Originally published on Forbes.com Aug 18th, 2014
April J. Rampton was sentenced to 21 months in federal prison for filing false claims for income tax refunds. She tried appealing her conviction to the Tenth Circuit, but that did not go well. Her defense was based on the theory of “collateral estoppel”, which was a new one on me.
This defense arises where a government agent authorizes a defendant “to engage in otherwise criminal conduct] . . . and the defendant, relying thereon, commits forbidden acts in the mistaken but reasonable, good faith belief that he has in fact been authorized to do so.
Ms. Rampton had filed for a tax refund using the OID technique, which is supported by a theory of “redemption”. She received a six figure refund and was so delighted that she started helping her friends do the same thing. Her argument, which went nowhere with the Tenth Circuit, was that the IRS more or less led her along by issuing the refund and that should be enough to avoid criminal liability. I actually have a little bit of sympathy for her, but I’ll give you a little background and you can decide for yourself.
What Is OID Really?
What is amazing about the OID scheme, is that it has absolutely nothing to do with OID, other than using the same form. The Tenth Circuit gave a pretty good explanation as to what OID really is.
When bonds and certain other debt instruments are issued at a discount to the value at maturity, the difference between the issue price and the redemption value is called “original issue discount” (OID). That difference in value can be said to arise from imputed interest on the original instrument, and the annual imputed interest is taxable income under federal law.
An instrument can also end up with original issue discount when the interest payments are less frequent than annually. My experience has been that even most accountants have trouble doing OID computations, but of course, most don’t have to do them. They just get the numbers on forms and put them on tax returns.
How Can OID Generate Big Refunds?
Legitimately it can’t. The 1099-OID form includes a box that indicates the amount of withholding on the income that is reported. People were filling out the forms for themselves and attaching them to their returns. The amount of withholding recorded was equal to or at least out of proportion to the income reported, thereby generating a substantial refund. Why did people think that this might be legitimate? Well that is a little difficult to explain. Here is some of the discussion from the decision.
Defendant’s explanation at trial, however, was incomprehensible. She testified to the following rationale for her entries on the 1099-OID forms:
hatever loans you had, anything that you had actually signed loan paperwork on, so car loans, mortgages, credit cards, that any of those—that the bank was able to take your loan paperwork and it became an asset and it became like cash to them. So this process was a way that we, as the person taking out the loan, would be able to have access to that money instead of the bank only having access to the money…. The I.R.S. is a tax collector for us …. he I.R.S. would become the middleman between us, the general public, and loan holders and the banks, and that they would be able to go to the banks and enforce this, so that they would have to actually pay us the money that they had been keeping from us.
According to the decision, Ms. Rampton absorbed this information from, among others, her step-father, Winston Shrout. Interestingly there is a Winston Shrout who has a website called “Solutions in Commerce”
The truth is… we live in a very complicated commercial world. A world so misunderstood and confusing, it’s easy for people to get into trouble without knowing how or why. My goal is to help folks understand how commerce really works, so that they have the knowledge and the confidence to safely navigate through the commercial maze.
The FAQ includes a question about where to find information on the “1099 OID process”. The answer is “The 1099 OID process is not one that Winston currently supports, advocates or lectures on. As such, we don’t have any products or information available involving that topic.” (Emphasis in orginal).
The only site I can find that still may be promoting this technique is Stop The Pirates, which is dedicated to helping you understand “the way things really work”.
Why Does It Even Seem To Work?
That is rather sad. Depending on your perspective, you can blame either the IRS or Congress or perhaps wish a plague on both their houses.
The IRS checks tax returns to be sure that they are complete, mathematically correct, and signed by the taxpayer (certifying that the information is true and correct). According to trial testimony by an IRS agent, however, congressionally mandated time limits for sending tax-refund checks to taxpayers limit the scope of review before a refund is sent. In particular, the IRS does not check returns against the 1099-OID information in its database before issuing refund checks.
The Court Rules On Her Defense
Here, Defendant states that she reasonably concluded that her conduct was lawful because the government sent her a refund based on the 1099-OID forms she prepared. But the forms falsely reported that more than $200,000 had been withheld to cover her income taxes. She admitted that this was a total lie. If the information on the forms had been true, she could properly have claimed a credit (and likely a refund) based on that withholding. Obviously the government took the OID forms as true, and no one could reasonably infer that the government’s response implied that she was entitled to a refund even if the information reported on the OID forms was false.
Defendant asserts that her reliance was reasonable because “here is simply no way a reasonable person could know the bureaucratic machinations of the IRS would allow it to issue checks even where agents see numerous obvious red flags in the tax documents,” and because numerous “other witnesses similarly believed the check validated the 1099-OID filing,” Nonsense. “Garbage in, garbage out” is a commonsense observation familiar to all. No reasonable person would be deluded into thinking that payment of the refund reflected that the government had audited her forms for accuracy, had discovered her deceit, and yet still decided that she was due the refund. The delusions of Defendant’s greedy associates do not make her reliance any more reasonable.
I have to say that I have some sympathy with the perspective that a reasonable person seeing the refund checks might want to take another look at the scheme. If they were incapable of understanding the reasoning behind the scheme and what OID actually is, it could be hard to resist. Something tells me that it might be people other than Ms. Rampton, who really belong in federal prison and that she is, herself, a victim of this scheme.
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