United States v. Elsass (978 F. Supp. 2d 901, 2013)

MEMORANDUM OPINION AND ORDER

PETER C. ECONOMUS, District Judge.

Presently pending before the Court are the Parties’ cross-motions for summary judgment (Docs. 212 & 230) and the Defendants’ Motion to Strike Certain Government Summary Judgment Exhibits (Doc. 236). For the reasons that follow, the Court will DISMISS without deciding the motion to strike, and GRANT in PART and DENY in PART the cross motions for summary judgment. Further, the Court GRANTS injunctive relief to the Government as specified in the Judgment and Permanent Injunction filed concurrently with this opinion and order.

I.

Plaintiff, the United States of America, brings the instant civil action against Defendants Tobias H. Elsass (“Elsass”), Fraud Recovery Group, Inc. (“FRG”), and Sensible Tax Services, Inc. (“STS”) seeking to enjoin the Defendants from providing certain services to taxpayers on the grounds that the Defendants have frequently engaged in practices that violate the tax laws.

FRG and STS are entities founded and controlled by Elsass. Collectively, the Defendants are in the business of helping taxpayers claim tax refunds through tax deductions for theft losses made allowable by § 165 of the Internal Revenue Code (“I.R.C.”), 26 U.S.C. § 165. The Defendants’ business focuses on purported theft losses arising from investment scams such as the one famously orchestrated by Bernie Madoff. Their business model consists of researching and identifying investment scams that might give rise to § 165 theft-loss deductions, marketing their services to the victims of such scams, and assisting the victims in filing amended tax returns to obtain a tax refund based on the loss sustained through the scam. In exchange for these services, the Defendants are compensated by a percentage of the refund obtained.

In bringing this action, the Government contends that the Defendants have frequently engaged in practices that run afoul of the I.R.C. and the rules and regulations governing the United States’ income tax scheme promulgated by the Treasury Department and the Internal Revenue Service (“IRS”). Among other allegations, the Government contends that the Defendants frequently and willfully have attempted to obtain theft-loss deductions for their customers in instances where doing so is improper or altogether groundless. To prevent the Defendants from continuing to operate in ways that it contends blatantly run afoul of the tax laws, the Government seeks to permanently enjoin the Defendants pursuant to §§ 7402, 7407, and 7408 of the I.R.C. from engaging in the business of assisting taxpayers with § 165 theft-loss deductions.

After conferring with the Parties as the case approached trial, the Court determined that the action could likely be resolved through cross-motions for summary judgment. (See Doc. 208.) The Parties have accordingly moved for summary judgment and briefing on the issues is now complete.

II.

Before discussing the Parties’ motions for summary judgment, the Court first considers the Defendants’ pending motion to strike Government Exhibits 77, 156, 157, 191, 286, 340, 341, 342, 353, 456, 458, 459, 479, 482, 483, 498, 501, 502, 503, and 504. (Doc. 236.) Defendants argue that the Court should not consider these documents on various grounds. However, as the Court has not relied upon any of the identified exhibits in deciding the pending summary judgment motions nor in determining the appropriate relief to the Government, it is unnecessary for the Court to decide the legal merits of the Defendants’ motion to strike. Accordingly, the Defendants’ Motion to Strike Certain Government Summary Judgment Exhibits (Doc. 236) is dismissed.

III.

A.

The Court now turns to the cross-motions for summary judgment. Summary judgment is proper where “the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed. R. Crv P. 56(a). The moving party bears the initial burden of “informing the district court of the basis for its motion, and identifying those portions of the ‘pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any,’ which it believes demonstrates the absence of a genuine issue of material fact.” Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986) (quoting prior version of Fed. R. Civ. P. 56). The movant may meet this burden by demonstrating the absence of evidence supporting one or more essential elements of the non-movant’s claim. Id. at 323-25, 106 S.Ct. 2548. Once the movant meets this burden, the opposing party “must set forth specific facts showing that there is a genuine issue for trial.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986) (quotation and citation omitted).

“In considering a motion for summary judgment, the Court must view the facts and draw all reasonable inferences therefrom in a light most favorable to the non-moving party.” Williams v. Belknap, 154 F.Supp.2d 1069, 1071 (E.D.Mich.2001) (citing 60 Ivy Street Corp. v. Alexander, 822 F.2d 1432, 1435 (6th Cir.1987)). The purpose of summary judgment “is not to resolve factual issues, but to determine if there are genuine issues of fact to be tried.” Abercrombie & Fitch Stores, Inc. v. Am. Eagle Outfitters, Inc., 130 F.Supp.2d 928, 930 (S.D.Ohio 1999). Ultimately, this Court must determine “whether the evidence presents a sufficient disagreement to require submission to a jury or whether it is so one-sided that one party must prevail as a matter of law.” Anderson, 477 U.S. at 251-52, 106 S.Ct. 2505.

B.

Prior to discussing the injunctive relief sought by the Government, the Court will first give a very brief overview of the Defendants and their business model. As explained below, the Court will also briefly dispose of the majority of the Government’s claims as they pertain to the conduct of STS.

Elsass was an attorney admitted to practice law in Ohio in 1980. (Elsass Dep. 14, Gov. Ex. 486, Doc. 226, PAGEID # 7486.) He ceased practicing law after his law license was suspended in 1998. (Id. at 16, Doc. 226, PAGEID #7488.) Prior to forming FRG, he worked as a salesman for a business known as JK Harris, “selling” § 165 theft loss deductions to victims of financial scams. (See id. at 39, Doc. 226, PAGEID # 7496.) After his employment with JK Harris ended in December 2005, he founded FRG the following January. (Id. at 170, Doc. 226-2, PAGEID # 7555.) Elsass initially operated FRG out of his home, but toward the end of 2008, he moved the business to its present location of 965 High Street in Worthington, Ohio. (United States’ Statement of Contested and Uncontested Facts, ¶ 11, Doc. 229-1, PAGEID ## 8192-93.)

Elsass is the President and Chief Executive Officer of FRG. (Elsass Dep. 199, Gov. Ex. 486, Doc. 226-3, PAGEID # 7564.) He is the company’s only officer and only shareholder. (Id.) FRG charges contingent fees for its services. Under the company’s initial fee structure, customers had two options; either they could make an advance cash payment, calculated as a percentage of the estimated tax refund, or the fee could be deferred and taken by FRG as a percentage of the actual refund received. (See id. at 254-55, Doc. 226-4, PAGEID ## 7584-85.) The current fee structure is similar, with prepay customers paying 15% of the expected return and deferred customers paying what Elsass terms a blended fee — 7.5% cash in advance and 20% of the final refund. (Id. at 637, Doc. 227-7, PAGEID # 7827.) According to Elsass, a large portion of FRG’s customers are elderly. (Id. at 76, Doc. 226, PAGEID # 7507.)

