False Return Conviction Provides Basis for Collateral Estoppel to Prevent Discharge

For a brief period the Tax Court treated a conviction for filing a false return, IRC 7206(1) as the basis for sustaining the civil fraud penalty using collateral estoppel.  The period ran from the decision in Considine v. Commissioner, 68 T.C. 52 (1977) to its reversal in Wright v. Commissioner, 84 T.C. 636 (1985) (reviewed).  In the recent unpublished bankruptcy appellate panel (BAP) case of Terrell v. IRS, BAP No. WO-16-007 (Bankr. 10th Feb 17,2017), the 10th Circuit BAP sustained the decision of the bankruptcy court and held that a guilty plea for filing a false return provides the basis for collaterally estopping the debtor from challenging the discharge of his taxes for the year of the plea.  Though unpublished, the opinion, without much analysis, pushes the scope of collateral estoppel on the issue of criminal conviction and civil fraud toward a more favorable position for the IRS.  Reasons exist for drawing a distinction between collateral estoppel in the bankruptcy discharge context and civil fraud penalty.  Had the court articulated those reasons, I would have come away from the opinion with a more comfortable feeling.

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The Tax Court opinions, cited above, determining first that collateral estoppel applies to civil fraud and then subsequently determining it does not provide lengthy analysis concerning the scope of a false return plea.  From the perspective of punishment both tax evasion, IRC 7201, and filing a false return will get the taxpayer to the same prison sentence almost every time.  Because the elements of the two crimes differ slightly and because proving the filing of a false return is slightly easier, prosecutors lean towards a false return conviction at times. Chief Counsel attorneys used to complain bitterly when Assistant United States Attorneys would accept a plea to a false return count rather than evasion because it meant a lot more work in the subsequent civil case; however, the change to 6201(a)(4) to allow assessment of the restitution amount may have taken some of the sting off of the situation.

The difference in the elements of the two crimes plays a role in deciding whether collateral estoppel applies.  The Tax Court examined this difference closely in its opinions applying the elements of the crimes to the civil fraud penalty while the BAP does not do spend as much time applying the elements of the crime to the elements of the applicable discharge statute.

In Considine the Tax Court reasoned:

(a) that it had previously held that a conviction for willfully attempting to avoid tax (I.R.C. § 7201) established fraudulent intent justifying a civil fraud penalty, see Amos v. Commissioner, 43 T.C. 50, aff’d, 360 F.2d 358 (4th Cir. 1965); (b) that the Supreme Court had held that “willfully” has the same meaning in section 7206(1) (false return) as in section 7201 (attempt to evade tax), see United States v. Bishop, 412 U.S. 346, 93 S.Ct. 2008, 36 L.Ed.2d 941 (1973); and (c) therefore that a conviction for filing a false return, without more, establishes fraud justifying the civil penalty.

Considine v. United States, 683 F.2d 1285, 1286 (9th Cir. 1982)(the 9th Circuit criticizes the Tax Court’s decision in citing to Considine v. Commissioner, 68 T.C. at 59-61)

In reconsidering and reversing Considine, the Tax Court in Wright stated:

“In a criminal action under section 7206(1), the issue actually litigated and necessarily determined is whether the taxpayer voluntarily and intentionally violated his or her known legal duty not to make a false statement as to any material matter on a return. The purpose of section 7206(1) is to facilitate the carrying out of respondent’s proper functions by punishing those who intentionally falsify their Federal income tax, and the penalty for such perjury is imposed irrespective of the tax consequences of the falsification. As noted above, the intent to evade taxes is not an element of the crime charged under section 7206(1). Thus, the crime is complete with the knowing, material falsification, and a conviction under section 7206(1) does not establish as a matter of law that the taxpayer violated the legal duty with an intent, or in an attempt, to evade taxes.” (internal citations omitted)

The IRS Chief Counsel’s office at page 63 of its Tax Crimes Handbook states that “there is no collateral estoppel as to civil fraud penalties under this section. The section 7206 (1) charge is keyed into a false item, not a tax deficiency. Collateral estoppel arises only with a conviction or guilty plea to tax evasion.”  Similarly, IRM 25.1.6.4.3 provides that “A conviction under IRC 7206(1), filing a false return, does not collaterally estop the taxpayer from asserting a defense to the civil fraud penalty since conviction under IRC 7206(1) does not require proof of fraudulent intent to evade federal income taxes. In these cases, additional development is required to establish the taxpayer’s intent to evade assessment of a tax to be due and owing.”

At issue in Terrell is whether the his guilty plea for a false return places him squarely within the elements of 523(a)(1)(C).  Section 523 of the bankruptcy code sets out the actions with respect to individual debtors that prevent, or except, the discharge of a debt.  Congress has added to the list over the years since the adoption of the bankruptcy code in 1978.  The list of excepted debts in 523 numbers 19 and several of those 19 subparagraphs of section 523(a) have more than one basis for excepting the debt from discharge.

