TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

The intersection of virtual currency with Bank Secrecy Act (BSA) and tax laws frequently results in a square peg, round hole problem.  All too often, regulators try to solve the problem as would a toddler, by pounding as hard as possible to make the square peg fit in the round hole.  Witness the IRS treating virtual currency as property, not currency, resulting in buying a latte at Starbuck with bitcoin as a taxable event requiring the computation of basis because the IRS hasn’t seen fit to establish “de minimis” transaction exclusions.  Unlike the IRS, FinCEN (another arm of the Treasury Department) treats virtual currency as currency and regulates it accordingly, at least most of the time.  And don’t get me started about how the SEC and CFTC apply securities and commodities regulations to virtual currency. The agencies’ conflicting regulations prove the adage: If you’re a hammer, everything looks like a nail.  It’s small wonder so few taxpayers have complied with tax laws surrounding virtual currency when the IRS’s rules make routine transactions using virtual currency into events that require the user to scurry home and input the transaction into an Excel spreadsheet before she forgets to log her basis and sale price.

Regarding the Foreign Bank Account Report (FBAR) form, practitioners have been wondering for years whether certain virtual currency holdings need to be reported.  Keep in mind that FinCEN has treated “exchangers and administrators of convertible virtual currency” as subject to the money transmitter rules under the BSA since 2013.  The BSA is designed in large part to require reporting of transactions that may be associated with illegal activity, resulting in law enforcement being able to identify the illegal activity through the BSA reports.  The purported anonymity of virtual currencies (some more than others) is attractive to those who want to remain off of the government’s radar screen, whether for illegal or other reasons.  Those who violate the BSA are subject to stiff civil and criminal penalties.  Essentially, FinCEN recognizes that people use virtual currencies as a cash alternative and that persons playing intermediary roles in virtual currency transactions should be treated like fiat currency intermediaries.  Despite making this clear pronouncement, it took seven years for FinCEN to clarify that virtual currency is not reportable on current FBAR forms in Notice 2020-2.   Filing Requirement for Virtual Currency (fincen.gov)

This conclusion was far from obvious.  Cryptocurrency exchanges are based both inside and outside the United States, and even US-based exchanges may have servers overseas.  It may even be impossible for an accountholder to know where precisely their cryptocurrency is being held by an exchange.  Perhaps an easier example from an FBAR perspective is “cold storage,” where the private keys giving access to the virtual currency are held in a device not attached to the Internet for security purposes.  If the cold storage device (which is normally portable) is overseas, then arguably the owner should be worried about filing an FBAR.

As nice as it is to hear that virtual currency holders have one less thing to worry about, FinCEN delivered this good news wrapped in bad news.  FinCEN announced that it intended to propose amending FBAR regulations to require reporting of virtual currency “as a type of reportable account.”  FinCEN offered no additional information, and the unanswered questions abound. how is “virtual currency” an “account”?  What factors demonstrate whether a virtual currency holding is foreign or domestic? 

At the same time, FinCEN proposed another rule to require money services businesses to report and keep records on certain transactions with “unhosted wallets.”  2020-28437.pdf (federalregister.gov)  The upshot of the “proposed” regulation – proposed in name only as FinCEN noted that the regulation is not subject to notice-and-comment rulemaking – is that any entity that qualifies as an MSB will have to conduct “know your customer” validation on the wallet owner and retain records for production to FinCEN. 

The effect of these two changes will be to substantially reduce anonymity vis a vis the US government as well as substantially increase the chance that owners of large crypto holdings will be targets for hackers, extortionists, and other miscreants.  It’s unclear whether additional regulation will make virtual currencies less attractive or, as some have argued, will bolster the legitimacy and lead to more widespread adoption.  The one certainty is that more regulation will lead to more work for lawyers and accountants.   

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis has been a principal at Hochman Salkin Toscher Perez P.C. since November 2016.  He spent 11 years as an AUSA in the Office of the U.S. Attorney (C.D. Cal), spending three years in the Tax Division where he handed civil and criminal tax cases and eight years in the Major Frauds Section of the Criminal Division where he handled white-collar, tax, and other fraud cases through jury trial and appeal.  As an AUSA, he served as the Bankruptcy Fraud coordinator, Financial Institution Fraud coordinator, and Securities Fraud coordinator.  Among other awards as a prosecutor, he received an award from the CDCA Bankruptcy Judges for combatting Bankruptcy Fraud and the U.S. Attorney General awarded him the Distinguished Service Award (DOJ’s highest litigation award) for his work on the $16 Billion RMBS settlement with Bank of America.  Before becoming an AUSA, Mr. Davis was a civil trial attorney in the Department of Justice’s Tax Division in Washington, D.C. for nearly 8 years, the last three of which he was recognized with Outstanding Attorney awards.  He is a magna cum laude and Order of the Coif graduate of Cornell Law School and cum laude graduate of Colgate University.

Mr. Davis represents individuals and closely held entities in federal and state criminal tax (including foreign-account and cryptocurrency) investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, and white-collar criminal investigations including campaign finance, FARA, money laundering, and health care fraud.

Last week, the Commissioner issued the Taxpayer First Act (TFA) report to Congress. The report will establish the framework of the IRS for the next 20 year, with a goal of improved employee training, increased taxpayer accessibility and making the IRS a more technology-driven organization. 

So what is the TFA and why is there a report?  The TFA was enacted in 2019 with the goal of changing the IRS’s structure, improving taxpayer service, improving enforcement procedures, and increasing IRS use of information technology and electronic systems.  The TFA had four Titles, “Putting Taxpayer’s First,” “21^st Century IRS,” “Miscellaneous Provisions” and “Budgetary Effects.”  These Titles included subtitles, for an Independent Office of Appeals, Improved Services, Organizational Modernization, Cybersecurity and Identity Theft, Expanded Use of Information Technology and Electronic Systems, and Reform of Laws Governing IRS Employees.  One of the provisions, TFA sec. 1203, dealt with innocent spouse relief.  As several writers have pointed out, one of the subsections of sec. 1203 reduced the Tax Court’s scope of review in innocent spouse cases rather than putting the taxpayer first. 

The TFA report focuses on three provisions of the TFA:  Sec. 1101, Taxpayer Services, Sec. 2402, Employee Training, and Sec. 1302, Organizational Structure.  The main focus of this blog will be the future organizational structure of the IRS.

But before turning to the IRS’s new organization, the IRS hopes to modernize taxpayer services, by making online access easier, reducing call wait times and the use of data analytics to “analyze behavioral research and other data to better identify and separate taxpayers who are intentionally violating our tax laws, minimizing compliance contacts where direct enforcement activity would not be necessary.”  Employee training will include “IRS University” to centralize training, TFA training for all IRS employees and continuing education for all employees.

