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  In the recent unpublished bankruptcy appellate panel (BAP) case of Terrell v. IRS, BAP No. WO-16-007 (Bankr. 10th Feb 17,2017), the 10th Circuit BAP sustained the decision of the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  Though unpublished, the opinion, without much analysis, pushes the scope of collateral estoppel on the issue of criminal conviction and civil fraud toward a more favorable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.

Former Tax Court Judge Kroupa Pleads Guilty to Conspiracy

We have written before about the indictment of former Tax Court Judge Kroupa and the collateral impact of her indictment.  Her husband pled guilty last month and on Friday, October 21, she also pled guilty.  If you have never gone to a guilty plea hearing, you should take the time to read the transcript of this hearing.  You will see how detailed the court is when accepting a plea seeking to foreclose all opportunity for the defendant to later argue that they were not really guilty of the count(s) to which they made a guilty plea.  Between the judge and the Assistant U.S. Attorney, it takes over 40 pages of transcript to get in all of the questions.  As you will see, the answers are short and sweet.

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Occasionally, I have clients or prospective clients in the clinic who have pled guilty to a tax crime. Some tell me they were not really guilty but just pled to end the process.  I remind them of their conversation with the judge at the taking of the plea.  Although most profess little memory of the event, I know they had to answer the essentially the same questions posed to former Judge Kroupa.  While many motivations to plea exist, after going through the plea process the defendant really has little room to wriggle.  In a recent HBO series, The Night Of, involving the taking of a state rather than a federal plea, the defendant cannot make the necessary statements of guilt and ends up going to trial.  Former Judge Kroupa gave all the right answers.  The Court accepted her guilty plea.  Now a sentence report must be written and a sentencing hearing held.

What does Former Judge Kroupa get by pleading guilty? She gets a reduction in the sentencing guidelines, she gets only one felony conviction, and she gets to avoid the stress and cost of trial.  Let’s look at each of the things she gets but not forget that in all likelihood she also gets to go to prison.  The guilty plea is not something she will go home and celebrate about.

Sentencing Guidelines

The Supreme Court decided several years ago that the federal sentencing guidelines provide guidance to federal judges in imposing criminal sentences; however, the guidelines do not impose mandatory time periods that the judges must follow. Despite the non-binding nature of the guidelines, most judges pay careful attention to them and for that reason so do most defendants.

For tax crimes the guidelines usually start with the amount of tax the defendant has underpaid due to their criminal action. That amount usually provides a baseline number in the guidelines which translates into a recommended sentence.  That, however, is just the start.  In the case of someone like former Judge Kroupa, the guidelines provide for enhancements because of her special knowledge of the tax laws and her special position in the system.  Because of these factors she received a higher number under the guidelines which translates into a higher sentence.  By pleading guilty, she receives a reduction because of acceptance of responsibility.  If you read the plea transcript you will see a discussion of the enhancements and the reduction.

Building on the base amount and the adjustments, the guideline in her case result in a recommended sentence of 30-37 months. The judge carefully explained in the plea hearing that she will not necessarily follow the guideline and the ultimate sentence could end up higher or lower.  The defendant receives no guarantees.  The sentencing report will influence the judge as could anything that happens between now and the time of sentencing; however, making the guilty plea does have the effect of reducing the guideline amount from what a guilty verdict would produce.  That provides motivation for pleading guilty in weighing the pros and cons.

Conviction

In pleading guilty former Judge Kroupa received the opportunity to plea to one count and have the remaining counts dismissed. This allows her to control the count to which she pleads guilty and the collateral impact of the plea.  She did not plead guilty to the felony of evasion of tax under IRC 7201 which carries with it the consequence of collateral estoppel on the fraud penalty.  I wrote recently about a very unusual case in which a guilty plea did not result in collateral estoppel.  By negotiating a plea agreement, she had several counts drop away.  This may prove beneficial to her although the Department of Justice need not be criticized for entering into the plea since the number of counts may have had little or no impact on the sentence and on the payment of the fraudulently unreported tax.

