Tax Notes

Administrative Law Practice Group Newsletter - Volume 3, Issue 3, Fall 1999

November 1, 1999

Rich Morrison

Nonscientific Expert Witnesses—Kumho Tire

In Kumho Tire Co. v. Carmichael, 526 U.S. 137 (Mar. 23, 1999), the Supreme Court made clear that testimony by nonscientific experts must be reliable in order to be admitted. Before Kumho Tire, it was unclear whether nonscientific testimony had to meet standards for reliability, because the two major court opinions that had required reliability had involved scientific experts rather than nonscientific experts. In Frye v. United States, 293 F. 1013 (D.C. Cir. 1923), the court had held that scientific testimony must be supported by theories generally accepted in the scientific community.1 And in Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993), which overturned Frye, the Court held that scientific theories must be reliable (although not necessarily "generally accepted"). Daubert set forth four nonexhaustive factors to be used in determining reliability: whether a theory or technique can be (and has been) tested, whether it has been subjected to peer review and publication, whether, in respect to a particular technique, there is a high known or potential rate of error, and whether the theory or technique enjoys general acceptance within a relevant scientific community.2

The plaintiffs in Kumho Tire were the owners of a van that suffered a tire blowout. They sought to admit the testimony of an expert who would say that the tire in question failed because of a manufacturing defect, and because its owners forgot to keep the tire filled with air. The district court held that the testimony was unreliable under Daubert due to various irregularities in the expert's method. The Supreme Court in Kumho Tire held that the district court was correct to apply Daubert, thus making it clear that Daubert extended to all expert testimony, scientific or nonscientific.

Kumho Tire affects the trials of tax cases. These trials often involve the expert testimony of "nonscientific" experts, such as economists, appraisers, accountants, and actuaries. Such experts must now pass the Daubert standard for reliability. So, in Gross v. Commissioner, 78 T.C.M. (CCH) 201 (July 29, 1999), the first Tax Court case to cite Kumho Tire, the court applied Daubert to the testimony of an appraiser, determining that his testimony was admissible because of the reliability of the method he used, a discounted cash-flow analysis.

The "Accountant-Client" Privilege

The IRS Restructuring and Reform Act of 1998 (signed into law on July 22, 1998) extended the attorney-client privilege to non-attorneys, including certain accountants, who are authorized to practice before the IRS. See I.R.C. § 7525. Although this new privilege is a good thing for taxpayers, allowing them to conduct confidential discussions with accountants, it may have too many limitations to be really useful. First, the IRS is the only agency to which this privilege applies. The privilege does not prevent the disclosure of information to other agencies like the SEC. Nor does it prevent disclosure in non-tax litigation, or apply to criminal tax proceedings. Further, the privilege applies only to communication that are related to "tax advice," as opposed to general business advice. Also, a communication is not privileged if it relates to a "tax shelter" (an arrangement which has avoidance of federal income tax as a significant purpose). And finally, the new privilege, like the attorney-client privilege, does not apply to information intended to be disclosed to third parties. So the privilege does not cover information used by your accountant to prepare your income tax returns.

Shifting of the Burden of Proof

Tax lawyers are familiar with the rule that the taxpayer bears the burden of proof with respect to establishing how much tax is owed. I.R.C. § 7491. The 1998 IRS Restructuring and Reform Act reversed this burden of proof in certain instances. However, like the "accountant" privilege discussed in the section directly above, the burden-shifting provision is notable for its limitations. First, corporate taxpayers are not covered unless their net worth is less than $7 million (figured by valuing the assets by their cost, as opposed to value). Furthermore, a taxpayer only benefits from the shift in burden of proof if the taxpayer has already presented "credible evidence" with respect to all relevant facts. In addition, the taxpayer must comply with any substantiation and record maintenance requirements. Furthermore, the taxpayer must have cooperated with reasonable IRS requests for facts, and, according to the legislative history of the 1998 IRS Restructuring and Reform Act, have exhausted all administrative remedies before coming to court.

The Tax Subsidy for Employer-Provided Health Plans

The private market for health care has been criticized in recent years on the grounds that consumers are too far removed from their health care providers. If this "disconnectedness" is such a problem, one wonders why patients don't buy their health insurance directly, instead of receiving it indirectly from their employers. The reason lies in the tax code, which provides an advantage to employer-provided care over directly-purchased care. Consider what happens if you buy $100 worth of health care directly. The economic cost is exactly $100, even net of taxes, because there is no deduction for health care expenditures. I.R.C. § 213 (Medical expenses are not deductible unless they exceed 7.5% of adjusted gross income.) Now suppose you purchase health care indirectly through your employer. In effect, you convince your employer to provide you with $100 in health care instead of an equal amount of wages. The cost to you of this employer-provided health care is the lost wages—$100. But you also get a tax advantage of $31 (assuming you are in the 31% bracket) because unlike the $100 in wages, employer-provided health care is not taxed under I.R.C. § 106. Therefore, you get $100 in benefits for only $69 (the $100 lost wages minus $31 in tax savings). No wonder you choose employer-provided care.

In addition to the tax subsidy described above, there is another way in which the law favors employer-provided health plans. Under ERISA, such plans are immune from lawsuits and from state regulations governing insurance. Immune from taxes, lawsuits, and regulations, employer-provided health care has squeezed out directly-purchased health care. The solution is to even the playing field between employer-provided health care and private-purchased health care.


1 Applying this general acceptance standard, the Frye court rejected expert testimony regarding the results of a lie detector test.
2 Daubert and Kumho Tire were based upon Fed. R. Evid. 702, which says that: "If scientific, technical or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise."

Rich Morrison is an attorney in private practice in Chicago. He chairs the Tax Working Group of the Federalist Society's Adminstrative Law & Regulation Practice Group.