Federal sentencing reform has been gathering steam over the past few years, as the chorus of voices critical of mandatory minimum sentences has reached a crescendo.  Congress first tackled the disparity between crack and powder cocaine sentences in the Fair Sentencing Act of 2010, which addressed a tiny, but important, sliver of oft-criticized drug sentences.  In November 2018, the Federal Sentencing Guidelines were modestly revised, encouraging judges to impose non-custodial sentences on nonviolent first offenders who are unlikely to reoffend.

On December 21, 2018, against the backdrop of a partial government shutdown looming due to a partisan divide over the Border Wall, President Trump signed the solidly bipartisan First Step Act.  Though criticized by some as too small a step, in today’s political environment any bipartisan step toward sentencing reform is praiseworthy.

What does the First Step Act do?

  • Makes retroactive the Fair Sentencing Act, thereby allowing defendants sentenced for crack cocaine crimes to apply for a reduction in their sentences. This will provide substantial work for the Department of Justice and U.S. Attorney’s Offices, as well as defense counsel who focus on such motions.
  • Allows certain incarcerated offenders – generally, low-risk – to obtain additional “good time” and “earned time” credits, after having been assessed by the Department of Justice for suitability for early release. As this assessment process doesn’t exist, DOJ is required to implement and periodically update a risk-assessment regime using evidence of what works and what doesn’t, and which offenders are likely to reoffend.
    • Good time credits already exist, as inmates can earn up to 15% good time credits, thereby only serving 85% of their imposed sentence. This simply increases their availability.
    • Earned time exists in a limited circumstance (the RDAP program for drug and alcohol abusers that can knock off up to 12 months from a sentence) and will now apply to inmates who participate in vocational, educational, substance abuse, mental health, anger-management, faith-based, and similar programs. These low-risk inmates will be allowed to move to halfway houses or home confinement more quickly than under prior law, thereby reducing the prison population in a way that should not materially increase the crime rate.
    • The list of those ineligible for such credits contains the usual suspects, such as murder, assassination, arson, kidnapping, terrorism, and child sexual abuse.
  • Expands the application of “safety valve” exception to mandatory minimum drug sentences.
  • Addresses a handful of “quality of life” issues affecting inmates. This includes prohibiting shackling inmates during pregnancy and shortly after delivery, eliminating solitary confinement for juveniles, releasing terminally ill and elderly offenders to home confinement, and prioritizing placing inmates near their families.

What’s in it for tax and white-collar defendants?

The First Step Act is the first tangible move by Congress toward what the United States Sentencing Commission has been urging for the past two years: using evidence-based decisions to place and rehabilitate inmates, instead of simply punishing and warehousing offenders.

The Act’s most-direct benefit for white collar offenders is the new mandate that the Bureau of Prisons maximize home confinement as allowed by law, which unfortunately is limited to the lesser of 10 percent of the imposed sentence or six months, whichever is less.  This should prove to be a small, but important, benefit to tax offenders, who along with other white-collar offenders overwhelmingly will fall into the low-risk designation, as they tend to be older, better-educated, non-violent, and have no criminal history.

Further, because many tax- and white-collar offenders are on the older end of the age spectrum, the liberalization of rules sending “elderly” offenders to home confinement, should also help.  The Act drops the age at which an offender is considered elderly, from 65 to 60 years old.  Other requirements favor fraud offenders, as to be eligible an offender must not have ever been convicted of a violent crime, never escaped from custody, and must be “at no substantial risk” of reoffending.  As noted in an article Steve Toscher and I wrote two years ago, available at http://www.taxlitigator.com/wp-content/uploads/2017/02/Proposed_Amendments.pdf , the recidivism rate for tax offenders is, as a category, perhaps the lowest of any other type of offender.  Particularly regarding FBAR offenders, who tend to be both at a very low risk of reoffending as well as at the higher end of the age spectrum, this change is good news for both currently incarcerated offenders as well as for defendants awaiting sentencing and looking for arguments in favor of a non-custodial sentence.

The indirect benefits, however, may be even more substantial than the direct ones.  With the First Step Act, Congress is signaling that incarceration is not the right answer for persons who are at a low risk of recidivism.  It prioritizes recidivism and rehabilitation over deterrence and imposing a “just punishment.”  This dovetails with recent amendments to the federal Sentencing Guidelines, which took effect in November 2018, and state that courts should consider a non-imprisonment sentence for nonviolent, first offenders who fall in Zones A and B of the Sentencing Table.  https://www.ussc.gov/sites/default/files/pdf/amendment-process/reader-friendly-amendments/20180430_RF.pdf.  Although many tax offenders fall in Zones C and D of the Table, the one-two punch of the First Step Act and the Guideline amendments provide powerful support for non-incarceration sentences for tax and other white-collar first offenders.

Because DOJ Tax and USAOs still seek the Guidelines sentence in most cases, we should expect to see the chasm between what defendants seek and what prosecutors recommend grow even wider.  If history is a good predictor, judges will move toward the defense recommendations more frequently than the prosecution recommendations in tax cases, as sentences have been dropping ever since the Supreme Court rendered the Guidelines advisory in United States v. Booker in 2005.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis is a principal at Hochman Salkin 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 served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the USAO’s Criminal Division, and the U.S. Attorney General awarded him the Distinguished Service Award for his work on the $16 Billion RMBS settlement with Bank of America.

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, and federal and state white-collar criminal investigations including money laundering and health care fraud.  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 (Streamlined Procedures and otherwise).

