Whistleblower Penalty

CAMPBELL v. COMM., Cite as 108 AFTR 2d 2011-XXXX, 09/28/2011




ALBERT D. CAMPBELL, Petitioner - Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent - Appellee.

Case Information:

Code Sec(s):

Court Name: IN THE UNITED STATES COURT OF APPEALS FOR THE ELEVENTH CIRCUIT,

Docket No.: No. 10-13677,

Date Decided: 09/28/2011.

Disposition:



HEADNOTE

.



Reference(s):



OPINION

IN THE UNITED STATES COURT OF APPEALS FOR THE ELEVENTH CIRCUIT,



Appeal from a Decision of the United States Tax Court



Before DUBINA, Chief Judge, HILL, Circuit Judge, and GOLDBERG, * Judge.



Judge: PER CURIAM:



Tax Court No. 21209-07



[PUBLISH]



Taxpayer Albert D. Campbell was awarded and received a net $5.25 million qui tam payment from the government as a “relator” in two lawsuits settled against government contractor Lockheed Martin (Lockheed) under the False Claims Act (FCA), 31 U.S.C. §§ 3729–3733 (2006). Campbell asserted that the award was not taxable. 1



The Tax Court disagreed. It held that the entire amount was includable in Campbell's gross income as the equivalent of a reward, Roco v. Comm'r, 121 T.C. 160, 164 (2003), pursuant to I.R.C. § 61(a); and (2) that he was liable for an accuracy-related penalty pursuant to I.R.C. § 6662(a), based on the omission of the award from his reported taxable income. Finding no clear error, we affirm the judgment of the Tax Court.



I.

Campbell is a sophisticated taxpayer. See Seven W. Enter., Inc. & Subs. v. Comm'r, 136 T.C. No. 26, 2011 WL 2260389, at 4 (T.C. June 7, 2011). He had a business degree in accounting. He began working for Lockheed in 1981. For eight years he was a financial analyst. After that, Lockheed promoted him to chief of cost control for a $3.5 billion contract held with the government. Campbell held that position until 1995.



In 1995, Campbell became a whistleblower against his former employer. He filed two lawsuits under the FCA, claiming that Lockheed had defrauded the United States. 2 In 2003, Lockheed settled with the government for $37.9 million. Campbell received a qui tam payment of $8.75 million for his role as relator. A Form 1099-MISC, Miscellaneous Income, was issued to him from the United States Department of Justice for $8.75 million.



The money was wired to Campbell's attorneys. They subtracted their 40% fee of $3.5 million, and sent Campbell a check for the remaining balance of $5.25 million.



Campbell prepared his 2003 tax return without consulting outside counsel. He displayed the $5.25 million sum on line 21 as “other income” but omitted the amount from the calculation of taxable income on line 40. His resulting taxable income was $793.



Campbell also attached Form 8275, Disclosure Statement, to his 2003 return. Without citing any authority in support of his assertions, he stated on the form that the $3.5 million in attorney's fees was not taxable income, and that the $5.25 million net qui tam payment was excludable from his taxable income.



In 2007, the Commissioner of Internal Revenue sent Campbell a notice of deficiency: (1) for failing to include the $5.25 million qui tam payment in his gross income under I.R.C. § 61(a); and (2) for an accuracy-related penalty under I.R.C. § 6662, as his exclusion of the qui tam payment resulted in a substantial understatement of income tax. Campbell filed a petition in the Tax Court. The Tax Court held in favor of the Commissioner on both issues. This appeal followed.



II.

In 2000, the Supreme Court held that a relator has standing to bring a qui tam action in federal court against a state agency because the FCA affected a partial assignment of the government's claim to the relator. See Vt. Agency of Natural Res. v. U.S. ex rel. Stevens, 120 S.Ct. 1858, 1863 (2000). 3 As the assignee of such a claim, a relator has standing to assert the injury-in-fact suffered by the government.Id. In Vermont Agency, the Supreme Court made no ruling on the taxability or non-taxability of aqui tam payment.



In Campbell's case, the Tax Court found that although the FCA affects a partial assignment of the claim for purposes of standing, the assignment of the claim does not change the taxability of the proceeds to him. See Roco, 121 T.C. at 164. Therefore, the qui tam payment is the equivalent of a reward, and taxable.Id. 4



III.

We review the Tax Court's application of the tax codede novo and its findings of fact for clear error.See Estate of Jelke v. Comm'r , 507 F.3d 1317, 1321 [100 AFTR 2d 2007-6694] (11th Cir. 2007). Whether a taxpayer acted with reasonable cause and in good faith is a question of fact. See Green v. Comm'r, 507 F.3d 857, 866 [100 AFTR 2d 2007-6562] (5th Cir. 2007).



IV.

Section 61(a) of the Internal Revenue Code defines gross income as “all income from whatever source derived.” I.R.C. § 61(a). There is no exclusion enumerated in the Code forqui tam awards. See Treas. Reg. § 1.61-1(a). “The taxpayer's qui tam relator's award, therefore, must constitute gross income unless the taxpayer is able to show that it is “expressly excepted by another provision in the Tax Code.”” Brooks v. United States, 383 F.3d 521, 523 [94 AFTR 2d 2004-5863] (6th Cir. 2004). The payment to a relator in a qui tam action is a financial incentive for a private person to provide information and prosecute claims relating to fraudulent activity. See United States ex rel. Semtner v. Med. Consultants, Inc., 170 F.R.D. 490, 495 (W.D.Okla. 1997). It is not a penalty imposed on the wrongdoer. Id.



Although the question of whether or not qui tam payments are includable in gross income is an issue of first impression in this circuit, other courts that have addressed this issue have uniformly concluded that they are. See Brooks, 383 F.3d at 525 (qui tam payments are not excludable from gross income as personal injuries inflicted upon the relator in tort); Roco, 121 T.C. at 164–65 (qui tam payments are the equivalent of a reward, and rewards are generally includable in gross income);Trantina v. United States , 512 F.3d 567, 570 [101 AFTR 2d 2008-443] n.2 (9th Cir. 2008) (the legal question is whether qui tam payments should be taxed as ordinary income or as a capital gain); Alderson v. United States, 718 F.Supp.2d 1186, 1191 (C.D.Cal. 2010) (the parties do not dispute that a qui tam award is taxable income, the dispute is whether or not the award is ordinary income or capital gain). We agree with our sister courts that qui tam payments are includable in gross income. 5



The taxpayer in Brooks was a physician who filed an FCA claim against a hospital and two of its doctors for submitting fraudulent Medicare and Medicaid bills to the government for payment. Brooks, 383 F.3d at 522. Dr. Brooks received a qui tam payment of $210,067. He included the relator's reward in gross income, and timely paid $78,607 in income taxes on that amount. Id.



Dr. Brooks also received a second settlement of $300,000, releasing the defendants from any personal injury claims, including claims for retaliation and defamation, as “damages received on account of personal injuries within the meaning of [I.R.C. §] 104(a)(2).” Brooks, 383 F.3d at 522. He excluded the $300,000 from his gross income as compensatory damages for personal injuries, under I.R.C. § 104(a)(2). Id.



Dr. Brooks then filed a claim for refund for the $78,607 in income tax that he had paid on the relator's award.Brooks , 383 F.3d at 522. The Commissioner disallowed his claim for refund and the district court agreed with the government. The Sixth Circuit affirmed finding “1) that the underlying cause of action (the FCA claim) is based upon contract fraud inflicted upon the government, not a tort inflicted upon the relator, and 2) that the relator received his award on account of initiating the prosecution of the FCA claim on behalf of the government, not on account of personal injuries inflicted upon himself, we therefore [affirm] the district court's holding that a qui tam relator's award is not excludable from gross income under [I.R.C.] § 104(a)(2).” Id. at 525.



Although no part of Campbell's case involved a tort action, we agree with the Sixth Circuit. Campbell initiated the prosecution of an FCA claim on behalf of the government. His relator award is not excludable from gross income. It is in the nature of a reward, and is includable in gross income. See Roco, 121 T.C. at 164.



V.

We now turn to the issue of whether or not Campbell is liable for a 20% accuracy-related penalty for underpayment under the Internal Revenue Code. A penalty is imposed when there is: (1) negligence or disregard of rules or regulations; or (2) substantial understatement of income tax. I.R.C. §§ 6662(a), (b). Negligence includes any failure to make a reasonable attempt to comply with the tax code. I.R.C. § 6662(c). Disregard of rules or regulations includes any careless, reckless, or intentional disregard. Id. 6



Campbell contends that he is not liable for the accuracy-related penalty because: (1) he disclosed thequi tam payment on his tax return, both on line 21 and on Form 8275; (2) there was reasonable cause for the omission; and (3) that he acted in good faith. The Commissioner contends that while the qui tam payments were “reflected” on Campbell's return, they were “dropped” in calculating his ultimate tax liability and that such underpayment resulted in a “substantial understatement of income” under I.R.C. § 6662(b). We agree. Campbell did not disclose the amount in good faith and with reasonable cause merely by mentioning them in two places on his return. He incredulously and conveniently ignored or overlooked the amount when it was time to do the math. He showed no reasonable cause for that omission. It was an overt and intentional act to underpay.



VI.

We now turn to whether Campbell satisfies either exception to the imposition of the 20% penalty. Did he provide: (a) substantial authority for the omission, (b) did he adequately disclose the omission, or (c) did he have a reasonable basis for the omission? I.R.C. § 6662(d)(2)(B). Did he have: (a) a reasonable cause for his position, or (b) did he prove that he acted in good faith: I.R.C. § 6664(c).



The Tax Court determined in its findings of fact that Campbell did not meet either exception. Campbell asserted that he relied upon substantial case law authority. He contends he made adequate disclosure and showed reasonable basis. The Tax Court found to the contrary. Campbell's citations to authority were no authority for his position. Certainly they are neither reasonable or persuasive. They are meritless. The Tax Court did not clearly err in finding that Campbell did not qualify for the first exception to the accuracy-related penalty under Section 6662(d)(2)(B).



Next Campbell claims he has provided reasonable cause for his position. The Tax Court found no such reasonable cause. Campbell claims he acted in good faith. Campbell is a sophisticated taxpayer who chose not to consult a professional tax consultant in preparing his return. The Tax Court did not clearly err in finding that Campbell did not qualify for the second exception to the accuracy-related penalty under Section 6664(c).



VII.

The Tax Court correctly concluded that the entire $5.25 million qui tam payment awarded to Campbell under the FCA was includable in gross income and that Campbell was liable for the Section 6662(a) accuracy-related penalty.



The judgment of the Tax Court is



AFFIRMED.

*





Honorable Richard W. Goldberg, United States Court of International Trade Judge, sitting by designation.

1



“Qui tam” is short for a Latin phrase which means he or she “who pursues this action on our Lord the King's behalf as well as his own.” Vt. Agency of Natural Res. v. U. S. ex rel. Stevens, 120 S.Ct. 1858, 1860 n.1 (2000). The individual who brings the qui tam suit on behalf of the government is referred to as a relator. Id. at 1860. The history of qui tam actions is discussed at length. Id. at 1863–65.

2



The United States intervened in the first lawsuit, but not the second.

3



Campbell's argument that, as the assignee of the United States' claim against Lockheed, he stands in the shoes of the government in receipt of a nontaxable recovery, is misplaced. See Vt. Agency, 120 S.Ct. at 1863. Also meritless is Campbell's reliance upon the 1930 Supreme Court case of Lucas v. Earl, 50 S.Ct. 241 [8 AFTR 10287] (1930), for the same proposition.

