The Treasury Inspector General for Tax Administration Issued a report to the IRS Commissioner on  May 23, 2019 pointing the way to increasing the efficacy of its Information Referral  Program to increase tax compliance and raise revenue.

The IRS has long had a program where the public could report  to the IRS alleged non-compliance with the tax laws. IRS received almost 300,000 Information Referrals in the last four fiscal years.  These Information  Referrals, filed on Form 3949-A, can range from claims of false exemptions or deductions, unreported income or failure to withhold tax — employment or otherwise. These forms are processed at a central Service Center and reviewed by technicians or examiners depending on the complexity and if the information seems promising, the information is sent out to the appropriate business unit of the IRS for further review and action. These business units could include the Small Business Self Employed, the Wage and Investment Division or even the Criminal Investigation Division. Some of course – those that are not so promising — end up in “retention” for future possible use.

These are not informants’ claims for rewards (although there may be some duplication) but just individuals and businesses providing the IRS information on a confidential basis, such as a disgruntled employee or a competitor who believes it is at a disadvantage.

Figure 1, below, from the TIGTA Report reflects the number of Information Referrals received over the last four fiscal years.

Figure 1: Forms 3949-A Received in FYs 2015 Through 2018

FY Total Receipts
2015 89,213
2016 72,593
2017 67,046
2018 61,890
Total 290,742

Source: Form 3949-A Inventory Reports, as of September 29, 2018.

What is really interesting is the amount of tax assessments made based on these Information Referrals — more than $246 million in additional tax for the fiscal years 2016-2018. Moreover, examinations emanating from Information Referrals produce almost twice as much revenue per examination as other sources of examinations.  This suggests that random public information reporting may be one of the most effective mechanisms of finding non- compliance.

See Figure 4 c, below, from the TIGTA Report.

Figure 4: Form 3949-A Examinations vs Other Sources for Examinations for FYs 2016 Through 2018 

  SB/SE Division W&I Division
  Form 3949-A Other Sources of Examinations Form 3949-A Other Sources of Examination
Total Examinations 6,636 1,214,048 6,750 1,406,448
Total Assessments $200,571,550 $22,329,977,944 $46,425,181 $6,521,042,199
Average Assessment Per Examination $30,225 $18,393 $6,878 $4,637

Source: Accounts Information Management System – Centralized Information System Reports for W&I and SB/SE Informant Examination Closures and Other Examination Closures.

The TIGTA Report has some very good suggestions that the IRS has agreed to implement. These include an online Information Referral portal for taxpayers to use, better communication to the public through its website, and up to date computer tracking — it’s presently largely manual — of the processing and use of these forms.  One might also assume with the computerization of the process, the IRS will be utilizing data analytics to help further develop the program.

Some advice to taxpayers-keep your tax positions to yourself. Many people out there would love to share your secrets with the IRS — even if they aren’t looking for a reward.

STEVEN TOSCHER – For more information please contact Steven Toscher – toscher@taxlitigator.com Mr. Toscher is a principal at Hochman Salkin Toscher Perez, P.C., specializing in civil and criminal tax litigation. Mr. Toscher is a Certified Tax Specialist in Taxation, the State Bar of California Board of Legal Specialization and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at www.taxlitigator.com.

The general rule is that under IRC Section 6672(a), a person “required to collect, truthfully account for, and pay over any tax…who willfully fails to collect such tax, or truthfully account for and pay over such tax” (known as trust fund taxes) is liable for a penalty equal to the total amount of the tax not paid over—even if that person was directed by a superior to not pay the tax.[i]  In Myers v. United States, Docket No 1:16-cv-01792 (11th Cir. May 6, 2019)[ii], the Eleventh Circuit addressed the narrow question of whether there is an exception to that general rule where the order to not pay the taxes came from a government agency.  Holding that the rule applies the same, the Eleventh Circuit affirmed the lower court’s decision rejecting the defense of “my boss told me not to pay,” where the boss in question was the U.S. Small Business Administration (“SBA”), a government agency.

The plaintiff in Myers v. United States was the CFO and co-president of two newspaper publishing companies, which were both owned by a parent company that had been licensed by the SBA as a Small Business Investment Company.  The SBA is an agency of the federal government that helps small businesses in the U.S. to start, build, and grow, by providing loans, loan guarantees, contracts, counseling sessions, and other forms of assistance.[iii]  As a Small business Investment Company, the parent company could issue debentures guaranteed by the SBA, and in turn, the SBA had the power to place the parent company into receivership.

In 2008, after violating the terms of its Small Business Investment Company license, the SBA filed suit in the Southern District of New York to place the parent company into receivership.  The Southern District of New York took “exclusive jurisdiction” of the parent company and all of its assets—including the two newspaper publishing subsidiaries—and appointed the SBA as the parent company’s receiver.  As receiver, the SBA was given “all powers, authorities, rights and privileges…[enjoyed] by the general partners, managers, officers and directors” of the company.

The following year, while the parent company was under the control of the SBA, the newspaper publishing companies failed to pay the required payroll taxes to the IRS, which are trust fund taxes under Section 6672(a).  As CFO and co-president, Myers had signature authority on the companies’ bank accounts, knew the payroll taxes were due, and approved payments to other vendors instead of paying the taxes over to the IRS.  As a result, the IRS assessed the trust fund tax penalties against Myers.  Myers argued that he should not be liable for the penalties because he was told by the SBA—a federal government agency—to prioritize other vendors over the trust fund taxes; however, the Eleventh Circuit held that Section 6672(a) “applies with equal force when a government agency receiver tells a taxpayer not to pay trust fund taxes.”

LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a principal at the law firm of Hochman Salkin Toscher Perez P.C. and represents clients throughout the United States and elsewhere in complex civil tax litigation and criminal tax prosecutions (jury and non-jury).  Ms. Strachan has experience in a wide range of civil and criminal tax cases, including cases involving technical valuation issues, issues of first impression, and sensitive examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise.  Additional information is available at http://www.taxlitigator.com.

[i] See, e.g., Thosteson v. United States, 331 F.3d 1294, 1300 (11th Cir. 2003) (“Acting, or rather failing to act, under orders from his superior does not negate [a defendant’s] culpability under the statute.”); Brounstein v. United States, 979 F.2d 952, 955 [71 AFTR 2d 93-1714] (3d. Cir. 1992) (“Instructions from a superior not to pay taxes do[es] not… take a person otherwise responsible under section 6672(a) out of that category.”).

[ii] Myers v. United States, Docket No 1:16-cv-01792 (11th Cir. May 6, 2019), available at http://media.ca11.uscourts.gov/opinions/pub/files/201811403.pdf.

[iii] U.S. Small Business Administration, https://www.sba.gov/about-sba/organization.

