SCOTUS Reports

Tag: Section 6663

  • Lon B. Isaacson v. Commissioner of Internal Revenue, T.C. Memo. 2020-17: Income Recognition and Civil Fraud Penalties in Tax Law

    Lon B. Isaacson v. Commissioner of Internal Revenue, T. C. Memo. 2020-17 (U. S. Tax Court, 2020)

    In Lon B. Isaacson v. Commissioner, the U. S. Tax Court upheld a significant tax deficiency and fraud penalty against attorney Lon B. Isaacson for failing to report over $2. 5 million in income from a clergy abuse settlement in 2007. The court rejected Isaacson’s argument that a fee dispute with clients prevented income recognition, applying judicial estoppel due to his inconsistent positions in prior legal proceedings. The decision underscores the importance of accurate income reporting and the consequences of fraudulent tax practices, particularly for legal professionals.

    Parties

    Lon B. Isaacson, the petitioner, sought a redetermination of his 2007 income tax liability from the Commissioner of Internal Revenue, the respondent. Isaacson was represented by Joseph A. Broyles, while the Commissioner was represented by Cassidy B. Collins, Andrea M. Faldermeyer, Christine A. Fukushima, and Priscilla A. Parrett.

    Facts

    Lon B. Isaacson, a disbarred attorney, represented four clients in a lawsuit against the Catholic Archdiocese of Los Angeles for childhood sexual abuse. In 2007, Isaacson secured a $12. 75 million settlement, asserting a 60% contingency fee. The settlement funds were deposited into an investment account at UBS, which Isaacson controlled and used for personal purposes. Isaacson did not report his claimed fee as income for 2007, despite having dominion and control over the funds. He maintained that no fee dispute existed in prior legal proceedings, which led to favorable outcomes in those cases. However, in the tax court, he argued that a fee dispute with two clients prevented him from recognizing the income, a position inconsistent with his prior representations.

    Procedural History

    The Commissioner determined a deficiency of $2,583,374 and a civil fraud penalty of $1,937,531 for Isaacson’s 2007 tax year. Isaacson petitioned the U. S. Tax Court for a redetermination. The case involved multiple concessions and focused on whether Isaacson failed to report taxable income for 2007 and whether he was liable for the civil fraud penalty. The court reviewed extensive evidence, including Isaacson’s prior legal proceedings and financial records.

    Issue(s)

    Whether Isaacson failed to report taxable income from his contingency fee for the 2007 tax year?

    Whether Isaacson is liable for the civil fraud penalty under section 6663 of the Internal Revenue Code for the 2007 tax year?

    Rule(s) of Law

    Under section 61(a) of the Internal Revenue Code, gross income includes all income from whatever source derived. For cash basis taxpayers, income must be reported in the year it is actually or constructively received. The doctrine of judicial estoppel prevents a party from asserting a position in a legal proceeding that is inconsistent with a position successfully maintained in a prior proceeding. Section 6663 imposes a 75% penalty on any underpayment of tax due to fraud, which must be proven by clear and convincing evidence.

    Holding

    The court held that Isaacson failed to report taxable income from his contingency fee for 2007 and was liable for the civil fraud penalty under section 6663. The court applied judicial estoppel to bar Isaacson’s claim of a fee dispute, as he had previously maintained that no such dispute existed in other legal proceedings. The court found that Isaacson had dominion and control over the settlement funds in 2007 and should have reported his fee as income for that year.

    Reasoning

    The court’s reasoning focused on several key points:

    – Isaacson’s prior representations in legal proceedings that no fee dispute existed were accepted and relied upon by other tribunals, leading to the application of judicial estoppel.

    – Isaacson’s failure to report his fee as income in 2007 was deemed fraudulent, supported by his consistent pattern of underreporting income, inadequate recordkeeping, and false testimony.

    – The court rejected Isaacson’s reliance on a purported tax opinion letter, finding it inadequate and based on false assumptions.

    – Isaacson’s use of the settlement funds for personal purposes and his failure to maintain proper financial records were seen as badges of fraud.

    – The court noted Isaacson’s legal background and experience in tax fraud cases, which informed its analysis of his intent and actions.

    Disposition

    The court entered a decision for the respondent, affirming the deficiency and the civil fraud penalty against Isaacson for the 2007 tax year.

    Significance/Impact

    This case highlights the strict application of income recognition rules for cash basis taxpayers and the severe consequences of tax fraud, particularly for legal professionals. It underscores the importance of consistent positions in legal proceedings and the potential application of judicial estoppel. The decision reinforces the need for accurate reporting of income and the maintenance of proper financial records, especially when handling client funds. The case also serves as a reminder of the rigorous standards applied by the U. S. Tax Court in assessing civil fraud penalties.

  • Mathews v. Commissioner, T.C. Memo. 2018-212: Fraudulent Intent in Tax Evasion

    Mathews v. Commissioner, T. C. Memo. 2018-212, United States Tax Court, 2018

    In Mathews v. Commissioner, the Tax Court ruled that the IRS failed to prove by clear and convincing evidence that Richard C. Mathews intended to evade taxes for the years 2007 and 2008. Despite Mathews’ prior convictions for filing false returns, the court found his genuine confusion about the taxability of income from his multilevel marketing programs persuasive. This decision underscores the importance of proving specific intent to evade taxes, rather than merely demonstrating false reporting, in tax fraud cases.

