Procedure Round Up(date):   Regulations, Mount Up! & State Law SOL Issue When Suing Promoters.

This will be a short post that touches on some temporary and final regulations that were issued in the last quarter of last year that impact tax procedure, specifically information reporting and the preparer due diligence rules, which we have previously covered.  The second portion of the post will deal with a state law statute of limitations issue from a tax shelter participant suing the promoter.

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Regulation Update

What is Keno?

Back in March of 2015, I wrote about the temporary regulations dealing with reporting of winnings from bingo, keno, and slot machines.  The Service has finalized those regulations, which can be found here.  I believe the final regulations are similar to the temporary regulations (although aspects regarding electronic slot machines were not included in the final regs). These rules peg the required reported winnings at $1,200 for bingo and slot machines (but $1,500 for keno).  Anyone have any idea why those amounts are different (or what keno is, I don’t go to casinos much)?  The information on the information reporting must include the name, address, and EIN of the payee, along with a description of the two types of ID used to verify the payee’s address.

Discharge Reporting- Buy Now, Three Years, No Payments!

I thought I had written up the proposed regulations from 2014 relating to the rules on discharge of indebtedness reporting when a borrower had not paid for more than three years, but I cannot find the post (very possible I just read about it and found it interesting).  Under Section 6050P, prior regulations treated nonpayment of debt for 36 months as an “identifiable event”, which indicated formal discharge of indebtedness and required the issuance of a Form 1099-C.  This caused many borrowers to believe the debt had been discharged, but it was simply an IRS reporting requirement.  Tax professionals, lenders and borrowers did not like the rule.  The final regulations can be found here.  The regulations eliminate the passage of that time frame as a reportable event, which is a good result.  This change may have come from discussions started in the ABA Tax Section, Low Income Taxpayer Committee.

Preparer Due Diligence Regs Updated.

The Government has issued temporary/proposed regulations regarding the preparer due diligence rules, which can be found here.  We’ve talked about preparer due diligence repeatedly on the blog, including one of our first posts (and most popular), where Les extensively discussed peeing in pools.  That was re-posted earlier this year, and can be found here.  In both 2014 and 2015, Section 6695 dealing with preparer due diligence was amended.  The penalty was indexed for inflation, and the due diligence requirements were expanded to include the Child Tax Credit, the Additional Child Tax Credit, and the American Opportunity Tax Credit.  The proposed regulations update the provisions to take into account these changes.

Information(less) Returns

In late December 2016, the Service issued guidance (Notice 2017-9) regarding the new de minimis safe harbor provisions enacted under the PATH act.  In general, failure to include all required information on an information return or payee statement will result in a penalty being imposed on the issuer.  The penalty is dependent on various factors, including the amount incorrectly reported, when it was not reported, how quickly it is rectified, and potentially other factors.

The penalty under Section 6721 can be reduced or eliminated in certain circumstances.  There is a de minimis exception to Section 6721, which allows the penalties to be waived if the error is corrected on or before August 1st in the year it is filed.  This is limited to the greater of ten returns or .5 percent of the information returns filed.  For returns required to be filed after December 31, 2016, there is a safe harbor that applies, where, if the information return has an error of $100 or less, or involves less than $25 of withholding, then the safe harbor applies, and no corrected return is required.  The notice is clear that this does not apply for intentional acts or intentional disregard.  It also indicates that regulations will be forthcoming regarding the safe harbor.

The de minimis safe harbor will not apply, however, if the payee elects out of the safe harbor.  Under Section 6721(c)(3)(B) and Section 6722(c)(3)(B), the payee can make an election and the payor has thirty days to furnish a corrected payee statement to the payee and the IRS.  If it is not done within thirty days the penalties will apply (it is possible for additional time in limited circumstances).

The payor must provide the manner for making such an election, which can be any reasonable manner including by writing, electronically or by telephone.  The payee must be told in writing the fashion in which the election can be made.  The notice goes on to indicate the timing of when the election must be made, and indicates the election must: 1) clearly state the election is being made; 2) the payee’s name, address, and TIN; 3) the type of statements and account numbers; and 4) the years in which the election should apply.

So, if you are super angry that Gigantor Bank and Lack of Trust Company misstated your 1099 by $4.37, you now have your avenue for redress.

Shelter Participant SOL Against Promotor Runs From Final Tax Court Ruling, Not Notice of Tax Deficiency

I initially saw this suit, and thought some aspect pertained to federal law claims against the tax shelter promoter, but the claims were state law based.  It is, however, still an interesting statute of limitations issue, that could impact future rulings based on state law.

In Kipnis v. Bayerische Hypo-Und Vereinsbank, AG, the Eleventh Circuit, following direction from the Florida Supreme Court, has reversed the district court in holding the statute of limitation on state based claims against a tax shelter promoter by a participant were not time barred.

The particular holding is for a relatively straightforward issue.  After the defendant admitted fault, the IRS issued a notice of deficiency to the plaintiff for his involvement in the shelter.  This occurred in October of 2007.  On November 1, 2012, there was a final tax court order disposing of the case (90 days thereafter appeal rights expired).  On November 4, 2013, plaintiff filed suit against the defendant alleging various state law claims including fraud from the promoting and selling of the transaction.

The defendants moved to have the case thrown out as being outside of Florida’s four and five year statute of limitations for the claims made.  The issue was appealed to the Eleventh Circuit, which sought guidance from the Florida Supreme Court on the issue, specifically:

Under Florida law and the facts in this case, do the claims of the plaintiff taxpayers relating to the CARDS tax shelter accrue at the time the IRS issues a notice of deficiency or when the taxpayer’s underlying dispute with the IRS is concluded or final.

The Florida Supreme Court, which the Eleventh Circuit followed, determined that the claims accrued at the time the tax court order became final, which was ninety days after the order was issued when the appeals period had passed. See Kipnis v. Bayerische Hypo-Und Vereinsbank, AG 202 So. 3d 859 (Fla. 2016).  I think this is inline generally with what the federal law would be in most analogous situations, but would invite others to comment on this aspect if they have thoughts.

Mixing a Pro Se Taxpayer and Confusing Innocent Spouse Deadlines Leads to Bad Result

In Vu v Commissioner, a summary case from late last year, the Tax Court held that a pro se taxpayer did not establish the Tax Court’s jurisdiction to hear an appeal of an IRS’s denial of a request for innocent spouse relief. What makes the case unusual is that the taxpayer Amanda Vu did file a petition requesting relief but she did so before the IRS issued what it styled as a notice of determination and just prior to 6 months elapsing after her request to the IRS for relief was made. In other words, her petition jumped the gun on the two separate avenues needed to confer the Tax Court’s jurisdiction.

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Before digging into the case I note that I came across the case and wrote a draft of this post without realizing that Carl and Keith are now representing the taxpayer Ms. Vu. As I discuss below, what intrigued me initially about the case was how the result was unfair. Carl and Keith and the Harvard Tax Clinic have filed a motion to set aside the dismissal and remove the case’s small case designation. I will discuss below why the Tax Court dismissed the case, and why I agree with the Tax Court judge that the outcome inequitable and hope that the legal argument Carl and Keith have advanced persuade the Tax Court to reconsider its approach.

I also note that we have discussed premature petitions before, albeit in the context of straight up deficiency cases. In Tax Court Order Finds Jurisdiction Even When Taxpayer Files a Petition Before the IRS Issues Notice of Deficiency a taxpayer filed a petition prior to the stat notice but in response to other correspondence IRS issued in its exam. I discussed how the Tax Court in Weiss v Commissioner went out of its way to confer jurisdiction, essentially allowing the taxpayer’s response to IRS motion to dismiss the case confer jurisdiction, so long as the taxpayer amended its petition and the IRS’s motion and the taxpayer’s response were issued prior to the actual 90-day period ran. I speculated that the problem of premature petitions filed in good faith was likely a common one, and that the Weisses were lucky in that the IRS motion, and their response, were within the 90-day period.

Vu was not nearly as fortunate as Weiss. I will simplify the facts to bring home the procedural conundrum Vu found herself in.

She, with a friend’s assistance, submitted a request for innocent spouse relief that she signed and dated February 28, 2014. IRS recorded it as received on March 24, 2014.

Vu testified that she received from IRS on June 12 an “Innocent Spouse Relief Lead Sheet” that was dated June 4, 2014. The document was designated Workpaper # 615 and reads in part:

Conclusion: (Reflects the final determination on the issue.)

Conclusion for 6015(b):

Note: A summary of your conclusion should go here. Ensure that reference is made as to what factors are met if allowing or granting partial relief, and what factors are not met

It was concluded that the Taxpayer does not meet innocent spouse relief under IRC 6015(b).

*******

Conclusion for 6015(c):

Note: A summary of your conclusion should go here. Ensure that reference is made as to what factors are met if allowing or denying partial relief, and what factors are not met if disallowing or granting partial relief.

It was concluded that the Taxpayer does not meet innocent spouse relief under IRC 6015(c).

*******

Conclusion for 6015(f):

Note: A summary of your conclusion should go here.

It was concluded that the Taxpayer does not meet innocent spouse relief under IRC 6015(f).

*******

Vu sent in a petition to Tax Court and it had a September 8, 2014 postmark, and Tax Court received it on September 12, 2014.

About one month after Vu filed her petition, on October 9, 2014 IRS mailed Vu a final determination denying her request for innocent spouse relief.

