Legitimate Claim of 5th Amendment on Tax Return Should not Result in Frivolous Return Penalty

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Tax Court Judge Holmes issued an order on November 6, 2015, holding that a petitioner’s claim of privilege under the 5th Amendment does not form the basis for assertion of the frivolous return penalty.  I have written before on this penalty which is imposed under IRC 6702(a)(1).  As required to implement this statute, the IRS publishes a list of frivolous positions but may assert the penalty for reasons that go beyond its own list.  Here it asserted the penalty based on one of the items on the list.  Citing the 5th amendment on a tax return is something that a tax protestor might do which is why such an assertion makes the list, but it is also something that someone with a legitimate fear of prosecution should do.  The employees at the Service Center will have a difficult time distinguishing between legitimate and frivolous assertions of the 5th amendment just looking at the return.  I suspect they generally default to presuming every assertion of the 5th amendment is a tax protestor tactic.   The Youssefzadeh case provides an example of the appropriate use of the 5th amendment privilege and the inappropriate use of this penalty.  The issue comes up in a collection due process (CDP) case which is also interesting because of the many posts we have had on when taxpayers can raise the merits of an assessable penalty in a CDP case or whether the opportunity to go to Appeals to contest the penalty bars the taxpayer from raising it in the CDP context.  For those with a subscription to Tax Notes, see Ajay Gupta’s excellent post on this case on November 17, 2015, which focuses much more on the background of the FBAR civil and criminal penalties.   Jack Townsend discusses this case as well in a good post summarizing the order in his Federal Tax Crimes blog.

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On Schedule B of his 2011 return Mr. Youssefzadeh asserted his 5th amendment right not to incriminate himself.  After the IRS assessed the frivolous return penalty, it began sending the collection notices including the notice of intent to levy.  He sent the IRS a request for a CDP hearing and raised the correctness of the assertion of the penalty in his circumstances.  The appeals officer upheld the imposition of the penalty in the determination letter and Mr. Youssefzadeh filed a Tax Court petition.  As frequently happens in CDP cases, the IRS filed a motion for summary judgment.  In a much less frequent occurrence, petitioner filed a cross motion for summary judgment.  Petitioner here had sophisticated representation from the Beverly Hills firm of Hochman, Salkin, Rettig Toscher & Perez, which many CDP petitioners do not.  Because the Court decides the case on the basis of the motions for summary judgment, the decision comes out in the form of an order rather than in the form of an opinion.

A few interesting aspects of the CDP case cause me to stop before going further with the case to comment on the proceeding.  Mr. Youssefzadeh filed his petition on June 25, 2014.  On May 27, 2015, the Court sent the notice of trial setting the trial on October 26, 2015.  The IRS did not file its motion for summary judgment until 14 months later on August 27, 2015, the last day to file a motion for summary judgment under the Tax Court Rule 121 which was revised in 2011 to prevent summary judgement motions at the last minute.  Because the case went through Appeals before the petition, the case was with Chief Counsel’s office for over 14 months before it decided to file the motion for summary judgment.  The staffing problems within Chief Counsel’s office undoubtedly contributed to the delay but this points out why CDP cases take so long to resolve.  Even though Congress seemed to expect an expedited process by giving the taxpayer only 30 days to request a CDP hearing and only 30 days to petition the Tax Court, as a practical matter those two points where the taxpayer must act quickly remain the only points during which the CDP process receives expedited treatment.  Carl Smith and I wrote about this several years ago detailing the time these cases spend in Appeals and the Court and the system does not seem to have changed.

Because petitioner lived in California at the time of filing the petition and because he contested the merits of the liability, venue for appeal in this CDP case is the 9th Circuit.  The 9th Circuit, in the case of Keller v. Commissioner is one of the Circuits that has limited the Tax Court to the administrative record in CDP cases.  Since the Tax Court is limited to the administrative record pursuant to the application of the Golsen rule, Judge Holmes issued an order on July 27, 2015, ordering the parties to stipulate to the administrative record by September 25, 2015.  I had not seen an order like this before because I do not practice in a circuit that has limited the Tax Court to the administrative record.  The order seems like a great way to cause the parties to prepare for the hearing.  I would be interested to hear how the order works.

