Tax Court Holds Whistleblower “Collected Proceeds” Includes Criminal Fines and Civil Forfeitures

The Tax Court had an important holding regarding whistleblower awards on August 3rd in Whistleblower 21276-13W v. Commissioner  (it is really hard to come up with bad puns about the case titles when they don’t include the names), where the whistleblower was successful in arguing, over the IRS’s objections, that criminal fines and civil forfeitures collected by the IRS were included in “collected proceeds” for whistleblower awards.  This is another IRS loss (seems like they lose all these whistleblower cases), and another case where it looks as though the IRS is actively attempting to thwart the program or minimize payments to whistleblowers.  Although I agree the government should not overpay awards, I still get the impression that the IRS has not found the right balance with what to contest in this realm.

In this case, the whistleblower provided information regarding a financial institution*** that eventually pled guilty to conspiring to defraud the IRS, filing false returns, and evading income tax.  As penance for its terrible behavior it paid the IRS $74MM and change (damn!) in tax restitution, criminal fines, and civil forfeitures under 18 USC § 3571.  The financial institution and the Service agreed that the tax restitution was $22MM, the fine was $22M, and the forfeiture was about $16MM (plus another $16MM previously forfeited).

Before getting to the underlying conflict in this case, it should be noted that Mr. and Mrs. Whistleblower already have had a tough go at getting paid.  These folks had already taken at least one stop to the Tax Court in Whistleblower 21276-13W v. Commissioner, 144 TC 290 (2015). We were lucky enough to have Dean Zerbe, the attorney on at least the 2015 case (current case has counsel listed as sealed) and essentially the guru of all that is IRS whistleblower claims, write up that case, which can be found here.  The 2015 case was a major case also, where the Service tried to argue the whistleblowers had failed to provide the evidence leading to the collection of tax (somewhat because they had not filed Form 211 very early on), and highlighted the immense importance of de novo review in these cases, as opposed to the abuse of discretion standard argued by the Service.  I would encourage everyone to review Dean’s prior post (and we’ll reach out and see if he has any comments on this case also).

Back to the August 3rd holding.  All parties agreed the whistleblowers were going to get paid 24%, but they did not agree on what.  The whistleblowers argued it should be 24% of the full recovery, but the Service argued it should only be based on the tax restitution.  That gave the whistleblowers about thirteen million reasons to ask the Court to clarify.


The Law – Don’t Blow the Statutory Interpretation!

Under Section 7623(b), certain whistleblowers are entitled to mandatory awards if certain requirements are met.  That amount can be between 15% and 30% of the “collected proceeds” under (b)(1), which has a parenthetical indicating that is “(including penalties, interest, additions to tax, and additional amounts),” and the sentence further states these amounts can be “resulting from the action (including any related actions) or from any settlement in response to such action.”

As stated above, the Service took the position collected proceeds did not include criminal penalties and civil forfeitures.  The Service based this on the claim that Section 7623 should only apply to proceeds assessed and collected under the federal tax laws found in Title 26 of the United States Code.  As the fines and forfeitures here were imposed under Chapter 18, they could then not be “collected proceeds” subject to the statute; unlike the restitution, which as per 2010 law can be assessed and collected in the same manner as tax.

The Whistleblowers responded, “screw you, we help you bust a tax cheat and this is how you treat us?”  That may be inaccurate, as I did not review the brief.  Their position, as summarized by the Court, was that the statute put no such restrictions on payments, and the total amount was a settlement resulting for actions taken by the IRS based on information provided by the whistleblowers.

The Court found the in favor of the whistleblowers, first, finding the statute was clear on its face; there was no restriction on collected proceeds to amounts assessed and collected under Title 26.  The Court further noted the statute was expansively  written with regard to collected amounts, and the IRS’s narrow reading was improper.  With the assistance of statutory construction, the Court found the term “proceeds” to be a “word of great generality.”  The Court declined to read limiting language into Congress’ broad language.  In addition, the Court stated that “internal revenue laws”, as used in various other places regarding the whistleblower statute, were not limited to those found in Title 26.  It gave various examples of this, and then dropped the hammer indicating “perhaps the most telling instance: The very provisions establishing the Whistleblower Office are found outside [Title 26].”

The Court did also highlight an interesting distinction to a similar prior holding, that facially appeared to hurt the whistleblower’s claim.  From the Tax Court:

Our holding in this matter is not in conflict with our holding in Whistleblower 22716-13W v. Commissioner, 146 T.C. __, wherein the Court examined the $2 million threshold requirement of section 7623(b)(5)(B). Section 7623(b)(5)(B) provides that for a whistleblower to qualify for the mandatory whistleblower award, “the tax, penalties, interest, additions to tax, and additional amounts in dispute [must] exceed $2,000,000.” … In arguing his case before us, the whistleblower asserted that FBAR penalties constituted an “additional amount” as used in section 7623(b)(5)(B).

We rejected the whistleblower’s assertion. In interpreting what constitutes “additional amounts” we held that the phrase “additional amounts” as it appears in the series in section 7623(b)(5)(B), i.e., “tax, penalties, interest, additions to tax, and additional amounts”, was a term of art. We noted that the phrase “additional amounts” when used in a series that also includes “tax” and either “additions to tax” or “additions to the tax” appeared nearly 40 times in title 26, and when the words were tied together, as they are in section 7623(b)(5)(B), they had a specific technical meaning. We stated we repeatedly have held that the phrase “additional amounts”, which the whistleblower sought to extend to FBAR penalties, “is a term of art that refers exclusively to the civil penalties enumerated in chapter 68, subchapter A” of title 26 which are assessed, collected, and paid in the same manner as taxes.

In reaching our holding, we determined that the wording in the threshold requirement of section 7623(b)(5)(B) (”if the tax, penalties, interest, additions to tax, and additional amounts in dispute exceed $2,000,000”) is different from that of section 7623(b)(1), which provides for an award of a percentage of the collected proceeds (”including penalties, interest, additions to tax, and additional amounts”).

A couple of parting thoughts. This is a major  win for whistleblowers, and it will be interesting to see if there is an appeal.  On a policy basis, I think this is the right decision.  I think a different decision could possibly result in bad outcomes, but I have not researched what I am about to bloviate on.  It does not seem inconceivable that the taxpayer, or other prosecuted party, and the government could negotiate the allocation of these amounts in a way that would detriment the whistleblower, who would not be involved in the negotiations.    And, the tax may not be the first item recouped by the Service, which could harm the whistleblower.  I should note, Jack Townsend beat us to the punch, and already published a write up of this case, which can be found here.  As always, a good summary, and a good conclusion, relating to the distinction raised by the Court above to the prior case relating to FBAR collections.  Jack states, “it would seem that, in light of this holding, the Tax Court is poised to hold that FBAR penalty collections would clearly be collected proceeds.”

Les also noted that Treasury regulations promulgated in 2014 limit the definition of collected proceeds to “amounts collected under the provisions of title 26, United States Code.” The regulations did not apply in this case, though unless the IRS and Treasury throw in the towel on this, the Tax Court will have to consider it in the future under Chevron.  While not written in a Chevron framework, however, this opinion is a strong indication that the Tax Court might strike down the regulatory definition of collected proceeds.


***Correction:  I noted in an earlier version that information was provided about a taxpayer and the taxpayer had negotiated the allocation above, but the prosecuted entity here is a bank that assisted other taxpayers in the evasion.  Jack Townsend was kind enough to email me about the error, and explain there is a good chance the restitution is an estimated figure and the Service may not know who the underlying taxpayers actually are.

Calculating Interest When the IRS Makes a Restitution Based Assessment

The case of United States v. Janean Del’Andrae provides further insight into what happens when the IRS makes an assessment based on a restitution order.  We have talked about restitution based assessments previously here and here.  This relatively new basis for assessment came into being with the passage of the Firearms Excise Tax Improvement Act of 2010 and the creation of IRC 6201(a)(4) allowing assessment based on restitution orders in criminal cases.  Some of the kinks are still being worked out and this case illustrates one of the kinks.  The district court’s decision to award attorney’s fees in this context confuses me and other aspects of the opinion confuse me.  That confusion may make for a confusing and disjointed post and I apologize.  The facts developed in the opinion do not seem to warrant an attorney’s fees award against the government here but I will circle back to that at the end.  Getting to the result of what interest the taxpayer owes following a restitution based assessment provides the most important aspect of this case.