 

In Bedrosian v United States the plaintiff paid 1% of a $975,789 FBAR penalty.  Not disputing jurisdiction, the Government counterclaimed for the unpaid balance with interest.  The district court held that Bedrosian was not liable for a willful FBAR penalty, even though he had known about the FBAR filing requirement.  The Government appealed to the Third Circuit.

On appeal, the parties agreed that the Little Tucker Act, 28 U.S.C. §1346(a)(2)  gave the district court jurisdiction, since it was a claim against the United States that did not exceed $10,000.  The Third Circuit issued its opinion, here, yesterday  Addressing an issue not raised by the parties, the Third Circuit held that  Bedrosian’s claim did not give the district court jurisdiction under the Little Tucker Act.  The Court reasoned that 28 U.S.C. §1346(a)(1) gives the district courts jurisdiction over actions for refund of any tax or penalty wrongfully collected “under the internal revenue laws.”  The Court reasoned that “internal revenue laws” encompass more than the Internal Revenue Code.  Since one of the reasons for enactment of the FBAR statute was to deter wealthy individuals from using offshore accounts to evade taxes, and the IRS has been delegated authority to enforce and assess FBAR penalties, the Court concluded the FBAR statute was an internal revenue law.  The Court was inclined to believe that the rule of Flora v. United States, 362 US 145 (1960) applied, which would mean that the district court had no jurisdiction over  Bedrosian’s initial claim since he did not full pay the assessment.  The Government’s counterclaim, however, gave the district court jurisdiction

There was another implication of the Little Tucker Act addressed by the Court: if Bedrosian’s claim was based on the Little Tucker Act, under 28 U.S.C. sec. 1295(a)(2) the Federal Circuit would have exclusive jurisdiction of appeals.  Sec. 1295(a)(2) gives the Federal Circuit exclusive jurisdiction over appeals from district court decisions where a claim arises under the Little Tucker Act, with certain exceptions.  In letter briefs filed with the Third Circuit, both parties argued that the exception in sec. 1295(a)(2) for claims founded upon a statute or regulation “providing for internal revenue” applied, but that Bedrosian’s claim for refund of the FBAR penalty was not a claim for refund of a penalty under the internal revenue laws, so sec. 1346(a)(1) did not apply.  The Third Circuit held that since the FBAR statute was an internal revenue law, the Third Court held it had jurisdiction over the appeal.

The Court then addressed the issue of whether the district court erred in holding that Bedrosian did not act willfully.  The Court held that willfulness encompasses not only voluntary, intentional or knowing violations, but also violations that are “reckless.”  While voluntary, intentional or knowing is a subjective standard, whether conduct is reckless is determined by “’an objective standard: action entailing “an unjustifiably high risk of harm that is either known or so obvious that it should be known’” Safeco, 551 U.S. at 68.”  Because the district court based its determination on  Bedrosian’s motivation and the egregiousness of his conduct compared with the conduct of taxpayers in other FBAR willful cases, the Circuit Court held  the district court did not conduct the correct analysis of whether Bedrosian’s conduct “satisfies the objective recklessness standard articulated in similar contexts” and  remanded the case back to the district court for further consideration.

Prior to the Third Circuit’s decision, both private practitioners and the Government viewed the FBAR statute as not being an internal revenue law.  If the Third Circuit is correct, a host of new issues come into play: a) is the FBAR penalty to be assessed like a tax under the Internal Revenue Code; b) do the claim for refund provisions apply: c) would IRS assessment and collection procedures apply; d) does a person against whom an FBAR penalty is assessed have CDP rights; e) can the IRS settle assessments for over $100,000 without DOJ approval; f) if a person had several offshore accounts, is the penalty to be treated as a divisible tax for purposes of ; and g) a  host of other issues.

Well, at least the Bank Secrecy Act originated in the House of Representatives, so Article I Section 7 of the Constitution is not implicated.

 

The Tax Court in Estate of Streightoff v. Commissioner, T.C. Memo 2018-178, here, faced two issues: whether an interest in a family limited partnership was an assignee interest and what discount should be applied.  Holding for the Commissioner, it determined that the interest was a partnership interest and not an assignee interest.  And since the expert for the Estate’s opinion was based on the assumption that the interest was an assignee interest, the Court sided with the Commissioner on the discount to be applied.

The facts are straight forward:  The decedent formed Streightoff Investment, L.P., on October 1, 2008, which held publicly traded securities, municipal bonds, mutual funds and cash.  Under the partnership agreement, partners holding 75% of the limited partnership interest were needed to change the general partner and approve the admission of a new limited partner.

The decedent gifted to his daughters, his sons and a former daughter-in-law limited partnership interest totaling 10.01% of the partnership.  He transferred 1% to Streightoff Management, LLC, as general partner, with his daughter as manager of the LLC.  He retained an 88.99% limited partnership interest, which he assigned to his living trust.  His daughter, as his power of attorney, signed all documents on the decedent’s behalf.

The decedent died on May 6, 2011.  The estate tax return reported a gross estate, less exclusion, of $5.051 million.  On the valuation date, the net asset value of the partnership was $8.212 million.  The estate tax return reported the value of his interest as $4.588 million after discounting it by 37.2% for lack of marketability, lack of control and lack of liquidity.  After an audit, the IRS issued a notice of deficiency determining that the value of the decedent’s interest in the partnership was $5.99 million.  The issues before the Court were 1) whether the Estate had a partnership interest or an assignee’s interest and 2) what the value was of that interest.

