Saturday, August 30, 2014

Taxpayer Denied Bankruptcy Discharge For BLIPS Related Tax Liability (8/30/14)

11 U.S.C. Section 523(a)(1)(C), here, provides in relevant part that a taxpayer may not be discharged in bankruptcy for a tax debt if one of two circumstance exist:  (i) "with respect to which the debtor made a fraudulent return" or (ii) the debtor "willfully attempted in any manner to evade or defeat such tax."

In In re Vaughn, ___ F.3d ___, 2014 U.S. App. LEXIS 16417 (10th Cir. 2014), here, the Court denied Vaughn a discharge for his tax debt arising from the bullshit tax shelter (the BLIPS variety).  In so doing, the court affirmed the bankruptcy court and the district court below.

It appears that, in denying the discharge, the courts relied principally upon the second basis for denial of discharge -- "willfully attempted in any manner to evade or defeat such tax."  The 10th Circuit found that Vaughn participated in a shaky shelter and then voluntarily depleted his assets during the long period of time before the Government finally assessed the tax liability.  (Readers will recall that substantial periods of time can elapse from  the time an  unreported tax liability arises and when it finally is assessed.)  The taxpayer claimed that his conduct was negligent at best, but not willful as required by the text of the statute, because it was before the IRS assessed the tax.  The 10th Circuit rejected the argument, holding as it had previously held that assessment of the tax is not required for the denial of discharge to apply.

Although the 10th Circuit apparently did not rely upon the first basis -- the taxpayer made a fraudulent return -- it appears from the history of BLIPS that the return was fraudulent because the BLIPS shelter was fraudulent.  I have noted that in another context -- Section 6501(c)(1), here, which has an unlimited statute of limitations "In the case of a false or fraudulent return with the intent to evade tax."  See for the most recent discussion, BASR Briefs On Issue of Unlimited Statute of Limitations for NonTaxpayer Fraud (Federal Tax Crimes Blog 8/27/14), here.  There is no textual requirement in Section 6501(c)(1) that the taxpayer make the fraudulent return; the text only requires that the return be fraudulent.  Taxpayers, of course, argue that, despite the lack of a textual requirement that the taxpayer be complicit on the fraud on the return, the text properly interpreted has an implicit requirement that the taxpayer have known the return was fraudulent and thus made a fraudulent return.  The few courts that have addressed the issue are split, with, as of now, the weight of authority that the taxpayer's fraud is not required.

In any event, the bankruptcy provision does seem textually to require the taxpayer's fraud.  Promoter or preparer fraud without the taxpayer's fraud is not sufficient to deny discharge.  So, that is not an issue.  And, as noted, the 10th Circuit seemed to have relied upon the taxpayer's fraud.  Nevertheless, the 10th Circuit did seem to at least advert to the issue of some culpability on Vaughn's part in filing the return claiming the fraudulent benefits of BLIPS (emphasis supplied):
Second, Appellant argues his "reliance on the advice of KPMG, his longtime tax advisor, that the BLIPS transaction was an aggressive but ultimately legitimate tax position might have been at worst unreasonable under the circumstances, making [Appellant] negligent," but not willful. (Appellant's Opening Br. at 23.) Appellant contends that because he innocently, even if unreasonably, relied on KPMG's advice, he cannot be found to have acted willfully. We find this argument unpersuasive under all of the circumstances in this case, particularly in light of the bankruptcy court's finding that Appellant's assertion of innocent reliance was "simply not credible." In re Vaughn, 463 B.R. at 548.
I think Vaughn's argument was in the context of claiming that his subsequent conduct dissipating his assets was not knowingly evasive of tax because he was continuing to rely upon the advice of KPMG during that period.  Nevertheless, it seems to me that the court discounted his reliance on KPMG at any time, including the time he filed his return, which would possibly raise an inference that he had made a fraudulent return.  But the court does not make that explicit.

