A-000002

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A-000003

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A-000004

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A-000005

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NOT FOR PUBLICATION
UNITED STATES DISTRICT COURT
DISTRICT OF NEW JERSEY
__________________________________________
)
FRANK GANGI, FERROUS MINER HOLDINGS )
LTD, BABP VI LLC, and GLOBAL NAPS INC, ) Hon. Garrett E. Brown, Jr.
)
Petitioners, ) Civil Action No. 10-24
v. )
) ORDER
UNITED STATES OF AMERICA, )
)
Respondent. )
__________________________________________)
This matter having come before the Court upon the petitions to quash (Doc. Nos. 1, 5)
filed by Petitioners Frank Gangi, Ferrous Miner Holdings, Ltd. (“Ferrous Miner”), BABP VI
LLC, and Global Naps Inc., upon the Government’s motion to enforce (Doc. No. 4), and upon
the August 25, 2010 Report and Recommendation filed by Magistrate Judge Douglas E. Arpert
(Doc. No. 12); and this Court having considered the parties’ submissions and decided the matter
without oral argument pursuant to Federal Rule of Civil Procedure 78; and for the reasons stated
in the accompanying Memorandum Opinion;
IT IS THIS 7th day of January, 2011,
ORDERED that the August 25, 2010 Report and Recommendation (Doc. No. 12) is
ADOPTED WITH MODIFICATIONS; and it is further
ORDERED that the Government’s motion to enforce (Doc. No. 4) is GRANTED IN
PART, such that the CitiBank and Sovereign Bank summonses may be enforced as against
Petitioner Gangi; and it is further
ORDERED that the petitions to quash (Doc. Nos. 1, 5) are GRANTED IN PART, such
A-000007

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that the CitiBank and Sovereign Bank summonses may not be enforced as against Petitioners
Ferrous Miner and BABP; and it further appearing that CitiBank has already submitted the
documents requested by the summons, it is further
ORDERED that the Government either destroy or return all the documents produced
under the CitiBank subpoena and reissue a summons limited to documents concerning Mr.
Gangi’s accounts and transactions, or it may screen out documents concerning the accounts of
Ferrous Miner and BABP; and it is further
ORDERED that the portion of the August 25, 2010 Report and Recommendation finding
that the IRS’s investigation did not violate the Internal Revenue Code’s statute of limitations is
VACATED.
/s/ Garrett E. Brown, Jr.
GARRETT E. BROWN, JR., U.S.D.J.
A-000008

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NOT FOR PUBLICATION
UNITED STATES DISTRICT COURT
DISTRICT OF NEW JERSEY
__________________________________________
)
FRANK GANGI, FERROUS MINER HOLDINGS )
LTD, BABP VI LLC, and GLOBAL NAPS INC, ) Hon. Garrett E. Brown, Jr.
)
Petitioners, ) Civil Action No. 10-24
v. )
) MEMORANDUM OPINION
UNITED STATES OF AMERICA, ) ADOPTING REPORT &
) RECOMMENDATION
Respondent. ) WITH MODIFICATIONS
__________________________________________)
BROWN, Chief Judge:
This matter comes before the Court upon the petitions (Doc. Nos. 1, 5) of Frank Gangi,
Ferrous Miner Holdings, Ltd., BABP VI, LLC, and Global Naps, Inc. (collectively “Petitioners”)
to quash the summonses served on third-parties CitiBank and Sovereign Bank by Internal
Revenue Agent Jackie Moss (“Agent Moss”). The summonses were issued on February 2, 2010
(CitiBank) and May 10, 2010 (Sovereign Bank), respectively, and sought information and
documents regarding the accounts and transactions of all Petitioners for the purposes of
determining the tax liability of Petitioner Gangi. (Moss Decl. Ex. 101 (CitiBank summons);
Doc. No. 5 Ex. A (Sovereign Bank summons).) The Government moves to enforce these
summonses. (Doc. No. 4; see also Doc. No. 9.)
