1. General. The general statute of limitations is 3 years. § 6501(a).
2. 25% Omission. In the case of a 25% omission of income, the statute of limitations is 6 years. § 6501(e). Many of the shelters exploited basis overstatements which, the cases have held, do not invoke this section, but the IRS may have put the quietus on those holdings by Regulation. See T.D. 9466, 2009-43 I.R.B. 551.
3. False Return. "In the case of a false or fraudulent return with the intent to evade tax," the statute of limitations is unlimited. § 6501(c)(1).
4. Willful Attempt to Evade Tax. "In case of a willful attempt in any manner to defeat or evade tax," the statute is unlimited. § 6501(c)(2).
I focus here on the third and fourth exceptions – principally the third – because the IRS imagines many of these abusive shelters -- the poster child being Son-of-Boss in its various iterations -- as fraudulent and somebody in the mix among the enablers and taxpayers had fraudulent intent to evade tax and thus necessarily willfully attempted to evade or defeat tax.
In Allen v. Commissioner, 128 T.C. 37 (2007), here, the Tax Court held that a tax return preparer's fraud would invoke the unlimited period of limitations in § 6501(c)(1) even if the taxpayer had no fraudulent intent. The court applied what it called a plain meaning interpretation of the statutory language quoted above.
The question in the case of fraudulent tax shelters is whether the taxpayer's standard defense that other professionals were involved so that he or she lacked fraudulent intent will avoid the application of the unlimited statute of limitations. Of course, the Government imagines that the taxpayers (or at least most of them who were not comatose) intended to defraud the Government of tax, but has not chosen so far to indict the taxpayers. I hear that the Government simply missed or did not timely pursue many of the abusive tax shelters within the applicable period -- 3 years or 6 years, as appropriate. Can the Government now pursue these shelters under an unlimited civil statute of limitations inspired by the Allen decision? Although certainly not authoritative, the Tax Notes publication of Allen was under the caption "Limitations Period Extended Regardless of Who Commits Fraud." I think a more technical analysis would get there also under Allen.
Let's look at Allen more closely. The Court applied a "plain meaning analysis" (pp. 39-40):
Nothing in the plain meaning of the statute suggests the limitations period is extended only in the case of the taxpayer's fraud. The statute keys the extension to the fraudulent nature of the return, not to the identity of the perpetrator of the fraud. Nor do we read the words "of the taxpayer" into the statute to require the taxpayer to have the intent to evade his or her own tax.Allen thus clearly stands for the proposition that a preparer's fraudulent intent suffices for the unlimited statute of limitations § 6501(c)(1). And, under the definition of return preparer in the Code and Regulations, a person other than the signing preparer who materially participates in the reporting of a fraudulent item could be a preparer within the scope of the holding. Finally, since all that is needed under the Allen analysis and, seemingly, the statute, is a "a false or fraudulent return with the intent to evade tax," then at least arguably the fraudulent intent of anyone involved materially in the reporting on the return, including the shelter promoters might be sufficient.
Respondent argues, and we agree, that statutes of limitations are strictly construed in favor of the Government. Badaracco v. Commissioner, 464 U.S. 386, 391, 104 S. Ct. 756, 78 L. Ed. 2d 549 (1984); Lucia v. United States, 474 F.2d 565, 570 (5th Cir. 1973). An extended limitations period is warranted in the case of a false or fraudulent return because of the special disadvantage to the Commissioner in investigating these types of returns. Badaracco v. Commissioner, supra at 398. Three years may not be sufficient for the Commissioner to investigate or prove fraudulent intent. Id. at 399.
We agree with respondent that the special disadvantage to the Commissioner in investigating fraudulent returns is present if the income tax return preparer committed the fraud that caused the taxes on the returns to be understated. Accordingly, taking into account our obligation to construe statutes of limitations strictly in favor of the Government, we conclude that the limitations period for assessing petitioner's taxes is extended if the taxes were understated due to fraud of the preparer.
