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John Finnegan v. Commissioner of Internal Revenue

United States Court of Appeals, Eleventh Circuit

June 11, 2019

JOHN FINNEGAN, JOAN FINNEGAN, Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

          Petition for Review of a Decision of the United States Tax Court Agency No. 8637-13

          Before TJOFLAT, and WILLIAM PRYOR, Circuit Judges, and MURPHY, [*] District Judge.

          TJOFLAT, CIRCUIT JUDGE:

         As many of us do, John and Joan Finnegan ("Taxpayers") hired someone to prepare their tax returns. For eight years, Taxpayers' return preparer included bogus claims on their returns. Taxpayers apparently were oblivious to this. The return preparer was indicted for his fraudulent behavior and pled guilty. Eventually, the IRS came calling: to recover the money it was due all along, the IRS issued a notice of deficiency to Taxpayers for those eight years.

         Taxpayers challenged the notice of deficiency in the Tax Court. They argued that the IRS waited too long to collect. Generally, the IRS must make assessments within three years after a tax return is filed.[1] But there's an exception, and the three-year window is suspended, "[i]n the case of a false or fraudulent return with the intent to evade tax."[2] (We call this the fraud exception.) Taxpayers argued that the fraud exception did not apply because the IRS could not meet its evidentiary burden and show that their returns were in fact fraudulent. Taxpayers admitted that their return preparer created fraudulent returns for his other clients, but, Taxpayers said, the IRS could not prove that the return preparer falsely or fraudulently prepared their returns. Crucially, Taxpayers conceded-time and time again-that if the Tax Court did find that their returns were fraudulent, the exception to the three-year window would be triggered.

          The case proceeded to trial before the Tax Court. At trial, the IRS presented prior testimony that the return preparer gave when he testified against one of his former business associates.[3] In this testimony, the return preparer said every tax return he prepared during the relevant time period included some fraudulent entries. Additionally, the IRS presented affidavit testimony from the return preparer. In the affidavit, he swore that he knowingly prepared false tax returns for Taxpayers during the relevant time period.

         The Tax Court ruled in favor of the IRS-it found that the return preparer had prepared Taxpayers' returns falsely or fraudulently with the intent to evade tax. Thus, the Court found, the fraud exception was triggered, and the IRS's notice of deficiency was timely. Taxpayers filed a motion for reconsideration. Having lost on the merits of their defense, they pivoted-or did a 180, really. In the motion, Taxpayers argued-for the first time-that the fraud exception was not triggered because they, the Taxpayers, had not falsely or fraudulently prepared their returns with intent to evade tax. That is, they claimed that fraud by a tax preparer (and not a taxpayer) did not trigger the fraud exception. The Tax Court held that Taxpayers waited too long to raise this legal argument and rejected it.

         On appeal, Taxpayers raise the same eleventh-hour argument and say that fraud by the tax preparer does not trigger the fraud exception. They also argue that the Tax Court erred by admitting the return preparer's former testimony and affidavit. We reject these arguments and affirm.

         We divide our discussion into three parts. First, we set out the facts and procedural history. Next, we consider the arguments on appeal. Finally, we conclude.

         I.

         A.

         An informant tipped off the IRS about Taxpayers' return preparer. In turn, the IRS launched an investigation, and here's what the investigation turned up: the return preparer and his associates prepared around 750 to 800 fraudulent returns every year for 11 years. These fraudulent returns had several common features. For example, the returns showed large refunds and partnership losses. The large partnership losses flowed through to the individual returns, and there were deductions for contributions to retirement plans. The bogus returns also noted payments between partnerships and their partners. The addresses for the partnerships changed; as a result, the partnership returns were filed with different IRS Centers, which lowered the chances of detection. Finally, many of the same dollar amounts repeated themselves and appeared on several of the fraudulent returns.

         Taxpayers' returns fit the mold. Taxpayers owned a rental property, and their return preparer advised them to run their rental income through a partnership. Taxpayers formed a partnership but never transferred ownership of the rental property to the partnership. In fact, they didn't even enter into a partnership agreement. The Taxpayers never wrote checks to the partnership; nor did the partnership write checks to them. Yet their partnership returns showed a capital contribution from one Taxpayer.

         The partnership returns also showed large losses. One year, the loss was caused in part by a guaranteed payment to the partners. Expenses also played a role in the loss, and at least two of the claimed expenses used the repeating dollar amounts that were common across many of the bogus returns. In turn, Taxpayers' individual returns claimed these losses. Eventually, they began claiming losses from a second partnership: one they had never heard of until the IRS got involved. The addresses of both partnerships changed over the years. And- unsurprisingly-Taxpayers' refunds increased over time.

