Tax Procedure Aspects of SEC Disgorgements For Taxes Underpaid (6/17/13)

Yesterday, I discussed on my Federal Tax Crimes Blog a case holding that the SEC can seek disgorgement of federal tax underpaid if it relates to securities fraud.  The case is  SEC v. Wyly, 2013 U.S. Dist. LEXIS 83897 (SD NY 6/13/13), here.  My blog on the case SEC Suit for Disgorgement of Federal Income Tax Related to Securities Fraud (6/16/13), here.

Today, I want to follow through on the tax procedure side if the court were ultimately to order disgorgement which, presumably, would be paid to the IRS.  What would the IRS do to the money.  Well, the IRS could apply it to the tax the Wylys underpaid (the basis for the disgorgement).  But, the IRS will first have to determine that it has an open statute of limitations to make the assessment.  Why, because Section 6401(a), here, treats as an overpayment any amount "assessed" after the statute of limitations.  Overpayments are refundable to the taxpayer.  So, unless the IRS has an open statute of limitations, any disgorgement attributable to the Wylys tax would have to be returned to them.  So, does the IRS have an open statute of limitations?  Only if the Wylys fraudulently underreported their taxes in question.  Perhaps that is the underlying theory of the SEC suit, although it is not clear from the case.  Indeed, the Court notes at the end that the parties could not make any definitive statement on that issue.  (Please refer to the case opinion and my Federal Tax Crimes blog discussion.)

Now, this does raise some collateral issues that the true afficionado of tax procedure would relish.  What if fraud were not involved so that the IRS could not assess but the IRS wanted to keep the money anyway?.  The clear import of Section 6401(a) seems to be that the IRS should not be able to retain any tax assessed or collected after the assessment statute of limitations.  Assuming the predicate (no fraud), this disgorgement treated as recovery of a tax when the IRS receives it would fall squarely within the scope of Section 6401(a).  What if the IRS does not assess and just holds on to the money, not wanting to return the money to the Wylys?  I am not sure what authority the IRS would have to do that, but as they say the golden rule may apply (he who has the gold makes the rules).  I suppose that the taxpayer would have to perhaps file a Tucker Act case in the Court of Federal Claims, perhaps combined with a refund suit (alternative pleadings, with the argument on the refund suit that the monies came from the SEC to the IRS as payment for -- or recompense for -- a tax and would have to be treated as a tax which would be refundable, even if the IRS did not book it as a tax collected).


Still, the ultimate issue would be whether the SEC disgorgement proceeding could ultimately be for naught and I don't have a definitive answer for that, other than that if the IRS asserts fraud so that there is no statute of limitations, then the IRS is sitting pretty on the funds.  I can't imagine that the SEC would be pressing the issue if the funds would just flow in a circular fashion back to the Wylys.

Which leads me to the question of why the IRS, who apparenty has known the underlying facts for a long time now, did not assert fraud and simply go directly after the Wylys by notice of deficiency and assessment?

One of those mysteries in the tax law.

I offer as a link here the discussion of Section 6401(a) from the current draft of my Federal Tax Procedure book.