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Showing posts with label lawsuit. Show all posts
Showing posts with label lawsuit. Show all posts

Monday, December 16, 2024

An Accounting Firm Gets Sued


I just saw that Baker Tilly has acquired Seiler LLP, a CPA firm located in San Francisco and practicing for well over half a century.

There is nothing unusual here. Many older CPAs are looking to retire. In some cases, the firm may have planned for transition and brought in, developed, and retained a pipeline of ownership-interested younger CPAs.  The older CPAs retire, the younger CPAs step up and the firm continues.

In other cases, there is no such pipeline, and the older CPA’s exit plan is a sale to another firm.

The matter caught my eye because a client is suing Seiler for negligence. The matter is still in court. I thought the grounds for negligence was … different.

It is not our usual brew of java, but let’s talk about it.

It starts with a married couple: Eric Freidenrich and Amy Macartney. They hired Seiler to prepare their 2019 joint tax return. The return was filed in December 2020.

COMMENT: You may be thinking that the return was filed late (that is, after October 15) and penalties and interest would be due. That is not true here, as the return showed an overpayment of almost $450 grand. There normally will be no interest and penalties on refund-due returns, as penalties and refunds normally apply only when balances are due the IRS. The risk to a refund return is waiting too long to file a return. Remember, the statute of limitations on filing is three years. Wait past those three years and you will lose your refund.

For some reason, Eric and Amy did not use a home address on their return. They instead used their financial advisor’s address, a practice they had followed for years.

Now, a couple of things happened after 2019 and during 2020 before Seiler filed the return:

·       Eric and Amy divorced.

·       The financial advisor moved.

On first blush, I would be concerned about the divorce. A CPA (or his/her firm) should think long and hard about representing a divorcing couple. The reason is simple: which one of the two is the client? Representing both can create a conflict of interest, and a CPA is supposed to maintain independence and avoid such conflicts. Failure to do so can result in a hearing before a State Board of Accountancy.

The refund arrived in April 2022.

The two had signed their separation agreement in June 2021.

The separation agreement included language that Eric would be responsible for additional taxes due during the term of marriage, but - to be fair - he would also be entitled to any refunds.

Amy did not know that the IRS refund got held up. The couple’s routine was to deposit in the couple’s Fidelity account, and the separation agreement had Amy receiving 60% of the Fidelity account.

The refund was almost $450 grand, and 60% of that – approximately $270 grand – would have gone to Amy.

She was not amused.

I would not be either.

She sued Seiler for negligence.

Notice that she did not sue her ex-husband.

Where is the negligence?

Seiler – as a firm – knew that that advisor had moved. It should have used the new address.

Did the tax team – a subset of Seiler – also know that the advisor had moved? Information moves well enough in a CPA firm, but it would be false to say that it moves flawlessly. It is possible that the tax department did not know, but Amy is suing Seiler, not the tax department.

Seiler (or rather, their attorney) tried to get the motion dismissed.

And there is a quick lesson here about torts. Torts are civil law. Think of torts as suing someone. You bring suit, not the government. It is conduct between private parties.

The idea behind a tort is to restore the injured party (as much as possible in the circumstance) to where he/she would have been had the other party not acted or failed to act. A goal of tort law is to see the world as it could have been, not as the world is now.

Well, under that description Amy would have received 60% of the IRS refund. Seiler injured her. Her ex did not injure her, as he stated in the divorce decree that he would keep any tax refunds relating to the marriage term.

The Court therefore saw reason for tort action and would not grant summary motion for dismissal.

What does this mean? It means that the Court will hear the case against Seiler for negligence.

As a tax CPA, it bothers me that I could get my firm sued for something I did not even know. That said, I get it. The firm knew. However, Eric and Amy saw the address on the return. Their attorneys would also have seen the address. Do we know if the financial advisor timely filed a change of address with the IRS? Seiler might not be the only party with some measure of fault. 


Monday, July 8, 2024

An Erroneous Tax Refund Check In The Mail

 

Let’s start with the Code section:

§ 6532 Periods of limitation on suits.

(b)  Suits by United States for recovery of erroneous refunds.