The first issue was a question of state law.  Under Texas law, an assignee of a partnership interest who has not been admitted to the partnership has the right to receive allocations of income, gain, loss and deduction and the right to receive distributions but does not have a the right to exercise any of the rights or powers of a partner.  The Estate argued the Trust was not admitted as a substitute partner and thus had only the rights of an assignee.  The Court did not buy the Estate’s argument.  The Federal tax effect of a transaction is governed by its substance and not its form and the Court looks beyond the formalities of intra-family partnership transactions.  The Court noted that the decedent assigned all his rights associated with his limited partnership interest, which included his right to vote as a limited partner, and all other rights under the partnership agreement and the trust agreed to abide by all provisions of the partnership agreement.  The Court held that based on the economic realities, and the fact that there was no significant difference between a limited partner and an assignee of a limited partnership interest, the transfer was of a limited partnership interest.

The Court then turned to valuation.  The fair market value standard uses a hypothetical willing buyer and a hypothetical willing seller, both of whom are “presumed to be dedicated to achieving the maximum economic advantage.”  Since the Estate acquired an 88.99% limited partnership interest, and thus could remove the general partner and effectively control the partnership, the Court sided with the IRS expert and determined that there was no discount for lack of control.  The experts for both sides applied a discount for lack of marketability.  The IRS expert used an 18% discount while the Estate’s expert used a 27.5% discount.  Since the Estate’s expert assumed that the interest was that of an assignee, the Court adopted the discount used by the IRS expert.

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

On November 20, 2018, the IRS rolled out its new updated procedures for taxpayers who wish to make voluntary disclosures.  The notice emphasizes that the voluntary disclosure procedures are designed for taxpayers who could face potential criminal prosecution.  Taxpayers who do not face potential criminal prosecution but failed to report all income from foreign sources or to file all forms to report foreign accounts or assets can come into compliance through the Streamlined Filing Compliance Procedures, the delinquent FBAR submission program, or the delinquent international information return submission procedures.  Other taxpayers who do not face potential criminal prosecution “can continue to correct past mistakes” by filing amended or past due tax returns.  To determine whether to apply for admission into the voluntary disclosure program, a taxpayer should consult with an attorney experienced in criminal tax cases who can advise on whether the taxpayer could face criminal prosecution.

The new program applies to any voluntary disclosures received after the date the 2014 Offshore Voluntary Disclosure Program closed, September 28, 2018.  Any taxpayer wishing to make a voluntary disclosure after that date must request preclearance from Criminal Investigation by either fax (267-466-1115) or by mail addressed to “IRS Criminal Investigation/Attn: Voluntary Disclosure Coordinator/2970 Market St./1-D04-100/Philadelphia, PA 19104.”  If CI grants preclearance, a taxpayer is then required to submit all required voluntary disclosure documents using an updated Form 14457, which will require detailed information from the taxpayer.  A copy of the current Form 14457 is here.  If CI preliminarily accepts the taxpayer’s voluntary disclosure, the case will then go to Large Business & International in Austin, Texas, which will route the case for civil examination.

Civil examiners are to apply a “civil resolution framework” to all cases.  The framework will require a taxpayer to file returns and reports and be examined for a six-year period.  This compares with the eight year period under the 2014 OVDP.  A taxpayer who makes a voluntary disclosure will be subjected to a 75% fraud penalty under either §6651(f) (fraudulent failure to file) or 6663 (fraudulent return) for the year with the largest tax liability.  If the taxpayer failed to file FBARs, willful penalties will be imposed in accordance with the guidelines in IRM 4.26.16 and 4.26.17.  These guidelines allow a penalty equal to 50% of the highest aggregate account balance and, where there are multiple years for which a willful penalty applies, an amount of up to 100% of the highest aggregate account balance.  The IRS examiner, at his or her discretion, can assert fraud penalties for more than one year “based on the facts and circumstances of the case” and can also assert penalties for failure to file information returns, again based on facts and circumstances.  If the taxpayer “fails to cooperate and resolve the examination by agreement” the examiner can apply a fraud penalty for more than six years.  IRS managers are to ensure that “penalties are applied consistently, fully developed and documented” in every case.  Taxpayers who fail to cooperate with civil disposition of the case can have preliminary acceptance revoked.

The text of the civil framework is:

  1. a) In general, voluntary disclosures will include a six-year disclosure period. The disclosure period will require examinations of the most recent six tax years. Disclosure and examination periods may vary as described below:
  2. In voluntary disclosures not resolved by agreement, the examiner has discretion to expand the scope to include the full duration of the noncompliance and may assert maximum penalties under the law with the approval of management.
  3. In cases where noncompliance involves fewer than the most recent six tax years, the voluntary disclosure must correct noncompliance for all tax periods involved.

iii. With the IRS’ review and consent, cooperative taxpayers may be allowed to expand the disclosure period. Taxpayers may wish to include additional tax years in the disclosure period for various reasons (e.g., correcting tax issues with other governments that require additional tax periods, correcting tax issues before a sale or acquisition of an entity, correcting tax issues relating to unreported taxable gifts in prior tax periods).