The IRS may not need collateral estoppel here in order to collect the proper amount of tax. She has already made some tax payments.  The 2010 change in the law regarding restitution allows the IRS to assess without having to issue a notice of deficiency the amount order for restitution.  When the IRS pursues a criminal tax case, it sets the civil case to the side until the criminal matter ends.  The end of her criminal case will mark the renewal of the civil tax audit.  Of course, she can agree to the taxes and penalties proposed by the IRS at the end of that audit and terminate the civil case without a fight.

If it does come to a fight about the imposition of the fraud penalty or additional amounts of tax not included in the restitution order, the IRS will issue a notice of deficiency and former Judge Kroupa will have the opportunity to litigate the correctness of the notice before the Tax Court. In such a case the Chief Counsel attorney will wish the plea included the IRC 7201 counts and former Judge Kroupa will undoubtedly wish that she did not have to go to Tax Court to get an opinion on the issue.  Of course, she can always pay and go to district court via the refund procedure.

Stress and Cost

The plea agreement transcript contains a detailed list of the medications former Judge Kroupa now takes. I do not know if she took any of these drugs before the criminal investigation but getting investigated for a criminal tax violation is extremely stressful.  I would not be surprised to learn that all or most of the drugs assist in dealing with the stress of the investigation.  With the plea agreement life will not turn into a bed of roses but the bleakest period may have passed.

Trying a criminal tax case not only creates additional stress but often depletes the bank account of the accused. Already, she will have paid handsomely for the representation she has received.  Many former criminal cases produce little tax revenue for the IRS because the defendant spends all of their money on the defense and has very limited job prospects after the conviction.  Ending the case with a plea saves some of the costs and may preserve assets to deal with the unpaid taxes and other necessary expenses.

Conclusion

The guilty plea brings the criminal phase of former Judge Kroupa’s case near to conclusion. The IRS has obtained the thing it wants most in a criminal case – publicity.  A case like this draws far more attention than the ordinary criminal tax prosecution.  Perhaps the silver lining for the tax system in this case is that is may provide more deterrence and this painful event will influence others to file their taxes correctly.

 

Ex Tyco CFO Swartz on the Hook for Tax For Millions “Borrowed”

An earlier version of this post originally appeared on the Forbes Procedurally Taxing site on October 18, 2016

 When Tyco was synonymous with greed, Mark Swartz and his boss Dennis Kozlowski were vilified as all that was wrong with corporate America. Swartz and Kozlowski were both released on parole in the last couple of years. Swartz, Tyco’s former CFO and Kozlowski’s right-hand man, has had a long-simmering dispute with the IRS over the tax consequences of $12.5 million he helped himself to back when he and Kozlowski were raiding the corporate coffers. This past week the Tax Court in Swartz v Commissioner resolved in favor of the IRS a partial summary judgment motion relating to the $12.5 million, and I will briefly describe it below.

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Back when Tyco was flying high, Swartz was participating in Tyco’s key executive loan program. The receipt of loan proceeds, however, is not gross income. The problem for Swartz was that he took steps that suggested he had no intent of repaying some of those proceeds:

In August 1999, a handwritten journal entry in Tyco’s accounting records mysteriously reduced Mr. Swartz’s outstanding loan balance by $12.5 million. Swartz did not make any payments on this loan to Tyco during the year at issue. He also did not include the $12.5 million on his Form 1040 (for example, as cancellation-of-debt income), and Tyco did not include the amount on Mr. Swartz’s W-2.

Tax Court Judge Mark Holmes, in his direct style, describes the hot water that Swartz found himself in:

In 2001, Mr. Swartz became a member of Tyco’s board of directors. Not too long afterward, the directors learned that Kozlowski was the target of a criminal investigation for possible state sales-tax violations by the district attorney in Manhattan. Kozlowski was indicted only a few days after this information surfaced and promptly resigned from the board. His replacement — John Fort — immediately retained a law firm to undertake a full and complete investigation of Tyco’s business including compensation and transactions between Tyco and its officers and directors. This led to a conversation (the details of which are unknown on this motion) between the law firm and Swartz about the mysterious 1999 journal entry. And the conversation led to the reversal of the journal entry. Mr. Swartz then repaid the money with interest.

