Author: Press

by Max Freedman, Business News Daily Contributing Writer
Featuring Yvonne R. Cort, Partner

Could the IRS’ new $79.6 billion in funding result in more small and midsize business audits? Experts discuss whether or not this concern is founded.

• Most tax experts agree that more SMB tax audits could be coming, but opinions differ about whether this increase in audit frequency will be meaningful.
• Payroll, tax and accounting software can all help you remain tax-compliant, and so can staying organized and honest. Separating your business and personal finances is important too.
• If you’re audited, read your audit letter thoroughly first. It’s also crucial to hire a tax professional and cooperate with IRS agents.
• This article is for SMB owners concerned about the potential for more frequent tax audits.

You might assume that a bill with a name like “Inflation Reduction Act” would only bring relief to the small business community, especially in a midterm election year. However, when the bill was signed into law, one provision had many small and midsize businesses (SMBs) worrying – and not about inflation. Some are concerned that the bill’s new round of IRS funding could lead to more SMB tax audits.

Is the notion of increased SMB tax audits founded or unfounded? And if it is founded, what can small businesses do to stay compliant and meet tax obligations? How should they handle an audit if they are subject to one? Below is an in-depth exploration of all these questions, with input from tax experts.

How did the Inflation Reduction Act affect IRS funding?

The Inflation Reduction Act, which went into effect on August 16, 2022, will funnel $79.6 billion into the IRS over the next decade. This is a significant cash infusion for the IRS, as the agency has often had its budget slashed over the past decade. The IRS has also experienced high employee turnover, with 23,000 employees leaving its employ since 2010.

According to Sarah York, an accountant with Keeper Tax and an enrolled agent with the IRS, the cash infusion is much needed. The hope is that this new cash infusion reverses the trend of budget cuts and brings stability to the agency.

“It’s revamping their phone systems, improving their computer systems, and hiring new and younger staff to kind of manage the problem,” York said of the new funding’s potential effects. “Right now, what most CPAs have been dealing with, especially in the last three years, is the staffing shortage at the IRS.”

Why would new IRS funding lead to more SMB tax audits?

The notion that extra IRS funding could make SMB tax audits more common stems from the agency’s recent history. Many of the employees who have left the agency are highly experienced auditors, leaving behind a staff less able to handle complex audits. Typically, the higher an entity’s income, the more complicated their audit will be. That means a thinned-out IRS could primarily target lower-income entities, including SMBs.

“You’ll hear people say [the IRS is] just auditing poor people,” said Eric Green, a tax attorney and partner with Green & Sklarz. “There’s a little truth to that because those folks are easier to audit through correspondence and office audits. But I don’t think any [IRS] commissioner … ever sat around and said, ‘let’s go after poor people.’”

Data from Syracuse University backs the notion that lower-income earners are audited more often. According to this data, in tax year 2021, the IRS audited 13 out of every 1,000 taxpayers with low annual revenue. The corresponding rate for all other taxpayers was 2.6 out of 1,000, meaning low-income taxpayers experienced five times as many audits.

Key takeaway: When the IRS lacks funding and employees, it may also lack the resources to conduct anything other than low-income taxpayer audits.

Do SMBs really have to worry about more tax audits?

The tax experts we spoke with said that the annual amount of SMB audits will likely increase in future years. However, these experts gave varying answers on the potential extent of this increase. We’ve broken down their opinions below.

Opinion 1: Yes, SMBs may need to worry about more audits.

According to Yvonne Cort, a tax attorney and partner at Capell Barnett Matalon & Schoenfeld LLP, the increase in SMB tax audits is already here.

“I’m already seeing an uptick in audits,” Cort said. “It’s there, they started, the letters are going out, and people are being audited.” Cort said that the IRS is auditing SMB owners to close the “tax gap,” which comprises “people who have not been paying, either through not filing [a return, or] they didn’t put down the right amount of tax owed.”

Keith Jones, a CPA who operates under the name TheCPATaxProblemSolver, agrees. “There’s probably going to be more audits and less help to taxpayers,” Jones said. He added that the new funding would likely go toward “revenue-generating spots and not customer service spots. The revenue generated would be [through] auditors.”

Logan Allec, a CPA and owner of tax relief company Choice Tax Relief, said he firmly believes that more SMB audits will result from the new funding since much of it is directed toward the IRS’s “civil enforcement” division.

