In Dingman v. Commissioner, T.C. Memo. 2011-116, while the taxpayer was under criminal investigation, the taxpayer's attorney delivered delinquent returns and checks for some of the tax due to the IRS criminal investigation special agent. The IRS processed the checks and credited the amounts to his account on February 19, 2003; what exactly happened procedurally to the returns is unclear. On February 26, 2006, the IRS assessed a Section 6651(f), fraudulent failure to file, penalty. Bottom line, the court held that February 19, 2003 was the latest date that the returns were filed (by inference from the fact that the checks were credited that date) and thus that the ultimate assessment was untimely.
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Showing posts with label Statutes of Limitations - Civil. Show all posts
Showing posts with label Statutes of Limitations - Civil. Show all posts
Tuesday, June 7, 2011
Saturday, June 12, 2010
Court of Federal Appeals Trashes Son-of-Boss Shelter
The Court of Appeals for the Federal Circuit called taxpayer foul in yet another Son-of-Boss tax shelter, this time another J&G / Daugerdas team variety. See the Stobie Creek opinion here. The Court found lack of economic substance and lack of business purpose. In effect, as in other shelters, the Court found the shelter, in layman's parlance, to be bullshit.
I write only for a narrow aspect. In rejecting the taxpayer's lament that the trial court had erroneously refused to hear from its expert witness, Stuart Smith, the Court of Appeals said (emphasis supplied):
I write only for a narrow aspect. In rejecting the taxpayer's lament that the trial court had erroneously refused to hear from its expert witness, Stuart Smith, the Court of Appeals said (emphasis supplied):
* * * Smith's proposed testimony consisted of a lengthy legal analysis of past precedent and assumed key factual representations underlying the J & G opinion were accurate, when in actuality they were false (and known to be so by the Welleses).In these types of opinions, the factual representations are usually the representations of the taxpayer (profit motive, etc.). If those are the factual representations referred to, this holding is equivalent to a finding that the ultimate taxpayers (either directly or through their lead representatives on the deal) committed the type of conduct that would, at the ultimate taxpayer level, constitute fraud, thus keeping their tax statute of limitations open for ever (per Section 6501(c)(1) or (2)), and thus short-circuiting the brouhaha surrounding the Regulations fix to the 6-year statute of limitations issue. (This is a bottom-line conclusion, for which I do not go into detail, but I discuss some of the details in some of my prior blogs here on civil statutes of limitation.) And, of course, this type of finding could suggest that a criminal case could be pursued, subject of course to the criminal statute of limitations which likely had expired absent some event refreshing the statute of limitations and subject of course also to the heightened burden of proof in criminal cases.
Monday, May 10, 2010
Civil Statutes of Limitation for Abusive Tax Shelters
The statute of limitations rules for civil cases rules are:
The IRS hoped that the regulations would be the law, regardless of prior precedent, including even the Supreme Court precedent in Colony. The IRS based its hope on the line of cases beginning with Chevron U.S.A. Inc. v. Natural Res. Def. Council, 467 U.S. 837 (1984) which gives the IRS broad authority to promulgate the law by regulation so long as the statute does not foreclose the interpretation adopted in the regulation -- i.e., the IRS may choose among reasonable interpretations of the statutory text. In National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005) ("Brand X") held that the IRS could by regulation overturn prior judicial precedent. Justice Thomas for the majority synthesized the holding of Chevron as follows:
Brand X thus grants (or recognizes) the IRS’s (or any agency’s) authority to change the prior judicial interpretation so long as the agency interpretation is not foreclosed as a reasonable interpretation of an otherwise ambiguous statute. In other words, if in order to resolve the case at hand, the prior judicial opinion applies an interpretation that it thinks best resolves the case but is not necessarily commanded as the only reasonable interpretation of the statute, the prior judicial opinion does not foreclose an agency from adopting an interpretation otherwise that is a different reasonable interpretation and qualify that interpretation for Chevron deference.
Of course everything turns upon whether the prior judicial opinion effectively forecloses other reasonable interpretations of the statute. This then can become a tough call, and drawing this line will be where the play comes in the application of Brand X’s vision of Chevron deference. This was the setting as to the new IRS regulations interpreting the 25% omission rule which could be read as overturning Colony.
