Limitation on Offset When the Government Seeks to Collect Restitution

The case of United States v. Taylor, No. 2:06-cr-00658 (E.D. PA 2021) brings out a limitation on the right to offset when the Government is collecting on a court-ordered restitution amount.  Here, the Government, specifically the Department of Justice, gets its hand slapped for levying on the social security of a convicted criminal.  The levy here is the 15% on social security that regularly arises with respect to outstanding federal tax obligations.  There is no indication in the opinion that the IRS made a restitution based assessment in this case or any kind of assessment.  This appears to be a case involving the payment of the court ordered restitution payment and not a derivative liability stemming from the restitution order.  The court does not mention the IRS other than in relation to the crime committed by the petitioner.

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Ms. Taylor and others were convicted of conspiracy to defraud the IRS.  The federal district court that sentenced her and then ordered her to pay a restitution judgment of $3.3 million.  The court, however, failed to take into account her financial resources and the Third Circuit vacated the restitution order and remanded the case so that the district court could make an appropriate determination of her ability to pay as well as her culpability.

On remand, the court determined her ability to pay was $100 per year and noted that the government could come back to the court for an increase if her circumstances changed.  This happened in 2012.  Between 2012 and 2019 when Ms. Taylor became eligible for aged-based social security benefits, the government did not return to the court to seek an increase, although it did make a preliminary determination that she could pay $25 a month.

The restitution payments were listed with the Bureau of Fiscal Services as available for offset pursuant to the Treasury Offset Program (TOP) because they were delinquent federal debts.  When the social security payments began, TOP began offsetting 15% of her social security (about $235 a month) and applied the funds taken from her monthly social security check to her outstanding restitution obligation.  She continued to comply with the court order to pay $100 a year.

When Ms. Taylor initially brought the action complaining of the TOP offset, she did so pro se.  The district court appointed Peter Hardy, one of the top white collar criminal defense attorneys in Philadelphia who also taught as an adjunct professor at Villanova when I was there and has guest posted for us in the past (for example, see this terrific post on the crime fraud exception to the attorney client privilege).  Undoubtedly, Ms. Taylor benefited from his appointment.

The court provides some background on the TOP program which we have discussed previously here and here

Ms. Taylor argued that she was in compliance with the restitution order, making the TOP offset inappropriate.  She also argued that her restitution debt was not delinquent, meaning it was not one the government should refer to TOP.  The Government argued that the referral to TOP was appropriate because she had a large outstanding debt.  The court finds that the debt is not delinquent:

“[U]nlike a civil judgment, the restitution order is the product of a ‘specific and detailed [statutory] scheme addressing the issuance . . . of restitution orders arising out of criminal prosecutions.’” Id. at 1204 (quoting United States v. Wyss, 744 F.3d 1214, 1217 (10th Cir. 2014)). Section 3572(d) states that “[a] person sentenced to pay a fine or other monetary penalty, including restitution, shall make such payment immediately, unless, in the interest of justice, the court provides for payment on a date certain or in installments.” 18 U.S.C. § 3572(d)(1). This subsection provides that the full payment of restitution is not due immediately if a court establishes a payment plan for restitution. See Martinez, 812 F.3d at 1205. Thus, “a defendant subject to an installment-based restitution order need only make payments at the intervals and in the amounts specified by the order.” Id. Section 3572 also explicitly defines when a payment of restitution is delinquent or in default. See 18 U.S.C. § 3572(h)-(i). A “payment of restitution is delinquent if a payment is more than 30 days late.” Id. § 3572(h). A “payment of restitution is in default if a payment is delinquent for more than 90 days. Notwithstanding any installment schedule, when a fine or payment of restitution is in default, the entire amount of the fine or restitution is due within 30 days after notification of the default.” Id. § 3572(i). These provisions “would be unnecessary, even meaningless, if the total restitution amount were already owed in full under an installment-based restitution order.” Martinez, 812 F.3d at 1205. It is evident from the structure and language of § 3572 that under an installment-based restitution order, the restitution debt only becomes delinquent when a defendant’s installment payment is more than 30 days late.

