IRS Suffers Defeat in Appeals Court as Jury's Finding of Return Preparer Penalty Reversed

The IRS suffered a major defeat last week in the Eleventh Circuit Court of Appeals, in Carlson v. United States, Case No. 12-13736 (June 13, 2014), as the appellate court reversed in part and vacated and remanded in part a decision from a Florida district court holding a tax preparer liable for penalties under Code Section 6701.  The eleventh circuit held that the burden of proof was not the usual minimum of a "preponderance of the evidence" (sometimes described as "more likely than not") but the higher "clear and convincing evidence" usually applied in civil fraud cases.  (Note: the clear/convincing standard is lower than the "beyond a reasonable doubt" standard.)  Appellant, Frances Carlson, was a return preparer for Jackson Hewitt tax services.

Section 6701(a) of the Internal Revenue Code, 26 U.S.C., provides for a penalty to be imposed on any person:

(1) who aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,

(2) who knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and

(3) who knows that such portion (if so used) would result in an understatement of the liability for tax of another person.

Under IRS Section 6701(b), the penalty is $1000 for essentially every return that the tax preparer knew was claiming a false understatement of tax, but the penalty is limited to one imposition for each year involving a particular taxpayer. For example, if a return preparer prepares knowingly false returns for Jimmy in 2010, 2011, and 2012,  and a knowingly false tax return and a false amended return for Jane in 2010, the return preparer would be penalized $3000 for Jimmy's three returns but only $1000 for the two filed for Jane.

In finding against the IRS, the Court noted several facts which implied that, even though Carlson prepared tax returns as her job for Jackson Hewitt, she was unsophisticated in tax matters and was not well educated or particularly well trained.  Rather, she relied mainly on a software program.  Nonetheless, she prepared 200-300 returns in her first year.  In her second year, she was promoted to corporate returns!  (Although the IRS is the loser in this case, it certainly doesn't reflect well on Jackson Hewitt either.  It does serve as a valuable reminder that a big name is no guarantee that the individual preparing your returns is very qualified.  The other big box preparation service, HR Block, on the other hand, if I recall right, spent a great deal of its advertising last year on how experienced some of its preparers were, perhaps trying to fight this perception.)

Her boss at JH was arrested in 2006 for drug and money laundering charges.  (Wow!)  The IRS later investigated the preparation business, at which time Carlson stopped working there, but had prepared more than a thousand returns during her tenure.  The IRS penalized her for 40 of those returns, she paid 15% down and sued in district court for a refund (which is unique to certain penalties).  The DOJ saw fit to defend only 27 of those 40 in a jury trial.

As you can see, Carlson is actually fairly sympathetic in this case.  The government's decision to litigate when there was a possible adverse decision on a purely legal issue was a hazardous one.  There is a saying in litigation that "bad facts make bad law."  If the DOJ was trying to avoid making bad law, this may have been the wrong case to push.

Contrary to the government’s argument, Section 6701, even though it doesn't use the word "fraud,"requires proof of fraud before penalties can be imposed.  Essentially, knowledge that a false item would make a false refund is fraud.

The case was remanded for a whole new trial.  The appeals court held the government was required to prove by clear and convincing evidence that the individual had actual knowledge that the returns she prepared for others contained an understatement of tax.  Thus, the instruction to the jury on the lower standard of proof was improper.  In a full sweep for the return preparer, the appeals court found the government's case wanting under any standard.  There was simply insufficient evidence to support the jury’s verdict that a tax preparer was liable for penalties under Section 6701.

 Further, government presented no evidence that the preparer knew that twelve of the returns understated the correct tax. The government was required to show that the preparer knew that the returns were fraudulent; it was insufficient for the government to show only that the returns contained errors.

In contrast, the preparer presented substantial evidence that she did not know the returns she prepared understated the correct tax. Moreover, the simple fact that many of the preparer's customers either failed to substantiate their deductions during the audit or were not cooperative during the IRS's later audit was not evidence that those clients had not presented substantiation to the preparer (or misled the preparer) at the time the returns were prepared.  A jury could not reasonably infer that the preparer knew the returns contained understatements based only on those clients' conduct during audits.

