IRS Loses Injunction Case Against Mother After Raising Its Eyebrow

May 19, 2023 by 2 Comments

This time of year, we honor mothers.  Perhaps the IRS should have brought this case earlier or later in the year.  In an opinion issued just two days after Mother’s Day adopting the Magistrate’s Report and Recommendation issued 11 days before Mother’s Day, the district court in United States v. DuBois, No. 9:23-cv-80279 (S.D. Fla. 2023) decided not to enjoin a mother from using proceeds from a settlement.  For different reasons prior posts have noted Mother’s Day here and here. 

The issue in the DuBois case turns on the interest of her son in the settlement which in turn depends on the proof the IRS can put forward.  This case serves as a good one for explaining the tactic of relying on cross rather than positive evidence and why that tactic fails here.

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Robert DuBois and his mother are beneficiaries of a trust.  In 2016 they brought an action against the trustee for breach of fiduciary duty.  While that suit was pending, the IRS brought suit against Mr. DuBois in 2021 for failure to pay income and other taxes.  The suit against Mr. DuBois resulted in a judgment for the IRS of almost $1.3 million.

On January 18, 2022, the IRS (or DOJ) met with Mr. DuBois to discuss payment of the judgment including his interest in the lawsuit initiated in 2016; however, the discussion did not result in an agreement.  The following day, Mr. DuBois and his mom met with their adversary in the suit against the trustee and that discussion led shortly thereafter to a global agreement to settle for $665,000.

After the agreement, Mr. DuBois’ attorney advised the opposing party that Mr. DuBois would not be a party to the settlement as he had previously assigned his interest in the action to his mother.  Although the opinion does not say this, it appears that he failed to mention that assignment during his discussion of the case with the IRS on January 18.

Mr. DuBois’ attempt to back out of signing the settlement agreement led the fiduciary to file a Motion to Enforce Settlement Agreement.  This reminded me of cases in which taxpayers sought to back out of settlements with the IRS which we have discussed previously here.  The court told Mr. DuBois he had to sign because the settlement was an enforceable agreement.  He signed as ordered and the defendant paid over the settlement amount to the attorney for Mr. DuBois and his mother.

Before signing the settlement agreement, however, Mr. DuBois also signed an assignment agreement assigning all of “his right, title, and interest in any settlement proceeds arising” from the suit to his mom.  The assignment called for no consideration other than her agreement to indemnify him from any claims arising out of his share of the proceeds.  It’s easy to see why the IRS would seek a fraudulent conveyance under these circumstances.  The facts are classic.  Despite a son’s natural affection for his mother and despite need to give her something for Mother’s Day, this gift struck the IRS as a bit much.

But, this is a story about the failure of the IRS to obtain an injunction so the story does not end here with what looks like a clear winner for the IRS.

The IRS brings a motion for preliminary injunction seeking to keep the mother from dissipating the proceeds of the settlement.  In a hearing on that motion, Peter Feaman, the attorney for the mother and son in the suit against the fiduciary, was called to testify.  He says that the son had verbally agreed to assign his interest at an earlier point and that he had advised the son to do so because the son’s claim against the fiduciary lacked merit.  The IRS’s unstated response is “Yeah, sure.”

The court notes that:

To prevail on a fraudulent transfer claim under 28 U.S.C. §3304(a)(1), the Government must show: (1) the transfer was made after the Government’s claim arose; (2) the debtor did not receive reasonably equivalent value in exchange for the transfer; and (3) the debtor was insolvent at the time of the transfer. United States v. Andrews, No. 1:09-CV-112 (HL), 2011 WL 13323634, at *2 (M.D. Ga. July 13, 2011) (discussing the elements of a fraudulent transfer claim).

The IRS argues Mr. DuBois should have received half of the settlement (less attorney’s fees – for those of you wondering about whether the attorney could take his fee before the IRS receives all of the proceeds based on its lien against Mr. DuBois see the superpriority provision of 6323(b)(6) allowing attorneys a superpriority in this situation even against a filed federal tax lien for creating the fund except in situations where the defendant is the federal government.)

The court cites again to the testimony of Peter Feaman who explained that during discovery in the case facts developed showing the son had lost his beneficial interest in the trust.  Mr. Feaman said that he decided to keep Mr. DuBois as a party because he felt this would help with negotiations.  He further said that he would have dropped the son if the case had gone to trial.  Other than cross-examining Mr. Feaman the IRS put on no affirmative evidence regarding the value of Mr. DuBois interest in the settlement.  I don’t consider the failure of the IRS to put on affirmative evidence to be a knock on the IRS or the DOJ attorney representing them in this case.  In a high percentage of cases the taxpayer controls the information and the government’s case is based on puncturing holes in the credibility of the taxpayer or the taxpayer’s witness.  My former colleague, Jan Pierce, described the government’s typical trial actions in these cases as “the raised eyebrow.”  Certainly, the facts here do merit a raised eyebrow; however, this is also a case in which the IRS is seeking an injunction and that raises the bar a bit.

The court’s take on the raised eyebrow here is

The Court finds Attorney Feaman’s testimony to be credible. As the moving party, the Government bears the burden of showing its entitlement to the “extraordinary and drastic remedy” of a preliminary injunction. All Care Nursing Serv., Inc., 887 F.2d at 1537. This is especially true where the Government essentially seeks a pre-judgment freeze of assets in the possession of a third party by way of an injunction. The Court finds the Government has not met this burden. This does not preclude a different result at trial, where the Government might come forward with different evidence to rebut Attorney Feaman’s opinion as to the value of Son’s interest in the settlement proceeds.

So, the IRS will have a second chance to win the case but at this stage the raised eyebrow does not work to win the issue.

The court notes that three other elements exist in order for the IRS to win, says that they don’t matter since the IRS must win all four elements and then proceeds to go through the other elements anyway.  It finds the other three elements would not keep it from issuing the injunction had the government prevailed on the first element.

The IRS does not bring many injunction cases of this type.  Perhaps the problem here is one reason.  In order to win it needed positive evidence and not just the unstated assumption that this smells to high heaven.  It could have hired another lawyer as an expert witness to evaluate the case and challenge the testimony of Mr. Feaman.  It made a tactical decision not to do so.  Maybe it would change tactics in a future case, but my guess is that it will most often continue to rely on the raised eyebrow.

Filed Under: Fraudulent Transfer, Injunction

Court Invokes Aesop’s Fables In Denying Government’s Request For Injunctive Relief

March 20, 2023 by 1 Comment

Recently Keith and Marilyn Ames wrote a separate subchapter in Saltzman and Book IRS Practice and Procedure addressing a district court’s authority to grant the government’s request for injunctive relief. These cases often arise when there are multiple quarters of unpaid employment taxes. In these cases, in addition trying to reduce an assessment to judgement, the government has requested broad injunctive relief to ensure future compliance. If a taxpayer fails to comply with the terms of the injunctive relief, the government can seek judicial sanctions, including imprisonment.