    Parties

    Richard C. Mathews, the petitioner, represented himself pro se. The respondent, the Commissioner of Internal Revenue, was represented by William F. Castor and H. Elizabeth H. Downs.

    Facts

    Richard C. Mathews, a former U. S. Army serviceman, operated a multilevel marketing business through various online programs, including Wealth Team International Association (WTIA) and others under the name Mathews Multi-Service. Mathews received membership fees through online payment systems and remitted portions to member-recruiters, believing that 90% of the funds belonged to others and that he had deductible expenses. He filed separate tax returns for 2007 and 2008, reporting minimal income from his business activities. Mathews had previously been convicted of filing false returns for tax years 2004 through 2008, but the court found his understanding of his tax liabilities to be genuinely confused due to his lack of sophistication in tax matters.

    Procedural History

    The IRS conducted a civil examination of Mathews’ 2005 return and later expanded it to include 2003, 2004, and 2006. Following a criminal investigation, Mathews was indicted and convicted of filing false returns for 2004 through 2008. The IRS then issued notices of deficiency for 2007 and 2008, asserting fraud penalties under section 6663. Mathews sought redetermination in the U. S. Tax Court, where a trial was held. The court determined that the IRS failed to meet its burden of proving fraudulent intent for 2007 and 2008, resulting in a decision for Mathews.

    Issue(s)

    Whether the IRS proved by clear and convincing evidence that Richard C. Mathews filed false and fraudulent returns with the intent to evade tax for the tax years 2007 and 2008?

    Rule(s) of Law

    Section 6501(c)(1) of the Internal Revenue Code extends the period of limitation for assessment if a taxpayer files a false or fraudulent return with the intent to evade tax. The Commissioner bears the burden of proving by clear and convincing evidence that an underpayment exists and that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Fraudulent intent must exist at the time the taxpayer files the return.

    Holding

    The Tax Court held that the IRS did not meet its burden of proving by clear and convincing evidence that Richard C. Mathews filed false and fraudulent returns with the intent to evade tax for the tax years 2007 and 2008. The court found Mathews’ genuine confusion about the taxability of his multilevel marketing income credible, given his lack of sophistication and financial acumen.

    Reasoning

    The court’s reasoning focused on several key points:

    – Mathews’ lack of sophistication and financial acumen was critical in assessing his intent. His background, including dropping out of high school and having no formal training in bookkeeping or taxation, contributed to his genuine confusion about his tax liabilities.

    – The court considered Mathews’ consistent statements about not knowing how to report income from his multilevel marketing programs, which were corroborated by notes from IRS agents during their investigations.

    – Despite Mathews’ prior convictions for filing false returns, the court noted that section 7206(1) convictions do not collaterally estop a taxpayer from denying fraudulent intent in a civil case, as intent to evade taxes is not an element of the crime.

    – The court emphasized that the burden of proof lies with the Commissioner to negate the possibility that the underreporting was attributable to a misunderstanding, which in this case was Mathews’ belief that most of the funds he received were owed to other members and that he had deductible expenses.

    – The court reviewed the ‘badges of fraud’ but found that Mathews’ conduct during the IRS investigations, while reprehensible, did not establish that his 2007 and 2008 returns were filed with fraudulent intent.

    Disposition

    The Tax Court entered decisions for Richard C. Mathews, denying the IRS the right to assess deficiencies and penalties for the tax years 2007 and 2008 due to the expiration of the statute of limitations under section 6501(a).

    Significance/Impact

    The Mathews decision highlights the importance of proving specific intent to evade taxes in civil fraud cases, particularly when the taxpayer demonstrates genuine confusion about their tax liabilities. It underscores that a conviction for filing false returns does not automatically establish fraudulent intent in a civil context. The ruling may influence how the IRS approaches similar cases, emphasizing the need for clear and convincing evidence of intent beyond mere false reporting. This case also illustrates the challenges the IRS faces in proving fraud against unsophisticated taxpayers and the necessity of considering the taxpayer’s understanding and background when assessing intent.

  • May v. Commissioner, 136 T.C. 153 (2011): Fraud Penalties and Tax Withholding Credits

    May v. Commissioner, 136 T. C. 153 (2011)

    In May v. Commissioner, the U. S. Tax Court upheld the imposition of fraud penalties under section 6663 against Mark May for underpaying taxes due to overstated withholding credits and disallowed state and local tax deductions. The court found that May, who controlled the finances of Maranatha Financial Group, Inc. , deliberately claimed credits for unremitted withholdings. This ruling clarifies the scope of the Tax Court’s jurisdiction over fraud penalties and the application of the fraud penalty when tax withholdings are not remitted to the government.

    Parties

    Plaintiffs/Appellants: Mark May and Cynthia May (Petitioners). Defendant/Appellee: Commissioner of Internal Revenue (Respondent). The case was consolidated for trial in the U. S. Tax Court.

