TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

The Internal Revenue Service (IRS) began sending contact letters this week reminding certain taxpayers that it has their information relating to deductions claimed for micro-captive insurance arrangements. The letters also asked taxpayers who stopped claiming deductions to provide certain information under penalty of perjury, including the final year a micro-captive deduction was claimed.  As for those taxpayers continuing to participate in micro-captive insurance transactions, the IRS recommends that the taxpayer consult an independent competent tax advisor on the proper treatment of past and future tax years and consider best options for any improperly claimed deductions, including the filing of amended returns.  The IRS refers to these as Letter 6336 (3-2020) on its web page and provides a hotline number to call for assistance.

Letters similar to these were generally expected after the IRS roll-out of its time-limited settlement offer made to certain taxpayers under examination, followed by its stern warning to the public on January 31, 2020 that the IRS will continue to vigorously pursue those involved in these and other similar abusive micro-captive transactions going forward.

We consider these letters, however, as an opportunity to revisit the legitimacy of the tax benefits claimed with respect to captive transactions.  Moreover, for appropriate taxpayers, these letter may present an opportunity to take proactive, corrective measures that may assist in avoiding onerous examinations and steep penalties that could otherwise be asserted against them.

Why are Micro-Captive Insurance Letters Issued?

The letter explains why the IRS is writing this letter and what steps are requested of the taxpayers.

The IRS states that:

         Why we’re writing to you

We have information that you’ve taken a deduction or other tax benefit related to micro-captive insurance on a prior year tax return and disclosed pursuant to Notice 2016-66 and Notice 2017-08.

Several recent U.S. Tax Court decisions have confirmed that certain  micro-captive  arrangements  are not eligible for claimed Federal tax benefits. We’re notifying you regarding IRS compliance activity in this area so you can make informed  decisions  about claiming  tax deductions for micro-captive insurance premiums. The IRS is increasing enforcement activity in this area and has deployed several examination teams to open additional examinations of returns that included micro-captive insurance transactions. Examinations may result in full disallowance of claimed micro-captive insurance deductions, inclusion of income by the captive entity, and imposition of applicable penalties.

What information is the IRS Requesting?

The letter requests that if a taxpayer is no longer claiming deductions or other tax benefits it should notify the IRS in writing  of:   (1) The last tax year in which the taxpayer claimed deductions or other tax benefits for micro-captive insurance premiums, and, if applicable, (2) the date the taxpayer ceased participating in the micro-captive insurance transaction.

If a taxpayer continues to participate in a micro-captive insurance transaction covered under Notice 2016-66, the letter states the taxpayer must continue to disclose participation in the transaction.  The letter also cautions that before filing the 2019 Federal income tax return, the IRS recommends the taxpayer consult an independent, competent tax advisor on the proper treatment for past and future tax years and consider the best options for any improperly claimed deductions or other tax benefit, including filing amended returns.

If there is a need to file amended tax returns for individual filers, the letter states write “Microcaptive”  at the top of the first page of the Form 1040X and mail the amended return to:

Internal Revenue Service
2970 Market Street
Philadelphia, PA 19104

For business filers using paper returns write “Microcaptive” at the top of the amended return and mail to the address listed on the instructions to the amended return.  Business filers filing electronic amended returns should list “Microcaptive” as the reason for filing the amended return.

The letter further  states that “We’ll take your actions in response to this letter into account when considering future compliance activity related to your micro-captive insurance arrangement.” and that it does not consider this letter an examination under the Internal Revenue Code or an audit of a tax return.

The IRS warns that if the IRS does not hear from the taxpayer by the “respond by” date it may refer the returns for examination.

Prior IRS Announcement – IR-2020-26

These letters follow the IRS announcement on January 31, 2020 stating that IRS enforcement activity in this area will be significantly increased.  On that date, the IRS informed  that it will deploy additional resources, which includes starting up 12 new examination teams comprised of employees from the IRS Large Business and International (LBI) and Small Business/Self-Employed (SB/SE) divisions that will address abusive transactions and open additional exams.   The IRS Announcement warned that examinations impacting micro-captive insurance transactions of several thousand taxpayers will be opened by these teams in the coming months.   Potential outcomes can include full disallowance of claimed captive insurance deductions, inclusion of income by the captive entity and imposition of all applicable penalties.

The Letter May Present an Opportunity to Potentially Avoid Protracted Examination and Penalties.

While typically receiving an inquiry from the IRS is never a good thing, the letter does raise the question whether taking proactive steps, such as reversing the transactions  on amended tax returns, could avoid an onerous examination that many individuals and captive entities endured, along with the steep penalties asserted in these examinations.  We are hopeful that it would.

