The Third Circuit released an unpublished decision on March 13, 2017,,[i] United States v. Chabot, that is the latest development in a series of decisions upholding the constitutionality of IRS summons for documents concerning a taxpayer’s foreign bank account under the authority of the Bank Secrecy Act of 1970 (“BSA”), even if production of those documents may incriminate the taxpayer.  Although taxpayers have argued that the records are protected by the Fifth Amendment act of production doctrine, the IRS has taken the position that the required records doctrine, an exception to the act of production doctrine under the Fifth Amendment, applies to such documents, because the BSA requires the documents to be maintained by the taxpayer in accordance with the regulations under the BSA, including under 31. C.F.R. section 1010.420.  In 2015, the Third Circuit joined the Second, Fourth, Fifth, Seventh, Ninth, and Eleventh Circuits as the seventh Circuit holding that the documents sought in a summons for information required by the BSA falls within the required records doctrine.[ii]

Background. After receiving information from the French competent authority pursuant to the United States-France income tax treaty, the IRS learned that the taxpayer husband was the beneficial owner of an undisclosed foreign bank account held at HSBC.  The IRS requested a summons interview, which the taxpayers appears for but asserted their Fifth Amendment privilege with respect to the foreign bank accounts.  The government followed with an administrative summons for documents, and after some back and forth between parties, the IRS amended its summons to narrow the scope of the summons to only those required to be maintained by the regulations. However the taxpayers refused to produce the requested documents.

In response to a petition the IRS filed to enforce the summons, the district court entered an Order to Show Cause directing the taxpayers to present any defense or opposition to the petition to enforce the summons. In response, the taxpayers argued that the Fifth Amendment Act of production doctrine applied and that the Required Records Doctrine did not apply.

Fifth Amendment Act of Production Doctrine. The Firth Amendment states that no person “shall be compelled in any criminal case to be a witness against himself.”[iii]  The Supreme Court has clarified that the privilege extends to the act of producing potentially incriminating documents, known as the act of production doctrine.[iv]  The rationale behind the Act of Production doctrine is that the act of producing documents requested in a subpoena has communicative aspects to it, wholly aside from the contents of the papers produced.[v]

Required Records Doctrine:  The Required Records Doctrine is an exception to the Act of Production doctrine, which originated in Shapiro v. United States, 335 U.S. 1 (1948).  The Court has subsequently articulated three factors or premises to analyze in determining whether the Required Records Doctrine Applies: First, the purpose of the United States’ inquiry must be essentially regulatory; second, information is to be obtained by requiring the preservation of records of a kind which the regulated party has customarily kept; and third, the records themselves must have assumed “public aspects  which render them at least analogous to a public document.”[vi]

District Court Holding. The district court found the Taxpayer’s arguments against the require records doctrine unpersuasive, because responding to the IRS’s summons does not necessarily result in admitting an FBAR violation or an element of a crime – holding a foreign bank account is not in and of itself illegal, so admitting to having a foreign bank account does not carry the risk of admitting to an inherently criminal activity.[vii]  The district court explained that “That the information contained in the required record may ultimately lead to criminal charges does not convert an essentially regulatory regulation into a criminal one.”[viii]  For the information to lead to a criminal charge, the government would have to prove that that the taxpayer acted willfully. Although the taxpayers also tried to distinguish their case on the basis that they at that time were just undergoing a civil audit and not a grand just investigation; however, the district court held this factor weighed against the taxpayer because the taxpayer arguably faces less of a risk of criminal prosecution.  The district court similarly rejected the taxpayer’s arguments that the records are not “customarily kept” based on the secrecy inherent in international banking or “publicly kept” because they are more analogous to general taxpayer records, with the district court finding that bank customers do customarily keep records of their bank accounts and the regulation requires that the records be kept at all times available for inspection as required by law.[ix]

The district court quoted In re Special February 11-1 Grand Jury Subpoena Dated Sep. 12, 2011, 691 F.3d 300, 309 (7th Cir. 2012), which explained that the “voluntary choice to engage in an activity that imposes record-keeping requirements under a civil regulatory scheme carries consequences, perhaps the most significant of which, is the possibility that those records might have to be turned over upon demand, notwithstanding any Fifth Amendment privilege.”  Accordingly, the district court granted the government’s petition to enforce the summons served on the taxpayers.  The district court’s decision was affirmed by the Third Circuit in United States v. Chabot, 793 F.3d 338 (3d Cir. 2015).

