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US Tax Procedures and Preparers (Wallwork, Osler)

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US Tax Procedures and Preparers (Wallwork, Osler)

  1. 1. U.S. Tax Procedures and Preparers March 3, 2016– Tax Department Lunch Adam Wallwork 2015n057
  2. 2. 2 TAX PROCEDURES IN U.S. COURTS
  3. 3. 3
  4. 4. Taxpayer’s Choice of Forum 4 TAX COURT CLAIMS COURT DISTRICT COURT TYPE OF COURT DEFICIENCY REFUND REFUND JURISDICTION 90-DAY LETTER PAY NOW LITIGATE LATER PAY NOW LITIGATE LATER INTEREST? YES NO NO EXPERTISE TAX TAX, CONTRACTS GENERAL OPPONENT IRS DOJ DOJ TRIER OF FACT JUDGE JUDGE JUDGE/JURY
  5. 5. Presumption of Correctness 5 EXCEPTION BURDEN OF PRODUCTION BURDEN OF PERSUASION FRAUD IRS IRS NEW MATTER IRS IRS SUBSTANTIAL OMISSIONS IRS IRS NAKED ASSESSMENT IRS TP PENALTIES IRS TP §7491(A) (BURDEN SHIFTING) IRS IRS
  6. 6. Statutes of Limitation 6  90-Day Letter Sent Within the Limitations Period - I.R.C. § 6212(a)  Filing a Return Begins the Running of the Statute (Except with Respect to Fraudulent Returns) General rule = 3 Years from Filing Date or Deemed-Filing Date. 6501(a), (b)(1)  Filing Date for Early Returns = Statutory Due Date (e.g., April 15th for Individuals)  Date Received for Late Returns (Including Automatic Extensions)  Exceptions  6 Years from Date of Filing for “Substantial Omissions” 25% of Gross Income – IRC 6501(e)  Unlimited Assessments  No Return = No Limitation (See IRC 6501(a), (c)(3))  Extensions by Agreement – 6501(c)(4)  “False or Fraudulent Return with Intent to Evade Tax” – 6501(c)(1)  “Willful Attempt to Defeat or Evade Tax” – 6501(c)(2)
  7. 7. DEFICIENCY LITIGATION 7  THE UNITED STATES TAX COURT  95% Of Taxpayers’ Claims  “Deficiency” = Amount has not been paid  Jurisdiction  Notice of Deficiency. I.R.C. 6212(a) (Jurisdictional)  Deficiency must be determined. Scar v. Comm’r, 814 F.2d 1363 (9th Cir. 1987)  Deficiency must be timely. I.R.C. 6501  The Bond Procedure: Stops Accrual of Interest (Rev. Proc. 84-58)  Golson Rule: Rule of Decision = Court of Appeal for Taxpayer
  8. 8. REFUND LITIGATION 8  CONCURRENT JURISDICTION - I.R.C. 7422(e)  U.S. Court of Federal Claims (“Claims Court”)  U.S District Court  “Refund” = “Pay first, litigate later.” Flora v. U.S. , 362 US 145 (1960)  Entire Deficiency for the Year Must be Paid  Litigate the Claim for Refund
  9. 9. Key Factors in Deciding Where to Litigate Your U.S. Tax Case 9  Taxpayer’s Resources  Claims Court/District Court = Pay First, Litigate Later  Tax Court = No Payment until Verdict (Avoid Accrued Interest through Bond Procedure, Rev. Proc. 84-58  Complexity of the Legal/Factual Claim  Claims Court/District Court = Pay First, Litigate Later  Tax Court = No Payment until Verdict (Avoid Accrued Interest through Bond Procedure, Rev. Proc. 84-58  THE RULE OF LAW  Cases of Third-Party Fraud = Outcome-Determinative  Claims Court = No Assessment Beyond 6 Years unless taxpayer commits the fraud  Tax Court = Assessment Allowed if Fraud by “Tax Return Preparer”
  10. 10. 10 TAX RETURN PREPARERS
  11. 11. Commercial Tax Preparation 11 Began to Develop after the Second World War because:  Wider Base of Federal Taxes  Less than 7% of U.S. persons owed income taxes before 1940  By 1945, 75% of Americans were liable for federal taxes  Increased Complexity  Studies show that people are more likely to hire tax-return preparers if their returns are “complex” (measured by the number of deductible items)  Revenue Act of 1918 (47 Pages) v 1954 Code (907 Pages)  Professional and Commercial Tax Preparation began after 1954  H&R Block founded in 1955  About 50% of U.S. Taxpayers Consulted Preparers by 1972.