This case represents a major "win" legal victory for this particular return preparer and a terrible defeat for the government.  However, the "win" is not that great if you consider the public shame the IRS has brought on the return preparer and Jackson Hewitt and the likely loss of business it may have caused her practice.  Hopefully, this case gives enough guidance to prevent similar cases from being pushed forward by the DOJ and IRS unnecessarily.

The Wilson Tax Law Group has extensive experience in return preparer penalties and criminal defense of tax return preparers. Please feel free to contact our firm with any inquiries on similar issues or any other tax problems.

IRS Suffers Defeat in Appeals Court as Jury's Finding of Return Preparer Penalty Reversed

The IRS suffered a major defeat last week in the Eleventh Circuit Court of Appeals, in Carlson v. United States, Case No. 12-13736 (June 13, 2014), as the appellate court reversed in part and vacated and remanded in part a decision from a Florida district court holding a tax preparer liable for penalties under Code Section 6701.  The eleventh circuit held that the burden of proof was not the usual minimum of a "preponderance of the evidence" (sometimes described as "more likely than not") but the higher "clear and convincing evidence" usually applied in civil fraud cases.  (Note: the clear/convincing standard is lower than the "beyond a reasonable doubt" standard.)  Appellant, Frances Carlson, was a return preparer for Jackson Hewitt tax services.

Section 6701(a) of the Internal Revenue Code, 26 U.S.C., provides for a penalty to be imposed on any person:

(1) who aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,

(2) who knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and

(3) who knows that such portion (if so used) would result in an understatement of the liability for tax of another person.

Under IRS Section 6701(b), the penalty is $1000 for essentially every return that the tax preparer knew was claiming a false understatement of tax, but the penalty is limited to one imposition for each year involving a particular taxpayer. For example, if a return preparer prepares knowingly false returns for Jimmy in 2010, 2011, and 2012,  and a knowingly false tax return and a false amended return for Jane in 2010, the return preparer would be penalized $3000 for Jimmy's three returns but only $1000 for the two filed for Jane.

In finding against the IRS, the Court noted several facts which implied that, even though Carlson prepared tax returns as her job for Jackson Hewitt, she was unsophisticated in tax matters and was not well educated or particularly well trained.  Rather, she relied mainly on a software program.  Nonetheless, she prepared 200-300 returns in her first year.  In her second year, she was promoted to corporate returns!  (Although the IRS is the loser in this case, it certainly doesn't reflect well on Jackson Hewitt either.  It does serve as a valuable reminder that a big name is no guarantee that the individual preparing your returns is very qualified.  The other big box preparation service, HR Block, on the other hand, if I recall right, spent a great deal of its advertising last year on how experienced some of its preparers were, perhaps trying to fight this perception.)

Her boss at JH was arrested in 2006 for drug and money laundering charges.  (Wow!)  The IRS later investigated the preparation business, at which time Carlson stopped working there, but had prepared more than a thousand returns during her tenure.  The IRS penalized her for 40 of those returns, she paid 15% down and sued in district court for a refund (which is unique to certain penalties).  The DOJ saw fit to defend only 27 of those 40 in a jury trial.

As you can see, Carlson is actually fairly sympathetic in this case.  The government's decision to litigate when there was a possible adverse decision on a purely legal issue was a hazardous one.  There is a saying in litigation that "bad facts make bad law."  If the DOJ was trying to avoid making bad law, this may have been the wrong case to push.

Contrary to the government’s argument, Section 6701, even though it doesn't use the word "fraud,"requires proof of fraud before penalties can be imposed.  Essentially, knowledge that a false item would make a false refund is fraud.

The case was remanded for a whole new trial.  The appeals court held the government was required to prove by clear and convincing evidence that the individual had actual knowledge that the returns she prepared for others contained an understatement of tax.  Thus, the instruction to the jury on the lower standard of proof was improper.  In a full sweep for the return preparer, the appeals court found the government's case wanting under any standard.  There was simply insufficient evidence to support the jury’s verdict that a tax preparer was liable for penalties under Section 6701.

 Further, government presented no evidence that the preparer knew that twelve of the returns understated the correct tax. The government was required to show that the preparer knew that the returns were fraudulent; it was insufficient for the government to show only that the returns contained errors.

