United States District Court, E.D. Pennsylvania
February 10, 2004.
DAVID A. COHEN et al.
UNITED STATES OF AMERICA
The opinion of the court was delivered by: STEWART DALZELL, District Judge
XÉlan, The Economic Association of Health Care Professionals,
is a California-based organization that has marketed "tax reduction
plans" and other services to tens of thousands of physicians under the
leadership of dentist-cum-financial guru L. Donald Guess.*fn1 Pursuant
to an investigation into the tax liability of two xélan members,
Doctors David and Margaret Cohen, the Internal Revenue Service has issued
summonses directing SEI Private Trust Company of Oaks, Pennsylvania, to
produce documents relating to a disability trust program with more than
$400 million in assets that it administered on xélan
behalf until September of 2003.*fn2
The Cohens and xélan have filed petitions to quash the
summonses, and the Government has filed an omnibus motion for summary
enforcement. For the reasons provided below, we dismiss the petitions to
quash and grant the Government's motion for enforcement.
Factual and Procedural Background
Petitioner Dr. David A. Cohen is a Florida orthodontist and the sole
full-time employee and shareholder of David Andrew Cohen, DMD, MS, PA.
His wife, petitioner Dr. Margaret Cohen, is a pathologist and employee of
Ameripath, Inc. In May of 1997, xelan prepared a "Tax Reduction Plan" for
David Cohen that promised to lower his federal income taxes from $143,040
to $49,880 per annum and enable him to achieve a "Critical Capital Mass"
of $3,000,000 by diverting as much of his practice's net income as
possible into purportedly tax-free and tax-deferred programs.
See Marien Decl. Ex. 1.
Around the time that her husband received his Tax Reduction Plan,
Margaret Cohen successfully lobbied Ameripath for leave to participate
in xelan. According to a document the IRS obtained, she sent Vice
President of Human Resources Stephen Fuller a xelan videotape along with
a letter containing the friendly warning that if the company wanted to
pathologists, "strategies must be developed to lower their tax
liability" because "[h]igh income employees . . . will not tolerate
the current structure of withholding from their salary for long." Marien
Decl. Ex. 7.
Between January of 1998 and June of 2002, the Cohens accumulated over
a million dollars in xelan-sponsored programs, thereby claiming hundreds
of thousands of dollars in tax savings. David Cohen's professional
corporation remitted about $393,500 in purported premiums to the xelan
disability insurance trust. Cohen did not report these premiums as
income, and the corporation fully deducted them as the qualified cost of
purchasing disability insurance for its employee. Ameripath similarly
withheld, pre-tax, some $504,852 from Margaret Cohen's salary and
remitted it to the disability insurance trust. Finally, David Cohen has
claimed charitable deductions for contributions of approximately
$200,000 to the xelan Foundation, which administers "personal public
charity foundations" from which "[d]octors and family members of doctors
may be compensated . . . for their own teaching, research, and other
pro-bono work on charitable projects important to them that are approved
for funding by the Board of Directors. . . ." Marien Decl. Ex. 1, at
The Internal Revenue Service is now examining the tax liabilities of
the Cohens and David Cohen's professional corporation for the years 1998
to 2001. Pursuant to its investigation, the Service has issued summonses
Private Trust Company to produce all documents in its possession
relating not only to the Cohens but also to all other participants in the
disability trust. The Cohens and xelan have filed petitions to quash
these summonses, arguing that the IRS is seeking information from SEI in
bad faith and that its purpose is to uncover the identities of other
xelan participants without complying with the procedural requirements for
a "John Doe" summons under I.R.C. § 7609(f).*fn3
The Internal Revenue Code grants the IRS authority to issue
administrative summonses for the production of "books, papers, records,
or other data" to determine the correctness of any return or the tax
liability of any person. I.R.C. § 7602(a)(1). The Supreme Court has
underscored the breadth of this power by analogizing it to that of a
grand jury, "which does not depend on a case or controversy for power to
get evidence but can investigate merely on suspicion that the law is
being violated, or even just because it wants assurance that it is not."
United States v. Powell, 379 U.S. 48, 57 (1964).
This Court has jurisdiction under I.R.C. §§ 7402(b) and 7604(a) to
enforce IRS summonses. Our Court of Appeals has observed that "[s]ummons
enforcement proceedings are designed to be summary in nature, and their
sole purpose is to ensure that
the IRS has issued the summons for a proper purpose and in good faith."
United States v. Rockwell Int'l, 897 F.2d 1255, 1261 (3d Cir.
