Restitution Based Assessment Upheld

In Engle v. Commissioner, T.C. Memo 2020-69 the Tax Court faced question of timing regarding the restitution ordered with respect to Mr. Engle.  We have written before about restitution based assessments (RBAs) including a post last month that collected earlier posts on the subject.   RBAs arrived on the scene a decade ago as part of the Firearms Excise Tax Improvement Act of 2010 (FETIA).  The Court indicates that the government made some concessions on interest and penalties based on its decision in Klein v. Commissioner, 149 T.C. 341 (2017) and, probably, on the IRS notice on this subject discussed in this post.

Having cleared out the interest and penalty issues, the parties were able to submit the case fully stipulated since the dispute in the case involved a purely legal issue.  Petitioner brought a CDP case because the IRS filed a notice of federal tax lien.  Since the assessment occurred without the taxpayer having the opportunity to contest the liability, he is able to obtain a hearing in the Tax Court on the merits of his claim. 

In 2004 Mr. Engle pled guilty to tax evasion under IRC 7201 for the year 1998.  The information brought by the U.S. Attorney’s office alleged that he evaded his taxes for 16 years between 1984 and 2002.  I must say that at this point in reading the opinion I was totally confused, because RBA only applies to restitution orders issued after the passage of FETIA, and it was not passed until six years after his guilty plea.  So, I read on hoping for enlightenment and I found it.

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For reasons not explained in the opinion it took two years before the sentencing hearing.  Maybe this should not surprise me having seen lots of news lately about the amount of time between the guilty plea of General Flynn and his sentencing but still the sentencing in most tax cases moves much quicker than this.  When the court sentenced Mr. Engle, it gave him four years of probation, including 18 months of home detention.  The court did not make a finding regarding the exact amount of tax loss the case involved.  It ordered that the exact amount of restitution would be determined by the IRS.  It ordered him to pay the IRS $25,000 immediately and $100,000 within 90 days.

The Government appealed the sentencing and on January 13, 2010, the 4th Circuit vacated the entire sentence and remanded the case for resentencing stating:

Under these circumstances, we cannot determine whether the sentence is reasonable without a fuller explanation of the reasoning behind the district court’s view that a term of imprisonment as recommended by the Guidelines was not warranted and why restitution alone would provide adequate deterrence in this case.  Because the district court’s explanation of its decision to vary significantly from the Guidelines’ sentencing recommendation is insufficient to permit meaningful appellate review, we must vacate the sentence and remand for new sentencing further proceedings.

The 4th Circuit also pointed to Mr. Engle’s failure to make any significant payment on his taxes during the four-year period before he was sentenced and advised the district court to reconsider the issue of restitution should it again conclude that restitution was not required.

In May, 2011 the district court held a hearing to resentence Mr. Engle.  Out of an abundance of caution to avoid getting reversed again, the court sentenced him to 60 months of incarceration with 14 months of supervised release thereafter.  While the original sentence seems out of line on the light side, this one seems to go a bit overboard but I don’t know all of the facts.  It also ordered him to pay restitution in the amount of $620,549.  No one appealed this amended judgment.

Now, a restitution order after the passage of FETIA exists, and the IRS made a RBA for most of the years between 1984 and 2001 totaling the exact amount of the restitution order.  In 2016 the IRS filed a notice of federal tax lien, which led to this CDP case in Tax Court.

In order to avoid the RBA Mr. Engle argued that the 2008 restitution order was not vacated or voided by the 4th Circuit’s decision, and the circuit court decision focused on the amount of time he was sentenced and not restitution.  Therefore, the IRS should not have made an RBA because the 2008 restitution order predates the passage of FETIA.  The Tax Court looks at the 4th Circuit’s decision and decides that it included a reversal of the restitution order as well as the sentencing order.  It pointed to the language in a footnote of the opinion discussed above in support of its conclusion.  Therefore, it concluded that the IRS appropriately made RBA based on the 2011 order.  The outcome here is not surprising even if the facts show a surprisingly slow imposition of sentencing.

Probably not too many cases still exist with this fact pattern. where the original restitution order predated FETIA and gets overturned on appeal and reentered after the passage of FETIA.  Here, the government succeeded in overturning the original order.  Much more common would be the taxpayer appealing the original order.  It’s possible a taxpayer could win their appeal only to have a new restitution order entered after the passage of FETIA, allowing the IRS to make an RBA.  Of course, the making of the RBA works well for the IRS, but the IRS can still use its normal assessment means if it cannot make an RBA and regularly does so if the restitution order does not equal the amount the IRS believes the taxpayer owes.

We are still relatively early in the life of RBAs.  Many original fact patterns will emerge.  RBAs allow the IRS to assess and start collecting on a liability much earlier than it could otherwise do.  The ability to collect early could make a significant difference in the collection outcome or could make no difference at all.  I have not seen a study on the effectiveness of RBAs in bringing into the treasury more money than the IRS collected under the system that existed prior to RBAs.  Such a study would allow us to really gage the effectiveness of this relatively new assessment tool.

Litigation of Tax Liability After Restitution Order

It has now been a decade since Congress began allowing the IRS to make restitution based assessments.  This area of the law is still in the growing phase.  We have blogged about issues regarding restitution based assessments here, here, here, here, here and here if you want more background on this.  The Saltzman-Book treatise also covers this topic extensively at ¶ 10.01[2][e] (addressing assessments generally) and ¶ 12.05[14][e][vi] (addressing criminal penalties) along with a stand-alone chapter on restitution based assessments at ¶ 12.06[5][a].

