Earlier this week, the Court of Federal Claims in BASR v. United States held that the Section 6501(c) provisions extending the statute of limitations for an unlimited time in fraud cases required an “intent to evade tax” by the taxpayer, and was not extended to fraudulent behavior by a third party. I write to add a little context showing why this is much more than just a technical statutes of limitation issue, and because for those who like just technical issues we recently updated the subchapter on statutes of limitation in Saltzman and Book’s IRS Practice & Procedure to consider the Second Circuit’s City Wide v Commissioner decision (which had reversed the Tax Court).
read more...The BASR case is getting significant attention—see, for example, Jack Townsend’s blog post on the issue. Jack’s post does an excellent job discussing the case’s interplay with the TEFRA provisions under Section 6229. He deftly analyzes prior cases such as Allen v Commissioner, where the Tax Court reached a contrary result. In BASR, the taxpayer entered into a, to steal Jack Townsend’s term, bulls**t tax shelter, by contributing cash and short positions in treasuries, which he claimed increased his basis in the entity. As most tax procedure buffs know, the Service had taken the position that an overstated basis could trigger an underpayment of more than twenty five percent of the tax due, thereby triggering a six year statute on assessment; however, during the pendency of the litigation, Home Concrete was decided by the Supreme Court, rendering that argument no longer viable. After losing the Home Concrete issue, the IRS in BASR argued that the unlimited statute of limitations due to fraud applied given the actions of the taxpayer’s agent, i.e., the lawyer who structured the bulls**t tax shelter.
As to context, this is yet another battle in the war that the IRS is fighting against unscrupulous third parties that advise taxpayers. BASR involves a fancy tax shelter implicating crazy amounts of fees and tax at issue. Yet, the issue is not limited to preparers and advisors taking advantage of legal ambiguities, exploiting technical rules, and designing deals that require three whiteboards to diagram. While BASR implicates sophisticated taxpayers, the IRS’ legal argument here is essentially the same it has made in cases that relate to unsophisticated taxpayers, where there is a low absolute amount of tax at issue and fairly unambiguous legal issues. I say absolute because assessments in low dollar cases where taxpayers are duped by preparers, such as in some EITC cases, can have devastating impact on those individuals even if the amount at issue is only a few thousand dollars.
An example of a different this issue coming up in less sophisticated matters is Eriksen v Commissioner, a memorandum Tax Court decision from 2012, which involved low dollar phony Schedule C expenses claimed by employees of the Oakland County Sheriff Department. The taxpayers in Eriksen used preparers who plead guilty to aiding and assisting in the preparation of a false federal income tax returns in violation of Section 7206(2). In Eriksen, the Tax Court applied Allen to find that a preparer’s fraud could extend the statute, but held the IRS had not met its burden to show that that the preparer’s actions in the particular returns at issue amounted to fraud rather than negligence. In other words, a preparer’s fraud on some returns was insufficient to taint other returns, even if those other returns had errors of the type that were implicated in the criminal case against the preparers.
As to what we wrote in Saltzman and Book’s IRS Practice & Procedure on City Wide, see below, which is excerpted from the Chapter 5.03[1][a] False or Fraudulent Returns. The citations are omitted, and the reader is directed to the source itself for the footnotes:
Compare Allen with City Wide v. Commissioner, where the Tax Court, looking at the statute of limitation extension attributable to willful attempts to defeat or evade under Section 6501(c)(2) (applicable to returns other than income or estate or gift tax returns), held that the IRS could not assess tax after the three-year statute expired, despite the preparer pleading guilty to the criminal offenses of money laundering and knowingly signing and preparing false employment tax returns. In City Wide the accountant took the taxpayer’s correct payroll tax returns and checks made out to the IRS for the correct amount of liability, and filed fraudulent employment tax returns reflecting lower liabilities. The accountant cashed checks the taxpayer had endorsed to pay the IRS, remitted lesser improper amounts, and pocketed the difference.In City Wide, the Tax Court distinguished Allen because the Service failed to prove that the accountant’s conduct reflected an intent to defeat or evade tax, rather than an effort to cover up his embezzlement scheme. It is hard to see how this distinction matters in light of Allen’s rationale that the unlimited statute of limitations arises