Kozlowski and Swartz were the subject of a multi-count indictment, including one that alleged that Mr. Swartz stole the $12.5 million from Tyco and another that alleged the conduct amounted to grand larceny under New York law.

At trial, Swartz argued that he thought the $12.5 million loan reduction was part of his bonus; after a hung jury in the first trial a second jury found Swartz guilty of those counts (and others) and sentenced him to 8 to 25 years.

What of the tax consequences of the $12.5 million? It is black-letter law that ill-gotten gains are gross income. In the tax dispute, Swartz took a different approach than what he argued in the criminal trial. In Tax Court he argued that his eventual repayment of the proceeds and Tyco’s actions in 2002 showing after the fact that a repayment obligation existed meant that his actions back in 1999 were null and void and thus there was no gross income in the first instance.

He did not raise this argument in the criminal trial, and IRS sought to use the doctrine of collateral estoppel to prevent him from arguing it in Tax Court.

The order lays out the general conditions for collateral estoppel:

  • an issue of law or fact in the second case is the same as one in the first case;
  • there has been a final judgment in the first case;
  • the party to be precluded is the same or in privity with a party in the first case;
  • the issue that is precluded was actually litigated in the first case; and
  • the controlling facts and legal principles are unchanged.

Swartz argued that there was no identity of issue or actual litigation because he did not make the argument he wanted to make in Tax Court in the criminal case. There was no dispute about elements 2 and 4. The focus was on whether the issue was the same in both matters. Finding in favor of the IRS, the order notes that “a party’s failure to make an argument about an issue in the first case doesn’t mean that he gets a do-over in the second.”

As the Restatement (Second) of Judgments, §27cmt.c (Am.LawInst.1982), concisely summarizes “if the party against whom preclusion is sought did in fact litigate an issue of ultimate fact and suffered an adverse determination, new evidentiary facts may not be brought forward to obtain a different determination of that ultimate fact. . . . And similarly if the issue was one of law, new arguments may not be presented to obtain a different determination of that issue.”

Parting Thoughts

The order notes that there are some cases which suggest that a thief’s agreement to return stolen property in the same year as the original taking can serve as an exception to the general rule that ill-gotten gains are gross income. It was possible that the argument Swartz sought to make may not have mattered for state law purposes but in fact may have mattered for tax purposes. Yet, the order notes that as a matter of law Swartz’s position did not address that narrow exception, as there was no agreement to return the funds to Tyco until 2002, “after he was caught.” If there were allegations that the facts may have led to a material difference under federal tax law, I suspect the order would have concluded differently.

Often the government argues that a conviction should serve to collaterally estop a taxpayer from arguing that the ill-gotten gains were not gross income. Keith discussed the somewhat unusual case of Senyszen v Commissioner where the Tax Court looked at the impact of a tax evasion conviction on the amount of the civil liability owed by the taxpayers and held that the IRS cannot use collateral estoppel to impose a liability where it otherwise does not exist.  As that case makes clear, courts have discretion to not apply it even when the basic conditions are satisfied. Moreover, sometimes embezzlement type convictions do not have the specificity in terms of the amount at issue, which could generate a separate dispute. Here as Judge Holmes notes, the amount itself was specific in the indictment, and Swartz is left to face the tax consequences of that conviction, though his later repayment of the $12.5 million may generate a deduction that perhaps will soften the blow somewhat.

 

 

Hiramanek Case Raises Issue of Collateral Estoppel When Spouse Intervenes as well as the Refusal of Tax Court to Accept Attempted Concession by IRS on Issue of Duress

Today, we welcome back guest blogger Patrick Thomas.  Patrick has just finished his Christine Brunswick Fellowship through which the ABA Tax Section sponsored his work for two years at the Low Income Taxpayer Clinic (LITC) located within the Neighborhood Christian Legal Clinic in Indianapolis, Indiana.  He will open the new LITC at Notre Dame Law School this fall as its first director.  He writes on an recent decision by Judge Halpern involving an interesting innocent spouse case with a couple of unusual procedural issues.  Keith