  12. 12. “Tax Return Preparers” 12  IRS has regulated professional and commercial tax preparers since 1976  I.R.C. 7701(a)(36) defines “Tax Return Preparers” as: Who are “Tax Return Preparers? 1. Any person who prepares for compensation, or who employs one or more persons to prepare for compensation 2. Any Return of Tax or any claim for refund of tax, as well as 3. Any person who prepares “a substantial portion” of the return or claim for refund.  “Any person” = Expressly includes both U.S. and foreign persons. Treas. Reg. 301.7701-15(e)  “Return of Tax” or “Claim for Refund” = (1) Requires a position as to an Item of Income but (2) Expressly excludes information returns  “Substantial portion” = Facts-and-Circumstances test unless aggregate tax positions are either: 1. Less than $10,000 or 2. Less than both $400,000 and 20 percent of the gross income shown on the return or claim for refund. Treas. Reg. § 301.7701- 15(b)(3)(ii) nd.
  13. 13. The Doctrine of Preparer Fraud 13  Traditional Rule:  Fraud Penalty and Statute-of-Limitations Extension are available only in cases of fraud on the part of a taxpayer or his/her agent.  “Put simply, tax-return preparers are not agents.” Loving v. I.R.S., 742 F.3d 1013 (D.C. Cir. 2014).  IRS Switches Course in 2001  FSA 200104006 (Jan. 29, 2001) (finding no liability in cases of preparer fraud)  FSA 200126019 (June 29, 2001) (imposing perpetual liability on same or similarly-situated preparer from his preparer’s fraud)  Allen v. Commissioner, 128 T.C. 37 (2007): “We are asked to decide for the first time whether the limitations period for assessing income tax under [the false-and-fraudulent return provision of] section 6501(c)(1)1 is extended if the tax on a return is understated due to the fraudulent intent of the income tax return preparer. We conclude that it is.”
  14. 14. Elements of Preparer Fraud 14  Requirements: “Clear and Convincing Evidence” that: (1) An underpayment of tax exists, and (2) The return preparer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of tax. WHY “Clear and Convincing” Proof?  IRS entitled to presumption of correctness – 7422(e)  “Fraud.--In any proceeding involving the issue whether the petitioner (i.e., taxpayer)] has been guilty of fraud with intent to evade tax, the burden of proof in respect of such issue shall be upon the Secretary.” I.R.C. § 7454(a)  The Petitioner = The Taxpayer  The Return Preparer = Not agents of Taxpayer. Loving v. I.R.S., 742 F.3d 1013 (D.C. Cir. 2014).  The issue in preparer-fraud cases is not “whether the petitioner has been guilty of fraud with intent to evade tax,” but whether his/her preparer was guilty.  How does I.R.C. § 7454(a) apply?
  15. 15. Split of Authority 15  DEFICIENCY LITIGATION:  Allen v. Comm’r, 128 T.C. 37, 38 (2007) (upholding otherwise- untimely assessment against a UPS truck driver who’s only fault was hiring a tax criminal)  City Wide Transit Inc. v. Comm’r, 709 F.3d 102 (2d Cir. 2013), rev’g, T.C. Memo. 2011-279, 102 T.C.M. (CCH) 542 (2011) (imposing liability on NYC bus company for tax frauds that were intended to cover up crimes against the company, itself)  REFUND LITIGATION:  BASR P’ship v. United States, 795 F.3d 1338, 1339–1357 (2015), aff’g, 113 Fed.Cl. 181 (2013) (rejecting Allen’s doctrine of preparer fraud).  Practice Tip: If the IRS is seeking to impose liability after the statutory period has passed, (1) pay the deficiency and (2) litigate in Claims Court
  16. 16. Is Allen Tolerable? 16  Justice Robert H. Jackson: “It probably would be all but intolerable . . . to have an income tax system under which there never would come a day of final settlement.”  Text: “In the case of a false or fraudulent return with intent to evade tax, [taxes may be assessed or collected,] at any time.” I.R.C. § 6501(c)(1).  “[T]he term ‘return’ means the return required to be filed by the taxpayer.” I.R.C. § 6501(a).  History: 97-Year-Old Provision only Applied to Agents before Allen  Policy: The Doctrine of Preparer fraud fails both elements of sound tax policy: (1) fairness to the taxpayer and (2) efficient tax collection
  17. 17. Evaluating the Policy of Preparer Fraud 17  Cases of preparer fraud only arise under Code § 6501(c)(1) when: (1) the taxpayer’s preparer has committed fraud against the IRS, (2) which resulted in an underpayment of taxes owed by the taxpayer and (3) which was not assessed by the IRS within three years of the date the taxpayer’s return was filed.  IRS data indicates that only about 1 in 11,765 taxpayers (0.000085%) will hire a fraudulent-return preparer  It is neither feasible nor economically rational for them to insure against this risk  And since the only way to avoid the risk of a fraudulent tax-return preparer is to avoid the industry, this uninsurable risk should cause a diminution in the use of tax-return preparers  THE QUESTION OF WHETHER THAT COST IS WORTH IT CAN BE ANSWERED BY EVALUATING WHETHER TAX FRAUD IS LIKELY TO BE REDUCED UNDER A RULE THAT DISCOURAGES THE USE OF THIRD-PARTY TAX PREPARERS
  18. 18. Empirical Analysis 18  Tax-return preparers filed 59% of U.S. tax returns over the decade from 2004-2013, while self-preparers accounted for only 41%.  Since 2013, the IRS Criminal Investigations Division has also kept statistics on fraudulent preparers, which show:  That only 7% (687) of the total number of persons indicted for tax fraud were professional preparers, while the other 93% (9,658) were self-preparers.  Of the 11,131 taxpayers prosecuted for tax fraud between 2013 and 2015, 93% (10,351) were prosecuted for returns they filed on their own behalf, while only 7% (780) were of such prosecutions were of abusive tax preparers.  Self-preparers also comprised 93.8% (8,599) and abusive preparers only 6.2% (204) of those sentenced for federal tax fraud during the years 2013–2015.
