The IRS was handed a huge defeat in federal district court on Tuesday when Judge Anne B. Conway of the Middle District of Florida ruled that the United States had not proved that even $1 of profits (ill-gotten gains) received by a tax preparer who had consented to a permanent injunction had resulted because of his fraud or illegal activities (internal citations omitted):
The Government asks for a disgorgement award in the amount of $11,176,763. Relying on cases that ordered disgorgement of a defendant’s gross receipts, the Government asks for the total of all fees received by [the Defendant’s] companies, in all three states, for the tax years 2012–2015. The Court concludes that the Government has not provided a reasonable approximation of [the Defendant’s] unjust enrichment.
The United States hired a statistical sampling expert to determine the percentage of fraudulent tax returns prepared by the Defendant, but Judge Conway rejected the expert’s methodologies and conclusions:
The Court finds it is unreasonable to approximate the total disgorgement award in this case based on a sample limited to one tax year and one geographical area….The Government’s sample provides no information as to the percentage of non-compliant tax returns in other years or in other states….Importantly, the Government’s expert testified that the sample data provides no information on whether the compliance rate from that sample is the same in other years. Accordingly, the Court finds that this sample is not generalizable to the universe of 13,000 tax returns.
The Court’s ruling here is important for three reasons: 1) it shows that federal district court judges do not merely rubber-stamp the IRS’s demands for relief; 2) it shows that the United States has the burden to prove wrongful conduct, not merely allege it; and 3) it shows that proper sampling methodologies must be used when the United States presents only a sample of tax returns prepared by a tax preparation company and demands that the court make inferences from that sample to all of the tax returns prepared by that tax preparation company.
When the D.C. Circuit shot down the IRS’s attempt to regulate taxpayers in February 2014 the Department of Justice stepped-up its program to shut down what it calls “fraudulent tax preparers” and “schemers and scammers,” in effect saying we may not be able to regulate them, but we can shut them down. This ruling is a significant setback for the program.
Full disclosure: The Pappas Group represents the Defendant in this case in another, unrelated matter, represents a tax preparer defendant in a case pending before Judge Conway, and several tax preparer defendants in cases before the Middle District of Florida.