* * * *
We conclude that the limitations period for assessment is extended under section 6501(c)(1) if the return is fraudulent, even though it was the preparer rather than petitioner who had the intent to evade tax. The plain meaning of the statute indicates that it is the fraudulent nature of the return that extends the limitations period. We therefore find that the limitations period for assessing tax against petitioner is extended indefinitely.
Professor Bryan Camp has criticized the Allen holding in two articles. Bryan T. Camp, Presumptions and Tax Return Preparer Fraud, 120 Tax Notes 167 (2008); and Bryan T. Camp, Tax Return Preparer Fraud and the Assessment Limitation Period, 116 Tax Notes 687 (Aug. 20, 2007). Professor Camp argues in his articles that the Tax Court mis-interpreted the plain language of the statute and that, in addition, the history of statute shows it is supposed to reach only bad-acting taxpayers. Professor Camp's analysis would thus not sweep in the fraudulent intent of enablers, whether they fit the technical definition of preparers or not.
So, we have two plain language advocates reaching opposite conclusions; which may suggest that the plain language is not so plain and that therefore resort to something other than plain language is critical and, as Professor Camp notes in his articles, a persuasive case can be made from the sources other than the statutory text that it is the fraudulent conduct of the taxpayer that must control both the unlimited statute of limitations and the civil fraud penalty. Nevertheless, we have Allen as the only direct authority, and it stands for the proposition that the conduct of others than the taxpayers may trigger the unlimited statute of limitations (albeit not the civil fraud penalty).
Professor Camp urges if Allen were correct (which he vigorously disputes) on the bare words of the statute, the IRS should exercise its enormous discretion to "walk away from these new powers that it has been granted [by the Allen case] and focus on the tools that Congress gave it to combat the problem of tax return preparer fraud." Professor Camp is presuming that the wholly innocent taxpayer (and not the bad-acting enablers) is being punished by the unlimited statute of limitations.
In the case of abusive tax shelters, however, the Government's imagination is that the taxpayers may not be wholly innocent. Tax benefits were created from thin air in an environment (often the reports are that the taxpayer or the taxpayer's advisors and even some of the enablers said early on that the shelter was "too good to be true" or some variation of that notion). Hence, if Professor Camp is wrong on the law and the IRS does actually have the tremendous discretion in the application of this interpretation, the IRS may desire to exercise the power in some cases and not in other cases. Are abusive tax shelters a case in which the IRS should or will exercise its powers?
If the Government tries, taxpayers will surely assert vigorously, as has Professor Camp, that Allen is wrongly decided, both as a matter of statutory interpretation and of policy. I think there is a reasonable chance that the Camp interpretation will prevail. I just think that Congress intended the panoply of provisions addressing return preparer and enabler abuses to cover the ground (and prosecutors have plenty of weapons against bad-acting tax shelter enablers) and did not intend to punish innocent taxpayers (which for this purpose includes perhaps not so innocent taxpayers whose intentions were not fraudulent) with an unlimited statute of limitations.
But, if Allen does prevail, the question then, of course, is that the Government can prove by clear and convincing evidence of fraud as to one or more enablers in the tax shelter chain with reasonable nexus to the return reporting position. Even if the Government could not or could but did not prosecute the taxpayers, it could still sweep those taxpayers into an unlimited civil statute of limitations, and put a lot of enablers’ actions in the line of fire. Of course, those innocent and not-so-innocent taxpayers might be able to push all or some of the cost to the bad-acting enablers through malpractice or related fraud claims.
Finally, in such a proceeding involving the unlimited statute of limitations, any of the enablers' convictions will not give rise to res judicata or collateral estoppel because the taxpayers are not in privity with them. But obviously, their convictions will be bad facts and may go a long way to meeting the Government's burden to prove fraud by clear and convincing evidence.
See my subsequent blog: Does the Preparer's Fraud Invoke the Unlimited Statute of Limitations? (8/5/12), here.