We welcome first time guest blogger Matthew Mueller. Matt practices in Florida representing individuals with tax issues and white collar crime issues. Prior to moving to private practice, he had the perfect background for the work he currently does. He represented the IRS in criminal prosecutions at the Department of Justice Tax Division, Criminal Section and then he moved to the United States Attorney’s Office in Tampa. He brings to this discussion of disgorgement over a decade of experience with these types of cases both inside and outside the government. Keith
As this blog has covered previously, the Department of Justice Tax Division has increasingly sought disgorgement from tax return preparers in civil injunction cases. This growing trend has been on display nationwide, but especially in the Middle and Southern Districts of Florida. While the government experienced some initial growing pains in court—see this prior post discussing an MDFL case in which the district court denied disgorgement—the effort to disgorge return preparers from their profits has continued. Last month, the Eleventh Circuit Court of Appeals issued an unpublished opinion in United States v. Stinson affirming the district court’s judgment entering a permanent injunction against the return preparer and affirming a $949,952.47 disgorgement order. Armed with favorable appellate precedent, return preparers and owners of tax preparation businesses should expect to see the government continue this trend.
read more...What is disgorgement?
Disgorgement is an equitable remedy employed by courts to prevent unjust enrichment. Case law defining the contours of disgorgement has largely evolved out of civil enforcement actions brought on behalf of the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and the Federal Trade Commission (FTC). Relying on precedent from the securities fraud context, the Eleventh Circuit in Stinson described disgorgement as follows:
“Disgorgement is an equitable remedy intended to prevent unjust enrichment.” S.E.C. v. Levin, 849 F.3d 995, 1006 (11th Cir. 2017) (quoting S.E.C. v. Monterosso, 756 F.3d 1326, 1337 (11th Cir. 2014)). To be entitled to disgorgement, the Government need only produce a reasonable approximation of the defendant’s ill-gotten gains. See S.E.C. v. Calvo, 378 F.3d 1211, 1217 (11th Cir. 2004). “Exactitude is not a requirement; so long as the measure of disgorgement is reasonable, any risk of uncertainty should fall on the wrongdoer whose illegal conduct created that uncertainty.” Id. (quotation marks omitted and alterations adopted).
United States v. Stinson, 2018 WL 2026928, at *6 (11th Cir. May 1, 2018). The Stinson Court affirmed that disgorgement was an available remedy under Title 26, United States Code, Section 7402(a).
Having established the authority to disgorge profits from a return preparer, the Court in Stinson went on to discuss the boundaries of this remedy in, at times, conflicting terms. The Court first points out that disgorgement is limited to the amount the defendant “profited from his wrongdoing.” Id. At the same time, the Court also asserts that courts have accepted gross receipts as a reasonable approximation of disgorgement “in cases involving the operation of a fraudulent business.” Id. The theory being that “wrongdoers are not entitled to deduct costs associated with committing their illegal acts.” Id. While gross revenue in a wholly fraudulent business might be a reasonable approximation of ill-gotten gains or profit, the issue is more complicated when applied to businesses that engage in legitimate business activity in conjunction with the alleged instances of fraud. In those instances, the government must show a link between the disgorgement amount they seek and the alleged fraudulent transactions.
Another outer boundary applicable to disgorgement is the five year statute of limitations found at Title 28, United States Code, Section 2462 for “an action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture.” In 2017, the Supreme Court rejected the SEC’s argument that there was no statute of limitations for disgorgement in securities fraud cases. Kokesh v. S.E.C., 137 S.Ct. 1635, 1645 (2017). In applying the five-year statute of limitations in Kokesh, the Court stressed that disgorgement “bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate.” Id. at 1644. While the Court was addressing disgorgement in SEC cases in Kokesh, the rationale extends to disgorgement sought in tax preparer injunction cases in all significant respects.
How does the government prove disgorgement?
As the government has increasingly sought disgorgement in tax return preparer cases, district courts have predictably undertaken a highly fact-intensive inquiry into the amount of disgorgement sought. As a result, in United States v. Mesadieu the district court refused to order disgorgement because the government failed differentiate between compliant and noncompliant returns and asked the court to extrapolate from one tax year and one geographical area. 180 F.Supp.3d 1113 (M.D. Fla. 2016). Yet in Stinson, the very same district court judge in Orlando awarded $949,952.47 out of the greater than $1.5 Million sought by the government at trial. The trial in Stinson spanned six days and included testimony by more than 15 taxpayers and deposition testimony by 41 witnesses including taxpayers. That disgorgement figure included so-called “Category 1” calculations based on 1,861 returns containing unreimbursed business expenses on Schedule A. The total disgorgement amount also included “Category 2” calculations based on returns prepared by Stinson himself, as opposed to his employees. The Eleventh Circuit found these calculations reasonable and supported by the record.
The Eleventh Circuit also disposed of Stinson’s argument that disgorgement could only include fees from tax returns specifically proven to be false returns. The Court invoked as an analogy the United States Sentencing Guidelines–for the proposition that only a reasonable estimate was required:
Although this was a civil matter, in the analogous criminal context, the U.S. Sentencing Guidelines “do not require that the sentencing court calculate the amount of loss with certainty or precision … [but only] a reasonable estimate based on the available facts.” United States v. Bryant, 128 F.3d 74, 75-76 (2d Cir. 1997). As we have held, a trial court may extrapolate from available evidence, and such extrapolation may occur without interviewing every customer and preparer for every allegedly false or fraudulent return. See United States v. Barber, 591 Fed.Appx. 809, 823-24 (11th Cir. 2014).