As the Court explains in the case, the new basis for assessment did not immediately cause the IRS to make assessments using this procedure. The IRS waited for instructions from its lawyers on what to do and those instructions initially came out in Chief Counsel Notice 2011-18.  Two years later in Chief Counsel Notice 2013-12 additional guidance was provided.  The Court states that “procedures for the assessment process were not officially developed until the Chief Counsel Notice 2013-12 was issued on July 31, 2013.”  That statement does not make sense to me because the 2013 notice does not deal with assessment procedures but rather with the process of how to handle a restitution case in litigation.  I think the Court may have misstated the purpose of this notice and the timing of the procedures for dealing with restitution based assessments.  The Notice issued in 2011 deals much more directly with assessment procedures.  Both of these notices are Chief Counsel notices designed to give guidance to Chief Counsel lawyers and not necessarily to the IRS.

Here, the taxpayer’s restitution order occurred in 2012. The delay of the IRS in implementing procedures for restitution assessments creates problems that ultimately lead to the award of attorney’s fees against the IRS but I am uncertain that the Court quite got the timing right in attributing the problem to the 2013 notice.  The place to focus on IRS procedures is not notices issued by Chief Counsel’s office but changes to the Internal Revenue Manual.  Here, the provisions for restitution based assessments first appeared in IRM 5.19.23 on June 6, 2014, and IRM 4.8.6 in October 7, 2014.  The new IRM provisions followed the Interim Guidance on Criminal Restitution Procedures issued in SBSE 04-0214-0013 dated February 5, 2014 Except for how this impacts the decision on attorney’s fees, it is not especially relevant but does create more confusion in trying to follow the opinion.

Janean Del’Andrae pled guilty to one count of tax evasion. The opinion is not clear about the count to which she pled or how many counts with which she was charged.  The IRS charged that she not only evaded her personal income taxes for the year 2005 but also that she participated in evading the taxes of Del-Co Western Corporation, a company in which she and her husband were officers.  The court makes a passing reference to payroll taxes but the remainder of the opinion seems to make it clear the evasion of corporate income taxes was the problem.  The sentencing court ordered restitution in the amount of $138,509.50 calculated to cover the corporate taxes for 2004 ($49,845.37) and 2005 ($38,307.13) as well as her individual income taxes for 2005 ($48,357.00).  The judgment against her was entered on July 11, 2012, and she stroked a check that day for the full amount of the restitution (making her an unusual defendant, most of whom do not have the money to pay the tax at this stage of their case) and tendered it to the clerk of court.  On September 17, 2012, the IRS received the payment.

The opinion does not state what happened next but maybe nothing happened. On September 12, 2014, the court granted defendant’s Motion to Enforce Plea Agreement and issued an order requiring the IRS to give the defendant credit for the restitution payment.  The order required the IRS to credit the payment on July 11, 2012 even though it took the court over 60 days to deliver the check to the IRS.  It appears the IRS was significantly delayed in making the assessment probably because it took the IRS a long time to develop the assessment procedures for restitution based assessments.  I agree that the defendant should get credit from the date of payment but wonder how the payment of the interest on the money for those 60 days was credited between the judicial and executive branches.

The court states that the IRS eventually assessed the appropriate amount of taxes. It also assessed interest on the taxes from the due date of the returns until July 11, 2012, when it gave credit to the defendant and the corporation for the payment of the taxes.  The assessment of interest occurred without using the deficiency procedures which seems appropriate under these circumstances.  The defendant continued to dispute the correct amount of the corporate liability for 2005 so the IRS did not assess the liability for that period.  One of the problems with this opinion is that the Court’s description of events does not use the terms that one might expect or use them with sufficient precision to allow me to know exactly what happened.  It is clear, however, that in March 2015 the corporation made a payment towards its 2013 liability.  In doing so it overpaid the 2013 liability by $65,917.  The IRS latched onto the overpayment and used it toward additional corporate and personal tax liabilities.  The use of this overpayment creates the focus of the litigation.  Defendant filed a motion for an order to show cause seeking answers concerning the application of the payments.  The balance of the opinion essentially focuses on how the IRS did and should have used the overpayment and why its actions were right or wrong.

The restitution order contemplated that the IRS would charge interest and penalties but did not order the payment of these amounts or spell them out in any way. The defendant argues that the IRS should not assess interest for the time prior to the date of the restitution order.  The defendant further argues that the IRS should follow deficiency procedures in order to assess interest on a tax liability determined by a restitution order.  The IRS argues that interest runs from the due date of the return for restitution payments as it does for all liabilities and further argues that the use of deficiency procedures is unnecessary to assess interest on the amount listed in a restitution order.  The court agreed with the IRS that interest on restitution assessments need not follow the deficiency procedure but may occur in the same manner as the assessment of the underlying tax assessed pursuant to the restitution procedure.

The second issue concerns the application of the overpayment on the 2013 corporate taxes to the personal liability of the defendant. The court says that the IRS argued that the application of a corporate payment to the personal liability of the individual is proper because “Defendant [the individual] and Del-Co are jointly and severally liable for the tax and related interest that Defendant evaded.”  The court further states that the IRS argued, “the joint and several liability arises because Defendant agreed to pay restitution for the loss caused by her evasion of Del-Co’s taxes.”  I am unconvinced that the IRS argued the case in the way described by the court.  If it did I am confused.  It is possible the IRS made an alter ego argument.  Whatever was argued, the court found that the defendant and the corporations were not jointly and severally liable and that the IRS should not take payments on the corporate account and apply them to the individual liability.  If the IRS position reflects a legal conclusion that every time an individual is convicted and restitution is ordered based on corporate and individual liabilities this type restitution order allows it to move money between the individual and corporate accounts, then this decision represents a repudiation of that position.  If the IRS was simply arguing here that, based on these facts, the finances of the corporation and the individuals merged, the IRS lost a factual argument.

After reaching this conclusion the Court found that “because the IRS delayed the application of Defendant’s restitution payments and may have improperly applied Del-Co’s overpayment to Defendant’s tax account, the Defendant incurred unnecessary costs to clarify the IRS’s actions” and therefore costs and attorney’s fees were ordered against the United States. The delay in applying the payments here seems to have resulted from the implementation of a new statute and did not harm petitioners.  I do not see that as a basis for awarding fees.  To the extent that the IRS inappropriately applied the payment of the corporation, I feel the court should have provided more information about the steps that were taken to fix the wrongful application before the court proceeding as a prerequisite to the award of attorney’s fees.

I take away from this case the reinforcement of the IRS position that interest may be assessed on restitution assessments in the same summary manner as the assessment of the tax itself. The application of payments issue, if it reflects a legal position asserted by the IRS in restitution cases, represents a victory for taxpayers.  Because I am unconvinced that the IRS was arguing this as a legal matter, I think that the application of payments issue is simply a factual determination that must be determined on a case by case basis.  There will be many more cases exploring the restitution assessment procedure as this becomes more common.  I hope they offer a clearer view of what the parties presented but even in the murky view offered by this case, the issue of interest in restitution cases gets a little clearer.

Restitution Based Assessment and Tax Return Preparers: An Uneasy Mix

At last week’s ABA Tax Section meeting in Chicago one of the panels I enjoyed most was the Civil and Criminal Tax Penalties discussion on tax preparer fraud moderated by Sara Neil of Capes Sokol (whose colleague Justin Gelfand has written on identity theft for us as a guest), with Scott Clarke from DOJ, Matt Mueller from Wiand Guerra King in Tampa and Paula Junghans from Zuckerman Spaeder in DC.

The panel’s materials included a 2015 case, United States v Horn, from the district court in Maryland. Horn involved a hearing regarding whether a return preparer who had pleaded guilty to one count of preparing and filing false returns in violation of 26 USC 7206(2) should be required to pay restitution. The opinion is by Judge Marvin Garbis, a former tax practitioner and author of books and articles on tax procedure. I do not know Judge Garbis personally but I recall one of my mentors Michael Saltzman admiring him for his tax procedure chops (no small feat as Michael’s talent was matched by a healthy and justified sense of tax procedure ego).

The opinion concludes for very practical reasons that the IRS should not be able to make a restitution based assessment (RBA) against Horn, and how it gets there rings some interesting tax procedure bells that I found worthy of a post.