 

Recovery of an erroneous refund by suit under section 7405 shall be allowed only if such suit is begun within 2 years after the making of such refund, except that such suit may be brought at any time within 5 years from the making of the refund if it appears that any part of the refund was induced by fraud or misrepresentation of a material fact.

 

I have not lost sleep trying to understand that sentence.

But someone has.

Let’s introduce Jeffrey Page. He filed a 2016 tax return showing a $3,463 refund. In early May 2017, he received a refund check of $491,104. We are told that the IRS made a clerical error.

COMMENT: Stay tuned for more observations from Captain Obvious.

Page held the check for almost a year, finally cashing it on April 5, 2018.

The IRS – having seen the check cash – wanted the excess refund repaid.

Page wanted to enjoy the spoils.

Enter back and forth. Eventually Page returned $210,000 and kept the rest.

On March 31, 2020, Treasury sued Page in district court.

Page blew it off.

Treasury saw an easy victory and asked the district court for default judgement.

The court said no.

Why?

The court started with March 31, 2020. It subtracted two years to arrive at March 31, 2018. The court said that it did not know when Page received the check, but it most likely was before that date. If so, more than two years had passed, and Treasury could not pass Section 6532(b). They would not grant default. Treasury would have to prove its case.

Treasury argued that it was not the check issuance date being tested but rather the check clearance date. If one used the clearance date, the suit was timely.

The district court was having none of that. It pointed to precedence – from the Ninth Circuit Court of Appeals - and dismissed the case.

The government appealed.

To the Ninth Circuit Court of Appeals, ironically.

The Ninth wanted to know when a refund was “made.”

within 2 years after the making of such refund …”

Is this when the refund is allowed or permitted or is it when the check clears or funds otherwise change hands?

The Ninth reasoned that merely holding the check does not rise to the threshold of “making” a refund.

Why, we ask?

Because Treasury could cancel the check.

OK. Score one for the government.

The Ninth further reasoned that the statute of limitations cannot start until the government is able to sue.

Why, we again ask?

Had Page shredded the check, could the government sue for nearly half a million dollars? Of course not. Well then, that indicates that a refund was not “made” when Page merely received a check.

Score two for the government.

The Ninth continued its reasoning, but we will fast forward to the conclusion:

… we hold that a refund is made when the check clears the Federal Reserve.”

Under that analysis, Treasury was timely in bring suit. The Ninth reversed the district court decision and remanded the case for further proceedings.

What do I think?

I see common sense, although I admit the Ninth has many times previously eluded common sense. Decide otherwise, however, and Treasury could be negatively impacted by factors as uncontrollable as poor mail delivery.

Or by Page’s curious delay in depositing the check.

Then again, maybe a non-professional was researching the matter, and it took a while to navigate to Section 6532 and its two years.

Our case this time was U.S. v Page, No 21-17083 (9th Cir. June 26, 2024).


Saturday, July 22, 2017

Lawless In Seattle

Did you hear that Seattle has a new income tax?

Sort of. Eventually. But maybe not.

The tax rate is 2.25 percent and will tag you if you are (1) single and earn more than $250,000 per year or (2) married and earn more than $500,000.

This is big-bucks land, and we normally would not dwell on this except…

Washington state has no income tax.

Let us get this right: Seattle wants to have an income tax in a state that has no income tax. Washington state considered an income tax back in the 1930s, but the courts found it unconstitutional.

You or I would live within the Seattle city limits … why?

Surely there are nice suburbs we could call home. Heck, Bill Gates and Jeff Bezos do not live in Seattle; they live in the suburbs.

There appear to be legal issues with this tax.

The state constitution, for example, requires taxes to be uniform within a class of property. The pro-tax side questions whether income is “property.”

The anti-tax side provides the Power Inc v Huntley case (1951), wherein the Washington Supreme Court stated:
It is no longer subject to question in this court that income is property.”
Must be something cryptic about the wording.

Then there is a law that bans Washington cities from taxing net income.

The pro-tax side argues that they are not taxing “net” income. No sir, they are taxing “adjusted” or “modified” or “found-under-the-cushions” income instead.

The anti-tax side says: seriously?

Then you have the third issue that Washington cities must have state authority to enact taxes.


The pro-tax side says it can do this under their Licenses and Permits authority.