On August 25, 2010, Magistrate Judge Douglas E. Arpert issued an opinion and order
denying the petitions and granting the Government’s motion to enforce. Magistrate Judge Arpert
concluded that the Government had satisfied the requirements for enforcement articulated in
1
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United States v. Powell, 379 U.S. 48 (1964), namely that IRS had a legitimate purpose for
conducting the investigation, that the inquiry may be relevant to the purpose, that the information
sought was not already within the Commissioner’s possession, and that the administrative steps
required by the Internal Revenue Code had been followed. (See Doc. No. 11 at 7–8.) By Letter
Order of September 3, 2010, this Court redesignated Judge Arpert’s August 25 opinion and order
as a Report and Recommendation (“R&R”) in accordance with the procedure approved in United
States v. Mueller, 930 F.2d 10, 12 (8th Cir. 1991) and United States v. First National Bank of
Atlanta, 628 F.2d 871, 873 (5th Cir. 1980). Petitioners timely filed objections to Magistrate
Judge Arpert’s R&R. By Letter Orders of October 5th and 28th, the Court permitted limited
discovery and supplemental briefing regarding the Government’s compliance with Internal
Revenue Code procedures.
Having carefully reviewed the parties’ submissions and conducted de novo review of
Magistrate Judge Arpert’s R&R, this Court will adopt the R&R with modifications, grant the
Government’s motion to enforce in part, and grant the petition to quash in part.
Standard of Review
Local Civil Rule 72.1 governs this Court’s review of Magistrate Judge Arpert’s R&R.
That rule provides that the Court “shall make a de novo determination of those portions [of
the R&R] to which objection is made and may accept, reject, or modify, in whole or in part, the
findings or recommendations made by the Magistrate Judge.” L. Civ. R. 72.1(c)(2); see also 28
U.S.C. § 636(b)(1)(C); Fed. R. Civ. P. 72(b). In conducting its review, the Court was mindful
that it “may consider the record developed before the Magistrate Judge, [and] mak[e] [its] own
determination on the basis of that record.” L. Civ. R. 72.1(c)(2); see also State Farm Indem. v.
2
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Fornaro, 227 F. Supp. 2d 229, 231 (D.N.J. 2002). This Court has jurisdiction to consider the
petition and the Government’s motion pursuant to 26 U.S.C. §§ 7402(b) and 7609(h).
The Powell Standard
IRC § 7602(a) authorizes the IRS to issue summonses for “[f]or the purpose of
ascertaining the correctness of any return, making a return where none has been made,
determining the liability of any person for any internal revenue tax . . . , or collecting any such
liability.” Pursuant to this provision, the IRS may “examine any books, papers, records, or other
data which may be relevant or material to such inquiry.” IRC § 7602(a)(1). “Summons
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, 1262 (3d Cir. 1990) (quoting United States v. Barrett,
837 F.2d 1341, 1349 (5th Cir.1988) (en banc) (per curiam)). The Supreme Court in United
States v. Powell established the following test for taxpayer challenges to IRS summons issued
pursuant to § 7602(a): the IRS must show (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 the Commissioner’s possession; and (4) that the administrative steps
required by the Internal Revenue Code have been followed. 379 U.S. 48, 57–58 (1964). The
Third Circuit has recognized that, under the Powell test, “[t]he taxpayer retains the right to
challenge the summons on any appropriate ground. The teaching of . . . decisions [since Powell]
is that an ‘appropriate ground’ for challenging the summons exists when the taxpayer disproves
one of the four elements of the government’s Powell showing, or otherwise demonstrates that
enforcement of the summons will result in an abuse of the court’s process.” Rockwell, 897 F.2d
3
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at 1262 (citations omitted).
Petitioners’ Objections to Magistrate Judge Arpert’s R&R
Petitioners make the following objections to Magistrate Arpert’s R&R: (1) that the statute
of limitations finding was premature, because the IRS has not yet sought to assess taxes; (2) that
Magistrate Judge Arpert applied an improper legal standard that failed to consider Petitioners’
claims that enforcement of the IRS summonses would result in the abuse of the court’s process;
and (3) that the IRS’s disparate treatment of taxpayers on the basis of their residence in the
Virgin Islands and their annual income-level demonstrates institutional bad faith that warrants
quashing the IRS summonses; (4) that Magistrate Judge Arpert improperly concluded that the
bank records sought from CitiBank and Sovereign Bank were relevant to a legitimate
investigatory purpose; and (5) that the IRS failed to demonstrate compliance with the advance-
notice requirements of IRC § 7602(c). The Government asserts, and Petitioners do not contest,
that the IRS does not currently have the information it seeks, under the third Powell prong. The
Court considers each objection in turn.
