TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

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

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

FBAR OVERVIEW

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

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

FBAR PENALTIES

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

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

FORM 8938 OVERVIEW  

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

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

DELINQUENT FILING OPTIONS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

AGOSTINO & ASSOCIATES –To download a great article prepared by our very close friends at the Law Firm of Agostino & Associates in Hackensack, NJ ( http://www.agostinolaw.com ), see the Agostino & Associates Newsletter – http://files.constantcontact.com/f7d16a55201/ab897fa2-b252-47cc-ba92-138337eb9269.pdf

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

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

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

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

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

FOR THE FULL ARTICLE SEE http://files.constantcontact.com/f7d16a55201/ab897fa2-b252-47cc-ba92-138337eb9269.pdf

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

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

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

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

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

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

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

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

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

As filing season heats up, taxpayers and preparers need to be aware of the many foreign reporting requirements. There is a lot more to know than an FBAR and a box on Schedule B.  Failure to know and follow the rules can be costly.  Edward S. Flume, a U.S. citizen residing in Mexico, had ownership interests in two Mexican corporations, but failed to file Forms 5471 and was hit with $10,000 penalties for 9 years, including multiple $10,000 penalties for 2 years. Flume v. Commissioner, T.C. Memo. 2017-21.

Mr. Flume had a 50% ownership in one corporation, later reducing his interest to 9%. In a second corporation, he and his wife each owned 50%, but later claimed they each only owner 9% despite total control of a UBS account in the corporation’s name.  Backdated documents supporting their reduced ownership did help them.  Mr. Flume had a tax preparation firm in Mexico prepare his returns, but he failed to inform them of his corporations.

Mr. Flume timely filed his tax returns for the years at issue, but did not file Forms 5471. The IRS audited Mr. Flume’s ownership of foreign corporations and assessed penalties for failure to file Forms 5471 under IRC §6679(a) for one year, and under IRC §6038(b) for the remaining years.  Mr. Flume didn’t pay and the IRS issued a Notice of Intent to Levy.  Mr. Flume requested a CDP hearing challenging the underlying liability.  The IRS sustained the collection action and Mr. Flume petitioned the Tax Court.

Taxpayers are required to file Form 5471 if they fall into one or more of several categories. The Court discussed the legal requirements in detail as follows:

“Section 6038(a)(1) imposes information reporting requirements on any U.S. person, as defined in section 957(c), who controls a foreign corporation. A person controls a foreign corporation if he owns or constructively owns stock that is more than 50% of the total combined voting power of all classes of voting stock or owns more than 50% of the total value of shares of all classes of stock. Sec. 6038(e)(2). A U.S. person must furnish, with respect to any foreign corporation which that person controls, information that the Secretary may prescribe. Sec. 6038(a)(1). Form 5471 and the accompanying schedules are used to satisfy the section 6038 reporting requirements. The Form 5471 must be filed with the U.S. person’s timely filed Federal income tax return. Sec. 1.6038-2(i), Income Tax Regs.

Additionally, the information reporting requirements prescribed in section 6038(a)(1) also are imposed on any U.S. person treated as a U.S. shareholder of a corporation that was a CFC for an uninterrupted period of 30 days during its annual accounting period and who owned stock in the CFC on the last day of the CFC’s annual accounting period. Secs. 951(a)(1), (b), 6038(a)(4); see also Rev. Proc. 92-70, sec. 2, 1992-2 C.B. 435, 436. A U.S. shareholder, with respect to any foreign corporation, is a U.S. person who owns under section 958(a), or is considered as owning under section 958(b), 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. Sec. 951(b).

Section 6046 requires information reporting by each U.S. citizen or resident who is at any time an officer or director of a foreign corporation, where more than 10% (by vote or value) of stock is owned by a U.S. person. Sec.6046(a)(1)(A). The stock ownership threshold is met if a U.S. person owns 10% or more of the total value of the foreign corporation’s stock or 10% or more of the total combined voting power of all classes of stock with voting rights. Sec. 6046(a)(2). A U.S. person who disposes of sufficient stock in the foreign corporation to reduce his interest to less than the stock ownership requirement is required to provide certain information with respect to the foreign corporation.  Sec. 1.6046-1(c)(1)(ii)(c), Income Tax Regs.”

