Pennsylvania: State Supreme Court upholds made-up tax assessment
In the case City of Philadelphia v. Lerner, the Pennsylvania Supreme Court upheld what it characterized as an “exorbitant assessment” against a taxpayer, albeit unsympathetic, that was invented out of whole cloth. The court, noting that the taxpayer had failed to provide any records from which the City could determine a taxable income, inferred that the assessment “apparently was not tied to any specific information in the City’s possession.” Instead, it was fabricated in order to get the taxpayer’s attention, and ultimately, force him to hand over his business records.
Background
In September 2004, the City received an anonymous letter accusing the taxpayer of concealing business income. The informant included checks it had made out to the taxpayer, several of which were issued by the taxpayer’s alleged business partner.
The City investigated the accusations, and in February of 2006, sent the taxpayer a letter asserting that he had failed to pay Philadelphia’s net profits tax and/or business income and receipts tax. The letter demanded that the taxpayer submit his previous five years of federal tax returns, a completed worksheet, and payment. Although the letter warned the taxpayer that his non-compliance would cause the City to file an enforcement action, the City never received a response. Thus, one month later, it sent the taxpayer a “final notice,” declaring that it would institute collection proceedings absent the taxpayer’s production of his federal tax returns within 10 days.
The record showed that the taxpayer testified that he mailed a response to the City, but the trial court found Lerner’s testimony to be self-serving and incredible, such that it did not enter the alleged response into evidence.
In November 2006, the City sent the taxpayer a delinquent tax bill, estimating his net business income to be $150,000. Of this, the Supreme Court opined the following:
This number apparently was not tied to any specific information in the City’s possession because, without [the taxpayer’s] tax records, the City had no idea how much [the taxpayer’s] businesses earned. The City hoped that, confronted with an exorbitant assessment, [the taxpayer] would hand over his business records. But this failed to get [the taxpayer’s] attention. He simply ignored the bill.
The City filed a complaint against the taxpayer to collect the assessment, to which he failed to respond, so the trial court granted the City default judgment. Upon discovering the default judgment, the taxpayer got the case reopened, then sent the City a letter stating that he had never received the delinquent tax bill, to which the City responded by providing a copy of that bill. Though the taxpayer admitted that he received this copy, he did not pay it, so the City reinstated and served its collection action complaint.
The taxpayer refused to cooperate with the City’s collection attempts, and the parties engaged in additional legal maneuvering. According to the Court, the taxpayer “sought to delay the City’s collection action with onerous discovery requests and frivolous filings. He served hundreds of interrogatories, requests for admissions, and requests for production of documents.”
At the same time, the taxpayer refused to disclose any information about his income, expenses, assets, and business interests. When the trial court ordered him to comply with discovery, the taxpayer again refused. The trial court would not allow the taxpayer to enter any evidence at trial that he had not disclosed to the City, and also precluded him from challenging the assessment of his tax liability at trial.
The trial court awarded the City $280,772.67, the sum of the principal liability of $74,907; $85,828.05 in interest; and $120,037.62 in penalties. But during trial, when asked how the City determines net business income if a taxpayer refuses to submit the necessary records, a revenue collection manager testified that the City “really just makes [it] up.” Indeed, the trial judge characterized the assessment as “basically an amount pulled out of the sky,” but nevertheless justified the amount on the rationale that the taxpayer had waived his right to challenge that assessment by failing to timely petition the Tax Review Board for review.
On appeal
The taxpayer appealed, on the grounds that despite his failure to exhaust his administrative remedies, he was still entitled to challenge the tax assessment “when the taxing authority’s own evidence demonstrates that the assessment has no basis in fact.” But both the appellate court and the Supreme Court agreed that he had waived his right to appeal on this ground because the only issue he raised at trial was that the City fabricated the assessment without any evidentiary basis.
The taxpayer appealed again, to the Supreme Court. That Court, in upholding the tax assessment, reasoned that
[i]t could not be more obvious that these are utterly distinct contentions. The former is a substantive challenge to the City’s assessment, whereas the latter concerns the trial court’s jurisdiction to hear such a challenge in the first place. By failing to comply with [the applicable rule, the taxpayer] waived the issue that he now requests this Court to address.
In so doing, the Court declined to “craft a special exception” for this taxpayer because “to afford [him] relief would permit litigants freely to skip the administrative process and attempt another bite at the tax apple in our trial courts…[the] process consists of rules, and [the taxpayer] has flouted them at every turn.”
The dissents
Two justices wrote dissenting opinions. Chief Justice Saylor opined that such a strict enforcement of the waiver doctrine runs counter to scholarship on the topic from various bar associations, and the Rules of Appellate Procedure. In asserting that courts should recognize exceptions for extraordinary circumstances, the Chief Justice contended that one such situation is when a court is called on to enforce a fraudulent or sham judgment, as in this case: “[a]t bottom, I simply do not believe that a court of last resort should in any way permit to be condoned or validated what appears very clearly, on this record, to be an arbitrary judgment obtained via such subversive means.”
Justice Donohue also wrote a dissenting opinion, whose rationale was very similar to that of the Chief Justice. Wrote Justice Donohue:
The Majority, in robotic adherence to common rules of efficiency, and without even a mention of this Court's overarching duty to protect and maintain public confidence in the integrity of Pennsylvania's court system, implicitly blesses the City's fraudulent behavior. Because this Court should, without exception, exercise our supervisory authority to ensure that the courts of this Commonwealth retain a steadfast fidelity to honesty and integrity, I must respectfully dissent.…[The] decisions of the courts below reflect an egregious misunderstanding of a fundamental principle that must guide our courts: to maintain public confidence, courts of this Commonwealth must retain their fidelity to honesty and integrity.…No party should be permitted to invoke judicial intervention to collect on an admittedly fraudulent assessment. To maintain public confidence, the courts of this Commonwealth must retain their fidelity to honesty and integrity.