On November 3, 2014, IRS filed an answer. In the answer it denied issuing a notice of determination from New Mexico and indicated that it issued a notice of determination from Phoenix on October 9, 2014. IRS did not in the answer indicate that the petition Vu filed was premature; that was too bad because if it had flagged the issue, the taxpayer, like the early bird in Weiss, could have cured her defect and filed a petition that would have clearly been timely.

On January 27, 2015 Vu, more than 90 days after issuing what it called a final determination and over four months after Vu filed her petition, IRS filed a motion to dismiss Vu’s petition on the ground that she filed it prior to the time that the IRS issued its October 9 notice of determination.

Vu did not respond to the Tax Court’s order ordering a response to the motion. The motion was argued at a June 2015 calendar in New Mexico.

The Law

A petition to Tax Court is timely in innocent spouse cases if it is made (1) within 90 days of the mailing of a notice of final determination of relief, or (2) if the IRS has not yet mailed a notice of determination, at any point after six months has transpired since the taxpayer’s request for relief was made with the Commissioner.

Applying the above rules to Vu meant that the Tax Court would have had jurisdiction under two alternate theories:

  • if it considered the IRS’s Innocent Spouse Relief Lead Sheet IRS issued sometime in June a notice of determination and Vu filed a petition within 90 days of that determination, or
  • if at the time she filed her petition to Tax Court 6 months had elapsed following her request for relief and IRS had issued no determination in the case.

On both grounds the Tax Court held that Vu came up empty leaving the Tax Court to conclude that it had no jurisdiction in the case.

Both issues are interesting and walk us down some complicated procedural rules. First let’s look at issue 1. The opinion indicates that it likely would have been willing to conclude that the Workpaper #615 correspondence was a determination, noting cases such as Barnes v Commissioner that neither the statute or regs impose a specific form or spell out the content of what should be in a determination and the language of the workpaper led the taxpayer to conclude it was a final IRS determination. The problem for Vu was that there was no evidence in the record when IRS issued that correspondence, making it impossible to conclude that the petition she filed was within 90-days (and allowing the court to punt on concluding definitively that the Workpaper was a determination).

There were two possible dates: June 4, when the document was dated, or June 12, when Vu claimed to receive it. Determining which was correct was key, because if it were issued on June12th the petition she mailed on September 8 would have been filed within 90 days, using the mailbox rule that allows date of mailing to be the date of filing. If it were issued on June 4th the petition would have been filed outside the 90-days.

According to the Tax Court Vu did not offer any evidence as to why June12th was the correct date:

As for the June 12, 2014, date, petitioner however did not present any evidence whatsoever showing that any relevant action occurred on June 12, 2014, and has specifically failed to establish that respondent provided her the requisite final determination notice on that date.

What about issue 2, the 6-month rule? That issue turned on whether Vu’s request was considered made on February 28, when she signed, dated and testified that she mailed it, or March 24, when IRS records treated the request as received. If the operative date were February, then Vu’s petition would have conferred jurisdiction, as the petition she mailed on September 8 and which the Tax Court received on September 12 would have been filed after 6 months had elapsed from her administrative request for relief and prior to the IRS’s issuance of the October 9 final determination.

Vu came up empty here too. How it gets there requires a detour to Section 7502, the mailbox rule. The Vu opinion treats the statutory language “made” in the same manner as if it interpreted when the request were filed. The opinion treated the request for relief as having been filed or made in March (when IRS received it) and not when  mailed in late February. It does so because the mailbox rule under Section 7502 is actually an exception to the general rule that a document is filed when it is received by the IRS. Recall that the mailbox rule of Section 7502 only applies when documents are filed with and received after the expiration of a filing period. Here, the filing period limitation relates to the time period to bring an administrative request for innocent spouse relief, and that limitation was years in the future:

Because petitioner’s Form 8857…was filed before respondent initiated any collection action with respect to that year (indeed, before respondent even issued the joint notice of deficiency to petitioner and Mr. Nguyen with respect to that year), we find that respondent timely received the form on March 24, 2014; section 7502 therefore does not apply, and the relevant date for section 6015(e)(1)(A)(i)(II) is not six months after the alleged mailing date of the form but six months after the date of receipt of the form, or September 25, 2014.

The opinion made clear why Vu came up short:

Consequently, we can exercise jurisdiction over the petition herein only if it was filed “at any time after the earlier of” October 9, 2014 [the date of the formal notice of determination], or September 25, 2014 [six months after Vu’s request was made], see sec. 6015(e)(1)(A)(i), and “not later than” January 7, 2015, see sec. 6015(e)(1)(A)(ii). Because the petition was filed with the Court on September 12, 2014, it does not meet this requirement and we thus lack jurisdiction over it.

This opinion noted the unfairness of the outcome:

While we acknowledge that this is an inequitable result, as petitioner filed her petition believing in good faith that it was timely and her opportunity to file another petition has now expired, we are unfortunately constrained by the statute, and our role is to apply the tax laws as written.

Final Thoughts

This is a bad outcome. I do not understand why counsel for IRS did not alert Vu of the premature petition issue earlier in the process. It appears that counsel for the IRS did not appreciate the 90-day issue fully until it filed the motion; otherwise one would have hoped that counsel would have filed the motion in lieu of the answer. That would have given Vu time to file a petition within the 90-day window, as the taxpayer in Weiss did. I also note that the IRS only raised the 6-month issue at the hearing itself on the motion, which was many months after the IRS filed its motion to dismiss.

We have discussed before the difficulties associated with confusing IRS correspondence. When you add to the mix the reality that many taxpayers are pro se and not equipped to understand the nuances of differing IRS procedures you can get to a place where a taxpayer is denied her day in court despite efforts to have her case heard.

There is a possibility that the Tax Court will change its mind and the case will get heard. Keith and Carl in their motion to set aside the dismissal argue that the IRS forfeited the right to make an SOL argument by waiting too long in this case, as it should have been made in the answer. This is an argument similar to the way the Supreme Court in the 2004 case of Kontrick v. Ryan held that a bankruptcy debtor waited too long in his case to raise the untimeliness of a creditor’s filing because the time period was not jurisdictional, so had to be raised earlier in the case.  Kontrick is the Supreme Court opinion that first began the narrowing of the use of the word “jurisdictional”.

We have discussed the issue of jurisdictional deadlines repeatedly; the most recent was Carl’s discussion of Tilden earlier this week, an opinion that does not help the argument in Vu. Admittedly there is no direct precedent in support of Vu’s argument, and the Tax Court in Pollock v Commissioner has previously held that the deadline under Section 6015(e)(1)(A) was jurisdictional and not subject to equitable tolling. To be sure, there is no long line of Supreme Court precedent holding deadlines under Section 6015 jurisdictional, and the Tax Court’s opinion in Pollock was prior to the Supreme Court and other courts’ narrowing of the term jurisdictional. Moreover, the language in Section 6015(e) consists of a single sentence containing both jurisdictional grants and time periods to file a petition, a type of statute that the Supreme Court has previously held to be not jurisdictional.

Keith and Carl have a few cases other than Vu in the pipeline making this argument and I hope the courts at a minimum address the changing law and meaningfully apply those changes to these and other deadlines where IRS conduct has contributed to taxpayer confusion and the denial of a day in court.

USVI – Residing or Vacationing (and What if You Pay Income Tax While only Vacationing)

I am sitting in my dining room writing, and there is freezing rain outside, I’ve got a terrible cold, and my wife is cleaning up some child’s vomit.  I can’t help but think how nice it would be to live somewhere much warmer, that wasn’t as affected by these seasonal illnesses ….  And, wouldn’t it be all the better if I paid far less in taxes?  Maybe I should trade Love Park for Love City (nickname of St. John’s, USVI—which is apparently giving people money to come visit)?

The United States Virgin Islands have shown up in a lot of tax procedure cases over the last decade (like a ton!, there are only around 100,000 residents, and it seems like there is an important case every week).  So why is that the case?

Well, it is, for some, a legal tax shelter.  Normally, a US Citizen must file his or her return with the Service on a specified date, and the Service must assess tax within three years of filing a return, but if no return is filed the period of limitations remains open indefinitely.  See Section 6501.  To be filed, “the returns must be delivered…to the specific individual…identified in the Code or Regulations.” See Allnut v. Comm’r.  This normally means somewhere with the Service.  The USVI however operates a “separate but interrelated tax system.” Huff v. Comm’r.  Bona fide USVI residents are required to only file tax returns with the USVI Bureau of Internal Revenue (“VIBIR”).  See Section 932(c)(2).  If the taxpayer is not a bona fide resident, but has USVI source income, the taxpayer must file with the VIBIR and the Service.  In an effort to bring businesses to the USVI, an economic development program was implemented in USVI, which allows for a reduction of USVI tax on certain USVI residents up to 90% of their income tax.  Not sure how much economic development it has spurred, but a lot of rich people began trying to be bona fide USVI residents (or at least claimed they were), and the IRS took exception.

Below is a discussion of a few cases relating to claims of USVI residency.  One will review the requirements of residency, and why parking a boat may not be enough. It also highlights the interesting SOL issue of whether a USVI return starts the limitations period when the taxpayer is not a USVI resident.  The final case below investigates what happens if a non-resident pays tax to USVI (claiming to be a resident) and the refund statute of limitations has passed after there has been a determination that the person was not a resident.