The penalties for failing to timely file a Form 5471 are $10,000 per corporation per annual accounting period. If notified by the IRS of the failure, additional penalties of up to $50,000 can apply.

Mr. Flume was required to file Form 5471 for various reasons depending on the year. To avoid the penalty a taxpayer must demonstrate reasonable cause.  As the Court points out, there are no regulations defining reasonable cause in the Form 5471 context, but court cases have generally required a taxpayer to demonstrate that he exercised ordinary business care and prudence, but was unable to file within the required time. United States v. Boyle, 469 U.S. 241, 246 (1985).  A taxpayer can also demonstrate reasonable cause by relying on his tax adviser.  The taxpayer must show that the adviser was competent, the taxpayer provided necessary and accurate information, and that he actually relied in good faith on the advice.

Mr. Flume argued that his preparer failed to advise him to the Form 5471 requirement. The only problem for Mr. Flume was that he didn’t inform his preparer that he had foreign corporations until one of the later years at issue.

Although this case is a Form 5471 case, there are lessons to be learned for all foreign reporting issues. The relationship between a taxpayer and his or her tax preparer is crucial.  If you do not tell your preparer about your foreign assets, you can’t expect proper reporting, and if hit with penalties you can’t rely on the advice not given.  As foreign penalties go, Form 5471 penalties are relatively low at $10,000 per corporation, per year.  Other penalties can be much more severe.

In an interesting footnote, the Court asked the parties to address the whether there were any prohibited ex parte communications between the IRS Office of Appeals and the originating function. Petitioner failed to address the issue and therefore is deemed to have conceded it.  In a CDP context, taxpayers should always make sure that the ex parte rules are followed and that any communication between the Settlement Officer and the Revenue Agent, for example, include you or your representative.

JONAHAN KALINSKI specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world.  He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.

Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters.  Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters.  Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.

Among other research tools available to taxpayers and practitioners, the Tax Court’s website is a valuable resource for those researching tax issues and can be particularly helpful for those preparing for a case before the Tax Court. The following is a guide to some of the resources available to the public on the Tax Court’s website: http://www.ustaxcourt.gov.

Opinion Search.[i]  Although Tax Court opinions are widely available on various subscription-based services, taxpayers and practitioners can access TC Opinions and Memorandum Opinions dating back to September 25, 1995, for free on the Tax Court website.  The Tax Court’s Opinion Search feature allows users to search for opinions by: (1) date; (2) petitioner’s name or a case name keyword; (3) judge; (4) type of opinion; and (5) a text search of the body of the opinion.  The default number of search results is set to 5, but can be changed to “All” so that the search returns all opinions that meet the search criteria.  This is a particularly convenient way to search for opinions written by the current Tax Court judges.

Orders Search.[ii]  Past pretrial orders issued by a judge can be a valuable tool for practitioners dealing with various trial and pretrial issues, including discovery disputes and questions regarding the admissibility of evidence.  While these issues are sometimes addressed in a TC Opinion or a Memorandum Opinion, they are often disposed of in a pretrial order by the judge.  Although under Rule 50(f) of the Tax Court Rules of Practice and Procedure these orders cannot be cited as precedent, the Orders Search feature can give taxpayers and practitioners the opportunity to gain insight into how a particular judge rules on various pretrial issues that may be relevant to their pending case.  These orders are not readily available outside of the Tax Court website and the Tax Court website makes it easy to search the orders, with similar search criteria to the Opinions Search page.

Docket Inquiry.[iii]  If there is a particular Tax Court case a taxpayer or practitioner is interested in, the Tax Court website features a Docket Inquiry, which allows users to look up a docket by docket number or by party name.  The Docket Inquiry page for a case shows the attorney information for each party, lists all of the filings in a case, and allows the user to view orders, opinions, and decisions the Court has filed in the case.  This feature is more limited than docket inquiry searches available for Federal district court cases through pacer.gov, because briefs and other filings by parties are not available electronically to the public for Tax Court cases.