RCW 35A.82.020
Licenses and permits—Excises for regulation.
A code city may exercise the authority authorized by general law for any class of city to license and revoke the same for cause, to regulate, make inspections and to impose excises for regulation or revenue in regard to all places and kinds of business, production, commerce, entertainment, exhibition, and upon all occupations, trades and professions and any other lawful activity: PROVIDED, That no license or permit to engage in any such activity or place shall be granted to any who shall not first comply with the general laws of the state.

No such license shall be granted to continue for longer than a period of one year from the date thereof and no license or excise shall be required where the same shall have been preempted by the state, nor where exempted by the state, including, but not limited to, the provisions of RCW 36.71.090 and chapter 73.04 RCW relating to veterans.

I am not making this up, folks.

Here is the mayor:
This legislation will face a legal challenge.”
And green is a color.
But let me tell you something: we welcome that legal challenge. We welcome that fight.”
Then why pick a fight, Floyd?
… lowering the property tax burden …, addressing the homelessness crisis; providing affordable housing, education and transit; … creating green jobs … meeting carbon reduction goals.”
Got it: verbigeration, the new college major. It will get you to that $15 minimum wage. At least until those jobs go away because they are too expensive.

Speaking of expense: who is bankrolling this issue while it is decided in court? Has the city banked so much money that a guaranteed legal battle is worth it?

If we need to pack the courts, will you be there with me?” thundered a councilperson.


Pack the courts? Should we bring bats too?  

The pro-tax side wants to be sued, hoping that a judge will legislate from the bench.

Needless to say, the anti-tax side is resisting, with calls for “civil disobedience.”

With exhortations not to file returns.

The state chair of the Republican party is encouraging
“… non-compliance, non-violent and non-paying”
Sounds almost Gandhi-esque.

It appears that neither side has any intention to observe – heck, even acknowledge – any pretense of law.

I am at a loss to see how this is good for anybody.

Friday, June 30, 2017

Issuing 1099s In Anger


Several years ago, I received an angry call from another CPA.

He had lost a couple of key partners, to which he responded with an almost Game-of-Thrones vindictiveness. He had been charged with issuing false Form 1099s to his former partners.

They dragged him into Court for this and other reasons.

I had looked into the 1099 matter. It is not every day a CPA is charged with issuing false tax forms.

Why would somebody do this: issue false 1099s?

Because chum in the water.

Let’s talk about the Petrunak case.

Petrunak was a pyrotechnician.

This guy made fireworks. He owned a company called Abyss Special FX, Inc. (Abyss), and he could do both indoor and outdoor fireworks displays.

This also meant that he was under regulation by the Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF).

A couple of ATF agents conducted a mandatory inspection and found a number of violations. Petrunak challenged their findings and had his day in administrative court. I do not know what the details were, but the judge revoked Petrunak’s fireworks license.

So much for Abyss and his paycheck.

Petrunak reckoned he lost a lot of money – both as real-money losses and as money he would have made except for the ATF agents.

He had time to think about it. He thought about it for five years.

He had Abyss send each of them a Form 1099-MISC for $250,000.

Half a million. He figured that was about what they had cost him.

Abyss deducted that half million. As Abyss was an S corporation, there was a big loss passed-through to Petrunak to use on his individual return.

Needless to say, both ATF agents omitted that 1099 from his/her individual tax return.

One agent however got pulled for audit.

The IRS wanted taxes of over $100 grand. She spent a lot of time contesting and unraveling that mess.

Exactly what Petrunak wanted. Forms 1099 are chum in the water to the IRS.

Problem is, the IRS pursued Petrunak after the ATF agent’s audit. He admitted to filing those 1099s, but he was right in doing so and those two had lied – to a judge, unbelievable! – and an IRS person told him that he might be able to issue 1099s for his business costs. He estimated his costs to be half a million.

The IRS charged him with three counts of making false and fraudulent IRS forms.

He fought back, going to the Seventh Circuit Court of Appeals.

How did it turn out?

Petrunak is going to prison for 24 months.

His accounting was fantastical, but I get his anger.

Circling back, the accountant who called me was angry because I did not agree with him.

To be kind, let’s say his side of story was … creative.

But then, have a CPA play in a field with accounts receivable, deferred compensation, cash transfers, buyout agreements and whatnot and a talented – and motivated - practitioner can get creative.