In Intermountain Insurance Service of Vail LLC v. Commissioner, 134 T.C. No. 11 (5/6/10), the Tax Court tackled that issue and held that Colony lived despite the regulation. The Tax Court held that the Colony interpretation of the statutory text foreclosed there being reasonable alternatives that the IRS could choose among by regulation. The concurring opinion by Judge Halpern ably contests that notion.
Obviously, the particular phenomenon that has the IRS so exercised is the fact that it views the extended 6 year statute of limitations to be important to its collection of the taxes avoided by the abusive shelter because the parties involved well-hid their perfidy. Intermountain arose in the context of the TEFRA iteration of the 25% omission rule, but as noted above there is another TEFRA 6 year statute -- for returns that are false or fraudulent. The IRS has noised for years that Son-of-Boss transactions were false or fraudulent and have indicted and convicted some of the enablers in these transactions. Although no taxpayers have been indicted or convicted, the prosecutors in the cases certainly felt that the taxpayers were complicit. So, the IRS could get a 6 year TEFRA statute if it could prove by clear and convincing evidence that the partnership return was false or fraudulent. It is unclear why the IRS has not taken that approach. Morever, if indeed the prosecutors could prove that the taxpayer partners were complicit in the fraud, then an unlimited statute would apply (whether by virtue of the TEFRA rule or, perhaps even, by the regular § 6501(c)(1) and (2) rule). And, to trace this even further, the IRS might argue that the fraud which infects the individual return is sufficient to invoke the holding of Allen v. Commissioner, 128 T.C. 37 (2007). (See my prior discussion of Allen here.) I have not traced such a line of argument out to the end, but simply suggest that I see no clear reason why it might not be available.
a. In non-TEFRA cases, the general rule is 3 years with two key exceptions in the case of tax shelters: (i) 6 years if a 25% omission of gross income is involved and (ii) no statute if fraud is involved. See Section 6501(c)(1) & 2 and (e)(1)(A) (prior to amendment by the HIRE Act).Many abusive tax shelters attempted to make sure the general 3 year statute of limitations would apply by (i) offering a packaged (Government would call "cookie-cutter") legal opinion so as (the promoters and taxpayers hoped) to avoid fraud and (ii) creating the shelter through a mechanism other than omission of gross income. One of the so-called loss generator strategies was to create artificial basis. The Son-of-Boss transactions were typical of this type of abusive tax shelter. I won't get into the details of that genre of shelter, but I will illustrate in a highly simplified example. Suppose a taxpayer had $50,000,000 of capital gain and his or her only other income was $1,000,000 in compensation. If the taxpayer omitted the capital gain from his or her return, he or she would easily have a 25% omission of income and the six year statute would apply. If, however, the taxpayer can generate artificial basis to offset the capital gain (say making the gain net of the artificial basis $50,000 rather than $50,000,000), the taxpayer has set the stage for an argument that the three year statute applies. The argument is based on the Supreme Court's holding in Colony Inc. v. Commissioner, 357 U.S. 28 (1958), which interpreted the 1939 Code equivalent of the Section 6501(e) 25% omission 6 year statute. The IRS has argued that Colony did not require that holding, but the courts have generally disagreed. As a result, the IRS promulgated regulations that, if valid, would sustain the IRS position and overrule the cases holding otherwise.
b. In TEFRA cases, the special statute of limitations (which may extend the limitations periods discussed in paragraph a.) a general 3 year rule with extended periods paralleling the general rules in paragraph a. in the case of: (i) false or fraudulent partnership returns (6 years except that partners "signing or participating in the preparation of" a false or fraudulent return) may be assessed at any time,” (ii) 6 years for 25% gross income omissions, (iii) unlimited if no return, and (iv) Service prepared returns. § 6229(a) &.(c).