1990). In determining whether the summonses are enforceable, we apply
Powell's burden-shifting regime. First, the Government must
make a prima facie showing that (1) the investigation will be conducted
pursuant to a legitimate purpose, (2) the inquiry may be relevant to
that purpose, (3) the information sought is not already within the
Commissioner's possession, and (4) the administrative steps that the
Code requires have been followed. Powell, 379 U.S. at 57-58.
The petitioner must then prove either that the Government has not
satisfied one of the elements of its prima facie case or that
enforcement of the summons would be an abuse of the court's process.
Id. Although the petitioner need not conclusively disprove the
prima facie case, he must point to serious weaknesses in the
Government's proffer or create a "substantial question in the court's
mind" concerning the Government's purpose. United States v.
Gertner, 65 F.3d 963, 967 (1st Cir. 1995).
A. The Government's Prima Facie Case
In support of its prima facie case, the Government has offered the
declarations of Internal Revenue Agent Catherine Johns, who is conducting
the Cohen audit, and Agent John L. Marien, an IRS Technical Advisor who
specializes in the improper uses of employee welfare benefit funds and is
assisting Agent Johns in her investigation. Upon scrutiny of these
affidavits, we conclude that the Government has established a prima
facie case for the enforcement of these summonses.
First, Agents Marien and Johns have declared that the Service is
seeking information from SEI for the legitimate purpose of determining
the Cohens' tax liability and that it can properly proceed under §
7602 because there has been no Justice Department referral. Johns Decl.
¶¶ Marien Decl. ¶¶ 37-38. It is well-settled that an affidavit of
the investigating officer is sufficient to make a prima facie case, and
we therefore find that the Government has established the first prong of
its prima facie case under Powell. Gertner, 65 F.3d at 966.
Somewhat more controversially, we find that the IRS has made a prima
facie showing that the examination of SEI's records may be relevant to
the Cohen audit, even though it will reveal the identities of other
insureds and the details of their participation in the trust. Agent
Marien's declaration offers two justifications for such an expansive
investigation. In the first place, he asserts that an examination of all
the records in SEI's possession may enable the IRS to confirm whether the
trust is, in fact, a program of insurance. Second, he declares that even
if the Service concludes that the trust indeed qualifies as insurance,
the investigation may assist the IRS in determining whether David Cohen's
corporation was entitled to deduct the full amount of the premiums it
paid on his behalf and whether both
Cohens could exclude remittances to the trust from their taxable
To grasp both the Government's position and our reasons for concluding
that it has met its burden under the second prong of the Powell
test, it is helpful to begin with a summary of the IRS's current
understanding of the disability trust's structure and operation.
According to Agent Marien, xelan touts the disability trust as a "new
approach to disability coverage `that combines savings along with the
disability coverage component.'" Marien Decl. ¶ 18 (quoting audiotape
presentation of Donald Guess). Doctors can contribute any amount from
$4,000 per annum up to their practices' entire net income to the program,
which is administered in the British Virgin Islands by Euro American
Trust and Management Services, Ltd. ("Euro American"). The Service
believes that in the years at issue here, about ninety-six percent of
premiums went into what Dr. Guess has termed "segregated accounts" at
SEI, and much like a 401(k) plan, these funds were placed in a variety of
investment vehicles of the participants' choosing.*fn4 Under the terms
of the program, a vested participant who does not become disabled is
entitled to a refund of premiums, along with the earnings on those
premiums that have accrued on a purportedly tax-deferred basis.
The Service is concerned that the trust may not, in fact, qualify as an
insurance scheme entitling its participants to the tax benefits that the
Cohens have so aggressively claimed. The United States Supreme Court long
ago held that for an arrangement to constitute insurance for federal
income tax purposes, it must shift to the insurance plan the
risk that a participant will experience a loss and distribute
each participant's risk of loss among all the participants.
Helvering v. Le Gierse, 312 U.S. 531, 539 (1941).
As Agent Marien has explained, the structure of the trust as well as
xélan's own reports to the Cohens lead the Service to suspect that
the trust does not bear the hallmarks of risk shifting and distribution.
The use of "segregated accounts," the ability of participants to direct
the investment of their funds, and xélan's provision of monthly
account statements suggest that the trust is more akin to a savings
plan than to a scheme of insurance. See, e.g., Marien Decl.