We would like to think that when the IRS invites taxpayers to file amended tax returns and states it will take the taxpayers actions into account when considering future compliance activity, it will consider these corrective actions as good faith gestures warranting the elimination  of penalties.  Moreover,  the IRS should  treat amended returns filed in response to these letter as Qualified Amended Returns, warranting penalty mitigation.

On the other hand, ignoring the letter is rarely the correct response.  Even those taxpayers with sound micro-captive transactions positions should fashion a response that addresses the merits of their position, and offers an explanation for the micro-captive benefits claimed.  Many individuals and businesses have legitimate reasons for micro-captive insurance arrangements.  In this COVID-19 new reality we all are facing, one can now plainly see the benefits of additional or gap insurance, such as business interruption insurance or the like.  However, absent a detailed explanation, the IRS may require the taxpayer to expend considerable resources before the legitimacy of the captive insurance plan is known to it.

Moreover, it is possible that for those taxpayers who respond appropriately, the IRS would at a minimum offer terms similar to the time-limited settlement initiative afforded to those under examination, in lieu of opening a full-blown examination against the taxpayer.   Importantly, the time-limited settlement initiative protected the IRS’ interests for years closed by statute, and it is likely that the IRS would want closed years considered as part of any resolution with the taxpayer. As such, amended tax returns alone may not fully address all of the concerns by the IRS.

As the IRS works through these cases, only time will tell how the IRS will respond.   For the time being, taxpayers have 45-days from the date of the letter to sort these issues out and respond accordingly.

For more information regarding this topic please contact Michel Stein – ms@taxlitigator.com   Mr. Stein is a principal at Hochman, Salkin,  Toscher & Perez, P.C. He is a former Attorney-Adviser of the U.S. Tax Court and is a Certified Specialist in Taxation Law by the State Bar of California, Board of Legal Specialization.  Mr. Stein represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. He has extensive experience with micro-captive insurance, voluntary disclosures and foreign account and asset reporting, and he frequently lectures throughout the country on these and other tax related topics.  Additional information is available at www.taxlitigator.com .

President Trump signed the Families First Coronavirus Response Act on March 18, 2020.  Division G of the Act provides for employers to be reimbursed dollar-for-dollar for coronavirus-affected paid sick leave and paid child care leave via payroll tax credits.  On March 20, the Treasury Department, the IRS and the Department of Labor announced plans for implementation of these provisions of the Act in IR 2020-57.

These provisions apply to businesses with fewer than 500 employees.  A business will receive a refundable tax credit to reimburse it dollar-for-dollar for providing coronavirus-related paid leave to employees.  Coronavirus-related leave is leave taken by employees who cannot work due to coronavirus-related Federal, State or Local quarantine or has been advised to self-quarantine, or because they have coronavirus symptoms or is seeking a medical diagnosis, or employees who are caring for an individual who is quarantined or self-quarantined, or the employee is caring for a son or daughter whose school or care facility is closed, or whose care provider is unavailable, due to COVID-19.

For each employee who is on coronavirus-related leave, the employer can receive a refundable credit for up to 80 hours for full-time employees. The credit is equal to the sick-leave paid the employee at his or her regular rate of pay up to a maximum of $511 a day and $5,110 in aggregate for a total of ten days.  For an employee who is caring for someone or for a son or daughter, the credit is equal to 2/3rds of the employee’s regular pay up to a maximum of $200 per day and $2,000 in the aggregate for 10 days.

In addition to the sick leave credit, if an employee cannot work because of the need to care for a child whose school or child care facility is closed or whose child-care provider is unavailable due to coronavirus, the employer can receive a refundable child care leave credit equal to 2/3rds of the employee’s regular pay, capped at $200 per day or $10,000 in the aggregate for a maximum of up to 10 weeks.  This is in addition to the sick-leave credit.  A business with  less than 50 employees are eligible for an exemption from this provision if the viability of the business is threatened.

Eligible employers are entitled to an additional tax credit based on the cost of health insurance for the employee during the leave period.

The employer can claim the credit by retaining an amount of payroll tax that would normally be paid to the IRS.  If the the payroll taxes are insufficient to cover the cost of qualified sick leave and child-care leave, the employer will be able to file a request for an accelerated payment from the IRS.  The IRS anticipates processing these requests in no more than two weeks.  Self-employed individuals are entitled to similar credits under similar circumstances that can be claimed on their income tax returns and will reduce estimated tax payments.

The tax credit is available for eligible paid sick and eligible paid child-care leave for the period March 20 through December 31, 2020.