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Parking Your Yacht and Staying at Ritz–Not Residency

In Commissioner v. Estate of Travis L. Sanders, the Eleventh Circuit reversed the Tax Court and remanded for additional fact findings regarding whether or not the decedent had ever been a resident of the USVI (and from the tone of the case, the Court gave fairly clear indication that the Tax Court should find he was not a resident).    The Tax Court opinion in Sanders can be found here.  The issue in the case was whether the filing of a USVI return started the statute of limitations, which the Court decided hinges on whether he was a resident of USVI.  As stated above, this has been a hot topic over the last few years, which we have not covered much on PT.

In Sanders, the taxpayer made his money on surge protectors (I think high end, not the consumer ones your computer is plugged into).  The more protectors he sold, the more his balance sheet surged.  In 2002, Mr. Sanders began spending some (but not much) time in the USVI.  From ’02 to ’04, the years in question, Mr. Sanders stayed at the Ritz, and then parked his yacht on the islands and stayed on the boat.  He spent somewhere between 8 and 18 days on the islands in ’02, between 49 and 78 days in ’03, and between 74 and 109 days in ’04.  He kept his FL home, never established a personal mailing address in the USVI, his girlfriend (eventually wife) remained in FL, his minor child lived in FL, and he spent considerable time at the company HQ in FL.

As to his work at the surge company, he became a limited partner in a USVI company, which employed him, and then contracted his services to the company he had created.  Mr. Sanders took the position that this was USVI source income, and that he was a USVI resident.  He then claimed the income was exempt from United States taxes (and it was potentially entitled to a 90 percent tax credit under USVI tax laws – hence the set up).

The IRS said this Caribbean dream was a little too dreamy, and in 2010 issued a notice of deficiency, alleging Mr. Sanders was not a bona fide USVI resident and that the set up was, as Jack Townsend would say, a b@!! $&!1 tax shelter.  Unfortunately, our Captain Sanders died in 2012, and did not get to see if his scheming worked.  In August, the Eleventh Circuit didn’t weigh in on the BS’iness of the tax shelter, but did overturn the Tax Court as to whether the statute of limitations prohibited the assessment.  Why did the courts disagree?

How to qualify as a USVI resident has changed somewhat over recent years, and, the discussion to follow regarding the statute of limitations on filing with VIBIR may no longer apply, as the Service and VIBIR entered into an information sharing agreement in ’07, and following that the Service agreed to treat certain returns filed with VIBIR as starting the statute of limitations regardless of whether the person was actually resident of USVI.

This was prior to ’07, and the Service took the position that Mr. Sanders was not a bona fide resident of the USVI in the years in question, and therefore the return he filed with VIBIR did not start the running of the statute of limitations in the United States.  Mr. Sanders (and the USVI government) argued he was a bona fide resident, and the statute had run.

The Court did not determine whether Mr. Sanders was or was not a bona fide resident, and remanded for further fact finding.  It was clear from the tenor of the opinion that based on the facts before the Court it strongly (very, very, very strongly) disagreed with the Tax Court conclusion that Mr. Sanders was a resident.

The more important holding, although not new law, was that the statute of limitations for filing his US Federal tax return would only run due to the VIBIR filing if Mr. Sanders was a bona fide resident (requiring a substantive finding of fact), and there was no good faith exception to this requirement implied in the statute.

In discussing the good faith exception, the Eleventh Circuit reviewed the meaning and use of the term bona fide and found it required objective proof.  The Court did note there are some fairness concerns in not having such an exception, but said that was not sufficient to read such an exception into the statute.  In addition, it noted that “entwining of the merits of a case with the statute of limitations is not uncommon in tax cases.”  The Eleventh Circuit rejected the good faith exception, holding filing with VIBIR only triggers the statute if the taxpayer is a bona fide resident (not merely that the taxpayer believes he is).

As to the bona fide residency, as mentioned above, the Eleventh Circuit gave a pretty heavy indication as to its feelings as to residency.  The Court stated that “[b]ecause the Tax Court never decided the nature and extent of Sanders’s physical presence, it cannot have properly weighed this factor.”  Further, “[e]ven Sanders’s own estimate that he spent 18 days in the USVI…places him on the island for only a small portion of time,” and “he had no personal home on the islands for any part of [the years in question].”  And, “[l]iving in a condominium partially owned by one’s employer (and which is not even available for every visit) does little to evidence an intention to reside there indefinitely…”, but the Court did note that moving the boat to the island and connecting it to utilities was slightly more indicative of residence; although, noted this was less strong evidence than a fixed home.  There were various other similar quotes, making it fairly clear the Court did not think Sanders was a bona fide resident.

Although I’ve discussed this type of planning in the past with clients for both USVI and PR (and other more exotic jurisdictions), this type of planning has a more common analogous state level planning topic; which is selecting a state level income tax residence (in my practice, it is usually someone in NY, NJ, MA, and less often PA, considering a move to FL).  Obviously, the analysis is different, but the advice is the same; you can’t just say you think you are a resident, you have to take meaningful steps that can prove you are.

Also, interesting to note, at least to me, that the Chief Justice of the Eleventh Circuit was appointed by George H. W. Bush, who once claimed residency in Texas while staying a limited number of days per year in the Houstonian, which Texas accepted and Maine, DC, and other states never questioned.  Perhaps the Houstonian is more homey than the Ritz.

Where Does My Entity Reside?

The Third Circuit had an interesting, albeit unsurprising, holding in the end of October relating to USVI residency of entities.  In VI Derivatives, LLC v. United States, the Third Circuit affirmed the district court’s denial of the taxpayer’s motion to dismiss for lack of subject matter jurisdiction, holding that res judicata barred the challenge to subject matter jurisdiction.  In VI Derivatives, various LLCs were challenging their residency, but the lower court had previously already determined the residency of the entity owners (the Ventos, more on them in a minute).  In that holding, the Court indicated there was no separate determination to be made regarding the entities, “Because those partnerships are pass-through entities…, they do not have residencies separate from their owners.”  When the entities filed a motion to dismiss for lack of subject matter jurisdiction based on residency, the District Court denied the motions, holding res judicata barred the challenge because the residency decision on the owners constituted a final judgement on the merits, which was not appealed.  The Third Circuit agreed.

For those of you who follow tax procedure closely, especially offshore matters, the Ventos are turning into a familiar family.  Cases pertaining to the capital gains ($180MM) generated from the sale of Richard’s Vento’s business have generated interesting holdings regarding USVI residency, summons enforcement, and FOIA (and probably others that I am forgetting).

And…

VI Non-Residents Cannot Claim FTC For VI Income Paid

Not a shocking holding either.  In Vento v. Comm’r, the Tax Court reviewed the case of Renee Vento (daughter of Richard), who claimed foreign tax credits on her United States return for tax she paid in the USVI.  In the year the tax arose, Renee lived in the US.  For the tax year, she filed her income tax return with VIBIR including the payment of tax claiming to be a USVI resident, and the IRS transferred her estimated US payments to VIBIR.  Later, the IRS and Courts determined she was not a USVI resident, and a notice of deficiency was issued.  An agreed assessment was determined, with Renee treated as a US resident.  Renee apparently sought a refund on the VIBIR return, but this was likely denied due to the passing of the statute of limitations.  Renee then attempted to seek credits on her US return under Section 901 for payments she made to VIBIR (and the IRS payments that were converted to VIBIR payments) for the tax year in question.  Renee also claimed that for the IRS or the Court to hold otherwise would unfairly subject her to double taxation in the US and USVI.

The IRS responded by arguing that Renee was not a USVI resident, and therefore the payments were not compulsory, so no credits could be issued.

The Tax Court agreed with the Service.  It found that Renee had no USVI source income, and therefore there was no obligation to pay tax, so the payments to VIBIR were not “taxes paid”.  Section 901(b)(1) allows a credit for “the amount of any income…tax paid or accrued during the taxable year to any…possession of the United States.”  The Court found that the holdings regarding residency did not appear to give much credence to Renee’s position, which it found undercut her argument that she had a reasonable basis for paying VIBIR.  The Court also found that Renee had not exhausted all of her potential remedies to reduce her liability to USVI.  As such, the Tax Court found Renee did not meet her burden of showing that she had validly paid tax to USVI.

Before getting to the equity argument, the Court did note that Congress did not intend that taxes paid to USVI be eligible for the foreign tax credit.  The Court viewed the coordination rules under Section 932(c) as eliminating the potential for double taxation that the FTC usually solved.  Further, the Regulations specifically state that for FTC purposes, USVI income of a Section 932(a) taxpayer is treated as income from sources within the United States.  See Reg. 1.932-1(g)(1)(ii)(B).  The Court did also note that Renee’s situation may allow her to “slip through the crack in the statutory framework,” as under the literal terms she did not earn any USVI income, but it did not believe Congress would have intended that result.  The Court did not, however, hold on this rationale, as the “taxes paid” reasoning was sufficient.

The holding ends with some statements pertaining to the equity argument:

Whatever sympathy we might have for petitioners, however, does not compel us to allow them a credit against their U.S. tax liabilities to which they are not legally entitled.16 To the extent that petitioners pay tax on the same income to both the United States and the Virgin Islands, they must seek a remedy elsewhere; they cannot find it in section 901.

