Monday, March 4, 2013

Second Circuit Holds That Fraud on the Return -- Even If Not the Taxpayer's -- Causes an Unlimited Civil Assessment Statute of Limitations to Apply (2/4/13; Material Corrections on 2/5/13)

I have written in the past on nontaxpayer fraud as the fulcrum for an unlimited statute of limitations under Section 6501(c)(1) & (2), here.  I provide a list of the most pertinent blogs on this issue.  The issue arose from the Tax Court's opinion in Allen v. Commissioner, 128 T.C. 37 (2007), which held for the first time that preparer fraud invokes the unlimited statute of limitations.  The IRS had earlier held that, where a joint tax return was filed, one spouse's fraud would permit the unlimited statute as to the innocent spouse.  But the conventional wisdom to that point was that some taxpayer fraud was required to the unlimited statute.  The Tax Court in Allen read the statute literally; it included no requirement of taxpayer fraud.

In City Wide Transit, Inc. v. Commissioner, 709 F.3d 102 (2d Cir. 2013), here and here, the Second Circuit -- the second court to confront the issue head on -- aligned itself with Allen in a case involving preparer fraud that was included on the return of otherwise innocent taxpayers.  I quote the key part of the Second Circuit decision:
In analyzing § 6501(c)(1), we remain mindful that "limitations statutes barring the collection of taxes otherwise due and unpaid are strictly construed in favor of the [Commissioner]." Bufferd v. Comm'r, 506 U.S. 523, 527 n.6 (1993) (internal quotation marks and citations omitted). "Accordingly, taking [that obligation] into account, we conclude that the limitations period for assessing [the taxpayer's] taxes is extended if the taxes were understated due to fraud of the preparer." Browning v. Comm'r, 102 T.C.M. (CCH) 460, 2011 WL 5289636, at *13 n.14 (2011) (quoting Allen v. Comm'r, 128 T.C. 37, 40, 2007 WL 654357, at *40 (2007)). This makes intuitive sense because "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 return to be understated." Allen, 2007 WL 654357, at *40.
So, the Second Circuit dealt perfunctorily with the Allen issue, but summarized the analysis.

A reader left a comment indicating that the taxpayer had effectively conceded the Allen issue as the Second Circuit Court indicated in footnote 3 of the opinion.  Sorry I had not focused on that, so I insert it here because it is important to the precedential or nonprecedential value of the Second Circuit's opinion:

   n3 In front of the tax court, City Wide argued that it was not liable for the returns Beg prepared where "(1) [City Wide] did not know of the preparer's defalcations; [and] (2) [City Wide] did not sign or knowingly allow to be filed a false return . . . ." Joint App'x 360; see also id. at 350-57 (developing the argument and citing cases). The Commissioner anticipated these claims on appeal and rebutted them in its opening brief. City Wide, however, conceded these issues in its response brief. City Wide Br. at 16. Moreover, each member of this panel asked City Wide whether it had intended this concession, and City Wide responded affirmatively to each of us in turn. Accordingly, we accept this concession without deciding whether certain factual situations might arise that sever the taxpayer's liability from the tax-preparer's wrongdoing.

In the text itself, of course, the Court seemed to accept the Allen holding, but with this limitation in the footnote, the precedential value of the rather cryptic seeming acceptance might be questioned.  And, truth be told, if you accept the proposition that, at least in some cases, fraud on the return in which only the preparer was culpable  keeps the statute open, it is difficult to imagine why that rule would not apply in all cases where taxpayer innocence and preparer culpability is involved.  Maybe the panel was just being very cautious on the issue and not effectively decide cases that were not before it.  But, it certainly does water down the precedential effect of City Wide.  (Thanks to Eliot for bringing this to my attention.)

I offer the following from the Government's opening brief that fleshes out the argument that the Court accepted summarily. Nothing material was offered in the subsequent briefing (the taxpayer's answering brief and the Government's reply brief (some emphases supplied).

