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United States v. Pugh

June 1, 2010

UNITED STATES OF AMERICA, PLAINTIFF,
v.
ARCHIE J. PUGH, JR. AND THEODORE PUGH, EACH INDIVIDUALLY AND D/B/A ARCHIE'S TAX & ACCOUNTING SERVICE, DEFENDANTS.



The opinion of the court was delivered by: Matsumoto, United States District Judge

MEMORANDUM & ORDER

Plaintiff, the United State of America ("plaintiff" or "Government") commenced this civil action against pro se defendants Archie J. Pugh, Jr. and Theodore Pugh, individually and doing business as Archie's Tax and Accounting Service (collectively, "Pughs" or "defendants"), seeking to enjoin them from engaging in conduct subject to penalty under the Internal Revenue Code and from acting as federal tax return preparers. Presently before this court is the Government's motion for summary judgment, seeking a permanent injunction pursuant to §§ 7402(a), 7407, and 7408 of the Internal Revenue Code (26 U.S.C.) ("I.R.C."). For the reasons set forth below, the Government's motion for summary judgment is granted and the defendants will be permanently enjoined pursuant to I.R.C. §§ 7402(a), 7407, and 7408, in accordance with the terms of the Order of Permanent Injunction, dated June 1, 2010, which is being filed concurrently with this Memorandum & Order.

BACKGROUND

I. Procedural History

The Government filed a complaint against pro se defendants Archie J. Pugh, Jr. and Theodore Pugh on June 19, 2007 for falsely marketing and preparing federal income tax returns based on a so-called "claim of right" tax-evasion scheme. (Doc. No. 1, Compl. ¶¶ 1, 7-15.) Defendants failed to appear in this matter and, on November 14, 2007, Judge Nicholas G. Garaufis granted the Government's motion for default judgment and permanently enjoined the defendants from, inter alia, marketing tax plans that advise customers to attempt to violate internal revenue laws, assisting others in evading payment of taxes and from acting as federal income tax return preparers pursuant to I.R.C. §§ 7402, 7407, and 7408. See United States v. Pugh, No. 07-CV-02456 (NGG)(VVP), 2007 WL 3539435, at *8-9 (E.D.N.Y. Nov. 14, 2007).

On November 28, 2007, Judge Garaufis re-opened the case and vacated the entry of default judgment and the permanent injunction against the defendants.*fn1 (11/28/07 Oral Order.) Thereafter, the defendants answered the complaint on January 30, 2008. (Doc. No. 15.) The Government subsequently moved for a preliminary injunction against the defendants on March 26, 2008. (Doc. Nos. 21-22.) The unopposed preliminary injunction motion was granted, and an order of preliminary injunction was entered on April 2, 2008, preliminarily enjoining the Pughs from, inter alia, marketing tax plans that advise customers to attempt to violate internal revenue laws, assisting others in evading payment of taxes and from acting as federal income tax return preparers pursuant to I.R.C. §§ 7402, 7407, and 7408, upon findings, inter alia, that defendants repeatedly and continually engaged in conduct subject to penalty under I.R.C. §§ 6694, 6695, and 6700. See United States v. Pugh, No. 07-CV-02456 (NGG)(VVP), 2008 WL 926069, at *2-3 (E.D.N.Y. Apr. 2, 2008). On August 20, 2008, this case was reassigned to the undersigned. (8/20/08 Doc. Entry.) The Government moved for summary judgment on June 1, 2009, seeking imposition of a permanent injunction with the same proscriptions as the preliminary injunction. (Doc. Nos. 41-52, 57.) Defendants opposed the motion. (Doc. Nos. 53-56.)

II. Legal Background

A. The "Claim of Right" Tax-Evasion Scheme and I.R.C. § 1341

The so-called "claim of right" doctrine at issue in this case is a discredited tax evasion scheme, which falsely asserts that neither an individual nor his income is subject to federal income tax. (Doc. No. 46, Decl. of Lori Dixon ("Dixon Decl."), Ex. 2, IRS Updates the "Dirty Dozen" for 2004: Agency Warns of New Scams.) The proponents of this scheme claim that money earned in exchange for personal labor or services does not constitute taxable income, and therefore, taxpayers are entitled to take a "claim of right" deduction on their federal income tax returns in the amount of compensation earned on their labor, which, in most cases, eliminates a participant's tax liability. (Dixon Decl. ¶ 8.) Advocates of the "claim of right" tax evasion scheme, such as the defendants, assert that these tax benefits are a common law or constitutional right, codified by section 1341 of the Internal Revenue Code. (Id.) As will be discussed below, the Pughs market and prepare federal income tax returns for customers based on the frivolous "claim of right" doctrine.