Vaughn did make the argument that a prior 10th Circuit case, Blum v. Commissioner, 737 F.3d 1303 (10th Cir. 2013), approving a negligence penalty in a BLIPS transaction for the tax involved supported that Vaughn was at best negligent in his actions here.  I suppose the taxpayer's argument could have included that, if a taxpayer's investment in and reporting of BLIPS itself was fraudulent, the 10th Circuit would have so held in Blum but only held that the investment and reporting was negligent.  And, the notion is that Vaughn should be able to ride on the coattails of that holding, both for the return filing and the subsequent conduct dissipating his assets.  The Court rejected the argument as follows
Third, Appellant suggests our recent opinion in Blum v. Commissioner, 737 F.3d 1303 (10th Cir. 2013), must control our review of this case. The facts in Blum are similar to those in Appellant's case. The plaintiff in Blum was a self-made business man who participated in a different tax shelter marketed by KPMG. The IRS sent the Blum plaintiff a notice disallowing the losses he claimed in connection with the tax shelter and imposing "two accuracy-related penalties for underpayment of taxes," id. at 1306, including a penalty for "negligent underpayment" under I.R.C. § 6662(b). The tax court upheld this decision. On appeal, we affirmed the imposition of the negligent underpayment penalty, despite the Blum plaintiff's assertion that he merely relied on KPMG's representations regarding the validity of the tax shelter. In the case before us, Appellant argues our decision affirming a negligent underpayment penalty in Blum "confirms[ that Appellant's] decision to rely on KPMG's tax advice is not blameless, but . . . does not rise to the level of intentional or knowing conduct either." (Appellant's Reply Br. at 17.) Appellant's suggestion that Blum controls our decision in this case is unpersuasive. Our decision to uphold a negligent underpayment penalty in Blum does not prove that Appellant's conduct in this case failed to rise above the level of negligence. The fact that the conduct in Blum was sufficient to support a finding of negligence does not require us to find the bankruptcy court's finding of willful evasion in this case to be clearly erroneous.
Merely because Blum may have been negligent, of course, does not mean that Vaughn was only negligent.  Indeed, the holding in Blum was that he was at least negligent.  Neither the 10th Circuit nor the Tax Court in the case held that Blum did not fraudulently sign his return.  If the IRS had asserted the fraud penalty, that issue would have been presented and decided, but it was not.  (Indeed, as I have noted before, the Government has been far too timid in letting taxpayers in these bullshit tax shelters off the fraud hook, but that is another subject).

Finally, the Court had this to say about Vaughn's argument that the language of the court below bespoke only negligence:
Finally, Appellant argues the bankruptcy court's order "couched all of its criticism of [Appellant's] conduct with terms generally used to describe negligent conduct." (Appellant's Reply Br. at 9.) Appellant particularly mentions the bankruptcy court's use of the terms "reasonably" and "known or should have known" as terms that he claims generally convey negligence rather than willfulness. While the bankruptcy court did use those terms in its opinion, it did not do so in a way suggesting Appellant's actions were merely negligent. Rather, in the context of the bankruptcy court's opinion as a whole, such language was simply used to express the bankruptcy court's conclusions that Appellant "must have been aware," In re Vaughn, 463 B.R. at 544, of the circumstances demonstrating the invalidity of his BLIPS losses, and that Appellant chose to claim those losses on his tax returns and to deplete his remaining assets, "knowing, as he must have, the BLIPS investment constituted an improper abusive tax shelter," id. at 547. Therefore, the language identified by Appellant as suggesting a negligence-based finding, when read in context, actually buttresses the bankruptcy court's finding that Appellant willfully attempted to evade his tax obligations.


  1. Sometimes comments get sent to the spam folder because the same poster has made multiple comments in a short time period and such comments contain links to other sites,

  2. As you have clarified the question, my answers would be.

    1. Assuming no willfulness / fraud, there would be no income tax penalties either on QD audit or post-SDOP audit. The only penalties that could apply are the accuracy-related penalties, and the amended returns are qualified amended returns in both cases. So there is no income tax penalty.

    2. People are concerned about the possibly large FBAR penalties and the dearth of available guidance as to how the IRS exercises its considerable discretion in asserting the FBAR penalties. For example, when will it assert $10,000 per account per year for nonwillful taxpayers? And, when will it assert 50% per year from multiple years for willful taxpayers? And, what is the dividing line -- if discernible -- between willful and nonwillful?