  1. b) Taxpayers must submit all required returns and reports for the disclosure period.
  2. c) Examiners will determine applicable taxes, interest, and penalties under existing law and procedures. Penalties will be asserted as follows:
  3. Except as set forth below, the civil penalty under I.R.C. § 6663 for fraud or the civil penalty under I.R.C. § 6651(f) for the fraudulent failure to file income tax returns will apply to the one tax year with the highest tax liability. For purposes of this memorandum, both penalties are referred to as the civil fraud penalty.
  4. In limited circumstances, examiners may apply the civil fraud penalty to more than one year in the six-year scope (up to all six years) based on the facts and circumstances of the case, for example, if there is no agreement as to the tax liability.

iii. Examiners may apply the civil fraud penalty beyond six years if the taxpayer fails to cooperate and resolve the examination by agreement.

  1. Willful FBAR penalties will be asserted in accordance with existing IRS penalty guidelines under IRM 4.26.16 and 4.26.17.
  2. A taxpayer is not precluded from requesting the imposition of accuracy related penalties under I.R.C. § 6662 instead of civil fraud penalties or non-willful FBAR penalties instead of willful penalties. Given the objective of the voluntary disclosure practice, granting requests for the imposition of lesser penalties is expected to be exceptional. Where the facts and the

law support the assertion of a civil fraud or willful FBAR penalty, a taxpayer must present convincing evidence to justify why the civil fraud penalty should not be imposed.

  1. Penalties for the failure to file information returns will not be automatically imposed. Examiner discretion will take into account the application of other penalties (such as civil fraud penalty and willful FBAR penalty) and resolve the examination by agreement.

vii. Penalties relating to excise taxes, employment taxes, estate and gift tax, etc. will be handled based upon the facts and circumstances with examiners coordinating with appropriate subject matter experts.

viii. Taxpayers retain the right to request an appeal with the Office of Appeals.

  1. d) The Service will provide procedures for civil examiners to request revocation of preliminary acceptance when taxpayers fail to cooperate with civil disposition of cases.
  2. e) All impacted IRM sections will be updated within two years of the date of this memorandum.

The original OVDP was criticized by National Taxpayer Advocate Nina Olsen for its “one-size-fits all” cookie-cutter approach that treated taxpayers who made honest mistakes the same as those who acted willfully.  As Ms. Olsen noted in a recent NTA Blog, “the IRS’s initial failure to design programs for benign actors probably eroded trust for the IRS, posing risks to voluntary compliance.”  The new voluntary disclosure program, with its emphasis on fraud penalties and FBAR willful penalties, is designed for those taxpayers Ms. Olsen would designate as truly bad actors.

While the IRS will update its IRM sections impacted by the new guidelines, the basics of its voluntary disclosure practice will remain in place: a) the disclosure must be truthful, complete and timely, b) the taxpayer must cooperate with the IRS to determine his or her correct tax liability, c) the taxpayer must pay or makes good faith arrangements to pay in full any tax, interest and penalties owed, and d) voluntary disclosure does not apply if the taxpayer had income from illegal sources.  And, as in the past, a voluntary disclosure will not immunize a taxpayer from criminal prosecution, although the IRS will probably not recommend criminal prosecution where the taxpayer complies with the program.

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 Treasury Inspector General for Tax Administration (“TIGTA”) is always on the lookout for the IRS’s flaws.  They hit the agency with both barrels last month, finding in consecutive audit reports that: (1) the IRS effectively ignores currency transaction reports (“CTRs”) in IRS civil cases; and, (2) even when civil auditors use bank-filed CTRs and suspicious activity reports (“SARs”) to identify possible tax cheats, most criminal referrals wither on the IRS-Criminal Investigations vine.

Under the Bank Secrecy Act (“BSA”), banks and other financial institutions are legally obligated to report cash transactions exceeding $10,000 in CTRs.  These same institutions are also required to file – in secret, without telling the taxpayer – SARs when the institutions identify suspicious patterns or activity, such as unusual cash transactions or repeated deposits of $9,900.  Avoiding the CTR reporting by always depositing less than $10,000 is itself a crime (structuring), but the reporting is also to try to detect illegal-source income and terrorist financing.  The CTRs and SARs are filed with another arm of the Treasury Department, the Financial Crimes Enforcement Network (“FinCEN”), but the IRS’s civil auditors and criminal investigators can access CTRs and SARs.

One might think that using SARs to identify viable civil audit targets and criminal investigations is like fishing with dynamite: a bank has already told the government that something looks fishy about the taxpayer.  The problem is the number of SARs filed: more than 2 million in 2017.   https://www.fincen.gov/reports/sar-stats.  The number of CTRs presumably is much higher, so the IRS has struggled with ensuring that CTR and SAR data is integrated with other tax data.

TIGTA warned the IRS in 2010 that it was missing the boat regarding using CTRs to identify tax non-filers.  The IRS pledged to do better, and TIGTA conducted a progress checked in eight years later.  In its September 21, 2018 report, https://www.treasury.gov/tigta/auditreports/2018reports/201830076fr.pdf, TIGTA noted little improvement.

When it is conducting BSA examination under Title 31, not the Title 26 tax code, the IRS can’t use the BSA exam as a pretext to do a tax examination.  However, if the BSA examination happens to reveal a possible tax violation, the BSA group refers the matter to IRS civil auditors in the Small Business/Self-Employed Division.  TIGTA wanted to find out what happened with the 3,000 or so referrals between 2015 and 2018.  TIGTA’s findings:

  • First, for most of the period, the IRS didn’t bother establishing procedures to process the referrals. In an organization so wedded to process, this caused referrals to fall into the expected bureaucratic black hole.  No one knew how long it was taking to process the referrals, and no tracking means no consequences for delay.  In the overworked IRS, this pushes the referrals to the bottom of the work pile.  Some referrals sat for three years between receipt and forwarding for possible audit.
    • The IRS agreed in response to TIGTA’s findings that it should start tracking BSA referrals, not surprisingly.
  • Second, one third of IRS auditors didn’t review CTRs before issuing no-change determinations, even when doing so would have revealed more than $100,000 of currency transactions.
    • The IRS disagreed with the percentage of missed CTRs but agreed with TIGTA’s recommendation to update the Internal Revenue Manual to emphasize that auditors should consult CTR information.

