Eleventh Circuit Affirms Disgorgement in Tax Return Preparer Case

We welcome first time guest blogger Matthew Mueller. Matt practices in Florida representing individuals with tax issues and white collar crime issues. Prior to moving to private practice, he had the perfect background for the work he currently does. He represented the IRS in criminal prosecutions at the Department of Justice Tax Division, Criminal Section and then he moved to the United States Attorney’s Office in Tampa. He brings to this discussion of disgorgement over a decade of experience with these types of cases both inside and outside the government. Keith

As this blog has covered previously, the Department of Justice Tax Division has increasingly sought disgorgement from tax return preparers in civil injunction cases. This growing trend has been on display nationwide, but especially in the Middle and Southern Districts of Florida. While the government experienced some initial growing pains in court—see this prior post discussing an MDFL case in which the district court denied disgorgement—the effort to disgorge return preparers from their profits has continued. Last month, the Eleventh Circuit Court of Appeals issued an unpublished opinion in United States v. Stinson affirming the district court’s judgment entering a permanent injunction against the return preparer and affirming a $949,952.47 disgorgement order.   Armed with favorable appellate precedent, return preparers and owners of tax preparation businesses should expect to see the government continue this trend.


What is disgorgement?

Disgorgement is an equitable remedy employed by courts to prevent unjust enrichment. Case law defining the contours of disgorgement has largely evolved out of civil enforcement actions brought on behalf of the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and the Federal Trade Commission (FTC). Relying on precedent from the securities fraud context, the Eleventh Circuit in Stinson described disgorgement as follows:

“Disgorgement is an equitable remedy intended to prevent unjust enrichment.” S.E.C. v. Levin, 849 F.3d 995, 1006 (11th Cir. 2017) (quoting S.E.C. v. Monterosso, 756 F.3d 1326, 1337 (11th Cir. 2014)). To be entitled to disgorgement, the Government need only produce a reasonable approximation of the defendant’s ill-gotten gains. See S.E.C. v. Calvo, 378 F.3d 1211, 1217 (11th Cir. 2004). “Exactitude is not a requirement; so long as the measure of disgorgement is reasonable, any risk of uncertainty should fall on the wrongdoer whose illegal conduct created that uncertainty.” Id. (quotation marks omitted and alterations adopted).

United States v. Stinson, 2018 WL 2026928, at *6 (11th Cir. May 1, 2018). The Stinson Court affirmed that disgorgement was an available remedy under Title 26, United States Code, Section 7402(a).

Having established the authority to disgorge profits from a return preparer, the Court in Stinson went on to discuss the boundaries of this remedy in, at times, conflicting terms. The Court first points out that disgorgement is limited to the amount the defendant “profited from his wrongdoing.” Id. At the same time, the Court also asserts that courts have accepted gross receipts as a reasonable approximation of disgorgement “in cases involving the operation of a fraudulent business.” Id. The theory being that “wrongdoers are not entitled to deduct costs associated with committing their illegal acts.” Id. While gross revenue in a wholly fraudulent business might be a reasonable approximation of ill-gotten gains or profit, the issue is more complicated when applied to businesses that engage in legitimate business activity in conjunction with the alleged instances of fraud. In those instances, the government must show a link between the disgorgement amount they seek and the alleged fraudulent transactions.

Another outer boundary applicable to disgorgement is the five year statute of limitations found at Title 28, United States Code, Section 2462 for “an action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture.” In 2017, the Supreme Court rejected the SEC’s argument that there was no statute of limitations for disgorgement in securities fraud cases. Kokesh v. S.E.C., 137 S.Ct. 1635, 1645 (2017). In applying the five-year statute of limitations in Kokesh, the Court stressed that disgorgement “bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate.” Id. at 1644. While the Court was addressing disgorgement in SEC cases in Kokesh, the rationale extends to disgorgement sought in tax preparer injunction cases in all significant respects.

How does the government prove disgorgement?

As the government has increasingly sought disgorgement in tax return preparer cases, district courts have predictably undertaken a highly fact-intensive inquiry into the amount of disgorgement sought. As a result, in United States v. Mesadieu the district court refused to order disgorgement because the government failed differentiate between compliant and noncompliant returns and asked the court to extrapolate from one tax year and one geographical area. 180 F.Supp.3d 1113 (M.D. Fla. 2016). Yet in Stinson, the very same district court judge in Orlando awarded $949,952.47 out of the greater than $1.5 Million sought by the government at trial. The trial in Stinson spanned six days and included testimony by more than 15 taxpayers and deposition testimony by 41 witnesses including taxpayers. That disgorgement figure included so-called “Category 1” calculations based on 1,861 returns containing unreimbursed business expenses on Schedule A. The total disgorgement amount also included “Category 2” calculations based on returns prepared by Stinson himself, as opposed to his employees. The Eleventh Circuit found these calculations reasonable and supported by the record.

