The Internal Revenue Service has included tax return preparer fraud on its “Dirty Dozen” list of common tax scams for 2019 and offered tips to help taxpayers avoid unscrupulous tax preparers. With the Tax Cuts and Jobs Act, the most sweeping tax reform legislation in more than 30 years now in effect, some taxpayers may choose to have a paid professional prepare their tax returns this year even if they have done it themselves in years past. The IRS reminds taxpayers to be careful when selecting a tax professional. Though most tax professionals provide honest, high-quality service, a minority of dishonest preparers operate each filing season perpetrating refund fraud, identity theft and other scams that hurt innocent taxpayers.

Compiled annually by the IRS, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter any time of the year, but many of these schemes peak during filing season as people prepare their tax returns or seek help from tax professionals. To help protect taxpayers, the IRS highlights each of these scams on twelve consecutive days to help raise awareness.

“Tax professionals provide an incredibly valuable service to taxpayers and our nation’s tax system,” said IRS Commissioner Chuck Rettig. “We encourage people to carefully choose who they trust with their most sensitive tax and financial information. There are some simple steps taxpayers can follow to make sure they’re getting good, professional help.”

The text of the IRS’s warning about tax return preparer fraud follows:

Tax return preparers are a vital part of the U.S. tax system. During tax year 2016, the most recent year for which complete figures are available, about 53.5 percent of taxpayers used a paid preparer. Selecting the right tax professional is vitally important. Taxpayers are ultimately responsible for the accuracy of their tax return, regardless of who prepares it. The IRS protects taxpayers by assessing significant civil penalties against shady return preparers and working with the Justice Department to shutdown scams and prosecute the criminals behind them.

Choose return preparers wisely

It is important to choose carefully when hiring an individual or firm to prepare a tax return. Well-intentioned taxpayers can be misled by preparers who don’t understand taxes or who mislead people into taking credits or deductions they aren’t entitled to claim. Scam preparers often do this to increase their fee.

Here are a few tips to consider to help avoid fraudsters:

– Look for a preparer who is available year-round. In the event questions come up about a tax return, taxpayers may need to contact the preparer after the filing season is over.

– Ask if the preparer has an IRS Preparer Tax Identification Number (PTIN). Paid tax return preparers are required to register with the IRS, have a PTIN and include it on tax returns.

– Inquire whether the tax return preparer has a professional credential (enrolled agent, certified public accountant or attorney), belongs to a professional organization or attends continuing education classes. Because tax law can be complex, competent tax preparers remain up-to-date on tax topics. The IRS website has more information regarding national tax professional organizations.

– Check the preparer’s qualifications. Use the IRS Directory of Federal Tax Return Preparers with Credentials and Select Qualifications. This tool can help locate a preparer with the preferred qualifications. A searchable and sortable listing of tax preparers registered with the IRS, the directory includes the name, city, state and zip code of attorneys, CPAs, enrolled agents, Annual Filing Season Program participants, enrolled retirement plan agents and enrolled actuaries.

– Check the preparer’s history. Check the Better Business Bureau website for information about the preparer. Look for disciplinary actions and the license status for credentialed preparers. For CPAs, check with the State Board of Accountancy. For attorneys, check with the State Bar Association. For Enrolled Agents, go to IRS.gov and search for “verify enrolled agent status” or check the Directory.

– Ask about service fees. Avoid preparers who base fees on a percentage of their client’s refund or boast bigger refunds than their competition. Don’t give tax documents, Social Security numbers or other information to a preparer if merely inquiring about their services and fees. Unfortunately, some unscrupulous preparers have used this information to improperly file returns without the taxpayer’s permission.

– Make sure the preparer offers IRS e-file and ask to e-file the tax return. Paid preparers who do taxes for more than 10 clients generally must file electronically. Since electronic filing began in the 1980s, the IRS has processed more than 1.5 billion e-filed individual tax returns. It’s the safest and most accurate way to file.

– Provide records and receipts. Good preparers ask to see these documents. They’ll also ask questions to determine the client’s total income, deductions, tax credits and other items. Do not hire a preparer who e-files a tax return using a pay stub instead of a Form W-2. This is against IRS e-file rules.

