Taxation Expert witnessA Ninth Circuit Panel of Judges Reinhardt, Tashima, and Paez heard the appeal of several taxpayers from the United States Tax Court’s determination of their tax liabilities.

In 2007, the Taxpayer pled guilty to willfully making a false tax return for the year 2000 in violation of 26 U.S.C. § 7206(1). In his plea agreement, he admitted that he had under reported his income from a chain of retail shops that he co-owned with his parents from 1998 to 2000.

The federal government started the recovery process of the unpaid taxes from the Taxpayers by serving them with Notices of Deficiency in 2009. The Notices stated their tax deficiencies as calculated by an IRS Agent. The Agent used the net worth method, which is an indirect method of reconstructing unreported income used when reliable records are unavailable, along with the dash method—an assumption that cash levels remained constant over the period under examination.

The Taxpayers petitioned the Tax Court for redetermination of their deficiencies, and filed a motion in limine to preclude the IRS Agent from testifying as a taxation expert witness. The Tax Court denied the motion, ruling that the Agent could testify as a lay witness on the “details of the methodology [she] employed to determine unreported income (but not the validity of said methodology).” The IRS Agent then testified at trial as to how she used the net worth method to calculate the Taxpayers’ tax deficiencies.

Accepting the Agent’s calculations, the Tax Court found the Taxpayers collectively liable for more than $214,000 in unpaid taxes. In addition, the Tax Court found the Taxpayer individually liable for an additional $73,000 in unpaid taxes and roughly $215,000 in fraud penalties. The Taxpayers appealed the Tax Court’s determinations.

The Taxpayers first argued that because the expert’s testimony was based on her specialized knowledge of accounting, the Tax Court erred in allowing her to testify without requiring the government to disclose her as an expert witness. The Ninth Circuit held that even assuming the IRS Agent’s testimony was expert opinion, this argument failed because Taxpayers didn’t shown prejudice.

The Court went on to find that the admission of expert testimony not disclosed like the tax expert’s in this case was harmless error where the witness was “qualified to deliver the opinion testimony,” and the opposing party didn’t demonstrate “how or why the [outcome] would have been different if he had been given notice” of the witness’ testimony.

Here, the Taxpayers didn’t dispute that the IRS Agent’s education and experience qualified her to apply the net worth method—and they didn’t show that her methodology was unreliable, identify any flaws in her calculations that were overlooked at trial, or otherwise demonstrated that disclosing her as a taxation expert could’ve made a difference to the result of the case.

In addition, the Taxpayers also argued that the Tax Court erred in accepting the Agent’s calculations because those calculations failed to account for cash that they had in their possession at the end of 1997. The Panel noted that Holland v. United States (U.S. 1954) states that in calculating a tax deficiency using the net worth method, the Commissioner must establish “with reasonable certainty” a taxpayer’s opening net worth—which is his or her net worth at the beginning of the time period under review. If, as of that time, the taxpayer had “substantial cash on hand” that wasn’t accounted for in the calculations, the net worth method may yield an overestimate of the taxpayer’s unreported income because “the net worth increase shown by the Government[]” and attributed to unreported income “is in reality not an increase at all.”

The Taxpayers claimed that at the end of 1997 (the start of the time period under review), they were holding “a hoard of excess cash comprised of funds” from the shops’ operations. The Tax Court found there wasn’t any cash hoard and concluded that the tax expert’s opening net worth figure had been proven to a reasonable certainty.

Whether “the cash hoard” claimed by the Taxpayers was actually in existence presented a simple question of fact, which is reviewed for clear error. The Tax Court’s finding that there was no cash hoard was not clearly erroneous, the Ninth Circuit said. The only evidence in support of the existence of this alleged hoard of cash was the Taxpayer’s testimony, which the Tax Court didn’t find credible and wasn’t required to accept.

The Taxpayers further argued that the Commissioner’s estimate of their opening net worth wasn’t reasonable because the shops undisputedly had some amount of cash on hand for operations at the end of 1997, which the Agent didn’t account for when she assumed zero as the cash on hand data point in applying the dash method. However, the Court of Appeals explained that the dash method isn’t an assumption that the taxpayer had no cash…but instead an assumption that the taxpayer’s cash levels remained constant for the years under examination.

The fact that the Taxpayers had some cash at the end of 1997 wasn’t inconsistent with an assumption of constant cash levels in 1998, 1999, and 2000. As a result, it didn’t invalidate the expert’s use of the dash method.

The judgment of the Tax Court was affirmed.

 

 

Worth v. Commissioner of Internal Revenue, 2016 U.S. App. LEXIS 22928 (9th Cir.
December 21, 2016)