Government Pursues FBAR Penalty in Civil Case

In United States v. McBride (D. Utah No. 2:09-cv-378-DB-BCW), the Government seeks to enforce civil penalty for failure to file FBARs for 2000 and 2001. The amount sought is the maximum under prior law ($100,000 per year). The defendant participated in an offshore scam orchestrated by Merrill Scott and Associates ("Merrill Scott"). (For more on Merrill Scott, see here and here. Suffice it to say for present purposes that it involved offshore entities and offshore banks.

The Government has filed motion for summary judgment. The memorandum in support of the motion is here, the complaint is here and Dennis Brager's discussion of the case is here. The Government's motion appears strong (at least if it is a fair statement of both the summary judgment evidence and the case itself); the defendant appears destined to lose even if he survives a motion for summary judgment. (Cf the Williams case discussed here.)  I thought readers of this blog might be most interested in the Government's statement of the willfully standard for the maximum FBAR penalty which is now up to 50% of the highest amount in the account for each year. The Government argues that the willfully standard in the FBAR civil penalty is not the same as willfully standard in the criminal tax statutes (interpreted in Cheek to require the intentional violation of a known legal duty). Rather, the Government argues that a lesser standard applies in civil cases and argues, protectively, that even were the Cheek standard to apply, it is met here for purposes of summary judgment. Here is the Government's discussion (pp. 18-20 of the Memorandum).

6. McBride’s failure to disclose the Accounts was willful


As it existed prior to an amendment that took effect in 2004, Section 5321(a)(5) authorized penalties against taxpayers who “willfully” violated Section 5314. “’[W]illfully’ is a ‘word of many meanings whose construction is often dependent on the context in which it appears.’” Safeco Ins. Co. of America v. Burr, 551 U.S. 47, 57 (2004) (quoting Bryan v. United States, 524 U.S. 184, 191 (1998)). In Ratzlaf v. United States, 510 U.S. 135 (1994), while interpreting the intent required for a criminal conviction under 31 U.S.C. § 5324, the United States Supreme Court noted that the test for “willfulness” in the context of criminal violations of Section 5314 is a “’“voluntary, intentional violation of a known legal duty.”’” Ratzlaf, 510 U.S. at 142 (quoting United States v. Sturman, 951 F.2d 1466, 1476 (6th Cir. 1991) (quoting Cheek v. United States, 498 U.S. 192, 201 (1991))). However, the test for “willfulness” set forth in Cheek is explicitly tied to the imposition of criminal, rather than civil, penalties. See Cheek, 498 U.S. at 199-2001. Accordingly, the the test for “willfulness” set forth in Cheek, and discussed in Ratzlaf, is inapplicable to civil cases.

When the term “willful” or “willfully” has been used in a criminal statute, we have regularly read the modifier as limiting liability to knowing violations. This reading of the term, however, is tailored to the criminal law, where it is characteristically used to require a criminal intent beyond the purpose otherwise required for guilt or an additional “bad purpose,” or specific intent to violate a known legal duty created by highly technical statutes. Thus we have consistently held that a defendant cannot harbor such criminal intent unless he “acted with knowledge that his conduct was unlawful.” Civil use of the term, however, typically presents neither the textual nor the substantive reasons for pegging the threshold of liability at knowledge of wrongdoing.

Safeco, 551 U.S. at 57, n.9 (citations and quotations omitted); see also Denbo v. United States, 988 F.2d 1029, 1034-35 (10th Cir. 1993). The civil standard for willfulness is satisfied where the individual at issue acts “voluntarily in withholding requested information, rather than accidentally or unconsciously,” Lefcourt v. United States, 125 F.3d 79, 83 (2d Cir. 1997), or in reckless disregard of statutory duty. Safeco, 551 U.S. at 57. Here, it is beyond dispute that McBride was aware of the FBAR reporting requirement, see SOF ¶¶ 6, 24, 25, 32, and that he nevertheless affirmatively denied having an interest in any reportable foreign account in his Individual Income Tax Returns for 2000 and 2001. See SOF ¶ 26. These facts are sufficient to satisfy the civil standard for willfulness.

