Edward Francis Bachner, IV & Rebecca Gay Bachner

United States Tax Court
T.C. Memo. 2023-148EDWARD FRANCIS BACHNER, IV
AND REBECCA GAY BACHNER,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
__________
Docket No. 23219-15. Filed December 13, 2023.
__________
Edward Francis Bachner, IV and Rebecca Gay Bachner, pro sese.
Alexander R. Roche, Eugene A. Kornel, Sarah E. Sexton Martinez, and
Mayer Y. Silber, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MORRISON, Judge: Petitioners, Edward Francis Bachner, IV
and Rebecca Gay Bachner, filed joint income tax returns for 2005, 2006,
and 2007. As explained later in this Opinion, these returns were false
in many respects, most significantly in that they claimed tax refunds
through fictitious income tax withholding. Respondent (IRS) issued
refunds to the Bachners.
In 2016 the IRS mailed a notice of deficiency to both the Bachners,
determining civil fraud penalties under section 6663 against Mr.
Bachner for 2005, 2006, and 2007 of $82,877, $164,671, and $146,259,
respectively. 1 The notice did not determine deficiencies in income tax.
1 Unless otherwise indicated, references to sections are to the Internal Revenue
Code of 1986, Title 26 U.S.C. (Code), in effect at all relevant times, regulation
references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all
Served 12/13/23
2
[*2] The notice stated the IRS had granted Mrs. Bachner full relief
under section 6015(b) for each year, and had mailed separate letters to
Mr. and Mrs. Bachner regarding that decision.
The Bachners filed a timely petition for redetermination of
section 6663 fraud penalties. They resided in Illinois when they filed
their petition.
In this Opinion we hold that the underpayment of tax for each
year is equal to the amount determined in the notice of deficiency and
that the entire amount of each underpayment is due to fraud.
FINDINGS OF FACT
The parties did not execute a stipulation of facts. Pursuant to
Rule 91(f)(3) the Court deemed stipulated paragraphs 1–15, 17–27, 29–
41, 43–59, 61, and 62, of the IRS’s August 10, 2016, proposed stipulation
of facts, and admitted Exhibits 1-J through 20-J attached to the same
document. At trial the Bachners did not appear, and no representative
appeared on their behalf. The IRS called one witness, Revenue Agent
Gregory C. Hines. He testified about the IRS’s initial determination of
the fraud penalty and managerial approval of the determination. The
IRS introduced Exhibits 21-R through 27-R, which the Court admitted.
The record of this case (not including the deemed stipulations) consists
of the following: (1) Exhibits 1-J through 20-J (i.e., the Rule 91(f)(3)
documents), (2) Exhibits 21-R through 27-R (i.e., the trial exhibits), and
(3) the testimony of Hines. Some of our findings of fact are made on
these three categories of evidence. Other findings of fact are the result
of judicial notice under Rule 201(b)(2) of the Federal Rules of Evidence. 2
In summary, our findings of fact are made on the following five sources:
(1) the deemed stipulations, (2) the Rule 91(f)(3) documents, (3) the trial
exhibits, (4) the testimony of Hines, and (5) judicially noticed facts.
Mrs. Bachner was a registered nurse (paragraph 2 of the deemed
stipulations). Mr. Bachner has a bachelor’s degree in business
relevant times, and Rule references are to the Tax Court Rules of Practice and
Procedure.
2 We notified the parties by our Order of October 3, 2023, that we were inclined
to take judicial notice of these facts. The Bachners objected. Their objections do not
raise any genuine questions about (1) the accuracy of the sources of the facts or (2) the
correctness of the facts. The facts concern basic procedural events in Mr. Bachner’s
criminal case, the most important aspects of which have already been deemed
established. Judicial notice is appropriate.
3
[*3] (paragraph 3 of the deemed stipulations). The record discloses little
else about the Bachners’ educational backgrounds and occupations.
I. The false returns for 2005, 2006, and 2007; Mr. Bachner’s orders
of tetrodotoxin; the $20 million insurance policy on Mrs. Bachner’s
life
During the years at issue, the Bachners were a married couple
with no children.
The Bachners filed joint Forms 1040, U.S. Individual Income Tax
Return, for 2005–07. Mr. Bachner prepared and filed the returns. As
explained later in this Opinion, the Bachners falsely claimed refunds on
these returns through reporting fictitious wages and fictitious
withholding. There were other erroneous items on the returns, also
explained later.
On August 17, 2006, the Bachners electronically submitted their
2005 return to the IRS. The return claimed two personal exemptions.
The Bachners’ 2005 return reported the following:
Item Amount
Income
Wages, salaries, tips, etc. $488,448
Other gains or losses (Form 4797) −22,054
Adjustments to income 0
Adjusted gross income 466,394
Itemized deductions (Schedule A)
State and local income taxes 69,607
Real estate taxes 9,578
Home mortgage interest and points 15,331
Miscellaneous deductions
Unreimbursed employee expenses 46,182
Tax preparation fees 525
Other expenses 6,575
2% AGI floor −9,328
Total −128,857
Net income 337,537
Exemptions 0
Taxable income 337,537
Tax 122,798
Federal income tax withheld −234,044
Refund 111,246
4
[*4] The miscellaneous deduction for “[o]ther expenses” claimed on
Schedule A, Itemized Deductions, was further described in the return as
expenses for investment counsel and advice.
On Form 4797, Sales of Business Property, which was included
with the 2005 return, the Bachners claimed a $22,054 capital loss
deduction for the sale or exchange of a Jeep Grand Cherokee. The
Bachners reported that the Jeep was acquired for $37,000 on June 30,
1997, that depreciation of $14,846 had been taken since acquisition, and
that the Jeep was sold for $100 on December 31, 2005.
The Bachners’ 2005 return included a fake Form W–2, Wage and
Tax Statement, purportedly issued by Rosetta-Wireless Corp. to Mr.
Bachner, reporting wages of $457,940 and federal income tax
withholding of $228,970. The Form W–2 also reported state income tax
withholding of $68,691. The information from this Form W–2 (all of
which was false) was reflected on the Bachners’ Form 1040 (for wages
and withholding) including the Schedule A (for state and local income
taxes).
The Bachners’ 2005 return included an authentic Form W–2
issued by the Camelot Schools, LLC, to Mrs. Bachner, reporting wages
of $30,508 and withholding of $5,074. The Form W–2 also reported state
income tax withholding of $916. The information from this Form W–2
was correct and was reflected on the Bachners’ Form 1040.
The 2005 return failed to report certain items of income and an
amount of income tax withholding.
The 2005 return claimed certain itemized deductions that were
disallowed by the notice of deficiency.
On or about October 19, 2006, the IRS paid a $111,201 refund to
the Bachners. The record does not explain why the amount refunded
was $45 less than the refund claimed per return ($111,246).
Starting in late 2006, Mr. Bachner used a false identity to order
shipments of a lethal neurotoxin called tetrodotoxin. 3 He placed and
received his first order for tetrodotoxin in November 2006.
3 Tetrodotoxin is a nerve toxin found in puffer fish and newts. J.E. Schmidt,
Attorney’s Dictionary of Medicine (2018). Tetrodotoxin poisoning “may progress to an
ascending paralysis, respiratory failure, cardiovascular collapse, and death within six
5
[*5] On April 10, 2007, the Bachners electronically submitted their
2006 return to the IRS. The return claimed two personal exemptions.
The Bachners’ 2006 return reported the following:
Item Amount
Income
Wages, salaries, tips, etc. $1,053,828
Adjustments to income (IRA deduction) −8,000
Adjusted gross income 1,045,828
Itemized deductions (Schedule A)
State and local income taxes 101,615
Real estate taxes 35,000
Home mortgage interest and points 15,000
Miscellaneous deductions
Unreimbursed employee expenses 50,389
2% AGI floor −20,917
Total −163,180
Net income 882,648
Exemptions −2,200
Taxable income 880,448
Tax 285,132
Federal income tax withheld −509,469
Federal telephone excise tax credit −40
Refund 224,377
The Bachners’ 2006 return included a fake Form W–2 purportedly
issued by EB Strategic Research, LLC, to Mr. Bachner, reporting wages
of $1 million and federal income tax withholding of $500,000. The Form
W–2 also reported state income tax withholding of $100,000. The
information from this Form W–2 (all of which was false) was reflected
in the Bachners’ Form 1040 (for wages and withholding) including the
Schedule A (for state and local income taxes).
The Bachners’ 2006 return included an authentic Form W–2
issued by the Metropolitan Life Insurance Co. to Mrs. Bachner,
reporting wages of $53,828 and withholding of $9,469. The Form W–2
also reported state withholding of $1,615. The information from this
Form W–2 was correct and was reflected on the Bachners’ Form 1040.
to 24 hours owing to paralysis of the respiratory muscles.” Attorneys’ Textbook of
Medicine ¶ 49B.40 (3d ed. 2019).