– Understand representation rules. Attorneys, CPAs and enrolled agents can represent any client before the IRS in any situation. Annual Filing Season Program participants may represent taxpayers in limited situations if they prepared and signed the tax return. However, non-credentialed preparers who do not participate in this program may only represent clients on returns they prepared and signed before the end of 2015.

– Never sign a blank or incomplete return.

– Review the tax return before signing. Be sure to ask questions if something is not clear or appears inaccurate. Any refund should go directly to the taxpayer – not into the preparer’s bank account. Reviewing the routing and bank account number on the completed return is always a good idea.

– Report abusive tax preparers to the IRS. Use Form 14157, Complaint: Tax Return Preparer. If a return preparer is suspected of filing or changing the return without the client’s consent, also file Form 14157-A, Return Preparer Fraud or Misconduct Affidavit. Forms are available on IRS.gov.

www.irs.gov/chooseataxpro has additional information to help taxpayers including tips on choosing a preparer, the differences in credentials and qualifications, as well as how to submit a complaint regarding an unscrupulous tax return preparer.

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Despite a steep drop in tax-related identity theft in recent years, the Internal Revenue Service warns taxpayers that the scam remains serious enough to earn a spot on the 2019 “Dirty Dozen” list of tax scams. “Taxpayers should continue to protect their sensitive tax and financial data to help protect against identity thieves,” IRS Commissioner Chuck Rettig said. “The IRS and the Security Summit partners in the states and the private sector have joined forces to improve our defenses against tax-related identity theft, sharply reducing the number of victims. But we encourage taxpayers to continue to be on the lookout for identity theft schemes, including email phishing attempts and other tax scams.”

Compiled annually by the IRS, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter any time of the year, but many of these schemes peak during filing season as people prepare their tax returns or seek help from tax professionals. To help protect taxpayers, the IRS highlights each of these scams on twelve consecutive days to help raise awareness.

The text of the IRS’s warning about identity theft follows:

Tax-related identity theft occurs when someone uses a stolen Social Security number or Individual Taxpayer Identification Number (ITIN) to file a fraudulent tax return claiming a refund.

The IRS, the states and the nation’s private-sector tax industry began working together in 2015 as the Security Summit to fight tax-related identity theft. Security Summit partners enacted a series of safeguards that are making inroads against identity thieves and protecting taxpayers. These safeguards include expanded information sharing among the Summit partners as well as strengthened internal IRS controls to guard against fraudulent tax returns.

Taxpayers should remember that identity thieves constantly strive to find a scheme that works. Once their ruse begins to fail as taxpayers become aware of their ploys, they change tactics. Taxpayers and tax professionals must remain vigilant to the various scams and schemes used for data thefts. Business filers should be aware that cybercriminals also file fraudulent Forms 1120, U.S. Corporate Income Tax Return, using stolen business identities and they, too, should be alert.

Security tips for taxpayers, tax professionals

The IRS and its partners remind taxpayers and tax professionals that they can do their part to help in this effort. Taxpayers and tax professionals should:

– Always use security software with firewall and antivirus protections. Make sure security software is turned on and can automatically update. Encrypt sensitive files such as tax records stored on the computer. Use strong passwords.

– Learn to recognize and avoid phishing emails and threatening phone calls and texts from thieves posing as legitimate organizations such as banks, credit card companies and government organizations, including the IRS. Do not click on links or download attachments from unknown or suspicious emails. Invest in good anti-spyware and anti-malware software protection.

– Protect personal data. Don’t routinely carry a Social Security card, and make sure tax records are secure. Treat personal information like cash; don’t leave it lying around.

The Security Summit has worked to increase awareness among taxpayers and tax professionals about tax-related identity theft and security steps through its “Taxes. Security. Together.” and “Protect Your Clients; Protect Yourself” campaigns.

Reversing the damage caused by identity theft is often a frustrating and complex process for victims. While identity thieves steal information from sources outside the tax system, the IRS is often the first to inform a victim that identity theft has occurred. The IRS is working diligently to resolve identity theft cases quickly. For more information, see the special identity theft section on IRS.gov.

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By Matthew D. Lee and Marissa Koblitz Kingman

In a ruling that significantly curbs the power of state and local law enforcement authorities to seek forfeiture of assets connected to criminal activity, the U.S. Supreme Court recently held that the Eighth Amendment’s Excessive Fines Clause applies to the states.