Foot note 16 states:

Our sympathy for petitioners would be tempered to the extent that tax avoidance motives prompted their claims to Virgin Islands residence. While the limited record before us is silent regarding petitioners’ motivations, our agreement to base our decision on the parties’ stipulations and admissions under Rule 122 does not require us to ignore the District Court’s observation in VI Derivatives, LLC v. United States…, aff’d in part, rev’d in part sub nom. Vento v. Dir. of V.I. Bureau of Internal Revenue… that “the timing of the [Vento] family’s decision to ‘move’ to the Virgin Islands is suspicious.” According to that court, Vento family members realized a significant gain as a result of a transaction that occurred at the beginning of 2001. Becoming Virgin Islands residents for that year held out the prospect of more than $9 million in tax savings to the family.

Sounds a bit like unclean hands.  Don’t argue equity after your tax fraud-ish behavior.  A bit harsher than the original taxpayer friendly Sanders holding before the Tax Court.

While reading the case, I wondered if the taxpayer could have made an argument about the amounts paid to the US that were “covered into” USVI (payments) pursuant to Section 7654.  That is the provision that makes the US pay over any tax collections it has to the possession.  I believe USVI intervened in this case (although I could be confusing my USVI residency cases), and the US was clearly a party.  It would seem both were on notice that their transfer of funds was potentially incorrect.  I have done no research on this, so the notion could be completely off base, but it was my initial thought while reading.

Procedure Grab Bag: CCAs – Suspended/Extended SOLs and Fraud Penalty

My last post was devoted to a CCA, which inspired me to pull a handful of other CCAs to highlight from the last few months.  The first CCA discusses the suspension of the SOL when a petition is filed with the Tax Court before a deficiency notice is issued (apparently, the IRM is wrong on this point in at least one spot).  The second touches on whether failing to disclose prior years gifts on a current gift tax return extends the statute of limitations for assessment on a gift tax return that was timely filed (this is pretty interesting because you cannot calculate the tax due without that information).  And, finally, a CCA on the imposition of the fraud penalty in various filing situations involving amended returns.

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CCA 201644020 – Suspension of SOL with Tax Court petition when no deficiency notice

We routinely call the statutory notice of deficiency the ticket to the Tax Court.  In general, when a taxpayer punches that ticket and heads for black robe review, the statute of limitations on assessment and collections is tolled during the pendency of the Tax Court case.  See Section 6503(a).  What happens when the petition is filed too soon, and the Court lacks jurisdiction?  Well, the IRM states that the SOL is not suspended.  IRM 8.20.7.21.2(4) states, “If the petition filed by the taxpayer is dismissed for lack of jurisdiction because the Service did not issue a SND, the ASED is not suspended and the case must be returned to the originating function…”  But, Chief Counsel disagrees. Section 6503(a) states:

The running of the period of limitations provided in section 6501 or 6502…shall (after the mailing of a notice under section 6212(a)) be suspended for the period during which the Secretary is prohibited from making the assessment or from collecting by the levy or a proceeding in court (and in any event, if a proceeding in respect of the deficiency is placed on the docket of the Tax Court, until the decision of the Tax Court becomes final), and for 60 days thereafter. (emph. added).

Chief Counsel believes the second parenthetical above extends the limitations period even when the Tax Court lacks jurisdiction because no notice of deficiency was issued.   The CCA further states, “Any indication in the IRM that the suspension does not apply if the Service did not mail a SND is incorrect.”  Time for an amendment to the IRM.  I think this is the correct result, but the Service likely had some reason for its position in the IRM, and might be worth reviewing if you are in a situation with the SOL might have run.

CCA 201643020

The issue in CCA 201643020 was whether the three year assessment period was extended due to improper disclosure…of prior gifts properly reported on prior returns.  In general, taxpayers making gifts must file a federal gift tax return, Form 709, by April 15th the year following the gift.  The Service, under Section 6501(a) has three years to assess tax after a proper return is filed.  If no return is filed, or there is not proper notification, the service may assess at any time under Section 6501(c)(9).

In the CCA, the Service sought guidance on whether a the statute of limitations was extended where in Year 31 a gift was made and reported on a timely filed gift tax return.  In previous years 1, years 6 through 9, and 15 prior gifts were reported on returns.  On the year 31 return, however, those prior gifts were not reported.  That information was necessary to calculate the correct amount of tax due.

Section 6501(c)(9) specifically states:

If any gift of property the value of which … is required to be shown on a return of tax imposed by chapter 12 (without regard to section 2503(b)), and is not shown on such return, any tax imposed by chapter 12 on such gift may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time. The preceding sentence shall not apply to any item which is disclosed in such return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature of such item.

Chief Counsel concluded that this requires a two step analysis.  Step one is if the gift was reported on the return.  If not, step two requires a determination if the item was adequately disclosed.  Counsel indicated it is arguable that the regulations were silent on the omission of prior gifts, but that the statutory language was clear.  Here, the gift was disclosed on the return, and the statutory requirements were met.  The period was not extended.  I was surprised there was not some type of Beard discussion regarding providing sufficient information to properly calculate the tax due.

CCA 201640016

Earlier this year, the Service also released CCA 201640016, which is Chief Counsel Advice covering the treatment of fraud penalties in various circumstances surrounding taxpayers filing returns and amended returns with invalid original issue discount claims.  The conclusions are not surprising, but it is a good summary of how the fraud penalties can apply.

The taxpayer participated in an “Original Issue Discount (OID) scheme” for multiple tax years.  The position take for the tax years was frivolous.  For tax year 1, the Service processed the return and issued a refund.  For tax year 2, the Service did not process the return or issue a refund. For tax year 3, the return was processed but the refund frozen.  The taxpayer would not cooperate with the Service’s criminal investigation, and was indicted and found guilty of various criminal charges.  Spouse of taxpayer at some point filed amended returns seeking even greater refunds based on the OID scheme, but those were also frozen (the dates are not included, but the story in my mind is that spouse brazenly did this after the conviction).

The issues in the CCA were:

  1. Are the original returns valid returns?
  2. If valid, is the underpayment subject to the Section 6663 fraud penalty?
  3. Did the amended returns result in underpayments such that the penalty could apply, even though the Service did not pay the refunds claimed?

The conclusions were:

  1. It is likely a court would consider the returns valid, even with the frivolous position, but, as an alternative position, any notice issued by the Service should also treat the returns as invalid and determine the fraudulent failure to file penalty under Section 6651(f).
  2. To the extent the return is valid, the return for which a refund was issued will give rise to an underpayment potentially subject to the fraud penalty under Section 6663. The non-processed returns or the ones with frozen refunds will not give rise to underpayments and Section 6663 iis inapplicable.  CC recommended the assertion of the Section 6676 penalty for erroneous claims for refund or credit.
  3. The amended returns did not result in underpayments, so the Section 6663 fraud penalty is inapplicable, but, again, the Service could impose the Section 6676 penalty.

So, the takeaway, if a taxpayer fails to file a valid return, or there is no “underpayment” on a fraudulent return, the Service cannot use Section 6663.  See Mohamed v. Comm’r, TC Memo. 2013-255 (where no valid return filed, no fraud penalty can be imposed).  In the CCA, Counsel believed the return was valid, but acknowledged potential issues with that position.  Under the Beard test, a return is valid if:

 four requirements are met: (1) it must contain sufficient data to calculate tax liability; (2) it must purport to be a return; (3) it must be an honest and reasonable attempt to satisfy the requirements of the tax law; and (4) it must be executed by the taxpayer under penalties of perjury. See Beard v. Comm’r,  82 T.C. 766 (1984). A return that is incorrect, or even fraudulent, may still be a valid return if “on its face [it] plausibly purports to be in compliance.” Badaracco v. Comm’r, 464 U.S. 386 (1984).

The only prong the CCA said was at issue was the third prong, that the return “must be an honest and reasonable attempt to satisfy the requirements of the tax law.”  As the taxpayer had been convicted of Filing False Claims with a Government Agency/Filing A False Income Tax Return, Aiding and Abetting, and Willful Attempt to Evade or Defeat the Payment of Tax, it is understandable why you would question if the returns were “an honest and reasonable attempt to satisfy the requirements of the tax law.”  Further, the Service had imposed the frivolous filing penalty under Section 6702, which only applies when the return information “on its face indicates that the self-assessment is substantially incorrect.”

The CCA notes, however, it is rare for courts to hold returns as invalid solely based on the third prong of Beard, but clearly there would be a valid argument for the taxpayers in this situation.  The CCA acknowledges that by stating “[t]o guard against the possibility that the returns are not valid, the Service should include the Section 6651(f) fraudulent failure to file penalty as an alternative position,” so the taxpayer could pick his poison.

As to the underpayment, Counsel highlighted that overstatements of withholding credits can give rise to an underpayment under the fraud penalty.  The definition was shown as a formula of Underpayment = W-(X+Y-Z).  W is the amount of tax due, X is the amount shown as due on the return, Y is amounts not shown but previously assessed, and Z is the amount of rebates made.  Where the refund was provided, the penalty could clearly apply.  In “frozen refund” situations, the Service has adopted the practice of treating that amount as a sum collected without assessment, which can cancel out the X and Y variables so no underpayment for the fraud penalty will exist.

But, as shown above, even if the fraud penalty may not apply, the Section 6651 penalty will likely apply if the return is invalid, or the frivolous position penalty under Section 6702 may apply.