 

In the second report, issued three days later, TIGTA took the IRS to task for the terrible return-on-investment demonstrated in BSA cases, which included cases involving Forms 8300 (essentially CTRs for businesses, not banks).  https://www.treasury.gov/tigta/auditreports/2018reports/201830071fr.pdf

 

Given that its budget has been cut to – and even into – the bone, the IRS tries to get the most bang for its criminal enforcement buck.  If that’s true, the IRS should pull the rip cord on its BSA enforcement efforts and move the resources to more-lucrative cases.

The title of TIGTA’s report says it all: “The IRS’s Bank Secrecy Act Program has Minimal Impact on Compliance.”  Why did it reach that conclusion?

  • Referrals from the IRS back to FinCEN for Title 31 (BSA) penalty cases go through long delays and don’t seem to change BSA compliance;
  • The BSA program spent nearly $100 million to assess (let alone collect) approximately $40 million (an abysmal rate, given that spending on tax assessments is always a good deal for taxpayers), in part because the IRS lets many violations slide and just issues warning letters instead of penalties because FinCEN and not the IRS has exclusive penalties authority;
  • Those tasked with BSA compliance called their efforts “a waste of time” because the IRS didn’t track whether anyone complied with the IRS’s warning letters, and the frequency of repeat offenders who suffered no consequences, was stark evidence of this fact;
  • The few (about 5 cases per year) referrals to IRS-CI for BSA prosecutions were mostly declined by IRS-CI, showing they don’t prioritize these cases; and
  • The IRS continues to separate virtual currency from BSA work, when it should be integrated with other Title 31 BSA work, and it only opened about 10% of a small number of virtual currency cases were even assigned to a BSA examiner (the upshot being that virtual currency violations remain nearly untouched by the IRS).

The upshot of the report is that it appears no person at the IRS has taken responsibility to ensure that the BSA program gets results.  Therefore, there have been no consequences for failure, no rewards for success, and no incentives for efficiency.  The lack of leadership equals lack of focus and results.

Will the new IRS Commissioner kill the BSA program in the name of directing scarce resources to higher-impact cases, or improve it as recommended by TIGTA?  It’s too early to tell.  Having both prosecuted legal-source structuring and, more recently, having represented targets of legal-source BSA investigations, I am of two minds as to the best outcome for the IRS and taxpayers.  The IRS has a lot of priorities and needs to direct its resources to get the most bang for the buck, but BSA violations can be the tip of an important iceberg of criminal activity and the IRS will never know how deep the criminal conduct goes without investigating.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis is a principal at Hochman Salkin 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 served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the USAO’s Criminal Division, and the U.S. Attorney General awarded him the Distinguished Service Award for his work on the $16 Billion RMBS settlement with Bank of America.

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, and federal and state white-collar criminal investigations including money laundering and health care fraud.  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 (Streamlined Procedures and otherwise).

 

When a partnership wants to sell real property it sometimes has a problem: some of the partners want to cash out while others want to do a like-kind exchange and remain invested in real property.  The “drop and swap” transaction was designed to address this problem.  Prior to the sale, the partnership distributes, in exchange for their partnership interests, tenancy-in-common (TIC) interests to partners who want to do a like-kind exchange.  At the close of escrow, the partners will get cash distributed to them.  The former partners will do a like-kind exchange through a qualified intermediary.  To ensure that those partners who want to do a like-kind exchange do not prolong or disrupt a sale by not agreeing to terms the partnership finds acceptable, these transactions are normally structured so that the TIC interests are distributed after the partnership and the buyer have entered into a contract.

For several years, the Franchise Tax Board has scrutinized “drop and swap” transactions and, in late 2016, in In re Giurbino, a non-precedential decision, the Board of Equalization upheld the FTB’s determinations that such a transaction did not qualify as a like-kind exchange and that the taxpayers were liable for an accuracy penalty.

The newly-constituted Office of Tax Appeals has done an about face and held for the taxpayer in a drop and swap transaction in Appeal of Mitchell (8/2/2018).  The facts in the case are similar to those in In re Giurbino.  The partnership, Con-Med, owned rental property.  It began negotiations with the lessee, which offered to buy the property for $6 million.  Con-Med and the lessee entered into a contract for the sale of the property.  Because two of the partners, the taxpayer and her mother, wanted to do a 1031 exchange, shortly before the close of escrow Con Med redeemed the taxpayer’s and her mother’s partnership interests and issued grant deeds transferring TIC interests in the property to them.  The partnership, the taxpayer and her mother signed grant deeds transferring their respective partnership interests to the buyer.  The escrow company transferred to a qualified intermediary the taxpayer’s and her mother’s aliquot share of sale proceeds.  Subsequently, replacement property was identified and purchased for the taxpayer and her mother.

The OTA held an evidentiary hearing before a panel of three administrative law judges.  The FTB argued that the transaction did not satisfy the exchange requirement because the partnership rather than the taxpayer sold the property.  It argued substance over form, that the taxpayer was merely a conduit for passing title and that she never had any of the benefits or burdens of ownership.  Finally it argued that the partnership made an anticipatory assignment of income.   The OTA rejected the FTB’s arguments and ruled for the taxpayer.