Administrative summonses are an important investigative tool of the IRS in fulfilling its statutory duty of “proceeding from time to time, through each internal revenue district and inquire after and concerning all persons who may be liable to pay any internal revenue tax.”  Internal Revenue Code (“IRC”) §7601(a).  Where a person served a summons fails to comply, the IRS can bring a summary proceeding to enforce the summons.  To obtain enforcement, the government must show (usually done by the affidavit of the IRS officer who issued the summons) that a) the summons was issued for a legitimate purpose; b) it seeks information that may be relevant to that purpose; c) the information sought is not already in the IRS’s possession; and d) the IRS has followed all administrative steps required by the I.R.C.  United States v. Powell, 379 U.S. 48, 57-58 (1964).  Once this Powell showing is made, the summoned party can only defeat enforcement if it can show that enforcement would be an abuse of process, 379 U.S. at 58, or another “appropriate ground,” including that the information sought is privileged or is sought for use in a criminal prosecution.  Reisman v Caplin, 375 U.S. 440, 449 (1963).

The courts, including the Supreme Court, broadly constructed the IRS’s summons power with respect to third-party record keepers, including so-called “John Doe” summonses.  Tiffany Fine Arts, Inc. v. United States, 469 U.S. 310, 315-316 (1985).  Concerned that the use of John Doe and other summonses to third parties could “unreasonably infringe on the civil rights of taxpayers, including the right of privacy,” H.R. Rep. 94-658 at p. 307, Congress enacted IRC §7609.  This section instituted procedures requiring notice to taxpayers when a summons was issued to a third-party (with certain limited exceptions) and provides any person entitled to notice with a right to intervene in any proceeding to enforce the summons and a right to bring an action in district court to quash the third-party summons.  IRC §7609(a)(2), (b).

In the case of a John Does summons, the IRS does not know the identity of the taxpayer (or class of taxpayers) about whom it is seeking information.  Because this makes the service of notice on the taxpayer impossible, Congress required district court approval before a John Doe summons could be served.  H.R. Rep. 94-658 at p. 307.  Section 7609(f) provides that a summons that does not identify the person with respect to whose liability it was issued may only be served if the IRS establishes to the satisfaction of a court that:

(1) the summons relates to the investigation of a particular person or ascertainable group or class of persons,

(2) there is a reasonable basis for believing that such person or group or class of persons may fail or may have failed to comply with any provision of any internal revenue law, and

(3) the information sought to be obtained from the examination of the records or testimony (and the identity of the person or persons with respect to whose liability the summons is issued) is not readily available from other sources.

The IRS and the Department of Justice have set up additional safeguards with respect to a John Doe summons.  While non-John Doe summonses can be served after approval by the issuing IRS officer’s manager, see Internal Revenue Manual ¶25.5.6.1.3 [2] (03/03/2017) and Exhibit 25.5.2.1 m, n, a John Doe summons must be approved by IRS Area or Associate Area Counsel, who will then refer the matter to the Department of Justice.  Internal Revenue Manual ¶25.5.7.3 [3], [4].  Before a proceeding is instituted in court for authorization to serve the John Doe summons, the summons must be approved by the Deputy Assistant Attorney General (Civil Trial Matters) of the Tax Division.  Department of Justice Tax Division Summons Enforcement Manual at §III.A.2.

This prolix preface gets us to the subject of this blog: Taylor Lohmeyer Law Firm PLLC v United States, 2019 WL 2124676 (WD Tex. 5/15/19), an action by a law firm to quash a John Doe summons issued for the names and other information relating to clients for whom the firm (between 1995 and 2017) “create[d] and maintain[ed] foreign bank accounts and foreign entities” that may have been used to hide taxable income.

Prior to service of this John Doe summons, the government petitioned the district court for an order authorizing it to serve the summons.  The petition was supported by a 30 page declaration from an IRS agent who had audited an unidentified client of the firm.  The IRS had assessed a deficiency of over $2 million tax on over $5 million of income the client had allegedly hidden through the use of “foreign accounts, foreign trusts, foreign corporations” set up by the law firm.  Attached to the declaration were more than 200 pages of exhibits, including memos from the law firm, letters between the law firm and firms in tax haven jurisdictions, transactional documents and excerpts from recorded interviews of both the taxpayer and a partner of the law firm.  It appears that the IRS obtained some documents because the taxpayer asserted reliance on advice of the law firm, thus waiving the attorney client privilege.  During the lawyer’s interview, he estimated that he had set up foreign entities for twenty to thirty other clients.  The lawyer died before the petition for service of the summons was filed.

In authorizing service of the summons, the district court determined that the requirements of §7609(f) had been satisfied.  The findings, made in an ex parte proceeding, cannot be challenged in a proceeding to enforce the summons.  United States v. Samuels, Kramer & Co., 712 F. 2d 1342, 1346 (9th Cir. 1983).  Because the government had met its burden under Powell to enforce the summons, the burden shifted to the law firm to establish that enforcement would be inappropriate.  The court held that the law firm failed to meet its burden.

The first claim of the law firm that the court addressed was that the affidavit submitted in support of the petition to serve the summons contained numerous inaccuracies.   In the court’s view, this was an attack on its finding in the prior proceeding that it was reasonable to believe that the persons about whom the information was sought failed to comply with the internal revenue laws.  Thus, it was not an issue that could be raised in the context of the enforcement proceeding.  Even if it could have been raised in the enforcement proceeding, the court held that issuance of the summons was proper.

The firm further argued that not only was the agent’s affidavit replete with misrepresentations, the audited taxpayer owed additional tax because he failed to follow the law firm’s advice.  According to the firm, it had reviewed the files of the clients for whom it had structured and maintained foreign grantor trusts and determined that all of them had followed the firm’s advice and thus did not owe additional tax.  The court viewed this argument as being two-fold: that enforcement would be an abuse of process and that the Government failed to meet the first two Powell requirements.   The court held that these allegations did not rebut the fact that investigating possible offshore tax evasion is a legitimate purpose and that the information sought is relevant to that purpose.  Because the law firm disavowed the implication the government acted with a sinister purpose, this undermined its claim of abuse of process.

The main issue raised by the law firm in opposition to enforcement of the summons was that providing the requested information would breach the attorney-client privilege.  The law firm did not produce a privilege log identifying any specific document or set of documents that were protected by the attorney client privilege.  The court held that the law firm could not use a blanket assertion of privilege but instead had to identify specific documents that it claimed were privileged.  The court noted that the identity of a client is not normally privileged except in those rare instances where the identity would be the “last link in an existing chain” of evidence that would likely lead to the client’s indictment.

The law firm argued that identifying the clients and services sought amounted to a violation of the attorney client privilege while the government argued that it was not seeking the advice given clients, just the identities of clients for whom the firm formed or maintained foreign entities or foreign accounts or assisted in foreign financial transactions and that the summons was tailored to avoid the attorney-client privilege.  [In fact, the summons sought more than taxpayer identities: an attachment to the summons contained 2 ½ pages of categories of documents sought.]

According to the firm, it had identified 32,000 documents that were responsive to the summons.  While given the opportunity to submit additional briefing on the attorney-client issue, the law firm failed to provide a privilege log specifying what documents it alleged were privileged and the reason for the claim of privilege.  The firm did produce redacted billing statements that indicated that it performed legal services and thus some documents sought were potentially privileged.  The court held that this was insufficient to establish that any specific documents sought were privileged.  Thus it ordered the summons enforced.