Contact Avram Salkin at salking@taxlitigator.com or 310-281-3200.  Mr. Salkin is “The Tax Lawyer’s Tax Lawyer” and a founding member of the firm with more than 50 years of extensive experience in resolving complex Federal and state tax controversies and disputes, in structuring and negotiating complex transactional matters (including the acquisition and disposition of real estate and businesses), family wealth planning, estate planning and probate. Avram Salkin is a Certified Specialist in both Taxation and Estate Planning, Trust and Probate Law, by The State Bar of California Board of Legal Specialization.  Mr. Salkin is a recipient of the Joanne M. Garvey Award from the Taxation Section of the California Lawyers Association in recognition of his lifetime achievement and outstanding contributions in the field of tax law, and of the UCLA Bruce I. Hochman Award in recognition of his outstanding proficiency in tax law. 

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.

Since our Blog post earlier this week regarding the initial tax payment (but not filing deadline) relief announced by Treasury Secretary Steven Mnuchin, the government has gone further.  As particularly important for busy tax preparers, the normal tax payment and filing deadline of April 15, 2020 have now both been extended until July 15, 2020.  The Treasury Secretary’s tweet on this point referenced both the filing deadlines and payments, without a reference to the prior relief limitations of $1,000,000 for individuals and $10,000,000 for corporations.

While this blog post is an update on this filing deadline with commentary, as opposed to a comprehensive update on the quickly developing and substantial legislative tax relief, below are links to both state and federal resources related to tax relief from CalCPA and the AICPA.

As preparers take a breath for perhaps half a day as the deadline is extended, their next step will be to absorb the substantial tax and other relief provisions, much of which is administered on the shoulders of the IRS and other state tax agencies.

Many of the continuing education programs for tax attorneys and tax preparers over the last few years have been focused on understanding Tax Cuts and Jobs Act, and the Qualified Business Income Deduction in particular.  With the economic outlook temporarily turned on its head, the optimistic Qualified Business Income Deduction provisions take on a new light.  The focus for many taxpayers may now be on losses in 2020.  The latest proposed relief provisions are already considering Net Operating Loss limitations that were added to the Tax Cuts and Jobs Act.  Additionally, the Senate has remembered the relief provided after the economic and real estate crash in 2008 and 2009, when they supercharged the net operating losses and the ability to carry them back.  As the legislation is in flux, we will see where the specific relief provisions settle.  In summary, an initial glimpse of the legislative stimulus is that it provides some of the “best hits” from the last 20 years and may apply many of them at once.

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

Treasury Secretary Steven Mnuchin stated Tuesday that individual taxpayers who owe the IRS up to $1 million and corporations that owe the IRS up to $10 million would be provided with an additional 90 day period to pay federal income taxes due April 15, although returns currently still need to be timely filed.  Failure to pay penalties and interest will not accrue on such taxes during this 90-day period.  Last Friday, California also provided relief by extending the date for tax return filing and payment for 60 days for individual returns and 90 days for partnership and LLC returns (they were due this week) until June 30, 2020.

As background and for historical context, California Wildfire Victims in 2019 were eligible for relief from various filing/payment deadlines that fell between November 2018 and April 30, 2019.  Thus, they had additional months to pay individual, corporate, S-Corporation, partnership, and estate and trust tax returns and payments.  Relief also included payroll tax and income tax estimated payments.

Once the President declares a major disaster to be present, the Treasury/IRS is permitted to postpone certain deadlines.  Specifically, under IRC Section 7508A, in the case of a taxpayer determined by the Secretary to be affected by a federally declared disaster, the Secretary may specify a period of up to 1 year that may be disregarded in determining, under the internal revenue laws, in respect of any tax liability of such taxpayer, whether the taxpayer timely filed any return or paid any tax, or filed a timely Tax Court petition, among other acts.  The specifics of relief for this filing season are still being issued, but a clear signal has been by provided by both federal and state governments that relief is appropriate.

IRS Collection Consequences

As the scope of relief becomes clarified, taxpayers currently addressing IRS administrative collection actions will need to continue to review their current compliance obligations.  Relief in this critical time may provide an opportunity to “catch up” and make timely (with the extension) filings and tax payments.  The failure to be currently compliant removes eligibility for many taxpayers for Installment Agreements or Offers in Compromise, so this imminent relief may provide opportunities when taxpayers may not have other otherwise achieved compliance.

While our country works together to get through this crisis, the prompt relief may permit some taxpayers to worry about one less thing.  It is unclear whether the IRS will issue a type of Collection Moratorium, which it often does during December to permit some relief during the holidays.  In any event, the facts and circumstances of the world and the financial condition of taxpayers may be drastically different than they were last month.  Any Form 433-A (the IRS financial statement) that was prepared in recent months probably just became irrelevant.

