Boyle Strikes Again: Incarcerated Individual Subject to Delinquency Penalties Even Though Attorney Embezzled Funds and Failed To File His Tax Returns

We have often discussed the reach of the 1985 Supreme Court case United States v. Boyle. Section 6651(a)(1) and (2) impose delinquency penalties for failing to file a tax return or pay a tax unless the taxpayer can establish that the failure was due to reasonable cause and not willful neglect.  Boyle essentially stands for the position that taxpayers have a nondelegable duty to be aware of tax deadlines. An agent’s incompetence or willful misconduct will not excuse the taxpayer from delinquency penalties.

Lindsay v US is the latest case to apply the principle.

read more...

Lindsay was incarcerated and executed a POA to Bertelson, an attorney, to manage his affairs, including filing his tax returns.  The attorney assured Lindsay he was doing so for the years 2012-15; instead he failed to file the returns and for good measure embezzled hundreds of thousands of dollars. The actions resulted in Lindsay receiving $705,414.61 in actual damages and $1 million in punitive damages.

Lindsay eventually filed his tax returns and paid over $425,000 in delinquency penalties. He filed a claim for refund; IRS rejected and he filed a suit in district court. The district court, contrary to the magistrate’s recommendation, granted the government’s motion to dismiss, citing Boyle as precluding a claim for relief. Following a timely appeal, the Fifth Circuit affirmed. In so doing it applied Boyle to Lindsay’s somewhat sympathetic circumstances:

Lindsay claims that he exercised ordinary business care and diligence by giving Bertelson his power of attorney and by directing Bertelson to file his income tax returns and to pay his taxes. Lindsay routinely asked Bertelson whether he was handling Lindsay’s tax obligations, and Bertelson said that he was. In Lindsay’s view, he has a reasonable cause for late filings and delayed payments because he used ordinary business care and prudence but was nevertheless unable to file his returns and pay his income taxes due to circumstances beyond his control, i.e., Bertelson’s malfeasance.

Lindsay’s position was rejected in BoyleBoyle established that taxpayers have a non-delegable duty to promptly file and pay their taxes. 469 U.S. at 249–50. Unlike cases where taxpayers seek and detrimentally rely on tax advice from experts, “one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due.” Id. at 251. Lindsay’s argument fails.

The opinion disposed of a couple of other of Lindsay’s arguments. He also raised the IRS’s own definition of unavoidable absence as excusing delinquency. Citing George v Comm’r, a 2019 TC Memo opinion that collects cases on the point, the Fifth Circuit panel emphasized that the mere fact of incarceration itself does not mean there was reasonable cause to miss deadlines.

Lindsay’s final argument was that  Boyle does not control in cases where a taxpayer is not “physically and mentally capable of knowing, remembering, and complying with a filing deadline.” The opinion stated that even if Boyle created an incapability exception he could have done more, “much like he conducted business and employed a CPA while incarcerated.” 

Conclusion

Lindsay, like many other taxpayers, is out of luck when it comes to trying to recover delinquency penalties that can be directly linked to an agent’s misconduct or incompetence. He did have some recourse, however, as he was awarded significant compensatory and punitive damages from his embezzling attorney. 

CIC Fallout: Anti Injunction Act Bars Motion for Protective Order

US v Meyer presents a somewhat unusual context for a court’s application of the Anti Injunction Act. Meyer stems from an injunction action due to allegations that Meyer promoted “an abusive tax scheme that result[ed] in scheme participants claiming unwarranted federal income tax deductions for bogus charitable contributions.” In 2018, the parties settled that suit and filed a joint motion for permanent injunction. The settlement expressly did not preclude the US from “pursuing other current or future civil or criminal matters or proceedings,” or preclude Defendant from “contesting his liability in any matter or proceeding.”

read more...

Following the settlement, the IRS began a civil investigation and proposed approximately $7 million in Section 6700 civil penalties. Following the proposed assessment, Meyer sought a protective order from the federal district court that had previously been the forum for the injunction proceeding. In particular, Meyer alleged that the IRS’s computation of the proposed 6700 penalty improperly relied on admissions he had made in the injunction proceeding, in violation of Federal Rule of Civil Procedure 36(b). FRCP 36(b) provides that “an admission under [Rule 36] is not an admission for any other purpose and cannot be used against the party in any other proceeding.”

The request for a protective order was initially heard by a magistrate judge.  In April, that judge issued a report and recommendation concluding that Meyer’s request for relief was barred under the AIA. In so doing, the magistrate judge held that the AIA applied even though Meyer did not bring the suit but instead sought a protective order in a suit that the US had brought (recall that the AIA provides that  “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person….”). Meyer had sought relief based upon a federal district court’s broad power under Fed Rule Civ Procedure 26 which upon a showing of “good cause,” provides that a court may issue a protective order providing a variety of remedies, such as precluding discovery altogether or “specifying terms … for the disclosure or discovery.”

In finding that the AIA barred the request for a protective order stemming from an alleged violation of Fed Rule Civ Procedure 36 from a government-brought injunction case, the magistrate noted that there was no case law squarely on point but looked to analogous cases applying the AIA where taxpayers sought to limit information that the IRS could use in civil proceedings. According to the magistrate, Meyer’s relief request was essentially requiring the IRS to recalculate the penalty and “preclude the IRS from using certain information to assess a tax penalty and is, therefore, impermissible under [the AIA].”

In finding that the AIA did not allow the court to issue a protective order, the magistrate punted on the issue as to whether Rule 36 had any impact on the IRS’s proposed penalty assessment, and whether a “proceeding” for Rule 36 purposes also included an IRS civil penalty examination.  The magistrate noted that the substantive issue could be teed up in a refund proceeding.