Even if it is assumed for the sake of argument that the criminal standard for willfulness applies, that standard is satisfied here. The criminal standard for willfulness is satisfied where the individual at issue is aware of the reporting requirement, but, for any reason, deliberately evades it. See United States v. Tatoyan, 474 F.3d 1174, 1179 (9th Cir. 2007) (evidence at trial was sufficient to support conviction for willful violation of the currency reporting requirement where defendants “knew they were required to file a report and that, for whatever reason, they deliberately evaded this requirement.”); see also Ratzlaf, 510 U.S. at 154 n.5 (Blackmun, J., dissenting) (under, inter alia, Section 5314, knowledge of the reporting requirement necessarily entails knowledge that the failure to report is illegal). Criminal willfulness may also “be proven through inference from conduct meant to conceal or mislead sources of income or other financial information.” Sturman, 951 F.2d at 1476-77; see also United States v. Dashney, 117 F.3d 1197, 1203 (10th Cir. 1997) (“[I]n the structuring context, ‘proof of concealment tends to prove knowledge of illegality.’”) (quoting United States v. Marder, 48 F.3d 564, 574 (1st Cir. 1995)). This standard is satisfied here as a matter of law. It is beyond dispute that in 2000 and 2001 McBride was aware of the FBAR reporting requirement, see SOF ¶¶ 6, 24, 25, 32, and that he nevertheless affirmatively denied having an interest in any reportable foreign account in his Individual Income Tax Returns for 2000 and 2001. See SOF ¶ 26. Moreover, McBride concealed his involvement in offshore activities from the individuals who prepared his Individual Income Tax Returns for 2000 and 2001. See SOF ¶¶ 27, 28. And when McBride was approached by the Internal Revenue Service and questioned regarding his offshore activities, he was not truthful. See SOF ¶¶ 29, 30, 31, 33. Finally, and perhaps most importantly, the entire Merrill Scott program which McBride purchased for $75,000 was primarily designed to help McBride avoid income tax by concealing the Clip Company’s true revenues in offshore shell-companies funded through kickbacks paid by the Clip Company’s manufacturer in Taiwan, while making those revenues available to McBride through, inter alia, phony loans. See SOF ¶¶ 5, 7, 9, 11, 13, 14. These undisputed facts are sufficient to demonstrate willfulness under either the civil or criminal standard.

Update on Fidelity International Advisor Currency Fund A

I previously blogged three times on the Fidelity International Advisor Currency Fund A case. The principal blog is titled "Judge Finds Ambassador's Tax Shelter Transactions Bullshit (Actually Worse Than That)." The other two blogs with peripheral issues are here and here. The Judge amended his opinion on October 6, 2010 (see here). The amendments do not change the good judge's scathing attack on the behavior of the parties involved.  Rather, the amendments deal principally with the penalty aspect of the opinion. Bottom line, in this TEFRA case proceeding, the good judge attempts to box the ultimate taxpayer in on the penalties to the extent the good judge possibly can. I include the significant new or revised excerpts below, even at the risk of boring the readers with TEFRA-speak. For some this might be boring, but note the skill with which the good judge weaves the web from which there may be no escape:

IV. Conclusions of Law

* * * *

G. Accuracy-Related Penalties

* * * *

61a. A partner's "outside basis" is the partner's basis in his or her partnership interest, A partnership's "inside basis" is the partnership's basis in its own property.
61b. In general, a partner's outside basis in a partnership is not a partnership item. Jade Trading, LLC v. United States, 598 F.3d 1372, 1379-80 (Fed. Cir. 2010). The partnership's inside basis is, however, a partnership item. Stobie Creek Investments LLC v. United States, 608 F.3d 1366, 1380 (Fed. Cir. 2010).
61c. Adjustments made pursuant to an election under 26 U.S.C. § 754 are also partnership items. Id.
61 d. This Court lacks jurisdiction over the imposition of a penalty in this partnership-level to the [*429] extent the penalty relates solely to outside basis. Jade Trading, 598 F.3d at 1379-80; Petaluma Fx Partners, LLC v. Comm'r, 591 F.3d 649, 655, 389 U.S. App. D.C. 64 (D.C. Cir. 2010). However, the Court has jurisdiction over the imposition of penalties relating to misstatements of inside basis and other inaccuracies relating to partnership items.
61e. Because partnerships do not pay income taxes, the actual calculation and imposition of any penalty is determined at a partner-level proceeding. This Court nonetheless has jurisdiction to determine the "applicability" of such a penalty in this proceeding. 26 U.S.C. § 6226(f).