On May 10, Judge Halpern issued a memorandum opinion in Hiramanek v. Commissioner, T.C. Memo. 2016-92, denying innocent spouse relief in a standalone petition under section 6015(e). This case presents an interesting application of the collateral estoppel doctrine, along with a good example of circumstances under which a purported joint tax return is signed under duress. Mr. Hiramanek, the Petitioner (and a certified public accountant), was denied the opportunity to argue that a joint return was filed because of his prior intervention in his ex-wife’s case before the Tax Court, where the Court found that because the purported joint return was signed by Mr. Hiramanek’s wife under duress, she could not be held liable for the deficiency on that return. Because Mr. Hiramanek had effectively litigated this issue previously before the Court, he could not raise it again in his own proceeding under section 6015(e).

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For tax year 2006, the IRS received what purported to be a joint tax return from the Hiramaneks. In March 2010 the IRS sent them a Notice of Deficiency, which determined a $27,222 deficiency, along with a $5,444 section 6662(a) penalty. Mrs. Hiramanek (“Ms. Kapadia” in the Court’s opinion) timely filed a petition, which both requested innocent spouse relief and disputed the deficiency in full. Mr. Hiramanek formally intervened in that case under Rule 325(b).

Prior to trial, Ms. Kapadia and the Service stipulated that she signed the purported joint return under duress and that therefore no deficiency existed with respect to her. The Court, however, did not accept the stipulation and proceeded to hold a trial on the duress issue. In his testimony at trial, Mr. Hiramanek disputed the allegations of duress, but otherwise did not introduce other relevant evidence.  Ms. Kapadia testified and introduced other evidence of a long history of abuse, along with the specific abuse that forced her signature on the tax return.

The Court found that Ms. Kapadia signed the return under duress and, accordingly, she was not liable for the deficiency. Specifically, the Court held Mr. Hiramanek’s contrary testimony not credible, while finding credible Ms. Kapadia’s testimony and evidence showing a history of abuse. (The Court also found that she qualified for relief under IRC § 66(c), which provides an exception from community property rules where spouses separately file). The Court’s ultimate findings as to the circumstances of duress are quite harrowing. According to the Court:

Throughout their marriage [Mr. Hiramanek] physical and verbally abused petitioner. During 2007 the abuse included threats against petitioner’s life, physical assaults, and verbal abuse. Petitioner documented several instances of abuse in a handwritten diary from December 13, 2005, to April 4, 2007.

In 2007 [Mr. Hiramanek] prepared a 2006 joint Federal income tax return . . . for himself and petitioner. On the evening of April 3, 2007, [Mr. Hiramanek] presented petitioner with a copy of the joint return for her signature. Petitioner refused to sign the return without first reviewing it. [Mr. Hiramanek] initially refused but, upon petitioner’s instance [sic], allowed her a quick glance at the return. Petitioner noticed that [Mr. Hiramanek] had claimed a casualty loss deduction of $35,000 for a break-in to their rental car while they were vacationing in Hawaii. [Mr. Hiramanek] had overstated the amount of the casualty loss deduction, and as a result, petitioner refused to sign the return.

Petitioner’s refusal to sign the return angered [Mr. Hiramanek]. He grabbed petitioner’s left arm and twisted it several times, resulting in bruising. He then struck petitioner on the back of the head with an open hand and pulled her hair with both hands. Finally, [Mr. Hiramanek] pushed petitioner on the jaw. Petitioner still refused to sign the return. Later that night, [Mr. Hiramanek] cornered petitioner in the bathroom and shoved her against the wall. He ordered her to the kitchen table and threatened her with physical harm and threatened that she would never see her children again if she did not sign the return. Petitioner, fearing for her safety, placed a scribble in the signature line of the return.

The next day . . . [Mr. Hiramanek] presented petitioner with a new version of the return in which he had removed the $35,000 casualty loss. Fearing for her safety, petitioner signed the return without review.

Hiramanek v. Commissioner, T.C. Memo. 2011-280, at 3-4 (Hiramanek I). Ms. Kapadia also filed a police report about this sequence of events, which she introduced at trial.