The provision relating to tax debts, 523(a)(1), has three separate bases for excepting a debt from discharge.  Subparagraph (A) excepts debts that achieve priority status under section 507(a)(8).  This subparagraph, in general terms, prevents debtors from discharging relatively new tax debts.  Subparagraph (B), which has been the subject of many posts, prevents debtors from discharging tax debts for which the debtor has never filed a return or filed a late return within two years of the filing of the bankruptcy petition.  Subparagraph (C) at issue in this case prevents debtors from discharging tax debts “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”

The question before the BAP concerns the language of the discharge exception for making a fraudulent return and the language of IRC 7206(1) for filing a false return.  Section 7206(1) holds a taxpayer liable for a felony tax offense if he “willfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter.”  Does this statute, which does not require any understatement of tax but merely a false statement, match the elements of bankruptcy code section 523(a)(1)(C) such that the conviction under IRC 7206(1) requires a finding of collateral estoppel regarding the discharge of the underlying taxes.

The BAP, after acknowledging that Mr. Terrell presented “no arguments as to why the bankruptcy court’s application of collateral estoppel was in error” says yes because (1) “the issue in the Criminal Case is identical to the issue presented in the Adversary Proceeding” because the same factual issues existed in both statutes; (2) his “guilty plea in the Criminal Case constitutes a full adjudication on the merits”; (3) both the debtor and the IRS were parties to the criminal case; and (4) the debtor “had a full and fair opportunity to litigate the Criminal Case.”

The language in 523(a)(1)(C) “made a fraudulent return” may sufficiently line up with the language of IRC 7206(1) to allow collateral estoppel to work here but I would like the court to work a little harder to make that connection for me.  The Tax Court eased into a similar conclusion with respect to the fraud penalty and an IRC 7206(1) conviction and then had to walk it back after the 9th Circuit brought its attention to the elements of that crime.  The standard of proof for the IRS in a 523(a)(1)(C) case is preponderance of evidence unlike the clear and convincing standard needed for sustaining the civil fraud penalty.  There are certainly differences between the Considine situation and the Terrell case but enough similarities to deserve more analysis.  I am not yet convinced.

Making up Rules

 

One of my sons has been in Indonesia for several months doing research while on sabbatical.  He is preparing to leave, and leaving requires that he go through a multi-step process.  One of the steps involved getting the signature on an appropriate form of someone from the Ministry of Research (I may have this name wrong) and a later step involved presenting the form as part of getting the exit visa.  At the later step, the person processing the exit visa insisted that in order to process the exit visa he had to have a copy of the identity card of the person signing the earlier form.  This requirement was not in the instructions or the regulations.  My son requested that the person call the Minister who signed off on the form.  At that point the person at the exit visa office backed down.  My son felt the request was part of an indirect request for a financial contribution by the person processing the exit visa.  Such requests are common in Indonesia, but not in the U.S.

In the U.S., however, we are not immune from requests that do not have grounding in the code, or regulations, or even the manual.  Sometimes we run into an office procedure that someone thought would be good but that makes accomplishing the transaction very difficult.  A recent CDP case involved one of these made up rules.  The disposition of the case demonstrates the benefit of having CDP and getting Tax Court oversight of some of the practices of the IRS.  Although this case does not have the importance of the Vinatieri v. Commissioner opinion in which the Tax Court struck down the IRS rule that a taxpayer must have filed all of their back tax returns in order to qualify for hardship status under IRC 6343, it has the same flavor.  The case, Houk v. Commissioner, Dk. No. 22140-15L, comes to us via designated order and not an opinion of the court.

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In Houk, the taxpayer wanted to raise the merits of their tax liability in the CDP context.  The Appeals Office determined that in order to properly raise the merits argument the taxpayer must submit an amended return.  The description of the merits issue in the request for a hearing and the related document were insufficient to cause the Appeals employee considering the CDP case to cause them to look at the merits argument.  The notes of the Appeals employee related to the CDP hearing stated:

“It appears taxpayers could be disputing the underlying liability issue.  Self-assessed – Taxpayers need to file an amended tax return [i.e. a Form 1040X] for the tax period in questioned [sic].”

In the determination letter, the Appeals employee stated:

Challenges to the liability

While you were allowed to challenge the amount and existence of underlying liability, you did not present any relevant, non-frivolous documents for consideration.  The taxpayers’ 2013 tax liability was determined based on the documents they submitted.  If any of the figures were in error, the taxpayers should have submitted a Form 1040X to the designated Service Center.”

The IRS filed a motion for summary judgment.  The Court determined that the Houks conceded the innocent spouse and collection alternative issues mentioned in their CDP request; however, the Court found that “Appeals acknowledged, and respondent’s counsel has not denied, that the Houks were entitled to challenge their self-reported 2013 income tax liability.  The record is clear that, at every turn, the Houks have raised this issue – in their Form 12153 requesting the CDP hearing, in the CDP hearing, and in their petition commencing this Tax Court case.”

The Court denies summary judgement because some of the administrative record was missing, but the remaining parts suggested that the IRS may not have considered the liability challenge because of taxpayers’ failure to submit a Form 1040X.  If Appeals denied the request for relief because of the failure to submit a Form 1040X, the denial was an abuse of discretion.  Because there may have been an abuse of discretion, the IRS did not show that no genuine dispute regarding the liability existed and without showing an absence of such a dispute, the predicate to a successful summary judgment request does not exist.

Nothing in the statute or the regulations requires that a taxpayer who files a return and later realizes that filing that return created a liability that is too big imposes on the taxpayer a duty to file an amended return in order to successfully challenge the liability in the CDP context.  It may be more convenient for Appeals to receive a Form 1040X in order to more easily understand and process the request, but convenience is not a factor mentioned in the statute.  The decision of the Court demonstrates that it will not join with the IRS in imposing made up rules in order to deny CDP relief.  If the taxpayers provided inadequate proof of the reason they owed less taxes than was shown on their originally filed tax returns, Appeals could have denied CDP relief on that basis.  The Houks have not won their case.  They still need to prove that the return overstated their tax liability but now they have the opportunity to do that in the Tax Court case.

