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Imposing Penalties After Restitution Assessment


The recent case of Ervin v. Commissioner, T.C. Memo 2021-75 affirms the ability of the IRS to impose penalties after it makes a restitution assessment.  This case does not create precedent or cover new ground but does provide a reminder of how the restitution based assessments work.  We have previously written about restitution based assessments most of which are collected in this post.  TIGTA issued a report on restitution based assessments earlier this month which I plan to discuss in a future post.

Mr. Ervin and his wife owned a real estate management company in Alabama and apparently received cash payments for many of the properties.  They were indicted in 2011 not only on tax evasion, IRC 7201, but also on title 18 charges of conspiracy to defraud the United States and aiding and abetting.  The conspiracy charge appears to stem from their efforts to avoid reporting of cash deposits by structuring the deposits to keep them under $10,000.  A jury convicted them on most counts, including tax evasion, for the years 2004-2006. 

A couple of things are a little unusual about their criminal case.  First, they were convicted of evasion even though they did not file tax returns from 2000-2009.  Proving evasion based on non-filing can be difficult.  No doubt the structuring aspect of the case was crucial to this proof.  The second thing I found a bit unusual was the ten-year length of their sentence.  As we discussed in the post describing the sentence of former Tax Court Judge Kroupa, sentencing in tax cases primarily turns on the dollars lost to the government.  Here, the IRS could calculate the loss not only over the years of the conviction but the other years of non-filing causing a total of over $1.4 million.  Because they went to trial, the Ervins would not have received any positive points in the sentencing calculation for acceptance of responsibility.  This is a substantial sentence for a financial crime of this type but not necessarily an inappropriate sentence under the guidelines or otherwise.

In addition to the sentence of time in prison, the court ordered restitution to the government of $1,436,508 for the estimated tax loss to the government for the ten years of unfiled returns.  The IRS made restitution based assessments and actually collected the full amount of the liability; however, it did not stop there.  In 2014, it sent petitioner Monty Ervin two notices of deficiency – one for 2002-2004 and one for 2005-2007.  These notices were based on penalties, additions to tax, the IRS felt he owed for these tax years.  The IRS imposed four separate penalties, though not for each period.  The penalties were for failure to file, failure to pay, failure to pay estimated tax and fraudulent failure to file.  The penalties total another several hundred thousand dollars.

From prison Mr. Ervin contested the imposition of the penalties, making two arguments: 1) the IRS could not impose penalties after making the restitution based assessments and 2) the IRS had already determined he could not pay so it should not impose the penalties and make assessments in this situation. 

The Court provided a brief overview of the applicable law which foretells the outcome of the case:

Section 6201(a)(4)(A) provides that “[t]he Secretary shall assess and collect the amount of restitution * * * [ordered by a sentencing court] for failure to pay any tax imposed under this title in the same manner as if such amount were such tax.” The IRS may not make such an assessment until the defendant has exhausted all appeals and the restitution order has become final. See sec. 6201(a)(4)(B). The restrictions on assessment imposed by section 6213 do not apply to restitution-based assessments. See sec. 6213(b)(5). The IRS therefore is not required to send the taxpayer a notice of deficiency before making an assessment of this kind.

[*9] In Klein v. Commissioner, 149 T.C. 341, 362 (2017), we held that “additions to tax do not arise on amounts assessed under section 6201(a)(4).” That is because a defendant’s restitution obligation “is not a civil tax liability,” id. at 361, or a “tax required to be shown on a return,” ibid. (quoting section 6651(a)(3)). Rather, restitution is assessed “in the same manner as if such amount were such tax.” Sec. 6201(a)(4)(A) (emphasis added). But we explained that the IRS was not thereby disabled from collecting such sums. “If the IRS wishes to collect * * * additions to tax, it is free to commence a civil examination of * * * [the taxpayer’s] returns at any time.” Klein, 149 T.C. at 362.

The IRS properly followed that procedure here. It made the assessment after the restitution order became final. It subsequently commenced a civil examination of petitioner’s individual liabilities for 2002-2007 and prepared SFRs, allocating him a portion of the relevant income and deductions. See supra ap. 4-5. It then calculated additions to tax based on the deficiencies so determined.

While the Court’s explanation of the law signals the ability of the IRS to follow a restitution based assessment with proposed penalty assessments, the Court analyzed each proposed penalty to determine if the imposition of the penalty appropriately matched the facts of the case.  After finding that the IRS appropriately applied the penalties, the Court granted summary judgment.

Petitioner may never pay this amount, as collection from someone coming off of 10 years of incarceration will be extremely difficult, but the legal principle here follows from prior determinations of the manner in which restitution based assessments work.  The design seeks to allow the IRS to make an assessment of the core amount of the tax determined in the criminal proceeding without having to wait many years for the end of the tax merits process to come to a conclusion.  The way this case played out demonstrates the benefit to the IRS of the restitution based assessment.  The criminal case essentially ended with the sentencing in June of 2012.  Now it is nine years later before the Tax Court case ends.  Prior to the restitution based assessment provisions, the IRS would have had to sit on its hands regarding collection until the end of the Tax Court case which would have allowed it to assess.  By making the restitution based assessment shortly after the end of the criminal case, the IRS stands a much better chance of collecting, and here it appears to have collected all of the tax.  The delay caused by the deficiency process and six years in the Tax Court may make its chances to collect the penalty portion of the case difficult, but the core of the liability in this case was recovered.  That’s a victory for the process.



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