Summer 2007 • Issue 25, page 10

Receivers: The IRS Wants You…To Do Its Job For It and Then Some!

By Rosen, Charles*

“Regrettably - and technically - a receiver is generally responsible for preparing and filing all current and prior unfiled returns for a taxpayer” C. Rosen, 2007

Caveat [Latin for “watch out!” - Ed.]: The following tax questions have been submitted to me for response. My answers are generic. Real life situations may dictate variations from the answers, depending upon all of the facts.

Q: A receiver is appointed for a company that has just ceased operations. The appointment was in the middle of the company’s fiscal year. The defendant destroyed all of the accounting records on the eve of the appointment. The receiver recovers $500,000 for the benefit of creditors. Without prior accounting records how does the receiver prepare a corporate tax return for the current fiscal year? Should the Receiver just file a receiver’s informational return for the period from the date of appointment forward?

A: A motivated receiver almost always has some way to reconstruct the taxpayer’s tax related information. It may take time, patience, a great deal of money and a good forensic accountant, but most of the time it can be done. However, since the records are likely to be incomplete, it is always recommended that a separate statement be appended to any tax or information return to make it clear that each return has been prepared using the best available information, and explaining (a) why the delay in filing the return, (b) what/how records were destroyed or otherwise made unavailable, and (c) what steps were taken to identify and use information to reconstruct the records.
That having been said, what can a receiver do to locate taxpayer related information? Here are a few possible sources of initial information. Some of these will likely lead to other sources of income and/or expenses.

  1. Order a copy of the last IRS income or information (i.e. partnership, LLC, 1120S, etc.) return that was actually filed.

  2. Locate the bank(s) or other accounts that were used by the business:

    Ask the landlord, mortgage company or auto lender for last payment information (plus information from loan applications). On what account was the payment written? If real property is owned, contact the county assessor to get a copy of the check used for the last tax payment (most of the payments are microfilmed or scanned) - to get the bank name and account number. If there is a personal property tax responsibility, do the same for that last tax payment.

  3. If real property was owned in California, pull a copy of the actual transfer deed to the taxpayer and determine the purchase price by taking the dollar amount of tax stamps on the deed, divide by $1.10 and multiply by $1000. This will give you a starting point for the taxpayer’s original basis in the property, especially if it has been sold or is to be sold by the receiver. Also locate from the county recorder or a title company a copy of any/all deeds of trust recorded immediately after the transfer deed was filed. This will give you a start on other costs incurred at the time of purchase and help determine the adjusted basis in the property.

  4. If records were kept via computer, determine if they were kept on some third party’s mainframe, if not on the taxpayer’s own computer, especially if a proprietary bookkeeping system was used other than QuickBooks, Quicken or a similar program. See if there were back-up discs kept, even if for prior periods of time.

  5. Pull a credit report on the taxpayer either from Experian, TransUnion, Equifax, Choicepointe, Dunn & Bradstreet, etc. and identify other potential leads for income and expense information.

  6. If a corporation, LLC or partnership, check the California Secretary of State’s web site for the name and address of the agent for service of process as it might be someone other than the bad actor in this drama.

  7. Contact the Better Business Bureau, local chamber of commerce, competitors, and/or neighbors as they may also have helpful information.

  8. An ex-spouse of the principal of a defendant is quite often a good source of information. Hate can be a wonderful and useful tool. [Ed. Note: You can tell Chuck used to work for the IRS can’t you!]

Once all of these sources and others have been surveyed, you can start to secure original source documents to help rebuild the taxpayer’s financial records. In today’s day and age it is very difficult to destroy all records. There should be some evidence of an audit trail that can be followed. And yes, I realize that available funds may limit the search, but a conscientious receiver will try, within fiscal reason, to do as much as possible to justify the returns that are to be prepared and thus avoid later potential tax audit pitfalls.

Q: Is a regulatory receiver who takes over a defunct (or about to become defunct) operation that was committing fraud required to file a tax return?