    Facts

    Mark May was the president, CEO, and a shareholder of Maranatha Financial Group, Inc. (Maranatha), a corporation with about 100 employees. During the years 1994, 1995, and 1996, Maranatha withheld taxes from employee paychecks, including May’s, but failed to remit these withholdings to federal, state, or local tax authorities. May had sole check signature authority over Maranatha’s corporate account and was aware of the failure to remit withholdings. He claimed withholding credits on his joint federal income tax returns with his wife, Cynthia May, for these unremitted amounts. Additionally, May claimed deductions for state and local income taxes allegedly paid through withholdings. May was later convicted of tax evasion and failure to pay over payroll taxes. The Commissioner of Internal Revenue determined deficiencies and assessed fraud penalties against May for these years.

    Procedural History

    The Commissioner issued a notice of deficiency for the tax years 1994, 1995, and 1996, determining deficiencies and fraud penalties against Mark and Cynthia May. The Mays timely filed a petition for redetermination with the U. S. Tax Court. The cases were consolidated for trial. The Commissioner conceded that Cynthia May was entitled to relief under section 6015 from joint and several liability for the years at issue, resolving all issues pertaining to her. The remaining issues for decision were the jurisdiction of the Tax Court over fraud penalties based on overstated withholding credits, May’s liability for these penalties, and his liability for deficiencies resulting from disallowed state and local tax deductions.

    Issue(s)

    1. Whether the U. S. Tax Court has jurisdiction to redetermine the underpayments for purposes of calculating the section 6663 fraud penalties when a portion of the underpayment for each taxable year resulted from overstated credits for taxes withheld from wages?
    2. Whether Mark May is liable for the section 6663 fraud penalties for the taxable years at issue with respect to the claimed withholding tax credits?
    3. Whether Mark May is liable for the deficiencies resulting from disallowed deductions for state and local income taxes paid and for section 6663 fraud penalties with respect to such deficiencies?

    Rule(s) of Law

    1. The jurisdiction of the U. S. Tax Court attaches upon the issuance of a valid notice of deficiency and the timely filing of a petition. Section 6665 provides that “additions to the tax, additional amounts, and penalties * * * shall be paid upon notice and demand and shall be assessed, collected, and paid in the same manner as taxes”.
    2. Fraud penalties under section 6663 require the Commissioner to prove by clear and convincing evidence that an underpayment of tax exists and that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes.
    3. An “underpayment” under section 6664 is defined as the amount by which any tax imposed exceeds the excess of the sum of the amount shown as the tax by the taxpayer on his return plus amounts not so shown previously assessed over the amount of rebates made. The amount shown as the tax by the taxpayer on his return is reduced by the excess of the amounts shown by the taxpayer on his return as credits for tax withheld over the amounts actually withheld or paid.

    Holding

    1. The U. S. Tax Court has jurisdiction to redetermine the underpayments for purposes of calculating the section 6663 fraud penalties when a portion of the underpayment for each taxable year resulted from overstated credits for taxes withheld from wages.
    2. Mark May is liable for the section 6663 fraud penalties for the taxable years at issue with respect to the claimed withholding tax credits.
    3. Mark May is liable for the deficiencies resulting from disallowed deductions for state and local income taxes paid and for section 6663 fraud penalties with respect to such deficiencies, except for $772 of the 1996 local income taxes for which he provided evidence of payment.

    Reasoning

    The court’s reasoning focused on the statutory framework and legal precedents. It relied on Rice v. Commissioner to establish jurisdiction over fraud penalties, emphasizing that the Tax Court’s jurisdiction extends to penalties assessed in the same manner as deficiencies. The court analyzed the definition of “underpayment” under section 6664 and its regulations, concluding that overstated withholding credits increase underpayments. The court rejected May’s arguments that no underpayment existed due to actual withholding, applying a functional test from United States v. Blanchard to determine that the funds never left May’s control and were thus not actually withheld. The court found clear and convincing evidence of May’s fraudulent intent based on his knowledge and control over the nonremittance of withholdings and his subsequent claiming of credits and deductions. The court also addressed the period of limitations, holding that May’s fraudulent actions extended the period under section 6501(c)(1).

    Disposition

    The court upheld the fraud penalties against Mark May for the underpayments resulting from overstated withholding credits and disallowed state and local tax deductions, except for $772 of the 1996 local income taxes. The court directed the entry of a decision under Rule 155 in docket No. 14385-05 and for the petitioner in docket No. 4782-07.

    Significance/Impact

    May v. Commissioner clarifies the Tax Court’s jurisdiction over fraud penalties based on overstated withholding credits and the application of the fraud penalty when tax withholdings are not remitted to the government. The case establishes a functional test for determining whether funds have been “actually withheld” and emphasizes the importance of the taxpayer’s control over withheld funds. This decision impacts the assessment of fraud penalties in cases involving nonremittance of withholdings and reinforces the broad scope of the Tax Court’s jurisdiction over such penalties. It also serves as a reminder of the severe consequences of fraudulent tax practices, particularly when involving corporate officers with control over corporate finances.