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.

Collecting Partnership Debt from General Partners

The 9th Circuit recently sustained the district court which sustained the bankruptcy court in the case of Pitts v. United States.  The taxpayer sought a determination that the taxes claimed against her in the bankruptcy proceeding were discharged.  The courts determined that the taxes were not discharged, rejecting various arguments that she presented.  The case breaks no new legal ground but serves to highlight how the IRS collects from general partners.  If you have this issue, you might look at IRM Part 5, specifically 5.1.21, 5.17.7, and 5.19.14.

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Ms. Pitts was the general partner of DIR Waterproofing. DIR failed to pay its employment taxes including both trust fund and non-trust fund portions. The IRS would typically make some effort to collect from the partnership and then seek to collect from the partners. The opinion does not describe the efforts made here, but the IRS did issue a notice of federal tax (NFTL) against Ms. Pitts. In these situations the IRS does not go through a separate assessment process for Ms. Pitts but uses the assessment made against the partnership in order to pursue collection against her. The NFTL would reference the partnership debt although it would make clear that the lien is against her. Because the debt arose through the partnership, she argued that it was a state law debt and the IRS was limited to collect as a state law creditor. The 9th Circuit made three separate explanations of why her arguments failed.

First, the court pointed out that under IRC 6321 Ms. Pitts was a person liable to pay any tax and, as such a person, a lien arises under federal law which attaches to all of her property and rights to property once the IRS makes demand for payment and payment is not made. This is federal law and not state law creating the lien. The court cited several cases in support of its position.

Next, the court found that the IRS can use all of its administrative enforcement tools because she is secondarily liable on this debt. The court cited to a Supreme Court decision, United States v. Galletti, 541 U.S. 114 (2004) that may have caused Ms. Pitts to make the arguments she made here but which should also have suggested to her that these arguments would likely fail. In Galletti, similarly situated taxpayers to Ms. Pitts went into bankruptcy where the IRS filed a proof of claim based on the assessment against the partnership in which they were general partners. The Gallettis argued that no debt existed against them because the IRS had not made an assessment against them (and the statute of limitations on assessment of the partnership debt had run by the time of the bankruptcy.) In that case, the bankruptcy court, the district court, and the 9th Circuit agreed with the Gallettis. These opinions relied upon the definition of ‘taxpayer’ in IRC 7701 and looked to the separate nature of the partners as taxpayers from the partnership. The IRS pushed the case to the Supreme Court, which held that the IRS did not need to make a separate assessment because the Gallettis were liable under state law as general partners of the partnership.

Writing for a unanimous Court, Justice Thomas said:

“Under a proper understanding of the function and nature of an assessment, it is clear that it is the tax that is assessed, not the taxpayer. See §6501(a) (“the amount of any tax … shall be assessed”); §6502(a) (“[w]here the assessment of any tax”). And in United States v. Updike, 281 U. S. 489 (1930), the Court, interpreting a predecessor to §6502, held that the limitations period resulting from a proper assessment governs “the extent of time for the enforcement of the tax liability,” id., at 495. In other words, the Court held that the statute of limitations attached to the debt as a whole. The basis of the liability in Updike was a tax imposed on the corporation, and the Court held that the same limitations period applied in a suit to collect the tax from the corporation as in a suit to collect the tax from the derivatively liable transferee. Id., at 494-496. See also United States v. Wright, 57 F. 3d 561, 563 (CA7 1995) (holding that, based on Updike‘s principle of “all-for-one, one-for-all,” the statute of limitations governs the debt as a whole).

Once a tax has been properly assessed, nothing in the Code requires the IRS to duplicate its efforts by separately assessing the same tax against individuals or entities who are not the actual taxpayers but are, by reason of state law, liable for payment of the taxpayer’s debt. The consequences of the assessment–in this case the extension of the statute of limitations for collection of the debt–attach to the tax debt without reference to the special circumstances of the secondarily liable parties.”

Ms. Pitts wants the courts to recognize that the assessment only applies to her because of the operation of state law and since it is the operation of state law causing her to become liable she wants the debt treated as state law debt and not tax debt with the exceptions to discharge applicable to tax debts. The 9th Circuit, perhaps still remembering the Galletti outcome, does not allow her to split hairs in this manner. State law plays an important role in creating the liability but her liability is for a federal tax debt.

The 9th Circuit rejects her argument that state law creates the statute of limitations. It also rejects her argument that the continuation by the IRS of its efforts to collect this debt violates the discharge injunction. I did not go back and read the earlier opinions to see the age of the debt. The trust fund portion of the partnership’s unpaid employment taxes will always be excepted from discharge because B.C. 507(a)(1)(C) will always make this a priority debt in bankruptcy and that will always make it excepted from discharge under B.C. 523(a)(1)(A). The non-trust fund portion of the partnership employment tax debt should become dischargeable for bankruptcy petitions filed more than three years after the employment tax return due date, assuming it timely filed the returns. The court engages in no analysis of this issue making me think that she is not entitled to a discharge of the non-trust fund portion; however, depending on the timing of the debt and the bankruptcy petition, this portion of her debt could potentially be discharged in her bankruptcy just as in the bankruptcy of the partnership itself.

This case demonstrates how the IRS will proceed to collect from a general partner. It simply uses the assessment against the partnership to open the full range of administrative collection tools given to it under the Code. The effort by Ms. Pitts to use the Galletti opinion to argue that the operation of state law which lets the IRS go after the general partners without a separate assessment should also limit the IRS in its ability to collect. The 9th Circuit rejects that limitation on the power of the IRS in this situation and, I think, its decision is correct. The issue brings up in another context the interplay between state law which creates certain rights and obligations and the federal tax collection law which builds upon the state created rights and obligations.

Procedure Grab Bag – Foreign Tax Credits

Two cases dealing with foreign tax credits, with very different litigation records; one being denied cert by SCOTUS (Albemarle, which we’ve covered before) and one tossed on summary judgement in the District Court (Estate of Herrick) with the taxpayer prevailing on making a late election where no late election was permissible.  The second case has pretty interesting regulatory interpretation.

No SCOTUS

The first has been covered here on PT before on at least two occasions.  SCOTUS has denied cert in Albemarle Corp. v. US.  When the Federal Circuit reviewed the case, I wrote the following in a SumOp:

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Hopping in the not-so-wayback-machine, in October of 2014, SumOp covered Albemarle Corp. v. US, where the Court of Federal Claims held that tax accruals related back to the original refund year under the “relation back doctrine” in a case dealing with the special statute of limitations for foreign tax credit cases.   As is often the case in SumOp, we did not delve too deeply into the issue, but I did link to a more robust write up.  It seems the taxpayers were not thrilled with the Court of Federal Claims and sought relief from the Federal Circuit.  Unfortunately for the taxpayer, the Fed Circuit sided with its robed brothers/sisters, and affirmed that the court lacked subject matter jurisdiction because the refund claim had not been made within the ten year limitations period under Section 6511(d)(3)(A).   This case deserves a few more lines.  The language in question states,  “the period shall be 10 years from the date prescribed  by law for filing the return for the year in which such taxes were actually paid or accrued.”   When the tax was paid or accrued is what generated the debate.