The court tells the government that if it wants more from Ms. Taylor it needs to come back to the court and request more.  It cannot simply offset at a time when she has continued to comply with the court’s order.  The court orders the government to stop the offset and to return to her all the money taken through TOP.  Perhaps the government will come looking for her and seek to raise the amount she must pay from $100 a year to a larger number.  Because she became unemployed as a result of the pandemic, this might prove difficult.

It’s unclear if the conspiracy to defraud the IRS could turn into a tax assessment.  If the IRS made a tax assessment of the liability or some part of the liability, it could collect on the tax liability independent of the restitution order and through a tax assessment could potentially levy on her social security.  Ms. Taylor, as part of her defense to the taking of the social security funds, argued that the taking of these funds put her into a difficult financial situation.  If the IRS made a tax assessment, it could not levy, even through TOP, if doing so would create financial hardship as defined by IRC 6343(a)(1)(D).  Convicted tax criminals generally make difficult taxpayers from whom to collect.  Ms. Taylor appears to fit into that category.

TIGTA Report on Restitution

Last week I wrote about a recent Tax Court order regarding restitution.  In that case, the taxpayer fully paid the tax included in the restitution order.  At issue in the case were penalties the IRS proposed against the taxpayers.  I pointed out at the conclusion of that post the significant benefit to the IRS of the ability to assess based on the restitution order because without that ability the IRS might have needed to wait years, until the conclusion of the Tax Court case, before it could assess and begin collection on the underlying tax liability.

A TIGTA report issued on June 7, 2021 suggests that the IRS fumbles the opportunity to make restitution based assessments in a number of criminal cases and that it makes the assessments much slower than the target dates for doing so.  In its response to the TIGTA report, the IRS basically said it agreed with the TIGTA findings and would work to improve the process.  In addition to the findings that the IRS failed to make some restitution assessments and made other assessments much slower than expected, TIGTA also found that the IRS was making assessments of interest and penalties through the restitution assessment process even though it should not.  In short, the report shows the IRS fumbling a very advantageous assessment process Congress handed to it in 2010.

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At the outset TIGTA gave some figures on the total amount of restitution ordered and collected.  It also noted that not every restitution order gives the IRS the right to assess:

From FYs 2016 to 2020, the courts ordered defendants to pay over $2.7 billion in criminal restitution to the IRS. During that same period, a total of $844 million in restitution was paid to the IRS, only 31 percent of the amount ordered. Figure 2 lists the amounts of restitution ordered and paid from FYs 2016 to 2020.

Figure 2: Amount of Restitution Ordered and Paid (FYs 2016–2020)
Fiscal YearsRestitution OrderedRestitution Paid18% of Restitution Paid
2016$603,400,000$322,903,34554%
2017$808,400,000$98,561,94912%
2018$444,800,000$149,900,66134%
2019$536,800,000$121,591,60123%
2020$328,800,000$151,436,04346%
Total$2,722,200,000$844,393,59831%
Source: Information Provided by CI and the SB/SE Division.

The low percentage of restitution paid to the IRS in recent years may not be indicative of the effectiveness of the law change providing for the assessment of restitution. As we previously described, the IRS only has the authority to assess the restitution ordered by the courts if the criminal offense was for a tax-related crime. Since the law change in Calendar Year (CY) 2010, CI devoted significant resources investigating cases for which the IRS did not have the authority to assess any restitution ordered. For instance, the IRS was unable to assess any restitution ordered if defendants were sentenced for crimes involving identity theft because the restitution is attributable to fictitious tax returns. During FYs 2013 through 2017, CI initiated over 4,000 investigations involving identity theft.