I contacted the IRS Practitioner Hotline when writing this blog and noted that the anticipated wait time was only two minutes.  As you review each client’s situation, consider whether the temporary relief provides an opportunity for your client to get compliant.  Please note that the IRS call centers can be used in unexpected ways to help around the country as we respond to natural disasters, but there was no wait his morning.  As noted above though, they appear to currently be open for business.  This week, a Revenue Officer faxed a payment confirmation, so we knew that the IRS received and processed the payment in a timely manner.

We are still waiting to see the scope of other tax relief as the Senate mulls the House’s Coronavirus Response Act.  In the interim, consider the administrative relief noted above and see how you can immediately provide financial relief for your clients.

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

You could be forgiven for thinking that law enforcement officers have to identify the location to be searched accurately when asking a judge to sign a search warrant.  The Fifth Circuit decided on March 4, 2020, that missing the address by ½ and not even describing the actual premises to be searched, aren’t big enough problems to throw out evidence obtained during the search.

Robert Scully co-owned (with his nephew and a third man) and operated a frozen-meals business that imported shrimp from Thailand.  Scully and his nephew arranged for relatives to inspect shrimp in Thailand, paid the relatives, and then skimmed some of the inspection commissions and didn’t report the receipt of the skimmed commissions on his tax returns.  The third owner uncovered the skim and reported Scully to the authorities.

Seeking evidence of tax and wire fraud crimes, the IRS Special Agent prepared and submitted a search warrant for Scully’s house at 1015 East Cliff Drive in Santa Cruz, California.  The SA really wanted to search Scully’s home office, which wasn’t connected to the house but was instead a separate structure behind the house.  The search warrant was defective in two important (although apparently not that important) ways: (1) had the SA checked utility records or with the post office, he would have learned that the home office had a different address than the residence: 1015 ½ East Cliff Drive; and (2) although the SA knew that the home office was unconnected to the house and he had even checked satellite images of the property, the SA didn’t even include the home office within the “premises to be searched” in the search warrant.  It isn’t fair to put all of the blame on the SA for the second error, as the local U.S. Attorney’s Office reviewed the search warrant before submitting it to a Magistrate Judge, and the Magistrate Judge reviewed it before signing it.  The second problem was obvious from the face of the warrant, as the SA described the home office as well as its importance in his affidavit in support of the search warrant, yet neither the AUSAs nor the Magistrate Judge noticed that the warrant itself (frequently the only document that agents assisting in the search will read) failed to mention the home office.

Recognizing that including the wrong address on the search warrant and not even mentioning the home office were both problems, the government paid lip service to the argument that the warrant was accurate, but fell back on the “good faith” defense to search warrant errors.  This defense is designed to save searches that were done in good faith reliance on the warrant that a Magistrate Judge had signed.  Appellate law has a low bar for the government to clear: so long as the search didn’t involve a “deliberate, reckless, or grossly negligent violation,” any evidence seized in a later-invalidated warrant can still be admitted against a defendant.

Taking up the two errors in the warrant, the Court of Appeals brushed past the government’s argument that the warrant sufficiently described the premises – no surprise, given that the address was wrong and the warrant didn’t mention the home office that yielded the evidence at issue – and marshalled facts to show that the errors weren’t deliberate, reckless, or grossly negligent.  The saving grace appears to have been that the SA who signed the search warrant affidavit (and made the aforementioned mistakes) briefed his fellow agents and personally took part in the search, permitting him to guide his fellow agents to the home office, avoid another structure on the property that was rented to someone else, and ensure that agents searched the right premises.  Further, the affidavit described the home office, so there was little doubt that the Magistrate Judge actually found probable cause to search the home office; the defect was just in the warrant and not in the affidavit and the warrant, which presumably would have been more troubling for the Court.  Left unsaid is that the agents did, in fact, search the right premises.  If they had searched and seized evidence of a crime at the wrong premises, such as the additional structure on the property rented to a third party, then the result could have been different.  It’s hard to ignore the effect of hindsight in situations like this.

The decision also underscores that trimming, as opposed to expanding, an indictment in response to post-indictment knowledge, is generally acceptable.  Here, prosecutors learned through deposing witnesses in Thailand that an allegation in the Indictment was incorrect, and they superseded the Indictment to eliminate that allegation and charges against the nephew, who died while awaiting trial.  The Court focused on whether the defendant had been prejudiced, and found none. Additionally, and not surprisingly, the Court rejected the defendant’s Speedy Trial violation argument, noting that the vast majority of the years-long trial delay was due to the defendant’s requests for more time.