6
[*6] The 2006 return failed to report certain items of income, and an
amount of income tax withholding.
The 2006 return reported certain itemized deductions that were
disallowed by the notice of deficiency.
On or about May 18, 2007, the IRS made a $224,343 refund to the
Bachners for the 2006 tax year, consisting of (1) a $218,133 payment and
(2) a $6,210 offset against the Bachners’ outstanding 2004 tax liability.
The record does not explain why the amounts of the debt-offset and the
refund ($6,210 + $218,133 = $224,343) were $34 less than the refund
claimed on the return ($224,377).
In September 2007, almost a year after his first tetrodotoxin
order, Mr. Bachner submitted an application for insurance on the life of
Mrs. Bachner. The application was for $20 million in coverage. The
application falsely claimed that Mrs. Bachner was the CEO of Trident
Solutions, LLC, and that Mrs. Bachner was a “key person” whose
“absence” would result in a loss to the company. In correspondence with
the insurance underwriters, Mr. Bachner claimed to be an agent acting
on behalf of Trident Solutions, LLC, and that Trident Solutions, LLC,
sought insurance on the life of Mrs. Bachner. Mrs. Bachner’s supposed
signature appears on the life insurance application.
In February 2008 Mr. Bachner wired a $39,989 premium to the
underwriter and a policy on Mrs. Bachner’s life was issued. The policy
insured Mrs. Bachner’s life for the three-month period from February 11
until May 11, 2008. Trident Solutions, LLC, was the beneficiary under
the insurance contract.
In February and March of 2008 Mr. Bachner placed and received
three orders of tetrodotoxin.
On April 15, 2008, the Bachners electronically submitted their
2007 return to the IRS. The return claimed two personal exemptions.
The Bachners’ 2007 return reported the following:
7
[*7] Item Amount
Income
Wages, salaries, tips, etc. $972,230
Adjustments to income 0
Adjusted gross income 972,230
Itemized deductions (Schedule A)
State and local income taxes 183,867
Real estate taxes 12,000
Home mortgage interest and points 18,000
Miscellaneous deductions
Unreimbursed employee expenses 77,310
2% AGI floor −19,445
Total −255,415
Net income 716,815
Exemptions −2,266
Taxable income 714,549
Tax 263,684
Federal income tax withheld −466,435
Refund 202,751
The Bachners’ 2007 return included a fake Form W–2 purportedly
issued by Fusion Marketing, LLC, to Mr. Bachner, reporting wages of
$910,000 and federal income tax withholding of $455,000. The Form
W–2 also reported state income tax withholding of $182,000. The
information from this Form W–2 (all of which was false) was reflected
in the Bachners’ Form 1040 (for wages and withholding) including the
Schedule A (for state and local income taxes).
The Bachners’ 2007 return included an authentic Form W–2
issued by the Metropolitan Life Insurance Co. to Mrs. Bachner,
reporting wages of $62,230 and federal income tax withholding of
$11,435. The Form W–2 also reported state income tax withholding of
$1,867. The information from this Form W–2 was correct and was
incorporated in the Bachners’ Form 1040.
The 2007 return failed to report certain items of income and an
amount of income tax withholding.
The 2007 return claimed certain itemized deductions that were
disallowed by the notice of deficiency.
On or about May 12, 2008, the IRS refunded $202,703 to the
Bachners for 2007, consisting of (1) a $170,617 payment and (2) a
$32,086 offset of a debt owed by the Bachners to another agency. The
record does not explain why the amounts of the debt-offset and the
8
[*8] refund ($32,086 + $170,617 = $202,703) were $48 less than the
refund claimed on the return ($202,751).
In June 2008, Mr. Bachner placed another order for tetrodotoxin.
On June 30, 2008, Mr. Bachner was arrested. On August 26,
2008, a federal grand jury indicted Mr. Bachner under 18 U.S.C. § 175(a)
on five counts of possessing a biological agent for use as a weapon and
under 18 U.S.C. § 175(b) on five counts of possessing a biological agent
without any justifiable research or other peaceful purpose. As a result,
Mr. Bachner became the criminal defendant in United States v. Bachner,
No. 3:08-cr-50029, filed on June 30, 2008, in the United States District
Court for the Northern District of Illinois.
About a year later, on June 16, 2009, a federal grand jury added
the following six counts to the ten counts in the original indictment:
• One count of wire fraud, under 18 U.S.C. § 1343, for wiring a
$39,989 premium to a life insurance company in a scheme to
defraud it and collect $20 million in life insurance proceeds;
• One count of soliciting another to commit a crime of violence
under 18 U.S.C. § 373(a);
• One count of use of interstate commerce facilities with the intent
to commit murder-for-hire under 18 U.S.C. § 1958(a);
• Three counts of making or presenting false claims to a United
States department or agency, under 18 U.S.C. § 287, for filing
false income tax refund claims with the IRS for 2005, 2006, and
2007, respectively.
On August 2, 2011, Mr. Bachner accepted a plea agreement and
pleaded guilty to three counts in the superseding indictment: one count
of wire fraud; one count of possessing a biological agent for use as a
weapon; and one count of making or presenting a false claim to the IRS
(for 2005).
As part of the plea agreement, Mr. Bachner “admitted” various
facts regarding the three counts to which he pleaded guilty. With
respect to the count for wire fraud, Mr. Bachner admitted the following:
(1) he bought a $20 million life insurance policy on the life of his wife in
a scheme to defraud the life insurance company through fraudulent
pretenses, representations, and omissions; (2) to justify the amount of
9
[*9] the coverage of the policy, he misrepresented his wife’s
employment, education, and work experience; and (3) he planned to
profit from the death of his wife by collecting proceeds from the
fraudulently obtained life insurance policy. With respect to the count
for possession of a biological agent for use as a weapon, Mr. Bachner
admitted that he knowingly acquired tetrodotoxin, using an alias, for
the purpose of using it as a weapon. With respect to the count of making
or presenting a false claim to the IRS for tax year 2005, Mr. Bachner
admitted the following: (1) he made and presented to the IRS a claim for
payment by filing a Form 1040 for tax year 2005; (2) he falsely claimed
that he had received income and that federal income tax had been
withheld from his income by Rosetta-Wireless Corp.; (3) as a result of
those false statements on the return, the return falsely claimed he was
entitled to a refund of $111,246; and (4) he made and presented the
return to the IRS knowing that the return and the claimed refund were
false, fictitious, and fraudulent.
As part of the plea agreement, Mr. Bachner admitted that he
engaged in certain conduct that constituted relevant conduct under U.S.
Sentencing Guideline § 1B1.3. See United States Sentencing
Commission, Guidelines Manual, § 3E1.1 (Nov. 2010). In particular, Mr.
Bachner admitted that for tax year 2006 (1) he made and presented to
the IRS a claim for payment by filing a Form 1040 and (2) the return
claimed a refund of withholding tax of $224,377, which he knew to be
false, fictitious, and fraudulent. And for tax year 2007 Mr. Bachner
admitted (1) he made and presented to the IRS a claim for payment by
filing a Form 1040 and (2) the return claimed a refund of withholding
tax of $224,377 which he knew to be false, fictitious, and fraudulent. 4
Mr. Bachner was sentenced to 92 months’ imprisonment on the
wire fraud and biological-agent-possession counts and 60 months’
imprisonment on the false-claim count, ordered to be served
concurrently. He was also ordered to pay $512,396 in restitution to the
United States Department of the Treasury. Mr. Bachner was in federal
custody from the date of his arrest, June 30, 2008, until his release on
March 4, 2015.
4 This $224,377 figure, in the plea agreement, appears to be a cut-and-paste
error from the previous taxable year. The Bachners’ 2007 return claimed a $202,751
tax refund.
10
[*10] II. Examination and notice of deficiency
A. Examination
The IRS selected the Bachners’ 2005–07 returns for examination.
Revenue Agent Gregory C. Hines conducted the examination.
B. Penalty approval form and 30-day letter
Hines made the initial determination that the Bachners were
liable for the section 6663 fraud penalty for the 2005–07 tax years and
prepared a penalty approval form to seek approval for the penalty.
Hines prepared the penalty approval form on or before August 1, 2013.
On that form, Hines checked the “Yes” box for the section 6663 fraud
penalty and checked the “Yes” box for the section 6662(b)(1) penalty as
an alternative position. Under the heading “Group Manager
Involvement,” Group Manager Roheel Subhani checked the “Approved”
box, wrote his initials, and dated the form “8/1/13.” At the time Subhani
approved the penalties, he was Hines’s immediate supervisor. The
penalty approval form named the “[t]axpayer” as “BACHNER, IV,
EDWARD F & REBECCA G.”
