District Court Sustains FBAR Willful Penalty But Rejects Fraudulent Failure to File Penalty for Income Tax (9/1/20)

 In United States v. DeMauro (D. N.H. Dkt. 17-cv-640-JL Order and Verdict After Bench Trial dtd. 8/28/20), CL here, the Court sustained the FBAR willful penalty but rejected the fraudulent failure to file penalty.  In both cases, in broad strokes the conduct penalized is the same.  If that statement is correct, the difference in outcome is based on the differing burdens of persuasion.  The Government must prove application of the FBAR willful penalty by a preponderance of the evidence; the Government must application of the fraudulent failure to file penalty by clear and convincing evidence.

The willful FBAR penalty requires that the conduct penalized (failure to report) be willful.  In the FBAR civil penalty context, the Courts have held willfulness is (i) specific knowing failure to file (more or less the Cheek standard) or (ii) willful blindness or reckless disregard of the obligation to report.

The fraudulent failure to file penalty, like the civil fraud penalty for filed returns companion in § 6663, requires fraud.  The following is from my Federal Tax Procedure Book in discussing civil fraud under § 6663, but the same applies for the fraudulent failure to file:

The Code does not define fraud, but it may be viewed as the civil counterpart of criminal tax evasion in § 7201. n1 Examples of how courts have stated civil fraud under § 6663 are:  (i)  civil fraud requires “intentional commission of an act or acts for the specific purpose of evading tax believed to be due and owing”; n2 and (ii) civil fraud requires that “the taxpayer have intended to evade taxes known to be due and owing by conduct intended to conceal, mislead or otherwise prevent the collection of taxes and that is an underpayment.”n3  In making the determination, as with criminal cases, courts will often look to certain common patterns indicating fraud–referred to as badges of fraud, such as unreported income, failure to keep adequate books, dealing in cash, etc.n4  The key differences between the two is that § 6663 is a civil penalty and has a lower burden of proof (clear and convincing rather than beyond a reasonable doubt) as I note later.
   n1 Anderson v. Commissioner, 698 F.3d 160, 164 (3d Cir. 2012), cert. denied 133 S. Ct. 2797, 133 S. Ct. 2797 (2013) (“the elements of evasion under 26 U.S.C. § 7201 and fraud under 26 U.S.C. § 6663 are identical.”).
   n2 Erikson v. Commissioner, T.C. Memo. 2012-194.
   n3 Nelson v. Commissioner, T.C. Memo. 1997-49; Zell v. Commissioner, 763 F. 2d 1139, 1142-1143 (3rd Cir. 1985) (“Fraud means "actual, intentional wrongdoing, and the intent required is the specific purpose to evade a tax believed to be owing.”); and Fiore v. Commissioner, T.C. Memo. 2013-21 (“Fraud is the ‘willful attempt to evade tax’” and using the criminal law concept of willful blindness to find the presence of civil fraud; note that, in the criminal law, the concept of willful blindness goes by several names.)
   n4 E.g., Kosinski v. Commissioner, 541 F.3d 671, 679-80 (6th Cir. 2008).  For use of a negative inference from assertion of the Fifth Amendment privilege in concluding that the IRS had met its burden of proving civil fraud by clear and convincing evidence, see Loren-Maltese v. Commissioner, T.C. Memo. 2012-214.

Tax Court Sustains § 6701 Penalty Against Preparer (7/10/19)

In Kapp v. Commissioner, T.C. Memo. 2019-84, here, the Tax Court sustained § 6701 penalties of $3,218,000 (after certain IRS concessions per slip op., at 114-115).

Section 6701 imposes a penalty on any person who (1) aids, assists, procures, or advises with respect to the preparation or presentation of any portion of a return, affidavit, claim, or other document, (2) knows (or has reason to believe) that the document will be used in connection with any material matter arising under the internal revenue laws, and (3) knows that the document would result in an understatement of another person's tax liability.   The penalty is $1,000 (increased to $10,000 for corporate returns) for each false document for each taxpayer for each tax period affected by the document (but no more than one penalty per period).  This penalty is the civil penalty analog to the tax crime of aiding and assisting, § 7206(2).

Kapp was a return preparer with a specialized client base as follows:  "(1) 75% were deep sea mariners, (2) 18% were tugboat mariners, (3) 5% were offshore mariners, (4) 1% were offshore oil rig workers, and (5) 1% were marine ferry drivers."