The IRS hoped that the regulations would be the law, regardless of prior precedent, including even the Supreme Court precedent in Colony. The IRS based its hope on the line of cases beginning with Chevron U.S.A. Inc. v. Natural Res. Def. Council, 467 U.S. 837 (1984) which gives the IRS broad authority to promulgate the law by regulation so long as the statute does not foreclose the interpretation adopted in the regulation -- i.e., the IRS may choose among reasonable interpretations of the statutory text. In National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005) ("Brand X") held that the IRS could by regulation overturn prior judicial precedent. Justice Thomas for the majority synthesized the holding of Chevron as follows:
In Chevron, this Court held that ambiguities in statutes within an agency's jurisdiction to administer are delegations of authority to the agency to fill the statutory gap in reasonable fashion. Filling these gaps, the Court explained, involves difficult policy choices that agencies are better equipped to make than courts. If a statute is ambiguous, and if the implementing agency's construction is reasonable, Chevron requires a federal court to accept the agency's construction of the statute, even if the agency's reading differs from what the court believes is the best statutory interpretation. (Citations omitted.)Then moving to whether an agency interpretation can trump an earlier court decision, Justice Thomas said:
A contrary rule would produce anomalous results. It would mean that whether an agency's interpretation of an ambiguous statute is entitled to Chevron deference would turn on the order in which the interpretations issue: If the court's construction came first, its construction would prevail, whereas if the agency's came first, the agency's construction would command Chevron deference.Justice Thomas then concluded: “A court's prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion.” Further emphasizing the point, Justice Thomas states: “Only a judicial precedent holding that the statute unambiguously forecloses the agency's interpretation, and therefore contains no gap for the agency to fill, displaces a conflicting agency construction.”
Brand X thus grants (or recognizes) the IRS’s (or any agency’s) authority to change the prior judicial interpretation so long as the agency interpretation is not foreclosed as a reasonable interpretation of an otherwise ambiguous statute. In other words, if in order to resolve the case at hand, the prior judicial opinion applies an interpretation that it thinks best resolves the case but is not necessarily commanded as the only reasonable interpretation of the statute, the prior judicial opinion does not foreclose an agency from adopting an interpretation otherwise that is a different reasonable interpretation and qualify that interpretation for Chevron deference.
Of course everything turns upon whether the prior judicial opinion effectively forecloses other reasonable interpretations of the statute. This then can become a tough call, and drawing this line will be where the play comes in the application of Brand X’s vision of Chevron deference. This was the setting as to the new IRS regulations interpreting the 25% omission rule which could be read as overturning Colony.
In Intermountain Insurance Service of Vail LLC v. Commissioner, 134 T.C. No. 11 (5/6/10), the Tax Court tackled that issue and held that Colony lived despite the regulation. The Tax Court held that the Colony interpretation of the statutory text foreclosed there being reasonable alternatives that the IRS could choose among by regulation. The concurring opinion by Judge Halpern ably contests that notion.
Obviously, the particular phenomenon that has the IRS so exercised is the fact that it views the extended 6 year statute of limitations to be important to its collection of the taxes avoided by the abusive shelter because the parties involved well-hid their perfidy. Intermountain arose in the context of the TEFRA iteration of the 25% omission rule, but as noted above there is another TEFRA 6 year statute -- for returns that are false or fraudulent. The IRS has noised for years that Son-of-Boss transactions were false or fraudulent and have indicted and convicted some of the enablers in these transactions. Although no taxpayers have been indicted or convicted, the prosecutors in the cases certainly felt that the taxpayers were complicit. So, the IRS could get a 6 year TEFRA statute if it could prove by clear and convincing evidence that the partnership return was false or fraudulent. It is unclear why the IRS has not taken that approach. Morever, if indeed the prosecutors could prove that the taxpayer partners were complicit in the fraud, then an unlimited statute would apply (whether by virtue of the TEFRA rule or, perhaps even, by the regular § 6501(c)(1) and (2) rule). And, to trace this even further, the IRS might argue that the fraud which infects the individual return is sufficient to invoke the holding of Allen v. Commissioner, 128 T.C. 37 (2007). (See my prior discussion of Allen here.) I have not traced such a line of argument out to the end, but simply suggest that I see no clear reason why it might not be available.