I.R.C. § 1341, however, does not entitle taxpayers to take a deduction in the amount of compensation earned. Pugh, 2007 WL 3539435, at *4; Sumter v. United States, 61 Fed. Cl. 517, 523-24 (Ct. Fed. Cl. 2004). Instead, the credit in I.R.C. § 1341*fn2 only applies to those situations where: 1) a taxpayer properly reported income in one year; 2) after the close of that tax year, it is established that taxpayer did not, in fact, have an unrestricted claim of right to that income; and 3) the taxpayer repays all or a portion of that income in a later year.

(I.R.C. § 1341; see also Dixon Decl. Ex. 3, Rev. Rul. 2004-29 at 2.) If a taxpayer meets all three criteria, he or she will receive a tax credit in the current taxable year, amounting to either the equivalent of a refund for income tax paid in the earlier year or a deduction from income in the year of repayment, whichever is more beneficial to the taxpayer. I.R.C. § 1341. Those espousing the "claim of right" tax evasion scheme, like the Pughs, do not instruct their customers that they would first have to show an overpayment in a previous tax year and return their earned income to their employers before being able to claim a deduction under I.R.C. § 1341.

B. Universal Rejection of the "Claim of Right" Tax-Evasion Scheme

The Internal Revenue Service ("IRS") has made clear that there is no "claim of right" doctrine under I.R.C. § 1341 or any other statute that allows an individual to take the position espoused by the Pughs that neither the individual nor the individual's income is subject to federal income taxes.

(See, e.g., Dixon Decl. Ex. 3, Rev. Rul. 2004-29 at 2.) The IRS has treated the so-called "claim of right" doctrine as simply another variation of the frivolous argument that compensation for personal services is not subject to taxation and has imposed criminal and civil penalties and permanent injunctions on tax preparers and taxpayers who attempt to avoid their tax obligations by taking this position. (Dixon Decl., Ex. 2, IRS Updates the "Dirty Dozen" for 2004: Agency Warns of New Scams at 1-2 (The "claim of right" deduction "is based on a complete misinterpretation of the Internal Revenue Code and has no basis in law.") & Ex. 3, Rev. Rul. 2004-29 at 1 ("There is no 'claim of right' doctrine under U.S. law, including the Internal Revenue Code, that permits an individual to take the position that either the individual or that individual's income is not subject to federal income tax.").)

Courts, too, have repeatedly rejected the argument that compensation for personal services is not subject to taxation, and have specifically rejected the so-called "claim of right" doctrine as lacking any basis in law. See, e.g., Sumter, 61 Fed. Cl. at 523-24 (holding taxpayer's "claim of right" theory, which she based on I.R.C. § 1341, was without any support in law and her contention that wages are not subject to the federal income tax to be a "specious claim"); United States v. Saladino, No. 04-CV-02100, 2005 U.S. Dist. LEXIS 38080, at *6-11 (C.D. Cal. Jan. 20, 2005) (discussing the frivolous nature of the "claim of right" program); United States v. Lloyd, No. 04-CV-00274, 2005 WL 3307281, at *6 (M.D.N.C. Dec. 6, 2005), aff'd, 2006 WL 1817074 (4th Cir. 2006) ("The claim of right program is simply yet another variation on the frivolous tax protestor argument that wages are not income."); see also Connor v. Comm'r of Internal Revenue, 770 F.2d 17, 20 (2d Cir. 1985) (per curiam) ("Wages are income. The argument that they are not has been rejected so frequently that the very raising of it justifies the imposition of sanctions.") (internal citation omitted)); Olson v. United States, 760 F.2d 1003, 1005 (9th Cir. 1985) (per curiam) (rejecting as frivolous taxpayer's contention that wages are not income); Abdo v. United States Internal Revenue Serv., 234 F. Supp. 2d 553, 563 (M.D.N.C. 2002) (finding defendant's tax avoidance argument to be another variation "of the same tired tax protestor 'wages are not income' argument that has long been deemed frivolous . . . [and] has been rejected as many times as it has been asserted"); Abrams v. Comm'r of Internal Revenue, 82 T.C. 403, 413 (1984) (rejecting as "frivolous and groundless" taxpayer's argument that his income in the form of wages is not subject to the federal income tax).