The court ended its discussion with the following observation:

As the Government suggests, “[u]pon this Court ordering enforcement of the summons, if Taylor Lohmeyer wishes to assert any claims of privilege as to any responsive documents, it may then do so, provided that any such claim of privilege is supported by a privilege log which details the foundation for each claim on a document-by-document basis.” Docket no. 7 at 8. Whether certain documents fit the Liebman argument the Firm advances is better decided individually or by discrete category.

As a result, the enforcement order may not be the end of the matter.  It will probably take a while for the firm and its counsel to review all 32,000 documents and provide a privilege log of those documents or categories of documents that are privileged.  If the law firm produces a privilege log and establishes that specific documents are privileged, it may still be able to keep the IRS from obtaining the documents.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

 

In 2010, Congress amended Internal Revenue Code (IRC) sec. 6201 by adding subsection (a)(4), which authorizes the IRS to assess and collect the amount of criminal restitution ordered for failure to pay any tax in the same manner as if the restitution was a tax.  The assessment could be made at any time after all appeals were concluded and the right to appeal from the criminal restitution order had expired.  The person against whom restitution was ordered could not challenge the restitution amount on the basis of the existence or amount of the underlying tax liability.  In Carpenter v Commissioner, 152 TC No. 12 (April 18, 2019), the Tax Court held that a payment schedule set by the district court in imposing restitution did not limit the IRS’s ability to assess or collect restitution.

Carpenter pled guilty to tax perjury (IRC 7206(1)) for 2005 and 2006.  He was sentenced by the district court to 27 months imprisonment and ordered to pay $507,995 restitution.  The district court found that Carpenter did not have the financial ability to pay a fine or interest on the amount of any penalty.  It ordered him to pay the restitution immediately but if he could not to so “he must pay $100 per month” until the restitution was paid.  Carpenter complied with the restitution payment schedule and, after his period of supervised release ended the court ordered that the unpaid restitution “be collected by civil means through the US Attorney’s Office.”  The US Attorney filed liens and levied Carpenter’s social security benefits.  The IRS, in the meantime, assessed the restitution, sent notice and demand for payment and followed with lien and levy CDP notices.  Carpenter protested on the ground that the IRS lacked authority to enforce the restitution order, could not initiate administrative collection action without a district court order and could not collect more than the amount set in the district court’s payment schedule.  He expressly waived his right to seek a collection alternative.  Appeals sustained the IRS’s collection action and Carpenter petitioned the Tax Court.

While the case was pending, the Tax Court in Klein v. Commissioner, 149 TC 341, held that sec. 6204(a)(4) was just a means to “facilitate bookkeeping.”  Thus, the IRS could not assess statutory interest and penalties under sec. 6201(a)(4), just the restitution amount.  The IRS therefore abated the interest and penalties assessed against Carpenter.   The Court further held that in enacting subsection (a)(4) Congress “expanded the authority to collect actively on criminal restitution orders following summary assessment,” including by exempting the assessment from the Code’s statute of limitations and limiting the ability to challenge the amount of restitution.  As a result, the IRS’s authority to assess and collect criminal tax restitution was independent of Title 18.

The Tax Court also rejected Carpenter’s argument that the district court‘s restitution order limits the amount the IRS could collect.  Although in restitution orders a district court can set a payment schedule which becomes part of a final judgement that may not be modified, Title 18 doesn’t require the IRS to obtain a court order before it can assess restitution.   Further, a restitution order is due immediately unless specified otherwise, including in the judge’s oral pronouncements at sentencing.   Where a court orders restitution is due only in accordance with a payment schedule and not immediately, the Government may only collect pursuant to the schedule.  But where the district court specifies immediate full payment, a payment schedule contained in the order does not limit the Government’s ability to pursue other means of securing the restitution amount.  At Carpenter’s sentencing the district court made it clear it did not intend to limit the IRS’s collection efforts.  The IRS acted properly in filing its notice of federal tax lien and in issuing its levy notice.  Further, under the statute Carpenter was barred from challenging the amount of restitution.  Appeals had considered all required matters and took into account the district court payment schedule and the US Attorney’s collection efforts.  Its determination was therefore sustained.

The Court ended by noting that although Carpenter did not propose any collection alternative, he could still do so outside of CDP by submitting an installment agreement request.

Restitution in a criminal case is meant to compensate the victims of a crime.  It is paid to the US Attorney and the restitution amount cannot be decreased or compromised.  As a result, regardless of the financial situation of a person convicted of a tax crime, neither the Department of Justice nor the IRS can agree to compromise a restitution order by settling for less than the full amount of restitution payable to the IRS.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez, P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

The Internal Revenue Service has broad authority to examine books and records and interview witnesses for the purposes of determining the liability of any person for taxes, penalties or interest and collecting any liability.  This authority includes the power to issue summonses, including to third-parties.  Under Powell v United States, 379 U.S. 48 (1964), the IRS is required to meet four requirements before a summons will be enforced: a) that the summons was issued for a legitimate purpose, b) the inquiry is relevant to that purpose, c) the information sought is not already in the government’s possession and 4) the IRS followed the procedures required under the Internal Revenue Code.  The IRS normally establishes these requirements by submitting a declaration from the agent conducting the investigation.

Because of the adverse impact an IRS audit could have on a taxpayer’s business or reputation, as part of the IRS Restructuring and Reform Act of 1998, Congress added subsection (c) to Internal Revenue Code sec. 7602, which provides that the IRS “may not contact any person other than the taxpayer with respect to the determination or collection of the tax liability of such taxpayer without providing reasonable notice in advance to the taxpayer that contacts with persons other than the taxpayer may be made.”  Although this provision has been part of the Internal Revenue Code, no published court of appeals decision has addressed what constitutes “reasonable notice in advance” until February 26, 2019, when the Ninth Circuit issued its opinion in J.B. v. United States, Docket No. 16-15999, http://cdn.ca9.uscourts.gov/datastore/opinions/2019/02/26/16-15999.pdf.

The taxpayers are “an elderly married couple.”  The husband  accepts appointments by the California Supreme Court to represent indigent criminal defendants in death penalty cases.  They had been audited for prior years, but in 2013 received notice from the IRS that they had been selected for a “compliance research audit” of their 2011 income tax return.  A compliance research audit is an in-depth examination that is so demanding that in 1988 Congress discontinued a similar program.  Briefly stated, it is the IRS equivalent of a proctology exam.

Included with the letter was an IRS publication, “Publication 1: Your Rights as a Taxpayer,” which had on page two a statement that the IRS normally deals with taxpayer and their authorized representatives directly, but sometimes seeks information from third parties.  After the letter, the IRS sent the taxpayers a document request.  The taxpayers responded by requesting that they be excused from the compliance research audit due to their advanced age and health and included declarations from the husband’s physician.  When the IRS refused the request, the taxpayers sued to stop the audit in district court.  Despite the pending suit, the IRS continued its audit, issuing a summons to the California Supreme Court seeking copies of all documents relating to payments to the husband in 2011.

The taxpayers first learned of the summons when their daughter, who was their representative, received notice of service by mail.  The taxpayers filed a petition to quash with the district court.  The district court found that the IRS satisfied the first three Powell requirements but not the fourth, since it determined that the statement about third party contacts in Publication 1did not constitute reasonable advance notice.  The district court reasoned that to constitute “reasonable advance notice” the notice had to be specific to a particular third party and not a general generic notice.  The IRS appealed to the Ninth Circuit.  The Ninth Circuit affirmed the district court holding that the IRS did not provide the required advance notice.