Contempt Hearing. When Mr. Chabot refused to comply with the court’s order enforcing the summons, the government moved to have the Chabots held in civil contempt for disobeying the enforcement order, and the District Court issued an order to show cause.  The civil contempt hearing focused on the Chabots’ argument that no responsive documents existed, because they lacked the requisite interest in any foreign bank accounts during the relevant period, and that Mr. Chabot had suffered a stroke which may have affected his ability to proceed.  The Chabots were able to introduce sufficient evidence that Mrs. Chabot did not have the requisite connection to any foreign financial accounts necessary for her to maintain documents under the BSA and the government withdrew its motion to hold Mrs. Chabot In contempt; however, the court found that Mr. Chabot was unable to establish his inability to comply with the order and was held in civil contempt.

Third Circuit Appeal of Contempt order. On appeal, the Third Circuit affirmed the district court’s decision, holding that Mr. Chabot failed to demonstrate his inability to comply with the summons or that he was being punished for asserting his Fifth Amendment right against self-incrimination.[x]  On appeal, Mr. Chabot argued that after he denied the existence of the documents, the government had the burden of proving their existence by clear and convincing evidence and that by failing to do so, the district court was punishing him for asserting his privilege against self- incrimination.

Rejecting Mr. Chabot’s arguments and affirming the district court, the Third Circuit held that under Supreme Court precedent[xi], once a party has shown that (1) a valid order existed; (2) the other party had knowledge of the order; and (3) disobeyed the order, the burden is then on the party who disobeyed the order to establish his inability to comply with the order.  Because Mr. Chabot failed to establish he was unable to comply with the court’s order, the Third Circuit sustained the finding of contempt. The Third Circuit held that the court’s determination that Mr. Chabot failed to demonstrate his inability to comply with the Court’s enforcement order was not dictated by his prior assertion of the privilege against self-incrimination.[xii]

LACEY STRACHAN – For more information please contact Lacey Strachan at Ms. Strachan is a senior tax attorney at Hochman, Salkin, Rettig, 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). She represents U.S. taxpayers in complex tax litigation before both federal and state courts, including the federal district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the Ninth Circuit Court of Appeals. Ms. Strachan has experience in a wide range of complex tax cases, including cases involving technical valuation issues.  She routinely represents and advises U.S. taxpayers in foreign and domestic voluntary disclosures, sensitive issue civil tax examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise, and in defending criminal tax fraud investigations and prosecutions. Additional information is available at

[i] United States v. Chabot, Docket No. 16-3873 (3rd Cir. March 13, 2017).

[ii] United States v. Chabot, 793 F.3d 338 (3d Cir. 2015).

[iii] U.S. Const. Amend. 5.

[iv] Fisher v.United States, 425 U.S. 391 (1975).

[v] Id.

[vi] Grosso v. United States, 390 U.S. 62, 67-68 (1968).

[vii] United States v. Chabot, No. 14-3055 (FLW), 2014 U.S. Dist. LEXIS 140656 (D.N.J. Oct. 3, 2014).

[viii] Id. (citing M.H. v. United States (In re Grand Jury Investigation M.H.), 648 F.3d 1067, 1075-75 (9th Cir. 2011).

[ix] United States v. Chabot, No. 14-3055 (FLW), 2014 U.S. Dist. LEXIS 140656 (D.N.J. Oct. 3, 2014).

[x] United States v. Chabot, Docket No. 16-3873 (3rd Cir. March 13, 2017).

[xi] United States v. Rylaner, 460 U.S. 752 (1983).

[xii] Id.

JONATHAN KALINSKI is a panelist with U.S. Tax Court Judge Juan Vasquez and IRS Deputy Area Counsel Catherine Chang re Anatomy of a Tax Court Case: Litigation Tips From the Experts – “Everything you need to know about navigating the complex world of Tax Court litigation. The discussion by an esteemed panel of experts includes all aspects of a Tax Court case, from beginning to end. Panel will cover filing a case, discovery, settlement strategies, motions, trial, experts, briefing, and everything else you need to know to litigate in Tax Court.”

Thursday, March 23 at noon (program 12:30 p.m. – 1:30 p.m.) at the Beverly Hills Bar Association, 9420 Wilshire Blvd., Second Floor, Beverly Hills, CA 90212. (Parking at 241 No. Canon Drive). Taxation Law Legal Specialization Credit.

EVERYONE IS INVITED – We look forward to seeing you ad appreciate your support for the Taxation Section of the Beverly Hills Bar Association. 