eFiling Rules and Instructions.[iv]  In addition to providing the full Tax Court Rules of Practice and Procedure[v] and background information about how to start a Tax Court case[vi], the Tax Court website also separately publishes a Practitioners’ Guide to Electronic Case Access and Filing[vii], which provides specific rules, instructions, and other guidance to taxpayers and practitioners about eFiling in a Tax Court case.  In the Tax Court, electronic filing (eFiling) is now mandatory for most parties represented by counsel (except for the initial petition, which currently must be filed in paper form) and is available, but not required, for pro se taxpayers through Petitioner Access.  In addition to providing basic background information about how to get started with eFiling, the Practitioner’s Guide provides rules and guidance on issues including good cause exception to eFiling, what documents may be eFiled, timeliness of eFiled documents, format and style of documents, service of eFiled document, how to handle errors made in eFiling documents, and also provides a checklist for eFiling and detailed eFiling Instructions.  Even if a practitioner understands how the eFiling system works, it is important for a practitioner to still be familiar with the Practitioner’s Guide because it contains specific rules pertaining to eFiled documents that are not included in the Tax Court’s Rules of Practice and Procedure.

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

[i] The direct link to the Opinions Search page is: http://www.ustaxcourt.gov/USTCInOP/OpinionSearch.aspx

[ii] The direct link to the Orders Search page is: http://www.ustaxcourt.gov/InternetOrders

[iii] The direct link to the Docket Inquiry page is: http://www.ustaxcourt.gov/docket.htm

[iv] General information about the Tax Court’s eAccess and eFiling procedures are available here: http://www.ustaxcourt.gov/electronic_access.htm

[v] The Tax Court Rules of Practice and Procedure are available here: http://www.ustaxcourt.gov/rules.htm

[vi] The Tax Court website includes a “Taxpayer Information” section (http://www.ustaxcourt.gov/taxpayer_info_intro.htm) that provides information on how to file a petition to begin a Tax Court case and an overview of how the Tax Court process works.  The Tax Court also provides information about fees (http://www.ustaxcourt.gov/fees.htm) and sample forms for certain filings (http://www.ustaxcourt.gov/forms.htm).

[vii] The direct link to the Practitioner’s Guide to Electronic Case Access and Filing is: http://www.ustaxcourt.gov/eaccess/Practitioners_Guide_to_eAccess_and_eFiling.pdf

Second Circuit Holds Justice Department’s Feet to the Fire to Prove the Fifth Amendment Doesn’t Apply in Two Cases

There is no Fifth Amendment protection for the content of most records, but the act of producing records is protected by the Fifth Amendment if the government could use the fact of a taxpayer having produced documents against her.  For example, if a sole proprietor kept two sets of books – one showing “real” revenue and another showing less revenue that he used to prepare tax returns – the books themselves would not be protected by the sole proprietor’s Fifth Amendment rights.  However, if the government subpoenaed all books and records from the sole proprietor, he could assert his Fifth Amendment rights against producing the books and records because the act of producing the books would incriminate him.  How?  By confirming that he knew there were two sets of books, and that the books being turned over were for his business as opposed to someone else’s business.  An experienced lawyer representing the sole proprietor would likely be successful at asserting a Fifth Amendment defense to producing records to the IRS and Department of Justice (“DOJ”).

The IRS and DOJ may counter with one of three common exceptions to this act-of-production privilege: (1) “collective entities” such as corporations don’t have Fifth Amendment rights, so the IRS could try to subpoena a corporation, trust, or LLC to designate a custodian and produce documents without regard to possible incrimination of the entity or its members; (2) if the subpoenaed records, such as certain foreign banking records, are required by law to be kept (aka the “required records exception”), then the government may successfully force a taxpayer to turn over records even if the act of producing incriminates the taxpayer; and (3) if the government already knows that the taxpayer has the records, then her production of documents isn’t incriminating because her possession thereof is a “foregone conclusion.”

