QUESTION: The Internal Revenue Service contends that I filed fraudulent returns. So the feds have billed me for back taxes and nondeductible interest charges. To really twist the knife, they want to assess sizable civil fraud penalties, also nondeductible. Fortunately, the government will not bring criminal charges, which could have meant a lengthy stay in the slammer. My contention is that mental problems caused me to file 1040 forms that were inaccurate but not fraudulent. According to my attorney, it is unlikely that the IRS will drop the fraud penalties. In that case, one of my options is to have the dispute resolved by the U.S. Tax Court, which is entirely independent of the IRS and is the only forum where I can contest additional taxes, interest and penalties without having to first pay the disputed amounts. How would you rate my chances of persuading the Tax Court to see things my way?
ANSWER: The outcome depends on the particular facts and circumstances of your case. Unsurprisingly, the court closely scrutinizes a claim that mental or other medical problems justifies relief from penalties. For instance, it was unmoved by the medical problems of certified public accountant Robert Parker of Champaign, Ill. Parker held top-level positions with the University of Illinois, its fund-raising foundation and a foundation-owned company, U.D. Corp.
Moreover, his moonlighting job was preparing tax returns.
In his off-hours, the Champaign CPA caroused at the Club Taray, which the Tax Court described as follows: “The nightclub featured female dancers as entertainment. The women danced on stage and slowly removed their clothes. When the dancers were off-stage, customers could purchase their companionship by buying them cherries and bubble bath powder.” Club patrons who wanted to consort with the strippers had to shell out big bucks for drinks, the court noted. “Cherries cost $12 each. The price of bubble bath powder started at $48 and increased depending on the degree of privacy sought.”
During a five-year period, Parker’s authority over U.D.’s checking account enabled him to embezzle $604,000, a misappropriation accomplished by writing checks, including $90,000 to Club Taray and $397,000 to women “engaged for sexual activity.” The following year, the state of Illinois convicted him on charges of criminal embezzlement. Then the IRS came on the scene, as Parker did not report the embezzled funds as income; the agency reckoned he was liable for back taxes of $347,000 and civil fraud penalties of $174,000, plus interest.
Wrong. He was more sinned against than sinning, explained the randy Parker to the Tax Court. He had been mentally ill and controlled by the women and the club’s manager, an assertion contradicted by their testimony that he alone decided when to write checks and in what amounts, and had never been threatened by them.
To bolster his claim that he was merely a conduit through which misappropriated funds were channeled to third parties, Parker claimed that he derived no benefit from or enjoyment in getting into bed with these women. “That was their idea; it wasn’t my idea.” The judge held that Parker owed the taxes and penalties, saying: “It is apparent that any illness he may have had did not interfere with his ability to recognize taxable income.”
Julian Block is a nationally renowned tax expert. You can e-mail questions and comments to him at firstname.lastname@example.org.