Wear That Badge of Fraud Boldly

Originally published on Passive Activities and Other Oxymorons on June 8th, 2011.
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The last of the tax season developments will be up soon.  The purpose of this blog is to provide a little bit of analysis on developments that are otherwise largely ignored.  This is by way of apologizing for the fact that these items are over two months old. If I think  time is of the essence on a development I will move it to the head of the line and even make a bonus post.  If you look at my blog roll you will find other bloggers who get to things more quickly than I do.  If you prefer to get things really slow though you should subscribe to AICPA publications as I discussed in this post.

STROM v. U.S., Cite as 107 AFTR 2d 2011-XXXX

This was fairly interesting case about non-qualified stock options.  Generally when non-qualified stock options are exercised the holder recognizes income based on the difference between the fair market value of the stock and the exercise price.  The income recognition is deferred, though, if the holder is precluded from selling the stock under SEC regulations :

In this opinion, we first interpret the phrase “could subject a person to suit under section 16(b)” and determine what that phrase requires a taxpayer to demonstrate before she can postpone tax consequences under § 83(c)(3). We then hold that the taxpayer here has not demonstrated an entitlement to deferral of tax consequences under § 83(c)(3)

So long as the sale of property at a profit could subject a person to suit under section 16(b) of the Securities Exchange Act of 1934, such person's rights in such property are — (A) subject to a substantial risk of forfeiture, and (B) not transferable.

This particular taxpayer did not qualify for the deferral.

Having established the standard for deferral of tax consequences under § 83(c)(3)—namely, a taxpayer must show that a § 16(b) suit premised on a sale of her stock would have had an objectively reasonable chance of success—we now turn to whether Strom has demonstrated that a sale of her InfoSpace stock could have subjected her to a § 16(b) suit meeting that standard.


To summarize our holdings: Under the SEC's interpretation of its rules, the vesting of Strom's unvested options did not constitute “purchases” under § 16(b). Thus, she is not entitled to defer the tax consequences of her option exercises under IRC § 83(c)(3), because she has not demonstrated that she could have been subject to a § 16(b) suit that had an objectively reasonable chance of success had she sold her stock at a profit in 1999 or 2000. A reasonably prudent and legally sophisticated person in Strom's position would have felt free to sell her property, because, if a § 16(b) suit had been brought against her, she would not have been forced to forfeit the profit obtained by the sale, nor would she have faced substantial legal expenses defending herself in a suit not readily dismissable.


Should any of these holdings appear anomalous, it is because § 83(c)(3)'s incorporation into the tax code of § 16(b) makes for strange bedfellows. The statutory and regulatory structures and purposes of the tax law and the securities law are distinct. In Strom's case, the interaction of the two statutory schemes means that she was not exposed to a realistic threat of forfeiting profits during the period when she was able to exercise options (and thereby incur tax consequences), because the period of concern for § 16(b) purposes had passed by then. There was therefore no overlap between the period of potential § 16(b) liability and the period Strom could incur tax consequences due to the options.

GREEN TREE SERVICING, LLC v. U.S., ET AL., Cite as 107 AFTR 2d 2011-XXXX

This one is interesting more for the light it sheds on the mortgage crisis than anything else.  A first mortgage on a property will have priority over subsequently filed federal tax liens.  What happened here was that a mortgage discharge was accidentally recorded.  Then the federal liens were recorded.  The entity wants to reinstate the mortgage and have it be superior to the federal liens.  The IRS argued that federal law prohibits that.  The Court ruled that federal law does not not necessarily prohibit the restored mortgage gaining priority, but that under state law, New Hampshire, the servicer did not qualify for the relief.

This case raises several questions about the availability of equitable relief to restore a mistakenly discharged mortgage to a position of priority over subsequent federal tax liens. The plaintiff, Green Tree Servicing, LLC, claims that its predecessor erroneously recorded a discharge of its mortgage on a parcel owned by defendants Dana E. and Kristi L. Ricker, and seeks to restore that mortgage to its original priority over intervening liens filed by the Internal Revenue Service.


Green Tree further explains that, because the mortgage securing Conseco's first loan was never recorded, Conseco “inadvertently executed and recorded a satisfaction of the new mortgage” when, presumably, it was intending to record a satisfaction of its first mortgage instead. Curiously, though, this did not happen until May 24, 2002--despite the fact that the first Conseco loan was satisfied as soon as the second Conseco loan was made, on October 9, 2001 (more than 7 months earlier). 2 Furthermore, as the government points out, Green Tree explains the filing of the satisfaction differently in its complaint, which alleges that, after the loan was assigned from Conseco to Green Tree (which would not seem to have been necessary if, as Green Tree says, Conseco simply changed its name to Green Tree) Conseco “executed, in error, a satisfaction of mortgage, rather than an assignment of mortgage and caused [it] to be recorded” (quotation marks and capitalization omitted).