In contrast, the preparer presented substantial evidence that she did not know the returns she prepared understated the correct tax. Moreover, the simple fact that many of the preparer's customers either failed to substantiate their deductions during the audit or were not cooperative during the IRS's later audit was not evidence that those clients had not presented substantiation to the preparer (or misled the preparer) at the time the returns were prepared.  A jury could not reasonably infer that the preparer knew the returns contained understatements based only on those clients' conduct during audits.

This case represents a major "win" legal victory for this particular return preparer and a terrible defeat for the government.  However, the "win" is not that great if you consider the public shame the IRS has brought on the return preparer and Jackson Hewitt and the likely loss of business it may have caused her practice.  Hopefully, this case gives enough guidance to prevent similar cases from being pushed forward by the DOJ and IRS unnecessarily.

The Wilson Tax Law Group has extensive experience in return preparer penalties and criminal defense of tax return preparers. Please feel free to contact our firm with any inquiries on similar issues or any other tax problems.

IRS Increases the FBAR Penalty for People with Offshore Accounts

In efforts to increase offshore tax compliance, the IRS just made brand new changes to its current offshore disclosure programs. 

The streamlined procedures have been expanded to accommodate a wider group of U.S. taxpayers who have unreported foreign financial accounts.  This is a very good thing because now more people can use the procedures than could have before.

The original streamlined procedures announced in 2012 were available only to non-resident, non-filers. Taxpayer submissions were subject to different degrees of review based on the amount of the tax due and the taxpayer’s response to a “risk” questionnaire.

The expanded streamlined procedures are available to a wider population of U.S. taxpayers living outside the country and, for the first time, to certain U.S. taxpayers residing in the United States. The changes include:

 • Eliminating a requirement that the taxpayer have $1,500 or less of unpaid tax per year;

 •  Eliminating the required risk questionnaire;

 •  Requiring the taxpayer to certify that previous failures to comply were due to non-willful conduct.

For eligible U.S. taxpayers residing outside the United States, all penalties will be waived. For eligible U.S. taxpayers residing in the United States, the only penalty will be a miscellaneous offshore penalty equal to 5 percent of the foreign financial assets that gave rise to the tax compliance issue.

 Offshore Voluntary Disclosure Program (OVDP) Modified: The changes announced today also make important modifications to the OVDP. The changes include:

 •  Requiring additional information from taxpayers applying to the program;

 •  Eliminating the existing reduced penalty percentage for certain non-willful taxpayers in light of the expansion of the streamlined procedures;

  •  Requiring taxpayers to submit all account statements and pay the offshore penalty at the time of the OVDP application;

 • Enabling taxpayers to submit voluminous records electronically rather than on paper;

 • Increasing the offshore penalty percentage (from 27.5% to 50%) if, before the taxpayer’s OVDP pre-clearance request is submitted, it becomes public that a financial institution where the taxpayer holds an account or another party facilitating the taxpayer’s offshore arrangement is under investigation by the IRS or Department of Justice.

I will add more in a later post.  You can find the news release here.   Please contact the Wilson Tax Law Group if you have questions about offshore bank account disclosures or FBAR matters under the July 1, 2014 or transitional procedures.  We have handled numerous offshore cases.

Update:  The IRS has published FAQ's for the Transition Rules drawing a clear line as to who can qualify for the pre-July 1, 2014 penalty rates.

Q: What if I made a request for OVDP pre-clearance before July 1, 2014, but not a full voluntary disclosure? 

A: A taxpayer will not be considered to be currently participating in OVDP for purposes of receiving transitional treatment unless, as of July 1, 2014, he has mailed to IRS Criminal Investigation his voluntary disclosure letter and attachments as described in OVDP FAQ 24.  Thus, a taxpayer who makes an offshore voluntary disclosure as outlined in FAQ 24 on or after July 1, 2014 will not be eligible for transitional treatment under OVDP, even though he may have made a request for OVDP pre-clearance before July 1, 2014.

These transitional FAQs can be found here.

The FAQ for the effective-July 1, 2014 OVDP can be found here.