4



Campbell's reliance upon footnote 2 in Roco, which stated that the Tax Court was not deciding whether a qui tam payment is a nontaxable share in the recovery of a reimbursement, is meritless.Roco v. Comm'r , 121 T.C. 160, 165 n.2 (2003). Here the Tax Court correctly found that, contrary to Campbell's argument, the footnote cannot be interpreted to mean that thequi tam payments are nontaxable shares in the recovery of a reimbursement. Roco held thatqui tam payments are the equivalent of a reward, and therefore taxable. Id. at 164.

5



We are also not persuaded by Campbell's argument that the legislative history of the FCA determines that we must hold otherwise.

6



A substantial understatement of income tax occurs in any year where the amount of the understatement exceeds the greater of ten percent (10%) of the amount required to be shown on the return or $5,000. I.R.C. § 6662(d)(1)(A). The understatement will be reduced if there was substantial authority for such treatment, or if the relevant facts are adequately disclosed in the return or attached statement, or if there was reasonable basis for such treatment. I.R.C. § 6662(d)(2)(B). An exception exists if the taxpayer can show reasonable cause for the understatement and that he or she acted in good faith. I.R.C. § 6664(c).

SE Health

CAMPBELL v. U.S., Cite as 110 AFTR 2d 2012-XXXX, 07/30/2012




FREDERICK B. CAMPBELL, Plaintiff, v. UNITED STATES OF AMERICA, and TIMOTHY GEITHNER, Defendants.

Case Information:

Code Sec(s):

Court Name: UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK,

Docket No.: 11-Civ-5782 (BSJ),

Date Decided: 07/30/2012.

Disposition:



HEADNOTE

.



Reference(s):



OPINION

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK,



OPINION & ORDER

Judge: BARBARA S. JONES UNITED STATES DISTRICT JUDGE



INTRODUCTION

Plaintiff pro se in this action, Frederick B. Campbell, seeks a declaration that §§ 106 and 162(1) of the Internal Revenue Code (“Tax Code”), 26 U.S.C. §§ 106, 162(1), are unconstitutional. For the reasons that follow, the United States Defendant's motion to dismiss is granted.



BACKGROUND

Section 106 of the Tax Code allows individuals who are employed by third-parties to exclude the cost of employer-provided health insurance benefits from their income, which reduces their income, Social Security, and Medicare tax liabilities. Section 162(1) allows individuals who are self-employed to deduct the cost of their health-insurance premiums from their income taxes, but not from their Social Security or Medicare taxes.



Plaintiff is self-employed and thus entitled to deduct the cost of his health-insurance premiums from his income taxes pursuant to § 162(1). The gravamen of Plaintiff's complaint is that it is unconstitutional for Congress to subsidize health care through §§ 106 and 162(1) of the Tax Code rather than through an appropriations law. (Am. Complaint, ¶¶ 20–23.) Defendant moves to dismiss the Complaint on the ground that Plaintiff lacks standing to sue.



LEGAL STANDARD

A Plaintiff's standing to sue is a threshold question, as it “determin[es] the power of the court to entertain the suit.” Warth v. Seldin, 422 U.S. 490, 498 (1975). To demonstrate standing, a plaintiff must show by a preponderance of the evidence that he has “suffered (1) a concrete, particularized, and actual or imminent injury-in-fact (2) that is traceable to defendant's conduct and (3) likely to be redressed by a favorable decision.” Woods v. Empire Health Choice, Inc., 574 F.3d 92, 96 (2d Cir. 2009) (citing Lujan v. Defenders of Wildlife, 504 U.S. 555, 560–61 (1992)); Luckett v. Bure, 290 F.3d 493, 497 (2d Cir. 2002).



DISCUSSION

Plaintiff here has not alleged an “injury in fact” caused by the challenged government conduct. Lujan, 504 U.S. at 560. For several reasons, the first injury that Plaintiff claims—that he pays higher taxes than individuals who are eligible for a tax exclusion under § 106 (Am. Complaint, ¶¶ 14–15)—is not cognizable. For one, Plaintiff has not alleged an “invasion of a legally protected interest” here, Lujan, 504 U.S. at 560, as Congress may enact tax laws that treat some taxpayers more favorably than others, consistent with the Constitution. See Regan v. Taxation with Representation of Wash., 461 U.S. 540, 547 [51 AFTR 2d 83-1294] (1983) (rejecting challenge to a tax law that favored some groups over others, stating, “[l]egislatures have especially broad latitude in creating classifications and distinctions in tax statutes”); see also Comm'r v. Nat'l Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 148 [33 AFTR 2d 74-1347]–49 (1974) (quoting New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 [13 AFTR 1180] (1934)) (“[T]he propriety of a deduction does not turn upon general equitable considerations, such as a demonstration of effective economic and practical equivalence. Rather, it “depends upon legislative grace.””). Moreover, the reason why Plaintiff's tax liability is calculated pursuant to § 162(1) rather than § 106 is the direct result of his decision to be self-employed; Congress has not imposed that choice on him, and so “he must live with the consequences of the federal tax code and the limitations it places upon him.” Campbell v. United States, No. 00-4746, 2001 WL 1262934 [88 AFTR 2d 2001-6762], at 4 (S.D.N.Y. Oct. 22, 2001).



Lastly, the injury is abstract. Though Plaintiff complains about his discrepant tax treatment for purposes of describing his harm, his chief complaint is that Congress has used the Tax Code—rather than an appropriations law—to distinguish between the self-employed and those who work for third-parties. But a complaint about Congress's lawmaking methods, or the constitutionality of its actions, is a generalized grievance, which Plaintiff lacks standing to pursue. See Valley Forge Christian Coll. v. Am. United for Separation of Church & State, Inc., 454 U.S. 464, 479 (1982).



The second injury that Plaintiff claims is also speculative. Plaintiff contends that allowing exclusions under § 106 will cause the government to lose revenue, which will require Congress to impose higher tax rates in general to compensate for that loss, ultimately making Plaintiff's tax liability higher than it would be otherwise. (Am. Complaint, ¶ 16.) Plaintiff cannot predict or presume to know why Congress raises or lowers taxes. And he has not alleged facts to suggest how §§ 106 and 162(1) relate to the remaining provisions of the Tax Code such that the repeal of the former would cause a net increase in revenue. Certainly, Plaintiff's vague assertions about Congress's future actions do not allege any injury to him that is “actual or imminent.” Lujan, 504 U.S. at 560; see Green Island Power Auth. v. F.E.R.C., 577 F.3d 148, 161 (2d Cir. 2009) (rejecting an alleged injury as speculative where it was based on a number of assumptions about the future conduct of a third party).



For similar reasons, the Court finds that Plaintiff's alleged harms would not be redressed by the relief that he seeks. See Lamar Advertising v. Town of Orchard Park, 356 F.3d 365, 373 (2d Cir. 2004) (quoting Lujan, 504 U.S. at 560) (“[I]t must be likely, as opposed to merely speculative, that the injury will be redressed by a favorable decision.”). The Court does not believe that a declaration that §§ 106 and 162(1) are unconstitutional would be likely to prompt Congress to subsidize healthcare costs differently; to lower taxes; or to replace §§ 106 and 162(1) with an appropriations law that accomplishes the same effects. Therefore, it is unclear to the Court how the relief that Plaintiff seeks could remedy the fact that his tax liability is higher than those employed by third-parties or prevent Congress from raising taxes in the future, for whatever reason.



CONCLUSION

For the reasons stated above, the Court finds that Plaintiff lacks standing to pursue this action. Because the Court has concluded that Plaintiff lacks standing, it dismisses as moot Plaintiff's motion for summary judgment.



The clerk of the Court is directed to terminate the motion at docket numbers 24 and 26 and to close the case.



SO ORDERED:



Barbara S. Jones



UNITED STATES DISTRICT JUDGE



Dated: New York, New York



July 30, 2012

If You Kill Your Parents It's Your Own Fault You are an Orphan

Here are a few items that I didn't quite get to in tax season.

CCA 201106015

The law firm provides one of its attorneys to perform legal services for a municipality. It's usually the same attorney every time. The firm sends an invoice to the municipality, and the municipality pays the firm. The municipality does not issue a Form 1099. The attorney is paid by the law firm. Small municipalities essentially contract out for these services when they can't afford their own full time city attorney.


The question is whether the IRS should assert that the attorney is an employee of the municipality, rather than an employee (or partner) of the law firm for purposes of the services provided to the municipality.


My answer is no. The attorney is not an employee of the municipality. ———————————

It is nice to know that sometimes national office will restrain the overzealous.  What they would be accomplishing other than creating aggravation for the small municipality is beyond me.

Roger S. Campbell, et ux. v. Commissioner, TC Memo 2011-42

There were a couple of issues in this case around substatntiation, but the main thing was a hobby loss question on Amway activities.  I remember going to some Amway presentations and it is really shocking to me that people can actually lose money on something that sounds like such a good deal.

Petitioners did not conduct the Amway activity in a businesslike manner. Although they maintained a separate bank account for the activity and maintained records for certain aspects of it, petitioners never used these records as an analytical tool for improving profitability. Mrs. Campbell testified that she did not know whether the Amway activity was profitable in any given year until she completed petitioners' tax return for that year which, for 2 of the taxable years in issue, did not occur until almost 2 years later. It is a fair inference that petitioners' recordkeeping was directed more towards substantiating deductions on a tax return than assessing the profitability of the Amway activity.


Considering all the facts and circumstances, including especially the confusing state of petitioners' Amway records, we conclude that a substantial portion of the costs of goods sold respondent disallowed for 1998 and 1999 represents Amway purchases that petitioners withdrew from inventory for personal use or use in their other businesses. This commingling of the Amway merchandise, resulting in substantial inaccuracies in reported costs of good sold, is further evidence that petitioners' Amway activity was not conducted in a businesslike fashion. It also resulted in petitioners' claiming business deductions for personal expenditures.


Although petitioners have prior entrepreneurial experience and both operated other businesses concurrently, they had no experience with operating a direct marketing distributorship before they were recruited as Amway distributors. Petitioners obtained advice only from their upline distributors and other interested Amway individuals, persons who had a direct financial interest in the maximization of petitioners' sales volume, without regard to petitioners' profitability.

In view of the foregoing, petitioners have failed to prove that they carried on their Amway activity with the requisite objective of making a profit. Consequently, their deductions arising from the Amway activity are limited by section 183.

In the presentations it was always about you recruiting people who recruit people and so on. It always seemed that somebody somewhere had to be selling an awful lot of soap for the thing to work.

U.S. v. THOMAS, Cite as 107 AFTR 2d 2011-1599

This was a protester who was complaining about having to file all his delinquent returns as a condition of his supervised release.  He figures the IRS already did substitute returns and that it was going to be hard to dig up records from that long ago.  The Court had no sympathy as they cited one of my favorite jokes.

We hold that the district court correctly calculated the applicable sentencing range and did not abuse its discretion in imposing an obligation to file all unfiled tax returns and pay all outstanding tax arrears as a condition of supervised release.

We note that any difficulties that may arise from the age of the necessary documents or the passage of time are entirely self-inflicted; had he complied with his duty to file the returns when they were initially due, there would be no such troubles. His contention on appeal that this state of affairs amounts to a “burden” imposed by the district court is absurd, like killing your parents and complaining of being an orphan.



