The opinion of the court was delivered by: LUONGO
On July 28, 1977, the District Director of Internal Revenue for Philadelphia made a termination assessment
of federal income tax liability against the plaintiff, Paul G. Loretto, Jr. At Loretto's request, the Secretary of the Treasury then reviewed the reasonableness of that assessment, pursuant to § 7429(a) of the Internal Revenue Code, 26 U.S.C.A. § 7429(a) (Supp. 1977), and affirmed the District Director. Loretto now seeks judicial review of the termination assessment. 26 U.S.C.A. § 7429(b)(2) (Supp. 1977).
For the reasons hereafter stated, I conclude that the assessment is "reasonable under the circumstances." 26 U.S.C.A. § 7429(b)(2)(A) (Supp. 1977).
The parties have stipulated to the following facts. Loretto lives with his wife and son in Chester, Pennsylvania, in a house that he and his wife own jointly. On February 10, 1977, Pennsylvania State Police officers, acting pursuant to a search warrant, entered and searched the Loretto home. In the course of their search, the police found $14,050 in cash under a mattress in the bedroom shared by Loretto and his wife. This money was then seized, and it has remained in the custody of the Pennsylvania State Police since the search. The police inventory form, submitted as an exhibit to the stipulation, discloses that the police also found in the home (and seized) an additional $2,418 in cash, two handguns, a quantity of marijuana in excess of three and a half pounds, more than a dozen vials and plastic bags that were suspected to contain cocaine, approximately ten vials and bottles containing unidentified capsules or pills, and a triple-beam balance. Loretto, his wife, and their son were arrested
and "charged with conspiracy and with possession with the intent to deliver controlled substances in violation of the laws of Pennsylvania." Stipulation paras. 6, 7. Loretto was convicted in the Delaware County Court of Common Pleas and has filed several post-trial motions; his wife and son were both acquitted of these charges. Finally, Loretto's previous criminal record prior to these charges includes a 1962 guilty plea to "burglary, larceny, conspiracy, and receiving stolen goods," and a 1967 guilty plea to "larceny and receiving stolen goods." Stipulation para. 8.
Affidavits submitted by the Government disclose the following additional facts. In mid-July of 1977, IRS Agent Lamb, upon learning some
of the facts just recounted, began to investigate Loretto's financial circumstances. Agent Lamb's inquiry revealed that Loretto had filed no federal income tax return for 1976, and that he had filed a return for 1975 that showed a tax liability of eighty-four dollars. In searching the property records for Philadelphia County and Delaware County (which encompasses Chester, Pennsylvania), Agent Lamb found no assets listed in Loretto's name. Finally, Agent Lamb found no recently-purchased automobiles listed in Loretto's name. Based on this information, Agent Lamb "proposed that [Loretto's] taxable year be terminated" pursuant to § 6851(a) of the Internal Revenue Code. Lamb Affidavit para. 11. Based on the same information, James T. Rideoutte, the District Director of Internal Revenue for Philadelphia, determined that Loretto was "designing quickly to place his property beyond the reach of the Government by either concealing it or dissipating it." Rideoutte Affidavit para. 2. Rideoutte notified Loretto of this determination in a letter dated July 27, 1977, stating that $5,015.18 in income tax for the period from January 1, 1977 to February 10, 1977 "is due and payable immediately." Exhibit A to Plaintiff's Brief, at 1. On July 28, 1977, Loretto's tax year was terminated for the period from January 1, 1977 to February 10, 1977. Rideoutte Affidavit para. 3. This action was taken pursuant to § 6851(a) of the Internal Revenue Code. See note 1 supra.
Loretto now seeks judicial review of the termination assessment, pursuant to § 7429(b) of the Code.
Section 7429(b)(2) provides that, in a case of this kind,
"the district court shall determine whether or not --
(A) the making of the assessment under section 6851, 6861, or 6862, as the case may be, is reasonable under the circumstances, and
(B) the amount so assessed or demanded as a result of the action taken under section 6851, 6861, or 6862, is appropriate under the circumstances."
