United States: Fraud Of Third-Party Does Not Extend The Statue Of Limitations Under Section 6501

On July 29, 2015, the United States Court of Appeals for the Federal Circuit in BASR Partnership v. U.S.¹⁸  affirmed a decision by the US Court of Federal Claims which  determined that Section 6501(a)'s three-year statute of limitations barred the Internal  Revenue Service ("IRS") from administratively adjusting, in 2010, the 1999 US  Partnership Tax Return filed by BASR Partnership ("BASR"). The Claims Court held that Section 6501(c)(1)'s suspension of the three-year limitation applies only when the  taxpayer—and not a third party—acts with the requisite "intent to evade tax."

Background

The facts were undisputed. In 1999, the Pettinati family intended to sell their printing  business, which would realize a large capital gain. Before the sale, Erwin Mayer, a lawyer  from the now-defunct law firm of Jenkins & Gilchrist, contacted the Pettinati family and  prepared a "tax advantaged investment opportunity," which involved establishing the  BASR Partnership. The Pettinati family hired Jenkins & Gilchrist, which recommended  the transaction that could reduce the amount of capital gain reported. Jenkins & Gilchrist  also provided a signed tax opinion, which attested to the legitimacy of the transaction.  The Pettinatis retained Malone & Bailey, who had no connection to Jenkins & Gilchrist, to  prepare their tax returns. Ultimately, by creating the BASR Partnership, the Pettinatis  greatly reduced the tax liability arising from the sale of their printing business.

In 2004, the IRS received a list of Jenkins & Gilchrist's clients, including the Pettinatis,  who had employed this type of tax-advantaged investment structure. In 2010, the IRS  issued a FPAA to BASR, which concluded that the transaction lacked economic substance  and accordingly, significantly increased the Pettinatis' tax liability for the 1999 tax  returns.

The taxpayers paid the tax and sued for a refund in the Claims Court. BASR sought  summary judgment, arguing that the adjustments and increased tax liability were  untimely under the three-year statute of limitations.¹⁹ The IRS asserted that the three-year period remained open under IRC § 6501(c)(1) because the case involved "a  fraud or fraudulent return with the intent to evade tax." The IRS conceded that the  Pettinatis and their tax preparers, Malone & Bailey, lacked the intent to evade tax. The  IRS asserted only that Erwin Mayer acted with intent to evade taxes when he conceived  and marketed the tax-advantaged investment structure.²⁰  In reply, BASR argued that the  three-year statute of limitations is suspended only when the taxpayer intended to evade  tax.

Statutory Analysis

Section 6501(c)(1) provides that "[i]n the case of a false or fraudulent return with the  intent to evade tax, the tax may be assessed ... at any time." The IRS argued that the  unlimited limitations period is triggered whenever any individual acts with intent to  evade tax and the tax return ultimately filed contains a falsity, without regard to how  remotely related that individual is to the actual tax return or to whether the taxpayer  appreciates that individual's intentions. In essence, the IRS argued that the court should  focus exclusively on the fraudulent nature of the tax return.

The Circuit Court rejected the IRS's argument and determined that Section 6501(c)(1)  was limited to the fraud of the taxpayer. The Circuit Court noted that Section 6501 is  silent as to which party or parties must have the requisite fraudulent intent to suspend  the statute of limitations. However, the Court looked to other Code provisions that dealt  with the consequences of intentional tax evasion to conclude that fraud must be by the  taxpayer, as opposed to by a third-party, who may have contributed to the filing of an  inaccurate tax return.²¹  First, the Court noted that Section 7454(a) provides that "[i]n any  proceeding involving the issue of whether the petitioner has been guilty of fraud with  intent to evade tax," the IRS bears the burden of proving the element of fraud. Thus,  under Section 7454(a), Congress considered the fraudulent intent of only the taxpayer.  Second, Section 6663(a), which requires the IRS to impose fraud penalties, provides that  "[i]f any part of any underpayment of tax required to be shown on a return is due to  fraud, their shall be added to the tax an amount equal to 75 percent of the portion of the  underpayment which is attributable to fraud." The Court noted that, like  Section 6501(c)(1), Section 6663(a) does not specify whether the "fraud must be  attributable to the taxpayer." Despite the similarities, the IRS argued that  Section 6663(a)'s fraud penalty applied only when the taxpayer commits fraud. The Court  found no basis where these two intent-based statutes could support the IRS's conflicting  interpretation.

The Circuit Court did not find the Tax Court's analysis in Allen v. Commissioner²² persuasive, where the Tax Court concluded that a tax preparer could supply the necessary  fraudulent intent to evade tax. The Circuit Court noted that the Tax Court's analysis did  not consider how its interpretation conflicted with the IRS's interpretation of Code  Sections 7454(a) and 6161. Similarly, the Court found the IRS's reliance on City Wide Transit, Inc. v. Commissioner,²³  to be misplaced, because City Wide did not address the  question of whether the tax preparer's intent was sufficient to trigger Section 6501(c)(1).

Lastly, the Circuit Court noted that the IRS's interpretation of Section 6501 was novel,  and inconsistent with its own Field Service Advisory. ²⁴  In the FSA, the IRS concluded  that, although "[s]ection 6501(c)(1) does not by its express language require that the  'intent to evade tax' be the personal intent of Taxpayer[.] [w]e nonetheless conclude that  the fraudulent intent of the tax return preparer is insufficient to make section 6501(c)(1)  applicable."

Chief Judge Prost dissented and stated that in the case of Section 6501(c)(1), which must  receive a strict construction in favor of the Government, Congress did not limit the statute  to the taxpayer's intent.

According to the dissent, judicial inquiry is complete by looking to the words of the statute where the statute's plan and unambiguous language does not  limit the intent to evade tax to only the taxpayer's intent.  Accordingly, the dissent opined that the intent to evade tax must only be present in a false  or fraudulent return, irrespective of who possesses that intent.

Footnotes

 18  BASR Partnership v. U.S., No. 2014-5037 (Fed. Cir., July 29, 2015)

 19  See, IRC §§ 6229(a) and 6501(a).

20  Slip Opn. at 7.

21  Slip Opn. at 13 – 15.

22  128 T.C. 37 (2007).

23  709 F.3d 102 (2d Cir. 2013)

24  IRS Field Service Advice Mem. 200104006.

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