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Catlett v. Commissioner (T.C. Memo. 2021-102)

On August 16, 2021, the Tax Court issued a Memorandum Opinion in the case of Catlett v. Commissioner (T.C. Memo. 2021-102). The primary issue presented in Catlett was whether the IRS satisfied its burdens of production and proof to dismiss the petition for lack of prosecution…because the petitioner died…in prison…on a 17 ½ year stint in the hoosegow for tax crimes and conspiracy to defraud the United States.

Background

Irvin Hannis Catlett, Jr. was not good at taxes…in life or in death.

Catlett v. Commissioner

You see, Irvin ran a tax mill called Tax Resolutions, Inc. in Maryland.  In the early 2000s, ol’ Irvin devised a tax shelter scheme.  But Irvin wasn’t alone.

Oh, no…he wasn’t alone by a long shot…

Irvin had a man on the inside—Mark Hunt, and IRS officer.  Irvin incorporated sham entities that the Tax Court referred to collectively as Motors Holding. He urged his clients to invest in these entities, describing them as automobile leasing and sales companies. He told his clients that their ownership in Motors Holding would generate substantial losses and positively eliminate their taxable income. He then prepared tax returns for these individuals reporting the fictitious losses.

Irvin and Officer Hunt engaged in this scheme for ten years. During that period, he prepared at least 250 tax returns for his clients reporting fictitious losses exceeding $22 million. Irvin assured his clients that the IRS would not catch wind of the scheme because he had Mr. Hunt working “on the inside” (quotes in the original).

The Indictment of Irvin

Catlett Not Good

In March 2010, Irvin was indicted in the U.S. District Court for the District of Maryland for—among other things—conspiracy to defraud the United States in violation of 18 U.S.C. § 371, aiding and assisting in the preparation of false tax documents in violation of IRC § 7206(2), and attempting to obstruct and impede the administration of the internal revenue laws in violation of IRC § 7212(a).

The indictment charged that petitioner “did willfully aid and assist in…the preparation…of income tax returns that were false and fraudulent…in that they reported nonpassive losses that had not [technically] been incurred.” Irvin allegedly did this by preparing “backwards” returns, i.e., “by first determining each client’s tax without including a tax shelter entity loss on the return and then adding to the return a fictitious loss from a tax shelter entity large enough to reduce the client’s tax to zero.”

Catlett Fraud CriminalIn November 2010, a jury convicted Irvin Haniss Catlett, Jr., on each count. On March 22, 2011, he was sentenced to 210 months’ (17 ½ years) in the pokey and ordered to pay restitution of $3,810,244, the amount of the Government’s estimated tax loss. After he was remanded to custody, the IRS initiated a civil examination of his individual income tax liabilities for 2006-2010.

The Exam and Delay

Catlett DelayYou cannot say that Ol’ Irvin didn’t put up a fight, though.  Even from behind steel bars, he was a cantankerous old thing.  The revenue agent (RA) assigned to conduct the examination issued document requests to petitioner, but he “declined to comply.” The RA then issued summonses to his banks. Petitioner filed no less than three lawsuits in an attempt to quash these summonses, but each attempt was unsuccessful. These actions delayed the IRS’ examination by 330 days and pissed of Uncle Sam something fierce.

The RA ultimately obtained voluminous bank records. The RA reconstructed Irvin’s income using the bank deposits method, concluding that the deposits into the corporate accounts, as well as into Irvin’s personal accounts, were beneficially owned by him. The RA determined that Irvin understated income by $407,988 for 2006, by $98,943 for 2007, and by $115,661 for 2008. The RA also determined that for each year, Irvin had claimed numerous unsubstantiated deductions.  The RA attempted to discuss his findings with Irvin, offering him the opportunity to supply evidence that certain deposits were nontaxable. But, once more, Irvin “declined the offer.”

Catlett Oh Dear 1Irvin filed no Federal income tax return for 2009 or 2010—well, for himself, that is. The RA accordingly prepared and certified, for those years, a substitute for return (SFR) that met the requirements of IRC § 6020(b). These SFRs show that petitioner failed to report $238,507 of income for 2009.  Irvin had a small tax liability for 2010, but that was to be expected, because 2010 was the year he was indicted for screwing the Federal fisc for 10 years.