Don’t File Your Collection Due Process Case Right Before the Statute of Limitations Expires

The case of United States v. Barbara Holmes provides an example of how a request for Collection Due Process (CDP) relief can extend the statute of limitations on collection and keep open the ability for the IRS to bring suit that might have otherwise expired.  Plaintiff’s attorney, who also happens to be her husband, may have made a reasonable decision to file the CDP request and the title of this post goes too far in suggesting that a taxpayer should never file a CDP request at the very end of the statute of limitations on collection; however, when the statute is short, careful thought about taking action, like making a CDP request or making an offer in compromise, must precede the request that will extend the statute of limitations on collection.

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The facts here demonstrate the dysfunction of the IRS more than the estate and bear discussion in analyzing what happened.

Mrs. Holmes is the executrix of the Estate of Shirley Bernhardt. The estate tax return was filed on July 16, 1998 and nothing in the opinion indicates that the return was untimely.  The estate tax return reported a liability of $700,024.34 which was remitted with the return.  The IRS audited the return, sent a notice of deficiency and eventually settled the Tax Court case.  As a result of the Tax Court case, on July 16, 2004, the IRS assessed an additional $233,309.20 plus interest; however, the assessment was erroneous because it failed to properly apply the state estate tax credit.  The opinion does state how the mistake was corrected but I expect that the IRS reduced the assessment with a partial abatement.  The remaining balance on the account at the time the IRS brought suit probably exceeded $200,000.

Although the opinion does not discuss it, I expect that the IRS properly issued notice and demand and then sent other letters in the notice stream. The opinion does state that on December 27, 2004, the IRS placed the case in the queue for collection by a revenue officer.  The opinion in this case comes from the Federal District Court in Houston causing me to believe that the collection case would have been assigned to a revenue officer group somewhere in southern Texas.   That group must be mighty shy of revenue officers because the case sat in the queue for approximately nine years.  The opinion does not state whether any payments occurred during that period or why the liability remained outstanding but on August 19, 2013, the opinion states that the IRS filed notices of federal tax lien in connection with the Estate’s unpaid taxes.

The filing of the notice of federal tax lien triggers the requirement that the IRS send to the taxpayer a CDP notice pursuant to IRC 6320 giving the taxpayer the opportunity for a hearing with Appeals and the opportunity to go to Tax Court, if Appeals issues a notice of determination.  The IRS has a lien under IRC 6324 for unpaid estate taxes that exists with full force without the need for the filing of a notice of federal tax lien. The IRS does not file a notice of federal tax lien for estate taxes but the estate tax lien expires after 10 years.  The IRS has the ability to file the notice of federal tax lien on the assessment it made after winning the Tax Court case.  Because of the gap here between the end of the estate tax lien in 2007 ten years after the death of the decedent and the filing of the notice of federal tax lien in 2013, the IRS placed the collection of the debt at risk to other creditors.  The actions regarding the collection of this debt suggest a high level of dysfunction in the collection division.

The opinion then says that the IRS sent to the taxpayer on September 27, 2013 the final notice of intent to levy. This notice would give the estate separate CDP rights and trigger its own 30-day period for filing a CDP request.  On October 5, 2013, the taxpayer sent to the IRS, by certified mail, a request for a CDP hearing.  That request clearly came within 30 days after the mailing of the levy notice and should have triggered a CDP hearing.  Assuming that nothing else had extended the statute of limitations on collection, the request for the CDP hearing also came during the 10th year after the assessment, at a time when there were about eight months left on the statute of limitations for collection.

When you get that close to the end of the statute of limitations on collection, you must carefully evaluate what you think will happen during the next eight months in order to decide if making the CDP request is in your best interest or if you think that letting the statute continue to march toward the end of the time period will bring the best result. There is no right answer because you do not know what the IRS will do during that eight months but you should have a very clear idea of what you expect to gain by bringing the CDP case if you go that route.

I do not know what benefit the taxpayer thought she might obtain by bringing the CDP case. She could not contest the underlying liability because the liability resulted from a Tax Court decision.  The one benefit I see to a CDP case in these circumstances is the ability to make an offer in compromise that you have the opportunity to have the Tax Court review if you think the IRS rejected it inappropriately.  I have written before that I think the IRS should not process offers in compromise from decedent’s estates for the same reasons it refuses to process offers from bankruptcy estates because a regime exists for contesting the non-payment of those types of liabilities.  Even though the IRS has not adopted my suggestion, getting an offer through on unpaid estate taxes can prove very difficult because of the personal liability of the executor and the existence of the like lien on the transferred property.

For some reason, Mrs. Holmes thought that brining a CDP case would prove beneficial; however, the IRS frustrated her attempt to obtain a CDP hearing. At the time of her request, the government was in the throes of one of the many government shut downs.  When the government shuts down, mail stacks up.  When mail stacks up, short cuts can occur in processing the mail when the disgruntled employees return from their paid time off.  For whatever reason, the CDP request was lost and this is where the case gets interesting.

The lost CDP request caused the general momentum on the case the IRS collection division was finally beginning to build to come to a standstill. The opinion does not say what happened between October 5, 2013 and May 2, 2014, just 10 weeks before the statute of limitations is set to expire if nothing suspends it.  On that day, counsel for the estate sent a letter to the IRS including a copy of the original CDP request from October 5, 2013.  Apparently, the May 2 letter did not convince the IRS that a timely CDP request was made by the estate because on June 2, 2014, counsel for the estate sent another letter to the IRS again arguing that the CDP occurred timely; however, this time he withdraws the CDP hearing request and instead asks for an equivalent hearing.

The estate sends a third letter on July 8 and on July 11, 2014, just five days before the statute of limitations would run on the 10-year period following assessment, the IRS sends the estate a letter saying it accepted the timely request for a CDP hearing. How nice.

The opinion does not say what happened as a result of the IRS accepting the CDP hearing request, but the parties must not have reached an agreement during the CDP process or this case would not exist. On March 10, 2015, the IRS filed suit against Mrs. Holmes individually, and in her capacity as executrix of the estate, and it filed suit against Mr. Holmes individually.  The estate argued that the suit was filed out of time.  The IRS argued that the estate’s timely request for a CDP hearing suspended the statute of limitations on collection and made the suit timely.

The Court found that the estate was estopped from making the argument that the misplacement of the CDP request by the IRS prevented the IRS from proving that the statute of limitations was suspended by that request. The Court ruled that the estate had a duty of consistency.  It had argued with the IRS and written to it several times that it had timely filed the CDP request and it could not argue that a timely CDP request did not exist.

“The elements of the duty of consistency are (1) a representation or report by the taxpayer; (2) on which the Commissioner has relied; and (3) an attempt by the taxpayer after the statute of limitations has run to change the previous representation or to recharacterize the situation in such a way as to harm the Commissioner.” Citing to Herrington v. Commissioner.

Because of its determination regarding the duty of consistency, the Court granted summary judgment with respect to the estate; however, the Court refused to grant summary judgment against Mr. and Mrs. Holmes in their individual capacities because of missteps the IRS had made with respect to the assessment. The estate may not have any funds remaining.  So, getting summary judgment against the estate provides a first step for the IRS to collect the unpaid estate tax liability but it may need to win the case against the individual defendants in order to collect the liability.  This could give further opportunity to report on the case.

No matter what the outcome, the filing of the CDP request during the final year of the statute of limitations on collection kept open the time frame for the IRS to bring this suit. Maybe the IRS would have brought the suit within the un-extended time frame.  We will never know.  The decision of the taxpayers to request the CDP hearing may have been the correct decision, but it is one that should occur only with a careful weighing of the perceived benefits against the granting to the government of additional time and the bringing to the government’s attention a case it has allowed to languish for almost 10 years.

Tax Court (Again) Sticks to Its Guns in Finnegan and Chooses Not to Revisit the Issue of Whether a Tax Return Preparer’s Fraud Indefinitely Extends the Statute of Limitations

Last week the Tax Court denied a motion to reconsider its decision in Finnegan v Commissioner. Earlier this year we discussed Finnegan in Tax Court Sticks to Its Guns and Holds Fraud of Preparer Can Indefinitely Extend Taxpayer’s SOL on Assessment. Finnegan is another of the handful of Tax Court cases that have held that the fraud of a tax return preparer can lead to an indefinite statute of limitations on assessment for the taxpayer. Whether a third party’s fraud can extend the statute of limitations is a hotly debated issue, both from a legal and policy perspective.

In this post, I will highlight why the Tax Court rejected the motion to reconsider its earlier decision.

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Last week’s order situated the issue:

At trial, petitioners could not remember or understand many of the entries on their returns, and instead contended that, without the return preparer’s testimony, respondent failed to prove that the entries were fraudulently made. The Court found that petitioners’ return preparer had in fact made fraudulent entries on petitioners’ returns with the intent to evade tax, and, relying on Allen v. Commissioner, 128 T.C. 37 (2007), held that the preparer’s fraud extended the statute of limitations.

As I discussed in my original post the taxpayers in Finnegan somewhat surprisingly did not argue that the 2007 Allen decision was wrongly decided. Recall that last year the majority opinion in the Court of Appeals for the Federal Circuit in the BASR Partnership case explicitly rejected the Tax Court’s approach in Allen. That opinion came out after the trial in Finnegan but almost a year before the Tax Court issued its opinion.