The Eleventh Circuit also disposed of Stinson’s argument that disgorgement could only include fees from tax returns specifically proven to be false returns. The Court invoked as an analogy the United States Sentencing Guidelines–for the proposition that only a reasonable estimate was required:

Although this was a civil matter, in the analogous criminal context, the U.S. Sentencing Guidelines “do not require that the sentencing court calculate the amount of loss with certainty or precision … [but only] a reasonable estimate based on the available facts.” United States v. Bryant, 128 F.3d 74, 75-76 (2d Cir. 1997). As we have held, a trial court may extrapolate from available evidence, and such extrapolation may occur without interviewing every customer and preparer for every allegedly false or fraudulent return. See United States v. Barber, 591 Fed.Appx. 809, 823-24 (11th Cir. 2014).

Clearly, the government’s ability to prove disgorgement in a given case will depend on its ability to demonstrate patterns and to persuade the court to make reasonable extrapolations from known samples.


In addition to defending against possible injunctions, and criminal charges in select cases, tax return preparers will have to continue to contend with disgorgement for the foreseeable future. The Department of Justice undoubtedly hopes the pain of separating preparers from their profits will serve as an additional deterrent against business practices that do not otherwise appear to be on the wane. Restitution is available as a remedy in criminal preparer prosecutions, but even that has posed some problems for the DOJ and IRS, see here, for example. In the meantime, practitioners who represent return preparation businesses and their owners can learn from cases like Stinson and the more developed body of law in the securities fraud context for guidance on how disgorgement should and should not be computed.








Flora and Preparer Penalties: Preparer Two Weeks Late to File Suit in District Court

As we move into tax season, it is worth remembering that IRS has a significant arsenal of civil and criminal penalties to address misbehaving preparers. I recently came across a federal district court case, Bailey v. United States that discussed an exception to the Flora full payment rule for preparers subject to penalties for preparing tax returns or refund claims that have understatements stemming from unreasonable positions or willful/reckless conduct. For preparers, that penalty can be fairly sizeable, as under Section 6694 the amount of the penalty is the greater of $1,000 for each return or refund claim ($5,000 if the understatement is due to willful or reckless conduct) or 50% (75% for willful/reckless conduct) of the income derived by the tax return preparer with respect to the return or claim for refund.


These penalties are not subject to the deficiency procedures, meaning that if IRS examines a preparer and determines that the preparer’s conduct in preparing the return or refund claim warrants a penalty, the preparer will generally have to pursue a refund suit to guarantee judicial review of the penalty. (I’ll skip the CDP discussion on this, a topic we also have discussed, which turns on whether a preparer has previously had an opportunity to dispute the penalty through its rights to have Appeals consider the matter).

We have often discussed the Flora rule, which requires full payment to ensure jurisdiction for a refund suit. Flora presents a considerable barrier, especially for moderate income persons subject to the penalty but also stemming from the fact that some civil penalties, including the variety of penalties preparers are subject to, can be very significant; Keith has written about that before here, suggesting perhaps it is time to rethink Flora in light of the impact and potential unfairness of requiring full payment to get a court to review the Service’s penalty determination.

Bailey implicates an implicit statutory exception to Flora for the 6694 penalties. IRS asserted $70,000 in penalties due to what IRS felt was his willful or reckless conduct. As per Section 6694(c)(1), if a preparer pays at least 15% of the Section 6694 penalty within 30 days of IRS making notice and demand, the preparer can stay collection and file a refund claim. Section 6694(c)(2) also provides that if a preparer fails to file suit in district court within the earlier of (1) 30 days after the Service denies his claim for refund or 30 days of the expiration of 6 months after the day on which he filed the claim for refund, then paragraph (1) of Section 6694(c) no longer applies. That suggests that a preparer can avoid the full payment rule; to that end see note 1 of the 2016 Bailey opinion, discussing the logical Flora implication of Section 6694(c)(2).

In Bailey, the preparer paid $10,500, or 15 percent of the penalty within 30 days of the IRS notice. He filed a refund claim on March 28, 2014. At the time of the suit, IRS did not deny the claim. Thirty days after the expiration of 6 months (and a day) from the time he filed his claim was October 29, 2014. Bailey filed his refund suit in district court on November 12, 2014. That filing was two weeks late, and he no longer was eligible to take advantage of the exception to Flora.

Because the preparer missed the deadline, the district court granted the government’s motion to dismiss the suit. The failure to comply with the time requirements in Section 6694(c)(2) meant that absent the preparer’s full payment of the penalty, the district court did not have subject matter jurisdiction over the suit. Because the dismissal was without prejudice, the preparer could cure his error by fully paying the balance and refiling his complaint.

Instead of full paying, the preparer filed another action in federal court in 2017; this time, the suit alleged personal misconduct among IRS employees; in light of a motion to dismiss the preparer filed a motion to substitute the US as a party to the suit and restated his allegations that his conduct did not warrant a penalty. In November of last year the court dismissed that suit.

Tax Procedure Grab Bag – Preparer Problems

Two quick items here.  First, the IRS in late April 2016 has issued final regs under Section 6708 regarding the penalty for material advisors for failure to make available lists with respect to reportable transactions.  General write up can be found on the TaxAdvisor webpage here.  Some changes have been viewed positively, as easing slightly the penalties on advisors.