* * * *
68a. Plaintiffs do not contest that this Court has jurisdiction to determine whether a valuation misstatement occurred with regard to the Fidelity High Tech transaction, and thus whether a valuation misstatement penalty applies.
68b. Here, the value or adjusted basis of property claimed on the 2001 and 2002 Fidelity High Tech partnership tax returns is 400% more than the correct amount of such value or adjusted basis.
68c. The "gross valuation misstatement" penalty of 26 U.S.C. § 6662(a), (b)(3), and (h) therefore applies as to the Fidelity High Tech transaction.
68d. Plaintiffs do, however, contest whether this Court has jurisdiction to determine whether a valuation misstatement occurred with regard to the Fidelity International transaction, and thus whether a valuation misstatement penalty applies. In substance, plaintiffs contend that any valuation misstatement as to Fidelity International concerned outside basis, not the partnership's inside basis, and is therefore not a partnership item.
68e. For the reasons set forth below, the Court concludes that the valuation misstatement as to the Fidelity International transaction occurred at the partnership level, and therefore it has jurisdiction over the applicability of any penalty related to that item.
68f. The assets of Fidelity International included both interest rate options that were contributed to the partnership and foreign currency options that the partnership itself purchased and sold. Fidelity International claimed losses in 2001 and 2002 that were generated by the disposition of those assets.
68g. Whether a partnership incurred a gain or a loss is a partnership item. Treas. Reg. § 301.6231(a)(3)-1(a)(1)(i). In order to ascertain whether a partnership incurred a gain or a loss from the disposition of its assets requires that the partnership must calculate its basis in those assets (that is, the inside basis). As noted, that inside basis is a partnership item.
68h. Fidelity International's reported losses were based in part on foreign currency options that were acquired and sold within the partnership. The partnership's calculation of basis for those options, and any gain or loss resulting from [*433] the sales, are partnership items.
68i. Fidelity International's reported losses were also based in part on interest rate options that were contributed to the partnership. The partnership necessarily used the basis of those options (that is, the inside basis) in determining whether the partnership sustained a gain or a loss. Again, the partnership's calculation of basis for those options, and any gain or loss resulting from the sales, are partnership items. See Treas. Reg. § 301.6231(a)(3)-1(c)(2) (the basis of contributed property is a partnership item); Stobie Creek, 608 F.3d at 1380.
68j. The partnership returns (Forms 1065) therefore contained valuation misstatements with respect to inside basis.
68k. Alternatively, the Fidelity International transaction lacked economic substance, and should be disregarded. The basis of a disregarded asset is zero. A valuation misstatement is thus inherent in the Fidelity International transaction as reported on the partnership returns. The overvalued basis was an integral part of the transaction, and the valuation misstatement thus bore a direct relationship to the underpayment of tax.
681. Here, the value or adjusted basis of property claimed on the [*434] 2001 and 2002 Fidelity International partnership tax returns is 400% more than the correct amount of such value or adjusted basis. See Treas. Reg. § 1.6662-5(g) ("the value or adjusted basis claimed on a return of any property with a correct value or adjusted basis of zero is considered to be 400 per cent or more of the correct amount.").
68m. The "gross valuation misstatement" penalty of 26 U.S.C. § 6662(a), (b)(3), and (h) therefore applies as to the Fidelity International transaction.
* * * *
69a. Here, the value or adjusted basis of property claimed on the partnership tax returns at issue is 200% more than the correct amount of such value or adjusted basis.
69b. The "substantial valuation misstatement" penalty of 26 U.S.C. § 6662(a) and (b)(3) therefore applies.
* * * *
71a. Here, as a result of the misstatements at the partnership level, the correct income tax of Richard Egan for the relevant years exceeded the reported tax by more than $5,000 and more than 10% of the tax required to be shown on the return.
71b. The "substantial understatement" penalty of 26 U.S.C. § 6662(a), (b)(2), and (d)(2)(A) therefore applies.
* * * *
86a. Here, Richard Egan did not report or pay the correct income tax for the relevant years because of negligence and disregard of rules and [*442] regulations as to the preparation and filing of the Fidelity High Tech and Fidelity International partnership tax returns for 2001 and 2002.
86b. The "negligence or disregard of rules or regulations" penalty of 26 U.S.C. § 6662(a) and (b)(1) therefore applies.
* * * *
92a. Here, to the extent that the matter is appropriately raised at the partnership level, there was no reasonable cause for any portion of any understatement of the income tax liability of Richard Egan with [*446] respect to his participation in the Fidelity High Tech and Fidelity International transactions, and Richard Egan did not act in good faith with respect to those transactions.

V. Summary of Factual Conclusions

* * * *

C. Penalty Issues

* * * *

9. The Fidelity High Tech and Fidelity International partnership tax returns for 2001 and 2002 contained gross valuation misstatements within the meaning of 26 U.S.C. § 6662(a), (b)(3), and (h), and the 40% penalty for such misstatements is therefore applicable to any understatement of income tax liability of Richard Egan arising out of those misstatements.
10. The Fidelity High Tech and Fidelity International partnership tax returns for 2001 and 2002 contained substantial valuation misstatements within the meaning of 26 U.S.C. § 6662(a) and (b)(3), and the 20% penalty for such misstatements is therefore applicable to any understatement of income tax liability of Richard Egan arising out of those misstatements.
11. As a result of misstatements on the Fidelity High Tech and Fidelity International partnership tax returns for 2001 and 2002, the correct income tax of Richard Egan exceeded the reported tax by more than $5,000 and [*451] more than 10% of the tax required to be shown on the return, and the 20% penalty for substantial understatement under 26 U.S.C. § 6662(a), (b)(2), and (d)(2)(A) is therefore applicable.
12. As a result of negligence and disregard of rules and regulations as to the preparation and filing of the Fidelity High Tech and Fidelity International partnership tax returns for 2001 and 2002, the correct income tax of Richard Egan was not reported or paid in the relevant years, and the 20% penalty for negligence or disregard of rules and regulations under 26 U.S.C. § 6662(a) and (b)(1) is therefore applicable.

VI. Conclusion

6. The following accuracy-related penalties are applicable to any understatement of the income tax liability of Richard Egan arising from the treatment of the Fidelity High Tech and Fidelity International transactions on the tax returns of those entities for the years 2001 and 2002.

a. a 40% penalty for gross valuation misstatement pursuant to § 6662(a), (b)(3), and (h);
b. a 20% penalty for substantial valuation misstatement pursuant to § 6662(a) and (b)(3);
c. a 20% penalty for substantial understatement of income tax pursuant to § 6662(a), (b)(2), and (d)(2)(A); and
d. a 20% penalty for negligence or disregard of rules and regulations pursuant to § 6662(a) and (b)(1).