To interpret the phrase “reasonable notice in advance” the Ninth Circuit looked to Supreme Court cases interpreting notice provisions in other contexts: to be adequate, notice must be “reasonably calculated, under all circumstances, to apprise interested parties” and “afford them an opportunity to present their objections.”  According to the Court, this interpretation was consistent with both the context in which the phrase is used and the broader context of the Internal Revenue Code as a whole.  While the Code generally prohibits disclosure of taxpayer information, sec. 7602(a) allows disclosure to ascertain “’the correctness of any return, making a return where none has been made, determining the liability of any person … or collecting any such liability.’”  Sec. 7602(c) was meant to protect taxpayers from unnecessary third-party contacts.  The exceptions to the notice requirement ( a) pending criminal investigation,  b) a good cause belief notice will jeopardize the IRS’s collection efforts or subject a third party to reprisal and c) taxpayer authorization for the contact) showed that Congress meant to give the taxpayer a meaningful opportunity to respond to the IRS request.

The Court further held that “reasonable notice in advance” did not require the IRS to provide the taxpayer with a list of people it might contact in advance, since what notice is reasonable depends on the facts.  It rejected the IRS argument that the title of subsection (c)(1), “General Notice,” made the section ambiguous.  The Court found in the legislative history support for the proposition that Congress intended IRS to provide notice reasonably calculated to apprise taxpayers that the IRS may contact third-parties.  The Court also noted that Treas. Reg. sec. 301.7602-2 nowhere suggests that the notice requirement is satisfied by mailing Publication 1.

Finally, the Court rejected the IRS’s argument that other courts have endorsed the notice in Publication 1, finding that district courts that have addressed the issue evaluated the totality of the circumstances in determining whether reasonable advance notice was given and that the Second Circuit, in an unpublished summary order, embraced a “totality of the circumstances” approach to determine whether the IRS provided reasonable advance notice.

Based on the facts of the case, the Ninth Circuit held that Publication 1 did not provide the taxpayers with reasonable advance notice that gave them a meaningful opportunity to volunteer their own records to avoid third-party contacts.  It noted that while the holding was based on the facts of the case “we are doubtful that Publication 1 alone will ever suffice to provide reasonable notice in advance to the taxpayer.”

In this case, the only notice to the taxpayers was in Publication 1, which was sent independent of any request for information.  There was no evidence that the IRS ever provided any later notice, even after the taxpayers requested that the audit be halted and had not provided documents requested by the IRS.  Thus, under the circumstances, the notice provided in Publication 1 was not adequate.

The Court also pointed out that there was no urgency in the IRS requesting information, since the research audit is designed to help the IRS improve its tax collection system and not because there is a belief that the taxpayers may have underreported tax.  Further, the summons was issued two years after commencement of the audit, to the California Supreme Court, which was effectively the taxpayer’s employer, and the IRS knew that the documents sought were potentially covered by attorney-client privilege and other litigation-related privileges.  Further, the records sought were ones that the IRS would have expected the taxpayers to have and to provide once the dispute over whether they should remain in the research audit program was resolved.

Finally, the Court noted that given the ongoing litigation, the IRS had the opportunity to inform the taxpayers if they did not provide the documents it would contact third parties for the information.  The Ninth Circuit ended its opinion as follows:

The IRS must comply with its statutory obligation to

provide reasonable notice in advance of contacting third

parties. Courts are not in the position to prescribe the exact

form of notice that is reasonable in every circumstance.

Under the circumstances here, however, reliance on

Publication 1 was plainly unreasonable, and there are no

doubt numerous other circumstances where the IRS needs to

take further steps to provide the reasonable and meaningful

notice Congress mandated. When the IRS seeks information

from an employer of a party with whom it is currently in

litigation and much of the information sought is covered by

common law and state-recognized privileges, additional

reasonable measures must be taken to provide meaningful

notice and an opportunity to respond, in order to avert the

potential third-party contact.

Taxpayers rarely prevail in summons enforcement proceedings.  The National Taxpayer Advocate reported in her 2014 Annual Report to Congress that of 102 summons cases in that year, the IRS won 97, the taxpayers won 2 and the remaining 3 cases resulted in decisions upholding the summons in part.  It is thus impressive for a taxpayer to prevail in a summons case, especially one involving a universal IRS practice: to provide a taxpayer with Publication 1 and no further explanation of either the taxpayers’ rights or that the IRS may contact third parties as part of its audit or investigation.  The decision could lead to the IRS reevaluating how it provides notice to taxpayers of potential third-party contacts.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez, P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

 

 

 

While many people are familiar with the phrase “Cash is King,” dealing in cash can, and often does, take on new meaning when it comes to the IRS. There is, of course, the obvious obligation to ensure that any, and all, cash received as income is properly reported annually on the appropriate tax return. However, that annual filing is not all that is required for some individuals and businesses who deal in large sums of cash. Specifically, for those who, in the course of a trade or business, receive more than $10,000 in cash in one transaction or in two or more related transactions, there are also obligations to file a Form 8300 Report of Cash Payments Over $10,000 Received in a Trade or Business.[1]

In light of the IRS’s not one, but two, recent announcements regarding Forms 8300, now is a really good time to focus on understanding and ensuring that such obligations are being met.

On February 21, 2019, the IRS issued IR-2019-20[2], urging businesses with obligations to file reports of cash transactions to take advantage of the speed and convenience of filing Forms 8300 electronically. Once the account is set up with the Financial Crimes Enforcement Network’s (“FINCEN”) BSA E-filing System, a business’s e-filing is not only faster and more convenient, but a free way to meet reporting obligations with the added benefit of receiving an automated acknowledgement of the receipt of your filing, which can come in handy should the IRS ever question your timely compliance with this obligation. Of course, businesses also have the option to file the Form 8300 on paper by mailing the form to the IRS at: Detroit Computing Center, P.O. Box 32621, Detroit, Michigan 48232.

Also, on February 21, 2019, the IRS released a fact sheet, FS-2019-1[3], to assist individuals and businesses to better decipher, among other things relevant to cash transactions, exactly who is covered, as well as what is considered a reportable cash transaction, for purposes of the Form 8300 reporting requirements.

For the purposes of Form 8300, the “who” is defined as an individual, company, corporation, partnership, association, trust or estate. Tax-exempt organizations which receive cash solely for the purposes of a charitable cash contribution need not file a Form 8300.[4] The “what” is reportable as cash is actually a bit broader than just dollar bills. Reportable transactions include coins, currency (U.S. or foreign), cashier’s checks, bank drafts, traveler’s checks, and money orders with a face value of $10,000 or less. However, a transaction which involves a personal check drawn on an account of the payor or cashier’s checks, bank drafts, traveler’s checks or money orders with a face value of more than $10,000, is not considered a cash transaction. It is also important to understand that not only is the receipt of a lump sum payment of cash in excess of $10,000 a reportable transaction, the receipt of cash in excess of $10,000 which is received in what is viewed by the IRS as a “related” transaction, e.g., amounts in excess of $10,000 which are broken down into smaller payments, but are part of the same business transaction, is also required to be reported. As such, cash payments, albeit not received in one lump sum, but which are received within a 24-hour time period and total in excess of $10,000, are related transactions and reportable on a Form 8300. But that’s not all. Even if cash, received in a trade or business, is paid over a time period which exceeds 24-hours but where the recipient either knows, or has reason to know, that each cash transaction is part of a series of connected transactions whereas if paid all at once would exceed $10,000, then the series of connected payments are considered by the IRS to be related transactions and thus, are also reportable on a Form 8300.  In all such circumstances, the recipient of the funds is required to file, by the 15th day after the date the cash transaction, or related transactions, occurred.