Facts and Legal Background

The parties stipulated that the preparer Judianne Horn provided 16 clients with tax returns that listed false deductions on Schedule A or false business losses on Schedule C. The stipulation laid out over a four-year period the understatements of tax liabilities on a year-by-year basis for Horn’s clients. The total understatement of tax liabilities for the 42 federal tax returns (not every client had a return filed in every year) was $281,764.

We have recently discussed in the revision to Saltzman and Book the 2010 legislative change codified in Section 6201(a)(4)(A) that allows the IRS to assess and collect restitution under an order in Title 18 section 3556 “in the same manner as if such amount were such tax.” We discussed restitution based assessments in SaltzBook Chapter 10 (dealing with assessments) and in Jack Townsend’s redo of Chapter 12 (dealing with tax crimes); Keith also discussed it in PT in a post last year.

There are lots of interesting issues that spin off this important administrative power, and Horn raises one, namely whether the IRS has the ability to use RBA powers when the offense at issue relates to a preparer’s misconduct that implicates multiple taxpayers with multiple tax liabilities.

As the opinion describes, Section 6201(a)(4)(A) results generally in the IRS substituting itself for district courts when it comes to the payment of a restitution obligation. As an example of this, the opinion notes that an RBA “effectively eliminates the power of the district court to provide for periodic payments of restitution in amounts determined by the court subject to revision should the defendant’s financial circumstances change.”

The Tension Arising from Restitution Based on Third Party Liability

The rub as Judge Garbis describes was that when restitution is based on tax liabilities of others (such as but not exclusively when the defendant is a return preparer) it creates problems for both the courts and IRS in setting the proper amount but even more so perhaps in monitoring the payments going forward:

This creates a substantial level of complexity for determining the amount of restitution to be imposed and imposes a substantial management burden on the IRS and the court to monitor, not only in the application of restitution payments made by the defendant but also collections made by the IRS from taxpayers whose liabilities are the subject of the restitution order.

To fully appreciate this statement it is necessary to contrast loss for sentencing guideline purposes and restitution. The $281,764 understatement I referred to above determines loss for sentencing guidelines purposes. The loss for guidelines purposes exists irrespective of any post-offense circumstances, whereas the nature of restitution in the tax context makes those very post-offense circumstances quite relevant:

The function of restitution is to require a defendant to restore to the victim of a crime the loss caused by the defendant’s criminal conduct. A restitution award is not to be issued for punitive purposes or to provide the victim with a profit. Thus, the amount of restitution should not exceed the loss to the victim actually cased by the defendant.

The Horn opinion brings this back to the IRS:

In the context of a false federal income tax return, the actual loss to the IRS for which restitution should be paid is the deficit in tax collected with regard to the return in question-i.e., the amount of tax that would have been reported due on an accurate, correct tax return and paid, reduced by the amount collected by the IRS with regard to that return. (emphasis added).

Moreover, as the opinion notes, the actual loss to the IRS for restitution would have to take into account the tax liability reported as if the returns were properly filed, including deductions or credits that the taxpayers failed to originally claim. The proper amount of tax liability would also be reduced by the amount reported to the IRS on the false returns as well as “reductions in the restitution balance due as the IRS received payments and applied them to the tax liability understatement for the return in question.”

Given that the liability at issue here turns on third parties (the taxpayers whose returns Horn prepared) the opinion notes that the task would be dependent upon both “the number and complexity of the substantive issues presented in a particular case.” The process for defense counsel was as Judge Garbis describes one that would essentially require counsel to inquire into all 42 returns:

Defense counsel could be accused of a failure to provide effective assistance unless he/she reviewed the IRS’s proposed adjustments to each of these 42 returns, presumably with the assistance of a qualified tax professional.

Judge Garbis notes that the review should lead to some process (at cost that may be borne by the State if the defendant is represented by appointed counsel) whereby the defendant could access records and even potentially interview witnesses in a search for offsetting adjustments.

Contrasting Restitution Based Assessment with Restitution That is Not Assessed

The opinion notes in footnote 8 that “there may be reasonably debatable issues” as to whether the IRS can make a restitution based assessment in this case though the court for purposes of the order assumed that it could. I will take a quick stroll through that issue. Recall that Section 6201(a)(4)(A) provides that the Service may only assess an amount of restitution ordered “for failure to pay any tax imposed under [Title 26].” As the Service itself explained in a notice issued in 2011 “not every conviction in a Title 26 criminal case will result in an order of restitution that will be assessable.” Whether the IRS can use its RBA powers as the IRS in the notice from 2011 explained is based on whether the “restitution ordered is traceable to a tax imposed by Title 26 (e.g., cases stemming from an underreporting of income, an inflated credit or expense, or an alleged overpayment of tax that results in a false refund)….”

Not every restitution order connected to a Title 26 offense is within the reach of 6201(a)(4)(A):

On the other hand, criminal cases in which the restitution ordered is not traceable to a tax – such as when a taxpayer submits false documents or tells lies during an examination – may not result in assessable restitution.

Whether aiding and assisting in preparing and filing someone else’s tax return constitutes an amount of restitution ordered “for failure to pay any tax” is a question that the Horn opinion sidesteps and that I suspect other opinions may tackle, though IRS lists in its 2011 notice the 7206(2) offense Hom pleaded guilty to as an offense that “may” meet the requirements for assessment.

Back to the Horn opinion and what it does address. In discussing RBA, the opinion notes that once restitution is assessed, the IRS can use its full collection powers, with the assessment also subject to interest and late payment penalties.

In contrast, when there is restitution that does not result in an RBA, the opinion emphasizes the broad discretion that solely resides in a sentencing court:

However, when issuing a restitution order that does not result in an RBA, a sentencing court can exercise its discretion and decide whether to set a fixed date for payment in full or a schedule for partial payments consistent with the court’s finding regarding the defendant’s financial circumstances.The opinion illustrates the discretion with examples as to what the court (unlike the IRS) might do: Often, when a defendant does not have the ability to make full payment immediately, a sentencing court will defer all, or part, of the payment obligation during the time a defendant is incarcerated and will set a periodic payment schedule with the first payment due when the defendant is released from prison. The restitution order can provide that the amount of each periodic payment is subject to change depending upon changes in a defendant’s financial circumstances. The sentencing court can require, or waive, the accrual of interest on the unpaid balance. There will be no automatic “late payment penalty” applied to any unpaid balance of the full amount of restitution. Rather, the district court would consider imposing a sanction for a failure to make a restitution payment, taking into account the court’s determination of the defendant’s financial ability to meet the obligation.

Managing Restitution 

The opinion notes the important distinctions between the way the IRS and sentencing courts manage or monitor the receipt of restitution payments.  First, the opinion describes how courts manage the process:

In the absence of an RBA, a defendant’s restitution obligation is reduced, dollar for dollar, as the defendant makes payments pursuant to the restitution order.

IRS on the other hand treats payments made pursuant to an RBA as involuntary, with IRS having discretion to allocate the payments as it chooses among tax, interest and penalties. IRS may even, as the opinion notes, allocate payments to any other of the defendant’s own assessed liabilities that are wholly unrelated to the offense giving rise to the RBA.

The IRS’s discretion is amplified when the restitution relates to an order stemming from a return preparer’s criminal offense, with the IRS having the ability to allocate payments “among the taxpayers and income tax returns for which restitution would be due.”

Judge Garbis thus sets the stage for an administrative mess that led in part to his concluding that he would not order restitution in the case. Recall that when imposing restitution the IRS is not to collect more than the correct amount of tax at issue. When there are multiple taxpayers and multiple potential assessments and collections from those third parties, unless there is a process to track those payments and allocate the payments to the individual liabilities it would be very difficult for the IRS to represent to the court that it would limit its collection on the preparer’s assessed restitution to reflect its collection from those third parties whose returns the IRS would presumably examine.

Somewhat surprisingly, the IRS attempted to minimize the administrative burdens with a representation that it would not seek to enforce the laws with respect to the 16 taxpayers who benefitted from Horn’s illegal actions:

[T]he Government has taken the position that it will not seek to collect income tax underpaid by – or, better put, unwarranted refund payments made to – the taxpayers who filed the false returns.

Perhaps IRS did so because it wanted precedent on the books that it could get restitution in a case such as this, or perhaps it did so because it knew that resource constraints limited it from examining those 16 taxpayers and the 42 returns at issue (I won’t even go the SOL issues stemming from third party fraud, an issue we have spoken about in the BASR v US case in a guest post by Robin Greenhouse).