 

JOB POSTING: CLINICAL FELLOW, FEDERAL TAX CLINIC AT HARVARD LAW SCHOOL

The tax clinic at Harvard has had a great clinical fellow this year, Caleb Smith.  Caleb is leaving Harvard to become the director of the clinic at University of Minnesota, a wonderful opportunity for him to direct one of the oldest and best tax clinics in the country.  Congratulations to occasional guest blogger Caleb Smith and continued success in the future.

I am using this space to post the announcement that the tax clinic at Harvard is seeking to find someone to replace Caleb.  The announcement is for a two year position although it has the possibility of reappointment at the end of that period.  Please contact Caleb (casmith@law.harvard.edu) if you want to know more about what the position entails or just want to congratulate him or contact me (kfogg@law.harvard.edu).  I plan to continue working in the Harvard clinic moving forward and am excited that Harvard is committing the resources to hire a full-time fellow with long term prospects.

The announcement contains a link to the Harvard’s human resources office but you can also use this link to get directly to the announcement.  The announcement also has a link to the web site of the Legal Services Center.  The other clinics and other clinicians at the Center make it a great environment in which to work.  Keith

Position Available:  The Legal Services Center of Harvard Law School (LSC) seeks to hire a Clinical Fellow in the Federal Tax Clinic.  The Clinic—through which Harvard Law students receive hands-on lawyering opportunities—provides direct legal representation in tax controversies to low-income taxpayers. The Clinic’s docket includes cases before the IRS, in Federal Tax Court, and in the U.S. Circuit Courts of Appeal.  Many of the Clinic’s cases raise cutting-edge issues regarding tax procedure and tax law.  The Fellow’s responsibilities will include screening cases for merit and law reform opportunities, representing clients, helping to manage the Clinic’s docket, contributing to community outreach and engagement efforts, and supporting the Clinic’s teaching mission. The Fellow will work closely with Clinical Professor Keith Fogg, who directs the Clinic.  The position represents a unique opportunity to join Harvard Law School’s clinical program, to work in a dynamic public interest and clinical teaching law office, and to develop lawyering and clinical teaching skills.  Salary is commensurate with experience.  The position is for an initial two-year appointment.  The possibility of reappointment depends on the availability of funding and Law School and project requirements.

Minimum Requirements: Candidates must have received a J.D. within the last three (3) years or expect to receive a J.D. in spring 2017.  Candidates must already be admitted to a state bar or be able to sit for a state bar exam in summer 2017 with the expectation of admission to a state bar in fall 2017.  Massachusetts bar admission is not required.  The successful candidate will have experience in tax law, whether clinical, pro bono, government, or private practice, and a demonstrated commitment to the needs of low-income taxpayers.

To Apply:  Applications must be submitted via Harvard’s Human Resources website.  Applicants should apply for the position designated as Clinical Fellow, Harvard Law School (ID #42289BR).   

About the Legal Services Center:  Located at the crossroads of Jamaica Plain and Roxbury in the City of Boston, we are a community-based clinical law program of Harvard Law School. Through five clinical offerings—Family Law/Domestic Violence Clinic, Predatory Lending/Consumer Protection Clinic, Housing Clinic, Veterans Legal Clinic, and Federal Tax Clinic—and numerous pro bono initiatives we provide essential legal services to low-income residents of Greater Boston and in some instances, where cases present important law reform opportunities, to clients outside our service area. Our longstanding mission is to educate law students for practice and professional service while simultaneously meeting the critical needs of the community. Since 1979, we have engaged in cutting-edge litigation and legal strategies to improve the lives of individual clients, to seek systemic change for the communities we serve, and to provide law students with a singular opportunity to develop fundamental lawyering skills within a public interest law setting. To these ends, we actively partner with a diverse array of organizations, including healthcare and social service providers and advocacy groups, and continually adapt our practice areas to meet the changing legal needs of our client communities. We encourage diversity, value unique voices, and pursue with passion our twin goals of teaching law students and advocating for clients. To learn more, please visit the LSC website.

 

When Can the IRS Reassess After Abatement

Guidance was issued on December 7, 2016, and released on March 31, 2017, regarding reassessment after abatement.  The Procedure and Administration Division of Chief Counsel’s office issued the guidance to an attorney in a field office.  The guidance addressed the following question:

“Whether the statute of limitations for assessment of the section 6651(a)(2) addition to tax for failure to pay remains open after an erroneous administrative First Time Abatement, such that the Service may reassess the addition to tax.”

The guidance concludes that the normal three year statute of limitations for assessment does not apply to the addition to tax imposed in 6651(a)(2) and, therefore, the IRS can reassess a failure to pay addition to tax at any time during the ten year statute of limitations for collection.  The guidance document, though relatively short, contains a couple of statute of limitations issues worth discussing.

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The facts giving rise to the opinion deserve brief mention.  In this case the taxpayer filed a joint return with her husband.  They reported the tax on the return but failed to pay the tax reported on the return.  Later they filed an amended return reporting more tax which they also failed to pay.  The taxpayer’s husband filed a bankruptcy petition but she did not.  The filing of the bankruptcy petition by one spouse causes the IRS to split the tax account from one master file account into two non-master file accounts.  Guest blogger Marilyn Ames discussed master file and non-master file accounts in an earlier post and understanding the differences is important in interpreting IRS transcripts.

