Newsletter of the Tax Procedure and Litigation CommitteeTaxation Section of the State Bar of California
In This Edition
Message from the Chair regarding the Tax Procedure and Litigation Committee meeting on August 30, 2013
David Klasing, Esq.
Minutes of the May 24, 2013 Committee Meeting
Joseph P. Wilson, Esq.
Joseph P. Wilson, Esq.
Committee and Submission Deadlines
Message From The Chair
Hello again from your outgoing TPL chair David Klasing!
It has been an honor to chair the Tax Procedure and Litigation Committee for the last year and the August 30th meeting discussed below will be the last meeting I officially preside over as my term nears the end. I would like to thank Jane Becker, (former Chair Elect), and Joseph Wilson, (Newsletter Editor) and Robert Horwitz (Liaison to the Executive Tax Committee) for their assistance in providing leadership to the TPL Committee over the last quarter.
The TPL Committee Leadership would like to thank Steve Mather, Esq. of Kajan, Mather and Barish and Joseph A. Broyles, Esq. for a great presentation delivered during the TPL Committee’s last meeting on May 24, 2013, at the Law Offices of A. Lavar Taylor on the new IRS Offer and Compromise guidelines. We also wish to thank those members of the Committee at large that have volunteered to write and present for the Washington and Sacramento Delegations, draft and submit articles and Quick Points for our Committee Newsletter and for the California Tax Lawyer Magazine, who have offered suggestions on programs for the 2013 Annual Tax Bar Meeting and who are developing webinars.
TPL Sponsored Topics for the 2013 Annual Tax Bar Meeting
We hope that everyone is planning to attend the 2013 Annual Tax Bar Meeting & California Tax Policy Conference from November 7th through the 9th at the Fairmont Hotel in San Jose featuring Keynote Speaker Nina Olson of the National Taxpayer Advocates Office. Our Committee has submitted for sponsorship and or co-sponsorship for the following programs at the 2013 Annual Tax Bar Meeting that have been approved by the Executive Tax Committee.
Tax Procedure & Litigation Track and Other Tax Courses
International Roundtable [Program #1]
Federal Tax Reform – Are We There Yet, Will We Get There? [Program #3]
Designing Your Tax Law Career [Program #7]
Hot Topics in Criminal Tax Matters [Program #11]
Tax Court Litigation: What Everyone Needs to Know [Program #12]
A Primer for Attorneys Serving on Nonprofit Boards [Program #13]
The Sales Tax Warriors: Defending Against Mark-Up Audits in the Golden State [Program #15]
Defensive Strategies in Complex Civil Audits [Program #19]
Ethics and Conflicts of Interest [Program #21]
Federal Procedural Roundtable [Program #23]
Current Developments in Corporate Taxation [Program #24]
International Tax Compliance [Program #25]
Tax Lessons from Tax Returns [Program #26]
Upcoming TPL Committee Member Meeting
The next meeting of the Tax Procedure and Litigation Committee will be on August 30, 2013, from 11:00 a.m. to 3:00 p.m. at Greenberg Traurig LLP, 4 Embarcadero Center, Suite 3000, San Francisco, CA 94111. The speakers are Special Assistant US Attorney Charles Parker, Assistant US Attorney Michael Pitman and Jay Weill. The panel will discuss tax refund litigation in U.S. District Court. We look forward to your attendance. For more information or to RSVP please contact Dave Klasing, Chair.
California Tax Lawyer
If you would like to have a “Quick Point” included in the upcoming issue of the California Tax Lawyer, send me any brief 400 to 600 word technical updates, procedural updates, observations on practice or policy matters, and commentaries you may want to include at email@example.com.
Tax Network Newsletter
We continue to solicit articles for upcoming editions of our Tax Network Newsletter. Please contact the incoming Newsletter editor, Carolyn Lee, if you would like more information or a helpful style manual for submitting articles for our next edition. The Newsletter continues to include wonderful information relevant to our members.
Bring Your Camera to The Annual Tax Bar Meeting and Quarterly Committee Meetings
The editors of the California Tax Lawyer would like to include pictures of our activities. Please send me via e-mail any JPEGS you may have from our meetings, and be sure to identify each person in the photo and the event at which the photo was taken.
Thanks to all those who have helped make Committee meetings successful and fun. Please come armed with “Hot Topics” for our upcoming meeting. Our members continue to lead, teach and provide insight in our field, so there is much to share.
I hope to see you in San Francisco in August!
David Klasing Esq. M.S.-Tax CPA
Minutes of the May 24, 2013 Committee Meeting
Submitted by Joseph Wilson, Esq.
The May 24, 2013 meeting of the TPL Committee was held at the Law Offices of A. Lavar Taylor in Santa Ana. Present were the Chair, David Klasing, the former Chair Elect, Jane Becker, the former First Vice Chair, Patrick Crawford and the Second Vice Chair & Newsletter Editor, Joseph P. Wilson. Also present were thirty or more committee members and other attendees.
Welcome and Introductions
The Chair welcomed members to the meeting and thanked Jane Becker and all those who worked so diligently in arranging the meeting.
Approval of Minutes
The first order of business was the approval of minutes of the last meeting. The Chair indicated the minutes of the last meeting were e-emailed to members in the last meeting. The minutes were then approved.
Announcement and Update
A brief discussion and announcement was brought up regarding the Employment Development Department. The members were informed that the EDD is experiencing the effects of the baby boomers. In the next few years there will be a high turnover in management and within ten years top officials will have less than 10 years seniority. Also, the EDD has been having issues with Unity of Enterprise and its Aces System. With respect to the Professional Employers Organizations, the EDD wants the PEO’s to file returns under individual entities instead of their own account. There is no legislation right now but EDD does not think they need it. It was mentioned that this creates certain issues related to software, double taxation, audit issues, and the potential for assessment of additional wages at the corporate level, and a potential tax rate issue, i.e., which entity will the rate be based upon. It was mentioned that Governor Jerry Brown has his own task force to propose a solution to the UI problem.
Steve Mather, Esq.
Mr. Mather discussed multiple changes
to the IRS’s OIC program, including the 12 month factor for cash OIC and the 24 month factor for a deferred OIC. The IRM states IRS must consider threat of bankruptcy; Vasquez – abuse of discretion to refuse more than recovery in bankruptcy. Also, there is question of whether a collection due process involving an OIC affects for the 3 year rule and 240 day rule in bankruptcy. Lavar Taylor commented about the rules and provided further discussion.
Mr. Gelford is in charge of the OIC program at the Franchise Tax Board. He discussed that before 1999, the FTB had only a 2% acceptance rate on OIC. However, he stated that times have changed and that the FTB has a much higher acceptance rate today. The FTB OIC program is not exactly the same as the IRS OIC program. Mr. Gelford mentioned that the FTB did not follow IRS fresh start. Also, the FTB does not have a doubt as to liability OIC. A taxpayer cannot dispute the tax if submitting an OIC to the FTB. Generally, the period of collection that the FTB uses is 5 years. However, it may be less depending on the circumstances on the individual submission (e.g. retirement within 2 years the FTB would use 2 years). Unlike the IRS, the FTB allows actual expenses and does not follow a standard expense amount. The FTB also uses a reasonable test. Post-bankruptcy lien issues are handled through the OIC unit. The general processing time for an OIC with the FTB is about 6-7 months. It takes about 90-120 days to have the OIC assigned to an officer and another 90 days to resolve after it has been assigned. Mr. Gelford stated that about 16% of OICs that have been accepted have collateral agreements. If a taxpayer wants to dispute an OIC rejection, Mr. Gelford stated that there is a quasi-appeals process. Basically, if the OIC is rejected, a taxpayer can ask for “re-evaluation.” This means that a more senior person within the same OIC Unit will review the case. It did not sound like many of the cases get overturned. Generally, if an OIC does not work for the FTB, the FTB will informally let the taxpayer know an amount that might be acceptable to the FTB. Mr. Gelford stated that the current OIC acceptance rate at the FTB is around 32%. The FTB processes 200 offers per month with 50-80 approvals per month.
Joseph Broyles, Esq.
Mr. Broyles provided a discussion about a real life OIC that he had submitted to the IRS on behalf of a client. Mr. Broyles discussed the importance of reading the offer requirements carefully.
The following hot topics were discussed:
IRS – served John Doe summons on assessor’s office for interfamily transfers – County Assessor’s office is being surveyed for family property transfers – computer generated report
IRS training budget has been cut 85%
Furlough days – affecting state via federal programs
The new EDR (Enterprise Data Revenue) program by FTB. The FTB is rolling out various phases of the program to improve processing of returns, payments and data to increase revenue. FTB now scans payments immediately upon receipt so no more floating checks for taxpayers. Returns are scanned in for faster processing. FTB is also analyzing data that allows them to focus their efforts on the cases where they can collect the most money. All phases to be rolled out by 2016. One huge benefit to FTB is that the contractor who is developing and implementing this program does not get paid if the program doesn’t perform
The committee adjourned. The next meeting of the Tax Procedure and Litigation Committee will be on August 30, 2013, from 11:00 to 3:00 p.m. in San Francisco at the following location:
Greenberg Traurig LLP
4 Embarcadero Center, Suite 3000
San Francisco, CA 94111
The speakers are Special Assistant US Attorney Charles Parker, Assistant US Attorney Michael Pitman and Jay Weill.
The panel will discuss tax litigation in U.S. District Court. We look forward to your attendance.
2013-14 TPL Officers
The Tax Procedure and Litigation Committee has four new officers for 2013-14! Please welcome new officers: LaVonne Lawson, Courtney Hopley, and Carolyn Lee. Joseph Wilson will remain on-board, as the Chair-Elect. Their contact information is as follows:
Chair: LaVonne Lawson,
Lawson Tax, Los Angeles, CA
Tel: (310) 231-1040, firstname.lastname@example.org
Chair-Elect: Joseph P. Wilson,
Law Offices of A. Lavar Taylor, Santa Ana, CA
Tel: (714) 546-0445, email@example.com
First Vice Chair & Secretary: Courtney Hopley,
Greenberg Traurig, San Francisco, CA
Tel: (415) 655-1314, firstname.lastname@example.org
Second Vice Chair & Editor: Carolyn Lee,
Abkin Law LLP, San Francisco, CA
Tel: (415) 956-3280, email@example.com
The IRS has Released Recommendations in Two Cases in an Actions Relating to Court Decisions Document Released in The Internal Revenue Bulletin
Submitted by Joseph Wilson, Esq.
The recommendation has been made that the IRS acquiesce in K.M. Wilson, U.S. Court of Appeals, Ninth Circuit; 10-72754, January 15, 2013, affirming the Tax Court, 99 TCM 155, TC Memo. 2010-134. The acquiescence relates to the appellate court’s holding that affirmed that the Tax Court properly considered new evidence and proceeded de novo to determine that an individual was eligible for equitable innocent spouse relief. The taxpayer requested equitable relief under Code Sec. 6015(f) from joint and several tax liabilities with her former husband. The Tax Court applied both a de novo scope of review and a de novo standard to grant the taxpayer relief. The de novo scope of review allowed the taxpayer to introduce evidence outside the administrative record, and the de novo standard allowed the court to determine whether the taxpayer was entitled to relief without regard to the IRS’s determination.
The Ninth Circuit interpreted Code Sec. 6015(e)(1) in conjunction with the mandate in Code Sec. 6015(f) “to consider the totality of the circumstances before making an equitable relief determination,” which the court noted would be impossible if the Tax Court limited its review to the administrative record. The IRS disagrees that Code Sec. 6015(e)(1) provides both a de novo scope of review and a de novo standard; however, it will no longer argue that the Tax Court should review Code Sec. 6015(f) cases for an abuse of discretion or that the court should limit its review to the administrative record.
Acquiescence was recommended by the IRS Chief Counsel in AOD 2012-07.
Media Space Nonacquiescence
The recommendation has also been made that the IRS not acquiesce to Media Space, Inc., 135 TC 424 (2010), vacating and remanding, 477 Fed Appx 857 (2nd Cir. Sep. 13, 2012). In that case, the Tax Court had characterized the taxpayer’s forbearance payments to its shareholders as Code Sec. 162 business expenses. The court held the forbearance payments were not required to be capitalized under Code Sec. 263(a) in one of the tax years at issues. The court further found that there was neither a reacquisition nor an exchange of stock to which either Code Secs. 162(k) or 361(c)(1) applied. The court also found the payments were not distributions under Code Sec. 301.
