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].

LETTERS FROM ABROAD: U.S. Taxpayers Receiving Letters from Their Foreign Banks May Have One Last Opportunity to Avoid Criminal Prosecution and Increased Civil Penalties

Authors: Matthew D. Lee, Jeffrey M. Rosenfeld & Jennifer L. Bell

Foreign banks from around the world are sending letters to account holders that they believe have, or had, a U.S. tax nexus (or other U.S. connection) requesting information to determine whether such account holders have disclosed their foreign bank accounts to the Internal Revenue Service (“IRS”). The letters from foreign banks generally require an account holder to disclose whether the account has been declared to the IRS through the filing of a Report of Foreign Bank and Financial Accounts (commonly known as the “FBAR”) form and/or a Form 1040 personal income tax return, participation in the various IRS Offshore Voluntary Disclosure Programs, or otherwise. Sometimes foreign banks request that the account holder submit an IRS Form W-9, which is generally required to be completed by U.S. account holders for tax reporting purposes.

The receipt of such a letter from a foreign bank typically prompts many questions, and this article seeks to answer some of the most frequently asked questions.

Why am I receiving a letter from my foreign bank?

The Foreign Account Tax Compliance Act (“FATCA”), a law enacted by Congress in 2010 and effective beginning July 1, 2014, is intended to identify noncompliance by U.S. taxpayers using offshore accounts. Under FATCA, foreign financial institutions will generally be required to comply with certain due diligence and annual reporting requirements regarding their U.S. account holders and enter into information sharing agreements with the United States. Foreign financial institutions that do not provide such information to the United States will face a stringent penalty—withholding of 30 percent of certain U.S. source payments such as interest and dividends.

Many U.S. taxpayers are receiving these letters because, in advance of the effective date of FATCA, foreign banks are undertaking the process of identifying account holders that have a U.S. tax nexus. A foreign bank may find that a taxpayer has a U.S. tax nexus through indicia such as having a phone number affiliated with an account that appears to be U.S.-based or a U.S. mailing address. If a foreign bank has identified an account as potentially having a U.S. tax nexus, the foreign bank is likely to send a letter to the account holder requesting the information discussed above.

What are the consequences of receiving a letter from my foreign bank?

If you have received a letter from a foreign bank, your account has likely been identified as potentially having a U.S. tax nexus. FATCA generally requires foreign banks to identify accounts with a U.S. tax nexus, and, as discussed above, in order to avoid significant penalties, beginning July 1, 2014, FATCA will require the foreign bank to submit to the IRS certain information related to the accounts that have been identified as having a U.S. tax nexus.

The consequences of the IRS receiving a U.S. taxpayer’s foreign account information can be dire if the U.S. taxpayer has not previously reported the foreign account on an FBAR and/or has not reported all of the income associated with the foreign account on a U.S. tax return. First, and perhaps most significant, once the IRS receives a U.S. taxpayer’s foreign account information, the U.S. taxpayer may no longer participate in the IRS offshore voluntary disclosure programs that are outlined below (assuming that the U.S. taxpayer has not already enrolled in such programs). As a result, the U.S. taxpayer may no longer be eligible for criminal amnesty and potentially lesser civil penalties. Also, the receipt of a U.S. taxpayer’s foreign account information may lead to an IRS tax audit, which can be extremely time consuming and expensive.

For these reasons, it is not in a U.S. taxpayer’s interest to simply ignore a letter received from a foreign bank. Though every case is different, a U.S. taxpayer may instead be better served by participating in one of the voluntary disclosure programs set forth below. It is also not in a U.S. taxpayer’s interest to close a foreign account in response to the letter and transfer the funds to another foreign bank. Aside from the civil and criminal penalties that might be imposed as a result of such conduct, the implementation of FATCA has dealt a severe, perhaps fatal, blow to bank secrecy, and U.S. taxpayers with undeclared foreign bank accounts can no longer assume that they will be protected by foreign bank secrecy laws or remain undetected by the U.S. government. Thus, simply closing a foreign account and transferring the funds elsewhere is a dangerous proposition.

What are my best options if I receive a letter from my foreign bank?

U.S. taxpayers with undeclared foreign bank accounts should immediately consult with knowledgeable tax counsel to review their options. Often the best option is to enroll in the IRS’ Offshore Voluntary Disclosure Program (the “OVDP”), the current amnesty initiative offered by the IRS. This may be the last opportunity for many U.S. taxpayers to enter into the program because, as discussed above, the implementation of FATCA (and associated influx of foreign bank account information that the IRS will receive under FATCA) may effectively eliminate the OVDP as a viable option for many U.S. taxpayers.