The two judge majority held that the taxpayer “continuously held” an interest in the property for investment purposes and that she intended to exchange it for like-kind property.  That the taxpayer’s ownership changed from holding through a partnership to direct ownership of a TIC interest was viewed as immaterial.  Since she transferred her interest to a qualified intermediary she met the requirements of §1031.

The majority rejected the substance over form and step transaction arguments on the ground that for a number of years prior to the sale the partners had been discussing a sale that allowed some of the partners to do a like-kind exchange.  A drop and swap was the only way to accommodate the wishes of the partners to either cash out or do a like-kind exchange.

With respect to the conduit argument, the majority held that since the grant deed to the taxpayer was valid on its face and Con Med negotiated on behalf of all its 17 partners, “that only Con Med’s name appears on counteroffers is simply a reflection of the state of the title to the Property at the time.”

In Court Holding, 324 US 331, the Court held that a corporation that  negotiated a sale of property was in substance the seller taxable on the gain even though, prior to the close of the transaction, it had deeded the property to its shareholders, who signed the sales agreement, completed the transaction and reported the gain on their tax returns.  The majority viewed Court Holding as inapplicable since it involved a corporation and was based on its facts.  The case before it did not involve an attempt to avoid taxes, merely to defer them through a 1031 exchange.  The majority also rejected the assignment of income argument on the ground that the partnership, as a pass-through entity, was not taxable on gain from the sale.

The dissent pointed out that the taxpayer was not involved in negotiations, was not mentioned in any of the counteroffers or the signed agreement and the redemption agreement recited that Con Med (not the taxpayer) was under contract to sell the property.  Con Med handled the negotiations and sold the property. Additionally, rents were paid to Con Med during the entire period up to the sale date and Con Med paid all expenses associated with the property, not the taxpayer.  Based on the notarized dates and filing dates, the deeds transferring TIC interests to the taxpayer and her mother were signed and filed one day before the deeds transferring the property to the buyer.

The dissent criticized the majority’s rejection of Court Holding, noting that it had been applied by both federal courts and the Board of Equalization to cases involving 1031 exchanges.  It also pointed out that the facts in Court Holding were more favorable to the taxpayer since the shareholders were the only ones who signed any sales contract whereas here the partnership, not the partner, signed all sales documents.  Thus, the dissent would have found that there was an assignment of income.

The dissent would also have found that in substance the transaction was a sale by the partnership, rejecting the taxpayer’s argument that the partnership negotiated the sale as her agent.  Further, contrary to the majority, there was no evidence that the taxpayer’s mother negotiated a sale on behalf of the taxpayer.  The dissent would have found that the partnership, not the taxpayer, negotiated and sold the property, and, therefore, the transaction was not a like-kind exchange.

The FTB has filed a petition for rehearing, which is currently pending. Because of the petition for rehearing, the opinion has not become final.  Whether the OTA will deny the petition or issue a new opinion remains to be seen.  If the OTA ultimately reaffirms its initial opinion and designates it as precedential, the FTB’s challenges to drop and swap transactions will  finally be over and application of the like kind exchange provisions in California will be consistent with the more liberal federal interpretations.

 

 

For more information please contact Robert S. Horwitz – horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., former Chair of the Taxation Section, California Lawyers’ Association, a former Assistant United States Attorney and a formed 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

Pro se petitioners James and Tina Loveland hit a home run in a CDP case that resulted in a formal Tax Court opinion, Loveland v. Commissioner, 151 T.C. No. 7 (September 25, 2018), here.  The Tax Court has three levels of opinions: 1) a formal Tax Court opinion, which is published in the Tax Court Reporter and has precedential value in future cases, 2) memorandum opinions which are not precedential although they are often cited by litigants; and 3) summary opinions, which are issued in cases where the amount in dispute is $50,000 or less and the taxpayer agrees to application of the Tax Court’s small case procedures.  Memorandum and summary opinions are not published by the Tax Court but are available on the Court’s website.  Formal Tax Court opinions comprise a fraction of all Tax Court opinions.  To merit a formal opinion, the Tax Court considered the Lovelands’ case to involve significant legal issues.  The issues under consideration are the scope of review by the Office of Appeals where the taxpayers had previously been afforded, but failed to avail themselves of, an opportunity to appeal a rejected collection alternative.

The Lovelands story is a sad commentary on life in what the news media calls “fly over America.”  The Lovelands live in Michigan.  During the 2008-2009 financial meltdown they lost their home in foreclosure.  Mr. Loveland developed heart problems and could no longer work.  Mrs. Loveland developed breast cancer.  As a result, they accrued over $60,000 in tax, penalties and interest for 2011-2014.  The IRS issued a notice of intent to levy under §6330.  In response, the Lovelands submitted an offer in compromise (OIC) to collections.  The OIC was rejected on the ground that there were no special circumstances and the Lovelands could full pay the tax.  They appealed the rejection and submitted an installment agreement request (“IA”).  They were told the IA could not be considered while they were appealing the rejection of the OIC, so they withdrew the appeal.

The Lovelands decided to get a loan to pay the tax down to under $50,000 so they could take advantage of the IRS’s streamlined processing of the IA request.  On the day they submitted the loan application the IRS filed a notice of federal tax lien.  The Lovelands filed a CDP request, seeking release of the lien because it disrupted their efforts to get a loan and caused economic hardship.  The Lovelands submitted their prior OIC with the attached financial information and their IA request.  The Lovelands pointed to Mr. Loveland’s health as a special circumstance.