 

IRS Increases the FBAR Penalty for People with Offshore Accounts

In efforts to increase offshore tax compliance, the IRS just made brand new changes to its current offshore disclosure programs. 

The streamlined procedures have been expanded to accommodate a wider group of U.S. taxpayers who have unreported foreign financial accounts.  This is a very good thing because now more people can use the procedures than could have before.

The original streamlined procedures announced in 2012 were available only to non-resident, non-filers. Taxpayer submissions were subject to different degrees of review based on the amount of the tax due and the taxpayer’s response to a “risk” questionnaire.

The expanded streamlined procedures are available to a wider population of U.S. taxpayers living outside the country and, for the first time, to certain U.S. taxpayers residing in the United States. The changes include:

 • Eliminating a requirement that the taxpayer have $1,500 or less of unpaid tax per year;

 •  Eliminating the required risk questionnaire;

 •  Requiring the taxpayer to certify that previous failures to comply were due to non-willful conduct.

For eligible U.S. taxpayers residing outside the United States, all penalties will be waived. For eligible U.S. taxpayers residing in the United States, the only penalty will be a miscellaneous offshore penalty equal to 5 percent of the foreign financial assets that gave rise to the tax compliance issue.

 Offshore Voluntary Disclosure Program (OVDP) Modified: The changes announced today also make important modifications to the OVDP. The changes include:

 •  Requiring additional information from taxpayers applying to the program;

 •  Eliminating the existing reduced penalty percentage for certain non-willful taxpayers in light of the expansion of the streamlined procedures;

  •  Requiring taxpayers to submit all account statements and pay the offshore penalty at the time of the OVDP application;

 • Enabling taxpayers to submit voluminous records electronically rather than on paper;

 • Increasing the offshore penalty percentage (from 27.5% to 50%) if, before the taxpayer’s OVDP pre-clearance request is submitted, it becomes public that a financial institution where the taxpayer holds an account or another party facilitating the taxpayer’s offshore arrangement is under investigation by the IRS or Department of Justice.

I will add more in a later post.  You can find the news release here.   Please contact the Wilson Tax Law Group if you have questions about offshore bank account disclosures or FBAR matters under the July 1, 2014 or transitional procedures.  We have handled numerous offshore cases.

Update:  The IRS has published FAQ's for the Transition Rules drawing a clear line as to who can qualify for the pre-July 1, 2014 penalty rates.

Q: What if I made a request for OVDP pre-clearance before July 1, 2014, but not a full voluntary disclosure? 

A: A taxpayer will not be considered to be currently participating in OVDP for purposes of receiving transitional treatment unless, as of July 1, 2014, he has mailed to IRS Criminal Investigation his voluntary disclosure letter and attachments as described in OVDP FAQ 24.  Thus, a taxpayer who makes an offshore voluntary disclosure as outlined in FAQ 24 on or after July 1, 2014 will not be eligible for transitional treatment under OVDP, even though he may have made a request for OVDP pre-clearance before July 1, 2014.

These transitional FAQs can be found here.

The FAQ for the effective-July 1, 2014 OVDP can be found here.

 

Tax Problems Facing Marijuana Dispensaries, This Time From the City of Los Angeles

The LA times published an interesting article about marijuana dispensaries operating in Los Angeles.  The article focuses on the interesting fact that as Los Angeles tries to clamp down on the number of marijuana dispensaries operating in Los Angeles by making them follow Proposition D requirements, more than 450 medical marijuana shops filed business tax renewals with the Office of Finance.  This number is more than three times as many stores than what is estimated to be allowed to stay open.  So while local lawmakers are troubled by the number of medical marijuana shops that still exist in Los Angeles, the Office of Finance has no problem cashing in on all the taxes being collected from them.  The article states that Los Angeles collected roughly $2.1 million from medical marijuana tax renewals this year, an Office of Finance staffer told a City Council committee Monday.

The interesting thing about this article is that City Council is upset that these people are paying business taxes because now the City cannot use tax evasion statutes as a method to shut them down.   It seems to me that these people are trying to comply with the tax code so whether or not they comply with Proposition D is not the tax-collecting agencies' business.   The City is so upset at all the business tax renewals, but has no problem collecting the roughly $2.1 million in revenues from medical marijuana shops.  Nor should they have any problem with it - Council members would be forfeiting their jobs if they took the position that the illegal businesses should be issued refunds.

