In Finnegan v. Commissioner, 2019 WL 2428109 (11th Cir. June 11, 2019), the Eleventh Circuit was asked to review whether a taxpayer may be indefinitely held responsible for the fraud of its paid tax return preparer. It is a question of special interest to small business owners that rely on an outside accountant to help with their taxes. Ultimately, the court chose not to answer the question because the taxpayer had not properly preserved the question at the lower court. The court’s decision not to review the issue leaves uncertainty for taxpayers in the Eleventh Circuit.
Section 6501 of the Internal Revenue Code sets out the statute of limitations for the IRS to review tax returns. Generally, the IRS only has three years to assess additional taxes after a tax return has been filed. However, there is no limitation on the ability to re-assess a false or fraudulent return. Courts are split on whether section 6501’s fraud exception applies where the fraud is committed by someone besides the taxpayer. The Tax Court and Second Circuit have held that third-party fraud allows for indefinite re-assessment while the Federal Circuit has held that the fraud exception only applies where the actual taxpayer has an intent to evade tax.
For eight years, the Finnegans’ tax return preparer entered false losses and deductions on all of his clients’ tax returns. When the tax return preparer pleaded guilty to fraud, the IRS sought to unwind those false losses and deductions on the Finnegans’ returns, along with penalties and interest. In the initial Tax Court case, the Finnegans only disputed whether their returns were in fact fraudulently prepared. They conceded that under Tax Court precedent, if fraud had occurred, the IRS had the authority to re-assess their past eight years of returns under section 6501 rather than the typical three-year limitation.
After the Tax Court ruled for the Commissioner on the factual issue, the Finnegans retained new counsel and requested reconsideration, asking the Tax Court to review its broad interpretation of section 6501’s fraud exception in light of the Federal Circuit’s recent narrow interpretation of the fraud exception. When the Tax Court rejected the motion for reconsideration, the Finnegans took the issue to the Eleventh Circuit.
The Eleventh Circuit declined to interpret the fraud exception of section 6501. Judge Tjoflat’s opinion explained that the waiver doctrine generally prevents the appellate court from considering an issue for the first time on appeal. Certain circumstances give the court the discretion to review new issues on appeal. The court acknowledged that one of these circumstances was present—the interpretation of the fraud exception was a significant legal question of broad impact or public concern—but nonetheless decided, on balance, not to exercise its discretion to consider the issue.
The IRS takes the position that it can go after taxpayers, including with penalties, for fraudulent returns whether or not the taxpayer knew of the fraud and no matter when the fraud occurred. Some courts have agreed with the IRS and some have disagreed. For now, the Eleventh Circuit has chosen to remain silent.
Posted by Phil Ogea.