The IRS had appealed the decision but the Court of Appeals for the Second Circuit dismissed the appeal as moot, after the taxpayer in the case conceded that the payments for the tax year at issue were required to be capitalized, and vacated the Tax Court’s decision. The IRS had argued that the legal questions presented in the appeal should be addressed but the court declined to do so.
Nonacquiescence was recommended by the IRS Chief Counsel in AOD 2012-08.
Law Offices of A. Lavar Taylor
6 Hutton Center Dr., Ste. 880
Santa Ana, CA 92707
IRC Section 6015: Powerful Taxpa
yer Protection Still in its Formative Years
Submitted by Carolyn M. Lee, Esq.
Reform Act of 1998 (RRA) must shine a light on one of the RRA’s undisputed achievements: the enactment of Internal Revenue Code §6015, providing relief from joint and several liability for taxes due to requesting spouses. Now a fifteen-year-old adolescent, §60151 is developing nicely under the nurturing oversight of a Congress and IRS seemingly committed to making relief available for those taxpayers the law was designed to protect. As with any adolescent, however, there are opportunities for continued growth. This article provides a brief history of §6015 and spotlights two grating aspects pertaining to the law that unnecessarily obstructs deserving taxpayers from obtaining relief.
Congressional Commitment to Making Relief Available
Section 6015 relief is a frequent subject of the Tax Procedure & Litigation Committee Cal Tax Network newsletter. Taxpayers who file joint federal income tax returns may be relieved of joint and several liability for taxes due thereon under limited circumstances described in §6015. Taxpayers granted such relief commonly are referred to as “innocent” spouses. 3 Congress consistently has legislated to make relief from joint and several liability for qualifying requesting spouses easier to obtain.
The RRA did not fabricate §6015 out of whole cloth. The section’s precedent was §6013(e), which initially provided relief only in cases involving an omission of income, and a narrow band of omitted income cases at that. Only applications arising from returns with omitted income, and with a substantial understatement of tax attributable to grossly erroneous items of the other spouse, could be considered. In 1984, relief was expanded to include deficiencies that arose from erroneous deductions or credits, though the omitted income restrictions continued in effect. In practical effect, relief under §6013(e) was difficult for many spouses to obtain.3 The Tax Court scolded the IRS for taking a “very narrow reading of a remedial statute [i.e., §6013(e)],” because the “innocent spouse provision should be construed and applied liberally in favor of those for whom it was designed to protect.”4
During 1997, Congressional committees undertook a complete makeover of the law in order to make relief more accessible. Their work resulted in the repeal of §6013(e) and the enactment of §6015.5 The newly enacted statute expanded the avenues of relief from one to three: relief for all joint filers (§6015(b) – similar to the repealed §6013(e) with fewer restrictions); relief for separated or divorced spouses by apportioning tax liabilities as though each spouse had filed a separate income tax return (§6015(c)); and equitable relief when relief was unavailable under §6015(b) and (c) but still warranted under certain circumstances (§6015(f)).
Another broadening feature of the RRA made §6015 relief available to qualifying requesting taxpayers regardless of the amount of the understatement, or for any erroneous item.6 It was “inappropriate to limit innocent spouse relief to the most egregious cases where the understatement is large and the tax position taken is grossly erroneous.”7 Further, the RRA provided the Tax Court jurisdiction to review any denial or failure to rule by the Service regarding an application for §6015 relief, including awarding refunds to a qualifying requesting spouse. Taken together, the new §6015 manifested Congress’s stated intent to provide, inter alia, “more generous innocent spouse relief.”8 Continuing this mission, all of the legislative changes to §6015 have been to broaden the opportunity for relief.
As an example, in 2011 a bill was introduced in the House of Representatives to remove time limits to request equitable relief under §6015(f).9 The Senate supported this initiative, describing equitable relief as a “‘safety valve’ for innocent spouses which takes into account all the facts and circumstances of each case.”10
The IRS of its own volition has become more permissive in its rules and procedures. Witness the 2012 publication of IRS Notice 2012-8, clarifying the analysis for equitable relief pursuant to §6015(f) such that more taxpayers, whose circumstances demonstrate they qualify under the spirit of the statute, receive Congress’s intended benefit. 11
So Why Aren’t We Satisfied?
Actually obtaining §6015 relief as a qualifying taxpayer is far from easy. At the federal level, this is due in part to inadequate regulatory and administrative guidance for determining a foundational element of eligibility: actual knowledge. In California, even requesting spouses who are granted §6015 relief may be liable for the deficiency by operation of the State’s community property laws. For activists in the tax community, there remains work to be done before §6015 can fully deliver on Congress’s intent to help those taxpayers for whom the law is designed to benefit.
Remove the Actual Knowledge Tripwire
Each of the three avenues to relief provided by §6015 includes consideration of whether the requesting spouse knew there was an understatement of tax attributable to the erroneous item on the joint tax return.
“Actual knowledge” is addressed by §1.6015-3(c)(2), Income Tax Regs.12 The regulation describes different tests to determine actual knowledge when the erroneous item is a deduction or credit versus when it is omitted income. The regulation is silent regarding how to determine actual knowledge when the item in issue is reported income but still erroneous, e.g., income reported as capital gain instead of ordinary income.
Put another way, the current regulation provides inadequate direction for determining a requesting spouse’s actual knowledge. There is no statutory basis for distinguishing actual knowledge by type of erroneous item. Under the current regulations, determinations for relief are unnecessarily eclectic and unpredictable at the administrative level, and some determinations may be legally incorrect.
The lack of guidance regarding the scope of proper analysis when determining actual knowledge is a serious problem for at least three reasons:
- No one knows how to handle the determination. For the requesting spouse who has the burden of proof in erroneous income cases, what should the taxpayer provide to substantia
te there was no actual knowledge of the erroneous item? On what basis will whatever evidence the requesting spouse provides be evaluated? What should the IRS professional evaluating the request for relief ask for from the taxpayer – or consider relevant? Within what context?
- The first problem leads naturally to the second: Without guidance as to the scope of the analysis, out of an abundance of caution, a default test has emerged: Is the item on the return? If yes, there was actual knowledge. Was there a Form W-2 attached to the return, or even referenced? That established actual knowledge. Put another way, if the erroneous item was visible on the return to the naked eye, the requesting spouse had actual knowledge.13 The folly of such a superficial determination was resolved for §6015 requests for relief involving erroneous deductions or credits, which are always present on the tax return. In these cases, the requesting spouse must have knowledge of the facts that made the deduction or credit erroneous. Mere knowledge of the item does not establish actual knowledge. The analysis of facts and circumstances that is required for erroneous deduction and credit cases should be extended to all §6015 requests for relief.
- Too many applications for §6015 relief are being rejected for the wrong reasons, and being rejected too soon. Actual knowledge is a foundational test which can result in the application being automatically denied or start the requesting spouse down a short path to rejection. Many §6015 applications for relief are being denied wrongly at their first review because of a superficial analysis of actual knowledge.
The Tax Court appears to have organically developed a consistently applied methodology to determine actual knowledge, regardless of the type of erroneous item or the avenue for relief: A requesting spouse has actual knowledge of an erroneous item if he or she had knowledge of the factual circumstances related to the erroneous item that caused the understatement of tax. Mere knowledge of the existence of the item is not enough for the Court. Unfortunately, to date none of the opinions forming this trend has called upon Congress or the IRS to codify this approach.
IRS field agents and §6015 specialists14 reviewing applications do not have discretion to apply analytical methodologies that diverge from those prescribed in the Regulations or the Internal Revenue Manual (I.R.M.).15 Even experienced Appeals Officers and IRS Counsel may feel restricted by the limited guidance for determining actual knowledge, particularly when large deficiencies are involved. Taxpayers who are denied §6015 relief because of an administrative decision that incorrectly turned on superficial awareness of an item are forced to turn to the courts – if they can. Not all requesting spouses have the financial wherewithal or the emotional stamina to press on after an administrative rejection. Most are unrepresented by counsel. As a consequence, in practical terms, these spouses may wrongly suffer the burden of liabilities that §6015 is intended to relieve. Properly evaluating requests for relief at the administrative level would make for the effective, efficient, and fair delivery of justice on an individual taxpayer basis as well as across the cohort of requesting spouses.
Inconsistency and ambiguity in a fundamental qualifying analysis such as the determination of actual knowledge are at odds with Congressional intent to benefit requesting spouses deserving of relief. The regulations should be revised to provide explicit guidance regarding a single methodology to determine whether a requesting spouse had actual knowledge of the factual circumstances related to the erroneous item that caused the understatement of tax- regardless of the type of erroneous item and regardless of whether relief is requested pursuant to §6015(b), (c), or (f). Such guidance will provide a credible roadmap for determining actual knowledge, yielding a greater number of accurate determinations at the earliest point of consideration and increased fairness across the population of requesting taxpayers. Cards and letters in support of this proposition, including case scenarios that would have been more correctly, fairly served by application of a single methodology for analyzing actual knowledge, based on the requesting spouse’s knowledge of the factual circumstances related to the erroneous item, may be sent to 1111 Constitution Avenue, Washington, DC.
And California said Ha! Community property trumps §6015 relief
While in most instances taxpayers seeking relief from joint and several liability pursuant to §6015 are divorced, relief is available for married requesting spouses who qualify under §6015(b) or (f). In addition, in some cases, divorced requesting spouses still may have community property. For example, the couple may have bifurcated their dissolution action in order to accelerate the termination of the marriage while reserving decisions concerning the division of community property. These situations may present a trap for requesting spouses.
Pursuant to California Family Code §910(a), “the community estate is liable for a debt incurred by either spouse before or during marriage, regardless of which spouse has the management and control of the property and regardless of whether one or both spouses are parties to the debt or to a judgment for the debt.” In other words, community property is available to satisfy a debt from either spouse, even if the other spouse is not responsible for the debt.16
More to the point of this article, in California, even when §6015 relief is granted to a requesting spouse, under California community property laws, the IRS can look to the community property share of a requesting spouse to collect a tax liability of the non-requesting spouse. 17
The analytical sequence is this: A federal tax lien arising under §6321 attaches to the property and the rights to property of the taxpayer.18 “State law controls in determining the nature of the legal interest which the taxpayer ha[s] in property.”19 “The federal tax lien statute does not create property rights but merely imposes consequences, federally defined, to rights created under State law.”20 By granting creditors recourse against the whole community estate on debts of only one spouse, California law implicitly establishes that spouse’s interest in the whole of the community property, at least to a degree sufficient for the IRS to impose tax liens under the Internal Revenue Code.21 If, under the law of the community property state in which the spouses reside, the IRS can look to community property to collect a liability of one
of the spouses, the determination that the other spouse is entitled to relief under §6015 does not affect the Service’s ability to collect the nonrequesting spouse’s liability from the community property.22
The Ordlock Court presented its reasons for permitting the IRS to collect against the entirety of a community’s assets even when §6015 relief had been granted. First, the Court found no evidence that Congress intended to place the IRS at a disadvantage in collecting the debt of one spouse when state law provides otherwise.23
In addition, disregarding community property laws in the context of §6015 could create a potential for abuse.24 “Because §6015 relief is often granted many years after the taxable year at issue, the timespan offers an opportunity to change the source of the payments that are otherwise community property. In an effort to avoid paying tax liabilities, married taxpayers in community property states could structure future payments so that ownership is attributable to the spouse requesting relief, while continuing a jointly financed lifestyle.”25
There is no exception in the law for divorced taxpayers who have yet to distribute their community assets; consequently, the grant of relief to a divorced spouse is little more than ashes as a defense against IRS collection demands. Tax attorneys advising in California family law matters should be strategically cautious when requesting §6105 relief. If community property has not been distributed, the request for relief should be delayed in order to protect the requesting spouse’s community share, being mindful that relief pursuant to §6015(b) must be elected within two years after the date the IRS has begun collection activities against the requesting spouse. 26 Applications for relief pursuant to §6015(f) relief must be made before the expiration of the §6502 period of limitation on collection of the income tax liability; generally, ten years after the tax was assessed.27
This inequity for California taxpayers who have been granted §6015 relief could be corrected by revision to the State statutes. Not every community property state thwarts the benefits of relief by permitting the Service’s collection arm to attach to the entirety of the community assets.28 Perhaps this issue is a worthy paper topic for the newly established California Bar Taxation Section’s Sacramento Delegation.
Section 6015 – Well Worth The Growing Pains.
Section 6015 has been reared with the intention of providing relief from joint and several liability for a deficiency of tax for deserving requesting spouses. The law has saved the financial lives of countless taxpayers. Practitioners’ continued plans for the law’s improvement reflect a drive to help §6015 achieve its very real potential; that is, a greater number of accurate determinations of requests for relief at the earliest point of consideration, resulting in increased fairness across the population of requesting spouses. In California, a way should be found to protect the community property share of requesting spouses so that the §6015 benefit once granted is not treated as non-existent by the IRS collection division.