In US v Olson a federal district court in Indiana denied the government’s request for injunctive relief, finding that the government had failed to make the case that relief was necessary or appropriate.

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Olson involves Bradley and Shirley Olson and their plumbing businesses. In its complaint the government alleged that the Olsons had about $300,000 in unpaid employment tax obligations over an almost ten-year period. The Olsons failed to respond, and the government requested that the court enter a default judgement for the unpaid assessed tax.

The government also sought injunctive relief, asking the court to compel the Olsons to follow the law in the future, report regularly to the IRS on their compliance, and grant the IRS the right to periodically inspect their books and records.

The district court reduced the assessment to judgement but denied the request for injunctive relief. The government asked the court to reconsider, and the court denied the request.

In denying, the court began its opinion with a tale from Aesop: 

A Dog, to whom the butcher had thrown a bone, was hurrying home with his prize as fast as he could go. As he crossed a narrow footbridge, he happened to look down and saw himself reflected in the quiet water as if in a mirror. But the greedy Dog thought he saw a real Dog carrying a bone much bigger than his own.

If he had stopped to think he would have known better. But instead of thinking, he dropped his bone and sprang at the Dog in the river, only to find himself swimming for dear life to reach the shore. At last he managed to scramble out, and as he stood sadly thinking about the good bone that had been lost, he realized what a stupid Dog he had been.

It is very foolish to be greedy.

Aesop & Milo Winter, The Aesop for Children 96 (1919).

From Aesop to the Tax Code

As we have previously discussed (see, for example, Keith’s 11th Circuit Reverses and Imposes an Injunction Against a Corporation for Failing to Pay), Section 7402(a) gives district courts broad equitable powers “as may be necessary or appropriate for the enforcement of the internal revenue laws.” Under this statutory authority, the government has successfully obtained injunctive-type relief that has resulted in court orders compelling future employment tax compliance that is backstopped by an order requiring more regular taxpayer reporting so the government can keep close watch on any future missteps.

The Olson opinion acknowledges the statutory power, although its initial opinion on the matter focused on a slightly different statutory footing that addresses injunctive powers on third parties like preparers, a remedy that the government has also increasingly sought.

From there, the opinion discussed the standard in the Seventh Circuit to grant injunctive relief, looking to a balance of the harms test, considering the potential harm to the government, the public and the affected parties. In discussing that balancing test, the Olson court notes that the Seventh Circuit invokes the standards for injunctive relief under Federal Rules of Civil Procedure 65(b), which considers the following:

Under Rule 65, “injunctive relief is appropriate if the applicant demonstrates ‘(1) that it has suffered an irreparable injury; (2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury; (3) that, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; and (4) that the public interest would not be disserved by a permanent injunction.’”

Much of the discussion turns to the government’s allegations that absent an injunction, its remedies are inadequate. The court strongly disagreed, first noting that inadequate is not the same as ineffectual, but rather must be “seriously deficient as compared to the harm suffered.”

And on that standard, the complaint as well as a revenue officer’s declaration came up short:

Here, the Government argues that it does not have an adequate remedy at law because “the IRS’s efforts to bring the Olsons into compliance have failed and because the Olsons will likely continue to obstruct the execution of the federal tax laws through their non-compliance.” Maybe, but none of that proves an inadequate remedy at law. The Government has shown here its ability to calculate Defendants’ tax obligations and to obtain a judgment in that amount. There is no reason to believe the Government couldn’t do so later if it determined that Defendants continued to violate the tax laws.

The opinion distinguishes cases where there was an inadequate remedy stemming from a money judgement alone, looking to cases where the courts blessed injunctions that reached individuals who were peddling tax protestor schemes or who had set up a return preparer shop that specialized in bogus returns.

For good measure, the court sees its role differently than the government:

The Court sees no basis to exercise its discretion to issue the broad injunction requested by the Government. The Court does not read § 7402 as allowing the IRS to deputize the federal courts into its enforcement arm every time a taxpayer is delinquent. To do so would be a waste of this Court’s valuable time and resources. No matter the standard, then, the Government’s request for an injunction is denied.

Conclusion

The court noted that the government did a little better than the dog in Aesop’s fable as “it will keep its original bone—but it will be no more successful at grabbing the illusory bone in the river.”

Employment tax noncompliance is a major IRS compliance focus, and is a big part of the tax gap.  It is not surprising that the government views the equities differently than the district court judge.

We will keep an eye on this to see if the government appeals.

For readers who want to dig deeper on the issue of injunctions, we review the differing standards that courts have applied in government requests for injunctive relief in Chapter 15 of Saltzman and Book.

Filed Under: Collection Activity, Injunction

11th Circuit Reverses and Imposes an Injunction Against a Corporation for Failing to Pay

September 16, 2019 by 1 Comment

We have discussed before the increasing practice of the Department of Justice Tax Division to seek an injunction against an operating business that pyramids its tax liabilities.  Pyramiding is the term used for taxpayers who keep building higher and higher tax liabilities by failing to pay period after period.  Usually, it applies to a company that fails to pay employment taxes by failing to withhold the income and employment taxes from its employees and pay the taxes over to the IRS.  Pyramiding typically occurs when a company lacks sufficient cash flow but sometimes it results simply from greed and a belief that the IRS will not catch the person and make them pay.

If a company pyramids its employment taxes and the IRS has no practical means of collecting from the company, the IRS, many years ago, would shut the company down, or attempt to do so, by issuing levies or seizing property even though the company had no equity in seized assets or funds in the bank.  By seizing assets of the business the IRS could effectively close the business temporarily and that might cause it to close permanently.  Other levies would frequently stop suppliers from supplying or banks from lending even if they produced no dollar return.  The goal of these seizures and levies was not to get money but to keep from losing more money.  The practice of no equity seizures went away over 30 years ago.  After the demise of no equity seizures, revenue officers longed for a tool to shut down the taxpayers in situations in which the taxpayer continued to run up liabilities no matter what the revenue officer tried to do. 

Finally, the government, after many years of discussing the possibility, decided that it could bring an injunction action seeking to stop the pyramiding taxpayer from running up additional liabilities.  Doing this through an injunction takes longer and cost more money from the perspective of the time and effort of the Department of Justice trial attorney but can prove an effective method of shutting down a business that continues to ignore the requirement to pay payroll taxes.  In United States v. Askins and Miller Orthapedeatrics, D.C. Docket No. 8:17-cv-00092-JDW-MAP (11th Cir. 2019), the 11th Circuit agreed with the IRS that an injunction of the business was appropriate remedy to stop a business from continuing to incur employment taxes.  In ruling for the IRS, the 11th Circuit reversed the decision of the district court which had denied the IRS injunctive relief.  The case represents an important circuit level discussion of what the IRS needs in order to succeed in obtaining injunctive relief.