STS is owned by FRG and was created in 2009 so that customer tax returns could be prepared in-house. (Id. at 71, PAGEID # 7506.) The Defendants represent that STS is still an active Ohio corporation, but that there is no present intention for it to again become actively involved in the theft-loss deduction business. (Defs.’ Mem. Opp’n 1 n. 1, Doc. 235, PAGEID # 8685.) Upon reviewing the extensive record produced by the Government, the Court concludes that the Government has failed to offer evidence linking STS directly to the enjoinable conduct of the other Defendants analyzed herein, with the exception of aiding and abetting the understatement of tax liability in violation of I.R.C. § 6701, as discussed in Part III.B.2.b, infra. However, given that STS is owned solely by Elsass through his ownership of FRG, the Court’s conclusion in this regard has no impact on the ultimate relief to the Government awarded concurrently with this decision. Nonetheless, the Court grants the Defendants’ motion for summary judgment as to the claims against STS with the exception of the violations of § 6701.

1.

Section 7407 of the I.R.C. vests the Court with authority to enjoin “tax return preparers” from engaging in certain conduct specified in that section. Further, if the Court determines that a person acting as a tax return preparer has “continually or repeatedly engaged in [the specified prohibited conduct] and that an injunction prohibiting such conduct would not be sufficient to prevent such person’s interference with the proper administration of [the I.R.C.],” it may enjoin the person from acting as a tax return preparer. 26 U.S.C. § 7407(b).

Here, the Government argues that the Defendants are tax return preparers as that term is defined by statute and that they have repeatedly engaged in a myriad of conduct made enjoinable pursuant to § 7407. Specifically, the Government contends that the record establishes (1) Elsass and FRG have violated 26 U.S.C. § 6694 (made enjoinable by § 7407(b)(1)(A)); (2) Elsass and FRG have violated 26 U.S.C. § 6695(f) (§ 7407(b)(1)(A)); (3) Elsass has misrepresented his eligibility to practice before the IRS (§ 7407(b)(1)(B)); and (4) Elsass and FRG have otherwise engaged in “fraudulent or deceptive conduct which substantially interferes with the proper administration of the Internal Revenue laws” (§ 7407(b)(1)(D)). Because it asserts that Elsass and FRG have repeatedly engaged in the prohibited conduct and that an injunction of specific conduct would not suffice to prevent their interference with the proper administration of the tax laws, the Government seeks an injunction preventing the Defendants from serving as tax return preparers.

a.

As the Court’s authority under § 7407 applies only to tax return preparers, the Court must first determine whether there is no dispute of material fact as to whether the Defendants meet the definition of that term. “Tax return preparer” is defined by the I.R.C. to mean:

any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return of tax imposed by this title or any claim for refund of tax imposed by this title. For purposes of the preceding sentence, the preparation of a substantial portion of a return or claim for refund shall be treated as if it were the preparation of such return or claim for refund.

26 U.S.C. § 7701(a)(36)(A). The term “person” is defined broadly by the I.R.C. to include individuals, partnerships, companies, and corporations. See id. § 7701(a)(1). According to the Seventh Circuit, one purpose of the broad definition of tax return preparer

was to ensure that the person who makes the decisions and calculations involved in preparing a particular return will be considered the preparer of that return, even if that person “does not actually place the figures on the lines of the taxpayer’s final tax return.” H.R.Rep. No. 658, 94th Cong., 2d Sess. 275, reprinted in 1976 U.S.C.C.A.N. 3171. Thus, furnishing of advice can make one a preparer, while mechanical assistance in preparing the return does not.

Goulding v. United States, 957 F.2d 1420, 1424-25 (7th Cir.1992).

Here, the Government has demonstrated that there are no genuine factual disputes as to whether the Defendants are tax return preparers. As an initial matter, it is undisputed that the Defendants receive compensation for their services in the form of a percentage of any tax refund received by their customers. Further, STS was undoubtedly a tax return preparer as the record reflects that it exists primarily for the purpose of completing amended tax returns for customers of FRG claiming § 165 theft loss deductions. (Elsass Dep. 71; Doc. 226, PAGEID # 7506.) STS also provided general preparation services to taxpayers outside the § 165 theft-loss deduction context. (See Gov. Ex. 293 at 1, Doc. 219-31, PAGEID #6267; Gov. Ex. 308 at 1, Doc. 220-4, PAGEID # 6328 (“[STS] is in the business of preparing current year tax returns.”).)

Regarding Elsass and FRG, the Government has directed the Court’s attention to some twenty-eight tax returns either signed by Elsass himself (in some cases on behalf of FRG), or listing FRG or STS as the firm employing the signer. (See Gov. Ex. 12, Doc. 212-13; Gov. Ex. 17, Doc. 212-18; Gov. Ex. 18, Doc. 212-19; Gov. Ex. 20, Doc. 212-21; Gov. Ex. 23, Doc. 212-24; Gov. Ex. 27, Doc. 213-1; Gov. Ex. 34, Doc. 213-8; Gov. Ex. 36, Doc. 213-10; Gov. Ex. 46, Doc. 213-20; Gov. Ex. 48, Doc. 213-22; Gov. Ex. 49, Doc. 213-23; Gov. Ex. 50, Doc. 213-24; Gov. Ex. 75, Doc. 214-6; Gov. Ex. 121, Doc. 215-10; Gov. Ex. 124, Doc. 215-13; Gov. Ex. 126, Doc. 215-15; Gov. Ex. 148, Doc. 215-37; Gov. Ex. 151, Doc. 216; Gov. Ex. 153, Doc. 216-2; Gov. Ex. 175, Doc. 216-27; Gov. Ex. 183, Doc. 216-35; Gov. Ex. 303, Doc. 219-40; Gov. Ex. 316, Doc. 220-12; Gov. Ex. 430, Doc. 224-21; Gov. Ex. 432, Doc. 224-23; Gov. Ex. 448, Doc. 224-36; Gov. Ex. 469, Doc. 225-21; Gov. Ex. 499, Doc. 228-12.) In addition to the individual returns included in the record, the Government has also submitted a chart indicating that it has identified 91 total returns listing either FRG or STS as the firm of the paid preparer and 112 total customers of Defendants whose returns were signed by Elsass personally. (See Gov. Ex. 457A, Doe. 225-1.) The Defendants have not attempted to dispute the Government’s contentions regarding these returns.