The OVDP is designed to encourage U.S. taxpayers with undisclosed foreign bank accounts and unreported income associated with those accounts to come into compliance with U.S. tax laws and avoid criminal prosecution. Taxpayers accepted into the OVDP must file amended tax returns for an eight year period and pay all back taxes, interest, and an accuracy related penalty of 20 percent of the taxes due, and a civil penalty equal to 27.5 percent of the highest aggregate value of the U.S. taxpayer’s foreign bank accounts during the eight-year period (subject to certain exceptions). Currently, there is no deadline for participation in this program, although the IRS has stated that it could end the program, or modify its terms, at any time.

Another option for U.S. taxpayers who live overseas (including dual citizens) and have not filed U.S. returns is the IRS’ streamlined non-resident compliance procedure. U.S. taxpayers that are eligible for this procedure are generally required to file delinquent tax returns for the past three years and delinquent FBARs for the past six years. All submissions are reviewed by the IRS, but the intensity of the review varies according to the level of compliance risk presented by the submission. For those taxpayers presenting a low compliance risk, the review will be expedited and the IRS generally will not assert penalties or pursue follow-up actions. Submissions that present a higher compliance risk are not eligible for the procedure and will be subject to a more thorough review and possibly a full examination (which in some cases may include more than three years), as well as the imposition of tax, interest and penalties.

Many U.S. taxpayers have sought to “roll-the-dice” and avoid civil penalties by attempting what is known as a “quiet disclosure.” In a quiet disclosure, a U.S. taxpayer may report previously-excluded foreign income on a tax return and/or report a previously-unreported foreign bank account on an FBAR on a going-forward basis pursuant to normal reporting procedures, without attempting to address noncompliance in previous tax years. Alternatively, a U.S. taxpayer may attempt to address past noncompliance by filing amended tax returns and/or delinquent FBARs for past tax years pursuant to normal reporting procedures. U.S. taxpayers should be aware that quiet disclosures may not be in their best interests because (1) quiet disclosures can trigger IRS audits, (2) quiet disclosures do not provide amnesty from criminal prosecution, and (3) the civil penalties imposed on a taxpayer who is audited can be substantially greater than the penalties that would have been assessed if the taxpayer entered into one of the voluntary disclosure alternatives set forth above.

Individuals with questions about FBAR or FATCA reporting, or who are considering making a voluntary disclosure to the IRS regarding foreign financial accounts, should consult experienced tax counsel to understand the benefits and the risk of the voluntary disclosure process. Blank Rome’s FBAR and FATCA compliance team has significant experience with FBAR and FATCA reporting obligations and the IRS voluntary disclosure programs, and can assist individuals in navigating these complicated reporting regimes.

To ensure compliance with IRS Circular 230, you are hereby notified that any discussion of federal tax issues in this advisory is not intended or written to be used, and it cannot be used by any person for the purpose of: (A) avoiding penalties that may be imposed on them under the Internal Revenue Code, and (B) promoting, marketing or recommending to another party any transaction or matter addressed herein. This disclosure is made in accordance with the rules of Treasury Department Circular 230 governing standards of practice before the Internal Revenue Service.

TIGTA Urges IRS to Scrutinize Tax Returns Claiming Foreign Earned Income Exclusion

The Treasury Inspector General for Tax Administration (TIGTA) issued an audit report on December 12, 2013, recommending that the Internal Revenue Service increase its scrutiny of tax returns claiming the Foreign Earned Income Exclusion.  The report, which is entitled “The Referral Process for Examinations of Tax Returns Claiming the Foreign Earned Income Exclusion Needs to Be Improved,” is available here

By way of background, to alleviate double taxation of taxpayers earning foreign income while residing overseas, IRC Section 911(a) provides for the Foreign Earned Income Exclusion (FEIE) and the Foreign Housing Exclusion/Deduction.  For Tax Year 2012, the FEIE allowed taxpayers to exclude foreign earned income of up to $95,100.   Qualifying taxpayers living and working in a foreign country may also claim a limited exclusion or deduction for the amount of their housing expenses.  These benefits can significantly reduce or eliminate taxpayers’ U.S. income tax liabilities regardless of whether they paid any foreign income taxes.

TIGTA found that of approximately 140 million individual income tax returns filed for tax year 2009, 372,119 (or 0.27 percent) tax returns included a Form 2555/2555-EZ, Foreign Earned Income/Foreign Earned Income Exclusion.  The exclusions, credits, and deductions claimed were as follows:

  • $23.3 billion in the FEIE.
  • $5 billion in foreign tax credits.
  • $2.7 billion in Foreign Housing Exclusions.
  • $102.6 million in Foreign Housing Deductions.