“$45.6 billion, is going towards civil enforcement,” Allec said. Civil enforcement, he added, encompasses “auditing and collecting taxes from certain groups that the IRS believes contributes to the tax gap,” including SMB owners.

Opinion 2: More audits will occur, but not to a meaningful extent.

Green told Business News Daily that concerns about a surge in SMB tax audits may be overstated, though a slight uptick should be expected.

“Do I think that the [new funding] will lead to more audits? Yes,” Green said. “Do I think that they’re gonna have 87,000 auditors breaking people’s doors down, grabbing stuff? No. That’s nonsense. The audit rate now is 1.3% … The percentage will go up, but not meaningfully.”

York agreed with Green’s assessment, adding that U.S. secretary of the treasury Janet Yellen has directed the IRS not to disproportionately target those with incomes of under $400,000. Still, York expects improved IRS operations will result in slightly more audits than years past.

“We shouldn’t see that big of a shift in the current audit rates for small business owners,” York said. “With the influx of resources, and as [the IRS] modernizes their computer systems, we could see more audits just because the technology is going to be more precise at picking up errors,” she said.

Andrew Griffith, proprietor of Andrew Griffith CPA, shared similar views. “I think much of this speculation is unfounded and unfortunate,” Griffith said. However, Griffith also said he “would not be surprised” if more audits did happen, “because that is part of … enforcing compliance with the tax code, and also [improving] the IRS’ own system issues.”

Tip: Even tax experts who think that SMB tax audit worries are exaggerated say that audits will indeed become more frequent. These experts believe the increase will be small, if not unnoticeable, but opinions vary. Other experts think the increase will be significant.

The tax experts we spoke with gave the following advice for keeping SMB taxes compliant to minimize audit risks.

1. Use the right software.
Whether you have employees or you only pay yourself from your business’s earnings, payroll software can help you remain compliant with tax regulations. The best payroll software platforms are regularly updated to reflect regulatory changes, which inherently keeps your business compliant. So too are many of the best accounting software platforms, which represent another type of technology that’s key to remaining compliant.

Did you know?: Some payroll services, such as Gusto, come with added HR services to further assist you with compliance. Read our Gusto payroll review to learn more.

You may want to consider using tax software alongside your payroll service. The best tax software, though not always superior to hiring an accountant depending on your business needs, can automate your tax filing process and streamline your compliance. TurboTax might be the first name that comes to mind when thinking about this software – and it’s our top tax software pick overall. Read our TurboTax review to find out why.

2. Keep your paperwork organized and substantiate your expenses.

Green said that organized paperwork is key to tax compliance, so pay attention to your recordkeeping practices.

“When you’re doing your tax return, all your documentation should be in one place,” Green said. “You set the groundwork [for a successful audit] when you get everything together for the return and keep it in one place.”

Green also said that when SMB owners get audited, it usually occurs long after filing their taxes. An audit can occur up to 18 months later, he said, so preemptively getting organized is always a smart move.

“Keep good records,” Cort said, adding that any paperwork for tax deductions should include justification for the expense. “I see a lot of people who don’t have adequate substantiation, especially for things like office supplies [or] stuff they’re buying [that] could just as easily be used at home as at the office.”

SMB owners should keep notes about their expenses, she added. For example, if you’re writing off a lunch meeting, it’s important to note who you’ve met with and what you discussed, so you can make it clear to the IRS why the lunch was indeed a business expense.

Griffith had similar advice. “[If] transactions are properly disclosed on the appropriate tax returns, that taxpayer has no real concerns about being audited.”

3. Separate your business and personal finances.

Here’s a piece of advice most SMB owners have probably heard before and could always stand to hear again: Open separate personal and business bank accounts.

“Don’t co-mingle your personal funds with your company funds,” Jones said. “You want two separate checking accounts. I’ve seen it so many times: [SMB owners] run everything through a personal account, so they have business and personal expenses coming from the same account. That’s a recipe for disaster.”

Allec gave similar advice. “If you give the IRS … all [your] bank statements and it’s a mix of personal bank statements that you ran your business through … it shows disorganization.”
That can make your audit more difficult, he said. Separating business and personal finances can solve this problem.

How to handle an audit

Below are some steps that can make a business tax audit more bearable.

