Tax Attorney Gets Taxpayer Favorable Sentence: Court Says Not So Fast

Tax fraud often results in harsh criminal tax penalties; however, you really never know what a particular tax crime sentence will be until you have your day in court, then the appeals for that sentence, and then possibly the appeals for those appeals. Take for example the case of United States v. Trupin.

According to the Second Circuit Court of Appeal:

Trupin’s [tax] crimes … employed a number of devices to avoid reporting over six million dollars in income over a period of six years. Trupin enlisted the aid of family members to claim ownership of certain assets, created phony paper trails, employed shell corporations and trusts, and shipped expensive assets to the Vancouver Islands in Canada.

The district court, in applying the federal sentencing guidelines, sentenced Turpin to a seven month prison sentence and three years of supervised release (AKA probation). Judge McKenna, the district court judge for the southern district of New York, had this to say about the sentencing guidelines that apply to tax crimes:

I am going to sentence at the lowest available sentencing range in this case. I don’t want to spend half an hour complaining about the guidelines, but this guideline is one of the worst I have ever seen.

The tax attorney must have done a pretty good job putting on this case, given the judge’s statements.

The government appealed the low sentence, arguing that the district court’s decision to impose a seven-month term of imprisonment — 34 months below the bottom of the applicable guidelines range — was unreasonable. Upon review, the second circuit court had this to say about the District Court Judge McKenna’s opinion:

During the initial sentencing hearing, the district court opined that “this guideline is one of the worst I have ever seen.” And at resentencing the court indicated that “a few weeks in jail for most of us would be a very, very significant punishment.” We have rejected general policy disagreements such as these on two occasions. Sentencing policy is for Congress and the Sentencing Commission, not judges.

It is rare to see an opinion where a circuit court overturns a determination that involves some factual determinations made by the lower court judge. In this case the lower court judge appears to have exercised his discretion to depart from the sentencing guidelines – which, at the time that the judge issued his opinion, was a right that judges were granted under a recent Supreme Court case.

Had the lower court judge been less vocal about his negative opinion of the sentencing guidelines, the government probably would not have been able to sustain their appeal and the taxpayer’s low sentence would probably have stood.

That leaves me wondering if the lower court wasn’t using this case (and this taxpayer) to test the waters to see exactly how far a judge can depart from the sentencing guidelines pursuant to the then-recent Supreme Court case that granted the courts this power….

January 26th, 2007 | No Comments »

Race, Discrimination, Schools — and the IRS?

Race, discrimination and education continue to be controversial subjects. These subjects can be even more controversial when taxes and the IRS are involved. Here is an excerpt from a final determination that was just handed down by the IRS with respect to a private school’s application for tax-exempt status:

As noted above, on August 16, 2004, you revised your bylaws to include a statement of your racially nondiscriminatory policy. A statement of your nondiscriminatory policy appears in your Student Handbook and brochure, and your brochure for counseling services. You have also submitted copies of notices of your nondiscriminatory policy and statements of such policy appearing in various newspapers over a period of years. However, the information submitted contains no evidence of actions such as active and vigorous recruitment of African-American students and teachers; financial assistance for African-American students, or non-going communication with members of the African-American community. We acknowledge that you have taken some positive steps in reaching out to the African-American community such as the receptions mentioned previously. Nevertheless, the facts and circumstances do not show that you have made an intensive and comprehensive effort at outreach directed specifically to the African-American community which could possibly result in the enrollment of black students and current employment of black teachers and administrators. Like the school described in Calhoun Academy v. Commissioner, supra, your interaction with black persons in the community is insufficient to demonstrate that you operate in a bona fide racially nondiscriminatory manner with respect to the enrollment of students and hiring of faculty and administrators.

All of the pertinent facts and circumstances lead us to conclude that you have failed to demonstrate that you have taken sufficient steps to overcome the inference of discrimination set forth in the above mentioned court cases. Thus, you have failed to establish that you operate in a bona fide racially nondiscriminatory manner.

Accordingly, you are not operated exclusively for exempt purposes under section 501(c)(3) of the Code, and thus you do not qualify for recognition of exemption as an organization described in section 501(c)(3). You must file federal income tax returns.