TIGTA then analyzed the cases in which the IRS made a restitution based assessment and those where it did not.  It found that the IRS collected almost 50% of the tax when it made a restitution based assessment and a very low percentage when it did not (or could not) make a restitution based assessment.  Based on this data, it seems that the IRS should seek even more expanded authority to make restitution based assessments, assuming it could show Congress that it would appropriately use the power granted to it.  Following the passage of the law allowing restitution based assessments, the IRS developed procedures for identifying the appropriate cases and processing the request for assessment from CI to SBSE.  As mentioned above, the IRS has done a weak job of following the procedures it established:

According to the IRM, CI is required to close its case and notify the civil functions of the amount of restitution ordered no later than 30 calendar days after final adjudication by a court. CI notifies the applicable functions within the SB/SE and W&I Divisions of the amount of restitution ordered by completing Form 13308, Criminal Investigation Closing Report, and Form 14104, Notification of Court Ordered Criminal Restitution Payable to the IRS, (hereafter we will refer to these as “closing documents”) and attaching the Judgment and Commitment Order (J&C). The closing documents sent to the civil functions can also include the plea agreement, indictment, and Special Agent Report.

We conducted testing to determine if the IRS properly assessed restitution when the courts sentenced and ordered 3,435 defendants to pay just over $2.5 billion in restitution to the IRS for tax-related crimes during FYs 2016 through 2019. Our analysis of CIMIS revealed that 418 of the 3,435 cases for which a total of $244 million in restitution was ordered were SIRF cases with no IRS conditions of probation or supervised release. The restitution ordered in these types of cases was not assessable. We compared the remaining 3,017 cases, for which restitution of nearly $2.3 billion was ordered, to Master File data obtained from the DCW. Our testing determined that the IRS made restitution assessments in 1,958 cases where defendants were ordered to pay nearly $1.3 billion in restitution. This left 1,059 cases for which the defendants were ordered to pay nearly $1 billion in restitution that was not assessed. Figure 4 presents the results of this testing to determine if restitution was assessed.

Figure 4: Analysis to Determine If the IRS Assessed Restitution
Restitution Assessment CategoryNumber of DefendantsTotal Restitution Ordered
Restitution Assessed1,958$1,295,060,577
SIRF418$244,134,937
Not Assessed1,059$979,749,303
Total3,435$2,518,944,817
Source: Analysis of CIMIS and Individual Master File data.

We selected a statistical sample of 140 of the 1,059 unassessed restitution cases and reviewed the associated Form 14104 to determine if CI indicated that the restitution was assessable. Our analysis identified 33 cases for which CI determined that restitution of more than $21.6 million was assessable. For the other 107 cases, among the more prevalent reasons the IRS did not assess the restitution was that CI determined that the restitution was not assessable (94 cases) or the case was currently under appeal (seven cases). We provided information for 33 cases to the SB/SE Division, and it responded that:

– In 19 cases, the restitution of just over $9 million was not assessed because the Technical Services Unit indicated that it did not receive the closing documents from CI. In 12 instances, CI acknowledged that the closing documents were never sent or were not sent timely. In seven instances, CI asserted that the documents were sent. The Technical Services Unit had to request the pertinent information from CI.

– In seven cases, restitution assessments of more than $10.2 million were delayed because of COVID-19. The Technical Services Unit eventually assessed the restitution in all seven cases by December 2020.

– In seven cases, restitution of almost $2.4 million was not assessable. This included * * * 1* * * for which the restitution was ordered solely as a condition of supervised release or probation. In these instances, the Technical Services Unit indicated that it would assess the restitution when the defendant is released from prison.

When we projected the results to the population, we estimate that restitution of $69 million was not assessed in 144 cases because CI did not send the closing documents or the documents could not be located. When forecast over five years, we estimate that a total of $345 million in restitution was not assessed in 720 cases.

By failing to follow its own procedures in CI in making the referral of the case for the restitution based assessment, the IRS appears to be leaving money on the table from individuals it has identified as tax cheats.  These individuals are likely to pay the tax if it keeps them from further time in prison but could become very difficult to pursue thereafter.  Fumbling the handoff from CI back to SBSE for assessment and collection seems most unfortunate after it has spent so many hours developing the criminal case and when the percentage of collection of restitution based assessments is relatively high.