After Subhani approved the penalties, Hines mailed a 30-day
letter to the Bachners. 5
C. Notice of deficiency
On June 11, 2015, the IRS mailed a notice of deficiency to the
Bachners. At the top of the notice of deficiency was the return address,
i.e., the writer’s address:
Department of the Treasury
Internal Revenue Service
Appeals Office
200 West Adams Street
Suite 600
Chicago, IL 60606
The notice of deficiency then gave the inside address, i.e., the name and
mailing information of the recipient:
5 The IRS did not introduce the 30-day letter into evidence. Our finding of fact
about the mailing of the 30-day letter is based on Hines’s testimony.
11
[*11] EDWARD F AND REBECCA G BACHNER
5704 MCKENZIE DR
LAKE IN THE HILLS IL 60156-5812
The notice of deficiency then stated the tax years and amounts of section
6663(a) penalties determined for each year. The notice of deficiency
then made the following salutation, i.e., greeting to the recipient: “Dear
Mr. Bachner.” The notice of deficiency then stated that “you” owe the
amounts in question and that “you” may file a Tax Court petition to
contest the determination. Parts of the notice of deficiency, such as the
Form 5278, Statement – Income Tax Changes, and Form 4549B, Income
Tax Examination Changes, state “Edward F & Rebecca G Bachner IV as
the name of the “taxpayer(s).” The notice of deficiency determined fraud
penalties under section 6663 for 2005, 2006, and 2007, in the respective
amounts of $82,877, $164,671, and $146,259. The notice of deficiency
did not determine deficiencies for 2005–07. The notice of deficiency
stated: “Rebecca Bachner has been granted innocent spouse relief under
the provisions of IRC 6015(b). She is not liable for tax, penalties, or
interest for 2005, 2006, 2007.” The notice of deficiency further stated:
“We have sent a separate letter to each spouse regarding our decision to
grant relief.”
1. 2005 determinations
The notice of deficiency determined that, contrary to the Form
W–2 allegedly issued by Rosetta-Wireless Corp. to Mr. Bachner stating
that he had wages of $457,940 and withholding of $228,970, Mr.
Bachner did not receive any of the wages reported from Rosetta-Wireless
Corp., and Rosetta-Wireless Corp. did not make the reported
withholdings.
The notice of deficiency also determined that the Bachners failed
to report the following amounts of gross income and withholding:
12
[*12]
Item of income Payor Payee Amount Withholding
of
income
Wages Adminstaff Co. II, Mr. Bachner $22,174 $1,588
L.P.
Wages Metropolitan Life Mrs. Bachner 19,331 3,368
Insurance Co.
Wages New England Life Mr. Bachner 2,769 237
Insurance Co.
Unemployment Illinois Department Mr. Bachner 8,736 872
compensation of Employment
Security
Nonemployee Shelter Inc. Mrs. Bachner 1,276 0
compensation
State income State of Illinois Mr. Bachner 1,462 0
tax refund Revenue Department
Stock sale Computershare Mr. Bachner 6,151 0
proceeds Shareholder Services
Inc.
Interest Bureau of the Public Mr. Bachner 2,292 0
Debt
Interest Bachner Family Mr. Bachner 114 0
Partnership Ltd.
Interest New York Life Mr. Bachner 21 0
Insurance Co.
Long-term Bachner Family Mr. Bachner 134 0
capital gains Partnership Ltd.
Ordinary Bachner Family Mr. Bachner 503 0
dividends Partnership Ltd.
Qualified Computershare Mr. Bachner 153 0
dividends Shareholder Services
Inc.
Qualified Mellon Investor Mr. Bachner 62 0
dividends Services
Qualified UMB Bank N.A. Mr. Bachner 27 0
dividends
Qualified Mellon Investor Mrs. Bachner 3 0
dividends Services
Total 65,208 6,065
The notice of deficiency also determined that the Bachners
improperly claimed a $22,054 capital loss deduction for the sale or
exchange of business property.
The notice of deficiency also determined that the Bachners
improperly claimed $109,807 in itemized deductions:
13
[*13] Item Per return Per notice Disallowed
State and local income taxes $69,607 $2,244 $67,363
Real estate taxes 9,578 6,469 3,109
Home mortgage interest deduction 15,331 10,337 4,994
Unreimbursed employee expenses 46,182 -0- 46,182
Tax preparation fees 525 -0- 525
Miscellaneous other expenses 6,575 -0- 6,575
Section 67(a) 2% floor −9,328 −1,913 N/A
Total itemized deductions 128,857 19,050 109,807
The section 67(a) 2% floor as determined by the IRS ($1,913) did
not affect the IRS’s computation of total itemized deductions because the
IRS determined that the amount of miscellaneous itemized deductions,
computed before the floor, was zero.
The notice of deficiency determined that the Bachners were
entitled to two personal exemptions, the same number claimed on the
return. The notice of deficiency computed that the total amount of
deductions corresponding to these exemptions was $6,400.
The notice of deficiency determined that $90 was the amount of
the deduction to which the Bachners were entitled for one-half of self-
employment tax liability. The Bachners’ 2005 return reported this
amount was zero.
The notice of deficiency determined an underpayment of $110,503
as follows:
Item Amount
Tax imposed $10,396
Tax shown on the return
Tax reported $122,798
Withholding overstatement − 222,905
Total −$100,107
Tax previously assessed 0
Amount of rebates made 0
Balance − (−)100,107
Underpayment 110,503
The notice of deficiency determined a fraud penalty under section
6663 of $82,877, computed as 75% of the $110,503 underpayment of tax.
14
[*14] 2. 2006 determinations
The notice of deficiency determined that, contrary to the Form
W–2 allegedly issued by EB Strategic Research, LLC, to Mr. Bachner
stating that he had wages of $1 million and withholding of $500,000, Mr.
Bachner did not receive any of the wages reported from EB Strategic
Research, LLC, and EB Strategic Research, LLC, did not make the
reported withholdings.
The notice of deficiency also determined that the Bachners failed
to report the following amounts of gross income and withholding:
Item of income Payor Payee Amount Withholding
of
income
Wages New England Life Mr. Bachner $9,230 $712
Insurance Co.
State income- State of Illinois Mr. Bachner 2,762 0
tax refund Revenue Department
Stock sale The Colbent Corp. Mr. Bachner 1,530 0
proceeds
Stock sale Computershare Mr. Bachner 1,724 0
proceeds Shareholder Services
Inc.
Interest Bachner Family Mr. Bachner 86 0
Partnership Ltd.
Interest Metropolitan Life Mr. Bachner 22 0
Insurance Co.
Interest Bank of America N.A. Mr. Bachner 12 0
Long-term Bachner Family Mr. Bachner 1,491 0
capital gains Partnership Ltd.
Ordinary Bachner Family Mr. Bachner 561 0
dividends Partnership Ltd.
Qualified Embarq Corp. Mr. Bachner 2 0
dividends
Qualified Mellon Investor Mr. Bachner 159 0
dividends Services
Qualified UMB Bank N.A. Mr. Bachner 6 0
dividends
Qualified Mellon Investor Mrs. Bachner 3 0
dividends Services
Total 17,588 712
The notice of deficiency also determined that the Bachners
improperly claimed $150,698 in itemized deductions:
15
[*15] Item Per return Per notice Disallowed
State and local income taxes $101,615 $1,892 $99,723
Real estate taxes 35,000 6,545 28,455
Home mortgage interest deduction 15,000 4,045 10,955
Unreimbursed employee expenses 50,389 0 50,389
Section 67(a) 2% floor −20,917 −1,268 0
Total itemized deductions 163,180 12,482 150,698
The section 67(a) 2% floor as determined by the IRS ($1,268) did not
affect the IRS’s computation of total itemized deductions because the
IRS determined that the amount of miscellaneous itemized deductions,
computed before the floor, was zero.
The notice of deficiency determined that the Bachners were
entitled to two personal exemptions, the same number claimed on the
return. The notice of deficiency computed that the total amount of
deductions corresponding to these exemptions was $4,400.
The notice of deficiency determined an underpayment of $219,561
as follows:
Item Amount
Tax imposed $5,405
Tax shown on the return
Tax reported $285,132
Withholding overstatement − 499,288
Total −$214,156
Tax previously assessed 0
Amount of rebates made 0
Balance − (−)214,156
Underpayment 219,561
The notice of deficiency determined a fraud penalty under section
6663 of $164,671, computed as 75% of the $219,561 underpayment of
tax.