The overall takeaway from the case?  The Affiant for any search warrant should brief his or her fellow agents and participate in any search to blunt the effect of any errors in the warrant.  On the flip side, the absence of the Affiant should be highlighted by any defense counsel seeking suppression.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis is a principal at Hochman Salkin Toscher Perez PC.  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 of the where he handed civil and criminal tax cases and 11 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, the U.S. Attorney General awarded him the Distinguished Service 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. 

Mr. Davis represents individuals and closely held entities in 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 federal and state white-collar criminal investigations including campaign finance, FARA, money laundering, and health care fraud.

You could be forgiven for thinking that law enforcement officers have to identify the location to be searched accurately when asking a judge to sign a search warrant.  The Fifth Circuit decided on March 4, 2020, that missing the address by ½ and not even describing the actual premises to be searched, aren’t big enough problems to throw out evidence obtained during the search.

Robert Scully co-owned (with his nephew and a third man) and operated a frozen-meals business that imported shrimp from Thailand.  Scully and his nephew arranged for relatives to inspect shrimp in Thailand, paid the relatives, and then skimmed some of the inspection commissions and didn’t report the receipt of the skimmed commissions on his tax returns.  The third owner uncovered the skim and reported Scully to the authorities.

Seeking evidence of tax and wire fraud crimes, the IRS Special Agent prepared and submitted a search warrant for Scully’s house at 1015 East Cliff Drive in Santa Cruz, California.  The SA really wanted to search Scully’s home office, which wasn’t connected to the house but was instead a separate structure behind the house.  The search warrant was defective in two important (although apparently not that important) ways: (1) had the SA checked utility records or with the post office, he would have learned that the home office had a different address than the residence: 1015 ½ East Cliff Drive; and (2) although the SA knew that the home office was unconnected to the house and he had even checked satellite images of the property, the SA didn’t even include the home office within the “premises to be searched” in the search warrant.  It isn’t fair to put all of the blame on the SA for the second error, as the local U.S. Attorney’s Office reviewed the search warrant before submitting it to a Magistrate Judge, and the Magistrate Judge reviewed it before signing it.  The second problem was obvious from the face of the warrant, as the SA described the home office as well as its importance in his affidavit in support of the search warrant, yet neither the AUSAs nor the Magistrate Judge noticed that the warrant itself (frequently the only document that agents assisting in the search will read) failed to mention the home office.

Recognizing that including the wrong address on the search warrant and not even mentioning the home office were both problems, the government paid lip service to the argument that the warrant was accurate, but fell back on the “good faith” defense to search warrant errors.  This defense is designed to save searches that were done in good faith reliance on the warrant that a Magistrate Judge had signed.  Appellate law has a low bar for the government to clear: so long as the search didn’t involve a “deliberate, reckless, or grossly negligent violation,” any evidence seized in a later-invalidated warrant can still be admitted against a defendant.

Taking up the two errors in the warrant, the Court of Appeals brushed past the government’s argument that the warrant sufficiently described the premises – no surprise, given that the address was wrong and the warrant didn’t mention the home office that yielded the evidence at issue – and marshalled facts to show that the errors weren’t deliberate, reckless, or grossly negligent.  The saving grace appears to have been that the SA who signed the search warrant affidavit (and made the aforementioned mistakes) briefed his fellow agents and personally took part in the search, permitting him to guide his fellow agents to the home office, avoid another structure on the property that was rented to someone else, and ensure that agents searched the right premises.  Further, the affidavit described the home office, so there was little doubt that the Magistrate Judge actually found probable cause to search the home office; the defect was just in the warrant and not in the affidavit and the warrant, which presumably would have been more troubling for the Court.  Left unsaid is that the agents did, in fact, search the right premises.  If they had searched and seized evidence of a crime at the wrong premises, such as the additional structure on the property rented to a third party, then the result could have been different.  It’s hard to ignore the effect of hindsight in situations like this.

The decision also underscores that trimming, as opposed to expanding, an indictment in response to post-indictment knowledge, is generally acceptable.  Here, prosecutors learned through deposing witnesses in Thailand that an allegation in the Indictment was incorrect, and they superseded the Indictment to eliminate that allegation and charges against the nephew, who died while awaiting trial.  The Court focused on whether the defendant had been prejudiced, and found none. Additionally, and not surprisingly, the Court rejected the defendant’s Speedy Trial violation argument, noting that the vast majority of the years-long trial delay was due to the defendant’s requests for more time.