Contributions to you are not deductible under section 170 of the Code.

In this context the IRS, a Washington DC-based organization that many Americans do not trust, finds itself in the role of being America’s moral gatekeeper. While these types of issues do need to be addressed, I can’t help but wonder if the IRS is the right forum and if a federal tax law is the best context under which to address them.

January 22nd, 2007 | No Comments »

How Tax Attorneys Use Statutory Construction

In Arnett v. Commissioner, the seventh circuit court of appeals confirms that Antarctica is not a “foreign country” for tax purposes.

Arnett was a US citizen stationed in Antarctica for purposes of his US corporate employer. Arnett claimed a Section 911 foreign earned income exclusion for amounts that he earned while stationed in Antarctica. The IRS assessed a deficiency for these excluded amounts because Antarctica is not a “foreign country,” pursuant to the definition spelled out in the IRS Treasury Regulations. The tax court and now the seventh circuit have upheld the IRS position.

While there are some very interesting issues surrounding whether income earned by US citizens working in non-governed lands (such as Antarctica) should be treated, for tax purposes, as if the income were earned in space or on the high seas, that is not why I am writing about this case.

The reason why I am writing about this case is that this court opinion provides a clear demonstration of how tax attorneys use the courts to change our tax laws.

Lets talk about “statutory construction.” At this point, you are probably thinking “okay, what do I care about that?” The answer is that “statutory construction” is one of the ways that (your?) tax attorneys can change losing cases into winning cases. Let me explain.

The term “statutory construction” essentially refers to how a tax statute or regulation is set out, how the words are employed or not employed, etc. In more famous instances the courts have used “statutory construction” analysis to find that the word “or” in a statute really means the word “and,” or vice versa, given how the statute was written or given the context of the statue.

Judges often use this type of analysis where they want to depart from the obvious meaning of the statute or to support their interpretation of the statute — validating their written opinion. We see statutory construction arguments mainly in cases where the judge wants to issue an opinion that reaches the right result or is fair given the particular facts in the case presented to them. Tax attorneys often use court opinions where judges have used “statutory construction” to make arguments and take positions for their clients that would not otherwise be feasible.

In this case the seventh circuit said the following with regard to the IRS Treasury Regulation:

Use of the same word in an interrelated regulation and in close proximity to one another “presents a classic case for application of the ‘normal rule of statutory construction that identical words used in different parts of the same act are intended to have the same meaning.’”

This language sounds harmless, right? Maybe not. The Treasury Regulations span several volumes and they are written and re-written by thousands of Treasury Department employees over the past hundred (or so) years. Because of this, our Treasury Regulations are replete with specific phrases that are understood to mean one thing in one particular regulation or section of the same regulation and they mean something entirely different for different regulations or different sections of the same regulation (the consolidated tax return regulations are notorious for this type of internal inconsistency).

Armed with the language cited by the seventh circuit in this case (and other statutory construction cases), tax attorneys can look to related regulations (either in location or in subject matter) to find inconsistent definitions or meanings of phrases in order to put on arguments that are helpful for their clients and, hopefully, for society.

Tax attorneys file this type of case away, with the hope of using the langauge to help clients’ in the future….

January 21st, 2007 | No Comments »

Audit Defense: An Open Invitation to Play the Audit Lottery?

A major player in the tax preparation business has opted to provide “audit defense” to clients who use its services to complete their state and federal tax returns. A careful review of this company’s contractual terms raises some serious issues for taxpayers and for the IRS.

The IRS employs a number of techniques to identify false or frivolous tax returns. However, due to the millions (if not billions) of tax forms filed with the IRS each year, millions (if not billions) of tax false or frivolous tax returns are accepted “as filed” by the IRS (and state tax revenue collection agencies). This is where the phrase “audit lottery” comes into play (recall the prior post about prisoners who submit false tax records to get tax refunds).

The term “audit lottery” refers to the attempt by taxpayers to under report their taxable income, claim tax attributes (such as tax deductions or credits) to which they are not entitled, or otherwise eliminate their tax liability, by guessing (or gambling) that the IRS and state taxing authorities will not recognize the deceit due to the number of tax forms that the IRS and state tax authorities process.

