In a merciful opinion written by retired Supreme Court Associate Justice Sandra Day O’Conner (sitting by designation pursuant to 28 USC §294(a)), the US Court of Appeals for the 11th Circuit ruled that Abelardo Ernest Cruz should not be prohibited from preparing tax returns as a penalty for his participation in a fraudulent tax return preparation scheme. The IRS proved that Cruz and others intentionally overstated deductions and credits on tax returns they prepared in order to increase refunds for their customers.
The Internal Revenue Code, at 26 USC §7407, permits a Federal District Court to prohibit a tax return preparer from taking an unreasonable position on future tax returns. If the court determines that the tax preparer has repeatedly engaged in fraudulent conduct and that an order enjoining the prohibited conduct is not sufficient to encourage compliance with the tax laws, it can impose what amounts to a business death penalty. The court, in appropriate circumstances, can terminate the tax preparation business “with extreme prejudice” and prohibit the offender from acting as a paid tax return preparer again.
The District Court where trial was held found that defendants had changed procedures, had taken steps to improve quality control and had begun requiring each of their clients to verify that their returns were prepared with the information the client provided. The District Court concluded that these changes went beyond procedures followed by most tax return preparers. For these reasons, the judge felt that it was sufficient remedy to impose a more limited penalty by simply prohibiting the defendants from continuing to take unreasonable positions on tax returns.
It is important to note that the IRS appealed the decision of the District Court and asked the Court of Appeals to impose a more severe penalty. This action was taken in spite of the fact that the that it appeared the defendants had mended their ways. The IRS argued that defendants knew or should have known the claimed deductions were unreasonable. Consequently, they felt no amount of education, training or change in procedure could reform a dishonest tax practitioner.