Lastly, it is of note that the IRS’s Form 8300 fact sheet ends with both a reminder and a cautionary note. The IRS is reminding businesses that they must give a customer written notice by January 31 of the year following the transaction that it filed Form 8300 to report the customer’s cash transaction, which also means that it is a good practice to keep a copy of every Form 8300 filed, whether done electronically or in paper form. Additionally, businesses are being warned that, while they may voluntarily file a Form 8300 to report a suspicious transaction below $10,000 which they suspect is being done in such amount to cause the business to avoid filing a Form 8300, the law prohibits the business from informing a customer that it marked the suspicious transaction box on the Form 8300.

For more information regarding the filing of Form 8300, including potential civil and criminal penalties for failure to properly comply with these cash reporting obligations, the IRS has also published a Form 8300 Reference Guide.[5]

 

Sandra R. Brown  ~ is a principal at Hochman Salkin, Toscher & Perez P.C., and specializes in representing individuals and organizations who are involved in criminal tax investigations, including related grand jury matters, court litigation and appeals, as well as representing and advising taxpayers involved in complex and sophisticated civil tax controversies, including representing and advising taxpayers in sensitive-issue audits and administrative appeals, as well as civil litigation in federal, state and tax court.  Prior to joining the firm, she served as the Acting United States Attorney, the First Assistant United States Attorney and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal).  Ms. Brown may be reached at brown@taxlitigator.com or 310.281.3200.

 

[1] https://www.irs.gov/pub/irs-pdf/f8300.pdf.

[2] https://www.irs.gov/newsroom/irs-urges-businesses-to-e-file-cash-transaction-reports-its-fast-easy-and-free.

[3] https://www.irs.gov/newsroom/cash-payment-report-helps-government-combat-money-laundering.

[4] Donors should consult Publication 526, Charitable Contributions regarding instructions on requirements for obtaining a written acknowledgement of cash contributions from tax-exempt organizations. The latest version of Publication 526 can be found at: https://www.irs.gov/publications/p526.

[5] https://www.irs.gov/businesses/small-businesses-self-employed/irs-form-8300-reference-guide

 

The United States Sentencing Commission  recently released a study of sentencing of federal offenders convicted of economic crimes.  The study included within the category of “economic crimes” thus sentenced under §2B1.1 of the United States Sentencing Guidelines (USSG), tax crimes and identity theft.  Tax crimes encompass Title 26 (Internal Revenue Code) violations, conspiracies to defraud the United States of taxes, and the use of stolen identities for filing tax forms (stolen identity refund frauds).

The study focused on offenders sentenced during the fiscal year ended September 30, 2017, but also included some data for fiscal 2013 through 2016.  Some interesting tidbits from the report include:

  1. The median loss of all crimes studied was just over $100,000. Four categories of crimes had over $700,000 median loss:  securities & investment crimes – $2.1 million; health care fraud – $1.08 million; mortgage fraud – $999,000; government procurement fraud – $739,000.  With an average loss of $398,000, tax fraud was well above the median  for all economic crimes but well under the median amounts for the four top categories of economic crimes.
  2. 1% of all federal defendants sentenced in FYE 2017 were sentenced for economic crimes. Tax crimes accounted for less than 5% of all defendants sentenced for economic crimes, or less than 0.5% of all defendants sentenced in fiscal 2017. The two categories of crimes that accounted for most defendants sentenced: drug crimes at 30.6% and unlawful entry into the US (25.5%).
  3. Tax crimes made up the following percentages of defendants sentenced between FYE 2013 and FYE 2017:

2013                2014           2015           2016           2017

2.8%                3.8%           4.5%           5.4%           4.5%

 

  1. The Ninth Circuit, which includes federal district courts in California, accounted for almost half of all defendants sentenced in federal criminal cases in 2017 (44.6%) but only 13.1% of defendants convicted of economic crimes.
  2. The Central District of California accounts for 31.5% of economic crimes sentenced in the Ninth Circuit in 2017 with 251 defendants, which is more than half of the total numbers in the Second Circuit (which includes New York) or the Seventh Circuit (which includes Illinois). Los Angeles leads the way in prosecuting economic crimes.
  3. Tax offenders made up 4% of all federal defendants sentenced for economic crimes in the Ninth Circuit in fiscal 2017. More defendants were sentenced for tax offenses in the Central District of California than in the other three districts in California combined.
  4. The Circuit with the most tax offenders sentenced in fiscal 2017: the Sixth Circuit (Michigan, Ohio and Kentucky), over half of whom were in the Western District of Michigan (think Kalamazoo). There were more defendants sentenced for tax offenses in the Western District of Michigan than in the Third Circuit (which includes Pennsylvania), the Second Circuit (which includes New York), the DC Circuit or the Seventh Circuit (which includes Illinois).
  5. Of defendants sentenced in FYE 2017 for tax crimes, 21.7% were in the 11th Circuit, 22.4% in the 6th Circuit and 11.8% in the 9th
  6. The race of persons sentenced for tax crimes in 2017 were: blacks (55.5%), whites (28.8%) and Hispanic (12.2%).
  7. Women accounted for 13.4% of all defendants sentenced in 2017, but 32.7% of defendants sentenced for economic crimes and 36.8% of defendants sentenced for tax crimes.
  8. The median age for tax offenders was 44; 23.5% had college degrees, 41.5% had some college but didn’t graduate; and the rest (35%) had no college.
  9. The study also looked at sentencing adjustments applied in economic crime cases. The frequency with which adjustments were applied to tax offenders sentenced in 2017:

 

Victim Adjustment (includes a person whose identity

is used unlawfully or without authorization)                          36.4%

Sophisticated means enhancement                                19.9%

Aggravating Role enhancement                                               13.2%

Mitigating Role enhancement                                         5.5%

Abuse of Trust/Use of Special Skill enhancement                   17.3%

 

  1. The sentencing guidelines have offender history categories, which is the number of prior convictions a defendant has. Category 1 (0 or 1 prior offense) is the lowest category.  The higher the category, the higher the potential sentence.  Over half of economic crimes offenders sentenced in 2017 fell into Criminal History Category 1, the highest percentage of any category of crimes.  7% of tax offenders were in category 1.
  2. At sentencing, offenders convicted of economic crimes had the lowest percentage incarcerated (66.3%) compared to 88% for all federal offenders sentenced in 2017 and the highest rate of probation only (20.8% versus 6.9% for all federal offenders). For tax offenders, the percentages were as follows:

Prison only                              71.7%

Prison and confinement           11%

Confinement and probation    6.3%

Probation only                         10%

  1. For those offenders sentenced, the average for all economic offenders in 2017 was 23 months in prison. This compares to an average prison term of 45 months for all federal offenders sentenced to a term of imprisonment.  The average period of imprisonment for tax offenders sentenced to prison was 31 months.

