TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

Causes of action based on penal statutes do not survive the defendant’s death while those based on remedial statutes survive death.  In this context, a remedial statute is one meant to compensate the victim for a harm suffered, while a penal statute is meant to impose damages upon a defendant for a general wrong.  Given the magnitude of the civil FBAR penalty ($10,000 for a non-willful violation and the greater of $100,000 or 50% of the amount in the account for willful violations), most people would conclude that an action to collect the civil FBAR penalty is a “penal” rather than a “remedial” cause of action and that it does not survive the death of the person assessed.  If you have kept track of willful FBAR penalty cases, you’d know that the district courts that have addressed the issue have held that a willful FBAR penalty survives the death of the defendant.  See, United States v. Estate of Garrity, 304 F. Supp. 3d 267 (D. Conn. 2018); United States v. Estate of Schoenfield, 344 F. Supp. 3d 1354 (M.D. Fla. 2018); United States v. Park, 389 F. Supp. 3d 561 (N.D. Ill. 2019); United States v. Green, 457 F. Supp. 3d 1262 (S.D. Fla. 2020); United States v. Wolin , 489 F. Supp. 3d 21 (E.D. N.Y. 2020).

Given the number of district court cases over the past three years holding that the willful FBAR penalty survives the defendant’s death, why a blog now on death and the FBAR penalty?  Because a recent opinion by the United States District Court for the Southern District of Texas, United States v. Gill, Dkt. No. H-18-4020, contains an in-depth analysis of whether the non-willful FBAR penalty was remedial or penal in the context of a motion to dismiss and concluded that it was remedial and survived death. 

First, just the facts: Gill was a naturalized U.S. citizen who had an interest in or signatory authority over numerous foreign bank accounts.  He failed to report foreign income on his 2005-2010 income tax returns and failed to file FBARs for those years.  The IRS assessed $740,848.00 in non-willful FBAR penalties against Gill and $55,304 in non-willful FBAR penalties against his wife.  The Government filed separate collection actions against Gill and his wife.  Gill answered and moved to consolidate the two cases. The motion was granted.  Shortly afterwards Gill died and his wife was appointed representative of his estate.  The estate then moved to dismiss the case against Gill under Fed. Rule Civ. Pro. 12(b)(6), failure to state a claim upon which relief can be granted, arguing that the FBAR penalty was penal and, thus, the Government’s claim did not survive Gill’s death.

The Court got down to analyzing the law by first stating the ground rules under Rule 12(b)(6):  on a motion to dismiss for failure to state a claim all questions of fact and all legal ambiguities are to be resolved in favor of the plaintiff, in this case the Government. 

The first question was whether under 28 U.S.C. sec. 2404 the claim against Mr. Gill survived his death.  That section provides that a civil action for damages brought by or on behalf of the United States survives the defendant’s death.  To answer this question requires a determination of whether the claim is primarily remedial or penal.

The general rule is that causes of action that seek remedial damages survive the defendant’s death while those that are penal do not.  A remedial action seeks damages for a specific harm suffered by a person while a penal action seeks damages for “a general wrong to the public.”  A three-part test (termed the In re Wood factors) is normally applied to make this determination: (1) is the purpose of the statute to address individual wrongs or a more general wrong to the public; (2) does the recovery go to the harmed individual or the public; and (3) is the recovery authorized by the statute “wholly disproportionate to the harm suffered.”  My initial reaction to this three-part test is that the civil FBAR penalty is a penal statute.  But there’s more. 

Under Hudson v. United States, 522 U.S. 93 (1997), when the Government is the plaintiff, the courts additionally consider whether the legislature labeled the “penalizing mechanism as civil or penal” and the seven-factor Kennedy test:

1. Does the sanction involve an affirmative disability or restraint;
2. Has it been regarded historically as punishment;
3. Does it only come into play upon a finding of scienter;
4. Does it promote the traditional aims of punishment — retribution and deterrence;
5. Is. the behavior to which it applies already a crime;
6. Is there an alternative, non-punitive purpose to which it may be rationally connected; and
7. Is it excessive in relation to the alternative purpose.

Finally, if the claim does not fall neatly into either category, you look to the primary purpose of the statute.

          The statute (31 U.S.C. Sec. 5324) and regulations impose a duty to report foreign accounts if the aggregate balance in the accounts exceed $10,000.  The penalties for violating the reporting requirement are $10,000 if the violation is not willful or the greater of $100,000 or 50% of the balance in the accounts where the violation is willful.  The Senate Report states the non-willful penalty “that applies without regard to willfulness will improve compliance with this [reporting] requirement.”   The Court saw this statement as supportive of the non-willful penalty having a deterrent purpose, which is usually associated with punishment, but noted that deterrence may serve both civil and criminal goals:

Since the penalties imposed are for non-willful violations, the deterrent purpose is towards a broader audience who will want to make sure they are following tax regulations to avoid steep penalties as opposed to punishing the individual upon whom the penalty is assessed — who obviously did not willfully fail to file.

