United States Tax Court Decision for the Week-Interest and Penalties on Criminal Restitution Award

A recent Tax Court decision was reported potentially dealing with tax litigation and interest and penalties added to a Criminal Restitution Award. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

IRS Cannot Add Interest and Penalties to Criminal Restitution Award

The Tax Court, in a case of first impression, held that the IRS may not assess and collect interest and penalties on a restitution award in a criminal conviction for failure to pay tax. The Tax Court found that restitution is treated as if it were a tax, but only for the limited purpose of allowing the IRS to create an account receivable against which the restitution can be credited. Klein v. Comm’r, 149 T.C. (2017).

Zipora and Samuel Klein, a married couple, pleaded guilty to willfully filing a false federal income tax return for 2006. Each was sentenced to prison and the couple was jointly ordered to pay restitution to the IRS. Mr. Klein admitted in his plea agreement that he had underreported income on the couple’s joint returns for 2003-2006. For sentencing purposes, the government presented a tax loss calculation of approximately $560,000 based on a reconstruction of the Kleins’ income for 2003-2006. The sentencing court disregarded the Kleins’ objections that the calculation did not include any deductions other than those reported on the returns filed for those years. U.S. sentencing guidelines permit the tax loss amount to be uncertain, and the sentencing court may make a reasonable estimate based on the available facts.

Pursuant to their plea agreements, the Kleins signed an IRS closing agreement acknowledging that their overall tax liabilities for 2003-2006 remained indeterminate. The Kleins waived all defenses, including the statute of limitations, and agreed that the IRS could audit their 2003-2006 returns at any time. Six years later, the IRS had not completed or even begun a civil examination for the Kleins’ 2003-2006 tax years.

In 2014, Mrs. Klein was released from custody and paid to the IRS the restitution amount in full. The government then released a previously filed notice of lien against her, stating that she had satisfied her payment obligations with respect to the restitution, together with all statutory additions. Two months later, the IRS filed a notice of federal tax lien (NFTL) against the Kleins, seeking interest and penalties for failure to pay with respect to the restitution amount. The IRS treated the tax loss amount as the underpayment for each year and used the original due dates of the returns as the commencement date for calculating interest.

The Kleins requested a collection due process hearing seeking withdrawal of the NFTL because they had paid the restitution. A settlement officer noted that the restitution portion of the assessment had been paid but that the assessed interest and penalties had not. The Kleins did not propose a collection alternative and the IRS issued notices of determination sustaining the NFTL filings. The notice showed a total balance due of almost $360,000, consisting entirely of assessed interest and penalties calculated on the amount of the restitution. The Kleins challenged the notice in the Tax Court.

Interest applies to any unpaid tax under Code Sec. 6601, and a penalty applies under Code Sec. 6651(a)(3) for the failure to pay the tax required to be shown on a return. Under Code Sec. 6201(a)(4), the IRS may assess and collect a criminal restitution award for failure to pay any tax in the same manner “as if” the amount were such a tax. The IRS acknowledged that restitution is not literally a tax, but argued that there was no meaningful difference between an amount that is assessed and collected as if it were a tax and an amount that is assessed and collected as a tax.

According to the IRS, interest and penalties are an inevitable adjunct of the civil tax collection procedure authorized by Code Sec. 6201(a)(4). The IRS cited language in the Internal Revenue Manual (IRM) stating that, because criminal restitution is assessed and collected the same as any civil tax assessment, interest and failure to pay penalties would apply as they would for any other civil tax assessment. It also drew a negative inference from Code Sec. 6305(a), which authorizes the IRS to assess and collect delinquent spousal support as if it were a tax. The wording of Code Sec. 6305(a) is similar to Code Sec. 6201(a)(4), but explicitly provides that no interest or penalties can be assessed or collected. The IRS argued that Congress could have included the same limiting language in Code Sec.6201(a)(4) if it had intended such treatment to apply.

The Tax Court held that Code Sec. 6201(a)(4) does not authorize the IRS to add underpayment interest or failure-to-pay penalties to a title 18 restitution award, and the IRS cannot assess or collect from the Kleins underpayment interest or additions to tax without first determining their civil tax liabilities. The court reasoned that the purpose of the “as if” language in Code Sec. 6201(a)(4) is to treat restitution as a tax only for the limited purpose of enabling the IRS to assess the amount in order to create an account receivable against which the restitution payment can be credited. According to the Tax Court, the inclusion of the word “if” in Code Sec 6201 was significant and had to be given effect.