1. Go over your audit letter with a fine-toothed comb.

If the IRS decides to audit you, it will send you a letter via USPS. You should open this letter immediately and read it closely. You should also note that the IRS will only send you an audit letter via USPS – other communications may be coming from scammers. As you read your audit letter, note everything that the IRS is asking you to provide.

“Usually, you’ll get something called an information document request,” Allec said. “That’ll tell you what the IRS is looking at.” Allec recommended reading this letter thoroughly, then sending the IRS all those records at once.

“If you make the auditor’s life easy, hopefully they’ll just move on to the next file,” he said. But it doesn’t always go that smoothly.

2. Hire a professional.

Most experts we spoke with stressed the importance of hiring a certified public accountant (CPA) to represent you during an audit. This makes sense: Tax audits are obviously anxiety-inducing, and it’s easy to make poor decisions under this mountain of stress. Tax professionals, on the other hand, deal with audits all the time, so they know how to approach audits rationally. They can – and should – be present with you and speak on your behalf in all audit affairs.

“You want to have professional representation,” Green said. “Do not try to handle this yourself.”

Jones agreed: “When you get audit letters, contact somebody and get representation.”

“When you get [an IRS] notice, that’s a good time to involve a tax professional,” York said.

However, York acknowledged that for some SMB owners, this may not be possible. In that case, she said, “Have your bank statements ready and recognize that, IRS auditors, they’re people and they want to help you. They want to make sure that you’re claiming what you’re allowed to claim. They’re gonna go in and look for things. If you work with them, they’ll work with you.”

3. Cooperate with auditors while being careful with their questions.

Remain professional when interacting with the IRS. No matter how frustrated you feel about being audited, any negativity can cause the IRS to think you’re hiding something. You’re better off being as kind and level-headed as possible, even if you’re upset on the inside. Keeping your cool might not feel great in the moment, but your kindness could bring your audit to a close sooner than later.

“People tend to be surprised at how understanding IRS auditors typically are when they go in and examine records,” York said. “They know small business owners don’t have the same accounting systems in place as big corporations. They’re willing to give grace and allowance for things if you approach it with the attitude, ‘We want to work with you.’”

That said, you should only answer auditor questions with the exact information the auditor is seeking. Anything more you say could open new doors for the IRS to pursue you through and add to your troubles. Green gave an insightful example.

“I have a taxpayer that shut down their consulting practice,” Green said. “The auditor noticed that, for the last two years, they had no income. The client said, ‘I wasn’t working at it.’ What the auditor heard is, ‘You’re not working at it, so it’s a hobby. You don’t get the deductions.’”

The auditor thus disallowed all the deductions.

“What a professional would’ve said is, ‘The taxpayer had ceased operations and was in their wind-down period, pursuant to regulations,’” Green said.

Green said he took this case to appeals and reversed the auditor’s elimination of the client’s deductions. This is just one of many examples where a tax professional can more expertly navigate an audit than a non-expert SMB owner.

Key takeaway: Reviewing your audit letter, working with a tax professional, and cooperating with auditors can make a tax audit less stressful.

More SMB audits might be coming, but you can be prepared

An increase in SMB audits doesn’t necessarily spell doom for your company. If you do get audited, sometimes simply sending the requested documentation to the IRS with professional help can quickly solve the problem. If the audit does continue thereafter, the advice in this article should help you come out on the other side unscathed.

Max Freedman is a content writer who has written hundreds of articles about small business strategy and operations, with a focus on finance and HR topics. He’s also published articles on payroll, small business funding, and content marketing. In addition to covering these business fundamentals, Max also writes about improving company culture, optimizing business social media pages, and choosing appropriate organizational structures for small businesses.

We are pleased to share recordings of the sessions so you can review and revisit the information shared during the Conference at your convenience.

Please click on any of the bullets below to access a presentation. If you have further questions or the matters discussed, please contact us at pr@cbmslaw.com at any time.