The recent case of Le v. Commissioner, T.C. Memo 2020-17 brings us back to the issues presented in a deficiency case following a restitution based assessment.  As is essentially required in these cases one of the petitioners, here the husband, Dung T. Le, was criminally prosecuted giving rise to a restitution order.  He was convicted of tax evasion under IRC 7201 pursuant to a plea agreement for the year 2006.  The prosecution occurred for the years 2004, 2005 and 2006 following an indictment on March 20, 2013. 

Because the criminal investigation process is slow, because the IRS defers civil action until the completion of the criminal aspects of the case conclude and because this case took four years to resolve in the Tax Court we discuss a case today involving years prior to the birth of around 30% of the world’s population.  The length of a case going through the criminal tax process provides the greatest reason for allowing assessment of some of the tax following the restitution phase of the criminal case.  As we will see, however, that assessment marks the beginning rather than the end of the assessment process in a case such as this.

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In connection with Petitioner Le’s plea agreement, he also agreed to pay restitution of $33,332 for 2006.  He paid that amount.  After he paid the restitution, the IRS finished the examination of the couple’s returns it had begun prior to the criminal case.  The examination resulted in a notice of deficiency for 2004, 2005 and 2006 in the amounts of $31,944, $44,178 and $40,706, respectively.  The IRS also asserted fraud penalties for each of the years.

Petitioner Le argued that the doctrine of collateral estoppel barred respondent from relitigating his 2006 liability since the criminal court determined the amount of his liability in the restitution order.  He loses this argument which came as no surprise.  The Court held that the order for criminal restitution did not comprise an essential part of the criminal conviction and was not an element of the conviction.  The Court also pointed out that the law is well settled that a restitution order has no effect on the authority of the IRS to determine a taxpayer’s correct civil tax liability citing Morse v. Commissioner, 419 F.3d 829, 833-835 (8th Cir. 2005).

After swatting away the argument that the restitution order in any way stopped the IRS from pursuing the correct liability in a follow up civil proceeding, the Court then marched through all of the reasons that he owed the additional tax.  That the taxpayer wanted to go through this after declining to go through it for criminal tax purposes surprises me but apparently he thought a sufficient chance existed that the IRS would not put on its proof to cause the creation of an opinion detailing the many ways in which he cheated on his federal taxes.  The Court also had little trouble finding that Mr. Le deserved to have the fraud penalty apply.

So, this case shows in a simple, straightforward manner the ability of the IRS to pursue civil assessment of additional taxes after making a restitution based assessment.  It offers very little, if anything, new.

Two other aspects of the case deserve quick mention.  First, the Court finds that Mr. Le’s wife does not owe the accuracy related penalty.  The fact that the IRS asserted the accuracy related penalty against Mrs. Tran also surprises me since I would have expected the government to know better.  Aside from hoping that the IRS attorneys read our blog posts explaining that if it cannot prove fraud against the spouse the Court can impose no lesser included penalties against her, because doing so would create an impermissible stacking of penalties as set out in Said v. Commissioner, T.C. Memo 2003-148, aff’d 112 F. App’x 608 (9th Cir. 2004), I hope that government attorneys know the law.  Seems like someone should have caught this argument unless the IRS seeks to change the law in which case perhaps we will see an appeal.  This is the second opinion within six months in which the IRS attorneys have made an argument that appears contrary to both the regulation, Treas. Reg. 1.6662-2(c), and the IRM, IRM 20.1.5.3.3.1 No Stacking Provision (12-13-2016).  Either the review of the IRS attorneys is lax or a change in position is afoot.

Second, the case contains an order sealing part of the record.  The order is unusual and its language caused me to read this passage a few times: “Pursuant to the Court’s Order dated July 10, 2018, portions of the exhibits were not properly redacted in accordance with Tax Court Rule 27(a), and the exhibits were not marked in accordance with Tax Court Rule 91(b).”  After reading the prior order, I came to understand this language as an odd way to refer back to an earlier order requiring redaction. 

Next the Court determines that since the material was not properly redacted, it is going to seal it.  It appears the Court sealed the record sua sponte.  Nothing in the order makes clear how the sealing of the record here meets the criteria for sealing discussed eloquently in a post by Sean Akins.  In its order dated July 10, 2018, the Court pointed out to the parties that they failed to properly redact documents in the stipulation in accordance with the Tax Court rules.  I am troubled that the remedy for failing to properly redact material in a stipulation, in which both parties were represented by counsel, would be to deny the public the right to the material in order to prevent the public from seeing material the parties were required to redact rather than to order the parties a second time to redact the material properly and resubmit it. 

It is quite possible that I am missing something in the order or outside of the order that drives the decision, but the order itself leaves me quite puzzled.  I doubt that any non-party cares what was in the stipulated documents, but if a non-party did care, it seems to me that non-party should have a right to see the documents following appropriate procedures without having to go through the lengthy and difficult process to unseal the record.  Counsel to the parties in this case could have been sanctioned for failing to follow the redaction rules and the prior specific order of the Court. The sanction instead falls on the person with a lawful right to see the records of the case. 

