California Bar Members Propose Tax Restitution Changes

In 2010, Congress added section 6401(a)(4) to the Internal Revenue Code, which requires the Internal Revenue Service (IRS) to assess and collect the amount of restitution under an order pursuant to 18 U.S.C. § 3556 for failure to pay any tax imposed under Title 26 in the same manner as if such amount were a tax. Sometimes, the IRS may be identified as the victim, and the district court therefore orders the defendant to pay a tax-related loss to the IRS. This new code section allows the IRS to use its administrative collection tools to collect the amount of the restitution order issued by the federal district court.

Congress made some additional changes with respect to restitution orders in 2010. First, Congress placed restrictions on the ability to challenge an IRS assessment of a restitution order issued by a federal district court. Section 6201(a)(4)(C). Second, a restitution-based assessment is not subject to deficiency procedures. Section 6213(b)(5). Third, Congress granted the IRS authority to make a restitution-based assessment at any time. Section 6501(c)(11).

There are significant procedural issues faced by a taxpayer who owes both criminal restitution and a civil tax liability. This paper proposes some workable solutions so that the interests of both the government and the taxpayer are better served.

This paper will draw from the following example: Assume that Johnson Flood is a prominent high-tech entrepreneur in California's Silicon Valley. After leaving a corporation he co-founded, Flood formed a new company that created software for the Department of Homeland Security ("DHS"). A former bookkeeper who worked for Flood's company informs the government that Flood has engaged in a scheme to defraud the government through the use of a sham invoicing scheme. The informant also contacts the IRS and says that Flood has failed to report substantial amounts of income that was deposited into an account in the name of his late mother, over which he has sole signatory authority. As a result of a grand jury investigation by the U.S. Attorney's Office, Flood is indicted on one count of conspiracy to defraud the United States under 18 U.S.C. § 371, three counts of making false claims to the United States under 18 U.S.C. § 287, and three counts of executing a false tax return under 26 U.S.C. § 7206(1) for 2008, 2009, and 2010.

Flood eventually pleads guilty to one count of making a false claim and one count of tax perjury. The stipulated loss due to the false claims is $850,000. The Government and Flood stipulate that the unreported gross receipts for the three years in the indictment are $1.6 million. The tax loss is $448,000 (28 percent of the unreported gross receipts).

As part of the plea deal, Flood agrees to pay restitution of $850,000 for the false claims loss and $448,000 for the tax loss. He also agrees to cooperate with the IRS to determine his correct tax liability and to be liable for a fraud penalty. The Court sentences Flood to 24 months incarceration on both counts, to run concurrently, followed by three years supervised release.

To enable the IRS to collect the amount of the restitution owed to the government, the IRS assesses the $448,000 restitution amount as if it were a tax under 26 U.S.C. § 6201(a)(4). As a result of false claims conviction, Flood's ability to do business with the Government ends. He liquidates his brokerage accounts and pays $700,000 towards restitution for the false claims loss and $100,000 toward restitution for the tax loss. While Flood is incarcerated, the IRS conducts an audit of his tax returns for 2008, 2009 and 2010. As a result of the audit, the IRS determines adjustments of $1,600,000 in unreported gross receipts, plus $710,000 in previously unclaimed deductions for net adjustments of $890,000 and a tax of $290,000. The IRS also imposes the civil fraud penalty. Flood does not petition the Tax Court and the IRS assesses tax of $290,000, plus a fraud penalty and interest.

When Flood is released from incarceration, he is able to find employment as a computer programmer. His income is sufficient to pay his living expenses, including a $4,800 a month mortgage. The Department of Justice is responsible for collection of the unpaid restitution order for both false claims and tax losses. Given Flood's current financial condition, he enters into a stipulation with the U.S. Attorney's Office that he will pay $250 a month toward the restitution amount, to be applied one-half to the tax loss and one-half to the false claims loss.

The IRS, however, determines that Flood's living expenses are above the national average and his housing expenses are above the amounts allowable. The IRS demands that Flood pay $2,800 a month. When he refuses, the IRS levies on his wages to collect the restitution. Since the restitution order is a judgment that may not be modified except under limited circumstances,³ the IRS continues collection action, even though Flood does not have the financial resources to pay in full the tax assessed (let alone the tax restitution amount).

Although Flood would be a suitable candidate for an offer in compromise, the IRS is prohibited from compromising the restitution amount. Since the Department of Justice has jurisdiction over the case, the IRS cannot compromise the tax liability it assessed. Flood is in a catch-22.

This paper proposes a workable solution to Flood's problem. Under the proposed legislative amendments, after Flood's conviction became final, the IRS would have sole jurisdiction to collect the restitution. Thus, Flood would not have to deal with two agencies in negotiating collection. Since collection would be handled by one agency, the Department of Justice could devote its resources to other matters. Because the IRS determined that the actual tax liability was less than the amount ordered as restitution, the district court could modify the sentence so that restitution did not exceed the tax loss. Finally, if the IRS determined that Flood could not pay off the full amount of restitution, the IRS could accept an offer in compromise. Thus, the IRS would not have to waste resources on attempting to collect taxes that were uncollectible.