In any event, in a part of the opinion that appeals to my Introduction to Federal Income Tax professor hat, Judge Garbis pointed to the potential tax issues created when a preparer would make restitution payments that would benefit her clients by offsetting their tax obligations:

Nevertheless, unless the I.R.S. can make a decision to grant these taxpayers a gift from the Department of the Treasury, it should seek to have these taxpayers comply with their future tax obligations. Hence, if the Defendant were now to make a restitution payment that is applied to a tax liability of W.W., a taxpayer who obtained more than $17,000 of unwarranted refunds, it would appear that W.W. would have taxable income in the year of the Defendant’s payments.

This conclusion relates to the notion illustrated in cases such as Old Colony that a person has gross income when someone else pays that person’s tax on his or her behalf. The Horn opinion thus states that even if the IRS were not going to examine the prior returns to reflect ensuring past compliance, “the I.R.S. should monitor continually its application of restitution payments and ensure future tax compliance by the taxpayers to whose tax liabilities the payments are allocated.” While I have not fully thought through the Old Colony issue that Judge Garbis raises (for example, is the possible inclusion of income dependent upon there being an assessed liability agains the taxpayer?), the discussion at least implicates issues of coordination and the mechanism that the IRS would or should use to credit any restitution payments against individual taxpayer liabilities.

The Court Concludes that Restitution is Not Appropriate

Having I think established that the IRS desire to seek an RBA in this case created a number of vexing issues, the opinion expressed doubt as to whether the IRS was up for the task of managing and monitoring on a going-forward basis:

Indeed, it appears doubtful that the I.R.S. can, realistically, keep the Defendant and the Court (Probation Officer) informed of its application of Defendant’s payments. Moreover, the Government has described no coherent existing, or proposed, practicable process for keeping track of, and advising the Court (Probation Officer) and Defendant of, the status of payments made by, or collected from, taxpayers with respect to tax liabilities included in the restitution amount.

The “bottom line” is that if a tax return preparer defendant is unable to make more than modest partial payment of the restitution obligation, then a restitution order resulting in an RBA would impose a monitoring obligation on the I.R.S. and the Court (i.e., the Probation Officer) that, if at all possible to meet, would cause disproportionate managerial problems for the I.R.S. and the Court. (footnotes omitted).

The complexity and “disproportionate management burden” on the IRS and the court thus led to the conclusion that it was inappropriate to issue a restitution order. That burden was exacerbated by the financial circumstances of the defendant, as the court noted that a restitution order causing an RBA might be appropriate perhaps when “prompt, full payment can be required.” The opinion concludes by noting that it could have required restitution that would not have led to an RBA but that it chose not to in this case.

Parting Thoughts

Jack Townsend has noted that the relatively new RBA powers create some administrative challenges even when the restitution relates to an offense stemming from the defendant’s own tax liability (see his 2014 discussion of Murphy v Commissioner and procedures associated with RBA over at his Federal Tax Crimes blog here, with its sensible recommendation that IRS issue regs under the RBA statute).

The Horn opinion touches on some practical and legal challenges associated with an RBA that implicates third parties and their respective tax liabilities. In an email exchange over this case Jack offers the observation that “some of the real or imagined administrative problems that Horn raises could be solved by simply wiping off restitution on the criminal side once it has been assessed.”  As Jack notes, that “would let the IRS’s collection tools work the way they always work. It would also take legislation.” While at it, Jack suggests that with the “IRS’s robust tax collection mechanisms delegating tax restitution collection to the IRS and getting the courts / probation office / U.S. Attorney out would be a good use of limited resources.”  Jack also suggests that it would make sense for any delegation to the IRS include the IRS having the power to compromise the assessed restitution. 

IRS and DOJ have many tools at their disposal to go after crooked preparers, but Horn serves notice that at least among judges willing to inquire how the IRS will go about its business, the IRS may not be able to use an RBA when it comes to convicted preparers.



Summary Opinions for July

Here we go with some of the tax procedures from July that we didn’t otherwise cover.  This is fairly long, but a lot of important cases and other materials.  Definitely worth a review.

  • Starting off with some internal guidance from the Service, it has held that the signature of the president of a corporation that subsequently merged into a new corporation was sufficient to make a power of attorney binding on the new corporation (the pres served in the same capacity in NewCo).  In CC Memo 20152301F, the Service determined it could rely on the agent’s agreement to extend the statute of limitations on assessment based on the power of attorney.  There is about 14 pages of redacted material, which makes for a fairly uninteresting read.  There was some federal law cited to allow for the Service reliance, but it also looked to IL law to determine if the POA was still valid. This would have a been a more interesting case had the president not remained president of the merged entity.
  • The Tax Court, in Obiakor v. Comm’r, has held that a taxpayer was entitled to a merits review by the Service and the court during a CDP case of the underlying liability for the TFRP where the Service properly sent the Letter 1153 to the taxpayer’s last known address, but the taxpayer failed to receive the letter.  The letter was returned to the Service as undeliverable, and the Service did not show an intent by the taxpayer to thwart receipt. This creates a parallel structure for TFRP cases with deficiency cases regarding the ability of the Tax Court to review the underlying liability when the taxpayer did not previously have an opportunity to do so based on failure to actually receive a notice mailed to their last known address.  Unfortunately for the taxpayer, in the Court’s de novo review, the Court also found the taxpayer failed to make any “cogent argument” showing he wasn’t liable.
  • In Devy v. Comm’r, the Tax Court had an interesting holding regarding a deficiency created by a taxpayer improperly claiming refundable credit.  The IRS allowed the credit requested on the return and then applied it against a child support obligation the taxpayer owed.  Subsequently, the IRS determined that he was not entitled to the credit and assessed a liability.  The Tax Court found it lacked the ability to review the Service’s application of the credit under Section 6402(g), which precludes any court in the US to review a reduction of a credit or refund for past due child support obligations under Section 6402(c), as well as other federal debts and state tax intercepts .  The taxpayer also argued that he should not have to repay the overpayment because the Service elected to apply it against the child support obligation, not pay it to him.  The Court stated that whether it is paid over to the taxpayer or intercepted, the deficiency was still owed by the taxpayer.  See Terry v. Comm’r, 91 TC 85 (1988).
  • With a lack of splits in the Circuits, SCOTUS has denied certiorari in Mallo v. IRS.  Mallo deals with the discharge of tax debts when the taxpayer files late tax returns.  Keith posted in early June on the Solicitor General’s position before SCOTUS, urging it to deny cert.  Keith’s post has a link to our prior coverage on this matter.
  • The DC Circuit had perhaps its final holding (probably not) in Tiger Eye Trading, LLC v. Comm’r, where it followed the recent SCOTUS holding in Woods, affirming the Tax Court’s holding that the gross valuation misstatement penalty applied to a tax shelter partnership, but the Court could not actually adjust the outside basis downward.  The actual adjustment had to be done in a partner level proceeding, but the Court did not have to work under the fiction that the partner had outside basis above zero in an entity that did not exist.  Taxpayers interested in this area should make sure to read our guest post by Professor Andy Grewal on the Petaluma decision by the DC Circuit that was decided on the same day, which can be found here.
  • In Shah v. Comm’r, the 7th Cir. reviewed the terms of a settlement agreement between a taxpayer and the Service which contained a stipulation of facts, but did not contain a calculation of the deficiency in any applicable year.  The Tax Court provided an extension to calculation the amount outstanding.  No agreement could be made, and the Service petitioned the Court to accept its calculation.  Various additional extension were obtained, and the taxpayers went radio silence (apparently for health issues and inability to understand the IRS calculations).  The Tax Court then ordered the taxpayers to show cause why the IRS calculations should not be accepted, instead of providing a trial date.  The taxpayer objected due to IRS mistakes, but the Court accepted the IRS calculations somewhat because the taxpayers had not been cooperative.  The Seventh Circuit reversed, and held that the Tax Court was mistaken in enforcing the settlement, because there was not a settlement agreement to enforce.  The Seventh Circuit indicated that informal agreements may be enforceable, but the court may “not force a settlement agreement on parties where no settlement was intended”. See Manko v. Comm’r, 69 TCM 1636 (1995).  The 7th Circuit further stated that it was clear the taxpayers never agreed to the calculations (which the IRS acknowledged).  At that point, the Service could have moved for summary judgement, or notified the Tax Court that a hearing was required, not petitioned to accept the calculations.  Keith should have a post in the near future on another 7th Circuit case dealing with what amounts to a settlement, where the agreement was enforced.  Should be a nice contrast to this case.
  • The Service has issued a PLR on a taxpayer’s criminal restitution being deductible as ordinary and necessary business expenses under Section 162(a).  In the PLR, the taxpayer was employed by a company that was in the business of selling “Z”.    That sounds like a cool designer drug rich people took in the 80’s, but for the PLR that was just the letter they assigned to the product/service.  Taxpayer and company were prosecuted for the horrible thing they did, and taxpayer entered into two agreements with the US.  In a separate plea agreement, he pled to two crimes, which resulted in incarceration, probation, a fine, and a special assessment, but no restitution.  In a settlement agreement, taxpayer agreed to restitution in an amount determine by the court.  Section 162(f) disallows a deduction for any fine or similar penalty paid to the government in violation of the law, but other payments to the USofA can be deductible under Section 162(a) as an ordinary and necessary business expense.  The PLR has a fairly lengthy discussion of when restitution could be deductible, and, in this case, determined that it was payable in the ordinary course of business, and not penalty or other punishment for the crime that would preclude it under Section 162(f), as those were decided under the separate settlement agreement.  The restitution was simply a repayment of government costs.
  • This kind of makes me sad.  The Tax Court has held that a guy who lived in Atlantic City casino hotels, had no other home, and gambled a lot was not a professional gambler.  See Boneparte v. Comm’r.  Nothing that procedurally interesting in this case, just a strange fact pattern.  Dude worked in NYC, and drove back and forth to Atlantic City every day to gamble between shifts at the Port Authority.  Every day.  The court went over the various factors in determining if the taxpayer is engaging in business, but the 11 years of losses seemed to make the Court feel he just liked gambling (addicted) and wasn’t really in it for the profits.
  • S-corporations are a strange tax intersection of normal corporations and partnerships (which are a strange tax intersection of entity taxation and individual taxation), but the Court of Federal Claims has held that s-corps are clearly corporations in determining interest on a taxpayer overpayments.  In Eaglehawk Carbon v. US, the Court held that the plain language of Section 6621(a) and (c)(3) were clear that corporations, including s-corporations, were owed interest at a reduced rate.
  • The Third Circuit in US v. Chabot  has joined all other Circuits (4th, 5th, 7th, & 11th – perhaps others)  that have reviewed this matter, holding that the required records doctrine compels bank records to be provided by a taxpayer even if the Fifth Amendment (self-incrimination) might apply.  We’ve covered this exception a couple times before, and you can find a little more analysis in a SumOp found here from January of 2014.  This is an important case and issue in general, and specifically in the offshore account area.  We will hopefully have more on this in the near future.
  • A Magistrate Judge for the District Court for the Southern District of Georgia has granted a taxpayer’s motion to keep its tax returns and records under seal, which the other party had filed as part of its pleadings.  The defendants in this case were The Consumer Law Group, PA and its owners, who apparently offered services in reducing consumer debt.  In 2012, the Florida AG’s office filed a complaint against them for unfair and deceptive trade practices, and for misrepresenting themselves as lawyers.   Two years prior it was charged in NC for the same thing.  One or more disgruntled customers filed suit against the defendants, and apparently attached various tax returns of the defendants to a pleading.    Presumably, these gents and their entity didn’t want folks to know how profitable their endeavor (scamming?) was, and moved to keep the records under seal.  The MJ balanced the presumption of openness against the defendants’ interest.  The request was not opposed, so the Court stated it was required to protect the public’s interest.  In the end, the Court found the defendant’s position credible, and found the confidential nature of returns under Section 6103 was sufficient to outweigh the public’s interest in the tax returns.