On March 6, 2014, the IRS issued petitioner a notice of deficiency for 2006-2010.  Irvin, quite the jailhouse tax attorney by this point, timely petitioned for redetermination in June 2014. This case was originally calendared for trial in November 2015, but it was “continued several times due to his incarceration.” In January 2020 he died while in prison—likely by a shiv crafted from the spine of a copy of the 1986 Code…but I’m just guessing, here.

Irving’s Kids Want Nothing to Do with the Tax Man

Catlett Off the StandThe IRS filed numerous status reports informing the Tax Court of his efforts to locate members of petitioner’s family. On November 19, 2020, Bartholomew Cirenza (my new favorite IRS Chief Counsel attorney, based on name only) represented that petitioner died intestate, that no fiduciary had been appointed for his estate, that no probate or other proceeding had been commenced in State court, that petitioner was survived by his brother and two children, and that none of these individuals intended to participate in this case. Bartholomew indicated that he would move to dismiss the case for lack of prosecution but that a trial would be necessary to enable him to meet his burdens of production and proof.

On June 11, 2021, Bartholomew moved to dismiss for lack of prosecution. The Tax Court took that motion under advisement and proceeded to trial.

The Dismissal

Catlett DismissedThe Tax Court may dismiss a case at any time and enter a decision against the taxpayer for failure to prosecute his case properly or failure to comply with the Tax Court’s orders and Rules. See Rule 123(b). If a taxpayer dies while his case is pending, the Tax Court will ordinarily substitute the taxpayer’s representative or successor as the proper party. See Rule 63(a). If there is no representative or successor, the Tax Court may ask the IRS to furnish the identities of individuals who possess a “monetary interest” in the outcome of the case. See Nordstrom v. Commissioner, 50 T.C. 30, 32 (1968). If no individual expresses an interest, or hides in the closet when the Tax Man comes a’knockin’, the Tax Court will dismiss the case for lack of prosecution. Id.

The Tax Court gave all three family members notice of the trial and offered them the opportunity to appear. They declined to appear, and no other representative appeared on Irvin’s behalf. Under these circumstances, the Tax Court had no choice but to dismiss the case for lack of prosecution. The decision that it entered sustained all adjustments insofar as Irvin bore the burden of proof. See Branson v. Commissioner, T.C. Memo. 2012-124.

A Discussion of the Fraud Penalty

Catlett Frowns on It
Indeed they do. Indeed they do.

Sure, Irvin had been convicted of criminal tax fraud, but interestingly enough, that’s not enough to establish civil tax fraud (even though criminal fraud must be proven beyond a reasonable doubt, and civil fraud need only be proven by clear and convincing evidence—a lower standard).  When the IRS asserts the civil fraud, it has the burden of proving fraud by clear and convincing evidence.  See IRC § 7454(a); Rule 142(b). To sustain his burden, respondent must establish two elements: (1) that there was an underpayment of tax for each year at issue and (2) that at least some portion of the underpayment for each year was due to fraud. Hebrank v. Commissioner, 81 T.C. 640, 642 (1983).

“If any part of any underpayment of tax required to be shown on a return is due to fraud,” IRC § 6663(a) imposes a penalty of 75% of the portion of the underpayment attributable to fraud.  Where the IRS determines fraud penalties for multiple tax years, its burden of proving fraud “applies separately for each of the years.” Vanover v. Commissioner, T.C. Memo. 2012-79 (quoting Temple v. Commissioner, T.C. Memo. 2000-337, aff’d, 62 F. App’x 605 (6th Cir. 2003)).

If the IRS proves that any portion of an underpayment for a particular year was attributable to fraud, then the entire underpayment shall be treated as attributable to fraud unless the taxpayer shows, by a preponderance of the evidence, that the balance was not so attributable. IRC § 6663(b).