1. Statute of Limitations
Petitioners first object to Magistrate Judge Arpert’s finding that “because Mr. Gangi did
not file a U.S. tax return for the years in question the statute of limitations has not expired.”
(R&R at 8.) The Court agrees that this finding is premature, because it addresses the merits of a
potential defense Petitioners could raise in the event that the IRS sought to assess tax penalties on
Petitioners. The IRS has not made such an assessment at this time; hence, consideration of their
potential defenses is premature. The Court will vacate this portion of Magistrate Judge Arpert’s
R&R, such that Petitioners will not be precluded from raising a statute-of-limitations defense in
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future proceedings, should the IRS assess new tax penalties for these tax years. This Court
expresses no opinion on the merits of such a defense.
However, the Court agrees with the primary point made by Magistrate Judge Arpert: that
the IRC statute of limitations does not definitively preclude the IRS from making such an
assessment in the future. (See id.) Petitioners had argued under the first Powell prong that the
IRS had no legitimate investigative purpose, because the IRC’s three-year statute of limitaitons,
IRC § 6501(a), barred the IRS from making further assessments against Petitioners. (Petrs.’
Omnibus Br. at 8.) Yet, the IRC statute of limitations applies to assessments of taxes, not to the
IRS’s investigative tools, like summonses. See, e.g., Powell, 379 U.S. at 57 (“Reading the
statutes as we do, the [IRS] Commissioner need not meet any standard of probable cause to
obtain enforcement of his summons, either before or after the three-year statute of limitations on
ordinary tax liabilities has expired.”); United States v. McHenry, 552 F. Supp. 2d 571, 574 (E.D.
Va. 2008) (“The three-year statute of limitations contained in 26 U.S.C. § 6501(a) plainly applies
only to assessment, not to summons or any other investigatory procedure.”). Furthermore, as
Magistrate Judge Arpert correctly noted, the IRC statute of limitations exempts from the
limitations period cases involving false or fraudulent returns, willful attempts to evade tax, and
the failure to file a return. IRC § 6501(c)(1)–(3). In this case, the IRS agent assigned to this
investigation claims that the IRS seeks documents from CitiBank and Sovereign Bank in order to
determine whether or not Mr. Gangi was a bona fide resident of the Virgin Islands for the tax
years 2000–2004. (Moss Decl. 3.) If Mr. Gangi was not a bona fide resident of the Virgin
Islands but derived income from sources within the Virgin Islands, the Code required him to file
a U.S. tax return for these years. IRC §§ 932(a)(1)–(2) (requiring the filing of tax returns in both
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the United States and the Virgin Islands). It is undisputed that Mr. Gangi did not file a U.S. tax
return for these tax years. Thus, one of the aforementioned exceptions to the IRC statute of
1
limitations (false return, willful evasion, failure to file) may apply, in which case the IRC statute
of limitations would not preclude further tax assessments against Petitioners. Consequently, the
Court rejects Petitioners’ objection to the extent that Petitioners maintain that the IRC statute of
limitations demonstrates that the IRS lacks a legitimate investigatory purpose under Powell.