Practitioner Experience with No Answers to the FBAR Question on Form 1040

Daniel Gottfried posted an article titled Proving Willfulness in FBAR Reporting – Checking “No” Ain’t Apropos. The article is reprinted also in Tax Notes at Tax Notes, Sept. 27, 2010, p. 1394; 128 Tax Notes 1394 (Sept. 27, 2010) and in Tax Notes at 2010 TNT 188-14.

The article presents the results of a survey of practitioners who assist U.S. taxpayer clients in making voluntary disclosures of foreign bank accounts as they relate to the U.S. income and estate tax obligations and the FBAR filing requirements.

The article relies upon considerable anecdotal experience of the survey participants to conclude that answering no to the FBAR question on Schedule B of the 1040 (or failing to answer it) is not persuasive evidence that the taxpayer knew of his or her obligation to file the FBAR. The truly draconian FBAR penalties require that the taxpayer know of the legal duty to file the FBAR and intend to fail to file the FBAR. That standard is practically the same as the willfulness standard for the commonly charged tax crimes, although the burden of proof would be lesser in a civil penalty case than in a criminal case and, as a consequence, there may be some relaxation of the articulation of the standard.

The difficulty of making an FBAR civil penalty case is shown in the recent case of United States v. Williams, Civil Action No. 1:09-cv-437 (E.D. Va., Sept. 1, 2010), which I blogged here. Williams indicates that the Government will have to place on strong evidence for the taxpayer's specific knowledge of the obligation and intent to fail to file. Williams certainly suggests that an even stronger case would be required for the criminal FBAR penalty.

Gottfried's survey and article and the Williams case suggest that taxpayers in the voluntary disclosure program should at least consider the opportunity to opt out and take their lumps under the standard FBAR civil penalty regime which, if consistently applied, may produce FBAR penalties less than the prescribed penalty under the voluntary disclosure program. Of course, when the income tax penalties are considered on an opt out, the taxpayer may have some difficulty avoiding the 20% accuracy related penalty because the IRS will consider most of them to be at least negligent. But it is doubtful that the Government would be able to establish civil fraud in many of these cases, so the income tax civil penalty should be a push at worst from the perspective of taxpayers having the facts that would motivate them to opt out of the settlement program civil penalty regime.

Government Fails to Prove Willfulness in FBAR Civil Case

In Williams v. United States (EDVA Civil Action No. 1:09-cv-437, decision dated 9/1/10), the court declined to find willfulness.

The opinion is relatively short, so I won't rehash the opinion. Some significant facts from the case are:

1. "Between 1993 and 2000 Williams deposited more than $7,000,000 in assets in the accounts, earning more than $800,000 in income over that period."

2. During the year in issue (2000, for which the FBAR was due 6/30/01), the Swiss were focusing on the accounts perhaps at the request of the U.S., the Swiss interviewed Williams about the accounts, the Swiss froze the accounts at the request of the U.S. and the U.S. was aware of the accounts (it is not stated whether that request was a tax driven request or some other law enforcement imperative request.) (The timing of some of these events were disputed by the Government, but the district judge would have none of that.)

3. On his 2000 1040, Williams failed to include the income from the accounts and, on Schedule B, failed to check the FBAR question.

4. Williams failed to file the FBAR by June 30, 2001.

5. Williams' lawyers and accountants had advised him of the requirement to file the FBAR.

6. The Government had not proved that Williams willfully failed to file the 2000 FBAR.

7. "On October 15, 2002, Williams disclosed the accounts by filing his income tax return for the tax year 2001."

8. On February 2003, Williams disclosed the accounts pursuant to an earlier version of the offshore voluntary account program (the OVCI program).

9. "On June 12, 2003, Williams pleaded guilty to one count of conspiracy to defraud the United States and to one count of criminal tax evasion in connection with funds held in the Swiss bank accounts during the years 1993 through 2000." (Apparently, Williams' attempt at voluntary disclosure did not work, presumably because the disclosure was not timely.)

10. "On January 18, 2007, Williams filed the TDF 90-22.1 form for all years going back to 1993, including tax year 2000."

The key legal holdings are:

1. The legal review standard is de novo, in which the Government must prove willfulness -- in this context the intent to violate a known legal duty.

2. The maximum penalty for the willful violation then was $100,000.

3. The court found on the facts presented that the Government had not proved that the defendant knew the legal duty in question. The Court reasoned:

In this case, the Government has failed to prove a "willful" violation. The Court finds that the Government's case does not adequately account for the difference between failing and willfully failing to disclose an interest in a foreign bank account. n5  Further, the Government fails to differentiate tax evasion from failing to check the box admitting the existence of a foreign bank account.
n5. It is worth noting that Congress has since amended 31 U.S.C. § 5321 to allow the government to assess a civil penalty for FBAR violations regardless of whether the violation is willful. See 31 U.S.C. § 5321(a)(5), as amended by P.L. 108-357. Further, the statute now provides a "reasonable cause" exception. See 31 U.S.C. § 5321(a)(5)(B)(ii). While the issue of Williams' liability under the statute as amended is not before the Court, the Court notes that Congress found it necessary to expand the coverage of § 5321 to address a class of conduct falling short of the "willful" standard solely accounted for under the old statute. Clearly, simply failing to file a Form TDF 90.22.1 was insufficient to subject an individual to liability for a civil penalty under the old statute.

