Tax Court in Brief | Fabian v. Comm’r | Fraudulent Returns, Constructive Receipt, and Guilty Plea | Don’t be Like Fabian

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The Tax Court in Brief – September 12th – September 16th, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

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Tax Litigation:  The Week of September 12th, 2022, through September 16th, 2022

Fabian v. Comm’r, T.C. Memo 2022-94| September 13, 2022 | Halpern, Judge | Dkt. No. 25589-14

Summary: “A tax return is not evidence of the truth of the statements in it.” Boiled down to a nutshell, this 44-page opinion regards taxpayer, Alan Fabian’s (Petitioner’s)—a highly-educated tax professional (CPA, no less)—effort to, essentially, defraud the United States Treasury through avoidance of his tax liability for periods dating back to 2002. The tax liabilities in issue were triggered by, among other things, elaborate and even coercive transactions and high-dollar but “ostensible” computer hardware sales-and-lease-back arrangements involving Petitioner and companies in which Petitioner owned or participated. (Aside: When the word “ostensible” is used repeatedly by the U.S. Tax Court to describe a taxpayer’s financial transactions, the tax-liability outcome for those transactions is, likely, not good for the taxpayer.) Petitioner’s spouse, Jacqueline Richards-Fabian, was also involved in the matter as the federal income tax returns in issue were joint returns. However, in a separate proceeding, she obtained certain innocent spouse relief, and the focus in this opinion was squarely on Petitioner. With regard to Petitioner: “Things . . . were not as they appeared.” To give a flavor of the legal troubles brought upon himself, in 2007, a criminal investigation culminated with a multicount grand jury indictment charging him with, among other crimes, mail fraud and making and subscribing a false tax return for 2003. Petitioner pleaded guilty to certain counts, and he signed a plea agreement and a supporting statement of facts summarizing events that occurred between 2001 and 2004 and that supported his guilty plea—a principal theme was fraud, including fraudulent transactions involving $32,000,000 and Petitioner’s use of such windfalls to generously donate to his children’s private school, to pay for private jet travel, etc. Ultimately, civil tax assessments were noticed and fraud penalties were assessed. Petitioner challenged those civil assessments and penalties.

If further details on Mr. Fabian’s nefariousness is desired, please seek out and review the opinion, in full. This Freeman Law Tax Court in Brief, however, will focus on the key outcomes and takeaways from the Tax Court’s opinion.

Key Issues: Did the IRS prove the underpayment of taxes in issue and that those underpayments were the result of fraud committed by Fabian?

Primary Holdings: Yes. The IRS proved, by clear and convincing evidence, that the Fabians both underpaid their 2002, 2003, and 2004 tax liabilities and that, with respect to those underpayments, Fabian acted with fraudulent intent. The fraud penalty applies to the entirety of the underpayments for those years.

Key Points of Law:

Periods of Limitation. Generally, the period of limitations to assess any unpaid income tax (including penalties and additions to tax) runs three years from the later of (1) the date a taxpayer files a return or (2) the last day prescribed by law or by regulations for filing the return. See 26 U.S.C. § 6501(a), (b)(1). If a taxpayer files a false or fraudulent return with the intent to evade tax, the tax may be assessed at any time. Id. at § 6501(c)(1). The period of limitations is an affirmative defense, which must be pleaded. If the taxpayer raises the defense and the IRS relies on section 6501(c)(1) to show that the period of limitations has not expired, the IRS bears the burden to prove that the taxpayer has filed a false or fraudulent return with the intent to evade tax for each year at issue. See id. at § 7454(a). Fraud for this purpose is defined as intentional wrongdoing by the taxpayer with the specific purpose of avoiding tax believed to be owed. See Schwartz v. Commissioner, T.C. Memo. 2016-144, at *19, aff’d in an unpublished order, No. 16-2502, 2017 WL 5125662 (6th Cir. Sept. 5, 2017).