Tuesday, April 27, 2010
Collateral Consequences of Tax Fraud - Bankruptcy Discharge Denied
Section 523(a)(1)(C) provides the taxes are not discharged "with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax." In Hawkins v. Franchise Board (Bankr Ct. ND CA No. 07-3139 4/23/10), the IRS and the California Franchise Tax Board sought to deny the debtors, husband and wife, bankruptcy discharge of their tax liabilities because (i) they had filed fraudulent returns and (ii) they had attempted to evade collection of tax "by dissipating his assets on unnecessary and unreasonable expenditures while he knew he owed taxes and knew he was insolvent."
The husband was well-educated and earned a lot of money working in Silicon Valley (Apple and Electronic Arts). He sold a large amount of stock and perceived a need to shelter the gain. He fell in with KPMG who hawked him FLIP and OPIS shelters (two of the shelters involved in the big KPMG criminal case in NYC). He then fell on hard times but continued to live a high lifestyle, even while knowing that he owed the IRS the tax. The Court noted that he continued the high lifestyle even after they were insolvent. After the IRS assessed some $21 million, he submitted an offer in compromise to pay about 38%. He paid some of the tax but still had unpaid tax. He and his wife filed Chapter 11 bankruptcy to deal with the tax liability. The Debtors then asked the bankruptcy court to confirm the discharge of the liability (i.e., the nonapplicability of the Section 523(a)(C) exception).
The IRS argued that the couple's returns claiming the FLIP and OPIS tax benefits were fraudulent at least as to the husband and that the their extravagant lifestyle as their finances cratered was an attempt to evade or defeat the tax. The court let the wife off the hook but hooked the husband as follows:
Fraudulent Return
The court held the husband had attempted to evade or defeat through his extravagant living after the tax debt accrued. The court recognized that some level of expenditures are required without constituting an attempt to evade or defeat, but the sheer extravagance in tough times (relatively) for the husband when a very large tax debt was due tipped the scale. The court lays out the damning details of the extravagant lifestyle. The court then sums up:
1. This statutory language for denial of discharge is not the same as the crime of evasion in Section 7201, but the concept is probably the same. The language does substantially track the unlimited civil statute of limitations provision in Section 6501(c)(1) and (2).
2. For prior discussion of the potential for an unlimited civil statute of limitations for investors in abusive tax shelters where the fraud was committed by the enablers, see my prior blog titled Civil Tax Statute of Limitations for Fraudulent Tax Shelters. Briefly, preparer fraud and perhaps enabler fraud will trigger the unlimited civil statute of limitations. For civil statute of limitations purposes, it does not appear that taxpayer culpability is required, so long as the action of someone in the chain causes the return to be fraudulent.
3. Note that the court ducked the issue of whether the taxpayer husband committed fraud because of his sophistication. Certainly that was the Government's claim as to the husband.
4. Note also that the court seemed to think that a tax professional would know that the opinions are fraudulent. This notion was gratuitous to its holding and may not have been adequately developed in the case, so that it is questionable how reliable it is.
The husband was well-educated and earned a lot of money working in Silicon Valley (Apple and Electronic Arts). He sold a large amount of stock and perceived a need to shelter the gain. He fell in with KPMG who hawked him FLIP and OPIS shelters (two of the shelters involved in the big KPMG criminal case in NYC). He then fell on hard times but continued to live a high lifestyle, even while knowing that he owed the IRS the tax. The Court noted that he continued the high lifestyle even after they were insolvent. After the IRS assessed some $21 million, he submitted an offer in compromise to pay about 38%. He paid some of the tax but still had unpaid tax. He and his wife filed Chapter 11 bankruptcy to deal with the tax liability. The Debtors then asked the bankruptcy court to confirm the discharge of the liability (i.e., the nonapplicability of the Section 523(a)(C) exception).