II. CURRENT LAW

The federal district court also may order restitution in any criminal case to the extent agreed to by the parties in a plea agreement. 18 U.S.C. § 3663(a)(3).

18 U.S.C. § 3612(c) vests the Attorney General with responsibility for collecting unpaid restitution and fines. See e.g., United States v. Fisher, 2013 U.S. Dist. LEXIS 165473 (E.D. Mich. Nov. 21, 2013) ("This authority is broad: the government may use any of the 'practices and procedures for the enforcement of a civil judgment under Federal law or State law.")

B. Firearms Excise Tax Improvement Act of 2010

In some criminal tax cases, the Internal Revenue Service may be identified as the victim, and therefore, the federal district court may order the defendant to pay restitution directly to the IRS for a tax-related loss. CC-2011-18 (8/26/2011). However, prior to 2010, neither Title 18 nor Title 26 provided the Service with the power to administratively collect on a restitution order because restitution is not a tax. Id.

In 2010, Congress expanded the IRS collection authority to ensure collection of unpaid restitution when it enacted the Firearms Excise Tax Improvement Act of 2010 ⁴ ("FETIA"). Section 3 of FETIA amended section 6201(a) by adding section 6201(a)(4), which provides the IRS the authority to assess and collect the amount of restitution under an order pursuant to 35 U.S.C. § 3556 in the same manner as if such amount were a tax.⁵ In short, the IRS may summarily assess certain orders of criminal restitution once the appeal period has expired. Section 6201(a)(4) provides, in relevant part:

Congress made two additional changes to the Internal Revenue Code in enacting FETIA. First, Congress added section 6213(b)(5), which provides that the restrictions applicable to deficiencies do not apply to assessments under section 6201(a)(4). In other words, a defendant has no right to file a petition in U.S. Tax Court to challenge the IRS' assessment of the amount of the restitution. Section 6213(b)(5) provides, in relevant part:

• The IRS can assess restitution ordered against a criminal defendant "even if the restitution relates to the unpaid income or employment tax liabilities of the corresponding business entity or employer." CC-2011-018 (8/26/2011), I:Q&A-4.

• If it is determined by a subsequent exam that the amount of restitution ordered is excessive, the IRS should contact the Tax Division or the appropriate U. S. Attorney's Office to request modification of the restitution order and that the taxpayer could also seek modification of the order. After the order is modified, the IRS could then abate part of the restitution assessment.Id., II:Q&A-10.

• The IRS can enter into an installment agreement with the taxpayer regarding a restitution-based assessment so long as it provides for the full payment of the assessment or allows sufficient time for collection of the full amount of the restitution-based assessment after completion of the installment agreement. Id., II Q&A-17.

• The Service cannot, however, accept an offer-in-compromise regarding the amount of the restitution ordered or the restitution-based assessment. Id., at Q&A-18.

First, the Notice provided that even if a taxpayer can reduce his or her civil tax liability by taking advantage of a carry back of a net operating loss, the taxpayer nevertheless must still full pay the amount of the restitution-based assessment. The Notice states, in part:

Secondly, Notice 2013-012 clarified the Service's position with respect to whether the Service could abate any portion of the assessment if the amount of the criminal restitution ordered and the subsequent restitution-based assessment is determined to be excessive by a subsequent examination. The Notice states, in part:

There, Ronald Isley was a founding member of the popular Isley Brothers singing group. In 2006, Mr. Isley was convicted of five counts of tax evasion and one count of willful failure to file and sentenced to three years imprisonment. As part of the sentence in his criminal case, the district court issued a judgment and probation commitment order (JPC order) requiring, in part, that Isley file and pay taxes owed for the years of the conviction and pay all taxes when due, and, if necessary, sell assets to satisfy his tax obligations. Id. at 12-13. While in prison, Mr. Isley timely filed Forms 12153, Request for a Collection Due process or Equivalent Hearing. As part of the CDP hearing, Mr. Isley submitted a Form 656, Offer in Compromise. The IRS Appeals rejected his offer in compromise on the ground that it lacked authority to compromise his tax liabilities, and the case proceeded to court.

The Tax Court held that IRS Appeals lacked authority to accept Isley's offer in compromise because it sought to compromise liabilities for conviction years, which had been referred to the Department of Justice for prosecution. Id. at 27. However, IRS Appeals could at least negotiate the terms of a potential offer in compromise, but could not unilaterally approve it. Id. The Tax Court reasoned, in part:

In United States v. Fisher, 2013 U.S. Dist. LEXIS 165473 (E.D. Mich. Nov. 21, 2013), the defendant Edward Fisher was convicted of conspiracy to defraud the United States and was ordered to pay criminal restitution to the IRS of $10,000,000. Fisher had repaid approximately $6,012.44 of the obligation, and under his current financial circumstances, agreed to pay the IRS $100 a month. The government applied for and received writes of garnishment for funds in Fisher's retirement accounts. Fisher moved to quash or modify the garnishments arguing, in part, that the garnishments violated his restitution agreement with the IRS.

