Tax Law Insights

Individuals who are the unfortunate subjects of federal criminal tax prosecution face prison terms, probation, fines, restrictions on travel and other punishment. Conviction of felony tax offenses results in certain Constitution rights being lost, such as the right to vote and bear arms.

As part of a conviction for federal criminal tax offenses, an individual will most likely also be sentenced to pay "restitution" to the federal government. Payment of restitution in a criminal tax case is designed to compensate the IRS for the loss caused by the defendant's wrongdoing.

In federal criminal tax cases, defendants are sentenced under the U.S. Sentencing Guidelines (now advisory and not mandatory). The sentence is based on the applicable "tax loss" to the Government resulting from the defendant's conduct. Any restitution award is based on the same tax-loss calculations that govern the defendant's sentencing under the Sentencing Guidelines. However, in determining the applicable "tax loss" under the Sentencing Guidelines, the Court will often use an estimate of the defendant's tax liability caused by his conduct because information often critical to determining a defendant's actual civil tax liability is not presented or made available to the Court at sentencing. Thus, any related restitution awarded to the Government by the Sentencing Court is also based on an estimate of tax liability, and is not determinative of the defendant's actual civil tax liability.

Procedurally, upon conviction and sentencing and where restitution is ordered, a criminal tax defendant must pay required restitution into the United States District Court. The United States Department of Justice monitors payment of restitution. Payment of restitution is often not paid at once by a defendant, but through payments over time. Once the District Court receives and processes criminal tax restitution payments, the District Court will then eventually transfer the restitution payments to the IRS. Here is where the problems can begin.

Beginning in 2010, Congress authorized the IRS to establish "restitution accounts" and to make related restitution-based assessments. These accounts were largely designed to be "holding accounts" for the IRS to accept restitution payments from the District Court and before the IRS made a civil tax assessment against a criminal tax defendant following criminal tax proceedings.

Following a criminal tax proceeding, the IRS will initiate a civil audit or examination of the defendant/taxpayer. A civil tax assessment will result, and be separately made by the IRS against the defendant/taxpayer, and also with civil penalties and interest due. Once the civil tax audit is completed and the assessment(s) are made, the IRS - in theory - should credit/transfer all restitution payments received and held by the IRS in its restitution accounts to the civil account assessments, and the restitution accounts - no longer needed - should of course then be closed. In practice, however, this has not been done by the IRS.

The IRS for years has taken the position that the restitution based assessments made for the restitution accounts are separate tax liabilities of a defendant/taxpayer, and which the IRS can separately collect, and to which it can also separately add penalties and interest. Where a defendant/taxpayer has made required restitution payments to the Government, and where the IRS has also assessed the following and related civil tax liabilities, this practice of the IRS is wrong. The restitution accounts should be closed, the defendant/taxpayer should receive full credit for all restitution payments made against the resulting civil tax assessments, and the IRS should not be allowed to separately charge penalties and interest on the restitution accounts.

In Klein V. United States, 149 T.C. No. 15 (2017) the United States Tax Court recently ruled that the IRS cannot separately assess penalties or interest on restitution accounts. However, the IRS is still administratively struggling with this decision, and all taxpayers may not be receiving the benefit of this decision now. The IRS also may not be properly crediting restitution payments to a taxpayer's civil assessment account. Where the IRS does not properly credit restitution payments to the taxpayer's civil assessment accounts, in addition to not reflecting the correct taxes being due, this can also result in the incorrect amount of interest (and certain penalties) being due on the civil assessment. Finally, the IRS is also making incorrect transfers and assessments on many restitution based accounts, and also civil accounts, resulting from criminal tax matters.

Criminal tax defendants face many daunting challenges in life after prosecution. Paying the correct tax should not one of them, and particularly where the individuals have paid the amount of restitution ordered by the court.