At the outset, two aspects of the district court's task under § 7429(b)(2) require clarification. First, the Government argues that the reviewing court "should give considerable weight and deference to the judgment of the Internal Revenue Service" in cases involving termination assessments. Supplemental Brief of the United States at 3. Although the statute itself is silent on this point, the report of the Senate Finance Committee on this provision of the Tax Reform Act of 1976 states plainly that "the district court is to make independent, de novo determinations" in considering (1) the reasonableness of the assessment, and (2) the appropriateness of the amount assessed. S. Rep. No. 94-938 (part I), 94th Cong., 2d Sess. 364-65 (1976), reprinted in  U.S. Code Cong. & Admin. News 3439, 3794. Moreover, the entire legislative history of § 7429(b)(2) demonstrates that this intention was shared by both houses of Congress. The bill originally reported out by the House Ways and Means Committee provided for limited judicial review of termination assessments only in the United States Tax Court. H.R. 10612, 94th Cong., 1st Sess. § 1209 (1975); H.R. Rep. No. 94-658, 94th Cong., 1st Sess. 303-04 (1975), reprinted in  U.S. Code Cong. & Admin. News 2897, 3199-200. The Senate Finance Committee amended H.R. 10612 to provide for, inter alia, review in the district courts, and it used the language quoted earlier in explaining the new provisions. Ultimately, the Conference Committee adopted the Senate amendment, which it described as authorizing "an expedited de novo determination of the reasonableness of the assessment" in district court. H.R. Conf. Rep. No. 94-1515, 94th Cong., 2d Sess. 484-85 (1976), reprinted in  U.S. Code Cong. & Admin. News 4118, 4189. In short, Congress without doubt intended that the district court make a wholly independent determination on the issue of reasonableness. Therefore, notwithstanding the considerable deference generally accorded to an agency's interpretation of the statute it administers,
the district court in reviewing a termination assessment should give no weight whatsoever to either (1) the initial decision by the Secretary (or his designate) that an assessment was justified under § 6851(a)(1) of the Code, or (2) the Secretary's affirmance of that initial decision on administrative appeal. The statute explicitly places the burden of proof with respect to the issue of reasonableness on the Secretary, 26 U.S.C.A. § 7429(g)(1) (Supp. 1977), and the reviewing court may not shift this burden by applying a presumption that the Secretary acted reasonably.
The second significant aspect of the scope of review under § 7429(b)(2) is that the inquiry is limited to whether or not making an assessment is "reasonable under the circumstances." 26 U.S.C.A. § 7429(b)(2)(A) (Supp. 1977). Although the reasonableness standard is somewhat indefinite,
and the legislative history unilluminating, a comparison of that standard with two of the standards articulated in the Administrative Procedure Act sheds some light on the intended scope of review under § 7429(b)(2)(A). The Administrative Procedure Act directs the reviewing court to set aside agency actions that are, inter alia, either "arbitrary, capricious, . . . or otherwise not in accordance with law," or "unsupported by substantial evidence in a case [involving formal rulemaking]." 5 U.S.C. § 706(2)(A), (E) (1970). Congress apparently intended that termination assessments be reviewed under a standard different than either of these two standards, for it employed different language in describing the applicable standard of review. The problem, then, is where the reasonableness test stands in relation to the "arbitrary and capricious" test and the "substantial evidence" test. A comparison of the three different standards suggests that "reasonable under the circumstances" means something more than "not arbitrary or capricious," and something less than "supported by substantial evidence."
See generally 5 U.S.C. § 706(2)(A), (E) (1970).