3. 2007 determinations
The notice of deficiency determined that, contrary to the Form
W–2 allegedly issued by Fusion Marketing, LLC, to Mr. Bachner stating
that he had wages of $910,000 and withholding of $455,000, Mr.
Bachner did not receive any of the wages reported from Fusion
Marketing, LLC, and Fusion Marketing, LLC, did not make the reported
withholdings.
16
[*16] The notice of deficiency also determined that the Bachners failed
to report the following amounts of gross income and withholding:
Item of income Payor Payee Amount Withholding
of
income
Wages Rosetta-Wireless Mr. Bachner $1,800 $57
Corp. 6
Interest Bachner Family Mr. Bachner 120 0
Partnership Ltd.
Interest New York Life Mr. Bachner 25 0
Insurance Co.
Interest Bank of America Mr. Bachner 70 0
N.A
Long-term capital Bachner Family Mr. Bachner 388 0
gains Partnership Ltd
Ordinary dividends Bachner Family Mr. Bachner 629 0
Partnership Ltd.
Qualified dividends Embarq Corp. Mr. Bachner 9 0
Qualified dividends Mellon Investor Mr. Bachner 79 0
Services
Total 3,120 57
The notice of deficiency also determined that the Bachners
improperly claimed $227,437 in itemized deductions:
Item Per return Per notice Disallowed
State and local income taxes $183,867 $1,921 $181,946
Real estate taxes 12,000 6,702 5,298
Home mortgage interest deduction 18,000 19,355 –1,355
Unreimbursed employee expenses 77,310 0 77,310
Section 67(a) 2% floor −19,445 −1,307 0
Total itemized deductions 255,415 27,978 227,437
The section 67(a) 2% floor as determined by the IRS ($1,307) did not
affect the IRS’s computation of total itemized deductions because the
IRS determined that the amount of miscellaneous itemized deductions,
computed before the floor, was zero.
The notice of deficiency determined that the Bachners were
entitled to two personal exemptions, the same number claimed on the
return. The notice of deficiency computed that the total amount of
deductions corresponding to these exemptions was $4,534.
6 See infra OPINION, Part IV.C, note 15.
17
[*17] The notice of deficiency determined an underpayment of $195,012
as follows:
Item Amount
Tax imposed $3,753
Tax shown on the return
Tax reported $263,684
Withholding overstatement −454,943
Total −$191,259
Tax previously assessed 0
Amount of rebates made 0
Balance − (−)191,259
Underpayment 195,012
The notice of deficiency determined a $146,259 fraud penalty
under section 6663, computed as 75% of the $195,012 underpayment of
tax.
OPINION
At the outset, we discuss certain terms related to jurisdiction and
to the section 6663 fraud penalty.
I. Definition of underpayment
The term “underpayment” is defined by the Code. It is relevant
to the amount of the fraud penalty under section 6663, which is 75% of
the portion of the underpayment of tax that is attributable to fraud.
An “underpayment” is defined in section 6664(a):
[T]he term “underpayment” means the amount by
which any tax imposed by this title exceeds the
excess of—
(1) the sum of—
(A) the amount shown as the tax by the
taxpayer on his return, plus
(B) amounts not so shown previously
assessed (or collected without assessment),
over
(2) the amount of rebates made.
18
[*18] The definition of an underpayment has four components: (1) the
“tax imposed,” § 6664(a); (2) “the amount shown as the tax by the
taxpayer on his return,” § 6664(a)(1)(A); (3) “amounts not so shown
previously assessed (or collected without assessment),” § 6664(a)(1)(B);
and (4) “the amount of rebates made,” § 6664(a)(2).
The definition of “underpayment” can be expressed using the
following mathematical formula:
The
Amounts
amount
not so
shown The
shown
as the amount
Tax previously
Underpayment = − tax by + − of
imposed assessed (or
the rebates
collected
taxpayer made
without
on his
assessment)
return
See Treas. Reg. § 1.6664-2(a). 7
Treasury Regulation § 1.6664-2(b) provides that the “tax
imposed” is determined without regard to credits for tax withheld on
wages under section 31 (or credits for tax withheld under section 33, 8 or
credits for payments of tax, or credits for payments of estimated tax).
Treas. Reg. § 1.6664-2(b)(1) and (2). The section 31 credit operates as
follows. An individual taxpayer is subject to income tax annually under
section 1. Section 3402(a)(1) requires employers paying of wages to
deduct and withhold the income tax from those wages. Under section
31, the amount withheld from wages is a credit against the tax imposed
under section 1.
7 This formula is the same formula found in Treasury Regulation § 1.6664-2(a),
except that we have omitted the short form of the variables used in the regulatory
formula. The formula given by the regulation is:
Underpayment = W − (X + Y − Z), where W = the amount of income tax
imposed; X = the amount shown as the tax by the taxpayer on his
return; Y = amounts not so shown previously assessed (or collected
without assessment); and Z = the amount of rebates made.
Id.
8 Section 33 provides for a credit for tax withheld at the source for nonresident
aliens and foreign corporations and is not relevant to the determinations in this
Opinion.
19
[*19] Treasury Regulation § 1.6664-2(c)(1) provides that “the amount
shown as the tax by the taxpayer on his return” is determined without
regard to credits for tax withheld on wages under section 31 (or credits
for tax withheld under section 33, or credits for payments of tax, or
credits for payments of estimated tax), except that when the taxpayer
overstates these amounts, the amount of overstatement will decrease
“the amount shown as the tax by the taxpayer on his return.” It follows
that the amount of the overstatement increases the underpayment. See
§ 6664(a)(1)(B); Snow v. Commissioner, 141 T.C. 238, 242 (2013); May v.
Commissioner, 137 T.C. 147, 152 (2011), aff’d per order, No. 12-1829,
2013 WL 1352477 (6th Cir. Feb. 19, 2013); Feller v. Commissioner, 135
T.C. 497, 503 (2010); Sadler v. Commissioner, 113 T.C. 99, 103 (1999).
Treasury Regulation § 1.6664-2(g) (example 3) provides the following
illustration:
[T]axpayer reported a tax liability of $10,000, estimated
tax payments of $15,000, and received a refund of $5,000.
Estimated tax payments actually made . . . were only
$7,000. For purposes of determining the amount of
underpayment subject to a penalty under section 6662 or
section 6663, the tax shown on the return is $2,000
(reported tax liability of $10,000 reduced by the overstated
estimated tax of $8,000 ($15,000−$7,000)). The
underpayment is $8,000 . . . .
Treasury Regulation § 1.6664-2(d) provides that “amounts not so
shown previously assessed” means “amounts assessed before the return
is filed that were not shown on the return.” The regulation also provides
that an amount “collected without assessment” means “the amount by
which the total of the credits allowable under section 31 . . . and section
33 . . . , estimated tax payments, and other payments in satisfaction of
tax liability made before the return is filed, exceed the tax shown on the
return (provided such excess has not been refunded or allowed as a
credit to the taxpayer).” Id.
Section 6664(a) provides that the phrase “the amount of rebates
made” means “so much of an abatement, credit, refund, or other
repayment, as was made on the ground that the tax imposed was less
than the excess of the amount specified in paragraph (1)[9] over the
rebates previously made.”
9 “Paragraph (1)” is section 6664(a)(1).
20
[*20] II. Definition of deficiency
Section 6213(a) prohibits the IRS from assessing a deficiency
without mailing a notice of deficiency to the taxpayer and permits the
taxpayer 90 days from the mailing of the notice of deficiency to file a
petition with the Tax Court for redetermination of the deficiency. The
notice of deficiency is the taxpayer’s “ticket” to the Court and a
prerequisite for the Court’s obtaining jurisdiction. Baron v.
Commissioner, 71 T.C. 1028, 1034 (1979).
A “deficiency” is defined in section 6211(a):
[T]he term “deficiency” means the amount by which the tax
imposed by subtitle A or B . . . exceeds the excess of—
(1) the sum of
(A) the amount shown as the tax by the
taxpayer upon his return, if a return was
made by the taxpayer and an amount was
shown as the tax by the taxpayer thereon,
plus
(B) the amounts previously assessed
(or collected without assessment) as a
deficiency, over—
(2) the amount of rebates, as defined in
subsection (b)(2), made.
Section 6211(b)(2) defines a “rebate” as “so much of an abatement,
credit, refund, or other repayment, as was made on the ground that the
tax imposed by subtitle A or B or chapter 41, 42, 43, or 44 was less than
the excess of the amount specified in subsection (a)(1) over the rebates
previously made.” Treasury Regulation § 301.6211-1(f) provides that a
“rebate” means so much of an abatement, credit, refund, or other
repayment as is made on the ground that the tax imposed is less than
the excess of (1) the amount shown as the tax by the taxpayer on the
return increased by the amount previously assessed (or collected
without assessment) as a deficiency over (2) the amount of rebates
previously made.