due to the Service’s disadvantage in investigating and detecting erroneous returns that have fraudulent positions.In addition to the arguable inconsistency in the Tax Court’s approach, there are other provisions the government has at its disposal to combat improper third party conduct (such as return preparer penalties and restitution) that seem more directly targeted to the culpable actors, and the fraud penalty itself under Section 6663 not triggered by fraudulent third-party actions. On appeal, the Second Circuit reversed the Tax Court and found that the accountant’s actions extended the statute indefinitely.The Second Circuit criticized the Tax Court for confusing motive and intent and held that the preparer’s motive for his action was beside the point. The Service only had to prove that the third party “intended to underpay the Commissioner taxes that City Wide owed when he filed a fraudulent return on City Wide’s behalf, not that he intended to avoid City Wide’s taxes for City Wide’s benefit.” In light of the taxpayer’s concession that the accountant filed false returns on its behalf (which was not made at the Tax Court), the court said it need not decide “whether certain factual situations might arise that sever the taxpayer’s liability from the tax-preparer’s wrongdoing.” The Court stated that the preparer’s actions were not remote or secondary to the fraudulent returns, though it did suggest that not all third-party fraudulent misconduct would by itself trigger the extended statute. Attributing a third-party’s fraud to the taxpayer for statute of limitations purposes gives the Service a powerful weapon, though it is unclear how far removed the third-party misconduct must be from the taxpayer’s tax liability in order to sever the unlimited extension.
Saltzman & Book, IRS Practice and Procedure, at Chapter 5.03[1][a] False or Fraudulent Returns
As Jack Townsend writes in his blog, I too am not sure how this issue will be resolved. I note that Bryan Camp, one of the most thoughtful commentators on tax procedure, has written an article in Tax Notes, where he discussed the legislative history and the policy in favor of closure such that the “fraud exception should be read to refer to the taxpayer’s fraud” and not any other party. See Bryan Camp, Presumptions and Tax Return Preparer Fraud, 120 Tax Notes 167 (2008). Last year, Jeremiah Coder wrote an article discussing inconsistent informal Service positions on the issue prior to Allen. He suggested that the Service approach may punish unsophisticated taxpayers. See Coder, The IRS’s Misguided Fraud Whodunit, 137 Tax Notes 7 (2012).
Coming on the heels of the oral argument in Loving last week, this issue implicates the important relationship of preparers and tax advisors to tax administration. IRS, as it gets more sophisticated in capturing data on preparers in light of its PTIN requirements (which recall are not impacted by Loving), is likely to be better equipped to track down taxpayers who may have used unscrupulous preparers. Detecting fraud though is never easy, and that is part of the reason why IRS wants the unlimited time to assess tax on returns tainted by an agent’s improper conduct. BASR presents a potential obstacle in the form of a contrary judicial statutory interpretation from that of the Tax Court and the Second Circuit. I suspect this is not the last we will hear from the courts on this issue.
About Leslie Book
To clarify, for careful readers of the Eriksen case, the 2012 Tax Court decision I describe in my post, the opinion nicely describes what the IRS must prove. According to the court, IRS “must prove for each return at issue that (1) an underpayment of tax exists, and (2) the return preparer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of tax.”
There were six taxpayers whose cases were consolidated in the Eriksen case. For five of the taxpayers, the IRS failed to prove the preparer’s intent to evade taxes; for one of the taxpayers, it did. The one where the court found IRS met its proof involved a taxpayer who credibly testified she never owned a gun in the years in question and she told as much to the preparer. Yet, the preparer put on the return as an unreimbursed employee expense the costs of ammunition and gun purchases. In light of that, the court stated that the return’s “entries were admittedly fictitious and obviously not able to be substantiated with supporting records.” It inferred that the preparer intended to evade taxes known to be owing from the taxpayer “by conduct intended to conceal, mislead, or otherwise prevent the collection of tax.” As such, the unlimited statute of limitations on assessment was applied to one of the six taxpayers in the Eriksen case.
The judge’s opinion in BASR cries for reversal. In his blog post, Professor Townsend correctly notes that section 6501(c)(1) applies when a return is fraudulent, and calls for no inquiry into the taxpayer’s subjective state of mind with the aim of finding a specific intent to defraud the Treasury.
