Tax Court in Brief | Metz v. Commissioner | Interplay of Criminal Tax, Civil Tax, and Civil Penalties

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Tax Court in Brief | Metz v. Commissioner | Interplay of Criminal Tax, Civil Tax, and Civil Penalties

The Tax Court in Brief – April 4th- April 8th, 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 April 4th, 2022, through April 8th, 2022

Metz v. Comm’r, T.C. Memo. 2022-33 | April 7, 2022 | Weiler, J. | Dkt. No. 16784-19

Short Summary: During tax years 2000 through 2008, Daniel Metz (“Petitioner”) worked as a professional engineer. Petitioner formed Metz & Associates, Inc. in 1994 and was the sole shareholder until 2007. At that time, he dissolved Metz & Associates, Inc. and formed Metz & Associates, LLC and held a 94% membership interest. During the years at issue, Petitioner was an employee of both entities and received a salary.

For tax years 2000 through 2007, Petitioner timely filed Forms 1120S for Metz & Associates, Inc. and timely filed Forms 1065 for Metz & Associates, LLC for tax years 2007 and 2008. However, Petitioner did not timely file Forms 1040 for those tax years. Instead, for tax years 2000 and 2001, Petitioner filed “Statements,” whereby he argued that he was not required to file Forms 1040. The Internal Revenue Service (“IRS”) initiated an audit in 2009, and Petitioner filed Forms 1040 for tax years 2000 through 2007. The IRS, however, prepared a substitute for return for tax year 2008.

As part of a fraudulent scheme to obtain withholding credits, Petitioner submitted forged Forms 1099-OID with his Forms 1040 for tax years 2000 through 2007—claiming $1,297,490 in fraudulent refunds. After the Criminal Investigation Division of the IRS opened an investigation for tax years 2005 through 2007, Petitioner was ultimately convicted and sentenced for three counts of filing false or fraudulent claims and one count of attempting to obstruct or interfere with the Internal Revenue Laws. Moreover, Petitioner failed to cooperate with the IRS, taking various actions, such as: arguing that he was not subject to the Internal Revenue Code, submitting interrogatories to the IRS, failing to comply with certain summonses and information document requests, and seeking an injunction to prevent the IRS from continuing its audit.

Pursuant to its audit and reconstructing Taxpayer’s income based on its bank statement analysis, the IRS issued a notice of deficiency for tax years 2000 through 2008, determining Petitioner was liable for certain tax deficiencies and additions to tax/penalties under Sections 6663(a), 6651(a)(1), 6651(a)(2), and 6654. Petitioner timely petitioned the Tax Court and submitted the case for decision without trial under Rule 122.

Key Issues:

  • (1) Whether Petitioner received unreported income for 2005 through 2008;
  • (2) Whether Petitioner is liable for civil fraud penalties under Section 6663 for 2000 through 2007;
  • (3) Whether Petitioner is liable for additions to tax under Section 6651(a)(1) for 2005 through 2008; and
  • (4) Whether Petitioner is liable for additions to tax under Sections 6651(a)(2) and (f) and 6654 for 2008.

Primary Holdings:

  • (1) Petitioner received unreported income for 2005 through 2008;
  • (2) Petitioner is liable for civil fraud penalties under Section 6663 for 2000 through 2007;
  • (3) Petitioner is liable for additions to tax under Section 6651(a)(1) for 2005 through 2008; and
  • (4) Petitioner is liable for additions to tax under Sections 6651(a)(2) and (f) and 6654 for 2008.

Key Points of Law:

  • The Commissioner’s deficiency determination ordinarily is entitled to a presumption of correctness. See Bone v. Comm’r, 324 F.3d 1289, 1293 (11th Cir. 2003), aff’g C. Memo. 2001-43.
  • Should a taxpayer fail to cooperate in the audit of his tax returns, wide latitude is afforded the Commissioner with respect to the method he may use to reconstruct that taxpayer’s income. Giddio v. Comm’r, 54 T.C. 1530 (1970).
  • The Commissioner may use any reasonable method which reflects the taxpayer’s income, including the bank deposits method. Cupp v. Comm’r, 65 T.C. 68, 82 (1975), aff’d without published opinion, 559 F.2d 1207 (3d Cir. 1977).
  • A federal district court may order restitution to the victim of a criminal offense. 18 U.S.C. § 3663(a). Although restitution in a tax case is based upon an estimate of civil tax liability, it is not determinative of a civil tax liability. See Morse v. Comm’r, 419 F.3d 829, 833–35 (8th Cir. 2005), aff’gC. Memo. 2003-332, 86 T.C.M. (CCH) 673; Hickman v. Comm’r, 183 F.3d 535, 537–38 (6th Cir. 1999), aff’g T.C. Memo. 1997-566.
  • For purposes of Section 6663(a), to meet its burden of proving fraud by clear and convincing evidence, the Commissioner must prove for each relevant year that (1) an underpayment of tax exists and (2) the underpayment was due to fraud. Sadler v. Comm’r, 113 T.C. 99, 102 (1999); Katz v. Comm’r, 90 T.C. 1130, 1143 (1988).
  • Circumstances that may indicate fraudulent intent, often called “badges of fraud,” include but are not limited to: (1) understating income, (2) keeping inadequate records, (3) giving implausible or inconsistent explanations of behavior, (4) concealing income or assets, (5) failing to cooperate with tax authorities, (6) engaging in illegal activities, (7) supplying incomplete or misleading information to a tax return preparer, (8) providing testimony that lacks credibility, (9) filing false documents (including false tax returns), (10) failing to file tax returns, and (11) dealing in cash. See, e.g., Schiff v. United States, 919 F.2d 830, 833 (2d Cir. 1990); Bradford v. Comm’r, 796 F.2d 303, 307–08 (9th Cir. 1986), aff’gC. Memo. 1984-601; Recklitis v. Comm’r, 91 T.C. 874, 910 (1988).
  • If the Commissioner meets the burden of production with respect to the liability of the taxpayer for additions to tax, the taxpayer has the burden of proving that failure to timely file was due to reasonable cause and not willful neglect. SeeR.C. § 6651(a)(1); Higbee v. Comm’r, 116 T.C. 438, 447 (2001).
  • The Tax Court considers the same elements as when considering the imposition of the addition to tax for fraud under Section 6663 in applying Section 6651(f) to determine whether a taxpayer’s failure to file his tax returns was fraudulent. See Clayton v. Comm’r, 102 T.C. 632, 653 (1994).
  • To meet its burden of production under Section 7491(c) with respect to the Section 6651(a)(2) addition to tax, the Commissioner must provide evidence of a tax return. See Wheeler v. Comm’r, 7 T.C. 200, 208–10 (2006), aff’d, 521 F.3d 1289 (10th Cir. 2008).
  • Except in very limited circumstances, seeR.C. § 6654(e)(3), Section 6654 provides no exception for reasonable cause or lack of willful neglect.

Insight: Metz effectively deals with the civil assessments by the IRS against a tax protester. Additionally, Metz discusses the interplay between criminal tax violations (i.e., restitution) and civil tax and penalty assessments. Taxpayers should be mindful of their income tax reporting obligations, particularly when they wholly own or have majority interests in business entities. However, if taxpayers engage in fraud and openly protest the IRS, they may face exposure to both criminal and civil penalties.