Fraudulent Amended Returns Filed by Company's Accountant Tolled Statute
(Parker's Federal Tax Bulletin: March 17, 2013)

More often than not, the Tax Court rules in favor of the IRS and federal appellate courts do not generally overrule the Tax Court. However, in City Wide Transit, Inc. v. Comm'r, 2013 PTC 27 (2d Cir. 3/1/13), the Second Circuit did just that it reversed the Tax Court, which had ruled against the IRS.

The question before the appellate court was this: Did a CPA impersonator that filed fraudulent tax returns on behalf of a company in order to embezzle money that the company otherwise owed the IRS, intentionally evade that company's taxes within the meaning of Code Sec. 6501(c)(1)? And, if the accountant did commit tax evasion, did he toll the statute of limitations by fraudulently amending tax returns that the company had already filed? In reversing the Tax Court, the Second Circuit concluded that the accountant intentionally evaded the corporation's taxes and thus triggered the statute of limitations tolling provision with respect to the corporation. Accordingly, the IRS could reach back in time and assesses taxes owed by the taxpayer at any time.

Facts

Ms. Ray Fouche owned several bus companies, including City Wide Transit, Inc. (City Wide). City Wide transported handicapped children throughout New York City. By the end of 1998, Fouche's bus companies, including City Wide, collectively accrued about $700,000 in outstanding payroll tax liabilities. To negotiate a reduction of these liabilities, Fouche hired Manzoor Beg, who falsely held himself out as a CPA. Fouche gave Beg a blank power of attorney. On behalf of City Wide, Fouche paid Beg $30,000 in April 1999 and promised him 25 percent of the amount he successfully saved City Wide as result of his negotiations. Fouche also hired a third-party payroll service, Brand's Paycheck, Inc., to prepare Form 941, Employer's Quarterly Federal Tax Return, for June 1997; December 1998; March 31, June 30, and December 31, 1999; and March 31, and June 30, 2000. For each of those last five quarters, Fouche drafted checks payable to the IRS sufficient to cover City Wide's liabilities and gave them, along with the corresponding returns that Brand's prepared, to Beg, who in turn promised to deliver them to the IRS revenue officer with whom he was negotiating.

Instead of filing the correct returns, however, Beg prepared, signed, and filed another set of returns on Forms 941 for those five quarters (i.e., the Beg returns). In those returns, Beg fraudulently added advance earned income credit (EIC) payments that significantly reduced City Wide's tax liabilities. Beg then altered the checks that City Wide drafted by changing the payee from the IRS to an account that he maintained at Habib American Bank in the name of Himalayan Hanoi Craft. He deposited or cashed those checks for his own personal use, and drafted new checks to cover City Wide's now fraudulently reduced tax liabilities.

Beg also prepared, signed, and filed amended Forms 941 for the June 1997 and December 1998 quarters (i.e., the Beg amendments) in order to add fraudulent EIC payments to the returns that City Wide previously filed. Beg did not personally benefit from these amendments but presumably filed them in an effort to conceal the fraudulent EIC payments he included in the returns that he drafted. Through this scheme, Beg embezzled hundreds of thousands of dollars from City Wide, and City Wide received certain tax refunds. The fraudulent EIC reductions totaled $372,000.

Upon discovering Beg's scheme, the government filed charges, and Beg pled guilty to preparing false tax returns for City Wide. A district court began sentencing proceeding, but Beg died during the course of those proceedings and the court, therefore, dismissed the case.

Based on Beg's guilty plea, the IRS began a civil examination of City Wide's returns to recover the taxes that had been underassessed as a result of Beg's fraud. Subsequently, the IRS assessed additional taxes owed by Wide City of $372,000. The IRS did not assess any fraud penalties against Fouche or City Wide.

Statute of Limitations

Under Code Sec. 6501(a), the IRS is required to assess any tax imposed within three years after the return was filed. This provision, however, contains certain exceptions that make the limitations period limitless. Code Sec. 6501(c)(1) provides that, in the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed at any time. Code Sec. 6501(c)(2) provides that in the case of a willful attempt in any manner to defeat or evade tax imposed, the tax may be imposed at any time.

Tax Court Case

City Wide challenged the IRS assessments as time barred because the assessments were outside of the three-year statute of limitations. On December 11, 2008, after various meetings and conversations with City Wide, the IRS issued a Notice of Determination that upheld the tax assessments. City Wide filed a petition with the Tax Court.

Before the Tax Court, City Wide argued that the three-year statute of limitations barred the IRS from the relevant assessments and that the Internal Revenue Code's tolling provisions were inapplicable. The Tax Court noted that the IRS could trigger the tolling provisions under Code Sec. 6501(c)(1), (2), or both by showing with clear and convincing evidence that Beg had the specific intent to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. The Tax Court concluded, however, that the IRS did not meet that standard.

Although the IRS pointed to a number of egregious acts Beg performed that caused the IRS to fail to collect the full amount of City Wide's taxes, the Tax Court held that those actions did not prove that Beg filed fraudulent returns intending to defeat or evade City Wide's taxes. According to the Tax Court, that tax evasion was only the incidental consequence or secondary effect of Beg's embezzlement scheme. The court found persuasive City Wide's argument that Beg intended only to cover up his embezzlement scheme and not defeat or evade City Wide's taxes. The IRS could not point to anything in the record, the Tax Court noted, that would cause the court to believe that City Wide's argument was meritless. Accordingly, the Tax Court concluded that the IRS was time barred from assessing the additional taxes. The IRS appealed.

Second Circuit's Decision

The Second Circuit began its analysis by noting that the burden of proving that a false or fraudulent return was filed with intent to evade tax is on the IRS and such proof must be made by clear and convincing evidence. However, the court stated, because tax evaders do not reveal their fraudulent evasion, the IRS may establish fraud through circumstantial evidence. To prove intentional evasion of tax, the IRS must establish that (1) an underpayment exists; and (2) some portion of the underpayment was due to fraud.

The court cited the Supreme Court decision in Bufferd v. Comm'r, 506 U.S. 523 (1993), in noting that limitations statutes barring the collection of taxes otherwise due and unpaid are strictly construed in favor of the IRS. The limitations period for assessing taxes, the court said, is extended if the taxes were understated due to fraud of the preparer.

The Second Circuit had before it a very narrow question: whether, considering all the evidence, the Tax Court made a mistake by concluding that the IRS failed to establish by clear and convincing evidence that Beg intended to evade City Wide's taxes through his embezzlement scheme. The court concluded that Beg's scheme clearly did, and the Tax Court made a mistake.

The Second Circuit said that, by concluding that the IRS failed to prove that Beg intended to evade City Wide's taxes and that, at best, tax evasion was but an incidental, secondary effect to Beg's embezzlement scheme, the Tax Court inappropriately substituted motive for intent.

The Second Circuit stated that Beg's motivation for fraudulently amending the June 1997 and December 1998 returns that City Wide had previously filed was unclear. He presumably did so, the court said, in order to cover up the false EICs he included on the five returns that he drafted and filed in the first instance. But, the court stated, Beg's motivations were inconsequential, and it was clear that he filed the two amended returns intending to evade tax for the foregoing reasons. The court concluded that the IRS presented clear and convincing evidence that Beg intended to evade City Wide's taxes for the seven taxable quarters in question, thereby triggering the tolling provision under Code Sec. 6501(c)(1).

Staff Editor Parker Tax Publishing

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