The IRS argued that the couple's returns claiming the FLIP and OPIS tax benefits were fraudulent at least as to the husband and that the their extravagant lifestyle as their finances cratered was an attempt to evade or defeat the tax. The court let the wife off the hook but hooked the husband as follows:
Fraudulent Return
It is a difficult question whether Trip Hawkins acted with intent to defraud in filing the returns in question. An objective, well-trained tax professional would have known that the claimed loss deductions lacked substance and would not be upheld if challenged. Trip Hawkins clearly has the financial acumen to understand why the FLIP and OPIS losses should not be allowed, and once the IRS challenged the deductions, Debtors never contended that the deductions were valid, and immediately tried to opt into a settlement program that would have allowed them only a small portion of the losses they claimed in their returns. At the same time, however, the FLIP and OPIS shelters were extremely complicated, and at the time Trip signed the returns in question, he held opinion letters from tax professionals stating that it was more likely than not that the claimed deductions would be upheld. These opinion letters were themselves so long and complex that they helped to disguise the lack of substance in the FLIP and OPIS transactions.Willful Attempt to Evade or Defeat
The court need not, and does not, decide whether Trip Hawkins acted with intent to defraud regarding 1997-2000 returns. As explained below, the Unpaid Taxes should be excepted from discharge on the basis that Trip caused Debtors to make unreasonable discretionary expenditures for an extended period of time after he became aware of tax obligations that he knew he could not pay.
The court held the husband had attempted to evade or defeat through his extravagant living after the tax debt accrued. The court recognized that some level of expenditures are required without constituting an attempt to evade or defeat, but the sheer extravagance in tough times (relatively) for the husband when a very large tax debt was due tipped the scale. The court lays out the damning details of the extravagant lifestyle. The court then sums up:
Trip Hawkins willfully evaded payment of that tax debt within the meaning of section 523(a)(1)(C) by causing Debtors to deplete their assets on large unnecessary expenditures for an extended period of time, while knowing that Debtors were insolvent, while knowing that Debtors had a $25 million tax debt that they could not pay and did not intend to repay, and while paying other creditors.JAT Comments:
1. This statutory language for denial of discharge is not the same as the crime of evasion in Section 7201, but the concept is probably the same. The language does substantially track the unlimited civil statute of limitations provision in Section 6501(c)(1) and (2).
2. For prior discussion of the potential for an unlimited civil statute of limitations for investors in abusive tax shelters where the fraud was committed by the enablers, see my prior blog titled Civil Tax Statute of Limitations for Fraudulent Tax Shelters. Briefly, preparer fraud and perhaps enabler fraud will trigger the unlimited civil statute of limitations. For civil statute of limitations purposes, it does not appear that taxpayer culpability is required, so long as the action of someone in the chain causes the return to be fraudulent.
3. Note that the court ducked the issue of whether the taxpayer husband committed fraud because of his sophistication. Certainly that was the Government's claim as to the husband.
4. Note also that the court seemed to think that a tax professional would know that the opinions are fraudulent. This notion was gratuitous to its holding and may not have been adequately developed in the case, so that it is questionable how reliable it is.
Saturday, December 19, 2009
Civil Tax Statute of Limitations for Fraudulent Tax Shelters
I address in this blog the civil statute of limitations for tax shelters. I start with the basics:
1. General. The general statute of limitations is 3 years. § 6501(a).
2. 25% Omission. In the case of a 25% omission of income, the statute of limitations is 6 years. § 6501(e). Many of the shelters exploited basis overstatements which, the cases have held, do not invoke this section, but the IRS may have put the quietus on those holdings by Regulation. See T.D. 9466, 2009-43 I.R.B. 551.
3. False Return. "In the case of a false or fraudulent return with the intent to evade tax," the statute of limitations is unlimited. § 6501(c)(1).
4. Willful Attempt to Evade Tax. "In case of a willful attempt in any manner to defeat or evade tax," the statute is unlimited. § 6105(c)(2).
I focus here on the third and fourth exceptions – principally the third – because the IRS imagines many of these abusive shelters -- the poster child being Son-of-Boss in its various iterations -- as fraudulent and somebody in the mix among the enablers and taxpayers had fraudulent intent to evade tax and thus necessarily willfully attempted to evade or defeat tax.
