Can A Taxpayer Be Responsible For Tax Preparer Fraud?

 

We are familiar with the statute of limitations. In general, the SoL means that you have three years to file a return, information important to know if you are due a refund. Likewise, the IRS has three years to audit or otherwise adjust your return, important to them if you owe additional tax.

The reason for the SoL is simple: it has to end sometime, otherwise the system could not function.  Could it be four years instead of three? Of course, and some states use four years. Still, the concept stands: the ferris wheel must stop so all parties can dismount.

A huge exception to the SoL is fraud. File a fraudulent return and the SoL never starts.

Odds are, neither you nor I are too sympathetic to someone who files a fraudulent return. I will point out, however, that not all knuckleheaded returns are necessarily fraudulent. For example, I am representing an IRS audit of a 2020 Schedule C (think self-employed). It has been one of the most frustrating audits of my career, and much of it is self-inflicted. I know the examiner had wondered how close the client was to the f-word; I could hear it in her word selection, pausing and voice. We spoke again Friday, and I could tell that she had moved away from that thought. There is no need to look for fraud when being a knucklehead suffices.

Here is a question for you:

You do not commit fraud but your tax preparer does. It could be deductions or credits to which you are not entitled. You do not look at the return too closely; after all, that is why you pay someone. He/she however did manage to get you the refund he/she had promised. Can you be held liable for his/her fraud?

Let’s look at the Allen case.

Allen was a truck driver for UPS. He had timely filed his tax return for the years 1999 and 2000. He gave all his tax documents to his tax preparer (Goosby) and then filed the resulting return with the IRS.

Mr. Goosby however had been juicing Allen’s itemized deductions: contributions, meals, computer, and other expenses. He must have been doing quite a bit of this, as the Criminal Investigations Division (CID, pronounced “Sid”) got involved.

COMMENT: CID is the part of the IRS that carries a gun. You want nothing to do with those guys.

Allen was a good guy, and he agreed with the IRS that there were bogus numbers on his return.

He did not agree that the tax years were open, though. The IRS notice of deficiency was sent in 2005 – that is, outside the normal three years. Allen felt that the tax years had closed.

He had a point.

However, look at Section 6501(c):

§ 6501 Limitations on assessment and collection.

(c)  Exceptions.

(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.

The Court pointed out that the law mentions a “false or fraudulent return.” It does not say that the fraud must be the taxpayer’s.

The year was open, and Allen owed the additional tax.

I get it. There is enough burden on the IRS when fraud is involved, and the Court was not going to add to the burden by reading into tax law that fraud be exclusively the taxpayer’s responsibility.

The IRS had helped its case, by the way, and the Court noticed.

How?

The IRS had not assessed penalties. All it wanted was additional tax plus interest.

I wish we could see more of that IRS and less of the automatic penalty dispenser that it has unfortunately become.

Allen reminds us to be careful when selecting a tax preparer. It is not always about getting the “largest” refund. Let’s be honest: for many if not most of us, there is a “correct” tax number. It is not as though we have teams of attorneys and CPAs sifting through vast amounts of transactions, all housed in different companies and travelling through numerous foreign countries and treaties before returning home to us. Anything other than that “correct” number is … well, a wrong number.  

Our case this time was Allen v Commissioner, 128 T.C. 4 (U.S.T.C. 2007).

Not Quite The Informal Claim Doctrine

 

I am looking at a district court opinion from Illinois.

I find the discussion of the numbers a bit confusing. It happens sometimes.

But there something here we should talk about.

We have recently discussed the tax concept of a “claim.” In normal-person-speak, it means you want the government to refund your money. The classic claim is an amended income tax return, but there can be claims for other-than-income taxes. It is its own niche, as using the wrong form can result in having your claim rejected.

Let’s look at the American Guardian Holdings case.

AGH filed its 2015 tax return on September 19, 2016.

Here are the numbers on the original tax return:     

	Original
Revenues	152,092,338
Taxable income	4,880,521
Tax	1,327,806

 The accountant found an error and amended the return on June 6, 2019.

			First
	Original		Original	Amended
Revenues	152,092,338		152,092,338	154,808,792
Taxable income	4,880,521		4,880,521	11,084,397
Tax	1,327,806		1,327,806	148,243
Refund				(1,179,563)

Let me see: The 2015 return would have been extended to October 15, 2016. The amended return was prepared June 6, 2019. Yep, we are within the statute of limitations.