Since a person acts willfully if he knows about the reporting requirement and intentionally fails to file an FBAR, to be non-willful a person would have to be ignorant of the reporting requirement.  Thus, to be deterred by the non-willful penalty a person would have to know about the reporting requirements.  But if a person knows of the filing requirement the failure to file would be willful, so people who are non-willful would not be deterred by the non-willful FBAR penalty.  Or is my reasoning faulty?

Moving on, the Estate pointed to a provision of the IRM stating that the FBAR penalties are to “promote compliance with FBAR reporting and record keeping requirements” and urged that this further supported the claim that the penalty was penal.  The Court readily brushed this aside since the IRM is not law, although it can provide guidelines “to assess the propriety of IRS actions.”  In any event, the Court found that this provision of the IRM does not indicate that the civil FBAR penalties are “primarily punitive such that the court should dismiss the claim at this time.”  In summation “The text of the statute, Congressional Record, and the IRS Manual inform the court’s analysis, and they indicate that the statute has some deterrent purpose but do not preclude a potential remedial purpose.”

The Court then looked at the cases cited by the parties.  The Government cited cases holding that the willful FBAR civil penalty is remedial and thus survives a defendant’s death and is enforceable against the estate.  All of these cases relied on the multi-factor Kennedy test.  Several of these cases stated that the civil FBAR penalty in part reimburses the Government for the “heavy expense” of investigation.

The Estate relied on United States v. Bajakajian, 524 U.S. 321 (1998), which noted that a civil forfeiture for violating the reporting requirement for taking cash out of the country was punishment.  Civil forfeiture required a finding of criminal conduct and thus the case was inapposite, as were the other cases relied on by the Estate: United States v. Simonelli, which dealt with whether the civil FBAR penalty was a tax that was discharged in bankruptcy or “a civil money penalty” that was not discharged; and cases dealing with whether the non-willful penalty was imposed per account or per form.

The Court found the Government’s cases more persuasive.  As a result, at this stage of the proceedings, it held that the non-willful FBAR penalty was remedial and survived the defendant’s death.  It denied the motion to dismiss.  The Court concluded:

Since at the motion to dismiss stage and ambiguities must be resolved in favor of the non-movant, the court finds that given the “close call” nature of this question, the doubt should be resolved in favor of the Government.

This may be a sign that the Court at a later stage of the proceeding may reach a different conclusion.  But maybe I am grasping at straws.

Robert S. Horwitz is a Principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere in 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.

We are pleased to announce that Sandra Brown and Steven Toscher along with Marty Schainbaum, Damon Rowe, and Richard Hassebrock will be speaking at the upcoming USD Sixth Annual USD School of Law – RJS Law Tax Controversy Institute webinar, “The IRS New Office of Fraud Enforcement—What Practitioners Can Expect, the Consequences and Best Practices” on Friday, July 16, 2021, 1:30 p.m. (PST).

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On June 10, 2019, John Lewis took to the floor of the House of Representatives to tout public to know it. “This is not a Republican or a Democratic bill,” Lewis said. “It is an American one,” a vital effort to reinvigorate a failing government agency.

If all else fails, Biden may be able to flip the script on Republicans. There has never been much proof of political influence at the IRS. (“They’re really not interested in your politics,” said Steven Toscher, a former IRS agent who now teaches at the University of Southern California. “It’s your pocketbook” they care about.)

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We are pleased to announce that Steven Toscher, Michel Stein and Cory Stigile will be speaking at the upcoming CalCPA webinar, “Handling the New IRS Global High Wealth Examinations” on Tuesday, June 29, 2021, 9:00 a.m. – 10:00 a.m. (PST).

The Global High Wealth Group is an industry group created by the IRS LB&I in 2009. The purpose of the Global High Wealth Group (also known as the “Wealth Squad”) is to bring together an IRS team of specialists to conduct detailed examinations of complex returns of high wealth individuals and their related entities. The IRS recently updated the Internal Revenue Manual governing high wealth audits and is poised to start the examination of hundreds of high net worth taxpayers this year. These examinations will typically involve pass-through businesses, related trusts, foreign holdings, tiered partnerships, and related tax-exempt organizations.