While the signed tax returns may not be entirely dispositive of the issue, the record also establishes that Elsass and FRG were the moving force behind the decisions and calculations regarding the returns. For instance, the record contains various memoranda from Elsass/FRG that provide instructions for how amended returns should be completed. (See Gov. Ex. 13, Doc. 212-14; Gov. Ex. 26, Doc. 213; Gov. Ex. 31, Doc. 213-5; Gov. Ex. 33, Doc. 213-7; Gov. Ex. 35, Doc. 213-9; Gov. Ex. 39, Doe. 213-13; Gov. Ex. 41, Doc. 213-15; Gov. Ex. 45, Doc. 213-19; Gov. Ex. 47, Doc. 213-21; Gov. Ex. 53, Doc. 213-27; Gov. Ex. 58, Doc. 213-32; Gov. Ex. 119, Doc. 215-8; Gov. Ex. 123, Doc. 215-12; Gov. Ex. 185, Doc. 216-37; Gov. Ex. 187, Doc. 216-39; Gov. Ex 190, Doc. 217-1; Gov. Ex. 195, Doc. 217-6; Gov. Ex. 304, Doc. 220; Gov. Ex. 367, Doc. 223; Gov. Ex. 417, Doc. 224-9; Gov. Ex. 422, Doc. 224-14; Gov. Ex 445, Doc. 224-34; Gov. Ex. 457B, Doc. 225-2; Gov. Ex. 476, Doc. 225-28.) These forms are labeled “INSTRUCTIONS FOR PREPARATION OF AMENDED RETURNS” and typically provide the name of the scam involved, the amount lost by the taxpayer, and the year of discovery, which, as explained infra, is important for the proper analysis of a § 165 theft-loss claim. Further, FRG’s website stated that one of the services provided to customers was “[a]ssistance in preparation and submission of all necessary forms and supporting documentation.” (Gov. Ex. 307 at 3, Doc. 220-3, PAGEID # 6318.)

According to Gwynn Kinsel, an attorney employed by FRG between November 2008 and December 2009,

[Elsass] ... directed how theft loss claims should be reported on the amended returns prepared for [FRG] customers---- [A]though [FRG] itself did not physically fill out the amended tax return forms for its customers, Mr. Elsass oversaw the actions of both the individuals employed by [STS] as well as outside tax preparers, issuing instructions for the tax preparers telling the preparer exactly how to prepare the return and asking for corrections if a return was not prepared to his satisfaction.

(Kinsel Decl. ¶ 9, Gov. Ex. 492, Doc. 228-5, PAGEID # 8099.)

While the Defendants assert that the in-house preparation of the actual amended tax returns by STS has now stopped and is outsourced to other entities, the record also reflects that Elsass himself is still involved in reviewing completed forms. (See Elsass Dep. 583, Gov. Ex. 486, Doc. 227-5, PAGEID # 7783 (Elsass describing request from employee on the day of his deposition that he review a return).) Further, the Court notes that the statutory definition of tax return preparer is broadly written to include those who “employ” others to prepare tax returns. Elsass and FRG accordingly can be considered tax return preparers by virtue of the fact that they currently hire entities to complete amended tax returns for FRG’s customers for a fee. Aside from the actual direction as to how tax forms should be completed and the retention of others to process forms, the Court also looks to the “upfront” research work done by FRG and Elsass identifying scams that may qualify for theft-loss treatment. (See Defs.’ Mem. Supp. Mot. Summ. J. 6-7, Doc. 230, PAGEID ## 8243-44.) As the information gathered through that research is ultimately used in supporting the customers’ individual theft-loss deductions, the Court considers this a significant factor in concluding that FRG and Elsass are tax return preparers.

Finally, the generation of revenue through tax refunds obtained via amended tax returns is the sine qua non of FRG’s business. While the Defendants claim that all of the actual tax preparation is now performed by independent tax professionals, and that FRG accordingly is only a firm that markets the services of these professionals as opposed to being a tax return preparer, the fee structure belies this contention. As noted by the Seventh Circuit in Goulding, Congress intended the definition of tax return preparer to encompass those contributing to the material decisions regarding tax returns. As such, to consider FRG and Elsass to be outside that definition based on structural technicalities would be contrary to the will of Congress.

The Defendants do little to contest the factual record cited by the Government tending to establish that they are tax return preparers within the meaning of § 7407, but instead rely on Judge Boas-berg’s recent decision in Loving v. I.R.S., 917 F.Supp.2d 67 (D.D.C.2013) to argue that they are not tax return preparers. Loving dealt with the Secretary of the Treasury’s authority to regulate tax return preparers involved only in preparing, signing, and submitting tax returns to the IRS under the authority granted by 31 U.S.C. § 330, which authorizes the Secretary to regulate “the practice of representatives of persons before the Department of the Treasury.” 31 U.S.C. § 330(a).

Judge Boasberg ultimately concluded that § 330 could not be interpreted to include those who merely prepare and file tax returns. In doing so, he noted that while the phrase “practice of representatives” is not defined, the phrase “advise and assist persons in presenting their cases” found in subsection 330(a)(2)(D) strongly suggested that Congress intended the term “representatives” to be limited only to those who assist taxpayers during audits and appeals. See Loving, 917 F.Supp.2d at 74. According to Judge Boasberg, “[failing a tax return would never, in normal usage, be described as ‘presenting a case.’ ” Id.

Contrary to the Defendants’ argument that Loving somehow stands for the proposition that they are not subject to injunction pursuant to § 7407, a careful reading of Judge Boasberg’s decision actually supports the Court’s conclusion that they are tax return preparers. In this regard, Judge Boasberg also looked to the broader statutory scheme when he determined that an expansive interpretation of 31 U.S.C. § 330 would contravene the will of Congress, summarizing his analysis as follows:

Two aspects of § 330’s statutory context prove especially important here. Both relate to § 330(b), which allows the IRS to penalize and disbar practicing representatives. • First, statutes scattered across Title 26 of the U.S.Code create a careful, regimented schedule of penalties for misdeeds by tax-return preparers. If the IRS had open-ended discretion under § 330(b) to impose a range of monetary penalties on tax-return preparers for almost any conduct the IRS chooses to regulate, those Title 26 statutes would be eclipsed. Second, if the IRS could “disbar” misbehaving tax-return preparers under § 330(b), a federal statute meant to address precisely those malefactors — 26 U.S.C. § 7407 — would lose all relevance.

Id. at 75-76, 917 F.Supp.2d 67. In other words, the category of tax professionals who challenged the IRS’ regulations of their activity issued pursuant to 31 U.S.C. § 330 in Loving, are covered by § 7407.

In sum, FRG and Elsass are compensated for guiding taxpayers through the process of amending previous years’ tax returns in order to obtain a tax refund arising from a § 165 theft loss. The generation of revenue through the filing of the amended returns is the very essence of FRG’s business, and is accomplished in part using information about the various scams researched by Elsass and FRG. At various times, Elsass and FRG’s employees actually completed and signed tax return forms. At other times, the forms were completed by third parties per Elsass/FRG’s instructions. At still others, third parties were employed by FRG to complete the forms. For these reasons, the Defendants are tax return preparers as that term is defined by § 7701 of the I.R.C. and are thus subject to the Court’s injunctive authority under § 7407.

b.

The Government requests the Court to permanently enjoin the Defendants from acting as tax return preparers pursuant to § 7407 on the grounds that the Defendants have continually or repeatedly engaged in several forms of conduct specified in that section. The Court will now consider the alleged conduct.

i.