Following the magistrate’s report, Meyer timely appealed the recommendation, with the district court then as per Fed Rule Civ Procedure 72 reviewing the matter on a de novo basis. The federal district court judge affirmed and adopted the magistrate’s order, though the opinion is somewhat noteworthy because it addresses Meyer’s additional filings with the court briefly dismissing Meyer’s argument that CIC Services supported finding that the AIA did not apply:

In the present case, the relief Defendant seeks falls squarely within the contours of the Anti-Injunction Act—namely, to limit the information the IRS may consider in its assessment of $7,066,039.00 in tax penalties under  § 6700. See ECF No. [98] at 5 (requesting that the Court “issue an order preventing the Government and its client, the IRS, from using [Defendant’s] Rule 36 Admissions to support factual conclusions in the IRS’s Section 6700 Penalty examination.”); ECF No. [105] at 10 (“request[ing] that this Court enter an order directing the Government that it may not use the Defendant’s RFA Responses for any purpose other than as admissions in this proceeding.”) (emphasis in original); see also CIC Serv., 141 S. Ct. at 1593 (“suits sought to prevent the levying of taxes … [cannot] go forward.”). Thus, the Court agrees with [the magistrate judge’s] conclusion that Defendant’s Motion is barred under the Anti-Injunction Act.

Conclusion

As did the magistrate judge’s, the district court’s order ended with a statement that Meyer was not without recourse as he could bring a refund proceeding and thus get a court to address the merits of Meyer’s claim that Federal Rule of Civil Procedure 36(b) should bar the IRS from using admissions from a separate injunction in calculating a 6700 penalty in a civil exam. Of course, a refund suit is predicated on Meyer satisfying Flora, though the 6700 penalty has special statutory rules allowing for partial payment to secure court review.

Reliance and Omitted Income: Taxpayer Cannot Avoid Penalties Even When Using Longtime Preparer

I do not prepare tax returns. But I feel for the long-suffering preparers who try their best to get the information from clients to prepare an accurate tax return.  For people with a variety of sources of income, like self-employed consultants with multiple clients, the process is burdensome—at least when compared to employees who more or less automatically get W-2s with withholding that tends to approximate liability.  I also feel for taxpayers who have income from a myriad of sources because collecting and insuring that the income from each source that gets reported can prove difficult.  Neither taxpayers nor preparers have a computer system akin to the IRS underreporter program that matches all of their third party returns against the amounts reported on the returns.  If such a program existed presubmission to the IRS, returns would be much more accurate.

read more...

The recent case of Walton v Commissioner involved a psychologist whose 2015 tax return failed to include almost $170,000 in compensation. Prior to 2015, Walton had been employed with a consulting firm. In 2015 she went out on her own and had multiple clients. When it came time to file her 2015 return, she attempted to give all her information to her preparer but, as we will see below, she may not have given all of her 1099’s and the preparer failed to include a sizable chunk of her income. The issue in the case involved substantial understatement penalties-namely whether the IRS satisfied the supervisory approval requirement under 6751(b) or whether her omission should be excused by good faith reliance on her longtime experienced CPA return preparer.

In this post I will discuss the latter issue though I note the opinion discusses that the 6751(b) approval was not necessary because of the exception to the supervisory approval requirement for a “penalty automatically calculated through electronic means.” The opinion discusses how Walton’s omission was flagged by the IRS’s Automatic Underreporting Program (AUR) and thus was “determined mathematically by a computer software program without the involvement of an IRS examiner” leading it to conclude that the penalty was “automatically calculated through electronic means.” (citing Walquist v Comm’r, which Keith discussed in Automatically Generated Penalties Do not Require Managerial Approval and which Bob Kamman also addressed in Some Facts About the Walquist Case, Along with Some Nuance).

After rejecting the 6751(b) defense the court turned to whether Walton had reasonable cause for the omission and whether she acted in good faith. In setting up the issue the opinion notes that reliance of a qualified and competent preparer is not enough; there must be evidence that the taxpayer acted with diligence and prudence. 

In evaluating whether she acted with both prudence and diligence, the opinion discusses the back and forth between Walton and her preparer. As a starting point the atmosphere here is bad: the return left off almost 1/3 of her total compensation. Yet the exchange showed she gave her preparer a starting point on income that was well in excess of the 1099’s she had sent over. In January of 2016 she sent an email to her preparer stating that “I am sure I need to pay taxes. If I did the math right, I earned about $525k in 1099 pay.” A month later Walton sent over a W-2 showing some income from her former employer as well as five 1099 MISC’s totaling over $350,000.  Fast forward to April 12: another CPA at the firm sent Walton an email asking a bunch of questions on unrelated issues as well as if she was sure that she had sent all the 1099’s as the total was well below the 525,000 estimate in her January email. 

Two days later Walton responded to the questions but did not answer the 1099 MISC question.  After that exchange the CPA firm obtained an extension to October 15th. On September 29 her preparer (who had done her taxes for twenty years and prepares over 1,000 returns a year) emailed Walton a list of things he needed to complete the return. That did not include a specific ask for 1099 MISC’s but instead focused on 1099- DIV, business and travel expenses and other issues. Walton responded and said that she “attached the 1099s to the last emails”, and the preparer replied that “I have all the 1099s and the kids accounts, … the taxes and interest on the house …[and] the charities as well.”

The opinion notes that it is the preparer’s practice when there is a discrepancy between a client estimate and documentation to rely on the numbers in the document. Unfortunately for Walton, she testified that she did not review the return before the preparer e-filed it as she trusted his expertise.  That admission was fatal to the defense—even though there was some uncertainty as to whether she gave all 1099 MISC’s to her preparer, the failure on Walton’s part to review the return led to a finding that she failed to act with the prudence and diligence necessary to avoid the penalty.