While the first Tax Court litigation was pending, Mr. Hiramanek filed his own request for innocent spouse relief with the Service, which was denied. He then petitioned the Tax Court for redetermination of his innocent spouse request, which eventually evolved into Hiramanek II. (Mr. Hiramanek appealed the first case all the way to the Supreme Court, which denied certiorari in late 2015. This resulted in a multi-year stay of the Hiramanek II proceedings. The Service filed a motion to lift the stay and for judgment on the pleadings on November 2, 2015.)

The Service argued that not only was no joint return filed, but Mr. Hiramanek was prohibited from arguing the existence of a joint return (a necessary predicate to innocent spouse relief) because of his involvement in the final determination in Hiramanek I. The Service specifically argued that the doctrines of res judicata and collateral estoppel gave Mr. Hiramanek only one bite at the apple on this issue—a bite he had already taken.

The Court largely agreed with the Service. It grounded its decision in the collateral estoppel doctrine, rather than res judicata; the Court recognized that IRC § 6015(g)(2) provides an exception to the res judicata doctrine, at least for innocent spouse petitions that are filed subsequent to the final determination of a tax deficiency.  As such, res judicata could not bar Mr. Hiramanek’s argument.

Mr. Hiramanek’s primary argument against the application of collateral estoppel was that the Court in Hiramanek I did not have jurisdiction to determine anything outside of the innocent spouse context once Ms. Kapadia formally withdrew her request for innocent spouse relief with the Service. However, because Ms. Kapadia filed her petition within the 90 day period after issuance of the Notice of Deficiency and included a “catch-all” request to invalidate the deficiency, the Court determined that they did have jurisdiction over any matter affecting the deficiency. Whether Ms. Kapadia signed the return under duress was centrally relevant to the existence of a deficiency; thus, the Court reasoned, they had jurisdiction to address that question.

Because Mr. Hiramanek actively participated in the resolution of the duress issue; that issue was identical to the dispositive issue in Hiramanek II; the Court had jurisdiction and rendered a final judgment; Mr. Hiramanek was a party to the prior litigation; and no operative facts had changed in the interim, Mr. Hiramanek was estopped from arguing that a joint return was filed. Therefore, because Mr. Hiramanek’s standalone petition necessitated a joint return and deficiency from which to seek relief—a requirement that could necessarily not be proven, given the collateral estoppel—the Court granted the Service’s motion for judgment on the pleadings.

This seems a fairly straightforward application of the collateral estoppel doctrine. However, there is a lesson to be learned for practitioners. Mr. Hiramanek was only prevented from relitigating the duress issue because he actively participated, as an intervenor, in the Hiramanek I litigation. Had he not formally intervened, collateral estoppel would provide no bar. Of course, the factual determinations would be highly probative evidence against his claim, so representatives of nonmoving spouses still would be well-advised to intervene in appropriate cases.

A more interesting situation could arise if the Court had accepted a settlement between Ms. Kapadia and the Service. In Dinger v. Commissioner, T.C. Memo. 2015-145, the Court concluded that a settlement, without a factual stipulation supporting the settlement, did not raise a collateral estoppel bar to subsequent litigation of the substantive facts actually underlying the settlement. Here, it appears the Service and Ms. Kapadia did have a factual stipulation that would have supported the settlement. But again, because Mr. Hiramanek would not have participated in that settlement, collateral estoppel would not apply. And, a stipulation alone would have less probative value than evidence introduced at trial, and would provide less finality to the petitioner seeking relief, as well as the Service.

Thus, in particularly compelling cases with substantial available evidence of abuse, like Ms. Kapadia’s, it may be prudent for an individual seeking innocent spouse relief, or the relief sought by Ms. Kapadia, to take this issue to trial and to accede to intervention by the nonmoving spouse. Even if the IRS Chief Counsel desires to grant innocent spouse relief, it may be in their interests to try the issue as well, given that it will save them from additional litigation down the line. Of course, this does not prevent tactics like Mr. Hiramanek’s that could extend the litigation, but given Hiramanek II, it appears that the Service could easily succeed with a motion for judgment on the pleadings in subsequent litigation brought by the nonmoving spouse.