More interesting to me, but somewhat substantive, is an update to the Cosentino case we covered in SumOp back in 2014, which can be found here.  In Cosentino, the Tax Court held that malpractice proceeds received by a taxpayer against his accountant were not taxable income.  The accountant had advised the taxpayers to enter into a transaction that was later determined to be a tax shelter.  The shelter was used to artificially inflate the basis in real estate, which didn’t work (very oversimplified, and you can find more on the specifics from Roberts and Holland here).  The taxpayers claimed they would not have entered into the transaction had they known it was bunk, and, as such, should be entitled to the tax back from the accountant.  They ended up getting $375,000.

The taxpayer’s argued that this was a replacement of capital, and, to the extent the replacement of capital didn’t exceed  basis, was not taxable.  The Service disagreed, stating the correct amount of tax on the sale of the property was sold (which it believed removed the case from a set of precedent that held if more than the proper amount of tax was paid, the recovery of the excess was not taxable).  The Court held that the taxpayers would have sold the property, but used Section 1031 to defer the tax, had they known the accountant was providing shady shelter advice, and then got a step up in basis at death—a bit speculative.  The Court holding essentially gave them the step up during lifetime, without possibly passing through the estate tax system.  An interesting result, but this is a difficult situation to put the parties back into their prior positions.

The Service did not appeal the case.  Apparently it didn’t view this as the winning case to take on appeal, didn’t like the venue, or wasn’t ready to keep arguing this point.  In April, however, the Service let us all know that it intends to continue litigating this issue in other cases.  See AOD 2016-001.  We do not see many IRS actions on decisions anymore these days, so this is pretty exciting.

There has been lots of other great coverage on this case.  We haven’t linked Ed Zollar’s writing enough here on SumOp, but we check his blog pretty frequently.  He wrote about the AOD here.   The always entertaining Tony Nitti also wrote about the case back in 2014 for Forbes.  You can find more background in that article, which is found here.

Extenders Bill Gives IRS Additional Powers to Impose Penalties on Preparers and Disallow Refundable Credits

Most readers at this point are probably aware of the passage of the Protecting Americans from Tax Hikes Act of 2015 (PATH). It has been getting mainstream attention for its (mostly) permanent extension on all sorts of benefits and expenditures embedded in the tax code.

In addition to PATH’s goodies, it has major procedural and administrative implications. Late-enacting legislation presents an administrative headache for IRS as it will be scrambling to get its tax season forms and instructions to line up with the law. Beyond the filing season implications and of particular significance for readers of Procedurally Taxing, the law has many procedural provisions. In this brief post, I will highlight some of the provisions that are directed at reducing errors generally associated with returns claiming refundable credits, as well as offer some brief commentary and suggest posts where we have discussed some of the issues implicated in the provisions. In a future post we will address the other procedural aspects of the legislation, which include provisions addressing venue of appeals of innocent spouse and CDP cases, a provision in response to the Kuretski Where is the Tax Court Located issue and a handful of others.

For those who want more than the summary here, note that the Joint Committee has published a technical explanation of the entire bill; Ways and Means has published a section by section summary as well. The actual language of the bill can be found here. Anthony Nitti over at Forbes has a nice summary of the substantive goodies in the bill, including a breakout of what is permanent and what has an expiration date.


Procedural Quid Pro Quo (Or the Pound of Flesh For the Extensions)

There are a bunch of provisions that can best be thought of as part of the quid pro quo associated with extensions and sweeteners to refundable credits that largely benefit lower-income and more moderate-income taxpayers. I will describe the main ones below.

Due Diligence

Effective for the 2016 tax year, Section 207 of PATH expands the due diligence rules that apply to EITC returns to returns with the Child Tax Credit and the American Opportunity Tax Credit to help pay for education expenses. I have written extensively on the due diligence penalty as applied to EITC over the past two years, including posts addressing challenges that IRS has in administering the rules and difficulties preparers face in due diligence audits. See for example Preparers and Due Diligence. The legislation requires Treasury to produce two reports relating to the due diligence rules (one for EITC and the other for CTC and AOTC), including studies on effectiveness and comparing due diligence rules to other measures to address noncompliance. Interestingly the law also requires the study to address whether “due diligence of this type should apply to other methods of tax filing….”, a nod to the issue we discussed in a few posts considering appropriations bill language that directed IRS to require self-prepared returns to have additional questions and schedules for EITC returns (more on that see Legislative Language Directs IRS to Make Self-Prepared EITC Returns More Burdensome).