* * * * 
B. The assessment period remains open under I.R.C. § 6501(c)(1) and (c)(2) if Beg prepared, signed, or filed City Wide’s fraudulent returns with the intent to evade tax. 
As a general rule, the Commissioner has three years from the date a payroll tax return is filed in which to assess a tax for the period for which the return is filed. I.R.C. § 6501(a). It is undisputed in this case that the payroll taxes the IRS seeks to collect from City Wide were assessed beyond the general, three-year period of I.R.C. § 6501(a). There are a number of exceptions to the general rule that taxes must be assessed within three years of the return, including two exceptions set forth in I.R.C. §§ 6501(c)(1) and (c)(2): 
(1) False return.—In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.
(2) Willful attempt to evade tax.—In case of a willful attempt in any manner to defeat or evade tax imposed by this title (other than tax imposed by subtitle A or B), the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time. 
Thus, under I.R.C. §§ 6501(c)(1) and (c)(2), taxes with respect to a “false or fraudulent return with the intent to evade tax” or “a willful attempt in any manner to defeat or evade tax” are not subject to the three-year limitation on assessment described in I.R.C. § 6501(a), but instead may be assessed (or collected without assessment) “at any time.”  
As the Supreme Court stated in Badaracco v. Commissioner, 464 U.S. 386 (1984), a limitations period, such as that described in I.R.C. § 6501, which operates “to bar rights of the Government, must receive a strict construction in favor of the Government.” 464 U.S. at 391 (citing E.I. Du Pont de Nemours & Co. v. Davis, 264 U.S. 456, 462 (1924)).   Specifically, “‘limitations statutes barring the collection of taxes otherwise due and unpaid are strictly construed in favor of the Government.’” Badaracco, 464 U.S. at 392 (quoting Lucia v. United States, 474 F.2d 565, 570 (5th Cir. 1973)). 
The exceptions to the general, three-year period for tax assessment in I.R.C. §§ 6501(c)(1) and (c)(2) – i.e., in the case of a “false or fraudulent return with the intent to evade tax” or “a willful attempt in any manner to defeat or evade tax” – are both phrased in the passive voice. The statute does not require that the fraud or willfulness that triggers the extended limitations periods of I.R.C. §§ 6501(c)(1) and (c)(2) be that of the taxpayer himself; it can, instead, be that of anyone signing or filing the return, or attempting to evade the taxes in issue.  n4
   n4 Congress could easily have made the unlimited assessment period dependent upon a showing that the taxpayer filed a false or fraudulent return with the intent to evade tax, or willfully attempted to evade or defeat tax, but did not do so. Indeed, a version of the Revenue Act of 1934 that passed the House Ways and Means Committee would have amended what is now I.R.C. § 6501(c)(1) to lift the assessment period only “if the taxpayer fails to file a return, or files a false or fraudulent return with intent to evade tax.” See H.R. 7835, 73d Cong., 2d Sess., § 276(a) (1934). But that language was discarded and replaced with the passive construction now found in I.R.C. § 6501(c)(1). See id.; see also Allen v. Commissioner, 128 T.C. 37, 39 n.3 ( 2007). 
Consequently, courts have routinely held that the assessment period remains open in cases of fraud or willful attempts to evade or defeat a tax where the perpetrator of the fraud or evasion was someone other than the taxpayer against whom the assessment is made. See, e.g., Ballard v. Commissioner, 740 F.2d 659, 663 (8th Cir. 1984) (“We therefore join those courts which have held that section 6501(c)(1) lifts the statute of limitations on tax assessments against both spouses when they file jointly and one has defrauded the government in the process.”); Richardson v. Commissioner, 509 F.3d 736, 745 (6th Cir. 2007) (“Although Gloria is not liable for Homer’s fraud penalties, Homer’s fraud lifts the statute of limitations for the ‘false or fraudulent return.’”) (emphasis in original); Estate of Upshaw v. Commissioner, 416 F.2d 737, 743 (7th Cir. 1969); Browning v. Commissioner, 102 T.C.M. (CCH) 460, 467 (2011) (limitations period open if either taxpayer or his accountant “intended to evade taxes [believed] to be owing”); Garavaglia v. Commissioner, 102 T.C.M. (CCH) 286, 304 (2011) (“In the case of a joint return, proof of fraudulent intent as to either joint taxpayer lifts the bar of the statute of limitations as to both taxpayers”); Allen, supra, 128 T.C. at 40.  