Now, about organizational change:  Presently, there seven people in the IRS who report directly to the Commissioner: a chief of staff, Chief of Appeals, National Taxpayer Advocate, Chief Counsel, Chief of Communications & Liaison, Deputy Commissioner for Operations Support and Deputy Commissioner for Services & Enforcement.  Under the Deputy Commissioner for Operations Support are things like Human Resources, CFO, procurement, diversity, etc.  Under the Deputy Commissioner for Services & Enforcement are the operating divisions, including CI, LB&I, SB/SE, Wage & Investment.  That structure will be gone under the IRS’s new organizational plan.

In the future there will be one Deputy Commissioner, who will fulfill such roles as assigned by the Commissioner and a Chief of Staff.  Added to Appeals, NTA, Chief Counsel and Chief Communications will be a new position, Chief Taxpayer Experience Officer, since the focus of the IRS will be to give taxpayers a better experience.  Also reporting directly to the Commissioner will be five Assistant Commissioners: (a) Relationships and Services; (b) Compliance; (c) Enterprise Change and Innovation; (d) Operations Management; and (e) Chief Information Officer.  The people who directly report to the Commissioner will be the “Senior Leadership Team,” which will set the overall strategic direction of the IRS and manage the executives who oversee the IRS’s day-to-day operations.

The Relationships and Services Division is completely new and will oversee the groups that deliver services and information to taxpayers, including Outreach & Education, Digital Services, Submission Processing (which I assume is processing returns), Identity Theft, etc.  The Report states that this division will put “all taxpayer-facing service channels under one division” and will integrate “digital, telephone, virtual and face-to-face channels seamlessly.”   The report details what each sub part of the division will focus on, such as the Assisted Services Office, which will oversee walk-in centers and toll—free phone lines, online text and video chat.

The Compliance Division will be reorganized.  LB&I, SB/SE, Wage & Investment, Exempt Organization will all be gone.  Instead, there will be Criminal Investigation, Whistleblower, Exam and Collection.   Exam will consolidate all exam operations that are currently spread among several units and Collection will be responsible for collection activities from all types of taxpayers (or as the report puts it, “all taxpayer segments”).  This is a similar structure to the one that existed for over 40 years before the 1998 restructuring act, i.e., an Examination Division, a Collection Division and a Criminal Investigation Division.  

Enterprise Change and Innovation Division:  Like the Relationships and Services Division, this division is completely new.  According to the Report this Division will “serve as the strategic planning and integration role across the agency, utilizing data management, analytics and business process improvement best practices to identify and implement enterprise-wide initiatives that would enable IRS to be more efficient and effective in serving taxpayers and administering the tax code.” 

The last two Divisions, Operations Management and Information Technology, will. take over the functions currently performed by the Operations Support Division.  Operations Management will take over functions such as Human Resources, Financial, Security, Procurement and Information Technology will take over cybersecurity, computing centers, networks service and similar IT functions.

According to the IRS website, the reorganization will mean for taxpayers more “seamless services,” quicker resolution of issues and more tools for interacting with the IRS.  For tax professionals it will  supposedly mean “a more seamless and consistent experience for tax professionals and their clients,” provide tax professionals with the “latest tools for communicating with the IRS,” and through the “Third—Party Relationships organization … facilitate collaborative networking with partners across tax administration and beyond.”  For IRS employees it will mean “an organization without silos” that can adapt quickly with less duplication of effort and the ability to deliver “a seamless experience for taxpayers.” 

While the new reorganization addresses some of the problems facing the IRS today how this will work out in practice is unknown, but the effort needs to be made and the goals of providing taxpayers with a more efficient and responsive IRS and improving the overall professionalism and knowledge of IRS personnel are worthy ones. 

IRS management should be applauded for recognizing that the organization  should strive to improve its performance and deliver on its mission of providing “America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.” The TFA report is a step in that direction.

Contact Steve Toscher at toscher@taxlitigator.com.  Mr. Toscher specializes in civil and criminal tax controversy and litigation.  He is a Certified Tax Specialist in Taxation, the State Bar of California Board of Legal Specialization, a Fellow of the American College of Tax Counsel and has received an “AV” rating from Martindale Hubbell. In addition to his law practice, Mr. Toscher has served as an Adjunct Professor at the USC Marshall School of Business since 1995, where he teaches tax procedure.  Mr. Toscher is past-Chair of the Taxation Section of the Los Angeles County Bar Association, a member of the Accounting and Tax Advisory Board of California State University, Los Angeles, Office of Continuing Education and was the 2018 recipient of the Joanne M. Garvey Award, which is given annually to recognize lifetime achievement and outstanding contributions to the field of tax law by a senior member of the California tax bar.

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

Occasionally I feel sorry for the attorneys in IRS National Office who have to write regulations for the tax laws enacted by Congress.  Gone are the days when Congress had members who could write simple, logical statutes, like the original sec. 162(f), enacted in 1969:

No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.

That’s it.  Under 25 words and it said all that needed to be said.  In 1975, the IRS promulgated regulations under sec. 162(f) that defined what was a “fine or similar penalty,” what was “a government” and what constituted a “violation of any law”, all in under 1000 words. 

So things stood for 48 years, until late 2017, when Congress got it into its head to amend sec. 162(f) as part of the Tax Cut and Jobs Act (TCJA).  Gone was the simple, elegant language of subsection (f), replaced by a 410-word subsection with exceptions with multi-prong tests and exceptions to the exception.  The main provision of sec. 162(f), carving out the prohibition on the deduction of fines or similar penalties, now reads:

(1) In general-Except as provided in the following paragraphs of this subsection, no deduction otherwise allowable shall be allowed under this chapter for any amount paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law.

The exception to this general rule are for (a) payments of restitution (determined by application of a multi-prong test and which has an exception for reimbursement to the government for the costs of any investigation or litigation), (b) payments ordered by a court in a suit in which the government is not a party, and (c) payments for “taxes due.”  And then there is a subparagraph under which certain nongovernmental entities are treated as governmental entities. 

TCJA also added sec. 6050X to the Code, which imposes a reporting requirement on any government or governmental entity for any suit or agreement concerning the violation of a law within the government or governmental entity’s authority or any investigation or inquiry concerning such a violation if the amount involved with respect to the violation or any investigation or inquiry is over $600.

The final regulations under the NEW! IMPROVED! subsection 162(f) were released on January 12, 2021.  A few of the highlights of the final regulations are discussed below.

Under the general rule of non-deductibility, 26 CFR sec. 162-21(a), the regulation makes it clear that (i) a fine or penalty is “an amount paid or incurred in relation to the violation of any civil or criminal law”  and (ii) a routine investigation or inquiry, such as an audit or inspection, of a regulated business that is not related to evidence of wrongdoing or suspected wrongdoing is not “an investigation or inquiry … into the potential violation of any law.” 