 

 

 

 

Collateral Estoppel in Civil Tax Case Following Conviction of Tax Evasion

In Senyszyn v. Commissioner, the Tax Court looks at the impact of a tax evasion conviction on the amount of the civil liability owed by the taxpayers and finds that the IRS cannot use collateral estoppel to impose a liability where it otherwise does not exist.  The opinion in the preceding sentence follows an earlier decision of the Court in which the IRS sought summary judgment.  The facts here create a bizarre result in that tax evasion convictions do not occur in situations in which the IRS cannot prove the taxpayers has evaded a tax liability and, yet, here the IRS cannot prove any tax liability in the civil case that followed the criminal conviction.  Usually, Chief Counsel attorneys love to litigate Tax Court cases in which the taxpayer pled guilty to tax evasion because the conviction makes proving the civil case so much easier.  When the conviction involves a lesser offense than the flagship conviction of tax evasion, the proof gets more difficult.  To make matters more embarrassing for the IRS in this case, the taxpayer is a former revenue agent.

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The criminal case seems pretty normal except that it involves an IRS employee. Mr. Senyszyn misappropriated funds from a business he appears to have taken over while working as a revenue agent. He stipulated in the criminal case that he failed to report $252,726 in income on the joint tax return filed for 2003 because he did not report the money that he misappropriated. The IRS always pursues criminal liability before it seeks to establish civil liability. When the IRS obtains a conviction for tax evasion under IRC 7201, case law provides that the conviction under 7201 necessarily dictates a civil liability for fraud under the principle of collateral estoppel. Here the IRS seeks to use the taxpayer’s stipulation of the amount of the unreported income as a further basis for collateral estoppel and the Tax Court draws the line at turning this stipulation into a tax amount for which it must determine liability. The Court found the decision novel enough to publish it as a case with precedent. What makes it precedential and how did the IRS lose a civil case against unrepresented taxpayers for which it obtained a criminal conviction?

Mr. Senyszyn got increasingly involved in the real estate business of David Hook during the late 1990s and early 2000s. The relationship soured, however, and Mr. Hook brought suit again Mr. Senyszyn on May 28, 2004. The complaint alleges that Mr. Senyszyn embezzled and converted a minimum of $400,000 which amount increased to $1,000,000 by the time of trial. In 2006 Mr. Senyszyn deeded his interest in all but one parcel of some property the parties had jointly purchased in partial settlement of the suit. The suit must have come to the attention of someone at the IRS who passed it along to the criminal folks who opened an investigation. A revenue agent was assigned to assist the criminal investigators and the RA tracked the transfers into and out of the business account in determining that Mr. Senyszyn netted $252,726 in 2003. The US Attorney in New Jersey charged Mr. Senyszyn with a four count indictment to which he pled guilty to tax evasion for 2003. Mr. Senyszyn later attempted to withdraw his guilty plea but his attempts to do so failed.

On June 30, 2008, Mr. and Mrs. Senyszyn filed an amended return for 2003. The amended return reports the $252,726 additional gross income but it also shows expenses in excess of that amount resulting in a net profit of -$223,279. The IRS received but did not process this amended return. The IRS argued that the reporting of the $252,726 on the amended return was an admission that petitioners received that amount of additional income in 2003. Just as it rejected the application of collateral estoppel to the amount based on the plea agreement, the Court rejected the reporting of this amount on the amended return as full agreement with the calculation of the IRS because they also claim a large deduction not calculated by the IRS. The Court states that the issue is whether the RA correctly computed the relevant amounts.

It finds that he did not. The Court found that Mr. Senyszyn returned to Mr. Hook more than $481,947 of benefits received in 2003. This meant that he returned more than he received based on the calculations provided to the Court. Because he returned more than he received, he did not have any income from his dealings with Mr. Hook. Having reached this factual conclusion, the Court next looks at the impact of collateral estoppel. The Court states that even though it concludes no deficiency exists based on the facts presented to it “we could apply the doctrine of collateral estoppel to uphold a deficiency in whatever minimum amount would justify Mr. Senyszyn’s conviction under section 7201.” The reason the Tax Court could determine some deficiency is that the conviction required at least some minimum amount of tax liability and since some minimum amount of liability had to exist for purposes of convicting him, the Tax Court could consider itself bound by the existence of that minimum amount whatever it might be.

