Recent Decisions in Favor of Taxpayers: Restitution Order Reversed; Denied IRS’s Summary Judgment Motion; and Granted a Hearing

It may seem that court decisions often trend in the IRS’s favor, meaning that the judicial scales seem to tip its way.  Three recent decisions, however, show that this is not always the case.

Reverse Restitution Order:  Pay Attention to Plea Agreement Language

Shondrell Campbell, the owner of a tax preparation business, Unlimited Tax Service, electronically filed a number of fraudulent tax returns in 2002, whereby any refunds were deposited in her account and then she remitted a lesser amount to her clients.  The IRS detected this fraudulent activity and suspended her electronic filing privileges.  Thereafter, Ms. Campbell caused others to electronically submit fraudulent returns that she had prepared, a total of 1,588 allegedly fraudulent returns from 2004 to 2010 that amounted to over $3 million in refunds.  After being charged in a twenty-count indictment, Ms. Campbell pled guilty to one count of filing a false tax return in 2009 and agreed to pay restitution.  The government argued that, for purposes of restitution, the court should consider all 1,588 fraudulent returns that Ms. Campbell allegedly caused to have filed (her “relevant conduct” and not just the one count of the plea agreement.  The district court agreed and ordered her to pay over $3 million in restitution. 

On appeal, the government first contended that Ms. Campbell waived her appellate rights in the plea agreement.  The appellate court disagreed:  pursuant to its language, the appeal waiver did not apply to a sentence “in excess of the statutory maximum.”  Because the restitution statute does not authorize an order that exceeds the victim’s losses (an order “in excess of the statutory maximum”), the appeal waiver did not bar her appeal.

On the merits, the appellate court then explained that restitution is generally available for losses from conduct of the offense of conviction.  Restitution to the IRS, however, is not authorized absent an agreement by the parties.  Here, the parties agreed to restitution, but there was no language in the plea agreement (or discussion at the change of plea hearing) to show that they intended for restitution to be based upon all alleged false returns.  Therefore, restitution could only be ordered for the loss associated with the one count of conviction, $7,500.  The $3 million restitution order was reversed.  [United States v. Campbell, No. 12-31172; decision found here].

The key point here appeared to be the language in the plea agreement.  If the plea agreement regarding restitution were any more expansive or referred specifically to “relevant conduct,” then the order could have possibly been upheld.

Denial of Summary Judgment:  Pay Attention to Plea Agreement Language

In another example of the importance of plea agreement language, the Tax Court recently denied the IRS’s motion for partial summary judgment that attempted to fix the amounts that husband-and-wife taxpayers understated in income based upon language in a plea agreement with the husband.

In 2006, the IRS executed search warrants at the taxpayers’ home and used car business and seized more than $2.7 million in cash.  Deficiency proceedings were commenced in the Tax Court but stayed pending a criminal investigation of the husband’s business.

In 2011, the husband entered into a plea agreement that stated that the government could establish that the taxpayer understated his income by approximately $500,000 in the years 2004 and 2005, resulting in a total tax loss for sentencing purposes of $109,000.

In the recommenced deficiency proceedings, the IRS argued that the amounts of understated income in the plea agreement were admissions.  The Tax Court disagreed.  While an admission in a plea agreement provides “strong evidence of the understatement amount[,…] it does not establish that there is no issue of fact as to the precise understatement amount.”  The taxpayers were successful in arguing that (1) the statement in the plea agreement merely recited what the government could prove and was not an agreement about the understatement amount; and (2) the understatement amounts in the plea agreement could not be accurate, because they would not result in the tax loss also stated in the plea agreement.  [Bobbie Ephrem, et ux. v. Commissioner, TC Memo 2014-12; decision found here].

That the plea agreement stated “could establish” rather than, for example, “shall prove” might have been the key language that controlled the outcome here.

Taxpayer Granted a Hearing in a Challenge to an IRS Summons

Finally, an appellate court ordered that a taxpayer was entitled to a hearing prior to an IRS summons being enforced.  In a case out of Florida, the IRS issued five administrative summonses seeking information regarding the tax liabilities of Dynamo Holdings Limited Partnership.  The IRS moved to enforce the summonses, which required a showing of:  (1) a legitimate purpose for the investigation; (2) the inquiry in the summons is relevant to the purpose; (3) the IRS does not already have the information sought; and (4) administrative steps required by the Code have been followed.  The taxpayer may defeat the IRS’s showing by either (1) disproving one of those four elements; or (2) showing that enforcement would be an abuse of the court’s process, such as if the summons was issued for an improper purpose.

In this case, the taxpayers argued that the IRS issued the summonses for at least four improper purposes, including in retribution for Dynamo’s refusal to extend a statute of limitations deadline.  The taxpayers argued that they were entitled to discovery and a hearing to explore this issue.  The district court denied the request, but the appellate court reversed, reasoning that (citations omitted):

…in situations such as this, requiring the taxpayer to provide factual support for an allegation of an improper purpose, without giving the taxpayer a meaningful opportunity to obtain such facts, saddles the taxpayer with an unreasonable circular burden, creating an impermissible “Catch 22.”  While “the scope of any adversarial hearing in this area is left to the discretion of the district court, binding Circuit authority requires that Appellants be given an opportunity “to ascertain whether the Service issued a given summons for an improper purpose”….Appellants should be permitted to “question IRS officials concerning the Service’s reasons for issuing the summons[es].”

This decision may not have a lasting impact because the Supreme Court agreed to hear it this term, and it might reverse this decision.  If the IRS were required to participate in an adversarial hearing every time a taxpayer alleged such an improper purpose, the IRS would then be “saddled” with a burden that would tax its resources and slow its enforcement efforts.  In the meantime, the case sheds light on the difficult burden facing taxpayers who seek to challenge an IRS summons.  [United States v. Clarke, et. al, No. 9:11-mc-80456; decision found here].

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