Reducing a Restitution Order

We welcome first time guest blogger, Meagan Horn. Meagan practices in Dallas, Texas as counsel with Thompson & Knight LLP.  She focuses her practice on tax controversy matters, at both the state and federal level.  She has also assisted the tax clinic at Harvard in some amicus brief projects.  Keith   

On March 6, 2020, the Seventh Circuit affirmed a district court decision allowing the government to remove certain restitution obligations of a taxpayer arising from his tax fraud conviction. (United States v. Simon, 2020 WL 1074729 (7th Cir. 2020), aff’g United States v. Simon, 2019 WL 422447 (N.D. Indiana 2019)). At first blush, it is a fairly unremarkable case with a defendant taxpayer on the lucky side of governmental restitution amendments, yet still shooting argumentative blanks at an issue that, at this point, just needs to be paid up and moved on from. 

But just as you are about to file the case into the trusty blue filing cabinet under your desk, you see the court has slipped in a little procedural law cliffhanger.  In just five sentences near the very end of the opinion, the court introduces the most curious of questions. Specifically, the court points out that the convicted defendant can’t reduce his restitution obligations since there has not been a change in his economic situation. Then it asks, if there hasn’t been any change to the defendant’s economic situation, how is it that, under these facts, the government had statutory authority to ask the court to make the restitution amendments?

It would seem a no brainer to allow a victim to seek to reduce the restitution requirements of the defendant, but as it turns out, it’s not that easy.

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A brief background is in order.  James Simon was convicted in 2010 of tax fraud and financial aid fraud. Simon was sentenced to six years in prison and three years of supervised release, and ordered to pay restitution to various parties of just over one million dollars.  Most of the ordered restitution was owed to the Internal Revenue Service, but some of the restitution was to be paid to various private schools that had been defrauded via the financial aid claims.  Several years later, the government filed a motion to amend the restitution order to reduce required payments to certain of the private schools. The court approved the motion the following day.

Approximately seven months later, Simon filed a pro se motion with the district court requesting reconsideration of the matter. He contended he did not receive a copy of the government’s motion and its attachments until several days after the district court had already granted the restitution amendments. In addition to rehashing several arguments he made at the sentencing phase, he raised concerns with the documentation that had been used to support the restitution amendments.  He further claimed his right to due process under the Fifth and Fourteenth Amendments had been violated when the court allowed the restitution order to be amended without his participation.

The district court quickly dismissed each of Simon’s concerns, noting Simon couldn’t relitigate issues raised at the sentencing phase and dismissing the documentation concerns. Further, the district court explained that for Simon to prevail on a due process claim, he must show a cognizable property interest, a deprivation of that interest, and a denial of due process.  Citing Dyab v. United States, No. 09-cr-0364 (1), 2018 WL 3031944, at *1 (D. Minn. June 19, 2018), the district court found that Simon could not have suffered a deprivation of his property interest, given the restitution order was amended to his benefit.

Simon appealed, raising new issues and rehashing old ones that could have been or should have been raised at the sentencing phase.  Without much discussion, the Seventh Circuit found each of Simon’s arguments were inappropriate at this phase and/or untimely and therefore waived. 

In concluding, however, the Seventh Circuit made an interesting observation.  What statutory avenue permitted the government to adjust the mandatory restitution order in the first place?  When the court asked the government what authority it relied on to adjust the restitution order, it cited 18 U.S.C. §3664(k). However, the court had dismissed Simon’s request to adjust the restitution order, finding that his economic situation had not changed; the Seventh Circuit observed that such section would be as inapplicable to the government as it was to Simon.  Nevertheless, the court found that Simon’s challenges were untimely, and found further comfort in the fact that Simon’s order was amended to his benefit. The issue was moot.  The end, they said.

Wait, what? Things just got juicy! I just sat up and started pushing too large of handfuls of popcorn into my mouth. And granted, I know it’s not the court’s job to answer these sorts of questions if they don’t have to.  But, still, what a cliffhanger!

In general, 18 U.S.C. § 3664 provides the procedures for issuance and enforcement of restitution.  §3664(o) declares restitution orders final judgments, with only a handful of exceptions.  Namely, the defendant has the right to file a timely appeal, and the order may be amended in certain situations when the victim’s losses are not known or quantifiable at the time of sentencing, when fines are also imposed, or when the defendant is in default on his or her restitution obligations. In addition, and this is the crux of the court’s discussion, a restitution order may be adjusted under §3664(k) when the defendant’s economic situation has changed.  So when the defendant’s economic situation hasn’t changed, and there aren’t any of the specific scenarios addressed in §3664(o), what does permit the government to request a change to a defendant’s restitution obligation?

Luckily, Judge Hamilton could sense the discomfort that such a cliffhanger would cause and wrote a concurring opinion to fill in a few gaps to, as he put it, “offer not a fully satisfactory answer but in essence a tracing of steps so that the choices are clear.”

After analyzing the inapplicability of §3664(o) in this particular situation, Judge Hamilton first offers as possible statutory authority for the amendments the government sought, §3664(m)(1)(A), which states, “[a]n order of restitution may be enforced by the United States in the manner provided for in subchapter C of chapter 227 and subchapter B of chapter 229 of this title, or by all other available and reasonable means.”  Judge Hamilton points out that the cross-references offered in §3664(m) give the government the authority to initiate enforcement actions or modifications of restitution and clearly contemplate that district courts will hear such matters.  He then offers, “with diffidence,” an argument that the district court simply has inherent authority to hear such matters. He rightly notes that the statutory references and cross-references providing specific authority to specific fact patterns weigh against an inherent authority argument (not to mention the general hesitancy of courts to apply inherent authority).  Nevertheless, he concludes, it is clear that someone must be in charge of hearing such matters, and no one is better suited to hear such issues than the court that imposed the sanctions in the first place.  He offers that if this analysis is not satisfactory, perhaps legislation should be enacted to make it clear.

