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Death, Taxes and Civil Penalties: Does the Taxpayer’s Death End IRS’s Ability to Collect Penalties?

Posted on June 6, 2014

In US v Molen et al.,[free link not yet available] the Eastern District of California a few weeks ago considered a summary judgment motion the US filed attempting to reduce tax assessments to judgments and to foreclose on real property. Two of the defendants in the case, James and Sandra Molen, were married. They operated a florist shop and rang up sizeable employment tax liabilities by making as the court stated “patently frivolous arguments that the compensation they pay employees did not constitute wages and that the federal courts cannot enforce federal tax laws outside of the District of Columbia.” For good measure, James and Sandra submitted income returns for a bunch of years claiming zero income. Typical protestor fare, and in addition to the employment tax issues, the IRS assessed frivolous return penalties under Section 6702.

After the government’s filing of the summary judgment motion, Sandra died. What interests me about the case is that the court had to wrestle with a question I had not thought much about; namely, do assessed civil penalties survive the death of a taxpayer? In this post I will describe the standard Molen used to determine whether civil penalties survive death, and offer thoughts about the issue as it may apply to other civil penalties. In light of the age of some taxpayers facing pretty high penalties for failing to file an FBAR, this issue may be of greater moment down the road.

Til Death Do Us Part

During the years in question, the penalty under Section 6702 was $500 per frivolous return (it is now at $5,000 per return/submission). If a statute authorizing the imposition of a civil penalty (as is 6702) is silent on the effect of the party’s death, the case law provides generally that survival turns on whether the penalty is considered civil or penal. As Molen spells out, it is well-settled that actions that are penal in nature do not survive death. Death is punishment enough.

What is civil and what is penal in nature? The non-tax case Supreme Court case of Hudson v US from 1997 is instructive. Hudson is a case involving a bank executive who got in trouble for making improper loans that he claimed were made to third parties but were actually made to him. The improper loans contributed to the bank’s failure. The Office of the Comptroller of Currency (OCC) fined Hudson $16,500 and he agreed to not “participate in any manner in the affairs of any banking institution without the written authorization of the OCC and all other relevant regulatory agencies” due to the violations. Hudson was also criminally prosecuted for the same conduct. Hudson argued that the criminal indictment on top of the civil sanction violated the double jeopardy clause of the Fifth Amendment. That clause prohibits multiple criminal punishments for the same offense.

How can a civil sanction trigger a double jeopardy problem? Hudson notes that some civil penalties are so “severe in purpose or effect” that courts may conclude that the legislature transforms “what was clearly intended as a civil remedy into a criminal penalty.” Well, severe is subjective, so the Hudson case gave some guidance on that, identifying factors that if present push the sanction to the criminal side of the scale, asking whether:

  1. the sanction involves an affirmative disability or restraint
  2. it has historically been regarded as a punishment;
  3. it comes into play only on a finding of scienter;
  4. its operation will promote the traditional aims of punishment—retribution and deterrence;
  5. the behavior to which it applies is already a crime;
  6. an alternative purpose [presumably alternate to the aims of retribution and deterrence] to which it may rationally be connected is assignable for it; and
  7. whether it appears excessive in relation to the alternative purpose assigned.

Given that a multi-factor test also does not lend itself to a court’s clear application, Hudson cautioned though that “only the clearest proof will suffice to override legislative intent and transform what has been denominated a civil remedy into a criminal penalty.” The upshot of Hudson for double jeopardy thus is a two-part test: first, did the legislature clearly intend for the statute to be a civil penalty? Second, even if the legislature intended a civil penalty, is the effect and purpose more in line with criminal sanctions in light of the above factors?

Molen looked to Hudson and Ninth Circuit cases involving civil tax penalties that both predated and came after Hudson. An old Ninth Circuit case from the 1930’s, Estate of Rau v Comm’r, concluded that the then 50% civil fraud penalty survived the taxpayer’s death. A 2007 Ninth Circuit case, Reiserer v US, also concluded that promoter shelter penalties survived the death of the promoter. The promoter penalties at issue were pretty sizeable, amounting to under Section 6700 “with respect to each [proscribed] activity …, a penalty” in the amount of the lesser of $1000 or 100% of the gross income derived by that promoter.” On top of 6700, the deceased defendant faced 6701 “aid and assist” penalties in the amount of up to $10,000 per corporate return.