Ex. 2 (account statement providing "market value" of segregated account
as of January 31, 1998). Moreover, xélan's marketing materials
and the individualized reports it has provided the Cohens describe trust
funds as an asset that they can draw on in the future, with nary a
reference to the possibility that xélan may use these funds to
pay other participants' claims. See Marien
Decl. ¶ 18 (noting that, in an audiotape presentation, Dr. Guess
describes the refund provision of the trust as an "equity feature");
Marien Decl. Exs. 4 & 5 ("annual updates" for David Cohen describing
funds in disability trust as "qualified plan asset," confirming that all
such assets "are available eventually to satisfy your lifestyle needs,"
and advising Cohen to place all surplus income in "various Xelan [sic]
pre-tax savings plans, i.e. . . . Disability Equity Trust Plans,
Malpractice Equity Trust Plans, Long Term Care Equity Trust Plans and
Family Public Charity/xelan Foundation Plans").
In addition, the IRS argues that even if the disability trust is
actually providing insurance, its investigation of the SEI records may
help it calculate the limits, if any, on the deductibility and
excludability of the hundreds of thousands of dollars in premiums that
the Cohens' employers have paid into the trust. An employer can deduct
contributions to a trust providing employee welfare benefits under I.R.C.
§ 162, but I.R.C. § 419 limits the employer's deduction to the
"qualified cost" of the insurance coverage that the trust actually
purchases on the employee's behalf. In view of the eyebrow-raising
amounts that the Cohens have arranged for their employers to remit to the
trust, it is entirely possible that these premiums are disproportionate
to the value of any insurance benefits the Cohens are deriving from the
We readily conclude that information in SEI's possession concerning the
general administration of the trust and
the Cohens' experience as participants are subjects relevant to their
audit. The more difficult question is whether the IRS has made a prima
facie showing that the wholesale disclosure of other participants'
identities and financial information is relevant here. The Service has
offered two major justifications for this aspect of the investigation
contemplated in the summonses. In the first place, the inquiry will
enable the Service to develop a more complete understanding of how
xélan and the other participants treated their contributions
and earnings as well as whether account activity provides evidence
of risk shifting and distribution.*fn5 According to the IRS, its
need to gather more complete information on the trust is
particularly pressing because xélan officials have been less
than forthcoming about the operation of the trust and because the
Insurance Company and Euro American are offshore entities beyond
even the long arm of the IRS.*fn6 Second, the IRS asserts that it
may need to contact other participants to verify their age, health,
occupation, and other risk factors in order to determine the qualified
cost of the Cohens' disability insurance. In other words, access to the
other participants' identities and whereabouts would allow the IRS
to reconstruct the actuarial underpinnings of the disability program, an
admittedly Herculean step but one that is well within the IRS's broad
As our discussion should make apparent, Agent Marien has offered a
highly particularized articulation of the Service's reasons for pursuing
the SEI investigation and how the information it hopes to uncover will
shed light on the Cohens' tax liability. We therefore conclude that the
IRS has made a prima facie showing of relevance. We now turn to consider
whether the Service has satisfied the third and fourth prongs of the
Under the third prong, the Service must show that the information
sought is not already within its possession. The IRS satisfies this
requirement because Agents Marien and Johns have declared that the
documents and testimony the IRS seeks from SEI in these summons are not
already in the Service's possession. Johns Decl. ¶ 7; Marien Decl.
¶ 39. Moreover, Agent Marien has amply substantiated this assertion
by detailing the IRS's difficulty in obtaining information from xelan
about the operation of the trust. Id. ¶ 35. Finally, xelan
has impliedly conceded that the IRS lacks complete information relating
to other participants by entering an appearance in these proceedings and
contesting its disclosure.
Fourth, and finally, the IRS must show that it has followed all
administrative steps required under the Internal
Revenue Code for the issuance of the summonses. Agent Johns has so
declared, and she has thus established this element of the Service's
prima facie case. Johns Decl. ¶ 8.
B. The Petitioners' Response to the Service's Prima Facie
Because the IRS has established a prima facie case for the enforcement
of these summonses, the burden shifts to xelan and the Cohens to prove
either that the Service has not satisfied one of the elements of its
prima facie case or that enforcement of the summons would be an abuse of
the court's process. The petitioners advance a number of arguments
against enforcement, each of which we examine in turn.
First, the petitioners argue that the IRS has failed to show that the
identities of other trust participants are relevant to the Cohen audit
because the trust does not, in fact, employ "segregated accounts" whose
fluctuating value could confirm whether or not the disability plan is a
program of insurance. Instead, xelan reports to us, the trust uses
employer contributions to pay premiums on a group insurance policy issued
by Doctors Benefit Insurance Company, participants have no ownership
interest in the invested reserves, and the monthly statements from SEI
merely show each participants' pro rata share of the trust's reserves,
which may or may not be refundable depending on the claims experience of
the entire pool of
insureds.*fn7 Buck Decl.*fn8 ¶¶ 11-13; Dunn Decl. ¶¶ 7-10.
