Court Rules Abusive Tax Shelter Penalty Has No SOL; Laches Also Not A Defense

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Groves v US involves a taxpayer who was assessed over $2M in penalties for failing to register transactions as tax shelters. The penalties stemmed from conduct in years 2002, 2004 and 2005, but the IRS did not assess the penalties until 2015. Groves argued that the IRS assessments, coming over a decade after the conduct that gave rise to the penalty, was too late. The federal district court for the Northern District of Illinois disagreed.

I will briefly explain the opinion below.

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Under statutory procedures that allow for a refund claim following partial payment of the tax shelter penalty, Groves paid 15%, and filed a refund claim alleging that the penalty was assessed outside the normal three-year statute of limitations under Section 6501(a) or a 5-year SOL under Title 28 that applies to civil penalties. He also alleged in the alternative that the doctrine of laches barred the government from assessing the penalty for conduct that stretched back the better part of a decade.

After IRS denied the claim, Groves filed suit in federal district court. The court agreed with the IRS, holding that the penalty under Section 6700 for failing to register a tax shelter was not subject to the normal statute of limitation scheme and that laches was of no help.

We are in the process of finishing the new chapter in Saltzman and Book on statutes of limitation (SOL); it should be out in the fall (with this chapter will mark the rewriting of all original 18 chapters in the book, with a new 19th chapter on CDP). In the SOL chapter we discuss the odd intersection of civil penalties and SOL issues. Many penalties are not subject to readily observable statutes of limitations. For civil penalties that are not “return-based” penalties, courts have increasingly found that those penalties are not subject to any statute of limitations.

What are non return-based penalties? The key feature is that the conduct that gives rise to the civil penalty is not tethered to the filing of a tax return; in other words, as in Groves, what triggered the liability was the conduct of promoting tax shelters and failing to inform the IRS of his promotion rather than the filing of a return.

Groves argued that because the Code states that the 6700 penalty is to be assessed and collected in the same manner as taxes it should thus be subject to the general SOL rules as per Section 6501(a). The opinion disagreed:

Section 6700 assessments do not depend on the filing of a tax return,” but rather “occur … after the IRS becomes aware that an individual’s activities are prohibited by Section 6700.” The mismatch between the triggering event under § 6501(a)—the taxpayer’s filing a return—and the basis for liability under § 6700—being involved in a tax shelter and making false statements about its benefits—makes the § 6501(a) limitations period an inappropriate fit for the assessment of § 6700 penalties.

Groves countered that there was a return at issue, that is, the individuals who took up his advice and filed returns taking positions consistent with his shelter advice. The court emphasized that the penalty under Section 6700 only looked to whether promoter makes “a statement that falsely touts the shelter’s tax benefits.”

The court also addressed 28 USC § 2462, a non-tax law based SOL that applies to civil penalties. That statute states that “[e]xcept as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued ….”

The opinion concluded (as have other courts) that the IRS assessment of a 6700 penalty does not arise from “an action, suit or proceeding” because the IRS assessment arises from in the court’s view an ex parte act rather than an adversarial adjudication. Adjudicative action is a prerequisite to the 28 USC § 2462 SOL applying. As support, the court emphasized that Groves had no right to any pre-assessment administrative adjudication of the penalty, and a number of courts have held that the assessment itself was agency conduct not in the nature of an action or suit for these purposes. Groves served up a number of other creative § 2462 arguments, but the court rejected them, largely on the grounds that the IRS imposition of the penalty was not in any way based on a hearing or other adversarial procedures.

Finally, the court considered whether laches applied. Laches is an equitable defense that gives the court the power to hold that a legal right or claim will not be enforced if a party unreasonably delays in bringing the claim and the delay prejudices the other party. There is uncertainty as to whether a laches claim can be made against the government in tax cases. A Fifth Circuit case, Sage v US, after concluding that no SOL applied to the 6700 penalty, stated in dicta that the doctrine was the only curb on IRS assessment power.

Groves is appealable to the 7th Circuit, and the district court noted that the circuit had not held whether laches is available as a defense to a government tax suit. (for an interesting discussion of laches, including its history, see Judge Posner’s discussion in the 7th Circuit Lantz case from 2010). Groves concluded that laches is probably not a defense in tax cases, and that even if laches were an available defense it only applied in narrow circumstances that were not present in the case. One of the circumstances is when there is an egregious delay. On that point  the court pointed to a 2005 Second Circuit case, Cayuga Indian Nation v Pataki. In Cayuga, the US intervened on behalf of the tribe in an ejectment action that stemmed from conduct over 200 years old and pertained to actions surrounding a treaty signed in 1795. Unlike Cayuga, “this case, by contrast, involves a delay of just over ten years. Although ten years is not an instant, the difference between a ten-year delay and a 200-year delay is one in kind, not of degree.” Another circumstance where laches may apply is when the government action pertains to an adjudication of private rights. As to that circumstance, the court noted that “few areas of government activity are more canonically sovereign than taxation.”

Parting Thoughts

It does to me seem odd that the government has no limits on when it can assess these (and some other) penalties. Over the last couple of decades there has been a vast increase in the number of civil penalties in the Code. When Congress gets around to revising the civil penalty regime, it would be well served to look at these non return based penalties and impose some outside limits on when the government can  assess these penalties.

 

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

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