The overall takeaway from the case?  The Affiant for any search warrant should brief his or her fellow agents and participate in any search to blunt the effect of any errors in the warrant.  On the flip side, the absence of the Affiant should be highlighted by any defense counsel seeking suppression.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis is a principal at Hochman Salkin Toscher Perez PC.  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 of the where he handed civil and criminal tax cases and 11 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, the U.S. Attorney General awarded him the Distinguished Service 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. 

Mr. Davis represents individuals and closely held entities in 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 federal and state white-collar criminal investigations including campaign finance, FARA, money laundering, and health care fraud. 

Section 1501 of the Internal Revenue Code allows a parent corporation and its subsidiaries to file a consolidated return that effectively treats the consolidated group as one entity for tax purposes.  The IRS has issued detailed regulations concerning consolidated groups.  It has not issued any regulations on how refunds to a consolidated group are to be distributed among members of the group.  In 1973 the Ninth Circuit decided In re Bob Richards Chrysler-Plymouth, Inc., 473 F.2d 262, holding that absent a tax allocation agreement under federal common law the tax refund belongs to the group member responsible for generating the loss that resulted in the refund.

Western Bancorp, Inc., was the parent corporation of Western Bank Corporation.  When the bank faced financial difficulties, it was placed in receivership and the FDIC was appointed receiver.  Western Bancorp. filed a chapter 7 bankruptcy petition and Mr. Rodriquez was appointed chapter 7 trustee.  As a result of net operating losses generated by the bank, the IRS issued a $4 million refund.  This initiated a fight between the chapter 7 receiver and the FDIC over who was entitled to the refund.  The Tenth Circuit in In re United Western Bancorp, Inc., 914 F. 3d 1262, 1269–1270 (2019), adopted the Ninth Circuit’s rule and held that the FDIC, as receiver for the bank, was entitled to a refund.

Because the Sixth Circuit had rejected the Bob Richards rule, the U.S. Supreme Court decided to hear the case in order “to decide Bob Richards fate.”  In Rodriquez v FDIC, ___ U.S. ____ (Feb. 25, 2020), Justice Gorsuch, writing for a unanimous court, buried Bob Richards, holding that in the absence of a tax allocation agreement you look to state law, not federal common law.

According to the Court, “judicial lawmaking in the form of federal common law plays a necessarily modest role under a Constitution that rests the federal government’s ‘Legislative Powers’ in Congress and reserves most other regulatory authority to the States.”  Citing Erie R. Co. v. Tompkins, 304 US 692 (a938) for the proposition that there is “no federal general common law,” the Court stated that absent express Congressional authorization, federal common lawmaking must be used only when “necessary to protect uniquely federal interests.”  Since there was no unique federal interest in how a refund is allocated among members of a consolidated group once it is issued, the Court held that the issue must be decided under state law.

So who got the refund?  The Supreme Court didn’t make that decision.  Instead it remanded the case to the courts below “for further proceedings consistent with this opinion.”

There are a couple of points of interest.  First, the Solicitor General, arguing on behalf of the FDIC, conceded that federal common law should not have been applied but that under state law the FDIC should get the refund.

Second, in tax cases federal courts normally look to state law to determine property rights, so in that sense the decision was not a major departure.  The case itself may however be a preview of the Court’s retreat from expansive reading of the powers of the federal courts and, potentially, federal agencies.

Third:  The federal courts have developed a body of rules concerning tax cases, including the sham transaction doctrine, the economic substance doctrine, the substance-over-form doctrine, and the tax benefit rule. The application of these rules may sometimes reach results different than those that would be reached if state law was applied, such as disregarding a transaction as a sham that a state court would respect.  It is doubtful that the federal courts will revisit these rules in light of the Rodriquez case, but you may find taxpayers trying to argue that state law, and not “federal common law” should apply if it would result in more favorable treatment.

Query: Would the Court have reached a different decision if the IRS had issued a regulation on how a refund is allocated among members of a consolidated group, absent express authorization from Congress to make that determination?

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

The Internal Revenue Service (“IRS”)  took a major step in enhancing its criminal fraud referral program by announcing a national coordinator who will oversee fraud referrals from all of the operating divisions.  Damon Rowe, formally the Executive Director of International Operations for IRS Criminal Investigations and former Special Agent in Charge of the Los Angeles and Dallas Field offices, has been appointed the Director of the newly created Fraud Enforcement Office. Mr. Rowe will serve as the principal adviser and consultant to IRS Division Commissioners and Deputy Commissioner on all issues involving Fraud Enforcement strategic plans, programs and policy.  His  responsibilities will include overseeing the IRS’s entire fraud referral program and will coordinate among all of the operating divisions (Small Business Self-Employed, Large Business International and Tax Exempt Government Organizations) in order to make sure they are all focused on the potential  for fraud referrals and the importance of fraud referrals to overall tax compliance. Importantly for practitioners, IRS charged a seasoned and experienced former executive of Criminal Investigations to ensure that only the best cases and those with real criminal potential get referred over to Criminal Investigations for further investigation.