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Ron Bell was an engineer who earned an MBA and went into finance.  After a number of years working for various financial firms, he set up his own company, Bell Capital Management, Inc. (“BCM”), in Atlanta, Georgia, to provide investment services and financial planning for clients.  He was quite successful.  From BCM’s founding throughout its history he was its sole shareholder and president.  Prior to 1996, he received a salary from BCM that was reported by the company as wages.  In 1996, Bell had BCM enter into contracts with offshore employee leasing companies (“OEL”).  For 1996 through 2001, the OELs “leased” Bell’s services to BCM, which paid the OELs what had formerly been paid as wages to Bell.  Bell remained president and sole shareholder of BCM and performed the same services that he previously performed as an employee.  However, in light of the offshore employee leasing contracts, BCM treated Bell as an independent contractor and thus, did not include the amounts paid to the OEL on its employment (Form 941) and unemployment (Form 940) tax returns.

Internal Revenue Code §7436 authorizes the IRS to issue a Notice of Determination of Worker Classification (“NDWC”) if it determines that a person treated by an employer as an independent contractor was an employee.  The employer can challenge the NDWC by petitioning the Tax Court.

The IRS issued a NDWC to BCM determining that Bell was an employee, not an independent contractor of BCM and that BCM owed FICA, FUTA and income tax withholding for the monies paid the OELs for 1996 through 2001, plus failure to deposit and fraud penalties.  BCM petitioned the Tax Court.  On June 14, 2021, the Tax Court issued its opinion in Bell Capital Management, Inc. v. Commissioner, Tax Court Memo. 2021-74, granting the IRS’s motion for summary judgment.

By way of background, Bell is not new to the Tax Court.  Foxworthy, Inc., v. Commissioner, T.C. Memo. 2009-203, aff’d, 494 F. App’x 964 (11^th Cir. 2012), dealt in part with the OEL transaction and held, among other things, that OEL transactions lacked economic substance, that the payments by BCM to the OELs was income to Bell that he constructively received when paid and that Bell was liable for the fraud penalty because the OEL and other transactions were for purposes of fraudulently underpaying tax. 

According to the Tax Court, in the current litigation, the summary judgment motion posed five issues: 1) did the decision in Foxworthy collaterally estopp BCM from claiming it was not liable for paying the employment taxes; 2) should Bell be legally classified as an employee of BCM; 3) was BCM liable for the employment tax as determined by the IRS; 4) was BCM liable for the fraud penalty; and 5) had the statute of limitations on assessment expired.

Under the doctrine of collateral estoppel, once an issue of fact or law is “actually and necessarily determined by a court of competent jurisdiction, that determination is conclusive in subsequent suits based on a different cause of action involving a party to the prior litigation.”  Collateral estoppel applies to both the parties in the first case and to those in privity with them.  Because Bell was the sole shareholder and president of BCM during the periods in issue, he and BCM were in privity for collateral estoppel purposes.  Whether the OEL transactions lacked economic substance and whether they were entered into so as to fraudulently underreport and underpay tax were actually litigated and necessary to the decision in Foxworthy.  The Tax Court held that BCM was therefore collaterally estopped to deny that the OEL transactions lacked economic substance and that they were entered into to fraudulently underreport and underpay tax.  Because the issues of Bell’s employment status, BCM’s withholding requirements and its intent were not essential to the decision in Foxworthy, BCM was not estopped from contesting them.  Little good that did it.

Under Internal Revenue Code §3121(d)(1), a corporate officer is considered an employee for employment tax purposes, unless the officer does not perform services (other than minor services) and neither receives nor is entitled to receive remuneration.  Bell was president of BCM during all times relevant and performed services that were not minor for which he received remuneration.  Thus, he was an employee of BCM under §3121(d)(1). 

There were two more issues to go: fraud penalty and statute of limitations.  The statute of limitations for assessing employment taxes is three years from the date the return is filed.  If the return was fraudulent, additional tax can be assessed at any time.  For purposes of the statute of limitations, the IRS had to prove that an underpayment of tax existed and that the taxpayer intended to evade tax.  When the taxpayer is a corporation, fraud turns on the intent of the corporate officers.  The Court held that BCM intentionally omitted payments for Bell’s benefit made to the OEL to evade tax.  First, prior to 1996 it reported payments to Bell as wages.  Second, Bell, in his capacity as a BCM officer, entered into the OEL transactions to evade tax.  The Court rejected BCM’s argument that the IRS failed to prove fraud because Bell was not the sole officer or sole decision maker since it offered no evidence that the actions of its other officers with respect to the OEL agreements were separate from Bell’s scheme to defraud the IRS.