This argument fails to address the Service's showing that the
disclosure of other participants' identities may help resolve the
qualified cost issue. In addition, Buck's and Dunn's descriptions of how
the trust operates vary so greatly from the representations in
xélan's own reports to the Cohens that the divergence itself
substantiates the IRS's case. As we note above, both the monthly
statements and xélan's annual updates create the impression
that the Cohens' premium contributions are still their assets. While some
day it may turn out that xélan's assurances to this Court
concerning the trust are true, the disjuncture between these
representations and the documents now in the Service's possession
underscores both the IRS's interest in developing a complete
understanding of the trust's operation and the relevancy of this
inquiry to the Cohen audit.
Second, the petitioners make the related argument that the SEI
summonses are, in essence, nullities because they call for the production
of documents relating to the Cohens' and other participants'
"investments" with SEI, whereas all the xelan-related funds at SEI were
held for and owned by Doctors Benefit Insurance Company. This argument is
too clever by half. The summonses themselves define the term "investment"
as "any funds held by or for SEI for the benefit of employers or their
respective employees as a result of their relationship with xelan" and
related entities. See, e.g., Johns Decl. Ex. 1 ¶ 14. Such a
definition encompasses the funds that SEI formerly held. Even on the
petitioners' version of how the trust operates, plan participants have a
beneficial interest in trust assets, as evidenced by the refund provision
that is such a prominent feature of the disability program and SEI's
production of monthly account statements.
Third, xelan and the Cohens argue that in compelling the production of
documents relating to trust participants other than the Cohens, the IRS
has circumvented the "John Doe" summons procedures of I.R.C. §
7609(f) and is acting in bad faith for the sole purpose of identifying
xelan participants and subjecting them to audits.*fn9 Section 7609(f)
requires the IRS to obtain judicial approval before issuing a summons
relevant to the tax liability of an unnamed party. However, the Supreme
Court has held that the Service need not comply with § 7609(f) where
it serves a summons with the dual purpose of investigating both known
and unknown taxpayers, so long as the information sought may be relevant
to a legitimate investigation of the named parties. Tiffany Fine
Arts, Inc. v. United States, 469 U.S. 310, 323-24 (1985).
The petitioners seek to escape the implications of Tiffany Fine
Arts by invoking a line of cases in which courts have refused to
enforce IRS summonses that would have required the disclosure of third
parties' identities. In United States v. Gertner, supra, for
example, two lawyers reported to the IRS that their firm had received
sizeable cash payments from a client, but they declined to disclose the
client's name on attorney-client confidentiality grounds. The IRS then
opened an investigation into the law firm's tax liability and issued
summonses for certain records that would have revealed the client's
identity. The district court concluded that the audit of the firm was a
pretext for the anticipated investigation of the client, and it refused
to enforce the summonses. Gertner, 65 F.3d at 965. The Court of
Appeals for the First Circuit upheld the district court, reasoning that
the case was distinguishable from Tiffany Fine Arts because
"the IRS did not have an actual interest in the investigation
of the taxpayer (the respondents' law firm), but only in
learning more about John Doe." Id. at 971 (emphasis in
original); see also David S. Tedder & Assoc., Inc. v.
States, 77 F.3d 1166, 1170 (9th Cir. 1996) (upholding district
court determination, after in camera review of lawyer's bank
records that were subject of summonses, that clients' names were not,
per se, relevant to lawyer's audit).
The difficulty with the petitioners' argument is that in both
Gertner and Tedder the courts found that the clients'
identities were not relevant to the tax liability of their attorneys.
Here, by contrast, we have already concluded that the identities of the
Cohens' fellow xelots (to coin a phrase) are relevant to the IRS's
examination of the Cohens, and thus Tiffany Fine Arts squarely
governs this case.*fn10
Fourth, the petitioners claim that the Government has failed to show
that the information sought through these summonses is not already in its
possession because xelan has already provided the IRS with thousands of
pages of documents, including account statements for three hundred other
trust participants and independent (but xelan-commissioned) actuarial
studies of the disability program. However, the fact that the IRS may
have already obtained copies of documents does not prevent it from
seeking the originals, and it would defeat the
Service's broad investigative powers were it required to rely on a
pot-pourri of xelan-produced documents to answer the questions that the
Cohen audit has prompted.*fn11 See United States v. Davey,
543 F.2d 996, 1000 (2d Cir. 1976) ("The Service should not be required
to rely on the taxpayer's affidavit that a print-out accurately
reproduces all information [requested on tapes as s]uch a holding would
run contrary to the investigatorial purpose of the audit."); United
States v. Administration Co., 1994 WL 240518, at *3 (N.D. Ill. May
31, 1994) ("That the IRS may have already obtained copies of documents
it seeks from other sources in the tax court case does not prevent its
seeking original documents from the respondents. The IRS is entitled,
and it is a legitimate purpose to summon, original documents so as to
check their consistency and completeness with those obtained
Fifth, the petitioners claim that the Government has failed to show the
relevance of SEI documents from 2002, a year not under examination in the
Cohen audit. The IRS may use its summons power to seek information
regarding a period outside the scope of an investigation provided it
satisfies the relevancy requirement we have already applied here.
