Tax Court Holds that Restitution Assessments under § 6201(a)(4) Do Not Permit Tax Interest and Additions (10/8/17)

Readers of this blog will likely recall that Congress adopted a statutory scheme to permit the IRS to assess tax restitution imposed in a criminal case without having to go through the predicate notice of deficiency and thereby expeditiously deploy the tax collection mechanisms (levy, etc.) dependent upon an assessment.  I collect a number of the more relevant blog entries on the subject at the end of this blog entry.

In Klein v. Commissioner, 149 T.C. ___, No. 15 (10/3/17), here, the Court held the § 6201(a)(4) "does not authorize R to add underpayment interest or failure-to-pay additions to tax to a title 18 restitution award, and R may not assess or collect from Ps underpayment interest or additions to tax without first determining their civil tax liabilities."

The relevant facts are simply stated and in some respects disturbing for reasons I will discuss later.  The taxpayers pled to tax perjury, § 7206(1), for 2006.  At sentencing, for the Guidelines tax loss calculation, the Government submitted a calculation indicating a tax loss of $562,179 (including the tax loss for the year of the plea, 2006, and the relevant conduct years, 2003-2005).  The taxpayers objected because, they asserted at sentencing, the calculations did not allow unclaimed deductions that would have significantly reduced the tax loss.  The Court adopted the Government's calculations for tax loss purposes to determine the base offense level and thus the final offense level.  For Sentencing Guidelines calculations, the Court adopted the conviction year and relevant conduct years for a tax loss of $562,179, but for the wife included only the year of conviction tax loss (2006).  But, the Court then ordered the taxpayers to pay, jointly and severally, restitution to the IRS of $562,179 based on the tax loss for the year of conviction and the relevant conduct years.

The assumption I think the sentencing court made was that tax loss for the Guidelines calculation and the tax loss for purposes of restitution are the same thing.  They are not the same concepts.  The numbers will sometimes be the same, but not necessarily.  For example, although not applicable in the case, the tax loss can include the intended tax loss whether or not a tax loss actually resulted.  More pertinent, the tax loss can omit unclaimed deductions otherwise permissible but the restitution amount should not because unclaimed deductions, if proved, means that the IRS did not suffer loss of the taxes covered by the unclaimed deductions.  Therefore, the Court should not simply adopt the tax loss calculation as the restitution amount where the defendant is asserting unclaimed deduction that may not be available in calculating the tax loss.  See Restitution Less than Tax Loss Based on Burden of Proof for Unclaimed Deductions; and Application of Section 3553(a) / Booker (Federal Tax Crimes Blog 1/19/14), here.

The problem as I discuss in some of the blog entries cataloged at the end of this blog entry is that simply adopting the tax loss may result in tax restitution exceeding the actual tax loss to the IRS.  And, once the restitution order becomes final, the IRS can assess and is unable to do anything about it even if it knows that the restitution assessment is excessive.  In other words, if indeed, the defendants in Klein had unclaimed deductions that would materially lower the actual tax loss to the IRS, they were screwed by the entry of the restitution order in the amount of $562,179.  (To avoid this injustice, I have previously argued that the tax restitution amount should be the lowest possible amount of the possible tax liability, with the IRS then making up any difference through its civil audit deficiency procedures.  See What Can Be Done If Tax Restitution Exceeds the Tax Due (Federal Tax Crimes Blog 9/2/13), here.

But that was not the precise point of the Klein opinion.  The question in Klein was whether the IRS could assert underpayment interest or additions to tax without auditing and asserting the tax liability upon which to base the interest and additions.  The IRS claimed that the assessment authority in § 6201(a)(4) gave it the authority to assert tax interest and additions.  Bottom line, the Court said that § 6201(a)(4) permits the assessment of the tax restitution "as if such amount were such tax."  It is not the tax but is treated as a tax to permit the assessment of the restitution amount.  The assessment does not permit the IRS to assess interest or additions to the tax as if it were really a tax assessment.

Basically, if the IRS wants to assess interest and additions, it has to audit the years, determine a deficiency (which does not take into account the restitution assessed under § 6201(a)(4)).  See Restitution Permits Double Assessments But Only One Collection (Federal Tax Crimes Blog 5/21/17),  here.