Abkin Law, LLP
150 California Street, Suite 2100
San Francisco, CA 94111
The Fraud of Your Tax Preparer May Extend The Statute of Limitations on Tax Assessments
Submitted by Steven Toscher, Esq. and Della Bauserman, Esq.
The Tax Court’s 2007 decision in V. Allen can be described as a submarine earthquake from which the tsunami has been picking up speed and may engulf many unsuspecting taxpayers. However, as one old-time lawyer told one of the authors, we are paid to be paranoid.
Steve Toscher and Della Bauserman discuss the consequences the Allen Tax Court decision has on the application of the statute of limitations.
Tsunamis are caused by submarine earthquakes. In the ocean, tsunamis have a small wave height and often go unnoticed. However, once they reach shore, tsunamis may have a devastating effect. The Tax Court’s 2007 decision in V. Allen 29 can be described as a submarine earthquake from which an unnoticed tsunami has been picking up speed and may engulf many unsuspecting taxpayers.
The issue in Allen was whether the taxpayer must have an intent to evade tax in order to keep the statute of limitations on assessment open indefinitely under Code Sec. 6501(c)(1).30 The Tax Court concluded the statute of limitations would remain open if the tax preparer had the intent to evade tax.31 To state this conclusion another way, the Tax Court allowed the statute of limitations on assessment to remain open forever32 when the tax preparer has fraudulently filed a tax return even if the innocent taxpayer was also defrauded by the tax preparer. This was a startling proposition–at least at first blush–for most of us in the tax litigation field.
While Allen was viewed by many as an outlier, it seems to have had staying power, and the IRS recently advised its agents that the issue should be developed where appropriate. The IRS has added Allento its INTERNAL REVENUE MANUAL.33 The Treasury Inspector General for Tax Administration also added, “[p]eriod of limitations also held open by fraudulent intent of third party (e.g., preparer). Allen …” to a fraud checklist that was an appendix to a memorandum sent to the Commissioner, Small Business/Self-Employed Division on March 13, 2013.34 The subject of the memorandum was “Final Audit Report–Actions Can Be Taken to Reinforce the Importance of Recognizing and Investigating Fraud.”35
Allen has potentially serious consequences–not only on the application of the statute of limitation under Code Sec. 6501, but also on th
e application of the statute of limitations under Code Sec. 6229(c) (for partners in partnerships). The IRS has even recently considered whether Allen affects the statute of limitations for shareholders of S corporations. Some might even argue that the logic of Allen suggests that the fraud of the preparer could implicate a fraud penalty on an innocent taxpayer–but this would seem a bit paranoid. However, as one old-time lawyer told one of the authors, we are paid to be paranoid.
Allen seemed to come out of the blue; however, there were warnings of the pending submarine earthquake. Prior to 2001, the perception was that the IRS would not extend the statute of limitations of an otherwise innocent taxpayer if there was fraud by the tax preparer. In 2001, the IRS changed its position and came up with the theory that a tax preparer’s intent to evade taxes could hold the statute of limitations open forever. In 2001, the IRS released two Field IRS Advice Memoranda (“the FSAs”), written six months apart, on substantially the same set of facts, by the same author, coming to the opposite conclusion on whether the tax preparer’s intent to evade taxes could allow the statute of limitations on assessment on the taxpayers return to remain open forever under Code Sec. 6501(c)(1).36
In these FSAs, the taxpayer was a truck driver that had heard that a tax preparer was able to obtain large refunds for truck drivers based on their diesel fuel purchases. 37 The taxpayer sought out the services of this preparer.38 The preparer knew that the taxpayer was not entitled to the diesel fuel excise credit upon which the refunds were based.39 The preparer was prosecuted for preparing false returns with respect to the taxpayer and several other drivers.40 The IRS proposed to issue a notice of deficiency outside of the three-year statute of limitations disallowing the diesel fuel credit.41 Although the IRS did not impose the fraud penalty under Code Sec. 6663, the IRS proposed relying on the fraud of the preparer to extend the statute of limitations under Code Sec. 6501(c)(1).42
In the first FSA issued in 2000, the IRS came to the conclusion that the fraudulent intent of the tax preparer was insufficient to extend the statute of limitations for the taxpayer.43 The IRS based this conclusion on the fact that, since Code Sec. 6501(c)(1) and Code Sec. 6663 were part of a single section of the Revenue Act of 1918, Congress intended for the term “fraud” to have the same meaning for both purposes.44 The FSA concludes the fraudulent intent of the tax preparer would be insufficient to extend the statute based on cases under Code Sec. 6663.45
In the second FSA, the IRS came to the opposite conclusion–that the fraudulent intent of the tax preparer could extend the statute of limitations for assessment for the taxpayer under Code Sec. 6501(c)(1).46 The second FSA relies on the following points:
Under agency law, the taxpayer bears the consequences of errors made by the tax preparer.49
The application of the badges of fraud is not appropriate in this case.50
The IRS is disadvantaged by the fraud the same whether the fraud is the fraud of the taxpayer or the fraud of the tax preparer.51
Same Statutory Language but Different Intent?
The first two points of the FSA revolve around the interpretation of the language in Code Sec. 6501(c)(1) and whether that language should be interpreted in a manner consistent with the identical language of Code Sec. 6663. The IRS interprets the passive voice of Code Sec. 6501(c)(1) as indicating that the intent of any person to evade tax is sufficient to allow the statute of limitations on assessment to remain open forever. The Tax Court interpreted the same passive voice in Code Sec. 6663 as requiring the intent to be the intent of the taxpayer in a series of cases decided in the 1950’s with facts similar to those in the FSAs.52 In those decisions, the Tax Court determined that, although the tax preparer filed a false and fraudulent return, the predecessor to Code Sec. 6663 did not apply because there was no proof that the taxpayer intended to defraud the Government. 53
The language in Code Sec. 6501(c)(1) should be interpreted the same as the language in Code Sec. 6663 because, not only were they passed as part of the same section of the Revenue Act of 1918, they are also on the same page, merely one sentence apart.54 An analysis of the statute strongly suggests that the language of both sections was intended to have the same meaning.
Beginning with the second to the last sentence of subsection (b) of section 250, the Revenue Act of 1918 states:
(b) … If the understatement is due to negligence on the part of the taxpayer, but without intent to defraud, there shall be added as part of the tax 5 per centum of the total amount of the deficien
cy, plus interest at the rate of 1 per centum per month on the amount of the deficiency of each installment from the time the installment was due.
If the understatement is false or fraudulent with the intent to evade the tax, then, in lieu of the penalty provided by section 3176 of the Revised Statutes, as amended, for false or fraudulent returns willfully made, but in addition to other penalties provided by law for false or fraudulent returns, there shall be added as part of the tax 50 per centum of the amount of the deficiency.
(c) If the return is made pursuant to section 3176 of the Revised Statutes as amended, the amount of tax determined to be due under such return shall be paid upon notice and demand by the collector.
(d) Except in the case of false or fraudulent returns with intent to evade tax, the amount of tax due under any return shall be determined and assessed by the Commissioner within five years after the return was due or was made, and no suit or proceeding for the collection of any tax shall be begun after the expiration of five years after the date when the return was due or was made. In the case of such false or fraudulent returns, the amount of tax due may be determined at any time after the return is filed, and the tax may be collected at any time after it becomes due.55
The last sentence of subsection (b) became Code Sec. 6663. The last sentence of subsection (d) became Code Sec. 6501(c)(1). The first sentence quoted above does not apply if the taxpayer has the intent to defraud. The following sentence lays out what rules do apply if the understatement is false or fraudulent because the taxpayer has the intent to evade. Subsection (d) is organized similarly to (b). The first sentence does not apply if the taxpayer has the intent to evade tax. Since Congress used the same wording in this sentence as it used in subsection (b) (two sentences previously and on the same page), the person required to have the intent to evade in (d) is the same as the person required to have the intent to evade in (b) – the taxpayer. The second sentence of subsection (d) lays out the rules if the return is false or fraudulent because the taxpayer has the intent to evade tax. The original context of Code Secs. 6663 and 6501 indicates that the person required to have the intent to evade in both statutes is the taxpayer.
Courts have consistently interpreted the words in Code Secs. 6501 and 6663 the same way.56 In fact, the Supreme Court in Badaraccorelied upon case law in G.M. Still57 under a predecessor to Code Sec. 6663 to interpret Code Sec. 6501(c)(1). In Still, the issue was whether a taxpayer could avoid the fraud penalty under a predecessor to Code Sec. 6663 after filing fraudulent returns by filing non-fraudulent amended returns and paying the tax owed.58In Badaracco, the issue was whether the extended statute of limitations in Code Sec. 6501(c)(1) applied if the taxpayer filed a fraudulent return and then subsequently filed a non-fraudulent amended return.59 In determining that a taxpayer who submits a fraudulent return does not purge the fraud by voluntary disclosure, the Supreme Court in Badaracco quoted Still.60 At the time, the IRS agreed that cases under Code Sec. 6663 should be used to interpret Code Sec. 6501(c)(1), since it cited Still in its brief to the Supreme Court for Badaracco to be used to interpret Code Sec. 6501(c)(1).61
In response to this argument in FSA 200126019, the IRS stated that while the elements of fraud may be the same under Code Sec. 6501(c) and Code Sec. 6663, the focus on the inquiry of intent may be different. The IRS stated that, “The focus in section 6501(c) is on whether fraud was committed in connection with the return, while the focus in section 6663 is on whether the taxpayer committed the fraud.”62 The IRS also noted that “for many years the fraud exception to the period of limitations and the fraud penalty have no longer been contained within the same statutory provision.”63
Suggesting that these similar statutory provisions–which were born from the same section of the same tax act–have different intent elements because they are no longer in the same section seems like a stretch. In Badaracco, the Supreme Court stated, “The word ‘return,’ however, appears no less than 64 times in §6501. Surely, Congress cannot rationally be thought to have given that word one meaning in §6501(a), and a totally different meaning in §§6501(b) through (q).”64 The same statutory interpretation should apply in construing who has “the intent to evade” when the language is found in the same section of an act of Congress only a sentence apart.
Granting the IRS an Unlimited Statute of Limitations Is Punitive
In FSA 200126019, the IRS justifies the application of an indefinite statute of limitations to an innocent taxpayer’s return by arguing that a fraudulent return places the IRS at a disadvantage whether or not the fraud is perpetrated by the taxpayer. This statement can only justify applying an unlimited statute of limitations to an innocent taxpayer if the punitive nature of extending the statute of limitations forever is ignored. The Supreme Court recognized the punitive nature of Code Sec. 6501(c)(1) in Badaracco. 65 The Supreme Court stated:
The substantive operation of the fraud provisions of the Code itself confirms the conclusion that §6501(c)(1) permits assessment at any time in fraud cases regardless of a taxpayer’s later repentance. It is established that a taxpayer who submits a fraudulent return does not purge the fraud by subsequent voluntary disclosure; the fraud was committed, and the offense completed, when the original return was prepared and filed.66
The Supreme Court later addressed the fairness of keeping the statute of limitations open forever:
Petitioners claim that it is unfair “to forever suspend a Sword of Damocles over a taxpayer who at one time may have filed a fraudulent return, but who has subsequently recanted and filed an amended return providing the Government with all
the information necessary to properly assess the tax.” But it seems to us that a taxpayer who has filed a fraudulent return with intent to evade tax hardly is in a position to complain of the fairness of a rule that facilitates the Commissioner’s collection of the tax due.67
Allen (the Earthquake)
In 2007, the concept that Code Sec. 6501(c)(1) only requires an intent to evade tax, not necessarily the taxpayer’s intent to evade tax, was presented to the Tax Court in Allen.68 The facts of Allen are similar to the facts in FSA 200104006 and FSA 200126019. In Allen, the taxpayer was a UPS driver who had Mr. Goosby prepare his income tax returns.69 Mr. Goosby claimed false and fraudulent itemized deductions on the tax returns for both years at issue.70Mr. Goosby was convicted of 30 violations of Code Sec. 7206(2) for willfully aiding and assisting in the preparation of false and fraudulent returns, but was not convicted on the basis of the taxpayer’s returns.71 The parties agreed on the following:
The taxpayer did not have the intent to evade tax.72
The false deductions on the taxpayer’s returns made the returns false and fraudulent.73
Mr. Goosby claimed the false deductions on the taxpayer’s returns with the intent to evade tax.74
The Tax Court determined that the statute of limitations was open on the taxpayer’s returns based on Mr. Goosby’s fraudulent intent.75 The Tax Court relied on the following points in its decision:
“Nothing in the plain meaning of the statute suggests the limitations period is extended only in the case of the taxpayer’s fraud.”76
The Tax Court was asked to decide this issue for the first time in this case.77
The IRS has a special disadvantage investigating fraudulent returns.78
Other cases have extended limitations periods in the Code due to third-party malfeasance.79
“To find otherwise would allow a taxpayer to receive the benefit of a fraudulent return by hiding behind the preparer.” 80
Plain Meaning of the Statute
The Tax Court determined that the plain meaning of Code Sec. 6501(c)(1) does not indicate that the statute of limitations is only extended by the taxpayer’s fraud.81 The Tax Court appeared to base this conclusion on the fact that in 1934, the House Ways and Means committee passed a version of Code Sec. 6501(c)(1) that would have clarified that the intent was the intent of the taxpayer and the Senate Finance Committee disregarded this language.82
The Tax Court does not appear to dispute that the language in Code Sec. 6501(c)(1) should be interpreted the same as the language in Code Sec. 6663.83 The Tax Court states, “[n]or do we read these cases to require that the person who causes a return to be fraudulent under section 6501 must be the person who owes the tax or against whom the fraud penalty is asserted under section 6663.”84 This statement implies that not only could the statute of limitations be extended due to the fraud of the tax preparer, but that the fraud penalty could also be asserted against the taxpayer as well.85
The Tax Court also noted that statutes of limitations are to be strictly construed in favor of the government.86 However, there is also another line of cases that state, “taxing acts, including provisions of limitation embodied therein, [are] to be construed liberally in favor of the taxpayer.”87 Given the importance of the statute of limitations for tax enforcement, the Tax Court’s choice of one rule of construction over another can be fairly questioned.