In reality, the juxtaposition between collecting taxes from someone while turning a blind eye to the source of the money is hardly a new story.  This happens every time the IRS comes in to count the drug money after the DEA makes a big bust.  Even illegal businesses have to pay taxes.  Nonetheless, you don't usually see the opposite scenario - e.g., the DEA swooping in after the IRS audits a tax return - as the City Council members seem to support here.   The sharing of tax information between taxing and law enforcement agencies is usually a one-way street.  In non-tax cases, the Federal tax privacy law, IRC Section 6103(i)(1), provides that the IRS can share return information with another federal investigative agency only with a court order.

The government relies on taxes to operate and it would inhibit people from filing true tax returns if they thought that the information would be made public or would be shared with other government agencies.  The privacy of tax return information was also a qualified privilege under Federal common law before Congress enacted Section 6103.  In this situation, it would behoove whoever is advocating and lobbying on behalf of the dispensaries to not only be familiar with the medical marijuana laws and business laws, but also tax law and policy.

As an attorney who understands criminal law and tax law, I can tell you that medical marijuana dispensaries get no breaks that other businesses get under the state tax code.  They are treated as illegal drug trafficking activities under the California Revenue and Taxation Code. So what does this mean? 

It means both the Feds and California will disallow all the business expenses of a marijuana dispensary that a normal business is entitled to deduct.  As a result, marijuana dispensaries will be taxed on their gross receipts for income tax purposes. California's tax code is basically "monkey see, monkey do," adopting the Federal tax code almost rule for rule.  Under Federal law, if a business violated public policy or is illegal, then it cannot take advantage of deductions or credits under the tax code.  Because federal tax law deems these activities as illegal drug trafficking activities, so does California.  These rules are completely screwed up because they encourage these types of businesses to operate under the radar for tax purposes.   Fortunately, it is not an entirely slam dunk case for the tax authorities because there are some legitimate tax "loopholes."  There are ways to operate so as to legitimately minimize these tax burdens.

Much of this is covered in a recent article I wrote on the Taxation Of Medical Marijuana Dispensaries.  I suggest any marijuana dispensary contact an experienced tax attorney who knows the marijuana dispensary tax rules inside and out.  There are ways to follow the tax rules and not have to pay taxes on the gross receipts of the dispensary.  Feel free to contact the Wilson Tax Law Group, if you have any questions. Our firm has significant experience addressing tax problems facing marijuana dispensaries.

Tax Problems Facing Marijuana Dispensaries, This Time From the City of Los Angeles

The LA times published an interesting article about marijuana dispensaries operating in Los Angeles.  The article focuses on the interesting fact that as Los Angeles tries to clamp down on the number of marijuana dispensaries operating in Los Angeles by making them follow Proposition D requirements, more than 450 medical marijuana shops filed business tax renewals with the Office of Finance.  This number is more than three times as many stores than what is estimated to be allowed to stay open.  So while local lawmakers are troubled by the number of medical marijuana shops that still exist in Los Angeles, the Office of Finance has no problem cashing in on all the taxes being collected from them.  The article states that Los Angeles collected roughly $2.1 million from medical marijuana tax renewals this year, an Office of Finance staffer told a City Council committee Monday.

The interesting thing about this article is that City Council is upset that these people are paying business taxes because now the City cannot use tax evasion statutes as a method to shut them down.   It seems to me that these people are trying to comply with the tax code so whether or not they comply with Proposition D is not the tax-collecting agencies' business.   The City is so upset at all the business tax renewals, but has no problem collecting the roughly $2.1 million in revenues from medical marijuana shops.  Nor should they have any problem with it - Council members would be forfeiting their jobs if they took the position that the illegal businesses should be issued refunds.