From a statistical sample of 2009 tax returns, TIGTA estimated that U.S. taxpayers living and working in foreign countries who claimed the FEIE reduced their federal income taxes by $562 million.  Taxpayers claiming the Foreign Housing Exclusion/Deduction reduced their federal income taxes by an additional $174 million for 2009.

In addition, during FY2009 through FY2011, 2,851 (or 99 percent) of the 2,876 individual income tax returns examined where a Form 2555/2555-EZ was present were not referred to an international examiner as required by IRS procedures.  TIGTA estimated that improving the audit referral process could result in approximately $2.7 million in additional tax assessments, or $13.5 million over five years.  Moreover, 1,583 examinations that were not required by the IRS to be referred might warrant referral to international examiners.  Referral of these tax returns could potentially result in approximately $1.5 million in additional tax assessments, or $7.5 million over five years.

As a result of its audit findings, TIGTA recommended that the IRS ensure that (1) domestic examiners and their managers are aware of the international referral criteria and (2) the international referral criteria process is evaluated to determine if it should be expanded to include the Wage and Investment Division.  In their response to the report, IRS officials agreed with the recommendations and plan to take corrective actions.

Fourth Circuit Affirms Responsible Officer Penalty Against Wife for Husband’s Unpaid Employment Taxes

On November 5, 2013, the Fourth Circuit upheld the assessment of a responsible officer penalty, pursuant to 26 U.S.C. § 6672, in the amount of $304,355.90 against a wife due to her husband’s failure to pay employment taxes to the Internal Revenue Service.  See Johnson v. United States, No. 12-1739 (Nov. 5, 2013) (opinion available here).

The Internal Revenue Code requires employers to withhold federal social security and income taxes from the wages of their employees.  See 26 U.S.C. §§ 3102(a), 3402(a). Because the employer holds these taxes as “special fund[s] in trust for the United States,” 26 U.S.C. § 7501(a), the withheld amounts are commonly referred to as “trust fund taxes,” Slodov v. United States, 436 U.S. 238, 243 (1978) (internal quotation marks omitted).  The Code “assure[s] compliance by the employer with its obligation . . . to pay” trust fund taxes by imposing personal liability on officers or agents of the employer responsible for “the employer’s decisions regarding withholding and payment” of the taxes.  Id. at 247 (interpreting 26 U.S.C. § 6672).  To that end, § 6672(a) of the Code provides that “[a]ny person required to collect, truthfully account for, and pay over any tax . . . who willfully fails” to do so shall be personally liable for “a penalty equal to the amount of the tax evaded, or not . . . paid over.”  26 U.S.C. § 6672(a).  Personal liability for a corporation’s unpaid trust fund taxes extends to any person who (1) is “responsible” for collection and payment of those taxes; and (2) “willfully fail[s]” to see that the taxes are paid.  Plett v. United States, 185 F.3d 216, 218 (4th Cir. 1999); O’Connor v. United States, 956 F.2d 48, 50 (4th Cir. 1992).

In the Johnson case, in 1969, Mr. Johnson (the husband) formed a non-profit corporation, Koba Institute, Inc., to perform various government contracts in conjunction with Koba Associates, Inc., a for-profit corporation that he owned and managed.  When Koba Associates failed to pay its payroll taxes in the mid-1990s, the IRS assessed trust fund recovery penalties against Mr. Johnson pursuant to 26 U.S.C. § 6672.  The outstanding payroll taxes, accompanied by the lien subsequently imposed on Mr. Johnson for the § 6672 trust fund recovery penalties, ultimately led Mr. Johnson to close Koba Associates. The presence of the lien limited Mr. Johnson’s ability to obtain credit for Koba Institute.

Mr. Johnson thereafter approached Mrs. Johnson (his wife) about restructuring Koba Institute so as to facilitate a continuation of their business.  In 1998, Koba Institute converted to a for-profit corporation under Maryland law, with Mrs. Johnson as its sole shareholder.  Because Mrs. Johnson was not encumbered by a lien like Mr. Johnson, her status as the corporation’s owner enabled Koba Institute to enter into leases and other contracts, as well as obtain lines of credit.

As the sole shareholder of Koba Institute, Mrs. Johnson elected herself as chair of the corporation’s board of directors in 2001.  According to the Johnsons, because they had agreed that Mrs. Johnson would be the primary caregiver of the couple’s children, Mrs. Johnson “delegated” and “entrusted” her authority in the corporation to Mr. Johnson, and thereafter elected Mr. Johnson president of Koba Institute on February 20, 2001, notwithstanding the contrary bylaw requirement.  Mrs. Johnson, in turn, served as the corporation’s vice president. 