This Issue Has Been Before the Tax Court Previously
While the Tax Court in Allen states that this is the first time it has considered the issue of whether the limitations period for assessing income tax under Code Sec. 6501(c)(1) is extended due to the fraudulent intent of the tax preparer,88 it appears the Tax Court has touched upon the issue before. In 1971, in a Memorandum Opinion, the Tax Court decided that since an individual did not have the required intent to evade tax, the statute of limitations was not extended. 89 The taxpayer was in a partnership with Mr. Bear.90 During the years at issue, Mr. Bear prepared both the partnership’s tax returns and the taxpayer’s tax returns.91 The taxpayer and Mr. Bear were both indicted by a federal grand jury for alleged fraudulent evasion of federal income taxes based on the understatement of income from the partnership.92 Mr. Bear pled guilty to all counts in the indictment, but the indictment was dismissed against the taxpayer.93 In finding that the taxpayer did not have the intent to commit fraud under the predecessor to Code Sec. 6663, the Tax Court stated:
In retrospect, petitioner was negligent in not exercising greater care in the supervision of his own personal affairs and was guilty of poor judgment in not verifying the correctness of his income tax returns. However, [n]egligence, careless indifference, or disregard of rules and regulations do not suffice to establish fraud. Furthermore, poor judgment and ignorance are not tantamount to fraud. There is lacking one essential element, the very heart of the fraud issue, namely, the intent to defraud the Government by calculated tax evasion. 94
In finding that the statute of limitation was not extended by Code Sec. 6501(c)(1), the Tax Court stated, “For the reasons set forth above [referring to the reasons that the taxpayer did not have intent to evade taxes for the fraud penalty], we hold that petitioners did not file false or fraudulent returns with the intent to evade tax for 1958 and 1959; and consequently, the assessment for those years is barred by the statute of limitations.”95
The IRS’s Disadvantage in Investigating Fraudulent Returns
Like the IRS in FSA 200126019, the Tax Court in Allen focused on the disadvantages to the IRS in investigating fraudulent returns.96As mentioned above, this justification for allowing the statute of limitations to remain open forever when the taxpayer is innocent loses much of its force and support in the law if Code Sec. 6501(c)(1) is a punitive provision. As discussed by Supreme Court in Badaracco, Code Sec. 6501(c)(1) is a punitive provision. Therefore, the provision should not be applied to an innocent taxpayer.
Other Cases Extending Limitations Periods in the Code Due to Third-Party Malfeasance Are not Analogous to Extending the Statute of Limitations Under Code Sec. 6501(c)(1) for Fraud
In referencing other cases that have extended limitations periods in the Code due to third-party malfeasance, the Tax Court cited two cases under Code Sec. 6532(b), one case where there was a joint return, and one case under Code Sec. 6229.97
Code Sec. 6532(b) states in part, “such suit may be brought at any time within 5 years from the making of the refund if it appears that any part of the refund was induced by fraud or misrepresentation of a material fact.” (Emphasis added.) Because Code Sec. 6532(b) includes the phrase “or misrepresentation of a material fact,” it lacks the intent element that is required for Code Sec. 6501(c)(1).
Joint returns are not comparable to third parties under Code Sec. 6501(c)(1) because the spouses filing the joint return are jointly and severally liable for the return. Third parties are not jointly and severally liable for the return.
The Tax Court in Allen cited a case “extending limitations period for assessing taxes of partners attributable to partnership items under sec. 6229(c) where [a] partner intended to evade taxes of other partners.”98 Code Sec. 6229(c)(1) extends the statute of limitations on assessment “If any partner has, with the intent to evade tax, signed or participated directly or indirectly in the preparation of a partnership return which includes a false or fraudulent item.” (Emphasis added.) In the case that the Tax Court cited, the Court of Appeals for the Federal Circuit found that a partner who had signed the returns in 1983 and 1984 had the intent to evade taxes in both years.99 This finding is in accordance with Code Sec. 6229(c)(1) which on the face of the statute requires that the partner have the intent to evade tax. The Federal Circuit did not extend the statute of limitations due the malfeasance of a third party beyond what is clearly stated on the face of the statute.
None of these cases are analogous to extending the statute of limitations on an innocent taxpayer’s return because of the fraudulent intent of a third party with the exception of the case under Code Sec. 6229(c)(1). In the case of Code Sec. 6229(c)(1), the extension due to the fraudulent intent of the third party is clearly stated in the statute. In addition, if the partner was innocent of the fraudulent intent, then the statute of limitations under Code Sec. 6229(c)(1) is only extended to six years instead of being extended forever as under Code Sec. 6501(c)(1).
Taxpayers Cannot Hide Behind Tax Preparers
To the extent that the Tax Court is concerned with taxpayers receiving the benefit of a fraudulent return by hiding behind tax preparers, there are ways to deal with that issue. More than 50 years before Allen was decided, the Tax Court was concerned with another taxpayer benefiting from a tax preparer’s fraudulent conduct.100 In F. Ambuhl, the taxpayer’s former husband and current partner in a business prepared the taxpayer’s tax returns.101The tax preparer was convicted of tax evasion with respect to his partnership income for the years at issue.102 The taxpayer admitted that all of her returns at issue were false and fraudulent, but denied that she had a fraudulent intent.103 The Tax Court compared this case with D.R. Fulton, where the preparation of false and fraudulent returns was found to be outside the scope of the taxpayer’s agent’s authority.104 The Tax Court concluded that the tax preparer in Ambuhl was generally known to be disreputable.105The taxpayer was aware of the tax preparer’s true character and
reputation.106 The taxpayer accepted and benefitted from the tax preparer’s fraudulent conduct.107 Therefore, the preparation and filing of such false and fraudulent returns were within the scope of the tax preparer’s authority as an agent of the taxpayer.108 The Tax Court found that “some part of the deficiency of the petitioner’s income tax for each of the years was due to fraud with intent to evade tax.”109 The Tax Court was thus able to prevent a taxpayer from hiding behind the tax preparer while consistently defining the intent in Code Sec. 6663 as the intent of the taxpayer. With the doctrine of “willful blindness” now included in civil fraudulent intent cases, neither the IRS nor the Tax Court will permit a culpable taxpayer to hide behind a fraudulent preparer.110
Since Allen, there have been a number of cases and a CCA that shed additional light on how the decision in Allen may be used by the IRS and interpreted by the courts in the future. In River City Ranches #1 Ltd.,111 P.W. Browning and S.M. Eriksen, the Tax Court indicated that it will follow Allen.
In this CCA, the issue was whether the statute of limitations could be extended for the personal return of a shareholder in an S corporation when the Form 1120S for the S corporation was fraudulent.113 The IRS determined that the statute of limitation under Code Sec. 6501(c)(1) would not be extended on this set of facts. 114 However, part of the reasoning as to why the statute of limitations would not be extended was based on the Tax Court decision in City Wide Transit.115 The Tax Court opinion in City Wide was recently overturned by the Second Circuit.116
In City Wide, Ms. Fouche retained Mr. Beg, an accountant, on behalf of the corporation for the sole purpose of negotiating with the IRS a reduction in the corporation’s outstanding employment tax liabilities for periods that are not at issue in this case.117 Ms. Fouche never requested for Mr. Beg to prepare any of the corporation’s Forms 941.118 Mr. Beg convinced Ms. Fouche that he had reached an agreement with the IRS.119 Mr. Beg claimed that he needed to deliver the corporation’s Forms 941 along with a certified check for the amount due as the forms became due as part of the agreement that he had reached with the IRS.120 Ms. Fouche delivered the correctly prepared forms to Mr. Beg and certified checks for the amount due payable to the IRS.121 Mr. Beg altered the checks and deposited them in a foreign bank account.122 Mr. Beg also altered the Forms 941 that he filed by fraudulently claiming that the corporation had made advance EIC payments to employees. Mr. Beg filed these altered forms with the IRS along with checks drawn on the foreign bank account for the lesser amounts due shown on the forms.123 Unbeknownst to Ms. Fouche, Mr. Beg also filed amended Forms 941, fraudulently claiming that the corporations had made advance EIC payments to employees in prior periods.124 Mr. Beg pled guilty to charges of knowingly and willfully signing false returns and knowingly and willfully preparing and presenting false tax returns.125
One of the issues was whether Mr. Beg willfully attempted to defeat or evade tax within the meaning of Code Sec. 6501(c)(2) in addition to whether Mr. Beg intended to evade tax within the meaning of Code Sec. 6501(c)(1).126 Under Code Sec. 6501(c)(2), there is no statute of limitations on assessment if there was a willful attempt to defeat or evade tax. Code Sec. 6501(c)(2) was not an issue in Allenbecause Code Sec. 6501(c)(2) does not apply to income tax. The Tax Court applied Allen to Code Sec. 6501(c)(2) and stated that Mr. Beg’s intent to evade taxes could keep the statute of limitations open under Code Sec. 6501(c)(2).127
The Tax Court found that the IRS had not proved that Mr. Beg intended to evade tax under Code Sec. 6501(c)(1) or that Mr. Beg willfully attempted to defeat or evade tax under Code Sec. 6501(c)(2).128 The Tax Court determined that Mr. Beg’s filing of the Forms 941 and amended Forms 941 was an incidental consequence or secondary effect of his embezzlement scheme.129 The IRS appealed to the Second Circuit.130
The Second Circuit reversed the Tax Court.131 A critical part of the Second Circuit’s opinion is footnote 3 where the court noted:
In front of the tax court, City Wide argued that it was not liable for the returns Beg prepared where (1) City Wide did not know of the preparer’s defalcations; and (2) City Wide did not sign or knowingly allow to be filed a false return. The Commissioner anticipated these claims on appeal and rebutted them in its opening brief. City Wide, however, conceded these issues in its response brief. Moreover, each member of this panel asked City Wide whether it had intended this concession, and City Wide responded affirmatively to each of us in turn. Accordingly, we accept this concession without deciding whether certain factual situations might arise that sever the taxpayer’s liability from the tax-preparer’s wrongdoing. 132
On its face, it appeared that the Second Circuit in City Wideendorsed the Tax Court’s decision in Allen, but that is not the case. The Second Circuit has not ruled on whose intent is necessary under Code Sec. 6501(c)(1) or Code Sec. 6501(c)(2).
The Tax Court’s decision in City Wide distinguishes Allen in finding that Mr. Beg’s filing of the Forms 941 and amended Forms 941 was an only an incidental consequence or secondary effect of his embezzlement scheme, which may well reflect the Tax Court’s reluctance to keep the statute of limitations open forever on the taxpayer’s returns when the taxpayer is innocent. The Second Circuit did not accept this distinguishing logic. However, in its footnote 3, the Second Circuit indicated that it may not be prepared to sign on to the logic of Allen.