The Code provides that actual tax and tax reported are computed
(for deficiency purposes) without regard to credits for tax withheld on
wages under section 31 (or credits for tax withheld under section 33, or
credits for payments of tax, or credits for payments of estimated tax).
§ 6211(b)(1); see also Treas. Reg. § 301.6211-1(b).
21
[*21] Thus, the definitions of “underpayment” in section 6664(a) and
“deficiency” in section 6211(a) diverge in their treatment of credits for
tax withheld on wages under section 31 (or credits for tax withheld
under section 33, or credits for payments of tax, or credits for payments
of estimated tax). A deficiency is determined without accounting for
these amounts, but an underpayment accounts for them by reducing the
tax shown on the return by the amount they are overstated. See
§ 6211(b)(1); Treas. Reg. § 1.6664-2(a).
III. Jurisdiction
A. Relevant jurisdictional principles
The Tax Court, like other federal courts, is a court of limited
jurisdiction and may exercise jurisdiction only to the extent authorized
by Congress. § 7442; Naftel v. Commissioner, 85 T.C. 527, 529 (1985).
If the Court finds that it does not have jurisdiction to consider an issue,
then the Court may not decide the issue. Naftel, 85 T.C. at 530. The
Court always has jurisdiction to determine whether it has jurisdiction.
Romann v. Commissioner, 111 T.C. 273, 280 (1998) (citing Wheeler’s
Peachtree Pharmacy, Inc. v. Commissioner, 35 T.C. 177, 179 (1960)).
“When a statutory provision is capable of two interpretations, ‘we are
inclined to adopt a construction which will permit us to retain
jurisdiction without doing violence to the statutory language.’” Bongam
v. Commissioner, 146 T.C. 52, 54–55 (2016) (quoting Traxler v.
Commissioner, 61 T.C. 97, 100 (1973)).
The Court has jurisdiction under section 6213(a) in a deficiency
proceeding only where the IRS issues a valid notice of deficiency and the
taxpayer files a timely petition for redetermination. §§ 6212 and 6213;
Rule 13(a), (c); Sanders v. Commissioner, No. 15143-22, 161 T.C., slip
op. at 8 (Nov. 2, 2023); Monge v. Commissioner, 93 T.C. 22, 27 (1989). In
the absence of a valid notice of deficiency, the Court is compelled to
dismiss the case for lack of jurisdiction. Monge, 93 T.C. at 27.
All individual taxpayers are subject to income tax annually under
section 1 and are required to file tax returns reporting their tax
liabilities under section 6011. A deficiency is defined for basic purposes
as the difference between the tax reported and the tax liability.
§ 6211(b)(1). See supra OPINION, Part II. If the IRS determines that
there is a deficiency, it is barred from assessing or collecting the
deficiency until it mails the taxpayer a notice of deficiency. § 6213(a).
The notice of deficiency permits the taxpayer to file a petition with the
22
[*22] Tax Court, which gives the Tax Court jurisdiction to redetermine
the deficiency. § 6213(a); see also § 6214(a).
Under section 6013(a) “[a] husband and wife may make a single
return jointly of income taxes.” Under Treasury Regulation § 1.6013-
4(b), “[i]f a joint return is made, the gross income and adjusted gross
income of husband and wife on the joint return are computed in an
aggregate amount and the deductions allowed and the taxable income
are likewise computed on an aggregate basis.” This regulation also
provides: “Although there are two taxpayers on a joint return, there is
only one taxable income. The tax on the joint return shall be computed
on the aggregate income and the liability with respect to the tax shall
be joint and several.” Id. As is the case for an individual taxpayer, the
IRS is barred from assessing or collecting the deficiency until it mails
the taxpayers a notice of deficiency. § 6213(a). In the case of a joint
return, “such notice of deficiency may be a single joint notice.”
§ 6212(b)(2). If the IRS has been notified by either spouse that separate
residences have been established, a duplicate of the original joint notice
must be mailed to each spouse at the last known address. Id. The joint
notice of deficiency permits the taxpayers to file a joint petition or
separate petitions with the Tax Court. § 6213(a); Camous v.
Commissioner, 67 T.C. 721, 735–36 (1977); Dolan v. Commissioner, 44
T.C. 420, 428 (1965). As with individual taxpayers, a valid notice of
deficiency and a timely petition give the Court jurisdiction. §§ 6212,
6213, and 6214; Rule 13(a).
Although section 6213(a) bars the IRS from assessing or collecting
a deficiency without mailing a notice of deficiency, section 6213(b)(1)
authorizes the IRS, without mailing a notice of deficiency, to assess and
collect tax that is greater than the tax reported on the return because of
the return’s mathematical error in calculating tax. A petition filed to
challenge such an assessment would be dismissed for lack of
jurisdiction. Pope v. Commissioner, T.C. Memo. 2020-62, at *8. Section
6201(a)(3) provides that if a return reports an overstated amount of
income tax withholding, the IRS may assess the overstated amount as a
mathematical error under section 6213(b)(1). If the taxpayer overstates
the amount of income tax withholding, the IRS could summarily assess
the withholding overstatement pursuant to the mathematical error
correction procedures of section 6201(a)(3) without sending the taxpayer
a notice of deficiency. § 6213(b)(1); Treas. Reg. § 301.6201-1(a)(3). 10 If,
10 In its brief the IRS states that it has made such a summary assessment of
overstated withholdings for the years at issue.
23
[*23] in this scenario, the taxpayer were to file a petition challenging
the assessment of the overstatement of withholding, the Court would
dismiss it for lack of jurisdiction. §§ 6201(a)(3), 6213(b)(1); Pope, T.C.
Memo. 2020-62, at *8.
Section 6663(a) imposes a penalty equal to 75% of the amount of
an underpayment due to fraud. The Court has jurisdiction in a situation
in which the taxpayer allegedly fails to report income, the IRS
determines a deficiency and a fraud penalty under section 6663, and the
taxpayer files a petition with the Tax Court. Further, the Court has
jurisdiction in a situation in which there is no deficiency determination,
the IRS seeks solely to impose a fraud penalty under section 6663, and
the taxpayer files a petition with the Tax Court. See Eck v.
Commissioner, 16 T.C. 511, 514–15 (1951) (taxpayer filed a return
reporting less tax than was owed, and then eliminated the deficiency by
paying the shortfall before the IRS issued the notice of deficiency), aff’d
per curiam, 202 F.2d 750 (2d Cir. 1953); Rice v. Commissioner, T.C.
Memo. 1999-65, slip op. at 5–6. For example, in Rice, the taxpayer
falsely claimed on his return that taxes had been withheld and included
with the return fake Forms W–2 to support this claim. Rice, T.C. Memo.
1999-65, slip op. at 5–6. The IRS issued a notice of deficiency which did
not determine a deficiency but did determine fraud penalties under
section 6663. Rice, T.C. Memo. 1999-65, slip op. at 5–6. The taxpayer
in Rice argued that the Court did not have jurisdiction because the
notice of deficiency did not determine a deficiency. Id. The Court
rejected this argument with the following explanation:
Section 6665 provides that “additions to the tax,
additional amounts, and penalties * * * shall be paid upon
notice and demand and shall be assessed, collected, and
paid in the same manner as taxes”. A deficiency in tax is
assessed, collected, and paid only after [the Commissioner]
makes a determination and sends a notice of that
determination in accordance with section 6213, which
provides for the jurisdiction of this Court. Thus, [the
Commissioner], in sending a notice determining [the
taxpayer] was liable for a section 6663 penalty, was
complying with the law that requires him to proceed in the
same manner as if there were a deficiency. “The statute
was intended to mean * * * that where such a notice was
sent, the Tax Court has jurisdiction.”
24
[*24] Id., slip. op. at 4 (quoting Eck, 16 T.C. at 515). Thus, a notice of
deficiency that determines a fraud penalty, but no deficiency, is a valid
basis for jurisdiction for the Court. Eck, 16 T.C. at 514–15; Rice, T.C.
Memo. 1999-65, slip op. at 5–6; see also May, 137 T.C. at 150–151
(holding that the Court had jurisdiction to redetermine section 6663
fraud penalties resulting from overstated withholding credits).
Section 6512(b)(1) gives the Court jurisdiction to determine an
overpayment. Once the Court has determined the amount of the
overpayment, “such amount shall, when the decision of the Tax Court
has become final, be credited or refunded to the taxpayer.” Id. Section
6512(b)(2) provides further:
If, after 120 days after a decision of the Tax Court has
become final, the Secretary has failed to refund the
overpayment determined by the Tax Court, together with
the interest thereon as provided in subchapter B of chapter
67, then the Tax Court, upon motion by the taxpayer, shall
have jurisdiction to order the refund of such overpayment
and interest.