The second part of the regulation, 26 CFR sec. 162-21(b), deals with amounts that will be treated as deductible as restitution, remediation or “to come into compliance with a law.”  First the taxpayer must meet an “identification requirement, which requires a court order or agreement that

(i) States that a payment is restitution, remediation or to comply with a law

(ii) States the purpose for which the restitution or remediation will be paid or the law with which the taxpayer must comply

This part is met if the order or agreement describes (i) the damage done, harm suffered or manner in which the taxpayer failed to comply with the law and (ii) the action required by the taxpayer.  The order or agreement need not identify the amount the taxpayer must pay or incur in order to be treated as a restitution, remediation or for the taxpayer to come into compliance with a law. 

The regulations further provide that to deduct an amount paid as restitution, remediation or for compliance with a law, the taxpayer must provide documentary evidence to prove that it was obligated by an order or agreement to pay the amount identified as restitution, remediation or to come into compliance with the law, the amounts paid or incurred and the dates; and that “based on the origin of the liability and the nature and purpose of the amount paid or incurred,” the amount was paid or incurred for restitution, remediation or to come into compliance with a law.  A taxpayer must meet both this test and the identification test to come within the exception to the disallowance of a deduction for the payment of an amount in relation to the violation of a civil or criminal law of sec. 162(f)(1). 

The third part of the regulation, 26 CFR sec. 162-21(c), deals with “other exceptions” and makes it clear that the prohibition on deducting amounts paid in relation to a violation of a law does not apply to a suit in which a government or governmental entity is not a party or a suit in which a government or governmental entity “enforces its rights as a private party.”  It also clarifies that it does not apply to amounts paid as tax or interest on tax, but it does apply to penalties imposed relating to tax and interest on the penalties.  Amounts paid or incurred as restitution for taxes under the Internal Revenue Code are deductible if the tax itself would otherwise be deductible, such as the payment of employment or excise taxes.

The fourth part of the regulation, 26 CFR sec. 162-21(d) concerns accounting for deductible payments, such as restitution.  The timing of the deduction is determined under sec. 461 (general rules for the taxable year of deduction) and related sections and regulations under those provisions.  And the tax benefit rule applies.

The fifth part of the regulation, 26 CFR sec. 162-21(e), contains definitions: government, nongovernmental entity treated as a governmental entity, remediation, disgorgement, amounts to come into compliance with a law, etc.  a whole smorgasbord of words and terms used in sec. 162(f) and the regulations are defined, including “Amounts not included,” which is reimbursement of a governmental entity for investigatory or litigation costs concerning the violation or potential violation of any law and amounts paid, at the taxpayer’s election, in lieu of a fine or penalty.  The sixth and final part, 26 CFR sec. 162-21(f), is a baker’s dozen of examples of how the regulations are to be applied.

What is to be learned from all of this, other than the fact that the regulations are reasonably to the point and intelligible?  If a client is involved in an administrative proceeding or litigation with the federal or a state government, a governmental entity, a foreign government or a securities exchange or board of trade, the client’s attorney should make sure that any settlement agreement, order or judgment clearly imposing a financial or other obligation on the client sets out what the nature of the obligation is (i.e., remediation, restitution, compliance with law), why the obligation is imposed and that the client keeps documentation establishing the amounts expended and the dates.  Otherwise, the client may not be able to deduct the amount paid or incurred under the agreement, order or judgment.

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

You’d think deciding whether something is a federal tax return would be easy: if it’s on a return form put out by the IRS, containing information sufficient to determine the taxpayer’s tax liability and signed under penalty of perjury by the taxpayer it’s a valid tax return.[1]  If only it were that simple.  Whether a specific document qualifies as a tax return is a question that has sometimes perplexed taxpayers, the IRS, and the Courts.  To address the question, the Tax Court in Beard v. Commissioner, 82 T.C. 766, 777 (1984), aff’d per curiam, 793 F.2d 139 (6th Cir. 1986), came up with a four-part test that has been adopted by many of the Courts of Appeals:

First, there must be sufficient data to calculate tax liability; second, the document must purport to be a return; third, there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and fourth, the taxpayer must execute the return under penalties of perjury.

Two recent appeals court decisions, Quezada v. IRS, __ F.3d __, 982 F.3d 931 (December 11, 2020), and Coffey v. Commissioner, 982 F.3d 1127 (8^th Cir. December 15, 2020), address the question of whether the taxpayer had filed a valid return and reached potentially contradictory conclusions.

First Quezada.  Mr. Quezada was a stone mason who performed masonry services for general contractors.  He hired independent contractors to do the work.  He issued Forms 1099 to each independent contractor, reporting the total compensation he paid to them.  Most of the Forms 1099 did not have tax identification numbers for the independent contractors.  Under IRC sec. 3406(a), Mr. Quezada was required to withhold from payments to these independent contractors a tax, calculated at a flat rate, and pay it over to the IRS.  When required by regulation, any person liable for any tax, is to “make a return or statement according to the forms and regulations prescribed by the Secretary… [and] include therein such information required by such forms or regulations.”  IRC sec. 6011(a).  A person subject to backup withholding is supposed to pay the amount owed and file a Form 945.  Treas. Reg. sec. 31.6011(a)-(4)(b).  For the years 2005 through 2008 Mr. Quezada didn’t file Forms 945 or pay backup withholding.  In 2014, the IRS assessed over $1.2 million in backup withholding, interest and penalties against him.

Mr. Quezada filed in bankruptcy and sought a determination that the assessments were time-barred.  He lost in bankruptcy court and district court but prevailed on appeal to the Fifth Circuit on his argument that his Forms 1099 and Form 1040, when combined, contained sufficient information to calculate his backup withholding liability and the filing of these forms started the statute of limitations for assessing backup withholding. 

The IRS argued that Treasury Regulations require the filing of Form 945 to report backup withholding and since Mr. Quezada did not file the form, he did not file the return and the statute of limitations never began to run.  The IRS relied on Commissioner v. Lane-Wells, 321 U.S. 217 (1944), where the Court held that a corporate tax return was not a personal holding company return and thus did not start the running of the statute of limitations.  Rejecting the IRS’s argument, the Fifth Circuit seized on language in Lane-Wells that the form filed by the taxpayer “did not show the facts on which liability could be predicated” and noted that some of the Supreme Court’s statements indicated that “the wrong form can be ‘the return’ so long as the form shows the facts on which liability could be predicated.”  Here, the Forms 1099 and 1040, taken together, contained sufficient data on which liability could be predicated, with the Forms 1099 showing the names and amount paid each independent contractor.

According to the Fifth Circuit “the better reading of Lane-Wells is that the taxpayer is not required to file the precise return prescribed by Treasury Regulations in order to start the limitations clock.  Instead, ‘the return’ is filed, and the limitations clock began to tick, when the taxpayer files a return that contains data sufficient (1) to show that the taxpayer is liable for the tax at issue and (2) to calculate the extent of that liability.”  Since Mr. Quezada’s returns contained sufficient data to show the liability for backup withholding, the Forms 1040 and 1099 he filed constituted the return.  Since the assessments were made more than three years after these forms were filed, they were time-barred.