In cases where CI made the handoff to SBSE, problems persisted because SBSE could not make the assessment in a timely fashion.  Speed can matter here because the assets of this group will diminish quickly.

Once CI prepared the closing documents, it took the Technical Services Unit an average of 198 calendar days to assess the restitution. Technical Services Unit personnel told us they face barriers in their efforts to timely assess restitution, including receiving incomplete or late packages from CI and the process of posting the actual assessments, which must pass through other Campus functions to be established. They indicated that they established a process to track restitution assessments to evaluate timeliness, but they agreed with the need to conduct periodic reviews. Figure 5 contains a breakdown of the number of days it took to assess the restitution.

Figure 5: Analysis of Days to Assess Restitution for the 68 Sample Cases
Restitution Assessment CategoryExpected Days to Complete51Average Days to Complete
From the Date of Final Adjudication by a Court Until the Date CI Forwarded the Closing Package to the Technical Services Unit3057
From the Date CI Forwarded the Closing Package Until the Date the Technical Services Unit Assessed Restitution75198
Total Days From the Date the Court Filed the J&C Until the Date the Technical Services Unit Assessed Restitution105255
   

In addition to these problems, TIGTA found that the IRS was not following the Tax Court decision in Klein v. Commissioner, 149 T.C. No. 15 (2017), which held that the IRS may not assess and collect interest and penalties on restitution ordered for a criminal conviction for failure to pay tax.  TIGTA notes the IRS actions after Klein provide another example of the IRS not protecting taxpayer rights reminiscent of its actions after losing the Rand case.  Rather than proactively abating the interest and penalty it knew was wrong, Chief Counsel’s office advised the IRS to wait and only make the abatement if a taxpayer brought up the issue. Despite this advice, the IRS did decide to identify and abate interest and penalties but so far has done so in only 31 of 676 cases TIGTA identified.  So, if you have a client in this situation, you may need to be proactive to get the penalty removed.

The final part of the report shows that the IRS was not following up on taxpayers meeting the conditions of probation and reporting violations to the probation officer.  This type of monitoring can be critical to success in collection.  From the description it appears that the handoff between CI and SBSE creates some of this problem.  While TIGTA did not make a formal recommendation on this point because it knows that IRS resources are strained, it stated:

The inability to properly monitor the conditions of probation or supervised release could be a contributing factor for why U.S. courts rarely revoked the probation or supervised release for defendants sentenced for tax-related crimes. The courts revoked probation in only 12 of the over 9,000 CI criminal investigations for which a defendant was sentenced for tax-related crimes during FYs 2016 through 2019. Courts will generally not revoke probation unless the failure to comply was willful. Because this can be hard to prove, this remedy is not widely invoked. One Special Agent in Charge we contacted also indicated that the resources of the USAOs are also limited, and * * * 1 * * *.

All in all, the report provides a picture of a program with much promise that is not meeting its potential.  The IRS has had a decade to work out these issues.  It can see from the percentage of dollars collected in cases in which a proper restitution based assessment occurs that the benefits of making this type of assessment are high.  It needs to find a way to reap the maximum benefits from this program and obtain money from the individuals it has determined represent the worst taxpayers.

Imposing Penalties After Restitution Assessment

The recent case of Ervin v. Commissioner, T.C. Memo 2021-75 affirms the ability of the IRS to impose penalties after it makes a restitution assessment.  This case does not create precedent or cover new ground but does provide a reminder of how the restitution based assessments work.  We have previously written about restitution based assessments most of which are collected in this post.  TIGTA issued a report on restitution based assessments earlier this month which I plan to discuss in a future post.