    3. SDOP does not protect against the willful people if the certification is false. Presumably it does protect from punitive application of the nonwillful penalties. By the reverse token, the taxpayer pays 5% to buy peace and many of those taxpayers might have obtain zero or a lower than 5% penalty in an FBAR audit after QD. By joining SDOP, the taxpayer is still subject to potential audit but, from the FBAR perspective, will not get the potential benefits of an audit if better than 5%.

    Jack Townsend

  3. I don't have enough anecdotal information to draw broad conclusions as to whether the transition rules held out false hopes for good nonwillful taxpayers. Keep in mind that the streamlined rules were designed to give taxpayers the alternative to joining OVDP and opting out where the nonwillful taxpayers would get a better result. So, when the IRS denies transition to persons already in OVDP, they can still opt out. The denial of transition does not mean that the IRS has made a determination of willfulness. So they can opt out and get a better result if they qualify.

    That is not, in my mind, a reason for the IRS to be stingy in denying transition. But, it does ultimately give the taxpayer the opportunity to opt out and get relief.

    Now, having said that, if I were representing a taxpayer denied transition relief, I would assess very had if opting out would be a good alternative. It is always possible that the IRS denied the transition on the basis of some information that it may have gotten from sources the taxpayer and the practitioner does not know about. If that is the case, the unwary taxpayer opting out could be in for a horrible surprise.

    Jack Townsend

  4. Jack,
    Thanks for the clarification.

    I see your point about some NW taxpayers being better getting a post-QD audit result that could be less than the 5%.

    Please help clarify on the last point you made.

    When you say Presumably it does protect from punitive application of the nonwillful penalties in your last point, I assume you are referring to punitive FBAR penalties. Right?

    If I am understanding correctly, in case of both post-QD and post-SDOP audits, there is no question of penalty on his overseas income. With his amendments, he has made up for that tax deficiency. However, it is the non filing of FBAR that they may penalize. Correct?

    Assuming I have understood so far, in either kind of audit:

    1. IRS wants to determine if tax payer willfully avoided filing an FBAR and thereby concealed overseas income
    2. Based on their NW/W determination, assess a FBAR related penalty which could range from zero to some punitive sum.


  5. Hi Ron. Things have not changed we have a real bully of an agent. I believe he delights in creating road blocks knowing the legal costs he creates for me every time he makes a mistake . My lawyers spend more time correcting his understanding of the law and the OVDP, then actually getting our case settled. All he sees is a big penalty win, without looking at the underlying facts. The IRS agents should really have an IRS lawyer looking over their shoulder to prevent these cases from escalating. He also hates being corrected and gets even more aggressive when he has to back down. In one instant I spent 5,000 in legal fees to correct a $500 mistake on his part. He admitted he had processed the amended returns incorrectly, but made me resubmit everything to correct his mistakes. Did he care? No. I think he would delight in knowing that I have to spend another 5,000 to prepare the certification document, just so he can reject it. So far my accounting and legal fees in the OVDP are 150,000 and I don't even have a 906 yet. I am an immigrant so I am not very familiar with tax laws or tax accounting, so I am forced to use lawyers and accountants, and believe me they also take advantage. They see a 2 million penalty and believe you should be happy to pay 200,000 to resolve it, even when it could be done for 25,000. The whole system is a profit making machine for everyone involved accept the tax payer. Someone needs to start a class action suit.

  6. Blackseal, I am really sorry to hear about your predicament. I think the fact that you have a relatively large foreign account balance is being wrongly used against you. Even my lawyer seems to think that having a large account means you are somehow willful.
    The agent clearly seems to be an axxhole as well and does'nt want his boss questioning why he let someone with such a large balance transition. If its not too late you may want to get his manager involved. i would also talk to your Congressman and TAS
    Did your Transition request get DENIED ? How did the IRS notify you- ie in writing- any reason given ?