CORY STIGILE will be speaking on Section: Settlements with the State Board of Equalization at a San Fernando Valley Bar Tax Section presentation on March 21, 2017 from noon to 1:00 PM at the SFVBA, 5567 Reseda Blvd., Ste 200, Tarzana.

EVERYONE IS INVITED – We look forward to seeing you and appreciate your support of the SFVBA Tax Section. 



An opinion that begins “Caligula posted the tax laws in such fine print and so high that his subjects could not read them” has to end well for the taxpayer. In Summa Holdings, Inc. v. Commissioner, No. 16-1712 (6th Cir. Feb. 16, 2017), the appellate court reversed the Tax Court and rejected the IRS’s invocation of a “substance over form” argument that sought to disregard a transaction set up in compliance with two Internal Revenue Code provisions that were designed to reduce taxes.

As the Sixth Circuit noted, it takes time, patience and money to learn how complex provisions of the Internal Revenue Code work. The Benenson family, with the assistance of its tax attorneys, used the “domestic international sales corporation” (“DISC”) and the Roth IRA provisions of the Code to avoid tax.

DISCs are an innovation of the Code designed to incentivize domestic corporations to export goods by allowing them to lower tax on export income. A corporation sets up a DISC to which it pays a commission of up to 4% of gross receipts or 50% of net income from qualified exports.  The DISC pays no corporate income tax on its commission income and can pay dividends to shareholders, who are often shareholders of the export corporation.  If the shareholder is a non-taxable entity or a corporation, it pays tax on the dividends at a 33% rate.

A taxpayer who sets up a Roth IRA pays tax on contributions but not on withdrawals, including accrued gains. A taxpayer cannot make contributions to an IRS if his income exceeds a certain level.

Summa Holdings is a manufacturing corporation. James Benenson, Jr., and trusts he formed for his two sons owned over 99% of the corporation’s stock.  In 2001, each of his sons set up a Roth IRA.  Each son contributed $3,500 to his Roth IRA.  Summa Holdings formed JC Export.  Each Roth IRA purchased 50% of the stock of JC Export for $1,500.  The Roth IRAs were the sole shareholders of JC Holdings, to which they transferred the JC Export stock.

JC Export acted as the DISC for Summa Holdings, which paid it commissions. JC Export distributed the commissions as dividends to JC Holdings, which paid tax on the dividends at a 33% rate.  The net dividend income was distributed to the two Roth IRAs as dividends.  Between 2002 and 2008 (the year in issue) JC Holdings distributed over $5.1 million to the Roth IRAs, each of which had accumulated over $3 million.

The IRS issued notices of deficiency. Determining that the substance of the transaction was to distribute Summa Holdings income to the sons without paying tax at the individual level, the IRS invoked the substance over form doctrine.  It disallowed the deductions taken by Summa Holdings as commissions and determined that the commissions were dividends to its shareholders.  It therefore asserted deficiencies against the corporation, Mr. Benenson and his two sons.  It gave a credit to JC Holdings for the 33% tax it paid.  Because each of the Benenson sons earned more than the allowable amount for making contributions to a Roth IRA, the IRS imposed a 6% excise tax on the contributions.  It also imposed accuracy penalties.  The Tax Court upheld the deficiencies but not the penalties and the taxpayers appealed.

The Sixth Circuit reversed. The crux of the Court’s decision was that since Roth IRAs and DISCs were designed by statute to reduce tax, there was nothing improper about a taxpayer using them to do just that.  The Court noted that under any other title of the United States Code this would end the matter:

But when it comes to the Internal Revenue Code, the Commissioner claims a right to reclassify Code-compliant transactions under the “substance-over-form doctrine” in order to respect “overarching . . . principles of federal taxation.” Appellee’s Br. 39, 41. Overarching indeed. As he sees it, the doctrine allows him to nullify the DISC commissions and dividends to the Roth IRAs on the ground that the purpose of the transactions was to sidestep the contribution limits on Roth IRAs and lower the tax obligations of the Benenson sons in the process. That is a step too far. It’s one thing to permit the Commissioner to recharacterize the economic substance of a transaction—to honor the fiscal realities of what taxpayers have done over the form in which they have done it. But it’s quite another to permit the Commissioner to recharacterize the meaning of statutes—to ignore their form, their words, in favor of his perception of their substance.

