Procedure & Administration
The Second Circuit held that the filing of fraudulent tax returns for a corporation by an accountant to embezzle money that was owed to the IRS was an intentional evasion of taxes that tolled the statute of limitation on assessment.
Background
Ray Fouche owned several bus companies, including City Wide Transit Inc. City Wide transported handicapped children throughout New York City. By the end of 1998, Fouche’s bus companies, including City Wide, collectively accrued about $700,000 in outstanding payroll tax liabilities.
To negotiate a reduction of these liabilities, Fouche hired Manzoor Beg, who falsely held himself out as a CPA, and gave him a blank power of attorney. Fouche also hired a third-party payroll service to prepare City Wide’s Forms 941, Employer’s Quarterly Federal Tax Return, for the quarters June 1997; December 1998; March 31, June 30, and Dec. 31, 1999; and March 31 and June 30, 2000. For each of those last five quarters, Fouche drafted checks payable to the IRS sufficient to cover City Wide’s liabilities and gave them, along with the corresponding returns, to Beg, who in turn promised to deliver them to the revenue officer with whom he was negotiating.
Instead of filing the correct returns, however, Beg prepared, signed, and filed another set of returns on Forms 941 for those five quarters. In those returns, Beg fraudulently added advance earned income credit (EIC) payments that significantly reduced City Wide’s tax liabilities. Beg then altered the checks that City Wide drafted by changing the payee, deposited or cashed those checks for his own personal use, and drafted new checks to cover City Wide’s fraudulently reduced tax liabilities on the returns he had prepared. He also subsequently filed amended Forms 941 for several previous periods with fraudulent EIC payment amounts, presumably in an effort to conceal his embezzlement.
Beg’s scheme was eventually uncovered, and in 2002 Beg was prosecuted. He pleaded guilty to preparing false tax returns, but died before sentencing. In 2004, the IRS commenced a civil examination of City Wide to recover the underassessed taxes due to Beg’s fraud and assessed City Wide additional taxes as a result of the examination in February 2007.
City Wide challenged the assessments administratively as time-barred under Sec. 6501(a), which requires that the IRS assess any tax within three years after a return is filed. However, the IRS upheld the assessment, ruling that the statute of limitation period on assessment had been tolled by Beg’s filing of the fraudulent tax returns under Sec. 6501(c)(1), which allows the IRS to assess a tax at any time in the case of a false and fraudulent return with the intent to evade tax. City Wide petitioned the Tax Court for relief.
The Tax Court’s Decision
The Tax Court held in favor of City Wide (City Wide Transit, Inc., T.C. Memo. 2011-279). While it found that the statute of limitation would have been tolled under the exception in Sec. 6501(c)(1) if Beg had the specific intent to evade City Wide’s taxes, it concluded that the IRS had failed to prove that Beg had this intent. The Tax Court found that while the IRS had shown that Beg had performed a number of “egregious” acts that caused the IRS to fail to collect all the tax that City Wide owed, this did not prove that Beg had intended to evade City Wide’s taxes and that tax evasion was only the incidental or secondary consequence of his embezzlement scheme.
Therefore, because three years had passed since Beg had filed the returns and the statute of limitation for assessment under Sec. 6501(a) had not been tolled, the IRS was time-barred from assessing any additional taxes against City Wide. The IRS appealed the Tax Court’s decision to the Second Circuit.
The Second Circuit Reverses
The Second Circuit reversed the Tax Court and held that Beg’s filing of the fraudulent returns triggered the tolling provision in Sec. 6501(c)(1) and that, therefore, the IRS was free to assess City Wide for the unpaid payroll taxes at any time. The court agreed with the Tax Court that the tolling provision in Sec. 6501(c)(1) was triggered only if Beg had intentionally evaded City Wide’s taxes as part of his embezzlement scheme, but that the Tax Court had clearly erred in finding he had not intentionally evaded the taxes.
The Second Circuit stated that by finding that the IRS had failed to prove that Beg intended to evade City Wide’s taxes and that, at best, tax evasion was but an “incidental,” “secondary effect” to Beg’s embezzlement scheme, the Tax Court had inappropriately substituted motive for intent. The Second Circuit explained that the motivations for submitting a fraudulent return were irrelevant and that Sec. 6501(c)(1) requires only that the IRS prove a fraudulent return was filed with an intent to evade paying a tax otherwise due. Thus, the exception would apply if a minor objective of a scheme that involved the filing of fraudulent returns was the evasion of federal taxes, even though the primary objective was to conceal another crime. The IRS only had to prove that Beg intended to underpay the taxes that City Wide owed when he filed a fraudulent return on City Wide’s behalf, not that he intended to avoid City Wide’s taxes for City Wide’s benefit.
In addition, the Second Circuit found that tax evasion was not an incidental or secondary effect to Beg’s scheme. The court stated, “The tax court’s analysis suggests that Beg’s tax evasion was an externality, as if shortchanging the Commissioner did not figure into Beg’s decision-making calculus. To the contrary, Beg’s scheme was tax evasion; tax evasion was not a subordinate element to a more grandiose scheme. It is of no consequence that Beg evaded City Wide’s taxes for his own benefit.”
The Second Circuit also pointed out that it would be another case if, for example, Beg had caused personal expenses to be recorded as corporate expenses on City Wide’s books, in turn causing City Wide to file a tax return that fraudulently understated its income. In that instance, Beg’s fraud on the company would have caused the company to file a false return, but a court could not assume that the company intended to evade a tax by filing that false return. However, this was not what had happened, and Beg was not a third-party unrelated to the preparation and filing of the returns.
Reflections
As a footnote to the opinion explains, City Wide conceded on appeal that it was responsible for the returns filed by Beg. Therefore, the court did not decide whether factual situations might arise where the taxpayer’s liability might be severed from the tax preparer’s wrongdoing, which effectively is what the position adopted by the Tax Court did.
City Wide Transit, Inc., No. 12-1040-ag (2d Cir. 3/1/13)