Presentations:

• Welcome / Introduction – Mission Driven Development™: What Have We Learned? Where Do We Go?
• Updates from the Office of the Attorney General
• Post-Covid Challenges and Opportunities: Judicatory Panel
• Succession & Legacy Planning
• Practical Legal Tips to Running Your (Religious) Corporation
• Re-imagining Ministry, Re-engaging Communities
• Accounting for Religious Corporations

PowerPoints:

• Updates from the Office of the Attorney General
• Re-imagining Ministry, Re-engaging Communities
• Succession & Legacy Planning
• Accounting for Religious Corporations

Building on the previous expansion granting Not-For-Profits and Religious Corporations permanent permission to hold meetings virtually, the NY Not-For-Profit Modernization Act further expands electronic participation in corporate meetings and aligns the law with the common practices of the Not-For-Profit and religious sector with specific changes to N-PCL Sections 614, 705, and 708. These changes are effective as of November 21, 2022.

 

Other Electronic Means (N-PCL Sections 614 and 708)

Under the N-PCL and unless prohibited by an entity’s corporate documents, any action which may be undertaken by a vote of the members [congregation] or the board of directors may be conducted without a meeting if all directors or members agree in writing. Prior to the NY Not-For-Profit Modernization Act, such consent needed to be either in writing or by means of electronic mail (e.g., by sending an email where in the body of the email consent to the action is provided).  The NY Not-For-Profit Modernization Act expands the methods beyond just electronical mail to “electronic mail and other electronic means,” which permits members and board members to vote using poll tools or text message, so long as the consent can reasonably be determined as authorized by the individual.

Terms of Replacement Directors (N-PCL Section 705)

The NY Not-For-Profit Modernization Act also changed how a vacant director position may be filled with a replacement director. N-PCL Section 705 previously limited the replacement director’s term to the next annual meeting of the corporation. Replacement directors may now serve the full remaining term of the directorship which they were elected to or a term which ends on the date of an annual meeting as determined by the other members of the board subject to the restrictions of law and the corporate documents of the entity.

Quorum and Director Conflicts (N-PCL Section 708)

The last change of the act is the wording of N-PCL Section 708, so that members of the board of directors who must recuse themselves from a vote due to a conflict of interest or related party transaction still count in determining if there was a quorum present at the meeting. Significantly, this means that recused directors may attend to help establish a quorum but no longer count for purposes of determining the number of affirmative votes necessary for a board action.

Please contact WMcManus@cbmslaw.com for questions regarding this update.

Late Portability Election: New Relief Available

The IRS has just changed the timeframe for filing a late portability election for federal estate tax purposes. This is extremely important to those who did not timely file a federal estate tax return (Form 706) when the first spouse died.

By Robert S. Barnett and Gregory L. Matalon

The IRS has just changed the timeframe for filing a late portability election for federal estate tax purposes. This is extremely important to those who did not timely file a federal estate tax return (Form 706) when the first spouse died. Previously, the IRS only allowed a late portability filing (in certain circumstances) within two years of death—this change extends the filing period to five years from date of death. Prior to this recent change, if Form 706 was not filed the executor would have to request special dispensation from the IRS: a private letter ruling request, which was costly and not guaranteed.

Background

Each U.S. citizen and U.S. resident is entitled to federal estate and gift tax exemptions of $12,060,000 in 2022. Prior to 2010, after a spouse died, complex planning and use of trusts was often necessary to secure the first deceased spouse’s federal estate exemption.  The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, provides relief for clients who fail to plan. The 2010 Act allows for the “portability” of the deceased spouse’s unused federal estate and gift tax exemption and was made effective for decedents dying and gifts made after Dec. 31, 2010.

In essence, portability allows the surviving spouse to utilize the available estate and gift exemption from the deceased spouse, without the use of complicated trusts and other planning mechanics. The 2010 Act refers to the “portable amount” as the deceased spousal unused exemption (often defined as DSUE).  DSUE is the lesser of the basic exclusion amount of the first deceased spouse; or the excess of the applicable exclusion amount of the last deceased spouse over the amount with respect to which a tentative tax is determined. While this definition is confusing, the following example provides clarity:

A spouse dies in 2022, having made no lifetime gifts and with a last will and testament that provides all assets pass to the surviving spouse. The surviving spouse will have the benefit of decedent’s full $12,060,000, to use during the life of the surviving spouse to make gifts, and the remaining exemption amount can be used by the executor of the surviving spouse’s estate to reduce the estate tax, even when the surviving spouse dies after 2026, which is when federal estate tax exemptions are reduced by one-half.