Reiserer identified why it felt that the Hudson test should apply to determine survivability of the civil penalty, as the taxpayer’s estate argued it had no relevance to the issue:

Reiserer asserts that the Hudson decision determining when a penalty is to be considered criminal for purposes of the Double Jeopardy Clause has no application to the law governing survival or abatement of penalties. He does not explicate reasons for the assertion, and there is no reason in principle to reject the Hudson analysis. That analysis is not driven by policies underlying the Double Jeopardy Clause. In Hudson, as in the case before us, the fundamental question is what effect to give to a statute as barring a subsequent proceeding. In that context, abatement is analogous to former jeopardy; each is a bar to the continuation of proceedings when those proceedings are grounded on a criminal statute. (emphasis added).

Reiserer explicitly applied Hudson’s multi-factor analysis, emphasizing factors 1 and 2 in finding that the civil penalties were not punitive in nature: “the statutes here involve only monetary penalties, and no “affirmative disability or restraint,” and “certainly nothing approaching the infamous punishment of imprisonment.” Those monetary penalties “have not been historically regarded as punishment.”

Resierer then discounted factors 3, 4 and 5, considered the amount of penalties potentially at issue not excessive, and noted the penalties’ remedial purpose:

the statutes at issue do have a scienter requirement in the sense that the conduct penalized must necessarily be committed knowingly. And while the statutes will serve the traditional aims of retribution and deterrence to some extent, the Supreme Court has recognized “that all civil penalties have some deterrent effect” and that “the mere presence of this purpose is insufficient to render a sanction criminal.”  The conduct addressed in the statutes may also be the basis for a criminal prosecution, but “[t]his fact is insufficient to render the money penalties … criminally punitive.”. Finally, §§ 6700 and 6701 serve the remedial goal of reimbursing the government for the costs in investigating tax fraud and for possible lost tax revenue, and the penalties are not excessive in relation to the statutes’ remedial goal. In sum, there is little to show, let alone the “clearest proof,” that the penalties are penal. (citations omitted).

In light of Resierer and Hudson, Molen concluded that the $500/return frivolous penalty withstood death and was not penal in purpose or effect: “A flat $500 penalty for each frivolous return appears to be far less onerous in the typical case than the penalties deemed to be civil in nature in both Estate of Rau and Reiserer. Accordingly, the court finds that the frivolous return penalties assessed against Sandra Molen…survive her death.”

Parting Thoughts

Given the high bar needed to push a civil penalty to the punitive side of the ledger, and that the penalties in Rau and Reiserer are substantial, I do not think the judge in Molen would have concluded differently if considering the heightened $5,000 frivolous return/submission penalty under current law. In reading the case though I am mindful of the recent Zwerner decision allowing for a civil penalty for willfully failing to file an FBAR of about $2.2 million on just under $1.7 million of account value. (Coverage of that has been widespread; see for example Robert Wood’s piece in Forbes Court Upholds Record FBAR Penalties, Exceeding Offshore Account Balance). Zwerner is 87 years old. I wish no ill-health on him but this issue may be of great importance to his family. While I have not researched this issue, it seems to me that the extent of the FBAR penalties pushes the scale towards nonsurvivability under Reiserer and Hudson. Wood’s Forbes post notes that the Zwerner court will likely be considering an 8th Amendment challenge based upon the penalties being excessive and disproportionate to the conduct. Even if it withstands constitutional scrutiny, Title 31 FBAR penalties are of a different kind than other penalties that taxpayers face. The excessive penalty and punitive aspect that triggers payment potentially well in excess of the balance in the account will likely in my view contribute to this penalty not surviving death. The Hudson standard is far from clear, however, and I would not be surprised if this issue pops up in FBAR cases.

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