Court of Appeals for the Federal Circuit Holds that Fraud by a Third Party Does Not Extend the Statute of Limitations by LACEY STRACHAN
In BASR Partnership, William F. Pettinati, Sr., Tax Matters Partner v. United States, No. 2014-5037 (Fed. Cir. July 29, 2015), the Court of Appeals for the Federal Circuit held that the statute of limitations period is suspended under Internal Revenue Code (“IRC”) Section 6501(c)(1) only when the IRS establishes that the taxpayer acted with the intent to evade tax — the intent of a third party, including a tax advisor, cannot extend the statute of limitations. The Federal Circuit’s holding in BASR Partnership is contrary to the earlier holding of the Tax Court in Allen v. Commissioner, 128 T.C. 37 (2007), which had held that fraud by a tax preparer can hold open the statute of limitations for a tax return. The Federal Circuit declined to follow Allen, finding the Tax Court’s reasoning to be unpersuasive.[i]
Statute of Limitations on Assessment. IRC Section 6501(a) provides that generally, the IRS is prohibited from assessing additional tax more than three years after a return is filed.[ii] However, there is an exception to this rule in the case of a fraudulent return. Among other exceptions, Section 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.”[iii] Section 6501(c) does not expressly specify whose intent is relevant for purposes of extending the statute of limitations.
Impact on S/L of Fraud by Others. In BASR Partnership, although the government had conceded that the three-year statute of limitations had expired, the government argued instead that the fraudulent intent of the taxpayer’s attorney, who had recommended and advised the taxpayer regarding the transactions at issue in the case, caused the statute of limitations to be open pursuant to Section 6501(c)(1).[iv] The taxpayer in BASR Partnership filed a motion for summary judgment at the trial court level on the grounds that the statute of limitations had expired, which the Court of Federal Claims granted.
In affirming the Claims Court’s holding, the Court of Appeals analyzed the overall statutory scheme of the Code, the case law, and the statute’s historical roots in concluding that it is only the intent of the taxpayer that triggers the suspension of the statute of limitations for fraud. The court rejected the government’s argument that the focus should be on the fraudulent nature of the return, explaining that the government’s argument “misses the mark” because a return becomes fraudulent only when someone acting with the intent to defraud makes a false entry on the return.[v] The court held that although the statute is silent on whose return is relevant, when viewed in the context of the statutory scheme as a whole, the other provisions in the Code strongly suggest that the “intent to evade tax” inquiry is confined to the taxpayer’s intent. In particular, the court noted that Section 7454(a) specifies that “’[i]n any proceeding involving the issue whether the petitioner has been guilty of fraud with intent to evade tax,’ the IRS bears the burden of proving the element of fraud.”[vi] Based on this, the court concluded that when pursuing fraudulent conduct, Congress considered the fraudulent intent of only the taxpayer, not of a third-party who advised or assisted the taxpayer.
The court also considered Section 6663(a), which imposes a 75 percent penalty on understatements due to fraud. Although Section 6663(a) is also silent as to whose intent is relevant, the government had conceded that the penalty under Section 6663(a) applies only when the taxpayer intends to evade tax, not when the fraud was committed by a third party. The court did not find any basis for distinguishing the meaning of “intent to evade tax” in Section 6663(a) from Section 6501(c)(1) and explained that the Government’s broad interpretation of Section 6501(c)(1) could have unintended and unfortunate consequences if applied to other code provisions.[vii]
Examining the historical roots of section 6501(c)(1), the court explained that in the Revenue Act of 1918, both the penalty provision and the statute of limitations provision relating to fraud appeared as subsections under the same Code section.[viii] Section 250(b) of the Revenue Act of 1918 imposed a penalty when an underpayment was due to the fraud of the taxpayer, and section 250(d) provided for the suspension of the statute of limitations for fraudulent returns. Because Section 250(b) made clear that no penalties would apply if the understatement was not due to the fault of the taxpayer, the reference to fraud in Section 250(b) must have pertained only to the fraud of the taxpayer. Two subsections later, the provision extending the statute of limitations borrowed the same “false or fraudulent with intent to evade tax” language from Section 250(b).
Based on the mirroring language and the Supreme Court’s rule that a word is presumed to have the same meaning in all subsections of the same statute, the Court of Appeals for the Federal Circuit concluded that “it becomes abundantly clear that the focal point of § 250 is the intent of the taxpayer.”[ix] Although those subsections were later recodified into separate statutory sections, the court concluded that nothing in the recodification and reorganization process altered the meaning of these terms.[x]
In considering the case law that has touched on this issue, the Court of Appeals declined to follow the Tax Court’s holding in Allen v. Commissioner, concluding that “we do not find the reasoning of the Tax Court persuasive.”[xi] The government also argued that a Second Circuit case supported its interpretation; however, the court explained that the government’s reliance was misplaced because in the Second Circuit case, the court did not actually address the question of whether the tax preparer’s intent was sufficient to trigger the suspended statute of limitations.[xii] Finally, the court noted that the IRS’ position on this issue had changed in recent years, citing a Field Service Advisory issued in 2001 in which the IRS concluded that “the fraudulent intent of the return preparer is insufficient to make section 6501(c)(1) applicable.”[xiii]
BASR – Fraud by Taxpayer Required to Extend S/L. Based on this analysis, the court concluded that the “language, structure, and history of the Code leads us to the conclusion that the Claims Court properly interpreted § 6501(c)(1) as limiting the IRS to the three-year limitations period unless the taxpayer possessed the intent to evade tax.”[xiv]
LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a tax attorney at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at http://www.taxlitigator.com.
[i] BASR Partnership, William F. Pettinati, Sr., Tax Matters Partner v. United States, No. 2014-5037 (Fed. Cir. July 29, 2015) at *16.
[ii] IRC § 6501(a) states, in pertinent part: “Except as otherwise provided in this section, the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed (whether or not such return was filed on or after the date prescribed)….”
[iii] Section 6501(c) sets forth 11 exceptions to the 3-year statute of limitations.
[iv] In BASR Partnership, the taxpayer’s attorney had pleaded guilty to conspiracy and tax evasion charges relating to his design and implementation of numerous fraudulent tax shelters. Id. at *7 n.2.
[v] Id. at *11.
[vi] Id. at *12 – *14.
[vii] Id. at *14-*15. As an example, the court explained that such an interpretation would prevent taxpayers in this situation from being able to receive an extension for payment of a tax deficiency under Section 6161, which prohibits the IRS from granting an extension to taxpayers when the tax deficiency in question is due to, in pertinent part, fraud with intent to evade tax. Id. at *15 – *16.
[viii] Id. at *20 – *22.
[ix] Id. at *22.
[xi] Id. at *16 – *18.
[xii] Id. at *18 – *19.
[xiii] Id. at *19.
[xiv] Id. at *24.