Civil forfeiture laws permit prosecutors and police to seize assets connected to criminal activity. Since the 1980s, the use of civil forfeiture has skyrocketed as part of the overall war on drugs as federal, state, and local law enforcement agencies have used it to seize billions of dollars worth of assets, such as automobiles, boats, airplanes and real estate, as well as cash and bank accounts.

The practice has become highly controversial, however, as most laws permit forfeiture against so-called “innocent owners” who have not been convicted of (or even charged with) a crime, and forfeitures are often wildly disproportionate to the underlying criminal offense. In addition, civil forfeiture laws often allow law enforcement agencies to retain the forfeited assets, thereby creating inherent conflicts of interest in forfeiture practices. At the federal level, forfeiture powers are constrained by the Excessive Fines Clause, but that provision has never been held to apply to the states.

Until now.

In a unanimous decision authored by Justice Ruth Bader Ginsburg, the Supreme Court limited the ability of state and local law enforcement agencies to seek civil forfeiture of assets alleged to be connected to criminal activity. In particular, the Court declares that state civil forfeitures should now be judged on whether they are grossly disproportionate to the gravity of the underlying offense.

In Timbs v. Indiana, the Supreme Court held that states must use the same type of analysis employed by the trial court in Timbs’s case, comparing the value of the seized vehicle to the maximum monetary penalty that could be assessed against him as part of his conviction. This decision should also provide much-needed protection to “innocent owners” of property subject to forfeiture.

Background

Tyson Timbs had pleaded guilty to state drug trafficking and theft charges. At the time of his arrest, the police also seized his Land Rover, which he purchased for approximately $42,000. The state later sought forfeiture of the vehicle, claiming that it had been used to transport heroin. The trial court denied the forfeiture request, finding that forfeiture of the Land Rover would be grossly disproportionate to the gravity of Timbs’s offense, thereby violating the Eighth Amendment’s Excessive Fines Clause. In making this finding, the trial court observed that the value of the Land Rover was more than four times the maximum $10,000 fine he faced for his drug conviction.

Indiana’s intermediate court of appeals affirmed, but the Indiana Supreme Court reversed, holding that the Excessive Fines Clause applies only to federal action and is inapplicable at the state level. The U.S. Supreme Court granted certiorari to address the question of whether the Eighth Amendment’s Excessive Fines Clause applies to the states, an issue that had never been addressed by the high court.

The Court’s Analysis

The Eighth Amendment proscribes that “[e]xcessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” In her opinion for the Court, Justice Ginsburg traced what she called the “venerable lineage” of the Excessive Fines Clause to 1215, when the Magna Carta mandated that economic sanctions “be proportioned to the wrong.” This principle was recognized in the U.S. colonies, first in the Virginia Declaration of Rights and later, by 1787, when eight state constitutions outlawed excessive fines. By 1868, the constitutions of nearly every state expressly prohibited excessive fines.

Justice Ginsburg also emphasized that the protection against excessive fines has been a “constant shield” in our country’s history, and must remain so. Protection against excessive punitive economic sanctions is both “fundamental to our scheme of ordered liberty” and “deeply rooted in this Nation’s history and tradition.” The case for concluding that the Excessive Fines Clause applies to the states, Justice Ginsburg concluded, is therefore “overwhelming.”

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In the second installment of its annual “Dirty Dozen” list, the Internal Revenue Service is warning taxpayers to be alert to tax time phone scams where aggressive criminals pose as IRS agents in hopes of stealing money or personal information. Phone scams or “vishing” (voice phishing) continue to pose a major threat. The scam has cost thousands of people millions of dollars in recent years, and the IRS continues to see variations on these aggressive calling schemes. The IRS also urges taxpayers to help protect themselves against phone scams and identity theft by reviewing safety tips prepared by the Security Summit, a collaborative effort between the IRS, states and the private-sector tax community.

Compiled annually by the IRS, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter any time of the year, but many of these schemes peak during filing season as people prepare their tax returns or seek help from tax professionals. To help protect taxpayers, the IRS highlights each of these scams on twelve consecutive days to help raise awareness.