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 The business at issue was run by two brothers.  The brothers had caused the business not to pay its employment taxes, both trust fund and non-trust fund, since 2010.  The brothers also created trust and other entity accounts in order to hide the assets of the business.  In many ways the case read as a textbook case for a criminal prosecution against the brothers. A high percentage of injunction cases seem to fit the bill for criminal prosecution and DOJ does prosecute people for failing to pay employment taxes – something it almost never did three decades ago.  I do not know what causes the decision to fall into the injunction box rather than the prosecution box, but here the government chose the civil route.

The court described the situation as follows:

“The IRS has tried several collection strategies over the years. It started with an effort to achieve voluntary compliance: IRS representatives have spoken with the Askins brothers “at least 34 times” since December 2010, including 27 in-person meetings. Twice they entered into installment agreements that set up monthly payments to bring Askins & Miller back into compliance, but the company defaulted both times. Two other times, they warned Askins & Miller that continued noncompliance could prompt the government to seek an injunction.

The IRS has employed more aggressive means as well. It served levies on “approximately two dozen entities,” but most “responded by indicating that there were no funds available to satisfy the levies.” Three entities paid some money, but not nearly enough to satisfy Askins & Miller’s debts or to keep pace with its accrual of new liabilities. Additionally, the IRS’s ability to collect payments through levies has been hampered by the defendants’attempts to hide Askins & Miller’s funds and to keep the balances in Askins & Miller’s accounts low. Between 2014 and 2016, the Askins brothers transferred money from Askins & Miller to “RVA Trust,” which operates a private hunting club for the brothers, and “RVA Investments,” an accounting business associated with their father. The IRS also discovered additional accounts at BankUnited and Stonegate Bank. It did not seek to levy RVA Trust, RVA Investments, or the bank accounts because it discovered them after this case had been referred to the Department of Justice and because the IRS believed that “there is a substantial risk that any new levy would result in opening new undisclosed accounts and moving the money there.”

When the IRS finally gave up on its administrative collection efforts and referred the case to the Department of Justice for the pursuit of an injunction, it met another obstacle.  The district court denied the motion without prejudice finding the declaration conclusory, and finding that the proposed injunction was “effectively an ‘obey-the-law’ injunction.”  The IRS filed a new declaration with the district court trying again to convince it to enjoin the taxpayer’s actions.  The district court again reached the conclusion that the requested injunction served as an order to obey the law.  After the second attempt at the district court, the IRS appealed.  While the case was pending in the district court, the taxpayer ran up even more liabilities.

To obtain a preliminary injunction under “the traditional factors,” the IRS must demonstrate 1) a substantial likelihood of success on the merits, 2) that it will suffer irreparable injury unless the injunction is issued, 3) that the threatened injury to the IRS outweighs whatever harm the proposed injunction might cause the defendants, and 4) that the injunction would not be adverse to the public interest.  The district court noted that the parties essentially agreed that three of the four traditional elements for an injunction case were met by the facts of the case, but felt that the IRS could obtain a judgment for damages and, therefore, did not face irreparable injury.  The IRS argued that such a judgment was meaningless under the circumstances since it had exhausted its administrative efforts with its powerful administrative tools in trying to collect the outstanding debt.

Taxpayers raised a question of whether the closure of their business rendered the case moot.  The court went through a thorough analysis of factors of mootness factors and determined that remanding the case to the district court for a determination of mootness would serve no purpose but delay stating:

“Given the undisputed facts before us, we do not believe that the defendants can satisfy their “heavy” and “formidable” burden of making it “absolutely clear” that their behavior will not recur. And “we are unpersuaded that a remand would further the expeditious resolution of the matter.” Sheely, 505 F.3d at 1188 n.15 (conducting mootness analysis without remanding for further fact finding). The district court already concluded that the defendants have “a proclivity for unlawful conduct” and are “likely to continue ignoring” their tax obligations. The record demonstrates a near-decade-long saga in which the IRS has pursued Askins & Miller time and again. Over that time span, the defendants have funneled money to new accounts and entities as the IRS closed in on the old ones. For at least the time between November 2015 and mid-2018, Askins & Miller continued as a going concern despite reporting “no investments, no accounts or notes receivable, no real estate, and no business equipment.” Against that backdrop — and in light of the defendants’ admissions that Askins & Miller “continues to exist” and that one of the brothers continues to practice medicine — “we can discern no reason for sending the question of mootness back to the district court for further review or fact finding.” Id.

Then the circuit court moved on to examine the issue of whether the IRS had an adequate remedy of law.  Addressing that issue, the court acknowledged that it had not addressed the issue in its past ruling.  It found that prospect of even more losses in the future made a compelling case for granting the injunction stating:

“The fact that the IRS is attempting to avoid future losses is key. As the IRS notes, it “is an involuntary creditor; it does not make a decision to extend credit.” In re Haas, 31 F.3d 1081, 1088 (11th Cir. 1994). As long as the brothers continue to accrue employment taxes, the IRS continues to lose money. This sets the IRS apart from the position of other creditors (who can cut their losses by refusing to extend additional credit), and — crucially — means that the injunction sought is not simply an attempt to provide security for past debts. Rather, the proposed injunction here would staunch the flow of ongoing future losses as the brothers continue to accumulate tax liabilities — unlike in cases where the loss has already been inflicted or would be attributable to a single event, where we have stated that injuries are irreparable only when they “cannot be undone through monetary remedies.” E.g., Scott, 612 F.3d at 1295 (quoting Cunningham v. Adams, 808 F.2d 815, 821 (11th Cir. 1987)).

Indeed, the record and the district court’s own findings demonstrate that the government’s proposed injunctive relief is “appropriate for the enforcement of the internal revenue laws,” 26 U.S.C. § 7402(a), and that the government will likely suffer irreparable injury absent an injunction. Among other things, the district court noted that Askins & Miller had “a proclivity for unlawful conduct,” had “diverted and misappropriated” the employment taxes it had withheld from its employees’ wages, and was “likely to continue ignoring” its employment tax obligations. The IRS’s declaration demonstrates that, over a period of several years, it expended considerable resources making numerous — and unsuccessful — attempts to collect Askins & Miller’s unpaid taxes. And in the face of all that, as the declaration explained, Askins & Miller is effectively judgment-proof. In short, the record amply demonstrates that, absent the requested injunction, the government will continue to suffer harm from Askins & Miller’s willful and continuing failure to comply with its employment tax obligations — including lost tax revenue and the expenditure of a disproportionate amount of its resources monitoring Askins & Miller and attempting to bring it into compliance — and that, in all likelihood, the government will never recoup these losses.”