Problem: AGH never sent the amended return.

Answer: AGH hired a new accountant.

The new accountant filed an amended return on September 19, 2019.

COMMENT: Still a few days left on the statute.

For some reason, the accountant incorporated the first amended (even though it had not been filed) into the second amended, resulting in the following hodgepodge:

		First		Second
		Original	Amended	Original	Amended
Revenues		154,808,792	141,773,572	154,808,792	?
Taxable income		11,084,397	7,446,746	11,084,397	?
Tax		1,327,806	148,243	1,327,806	0
Refund			(1,179,563)		(148,243)
Total refund					(1,327,806)

Huh? I would find that second amended confusing. On first impression it appears that AGH is filing a claim for $148,243, but that is incorrect. AGH was stacking the second amended on top of its first. AGH is filing a claim for $1,327,806, which is the entire tax on the original return.

Not surprisingly, the IRS also responded with “huh?” It could not process the second amended return because the “Original” numbers did not match its records.

AGH responded by filing yet another amended return (third amended). Mind you, at this point it was after October 15, 2019, and the statute of limitations was in the rear view mirror.

AGH did the following:

(1)  AGH explained that the new and shiny (third) amended return incorporated the previously (non-filed) first amended return and the second (actually filed) amended return. As a consequence, the “previously-filed amended return for 2015 should be discarded.”

COMMENT: NO! 

(2)  AGH further explained that it was filing Form 1120-PC (a specialized tax form for property and casualty insurance companies) as its third amended return rather than the Form 1120 originally filed because it had received permission to change its method of accounting.

COMMENT: NO!!

I am somewhat shocked at how deep a hole AGH had dug, and more shocked that it kept digging.

Let’s go through the wreckage:

(1)  AGH filed its (second) amended return/claim within the statute of limitations.

(2)  This creates an issue if the claim is imperfect, as one would be perfecting the claim AFTER the statute expires. Fortunately, there is a way (called the informal claim doctrine) that allows one to perfect a claim after the original filing date and still retain the benefit of that original date. 

(3)  The IRS immediately seized on the “previously-filed amended return for 2015 should be discarded” statement to argue that AGH had violated the informal claim doctrine.  If the second amended return was discarded, there was no timely-filed return to which the informal claim doctrine could attach. Fortunately, the Court decided that the use of the word “discard” did not actually mean what it sounded like. AGH dodged a bullet, but it should never have fired.

(4)  That leaves the third amended return, which was filed after the statute expired. AGH of course argued informal claim, but it had committed a fatal act by changing its method of accounting. You see, the informal claim allows one to clarify, document and explain whatever issue is vague or in dispute within the claim at issue. What one is not allowed to do is to change the facts. AGH had changed the facts by changing its method of accounting, meaning its third amended return could not be linked to the second via the informal claim doctrine.

(5)  Standing on its own, the third amended of course failed as it was filed after the statute had expired.    

This case is a nightmare. I am curious whether there was a CPA or law firm involved; if so, a malpractice suit is almost a given. If the work was done in-house, then … AGH needs to tighten up its hiring standards. The case reads like there were no adults in the room.

All is not lost for AGH, however.

Remember that AGH filed its second amended return within the statute of limitations.  The matter then went off the rails and the Court booted the third amended return.

But that leaves the second amended. Can AGH resuscitate it, as technically the Court dismissed the third claim but not necessarily the second?  It would likely require additional litigation and associated legal fees, and I would expect the IRS to fight tooth and nail. AGH would have to weigh the cost-benefit.

Our case this time was American Guardian Holdings, Inc v United States of America, No. 1:2023cv 01482, Northern District of Illinois.

A Current Individual Tax Audit

 

We have an IRS audit at Galactic Command. It is of a self-employed individual. The self-employeds have maintained a reasonable audit rate, even as other individual audit rates have plummeted in recent years.

I was speaking with the examiner on Friday, lining up submission dates for records and documents. We set tentative dates, but she reminded me that Congress was going into budget talks this weekend.  Depending on the resolution, she might be furloughed next week. No prob, we will play it by ear.