Reviewing the legislative history, the Tax Court determined that Congress’s intent was to address the IRS’s lack of a proper accounting mechanism to credit receipts of restitution payments by giving the IRS early assessment authority for such awards. The Tax Court noted that the IRS usually waits until after a criminal proceeding to begin an audit to determine the taxpayer’s civil liabilities, so the timing created a bookkeeping issue for the IRS. Although the legislative history included a legislator’s floor speech expressing the belief that the bill would permit the assessment and collection of restitution awards for victims of crime in the same manner as delinquent taxes are assessed and collected, the Tax Court found that contemporaneous remarks of a sponsor of legislation are not controlling in analyzing legislative history.

The Tax Court rejected the IRS’s reliance on the IRM, finding the relevant IRM provisions to be short on analysis. The Tax Court noted that IRM provisions do not bind the courts and reasoned that the deference due to an agency manual depends on its thoroughness, logic and expertness. According to the Tax Court, on a question of statutory construction, the IRM would have limited power to persuade in any event and especially given its lack of analysis on this issue.

The Tax Court also disagreed with the IRS’s conclusion that Code Sec. 6305(a) proved Congress knew how to draft limiting language and would have done so in Code Sec. 6201(a)(4) if it intended to limit assessments of interest and penalties on restitution awards. The Tax Court reasoned that such an inference is strongest when the provisions were considered simultaneously and that there was no reason to believe that the Congress that enacted Code Sec. 6201(a)(4)35 years after Code Sec. 6305(a)(4) considered, but decided against, providing such an exclusion in Code Sec. 6201(a)(4).

The Tax Court noted that the differences between a tax loss calculation in a criminal tax case and civil tax liability supported its conclusion. According to the Tax Court, restitution is designed to compensate the IRS for the loss caused by the wrongdoing, while civil tax liability is typically determined after the criminal proceeding. The civil tax liability may be higher or lower than the tax loss that formed the basis of the restitution award. To the Tax Court, this showed the basic flaw in the IRS’s argument that a restitution award should be equated with a tax. A tax loss calculation is a simplified calculation intended to avoid complex disputes over adjustments and deductions during sentencing, where the yardstick for measuring tax loss is typically not understated taxable income but underreported gross income. By contrast, unclaimed deductions for legitimate expenses are fully available to the taxpayer in determining civil tax liability in an IRS audit. To the Tax Court, the difference between a restitution award and civil tax liability showed why restitution could not be equated to a tax.

The Tax Court concluded that a restitution obligation is not a civil tax liability and that Congress did not change that fact when it authorized the IRS to assess and collect restitution in the same manner as if it were a tax. According to the Tax Court, the Kleins had waived all defenses so the IRS was free to begin an audit of their civil tax liabilities, to which interest and penalties could be imposed; in that event, the interest and penalties would be determined by reference not to the tax loss calculation but to the Kleins’ actual tax liabilities.

United States Tax Court Decision for the Week and Filing Status

A recent Tax Court decision was reported potentially dealing with tax litigation and filing status of Joint v. Separate returns. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Taxpayer Can File Joint Return After Original Return Erroneously Reported Single Status

The Tax Court held that a return that a taxpayer originally filed, erroneously claiming single status, did not constitute a “separate return” within the meaning of Code Sec. 6013(b) and, thus, the taxpayer and his wife were entitled to file a joint return and pay joint return tax rates for the year at issue. The Tax Court concluded that the term “separate return” means a return on which a married taxpayer has claimed the permissible status of married filing separately, rather than a return on which a married taxpayer has claimed a filing status not properly available to him or her. Camara v. Comm’r, 149 T.C. No. 13 (2017).

Facts

Fansu Camara was married to Aminata Jatta. Nevertheless, on his 2012 Form 1040, which he filed on April 15, 2013, Mr. Camara erroneously checked the box for single filing status. In a notice of deficiency issued to Mr. Camara for his 2012 tax year, the IRS changed his filing status from single to married filing separately. On May 8, 2015, Mr. Camara and Ms. Jatta timely petitioned the Tax Court with respect to that notice of deficiency as well as a notice of deficiency that the IRS issued to them for their 2013 tax year. On May 27, 2016, Mr. Camara and Ms. Jatta filed with the IRS a joint 2012 return, which they had both signed. Ms. Jatta had not previously filed a 2012 return.

