District Court Rules Against Government in Starr International Erroneous Refund Case

Today’s returning guest blogger is Sean Akins. Sean is a partner at Covington & Burling, LLP. His practice includes representing corporations, partnerships, and individuals in tax controversy matters. Sean is a co-author of Kafka, Cavanagh & Akins: Litigation of Federal Civil Tax Controversies and a co-author of Effectively Representing Your Client Before the IRS, Chapter 7, Litigation in the Tax Court. Sean is also a Nolan Fellow (2014-2015) of the Section of Taxation of the American Bar Association, and an Associate Member of the J. Edgar Murdock American Inns of Court (U.S. Tax Court).

In this post, Sean writes about an important district court opinion addressing the time when the government can bring an erroneous refund suit. Les

Taxpayers who have been paid refunds by the IRS can breathe a little easier following last week’s decision in the Starr International case. Prior rulings in Starr have been covered by Les Book here, here, and here. This most recent, and perhaps final, aspect of the case relates to the application of the extended five-year period of limitations in erroneous refund actions brought by the Government.

In Starr’s case, the Government asserted that an erroneous refund action brought four years after a refund was paid to Starr was timely because section 6532(b)’s extended five-year period of limitations applied. The reason? According to the Government, Starr knew or should have known it was not entitled to the refund, and so when Starr filed its refund claim reporting on the face of the return that it was owed approximately $21 million, that representation constituted a misrepresentation of material fact that triggered the extended limitations period. The Government posited that Starr should have instead reported on the face of the return a $0 refund, and then later explained in the attached statement of facts and grounds that it was actually seeking a $21 million refund.


The district court, citing an amicus brief filed in the case by (shameless plug) Les Book, Fred Murray, and myself [Editor’s note: Sean was the principal drafter], rejected the Government’s argument, and held that no misrepresentation of material fact exists when a taxpayer reports on the face of the tax return the amount of refund to which the taxpayer reasonably believes it is entitled.


In 2007, Starr, a Swiss company, sought from the United States Competent Authority (“USCA”) a determination that it was entitled to a reduced rate of withholding on stock dividends it received. In 2010, the USCA denied that request, which lead Starr to file two claims for refund: one for its 2007 tax year, filed on an amended Form 1120-F, and one for its 2008 tax year, filed on an originally filed Form 1120-F. In 2011, the IRS granted and paid the 2008 refund claim, but took no action on the 2007 refund claim. Rather than seek immediate court review of the 2007 refund claim, Starr waited until 2014 to file suit. By that time, two important statutes of limitations had expired: (i) the three-year period within which the IRS could have assessed a deficiency of tax for the 2008 tax year, and (ii) the two-year period within which the IRS could have initiated an erroneous refund action to claw-back the refund it had previously paid.

After Starr filed suit with respect to the 2007 tax year refund, the Government counterclaimed, seeking a return of the $21 million the Government alleged was erroneously paid. The Government argued that the extended five-year period of limitations applied, rather than the standard two-year period. In order to secure the lengthier period of limitations, the Government was required to show that “the refund was induced by fraud or misrepresentation of a material fact.” Section 6532(b).

The Government asserted that Starr had misrepresented material facts in three ways: (i) Starr reported on line 9 of the Form 1120-F that it was entitled to a $21 million refund; (ii) Starr failed to notify the USCA that it was filing the 2008 refund claim; and (iii) Starr did not expressly notify the IRS service center that the service center lacked jurisdiction to issue a refund.

The district court rightly rejected all three of these as constituting misrepresentations of material fact, but I’ll focus on the first as the most significant of the bunch.

The District Court’s Decision

The district court does a good job of describing the Government’s theory regarding the first alleged misrepresentation (citations to the record omitted):

The Government argues that Starr’s “representation on line 9 of its return that it was due a refund of over $21 million was a misrepresentation of material fact.” In the Government’s view, even if Starr had to file the request to preserve its ability to seek judicial review of the USCA’s treaty benefits determination, it should have either requested $0 or left line 9 of the form blank. According to the Government, taking “this precaution would have allowed [Starr] to litigate the merits of the USCA denial determination in court” without inducing the Ogden Service Center to actually issue the refund.

There are a host of reasons why the Government’s position can’t be the right answer. First and foremost, the Code’s regulations and the Form 1120-F and its instructions require the taxpayer to state the amount of refund to which the taxpayer believes it is entitled. Specifically, Treasury Regulation section 301.6402-3(a)(5) provides that a refund claim must “contain[] a statement setting forth the amount determined as an overpayment.” Moreover, Lines 8 and 9 of the Form 1120-F state that the taxpayer must “enter the amount overpaid” and “that portion” being claimed as a refund. The instructions to Form 1120-F further confirm that an actual amount must be reported, stating that to claim a refund of withheld taxes, the taxpayer must enter on Line 9 “the amount to be refunded to you.” The Court rightly added that “[a]ccepting the Government’s argument would imply that taxpayers—many of whom are less sophisticated as Starr—should ignore this plain instruction, lest they be accused of making a misrepresentation.”

The district court also pointed out that the Government’s position was inapposite to its arguments in many other cases, where the Government has asserted (often successfully) that a taxpayer’s failure to fully inform the IRS of the amount and basis for its refund claim violate the variance doctrine and/or section 6402’s procedural requirement to report the refund amount. Moreover, the district court hypothesized that if Starr were to report that it was owed $0 on the face of its return, one of two untenable situations could arise:

(1) the IRS would ‘grant’ the $0 request, in which case Starr has no further right to seek the $21 million it believes it is owed; or (2) the IRS would deny the refund claim, in which case it could at least argue (as it has in the past) that Starr cannot seek more than it initially requested. Either way, Starr would have risked not being able to receive its $21 million refund . . . .”