4. The court was not persuaded, on these facts, that Williams' no answer to the foreign account question on his 2000 1040 Schedule B gave his the requirement knowledge of the legal duty.

5. Moreover, since the accounts were surely known by all, including the U.S. by June 30, 2001, it would make no sense for Williams not to disclose them by filing the FBAR.

6. Williams was not estopped by his evasion guilty plea.

The Government argues that Williams' guilty plea should estop him from arguing that he did not willfully violate § 5314 for the tax year 2000. However, the evidence introduced at trial established that the scope of the facts established by Williams' 2003 guilty plea are not as broad as the Government suggests, and there remains a factual incongruence between those facts necessary to his guilty plea to tax evasion and those establishing a willful violation of § 5314. That Williams intentionally failed to report income in an effort to evade income taxes is a separate matter from whether Williams specifically failed to comply with disclosure requirements contained in § 5314 applicable to the ALQI accounts for the year 2000. As Williams put it in his testimony at trial, "I was prosecuted for failing to disclose income. To the best of my knowledge I wasn't prosecuted for failing to check that box." Tr. at 34.

I think the case illustrates the difficulty the Government will meet in establishing willfulness for the truly draconian FBAR penalty (in its present iteration).  Perhaps this will encourage at least some taxpayers in the current voluntary disclosure initiative to opt out and be subject to the normal FBAR penalty regime.  Assuming that the Government cannot meet the high standard (as illustrated by this case), the penalty costs could be a whole lot less than the program requires.

Civil Penalties in the Mix - the Qualified Amended Return Gambit

I write today on a civil penalty, one of the accuracy related penalties in § 6662. You will recall that the IRS had great angst about the Son-of-Boss tax shelters. For a simplified explanation of how this shelter works, see here. The Government / grand jury have indicted some of the enablers for such shelters, and those indictments have been the topic or background for many of my posts.

Although the Government imagined that the taxpayers themselves acted criminally in taking such shelters and reporting their "too good to be true" positions on their tax returns, the IRS offered a settlement initiative for the taxpayers. That initiative was originally reported in IR-2004-54, on May 5, 2004. For complete links to the IRS positions on this initiative see here. The settlement under the initiative was included (i) taxpayer concession of 100 percent of the tax benefit claimed, (2) deduction of out of pocket costs, and a penalty that, although not set forth in the Notice was 10%. if it was the taxpayer's only abusive shelter or 20% if the taxpayer had other abusive shelters.  The Notice warned that:

Taxpayers not participating in the settlement will receive a statutory notice of deficiency (90 day letter) disallowing all losses and out of pocket costs and will be assessed maximum applicable penalties.

Note the cautionary warning of assessment of maximum applicable penalties.  Of course, the maximum potentially applicable civil penalty is the 75% civil fraud penalty in § 6663.

In Bergmann v. Commissioner, T.C. Memo. 2009-289, taxpayers (husband and wife) not participating in the special IRS settlement initiative instead filed an amended return reversing all the tax benefits that the IRS thought was abusive, and paying the tax and interest accordingly. The IRS swooped in and asserted the 40% gross valuation misstatement penalty under § 6662(h). The taxpayers claimed that the amended return was a qualified amended return under Regs. § 1.6664-2(c)(2) and filed a motion for the Tax Court to render summary judgment on that issue.

The Court framed the issue as follows:

A "qualified amended return" is an amended return filed after the due date of the return for the taxable year and before the earlier of certain events. See sec. 1.6664-2(c)(3), Income Tax Regs. At issue here is whether petitioners filed the amended return before respondent contacted "any person described in section 6700(a)" concerning examination of a section 6700(a) activity from which petitioners directly or indirectly claimed a benefit on the original return. See sec. 1.6664-2(c)(3)(ii), Income Tax Regs. If respondent contacted such a person concerning such an activity before petitioners submitted the amended return, then the return would not be a "qualified amended return," and the accuracy-related penalty may still apply. The parties disagree whether KPMG is a "person described in section 6700(a)." We now turn to that issue.

The facts showed that the IRS, by 2002, began investigating KPMG, a promoter / enabler for many allegedly abusive shelters and, evidently, including the one in issue in this case, for its tax shelter activity and had served regular IRS summonses (as opposed to John Doe summonses) upon KPMG. The IRS nevertheless had not become aware of the taxpayers' use of the Son-of-Boss shelters before the taxpayers filed their amended return. The issue then was whether, as to these taxpayers, KPMG was a person described in § 6700(a). The Tax Court (Judge Kroupa) said it did not have enough facts to render summary judgment:

We have carefully considered the materials the parties submitted in connection with petitioners' motion for summary judgment. We are unable to conclude, on the facts presented to the Court at this juncture, whether KPMG qualifies as a "person" under section 6700(a) and thus, whether petitioners' amended return is a "qualified amended return." We find genuine issues of material fact remain concerning this issue. See Sala v. United States, 552 F. Supp. 2d 1167, 1204 (D. Colo. 2008) (the relevant inquiry is whether the third party was contacted regarding the taxpayers' particular transactions). These material facts include those respondent noted in his response to petitioners' reply memorandum. Specifically, factual disputes exist whether KPMG is a "person described in section 6700(a)," and if it is, whether and when respondent first contacted KPMG concerning promotion of tax shelter transactions with respect to which petitioners directly or indirectly claimed tax benefits on the original return. These material facts need to be further developed before the Court can determine whether the amended return is a "qualified amended return." Accordingly, petitioners are not entitled to summary judgment on this issue.