  7. Jack and all
    1.What ' other information' could the IRS possibly have ? They already HAVE ALL the BANK statements etc for 8 years?. Can the IRS access your email account ?
    2. ANY other results on any transition requests ie. how many approved / denied ?
    I'm hearing that the IRS is no longer responding quickly to transition requests, I know of atleast one pending for 1+ month
    3. I hear a lot about 'Did the taxpayer tell the Bank to change the mailing address.?' This is NOT necessarily an indication of willfulness. In the case of co -owned accounts, the tax payer may NOT WANT to receive correspondence / statements in the US if he is taking a passive role and the accounts are managed by the overseas co -owner

  8. I am rally sorry to hear that you had to waste so much money but I am a bit confused. I thought that all what you did was not to file FBARs but checked the appropriate box on the return to show that you have foreign accounts. Were there any other bad facts ?

  9. No the transition has not yet been denied because my lawyer says he is still thinking about the value of the transition and has not applied formally. He thinks I have reasonable cause and maybe an opt out would be better. Of course the opt is better for him, because the billing goes on. He also thinks that the agent is so biased it is a waste of time and their formal denial of the certification will bias the next examiner we get in opt out. I just want out after more than 2 years in this nightmare. We have had discussions with the manager and at times he has overridden the agent, but most of the time he has his back. When asked a direct question of whether they would support a non-willful transition, they refuse to give an answer, just laugh. Now they have asked for another one year extension on the SOL's. I guess they think they are in for a long battle, or they are so overwhelmed they need another year to process my case.

  10. Jack and all, ON ANOTHER MATTER, for the certification for transitional treatment from OVDP to SDOP I have 2 questions: 1) When doing the 5% penalty calculation, do we have to include foreign accounts just in our own name, or do we also have to include those in which we have signature authority? 2)Do FBARs count for the 5 limit on international returns? I think you responded to this FBAR question Jack? Not sure. Sorry.

  11. I agree - you raise some good points about good or bad facts in his case

  12. RON,

    I don't have a definitive answer. I think the right answer, however, is that signatory only accounts are not included. There is some uncertainty because of the way the relief is described.

    I hope someone else has addressed this issue and gotten some feedback from the service. If so, please post it here.

    Jack Townsend

  13. Blackseal, if they are asking for an SOL extension, then you could also protect yourself with a protective refund request (within 2 yrs of having paid the tax on the amended returns) just in case you decide to opt out. Jack has discussed this at length.

  14. A valid 872 extension will protect the statute of limitations for refund of income tax, penalties and interest. The problem is that the Form 872 is not valid for years that were closed when the Form 872 was signed. Hence, you will need to file a protective claim for refund to guard against the possibility of opt out. It is not important if you stay in OVDP or accept Streamlined, but it is important if you are in OVDP and may opt out. Also, if the income tax payments for the earlier years were actually posted to a year that was open when the Form 872 was executed by the IRS, then the refund year would be open.

    Jack Townsend

  15. Jack do you know of anyone that opted out and got their tax, interest and 20% accuracy penalty refunded for closed years. I heard that the IRS has not given any opt outs a tax refund.

  16. Yes. If the assessment statute of limitations is closed, the money will be refunded on opt out, provided that the refund statute of limitations is open.

    Jack Townsend

  17. Hi Jack, I had posted this previously but you may have missed it.

    In response to one of my previous post, I see your point that some NW taxpayers may be better off with QD since their post-QD audit result could be less than the 5% SDOP penalty.

    1. You also said SDOP does not protect against the willful people if the certification is false. Presumably it does protect from punitive application of the nonwillful penalties.
    By that you meant punitive application of FBAR nonwillful penalties. Right?

    2. If I am understanding correctly, in case of both post-QD and post-SDOP audits, there is no question of penalty on his overseas income. With his amendments, he has made up for that tax deficiency. However, it is the non filing of FBAR that they may penalize. Correct?

    3. So in either kind of audit:
    a. IRS wants to determine if tax payer willfully avoided filing an FBAR and thereby concealed overseas income
    b. Based on their NW/W determination, assess a FBAR related penalty which could range from zero to some punitive sum.
    c. In some cases, taking SDOP route (over QD) MAY keep that FBAR penalty from getting punitive.
    All three points correctly stated?

