Using a Refund Suit to Remedy Identity Theft of Return Preparer Fraud

Today, we welcome guest blogger, Robert G. Nassau.  Professor Nassau teaches at Syracuse University College of Law and directs the low income taxpayer clinic (LITC) there.  Today, he discusses twin problems that have plagued my taxpayers, identity theft and preparer fraud.  He has employed refund suits before to resolve cases in which the IRS has frozen a taxpayer’s earned income tax credit and in the post today he explains how he used a refund suit to solve a seemingly intractable identity theft/preparer fraud issue.  His pioneering and innovative use of refund suits to craft favorable results for his clients is probably what caused him to become the author of the chapter on refunds in the book “Effectively Representing Your Client before the IRS.”  The book is gearing up for its seventh edition in 2017 and Professor Nassau has signed on for another update of the refund chapter.  Keith

As all tax professionals know, tax-related identity theft and return preparer fraud are widespread, and trying to assist a victim of these crimes – despite significant procedural improvements made by the Internal Revenue Service – can make one envy Sisyphus and his Boulder Problem.  Recently, the Syracuse University College of Law Low Income Taxpayer Clinic successfully resolved one such taxpayer’s ordeal – and did it by filing a refund suit in Federal District Court.  This is his story.

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The Taxpayer.

Prior to 2011, John Doe (not his real name) had traditionally prepared and filed his own tax returns, and had never had any problems.  When he was working on his 2011 return, his calculations were not leading to his accustomed refund.  When he mentioned his dilemma to a friend, she suggested that he contact Bonnie Parker (not her real name), who, according to the friend, was very knowledgeable in all things tax.  John went to Bonnie, showed her his W-2, and gave her some additional personal information.  Bonnie said she would look into it and get back to him, but she never did.  John never saw her again.  John himself did not timely file his 2011 return, because he was considering filing for bankruptcy, and thought he had three years to file the return.

The Crime Perpetrated.

Unbeknownst, at the time, to John, Bonnie submitted a fraudulent return using John’s identity and some of his legitimate information, and received a refund of about $5,000.

The Crime Discovered.

In early 2013, John realized that something was amiss, as he started to get collection notices regarding “his” 2011 tax return.  The Service had audited John’s “return” on the basis of both automated underreporting and child-based benefits.  Because the audit was ignored, John now found himself assessed close to $6,000.

The Failure of Traditional Remedies.

Having “put two and two together,” John filed his real 2011 return in the summer of 2013, claiming a refund of about $2,000.  This return was not processed.  In early 2014, John went to his local Taxpayer Assistance Center, where he was encouraged to submit an Identity Theft Affidavit (IRS Form 14039), which he did.  This did not solve the problem.  Later in 2014 he was told to submit a Tax Return Preparer Fraud or Misconduct Affidavit (IRS Form 14157-A), and a Complaint: Tax Return Preparer (IRS Form 14157).  John submitted both of these Forms.  He also filed a police report with the Syracuse Police Department.  None of this solved his problem.  In fact, while he was trying to solve his 2011 problem, his refunds for 2012 and 2013 (and, later 2014) were all offset and applied to his 2011 “debt,” reducing it to around $2,000.  In early 2015, John sought help from the Taxpayer Advocate Service, which, despite diligent efforts by his Case Advocate, was unable to fix the problem.  Apparently, the Service was confused by whether this was an Identity Theft case or a Return Preparer Fraud case.  In addition, the Service was suspicious of John and his “relationship” with Bonnie.  Ultimately, his Case Advocate suggested that he contact the Syracuse LITC.

Commencement of the Refund Suit.

Concluding that it would be fruitless to try to solve John’s problem administratively (that train had left the station and was not coming back), the Syracuse LITC decided to file a refund suit on John’s behalf in Federal District Court, which it did in November 2015.  The Complaint sought a recovery of John’s claimed refunds on his actual 2011, 2012, 2013 and 2014 returns. In our view, because each of those returns had claimed a refund; six months had passed since each return had been filed; and it was not more than two years from John’s receipt of a notice of disallowance with respect to any of his claims (there had been no such notices), the District Court had jurisdiction to hear his case.  (Section 6532(a)(1) of the Code.)

The Department of Justice Answers.

In his Answer, the attorney for the Department of Justice raised two interesting points (while denying most of the factual assertions for lack of knowledge): (1) the refunds for 2012, 2013 and 2014 had actually been granted – they had just been offset to 2011, therefore, there was no issue for those years; and (2) there might be a jurisdictional issue regarding 2011, because there was currently a balance due for 2011, and, pursuant to United States v. Flora, one cannot bring a refund suit if one still owes any part of the taxes assessed for that year.  While this first point is not without a good deal of merit, the second point creates a fascinating potential Catch-22 (fascinating from a tax law perspective, not from a solve-the-problem perspective).  If the DOJ attorney were correct, the Court would implicitly have to conclude that the fraudulent return was the real return, when the case is premised on the fact that the fraudulent return is fraudulent and the real return shows a refund (hence no Flora issue).  Effectively, if the DOJ attorney were correct, one might never get his “day in court” to prove that he was the victim of identity theft or return prepare fraud.

How It Played Out.

While reserving his Flora argument, the DOJ attorney flew to Syracuse to depose John.  Having listened to John’s story in person, and having done some independent sleuthing of his own, the DOJ attorney concluded that John was telling the truth.  He arranged to have the fraudulent 2011 return (and its liability) purged from the system, and John’s actual 2011 return respected and processed.  Interestingly, that actual 2011 return wound up showing a small liability, but it was more than offset by John’s 2012, 2013, 2014 and 2015 refunds, so he received a significant check.  It took thirteen months from the time John filed his refund suit until the time his account was rectified and he received his proper refund.

Lessons and Observations.

Given John’s – and even TAS’s – inability to solve his tax problem administratively, a refund suit seemed his best, if not only, resort.  While it took over a year to reach the correct result, the refund suit brought with it an intelligent, diligent and dedicated DOJ attorney who, to his credit, seemed more concerned with reaching the correct result than with trying to set a new jurisdictional precedent.  It also brought a Judge who seemed to believe John from the “get-go,” and who prodded the parties toward settlement.  While we would certainly recommend fully exhausting one’s administrative avenues of relief first, where those have proven unsuccessful, we would encourage taxpayers to file refund suits to get the result they deserve.