At last week’s ABA Tax Section meeting in Chicago one of the panels I enjoyed most was the Civil and Criminal Tax Penalties discussion on tax preparer fraud moderated by Sara Neil of Capes Sokol (whose colleague Justin Gelfand has written on identity theft for us as a guest), with Scott Clarke from DOJ, Matt Mueller from Wiand Guerra King in Tampa and Paula Junghans from Zuckerman Spaeder in DC.
The panel’s materials included a 2015 case, United States v Horn, from the district court in Maryland. Horn involved a hearing regarding whether a return preparer who had pleaded guilty to one count of preparing and filing false returns in violation of 26 USC 7206(2) should be required to pay restitution. The opinion is by Judge Marvin Garbis, a former tax practitioner and author of books and articles on tax procedure. I do not know Judge Garbis personally but I recall one of my mentors Michael Saltzman admiring him for his tax procedure chops (no small feat as Michael’s talent was matched by a healthy and justified sense of tax procedure ego).
The opinion concludes for very practical reasons that the IRS should not be able to make a restitution based assessment (RBA) against Horn, and how it gets there rings some interesting tax procedure bells that I found worthy of a post.
Facts and Legal Background
The parties stipulated that the preparer Judianne Horn provided 16 clients with tax returns that listed false deductions on Schedule A or false business losses on Schedule C. The stipulation laid out over a four-year period the understatements of tax liabilities on a year-by-year basis for Horn’s clients. The total understatement of tax liabilities for the 42 federal tax returns (not every client had a return filed in every year) was $281,764.
We have recently discussed in the revision to Saltzman and Book the 2010 legislative change codified in Section 6201(a)(4)(A) that allows the IRS to assess and collect restitution under an order in Title 18 section 3556 “in the same manner as if such amount were such tax.” We discussed restitution based assessments in SaltzBook Chapter 10 (dealing with assessments) and in Jack Townsend’s redo of Chapter 12 (dealing with tax crimes); Keith also discussed it in PT in a post last year.
There are lots of interesting issues that spin off this important administrative power, and Horn raises one, namely whether the IRS has the ability to use RBA powers when the offense at issue relates to a preparer’s misconduct that implicates multiple taxpayers with multiple tax liabilities.
As the opinion describes, Section 6201(a)(4)(A) results generally in the IRS substituting itself for district courts when it comes to the payment of a restitution obligation. As an example of this, the opinion notes that an RBA “effectively eliminates the power of the district court to provide for periodic payments of restitution in amounts determined by the court subject to revision should the defendant’s financial circumstances change.”
The Tension Arising from Restitution Based on Third Party Liability
The rub as Judge Garbis describes was that when restitution is based on tax liabilities of others (such as but not exclusively when the defendant is a return preparer) it creates problems for both the courts and IRS in setting the proper amount but even more so perhaps in monitoring the payments going forward:
This creates a substantial level of complexity for determining the amount of restitution to be imposed and imposes a substantial management burden on the IRS and the court to monitor, not only in the application of restitution payments made by the defendant but also collections made by the IRS from taxpayers whose liabilities are the subject of the restitution order.
To fully appreciate this statement it is necessary to contrast loss for sentencing guideline purposes and restitution. The $281,764 understatement I referred to above determines loss for sentencing guidelines purposes. The loss for guidelines purposes exists irrespective of any post-offense circumstances, whereas the nature of restitution in the tax context makes those very post-offense circumstances quite relevant:
The function of restitution is to require a defendant to restore to the victim of a crime the loss caused by the defendant’s criminal conduct. A restitution award is not to be issued for punitive purposes or to provide the victim with a profit. Thus, the amount of restitution should not exceed the loss to the victim actually cased by the defendant.
The Horn opinion brings this back to the IRS:
In the context of a false federal income tax return, the actual loss to the IRS for which restitution should be paid is the deficit in tax collected with regard to the return in question-i.e., the amount of tax that would have been reported due on an accurate, correct tax return and paid, reduced by the amount collected by the IRS with regard to that return. (emphasis added).
Moreover, as the opinion notes, the actual loss to the IRS for restitution would have to take into account the tax liability reported as if the returns were properly filed, including deductions or credits that the taxpayers failed to originally claim. The proper amount of tax liability would also be reduced by the amount reported to the IRS on the false returns as well as “reductions in the restitution balance due as the IRS received payments and applied them to the tax liability understatement for the return in question.”