Having determined that the IRS did not have an adequate remedy at law, the circuit court ended by addressing the district court’s concern that the IRS merely sought an obey the law injunction.  Here, it stated that:

“Finally, the proposed injunction goes well beyond merely requiring compliance with the employment tax laws. In fact, it lists numerous concrete actions for the defendants to take — to name only a few, segregating their funds, informing the IRS of any new business ventures, and filing various periodic affidavits — well beyond what a simple “obey-the-law” injunction would look like. In short, this case does not raise the sort of fair notice concerns that Rule 65(d) is designed to address.”

The Askins and Miller case represents a major victory for the IRS.  The problem with pyramiding business taxes needs a solution.  After many years of floundering to find a solution, the IRS has combined with the Tax Division of the Department of Justice over the past decade (or more) to pursue injunctions against the most egregious taxpayers engaged in pyramiding in situations in which the decision is made not to prosecute.  This is a great development for everyone except the taxpayers who pyramid.  The government needs to aggressively pursue these taxpayers.  Doing so requires significant resources, but success can stop taxpayers who fail to pay year after year.  The 11th Circuit provides a great discussion for how to stop this action.  The effort expended in succeeding here shows the difficulty the government encounters as it seeks to stop this type of taxpayer action and the amount of resources it must expend to do so.

Filed Under: Employment Taxes, Injunction

Eleventh Circuit Affirms Disgorgement in Tax Return Preparer Case

July 3, 2018 by 2 Comments

We welcome first time guest blogger Matthew Mueller. Matt practices in Florida representing individuals with tax issues and white collar crime issues. Prior to moving to private practice, he had the perfect background for the work he currently does. He represented the IRS in criminal prosecutions at the Department of Justice Tax Division, Criminal Section and then he moved to the United States Attorney’s Office in Tampa. He brings to this discussion of disgorgement over a decade of experience with these types of cases both inside and outside the government. Keith

As this blog has covered previously, the Department of Justice Tax Division has increasingly sought disgorgement from tax return preparers in civil injunction cases. This growing trend has been on display nationwide, but especially in the Middle and Southern Districts of Florida. While the government experienced some initial growing pains in court—see this prior post discussing an MDFL case in which the district court denied disgorgement—the effort to disgorge return preparers from their profits has continued. Last month, the Eleventh Circuit Court of Appeals issued an unpublished opinion in United States v. Stinson affirming the district court’s judgment entering a permanent injunction against the return preparer and affirming a $949,952.47 disgorgement order.   Armed with favorable appellate precedent, return preparers and owners of tax preparation businesses should expect to see the government continue this trend.

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What is disgorgement?

Disgorgement is an equitable remedy employed by courts to prevent unjust enrichment. Case law defining the contours of disgorgement has largely evolved out of civil enforcement actions brought on behalf of the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and the Federal Trade Commission (FTC). Relying on precedent from the securities fraud context, the Eleventh Circuit in Stinson described disgorgement as follows:

“Disgorgement is an equitable remedy intended to prevent unjust enrichment.” S.E.C. v. Levin, 849 F.3d 995, 1006 (11th Cir. 2017) (quoting S.E.C. v. Monterosso, 756 F.3d 1326, 1337 (11th Cir. 2014)). To be entitled to disgorgement, the Government need only produce a reasonable approximation of the defendant’s ill-gotten gains. See S.E.C. v. Calvo, 378 F.3d 1211, 1217 (11th Cir. 2004). “Exactitude is not a requirement; so long as the measure of disgorgement is reasonable, any risk of uncertainty should fall on the wrongdoer whose illegal conduct created that uncertainty.” Id. (quotation marks omitted and alterations adopted).

United States v. Stinson, 2018 WL 2026928, at *6 (11th Cir. May 1, 2018). The Stinson Court affirmed that disgorgement was an available remedy under Title 26, United States Code, Section 7402(a).

Having established the authority to disgorge profits from a return preparer, the Court in Stinson went on to discuss the boundaries of this remedy in, at times, conflicting terms. The Court first points out that disgorgement is limited to the amount the defendant “profited from his wrongdoing.” Id. At the same time, the Court also asserts that courts have accepted gross receipts as a reasonable approximation of disgorgement “in cases involving the operation of a fraudulent business.” Id. The theory being that “wrongdoers are not entitled to deduct costs associated with committing their illegal acts.” Id. While gross revenue in a wholly fraudulent business might be a reasonable approximation of ill-gotten gains or profit, the issue is more complicated when applied to businesses that engage in legitimate business activity in conjunction with the alleged instances of fraud. In those instances, the government must show a link between the disgorgement amount they seek and the alleged fraudulent transactions.

Another outer boundary applicable to disgorgement is the five year statute of limitations found at Title 28, United States Code, Section 2462 for “an action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture.” In 2017, the Supreme Court rejected the SEC’s argument that there was no statute of limitations for disgorgement in securities fraud cases. Kokesh v. S.E.C., 137 S.Ct. 1635, 1645 (2017). In applying the five-year statute of limitations in Kokesh, the Court stressed that disgorgement “bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate.” Id. at 1644. While the Court was addressing disgorgement in SEC cases in Kokesh, the rationale extends to disgorgement sought in tax preparer injunction cases in all significant respects.

How does the government prove disgorgement?

As the government has increasingly sought disgorgement in tax return preparer cases, district courts have predictably undertaken a highly fact-intensive inquiry into the amount of disgorgement sought. As a result, in United States v. Mesadieu the district court refused to order disgorgement because the government failed differentiate between compliant and noncompliant returns and asked the court to extrapolate from one tax year and one geographical area. 180 F.Supp.3d 1113 (M.D. Fla. 2016). Yet in Stinson, the very same district court judge in Orlando awarded $949,952.47 out of the greater than $1.5 Million sought by the government at trial. The trial in Stinson spanned six days and included testimony by more than 15 taxpayers and deposition testimony by 41 witnesses including taxpayers. That disgorgement figure included so-called “Category 1” calculations based on 1,861 returns containing unreimbursed business expenses on Schedule A. The total disgorgement amount also included “Category 2” calculations based on returns prepared by Stinson himself, as opposed to his employees. The Eleventh Circuit found these calculations reasonable and supported by the record.

The Eleventh Circuit also disposed of Stinson’s argument that disgorgement could only include fees from tax returns specifically proven to be false returns. The Court invoked as an analogy the United States Sentencing Guidelines–for the proposition that only a reasonable estimate was required:

Although this was a civil matter, in the analogous criminal context, the U.S. Sentencing Guidelines “do not require that the sentencing court calculate the amount of loss with certainty or precision … [but only] a reasonable estimate based on the available facts.” United States v. Bryant, 128 F.3d 74, 75-76 (2d Cir. 1997). As we have held, a trial court may extrapolate from available evidence, and such extrapolation may occur without interviewing every customer and preparer for every allegedly false or fraudulent return. See United States v. Barber, 591 Fed.Appx. 809, 823-24 (11th Cir. 2014).