In Allen v. Commissioner, 128 T.C. 37 (2007), the Tax Court held that a tax return preparer's fraud would invoke the unlimited period of limitations in § 6501(c)(1) even if the taxpayer had no fraudulent intent. The court applied what it called a plain meaning interpretation of the statutory language quoted above.
The question in the case of fraudulent tax shelters is whether the taxpayer's standard defense that other professionals were involved so that he or she lacked fraudulent intent will avoid the application of the unlimited statute of limitations. Of course, the Government imagines that the taxpayers (or at least most of them who were not comatose) intended to defraud the Government of tax, but has not chosen so far to indict the taxpayers. I hear that the Government simply missed or did not timely pursue many of the abusive tax shelters within the applicable period -- 3 years or 6 years, as appropriate. Can the Government now pursue these shelters under an unlimited civil statute of limitations inspired by the Allen decision? Although certainly not authoritative, the Tax Notes publication of Allen was under the caption "Limitations Period Extended Regardless of Who Commits Fraud." I think a more technical analysis would get there also under Allen.
Let's look at Allen more closely. The Court applied a "plain meaning analysis" (pp. 39-40):
Professor Bryan Camp has criticized the Allen holding in two articles. Bryan T. Camp, Presumptions and Tax Return Preparer Fraud, 120 Tax Notes 167 (2008); and Bryan T. Camp, Tax Return Preparer Fraud and the Assessment Limitation Period, 116 Tax Notes 687 (Aug. 20, 2007). Professor Camp argues in his articles that the Tax Court mis-interpreted the plain language of the statute and that, in addition, the history of statute shows it is supposed to reach only bad-acting taxpayers. Professor Camp's analysis would thus not sweep in the fraudulent intent of enablers, whether they fit the technical definition of preparers or not.
So, we have two plain language advocates reaching opposite conclusions; which may suggest that the plain language is not so plain and that therefore resort to something other than plain language is critical and, as Professor Camp notes in his articles, a persuasive case can be made from the sources other than the statutory text that it is the fraudulent conduct of the taxpayer that must control both the unlimited statute of limitations and the civil fraud penalty. Nevertheless, we have Allen as the only direct authority, and it stands for the proposition that the conduct of others than the taxpayers may trigger the unlimited statute of limitations (albeit not the civil fraud penalty).
Professor Camp urges if Allen were correct (which he vigorously disputes) on the bare words of the statute, the IRS should exercise its enormous discretion to "walk away from these new powers that it has been granted [by the Allen case] and focus on the tools that Congress gave it to combat the problem of tax return preparer fraud." Professor Camp is presuming that the wholly innocent taxpayer (and not the bad-acting enablers) is being punished by the unlimited statute of limitations.
In the case of abusive tax shelters, however, the Government's imagination is that the taxpayers may not be wholly innocent. Tax benefits were created from thin air in an environment (often the reports are that the taxpayer or the taxpayer's advisors and even some of the enablers said early on that the shelter was "too good to be true" or some variation of that notion). Hence, if Professor Camp is wrong on the law and the IRS does actually have the tremendous discretion in the application of this interpretation, the IRS may desire to exercise the power in some cases and not in other cases. Are abusive tax shelters a case in which the IRS should or will exercise its powers?
If the Government tries, taxpayers will surely assert vigorously, as has Professor Camp, that Allen is wrongly decided, both as a matter of statutory interpretation and of policy. I think there is a reasonable chance that the Camp interpretation will prevail. I just think that Congress intended the panoply of provisions addressing return preparer and enabler abuses to cover the ground (and prosecutors have plenty of weapons against bad-acting tax shelter enablers) and did not intend to punish innocent taxpayers (which for this purpose includes perhaps not so innocent taxpayers whose intentions were not fraudulent) with an unlimited statute of limitations.
But, if Allen does prevail, the question then, of course, is that the Government can prove by clear and convincing evidence of fraud as to one or more enablers in the tax shelter chain with reasonable nexus to the return reporting position. Even if the Government could not or could but did not prosecute the taxpayers, it could still sweep those taxpayers into an unlimited civil statute of limitations, and put a lot of enablers’ actions in the line of fire. Of course, those innocent and not-so-innocent taxpayers might be able to push all or some of the cost to the bad-acting enablers through malpractice or related fraud claims.