In August 2016, the Second Circuit Court of Appeals shot down the DOJ and IRS’s attempt to use the foregone conclusion exception to the act-of-production privilege. In United States v. Greenfield, 831 F3d 406 (2d Cir. 2016), the Court noted that an employee of a Liechtenstein bank had leaked bank documents in 2008 showing that clients, including Mr. Greenfield, appeared to have had foreign bank accounts in 2001.  In 2013, acting on the leaked documents, the IRS subpoenaed the taxpayers to produce foreign bank records, and the taxpayer’s lawyers responded by claiming the act-of-production privilege.  After the district court ruled against the taxpayers, the Second Circuit reversed the district court’s decision and held that the fact that the taxpayers may have had documents ten years before the subpoena, is insufficient for the government to meet its burden to show (a) the documents still exist, (b) they are authentic without having to rely on the taxpayer to authenticate them, and (c) they have remained in the taxpayer’s possession.  The Second Circuit noted that generally the government has met its burden in cases involving much shorter periods – weeks or months – and events such as the death of the family patriarch here made it likely that the documents would have been destroyed.  The appellate court went out of its way to explain how continued possession of documents could be incriminatory, and that two years was too long to assume that a taxpayer would keep important documents such as expired passports.  Although the Second Circuit asserted that it was thoroughly analyzing the case so as to give the government a roadmap to strengthen its evidence and then serve another summons, in reality it will be very difficult for the government to overcome the hurdles that the Second Circuit erected without finding an eyewitness who recently saw the documents.

Proving Greenfield was no fluke, last week the Second Circuit reversed a district court’s order compelling a taxpayer to turn over records and testify about them.  In United States v. Fridman, 2016 TNT 240-13, the district court had found all three exceptions applied to the IRS subpoena issued to the taxpayer’s trust, for records of foreign bank accounts. The Second Circuit wasn’t satisfied with the district court’s unsupported conclusions, noting the district court hadn’t explained why any of those exceptions applied to particular documents.  The appellate court sent the case back to the district court to explain in detail – if it could – which exception applied and to which documents.

The cases reinforce why lawyers should press the government to show how it has met its heavy burden to prove an exception to the Fifth Amendment’s act-of-production protection.

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

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

The Tax Court issued a reminder that a partner’s distributive share of partnership income is taxable to the partner even if he never actually receives money.[1]  Also, ignoring your tax professional’s advice does not constitute “reasonable cause”.

Walter Mack, a partner at a New York law firm received a K-1 showing his distributive share of income as $479,743.[2]  He reported $75,000 as income, claiming that under New York State law he was required to use the rest to pay his firm’s expenses in an effort to keep the firm from going out of business.[3]

Mr. Mack’s position was that because of the 2008 recession, other partners could not cover the firm’s expenses so he needed to step in. Mr. Mack sought the advice of tax professionals who advised him that although the tax law might be unfair, he needed to report his entire distributive share as income.  He decided to ignore their advice and “face the consequences”.[4]  He prepared his own return and reported a total of $75,000 from his firm.

Not surprisingly, the IRS audited Mr. Mack and issued a Notice of Deficiency, adding an accuracy-related penalty to the unreported income. The IRS filed for summary judgment and the Court granted the motion.  Summary judgment is not used in Tax Court nearly as much as state courts or Federal District Courts, and is usually seen in Collection Due Process cases.  This case shows that it can be used effectively in a deficiency case, where the facts are not really in dispute.

The result in this case is obvious, but a reminder that income does not have to actually be received to be taxable. The Court notes that Mr. Mack’s did not allege that his firm failed to claim expenses, which would have reduced its income and therefore his distributive share.  It also points out that if Mr. Mack’s putting his share back into the firm was a capital contribution, that it is not deductible.

This case also highlights that ability to pay is not a winning argument in a deficiency case. That might be an argument raised with a revenue agent or appeals officer in the hopes that they will choose to settle the case, but the Tax Court will not consider it.  Ability to pay is of course an argument for collections and could come before the Court through a Collection Due Process case.

Finally, to no one’s surprise, the Court held the Macks liable for the accuracy-related penalty. The opinion puts it perfectly.

“Mr. Mack admits that tax professionals explained to him that the tax law required him (albeit “unfairly”, they said) to report his share of the partnership income (and advised him to dissolve the firm in order to stay in compliance with his own tax obligations), and that he disregarded their advice and affirmatively decided not to do so but instead to “face the consequence”. The accuracy-related penalty is now part of that consequence.”

JONATHAN KALINSKI specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world.  He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.

Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters.  Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters.  Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.

[1] Mack v. Commissioner, T.C. Memo. 2016-229.

[2] Id.

[3] Id.

[4] Id.