Clearly, the government’s ability to prove disgorgement in a given case will depend on its ability to demonstrate patterns and to persuade the court to make reasonable extrapolations from known samples.
Conclusion
In addition to defending against possible injunctions, and criminal charges in select cases, tax return preparers will have to continue to contend with disgorgement for the foreseeable future. The Department of Justice undoubtedly hopes the pain of separating preparers from their profits will serve as an additional deterrent against business practices that do not otherwise appear to be on the wane. Restitution is available as a remedy in criminal preparer prosecutions, but even that has posed some problems for the DOJ and IRS, see here, for example. In the meantime, practitioners who represent return preparation businesses and their owners can learn from cases like Stinson and the more developed body of law in the securities fraud context for guidance on how disgorgement should and should not be computed.
Thanks, Mr. Mueller, for this significant story. But the headline should be, “How to make a million dollars in three years and avoid jail.” The questions it raises are: Why did it take two years for IRS to detect massive preparer misconduct, and three years to shut it down? For those who didn’t click on the link, here from the opinion are the case’s “factual background and procedural history.”
“Stinson began his tax preparation career in 2010 as a manager for LBS Tax Services (“LBS”), a storefront tax preparation business based in Orlando, Florida. Without prior experience or training in tax return preparation, in 2011 and 2012, he personally prepared individual tax returns for hundreds of customers. By 2013, Stinson had become a franchise owner of ten LBS stores with locations in Florida, Georgia, Alabama, and North Carolina. Situated in low-income areas, Stinson’s stores engaged in aggressive, “guerrilla marketing” and directly targeted “underprivileged, undereducated poor people.”
“The practice at Stinson’s stores was to not charge an upfront fee for each tax return prepared for a customer but to extract the fee from the customers’ tax refunds. He often charged in excess of $600 per return, sometimes as much as $999, usually without informing the taxpayer of the fee amount. The goal was to secure the maximum refund to satisfy the customer and deduct a larger fee. To this end, Stinson and his tax preparers would falsify customers’ information to claim the maximum earned income tax credit (“EITC”) by: claiming fictitious dependents, fabricating unreimbursed employee business expenses and charitable contributions, and falsifying business income or expenses.
“The Government filed a complaint in 2014 seeking, under §§ 7402, 7407, and 7408 of the Internal Revenue Code (“I.R.C.”), to enjoin Stinson, “individually and doing business as LBS Tax Services and Nation Tax Services, LLC,” from “acting as a federal tax return preparer or requesting, assisting in, or directing the preparation or filing of federal tax returns, amended returns, or other related documents or forms for any person or entity other than himself.” Specifically, the Government alleged that Stinson:
“1. falsified deductions on Form 1040 Schedule A to reduce customers’ taxable income by reporting personal expenses as business expenses and falsified unreimbursed employee expenses and charitable contributions;
“2. falsified Form 1040 Schedule C deductions by fabricating businesses and reporting profits or losses from a false business or inflating profits and losses from an actual business;
“3. claimed false education credits;
“4. falsified customers’ earned income tax credits;
“5. failed to conduct proper due diligence; and
“6. failed to disclose fees and provide customers complete copies of their tax returns.”
“. . .In 2015, the Government asked the district court to preliminarily enjoin Stinson from employing his tax return preparation business in order “[t]o prevent Stinson’s continued and repeated fraud” during the pending trial proceedings. The district court granted this motion, and Stinson filed an interlocutory appeal. In September 2016, we affirmed the preliminary injunction.”
For the story behind the story, I found an article in the Tampa Bay Tribune from March 2017. The (civil case) defendant turns out to have been 25 years old when he started his career in tax return preparation, and only 28 when he owned the multistate chain of shops. He had a degree from the University of South Florida, in criminology.
Is he devastated by the news that he is permanently enjoined from preparing tax returns? The Court notes, “the injunction does not prohibit Stinson from pursuing other ventures, such as his real estate rental business.” And he does not have to disgorge the profits he may have made in the last six years from investing his tax-preparation fees in real estate. The House Price Index for Florida (source: Federal Reserve Bank of St. Louis, “FRED”) has increased 65 percent from the second quarter of 2012 to the first quarter of 2018.
The only losers in this case might be the thousands of taxpayers whose returns were audited when IRS slowly pursued this case.
And was it IRS sleuthing that uncovered this problem in 2014? More likely, they were just watching television news when the media found it, starting in 2010. A story from the ABC affiliate in Orlando reported in June 2013:
ORLANDO, Fla. – Action 9 first exposed LBS Tax Services three years ago when people who used the business to file their federal returns said they had been slammed with phony fees.
The company is being investigated by Orlando police and the attorney general on charges of fraud, racketeering and money-laundering.
Action 9’s Todd Ulrich was there Tuesday when Orlando police and state investigators raided LBS Tax Services headquarters and the home of its president.
Officials said there could be hundreds of victims, even beyond Florida.
“The main office for dozens of LBS Tax Services locations in several states is pretty much empty Tuesday after investigators seized tax returns, records and computers in a major fraud investigation. Investigators served search warrants at the headquarters and four other locations. No one at LBS Tax Services is talking.
“Since 2010, Action 9 investigations found consumers who thought they paid $75 for tax preparation, then said the company took hundreds out of their tax refunds. Investigators said LBS Tax Services trained many of its employees how to hide fees and cheat hundreds of customers.”
Matt,
Thanks for highlighting this little-known (or used) area of the law. One has to wonder why the government didn’t pursue a criminal prosecution of the defendant, given the extensive resources that it obviously took to obtain a $900K-plus disgorgement judgment.