Clearly, the government’s ability to prove disgorgement in a given case will depend on its ability to demonstrate patterns and to persuade the court to make reasonable extrapolations from known samples.

Conclusion

In addition to defending against possible injunctions, and criminal charges in select cases, tax return preparers will have to continue to contend with disgorgement for the foreseeable future. The Department of Justice undoubtedly hopes the pain of separating preparers from their profits will serve as an additional deterrent against business practices that do not otherwise appear to be on the wane. Restitution is available as a remedy in criminal preparer prosecutions, but even that has posed some problems for the DOJ and IRS, see here, for example. In the meantime, practitioners who represent return preparation businesses and their owners can learn from cases like Stinson and the more developed body of law in the securities fraud context for guidance on how disgorgement should and should not be computed.

 

 

 

 

 

 

 

Filed Under: Injunction, miscellaneous, Preparer Penalties Tagged With:

Injunctions as a Tool to Prevent Pyramiding of Employment Taxes

May 15, 2018 by 3 Comments

Christine and I just returned from the ABA Tax Section May meeting.  In this brief post I want to flag an issue that DOJ attorney Noreene Stehlik and Chaya Kundra discussed at an Employment Tax panel entitled “Employment Tax Liabilities and IRS Collections” as well as a case that the Civil and Criminal Tax Penalties committee flagged. In the employment tax panel, the panelists discussed the various tools that DOJ and IRS have to go after employers who pyramid employment tax liabilities by withholding taxes from employees but then failing to remit the taxes to the government.

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Section 6672 allows the government to pierce the corporate veil and creates personal liability for delinquent employment taxes. Keith has written extensively about Section 6672 (see here). The ability to go after people in their individual capacity is powerful. Yet IRS and DOJ have been proactive in using even harsher tools to combat repeat offenders. That has included an uptick in criminal prosecutions and using injunction suits against the employer, owners or principal officers of delinquent employers.

In the last few years there have been a handful of employment tax injunction cases that have led to orders discussing the practice and power that the government has to use injunction as a remedy in this context. The statutory hook is Section 7402(a), which authorizes district courts to take a number of measures related to the enforcement of the internal revenue laws, including enjoining taxpayers from taking future conduct or requiring that taxpayers do specific acts.

While courts have long had this power, and IRS and DOJ have used it over the years, its use is growing. Last fall Keith drafted a new subchapter in Saltzman and Book Chapter 14A discussing the issue.  There are no statutory guidelines or time limitations for a civil injunction. The terms could last indefinitely, and the relief requested could be narrowly tailored or rather broad.

The new subchapter discusses the differing approaches district courts have taken, with some courts requiring  the government prove that it meets traditional standards for equitable relief, and other courts not starting the analysis from traditional equitable factors but considering whether the relief is appropriate for the enforcement of the laws in light of the statutory language in Section 7402(a).

Also at the meeting last week the Civil and Criminal Penalties Committee panel discussed a court order from earlier this year that did not grant injunctive relief in connection with multiple years of employment tax noncompliance. In US v Askins and Miller Orthopaedics, the Middle District of Florida denied the government’s request for injunctive relief (as an aside there seem to be a lot of doctor and dentist cases involving employment taxes); the request for injunctive relief was both broad (stating that the key individuals would be responsible for filing and paying on time) and specific (for example, detailing payment schedules and permitted ways for payroll processing companies to be involved to assist in meeting obligations). For over eight years the government had made numerous attempts to bring the practice into employment tax compliance. The order discusses the futility of levies, the apparent diversion of funds to an account that funded a private hunting club and allegations of a failure to disclose all bank accounts. Noting that the  collection efforts failed, the district court still did not grant the relief requested. In finding against the government, the court looked to traditional standards that would justify equitable relief, i.e., the government had to show absence of an alternate adequate remedy and the likelihood of suffering irreparable injury of denied relief.  That, in the courts view, cut against the injunction, as the government was bringing its traditional collection case for a money judgment for the unpaid taxes.

While the court sympathized with the government’s challenges in the past and its argument that it would have a difficult time collecting, that was not enough, as the order leaned heavily on the government’s ability to fashion a remedy in line with other creditors’ rights:

Bringing an action to recover money damages `does not entitle the claimant to equitable relief simply because the complaint alleges uncertainty of collectibility of a judgment if a fund of money is permitted to be disbursed. The test of the inadequacy of a remedy at law is whether a judgment could be obtained, not whether, once obtained it will be collectible.’ (citation omitted).

Conclusion

As we discuss in Saltzman and Book, even when courts do not rely on a traditional approach under equity to determine when an injunction is warranted, the government’s power is not unlimited.  I am sympathetic with the government in these cases, especially when there are pyramiding liabilities and repeated unsuccessful attempts to encourage voluntary compliance and efforts to defeat collection. Employment tax noncompliance is a major systemic problem, and the threat of contempt seems proportionate in light of repeat offenders who are tempted to view employment tax funds as a source to keep businesses afloat and who take affirmative steps to defeat collection.

We all suffer when employment taxes pile up, and it seems that this stubborn problem is need of more robust powers that are short of criminal prosecution but have more teeth than traditional collection suits.

Filed Under: Injunction, TFRP

Enjoining Pyramiding Taxpayers

November 17, 2017 by Leave a Comment

Over the past 10-15 years, the Department of Justice Tax Division has become much more aggressive about bringing injunction actions against taxpayers who fail to pay their employment taxes over an extended period of time. The IRS calls the repeated failure to pay employment taxes “pyramiding” and views this as one of the most serious types of bad tax behavior, following such other types of bad behavior as evasion and tax shelter promotion. While the IRS has a long history of prosecuting tax evasion and a pretty solid record of getting legislation to root out and aggressively pursuing tax shelter promoters, it has suffered for a long time with the issue of how to stop pyramiding. We are adding some material on injunctions to Chapter 14 of Saltzman and Book, IRS Practice and Procedure which led us to pay more careful attention to the recent cases coming out on this issue. As you will see from the discussion below, the rules governing the enjoining of taxpayers from continuing a business have not been uniformly developed and applied.