Finally, in such a proceeding involving the unlimited statute of limitations, any of the enablers' convictions will not give rise to res judicata or collateral estoppel because the taxpayers are not in privity with them. But obviously, their convictions will be bad facts and may go a long way to meeting the Government's burden to prove fraud by clear and convincing evidence.
1. General. The general statute of limitations is 3 years. § 6501(a).
2. 25% Omission. In the case of a 25% omission of income, the statute of limitations is 6 years. § 6501(e). Many of the shelters exploited basis overstatements which, the cases have held, do not invoke this section, but the IRS may have put the quietus on those holdings by Regulation. See T.D. 9466, 2009-43 I.R.B. 551.
3. False Return. "In the case of a false or fraudulent return with the intent to evade tax," the statute of limitations is unlimited. § 6501(c)(1).
4. Willful Attempt to Evade Tax. "In case of a willful attempt in any manner to defeat or evade tax," the statute is unlimited. § 6105(c)(2).
I focus here on the third and fourth exceptions – principally the third – because the IRS imagines many of these abusive shelters -- the poster child being Son-of-Boss in its various iterations -- as fraudulent and somebody in the mix among the enablers and taxpayers had fraudulent intent to evade tax and thus necessarily willfully attempted to evade or defeat tax.
In Allen v. Commissioner, 128 T.C. 37 (2007), the Tax Court held that a tax return preparer's fraud would invoke the unlimited period of limitations in § 6501(c)(1) even if the taxpayer had no fraudulent intent. The court applied what it called a plain meaning interpretation of the statutory language quoted above.
The question in the case of fraudulent tax shelters is whether the taxpayer's standard defense that other professionals were involved so that he or she lacked fraudulent intent will avoid the application of the unlimited statute of limitations. Of course, the Government imagines that the taxpayers (or at least most of them who were not comatose) intended to defraud the Government of tax, but has not chosen so far to indict the taxpayers. I hear that the Government simply missed or did not timely pursue many of the abusive tax shelters within the applicable period -- 3 years or 6 years, as appropriate. Can the Government now pursue these shelters under an unlimited civil statute of limitations inspired by the Allen decision? Although certainly not authoritative, the Tax Notes publication of Allen was under the caption "Limitations Period Extended Regardless of Who Commits Fraud." I think a more technical analysis would get there also under Allen.
Let's look at Allen more closely. The Court applied a "plain meaning analysis" (pp. 39-40):
Nothing in the plain meaning of the statute suggests the limitations period is extended only in the case of the taxpayer's fraud. The statute keys the extension to the fraudulent nature of the return, not to the identity of the perpetrator of the fraud. Nor do we read the words "of the taxpayer" into the statute to require the taxpayer to have the intent to evade his or her own tax.Allen thus clearly stands for the proposition that a preparer's fraudulent intent suffices for the unlimited statute of limitations § 6501(c)(1). And, under the definition of return preparer in the Code and Regulations, a person other than the signing preparer who materially participates in the reporting of a fraudulent item could be a preparer within the scope of the holding. Finally, since all that is needed under the Allen analysis and, seemingly, the statute, is a "a false or fraudulent return with the intent to evade tax," then at least arguably the fraudulent intent of anyone involved materially in the reporting on the return, including the shelter promoters might be sufficient.
Respondent argues, and we agree, that statutes of limitations are strictly construed in favor of the Government. Badaracco v. Commissioner, 464 U.S. 386, 391, 104 S. Ct. 756, 78 L. Ed. 2d 549 (1984); Lucia v. United States, 474 F.2d 565, 570 (5th Cir. 1973). An extended limitations period is warranted in the case of a false or fraudulent return because of the special disadvantage to the Commissioner in investigating these types of returns. Badaracco v. Commissioner, supra at 398. Three years may not be sufficient for the Commissioner to investigate or prove fraudulent intent. Id. at 399.