Depending on the timing of the bankruptcy, the husband might have discharged the 6651(a)(2) liability.  For penalties and additions to tax, the provision governing discharge is found in BC 523(a)(7) and has a three year rule.  For the same reason, discussed below, that the normal assessment rules do not apply to the 6651(a)(2) liability, the three year rule is a little different in a failure to pay situation since the liability derives from post-return actions (or inactions.)  Whether the husband discharged this liability does not matter in this advisory opinion.  The opinion focuses on the wife’s liability.  Because she did not file bankruptcy, her husband’s discharge, if any, will have no impact on her.  He might discharge not only the 6651(a)(2) liability but the tax and the interest.  She would still have a liability for these amounts no matter how her husband’s bankruptcy treats them with respect to him.

Because she still owes this liability, she called the IRS and requested first time abatement.  Steve has written a couple of excellent posts on first time abatement (FTA), here and here, which have proven to be among the most popular posts of all time.  FTA more frequently occurs with late filing and not late payment but here the IRS person on the phone granted her FTA for late payment.  However, sometime after granting her FTA, the IRS determined that it made a mistake because “she had a penalty or addition to tax within the three years prior to the tax period at issue.”  I suspect the mistake related to the placing of her liability for the tax in a non-master file account.

When the IRS mistakenly abates a liability, it has a few good, but old, cases on which it relies to reverse the mistake and it cites to those cases in the advisory opinion.  The first case is Carlin v. United States, 100 F. Supp. 451 (Ct. Cl. 1951) which held that “if the Commissioner abates the assessment, it ceases to exist or to have any effect thereafter.  The Commissioner cannot subsequently rescind his actions or restore the assessment, but must rather make a new assessment unless, of course, the statute of limitations has previously expired.”  The second case always cited in these situations is Crompton-Richmond v. United States, 311 F. Supp. 1184 (S.D.N.Y. 1970) holding that “if the statute of limitations has not run, the IRS may simply make a new assessment of the tax liability that has been abated.”

These cases allow the IRS to essentially have a “do over” when it erroneously abatement a taxpayer’s liability; however, they limit the do over to the statute of limitations.  Although neither of the quotes in the preceding paragraph make precisely clear which statute of limitations it means, the relevant statute of limitations in these cases is the statute of limitations on assessment.  That gives the IRS a relatively short window within which to fix the problem.  The normal rule on the statute of limitations for assessment of three years from the due date of the return does not apply, however, if the liability comes from 6651(a)(2).

The guidance explains that the assessment period for a 6651(a)(2) liability cannot end three years from the due date (or filing date) of a return because this addition to tax runs for 50 months after the filing date.  During the 50 months after the filing date, the taxpayer gets hit with another liability under the statute for every month that passes based on the outstanding liability as of that month.  Because the assessment of this liability must extend past the normal three year period for assessment, the guidance concludes that the time period for assessment remains open for the ten year statute of limitations on collection.  As with the reassessment after abatement case law, the case law on this ten year statute of limitations is fairly thin and exists in lower court opinions.  The leading case is United States v. Estate of Hurd, 115 A.F.T.R.2d 2015-38 (C.D. Cal 2015).

So, the guidance concludes that because the statute of limitations on collection remained open in W’s case the IRS could reverse the abatement and reassess the liability against her.  The guidance is not surprising and does not break new ground but because this issue does not arise and get discussed very often the guidance is worth looking at if you have a reassessment situation.

 

Continued Developments in Taxpayer attempts to Litigate the Merits of Taxes in Collection Due Process Cases

As we have reported before, here, occasional guest blogger Lavar Taylor brought three appeals into the circuit courts.  Two circuit courts have ruled thus far and both sustained the decision of the Tax Court upholding the regulation promulgated by the IRS which prevents a taxpayer from bring a merits dispute in a collection due process (CDP) case if the taxpayer had the opportunity for a conference with Appeals prior to bringing the CDP case even if the opportunity to go to Appeals did not include an opportunity to contest the matter in court.  We are still waiting on the third circuit court in which Lavar made his arguments to decide the case that came before it in order to determine if a split in the circuits on this issue might lead to Supreme Court review.  Meanwhile, the Keller Tank decision decided by the 10th Circuit has had further developments and the Tax Court continues to decide cases on this issue.  Both the new developments in Keller Tank and the recent activity in the Tax Court deserve mention.

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On March 31, 2017, the IRS filed a request with the 10th Circuit in the Keller Tank case entitled “APPELLEE’S MOTION TO AMEND OPINION TO CLARIFY AUTHORITY OF IRS OFFICE OF APPEALS OVER RESCISSION OF I.R.C. § 6707A PENALTIES.”  In the motion, the IRS requests that the 10th Circuit amend the opinion in the case, which was entirely favorable to the IRS, to remove language suggesting that the Appeals Office could rescind the 6707A penalty.  The motion states that the Commissioner has not delegated that authority to Appeals and that the opinion could mislead others.  You do not often see the winning party asking the court to rewrite its opinion but the reason for the request makes perfect sense for an agency trying to administer a statute and wanting to make sure that parties follow the correct procedure when requesting remedies.