Finally, the District Court recognized that the Government’s position would moot the standard two-year period of limitations for erroneous refund actions:

Under the Government’s theory, a taxpayer would be misrepresenting a material fact every time she asked for a refund the Government believed she was not entitled to. And if that were so, there would be no need for an extended limitations period for misrepresentations of material fact because every erroneously issued refund would be the product of a misrepresentation. That cannot be right.”

Based on the foregoing, the Court rejected the notion that Starr had misrepresented a material fact, and found the extended period of limitations for an erroneous refund action inapplicable.


Because the district court found that there was no misrepresentation of material fact, it was not required to evaluate whether any such misrepresentations induced the IRS to issue the $21 million refund. Notwithstanding this point, it’s worth noting that the Government claimed to have been induced to issue the refund, at least in part, because Starr’s refund claim was voluminous and the IRS lacked the resources to review such a lengthy tax return. Indeed, the Government had argued that Starr “had no basis to have ‘reasonably expected’ that the Service Center would review the over 100-pages of attachments” to its return. Reply in Support of the United States’ Motion for Summary Judgment on the Counterclaim at p. 7.

This is a troubling argument for the Government to make. Starr not only told the IRS, in its attached statement of facts and grounds, that the USCA had previously considered and rejected Starr’s treaty benefits request, but it also attached to its return the letter from USCA denying those treaty benefits. A review of these materials, even a cursory one, would have informed a service center agent that the refund claim should likely have been denied.

Yet it is these very documents the Government points to when arguing that Starr had buried a strained service center in voluminous detail, thereby inducing it to pay a $21 million refund rather than examine the return. Ironically, had Starr failed to make those disclosures, and had the service center paid the refund, Star would likely have faced a stronger argument from the Government that it had misrepresented material facts by failing to include those disclosures.

In short, the Government’s argument that Starr’s disclosures contributed to the service center issuing a refund is a troubling one, as it seeks to punish a taxpayer for over-disclosing, rather than under-disclosing, a return position.

Section 6676 – the Problem Penalty

Today we welcome first-time guest poster Professor Del Wright from the Valparaiso University School of Law. In this post Professor Wright describes some of the many problems with the civil penalty imposed on excessive refund claims, an issue he tackled head-on in an excellent forthcoming article in the Akron Law Journal. Professor Wright’s article and post illustrate the increasing need for civil penalty reform, including a more thoughtful approach to the means of challenging IRS imposition of penalties, an issue we have discussed before and likely will again, and one that Professor Wright has also discussed in a draft article that we hope he will also describe in a future PT post. Les

In a number of posts, Procedurally Taxing has identified problems with the IRS enforcement of penalties, particularly penalties assessed against refundable tax credits. In my article, Bogus Refunds & Bad Penalties: The Feckless and Fixable Refund Penalty System, I address the largely unutilized section 6676 penalty, offer reasons why the IRS has been reluctant to impose the penalty, and explore the Pandora’s box of issues that will be opened if the IRS seeks to impose it more aggressively.


Section 6676 provides generally that an erroneous claim for refund on an income tax return is subject to a 20% penalty, based on the “excessive amount” of the penalty, i.e., the amount by which a taxpayer’s claim for refund exceeds the allowable claim. Lastly, the law excuses taxpayers whose claims have a “reasonable basis,” a term undefined in the statute.

Section 6676 was enacted in 2007, based on concerns by both TIGTA and the Joint Committee on Taxation that erroneous refund claims were straining IRS resources and impeding effective tax administration.Congress later amended section 6676 in 2010, creating section 6676(c), which uselessly extended the section 6676 refund penalty to refund claims based on transactions lacking economic substance. No reported evidence indicates that the economic substance erroneous refund penalty has ever been applied (a search of “economic substance” and section 6676(c) yields no results).

My article highlights problems with the law since enactment and portends future problems. I make the point that erroneous claims for refunds are made primarily by three groups:

  1. Fraudsters – individuals filing fraudulent tax returns to claim an undeserved refund;
  2. Gamers – mostly high net worth individuals seeking to game the tax system, through aggressive tax avoidance maneuvers, to generate refunds; and
  3. Strivers – low income individuals seeking refunds based on mistakes of law or fact. I chose the sobriquet “Strivers” because many of the problems with Section 6676 arise in connection with the means-tested refundable tax credits, such as the First Time Homebuyers Credit or the Additional Child Tax Credit (“refundable credits”), largely created to help the working poor.

While section 6676 was drafted to combat all three, the Strivers will bear the brunt of the poorly-drafted section 6676 regime. My reasoning is as follows:

  • The overwhelming majority of Fraudster refund claims are based on identity theft or other fraudulent and/or criminal activity. An idiosyncratic tax penalty like section 6676 for every instance of fraud will have little deterrent effect on those individuals. Moreover, the IRS has far more powerful weapons in its arsenal to attack fraud than section 6676.
  • As a preliminary matter, Gamers are rarely eligible to receive refundable tax credits, as many refundable credits phase out at higher levels of income. Thus, Gamers would only make an erroneous claim for refund on a tax return after they had already paid tax. However, broadly speaking, Gamers enter into tax avoidance maneuvers not to generate false refunds, but to avoid paying taxes in the first place. Because the U.S. tax system allows most non-wage income to be reported after the fact, Gamers have a greater opportunity to structure transaction to avoid tax, and if they request a refund, it is usually after the IRS has challenged a particular set of transactions. At that point, the section 6676 is inapplicable, because the law covers only erroneous refund claims made on a return. Moreover, as I point out in the article, to the extent a tax avoidance maneuver could generate a section 6676 penalty, Gamers are able to avoid the penalty entirely through strategic tax planning.

