Tax Court Rejects Frivolous Filing Penalty for Taxpayer Invoking the Fifth Amendment in Tax Return

On November 6, 2015, the United States Tax Court issued its opinion in Youssefzadeh v. Commisioner, Docket No. 14868-14L, in which it held that the taxpayer was not subject to the penalties for filing a frivolous tax return where the taxpayer omitted certain information on Schedule B, while reporting the total amount of interest, under a claim of the 5th Amendment right against self incrimination in relation to unfiled FBARs.  The case arose from a CDP hearing and was resolved on summary judgment.  The case is identified as non-precedential except as provided in Tax Court Rule 50(f).

In order for frivolous return penalties to apply three criterion must be met.  First, the document must purport to be a tax return.  Second, the return must either appear to be substantially incorrect or omit enough information from the return for the IRS to be prevented from judging the substantial correctness of the self-assessment.  Third, the position must either be frivolous or demonstrate the desire to impede the IRS’s administration of the tax laws.

The Court found that IRS failed to meet the second criterion because the return was still substantially correct, noting that the taxpayer redacted only the source of one payer of interest and included to the total amount of interest.  The Court also found that the IRS failed to meet the second test because frivolous assertion of the 5th Amendment applied only to “blanket assertions” as a basis for not providing any financial information.

Finally, the Court rebuked the IRS’s over-zealousness in asserting the penalty, stating, “The Commissioner’s assertion without further analysis that a claim of the Fifth Amendment privilege on a return must in all cases be frivolous is simply wrong.”  After a thorough analysis of the standard for a valid assertion of the Fifth Amendment (which is worth adding to any tax attorney’s repertoire, if she hasn’t already), the Court found that, “[b]ecause the lines that Youssefzadeh redacted ask for information that triggers the duty to file an FBAR, and because willful failure to file an FBAR is a crime, we hold that Youssefzadeh has shown us a real and appreciable danger of self-incrimination by being compelled to answer the questions on Section B.”

Each case is different, of course, and this very limited holding would not apply to all taxpayers (and this taxpayer’s approach should really never be taken without the advice and support of a competent tax attorney, in my opinion), but this was a serious blow to the IRS.

Daniel Layton, the author of this post, is the principal of Tax Attorney OC.  He is a former IRS attorney and former federal prosecutor.