“Taxpayers should be on the lookout for unexpected and aggressive phone calls purportedly coming from the IRS,” said IRS Commissioner Chuck Rettig. “These calls can feature scam artists aggressively ordering immediate payment and making threats against a person. Don’t fall for these.”

The text of the IRS’s warning about telephone scams follows:

Beginning early in the filing season, the IRS generally sees an upswing in scam phone calls threatening arrest, deportation or license revocation, if the victim doesn’t pay a bogus tax bill. These calls most often take the form of a “robo-call” (a text-to-speech recorded voicemail with instructions to call back a specific telephone number), but in some cases may be made by a real person. These con artists may have some of the taxpayer’s information, including their address, the last four digits of their Social Security number or other personal details.

The Treasury Inspector General for Tax Administration (TIGTA), the federal agency that investigates tax-related phone scams, says these types of scams have cost 14,700 victims a total of more than $72 million since October 2013.

How do the scams work?

Criminals make unsolicited calls and leave voicemails with urgent callback requests claiming to be IRS officials. They demand that the victim pay a bogus tax bill by sending cash through a wire transfer, prepaid debit card or gift card.

Many phone scammers use threats to intimidate and bully a victim into paying. The phone scammers may alter or “spoof” their caller ID to make it look like the IRS or another agency is calling. The callers may use IRS employee titles and fake badge numbers to appear legitimate.

The IRS also reminds taxpayers that scammers often change tactics. Variations of the IRS impersonation scam continue year-round and tend to peak when scammers find prime opportunities to strike. Tax scams can be more believable during the tax filing season when people are thinking about their taxes.

Here are some things the scammers often do, but the IRS will not do. Taxpayers should remember that any one of these is a tell-tale sign of a scam.

The IRS will never:

– Call to demand immediate payment using a specific payment method such as a prepaid debit card, gift card or wire transfer. Generally, the IRS will first mail a bill to any taxpayer who owes taxes.

– Threaten to immediately bring in local police or other law-enforcement groups to have the taxpayer arrested for not paying.

– Demand that taxes be paid without giving taxpayers the opportunity to question or appeal the amount owed.

– Ask for credit or debit card numbers over the phone.

– Call about an unexpected refund.

For taxpayers who don’t owe taxes or don’t think they do:

– Please report IRS or Treasury-related fraudulent calls to phishing@irs.gov (Subject: IRS Phone Scam).

– Do not give out any information. Hang up immediately. The longer the con artist is engaged; the more opportunity he/she believes exists, potentially prompting more calls.

– Contact TIGTA to report the call. Use their IRS Impersonation Scam Reporting web page. Alternatively, call 800-366-4484.

– Report it to the Federal Trade Commission. Use the “FTC Complaint Assistant” on FTC.gov. Please add “IRS Telephone Scam” in the notes.

For those who owe taxes or think they do:

– Call the IRS at 800-829-1040. IRS workers can help.

– View tax account online. Taxpayers can see their past 24 months of payment history, payoff amount and balance of each tax year owed.

Stay alert to scams that use the IRS or other legitimate companies and agencies as a lure. Tax scams can happen any time of year, not just at tax time. For more information visit Tax Scams and Consumer Alerts on IRS.gov.

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With the 2019 tax filing season in full swing, and April 15 only a few days away, the Internal Revenue Service has once again unveiled its annual list of the most prevalent tax scams facing taxpayers and tax professionals, which it calls the “Dirty Dozen.” Leading the “Dirty Dozen” for 2019 are internet-based “phishing” scams that lead to tax-related fraud and identity theft. The IRS warns taxpayers, businesses and tax professionals to be alert for a continuing surge of fake emails, text messages, websites and social media attempts to steal personal information. These attacks tend to increase during tax season and remain a major danger of identity theft.

Compiled annually by the IRS, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter any time of the year, but many of these schemes peak during filing season as people prepare their tax returns or seek help from tax professionals. To help protect taxpayers, the IRS highlights each of these scams on twelve consecutive days to help raise awareness.

