Earlier this week, the Court of Federal Claims in BASR v. United States held that the Section 6501(c) provisions extending the statute of limitations for an unlimited time in fraud cases required an “intent to evade tax” by the taxpayer, and was not extended to fraudulent behavior by a third party. I write to add a little context showing why this is much more than just a technical statutes of limitation issue, and because for those who like just technical issues we recently updated the subchapter on statutes of limitation in Saltzman and Book’s IRS Practice & Procedure to consider the Second Circuit’s City Wide v Commissioner decision (which had reversed the Tax Court).
The BASR case is getting significant attention—see, for example, Jack Townsend’s blog post on the issue. Jack’s post does an excellent job discussing the case’s interplay with the TEFRA provisions under Section 6229. He deftly analyzes prior cases such as Allen v Commissioner, where the Tax Court reached a contrary result. In BASR, the taxpayer entered into a, to steal Jack Townsend’s term, bulls**t tax shelter, by contributing cash and short positions in treasuries, which he claimed increased his basis in the entity. As most tax procedure buffs know, the Service had taken the position that an overstated basis could trigger an underpayment of more than twenty five percent of the tax due, thereby triggering a six year statute on assessment; however, during the pendency of the litigation, Home Concrete was decided by the Supreme Court, rendering that argument no longer viable. After losing the Home Concrete issue, the IRS in BASR argued that the unlimited statute of limitations due to fraud applied given the actions of the taxpayer’s agent, i.e., the lawyer who structured the bulls**t tax shelter.
As to context, this is yet another battle in the war that the IRS is fighting against unscrupulous third parties that advise taxpayers. BASR involves a fancy tax shelter implicating crazy amounts of fees and tax at issue. Yet, the issue is not limited to preparers and advisors taking advantage of legal ambiguities, exploiting technical rules, and designing deals that require three whiteboards to diagram. While BASR implicates sophisticated taxpayers, the IRS’ legal argument here is essentially the same it has made in cases that relate to unsophisticated taxpayers, where there is a low absolute amount of tax at issue and fairly unambiguous legal issues. I say absolute because assessments in low dollar cases where taxpayers are duped by preparers, such as in some EITC cases, can have devastating impact on those individuals even if the amount at issue is only a few thousand dollars.
An example of a different this issue coming up in less sophisticated matters is Eriksen v Commissioner, a memorandum Tax Court decision from 2012, which involved low dollar phony Schedule C expenses claimed by employees of the Oakland County Sheriff Department. The taxpayers in Eriksen used preparers who plead guilty to aiding and assisting in the preparation of a false federal income tax returns in violation of Section 7206(2). In Eriksen, the Tax Court applied Allen to find that a preparer’s fraud could extend the statute, but held the IRS had not met its burden to show that that the preparer’s actions in the particular returns at issue amounted to fraud rather than negligence. In other words, a preparer’s fraud on some returns was insufficient to taint other returns, even if those other returns had errors of the type that were implicated in the criminal case against the preparers.
As to what we wrote in Saltzman and Book’s IRS Practice & Procedure on City Wide, see below, which is excerpted from the Chapter 5.03[a] False or Fraudulent Returns. The citations are omitted, and the reader is directed to the source itself for the footnotes:
Compare Allen with City Wide v. Commissioner, where the Tax Court, looking at the statute of limitation extension attributable to willful attempts to defeat or evade under Section 6501(c)(2) (applicable to returns other than income or estate or gift tax returns), held that the IRS could not assess tax after the three-year statute expired, despite the preparer pleading guilty to the criminal offenses of money laundering and knowingly signing and preparing false employment tax returns. In City Wide the accountant took the taxpayer’s correct payroll tax returns and checks made out to the IRS for the correct amount of liability, and filed fraudulent employment tax returns reflecting lower liabilities. The accountant cashed checks the taxpayer had endorsed to pay the IRS, remitted lesser improper amounts, and pocketed the difference. In City Wide, the Tax Court distinguished Allen because the Service failed to prove that the accountant’s conduct reflected an intent to defeat or evade tax, rather than an effort to cover up his embezzlement scheme. It is hard to see how this distinction matters in light of Allen’s rationale that the unlimited statute of limitations arises due to the Service’s disadvantage in investigating and detecting erroneous returns that have fraudulent positions. In addition to the arguable inconsistency in the Tax Court’s approach, there are other provisions the government has at its disposal to combat improper third party conduct (such as return preparer penalties and restitution) that seem more directly targeted to the culpable actors, and the fraud penalty itself under Section 6663 not triggered by fraudulent third-party actions. On appeal, the Second Circuit reversed the Tax Court and found that the accountant’s actions extended the statute indefinitely. The Second Circuit criticized the Tax Court for confusing motive and intent and held that the preparer’s motive for his action was beside the point. The Service only had to prove that the third party “intended to underpay the Commissioner taxes that City Wide owed when he filed a fraudulent return on City Wide’s behalf, not that he intended to avoid City Wide’s taxes for City Wide’s benefit.” In light of the taxpayer’s concession that the accountant filed false returns on its behalf (which was not made at the Tax Court), the court said it need not decide “whether certain factual situations might arise that sever the taxpayer’s liability from the tax-preparer’s wrongdoing.” The Court stated that the preparer’s actions were not remote or secondary to the fraudulent returns, though it did suggest that not all third-party fraudulent misconduct would by itself trigger the extended statute. Attributing a third-party’s fraud to the taxpayer for statute of limitations purposes gives the Service a powerful weapon, though it is unclear how far removed the third-party misconduct must be from the taxpayer’s tax liability in order to sever the unlimited extension.
Saltzman & Book, IRS Practice and Procedure, at Chapter 5.03[a] False or Fraudulent Returns
As Jack Townsend writes in his blog, I too am not sure how this issue will be resolved. I note that Bryan Camp, one of the most thoughtful commentators on tax procedure, has written an article in Tax Notes, where he discussed the legislative history and the policy in favor of closure such that the “fraud exception should be read to refer to the taxpayer’s fraud” and not any other party. See Bryan Camp, Presumptions and Tax Return Preparer Fraud, 120 Tax Notes 167 (2008). Last year, Jeremiah Coder wrote an article discussing inconsistent informal Service positions on the issue prior to Allen. He suggested that the Service approach may punish unsophisticated taxpayers. See Coder, The IRS’s Misguided Fraud Whodunit, 137 Tax Notes 7 (2012).
Coming on the heels of the oral argument in Loving last week, this issue implicates the important relationship of preparers and tax advisors to tax administration. IRS, as it gets more sophisticated in capturing data on preparers in light of its PTIN requirements (which recall are not impacted by Loving), is likely to be better equipped to track down taxpayers who may have used unscrupulous preparers. Detecting fraud though is never easy, and that is part of the reason why IRS wants the unlimited time to assess tax on returns tainted by an agent’s improper conduct. BASR presents a potential obstacle in the form of a contrary judicial statutory interpretation from that of the Tax Court and the Second Circuit. I suspect this is not the last we will hear from the courts on this issue.