The most recent former Acting Assistant Attorney General in charge of the Tax Division, Caroline Ciraolo, made it one of her signature enforcement efforts to prosecute and/or enjoin taxpayers who engaged in pyramiding. Some of the DOJ press releases on this effort provide a flavor for what they have done in this area: general discussion; injunction in Texas; injunction in Pennsylvania; injunction in Iowa; and injunction in New York. Prosecution has long been a desired effort by the folks in collection at the IRS, and I am sure they were delighted with this effort. The civil action that parallels prosecution for failure to pay employment taxes is an injunction action. Like prosecution, this is a labor intensive effort both on the part of the IRS and DOJ. A pair of cases this summer tell some of the story of the effort to root out pyramiding through suits to enjoin the taxpayers engaged in the activity. Usually, these types of suits are coupled with other actions such as reducing the liability to judgment and foreclosing the tax lien on some property.

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Under the general authority granted by Section 7402(a), the Service can bring an injunction action in certain circumstances in order to stop a taxpayer from taking or continuing certain actions. The Service uses its injunctive authority, and this is authority that it uses sparingly, to seek to stop taxpayers from pyramiding employment taxes in circumstances in which the taxpayer has demonstrated a long term pattern of failing to pay employment taxes. Courts have not provided clear guidance on exactly what the Service must show in order to obtain injunctive relief. Because granting injunctive relief will generally result in the taxpayer losing the right to engage in business, courts carefully look at the request. While seeking criminal prosecution against the responsible officer(s) of a business that has a long history of pyramiding employment taxes provides an alternative to seeking injunctive relief to stop a business from operating and continuing to pyramid, each type of relief places a high burden of proof on the Service as well as a high cost in time and effort.

In United States v. Padron, the court granted injunctive relief in a decision entered in May, 2017. In the Padron case, the Service brought suit against both the individual responsible for running the business and the business itself. The defendants did not vigorously defend the action. The business defaulted and the individual agreed to enter into a consent judgment that included the injunction. Nonetheless, the court saw the need to carefully review the case in order to determine if injunctive action was appropriate including whether the claim of the Service for injunctive relief had merit. The court found the claim for injunctive relief had merit only after looking at the standard it should apply, and noting that the 5th Circuit had not ruled on the issue.

The court stated that the issue of what constitutes a sufficient basis for a permanent injunction under Section 7402(a) has created a split in authority among the courts that have addressed it. Some courts require the Service to show the traditional factors for use of the equitable remedy of injunction. As we discuss in more detail in the Saltzman chapter, the majority of courts permit an injunction under Section 7402(a) if the government shows “that an injunction is appropriate for the enforcement of the internal revenue laws, without reference to the traditional equitable factors.” Having determined that it had a sufficient basis for entering a permanent injunction against the business, the court had little trouble finding that it had a basis for entering one against the individual responsible officer of the business.

Reflecting the split of authority on the issue, in US v Moore, the district court in New Jersey reached the opposite conclusion, a case in which the taxpayer did not contest the imposition of an injunction. The Service sought a default judgment, including an injunction against a taxpayer running a dental practice. The principal of the business failed to pay employment taxes over a 20-year period. The Service clearly proved the long term failure to pay; however, the court found that it must determine if “this relief is necessary and proper ‘in light of the public interest involved.’” Similar to the court in the Padron case, the court in the Moore case found no controlling circuit authority and looked for authority from the other district courts in its circuit.

Even though it quoted language stating that the standard included the totality of the circumstances such as the reasonable likelihood that the taxpayer would violate federal tax laws again, the court in Moore found that “applying that standard, the injunction sought by the United States is overbroad and premature. It would force a shutdown of Dr. Moore’s dental practice and stop him from practicing dentistry entirely until the tax liabilities are paid. Such a harsh result is not only unprecedented but also premature given that no efforts or supplemental proceedings have been taken to satisfy this judgment.” At the same time it sought the injunction, the Service obtained a judgment against Mr. Moore for his failure to pay taxes over a substantial period.

While the Service has the ability to obtain an injunction, the Moore case shows that courts have split in a fairly significant manner on the appropriateness of this remedy or the proof that the Service must provide in order to obtain an injunction. The Moore case involves a very long period of non-payment and high amounts of non-payment. Much of the non-payment of employment taxes no doubt got credited to Mr. Moore when he filed his own individual tax return each year. I proposed in a law review article many years ago that responsible officers should not get withholding credit on their own returns when the business does not pay over the withheld taxes to the IRS. Mr. Moore seems like a poster child for that recommendation. Though the district court in Moore was concerned that he would not be able to repay the taxes if he can no longer practice dentistry, I do not think the injunction prohibits him from practicing dentistry as an employee of another dentist. It just seeks to keep him from running his own business and not paying his taxes. The facts in his case convince me that he should be an employee and not a business owner.

Filed Under: Injunction

Court Rejects Government Efforts to Award Disgorgement in Preparer Injunction Case

July 6, 2016 by Leave a Comment

Keith, Stephen and I have recently discussed a number of issues spinning from preparer misconduct, including the government attempting to use the Code’s broad injunction powers to shut down preparers who are gaming the system. Keith and I have also discussed a somewhat newer trend, with the government seeking the equitable remedy of disgorgement to force illicit preparers to give back some or all of the proceeds of their crooked return prep business. US v Mesadieu, a case from earlier this year out of a district court Florida, shows that there are limits on the government’s use of disgorgement as a remedy, at least in terms of its establishing the amount of disgorgement that the government may be entitled to receive. It also raises some questions about the remedy, and in particular whether the Mesadieu opinion might throw some roadblocks in these types of cases.

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The case arose from the government’s seeking injunctive relief stemming from preparer Douglas Mesadieu, who had set up offices in Georgia, Florida and Texas, using eight entities that prepared around thirteen thousand returns in a three-year period. The allegations included that Mesadieu and others affiliated with Mesadieu and the entities goosed income and created deductions to place clients in position to receive the EITC (similar to what Carl Smith discussed in The Often Topsy-turvy World of EITC Litigation where at times the amount of the credit exceeds any income or SE tax liability):

The Government’s evidence shows that one of the ways Mesadieu’s companies’ manipulate the EITC is to create fake businesses to list on the taxpayer’s Schedule C, such as a transport services business, hair salon, or barber shop. Other times, the taxpayer’s Schedule C claims losses for a business but did not list a business name

Another tactic is to claim false unreimbursed employee expenses on a Schedule A. For example, expenses for non-deductible commuter miles or other business-related expenses for unreimbursed meals or uniforms would be claimed.

The schemes involved more than the EITC, as the government alleged that “[a]nother often-used strategy is to claim false charitable donations or education credits that the taxpayer testified he or she did not actually pay and did not tell the tax return preparer that the amounts were paid.”

While the court issued an order granting the government’s expansive injunction request, it ruled against the government on disgorgement. Mesadieu had two main arguments when it came to the disgorgement issue: 1) the court did not have power to order disgorgement in cases arising from return preparer injunction proceedings and 2) even if it did the government did not establish how much should be disgorged.