Conclusion

In reading this opinion I was reminded of one of my early blog posts back in 2013,  Omitted Income, Accuracy-Related Penalties and Reasonable Cause. That post discussed Andersen v Comm’r, a summary opinion where a taxpayer also used a longtime preparer and left off a significant amount of W-2 income (about $28,000) from the return, but the court still found that they should not be subject to civil penalties. The opinion found that the taxpayer acted with reasonable cause and good faith, looking to an almost 50 year record of taxpayer compliance, only a slight difference in income from the year in question and the prior year’s return and circumstances that showed how the preparer mistakenly believed that he had all the information returns from the taxpayers. 

All of these cases are fact specific. Walton does reveal how burdensome our filing system is. The amount of time necessary to fish for all information returns is wasteful and prone to error. Taxpayers can set up online accounts with the IRS so that they (and their preparers) can see what information returns IRS has received, but that system is not easily accessible. While I understand the court’s conclusion in Walton, we would all be better off if taxpayers and their preparers could easily see all information returns on file. Our system does not make it easy. I am glad I do not prepare tax returns for a living.

How to Apply the Gross Valuation Misstatement When a Gift is a Sham

As we are reviewing cases from the past few months for the next update in Saltzman and Book IRS Practice and Procedure I have noted a few developments that we have not discussed in PT. A number involve civil penalties. One case is Fakiris v Commissioner, where in November the Tax Court issued a supplemental opinion from a 2017 opinion where it applied the gross valuation misstatement penalty to a purported charitable contribution of a vaudeville era Staten Island movie theater. Fakiris involves restrictions on that gift, leading the Tax Court to conclude that donation was conditional and that there was no completed gift or contribution under Section 170. That in turn triggered Section 6662(h), which imposes an accuracy-related equal to 40% of the portion of the underpayment of tax attributable to a gross valuation misstatement. Following the 2017 opinion, the IRS filed a motion for reconsideration, arguing that the original opinion improperly applied the 6662(h) accuracy-related penalty.

read more...

The original Fakiris opinion (Fakiris 1) was rich with interesting procedural issues, including affirming that 2006 legislative changes, which lowered the threshold for gross valuation misstatements from 400% to 200% and eliminated the reasonable cause exception, applied when the original contribution arose prior to the law’s effective date but the deduction continued to a year when the taxpayer took a carryover deduction. How could a pre-legislation transaction be covered by legislation that was not retroactive? According to the Tax Court, a taxpayer who takes carryover deductions reaffirms its original misstatement in later post-effective date years.

In addition, Fakiris 1 held that the penalty applied even when the court found that there was no effective contribution or gift for federal tax purposes. It reached that conclusion by citing to and briefly discussing the Supreme Court’s 2013 decision in Woods v United States. Prior to Woods, some courts of appeal had held that when deduction or credit is disallowed in full, any underpayment is not “attributable to” a valuation misstatement for purposes of the accuracy-related penalties. Woods rejected that approach and held that the accuracy-related penalty for valuation misstatements applies when the relevant transaction is disregarded for lack of economic substance. As the Tax Court said in its 2017 opinion, “[w]hen the correct value of contributed property is zero and the value claimed is greater than zero, the gross valuation misstatement penalty applies.”

Despite the IRS’s 2017 win in Fakiris 1, the IRS filed a motion for reconsideration. In its motion, the IRS agreed with the original opinion’s conclusion that the transfer of the theater was not a gift but argued that the original opinion misapplied Woods. In particular the motion argued that the original opinon failed to properly apply the gross valuation misstatement penalty, contrasting how courts have approached the valuation penalty post-Woods in façade and conservation easement cases. 

In a somewhat unusual move, the Tax Court granted the motion for reconsideration. Last year the Tax Court issued its supplemental opinion, which affirmed its prior holding and expanded on its original rationale. As an initial matter, it explained why the original transfer was not effective to be treated as a gift or contribution for tax purposes, with a sharper focus on the degree of dominion and control that the donor/seller maintained over the property. In addition it more closely aligned its analysis with cases analogizing failed gifts to shams. After expanding on its rationale for finding that there was no gift, the supplemental opinion turns to the main issue on reconsideration:

What is the “correct value” of “property” that is claimed to be donated but is not actually donated? Or, more precisely: Is the value that of the property that was reported to have been contributed, as respondent would have it be, or the value of the property that was actually contributed? 

All of this is important because of the triggering rules in Section 6662. Recall that accuracy-related penalties apply when there is a substantial valuation misstatement as per Section 6662(b)(3), The base penalty is 20 percent, but that is doubled in certain cases that involve a gross valuation misstatement, as per Section 6662(h)(1). A “substantial” valuation misstatement arises if the value of transferred property is overstated by 150 percent or more of the correct value. The penalty is classified as a “gross” valuation misstatement and the penalty rate is doubled to 40% if the value is overstated by 200% or more of the correct value. 

The penalty is more important since the Supreme Court decided United States v. Woods, 571 U.S. 31 (2013), which held that a valuation penalty applied even when an entire transaction was disregarded (some courts had previously held that the understatement was not attributable to valuation misstatements when an entire transaction was disregarded). Regulations under Section 6662 also provide that there is a gross valuation misstatement  (and thus a steep 40% penalty) when the correct value of property is zero and the value claimed on the return for such property is greater than zero.

Back to Fakiris 2. The IRS on reconsideration argued that the trigger for the penalty required a comparison between the actual value of the theater and the value of what was in fact transferred to the donee/buyer. Under the IRS’s approach on reconsideration either the 20% substantial misstatement or 40% gross misstatement penalty would not automatically apply to Fakaris. The IRS essentially argued for the court to compare the value of the theater without restrictions with the value of what was in fact transferred, i.e., a theater with substantial restrictions. Under the IRS’s approach, if the value of the theater without any restrictions was greater than or equal to twice the value of the theater with the restrictions, the taxpayer would be subject to a 40% accuracy related penalty. This differed from Fakaris 1, which had held that the gross valuation penalty automatically applied when the court found that the restrictions effectively rendered the purported gift a sham.