In the case, a Belgium subsidiary and its parent company, Albemarle entered into a transaction, which they erroneously thought was exempt from tax, so no Belgian tax was paid.  Years in question were ’97 through ‘01.  In 2002, Albemarle was assessed tax on aspects of the transaction in Belgium, and paid the tax that was due.   In 2009, Albemarle filed amended US returns seeking about $1.5MM in refunds due to the foreign tax credit for the Belgian tax.  Service granted for ’99 to ’01, but not ’97 or ’98 because those were outside the ten year statute for claims related to the foreign tax credit under Section 6511(d)(3)(A).  Albemarle claimed that the language “from the date…such taxes were actually…accrued” means the year in which the foreign tax liability was finalized, which would be 2002 instead of the year the tax originated.  Both the lower court and the Circuit Court found that the statute ran from the year of origin.  The Circuit Court came to this conclusion after a fairly lengthy discussion of what “accrue” and “actually” mean, plus a trip through the legislative history and various doctrines, including the “all events test”, the “contested tax doctrine”, and the “relation back” doctrine.  The Court found the “relation back” doctrine was key for this issue, which states the tax “is accruable for the taxable year to which it relates even though the taxpayer contests the liability therefor and such tax is not paid until a later year.” See Rev. Rul. 58-55.  This can result in a different accrual date for crediting the tax against US taxes under the “relation back” test and when the right to claim the credit arises, which is governed by the “contested tax” doctrine.

At that time, McDermott, Will and Emery posted some “Thought Leadership” (I’ve hated that term for a long time, but the summary is extensive and helpful), which can be found here.  The final paragraph of their advice is right on the mark, indicating there is no circuit split, so there likely would be no SCOTUS review.  It also provides great additional parting advice, stating:

Taxpayers in similar situations wishing to take positions contrary to the Federal Circuit’s decision, and without any option other than litigation, may want to file suits in local district court to avoid the negative precedent. Taxpayers may also want to consider filing protective refund claims in situations where it does not appear that a tax payment to a foreign jurisdiction will actually be made (and there will be enough time to file a formal refund claim with the IRS) within 10 years from the date the U.S. federal income tax return was filed to avoid the situation in Albemarle.

Not so late election

The second foreign tax credit case is the Estate of Herrick v. United States from the District Court for the Central District of Utah, where an estate filed late income tax returns seeking a refund for a decedent who had resided and worked in the Philippines for a number of years.  The taxpayer failed to file income tax returns during that period, under the mistaken belief that no income tax would be due because of credits for the foreign tax he was paying (not how that works).  The Service created SFRs, and assessed and collected over a $1MM in tax for the years in question.  The taxpayer sought summary judgement on its refund claim, which the IRS was contesting, arguing the taxpayer was not entitled to the credit or exclusion for foreign income taxes or that there were insufficient facts to establish that he was entitled to the same.

Under Section 911, some taxpayers living and working abroad in some circumstances can exclude a portion of the foreign earned income, and under Section 901, there is a credit for foreign tax that is paid, which can be applied against US income tax (as most of our readers know, under Section 61, the United States generally treats all income of its citizens, wherever earned, as being taxable income—these provisions help to reduce the potential for double taxation with the other jurisdictions).

As to the second claim, that insufficient evidence was available regarding the credits, the IRS position largely applied to one year.  For all other years, the taxpayer had showed copies of its returns, copies of his employer’s information related to him for the years in question, and the taxing authority in the Philippines verified all the information, including payment.  For one year, only a copy of the return and the employer’s information was available.  The Court found this was sufficient evidence to show proof of payment.

The second argument the Service made was that the taxpayer could not obtain the foreign earned income exclusion under Section 911 because the taxpayer had not made the election on a timely filed return or within one year of a timely filed return.  See Treas. Reg. 1.911-7(a)(2)(i).  Seems damning.

The Court, however, stated that the Service was only looking to subsections (A) through (C), and not giving consideration to subsection (D) in the Regulations allowing for elections to made when:

(D) With an income tax return filed after the period described in paragraphs (a)(2)(I) (A), (B), or (C) of this section provided –

(1)  The taxpayer owes no federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached either before or after the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion; or

(2)  The taxpayer owes federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached before the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion.

The Court found the first prong under (D) did not apply.  The taxpayer claimed that it did not owe any federal income tax, because the IRS had already assessed and collected an amount over the total amount outstanding.  The Court stated, however, the fact that no tax was due at the time of filing was not the question, and the determination was whether any tax was due for the year, which had been the case but the Service had already collected that amount via levy.

The Court, however, held that the second prong did apply.  The Court found the Service had not discovered the failed election.  The Court found the Service had determined the taxpayer failed to file returns for the years in question, but that was not the same as discovering the taxpayer failed to make the election (would anyone be surprised if the Service doesn’t concede this point in other jurisdictions?).  This allowed the taxpayer to make the election on the late filed returns.

Calculating Interest When the IRS Makes a Restitution Based Assessment

The case of United States v. Janean Del’Andrae provides further insight into what happens when the IRS makes an assessment based on a restitution order.  We have talked about restitution based assessments previously here and here.  This relatively new basis for assessment came into being with the passage of the Firearms Excise Tax Improvement Act of 2010 and the creation of IRC 6201(a)(4) allowing assessment based on restitution orders in criminal cases.  Some of the kinks are still being worked out and this case illustrates one of the kinks.  The district court’s decision to award attorney’s fees in this context confuses me and other aspects of the opinion confuse me.  That confusion may make for a confusing and disjointed post and I apologize.  The facts developed in the opinion do not seem to warrant an attorney’s fees award against the government here but I will circle back to that at the end.  Getting to the result of what interest the taxpayer owes following a restitution based assessment provides the most important aspect of this case.

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As the Court explains in the case, the new basis for assessment did not immediately cause the IRS to make assessments using this procedure. The IRS waited for instructions from its lawyers on what to do and those instructions initially came out in Chief Counsel Notice 2011-18.  Two years later in Chief Counsel Notice 2013-12 additional guidance was provided.  The Court states that “procedures for the assessment process were not officially developed until the Chief Counsel Notice 2013-12 was issued on July 31, 2013.”  That statement does not make sense to me because the 2013 notice does not deal with assessment procedures but rather with the process of how to handle a restitution case in litigation.  I think the Court may have misstated the purpose of this notice and the timing of the procedures for dealing with restitution based assessments.  The Notice issued in 2011 deals much more directly with assessment procedures.  Both of these notices are Chief Counsel notices designed to give guidance to Chief Counsel lawyers and not necessarily to the IRS.