With respect to Irvin Hannis Catlett, Jr., the IRS has carried his burden of proving that Irvin underreported his income and underpaid his tax for 2006-2008. The remaining question is whether any portion of these underpayments was due to fraud.

What is Fraud?

Fraud is an intentional wrongdoing designed to evade tax believed to be owing. Neely v. Commissioner, 116 T.C. 79, 86 (2001).  The existence of fraud is a question of fact to be resolved upon consideration of the entire record. Estate of Pittard v. Commissioner, 69 T.C. 391, 400 (1977). Fraud is not to be presumed or based upon mere suspicion. Petzoldt v. Commissioner, 92 T.C. 661, 699-700 (1989). However, because direct proof of a taxpayer’s intent is rarely available, fraudulent intent may be established by circumstantial evidence. Id. at 699.

The IRS satisfies its burden of proof by showing that “the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes.” Parks v. Commissioner, 94 T.C. 654, 661 (1990). The taxpayer’s entire course of conduct may be examined to establish the requisite intent, and an intent to mislead may be inferred from a pattern of conduct. Webb v. Commissioner, 394 F.2d 366, 379 (5th Cir. 1968), aff’g T.C. Memo. 1966-81; Stone v. Commissioner, 56 T.C. 213, 224 (1971).

Catlett FalsehoodCircumstances that may indicate fraudulent intent, often called “badges of fraud,” include but are not limited to:[1]

  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.

No single factor is dispositive, but the existence of several factors “is persuasive circumstantial evidence of fraud.” Vanover, T.C. Memo. 2012-79.  Several of these factors are neutral or inapposite here. Because Irvin was, himself, a professional return preparer, he had no need to supply information to such a person, and because he declined to participate in the IRS examination, he had no occasion to make implausible statements. Nevertheless, after thorough review of the record, the Tax Court concluded that at least six badges of fraud demonstrate that Irvin acted with fraudulent intent.

Understating Income

A pattern of substantially understating income for multiple years is strong evidence of fraud, particularly if the understatements are not satisfactorily explained. See Vanover, T.C. Memo. 2012-79. Given the source of this income, the substantial amounts underreported, and Irvin’s pattern of underreporting, these understatements are persuasive evidence of fraudulent intent.  Game, IRS.

Keeping Inadequate Records

Catlett DeclinedIrvin failed to maintain adequate records and supply them to the IRS. The RA repeatedly asked Irvin to provide records of his banking activity and to substantiate the deductions he claimed. Irvin “declined” to provide any documents whatsoever, and he offered no explanation as to why he did not provide them. He then commenced three separate lawsuits, all meritless, in an effort to prevent the IRS from getting records from his banks. Irvin’s pattern of activity is a textbook example of a taxpayer’s intent “to conceal information” from the IRS. See Meier v. Commissioner, 91 T.C. 273, 302 (1988).  Game, IRS.

Concealing Income or Assets

A willful attempt to evade tax may be inferred from a taxpayer’s concealment of income or assets. Spies v. United States, 317 U.S. 492, 499 (1943). Irvin used a tax preparation business to hide an illegal tax shelter scheme. He persuaded his clients to “invest” in sham entities. He opened bank accounts for these entities in which he deposited more than $1 million. He did not report this income or disclose his control over the bank accounts…and he took numerous steps to avoid detection: He described the sham entities as automobile leasing and sales companies; he claimed that the entities incurred millions of dollars in bogus losses; and he partnered with an IRS officer to persuade clients that his illegal scheme would escape IRS scrutiny.

Stated simply, his entire course of conduct revealed a “deliberate intent to conceal income and assets.”  Game, IRS.

Failure To Cooperate With Tax Authorities

Catlett Dont Want ToPetitioner did not cooperate with the IRS during the examination. He failed to provide any documents to substantiate the deductions claimed on his returns. He refused to supply the RA with his banking records, and he filed three meritless lawsuits in an effort to quash summonses issued to his banks. These actions, which protracted the audit by almost a year, evidence an intent to obstruct the RA’s examination.  Game, IRS.