“Taxpayers should be on constant guard for these phishing schemes, which can be tricky and cleverly disguised to look like it’s the IRS,” said IRS Commissioner Chuck Rettig. “Watch out for emails and other scams posing as the IRS, promising a big refund or personally threatening people. Don’t open attachments and click on links in emails. Don’t fall victim to phishing or other common scams.” The IRS also urges taxpayers to learn how to protect themselves by reviewing safety tips prepared by the Security Summit, a collaborative effort between the IRS, state revenue departments and the private-sector tax community. “Taking some basic security steps and being cautious can help protect people and their sensitive tax and financial data,” Rettig said.

The text of the IRS’s warning regarding phishing scams follows:

New variations on phishing schemes

The IRS continues to see a steady stream of new and evolving phishing schemes as criminals work to victimize taxpayers throughout the year. Whether through legitimate-looking emails with fake, but convincing website landing pages, or social media approaches, perhaps using a shortened URL, the end goal is the same for these con artists: stealing personal information.

In one variation, taxpayers are victimized by a creative scheme that involves their own bank account. After stealing personal data and filing fraudulent tax returns, criminals use taxpayers’ bank accounts to direct deposit tax refunds. Thieves then use various tactics to reclaim the refund from the taxpayer, including falsely claiming to be from a collection agency or the IRS. The IRS encourages taxpayers to review some basic tips if they see an unexpected deposit in their bank account.

Schemes aimed at tax pros, payroll offices, human resources personnel

The IRS has also seen more advanced phishing schemes targeting the personal or financial information available in the files of tax professionals, payroll professionals, human resources personnel, schools and organizations such as Form W-2 information. These targeted scams are known as business email compromise (BEC) or business email spoofing (BES) scams.

Depending on the variation of the scam (and there are several), criminals will pose as:

– a business asking the recipient to pay a fake invoice

– as an employee seeking to re-route a direct deposit

– or as someone the taxpayer trusts or recognizes, such as an executive, to initiate a wire transfer.

The IRS warned of the direct deposit variation of the BEC/BES scam in December 2018, and continues to receive reports of direct deposit scams reported to phishing@irs.gov. The Direct Deposit and other BEC/BES variations should be forwarded to the Internet Crime Complaint Center (IC3). The IRS requests that Form W-2 scams be reported to: phishing@irs.gov (Subject: W-2 Scam).

Criminals may use the email credentials from a successful phishing attack, known as an email account compromise, to send phishing emails to the victim’s email contacts. Tax preparers should be wary of unsolicited email from personal or business contacts especially the more commonly observed scams, like new client solicitations.

Malicious emails and websites can infect a taxpayer’s computer with malware without the user knowing it. The malware downloads in the background, giving the criminal access to the device, enabling them to access any sensitive files or even track keyboard strokes, exposing login victim’s information.

For those participating in these schemes, such activity can lead to significant penalties and possible criminal prosecution. Both the Treasury Inspector General for Tax Administration (TIGTA), which handles scams involving IRS impersonation, and the IRS Criminal Investigation Division work closely with the Department of Justice to shut down scams and prosecute the criminals behind them.

Tax Professional Alert

Numerous data breaches across the country mean the tax preparation community must be on high alert to unusual activity, particularly during the tax filing season. Criminals increasingly target tax professionals, deploying various types of phishing emails in an attempt to access client data. Thieves may use this data to impersonate taxpayers and file fraudulent tax returns for refunds.

As part of the Security Summit initiative, the IRS has joined with representatives of the software industry, tax preparation firms, payroll and tax financial product processors and state tax administrators to combat identity theft refund fraud to protect the nation’s taxpayers.

The Security Summit partners encourage tax practitioners to be wary of communicating solely by email with potential or existing clients, especially if unusual requests are made. Data breach thefts have given thieves millions of identity data points including names, addresses, Social Security numbers and email addresses. If in doubt, tax practitioners should call to confirm a client’s identity.

Reporting Phishing Attempts

If a taxpayer receives an unsolicited email or social media attempt that appears to be from either the IRS or an organization closely linked to the IRS, such as the Electronic Federal Tax Payment System (EFTPS), they should report it by sending it to phishing@irs.gov. Learn more by going to the Report Phishing and Online Scams page on IRS.gov.

Tax professionals who receive unsolicited and suspicious emails that appear to be from the IRS and/or are tax-related (like those related to the e-Services program) also should report it to: phishing@irs.gov.

The IRS generally does not initiate contact with taxpayers by email to request personal or financial information. This includes any type of electronic communication, such as text messages and social media channels.

