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 v. Commissioner 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 to Catlett v. Commissioner
Irvin Hannis Catlett, Jr. was not good at taxes…in life or in death.
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
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.”
The Exam and Delay
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.”
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
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
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
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).
- understating income;
- keeping inadequate records;
- giving implausible or inconsistent explanations of behavior;
- concealing income or assets;
- failing to cooperate with tax authorities;
- engaging in illegal activities;
- supplying incomplete or misleading information to a tax return preparer;
- providing testimony that lacks credibility;
- filing false documents (including false tax returns);
- failing to file tax returns; and
- 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
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
Engaging in Illegal Activities
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
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).
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).