This is a relatively new client for us. We did not prepare the records or the tax returns for the two years under audit. We requested underlying records, but there was little there for the first year and only slightly more for the second. We then did a cash analysis, knowing that the IRS would be doing the same.

COMMENT: The IRS will commonly request all twelve bank statements for a business-related bank account. The examiner adds up the deposits for the twelve months and compares the total to revenues reported on the tax return. If the tax return is higher, the IRS will probably leave the matter alone. If the tax return is lower, however, the IRS will want to know why.

We had a problem with the analysis for the first year: our numbers had no resemblance to the return filed. Our numbers were higher across the board: higher deposits, higher disbursements, higher excess of deposits over disbursements.

Higher by a lot.

The accountant asked me: do you think …?

Nope, not for a moment.

Implicit here is fraud.

There are two types of tax fraud: civil and criminal. Yes, I get it: if you have criminal, you are virtually certain to have civil, but that is not our point. Our point is that there is no statute of limitations on civil fraud. The IRS could go back a decade or more - if they wanted to.

I do not see fraud here. I do see incompetence. I think someone started using a popular business accounting software, downloading bank statements and whatnot to release their inner accountant. There are easy errors to one not familiar: you do not download all months for an account; you do not download all the accounts; you fail to account for credit cards; you fail to account for cash transactions.

OK, that last one could be a problem, if significant.

The matter reminded me of a famous tax case.

It is easy to understand someone committing fraud on his/her tax return. Put too much in, leave too much out. Do it deliberately and with malintent and you might have fraud.

Question: can you be responsible for your tax preparer’s fraud?

Vincent Allen was a UPS driver in Memphis. He used a professional preparer (Goosby) for 1999 and 2000.  Allen did the usual: he gave Goosby his W-2, his mortgage interest statement, property taxes and whatnot. Standard stuff.

Goosby went to town on miscellaneous itemized deductions; He goosed numbers for a pager, computer, meals, mileage and so forth. He was creative.

The IRS came down hard, understandably.

They also wanted fraud penalties.

Allen had an immediate defense: the three-year statute had run.

The IRS was curt: the three years does not apply if there is fraud.

Allen argued the obvious:

How was I supposed to know?

Off to Tax Court they went.

The Court looked at the following Code section:

 § 6501 Limitations on assessment and collection

(c)  Exceptions.

(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.

The Court noted there was no requirement that the “intent to evade” be the taxpayer’s.

The statute was open.

Allen owed tax.

The IRS - in a rare moment of mercy - did not press for penalties. It just wanted the tax, and the Court agreed.

The Allen decision reminds us that there is some responsibility when selecting a tax preparer. One is expected to review his/her return, and – if it seems too good …. Well, you know the rest of that cliche.

Do I think our client committed fraud?

Not for a moment.

Might the IRS examiner think so, however?

It crossed my mind. We’ll see.

Our case this time was Allen v Commissioner, 128. T.C. 37.

Waiting Too Long For Refund Of Excess Withholdings

It happens when someone fails to file with the IRS. It might be a “sleeping dog” rationalization, but people will allow a string of tax years to go unfiled, even if some of those years have refunds rather than tax due.

This is a trap, and I saw it sprung earlier this year on a widow. It was unfortunate, as she still has kids at home and could use the money.

The trap is that tax refunds are not payable after a period of time. The Code wants closure on tax matters. The IRS has three years to audit you. You in turn have three years to request a refund. These are general rules, and there are relief valves for the unusual situation: the IRS can request you to voluntarily extend the statute, for example, or you can file a protective claim if your three years are running out.

Let’s look at the Golden case.

Michael Golden did not file his 2015 tax return. In fact, he waited so long that the IRS prepared a return for him (called a substitute for return or SFR). The IRS does not spot a taxpayer any breaks when they do this (no itemized deductions or head of household status, for example). The IRS instead is trying to get a taxpayer’s attention, prompting them to file a return and opt back into the system. In April 2021 (five years after the return was actually due) the IRS issued its notice of deficiency (NOD, sometimes referred to as SNOD). The SNOD is the IRS trying to perfect its assessment prior to sending the account to Collections for their tender mercies. The SNOD showed tax due.

A few days after receiving the SNOD, Golden filed his 2015 tax return. It showed a refund.