The couple and the IRS agreed that if Mr. Camara and Ms. Jatta were entitled to elect joint filing status for 2012, the joint return that they filed on May 27, 2016 – after receiving the notice of deficiency and petitioning the Tax Court – correctly reflected their 2012 tax liability with certain agreed-upon changes. And the IRS conceded that Mr. Camara and Ms. Jatta met the substantive requirements for joint filing status and rates for 2012. However, the IRS contended that Code Sec. 6013(b)(2) barred Mr. Camara and Ms. Jatta from filing a joint return, and consequently, they were procedurally barred from claiming the benefits generally available to married taxpayers who file a joint return.

Code Sec. 6013 governs whether a married couple may file a joint return. Under Code Sec. 6013(a), a married couple can “make a single return jointly of income taxes” subject to three restrictions, which are not applicable in this case. Code Sec. 6013(b) permits married taxpayers to elect in certain circumstances to switch from a separate return to a joint return. Code Sec. 6013(b)(1) provides that if an individual has filed a “separate return” for a tax year for which that individual and his or her spouse could have filed a joint return, that individual and his or her spouse may nevertheless “make a joint return” for that year. Because the Code Sec. 6013(b) election applies only where an individual has filed a separate return, limitation under Code Sec. 6013(b)(2) likewise apply only if the individual has filed a separate return. The term “separate return” in Code Sec. 6013(b)(1) is not defined in the Code or the regulations.

IRS Arguments

The IRS argued that Mr. Camara’s original 2012 return, on which he erroneously claimed single filing status, constituted a “separate return” within the meaning of Code Sec. 6013(b)(1) and, consequently, two limitations under Code Sec. 6013(b)(2) applied to prevent Mr. Camara from making the Code Sec. 6013(b) election to switch to a joint return. The two limitations that the IRS invoked were in Code Sec. 6013(b)(2)(A) and Code Sec. 6013(b)(2)(B). The first limitation bars the Code Sec. 6013(b) election after three years from the filing deadline (without extensions) for filing the return for that year. The second limitation bars the Code Sec. 6013(b) election after there has been mailed to either spouse, with respect to such tax year, a notice of deficiency, if the spouse, as to such notice, files a petition with the Tax Court within 90 days.

According to the IRS, the two limitations were satisfied because: (1) the date on which Mr. Camara and Ms. Jatta filed a joint return – May 27, 2016 – was more than three years after Mr. Camara filed a separate return; and (2) Mr. Camara received a notice of deficiency, and filed a petition with the Tax Court before filing a joint return.

The IRS also cited the Sixth Circuit’s decision in Morgan v. Comm’r, 807 F.2d 81 (6th Cir. 1986), aff’g T.C. Memo. 1984-384, as compelling a decision in its favor. Morgan involved married taxpayers who filed “protest returns” claiming married filing jointly status for some years and married filing separately status for other years. Affirming the Tax Court, the Sixth Circuit in Morgan held that Code Sec. 6013(b)(2) precluded the husband from claiming the benefits of joint return filing status after the IRS issued a notice of deficiency calculating his tax on the basis of married filing separately.

Tax Court Holding

The Tax Court held that the 2012 return that Mr. Camera originally filed, erroneously claiming single status, did not constitute a “separate return” within the meaning of Code Sec. 6013(b). Thus, Mr. Camera and his wife were entitled to file a joint return and pay joint return tax rates for that year.

The Tax Court began its analysis by noting that the issue raised by the IRS has not been formally addressed by the Tax Court in a reported or reviewed opinion. The court also noted that no Court of Appeals has held that a single return or a head of household return is a separate return for the purposes of Code Sec. 6013(b) and the two Appeals Court cases that have considered this issue, Ibrahim v. Comm’r, 788 F.3d 834 (8th Cir. 2015) and Glaze v. Comm’r, 641 F.2d 339 (5th Cir. 1981), have held the opposite. The court also observed that some Memorandum Opinions had interpreted “separate return” to include a single return or a head of household return for this purpose. For the most part, however, those Memorandum Opinions merely accepted the rationale of earlier cases, and the ultimate authority for those Memorandum Opinions appeared to be traceable to earlier cases where the effect of an erroneous claim of filing status was neither addressed nor even presented as an issue.