Appeals rejected the request for lien release.  It rejected the IA request on the ground that the taxpayers failed to submit any financial information.  The Appeals Officer never looked at the OIC or the accompanying financial information and did not address the OIC, Mr. Loveland’s health or any special circumstances.  The Lovelands petitioned the Tax Court for review of Appeals’ determination.  The IRS moved for summary judgment.  Finding that the Commissioner had abused his discretion, the Court denied the motion.

The first issue was whether the IRS abused its discretion in failing to consider the OIC.  The IRS took the position that since the Lovelands discussed the OIC with a revenue agent and filed an appeal, which was withdrawn, there was a prior administrative proceeding that precluded consideration by Appeals.  Wrong, said the Tax Court.  Under §6330(c)(4)(A)(i),  an issue may not be considered in a CDP hearing if it “was raised and considered in a previous hearing under section 6320 or in any other previous administrative or judicial proceeding.”   Additionally, under the regulations, the taxpayer must have meaningfully participated in the hearing or proceeding.

The Tax Court held that while the Lovelands had an opportunity for prior Appeals Office review of the OIC, they did not avail themselves of that opportunity and, thus, the OIC was never actually considered in a prior administrative or judicial proceeding.  This was contrasted with disputing the underlying liability, which can only be considered if the taxpayer did not have an opportunity to challenge the liability.  Discussions and negotiations with a revenue officer do not cut the mustard.  Thus, in failing to consider the OIC during the appeal, the IRS abused its discretion.

The Tax Court also held that the IRS abused its discretion in failing to consider the IA on the ground that the Lovelands did not submit financial information.  The financial information was part of the OIC package that was submitted to, but never reviewed by, Appeals.  Appeals did not reject the financial information on the ground that it was incomplete or outdated.

Finally, the Tax Court addressed the IRS’s failure to consider whether extraordinary circumstances existed to justify the OIC due to Mr. Loveland’s poor health.  Although the Lovelands raised this issue before Appeals, it was not addressed or considered by Appeals.  In not considering and addressing the Lovelands’ economic hardship claim the IRS abused its discretion.

Effectively, three strikes and the IRS was out.  The case will ultimately go back to IRS Appeals to address the issues that it failed to previously address.

 

For more information please contact Robert S. Horwitz – horwitz@taxlitigator.com 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 http://www.taxlitigator.com.

 

Since Mayo Foundation v United States, 562 US 544 (2011), the IRS has given lip service to the proposition that rules governing judicial review of administrative agency action apply to the IRS.  The Tax Court’s order granting the taxpayer’s summary judgment motion in Renka, Inc. v. Commissioner, Dkt. No. 15988-11 R (Aug. 16, 2018), here, shows that the IRS has yet to fully understand what that means.

Renka, Inc., petitioned the Tax Court to determine whether the ESOP that owned 100% of its stock qualified as a tax-exempt trust for tax years ending December 31, 1998, and subsequent plan years.  Renka was the exclusive agent for American Nutrition Corp. (ANC) in soliciting, negotiating and securing orders for ANC products.  The IRS’s determination had two stated bases: first, Renka and ANC were a controlled group under IRC §414(h) and second, Renka and ANC were an affiliated service group under IRC §414(m)(5).  If either were correct, then Renka and ANC would have to be considered together to determine whether non-highly compensated employees benefitted equally with highly compensated employees.

Initially, the IRS moved for summary judgment on the ground that ANC and Ranka were a controlled group in 1999.  The Tax Court denied the motion, holding that a) Renka and ANC were not a controlled group and b) under the Chenery doctrine (named after SEC v. Chenery Corp., 332 U.S. 194 (1947)), a court is required to judge an agency’s action by the grounds invoked by the agency at the time of the action rather than by after-the-fact rationalizations.  Since the IRS determination dealt with the year ending December 31, 1998, facts relating to 1999 could not be considered.

The parties then filed cross-motions for summary judgment.  Renka argued that its ESOP qualified in 1998.  The IRS argued that Renka and ANC were an affiliated service group based on facts relating to 1999.

The Tax Court denied the IRS motion and granted the taxpayers’ motion.  First, the Court noted that Chenery prevents the IRS from using facts from 1999 to uphold a determination for 1998.  The Court rejected the IRS’s argument that if it strips away all extraneous matter, the determination is correct.  According to the Court, this was like saying “if we ignore all the things he (IRS) did wrong, then he was right.”  The IRS admitted the grounds given in the determination letter were wrong.  The upshot: the determination an abuse of discretion.

Next, the Court held that the IRS could not justify its determination by claiming it was a “continuing determination” since it applied to all years because the determination was made for the 1998 tax year; if the ESOP didn’t qualify for 1998, it didn’t qualify in later years.

The Court also rejected the IRS’s argument that a proposed regulation supported its position.  Even if Chenery did not apply, the proposed regulation would have no more weight than an argument in a brief and, contrary to the IRS, the regulation did not state that marketing was tantamount to managing.  Additionally, the regulation was withdrawn in 1993, so that it couldn’t be relied on to justify the IRS’s action for the 1998 tax year.  There was no way the IRS could “edit the rationale he gave into something that isn’t an abuse of discretion.”

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – horwitz@taxlitigator.com 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 http://www.taxlitigator.com.