In order for the surviving spouse to utilize the remaining exemption of the first deceased spouse, the executor of the decedent’s estate must elect portability of DSUE on a timely-filed Form 706. Treas. Reg. §20.2010-2 states that the timely filed election is made with the Form 706 within nine months after the decedents date of death, or on the last day for the required filing if a proper extension of time has been obtained. The regulations state that the Form 706 must be properly prepared; however, special rules allow for streamlined reporting with respect to estates and transfers which are deductible under the marital deduction and/or charitable deduction provisions. The amount of DSUE portable to the surviving spouse is calculated and reported to the IRS on Form 706, page 4, Part 6, §C. Many estates will be able to utilize this streamlined reporting and are only required to report the description, ownership, and beneficiary of such property along with the executor’s best estimate of value. The reporting allows for a cost-effective method of preparing the Form 706.

Late Filing Relief

Many taxpayers failed to file Form 706 because the value of the first deceased spouse’s estate did not require such a filing. However, asset appreciation, together with assets owned by the surviving spouse, and the upcoming reduction to the federal estate and gift tax exemptions has many surviving spouses wishing to make late portability elections.

The IRS recently issued Rev. Proc. 2022-32 which extends the two-year relief period from Rev. Proc. 2017-34 to five years. The IRS has stated that the purpose of this new procedure is to reduce the number of private letter ruling requests, thereby alleviating a burden on the IRS and taxpayers. Under this simplified method the executor makes the portability election by filing a complete and properly prepared Form 706 on or before the fifth anniversary of the decedent’s date of death and placing on the top of the Form 706 “FILED PURSUANT TO REV. PROC. 2022-32 TO ELECT PORTABILITY UNDER SEC. 2010(c)(5)(A).” This procedure is extremely beneficial and will save the time and expense of filing a private letter ruling request. Decedents who were citizens or residents of the United States on the date of death are eligible to use this simplified method provided the gross estate was under the filing threshold. No user fee is required for returns filed under the Revenue Procedure, thereby making a late portability election cost-effective for taxpayers. Estates that have not elected portability on a timely-filed Form 706 or utilized Rev. Proc 2017-34, should consider filing under the new guidance.

Estates Beyond the Fifth Anniversary of Death

The Revenue Procedure clarifies that if the estate is not within the scope encompassed by the procedure due to the five-year election period (but not due to the size of the estate) the executor may request an extension of time to make the portability election by submitting a private letter ruling request under the provisions of Treas. Reg. §301.9100-3. From experience, private letter ruling requests for portability are generally granted favorable relief if the estate was under the required estate tax filing threshold. Due to the cost of obtaining the private letter ruling, many estates do not seek relief.

Example: Portability Election Tax Savings

Facts: H dies in 2019 having a taxable estate of $5,000,000 consisting of a residence valued at $1,750,000, an IRA of $500,000 and stocks and bonds of $2,750,000. Surviving spouse receives all of H’s assets pursuant to H’s will and/or beneficiary designation, and therefore H has no taxable estate. H’s estate is also under the federal estate tax filing threshold and the procedure under Rev. Proc. 2022-32 is available. H’s surviving spouse dies in January 2026 with a total estate of $8,000,000. No portability election was made.

Law: In 2019, the federal estate tax basic exclusion amount was $11,400,000. On Jan. 1, 2026, the federal estate tax exemption will be reduced by one-half (currently the federal estate tax basic exclusion amount is $12,060,000). As such, assume a 2026 federal estate tax exemption of $6,500,000.

Issue and Analysis: Should the executor of H’s estate file a Form 706 under the guidance provided in Rev. Proc. 2022-32? Without a portability election, the surviving spouse’s estate would be subject to a federal estate tax (at a tax rate of 40% and assuming no deductions) of $600,000.

The executor of H’s estate should file a federal estate tax return to elect portability. By electing portability, the federal estate tax at the surviving spouse’s death will be zero thanks to Rev. Proc. 2022-32.

If the surviving spouse lives in New York state, a state level estate tax (assuming no deductions) of $773,200, will be due. Note: For federal estate tax purposes the New York state estate tax is a deduction—thereby reducing the federal estate tax estimated above to $290,720, instead of $600,000.

While not a focus of this article, with pre- and post-mortem estate planning, including the use of a renunciation and a properly drafted credit shelter trust, the New York state estate tax calculated above can also be eliminated—a savings to the beneficiaries of the estate of $773,200. New York state does not have portability for the unused New York state estate tax exemption and the prior need for more complex planning is necessary.