Here, the taxpayer’s restitution order occurred in 2012. The delay of the IRS in implementing procedures for restitution assessments creates problems that ultimately lead to the award of attorney’s fees against the IRS but I am uncertain that the Court quite got the timing right in attributing the problem to the 2013 notice.  The place to focus on IRS procedures is not notices issued by Chief Counsel’s office but changes to the Internal Revenue Manual.  Here, the provisions for restitution based assessments first appeared in IRM 5.19.23 on June 6, 2014, and IRM 4.8.6 in October 7, 2014.  The new IRM provisions followed the Interim Guidance on Criminal Restitution Procedures issued in SBSE 04-0214-0013 dated February 5, 2014 Except for how this impacts the decision on attorney’s fees, it is not especially relevant but does create more confusion in trying to follow the opinion.

Janean Del’Andrae pled guilty to one count of tax evasion. The opinion is not clear about the count to which she pled or how many counts with which she was charged.  The IRS charged that she not only evaded her personal income taxes for the year 2005 but also that she participated in evading the taxes of Del-Co Western Corporation, a company in which she and her husband were officers.  The court makes a passing reference to payroll taxes but the remainder of the opinion seems to make it clear the evasion of corporate income taxes was the problem.  The sentencing court ordered restitution in the amount of $138,509.50 calculated to cover the corporate taxes for 2004 ($49,845.37) and 2005 ($38,307.13) as well as her individual income taxes for 2005 ($48,357.00).  The judgment against her was entered on July 11, 2012, and she stroked a check that day for the full amount of the restitution (making her an unusual defendant, most of whom do not have the money to pay the tax at this stage of their case) and tendered it to the clerk of court.  On September 17, 2012, the IRS received the payment.

The opinion does not state what happened next but maybe nothing happened. On September 12, 2014, the court granted defendant’s Motion to Enforce Plea Agreement and issued an order requiring the IRS to give the defendant credit for the restitution payment.  The order required the IRS to credit the payment on July 11, 2012 even though it took the court over 60 days to deliver the check to the IRS.  It appears the IRS was significantly delayed in making the assessment probably because it took the IRS a long time to develop the assessment procedures for restitution based assessments.  I agree that the defendant should get credit from the date of payment but wonder how the payment of the interest on the money for those 60 days was credited between the judicial and executive branches.

The court states that the IRS eventually assessed the appropriate amount of taxes. It also assessed interest on the taxes from the due date of the returns until July 11, 2012, when it gave credit to the defendant and the corporation for the payment of the taxes.  The assessment of interest occurred without using the deficiency procedures which seems appropriate under these circumstances.  The defendant continued to dispute the correct amount of the corporate liability for 2005 so the IRS did not assess the liability for that period.  One of the problems with this opinion is that the Court’s description of events does not use the terms that one might expect or use them with sufficient precision to allow me to know exactly what happened.  It is clear, however, that in March 2015 the corporation made a payment towards its 2013 liability.  In doing so it overpaid the 2013 liability by $65,917.  The IRS latched onto the overpayment and used it toward additional corporate and personal tax liabilities.  The use of this overpayment creates the focus of the litigation.  Defendant filed a motion for an order to show cause seeking answers concerning the application of the payments.  The balance of the opinion essentially focuses on how the IRS did and should have used the overpayment and why its actions were right or wrong.

The restitution order contemplated that the IRS would charge interest and penalties but did not order the payment of these amounts or spell them out in any way. The defendant argues that the IRS should not assess interest for the time prior to the date of the restitution order.  The defendant further argues that the IRS should follow deficiency procedures in order to assess interest on a tax liability determined by a restitution order.  The IRS argues that interest runs from the due date of the return for restitution payments as it does for all liabilities and further argues that the use of deficiency procedures is unnecessary to assess interest on the amount listed in a restitution order.  The court agreed with the IRS that interest on restitution assessments need not follow the deficiency procedure but may occur in the same manner as the assessment of the underlying tax assessed pursuant to the restitution procedure.

The second issue concerns the application of the overpayment on the 2013 corporate taxes to the personal liability of the defendant. The court says that the IRS argued that the application of a corporate payment to the personal liability of the individual is proper because “Defendant [the individual] and Del-Co are jointly and severally liable for the tax and related interest that Defendant evaded.”  The court further states that the IRS argued, “the joint and several liability arises because Defendant agreed to pay restitution for the loss caused by her evasion of Del-Co’s taxes.”  I am unconvinced that the IRS argued the case in the way described by the court.  If it did I am confused.  It is possible the IRS made an alter ego argument.  Whatever was argued, the court found that the defendant and the corporations were not jointly and severally liable and that the IRS should not take payments on the corporate account and apply them to the individual liability.  If the IRS position reflects a legal conclusion that every time an individual is convicted and restitution is ordered based on corporate and individual liabilities this type restitution order allows it to move money between the individual and corporate accounts, then this decision represents a repudiation of that position.  If the IRS was simply arguing here that, based on these facts, the finances of the corporation and the individuals merged, the IRS lost a factual argument.

After reaching this conclusion the Court found that “because the IRS delayed the application of Defendant’s restitution payments and may have improperly applied Del-Co’s overpayment to Defendant’s tax account, the Defendant incurred unnecessary costs to clarify the IRS’s actions” and therefore costs and attorney’s fees were ordered against the United States. The delay in applying the payments here seems to have resulted from the implementation of a new statute and did not harm petitioners.  I do not see that as a basis for awarding fees.  To the extent that the IRS inappropriately applied the payment of the corporation, I feel the court should have provided more information about the steps that were taken to fix the wrongful application before the court proceeding as a prerequisite to the award of attorney’s fees.

I take away from this case the reinforcement of the IRS position that interest may be assessed on restitution assessments in the same summary manner as the assessment of the tax itself. The application of payments issue, if it reflects a legal position asserted by the IRS in restitution cases, represents a victory for taxpayers.  Because I am unconvinced that the IRS was arguing this as a legal matter, I think that the application of payments issue is simply a factual determination that must be determined on a case by case basis.  There will be many more cases exploring the restitution assessment procedure as this becomes more common.  I hope they offer a clearer view of what the parties presented but even in the murky view offered by this case, the issue of interest in restitution cases gets a little clearer.

Summary Opinions for November

1973_GMC_MotorhomeHere is a summary of some of the other tax procedure items we didn’t otherwise cover in November.  This is heavy on tax procedure intersecting with doctors (including one using his RV to assist his practice).  Also, important updates on the AICPA case, US v. Rozbruch, and the DOJ focusing on employment withholding issues.