In reality, the juxtaposition between collecting taxes from someone while turning a blind eye to the source of the money is hardly a new story.  This happens every time the IRS comes in to count the drug money after the DEA makes a big bust.  Even illegal businesses have to pay taxes.  Nonetheless, you don't usually see the opposite scenario - e.g., the DEA swooping in after the IRS audits a tax return - as the City Council members seem to support here.   The sharing of tax information between taxing and law enforcement agencies is usually a one-way street.  In non-tax cases, the Federal tax privacy law, IRC Section 6103(i)(1), provides that the IRS can share return information with another federal investigative agency only with a court order.

The government relies on taxes to operate and it would inhibit people from filing true tax returns if they thought that the information would be made public or would be shared with other government agencies.  The privacy of tax return information was also a qualified privilege under Federal common law before Congress enacted Section 6103.  In this situation, it would behoove whoever is advocating and lobbying on behalf of the dispensaries to not only be familiar with the medical marijuana laws and business laws, but also tax law and policy.

As an attorney who understands criminal law and tax law, I can tell you that medical marijuana dispensaries get no breaks that other businesses get under the state tax code.  They are treated as illegal drug trafficking activities under the California Revenue and Taxation Code. So what does this mean? 

It means both the Feds and California will disallow all the business expenses of a marijuana dispensary that a normal business is entitled to deduct.  As a result, marijuana dispensaries will be taxed on their gross receipts for income tax purposes. California's tax code is basically "monkey see, monkey do," adopting the Federal tax code almost rule for rule.  Under Federal law, if a business violated public policy or is illegal, then it cannot take advantage of deductions or credits under the tax code.  Because federal tax law deems these activities as illegal drug trafficking activities, so does California.  These rules are completely screwed up because they encourage these types of businesses to operate under the radar for tax purposes.   Fortunately, it is not an entirely slam dunk case for the tax authorities because there are some legitimate tax "loopholes."  There are ways to operate so as to legitimately minimize these tax burdens.

Much of this is covered in a recent article I wrote on the Taxation Of Medical Marijuana Dispensaries.  I suggest any marijuana dispensary contact an experienced tax attorney who knows the marijuana dispensary tax rules inside and out.  There are ways to follow the tax rules and not have to pay taxes on the gross receipts of the dispensary.  Feel free to contact the Wilson Tax Law Group, if you have any questions. Our firm has significant experience addressing tax problems facing marijuana dispensaries.

IRS (Probably) Spent More Money than Tax Owed in Symbolic Tax Court Victory

Symbolic of what?  I'll leave that to you.  From a Tax Court opinion released earlier this week, file this under Ridiculous Things the IRS Does:

Taxpayers filed a perfectly correct return listing their taxable social security income on the correct line.  IRS received the return and, using its big brain, decided the social security income was nontaxable, recalculates the tax, and issued the taxpayers an additional $548 refund.  Somehow, the IRS later realized the taxpayers were right and they shouldn't have sent the extra dollar bills, so they audited the couple and demanded they repay the $548.  When the couple declined, the IRS issued a notice of deficiency, on which the couple appealed to the tax court.  Somehow, probably driven by the couple's righteous indignation, the case went all the way to trial, where it was decided in a judicial opinion.  The taxpayers argued they shouldn't have to pay for the IRS's mistake, but the court found in favor of the government.

Granted, the taxpayers were technically in the wrong under the law - a "rebate refund" can be reclaimed by the IRS through examination procedures.  Also, "easy come, easy go" should prevail here.

But the real losers here are the American taxpayers.  Someone in the IRS decided it would be worthwhile to take this thing all the way, over a few measly dollars, and issue a notice of deficiency, giving appeal rights - a ticket to the Tax Court - to these taxpayers.  Hours of some IRS auditor's time dealing with these taxpayers, hours of time spent by paralegals, secretaries, and attorneys at the IRS Office of Chief Counsel to prepare and try the case, and hours spent by the judge, his/her staff, and the judicial clerk to arrive at this opinion. (And don't forget the cost of gas to Tax Court for the IRS Attorney, mailing costs for pleadings, and the cost of flying the judge to Texas and setting him/her up in a hotel to try the case.) Chances this cost the government and, by extension, the American people, far more than its worth are pretty high.  The full opinion can be found here.

Posted by our Newport Coast Tax Attorney at wilsontaxlaw.com.