Extension of Ban and Expansion of Math Error

Section 208 of Path (pages 114-119 of the bill itself) is perhaps the most controversial and onerous of the pound of flesh provisions. It does three main things:

  1. It extends the two and ten-year ban that applies to EITC taxpayers to also include returns claiming the CTC and AOTC. The ban will bar individuals from claiming the CTC and AOTC for ten years if there is a determination that the claim was due to fraud and for two years if they are found to have recklessly or intentionally disregarded the rules;
  2. It allows IRS to use math error procedures if a taxpayer claims one of the credits in a year in which the ban is in place; and
  3. It allows IRS to impose special certification requirements (already in place for EITC) for taxpayers who have had a CTC or AOTC denied through deficiency procedures prior to claiming one of those credits in a future year. Absent certification, IRS can use math error procedures to deny the claimed credits in a year after the credit has been reversed through deficiency procedures (interesting issues lurk here on the intersection of math error and deficiency procedures when the return generating a reversal in that later year also may generate a proposed deficiency).

On numerous occasions I and others have expressed deep reservations about the IRS’s administration of the EITC ban and its use of existing math error powers. See for example a post from last year on possible math error expansion, and a post discussing a case illustrating the difficulties IRS has in administering the ban. I will come back and discuss in a standalone post the reason why this penalty is bad tax administration (and potentially subject to challenge) but at a minimum its expansion requires a major commitment on the IRS’s part in providing detailed standards in imposing the ban and procedures for taxpayers potentially subject to the ban. To that end,  I point readers to the study from the National Taxpayer Advocate 2013 annual report, where there is a detailed discussion of IRS often failing to follow procedures in imposing the ban. In that report the NTA notes how “the IRS applies the two-year ban on the basis of unexamined assumptions about the taxpayer’s state of mind or even presupposes reckless or intentional disregard of the rules and regulations, potentially causing significant harm to taxpayers who may be entitled to EITC in a subsequent year.”

Reversal of Rand

Note that Section 209 of the legislation also includes a reversal of Rand so that the definition of underpayment now matches the definition of deficiency. Under the new law,  the accuracy-related penalty can be applied to any part of a reduced refundable credit subject to deficiency procedures.

More Focus on Preparers

While the legislation does not give IRS authority to regulate unlicensed preparers, it does in Section 210 increase the penalty applicable to paid tax preparers who engage in willful or reckless conduct. The provision expands the penalty for tax preparers who engage in willful or reckless conduct to the greater of $5,000 or 75 percent of the preparer’s income with respect to the return (it was 50% under prior law). The provision applies to returns prepared for tax years ending after the date of enactment.


On the positive side of the ledger Section 401 requires that IRS employees are familiar with and act in accordance with the taxpayer bill of rights. Those rights include the following:

The Right to Be Informed

The Right to Quality Service

The Right to Pay No More than the Correct Amount of Tax

The Right to Challenge the IRS’s Position and Be Heard

The Right to Appeal an IRS Decision in an Independent Forum

The Right to Finality

The Right to Privacy

The Right to Confidentiality

The Right to Retain Representation

The Right to a Fair and Just Tax System

It remains to be seen whether the IRS’s additional powers to penalize preparers and taxpayers as set forth in PATH can or more accurately will be reconciled with taxpayer rights. The commitment to taxpayer rights requires not just that IRS employees are familiar with those rights, but training and a commitment to procedures that protect those rights. While PATH has opened the door to expanded credits, that door can be easily shut for eligible taxpayers if IRS fails to respect (and Congress does not recognize) the challenges associated with administering those programs.




Tax Court Holds Preparer Who Placed Truncated Social Security Number on Returns Subject to Penalties

If a paid tax return preparer fails to put the proper identifying number on a return, IRS can slap a $50 penalty per return. Anyanwu v Commissioner, a recent summary opinion, reveals the possible harsh consequences of the rule. Anyanwu highlights that some rules meant to ensure oversight over preparers are divorced from any consideration as to whether the preparer’s returns were accurate or whether the preparers themselves accurately reported the income on their tax returns.

In this post I will give some background and describe the case.


For tax returns submitted after 2010, preparers who prepare a return for compensation must place a preparer tax identification number (PTIN) on the return. Prior to that, preparers could satisfy the requirement alternatively by placing their full social security number on the return. A paid preparer’s failure to place the appropriate number on the return leads to a $50/return civil penalty, absent reasonable cause.

In 2009 CPA Valentine Anyanwu prepared 134 tax returns as part of his side tax return prep business; he reported the income from that business in 2010. IRS examined Valentine’s 2010 income tax return and as part of the exam it pulled returns he prepared and signed in 2009. In connection with the examination of his income tax return where it looked at his bank account information, IRS was able to identify 90 payments that he received from his prep business. Valentine had estimated that he had done 76 returns for compensation; the rest he claimed were freebies for friends and family.

Upon reviewing the 2009 returns, IRS found that he failed to place a PTIN or full social security number on any of the returns. It was Valentine’s practice in 2009 to sign, place his phone number and address and also put his last 4 numbers of his Social Security number on the returns. Asked why he placed only the last 4 digits he claimed that he did so because he was a prior identity theft victim, though it was not clear why he chose that path rather than getting a PTIN.