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Mr. Ervin and his wife owned a real estate management company in Alabama and apparently received cash payments for many of the properties.  They were indicted in 2011 not only on tax evasion, IRC 7201, but also on title 18 charges of conspiracy to defraud the United States and aiding and abetting.  The conspiracy charge appears to stem from their efforts to avoid reporting of cash deposits by structuring the deposits to keep them under $10,000.  A jury convicted them on most counts, including tax evasion, for the years 2004-2006. 

A couple of things are a little unusual about their criminal case.  First, they were convicted of evasion even though they did not file tax returns from 2000-2009.  Proving evasion based on non-filing can be difficult.  No doubt the structuring aspect of the case was crucial to this proof.  The second thing I found a bit unusual was the ten-year length of their sentence.  As we discussed in the post describing the sentence of former Tax Court Judge Kroupa, sentencing in tax cases primarily turns on the dollars lost to the government.  Here, the IRS could calculate the loss not only over the years of the conviction but the other years of non-filing causing a total of over $1.4 million.  Because they went to trial, the Ervins would not have received any positive points in the sentencing calculation for acceptance of responsibility.  This is a substantial sentence for a financial crime of this type but not necessarily an inappropriate sentence under the guidelines or otherwise.

In addition to the sentence of time in prison, the court ordered restitution to the government of $1,436,508 for the estimated tax loss to the government for the ten years of unfiled returns.  The IRS made restitution based assessments and actually collected the full amount of the liability; however, it did not stop there.  In 2014, it sent petitioner Monty Ervin two notices of deficiency – one for 2002-2004 and one for 2005-2007.  These notices were based on penalties, additions to tax, the IRS felt he owed for these tax years.  The IRS imposed four separate penalties, though not for each period.  The penalties were for failure to file, failure to pay, failure to pay estimated tax and fraudulent failure to file.  The penalties total another several hundred thousand dollars.

From prison Mr. Ervin contested the imposition of the penalties, making two arguments: 1) the IRS could not impose penalties after making the restitution based assessments and 2) the IRS had already determined he could not pay so it should not impose the penalties and make assessments in this situation. 

The Court provided a brief overview of the applicable law which foretells the outcome of the case:

Section 6201(a)(4)(A) provides that “[t]he Secretary shall assess and collect the amount of restitution * * * [ordered by a sentencing court] for failure to pay any tax imposed under this title in the same manner as if such amount were such tax.” The IRS may not make such an assessment until the defendant has exhausted all appeals and the restitution order has become final. See sec. 6201(a)(4)(B). The restrictions on assessment imposed by section 6213 do not apply to restitution-based assessments. See sec. 6213(b)(5). The IRS therefore is not required to send the taxpayer a notice of deficiency before making an assessment of this kind.

[*9] In Klein v. Commissioner, 149 T.C. 341, 362 (2017), we held that “additions to tax do not arise on amounts assessed under section 6201(a)(4).” That is because a defendant’s restitution obligation “is not a civil tax liability,” id. at 361, or a “tax required to be shown on a return,” ibid. (quoting section 6651(a)(3)). Rather, restitution is assessed “in the same manner as if such amount were such tax.” Sec. 6201(a)(4)(A) (emphasis added). But we explained that the IRS was not thereby disabled from collecting such sums. “If the IRS wishes to collect * * * additions to tax, it is free to commence a civil examination of * * * [the taxpayer’s] returns at any time.” Klein, 149 T.C. at 362.

The IRS properly followed that procedure here. It made the assessment after the restitution order became final. It subsequently commenced a civil examination of petitioner’s individual liabilities for 2002-2007 and prepared SFRs, allocating him a portion of the relevant income and deductions. See supra ap. 4-5. It then calculated additions to tax based on the deficiencies so determined.

While the Court’s explanation of the law signals the ability of the IRS to follow a restitution based assessment with proposed penalty assessments, the Court analyzed each proposed penalty to determine if the imposition of the penalty appropriately matched the facts of the case.  After finding that the IRS appropriately applied the penalties, the Court granted summary judgment.