Following on the heels of the motion by the IRS, on April 7, 2017, the taxpayer filed a PETITION FOR REHEARING AND REQUEST FOR REHEARING EN BANC.  In this petition, the taxpayer essentially asks the court to reconsider its decision and sets out the reasons why it should do so.  We will continue to follow the developments in this case as well look for the final circuit court opinion.

Meanwhile, back in the Tax Court a couple of decisions on this topic deserve brief mention and discussion.  The first was an order and decision issued by Judge Holmes on January 3, 2017 in White v. Commissioner, Dk. No. 9967-15L.  Mr. White filed his 2008 return in 2013.  The IRS not only assessed the taxes reflected on the return but also assessed penalties for late filing and late payment.  In his CDP case Mr. White wanted to contest the penalties.  Judge Holmes set out the timeline regarding the penalties and Mr. White’s efforts to contest them in the order:

-October 4, 2013 — Mr. White writes to IRS Appeals to ask for relief from the penalties;

– January 24, 2014 — IRS Appeals denies his request;

-April 9, 2014 — Mr. White files an administrative appeal of the denial;

-May 20, 2014 — while this administrative appeal is pending, the IRS sends Mr. White a notice of federal tax lien;

-June 6, 2014 — Mr. White files his request for a CDP hearing and states that he only wants to challenge the penalties;

-October 28, 2014 — The administrative appeal leads to a partial abatement of the penalties;

-December 24, 2014 — the Appeals settlement officer conducting the CDP hearing writes to Mr. White to schedule the hearing but warns him that his filing of a request with IRS Appeals and pursuit of an administrative appeal constituted his one chance to challenge his liability;

-March 17, 2015 — The Appeals settlement officer issues the notice of determination in which he rules that Mr. White may not challenge the penalties in a CDP hearing because he had challenged them administratively.

Mr. White pressed for consideration of the penalty assessment amount in the CDP hearing.  The IRS filed a motion for summary judgement.  Because he never received a notice of deficiency regarding the underlying taxes, since they are taxes on his return filed without remittance, Montgomery v. Commissioner would allow him to contest the taxes in the CDP hearing but what about the penalties which he contested prior to the CDP hearing in appeals in the penalty abatement context.

The relevant regulation is 26 CFR § 301.6320-1(e)(3), A-E2  and it provides:

“An opportunity to dispute the underlying liability includes a prior opportunity for a conference with Appeals that was offered either before or after the assessment of the liability. An opportunity for a conference with Appeals prior to the assessment of a tax subject to deficiency procedures is not a prior opportunity for this purpose.”

The Court notes that the second sentence of the regulation does not apply because his opportunity for a conference with Appeals came after and not before the assessment of the tax.  In its brief in support of the summary judgment motion, the IRS cited to two trust fund recovery penalty cases in which the taxpayer received a hearing with Appeals but TFRP cases have their own special regime for obtaining Appeals conferences.  Even though the IRS apparently did not cite to Lewis v. Commissioner, 128 T.C. 48 (2007), Judge Holmes looks at it and finds the facts essentially identical.  On the basis of Lewis, he upholds the determination of Appeals and grants the motion for summary judgment.

The decision in White raises the question of what would have happened to Mr. White’s request to have the penalties reviewed by the Tax Court in the CDP case if he had not first sought to have Appeals look at them.  I think that he may have gotten his review.  If I am right, perhaps taxpayers should not engage in the penalty abatement process immediately after filing a late return but wait until the CDP process begins.  That is not the most efficient result but taxpayers who want the ability to challenge the denial of penalty abatement in court must wait for CDP or fully pay and sue for refund.

On March 29, 2017, Judge Lauber issued an opinion in Bitter v. Commissioner, T.C. Memo 2017-46.  The Bitter case is another 6707A case.  The Court picks up on the two recent circuit court decisions and cites them in the decision.  The case shows what taxpayers should expect if they seek to litigate the merits in a CDP case of this type of penalty.  The door is firmly shut and will only open if a circuit court agrees with the argument that the regulation goes too far by preventing taxpayers who can only obtain review from Appeals from raising the merits of the underlying liability in a CDP case.  Judge Lauber goes through all of the recent decisions if you want a thorough update on the state of the law in this area.

The Interplay of Restitution and Deficiency Assessments

As we have discussed before here, here and here, in 2010 Congress amended 6201(a)(4) to permit the IRS to make an immediate assessment based on an order of restitution in a criminal case.  In Rozin v. Commissioner, T.C. Memo 2017-52 the Tax Court continues to instruct taxpayers on the interplay between restitution assessments and deficiency assessments.  The opinion comes close to being an advisory opinion because very little separated the position of the IRS and the petitioner; however, the opinion brings clarity to the role of restitution assessments and payments.

In 2008 Mr. Rozin was convicted of two tax crimes and conspiracy with respect to his 1998 return.  On October 29, 2010, he sent the IRS a payment of $387,687 based on the tax loss from his criminal actions as calculated by the U.S. Probation Department.  On February 4, 2011, the federal district court entered an order of restitution in the amount of $775,294 and in July of 2011, he essentially paid the balance of the liability.  His conviction was affirmed by the 6th Circuit in 2012.  I do not know if anyone has studied the impact of the change in the law in 2010 on the amount the IRS collects following criminal convictions but I expect the impact is significant.  The full payment in this case of such a large amount may not be solely or even partially attributable to the law change but signifies a good trend in criminal tax cases for the IRS and particularly its collection division.  Because the IRS delays traditional assessment and collection until after it has finished with the criminal aspect of the case, many criminally convicted taxpayers have few resources left with which to satisfy the civil liability once the criminal case comes to an end.  The revenue agents usually get a relatively simple case because the special agents provide a clear roadmap to the needed adjustments but the revenue officers often ended up with an uncollectible account that sat in their inventory gathering dust.