That leaves the Strivers, and section 6676 does a poor job in creating a fair penalty for them.

Problems with Section 6676

There are myriad problems with section 6676, and others have identified and discussed those problems in this blog and elsewhere. I will address two largely unaddressed problems highlighted in my article. The first problem relates to the circumstances in which the penalty will apply.

Prior to the Tax Court’s decision in Rand v. Commissioner, 1141 T.C. 376 (2013), the IRS asserted section 6662 or 6663 penalties on disallowed refundable credits, whether the disallowed credits would have caused a reduction in tax (i.e., an underpayment) or generated a refund. Taxpayers faced with such penalties could contest those penalties through deficiency procedures, and could rely on section 6664(c)’s reasonable cause defense. That changed after Rand, and changed again after the IRS issued PMTA 2014-015 (the “PMTA”)

As noted in this blog, “In Rand, a majority of Tax Court judges held that, for purposes of section 6662′s accuracy-related penalty, the “underpayment” at section 6664(a) on which the penalty could be imposed did not include disallowed refundable tax credits — except to the extent that such credits reduced the tax down to zero, but not below zero. “ The IRS ultimately conceded the Rand issue and issued the PMTA to address some of the open questions with the law.

According to the PMTA (and consistent with Rand), if the excessive claim is part of an underpayment, the appropriate penalty is the section 6662 negligence penalty (or, if applicable, the section 6663 fraud penalty). Therefore, for a non-fraudulent erroneous refund claim, if the section 6662 or 6663 penalty applied, the taxpayer could rely on the section 6664(c) reasonable cause defense. However, if the excessive claim is not part of an underpayment, then the appropriate penalty is section 6676, and a taxpayer’s only defense is the reasonable basis. Nothing in the law or regulations for section 6676 defines “reasonable basis,” but in the PMTA, the IRS asserted that reasonable basis in section 6676 has the same meaning as in Treas. Reg. § 1.6662-3(b)(3).

Although the PMTA was likely correct in using Treas. Reg. § 1.6662-3(b)(3) to define reasonable basis in section 6676, in my article, I argue that the reasonable basis standard neither makes sense in the context of the taxpayers claiming refundable credits, nor is what Congress intended. As explained below, this is one of the few times what my professors (U. of Chicago) jokingly called in law school the “Yale” method of statutory construction should have been employed: when the legislative history is unclear, look to the statute.

As part of the 2007 Joint Committee Report that discussed what was to become section 6676, the Joint Committee contemplated a reasonable cause exception to the then-proposed section 6676 penalty. Specifically, the JCT Report noted that the penalty would apply absent a reasonable basis or if “the taxpayer did not have reasonable cause.” However, the reasonable cause defense was excluded from the final bill, leaving only the “reasonable basis” exception. Nothing in the record suggests that this was a conscious choice by Congress. A possible explanation is that in actually drafting the provision, the drafters may have concluded incorrectly that “reasonable basis” and “reasonable cause,” both undefined in the JCT Report, were one in the same, and truncated the latter as redundant. However, that small change has large implications for taxpayers, particularly the Strivers.

That reasonable basis definition eliminates penalties only for transactions with one or more valid legal, as opposed to factual, justifications. Thus, unlike the reasonable cause defenses, taxpayers cannot rely on good faith legal or factual errors to escape section 6676 penalties. Moreover, as the Taxpayer Advocate noted in her 2014 Annual Report, the reasonable basis standard excludes “IRS forms or accompanying instructions, IRS publications, or IRS answers to Frequently Asked Questions,” i.e., precisely the types of guidance Strivers claiming means-tested refundable credits are likely to rely upon. This problem is exacerbated by the fact that if the excessive claim is included in an understatement and section 6662 applies, the taxpayer can use the reasonable cause defense. There is no good policy reason that the availability of the reasonable cause defense should turn on the vagaries of whether the erroneous claim generates an understatement.

The second problem with section 6676 relates to the lack of an explicit right to a pre-assessment challenge. Before discussing the pre-assessment issues, it is important to first understand how taxpayers may challenge a section 6676 penalty. According to the PMTA, that right depends on whether the erroneous claim generates (1) an understatement or (2) a claim for refund. Those situations are discussed below:

Situation 1 – Understatement

If the disallowance generates an understatement, the IRS can issue a deficiency notice and the taxpayer can challenge the disallowance through deficiency procedures. However, as noted in an earlier post [here], it is not entirely clear that the Tax Court has jurisdiction, in a deficiency proceeding, to adjudicate section 6676 penalties. According to the PMTA, the IRS believes such penalties are within the purview of the Tax Court, based on Smith v. Commissioner, 133 T.C. 424, 429 (2009). The IRS reasoning is curious. In the PMTA, the IRS relies on the following statement in Smith:

“If a penalty is not dependent on the determination of a deficiency, then the penalty is not subject to deficiency procedures.”

Based on that statement, the IRS uses the counterfactual to conclude that if a penalty is dependent on the determination of a deficiency (here, an underpayment based on the reduction in tax), then the penalty is subject to deficiency procedures. The IRS argument is an informal fallacy (and No True Scotsman), because nothing in the Tax Court’s language explicitly supports its proposed conclusion. Whether the Tax Court will extend its jurisdiction to section 6676 remains to be seen, but as Les has noted in the Saltzman Book treatise the penalty “should not be subject to the deficiency procedures” and as Carl Smith has noted in a post in Procedurally Taxing, in such a situation, “the Tax Court will likely dismiss the section 6676 penalty…for lack of jurisdiction.”