Basically, on many returns he prepared, Kapp deducted claimed miscellaneous itemized deductions for unreimbursed employee business meals and incidental expenses, computed by using the full Federal per diem rates for the meals and incidental expenses (M&IE rate) referenced in Rev. Proc. 96-28, 1996-1 C.B. 686, superseding Rev. Proc. 94-77, 1994-2 C.B. 825, multiplied by the number of days traveling for work.

The problem was that the employer paid the meal expenses.  In Tax Court litigation for two of his clients (although he did not represent them in the Tax Court), the Tax Court held that the taxpayers could not deduct the per diem for meal expenses that the employer rather than they incurred.  Kapp read those decisions shortly after they were issue in September 2000.

Kapp then "began advising his tugboat mariner clients and some of his other mariner clients that they were allowed to claim meals expense deductions even if meals were provided by their employers."  (Slip op., at pp. 20-21.) Kapp set up a website advertising the ability to obtain large income tax returns, falsely stating "that he successfully sued the IRS in the Tax Court and won “his cases”.  (Slip op., at pp. 21-22.)  He also published articles and documents with the same claims.  (Slip op. pp. 23-29.)

Kapp then prepared returns for his large base of clients claiming the meal expense without questioning whether the employer paid the meal expenses (as was industry practice).

The IRS objected on audit.  Throughout the audit, Kapp argued that the Tax Court opinions were favorable to his position.  (Slip Op. at pp. 42-51.) He was wrong on that point.  Not just wrong, but clearly wrong.  And he kept it up.

DOj then filed a suit for injunction and prevailed. (Slip op., pp. at pp. 55-61.)

After the injunction, the Tax Court rendered opinions for two of Kapp's petitioners denying their claimed per diem deduction for meals paid for by the employer.

The IRS then issued its § 6701 penalty assessment against Kapp.

The Tax Court's "Opinion" section (beginning on Slip Op., at p. 75) then decides the following key issues (I omit some issues, such as some evidentiary issues, I don't deem important for most readers, although they were certainly important for Kapp):

Another Confluence of Legal Interpretation and Fact Finding (1/19/19)

Earlier today I posted on a confluence of legal interpretation and fact finding:  Law Finding (The Chevron Framework) and Fact Finding in Trials (Federal Tax Crimes Blog 1/19/19), here.  I offer here another instance of that.

In my current working draft of my Federal Tax Procedure Book, I discuss the more likely than not standard for legal opinions as to tax benefits.  That more likely than not standard says, in effect, that the legal opinion or belief in the legal opinion must be greater than 50% in order to avoid some penalties. 

A similar more likely than not construct is often used to describe the level of belief that a fact finder (judge or jury) in a trial must have in order to find by a preponderance of the evidence that the party bearing the burden of persuasion (usually a plaintiff) has met the burden.

I have added the following as a footnote:

Fact burden of proof theory has a similar analysis.  As I discuss later in the book (starting on p. ___), the preponderance of the evidence as to a fact is often described as more likely than not, which is quantified in percentages as being greater than 50% in order to find the fact.  Conversely, if the trier is either 50-50 (called a state of equipoise) or less as to the fact, the fact cannot be found, meaning that the party bearing the burden of persuasion on the issue loses.  That same type of analysis applies to legal conclusions for tax opinions.  If the adviser is 50-50 (state of equipoise) or less on the legal issue, then the adviser cannot render a more likely than not opinion.  If the adviser is more than 50% on the legal issue, he can render a more likely than not opinion.  Of course, the difference between 49% and 51% opinions is razor thin and probably impossible to quantify with sufficient confidence to render a more likely than not legal opinion.  And the potential for error is compounded when subsequent legal conclusions depend upon the correctness of an earlier conclusion that itself may be uncertain.  Example: Legal issue 1 is barely more likely than not, say 51%; Legal issue 2, which depends on Legal issue 1 is at 51%.  Is the overall opinion that the tax benefits will be achieved at 51% or some lesser number (in this case around 26%).  How does the legal adviser render the opinion?  Heather Field, Tax Opinions & Probability Theory: Lessons From Donald Trump, 156 Tax Notes 61 (7/3/17).

Failure of Taxpayers' Proof of Value Loses Case (10/8/14)

In Cavallaro v. Commissioner, T.C. Memo 2014-189, here, the Tax Court held that the parents owning a company merged with a company owned by the children had not received enough value in the merged companies and thereby made a gift to the children.  The court also held that the parents had reasonable cause to rely upon their tax advisors and thus avoided penalties.