2. Incomplete Legal Standard
Petitioners next argue that Magistrate Judge Arpert application of the Powell standard
was incomplete, because the R&R failed to account for Petitioners’ challenges on the
“appropriate ground[s]. . . . that enforcement of the summons will result in an abuse of the
court’s process.” (Petrs.’ Objections at 8.) Petitioners are correct that the Third Circuit in
Rockwell recognized that a taxpayer could challenge an IRS summons on such grounds, see
1
In their original petition brief, Petitioners cited cases holding that failure-to-file
exceptions to Code limitations provisions did not apply to cases where the taxpayer submitted the
incorrect tax form, but still gave the IRS all the data it needed to assess the tax. See, e.g.,
Germantown Trust Co. v. Comm’r of Internal Revenue, 309 U.S. 304 (1940); Standard Office
Bldg. Corp. v. United States, 819 F.2d 1371 (7th Cir. 1987). Yet, neither case addressed whether
the failure to file tax returns with both the United States and the Virgin Islands, as required by
IRC § 932(a), constituted a failure-to-file exception to the statute of limitations, as opposed to a
wrong-form filing, which is not exempted from the limitations period. More importantly,
though, these cases dealt with a tax assessment, not an IRS summons, which is issued during the
investigative phase prior to a tax assessment. Even if the failure-to-file exception was
categorically not applicable to Petitioners’ failure to file U.S. tax returns, the other two
exceptions might still apply, if the IRS found that Petitioners filed a false return or willfully
attempted to evade tax liability. As noted above, at this stage—a petition to quash an IRS
subpoena—this Court need not consider the merits of Petitioners’ statute of limitations defense;
this Court need only determine whether the IRS has a legitimate investigatory purpose. Under
these circumstances, the Court cannot say that these cases or the IRC statute of limitations
demonstrates that the IRS does not have a legitimate investigation purpose to issue these
summonses.
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Rockwell, 897 F.2d at 1262. However, the Court notes that the R&R properly acknowledged this
rule, even though it did not cite a Third Circuit precedent. (See R&R at 7 (noting that, after the
Government has made its Powell showing, “the burden shifts to the party contesting the
enforcement of the summons to disprove one of the [Powell] elements . . . or demonstrate to the
Court that enforcement of the Summonses would constitute an abuse of the court’s process”)
(citations omitted).) Thus, Petitioners’ objection is not that Magistrate Judge Arpert applied an
incorrect legal standard, but that he did not articulate reasons for rejecting their abuse-of-process
arguments. The R&R does not expressly address the abuse-of-process arguments. However,
because this Court exercises de novo review, this does not require granting Petitioners the relief
sought, but rather requires this Court to address the issue.
3. Institutional Bad Faith
Petitioners argue that the IRS’s policies with regard to investigating the returns of Virgin
Islands residents are arbitrary and unconstitutional, and therefore, that enforcement of these
summonses would result in an abuse of process. Specifically, Petitioners challenge the statute-
of-limitations policies adopted by IRS Notices 2007-19 and 2007-31. The former provided an
interim rule that, for U.S. citizens and residents claiming to be bona fide residents of the Virgin
Islands, the filing of a tax return with the Virgin Islands will start the federal statute of limitations
if the taxpayer had a gross income of less than $75,000. Notice 2007-19, available at
www.irs.gov. The latter amended Notice 2007-19 for taxable years 2006 and later, such that the
filing of a tax return with the Virgin Islands started the federal statute of limitations for all U.S.
citizens and residents claiming to be bona fide residents of the Virgin Islands, regardless of the
taxpayer’s income. Notice 2007-31, available at www.irs.gov. Petitioners contend that these
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policies demonstrate violations of the equal protection component of the Fifth Amendment’s Due
Process Clause, see Bolling v. Sharpe, 347 U.S. 497 (1954), because they discriminated against
certain taxpayers on the basis of residency and income level. Furthermore, Petitioners note that
criticisms of these policies appearing in a 2009 report by the IRS Taxpayer Advocate
demonstrates the IRS’s institutional bad faith in conducting investigations of the tax returns of
Virgin Islands residents. (See Petition Ex. E, Taxpayer Advocate Service, 2009 Annual Report
to Congress, Vol. I, Legislative Recommendation No. 10 (hereinafter “TAS Report”).)