This principle – that fraud in the return eliminates any limitations period on assessment – is an old one, and has been present in every general income tax statute since 1918. See Badaracco, 464 U.S. at 393 n.7 (1984) (collecting citations). It is grounded, in part, on the obvious fact that “fraud cases ordinarily are more difficult to investigate than cases marked for routine tax audits.” Badaracco, 464 U.S. at 398. Moreover, many fraud cases (including this one) lead to a referral to the Department of Justice for criminal prosecution, and in such cases “the Commissioner frequently is forced to place a civil audit in abeyance when a criminal prosecution is recommended.” 464 U.S. at 499; see also I.R.C. § 7602(d) (prohibiting administrative summonses against a person who has been referred to the Justice Department for possible prosecution, until the Attorney General decides not to prosecute the case or a “final disposition” of any criminal proceeding against such person). The difficulties of determining the correct tax  liability in cases of fraud or willful attempts at evasion do not depend upon the identity of the perpetrator of the fraud.  
Moreover, the risk of loss due to a return preparer’s fraud is properly borne by the taxpayer who gave the agent the apparent authority to commit the fraud. See Restatement (Second) of Agency § 261 (1958) (“A principal who puts a servant or other agent in a position which enables the agent, while apparently acting within his authority, to commit a fraud upon third persons is subject to liability to such third persons for the fraud.”) Under long-standing agency principles, a principal is liable if “the agent’s position facilitates . . . the fraud, in that from the point of view of the third person the transaction seems regular on its face and the agent appears to be acting in the ordinary course of the business confided to him.” See id. at comment a. This is so even where the principal is entirely innocent, has received no benefit from the transaction, and where the agent has acted solely for his own purposes. Id. 
Courts have not drawn a distinction between cases in which the taxpayer filed a false or fraudulent return with the intent to evade tax, and those in which the taxpayer’s accountant or other agent filed a false or fraudulent return with the intent to evade tax. In Allen v.Commissioner, 128 T.C. 37 (2007), for instance, the taxpayer, a UPS truck driver, turned over his financial information to a paid return preparer, who prepared and filed returns claiming false and fraudulent deductions. The return preparer was eventually convicted under I.R.C. § 7206(2) for preparing false and fraudulent returns, and the IRS issued a notice of deficiency to the taxpayer after the expiration of the general, three-year assessment period. Allen challenged the timeliness of the notice, and the parties stipulated that the returns were false and fraudulent, but that the taxpayer himself did not have any intent to evade tax. 128 T.C. at 38. 
In ruling for the government, the Tax Court rejected the taxpayer’s argument that “only the intent of the taxpayer, not the preparer, is relevant to whether the returns were fraudulent so as to extend the limitations period.” 128 T.C. at 39. The court held that the plain language of the statute did not require that the fraud be the taxpayer’s:  
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.
Id. at 40. n5
   n5  Similarly, in the partnership context, the unlimited limitations period of I.R.C. § 6229(c)(1), which applies when a partner has signed or participated in preparation of a return containing a fraudulent item with intent to evade tax, has been held to apply even if the signing partner does not reduce his own taxes and only intended to evade the taxes of the other partners. Transpac Drilling Venture 1983-2 v. United States, 83 F.3d 1410, 1414-15 (Fed. Cir. 1996) (“there is no requirement in § 6229(c)(1) that the taxes the signer of the partnership return intended to evade must have been the signer’s own,” and the statute “refers only to the ‘intent to evade taxes.’”)  
   Likewise, the statute of limitations for the United States to bring an action to recover an erroneous refund, which is extended from two years to five “if it appears that any part of the refund was induced by fraud or misrepresentation of a material fact,” I.R.C. § 6532(b), has been held to apply where the fraud was that of someone other than the taxpayer. United States v. McLean, 390 F. Supp. 2d 475, 479 (D. Md. 2005) (“[W]hether or not McLean was a knowing participant in the fraud is of no consequence. Material misrepresentations were made in the tax forms which brought McLean a substantial windfall and she owes that money back to the United States.”); United States v. Southland Oil Co., 339 F. Supp. 2d 764, 766-67 (S.D. Miss. 2004) (“Under a plain reading of § 6532(b), Defendant need not have ‘committed’ fraud or have fraud ‘imputed’ to it for the Government to have the benefit of the longer period to investigate and recover erroneous refunds.”). 