The primary tools that the IRS has to combat and deter this type of activity are IRS tax penalties and interest and, in some cases, criminal penalties. Unfortunately (this is me speaking as a taxpayer), tax penalties and interest, whether civil or criminal, are typically only applied in cases where the IRS detects the taxpayer’s false or frivolous tax return. Taxpayers who play the audit lottery make an affirmative decision to couch these costs in light of the relatively low chances of actually being audited. Of course, taxpayers also have to factor in the costs associated with hiring tax counsel if their false or frivolous tax forms are caught and the headaches involved in this process.

This brings me to the so-called “audit defense” service provided by this major tax return preparation company (technically it appears that this company has created a separate legal entity to provide this service to shield or segregate the legal liability associated with the endeavor), as this service purports to relieve some of the costs associated with hiring tax counsel and with the headaches involved.

Because the “audit defense membership agreement” does not exclude taxpayers who make false or fraudulent representations in their tax returns, it appears that taxpayers will still be entitled to “audit defense” using this company’s services if they (1) misrepresent their tax and factual information or (2) they take positions that are contrary to our tax laws (even if the misrepresentation or position is blatantly false or frivolous). If either case, this “audit defense” service seems to imply that the company – free of charge – will help the taxpayer address IRS and state tax law issues if a state or IRS tax audit arises from the tax returns prepared using this company’s services.

This free service will most likely encourage taxpayers to take false or frivolous tax positions, with the expectation that they will be “represented” should an IRS or state audit occur. Taxpayers may think “what is the risk, if I get free tax representation?”

Before taxpayers make this leap of faith, they should be aware of how the term “defense” is defined. In the contractual agreement for this particular company the term “audit defense” specifically excludes representing clients in court or providing legal advice. As such, many taxpayers may falsely believe that this “defense” includes services that, by law, only tax lawyers can advise taxpayers on (and most tax attorneys will not be able to participate in these cases pursuant to this company’s agreement because the company’s agreement uses the term “specialist,” which is a violation of the ethical rules for many state attorney regulation rules). The agreement does not specify how the services by these “Specialists” are limited and the agreement does not specify what education and experience these “Specialists” have (or if the “Specalists” are even located in the United States). Many taxpayers may find themselves in the position of having their “audit defense” not being able to provide any real “defense” at all.

There are several other factors that taxpayers must consider before relying on this company’s “audit defense” service. For example, the terms of the contractual agreement for this particular company also denies help to taxpayers who do not report IRS or state notices to the “audit defense” company within 15 days of the “date of the first notice.”

It is probably safe to say that most taxpayers do not understand that the IRS backdates notices and other IRS notices are not dated at all, which results in many taxpayers not receiving IRS notices within 15 days. Moreover, many IRS notices are sent to the wrong address or delivered to the wrong address and even when notices are delivered, many taxpayers do not receive them until weeks if not months later (think of the taxpayer who is sick or on vacation). In these cases the taxpayer’s “audit defense” appears to be 100% zero.

The agreement also seems to exclude IRS claims that are brought beyond the period that the IRS and states have to collect the taxes, which ignores the fact that the IRS and some states have a practice of sending out random notices after the collection expiration date with, apparently, the hope that taxpayers will pay the tax without knowing that the collection statute has expired. It appears that the “audit defense” by this company will not cover taxpayers who find themselves in this position.

The agreement for this company also specifies that taxpayers are required to “[p]rovide the [audit defense company with] information and documentation necessary to substantiate the various items of income and expense in question so that your Specialist(s) can prepare your defense”. This ignores the realtiy that not all taxable transactions must be documented, many taxable transactions are never docuemnted, and many documents are lost, stolen or destroyed. If taxpayers could document every transaction, then there would be no need for “audit defsense” in the first place – because taxpayers could just provide their documents to the IRS and/or state – remember that legal tax services are specifically excluded from this agreement (and that does not address the taxspayers who will have to turn over boxes and boxes of documents to this third party — some of which may include documents incriminating evidence, which would most likely waive any right of the taxpayer to keep those records private). In these cases the taxpayer will have breached the agreement, therefore not entitiling the taxpayer to any “audit defense.”