Specifically, Petitioners point to the following statements made in the report: that “the IRS has
singled out a small group of USVI taxpayers for special treatment—the very types of high
income taxpayers that federal tax incentives are seeking to attract to the USVI—by effectively
eliminating the [statute of limitations] applicable to them but not the [statute of limitations]
applicable to other similarly situated taxpayers”; that “the IRS has, without legislation, upset
longstanding expectations by singling out for special treatment those taxpayers with gross
incomes of more than $75,000 who are claiming USVI residency”; and that “[t]he IRS’s repeated
failure to provide . . . information [regarding USVI cases] to [the Taxpayer Advocate Service], an
entity designed by Congress to protect taxpayer rights, is cause for concern.” See TAS Report at
391–92, 397, 399. “At some point,” Petitioners argue, “a court must take a hard look at the
actions of the IRS to ascertain whether the IRS has or is acting in good faith.” (Pet’r’s
Objections at 11.)
Petitioners have not persuaded the Court that the IRS acted in bad faith with regard to its
investigation of Petitioners. In considering bad faith under Powell, the Third Circuit has
instructed that “where the taxpayer can prove that the summons is issued solely to harass him, or
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to force him to settle a collateral dispute, or that the IRS is acting solely as an
information-gathering agency for other departments, such as the Department of Justice, or the
FBI, the summons will be unenforceable because of the IRS’s bad faith.” Pickel v. United States,
746 F.2d 176,185 (3d Cir. 1984) (reversing district court’s quashing of IRS summons, where
petitioners did not present evidence of bad faith) (citations omitted). The Circuit explained in
Rockwell that the good faith inquiry inheres in the Powell consideration of a legitimate
investigative purpose, in that “the requirement of legitimate purpose means nothing
more than that the government’s summons must be issued in good faith pursuant to one of the
powers granted under 26 U.S.C. § 7602.” 897 F.2d at 1262. Further, in the context of similar
administrative summonses issued by the SEC, the Circuit has indicated that “non-frivolous
allegations of [abuse of process] do constitute sufficient grounds for further proceedings,
including discovery.” SEC v. Wheeling-Pittsburgh Steel Corp., 648 F.2d 118, 128 (3d Cir. 1981)
(en banc).
Other than the length of the investigation (five years), Petitioners have presented no
evidence that the IRS has conducted its investigation of Petitioners with an improper purpose,
such as harassment. Instead, Petitioners arguments, if correct, would invalidate any IRS
summons issued pursuant to these policies to investigate tax anomalies in the Virgin Islands.
Such a position does not present a non-frivolous claim of abuse-of-process, but challenges the
IRS’s investigatory discretion. Cf. Wheeling-Pittsburgh, 648 F.2d at 127–29 (permitting
discovery on the allegation that a Congressman improperly influenced the SEC’s investigative
process, but noting that the court “w[ould] not countenance judicial interference with agency
decisions to conduct investigations”). The Court finds that Petitioners’ “institutional bad faith”
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arguments are premature.
The instant dispute, coming prior to the assessment of any tax penalties, does not involve
a claim that the IRS violated Petitioners’ constitutional or statutory rights. Rather, it involves
Petitioners’ claims that the IRS has exceeded the scope of its investigatory authority under law.
The IRS has asserted a legitimate investigatory purpose—to determine whether or not Mr. Gangi
was a bona fide resident of the Virgin Islands for purposes of determining whether or not he
satisfied his federal income tax liabilities. (See Moss Decl. 3, 14.) As noted above, failure-to-
file and fraudulent filing exceptions to the IRC statute of limitations may apply, and thus the IRC
statute of limitations does not render the IRS’s investigation in this case illegitimate. Should the
IRS ultimately seek to assess tax penalties in the future, Petitioners will then have the
opportunity to assert these constitutional and statutory defenses, and the court will then have the
opportunity to determine whether the IRS’s conduct deprived Petitioners of their constitutional
and statutory rights.
The TSA Report, while a reasonable policy proposal for improving the fairness,
transparency, and efficiency of IRS investigations, does not demonstrate that the IRS has acted in
bad faith by investigating Petitioners’ tax liabilities. Indeed, the TSA Report recognizes the
existing exceptions to the IRC statute of limitations for failure-to-file and fraudulent filings.