The Tax Court disagreed with the IRS, mainly distinguishing two easement cases. While in those cases the courts had disallowed deductions due to donors failing to comply with substantiation requirements there also was a valid transfer of something of value. In contrast on reconsideration the Tax Court held that its holding in Fakiris 1 was directly premised on the finding that the donee transferred nothing: 

In both [easement] cases we proceeded on the assumption that a discernible property right had been validly transferred from the donor to the donee. In other words, some quantum of property rights had been transferred from donor to donee, and the charitable contribution deduction was disallowed for failure to satisfy statutory requirements of substantiation. For that reason, a determination of the value of that quantum of property transferred was necessary to calculate the applicability and amount of the section 6662(h) penalty. The same is not true here; the transfer itself was a sham, with the result that the value of the property claimed to have been contributed is zero for purposes of the penalty.

As a final matter, the Tax Court emphasized that even if it were inclined to accept the IRS’s approach on reconsideration and conclude that there was some transfer/gift for federal income tax purposes, the record “is devoid of any evidence supporting a value for whatever could be said to have been transferred.” 

Conclusion

With the IRS urging a taxpayer friendly interpretation of the valuation misstatement penalty, the procedural posture of Fakiris is somewhat unusual. To be sure, the IRS could effectively disregard the Tax Court’s reasoning and choose to apply penalties regime consistent with what its position on reconsideration. Under Fakiris 1 and 2 if a purported charitable contribution is disallowed due to a finding that restrictions placed on the donee effectively render an initial gift or contribution as incomplete the effect is likely an automatic 40% penalty.

On the other hand, as a practical matter I am not sure that the difference matters much. Once misstatement penalties apply when the disallowance stems from threshold legal determinations in cases where a court (as in Fakiris) find that the donor maintains a degree of control over the supposedly gifted asset, I assume that the value of the asset is likely to be sufficiently low enough to trigger the 40% gross valuation misstatement anyway. 

Padda v Comm’r: Possible Opening in Defending Against Late Filing Penalty When Preparer Fails to E-file Timely

Courts have generally not excused taxpayers from late filing penalties when the taxpayer defense is that that the return preparer was responsible for the delinquency.  Decades ago the Supreme Court in Boyle held that reliance on a third party to file a return does not establish reasonable cause because “[i]t requires no special training or effort to ascertain a deadline and make sure that it is met.”  We have previously discussed how Boyle seems incongruent with e-filing. As I noted last year in Update on Haynes v US: Fifth Circuit Remands and Punts on Whether Boyle Applies in E-Filing Cases “the basic question is whether courts should reconsider the bright line Boyle rule when a taxpayer provides her tax information to her preparer and the preparer purports to e-file the return, but for some reason the IRS rejects the return and the taxpayer arguably has little reason to suspect that the return was not actually filed.”

So far taxpayers have not been successful in arguing that courts should distinguish BoylePadda v Commissioner is the latest case applying Boyle in these circumstances. Like other cases where the taxpayer’s late filing was due to a preparer’s mistake the court did not relieve the taxpayer from penalties. What is unusual though is that in rejecting the defense Padda implicitly acknowledges that differing circumstances might lead to a taxpayer win.

read more...

I will summarize the facts and discuss the slight opening the opinion suggests.

The opinion nicely summarizes what went wrong:

Padda and Kane’s 2012 federal individual income tax return was due October 15, 2013. On October 15, 2013, Padda and Kane signed IRS Form 8879, “IRS e-file Signature Authorization” to authorize Ehrenreich’s accounting firm to electronically file their 2012 Form 1040, “U.S. Individual Income Tax Return”. On October 15, 2013, Ehrenreich’s accounting firm was electronically filing several tax returns just before midnight. Ehrenreich’s accounting firm created an electronic version of Padda and Kane’s return on October 15, 2013, at 11:59 p.m. It transmitted the electronic version to the IRS on October 16, 2013, at 12 a.m. On October 16, 2013, the IRS rejected the return as a duplicate submission. Ehrenreich’s accounting firm electronically resent the return on October 25, 2013, and it was received and accepted by the IRS the same day.

Prior to trial, the IRS and spouses Padda and Kane stipulated that the return was filed on October 25, 2013. The IRS had proposed late filing penalties under Section 6651, which trigger a 5% penalty of the amount required to be shown on the return if the failure to file is under a month, as the case here. In arguing that they had exercised reasonable care and prudence, the taxpayers explained that “1) Ehrenreich’s accounting firm pressed a button only a few seconds late, (2) they relied on Ehrenreich’s accounting firm to timely file the return, and
(3) they themselves could not have pressed the button to timely file the return.”

In rejecting the defense, the Padda opinion cites to Boyle and other cases which provide that taxpayers cannot delegate their filing obligation other than in circumstances where the advice pertains to whether a return needs to be filed at all. 

What I find interesting is that the opinion could have just cited Boyle and stopped there. Instead, it suggested that a relationship with a preparer who had history with the taxpayer of submitting e-filed returns on time might have led to a different outcome:

Even if sometimes it might be reasonable for a taxpayer to rely on his or her accountant to timely file his or her returns (contrary to the caselaw), it was not reasonable in this particular case for Padda and Kane to rely on Ehrenreich’s firm to timely file their return. Padda and Kane have relied on Ehrenreich’s firm to file their returns every year since at least 2006. And every year since then, except for 2011, their return was filed late. Yet they have continued to use Ehrenreich’s firm to file their return year after year. Padda and Kane’s failure to ensure that Ehrenreich’s firm timely filed their 2012 return demonstrates a lack of ordinary business care, particularly in the light of the firm’s history of delinquent filings.

Given the the firm’s delinquent filing history, the opinion concluded that the taxpayers failed to establish that they had reasonable cause for the late filing.