Situation 2 – Claim For Refund

If the disallowance generates a claim for refund, the IRS can immediately assess a penalty. To challenge the penalty, the taxpayer could either pay the penalty and sue for refund, or wait until the IRS sought to collect, and use the collection due process procedures. In either case, if the refund claim was factually erroneous, the taxpayer’s only defense would be to demonstrate that there was a “reasonable basis” for the error, pursuant to Treas. Reg. § 1.6662–3(b)(3).

In my article, I argue that the failure to provide a pre-assessment challenge to the section 6676 penalty may not pass constitutional muster. The crux of that argument is that filing a claim for refund is a long-recognized form of First Amendment petitioning activity that deserves especially broad protection under the Noerr-Pennington doctrine. That doctrine generally holds that absent proof the petitioning activity is a sham or “objectively baseless,” any infringement upon that petitioning activity, such as section 6676’s immediately assessable penalty, may not pass constitutional muster. That “objectively baseless” standard was set forth in in Professional Real Estate Investors, Inc. v. Columbia Pictures Industries, Inc., 508 U.S. 49 (1993) (“PRE”), and requires a court to find that that “no reasonable litigant could realistically expect success on the merits.” Id. at 60-61. That issue was recently the subject of an article [link free for ABA members] in The Tax Lawyer, Derek Ho & Christopher Klimmek, Penalizing Tax Petitions: Why the Erroneous Refund Penalty in Section 6676 Violates Taxpayers’ First Amendment Rights, 68 Tax Law. 463 (2015).

The “reasonable basis” standard for penalty relief is significantly higher than the “objectively baseless,” standard set forth in PRE. Thus, the penalty is akin to a strict liability penalty, and subject to challenge on constitutional grounds absent some mechanism to protect taxpayers. Possibly recognizing that risk, the IRS asserted in the PMTA that “it has been [it]’s practice to provide administrative appeal rights prior to assessment of the section 6676 penalty.” However, nothing in the law or regulations requires the IRS to do so, and if it fails to offer those rights, a taxpayer (and, most likely, a law school tax clinic), will have an interesting constitutional question to litigate.

Summary Opinions for the week ending 3/27/15

How could I not start with John Oliver and Michael Bolton singing about the IRS.  This link is not really great for work, and to say it is sophomoric may overstate the sophistication and maturity.  Sexy singing is at the end of a fairly long clip, which is all pretty funny (on the IRS, “it combines two things we hate, people taking our money and math”).  This is probably the funniest Michael Bolton clip from the month, which is really impressive since it is about the IRS and he recently recreated the Office Space scenes with the character sharing his name – if you liked that movie, you should find the clip.  Equally as entertaining and enlightening were our guest posters during the week ending March 27, 2015.  Peter Hardy and Carolyn Kendall of Post & Schell did a two part post (found here and here) regarding the definition of willfulness in civil offshore enforcement cases.  First time guest poster, Bob Nadler, posted on the recent Sanchez case dealing with an interesting innocent spouse issue that hinged on whether a joint return was actually filed.  Thank you again for the great content.

I also need to thank our guest posters from the last week and a half.  Carlton Smith provided two of the three posts on the Godfrey case, the last of which can be found here and links to the first two.  Godfrey is an interesting case raising a couple issues regarding appropriate notice with collection actions.  We were also pleased to have Prof. Bryan Camp with a three part post on Eight Tax Myths, the last of which can be found here and links the first two.  Both sets of posts were very well received, and both generated a fair amount of discussion.  I would encourage everyone who has not read both sets to do so, and, for those who have, you might consider going back and reading the comments and responses.

To the other procedure: 

  • In a FOIA dump, the Service has released PMTA 2014-015, which discusses the erroneous refund penalty under Section 6676.  The following points are discussed in the memo:

1. Does the Section 6676 penalty apply to refund claims made on Form 1040 and Form 1040X and does it matter whether the Service has paid the claim?

2. Does the nature of the item to which the excessive amount is attributable have any bearing on the penalty?

3. Is the Section 6676 penalty subject to deficiency procedures?

4. Are there any specific taxpayer notifications required for the penalty to apply?

5. Does the ‘reasonable basis’ exception to the Section 6676 penalty have the same general meaning as the reasonable basis exception to negligence found in Reg. 1.6662-3(b)(3)?

 I’m not sure there are any earth-shattering realizations to be found in the IRS response, but some points seem worth noting.  As to the first point, the Service stated the penalty can be imposed even when the IRS does not actually refund the amount requested.  For the second point, the Service discussed the various situations where other penalties would apply (reportable transactions, EIC, etc.).  As to the third question, the Service stated the general rule that the penalty is not subject to the deficiency procedures, but stated that for some refundable credit cases the penalty will have to be assessed pursuant to the procedures.  No court has apparently addressed either point.  The last thing that jumped out at me was that the Service stated the reasonable basis exception under Section 6676 has the same meaning as under the accuracy related penalty provisions found in Section 6662, which is not news, but good reinforcement of the prior position.

