Harrington v. Commissioner
In Harrington v. Commissioner of Internal Revenue, George S. Harrington (Harrington) challenged tax deficiencies and fraud penalties assessed for tax years 2005 through 2010. The Internal Revenue Service (IRS) opened an examination into Harrington’s tax returns after the U.S. Department of Justice (DOJ) and a multinational finance company entered into a deferred prosecution agreement that revealed information on Harrington.
The IRS concluded that for tax years 2005 through 2010, Harrington had unreported income from unreported accounts in the Cayman Islands, and therefore, he was liable for deficiencies and penalties due to those unreported offshore assets. Harrington filed a petition for redetermination in the U.S. Tax Court challenging the assessed deficiencies and penalties. The Tax Court sustained the assessments and penalties for all tax years except 2010. Harrington appealed, but the U.S. Court of Appeals for the Tenth Circuit affirmed the Tax Court’s decision.
Harrington is a U.S. citizen who spends half of the year in the U.S. and the other half in New Zealand. Harrington reported income from bank accounts in New Zealand on his original income tax returns for tax years 2005 through 2009. He also filed Filing Reports of Foreign Banks and Financial Accounts (FBARs) for those accounts as required by the Bank Secrecy Act.
In 2009, UBS AG, a Swiss multinational investment and financial services company, entered into a deferred prosecution agreement with the DOJ in connection with charges of participating in conspiracy to defraud the U.S. by maintaining bank accounts that were designed to conceal a U.S. taxpayer’s ownership in such accounts. Per the agreement, UBS AG provided the DOJ with information about many of its account holders, including Harrington.
Relying on information disclosed in the agreement, revenue agent Jane McManus (McManus) opened an examination into Harrington’s tax returns in 2012. Two years into McManus’s examination, Harrington submitted amended tax returns disclosing his interest in the previously unreported Cayman Islands accounts. At this time, he also filed updated FBARs for those accounts.
After considering both the original and amended tax returns, McManus concluded that Harrington had unreported income from dividends, interest, and capital gains from previously unreported foreign accounts in the Cayman Islands and calculated his tax deficiency and fraud penalties accordingly. Based on McManus’s report, her supervisor, Kimberly Slack (Slack), signed a Civil Penalty Approval Form on March 17, 2016.
McManus informed Harrington of the proposed tax deficiencies and fraud penalties for tax years 2005 through 2010 via a letter dated April 20, 2016. In response, Harrington filed a petition for redetermination in the Tax Court challenging the assessed deficiencies and penalties. The Tax Court held a one-day hearing, after which they sustained the assessments and penalties for all tax years except 2010. Harrington appealed their decision.
Harrington argued that “(1) the Tax Court erred in finding fraud in connection with his tax returns for 2005-09, (2) the statute of limitations barred assessment of taxes for those years, and (3) Ms. McManus did not obtain the necessary supervisory approval before assessing fraud penalties.”
Harrington argued that the Tax Court erred in finding he underpaid taxes for tax years 2005 through 2009 and in finding his originally filed returns were fraudulently filed with the intent to evade payment of income tax. In particular, he argued that his amended returns should not have been considered evidence of underreported income because he submitted the amended return by mistake at McManus’s demand and his counsel’s erroneous advice.
The Tax Court stated precedent that held positions taken in a tax return signed by a taxpayer may be treated as admissions. Nevertheless, it still weighed Harrington’s testimony that he submitted the amended returns at the demand of McManus against McManus’s testimony that denied the same. The appellate court refused to reweigh the testimony evidence on appellate review.
The Tax Court defined fraud as actual, intentional wrongdoing, and the intent required is the specific purpose to evade a tax believed to be owed. If the Commissioner established that any portion of an underpayment was attributable to fraud, the entire underpayment is treated as attributable to fraud, except with respect to any portion of the underpayment that the taxpayer established (by a preponderance of the evidence) was not attributable to fraud.