Conclusion

We wait for perhaps better facts for a court to distinguish Boyle. The Boyle-blanket rule seems out of place in today’s world where there may be little way to monitor preparers who taxpayers should be able to expect can meet a deadline. Padda suggests, though does not explicitly embrace, that some reliance may be reasonable, but when there is a long past history of delinquency, even if the taxpayer was not in a position to monitor the particular filing, it will be difficult to find that the taxpayer has a winning reasonable cause defense.

Imposing the Fraud Penalty after Prosecution While Satisfying IRC 6751(b)

In Minemyer v. Commissioner, T.C. Memo 2020-99 the Tax Court determined that the IRS failed to prove it made a timely approval of the fraud penalty and determined that the IRS could not assess the penalty in this case.  Because Mr. Minemyer had the fraud penalty imposed after a successful prosecution of him for tax evasion under IRC 7201, I found the application of IRC 6751(b) here produced a surprising result, though I cannot say the decision is incorrect and sympathize with any effort to parse through the language of this statute.  The Tax Court seeks to enforce a bright line rule even though the circumstances of this case which follows a criminal conviction present a somewhat different situation than the ordinary imposition of a civil penalty

read more...

In a case like this, IRS policy ties the hands of the revenue agent and the immediate supervisor making the imposition of the fraud penalty against Mr. Minemyer a foregone conclusion.  In some respects, the imposition of the penalty here acts somewhat like the penalties imposed by computer because the IRS imposes the penalty automatically by virtue of its policy and not imposing the penalty requires the agent to obtain approvals.  The apparent legislative goal in passing IRC 6751(b) was to prevent the IRS from using penalties as a bargaining chip.  The goal serves a laudable purpose and a more clearly written statute enforcing that goal would receive support from everyone.  We have written before on many occasions, samples found here and here, about the defects in the statutory language of IRC 6751(b).

Here, the goal of the statute really plays no part in the imposition of the penalty.  If the IRS makes a determination that someone has committed tax evasion and refers the case to the Department of Justice for prosecution, the imposition of the fraud penalty could come as no surprise – and particularly so when the person is actually convicted of tax evasion.  In a case such as this, the imposition of the penalty must occur pursuant to the Internal Revenue Manual 25.1.6.2(9) unless the revenue agent or the supervisor get permission at a high level to not impose the fraud penalty.

The revenue agent apparently visited Mr. Minemyer in prison to secure his signature on Form 4549 consenting to the assessment of the tax and the fraud penalty.  Mr. Minemyer apparently did sign the Form 4549 but later withdrew his consent asserting that he signed it under duress.  At the Tax Court trial, the IRS did not produce the Form 4549.

This case involves the tax years 2000 and 2001.  So, the years come after the passage of IRC 6751(b) in 1998 but well before the IRS focused on compliance with IRC 6751(b).  The conviction here occurred in 2009 before the passage of the statute permitting restitution based assessments discussed here.

Nonetheless, the revenue agent actually obtained the signature of the immediate supervisor before the IRS sent the 30-day letter.  The problem the Court has with the penalty approval here turns again on the language of the poorly crafted statute, which requires the supervisor’s signature before the “initial determination” regarding the imposition of the penalty.  Here, the effort to have Mr. Minemyer sign the Form 4549 occurred prior to the sending of the 30-day letter and may have been the initial determination, which may require the IRS demonstrate supervisory approval at an earlier stage than the 30-day letter.  Here’s what the Court says:

In Frost v. Commissioner, 154 T.C. ___, ___ (slip op. at 21-22) (Jan. 7, 2020), we held that “the Commissioner’s introduction of evidence of written approval of a penalty before a formal communication of the penalty to the taxpayer is sufficient to carry his initial burden of production under section 7491(c) to show that he complied with the procedural requirement of section 6751(b)(1).” As in Frost, respondent here introduced evidence of written approval of the penalty before a formal communication (i.e., the 30-day letter). Also as in Frost, petitioner has not claimed that there was a prior initial penalty determination. Unlike Frost, our record does support the conclusion that respondent may have formally communicated his initial penalty determination to petitioner before the 30-day letter. Cf. Frost v. Commissioner, 154 T.C. at ___ (slip op. at 23) (“[P]etitioner has not claimed, nor does the record support a conclusion, that respondent formally communicated his initial penalty determination to petitioner before the date that the examining agent’s manager signed the Civil Penalty Approval Form.” (Emphasis added.)).

When the revenue agent visited petitioner in prison, he provided petitioner a Form 4549, which petitioner signed. Petitioner contends that he was under duress to sign the Form 4549 and for that reason he withdrew his consent. During respondent’s counsel’s opening statement at trial he contended that petitioner [*8] received a preliminary form before the formal communication in the 30-day letter and that petitioner signed it, agreeing to the fraud penalty for 2001. This statement is an acknowledgment that the Form 4549 communicated an intention to impose a penalty.

Respondent did not offer this Form 4549 into evidence. Therefore, we cannot determine whether the Form 4549 or the 30-day letter was the initial determination for the purpose of section 6751(b). Without the Form 4549 we cannot determine whether that form clearly reflected the revenue agent’s conclusion that petitioner should be subject to a penalty. See Carter v. Commissioner, at *30. If the Form 4549 was the initial determination of the fraud penalty for 2001, there is no evidence of its timely written approval. 

Accordingly, we conclude respondent has not met the burden of production for the determination of the section 6663(a) fraud penalty for 2001. Therefore, petitioner is not liable for the fraud penalty for 2001.

The tossing of the fraud penalty against someone convicted of tax evasion on this technicality seems a bit harsh and out of sync with the purpose of the statute but the Court must deal with a poorly written statute and seeks to establish bright line rules.  Perhaps this situation would not occur going forward because of the heightened emphasis on IRC 6751(b) at the IRS due to all of the litigation.  Maybe Congress did not care when the IRS lost lots of penalties due to the application of IRC 6751(b), since the IRS takes an approach to penalties that many might view as too zealous.  Imposing the fraud penalty against someone convicted of tax evasion can hardly fall into the over-zealous category and failing to impose the penalty on a convicted tax felon for a technicality like this should cause Congress to think about writing this provision in language that fits with the language of the tax code.