While a 7201 conviction requires the existence of a minimum amount of tax, it does not require the existence of any specific minimum amount. So, the Court grapples with the effect of collateral estoppel in a situation in which it has found no deficiency in its own proceeding and notes that it has not previously faced this question. The Court states that “we conclude that the purposes of the doctrine would not be served by upholding a deficiency unsupported by the evidence presented. Upholding a minimum deficiency would not promote judicial economy.” A main purpose of collateral estoppel is judicial economy so that once a court determination occurs subsequent courts will not need to relitigate the same issue. Since the Tax Court needs to look at the deficiency amount even when a 7201 conviction exists, to take that look and determine no tax exists does not really require any additional resources. So, the Tax Court refuses here to make up some minimum amount of deficiency just to support that element of the criminal conviction. Because it does not find a deficiency, it also does not impose the fraud penalty.

These facts will not often occur but they do give hope to petitioners convicted of tax evasion that on the amount of the liability, they will get an opportunity to present evidence to the Tax Court in support of a different number than existed in the criminal plea agreement. Because this case involved a plea and not a trial, it is possible the outcome would differ following a conviction by trial.

The Tax Court also noted that it thought it unlikely Mr. Senyszyn had returned all of the money he took from Mr. Hook during the years 2002-2004 and stated that it only had 2003 before it. It also rejected petitioners’ claim for a refund. In rejecting the claim for refund, it cited to the fact that the filing of the petition in this case well after the time frame for filing a refund claim. It did not mention the timing of the filing of the amended return by petitioners but that also appeared to come after the period for a timely refund claim.

 

Another Reason Tax Professors Don’t Need to Invent Hypotheticals 

Today’s guest post is from Professor James Edward Maule, a colleague of mine and Keith’s at Villanova’s Charles Widger School of Law, who many moons ago taught Stephen in Villanova’s Graduate Tax Program. This post originally appeared earlier this month in Mauled Again, Jim’s eclectic blog that in his words offers “more than occasional commentary on tax law, legal education, the First Amendment, religion, and law generally, with sporadic attempts to connect all of this to genealogy, theology, music, model trains, and chocolate chip cookies.” Jim’s blog was an inspiration to us, and his creative mind and far-reaching interests have touched on many topics (in the last few weeks alone he has discussed a proposal to include driver license numbers to reduce identity theft, taxation of powerball winnings, and genealogy). He also years ago when I transitioned from the tax clinic to teaching doctrinal courses offered up a generous series of posts that contained his views on how and what to teach in a Basic Income Tax Course, leading a tax prof colleague to refer to Jim as the “Yoda of tax teachers.”

In this post, Jim offers some thoughts on a recent Tax Court case that has the ingredients of a bad movie, but also sweeps in some interesting procedural issues relating to collateral estoppel and rescission. Les

A recent Tax Court decision, Blagaich v. Comr., T. C. Memo 2016-2 should provide some interesting classroom questions for those teaching the basic federal income tax course. It also is providing some interesting insights for myself, and hopefully for readers of MauledAgain (and now Procedurally Taxing).

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The taxpayer was involved in a romantic relationship with Lewis E. Burns from late 2009 until early 2011. During 2010, when the taxpayer was 54 and Burns was 72, he transferred to her property worth at least $743, 819, including cash and a Corvette. At the end of November in that year, the taxpayer and Burns entered into a written agreement intended to confirm their commitment to each other and to provide financial accommodation for her. They had no intention to marry and the agreement was, at least in some respects, intended to formalize their “respect, appreciation and affection for each other” in the way a marriage otherwise would do. The agreement provided that the parties “shall respect each other and shall continue to spend time with each other consistent with their past practice”, and that both “shall be faithful to each other and shall refrain from engaging in intimate or other romantic relations with any other individual”. The agreement also required Burns to make an immediate payment of $400,000 to the taxpayer, which he did. Soon thereafter, the relationship soured, an on March 10, 2011, the taxpayer moved out of Burns’ house, and on the next day he sent her a notice of termination of the agreement. Shortly thereafter, he concluded that she had been involved in a romantic relationship with another man throughout the relationship between himself and the taxpayer.