Of course.

Golden wanted his refund. The IRS said it could not issue a refund.

There is a technical rule.  

Here it is:

         Section 6511(a)  Period of limitation on filing claim.

Claim for credit or refund of an overpayment of any tax imposed by this title in respect of which tax the taxpayer is required to file a return shall be filed by the taxpayer within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later, or if no return was filed by the taxpayer, within 2 years from the time the tax was paid. Claim for credit or refund of an overpayment of any tax imposed by this title which is required to be paid by means of a stamp shall be filed by the taxpayer within 3 years from the time the tax was paid.

Tax law can be tricky, but there are two rules here:

(1) The default period is three years (to coincide with the statute of limitations). The period starts on April 15 (when the return is due) and ends 3 years later, unless one requested an extension, in which case the default period also includes the extension (normally to October 15).

(2) Refuse to go along with the default rule and you might trigger the second rule: only taxes paid within two years of filing can be refunded.

As a generalization, you do not want the second rule. Why limit yourself to taxes paid within two years when you can have taxes paid within three years (and the extension period, if an extension was requested).

The IRS was also looking at this shiny:

Section 6511(b) Limitation on allowance of credits and refunds.

(1)  Filing of claim within prescribed period.

No credit or refund shall be allowed or made after the expiration of the period of limitation prescribed in subsection (a) for the filing of a claim for credit or refund, unless a claim for credit or refund is filed by the taxpayer within such period.

Notice that Congress included the phrase “shall be allowed.” Another way to say this is that – if you do not fit within the three-year test or the two-year test – your refund claim “shall” not be allowed. This was the IRS position: hey, we do not have much discretion here.

Let’s review the dates for Golden.

We are talking about his 2015 return. The return was due April 15, 2016. Add three years. Let’s be kind and add three years plus the extension. His three years clock-out on October 15, 2019. Three years will not get you to a refund.

The two year rule is even worse.

Golden argued fairness. He was working in the private sector as well as the Navy Reserve, and the demands therefrom made his life “extremely difficult.” In tax terms, this argument is referred to as “equity.” Some courts can consider equitable arguments, but the Tax Court is not one of them.

Here is the Court:

          We sympathize with petitioner’s predicament.

The Supreme Court has made clear that the limitations on refunds of overpayments prescribed in section 6512(b)(3) shall be given effect, consistent with Congress’s intent as expressed in the plain text of the statute, regardless of any perceived harshness to the taxpayer. See Commissioner v. Lundy, 516 U.S. at 250–53. Because Congress has not given us authority to award refunds based solely on equitable factors, we are compelled to grant respondent’s Motion for Summary Judgment.”

It was not a total loss for Golden, however. Since he did file a return, the IRS reduced his 2015 tax due to zero. He did not owe anything. He could not, however, recover any overpayment. He left that 2015 refund on the table.

What do you do if you are caught in a work situation like Golden? It is not a perfect answer, but file with the information you can readily assemble. Pay someone to prepare the return (within reason, of course). Hey, maybe you missed interest on a small money market account or took the standard deduction when itemized deductions would have given you a smidgeon more. The IRS will let you know about the first one (computer matching), and if there is enough money there you can amend later (the second one). At least you will get your basic refund claim in.

Our case this time was Golden v Commissioner, T.C. Memo 023-103.

Why You Always Use Certified-Mail For A Paper-Filed Return

Just about all tax returns are moving to electronic filing.

It makes sense. Our server sends a return to the government server, starting the automated processing of the return. Minimal manpower, highly automated, more efficient.

COMMENT: Electronic filing however does allow states and other filing authorities to include filing “bombs,” which can be very frustrating. We had a bomb recently with the District of Columbia. It could have been resolved – should have, in fact – but that would have required someone in D.C.  to answer our e-mail request or telephone call. Belatedly realizing this was a bar too high, we called the client to inform them of a change in plans. We would be paper filing instead.

Sometimes a state will say they never received a return. Our software maintains log events, such as electronic transmission of returns and their acceptance by the taxing authority. Tennessee has done this over the last few years as they updated some of their systems. Fortunately, the matter generally resolves when we present proof of electronic filing.