Who’s (Lien is) on First?

United States v. de Cespedes has a horrible back story involving the realization of the American dream, followed by a meteoric fall (I think both Bill Nye and Neil deGrasse are okay with that usage of the term meteoric) from grace due to defrauding various health care companies, along with the IRS, and eventually lien priority questions for one offender.  The specific lien issues revolved around which creditor should be paid first from the sale of a homestead; the IRS for a tax lien, a third party creditor with a prior lien, or the federal government for non-tax restitution that was filed after both?  In the end the federal government won, with the non-tax restitution trumping, followed by the tax lien.  This was the optimal result for the government, and a bad deal for the offender’s ex-spouse, who was in possession of the home and only liable for the tax lien.

In 1980, Carlos and Jorge de Cespedes started Pharmed Group, growing it to over $60MM in revenue a year, becoming a large distributor of medical, surgical and pharmaceutical supplies working with large health systems and major pharma companies.  The brothers came from humble beginnings, coming to the United States as young boys from Cuba without their parents, and growing up in an orphanage (I took this back story from the Pharmed Group Wikipedia page here).

Unfortunately, in the early 2000s, business started to falter, and various lawsuits sprung up, which you can read about here.  As business got worse, it became evident the brothers were defrauding just about everyone and were evading taxes.  Although they both pled guilty to a multitude of offenses, the rest of the post focuses on some of the difficulties Carlos faced following his conviction.

On January 7, 2009, Carlos was convicted of wire fraud in violation of 18 USC 1349, and ordered to pay joint restitution with the other defendants of about $7MM.  On March 13, 2009, Carlos and his then wife, Martha, entered into a closing agreement with the Service, agreeing to an assessment of tax, penalties and interest of around $4MM for tax years 2001 through 2003.  Presumably tax was assessed shortly thereafter, liens automatically arose at that point, and were filed on March 24, 2010, May 13, 2010 and June 23, 2010.  On February 20, 2009, a civil suit was brought against the de Cespedes, which was finalized on August 7, 2009, wherein the plaintiff obtained a judgement of about $17.6MM.  In February of 2009, Martha filed for divorce against Carlos.  On December 15, 2010, Carlos transferred his interest in their primary residence, which was a homestead under Florida law, to Martha pursuant to the divorce settlement.  To summarize:

  • January 7, 2009 wire fraud conviction with restitution (no lien filed).
  • February 20, 2009 civil suit brought.
  • March 13, 2009 closing agreement with Service.
  • August 2009 judgement and lien in civil suit.
  • In March, May and June of 2010 tax liens filed.

Eventually, the homestead was sold, and there were a lot of creditors with their hands out, but nowhere near enough funds to pay everyone.  This obviously matters to the creditors, who may have had limited other opportunities to collect.  But, it also mattered to the ex-Ms. de Cespedes, who was a joint debtor with her husband on only one of the debts- the taxes owed.  Two issues arose before the courts. In 2014, the District Court for the District of Southern Florida (can’t find a free link – sorry) focused on whether the government, specifically the tax claims, had priority over the civil plaintiff.   Here, it was clear the civil plaintiff won the race to the court house, but in a surprising twist based on Florida homestead law, discussed below, the Service took priority.  In 2015, the Eleventh Circuit reviewed the priority of the non-tax restitution payments compared to the tax lien, and found that the restitution had priority over the tax lien.  This hinged on the treatment of the non-tax restitution as a tax lien.


Focusing first on the tax lien priority over the civil liability, the Court indicated the tax lien occurs at the time of assessment and applies to all property owned by the taxpayer, but under Sections 6323(a) and (f) the lien is not valid against another “judgement lien creditor” until notice of the tax lien has been field. This is a rule most of us know, and one that makes sense. In de Cespedes, the civil plaintiff filed its judgement on August 7, 2009, months before the IRS liens were recorded in May and June of 2010, which would seem to indicate the civil plaintiffs won the race to the court house, and therefore should get paid.

Under Florida law, however, there was question of whether the civil creditor was a “judgment lien creditor” in August of 2009, and, unfortunately for it, the Court found it was not.  Under the Florida Constitution, “[t]here shall be exempt from forced sale under process of any court, and no judgement, decree or execution shall be a lien thereon, except for the payment of taxes and assessments thereon…the following property owned by a natural person: (1) a homestead…” Fl. Const. art. X, §4(a)(1).  Quoting the District Court for the Middle District of Florida, the Court stated this homestead exemption was to be liberally contributed, and shields the home from all claims of creditors, with limited exceptions (one of which is taxes).  See Dowling v. Davis, 2006 WL 2331070 (MD Fl. 2006).  The Court found that the house retained the homestead status until  at least December of 2010, which was after the lien filings by the Service.  When the home was sold, the government was to get paid since it had a valid lien, and the civil plaintiff was stuck empty handed.