Section 7407 makes enjoinable “any conduct subject to penalty under [I.R.C.] section 6694.” 26 U.S.C. § 7407(b)(1)(A). Section 6694 establishes two penalties for the understatement of tax liability by tax return preparers. First, a tax return preparer may be penalized for an understatement of liability due to an “unreasonable position” where the preparer “knew (or reasonably should have known) of the position.” Id. § 6694(a)(1). A tax return preparer cannot be penalized for an unreasonable position if the preparer can show that “there is reasonable cause for the understatement and the tax return preparer acted in good faith.” Id. § 6694(a)(3). Second, a tax return preparer may also be penalized pursuant to § 6694 in instances where an understatement of tax liability is the result of either a) “a willful attempt in any manner to understate the liability for tax on the return or claim” or b) “a reckless or intentional disregard of rules or regulations.” Id. 26 U.S.C. § 6694(b). There is no reasonable cause/good faith defense to a § 6694(b) violation.

Here, the Government contends that Elsass and FRG have repeatedly understated the tax liability of their customers through the use § 165 theft-loss deductions based on willful or reckless conduct. Accordingly, before evaluating the conduct in question, a brief overview of the law governing § 165 theft-loss deductions is in order. Section 165 allows taxpayers to deduct losses not “compensated for by insurance or otherwise.” 26 U.S.C. § 165(a). Included within the permissible § 165 loss deductions for individuals are losses arising from theft. See id. § 165(c, e). A theft loss might give rise to a net operating loss, which may be carried backward for up to three years and forward for twenty years. See id. § 172(a), (b)(1)(F). Further, characterizing a loss as resulting from theft rather than an ordinary capital loss is advantageous to a taxpayer because theft losses are not subject to the $3,000 cap applicable to capital losses. See 26 U.S.C. § 1211(b).

The term “theft” includes, but is not limited to, larceny, embezzlement, and robbery. See 26 C.F.R. § 1.165-8(d). According to the Fifth Circuit, theft is “a word of general and broad connotation, intended to cover and covering any criminal appropriation of another’s property to the use of the taker, particularly including theft by swindling, false pretenses, and any other form of guile.” Edwards v. Bromberg, 232 F.2d 107, 110 (5th Cir. 1956). To establish a theft loss, the taxpayer “must prove that the loss resulted from a taking of property that was illegal under the law of the jurisdiction in which it occurred and was done with criminal intent.” Rev.Rul. 2009-9, 2009-14 I.R.B. 735 (citing Rev.Rul. 72-112, 1972-1 C.B. 60.). While an actual criminal conviction for theft is not required, it may establish conclusively that theft occurred. See Vietzke v. Comm’r, 37 T.C. 504, 510 (1961).

Losses for theft are “treated as sustained during the taxable year in which the taxpayer discovers such loss.” 26 U.S.C. § 165(e). However,

if in the year of discovery there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained, for purposes of section 165, until the taxable year in which it can be ascertained with reasonable certainty whether or not such reimbursement will be received.

26 C.F.R. § 1.165 — 1(d)(3). See also Jeppsen v. Comm’r, 128 F.3d 1410, 1414 (10th Cir.1997) (“the existence of a claim of reimbursement with a reasonable prospect of recovery will prevent a loss from being considered as ‘sustained’ unless and until it is determined with reasonable certainty that such reimbursement will not be obtained”). All facts and circumstances must be considered to determine if a taxpayer has a “reasonable prospect for recovery.” See 26 C.F.R. § 1.165-l(d)(2)(i).

“A reasonable prospect of recovery exists when the taxpayer has bona fide claims for recoupment from third parties or otherwise, and when there is a substantial possibility that such claims will be decided in his favor.” Ramsay Scarlett and Co., Inc. v. Comm’r, 61 T.C. 795, 811 (1974). Conversely, a taxpayer will not be prevented from claiming a theft loss where the possibility of recovery is “remote or nebulous.” Vincentini v. Comm’r, 429 Fed.Appx. 560, 564 (6th Cir.2011) (citing United States v. S.S. White Dental Mfg. Co. of Pa., 274 U.S. 398, 402-03, 47 S.Ct. 598, 71 L.Ed. 1120 (1927)). “The ‘reasonableness’ of a taxpayer’s prospect of recovery is primarily tested objectively, although a court may consider to a limited extent evidence of the taxpayer’s subjective contemporaneous assessment of his own prospect of recovery.” Jeppsen, 128 F.3d at 1418.

Whether a reasonable prospect for recovery exists must be considered at the time the taxpayer elects to claim the theft-loss deduction. See Scofield’s Estate v. Comm’r, 266 F.2d 154, 163 (6th Cir.1959) (“The only fair test is foresight, not hindsight.”). See also Vincentini, 429 Fed.Appx. at 564 (“the Court must examine a taxpayer’s reasonable expectations at the close of the taxable year in which the deduction was claimed”). Finally, the taxpayer bears the burden of establishing entitlement to a tax deduction. See Interstate Transit Lines v. Comm’r, 319 U.S. 590, 593, 63 S.Ct. 1279, 87 L.Ed. 1607 (1943). As such, a taxpayer is not entitled to a § 165 theft-loss deduction if the likelihood of recovery as of the end of the tax year in question is unknowable. See Jeppsen, 128 F.3d at 1418. “Speculation and conjecture will not support a taxpayer deduction under [§ 165].” Vincentini, 429 Fed.Appx. at 564.

The Government alleges that Elsass and FRG have repeatedly understated the tax liability of their clients by claiming improper theft-loss deductions in a manner penalizable under § 6694. The Government points the Court’s attention to several purported financial “scams” involving the Defendants’ customers and other of the Defendants’ conduct, and has submitted evidence that in claiming theft losses arising from their customers’ losses, Elsass and FRG: 1) claimed theft losses in cases where the losses were not criminal in nature under the relevant state law; 2) prematurely claimed theft losses before it could be ascertained with reasonable certainty that the customer had no reasonable likelihood of recovery; 3) claimed theft losses for persons not entitled to claim the loss; and 4) used incorrect tax forms to improperly inflate customers’ refunds. The Court will thus next consider whether the theft loss deductions identified by the Government were improper, and, if so, whether Elsass and FRG’s actions in serving as the tax return preparers for these deductions are subject to penalty under § 6694.

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The first financial “scam” involved an entity named American Business Financial Services (“ABFS”), which sold high interest rate notes to investors backed by sub-prime mortgages. See In re Am. Bus. Fin. Servs., Inc., 360 B.R. 74, 77 (Bankr.D.Del.2007). ABFS ultimately became insolvent and filed for bankruptcy in January 2005. Id. As of 2010, Elsass and his companies prepared amended tax returns claiming theft losses for 372 customers who had lost their investments in ABFS. (United States’ Statement of Contested and Uncontested Facts, ¶ 57, Doe. 229-1, PAGEID #8207.) The Defendants’ ABFS customers received collectively approximately $3.6 million in tax refunds as a result of these amended returns. (Id.) The Government, however, contends that the theft losses claimed by the Defendants on behalf of their ABFS customers were improper and ignored the legal requirements for § 165 theft-loss deductions that the loss involve criminal intent and that the loss be claimed only after the taxpayer can establish with reasonable certainty that no recovery will be made. The Court agrees.