  • Harper Int’l Corp v. US is a case we (I) missed in January (see page 13 of this PDF for a more robust recitation of facts and holding).  In the case, the IRS denied a refund request.  On May 2, 2012 the IRS issued a Notice of Disallowance, which stated the taxpayer had two years to challenge the determination.  About a month later, another notice was received by the taxpayer, stating the claim was rejected and another formal Notice of Disallowance would be issued – but it never was.  Taxpayer petitioned the Court of Federal Claims in June of 2014, more than two years after the first letter, but less than two years after the second letter.  The Court of Federal Claims held that although equitable provisions might apply, it was not reasonable for the taxpayer to rely on the second notice (and they failed to comply even if using the date of the second notice because timely mailing was not timely filing for CFC).
  • Another sham(wow) partnership case in CNT Invest., LLC v. Comm’r, where the Tax Court has held that gain recognized in a collapsed step of a multi-step transaction was gross income for determining the extended statute of limitations under Section 6501(3)(1)(A).  Case also confirmed limitations period was the longer of the period found under Section 6229 or Section 6501.
  • Businessweek thinks the IRS sucks.  The reasons are largely outlined by the John Oliver video above.  I’m sure this has generated a lot of scoffs, but I honestly do try to keep this in mind as I sit on hold for 90 minutes.  Maybe it helps me from being a complete jerk to the person who eventually picks up.  Solid chance that person’s day is worse than mine. How much longer before this all implodes? Is that the goal?  Might work.
  • Kardash v. Commissioner was decided by the Tax Court on the 18th, and has a good discussion of transferee liability but a difficult result for taxpayer minority shareholders in a company where the Service found transferee liability for tax due that was the result of theft by the majority shareholders.  This is going to get a little longwinded, sorry.  In Kardash, a concrete company was largely owned by two shareholders, who controlled all aspects of the business.  Two other minor shareholders oversaw sales and operations; neither had any control over the overall management or finances of the company.  During the early 2000s, the company was very successful and the minority shareholders received huge additional compensation.  Unfortunately, during this time, the majority shareholders were plundering the coffers and not paying any taxes ( one of whom is in the clink and the other is no longer with us).  Here is some more background on that sad story.  The finances of this company were apparently open for the taking, as two other employees were jailed for stealing over $5.5MM from it before the IRS got involved.  On audit, for 2003 to 2007, the Service assessed over $120MM in tax, penalties and interest.  The company was insolvent at that point, payment was not possible, and the company and the Service entered into an installment agreement to pay $70,000 a year until the end of time.  The Service reached agreements with the two majority shareholders, but substantial amounts of tax were still outstanding.  The Service then attempted to recoup a portion of the remaining amount from the minority shareholders pursuant to Section 6901(a).  For Kardash, the amount was around $4MM.  There were a host of questions before the Court regarding the IRS’s collection actions against the company and majority shareholders cutting off liability, but what I found interesting was the issue about whether, under state law, the minority shareholders were responsible for the tax due to fraudulent transfers to them by the majority shareholders.

For the fraud, the Court looked to Florida law to determine the extent of the potential transferee liability.  As an initial point, the Court did not aggregate the transfers with those of the majority shareholders (contrary to the Service argument), and instead looked at each payment to the minority shareholders to determine constructive or actual fraud of each payment.  The FL statute provides that if the company did not receive “reasonably equivalent value” for the payments, they may be fraud if: “(1) the debtor was engaged…in a business…for which the remaining assets of the debtor were unreasonably small…;(2) the debtor intended to incur…debts beyond his ability to pay as they became due; and (3) the debtor was insolvent at the time of the transfer or became insolvent as a result of the transfer.”  Kardash argued his work for the company was reasonably equivalent value, and the Court agreed for certain “loans” in 2003 and 2004, which were really advanced on compensation.  For 2005 through 2007, the funds were provided to Kardash in the form of a dividend from the Company.  The Court noted the conflict in cases regarding the treatment of dividends as “reasonably equivalent value” as compensation for work done.  The Court seems to indicate the general position is that dividends are not compensation for services rendered and therefore not an exchange for value.  In the limited cases holding the opposite, the dividend has been directly tied to work provided.  See In re Northlake Foods, Inc., 715 F3d 1251 (11th Cir.) (holding dividend made as tax distribution to pay tax due on s-corp shares); In re TC Liquidations, LLC 463 BR 257 (ED NY 2011) (dividend made to shareholder to repay loans taken out to expand business).  Although I have not read these cases, this seems like a point that could be open to other interpretation in this case.  The dividends here effectively replaced a prior bonus program.  The program was stopped and the company made the loan/advances to the minority shareholders because the company knew the minority shareholders needed that level of compensation.  This was a temporary solution until the dividends were to start.  Since at least a portion was compensation provided in a different form, a finding that it was received in exchange for equivalent value would not seem unreasonable in this case.  The Court did address this by stating the company did not benefit from the dividends as clearly as in the above two cases, but I am not sure I agree.  Had the dividends not be issued to take the place of the prior bonus program and advances, the minority shareholders may have left.  During the period in question, the company was very successful, arguably because of the minority shareholders.  The second reason is that the company and shareholders treated it as dividend income and not compensation.  Although a factor worth consider, I am not sure it has to be dispositive.

The issue of insolvency was reviewed next, with a few pages devoted to the debts and income stream.  The Court relied on the IRS’s expert’s opinion that since there were no tax returns, no buyer would ever pay more than the gross value for the land and tangibles, and the company had no intangibles.  Based on that, the company was insolvent most of, if not the entire time.  Interestingly, the opinion includes the gross revenue, but I don’t think it includes the asset values.  Ignoring the various other ways to value a company, I think this is also open to other interpretation.  I am not sure the conclusion that no one would be willing to buy the company is correct—obviously that would be a substantial risk, but business people often take risk if the reward appears sufficient.  I am also not sure the value of the intangibles was $0, since the revenue for the years in question was north of $100MM, which was substantially more than the hard assets.  Clearly, the company, as a going concern, had some value that exceeded hard assets.  The company may have still been insolvent, I just wasn’t sold on those particular points.  An interesting case, and what seems to be a tough result for some transferees who were screwed by their employer.

