The Seventh Circuit Court of Appeals decided the case of Bachner v. Commissioner, No. 24-1420[^1], on January 7, 2025, which provides a clear illustration of how the IRS and courts handle cases of fraudulent tax returns and the assessment of penalties. This case particularly highlights the complexities surrounding the calculation of underpayments when taxpayers fraudulently overstate their withholdings.

Factual Background

Edward Bachner, along with his wife, Rebecca, filed joint tax returns for the years 2005 to 2007. During these years, Edward engaged in a scheme to fraudulently inflate his income and tax withholdings, resulting in claims for unwarranted refunds from the U.S. Treasury. In addition, Edward also illegally obtained a dangerous substance and fraudulently procured a life insurance policy, leading to federal criminal charges. He pled guilty to making a false claim to the IRS for 2005, possessing a biological agent for use as a weapon, and wire fraud. As part of his plea agreement, Edward admitted to submitting false refund claims for 2006 and 2007 as well. He served seven years in federal prison. Upon his release, the IRS issued a notice of deficiency for the tax years 2005-2007, seeking to recover civil fraud penalties under § 6663(a) of the Internal Revenue Code. The IRS sought a total of $393,807 in penalties. The Bachners challenged the notice in Tax Court, which ruled against them. They then appealed to the Seventh Circuit. Rebecca was later dismissed from the appeal after the court determined that she lacked standing due to her innocent spouse status.

Key Legal Issues

The appeal raised several key legal issues:

Validity of the Notice of Deficiency: The Bachners argued that the notice was invalid because it only identified penalties and not a “deficiency” as defined by § 6211 of the Internal Revenue Code. They also contended that the statute of limitations had expired and that the notice improperly included Rebecca.
Underpayment of Taxes: The Bachners argued that they did not underpay taxes but merely received excess refunds. They claimed Edward could not be liable for fraud penalties arising from an underpayment of taxes under § 6663(a).
Tax Court Jurisdiction: The Bachners argued that the Tax Court lacked jurisdiction because there was no “deficiency” in tax payments.
Application of Fraud Penalties: The court considered whether the Tax Court properly imposed the fraud penalties when they insisted they did not underpay taxes.
Evidentiary Issues: The court considered if the Tax Court erred in accepting the IRS’s stipulations about the false tax returns over the Bachners’ assertion of their privilege against self-incrimination.

Court’s Analysis and Decision

The Seventh Circuit upheld the Tax Court’s decision, addressing each of the Bachners’ arguments:

Standing: The court first addressed the issue of standing. It found that Edward had standing because he was directly affected by the penalty. However, Rebecca was dismissed from the appeal because she was granted innocent-spouse status and thus was not injured by the judgment. The court cited Lujan v. Defenders of Wildlife, 504 U.S. 555, 560–61 (1992) and Spokeo, Inc. v. Robins, 578 U.S. 330, 339–40 (2016) to define what constitutes injury for the purposes of standing. The court cited I.R.C. § 6015 and Rogers v. Comm’r, 9 F.4th 576, 579 (7th Cir. 2021) to define innocent spouse relief and its effect on standing.
Jurisdiction: The court found that the Tax Court had jurisdiction. While a deficiency is typically required for jurisdiction, the court explained that penalties are treated the same as taxes under § 6665(a) of the Internal Revenue Code. The court cited I.R.C. §§ 6212-14 and Murray v. Comm’r, 24 F.3d 901, 903 (7th Cir. 1994) regarding the Tax Court’s jurisdiction over tax deficiency cases. The court noted that the IRS issued a valid notice of determination, which, combined with the Bachner’s timely petition, provided the Tax Court jurisdiction to hear the case. The court cited I.R.C. § 6213(a) and Tax Court Rule 13(a) to support that conclusion.
Underpayment: The court rejected the Bachner’s argument that they did not underpay taxes, explaining that § 6663(a) imposes a penalty when a taxpayer underpays taxes due to fraud. The court referenced § 6664(a), which explains that an underpayment occurs when the tax determined by the IRS exceeds what the taxpayer reported. The court cited Treasury Reg. § 1.6664-2(c)(1), which specifies that the amount of tax reported is reduced by the excess of the withholdings reported over the amount actually withheld. The court explained that this means that the underpayment increases for purposes of the fraud penalty when a taxpayer overstates their withholdings. By overstating his withholdings, Edward created an underpayment for the purposes of computing the fraud penalty. The court demonstrated this with an example using the 2005 tax year. The court found that Edward’s fraudulent overstatement of his tax withholdings led to an underpayment, which provided the basis for the fraud penalty.
Other Arguments: The court dismissed the remaining arguments, including the contention that the notice of deficiency was invalid because it included Rebecca’s name. The court cited I.R.C. §§ 6751(a), 7522(a) and Portillo v. Comm’r, 932 F.2d 1128, 1132 (5th Cir. 1991) to support its holding that the notice contained all necessary information. The court held that the assessment was not time barred as I.R.C. § 6501(c)(1) states that it can be made at any time in the case of a fraudulent return with the intent to evade tax. The court further noted that the record did not support the argument that the IRS did not conduct a proper audit and any procedural deviations would not matter unless they produced an assessment without factual foundation. The court cited Zuhone v. Comm’r, 883 F.2d 1317, 1326–27 (7th Cir. 1989) to support its holding on that point. Finally, the court held that there was no evidence of bias by the Tax Court and that the assertion of privilege against self-incrimination was properly overruled. The court cited Liteky v. United States, 510 U.S. 540, 555 (1994) to support its holding on the bias issue and Hiibel v. Sixth Jud. Dist. Ct., 542 U.S. 177, 190 (2004) to support its conclusion about the privilege issue.

Conclusion

The Seventh Circuit affirmed the Tax Court’s decision and upheld the fraud penalties against Edward Bachner. This case serves as a reminder that penalties can be imposed when a taxpayer fraudulently overstates their withholdings, creating an underpayment for the purposes of calculating fraud penalties.

[^1]: Bachner v. Commissioner, CA7, Docket No. 24-1420, January 7, 2025, https://media.ca7.uscourts.gov/cgi-bin/OpinionsWeb/processWebInputExternal.pl?Submit=Display&Path=Y2025/D01-07/C:24-1420:J:Scudder:aut:T:fnOp:N:3315098:S:0