As originally conceived and as traditionally used, the substance-over-form doctrine has something to it. In writing the tax laws, Congress uses many general terms—“income,” “indebtedness,” “corporate reorganization”—that refer to real-world economic activities, and it assigns tax consequences to those activities. When the courts decide how to classify a transaction, they focus, quite appropriately, on the transaction’s workaday realities, not the labels used by the taxpayers. Take “income.” If a taxpayer receives something of value, 26 U.S.C. § 61(a), he can call it whatever he wants—this, that, or something else. What the taxpayer cannot do is claim that the label he affixes on the transaction precludes it from being “income” under the Code or prevents the courts from treating it as “income” under the Code. Slip op. at 6-7.

As the Court noted, the sham transaction doctrine also disregards labels put on a transaction in order to look at economic reality. But the substance over form and the sham transaction doctrines do not “give the Commissioner purchasing power here.”  Both DISC and Roth IRAs are creatures of Congress designed to help taxpayers reduce taxes.  The Court therefore found it odd for the IRS to reject the transactions at issue “in the service of general concerns about tax avoidance.  It chided the IRS Commissioner for using these doctrines to “avoid tax consequences he doesn’t like”:

The substance-over-form doctrine, it seems to us, makes sense only when it holds true to its roots—when the taxpayer’s formal characterization of a transaction fails to capture economic reality and would distort the meaning of the Code in the process. But who is to say that a low- tax means of achieving a legitimate business end is any less “substantive” than the higher-taxed alternative? There is no “patriotic duty to increase one’s taxes,” as Judge Learned Hand memorably told us in the case that gave rise to the economic-substance doctrine.Slip op. at 10.

This decision will hearten taxpayers who try to utilize the Code in order to minimize their tax in ways that Congress mandated. It will also undoubtedly be used to justify abusive transactions.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and 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

Son-of-BOSS is one of the more infamous tax shelter scams of the late 1990s, early 2000s. The BASR Partnership engaged in a Son-of-BOSS tax shelter to save its partners millions in taxes.  The IRS proposed adjustments to BASR’s partnership return.  If the adjustments were sustained, BASR’s partners would have owed tax on $6.6 million of gain, plus penalties and interest.  BASR beat the government on procedural grounds.  It then got an award of attorney fees and costs against the government.

The IRS did not issue a Final Partnership Administrative Adjustment (FPAA) until after the normal period of limitations had expired. The government argued that the fraud of the return preparer extended the period of limitations.  The “return preparer” was an attorney at Jenkins & Gilchrist and not the accountant who actually prepared the returns.  The Court of Federal Claims rejected the government’s argument.  The Court of Appeals for the Federal Circuit affirmed.

While the case was pending in the claims court, BASR made a written offer to settle by paying $1 to the IRS. After the claims court was affirmed, BASR moved for an award of attorney fees and costs under Internal Revenue Code §7430, which allows a prevailing party to recover attorney fees from the government in a tax case.  The court granted the motion and awarded BASR attorney fees and costs of $314,710.69.

Under §7430, a court may award “litigation costs,” including attorney fees, to a taxpayer who is a “prevailing party” if the government’s position in a case involving the “determination, collection or refund” of any tax is not “substantially justified” and the taxpayer’s net worth does not exceed a statutory amount ($2 million for an individual and $7 million for an entity) on the date the case is filed.  A taxpayer who makes a “qualified offer” during the “qualified offer period” (i.e., from the date that the IRS issues the first notice of proposed deficiency for which administrative review is available until 30 days before the case is first set for trial) can be awarded litigation costs if the amount of the offer is equal to or less than the amount of the taxpayer’s liability as determined by the court.  Where there is a qualified offer, the taxpayer does not have to show that it was the “prevailing party” or that the government’s position was not substantially justified in order to be awarded litigation costs.  The litigation costs that can be awarded are those incurred after the offer is made.

In reaching its decision, the court rejected each of the government’s arguments: that BASR Partnership was not a party (a position that was contrary to IRS regulations); that a tax liability was not an issue (while the partnership is not taxable, its partners are); that the offer was not a “qualified offer” and was a sham; and that BASR did not incur costs, since the fees were paid by its partners.

The court awarded attorney fees incurred from the date of the $1 offer, including those incurred in preparing and defending the motion for fees. The court awarded fees in an amount above the statutory rate because of the complexity of the issues raised at both the trial and appellate court levels.