Given that the liability at issue here turns on third parties (the taxpayers whose returns Horn prepared) the opinion notes that the task would be dependent upon both “the number and complexity of the substantive issues presented in a particular case.” The process for defense counsel was as Judge Garbis describes one that would essentially require counsel to inquire into all 42 returns:
Defense counsel could be accused of a failure to provide effective assistance unless he/she reviewed the IRS’s proposed adjustments to each of these 42 returns, presumably with the assistance of a qualified tax professional.
Judge Garbis notes that the review should lead to some process (at cost that may be borne by the State if the defendant is represented by appointed counsel) whereby the defendant could access records and even potentially interview witnesses in a search for offsetting adjustments.
Contrasting Restitution Based Assessment with Restitution That is Not Assessed
The opinion notes in footnote 8 that “there may be reasonably debatable issues” as to whether the IRS can make a restitution based assessment in this case though the court for purposes of the order assumed that it could. I will take a quick stroll through that issue. Recall that Section 6201(a)(4)(A) provides that the Service may only assess an amount of restitution ordered “for failure to pay any tax imposed under [Title 26].” As the Service itself explained in a notice issued in 2011 “not every conviction in a Title 26 criminal case will result in an order of restitution that will be assessable.” Whether the IRS can use its RBA powers as the IRS in the notice from 2011 explained is based on whether the “restitution ordered is traceable to a tax imposed by Title 26 (e.g., cases stemming from an underreporting of income, an inflated credit or expense, or an alleged overpayment of tax that results in a false refund)….”
Not every restitution order connected to a Title 26 offense is within the reach of 6201(a)(4)(A):
On the other hand, criminal cases in which the restitution ordered is not traceable to a tax – such as when a taxpayer submits false documents or tells lies during an examination – may not result in assessable restitution.
Whether aiding and assisting in preparing and filing someone else’s tax return constitutes an amount of restitution ordered “for failure to pay any tax” is a question that the Horn opinion sidesteps and that I suspect other opinions may tackle, though IRS lists in its 2011 notice the 7206(2) offense Hom pleaded guilty to as an offense that “may” meet the requirements for assessment.
Back to the Horn opinion and what it does address. In discussing RBA, the opinion notes that once restitution is assessed, the IRS can use its full collection powers, with the assessment also subject to interest and late payment penalties.
In contrast, when there is restitution that does not result in an RBA, the opinion emphasizes the broad discretion that solely resides in a sentencing court:
However, when issuing a restitution order that does not result in an RBA, a sentencing court can exercise its discretion and decide whether to set a fixed date for payment in full or a schedule for partial payments consistent with the court’s finding regarding the defendant’s financial circumstances.The opinion illustrates the discretion with examples as to what the court (unlike the IRS) might do: Often, when a defendant does not have the ability to make full payment immediately, a sentencing court will defer all, or part, of the payment obligation during the time a defendant is incarcerated and will set a periodic payment schedule with the first payment due when the defendant is released from prison. The restitution order can provide that the amount of each periodic payment is subject to change depending upon changes in a defendant’s financial circumstances. The sentencing court can require, or waive, the accrual of interest on the unpaid balance. There will be no automatic “late payment penalty” applied to any unpaid balance of the full amount of restitution. Rather, the district court would consider imposing a sanction for a failure to make a restitution payment, taking into account the court’s determination of the defendant’s financial ability to meet the obligation.
The opinion notes the important distinctions between the way the IRS and sentencing courts manage or monitor the receipt of restitution payments. First, the opinion describes how courts manage the process:
In the absence of an RBA, a defendant’s restitution obligation is reduced, dollar for dollar, as the defendant makes payments pursuant to the restitution order.
IRS on the other hand treats payments made pursuant to an RBA as involuntary, with IRS having discretion to allocate the payments as it chooses among tax, interest and penalties. IRS may even, as the opinion notes, allocate payments to any other of the defendant’s own assessed liabilities that are wholly unrelated to the offense giving rise to the RBA.
The IRS’s discretion is amplified when the restitution relates to an order stemming from a return preparer’s criminal offense, with the IRS having the ability to allocate payments “among the taxpayers and income tax returns for which restitution would be due.”
Judge Garbis thus sets the stage for an administrative mess that led in part to his concluding that he would not order restitution in the case. Recall that when imposing restitution the IRS is not to collect more than the correct amount of tax at issue. When there are multiple taxpayers and multiple potential assessments and collections from those third parties, unless there is a process to track those payments and allocate the payments to the individual liabilities it would be very difficult for the IRS to represent to the court that it would limit its collection on the preparer’s assessed restitution to reflect its collection from those third parties whose returns the IRS would presumably examine.