Following the 2014 decision, the home’s equity was not all applied to the tax liability.  Of the remaining funds, fifty percent of the home’s equity value was paid towards the restitution owed by only Carlos de Cespedes.  The other fifty percent was paid towards the jointly owned tax debt.  It is understandable to question how this could have occurred, because the non-tax lien of one spouse would seem to be precluded by the homestead exemption above.  Martha appealed that allocation, arguing the tax lien had priority and all the remaining equity should have been applied towards the joint tax debt.

Specifically, Martha argued that the tax liens were created upon the assessment of the tax liability by the Service, or, in the alterative, the liens arose at the time of the closing agreement being signed.  Second, Martha also argued that the non-tax restitution lien could not attach to the property because it was tenants by the entireties property owned jointly by them.

The Court did not find these arguments persuasive.  Pursuant to the applicable federal statute, the restitution order was treated as “a liability for tax assessed under the [IRC]”.  See 18 USC 3613(c).  When the restitution order was recorded and notice of the lien was provided, the lien was treated as a federal tax lien. See 18 USC 3613(d)&(f). This allowed the lien to attach to the property regardless of the homestead exemption.  The statute found in 18 USC 3616 is a federal criminal procedure statute that assists in the federal government collecting restitution for various non-tax crimes.  The treatment of that restitution as “tax” creates an interesting anomaly in this case where there are competing government claims on co-owned property, and also can have an interesting impact in other areas (e.g. garnishment of qualified plans, see US v. Sawaf, 74 F3d 119 (6th Cir. 1996)).  If the restitution is payable to the victims in some manner, it also creates a priority right in someone other than the government, possibly defeating the government in a situation like de Cespedes.

Likewise, the Court did not agree with the argument that the restitution order could not attach to the joint property, following United States v. Craft, and holding entireties interests are property or rights to property that can be attached. 535 US 274 (2002).  The Court did note that Florida law exempts entireties property from execution of the debts of one spouse, but held this was trumped by federal law.  See United States v. Ryals, 480 F3d 1101 (11th Cir. 2007).

In terms of timing, the Court stated a restitution lien arose in favor of the United States upon the entry of the judgement on January 7, 2009, which attached to all property and rights to property and was treated as a tax lien.  It further stated that this put the lien on equal footing with the tax debt, and it received priority under the general rule of first in time, first in right under Griswold v. United States, 59 F3d 1571 (11th Cir. 1995).  The tax lien would not have arisen until the assessment, which would have followed the execution of the closing agreement.  The Court noted that the signing of the closing agreement itself did not cause assessment, which is correct, but doesn’t really seem to matter, since even the signing of the closing agreement was after the January 7th date when the restitution judgment was recorded and the federal tax lien type of lien came into existence.

This case presents the interesting competition between a real federal tax lien and a faux federal tax lien.  Because the faux federal tax lien created by the restitution judgment has all of the characteristics of the real federal tax lien, the creation of the faux federal tax lien prior to the creation of the actual federal tax lien allows the faux FTL to come first in a priority fight between the two federal tax liens.    See also US v. Vermont, 377 US 351 (1964)(“first in time is first in right”).  Here, the payment of the restitution was to the detriment of the Service, but probably provided more benefit to the federal government as a whole, since two people remained liable for the tax debt, one of whom was not in jail (this assumes the restitution amount remained with the government).

Overall, the case was not groundbreaking, but showed two interesting quirks in lien law with one created by the impact of the Homestead exemption on judgment lien creditors, and the other with the interplay of the faux federal tax lien created by certain non-tax restitution orders versus the real federal tax lien.

Summary Opinions for 12/19/14 to 1/05/15

Back in the saddle after quite a few weeks off.  Holidays, home renovations, and the passing of my maternal grandfather (phenomenal guy, who will be incredibly missed by everyone who knew him) took priority over blogging.  SumOp isn’t usually that time sensitive though, so we can pack three weeks into one post.

Here are the items we found interesting that we didn’t otherwise cover over:

  • Let’s start off with Jack Townsend’s Federal Tax Crimes blog, and his post on Muncy v. Comm’r, which can be found here.  This Muncy is a gentleman who was not fond of following tax laws, and not the quaint town in north central Pennsylvania where I lived as a teenager.  Leroy Muncy created some type of fake employment agency and amazingly convinced his employer to pay his wages to this fake company in an effort to stop paying employment taxes.  I would guess he ran inflated expenses through the company to decrease his income taxes also, but that is just speculation.  When his fake employment company concept failed, he claimed he was a “sovereign living soul”, not subject to the rules of his home state of Arkansas or the United States of America. The civil court found he had failed his sovereign citizenship test (because it is made up and never recognized as a valid argument). Fast forward a few years, and there was criminal tax restitution and a potentially larger civil liability outstanding.  The Tax Court discussed the new legislation allowing immediate tax restitution on the criminal amount, and the issues that could cause in requiring a notice of deficiency for the full civil amount (which includes the criminal restitution amount).  Jack discusses the issue and provides his thoughts in the post.
  • Chief Counsel determined that employment tax liabilities and worker classifications were not partnership items under TEFRA, as they were items imposed and determined under Subtitle C, whereas TEFRA partnership items are those found under Subtitle A.  See LAFA 20145001F.  This general position has been stated before.  For an interesting discussion regarding this topic, and when related items of income may require TEFRA proceedings see CC Memo 200215053.
  • The Service shared its international tax training materials, which are found here.  There is a lot of material, and I have not gotten through it all yet.  The Service did caution that such training does not constitute pronouncements of law, and cannot be relied upon…but it will show how your agent will be approaching your audit.  Some of the units provide good overviews, while others dig down into specifics, like “Disposition of a Portion of an Integrated Hedge.”  My wife literally fell asleep when I was explaining that unit to her (or pretended to be asleep so I would stop talking).
  • The Fourth Circuit, in Wolff v. US,  in early December had a bankruptcy holding that I doubt is breaking new ground regarding preferential transfers (see Begier v. IRS. 496 US 53, cited by the 4th Cir.), but I hadn’t reviewed a case on the specific matter before.  The issue and holding, as outlined by the Court were:

whether the trustee in bankruptcy may reclaim as property of the debtor the approximately $28 million transferred by the debtor to the IRS during the 90 days preceding the filing of the bankruptcy petition. We agree with the bankruptcy court and the district court that, as a matter of law, the debtor lacked an equitable interest in the funds paid over to the IRS, and therefore we affirm the judgment.

The Fourth Circuit found that the property lacked the prerequisite of being the debtor’s property, because under applicable state law it held the funds in express trust and had no interest in the assets or discretion to use those funds for anything other than paying the government.

  • In US v. Titan International, the Service sought to obtain enforcement of its summons looking for the company’s 2009 airplane flight logs and general ledger in connection with its 2010 audit.  The taxpayer objected, as the Service has previously audited its 2009 return, and reviewed the requested documents. The taxpayer attempted to rely upon Section 7605(b), which generally states taxpayers do not have to hand over their books and records multiple times for the same year.  In Titan, the IRS argued it needed the documents to verify a 2010 deduction, and did not intend to review 2009 again.  The Court found the testimony and reasoning of the Service valid, and enforced the summons. This drives me crazy also (especially when they ask for the return), though the law (as Titan explains) gives the Service quite a bit of leeway to examine records from a previously examined year if the records relate to another possible year’s liability.
  • “Double-D Ranch” seems like a place in Nevada my wife would be very upset to find credit card receipts from, but it was apparently a far less seedy tax shelter for the one-time American Home Products (Wyeth) owner, Albert Diebold.  The Ninth Circuit found that shareholders, here the Salus Mundi Foundation, were responsible for a corporation’s taxes based on the state fraudulent conveyance statute and the transferee liability rules. See Salus Mundi Foundation v. Comm’r.   Peter Reilly has coverage at Forbes, where he loops in Frodo Baggins, all the tax shelter goodness, and the Diebold family history, found here.  If this all sounds familiar, it’s because the Second Circuit reviewed the exact same facts in Diebold Foundation v. Comm’r from 2013, which the Ninth Circuit looked to in its holding.
  • Southern District of Mississippi denied the Government’s motion to dismiss a taxpayer’s son’s action for quiet title on property the IRS was trying to foreclose its liens upon for the father’s taxes based on nominee theory; the Government argued that Sections 6325(b)(4) and Section 7426(b)(4) relating to some expedited lien remedies were the only remedies available to the taxpayer.  The Court in US v. McFarland disagreed, holding those were available remedies, but did not foreclose a quiet title action under 28 USC 2410.
  • In Larry J. Austin v. Comm’r (there was a Larry P. Austin case decided a few days later by the Tax Court – little confusing), the IRS prevailed in showing it was substantially justified in its position regarding foreign interest on accounts held in the name of the taxpayer, even though the interest was not actually taxable to the taxpayer.  Although the taxpayer prevailed on the item and amount in controversy, and met the financial thresholds for fees, the Service position was reasonable enough to prevent the imposition of costs.  A qualified offer was presumably not provided in this matter; although, there was a stipulated settlement, so the Service could have argued the concession was not the taxpayer prevailing, perhaps making such an offer useless.  We’ve discussed that before here and here (and I don’t like the court holdings very much).
  • John Doe is apparently involved in shipping, not just banking.  The DOJ has issued summonses to FedEx, DHL, and UPS to obtain information about clients who may be facilitating illegal activity resulting in tax fraud.  Robert Woods at Forbes has coverage here.