As Townsend points out, the BASR opinion goes astray when the judge reads the last sentence of section 6501(a) to imply that fraudulent intent of the taxpayer is necessary for section 6501(c)(1) to apply. The court’s interpretation of section 6501(a)’s last sentence also conflicts with the case law holding that information disclosed on a partnership return is deemed to be information disclosed on the partner’s return for purposes of determining whether the adequate disclosure exception to the 6-year statute of limitations under section 6501(e) applies to the partner (at least where the partner’s return properly identifies the related partnership), e.g., Harlan, 116 T.C. 31. It makes no sense to say that a fraudulent disclosure on a partnership return is attributed to a partner for purposes of section 6501(e), but not section 6501(c)(1). See Badaracco, 464 U.S. at 395-96 (stating that sections 6501(c)(1) and 6501(e) should not be interpreted to produce inconsistent treatment of taxpayers).
Another curious omission is the BASR court’s failure to mention who signed the two Forms 1065 on behalf of the partnership. The opinion states that the elder Pettinati “filed” the two partnership returns at issue, but not whether he signed them. It appears that Mr. Pettinati did in fact sign both partnership returns (which were filed with the court as exhibits to the taxpayer’s summary judgment motion and can be viewed on the court’s ECF website). According to the jurat, Mr. Pettinati reviewed the partnership returns before signing them and asserted his belief that the returns were true, correct, and complete. In Allen, the Tax Court found the taxpayer’s signature on a return, subject to the jurat, to be a factor supporting the application of section 6501(c)(1), even though the return preparer allegedly was responsible for the fraudulent contents of the return. The BASR court did not address the significance of Mr. Pettinati’s signatures on the partnership returns, or his review (if any) of the returns before he signed them. Oddly, the government did not raise the issue in its brief.
Next, assuming for discussion’s sake that section 6501(c)(1) requires a finding of specific fraudulent intent on the part of the taxpayer, when should a return preparer’s fraud in preparing the return be imputed to the taxpayer? The answer should not be “always” or “never,” because it turns on the facts and circumstances of each case. Indeed, BASR, Allen, and City View involved materially different facts. As a result, these cases suggest no all-or-nothing split of authority.
Should the return preparer’s fraud be imputed to the taxpayer as a matter of law under an agency theory? An agency analysis is consistent with the City View decision. The owner of a corporation hired a return preparer who prepared fraudulent corporate employment tax returns, signed them, and filed them with the IRS. Corporations of necessity act solely through agents. Obviously the fraudulent return preparer did not act outside the scope of his agency by preparing and filing the corporation’s employment tax returns. It’s also important to keep in mind that the issue was whether section 6501(c)(1) allowed the IRS to assess the employment taxes against City Wide, not whether the IRS could make section 6672 assessments against City Wide’s owner for the trust fund portion of the employment taxes.
Alternatively, as a factual matter, one could impute the return preparer’s fraud to the taxpayer if the evidence supports a finding that the taxpayer had constructive knowledge of the fraud. This approach would involve a traditional “badges of fraud” kind of inquiry. But the plain text of section 6501(c)(1) does not suggest Congress had such an inquiry in mind.
Richard—thank you for your thoughtful comment.
BASR raises a very difficult issue, with arguments relating to statutory interpretation, maxims of construction and policy arguments on both sides. I think Bryan Camp’s articles from 2008 and 2007 in Tax Notes present the arguments against the position you espouse better than the BASR opinion. Camp, Presumptions and Tax Return Preparer Fraud; Bryan T. Camp, Tax Return Preparer Fraud and the Assessment Statute of Limitations. (Both pieces are on ssrn and downloadable–see http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=364489)
The articles, as is typical with Professor Camp’s work, approach the issue from a number of different perspectives, including statutory analysis, the use of presumptions , and whether as a policy matter, it is good tax administration for the IRS to attack old liabilities absent fraud of the taxpayer.
As to the policy, I am sympathetic to the IRS’s efforts. I am convinced that preparers, and other third parties, have an outsized influence on taxpayer decisions to comply with the law. I think that is true both with respect to complex issues like that in BASR, and also less complex issues like that in Eriksen I describe in the post. Yet, as to the latter cases, I am more wary of the power and effect of an unlimited statute, as I suspect the degree of taxpayer culpability is less and the impact of an assessment greater.
As to the legal issue, I will not repeat all of Professor Camp’s analysis, though he convinces me that the plain language and legislative history of the 6501(c) suggest that the fraud at issue should be that of the taxpayer, and not a third party.