Barquero v. United States, 18 F.3d 1311, 1318 (5th Cir. 1994).
Here, Agent Marien's declaration establishes that information from 2002
may help the
IRS answer its questions about the operation of the trust. The Cohens
were still participating in the disability program in 2002, and the
petitioners have not even attempted to show that the disability trust in
2002 underwent a change so radical that documents from that year could
not shed light on its operation in the period under investigation.
Sixth, in a last-ditch effort to stave off the disclosure of other
participants' identities, xelan has stipulated that the SEI account
statements will not evidence risk shifting and distribution. However,
this stratagem fails because, as we have already noted, the other
participants' identities are relevant to the Service's inquiry into the
qualified cost issue. Moreover, as the Government has forcefully argued,
there is no authority for the proposition that a taxpayer (or interested
third party such as xelan) can by making such a stipulation hobble the
power of the IRS to draw its own conclusions on a subject relevant to a
taxpayer's liability. The IRS, in short, always has the right to cut the
Finally, we address the petitioners' request for an evidentiary
hearing. Our Court of Appeals has directed that a hearing is warranted
where the taxpayer has factually refuted material Government allegations
or has factually supported an affirmative defense. United States v.
Garden State Nat'l Bank, 607 F.2d 61, 71 (3d Cir. 1979). A review
of the petitioners' efforts to show the existence of disputed factual
issues shows that they have not satisfied this standard. In the first
they have produced a sizeable body of evidence in support of their
contention that the disability trust program is actuarially sound and
satisfies the definition of insurance. While this evidence is certainly
relevant to the petitioners' underlying dispute with the Service, it does
not call into question the Service's purpose in seeking additional
information or verifying xelan's representations concerning the trust.
The petitioners also point to what they characterize as the IRS's
pattern of "subterfuge, deception and harassment" in its dealings with
xelan to support their request for an evidentiary hearing, as well as
restate their overarching claim that bad faith taints these summonses.
Petitioners' Mem. at 6. According to the petitioners, IRS Agent John Wong
stole a list of contributors to the xelan Foundation during a 2001
examination into the Foundation's tax-exempt status. The list found its
way to IRS agents in Florida, and a number of xelan participants received
notices of examination suspiciously soon thereafter. The (alleged)
treachery of Agent Wong is the subject of a lawsuit in California and has
prompted an internal IRS investigation. Jacquot Decl. ¶ 7-24;
Suverkrubbe Decl., at 4 (noting that the IRS Inspector General for Tax
Administration has commenced an investigation of Agent Wong and that he
is currently on administrative leave).
To substantiate their claim that the Service's conduct demonstrates bad
faith such that enforcement of the summonses would amount to an abuse of
process, the petitioners must show
that the IRS, as an institution, issued the summonses with some
illegitimate intent or that particular agents' motives "infected the
institutional posture of the IRS." 2121 Arlington Heights Corp. v.
I.R.S., 109 F.3d 1221, 1226 (7th Cir. 1997), citing United
States v. LaSalle Nat'l Bank, 437 U.S. 298, 316 (1978).
Measured against this exacting standard, the petitioners' allegations
regarding Agent Wong and his colleagues are not grounds for conducting an
evidentiary hearing, much less quashing the summonses at issue here. Even
if we assume that the alleged subterfuge of Wong and the other agents
stemmed from their desire to harass xelan and its members, the fact that
the IRS is conducting its own investigation of this incident belies any
claim that these agents' motive has infected the institutional posture of
the Cohen audit.
For all the reasons provided above, we conclude that the petitioners
have not created a substantial question as to the validity of the
Government's purpose in investigating SEI's xelan-related records
pursuant to its examination of the Cohens's tax liability. We will
therefore deny the request for an evidentiary hearing, deny the petitions
to quash, and grant the Government's motion for summary