The resolution of the statute of limitation issue also resolved the fraud penalty issue.  The Court rejected BCM’s claim that the fraud penalty violated the Eighth Amendment, since it is remedial and not punitive.  It also rejected the argument that the amount of tax was overstated because BCM was entitled to “an unquantified credit” for employment tax allegedly paid by the OELs.  The issue before the Court was whether BCM was the employer liable to pay employment tax on Bell’s wages, which it was.  The Court noted that it was “not subjecting Mr. Bell’s wages to a second employment tax,” implying that BCM would get a credit for any employment tax and income tax paid with respect to Mr. Bell’s wages.  This is consistent with IRS practice, since while several people can be liable for unpaid employment taxes, the IRS will only collect the entire amount of tax once.

Treating someone as an independent contractor whom the employer knows should be treated as an employee can result in fraud penalties (and possibly criminal charges).  While the employment tax on Bell’s wages won’t be paid twice, in attempting to game the system, Bell wound up owing two fraud penalties, one against himself (in Foxworthy) and one against BCM (in Bell), for the same payments. 

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

We are very proud to be part of the team that prepared the Supreme Court amicus brief on behalf of the American College of Tax Counsel seeking certiorari on this very important issue concerning IRS John Doe summonses and the attorney-client privilege and tax attorneys.

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We are pleased to announce that Steven Toscher, Michel Stein and Evan Davis will be speaking at the upcoming Spidell webinar, “Cryptocurrency Tax Compliance in the Post $30,000 Bitcoin World” on Wednesday, June 23, 2021, 10:00 a.m. – 12:00 p.m. (PST).

The IRS is coming down on taxation of cryptocurrency. When you ask your client about use of Bitcoin and other forms of cryptocurrency, be ready to handle the tax treatment. At this webinar you will:

• Review recent IRS enforcement actions
• Understand the various valuation issues
• Learn proper tax reporting requirements for cryptocurrency exchanges
• Grasp the disclosure requirements for crypto-currency ownership
• Uncover how criminal investigations and prosecutions can result from failing to report cryptocurrency transactions properly

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On May 13, 2021, the Supreme Court in CIC Services, Inc. v. Internal Revenue Service held that the Anti-Injunction Act did not bar an action to enjoin an IRS listed transaction notice because it allegedly failed to comply with the Administrative Procedures Act (“APA”) notice and comment provisions.  See, https://www.taxlitigator.com/and-now-for-something-completely-different-supreme-court-holds-suit-to-enjoin-irs-notice-not-barred-by-the-anti-injunction-act-by-robert-s-horwitz/.  On the same day, a district court issued an opinion in Mann Construction v. United States, Docket No. 1:20-cv-11307 (ED Mich. 5/13/2021), holding that the APA did not apply to listed transaction notices.  Given the Supreme Court’s decision in CIC Services, Inc., Mann Construction received little attention.  Since the district courts in both cases are in the Sixth Circuit, if Mann Construction is appealed and affirmed, it could result in a dismissal of CIC Services when it is remanded back to district court.

First, the facts:  In 2007 the IRS issued Notice 2007-83.  The Notice designated as listed transactions certain trust arrangements claiming to be welfare benefit funds that involved cash value life insurance and purported to result in federal income and employment tax benefits.  Persons required to disclose or register such transactions, who failed to do so, were subject to penalties under IRC sec. 6707A.

Six years after the Notice was issued, Mann Construction set up a Death Benefit Trust.  With its S corporation return for 2013, the company attached a Form 8275 disclosure statement describing the Death Benefit Trust and the rationale for its claiming deductions with respect to the trust on its return.  It did not file a Form 8886, the reportable transaction disclosure statement.  The IRS audited Mann Construction, disallowed the deductions, which resulted in increased tax liabilities for its two shareholders, and assessed 6707A penalties against the company and its shareholders.  They paid the penalties, filed claims for refund and six months later filed a refund action in district court.

The complaint alleged four causes of action, three of which were for violation of the APA: (a) that the Notice was unauthorized agency action; (b) that the Notice was arbitrary and capricious; and (c) that it was issued in violation of the APA’s notice and comment procedures.  The fourth cause of action was that Mann Construction’s Death Benefit Trust was not a listed transaction.  The Government moved to dismiss for failure to state a claim.  The Court granted the motion as to all but the claim that the Notice was issued in violation of APA notice and comment procedures, since plaintiffs “plausibly alleged that the Notice is a legislative rule that should be set aside for failure to comply with notice and comment.”  The parties then filed cross-motions for summary judgment.

The Court framed the issue as “whether the IRS was required to provide public notice and an opportunity for comment before promulgating the Notice.” 