Petitioner may never pay this amount, as collection from someone coming off of 10 years of incarceration will be extremely difficult, but the legal principle here follows from prior determinations of the manner in which restitution based assessments work.  The design seeks to allow the IRS to make an assessment of the core amount of the tax determined in the criminal proceeding without having to wait many years for the end of the tax merits process to come to a conclusion.  The way this case played out demonstrates the benefit to the IRS of the restitution based assessment.  The criminal case essentially ended with the sentencing in June of 2012.  Now it is nine years later before the Tax Court case ends.  Prior to the restitution based assessment provisions, the IRS would have had to sit on its hands regarding collection until the end of the Tax Court case which would have allowed it to assess.  By making the restitution based assessment shortly after the end of the criminal case, the IRS stands a much better chance of collecting, and here it appears to have collected all of the tax.  The delay caused by the deficiency process and six years in the Tax Court may make its chances to collect the penalty portion of the case difficult, but the core of the liability in this case was recovered.  That’s a victory for the process.

Restitution Based Assessments

We note that the Practical Tax Lawyer (“PTL”) is looking for authors.  PTL gives the general practice and small firm lawyer short, practical “how-to” or “intro to” sorts of articles on tax.  PTL especially welcome articles that help practitioners think about how to deal with recent changes in the law, regulations, or IRS litigating position that might affect a tax practice.  So any articles on navigating the various COVID issues would be terrific!  The articles might be on procedural issues dealing with the COVID-impaired IRS, such as filing, amending returns, dealing with multiple tax years or strange notices.  Or articles could be on substantive COVID provisions like the PPP loans, EIP payments, etc.  PTL articles tend to be short (1,800 to 5,000 words) but longer articles are welcome too.  This is a great opportunity for anyone who wants to dip their toes into writing, or perhaps expand a blog post into a short article that would reach a broader audience that loyal PT readers.  If interested, contact Bryan Camp at bryan.camp@ttu.edu who will then connect you to the PTL editor, Dara Lovitz.  There’s no money in it, unfortunately.  Just pride of authorship, and creation of reputation. 

We have written about restitution based assessments before on several occasions some of which are found, here, here and here.  Tax Notes recently published a series of internal Chief Counsel email advisory opinions on these assessments that collectively are worth mention.  The emails focus on a case, United States v. Westbrooks, 858 F.3d 317 (5th Cir. 2017) which we have not previously blogged.  I will spend some time on the case and then on the emails addressing issues raised by Westbrooks.

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Tammy Westbrooks had two tax preparation businesses, one in North Carolina and one in Texas.  She was indicted for overstating expenses of the businesses and convicted of corruptly endeavoring to obstruct the administration of the tax code in violation of IRC 7212(a) as well as three counts of filing false tax returns in violation of IRC 7206(1).  Upon conviction the court imposed a sentence of 40 months and it also ordered her to pay $273,460 in restitution to the IRS in quarterly installments of $25 or half of prison earnings, whichever is greater, while incarcerated, and in the monthly amount of $400 or ten percent of gross earnings, whichever is greater, during the year of supervised release that would follow her prison term.

She appealed the conviction on the obstruction count and the restitution order.  The Fifth Circuit upheld the conviction but modified the restitution order.  Most of the opinion concerns her arguments regarding the appropriateness of the conviction on obstruction, but I will only discuss the restitution aspect of the opinion.  With respect to the restitution order she argued:

the district court’s order of restitution was not authorized because: (1) the court imposed restitution as part of her sentence under a general restitution statute, which is not permitted for Title 26 offenses; and (2) even if the court imposed restitution as a condition of supervised release, which is permitted for Title 26 offenses, it was not authorized to do so because she did not agree to restitution in a plea bargain.