III. Factual Background

The following facts are based upon the Government's Local Rule 56.1 statement, and the supporting declarations and exhibits attached thereto,*fn3 and upon the defendants' submissions*fn4 and are undisputed except as noted below.

C. The Defendants*fn5

Archie J. Pugh, Jr. ("Archie") is the sole proprietor of Archie's Tax and Accounting Service operated out of 136-17 Thurston Street, Jamaica, New York. (Doc. No. 43, United States Statement of Facts in Support of its Motion for Summary Judgment ("Pl.'s 56.1 Stmt.") ¶ 1; Doc. No. 54, Defendants' Statement of Facts in Support of its Opposition Motion Against Summary Judgment ("Defs.' 56.1") ¶ 1); Doc. No. 55, Decl. of Archie Pugh ("A. Pugh Decl.") ¶¶ 4, 11.) According to Archie, he has worked in the field of tax return preparation and accounting for more than 30 years and received a Certificate of Graduation from the National Tax Training School in 1989. (A. Pugh Decl. ¶¶ 2, 4.)

Archie's brother, Theodore Pugh ("Theodore"), prepares federal income tax returns from the same location. (Pl.'s 56.1 Stmt ¶ 1; Defs.' 56.1 Stmt. ¶ 1; A. Pugh Decl. ¶¶ 5, 11.) According to both Archie and Theodore, Theodore never worked for, was not employed by, nor authored documents in connection with Archie's Tax and Accounting Service. (A. Pugh Decl. ¶ 5; Doc. No. 56, Decl. of Theodore Pugh ("T. Pugh Decl.") ¶ 6.) However, Archie states that he allowed Theodore to prepare tax returns for Theodore's customers on Archie's computer because Theodore did not have the equipment necessary for electronic filing. (A. Pugh Decl. ¶ 5.) The Government, however, submits declarations stating that Theodore prepared tax returns for Archie's Tax and Accounting Service. (Dixon Decl. ¶ 5; Doc. No. 50, Decl. of Madeline Rivera ("Rivera Decl.") ¶ 4.)

Although the exact number of federal income tax returns prepared by the Pughs every year is unknown because, in many cases, they do not sign as the paid preparers, the IRS has identified 680 federal income tax returns between 2001 and 2004 and 712 federal income tax returns from 2007 through March 2009*fn6 bearing one of the defendants' social security numbers or electronic identification number as paid preparer.*fn7 (Dixon Decl. ¶ 6 & n.1.) According to Archie, he prepared approximately 420 tax returns electronically "as a paid preparer" between 2001 and 2004. (Defs.' 56.1 ¶ 2; A. Pugh Decl. ¶ 12.)

Both Pughs assert that currently they are no longer acting as federal income tax preparers because of the preliminary injunction entered against them. (T. Pugh Decl. ¶ 2 (stating he is currently unemployed due to the preliminary injunction); A. Pugh ¶ 10 (stating that, because of the preliminary injunction entered against him, he has notified his customers that he is out of business as of the tax year 2009).) As of March 6, 2009, however, the Government presents undisputed evidence that Archie prepared 51 federal tax returns in the year 2009 and Theodore prepared 42 federal tax returns in the year 2009, all in violation of this court's April 2, 2008 Preliminary Injunction Order, which enjoined the Pughs from, inter alia, acting as federal tax preparers and preparing or filing returns for anyone other than themselves. (Dixon Decl. ¶ 6 & n.1.) In fact, Archie admits to preparing "normal" tax returns that "did not involve any 'claims what so ever [sic]'" in 2008 and 2009, explaining "[i]f the preliminary injunction on 04 02, 2008 [sic] applied to normal tax returns as well, My [sic] children and I would be destitute now and the preparation of this opposition for summary judgment would not be possible." (A. Pugh Decl. ¶ 10.) Archie states, however, that he has notified his customers that he is out of business as of tax year 2009. (Id.) Thus, it is undisputed that both Pughs violated the preliminary injunction for at least the first few months of 2009.