As to what presumptions the courts should consider in this issue, I point to one part of Camp’s 2008 article. There, he compares the IRS position in Allen with the Lauckner case. In Lauckner (a case I worked on in practice with the late Michael Saltzman), in the 1990’s the IRS argued that because responsible persons did not file a return–the liability derived from the employer’s Form 941–there was no sol on assessment. IRS, as Camp said
“asserted a bold new position: The section 6501(a) limitation period did not apply to section 6672 assessments. Raising the Badaracco banner, the IRS assaulted its own long-held interpretation. The IRS argued — sensibly enough if one were writing on a blank slate — that because people did not report their actual conduct on the Form 941, those returns could not serve the function of a return that would trigger a limitations period. In fact, there simply was no form that could function as “the return” necessary to trigger section 6501(a). Just as taxpayers did not report fraud on “the return,” they did not report a willful failure to account for or pay over.
In the district court opinion, Judge Sarokin stated that “[w]here no fraudulent conduct on the part of the taxpayer is alleged, taxing acts, including provisions of limitation embodied therein, are to be construed liberally in favor of the taxpayer.”
You make strong arguments as to why the BASR case should be reversed. This is a tough issue. There are presumptions and statutory constriction maxims that will favor the IRS position. I suspect that courts will be wrestling with this for some time.
Les, many thanks for raising this interesting issue. I read Professor Camp’s articles on this subject back in 2007 and 2008, and revisited them tonight. Even though I don’t agree with all that he says, Camp argues persuasively.
Let me raise a couple more textual considerations (neither of which were mentioned by the BASR court).
Section 6501(c)(1) applies to “a false or fraudulent return with the intent to evade tax,” but is silent on whether “the intent to evade tax” must be the taxpayer’s intent. In contrast, section 6229(c)(1) applies “[i]f any partner has, with the intent to evade tax, signed or participated directly or indirectly in the preparation of a partnership return which includes a false or fraudulent item.”
Section 6229(c)(1) seems specifically tailored to the fact pattern in BASR, especially since the statute draws an important distinction between partners who sign or participate in the preparation of a fraudulent partnership return, and are subject to an unlimited statute of limitations under section 6229(c)(1)(A), and other partners who are subject to only a six-year limitation period under section 6229(c)(1)(B). Giving section 6229(c)(1) controlling weight would seem to raise a conflict, however, with the generally settled principle that the limitation period under section 6229 does not displace the otherwise applicable section 6501 limitation period; that is, section 6229 may only lengthen, not shorten, the section 6501 period (e.g., Rhone-Poulenc, Andantech, AD Global, Curr-Spec). More on this in a moment.
The distinctive phrasing of section 6229(c)(1) may buttress the government’s view that section 6501(c)(1) does not require the government to show the taxpayer (as opposed to the return preparer) had “the intent to evade tax.”
On the other hand, if section 6501(c)(1) does not require the taxpayer to have “the intent to evade tax,” and section 6501 trumps section 6229, that renders section 6229(c)(1)(A) meaningless. (As an aside, section 6229(c)(1)(B) would not be rendered meaningless because it would extend the three-year period under section 6501(a) to six years for partners who played no role in the fraudulent partnership return.) The rationale that undergirds the Rhone-Poulenc line of cases – that the purpose of section 6229 is to lengthen the section 6501 period in certain situations involving partnership returns – is simply irrelevant. It is nonsensical to speak of lengthening the unlimited period under section 6501(c)(1).
Section 6229(c)(1)(A) could lengthen the normal three-year limitation period under section 6501(a), but, again, that result would cause section 6229(c)(1)(A) to displace section 6501(c)(1), contrary to the Rhone-Poulenc line of cases.
The taxpayer in BASR argued that the government’s position rendered section 6229(c)(1) meaningless. In a strange turn of events, the court’s opinion gave that argument, and section 6229(c)(1) itself, no meaningful consideration. Unlike the court’s stated reasoning, which fell short in several ways, the taxpayer’s argument concerning section 6229(c)(1) provided considerable support for the court’s ultimate decision.
The bottom line is that BASR presents an issue that may require courts to re-examine, at least in the context of fraudulent partnership returns, the reasoning of the Rhone-Poulenc line of cases.