         The return preparer was indicted and pled guilty to conspiring to defraud the United States and to interfering with the administration of the internal revenue laws. The return preparer then testified against one of his former business associates. During the testimony, the return preparer said that "[e]ach and every one" of the returns he prepared during the relevant time "contain[ed] some fraudulent entries." Taxpayers were not part of the grand jury investigation into the return preparer and his associates. Nor were Taxpayers' returns used to support the indictments against the return preparer and his associates.

         Roughly five years after the dust settled in the criminal proceedings, the IRS came calling: it issued a notice of deficiency to Taxpayers for the eight years that Taxpayers submitted fraudulent returns. The IRS also tacked on a 20% accuracy-related penalty for each year based on Taxpayers' negligence.

         B.

         1.

         Taxpayers challenged the notice of deficiency and filed a petition in the Tax Court. In the petition, Taxpayers claimed the IRS had missed the three-year collection window and thus was too late. The IRS answered and alleged that the fraud exception to the three-year window applied because the return preparer had fraudulently prepared Taxpayers' returns with intent to evade tax.

         The IRS relied on the Tax Court's decision in Allen v. Commissioner, 128 T.C. 37 (2007), to support its reading of the fraud exception. In Allen, the Tax Court held that the fraud exception is triggered, and the three-year window suspended, by the return preparer's fraudulent intent. 128 T.C. at 37. The petitioner argued that the fraud exception was triggered only by the taxpayer's fraudulent intent, and the Court expressly rejected that argument. Id. at 39-40. It explained, "The statute keys the extension to the fraudulent nature of the return, not to the identity of the perpetrator of the fraud," and the Court declined to read "of the taxpayers" into the statute. Id. at 40.

         The IRS didn't hide the Allen ball, either; it cited Allen again and again. During informal discovery, the IRS responded to a discovery request and explained that it was not barred by the statute of limitations, and it cited Allen as authority for that statement. During pretrial motion practice, the IRS cited Allen five more times. It cited Allen again in its pretrial memorandum and in both briefs that it filed after the trial.

         Taxpayers' defense, at least before the Tax Court handed down its decision, was this: the IRS didn't have enough evidence to show that Taxpayers' fraudster return preparer had falsely or fraudulently prepared their returns. Thus, according to Taxpayers, because there was no showing of fraud, the fraud exception was not triggered. Indeed, this is the argument they made in their opening brief, under the heading "because Respondent failed to prove fraud by clear and convincing evidence, the period of limitations within which to assess additional taxes is time barred." And to support their argument, Taxpayers relied on Eriksen v. Commissioner, 104 T.C.M. (CCH) 46, 2012 WL 2865875 (2012). As here, the IRS in Eriksen argued that the fraud exception was triggered based on the fraudulent intent of the petitioners' return preparers. 2012 WL 2865875, at *1. And as here, the issue before the Tax Court in Eriksen was "whether [the IRS] ha[d] clearly and convincingly proven that any of petitioners' returns w[ere] false or fraudulent." Id. The Court in Eriksen found that the IRS met its burden for some petitioners but not for others. Id. So, Taxpayers relied on Eriksen and argued that the case against them was most like the case against the petitioners for which the IRS came up short in proving fraud. Doing so, Taxpayers never challenged Allen as an appropriate hook for triggering the fraud exception.

         Before the Tax Court issued its decision, Taxpayers never challenged Allen or its logic at all. They stipulated before trial that

[t]he only issue in dispute is whether [Taxpayers'] individual income tax returns and partnership tax returns for the years at issue were false and fraudulent and prepared with the intent to defeat or evade tax. . . . If the answer is [yes], then the asserted deficiencies and accuracy-related penalties will not be challenged by [Taxpayers].

         And during their opening statement at trial, Taxpayers said this:

So any fraud that may be proved by [the return preparer] . . . it's attributed to the [Taxpayers] personally, and they're [the IRS] alleging that it's a fraudulent return. And under Allen v. Commissioner, therefore, it would be proper for this Court to find fraud because . . . of the preparer's activities.
But we don't have any evidence that was related by [the IRS] to the effect that [the] [fraudulent] activity also concerned [Taxpayers], as well as [the return preparer's] other numerous clients.

         Finally, resolving any doubt about Taxpayers' position on the Allen case, the Tax Court asked Taxpayers-point blank-whether they contested it:

THE COURT: There is no objection as to the statute of limitations in this case; is that correct?
[TAXPAYERS]: Yes, there is.
THE COURT: There is. And what's the basis for the objection?
[TAXPAYERS]: The tax years are 1994 through 2001. So under [ยง] 6501(a), that's beyond the three-year statute of limitations. [The IRS] alleges that under 6501(c), if there's clear and convincing evidence of fraudulent intent or filing with intent to evade, ...

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