Jeffrey S. Charlton, et ux., et al. v. Commissioner, TC Memo 2011-51

This was a statute of limitations case.  The underlying plan was clearly a loser:

During 1998, Jeffrey and Timothy formed Graphic Connections Group, LLC; Wealth Builders International, LLC; and Golf Links Display Group, LLC (collectively, the partnerships). Pursuant to the partnerships' operating agreements, Jeffrey and Timothy each had a 1-percent interest, and the domestic trusts had a 98- percent interest, in each of the partnerships. The domestic trusts paid the personal expenses of Jeffrey's and Timothy's families and distributed income to the Belize trusts. Jeffrey and Timothy used foreign bank accounts in Belize and Antigua to access the income. On August 1, 1999, Token Trust purchased Titan Trust's and Timothy's interests in the partnerships.

One of my rules is to not get involved in any plan that includes a place I can't easily point out on the map. (Belize is in Central America by the way.  You probably already knew that.)  As it turned out though the Tax Court believed that Mr. Charlton was gullible rather than fraudulent:

Jeffrey, who undoubtedly had a penchant for fast and easy money, foolhardily followed the Aegis system (i.e., structuring the transactions and resisting the IRS audit). See Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992); Gajewski v. Commissioner, supra. Nevertheless, Jeffrey maintained adequate records and made all pertinent information available to Mr. Moore, his longtime trusted, yet imprudent, CPA. See Niedringhaus v. Commissioner, supra at 211. To his detriment, Jeffrey relied on the professional judgment of Mr. Moore, who inexplicably believed in and acquiesced to an elaborate scheme designed by con artists. See Estate of Temple v. Commissioner, 67 T.C. 143, 162 (1976) (holding that reliance upon an accountant to prepare accurate returns may negate fraudulent intent if the accountant was supplied with all the information necessary to prepare the returns); Marinzulich v. Commissioner, 31 T.C. 487, 490 (1958) (holding that a taxpayer's reliance upon his accountant to prepare an accurate return may indicate an absence of fraudulent intent).

If you are using Mr. Charlton as a guide to your future plans, I would point out that if you go shopping for a CPA who is as gullible as you are, you might not be able to rely on who ever you end up with.  If you talk to two of them and neither one will drink the Kool-Aid with you, give it up.

Another SE Scheme That Didn't Work

Renkemeyer, Campbell and Weaver, LLP, et al. v. Commissioner, 136 T.C. No. 7

I often tell my daughter stories about my grandmothers, Nanna Reilly and Nanna Lyons.  When ever I start the story she has to clarify whether I'm talking about the one who liked TV wrestling or the one who smoked.  In case she is reading this, this is about the one who smoked, Nanna Lyons, whose house I grew up in.  Nanna Lyons had a great admiration for her deceased husband, for whom I am named, the New York Yankees and, possibly above all, Franklin Delano Roosevelt.  I could hear her talking to herself from time to time about the greatness of FDR.  It always started with "Social Security".  You see Peter Lyons died in 1940, having paid by my rough estimate about $20 in social security taxes which his widow had more than recovered by the time my father took charge of the air raid wardens of Fairview NJ in 1942.  She collected until her death in 1966 and I am certain that I had Franklin Delano Roosevelt to thank for all those nickels I earned going to the corner store to purchase packs of Kents.

Many of my contemporaries do not think that Social Security is quite the good deal that Nanna Lyons perceived and come up with a variety of schemes to avoid paying social security taxes (including self employment tax).  Renkemeyer, Campbell and Weaver LLP (RCW) came up with an interesting one.

For the law firm's tax year ended April 30, 2004, three of the law firm's partners were attorneys performing legal services. The fourth partner was an S corporation owned by a tax-exempt ESOP whose beneficiaries were the law firm's three attorney partners. For tax year ended April 30, 2005, the law firm's only partners were the three attorneys.


Approximately 99 percent of the law firm's net business income for its tax year ended April 30, 2004, was derived from legal services rendered by the three attorney partners.


For tax year ended April 30, 2004, the law firm allocated 87.557 percent of its net business income to the S corporation.

There was a little bit of the shoemakers children phenomenon at work as the team of tax attorneys could not find their own partnership agreement.

Petitioner asserts that the special allocation of the net business income of the law firm for its 2004 tax year was proper because the allocation was made pursuant to the provisions of the partnership agreement. But as noted supra p. 4, the partnership agreement effective for the 2004 tax year is not in the record.


In 2005, they took a different approach.  The corporation was eliminated as a partner and they divided their interest into general partnership interests and limited partnerships.  Apparently the plan was that the income attributable to the limited partnership interest would not be subject to SE tax.  That didn't work either.

The thing that was bothering me the most about this case is that there appear to have been no penalties asserted.  In a similar SE avoidance scheme, which I have a recent post about, Dr. Tony Robucci, a psychiatrist, was assessed penalties even though he was relying on an attorney CPA advisor.  The Tax Court seemed to think he should have sought a second opinion.  At least one of these fellows was himself a tax attorney, so you would think they would be held to a higher standard.

Perhaps it is because of another adjustment:

Further, respondent reduced the law firm's gross business revenues by $905,000 (and consequently reduced the law firm's net business income) after determining that a legal fee in a like amount had not been received during the 2004 tax year.

Sometimes we lose track of the basics.  Cash basis taxpayers who only report the income that they actually receive don't have to pay as much as those who report more than that.  You would think that the Tax Matters Partner Troy Renkenmeyer would be sensitive to that given his background with Arthur Andersen, where they got into all those difficulties about revenue recognition.

Selling Soap as a Hobby - Amway IBO's in Tax Court

Roger S. Campbell, et ux. v. Commissioner, TC Memo 2011-42




The Amway distributorship system is well known to respondent and this Court
Friscia Construction, Inc., et al. v. Commissioner, TC Memo 2000-192

I included the Campbell case in one of my group posts.  It concerned someone whose Amway activities were considered a hobby by the Tax Court denying them deductions for losses.  That portion of the post was picked up by someone who calls himself Joecool and posted on his blog under the title "Do IBO's have a clue about business?".  I found that there are quite a few blogs dedicated to pointing out the downside of the Amway experience including Married To An Ambot by Anna Banana :

My story of what its like to be married to an Amway cult follower. I expose the lies that our upline told and what happens at Amway meetings and functions. I leave the explanations of why Amway is a poor business opportunity or the tool scam to other bloggers. This blog mainly exists to curse out my former upline, aka the cult leaders, and to let everyone know what kind of idiots I had to put up with. Feel free to join in or live vicariously.

Come on Anna, stop holding back. Tell us how you really feel.

 So I got motivated to look at what was in the database I prowl for my little tax jewels had on Amway.  As the above quote from Friscia Construction indicates, there is quite a bit.  "The Court" is the Tax Court.  "Respondent" is the IRS (In all Tax Court cases the taxpayer is "The Petitioner" and IRS is "The Respondent").  Friscia Construction is unusual among the cases I found.  It is about the IRS challenging  the deductions of a profitable Amway distributor.

Although originally focused on soap, Amway sells a variety of household products through its multi-level marketing system.  In case you have never been invited to an Amway presentation or, more likely, didn't go when you were invited, the emphasis is not so much on the products or even selling the products.  It's about getting other people to sell the product, who in turn get other people and so on with you sitting at the top of your pyramid (only they make it real clear its not a pyramid). 

Bloggers like Joecool and Anna Banana claim that there are very few people who make money at it.  Those that do probably don't make as much as they claim, since those in the "upline" need to paint a glowing picture to motivate the "downline" IBO's (Independent Business Owners).  Further, the bloggers claim that most of the soap and other stuff is actually bought by the IBO's themselves.  Finally, the "upline Diamonds" make most of their money from selling "tools" (i.e. motivational tapes and the like) to the downline.

The other attraction of Amway to some people is that it might allow them to deduct as business expenses things like cars, part of their home or entertainment that they would have spent anyway.  That's probably the aspect of Amway that the IRS finds most interesting.  Joecool did a post on how some IBO's think of their income tax refunds (generated by Amway losses sheltering other income) as profit.

To me the most interesting thing that I found in my search is this excerpt from the Internal Revenue Manual for examiners who are doing information requests:

.4.4.3.39 — Amway Corporation
[Last Revised: 12-10-2007]
(1) Amway Corporation has waived the hand delivery requirements of 26 USC §7603 and will accept summonses by personal service, mail, or overnight service at Amway Corporation, 7575 E. Fulton, Ada, MI 49355, Attn.: Director, Legal Division. Direct distributors who further qualify for profit sharing bonuses receive the non-cash part of that bonus through a mutual fund account administered by Amway Mutual Fund, Inc., 7575 E. Fulton, Ada, MI 49355, which requires a separate summons

Now I am subject to the AICPA Statements of Standards on Tax Practice, which among other things forbids me from giving clients advice based on what I believe the audit selection process of a taxing authority is.  I wouldn't do it anyway, because I think most people who give that type of advice are guessing.  Even if you happen to be one of my clients, I'm speaking to you purely as a reader here when I give you this advice:

                                                You don't tug on Superman's cape
                                                You don't spit into the wind
                                                You don't pull the mask off that old Lone Ranger

And you don't take no Schedule C losses from an arrangement with a company that IRS examiners have on speed-dial.

I found 23 cases of IBO's who fought the IRS in Court.  (A couple appealed, but I only counted them once)They pretty much all lost.  In these type of cases there are really three ways you are denied deductions.  The first is substantiation.  You didn't prove it.  Next is that the expenses are not really ordinary and necessary expenses of the business.  When you are talking about cars and business use of the home, those two issues can get blurred together.  The third is that there really isn't any business there.  Taxpayers fight the IRS and win on that issue frequently even a Vietnamese couple whose "business" was playing slot machines using the principles of Feng Shui.  Amway IBO's who take on the IRS on the Section 183 "hobby loss" issue almost always lose.

One of the most common themes is that IBO's seek advice generally only from their "uplines", who of course are not disinterested.  They also do not seem to put any energy into trying to control their expenses.  I'm going to give you a little snippet from each of the cases and comment a bit on some of them.

LOPEZ v. COMM., Cite as 94 AFTR 2d 2004-7075 
Jorge N. Lopez, et ux. v. Commissioner , TC Memo 2003-142

Tax Court properly determined that engineer and wife weren't entitled to business deduction for expenses incurred in connection with their Amway products distribution activity because they didn't engage in activity for profit: although taxpayers showed proof of profit motive, such wasn't sufficient to override govt.'s evidence that included their failure to keep businesslike records, their failure to alter unprofitable methods, their non-dependence on activity income, and their use of activity to socialize with friends and family.
 
In their own Amway activities, which began in 1996, the Lopezes sold products at cost to both their downline distributors and their customers, which practice eliminated retail sales as a source of gross income. They chose instead to focus their efforts on developing a network of downline distributors to generate performance bonuses.  Relying on Amway brochures, the Lopezes concluded that they would need to achieve and maintain a monthly point value of 4,000 for their Amway activities to be profitable. In 1998 and 1999, the Lopezes' point value did not exceed 372 points in any month.


The only advice they sought for their Amway activities was from upline distributors, and when they received unsolicited advice from their accountant, they disregarded it. During the years in question, Mr. Lopez was employed full-time as a petroleum engineer, and Mrs. Lopez was a homemaker.

The tax court ultimately was not persuaded that the Lopezes' primary motive for conducting their Amway activities was for income or profit. It found that the conduct of their Amway activity “virtually precluded any possibility of realizing a profit.” The Lopezes' lack of a business plan for recouping losses and achieving profitable levels of activity indicated the absence of a profit motive. In the face of four consecutive years of losses, the Lopezes still did not change their approach to increase the likelihood of earning a profit. The tax court further found that the Lopezes did not conduct market research to help them assess the potential profitability of their activities. It also noted that, although the Lopezes had no prior business experience, they accepted the advice of upline distributors rather than seeking advice from unbiased, independent business sources.

