A taxpayer who wants to pursue a refund claim must “pay first and litigate later.” Flora v. United States, 375 U.S. 63, 75 (1958) (citations omitted). Some taxes, however, are divisible, including the trust fund recovery penalty imposed under Section 6672 of the Internal Revenue Code. Pstay v. United States, 442 F.2d 1154, 1159 (3d Cir. 1971). Because the trust fund recovery penalty is a divisible tax, the payment of a single assessment relating to a single employee is sufficient to create jurisdiction over a refund claim, and the government counterclaims for the balance.
Last week, the Court of Federal Claim considered an interesting argument over the full payment rule of Flora. The case involved a penalty assessed under Section 6707 of the Code for failure to register a tax shelter under Section 6111. Diversified Group, Inc. v. United States, 2015 U.S. Claims LEXIS 1101 (Fed. Claims Aug. 26, 2015). The taxpayers were a merchant banking firm, Diversified Group, and its principal, James Haber; they had arranged tax shelter transactions over a three year period, commencing in 1999. Diversified Group, 2015 U.S. Claims LEXIS 1101, slip op. at *1-*2. After a lengthy audit that commenced in 2002, Haber and his company were assessed with a penalty for failure to register a tax shelter; the penalty was 24.9 million dollars, which was one percent of the aggregate investment of each client in the shelter. The IRS then demanded payment in February 2014. Id., slip op. at *7-*9.
To pursue a refund claim, each of the taxpayers tendered one percent of a single client’s aggregate investment in a representative shelter transaction. Id., slip op. at *9-*10. The IRS denied the claims, noting that the amounts tendered were not sufficient. Id., slip op. at *10. Huber and his company then filed a refund action in the Court of Federal Claims.
The government responded with a motion to dismiss for lack of subject matter jurisdiction. The plaintiffs sought to treat the 24.9 million dollar as a divisible tax, arguing that “the court’s sole focus should be each of the 193 individual transactions within the tax shelter.” Id., slip op. at *18. The court rejected this argument, which it considered “novel.”
The taxpayers were apparently relying on two cases, Noske v. United States, 911 F.2d 133 (8th Cir. 1990), and Humphrey v. United States, 854 F. Supp. 2d 1301 (N.D. Ga. 2011), to support their contention that the penalty imposed upon them was divisible. In response, the government contended that the case involved a single penalty that was imposed based upon a single act: the failure to register a tax shelter. Id., slip op. at *19-*20.
The Court of Federal Claims began its analysis by considering the relevant statutory language, commencing with the requirement of Section 6111(a) that “any reportable transaction” be registered with the IRS. Id., slip op. at *22. Next the court examined the definition of “reportable transaction” and determined that it was applicable Id. (citing 26 U.S.C. § 6707A(c)(1) (2006)). Then the court considered the language of Section 6707 noting that a person who fails to register a “reportable transaction” or furnishes false or incomplete information is subject to “a penalty with respect to such return.” Id., slip op. at *23 (quoting 26 U.S.C. § 6707(a)).
In the court’s view, the language of Section 6707(a) imposed a single penalty; in contrast a divisible tax is one that “represents the aggregate of taxes due on multiple transactions.” Id., slip op. at *25 (quoting Rocovich v. United States, 933 F.2d 991, 995 (Fed. Cir. 1991)). After citing excise taxes and employment taxes as examples of a divisible tax, the court concluded that the penalty at issue was fundamentally different: the penalty was imposed for a single act, the failure to register the tax shelter, and “neither the number of clients that participated in the tax shelter nor the number of commercial steps necessary to accomplish that participation in the tax shelter triggers liability. . . .” Id., slip op. at *27-*28.
In another post, I will address the court’s treatment of the Noske and Humphrey opinions, which the taxpayers had relied upon to support their jurisdictional argument.