Here the joint motions for summary judgment eliminated the need for a trial of the case.  The petitioner filed the 2011 return filling out “most of the lines in a normal fashion.”  On Schedule B where he had to report dividends and interest he did not answer some of the questions and instead invoked his 5th amendment privilege against self incrimination.  The opinion states that “the IRS warned that it would assess a frivolous return penalty against him unless he filed a return with all of the required information.”  I imagine that this warning came from the Service Center as it processed the return but that is not clear.  Whatever part of the IRS that made the request, petitioner refused to fill in the lines where he had invoked the 5th amendment.  The case sets up the issue in simple fashion because Mr. Youssefzadeh’s argument was simply that he had a valid 5th Amendment claim, he had no desire to waste the time of the IRS but also no desire to incriminate himself by putting the missing information on the return.  Does a valid assertion of the 5th amendment on the return allow the IRS to assert a frivolous return penalty or is a valid assertion of the right to not incriminate oneself also a basis for the IRS to assess a civil penalty.

To successfully assess a frivolous return penalty, the IRS must show three things: (1) the document purports to be a return; (2) the return omits enough information to keep the IRS from judging the substantial correctness of the return or appears substantially incorrect and (3) taxpayer’s position must be frivolous or demonstrate a desire to impede the IRS.  The Court quickly found the document purported by be a return.  It decided on a closer question that the return contained sufficient information.  The IRS fought over this factor arguing that the missing information was needed to determine if the tax shown on the return was correct.  The Court, however, determined that the test was not complete correctness but substantial correctness and the return met that standard.

On the third factor the IRS relied on its Notice 2010-33 implementing section 6702.  The Court acknowledged that the notice lists use of the 5th Amendment on a return as a basis for assertion of the penalty but found that the notice does not discuss the legitimate use of the 5th Amendment.  Because the tactic of using the 5th Amendment in inappropriate circumstances has been adopted over the years by tax protestors, the legitimate use of the 5th Amendment has out due to so much inappropriate use.  Relevant IRS provisions (See IRM 4.10.12.1.1(10) and 4.10.12.1.2(6)) talk about “blanket assertion of the 5th amendment.  Here, the return made a precise use of the 5th amendment with respect to certain questions but not a blanket assertion.  In Garner v. United States the Supreme Court has held that taxpayers may make a legitimate assertion of the 5th Amendment on a tax return.

Mr. Youssefzadeh argued that 31 USC 5314 and 5322 make it a crime to willfully fail to file a Report of Foreign Bank and Financial Accounts (FBAR).  The IRS could have easily used his answers to the questions he failed to answer to determine that should have filed an FBAR. The Court found that “because the lines that Youssefzadeh redacted ask for information that triggers the duty to file an FBAR and because willful failure to file an FBAR is a crime, we hold that Youssefzadeh has shown us a real and appreciable danger of self-incrimination…”  The Court, therefore, held that the penalty should not apply in his case.  This seems like the only result that does not penalize a taxpayer for the proper use of the right against self-incrimination.  Of course, Mr. Youssefzadeh has brought a lot of attention upon himself.  He may need to continue to employ his lawyers because his problems may not be over with the removal of the penalty if the IRS can identify his FBAR failure (assuming there was such a failure.)

Here the Court and the IRS allowed Mr. Youssefzadeh to raise the merits of the penalty without discussion of the Perkins case or the CDP regulation denying taxpayers the right to raise arguments where the taxpayer previously had an opportunity to go to Appeals.

 

 

Comments

  1. Carl Smith says:

    I suspect that this is a minor victory for the taxpayer that won’t be repeated when the IRS issues a summons to him for any records required to be kept by 31 CFR 1010.420, which states:

    Records of accounts required by § 1010.350 to be reported to the Commissioner of Internal Revenue shall be retained by each person having a financial interest in or signature or other authority over any such account. Such records shall contain the name in which each such account is maintained, the number or other designation of such account, the name and address of the foreign bank or other person with whom such account is maintained, the type of such account, and the maximum value of each such account during the reporting period. Such records shall be retained for a period of 5 years and shall be kept at all times available for inspection as authorized by law.