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I’ve got a bunch of Jack Townsend love to start SumOp.  He covered a bunch of great tax procedure items last month.  No reason for me to do an inferior write up, when I can just link him.  First is his coverage of the Dr. Bradner conviction for wire fraud and tax evasion found on Jack’s Federal Tax Crime’s blog.  Why is this case interesting?  Because it seems like this Doc turned his divorce into some serious tax crimes, hiding millions offshore.  He then tried to bring the money back to the US, but someone in the offshore jurisdiction had flipped on him, and Homeland Security seized the funds ($4.6MM – I should have become a plastic surgeon!).  His ex is probably ecstatic that the Feds were able to track down some marital assets.   I am sure that will help keep her in the standard of living she has become accustom to.

  • I know I’ve said this before, but you should really follow Jack Townsend’s blogs.  From his Federal Tax Procedure Blog, a write up of the Second Circuit affirming the district court in United States v. Rozbruch.  Frank Agostino previously wrote up the district court case for us with his associates Brian Burton and Lawrence Sannicandro.  That post, entitled, Procedural Challenges to Penalties: Section 6751(b)(1)’s Signed Supervisory Approval Requirement can be found here.  Those gents are pretty knowledgeable about this topic, as they are the lawyers for the taxpayer. As Jack explains, the Second Circuit introduces a new phrase, “functional satisfaction” (sort of like substantial compliance) as a way to find for the IRS in a case considering the application of Section 6751(b) to the trust fund recovery penalty.
  • The Tax Court in Trumbly v. Comm’r  has held that sanctions could not be imposed against the Service under Section 6673(a)(2) where the settlement officer incorrectly declared the administrative record consisted of 88 exhibits that were supposed to be attached to the declaration but were not actually attached.  The Chief Counsel lawyer failed to realize the issue, and forwarded other documents, claiming it was the record.  The Court held that the Chief Counsel lawyer failed to review the documents closely, and did not intentionally forward incorrect documents.  The Court did not believe the actions raised to the level of bad faith (majority position), recklessness or another lesser degree of culpability (minority position).  Not a bad result from failing to review your file!
  • This isn’t that procedure related, but I found the case interesting, and I’ve renamed the Tax Court case Cartwright v. Comm’r as “Breaking Bones”.  Dr. Cartwright, a surgeon, used a mobile home as his “mobile office” parked in the hospital parking lot.  He didn’t treat people in his mobile home (which is good, because that could seem somewhat creepy), but he did paperwork and research while in the RV.  Cartwright attempted to deduct expenses related to the RV, including depreciation.  The Court found that the deductions were allowable, but only up to the percentages calculated by the Service for business use verse personal use.  I’m definitely buying an Airstream and taking Procedurally Taxing on the road (after we find a way to monetize this).
  • The IRS thinks you should pick your tax return preparer carefully (because it and Congress have created a monstrosity of Code and Regs, and it is pretty easy for preparers to steal from you).
  • Les wrote about AICPA defending CPA turf in September.  In the post, he discussed the actions the AICPA has been taking, including the oral argument in its case challenging the voluntary education and testing regime.  As Les stated:

The issue on appeal revolves whether the AICPA has standing to challenge the plan in court rather than the merits of the suit. The panel and AICPA’s focus was on so-called competitive standing, which essentially gives a hook for litigants to challenge an action in court if the litigant can show an imminent or actual increase in competition as a result of the regulation.

On October 30th, the Court of Appeals for the District of Columbia reversed the lower court, and held that the AICPA had standing to challenge the IRS’s Annual Filing Season Program, where the IRS created a voluntary program to somewhat regulate unenrolled return preparers.  The Court found the AICPA had “competitive standing”, which Les highlighted in his post as the argument the Court seemed to latch on to.   For more info on this topic, those of you with Tax Notes subscriptions can look to the November 2nd article, “AICPA Has Standing to Challenge IRS Return Preparer Program”.  Les was quoted in the post, discussing the underlying reasons for the challenge.

  • Service issued CCA 201545017 which deals with a fairly technical timely (e)mailing is timely (e)filing issue with an amended return for a corporation that was rejected from electronic filing and the corporation subsequently paper filed.  The corporation was required to efile the amended return pursuant to Treas. Reg. 301.6011-5(d)(4). Notice 2010-13 outlines the procedure for what should occur if a return is rejected for efiling to ensure timely mailing/timely filing, and requires contacting the Service, obtaining assistance, and then eventually obtaining a waiver from efiling.  There is a ten day window for this to occur.  The corporation may have skipped some of the required steps and just paper filed.  The Service found this was timely filing, and skipping the steps in the notice was not fatal.  The Service did note, however, that efiling for the year in question was no longer available, so the intermediate steps were futile.  A paper return would have been required.  It isn’t clear if the Service would have come to the same conclusion if efiling was possible.
  • Sticking with CCAs, in November the IRS also released CCA 201545016 dealing with when the IRS could reassess abated assessment on a valid return where the taxpayer later pled guilty to filing false claims.   The CCA is long, and has a fairly in depth tax pattern discussed, covering whether various returns were valid (some were not because the jurat was crossed out), and whether income was excessive when potentially overstated, and therefore abatable.  For the valid returns, where income was overstated, the Service could abate under Section 6404, but the CCA warned that the Service could not reassess unless the limitations period was still open, so abatement should be carefully considered.

 

 

Summary Opinions for 10/2/15 to 10/16/15

Lots of discussion of revenue procedures in this Sum Op, including what deference should be afforded.  Plus, an interesting TEFRA cert denial, terrible financial disability case, new IRS pilot program, and the IRS changing its policy on levying some Social Security payments.