Since the Mr and Mrs Lopez appealed, they got to lose twice.

OGDEN v. COMM., Cite as 87 AFTR 2d 2001-1299
Michael A. Ogden, et ux. v. Commissioner, TC Memo 1999-397
 Contrary to the Ogdens' contention, evidence of profit is not determinative of whether a profit motive exists. See id. at 876 (no single tax regulation factor, nor the existence of a majority of factors, is determinative of whether a profit motive exists). There is overwhelming evidence in the record that, if believed, supports a conclusion that the Ogdens maintained their Amway activity for deductions, personal pleasure and to offset wages. The tax court did not abuse its discretion in denying the motion for reconsideration.

Amway does not have a quota for sales, its products do not have to be sold above cost, and its distributors are not required to sponsor downline distributors. An Amway brochure, The Amway Business Review, states that the potential for earning income increases as the number of distributors in a sponsor's group grows and as sales increase. Distributors devote as little or as much of their time to Amway activities as they desire. The eight page Amway Business Review in large blocks on four of its pages highlights the fact that “The Average Monthly Gross Income for “Active” Distributors was $88.”

We believe Amway distributors may be biased when discussing Amway because they have a natural desire to advance the organization and/or obtain income from a downliner.


ELLIOTT v. COMMISSIONER, 90 TC 960

Deductions denied for business expenses and depreciation connected with Amway distributorship. Activities were conducted in unbusinesslike manner, taxpayers maintained full-time jobs, and little distinction was made between Amway activities and personal social activities. Also, IRS properly imposed penalties for failure to timely file and negligent or intentional disregard of rules.

A further indication of the unbusinesslike fashion in which petitioners conducted their Amway activity was the thin line dividing business activities from personal and [pg. 973]recreational activities. Petitioners offered scant evidence that their Amway activity required them to do anything other than to maintain an active social life. Although they occasionally attended seminars, most of their activity involved giving parties and taking people out to restaurants. While there is no requirement that profit-oriented work be onerous and unpleasant, the evidence presented by petitioners does not indicate activity motivated by a profit objective. On the contrary, the evidence shows that petitioners made some small modifications in their routine social life, kept cursory notes about their activities, and claimed deductions for the cost of nearly everything they owned or did. On this record, we find as a fact that petitioners' activities were motivated by a desire to avoid tax rather than a desire to generate income.

Roger S. Campbell, et ux. v. Commissioner, TC Memo 2011-42

Activities not for profit—profit objective—distributorship and direct marketing activities. Code Sec. 183 deduction limits applied to expenses pro se married real estate and construction business operators claimed in connection with Amway distributorship activity that they engaged in without requisite profit objective. Lack of profit objective was shown by facts that taxpayers commingled expenses, had no idea if they were making profit for any given year until they filed that year's return, didn't keep complete records, and otherwise didn't conduct activity in businesslike manner. It was also telling that taxpayers didn't have experience in this type of activity, didn't seek out independent advice, used activity losses to offset their real estate and construction business income, and stated that they would continue with activity regardless of whether it ever turned profit. Countervailing facts that they spent significant time on activity and increased gross receipts during years at issue weren't dispositive considering overall record.

Kenneth J. Nissley, et ux. v. Commissioner, TC Memo 2000-178

Activities not for profit—Amway distributorship. Husband and wife/CPAs didn't engage in Amway distributorship activity for profit: taxpayers incurred substantial losses for 8 consecutive years; and didn't conduct activity in business-like manner where they kept separate bank account and records to “guarantee” deductions


Kenneth C. Theisen, et ux. v. Commissioner, TC Memo 1997-539

 Full-time IRS agent and travel agent-wife didn't operate Amway distributorship for profit, so weren't entitled to deductions from activity: taxpayers didn't conduct activity in business-like manner where they didn't have business plan, perform break-even analysis or have budget; admitted that benefits included ability to buy discounted products for personal use; testified that distributorship was for financial gain and personal purchases were more than purchases acquired for resale; reported losses for 5 consecutive years; couldn't explain how or when distributorship would become profitable or why auto and telephone expenses increased without corresponding revenue increase; kept income and expense ledger for substantiation purposes only; and intentionally excluded cost of motivational tapes from costs of goods sold to avoid disclosing negative gross income on returns

Generally, no. The way the plan is written is, you're taught to purchase things from yourself for yourself, and you get other people — say, Look. Just change your buying habits. Don't go to HEB. Don't go to Eckerd's. Don't go to Sam's. You get access to all these products. Change your buying habits. Buy things for yourself

Petitioner also conceded that petitioners' personal purchases were more than the purchases they acquired for resale to other customers or downline distributors. Specifically, petitioner admitted that in 1992 he bought $4,500 of products for personal use and $3,262 of products for other purposes. For 1993, he conceded he bought $10,729 of products for personal use and $4,991 of products for other purposes.



Bryan J. Brennan, et ux. v. Commissioner, TC Memo 1997-60

1. Litigation costs—substantial justification for IRS position—distributorship conducted for profit. Taxpayers were denied litigation costs with respect to underlying case challenging IRS's disallowance of their business deductions: IRS was substantially justified in its position that taxpayer didn't conduct household product distributorship with requisite profit objective under Code Sec. 183 . Taxpayers had losses for 7 consecutive years, yet earned substantial income from other sources for 2 of those years, and didn't provide IRS with business plan or profit projection; and similar distributorship-related activities had been found to contain elements of personal pleasure. Also, IRS's concession of the issue within 5 months of filing answer and 2 months of receiving additional information was reasonable.

This is a case of the taxpayer actually settling favorably with the IRS.  They were, however, not able to recoup attorneys fees.

William B. Hart, et ux. v. Commissioner, TC Memo 1995-55

Taxpayers weren't entitled to deduct business loss related to Amway distributorship: taxpayers didn't engage in activity for profit. Expenses of distributorship activity related mainly to social functions: taxpayers attended seminars in Colorado and California, and monthly dinners with their “network”; taxpayer-husband took guest who was interested in finding out more about distributorship on fishing trip; and “supplies” expense included groceries bought while taxpayers were away delivering products or visiting clients. Court rejected argument that activity was conducted in businesslike manner because taxpayers kept records, sought expert counseling, and devoted time and effort to distributorship: they didn't utilize records in way to help them make profit; they didn't seek advice on how to cut back on expenses; many of expenses claimed had significant elements of personal pleasure; and due to distributorship's low receipts it appeared that taxpayers used their time spending money on entertainment rather than focusing on earning profit.

Negligence penalty was upheld: despite Tax Court's warning in prior case that taxpayers couldn't translate their Amway business into deduction for personal aspects of their lives, taxpayers again attempted to deduct clearly personal expenses in guise of distributorship activity, which they had failed to show was being operated for profit. But taxpayers weren't liable for penalty for filing late return: recent death of taxpayers' son was reasonable cause for delay in filing return; and there was no willful neglect.

Petitioners do not appear to have heeded our warning, and respondent was not as charitable this time. Again petitioners have attempted to deduct clearly personal expenses in the guise of an Amway activity that they failed to show was being operated for a profit. We sustain respondent on this issue.



Thomas P. Poast, TC Memo 1994-399

IRS proved that taxpayers, full-time automobile workers, lacked requisite profit objective in carrying on their Amway distributorship activity. Taxpayers failed to conduct activity in businesslike manner: taxpayers maintained incomplete sales records, used solely to help to substantiate claimed deductions; they failed to isolate business expenses from personal expenses; and taxpayers kept no realistic and reasonable budget despite incurring substantial net losses in all prior years. Further, taxpayers' claim that they sought expert counseling regarding business techniques was rejected: taxpayers abandoned "ineffective" techniques without performing cost/benefit analysis of techniques; and techniques received from "upliners" (who had financial stake in taxpayers' sales) were never seriously utilized. Also, much of the time taxpayers spent on Amway activity involved substantial pleasurable personal aspects.



Shortly before becoming involved with their Amway activity, petitioners attended a seminar conducted by an insurance agent, Donald Fletcher, who conducted similar seminars nationwide. Fletcher promoted his life insurance product, while suggesting to the participants of the seminars that the premiums be funded by tax savings generated by deducting largely personal expenses through a home based business like Amway.  Fletcher offered to prepare participants' tax returns and provide representation in audits for a cost of $125.


We find not only that the techniques were not seriously utilized, but also that, for the most part, petitioners' advisers were not experts as much as they were upliners with a financial stake in petitioners' retail and downline sales. Neither petitioners nor their advisers appeared to be even vaguely interested in the importance of cutting back their expenses.

Gerald Eugene Swaffar, TC Memo 1992-180

IRS failed to prove that taxpayer's Amway activities weren't carried on for profit. Deductions for expenses related to Amway activities were allowed only to extent conceded by IRS: taxpayers failed to substantiate expenses in excess of that amount. Penalties for negligence and substantial understatement were imposed

At trial, respondent contended for the first time that petitioner's Amway activities were not engaged in with the requisite profit objective under section 183. Such new matter requires that the burden of proof be placed on respondent. See Rule 142(a). Respondent further contends that, assuming the Amway activity was entered into with a bona fide profit objective, petitioner has failed to establish that the above expenditures were incurred and were ordinary and necessary in carrying on a trade or business, pursuant to section 1.

An analysis of petitioner's Amway activities requires this Court to conclude, without analyzing in depth all nine factors, that respondent has not carried her burden of showing that petitioner did not engage in the Amway activity with an actual and honest objective to make a profit. We emphasize that we do not affirmatively conclude that petitioners had a profit objective, but only that respondent has failed to prove that petitioners lacked such an objective.


Sometimes it is better to be lucky than good.  If in its deficiency notice the IRS asserts that you didn't have a profit motive, it is up to you to prove that you did.  In this case, the IRS raised the issue later, which shifted the burden of proof.  The IRS couldn't prove that they didn't have a profit motive. 

Gerald W. Jordan, TC Memo 1991-50

Amway distributor was allowed to deduct expenses for travel, incentive prizes, and seminars: expenses were ordinary and necessary. Deductions were allowed in part for meal and car expenses, and were denied for gift expenses, because taxpayer didn't fully substantiate claims.

Another win for an IBO.  Hooray.  Too bad they didn't do a better job on substantiation.

Joseph M. Ransom, TC Memo 1990-381


Taxpayer wasn't engaged in Amway distribution activity with profit objective. Factors tending to indicate lack of profit motive were: absence of separate checking account; failure to cut costs or recruit new distributors; and substantial income from other sources (with attempted Amway deductions that would have almost eliminated tax he would otherwise owe on that income).


Peter S. Rubin, TC Memo 1989-290

Deductions attributable to Amway distributorship activities were disallowed to extent they exceeded gross income from those activities, which weren't engaged in for profit: taxpayers kept records in cursory and sloppy manner, and they engaged in distributorship activities to claim tax deductions for personal expenditures and to purchase Amway products at sizeable discounts for their own use.

Dewitt Talmadge Ferrell, Jr., TC Memo 1987-102

Losses claimed by airline pilot and housewife were limited where their business activities, involving selling of Amway products, sundials, and posters, weren't engaged in with profit objective, but rather were conducted primarily to generate tax deductions and credits for personal expenses. Revenues were of secondary importance to taxpayers who had no sales expertise and made no effort to obtain any, didn't maintain reliable records, and devoted little effort to sales. Burden of proof was on taxpayers since they didn't show that business ever reported profit before years in issue; Sec. 183(d) presumption didn't apply.