Notes:        

(1) The Court failed to consider the effect of Mayo Foundation v. United States, 562 U.S. 44 (2011), which held that Chevron deference applies to Treasury Regulations.  Maybe I’m wrong, but under Chevron, since the backup withholding statute states that the “Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purpose of this section” and the regulation was not contrary to existing Supreme Court precedent, under Chevron it should have been accorded deference.

(2) The IRS based its assessments entirely on the information contained in the Forms 1099s and 1040s.  The 1099s revealed that many of the independent contractors did not provide Mr. Quezada with their SSNs, which the IRS should have realized when it processed the 1099s, which were apparently filed timely.  There does not seem to be any reason why the IRS took several years after the filing of the 1099s for 2008 to wake up to this fact and make the assessments against him. 

(3) Assume a taxpayer files a Form 8938 that lists foreign bank accounts, but not FBARs.  Would the filing of the Form 8938 be a defense against the FBAR penalty? Or the filing of an FBAR be a defense against the penalty for failing to file Form 8938? 

Which takes us to Coffey.  This is a case where the taxpayers claimed to be residents of the U.S. Virgin Islands.  They filed income tax returns for 2003 and 2004 with the U.S.V.I. but not with the IRS.  The IRS determined the taxpayers weren’t bona fide U.S.V.I. residents and issued a notice of deficiency.  The taxpayers petitioned the Tax Court.

Bona fide U.S.V.I. residents file returns with the U.S.V.I. And pay a reduced tax rate on U.S.V.I.-related income.  A person who is not a bona fide U.S.V.I. resident who has U.S.V.I. source income files returns with both the U.S.V.I. and the IRS. 

The U.S.V.I. sent the IRS the first two pages of the taxpayers’ U.S.V.I. returns shortly after they were filed.  The IRS processed the returns and then remitted the taxpayers’ prepayments to the U.S.V.I., which refunded overpayments to the taxpayers.  The IRS issued the notice of deficiency to the taxpayers in 2009, more than three years after it received the taxpayers’ returns from the U.S.V.I.  In Tax Court, the taxpayers moved for summary judgment on the ground that the deficiency notices were barred by the statute of limitations.  The Tax Court agreed, finding that the taxpayers’ returns were filed with the IRS more than three years before the notices were issued.  The Eighth Circuit reversed.

IRC section 932(a)(2) requires persons who are nonresidents of the U.S.V.I. with U.S.V.I. related income to file returns with “both the United States and the Virgin Islands.”  The Eighth Circuit treated the taxpayers as nonresidents for purposes of the appeal and noted that statutes of limitation are strictly construed in favor of the Government.

The taxpayers claimed (a) that the U.S.V.I. sending their tax documents to the IRS was filing with the United States and (b) that filing their returns with the U.S.V.I.  met their nonresident filing requirement.  The Tax Court had agreed with the first argument, even though the taxpayers did not know or explicitly approve of the U.S.V.I. sending their returns to the IRS.

According to the Eighth Circuit, the taxpayers were required to show “meticulous compliance” with all filing requirements contained in the IRC and Treasury Regulations.  (This of course was something that Mr. Quezada had failed to do.)  “Returns are ‘filed’ if ‘delivered, in the appropriate form, to the specific individual or individuals identified in the Code or Regulations.”  Furthermore, “the three year statute of limitations begins only after the taxpayer’s ‘returns were filed.’  [citation omitted]. The IRS’s actual knowledge is not a filing ….  Without a filing, the statute of limitations in section 6501(a) does not begin when the IRS received the information.”

The Eighth Circuit held that the U.S.V.I.’s sending the first two pages of the return was not a “filing.”  It was undisputed that the Coffeys did not intend to file returns with the IRS, but only with the U.S.V.I.  The U.S.V.I. did not file any returns with the IRS, the Coffeys did not authorize it to file returns and did not even know that the U.S.V.I. sent the tax documents to the IRS.  Thus, the IRS’s processing of the documents did not “create a filing.”

That the Coffeys’ returns were honest and genuine does not affect whether they were filed with the IRS.  That the IRS receives and processes returns from the U.S.V.I. does not satisfy the filing requirement, since the U.S.V.I. is a separate taxing entity and the IRC doesn’t “create an exception for a taxpayer’s mistaken position about residency.”  It was also irrelevant that the returns filed with the U.S.V.I. are identical to federal tax returns since the returns were not filed with the IRS.

The Eighth Circuit ended its analysis that “without a filing, the documents are not an honest and genuine attempt to satisfy the tax laws and are not filed returns.  The Coffeys did not file returns with the IRS, but only returns with the” U.S.V.I.”  Thus, the statute of limitations on assessment for the years in issue had never started to run.

As noted in the Tax Court’s opinion, the IRS transcripts of account for the Coffeys had entries for a return received date and a return processed date for the returns the U.S.V.I. transmitted to the IRS.  If the IRS’s internal records treated the tax documents as returns that were received and processed in the same manner as returns a taxpayer “files,” why weren’t the Coffeys’ returns “filed” with the IRS?  The Tax Court’s decision focused on whether the returns received from the U.S.V.I. met the Beard test and determined that they did.  It seemed apparent to the Tax Court that the documents were filed with the IRS.   One thing the Tax Court found troubling was that the IRS began audits of the Coffeys within two years after it received the returns but dawdled, did not seek statute extensions, and waited several years before issuing the notices of deficiency.

So what do we make of this?  If the Fifth Circuit required “meticulous compliance” with the requirements of the Code and Regulations, it would have affirmed and not reversed the bankruptcy and district court.  But would the Eighth Circuit have affirmed the Tax Court if it applied the Fifth Circuit’s reasoning?  Not necessarily.  First, unlike Mr. Quezada, the Coffeys did not file their returns with the IRS; they were sent to the IRS by the U.S.V.I.  Second, while there was no claim that the Coffeys’ returns understated income or overstated deductions and credits, the tax documents sent to the IRS did not contain all the information needed to determine their liability because the Coffeys’ claimed they were bona fide residents of the U.S.V.I. Their returns thus did not have all the information needed to determine their liability.   But while Mr. Quezada’s Forms 1099 and 1040 contained sufficient information to determine his liability, did he intend for them to meet his backup withholding filing obligation? 

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

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[1]We won’t even discuss the potential problems with “tax returns” electronically filed by a paid return preparer, where the taxpayer does not sign the return but instead signs Form 8879, IRS e-file Signature Authorization, and the return preparer’s PIN is treated as the taxpayer’s signature.  That will be reserved for another day or another blog.