Part of the reason that tax statistics skew they way they do based on race, education and length of sentences is that stolen identity refund fraud is included in the sentencing statistics.  Many of these cases involve organized criminal gangs that obtain stolen identity information (name, social security number, etc.) and, using that information, file false returns to obtain refunds.

Note that the statistics reported by the USSG do not jibe with IRS Criminal Investigation’s statistics about percentage of defendants sentenced to prison and average term of imprisonment.  This is because CI investigates Bank Secrecy Act violations and money laundering and is involved in public corruption and drug prosecutions, among other non-tax crimes.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez, P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

           

Sentencing for all serious federal noncapital crimes begins with the United States Sentencing Guidelines (“USSG” or “Guidelines”). The Guidelines establish a series of escalating sentencing ranges based on the circumstances of the offense, e.g., the crimes for which the defendant has been convicted, and the criminal record of the defendant.[1]

For sentencing of federal crimes involving fraud and deceit, one of the circumstances of the offense that can subject a defendant to an increase in his or her Guideline offense level involves where the defendant’s criminal conduct violated “any prior, specific judicial or administrative order.” USSG § 2B1.1(b)(9)(C).[2]  Earlier this week, the Tenth Circuit in United States v. Iley,[3] affirmed the District Court’s application of this enhancement to the sentencing imposed on an accountant, who was the subject of an administrative order for negligent conduct involving his accounting practice, in relation to his conviction for charges involving wire fraud and aiding and abetting in the preparation of a false return.

Donald Iley who, until 2015, was licensed by the Colorado Board of Accountancy (“Board”), performed services for clients that included the calculation of payroll taxes and the preparation of tax forms, as well as the collection and remittance of money to pay these payroll taxes. The Board, having received multiple complaints about Iley’s tax-preparation practices, began an administrative investigation. In resolution of that matter, Iley admitted to engaging in professionally negligent conduct and, pursuant to an administrative order, was placed on a five-year probationary period. Among the acts for which Iley was disciplined was his taking of a client’s money rather than paying it, as intended, over to the IRS to pay the client’s payroll taxes.

While on probation and subject to the administrative order, Iley defrauded his clients of more than $11 million by telling them that he was paying the funds to the IRS for payroll taxes, when, instead, he was using such funds for personal purposes. Ultimately, Iley pleaded guilty to one count of wire fraud and one count of aiding in the preparation of a false tax returns.

Prior to sentencing, the U.S. Probation Office (“USPO”) prepared a Probation Sentence Report (“PSR”) and computed Iley’s advisory Guideline range as 97 to 121 months’ imprisonment. This calculation included a two-level enhancement under § 2B1.1(b)(9)(C) for Iley’s alleged violation of the administrative order. Absent this two-level enhancement, Iley’s advisory Guidelines sentencing range would have been calculated at 77 to 97 months’ imprisonment.

It should also be noted here that a federal judge is not mandated to sentence a defendant within the advisory Guideline range, but instead is limited only by Congressionally established statutory maximum penalties and the minimum penalty, if any, applicable to the federal crime(s) of conviction. In this case, the sentencing court, finding good cause, deviated from the advisory Guideline range and sentenced Iley to 151 months incarceration.[4]  This deviation was a 30-month upward departure from the high-end of the advisory Guideline range of 97-121 months.

Iley ultimately appealed his sentence. His appeal, however, only challenged the two-level enhancement set forth in § 2B1.1(b)(9)(C), asserting two arguments as to why the District Court erred in its application of this enhancement as follows: (1) § 2B1.1(b)(9)(C) only applies when a defendant does something that an agency had expressly forbidden him from doing, and since the administrative order did not expressly enjoy him from committing the same or similar fraudulent conduct for which he was ultimately convicted, he didn’t violate the order; specifically, “the administrative order clearly delineates the conditions of Mr. Iley’s probation, and none of those conditions includes an order not to commit fraud”; and, (2) the administrative order punished him for negligence, not fraud, thus, his fraudulent conduct did not violate the order because negligence and fraud are different.

The Government disagreed with Iley’s arguments and, in support of the District Court’s application of the enhancement argued on appeal that: (1) although the administrative order did not explicitly enjoin Iley from committing the fraudulent conduct underlying the conviction, such conduct was an unmistakable implication of the order; and, (2) it is irrelevant that the administrative order disciplined Iley for negligent conduct, where his subsequent conviction was for fraudulent acts, as by punishing even negligent conduct, the order necessarily prohibited Iley from engaging in the same conduct fraudulently as well.

The Tenth Circuit, finding this issue to be a legal question subject to a de novo standard of review, affirmed the District Court’s application of the two-level enhancement, and set forth the following conclusions: (1) § 2B1.1(b)(9)(C) may apply without an explicit injunction when, as here, the prior order (i) imposed a concrete punishment, such as a fine, on the defendant for the same or similar conduct at issue in the defendant’s subsequent offense; (ii) imposed prospective, remedial conditions or obligations, like practice monitoring and the filing of quarterly reports – through a probationary term or otherwise – that were reasonably calculated to curtail future instances of the conduct at issue; and (iii) nevertheless the defendant perpetrated that prohibited conduct while the order was still in effect; and, (2) there is no reason to read a symmetry-of-mental-state requirement into § 2B1.1(b)(9)(C), where the defendant engages in the same or similar prohibited conduct with a higher level of “aggravated criminal intent” or, put another way, not only would the two-level enhancement apply where the defendant’s subsequent criminal conduct was done with the same level of culpable intent prohibited by the order, but it also applied where the defendant, undeterred from “brazenly upping his game” engaged in the conduct with a higher level of criminal intent.

 

As a result, Iley’s sentence of 151 months was upheld.

 

Sandra R. Brown  ~ is a principal at Hochman Salkin, Toscher & Perez P.C., and specializes in representing individuals and organizations who are involved in criminal tax investigations, including related grand jury matters, court litigation and appeals, as well as representing and advising taxpayers involved in complex and sophisticated civil tax controversies, including representing and advising taxpayers in sensitive-issue audits and administrative appeals, as well as civil litigation in federal, state and tax court.  Prior to joining the firm, she served as the Acting United States Attorney, the First Assistant United States Attorney and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal).  Ms. Brown may be reached at brown@taxlitigator.com or 310.281.3217.

[1]  How the Federal Sentencing Guidelines Work: An Abridged Overview (2015) https://fas.org/sgp/crs/misc/R41697.pdf

[2] United States Sentencing Commission Guidelines Manual.

