Does the Preparer's Fraud Invoke the Unlimited Statute of Limitations? (8/5/12)

In Allen v. Commissioner, 128 T.C. 37 (2007), here, the Tax Court (Judge Kroupa) held that Section 6501(c)(1) imposes an unlimited statute of limitations for the preparer's fraud in preparing the tax return.  This blog asserts that that holding is incorrect.  I should note that the opinion has only sporadically been referred to and there are no authoritative decisions other than Allen to test the validity of its analysis or my arguments for that analysis being incorrect.

The background is straightforward and known to most readers of this blog.  Section 6501(a), here, creates a general rule that the statute of limitations is three years from the date of filing the return.  Section 6501(c) creates certain exceptions, the pertinent of which is:

(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.

The other significant civil consequence of fraud is the 75% civil fraud penalty in 6663(a), here.  That statute is:

(a) Imposition of penalty.  If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

The Allen Court read Section 6501(c)(1) according to what it claimed was a "plain meaning analysis."  The statute does not limit the fraud to the taxpayer's fraud.  If the return is fraudulent, the unlimited statute applies regardless of whose fraud is involved.  The preparer's fraud suffices.

In my view, the Allen Court is wrong.  First, one consequence of reading this statute literally, would logically mean that the fraud penalty applies when the preparer's rather than the taxpayer's fraud was involved.  The IRS did not assert the fraud penalty in Allen, so the Tax Court did not have to come to grips with this issue.  However, there is nothing in the bare text of the civil fraud penalty that limits the term "fraud" on the return to the taxpayer's fraud.  Of course, the taxpayer's own fraud has always been required for the civil fraud penalty.  (Cf. Section 6663(c) ("In the case of a joint return, this section shall not apply with respect to a spouse unless some part of the underpayment is due to the fraud of such spouse.").)  Still, so far as we can tell, Allen was the first time the IRS urged that a nontaxpayer's fraud with respect to a return can open the statute of limitations under Section 6501(c)(1), so it is not inconceivable that the same analysis might apply to the civil fraud penalty.  In this regard, the IRS wisely did not assert the civil fraud penalty.  I say wisely because such heavy handedness might have caused it to lose the statute of limitations issue.  Still, as I shall note, given the correlation of the two consequences of fraud, it seems to me illogical to treat the two consequences differently.  I think that given the choice of both to apply or neither, the only logical one from a tax policy standpoint is that neither should apply.

Second, and consistent with that logical analysis based on the statutes, the legislative history and context  is only superficially analyzed in Allen because Judge Kroupa perceived some "plain meaning" from the statutory text and really did not go much beyond that.  This may not be all Judge Kroupa's  fault because the interpretive tools beyond plain meaning were poorly briefed by both parties.  From the the taxpayer's perspective, the taxpayer did not have enough at stake to do a really in-depth briefing that the issue of the first impression deserved, but that does not excuse the IRS rather superficial briefs.  (For readers interested in pursuing this further, I provide links below for the briefs in Allen.)

Third, when we move beyond the text's "plain meaning" -- a plain meaning discerned judicially the first time in Allen in 2007 after the key text had been in the law  for over 80 years -- the other tools of statutory interpretation demonstrate persuasively that Allen in wrong.  I have recently "briefed" this issue in an IRS Appeals, so I will cut and paste here (slightly modified), the key portions of the argument I made:

Your legal premise is based solely on Allen v. Commissioner, 128 T.C. 37 (2007).  Allen held that a preparer’s fraud with respect to a tax return results in an unlimited statute of limitations under Section 6501(c)(1).  Your premise is that there is no litigating hazard with respect to Allen’s holding.  That premise is demonstrably incorrect.  