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Our colleagues Richard S. Caputo and Jacqueline Motyl have published the second of their two-part Alert to guide nonprofit organizations in preparing for upcoming tax filing deadlines and best practices for the onset of a fiscal year.  In Part 1 (available here), they discussed Form 990/990-PF requirements, Solicitation of Funds registration requirements, Change in Officer/Director notification requirements, and appropriate insurance coverage.  In Part II (available here), they focus on donor letters, bylaws and corporate records.

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The Tax Court’s recent decision in Walquist v. Commissioner, 152 T.C. No. 3, further clarified the application of the supervisor approval requirement under section 6751(b)(1), which has been a key issue since Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017).  In Walquist, the Tax Court held that accuracy-related penalties determined by an IRS computer program without human review are “automatically calculated through electronic means” under section 6751(b)(2)(B).  As a result, those penalties are exempt from the written supervisor approval requirement under section 6751(b)(1).

The petitioners in Walquist failed to report compensation for 2014.  The IRS’ computer document matching recognized the underreporting, and the IRS processed the examination of the Walquist’s return through its Automated Correspondence Exam system using its Correspondence Examination Automated Support (CEAS) software program.  The Tax Court explained that this software is designed to process cases “with minimal to no tax examiner involvement until a taxpayer reply is received.”  The CEAS program eventually issued the petitioners a general 30-day letter, which systematically included an accuracy-related penalty.  The petitioners failed to respond to the 30-day letter, so the CEAS program issued them a notice of deficiency, which included the accuracy-related penalty from the 30-day letter.

The petitioners filed a purported petition with the Tax Court, which consisted of the notice of deficiency and appended various documents containing assertions commonly advanced by tax protesters.  Even in such cases, the IRS’ burden of production generally includes establishing compliance with section 6751(b), which requires that penalties be “personally approved (in writing) by the immediate supervisor of the individual making such determination.”  See Chai, 851 F.3d at 217.

Supervisor approval, however, is not required for “any other penalty automatically calculated through electronic means.”  IRC 6751(b)(2)(B).  The Tax Court held that an accuracy-related penalty determined by an IRS computer program is a “penalty automatically calculated through electronic means.”  The Tax Court pointed out that if the penalty at issue was not a “penalty automatically calculated through electronic means,” it would be difficult to conceive what type of penalty would qualify for the statutory exception to the supervisor approval requirement.

With the 2018 tax filing season in full swing, the Internal Revenue Service today kicked off its annual countdown of the twelve most prevalent tax scams facing taxpayers. Compiled annually by the IRS, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter any time of the year, but many of these schemes peak during filing season as individuals prepare their tax returns or seek help from tax professionals. As in prior years, the IRS will highlight each of these scams on twelve consecutive days in order to help protect taxpayers and raise awareness. In subsequent posts, we will report on each of the “Dirty Dozen” scams as they are unveiled by the IRS.

For more up-to-date coverage from Tax Controversy and Financial Crimes Report, please subscribe by clicking here.

I have written before about the battles being fought by cannabis businesses facing IRS examinations.  IRS audits raise many issues for state legal cannabis businesses operating in violation of the Controlled Substances Act. In some situations, taxpayers have struggled to resolve IRS examinations while addressing concerns that incriminating evidence provided to the IRS could fall into the hands of law enforcement. This week, the Tenth Circuit issued its ruling addressing these very concerns.

The Tax Court ruled in Feinberg v. Comm’r, T.C. Memo 2017-211, that the taxpayer failed to substantiate cost of goods sold when instead of submitting evidence of the amounts spend on inventory, it submitted an expert report in an effort to convince the court to make a determination of cost of goods sold based on industry averages.  However, the expert report was excluded and the court determined that without actual documents, the IRS determination of cost of goods sold would stand.  Further, because there was no substantiation of ordinary and necessary expenses claimed under Section 162, the Tax Court held that it did not need to address the application of Section 280E (the code section which disallows ordinary and necessary business deductions for businesses trafficking in controlled substances).  My discussion of the Tax Court opinion is available here.