As mentioned above, the imposition of the fraud penalty against Mr. Minemyer occurred as automatically as the penalty imposed by computers.  Individuals convicted of violations of IRC 7201 always get the fraud penalty.  The IRS views it as inappropriate to ask the Department of Justice to prosecute someone for tax evasion with a guilt beyond a reasonable doubt standard and not pursue the civil fraud penalty thereafter.  My thinking on this case is no doubt colored by my view that to not impose the fraud penalty here the revenue agent and the immediate supervisor would have needed to move heaven and earth and that everyone knew this.  I realize those penalty administrative norms do not match the language of this poorly worded statute, but Mr. Minemyer’s civil fraud penalty was, in reality, approved the day his case was referred to DOJ for prosecution.  The revenue agent and the immediate supervisor served as no more than window dressing in the imposition of the penalty in a case such as this.

The decision in this case was entered on July 1, 2020, just three months and six days short of the 10-year anniversary of the filing of the petition in this case back in October of 2010.  The IRS must regret that the case did not reach a decision point during the first five years of its existence before the jurisprudence on Graev developed.  This would have been a slam dunk case for the IRS back during that period.

ACA Penalty Notices May Not Meet Section 6751(b) Requirements

We welcome back guest blogger Rochelle Hodes.  Rochelle is a Principal in Washington National Tax at Crowe LLP and was previously Associate Tax Legislative Counsel with Treasury. As we prepare to gear back up for IRS enforcement activity, she provides a timely discussion of the ever popular IRC 6751(b) and another way it may help your client when the IRS seeks to penalize.  Keith

Section 6751(b)(1) generally provides that no penalty can be assessed unless the initial determination of such assessment is personally approved in writing by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.  Written supervisory approval is not required to impose a penalty under Section 6651, 6654, or 6655.  Written supervisory approval also is not required to impose a penalty that is automatically calculated through electronic means. 

Section 6751(b) has been covered many times in the Procedurally Taxing blog. Generally, the Tax Court will not sustain the IRS’s assertion of a penalty if the IRS cannot demonstrate that written supervisory approval is not obtained prior to the initial determination of assessment of the penalty.  The latest in this line of cases is Kroner v. Commissioner, T.C. Memo. 2020-73 (June 1, 2020), which further fine-tunes earlier holdings regarding when the initial determination of the penalty is made. 

read more...

Prior to Kroner, the Tax Court ruled in Clay v. Commissioner, 152 T.C. 223, 249 (2019), blogged here, and Belair Woods, LLC v. Commissioner, 154 T.C. ___ (Jan. 6, 2020), blogged here, that the initial determination is the date on which the IRS formally communicates to the taxpayer Examination’s determination to assert a penalty and notifies the taxpayer of their right to appeal that determination.  In Clay, that court held that the initial determination was the date that the IRS issued the revenue agent’s report (RAR) and the 30-day letter. In Belair, the court held that the initial determination was the date that the IRS issued the 60-day letter, which in the case of a TEFRA partnership is the notice that communicates Examination’s determination that penalties should be imposed and notifies the taxpayer of their right to go to Appeals. 

In Kroner, the IRS issued a Letter 915, which is an examination report transmittal, to notify the taxpayer that Examination is proposing penalties and that the taxpayer has a right to go to Appeals.  Later, the IRS sent the taxpayer an RAR and a 30-day letter.  The written supervisory approval for penalties was issued after the Letter 915 was sent and before the RAR and 30-day letter were sent.  The Tax Court held that regardless of what the IRS calls the notice that provides the taxpayer with its determination of penalties and notification of the right to go to Appeals and regardless of the IRS’s intent, the initial determination for purposes of section 6751(b) is the first time examination determines that it will assert the penalty and notifies the taxpayer that they have a right to appeal that determination.  In Kroner, the court held that this occurred when the IRS issued the Letter 915.  Accordingly, written supervisory approval was issued after the initial determination for purposes of section 6751(b), and the penalty was not sustained.

On May 20, 2020, the IRS issued an immediately effective interim IRM 20.1.1.2.3.1 on the timing of supervisory approval:

For all penalties subject to section 6751(b)(1), written supervisory approval required under section 6751(b)(1) must be obtained prior to issuing any written communication of penalties to a taxpayer that offers the taxpayer an opportunity to sign an agreement or consent to assessment or proposal of the penalty.

Not long before Kroner was decided and the interim IRM guidance above was released, I had a client who received an IRS form letter, Form 5005-A (Rev 7-2018), imposing immediately assessable information reporting penalties under section 6721 and section 6722 for 2017 for failure to timely file Forms 1094-C and 1095-C.  This letter is one of several form letters that are being issued under the IRS’s ACA employer compliance initiative. Under section 6056, employers are required to file and furnish these ACA-related forms to report offers of health coverage. 

The Form 5005-A states that the taxpayer can agree with the penalty and pay it.  If the taxpayer disagrees, the letter states that the taxpayer will “have the opportunity to appeal the penalties after we send you a formal request for payment.” A Form 866-A, Explanation of Items, is attached explaining the basis for assertion of penalties.  The conclusion section states: “Subject to managerial approval, because the Employer failed to file Form(s) 1094-C and 1095-C and furnish Forms 1095-C as required pursuant to section 6056, the employer is subject to the penalties under IRC 6721 and IRC 6722 calculated above.”