The moral of the story: if you are in a dispute with the IRS and the IRS has issued a thirty-day letter, make a qualified offer.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and 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

Posted by: mstein10 | March 6, 2017

Beware of New FBAR Filing Deadline by MICHEL STEIN

For calendar 2016 and beyond, the due date for annual Reports of Foreign Bank and Financial Account (FBAR) filings for is April 15.  This date change was mandated by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, which changed the FBAR due date to April 15 to coincide with the Federal income tax filing season.  The Act also mandates a maximum six-month extension of the filing deadline.  To implement the statute with minimal burden to the public, FinCEN will grant filers failing to meet the FBAR annual due date of April 15 an automatic extension to October 15 each year.  Accordingly, specific requests for this extension are not required.

For the 2016 year, the due date for FBARs filings for foreign financial accounts maintained during calendar year is April 18, 2017, consistent with the Federal income tax due date.


Taxpayers with an interest in, or signature or other authority over, foreign financial accounts whose aggregate value exceeded $10,000 at any time during 2015 must file FBARs. A U.S. person may have a reporting obligation even though the foreign financial account does not generate any taxable income. Taxpayers also report their interest foreign financial accounts by (1) completing boxes 7a and 7b on Form 1040 Schedule B.

Generally, all FinCEN forms must be filed electronically. E-filers will receive an acknowledgement of each submission. The online FinCEN Form 114 allows the filer to enter the calendar year reported, including past years.


The failure to timely file the FBAR can be subject to civil penalties and possibly criminal sanctions (i.e., imprisonment). The statutory civil penalties might be $10,000 per year for a non-willful failure but a willful failure to file could, by statute, be subject to civil penalties equivalent to the greater of $100,000 or 50% of the balance in an unreported foreign account, per year, for up to six tax years. Non-willful penalties might be avoided if there is “reasonable cause” for the failure to timely file the FBAR.

Generally, the IRS will not impose a penalty for the failure to file the delinquent FBARs if income from the foreign financial accounts reported on the delinquent FBARs is properly reported and taxes have been timely paid on the U.S. tax return, and the taxpayer has not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.


Taxpayers with specified foreign financial assets that exceed certain thresholds must report those assets to the IRS on Form 8938, Statement of Specified Foreign Financial Assets, which is filed with an income tax return. The Form 8938 filing requirement does not replace or otherwise affect the requirement to file FBAR.

Taxpayers living in the U.S. must report specified foreign financial assets on Form 8938 (filed with their income tax return) if the total value of those assets exceeds $50,000 at the end of the tax year or if the total value was more than $75,000 at any time during the tax year for taxpayers filing as single or married filing separately (or if the total value of specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year for taxpayers filing as married filing jointly).


Taxpayers who are not in compliance with their reporting and filing options regarding undeclared interests in foreign financial accounts and assets should consider various options to come into compliance, including:

(a)    2014 OVDP.   The OVDP is designed for taxpayers seeking certainty in the resolution of their previously undisclosed interest in a foreign financial account. For those who might be considered to have “willfully” failed to timely file an FBAR or similar, the OVDP avoids exposure to numerous additional penalties associated with the income tax returns and various required foreign information reports, a detailed examination, and limits the number of tax years at issue while also providing certainty with respect to the avoidance of a referral for criminal tax prosecution.

(b)   Streamlined Procedures for Non-Willful Violations. In addition to the OVDP, the IRS maintains other more streamlined procedures designed to encourage non-willful taxpayers to come into compliance. Taxpayers using either the Streamlined Foreign Offshore Procedures (for those who satisfy the applicable non-residency requirement) or the Streamlined Domestic Offshore Procedures are required to certify that their failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to “non-willful” conduct.  For these Streamlined Procedures, “non-willful conduct” has been specifically defined as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”

(c)    Delinquent Submission Procedures. Taxpayers who do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who have reasonable cause for not filing a required FBAR or other international disclosure forms, should considering filing the delinquent FBARs or other delinquent forms according to the instructions, along with a statement of all facts establishing reasonable cause for the failure to file. FBARs or delinquent information returns will not be automatically subject to audit but may be selected for audit through the existing IRS audit selection processes that are in place for any tax or information returns.

As the Government refines the reporting rules for foreign accounts and assets, one should expect continued attention in this area.  Anyone lacking in compliance, should consult a tax professional with experience and expertise in these matters. 

MICHEL R. STEIN – For more information please contact Michel Stein –  Mr. Stein is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Mr. Stein has significant experience in matters involving previously undeclared interests in foreign financial accounts and assets, the IRS Offshore Voluntary Compliance Program (OVDP) and the IRS Streamlined Filing Compliance Procedures. Additional information is available at

A Nevada federal judge recently denied a taxpayer’s summary judgment motion in a case that highlights the risks of non-compliance with federal laws, even when your lawyer is advising you to do so. It also shows why lawyers should avoid advising a client not to file a timely tax return, for their own sake as well as the client’s.

