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Tran v. Commissioner (T.C. Memo. 2020-27)

On February 26, 2020, the Tax Court issued a Memorandum Opinion in the case of Tran v. Commissioner (T.C. Memo. 2020-27). The three primary issues presented in Tran were (1) whether the IRS is barred by the doctrine of collateral estoppel from relitigating the petitioners’ tax liability for 2006; (2) whether the petitioners failed to report gross receipts on Schedule C (Profits or Loss From Business) with regard to their nail salons in 2004, 2005, and 2006; and (3) whether both the petitioner-husband and petitioner-wife were liable for the civil fraud penalty of IRC § 6663 and the accuracy related penalty of IRC § 6662, respectively.

Background

The petitioner-husband (Le) and the petitioner-wife (Tran) owned and operated CA Nails and Cali Nails in Lincoln, Nebraska. Tran, whose first name is Nghia, goes by the stage name “Nancy.” Le, whose first name is Dung, goes by Dung.

In 2013, Dung was indicted on three counts of attempting to evade and defeat tax under IRC § 7201 for tax years 2004, 2005, and 2006. Dung pleaded guilty to the charges brought with respect to tax year 2006, and, in exchange, the prosecutor dropped the charges for 2004 and 2005. In connection with his plea, Dung agreed to pay restitution of $33,332 to the IRS. Dung so paid, and the petitioners’ 2006 tax account was credited for the payment.

Importantly for this Tax Court case, in the plea agreement, Dung agreed that (a) he had affirmatively attempted to evade or defeat tax and the payment thereof for calendar year 2006; (b) additional tax was due and owing for calendar year 2006; and (c) Dung’s acts in attempting to evade or defeat tax or the payment thereof were willful. In essence, therefore, Dung admitted that he was, for all intents and purposes, pretty much the modern Vietnamese version of Al Capone.

After much investigation by the IRS (civil and criminal divisions), in which Dung was less than forthcoming, including deleting “memo” lines in checks that reported whether the check was for a pedicure, manicure, or otherwise, and inserting statements like “loan” or “gift from relative,” the IRS issued a statutory notice of deficiency (SNOD) to the petitioners for 2004, 2005, and 2006. In the SNOD, the IRS asserted the civil fraud penalty under IRC § 6663 against Dung for all years and, alternatively, the accuracy related penalty under IRC § 6662(a) (against both Dung and Nancy) for all years and for any portion of the underpayments to which the civil fraud penalty didn’t stick.

Burden of Proof

The IRS’s determinations in a notice of deficiency are presumed correct under most circumstances; the taxpayer bears the burden of proving those determinations erroneous. Tax Court Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In cases where the IRS alleges that a taxpayer has failed to report income, the IRS must provide “some” predicate evidence that connects the taxpayer with the income-producing activity. See Day v. Commissioner, 975 F.2d 534, 537 (8th Cir. 1992), aff’g in part, rev’g in part T.C. Memo. 1991-140; De Cavalcante v. Commissioner, 620 F.2d 23 (3d Cir. 1980), aff’g Barrasso v. Commissioner, T.C. Memo. 1978-432; Tucker v. Commissioner, T.C. Memo. 2014-51, *12.

The burden of production on the IRS is quite low, but it still exists (and this fact has bitten the IRS in the butt on more than one occasion). Once the IRS has produced even a mere peppercorn of evidence linking the taxpayer to an income-producing activity, the burden of proof shifts to the taxpayer to prove by a preponderance of the evidence that the IRS’s determinations are arbitrary or erroneous. Helvering v. Taylor, 293 U.S. 507, 515 (1935); Tokarski v. Commissioner, 87 T.C. 74 (1986). With respect to the civil fraud penalty under IRC § 6663, however, the IRS does bear the burden to prove by clear and convincing evidence that its determinations were proper. IRC § 7454(a); Tax Court Rule 142(b); see Petzoldt v. Commissioner, 92 T.C. 661, 699 (1989).

Yes, the scales of burden are weighted substantially in the IRS’s favor, but this really should not come as to great a shock to anyone who has ever had an authority figure rely on “because I said so, dammit,” as authority sufficient to end an argument. It’s the government. They do not have to play by the same rules – never have, never will. But for cases like this one, I am not going to lose any sleep about it. Dung was about as stereotypical a tax evader / fraudster as they come, and, in the end, Dung was just so full of…well…himself.

Bank Deposits Analysis

The IRS reconstructed the petitioners’ income through a detailed analysis of all of their business and personal bank accounts. This “bank deposits” method of reconstruction has long been sanctioned by the courts as reasonable in determining a taxpayer’s income, whether or not the taxpayer has produced evidence of the transactions in question. Clayton v. Commissioner, 102 T.C. 632, 645 (1994); DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992); Edwards v. Commissioner, T.C. Memo. 2014-57, *12.