I present this case in this Federal Tax Crimes Blog to remind practitioners of the qualified amended return opportunity to correct erroneous positions by amended return. A qualified amended return is an amended return filed after the original due date of the return (determined with extensions) but before any of the following events: (i) the date the taxpayer is first contacted for examination of the return; (ii) the date any person is contacted for a tax shelter promoter examination under § 6700; (iii) as to a pass-through entity item, the date the entity is first contacted for examination; (iv) the date a John Doe Summons is issued to identify the name of the taxpayer; and (v) as to certain tax shelter items, the dates of certain IRS initiatives published in the Internal Revenue Bulletin. § 1.6664-2(c)(2). The daily grist of a tax practitioner's mill is the new client who, from conscience or otherwise, wants to get right with the IRS after filing one or more fraudulent or at least incorrect returns. The standard advice (barring some most unusual wrinkles), after determining that the taxpayer is not under investigation, is to have him or her file amended returns for some number of years (that a different blog discussion). Anecdotally from my practice over many years and my discussions with others, the amended returns will almost invariably not draw any penalty because the IRS will have no reason to believe that they are not qualified amended returns. The IRS will have to launch an investigation which, given its allocation of limited resources, it might not do with an amended return in hand that likely corrects all material problems (or at least the ones that the IRS could find on audit). And, even if the IRS were to launch an investigation, in most cases the only way the IRS can avoid the penalty-neutralizing effect of the amended return as a qualified amended return is to allege that the original position on the return is fraudulent. See § 6664(c)(2). The IRS has to prove fraud by clear and convincing evidence and given that burden will often not have any incentive to deploy its investigative resources to build a fraud case in order to assert an accuracy related penalty. In most cases, even in cases where the taxpayer in fact may have committed fraud on the original return, the system will simply pass him by.  And, you will note that the IRS does not assert fraud in the Bergmann case as a basis for disqualifying the amended return as a qualified amended return.

As I tell my students, when a client walks in with this profile (one or more fraudulent or potentially fraudulent or just incorrect prior year returns), your job is very limited. Get him to an accountant and get the amended returns filed ASAP.

Congress Watch -- The Political Theater

It is nice to know that our Congressmen are on the watch. Here is a press release from Congressman John R. Carter, R-Texas, on his new bill titled the Geithner Penalty Waiver Act. The Act would impose the same penalty rate for persons joiniing the special voluntary disclosure program as imposed on Timothy Geithner, the Secretary of Treasury. The rhetoric is interesting; seems to me more for political theater than being a serious proposal.

Get in Line Brother #18c - McCarthy, the Financial Side and Bits and Pieces

This will be my last planned foray into the McCarthy indictment.

The Financial Side

1. Civil Taxes, Penalties and Interest. McCarthy agrees to pay the tax, interest and civil fraud penalty on the tax on "the net income on all funds held in foreign bank accounts" for calendar years 2003-2007. He had not yet filed his 2008 tax return, so presumably he will report that correctly and not be subject to any penalty. The amount of tax and thus resulting interest and fraud penalty is not stated, so this promise to pay apparently does permit him to contest the amount of tax on which interest and civil fraud penalty will be based. Note that this agreement assumes other foreign accounts used for tax evasion; by contrast, his sentencing factors are designed to consider only the UBS account disclosed by UBS. He further agrees to cooperate in making the appropriate calculations. The settlement is basically the same as the current voluntary disclosure initiative, except particpants in the initiative pay a 20% accuracy related penalty rather than the 75% fraud penalty.

2. FBAR Penalty. McCarthy agrees to a single FBAR penalty of 50% in the one identified UBS account for the highest amount year during the period from 2003-2008. Why are the other accounts left out of this penalty? He did after all admit willfulness in failing to file them. Note, however, that this settlement is consistent with the current voluntary disclosure initiative, except that the penalty for that single year is 50% rather than 20% as is offered in the voluntary initiative, but the 20% applies to all foreign accounts whereas McCarthy's deal is 50% of a single account. Real comparisons to the financial cost of the current iniative therefore cannot be made because the plea documents do not provide the necessary information.