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  • The IRS has released Notice 2015-72, which contains a proposed Revenue Procedure that would update the administrative appeals process for docketed Tax Court cases and update Rev. Proc. 87-24.  The Service indicates the update is appropriate given the various reorganizations of the Service since ’87 (right after the Mets last won the World Series), the increase in Tax Court litigation, and the new IRS procedures regarding workload. The changes do not drastically modify the general framework, but do have some modifications, including outlining more specifically how cases that are not immediately referred to Appeals should be handled, and providing additional guidance on keeping Appeals independent.  The IRS has requested comment on the changes by November 16, 2015.  For more specifics on the changes, Thomson Reuters has content here, as does Professor Timothy Todd at Forbes here.
  • Another day, another taxpayer loss under Section 6511(h) for financial disability.  Often, these fact patterns make the IRS look harsh.  In Reilly v. United States, the District Court for the District of Central California held that the taxpayer had failed to meet the requirements of Rev. Proc. 99-21.  In Reilly, a married couple attempted to obtain refunds for various past years where tax had been overpaid but returns were not filed.  The taxpayers claimed financial disability to toll the statute on refunds under Section 6011(h).  In the year where tax returns were first not filed, the husband was diagnosed with terminal pulmonary disease and various other related health issues, which were debilitating.  The wife, who for 39 years had not dealt with the family finances, fell into a deep depression, and failed to handle the financial affairs or attend to her ailing husband.  The husband’s doctor provided an opinion stating the lack of compliance was due to hubby’s health, and likely due to wife’s depression.  The Service, however, denied the request for tolling because the doctor was not wife’s physician, and that the letter did not include the certification as to its contents.  The claim also lacked the statement by husband that no one had the authority to act on his financial behalf.  The Court found the Service was correct, and that information was lacking (although it might have held substantial compliance if it had just been the doctor statement for husband missing the certification).  At trial additional information was provided to show the missing elements, but it was too late (and didn’t 100% comply).  Tough result for folks who probably could have used the assistance and likely could have complied had they fully understood the requirements.  It would be nice to see more cases arguing against any deference to Rev. Proc. 99-21, or for the Service to update its procedure.   Especially when a courts states, “[t]he Secretary has set forth regulations governing proof of financial disability at Rev. Proc. 99-21,” which was the case here.   Revenue Procedures are not regulations and generally should not receive the same deference.  Carlton Smith and Keith may have both discussed that point as regard this particular Rev. Proc. on PT in the past.  Probably just a loose use of the term “regulations”, but worth flagging.
  • Agostino and Associates has published their October Monthly Journal of Tax Controversy, which can be downloaded here. Quality work, as always.
  • IRS has announced a pilot program to test the authenticity of W-2s by working in conjunction with payroll companies.  This blog has recreated the Thompson Reuters Checkpoint news post on the topic.
  • About a year ago in SumOp, we discussed the JT USA, LP v. Comm’r, where the 9th Cir. reversed the Tax Court holding a partner had to completely elect out of TEFRA and treat all items as non-partnership items, and could not do it with only some items.  SCOTUS won’t review the matter.  Some additional background on the case can be found on Law360 here.
  • Periodically, Carlton Smith is kind enough to forward me articles from various news outlets regarding tax policy and administration.  This NYT article was one such post, which discusses academic and nonprofit computer scientists that are creating algorithms that assist in determining when tax evasion is occurring.  The code maps out the various entities and transactions found in specific shelters, and then assists in flagging those when found in taxpayer returns.  The stereotype of the unfeeling, robotic IRS agent might have just taken one step closer to an actual robot reality.  To all of our young readers out there, “I just want to say one word to you.  Just one word…Plastics.”  Just kidding. Two words, “computer science”.
  • Carlton also forwarded me this article regarding the passing of Jerry S. Parr, the Secret Service agent who was credited with saving President Regan during the 1981 assassination attempt.  This was just one example of a life of service that touched many people.  Our condolences go out to the Parr family, including his wife, retired Tax Court Judge Carolyn Parr.
  • In an internal memo for SB/SE, the Service has indicated a policy decision was made that under the Federal Payment Levy Program, SSA disability insurance payments will not be subject to the 15% levy.
  • A novel SOL suspension case was decided by the District Court for the Western District of North Carolina in United States v. Godley.   In Godley, an estate had obtained an extension to pay estate tax under Section 6166 on certain closely held business interests held by the decedent.  Under Section 6166, the estate can have up to five years of non-payment, followed by ten years of equal installment payments.  Under Section 6502(a), the Service usually has ten years to collect assessed tax, but under Section 6503(d) that period is suspended while Section 6166 payments are outstanding.  The question in Godley was when the suspension stops if installment payments are not made.  The Court held that failure to pay is not enough on its own, and that notice and demand by the Service of payment is needed.  The Court further stated the statute does not specify what constitutes notice and demand, and, after reviewing applicable law, found notice and demand occurred when the IRS notified the taxpayer about the unpaid tax, and stated the amount it demanded to be paid (makes sense).  There is a little more nuance in the case, regarding exactly what was in the IRS letters, but, generally, the Service sent notices stating the amount due that had to be paid, and said the taxpayer would be booted from the installment payment plan if not immediately brought current. The Service argued it was not the type of notice and demand required.  The Court disagreed, and found the notice and demand in the IRS letter terminated the suspension of the SOL.  Godliness (you got the bad pun, right) is next to cleanliness, and Les has been cleaning up the collections content in Saltz Book, including adding a much more insightful discussion of Godley.  The new chapter has actually been substantially reworked, and we are happy that it will be available on Checkpoint (and probably Westlaw) in December, and in print in January!
  • Last year around this time, Carlton Smith wrote “Hurray! A Tax Court Judge Decides an Innocent Spouse Case without Discussing Rev. Proc. 2013-34”, which, as the title indicated, was a discussion of Varela v. Comm’r, where the Tax Court held that a spouse was entitled to innocent spouse relief under Section 6015(b) because holding the spouse responsible would be inequitable under subsection (b)(1)(D).  In the post, Carlton advocates for Judges forgoing a review of the ever changing Revenue Procedure that indicates what the Service views as inequitable.  Carlton articulates well that “inequitable” doesn’t change, but the IRS view of “inequitable” does, which he believes is incorrect.  Hence, the Hurray! when the Tax Court made an inequitable determination without the Rev. Proc.  Well, it appears this is catchier than a T-Swift song, as Judge Goeke in Scott v. Commissioner  has held that it would be inequitable to impose tax (at least partially) on a spouse, and cites to only the applicable statute and prior judicial opinions.  Hurray!

 

Restitution Based Assessment and Tax Return Preparers: An Uneasy Mix

At last week’s ABA Tax Section meeting in Chicago one of the panels I enjoyed most was the Civil and Criminal Tax Penalties discussion on tax preparer fraud moderated by Sara Neil of Capes Sokol (whose colleague Justin Gelfand has written on identity theft for us as a guest), with Scott Clarke from DOJ, Matt Mueller from Wiand Guerra King in Tampa and Paula Junghans from Zuckerman Spaeder in DC.

The panel’s materials included a 2015 case, United States v Horn, from the district court in Maryland. Horn involved a hearing regarding whether a return preparer who had pleaded guilty to one count of preparing and filing false returns in violation of 26 USC 7206(2) should be required to pay restitution. The opinion is by Judge Marvin Garbis, a former tax practitioner and author of books and articles on tax procedure. I do not know Judge Garbis personally but I recall one of my mentors Michael Saltzman admiring him for his tax procedure chops (no small feat as Michael’s talent was matched by a healthy and justified sense of tax procedure ego).