After reviewing the returns Valentine prepared based upon a client list he gave to the IRS, IRS assessed $6,700 in penalties, or $50 on the 134 2009 returns he submitted. An interesting side note: at trial the examining agent also testified that it was able to generate a list from the Service Center of all the returns that Valentine prepared. Asked how it generated the list, “the examining agent was unclear on how this list was generated, stating at trial that ‘somebody would have pushed some kind of button, I guess’.”

IRS issued a notice of intent to levy and Valentine challenged the penalty in a Tax Court CDP case, as the penalty is not subject to deficiency procedures.

The opinion is pretty brief and there are two main findings. First, the Tax Court found that there was evidence that only 90 of the returns were done for compensation, so it abated the portion of the assessment that related to the 44 returns where the IRS failed to meet the burden of production that he received compensation. In effect, the penalty went from $6,700 to $4,500.

Valentine requested that the IRS abate the entire penalty, leading to the more interesting finding that Valentine did not have reasonable cause for his actions. Here was his argument:

Mr. Anyanwu claims that his failure to include his full identifying number on the returns he prepared was based on reasonable cause and not due to willful neglect. To support his claim, Mr. Anyanwu testified that he had been a victim of identity theft in the past and thus feared disclosing his full Social Security number. Mr. Anyanwu stated that he believed that the IRS could properly identify him as the return preparer with only the last four digits of his Social Security number, name, address, and phone number.

The Tax Court gave credence to his privacy concerns, but found that it was not enough to constitute reasonable cause because he could have gotten a PTIN and protected his social security number:

While we acknowledge that privacy concerns are important, we find that Mr. Anyanwu has failed to show that he had reasonable cause. Mr. Anyanwu could have satisfied his privacy concerns within the rules by obtaining and using a PTIN instead of his full Social Security number on the returns he prepared.

Parting Thoughts

In upholding the penalties, the Tax Court reaches a sensible conclusion but I sympathize with Valentine in this case at least on the facts as reported in the opinion. The purpose of civil penalties is to promote voluntary compliance. Valentine did give the IRS what it would need to correlate him with the returns he prepared, and that is what the preparer identification rules generally are meant to achieve. In addition, the mandatory PTIN rules were not yet in effect, and some preparers (especially those who were not large preparers like Valentine) may not have been fully aware of the PTIN rules, though the opinion does not address that. Moreover, there is no suggestion in the opinion that the returns he prepared were inaccurate. On top of all that, there are legitimate privacy concerns that people have when it comes to IRS or the government for that matter safeguarding information, especially when the preparer as in this case was a prior identity theft victim.

While I have been a strong advocate for oversight over preparers, including recommending about a decade ago that IRS require preparers to use a uniform identifying number on returns to facilitate accountability and visibility, when faced with its application in this case I sympathize with the preparer who now faces thousands in penalties for a business that I suspect was not his principal business activity. While it is hard to armchair quarterback when there may be other facts, in reading this opinion I am left with the feeling that IRS should have exercised discretion and let this one pass with a warning that in future years a failure to properly identify the returns will generate penalties.

In a follow up post to this I will look at how TIGTA has criticized IRS for its failure to use its PTIN authority fully, a troubling criticism for those like me who believe that the IRS should have expanded powers to oversee the hundreds of thousands of unlicensed commercial preparers.



Summary Opinions for April 10th through 24th

Another slightly stale SumOp, but again full with lots of very interesting tax procedure nuggets.  This post is very heavy on the Chief Counsel Advice, much of which deals with statutes of limitations.

I also wanted to point out that you can read Keith’s acceptance speech for the Janet R. Spragens Pro Bono Award staring on page 8 of the ABA Tax Section NewsQuarterly found here.  We previously covered Keith’s honor here.

As our readers know, we at PT are big fans of tax clinics and the wonderful work the clinics do throughout the country.  Les has an article forthcoming in the Tax Lawyer on the benefits derived by students, taxpayers, and the entire tax system, which can be found here. Keith has previously written on the history of low income taxpayer clinics, and his article can be found here.

I also have to congratulate Keith on his temporary relocation over the next year.  The University of Harvard has decided to expand its array of clinics, and will be starting a low income taxpayer clinic.  Keith will be a visiting professor at Harvard for academic year 2015-2016 to set up the clinic.

And, the other tax procedure items:

  • Last year, Les wrote about the Nacchio case involving the ex-Qwest CEO who was convicted of insider trading and directed to pay a substantial fine and forfeit the profits from the sale of his stock in the company.  Nacchio filed for a refund of tax he paid on those profits, claiming Section 1341 would allow him to treat it as if he never had the gain.  Janet Novak of Forbes on May 1st, had an update on the case found here.  The government has agreed to stipulate the facts of the case, allowing it to bypass a hearing that would have likely discussed in detail the NSA program Mr. Nacchio turned down on behalf of Qwest prior to his investigation.  Janet has a summary of the DOJ’s various arguments as to why it should win based on the law, and it is likely such an appeal is going to occur shortly.  Interestingly, on March 27th, the Service released CCA 201513003, which discusses the Service’s view as to the deductibility of the restitution as a business expense under Section 162.  The issue was whether payments in lieu of forfeiture from a deferred prosecution agreement were deductible.  The advice attached the response from the DOJ in Nacchio where it argued the same issue, although the response was not attached to the released document.  I had initially wondered if the CCA dealt with the Nacchio case, but it appears the Service has a couple cases on the issue.
  • The Northern District of California recently decided US v. McEligot, where the Court held that taxpayers did not have an absolute right to be present during a third party interview pursuant to a summons.  In McEligot, a taxpayer’s accountant refused to answer IRS questions without the taxpayer’s lawyer present. The Court found the accountant had no right to refuse because the Service would not allow the taxpayer or his representative to be involved in the interview.
  • In other CCA news, the Service has issued its position on the assessment period for the Section 6694 preparer penalty for filing a refund request based on an unreasonable position and how long the preparer would then have to request a refund of the penalty amount.  Section 6696(d) houses the statute, and there would be a three year assessment period following the alleged improper refund request.  The preparer would then have three years to seek a refund of the penalty once paid.
  • This is a depressing case.  In Gurule v. Comm’r, the Tax Court remanded a CDP case involving the sustaining of a proposed levy, and whether the Appeals Officer abused his discretion in rejecting an OIC submitted for doubt as to collectability and, in the alternative, rejected an installment agreement (the SNOD may not have been properly sent either).  The primary issue in the collection matters was whether or not the Officer properly considered the economic hardship faced by the family.  In the case, the wife and son had severe medical issues, resulting in high bills.  Wife had a neurological disease resulting in seizures and multiple brain surgeries, and son was in an accident resulting in brain injuries.  The husband had lost his job, and he was using his 401(k) to pay necessary living expenses.  The officer treated the 401(k) loan as a dissipated asset, in particular the loans taken after the taxpayers knew of the outstanding tax.  “Dissipated assets” can be included in in the reasonable collection potential, which is a policy decision to deter delinquent taxpayers from squandering assets when they have outstanding tax liabilities.  An asset, however, should not be considered dissipated if it was needed to provide for necessary living expenses (like medical bills required to keep someone alive).  The Court also directed Appeals to request petitioners to provide documents regarding the son’s death, and how that could impact their collection potential.  While the debate raged on between the Service and the taxpayer, the taxpayer took an additional loan against his 401(k) to pay for his son’s funeral, which the Service found inappropriate.  I really need to start trying to be more thankful for what I have.
  • Chief Counsel has issued legal advice regarding who is authorized to sign a power of attorney for a partnership or LLC.  The issue and conclusion are as follows:

a. Who is authorized to sign a POA appointing a representative for a partnership or limited liability company (LLC) being examined in a TEFRA partnership-level examination?

b. Who is authorized to sign a POA appointing a representative for a partnership or limited liability company for other purposes?

CONCLUSIONS:  A general partner or, in the case of an LLC, a member-manager, may sign a POA for purposes of a TEFRA partnership-level examination or for other tax purposes of the partnership. A POA can also be secured from a limited partner or LLC member for the purposes of securing partnership item information and disclosing partnership information to the POA. In the case of an LLC that has no member who is also a manager, the non-member managers may sign the POA for purposes of establishing that it would be appropriate and helpful to secure partnership item information including securing documents and discussing the information with the designated individual.

KPMG has some coverage and insight here.

  • More tolling content due to financial disability.  In very interesting Chief Counsel Advice, the Service has taken the position that Section 6511(h) does not extend the three year limitations period for net operating losses or capital loss carrybacks.  In the advice, the Service states that Section 6511(h) specifically is limited to the statutes under (a)(b) and (c).  The NOL and capital loss carrybacks are found under Section (d)(2), and therefore not extended by financial disability.


Preparers and Due Diligence

IRS has posted its directory of searchable preparers with PTINs  who are CPA’s, attorneys or enrolled agents or who have opted in to its voluntary certification system under the Annual Filing Season Program; the link that allows you to search the directory is available here. The directory allows people to “research tax return preparers near you or to determine the type of credentials or qualifications held by a specific tax professional.”

The directory allows you to  limit searches to differing types of preparers and allows you to search by zip code. I ran a search and was able to find some local preparers. The directory does not include preparers who have a PTIN who are not attorneys, CPAs, enrolled agents or Annual Filing Season Program participants. It is a good tool that will allow the public to do some due diligence before hiring a preparer.

EITC Due Diligence: Indexed to Inflation

One item that slipped by me from late last year was the indexing of certain penalties to inflation; that came in as per the Tax Increase Prevention Act of 2014 in December. Not all penalties are indexed, but the due diligence penalty for EITC preparers is. The penalty will bump up to $505 per failure in 2015.

EITC Due Diligence: The Taxpayer With No Deductions and Rounded Income

IRS has been releasing items that make up the dirty dozen list of tax scams for 2015. One that made it this year is falsifying income to qualify or goose the amount of refundable credits. As IRS states,

Some people falsely increase the income they report to the IRS. This scam involves inflating or including income on a tax return that was never earned, either as wages or as self-employment income, usually in order to maximize refundable credits.