At oral argument, the taxpayer is argued that it was backed into a corner when, after the IRS agreed that whether Section 162 deductions where substantiated was not an issue for trial, the Tax Court determined that Section 280E did not apply because of a lack of evidence that the taxpayer was trafficking in controlled substances, yet denied Section 162 deductions for lack of substantiation.   The Commissioner agreed that substantiation was not an issue for trial, but argued that the taxpayer did not in fact substantiate any expenses – because it asserted its Fifth Amendment privilege in response to discovery requests – and that there was enough evidence in the record to support a finding that the taxpayer was trafficking in controlled substances, allowing the court to agree that the IRS was correct in determining that Section 280E applied to the taxpayer.

The Tenth Circuit’s ruling is enlightening.  The panel agreed with the parties that the Tax Court erred in denying the business expense deductions for failure to substantiate them under Section 162 because substantiation was a new matter upon which the IRS carried the burden of proof.  However, the panel went on to conclude that based on the evidence in the record, it could affirm the Tax Court’s ruling on the alternative ground that the taxpayer did not meet their burden of proving that the IRS erred in denying the deductions under Section 280E.

The Tenth Circuit rejected the taxpayer’s argument that requiring them to prove that they were not trafficking in a controlled substance violated their Fifth Amendment privilege.  The taxpayer cited several Fifth Amendment cases where petitioners “were prosecuted for failing to comply with a statute compelling them to provide self-incriminating information.”  In those cases, the Fifth Amendment privilege provided a complete defense.  Those situations were distinguished from the instant case, involving the filing of a tax return, because the taxpayer failed “to explain how requiring them to bear the burden of proving the IRS erred in applying § 280E to calculate their civil tax liability is a form of compulsion equivalent to a statute that imposes criminal liability for failing to provide information subjecting the party to liability under another criminal statute.”  The court concluded that “the Taxpayers must choose between providing evidence that they are not engaged in the trafficking of a controlled substance or forgoing the tax deductions available by the grace of Congress.”  In other words, whether you get to take a deduction is a different matter altogether than facing criminal prosecution for failing to comply with a statute.  The court further noted that when asserting the privilege against self-incrimination, one must bear the consequences of the lack of evidence.  While normally the lack of evidence could benefit a party facing criminal prosecution, here the lack of evidence results in a particular application of the tax laws, not criminal liability.

The court next picked up where the Tax Court left off and considered whether the taxpayer had provided evidence refuting the IRS determination that the taxpayer was trafficking in a controlled substance.  Because the taxpayer did not identify any evidence showing the IRS had erred in this determination, the court concluded that they had not met their burden.  This was the court’s basis for affirming the Tax Court’s conclusion.

This ruling breaks new ground by directly addressing the issue of Fifth Amendment privilege in examinations where the IRS takes the position that Section 280E applies.  Because the court determined there is no violation of the taxpayer’s Fifth Amendment privilege, taxpayers in the Tenth Circuit should be cooperative during examinations to avoid denial of costs to which they are entitled.

 

Fox attorneys Ian M. Comisky and Matthew D. Lee will be speaking on criminal tax enforcement panels at the Federal Bar Association’s 2019 Tax Law Conference to be held on March 7-8, 2019, in Washington, D.C.

Ian will be leading a panel entitled “International Hot Topics in Tax Enforcement” which will seek to answer this question: Is charging tax fraud as a money laundering offense a reach too far? Traditionally, tax evasion has not been charged as mail fraud or wire fraud and therefore has not been charged as a predicate for a money laundering offense. However, one recent case in the Southern District of New York arising out of the Panama Papers has charged a tax offense as wire fraud and as a predicate for an international money laundering charge. This panel will review the existing law and guidance in this area and discuss when money laundering can be charged in connection with a tax crime.

Matt will be part of a panel entitled “Domestic Hot Topics in Tax Enforcement” that will address issues suggested by recent developments in domestic criminal tax matters, including: growth of I.R.S. Criminal Investigation (I.R.S.-CI) in 2019; new special agent classes; the Nationally Coordinated Investigations Unit (NCIU); efforts to deal with cryptocurrency; current investigation and prosecution priorities; impact of the federal government shutdown; charging decisions in light of Marinello, Yusuf, and recent cases; and practical issues in prosecuting and defending criminal tax cases.

For more up-to-date coverage from Tax Controversy and Financial Crimes Report, please subscribe by clicking here.