In 2001, the IRS changed its interpretation of Code Sec. 6501(c)(1) to include the intent of third parties. In 2007, the Tax Court agreed with the IRS in Allen, that the intent of a third party could keep the statute of limitations open forever under Code Sec. 6501(c)(1), even when the taxpayer was innocent.
The Tax Court has shown some uneasiness with leaving open the statute of limitations for innocent taxpayers and rightfully so, but has continued to follow its decision in Allen. None of the Courts of Appeals have yet ruled on whether the Tax Court was correct in Allen.
Taxpayers and their representatives need to prepare for the IRS to test the limits of its new found power. City Wide raises the specter of identity fraud. The facts of that case are close to an identity fraud case. If a fraudulent return is filed for the purposes of identity fraud without the taxpayer’s knowledge and the taxpayer later files a correct return, is the statute of limitations for that tax return open forever under a combination of Allen and Badaracco? That would be an absurd result.
On a more positive note, in Eriksen, the Tax Court gave us a clue as to how to deal with the IRS’s new found power. The IRS still has a high bar to prove the fraudulent intent of the third party.133Therefore, practitioners should not stipulate to the fraud of the third party.
Allen can mean no statute of limitations for innocent taxpayers, who may not know who they are until the IRS comes knocking on their door years after their tax preparer has been investigated and convicted of tax fraud. The Supreme Court has previously addressed the issue of having no statute of limitations in the income tax system and stated:
It probably would be all but intolerable, at least Congress has regarded it as ill-advised, to have an income tax system under which there never would come a day of final settlement and which required both the taxpayer and the Government to stand ready forever and a day to produce vouchers, prove events, establish values and recall details of all that goes into an income tax contest. Hence, a statute of limitation is an almost indispensable element of fairness as well as of practical administration of an income tax policy. 134
The passive language of Code Secs. 6501(c)(1) and 6663 does not specifically state whose intent the statute is referring to – perhaps because tax statutes governing taxpayers are referring to taxpayers and not third-parties – unless, of course, the statute expressly refers to the action or state of mind of a third party. Given the historical and understood interpretation that fraud statutes refer to the fraud of the taxpayer and the importance of the statute of limitations to tax enforcement and administration, an unlimited statute of limitation should require a clear expression of Congressional intent instead of a mere inference from the passive language of the statute.
Hochman, Salkin, Rettig, Toscher & Perez
9150 Wilshire Blvd., Suite 300
Beverly Hills, California 90212
When will The IRS Use the Allen Case To Keep the Statute Open?
Submitted by Robert S. Horwitz, Esq.
“Only the little people pay taxes”
– Leona Helmsley
This article is like a small aftershock following the tsunami of the article by Steve Toscher and Della Bauserman on the Allen case. While the Allen case is significant, as a practical matter, its reach may extend primarily to lower and moderate-income taxpayers who had the misfortune of having their returns prepared by fly-by-night return preparation services that prey on the naïve and the poor. As noted in Jack Townsend’s Federal Criminal Tax Blog posting of 3/27/13, “Just look at the tax prosecutions roster: they pick on the small and relatively defenseless, while big fish seem to swim away–certainly, few bigger fish are to be found in the roster of criminal tax prosecutions and that speaks volumes.” This is exemplified by the four published decisions in which the IRS successfully raised the claim that the fraud of the preparer kept open the statute of limitations under IRC sec. 6501(c)(1).
The taxpayer in Allen was a truck driver whose returns were prepared by Gregory Goosby, who claimed false Schedule A deductions. The case was tried to on stipulated facts under Tax Court Rule 122. The taxpayer was unaware of the false deductions and had no intent to evade tax. Goosby was convicted of 30 counts of aiding and abetting the filing of false and fraudulent tax returns (IRC sec. 7206(2)). Mr. Allen’s returns were not among those that formed the basis of the conviction. Nonetheless, Mr. Allen stipulated for purposes of the Tax Court case that deductions claimed on the returns were false and fraudulent, that he personally had no intent to evade tax, and that Goosby claimed the false deductions with intent to evade tax. Since a conviction under sec. 7206 does not require proof of either tax loss or an intent to evade, absent the stipulation the IRS would have had to prove intent to evade by clear and convincing evidence. As a result of the stipulation, the Tax Court was faced with a simple question: was the return preparer’s intent to evade sufficient to apply the fraud exception. Its answer was yes.
In City Wide Transit, 709 F.3d 102 (2nd Cir. 2013), the trial
was also on stipulated facts under Tax Court Rule 122, as in Allen. the taxpayer stipulated 1) that a payroll service prepared accurate returns for the periods in issue, 2) that the taxpayer gave the returns and checks to pay the IRS to an accountant, Monsour Beg, who was hired to resolve the taxpayer’s payroll tax problems, 3) that Beg prepared false returns that claimed EICs that the taxpayer was not entitled to claim, 4) that Beg altered the checks to the IRS and deposited them in an account he controlled, 5) that Beg signed and filed the false returns and sent in checks for the tax shown owing on those returns and 6) that Beg defrauded the taxpayer out of $280,000, which was the difference between the amount of tax owed as reflected on the original returns and the amount owed as reflected on the altered returns. The Tax Court held that Beg’s primary purpose in preparing the false returns was to defraud the taxpayer, that the IRS had failed to prove by clear and convincing evidence that Beg intended to evade tax and, therefore, that the fraud exception did not apply. As recounted in the Toscher/Bauserman article, the Second Circuit reversed, holding that Beg intended to evade tax and his intent was attributable to the taxpayer. So we have two cases in which the taxpayer stipulated that the return preparer intentionally prepared and filed false and fraudulent returns.
In Eriksen v Commissioner, TC Memo 2012-194, the taxpayers were four Michigan sheriff’s deputies whose returns were prepared by return preparers who pled guilty to 7206(2) by preparing returns claiming bogus deductions. Three of the deputies testified that they had expenses of the types claimed on the returns for the years in question, but did not have any records showing how much they paid or whether the amounts deducted were consistent with the information that they had provided the return preparer. The fourth deputy testified that she did not have one type of expense claimed on the returns that were prepared for her and never told the preparer that she had that type of expense. The Tax Court held that although the testimony of the first three deputies was vague and the return preparers’ convictions raised a suspicion of fraud, this was not enough to meet the IRS’s burden of proving fraud by clear and convincing evidence. As to the fourth deputy, since she claimed that she never had one type of expense claimed on her returns and did not tell the preparer she did, this was sufficient evidence to show that the return preparer prepared a false and fraudulent return with the intent to evade tax.
Recently, in Ames-Meshelke v Commissioner, T.C. Memo 2013-176 (8/1/2013), the taxpayer was involved in a trust scam in which her business made payments to three trusts. The funds paid to the trusts were used for the taxpayer’s personal benefit. She used a return preparer associated with the trust promoter. For the first year, the return preparer deducted on her return the amount she paid to set the trust up. For the next two years, he deducted the payments to the trusts as costs of goods sold, rent and management fees. The return preparer and the trust promoter were both convicted of conspiracy to defraud the IRS through the trust scheme. The IRS subsequently issued notices of deficiency to the taxpayer. The notices were barred as to the first three years absent the fraud exception applying.
At trial, the return preparer testified that he believed the trust arrangement was legitimate and that he considered the payment to set up the trust as a legitimate expenditure, although in retrospect he thought it should have been amortized rather than deducted. For the next two years, the return preparer deducted the payments to the trusts as business expenses at the promoter’s direction and without any evidence a) that the payments were related to the taxpayer’s business, or b) that the trusts ever provided anything to the taxpayer. The return preparer knew the funds paid to the trust were available for the taxpayer’s personal use. The Court held that there was no fraud for the first year, since the expense was incurred and the preparer believed that the monies paid to set up the trusts were deductible. For the next two years, the Court held that the returns were false and fraudulent since the return preparer knowingly mischaracterized the payments as business expenses, knew they were for the taxpayer’s personal use and did not include them in the taxpayer’s business.
Several things are readily apparent. First, where the taxpayer stipulates that the return is false and was not based on information that he or she provided to the return preparer, the court concludes that the return was false and fraudulent. Second, the amounts of deficiencies asserted by the IRS are often minimal: the largest deficiency in Eriksen was $1,086 for one year. For several of the years involved, the proposed deficiencies were under $500. The proposed deficiencies in Allen totaled approximately $12,000 for two years. Third, the taxpayers were themselves victimized by unscrupulous return preparers of the type highlighted in the National Taxpayer Advocate’s 2007 and 2008 reports to Congress. National Taxpayer Advocate’s 2008 Annual Report to Congress, Vol. II at pp. 74 ff; National Taxpayer Advocate’s 2007 Annual Report to Congress, Vol. II at pp. 44 ff. These are the same types of return preparers who are the typical targets of most criminal and civil return preparer tax cases, as seen by the press releases posted on the Tax Division’s website at http://www.justice.gov/tax/taxpress2013.htm.
While some high-income taxpayers have their returns prepared by similar types of return preparers, those who engaged in abusive tax avoidance transactions will not be affected by Allen. Several years ago, the IRS argued that the six-year statute of limitations on substantial understatements of gross income applies to understatements resulting from overstatements of basis. After several years of litigation, it lost that issue in United States v. Home Concrete & Supply, 2012 U.S. LEXIS 3274 (S. Ct. 1/17/2012). The IRS did not claim that the statute remained open due to preparer fraud in any of these cases.
The initial hurdle faced by the Government in a tax shelter case is that abusive tax shelters are like nesting dolls: there are several layers of entities between the taxpayer and the transaction. Whether the shelter is a BOSS, Son of BOSS, CARDS, BOB or other scam, the loss that flows through to the taxpayer comes from a partnership whose members include flow-through entities. As a result, the TEFRA partnership rules apply. Treas. Reg. §301.6231(a)(1)-1(a)(2). Sec. 6229(c)(1) is the TEFRA fraud exception, which provides:
If any partner has, with the intent to evade tax, signed or participated directly or indirectly in the preparation of a partnership return which includes a false or fraudulent item–
(A) in the case of partners so signing or participating in the preparation of the return, any tax imposed by subtitle A which is attributable to any partnership item (or affected item) for the partnership taxable year to which the return relates may be assessed at any time, and
(B) in the case of all other partners, subsection (a) shall be applied with respect to such return by substituting “6 years” for “3 years.”
If the taxpayer did not sign or participate in the preparation of the partnership return that generated the loss, or did so without the intent to evade tax, the statute of limitations on adjustments resulting from the partnership return is no more than 6 years with fraud. Transpac Drilling Ventures v. United States, 83 F3d 1410 (Fed. Cir. 1996); River City Ranches #1, Ltd. v. Commissioner, 94 TCM 1 (2007), aff’d 313 Fed. Appx. 935 (9th Cir. 2009). The intent of the preparer of the partnership return is thus irrelevant.
If the taxpayers filed their individual income tax return with the intent to evade tax, this could also keep the unlimited statute of li
mitations open, even if the taxpayer neither signed nor participated in the preparation of the partnership return. See Charlton v. Commissioner, 101 TCM 1236 (2011). Given the limitation on the reach of sec. 6229(c)(1), however, a Court may balk at extending the Allen rationale in a TEFRA partnership situation. In CCA 201238026, Chief Counsel advised the IRS that a fraudulent S corporation return does not hold open the statute of limitations on the return of a shareholder who did not commit the fraud. The CCA concluded that the issue was not whether the S corporation return was fraudulent, but whether there was intent to evade tax of the non-fraudulent shareholder. The CCA discussed, in passing, the TEFRA fraud rules, noting that the statute for non-fraudulent partners is 6 years.
A CCA is not binding on the Courts and the IRS may rethink its position in light of its successful appeal of the City Wide Transitcase. Even if it does, the Government would still need to show that the taxpayer’s return was prepared with the intent to evade tax, not that the entity’s return was prepared with the intent to evade tax. Thus, even if a Court was persuaded that Allen applied, the Government would still have to show that the person who prepared the taxpayer’s return (as opposed to the person who prepared the partnership return) did so with the requisite intent. This could pose a formidable hurdle for the Government to surmount.
