Can Tax Preparer Recover Damages for Revoked EFIN

The recent decision rendered by the Court of Federal Claims in Snyder & Associates v. United States provides a stark reminder about the perils of building a business based on a government privilege or license – in this case the ability to electronically file tax returns for clients.  It also provides a reminder of the limitations of federal employees to bind the government for which they work.

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Snyder & Associates engaged in return preparation in the Los Angeles area.  It had a symbiotic relationship with a lender that funded refund anticipation loans (RALs).  Even though RALs ended several years ago, at least in their first decade of the 21st Century form, this case relates back to that era.  The same person owned both the return preparation firm and the lender.  Nothing in the opinion suggests that the businesses or the owner of the businesses engaged in inappropriate activity; however, one of the associates of the business, Nancy Hilton, who prepared returns there in the capacity of an independent contractor, did engage in fraudulent activity.

Ms. Hilton approached the IRS criminal investigators and advised them of the scheme in which she participated.  The scheme used stolen identities to seek benefits through tax filing.  After she brought the scheme to the IRS, Special Agents sought to use her to set up a sting.  For the sting to work, the IRS wanted Ms. Hilton’s co-conspirators to cash the checks written as refund anticipation loans.  Cashing those checks meant pulling money out of the lender side of the business.  The owner initially balked at the plan because of concerns of losing the money.  One of the special agents directly stated or implied that the IRS would make the lender whole.  The sting went forward.  In the end, the IRS declined to make the lender whole and, to add insult to injury, it terminated the EFIN license held by Snyder & Associates – an act which effectively terminated the return preparation business.

The business sued to recover the funds lost through the sting operation and to restore its EFIN privileges.  It lost on both counts.

With respect to the money lost in the sting, the issue turned on the authority of the special agent to bind the government.  I am probably oversimplifying this, but my experience working in the federal government for over 30 years suggests that first line employees like special agents, revenue agents, revenue officers, attorneys, etc., have extremely limited ability to bind the government.  Almost everything that they do which might create a monetary liability for the government must first be approved by their supervisors.  The principle extends beyond contracting for repayment of a sting obligation or other monetary obligations to matters such as settlement authority or referral authority.  There is a fairly elaborate system of delegation orders granting authority for certain acts.  The system generally does not go lower than the front line manager and frequently does not go that low.

Snyder & Associates ran full force into this system.  The special agent who told it that the money used to pay the fraudulent RALs would be repaid to the business by the government simply did not have the authority to bind the IRS.  The Court expended little effort in denying this claim for relief because the IRS had not committed itself to repayment of losses.  Based on my experience, the special agent who made the representation will receive counseling about their scope of employment which will include a discussion about not doing this again.  Such counseling will be cold comfort to the business that has lost the money with little or no hope of recovering it from the participants in the fraudulent scheme who will also owe the IRS and whose debt to the IRS will generally have a higher priority than the debt to the business.

Having lost the money spent to support the sting, the business then sought to reobtain the right to electronically file returns which the IRS pulled at approximately the same time the business cooperated with the sting operation.  The business argued that the termination of the EFIN rights was an improper taking of a property interest.  The Court points out that the IRS did not take the business or in any way deny the business use of the business.  The termination of the EFIN certainly impacted the business but the business had “no cognizable property interest in their EFIN in the first place.”  Citing Mitchell Arms v. United States, the Court stated that “when a party receives a permit to engage in an activity ‘which, from the start, is subject to pervasive Government control,’ no cognizable property interest capable of supporting a takings claim ever arises in that permit.”

Although the Mitchell Arms case involved the import and sale of assault rifles rather than electronic filing of returns, the Court found the action of ATF in that case exactly paralleled the action of the IRS in this one.  Because no property interest attached to the EFIN, the termination of the right to electronically file could not constitute a taking under the constitution.

Conclusion

The decision here, though harsh, does not cover new ground.  The business had good reason to expect the IRS would make it whole for assisting with the sting operation based on the representations of the special agent.  Not everyone knows of the limitations governing federal employees.  The case reminds us to take care in contracting or thinking we have contracted with the federal government.  Authority is critical.  Here, the special agent did not have proper authority to bind the IRS and the actions of other IRS officials did not act to ratify the actions of the special agent.

Similarly, licenses like EFINs do not come with a guarantee or with special protections.  When a business relies on the EFIN for its financial life, it must take extreme care to avoid actions that can result in its removal.  Even though the actions here appear to be those of an independent contractor working with the business, the concern of the IRS about fraudulent return filing schemes ends up punishing the business as well as the individual perpetrator in an effort to keep the system clean.  The result here reaches a much different result for the preparer than the D.C. Circuit in Loving because of the difference in the nature of the fight.  In Loving, the IRS sought to assert its authority over a previously unregulated matter – tax return preparation.  Here, the IRS exercised control over use of its electronic filing procedures something which it has carefully regulated from the start.  The challenge was not to the IRS ability to regulate electronic filing but whether the business had a property interest in the ability to electronically file.

 

Electronic Tax Administration Advisory Committee Report to Congress: Updates on E-Filing, Refund Fraud and Identity Theft

Last month the Electronic Tax Administration Advisory Committee issued its annual report to Congress. ETAAC was born in the 98 Restructuring Act; it is an advisory committee that is made up of a number of volunteers from the private sector, consumer advocacy groups and state tax administrators. As I discuss below, the report considers e-filing and refund fraud and identity theft issues.

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When formed in 98, ETAAC’s mission was principally directed at IRS reaching an 80% rate of electronic return filing; this year’s report details the substantial progress in meeting that target, though there is a range in e-filing that is based on type of return. For example individual income tax returns are e-filed at around 88%; exempt org returns are in the mid-60% range. ETAAC projects this year that the overall electronic filing for all returns will exceed 80%.

