Yesterday, I started to explain the basis for the determination that jeopardy did not exist in former Senator Fumo’s case. I primarily discussed the aspect of the case court found troubling. and used that discussion to raise a systemic problem with IRS examinations, revenue agents pay no attention to what a taxpayer does with assets while they audit returns. The troubling aspect of the case for the court and for me was the four year period of the audit – a remarkable pace.
The case involved more than simply a snail’s pace audit during which the IRS paid no attention to the transfer of almost all of the taxpayer’s assets. In addition to transferring his cash assets and fully or partially transferring his real property assets, former Senator Fumo also made statements to his ex-wife that he intended to make himself judgment proof while still retaining control of his assets. These statements generally do not lead to a good outcome for someone trying to fend off a jeopardy assessment. However, they were not enough to carry the day for the IRS. . So, how did the court find that the jeopardy assessment should be abated considering there was a transfer of a significant amount of assets coupled with damaging statements that seemed to cry out for a determination of jeopardy?
Certainly, the evidence presented played a critical role in the outcome. As I will discuss below, two other issues present themselves here. The first, and less important, concerns the Court’s possible misunderstanding of the case. It made a couple of statements that left me thinking it did not quite understand enough about tax procedure to understand the result of its opinion. It is also possible that I read more into those statements than I should. The second issue concerns the structure of the jeopardy assessment statute and the problems that structure creates for the IRS in a case where the taxpayer has/had significant real property assets.read more...
The Asset Transfers
The court looked closely at each of the transfers and at the statements in determining whether former Senator Fumo’s actions warranted a determination of jeopardy. Just as the revenue agent did not move quickly to complete the audit of the income tax returns, the court did not race to its conclusions. It wrote a lengthy opinion working carefully through the applicable regulations and the facts in the case. The transferred assets fell broadly into two categories – cash and real property. Former Senator Fumo transferred a significant amount of money to his son right about the time the prison sentence began. Despite the fact that much of the money transferred from Senator Fumo’s bank accounts ended up in bank accounts owned solely in the name of the son, the court found that the money transfers were reasonable because the son took on the obligation of paying the bills while he father served time in prison. The son showed a fair amount of the money was going to pay for the father’s bills. I could not tell from the opinion that all of the money went for the father’s bills or that the son had returned the money now that the father could handle his own financial affairs again. Perhaps my concerns about that aspect of the story seek a level of proof beyond the required showing of general use of the funds for the father’s affairs. This part of the proof distinguished this case from others where courts upheld the jeopardy determination.
The court found the explanations about the real estate transfers reasonable as well. The general explanation here involved estate planning. The “Bush tax credits” were set to expire on December 31, 2011, former Senator Fumo’s accountant advised him to make gifts before they expired in order to do some estate planning. The transfers, except for one, kept the property partially in the name of former Senator Fumo because he transferred his property from himself to himself and his son or himself and his girlfriend as joint tenants with rights of survivorship. Steve may write a follow up post on whether the alleged estate planning aspect of these transfers had meaning. I found myself much less convinced by the story about the transfer of the property in comparison to giving his son control of the bank account. Making property transfers like this while an audit is underway, even a slow moving audit and even transfers with retention of a partial interest, seems inappropriate. I think the court did not have the right statutory tools to deal with this behavior and I would change the statute as discussed below.
The Damaging Statements
After working through the transfers the court addressed the damning statements written to his former wife in which he states he wants to put his assets in someone else’s name while retaining control and put the assets beyond the reach of the government. The court found they “were written in the context of seeking her input and assistance regarding what he believed was a necessary renegotiation of the loan he had with a family trust account and more generally how to handle their daughter’s trust.” Former Senator Fumo testified that the correspondence was not “about IRS concerns” but rather renegotiation of a loan with a family partnership. The court found the explanations were convincing and found that the IRS did not find the existence of the correspondence until several months after the jeopardy assessment and therefore could not rely on the correspondence to show jeopardy. I found the language about putting property beyond the government’s reach hard to reconcile with a family trust dispute but I did not read the transcript and perhaps a link exists that has passed me by. I think the court simply did not find the words overcame the acts and the acts did not rise to the level of a jeopardy assessment. The actions do matter much more. Words like these can support a court’s decision or be brushed away when not supportive. I do not fault the court for brushing them aside given its conclusion on the actions.
The Court’s Apparent Misunderstanding of Assessment and Federal Tax Liens
The court made two statements that make me think it does not quite understand what it has done. First, it said “when Plaintiff was assessed with additional income taxes of approximately $2 million in October, 2012, the IRS did not believe a jeopardy assessment was necessary.” This statement shows that the court does not understand the word assessment even though assessment is what the proceeding is all about. The IRS did not make an assessment in October 2012 because it could not. At that point it issued a notice of deficiency. Had the IRS thought that jeopardy existed at that point, it would have made a jeopardy assessment. The demonstrated lack of understanding of assessment leads to a lack of understanding of the lien which leads to a worry that the court may not understand what it has done here.
