Originally published on Forbes.com June 18th, 2014
Here’s a tip if you are seeking to get started as a tax preparer. Don’t go to work for somebody who also distributes cocaine and runs a Ponzi scheme. That is probably the real reason that Frances Carlson found herself before a jury facing $148,000 in penalties for preparing returns that turned out to have deficiencies. Her boss, Daniel Prewett, died in 2013 while in federal prison serving an 18-year sentence for money laundering. He ran a Jackson Hewitt franchise and traded on Jackson Hewitt’s credibility to direct clients into the entirely unrelated JH Investments which was where the Ponzi scheme lived.
There is a joke about auditors. They are like the soldiers who come in after the battle is over to bayonet the wounded.It definitely fits this situation. Apparently in the wake of all the other issues many of Prewett’s customers had their tax returns audited. The deficiencies in their returns led to the assertions of penalties under Code Section 6701 “aiding and abetting understatement of tax liability” against Ms. Carlson. The penalty is $1,000 per, $10,000 if it is a corporate liability. That can add up pretty quick. A jury agreed with the government on $135,000 of the penalties against Ms.Carlson.
The Government only presented evidence that an auditor identified deductions that the taxpayer could not substantiate. In contrast, Carlson presented substantial evidence from multiple witnesses showing that she did not know the returns understated the correct tax. As the Government notes, the jury was free to disbelieve Carlson’s witnesses. But, even if the jury completely discredited every one of Carlson’s witnesses and Carlson’s own testimony, the Government still failed to adduce evidence meeting its burden of proof.
A jury can reasonably infer from an audit finding an error that the return in fact understated the correct tax. However, this evidence does not tell us why the return understated the correct tax or-more importantly-whether Carlson actually knew the return was inaccurate. High error rates are normal even among the IRS’s own tax preparers.
The case makes an interesting read as it enumerates examples of what appears to be overreach on the part of government in its attack on Ms.Carlson. The best example is probably this one.
An IRS auditor concluded that Mr. and Mrs. Edwards’s return included an improperly filed Schedule C.
At trial, the Government did not present any evidence that Carlson knew the return understated tax. In contrast, the Government’s witnesses-IRS auditors- testified that the return was either correctly filed or was as accurate as possible under the circumstances. Carlson testified that she thought and still thinks that the correct way to report Mr. and Mrs. Edwards’s income is on a Schedule C. The Edwards’s prior individual return from 2005, which Carlson did not prepare, also reported their compensation on a Schedule C form. The IRS auditor testified that the method for reporting the income was a close judgment call, even though he disagreed with how it was reported. The IRS auditor also testified that because Edwards was not properly listed as an employee of his company the only accurate approach was to report the income on a Schedule C. A different IRS agent testified that the correct method was to report this income on a Schedule C.
Instead of presenting any evidence that Carlson knew the return understated the correct tax, the Government merely presented the audit results-which were contradicted by the testimony of IRS agents-and asked the jury to infer that Carlson actually knew the return understated the correct tax. Without supporting evidence, such an inference is unreasonable speculation. Accordingly, the Government did not meet the burden of proving that Carlson actually knew the return understated the correct tax.
Presumably, the employer had issues a 1099-MISC when a W-2 was called for. This is not something that the preparer of the individual return can be expected to sort out.
Were it not for the colorful surrounding story I might have skipped this case, since it is more a matter for Jack Townsend who blogs on criminal tax issues. Jack was also pleased with the decision and he hopes that it might be a useful precedent for people who are defending themselves against the draconian FBAR penalties. In his piece on this case, he wrote:
I have urged that the burden of proof for FBAR willfulness should be clear and convincing for the same reasons as for civil fraud. This newCarlson case, I think, holds some possibility that at least the Eleventh Circuit might be open to this analysis. I note in this regard that Zwerner would have been appealable to the 11th Circuit, the Court deciding Carlson. The Zwerner case settled last week, but I wonder whether, had the Carlson decision been rendered earlier, the case might not have been settled or, possibly, the Government might have accepted a better settlement.
You get hit with an FBAR for failing to report the existence of a foreign bank account. If the failure is willful, the penalty is the greater of $100,000 or 50% of the peak balance in the account for the year. Joe Kristan has called the IRS treatment of FBAR “violators” the equivalent of shooting people for jaywalking. Upping the evidence standard might be a positive step.
The career lesson remains. Doing a straight job of tax preparation for an entity where there is a lot of other sketchy stuff going on can lead to disproportionate grief for the tax preparer, so be cautious in your choice of employer.
You can follow me on twitter @peterreillycpa.