TSA Report at 396. Such policy arguments are properly directed towards the political branches
of government. To countenance such a facial challenge to the IRS’s investigatory policies at this
preliminary stage would effectively preclude the IRS from using administrative summonses to
investigate instances of such tax misfeasance (failure-to-file, fraudulent filings) in the Virgin
Islands, and would open the door to judicial management of IRS investigations, whenever a
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taxpayer objects to the IRS’s “institutional” bad faith. Such limitations would significantly
hinder the IRS in its legitimate law enforcement functions. The Court finds this prospect
inconsistent with the broad investigatory powers accorded to the IRS by IRC § 7602(a), and the
“summary” nature of enforcement proceedings under Powell, see Rockwell, 897 F.2d at 1264.
Besides the statute of limitations and institutional bad faith arguments, Petitioners do not
contest that the IRS has a legitimate investigative purpose, under the first prong of Powell, to
ascertain whether the taxpayers are bona fide residents of the Virgin Islands. The Government
notes that the IRS has discovered a common tax scheme, whereby taxpayers can reduce their tax
liabilities by up to 90% by (a) purporting to become a Virgin Islands resident by establishing
certain contacts with the USVI; (b) purporting to terminate an existing employment relationship
with one’s employer; (c) joining or establishing a business entity in the Virgin Islands; (d) having
that business enter into a contract for the same services with the former employer; (e) continuing
to provide services to the original employer via the new business entity, rather than as an
employee; (f) funneling payment for these services through the new business entity; and (g)
reporting this income on a tax return in the Virgin Islands and claiming tax benefits under the
Virgin Islands’ Economic Development Program (EDP). See IRS Notice 2004-45, available at
www.irs.gov; see also Twin Palms Resort LLC v. United States, Civ. No. 09-61062, unpublished
order in Chambers, at 1–2 (S.D. Fla. Nov. 4, 2009) (Moss Decl. Ex. 100). This Court does not
doubt that the IRS has a legitimate interest in ferreting out such fraudulent returns.
4. Materials Relevant to Legitimate Investigative Purpose
Petitioners next contend that the Government cannot satisfy the second Powell prong,
because the bank records sought in the summonses were not relevant to determining whether or
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not Mr. Gangi was a bona fide resident of the Virgin Islands. Such records are irrelevant,
Petitioners argue, because modern technology permits individuals to maintain bank accounts and
authorize transactions remotely from anywhere around the world. This Court disagrees.
Because of the permissive language in IRC § 7602(a), the relevancy threshold under
Powell is not demanding. See IRC § 7602(a)(1) (authorizing the Government to “examine any
books, papers, records, or other data which may be relevant or material to [tax collections
inquiries]” (emphasis added)). Indeed, the Third Circuit has recognized that IRC § 7602(a) sets a
“rather liberal standard of relevance” that permits the Government to obtain “information that has
only ‘potential relevance’ to the investigation.” Rockwell, 897 F.2d at 1263 (quoting United
States v. Arthur Young & Co., 465 U.S. 805, 814 (1984)). Although the Court recognizes the
conveniences of modern technology, the Court cannot categorically say that bank records have no
relevance to a consideration of residency. See accord Twin Palms, Civ. No. 09-61062,
unpublished order in Chambers, at 9; cf. Vazquez v. C.I.R., T.C. Memo. 1993-368, 1993 WL
315404, at *4 (T.C. Aug. 19, 1993) (considering taxpayer’s Puerto Rican bank account, in
determining that he was a bona fide resident of Puerto Rico for tax purposes).
5. Non-Compliance With IRC § 7602(c)’s Advance Notice Requirement
Finally, Petitioners object that the R&R summarily rejected their position with regard to
the fourth prong of the Powell test, compliance with applicable administrative procedures under
the IRC. Petitioners contend that the administrative summonses themselves revealed that the IRS
failed to give the advance notice required by IRC § 7602(c), and that Magistrate Judge Arpert
improperly relied on the declaration of Agent Moss, which stated that the IRS had complied with
all applicable administrative procedures under the IRC during this investigation. (See Moss
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Decl. 13.) By Letter Orders of October 5th and 28th, the Court permitted limited discovery and
supplemental briefing regarding the Government’s compliance with IRC § 7602(c), and the
parties timely filed responsive submissions.