But, of course, if the IRS were to do the audit and make the tax determination, it would be required to give the taxpayers the benefit of the unclaimed deductions if they proved them.  Then the resulting deficiency assessment would be out of whack with the tax restitution amount assessed under § 6201(a)(4) and might permit the taxpayers to seek some ex post facto relief from the sentencing court (e.g., by lowering the tax restitution, thus creating an overpayment somewhere on the IRS's books that would have to be refunded).  In this regard, the Tax Court noted that, at sentencing when the taxpayers complained that the restitution amount was too large:

During the sentencing hearing the District Court indicated that it would consider modifying the restitution order if petitioners' 2003-2006 Federal tax liabilities were determined to be less than $562,179.

Perhaps more disturbing, the Court notes the following (bold-face supplied by JAT):

In June 2012 petitioners filed amended individual returns for 2003-2006 showing aggregate additional tax due of $106,578. On August 31, 2012, the date their restitution payment was due, they moved the District Court to vacate their sentences under 28 U.S.C. sec. 2255, urging that the tax-loss calculation underlying their sentences was erroneous. In support of that contention, they pointed to IRS spreadsheets, of which they had recently become aware, indicating that they could be entitled to substantial additional deductions against their 2003-2006 income, which the Government had failed to take into account when calculating the $562,179 tax loss. If all proper deductions were allowed, petitioners contended, the tax loss for 2003-2006 would be only $106,578, i.e., the aggregate additional tax liabilities shown on their recently filed amended returns.

I think the Court was not very careful in failing to distinguish in this paragraph between the tax loss -- a Guidelines calculation concept -- and the restitution amount.  It could be that, for any number of reasons, a tax loss calculation could be much large than the underlying actual tax loss to the Government (e.g., unclaimed deductions unrelated to the income inclusion on which the tax loss is based).  The Court makes similar confusing statements later which in the section titled "C. Tax Loss vs. Civil Tax Liability," beginning on p. 29.  Bottom-line, tax loss and tax restitution are two different concepts.

Basically, if the allegations are true (that's a big if), the Government submitted a tax restitution amount that it knew or should have known was excessive.

And, then the IRS's subsequent failure to conduct an audit which, again assuming the allegations of unclaimed deductions are true, would have shown the restitution to be excessive.  In this regard, the taxpayers did file amended returns claiming those deductions, so the IRS should have had at least a hint that something was amiss.  And, not only did the IRS not  do that audit, it sought to bootstrap interest and additions to tax based on the calculation that there was every indication was excessive.  Not a pretty picture if those allegations are true.

So, the Tax Court gave a partial fix.  It could not do anything about the restitution amount assessed under § 6201(a)(4), but it damn sure could preclude the IRS bootstrapping additional suspect amounts based on that suspect restitution amount.

JAT further comments:

1.  For lovers of the subjunctive mood, which the court says "Clauses of this type are commonly used to express a counterfactual hypothesis,"  please read the entire opinion.

2. The Court rejected the IRS's reliance on self-serving IRM instructions:  "These IRM provisions, while long on instructions, are short on analysis. It is well established that IRM provisions do not bind the courts."

3.  I haven't chased this down, but the Court refers to the restitution as a Title 18 restitution.  Apparently, in the plea agreement, the taxpayers did not agree either to the tax loss amount or the restitution amount.  Since there is no Title 18 restitution for Title 26 crimes, presumably the court imposed restitution for some other benefit granted the defendants.  But, I  just have not chased that down and likely will not.

Prior relevant blog entries in reverse chronological order:

• Restitution Permits Double Assessments But Only One Collection (Federal Tax Crimes Blog 5/21/17), here.
• Compromises of Nonrestitution Assessments with Restitution Assessments Unpaid (Federal Tax Crimes Blog 1/24/17), here.
• The New Provision for Tax Restitution and Ex Post Facto (Federal Tax Crimes Blog 1/20/14), here.
• Can Restitution Be Reduced by Payments on the Tax Liability Subject to Restitution? (Federal Tax Crimes Blog 10/26/13), here.
• More on the Relationship Between Tax Liability and Tax Restitution Assessed as a Tax (Federal Tax Crimes Blog 10/25/13), here.
• What Can Be Done If Tax Restitution Exceeds the Tax Due (Federal Tax Crimes Blog 9/2/13), here.
• Tax Restitution and Doubt As to Amount (Federal Tax Crimes Blog 7/10/13), here.
• New Statute for Civil Effect of Restitution in Tax Cases (Federal Tax Crimes Blog 2/11/11), here.