Theodore Lee waited three years to file his 2006 return, and the IRS assessed taxes as well as late-filing and late-payment penalties against him. Lee paid the taxes and filed suit against the IRS.  In a summary judgment motion, Lee asserted the penalties and interest should be wiped out, because he was under audit for 1999 to 2005 tax years and —on his attorney’s advice — he didn’t want to file his 2006 returns the same way as his 1999-2005 returns because the IRS might see yet another return as a criminal act.  Lee claimed that his choice not to file was protected by the Fifth Amendment, which meant any penalty would be unconstitutional.  Once the audit was over in 2010, he accepted the IRS’s findings from the 1999-2005 audit and filed the 2006 return consistent with the IRS’s findings.

The district judge didn’t buy the excuse, at least not as a reason to grant summary judgment. Generally, a taxpayer can’t refuse to file a return on Fifth Amendment grounds, and if she’s afraid of incriminating herself, she has to file the return and assert the Fifth Amendment on a line-by-line basis.  For example, if someone earns money from an illegal business, he needs to report the income on his return but may be able to write “Fifth Amendment” in the section that asks for the source of the income.

The judge found the taxpayer’s declarations lacking. His lawyer’s declaration stated that Lee delayed filing on the lawyer’s advice, because he feared prosecution if he filed a timely 2006 return.  Lee, whose explanations for non-filing appear to have changed over time, claimed the same thing in his declaration.  The district court was skeptical of the explanation, but said that even if it bought Lee’s current version, he couldn’t claim the Fifth Amendment as a reason for non-filing.  Further, it was unclear whether Lee was under criminal investigation or civil audit at the time, which would further impact whether his decision not to file was appropriate.  The case will proceed to trial.

Left unsaid in the opinion is how risky this advice was. First, a lawyer can get in trouble both with the State Bar as well as with federal prosecutors if, indeed, the lawyer advised a client to break the law.  It is a crime willfully not to file a tax return, and relying on advice of counsel isn’t technically a defense to this crime – none of the elements require bad faith that would be negated by advice.  If a client is already under criminal investigation – the record for Mr. Lee apparently did not support that he was under criminal investigation, beyond his lawyer’s assertion that he was “under investigation and audit” – then it is prudent to advise the client about the pros and cons of filing returns during the criminal investigation so the client can make his own decision.  But, that’s a far cry from telling a client not to file.

Moving beyond risk to the lawyer, this course is also risky for the client. If a client isn’t already under criminal investigation, then advising them not to file is almost daring the government to open a criminal investigation for non-filing.  Usually, the IRS waits until someone fails to file for three years before opening an investigation, but these aren’t hard and fast rules and the Revenue Agent conducting the civil audit may use the non-filing as a reason to refer the entire case to Criminal Investigation.  Although the taxpayer likely doesn’t feel this way, he’s lucky that he’s only arguing about having to pay civil penalties instead of trying to defend against a failure-to-file criminal charge.

A few different approaches can be considered when faced with a civil audit where the taxpayer has concerns about making incriminating admissions in a current-year return.

  • First, the taxpayer should, at a minimum, pay – either as a deposit or otherwise – the tax that the IRS might later claim is due. Even if returns aren’t filed with the payment, this will prevent non-payment penalties from being imposed, which can dwarf late-filing penalties.
  • A client should also consider filing the return based on the expected IRS position and include a statement that the IRS is auditing earlier returns, but the taxpayer is paying what the IRS may say he owes out of an abundance of caution. The taxpayer can pay the associated tax and file a claim for refund at the appropriate time. I would consider waiting until the last minute to file the refund claim, so as to avoid instituting a civil suit in which the government could depose the taxpayer and thereby get free discovery for any criminal case.
  • Alternatively, to the extent that a particular line-item could incriminate the client, the client should skip the explanation and instead write “Fifth Amendment” on each line in lieu of providing information. Generally, total income must be reported, but sources of income and similar information could be subject to a valid Fifth Amendment claim. By filing the return and paying the highest likely amount of taxes, the IRS couldn’t assess penalties and this could even take the wind out of the sails of any brewing criminal investigation.

Much of this advice applies with equal force even when there’s an ongoing criminal investigation. Regardless of the situation, a taxpayer should hire an experienced, careful lawyer to advise her before taking any of these actions.