The Letter 5005-A and Form 866-A are striking in three regards:  1) The letters clearly communicate Examination’s determination to impose the penalty; 2) the Letter 5005-A is less clear about the opportunity to go to appeals because it delays the opportunity until a formal request for payment is made, but there is clear notification that the right to go to Appeals exists and can be exercised; and 3) the Form 866-A takes the guess work out of whether there was supervisory approval—it states affirmatively that there has not yet been supervisory approval. 

Kroner makes it clear that the name or number of the form the IRS uses to communicate the determination and right to appeal is of no consequence.  As applied to the Letter 5005-A, there is a determination and arguably there is notification of the right to appeal, therefore, the date of this notice is the initial determination of the penalty.  Since according to the Form 866-A there was no supervisory approval before the date the Letter 5005-A was issued, the IRS has failed to satisfy section 6751(b) and the penalties should not apply. 

Even if the “notice of the right to go to Appeals” prong of Kroner is not satisfied, the Letter 5005-A clearly meets the standard for when supervisory approval is required under the interim IRM provisions because the taxpayer is provided the opportunity to agree with and pay the penalty.  While the interim IRM provisions were issued on May 20, 2020, they represent the IRS interpretation of how they should be complying with section 6751(b).  Therefore, failure to comply with the interim IRM provisions in the past should be a failure to comply with section 6751(b). 

IRS is currently sending penalty notices that were being held back due to the pandemic.  For penalties other than sections 6651, 6654, and 6655, practitioners should carefully review notices to evaluate whether section 6751(b) applies and if so, whether the letter is an initial determination required to be preceded by written supervisory approval.

Is IRS Too Soft on People Claiming EITC? Treasury Says Yes and Also Suggests No

The pressure on the IRS to deliver the economic impact payment (EIP) highlights some of the general challenges the IRS faces when Congress tasks the IRS to deliver benefits.  With respect to the EIP, faced with a public that needs the money that Congress has earmarked, IRS has had to move quickly. In times like these, when balancing speed with accuracy, IRS should and admirably has erred on the side of speed.  With lives upended and millions of Americans struggling, this is the right call. 

As an administrator that regularly gets taken to task when it comes to its administration of refundable credits like the EITC, IRS faces a similar trade off in its more routine day to day work.  IRS knows that millions of Americans rely on those Code-based benefits. At the same time, about 25% of the EITC is classified as an improper payment, as Congress has been sure to remind Commissioner Rettig when he has been up on the Hill.

Two recent publications highlight the competing pressures the IRS faces as a result of it having responsibility for administering the EITC.  One is a TIGTA report taking the IRS to task for failing to impose civil penalties and bans on individuals who appear to be improperly claiming the EITC. The other is a Treasury Office of Tax Analysis (OTA) working paper that emphasizes that the vast majority of people claiming the EITC have an eligible familial relationship with a claimed qualifying child.

For folks who are looking for differing perspectives on an issue I suggest that you read both, back to back.  If reading TIGTA reports and OTA working papers is not your ideal way of spending an afternoon, in this post I will discuss the highlights of both.

read more...

TIGTA: IRS Not Doing Enough to Deter and Punish Improper Claimants

First, the TIGTA Report. TIGTA’s steady drumbeat on EITC and refundable credits is that IRS is not using the enforcement tools that Congress has given to it. 

Congress provided the IRS with tools to address taxpayers identified as submitting fraudulent or reckless refundable credit claims. These tools include the authority to assess the erroneous refund penalty and require taxpayers to recertify that they meet refundable credit eligibility requirements for credits claimed on a return filed subsequent to disallowance of a credit, and the ability to apply two-year or 10-year bans on taxpayers who disregard credit eligibility rules. However, the IRS does not use these tools to the extent possible to address erroneous credit payments. 

What are the consequences of IRS not using its robust power to sanction taxpayers? In TIGTA’s view,

[t]he ineffective use of the various authorities provided in the I.R.C. is a contributing factor in the high rate of improper payments. The IRS estimates that 25 percent ($18.4 billion) of EITC payments made in Fiscal Year 2018 were improper payments. The IRS also estimates that nearly 33 percent ($8.7 billion) of ACTC payments made during Tax Years 2009 through 2011, and more than 31 percent ($5.3 billion) of AOTC payments made during Tax Year 2012, were potentially improper. 

The main gripe TIGTA emphasizes is that the IRS has failed to use its power to impose a 20% erroneous refund penalty under Section 6676, a power that Congress amended a few years ago to specifically apply to individuals erroneously claiming refundable credits like the EITC:

In Years 2015, 2016, and 2017, the IRS assessed the erroneous refund penalty on 3,190 erroneous claims totaling $2.7 million. However, our analysis identified 494,555 withholding and refundable credits disallowed for Tax Years 2015, 2016, and 2017 (as of December 27, 2018). These taxpayers filed 798,504 tax returns that claimed more than $2.6 billion in improper withholding or refundable credits. Applying the 20 percent erroneous penalty rate to the disallowed credits computes to almost $534.7 million in penalties that the IRS potentially could have assessed. 

TIGTA goes on state that IRS has studied the impact of the few cases when IRS has in fact imposed the 6676 penalty, and it appears that IRS is teeing up some recommendations based upon its study (FYI – I have not seen the study nor do I know if IRS is planning on releasing it; it would be interesting as well to see how much tax is collected out of previously assessed penalties—I suspect not much). 

The report also criticizes IRS for failing to systematically impose a two-year ban on taxpayers who in TIGTA’s view are recklessly or intentionally disregarding rules and faulty IRS processes for allowing individuals to recertify eligibility for the EITC (and other disallowed credits). As to the ban, TIGTA notes that in successive years people appear to be incorrectly claiming the EITC. ( Note: as advocates know appearances may be misleading as claimants may be unaware of the rules or simply not able to document meeting eligibility criteria. For more on the ban, see Bob Probasco’s excellent three part series, The EITC Ban-Further Thoughts Part 1Part 2 and Part 3.) In a heavily redacted section, TIGTA suggests that the IRS should impose the ban earlier and more frequently. This would free scarce audit resources to investigate other individuals and prevent erroneous claims.