  19. 19. 19 U.S. Self-Prepared Returns 59% U.S. Preparer Returns 41% 2004-2013 U.S. Returns Filed by Self-Preparers and Professional Preparers U.S. Self-Prepared Returns U.S. Preparer Returns
  20. 20. U.S. Tax Fraud Prosecutions 2013-2015 20 2013 2014 2015 U.S. Taxpayers Prosecuted 4,083 3,217 3,051 U.S. Tax Preparers Prosecuted 281 261 238 4,083 3,217 3,051 281 261 238 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 U.S. Taxpayers Prosecuted U.S. Tax Preparers Prosecuted
  21. 21. U.S. Tax Fraud Indictments 2013-2015 21 2013 2014 2015 U.S. Taxpayers Indicted 3,632 3,042 2,984 U.S. Tax Preparers Indicted 233 230 224 3,632 3,042 2,984 233 230 224 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 U.S. Taxpayers Indicted U.S. Tax Preparers Indicted
  22. 22. U.S. Tax Evaders Sentenced 22 1 2 3 U.S. Taxpayers Sentenced 2,626 3,085 2,888 U.S. Tax Preparers Sentenced 186 183 204 2,626 3,085 2,888 186 183 204 0 500 1,000 1,500 2,000 2,500 3,000 3,500 U.S. Taxpayers Sentenced U.S. Tax Preparers Sentenced
  23. 23. Statistical Testing 23  Statistical Testing: In order to test whether tax-return preparers are less likely than self-preparers to be indicted for tax fraud, and hence more likely to prepare returns honestly than individual taxpayers, I ran a chi-squared test with one degree of freedom with the null hypothesis that tax-return preparers are indicted in the same proportion as self-preparers for their respectively-filed returns  The Chi-Squared Test was run on indictments rather than prosecutions or sentencing because I found tax-fraud indictments to be the most reliable: (1) Indictments must be based on probable cause, (2) They require agreement between the IRS and DOJ on whether the indictment should be issued, and (3) They are less likely than sentences to be underinclusive.  Results: The resulting p-value was less than 0.00001, requiring us to a near-statistical certainty to reject the null hypothesis and providing compelling evidence that self-preparers are more likely to be indicted for tax fraud than professional preparers
  24. 24. Results of Testing and Conclusions 24  Results of Chi-Squared Test of the Null Hypothesis:  Null Hypothesis: That tax-return preparers are indicted in the same proportion as self-preparers for their respectively-filed returns  The Chi-Squared Test’s p-value was less than 0.00001, requiring us to a near-statistical certainty to reject the null hypothesis.  The results of testing expected versus observed indictments for tax fraud by self-filers and tax-return preparers provides compelling evidence that self-preparers are more likely to be indicted for tax fraud than professional preparers  Odds Ratio: On the basis of the same data, I found that individual filers are at 22.19 times greater odds of being indicted than preparers
  25. 25. Conclusions 25 THE EMPIRICAL RESULTS CONTRADICT THE POLICY ARGUMENTS IN FAVOR OF THE PREPARER FRAUD DOCTRINE THEY DEMONSTRATE THAT THE IRS SHOULD BE ENCOURAGING TAX PREPARATION RATHER THAN PUNISHING THOSE WHO USE PREPARES WE CAN ONLY HOPE THEY WILL

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