B. Issues over which the Court has jurisdiction
The Bachners contend generally that the Court does not have
jurisdiction over any aspect of the case. They also make specific
challenges to jurisdiction.
We have jurisdiction to determine the amount of the
underpayment under section 6663(a) for each year. §§ 6213(a), 6665.
We observe that one component of an underpayment is the tax imposed
and that the determinations in the notice of deficiency calculated the tax
imposed on a joint basis for each year.
We have jurisdiction to determine, for each year, the portion of
the underpayment due to fraud under section 6663(a). §§ 6213(a), 6665.
We have jurisdiction to determine the amount of any
overpayment for any of the years. § 6512(b)(1).
We now consider the Bachners’ specific challenges to our
jurisdiction.
25
[*25] C. The validity of the notice of deficiency
The Bachners argue that because the notice of deficiency did not
determine a deficiency under section 6211, the notice was invalid and
the Court does not have jurisdiction as to either Mrs. Bachner or Mr.
Bachner.
A notice of deficiency that determines a fraud penalty under
section 6663, but no deficiency, is a valid basis for the Court to take
jurisdiction (upon the filing of a timely petition) to determine the
amount of the underpayment and the amount of the underpayment due
to fraud. §§ 6212, 6213, and 6214; Rule 13(a), (c); Eck, 16 T.C. at 514–
15; Rice, T.C. Memo. 1999-65, slip op. at 5–6.
We hold that the notice of deficiency is valid.
D. Jurisdiction as to Mrs. Bachner
The Bachners argue that because the IRS granted Mrs. Bachner
full innocent spouse relief under section 6015(b) and is not asserting the
fraud penalties (or any other liability) against her, the notice erred in
listing her as an addressee. (The notice of deficiency names both
Bachners as addressees in the inside address. It also names both
Bachners as “taxpayer(s).”) The Bachners conclude that the notice of
deficiency is invalid as to Mrs. Bachner and that she should be dismissed
from this case. 11 Before trial the IRS had opposed dismissing Mrs.
Bachner from the case, contending that the redetermination of Mr. and
Mrs. Bachner’s joint tax liabilities for years 2005, 2006, and 2007 is
under the exclusive jurisdiction of the Court, and that Mrs. Bachner has
standing to make an overpayment claim. The IRS now contends (in a
footnote in its opening brief) that “[i]t is debatable as to whether
petitioner-wife should be a party to this case, as the notice was only
directed to Bachner (the notice of deficiency contains the salutation
‘Dear Mr. Bachner’).”
Both Mr. and Mrs. Bachner were issued a valid notice of
deficiency for 2005, 2006, and 2007. See supra OPINION, Part III.C.
11 The Bachners previously moved to dismiss Mrs. Bachner and sought to
invalidate the notice of deficiency as to Mr. Bachner; but the motions were denied
without prejudice because they did not take into account facts subsequently deemed
established under Rule 91(f).
26
[*26] Both Mr. and Mrs. Bachner timely petitioned the Court. Both
“Edward Francis Bachner, IV” and “Rebecca Gay Bachner” are named
as petitioners on the first page of the Petition. Both Mr. and Mrs.
Bachner signed the Petition.
The IRS’s determination of fraud penalties, the mailing of the
notice of deficiency, and the timely filed Petition conferred jurisdiction
on the Court. Once the Court acquires jurisdiction, that jurisdiction
extends to the entire subject matter of the correct tax for the relevant
taxable year. § 6214(a); Naftel, 85 T.C. at 533. Likewise, under section
6512(b)(1), the Court has jurisdiction to determine an overpayment, and
to determine the amount of an overpayment.
Theoretically, if the Court determined an overpayment for any of
the tax years at issue, the amount of that overpayment would be
credited or refunded to the Bachners when the decision of the Tax Court
became final. See § 6512(b)(1). 12
We hold that the Court has jurisdiction as to Mrs. Bachner on the
basis of the issuance of a valid notice of deficiency that was timely
petitioned, thus giving the Court the theoretical ability to determine
that she, together with Mr. Bachner, made overpayments for the years
at issue. See §§ 6511(b)(2), 6512(b)(3).
E. Jurisdiction as to Mr. Bachner
The Bachners also argue that because the notice of deficiency is
supposedly invalid as to Mrs. Bachner, it is invalid as to Mr. Bachner.
First, we held supra OPINION, Part III.D, that the notice is valid as to
Mrs. Bachner. Second, even if the notice were invalid as to her, it would
remain valid as to him. In Baron, 71 T.C. at 1035, we held that although
a joint notice of deficiency was invalid as to the husband (because he was
bankrupt), it was valid as to his nonbankrupt wife, and thus the Court
had jurisdiction as to his wife, who filed a timely petition with the Court.
We explained:
Ruby [nonbankrupt wife] is a separate taxpayer, and she
received notice that [the Commissioner] had determined a
deficiency in her taxes. We find nothing that would
invalidate the notice of deficiency to Ruby or make it a
12 Although we have jurisdiction to determine that the Bachners made an
overpayment, see § 6512(b)(1), the record does not show that they made an
overpayment for any of the tax years at issue.
27
[*27] nullity. And since Ruby filed a petition in this Court for a
redetermination of that deficiency, this Court has
jurisdiction with respect to Ruby.
Id. Thus, even if the notice of deficiency were invalid as to Mrs. Bachner,
that would not force the conclusion that it is invalid as to Mr. Bachner.
We hold that the notice of deficiency is valid as to Mr. Bachner
and that we have jurisdiction as to Mr. Bachner.
IV. Section 6663 fraud penalties
Section 6663(a) provides: “If any part of any underpayment of tax
required to be shown on a return is due to fraud, there shall be added to
the tax an amount equal to 75 percent of the portion of the
underpayment which is attributable to fraud.” Section 7454(a) provides:
“In any proceeding involving the issue whether the petitioner has been
guilty of fraud with intent to evade tax, the burden of proof in respect of
such issue shall be upon the Secretary.” Rule 142(b) provides: “In any
case involving the issue of fraud with intent to evade tax, the burden of
proof in respect of that issue is on the respondent, and that burden of
proof is to be carried by clear and convincing evidence. See Code sec.
7454(a).” Section 6663(b) provides that if the IRS “establishes that any
portion of an underpayment is attributable to fraud, the entire
underpayment shall be treated as attributable to fraud, except with
respect to any portion of the underpayment which the taxpayer
establishes (by a preponderance of the evidence) is not attributable to
fraud.”
To satisfy the burden of proof for fraud that is imposed by section
7454(a) and Rule 142(b), the IRS must prove by clear and convincing
evidence that “an underpayment exists for the years in issue and that
some portion of the underpayment is due to fraud.” Petzoldt v.
Commissioner, 92 T.C. 661, 699 (1989). The IRS need not prove the
amount of the underpayment by clear and convincing evidence. Zack v.
Commissioner, 692 F.2d 28 (6th Cir. 1982); DiLeo v. Commissioner, 96
T.C. 858, 873 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992); Shaw v.
Commissioner, 27 T.C. 561, 570 (1956), aff’d, 252 F.2d 681 (6th Cir.
1958).
If the IRS proves by clear and convincing evidence that a portion
of the underpayment is due to fraud, the total amount of the
underpayment for the year is then determined under the ordinary
burden-of-proof rules. Zack v. Commissioner, 692 F.2d at 29.
28
[*28] Ordinarily, the determination of the amount of the underpayment
in the notice of deficiency is presumed correct, 13 and therefore the
taxpayer has the burden of proving that amount is incorrect. Rule
142(a); Helvering v. Taylor, 293 U.S. 507, 515 (1935); Welch v. Helvering,
290 U.S. 111, 115 (1933). This burden is satisfied by a preponderance
of evidence. Freeman v. Commissioner, 33 T.C. 323, 328 (1959).
Furthermore, if the IRS proves by clear and convincing evidence
that a portion of the underpayment is due to fraud, then the entire
underpayment is treated as attributable to fraud, except with respect to
any portion of the underpayment which the taxpayer establishes by a
preponderance of the evidence is not attributable to fraud. § 6663(b).
The courts have recognized that certain factors are indicators of
fraud. These factors include substantially understating income for
several years, engaging in illegal activities, and filing false documents.
Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992); Smith v.
Commissioner, 91 T.C. 1049, 1052, 1059–60 (1988), aff’d, 926 F.2d 1470(6th Cir. 1991); Recklitis v. Commissioner, 91 T.C. 874, 910 (1988); see
also Feller, 135 T.C. at 502. In determining the existence of fraud, the
taxpayer’s entire course of conduct may be considered. Stone v.