If that is not bad enough, the terms for this particular tax preparation service specify that it “does not prepare or amend our members’ Federal, State or Local income tax returns.” Hello? Many tax remedies require taxpayers to file amended tax return, especially since the IRS has recently issued new regulations defining what constitutes an amended tax return.

And that is just the start. The contractual terms for this company also exclude “audit defese” for entities that taxpayers have an ownership interest in,” which will exclude almost all Schedule C small business oweners; it excludes late filed tax returns, regardless of whether the taxpayer was at fault for the late filing; it excludes other tax issues that may arise (such as employment taxes that are assessed due to an income tax audit); and the company “reserves the right to cease providing service where reasonably warranted,” which means that they can leave their clients high and dry should push come to shove.

After reviewing the terms, I am left wondering what kind of “audit defense” this really is? The answer in my mind is that it is only another marketing ploy. Unfortunately many taxpayers may be mislead into beleiveing that this company will acutally provide them with “audit defense.”

January 20th, 2007 | No Comments »

Taxpayer is a Day Late: IRS Attorney Prevails

I recently attended a legal seminar put on by the Texas Bar Association in which an attorney who was nearing retirement was lamenting the decline of the legal profession. That attorney cited examples of other attorneys using court rules to gain a competitive advantage over the other party, even though minor instances of non-compliance with the court rule would not have impacted the case. The attorney concluded that these other attorneys were “lawyers,” but not “professionals.” That brings me to today’s Austin v. Commissioner case.

Austin failed to timely file federal tax returns. The IRS imposed failure to file and failure to pay penalties. The IRS mailed Austin a notice of deficiency (also known as a 90-day letter), which required Austin to file a tax court petition by May 7, 2006 – which was a Sunday. The tax court received the tax court petition on May 10th, the handwritten FedEx label was marked May 8th, and the computer generated FedEx label was marked May 9th. The FedEx tracking information specified that the package was picked up on May 9th at 5:22 p.m.

The IRS attorney filed a Motion To Dismiss For Lack Of Jurisdiction on the ground that the petition was not filed with the Court within the 90-day timeframe prescribed by statute. The taxpayer objected to the IRS motion, stating that:

[O]n May 4, 2006, she flew to Baltimore, Maryland, to attend a trade show; that she stayed at the Days Inn while in Baltimore; that she signed the petition on Sunday, May 7, 2006; that she completed the customer handwritten label at about 8 a.m. on Monday, May 8, 2006, and affixed it to the FedEx envelope; that she placed the petition in the FedEx envelope, which she then handed to the front desk clerk of the Days Inn with the understanding that the envelope would be picked up later that day by FedEx; that the front desk clerk placed the envelope in the hotel’s “pickup box”; and that, upon returning to the hotel after the trade show later that day, she inquired about the envelope and was told by a front desk clerk that the “pickup box” was empty. In sum, petitioner asserts that “There was no reason for me to think that my FEDEX package had not been picked up on the 8th.”

As required by law, the tax court dismissed the taxpayers tax court case due to the IRS attorney’s request – denying the taxpayer the ability to have her day in court. The IRS attorney prevailed over an unrepresented taxpayer due to the taxpayer missing a filing deadline by one day.

According to the position by the attorney cited at the beginning of this article, a tax lawyer practicing fifty years ago would never have filed this kind of motion given these facts. The taxpayer would have had her day in court, and she would have won or lost in court. Cases like this leave me wondering if perhaps that old attorney was right about the legal profession.

January 16th, 2007 | No Comments »

Prisoners Still Filing False Tax Returns: Yet Another Problem Facing the IRS

Criminals incarcerated in prison often file false tax returns with the hope of obtaining tax refunds. In many cases the IRS does in fact issue erroneous tax refunds in this type of scheme (I remember hearing once that the IRS pays out a couple of million dollars in false tax refunds due to these tax schemes each year). The recent case of US v. Wardell shows how this type of tax scheme usually plays out.

Wardell is a prisoner incarcerated in a Colorado state prison. While in prison, Wardell prepared false tax returns and W-2 forms in an effort to obtain tax refunds for himself and other prisoners. The court noted that even though Wardell was incarcerated, he:

was able to use numerous individuals and fictitious entities, addresses, and paperwork to create the illusion that he earned income and was entitled to multiple tax refunds. He filed a large number of false returns in the names of inmates without their knowledge, used false addresses outside of the Colorado prison system, and intentionally mislabeled his mail as “legal mail” in order avoid detection. Wardell also sent false returns to multiple IRS service centers around the country, created and used false W-2 Forms and other paperwork to legitimize his … claims. He conspired with other inmates to further the scheme.

Wardell was indicted on twenty tax-fraud related offenses, four counts of making false statements in tax returns, and fifteen counts of aiding and assisting the presentation of false tax returns. Wardell was convicted on all but two counts. The district court, in applying the federal sentencing guidelines, enhanced the sentence because the offenses involved “sophisticated means.” Wardell was sentenced to ninety-six months imprisonment for his tax crimes.

Wardell argued that “his scheme lacked shell corporations, offshore accounts, dummy boards of directors, blind paper trails, or multi-national transactions (in addition to the fact that his actions were patently detectable), his tax scheme was routine and conventional.” Thus, Wardell argued that his simple tax crimes did not involve “sophisticated means,” and if the court held that they did, that all tax crimes would require this type of sentencing enhancement.

The court disagreed, finding that Wardell’s

fraudulent conduct was not a garden variety fraud. His was not simply a case of claiming to have paid withholding taxes not paid or of not disclosing income to one’s accountant.

This type of tax scheme is very problematic for the IRS. Essentially these prisoners are betting that the IRS will overlook their false submissions given the millions (if not billions) of tax forms that the IRS processes each year. The court opinion does not specify whether the IRS issued tax refunds to Wardell or if (or how) Wardell cashed those checks, but for every false tax refund issued to a prisoner that is detected there are likely several prisoners who have received false tax refunds that have not been detected.

January 15th, 2007 | No Comments »

Doctor Battles IRS Summons (and Loses)

The IRS summons is the most powerful too that the IRS has in its tax collection arsenal. The recent US v. Battle provides a good example of how the IRS uses the summons.

The taxpayer in this case is a Houston physician who filed “inaccurate tax returns” (to the tune of $600,000) for four tax years and filed no tax returns for six tax years. The IRS no doubt sent the doctor an information document request to gather the doctor’s records, but the IRS was not satisfied with the doctor’s response. The IRS then issued the doctor a summons to request the doctor turn over his records; however, the doctor failed to comply with the summons.

Pursuant to the standard procedures, the IRS then petitioned the district court to enforce the summons. The doctor opted to represent himself at this hearing. Unfortunately the doctor tried to use the hearing to contest the underlying tax assessment, etc. As the court noted, the summons enforcement hearing is not the forum to contest the underlying tax assessment. Rather, the issue in a summons enforcement hearing is whether the taxpayer is required to turn over documents.

The district court ordered the doctor to appear in two weeks with an “attorney or accountant” to present the doctor’s challenges to the summons and to bring the records that the IRS requested to court with him. The court also suggested that the doctor pay 70% of the taxes assessed by the IRS to demonstrate the doctor’s good faith effort to comply with our tax laws. The doctor appeared in court on the proscribed day with an accountant, but without a tax attorney or the records and without paying any taxes. The court entered an enforcement order, requiring the doctor to appear with the records later that same day.

The doctor showed up later that day, again without the records or a tax attorney. The doctor argued that he had a Fifth Amendment right to not produce the documents, which the court gave little credence to. The court then held the doctor in contempt of court and had him taken into custody. Three days later the doctor’s associate produced the requested records and the doctor was set free.

The doctor then appealed the contempt order and the enforcement order to the Fifth Circuit Court of Appeal – again, without the help of a tax attorney. In this appeal, the doctor made various arguments – all of which were, well, unsuccessful.

The taxpayer in this case probably devoted a lot of time to preparing and presenting his case and what does he have to show for it (other than three days of free room and board)? We all have to pick our battles in life, and usually contesting an IRS summons without sound arguments and competent tax counsel isn’t a battle worth fighting. This taxpayer would have been better of by (1) being honest and providing the IRS will his records, (2) coming clean and filing amended tax returns as quick as possible, and (3) hiring a tax attorney to help him with his IRS troubles.

January 12th, 2007 | No Comments »