Is Disgorgement an Appropriate Remedy?

Mesadieu argued initially that the court should not have the power to compel disgorgement. In response to a previous motion, the district court held that courts had wide power under Section 7402(a) to order a disgorgement of a preparer’s ill-gotten gains. That section gives federal district courts jurisdiction “to make and issue in civil actions, writs and orders of injunction, and of ne exeat republica, orders appointing receivers, and such other orders and processes, and to render such judgments and decrees as may be necessary or appropriate for the enforcement of the internal revenue laws.” The statute also states that the remedies listed in Section 7402(a) “are in addition to and not exclusive of any and all other remedies of the United States in such courts or otherwise to enforce such laws.”

The emphasized statutory language in Section 7402(a) is what courts have relied on in allowing the government to seek disgorgement in preparer scheme cases. While not every type of federal case inherently implicates disgorgement powers, in upholding the right to order disgorgement in injunction cases against preparers the Mesadieu opinion distinguishes other statutes that are more narrowly drawn or which do not involve the public interest associated with revenue laws. The opinion discusses generally how 7402(a) “encompasses a broad range of powers necessary to compel compliance with the tax laws.” United States v. Ernst & Whinney, 735 F.2d 1296, 1300 (11th Cir. 1984). It also relies on cases that had specifically blessed disgorgement as an appropriate remedy under Section 7402(a) in similar circumstances.

How Much Disgorgement?

While the court found that it could order disgorgement, it held against the government, finding that the government failed to establish how much disgorgement was appropriate. Here is how it got there. The government argued first that all of Mesadieu and his related entities’ gross receipts should be disgorged or in the alternative, disgorgement would be based on the fees that related to an estimated percentage of the non-compliant returns. The amount that should be disgorged depends on the extent of the fraudulent activity; i.e., how much of the return preparation proceeds was attributable to the misconduct. To establish the misconduct, the government put on an expert, an IRS Senior Research Analyst, who problematically looked at returns from only one year and in one location:

To establish the amount of disgorgement, the Government relied on a random sampling of tax returns prepared by Mesadieu’s companies. In total, for all years of tax preparation, Mesadieu’s companies prepared around 13,000 tax returns. However, the random sample that the Government presented at trial consisted of only 230 tax returns prepared in Houston, Texas for the tax year 2012. The overall pool of tax returns from which the 230 were selected was approximately 3,600. Despite that 230 tax returns were selected for the random sample, only 115 taxpayers were interviewed regarding their tax returns to determine whether the information on the tax return was fraudulent. Those customers interviewed were not put under oath. From this, the Government’s expert testified that the percentage of “non-compliant” tax returns–meaning, a taxpayer underreports his taxes due–was 82.6%. Additionally, it is possible that as many as 25% of the tax returns were “compliant,” or correctly reported.

As an initial matter the court discussed the standard to determine the amount of disgorgement, emphasizing that the plaintiff only need “produce a reasonable approximation of the defendant’s ill-gotten gains.” Once the estimate is shown, the defendant has the burden to show that the plaintiff’s estimate was not reasonable. However if there are shoddy records and the estimation cannot be shown and “the exact amount of illicit gains cannot be accomplished without incurring inordinate expense,’ a court may set disgorgement at the ‘more readily measurable proceeds received from the unlawful transactions.'” (citations omitted).

The court emphasized that there must be a “relationship between the amount of disgorgement and the amount of ill-gotten gain,” and a district court may not order disgorgement of an amount obtained without wrongdoing or obtained during a period where there is no record evidence of fraud. (citing to C.F.T.C. v. Sidoti, 178 F.3d 1132, 1138 (11th Cir. 1999)). Given that the expert testified that some of the returns were compliant, the opinion rejected the government’s argument that all of the receipts were subject to disgorgement, distinguishing cases where courts ordered all of the proceeds to be disgorged:

[T]hese cases are distinguishable because they involve an entire fraud. In those cases, either all of the defendant’s conduct was fraudulent or the defendant’s illegitimate activity is indecipherable from his legitimate activity. See, S.E.C. v. Lauer, 478 F. App’x 550, 557 (11th Cir. 2012)…In contrast, in the present case, Mesadieu’s tax preparation stores did not always prepare taxes fraudulently.

The opinion notes that while Section 7402(a) is broad, a “court’s power to order disgorgement is not unlimited.” The opinion describes and distinguishes  cases where all the proceeds were disgorged (like FTC cases involving phony claims in telemarketing and infomercials) where courts have struggled to distinguish legitimate gains from illegitimate gains, or cases where the facts make it impractical to distinguish between legitimate and illegitimate activity. The opinion emphasizes that its disgorgement power “extends only to the amount the defendant profited from his wrongdoing….Any additional sum is impermissible as it would constitute a penalty.”

The opinion then turned to the government’s alternative argument that an estimated percentage of non-compliant returns should provide the basis for disgorgement:

As the Court has determined that a disgorgement award of gross receipts is not a reasonable approximation, the Court must next consider the Government’s argument that the estimated percentage of non-compliant tax returns from the Texas sample is a sound methodology for separating illegal proceeds from legal ones. Under this method, the Government asks the Court to utilize the confidence interval of the non-compliant tax returns (73%-91.7%) to calculate Mesadieu’s companies’ illegal proceeds. To clarify, the Government urges the Court to use this percentage derived solely from the Texas sample of 2012 tax returns and apply it to the total gross profits of Mesadieu’s companies from its operations in all three states and for tax years 2013, 2014, and 2015.

Mesadieu argued that the government’s alternative approach was unreasonable because it essentially extrapolated from returns prepared in Texas and only looked at one year and failed to take into account the entire operations. The opinion agreed that reliance on such a limited sample was not reasonable:

The Court finds it is unreasonable to approximate the total disgorgement award in this case based on a sample limited to one tax year and one geographical area. Utilizing a random sample from a pool of only 3,600 tax returns to make a conclusion about 13,000 tax returns is not reasonable. There are approximately 9,400 tax returns that were inevitably not capable of selection. The Government’s sample provides no information as to the percentage of non-compliant tax returns in other years or in other states. The Government’s expert testified only as to the soundness of the sample methodology for the pool of 3,600 tax returns from which the sample was selected. Importantly, the Government’s expert testified that the sample data provides no information on whether the compliance rate from that sample is the same in other years. Accordingly, the Court finds that this sample is not generalizable to the universe of 13,000 tax returns.

Parting Thoughts

 The Mesadieu opinion does not throw up an impossible burden for the government, as the government should have pulled most of the returns prepared by this business and should have had the ability to get pretty specific. While the opinion also notes a technical foot fault in that the government did not join the specific entities that Mesadieu controlled and questioned whether it could have ordered disgorgement with respect to the fees that those entities received, that too is remediable in future cases. If in the future the government dots the i’s and crosses the t’s in proving a reasonable approximation of returns with phony deductions and credits and properly joins all parties, what is the value of the disgorgement to the government?