EVAN J. DAVIS – For more information please contact Evan Davis – or 310.281.3200. Mr. Davis is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) handling civil and criminal tax cases and, subsequently, of the Major Frauds Section of the Criminal Division of the Office of the U.S. Attorney (C.D. Cal) handling white-collar, tax and other fraud cases through jury trial and appeal. He has served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the Criminal Division.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, federal and state white collar criminal investigations. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (OVDP, Streamlined Procedures and otherwise).

In IRS Private Letter Ruling 201706006, the IRS ruled that a Taxpayer’s lump sum payments of “alimony” ordered pursuant to a court judgment effectuating the Taxpayer’s and the ex-spouse’s agreement did not constitute alimony because they did not meet the requirements set forth in IRC Section 71(b).

I.R.C. section 71(a) provides that gross income includes amounts received as alimony or separate maintenance payments.  Under Section 71(b)(1) “alimony or separate maintenance payment” means “any payment in cash if — (A) such payment is received by (or on behalf of) a spouse under a divorce or  separation instrument, (B) the divorce or separation instrument does not designate such payment as a payment  which is not includible in gross income under section 71 and not allowable as a deduction under section 215, (C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the payor spouse  are not members of the same household at the time such payment is made, and (D) there is no liability to make such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payment after the death of the payee spouse.”

In evaluating the requirements in I.R.C. section 71(a), the ruling noted that the mere labeling of the payments as “alimony” did not the federal tax consequences of the payment. The PLR acknowledged that first, third and fourth requirements were met, but took issue with the second requirement that the payment not be designated as income to the recipient or not deductible by the paying spouse.  The court judgment contained an express designation that the lump sum payments were not includible in the Ex-spouse’s income.  Even though code sections 71 and 215 were not referenced in the court order, the instrument provided clear, explicit, and express direction that the payments would not be income to the recipient spouse such that the second requirement was not met[1].  Moreover, it did not help that the parties agreed that a separate annual alimony payment was taxable to the payee spouse and deductible by the Taxpayer.

While the PLR is provides limited guidance on a specific fact pattern, it provides a helpful reminder of how the Service or the courts will look at the impact of the underlying documents when evaluating the tax consequences for payments under the Internal Revenue Code.  Clients (or the IRS) may assert that form driven facts like the issuance of a 1099, or the labeling of a payment as “alimony,” impact the tax characterization of a payment, but courts can look to underlying state law, the relevant pleadings, any settlement agreements or decrees, or the underlying substance of the payments to determine the correct tax characterization. 

CORY STIGILE – For more information please contact Cory Stigile –  Mr. Stigile is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a CPA licensed in California, the past-President of the Los Angeles Chapter of CalCPA and a Certified Specialist in Taxation Law by The State Bar of California, Board of Legal Specialization. Mr. Stigile specializes in tax controversies as well as tax, business, and international tax. His representation includes Federal and state civil and criminal tax controversy matters and tax litigation, including sensitive tax-related examinations and investigations for individuals, business enterprises, partnerships, limited liability companies, and corporations. His practice also includes complex civil tax examinations. Additional information is available at



[1] See Baker v. Commissioner, T.C. Memo. 2000-164.


AGOSTINO & ASSOCIATES –To download a great article prepared by our very close friends at the Law Firm of Agostino & Associates in Hackensack, NJ ( ), see the Agostino & Associates Newsletter –

Representing Taxpayers in Tax Controversies Involving the Reconstruction of Income, Expenses & Credits by Frank Agostino, Esq., Caren Zahn, EA or Michael Wallace, EA. – The goal of this article is to review the Internal Revenue Code’s record keeping requirements, as well as the methods recognized by the Courts to reconstruct income and expenses.

Audited taxpayers generally ask: How long does a taxpayer keep records that support business income and expense deductions? Is it permissible to discard the records after the three year limitation on assessment (Section 6501) or perhaps the six year statute for fraud (Section 6531)? Or, should the records be maintained until after the 10 year collection period under Section 6502 has run?

The IRS requires that records be retained “so long as the contents thereof may become material in the administration of any internal revenue law.” In other words, best practice is to maintain records until the collection statute expires. International taxpayers maintaining books and records outside the United States must substantiate transactions as if such records were maintained within the United States and follow the same retention requirement period.

This article explains that where a taxpayer’s records are lost, inadequate or untrustworthy, the Court’s have accepted various methods for determining the correct amount of income and expense. These methods involve the development of circumstantial proof, generally through the use of bank deposits, various income/ expense ratios, or volume based analyses. These methods are especially useful to reconstruct a cash intensive business’s income and expenses. Thus, practitioners who work with cash businesses particularly should be familiar with these methods. The methods reviewed in this article are: Source and Application of Funds, Bank Deposit and Cash Expenditure, Markup, and Unit and Volume.