A: Yes, there is no difference in responsibilities with respect to the filing and paying of current tax liabilities of the receivership and preparing, filing and paying past tax returns and liabilities of the defendant. It might be tougher to validate information to be included on a return, but it might also be very possible to do it. (It may also be incumbent on the receiver to prepare and file amended returns for prior tax years to correct erroneous or fraudulently filed returns. Sometimes this is necessary if it is believed there are net loss carryforwards that a receiver can use for later years.)

Q: What is the liability of a receiver who fails to file a final tax return if there are no taxes due.

A: Technically, nothing would likely happen to the receiver if the tax is zero. However, if a final return is not filed how does the I.R.S. know that the tax return will have no tax due? Most experienced personnel with the Service know that if they receive a letter or a telephone call and are informed the return is unfiled, but that no tax will be due, they will simply program the IRS computer that no return is due. Insolvency situations normally do not generate income that would be taxable. Want a shortcut? If the entity will be completely defunct after the receivership ends, take a copy of the most recent notice from the IRS demanding the unfiled return and draw a thick line diagonally across the notice; and with a felt pen or red pen mark it ATC 591 - no longer liable, then sign and date it including the title or position of the signer, and mail it back to the address on the notice. That will be that. If, on the other hand it is not clear whether the taxpayer entity will continue to exist after the receivership, do the same as above for a no tax due return, but mark it ATC 590 - not liable for this tax period only. Call it magic, if you will, but this usually works.

Many employees at the IRS and the state taxing agencies are cognizant of the difficulties faced by a receiver in preparing tax returns or even in having funds from which such returns can be prepared. Some personnel are not as knowledgeable. Regrettably - and technically - a receiver is generally responsible for preparing and filing all current and prior unfiled returns for a taxpayer. There are some exceptions. First, the receiver is only responsible for filing returns if the receiver has custody or control over all - or substantially all - of the taxpayer’s assets. If the receiver does not have control over the assets, then the receiver has to make the records available to the defendant-taxpayer so they can prepare the returns. My recommendation: Send a certified mail letter, return receipt requested, to the individual responsible for the taxpayer entity and to counsel, making the records available for review. If the offer is accepted, allow full and unfettered access to the records, no matter how voluminous, but keep an eagle-eye on the taxpayer during access to the records, and don’t let anyone take anything except copies. Be prepared to document that access was granted and obtained by the taxpayer.

Q: A receiver discovers that a company has been defrauding the taxing authorities for years by under-reporting income. What are the Receiver’s responsibilities: do nothing; inform the proper taxing agencies; prepare and file amended returns; or file informational returns for the tax periods of the Receivership?

A: A receiver is an officer of the court that appointed him/her. Unlike an attorney who is an officer of the court and who is supposed to zealously represent his client (hopefully without lies or deceit - but not so sure even that is required under the ABA’s Canon of Ethics), the receiver is to do the right thing. Therefore, a receiver is charged with filing accurate returns. Accordingly, the receiver should review previously filed income tax returns and if they are found to be grossly erroneous, the receiver should have amended returns prepared and filed.

Keep in mind that if income is under-reported on a return by 25% or more, the Internal Revenue Code holds that it is the same thing as not having filed a tax return. Normally, the IRS will only require returns or amended returns for the immediate three years past, since this is the normal maximum time frame for which an audit would be conducted. However, if it is determined that fraud was involved, the IRS may and often does extend an audit to include a total of six years. The same is true for grossly under-reported payroll tax liabilities. Further, for either under-reported income or payroll tax liabilities if fraud is found, the Service may seek a Federal criminal indictment of the offending parties, but this should not be the concern of the receiver unless he/she continues to perpetuate the scam. Also keep in mind that under the Federal sentencing guidelines a convicted person will serve significant prison time. Times have changed. It’s not as it was, where a very light or suspended sentence was often given.

*Charles F. Rosen is an attorney with the firm Law Offices of A. Lavar Taylor and is an expert in receivership and bankruptcy tax law. Mr. Rosen served as bankruptcy advisor for the Special Procedures Branch of the Internal Revenue Service for more than twenty years.