No criminal charges were ever filed against ABFS or its principals. The record includes an internal FRG document indicating awareness of this fact. (See Gov. Ex. 3 at 2, Doc. 212-4, PAGEID # 4327.) The record also includes a document titled “AMERICAN BUSINESS FINANCIAL SERVICES (ABFS) 165(C)(2) SUMMARY” prepared by FRG corporate counsel Gwynn Kinsel, and used by FRG in attempting to justify ABFS theft-loss claims to the IRS. (See Gov. Ex. 24, Doc. 212-25.) With regard to the issue of criminality, this document states in part:

Here, ABFS induced investors to invest with their company based on false and misleading prospectuses and registration statements. Johnson v. American Business Financial Services, No. 05-cv-00232 (E.D.Pa.2005), Complaint at 7. These actions by ABFS constitute theft by swindling or false pretenses....

In addition, the principals of ABFS were using the investors’ money for purposes not agreed to by the investors. The principals of ABFS were paying themselves and family members exorbitant salaries and bonuses while the company was insolvent. Also, the principals “essentially used ABFS as the Santilli family bank” and made excessive purchases that were not business related. Miller v. Santilli No. 1225, Commerce Program, Control Nos. 041182, 061519, 061580 (Philadelphia County Ct. C.P., July 2006) Op. at 3. These actions amount to conversion, the taking of property of another without his or her permission or beyond the scope of the permission. Gilbert Law Dictionary. Again, this is a theft for § 165(c)(2) purposes.

The Secretary of State in Illinois found the actions of ABFS to be fraud and conversion. In the matter of: Jerry Rapport and, Anthony Santilli, File No. 0500015, Temporary Order of Prohibition (Secretary of State, 111.). This finding is sufficient to prove that the actions of ABFS amounted to theft for 165(c)(2) purposes.

(Id. at 1, PAGEID # 4489.)

The information quoted above, may, at first blush, appear somewhat convincing. However, careful consideration reveals that the information borders on misleading and fails to establish the criminal intent requirement of a § 165 theft-loss deduction. First, as noted by the Government, FRG’s “proof’ regarding the false prospectuses and registration statements comes from a complaint filed in a civil class action in the Eastern District of Pennsylvania. As trained attorneys, Elsass and Kinsel were undoubtedly aware that allegations contained in a civil complaint are just that: allegations, which require actual evidence to establish. Further, in the second paragraph quoted above, Kinsel cites a decision in a Pennsylvania state court in an action brought by George Miller, the trustee of ABFS’ bankruptcy estate. Perhaps in quoting an actual legal decision, Kinsel was hoping to add a sort of judicial imprimatur to FRG’s position. To the contrary, a review of the opinion reveals that in the cited portion, the Court was merely quoting directly from Miller’s complaint in deciding a motion for judgment on the pleadings filed by the case’s defendants. (See id. at 23, PAGEID # 4511.)

The action taken by the Illinois Secretary of State and cited by FRG in the ABFS Summary is also of questionable relevance to the issue of criminal intent. On April 8, 2005, the Secretary issued a document known as a temporary order of prohibition against ABFS itself and ABFS principals Anthony Santilli and Jerry Rappaport. (See Gov. Ex. 7, Doc. 212-8.) The Secretary’s authority for issuing the temporary order of prohibition against ABFS arises under Section 11 of the Illinois Securities Law of 1953, 815 ILL. COMP. STAT. 5/11, which provides that:

Anything herein contained to the contrary notwithstanding, the Secretary of State may temporarily prohibit or suspend, for a maximum period of 90 days, by an order effective immediately, the offer or sale or registration of securities ... without the notice and prior hearing in this subsection prescribed, if the Secretary of State shall in his or her opinion, based on credible evidence, deem it necessary to prevent an imminent violation of this Act or to prevent losses to investors which the Secretary of State reasonably believes will occur as a result of a prior violation of this Act.... The temporary order shall set forth the grounds for the action and shall advise that the respondent may request a hearing, that the request for a hearing will not stop the effectiveness of the temporary order and that respondent’s failure to request a hearing within 30 days after the date of the entry of the temporary order shall constitute an admission of any facts alleged therein and shall constitute sufficient basis to make the temporary order final.

Id. 5/ll(F)(2). While the Illinois Securities Law does establish criminal penalties, see id. 5/14, the Court notes that the action taken by the Secretary regarding ABFS cited by the Defendants is administrative in nature. Furthermore, the temporary order of prohibition, while immediately effective, is akin to a complaint in a civil case in that the subjects of the order are provided an opportunity to contest the allegations within the order at an administrative hearing.

Accordingly, in justifying the ABFS theft-loss deductions, FRG and Elsass failed to establish the requisite criminal intent. Several recent Court decisions reflect the absence of evidence of this element. See, e.g., Labus v. United States, No. 5:11-cv-01856, 2012 WL 4483809, *4, 2012 U.S. Dist. LEXIS 139226, *10-*11 (N.D.Ohio Sept. 27, 2012) (“the record is devoid of any evidence that would suggest that ABFS possessed the criminal intent to ‘deprive’ Plaintiff of his investment money without any plan of paying back the principal investments. Instead, the record reflects that ABFS sent Plaintiff monthly interest checks from his four investments for some time prior to filing for Chapter 7 bankruptcy. This fact alone contradicts Plaintiffs contention in his complaint that ABFS acted with the criminal intent to deprive him of his investment money.”); Wazgar v. United States, No. 3:11-cv-311, slip op. at 2 (S.D.Ohio Sept. 25, 2012) (“The Wazgars were not the victim of a ‘theft’ by AFBS as defined by applicable state law.”).

In the portion of their brief in response to the Government’s motion for summary judgment, the Defendants spend much of their argument attacking the deposition testimony of Catherine Johns and repeating the conclusory assertion that the ABFS losses were criminal in nature. However, this line of argumentation ignores the fact that the burden is on the taxpayer to establish the validity of a tax deduction. Just as with their interactions with the IRS, the Defendants have here failed to produce any evidence tending to establish the criminal nature of the ABFS losses.

The lack of criminality renders any prospective theft-loss deduction based on ABFS losses improper. According to the Government, however, even if ABFS losses could be considered criminal in nature, Elsass and FRG also improperly claimed 2005 as the year of discovery for such losses on 261 of the 263 amended returns related to ABFS filed between November 2007 and December 2009. (Pond Decl. ¶¶ 28-29, Gov. Ex. 491, Doc. 228-4, PAGEID # 8094.)