Instead the Finnegans focused their energies on whether there was a sufficient connection between the preparer’s fraud and the specific returns that the IRS subsequently examined. Even under Allen, it is not enough for the IRS to show that the preparer was crooked; IRS had the burden to show that the preparer’s fraud was connected to the specific returns at issue. For the most part, IRS prevailed on that in the original Finnegan decision, and the IRS was able to assess tax that would otherwise have been barred under a three-year statute of limitation.

After the loss, however, the taxpayers had a change of heart, and argued that the Tax Court’s Allen decision was wrong. In addition, the American College of Tax Counsel filed a motion for leave to file an amicus brief to assist the taxpayers (for more on the amicus process generally see Carl Smith’s discussion here). The order discusses the motion and memorandum filed in support of the motion:

In their Motion and Memo, petitioners contend, for the first time, that Allen was incorrectly decided. On July 29, 2015, the US Court of Appeals for the Federal Circuit issued BASR P’ship v. United States, 795 F.3d 1338 (Fed. Cir. 2015), in which the majority opinion of a three-judge panel criticized Allen and held that section 6501(c)(1) applies only when it is the taxpayer who commits fraud. Petitioners contend that BASR P’ship provides a “reason to justify relief” from our opinion because it is a “Court of Appeals [decision] that affects the decided issues “and shows that Allen constitutes an error of law.” T.C. Rule 1 (b); Fed. R. Civ. P. 60(b); Ritter v. Smith, 811 F.2d 1398, 1401 (11th Cir. 1987).

Key to the argument is the BASR Partnership case. Guest poster Robin Greenhouse discussed BASR Partnership in Whose Intent to Evade Tax Is It? The order discusses BASR and, as the original opinion stated, emphasizes that a federal circuit opinion is not binding precedent on the Tax Court. The order goes on to distinguish BASR on the facts, minimize its application and at the same time remind the litigants how difficult the standard is to get a judge to reconsider an earlier opinion, especially when there was a chance to raise the argument earlier (for more on requesting reconsiderations, see Keith’s Motion for Reconsideration).

As to the factual distinction, the order notes that in BASR the fraud was not of a return preparer but it involved a partnership and an advisor, and the special SOL applicable in TEFRA proceedings, an important consideration in the BASR concurring opinion. Moreover, the order notes that there were no allegations in BASR that either the return preparer or the taxpayer knew of the fraud and that there was a dissenting and concurring opinion, suggesting that there was “no consensus even among the three judge panel that Allen was incorrectly decided.”

As to the reconsideration process, the order states that it “is an extraordinary remedy and is not a substitute for an appeal.” The order notes that the litigants failed to raise the argument that Allen was wrongly decided until after the Tax Court issued its opinion and only did so for the first time in its reconsideration motion:

Additionally, it would be improper to grant the Motion on procedural grounds. A motion for reconsideration is not the proper mechanism by which to raise new legal theories. Robin Haft Trust, et al. v. Commissioner, 62 T.C. 145. Petitioners, who were represented at trial, failed to challenge Allen despite having multiple opportunities to do so. Although the appeal of BASR P’ship had not been decided at the time of trial and briefing, the Court of Federal Claims decision in BASR P’ship, 113 Fed. Cl. 181 (2013), had been. Yet it was respondent, not petitioners, who noted the case in his brief. The Model Rules of Professional Conduct did not prohibit petitioners from challenging Allen at that time, because the argument could have been made in good faith. It was also respondent who alerted the Court when the decision of the Federal Circuit on appeal was issued. Although an additional 11 months passed before this Court issued its opinion in the instant case, petitioners still failed to challenge Allen at that time.

Parting Thoughts

In light of the above, the Tax Court rejected the motions for reconsideration and the ACTC’s motion for leave to file an amicus brief. It seemed as if the taxpayers in Finnegan may have missed an opportunity to get a fresh look at the Tax Court’s controversial Allen decision. If they appeal and raise the issue in their appeal it is possible that the 11th Circuit (where an appeal would lie) would not allow them to raise the new argument. Generally, appeals courts do not take kindly to a new argument raised for the first time on appeal, though appellate courts have considerable discretion to allow arguments (a brief though somewhat dated primer on the topic from Aaron Bayer  in the National Law Journal gives some rules of thumb on this).

Even if Finnegan cannot raise the issue on appeal, there is little doubt that other courts will be weighing in on this issue. As we have discussed before, there are plenty of taxpayers who have had returns prepared by crooked preparers. As years and interest pile on, for unsophisticated taxpayers an unlimited SOL and IRS pursuit could mean substantial liabilities. That an attempted amicus, the American College of Tax Counsel, joined this scrum suggests a recognition of the importance of this issue to tax administration (Disclosure: Keith and I are fellows of the ACTC but had no role in motion for leave to file an amicus or the motion for reconsideration).

A final thought. For those who want some more on this topic, I discussed the merits more robustly and provided links to some helpful sources after the Court of Federal Claims decided BASR in Court of Federal Claims Holds that Agent’s Fraud Does Not Extend Statute of Limitations.

 

Tax Court Sticks to Its Guns and Holds Fraud of Preparer Can Indefinitely Extend Taxpayer’s SOL on Assessment

When a taxpayer commits fraud it is black letter law that the statute of limitations (SOL) on assessment remains open indefinitely. In the last decade or so IRS has taken the fraud issue one step further, essentially arguing that a third party’s fraudulent conduct that is connected to the taxpayer’s tax return can also indefinitely extend the taxpayer’s SOL. IRS has used this argument both in the context of sophisticated taxpayers engaging in advisor-created mind-numbingly complex tax shelters and in simple cases where preparers are goosing Schedule C deductions.

IRS has cracked down on crooked preparers, and in doing so it often pulls those preparers’ returns. Because fraud is difficult to both detect and prove (and at times the preparers do not sign the returns they prepare), it takes a long time for IRS to track down the crooked preparers’ tax returns. The upshot is that absent the indefinite SOL when IRS does track down the returns IRS is out of luck. On the other hand, as SOLs are meant to provide some finality an indefinite SOL can provide the tools for a crippling assessment with years of interest on top of civil penalties.

As we have previously discussed, the courts are split on whether a third party’s conduct can extend the taxpayer’s SOL. For example, in 2007 the Tax Court in Allen v Commissioner held that the third party’s fraud extends the taxpayer’s SOL; in 2015, a divided opinion the Court of Appeals for the Federal Circuit in BASR v Commissioner rejected the Tax Court’s Allen approach. Guest poster Robin Greenhouse discussed BASR in PT here; I discussed the lower court’s BASR opinion here.

This very issue presented itself in last week’s Tax Court case Finnegan v Commissioner. In this post I discuss that case and offer some observations.

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The Finnegan Facts

In Finnegan v Commissioner the taxpayers were a plumber and an employee of a community college who owned a rental property in Daytona, Florida they purchased in 1988 for $60,000. After their longtime preparer moved, they hired a new preparer, Duane Howell, who gave the following advice intending to allow the Finengans the opportunity to shelter the income from the rental property:

Mr. Howell advised petitioners that they should form a partnership to report their rental activity. Mr. Howell incorrectly explained that forming the partnership would allow petitioners to contribute moneys they received from the condo rentals to a Keogh/self-employment retirement plan account. With Mr. Howell’s help, petitioners formed a partnership named “Jomarjen”, which appears in every Schedule E, Supplemental Income and Loss, of petitioners’ Forms 1040, U.S. Individual Income Tax Return, for the years in issue.

Petitioners did not draft a partnership agreement for Jomarjen, and the filing address for the partnership return changed from year to year. Other than creating Jomarjen, petitioners did not change anything concerning the operation of their rental investment. Condo Rentals of Daytona continued to manage the renting of the condo and made payments of the rental revenues to petitioner Joan Finnegan, issuing her Forms 1099-MISC, Miscellaneous Income, rather than to Jomarjen. If, for any reason, petitioners communicated directly with their tenants, they did so individually, and not as Jomarjen. Petitioners never transferred title of the condo to Jomarjen. Petitioners never wrote checks to Jomarjen and Jomarjen never wrote checks to petitioners. Petitioners did not have a separate office for their condo rental activity.

The Tax Court described the scheme further:

[T]he Finnegan’s ] Forms 1040, Schedules E for tax years 1997, 1998, 1999, 2000, and 2001 show Gannan Co. in addition to Jomarjen. Gannan Co.’s partnership returns report petitioners as the sole partnership owners. At trial petitioners testified that they did not know what Gannan Co. was, that they learned the name only after the examination of their returns, and that it does not exist. Petitioners also testified that after following Mr. Howell’s advice, their tax returns became very thick and they received larger refunds than in years past.

While Howell did not testify in the Finnegan trial, there was testimony from one of Howell’s associates and an IRS Special agent. In addition, the IRS was also able to get into evidence an affidavit from Howell and Howell’s testimony in a prior criminal trial of another of Howell’s associates. The evidence showed that Howell was preparing 750 or so returns per year with a pattern of conduct that included false partnerships and falsified income to allow Keogh contributions. In addition, he did not sign the returns as preparer, instead using of fake entity names to mask his identity.

The Finnegans’ returns fit the pattern on Howell’s clients. IRS after extending significant resources on Howell’s prosecution examined the Finnegans’ 1994-2001 returns. IRS stipulated that but for Allen v Comm’r, the SOL on assessment had expired.