Do you remember when – not too many years ago – standard professional advice was to send tax returns using either certified or registered mail? That was that era’s equivalent of today’s electronic filing. We used to, back in the Stone Age, send our April 15^th individual extensions as follows:

·      Include multiple extensions per envelope. There could be several envelopes depending on the number of extensions.

·      Include a cover sheet detailing the extensions included in the envelope.

·      Certify the mailing of the envelope.

The problem with this procedure is that it could be abused. One could mail an empty envelope to the IRS, certifying the same. If any question came up, one could point to that envelope as “proof” of whatever. I do not know how often this happened in practice, but I recall having this very conversation with IRS representatives.

This reminds me of a recent case dealing with an issue arising from putting a paper-filed return in the mail. As we move exclusively to electronic filing, this issue will transition to history – along with rotary phones and rolodexes.

Let’s talk about the Pond case.

The IRS audited Stephen Pond’s return and made a mistake, concluding that Pond had underpaid his taxes. Pond paid the notice for tax due and interest on the 2012 tax year. The matter also affected 2013, so Pond overpaid his taxes for that year also. Pond’s accountant caught the mistake and filed for a refund for both years.

The accountant did the following:

(1)  He mailed the 2012 and 2013 tax refund claims in the same envelope to Holtsville, New York.

(2) He mailed a claim for refund of overpaid 2012 interest to Covington, Kentucky, which in turn forwarded the matter to Andover, Massachusetts.

Andover responded first. It wanted proof of the underlying 2012 filing (as the overpaid interest was for 2012). It took a while, but Pond eventually received his 2012 refund, including interest.

Time passed. There was no word about 2013. Pond contacted the IRS and was told the IRS never received the 2013 amended return.

COMMENT: While not said, I have a very good guess what happened. The IRS has had a penchant for stapling together whatever arrives in a single envelope. For years I have recommended separate envelopes for separate returns, as I was concerned about this possibility. It raised the cost of mailing, but I was trying to avoid the staple-everything-together scenario.

Pond sent a duplicate copy of his 2013 amended return.

Months went by. Crickets.

Pond contacted Holtsville and was informed that the IRS had closed the 2013 file.

Oh, oh.

A couple of weeks later Pond received the formal notice that the IRS was denying 2013 because it had been filed after statute of limitations had run.

Pond filed a formal protest. He filed with Appeals. He eventually brought suit in district court. The district court held against Pond, so he is now in Appeals Court.

This is tax arcana here that we will summarize.

     (1)  The general way to satisfy a statutory filing requirement is physical delivery.

(2)  Mail can constitute physical delivery.

a.    However, things can happen after one drops an envelope into the mailbox. The post office can lose it, for example. It would be unfair to hold someone responsible for a post office error, so physical delivery has a “mailbox” subrule:

If one can prove that an item was mailed, the subrule presumes that the item was timely delivered.

NOTE: Mind you, one still must prove that one timely put the item in the mail.

(3)  Congress codified the mailbox rule in 1954 via Section 7502. That section first included certified and registered mail as acceptable proof of filing, and the rule has been expanded over the years to include private delivery services and electronic filing.

(4) The question before the Court was whether Section 7502 supplanted prior common law (physical delivery, mailbox rule) or rather was supplementary to it.

a.    Believe it or not, the courts have split on this issue.

b.    What difference does it make? Let me give an example.      

There is an envelope bearing a postmark date of October 5, 20XX (that is, before the October 15^th extension deadline). The mail was not certified, registered, or delivered by an approved private delivery service.

If Section 7502 supplanted common law, then one could not point to that October 5 date as proof of timely filing. The only protected filings are certified or registered mail, private delivery service or electronic filing.

If Section 7502 supplemented but did not override common law, then that October 5 date would suffice as proof of timely mailing.

Let’s fast forward. The Appeals Court determined that Pond did not qualify under the safe harbors of Section 7502, as he did not use certified or registered mail. He could still prove his case under common law, however. Appeals remanded the case to the District Court, and Pond will have his opportunity to prove physical delivery.

My thoughts?

If you are paper filing – especially for a refund - always, always certify the mailing. Mind you, electronic filing is better, but let’s assume that electronic filing is not available for your unique filing situation. Pond did not do this and look at the nightmare he is going through.

Our case this time was Stephen K Pond v U.S., Docket No 22-1537, CA4, May 26, 2023.