J.H. Schroeder, TC Memo 1986-583


As to the Amway distributorship fee, petitioner failed to show that he conducted his Amway affairs in connection with a trade or business or an activity engaged in for profit. Petitioner made no sales of Amway products and had no income from his Amway operations during 1981. He failed to possess the requisite profit objective, since he admittedly became a distributor solely for the purpose of being able to purchase items at discount prices by virtue of his status as a "dealer". See section 183.



Harry Mitchell Goldstein, TC Memo 1986-339

Taxpayers' Amway activities weren't trade or business and weren't engaged in for profit but were undertaken primarily to obtain tax deductions and credits; business expenses, investment credit, and child care credit denied. Taxpayers' (husband and wife) activities weren't carried on in businesslike manner, they both had full-time jobs, and they had very little success in obtaining other distributors or selling products. Taxpayers had become Amway distributors and claimed losses based on business deductions and credits.

Q. How many sales did you make in 1980?
A. Sales—1980—Probably not even $5 worth, because we did not get any new people coming in, you see. We just mostly went in for ourselves and then get the other people coming in with us.
Q. So it is your testimony that your total income from Amway in 1979 and 1980 was less than $5?
A. Yes.
Q. Are you still in the Amway business?
A. Yes. We like the products and you can't get them any other way.

John Alcala, TC Memo 1984-664

On this record, there arises the strong suspicion that petitioners became Amway distributors primarily for the purpose of providing themselves with Amway merchandise which they could not otherwise obtain, while, at the same time, providing themselves with considerable tax deductions. Compare Barcus v. Commissioner, T.C. Memo. 1973-138 We make no such finding herein, but we do hold that petitioners have failed to carry their necessary burden of proof to establish that they entered into a bona fide business enterprise with the intention and objective of making a profit. McCormick v. Commissioner, T.C. Memo. 1969-261

Randall B. Ollett, et ux. v. Commissioner, TC Summary Opinion 2004-103

In addition to the travel-related expenses, petitioners also had expenses of $3,571 in 1999 and $710 in 2000 for professional books and other materials that were part of Amway's “training program”. These books were recommended by petitioners' upline network and may be described as general self-motivation books. Petitioners also purchased various audio tapes that included stories told by other Amway distributors of how they built successful networks.


As noted above, petitioners' revenue from the Amway activity for the years in issue was minimal, and even that amount was attributable in part to petitioners' purchases of household goods for their own personal use. When asked about how they intended to turn their losses into profits, Mr. Ollett responded: “The only way I can solve it is to talk to more people. And there, in essence, is the challenge that I have, which is finding those people”.

Petitioners did not have any sales experience prior to becoming Amway distributors. Petitioners relied exclusively on their upline distributors, who stood to benefit from petitioners' participation, for advice and training. They did not seek independent business advice at the beginning of their Amway activity to assess their potential for success, and they did not seek independent business advice for turning around years of operating losses. Petitioners' failure to seek independent business advice strongly suggests that petitioners did not carry on the Amway distributorship in a businesslike manner.

Joe Guadagno, et ux. v. Commissioner, TC Summary Opinion 2003-88

Included with petitioners' timely filed return for each year is a Schedule C, Profit or Loss From Business. Each return was prepared by a certified public account who also was an Amway distributor. Petitioners' Schedules C for 1996 and 1997 list their principal business as “Amway”. For 1998, petitioners' Schedule C lists their principal business as “DistConsumerProduct”. Petitioners reported net losses of $26,264, $24,047, and $19,810 on their Schedules C for 1996, 1997, and 1998, respectively.



Before becoming Amway distributors, petitioners had neither experience with Amway nor experience in running a business. Nevertheless, they did not seek independent business advice at the outset, and they did not seek independent business advice afterwards even though losses were sustained year after year. Instead, they relied upon other Amway distributors whose advice is more accurately characterized as personal motivational advice than strategic business advice.

Larry Minnick, et ux. v. Commissioner, TC Summary Opinion 2002-147

As previously stated, more weight must be given to objective facts indicating a profit objective than to petitioners' statement of intent. Dreicer v. Commissioner, supra. After considering the objective factors detailed above, we find especially relevant the manner in which petitioners carried on the Amway activity and petitioners' history of losses and lack of profits. We find from these and the other objective facts in the record that petitioners did not have an actual and honest intent to profit from the Amway activity in 1996 and 1997.

Broadrick R. Moore, et al. v. Commissioner, TC Summary Opinion 2001-173



Considering the record in its entirety, we are satisfied that petitioners did not have the actual, honest, and bona fide objective of making a profit. It appears that they became Amway distributors simply to deduct expenses for items of a personal nature

Karl Meyer, et ux. v. Commissioner, TC Summary Opinion 2001-157


The Amway “pyramid” incentive system is promoted by Amway in the form of the “9-4-2 plan”.  Under the “9-4-2 plan”, each Amway distributor is encouraged to personally recruit 9 “downline” distributors, each of whom in turn is encouraged to recruit at least 4 “downline” distributors, each of whom in turn is encouraged to recruit at least 2 “downline” distributors (for a total of 117 “downline” distributors in the initial distributor's organization). The “9-4-2 plan” is promoted as the theoretical break-even point for a distributorship, assuming that (1) the distributor and each “downline” distributor within the distributor's organization purchases $200 of Amway products per month and that (2) the distributor does not have expenses exceeding $2,000 per month. At least in theory, the potential for profit is enhanced as each of the 117 “downline” distributors in the distributor's network successfully implements the “9-4-2 plan”.


The Amway “9-4-2 plan” does not provide meaningful guidance to distributors regarding how expenses incurred in pursuing an Amway activity may be reduced

Despite their lack of experience with either Amway or an Amway type activity, petitioners never sought meaningful counsel from disinterested third parties. Rather, petitioners relied principally on advice from “upline” distributors and other interested Amway individuals

James R. Landrum, et ux. v. Commissioner, TC Summary Opinion 2001-112



Prior to the years in issue, petitioners had three separate experiences with Amway, beginning in 1974. Mr. Landrum was a corporal in the Marine Corps and was stationed in Hawaii in 1974. His Amway activity consisted of purchasing cases of wax from an Amway distributor at wholesale, selling “a case or two a month to [his] friends,” and keeping the difference between the wholesale and retail prices. He ceased his activities with Amway in 1976 when he was transferred from Hawaii and then released from active duty with the Marine Corps. After their marriage in 1977, petitioners participated in an Amway distributorship. Their experience with Amway was unprofitable, and they terminated it after 2 years. Petitioners became involved with Amway a third time in 1985, while Mr. Landrum was employed at Goodyear. Although petitioners had about 50 persons reporting to them, directly or indirectly, in the pyramid structure of Amway, there were insufficient sales for profit. Petitioners' third Amway venture lasted approximately 2 years, and again, petitioners terminated the activity for lack of profit. In late 1995, petitioners were introduced to Amway a fourth time by friends of Mrs. Landrum. This fourth Amway experience is the subject of the present controversy.

Mr. Landrum estimated that the person who established a successful 6-4-2 grouping would receive $1,800 to $2,200 in monthly commissions and then might proceed to gain even greater benefits as a “direct distributor” who might then triple his organization and receive an “Emerald bonus” and then expand to have six legs and a “Diamond organization”. According to Mr. Landrum, Amway distributors with an emerald organization make $75,000 to $100,000 annually, and those with a diamond organization make $125,000 to $250,000 yearly, “And it goes up from there” as he put it.

Conclusion:

23 cases on the same issue is a goodly number, but of course they are over a long period of time.  It's clearly not a random sample.  If you are say the 20th case like this either you didn't do your homework or you are really stubborn.  The other thing that biases this is that the IRS picks the worst cases to contest.  Before you get a "90 day letter", which is what allows you to go to Tax Court, you can have an independent appeal in the IRS.  Once you file to go to Tax Court, the case will get kicked back to appeals to see if they can settle. At that point appeals can consider "hazards of litigation". So there are probably many people who got decent settlements from the IRS. Of course there are also many who just wrote a check to close out the audit.  All in all, though, if the reason you want to start a business is so that you can deduct money you spend anyway (Something I advise you not to do), Amway is probably one of the worst things that you could pick.  It's worse than horse breeding, which the IRS seems to have a particular antipathy for, but the Tax Court often allows.

Interestingly, I did not find any cases of people who were using other types of tax shelters to shelter their Amway income.  Also, if the Amway dream is really true, you would think I would find a case like that of Peter Morton, who was being challenged on deducting his jet expenses, only with the taxpayer being a Quintuple Diamond Super Duper Amway guy.  At the Amway meeting I went to they said that they were glad not everybody took advantage of the Amway opportunity, since they needed pilots for their planes and the like.

All in all, I would say that while not determinative, the record in the tax court is supportive of Joecool and Anna Bannana.  At least, there are some more stories for them.

Injunction

U.S. v. STOVER, JR., Cite as 108 AFTR 2d 2011-XXXX, 08/16/2011




UNITED STATES of America, Plaintiff - Appellee, v. A. Blair Stover, Jr., Defendant - Appellant.

Case Information:

Code Sec(s):

Court Name: United States Court of Appeals FOR THE EIGHTH CIRCUIT,

Docket No.: No. 10-3012,

Date Decided: 08/16/2011Submitted: June 17, 2011.

Disposition:



HEADNOTE

.



Reference(s):



OPINION

United States Court of Appeals FOR THE EIGHTH CIRCUIT,



Appeal from the United States District Court for the Western District of Missouri.



Before MURPHY and SMITH, Circuit Judges, and SCHREIER, 1 District Judge.



Judge: MURPHY, Circuit Judge.



The United States brought this civil action under 26 U.S.C. § 7408 to enjoin A. Blair Stover, Jr. from promoting several fraudulent tax schemes. After a court trial the district court 2 permanently enjoined Stover from promoting his schemes, ordered him to advise the Internal Revenue Service (IRS) of any tax arrangements or business entities formed at his direction, and required him to provide a copy of its order to his clients. On appeal, Stover argues that the injunction was not supported by adequate factual findings and legal conclusions, and that it was overbroad, an impermissible delegation of Article III power, and an unconstitutional prior restraint. We affirm.



I.

In all material respects the following facts are undisputed and were recounted by the district court. For many years Stover has worked for several accounting firms in Missouri. He received undergraduate and graduate degrees in business administration with an emphasis in marketing and finance and has earned a law degree from the University of Missouri at Kansas City. He has been licensed to practice law in Missouri since 1990 and remains a member of the Missouri bar. Stover has also taken courses towards an L.L.M. in taxation and has passed the tests to become a certified public accountant (CPA), but he does not have his CPA license.



For several years in the early 1990s, Stover worked for the accounting firm of Coopers and Lybrand. His duties included preparing requests for IRS rulings as well as researching and drafting opinions and memoranda on tax issues. In 1993 Stover began working at the accounting firm of Grant Thornton LLP as a tax manager. Over the next eight years he rose to senior tax manager and tax principal at Grant Thornton. Then in 2001 Stover joined Kruse Mennillo LLP, another accounting firm, as an equity partner. Stover's role at Kruse Mennillo was to be a “rainmaker” who promoted new business ventures to reduce clients' tax liability.



During his time at Grant Thornton and Kruse Mennillo, Stover promoted, sold, and organized several different tax arrangements, three of which are the focus of this appeal. Each was premised on a small business owner transferring income from his business, labeled the “operating company,” to a separate and newly created entity denominated as a “management company.” Under each scheme the operating company would retain the management company to perform “management services.” Fees paid by the operating company to the management company would be deducted from the operating company's taxable income. The management company's income would then be deferred or completely excluded from taxation through devices such as the accrual method, employee stock ownership plans (ESOPs), and Roth IRAs.