Engaging in Illegal Activities

Catlett Con ArtistsIrvin was indicted and convicted on 12 counts, including conspiracy to defraud the United States in violation of 18 U.S.C. § 371 and aiding in the preparation of false tax documents in violation of IRC § 7206(2). He convinced clients to invest in sham entities by the promise of tax losses. He then prepared false returns for those clients.

Indeed, the indictment alleged, he prepared “backwards” returns “by first determining each client’s tax without including a tax shelter entity loss on the return and then adding to the return a fictitious loss from a tax shelter entity large enough to reduce the client’s tax to zero.” As a tax return preparer, he must have known that this was illegal. Indeed, he partnered with an IRS officer, whom he described as his “man on the inside,” to induce clients to participate in his scheme. All of these illegal shenanigans evidence fraud. See Dung Le v. Commissioner, T.C. Memo. 2020-27. Set, IRS.

Filing False Documents

Catlett Malarkey 1Irvin was convicted of violating IRC § 7206(2) and IRC § 7212(a) by preparing false and fraudulent income tax returns for his clients. During the examination the RA discovered that petitioner had prepared at least 250 fraudulent returns reporting more than $22 million in bogus losses. He also filed false or misleading articles of incorporation, prospectuses, and stock certificates for the sham entities deployed to carry out his tax shelter scheme.

Irvin likewise filed false returns on his own behalf for 2006-2008, omitting more than $600,000 of gross income. As a professional return preparer, he must have recognized his obligation to report this income. These false documents furnish additional evidence of fraudulent intent.  Match, IRS.

It should come as no surprise to those keeping score at home that the Tax Court had little trouble concluding that the IRS established by clear and convincing evidence that the underpayments of tax for 2006-2008 were attributable to fraud.  Lots and lots of fraud. Irvin submitted no evidence showing that any portions of these underpayments were not due to fraud, because you know, he was dead. The IRS, therefore, could assess the deficiencies and penalties for 2006-2008 at any time pursuant to IRC § 6501(c)(1).

Interesting Note on Fraudulent Failure to File Penalty

You’ll remember that Bartholomew also alleged that Irvin fraudulently failed to file his 2009 return.  IRC § 6651(f) provides that, “[i]f any failure to file any return is fraudulent,” the addition to tax imposed by IRC § 6651(a)(1) shall accrue at a rate of 15% per month, not to exceed 75% in the aggregate. Bartholomew has the burden of proving fraud, and he must prove it by clear and convincing evidence. See IRC § 7454(a); Rule 142(b).

Where dismissal for lack of prosecution is appropriate, the IRS can satisfy its burden by presenting, “either in the pleadings or at trial…sufficient facts to sustain a finding of fraud.” Fifer v. Commissioner, T.C. Memo. 1993-44; see also Smith v. Commissioner, 91 T.C. 1049, 1058 (1988) (holding that “the Commissioner’s pleadings must allege specific facts sufficient to sustain a finding of fraud before he will be entitled to a” default judgment), aff’d, 926 F.2d 1470 (6th Cir. 1991).

Catlett No

The trouble was, when Irvin’s 2009 return was due (April 15, 2010), he had just been indicted for tax crimes.  Under these circumstances, the Tax Court observed that Irvin’s failure to file his 2009 return may have been attributable to various causes, e.g., distraction occasioned by the criminal prosecution, advice of counsel, or reluctance to take a position inconsistent with the positions taken on his prior returns. Considering the record as a whole (including the facts contained in Bartholomew’s pleadings), the Tax Court concluded that Bartholomew did not carry his burden of proving that Irvin’s failure to file for 2009 was fraudulent. As such, the Tax Court did not sustain the IRC § 6651(f) addition to tax for 2009.

Footnote:

[1] See Schiff v. United States, 919 F.2d 830, 833 (2d Cir. 1990); Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), aff’g T.C. Memo. 1984-601; Parks, 94 T.C. at 664-665; Recklitis v. Commissioner, 91 T.C. 874, 910 (1988); Morse v. Commissioner, T.C. Memo. 2003-332, aff’d, 419 F.3d 829 (8th Cir. 2005).

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