Usually, the taxpayer’s return is not prepared and signed by the promoter who came up with and hawked the scam or a return preparer affiliated with the promoter. This is true whether the transaction was designed specifically for the taxpayer (normally a large corporation, as in Chemtech Royalty Associates, L.P. v. United States, 2013 U.S. Dist. LEXIS 26329 (MD LA 2/26/2013) (tax plan formulated by Goldman Sachs and Spalding & King)) or a mass-marketed cookie-cutter variety tax plan as in Crispin v. Commissioner, 708 F.3d 507 (3rd Cir. 2013) (a CARDS transaction hawked by a promoter with a ready-made legal opinion). The person who prepared the taxpayer’s return will have relied on a K-1 or on an opinion letter written by a reputable law firm (Brown & Wood, Jenkins & Gilcrist) or CPA firm (KPMG, EY, etc.).
The definition of “return preparer” includes a person who “renders tax advice on a position that is directly relevant to the determination of the existence, characterization, or amount of an entry on a return or claim for refund….” Treas. Reg. sec. 301.7701-15(b)(3)(i). Given this definition, under Allen, the fraud of the tax advisor who concocted the scam could make the extended statute of limitations applicable. To do this, however, the Government would have to prove by clear and convincing evidence that the tax advisor 1) was convicted of a tax crime related to the type of shelter that was used by the taxpayer, 2) was personally involved in providing the tax advice used to prepare the taxpayers’ return, and 3) that the tax advice provided the taxpayer was given with the intent to evade tax owed by the taxpayer.
There probably would not be privity between the taxpayer and the convicted tax advisor, see Taylor v. Sturgell, 553 US 880 (2008), so that the conviction would not preclude the taxpayer from litigating any issue. A taxpayer with millions of dollars at stake is not going to stipulate that his return was false or fraudulent or that it was prepared with the intent to evade tax. The Government would thus be forced to retry in Tax Court the criminal tax case. If the tax advisor pled guilty, this could require filing a F.R.Crim. Pro. Rule 6(e) motion to obtain grand jury materials.
Whether the IRS will consider relying on Allen to go after taxpayers who engaged in abusive transactions structured by convicted felons has yet to be seen. At this time, however, what Leona Helmsley said more than a quarter of a century ago holds true today. The IRS will use Allen to assert deficiencies primarily against low and moderate-income taxpayers who fell prey to unscrupulous return preparers. With only a few thousand dollars at stake per taxpayer and without legal advice or representation, many of these taxpayers will end up paying what the IRS claims is due. Well-heeled taxpayers, who invested in shelters promoted by high-priced law and accounting firms, however, will probably not find the IRS claiming that the statute of limitations on assessment remains open due to the fraud of the advisor who cooked up their tax shelter scam.
Law Offices of A. Lavar Taylor
6 Hutton Center Dr., Ste. 880
Santa Ana, CA 92707
IRS Subject to Fraudulent Transfer Rules
Submitted by Bruce Givner, Esq.
In United States of America v. Equipment Acquisition Resources, Inc., Bankruptcy No. 09 B 39937 (N.D. Illinois – January 4, 2013) the Internal Revenue Service (“IRS”) was on the wrong side of a fraudulent transfer argument. The background of the case is fascinating: Equipment Acquisition Resources (“EAR”) purported to finance refurbished semi-conductor making machinery. It was so profitable that, as an “S” corporation, between October, 2007, and December, 2008, it made nine payments to the IRS on behalf of three shareholders, totaling almost $5,000,000. The profits were based on double- and triple-financing imaginary equipment to about 20 equipment lessors, including U.S. Bancorp; SunTrust; IBM Credit; and Comerica. In fact it was a $175,000,000 Ponzi scheme.
The bankruptcy trustee sued the IRS to recover the funds that EAR paid to cover the shareholders’ tax liabilities. (The bankruptcy court dismissed all counts against the individual taxpayers and approved a settlement agreement reached by the bankruptcy trustee and the IRS on certain claims.) The United States, on the IRS’s behalf, moved to dismiss the bankruptcy trustee’s action on the ground of “sovereign immunity.” The intent to waive immunity in this area is – despite the government’s assertions in this case to the contrary – unequivocal. Bankruptcy Code §106(a)(1) provides that despite “an assertion of sovereign immunity, [it] is abrogated as to a governmental unit to the extent set forth in this section with respect to…Section…544.” Section 544 of the Bankruptcy Code refers, in this case, to the Illinois Uniform Fraudulent Transfer Act. The federal district court applied the “plain meaning rule” and held simply that “…there is no ambiguity. §106(a)(1) eliminates the sovereign immunity defense with respect to any §544 claims.”
The government next argued that the bankruptcy trustee’s action was time barred under the rules applicable to tax refunds. Internal Revenue Code (“IRC”) §§7426 and 7422(a). IRC §7426 waives sovereign immunity for suits by non-taxpayers to recover money or property wrongfully levied by the IRS on the condition that it is filed within a nine-month period. IRC §6532(c). However, the court held that IRC §7426 does not apply to this bankruptcy issue: voluntary tax payments made by third parties. Under IRC §7422(a), an administrative claim for a tax refund must be filed before a claimant may bring suit. Generally a refund claim must be submitted to the IRS within two years of the contested payment. IRC §6511(a). The court held that EAR’s state-law fraudulent transfer claim to recover a federal tax payment is not a “refund” claim: “The premise of EAR’s claim is not that the shareholders overpaid their tax, but that the moneys used to pay the tax were fraudulently transferred.” As a result, the federal district court held that IRC §7422(a) does not apply.
The government’s third and final argument was that the fraudulent transfer rules do not apply to EAR’s payment because it was made on behalf of a third-party and was accepted by a good faith creditor. Under the Illinois Fraudulent Transfer Act that is a defense only if the claim is based on “actual” fr
aud. Instead, in this situation, the claim was based on “constructive” fraud, and the court refused to expand the exception’s applicability.
The lesson of the case is that the fraudulent transfer rules do not care whether you are an individual; a corporation; or the United States of America. No matter who you are, you cannot benefit from a fraudulent transfer.
Givner & Kaye
12100 Wilshire Blvd., Suite 445
Los Angeles, California 90025
Recent Cases of Interest
Submitted by Robert S. Horwitz, Esq.
During the last weeks of its 2012-13 term, the Supreme Court issued opinions in two tax cases. One of these cases, United States v. Windsor, held that the Defense of Marriage Act violated the equal protection clause of the Fifth Amendment and, therefore, the respondent, as executor of her late same sex spouse’s estate, was entitled to a refund of estate tax. The other case, United States v. Davila, 133 S. Ct. 2139; 186 L. Ed. 2d 139; 2013 U.S. LEXIS 4541 (S.Ct. June 13, 2018), arises out of a criminal tax prosecution and involves whether a violation of F.R.Crim.Pro. Rule 11(c)(1) is a structural error that automatically vitiates a guilty plea. Unlike Windsor, the Davila case has not been the subject of much press coverage or been written up in many legal journals.
In May 2009, Davila was indicted on 34 counts of violating §7206(1) by filing 120 false tax returns and getting over $423,000 in refunds. In January 2010, Davila sent a letter to the district court complaining about his appointed counsel on the ground that the attorney urged him to plead guilty and had not suggested any potential defenses. A magistrate judge held an in camera hearing with Davila and his attorney. The magistrate judge advised Davila that if the attorney was removed, new counsel would not be appointed but that Davila could represent himself. Addressing Davila’s concerns about his attorney’s urging him to plead, the magistrate judge stated that it might be good to accept responsibility and plead without “wasting the court’s time [and] cause the Government to have to spend a bunch of money” on an open and shut case. The magistrate also said that there may not be any available defenses. He urged Davila to cooperate, given his prior criminal history, in order to get a downward adjustment at sentencing.
Over three months later, Davila pled guilty. At the change of plea hearing, Davila stated that he was neither forced no pressured to plea and did not mention the hearing before the magistrate. The district court judge accepted Davila’s guilty plea. Before sentencing, Davila moved to vacate the plea on the ground that his plea was “strategic.” The motion was denied and Davila was sentenced to 115 months due to his extensive criminal history. A new attorney was appointed to represent Davila on appeal. He argued (and the Government conceded) that the magistrate’s statement violated F.R.Crim.Pro. Rule 11(c)(1) and, therefore, the plea should be set aside. The Government argued that due to the time gap between the magistrate’s statement and the guilty plea, the violation did not affect Davila’s substantial rights. The Eleventh Circuit held that the violation required the automatic vacating of the guilty plea without any need to show that the error was prejudicial.
Due to a conflict between the circuits on whether a violation of Rule 11(c)(1) requires the automatic vacating of a guilty plea, the Supreme Court granted certiorari. It reversed and remanded the case for further proceedings.
The Court began its analysis by reviewing the history of Rule 11(c)(1). Prior to the Rule, judges frequently participated in plea negotiations. The rule was added by the 1974 amendments to the Federal Rules of Criminal Procedure due to concerns that a defendant might be induced to plead guilty so as not to displease the judge who would preside at trial and to facilitate the ability to objectively evaluate the voluntariness of the plea. Added in 1983, F.R.Crim.Pro. Rule 11(h) provides that a variance from Rule 11 requirements is harmless error if it does not affect substantial rights.
Subsection (h) was added to make it clear that violations of Rule 11 are not exempt from harmless error analysis under the Rules 52(a) and (b) plain error rule. Under plain error analysis, a defendant who failed to object at trial has the burden of proving that, but for the error, he would not have been convicted. The Court concluded that Rule 11(c)(1) was a prophylactic measure impelled by due process and was not a Constitutional right. A violation of Rule 11(c)(1) was, thus, not a structural error that requires automatic reversal.
In the case before it, the plea hearing was not held immediately after the hearing before the magistrate judge. At the plea hearing the defendant stated that he was neither forced nor pressured to plead guilty. When he did seek to vacate his plea, he asserted that he pled as a matter of strategy. There was nothing on the face of the plea that would lead to the presumption that the plea resulted from the magistrate’s statements. The court reversed and remanded the case to the Court of Appeals to consider whether, due to the particular facts of the case, the plea should be vacated as a result of a Rule 11(c)(1) violation.
Sometimes the Government charges a return preparer in a tax case under criminal statutes other than those contained in Title 26 and conspiracy to defraud the United States. In United States v. Stargell, 2013 U.S. App. LEXIS 15953 (9th Cir. 8/22013), a return preparer, Willena Stargell, was convicted on 12 felony counts arising out of her work as a tax preparer: 4 counts of IRC §7206(2), 4 counts of wire fraud affecting a financial institution (18 USC §1343), 2 counts of wire fraud (18 USC §1343) and 2 counts of identity theft (18 USC §1028A). On appeal, Stargell claimed that the district court 1) should have granted a judgment of acquittal on the counts of wire fraud affecting a financial institution, 2) erred in allowing the identity theft convictions without excluding the possibility that they were based on pre-enactment conduct, 3) erred in allowing her former attorney to testify at sentencing, and 4) improperly calculated the loss and restitution amounts. All to no avail.
Stargell had taken a tax preparation course and gotten certified as a return preparer by California. She went to work for Liberty Tax Services in Moreno Valley, CA. After she was terminated, she started “Liberty Bell Tax Services” (LBTS). At LBTS, she prepared returns containing false statements and engaged in a scheme to obtain refund anticipation loans (“RALs”) from banks based on the false returns that used the names and social security numbers of clients. The banks would issue the loans with the expectation of receiving the refund. In some cases, the IRS detected the fraud and did not issue a refund, resulting in a loss to the banks. After a sentencing hearing, the district court ordered restitution of $362,796 and sentenced Stargell to 42 months imprisonment.
The Ninth Circuit found Stargell’s claim that the Government failed to prove that her actions “affected a financial institution” within the meaning of 18 USC §1343 “unpersuasive.” A defendant found guilty of wire fraud affecting a financial institution faces a longer prison term (30 years as opposed to 20 years) and a greater fine ($1 million) than one who defrauds a mere mortal. The Ninth Circuit reviewed the record evidence to determine whether there was evidence sufficient to support a verdict of guilty beyond a reasonable doubt. As part of its evidence, a CI agent testified as a summary witness based on a review of 143 tax returns listing the defendant or LBTS as the return preparer. Each contained a false wage and/or withholding amount (usually both) and sought a refund. The total refunds sought were $598,657, of which $276,331 was paid by the IRS. The evidence a
lso established that banks funded RALs for all 143 tax returns. Where the IRS did not issue a refund, the bank was unable to recoup the loss. A senior risk analyst for a bank testified that 79.9% of RALs issued in connection with returns prepared by Stargell resulted in a loss as compared to a 1% loss on non-fraudulent RALs. Banks lost money on two of the four counts of wire fraud affecting a financial institution.