D. The Defendants' "Claim of Right" Promotion

The Government presents undisputed evidence that, from at least 1998, the Pughs have been promoting and preparing returns based on the so-called "claim of right" program. (Dixon Decl. ¶ 7.) Specifically, since April 2003, the IRS has referred to the IRS Frivolous Return Program ("FRP")*fn8 92 frivolous filings of returns and claims prepared by Archie and Theodore and has identified at least 79 returns prepared by the Pughs for 45 customers claiming "unrestricted claim of right" deductions between 1998 and 2005. (Dixon Decl. ¶ 9 & Ex. 4; Doc. No. 45, Decl. of Shauna Henline ("Henline Decl.") ¶¶ 6, 8.) These 79 "claim of right" returns examined by the IRS deduct over $3.8 million in wage income from the taxpayers' adjusted gross income and claim over $500,000 in tax refunds. (Dixon Decl. ¶ 15 & Ex. 4.) In some customers' individual tax returns, the Pughs deducted wage income in amounts as high as $284,421, $112,732 and $107,465 on the basis of the "claim of right" scheme. (Dixon Decl. ¶ 15 & Ex. 4.)

The Government's undisputed evidence demonstrates that the Pughs, like other promoters of the "claim of right" program, falsely advise their customers that it is permissible to exclude from taxation all compensation for personal services or labor rendered, and repeatedly prepare income tax returns for customers deducting the amount their clients receive as wages. (Dixon Decl. ¶ 8; T. Pugh Decl. ¶ 22; A. Pugh ¶ 9; Defs.' 56.1 ¶ 3; Rivera Decl. ¶ 6; Doc. No. 47, Decl. of Joan Williams ("Williams Decl.") ¶¶ 4-5; Doc. No. 48, Decl. of Cheryle Prentis ("Prentis Decl.") ¶ 4.) The Pughs cite to 26 U.S.C. § 1341(a)(5)(B) for the proposition that "compensation for personal services actually rendered" by "white citizens" is "immune from taxation" under the "14th Amendment" and disclose this frivolous position on IRS Form 8275, entitled "Disclosure Statements." (Dixon Decl. ¶¶ 7-8 & Exs. 1A-D, 5, 7, 10, 11; Defs.' 56.1 ¶ 3.)

The undisputed evidence further establishes that, although the Pughs prepared the returns at issue, the Pughs did not sign these returns as the paid preparers. (Dixon Decl. ¶¶ 6, 14; Henline Decl. ¶ 7.) Instead, the Pughs have their customers sign the tax returns, and either leave the "Paid Preparer's" signature block blank or type "SELF PREPARED" therein in order to conceal their identity as the preparers. (Henline Decl. ¶¶ 7, 8; Dixon Decl., Exs. 7, 10, 11 ("SELF PREPARED" typed in paid preparer's signature block); Dixon Decl., Exs. 5, 6, 8, 9 (paid preparer's signature block left blank).) The Government proffers undisputed evidence that the Pughs were responsible for preparing the returns in question based on: (1) the defendants' customers' identification of the defendants as the individuals who prepared and filed their tax returns containing "claim of right" deductions, even though the defendants did not sign those returns; and (2) the common patterns identified by the FRP linking the frivolous tax returns to the Pughs. (Henline Decl. ¶ 8.)