Petitioner Frank Gangi filed an affidavit attesting to the following facts: (i) that he was
the sole owner of Petitioners BABP VI, LLC (“BABP”) and Ferrous Miner Holdings, Ltd.
(“Ferrous Miner”); (ii) that the Law Office of Marjorie Roberts, P.C. (the registered agent of
BABP) received correspondence from Agent Moss on or about February 2, 2010, which
contained IRS Form 4564, Publication 1, and Publication 3498; (iii) that the February 2, 2010
correspondence was the first correspondence he received that indicated that BABP was under
examination by the IRS; (iv) that he received similar correspondence from Agent Moss with
respect to the IRS’s investigation of Ferrous Miner on or about February 3, 2010; and (v) that the
February 3 correspondence was the first correspondence he received that indicated that Ferrous
Miner was under investigation by the IRS. (Gangi. Aff.) The Government responded with the
Declaration of IRS Agent William Everett, whose review of IRS records revealed that the IRS
sent a Letter 3164 to Mr. Gangi on December 19, 2005, that advised him that the IRS may
contact third parties in connection with its investigation of his federal tax liabilities. (Everett
Decl. & Ex. 102 (Letter of December 19, 2005, Form 3164.) The Government argues that this
advance notice to Mr. Gangi satisfies IRC § 7602, and that the subsequent notice to BABP and
Ferrous Miner was sufficient under IRC § 7609(a)(1), which permits contemporaneous notice,
within three days, to “any person (other than the person summoned) who is identified in the
summons.” (Doc. No. 21, Gov’t Supp. Br. at 2.) Given the opportunity to reply, Petitioners did
not deny that Mr. Gangi received advance notice of third-party contact, but respond that IRC
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§ 7602(c) required advance notice to BABP and Ferrous Miner as well, because the IRS
summonses sought documents concerning these entities too.
IRC § 7602(c) provides in pertinent part:
An officer or employee of the Internal Revenue Service may not contact
any person other than the taxpayer with respect to the determination or
collection of the tax liability of such taxpayer without providing
reasonable notice in advance to the taxpayer that contacts with persons
other than the taxpayer may be made.
The Government has provided competent evidence, and Petitioners do not dispute, that the IRS
gave advance notice to Mr. Gangi prior to contacting third parties “with respect to the
determination or collection of the tax liability of such taxpayer.” Thus, IRC § 7602(c) does not
preclude enforcement of the summonses as against Mr. Gangi. However, because the
summonses also sought documents concerning Mr. Gangi’s wholly-owned businesses BABP and
Ferrous Miner, the question remains whether IRC § 7602(c) required the IRS to provide separate
advance notice to Petitioners BABP and Ferrous Miner prior to contacting third parties.
The Government argues that advance notice was not required, but rather that
2
contemporaneous notice under IRC § 7609 sufficed, because BABP and Ferrous Miner were not
the “taxpayers” under investigation, as reflected by the caption on the summons, which indicated
that the summonses were issued “In the matter of United States Income Tax Liability of Frank
Gangi.” This response is not entirely satisfactory, because, as Petitioners note, BABP and
Ferrous Miner both received notices contemporaneous with the first, CitiBank summons
2
IRC § 7609 permits contemporaneous notice (within three days of service of summons,
so long as the date of service is not more than 23 days before the date of production) to “any
person” who “is identified in the summons,” if the summons requires the submission of evidence
relating to that person.
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(February 2, February 3) that they were under investigation for their tax liability for tax years
2000–2004. (See Compl. Exs. C, D.) The Government also cites Thompson v. United States,
2008 WL 4279474 (S.D. Tex. Sept. 11, 2008) for the proposition that a taxpayer’s controlled
3
business entities need not receive advance notice, but this case does not appear to address the
notice required by IRC §7602(c) for a taxpayer’s wholly-owned corporations, where those
corporations were also “taxpayers” under investigation. See id. at *6–7 (addressing taxpayer’s
argument that he had not received sufficient advance notice of third-party contact, and noting that
the IRS complied with the notice requirements of IRC § 7609).
