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.

 

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 Practitioner, as a litigator, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Modified Child Support Order Didn’t Contradict Taxpayer’s Claim That He Was Custodial Parent

The United States Tax Court held that a taxpayer was entitled to take dependency exemptions, the earned income tax credit, and child tax credits for the year at issue. The court found that the IRS’s argument that the taxpayer wasn’t the custodial parent and wasn’t entitled to the exemptions and credits was entirely based on a child support order effective after the year at issue, and thus inapplicable. The court also determined that the taxpayer had reasonable cause for incorrectly claiming head of household filing status and thus was not liable for penalties assessed by the IRS. Tsehay v. Comm’r, T.C. Memo. 2016-200.

Background

Yosef Tsehay, whose first language is not English, worked as a custodian at a community college in Washington. He and his wife were married in 2001 and over the years their relationship was “on-again, off-again.” During 2013, the two were married and living together with their five children in a public housing apartment. Tsehay’s wife was responsible for paying the rent on the public housing unit, and he paid for food and other expenses of his family. In 2014, the couple separated, and during 2015 they were undergoing divorce proceedings.

Although Tsehay paid a tax return preparer to prepare his return, Tsehay electronically filed the 2013 Form 1040A himself. On the return, he claimed: (1) dependency exemption deductions for four children; (2) the earned income tax credit (EITC) for three children; (3) the child tax credit (CTC) for four children; and (4) head of household filing status. He did not attach a Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or a statement conforming to the substance of a Form 8332, to his Form 1040A for tax year 2013.

Following an audit, the IRS disallowed Tsehay’s claimed dependency exemption deductions, earned income tax credit, and child tax credit for 2013. The IRS also changed his filing status from head of household to single and determined an accuracy-related penalty under Code Sec. 6662(a).

Analysis

Under Code Sec. 151(c), an individual is allowed an exemption deduction for each “dependent,” which is generally defined as a qualifying relative or a qualifying child. In addition, taxpayers are entitled to claim the EITC under Code Sec. 32 and the CTC under Code Sec. 24 for qualifying children. Under Code Sec. 152(c), to be a qualifying child of the taxpayer, the child must have had the same principle place of above as the taxpayer for more than one-half of the tax year.

Under Code Sec. 2(b), a taxpayer can file as a head of household if the taxpayer is unmarried, has paid more than half the cost of keeping up a home for the year, and a qualifying person has lived with the taxpayer for more than half the year.

The Tax Court noted that the IRS’s determinations stemmed from its records showing that Tsehay was not the custodial parent of his minor children and from his failure to attach a copy of Form 8332 or its equivalent to his return. The IRS provided a copy of a child support order to establish that Tsehay was in fact a “noncustodial parent.” However, the court stated, the child support order was entered August 3, 2015, and thus did not apply for the year at issue. The court determined Tsehay had sufficiently established that he and his wife were married during 2013, and thus a Form 8332 to claim dependency exemptions was not required.

The court noted the children claimed on Tsehay’s return as dependents had the same principal place of abode as he did for more than one-half of the year at issue and were his qualifying chidlren, and determined that he was entitled to the dependency exemption deductions claimed on his 2013 return. In addition, because he had “three or more” qualifying children for tax year 2013, the court determined he was entitled to the earned income credit and to child tax credits and the additional child tax credits claimed.

With regard to his filing status, Tsehay explained to the court that because he and his wife had separated by the time he was ready to file his 2013 tax return, he had asked his preparer to file for him as “married filing separately.” The court noted that the preparer erroneously filed his return as “head of household.” Because Tsehay was married for 2013, the court stated he could not qualify for head of household filing status, and noted he also was not eligible to file as single as claimed by the IRS. Instead, the court said, his correct filing status for 2013 was in fact married filing separately.

With regard to the accuracy related penalty, the court observed that Tsehay had a language barrier, sought and relied on professional advice, and was separated from his wife when he filed his return. Under those circumstances, the court stated, Tsehay had reasonable cause and acted in good faith in filing his returns, and declined to impose penalties.

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 Practitioner, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Wife Who Spent Time Caring for Disabled Son Was Not a Responsible Person for Payroll Tax Purposes

The Tax Court held in Fitzpatrick v. Comm’r, T.C. Memo. 2016-199 that the wife of a silent owner of a restaurant and wine bar was not a responsible person and was not liable for trust fund recovery penalties with respect to unpaid employment taxes. The court noted that the woman spent most of her time taking care of her severely disabled son and her role at the restaurant was ministerial.

In 2004, James Stamps and Edward Fitzpatrick purchased the franchise rights to a wine bar and restaurant in Jacksonville, Florida, called the Grape. They agreed to be equal partners with James being the president and managing partner overseeing the business operations while Edward would be a silent partner and passive investor with some executive authority but no day-to-day duties.

Edward’s wife, Christina, has a high school education had no ownership interest in the business. Her primary responsibility during the years at issue was to serve as caregiver to her disabled son, Evan, who suffers from a rare metabolic disorder called citrullinemia. As a result of the disorder, Evan has severe autism, cerebral palsy, and limited mobility. He is required to take over 50 pills a day and cannot be left for any significant amount of time without adult supervision. Because of the substantial amount of attention Evan required, Christina was unable to devote significant effort to any business enterprise.