In December I had an FBAR roundup, where I wrote about three recent FBAR cases, two willful cases the IRS won (the Fourth Circuit’s decision in US v. Horwitz and the district court’s decision on remand in Bedrosian v. US) and the IRS loss in a non-willful case (US v. Bittner).  This week a district court in Connecticut handed the IRS a loss in another non-willful FBAR case, U.S. v. Kaufman, 18-cv-00787 (Jan. 11, 2021).  As in Bittner, the parties filed cross motions for summary judgment and presented the court with two issues: a) whether the maximum $10,000 non-willful penalty was per account or per annual filing and b) whether the defendant had “reasonable cause” for not filing an FBAR form.  The result was the same as in Bittner: the defendant did not have reasonable cause, but the non-willful penalty was per annual form not per account.

A little background:  Mr. Kaufman is a U.S. citizen who has resided in Israel since 1979.  He had multiple financial accounts in Israel.  In 2008 he had a beneficial interest in or signatory authority over 13 Israeli accounts, in 2009 there were 12 accounts and in 2010 there were 17 accounts.  Mr. Kaufman’s U.S. tax returns were prepared by an American accounting firm.  Each year, the accountants would ask if he had any foreign accounts and would advise him that if he did, he may need to file FBAR forms.  Each year he told his accountants he did not have any foreign accounts.  When asked how he paid his bills, he claimed it was out of a U.S. brokerage account, so they checked the “no” box to the question on the return whether he had foreign accounts.  Notwithstanding this evidence, Mr. Kaufman claimed he did not learn of the FBAR filing requirement until September 2011.  He also claimed that he suffered a heart attack in late 2010 and was involved in an auto accident in 2011 and that these affected his cognitive abilities.

The first issue the Court addressed was the reasonable cause defense.  To escape liability for the non-willful penalty a person must show “reasonable cause” and that the amount in the account was accurately reported.  The Court focused on the “reasonable cause” prong.  Since “reasonable cause” is not defined in the FBAR statute, the Court looked to the reasonable cause defense to penalties in Internal Revenue Code sections 6651 and 6664, noting that under US v. Boyle, 469 U.S. 241 (1985), failure to timely file a return is not excused by reliance on an agent.  Given the facts, including the taxpayer being told by his CPAs that he did not have foreign accounts and used a U.S. brokerage account to pay his bills, the Court found there was no reasonable cause.  Thus, he was liable for the non-willful penalty. 

Now the Court had to decide whether the maximum penalty was $10,000 per year, or whether the IRS could assess the non-willful penalty on an account by account basis, with the maximum penalty per account being $10,000.  This was a question of interpreting the statute, the starting point for which is the “plain meaning” rule, i.e., the language in a statute is given its plain meaning.    The problem was that the language in the statute was not clear on whether the maximum non-willful penalty was to be applied on an annual basis or an account-by-account basis.  The Government pointed to the language in the willful penalty provisions of the statute, which refer to “balance in the account” and “existence of an account” as requiring the non-willful penalty to apply on an account by account basis.  Mr. Kaufman argued that this language “reveals exactly the opposite.  The Court agrees with Kaufman.”  The Court followed the logic of the Bittner court.

The Court, relying on Bittner, reasoned that the language in the willful penalty provision shows that Congress knew how to make penalties account specific.  It drew a negative inference from the exclusion of language in the non-willful provision of language that was in the willful provision of the statute that Congress did not intend for the non-willful penalty to apply per account.  To buttress its determination, the Court found it significant that the regulations provide as the threshold for filing the FBAR form an aggregate balance in all accounts of over $10,000 since it makes no sense to assess a non-willful penalty per account when the reporting obligation is based on the aggregate balance and not on the number of accounts. 

Under both willful and non-willful penalties “the violation flows from the failure to file a timely and accurate FBAR.  The only difference is that the manner for calculating the statutory cap for penalties for willful violations involves an analysis that includes consideration of the balance in the accounts, while no such analysis is required for non-willful violations.”  (Slip. Op. at 18-10.)

The Government’s interpretation “could readily result in disparate outcomes among similarly situated people” based solely on the number of accounts and a person who had several accounts who  was non-willful “could be exposed to a significantly higher penalty than a willful violator.”  The Court found as conjecture the Government’s argument that limiting the penalty for non-willful violations to $10,000 per year would decrease the penalties deterrence value.  The Court noted that for the first three decades of the statutes existence there was only a willful penalty and when Congress added the non-willful penalty it was aware that the willful penalty used the account balance as a cap, something the Court found persuasive evidence that Congress did not want the non-willful penalty to be applied on a per account basis.  The Court found unpersuasive the district court’s decision in US v. Boyd.

Boyd is currently on appeal to the Ninth Circuit, which heard oral argument last summer.  Counsel for Ms. Boyd has already sent a copy of the Kaufman decision to the Ninth Circuit.  We can only wait to see whether the Ninth Circuit finds the reasoning in Kaufman and Bittner persuasive.

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

It has been a while since I blogged on FBAR cases, but three cases over the past few months deserve mention.  Two were willful cases where the courts held that the taxpayers were liable for the FBAR willful penalty: the Fourth Circuit’s affirmance of the district court’s grant of the Government’s summary judgement motion in United States v. Horowitz (no relation) and the district court’s decision on remand in Bedrosian v. United States.  The third was a case dealing with whether the non-willful FBAR penalty is assessed on an account-by-account basis, United States v. Bittner.

The taxpayers in Horowitz had worked for a number of years in Saudi Arabia.  The deposited a large part of their income into a local bank.  Since that bank did not pay interest on deposits, they eventually transferred the funds to a Swiss bank account.  The amount in the Swiss account eventually reached over $1.6 million and was their main financial asset.  Eventually, they had the funds placed in UBS account.  When they returned to the U.S., they did not give UBS their mailing address.

Dr. and Mrs. Horowitz reported on their U.S. income tax returns the income they earned in Saudi Arabia and the interest earned on their U.S. bank accounts, so they knew that foreign income and interest income were both reported.  They never told their CPA about the Swiss account or asked if interest on a foreign account was subject to U.S. income tax.  They did, however, tell friends about the Swiss account.

In 2008 they were told by UBS that they had to close their account because UBS no longer was accepting U.S. citizens as customers.  They moved the funds to another Swiss bank.  The account opening forms directed the bank to hold mail and Dr. Horowitz initialed each page. 

The taxpayers entered the Offshore Voluntary Compliance Initiative and paid the tax due on previously unreported foreign income,  but in 2012 they opted out. In June 2014, the IRS assessed willful penalties against them.  In 2016, the Government sued to collect the willful penalty.  The district court entered summary judgment in favor of the Government and the Horowitzes appealed.

The Horowitzes raised four arguments on appeal.  First, they argued that under United States v. Ratzlaf, 510 U.S. 135 (1994), willful for purposes of criminal penalties under the Bank Secrecy Act requires actual knowledge that one is violating the law.  They argued that “willful” for purposes of civil penalties under the Bank Secrecy Act should have the same meaning.  The Court noted that the Supreme Court had remarked that “willful” is a term with many meanings and, in Safeco Ins. Co. v. Burr, 551 U.S. 47 (2007), the Supreme Court in the civil context “willful” includes “reckless disregard.”  The Court concluded that for purposes of the civil FBAR willful penalty, willful includes both actual knowledge and reckless disregard, which is determined under an objective standard: a person acts with reckless disregard if he acts or fails to act “in the face of an unjustifiably high risk of harm that is either known or so obvious that I should be known.”  This differs from criminal recklessness and willful blindness, both of which include an objective element.  Nor is reckless disregard negligence, sine it requires “a high risk of harm, objectively assessed.”  It agreed with the Third Circuit in Bedrosian that recklessness is established if the taxpayer “(1) clearly ought to have known that (2) there was a grave risk that an accurate FBAR was not being filed and if (3) he was in a position to find out for certain very easily.”

You probably know the background in Bedrosian.  As you may recall, Bedrosian claimed his former accountant, now deceased, told him about the FBAR requirements but told him since he failed to file in prior years, he didn’t have to file (I guess because he was “grandfathered” ?) Bedrosian subsequently filed an FBAR that reported only one of two accounts he had overseas.  The district court held that Bedrosian was not liable for the willful FBAR penalty, the Third Circuit held that a) the FBAR penalty is a penalty under the internal revenue laws, so that the district court did not have jurisdiction over the taxpayer’s suit for refund of a partial payment towards the penalty, b) the district court had jurisdiction over the Government’s counterclaim for the unpaid balance of the FBAR penalty, and c) the district court would have to consider whether the plaintiff acted willfully under the “reckless standard” based on other Third Circuit cases in the “taxation realm.” 

The second argument raised by the Horowitzes was that evidence did not support the district court’s determination.  The Fourth Circuit held this argument was hogwash.  The Horowitzes knew a significant part of their savings were in the foreign accounts; that income they earned in Saudi Arabia was taxable by the U.S. and that interest on U.S. accounts was taxable by the U.S. and gave their CPA information about the interest on their U.S. accounts each year.  Nevertheless, they never asked their CPA if foreign interest was taxable by the U.S. and never informed the CPA about their foreign account.  They did not give their U.S. mailing address to UBS and had their second Swiss bank hold  the mail.  Additionally, they failed to closely review their returns which reported they had no foreign accounts and signed the returns under penalties of perjury.  The Fourth Circuit held that the evidence clearly established that the Horowitzes “ought to have known” that they were failing to fulfill their obligation to disclose their Swiss accounts and could easily have found out that duty. 

The Horowitzes also argued that if they willfully failed to file FBAR returns, under the applicable regulations, the maximum penalty per year was limited to $100,000.  Joining the Federal Circuit, the Fourth Circuit rejected this argument, finding that the 2004 amendments to the civil FBAR penalty voided the regulation and Treasury’s failure to amend the regulation did not abrogate the statute.

Finally, the Horowitzes argued that the assessment  was not  timely.  The statute of limitations was June 30, 2014 and the IRS had made the assessment on June 13, 2014.  Subsequently, when the Horowitzes filed a protest with appeals, an IRS employee removed the assessment date without abating the assessment.   The Court held that the June 13, 2014 assessment was never abated or reversed and removing the assessment date did not change the date of the assessment.  Thus, the Court held that the assessment was. Timely.

Now to Bedrosian on remand: Surprise, surprise.  Applying the following description of the reckless standard for willfulness, the district court held that Bedrosian acted willfully (quoting from the Third Circuit’s opinion):

A person commits a reckless violation of the FBAR statute by engaging in conduct that violates an objective standard: action entailing an unjustifiably high risk of harm that is either known or so obvious that it should be known.

After considering several Third Circuit cases involving the trust fund recovery penalty, the district court held that based on the evidence, including the following, “Bedrosian’s conduct was reckless and therefore willful”:

1. Bedrosian cooperated with the Government “only after he was exposed as having hidden foreign accounts.”
2. Bedrosian’s FBAR only disclosed one of two Swiss accounts and he moved the funds in the undisclosed account to a different bank rather than repatriate them.
3. Bedrosian admitted he saw a Wall Street Journal article about the federal government tracking mail coming to the United States from overseas and thus was aware of the possibility it would learn of his offshore accounts if mail was sent to him by the Swiss bank.
4. Bedrosian’s Swiss accounts were on “mail hold,” as he was undoubtedly aware of.
5. His FBAR checked the box for having less than $1 million in the account when he knew the total in his accounts was over $1 million.

According to the district court, many of the circumstances cited by the Fourth Circuit in Horowitz were present in Bedrosian’s case:

1. Bedrosian knew of the FBAR reporting requirements and the Horowitz’s knew they their world-wide income was taxed
2. Both used mail holds for correspondence from their Swiss bank
3. Both had significant amounts in their offshore accounts
4. Both signed returns under penalties of perjury and representing that the answers were true.

The district court interpreted non-FBAR tax cases to “generally support that when a taxpayer is responsible for reviewing tax forms and signing checks, the taxpayer is responsible for errors that would have been apparent had they reviewed such forms and checks closely.”  Bedrosian knew there was more than $1 million his Swiss accounts but the FBAR form he signed checked the box for under $1 million.  He thus knew or should have known the form he signed was inaccurate and therefore acted willfully.  

Based on this standard of willfulness, anyone who signs a return that contains an error that he or she would have caught had the return been read over carefully, has willfully signed an inaccurate return.  I don’t know if that is what Congress had in mind when it used the word “willfully” in the FBAR statute but that is where it appears we have ended up.

The Government has been pushing the line that the FBAR penalty is assessed on an account-by-account basis.  Thus, a person whose failure to report several accounts is non-willful can be assessed a penalty of $10,000 for each unreported account.  Similarly, where a person willfully fails to report multiple accounts can be assessed a penalty equal to the greater of $100,000 or 50% of the value of the account. The Government won the first reported decision on multiple non-willful penalties, United States v. Boyd, (CD CA), appeal pending (9^th Circuit).  On June 29, 2020, a district court judge in Texas held, in a thoughtful opinion, that the non-willful FBAR penalty is applied per FBAR form and not per account, so that a non-willful penalty cannot exceed $10,000 per year.  United States v. Bittner, 126 AFTR 2d 2020-5051 (E.D. Tex. 6/29/2020).