The SOL Remains Open

In Finnegan, the Tax Court reaffirmed its commitment to Allen, stating  the following at note 6:

We see no reason to revisit Allen v. Commissioner, 128 T.C. 37 (2007), on account of BASR P’ship v. United States, 113 Fed. Cl. 181 (2013), aff’d, 795 F.3d 1338 (Fed. Cir. 2015). In the Court of Appeals for the Federal Circuit’s opinion, a persuasive dissent was filed, as well as a concurring opinion that relied on sec. 6229, a provision inapplicable in the instant case. Accordingly, even in cases appealable in the Federal Circuit, it is unclear whether, in the absence of the application of sec. 6229, which interpretation of sec. 6501(c)(1) would prevail. Moreover, there is no jurisdiction for appeal of any decision of the Tax Court to the Court of Appeals for the Federal Circuit. Sec. 7482(a)(1). Additionally, the parties have not cited BASR P’ship and do not contend we should revisit Allen. Thus, Allen is controlling precedent in the instant case, and we do not revisit the analysis and conclusion in that Opinion.

Jack Townsend in his Federal Tax Crimes blog discusses the Finnegan case here and observes that the case highlights the importance of forum choices, with the Court of Federal Claims offering the best option for taxpayers (though Flora requires full payment for that forum). As an aside, Jack has been all over this issue, and in my view has persuasively made the case why the Tax Court approach in Allen is wrong (see here), as has Bryan Camp, in a 2008 Tax Notes article here.

Some Observations

I find it interesting that Finnegan did not cite to City Wide in its note 6 discussion of why it was not revisiting Allen. It suggests perhaps that the Tax Court took a cautious view of the Second Circuit’s opinion’s reach. In City Wide Transit, the Second Circuit seemed to bless the view that a third party’s fraud can extend the sol, though as Jack Townsend has discussed, the precedential effect of City Wide is suspect due to taxpayer concessions on the issue.

Given Finnegan’s  concession on Allen as discussed in note 6 above, it is not clear to me that this case will be the vehicle for situating a more defined circuit split on the issue. In Finnegan, as note 6 states, the taxpayers did not argue that the Tax Court was wrong in Allen (analogous perhaps to the taxpayer concession in City Wide) but focused its SOL argument on the issue as to whether the IRS was able to sufficiently connect the preparer’s fraud to the taxpayer’s return in question.

The focus in Finnegan thus was on a secondary though important issue: just because a third party engages in some fraudulent activity does not lead to an automatic poisoning of the return. A case in point in Eriksen v Commissioner, which I discussed in my BASR post a couple of years ago:

An example of a different this issue coming up in less sophisticated matters is  Eriksen v Commissioner, a memorandum Tax Court decision from 2012, which involved low dollar phony Schedule C expenses claimed by employees of the Oakland County Sheriff Department. The taxpayers in Eriksen used preparers who plead guilty to aiding and assisting in the preparation of a false federal income tax returns in violation of Section 7206(2). In Eriksen, the Tax Court applied Allen to find that a preparer’s fraud could extend the statute, but held the IRS had not met its burden to show that that the preparer’s actions in the particular returns at issue amounted to fraud rather than negligence. In other words, a preparer’s fraud on some returns was insufficient to taint other returns, even if those other returns had errors of the type that were implicated in the criminal case against the preparers.

In distinguishing Eriksen the Tax Court in Finnegan dug a bit deeper. In fact, Eriksen involved six taxpayers whose returns were prepared by convicted preparer and the Tax Court found for the taxpayer in five of the six taxpayers. The IRS was successful, however, in arguing that the statute was extended for one of the taxpayers in that case in part because the IRS was able to prove at trial that the errors on the sixth return were of the type that were of the type that were the subject of the crime and the sixth taxpayer herself testified that she did not incur the expenses on the return.

The taxpayer in Finnegan hung his hat on Eriksen, but the last week’s opinion finds that the facts in Finnegan were more like the unlucky sixth Eriksen taxpayer than the first five:

Petitioners contend that Eriksen stands for the proposition that, to establish fraud, the Commissioner must prove a “direct link” between the commission of fraud and a taxpayer’s return. Petitioners strongly imply that the only way to establish such a direct link is through the preparer’s testimony. In Eriksen, the Commissioner established the existence of fraud by matching the incorrect information on the taxpayer’s return to the preparer’s modus operandi. In other words, even taking petitioners’ contention into account, there are ways of providing an evidentiary link that do not involve a preparer’s specific testimony as to a particular taxpayer.

Petitioners also contend that their circumstances are similar to those of the first five Eriksen taxpayers because, without a connection or direct link between Mr. Howell’s wrongdoing and petitioners or their partnerships, respondent’s evidence rises only to the level of “a suspicion of fraud”. We do not agree. Respondent has already shown that petitioners’ returns include significant errors, namely, Jomarjen’s gross income above and beyond the revenues collected by Condo Rentals of Daytona and the Gannan Co. partnership’s entries on petitioners’ returns. Respondent provided additional testimony that identified specific figures in petitioners’ returns, e.g., $4,896, which were frequent fabrications of Howell’s. Additionally, the preparer in Eriksen testified in his plea allocution that not all returns he prepared were fraudulent. Id. at *4. Mr. Howell testified that every return he prepared included at least some fraudulent entries, and because of these false entries, was “dirty”.

Finnegan now sits in the pantheon of cases that should give taxpayers caution when hiring a return preparer. When something is too good to be true, the preparer’s shenanigans can come back to haunt a taxpayer years after the fact. With the passage of time small tax savings can multiply to sizeable deficiencies due to interest and penalties. No doubt other courts will be weighing in on the IRS’s attempts to reach taxpayers who benefitted from preparer misconduct, and I would not be surprised if this issue eventually is before the Supreme Court.

Update: An earlier version of this post indicated that this case was appealable to the Second Circuit. While the taxpayers lived in NY at the time the returns at issue were filed, in 2003 they moved to Florida, where they resided at the time they filed the petition in this case. Absent stipulation, this case is appealable to the 11th Circuit. 

 

Adams v. Comm’r: How Not to File an Appeal from the Tax Court

Carl Smith discusses the challenges that pro se taxpayers faced in trying to timely file an appeal of a Tax Court case. Les

On May 20, 2016, through an unpublished order in Adams v Commissioner, the Fourth Circuit dismissed for lack of jurisdiction an untimely appeal from a Tax Court deficiency case. Adams presents a veritable law school exam question of how not to file a timely appeal. The pro se taxpayers in the case tried multiple ways to file a timely appeal, but to no avail. This case provides a convenient review of what you can and cannot do to file a timely appeal from the Tax Court. But, in this post, I also raise the question whether the Fourth Circuit was correct in dismissing the untimely appeal from the Tax Court for lack of jurisdiction; I think the dismissal should have been on the merits, though there was little practical difference in this case either way.

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Adams Facts

Substantively, the Adams case was not likely to prevail on the merits, anyway. The Adamses had omitted from their 2010 income tax return part of the qualified plan distributions that the husband took after he was discharged from his Defense Department job and could not find replacement work. So, the IRS sent the Adamses a notice of deficiency seeking income tax on the underreported distributions, as well as a § 72(t) 10% penalty for early withdrawal and a 20% accuracy-related penalty on the deficiency. In response, the Adamses timely filed a pro se Tax Court petition.

On August 17, 2015, the Tax Court issued its opinion at T.C. Memo. 2015-162, holding that it could not exempt the taxpayers from taxation on the distributions under some undefined equitable exception that the taxpayers sought on the ground that the husband’s discharge was discriminatory. At trial, the Adamses were afforded an opportunity, at least, to substantiate any medical expenses that might have reduced the 10% penalty, but the taxpayers did not do so, contending that the receipts were too voluminous to produce and too expensive to photocopy. So, the court sustained the § 72(t) penalty in full. The court also found a substantial understatement of tax as to which there was no reasonable cause and good faith, so it sustained the accuracy-related penalty in full.

On August 26, 2015, the Tax Court entered its decision consistent with the opinion.

On September 2, 2015, the taxpayers tried to electronically file in the Tax Court a notice of appeal, but since there is no tab on the court’s electronic filing system for a notice of appeal, they filed the notice of appeal under the “memorandum” tab.

On September 4, 2015, the Tax Court issued an order striking the attempted filing and pointing out to the taxpayers that a notice of appeal is one of the documents that must be filed with the Tax Court on paper, not electronically. The court’s order also noted that, under Tax Court Rules 161 and 162, respectively, unless otherwise permitted by the court, a motion for reconsideration of an opinion had to be filed within 30 days of the service of the opinion, and a motion to vacate a decision had to be filed within 30 days of the entry of the decision.

On September 16, 2015, the taxpayers filed a timely motion for reconsideration of the opinion under Rule 161 – again arguing for an equitable exception to taxation of the distributions. In an order dated September 29, 2015, but served on September 30, 2015, the Tax Court denied the motion.

On October 12, 2015, the taxpayers filed a motion for a new trial that was stamped denied on October 16, 2015.

On November 23, 2015, the taxpayers again tried to file a notice of appeal electronically in the Tax Court under the memorandum tab. On November 24, 2015, the Tax Court issued an order striking the attempted filing and again pointing out to the taxpayers that a notice of appeal is one of the documents that must be filed with the Tax Court on paper.

On November 24, 2015, December 11, 2015, and December 19, 2015, the taxpayers again electronically filed various papers under the memorandum tab. On January 5, 2016, the Tax Court issued an order striking the attempted filings and again pointing out to the taxpayers that a notice of appeal is one of the documents that must be filed with the Tax Court on paper.