The Tax Court noted that its decision in the instant case would be appealable to the Sixth Circuit. However, the court rejected the IRS’s argument that the Sixth Circuit’s holding in Morgan compelled it to rule in the IRS’s favor. Morgan, the court said, did not squarely address the issue presented in the instant case because Morgan did not explain the effect under Code Sec. 6013(b) of a married taxpayer’s initial filings of a return erroneously claiming single status.

The court did find, however, that the Fifth Circuit, in Glaze, squarely addressed the issue. In Glaze, the Fifth Circuit held that filing a return with an erroneous claim to an impermissible filing status (i.e., a filing status of single when the taxpayer was married) did not constitute an “election” to file a separate return. The Fifth Circuit in Morgan, the court observed, distinguished Glaze on the grounds that Glaze involved no protest return and the taxpayer had not attempted to file a return as a married taxpayer originally. The Tax Court found that Mr. Camara’s case was distinguishable from Morgan on the same grounds on which Glaze was distinguished in Morgan. Mr. Camara neither filed a protest return nor attempted to file a return as a married taxpayer originally.

Considering the context of Code Sec. 6013(b) as a whole and giving due regard to the Fifth Circuit’s opinion in Glaze, as well as an Eight Circuit’s opinion in Ibrahim, the Tax Court concluded that the term “separate return” means a return on which a married taxpayer has claimed the permissible status of married filing separately, rather than a return on which a married taxpayer has claimed a filing status not properly available to him or her.

Finally, the court also noted that the legislative history showed that Code Sec. 6013(b)(1) was intended only to provide taxpayers flexibility in switching from a proper initial election to file a separate return to an election to file a joint return; it was not intended to foreclose correction of an erroneous initial retur

United States Tax Court Decision for the Week and Gambling Winnings

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation and gambling winnings and standard deduction v. itemized deductions. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Taxpayers Who Elected Standard Deduction Can’t Deduct Gambling Losses

The Tax Court held that a couple was taxable on gambling winnings shown on their Form W-2G and, because the couple could not substantiate how much was spent in producing the winnings, no reduction was allowed. The court also found that the couple’s election to take the standard deduction precluded them from taking an itemized deduction for their gambling losses. Viso v. Comm’r, T.C. Memo. 2017-154.

During 2013, William Viso engaged in a variety of recreational gambling activities: he bet on college and professional sports, played slot machines, and bought lottery tickets. That year, he won $5,060 on slot machines at three different casinos. The gambling winnings were reported on Forms W-2G, Certain Gambling Winnings. That same year, Viso and his wife sustained approximately $7,000 in gambling losses.

On their joint Form 1040, the Visos did not report any gambling winnings or losses for the 2013 tax year. They claimed a standard deduction of $12,200. The IRS assessed a tax deficiency after including the $5,060 of gambling winnings in the couple’s 2013 income.

The Visos did not challenge the accuracy of the gross gambling winnings included in their income; instead they argued that those amounts should be reduced by the amounts of bets they placed to produce their winnings. Although the couple introduced evidence of losses at another casino (in addition to lottery tickets and sporting bets), they produced no evidence as to how much William bet to produce the winnings reflected on the Forms W-2G.

For tax purposes, gambling losses are treated in one of two ways. Taxpayers engaged in the trade or business of gambling may deduct their gambling losses against their gambling winnings “above the line” as a trade or business expense in arriving at adjusted gross income. In the case of taxpayers not engaged in the trade or business of gambling, gambling losses are allowable as an itemized deduction, but only to the extent of gambling winnings.

The Tax Court held that the couple’s election to take the standard deduction precluded them from taking an itemized deduction for their gambling losses. In addition, because they could not substantiate how much was spent in producing the winnings reflected on Forms W-2G, no reduction was allowed. In reaching its conclusion, the court cited Torpie v. Comm’r, T.C. Memo. 2000-168 which held that, in order to claim any Schedule A itemized deductions, a taxpayer must forgo the standard deduction.

The Tax Court noted that the couple’s standard deduction of $12,200 exceeded their potential itemized deduction for gambling losses of $5,060. Thus, the court said, the couple’s election to take the standard deduction resulted in a larger deduction than if they had taken an itemized deduction for their gambling losses. Since the couple elected to take the standard deduction, the court held they could not take an itemized deduction for their gambling losses to offset their gambling winnings.