He did.

Problem was: he picked a fight with tax CPAs. Two of them.

Bad call. 

It cost him a few bucks.

Thursday, September 17, 2015

Amos And Rodman



Do you remember Dennis Rodman?

He is more recently associated with traveling to North Korea and functioning as an off-the-record ambassador with Kim Jong-un, the dictator of that country. In the 1990s he was better known for playing with Michael Jordan and Scottie Pippen on the Chicago Bulls.

Early in 1997 the Bulls were playing the Minnesota Timberwolves. Rodman went after a loose ball, falling into a group of photographers on the sidelines. Rodman twisted his ankle. While getting back on his feet he kicked one of the photographers in the groin.


The photographer’s name was Eugene Amos. He went to a hospital, where he had difficulty walking and was in noticeable pain. The doctors offered pain medication but he refused, explaining that he was already taking medications for a preexisting back injury. Some dispute arose, and Amos left the hospital without being discharged.

He hired an attorney immediately upon leaving. 

The next day Amos went to another hospital. He complained about his groin, but the doctors did not notice anything other than the expected swelling. They were concerned about his back, though, and took a round of X-rays.

Before the lawsuit was filed, Rodman paid him $200,000 to go away.

Oh, and Amos had to sign a confidentiality provision to not discuss the matter. Standard stuff, but given that we are talking about it the agreement did not hold up as expected.

There is a Code section that addresses physical injuries:
          § 104 Compensation for injuries or sickness.
(a)  In general.
Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include-
(1)   amounts received under workmen's compensation acts as compensation for personal injuries or sickness;
(2)  the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;

Relying upon Section 104(a)(2), Amos excluded the $200,000 from his 1997 tax return.

Wouldn’t you know the IRS pulled his return for audit?

And they disagreed with his exclusion of the $200,000 from taxable income. Why? As far as they were concerned, Rodman paid Amos all but $1 of the $200,000 to keep his mouth shut. The IRS was, however, willing to exclude the $1 from income.

Amos disagreed. He took one in the orchestra, after all.

Off to Tax Court they went.

The IRS argued that Amos had not proven his physical injuries, and that Mr. Rodman himself was skeptical that Amos sustained any injuries to speak of. The IRS further argued that Amos was required to pay $200,000 in damages to Rodman should he violate the confidentiality agreement, clearly indicating that Rodman did not intend to pay anything for alleged physical injuries.

The Court immediately dismissed the first argument, noting that if an action has its origin in a physical injury, then damages therefrom are treated as payments received on account of the injury.

The Court decided that the “dominant” reason for the settlement was to compensate Amos for his claimed injuries. However, the settlement also indicated that Rodman was paying some portion for Amos not to:

(1)   Defame Rodman
(2)   Disclose either the existence or amount of the settlement
(3)   Publicize facts relating to the incident, and
(4)   Assist in criminal prosecution against Rodman

Problem is, the agreement did not separate how much was paid for what.

The Court did what it had done many times before: it came up with a number.

The Court decided that $120,000 was payable for physical injuries and $80,000 was paid for confidentiality terms. Therefore $120,000 could be excluded under Section 104(a)(2). The $80,000 could not.

The Amos decision changed how personal injury attorneys draft documents. It is now expected that the injured party will not want to sign any confidentiality agreement. If there is one, anticipate the injured party to stipulate a nominal amount to the agreement and to request indemnification for any resulting taxes, penalties, interest, attorney fees and court costs.

And that is how Dennis Rodman contributed to the tax literature.


Friday, December 5, 2014

Is Suing Your Tax Advisor Taxable?



For those who know me or occasionally read my blog, you know that I am not a “high wire” type of tax practitioner. Pushing the edges of tax law is for the very wealthy and largest of taxpayers: think Apple or Donald Trump. This is – generally speaking - not an exercise for the average person. 

I understand the frustration. A number of years ago I was called upon to research the tax consequence for an ownership structure involving an S corporation with four trusts for two daughters. This structure predated me and had worked well in profitable years, but I (unfortunately) got called upon for a year when the company was unprofitable. The issue was straightforward: were the losses “active” or “passive” to the trusts and, by extension, to the daughters behind the trusts. There was some serious money here in the way of tax refunds – if the trusts/daughters could use the losses. This active/passive law change happened in 1986, and here I was researching during the aughts – approximately 20 years later. The IRS had refused to provide direction in this area, although there were off record comments by IRS officials that were against our clients’ interests. I strongly disagreed with those comments, by the way.