Bits and Pieces

1. Grand jury matters. The defendant agrees to "give up any and all objections that could be asserted" to the IRS about the IRS recieving "materials or information obtained during the criminal investigation of this matter, include materials and information obtained through the grand jury process." I have blogged facets this issue here. So, I summarily note here, that the agreement is a recognition that these materials were not obtained in an IRS investigation because the IRS can share with other IRS components the fruits of its investigation without any such waiver from the defendant (or taxpayer). This agreement is really an attempt by the Government to end run FRCrP Rule 6(e) which imposes grand jury secrecy. The agreement seems to treat Rule 6(e) as a right that the person to whom the materials relate can waive. My understanding is that the rationale of Rule 6(e) sweeps broader than that and goes to the heart of the grand jury system to keep such matters secret until released in a proper way. The proper way grand jury material gets released is in the courtroom, a public forum, pursuant to a proper proceeding or by a Rule 6(e) order. Because of the plea agreement, there is no public proceeding in which all of these documents will be introduced and thus available to the IRS. (I suppose the IRS could force them into the public record in a sentencing hearing proceeding about the tax loss number and, perhaps, about the proper Section Two Part S calculations.) And, a Rule 6(e) order for the release to the IRS for civil tax purposes is expressly prohibited by Supreme Court authority. (I guess the IRS might be able to thread that needle by having the defendant agree to contractual restitution for these amounts and seeing if the court would have some type of public proceeding to permit it to dump the documents into the public record, but that would be too blatant an end-run around Rule 6(e).) I have had this genre of battle with an AUSA before who requested a similar waiver. I told him that my client would give it, but I did not think a waiver really solved his 6(e) problem. I think he agreed with my analysis because he then backed off the request and found another way to get around 6(e) -- by delivering all the documents back to the defendant whereupon the IRS had access to them through its usual processes. The solution may not be available in the McCarthy case because the documents are probably not the defendant's documents. The IRS would have to release them to UBS and whether or not UBS would then have an incentive -- either by compulsory process or otherwise -- to give them over to the IRS civil division is unknown. However, the agreement could have required McCarthy to request these documents from UBS and then turn them over to the IRS. The point I am making at too much length is that the Government simply solved the problem in the wrong way.

2. Restitution? The plea states that "Defendant understands that the Court may order defendant to pay any additional taxes, interest and penalties that defendant owes to the United States and may order defendant to pay any additional fines that defendant owes to the United States." Plea ¶ 5. The plea cites no authority for the taxes, penalties and interest reimbursement, and I am aware of no authority for it unless the defendant agrees to contractual restitution which would, then, permit court enforcement of the contract. In this regard, independent of contractual restitution, restitution is permitted only for the crime of conviction (tax crimes is not one, but the crime of conviction is not a tax crime). The crime of conviction is the failure to file an information report, and there is no dollar harm to the United States from failure to file an information report. Of course, the IRS does have the full array of tax determination, assessment and collection tools for any tax, interest and penalties.

Fifth Circuit Decides Klamath on Economic Substance for Tax Shelters

The Fifth Circuit has rendered its long-awaited decision in Klamath Strategic Investment Fund v. United States, ___ F.3d ___ (5th Cir. 2009). By way of background, Klamath involved the BLIPS tax shelter that was involved in the star-crossed KPMG individual defendants criminal indictment way back in 2004 (as well as the related KPMG deferred prosecution agreement). After slapping the Government for prosecutorial abuse in that case and dismissing most of the defendants (dismissal sustained in United States v. Stein, 541 F.3d 130 (2d Cir. 2008)), the Government finally took four of the defendants to trial and obtained a conviction on the BLIPS shelters in December 2008. During the winding journey that started at least by 2004 and ended in those convictions in December 2008, the Government had pulled out all the stops to prevent the issue of viability of the BLIPS shelter from being decided in a civil case. Obviously, the reason was that, if a taxpayer prevailed in a civil case or even avoided penalties in a civil case, the Government's charges in the criminal case might not pass the requirement that the legal duty be certain in order to support criminal charges (as established by the Supreme Court in James and in a number of cases from the courts of appeals, including Garber (5th Circuit), Dahlstrom (9th Circuit) and Pirro (2d Circuit).

Notwithstanding the Government's determined attempt to avoid a civil test of its claims about BLIPS, the district court in Klamath refused to stay the case and took it to resolution, hence the court of appeals case. In the district court, the court made a critical pre-trial ruling sustaining the legal superstructure employed in BLIPS (and many other tax shelters) which centered on an application of the Helmer case to allow, in effect, a cost-free basis in a partnership interest from a conditional obligation. At trial, however, the court held that (1) notwithstanding its previous holding that Helmer works (or at least worked at the time the shelter was implemented), the BLIPS transaction in the case failed the economic substance test and thus the IRS adjustments at the partnership level were correct but (2) (a) the accuracy related penalty did not apply and (b) in any event, partnership established the defense of reasonable cause and good faith defense precluded the IRS's claim for the accuracy related penalties. The partnership appealed the first holding (on the economic substance test), and the Government appealed the holdings on (1) that the penalty did not apply and (2) the predicate holding that the Helmer gambit in the case worked.
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Collateral Estoppel to Corporation After Conviction of President and Sole Shareholder