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Former IRS Agent and Wife Liable for $73,000 in Fraud Penalties:In Langer v. Comm’r, T.C. Memo. 2017-92, the Tax Court held that a couple’s repeated concealment of income by overstating deductions on their 2011-2013 tax returns exemplified a pattern of fraudulent behavior and the couple was thus liable for fraud penalties of approximately $73,000. The court noted that the husband had been an IRS agent for more than 29 years and that the couple’s explanations regarding the deductions taken on their returns were implausible and unpersuasive.

UNITED STATES TAX COURT

T.C. Memo. 2017-92-CIVIL FRAUD

May 30, 2017.

HENRY LANGER AND PATRICIA LANGER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22719-15.

Thomas Edward Brever , for petitioners.

Christina L. Cook and John Schmittdiel , for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NEGA, Judge : Respondent issued a notice of deficiency to petitioners determining deficiencies in income tax and fraud penalties as follows:1

[*2]

                           Penalty

Year     Deficiency1     sec. 6663(a)

2011       $36,595        $27,446.25

2012        27,386         20,539.50

2013        33,689         25,266.75

__________

1The amounts referred to herein reflect an agreement by the parties to
revised deficiencies in Federal income tax as reflected on Form 5278,
Statement–Income Tax Changes, and are less than respondent’s initial
determinations in the notice of deficiency.

Petitioners conceded in full the deficiencies for tax years 2011-13. The only issue for decision is whether petitioners are liable for fraud penalties under section 6663 for tax years 2011-13.

FINDINGS OF FACT

Some of the facts are stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Minnesota when the petition was timely filed.

Henry Langer was an Internal Revenue Service revenue agent for over 29 years and received training in determining allowable business expense deductions; he was also a certified forensic examiner. Petitioners have a history of claiming [*3] business expense deductions for obvious personal expenses and expenses they could not substantiate. See, e.g. , Langer v. Commissioner (Langer I ), T.C. Memo. 2008-255, 96 T.C.M. (CCH) 334, 339 (2008) (“[P]etitioners claimed as business expense deductions many obviously personal items . A former Internal Revenue Service agent should have known better .” (Emphasis added.)), aff’d without published opinion , 378 F. App’x 598 (8th Cir. 2010); Langer v. Commissioner (Langer II ), T.C. Memo. 1992-46, 63 T.C.M. (CCH) 1900 (1992), aff’d , 989 F.2d 294 (8th Cir. 1993); Langer v. Commissioner (Langer III ), T.C. Memo. 1990-268, 59 T.C.M. (CCH) 740, 746 (1990) (holding petitioners liable for an addition to tax under section 6653(a) for negligence because petitioners’ conduct suggested a “pattern of carelessness” and because petitioners used methods for determining deductions that had “no basis in the law”), aff’d , 980 F.2d 1198 (8th Cir. 1992).

Respondent disallowed $113,194, $67,186, and $84,087 of petitioners’ claimed deductions on Schedules C, Profit or Loss From Business, for 2011-13, respectively, as personal expenses; many of petitioners’ claimed and disallowed expense deductions were identical to those disallowed as personal expenses in Langer I and Langer II , including expenses for parties, gifts, flowers, vases, and holiday decorations, to name a few.

[*4] OPINION

The Commissioner must establish by clear and convincing evidence that, for each year at issue, an underpayment of tax exists and that some portion of the underpayment is due to fraud. Secs. 6663(a), 7454(a); Rule 142(b). The Commissioner must show that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes. Katz v. Commissioner , 90 T.C. 1130, 1143 (1988). The taxpayer’s entire course of conduct may establish the requisite fraudulent intent. Stone v. Commissioner , 56 T.C. 213, 223-224 (1971).