Judge Hamilton is right – there is no explicit statutory authority for the government to reduce a defendant’s restitution obligation in a situation such as Simon’s. And I’m not convinced that §3664(m) does the trick. In this case, however, I’m not troubled by an argument that the district court has inherent authority to oversee adjustments of the type at issue here.  The district court rightfully noted its limitation to adjust a restitution order to the detriment of the defendant.  Inherent authority must be exercised with restraint, but here, I have trouble seeing any harm that could ever arise from a court exercising authority to adjust its own restitution order at the request of a victim to the benefit of a defendant.  Given that, it seems entirely appropriate to read in a district court’s inherent authority to address these sorts of issues, and I see no need to bog the code down with a legislative fix. What do you think?

Interest and Penalties on Restitution-Based Assessments

On June 27, 2019, the Office of Chief Counsel, IRS published Notice CC-2019-004 to update a notice it issued eight years ago shortly after the IRS was given permission by Congress to make assessments based on restitution orders. We have written about assessments based on restitution orders before here, here and here. The idea to allow the IRS to make assessments based on these orders improved the process for handling the civil side of criminal cases. Before the change in the law, the IRS had to go through the entire deficiency process before it could begin the collection process. Many taxpayers who go through the criminal process already have a significantly diminished ability to satisfy any subsequent assessment of the tax relating to the crime. For those taxpayers who did have the post criminal process ability to pay the tax, the sometimes multiyear process needed by the IRS to achieve an assessment further winnowed the group with an ability to pay.

So, in general, the innovation of restitution-based assessments greatly improved the process; however, these assessments have limitations and almost 10 years after these types of assessments were approved, the limitations are still being refined. This notice addresses limitations on restitution-based assessments when it comes to interest and penalties. Keep in mind that although Congress granted the IRS the ability to make an assessment of tax after the imposition of a restitution order it did not prevent the IRS from continuing to use its traditional bases for making an assessment and those traditional bases could fill the gaps left by restitution based assessments in those situations in which pursuing the additional steps to assessment would make good sense.

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In its original notice regarding restitution based assessments, Notice CC-2011-018, the IRS took the position that underpayment interest under IRC 6601 would accrue on the restitution assessment. In Klein v. Commissioner, 149 T.C. No. 15 (2017), blogged here, the Tax Court disagreed. The new notice states:

Consistent with Klein, if a taxpayer challenges in litigation the accrual of interest on an amount of restitution assessed under section 6201(a)(4)(A), the interest should be abated.

Does this mean that taxpayers who do not challenge the imposition of this interest in litigation must still pay it? Is this an example of Sludge where the IRS knows that it shouldn’t do something but refuses to establish the administrative process for fixing the problem, forcing taxpayers and the courts to do that work for them? I do not understand why the IRS would only eliminate the accrual of this interest in litigation and not just do it or at least do it upon an administrative request by the taxpayer. Perhaps readers will comment on why the IRS has adopted this position which will only benefit taxpayers who bring an action against the IRS in court.

In the following sentence the IRS limits the situations in which it will abate the accrued interest to those situations in which the restitution order does not include interest. I do not know the percentage of restitution orders that mention interest. Obviously, this is something that the IRS would want to work with the U.S. Attorneys around the country to insure is included in restitution orders. Usually, taxpayers would have a very limited ability to keep this language out of the restitution order. So, I see it as a matter of educating the prosecutors to make sure the language appears in the restitution order. If prosecutors become sufficiently educated on the subject, the IRS may have a means of circumventing the adverse decision in Klein or at least setting up for additional litigation over whether 6201(a)(4)(A) allows the assessment of accrued interest.

The new notice does refer back to the original notice on the issue of interest accruing under 18 USC 3612(f) and continues to take the position that even though the United States can seek interest on the restitution ordered amount the IRS cannot assess interest under that provision. The Department of Justice could, however, go after the person to obtain this interest.

The Notice next turns to the failure to pay penalty. For taxpayers assessed in the traditional IRS ways, the making of the assessment will trigger the penalty which runs at .5% per month up to a total of no more than 25% if the assessed amount remains unpaid for 50 months. In Klein the Tax Court also held that the IRS lacks authority to assess and collect this penalty based on a restitution assessment. The penalty applies to the failure to pay the tax required to be shown on a return; however, the restitution assessment is not an assessment of tax. So, the Notice provides that “the failure to pay penalty does not apply to an amount of restitution assessed under section 6201(a)(4)(A).”

Again, the Notice provides that if the restitution order makes this penalty a component of the restitution order “the taxpayer is liable for the failure to pay penalty included in the order.” The Notice notes that these situations will be rare.

Without data regarding how much the IRS collects on restitution orders, it’s hard to say how much the limitation on the collection of interest and penalties based on restitution orders impacts the overall collection of tax liabilities. Because my experience trying to collect from people who have gone through the criminal tax process suggests that collection from these individuals often results in low yields, I think that the limitation on the ability of the IRS to collect certain interest and penalties based on the restitution order does not negatively impact the Service in any significant way. For those individuals for whom it identifies a continued ability to pay it can go through the traditional means of making an assessment while pursuing collection of the tax it has assessed as a result of the restitution order.