Koba Institute’s board of directors — comprised of the Johnsons and an unrelated corporate secretary — unanimously approved a resolution authorizing Mr. Johnson (as president) and Mrs. Johnson (as vice president) to sign corporate checks and conduct financial transactions on behalf of the organization.  In addition, Koba Institute’s payroll account provided that Mrs. Johnson had the power to “sign singularly” on that account.

Having “delegated” her authority to Mr. Johnson, Mrs. Johnson’s actual involvement at Koba Institute was limited during the 2001 through 2004 period.  She did maintain an office at Koba Institute and received an annual salary ranging from approximately $100,000 to $193,000, as well as a corporate car and cell phone.  In addition, the rent for Mrs. Johnson’s residence, shared with Mr. Johnson, was provided by Koba Institute. 

In the 2001 to 2004 period, Mrs. Johnson only came to work once per month.  When she did so, she would approve any board resolutions, such as ratification of Mr. Johnson’s acts as president, or perform tasks in the human resources department.  Mr. Johnson made the ultimate decisions regarding the hiring and firing of employees.  Indeed, because Mr. Johnson oversaw the corporation’s day-to-day operations, other employees viewed him as “the one who decides everything” and went to Mr. Johnson – rather than Mrs. Johnson – with any questions that arose in the business, including financial matters such as the payment of payroll taxes.

When Mr. Johnson was out of the office, he left explicit instructions for Mrs. Johnson to follow on Koba Institute business, including which checks to sign in his absence.  Because of her limited involvement with the corporation’s daily operations, however, Mrs. Johnson was unaware of “the background or the context” for these checks and did not feel comfortable signing any checks that Mr. Johnson had not authorized.  Accordingly, from 2001 through 2004, she never attempted to write checks that Mr. Johnson had not already approved.

Near the end of 2004, Mrs. Johnson received a notice from the IRS that Koba Institute had not paid its payroll taxes for several quarters from 2001 through 2004.  Prior to that time, Mrs. Johnson was unaware that the payroll taxes were unpaid.  Upon receipt of the notice, she had “a serious talk” with Mr. Johnson and “told him” that the situation was “unacceptable” and that Koba Institute had “to take steps to make sure that it [did not] happen again.”  Mrs. Johnson then fired the finance director, who had been tasked with making payroll tax payments, and “directed Mr. Johnson to personally handle all future tax payments as of January 2005.”  She “required” Mr. Johnson to provide her with “visual proof” of all withholding tax payments that Koba Institute subsequently made.  Additionally, at least with regard to the payroll account, Mrs. Johnson no longer followed the prior procedure for check authorization; that is, she no longer required instruction from Mr. Johnson before writing checks herself from the payroll account for payment of the taxes.

Due to Mrs. Johnson’s “revamped oversight of tax payments,” Koba Institute began remitting its post-2004 payroll taxes to the IRS in full and, generally, on time.  The corporation did not, however, pay the outstanding delinquent payroll taxes for the 2001 through 2004 delinquent periods although it continued to pay its other business debts, such as employee wages and Mrs. Johnson’s compensation.  Subsequently, the IRS assessed trust fund recovery penalties against Mr. and Mrs. Johnson individually, pursuant to 26 U.S.C. § 6672.

Mrs. Johnson later paid $351.00 toward her assessed penalty, and filed a refund suit in district court, asserting that the § 6672 assessment against her was erroneous.

After the district court upheld the responsible officer penalty assessments, the Johnsons filed an appeal to the Fourth Circuit.  The court of appeals first addressed whether Mrs. Johnson was a “person responsible” for the payment of Koba Institute’s withholding taxes.  The Code defines a “responsible person” as one “required to collect, truthfully account for, and pay over any tax.”  26 U.S.C. § 6672(a).  The Supreme Court has interpreted this statutory language to apply to all “persons responsible for collection of third-party taxes and not . . . [only] to those persons in a position to perform all three of the enumerated duties.” Slodov, 436 U.S. at 250.  Thus, the Code deems anyone required to “collect” or “account for” or “remit” taxes a “responsible person” for purposes of § 6672.

The Fourth Circuit found the following facts relevant to the determination of whether Mrs. Johnson was responsible for the payment of withholding taxes:

Mrs. Johnson had been the corporation’s sole shareholder since 1998 and consequently had the effective power to change the officers and directors as she chose and thereby direct the business of the corporation.  Separately as both vice president and chair of the board of directors since early 2001, Mrs. Johnson enjoyed considerable actual authority at Koba Institute.