Petitioners conceded in full the deficiencies for 2011-13, and therefore respondent satisfied his burden of proving an underpayment of tax for each year at issue. Respondent established that, for each year at issue, petitioners’ underpayment of tax was fraudulent and that they intended to conceal taxable income and prevent the collection of tax by overstating deductions and claiming nondeductible and obvious personal expenditures as business expenses. See Rahall v. Commissioner , T.C. Memo. 2011-101, 101 T.C.M. (CCH) 1486, 1492 (2011) (“An additional badge of fraud includes a taxpayer disguising nondeductible personal expenditures as business expenses.”). Mr. Langer’s nearly 30 years of experience as a revenue agent and petitioners’ history before this Court for identical issues are relevant considerations in determining whether they had [*5] fraudulent intent. See Beaver v. Commissioner , 55 T.C. 85, 93-94 (1970) (stating that petitioner’s business experience is a relevant consideration in determining whether he had fraudulent intent). Petitioners’ repeated concealment of income by overstating deductions exemplifies a pattern of fraudulent behavior, and their explanations are implausible and unpersuasive. See McGraw v. Commissioner , 384 F.3d 965, 971 (8th Cir. 2004) (“[A] consistent pattern of sizeable underreporting of income * * * and unsatisfactory explanations for such underreporting also can establish fraud.”), aff’g Butler v. Commissioner , T.C. Memo. 2002-314; Sanchez v. Commissioner , T.C. Memo. 2014-174, at *17 (stating that “a pattern of conduct that evidences an intent to mislead” is one of the “badges of fraud” from which fraudulent intent can be inferred), aff’d , ___ F. App’x ___, 2016 WL 7336626 (9th Cir. Dec. 19, 2016); Bruce Goldberg, Inc. v. Commissioner , T.C. Memo. 1989-582, 58 T.C.M. (CCH) 519, 529 (1989) (“[F]raud may sometimes be inferred from a pattern of overstating deductions.”). Accordingly, petitioners are liable for the fraud penalties under section 6663 for all years at issue.

[*6] To reflect the foregoing,

Decision will be entered under Rule 155 .

Footnotes

1Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

[End of Document]

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Former IRS Agent and Wife Liable for $73,000 in Fraud Penalties:In Langer v. Comm’r, T.C. Memo. 2017-92, the Tax Court held that a couple’s repeated concealment of income by overstating deductions on their 2011-2013 tax returns exemplified a pattern of fraudulent behavior and the couple was thus liable for fraud penalties of approximately $73,000. The court noted that the husband had been an IRS agent for more than 29 years and that the couple’s explanations regarding the deductions taken on their returns were implausible and unpersuasive.

UNITED STATES TAX COURT

T.C. Memo. 2017-92-CIVIL FRAUD

May 30, 2017.

HENRY LANGER AND PATRICIA LANGER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22719-15.

Thomas Edward Brever , for petitioners.

Christina L. Cook and John Schmittdiel , for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NEGA, Judge : Respondent issued a notice of deficiency to petitioners determining deficiencies in income tax and fraud penalties as follows:1

[*2]

                           Penalty

Year     Deficiency1     sec. 6663(a)

2011       $36,595        $27,446.25

2012        27,386         20,539.50

2013        33,689         25,266.75

__________

1The amounts referred to herein reflect an agreement by the parties to
revised deficiencies in Federal income tax as reflected on Form 5278,
Statement–Income Tax Changes, and are less than respondent’s initial
determinations in the notice of deficiency.

Petitioners conceded in full the deficiencies for tax years 2011-13. The only issue for decision is whether petitioners are liable for fraud penalties under section 6663 for tax years 2011-13.

FINDINGS OF FACT

Some of the facts are stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Minnesota when the petition was timely filed.

Henry Langer was an Internal Revenue Service revenue agent for over 29 years and received training in determining allowable business expense deductions; he was also a certified forensic examiner. Petitioners have a history of claiming [*3] business expense deductions for obvious personal expenses and expenses they could not substantiate. See, e.g. , Langer v. Commissioner (Langer I ), T.C. Memo. 2008-255, 96 T.C.M. (CCH) 334, 339 (2008) (“[P]etitioners claimed as business expense deductions many obviously personal items . A former Internal Revenue Service agent should have known better .” (Emphasis added.)), aff’d without published opinion , 378 F. App’x 598 (8th Cir. 2010); Langer v. Commissioner (Langer II ), T.C. Memo. 1992-46, 63 T.C.M. (CCH) 1900 (1992), aff’d , 989 F.2d 294 (8th Cir. 1993); Langer v. Commissioner (Langer III ), T.C. Memo. 1990-268, 59 T.C.M. (CCH) 740, 746 (1990) (holding petitioners liable for an addition to tax under section 6653(a) for negligence because petitioners’ conduct suggested a “pattern of carelessness” and because petitioners used methods for determining deductions that had “no basis in the law”), aff’d , 980 F.2d 1198 (8th Cir. 1992).