The new notice brings the guidance of the Service into line with the decision of the Tax Court. The Tax Court’s decision makes sense. For those individuals assessed between 2010 and the timing of this notice, I expect that it will be difficult to get the Service to abate the interest and penalties it now acknowledges it should not have made. Some of these individuals may be entitled to a refund. Others will want the assessments abated in order to reduce the amount the IRS collects from them. Some will be so judgment proof that this may not matter.

Restitution Order, IRA Account, Community Property = Unfortunate Result for Non-Liable Spouse

It’s never a good thing for your spouse to be the subject of a $2,165,126 restitution order. You know when that comes out in the first few sentences of an opinion that things do not look good for the non-liable spouse. That proves true in United States v. Berry, No. 4:17-cr-00385 (S.D. Tex. 2018).

From the perspective of the IRS, this case presents the not always available situation of a wayward party who still has assets after a criminal prosecution. Here, the asset takes the form of an IRA. An IRA generally does not provide the best place to hold assets if you seek to protect them from creditors. Here, the court mentions the general rule that ERISA does not govern IRAs as a shorthand way to state that the substantial protections from creditors afforded to individuals holding assets in an account covered by ERISA do not apply when the retirement account instead exists in an IRA. The court does not make mention of the fact that ERISA’s protections do not insulate a taxpayer from the collection tools available to the IRS. Because of the way this case arises, I am unsure if the IRS tools are available here. So, the fact the account existed in an IRA could make a crucial difference not always present in federal tax collection cases.

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The Berrys live in Texas although I am unsure where Mrs. Berry is serving her 51 month sentence for wire fraud, mail fraud and filing a false tax return in violation of IRC 7206. In this case the government seeks to obtain 100% of Mrs. Berry’s retirement account and 50% of Mr. Berry’s account. The Berrys make four legal arguments and one equitable argument in an effort to protect their accounts. I will go through the arguments in the order presented by the court. Spoiler alert – none of the arguments work for the Berrys.

Federal Pre-emption

They argue that retirement funds are not community property. The retirement accounts are IRAs. The court finds that because the funds are held in IRAs and not ERISA protected retirement accounts, no pre-emption of state community property laws exists.

State Law

They argue that the retirement accounts are governed by Pennsylvania law because the custodial agreement says that the funds are governed by the law of that state which happens to be the state where Vanguard is located. Mrs. Berry argues that Pennsylvania law (and Texas law if PA law does not apply) waives her rights in the accounts and removes them from community property. She did not sign a specific waiver of her community interest in the property. Because she did not waive her interest in community property, the court finds that the retirement accounts are community property allowing the restitution liens to attach. The court cites United States v. Elashi, 789 F.3d 537, 551 (5th Cir. 2015) in support of its position. Since Mrs. Berry had a ½ interest in Mr. Berry’s solely managed community property, the government can seek to obtain her half interest in that account.

Consumer Credit Protection Act

The Berrys argue that even if the government can reach half of Mr. Berry’s retirement account despite the previous two arguments, its ability to reach Mrs. Berry’s community property interest in Mr. Berry’s property is limited to no more than 25% pursuant to section 30 of the Consumer Credit Protection Act. This Act limits the maximum garnishment to 25% of the earnings for that week. The court finds that the weekly limitation imposed by this act depends on whether Mr. Berry is limited to receiving periodic payments or has the ability to cash out. Because he has the ability to take out the entire amount at any time, the government is not limited in the amount of Mrs. Berry’s interest that it can obtain.

Facially Invalid

The Berrys argue that the writ of garnishment issued in this case overstates the amount due because it includes a future debt to the IRS not currently due. The court finds that the amount listed does not invalidate the writ of garnishment.

Equity for Mr. Berry

The Berrys argue that even if their legal arguments do not prevail it would be a significant strain on Mr. Berry to allow the government to take half of his retirement account. The case does not make clear how his finances would be impacted by the taking of half of this account. Certainly taking half of funds in his IRA limits his future ability to take distributions but what that does to his finances is unclear. Perhaps the court does not go into this type of detail because the court finds this type of equitable argument to be unavailing where the government has the legal right to take the property. It seems that the Berrys were essentially asking for the court to create something akin to the Rodgers factors and apply them to this situation.

I think that something could be made of the Rodgers factors in a case like this if the facts support Mr. Berry’s need for the funds in order to avoid seeking benefits from the state. The equitable portion of the opinion is too short to provide an adequate description of the arguments made by the Berrys or the thought process of the court.

Conclusion

Similar to the result in bankruptcy, holding funds in an IRA provides little more protection from creditors than holding funds in an ordinary bank account. Because the government is collecting pursuant to a restitution order rather than a tax assessment, its ability to use the powerful collection tools of the IRC may be limited but that does not matter here. The court does not discuss whether the restitution order would allow the IRS to assess all of part of the amount in the order. If some or all of the restitution order covered taxes, then it could have gone about collection by first assessing the taxes and then pursuing normal federal tax collection alternatives as discussed here.

 

Designated Orders 12/18/2017 – 12/22/2017: Basis, Discretion to Reject Offers and Restitution Interest

Regular DO guest poster Professor Samantha Galvin of the University of Denver catches us up on some interesting designated orders during a busy pre-holiday week at the Tax Court. Les

The Tax Court issued seventeen designated orders the week ending December 22. Prior to reviewing them closely, I assumed it was a push to get a lot accomplished before the holidays and the end of the year, but nine of the seventeen designated orders (including three consolidated dockets) were issued in light of the Graev decision and many were discussed as part of Keith’s post here.

