Musa v. Comm'r of Internal Revenue

• Decision Date: 26 April 2017
• Docket Number: No. 16-1841,16-1841
• Citation: 854 F.3d 934
• Parties: Alaa I. MUSA, Petitioner–Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

854 F.3d 934

Alaa I. MUSA, Petitioner–Appellant,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.

No. 16-1841

United States Court of Appeals, Seventh Circuit.

Argued January 12, 2017

Decided April 26, 2017

Timothy L. Baldwin, Attorney, Law Office of Timothy L. Baldwin, Ohioma Emil Ovbiagele, Attorney, JB Enterprises, S.C., Milwaukee, WI, for Petitioner–Appellant.

Ivan Clay Dale, Joan I. Oppenheimer, Attorneys, Department of Justice, Tax Division, Appellate Section, Gilbert Steven Rothenberg, Attorney, Department of Justice, Office of the Attorney General, Washington, DC, for Respondent–Appellee.

Before Bauer, Sykes, and Hamilton, Circuit Judges.

Hamilton, Circuit Judge.

The central issue in this appeal from the Tax Court is how to apply the "duty of consistency," an equitable tax doctrine analogous to judicial estoppel, which prevents a party from prevailing in a court proceeding by taking one position and then taking a contradictory position in a later case. See Kielmar v. Commissioner , 884 F.2d 959, 965 (7th Cir. 1989). The Tax Court correctly applied the duty of consistency in this case to prevent a taxpayer's unfair tactic to minimize the consequences of his fraud.

Appellant Alaa Musa owns and operates a restaurant in Milwaukee, Wisconsin. The Commissioner of Internal Revenue determined that Musa made numerous misrepresentations on his tax returns, including underreporting his federal income taxes by more than $500,000 for the years 2006 to 2010. Musa challenged this determination in the Tax Court. The Tax Court upheld the Commissioner's determination, including a civil fraud penalty. On appeal, Musa does not challenge the fraud finding. Instead, he makes arguments that are heavy on chutzpah but light on reasoning or any sense of basic fairness.

Musa's central argument is that after his fraud was discovered, the Commissioner should have allowed him additional deductions on his individual tax returns based on amended employment tax returns in which Musa had corrected earlier false underreporting of wages. He made these corrections, however, only after the statute of limitations had run on the Commissioner's ability to collect the correct amounts of employment taxes that Musa's amended returns admitted were due. Musa argues that the Tax Court mishandled this issue by permitting the Commissioner to amend his answer to add the affirmative defense of the duty of consistency under tax law, and then erred by granting partial summary judgment to the Commissioner on that defense. Musa also argues that the Tax Court erred by denying his request to recall a witness. Musa's claims are without merit. We affirm the decision of the Tax Court.

I. Factual and Procedural Background

A. Musa's Fraudulent Tax Filings

Musa opened his restaurant in 2005. He is the sole member of the limited liability company that owns and operates the restaurant. Since its early days, Musa's family members regularly worked as employees at the restaurant, and he paid them based on informal agreements. Musa did not report their wages to the company the restaurant hired to assist with payroll. The payroll company's services included withholding required taxes from employees' paychecks, issuing annual wage and tax statements to employees and the IRS, and filing Musa's quarterly employment tax returns.

Musa gave the payroll company his employees' information over the phone on a biweekly basis. He did not include any of his family members in the information that he provided between 2006 and 2008. He included only two of his family members during 2009 and 2010. Instead, Musa paid family employees in cash under the table and maintained no record of these payments. He also underreported the amount his staff received in tips.

At the same time, Musa was underreporting the restaurant's revenues on his individual tax returns and the restaurant's Wisconsin monthly sales tax returns for 2006 to 2008. He did this by lying to his then-accountant, J & M Accounting and Tax Services. Musa reported the restaurant's monthly sales over the phone to J & M. He gave the accounting firm in-accurate information and failed to disclose relevant banking information.

B. Investigation and Tax Court Proceedings

The IRS began to audit Musa in 2009. The examination started with Musa's 2007 income tax return, but soon expanded to include his returns from 2006 and 2008. A review of the bank statements for Musa and the restaurant revealed that the amount of credit card deposits in the restaurant's account exceeded the amount Musa reported on his income tax returns. The IRS considered pursuing criminal charges against Musa for his tax fraud but ultimately opted for only civil remedies.

While under audit, Musa hired accountant Charles Sturm to replace J & M. Sturm prepared returns for 2009 and 2010 and amended returns for 2006 to 2008. Musa signed the amended returns for 2006 and 2007 in October 2011.

On August 21, 2012, the IRS sent Musa a Notice of Deficiency for tax years 2006 to 2010. Musa then petitioned the Tax Court for a redetermination of his tax deficiency. He challenged many aspects of the deficiency notice, including the Commissioner's determination that his underpayment was due to fraud. On September 23, 2013, Musa responded to the Commissioner's discovery request and provided a spread-sheet listing employees who he claimed had been paid additional wages but who were not previously included in the restaurant's wage statements. Over the next few months, the restaurant submitted amended wage and tax statements, as well as amended quarterly employment tax returns for 2006 to 2010. Based on these amended returns, Musa sought additional deductions from his income tax liabilities. On the amended forms for 2007 and 2010, Musa claimed that he first learned about these errors on May 2, 2012. Musa provided copies of these amended statements to the Commissioner on January 10, 2014.

Contrary to Musa's arguments on appeal, the Commissioner responded promptly to Musa's tactic. Just a month later in a conference call with the Tax Court and Musa, the Commissioner raised the affirmative defense of the duty of consistency. He argued that the doctrine prevents Musa from claiming new expense deductions on his income tax returns for wages paid between 2006 and 2009 because the IRS had relied on those representations and because the period for assessing employment taxes on those wages had expired. The Commissioner also made this argument in his pretrial memorandum on February 24, 2014.

Because the duty of consistency is an affirmative defense, the Commissioner sought and was granted leave to amend his answer in March 2014. The Commissioner also sought partial summary judgment on this defense, and the Tax Court ruled in his favor on March 27, 2014. The Tax Court denied Musa's motion to reconsider its decisions on the amendment and partial summary judgment.

The Tax Court held a trial on the remaining issues in May 2014. One issue was Musa's liability for the fraud penalty for his underpayments from 2006 to 2010. The fraud penalty was supported by an accountant from J & M who testified that Musa had not been forthcoming with certain financial information, such as the existence of numerous bank accounts. Musa tried to rebut that testimony with testimony by his new accountant, Sturm. After Sturm testified and the court gave Musa a chance to question him again on re-direct examination, the court dismissed the witness. The Commissioner then introduced Exhibit 128, which was an interrogatory response by Musa identifying eleven of his bank accounts. Musa did not object to Exhibit 128.

During the trial, the court permitted the testimony of three witnesses (Musa's family members) to be delayed so they could discuss with counsel the potential criminal ramifications of their testimony. After the trial had otherwise concluded, during a conference call to arrange for the testimony of these remaining witnesses, Musa's counsel asked to recall accountant Sturm for further questioning regarding Exhibit 128. The Tax Court denied the motion because Musa had not objected to Exhibit 128, Sturm already had a chance to discuss the subject matter of the exhibit, and further delay would prejudice the Commissioner.

On March 25, 2015, the Tax Court issued a memorandum opinion ruling in favor of the Commissioner and holding Musa liable for his deficiency and the fraud penalty. To support this conclusion, the court pointed out that Musa had: (1) understated his income; (2) failed to keep adequate records; (3) offered implausible explanations for his behavior; (4) concealed income; (5) failed to cooperate with tax officials; (6) failed to file Forms W-2 and 1099-MISC for all employees; (7) filed false documents; (8) failed to make estimated tax payments; and (9) relied extensively on cash payments. The court determined that Musa owed over $500,000 in income tax for years 2006 to 2010 and over $380,000 in fraud penalties.

On appeal, Musa does not deny that he filed fraudulent income and employment tax returns. Instead, he argues that the Tax Court erred in two ways: first in its rulings on the duty of consistency and second in denying his request to recall accountant Sturm.

II. Analysis

A. Duty of Consistency

1. Amendment to Answer

We review for abuse of discretion the Tax Court's decision to allow the Commissioner to amend his answer. See Estate of Kanter v. Commissioner , 337 F.3d 833, 851 (7th Cir. 2003), rev'd on other grounds , Ballard v. Commissioner , 544 U.S. 40, 125 S.Ct. 1270, 161 L.Ed.2d 227 (2005). The Tax Court enjoyed ample discretion to permit this amendment of the pleading. Rule 41(a) of the Rules of Practice and Procedure of the Tax Court provides: "A party may amend a pleading once as a matter of course at any time before a responsive pleading is served.... Otherwise a party may amend a pleading only by leave of Court or by written consent of the adverse party, and leave shall be freely given when justice so requires." This...