Conclusion

Rev. Proc. 2022-32 provides a cost-effective method to file a Form 706 to make a late portability election. With increased client wealth and the reduction to the federal estate tax exemption on Jan. 1, 2026, attorneys and tax advisors should recommend portability for all current and older estates to reduce or eliminate federal estate tax. Attorneys should communicate these rules and document their client’s decision in their files.

Gregory L. Matalon (gmatalon@cbmslaw.com) is a trusts and estates partner at Capell Barnett Matalon & Schoenfeld. Robert S. Barnett (rbarnett@cbmslaw.com) is a tax and business partner at the firm.

by Peter S. Sanders, Michelangelo Macchiarella and Marissa Cohen

The courts are cracking down on late discovery and no one is exempt, not even a former president of the United States. Donald Trump learned that lesson recently when a New York judge fined him $10,000 a day for failing to meet his discovery obligations on schedule. Though Trump’s fine was later capped at $110,000, the judge warned him that additional fines will be imposed – retroactively – if there is a further missed deadline.

At issue are CPLR 3126 and CPLR 5104. While CPLR 5104 applies to the Trump case, most of the late discovery cases have involved CPLR 3126.

Indeed, in the state courts of New York, getting an opposing party to comply with discovery demands has been a notoriously long and challenging process. However, recent trends suggest that appellate and lower court judges have become much more active in imposing sanctions against recalcitrant litigants under CPLR 3126. This trend toward preventing prolonged litigation and disobedience with court orders allows CPLR 3126’s provisions to serve as an effective tool for parties to obtain relief. A motion under this section often results in a conditional order allowing an additional time-limited opportunity to cure. Such an order can simultaneously serve equity, the preference for determinations on the merits, finality and provide protection against reversal on appeal. Properly drafted and enforced, it can promote just results and judicial economy, but only if the conditional order is given its intended effect. If unenforced, whether out of a sense of leniency or sympathy, it can unintentionally embolden noncompliant parties when continued obstruction is not met with the certitude of the prescribed consequences. It is the advocate’s job to convince the court to follow its own orders for these reasons and because the aggrieved party has a right to rely on the court following through on its word. Indeed, although not essential to a right to such reliance, an aggrieved party may even have forgone other remedies to its detriment in reliance on the enforcement of such an order.

CPLR 3126 Has a History of Judicial Non-Enforcement

CPLR 3126 states that a court may impose discovery sanctions, including the striking of a pleading or preclusion of evidence, where a party “refuses to obey an order for disclosure or willfully fails to disclose information which the court finds ought to have been disclosed.” But many courts have been reluctant to grant relief under the statute. This reluctance flies in the face of appellate authority that is heavily weighted to the contrary. Indeed, the reader may notice that the word “conditional” does not appear in the text of the statute; rather, the “conditional” portion of CPLR 3126 is a creature of judicial invention meant to temper the “drastic remedies” afforded under the statute in favor of hearing the matter on the merits. When a court refuses to follow its own conditional order and impose its sanctions, this is essentially a judicial act of clemency that implicates the non-offending party’s right to discovery. But litigation on the merits is a privilege that can be lost when procedure is abused, especially when that abuse prejudices a party playing by the rules.

In the leading case from the Court of Appeals,[1] the court urged greater use of discovery sanctions when it firmly stated, “[L]itigation cannot be conducted efficiently if deadlines are not taken seriously, and we make clear again, as we have several times before, that disregard of deadlines should not and will not be tolerated.”[2] This pronouncement, however, has been followed in the lower courts to varying degrees over the last decade.

As a general procedural roadmap, “A court may resort to the drastic remedies” such as “striking a pleading or precluding evidence upon a clear showing that a party’s failure to comply with a disclosure order was the result of willful and contumacious conduct.”[3] Such failure may be demonstrated by showing a lack of timely compliance with a self-executing conditional order.[4] Once a moving party establishes that the failure to comply with a disclosure order was willful, contumacious or in bad faith, the burden shifts to the opposing party to offer a reasonable excuse for its failure to timely or materially comply.[5]

In practice, however, it may take more than one discovery motion to lay the groundwork for sanctions that preclude claims or defenses, strike pleadings, or invoke negative inferences.[6] The courts have not been eager to issue or enforce sanctions because of the “willfulness inquiry” that must be conducted under CPLR 3126 before issuance of sanctions, including those that may spring from a conditional order. The clearest and simplest evidence of “willfulness” is found in repeated non-compliance with court orders. Thus, when the rule that is meant to promote expeditious and efficient litigation is misapplied by courts reluctant to enforce it, it forces litigants to file successive compliance motions.