The corporation’s bylaws, board resolutions, and banking documents demonstrate that Mrs. Johnson was a “responsible person,” as it is clear that she had effective control of the corporation, including its finances. . . . The foregoing corporate documents indicate that Mrs. Johnson, while serving as chair of the board, would also serve as president of the corporation, a role that included authority to manage Koba Institute’s daily affairs and to execute checks and other legal documents on its behalf. Although Mrs. Johnson “delegated” and “entrusted” this authority to Mr. Johnson prior to 2005, . . . remaining only minimally involved in the corporation’s affairs as board chair and vice president, delegation of such authority does not relieve a taxpayer of responsibility under § 6672. . . . A taxpayer may be a “responsible person” if she “had the authority required to exercise significant control over the corporation’s financial affairs, regardless of whether [s]he exercised such control in fact.” . . .  Thus, despite delegating her authority to Mr. Johnson and permitting him to run the corporation’s daily affairs, Mrs. Johnson remained a “responsible person” because she had effective control of the corporation and the effective power to direct the corporation’s business choices, including the withholding and payment of trust fund taxes.

Although Mrs. Johnson maintains that any authority she held was merely technical in nature, the undisputed evidence establishes that she possessed both legal and actual authority over Koba Institute.  . . . Mrs. Johnson’s voluntary minimal involvement in daily corporate affairs before 2005, however, and assertions that Mr. Johnson exercised all daily operating authority fail to create a genuine dispute of material fact regarding limitations on her effective power as to the trust fund taxes.  Any deferral by Mrs. Johnson in the exercise of her authority never altered the fact that she possessed “effective power” over Koba Institute at all times. . . .  Indeed, Mrs. Johnson’s actions immediately after learning of the tax delinquencies in December 2004 – a period that “cast[s] light” on her responsibility from 2001 through 2004 – demonstrate that her actual authority was co-extensive with the legal authority she possessed. . . . Mrs. Johnson admits in her pleadings that she “fired the finance director,” the employee tasked with making payroll tax payments, as soon as she discovered that Koba Institute had not remitted these taxes as required by law.  She also “directed Mr. Johnson to personally handle all future tax payments as of January 2005” and “required” him to provide her with “visual proof” of all tax payments the corporation made.  These admissions indicate that Mrs. Johnson’s status in the corporation during the quarters at issue enabled her to have “substantial input into [its financial] decisions [from 2001 through 2005], had [s]he wished to exert [her] authority.”

Moreover, the fact that, from 2001 through 2004, Mrs. Johnson followed the corporation’s internal policy and did not write checks without knowing that Mr. Johnson had previously approved them does not negate § 6672 “responsible person” status. . . . Although she followed corporate procedure without exception during that time, it is undisputed that Mrs. Johnson ceased following this policy almost immediately upon learning of the 2001-2004 payroll tax deficiencies and could have done so at any earlier time.  Following her “revamped oversight of tax payments,” Mrs. Johnson would write checks from the payroll account without any instruction from Mr. Johnson. . . . Accordingly, the fact that Mrs. Johnson previously chose not to write checks without Mr. Johnson’s approval does not show that she was prevented earlier from doing so other than by her own choice. . . . The record also indicates that Koba Institute opened several operating accounts between 2001 and 2005, and that on each of those accounts, Mrs. Johnson was fully authorized to write checks and execute other bank documents.

While she may not have been running the day-to-day operations of the corporation between 2001 and 2004, Mrs. Johnson had a non-delegable responsibility to monitor Koba Institute’s financial affairs. . . . Mrs. Johnson had the effective power to exercise authority when she chose to do so, even though she chose at times to voluntarily limit her involvement in corporate affairs.  Although Mrs. Johnson often chose not to exercise the authority which she possessed, such a decision is insufficient to permit a taxpayer to avoid § 6672 responsibility. . . . Moreover, after 2004, while the prior periods’ payroll taxes remained unpaid, Mrs. Johnson actively exercised her authority over the affairs of Koba Institute while continuing to receive substantial compensation and benefits from the corporation.  

We therefore conclude that the Government presented undisputed evidence that established as a matter of law that Mrs. Johnson was a “responsible person” under § 6672 during the relevant tax periods because she had the effective power to pay the trust fund taxes of Koba Institute.