These schemes would soon pose numerous tax law problems. It is undisputed that the management companies did not provide any management services to the operating companies; instead, the management fees would be set by Stover at a “defensible” amount necessary to offset a large portion of the operating company's income. In some cases the management company had no employees or bank accounts, and the management fees were recorded only on paper. As explained below, the district court found that deferral or exclusion from taxation of these fees violated laws defining when services are properly accrued, “top heavy” rules for ESOPs, and contribution and income limits for Roth IRAs.



The first structure Stover promoted was the “Parallel C” scheme, which had been developed and promoted by others at Grant Thornton before Stover began working there. Parallel C structures were sold to small business owners who owned subchapter S corporations and used a January 1 to December 31 tax year. 3 In December, near the end of the tax year, the operating company would pay a large “management fee” to a management company newly created at Stover's direction for bogus management services the company did not actually provide. 4



The operating company would accrue these purported management fees for the following year to offset most or all of its income for the current year. In turn, the management company would elect to follow a December 1 to November 30 fiscal year, and would not become liable for tax on the income until the end of its tax year. In effect this arrangement allowed the operating companies improperly to defer taxation on most or all of their income for eleven months. See also United States v. Davison, No. 08-0120-CV-W-GAF, 2010 WL 1935951 [105 AFTR 2d 2010-2278], at 1 (W.D. Mo. May 11, 2010) (describing a similar Parallel C scheme by Stover's former business partner).



The district court found that two particular Parallel C structures set up by Stover violated tax laws, but noted that there was evidence of “many others.” It determined that the Parallel C structures violated rules for accrual of fees for services, see 26 U.S.C. § 461(h), requirements for the deduction of ordinary and necessary business expenses, see 26 U.S.C. § 162(a), and the principle that structures creating tax benefits must have economic substance. See Gregory v. Helvering, 293 U.S. 465, 469–70 [14 AFTR 1191] (1935).



While at Grant Thornton and for a short time at Kruse Mennillo, Stover sought to defer his clients' tax liability further using a second scheme known as an “ESOP/S” structure. The ESOP/S worked similarly to the Parallel C structure, with an added element: the management company would elect subchapter S status and Stover would create an employee stock ownership plan (ESOP) as the owner of the management company's stock. The ESOP's sole beneficiary would be the owner or owners of the operating company. Because an ESOP's income is not subject to taxation until distribution, this second scheme indefinitely deferred taxation on income until the money was distributed from the ESOP. See Davison, 2010 WL 1935951 [105 AFTR 2d 2010-2278], at 1.



The district court identified five particular ESOP/S structures that violated various tax laws but stated that the record showed that Stover sold “more than twenty” of them. It found that the ESOP/S arrangements “suffered from a lack of business purpose,” “failed to insure the requirements for arm's length transactions were satisfied,” and violated so called “top heavy” rules regulating ESOPs. See 26 U.S.C. §§ 414(b), 416, 1563(a)(2). It also pointed out that after Congress expressly outlawed ESOP/S schemes, see 26 U.S.C. § 409(p), Stover created an arrangement by which a previously created “shelf corporation” was used to create an ESOP, in an effort to backdate the ESOP and avoid the effective date of the new legislation.



After he began working at Kruse Mennillo and Congress had outlawed the ESOP/S structures, Stover developed and promoted the “Roth/S” structure. Like the two other schemes, the Roth/S involved creating a management company eligible for a subchapter S election. A Roth IRA would then purchase the management company's stock, and the Roth IRA's sole beneficiary was the owner of the operating company. The management fees would reduce the operating company's income, the management company's income would not be taxed because it passed through to its owners because of the subchapter S election, and the income allocations to the IRA would not be taxed because a Roth IRA's earnings are not taxable so long as any distributions are made after age 59 1/2 . As the district court explained, any amount Stover designated as management fees “would forever escape taxation.”



The district court identified two specific Roth/S arrangements Stover promoted, but found that a conservative estimate indicated that he “sold between thirty-five and forty Roth/S arrangements.” The district court determined that these arrangements failed to have any economic substance, violated contribution and income limits governing Roth IRAs, see 26 U.S.C. § 408A(c)(2)–(3), and contravened IRS Notice 2004-8. That notice had expressly declared that similar schemes were “abusive” and had required those owning and promoting them to disclose them to the IRS and to register them as tax shelters. See Notice 2004-8, 2004-1 C.B. 333 (2004).



As Stover promoted and sold these tax schemes, several of his clients raised questions about their validity. Daria Ussary, an office manager for one of his clients, told Stover that she was not comfortable making journal entries requested by him for the company's books because they “didn't make any sense” to her. She left her position as office manager because of her concern about his schemes' validity. Other clients testified that Stover described the deductions for management fees as mere “paperwork transaction[s],” because the management companies “really didn't provide us any services.” When one of his clients questioned whether it was a “legal and standard practice” to use management companies to deduct large, bogus management fees, Stover replied that it was. Stover told Ussary that he was “educated and he had gone to the best schools” and that she should just let Stover do his job.



The IRS conducted a lengthy and costly investigation into Stover's schemes. The district court found that agent Rhonda Kimball spent over three thousand hours (more than one year's normal work) unraveling transactions for just two of Stover's clients. It also found that even the most conservative estimate of the tax loss to the government caused by Stover's schemes was $100 million, and potentially as high as $800 million. Agent Janice Mallon testified that a “reasonable estimation” of the government's tax loss was $300 million. Apart from those costs, most of Stover's clients had to pay other professionals to “undo” the structures Stover promoted, organized, and sold. Many had to pay penalties to the government.



In February 2008, the government filed this action under 26 U.S.C. § 7408 to enjoin Stover from organizing or promoting these fraudulent tax schemes. After a court trial the district court entered an injunction in favor of the government. On appeal Stover challenges each paragraph of the injunction, which states as modified:



(1.) Defendant is enjoined from organizing, establishing, promoting, selling, offering for sale, or helping to organize, establish, promote, sell or offer for sale any tax plan involving the parallel C, ESOP/S, or Roth/S structures as described herein.

(2.) Defendant is enjoined from organizing, establishing, promoting, selling, offering for sale or assisting in any financial or tax related arrangement without submitting, in writing to an IRS designee, a detailed plan explaining the financial or tax arrangement and all steps necessary for the arrangement to be legal under the tax code. No such plan shall be implemented by defendant or with his assistance unless IRS approval is granted or thirty (30) days have passed since defendant sought approval. If the IRS does not respond within thirty (30) days, Stover and his client may proceed subject to later review by the IRS[.]

(3.) Defendant shall advise the IRS' designee of any business entity (corporation, LLC, LLP, limited partnership, etc.) formed by him or at his direction. This shall occur within thirty days of the entities' formation. The information provided shall include copies of the documents filed with the appropriate authorities to form the entity (e.g., Articles of Incorporation). Defendant shall advise the principals of any such entity about this requirement.

(4.) Defendant shall advise the IRS' designee of any new clients who consult with Defendant or retain his services for the purpose of obtaining tax advice, including other professionals' clients for whom Defendant provides such services. This shall occur within thirty days of the provision of the advice or consultation. Defendant will be required to advise the individual(s) with whom he consults or to whom he provides advice about this requirement. Before consulting, providing advice or offering a letter of engagement, Defendant shall obtain the consent of any such client to the disclosure of the information required by this paragraph.

(5.) Defendant shall provide a copy of this Order to (1) each of his current clients and (2) any other client of Kruse Mennillo for whom he provided advice, either to the client or to another member or employee of the firm for the benefit of that client.

II.

We review the district court's permanent injunction under 26 U.S.C. § 7408 for abuse of discretion. See United States v. Davison, 407 F. App'x 997, 997 [107 AFTR 2d 2011-670] (8th Cir. 2011) (permanent injunction under § 7402(a)); United States v. Benson, 561 F.3d 718, 721 [103 AFTR 2d 2009-1601] (7th Cir.), cert. denied, 130 S. Ct. 759 (2009); United States v. Schulz, 517 F.3d 606, 607 [101 AFTR 2d 2008-937] (2d Cir.) (per curiam), cert. denied, 129 S. Ct. 435 (2008); United States v. Gleason, 432 F.3d 678, 681 [96 AFTR 2d 2005-7538] (6th Cir. 2005); United States v. Bell, 414 F.3d 474, 478 [96 AFTR 2d 2005-5155] (3d Cir. 2005). The district court abuses its discretion only if it applies the wrong legal standard, misapplies the correct legal standard, or relies on clearly erroneous findings of fact. Gleason, 432 F.3d at 681–82.



Here, the government sought equitable relief expressly authorized by 26 U.S.C. § 7408(a). “When an injunction is explicitly authorized by statute, proper discretion usually requires its issuance if the prerequisites for the remedy have been demonstrated and the injunction would fulfill the legislative purpose.” United States v. White, 769 F.2d 511, 515 [56 AFTR 2d 85-6430] (8th Cir. 1985), citing United States v. Buttorff, 761 F.2d 1056, 1059 [56 AFTR 2d 85-5247] (5th Cir. 1985). The traditional criteria for permanent injunctive relief need not be discussed. See United States v. Landsberger, 692 F.2d 501, 503–04 [50 AFTR 2d 82-5445] (8th Cir. 1982) (affirming a permanent injunction under 26 U.S.C. §§ 7402 and 7407 without discussing the criteria for a permanent injunction).



26 U.S.C. § 7408 authorizes the United States to obtain an injunction if the court finds (1) that the person has engaged in “specified conduct,” and (2) that “injunctive relief is appropriate to prevent recurrence of such conduct.” As relevant here, “specified conduct” is “any action, or failure to take action,” which is subject to penalty under section 6700. Id. § 7408(c)(1). 5 If both requirements are satisfied the court may enjoin any activity subject to penalty under the tax code. Id. § 7408(b).



Generally speaking, section 6700 requires that the government prove that the defendant was involved in an abusive tax shelter and that he knowingly made false statements about the tax benefits investors would receive if they participated in it. United States v. Raymond, 228 F.3d 804, 811 [86 AFTR 2d 2000-6196] (7th Cir. 2000), cert. denied, 533 U.S. 902 (2001); see Gates v. United States, 874 F.2d 584, 586 [63 AFTR 2d 89-1457] (8th Cir. 1989). 6 Courts applying § 6700 have identified four elements the government must prove: (1) organization or participation in the sale of certain investment plans or arrangements; (2) statements by the defendant regarding the allowability of deductions or tax credits, the excludability of income, or the securing of other tax benefits; (3) knowledge or reason to know that the statements are false; and (4) statements which pertain to a material matter. See Benson, 561 F.3d at 721–22; Gleason, 432 F.3d at 682; United States v. Estate Pres. Servs., 202 F.3d 1093, 1098 [85 AFTR 2d 2000-603] (9th Cir. 2000); United States v. Campbell, 897 F.2d 1317, 1320 [65 AFTR 2d 90-1003] (5th Cir. 1990). If each of the factors is satisfied, a district court may issue an injunction if it is “appropriate to prevent recurrence of such conduct.” 26 U.S.C. § 7408(b)(2).



A.

In a comprehensive forty five page order the district court concluded that the government had proven each of the statutory elements. It had shown that Stover knowingly made false statements with respect to the Parallel C, ESOP/S and Roth/S structures that caused his clients to purchase them. Stover's principal argument on appeal is that the district court's findings and conclusions were insufficient to support an injunction because they did not precisely parallel the language in § 6700. For example, Stover argues that the district court did not make any finding that he “made false (and material) statements, in connection with the organization or sale of an entity, plan or arrangement, with respect to the allowability of any income-tax deduction or credit, the excludability of any income, or the security of any other tax benefit, by reason of holding an interest in the entity, or participating in the plan or arrangement.”