I focus here on the valuation issue of whether a gift was made.  The law is clear that a gift can be made under such circumstances if one party shifts value to other related parties.  The Court resolved the actual value issue on the basis of the burden of proof.  Most of the time, valuation issues are decided after each side has proffered expert testimony with the Court finding a value somewhere in between.  Even where the parties are reasonable in their valuations, they are usually reasonably aggressive positions and the value really is somewhere in between.  In Cavallaro, however, the Court found the value the Commissioner claimed because, it found, that taxpayers had failed to meet the burden of proof imposed upon them.  Basically, the potential for a shift in value from the parents to the children occurred only if the parents' company did not own certain valuable technology.  The parents' claim was that the children's company owned the valuable technology, hence the parents did not receive less than they contributed to the merger and did not make a gift to the children.  The parents' experts made their expert reports assuming the validity of the claim that the parents' company did not own the technology.  The Court found, however, that the parents' company did own the technology, thereby rendering the parent's expert witness reports irrelevant.  All the Court then had was the claim by the Commissioner (which had been reduced from the amount originally asserted in the notice of deficiency), supported, of course, by the Commissioner's expert report.  The Court thus had no basis for doing anything other than sustaining the Commissioner based on the taxpayers' failure to meet the burden of proof.

Key components of the holding are:

1.  The Court first held that the taxpayers had the burden of proof even though the IRS had substantially reduced its valuation from the amount originally asserted in the notice of deficiency.  The Court reasoned.

In general, the IRS's notice of deficiency is presumed correct, "and the petitioner has the burden of proving it to be wrong". Welch v. Helvering, 290 U.S. 111, 115, 54 S. Ct. 8, 78 L. Ed. 212, 1933-2 C.B. 112 (1933); see also Rule 142(a). The Commissioner has conceded that the taxable gifts totaled not $46.1 million (as in the notices of deficiency) but instead $29.6 million (as yielded by Mr. Bello's analysis). Where the Commissioner has made a partial concession of the determination in the notice of deficiency, the petitioner has the burden to prove that remaining determination wrong. See Silverman v. Commissioner, 538 F.2d 927, 930 (2d Cir. 1976) [**52]   (holding that the burden of proof does not shift where the Commissioner's change of position operates in favor of the taxpayer), aff'g T.C. Memo. 1974-285; cf. Rule 142 (shifting the burden "in respect of * * * increases in deficiency").

2.  The Court then rejected the argument that the reduction shifted the burden under Tax Court Rule 142(a)(1) which imposes the burden of proof on the commissioner "in respect of a new matter."  For much the same reason as Silverman, the Court rejected the argument.  The Court did say that the IRS's assertion of the accuracy related penalty rather than the fraud penalty was a new matter (even though the taxpayer's claim of reasonable cause would have been a defense to the fraud penalty originally asserted); and in any event, the Court found the defense proved so neither penalty applied.

Eleventh Circuit Holds Clear and Convincing Evidence Required for Section 6701 Penalty; Can Reasoning be Extended to FBAR Willful Penalty? (6/14/14)

In United States v. Carlson, ___ F.3d  ___, 2014 U.S. App. LEXIS 11001 (11th Cir. 6/13/14), here, the issue was the plaintiff's liability for " aiding and abetting understatement of tax liability in violation of I.R.C. § 6701."  Section 6701 is here.  In relevant part, Section 6701 imposes the penalty upon a person:

(1) who aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,
(2) who knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and
(3) who knows that such portion (if so used) would result in an understatement of the liability for tax of another person.

Section 6701 may be viewed as the civil penalty analog to the tax crime of aiding and assisting, Section 7206(2), here.

One issue on the appeal was the appropriate burden of  proof the Government must bear.  Carlson argued that it was by clear and convincing evidence; the Government argued that it was by a preponderance.  The Court held that the standard of proof is by clear and  convincing evidence.  Here is the Court's discussion:

I. The Government must prove violations of I.R.C. § 6701 by clear and convincing evidence. 

At trial, the parties disputed the correct standard of proof. Carlson contends the correct standard should be clear and convincing evidence while the Government contends the correct standard is a preponderance of the evidence. The district court agreed with the Government and instructed the jury that the Government must prove its case by a preponderance of the evidence. We conclude that this instruction misstated the law. 