With regard to the year of discovery issue, the record reflects that after 2005, bankruptcy trustee George Miller was pursuing litigation to recover damages in excess of $800,000,000 for ABFS’ creditors. (See, e.g., Gov. Ex. 8 at 1, Doc. 212-9, PAGEID # 4350; Gov. Ex. 10, Doc. 212-11.) Class action litigation was also maintained on behalf of those who purchased notes from ABFS, and a settlement was achieved in 2008. (See Gov. Ex. 32, Doc. 213-6.) The record also includes an internal FRG document regarding ABFS stating the year of discovery as 2005, but also recognizing that the bankruptcy had only been initiated in January of that year. (See Gov. Ex. 1, Doc. 212-2.) This document also references the nearly $17 million class action settlement reached in November 2008. (See id.)

FRG’s ABFS Summary used in responding to IRS concerns over theft-loss deductions taken by FRG’s clients also attempts to justify 2005 as the correct year of discovery, stating that:

Here, ABFS filed bankruptcy in January of 2005, and therefore the loss was discovered by investors in 2005. Once the company filed bankruptcy, a reasonable person would believe that there was no prospect of recovery. Then, in September of 2005 it became clear that there was not going to be any recovery based on the bankruptcy trustee’s Status Update # 1. The update noted that ABFS’s assets were estimated at $45,400,000 and the first secured lender has a secured debt of $75,000,000. Therefore, once the secured debt is paid, there will be no money left over for the unsecured investors and thus there was no reasonable prospect of recover in 2005.

(Gov. Ex. 24 at 2-3, Doc. 212-25, PAGEID ## 4489-90.)

As with FRG’s position regarding criminality, this information borders on misleading, ignores pertinent facts, and was used repeatedly by Elsass and FRG in attempting to justify ABFS theft-losses to the IRS. For instance, Miller’s first status update, dated September 1, 2005, does list available assets of $45,400,000 and secured debt belonging to Greenwich Capital of $75,000,000. (See Gov. Ex. 25 at 3, Doc. 212-26, PAGEID #4543.) The update also mentions, however, that in addition to the $45 million in assets, there were 19 mortgage residuals known as “I/O Strips” pending valuation that could have been worth between $40 million and $180 million. (See id.) Subsequent status updates from 2005 were also ignored. Update 3, dated November 1, 2005, for example, references partial payment made to Greenwich Capital and states that liquidation of the I/O strips plus other assets should be enough to cover the remaining debt. (See Gov. Ex. 6 at 2, Doc. 212-7, PAGE ID # 4334.) The update goes on to state that “I cannot estimate, at this time, the amounts left for any other creditors.” (Id.) Update 3 also mentions that Miller is exploring the possibility of litigation against various third parties, noting that recovery from litigation could take as long as three years. (See id.)

From the record before it, the Court concludes that, even if ABFS losses could be considered criminal in nature, Elsass and FRG’s attempt to claim 2005 as the year of discovery for many of their ABFS clients was not proper. As noted above, it is a taxpayer’s burden to prove a deduction. Further, with regard to § 165 theft-loss deductions, if the likelihood of recovery at the end of a given tax year is simply unknowable, that year cannot be used as the year of discovery. Here, the status updates produced by Miller in 2005 demonstrate that, at the very least, the prospects of recovery remained unknowable as of the end of that year because recovery efforts were only just beginning. These reports show Miller’s ongoing efforts to liquidate ABFS, to evaluate potential recoveries through litigation, and Miller’s assertion that it was impossible to estimate possible returns for creditors other than Greenwich Capital.

Having determined that the theft-loss deductions related to ABFS investment losses claimed by Elsass and FRG were improper, the Court must now consider whether their conduct in claiming the deductions on behalf of their clients is subject to penalty under § 6694. As an initial matter, the improper deductions resulted in an understatement of the tax liability for the Defendants’ clients within the meaning of § 6694 by allowing the clients to claim inflated tax refunds. See 26 U.S.C. § 6694(e) (understatement includes “overstatement of the net amount creditable or refundable”).

Further, the Court concludes that there is no material issue of fact as to whether Elsass and FRG’s conduct violated § 6694(b), which subjects to penalty understatements resulting from willful conduct or a reckless or intentional disregard for IRS rules and regulations. The Treasury Department’s regulations provide that “[a] preparer is considered to have willfully attempted to understate liability if the preparer disregards, in an attempt wrongfully to reduce the tax liability of the taxpayer, information furnished by the taxpayer or other persons.” 26 C.F.R. § 1.6694-3(b). “[Wjillfulness does not require fraudulent intent or an evil motive; it merely requires a conscious act or omission made in the knowledge that a duty is therefore not being met.” Pickering v. United States, 691 F.2d 853, 855 (8th Cir.1982) (per curiam) (citations omitted).

With respect to reckless or intentional disregard of rules or regulations, the regulations provide that:

a preparer is considered to have recklessly or intentionally disregarded a rule or regulation if the preparer takes a position on the return or claim for refund that is contrary to a rule or regulation ... and the preparer knows, of, or is reckless in not knowing of, the rule or regulation in question. A preparer is reckless in not knowing of a rule or regulation if the preparer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable preparer would observe in the situation.

26 C.F.R. § 1.6694-3(c)(l). The term “rule or regulation” is defined broadly to include the I.R.C., regulations issued under the I.R.C., and revenue rulings or notices published in the Internal Revenue Bulletin. See id. § 1.6694-3(e). Finally, the regulations provide that the Government bears the burden of proving that a preparer willfully understated tax liability but that the preparer bears the burden of proving that he or she did not recklessly or intentionally disregard a rule or regulation. Id. § 1.6694-3(h). See also 26 U.S.C. § 7427.

By continually insisting that 2005 was the proper year of discovery for purported ABFS theft losses, Elsass and FRG chose to distort and ignore pertinent information supplied by the bankruptcy trustee, George Miller, that strongly suggested that as of the end of 2005, the prospects for recovery were unknowable. Elsass personally instructed those completing ABFS amended tax returns to use 2005 as the year of discovery. (See Gov. Ex. 31, Doc. 213-5; Gov. Ex. 33, Doc. 213-7; Gov. Ex. 35, Doc. 213-9; Gov. Ex. 39, Doc. 213-13; Gov. Ex. 41, Doc. 213-15; Gov. Ex. 45, Doc. 213-19; Gov. Ex. 47, Doc. 213-21.)

Further, Elsass and FRG ignored the lack of criminal origin of the ABFS losses, which also demonstrates a reckless disregard for the criminality prerequisite of proper theft-loss deductions, as noted in revenue rulings. See Rev.Rul. 2009-9, 2009-14 I.R.B. 735 (citing Rev.Rul. 72-112, 1972-1 C.B. 60.). In this regard, Elsass is familiar with the legal precedent governing Section 165 theft-loss deductions. (Elsass Dep. 157-58, Gov. Ex. 486, Doc. 226-2, PAGEID ## 7550-51.) He is aware that the burden is on the taxpayer to prove every element of such a deduction:

Q. Do you understand that there’s a treasury regulation or a guidance saying you have to file certain things with the 165 claim to substantiate it?