The TIGTA report also discusses recertification. For individuals who have had credits denied through deficiency procedures, Section 32(k) provides that “no credit shall be allowed under this section for any subsequent taxable year unless the taxpayer provides such information as the Secretary may require to demonstrate eligibility for such credit.” TIGTA highlights IRS problems with its processes to ensure that taxpayers who recertify are in fact eligible for the claimed credits.

OTA: The “Improper” EITC Claimants Look Like the Proper Claimants

The OTA paper looks at the EITC very a different perspective. While noting the stubborn 25% or so improper payment rate, OTA attempts to study the characteristics of the people who are not eligible or who appear to be overclaiming the credit. The reason for the inquiry is to help frame the debate around improper payment rates. As OTA notes, 

from the social welfare perspective, policymakers might view a case where a child lived with her low-income grandmother for 6 months of the year differently from a case where an unrelated person claimed a child she did not live with at all; but, both cases would be counted equally in computing the EITC error rate.

What the improper payment rates alone fail to tell us is context. 

When a taxpayer fails to meet the qualifying child tests for an EITC claim, it is generally unknown how closely this taxpayer is related to the child and whether another taxpayer could have correctly claimed the child. 

It is possible for more than one taxpayer to have provided some care for the child during the year, but no single taxpayer to be eligible to claim the EITC for that child under the law (e.g., the child does not live with any taxpayer for more than half the year). In other cases, the erroneous claim may have precluded the actual caregiver from claiming the child. 

What OTA does in the paper is to provide more detail to allow for a “more nuanced consideration of EITC qualifying child errors and the associated social welfare implications.”

What kind of nuance did OTA look to identify? Essentially OTA looked to see if there was a family relationship between the adult and the child claimed as a qualifying child:

Specifically, we analyzed the intensity of the familial relationship between the child and the actual claimant as well as the length of the shared residency, providing information about whether the claim, despite being erroneous, might nonetheless have supported a low-income worker caring for a child. In addition, we studied possible reasons why the “wrong” taxpayer may have claimed the child—whether this occurred due to complicated family circumstances, intentional credit-maximizing behavior, or other reasons—to better understand the causes of EITC noncompliance. Finally, we estimated the credit that could have been received by the parent who did not already claim the child and was potentially the actual caregiver. This result offers an insight into the extent to which the EITC improper payment estimates may overstate not only the social welfare loss but also the monetary loss to the government. 

OTA’s study showed that in the overwhelming number of cases, when there was an error, there still was a close familial relationship between the adult and the child or children, though typically the adult was not the child’s biological parent:

Our analysis suggests an intense relationship between the child and the claiming taxpayer in most cases. About 87 percent of the children, despite being claimed with qualifying child errors, had a valid familial relationship (84 percent) or lived with the taxpayer for more than half of the year (7 percent) or both. However, compared to children who met all of the qualifying child tests, the children in our sample were much less likely to be the son or daughter of the taxpayer, and more likely to have other valid familial relationships (e.g., grandchild or nephew/niece) with the taxpayer. 

The whole paper deserves a careful read, but the bottom line conclusion is that the majority of children claimed with qualifying child errors had an eligible familial relationship with their claimants and in a majority of the cases there was no parent who under current eligibility criteria could in fact be eligible to claim a child.

Furthermore, about 60 percent of the children did not appear to have a parent who could be the “right” taxpayer, as stipulated by law, who could file a claim. We conclude that a substantial portion of erroneous EITC claims likely helped support children in low-income families despite those children being claimed in error. Parents of another 4 percent of children were found to have filed a duplicate claim with the taxpayer under audit. For the remaining 36 percent of children, who had a tax-filing parent not already claiming the child, the family members’ filing patterns were consistent with the credit-maximizing motive in 85 percent of cases. We offer a few explanations, including taxpayer confusion about EITC rules or law changes, to account for the claiming pattern of the remaining 15 percent of cases. Finally, we estimate that the forgone credit that could have been received by non-claiming parents amounted to about 10 percent of the total overclaims attributable to qualifying child errors, or 4 percent of all EITC overclaims. Taken together, these results suggest that the official improper payment rate overstates the social welfare loss and monetary loss to the government.  (emphasis added)

Conclusion

At the end of the day, the OTA study and TIGTA report are likely to appeal to differing parts of the trade off I discussed in the introduction. It could very well be that administrators (and readers and Congress for that matter) do not necessarily value social welfare concerns in the same way that I or others do.  People could place a higher value on rule following. After all, Congress is responsible for determining the eligibility criteria, and it could change the criteria to reach some of the adults who are improperly claiming the credit (I and others have suggested this in past papers, most recently from me in the special report to Congress on the EITC that was part of the TAS FY 2020 Objectives Report). 

How does the current pandemic and economic crisis influence this issue? If I were in the IRS now, I would be strongly advocating for the IRS to slow down on the TIGTA recommendation to impose more civil penalties and sanctions on EITC claimants. Context matters. People are struggling. While it should not mean a green light for allowing erroneous claims to go out of the door, OTA helps us understand that the overwhelming majority of Americans who appear to be improperly claiming the credit have a close family relationship with the children identified on their tax return. 

When the current crisis clears, Congress should take a hard look at the EITC and other credits. It could help the IRS by boosting the childless EITC, which in addition to helping millions of working Americans will also likely decrease incentives for people to share children to ensure eligibility. Congress should also reconsider the eligibility requirements that are difficult and expensive for the IRS to verify and which make less sense in today’s world, like pegging eligibility on arbitrary residency rules that 1) may understate the importance of family members who are connected financially and emotionally but who do not live with a child for more than 6 months and 2) do not work well when there are multigenerational families living together.