Stargell argued that since banks did not lose money in two of the four counts, the evidence was insufficient to support the conviction. The Government argued that loans based on fraudulent returns are much riskier than loans based on non-fraudulent returns, so Stargell’s acts affected the banks by exposing them to a greater risk of loss even if there was no actual loss. Noting that other circuits had held, in other contexts, that an increased risk of loss “affects” a financial institution, the Ninth Circuit held that Stargell’s acts subjected the banks to an increased risk of loss and, thus, her fraud affected a financial institution.
Sec. 1028A makes it a felony to knowingly use another person’s identity without lawful authority in the course of committing another felony. Stargell argued on appeal that many of the predicate acts for the identity theft counts occurred prior to enactment of §1028A in July, 2004, and thus the jury may have convicted her based on pre-enactment conduct (a violation of the prohibition on ex post factolaws). At trial, the Government introduced evidence that Stargell’s wire fraud scheme began in February, 2004 and ended in January, 2005. The Court held that since the returns that were the basis of the wire fraud counts were not transmitted until January, 2005, the predicate offenses were all committed after enactment of §1028A. Thus, Stargell’s conviction under §1028A was not erroneous.
Stargell’s next argument was that the Government “infringed on the core of her defense counsel’s role” by allowing her former attorney to testify regarding the loss. Because Stargell’s defense attorney, and not the Government, called her former attorney as a witness there was no interference. Furthermore, since the attorney only testified about his review of documents obtained from the IRS, the attorney-client privilege was not implicated.
Finally, Stargell argued that there were numerous errors in the district court’s computation of restitution. She argued that the district court did not make a specific finding as to the amount of loss. This was rejected since the district court expressly approved the Government’s computation of the loss amount and held that the Government proved the loss. Next, she argued that the district court’s finding of the amount of loss was not supported by the evidence. The Ninth Circuit noted that in criminal cases involving a tax offense, the total amount of loss is the “amount that was the object of the offense.” In this case, the amount that was the object of the offense was the total amount that would have been lost had Stargell’s scheme been successful. This was the total amount of refunds claimed on the false returns that she filed, even though this was more than the actual loss. In response to Stargell’s argument that the loss amount should have been reduced by the refund that the taxpayers were actually entitled to, the Court responded that she did not produce any evidence that she either intended to give or did give the refunds to the taxpayers. The district court’s acceptance of the Government’s tax loss figures was a reasonable estimate of loss based on the available evidence. Thus, the restitution amount was affirmed.
Another case involving criminal restitution in a tax case, in this case in the amount of $6,457.500, is United States v. Wirth, 2013 U.S. App. LEXIS 13201 (8th Cir., 6/27/2013). The defendant on appeal challenged the district court’s restitution order on a number of grounds.
Wirth was a CPA turned real estate developer. He developed and managed a number of properties through his S corporation, The Wirth Company (TWC) and related entities. The IRS began a civil audit of one of his companies. It expanded into an audit of his and his wife’s personal income tax returns before morphing into a criminal investigation. Ultimately, Wirth, his wife and his CPA were indicted for conspiracy to defraud the United States (a Klien conspiracy (18 USC §371)) and for various Title 26 counts.
Wirth pled guilty to conspiracy. As the facts supporting the plea, the agreement recited that Wirth, his wife and his CPA conspired to evade his and his wife’s taxes, used the funds of TWC and related entities to pay personal expenses, which were deducted on the entity returns, causing TWC’s income to be understated together with that of Wirth and his wife. Funds of TWC were used to purchase an island for $2 million for Wirth and to build a home on the island, at a cost of approximately $3 million. The plea also recited that TWC understated wages paid to Wirth, thus reducing employment tax, that he caused TWC to underreport fee income and made adjustments to decrease income at profitable entities and increase income at unprofitable entities. The plea agreement provided that Wirth would pay restitution, but it left the amount of restitution to be decided by the court.
After a two day hearing, the court ordered Wirth to pay restitution of $6,457,500 based on underpayments of income tax for 2003, 2004 and 2005, and sentenced him to 54 months imprisonment. The court ordered that while incarcerated, Wirth would pay $25 a month toward restitution if he was employed in prison. He appealed the restitution order.
The Court began its analysis by stating that a restitution order is reviewed for abuse of discretion and that the Government had to prove the amount of loss by a preponderance of evidence. The Court then addressed each of Wirth’s claims of error.
Wirth’s initial claim was that the district court erred in not allowing him to reduce the tax loss by NOLs reported on his 2002 and 2007 tax returns. The district court had rejected Wirth’s claim because the losses were based on his tax returns for 2002 and 2007, which it found not credible. Based on the scope of Wirth’s fraud, the disarray of his records and the fact that the CPA who was indicted as a co-conspirator prepared those returns, the Court of Appeals held that the district court did not clearly err.
Wirth next argued that the district court erred in giving him a zero basis in his business. The Court of Appeals held that the district court did not err, pointing to the fact that a) Wirth did not keep track of his basis, b) TWC’s controller testified that he heard the CPA state that Wirth had no basis; and c) the CPA admitted that Wirth had no basis in his sentencing memo. The Court also rejected Wirth’s argument that the district court erred in using 39-year straight line depreciation for business assets rather than accelerated depreciation with a shorter life.
Wirth next argued that the IRS agent erroneously assumed that he used TWC loan proceeds to pay for personal expenses when calculating gain in excess of basis. Wirth claimed that the loan proceeds were used to manage TWC properties. The Court rejected this argument because Wirth admitted that he used millions of dollars of TWC funds to pay for personal expenses and the IRS agent’s testimony and documents supported the Government’s claim about the personal use of loan proceeds.
Wirth then challenged the sufficiency of the evidence, which consisted of the IRS agent’s testimony, together with exhibits summarizing and explaining his calculations and adjustments. The Court found this argument lacking, stating: “In light of TWC’s abysmal bookkeeping records … Wirth is hardly in a position to insist that the district court’s restitution award be calculated with Pythagorean precision.” The district court’s oral and written findings were adequate to support its restitution order.
Having these assaults repulsed did not deter Wirth from launching another attack on the district court’s order
. He next argued that the district court erred by including boat-related expenses in calculating restitution, on the ground that the boat was used in TWC’s business. This got nowhere. The Court again pointed out that Wirth had admitted in the plea agreement that TWC funds were used for personal expenses and victim restitution may be awarded for criminal conduct that is part of a broad scheme to defraud, even if the defendant is not convicted for each fraudulent act in the scheme. In concluding that boat-related expenses were personal and were unlawfully deducted by TWC, the district court did not err.
Wirth fell back on his two final claims: the court’s payment schedule, under which he was only to make minimal payments while incarcerated and a claim that the restitution issue was too complex to be decided in the context of a sentencing hearing. The first claim was rejected since 18 U.S.C. §3664(f) allows the court to order minimal payments if justified by the defendant’s financial situation. Given Wirth’s current personal finances, including a pending bankruptcy and the possibility of future collection procedures by the IRS under 26 U.S.C. §6201, the district court did not err in this regard. [Sec. 6201(a)(4) authorizes the Secretary to assess and collect the amount of any restitution order for taxes in the same way as a tax. The assessment is to be made after the conclusion of any appeals in the criminal case and the time for further appeals has expired. A restitution order for unpaid taxes cannot be challenged in a later proceeding.]
Wirth’s second claim was also rejected. Although 18 USC §3663A(e)(3)(B) allows the court to decline to make a restitution award if the case is so complex that calculating the loss would complicate or prolong sentencing, it was not error in this case where there was only one victim, two witnesses and the restitution hearing took only one day. Having rejected all of Wirth’s arguments, the Court affirmed the district court’s restitution order.
There are two articles in this issue of Tax Network on the Allencase. This month (August, 2013), the Tax Court once again held that a preparer’s fraud kept open the statute of limitations on assessments against the taxpayer in Ames-Meshelke v. Commissioner, T.C. Memo. 2013-176 (8/1/2013). The taxpayer was a chiropractor in a small town in Illinois. She met a “financial planner” and shelter promoter named Palmer who was also a charismatic evangelical minister. In 1993, Palmer got her involved in a trust scam through which she diverted funds from her chiropractic business to three trusts, which used the funds to pay the taxpayer’s personal expenses. The taxpayer paid Palmer $46,000 to set up the trusts. None of the trusts ever filed returns or applied for EINs.
The taxpayer was referred by Palmer to a return preparer named Larson. Larson had met Palmer, who convinced him that the trust scheme was legitimate. On the taxpayer’s schedule C for 2003, Larson deducted the $46,000 payment as an ordinary and necessary business expense. In 1994, at Palmer’s suggestion, the taxpayer incorporated her chiropractic business as a C corporation. The corporation paid $144,000 in both 1994 and 1995 to the trusts, which used the funds to pay the taxpayer’s personal expenses. On the corporate returns for 1994 and 1995, Larson deducted the payments to the trusts as costs of goods sold, rent and management fees. None of the payments were included in the taxpayer’s income.
In 1996, the taxpayer heard about the Aegis trust scheme as a way to reduce taxes. She told Palmer, who said he would set up a similar trust structure for her at a lower cost than Aegis. Palmer set up a business trust that reported all of the income and expenses of the chiropractic business. The trust’s sole beneficiary was a foreign trust, which filed a 1040NR claiming that all of its income had been distributed to its beneficiaries. In fact, the money ultimately went into an account controlled by the taxpayer, where the funds were used for her personal expenses. None of the funds were picked up by her in income. Palmer also induced the taxpayer to invest part of her tax savings with him. For a brief period of time, Palmer would report gains to the taxpayer that he allegedly reinvested on her behalf. She invested more. [Sounds like a Ponzi scheme.]
When people started to wise up to Palmer, he fled to New Zealand. He was extradited in 2001. He and Larson were charged with conspiring to defraud the IRS through the marketing of an abusive trust scheme in violation of 18 USC §371. In 2002, Larson pled guilty. Palmer went to trial and was convicted.
In 2002, following the criminal convictions, the IRS issued a notice of deficiency to the taxpayer for 1996. In 2003, it issued a notice of deficiency for 1993, 1994, 1995 and 1997. The taxpayer petitioned the Tax Court. She conceded the computations of unpaid tax for 1993, 1994, and 1995, but claimed that the notices were time barred and denied that there was preparer fraud. The IRS claimed that the statute of limitations remained open for all years.
According to the Tax Court, in order to prove that the fraud exception applied, the IRS had to prove by clear and convincing evidence that Larson intended to evade tax known to be owed by the taxpayer through conduct intended to conceal, mislead or otherwise prevent collection of tax. Fraud implies bad faith, intentional wrongdoing and a sinister motive whereas negligence or gross negligence implies a breach of a duty of care.
At trial, Larson testified that he believed that Palmer’s trust arrangements were legitimate and that the amount he claimed as a deduction on the 1993 return was a payment for setting up the trust. He also testified that when he prepared the return he believed it was appropriate to deduct the payment, but now he believes that he should, instead, have amortized it. The Court found his testimony on this point credible and held that there was no fraud as to the 1993 return.
For 1994 and 1995, Larson deducted payments to the trust as expenses of the taxpayer’s C Corporation, even though there was no evidence that they were related to the business or that the business received any goods, services, rental equipment or anything of value for the payments. This was contrasted with 1993, where the taxpayer paid to have the trusts set up. Larson mischaracterized the payments to the trusts in accordance with Palmer’s instructions. Larson knew that the trusts were set up to reduce the taxable income of the taxpayer, that the trusts were not filing returns, thus avoiding tax on the funds they received, and that the taxpayer had the personal use of the funds. The Tax Court found that the mischaracterization of the payments to the trust as business expenses showed fraudulent intent by Larson. Fraudulent intent was also shown by the fact that he did not include the payments in the taxpayer’s income when he knew that the funds were used for her benefit. Thus, the statute of limitations remained open for those years.
As to 1996 and 1997, the notices of deficiency were issued within 6 years of the date the returns were filed and there were substantial understatements of gross income by the taxpayer. Thus, the statute of limitations for each of those years was open.
The taxpayer conceded that the trusts were shams, so that the money that went to the trusts was includible in her income. The money siphoned from her corporation in 1994 and 1995 were constructive dividends. Since the trusts used in 1996 and 1997 were shams, the income paid to them was reportable by the taxpayer in those years.
The taxpayer claimed that she was entitled to a theft loss due to Palmer’s investment scam and that she was entitled to carry the loss back to the years in issue. The Tax Court rejected this argument. The taxpayer did not provide evidence of the amount of loss. Additionally, she was a member of a class action lawsuit against Palmer seeking reimbursement. Thus, she had not shown that there was no hope of recovery in the years involved in the Tax Cou
rt case or in any year that would carry back to the years in issue.
