FREQUENT EITC-ABUSING PREPARERS PERMANENTLY ENJOINED FROM PREPARING RETURNS:

NSTPEarned Income Tax Credit, Individual Taxpayers, Internal Revenue Service (IRS), Penalties, Tax Professionals, Tax Professionals, Taxpayer, Uncategorized

Wells, (DC MS 6/5/2018) 121 AFTR 2d ¶ 2018-826

A district court has permanently enjoined a pair of return preparers, who prepared thousands of federal income tax returns that falsified business income in order to boost the Earned Income Tax Credits (EITCs; also known as Earned Income Credits or EICs) that their clients could claim, from preparing tax returns for others.

Background. Code Sec.7407 empowers district courts to enjoin a tax return preparer from preparing federal tax returns for others if the court finds that:

  1. The tax return preparer has “continually or repeatedly” violated Code Sec. 6694 (dealing with the understatement of taxpayer’s liability by tax return preparer) or Code Sec. 6695 (dealing with assessable penalties with respect to tax preparation); and
  2. An injunction prohibiting only violations of Code Sec. 6694 or Code Sec. 6695 would not suffice to prevent the tax return preparer from interfering with the proper administration of the Code.

District courts may enter an injunction under Code Sec. 7408 if they find that

  1. A person has engaged in conduct subject to penalty under Code Sec. 6700, Code Sec. 6701, Code Sec. 6707, or Code Sec. 6708; and
  2. Injunctive relief is “appropriate” to prevent recurrence of such conduct.

Code Sec. 6701 imposes a penalty upon any person who aids or assists in, procures, or advises with respect to, the preparation of any portion of a return with the knowledge that the return will be used in connection with any material matter arising under the internal revenue laws and, if so used, would result in an understatement of the liability for tax of another person.

Code Sec. 7402(a) permits district courts to issue such injunctions “as may be necessary or appropriate for the enforcement of the internal revenue laws”.

Facts. Taxpayers Wells and Stephens were partners in a tax preparation business. They prepared thousands of federal income tax returns that falsified business income in order to boost the EITCs that their clients could claim. Wells and Stephens had prepared 709 federal income tax returns for the 2017 filing year; 89% of them claimed the EITC.

Court enjoins preparers under Code Secs. 7407, 7408 and 7402(a).  The court permanently enjoined the preparers from preparing federal returns under Code Sec. 7407, Code Sec. 7408 and Code Sec. 7402(a).

Sec. 7407 injunction. Wells and Stephens repeatedly violated Code Sec. 6694 and Code Sec. 6695. Regarding Code Sec. 6694, Wells and Stephens prepared returns that knowingly understated customers’ tax liabilities. And regarding Code Sec. 6695, Wells and Stephens repeatedly failed to exercise due diligence in determining the eligibility of their customers to claim EITCs.

The court said that a narrower injunction, prohibiting Wells and Stephens from violating Code Sec. 6694 or Code Sec. 6695, would not do. It concluded that a permanent injunction prohibiting Wells and Stephens from acting as tax return preparers was necessary to prevent them from interfering with the proper administration of the internal revenue laws.

In coming to this conclusion, the court looked to:

  • The egregiousness of the preparers’ conduct;
  • The isolated or recurrent nature of the infraction; and
  • The extent of the preparers’ participation in the offense.

First, the Court said, Wells’s and Stephens’s conduct was egregious. Wells and Stephens reported non-existent businesses and fabricated losses linked to them. They also withheld tax documents from customers and bilked the Government of “likely several million dollars”. Second, Wells’s and Stephens’s conduct was recurrent: during a 4-year span, Wells and Stephens prepared 5,410 returns; many, if not all, were fraudulent. And third, Wells and Stephens falsified the returns and so “directly participated” in the misconduct that supplied the basis for the permanent injunction.

The court said that a narrower injunction would not protect the Government’s interest in the proper administration of the Code. The scale of the schemes, the brazenness of the fraud, and the continuation of operations well into 2017 suggested that Wells and Stephens would continue to falsify returns if they were not permanently enjoined from preparing returns for others. “What is more, permanently enjoining Defendants would save IRS the cost of investigating Defendants’ future violations and promote respect for the Code.”

Sec. 7408 injunction. Wells and Stephens engaged in conduct subject to penalty under Code Sec. 6701. Wells and Stephens knowingly prepared returns that understated customers’ tax liability by claiming EITCs to which customers were not entitled. And because they continued their falsifications into 2017, the court concluded that there was no indication that, if not enjoined, they would stop engaging in such activity.

Sec. 7402(a) injunction. The court noted that Fifth Circuit opinions offer limited guidance in interpreting Code Sec. 7402(a). The cases do not, for example, articulate a standard for issuing a permanent injunction under Code Sec. 7402(a). So the district courts in this circuit have simply applied the statute as it reads, asking whether the Government has shown that an injunction is “necessary or appropriate” to enforce the internal revenue laws.

The court concluded that a Code Sec. 7402(a) injunction was appropriate to enforce the internal revenue laws, “for essentially the same reasons” it stated with respect to Code Sec. 7407.