Under the Eleventh Circuit's longstanding precedent, the Government must prove fraud in civil tax cases by clear and convincing evidence. See, e.g., Ballard v. Comm'r of Internal Revenue, 522 F.3d 1229, 1234 (11th Cir. 2008) ("The Commissioner has the burden of proving allegations of fraud by clear and convincing evidence."); Korecky v. Comm'r of Internal Revenue, 781 F.3d 1566, 1568 (11th Cir. 1986) ("The IRS bears the burden of proving fraud, which must be established by clear and convincing evidence."); Marsellus v. Comm'r of Internal Revenue, 544 F.2d 883, 885 (5th Cir. 1977) (holding fraud must be proved by clear and convincing evidence); Webb v. Comm'r of Internal Revenue, 394 F.2d 366, 378 (5th Cir. 1968) (same); Goldberg v. Comm'r of Internal Revenue, 239 F.3d 316, 320 (5th Cir. 1956) ("The Commissioner has the burden of proving fraud by clear and convincing evidence."); Jemison v. Comm'r of Internal Revenue, 45 F.2d 4, 5-6 (5th Cir. 1930) ("Fraud is not to be presumed, but must be determined from clear and convincing evidence, considering all the facts and circumstances of the case."). Our sister courts of appeals follow the same rule. See, e.g., Grossman v. Comm'r of Internal Revenue, 182 F.3d 275, 277 (4th Cir. 1999) (holding that a finding of fraud must be supported by clear and convincing evidence); Lessmann v. Comm'r of Internal Revenue, 327 F.2d 990, 993 (8th Cir. 1964) (same); Davis v. Comm'r of Internal Revenue, 184 F.2d 86, 86 (10th Cir. 1950) (same);Rogers v. Comm'r of Internal Revenue, 111 F.2d 987, 989 (6th Cir. 1940) ("Fraud cannot be lightly inferred, but must be established by clear and convincing proof."); Duffin v. Lucas, 55 F.2d 786, 798 (6th Cir. 1932) (same); Griffiths v. Comm'r of Internal Revenue, 50 F.2d 782, 786 (7th Cir. 1931) ("Fraud is never presumed but must be determined from clear and convincing evidence, considering all the facts and circumstances of the case.").

Government Refusal to Grant Immunity Shifts Burden of Proof to IRS in Tax Court Case (9/24/13)

In an Order dated 9/17/13 in AD Investment 2000 Fund LLC v. Commissioner (Dkt Nos. Docket No. 9177-08, 9178-08), here, the Tax Court (Judge Halpern) shifted the burden of proof to the Commissioner because the Government declined to assure the Court that a witness -- allegedly the key witness -- would not be prosecuted.  The term for such assurance is immunity.

The background, highly summarized, is that one James Haber was a promoter of a tax shelter in which the taxpayer, an LLC treated as a partnership, participated.  I cannot say that I am familiar with the particular shelter involved, but I am familiar with Haber's tax shelter activity.  He was long a subject and perhaps a target of the major tax shelter probes and prosecutions in SD NY (those probes, some of which involved Haber shelters, included the KPMG, E&Y and Daugerdas / Jenkens probes beginning in the early to mid-2000s).  For some reason never known to me, Haber was never prosecuted despite the fact that he was at the center of shelters that were prosecuted against others.

The taxpayer in this case argued that Haber was at the center of the shelter and was the key witness.  "Petitioners represent, and respondent does not contradict, that the principal witness having knowledge of these issues is James Haber, the President of The Diversified Group Incorporated. Diversified is the Tax Matters Partner of AD Investment and AD Global.

The Tax Court sustained Haber's assertion of the Fifth Amendment privilege.  The taxpayer urged that it was not fair that the Government's continued threat of prosecution of Haber should prevent it from getting a fair trial based on truth and not failure to meet the normal burden of proof assigned to taxpayers in the Tax Court.

Petitioners represent, and respondent does not contradict, that, in the absence of Mr. Haber's testimony, petitioners will find it difficult or impossible to carry their burden of proof at trial. Petitioners describe Mr. Haber's role in the transactions at issue; they list facts that they will be difficult or impossible to prove without his testimony.

At the Court's suggestion, the IRS attorney asked USAO SDNY "whether the United States Attorney would be willing to grant Mr. Haber immunity in connection with his tax shelter activities."  USAO SDNY responded "that the United States Attorney would not do so 'and would not explain why.'"

The taxpayer urged that, in effect, the  IRS and the USAO for SDNY which refused to grant immunity were agencies of one Government and should not impair the search for truth and the Court's obligation to render justice by forcing on the taxpayer a burden that its own actions prevented it from meeting.