The defendant in Bittner was born in Romania, moved to the U.S. in 1982, became a naturalized U.S. citizen, and returned to Romania in 1990.  In Romania, he became a very successful businessman, operating several businesses and opening a number of foreign accounts.  He returned to the U.S. in 2011.  During the years he lived in Romania he had earned over $70 million.  Between 2007 and 2011 he had, at any one time, between 51 and 61 foreign financial accounts.  He did not file timely FBARs for these years, so the IRS assessed non-willful FBAR penalties against him totaling $2.72 million.  The Government sued to collect the penalties.  Because Bittner admitted to having a financial interest in some, but not all, of the accounts, the Government moved for partial summary judgment as to those accounts.  The penalties on the admitted accounts totaled $1.77 million.  Bittner filed a cross-motion for partial summary judgment. 

The Court framed the issue as:

Does the civil penalty provided by 31 U.S.C.  31 U.S.C. 5321(a)(5)(A) and (B)(i) for non-willful violation(s) of the regulations implementing 31 U.S.C. 5314 apply per foreign financial account maintained per year but not properly or timely reported on an annual FBAR, or per annual FBAR report not properly or timely filed?

The Court stated it was conducting analysis of the text of the statute in light of the statutory and regulatory framework in which it appears.  Since section 5321(a)(5)(A) provides for a penalty “on any person who violates, or causes any violation of, any provision of section 5314,” the question became what is a “violation” of the statute.  Under the regulations then in effect, “the form prescribe under section 5314 is the [FBAR] or any successor form which is to be filed on or before June 30 of the calendar year  for foreign accounts maintained during the immediately preceding calendar year.  According to the Court, the parties agreed that, based on this language, the failure to file the annual FBAR is the violation that triggers the penalty.  The dispute was whether, where there are multiple accounts, does the failure to file the FBAR form constitute a separate violation for each account or one violation.

            The Court looked to the language of  the willful penalty , which bases the amount of the penalty “in the case of a violation involving a failure to report the existence of an account or any identifying information required to be provided with respect to an account, the balance in the account at the time of the violation.”  From this language, the Court concluded that Congress intended the willful penalty to be applied on an account by account basis.

            The Court then looked at the language of the non-willful penalty and the reasonable cause exception.  While the reasonable cause exception to the non-willful penalty was related to the “balance in the account,” the non-willful penalty itself did not contain any reference to “account” or “balance in the account.”   The Court presumed that Congress acted intentionally when it drafted the non-willful penalty language without these references.  Further, because the BSA aimed “to avoid burdening unreasonably a person making a transaction with a foreign financial agency,” an individual required to file an FBAR form was only required to file one report for each year.  As a result, “it stands to reason that a ‘violation’ of the statute would attach directly to the obligation that the statute creates – the filing of a single report – rather than attaching to each individual foreign financial account maintained.”  Additionally, no matter how many foreign accounts a person has the requirement to file an FBAR is only triggered if the aggregate balance in the accounts is over $10,000.  It thus made no sense “to impose per-account penalties for non-willful FBAR violations when the number of foreign financial accounts an individual maintains has no bearing whatsoever on that individual’s obligation to file an FBAR in the first place.”

            The Court rejected the government’s arguments that since the reasonable cause exception relates to the “balance in the account” the penalty must apply per account and that since the willful penalty applies on a per-account basis, so must the non willful penalty.  While Congress may have had good reason to assess the willful penalty on a per-account basis and look to the balance in the account to determine the applicability of the reasonable cause exception was no reason to conclude that it meant for the non-willful penalty to apply for a per-account basis given the statutory language.

            According to the Court, adopting its “per form” reading avoids the “absurd outcome that Congress could not have intended in drafting the statute.”  The Court used as an example of this absurd result two individuals with multiple offshore accounts with $1 million.  One had two accounts and the other had 20.  Even though both failures to file were non-willful, based on the government’s reading, the individual with 2 accounts would face a maximum penalty of $20,000 while the individual with 20 accounts would face a maximum penalty of $200,000.  As to the government’s argument that investigation costs increase with the number of accounts, the Court found this insufficient to overcome the statutory language, especially since an individual with 25 or more accounts would not have to list any of the accounts on the FBAR. 

The Court also rejected the government’s reliance on United States v. Boyd (CD CA) appeal pending (9^th Circuit) since the Boyd court did not explain why it found the government’s interpretation more reasonable, the case was not binding precedent and the Court disagreed with it.  The Court ended its discussion of the issue as follows:

To conclude, Congress used the word “account” or “accounts” over one hundred (100) times throughout the BSA. But remarkably, it omitted any mention of “account” or “accounts” in § 5321(a)(5)(A) and (B)(i).  At the end of the day, the Court will not insert words into statutes that are not there. E.E.O.C. v. Abercrombie & Fitch Stores, Inc. , 135 S. Ct. 2028, 2033 (2015) (“The problem with this approach is the one that inheres in most incorrect interpretations of statutes: It asks us to add words to the law to produce what is thought to be a desirable result.  That is Congress’s province. We construe [a statute’s] silence as exactly that: silence.”); 62 Cases, More or Less, Each Containing Six Jars of Jam v. United States, 340 U.S. 593, 596 (1951) (“After all, Congress expresses its purpose by words. It is for us to ascertain-neither to add nor to subtract, neither to delete nor to distort.”); see also King v. Burwell, 135 S. Ct. 2480, 2505 [115 AFTR 2d 2015-2203] (2015) (Scalia, J., dissenting) (quoting Pavelic & LeFlore v. Marvel Entertainment Group, Div. of Cadence Indus. Corp., 493 U.S. 120, 126 (1989)) (“They made Congress, not this Court, responsible for both making laws and mending them. This Court holds only the judicial power-the power to pronounce the law as Congress has enacted it….  We must always remember, therefore, that ‘[o]ur task is to apply the text, not to improve upon it.'”).  Congress knew how to make the non-willful FBAR penalty vary with the number of foreign financial accounts maintained, but it did not do so.  That is the end of the road.

Finally, the Court determined that since Bittner did not file FBAR forms for the years in issue, the reasonable cause exception did not apply.

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

The Due Process Protections Act (DPPA)[i], was signed into law and became effective October 21, 2020.  The DPPA effectively provides federal judges with greater supervisory authority over the federal government’s disclosure of exculpatory evidence in criminal prosecutions.