The court ruled that 18 U.S.C. § 3612(c) vests the Attorney General with the responsibility for collecting unpaid restitution and fines. This authority is broad and there is no exception for retirement accounts. The court rejected Fisher's argument that the garnishments violate his payment agreement with the IRS because a payment schedule does not serve as a bar to further collection efforts.

Fisher stands for the proposition that a repayment plan with the IRS does not bar further collection efforts by the Department of Justice, including garnishment of retirement accounts.

III. REASONS FOR SUGGESTED CHANGES

The enactment of section 6201(a)(4) creates a number of procedural issues for a taxpayer who owes both criminal restitution and a civil tax liability, as outlined below.

• There is no coordinated procedure with respect to entering into a repayment plan with respect to criminal restitution and a civil tax liability. Criminal restitution and a civil tax liability are separate and distinct. Separate payment plans must be entered into with the Department of Justice and the IRS.

• Both the IRS and the Department of Justice can take enforced collection action at the same time. This means that a taxpayer could be forced to default on one payment plan with one agency due to enforced collection action by the other agency.

• The IRS lacks authority to accept an offer-in-compromise regarding the amount of the restitution order or the restitution-based assessment. This was illustrated by the Isley case. This means that a taxpayer can never compromise the amount of restitution, even where the IRS determines that he will never be able to pay in full the amount assessed. The restitution order, once it becomes final, cannot be modified.

• While a taxpayer has Collection Due Process rights under sections 6320 and 6330, when the Service attempts to collect a restitution-based assessment, the IRS cannot enter into any installment agreement or offer-in-compromise that would result in the taxpayer paying less than the ordered restitution amount.

• Although the IRS can enter into an installment agreement with the taxpayer regarding a restitution-based assessment, the Department of Justice can nevertheless take collection action against the taxpayer to satisfy the restitution order. This scenario was illustrated in the Fisher case.

• The IRS lacks the authority to abate any portion of the assessment, even if the IRS determines that the restitution-based assessment is excessive by a subsequent examination. The taxpayer must still full pay the amount of the restitution-based assessment, even if the amount is excessive.

To address these issues, this paper poses that legislation be enacted to amend 26 USC § 6401(a)(4) by adding the following provisions:

• The IRS has sole authority to collect the restitution amount, after assessment of the restitution amount under section 6401(a)(4). This could be accomplished, for example, by an inter-agency delegation of authority to the IRS, and the advantage of this proposal is that it does not require a change to the statute.

• The crux of the problem may lie with Title 18 because restitution orders may be modified only in limited situations. A proposed solution would be to modify the relevant statute(s) in Title 18 to allow more liberal modifications of the restitution order in tax cases. This way, if there is a determination by the IRS or a court (including the Tax Court) that the underpayment of tax for the years covered by the restitution order is less than the amount of restitution, upon motion by the Government or the defendant, the district court may modify the restitution order upon motion by the Government or the defendant, if the IRS or a court (including the Tax Court) determines that the underpayment of tax for the years covered by the restitution order is less than the amount of restitution; and

• The IRS can compromise the restitution amount that was assessed as a tax under section 6401(a)(4), subject to approval by the federal district court that ordered restitution. Again, this would require a legislative fix.

This paper has attempted to provide a framework for discussion purposes with respect to restitution orders in criminal tax cases. The current state of the law creates uncertainty with respect to these matters, and taxpayers need specific and constructive guidance in this area.

² The views expressed herein are those of the authors and do not necessarily reflect the views of the Law Offices of Steven L. Walker and/or the Law Offices of A. Lavar Taylor. The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, or tax advice or as an opinion by the law firm to the reader. The reader is also cautioned that the material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require considerations of non-tax and other factors if any action is to be contemplated. The reader should contact his or her tax advisor prior to taking any action based on this information. The Law Offices of Steven L. Walker and/or The Law Offices of A. Lavar Taylor assume no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

³ A restitution order may be modified only in limited circumstances. See e.g., Fed. R. Crim. Proc. 35(allowing the district court to correct a sentence within 14 days for "arithmetical, technical, or other clear error"); 18 U.S.C. § 3742 (on remand after appeal); 18 U.S.C.§ 3664(d)(5) (allowing the victim to seek increased restitution); 18 U.S.C. § 3664(k) (adjusting payment schedule due to a change in defendant's financial condition that affects his ability to pay); 18 U.S.C.§ 3572 (allowing the district court to adjust a payment schedule); 18 U.S.C.§ 3613a (modification or revocation of probation or supervised release or resentencing where a defendant defaults in paying restitution); upon resentencing.

⁴ P.L. No. 111-237, § 3.

⁵ The legislative history to section 6201(a)(4) provides little, if any, guidance as to why Congress believed that the criminal restitution payable to the IRS should be assessed as if it were a civil tax.

⁶Isley did not involve a restitution order but a judgment and probation commitment order (JPC order), and so the order could be modified, unlike a restitution order.