IRS Can Re-litigate Tax Liability in Civil Court After it was Previously Resolved in a Criminal Proceeding

EXECUTIVE SUMMARY

The doctrine of collateral estoppel does not bar the IRS’s pursuit of civil tax liability, even where the same liability was previously resolved in a criminal proceeding.

IRS Can Re-litigate Tax Liability in Civil Court
After it was Previously Resolved in a Criminal Proceeding

Eli S. Noff, Esq., Partner

Mary Lundstedt, Esq., Associate

Taxpayers should remember that, depending on the circumstances, the Internal Revenue Service (IRS) may successfully pursue and recoup both civil deficiencies and criminal restitution for the same offense. Typically, a criminal investigation is formally closed before civil liabilities and penalties are assessed through an IRS examination, although the reverse is possible as well. And, at the end of a criminal investigation, a restitution order may be ordered by the judge which is based on a determination of a disputed tax liability.

There are various reasons which may cause a civil tax liability amount to different from a criminal tax liability amount, including but not limited to:

A. Adjustments of a controversial or offsetting nature may not be included in a criminal tax computation to remove controversial issues from the criminal action.

B. Adjustments of a minor, technical, or a non-fraudulent nature may be considered solely for civil purposes.

C. Evidence that may not meet the burden of proof necessary in a criminal investigation may be adequate for a civil case.[1]

Recently, in Le v. Commissioner, the Tax Court determined that the doctrine of collateral estoppel does not bar the IRS's subsequent pursuit of civil tax liabilities in the case of a taxpayer who pleaded guilty to criminal tax evasion charges and paid more than $30,000 in restitution to the IRS.[2] Taxpayers who find themselves in comparable situations are well-advised to seek a highly competent tax professional who understands the complex interplay involved with a tax matter that attracts both civil and criminal attention.

Facts

Taxpayers, husband and wife, were married throughout 2004, 2005 and 2006 and owned and operated two nail salons. In March of 2013, taxpayers were indicted on three counts of attempting to evade and defeat tax for tax years 2004, 2005 and 2006.

Both taxpayers were authorized signatories on the business checking accounts and their joint personal checking account; however, only husband was an authorized signatory on his personal savings account. During the years at issue, husband made various deposits of business checks into the personal accounts.

In 2007, the IRS began examining tax returns for 2004, 2005 and 2006. Husband provided false information to the revenue agent during the examination. Husband admitted to the agent that he did not want his wife to know about all of the money that he spent.

As such, the IRS referred the case to the Criminal Investigation Division (CID) for many reasons, including:

untruthful responses to information document requests; numerous instances of small deposits which actually consisted of numerous business checks with cash back; petitioners' failure to report the business income deposited into their personal accounts; their failure to include June and December 2004 business deposits in income; numerous alterations of records including whiting out, cutting, and pasting information on false checks to make the amounts appear nontaxable; unreported income; and petitioners' inconsistent statements.[3]

In September of 2013, husband pleaded guilty to one of the counts, and in exchange the other counts were dismissed. Husband's plea agreement included his admission: (1) to attempting to evade or defeat tax or payment thereof for tax year 2006; (2) that an additional tax was owed for tax year 2006; and (3) his actions were willful.

The District Court entered its judgment in December of 2013. Husband agreed to pay restitution in the amount of $33,332 to the IRS. The restitution accounted for additional business checks deposited in taxpayers' personal bank accounts, but excluded cash deposited in taxpayers' personal accounts. Husband paid the restitution in full and taxpayers' 2006 account was credited for the payment.

In the ensuing civil examination, Taxpayers and the IRS agreed that taxpayers would concede the IRS's expense adjustments made for all years in issue if the taxpayers' civil tax liabilities were not limited to the amount paid in restitution[E1] .

By February of 2014, the IRS group manager had approved Internal Revenue Code (IRC) §6663 fraud penalties against husband and IRC §6662(a) accuracy-related penalties for negligence and substantial understatement of income tax, in the alternative, for both taxpayers regarding all years at issue.

In November of 2015, the IRS issued a notice of deficiency determining: (1) income tax deficiencies for tax years 2004, 2005 and 2006 exceeding $100,000 in total, and (2) that husband was liable for IRC §6663 fraud penalties for those years in an amount exceeding $87,000. Alternatively, the IRS determined that taxpayers were liable for "the accuracy-related penalty, pursuant to [IRC §] 6662(a), for any portion of an underpayment to which it was determined that the fraud penalty did not apply."[4]

Applicable Law and Analysis

First, the Tax Court considered husband's argument that the doctrine of collateral estoppel should bar the IRS from relitigating his 2006 tax liability since it was previously determined in the criminal restitution order. The Tax Court clarified that collateral estoppel bars the re-litigation of an issue under the following circumstances:

(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."[5]

The Tax Court then, referring to the decision in Hickman v. Commissioner,[7]stated that a criminal restitution order is not essential to the judgment in the criminal matter, because the restitution order is not an element of the crime for which the individual was convicted. Moreover, the Tax Court noted that a court's decision to order (or 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."[7] Thus, the Tax Court determined that the doctrine of collateral estoppel was inapplicable in this case; thus, the IRS was not barred from litigating husband's civil tax liability for tax years 2004, 2005, and 2006.

The Tax Court proceeded to find that for each tax year at issue, included 2006, taxpayers failed to report income from their businesses. Specifically, the Tax Court determined that they failed to report income in the amounts of $45,567.92, $33,200.89, and $84,475.01 for 2004, 2005, and 2006, respectively. Additionally, the Tax Court found that the taxpayers had not substantiated any of the expenses disallowed by the IRS.

Significantly, the Tax Court considered that husband was the person responsible for behavior resulting in fraud penalties. As such, husband was found liable for IRC §6663 fraud penalties for tax years 2004, 2005, and 2006. However, the Tax Court emphasized that "[t]he 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." [8] Thus, the Tax Court found that wife was not liable for the IRC §6662 accuracy-related penalties.

Lastly, the Tax Court ruled that both taxpayers also failed to report additional state tax refunds on tax returns for tax years 2004 and 2006; thus, taxpayers were held liable for IRC §6662(a) negligence penalties for those years.

Conclusion

Although the doctrine of collateral estoppel exists to prevent the re-litigation of the valid and final determination of an issue of ultimate fact, the Tax Court does not find that doctrine applicable when the IRS wants to re-litigate a tax liability in civil court after that same liability was resolved in criminal court. Specifically, the Tax Court does not consider a criminal restitution order to be essential to the judgment; thus, the restitution order is not an element of the crime for which the individual was previously convicted. Anyone potentially facing criminal and civil tax sanctions, should consult with a tax professional as soon as possible.

If you have questions or concerns about criminal restitution or civil tax liabilties (or both), contact Eli Noff of Frost & Associates, LLC today at 410-497-5947.


[1] Internal Revenue Manual section 9.5.13.2.1 (01-06-2009).

[2] T.C. Memo 2020-27 (Feb. 26, 2020).

[3] Id. at 16-17.

[4] Id. at 17-18.

[5] Id. at 21, citing Anderson v. Genuine Parts Co., 128 F.3d 1267, 1273 (8th Cir. 1997).

[6] 183 F.3d 535, 538 (6th Cir. 1999), aff'g T.C. Memo. 1997-566.

[7] Le v. Commissioner, at 22, citing Morse v. Commissioner, 419 F.3d 829, 833-835 (8th Cir. 2005).

[8] Id. at 38.

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