In Hi-Q Personnel Inc. v. Commissioner; 132 T.C. No. 13 (5/4/09), the Tax Court applied the doctrine of collateral estoppel from the conviction of the president and sole shareholder under Section 7202 (failure to withhold and pay over) to the corporation. Since collateral estoppel usually applies only to the same shareholder, the Tax Court found that there was sufficient privity between the president and sole shareholder on the one hand and the corporation on the other. The Tax Court noted the truism that corporations act through their officers and, given his relationship, the president's actions were the corporation's actions. The Tax Court alternatively made an affirmative finding independent of collateral estoppel that the corporation was guilty of fraud with respect to the failure to withhold and pay over. As a result of those alternative holdings:

1. The corporation was liable for the payroll taxes.

2. The corporation was liable for the civil fraud penalty.

3. The unlimited statute of limitations applies.

Collateral Estoppel after Tax Evasion Conviction

The law is clear that, upon conviction for tax evasion, the taxpayer is estopped in the inevitable civil proceeding from asserting that civil fraud was involved. Two consequences then flow from the presence of civil fraud -- (i) liability for the civil fraud penalty in Section 6663 and (ii) an open statute of limitations if the statute of limitations for assessment is otherwise barred under the normal 3 and 6 year rules.

Normally, the application of the rule is straigtforward. For example, assume that the taxpayer is charged in the criminal case with 4 counts of tax evasion -- one count each for years 1 - 4 and that he is convicted for years 1 & 2 and acquitted for years 3 & 4. This rule says that the taxpayer is collaterally estopped to deny civil fraud for years 1 & 2, thus being subject to the penalty and an open statute of limitations for years 1 & 2. The IRS may still assert civil fraud for years 3 & 4 for which the taxpayer was acquitted of tax evasion, but the IRS will have to meet the predicate requirement that the IRS prove civil fraud by clear and convincing evidence.

In Williams v. Commissioner, T.C. Memo 2009-81, these concepts were applied in a context that I have not yet personally encountered or even seen in my readings. In that case, in the superseding indictment, the Government charged Williams with one count of conspiracy and one count of tax evasion. These charges arose from the use of offshore accounts to evade tax on large amounts of unreported income exceeding $8MM over eight years from 1993 to 2000. The tax evasion count included those 8 tax years in the single tax evasion count rather than in mutliple counts, one for each year. The taxpayer pled guilty to that single count. The straightforward application of the collateral estoppel rule suggests, that absent some other factor, Williams would be collaterally estopped as to civil fraud for those years. Williams argued otherwise. As best I understand Williams' argument, he was asserting that his plea meant only that, in one or more but less than all of the 8 years, he committed tax evasion and thus there is no collateral estoppel as to any particular year. That is not the way the tax evasion count to which he pled was worded, of course, and that ultimately made his argument untenable. (This intepretation of the wording of the count was supported by the plea allocution.)

This was a straightforward holding and hardly worthy of comment. The only reason I even mention the case at all is the inclusion of 8 years of tax evasion in a single count. I have observed tax evasion (and other tax crimes, such as Section 7206(1) charges for tax return crimes) for multiple years charged as a separate count for each tax year. Perhaps others have other experience in this regard.

I was trying to imagine why the Government would have asserted the eight years evasion in a single count. Since this was a superseding indictment it was probably the result of a plea agreement. By pleading to only two 5 year counts, Mr. Williams capped his risk of incarceration to 10 years. But, my rough and ready calculation of the sentence under the 2000 sentencing guidelines would suggest that, with a 3 level reduction for acceptance of responsibility, he would have had a Guidelines sentence (considering both the conspiracy count and the tax evasion count) well below 10 years, so he probably did not need to cap his sentence at 10 years. But, from the Government's perspective, it did not need any more than one count of tax evasion which coupled with the conspiracy count would give the court up to 10 years in which to sentence. Usually, in my experience, the way that would be done is to charge the 8 counts of tax evasion, have the defendant plead to one, and drop the remainder upon the acceptance of the plea. Then, for sentencing purposes, all of the tax losses involved in the dropped counts would be considered as relevant conduct and included in the Guidelines calculations anyway. So, the result in the criminal case was not affected at all by charging the tax evasion in one count rather than 8. Where it could make a difference is where additional counts of conviction are required in order to achieve an appropriate sentence. Let's say, for example, that three years of tax evasion are involved and $100,000,000 of tax loss is involved. The current -- i.e., 2008 -- Guidelines sentence with only a 3 level reduction for acceptance of responsibility would produce an offense level of 29 which produces a sentencing range of 87-108 months. Then, of course, more than one count of conviction would be required to achieve a Guidelines sentence (assuming, of course, that the sentencing court wanted a Guidelines sentence or wanted a Booker sentence exceeding the 5 years available for one count).

And, of course, by including the 8 counts in a single count to which the taxpayer pled, the Government did get collateral estoppel in the ensuing civil case. In my experience, the Government now imposes a restitution agreement in the plea agreement (i.e., the taxpayer is not forced to agree to restitution, but if it wants a plea deal, he must). Depending upon how the restitution agreement is worded, the taxpayer may be foreclosed from trying to avoid civil fraud with respect to any dismissed counts that are included as amounts required to be paid as restitution.