The Court is not persuaded that contemporaneous notice of Ferrous Miner and BABP
under IRC § 7609 suffices, because Ferrous Miner and BABP are currently “taxpayers” under
investigation, and the summonses sought documents from third-parties that would be relevant to
an assessment of their tax liabilities. One of the motivating purposes for IRC § 7602(c) was
Congress’s concern that IRS contacts with third-parties “may have a chilling effect on the
taxpayer’s business and could damage the taxpayer’s reputation in the community. Accordingly,
. . . taxpayers should have the opportunity to resolve issues and volunteer information before the
IRS contacts third parties.” S. Rep. No. 105-174, at 77 (1998); see also United States v. Jillson,
No. 99-Civ-14223, 1999 WL 1249414, at *3 (S.D. Fla. Oct. 28, 1999). To permit advance
notice of one taxpayer to satisfy the advance-notice requirements with regard to other taxpayers
under investigation, even where those taxpayers are entities wholly-owned by the taxpayer under
3
The Government also cites Phillips v. United States, 178 F.3d 1295 (6th Cir. 1999) (per
curiam, unpublished decision), for this proposition, but this case did not consider the effect of the
recently-passed advance-notice requirement, see Pub.L. No. 105-206, § 3417, 112 Stat. 685, 757
(1998), now codified at IRC § 7602(c).
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investigation, would undercut the public policy advanced by IRC § 7602(c). The failure to
provide the advance notice required by IRC § 7602(c) defeats the fourth prong of the Powell test,
and precludes enforcement of the summonses in a manner that would reveal information
regarding against Ferrous Miner and BABP. See Jillson, 1999 WL 1249414, at *3 (quashing IRS
summons where corporation did not receive advance notice under IRC § 7602(c) before IRS
issued summonses upon the corporations officers).
However, the IRS’s failure to provide advance notice to these legal entities does not
evince bad faith so as to render the summonses void in their entirety. As noted above, the IRS
gave advance notice of third-party contact to Mr. Gangi. The Court will grant Petitioners’
motion to quash in part and excise the portion of the summonses seeking information concerning
4
Ferrous Miner and BABP. The Court notes that the Government has already received the
documents requested by the CitiBank summons and placed them under seal, pending the Court’s
consideration of this petition. (See Doc. 19.) The Court will order the Government to separate
documents relating to Ferrous Miner and BABP’s accounts and business transactions, in the
presence of Petitioners’ representative, for either destruction or return to CitiBank; in the
alternative, the Government may dispose of the documents and issue a new summons upon
CitiBank seeking documents concerning Mr. Gangi’s personal accounts and transactions. With
regard to the Sovereign Bank summons, the Court will enforce the summons only to the extent
that it seeks documents concerning Mr. Gangi’s personal accounts with that institution.
4
The Court notes that the parties’ supplemental submissions did not address the notice, if
any, provided to Petitioner Global Naps, Inc. Because the summonses sought information
concerning this Petitioner as well, the summonses shall be quashed as to this entity, too, if it was
not provided with advance notice under IRC § 7602(c).
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Sovereign Bank may withhold documents relating to Ferrous Miner and BABP. The IRS may
issue further summonses seeking information about Ferrous Miner and BABP after providing
advance notice to these entities consistent with IRC § 7602(c).
Conclusion
Having conducted de novo review and determined that the summonses satisfy the Powell
standard, to the extent that they seek information regarding Petitioner Gangi, the Court will adopt
Magistrate Judge Arpert’s Report and Recommendation with modifications, and the Court will
grant the Government’s motion to enforce in part (Doc. No. 4). Because the Court finds that the
IRS did not comply with the administrative requirements of the Internal Revenue Code with
respect to Petitioners Ferrous Miner and BABP, the Court will grant the petitions to quash (Doc.
Nos. 1, 5) in part and require the Government to comply with the advance-notice requirements of
IRC § 7602(c) as described above. The portion of the R&R finding no violation of the IRC
statute of limitations will be vacated. An appropriate form of Order accompanies this
Memorandum Opinion.
Dated: January 7, 2011
17
/s/ Garrett E. Brown, Jr.
GARRETT E. BROWN, JR., U.S.D.J.
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