What do you do?

I advised the client that a decision to claim the losses would be a simultaneous decision to hire a tax attorney if the returns got audited and the losses disallowed. I believed there was a reasonable chance we would eventually win, but I also believed we would have to be committed to litigation. I thought the IRS was unlikely to roll on the matter, but our willingness to go to Tax Court might give them pause. 

I was not a popular guy.

But to say otherwise would be to invite a malpractice lawsuit should the whole thing go south.

And this was a fairly prosaic area of tax law, far and remote from any tax shelter. There was no “shelter” there. There was, rather, the unwillingness of the IRS to clarify a tax law that was old enough to go to college.

I am reading about a CPA firm that decided to advise a tax shelter. It went south. They got sued. It cost them $375,000.

Here is a question that we have not discussed before: is the $375,000 taxable to the (former) client?

Let’s discuss the case.

The Cosentinos and their controlled entities (G.A.C. Investments, LLC and Consentino Estates, LLC) had a track record of Section 1031 exchanges and real estate.


COMMENT: A Section 1031 is also known as a “like kind” exchange, whereby one trades one piece of property for another. If done correctly, there is no tax on the exchange.


The Consentinos played a conservative game, as they had an adult disabled daughter who would always need assistance. They accumulated real estate via Section 1031 transactions, with the intent that – upon their death – the daughter would inherit. They were looking out for her.

They were looking at one more exchange when their CPA firm presented an alternative tax strategy that would allow them to (a) receive cash from the deal and (b) defer taxes. The Consentinos had been down this road before, and receiving cash was not their understanding of a Section 1031. Nonetheless the advisors assured them, and the Consentinos went ahead with the strategy.

OBSERVATION: It is very difficult to walk away from a Section 1031 with cash in hand and yet avoid tax.

Wouldn’t you know that the strategy was declared a tax shelter?

The IRS bounced the whole thing. There was almost $600,000 in federal and state taxes, interest and penalties. Not to mention what they paid the CPA firm for structuring the transaction.

The Consentinos did what you or I would do: they sued the CPA firm. They won and received $375,000. They did not report or pay tax on said $375,000, reasoning that it was less than the tax they paid. The IRS sent them a love letter noting the oversight and asking for the tax.

Both parties were Tax Court bound.

The taxpayers relied upon several cases, a key one being Clark v Commissioner. The Clarks had filed a joint rather than a married-filing-separately return on the advice of their tax advisor. It was a bad decision, as filing-jointly cost them approximately $20,000 more than filing-separately. They sued their advisor and won.

The Court decided that the $20,000 was not income to the Clarks, as they were merely being reimbursed for the $20,000 they overpaid in taxes. There was no net increase in their wealth; rather they were just being made whole.

The Clark decision has been around since 1939, so it is “established” law as far as established can be.

The Court decided that the same principle applied to the Cosentinos. To the extent that they were being made whole, there was nothing to tax. This meant, for example:

·        To extent that anything was taxable, it shall be a fraction (using the $375,000 as the numerator and total losses as the denominator).
·        The amount allocable to federal tax is nontaxable, as the Cosentinos are merely being reimbursed.
·        The amount allocable to state taxes however will be taxable, to the extent that the Cosentinos had previously deducted state taxes and received a tax benefit from the deduction.
·        The same concept (as for state taxes) applied to the accounting fees. Accounting fees would have been deducted –meaning there was a tax benefit. Now that they were repaid, that tax benefit swings and becomes a tax detriment, resulting in tax.

There were some other expense categories which we won’t discuss.

By the way, the Court’s reasoning is referred to as the “origin of the claim” doctrine, and it is the foundation for the taxation of lawsuit and settlement proceeds.  

So the IRS won a bit, as the Cosentinos had excluded the whole amount, whereas the Court wanted a ratio, meaning that some of the $375,000 was taxable.

Are you curious what the CPA firm charged for this fiasco?

$45,000.