Having found Mrs. Johnson a “responsible person,” the Fourth Circuit then turned to the other necessary element of § 6672 liability — whether she “willfully” failed to collect, account for, or remit payroll taxes to the United States.  This inquiry focuses on whether Mrs. Johnson had “knowledge of nonpayment or reckless disregard of whether the payments were being made.”  Plett, 185 F.3d at 219.  The Court readily found evidence of willfulness, as follows:

The record demonstrates that Koba Institute continued to make payments to other creditors using unencumbered funds following Mrs. Johnson’s receipt of the IRS notice in December 2004.  The Government has produced numerous salary checks that the corporation issued to Mrs. Johnson in 2005, which Mrs. Johnson readily cashed.  Yet it is undisputed that Mrs. Johnson, a “responsible person,” knew that payroll taxes for numerous quarters from 2001 through 2004 remained unpaid. Mrs. Johnson’s failure to remedy the payroll tax deficiencies upon learning of their existence in December 2004, while directing corporate payments elsewhere, including to herself, constitutes “willful” conduct under § 6672. This is particularly so given that, at Mrs. Johnson’s direction, Koba Institute paid other creditors during this period. And, as noted earlier, during the 2001 to 2004 delinquent tax periods, Mrs. Johnson received well in excess of $500,000 in compensation and benefits from the corporation while the payroll taxes went unpaid. . . . Even viewing the evidence in the light most favorable to Mrs. Johnson, we conclude that the record allows no conclusion other than that the failure to pay the payroll taxes was willful on Mrs. Johnson’s part.

Based upon its finding that Mrs. Johnson was a “responsible officer” and that the failure to pay employment taxes was willful, the Court affirmed the assessed penalties.

The Johnson case illustrates that personal liability may be assessed against corporate officers where a company fails to pay over employment taxes, even if the corporate officer was unaware of the failure to pay in prior periods.  Once the corporate officer learns of the tax delinquency, he or she has a duty to ensure that corporate funds are used to pay off those liabilities.  If the corporate officer fails to do so, personal liability for those taxes may be asserted. 

IRS Announces Nationwide Rollout of Fast Track Settlement Program for Small Businesses and Self-Employed Individuals

On November 6, 2013, the IRS announced the nationwide rollout of its Fast Track Settlement (“FTS”) program, a streamlined program designed to help small businesses and self-employed individuals who are under examination by the IRS’ Small Business/Self Employed (“SB/SE”) Division more quickly settle their differences with the IRS.  Prior to yesterday’s announcement, the FTS program was a pilot program whose availability was limited to certain jurisdictions.

The FTS program, now available nationwide, is structured to expedite SB/SE case settlement through alternative dispute resolution techniques.  The techniques utilized by the program, as stated in the IRS’ Announcement 2011-5, “enable SB/SE taxpayers that currently have unagreed issues in at least one open year under examination to work together with SB/SE and the Office of Appeals to resolve outstanding issues while the case is still in SB/SE jurisdiction.”   The program is designed to save taxpayers time and to avoid formal appeals and lengthy litigation processes.

Subject to certain exceptions listed in Announcement 2011-5, the FTS program is generally available for cases under the jurisdiction of the IRS’ SB/SE Division if:  (1)  the issue(s) in dispute are fully developed,  (2) the taxpayer has submitted a written statement responding to the IRS’ position on the disputed issue(s) and (3) there are a limited number of issues in dispute.  A taxpayer who is interested in participating in the FTS program, or who has questions about the program and its suitability for the taxpayer’s case, should contact the Examination or Specialty Program group manager for the audit.   To apply for the FTS program, the taxpayer and the group manager must submit a Form 14017, Application for Fast Track Settlement to the Appeals Team Manager, along with the taxpayer’s written response to the IRS’ stated position on the disputed issue(s).  More background on the program and the application process is provided in Announcement 2011-15 and on the IRS’ Alternative Dispute Resolution webpage.

IRS Issues Directive On Enforcement Process for Information Document Requests – Large Business & International Division

Yesterday, November 4, 2013, the IRS issued a directive to its Large Business and International examiners and specialists regarding a soon-to-be implemented Information Document Request (“IDR”) enforcement process.   The new IDR enforcement process, currently set to take effect January 2, 2014, requires examiners in the Large Business and International division to use a three step enforcement process when a taxpayer does not timely respond to an applicable IDR. The enforcement process only applies to IDRs issued (1) on or after June 30, 2013 and (2) in accordance with recent IRS guidelines requiring issue-focused requests and a discussion between the examiner and the taxpayer establishing a response date.   The thirteen requirements for issuing IDRs are provided in Attachment 1 to the November 4 directive and guidelines on issuing IDRs are detailed in a June 18, 2013 directive.

