Extension Time The IRS Gets Extra Time to Assess Tax Based on Preparer Fraud Podcast of March 10, 2007 Feed address for Podcast subscription: http://feeds.feedburner.com/edzollarstaxupdate Home page for Podcast: 2007 The TaxUpdate podcast is intended for tax professionals and is not designed for those not skilled in independent tax research. All readers and listeners are expected to do their own research to confirm items raised in this presentation before relying upon the positions presented. The Podcast and this document may be reproduced freely so long as no fee is charged for the use of this document. Such prohibited use would include using this podcast or document as part of a CPE presentation for which a fee is charged. This podcast is sponsored by Leimberg Information Services, located on the web at http://www.leimbergservices.com. Leimberg Information Services offers email newsletters on tax related matters, as well as access to a library of useful information to tax practitioners that subscribe to their services. Preparer Fraud Taints Taxpayer This week the Tax Court issued a ruling that held that a tax preparer s bad acts in preparing a fraudulent tax return allowed for an unlimited extension of time for the IRS to assess tax against a taxpayer even if the taxpayer him or herself did not commit the fraud. The case in question is Allen v. Commissioner 128 TC No. 4. The case is a useful one to use to remind clients why you shouldn t merely opinion shop (or, better yet, refund shop) in selecting a tax professional to work with if someone promises something that sounds too good to be true, the taxpayer may be stuck with serious consequences if it turns out it really is too good to be true. - 1 -
Statute for Assessing Tax Reason dictates that, in general, both the IRS and the taxpayer have a limited period of time in most cases to revise a tax return. If that were not the case taxpayers would end up having to maintain all of their tax records forever, creating an unreasonable burden for compliance. For that reason, we find rules related to the limitation of time during which the IRS can ask for additional tax. If the IRS misses that deadline, the taxpayer would be able to forget about the year in question and not worry about future liability for that year. The rule on the limitation of time for the assessment of tax by the IRS is found in IRC Section 6501. The general rule is found in 6501(a) which provides: (a) General rule Except as otherwise provided in this section, the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed (whether or not such return was filed on or after the date prescribed) or, if the tax is payable by stamp, at any time after such tax became due and before the expiration of 3 years after the date on which any part of such tax was paid, and no proceeding in court without assessment for the collection of such tax shall be begun after the expiration of such period. For purposes of this chapter, the term "return" means the return required to be filed by the taxpayer (and does not include a return of any person from whom the taxpayer has received an item of income, gain, loss, deduction, or credit). The issue in this case deals with the otherwise provided provisions found in 6501, specifically 6501(c)(1) which provides: (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. Note that if 6501(c)(1) is found to apply to a return, the tax may be assessed at any time so there s no three year statute of limitations to protect the taxpayer down the line against an assessment of tax. The key question that is looked at in the case in question is whether the taxpayer must be culpable him/herself in the fraudulent aspects of the tax returns or whether the only issue is that the IRS must show there was fraud inherent in the acts of some party to the return in question, even if that party was the paid preparer, thus creating a fraudulent return. - 2 -
The Allen Case In the Allen case, we find a UPS truck driver who engaged the services of a tax preparer and gave the preparer his W-2, 401(k) statements, mortgage interest statement and property statements for the years in question (1999 and 2000). But it turned out the preparer in question did not necessarily limit himself to just that information to prepare Mr. Allen s returns. Rather, the court notes: Mr. Goosby prepared petitioner's returns for the years at issue and claimed false and fraudulent Schedule A, Itemized Deductions, for both years. The false deductions included deductions for charitable contributions, meals and entertainment, and pager and computer expenses, as well as various other expenses. Petitioner received complete copies of petitioner's returns for the years at issue after they had been filed, but he did not file an amended tax return for either year. While not totally clear from that final sentence, it would appear likely that the preparer sent the returns themselves in through efile prior to actually providing the taxpayer with copies of the return. Thus, it appears, the taxpayer was not aware of the fraud until after the fraudulent return was filed with the IRS, at least for the first year in question. The tax preparer ended up coming to the notice of the IRS CID division and the taxpayer ended up becoming very personally aware of this matter. As the court noted: Two special agents of respondent's Criminal Investigation Division interviewed petitioner concerning Mr. Goosby's preparation of his income tax returns. Mr. Goosby was indicted, tried, and convicted of 30 violations of section 7206(2) (willfully aiding and assisting in the preparation of false and fraudulent income tax returns) in 2006, although petitioner's returns for the years at issue were not used as the basis for any counts of the indictment. Is the IRS Too Late to Collect the Tax? The IRS issued their notice adjusting the tax preparer s creative adjustments to Mr. Allen s returns on March 22, 2005 for both the 1999 and 2000 returns, after the expiration of the standard three year statute of limitations on both of those returns. The IRS position was that the returns themselves were clearly fraudulent the preparer had invented deductions with clear objective of evading the tax on behalf of taxpayer, a feat which also had the effect of helping his marketing to taxpayers who believe that the best way to judge a good tax preparer is by the size of the refund they get and clearly his were larger than those of most of his competitors who, for whatever reason, felt that they should not create works of fiction for their clients. Prior to trial, the parties specifically agreed to the following points: - 3 -