First, the Government submits a list of known clients for whom the Pughs prepared tax returns claiming deductions based on the "claim of right" scheme (Dixon Decl. ¶ 14 & Ex. 4), in addition to declarations from six of these clients, namely, Joan Williams, Cheryle Prentis, Cassandra Pannell (listed on IRS records under her married name Cassandra Mosley), Madeline Rivera, Gregory Trammell, Mark Mobley, and questionnaires from clients Mark Mobley and William Lloyd, each of whom identifies either Archie or Theodore Pugh as the paid preparer of their tax returns for tax years 2003 and/or 2004. (See Williams Decl. ¶ 3; Prentis Decl. ¶ 3; Doc. No. 49, Decl. of Cassandra Pannell ("Pannell Decl.") ¶ 2; Rivera Decl. ¶ 3; Doc. No. 51, Decl. of Gregory Trammell ("Trammell Decl.") ¶ 3; Doc. No. 52, Decl. of Mark Mobley ("Mobley Decl.") ¶ 3; see also Dixon Decl., Exs. 12, 13.) These clients specifically state that one of the defendants prepared their tax returns but did not sign the return as the tax return preparer. (See, e.g., Williams Decl. ¶¶ 6-7 ("[Theodore Pugh] told me to sign the return, which I did, and then he took it to mail. Theodore Pugh did not sign my return as the tax return preparer even though he was the one who prepared my return."); Dixon Decl., Ex. 7 (2003 tax return of Joan Williams, with "self-prepared" typed in signature block); Pannell Decl. ¶ 6 ("After Archie Pugh prepared my federal income tax return, he called me and I came over to his house to sign it . . . [but he] did not sign my return as the paid preparer. In fact, no one signed as the paid preparer. In previous years, Archie Pugh had put his signature stamp on the federal income tax returns, but he did not do so for my 2003 return."); Prentis Decl. ¶ 5 (Theodore Pugh "told me, 'Don't tell anyone that I did your taxes.' He said that was because the federal government didn't want people to know about the claim he had uncovered."); Dixon Decl., Ex. 10 (2003 tax return of Cheryle Prentis, with "self-prepared" typed in signature block); see generally Dixon Decl. ¶ 27 (a)-(e); Trammell Decl. ¶ 4; Mobley Decl. ¶ 4.)

Further, the FRP identified common patterns among tax returns claiming deductions based on the frivolous "claim of right" doctrine, which the Government asserts "made it evident that the 'self-prepared' returns were in fact prepared by the Pughs." (Pl.'s 56.1 Stmt ¶ 17.) For example, on IRS Forms 1040: 1) line 70, which is the line requesting a routing number to directly deposit any refund, contains the words "NO DEPOSIT" and "NO DEPOSIT REQUESTED" in all capital letters; and 2) Schedule A, line 27 contains the words: "UNRESTRICTED CLAIM OF RIGHT" and "SEE FORM 8275" typed in capital letters in the same font. (Henline Decl. ¶ 8; Dixon Decl., Exs. 5-12.) On IRS Form 8275 "Disclosure Statements," attached to the federal income tax returns: 1) the taxpayer's name is printed in irregularly large font; 2) line 1 uses identical language, claiming a deduction for "Compensation for personal services actually Rendered" with the initial "C" in "Compensation" and the initial "R" in "Rendered" capitalized on each return; and 3) the Part II, "Detailed Explanation" section states, "See part IV for the law authorizing the deduction" and the Part IV, "Explanations (continued from Parts I and/or II)" section contains an enumerated paragraph, labeled (a) through (h), with the following identical formatting and statements:

(a) The claim is founded upon a common law immunity which rendered any money earned from the right of accession immune from taxation.

(b) The 14th Amendment extended this right to United States citizens.

(c) The United States Code defined this immunity as a "white citizen" right for the United States citizens in Title 42, Sec. 1981.

(d) Treasury regulations (Title 26) stipulate the deduction is a "Claim of Right".

(e) United States Code Title 26, Section 1341(a)(5)(B) allows this civil right to be claimed in the following manner: "or the corresponding provision of prior revenue laws"

(f) and: "For purposes of paragraph (5)(B), the corresponding provisions of the internal Revenue Code of 1939, shall be chapter 1 of such code".

(g) The Internal Revenue Code of 1939, chapter 1, Subchapter B, Section 23 entitled "Deduction From Gross Income" Which allows a deduction for "compensation for personal services actually rendered".

(h) The party claiming this civil right is a United States citizen. (Dixon Decl., Exs. 1A-D, 5, 7, 10, 11; Henline Decl. ¶ 8.) The Government proffers that "[a]ll of these characteristics match returns either known to have been prepared by the Pughs or later established to have been prepared by the Pughs." (Pl.'s 56.1 Stmt ¶ 17.) The Government has attached, and the court has examined, the corresponding tax returns for many of the defendants' clients, which exhibit the patterns described above. (See Dixon Decl., Exs. 1A-D, 5-11.)

