Catlett v. Comm’r, No. 13058-14, T.C. Memo 2021-102 | August 16, 2021 | Lauber | Dkt. No. 13058-14

Short Summary:  The taxpayer was convicted in 2011 on Federal criminal charges, including tax crimes and conspiracy to defraud the United States. In March 2011 he was sentenced to 210 months in prison. After he was remanded to custody, the IRS completed a civil examination of his 2006-2010 tax years.  The IRS subsequently assessed substantial deficiencies, along with additions to tax and penalties.  The taxpayer timely petitioned the Tax Court in June 2014.  However, because of his incarceration, the case was repeatedly continued.  The taxpayer died in January 2020, and the IRS filed a motion to dismiss the case based on lack of prosecution.

Key Issue:  The key issue is the standard for dismissal when a taxpayer fails to prosecute their case.  Various burdens come into play that the IRS must still meet despite the failure of the taxpayer to prosecute his case.

Primary Holdings: 

• The IRS satisfied its burden of production by introducing extensive banking records obtained from third-party institutions. These records establish that the taxpayer during 2006-2010 deposited more than $1.7 million into various accounts that he controlled. The checks thus deposited were issued by the taxpayer’s clients for services he provided in connection with the tax shelter scheme, including tax return preparation. Taxpayer failed to report most of these payments on his tax returns for 2006-2008, and he filed no return for 2009 or 2010.
• The balance of the deficiencies for 2006-2008 resulted from the disallowance of expense deductions. Taxpayer bears the burden of proving his entitlement to these deductions. Rule 142(a); see sec. 1.6001-1 (a), Income Tax Regs. At no point during the examination (or subsequently) did the taxpayer supply any evidence to substantiate his claimed deductions. Therefore, the Court sustained the deficiencies to the extent they are not barred by the period of limitations.
• Analyzing limitations, the Court first found that, for 2009 and 2010, the taxpayer filed no return. Therefore, pursuant to I.R.C. § 6501(c)(3), the tax for those years can be assessed at any time.
• For tax years 2007 and 2008, the Court found that the taxpayer omitted more than 25% of the gross income stated in the return, and therefore, the 6-year statute of limitations applied pursuant to I.R.C. § 6501(e).
• Looking at 2006, the Court first found that the 6-year statute of limitations applied and that it would normally have expired on August 21, 2013 – prior to the IRS assessment. However, applying § 7609(e)(1), the Court found that the limitations period was suspended during the 330 days in which the taxpayer had litigated motions to quash the IRS summonses to his banks.  Therefore, the 6-year period had been extended to July 17, 2014, and the notice of deficiency was therefore timely.
• Finally, the Court found, alternatively, that the IRS satisfied its burden of proving the taxpayers’ fraud for tax years 2006-2008. Therefore, § 6501(c)(1), which provides that a tax may be assessed at any time where a taxpayer has filed a false or fraudulent return, provided an alternative basis for finding the notice of deficiency timely as to all years at issue
• The Court assessed fraud penalties after conducting an analysis of various badges of fraud, in which it found the existence of at least six badges of fraud on the part of the taxpayer
• The Court found that the IRS had satisfied all of its burdens related to the assessment of penalties, and therefore all penalty assessments—including fraud penalties, failure to file penalties, and failure to pay penalties—were all upheld.

Key Points of Law:

• Under Tax Court Rule 123(b), the Court may dismiss a case at any time and enter a decision against the taxpayer for failure to prosecute his case properly or failure to comply with the Court’s orders and Rules.
• If a taxpayer dies while his case is pending, ordinarily the taxpayer’s representative or successor would be substituted as the proper party. See Rule 63(a).
• If there is no representative or successor, the Court can ask the IRS to furnish the identities of individuals who possess a “monetary interest” in the outcome of the case. If no individual expresses an interest, then the case will be dismissed for lack of prosecution.
• The IRS’ determinations in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of proving them erroneous. See Rule 142(a) .
• In unreported income cases, the Commissioner must generally establish a “minimal evidentiary showing” connecting the taxpayer with the income-producing activity, see Blohm v. Commissioner, 994 F.2d 1542, 1548-1549 (11th Cir. 1993), aff’g T.C. Memo. 1991-636 , or demonstrate that the taxpayer actually received unreported income, see Edwards v. Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982).
• Once the Commissioner makes the required threshold showing, the burden shifts to the taxpayer to prove by a preponderance of the evidence that the Commissioner’s determinations are arbitrary or erroneous.
• If a taxpayer fails to file a return, then the tax for those years may be assessed at any time. 6501(c)(3).
• Where a taxpayer substantially underreports income by 25% or more, the normal 3-year statute of limitations becomes 6 years. 6501(e)(1)(A)(i)
• The limitations period is suspended during any period in which a taxpayer litigates motions to quash IRS summonses to parties with respect to that taxpayer’s liability. 7609(e)(1).
• When determining fraudulent intent on the part of a taxpayer, Courts look at various badges of fraud to determine the existence of the required intent. Such badges of fraud include:
  • 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.

Insight:  This case represents a tragic set of facts in which a taxpayer checked all the boxes to earn a finding of filing fraudulent returns.  From a procedural standpoint, however, this case provides a useful guide to the various burdens applicable to both taxpayers and the IRS in Tax Court.

Have a question? Contact Jason Freeman, Freeman Law.

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