We reject Stover's hypertechnical criticism of the district court's order. Section 6700 is a linguistically complex and intricate statute, and the district court need not include the entire statutory language in each of its findings and conclusions. As long as the district court's injunctive order, read as a whole, demonstrates that each of the statutory criteria is satisfied, we will find no abuse of discretion. See Gleason, 432 F.3d at 681–82. And as we explain below, the district court's exhaustive order more than satisfies each of the four requirements in § 6700.



Abusive tax promoters must either organize, promote, or sell qualified tax shelters to come within the scope of §§ 7408 and 6700. This element should be defined “broad[ly],” and is satisfied simply by “selling an illegal method by which to avoid paying taxes.” Benson, 561 F.3d at 722; see United States v. Kaun, 827 F.2d 1144, 1147 [60 AFTR 2d 87-5623], 1149 (7th Cir. 1987) (noting that any arrangement, plan, or investment whose principal purpose is the avoidance or evasion of federal income tax qualifies).



Stover argues that the district court's findings on this element were insufficient because they show only that Stover implemented or executed, rather than organized or sold, his tax avoidance schemes. In Stover's words, the only statements he made were “in the context of the implementation of the arrangement[s],” rather than in connection with their “organization or sale.” App. Br. at 39 (emphasis in original). The government responds that Stover indisputably promoted and sold the three schemes and thus that this element of the statute is clearly satisfied.



We agree with the government. The record demonstrates that Stover “set up” a Roth/S structure for his client Raymond Anderson, and Parallel C and ESOP/S arrangements for Donald Clark, just as two examples. To “set up” is to organize a business entity. Stover's argument that he merely “implemented” or “executed” these arrangements therefore rings hollow. This is especially true in light of the voluminous testimony that Stover's clients specifically sought to use his schemes to reduce their tax liability. Because Stover sold his clients “an illegal method by which to avoid paying taxes,” we conclude that he organized, promoted, and sold tax abusive schemes within the meaning of § 6700. See Benson, 561 F.3d at 722.



Stover next argues that the district court's findings that he “recommended” or “advised” his clients to purchase the tax avoidance structures were insufficient. He suggests that the content of his “assurances” is unclear from the district court's order, such that any statements he made could not fall within the ambit of § 6700.



Stover's position is contrary to well settled law. At least two types of statements are covered by § 6700: those “directly addressing the availability of tax benefits,” as well as those “concerning factual matters that are relevant to the availability of tax benefits.” Campbell, 897 F.2d at 1320. The record shows that Stover made both types. As the district court found, he “advised his clients to set up these entities in order to save taxes.” That his statements came in the form of recommendations and advice does not make them any less authoritative. See, e.g., Gleason, 432 F.3d at 684 (tax protester's “advice” qualified as a statement under § 6700). The district court's findings sufficed to show that Stover made qualifying statements under § 6700.



Stover's principal argument on appeal is that even if he gave his clients advice and made recommendations, the district court “failed to acknowledge the requirement that a statement, in order to be within the scope of [ § 6700], must be false (or fraudulent),” and that it failed to analyze whether any statement Stover made was actually false. Stover further asserts that a statement “cannot be considered “false or fraudulent,” unless it is actually contrary to the law. App. Br. at 35 (emphasis in original). For Stover, a statement is only contrary to the law when “a reasonable, well-informed analysis would lead a knowledgeable tax professional to conclude that it has a zero (or nearly zero) percent chance of being upheld on the merits.” Id. Stover cites no authority for this exceedingly narrow concept, and we could find none.



We have defined “false” in the tax law context as “untrue and known to be untrue when made.” United States v. Holecek, 739 F.2d 331, 335 [54 AFTR 2d 84-5505] (8th Cir. 1984), cert. denied, 469 U.S. 1218 (1985). Thus, Stover's statements about the Parallel C, ESOP/S, and Roth/S schemes would be false under § 6700 if when he made them he knew or had reason to know they were untrue. The district court's order is consistent with this definition of falsity. Contrary to Stover's assertions, it acknowledged that his statements must have been false to fall within the ambit of § 6700. The district court expressly cited § 6700 as penalizing a person who “knows or has reason to know that the statement is false or fraudulent.” The court went on to analyze statements Stover made as he organized, promoted, and sold the Parallel C, ESOP/S, and Roth/S arrangements, and it expressly considered factors relevant to a defendant's knowledge of the falsity of his statements. These included the extent of Stover's reliance on knowledgeable professionals, his level of sophistication and education, and his familiarity with tax matters. Gleason, 432 F.3d at 683; Estate Preservation Services, 202 F.3d at 1103; Kaun, 827 F.2d at 1149.



With respect to the Parallel C structures, the district court found that Stover began recommending them to Grant Thornton's clients after he started working there and that his sole motivation “in promoting [them] was to defer recognition of income.” It found that Stover advised one client to form a Parallel C structure solely “in order to reduce taxes,” even though there was no evidence of “any effort to properly value the “services” the management company] would be providing.” It also found that Stover advised another client “to adopt the parallel C structure” even though the management company “did not actually pay management fees; the income and expenses only appeared as entries on the companies' books.” When Stover's client Donald Clark questioned whether it was a “legal and standard practice” to create sham management companies solely for tax savings purposes, Stover replied that it was. Stover's statements were false because they untruthfully conveyed that his clients' tax arrangements did not need to have economic substance. See Campbell, 897 F.2d at 1320–21 (disregarding an abusive tax promoter's transactions because they lacked economic substance); United States v. Philatelic Leasing, Ltd., 794 F.2d 781, 786 [58 AFTR 2d 86-5285] (2d Cir. 1986) (same). Stover's statements with regard to the ESOP/S and Roth/S arrangements suffered from these same infirmities.



Stover's statements regarding all three schemes were also false because of what he failed to convey: that deductions taken under 26 U.S.C. § 162(a) must be “ordinary and necessary” for the deducting business. The district court found that Stover “advised his clients to set up these entities in order to save taxes without also advising them of the potential pitfalls and the actions necessary to guard against the obvious conclusion that the transaction was a sham and bore no relation to reality.” Section 7408(c) includes “failure to take action” as conduct subject to penalty, and courts have repeatedly held that a tax promoter's failure to advise his clients of the requirements for a proper deduction qualifies as a false statement. See, e.g., Gleason, 432 F.3d at 682–83 (tax protester's failure to “properly qualify” his assertions about the deductibility of everyday household expenses under § 162(a) amounted to “flagrantly false” statements); Estate Preservation Services, 202 F.3d at 1101 (scheme promoting deduction under § 162(a) which was merely a “camouflaged assignment of income” solely to gain a tax advantage was thus a false statement).



With respect to the ESOP/S arrangements, the district court found that Stover persuaded his clients to create operating and management companies with the same group of people owning stock in both. He then failed to notify his clients of tax code provisions disqualifying ESOPs that favor key employees. See 26 U.S.C. § 416 (discussing “special rules for top-heavy plans”); Id. § 414(b) (treating all employees of a controlled group of corporations as employed by a single employer); Id. § 1563(a) (defining a “controlled group of corporations”). Given Stover's years of tax and accounting experience and his significant education in the area, he had reason to know that such schemes were invalid. The failure to notify his clients that he had created invalid ESOPs was therefore a knowingly false omission under § 6700. See Campbell, 897 F.2d at 1322 (“[T]he reason to know standard allows imputation of knowledge so long as it is commensurate with the level of comprehension required by the speaker's role in the transaction.”), citing H.R. Rep. No. 97-760, at 572 (1982) (Conf. Rep.), as reprinted in 1982 U.S.C.C.A.N. 1190, 1344.



The district court also found that Stover intentionally circumvented legislation specifically designed to outlaw this type of ESOP/S scheme. See 26 U.S.C. § 409(p). Because the new law only applied to plans established after March 14, 2001, Stover arranged for client Thomas Barnes to obtain a previously created “shelf corporation” which had purportedly already created an ESOP. The district court found that this scheme was “legally unsupportable” because the shelf corporation “had no employees” at the time Barnes purchased it, meaning it “could not have an ESOP.” We agree that this “backdating” of a corporation to avoid newly enacted legislation qualifies as a fraudulent statement under § 6700.



With respect to the Roth/S arrangements, the district court found that Stover began promoting the schemes in late 2001 and early 2002, and that a “key selling point” for Stover's clients was that any amount designated as management fees would “forever escape taxation.” It noted that to someone of Stover's experience and sophistication, complete exclusion from taxation of such large amounts of income “should have been a clue to [Stover] that the structure was unlawful.” It further found that the Roth/S skirted income limits applicable to Roth IRAs. By reducing the operating company's income, the Roth/S decreased the owner's income and thus made the owner eligible for a Roth IRA which he would otherwise not have been. See 26 U.S.C. § 408A(c)(3). Similarly, the Roth/S scheme circumvented statutory contribution limits on IRAs because the amount deposited into the IRA to purchase management company stock was far less than the actual value of the stock by virtue of the management fees which would soon be transferred to it. See 26 U.S.C. §§ 219(b), 408A(c)(2). Stover never advised his clients to pay the excise tax for excess contributions, see 26 U.S.C. § 4973, and instead just assumed that the contribution limit had not been exceeded. Compare Davison, 2010 WL 1935951 [105 AFTR 2d 2010-2278], at 9–10 (describing how similar schemes by Stover's former partner “flout[ed]” the tax laws).



Stover's statements were also false because they were contrary to express IRS guidance. In December 2003 the IRS published Notice 2004-8, entitled “Abusive Roth IRA Transactions.” That notice described arrangements which were designed to “avoid the limitations on contributions to Roth IRAs” and declared that such transactions and any similar transactions were “listed” transactions which needed to be described to the IRS. A listed transaction was defined as any transaction between a person or any business controlled by that person and any corporation whose shares were owned by a Roth IRA formed for the benefit of that person. See Notice 2004-8, 2004-4 I.R.B. 333, 2004-1 C.B. 333 (2004). This describes perfectly the Roth/S arrangements organized, promoted, and sold by Stover.



As the district court found, Stover nonetheless advised his clients that disclosure of the Roth/S structures was not necessary, principally because Notice 2004-8 did not apply to S corporations and because the Roth/S structures were not “substantially similar” to those described in the Notice. The district court assessed Stover's reasoning as “so specious that he should have known it was wrong,” since S corporations are still corporations and since the Roth/S arrangement is substantially similar to the Roth/C structure described in the Notice. The district court did not clearly err in finding that Stover ignored applicable tax authorities, considering them “unworthy of acceptance.” We conclude that Stover made numerous false statements in connection with the sale of the Parallel C, ESOP/S and Roth/S arrangements.



Stover finally argues that the district court's findings about his statements were insufficient because in none of them was “the amount of the management fee ... already determined,” and that “only under such circumstances” could any of his statements have been false and material. App. Br. at 37 (emphasis in original). Stover thus argues that his statements did not “pertain to a material matter” under section 6700 because they did not include specific dollar amounts.



A matter is material if it would have a “substantial impact on the decision making process of a reasonably prudent investor.” S. Rep. No. 97-494, at 267 (1982), as reprinted in 1982 U.S.C.C.A.N. 781, 1015. See also Benson, 561 F.3d at 724; Gleason, 432 F.3d at 683; Buttorff, 761 F.2d at 1062. The district court found that the amount and nature of the management fees Stover directed his clients to deduct “were material for financial statement purposes.” It also cited numerous examples of Stover's clients who purchased his schemes because of the significant tax advantages the schemes purported to confer.