[3] United States v. Donald Iley, ___F.3d ___, 2019 WL 418502 (10th Cir. 2/4/19)

[4] https://www.justice.gov/usao-co/pr/parker-cpa-sentenced-125-years-prison-wire-fraud-and-aiding-and-assisting-preparation

I recently blogged about Kimble v. United States, where the Court of Federal Claims granted summary judgment in favor of the Government in an FBAR willful case, holding that the taxpayer’s signing a return that incorrectly checked the “no” box to the question whether she had foreign accounts was sufficient to establish willfulness.  The Kimble court has now been joined by the district court in Maryland in United States v. Horowitz, Case No. PWG-16-1997 (Md., 1/18/19).

Peter Horowitz is an anesthesiologist.  He and his wife Susan lived in Saudi Arabia from 1984-2001, where Peter worked.  In 1988, they set up a joint account at UBS in Switzerland with money earned in Saudi Arabia.  At one point, the account balance reached almost $2 million.  When the couple returned to the U.S., they closed accounts they had in Saudi Arabia but kept open the UBS account.

In late 2008, Peter closed the UBS account and opened an account at Finter Bank in Switzerland.  He planned to open a joint account, but since Susan was not with him, the bank only allowed him to open an account in his name.  After 2008, Susan was added to the account.

Peter provided their CPAs with information to prepare their tax returns.  He did not inform the CPAs about the foreign accounts or ask about whether he was required to report the accounts to the IRS.  The Horowitz’s did not file FBARs for either 2007 or 2008.  Their returns for both years checked “no” to the question on Schedule B whether they had foreign financial accounts.  In 2010 they disclosed their foreign accounts.  They entered the Offshore Voluntary Disclosure program, but in December 2012, opted out.  In June 2014, the IRS assessed FBAR penalties against both Peter and Susan for 2007 and 2008.  Each penalty was equal to 25% of the amount in the account ($247,030) on the date the FBAR was due.  The assessment form was prepared by the FBAR Penalty Coordinator and signed by her manager.  The penalties for 2007 ere based on the UBS account and for 2008 were based on the Finter account.

The taxpayers protested to IRS Appeals.  Appeals requested that the penalty be removed as premature.  The penalty coordinator removed the penalty input date.  After Appeals upheld the penalty, in 2016, the penalty coordinator reentered the penalty input date.

The Government sued to collect the penalties and moved for summary judgment.  The taxpayers filed cross-motions for summary judgment.

The first issue before the Court was whether the maximum penalty was limited to $100,000 based on Treas. Reg. 31 CFR 1010.820(g)(2), which caps the willful penalty at $100,000.  District courts in Texas (U.S. v. Colliot) and Colorado (U.S. v. Wadhan) have held that the regulation controls and, therefore, the penalty may not exceed $100,000.  The Court of Federal Claims in Norman v. U.S. and Kimble held that the regulation conflicts with the statute and is invalid.  The Court found the Kimble case “persuasive” and, relying in part on the Internal Revenue Manual, held that the regulation conflicted with the statute and, therefore, the IRS could assess willful penalties equal to up to 50% of the amount in the account on the date of the violation.

The Court next rejected the claim that the penalty had been reversed in 2014 and was thus time barred.  According to the Court, the Horowitz’s failed to meet their burden of proving the claim was barred.  Assuming removal of the penalty input date was a reversal of the penalty, there was no evidence that the penalty coordinator was authorized to reverse a penalty assessment, no managerial approval of a reversal was shown and since DOJ alone can compromise assessed FBAR penalties of over $100,000, the penalty coordinator could not have validly reversed the assessment.

The Court granted Susan partial summary judgment.  Only a U.S. person with a beneficial interest in or signatory authority over a foreign account is required to file an FBAR.  The 2008 penalty against Susan was based on the Finter account.  She did not have an interest in or signatory authority over that account in 2008.  Thus she was not liable for an FBAR penalty for that year.  That the IRS could have assessed a penalty against her based on the UBS account, which she had an interest in, or could have assessed a 50% penalty against Peter was irrelevant to the question of whether she was liable for a penalty for not reporting the Finter account.

The Court upheld the willful penalties against Peter for both years and against Susan for 2007.  Although there was no evidence that either actually knew about the requirement to file an FBAR and their CPAs did not ask about foreign accounts or explain the FBAR requirements or the Schedule B questions to them, this was irrelevant.  By virtue of signing the return under penalties of perjury and failing to discuss their foreign accounts with their CPAs, they showed a conscious effort to avoid learning about the reporting requirements and thus acted willfully.

For reasons previously discussed in my January 2 blog on Kimble, https://taxlitigator.me/ , I find the willingness of courts to base liability for the FBAR willful penalty on what is constructive knowledge and the cavalier manner in which the Court of Federal Claims dismissed the Colliot decision disturbing.  If the Kimble and Horowitz decisions gain wide acceptance, taxpayers will have virtually no chance of prevailing in a willful penalty case.  And we will see another one and another one and another one bite the dust.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez, P.C., former Chair of the Taxation Section, California Lawyers’ Association, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

 

The Court of Federal Claims (CFC) just  issued its Memorandum Opinion and Final Order granting summary judgment to the Government in Alice Kimble v United States, No. 17-421 (December 27, 2018), an FBAR willful case.  The opinion is a stunning victory for the Government: the Court granted summary judgment on the issue of willfulness based solely on the fact that Kimble signed a 2007 income tax return without first reading it and the return falsely answered “no” to the question whether she had any foreign bank accounts.

Kimble had accounts at HSBC and UBS.  Before late 2008, she had no actual knowledge of the requirement to report foreign accounts to the US.  She was accepted into the 2009 Offshore Voluntary Disclosure Program.  She filed amended returns that reported income from the offshore accounts but, for an unexplained reason, the box on schedule B asking whether she had offshore accounts was checked “no.”  She ultimately withdrew from OVDP on the advice of her attorney because the proposed “offshore penalty” (20% of the maximum account balance over a six year period) was too high.  The IRS assessed an FBAR penalty of $697,229, equal to 50% of the high balance in the account.  Kimble paid the penalty and sued for recovery in the CFC.

After discovery, the parties filed a stipulation of facts and cross motions for summary judgment.  The stipulation included the following facts:

  • Plaintiff did not review her individual income tax returns for accuracy for tax years 2003 through 2008. Stip. ¶46.
  • Plaintiff answered “No” to Question 7(a) on her 2007 income tax return, falsely representing under penalty of perjury, that she had no foreign bank accounts. Stip. ¶48.

The court found that these two stipulations established that plaintiff’s conduct was in “reckless disregard” of the legal duty to file FBAR reports.  According to the court, a taxpayer who signs a tax return is charged with constructive knowledge of its contents and thus cannot claim lack of knowledge.  While acknowledging that Kimble was not obligated to inform her accountant of the offshore accounts or to ask him about reporting requirements, this did “not affect the court’s determination that Plaintiff’s conduct in this case was ‘willful.’”  In effect, the CFC opinion makes the FBAR willful penalty a strict liability statute.  The non-willful penalty would appear to only apply if the taxpayer files an FBAR form listing all accounts but makes a clerical error, such as  in the amount in the account or the account number.