If a taxpayer does not timely respond to a IDR that is subject to the new enforcement process, a three step process is set in motion, consisting of: (1) a Delinquency Notice providing a set amount of time to comply, (2) if the taxpayer does not provide a complete response to the IDR  by the date set in the Delinquency Notice, a Pre-Summons Letter requiring response by another set date, and (3) if a complete response to the IDR is not provided by the response date in the Pre-Summons Letter, a Summons for the information.

Although this new enforcement process for the Large Business and International Division will take effect January 2, 2014, the directive states that no Delinquency Notices will be issued prior to February 3, 2014.   Corporate taxpayers who receive an IDR that is dated June 30, 2013 or after may be subject to the new enforcement process and should be aware of both the revised audit process (as detailed in the June 18, 2013 directive) and the response dates required by such process and the new enforcement process discussed in the November 4, 2013 directive.

TIGTA Again Critical of IRS Correspondence Audit Process

The Treasury Department’s Inspector General for Tax Administration (TIGTA) has issued another audit report critical of the IRS correspondence audit process.  (See prior post here.)  In its latest audit report, entitled “Actions Are Needed to Strengthen the National Quality Review System for Correspondence Audits,” TIGTA found that problems with correspondence audits are not always recognized and reported, resulting in missed opportunities for the IRS to reduce noncompliance that contributes to the Tax Gap and promote tax system fairness among taxpayers. 

In contrast to the more detailed and lengthy face-to-face audit at an IRS office or in the field at a taxpayer’s place of business, the correspondence audit process is conducted by mail and is less intrusive, more automated, and conducted by examiners who are trained to deal with less complex tax issues.  Because of its automated features and less complex tax issues, the correspondence audit process enables the IRS to reach more taxpayers at a lower cost.  The IRS currently conducts correspondence audits in approximately 37 program areas.

By FY2008 and FY2012, the IRS conducted almost 5.7 million correspondence audits and recommended approximately $40.4 billion in additional taxes.  This represents about 77 percent of all audits the IRS conducted of individual income tax returns and about 56 percent of the estimated $72.4 billion in recommended additional taxes resulting from those audits.  The responsibility for conducting correspondence audits rests largely with the IRS’s Small Business/Self-Employed (SB/SE) Division, which handles complex individual tax returns, and its Wage and Investment Division, which handles simple tax returns filed by individuals reporting wages, interest, dividends, and other investment income.

The correspondence audit process typically begins with the IRS mailing a computer-generated letter from one of its campuses to a taxpayer. The letter outlines the examination process, identifies one or more items on the tax return being questioned, and requests supporting information to resolve the questionable items. Once the requested information is returned, examiners review it to determine whether it resolves the questions.  If the questions can be sufficiently answered by the information provided, the audit is generally closed without any changes to the tax; if not, the taxpayer is sent a letter requesting more information or indicating a recommended change to the tax.  The taxpayer can thereafter:

  • Agree with the examiner;
  • Provide the examiner with clarifying information; or
  • Appeal the decision to the IRS’s Office of Appeals.

In instances where the taxpayer does not respond to IRS letters, the examiner’s recommended tax changes are assessed by default and the taxpayer will generally have to file a petition in the U.S. Tax Court to contest the assessment.

To ensure that correspondence audits are conducted in a quality manner, the IRS uses a comprehensive quality review system.  The system includes a statistical sampling of correspondence audits.  The IRS has established seven auditing quality standards.  Each standard has key elements that elaborate on and further define the overall standard.  For example, one of the key elements for Adequate Consideration of Significant Issues instructs examiners to consider and/or pursue audits of the prior and/or subsequent year returns when they contain the same issues as in the year examined.  (A recent TIGTA audit report criticized the IRS for failing to pursue correspondence audits of prior and/or subsequent years.)  Another quality standard examines whether applicable penalties were considered and applied correctly.

The quality review system is conducted at the management level, where “first line managers” review the documentation for a sample of audit case files to identify and correct quality problems in conjunction with evaluating the performance of the examiners they supervise.  In addition, each of the five IRS campus sites that conduct correspondence audits also perform quality review audits as part of the IRS-wide National Quality Review System (NQRS).

TIGTA’s audit discovered that the National Quality Review System should be strengthened because numerous errors were found during the audit process.  TIGTA found numerous errors in tests of the accuracy-related penalty determination category that were not detected and reported by NQRS quality reviewers.  For example, TIGTA found that in cases where examiners disallowed itemized deductions in excess of $20,000 due to lack of documentation, no negligence penalty was asserted.  Similarly, TIGTA found that in cases were taxpayers understated their tax liabilities, penalties were not considered.  TIGTA also found “inconsistency and confusion” over when, and if, the scope of single-year audit should be expanded to include prior and/or subsequent years. 