Applying these principles to this case, the IRS was not barred from assessing, at any time, the payroll taxes associated with City Wide’s false and fraudulent returns for the covered periods where (as here) City Wide’s accountant (Beg) signed or filed them with the IRS with the intent to evade tax, even though City Wide’s owner and president (Fouche) was unaware of the fraud. 
JAT Comments on Government's Position Accepted, Perhaps Equivocally, by CA2:
  1. I do not have convenient access to the legislative history cited in footnote 4 of the Government's brief, but the the Government cites nothing more than that the rejected proposed statutory language would have required the taxpayer's fraud.  I do wonder whether the legislative history would have spoken to whether Congress proposed the wording change to change its understanding of the law or simply thought it was merely restating its interpretation of the law.  The same question may be asked differently:  Was the failure of the proposal an indication of Congress' intent that the statute apply if nontaxpayer fraud is involved.  Either may not be the best evidence of Congress' intent for the original enactment, but still  it would be helpful to know. Perhaps the legislative history does not speak to that issue.  (On this issue, I recall from my days at DOJ Tax Appellate that there is "secret" -- perhaps a better word might be classified -- legislative history sometime in the 1930's; DOJ Tax had access, but had to get approval from the tax writing committee to cite that secret history in any publicly filed document.)
  2. The agency theory is, in my mind, suspect.  There is no suggestion that these taxpayers authorized the preparer to commit fraud or agreed that fraud was within the scope of the agency.  If that were true, then the taxpayers would have committed the fraud (either actually or perhaps by some extension of the concept of willful blindness) and the unlimited statute would clearly apply.
  3. Why isn't the IRS going after all the fraudulent  tax shelters -- including the ones involved in Home Concrete -- on this basis?  Perhaps I will post something on that later, although I did raise the general issue in my earlier blogs.
My prior Federal Tax Crimes blogs discussing this issue (in reverse chronological order):
  1. Aegis Convictions Affirmed Installment # 2 - The Allen Section 6501(c)(1) Issue (9/30/12), here.
  2. IRS Queasiness Over the Reaches of Allen (9/22/12), here.
  3. Does the Preparer's Fraud Invoke the Unlimited Statute of Limitations? (8/5/12), here.
  4. The Supreme Court Blesses Taxpayers Sheltering and Hiding Income from Six-Year Statute of Limitations (4/25/12), here.
  5. Court of Federal Appeals Trashes Son-of-Boss Shelter (6/12/10), here.
  6. Civil Statutes of Limitation for Abusive Tax Shelters (5/10/10), here.
  7. Civil Tax Statute of Limitations for Fraudulent Tax Shelters (12/19/09), here.
JAT Errata Note on 3/5/13:  In the version of this blog posted on 3/4/13, I erroneously merged the Government's brief with the Court opinion.  I apologize to readers for that error.  I have not corrected it.


  1. You raise a good point: Why is the IRS/DOJ not going after nonsense tax shelters in this basis? And why, in God's name, are major penalties not been asserted when the underlying tax return is deemed fraudulent?

  2. The taxpayer in City Wide expressly waived the argument that the fraud on the return had to be that of the taxpayer itself. See footnote 3 of the 2d Circuit's opinion. It also, as far as I can tell from the opinion, failed to raise the argument that the accountant was not acting within the scope of his agency because of the adverse interest exception. So, IMHO, those issues remain open in the Second Circuit.

  3. Thanks, Eliot. I have just revised the discussion. Please keep me in honest in my discussions in the future.

    Jack Townsend

  4. I certainly didn't mean to suggest that you weren't honest. I am a little puzzled by the taxpayer's position on appeal-- arguing a weak issue and waiving potentially stronger issues-- and, judging from footnote 3 of the court's opinion, the 2d Circuit was apparently puzzled by it as well.

  5. Thanks, Eliot. Was just using a figure of speech. But I do appreciate comments that help me put the best information forward.

    It is also a puzzle to me why the taxpayer would not have made the argument that Allen is wrong on that issue.

    Jack Townsend


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