The opinion concludes for very practical reasons that the IRS should not be able to make a restitution based assessment (RBA) against Horn, and how it gets there rings some interesting tax procedure bells that I found worthy of a post.

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Facts and Legal Background

The parties stipulated that the preparer Judianne Horn provided 16 clients with tax returns that listed false deductions on Schedule A or false business losses on Schedule C. The stipulation laid out over a four-year period the understatements of tax liabilities on a year-by-year basis for Horn’s clients. The total understatement of tax liabilities for the 42 federal tax returns (not every client had a return filed in every year) was $281,764.

We have recently discussed in the revision to Saltzman and Book the 2010 legislative change codified in Section 6201(a)(4)(A) that allows the IRS to assess and collect restitution under an order in Title 18 section 3556 “in the same manner as if such amount were such tax.” We discussed restitution based assessments in SaltzBook Chapter 10 (dealing with assessments) and in Jack Townsend’s redo of Chapter 12 (dealing with tax crimes); Keith also discussed it in PT in a post last year.

There are lots of interesting issues that spin off this important administrative power, and Horn raises one, namely whether the IRS has the ability to use RBA powers when the offense at issue relates to a preparer’s misconduct that implicates multiple taxpayers with multiple tax liabilities.

As the opinion describes, Section 6201(a)(4)(A) results generally in the IRS substituting itself for district courts when it comes to the payment of a restitution obligation. As an example of this, the opinion notes that an RBA “effectively eliminates the power of the district court to provide for periodic payments of restitution in amounts determined by the court subject to revision should the defendant’s financial circumstances change.”

The Tension Arising from Restitution Based on Third Party Liability

The rub as Judge Garbis describes was that when restitution is based on tax liabilities of others (such as but not exclusively when the defendant is a return preparer) it creates problems for both the courts and IRS in setting the proper amount but even more so perhaps in monitoring the payments going forward:

This creates a substantial level of complexity for determining the amount of restitution to be imposed and imposes a substantial management burden on the IRS and the court to monitor, not only in the application of restitution payments made by the defendant but also collections made by the IRS from taxpayers whose liabilities are the subject of the restitution order.

To fully appreciate this statement it is necessary to contrast loss for sentencing guideline purposes and restitution. The $281,764 understatement I referred to above determines loss for sentencing guidelines purposes. The loss for guidelines purposes exists irrespective of any post-offense circumstances, whereas the nature of restitution in the tax context makes those very post-offense circumstances quite relevant:

The function of restitution is to require a defendant to restore to the victim of a crime the loss caused by the defendant’s criminal conduct. A restitution award is not to be issued for punitive purposes or to provide the victim with a profit. Thus, the amount of restitution should not exceed the loss to the victim actually cased by the defendant.

The Horn opinion brings this back to the IRS:

In the context of a false federal income tax return, the actual loss to the IRS for which restitution should be paid is the deficit in tax collected with regard to the return in question-i.e., the amount of tax that would have been reported due on an accurate, correct tax return and paid, reduced by the amount collected by the IRS with regard to that return. (emphasis added).

Moreover, as the opinion notes, the actual loss to the IRS for restitution would have to take into account the tax liability reported as if the returns were properly filed, including deductions or credits that the taxpayers failed to originally claim. The proper amount of tax liability would also be reduced by the amount reported to the IRS on the false returns as well as “reductions in the restitution balance due as the IRS received payments and applied them to the tax liability understatement for the return in question.”

Given that the liability at issue here turns on third parties (the taxpayers whose returns Horn prepared) the opinion notes that the task would be dependent upon both “the number and complexity of the substantive issues presented in a particular case.” The process for defense counsel was as Judge Garbis describes one that would essentially require counsel to inquire into all 42 returns:

Defense counsel could be accused of a failure to provide effective assistance unless he/she reviewed the IRS’s proposed adjustments to each of these 42 returns, presumably with the assistance of a qualified tax professional.

Judge Garbis notes that the review should lead to some process (at cost that may be borne by the State if the defendant is represented by appointed counsel) whereby the defendant could access records and even potentially interview witnesses in a search for offsetting adjustments.

Contrasting Restitution Based Assessment with Restitution That is Not Assessed

The opinion notes in footnote 8 that “there may be reasonably debatable issues” as to whether the IRS can make a restitution based assessment in this case though the court for purposes of the order assumed that it could. I will take a quick stroll through that issue. Recall that Section 6201(a)(4)(A) provides that the Service may only assess an amount of restitution ordered “for failure to pay any tax imposed under [Title 26].” As the Service itself explained in a notice issued in 2011 “not every conviction in a Title 26 criminal case will result in an order of restitution that will be assessable.” Whether the IRS can use its RBA powers as the IRS in the notice from 2011 explained is based on whether the “restitution ordered is traceable to a tax imposed by Title 26 (e.g., cases stemming from an underreporting of income, an inflated credit or expense, or an alleged overpayment of tax that results in a false refund)….”

Not every restitution order connected to a Title 26 offense is within the reach of 6201(a)(4)(A):

On the other hand, criminal cases in which the restitution ordered is not traceable to a tax – such as when a taxpayer submits false documents or tells lies during an examination – may not result in assessable restitution.

Whether aiding and assisting in preparing and filing someone else’s tax return constitutes an amount of restitution ordered “for failure to pay any tax” is a question that the Horn opinion sidesteps and that I suspect other opinions may tackle, though IRS lists in its 2011 notice the 7206(2) offense Hom pleaded guilty to as an offense that “may” meet the requirements for assessment.

Back to the Horn opinion and what it does address. In discussing RBA, the opinion notes that once restitution is assessed, the IRS can use its full collection powers, with the assessment also subject to interest and late payment penalties.

In contrast, when there is restitution that does not result in an RBA, the opinion emphasizes the broad discretion that solely resides in a sentencing court:

However, when issuing a restitution order that does not result in an RBA, a sentencing court can exercise its discretion and decide whether to set a fixed date for payment in full or a schedule for partial payments consistent with the court’s finding regarding the defendant’s financial circumstances.The opinion illustrates the discretion with examples as to what the court (unlike the IRS) might do: Often, when a defendant does not have the ability to make full payment immediately, a sentencing court will defer all, or part, of the payment obligation during the time a defendant is incarcerated and will set a periodic payment schedule with the first payment due when the defendant is released from prison. The restitution order can provide that the amount of each periodic payment is subject to change depending upon changes in a defendant’s financial circumstances. The sentencing court can require, or waive, the accrual of interest on the unpaid balance. There will be no automatic “late payment penalty” applied to any unpaid balance of the full amount of restitution. Rather, the district court would consider imposing a sanction for a failure to make a restitution payment, taking into account the court’s determination of the defendant’s financial ability to meet the obligation.