    In United States v. Chabot, 793 F.3d 338 (3d Cir. 2014) — where cert. was denied just this past Monday — the IRS issued a summons for such records, and the taxpayer declined to provide them, citing his Fifth Amendment privilege against self-incrimination. The taxpayer argued that merely admitting to the existence of such records and authenticating them by producing them would, combined with his lack of filing an FBAR, substantially make a government criminal case against him for failing to file an FBAR. The Third Circuit joined all six other Circuits to have considered this question and ruled that the information and documents needed to be produced under the required records exception to the Fifth Amendment privilege.

    • First, the Fifth Amendment is part of a Bill of Rights–not a bill of “privileges.”

      Second, despite common belief (even, unfortunately, among attorneys), the Fifth Amendment right is not merely one against “self-incrimination.” Instead, the Fifth Amendment bars the federal government from compelling someone to become a witness against himself in any criminal case. That right, then, is far broader than the mere “privilege against self-incrimination.”

      Third, the 1st Congress proposed the Bill of Rights to “prevent a misconstruction or abuse” of the federal government’s powers–including the taxing powers. See Bill of Rights Preamble. But the seven federal courts of appeal that have upheld IRS summonses on a purported “required records” exception to the Fifth Amendment have tossed that important right into the judicial garbage can.

      Fourth, the same seven federal courts of appeals who apply the bogus “required records exception to the Fifth Amendment” also routinely violate individuals’ Fifth Amendment rights in the opposite way. Those courts (and a few others) will uphold an IRS summons on the equally bogus “voluntarily created records exception to the Fifth Amendment.”

      In other words, these guardians of justice have turned the Fifth Amendment from a right into a near Catch-22. On one hand, if the law requires one to keep certain records, then the individual must surrender those records to the IRS because the Fifth Amendment is inapplicable. On the other hand, if the individual created those records voluntarily, then the individual must still surrender those records to the IRS because the Fifth Amendment is inapplicable. Under a constitution that was meant to “establish justice,” those judicial holdings are absurd.

      The IRS may, as Carl anticipates, summons Mr. Youssefzadeh to produce his “required records.” If it does, then I would encourage Mr. Rettig & Co. to abandon the judicially-trashed Fifth Amendment defense for another constitutional defense:

      The Fourth Amendment.

      The Fourth Amendment prohibits the federal government from conducting unreasonable searches and seizures of one’s papers. The IRS’s search for, and its intended seizure of, one’s papers to use as evidence to support a criminal charge is per se unreasonable.

      If the courts throw out the Fourth Amendment too, then it’s time for “We, the People” to demand that our U.S. House members initiate judicial impeachment inquiries.

  2. The Tax Court and the IRS had two good reasons for allowing Mr. Youssefzadeh to raise the merits of the frivolous return penalty in his CDP case:

    1. Mr. Youssefzadeh did NOT have a prior opportunity to dispute his penalty liability because,

    2. IRS Office of Appeals jurisdiction does not extend to cases that, among other things, solely involve a failure or a refusal to comply with the tax laws on a constitutional ground. See 26 CFR 601.106(b), IRM Part 8.1.1.3.1 (02-10-2012).

    The Tax Court and the IRS were therefore correct to have allowed Mr. Youssefzadeh to challenge his frivolous return penalty liability at the CDP level. In reviewing that liability challenge, the Tax Court reached the correct result.

  3. Norman Diamond says:

    “I suspect they generally default to presuming every assertion of the 5th amendment is a tax protestor tactic.”

    I think they don’t, and I wonder why they did in the Youssefzadeh case. The IRS’s Tax Crimes Handbook is dated 2009 and discusses cases such as Garner. The IRS knows that the 5th amendment allows a “privilege” (which should be a right) on particular questions while it does not allow complete failure to file a return. Notice 2010-33 is consistent with that too; one listed frivolous position is “(f) The Fifth Amendment privilege against self-incrimination grants taxpayers the right not to file returns or the right to withhold all financial information from the Service” and does not target particular questions.

    The IRS understands it but the Department of Justice does not. Tax Court allowed testimony under seal but other courts did not. The Federal Circuit overturned Supreme Court cases including Garner in order to overturn the IRS’s administrative acceptance of a tax return. The IRS isn’t even obeying the Federal Circuit — the IRS continues to insist that it accepted that return.

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