The IRS’s bank deposits analysis reflected numerous cash deposits which the petitioners failed to establish were from nontaxable sources. Bank deposits constitute prima facie evidence of taxable income. Tokarski, 87 T.C. at 77; see also Parks v. Commissioner, 94 T.C. 654, 658 (1990). Respondent’s method used to determine the petitioners’ income was rationally based, reasonable, and logical, and if that’s good enough for Mr. Spock, it’s good enough for the Tax Court. As such, the Tax Court found that the bank deposits reconstruction was not arbitrary and was entitled to the presumption of correctness.

Having shown that Dung’s deposits were income, and that the far exceeded what Dung and Nancy reported as income, it became Dung’s turn to persuade the Tax Court that the deposits were nontaxable. Dung was gifted in many areas, primarily involving acrylics and crystal gel, but the Dazzling Pearl nail polish that he used to “white-out” the memo lines in the checks, over which he scrawled pitiable excuses for nontaxable items, did not instill in the Tax Court the kind of confidence his clients had in Dung. Dodge v. Commissioner, 981 F.2d 350, 354 (8th Cir. 1992), aff’g in part, rev’g in part 96 T.C. 172 (1991).

Collateral Estoppel

Dung argued that the IRS should be estopped from re-litigating the civil fraud penalty for 2006, after all, he had already admitted to defrauding the government in another suit. Surely, Dung thought to himself and later expressed to the Tax Court, the selfsame government could not use his admission against him again; it just wasn’t fair. Alas, poor Dung did not manage to convince the Tax Court, which, to its credit, stopped short of reminding Dung that it, too, was an Article Three appendage of the selfsame government.

Collateral estoppel bars re-litigation of an issue where (1) the party sought to be precluded in the second suit was a party, or privy to a party, in the prior suit; (2) the issue sought to be precluded is the same as the issue involved in the prior action; (3) the issue was “actually litigated” in the prior action; (4) the issue was determined by a valid and final judgment; and (5) the determination in the prior action was “essential to the prior judgment.” Anderson v. Genuine Parts Co., 128 F.3d 1267, 1273 (8th Cir. 1997). The Tax Court concluded that, though a creative legal argument, collateral estoppel did not apply to Dung.

Collateral estoppel at its most basic is “issue preclusion,” which is a fancy way to say, if one court has already decided the issue, another court will not review or revisit the underlying issue. Hickman v. Commissioner, 183 F.3d 535, 537 (6th Cir. 1999), aff’g T.C. Memo. 1997-566. Stated differently, what’s decided is decided, except when it’s not actually decided, as with the decidedly dumb Dung.

You see, Dung was not convicted of a crime, not strictly speaking. He committed one, or forty-odd ones. (Candidly, I stopped counting). Not only did he commit a crime, Dung admitted to doing so; however, he was not actually convicted. For those of you who don’t litigate much, this means that the judge didn’t, a-la Perry Mason, bang his hammer (gavel) on his table (bench) with certainty, thereby closing the door on the issue of whether Dung was guilty. (Spoiler: Dung definitely did do dastardly deeds.)

Dung was ordered to pay restitution. The order was final, but it was not a judgment on the facts. By confessing to his tax-sins, the underlying issues of Dung’s liability had not been “actually and necessarily determined” by the jury, and by extension, the court. Hickman, 183 F.3d at 538. Thus, Dung’s confession was not necessarily in his best interest (as far as to the forthcoming tax proceedings against him. Not only did he admit to the underlying acts, his admission (1) made the IRS’s job really damn easy, and (2) prevented him from succeeding on the argument that the Tax Court was collaterally estopped from going after him for the very same misdeeds in 2006 in a separate proceeding.

This issue (whether collateral estoppel applied to an admission and an order of criminal restitution) had already been decided by the Tax Court in 2003 in the case of Morse v. Commissioner, T.C. Memo. 2003-332, aff’d, 419 F.3d 829 (8th Cir. 2005), when the Tax Court found that a sentencing court’s ordering of (or decision not to order) restitution has no effect on the IRS’ authority to determine the taxpayer’s correct civil tax liability and to assess and collect that liability. To recap, Dung’s issues hadn’t been decided by the trial court, but the decision of the Tax Court regarding the nondecision of issues by the trial court had previously been decided by the Tax Court. This much quickly became clear to Dung.

Civil Fraud Penalty

If any part of the underpayment of tax required to be shown on a return is due to fraud, there is an addition to tax of 75% of the portion of the underpayment that is attributable to fraud. IRC § 6663(a). If the IRS establishes that any portion of the underpayment, no matter how small, is attributable to fraud, the entire underpayment is tainted with fraud. Thus, the Tax Court will attribute fraud to the whole underpayment, unless the taxpayer can establish by a preponderance of the evidence that a portion or portions of the underpayment are not attributable to fraud. See IRC § 6663(b); DiLeo v. Commissioner, 96 T.C. at 874; Taylor v. Commissioner, T.C. Memo. 1995-269, *5, aff’d without published opinion, 108 F.3d 1388 (10th Cir. 1997).