Managing Restitution 

The opinion notes the important distinctions between the way the IRS and sentencing courts manage or monitor the receipt of restitution payments.  First, the opinion describes how courts manage the process:

In the absence of an RBA, a defendant’s restitution obligation is reduced, dollar for dollar, as the defendant makes payments pursuant to the restitution order.

IRS on the other hand treats payments made pursuant to an RBA as involuntary, with IRS having discretion to allocate the payments as it chooses among tax, interest and penalties. IRS may even, as the opinion notes, allocate payments to any other of the defendant’s own assessed liabilities that are wholly unrelated to the offense giving rise to the RBA.

The IRS’s discretion is amplified when the restitution relates to an order stemming from a return preparer’s criminal offense, with the IRS having the ability to allocate payments “among the taxpayers and income tax returns for which restitution would be due.”

Judge Garbis thus sets the stage for an administrative mess that led in part to his concluding that he would not order restitution in the case. Recall that when imposing restitution the IRS is not to collect more than the correct amount of tax at issue. When there are multiple taxpayers and multiple potential assessments and collections from those third parties, unless there is a process to track those payments and allocate the payments to the individual liabilities it would be very difficult for the IRS to represent to the court that it would limit its collection on the preparer’s assessed restitution to reflect its collection from those third parties whose returns the IRS would presumably examine.

Somewhat surprisingly, the IRS attempted to minimize the administrative burdens with a representation that it would not seek to enforce the laws with respect to the 16 taxpayers who benefitted from Horn’s illegal actions:

[T]he Government has taken the position that it will not seek to collect income tax underpaid by – or, better put, unwarranted refund payments made to – the taxpayers who filed the false returns.

Perhaps IRS did so because it wanted precedent on the books that it could get restitution in a case such as this, or perhaps it did so because it knew that resource constraints limited it from examining those 16 taxpayers and the 42 returns at issue (I won’t even go the SOL issues stemming from third party fraud, an issue we have spoken about in the BASR v US case in a guest post by Robin Greenhouse).

In any event, in a part of the opinion that appeals to my Introduction to Federal Income Tax professor hat, Judge Garbis pointed to the potential tax issues created when a preparer would make restitution payments that would benefit her clients by offsetting their tax obligations:

Nevertheless, unless the I.R.S. can make a decision to grant these taxpayers a gift from the Department of the Treasury, it should seek to have these taxpayers comply with their future tax obligations. Hence, if the Defendant were now to make a restitution payment that is applied to a tax liability of W.W., a taxpayer who obtained more than $17,000 of unwarranted refunds, it would appear that W.W. would have taxable income in the year of the Defendant’s payments.

This conclusion relates to the notion illustrated in cases such as Old Colony that a person has gross income when someone else pays that person’s tax on his or her behalf. The Horn opinion thus states that even if the IRS were not going to examine the prior returns to reflect ensuring past compliance, “the I.R.S. should monitor continually its application of restitution payments and ensure future tax compliance by the taxpayers to whose tax liabilities the payments are allocated.” While I have not fully thought through the Old Colony issue that Judge Garbis raises (for example, is the possible inclusion of income dependent upon there being an assessed liability agains the taxpayer?), the discussion at least implicates issues of coordination and the mechanism that the IRS would or should use to credit any restitution payments against individual taxpayer liabilities.

The Court Concludes that Restitution is Not Appropriate

Having I think established that the IRS desire to seek an RBA in this case created a number of vexing issues, the opinion expressed doubt as to whether the IRS was up for the task of managing and monitoring on a going-forward basis:

Indeed, it appears doubtful that the I.R.S. can, realistically, keep the Defendant and the Court (Probation Officer) informed of its application of Defendant’s payments. Moreover, the Government has described no coherent existing, or proposed, practicable process for keeping track of, and advising the Court (Probation Officer) and Defendant of, the status of payments made by, or collected from, taxpayers with respect to tax liabilities included in the restitution amount.

The “bottom line” is that if a tax return preparer defendant is unable to make more than modest partial payment of the restitution obligation, then a restitution order resulting in an RBA would impose a monitoring obligation on the I.R.S. and the Court (i.e., the Probation Officer) that, if at all possible to meet, would cause disproportionate managerial problems for the I.R.S. and the Court. (footnotes omitted).

The complexity and “disproportionate management burden” on the IRS and the court thus led to the conclusion that it was inappropriate to issue a restitution order. That burden was exacerbated by the financial circumstances of the defendant, as the court noted that a restitution order causing an RBA might be appropriate perhaps when “prompt, full payment can be required.” The opinion concludes by noting that it could have required restitution that would not have led to an RBA but that it chose not to in this case.

Parting Thoughts

Jack Townsend has noted that the relatively new RBA powers create some administrative challenges even when the restitution relates to an offense stemming from the defendant’s own tax liability (see his 2014 discussion of Murphy v Commissioner and procedures associated with RBA over at his Federal Tax Crimes blog here, with its sensible recommendation that IRS issue regs under the RBA statute).

The Horn opinion touches on some practical and legal challenges associated with an RBA that implicates third parties and their respective tax liabilities. In an email exchange over this case Jack offers the observation that “some of the real or imagined administrative problems that Horn raises could be solved by simply wiping off restitution on the criminal side once it has been assessed.”  As Jack notes, that “would let the IRS’s collection tools work the way they always work. It would also take legislation.” While at it, Jack suggests that with the “IRS’s robust tax collection mechanisms delegating tax restitution collection to the IRS and getting the courts / probation office / U.S. Attorney out would be a good use of limited resources.”  Jack also suggests that it would make sense for any delegation to the IRS include the IRS having the power to compromise the assessed restitution. 

IRS and DOJ have many tools at their disposal to go after crooked preparers, but Horn serves notice that at least among judges willing to inquire how the IRS will go about its business, the IRS may not be able to use an RBA when it comes to convicted preparers.

 

 

Impact of Bankruptcy Determination of Tax Liability on Tax Court Case and on Assessment Timing

When a taxpayer goes into bankruptcy, a new forum for tax litigation opens up, or potentially opens up, based on section 505 of the Bankruptcy Code. This section provides in pertinent part that “the [bankruptcy] court may determine the amount or legality of any tax, any fine or any penalty relating to a tax, or any addition to tax, whether or not previously assessed, whether or not paid, ….“  The recent case of Snyder v. Commissioner provides insight into the impact of a bankruptcy decision on the merits of a tax liability on a Tax Court case.  It also demonstrates the res judicata effect of the Bankruptcy Court’s decision on the tax matters decided in the case.

The Snyders appear comfortable in bringing court actions. Here, we see the result that court proceedings can have on the statute of limitations.  The recently decided Tax Court case in a collection due process (CDP) case concerns the tax years 1988 and 1989.  Because of years of litigation and a late start to the assessment of the liabilities for those years, the statute of limitations on collection remains open and still has years to run.