In fact, IRS has published on its web site a lot of informal information about preparer due diligence, including a list of common due diligence questions and a summary of the due diligence rules as fleshed out in regs. There are training videos and power points discussing scenarios, including a presentation that relates to a person coming in with exactly $12,000 of income from a house cleaning business. The person reports no expenses and has no written records.

In certain cases the amount of the refundable credit will far exceed any tax liability so IRS may be skeptical when there are no records or information returns associated with the self-employment income. The EITC presentation points to an old revenue ruling that stands for the proposition that a taxpayer must report all income and deductions associated with a self-employed business (Rev Rul 56-407). Bottom line, IRS suggests preparers need to do some digging if someone comes in with a rounded amount of self-employment income, no deductions and no records. ( I note that many house cleaners are likely W2 employees and it is possible that the supplies etc are truly paid for by the homeowners so maybe there are no deductions to be had).

Due diligence is so fact and circumstance-specific; it is helpful for sure that IRS is announcing via its web site areas where it thinks a preparer is under a duty to make inquiries. I think that the advice it is giving in this area could probably benefit from input from preparers and others, and FAQ’s in web sites and power points are not the kind of reasoned guidance that in my mind is needed in this area.

I suspect that with increased IRS audits and visits of preparers we may see some more guidance, or at the very least some case law fleshing out the standards as these penalties can really add up at $505 per mistake.


Summary Opinions for 11/07/14 & 11/14/14

Trying to get somewhat back on schedule with the SumOp’s, so we are covering two weeks of material in this post.

First, I want to note that Keith has a really interesting post up on Forbes regarding Microsoft filing a FOIA suit yesterday against the IRS to determine the extent to which the IRS is using an independent contract (here the law firm Quinn Emanuel) in its examination.  This is going to be a very hot  topic moving forward.  That post will find its way to PT later today, but probably not until late in the afternoon.

Before getting to the items we missed over the last few weeks, we had a very strong guest post by Christopher Rizek on the Sexton v. Hawkins case, which was very well received two weeks ago. You should check it out if you didn’t read it when we originally posted.  In October, we had a somewhat related post from Michael Desmond on the future role of Circular 230 in tax compliance, which can be found here.  The comments to that post, which are found here, have recently expanded significantly, as various Villanova LLM students were asked to respond as part of their professional responsibility class.  The students provide some quality feedback, astute observations, and ask some good follow up questions.

To the other procedure.

  • Veolia Environment is still fighting with the IRS over document discovery.  We touched on this last year around this time.  The case again discusses privilege regarding various draft reports by experts, and other lawyer communications.  For one draft valuation, which was then shared with the company’s accountants at PWC, the Court found privilege had not been waived, stating, “PWC is not an adversary nor a conduit to an adversary.”  That seems like a favorable view on what is required to blow privilege.  The case goes through many other specifics as to the types of documents that remained privileged.
  • Jumping to a case from early October that we (I) missed in Comparini v. Comm’r, where the Tax Court determined it had jurisdiction to review an IRS determination to deny the taxpayers’ whistleblower claim.  The letter was not formatted as a determination, and prior letters had been sent to taxpayers; however, letter was the first one to use term “determination”, stated the matter was closed, and did not indicate any further administrative procedures were available.  The Court found that prior letter could have been a determination, but this later letter was also a determination (there is an interesting back and forth in the concurring and majority opinion about the basis for jurisdiction).  The concurring opinion, and Judge Holmes in comments to the CA Bar Association, both noted that the Court is having to spend a lot of time on procedural matters and jurisdictional questions due to the Whistleblower Offices’ habit of issuing various statements that seem to be determinations, and not having set forms for indicating when a determination had been made.  Tax Litigation Survey has coverage here.
  • Another older item that I didn’t catch.  The Service issued an Action on Decision  with regard to the Dixon case from last September, which we wrote about here.  The case had to do with an employer’s ability to designate employment tax payments that were not withheld at the source.  The Service believes the Tax Court was wrong in Dixon in deciding such payments can be designated against a taxpayer’s specific liability.
  • From Jack Townsend’s Federal Tax Crimes Blog, a discussion of the jury instructions in the Weil case as regard the good faith defense.  Not a long post, but interesting summary of this attack on the government’s case, and how the instructions could have influenced the jury.
  • Earlier this year, Google killed off one of its coupon saving sites, Zavers (reminds me of Zima’s “zomething different” slogan—don’t use Z’s where they are not needed—your company will fail), but the remains of the aggressive tax planning of Zavers’ chief technology officer have been resurrected by the Tax Court in Brinkley v. Comm’r.  As a side note, it is nice to be Google, who bought Zavers for close to $100MM in 2011, probably spent a bundle more on it, and are now walking away, as it was not growing fast enough (so says the article linked above).  The underlying matter has to do with Mr. Brinkley’s characterization of his income as capital gains, whereas the Service and Tax Court thought a portion should be ordinary income.  He had apparently been very clear that his ownership should never dip below 3% of the stock, which Zavers agreed to; however, at the time of the Google purchase, he owned around 1%.  In the end, he was paid as though he still held 3%.  The two tax procedure items involved the shifting of the burden, and reliance on a practitioner as reasonable cause.  Neither treads new ground.