A final issue regarding the reviewing court's task under § 7429(b)(2)(A) requires discussion. The issue is: should the reviewing court take into consideration information bearing on the reasonableness of the assessment that was unavailable to the IRS when it decided to make the assessment? The statute itself is silent on this question, and legislative history provides only a probable answer. As noted earlier, the House Ways and Means Committee originally reported out a bill that authorized only limited Tax Court review of termination assessments. Under that bill, the Tax Court was to determine "(1) whether there was reasonable cause for . . . terminating the taxable year; [and] (2) whether the amount assessed . . . was appropriate under the circumstances." H.R. Rep. No. 94-658, 94th Cong., 1st Sess. 303 (1975), reprinted in  U.S. Code Cong. & Admin. News 2897, 3199 (emphasis added). The House report went on to clarify (2): "[The] issue to be determined is whether, based on the information then available to the Internal Revenue Service, the amount of the assessment is reasonable." Id. 304,  U.S. Code Cong. & Admin. News at 3200. Thus, under the House bill, the Tax Court apparently was to determine both the reasonableness of the assessment and the appropriateness of the amount assessed based only on information available to the Service at the time it acted. The Senate Finance Committee, however, subsequently amended H.R. 10612 in two material respects. Under the amended bill, an aggrieved taxpayer would first seek administrative review by the Secretary, and, if judicial review was ultimately sought, it would be in district court rather than in the Tax Court. H.R. Conf. Rep. No. 94-1515, 94th Cong., 2d Sess. 484 (1976), reprinted in  U.S. Code Cong. & Admin. News 4118, 4188-89. The Senate Report makes it absolutely clear that neither the initial administrative review nor the judicial review should be confined to information available to the Service when it acted; rather, any relevant information should be considered, both in determining the reasonableness of the assessment and in determining the appropriateness of the amount assessed. S. Rep. No. 94-938 (part I), 94th Cong., 2d Sess. 364-65 (1976), reprinted in  U.S. Code Cong. & Admin. News 3439, 3793-94. The report of the Conference Committee states only that the Senate amendment has been adopted, and makes no mention of this evidentiary issue. H.R. Conf. Rep. No. 94-1515, 94th Cong., 2d Sess. 484-85 (1976), reprinted in  U.S. Code Cong. & Admin. News 4118, 4188-89. A strong inference that the Senate position on this issue was also adopted can be drawn, however, from the language of § 7429(b)(2) as enacted: it requires a determination of whether "(A) the making of the assessment . . . is reasonable under the circumstances, and (B) the amount so assessed . . . is appropriate under the circumstances" (emphasis added).
It thus seems fairly clear that the House bill required a determination of whether the assessment was reasonable (and appropriate in amount) at the time it was made, and that the House report language quoted earlier simply spelled out the inconsistency of making this determination based (in part) on information that was unavailable at the time the Service acted. The Senate amendment, on the other hand, contemplated a finding as to whether the assessment "is" reasonable and appropriate, and the Senate report made it explicit that a finding on present reasonableness should incorporate all the relevant information presently available. Inasmuch as the conferees adopted the language of the Senate bill, I conclude that the likely intent of Congress was that in determining reasonableness and appropriateness, "the [district] court is to take into account not only information available to the Service at the time of the assessment but also any other information which bears on these issues." S. Rep. No. 94-938 (part I), 94th Cong., 2d Sess. 365 (1976), reprinted in  U.S. Code Cong. & Admin. News 3439, 3794. Accordingly, I will proceed to evaluate the IRS' conduct in this case based on the facts as stated earlier in this opinion, notwithstanding that Agent Lamb apparently had not learned some of these facts when he recommended that an assessment be made against Loretto. See note 4 supra.
Although the question is a close one, I conclude that the Secretary has carried his burden of proof as to the reasonableness of this assessment. The inference is not a compelling one, but it is reasonable to conclude from the facts of this case that Loretto was earning income through illegal activities, such as the sale of marijuana and cocaine, and not reporting this income to IRS.
This conclusion is supported by the substantial quantities of marijuana and "suspected" cocaine found in the Loretto home, taken in conjunction with the $14,050 also found there and with Loretto's failure to report any appreciable income for either 1975 or 1976. To this conclusion must be added Agent Lamb's inability to locate any assets in Loretto's name that might be used by the IRS to satisfy the tax liability on such unreported income. Thus, the Secretary had sufficient reason to find that Loretto was "designing quickly to place [his] property beyond the reach of the Government by either concealing it or dissipating it." Exhibit A to Plaintiff's Brief, at 1. See generally 26 U.S.C.A. § 6851(a)(1) (Supp. 1977), set out in note 1 supra. Section 6851(a)(1) plainly authorizes a termination assessment based on such a finding, and thus I am constrained to hold that this assessment was "reasonable under the circumstances."
Loretto advances several arguments for abatement of the assessment. First, he contends that the Secretary had no basis in fact for the conclusion that Loretto might conceal or dissipate the $16,468 seized during the search of his home, because that money was in the custody of the Pennsylvania State Police when the assessment was made. Nothing has occurred since then, the argument continues, to provide that factual basis; indeed, Loretto "has made no formal demand on the Pennsylvania State Police for the return of the seized currency." Stipulation para. 11. I will assume, without deciding, that if Loretto can prevail on this point, the entire ...