A taxpayer victory this spring in a captive insurance dispute involving promoter penalties shows that despite the IRS’s willingness to litigate such cases, the government won’t automatically be successful—particularly in terms of its burden to establish taxpayer knowledge in these cases.
Although a jury determined the April outcome in Ankner v. U.S. based on fact, rather than a judge ruling on matters of law, the case highlights vulnerabilities in the government’s pursuit of Internal Revenue Code Section 6700 disputes—or disputes about penalties concerning alleged abusive tax shelters.
The jury’s findings, and an earlier ruling from the US Middle District Court for the District of Florida, indicate that if similar cases go to trial, the government likely will have to meet its burden of proof for all elements necessary to assess the so-called promoter penalty.
In these cases, although a taxpayer must file the case against the government for the allegedly erroneously assessed penalty, the government must show that the elements of the penalty are met.
Practitioners should be aware of two key evidentiary hurdles the government must establish. First, was there a false statement concerning the tax implications of the transaction under display? Second, did the supposed promoter who made the statement “know or have reason to know” that the statement was false?
Ankner involved a captive manager who assisted small businesses looking to create and operate small captive insurance companies that would qualify under Section 831(b). Rather than focusing on the statements directly relating to tax benefits, the government alleged the captives managed by an Ankner affiliate weren’t real insurance companies. Consequently, it argued that Ankner and the affiliates made false statements related to those insurance arrangements and the tax benefits associated with them.
After paying part of the assessment as permitted in these types of penalties, Ankner sued to contest the approximately $4 million in penalties assessed by the IRS related to tax years 2010 to 2016. The jury ultimately found that the government hadn’t carried its burden and that Ankner wasn’t liable for the penalty.
While there are many Section 6700 investigations under way involving captive managers, Ankner is the first case in this area to have gone to trial and serves as an example of how these cases should be handled.
Case Examples
Historically, litigated cases involving this tax penalty involved disputes brought by the government that primarily deal with egregious tax shelter transactions. In these cases, the government would focus on individuals blatantly promoting programs or arrangements focused on avoiding taxes, while seeking injunctions and pursuing applicable penalties.
A prime example is United States v. Schulz, a case out of the Northern District of New York involving a taxpayer creating two companies that instructed taxpayers how to avoid income taxes.
In the Schulz case, the court found in a summary judgment opinion that the taxpayer had formed two nonprofit organizations to market a nationwide tax-fraud and avoidance schemes to aid individuals to stop withholding, paying, and filing federal taxes. The taxpayer did this by providing misleading forms based on representations and legal positions previously rejected by the courts.
This fraud was so blatantly a tax shelter that after summary judgment, the only thing left to be decided was what income should be included when calculating the amount of the penalty.
Likewise in U.S. v. RaPower-3 LLC, a taxpayer was enjoined from promoting an abusive solar energy tax scheme that marketed solar technology that wasn’t and never would be capable of providing any sort of electrical power or other useful energy.
Yet the company generated millions of dollars from promoting the technology by leasing components through a multilevel marketing scheme and promising the component buyers favorable income tax consequences. Unsurprisingly, after a bench trial, the court found the taxpayer liable for Section 6700 penalties, a decision that was affirmed by the Tenth Circuit.
However, it can’t be ignored how ruinous such penalties can be to a business. For example, the US Court of Appeals for the Ninth Circuit affirmed the imposition of an $8.5 million Section 6700 penalty in August 2023 in Tarpey v. United States. Here, the Ninth Circuit affirmed the lower court’s decision that the penalized activities included the taxpayer’s entire timeshare-donation business as opposed to just the funds garnered from his false-statement appraisals.
Key Takeaways
Section 6700 of the tax code—which punishes individuals who promote tax shelters—is relatively broad and allows for penalties of up to 50% “of the gross income derived (or to be derived) from the activity involved.”
Because the penalty can be assessed against any business determined to be a promoter, and the penalty is often hefty and based on the IRS’s broad view about what to include when calculating the amount, the shift to inflict this penalty on industries suddenly disfavored by the government should give taxpayers and practitioners pause.
The Ankner case likely is a sign of things to come. The government will continue to use Section 6700 not just in captive insurance matters but also in any industry in which the IRS believes there is a conceivable case for tax shelter promotion.
Tax practitioners have already hypothesized that the IRS and its Office of Promoter Investigations will use Section 6700 penalties to thwart what the government views as the promotion of abusive employee retention credit claims. The ERC voluntary disclosure program further supports this prediction.
Yet, as demonstrated by Ankner, taxpayers in these industries can prevail when adequately prepared. Practitioners representing taxpayers in similar situations should work to shift the case from the merits of the underlying arrangement and instead keep the case properly focused on whether each element of Section 6700 has been met.
Practitioners can take some solace that the government holds the evidentiary burden in these matters, and that the Department of Justice has sometimes shown a willingness to negotiate in these disputes. But the government’s initiation of Section 6700 disputes will only increase as IRS resources increase.
The case is Ankner v. United States, M.D. Fla., No. 2:21-cv-00330.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Steven Miller is partner at Zerbe, Miller, Fingeret, Frank & Jadav and served as IRS acting commissioner.
Matthew Reddington is partner at Zerbe, Miller, Fingeret, Frank & Jadav and served as a senior attorney for the IRS’s Office of Chief Counsel.
Janine Campanaro is senior litigation attorney at Zerbe, Miller, Fingeret, Frank & Jadav.
The authors served as counsel in Ankner v. United States.
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