According to a DOJ filing on November 30, 2015, the taxpayer attempted to file a paper notice of appeal with the Fourth Circuit, but no case was set up. An appeals court is the wrong court in which to file a notice of appeal from the Tax Court. The notice of appeal must be filed with the Tax Court.

On January 12, 2016, the taxpayer finally filed with the Tax Court a paper notice of appeal to the Fourth Circuit. As a result of this filing, the Fourth Circuit established a docket for the appeal, Docket No. 16-1043.

DOJ Arguments

In the Fourth Circuit, the DOJ argued that the appeal should be dismissed for lack of jurisdiction as untimely for several reasons:

First, the normal rule is that an appeal is timely filed if it is filed on paper with the Tax Court within 90 days of entry of the decision. § 7483, FRAP Rule 13(a)(1)(A); Tax Court Rule 190(a). Ninety days from the entry of decision was November 24, 2015, yet the notice of appeal was filed with the Tax Court on paper only on January 12, 2016. Therefore, absent something that extended the period, the filing was untimely.

Second, the timely filing of a motion to vacate under Tax Court Rule 162 could have extended the time to appeal. Under FRAP Rule 13(a)(1)(B), the 90-day time to appeal would commence anew on the date an order was entered by the Tax Court denying such motion. However, the taxpayers never filed such a motion to vacate the decision.

Third, there is a bit of disagreement among the Circuit courts as to whether the filing of a timely motion to reconsider an opinion under Tax Court Rule 161 can serve to extend the time period to appeal. FRAP Rule 13(a)(1)(B) does not expressly provide for tolling in that situation. The Ninth Circuit in Nordvik v. Commissioner, 67 F.3d 1489, 1493 (9th Cir. 1995), has held that a timely Tax Court Rule 161 motion tolls the appeal period. The Tenth Circuit reached the opposite conclusion in Mitchell v. Commissioner, 283 Fed. Appx. 641, 644 (10th Cir. 2008), observing that it “has never given tolling effect in a tax appeal to a motion for reconsideration, which is not mentioned in Rule 13.” In Spencer Med. Assocs. v. Commissioner, 155 F.3d 268, 269-271 (4th Cir. 1998), the Fourth Circuit declined to address the issue whether a timely Tax Court Rule 161 motion for reconsideration tolls the appeal period, since the motion for reconsideration there was untimely and thus would not have tolled the appeal period in any event.

The DOJ argued in Adams that the better view was that a motion for reconsideration does not extend the time to appeal from the Tax Court. However, even though the motion in this case was timely filed, it was denied on September 29, 2015. Ninety days after that date was December 28, 2015. Yet the appeal was only properly filed on January 12, 2016, so the notice of appeal would have been late, even if the motion for reconsideration’s denial restarted a 90-day appeal period.

Fourth, FRAP Rule 4(d) states: “If a notice of appeal in either a civil or a criminal case is mistakenly filed in the court of appeals, the clerk of that court must note on the notice the date when it was received and send it to the district clerk. The notice is then considered filed in the district court on the date so noted.” However, the mistaken filing in the Fourth Circuit by the taxpayers here on November 30, 2015, was not with respect to an appeal from a district court. So, FRAP Rule 4(d) did not apply, and there was no comparable rule for appeals from the Tax Court. In any case, even if one could file a notice of appeal from a Tax Court decision in a Court of Appeal under a rule similar to FRAP Rule 4(d), the November 30, 2015 filing was 6 days late – i.e., 6 days beyond the 90-day period starting from the date of the Tax Court decision herein (August 26, 2015).

Finally, the DOJ argued that the 90-day period in section 7483 in which to file an appeal from the Tax Court is jurisdictional. Therefore, it cannot be extended for equitable reasons – i.e., it cannot be equitably tolled, even if the taxpayers could prove the necessary facts for tolling. Timely filing an appeal in the wrong forum is often a ground for equitable tolling of nonjurisdictional filing periods. See Mannella v. Commissioner, 631 F.3d 115, 125 (3d Cir. 2011). The DOJ did not want the taxpayer to be able to argue that timely filing the notice of appeal in the Tax Court by the wrong method (electronically) could be excused under equitable tolling.

Fourth Circuit’s Ruling

The Fourth Circuit, in an unpublished opinion, did not discuss each of the arguments that the DOJ raised. Instead, it wrote merely:

A notice of appeal from a decision of the tax court must be filed within ninety days after the decision is entered. 26 U.S.C. section 7483 (2012); Spenser Med. Assocs. v. Comm’r, 155 F.3d 268, 269 (4th Cir. 1998). The timely filing of a notice of appeal is a jurisdictional requirement. Bowles v. Russell, 551 U.S. 205, 213-14 (2007).

The tax court’s order was entered on the docket on August 26, 2015. The notice of appeal was filed on January 12, 2016. Because taxpayers failed to file a timely notice of appeal, and because this jurisdictional appeal period is not subject to equitable tolling, see Bowles, 551 U.S. at 214, we dismiss the appeal.

Observations

On these facts, the court clearly made the right decision to dismiss the appeal, but I question whether the appeal should have been dismissed for lack of jurisdiction. I believe that it should have been dismissed on the merits. This wouldn’t make a material difference in this case, but it could have in a different case where, say, a taxpayer filed a timely notice of appeal in the Circuit court (the wrong place) and so wanted to argue for equitable tolling.

In my opinion, the 90-day time period in § 7483 to file an appeal from the Tax Court is not jurisdictional and is subject to equitable tolling under the right facts under the current Supreme Court case law on jurisdiction and equitable tolling that Keith and I have repeatedly cited in PT posts in recent years. See, e.g., my post on Volpicelli v. United States, 777 F.3d 1042 (9th Cir. 2015)

As you know from prior posts here, here, and here, Keith and I are in the midst of litigating test cases in the Tax Court and the Ninth Circuit in which we argue that the time periods in which to file Tax Court petitions in Collection Due Process cases under § 6330(d)(1) and in stand-alone innocent spouse cases under § 6015(e)(1)(A) are not jurisdictional and are subject to equitable tolling under recent, non-tax Supreme Court case law. We are seeking to overturn existing Tax Court precedent, which has not considered the recent Supreme Court case law. Under that case law, such as Musacchio v. United States, 136 S. Ct. 709 (2016); United States v. Wong, 135 S. Ct. 1625 (2015); Sebelius v. Auburn Regional Med. Cntr., 133 S. Ct. 817 (2013); and Henderson v. Shinseki, 562 U.S. 428 (2011), time periods to file in court are no longer considered jurisdictional unless Congress has clearly stated a preference that the time period be jurisdictional. The Court has noted, under the current rule, “the rarity of jurisdictional time limits”; Wong, supra, at 1632; and stated, “This Court has often explained that Congress’s separation of a filing deadline from a jurisdictional grant indicates that the time bar is not jurisdictional.” Id. at 1633. The only exception to this rule is that, so as not to overturn the expectations of Congress, for stare decisis reasons, the Supreme Court will ignore its current case law if there exists a string of Supreme Court authority on the exact statutory time period going back 100 years or more holding the time period jurisdictional.

The current Supreme Court jurisdictional rules show that the 90-day period under § 7483 to file an appeal from the Tax Court is not jurisdictional. Congress has not clearly stated in § 7483 that the period is jurisdictional. For example, there is no provision in § 7483 that speaks to the jurisdiction of the appeals courts. Indeed, the jurisdictional grant to Circuit courts to hear appeals is elsewhere, at § 7482(a)(1), and contains no references to a time period in which to file.

Then, what of the Fourth Circuit’s citation of Bowles v. Russell, 551 U.S. 205 (2007), in support of its Adams holding that the time in which to file an appeal from the Tax Court is jurisdictional? In Bowles, the question was whether the 30- and 60-day periods under 28 U.S.C. § 2107(a) and (b) in which to file appeals from the district courts in civil cases were jurisdictional. 28 U.S.C. § 2107(c) allows the district court to extend the time to file an appeal for up to 14 days in certain circumstances. In the case, a district court accidentally issued an order extending the time to file an appeal by 17 days, and the appellant relied on that order to his detriment. Only because the Court has for over 100 year had held the § 2107 appeal period jurisdictional did the Court stick with that holding. Since I can locate no Supreme Court opinion holding that the § 7483 period in which to file appeals from the Tax Court is jurisdictional, there is no stare decisis exception available to the current case law that generally makes filing deadlines nonjurisdictional.

The § 7483 time period is also likely subject to equitable tolling, since it is more akin to the simple 1-year period under 28 U.S.C. § 2244(d) to file for death penalty habeas review in district court that was held subject to equitable tolling in Holland v. Florida, 560 U.S. 631 (2010), than it is like the complex, multi-exception time periods under § 6511 to file tax refund claims that was held not subject to equitable tolling in United States v. Brockamp, 519 U.S. 347 (1997).

Precedential case law from various Circuits, including the Fourth Circuit, that has held the Tax Court appeals period to be jurisdictional generally predates and always lacks discussion of current Supreme Court case law on jurisdiction and equitable tolling. Such case law as Spencer Med. Assocs. v. Commissioner, 155 F.3d 268, 269 (4th Cir. 1998); Okon v. Commissioner, 26 F.3d 1025 (10th Cir. 1994), and Davies v. Commissioner, 715 F.2d 435 (9th Cir. 1983), is ripe for overruling.