Commissioner, 56 T.C. 213, 223–24 (1971); Otsuki v. Commissioner, 53
T.C. 96, 105–06 (1969).
In the case of a joint return, the fraud penalty “shall not apply
with respect to a spouse unless some part of the underpayment is due to
the fraud of such spouse.” § 6663(c). In other words, the fraudulent
intent of one spouse is not imputed to the other. See Stone, 56 T.C. at227–28; Norris v. Commissioner, T.C. Memo. 2011-161, slip op. at 20.
Under section 6751(b), the fraud penalty must be approved in
writing by the immediate supervisor of the IRS employee who initially
determined to impose the penalty. See § 7491(c); Clay v. Commissioner,
152 T.C. 223, 248–50 (2019), aff’d, 990 F.3d 1296 (11th Cir. 2021); Graev
v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and
overruling in part 147 T.C. 460 (2016). The written approval of the
initial penalty determination must be obtained before the proposed
penalty is first formally communicated to the taxpayer in writing. Frost
v. Commissioner, 154 T.C. 23, 32–35 (2020); Clay, 152 T.C. at 248–50;
see also Graev, 149 T.C. at 493. In this case the IRS satisfied the section
13 However, the presumption of correctness will not attach if the IRS fails to
produce any evidence linking the taxpayer with income-producing activity. Pittman v.
Commissioner, 100 F.3d 1308, 1313 (7th Cir. 1996), aff’g T.C. Memo. 1995-243.
29
[*29] 6751(b) procedural requirements for imposing section 6663 fraud
penalties. Supervisory approval must occur before the first formal
communication of the penalty to the taxpayer. Clay, 152 T.C. at 248–
50. The date of supervisory approval of the section 6663 fraud penalties
was August 1, 2013. The supervisory approval took place before the
sending of the 90-day letter, which was a formal communication of the
penalty to the Bachners. The supervisory approval also took place
before the sending of the 30-day letter, which may or may not have been
a formal communication of the penalty to the Bachners. The 30-day
letter is not in the record. With the possible exception of the 30-day
letter, there is no evidence that the IRS made a formal communication
of the penalty to the Bachners before the 90-day letter. Thus, the IRS
has satisfied section 6751(b).
We must still resolve the Bachners’ challenge to the
determinations in the notice of deficiency that they had underpayments
of $110,503 for 2005, $219,561 for 2006, and $195,012 for 2007 and that
the underpayments were due to fraud. 14
A. 2005The IRS proved by clear and convincing evidence that the 2005
return was incorrect in reporting that Rosetta-Wireless Corp. withheld
$228,970 of federal income tax from Mr. Bachner’s wages, thus
establishing by clear and convincing evidence that there was an
underpayment for the year. The return’s claim (that $228,970 was
withheld) reflected the same amount stated on the Form W–2 allegedly
issued by Rosetta-Wireless Corp. to Mr. Bachner. Paragraph 26 of the
deemed stipulations states that this Form W–2 was fake. Therefore,
there was an underpayment for 2005 related to this fake Form W–2.
The IRS proved by clear and convincing evidence that this
misreporting was due to fraud. The function and effect of the fake Form
14 The doctrine of collateral estoppel (sometimes referred to as issue
preclusion), which prevents the relitigation of an issue that has been previously
litigated between the parties and later recurs in other litigation between the parties,
Koprowski v. Commissioner, 138 T.C. 54, 60 (2012), is inapplicable in this case.
Although Mr. Bachner pleaded guilty to making a false claim to the IRS, in violation
of 18 U.S.C. § 287, for the 2005 return, he is not collaterally estopped from litigating
the fraud penalties because intent to evade tax is an element of liability for civil tax
fraud but is not an element of the crime of making a false claim to the United States.
Compare 18 U.S.C. § 287, with § 6663. Therefore, while Mr. Bachner’s guilty plea and
underlying conduct may be relevant to fraudulent intent, he is not precluded from
litigating the fraud penalties under section 6663 in this case.
30
[*30] W–2 was to convince the IRS that taxes had been overwithheld
from Mr. Bachner’s wages. Mr. Bachner falsified this Form W–2,
purportedly issued by Rosetta-Wireless Corp., and attached the fake
Form W–2 to the Form 1040 for 2005. On the Form 1040, Mr. Bachner
requested a tax refund of $111,246 based on $228,970 (the withholding
claimed on the fake Form W–2) and $5,074 that was actually withheld
from Mrs. Bachner’s wages. Filing this false Form W–2 demonstrates
that the withholding claim on the return was fraudulent. See Feller, 135
T.C. at 502 (stating that filing false documents is an indicator of fraud);
Recklitis, 91 T.C. at 910 (same). That Mr. Bachner continued to use the
same ploy involving fake Forms W–2 over the next two years also
demonstrates that the 2005 return’s claim of withholding was
fraudulent. See Stone, 56 T.C. at 223–24 (stating that a taxpayer’s
entire course of conduct can be an indicator of fraud); Otsuki, 53 T.C.
at 105–06 (same). As part of his criminal case, Mr. Bachner pleaded
guilty to making a false claim on the federal Government through the
filing of the 2005 return. This also indicates fraud.
The IRS determined that the total underpayment for 2005 was
$110,503. The alleged errors on the return giving rise to this
underpayment can be divided into four types.
The first type is the reporting of federal income tax withholding
by Rosetta-Wireless Corp., which was related to reporting that Rosetta-
Wireless Corp. paid a fictitious amount of wages to Mr. Bachner. We
have held that the IRS proved this type of error by clear and convincing
evidence.
The second type is failing to report wages of $2,769 and
withholding of $237 from New England Life Insurance Co. and wages of
$22,174 and withholding of $1,588 from Adminstaff Cos. II, L.P. That
the return erred in this regard is established by paragraphs 20, 21, 22,
and 27 of the deemed stipulations.
The third type is failing to report wages of $19,331 from
Metropolitan Life Insurance Co. and withholding of $3,368,
unemployment compensation, nonemployee compensation, a state
income tax refund, stock sale proceeds, interest, long-term capital gains,
ordinary dividends, and qualified dividends. That the return erred in
this regard is established by a preponderance of the evidence in the form
of IRS records of third-party reporting, which are Exhibits 6-J and 7-J.
31
[*31] The fourth type is improperly claiming itemized deductions for
state income taxes, real estate taxes, home mortgage interest,
unreimbursed employee expenses, tax preparation fees, and
miscellaneous other expenses. For this type of error, there is no evidence
in the record regarding whether the return was correct. Therefore, the
Bachners have failed to disprove the notice of deficiency’s determination
of these errors by a preponderance of the evidence.
The Bachners have not proven by a preponderance of the evidence
that the underpayment for 2005 is less than that determined in the
notice of deficiency. We accordingly hold that the Bachners have an
underpayment of tax of $110,503 for the tax year 2005. See Rule 142(a);
Helvering v. Taylor, 293 U.S. at 515; Welch v. Helvering, 290 U.S. at 115;
Freeman, 33 T.C. at 328. For the tax year 2005 Mr. Bachner has not
established by a preponderance of the evidence that any portion of the
underpayment was not attributable to fraud.
Therefore, Mr. Bachner is liable for the section 6663 fraud penalty
for the entire underpayment for 2005. See § 6663; Zack v.
Commissioner, 692 F.2d at 29; DiLeo, 96 T.C. at 873; Freeman, 33 T.C.
at 328.
B. 2006
The IRS proved by clear and convincing evidence that the 2006
return was incorrect in reporting that EB Strategic Research, LLC,
withheld $500,000 of federal income tax from Mr. Bachner’s wages, thus
establishing there was an underpayment for the year. The return’s
claim (that $500,000 was withheld) reflected the same amount stated on
the Form W–2 allegedly issued by EB Strategic Research, LLC, to Mr.
Bachner. Paragraph 41 of the deemed stipulations states that this Form
W–2 was fake. Therefore, there was an underpayment for 2006 related
to this fake Form W–2.
The IRS proved by clear and convincing evidence that this
misreporting was due to fraud. The function and effect of the fake Form
W–2 was to convince the IRS that taxes had been overwithheld from Mr.
Bachner’s wages. Mr. Bachner falsified this Form W–2, purportedly
issued by EB Strategic Research, LLC, and attached the fake Form W–2
to the Form 1040 for 2006. On the Form 1040, Mr. Bachner requested
a tax refund of $224,377 based on $500,000 (the withholding claimed on
the fake Form W–2) and $9,469 that was actually withheld from Mrs.