CPLR 3126 in the Post-Pandemic Era

New York’s legal landscape has indisputably transformed because of the COVID-19 pandemic, moving more toward virtual and efficient litigation practices, which seems to be why the courts have begun to take discovery delays more seriously. One reason may be that the courts, which had operated with relatively more manageable caseloads, suddenly had to adjust to newly revived cases that had been languishing in the interim, including numerous outstanding discovery demands.

In a recent case (that our firm handled, but will remain unnamed as an appeal is still pending), we unsuccessfully sought enforcement of a conditional sanctions order by means of summary judgment after that order had become absolute. The Supreme Court had repeatedly referred continuing disputes over noncompliance to a discovery referee, resulting in a succession of orders, including one where the court ordered compensation to our client for legal fees of over $168,000. Those fees were found to have been incurred as a direct result of the defendants’ refusal to comply with their discovery obligations. Nevertheless, the defendants were still allowed a further extension of time to comply before the court’s conditional order was to trigger the remaining “drastic remedy” sanctions under CPLR 3126. The defendants, despite submitting further documents in response to the conditional sanctions order, were found to continue to be materially noncompliant after the self-executing deadline converted the order from conditional to absolute.

We then moved for summary judgment once (1) “willfulness” was established by demonstrating a pattern of non-compliance with several orders; (2) a self-executing conditional order was issued in final redress; and (3) the defendant had still not complied. We argued that the court was without discretion to deny a motion for summary judgment once the conditional order had “sprung” and become absolute. Initially, the court rejected our motion and, in an apparent attempt at further leniency and preference for a trial on the merits, reserved the 3126 sanctions for trial. However, upon re-argument, the court reversed itself as having admittedly overlooked the absolute nature of the conditional order at issue and struck the non-disclosing party’s answer and counterclaims and resolved all relevant claims in the pleadings in the plaintiff’s favor. Reversal on re-argument is a rarity but was warranted in light of the prevailing authority and the court’s recognition that no lesser remedy could properly rectify the prejudice caused to the aggrieved party.

In one case, an appellate court reversed a CPLR 3126 order that merely precluded a non-disclosing party from introducing evidence and substituting a wholesale striking of the non-disclosing party’s answer as proper after years of non-compliance.[7]

Another appellate court reversed the trial court’s denial of summary judgement where a conditional order had merely precluded the non-movant from presenting evidence in opposition, ostensibly as logically inconsistent.[8] This recognition of the logical inconsistency or insufficiency of certain lesser sanctions is noteworthy. Far too often courts fail to recognize that the non-disclosing party’s goals may still be achieved, and the aggrieved party still prejudiced, if a sanction fails to provide a complete remedy.

In another case, the appellate court reversed an order of the Supreme Court that had granted the non-disclosing party additional time to comply with a discovery order after a compliance deadline had already passed. In that case, a Compliance Conference Order had already been issued that stated, “Failure to comply [within 30 days] will result in preclusion.” Upon a motion for sanctions under CPLR 3126, however, the Supreme Court ignored its own order and allowed the non-disclosing party additional time to comply without any finding that the defaulting party had made a showing that its default was excusable. The appellate court reversed this order by directing that the motion under CPLR 3126 should have been granted as to preclusion in light of the conditional order’s mandatory language. The appellate court’s decision here is in line with the principle that when a court says that an order will result in a specified sanction, that court should follow its own orders and apply the sanction in the absence of extraordinary circumstances.