The parties also agree that petitioner himself did not have the intent to evade tax, but Mr. Goosby claimed the false deductions for the years at issue on petitioner's returns with the intent to evade tax. So we now are down to the issue of law can the IRS apply 6501(c)(1) in a case where the taxpayer himself had no fraudulent intent to evade tax but the preparer did? Analysis of the Issue The taxpayer contends that only the general rule of 6501(a) applies, and the IRS simply filed their assessment too late. Petitioner alleges that the limitations periods for assessment of taxes with respect to petitioner's returns for the years at issue expired before respondent issued petitioner the deficiency notice. Respondent argues that the preparer's fraudulent intent to evade tax is sufficient to keep the limitations periods open. Petitioner counters that only the intent of the taxpayer, not the preparer, is relevant to whether the returns were fraudulent so as to extend the limitations period. The Court considers this argument, but notes that they find nothing in the plain language of the statute that limits 6501(c)(1) in the way the taxpayer argues. The Court notes: The statute provides that the tax may be assessed at any time "[i]n the case of a false or fraudulent return with the intent to evade tax." Sec. 6501(c)(1). Notably absent from this provision is any express requirement that the fraud be the taxpayer's. Nothing in the plain meaning of the statute suggests the limitations period is extended only in the case of the taxpayer's fraud. The statute keys the extension to the fraudulent nature of the return, not to the identity of the perpetrator of the fraud. Nor do we read the words "of the taxpayer" into the statute to require the taxpayer to have the intent to evade his or her own tax. The Court goes on to explain why this result makes sense by looking that IRS s arguments in the case and notes: Respondent argues, and we agree, that statutes of limitations are strictly construed in favor of the Government. Badaracco v. Commissioner, 464 U.S. 386, 391 (1984); Lucia v. United States, 474 F.2d 565, 570 (5th Cir. 1973). An extended limitations period is warranted in the case of a false or fraudulent return because of the special disadvantage to the Commissioner in investigating these types of returns. Badaracco v. Commissioner, supra at 398. Three years may not be sufficient for the Commissioner to investigate or prove fraudulent intent. Id. at 399. - 4 -
We agree with respondent that the special disadvantage to the Commissioner in investigating fraudulent returns is present if the income tax return preparer committed the fraud that caused the taxes on the returns to be understated. Accordingly, taking into account our obligation to construe statutes of limitations strictly in favor of the Government, we conclude that the limitations period for assessing petitioner's taxes is extended if the taxes were understated due to fraud of the preparer. The Court goes on to dismiss cases the taxpayer cites for the proposition that the fraud must be the taxpayers by noting that in the cases in question it was the taxpayer that committed the fraud so those cases do not provide guidance for cases where there was a clear indication of fraud involving another party. What About the Burden on the Taxpayer? Finally, the taxpayer argues the point that began this article that the statute of limitations is designed to limit the burden on taxpayers, and this case would taxpayers would have to keep their records forever since merely knowing that the taxpayer had not committed fraud would not be enough. The taxpayer is now charged with assessing whether his preparer acted fraudulently. The Court did not have sympathy for this argument. The Court notes: Petitioner also argues that extending the limitations period for the fraudulent intent of the preparer would be unfairly burdensome because it would require taxpayers to keep records indefinitely. We disagree. Taxpayers are charged with the knowledge, awareness, and responsibility for their tax returns. Magill v. Commissioner, 70 T.C. 465, 479-480 (1978), affd. 651 F.2d 1233 (6th Cir. 1981); Teschner v. Commissioner, T.C. Memo. 1997-498. The taxpayer, not the preparer, has the ultimate responsibility to file his or her return and pay the tax due. Kooyers v. Commissioner, T.C. Memo. 2004-281. This duty cannot generally be avoided by relying on an agent. Estate of Clause v. Commissioner, 122 T.C. 115, 123-124 (2004); Am. Props., Inc. v. Commissioner, 28 T.C. 1100, 1116-1117 (1957), affd. 262 F.2d 150 (9th Cir. 1958). We do not find it unduly burdensome for taxpayers to review their returns for items that are obviously false or incorrect. It is every taxpayer's obligation. Petitioner cannot hide behind an agent's fraudulent preparation of his returns and escape paying tax if the Government is unable to investigate fully the fraud within the limitations period. The Commissioner has just as much need for an extended limitations period to investigate and examine taxpayers who sign and allow to be filed returns that greatly overstate expenses or include fictitious expenses whether the fraud was committed by the taxpayer or the taxpayer's preparer. To find otherwise would allow a taxpayer to receive the benefit of a fraudulent return by hiding behind the - 5 -
preparer. Taxpayers whose returns are fraudulent owing to fraud committed by the preparers would escape their tax liability if the Commissioner were unable to identify or investigate the fraud within the normal 3-year period. The above analysis should prove useful when explaining to clients why they have a responsibility in selecting a competent preparer, and why at times you don t take positions that they insist other people have told them their tax guy has taken in the past and they haven t had a problem. Conclusions One item we should consider about this matter, though, is what our advice should be if we take over a client where potentially problematic returns have been filed in the past. Presuming the IRS s position is sustained in other cases (and note that this is a published Tax Court decision, so you re going to end up with this result in Tax Court so a client would have to be willing to go other routes), taxpayers who have worked with problem preparers in the past should be warned about their exposure and potential issues moving forward. - 6 -