In late March of 2011, Burns sued the taxpayer in the Circuit Court for the Eighteenth Judicial District, DuPage County, Illinois, seeking nullification of the agreement, return of the Corvette and a diamond ring, and an order directing the taxpayer to return cash “and other accommodations” that Burns had provided to her, totaling more than $700,000. On April 8, 2011, Burns caused there to be filed with the IRS a Form 1099-MISC, reporting a transfer to the taxpayer of $743,819 in 2010. Based on the Form 1099, the IRS asserted a deficiency against the taxpayer, who filed a petition in the Tax Court on March 8, 2013. The IRS learned of the state court action and in May of 2103 requested the taxpayer’s attorney to provide copies of depositions taken in the case, any filings and motions relating to the Form 1099-MISC, and the fraudulent inducement claim asserted by Burns. In October 2013, the taxpayer moved for a continuance, reporting that the IRS did not object, and the Tax Court granted the motion. At some point during this time, Burns died.

In November 2013, after trial, the state court found that the taxpayer had fraudulently induced Burns to enter into the agreement, and entered a judgment ordering her to pay $400,000 to Burns’ Estate. The court held that the Corvette, the ring, and $273,819 in checks were “clearly gifts” to the taxpayer that she was entitled to keep. Subsequently, the executors of the estate caused an amended Form 1099-MISC to be issued, reporting $400,000 of income, and noting that the taxpayer had paid the $400,000 pursuant to the state court order.

The taxpayer then moved in the Tax Court for summary adjudication. The taxpayer relied on two arguments.

First, the taxpayer argued that $343,819 of the amount transferred to her by Burns was excluded from gross income as “clearly gifts.” She also argued that the IRS was estopped by the state court decision from denying that this amount represented gifts. The IRS argued that it was not so estopped because it was not a party nor in privity with any party in the state court action. The Tax Court agreed with the IRS and rejected the taxpayer’s collateral estoppel claim. The court rejected the idea that the IRS was estopped because it took steps to keep itself informed about the state court action. It also rejected the argument that the IRS bound itself to the outcome of the state court case by agreeing to a continuance in the Tax Court proceedings.

Second, the taxpayer also argued that the $400,000 portion of the transfers was not gross income under the doctrine of rescission. In other words, because she returned the money she ought to be treated as having not received it in the first place. The IRS argued that the doctrine of rescission was not applicable because the taxpayer did not return the $400,000 to Burns in 2010. The Tax Court agreed with the IRS, explaining that the doctrine of rescission is a narrow exception to the claim of right doctrine, which requires cash method taxpayers to include gross income in the year received if acquired without consensual recognition, express or implied, of an obligation to repay and without restriction as to disposition. The doctrine of rescission applies if the amount that is received is returned within the same taxable year. The Tax Court rejected the taxpayer’s reliance on cases in which the obligation to return the amounts that had been received had been acknowledged in the year of receipt even though actual repayment was made following that year, because in this instance the taxpayer did not acknowledge, in 2010, any obligation to return the $400,000.

Accordingly, the Tax Court issued an order denying the taxpayer’s motion for summary adjudication. Whether any portion of the $743,819 constitutes gross income to the taxpayer, or can be excluded as a gift, remains to be decided. Though it has been reported that the $400,000 payment for being monogamous was gross income, the taxpayer still has the opportunity to argue that the amounts received were gifts, particularly the amounts received before she and Burns entered into the agreement. Whether she succeeds remains to be seen.

For students in the basic federal income tax class, the question is simple. “Suppose your romantic partner pays you to remain monogamous. Do you have gross income?” When a student objects that “no one does that,” there now is proof that people do. Perhaps not very many people, but sometimes the most interesting tax cases arise from activities in which very few people participate.