Collection of Restitution Payments by the IRS

In the past few years it has become easy to think of Congress as a place where ideas go to die. They just seem incapable of passing laws that cry out for passage because of partisan gridlock. Yet, in the midst of their seeming inability to do anything, they passed a law in 2010 that makes complete sense and has the ability to change the game in collecting from taxpayers convicted of tax crimes. Les and I have talked about writing on the amendment to IRC 6201(c)(4) in the Firearms Excise Tax Improvement Act of 2010 since we started the blog. I will take a crack at it here. He has recently updated Chapter 10 of Saltzman to include a detailed discussion of the changes resulting from restitution based assessments.  I am sure we will write more because the impact of the law has already produced a number of interesting cases.


Historical Pattern of Collection in Criminal Cases

The basic idea behind the change to IRC 6201(c)(4) concerns assessment at an earlier stage. Because the IRS stops civil action when it pursues a criminal case, a typical criminal case presents the absolute perfect model for collection failure. An IRS Special Agent will investigate a suspected tax criminal for months or years while the IRS revenue agents and revenue officers stand on the sidelines. During this time the criminal investigation generally does an excellent job of destroying the taxpayer’s economic reputation and simultaneously drains the taxpayer of most or all of their liquid assets to pay for the defense against the criminal charges. After several months, or years, the indictment of the taxpayer finally occurs. The taxpayer pleads guilty or has a trial, the post-conviction actions occur and finally, after all of this the revenue agent would come in to begin the civil audit so that the IRS could assess the additional tax resulting from the criminal investigation. The taxpayer, who by the point is often incarcerated, has little interest in signing a consent form agreeing to the assessment, usually drags out the audit and often would go to Tax Court which further delays the assessment. At some point now several years after the criminal investigation began, the IRS would finally make the assessment and the revenue officer would begin the impossible task of collecting from a taxpayer who is either still in prison or recently released therefrom, who has no job – or a poor job, and has no assets.

How Restitution Based Assessment Changes the Historical Timeline

IRC 6201(c)(4) seeks to change this timeline. Whether moving the collection point earlier in the process but still post criminal investigation and conviction will make a real difference in collection still remains to be seen. If nothing else, the change can allow the IRS to eliminate spending the revenue agent’s time on this case freeing up the revenue agent to audit one of the 2 or 3 people in the United States still unlucky enough to actually get audited. The assessment resulting under IRC 6201(c)(4) comes from the amount of tax the court in the criminal case orders the taxpayer to pay to the United States as restitution. That assessment does not stop the IRS from auditing the taxpayer to establish that the taxpayer owes more tax than the criminal court ordered as restitution but it does give the IRS the opportunity to set a baseline on the assessment it can make and to make the assessment much earlier than before – especially in cases in which the taxpayer availed themselves of the Tax Court as a pre-assessment forum.

Challenges Facing the IRS in Collecting Even the Restitution Based Assessment

Challenges still exist in collecting from taxpayers who have gone through the criminal process and significant resource issues also exist. The challenges and resource issues exist both in exam and collection. One of the challenges these cases is the much higher likelihood in these cases of the transfer of assets to third parties to defeat collection. The ability to make a much earlier assessment and involve a revenue officer at a much earlier stage can make a real difference if the taxpayer has engaged in transfers of property in an attempt to defeat the collection of the tax. Given that the individuals in this group have already engaged in some criminal tax behavior, the existence of transfers from this group seems much more likely than in the general population.

In a criminal case the IRS uses significant resources to obtain a conviction. It knows at the outset that it may not recover an amount from the investigated taxpayer equal to the cost of the investigation. To get to the finish line successfully, it may spend hundreds or occasionally thousands of hours of the special agent’s time. Sometimes criminal cases also involve a significant time commitment of a cooperating revenue agent. In all events, the case uses a great deal of the precious few resources the IRS has available. The time spent on the criminal case may well represent an appropriate expenditure of resources if the conviction convinces others in the community to pay their taxes. That theory of deterrence drives the decision to devote the resources to these cases and to hold off collection until after the criminal case.

Having expended so many resources, the IRS exhibits much reluctance to walk away from these taxpayers even where its actions have rendered them incapable of paying the resulting taxes. The failure to pursue these individuals vigorously to collect the tax might reflect poorly on the IRS since convicted tax criminals represent “the worst” taxpayers and those most deserving of the full complement of collection powers granted to the IRS. Yet, using those powers on these individuals often proves a waste of time since many of them have little or nothing left with which to pay the taxes.

With the ability to assess the amount of the restitution order, the IRS could decide not to spend revenue agent time assessing additional taxes it will never collect. It could also decide not to spend significant revenue officer time chasing after a taxpayer who is in jail or just out of jail looking for their assets. With the new power to assess, it would seem logical for the IRS to convene a team of its employees at the end of the criminal case to make a decision, in conjunction with the probation officer, whether this taxpayer is worth any further expenditure of resources or whether the existence of the assessment, the subsequent notice of federal tax lien and the payment on the probation order represents the best the IRS is likely to do in that case. If so, the IRS could stand down further use of its resources awaiting a review of the case several years in the future.

I have not seen evidence that the IRS has adopted an approach similar to what I suggest here. I say that because the low income taxpayer clinic I direct has a few post-tax crime conviction clients who the IRS continues to pursue with revenue officer resources. These individuals have outstanding liabilities that merit attention from a revenue officer from the perspective of the total amount owed but they have nothing to offer to satisfy the liability except the meager payments they already make on the restitution order itself.

Probation officers work with these individuals to determine the amount they can pay toward the restitution order. They base their determination on factors similar to those used by revenue officers. Having revenue officers chase after these individuals to try to collect more taxes when the probation officer has already caused them to commit the maximum possible amount (and sometimes beyond) of the income to the restitution order makes little sense to me. In this context, I read the March 4, 2014, change to IRM 5.14.4 “Interim Guidance on Establishing Installment Agreements on Restitution-Based Assessments and Related Civil Assessments.” Before commenting on the new IRM guidance, I do want to mention that some convicted individuals do continue to have significant assets either under their direct ownership or held by nominees. I think the IRS should continue to pursue those individuals to the full extent of its powers. My comments here reflect a concern that the IRS does not triage these cases at the appropriate stage to determine which individuals have assets making it worthwhile to go full out and which individuals have little or nothing left with few prospects of additional income or assets with which to pay the tax.

New Manual Provisions for Establishing Installment Agreements in Restitution Based Assessments

The new manual provisions refer to the position of Advisory Probation Liaison (APL). They may be found at found here. The provision states:

Probation controls on taxpayers convicted of tax crimes are handled by Advisory. Probation cases with IRS-related conditions are monitored by Advisors designated as probation liaisons. The Advisory probation liaison is responsible for :

  • coordinating any civil enforcement actions with Technical Services (Exam) and any revenue agent assigned to the case,


  • monitoring all cases with IRS-related conditions of probation and following up on any OIs issued to the field exchanging information with CI and Technical Services (Exam) to reconcile the status and actions pending in all probation cases on a semi-annual basis


See IRM, Advisory Actions – Probation Cases, for further procedural guidelines.