I discuss three of the eight non-Graev designated orders below. The five remaining orders not discussed involve: 1) a petitioner’s motion for reconsideration relating to a 6621(c) penalty (here and discussed briefly below); 2) a denial of a petitioner’s motion for summary judgment and motion to compel discovery (here); 3) a grant of respondent’s motion for summary judgment in a CDP case where petitioners’ failed to propose a collection alternative (here); 4) a denial of petitioner’s motion for reconsideration on a consolidated docket (here); and 5) a grant of respondent’s motion for summary judgment in a CDP case where a petitioner improperly attempted to raise an underlying liability (here).

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The issues discussed below include an interesting basis computation question when a seller transfers a partial interest in property to a taxpayer that improved the property prior to a subsequent sale to a third party, Appeals’ discretion to reject offers in compromise, and restitution interest abatement and res judicata.

Court Corrects Computations to Basis When There is an Interim Sale of an Interest in Property

Docket No. 021378-03, Stephen M. Gaggero v. C.I.R. (Order here)

It is rare for the Tax Court to grant a petitioner’s motion for reconsideration but it happened, in part, in two different cases two weeks ago. I only discuss this case. The other case involves a section 6621(c) penalty, but the motion is granted only to change certain phrases in the original opinion to reflect the Court’s intended meaning.

To be successful with a motion for reconsideration a petitioner must show that the Court made more than a harmless error pursuant to Rule 160. In this case the error in the original opinion, according to the Court, was a failure to understand that the sale of a share of property to a construction company in exchange for the construction company’s improvements made to the property should have been reflected in petitioner’s adjusted basis when he and the construction company jointly sold the property to a third party in a subsequent transaction. In essence the petitioner sought to add the FMV of the services he received from the constriction company to the basis for purposes of both the initial transfer of a partial interest to the construction company and on the subsequent third party sale.

This error could have been corrected using Rule 155 computations, but the parties cannot agree on the correct numbers. Pursuant to Rule 155(b) if the parties cannot agree, the Court has the discretion to grant them an opportunity to present arguments about the amounts so that the Court can determine the correct amount and enter its decision accordingly.

In this designated order, the Court looks to the closest analogous case which is Hall v. Commissioner, 65 T.C.M. 2575 (1993). In Hall it was held that, “the value of the carpenter’s services did not increase the sellers’ basis in the property for the sale to the carpenter but would increase the basis in the remaining share of the property on any later sale to a third party.” The parties cannot agree about the way the rule in Hall should apply to petitioner’s case. Petitioner argues that the portion of the property exchanged for the construction company’s services should increase his basis on both the partial sale to the construction company and the joint sale to the third party; whereas Respondent argues that the increase in basis should only apply on the joint sale to the third party.

The Court finds that respondent’s application of Hall is correct and the amount determined in the original opinion is not correct. The Court proceeds to go through a calculation using what it has now determined to be the correct amount.

The other findings and holdings from the original opinion are unchanged but require another attempt at Rule 155 computations, however, with the Hall-related dispute laid to rest hopefully the parties will agree going forward.

Offers and IRS Discretion

Docket No. 25587-15SL, Randolph and Jennifer Jennings v. C.I.R. (Order here)

In this designated order the Court is ruling on cross-motions for summary judgment. The case originates from a notice of determination issued after a timely requested CDP hearing on a proposed levy. Petitioners indicated that they wished to submit offer in compromise in their CDP request, but submitted the offer prior to the IRS acknowledging the CDP request and prior to the hearing. The settlement officer learned that the offer had already been submitted and waited for a decision from the offer unit before evaluating the proposed collection alternative.

The offer unit determined petitioners’ reasonable collection potential was higher than the amount of their offer, in part due to the cash surrender value of a life insurance policy. Following the offer unit’s reasoning, the settlement office also rejected the OIC but first allowed petitioners to increase the amount of their offer which would have required them to surrender the life insurance policy. Petitioners were not willing to surrender the policy, so the settlement officer issued a notice of determination sustaining the proposed levy.

Petitioners argue the settlement officer abused her discretion by not considering their poor health and limited employment opportunities, but the Court finds the offer unit considered these things. Petitioners did not propose a different collection alternative other than the offer.

The Court denies petitioners’ motion for summary judgment and grants respondent’s motion. The Court highlights the fact that accepting or rejecting an offer is within the IRS’s discretion and the Court does not interfere with that discretion unless it finds the decision is arbitrary. In this case it is not arbitrary for the IRS to sustain the levy because petitioners’ offer was rejected, petitioners refused to increase the offer amount, and they did not propose any other collection alternatives.

Restitution Res Judicata

Docket No. 12358-16, Debra J. Ray v. C.I.R. (Order here)

This case involves petitioner’s arguments that the IRS improperly assessed interest on her District Court ordered restitution and that the restitution had already been paid in full. Both parties have moved for summary judgment.

Petitioner was ordered by the District Court to make restitution payments after being convicted of criminal tax fraud for filing a false tax return. In that case, the District Court agreed to waive interest and applied a $250 credit toward the restitution. A few months after the District Court decision was made, petitioner paid the restitution in full and the U.S. Attorney filed a satisfaction of judgment with the District Court.