James and Edward formed Dey Corp., Inc. Dey Corp. purchased and operated the Grape franchise. James was the only person listed in the articles of incorporation as an officer and director. Shortly after James and Edward began engaging in preliminary business matters, James was unexpectedly hired for a short-term job at a beverage distributor in Puerto Rico. Therefore most of the preopening responsibilities fell upon Edward. Because of his busy schedule, Edward directed Christina to carry out some of those responsibilities. She opened bank accounts and engaged the services of Paychex, a payroll company. One of the services provided by Paychex was the payment of payroll taxes and electronically filing Forms 941, Employer’s Quarterly Federal Tax Return.

The Grape opened in March 2005 and was run primarily by James and a general manager he hired, Kris Chislett. Kris was responsible for carrying out the day-to-day business operations and was Paychex’s main contact during the periods at issue, and he maintained control over the payroll process.

Christina did not have a significant role at the Grape. Her main responsibilities were delivering checks, relaying electronic bank account balances to Kris, and delivering the business’ mail that was sent to her private mailbox. She occasionally transferred funds to and from the corporate bank account at the direction of James or her husband and sometimes issued checks at their direction for some of the business’ recurring monthly expenses. Christina made no operational decisions and did not have the background, education, or training to hold a management position at the Grape. Because no one was usually at Grape on the Tuesday morning the PayChex payroll package was delivered, Paychex started delivering the Grape’s payroll package to Christina and Edward’s home. It was usually necessary for Christina to sign the checks because Tuesday was Kris’s day off and there was no one else onsite available to sign the payroll checks. Christina was not responsible for and did not review statements included in the Paychex package.

Within a year of opening, the Grape was losing money. In 2008, Paychex attempts to withdraw money from the Dey Corp bank account to cover payroll taxes were rejected. Paychex continued to produce payroll checks and reference copies of Forms 941 and debit the funds from the Dey Corp bank account. However, it did not debit the payroll tax portion from the account, make payroll deposits on the business’ behalf, or file Forms 941. Christina was unaware these services had been canceled.

The Grape closed in 2011 and shortly thereafter, an IRS investigator went to the office of Dey Corp.’s CPA to discuss unpaid payroll taxes from the third quarter of 2008 through the closing of the restaurant. The CPA contacted Edward and Christina and notified them of the unpaid payroll taxes. This was the first time the couple had knowledge that federal payroll deposits had not been made for various quarters and that Forms 941 remained unfiled.

After conducting an investigation, an IRS officer recommended assessing trust fund recovery penalties (TFRPs) under Code Sec. 6672 against James, Kris, and Christina. Both James and Kris successfully administratively contested the assessments. James filed a request for abatement which was granted and Kris was granted relief by the IRS Office of Appeals. Christina challenged the liabilities during her CDP hearing but the IRS found her to be liable for the penalties which added up to over $150,000. Christina then took her case to the Tax Court.

Before the Tax Court, the IRS argued that Christina exercised substantial financial control over Dey Corp. and that at all times was a de facto officer of the corporation because she opened two corporate bank accounts, had signatory authority on both accounts, and signed checks on behalf of the corporation.

Christina argued that she lacked decision-making authority and did not exercise significant control over corporate affairs. She further asserted that despite her signatory authority, she was not a responsible person within the meaning of Code Sec. 6672 because she had a limited role in the business’ payroll process and merely signed payroll checks for the convenience of the corporation. According to Christina, James and Kris were responsible for running the corporation day to day and her duties were ministerial.

The Tax Court held that Christina was not a responsible person and thus was not liable for the TFRPs assessed against her. The court began by noting that liability for a TFRP is imposed only on (1) a responsible person who (2) willfully fails to collect, account for, or pay over the withheld tax. The court also commented on the credibility of the nine witnesses called to testify. The court found Christina and Edward, as well as a couple other witnesses to be credible. However, the court did not find the testimony of James, Kris, and another individual to be credible. The court also had little confidence in any of the documents the IRS obtained from Kris. The court found that the preponderance of the evidence showed that Christina’s role was ministerial and that she lacked decision-making authority.

The court also noted that Christina spent most of her time taking care of her disabled son and, that as a result of having to constantly lift Evan, she developed spinal stenosis which required periodic injections and epidurals. Consequently, she usually visited the corporation only once a week, on Tuesdays, for less than an hour each time.

Finally, the court said it was puzzled by the fact that James, the president of the corporation and a hands-on owner, and Kris, the day to-day manager, successfully evaded in the administrative phase any personal liability for the TFRPs.

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 Practitioner, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

IRS Collection Actions Were Abuse of Discretion Where the Settlement Officer Used Wrong Address: In Talbot v. Comm’r, T.C. Memo. 2016-191, the Tax Court determined that an IRS settlement officer (SO) abused her discretion in sustaining a levy and notice of federal tax lien for three of a taxpayer’s seven tax years because she had failed to properly verify that deficiency notices had been mailed to the taxpayer’s last known address for those years. The court noted the SO relied solely on the IRS’s certified mailing list, which contained an incorrect address for the taxpayer.

ROBERT TALBOT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent