Two Taxpayers Commit Tax Fraud: Should They Get Separate Trials?

While a taxpayer who commits tax fraud is entitled to a hearing, in United States v. Robbins the question is whether the taxpayer is entitled to a separate hearing.

Lee Robbins founded Robbins & Associates, which was a bookkeeping and tax return preparation business located in Georgia and Oklahoma. Robbins recruited, hired, and trained Gabriel Bonner. Bonner operated the Tulsa office and Robbins operated the Atlanta office; however, Robbins continued to review and e-file the tax returns prepared by Bonner.

Unfortunately, Robbins & Associates had a practice of helping clients minimize their tax payments and maximizing their refunds by falsely characterizing nondeductible personal expenses as deductible business expenses.

Both Robbins and Bonner were indicted for conspiracy to defraud the IRS, Robbins was indicted for fifteen counts of aiding and assisting the preparation and submission of false and fraudulent tax returns, and Bonner was indicted for fifty different counts of aiding and assisting the preparation and submission of false and fraudulent tax returns.

The end result: Bonner was acquitted on all charges and Robbins was found not guilty of conspiracy but guilty of the 15 individual counts.

Robbins filed a pre-trial motion asking for a separate trial, because he felt that he would be prejudiced by being tried with Bonner. The district court denied Robbins’ motion.

The appellate court opinion found that Robbins defense was antagonistic to Bonner’s defense, but not that whether the defenses presented were so antagonistic that they were mutually exclusive, so that the acceptance of one party’s defense would tend to preclude the acquittal of the other, or that the guilt of one defendant tends to establish the innocence of the other.

At trial, Robbins and Bonner each attempted to cast all blame for tax fraud on the other. The court opinion states in part:

Bonner testified that it was … Robbins who “caused all the wrong and illegal tax returns to be filed.” And, according to Robbins, “Bonner’s counsel sought to deliberately undermine Robbins’ defense at trial with every witness so that Bonner appeared only to be someone who was a data clerk.” Robbins also complains that Bonner’s counsel acted as an “additional prosecutor” by identifying himself as a former prosecutor and telling the jury to disbelieve the arguments made by Robbins’ [tax] attorney.

The courts often have to make difficult decisions. On the one hand, Robbins very well could have been prejudiced by having a joint trial with Bonner. I once heard a famous Texas criminal lawyer say that a joint trial will either allow the jury to be swayed by a more sympathetic co-defendant or it will allow a less likeable co-defendant sour the jury (in true Texas trial attorney form, the Texas attorney couched these ideas in terms of the sweet perfume of a beautiful woman and something about throwing a skunk in the jury box…).

On the other hand, combining tax fraud cases can speed the trial along and save the parties the time and expense associated with presenting the same evidence to two different juries.

Given the severity of the consequences in tax fraud cases and the disparate results, I might be more inclined to believe that perhaps Robbins should have been given a separate trial. Then again, Robbins picked recruited and hired his partner in crime, so maybe a joint trial with his partner was warranted….

April 2nd, 2007 | No Comments »

IRS Says When a Grape is No Longer a Grape

We all know that (most) wines come from grapes, but many of us might not know exactly when grapes turn into wine for federal income tax purposes. According to the IRS (in Chief Counsel Advice Memorandum 200713023), grapes turn into wine when a taxpayer begins crushing the grapes. This IRS Memorandum highlights a few of the tax planning considerations for businesses that produce and sell their own goods.

In general, taxpayers are not entitled to immediately deduct the cost associated with producing a good. Rather, the taxpayer has to add the associated costs to their tax basis in the good, which permits the taxpayer to claim tax deductions over time or it reduces the amount of taxable gain that the taxpayer will have when they sell the good. Production costs can include everything from direct labor and materials costs to indirect rents, taxes, and other costs.

This is problematic for taxpayers who grow grapes and operate wineries, as it appears that the taxpayer would have to capitalize all of their expenses up until the time that the wine was sold. This would be especially harmful for wineries because the wine making process can take many years.

This Chief Counsel Advice Memorandum says that this is not the case. Instead, the IRS will treat the grape growing and winery functions as separate businesses – even though (1) “the grapes themselves are never subject to a ‘sale or other disposition’ as these terms are customarily used in federal income tax law” and (2) the taxpayer did not operate their business as two separate and distinct businesses.

Of course, the taxpayer could have just separated out their different business functions by operating two or more separate and distinct operations. This could provide the taxpayer with the ability to choose what items it wanted to capitalize or deduct and when….

March 31st, 2007 | No Comments »

Yet Another Lottery-Related Tax Question

Here is yet another lottery-related tax question: Does a state lottery have to withhold tax from lotto winnings if a single taxpayer wins more than one lottery prize from the same lotto ticket where the total winnings exceed $5,000, but the individual winnings do not exceed $5,000?

The IRS recently held that the state would not have to withhold the tax as long as the lotto numbers were different. The IRS reasoned that a lotto ticket that had different winning numbers were not “identical wagers.” Identical wagers are treated as a single wager.

The IRS uses these examples: placing two bets on the same horse in a horse race would be an “identical wager” and it would be treated as only one wager. But, there would be no “identical wager” where one bet was placed with the track and the other bet were placed with an off-track betting establishment. Similarly, there would be no “identical wager” if the bets were placed with the same establishment but one bet was for a trifecta and the other an exacta.

In this case, the IRS said that the lottery numbers would have to be identical for the bet to be an “identical wager.” The state lotto would only have to withhold tax if the winning lottery ticket had the same numbers, because the winnings were treated as different wagers and the individual winnings did not exceed the $5,000 withholding requirement limit.

March 30th, 2007 | No Comments »

Does Anyone Really Win the Lottery?

The Prebola v. Commissioner case serves as a reminder that winning the lottery requires significant tax planning. It also serves as a reminder that absent advanced tax planning, the federal and state governments are the only true lottery winners.

Lottery winnings are treated as income from gambling. As noted in the Prebola case, lottery winnings are accorded ordinary tax treatment, rather than capital gains tax treatment. This means that the federal government can impose a 38%+ tax on significant lottery winnings at the time that the taxpayer receives the winnings. The state and city governments where the taxpayer resides may also impose taxes on the lottery winnings at the time that the taxpayer receives the winnings. These taxes could approach 10%+, as is the case for taxpayers in some cities in Colorado.

If that is not bad enough, both the federal and local governments may impose capital gains taxes on proceeds derived from invested lottery winnings. These taxes could exceed 20%+ of the gains. In addition, the federal and local governments may collect excise and other taxes on items purchased with lottery winnings. These taxes could exceed 10%+ of the cost of the items purchased.

And still, the federal and state governments may impose a tax on gifted or unspent lottery winnings. These taxes could exceed 50%+ of the unspent lottery winnings.

For those keeping tabs, the total tax liability can exceed 100% of the lotto winnings — which shows who really wins the lottery.

It appears that Prebola did not present any real claims by bringing suit against the IRS, but, given the amount of taxes that she, and other lottery winners, have to pay, one can understand her frustration. Of course, hiring a tax attorney to help restructure her lottery winnings might be a more productive way to vent her frustrations.

March 28th, 2007 | No Comments »

IRS Obtains Promissory Note: Can it Collect on the Note?

In United States v. Spangler, the Eleventh Circuit Court of Appeals upheld a lower court order requiring a taxpayer to transfer a promissory note to the government so that the note payments would be credited towards the amount of the taxpayer’s court ordered tax restitution.

Given that the IRS has a poor track record in collecting taxes from taxpayers via the traditional avenues, this scenario raises the question as to whether the IRS would be able to collect tax payments from third parties via a promissory note.

Generally an individual – be it a taxpayer or the government – steps into the shoes of the person who holds a promissory note and it acquires the rights of that person. If the individual is a taxpayer whose promissory note is seized by the government or turned over to the government via a court proceeding, the analysis then focuses on what rights the individual taxpayer had in the note.

A more precise question is whether the taxpayer who held the note was a “holder in due course.” A “holder in due course” is any person that acquires a negotiable promissory note without knowledge of any claims or defenses associated with the note. The individual who makes payments on a note that is held by a “holder in due course” is generally not justified in refusing to pay the third party due to defenses or claims that he or she may have against the original note holder.

A taxpayer who committed fraud related to the note would probably not qualify as a “holder in due course,” because their fraud would create a claim and defense to payment of the note. Similarly, taxpayers could structure the promissory note so that it is non-negotiable and/or only acquire non-negotiable notes – which would ensure that the government or other parties would might obtain the note would never qualify as a “holder in due course.”

If the taxpayer were not a “holder in due course,” a third party who was subject to the note could raise the defense of fraud, duress or illegality of the transaction in an effort to rescind the note and to recover the instrument or its proceeds. If the note were held by the government, the person making the payments could raise these defenses in order to recover the note proceeds from the government and to rescind the note.

It would be even more interesting if the third party raised a fraud defense, as the government would have to argue that the taxpayer – the same taxpayer that it convicted of tax fraud – did not commit fraud in order for the government to collect on the promissory note. This could create a conflict of interest for the government – one that tax criminals could conceivably, given the right facts, use to overturn their criminal tax fraud sentences.

Does this mean that taxpayers who are facing criminal tax fraud charges can simply transfer assets to a third party in exchange for a promissory note, with the aim of having the third party rescind or void the note and reclaim the note proceeds once the government obtains possession of the note?

The answer is probably not, as the government would likely pursue the third party for fraud as well and/or impose transferee liability upon the third party. The risk is simply too great. Although, this type of case would raise some very interesting issues and the government may find itself running into more of these cases due to the rising number of mortgage foreclosures and the recent increase in private investors purchasing promissory notes.

March 20th, 2007 | No Comments »

“Rule of Thumb:” IRS Employees Not Subject to Ethical or Moral Standards

Unlike tax attorneys, IRS employees are not subject to any ethical or moral standards. Take the case of Wormley v. Department of the Treasury. The Wormley case presents the unusual question as to whether an IRS employee should be fired if she is arrested and convicted of assault for “biting off a portion of her neighbor’s thumb during a physical altercation.”

The court opinion sets out the following facts: Patricia Wormley was employed as an IRS tax examining clerk in Philadelphia. Wormely was belligerent with her manager when the manager attempted to discuss Wormley’s training period performance. The IRS discovered that Wormely had been arrested when the IRS was investigating Wormley’s background (apparently after Wormely was already employed with the IRS).

After Wormely was convicted of simple assault, the IRS issued a letter to Wormley indicating that she would be removed from her position due to (1) her attack upon her neighbor, (2) her assault conviction, and (3) her inappropriate behavior toward her manager. The letter also mentioned that Wormley had “three [prior] instances of misbehavior.”

Wormely appealed the IRS determination. The IRS, an administrative law judge, and the Court of Appeals for the Federal Circuit held that “the removal penalty was reasonable considering Ms. Wormley’s potential for behaving violently and that her job involved working in close proximity to her co-workers and dealing personally with the general public.”

The Wormely case highlights one of the major problems with the IRS; namely, IRS employees are not held to any ethical or moral standard. Three documented instances of “misbehavior” should be sufficient to warrant termination – absent an arrest for assault or confronting an IRS manager (If there were three documented instances of “misbehavior,” one is left wondering how many instances of “misbehavior” were not documented).

The Taxpayer Bill of Rights is the only body of rules that come close to imposing standards on IRS employees, but these Rights are so basic that they do not really address ethical or moral standards for IRS employees.

Compare this to the lengthy do and do-not standards imposed on tax attorneys via state bar ethics rules, administrative rulings, court cases, and even IRS proclamations.

As the tax practitioner community is well aware, the IRS has been working on Circular 230 and its Office of Professional Responsibility to “strengthen professional standards” for non-IRS employee tax practitioners.