Then several things happened around the same time, the IRS: assessed liability for tax year 2000, assessed restitution and interest finding that petitioner had not fully paid the restitution, and applied her restitution payment toward the tax year 2000 liability.

The IRS issued a Notice of Tax Lien Filing on the restitution amount and interest. Petitioner timely requested a CDP hearing.

Petitioner claimed she had paid restitution in full. After clearing up confusion about whether the lien was filed on the restitution or liability amount, but instead of looking into underlying issue, the settlement officer agreed to withdraw the lien and placed petitioner’s account into currently not collectable status. The interest on the restitution was not abated and petitioner’s claim that she did not owe restitution was not considered.

Petitioner then appealed the CDP determination. The appeals officer examined petitioner’s case and determined that interest abatement was not appropriate since there were not any substantial ministerial or managerial acts that would warrant an abatement of interest. The appeals officer also determined that petitioner still owed $250 of restitution.

As for the interest component, the Tax Court had decided a similar issue in Klein v. Commissioner, 149 T.C. No. 15 (2017); Les discussed Klein in a post here, where he noted that Klein was an important case and one of first impression. The Klein opinion came out after the petitioner filed her petition but before her trial date. In Klein, after a thorough analysis, the Court held it did not have the ability to charge interest on restitution payments under section 6601. As a result of Klein, respondent concedes that petitioner should not be liable for interest on the restitution amount, but whether she still owes any restitution is at issue.

Since petitioner did not have an opportunity to raise the underlying restitution liability previously, the Tax Court’s review is de novo. The Court looks to the doctrine of res judicata which requires that: 1) the parties in the current action must be the same or in privity with the parties of a previous action; 2) the claims in the current action must be in substance the same as the claims in the previous action; and 3) the earlier action must have resulted in a final judgment on the merits.

The Court finds the requirements are met: 1) the parties are the same as both cases involve the petitioner and the government (albeit different agents of the government); 2) the claims in substance both involve whether petitioner paid the restitution required by the judgment; and 3) the satisfaction of judgment filed by the District Attorney is a final judgment which binds the IRS and extinguishes the IRS’s right to collect any additional restitution.

 

As a result, the Court grants petitioner’s motion for summary judgment and respondent is ordered to abate the restitution assessment and corresponding interest.

As If: Tax Court Holds that Restitution Assessment Does Not Attract Late Payment Penalties or Interest

This week in Klein v Commissioner the Tax Court in a division opinion held that assessments of restitution do not generate underpayment interest or late payment penalties. This is an important holding and a case of first impression.

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Section 6201(a)(4) gives the Service to power to assess restitution “in the same manner as if such amount were such tax.” Following a restitution assessment, Internal Revenue Manual provisions and Service policy has been to impose underpayment interest and late payment penalties on amounts that are unpaid similar to other unpaid tax.

To the facts at hand. In Klein, after some delay, the taxpayer fully paid the restitution, as well as interest that accrued pursuant to the statute in Title 18 that allowed for restitution. The taxpayer did not pay the separate Title 26 interest and late payment penalties that the Service imposed and assessed.

The IRS commenced administrative collection with respect to the unpaid interest and penalties. In a CDP proceeding the taxpayer challenged the Service’s right to impose underpayment interest and civil penalties, having claimed that it fully paid what was due.

The taxpayer had to clear the hurdle that she could challenge the Service’s imposition of penalties and interest in the CDP proceeding. The Court found that it was possible, noting that in a CDP proceeding, “underlying tax liability refers to the assessed liabilities that the IRS is seeking to collect via the challenged lien or levy.”

The opinion then considered the Service’s interest and penalty procedures in place for restitution assessments under the Internal Revenue Manual. The Tax Court held that the statutory language that gives IRS the power to assess restitution “as if” it were a tax does not transform the assessed restitution into a tax for purposes of the penalty and interest provisions. In doing so, the opinion discusses how the statute is drafted in the subjunctive mood.

For those who may have forgotten their Latin, the opinion explains what that means:

This clause is drafted in the subjunctive mood. Clauses of this type are commonly used to express a counterfactual hypothesis. See, e.g., Andrea A. Lunsford, The St. Martin’s Handbook 633 (5th ed. 2003) (describing the subjunctive mood as expressing “a wish, suggestion, requirement, or a condi- tion contrary to fact”). For example, assume a statute providing that certain per- sons (green card holders, perhaps) shall be treated “in the same manner as if they were citizens.” In such a statute, Congress would necessarily presume that such persons were not in fact citizens, providing merely that they should be accorded the treatment which citizens receive.

So as Alicia Silverstone in Clueless can attest, “as if” is an important phrase. As the opinion explains, the “as if” in the statute provides “the counterfactual hypothesis that restitution is a tax for the limited purpose of enabling the IRS to assess that amount, thus creating an account receivable on the taxpayer’s transcript against which the restitution payment can be credited.” It is treated like a tax but is not a tax.

In addition to parsing the statute, the opinion notes that the criminal concepts of tax loss and restitution do not neatly equate with the concepts of civil tax liability. In 2010 when Congress gave the IRS the power to assess (and collect) restitution it did not alter the fundamental distinction between the separate criminal and civil concepts.