The Fifth Circuit found that 

Neither the Victim and Witness Protection Act, 18 U.S.C. § 3663, nor the Mandatory Victim Restitution Act, 18 U.S.C. § 3663A, allow restitution for a tax code offense under Title 26 (as opposed to offenses described in the general criminal code of Title 18). But several statutes, read together, allow district courts to order restitution for tax offenses as a condition of supervised release….  Courts’ broad authority to order restitution as a condition of supervised release in tax cases is recognized in the Sentencing Guidelines and generally in the federal courts. See U.S.S.G. § 5E1.1(a)(2) ; United States v. Batson, 608 F.3d 630, 635 (9th Cir. 2010)

The court concluded that the judgment wrongly required her to make restitution payments while still in prison.  It decided that the best means of fixing the error was to modify the judgment to only require restitution after her release. She argued that because this was a tax offense, the district court did not have authority to require restitution during supervised release but the Fifth Circuit disagreed.

Next, she argued that the amount of the restitution was too high and the tax loss calculation, which would impact her sentence under the guidelines, was improperly calculated.  The Fifth Circuit noted that restitution is limited to the loss caused by the conviction. It also noted that this issue is one where it reviewed the amount of the restitution order for abuse of discretion, putting a tall barrier to success before her.  The court looked at the trial court record and determined that the amount of the restitution award was not clearly erroneous.  For purposes of this discussion the main takeaway from this restitution issue is the high bar a defendant faces to reduce the decision of the trial court.  The more important restitution issue in the case is the limitation of the time during which the defendant must pay the restitution.

With this background, there was four advisory opinions recently published although issued over the course of the past year.

In CCA_2020090314343344 which was written on September 3, 2020, the advice provided was

The restitution in this case is assessable and is not subject to the Westbrooks limitations on assessment and collection. The judgment lists the restitution as a criminal monetary penalty as well as a condition of supervised release. Normally, where restitution is listed as a criminal monetary penalty, it is imposed as an independent part of the sentence. In addition, the plea agreement provides for the defendant to pay restitution.

In CCA_2020100911062544 which was written on October 9, 2020, the advice provided was

This is not a Westbrooks case. The activity for which the defendant was convicted under Title 18 (* * *) embraces conduct for all of the years for which restitution was ordered, and offense for which the defendant was convicted is described in 18 USC 3663A(c)(1). Restitution was therefore mandatory under the Mandatory Victims Restitution Act and the court thus had the power to impose it as an independent portion of the sentence. The court did so, as shown on p. * * * of the judgment.

In CCA_2020100914392144 which was also written on October 9, 2020, the advice provided was

This is not a Westbrooks case because restitution was imposed as an independent part of the sentence pursuant to a plea agreement. However, the government is only one of the victims of the crime in count * * *. Where there are victims other than the government, the government is only paid after the other victims have been paid. Accordingly, the government cannot collect on the restitution-based assessment until the non-government victims have been paid.

In CCA_2020111810055044 which was written on November 18, 2020, the advice provided was

The IRS is obliged only to assess and collect restitution during the period of supervised release. This is technically not a Westbrooks case because the district court had authority to impose restitution independently. However, the district court did not do so in this case. The judgment describes the restitution imposed solely as a condition of supervised release and not under the portion that describes the rest of the sentence. We also confirmed from the Department of Justice that the government’s understanding was that restitution was imposed solely as a condition of supervised release. Accordingly, for the reasons stated in PMTA 2018-19, the IRS is obliged to only assess and collect restitution during the period of supervised release.

The advisory opinions reflect that the IRS is paying careful attention to the restitution orders and its ability to pursue collection under those orders.  This suggests that if you are representing someone who has been the subject of a restitution based assessment you should also pay careful attention to the restitution order and how the timing of that order works.  As discussed in the prior posts there are limitations on restitution based assessments.  The provision allowing these assessments gives the IRS the opportunity to assess shortly after a criminal conviction or plea eliminating the need for the IRS to go through what could be a very lengthy deficiency assessment process prior to assessment.  The quickness provided by this assessment provides a significant benefit to the IRS and fills a gap in time created by the deficiency assessment process; however, the restitution assessment comes with some limitations on the IRS’s normal collection powers.

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.