My personal opinion is that the IRS should extend these new “high” Circular 230 standards to its own employees before even beginning to think about extending them to non-IRS tax practitioners. This seems like a logical step if the goal really is to “strengthen professional standards.”

If Wormley were subject to Circular 230, she would probably have found herself before the United States Merit Systems Protection Board much sooner — perhaps with her first, second or third instance of misconduct.

Until the IRS opts to impose any standards on its employees, non-IRS employee tax attorneys will have to advise their clients that the “rule of thumb” is that IRS employees are not bound by any moral or ethical standards and that, absent extreme circumstances, IRS employees who “misbehave” will not lose their jobs and they will not be subject to any other IRS sanctions.

March 16th, 2007 | No Comments »

IRS Incentive to Delay Processing Cases: Extra Tax Penalties & Interest

I think that most citizens would agree that the IRS should not benefit from failing to do its job in a timely manner. The recent United States v. Ryals case provides an example of how the IRS can benefit from denying taxpayer claims and delaying the collection of taxes.

Ryals owed taxes for tax years 1977 and 1978. The tax court found Ryals liable for these taxes in 1989 and the IRS assessed the taxes at that time. By March 2003 Ryals tax liability had grown (due to tax penalties and interest) from just over $500,000, which was the amount assessed, to just over $1,500,000.

Between 1989 and 2003 Ryals was convicted of a tax crime and he submitted two offers in compromise that were rejected by the IRS. The IRS filed suit against Ryals for the unpaid tax on May 20, 2003. The main question for the court was whether the IRS collection statute had expired.

The court looked at the impact of three Congressional amendments which addressed whether submitting an offer in compromise tolls the IRS collections statute, to conclude that the collections statute expired 19 days AFTER the IRS filed suit against Ryals – which, unfortunately for Ryals, made it possible for the IRS to maintain its tax court case.

Here is a quote from the court’s opinion that I couldn’t resist mentioning: “Whether or not such a construction is at odds with temporary regulations issued, congressional intent, or the initial position of the Government as stated in its motion for summary judgment is irrelevant because the clear words of the statute command this result.” I really like this sentence. It is powerful. There is nothing like a court disregarding IRS-created law, Congress, an IRS attorney, and a taxpayer all in one sentence….

The court did agree with the IRS position that an IRS wage levy by the IRS can in fact continue after an offer in compromise is “pending,” so long as the wage levy was filed prior to the IRS accepting an offer in compromise for consideration. I personally do not agree with this “law,” as it gives IRS employees a strong incentive to delay in accepting offers in compromise for consideration.

Many of us will remember last year’s move by the IRS to consolidate the offer in compromise program by having all offers that are submitted be screened by one IRS office – which was supposed to speed up the offer processing time. This move has not only slowed down the processing of offers in compromise (yes, the IRS is actually getting slower), it also puts the IRS in a very good position to delay processing offers where a wage levy should be filed against taxpayers (the very thing that the IRS chides taxpayers for doing – even though IRS employees do it too).

Under the old IRS procedure for processing offers in compromise, the appeals office would not be able to have direct and impermissible contact with the exam or collections function to determine whether a wage levy was appropriate. Now, the offer processing center probably can have this type of contact as it does not seem to be impermissible ex parte contact (in that the appeals officer or even office that ultimately considers the case is not the one that initially received the offer in compromise for processing).

Cases like this really are unfortunate. Taxpayers should not be penalized by coming forward to make offers to settle their tax liabilities.

Also, taxpayers should demand something more of their chief tax collection agency. Having to argue about 19 days when the IRS had over 20 years to collect this tax has to be embarrassing for IRS administrators and employees (to say the least) and having to live with a tax debt for two decades is unduly burdensome for taxpayers.

There is something wrong with the IRS being rewarded for incompetence by being able to obtain a court judgment for a million dollars worth of penalties and interest that it would not have been entitled to collect had it done its job sooner rather than later.

March 15th, 2007 | No Comments »