The appointment of  Mr. Rowe comes on the heels of last year’s appointment of Eric Hylton formerly Deputy Director of Criminal Investigations, to be the Commissioner of the Small Business Self-Employed Division. It reflects a continuing trend in the IRS tapping its best and brightest in order to make sure that all operation divisions are operating with common purpose – fair enforcement of the tax laws.

Steven Toscher is the Managing Principal of Hochman Salkin Toscher Perez P.C., where he has been specializing in civil and criminal tax litigation for more than 30 years.  He is a former Trial Attorney with the Tax Division of the U.S. Department of Justice. 

Sandra R. Brown is a principal at Hochman Salkin, Toscher Perez P.C., and specializes in representing individuals and organizations who are involved in criminal tax investigations, including related grand jury matters, court litigation and appeals, as well as representing and advising taxpayers involved in complex civil and criminal tax matters.  Prior to joining the firm, she was Acting U.S. Attorney for the Central District of California and Chief of the Tax Division in the U.S. Attorney’s Office.

I recently blogged on the Eleventh Circuit’s decision in In re Shek rejecting First, Fifth and Tenth Circuit precedent that a late return filed two years or more before bankruptcy is not discharged.  Today I am blogging on another recent bankruptcy case, In re Harold, 2020 WL 709866 (B. Ct. M.D. Mich. 2/12/2020), which addressed whether the debtor, Patricia Harold, attempted to evade or defeat tax, thus making otherwise dischargeable taxes not dischargeable under Bankruptcy Code §523(a)(1)(C).

The debtor was a successful obstetrician-gynecologist in Detroit.  She had a professional corporation that was a member of an LLC with another obstetrician-gynecologist.  She owed taxes for 2004-2012 and 2014.  The taxes for 2012 and 2014 were not dischargeable as priority taxes and the taxes for 2008 and 2010 were not dischargeable because the returns were filed late and less than two years before she filed for bankruptcy.  The question before the bankruptcy court was whether the taxes for the remaining years were not dischargeable under Bankruptcy Code 523(a)(1)(C).  That section provides that a tax is not discharged “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”

The case was complicated by its procedural posture: the IRS was the debtor’s largest creditor.  It had obtained orders that the Estate had no interest in the debtor’s residence and lifting the stay to allow it to bring a district court action to foreclose its tax liens.

The debtor’s husband had been convicted of bank and tax fraud and lost his CPA license.  They had a son and a daughter.  Her husband to handle all tax matters.  The debtor was the main income earner in the family.  During the years for which she did not pay tax her average gross receipts from her practice were more than $500,000 and her net income ranged between $170,000 and over $350,000.  Their returns for the years in issue were often filed late and the tax shown due was not paid.

The debtor and her husband entered into an installment agreement with the IRS that they defaulted on.  During this period the debtor and her husband maintained “a comfortable, even affluent, lifestyle.  They purchased a new home in 2005 under a land sale contract before they sold their existing home; they ended up making monthly mortgage payments on two homes until the bank foreclosed on the first home in 2009.  Devout Catholics, they sent their children to Catholic grade schools, high schools and universities and spent over $325,000 on their children’s private schooling while their tax obligations went unpaid.  They took a number of family vacations and personal trips, and leased “high-end” autos that cost between $600 and $800 a month, including Lexuses, Cadillacs and  Jaguar.

In 2016, the debtor filed a chapter 7 bankruptcy to deal with her tax debt.  While the bankruptcy and IRS foreclosure suit were pending, a client of the debtor’s husband “purchased” their home and purportedly leased it back to them.  The debtor admitted this was done to avoid foreclosure by the IRS. The debtor did not disclose this to her attorneys, the IRS, the district court or the bankruptcy court until after the IRS moved to appoint a receiver to sell the property.  At the trial in bankruptcy court, she could produce no lease agreements, rent checks or other documents supporting her claim that she and her husband were renting the property

The bankruptcy court was in the Sixth Circuit.  Beginning with In re Toti, 24 F. 3^rd 806 (1994), the Sixth Circuit developed a two-part test to determine whether a debtor attempted to evade or defeat tax.  The first part focuses on the debtor’s conduct: did the debtor engage in affirmative acts to avoid assessment or payment of tax.  The second part focused on mental state: did the debtor know of the duty to pay tax and voluntarily and intentionally violate that duty.  The mere failure to pay tax for a number of years was not enough to prove an attempt to evade or defeat.