Fraud is defined as the intentional wrongdoing of a taxpayer to evade tax believed to be owing. Petzoldt, 92 T.C. at 698. Fraud will never be imputed or presumed. Parks, 94 T.C. at 660. The existence of fraud is a question of fact to be resolved upon consideration of the entire record. Id.; Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), aff’d without published opinion, 578 F.2d 1383 (8th Cir. 1978).

To establish fraud, the IRS must prove for each year fraud is asserted that an underpayment of tax exists, and the taxpayer had fraudulent intent. Parks, 94 T.C. at 660-61; Clayton, 102 T.C. at 647. “Intent” in this context means that the taxpayer knowingly intended to evade taxes that the taxpayer knew to be owing, and that such evasion was accomplished by conduct that the taxpayer undertook, intending to conceal, mislead, or otherwise prevent the collection of taxes.

Direct proof of a taxpayer’s intent is rarely available (unless you’re Dung, and you’ve already admitted to it); therefore, the Tax Court permits fraudulent intent to be established by circumstantial evidence and further permits reasonable inferences to be drawn from the relevant facts. Spies v. United States, 317 U.S. 492, 499 (1943); Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), aff’g T.C. Memo. 1984-601. The taxpayer’s entire course of conduct may be examined to establish the requisite intent. Stone v. Commissioner, 56 T.C. 213, 224 (1971); Otsuki v. Commissioner, 53 T.C. 96, 105-106 (1969); Romer v. Commissioner, T.C. Memo. 2001-168. When the allegations of fraud are intertwined with unreported income and indirectly reconstructed income, as they are in this case, the IRS may prove an underpayment by proving the likely source of the unreported income. See Holland v. United States, 348 U.S. 121, 132-138 (1954); Brooks v. Commissioner, 82 T.C. 413, 431-432 (1984), aff’d without published opinion, 772 F.2d 910 (9th Cir. 1985).

In determining whether there was fraudulent intent, the Tax Court looks at a nonexclusive list of factors, or “badges of fraud.” See Bradford v. Commissioner, 796 F.2d at 307; Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992); Recklitis v. Commissioner, 91 T.C. 874, 910 (1988); Taylor, T.C. Memo. 1995-269 at *5. Those badges 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; and (7) dealing extensively in cash. See Spies, 317 U.S. at 499. No single factor is dispositive; however, the existence of several factors “is persuasive circumstantial evidence of fraud.” Vanover v. Commissioner, T.C. Memo. 2012-79, *4.

Usually, a taxpayer found liable for the civil fraud penalty may be found wearing two, maybe three “badges.” Dung, however, had the full set, like Brian, the pretty-boy waiter at Chotchkie’s with suspenders bedazzled with thirty-seven pieces of “flair.”

The Tax Court observed that Dung knew that the tax returns he filed were fraudulent. He knowingly engaged in a scheme to avoid (evade) tax for the years in issue by diverting checks and cash from his two nail salons (California in name, Nebraska in location) and depositing them in his personal accounts, thereby knowingly understating or otherwise concealing his income.

The court did not even accept Dung’s excuse that he deposited money into his personal accounts, because he was afraid Nancy would find out about his spending habits. (I didn’t even have to make that one up – “Petitioner Le admitted to the agents that he spent a lot of money…and did not want his wife, petitioner [Nancy a/k/a Nghia], to know.” See Tran at *16.)

Interaction between Fraud and Accuracy-Related Penalties

Nancy, who was the real victim here (well, along with justice, the American taxpayer, and every other man, woman, or child named Dung whose good name was sullied by petitioner-Dung’s actions), did escape personal ignominy. (She escaped in name only, as she was still jointly and severally liable for Dung’s fraud, having filed jointly.) The Tax Court held that the accuracy-related penalty cannot be imposed on one spouse where the other spouse is liable for the fraud penalty, as this would lead to impermissible stacking of penalties. See IRC § 6662(b); Said v. Commissioner, T.C. Memo. 2003-148, aff’d, 112 F. App’x 608 (9th Cir. 2004).

The IRS did not assert fraud penalties against Nancy, but it did allege that she is liable for the IRC § 6662(a) accuracy-related penalty for each year in issue. However, because Dung is liable for the IRC § 6663 fraud penalty for each year in issue, dear, sweet Nancy was not liable for the accuracy-related penalties. She could, therefore, go on painting French tips on obscenely long acrylic nails with a clear conscience all the while jabbering (in angry Vietnamese) to the little woman next to her, “Carol,” who never lost her focus while painting the gnarled toenails of a Cornhusker, about how Dung done did her wrong.

Original opinion: (T.C. Memo. 2020-27) Tran v. Commissioner

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