Bachner’s wages. Filing this false Form W–2 demonstrates that the
32
[*32] return’s claim of withholding was fraudulent. See Feller, 135 T.C.
at 502 (stating that filing false documents is an indicator of fraud);
Recklitis, 91 T.C. at 910 (same). Mr. Bachner’s use of the same ploy
involving fake Forms W–2 over three tax years (2005–07) also
demonstrates that the 2006 return’s claim of withholding was
fraudulent. See Stone, 56 T.C. at 223–24 (stating that taxpayer’s entire
course of conduct can be an indicator of fraud); Otsuki, 53 T.C. at 105–
06 (same). As part of his plea agreement, Mr. Bachner admitted that he
knew the report of withholding was false. This also indicates fraud.
The IRS determined that the total underpayment for 2006 was
$219,561. The alleged errors on the return giving rise to this
underpayment can be divided into five types.
The first type was the report of federal income tax withholding by
EB Strategic Research, LLC, which was related to a reporting that EB
Strategic Research, LLC, paid a fictitious amount of wages to Mr.
Bachner. We have held that the IRS proved this type of error by clear
and convincing evidence.
The second type is the underreporting of other wages. As to the
underreporting of other wages, the notice of deficiency determined that
Mr. Bachner failed to report wages of $9,230 and withholding of $712
from New England Life Insurance Co. That the return erred in this
regard is established by paragraphs 35, 36, and 40 of the deemed
stipulations.
The third type is underreporting of interest income. The notice of
deficiency determined that Mr. Bachner failed to report $12 of interest
income from Bank of America. That the return erred in this regard is
established by a preponderance of the evidence in the form of bank
statements admitted at trial as Exhibit 27-R and IRS records of third-
party reporting, which is Exhibit 11-J.
The fourth type is failing to report a state income tax refund,
stock sale proceeds, interest, long-term capital gains, ordinary
dividends, and qualified dividends. That the return erred in this regard
is established by a preponderance of the evidence in the form of IRS
records of third-party reporting, which are Exhibits 11-J and 12-J.
The fifth type is improperly claiming itemized deductions for
state income taxes, real estate taxes, home mortgage interest, and
unreimbursed employee expenses. For this type of error there is no
evidence in the record regarding whether the return was correct.
33
[*33] Therefore, the Bachners have failed to disprove the notice of
deficiency’s determination of these errors by a preponderance of the
evidence.
The Bachners have not proven by a preponderance of the evidence
that the underpayment for 2006 is less than that determined in the
notice of deficiency. We accordingly hold that the Bachners have an
underpayment of tax of $219,561 for the tax year 2006. See Rule 142(a);
Helvering v. Taylor, 293 U.S. at 515; Welch v. Helvering, 290 U.S. at 115;
Freeman, 33 T.C. at 328.
For the tax year 2006, Mr. Bachner has not established by a
preponderance of the evidence that any portion of the underpayment
was not attributable to fraud.
Therefore, Mr. Bachner is liable for the section 6663 fraud penalty
for the entire underpayment for 2006. See § 6663; Zack v.
Commissioner, 692 F.2d at 29; DiLeo, 96 T.C. at 873; Freeman, 33 T.C.
at 328.
C. 2007
The IRS proved by clear and convincing evidence that the 2007
return was incorrect in reporting that Fusion Marketing, LLC, withheld
$455,000 of federal income tax from Mr. Bachner’s wages, thus
establishing by clear and convincing evidence there was an
underpayment for the year. The return’s claim (that $455,000 was
withheld) reflected the same amount stated on the Form W–2 allegedly
issued by Fusion Marketing, LLC, to Mr. Bachner. Paragraph 59 of the
deemed stipulations states that this Form W–2 was fake. Therefore,
there was an underpayment for 2007 related to this fake Form W–2.
The IRS proved by clear and convincing evidence that this
misreporting was due to fraud. The function and effect of the fake Form
W–2 was to convince the IRS that taxes had been overwithheld from Mr.
Bachner’s wages. Mr. Bachner falsified this Form W–2, purportedly
issued by Fusion Marketing, LLC, and attached the fake Form W–2 to
the Form 1040 for 2007. On the Form 1040, Mr. Bachner requested a
tax refund of $202,751 based on $455,000 (the withholding claimed on
the fake Form W–2) and $11,435 that was actually withheld from Mrs.
Bachner’s wages. Filing this false Form W–2 demonstrates that the
return’s claim of withholding was fraudulent. See Feller, 135 T.C. at 502(stating that filing false documents is an indicator of fraud); Recklitis,
91 T.C. at 910 (same). Mr. Bachner’s use of the same ploy involving fake
34
[*34] Forms W–2 over three tax years (2005–07) also demonstrates that
the 2007 return’s claim of withholding was fraudulent. See Stone, 56
T.C. at 223–24 (stating that taxpayer’s entire course of conduct can be
an indicator of fraud); Otsuki, 53 T.C. at 105–06 (same). As part of his
plea agreement, Mr. Bachner admitted that he knew the report of
withholding was false. This also indicates fraud.
The IRS determined that the total underpayment for 2007 was
$195,012. The alleged errors on the return giving rise to this
underpayment can be divided into five types.
The first type was the report of federal income tax withholding by
Fusion Marketing, LLC, which was related to a reporting that Fusion
Marketing, LLC, paid a fictitious amount of wages to Mr. Bachner. We
have held that the IRS proved this type of error by clear and convincing
evidence.
The second type is the underreporting of other wages. The notice
of deficiency determined that Mr. Bachner failed to report wages of
$1,800 and withholding of $57. 15 That the return erred in this regard is
established by paragraphs 51, 52, and 58, of the deemed stipulations.
The third type is underreporting of interest income. The notice of
deficiency determined that Mr. Bachner failed to report $70 of interest
income from Bank of America. That the return erred in this regard is
established by a preponderance of the evidence in the form of bank
statements admitted at trial as Exhibit 27-R and IRS records of third-
party reporting, which is Exhibit 17-J.
The fourth type is failing to report interest, long-term capital
gains, ordinary dividends, and qualified dividends. That the return
erred in this regard is established by a preponderance of the evidence in
15 According to the stipulations and Exhibit 18-J, a wage and income transcript
for Mr. Bachner for 2007, Mr. Bachner earned the $1,800 of wages from Embarq Corp.
However, Exhibit 17-J, also a wage and income transcript for Mr. Bachner for 2007,
states that Mr. Bachner earned these wages from Rosetta-Wireless Corp. In its
opening brief, the IRS states that although the stipulations show that Mr. Bachner
earned this income from Embarq Corp., Mr. Bachner, in fact, earned the income from
Rosetta-Wireless Corp. The IRS explains that Exhibit 18-J, which “refers to Embarq
Corporation” shows only “summary” information and that Exhibit 17-J, which shows
Rosetta-Wireless Corp. as the payor, should be relied upon. Because the stipulations
and Exhibits 17-J and 18-J establish that Mr. Bachner failed to report wages of $1,800
and withholding of $57, it does not matter for the purposes of this Opinion whether
Embarq Corp. or Rosetta-Wireless Corp. was the employer.
35
[*35] the form of IRS records of third-party reporting, which is Exhibit
17-J.
The fifth type is improperly claiming itemized deductions for
state income taxes, for real estate taxes, home mortgage interest, and
unreimbursed employee expenses. For this type of error, there is no
evidence in the record regarding whether the return was correct.
Therefore, the Bachners have failed to disprove the notice of deficiency’s
determination of these errors by a preponderance of the evidence.
The Bachners have not proven by a preponderance of the evidence
that the underpayment for 2007 is less than that determined in the
notice of deficiency. We accordingly hold that the Bachners have an
underpayment of tax of $195,012 for the tax year 2007. See Rule 142(a);
Helvering v. Taylor, 293 U.S. at 515; Welch v. Helvering, 290 U.S. at 115;
Freeman, 33 T.C. at 328.
For the tax year 2007, Mr. Bachner has not established by a
preponderance of the evidence that any portion of the underpayment
was not attributable to fraud.
Therefore, Mr. Bachner is liable for a section 6663 fraud penalty
for the entire underpayment for 2007. See § 6663; Zack v.
Commissioner, 692 F.2d at 29; DiLeo, 96 T.C. at 873; Freeman, 33 T.C.
at 328.
V. Conclusion
We have considered all of the parties’ arguments, and, to the
extent not addressed herein, we conclude that they are moot, irrelevant,
or without merit.
To reflect the foregoing,
Decision will be entered that there are section 6663 penalties due
from petitioner Edward Francis Bachner, IV of $82,877 for 2005,
$164,671 for 2006, and $146,259 for 2007; and there are no overpayments
due to petitioners Edward Francis Bachner, IV and Rebecca Gay
Bachner for 2005, 2006, and 2007.