We agree with the district court that Stover's statements were material under § 6700. There is a wealth of record evidence that Stover's clients purchased his tax arrangements in large degree because of the tax advantages he promoted. He promised to reduce his clients' taxable income by hundreds of thousands of dollars. Any such promise would have had a substantial impact on the decision making process of a reasonably prudent investor. See Gleason, 432 F.3d at 683 (abusive tax promoter's “exaggerations and misstatements” about his tax schemes “undoubtedly influenced individuals deciding whether to purchase” them).



Stover's argument on this issue is also entirely without legal support. Section 6700 does not require inclusion of specific dollar amounts for a statement to be false or material. All that the statute requires is that a defendant have knowingly made a false or fraudulent statement pertaining to a material matter in connection with the organization or promotion of covered tax arrangements. That requirement is more than satisfied in Stover's case especially in light of his level of education, sophistication, and experience handling tax matters, Gleason, 432 F.3d at 683; Raymond, 228 F.3d at 812, and in light of the overwhelming testimony that his clients purchased his schemes because of the numerous tax advantages he promised his arrangements would provide. See White, 769 F.2d at 515; Buttorff, 761 F.2d at 1062.



In sum, the district court did not err in finding that Stover promoted, sold, and organized three different tax schemes and knowingly made false statements in connection with them which caused his clients to purchase them. The first element of § 7408—that the defendant have engaged in “specified conduct”—is therefore satisfied. See 26 U.S.C. §§ 7408(b)(1), 7408(c)(1), 6700.



B.

Section 7408(b)(2) and applicable cases further require a finding that “injunctive relief is appropriate to prevent recurrence of such conduct” based on the totality of the circumstances. The following factors are relevant to this inquiry: the gravity of harm caused by the offense; the extent of the defendant's participation and degree of scienter; the isolated or recurrent nature of the infraction; the degree to which the defendant recognized the culpability of the conduct; the sincerity of any promises not to commit future violations; and the likelihood that the defendant's customary business activities might again lead to a similar transaction. See, e.g., Benson, 561 F.3d at 724; Gleason, 432 F.3d at 683; United States v. Schiff, 379 F.3d 621, 625 [94 AFTR 2d 2004-5460] (9th Cir. 2004), cert. denied, 546 U.S. 812 (2005).



On his appeal Stover hardly challenges the district court's findings on this statutory element. Given the millions of dollars in tax loss to the government and the significant additional penalties paid by his clients, his experience and sophistication in tax matters, his continued efforts to circumvent applicable tax provisions, and his continued failure to recognize his own culpability (even on appeal), we agree that injunctive relief is necessary to prevent Stover from continuing to organize, sell, and promote illegal tax schemes. See Benson, 561 F.3d at 724 (injunction necessary when defendant's conduct “was not isolated, but continuous,” he did “not acknowledge his culpability,” and despite his assurances, he was “not likely to stop without an injunction”); Raymond, 228 F.3d at 814 (injunction necessary in part because of the government's significant loss and large administrative burden, the defendants' activities “were not an isolated instance of misconduct,” and the defendants had not expressed remorse and had steadfastly maintained their total lack of culpability). The district court's findings of fact and legal conclusions satisfied the elements of § 7408, and we therefore conclude that an injunction was appropriate.



III.

Stover next argues that the permanent injunction exceeded the scope of available relief under § 7408. He specifically takes issue with the district court's failure to “confine” the enjoined conduct to “the making of statements of the kind subject to penalty under § 6700.” He also argues that the last three paragraphs of the injunction impermissibly mandate “affirmative conduct,” rather than simply preventing him from making false or fraudulent statements.



Stover misapprehends both the plain language of § 7408 and the many appellate decisions interpreting it. Once the statutory prerequisites are satisfied, section 7408(b) authorizes a district court to enjoin tax protesters “from engaging in such conduct or in any other activity subject to penalty” under Title 26. The scope of prohibitable conduct is “broad,” Benson, 561 F.3d at 722, and should be construed towards achieving the purpose underlying § 7408 to penalize “promoters of abusive tax shelters and other abusive tax avoidance schemes.” White, 769 F.2d at 515 (quotation omitted); see also Kaun, 827 F.2d at 1147. The injunction prohibits Stover from organizing, promoting, or selling tax schemes without express or tacit approval of the IRS, and that type of activity qualifies as “other activity subject to penalty” within the meaning of § 7408(a).



Stover also incorrectly suggests that § 7408 does not authorize district courts to mandate “affirmative conduct.” Numerous appellate decisions have affirmed injunctions ordering promoters of abusive tax schemes to take affirmative actions like providing a copy of the injunction to their clients or supplying the IRS with client names and contact information. See, e.g., Schulz, 517 F.3d at 607–08 (affirming order requiring the tax protester to provide the government his clients' names and their contact information and to notify the clients of the injunction); Bell, 414 F.3d at 477 n. 3 items 2–4, 481–84 (affirming order requiring tax protester to notify past clients of bogus tax scheme, to provide the government with his client names and contact information, and to send copies of clients' returns to counsel for the government); Schiff, 379 F.3d at 630–31 (affirming preliminary order to post a copy of injunction on tax protester's website); Campbell, 897 F.2d at 1323 (affirming order to notify the IRS of any tax shelter with 30 day approval period and to notify clients of the injunction); see also Benson, 561 F.3d at 726–28 (reversing the denial of the government's request to require the abusive tax promoter to divulge his customer list to the IRS). Just as “mandated disclosure of factual, commercial information does not offend the First Amendment,” Schiff, 379 F.3d at 630, it also does not exceed the scope of § 7408. The district court did not err in ordering Stover to advise the IRS of business entities formed at his direction or of new clients he retains, or in requiring him to provide a copy of its order to his or Kruse Mennillo's current clients.



IV.

Stover next argues that the provision requiring express or tacit IRS approval before Stover organizes, promotes, or sells future tax schemes is an impermissible delegation of Article III authority. He argues that the district court delegated to the IRS “the function of determining what arrangements (other than the Parallel C, ESOP/S and Roth/S structures) are within the scope of the injunction,” and that this amounts to an unconstitutional delegation of Article III power to a nonjudicial officer.



Stover misunderstands this paragraph of the injunction. Paragraph two merely requires IRS approval before Stover organizes, sells, or promotes any new tax avoidance schemes. If the IRS does not give approval and Stover nevertheless believes his scheme comports with § 7408 and other tax laws, he can move the district court to modify the injunction or to specify that certain conduct is not prohibited. And if the IRS were to fail to respond to any of Stover's proposed schemes within the 30 day window of the provision, the injunction authorizes Stover to implement the scheme, subject to any later review by the IRS. We agree with the government that requiring Stover to notify the IRS of any new proposed tax avoidance arrangements is a reasonable requirement in light of his habit of promoting tax fraud schemes and attempting to avoid IRS detection. Both this court and others have upheld similar provisions in the past. See Davison, 2010 WL 1935951 [105 AFTR 2d 2010-2278], at 17 (requiring Stover's former business partner to notify an IRS designee of new clients and entities for whom he provided tax advice), aff'd, 407 F. App'x at 997; Campbell, 897 F.2d at 1323 (requiring promoter of abusive tax scheme to provide the IRS notice of intent to organize or sell any new tax shelter and to wait 30 days before promoting or selling it). Paragraph two of the injunction is not an impermissible delegation of Article III authority.



V.

Stover finally argues that the district court's injunction is an unconstitutional prior restraint of otherwise protected speech. Given the “heavy presumption” against prior restraints, Kaun, 827 F.2d at 1150, Stover argues that the injunction does not pass constitutional muster, especially since it is not expressly limited to a prohibition on making false or misleading commercial statements.



The government responds that Stover waived this argument since he failed to raise any First Amendment issues below. See, e.g., Campbell v. Davol, Inc., 620 F.3d 887, 891 (8th Cir. 2010) (“It is old and well-settled law that issues not raised in the trial court cannot be considered by this court as a basis for reversal.”). In reply, Stover argues that the present appeal is the “first reasonable opportunity” he has had to raise the First Amendment challenge, given that he “was not presented with the contours of the present injunction” until after it was issued.



Stover's assertions do not comport with the record. In its complaint, the government sought extremely broad injunctive relief, including much of the relief in the district court's permanent injunction. In fact, the government even sought to enjoin Stover from “aiding, assisting, and/or advising with respect to the preparation of any federal tax return or representing customers before the IRS.” The district court wisely recognized that such a lifetime prohibition on performing any tax preparation services would have posed more serious First Amendment problems and chose not to include that provision. Yet Stover's trial brief never raised any First Amendment concerns. We conclude that he waived this issue. See Davol, Inc., 620 F.3d at 891.



Even if Stover had not waived his First Amendment objections, they would be foreclosed by circuit precedent. We held in White that the First Amendment “does not protect commercial speech which promotes an illegal activity or transaction,” and affirmed the district court's permanent injunction in that case. 769 F.2d at 516–17. Stover's various tax schemes were “not only completely misleading, but [they] also promoted tax evasion and abusive tax avoidance.” Id. at 517. We thus join every other appellate court to consider the issue in holding that injunctions narrowly tailored to restrict false or fraudulent commercial tax advice do not violate the First Amendment. See, e.g., Benson, 561 F.3d 718, 725–27 [103 AFTR 2d 2009-1601] (7th Cir. 2009); Schulz, 517 F.3d 606, 607–08 [101 AFTR 2d 2008-937] (2d Cir. 2008); Bell, 414 F.3d 474, 481–84 [96 AFTR 2d 2005-5155] (3rd Cir. 2005); Schiff, 379 F.3d 621, 630–31 [94 AFTR 2d 2004-5460] (9th Cir. 2004); Campbell, 897 F.2d 1317, 1323 [65 AFTR 2d 90-1003] (5th Cir. 1990). See generally Central Hudson Gas & Elec. Corp. v. Pub. Serv. Comm'n of N.Y., 447 U.S. 557, 563–64 (1980).



VI.

For the foregoing reasons, the judgment of the district court is affirmed.

1





The Honorable Karen E. Schreier, Chief Judge, United States District Court for the District of South Dakota, sitting by designation.

2



The Honorable Ortrie D. Smith, United States District Judge for the Western District of Missouri.

3



See 26 U.S.C. §§ 1361–66. Subchapter S corporations pass their earnings through to the owners, preventing double taxation of the business's earnings.

4



According to the complaint, the management companies were to provide payroll services, negotiate leases, obtain insurance policies, and purchase and resell office equipment and supplies. None of these services was ever provided.

5



Specified conduct also includes conduct subject to penalty under § 6701, which imposes penalties for any person who assists in the preparation or presentation of any tax document while knowing that document will result in an understatement of the tax liability of another person. Though the government also invoked § 6701 as authority for the injunction, the district court found it unnecessary to “complicate or lengthen” its order by discussing that section. It noted, however, that “in large measure” its analysis would justify a finding that Stover had also violated § 6701.

6



In relevant part, section 6700 imposes penalties on any person who–

((1))

((A)) organizes (or assists in the organization of)—

((i)) a partnership or other entity,

((ii)) any investment plan or arrangement, or

((iii)) any other plan or arrangement, or

((B)) participates (directly or indirectly) in the sale of any interest in an entity or plan or arrangement referred to in subparagraph (A), and

((2)) makes or furnishes or causes another person to furnish (in connection with such organization or sale)—

((A)) a statement with respect to the allowability of any deduction or credit, the excludability of any income, or the securing of any other tax benefit by reason of holding an interest in the entity or participating in the plan or arrangement which the person knows or has reason to know is false or fraudulent as to any material matter.