The government objects to this relief on two principal grounds. First, the government maintains that federal law, which, again, controls the priority of its liens here, does not allow the reinstatement of a discharged mortgage to a position of seniority over subsequently filed tax liens, regardless of whether state law would. Second, the government argues that, in any event, Green Tree has not demonstrated its entitlement to the equitable reinstatement of the mortgage under New Hampshire law. The court disagrees with the government's first point but agrees with its second point. As a result, Green Tree's motion for summary judgment must be denied.

IN RE: KRAUSE, Cite as 107 AFTR 2d 2011-XXXX

This was an appeal of a bankruptcy case where IRS liens were allowed against property transferred to a trust.  I like some of the language which is why I am sharing some of it.

Can a taxpayer avoid the IRS by moving money to a “diet cookie” company and then destroying records that might show the company to be a sham? Or by transferring assets to his “children's trusts” only to use the trusts to pay for his country club membership, buy cars, and fund his lifestyle? The answer, of course, is no. Why this is so takes a bit more explanation.

To determine whether a conveyance is fraudulent and so void as a matter of state law, Kansas law directs us to look for “six badges or indicia of fraud”: “(1) a relationship between the grantor and grantee; (2) the grantee's knowledge of litigation against the grantor; (3) insolvency of the grantor; (4) a belief on the grantee's part that the contract was the grantor's last asset subject to a Kansas execution; (5) inadequacy of consideration; and (6) consummation of the transaction contrary to normal business procedures.” Koch Eng'g Co. v. Faulconer, 716 P.2d 180, 184 (Kan. 1986) (internal quotation omitted).


Mr. Krause wears these badges boldly. In setting up the “children's trusts,” he transferred money first to his wife who, in turn, transferred them to the trusts, all for no consideration. Mr. Krause also transferred various insurance policies to the trusts, again for no consideration. Each of these transfers took place after Mr. Krause knew the IRS was conducting an audit of his taxes and after the IRS issued a notice disallowing certain of his claimed losses. And while Mr. Krause's brother, Richard, served as trustee for the children's trusts, both he and Mrs. Krause have admitted that Mr. Krause controlled the assets in question at all times. Indeed, Mr. Krause maintained no personal bank account after 2000 but instead used the children's trusts to pay for his country-club memberships, car loans, and other personal expenses. And Mr. Krause did all this without objection from Richard, who candidly described his philosophy toward the trusts as “stick your head in the sand and then you don't know what is going on.” Aplt's App. vol. 1, at 300. In light of these remarkable and undisputed facts, badges of fraud all, it is plain that Mr. Krause remained the owner of the transferred assets; that the children's trusts held those assets simply as his nominees; and that those assets are subject to attachment by Mr. Krause's creditors under Kansas law.See also William D. Elliott, Federal Tax Collections, Liens and Levies ¶ 9.10[1] (2d ed. 2000) (“The subject of nominee liens refers to situations when taxpayer's property or rights to property is held in the name of another or transferred to another party.”).

U.S. v. SIMMONS, Cite as 107 AFTR 2d 2011-XXXX

This one has a really impressive number.

Joyce M. Simmons appeals the sentence imposed following her guilty plea conviction for six counts of preparation of false tax returns. The district court sentenced Simmons to the statutory maximum sentence of three years of imprisonment on each count, and it ordered that the sentences would run consecutively for a total of 216 months. It also ordered Simmons to pay $28,261,295.08 in restitution to the Internal Revenue Service (IRS)

The evidence in the pre-sentence report (PSR) and the testimony of IRS Agent Shannon Dawson established the method by which the estimated tax loss was calculated. While Simmons correctly states that the forty-one tax returns investigated by Agent Dawson were not a completely random sample, the record does not indicate that those returns would have a higher falsity rate than any other returns prepared by Simmons. Moreover, the PSR correctly noted that Agent Dawson's calculation was conservative because she used the lower of two reasonable falsity percentages that she calculated from the investigated sample, and she did not include any tax loss from approximately 3,000 tax returns prepared by Simmons that did not include a Schedule C.

Simmons next argues that the district court erred by applying an enhancement for her utilizing sophisticated means during the offense. She contends that the means she utilized were not sophisticated and that an enhancement for use of a special skill pursuant to U.S.S.G. § 3B1.3 should not have applied because she received an enhancement for being in the business of preparing tax returns. She asserts that the enhancement was not appropriate because a sophisticated means enhancement was not applied in United States v. Poltonowicz, 353 F. App'x 690 [104 AFTR 2d 2009-7564] (3d Cir. 2009), even though the defendant in that tax preparation fraud case had previously worked as an analyst for the IRS criminal investigation division.


Other than that she was appealing the length of her sentence.  While I sometimes find that stuff interesting I'm not going into it any further.  I was disappointed that there was not more explanation of the scam that she was running.