Respondent disallowed $113,194, $67,186, and $84,087 of petitioners’ claimed deductions on Schedules C, Profit or Loss From Business, for 2011-13, respectively, as personal expenses; many of petitioners’ claimed and disallowed expense deductions were identical to those disallowed as personal expenses in Langer I and Langer II , including expenses for parties, gifts, flowers, vases, and holiday decorations, to name a few.

[*4] OPINION

The Commissioner must establish by clear and convincing evidence that, for each year at issue, an underpayment of tax exists and that some portion of the underpayment is due to fraud. Secs. 6663(a), 7454(a); Rule 142(b). The Commissioner must show that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes. Katz v. Commissioner , 90 T.C. 1130, 1143 (1988). The taxpayer’s entire course of conduct may establish the requisite fraudulent intent. Stone v. Commissioner , 56 T.C. 213, 223-224 (1971).

Petitioners conceded in full the deficiencies for 2011-13, and therefore respondent satisfied his burden of proving an underpayment of tax for each year at issue. Respondent established that, for each year at issue, petitioners’ underpayment of tax was fraudulent and that they intended to conceal taxable income and prevent the collection of tax by overstating deductions and claiming nondeductible and obvious personal expenditures as business expenses. See Rahall v. Commissioner , T.C. Memo. 2011-101, 101 T.C.M. (CCH) 1486, 1492 (2011) (“An additional badge of fraud includes a taxpayer disguising nondeductible personal expenditures as business expenses.”). Mr. Langer’s nearly 30 years of experience as a revenue agent and petitioners’ history before this Court for identical issues are relevant considerations in determining whether they had [*5] fraudulent intent. See Beaver v. Commissioner , 55 T.C. 85, 93-94 (1970) (stating that petitioner’s business experience is a relevant consideration in determining whether he had fraudulent intent). Petitioners’ repeated concealment of income by overstating deductions exemplifies a pattern of fraudulent behavior, and their explanations are implausible and unpersuasive. See McGraw v. Commissioner , 384 F.3d 965, 971 (8th Cir. 2004) (“[A] consistent pattern of sizeable underreporting of income * * * and unsatisfactory explanations for such underreporting also can establish fraud.”), aff’g Butler v. Commissioner , T.C. Memo. 2002-314; Sanchez v. Commissioner , T.C. Memo. 2014-174, at *17 (stating that “a pattern of conduct that evidences an intent to mislead” is one of the “badges of fraud” from which fraudulent intent can be inferred), aff’d , ___ F. App’x ___, 2016 WL 7336626 (9th Cir. Dec. 19, 2016); Bruce Goldberg, Inc. v. Commissioner , T.C. Memo. 1989-582, 58 T.C.M. (CCH) 519, 529 (1989) (“[F]raud may sometimes be inferred from a pattern of overstating deductions.”). Accordingly, petitioners are liable for the fraud penalties under section 6663 for all years at issue.

[*6] To reflect the foregoing,

Decision will be entered under Rule 155 .

Footnotes

1Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

[End of Document]

 

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Court Calls Taxpayer’s Arguments “Heavy on Chutzpah”; Duty of Consistency Prevents Additional Deductions-CIVIL FRAUD

The Tax Court held that a restaurant owner who underreported his employees’ wages for years that were outside of the three-year assessment period could not later amend his returns to increase the amount of wages he paid in order to claim additional deductions. The duty of consistency prevented him from taking a contradictory position after the statute of limitations had run in order to change a previous representation to the detriment of the IRS. Musa v. Comm’r, 2017 PTC 200 (7th Cir. 2017).

Background

Alaa Musa owns and operates a restaurant in Milwaukee, Wisconsin. For the years 2006 to 2010, the IRS determined that Musa underreported his income taxes by more than $500,000 and made numerous other misrepresentations on his tax returns. Musa employed his family members and did not report their wages to the company he hired to assist with payroll. The payroll company’s services included withholding the required taxes from employees’ paychecks, issuing Forms W-2 to the employees and the IRS, and filing Musa’s quarterly employment tax returns. Between 2006 and 2008, Musa did not include any of his family members’ earnings when he reported his employees’ information to the payroll company. For 2009 and 2010, he included only two family members’ wages. He also underreported the restaurant’s revenues on his individual tax returns by giving inaccurate information to his accountant.