Because the existence of fraud is ordinarily not susceptible of direct proof, it must generally be determined from surrounding inferences and circumstances fairly deductible from the conduct of the parties. Accordingly, the Tax Court reviewed Harrington’s entire course of conduct to determine whether there existed “badges of fraud,” which include but are not limited to:
- understating income,
- keeping inadequate records,
- giving implausible or inconsistent explanations of behavior,
- concealing income or assets,
- failing to cooperate with tax authorities,
- engaging in illegal activities,
- supplying incomplete or misleading information to a tax return preparer,
- providing testimony that lacks credibility,
- filing false documents (including false tax returns),
- failing to file tax returns, and
- dealing in cash.
Based on the amended tax returns and the records obtained through UBS AG’s deferred prosecution agreement, the Tax Court found that Harrington substantially understated his income for the tax years in question; that he provided changing and implausible explanations regarding the accounts to McManus during her examination (including the false claim that he never received account statements); that he held millions of dollars in offshore UBS AG accounts in the names of shell companies and fictitious entities situated in tax havens; that his shifting and misleading statements to McManus evidenced a failure to cooperate; that he did not testify credibly; and that the original tax returns he filed were false. The Tax Court found that the above-mentioned “badges of fraud” were present and demonstrated that Harrington acted with fraudulent intent.
On appeal, Harrington primarily restated his arguments from his post-trial briefing before the Tax Court. He argued that his testimony was, in fact, plausible and consistent; that he never exercised ownership or control over assets in the offshore accounts; that he cooperated with McManus during her examination; and that his originally filed tax returns, which did not acknowledge any ownership in the offshore accounts, were true and correct.
Nevertheless, these arguments were based on factual conclusions, and the appellate court stated that it did not have the authority to change the Tax Court’s factual findings. Thus, the appellate court affirmed the Tax Court’s holding that Harrington’s initially filed returns were false and fraudulent with the intent to evade tax.
Harrington also argued that the statute of limitations had run on the Commissioner’s authority to impose the tax assessments. The court responded by referring to Section 6501(c)(1), which states that “[i]n the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed … at any time.” Because the appellate court had affirmed the Tax Court’s finding that Harrington’s initially filed returns were false and fraudulent with the intent to evade tax, the appellate court affirmed the Tax Court’s conclusion that the statute of limitations did not bar the assessment.
Harrington argued that the penalty assessments were void for failure to obtain prior supervisory approval under Section 6751(b), which provides that “[n]o penalty … shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination.” The Tax Court has held that Section 6751(b) requires supervisory approval before the revenue agent formally communicates the decision to impose penalties to the taxpayer. McManus’s case activity record, internal emails, and the handwritten date next to Slack’s approval signature supported that McManus obtained supervisory approval on March 17, 2016, before sending Harrington a notice of deficiency on April 20, 2016.
Harrington argued that McManus and Slack improperly backdated the supervisory approval form. He supported his position by referring to a typewritten date of June 14, 2016, in the upper corner of the form. The Tax Court considered and rejected this factual claim, finding no evidence to suggest that McManus and Slack engaged in falsifying documents. Furthermore, the Tax Court noted how there is a presumption that public officers have properly discharged their official duties in the absence of clear and convincing evidence to the contrary. The Tax Court found Mr. Harrington did not overcome that presumption here. The appellate court reiterated that it does not have the power to change factual determinations and thus rejected Harrington’s argument.
The Tenth Circuit Court of Appeals affirmed the Tax Court’s ruling that Harrington’s initially filed returns were false and fraudulent with the intent to evade tax, that the statute of limitations did not bar the assessment, and that there is no evidence to suggest that McManus and Slack falsified documents nor did Harrington overcome the presumption that McManus and Slack have properly discharged their official duties. Exercising jurisdiction under Section 7482(a)(1), the Tenth Circuit Court of Appeals affirmed the Tax Court’s decision concluding that Harrington was liable for tax deficiencies and fraud penalties on his income tax forms for tax years 2005 through 2009 due to unreported offshore assets.
This article first appeared in the March 2023 Edition of the Estate Planning Journal.
Frank Baldino is an estates and trusts attorney who helps people throughout the greater Washington, DC area protect assets for their families and future generations through careful estate tax planning. For more information, contact Frank at (301) 657-0175 or [email protected].