Intent to Defraud. Imposition of the civil fraud penalty is appropriate upon the IRS showing, by clear and convincing evidence, that the taxpayer intended to evade taxes believed to be owing by conduct designed to conceal, mislead, or otherwise prevent the collection of taxes. Id.; see also Neely v. Commissioner, 116 T.C. 79, 85 (2001). Intent may be proved by circumstantial evidence and reasonable inferences from the facts. See Feller v. Commissioner, 135 T.C. 497, 501–02 (2010). If any part of a return is determined to be the result of fraud, a taxpayer may not assert as a defense that the period of limitations has expired. See Lowy v. Commissioner, 288 F.2d 517, 520 (2d Cir. 1961), aff’g T.C. Memo. 1960-32; Garavaglia v. Commissioner, T.C. Memo. 2011-228, 2011 WL 4448913, at *30, aff’d, 521 F. App’x 476 (6th Cir. 2013). It is sufficient to satisfy section 6501(c)(1) that one spouse filing a joint return had the requisite fraudulent intent. See, e.g., Vannaman v. Commissioner, 54 T.C. 1011, 1018 (1970).

Guilty Plea.  A taxpayer’s admissions of tax fraud in a criminal proceeding guilty plea are sufficient for the Tax Court to conclude that the taxpayer intended to evade taxes believed to be owing for the years in issue in the plea. The Tax Court often relies on statements in a taxpayer’s plea agreement in his or her criminal case as evidence of fraud in a following civil fraud penalty case.

Corporate Dividends and Respecting Corporate Form for Tax Purposes. The threshold for respecting the corporate form for tax purposes is low. See Moline Props., Inc. v. Commissioner, 319 U.S. 436, 438–39 (1943). Sections 301 and 316 govern the characterization of a corporate distribution of property to a shareholder with respect to its stock. If the distributing corporation has sufficient earnings and profits, then the distribution is a dividend, which is included in the shareholder’s gross income. 26 U.S.C. §§ 301(c)(1), 316. If the distribution exceeds the corporation’s earnings and profits, the excess is, first, a return of capital, and any remaining amount is taxed as capital gain. Id. at § 301(c). Among the items entering the computation of corporate earnings and profits for a particular period are items includible in gross income under section 61. See Treas. Reg. § 1.312-6(b). Gross income includes income derived from a business, regardless of whether the business is lawful or whether the money was obtained unlawfully. See 26 U.S.C. § 61(a)(2); James v. United States, 366 U.S. 213, 221 (1961); United States v. Sullivan, 274 U.S. 259, 263 (1927). Generally, the taxpayer bears the burden of proving that the corporation lacks sufficient earnings and profits to support dividend treatment. Truesdell v. Commissioner, 89 T.C. 1280, 1295–96 (1987).

Constructive Receipt of Dividend. Characterization of a payment by a corporation as a distribution with respect to its stock depends neither upon the corporation’s formally declaring a dividend nor upon a shareholder’s actually receiving it. See, e.g., Boulware v. United States, 552 U.S. 421, 430 (2008); Combs v. Commissioner, T.C. Memo. 2019-96, at *12-13, aff’d, 859 F. App’x 807 (9th Cir. 2021). A dividend not formally declared is a constructive dividend. The test for a constructive dividend has two prongs: 1. the corporation must have conferred an economic benefit on the shareholder without expectation of repayment, and, 2. the benefit conferred by the corporation must primarily advance the shareholder’s personal interest as opposed to the business interest of the corporation. See, e.g., Midwest Stainless, Inc. v. Commissioner, T.C. Memo. 2000-314, 2000 WL 1470664, at *4.

Fraud Penalty. “If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.” 26 U.S.C. § 6663(a). If the IRS establishes that some part of an underpayment was due to fraud, the entire underpayment is treated as attributable to fraud unless the taxpayer proves otherwise. Id. at § 6663(b). The fraud penalty may be applied against a spouse only where some part of the underpayment is due to the fraud of the spouse. Id. at § 6663(c). No fraud penalty will be imposed with respect to any portion of an underpayment if the taxpayer can show “that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to [it].” Id. at § 6664(c)(1); see id. at § 6664(a) (defining “underpayment”); 26 C.F.R. § 1.6664-2(c)(1) (interpreting “underpayment”). “A taxpayer’s conviction pursuant to section 7206(1) estops him or her from contesting that an underpayment exists for the years at issue in the criminal case.” Laciny, T.C. Memo. 2013-107, at *15; see also Seiffert v. Commissioner, T.C. Memo. 2014-4, at *13, supplemented by T.C. Memo. 2014-61.

Insights: See Fabian engage in elaborate, ostensible, and unlawful tax shelters. See Fabian basically force his spouse to seek available (but not guaranteed) legal and equitable relief through an innocent spouse proceeding. See Fabian abuse his authority as officer of affiliated companies to benefit himself and cause other companies to transfer funds for his benefit through corrupt schemes to obtain money from the funding sources.

Don’t be like Fabian.