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The Tax Court case is about whether there should be a Tax Court case.  Mr. Rozin paid the tax.  The IRS assessed the tax.  He objects to the deficiency determined by the IRS a few years after he thought he had taken care of the tax problem.  After he thinks he has paid everything, here comes the IRS examiner wanting to reopen the wound and go back over his 1998 tax year fifteen years after the end of the tax year at issue.  Essentially, Mr. Rozin argues that the restitution assessment and his payment should have ended the matter and the IRS should not get to assess the taxes again.  He agrees with the IRS that he underreported $392,083 in tax on his 1998 return and that because he did so fraudulently the 75% penalty of 6663 applies in the amount of $294,062.

The IRS argues that the new statute allowing it to immediately assess the restitution amount does not allow it to credit Mr. Rozin’s account until the deficiency and fraud penalty are assessed.  It cites to IRC 6201(a)(4); 6213(a) and (b)(5) and to Schwartz v. Commissioner, T.C. Memo 2016-144.  The IRS makes clear that once it assesses the tax through the deficiency procedures that it will apply the payment he made during the restitution process.  So, Mr. Rozin knows from the outset of this case that the deficiency assessment will add nothing to the liability created by the restitution order with the possible exception of interest.

 

The Court carefully explains the difference between the restitution assessment and the proposed deficiency assessment.  It states that:

“A deficiency must first exist before restitution remittances for taxes owed can be applied to reduce that deficiency.  In other words, the restitution assessment, which is assessed ‘as if’ it were a tax, cannot offset a tax assessment until a tax assessment of the deficiency has been made.  The amount of a deficiency turns not on what payments have been applied to an account, but rather on what assessments have been made with respect to that account.”

Mr. Rozin argues that the IRS made a mistake in calculating his liability in the notice of deficiency because it did not give him credit for the payments he made.  The Court points out that the IRS should not give credit for these payments in the notice of deficiency, not because he will not ultimately get credit for them, but because these amounts were not “shown as tax” on his 1998 and the IRS has not made an additional civil tax assessments on that period.  Even though the IRS did previously assess based on the restitution order, the previous assessment was a summary assessment and not a deficiency assessment.  The restitution assessment does not create a final determination of civil liability.

“Thus, petitioner’s restitution payments are not included as ‘amounts previously assessed… as a deficiency,’ and respondent was not permitted to reduce his determination by those payments under 6211(a)(1)(B)….  Because restitution does not fit within the definition of a deficiency under section 6211, restitution payments made do not reduce or discharge a deficiency determination before the deficiency is assessed.”

The Court points out that by refusing to sign the waiver on assessment the IRS sought to have him sign in lieu of sending the notice of deficiency, Mr. Rozin prevented the IRS from doing the very thing he wants it to do.  Yet, by bringing the suit Mr. Rozin allowed the Court to provide us with a further explanation of how the restitution assessment and the deficiency assess work together.  If you have to lose a Tax Court case it is better to lose one in which the Court tells you that its decision to allow the IRS to assess the amounts in the notice of deficiency will be covered by your previous payment.  This will not happen in every restitution case.  The notice of deficiency could establish a liability far in excess of the restitution payment ordered in the criminal case.  Mr. Rozin’s full payment of the restitution order is also someone out of the norm as many individuals who go through the criminal process lack sufficient resources to make full payment at the conclusion of that process.  From a collection point of view the case demonstrates how the change in the law to allow the IRS to assess the restitution amount works well even if it creates duplication in the assessment process that confused Mr. Rozin.

Seeking Disclosure of Return Information in Tax Court Case

On April 5, 2017, the Tax Court rendered a fully reviewed T.C. opinion in the case of Mescalero Apache Tribe v. Commissioner, 148 T.C. No. 11.  We do not often have two disclosure cases in one week.  It doesn’t get much better than this.

After President Nixon tried to run roughshod over the tax information of his enemies and Congress reacted with the new, extremely beefed up section 6103 in 1976, Chief Counsel, IRS soon thereafter created the Disclosure Division.  As you might imagine, new attorneys did not flock to that Division as their first (or second or third) choice.  So, Chief Counsel’s office created a rule that if you worked in the Disclosure Division for three years, you got first choice on any opening in the country.  That rule suggests how sought after a career focused on the disclosure laws was, at least with lawyers in Chief Counsel’s office; however, the disclosure provisions, despite their non-glamorous reputation, contain many important policy issues a number of which have split the circuits.  The Mescalero Apache Tribe case demonstrates one of the interesting issues that can lurk in the disclosure provisions.