A. You have to prove the elements, and the burden of proof is upon the taxpayer. It says very clearly in the case law and the revenue rulings.

(Id. at 518, Doc. 227-3, PAGEID # 7731.) Elsass is also aware that criminal intent is one of the required elements. (See id. at 517-18, PAGEID ##7730-31; 553-54, Doc. 227-4, PAGEID ##7456-57.) The record also reflects that FRG employees receive training from Elsass as to the requirements of § 165 theft-loss deductions. (See United States’ Statement of Contested and Uncontested Facts, ¶ 21, Doc. 229-1, PAGEID # 8195.)

The egregiousness of FRG and Elsass’ conduct regarding ABFS is amplified by the fact that they continued to prepare hundreds of amended tax returns for their clients in the face of mounting IRS concerns. Between November 2007 and December 2009, FRG made 263 theft-loss claims based on lost ABFS investments, the vast majority of which used 2005 as the year of discovery. (Pond Decl. ¶¶ 28-29, Gov. Ex. 491, Doc. 228-4, PAGEID # 8094.) However, during that same time period, the IRS sent 137 notices of disallowance regarding ABFS to the individual taxpayers and/or FRG employees. (Id. ¶ 30, PAGEID # 8095. See also Gov. Ex. 30 at 3, Doc. 213-4, PAGEID # 4579 (October 17, 2008 letter to taxpayers Donald and Zoe Sloan explaining disallowance of claimed ABFS theft loss on ground that, inter alia, they failed to prove that theft had occurred).) The first disallowance notice from the IRS is dated April 30, 2008. (Gov. Ex. 461, Doc. 225-14.) As of December 2009, FRG had filed 168 ABFS theft-loss claims after the IRS issued this first notice of disallowance. (Id.)

The record also shows that, in filing and defending ABFS claims, Elsass and FRG continuously relied on the disingenuous legal and factual positions contained in their ABFS Summary as they responded to the concerns raised by the IRS regarding the claimed ABFS theft losses. (See, e.g., Gov. Ex. 40 at 1-2, Doc. 213-14, PAGEID ## 4684-85 (February 16, 2009 letter from Elsass and Kinsel to David Zito); Gov. Ex. 43 at 1, Doc. 213-17, PAGEID #4709 (February 25, 2009 letter from Kinsel to Kimberly Putnam); Gov. Ex. 51 at 1, Doc. 213-25, PAGEID #4802 (July 27, 2009 letter from FRG Corporate Counsel Laurie Wirt to Stephen Martin); Gov. Ex. 52 at 1, Doc. 213-26, PAGEID #4818 (August 18, 2009 letter from Kinsel to Carmen Urquia); Gov. Ex. 56, Doc. 213-30 (October 29, 2009 letter from Kinsel to Shelly Welker); Gov. Ex. 57, Doc. 213-31 (November 5, 2009 letter from Wirt to D. Caiazza); Gov. Ex. 59, Doc. 213-33 (November 23, 2009 letter from Kinsel to Greg Nygren); Gov. Ex. 62, Doc. 213-36 (March 11, 2010 letter from Wirt to S. Pritchard); Gov. Ex. 65 at 4-6, Doc. 213-38, PAGEID ## 4904-06 (April 6, 2010 letter from Wirt to Steven Rowe); Gov. Ex. 67 at 2-3, Doc. 213-40, PAGEID ##4915-16 (June 9, 2010 letter from Chad Dworkin of FRG to Thomas Hynes); Gov. Ex. 68 at 1-2, Doc. 214, PAGEID ## 4917-18 (June 14, 2010 letter from Wirt to David Evans); Gov. Ex. 70 at 9-10, Doc. 214-2, PAGEID ##4931-32 (July 20, 2010 letter from Christopher Camboni of FRG to Anne Fleming); Gov. Ex. 473 at 1-2, Doc. 225-25, PAGEID ## 7207-08 (March 27, 2009 letter from Kinsel to Luis Repollet).)

In concluding its discussion of ABFS, the Court draws attention to Government Exhibit 309, which, in the Court’s view, serves to illustrate the callousness toward the theft-loss rules and regulations demonstrated by Elsass and FRG. That exhibit is an internal FRG document listing the years of discovery for various scams researched by FRG. ABFS is listed in 2005, but includes a notation that says, “Per Toby this can be put in '06 if it works better.” (Gov. Ex. 309 at 1, Doc. 220-5, PAGEID #6330.) For the above-stated reasons, the Court concludes that Elsass and FRG, acting as tax return preparers, improperly claimed § 165 theft-losses on behalf of clients who had suffered losses of ABFS investments, and that FRG and Elsass’ conduct in doing so is subject to penalty under § 6694(b).

II.

The second scam cited by the Government involved Joanne and Man Schneider, who orchestrated a massive Ponzi scheme by selling high-return promissory notes to investors and then paying the interest owed to earlier investors with cash received from later investors. See Cramer v. United States, 885 F.Supp.2d 859, 860 (N.D.Ohio 2012). Between April 2006 and January 2010, FRG was involved in making 30 theft-loss claims related to the Schneiders’ scheme, with the IRS sending a total of 29 notices of disallowance related to those claims to FRG clients and/or FRG employees. (Pond Deck ¶¶ 32-33, Gov. Ex. 491, Doc. 228-4, PAGEID # 8095.) After receiving the first notice of disallowance in March 2007, FRG served as tax return preparer for 19 additional Schneider theft-loss claims. (Id. ¶ 34.) The Government concedes that the Schneider Ponzi scheme was criminal in nature, but instead contends that Elsass and FRG willfully and/or recklessly filed theft-loss claims using improper years of discovery. The Court again agrees.

The chronology relevant to the Schneiders’ scheme was summarized by Judge Oliver as follows:

The Ohio Department of Commerce (“ODC”) filed ODC v. Schneider on Dec. 1, 2004 in the Cuyahoga County Court of Common Pleas in order to stop the Schneiders from selling unsecured promissory notes. The ODC successfully obtained a preliminary injunction against the Schneiders. The court also appointed a special master — Matthew Fornshell, former director of enforcement for the Ohio Division of Securities — to supervise compliance with the injunction.... By the time the suit was filed, the Schneiders owed approximately $60 million in unpaid notes, but none of the notes were in default as of December 2004. The Schneiders continued to sell the notes in violation of the court’s order until February 2005 when their assets were frozen. The court then elevated Fornshell to Receiver to oversee the liquidation of the Schneiders’s assets and the distribution of those assets to investors.