In management’s response to the TIGTA audit, IRS largely agreed with the findings and recommendations.  As a result, we expect to see a greater focus from examiners and their managers on the assertion of penalties, where appropriate, during the correspondence audit process.  We also expect to see more prior and/or subsequent year audits in this area.

IRS Releases More FATCA Guidance Including Draft FFI Agreement

With the January 1, 2014 implementation date for the Foreign Account Tax Compliance Act (FATCA) fast approaching, the IRS issued additional guidance today, including a long-awaited and much anticipated draft Foreign Financial Institution (FFI) Agreement.  In Notice 2013-69, the IRS provides the following:

  • guidance to FFIs entering into agreements directly with the IRS, and to those reporting through a Model 2 IGA. 
  • incorporates updates to certain due diligence, withholding, and other reporting requirements, and
  • a draft FFI agreement which will be finalized by December 31, 2013.

In a press release which accompanied Notice 2013-69, the Treasury Department and IRS assert that “FATCA is rapidly becoming the global standard in the effort to curb offshore tax evasion” (despite generating considerably fury around the world) and state that to date, Treasury has signed nine Intergovernmental Agreements (IGAs), reached 16 agreements in substance, and is engaged in related conversations with many more jurisdictions.

According to Deputy Assistant Secretary for International Tax Affairs Robert B. Stack, “The [FFI} Agreement and forthcoming guidance have been designed to minimize administrative burdens and related costs for foreign financial institutions and withholding agents.  Today’s preview demonstrates the Administration’s commitment to ensuring full global cooperation and a smooth implementation.” 

IRS Delays Start Date of 2014 Tax Filing Season

The IRS issued a news release on October 22, 2013 announcing that, as a result of the 16-day government shutdown, the agency will delay the start of the 2014 tax filing season by one to two weeks.  The news release, available here, provides that the IRS will begin accepting and processing 2013 individual tax returns no earlier than January 28, 2014 and no later than February 4, 2014, a one to two week delay from the original start date of January 21, 2014.   The release states that the exact start date will be announced in December 2013 and that there is no advantage to filing a paper tax return before the opening date.  Rather, the agency encourages taxpayers to e-file their tax returns and request to receive their refunds by direct deposit, stating that such taxpayers will “receive their tax refunds much faster.”  Notably, the news release confirms that the April 15, 2014 filing deadline for 2013 tax returns, set by statute, will  remain in place.  Taxpayers may request an automatic six-month filing extension by filing a Form 4868 with the IRS on or prior to April 15, 2014.

Although the IRS resumed operations on October 17, 2013 (see prior post here), the agency is still continuing to assess the impact of the shutdown on its operations.  Taxpayers should be mindful of the IRS’ request in the news release to wait to call or visit the agency if a tax issue is not urgent.   

Another Casualty of the Government Shutdown: Tax Court Shuttered

We previously discussed the impact of the federal government shutdown on the Internal Revenue Service (see prior post here) and how IRS operations have virtually ground to a halt since October 1, 2013, the first day of the shutdown.  Another government agency impacted by the shutdown is the United States Tax Court in Washington, D.C., which has been closed since October 1.  According to a notice posted on the Tax Court website, no pleadings will be received by the court (including through the eFiling system), and no pleadings will be served by the court, until further notice.  Due dates previously established by court rules or court order are extended by the number of days that court operations are suspended.

However, because the Tax Court lacks the authority to extend statutory filing deadlines imposed by the Internal Revenue Code, taxpayers must still comply with such deadlines.  For example, IRC 6213(a) requires a taxpayer to file a petition for redetermination of a deficiency within 90 days after mailing of a statutory notice of deficiency.  This deadline is not extended as a result of the government shutdown, so any affected taxpayer must still timely file a petition.  The Tax Court advises taxpayers that hand-delivery is not available because of closure of the court, so petitions must be sent by U.S. mail or an approved private carrier such as Federal Express.  No Tax Court personnel will be available to confirm receipt, so taxpayers and practitioners would be well-advised to utilize a delivery service that provides proof of delivery.

In a more recent notice published on the IRS website, the court has announced that all trial sessions scheduled to begin on October 7 and 8, 2013, have been cancelled.  These particular trial sessions were scheduled for Baltimore, Chicago, Dallas, Detroit, Miami, New Orleans, Pittsburgh, and Washington, D.C.

In contrast, other federal courts (district courts, Courts of Appeals, and the U.S. Supreme Court) remain open, at least until October 15, when federal court funding is expected to run out.