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Before I move on to the disclosure issue, I want to pause and discuss an issue that the Court discusses in a footnote – appellate venue in cases brought by Indian tribes.  The issue of appellate venue in Tax Court cases has importance to the outcome of the case at the trial level because of the Golsen rule under which the Tax Court will follow the law of the circuit to which the case will be appealed.  The failure to update the appellate venue rules in 1998 when Congress created several new ways to obtain Tax Court jurisdiction led to some interesting issues we have blogged here and here.  In this case the Tax Court notes that the rules of appellate venue discuss individuals and corporations but not Indian tribes which have a sovereign nation like status.  So, the appellate venue for a Tax Court case involving a tribe put the court in uncharted waters.  It defaulted to looking to the law of the 10th Circuit which is the circuit where the tribal lands of the tribe appearing before the court are located.  I suspect that most readers will have few cases in which they represent an Indian tribe in Tax Court but the case points out in yet another context a hole that exists in the appellate venue of the Tax Court and how that hole can impact the resolution of the case when a circuit split exists on an issue.

The taxpayer is an Indian tribe that hired workers.  At issue in the Tax Court case is the classification of those workers as independent contractors or employees.  The tribe classified the works as independent contractors and the IRS seeks in the case to obtain a determination that the workers were employees.  If the IRS wins this argument, the tribe would owe the taxes on the workers under the theory that its failure to properly classify the workers and consequent failure to withhold taxes with each payment caused the non-payment of the taxes.  Section 3402(d) allows a company deemed to have employees rather than independent contractors to avoid the additional liability to the extent that the company can show that the workers independently paid the taxes to the IRS.  This offers a significant way out of what could be a heavy tax liability; however, there is one catch – the payment by the employees of their taxes is return information under IRC 6103 and return information, like tax returns themselves, comes under the broad umbrella of the protection from disclosure.

The structure of 6103 basically sets out the broad general rule at the outset that returns and return information is covered by the disclosure provisions and cannot be disclosed by the IRS.  The lengthy code section then has a multitude of exceptions.  At issue in this case is the application of one or more of the exceptions.  The case is a slightly unusual disclosure case in that both the IRS and the taxpayer before the court know the names of all of the individuals who worked for the tribe.  So, the tribe does not want taxpayer identity information but simply whether the identified individuals paid their taxes for the years at issue so that the tribe knows if the defense available in 3402(d) protects it.  Before seeking the information in discovery in the Tax Court case, the tribe sought to gather the information from the individuals who previously worked with it.  Because of time and mobility of the work force and maybe because some of the former workers did not want to provide the information, the tribe was unable to get information about all of its former workers.  So, it sent a discovery request to the IRS seeking to obtain information about a group of identified former workers and whether they paid taxes on the compensation they received.  The IRS objected to the request citing the general rule that it may not disclose this return information.  The tribe brought an action to enforce discovery citing to an exception in 6103(h) and the Tax Court, in a fully reviewed, unanimous opinion, holds that the tribe is entitled to the information through discovery.

This is a big deal for taxpayers who need information from the IRS in order to defend themselves in a tax matter.  The decision here will not open the IRS records in every case but it does provide a model for seeking information in Tax Court cases.  Because the Tax Court had not previously addressed this issue, it did so here through court conference.

As the Tax Court examined the issue of whether 6103(h)(4) provides an exception to the general rule of nondisclosure, it found the circuits were split.  The 5th Circuit held that this subsection applied to disclosures to certain federal officers because of the title of the section; however, the 10th Circuit held the 6103(h)(4), unlike earlier subparagraphs of the subsection,” speaks specifically of disclosure in a judicial or administrative tax proceeding with no indication that disclosure should be limited to officials.”  The Tax Court found that most courts had followed the 10th Circuit; however, the fact that (h)(4) created an opportunity for disclosure in a court proceeding did not mean that its language required or allowed disclosure in this circumstance.  So, the Tax Court had to look further at the statute.  Subparagraph (h)(4)(B) refers to returns and return information and another part refers only to returns.  Without getting into a significant discussion of returns and return information, it is important to understand that these are two different classes of information protected by 6103 and the tribe wants return information.  Two circuits found the subsequent reference to returns which omitted the phrase return information to create a limitation on the disclosure of return information.  The 10th Circuit had two opinions which, in different contexts, did not impose that limitation.

The Tax Court avoided that issue by looking at 6103(h)(4)(C) which allows for disclosure of both returns and return information; however, it limits disclosure to situations in which “return or return information directly relates to a transactional relationship between a person who is a party to the proceeding and the taxpayer which directly affects the resolution of an issue in the proceeding.”  So, the Tax Court needed to decide if the employer/worker relationship is a transactional relationship and whether the return information of the workers directly relates to this relationship and whether “information related to the transactional relationship directly affect(s) the resolution of the issue in this case.”

The court found that the relationship met the necessary test, that the return information directly relates to this relationship and that the return information directly affects the resolution of an issue in the case.  So, it found the return information disclosable but that did not end the matter because the IRS objected that even if it is disclosable “it is still not discoverable.”  The IRS pointed to the fact that the tribe bore the burden of proof that the workers paid their taxes.  This seems like a cruel argument if the IRS has the information that will allow the taxpayer to win their case and does not have to give it to the taxpayer because the taxpayer must prove their case.  The Tax Court found that just because the tribe had the burden of proof does not mean that discovery cannot be had of the IRS citing to Tax Court Rule 70(b) which says parties can discover information “regardless of the burden of proof involved.”  Keep in mind that sometimes the IRS has the burden of proof and it should be careful of arguments like this that could limit its ability to obtain information from the taxpayer through discovery.