Keith discussed the government’s use of its injunction and disgorgement powers in Return Preparer Shenanigans and expressed some skepticism that both remedies were likely to be effective, comparing them to “trying to pull up individual dandelions instead of putting down a fertilizer that kills them and prohibits growth. Aside from having to pull them up one by one, you invariably do not get the roots so it pops back up before long.” Likewise, Keith said he would be “surprised if the return preparation fees are sitting around in a bank account just waiting to be disgorged.”

If Keith’s skepticism is correct, I am not sure why the government would pursue disgorgement as a remedy though I have previously discussed in Restitution Based Assessment and Bad Tax Return Preparers: An Uneasy Mix why the government may have difficulties in pursuing restitution in these types of cases, perhaps thus making disgorgement more attractive. Alternatively, it could go the route of preparer penalties, assessable without deficiency procedures and then subject to administrative collection. Any result that ties in the preparer misconduct to dollars, however, suffers from the same “you cannot get blood from a stone” problem that Keith flagged.

In any event, the tax system is still plagued with preparers (and taxpayers) who view the tax system as an unwatched cookie jar. DOJ is emphasizing its injunction tools as part of its efforts to root out schemes and scams and it will likely try to use some means to impose a monetary cost on the preparers. I suspect we will see more of these cases and perhaps gain some more insight on calculating the amount of disgorgment when preparers such as Mesadieu have many thousands of returns spread across entities and multiple states.

Filed Under: Injunction

DOJ Cracking Down on Preparers Using its Injunction Powers and Requiring Preparer to Disgorge Illicit Profits

June 28, 2016 by 6 Comments

The government has lots of tools at its disposal when it comes to going after the effects of crooked preparers. Last week I wrote about how the fraud of a preparer can have consequences for the taxpayer and indefinitely extend a taxpayer’s SOL on assessment.   DOJ often goes after the illicit preparer as well, sometimes using its vast civil remedies, including injunctions, as Keith discussed in Return Preparer Shenanigans.

This past month the DOJ has been busy releasing information trumpeting its efforts to get civil injunctions against prepares as well as requiring those preparers to disgorge their profits. Preparers that submit returns with phony refundable credits seem to be getting a great deal of attention.

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For example, last week the DOJ press release Federal Court Bars Florida Man from Preparing Tax Returns for Others and Enters $1 Million Disgorgement Judgment discusses how a district court in Florida entered an injunction and disgorgement order stemming from the facts as alleged below:

In September 2014, the United States filed a civil injunction complaint against Pierre-Louis alleging that he and his employees prepared fraudulent tax returns for customers.  The complaint alleged that return preparers in Pierre-Louis’s business targeted primarily low- to moderate-income customers with deceptive and misleading advertisements; prepared and filed fraudulent tax returns to increase their customers’ refunds; and profited through unconscionable, exorbitant and often undisclosed fees—all at the expense of their customers and the U.S. Treasury.  According to the complaint, Pierre-Louis and his employees prepared federal tax returns on which they falsely claimed earned income and education credits, reported improper filing statuses, concocted phony businesses, claimed bogus income and expenses related to the non-existent businesses and fabricated job-related expenses.  The complaint also named Jehoakim Victor and Lauri Rodriguez, allegedly former managers at Pierre-Louis’s tax preparation stores, as defendants.  In February 2015, the court permanently enjoined Victor and Rodriguez from preparing tax returns for others and from owning or operating a tax return preparation business.  Victor and Rodriguez agreed to entry of the injunction without admitting the allegations in the complaint.

The order itself is interesting and details just how far-reaching the government’s powers reach under those provisions, enjoining the preparer from preparing or assisting in preparing returns for others and essentially prohibiting him from having any commercial activity related to the preparation of tax returns, including getting a PTIN or EFIN.

The order also requires the preparer to turn over the identities of all people whose returns were prepared by the defendant and his related businesses, all the employees of the defendant and the related entities and also prohibits the defendant from selling any customer list. That customer list can lead to the issue I discussed last week, as it is likely that the IRS will systematically go after those individuals whose returns were prepared by this preparer.

In addition to the injunction, the order requires the defendant to cough up $1 million as a “for the disgorgement of the proceeds that Kerny Pierre-Louis received for the preparation of tax returns making or reporting false or fraudulent claims, deductions, credits, income, expenses, or other information resulting in the understatement of taxes.”

I have not focused much on the government’s use of general disgorgement powers to go after preparers. Disgorgement is an equitable remedy that has its roots in undoing enrichment rather than punishing and is meant to force the preparer to return profits from the improper activity. That disgorgement is not punitive may have significant consequences as to the deductibility of any such payments, as discussed in this McGuire Woods blog post discussing how the IRS in Field Service Advice opined that a Food and Drug Administration disgorgement order was not a non deductible fine or penalty under Section 162(f).

I have seen a number of disgorgement orders in return preparer cases recently and I suspect that they are now part and parcel of the government’s tool kit.

Some Observations

I am in DC this week attending a summit that the Commissioner has convened on the Earned Income Tax Credit. I have been interested in the EITC, and its administration, for years, starting with my time as a director of a low income taxpayer clinic.  I saw early on in my time as director claimants who used a return preparer that was either incompetent or unscrupulous, or both. Assigning blame between claimants or preparers and getting at the root cause of the source of the incorrect claim is a tricky business, and there have been very few meaningful qualitative studies that identify the extent of demand (claimant) or supply (preparer) driven noncompliance. As I have written previously, there is an interesting and complex relationship between preparers and claimants, and government efforts both before the fact (though regulation and oversight, including due diligence) and after the fact (including injunctions and preparer penalties, both civil and criminal) attempt to change the dynamics in that relationship.

In the blog and in other articles I have written about the various ways that the government has sough to change this dynamic. I am working on a longer paper that looks at compliance issues in some more detail. Most of what Congress has done in this area over the past decade has been to increase penalties and allow IRS to detect and unwind erroneous credits through the use of a more automatic reportable error that dispenses with traditional deficiency procedures(though IRS wants even more of that power). I am interested in learning from others at the summit, as this is a problem that is in need of solutions from many differing perspectives, not just increasing penalties and removing barriers to assessment.

UPDATE 7/1 After initially posting I learned that IRS last month has issued a CCA that held that certain disgorgement payments made to the Securities and Exchange Commission for violating the Foreign Corrupt Practices Act were not deductible. There is a lot of commentary on that substantive issue. For example, see Lawrence Hill from Shearman in the FCPA Report.

Filed Under: Earned Income Credit, Injunction