The second statement occurs later in the opinion. In talking about the problem of the transferred properties the court says this is not a problem because the IRS knows the identities of the parties receiving the transferred interests – the son and the fiancée. Knowing their identities is not the real problem. Stopping them from further transferring or tying up the property is the problem and without an assessment the IRS cannot do anything about that, but sadly, the court seems to think that it can. The court says “Defendant has already filed a nominee lien against Plaintiff’s fiancée.” That statement suggests the court thinks the nominee lien will continue to exist after this opinion. The opinion results in the abatement of the underlying assessment and will cause the IRS to release all of the liens it as filed including the nominee liens
The court’s misunderstanding of assessment and apparent misunderstanding of liens leaves me wondering if it thinks that the IRS is somehow protected from further transfer of the property. It received an expert opinion report from a prominent local tax practitioner addressing things the IRS can do to recover the property. I found the conclusion of this report, that the IRS may be better off because of the transfers since it has the ability to sue more people to recover the proposed deficiencies, rather remarkable. Sure, it can pursue claims against them but that does not guarantee recovery. The better course is to tie up the property with nominee and “regular” tax liens. The IRS cannot do that now until the end of the Tax Court case which could be years away. The IRS unsuccessfully objected to admission of the report. I did not read the trial transcript. The report seemed like a great opportunity to examine the expert and bring out all of the possibilities.
A Better Way
I would like the court to have upheld the jeopardy assessment for the purpose of allowing the IRS to file liens but not to levy. Because of the amount and value of real property in this case, the filing of liens could serve to protect the interests of the IRS without creating a major cash flow problem for former Senator Fumo while he contests the correctness of the IRS determination of his liability. While Congress has recognized the distinction between lien and levy in the Collection Due Process (CDP) context in a similar setting, it did not make a distinction between lien and levy in the jeopardy context. The district court either had to give a thumb’s up or down on the assessment and the lien and levy rode together in that determination. Other jeopardy cases exist like this one where what the IRS really needs to do is tie up property to keep it from dissipating during the sometimes lengthy path to normal assessment. It should have a mechanism for doing so. The jeopardy statute should allow the court to make a two part determination with respect to assessment and allow the IRS to make an assessment establishing the lien with a lesser showing while only allowing it to make a levy when a heavier showing is made.
The transfer of the cash and its use to pay bills during the period of incarceration rang true enough in the case to make the need for levy action a weak need in this setting. The success on that story colored the court’s view of the need for jeopardy particularly if it held an erroneous view of the assessment and lien provisions.
Consequences of the Loss of the Lien if Bankruptcy Ensues
The loss of the lien also matters if former Senator Fumo decides to visit the bankruptcy court. By chance, most of the liabilities the IRS says he owes are currently dischargeable. The lien, or the absence of the lien or of the filed notice of federal tax lien, could play a big role if bankruptcy is in his future. The IRS says he owes three types of taxes and sent him three notices of deficiency giving rise to three Tax Court cases. Each of these liabilities has its own discharge rules although two overlap here. First, the IRS says he owes income taxes. The tax years of the income tax liabilities extend back for more than a decade. These old taxes do not get priority treatment in the bankruptcy code because only the fraud penalty is keeping open the statute of limitations. If the IRS can prove fraud, the income taxes are excepted from discharge (meaning he still will owe them after bankruptcy) by BC 523(a)(1)(C); however the fraud penalty equal to 75% of the tax liability would not survive bankruptcy because of the age of the tax years and the limitation of BC 523(a)(7) to penalties accruing within three years of the bankruptcy petition. The only way the IRS would recover anything on the fraud penalty would be if it had a filed federal tax lien or if the estate had enough money to pay general unsecured claims.
The gift tax is an excise tax. Excise taxes only retain their priority for three years from the due date of the return on the gift. The IRS alleges that the gift took place in 2009 which is more than three years ago. The IRS will have a general unsecured claim on the gift tax which would be discharged in bankruptcy the same way the fraud penalty would be discharged. Without a lien, the IRS might recover little. The third liability is an excise tax for wrongfully dealing with an exempt organization. The wrongful acts occurred more than three years ago making this a general unsecured claim, it might also be an unsecured claim because the code section giving rise to the liability is treated as a penalty provision for bankruptcy purposes. Either way, this debt gets discharged in bankruptcy similar to the gift tax and the fraud penalty. Bankruptcy may not occur because former Senator Fumo has too many assets to make it worthwhile or he has concerns that fraudulent transfer actions against his son and fiancée might create too much trouble but depending on his finances moving forward, it remains a potentially attractive option for eliminating almost all of the liabilities in the absence of the lien.
This was a close case. Former Senator Fumo’s counsel did an excellent job addressing the important issues and convincing the court that the actions supporting jeopardy really resulted from other issues. The prompt payment of the sizeable restitution and fines no doubt also played a role in the decision. If former Senator Fumo still has significant assets when the Tax Court case reaches its conclusion, this decision matters little to the IRS. The jeopardy assessment seeks to protect it from financial loss. It will lose nothing if it succeeds in establishing the liability and he promptly pays up. Of course, if he wins in Tax Court, it also suffers no financial loss. I am concerned about the property transfers and would like to have a system that prevents further transfers during the slow process of determining the liability. Until Congress becomes concerned about this, my private concerns do not matter.