  • The Service has issued internal guidance indicating that it will no longer allow taxpayers to enter into installment agreements for post-petition liabilities when the taxpayer has filed for Chapter 13 bankruptcy.  The guidance indicates that this was previously allowed in some jurisdictions, but that the Service believes this potentially violates the BR stay.
  • 2014 data book has been issued by the Service in electronic form, and can be found here.  Lots of interesting stuff.  Looks like 40% of penalties were abated in terms of amount.  Less business returns, but more individual in 2014 than 2013.
  • Barry and Michelle paid an effective tax rate of 18.8% (maybe slightly higher –I’m finding some conflicting reports and too lazy to do the math) for federal income tax purposes.  I think that is a little higher than mine…although we made slightly different amounts.

Summary Opinions for 6/13/14

Week late, and more than a buck short, here is last week’s Summary Opinions.  This week had a lot of really interesting procedure items, including the Clarke summons case being decided by SCOTUS, which Les covered here, and the final Circ. 230 regulations, which Michael Desmond covered for us here.  I still have my disclaimer in my email auto-signature.  Have to get around to that someday.

We also had the pleasure of welcoming Professor Andy Grewal (great professor, excellent scholar, but, most importantly, he named “Summary Opinions”) as a guest poster, where he discussed TEFRA jurisdiction and sham partnerships.   Thanks to both our guest posters.  As always, I will blame that wonderful content for bumping Summary Opinions all the way to the end of the week (but in reality, my day job got in the way).

So what happened last week that wasn’t covered?  A lot of really interesting stuff.  Here you go:

  • Jack Townsend’s Federal Tax Procedure Blog and Federal Tax Crimes Blog had a nice write up of US v. Carlson, which reviewed the plaintiff’s liability for the Section 6701 aiding and abetting understatement penalty.  Jack’s post focuses on the government’s standard of proof, which the 11th Cir. said was clear and convincing.  Jack follows that up with a good discussion on extending this rationale to FBAR willfulness.


  • Hom getting tired of coming up with bad puns for Mr. Hom (not really, I love them).  So, our favorite online gambler/tax procedure renegade, John Hom, lost yet another tax procedure case in district court.  Mr. Hom had accounts with various online poker companies outside of the US, which Mr. Hom failed to disclose on timely filed FBARs.  Mr. Hom contested the filing requirements and penalties by arguing the accounts weren’t bank accounts or other financial accounts.  The court quickly dispatched these claims by indicating the accounts fall within the definitions.  Best/worst line from case,  “The Court has tried to appoint a free lawyer for defendant—but no one would take the case.”  This was done probably because the issue was novel, and potentially far reaching.  Jack Townsend has a strong write up of the case here.  If the online poker account is the equivalent of a bank account, how far does the statute reach?


  • Our hammer lobbing (if you actually read all of our comments, that may make sense, otherwise it’s an inside joke, which I’ll try not to do often) frequent reader/commenter, Bob Kamman, tipped us to YRC Regional Trans v. Comm’r, which is a refund jurisdiction case, where the Tax Court told the Service to scram – because procedure says so.  The facts are somewhat complicated, as this is an NOL refund involving an acquisition where the target company’s subsequent NOL was carried back to the purchaser’s prior tax years.  But, boiled down, YRC had an NOL for 2008.  That was carried back for a tentative refund for 1999 on the purchaser’s books.  IRS issued a refund check on Sept. 30, 2009 for $351k and change.  Both parties agreed that was a rebate refund under Section 6211(b)(2).  On April 2, 2010, the Service issued another check in a similar amount of $357k and change. Taxpayer said thank you very much and deposited the second check.


Simple so far, but this will require a second paragraph.  Sometime later, the Service decreased the 2008 NOL, resulting in the 1999 carryback refund decreasing by around $64k.  The Service then increased that deficiency by the second erroneous refund amount.  What is really at question is whether or not the second refund was a rebate refund or a nonrebate refund, and how the Service can go about recovering each.  The Court has a good discussion on this point.  Essentially, an IRS error in issuing two refunds, regardless of the underlying reason, is a nonrebate refund.  Nonrebate refunds can only be obtained under Section 7405 procedures, which the Tax Court has held it does not have jurisdiction over.  Assuming the Service is not time barred, they could bring this in other federal courts.  In addition to bringing this suit in the appropriate courts, the Service also takes the position that it can offset this type of nonrebate erroneous refund against future refunds (based on common law principals, not the Code). See CCA 200137051.  I have never looked into that issue, and would not agree to that position until I had researched it further.  I believe Keith is going to write some additional commentary on this, and another erroneous refund case from last week that was brought to our attention by a good friend to the blog.


  • In Ruscitto v. U.S., an MJ recommended summary judgment in favor of the feds in a case where the income tax refund of a husband and wife was applied against hubby’s TFRP.  Wife argued that a portion of the refund was due to her, as her income from her Form 1099-C (cancellation of debt) gave rise to a portion of the income.  The Court found the claim was untimely, and could not review the claim.


  • SCOTUS has held that inherited IRAs are not retirement funds under 11 USC 522(b)(3)(C), meaning they are not exempt from the bankruptcy estate.  See Clark v. Rameker. Keith hopes to provide insight on this in the coming days or weeks.