First, procedurally, the Allen decision merely is that Judge’s determination of the law in the case before her.  That decision is controlling only in the Tax Court but only so long as the Tax Court does not consider it in full court review.  That means that, in the Taxpayers’ case, if the Taxpayers choose to litigate in the Tax Court, the Tax Court could reconsider the issue and, upon more thorough review (fully warranted as I note below), reverse the holding in Allen.  More importantly, even if these Taxpayers litigated in the Tax Court, they could appeal to the Fifth Circuit where the issue would be decided de novo. De novo review means that the Allen opinion is not authority for the Fifth Circuit, except as the Court is persuaded by the reasoning of Allen which, as we demonstrate below, is highly questionable.  Furthermore, in the same vein, the Taxpayers can litigate in some other forum – specifically in the district court or the Court of Federal Claims – where the issue would be decided de novo at the trial level and also at the appellate levels.  So, the issue before you is not whether Allen is controlling (it is not), but whether a court would consider on de novo review that Allen properly applied the law.  We will demonstrate below that Allen did not properly apply the law and that there is substantial likelihood that any court on de novo review (including the Tax Court on full court review) would reach a conclusion contrary to the holding in Allen.  In the current context, that means that your premise of no litigating hazards on the Allen issue is false. 

Since you just assume the propriety of your legal premise, your letter does not indicate an awareness of just how tenuous the premise is.  You discuss the four cases in which courts have mentioned the Allen opinion; however, not a single case has discussed merits of Allen, indicated approval of Allen’s holding, or applied Allen to any preparer’s fraud.  It is a lone wolf opinion.  Allen is the first and only time in the statute’s 80+ years of existence that any court has interpreted the statute that way. Indeed, the other authoritative pronouncement on all of those 80+ years was the IRS’s own Field Service Advice 200104006, here, along with a published letter from the drafter of that FSA criticizing the Allen opinion and noting that, in all events, it is far from certain that it is a correct holding. 

Importantly, as to the merits, the Allen holding was completely destroyed in laborious detail by Professor Bryan Camp in two articles, copies of which I also enclose with this letter.  Those articles are Bryan T. Camp, Tax Return Preparer Fraud and the Assessment Limitation Period, 116 Tax Notes 687 (Aug. 20, 2007); and Bryan T. Camp, Presumptions and Tax Return Preparer Fraud, 120 Tax Notes 167 (2008).  Without getting into theories of statutory interpretation, the interpretation of complex and interrelated tax statutes must consider the statutory text’s context with the interrelated structure and the substantial history of the provision and related provisions.  The judge in Allen made no attempt to make that type of analysis. Professor Camp does the hard work and proper analysis demands a different conclusion.
The fact that Allen is a lone wolf opinion after 80+ years during which, it is fair to say, the IRS could have asserted this interpretation to resolution in thousands of cases (certainly, over the years, the IRS has known about many thousands of taxpayers with otherwise closed years involving fraudulent returns prepared by return preparers) should raise red flags.  And, the fact that Allen has not been applied a single time in any decided case since it was decided to force open a taxpayer’s statute of limitations should also be telling.

Finally, I note that one of the arguments I make is that the IRS ignored the Allen interpretation for years, and chose to raise and pursue it only in a case where it lined the strong (the IRS) against the weak (this small fish taxpayer) where the fight was necessarily skewed.  The IRS had plenty of opportunity to pursue this argument in cases where the fight would have been more equal and fair.  Thus, in all of the abusive tax shelter cases such as the son-of-boss cases where the Government convicted enablers of tax evasion with respect to returns filed by taxpayers (who, for the sake of submitting the cases to the juries, it conceded did not commit tax fraud).  The Government strived mightily in those cases to obtain the 25% omission six year statute of limitations in Section 6501(e) but failed in United States v. Home Concrete, ___ U.S. ___, 132 S.Ct. 1836 (2012), here.  What was that fight all about if the returns were fraudulent (as many surely were because the Government had proved that in criminal cases), thus permitting an unlimited statute of limitations.  I cannot speculate why the Government did not pursue the Allen notions in fair fights, but I do know that it did not pursue the argument if fair fights.  The Government has yet to join this issue in a fair fight.  See in this regard my prior blog Civil Tax Statute of Limitations for Fraudulent Tax Shelters (Federal Tax Crimes Blog 12/19/09), here.

Allen Briefs:
Respondent's (IRS's) Opening Brief, here.
Petitioner's (Taxpayer's) Opening Brief, here.
Respondent's (IRS's) Reply Brief, here.

I discuss the Allen case and arguments against it in the texts as follows:  (i) in the footnoted version on pp. 172-173 (text and footnotes 600-603; and (ii) in the nonfootnoted version on p. 122.