To be sure, if the Service gets around to a civil examination, it can potentially generate an assessment that would be based on deficiency procedures. (for readers who would like more background on the interplay of the deficiency assessment procedures and the relatively new restitution assessment procedures see Keith’s post from this past spring discussing the issue here). If the Service were to conduct a civil examination and the amount assessed under deficiency procedures is both unpaid and exceeds what has previously been collected, it will be possible for Title 26 interest and civil penalties to start running.

 

The Interplay of Restitution and Deficiency Assessments

As we have discussed before here, here and here, in 2010 Congress amended 6201(a)(4) to permit the IRS to make an immediate assessment based on an order of restitution in a criminal case.  In Rozin v. Commissioner, T.C. Memo 2017-52 the Tax Court continues to instruct taxpayers on the interplay between restitution assessments and deficiency assessments.  The opinion comes close to being an advisory opinion because very little separated the position of the IRS and the petitioner; however, the opinion brings clarity to the role of restitution assessments and payments.

In 2008 Mr. Rozin was convicted of two tax crimes and conspiracy with respect to his 1998 return.  On October 29, 2010, he sent the IRS a payment of $387,687 based on the tax loss from his criminal actions as calculated by the U.S. Probation Department.  On February 4, 2011, the federal district court entered an order of restitution in the amount of $775,294 and in July of 2011, he essentially paid the balance of the liability.  His conviction was affirmed by the 6th Circuit in 2012.  I do not know if anyone has studied the impact of the change in the law in 2010 on the amount the IRS collects following criminal convictions but I expect the impact is significant.  The full payment in this case of such a large amount may not be solely or even partially attributable to the law change but signifies a good trend in criminal tax cases for the IRS and particularly its collection division.  Because the IRS delays traditional assessment and collection until after it has finished with the criminal aspect of the case, many criminally convicted taxpayers have few resources left with which to satisfy the civil liability once the criminal case comes to an end.  The revenue agents usually get a relatively simple case because the special agents provide a clear roadmap to the needed adjustments but the revenue officers often ended up with an uncollectible account that sat in their inventory gathering dust.

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The Tax Court case is about whether there should be a Tax Court case.  Mr. Rozin paid the tax.  The IRS assessed the tax.  He objects to the deficiency determined by the IRS a few years after he thought he had taken care of the tax problem.  After he thinks he has paid everything, here comes the IRS examiner wanting to reopen the wound and go back over his 1998 tax year fifteen years after the end of the tax year at issue.  Essentially, Mr. Rozin argues that the restitution assessment and his payment should have ended the matter and the IRS should not get to assess the taxes again.  He agrees with the IRS that he underreported $392,083 in tax on his 1998 return and that because he did so fraudulently the 75% penalty of 6663 applies in the amount of $294,062.

The IRS argues that the new statute allowing it to immediately assess the restitution amount does not allow it to credit Mr. Rozin’s account until the deficiency and fraud penalty are assessed.  It cites to IRC 6201(a)(4); 6213(a) and (b)(5) and to Schwartz v. Commissioner, T.C. Memo 2016-144.  The IRS makes clear that once it assesses the tax through the deficiency procedures that it will apply the payment he made during the restitution process.  So, Mr. Rozin knows from the outset of this case that the deficiency assessment will add nothing to the liability created by the restitution order with the possible exception of interest.

 

The Court carefully explains the difference between the restitution assessment and the proposed deficiency assessment.  It states that:

“A deficiency must first exist before restitution remittances for taxes owed can be applied to reduce that deficiency.  In other words, the restitution assessment, which is assessed ‘as if’ it were a tax, cannot offset a tax assessment until a tax assessment of the deficiency has been made.  The amount of a deficiency turns not on what payments have been applied to an account, but rather on what assessments have been made with respect to that account.”

Mr. Rozin argues that the IRS made a mistake in calculating his liability in the notice of deficiency because it did not give him credit for the payments he made.  The Court points out that the IRS should not give credit for these payments in the notice of deficiency, not because he will not ultimately get credit for them, but because these amounts were not “shown as tax” on his 1998 and the IRS has not made an additional civil tax assessments on that period.  Even though the IRS did previously assess based on the restitution order, the previous assessment was a summary assessment and not a deficiency assessment.  The restitution assessment does not create a final determination of civil liability.

“Thus, petitioner’s restitution payments are not included as ‘amounts previously assessed… as a deficiency,’ and respondent was not permitted to reduce his determination by those payments under 6211(a)(1)(B)….  Because restitution does not fit within the definition of a deficiency under section 6211, restitution payments made do not reduce or discharge a deficiency determination before the deficiency is assessed.”

The Court points out that by refusing to sign the waiver on assessment the IRS sought to have him sign in lieu of sending the notice of deficiency, Mr. Rozin prevented the IRS from doing the very thing he wants it to do.  Yet, by bringing the suit Mr. Rozin allowed the Court to provide us with a further explanation of how the restitution assessment and the deficiency assess work together.  If you have to lose a Tax Court case it is better to lose one in which the Court tells you that its decision to allow the IRS to assess the amounts in the notice of deficiency will be covered by your previous payment.  This will not happen in every restitution case.  The notice of deficiency could establish a liability far in excess of the restitution payment ordered in the criminal case.  Mr. Rozin’s full payment of the restitution order is also someone out of the norm as many individuals who go through the criminal process lack sufficient resources to make full payment at the conclusion of that process.  From a collection point of view the case demonstrates how the change in the law to allow the IRS to assess the restitution amount works well even if it creates duplication in the assessment process that confused Mr. Rozin.