These post-pandemic cases show that lower court and appellate judges are no longer as inclined to forgive repeated discovery delays as had been the case. However, should a movant be able to demonstrate a reasonable excuse for the failure to timely or properly comply, an appellate court may reverse a denial of a motion to vacate a conditional order that had become absolute, thus providing a rare and proper escape valve when bona fide good cause for untimely or insufficient compliance can be shown.[9]

New York’s trend toward holding parties accountable for failing to comply with discovery goes beyond CPLR 3126. In New York v. The Trump Organization, Inc., et al.,[10] on April 26, 2022, former President Donald Trump was found to be in civil contempt in violation of CPLR 5104 for failing to comply with a subpoena within 14 days of the order compelling compliance, extended by stipulation for another 30 days (Hon. Arthur F. Engoron). The ruling stemmed from former President Trump’s failure to prove that he thoroughly looked for the demanded documents, acted in good faith to comply with the court’s order and asserted anything other than boilerplate language when submitting his response to the subpoena. In that case, as in ours, the party charged with producing documents cannot merely claim they don’t have them without explaining in a sworn affidavit the details of their record keeping practices and bona fide efforts to locate the documents.[11] Judge Engoron fined former President Trump $10,000 per day for non-compliance. The following day, Trump submitted a personal affidavit, which the court rejected as still insufficient to purge contempt. However, on May 11, 2022, the court “conditionally” purged the contempt pending submission of additional affidavits and payment of the fines that had accrued so far, in the amount of $110,000, but warned that contempt charges could be re-imposed with additional fines accruing retroactively to the date they were suspended if sufficient affidavits were not submitted. Although applied under a slightly different standard than found in CPLR 3126, the core of the ruling is the same: “disobedience to a lawful mandate of the court.”[12] Trump’s case illustrates that sanctions may and will be imposed for ignoring court orders and deadlines. The intolerance toward disobedient parties might be a leitmotif that is rising to a crescendo in post-pandemic New York.

Conclusion

Inevitably, there is still some play as to how many orders have to be issued and how long and egregious the non-compliance of your adversary must be to warrant sanctions. Litigants with bona fide claims or defenses rarely have any reason not to enthusiastically produce evidence supporting their position. But if and when a conditional order is issued, it is imperative for advocates to argue that there is little to no discretion involved in applying the prescribed sanctions of that order should non-compliance continue. Absolute means absolute. If a court still will not enter the sanctions, attorneys should make the argument that at some point the preference for leniency and a determination on the merits is outweighed by the individual and institutional harm rendered by abusive and inexcusable noncompliance. The appellate courts, including no less than the state’s highest court, have quite clearly signaled that attempts at leniency have been abused for too long and to the detriment of the litigants who play by the rules. This has disincentivized compliance, and the recent trend of enforcement recognizes that. It is welcome and long overdue.

Peter S. Sanders is the managing litigation partner at Capell Barnett Matalon & Schoenfeld and has taught CLE classes on the enforcement of discovery obligations under CPLR 3126.

Michelangelo Macchiarella is an associate attorney in the litigation department at Capell Barnett Matalon & Schoenfeld.

Marissa B. Cohen is a law clerk at Capell Barnett Matalon & Schoenfeld. She earned her LLM in Constitutional Law this spring from Emory University School of Law.

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[1] Gibbs v. St. Barnabas Hosp., 16 N.Y.3d 74 (2010).

[2] Id. at 83.

[3] Peterson v. New York Cent. Mut. Fire Ins. Co., 174 A.D.3d 1386, 1387 (2019).

[4] Gibbs, 16 N.Y.3d at 82; Keller v. Merchant Capital Portfolios, LLC, 103 A.D.3d 532 (1st Dep’t 2013).

[5] Id.

[6] See 4 N.Y. Prac., Com. Litig. in NY State Courts, § 30:54 (5th ed. 2021); see also Patrick Connors, CPLR 3126 Conditional Orders Requiring Disclosure “Can’t Get No Respect,” 73 Alb. L. Rev. 853 (2010).

[7] See Henry v. Atlantis Rehab. and Res. Healthcare Facility, LLC, 194 A.D.3d 1021 (2d Dep’t 2021).

[8] Ubuzoh v. Mueller, 164 N.Y.S.3d 442 (Mem) (1st Dep’t 2022).

[9] Papadopoulos v. Metropolitan Transportation Authority, 192 A.D.3d 430 (1st Dep’t 2021); but cf. J.G. by Quaisha K. v. Fortress CD, LLC, 199 A.D.3d 571 (1st Dep’t 2021).

[10] Index No. 451685/2020 (Sup. Ct., N.Y. Co. 2020).

[11] See Jackson v. City of New York, 185 A.D.2d 768 (1992).

[12] Judiciary Law § 753(A)(1).