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Is the IRS playing hardball during its tax audits?

A recent federal court ruling in favor of the IRS should send a cautionary note to both individual and business taxpayers alike.

Two former top executives at Sprint Corp. brought the case, seeking $159.4 million in damages against the IRS. The individuals had been under investigation by IRS officials for an alleged tax shelter. When the individuals disclosed to their company that they were involved in a tax audit, however, they lost their jobs.

The IRS disputed whether the executives had lawfully protected certain stock options from capital gains taxes. Yet the executives claimed the IRS had used deceit and misrepresentation during the audit. In particular, the executives claimed that IRS officials had collaborated with their tax advisor, Ernst & Young, in undermining their ability to mount a defense.

The executives had purchased the tax shelters from Ernst & Young. However, they claimed that the IRS helped the accounting company hide certain information about previous criminal and civil probes into the shelters, leaving the executives unable to justify their behavior to their board. Notably, Ernst & Young agreed to a $123 million settlement with the IRS several years later over the criminal probe.

As a matter of law, the IRS generally has immunity against legal claims brought by taxpayers, save for a few exceptions to that sovereign immunity. However, immunity might be waived if an IRS employee committed an unlawful act while acting within the scope of his or her employment. Alternatively, if an IRS employee’s wrongdoing was outside the scope of employment, he or she might face individual liability. In our next post, we apply these theories to the executives' story.

Source: Reuters, “IRS beats ex-Sprint CEO, COO lawsuit over tax shelter scandal,” Jonathan Stempel, March 23, 2017

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