On the shifting of the burden, the taxpayer argued that he offered reasonable evidence that an item of income reported on an information return was incorrect, shifting the burden under Section 6201.  The Court, however, was relying on other evidence submitted by the IRS, and not the information return, so the burden did not shift.  Mr. Brinkley also argued that he complied with Section 7491, and produced “credible evidence to support his position as to a factual issue, complie[d] with substantiation requirements, and cooperate[d] with the Secretary with regard to all reasonable requests for information,” but the Court found that Mr. Brinkley failed to offer any credible evidence of his position.

As to the reliance, the Court found that Mr. Brinkley failed to disclose his percentage of the stock to his advisers, how much that was valued at, and  did not provide them with all the documents from the deal.  It is clear law that where the adviser is not informed of all pertinent information, the taxpayer cannot rely on the adviser’s advice or work to get out of a penalty.

  • Susquehanna Bank, which was purchased last week by a North Carolina bank, recently won a lien priority case in the Fourth Circuit.  The Court held the district court incorrectly determined a trust deed, which the bank received prior to the IRS lien, but failed to record, was entitled to priority under Section 6323(h) based on Maryland law relating the recording of the trust deed back to the execution date.  However, the holding was affirmed because the bank was protected by Maryland’s equitable conversion law, which directs that when a taxpayer executes a deed in exchange for a loan prior to a lien filing, the deed took priority.
  • Kurko v. Comm’r is packed with tax procedure.  Lew Taishoff’s blog has some coverage here.   The cases discusses credit elect overpayment jurisdiction before the tax court, tolling for financial disability under Section 6511(h), how those interact, and the Court’s “next friend” rules under Tax Court Rule 60(d).  The Court encouraged Ms. Kurko, who suffered from substantial mental health issues, to have someone file a Motion to Be Recognized as Next Friend.  The Court said such motion should recite that:

o   The person filing would like to be recognized as Ms. Kurko’s next friend and would represent her best interests;

o   That Ms. Kurko cannot prosecute the case without help;

o   The person has a significant relationship with Ms. Kurko; and

o   There is no other person better suited to serve as next friend.

  • The Tax Court had occasion to review the 2006 changes to Section 6664, and the removal of the reasonable cause defense to the gross valuation misstatement penalty in Reisner v. Comm’r.  Prior to 2006, old Section 6664(c)(2) allowed the reasonable cause defense to the penalty when value was provided by a qualified appraiser and the taxpayer made a good faith attempt to determine the value.  That was tossed in the 2006 amendment for gross valuation misstatements (those with only substantial valuation misstatements can still show reasonable cause).  In Reisner, the taxpayer received a charitable deduction for a façade easement.  A portion carried forward to 2005 and 2006.  The Service determined the donation was valueless, and no deductions were allowed.  The gross valuation misstatement penalty was not imposed in 2004 or 2005 because the taxpayer was able to show reasonable cause.  For 2006, the return was filed after the changes to the statute, and the Service imposed the penalty on the carryover charitable deduction.  The Court held the penalty was correctly imposed, stating:

Because their 2006 return was filed after the effective date of 2006 amendments to I.R.C. sec. 6664(c)(3), Ps are precluded under that section from raising a reasonable cause defense to imposition of the gross valuation misstatement penalty for the underpayment on their 2006 return attributable to the carryover of their charitable contribution deduction.

An interesting result, where the action was protected in the initial year, but the statutory change resulted on penalties in future years based on the same transaction.

  • The Ninth Circuit reversed the Tax Court in JT USA, LP v. Comm’r, holding Section 6223(e)(3)(B) was clear and unambiguous and did not allow a partner in a partnership to elect out of the TEFRA proceedings unless the partner elects to have all his or her partnership items treated as non-partnership items.  For the majority, that was all partnership items, regardless if those were owned through other entities.  From the case:


26 U.S.C. § 6223(e)(3)(B), entitled “Notice to Partners of Proceedings,” reads in pertinent part, “In any case to which this subsection applies, if paragraph (2) does not apply, the partner shall be a party to the proceedings unless such partner elects – . . . (B) to have the partnership items of the partner for the partnership taxable year to which the proceeding relates treated as nonpartnership items.

In the prior proceeding, the tax Court held that that “§ 6223(e)(3)(B) permits taxpayers to opt out of the partnership proceeding with respect to their indirect interests but to leave in that proceeding their alleged remaining direct partnership interests.”  The Ninth Circuit disagreed, and said that the plain language states it is all or nothing when it comes to opt out.  The opinion was split, and the dissent stated the taxpayer should have the ability to completely elect out with regard to their direct interests in the partnership, but not do so with the indirect interest in the partners (and/or the other way).  I found this surprising, and my initial (somewhat uninformed) thought is that the tax court had this right.