Thursday, April 26, 2018

Second Circuit Holds Onerous § 6707 Penalty -- $61 Million -- Based on BullShit Tax Shelter Subject to Flora Full Payment Rule (4/26/18; 5/8/18)

In Larson v. United States, ___ F.3d ___, 2018 U.S. App. LEXIS 10418 (2d Cir. 2018), here, the Second Circuit held that, in order to pursue the refund suit for the § 6707 penalty, Larson, a convicted tax shelter promoter, had to prepay the $67,661,349 penalty assessed.  Needless to say, the tax shelter was of the BullShit genre.  I had written on this litigation at the trial level.  SD NY District Court Rejects Partial Payment § 6707 Penalty Refund Suit (Federal Tax Crimes Blog 1/2/17; 1/9/17), here.

The Court of Appeals applied the Flora rule which generally requires full payment for refund suit. Flora v. United States (Flora I), 357 U.S. 63 (1958); and Flora v. United States (Flora II), 362 U.S. 145 (1960).  The opinion is straight-forward in stating the rule and rejecting Larson's claims under the Fifth Amendment, the APA and the Eighth Amendment.

The opinion does state, though, that something may be amiss quotation marks omitted):
We close with a final thought. The notion that a taxpayer can be assessed a penalty of $61 million or more without any judicial review unless he first pays the penalty in full seems troubling, particularly where, as Larson alleges here, the taxpayer is unable to do so. But, while the Flora rule may result in economic hardship in some cases, it is Congress' responsibility to amend the law. 
Larson and those similarly subject to this and other potentially onerous penalties may ultimately litigate in the following possible venues:
  • In a collection suit brought by the Government to reduce the penalty to judgment, usually brought just short of the 10 year collection period. 
  • A CDP proceeding, with Tax Court prepayment remedy, See IRM (10-01-2012), IRC 6707 or 6707A Disclosure Penalties ("2. A taxpayer may dispute a IRC 6707 and IRC 6707A penalty in CDP if the taxpayer did not have a prior opportunity to do so")
  • Perhaps in a bankruptcy proceeding, but I have not researched that issue. [See the Addendum immediately below which answers this question.]
ADDENDUM 5/8/18 4:10PM:

In an answer to the bankruptcy point above Lavar Taylor an outstanding practitioner in this area (Lavar's bio is here) says in a comment to a posting on the Procedurally Taxing Blog, Carlton Smith, Larson Part I Post: Full-Payment Rule of Refund Suits Held to Apply to Assessable Penalties (5/6/18), here,:
May 7, 2018 at 10:40 pm 
In a bankruptcy case, the penalty could be litigated if the IRS filed a claim for the penalty. The Court would also have jurisdiction to determine the amount of the penalty under section 505(a) in the absence of the filing of a claim by the IRS, but the government might bring an abstention motion, which might or might be granted. 
The most important point as far as I am concerned is that the penalty is completely dischargeable in Bankruptcy if the conduct giving rise to the penalty occurred more than three years prior to the date of the Bankruptcy petition. I have represented multiple clients who discharged 6700/6701 penalties in Bankruptcy
ADDENDUM 5/7/18 1:30PM:

Carlton Smith has an excellent Guest Blogger discussion of Larson in Larson Part I Post: Full-Payment Rule of Refund Suits Held to Apply to Assessable Penalties (Procedurally Taxing Blog 5/6/18), here.  The posting has links to all of the briefs.

In summary, Smith presents the arguments for Larson based on on a close reading of the Supreme Court's landmark Flora decisions--yes there were two required to resolve the case.  Flora v. United States, 357 U.S. 63 (1958) , here (often referred to as “Flora I”); and 362 U.S. 145 (1960), here (often referred to as “Flora II”) and a subsequent opinion in Laing v. United States, 423 U.S. 161 (1976), here.  The nub of the argument is that based on the actual opinions in Flora and Laing and, most importantly, the Solicitor General's arguments (referred to as concessions) particularly in Laing, the full payment rule for income tax cases applies only where there is a prepayment forum in the U.S. Tax Court case.  Generally, this requires a tax subject to the deficiency notice procedure offering a prepayment remedy in the Tax Court.  Smith deftly traces the trajectory and makes a powerful case that Flora should not apply to assessments that are not preceded by a prepayment judicial remedy.  Smith also provides links to the briefs filed in Larson.

Smith's post indicates that Keith Fogg, a sponsor of the Procedurally Taxing Blog will do a subsequent post (presumably Part II) on the amicus brief filed by the tax clinics at Harvard and Georgia State.

ADDENDUM 5/9/18 2:45PM:

For Peter Reilly's discussion of the district court opinion, with some helpful background on Laron's promoter activities and misconduct, see Peter J. Reilly, Tax Shelter Guru Gets $60 Million IRS Penalty And No Day In Court (Forbes 1/7/17), here.

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