A Shifting Focus to Refund Fraud and Identity Theft

With ETAAC essentially fulfilling its primary mission, last year its charter was amended to include the problem of Identity Theft Tax Refund Fraud (ITTRF), which, as the report states, threatens to undermine the integrity of our tax system:

America’s voluntary compliance tax system and electronic tax filing systems exist, and succeed, because of the trust and confidence of the American taxpayers (and policy makers). Any corrosion of trust in filing tax returns electronically would result in reverting back to the less-efficient and very costly “paper model.” That option is neither feasible any longer nor desirable.

The report discusses the IRS’s convening of a Security Summit and last year’s special $290 million appropriation to “improve service to taxpayers, strengthen cybersecurity and expand their ability to address identity theft.” The main goals relating to ITTRF include educating and protecting taxpayers, strengthening cyber defenses and detecting and preventing fraud early in the process.

The report discusses a number of ITTRF successes in the past year:

  • From January through April 2016, the IRS stopped $1.1 billion in fraudulent refunds claimed by identity thieves on 171,000 tax returns; compared to $754 million in fraudulent refunds claimed on 141,000 returns for the same period in 2015. Better data from returns and information about schemes meant better filters to identify identity theft tax returns.
  • Thanks to leads reported from industry partners, the IRS suspended 36,000 suspicious returns for further review from January through May 8, 2016, and $148 million in claimed refunds; twice the amount of the same period in 2015 of 15,000 returns claiming $98 million. Industry’s proactive efforts helped protect taxpayers and revenue.
  • The number of anticipated taxpayer victims fell between/during 2015 to 2016. Since January, the IRS Identity Theft Victim Assistance function experienced a marked drop of 48 percent in receipts, which includes Identity Theft Affidavits (Form 14039) filed by victims and other identity theft related correspondence.
  • The number of refunds that banks and financial institutions return to the IRS because they appear suspicious dropped by 66 percent. This is another indication that improved data led to better filters which reduced the number of bad refunds being issued.
  • Security Summit partners issued warnings to the public, especially payroll industry, human resources, and tax preparers, of emerging scams in which criminals either posed as company executives to steal employee Form W-2 information or criminals using technology to gain remote control of preparers’ office computers.

E-file Signature Verification

While ETAAC shifts its focus to include security and fraud detection, it still examines how IRS is doing in the e-file arena. One area in the report that I think warrants further reflection is ETAAC’s recommendation that IRS improve its ability to allow taxpayers to verify an e-filed return. The report discusses the history of signing and verifying an e-filed return, which now requires that the taxpayer have access to the prior year’s AGI or a special PIN.  While most software will allow for those numbers to carry over from last year’s returns, at times taxpayers may not know last year’s AGI or the PIN (e.g., when there is a switch in software) and ETAAC tells us that this has triggered many taxpayers abandoning e-filing and reverting to paper filing.

The report discusses how the IRS Get Transcript online tool ostensibly could facilitate taxpayers getting access to their last year’s AGI but that access has a clunky authentication process that has led to a very high fail rate for users (the Report also discusses the compromising of a prior iteration of the Get Transcript online tool and other data breaches).

As IRS works out the kinks with its “Future State” platform, authentication and ease of taxpayer access will be crucial. Of course, given the backdrop of dedicated and as the report notes nimble and dedicated criminals who continue to probe for weaknesses this will continue to be a challenge for IRS and its partners.

Filing a Day Late Can Be Timely Under Tax Court E-Filing Rules and So is Filing an Income Tax Return Ten Days Later After E-File Rejection

Today’s brief post discusses a couple of technology related issues. The first comes on a tip of the hat to Lew Taishoff, who posted on Ryder v Commissioner. Ryder involved the IRS’s moving on January 30, 2016 to file amended answers. The problem from the taxpayer’s perspective was that at trial calendar the IRS was ordered to move to amend the answers by January 29, 2016. With the January 30 filing, taxpayer objected, claiming the filing was out of time.

Judge Holmes, in his direct style, addressed the issue, starting his order with the question “When is a deadline of January 29, 2016 met by filing a document on January 30?” He answered as follows:

Petitioners objected because the motions were filed out of time. All ready to pounce on dilatory counsel, the Court set up a conference call on March 8, 2016. Respondent’s counsel patiently pointed out to us and petitioners’ counsel the Court’s own website, where we have posted the Practitioners ‘ Guide to Electronic Case Access and Filing. Page 32 plainly states that “A document is considered timely filed if it is electronically transmitted no later than 6:00 a.m. Eastern time on the day after the last day for filing.” United StatesTax Court, http://www.ustaxcourt.gov/electronic access.htm (last visited March 21, 2016).

The issue in Ryder reminds me of the rewritten Chapter 4 of the Saltzman/Book treatise IRS Practice and Procedure which I have been working on with Marilyn Ames. In the rewritten chapter (coming out in the next month or so) we discuss the numerous developments in the 7502 timely mailing equals timely filing rules (many discussed in PT). Given the shift to e-filing since the original time that the book was written, we also added an extensive discussion of the e-file rules, including when IRS rejects an e-filed individual income tax return that cannot be rectified taxpayers “must file the paper return by the later of the due date of the return or ten calendar days after the date the IRS gives notification that it rejected the electronic portion of the return or that the return cannot be accepted for processing.” (as per the Handbook for Authorized E-file Providers of Individual Income Tax Returns). The Handbook at page 30 (Pub 1345) also goes on to state that the taxpayer when snail mailing the return should include an explanation why they are filing the return after its due date.