Many tax professionals are uncomfortable preparing income tax returns for taxpayers who deal in cash, especially those who lack receipts to prove their income and expenses. They need not be. The teaching of the cases and Circular 230 is that the goal of all tax professionals is to assist the taxpayer calculate the “correct tax.” Tax professionals representing taxpayers without adequate books and records should familiarize themselves with the rules, regulations and case law applicable to income reconstruction. If you or your client needs assistance with issues involving reconstruction of income or expense records, please contact Agostino & Associates with any questions.


AGOSTINO & ASSOCIATES, with a national practice based in Hackensack, NJ, specializes in tax and tax controversies (civil and criminal), offers in compromise, voluntary disclosures, tax lien discharges, innocent spouse determinations, forfeitures, estate planning and probate, contract and contract litigation. A firm comprised truly great, caring people who want the best for their clients!

For further information, contact Frank Agostino, Esq., Caren Zahn, EA or Michael Wallace, EA.- directly at (201) 488-5400 or visit

Posted by: evanjdavis | February 14, 2017

IRS Reiterates its Focus on Captive Insurers by EVAN J. DAVIS

Back in November 2016, I wrote about the IRS’s recent designation of “micro-captive” insurance arrangements as “transactions of interest.” In Notice 2016-66, the IRS required most captive insurers to file a form describing who sold and set up the captive, among other things.  Presumably, the IRS wanted that information to quickly determine which persons to target for possible promoter penalties or even criminal prosecution.

On January 31, 2017, the IRS issued a notice showing that its focus on captive insurers won’t be going away anytime soon.   The IRS’s Large Business and International Division issued a statement identifying 13 “campaigns” that target “compliance issues” that greatly concern LB&I.  The IRS’s notice suggests that the agency is focusing its scarce resources on a handful of issues to get the most bang for the buck, instead of hoping to catch issues with a randomized approach.  The list of 13 campaigns contains some of the usual suspects for LB&I, including Offshore Voluntary Disclosure Program rejects, related-party transactions, and repatriation schemes.  However, the bulk of the campaigns are issues or schemes that the IRS has more-recently identified as possible tax dodges.  And that includes “micro-captive” insurance companies.

After stating what micro-captive insurance companies do – often wholly owned by the insured, they provide insurance to related companies, allowing a premium deduction to the insured and, if the rules are followed, tax-advantaged treatment of premiums by the captive – the IRS described its concerns with captives. In particular, the IRS believes “the manner in which the [insurance] contracts are interpreted, administered, and applied is inconsistent with arm’s length transactions and sound business practices.”  In plain English, the IRS is concerned that: the insurance policies aren’t targeting real risks (think hurricane insurance in Nebraska); the premiums are set to maximize tax savings instead of based on actuarial analysis of the risks; or the captives are administered as personal piggy banks instead of true insurers.

The IRS then gave the answer that many of us were expecting after it issued Notice 2016-66 and required thousands of captive insurers to file a disclosure form: it will be conducting issue-based examinations of captives. The surprising part of the announcement – which may be disconcerting to captives that have pushed the boundaries – is that the IRS also announced that it developed a training strategy for the campaign.  Given how few IRS employees currently understand captive insurers, the agency’s captive-insurance experts were presumably overwhelmed with the disclosure forms.  The IRS stepped up with money and personnel, so this campaign appears to have legs.

Left unsaid is how many of the issue-based examinations will lead not just to audit adjustments but also civil penalties and criminal prosecutions of both clients and, more likely, promoters. The IRS will expect a return on its investment, and that spells bad news for the more-aggressive promoters and clients.  The only silver lining is that – having investigated a captive insurer while I was a federal prosecutor – captives are sufficiently complicated that very few situations would make a compelling criminal case, and neither the IRS nor the Department of Justice likes to lose a tax prosecution.

EVAN DAVIS – For more information please contact Evan Davis – or 310.281.3200. Mr. Davis is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) handling civil and criminal tax cases and, subsequently, of the Major Frauds Section of the Criminal Division of the Office of the U.S. Attorney (C.D. Cal) handling white-collar, tax and other fraud cases through jury trial and appeal. He has served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the Criminal Division.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, federal and state white collar criminal investigations. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (OVDP, Streamlined Procedures and otherwise).

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