  • In honor of Fathers’ Day, Going Concern has a post about paternity leave.  My wife has always given me a hard time about how long I took off after each of our daughters was born.  She claims cumulative total, I took off one day.  Two months ago she found out my firm has a paid paternity leave of six weeks…she was not thrilled.


  • I should have asked Keith about this case before writing it up, as his knowledge of taxes and bankruptcy is far superior to mine, but In Re: Pugh struck me as interesting.  In the case before the Eastern District of Wisconsin Bankruptcy Court, the debtor entered into Chap 13 bankruptcy (keep your assets, but have to pay your debts over 5 years), and entered into a repayment plan on July 30, 2013.  The Chap 13 plan provided that the debtor “would retain any net federal and state refunds”.  Following the plan, the Service audited the debtor’s 2011 return, resulting in a deficiency which was provided to the court.  The debtor then filed a 2013 return, requesting a refund, which the Service used to offset against the 2011 deficiency.  The taxpayer took exception, since the plan said she was to receive refunds and the 2013 tax year occurred after the filing of the bankruptcy petition.    The Court noted that when the debt and refund are both prepetition, the Service does not need to seek relief from the automatic stay; however, here the refund was post-petition.  The Court highlighted the split on this issue, with some courts holding the Service has the right to offset under Section 6402(a), leaving the “net refund” to be calculated after the setoff.  Others have held Section 6402 does not lift the stay, and the assets must pass to debtor or, at the least, the Service must ask permission before making an offset such as this.  The court in Pugh sided with the first set of cases, holding the power under the Code trumped the bankruptcy stay.  These cases seem to arise somewhat frequently.  I suspect we will see some additional Circuit Court guidance in the near future.


The Tax Procedure Roundup for 10/18/13

At first I thought the week was slow again, but it turns out I was too busy with client matters to realize there was a fair amount of interesting tax procedure and policy content published.   Here are a few things I caught up on at the end of this week:

  • Government is back up and running, which is good.  Service is back in business, and Tax Court has reopened and is rescheduling matters.  Coverage can be found here and at  Tax Girl here.   PTIN renewal for 2014 may have to be postponed until later this year or until 2014 due to the government shut down (***reader Bob Kamman pointed out the original post may have been incorrect; read the comments below for further discussion***).  Don’t Mess With Taxes hypothesizes the shutdown could impact filing next year.
  • Forbes contributor Joe Harpaz has a post on innovation and tax policy found here.  This is more tax policy than procedure, but we are fans of that also.  The article outlines recent research into the most innovative companies based on patents, and connections between the geographic locations of those companies and the applicable government’s tax policy on R&D.
  • More from the Forbes tax blog, which has a post on a study showing that taxpayers with a balance due are more likely to cheat than those who are owed a refund, which can be found here.  Mr. Reilly describe this “stupinomics” (his term for loss aversion and behavior economics—which probably could apply to a much broader range of economic transactions) phenomena, which most tax preparers probably assumed to be the case.  Even though all tax planners state it is bad planning to give the Service an interest free loan and overpay, I always do it, because I know I will be ticked off when I have to cut the Treasury a check on April 15.  This is based on the same idea.  Owing makes us angry, refunds are fun.    It is not hard to see a few ways to use this to reduce fraud (assuming the report is true, and I have not reviewed any aspect of it beyond this article), but those would likely meet resistance.
  • An article can be found here discussing the IRS guidance issued in January of 2013 regarding the use by tax preparers of tax or other information obtaining when preparing returns to solicit other business.  The article is by Thomas Manisero of Wilson Elser.  It is not very long, and does not delve too far into this area, but does highlight something practitioners often do not think much about and the somewhat simple solution (obtaining consent) to the issue.
  • Here is a synopsis of Vandenheede v. Vecchio, which was decided on October 1, 2013.  I read a summary last week, and did not initially pick up on anything of interest.  The summary from Bryan Cave showed it was fairly interesting, where the Sixth Circuit affirmed the lower court’s granting of a motion for summary judgment of the case when a recipient of funds from a trust had sued the co-trustees for filing fraudulent information returns under Section 7434.  The trustees treated distributions to this woman as income from a trade or business, and 1099’d her.  She felt the payments were reimbursements for her and her husband’s living expenses, and the Form 1099s were fraudulent.  The case was dismissed because the trustees were held to not be the “filer” of the Form 1099s since the income and deductions of the trust were required to be placed on the settlor/husband’s personal income tax return.  Here is the Sixth Circuit’s opinion.
  • SCOTUS denied the taxpayer’s petition for certiorari in Knappe v. United States, where a taxpayer was seeking to demonstrate reasonable cause under Section 6651 by relying on an accountant or attorney who erroneously advised the taxpayer on the due date of a Form 706.  I am going to write more about this case during this week, and have some comments on the handful of other cases on this same topic that have been reported over the last year.
  • Jack Townsend uses bad words again, which I like, in describing a bull$h*! or not-BS tax shelter decision in the Santander Holdings USA case, which can be found on his tax procedure blog here.  The post lifts language from the case to describe the tax shelter, but what is more important is the discussion of substance over form doctrine, with the Judge in Santander holding that it “is a legal question, to be answered by judges, not economists,” and did not put any weight on Government’s expert testimony.  This will be an interesting holding moving forward, as most other Courts appear to rely somewhat heavily on the expert opinions in determining substance over form.  If you read Mr. Townsend’s post, you should also read Richard Jacobus’ comment to the point.  He highlights his other perceived issues with the holding, which are insightful.
  • The Service lost a motion for summary judgment in Suntrust Mortgage Inc. v. US in the District Court of Maryland, where the Service tried to stop a mortgage holder’s quiet title action to determine priority over the Service’s lien.  Order can be found here.   The mortgage company’s argument as to title is that that equitable subrogation protects its mortgage on the property because the borrower used the new mortgage to pay off two prior mortgages.  This issue has yet to be decided.  The motion the Government lost was a 12(b)(6) motion, arguing sovereign immunity or, in the alternative, this was not a proper use of a quiet title action.  The Court stated sovereign immunity had been waived as to quiet title matters, and the question was if “an action by a non-taxpayer to establish the priority of his mortgage lien over the government’s tax lien a ‘quiet title’ action under the statute.”  The Court found the majority rule is that this was a permissible action.
  • And, I’ve found the answer to why my client’s don’t donate more to charity.  Thanks to TaxProfBlog.
  • There is an amazing amount of tax discussion regarding lap dances, such as Philly’s amusement tax being blocked from applying to such amusements found here (thanks to MauledAgain) and the attempt of a New York club to exempt its dances from the sale and use tax based on an exception for the dramatic arts found here.  Not really tax procedure related, but appealing to readers’ more prurient interests is sure to drive up page views.
  • And, of course, the best stuff on the internet: Les posted twice on the Kuretski case, the most recent can be found here, which is generating some interesting  discussion on our blog and on others; and,  Keith posted on the Frazier erroneous refund case here, and has a good discussion of the intersection of bankruptcy and tax.

