Return Preparer's Fraud Suspended Couple's Statute of Limitations on Assessment

(Parker Tax Publishing June 2019)

The Eleventh Circuit affirmed a Tax Court decision holding that, where a married couple's return preparer included bogus claims on their returns for eight years and the taxpayers were oblivious to the preparer's conduct, the return preparer's fraudulent behavior suspended the three-year statute of limitations on assessments under Code Sec. 6501. The Eleventh Circuit found that the taxpayers waived the argument, which they raised for the first time on appeal, that the fraud exception was not triggered because the taxpayers had not falsely or fraudulently prepared their returns with intent to evade tax. Finnegan v. Comm'r, 2019 PTC 211 (11th Cir. 2019).

Background

John and Joan Finnegan hired a tax return preparer who, apparently without their knowledge, included bogus claims on their returns for eight years. An informant tipped off the IRS about the return preparer, leading to an IRS investigation which revealed that the preparer and his associates prepared around 750 to 800 fraudulent returns every year for 11 years. These fraudulent returns had several common features, including large refunds and partnership losses. The addresses for the partnerships changed and as a result, the partnership returns were filed with different IRS Centers, lowering the chances of detection. Many of the same dollar amounts repeated themselves and appeared on several of the fraudulent returns.

The return preparer was indicted and pled guilty to conspiring to defraud the United States and to interfering with the administration of the internal revenue laws. The return preparer then testified against one of his former business associates. During his testimony, the return preparer said that each and every one of the returns he prepared during the relevant time contained some fraudulent entries. The Finnegans were not part of the grand jury investigation into the return preparer and his associates, nor were their returns used to support the indictments against the return preparer and his associates.

Roughly five years after the criminal proceedings, the IRS issued a notice of deficiency to the Finnegans for the eight years that they submitted fraudulent returns. The Finnegans challenged the notice in the Tax Court.

Tax Court Proceedings

The Finnegans argued that, under Code Sec. 6501(a), the IRS had to make assessments within three years after their tax returns were filed. The IRS responded that the fraud exception to the three-year window in Code Sec. 6501(c)(1) applied because the return preparer had fraudulently prepared the Finnegans' returns with the intent to evade tax. The IRS relied on Allen v. Comm'r, 128 T.C. 37 (2007), where the Tax Court held that the fraud exception is triggered, and the three-year window is suspended, by a return preparer's fraudulent intent. The Finnegans did not contest Allen, at least not before the Tax Court issued its decision. Rather, they argued that the IRS did not have enough evidence to prove the return preparer's fraud.

The Tax Court agreed with the IRS, finding that the fraud exception applied because, under Allen, the return preparer's fraud was enough to trigger the exception. However, the Tax Court noted that a Court of Federal Claims decision, BASR Partnership v. U.S., 2013 PTC 293 (Fed. Cl. 2013), declined to follow Allen. While the Finnegans' case was submitted, but before the Tax Court issued its decision, the Federal Circuit affirmed the Court of Federal Claims decision in BASR Partnership v. U.S., 2015 PTC 263 (Fed. Cir. 2015). The Tax Court flagged these two cases but explained in a footnote that they provided no reason to revisit Allen.

The Finnegans filed a motion for reconsideration, arguing that the Tax Court erred in deciding not to revisit Allen and should overrule that decision. The Tax Court denied the motion, reasoning that the Finnegans had multiple chances to challenge Allen but chose not to, and therefore had waived that argument under the waiver doctrine. The Finnegans appealed to the Eleventh Circuit.

Eleventh Circuit's Analysis

On appeal, the Finnegans again argued that Allen was wrongly decided and that the court should exercise its discretion and not enforce the waiver doctrine. They also contended that the Tax Court abused its discretion by admitting the return preparer's out-of-court statements.

The Eleventh Circuit held that the Finnegans waived their argument that Allen was wrongly decided by failing to raise it before the Tax Court. The court reasoned that the Finnegans knew the IRS was relying on Allen and did not challenge it before, during, or after the Tax Court trial. The court noted that, in fact, they explicitly told the Tax Court they admitted to Allen and were not challenging it. The Eleventh Circuit rejected the Finnegans' contention that it had an independent duty to apply the correct law to the facts, even if neither party argued for the correct application of the law. In the court's view, such a rule would impose an independent duty on courts to interpret statutes exhaustively and decide issues outside of the adversarial process.

The Eleventh Circuit also declined to exercise its discretion and not enforce the waiver doctrine. The court noted that it may consider an issue for the first time on appeal only in limited circumstances. In this case, considering the Finnegans' argument would mean that the IRS would have to retry its case, focusing more on showing the Finnegans' intent, with the result that a lot of the time and resources that went into litigating the case would be wasted. The court also found that declining to consider the issue would not violate the Finnegans' rights but only deny them the opportunity to correct a strategic decision that ultimately failed, while allowing the Finnegans to challenge Allen with the benefit of hindsight would sandbag the IRS.

The Eleventh Circuit further held that the Tax Court properly admitted the return preparer's prior testimony when he appeared as a witness against his former business associate. The Eleventh Circuit agreed with the Tax Court that the statements satisfied an exception to the hearsay rule.

For a discussion of the fraud exception to the statute of limitations on assessments, see Parker Tax ¶260,130.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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