The Government further submits unrebutted evidence that the defendants' preparation of many of these "claim of right" returns was contemporaneous with 2004 and 2005 IRS Revenue Rulings and IRS annual consumer warnings that tax return preparers and taxpayers would face civil and criminal penalties for using or marketing the "claim of right." (Dixon Decl. ¶¶ 12-14, Ex. 2 & 3; Henline Decl. ¶¶ 10-12 ("During the time these warning were issued by the IRS, the Pughs prepared numerous returns based on the frivolous "claim of right" scheme.").)

The Government submits undisputed evidence that the filing of frivolous tax returns has placed a substantial burden on the defendants' customers and on the IRS. First, many of the defendants' clients have been exposed to potential civil and criminal penalties by having the defendants' prepare and file frivolous tax returns on their behalf, and have been forced to pay back to the Government their deficiencies, in addition to penalties, interest, and fees. (Williams Decl. ¶ 11; Prentis Decl. ¶ 7; Trammel Decl. ¶¶ 5-6; Mobley Decl. ¶¶ 5-8; Rivera ¶ 8; see also Dixon Decl., Ex. 2.) Moreover, the Pughs' frivolous "claim of right" returns have deducted over $3.8 million in wage income from the taxpayers' adjusted gross income and claimed over $500,000 in bogus tax refunds. (Dixon Decl. ¶ 15 & Ex. 4.) The Government has additionally incurred the burden and expense of investigating the defendants' tax preparation services, responding to and processing the frivolous documents that the Pughs have filed or caused to be filed with the IRS, as well as issuing and then recovering erroneous refunds. (Henline Decl. ¶¶ 6, 8, 13-15; Dixon Decl. ¶ 15.)

E. The Defendants' Opposition to Summary Judgment

In opposition to the Government's motion for summary judgment, the defendants do not specifically deny the Government's factual showing, but instead state in a conclusory fashion that they "did not engage in conduct subject to penalty under the Internal Revenue Code that would prevent [them] from preparing federal electronic tax returns, or federal tax returns as alleged by Plaintiff." (Defs.' Opp. at 1.) In direct contradiction of that statement, Theodore admits in his declaration that he "did make a statement to tax payers [sic] involved in filing disclosure returns*fn9 that there is no Federal statute that subjects the[ir] earning[s], the portion which represents compensation for services actually rendered as taxable" and only ceased "produc[ing] . . . prepar[ing] . . . [and] assist[ing] in the preparation of returns involving disclosure" beginning in tax year 2005 "due to the legal conflicts between [the] IRS and the actual laws by which the IRS enforce." (T. Pugh Decl. ¶¶ 22-23, 26.) Theodore states, however, that allegations regarding the preparation of frivolous tax returns in the years 2006 through 2008 "are absolutely false." (Id. ¶ 24.) He makes no such claim as to frivolous tax returns prepared in 1998 through 2004. Likewise, Archie admits to assisting in the preparation of returns for customers "who requested to take the ['claim of right'] deduction," which were filed as self-prepared, but says that he was not paid for these services. (A. Pugh Decl. ¶ 9 ("I did assist in the preparation of some returns under disclosure but no fee was paid to me for this.").) Archie states that, in 2008 and 2009, he only prepared "normal" tax returns, which "did not involve any 'claims what so ever [sic].'" (Id. ¶ 10.)

Although difficult to decipher, the defendants appear to raise the following arguments: 1) their failure to file or sign "self-prepared returns" and "returns under disclosure" somehow absolves them of liability (Defs.' 56.1 Stmt ¶ 2; A. Pugh Decl. ¶ 9; T. Pugh Decl. ¶ 18 ("That I have never signed or authored anyone's name to any document which plaintiff has presented")); (2) they were unaware that the "claim of right" position was frivolous at the time the "claim of right" returns were "voluntarily filed" (Defs.' 56.1 Stmt ¶ 3 ("At the time the returns under disclosure were filed[,] the defendants were not aware of any actions taken by the IRS cited in previous legal cases as cited by respondent . . . [and] were unaware until 2005 that there were problems with the ...


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