The bankruptcy court held that the debtor attempted to evade or defeat tax.  The bankruptcy court found that the IRS proved the taxpayer engaged in affirmative acts to avoid payment of tax: she had a substantial income, yet consistently failed to pay the tax, instead spending large sums on non-discretionary items, including vacations, cars and her private schools for her children.  The IRS also proved the taxpayer had the requisite mental state: she knew she owed the tax but voluntarily and intentionally decided to pay substantial sums for non-discretionary items, including her children’s private schooling, rather than pay the tax and let her husband handle tax matters even though he had been convicted of tax fraud.  Finally, after filing for bankruptcy, she entered into the purported sale and lease back of her home to keep the IRS from foreclosing.

The Sixth Circuit conduct test focuses on the taxpayer’s lifestyle.  The Ninth Circuit in Hawkins v. FTB, 769 F. 3^rd 662 (9^th Cir. 2014), rejected the test used by the Sixth Circuit and other circuits and held that to prove an attempt to evade or defeat the taxing agency must show that the debtor acted with the specific intent to evade or defeat the tax and that profligate spending while knowing tax wasn’t paid was insufficient.  The Ninth Circuit distinguished cases decided by other circuits, noting that in each one the taxpayer engaged in conduct, such as transferring assets to nominees, that could support a finding of specific intent.  So while Dr. Harold’s spending on her kids’ schooling would not have been relevant, the sale and lease back transaction may have been sufficient in the Ninth Circuit to support a finding of an attempt to evade or defeat.

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.

On February 19, 2020, the IRS issued IR-2020-34, which states the IRS “will step up efforts to visit high-income taxpayers who in prior years have failed to timely file one or more of their tax returns.” If the Commissioner of Internal Revenue Charles P. Rettig was speaking, he might say that high income taxpayers who have failed to file their federal tax returns should not complain –they have been given fair warning.
In September of 2019, Eric Hylton, the former deputy chief of IRS Criminal Investigation Division, became the SBSE Commissioner. He recently announced that SBSE would use data analytics to identify high-income non-filers. This data analytics also can be used to identify tax preparers who promote false tax returns, as well as businesses with large amounts of unpaid employment taxes.
Hylton’s goal is to integrate CI division analytics to his new role in SBSE, and he hopes data analysts from CI can work with Revenue Agents and Revenue Officers to develop new techniques that SBSE will use in its enforcement.
In Fiscal Year 2018, the IRS identified 73.4 million taxpayers that failed to file a tax return, including 10.6 million individuals and 62.8 million businesses. For Tax Year 2016, the most recent year estimated by the IRS, delinquencies associated with non-filers were approximately $37.5 billion, fertile ground for the deployment of tax resources and that is what the recent announcement is about: “IRS revenue officers across the country will increase face-to-face visits with high-income taxpayers who haven’t filed tax returns in 2018 or previous years.”
Failure to file tax returns can have severe consequences. IRC § 6651(a)(1) imposes substantial additions to tax for a failure to file a tax return. Moreover, fraud referrals from the IRS Collection Division have been increasing. There are potential criminal consequences as well: IRC § 7203 makes it a misdemeanor to failure to file; if convicted, a taxpayer can be fined up to $25,000 ($100,000 for corporations) in fines and up to 1 year in prison. Under IRC §7201, a willful failure to file, combined with affirmative acts of evasion, could lead to a potential felony conviction for tax evasion, which can result in up to 5 years in prison.
Taxpayers who have failed to file a tax return should immediately consider taking advantage of the IRS’s Voluntary Disclosure practice. Taxpayers who qualify have the opportunity to cooperate with the IRS to get into tax compliance while avoiding criminal investigation and prosecution for the failure to file a tax return.
The IRS announcement indicates that Revenue Officers will be visiting high-income non-filers who generally received income in excess of $100,000 during the tax year—and do not be surprised—Revenue Officer visits are usually unannounced. Ask for identification and treat them with professional courtesy and respect, but also immediately contact a competent tax professional. It’s a serous matter.
Steven Toscher is the Managing Principal of Hochman Salkin Toscher Perez P.C., where he has been specializing in civil and criminal tax litigation for more than 30 years. He is former Trial Attorney with the Tax Division of the U.S. Department of Justice.
Gary Markarian is an associate at Hochman Salkin Toscher Perez P.C., and a recent graduate of the joint JD/LL.M. Taxation program at Loyola Law School, Los Angeles.