Erroneous Refund Case Reveals the Intersection of Bankruptcy and Tax Procedure

A recent erroneous refund case provides an opportunity to talk about some similarities and differences between that statute and “regular” fraud cases.  On August 27, 2013, United States Magistrate Judge Paige Gossett entered an opinion determining that Gloria Frazier received a $51,060.00 erroneous refund on February 16, 1999.

The first thing that caught my eye here was the timing of the refund.  It was issued more than 14 years ago.  How, I wondered, could a decision favorable to the Government appear in an erroneous refund case that long after the issuance of the refund?  The first difference between the fraud provision in erroneous refund cases and in “regular” tax cases is the fixed time frame for bringing the erroneous refund suit – five years after the refund.  Any suit brought within five years after February 16, 1999, should have been decided by a magistrate judge long before the end of 2013.  The judge explained why the opinion came out so long after the erroneous refund with a cryptic reference to multiple bankruptcy filings by the defendant. 

The bankruptcy aspects of the case deserve discussion.


I did not research Ms. Frazier’s bankruptcy filing history but the case provides a glimpse at a provision of the automatic stay that most tax lawyers do not see.  Upon the filing of a bankruptcy petition, the automatic stay stops, or stays, the actions described in the eight subparagraphs of B.C. section 362(a). Tax lawyers frequently see Tax Court cases stayed by B.C. 362(a)(8).  Tax practitioners involved in collection cases regularly see collection stopped by a bankruptcy filing because of B.C. 362(a)(6).  Although the Court does not explicitly say so, the Frazier case involves the stay of B.C. 362(a)(1), which stops the commencement or continuation of a proceeding against the debtor that could have been commenced before the filing of the bankruptcy petition.  Seeing (a)(1) in action to stay a tax case provides a rare opportunity because the IRS, through the Tax Division of the Department of Justice, brings so few affirmative suits and those suits infrequently intersect with bankruptcy.

In addition to the automatic stay aspect of the Frazier case, it also presents an opportunity to think about the discharge of the erroneous refund liability now determined against her.  This liability will not have priority status as a claim against the estate.  The IRS could record the judgment and perhaps obtain secured status.  Assuming Ms. Frazier does not have property to which the judgment lien could attach, the IRS will have a general unsecured claim.  Assuming further that Ms. Frazier will choose to go into bankruptcy again in the future, the question of discharge regarding this liability may soon come.  (It may have already arisen in her earlier bankruptcy cases since the existence of the erroneous refund case would have formed the basis for a claim by the IRS in those earlier bankruptcy cases.  Without researching those cases, I will assume that dismissal or some other event occurred prior to discharge since the parties pursued the erroneous refund case without discussing the discharge injunction and without discussing litigation in the bankruptcy court that would have established the claim as non-dischargeable and might have had a collateral impact on this litigation.) 

The discharge issue here will turn on the application of the exception to discharge found in BC 523(a)(1)(C), which provides that tax debts are excepted from discharge (not discharged) if “the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” Did Ms. Frazier make a fraudulent return when she filed the return resulting in the erroneous refund?  The decision in the erroneous refund case would not seem to provide the same collateral estoppal benefits that a civil or criminal fraud penalty case would since the language of erroneous refund statute mentions either fraud or material misrepresentation.  The court appeared to decide the case on the material misrepresentation prong of the test for extending the erroneous refund statute of limitations. 

Even if fraud existed in the filing of the claim for the refund, the preparer of the return, rather than Ms. Frazier, may have perpetrated the fraud.  If the fraud in the refund claim stems from the actions of the preparer rather than the debtor, the application of the exception to discharge under BC 523(a)(1)(C) may not apply.  This type of derivative fraud, which the Tax Court approved as keeping open the statute of limitations in Allen v. Commissioner and which Les recently wrote about concerning the BASR v. United States case, may not apply to prevent the discharge of a debt. Given Ms. Frazier’s apparent willingness to use the bankruptcy process, this case may offer the opportunity to see how the erroneous refund provision keeping open the statute of limitations where fraud or material misrepresentation exist mesh with the exception to discharge provision for attempting to evade or defeat the tax.

I will write separately about the more traditional tax aspects of the Frazier case.