The manual describes APL as a coordinator of action but does not seem to vest this advisor with the ability to make decisions on whether to work or walk away from a case. Maybe I am pessimist but I think that very few restitution based assessments will result in an installment agreement. The taxpayer resides in a prison or has recently resided there, almost always has a fairly decent sized liability since little point exists in prosecuting someone with a small liability and usually has no job or a poorly paying job. This situation does not generally cry out for an installment payment that will fully pay the liability. Add to that mix the fact that the individual will usually have the equivalent of an installment payment due to the probation officer as a restitution payment and that payment was set based on the individual’s ability to pay. To have a successful installment agreement, the IRS must find the post-conviction taxpayer who convinced the probation officer that he could not pay more toward his restitution each month but who actually has enough additional money each month to pay the IRS at a rate that will satisfy the assessment in full within 10 years.

The new manual provision requires the assignment of a revenue officer to any effort to establish an installment agreement in these cases. This provision makes sense because of the restrictions on collecting restitution based assessments. Putting the collection of these assessments into the hands of the Automated Call Sites would not work. These assessments require special handling because the IRS cannot compromise restitution based assessments. Compromising such assessments would amount to the IRS undermining the restitution order of the district court judge. So, the language of the new manual provisions carefully describes the need for installment agreements of these assessments that will fully pay the liability over the life of the assessment and not partial pay installment agreements. It does contemplate the possibility that the installment agreement might include assessed liabilities in addition to those assessed through the restitution process and that a partial pay installment agreement could work for those additional assessed liabilities.

The new manual provision requires the revenue officer to work closely with the Advisory Probation Liaison who will know the conditions of probation and who should coordinate with the Department of Justice and the personnel assigned there to work the case. If you are representing a taxpayer against whom a restitution based assessment exists, the best course of action for dealing with the IRS might involve locating and working directly with the Advisory Probation Liaison. Individual Revenue Officers may face few of these type cases and have little training on how to address them. They may the taxpayer to provide significant documentation to complete their files when the advisor may have a much better understanding of the entirety of the circumstances.

Realistic Options Facing the Taxpayer and the IRS Following Restitution Based Assessments

Where a restitution based assessment exists, the taxpayer has few realistic collection options. Offer in compromise is not available because compromising the liability amounts to the IRS undercutting the court’s restitution order. For the same reason a partial pay installment agreement will not work. Installment agreements will rarely work for the practical reasons discussed above. With the possibility of an offer or the likelihood of an installment agreement, the IRS and the taxpayer are left with currently not collectible coupled with a notice of federal tax lien. Some post-conviction taxpayers have sufficient assets to draw upon to partially or fully pay the liability. Some will have jobs that pay a good salary although even those individuals may not have anything left each month after making their restitution payments.

This manual change recognizes the legal need for special handling of restitution based assessments. It does not recognize the practical issues presented. The real collection success stories that will result from restitution based assessments will not come in the installment agreement area. They will come because of the early intervention of a revenue officer working with a Chief Counsel attorney finding hidden assets and using the federal tax lien coupled with the tools for recovering transferred assets. The IRS should focus its efforts on post-conviction taxpayers who have either transferred assets or have sufficient assets remaining which they have not voluntarily liquidated to satisfy the liability. Efforts to obtain installment agreements from this group seem like wasted efforts.

Summary Opinions for 11/29/2013

Happy Holidays!  Sorry for the delay in posting, hectic weekend, but what a great weekend.  Thanksgiving, the start of Hanukkah, Keith had his first grandson, and it seemed like every third car had a Christmas tree tied to the top.  Although it was a short week, there was still some excellent procedure news.  Let’s start with a few Thanksgiving related items.

  • I found this estimate of the amount of taxes paid on the average Thanksgiving dinner on Accounting Today.  The Tax Foundation has a summary of travel taxes and tolls (road taxes) for travel along the northeast found here.  I’m not sure how accurate either are, but interesting posts about Thanksgiving and taxes.
  • Jack Townsend’s Tax Procedure Blog has a summary of Eichelburg v. Comm’r, where the taxpayer’s claim was tossed for failing to timely file under the timely mailing is timely filing rule in Section 7502.  His sin—thriftiness (and not following the rules).  He went for the FedEx Express Saver, which is not an enumerated acceptable private delivery service under Notice 2004-83.
  • From the Freakanomics blog, a podcast regarding fighting poverty. This post has to do with charity, but I think the concepts apply to the reallocation of assets (EITC) under the Code and the incentives that could raise a family up the socioeconomic ladder (student loan interest deduction, mortgage interest deduction).  Oversimplifying the post, cash infusions are great at doing certain things like eliminating a current need, but not very good at assisting a family in moving out of poverty.  Although this is not a stunning revelation, the stories and examples are very interesting, and made me wonder if we had good evidence behind a lot of the incentives and deterrents under the code.  More behavioral economics.  Perhaps we should change this to a behavioral economics blog.
  • MauledAgain has a discussion of the Tax Court’s holding in Jibril v. Comm’r, where the Court disallowed dependency exemptions for a taxpayer’s cousins.  The Court held that cousins did not fall within “qualifying children” under Section 152(c)(2) or “qualifying relatives” under Section 152(d)(2).  Although this is not a novel holding, the last paragraph of Jim Maule’s post highlights the Court’s comments regarding the “sympathetic” taxpayer, and outlines some suggestions  from Professor Maule on how to eliminate the harsh application of the statue when family members are supporting family members not specifically outlined in the statute.
  • Messrs. Lipton, Richardson, and Jenner, attorneys at Baker & McKenzie, have written an article published at 119 Journal of Taxation 267 (December 2013), about the Tax Court holding in Barnes Group, Inc. v. Comm’r, concluding that the Tax Court wrongly applied the step transaction doctrine and discussing the imposition of penalties even though the taxpayer had a “substantial authority” opinion from PWC.  The Baker attorneys disagree with the collapsing of the transaction under step-transaction, arguing that the transaction was very similar to a Rev. Rul. previously issued, and the differences were minor technicalities. What caught my eye was the discussion regarding the imposition of penalties even though PWC had issued a substantial authority opinion.  Initially, I thought this was going to be more like the Canal Corp case, where the Court found the messy, aggressive opinion by PWC was not reasonable to rely upon.  However, upon reviewing Barnes, the holding regarding the penalty was that Barnes failed to follow PWC’s advice when it did not comply with the “mere technicalities”, and waived its right to rely on PWC’s opinion.  The Baker attorneys felt reasonable cause should be available, since the taxpayer relied on a competent advisor and that this opinion created substantial issues regarding advisor reliance.  I, personally, thought the step-transaction doctrine was the key, and the case did not tread any new ground on advisor reliance.
  • The Tax Court, in Meyer v. Comm’r, remanded a case back to Appeals for review after the SO failed to properly verify that statutory notice had been issued after the IRS issued a substitute for return.  The case has a good discussion of the IRS procedures in this area, including how an SFR relates to a stat notice and how Appeals is supposed to verify that the IRS issued a stat notice when the taxpayer claims to have not received it.  In light of Appeals not having adequately verified the stat notice’s issuance, there was also a discussion regarding whether the Court should remand or simply hold for the taxpayer. In this case, the Tax Court remanded, though it suggested that in the future, it may toss not remand and find for the taxpayer, and invalidate the assessment. If time permits, we may have more on this case later in the week or next week.
  • Chief Counsel has issued advice, found here, regarding whether the Service must apply restitution payments required because of corporate income tax to the income tax, or whether it may be applied to other unpaid liabilities.  Counsel determined that the Service can apply the payments as involuntary payments, in the Service’s best interests.  Counsel relied on US v. Pepperman, out of the Third Circuit, which held that involuntary payments are defined as “any payment received by…the United States as a result of distrait or levy or from a legal proceeding in which the Government is seeking to collect its delinquent taxes or file a claim therefor.”  Counsel determined that restitution only comes from court orders or settlements, and therefore was an involuntary payment.  I would be surprised if there was not some argument to the contrary. This notice relates to restitution that arose prior to the effective date of Section 6201(a)(4), which allows IRS to assess certain orders of restitution.  Either way, practitioners should be cognizant of this issue. Saltzman and Book Chapter 10 (revised and coming out next month) has a thorough discussion on the new restitution provisions, and I suspect a post on this coming up soon.
  • Last week we touched on Notices 2013-78 and 2013-79, which contained draft procedures for seeking competent authority assistance and advance pricing agreements.  KPMG provides a small summary of some of the changes in the new notices. I will either try to provide more information regarding these notices in the coming days and weeks, or find other good summaries, as the changes are substantial and important.