In a case like this the IRS represents the interest of the 70 individuals whose return information will come out even though they have no voice in the matter.  The IRS defense of disclosure makes sense but so does the Court’s determination that the information meets the exception in the statute.  Failure to allow the information to come out could cause the tribe to pay a tax which its workers already paid.  The competing policy interest of the protection of the worker’s return information and the tribe’s interests properly fall on the side of preventing the tribe from having to pay a tax it should not owe.  The case does not talk about how the return information of the workers might be protected as the information is disclosed but that issue is present.

Mailing Your Revenue Agent’s Report to a Stranger

The recent Second Circuit case of Minda v. United States, addresses the damages the IRS must pay when it sends detailed information about a taxpayer to an unrelated third party.  The issues in the case did not involve whether a disclosure violation occurred but the appropriate amount of damages for the violation.  The IRS prevailed in the sense that it limited the damages to the lowest possible amount.  The court’s analysis provides insight for others who might find their tax information wrongfully disclosed.  If you feel the IRS got off too lightly, the remedy may lie in stronger legislation.

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The IRS examined the 2007 return of Gary Minda and Nancy Findlay Frost.  The examination resulted in proposed adjustments which the revenue agent’s report (RAR) set forth.  The RAR, as usual, contained a fair amount of information about the taxpayers, such as their social security numbers and financial information.  All of this type of information fits under the definition of “return information” in IRC 6103.  The IRS mailed the RAR to an unrelated third party in Ohio.  I did not see in the opinion where Gary and Nancy live but assume from the fact they brought their wrongful disclosure action in the Eastern District of New York that the did not live in Ohio at the time of the mailing of the RAR report.  The individual in Ohio who received the report gave it to his attorney who wrote to the IRS advising the IRS of the erroneous mailing.  The attorney for the third party also sent a copy of the report to Gary and Nancy whose address, I assume, was a party of the many pieces of information in the RAR identifying them and their finances.

Gary and Nancy complained to the IRS about the fact their RAR was sent to Ohio.  The Treasury Inspector General for Tax Administration (TIGTA) conducted an investigation and found that Gary and Nancy’s examination occurred about the same time as the individual in Ohio, somehow the reports got comingled, and TIGTA could not identify the person who sent the RAR to the third party in Ohio.  The circumstances surrounding the disclosure seemed inadvertent.  The court found that Gary and Nancy “did not suffer any actual damages as a result of the unauthorized disclosure of their return information.”

When Gary and Nancy brought suit in district court seeking damages for unauthorized disclosure the IRS conceded the unauthorized disclosure and conceded liability for statutory damages but denied that they should receive any other relief.  The IRS moved for summary judgment contending that the damages were limited to $1,000 each.  The EDNY granted the motion.  The Second Circuit looked at 6103(b)(8) which provides that a disclosure is “the making known to any person in any manner whatever a return or return information” and then at 7431 which governs damages for wrongful disclosure.  When the IRS makes a wrongful disclosure, taxpayers can bring a civil action in the appropriate district court which they did here.  Section 7431(c) provides that the IRS is liable for the greater of “(A) $1,000 for each act of unauthorized inspection or disclosure of a return or return information with respect to which such defendant is found liable or (B) the sum of (i) the actual damages sustained by the plaintiff as a result of such unauthorized inspection or disclosure, plus (ii) in the case of a willful inspection or disclosure or an inspection or disclosure which is the result of gross negligence, punitive damages, plus (2) the cost of the action, plus…” reasonable attorney’s fees it the action met the criteria for (ii).

Because the IRS conceded that an unlawful disclosure occurred and petitioners conceded they had no actual damages, the issue before the court turned on whether the negligent or willful standard applied.  In determining the amount of statutory damages the court had to decide what the statute meant when it said “each act.”  Was the mailing of the RAR to the wrong person the act – meaning that a single act occurred and limiting the damages to that single act or did many acts occur because the single document contained many disclosures of return information.  The court found that the statute description look at acts and did not say “for each item of return information disclosed.”  The word “each” served as a modifier of act and not information.  After going through its analysis of the statute, the Second Circuit also bolstered its determination with the statement that 7431 provides a waiver of sovereign immunity and those waivers must be strictly construed.  So, the Second Circuit sustained the decision of the district court and limited the recovery of damages to $1,000 for each person based on the act of wrongfully mailing the document once.

Next, the court took up plaintiffs’ argument that they should receive punitive damages.  Because plaintiffs must essentially rely on the investigation by TIGTA and did not have a way to conduct their own investigation (not that I am suggesting their own investigation would necessarily have led to a different conclusion), they are hamstrung on this part of their case.  They really had no evidence that someone at the IRS engaged in aggravated conduct or that the action in mailing the RAR to the wrong place resulted from wanton or reckless disregard or their rights.  So, they could get no traction on this issue.  The government argued that a taxpayer can only receive a punitive damage award if the disclosure resulted in actual damages.  The Second Circuit did not reach this issue but noted a split between the 4th and 5th Circuits on this interpretation.

The outcome here does not surprise me given that the wrongful disclosure did not result in actual damages.  This type of wrongful disclosure may occur more frequently that we see litigation because the IRS will concede the violation and offer statutory damages.  Not many taxpayers push for additional damages because doing so involves resources and costs.  With the possibility that taxpayers in New York could have their case handled anywhere in the US, these types of mistakes will happen.  The inability of TIGTA to get to the source of the problem is perhaps more troubling than the inability of the taxpayers to get a greater award.  Without figuring out why the IRS system went wrong here, corrective action may not occur.