In 2009, the IRS audited Musa starting with his 2007 return, then expanded the audit to include his returns from 2006 to 2008. The IRS reviewed the bank statements for Musa and the restaurant and found that the amount of credit card deposits in the restaurant’s account exceeded what Musa had reported on his returns. The IRS decided to pursue Musa for civil tax fraud. While under audit, Musa hired a new accountant to prepare his 2009 and 2010 returns and to file amended employment tax returns for 2006 to 2008. He made these corrections, however, only after the statute of limitations had run on the IRS’s ability to collect the correct amounts of employment taxes that Musa’s amended returns admitted were due.

In 2012, the IRS sent Musa a notice of income tax deficiency for 2006 to 2010. Musa challenged the notice in the Tax Court. In 2013, Musa responded to a discovery request by providing a list of employees who he claimed had been paid additional wages. Musa claimed he was entitled to additional deductions for these wages in calculating his income tax liabilities.

The IRS argued that Musa’s duty of consistency prevented him from claiming new expense deductions on his income tax returns for wages paid between 2006 and 2009 because the IRS had relied on representations made by Musa in his original reports of employee wages in the restaurant’s quarterly tax returns and because the three-year period under Code Sec. 6501 for assessing employment taxes on those wages had expired. The Tax Court ruled in the IRS’s favor and determined that Musa had understated his income, failed to keep adequate records, concealed income, failed to file Forms W-2 and 1099-MISC for all employees, filed false documents, and failed to make estimated tax payments. The Tax Court found him liable for over $500,000 in income tax for 2006 to 2010, and over $380,000 in fraud penalties.

Analysis

The duty of consistency is an equitable tax doctrine which prevents a party from prevailing in a court proceeding by taking one position and then taking a contradictory position in a later case. It applies when there has been a representation by the taxpayer on which the IRS has relied followed by an attempt after the statute of limitations has run to change the previous representation or to recharacterize the situation in a way that harms the IRS.

Musa appealed to the Seventh Circuit. On appeal, Musa conceded that he had filed fraudulent income and employment tax returns but said the Tax Court had erred in its ruling on the duty of consistency. Calling Musa’s arguments “heavy on chutzpah but light on reasoning or any sense of basic fairness,” the Seventh Circuit affirmed the Tax Court.

The Seventh Circuit agreed with the IRS that Musa violated the duty of consistency. First, Musa made representations on his employment tax filings for 2006 to 2009 that the restaurant paid its employees certain sums in non-tip wages. Then, in 2013, Musa amended his filings to add wages that he had paid to his employees but failed to report for those same years. The court found that the IRS had relied on Musa’s original representations because it assessed employment taxes based on the original filings.

Musa argued that the IRS did not rely on the employment returns because it should have known that the returns were inaccurate. Musa claimed that the IRS either had all the facts available to it or had the opportunity to gain such knowledge before the limitations period expired, so the IRS did not “rely” on Musa’s false representations. In other words, Musa argued, after the IRS discovered his income tax fraud and he submitted amended income tax returns, the IRS should have induced from the amended income tax returns that the restaurant’s quarterly employment tax returns had also been incorrect.

The Seventh Circuit found there was no merit to Musa’s claim that the IRS lost its ability to rely on Musa’s employment tax returns because Musa amended his income tax returns. The court reasoned that the tax system is based on self-reporting and the IRS must be able to rely on truthful reporting for the system to function. In the court’s view, the IRS was permitted to take at face value the representations on Musa’s original employment tax returns and the duty of consistency prevented Musa from claiming the additional deductions which Musa tried to use to offset the consequences of his own fraud.

 

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A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Practitioner, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

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ROBERT CARTER, JR. AND LOLA CARTER,
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The United States Tax Court held that the IRS failed to prove a couple’s fraudulent intent in underpaying their taxes, and they are not liable for fraud penalties; the court sustained an accuracy-related penalty for negligence, finding that they understated their tax liability for one year by failing to report income and claiming unsubstantiated deductions.

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Practitioner, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

JAMES A. ERICSON AND REBECCA A. ERICSON,
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The United States Tax Court, declining to reconsider the validity of reg.section 1.162-5(b)(1), held that an accountant who prepared returns and provided other financial services for clients couldn’t deduct his tuition and fees for law school, finding that law school qualified him for a new trade or business as described in the regulation.

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Practitioner, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

EMMANUEL A. SANTOS,
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