The APA sets up a three-step procedure for notice and comment rulemaking: (a) issued a general notice of proposed rulemaking; (b)  allow interested parties an opportunity to participate; and (c) include in the final rule a “concise general statement of [its] basis and purpose.”  Not all rulemaking is subject to these procedures if Congress exempts them from the procedures.  In its summary judgment motion, the Government argued that Congress authorized the IRS to promulgate listed transaction notices without a notice and comment period.  The taxpayers argued that they were not exempted from APA’s notice and comment rulemaking procedures.

Sec. 6707A defines “listed transaction” by reference to transactions identified by the Secretary for purposes of sec. 6011 and defines “reportable transaction” by reference to the regulations promulgated under sec. 6011.  Treas. Reg. sec. 6011-4 states that reportable transactions are ones the IRS has “identified by notice, regulation, or other form of published guidance as a listed transaction.”  The Government argued that by incorporating the regulation into the statute, Congress intended the IRS to continue following the regulation, including identifying listed transactions via notice.  Although neither sec. 6707A nor the regulations mention the APA, in Marcello v Bonds, 349 U.S. 302 (1955), the Court held that the Immigration & Naturalization Act (“INA”), rather than the APA, governed deportation proceedings even though the INA did not have any clause expressly superseding the APA, because the legislative history of the INA made it clear the INA was to be the sole source for deportation procedures.  In subsequent cases the courts had looked to the statutory text and structure and legislative history to determine whether the APA applied. 

The taxpayers argued that the APA is to apply unless the statutory procedure could not be reconciled with it.  The Court acknowledged that listed transaction notices could be issued after a notice and comment period, but that doing so would undermine a principal purpose of the 6707A regime: to allow the IRS to identify questionable transactions as early as possible.  In incorporating the regulations, Congress “endorsed the flexible reporting regime that the IRS had already developed.”  The Court held that listed transaction notices under sec. 6707A can be issued without following APA notice and comment rulemaking procedures.  It therefore granted the Government’s motion, denied the taxpayers’ motion, and ordered the case dismissed.             

The case probably gives us a preview of what the IRS will argue on remand in CIC Services: that the notice and comment rulemaking provisions of the APA do not apply to listed transaction notices under sec. 6707A, such as the captive insurance listed transaction notice.  The Court made clear, however, that whether the APA applies to a particular IRS notice or rule depends on an examination of the language of the statute, the statutory scheme and the legislative history.  And since this is a district court decision, it is not binding precedent on other courts and at best has persuasive value. 

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

We are pleased to invite you to register now for the 13th Annual NYU Tax Controversy Forum Webinar to be held June 24 and 25. You do not want to miss this program.

Co-Chairs Bryan Skarlatos and Steven Toscher are pleased to announce this year’s NYU Tax Controversy Forum which will feature updates on what the IRS is doing to enhance compliance through communication and enforcement. Panels will highlight the new IRS focus on intra-agency collaboration, new initiatives with respect to penalties and fraud referrals, and IRS’ handling of tax collection challenges. Tune in from your computer, at home or the office, to hear Tax Compliance and Procedure Updates from senior IRS personnel. We are excited that the following officials of the IRS have agreed to speak at this year’s program. 

• Charles P. Rettig, Commissioner, Internal Revenue Service

• Nikole Flax, Deputy Commissioner, Large Business and International Division, Internal Revenue Service

• Darren John Guillot, Commissioner, Small Business/Self-Employed Division, Collection, Internal Revenue Service

• De Lon Harris, Commissioner, Small Business/Self-Employed Division, Examination, Internal Revenue Service

• James C. Lee, Chief, Internal Revenue Service Criminal Investigation

• Douglas O’Donnell, Deputy Commissioner, Services and Enforcement, Internal Revenue Service

We are pleased to announce that Evan Davis, along with Ian M. Comisky, Deborah L. Connor and Andrew Winerman will be speaking at the upcoming 13th Annual NYU Tax Controversy Forum webinar, “Shining a Light on Dirty Money: Corporate Transparency and Anti-Money Laundering Acts of 2020” on Friday, June 25, 2021, 3:30 p.m. – 4:30 p.m. (PST).

Last year, Congress passed the first major overhaul of the Bank Secrecy Act (“BSA”) in fifty years. The new law requires certain entities to report the identities of their beneficial owners, enhances the government’s ability to obtain foreign bank records, creates new reporting requirements for crypto currencies and antiquities dealers, expands the powers and duties of FinCEN, enhances inter-agency information sharing, and establishes a new whistleblower program for violations of the BSA. This panel explains these new provisions and how they could affect your clients.

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