Consistent with the CFC’s earlier decision in Norman v United States, the court also held that the regulation at 31 CFR sec. 1010.820 was rendered nugatory by the 2004 amendment to the FBAR penalty statute.  The court’s resolution of this issue follows:

On October 22, 2004, Congress enacted a new statute that increased the statutory maximum penalty for a “willful” violation to “the greater of [] $100,000, or [] 50 percent of the . . . balance in the account at the time of the violation.” See American Jobs Creation Act of 2004, Pub. L. No. 108-357, 118 Stat. 1418, 1586, § 821 (Oct. 22, 2004) (“Jobs Creation Act”). And, on July 1, 2008, the IRS issued I.R.M. § 4.26.16.4.5.1, that stated: “At the time of this writing, the regulations at [31 C.F.R. § 1010.820] have not been revised to reflect the change in the willfulness penalty ceiling.” I.R.M. § 4.26.16.4.5.1. The IRS, however, warned that, “the statute [i.e., the Jobs Creation Act] is self-executing and the new penalty ceilings apply.” I.R.M. § 4.26.16.4.5.1. Although, the Jobs Creation Act is inconsistent with 31 C.F.R. § 1010.820(g)(2), it is settled law that an agency’s regulations “must be consistent with the statute under which they are promulgated.” United States v. Larionoff, 431 U.S. 864, 873 (1977). Since the civil penalty amount for a “willful” violation in 31 U.S.C. § 5321(a)(5) (2003) was replaced with 31 U.S.C. § 5321(a)(5)(C)(i) (2004), the April 8, 1987 regulations are “no longer valid.” Norman, 138 Fed. Cl. at 196.

The court ignores the fact that the regulation was renumbered and then amended after 2004 (still maintaining the $100,000 maximum) and regulations were promulgated on adjusting the $100,000 for inflation.  Unless the Federal Circuit reverses the CFC, the CFC will be an unfriendly forum for taxpayers seeking a refund of the FBAR penalty.

Speaking of what is willful, I want to look at how the Third Circuit treated that issue in Bedrosian.   I  recently blogged on the Third Circuit’s holding that the FBAR penalty arose under the internal revenue laws, implicating the Flora full-pay rule, while paying scant attention to the court’s holding that the willfulness standard for the FBAR penalty had two components: knowing conduct and reckless conduct.  Since the district court only decided the knowing component.  The district court was reversed and the case remanded so it could determine whether Bedrosian acted recklessly.

The Third Circuit cited United States v. Carrigan, 31 F3d 130 (3rd Cir. 1994), a trust fund penalty case in which it held that a person “willfully” fails to collect, account for and pay over withholding tax if he “demonstrates a reckless disregard for whether taxes have been paid.”  In Carrigan, the Third Circuit reversed summary judgment in favor of the United States on two grounds: first, there were facts from which a jury could decide the defendant was not a responsible person and second, there were facts from which a jury could find that he did not act with reckless disregard since the only check he signed was to pay the IRS.

The Third Circuit did not invoke the “constructive knowledge” theory relied on by the CFC in Kimble and, previously, by the Fourth Circuit in United States v. Williams and the Utah District Court in United States v. McBride.  Since Bedrosian filed an FBAR for the year in question, but failed to list the larger of his two accounts, the Third Circuit could have held that he is deemed to have constructive knowledge (a) that he was required to report all of his accounts and (b) that he failed to report one account.  It did not.  This could indicate that the Third Circuit does not agree with the constructive knowledge theory.

So far one district court has explicitly rejected the constructive knowledge theory.  The court in United States v Flume, 2018 WL 4378161 (S.D. TX Aug. 22, 2018), denied the Government’s summary judgment motion.  It held that the defendant’s declaration claiming he did not know of the FBAR requirement and disputing testimony by other witnesses was sufficient to raise a material issue of fact over whether Flume acted willfully.  That Flume’s declaration was self-serving was irrelevant for purposes of a summary judgment motion since the court was prohibited from making credibility determinations.

Having rejected the Government’s contention that Flume had actual knowledge, the court then addressed the issue of whether Flume acted with reckless disregard.  It rejected the Williams and McBride holdings that a taxpayer is deemed to have “constructive knowledge” of the FBAR requirement from the fact that he signed an income tax return.  The court gave three grounds for finding this theory unpersuasive:  1) it ignores the distinction between willful and non-willful violations since, if every taxpayer by signing a return is presumed to know of the need to file an FBAR “it is difficult to conceive of how a violation could be nonwillful”; 2) it would require the court to presume that Flume had examined his returns and thus knew of the FBAR requirement, which it would not do on summary judgment; 3) the theory is “rooted in a faulty policy argument”  since constructive knowledge means that even though  a person does not have actual knowledge, the law pretends you do for policy reasons.

The Flume court also held that summary judgment was not appropriate on the question of whether Flume acted recklessly. Although Flume admitted he did not read the FBAR instructions, the court gave two reasons why this may not have been reckless: a) Flume may have relied on his CPA to read the instructions and b) since the instructions stated that there were exceptions, Flume might have believed his CPA determined an exception applied.

I had hoped that the district court’s order in Flume was a sign that the constructive knowledge theory is losing ground in the courts.  Apparently it is not.  Based on the CFC’s opinion in Kimble expect to see the Government moving for summary judgment in more FBAR cases.  Whether more courts will accept the constructive knowledge theory in FBAR cases or whether they will imbue the term “willful” with meaning is still an open question.  In any event, it will a long time before we have any definitive answer on this issue.

As an aside, Flume was the petitioner in an earlier case involving his foreign accounts: Flume v Commissioner, T.C. Memo. 2017-21, a collection due process case where the Tax Court held that the Flume was liable for penalties under IRC sec. 6038(b) for failing to file Forms 5471.  Flume’s two cases highlight the fact that often a taxpayer who fails to file an FBAR may also face penalties for failing to file foreign information reports required by secs. 6038-6038D.

Another aside, are the courts wrong in treating “reckless” conduct as willful?  Reckless and willful are not treated as identical by Congress.  Sec. 6662(c), which imposes a negligence penalty, states “the term ‘disregard’ includes any careless, reckless, or intentional disregard.”  Congress clearly distinguished intentional conduct from reckless conduct, so why can’t the courts, especially if, as the Third Circuit found, the FBAR penalty is an “internal revenue law”?

A few other asides on Bedrosian.  If the Third Circuit is correct that the FBAR penalty arises under the internal revenue laws, then 26 USC §7422 applies, which presents some unanswered questions.  Section 7422 waives sovereign immunity for suits seeking the refund of “any internal revenue tax … or any penalty,” and requires that a claim for refund be filed as a prerequisite to filing a lawsuit.  So to sue to recover payments toward an FBAR penalty, a claim for refund would need to be filed.  The period of limitations for refund suits would also apply to FBAR suits.  26 U.S.C. §6532(a)(1) provides that no suit “for the recovery of any internal revenue tax, penalty, or other sum” until 6 months after a claim for refund is filed nor more than two years after the date a notice of claim disallowance is mailed.  Since the period of limitation for filing a refund claim only applies a claim for refund or credit of “any tax imposed by this title,” 26 U.S.C. §6511(a), that period would not apply to claims for refund of FBAR penalty payments.  Neither would the general 6-year limitation on filing civil actions against the United States, which only governs commencement of judicial proceedings.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez, P.C., former Chair of the Taxation Section, California Lawyers’ Association, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

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