Somewhat surprisingly, the IRS attempted to minimize the administrative burdens with a representation that it would not seek to enforce the laws with respect to the 16 taxpayers who benefitted from Horn’s illegal actions:
[T]he Government has taken the position that it will not seek to collect income tax underpaid by – or, better put, unwarranted refund payments made to – the taxpayers who filed the false returns.
Perhaps IRS did so because it wanted precedent on the books that it could get restitution in a case such as this, or perhaps it did so because it knew that resource constraints limited it from examining those 16 taxpayers and the 42 returns at issue (I won’t even go the SOL issues stemming from third party fraud, an issue we have spoken about in the BASR v US case in a guest post by Robin Greenhouse).
In any event, in a part of the opinion that appeals to my Introduction to Federal Income Tax professor hat, Judge Garbis pointed to the potential tax issues created when a preparer would make restitution payments that would benefit her clients by offsetting their tax obligations:
Nevertheless, unless the I.R.S. can make a decision to grant these taxpayers a gift from the Department of the Treasury, it should seek to have these taxpayers comply with their future tax obligations. Hence, if the Defendant were now to make a restitution payment that is applied to a tax liability of W.W., a taxpayer who obtained more than $17,000 of unwarranted refunds, it would appear that W.W. would have taxable income in the year of the Defendant’s payments.
This conclusion relates to the notion illustrated in cases such as Old Colony that a person has gross income when someone else pays that person’s tax on his or her behalf. The Horn opinion thus states that even if the IRS were not going to examine the prior returns to reflect ensuring past compliance, “the I.R.S. should monitor continually its application of restitution payments and ensure future tax compliance by the taxpayers to whose tax liabilities the payments are allocated.” While I have not fully thought through the Old Colony issue that Judge Garbis raises (for example, is the possible inclusion of income dependent upon there being an assessed liability agains the taxpayer?), the discussion at least implicates issues of coordination and the mechanism that the IRS would or should use to credit any restitution payments against individual taxpayer liabilities.
The Court Concludes that Restitution is Not Appropriate
Having I think established that the IRS desire to seek an RBA in this case created a number of vexing issues, the opinion expressed doubt as to whether the IRS was up for the task of managing and monitoring on a going-forward basis:
Indeed, it appears doubtful that the I.R.S. can, realistically, keep the Defendant and the Court (Probation Officer) informed of its application of Defendant’s payments. Moreover, the Government has described no coherent existing, or proposed, practicable process for keeping track of, and advising the Court (Probation Officer) and Defendant of, the status of payments made by, or collected from, taxpayers with respect to tax liabilities included in the restitution amount.
The “bottom line” is that if a tax return preparer defendant is unable to make more than modest partial payment of the restitution obligation, then a restitution order resulting in an RBA would impose a monitoring obligation on the I.R.S. and the Court (i.e., the Probation Officer) that, if at all possible to meet, would cause disproportionate managerial problems for the I.R.S. and the Court. (footnotes omitted).
The complexity and “disproportionate management burden” on the IRS and the court thus led to the conclusion that it was inappropriate to issue a restitution order. That burden was exacerbated by the financial circumstances of the defendant, as the court noted that a restitution order causing an RBA might be appropriate perhaps when “prompt, full payment can be required.” The opinion concludes by noting that it could have required restitution that would not have led to an RBA but that it chose not to in this case.
Jack Townsend has noted that the relatively new RBA powers create some administrative challenges even when the restitution relates to an offense stemming from the defendant’s own tax liability (see his 2014 discussion of Murphy v Commissioner and procedures associated with RBA over at his Federal Tax Crimes blog here, with its sensible recommendation that IRS issue regs under the RBA statute).
The Horn opinion touches on some practical and legal challenges associated with an RBA that implicates third parties and their respective tax liabilities. In an email exchange over this case Jack offers the observation that “some of the real or imagined administrative problems that Horn raises could be solved by simply wiping off restitution on the criminal side once it has been assessed.” As Jack notes, that “would let the IRS’s collection tools work the way they always work. It would also take legislation.” While at it, Jack suggests that with the “IRS’s robust tax collection mechanisms delegating tax restitution collection to the IRS and getting the courts / probation office / U.S. Attorney out would be a good use of limited resources.” Jack also suggests that it would make sense for any delegation to the IRS include the IRS having the power to compromise the assessed restitution.
IRS and DOJ have many tools at their disposal to go after crooked preparers, but Horn serves notice that at least among judges willing to inquire how the IRS will go about its business, the IRS may not be able to use an RBA when it comes to convicted preparers.