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While it is not clear from the recent Tax Court opinion what caused the mailing of the notice of deficiency for 1988 and 1989 on September 25, 1997, the mailing of that notice appears timely based on the absence of a challenge. The Snyders timely filed a Tax Court petition based on the notice of deficiency and proceeded toward trial in Washington DC on a trial calendar scheduled to start on March 15 (the Ides of March), 1999.  On that fateful day the Snyders filed a chapter 13 petition in the bankruptcy court for the District of Maryland.  Filing the bankruptcy petition invoked Bankruptcy Code section 368(a)(8) of the automatic stay and stopped the Tax Court case in its tracks.  Although the opinion does not state why the Snyders chose this day to file their bankruptcy petition, I suspect it had much to do with pending Tax Court trial and little to do with the anniversary of the death of Julius Ceasar.

Having filed the bankruptcy proceeding, the Snyders decided to avail themselves of the new forum in which to litigate their tax matter; however, it took over four years, until April 18, 2003, before the bankruptcy court issued an order concerning their liability.  The Snyders appealed the order of the bankruptcy court, the District Court remanded the case for further consideration and over three years later on October 30, 2006, the bankruptcy court issued an order on remand determining that the notice of deficiency was proper and the Snyders owed about $150,000 for the two years combined.  They appealed again and this time went even to the Fourth Circuit which upheld the bankruptcy court’s determination on May 11, 2007.

All this time the Tax Court case remained open and suspended. While the bankruptcy court took over the litigation of the merits of the Snyders’ liabilities for 1988 and 1989 and while the automatic stay suspended the Tax Court proceeding, the end of the merits litigation on the bankruptcy side of the case did not terminate the Tax Court case.  In these circumstances, the Tax Court enters a decision once the stay lifts.  The decision document entered in the Tax Court case mirrors the decision of the bankruptcy court and serves as the action that allows the Tax Court to close its case.  Usually, the Tax Court orders the parties to provide status reports on the progress of the bankruptcy case during the period of the automatic stay.  Without looking at the docket sheet in the case, I imagine that the attorney for the IRS in this case filed numerous status reports over the eight year period the case worked its way to resolution in the bankruptcy court process.

So, the IRS finally won a victory allowing it to assess a tax liability for tax years that ended approximately 20 years earlier. In the recently decided CDP case the Snyders argued that the IRS jumped the gun in making this assessment.  It is this argument and its resolution that provides the most interesting aspect of the case for me because very few cases illustrate the interplay of the bankruptcy and Tax Court decisions as they impact the timing of the assessment.  Before we get to the discussion of the resolution of the timing of the assessment, it is necessary to set the scene by talking about the collection due process case.

On May 11, 2007, the Tax Court entered its order determining the amount of the deficiencies for 1988 and 1989 in the Tax Court case filed almost ten years earlier in December 1997. I can only imagine that someone in the Tax Court clerk’s office was glad to get that case off of their desk.  The IRS assessed the taxes for those years on July 23, 1997 – 73 days later.  Upon making this assessment the IRS should have sent notice and demand letters to the taxpayers within 60 days.  Because the Snyders put this at issue in the CDP hearing the Tax Court determined, based on certified transcripts provided by the IRS, that notice and demand went to the Snyders on July 23 and August 27, 2007.  The timing of the notices falls well within the 60 day period required by IRC 6303.

Having sent notice and demand, one can only imagine without seeing the entire file of the IRS that the IRS sent other notices to the Snyders and they did not pay. Because this case bears the Docket Number 8740-13L, I conclude that the IRS eventually sent the taxpayers a notice of intent to levy or filed a notice of federal tax lien, or both, and that the collection action caused the Snyders to timely request a CDP hearing.  The Tax Court case does not mention when the CDP notice issued so determining how long the case sat in Appeals is not possible based on the opinion.  Unless it sat in Appeals a long time, it took the IRS several years after making the assessment to get to the point of issuing the CDP notice that gave rise to the most recent Tax Court case.  Given the amount of the liability, I would have expected the IRS to quickly file the notice of federal tax lien which would have triggered an opportunity for a CDP hearing; however, this timing issue does not come out in the opinion just as the length of time the case spent in Appeals does not come out.  No matter the timing of the collection actions or the Appeals consideration of those actions, Appeals eventually issued a determination letter upholding the collection action and taxpayers petitioned the Tax Court on April 22, 2013.

The four page electronic Tax Court docket sheet on the CDP case shows that the Snyders take litigation seriously. They filed a series of motions and discovery requests from the outset of the case.  The IRS filed a motion for summary judgment on November 7, 2014, over 18 months after the filing of the petition.  The Tax Court decision accepts the IRS motion for summary judgment and does so because almost all of the issues raised by the Snyders in the proceeding such as the validity of the original notice of deficiency, the amount of their deficiency and the innocent spouse status of Marion Snyder were previously decided by the bankruptcy court and cannot be relitigated in CDP proceeding based on the principle of res judicata.  This portion of the opinion provides a routine application of res judicata in the various issues raised again by the Snyders.

As mentioned above the interesting aspect of the case comes in the discussion of their attack on the timing of the assessment. The assessment occurred 73 days after the entry of the Tax Court’s decision.  The Snyders argued that IRC 6213(a) prohibited the IRS from assessing the tax until 90 days after the entry of the Tax Court decision due to section 7481(a)(1).  Because of the prior determination of the bankruptcy court, section 6213 does not control the assessment date in this case as it does with most Tax Court litigation.  Instead, section 6871(a) controls.  Rather than creating a 90 day waiting period, section 6871(a) “provides, in part that any deficiency with respect to income tax determined by the Secretary may be assessed immediately, despite the restrictions imposed by section 6213(a) on assessments, if the liability for the tax has become res judicata pursuant to a determination in a bankruptcy case under title 11 of the United States Code.  See Freytag v. Commissioner .  Thus, when a tax liability is determined by the bankruptcy court, the restrictions imposed on assessment by section 6213(a) do not apply, including the restriction that the Commissioner wait until the 90-day period expires before making an assessment.”

Because the bankruptcy court had previously determined that taxpayers owed a deficiency for the taxes, the decision of that court on the liability was res judicata at the time of the entry of the Tax Court decision even through an appeal of the bankruptcy court’s finding were on appeal to the Fourth Circuit. The Tax Court also rejected the arguments of petitioners that the IRS did not follow its own manual procedures regarding the assessments saying that the manual does not control the legality of the assessments and that the assessment was legal pursuant to section 6871(b).  While this outcome does not set precedent, it provides insight into the processing of a case where the taxpayer invokes the right to litigate in bankruptcy after initially petitioning the Tax Court to decide the proposed deficiency.