  18. Yes. I opted out and got 1) My taxes back for closed years - the agent even made point of informing me about this. 2) The Accuracy penalties were removed, 3) I had two years that were not closed because nothing had ever been filed and I argued Reasonable Cause and got these penalties back, 4) No FBAR penalty - I got eight years of Letter 3800, which is the warning letter.

    Three things you should note:
    1) I have been resident outside of the US for more than 25 years
    2) I did not have as much money as you seem to have abroad. From what you have mentioned, at best I had about half of that.
    3) if you have PFIC, think carefully what that means when you opt out. Do the calculations for the default 1291 method. When you opt out, you can no longer use the OVDP MTM method during the OVDI period and afterwards. I wanted to get rid of a PFIC and the taxes on this action were more than the value of the fund. The 1291 PFIC regime is very punitive.

    If you have not already, you can read my experience on Jack's blog.

  19. Jack, you are right about the SoL being closed in order to get the tax refund. My case was closed in mid 2013 and the years that I owed taxes were all 2006 or earlier. Also, my opt out case was closed exactly before the Refund Statute of Limitations ran out.

  20. 1. Yes. That, however, is my extrapolation.

    2. Yes, so long as the nonwillful certification is correct (which means, in the income tax context, nonfraudulent). However, upon audit, the IRS could determine willfulness for the FBAR penalty and fraud for the income tax. The consequence of fraud for the income tax is that (i) all years for which there is fraud are open for adjustment and (ii) the 75% civil fraud penalty could apply.

    3. Subject to and as clarified above, I think a, b and c are correct.

    Jack Townsend

  21. @ anon5percent, you presumably failed to file for some years but not for others. How did the IRS request to the failure to file given that you had filed previously (and that many expats routinely fail to file on time)? Thanks

  22. I had two different reasons that are not common reasons for not filing. Note: my filing history was consistent outside of those two years and I think the good history helped my reasonable cause arguments.

    One of the years that I did not file was due to information that my OVDI lawyer gave me. He told me not to file the year I went into the OVD program. He told me that year's filing would be taken care of as part of the OVD program. The agent confirmed that this is what they were telling the lawyers at the time. They were telling lawyers to get people into the program and filing could be dealt with in the program. The agent agreed that it was reasonable cause as I was following IRS instructions. I was lucky in that my agent knew my ex-lawyer and knew that is what had been said. I had already fired my lawyer about 8 months before the agent got my case, but my case was assigned to the office closest to where my ex-lawyer was located. So this helped me.

    The other instance was that my employer took responsibility for not filing for the other year that was not filed. I was working in a third country and had a contract with a non-US company that required my employer to take care of all my taxes, including filing. The company recognized that they did not meet their obligations in spite of actions on my part to have them file my US taxes (email proof). They took responsibility for giving me wrong information that made me think all was in order. They had also filed and paid taxes for me in the country where I was working. I had also filed in the country where I permanently resided as I was obligated to file there, so it was clear that I was doing my best to file.

    Unfortunately, for most US Persons living outside of America this is not very helpful. However, it does show the range of complicated circumstances that American citizens living abroad have to face when filing. I also think it is excellent proof that the IRS was constantly changing policy during the OVD programs and this complicated matters for those in those programs. I was lucky in that my agent knew what had been said previously.

  23. Jack/all,

    Do you know if the iRS has created a new form for those in the OVDP requesting transitional treatment to SDOP? If not, has anyone created their own and had it accepted by the IRS?

  24. RON,

    1. I am not aware of a new form.

    2. I was told by the Agent to use the regular streamlined form, but to modify it as appropriate. That meant cloning the form into a word processing template and making the changes that were appropriate. For example, I added an introductory paragraph stating that it is a modified template and why I made modifications. The key, of course, is that the certification of nonwillfulness must be in the exact language they require.

    I recommend, however, that before doing that, you should discuss it with the Agent.

    Jack Townsend

  25. More of a poll question here.

    Have any of you recently heard how straight (i.e. non-transition) SDOP's are faring? Are they getting the same pushback like (from ovdp-transition) cases. Thanks!


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