Finally, the Court imposed the accuracy-related penalty. The taxpayer was not entitled to rely on the promoter nor was she entitled to rely on a return preparer that she was referred to by the promoter. In moving money into accounts she controlled without picking the income up on any tax return, the Tax Court held that the taxpayer acted in bad faith.
The IRS is required to mail the notice of deficiency to a taxpayer at the taxpayer’s last known address. Where the notice is not mailed to the last known address and the taxpayer does not learn of the notice in adequate time to file a Tax Court petition, he can file a late petition and have it dismissed for lack of jurisdiction due to the IRS’s failure to send the notice to the last-known address. In Estate of Simon v. Commissioner, T.C. Memo. 2013-174 (7/29/2013), the taxpayer claimed that a Final Partnership Administrative Adjustment notice had not been sent to the correct address and, therefore, an affected-item notice of deficiency was invalid.
The taxpayers had purchased a Son of BOSS shelter to reduce their tax liability. The taxpayer husband (deceased) formed an LLC (AIL) and the taxpayer wife formed and S corporation (AII). Charlevaux, a general partnership, was formed in which AIL was a 90% partner. An unrelated third party was the other partner. AIL contributed offsetting digital options to Charlevaux. Following the normal Son of BOSS drill, the offsetting digital options were allowed to expire. The next day, Charlevaux purchased publicly traded stock. AIL contributed its interest in Charlevaux to AII, which then terminated and distributed all its assets (mainly the stock) to AII. AII sold the stock, claimed an inflated basis and took a large loss, which flowed through to the Simon’s tax return.
Charlevaux filed its first and final return with the IRS. It did not list a tax matters partner and listed an address at Petoskey, Michigan, which was at that time the place where the taxpayers resided. The K-1 listed the same address for AIL. In 2001, the taxpayers moved to another Equestrian Way in another town in Michigan. No notice of change of address was ever sent to the IRS for Charlevaux.
In 2004 the IRS issued a notice of beginning of partnership proceedings to Charlevaux at the Petoskey address, which was returned as undeliverable. It also mailed a copy of the notice to AIL and to the taxpayers at their new address. The taxpayers signed several extensions regarding tax attributable to partnership items during the pendency of the audit.
In 2010, the IRS issued a FPAA to Charlevaux, which it mailed to the Petoskey address, but not to the taxpayers’ new address. The FPAA was returned as not deliverable. The FPAA was never challenged and was defaulted. In 2011, the IRS issued an affected items notice of deficiency to the taxpayers asserting a deficiency in the amount of $1,293,264, an accuracy penalty of $450,961 and a late filing penalty of $117,577. The taxpayers filed a petition, which they moved to dismiss for lack of jurisdiction on the ground that the FPAA was not mailed to the proper address. The IRS moved to dismiss the petition as it related to the accuracy penalty on the ground that it was a partnership item that could not be challenged in partner-level proceedings.
The taxpayers argued that while normally penalties are partnership level items, this was not the case here because the IRS failed to give proper notice of the FPAA under IRC §6223(a) since the IRS knew as of March, 2004, that the Petoskey address was not valid and that the taxpayers’ new address was the correct address to which to send correspondence. According to the taxpayers, the IRS did not make a good faith effort to serve the FPAA since it knew that the Petoskey address was not valid.
The Court rejected the taxpayers’ argument that the IRS is required to give notice of the FPAA to certain partners before issuing an affected items deficiency notice to the partners. The Court had jurisdiction over the petition as it related to tax and the §6651(a) addition. The accuracy penalty was determined at the partnership level and not subject to deficiency proceedings even if partner-level determinations were needed before assessing the penalty.
Addressing the taxpayers’ argument that a proper FPAA notice was not given, the Court stated that under §6223(a), notice must be given regarding the beginning and end of partnership proceedings by sending notice to certain partners at the address shown on the partnership return. If there is an indirect partner, notice must be given to the indirect partner in lieu of pass-through partners. If the IRS fails to give proper notice to a partner, the partner may elect to have the adjustments apply to the partner. If there is no election, the items are characterized as non-partnership items.
There are two ways in which the IRS can get a partner’s name, address and partnership income interest: from the partnership return or from a written statement meeting the requirements of §301.6223(c)-1T. The IRS may, but is not required, to use other available information in its possession. The IRS is not required to search its records for the most recent address if an address is not provided under either of the two approved methods.
The taxpayers argued that the IRS had and used the taxpayers’ new address and failed to act in good faith by not sending the FPAA to the taxpayers’ new address. Given the regulation and the fact that no court has required the IRS to use another method, the Court rejected the taxpayers’ argument. The IRS followed the proper regulatory procedures. It is not required to do more. The taxpayers did not explain why they did not notify the IRS of the new address in accordance with the regulations. Thus, ” the fact that an FPAA was not mailed to the Equestrian Way address is due to their own inaction.” Since the IRS gave proper notice, its motion was granted and the taxpayers’ was denied.
In Tax Court, timely mailing of a petition is timely filing. This is not the case in a refund suit, as the taxpayer found out in Langan v. United States, 2013 U.S. Claims LEXIS 740 (Ct.Fed.Cl. 6/28/2013). The plaintiff was the executor of an estate that disputed a deficiency which it paid. It filed a timely claim for refund, which was denied by letter dated December 16, 2009. On Thursday, December 15, 2011, the taxpayer’s attorney brought an envelope addressed to the Claims Court that contained a complaint for refund to the 24 hour mailing window at a post office in Boston. The complaint was received and filed by the Court of Federal Claims on Monday, December 19. The United States moved to dismiss the complaint since it was not filed within two years of the date that the refund claim was denied, as required by IRC §6532.
The Court began its opinion by noting that the filing deadline for a claim against the United States “is a condition to the waiver of sovereign immunity and must be strictly construed.” The Court considered all of the evidence offered to determine jurisdiction. Plaintiff’s attorney provided an affidavit that he brought the complaint to the 24-hour mailing window at the Boston post office at 11 pm on December 15, 2011 and sent it express mail. He stated that he was informed by the postal employee that, barring unforeseen circumstances, the packet would be delivered by December 16, even though the “Track & Confirm” record shows that the guaranteed delivery date was December 17. The attorney further asserted that, based on his experience, a document mailed from the 24 hour window always got to Washington, D.C., by the next business day.
In support of its motion, the Government submitted the “Track & Confirm” record and a printout from the Postal Service website that mail sent from the Boston 24 hour window will arrive the next business day in Washington, D.C., if it is brought to the window by 8 p.m.
In Charlson Realty Co. v. United States, 384 F.2nd 434 (Cl.Ct. 1969), the Court of Claim
s applied a rule that a properly sealed, stamped, addressed and deposited letter is presumed to reach the addressee “in due course of the mails” and, thus, where a plaintiff mailed a complaint within sufficient time to reach the Claims Court, this presumption overcame the filing date on the complaint. This presumption, however, could be rebutted by “direct, positive, clear and convincing evidence which is uncontradicted.” At one point, the Claims Court had temporarily codified Charlson in in former Court of Federal Claims Rule 3(b)(2), but this subsection was deleted by a 2002 amendment. Nonetheless, the Court had applied the Charlson rule in a 2010 case and held the presumption applied where the plaintiff presented evidence that it had mailed the complaint in sufficient time to reach the Court in the ordinary course of the mails.
Here, the plaintiff had not presented evidence that would require application of the Charlson rule. First, despite the attorney’s declaration, the USPS website gave 8 p.m. as the cutoff time to ensure next day delivery. Unlike the plaintiffs in the prior cases, the plaintiff here did not act reasonably by waiting until 11 p.m. on the last possible day to file by mail, plus the plaintiff’s attorney admitted that the complaint did not arrive until December 19. To ensure timely filing, the Court pointed out that the plaintiff should have driven to D.C. so as to arrive before the close of business on December 16. Thus, the Court granted the Government’s motion to dismiss.
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2 Relief under §6015 frequently is referred to as “innocent” spouse relief. Some have observed that this implies there are “guilty” spouses, which may be unfairly pejorative as the term refers to the non-requesting spouse. This paper will refer to “requesting” and “non-requesting” spouses and §6015 relief, rather than “innocent” spouses and “innocent” spouse relief. Back
6 Prior to the passage of the IRS Restructuring and Reform Act of 1998 (the RRA), the threshold for requesting relief was a deficiency of the greater of $500 or ten percent (10%) of the requesting spouse’s adjusted gross income if the adjusted gross income was $20,000 or less; otherwise, the specified percentage was twenty-five percent (25%). The RRA eliminated these threshold requirements, making relief available regardless of the amount of deficiency.Back
9 H.R.1450, 112th Congress, Representative Bachman (MN-6) (introduced 4/8/2011), to amend the Internal Revenue Code of 1986 to eliminate any time limitation for granting equitable innocent spouse relief. Back
11 See Notice 2012-8, 2012-4 I.R.B. 309, which published a proposed Revenue Procedure to update Rev. Proc. 2003-61, 2003-2 C.B. 296. Notice 2012-8 states that until the Revenue Procedure is finalized, the Service will apply the provisions in the proposed Revenue Procedure instead of Rev. Proc. 2003-61 when evaluating claims for equitable relief under §6015(f). Accordingly, this article references Notice 2012-8. Back
12 The actual knowledge test for §6015(b), available to all taxpayers, and §6015(c), available to divorced or separated taxpayers seeking to apportion income to the nonrequesting spouse, is defined by §1.6015-3(c)(2), Income Tax Regs. See §1.6015-2(c), Income Tax Regs., pertaining to §6015(b); §1.6015-3, Income Tax Regs., governs §6015(c). Actual knowledge of the erroneous item giving rise to a deficiency is a factor in determining relief on equitable grounds when there is an understatement of tax or an underpayment, under §6015(f). Notice 2012-8, sec. 4.03(2)(c)(i). Back
13 In slightly more extreme circumstances, some IRS professionals have argued that the mere act of signing the return, beneath the jurat affirming the return is true and accurate, constitutes actual knowledge regardless of facts to the contrary. Back
28 Not all community property states permit creditors to collect the separate debt of one spouse from the community assets of both spouses. For example, in Washington, a creditor, including the IRS, whose claim is valid against only one spouse can only collect half the value of any community property asset. See United States Back
32 “[U]nder §6901(c) the Commissioner is entitled to asses deficiencies against a taxpayer’s beneficiaries after his or her death for one year after the limitations period runs. Since the limitations period will never run, the Commissioner may presumably hound a taxpayer’s beneficiaries and their descendants in perpetuity.” E. Badaracco, Sr., SCt, 84-1 USTC ¶9150, 464 US 386, 406, note 7 (1984) (Stevens, J., dissenting). Back
33 IRM §25.6.23-3(4) states, “ASED alpha code OO can be used when the IRS is relying on the fraudulent acts and intent to evade tax on the part of the return preparer to keep the assessment statute open on the returns of the preparer’s clients, see Allen.” Back
49 Id. The Third Circuit has rejected this agency argument in Asphalt Industries, Inc., CA-3, 67-2 USTC ¶ 9620, 384 F2d 229, 235 (1967) (stating that there was no apparent authority to commit fraud and that the government was not an innocent third party that was misled.) Back
50 FSA 200126019. The Tax Court has applied the badges of fraud in post-Allen cases. See P.W. Browning, 102 TCM 460, Dec. 58,803(M), TC Memo. 2011-261, *45-*55; S.M. Eriksen, 104 TCM 146, Dec. 59,117(M), TC Memo. 2012-194, *26-*36. Back
56 E.g., Asphalt Industries, supra note 21, 384 F2d, at 232; U.R. Neely, 116 TC 79, 85, Dec. 54,241 (2001); Rhone-Poulenc Surfactants & Specialties, 114 TC 533, 548, Dec. 53,929 (2000); L.K. Murphy, 69 TCM 1916, Dec. 50,485(M), TC Memo. 1995-76, *30 (with respect to the predecessor to Code Sec. 6663); Gong Y.T. Chin, 67 TCM 2140, Dec. 49,663(M), TC Memo. 1994-54, *38 (same); J. Williamson, 65 TCM 2854, Dec. 49,078(M), TC Memo. 1993-246, *53-*54 (same); H. Richman, 65 TCM 1808, Dec. 48,836(M), TC Memo. 1993-32, *9 (same); W.H. Callahan, 63 TCM 2285, Dec. 48,050(M), TC Memo. 1992-132, *26 (same). Back
85 Note that, if the Tax Court does agree that the language in Code Sec. 6501(c) should be interpreted the same as the language in Code Sec. 6663, then the fraudulent intent required should be the intent of the taxpayer as in Fulton et al. Back