A prosecutor’s obligation to disclose exculpatory evidence to the defense after charging a defendant with a federal crime is not new.  In fact, it is both part of the due process obligations guaranteed to defendants under the Fifth and Fourteenth Amendments to the U.S. Constitution as well as clearly set forth in the U.S. Supreme Court’s 1963 decision in Brady v. Maryland[ii] mandating prosecutors disclose to the accused all “favorable” evidence that is “material either to guilt or to punishment” under the defense’s theory of the case.  The prosecutor’s duty to disclosure of exculpatory evidence to the defense is often referred to as the government’s Brady obligations.  A failure to provide the defense with Brady material in the possession of the prosecution team[iii] is deemed a constitutional violation, regardless of whether the individual prosecutor is aware of the evidence or not and despite whether the prosecutor acted in good faith or not.[iv]  Furthermore, the government’s Brady obligations exist even if the defendant does not specifically request the information.[v]

In technical terms, the DPPA amends Rule 5 of the Federal Rule of Criminal Procedure, which addresses Initial Appearances in Court by defendants, by creating new Rule 5(f), titled “Reminder of Prosecutorial Obligations”, which now provides:

• IN GENERAL. — In all criminal proceedings, on the first scheduled court date when both prosecutor and defense counsel are present, the judge shall issue an oral and written order to prosecution and defense counsel that confirms the disclosure obligation of the prosecutor under Brady v. Maryland, 373 U.S. 83(1963) and its progeny, and the possible consequences of violating such order under applicable law.
• FORMATION OF ORDER. — Each judicial council in which a district court is located shall promulgate a model order for the purpose of paragraph (1) that the court may use as it determines is appropriate.

While DPPA does not alter the substantive nature of the federal government’s Brady obligations nor does it mandate a national standard for the required oral and written orders, instead deferring to the judicial counsel of each circuit, of which, it should be noted, there are 12,[vi] it does require a consistent rule in each district and, under that rule, an order which will provide federal judges with enhanced supervisor authority over prosecutors and directly put federal prosecutors on notice of the possible consequences of violating their Brady obligations.  Additionally, although the DPPA does not mandate a specific timing for the disclosure of Brady information, and noting that current DOJ policy directs the government’s Brady disclosures be made in sufficient time to permit the defendant to make effective use of that information at trial,[vii] the DPPA is clearly intended to reinforce the message to federal prosecutors that the production of exculpatory material is a priority.  Now, with the additional requirements of a mandated Rule 5(f) court order, that message comes with judicial oversight and, where necessary, consequences to the government that include, but are not limited to, exclusion of evidence, adverse jury instructions, dismissal of charges, contempt proceedings and sanctions for noncompliance with a Rule 5(f) court order.

SANDRA R. BROWN – Ms. Brown has been a principal at Hochman Salkin Toscher Perez PC since March 2018.  Prior to joining the firm, Ms. Brown spent more than 26 years as a federal trial attorney, including serving as the Acting United States Attorney, the First Assistance United States Attorney and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal).  Ms. Brown’s broad range of experience in complex civil tax controversies and criminal tax investigations and litigation includes having handled over 2,000 cases on behalf of the United States before the United States District Court, the Ninth Circuit Court of Appeals, the United States Bankruptcy Appellate Panel and the California Superior Court.  In addition to other honors, commendations and awards, Ms. Brown has received the Internal Revenue Service Criminal Investigation Chief’s Award and the IRS’s Mitchell Rogovin National Outstanding Support of the Office of Chief Counsel Award, respectively, the two most prestigious criminal and civil awards available for presentation by the IRS to a Department of Justice employee.

Ms. Brown represents individuals and entities on a national and local level in complex federal criminal investigations and litigation as well as sensitive civil tax controversy examinations and litigation matters.  Ms. Brown obtained her LL.M. in Taxation from the University of Denver, is a fellow of the American College of Tax Counsel, co-chair of the NYU Tax Controversy Section, and a member of the Women’s White Collar Defense Association.  Ms. Brown may be reached at brown@taxlitigator.com or 310.281.3217.     

---

[i] Pub. L. N. 116-182, 234 Stat. 894 (Oct. 21, 2020).

[ii] United States v. Brady, 373 U.S. 83 (1963).

[iii] Kyles v. Whitley, 514 U.S. 419, 437 (1995).

[iv] Id., at 87.

[v] United States v. Agurs, 427 U.S. 97 (1976).

[vi] See https://www.uscourts.gov/about-federal-courts/governance-judicial-conference.  Under 28 U.S.C. § 332, each circuit has a judicial council composed of chief judge and an equal number of circuit and district judges; Under sec. 28 U.S.C. § 41 there are 13 circuits: the DC Circuit, the

1st – 11th Circuits, and the Federal Circuit.  Since the Federal Circuit does not hear appeals in criminal cases, only 12 of the judicial councils will promulgate model orders.

[vii] Justice Manual § 9-5.001.

We hope you are all staying healthy and safe. It has been challenging year—but it looks as if we are starting to turn the corner.

Please join us Monday through Wednesday, January 25-27, 2021 for the USC Gould School of Law 2021 Virtual Tax Institute. This year’s Institute has a stellar line up of tax superstars.  Learn the latest tax law developments for corporations, privately-held businesses, individuals, partnerships and real estate transactions, and important ethics, compliance, enforcement and estate planning solutions.

We are very proud that three of our principals have been chosen to speak at this prestigious event:

• Dennis Perez on Representing the High Income Non-filer in the New Non-filer Enforcement Environment
  
• Michel Stein on Handling the IRS New Wealth Examinations-Lessons from the Past and Guidance for the Future
  
• Sandra Brown on Why Your Client’s Chances of Criminal Prosecution and Civil Fraud Penalties has Dramatically Increased – The IRS New Office of Fraud Enforcement

The Institute is also excited  that two of the nation’s top tax officials, Michael Desmond, IRS Chief Counsel and  Erin Collins, IRS Taxpayer Advocate, will be giving keynote presentations.

For programming and registration details for the USC Gould School of Law 2021 Tax Institute Click Here.

We are pleased to announce that Evan Davis will be speaking at the upcoming LACBA webinar, “What to Do When the Feds Come Knocking: The Do’s and Don’ts” on Tuesday, December 8, 2020, 5:00 p.m. – 6:00 p.m. (PST).

Many industries are now regulated by government agencies.  Even companies not in heavily-regulated industries face the real prospect of government investigations if they received stimulus funds under the CARES Act.  Sooner or later, most companies will come into contact with representatives of law enforcement.  Being prepared is more important than ever before.  Companies and executives should be prepared when investigators “knock on your door.” 

Join a panel of experts to learn about these important topics:

• Typical law enforcement investigative tools 
• Responding to government subpoenas
• Responding to search warrants
• Department of Justice focus on company executives
• Avoiding allegations of obstruction of justice
• Be prepared: Takeaways for clients

Please join us. For full programming details Click Here.

We are pleased to announce the 37th Annual National Institute on Criminal Tax Fraud and the 10th Annual National Institute on Tax Controversy is going virtual and will be held on February 24-26th, 2021. As usual, we anticipate a line-up of all-star government and private practice practitioners discussing the cutting edge issues in civil and criminal tax enforcement. More to come.

The 37th Annual National Institute on Criminal Tax Fraud and the 10th Annual National Institute on Tax Controversy is the yearly gathering of the criminal tax controversy and criminal tax defense bar. This program brings together high-level government representatives, judges, corporate counsel, and private practitioners engaged in all aspects of tax controversy, tax litigation, and criminal tax prosecutions and defense. Please join us.

Click Here for More Information.