 

Taxpayers often find dealing with the IRS so stressful a root canal without anesthetic is preferable.  One couple may be able to recover emotional distress damages for the way they were treated by the IRS.  The taxpayers in Hunsaker v. United States, Dkt. No. 16-35991 (9th Cir. Aug. 30, 2018), here, filed a bankruptcy petition under chapter 13.  After the petition was filed, the IRS sent them routine collection notices.  The taxpayers responded by filing an adversary proceeding for violation of the automatic stay, seeking injunctive relief and emotional distress damages.  The Government conceded the violation of the bankruptcy automatic stay and argued that sovereign immunity barred emotional distress damages against the Government.  The Bankruptcy Court rejected the argument and awarded $4,000 in damages for emotional distress.  The district court reversed on the ground of sovereign immunity.  The taxpayers appealed to the Ninth Circuit, which reversed.

The Ninth Circuit framed the issue as one involving the interplay between Bankruptcy Code §§106(a) and 362(k).  Sec. 106(a) waives sovereign immunity “to the extent set forth in this section” including for monetary damages, but not punitive damages.  After a bankruptcy petition is filed Bankruptcy Code §362 imposes an automatic stay on various types of activities to collect a debt.  Sec. 362(k) allows a debtor injured by violation of an automatic stay to collect actual damages, including costs and attorney’s fees.

The Ninth Circuit reasoned that §106(a)’s waiver encompasses a money recovery for damages other than punitive damages.  Since damages for emotional distress are a form of monetary relief and are not punitive damages, they are covered by §106(a)’s waiver.  The Court had previously ruled that emotional distress damages are actual damages recoverable under §362(k).

The Court rejected the Government’s argument that “money recovery” is limited to restoring to the estate money unlawfully in the possession of the United States, finding this interpretation contrary to the statute’s plain text, which excludes only punitive damages.  The Court rejected the contrary holding of United States v. Rivera-Torres, 432 F. 2d 20 (1st Cir. 2005), believing that case misconstrued the effect of the 1994 amendment to §106(a).  In the Ninth Circuit’s view the “plain language of the statute is dispositive.”

The Court concluded “In sum, sovereign immunity does not preclude an award of emotional distress damages against the United States for willful violation of the Bankruptcy Code’s automatic stay.”  It remanded the case to the district court to consider the Government’s challenge to the merits of the taxpayer’s claim.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – horwitz@taxlitigator.com 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 http://www.taxlitigator.com.

 

 

Posted by: Cory Stigile | September 18, 2018

How Long Should You Keep Tax-Related Records? by CORY STIGILE

The length of time you should keep a document depends on the action, expense, or event which the document records. Generally, you must keep your records that support an item of income, deduction or credit shown on your tax return until the period of limitations for that tax return runs out. For most taxpayers, the general recommendation is to retain copies of tax returns and supporting documents at least three years. Some documents should be kept up to seven years in case a taxpayer needs to file an amended return or if questions arise. Taxpayers should retain records relating to real estate for at least seven years after disposing of the property.

Health care information statements should be kept with other tax records. Taxpayers do not need to send these forms to IRS as proof of health coverage. The records taxpayers should keep include records of any employer-provided coverage, premiums paid, advance payments of the premium tax credit received and type of coverage. Taxpayers should keep these — as they do other tax records — generally for three years after they file their tax returns.

Whether stored on paper or kept electronically, taxpayers are urged to keep tax records safe and secure, especially any documents bearing Social Security numbers. Consider scanning paper tax and financial records into a format that can be encrypted and stored securely on a flash drive, CD or DVD with photos or videos of valuables.

Now is a good time to set up a system to keep tax records safe and easy to find when filing next year, applying for a home loan or financial aid. Tax records must support the income, deductions and credits claimed on returns. Taxpayers need to keep these records if the IRS asks questions about a tax return or to file an amended return.

Keep tax, financial and health records safe and secure whether stored on paper or kept electronically. When records are no longer needed for tax purposes, ensure the data is properly destroyed to prevent the information from being used by identity thieves.

The period of limitations is the period of time in which you can amend your tax return to claim a credit or refund, or the IRS can assess additional tax. Unless otherwise stated, the years refer to the period after the income tax return was filed. Returns filed before the due date are treated as filed on the due date. Filed tax returns can be helpful in preparing future tax returns and making computations if you file an amended return.

Period of Limitations that generally apply to income tax returns:

  1. Keep records for 3 years, if situations (4) and (5) below do not apply to you.
  2. Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return.
  3. Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
  4. Keep records of gross income for 6 years, which is the statute of limitations for assessment where a return omits more than 25% of gross income or 25% of gross receipts of a trade or business. Examples where this can occur is reclassification of a related-party loan as income, constructive dividends, failure to report alimony, failure to report discharge of debt income, and failure to report income from a pass-through entity.
  5. Keep records indefinitely if have not filed a return.
  6. Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.

The following questions should be applied to each record as you decide whether to keep a document or throw it away.

Are the records connected to property? Generally, keep records relating to property until the period of limitations expires for the year in which you dispose of the property. You must keep these records to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when you sell or otherwise dispose of the property.

If you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up, increased by any money you paid. You must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property. 

What should I do with my records for nontax purposes? When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.

Caveats:  There is no statute of limitations on assessment where the taxpayer files a fraudulent return.  If the taxpayer was required to file reports relating to foreign assets or foreign transfers, the statute of limitations does not begin to run until those reports are filed.

CORY STIGILE – For more information please contact Cory Stigile – stigile@taxlitigator.com  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 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 www.taxlitigator.com

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