We agree with respondent that the special disadvantage to the Commissioner in investigating fraudulent returns is present if the income tax return preparer committed the fraud that caused the taxes on the returns to be understated. Accordingly, taking into account our obligation to construe statutes of limitations strictly in favor of the Government, we conclude that the limitations period for assessing petitioner's taxes is extended if the taxes were understated due to fraud of the preparer.
* * * *
We conclude that the limitations period for assessment is extended under section 6501(c)(1) if the return is fraudulent, even though it was the preparer rather than petitioner who had the intent to evade tax. The plain meaning of the statute indicates that it is the fraudulent nature of the return that extends the limitations period. We therefore find that the limitations period for assessing tax against petitioner is extended indefinitely.
Professor Bryan Camp has criticized the Allen holding in two articles. Bryan T. Camp, Presumptions and Tax Return Preparer Fraud, 120 Tax Notes 167 (2008); and Bryan T. Camp, Tax Return Preparer Fraud and the Assessment Limitation Period, 116 Tax Notes 687 (Aug. 20, 2007). Professor Camp argues in his articles that the Tax Court mis-interpreted the plain language of the statute and that, in addition, the history of statute shows it is supposed to reach only bad-acting taxpayers. Professor Camp's analysis would thus not sweep in the fraudulent intent of enablers, whether they fit the technical definition of preparers or not.
So, we have two plain language advocates reaching opposite conclusions; which may suggest that the plain language is not so plain and that therefore resort to something other than plain language is critical and, as Professor Camp notes in his articles, a persuasive case can be made from the sources other than the statutory text that it is the fraudulent conduct of the taxpayer that must control both the unlimited statute of limitations and the civil fraud penalty. Nevertheless, we have Allen as the only direct authority, and it stands for the proposition that the conduct of others than the taxpayers may trigger the unlimited statute of limitations (albeit not the civil fraud penalty).
Professor Camp urges if Allen were correct (which he vigorously disputes) on the bare words of the statute, the IRS should exercise its enormous discretion to "walk away from these new powers that it has been granted [by the Allen case] and focus on the tools that Congress gave it to combat the problem of tax return preparer fraud." Professor Camp is presuming that the wholly innocent taxpayer (and not the bad-acting enablers) is being punished by the unlimited statute of limitations.
In the case of abusive tax shelters, however, the Government's imagination is that the taxpayers may not be wholly innocent. Tax benefits were created from thin air in an environment (often the reports are that the taxpayer or the taxpayer's advisors and even some of the enablers said early on that the shelter was "too good to be true" or some variation of that notion). Hence, if Professor Camp is wrong on the law and the IRS does actually have the tremendous discretion in the application of this interpretation, the IRS may desire to exercise the power in some cases and not in other cases. Are abusive tax shelters a case in which the IRS should or will exercise its powers?
If the Government tries, taxpayers will surely assert vigorously, as has Professor Camp, that Allen is wrongly decided, both as a matter of statutory interpretation and of policy. I think there is a reasonable chance that the Camp interpretation will prevail. I just think that Congress intended the panoply of provisions addressing return preparer and enabler abuses to cover the ground (and prosecutors have plenty of weapons against bad-acting tax shelter enablers) and did not intend to punish innocent taxpayers (which for this purpose includes perhaps not so innocent taxpayers whose intentions were not fraudulent) with an unlimited statute of limitations.
But, if Allen does prevail, the question then, of course, is that the Government can prove by clear and convincing evidence of fraud as to one or more enablers in the tax shelter chain with reasonable nexus to the return reporting position. Even if the Government could not or could but did not prosecute the taxpayers, it could still sweep those taxpayers into an unlimited civil statute of limitations, and put a lot of enablers’ actions in the line of fire. Of course, those innocent and not-so-innocent taxpayers might be able to push all or some of the cost to the bad-acting enablers through malpractice or related fraud claims.
Finally, in such a proceeding involving the unlimited statute of limitations, any of the enablers' convictions will not give rise to res judicata or collateral estoppel because the taxpayers are not in privity with them. But obviously, their convictions will be bad facts and may go a long way to meeting the Government's burden to prove fraud by clear and convincing evidence.
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