In his capacity as Receiver, Fornshell filed periodic updates with the court. In a filing made on [sic] December 2008 as part of the ODC v. Schneider litigation, the Receiver reported that the liquidation of the Schneiders’s assets yielded a total of $20,955,622.98. In the same report, the Receiver also told the court it was unknown how much of the Schneiders’s assets would be distributed to unsecured investors until the claims of secured investors were resolved. Of that approximately $21 million, secured creditors eventually made claims in the amount of $20 million dollars.

Plaintiffs were also involved in two other suits concerning their investments with the Schneiders, both filed by the Receiver. The first suit was Kathy Young v. First Merit Bank, filed on May 10, 2006 and the second was Fornshell v. First-Merit Corp., filed on May 24, 2006. Fornshell was brought by the court-appointed Receiver on behalf of unsecured creditors. Plaintiffs recovered 17% of their investment, in the amount $11,900, on December 12, 2011 from a settlement in Forshnell v. FirstMerit. On December 27, 2011, the Receiver notified unsecured investors that he did not expect additional funds to become available for reimbursement.

Cramer, 885 F.Supp.2d at 860-61 (citations omitted).

FRG initially submitted amended tax returns on behalf of clients claiming Schneider theft losses using 2004 as the year of discovery. (Gov. Ex. 95, Doc. 214-25; Gov. Ex. 97, Doc. 214-27; Gov. Ex. 98, Doc. 214-28.) The IRS then began to disallow these claimed theft losses on the ground that, as of the end of 2004, the potential for recovery remained unknown. (See Gov. Ex. 109 at 4, Doc. 214-39, PAGEID #5141.) Significantly, Elsass and FRG continued to market 2004 as the year of discovery to potential clients after the IRS began determining that the use of 2004 was improper. (See Gov. Ex. 113, Doc. 215-2 (March 5, 2008 letter from Elsass to potential customers identifying 2004 as Schneider year of discovery); Gov. Ex. 109 at 4, Doc. 214-39, PAGEID # 5141 (November 2007 notice of disallowance of Schneider theft-loss claim of Richard Pavlieh on the grounds that taxpayer could not establish that no reasonable prospect for recovery existed in 2004).)

For several customers for whom the IRS ruled that 2004 was not a proper year of discovery, Elsass and FRG would re-file claims using later years of discovery. (See Gov. Ex. 106, Doc. 214-36; Gov. Ex. 118, Doc. 215-7; Gov. Ex. 119, Doc. 215-8; Gov. Ex. 123, Doc. 215-12; Gov. Ex. 130, Doc. 215-19.) For example, FRG used 2007 as the year of discovery in several instances, including for some taxpayers for whom it had initially used 2004. (See Gov. Ex. 121, Doc. 215-10; Gov. Ex. 124, Doc. 215-13; Gov. Ex. 126, Doc. 215-15.) As with the 2004 amended returns, the IRS also denied 2007-Schneider claims on the ground that recovery was still possible as of that time. (Gov. Ex. 61 at 20, Doc. 213-35, PAGEID # 4864 (March 10, 2010 notice of disallowance regarding Schneider theft-loss claimed by Stephen and Karen Wazgar on the grounds, inter alia, there existed a potential future recovery in 2007).)

As the IRS indicated in its disallowance notices, it was improper for Elsass and FRG to use years between 2004 and 2007 as the year of discovery for Schneider theft-loss deductions because reasonable prospects for recovery existed during that time period or the prospects were simply unknowable. As of the end of 2004, recovery efforts were only in there very initial stages and, as of the end of 2007, the recovery efforts remained ongoing. The Ohio Department of Commerce had initiated litigation against the Schneiders in late 2004, and, as of December of that year, the Cuyahoga County Court of Common Pleas had only just appointed Fornshell as special master to evaluate the Schneiders’ plan to repay investors. (See Gov. Ex. 80 at 2, Doc. 214-11, PAGEID # 5052.) As of that time, the Schneider’s had not yet defaulted on the notes. Cram-er, 885 F.Supp.2d at 861.

The record contains a declaration from Schneider receiver Matthew Fornshell. In it, Fornshell describes instances where Elsass contacted him in failed efforts to obtain a list of investors who lost money to the Schneider scheme. (See Fornshell Decl. ¶¶ 4-5, Gov. Ex. 493, Doc. 228-6, PAGEID # 8108-09.) According to Fornshell, efforts to recover money for the Schneiders’ creditors began in February 2005 and remain ongoing. (Id. ¶ 3, PAGEID # 8108.) Further, Fornshell states that, in the early stages of the receivership, his consistent response to inquiries from investors concerning recovery of lost funds was “that I was unable to determine the amounts that would be distributed with any degree of certainty.” (Id. ¶ 9, PAGEID # 8109.)

The record also contains a March 2006 email from Fornshell describing the prospects for recovery for the unsecured Schneider investors. (See Gov. Ex. 104, Doc. 214-34.) In the email, Fornshell discusses the proposed liquidation of Schneider assets, concluding that of the $15-$20 million likely to be realized through liquidation, all but $2-$4 million would likely be paid to secured creditors. (See id.) The remaining $2-$4 million would be used to compensate the unsecured investors and pay fees. (See id.) Significantly, however, Fornshell also mentions the prospect of litigation against third parties, stating that proceeds would benefit unsecured creditors, but that a successful result could take as long as two years. (See id.) Elsass received this email in March 2007. (See id.) As noted by Judge Oliver, the liquidation actually yielded about $21 million, with $20 million claimed by secured creditors. Fornshell’s litigation was also successful — resulting in a settlement and some recovery to unsecured investors. However, as of the time Fornshell sent the email, possible recovery on the litigation remained up to two years in the future, or around March 2008 in a worst-case scenario. (See also Gov. Ex. 100 at 1, Doc. 214-30, PAGEID # 5120 (January 22, 2007 letter from Fornshell to Schneider investors providing update on recovery efforts, states “While it is difficult to set specific time lines for determining when distributions can be made, and to whom they can be made to, I anticipate that process will begin during the first half of 2007.”).)

As noted previously, the burden is on the taxpayer to prove entitlement to a deduction, and where the prospect of recovery is unknowable in a given year, that year cannot serve as the year of discovery for a theft-loss deduction. Here, given the unknowable prospects for recovery at the end of 2004, evidenced by the fact that recovery efforts had only just begun, and the ongoing recovery efforts of Fornshell through 2007, which would have appeared promising as of the end of that year for at least partial recovery based on the incomplete liquidation of the assets seized from the Schneiders and the third-party litigation, Elsass and FRG simply could not establish that no reasonable prospects for recovery existed either as of the end of 2004 or the end of 2007. Judge Oliver reached essentially the same conclusion in both Cramer and Zinn v. United States, 885 F.Supp.2d 866 (N.D.Ohio 2012)— granting summary judgment to the Government on the grounds that the taxpayers lacked evidence to establish that no reasonable prospects for recovery existed with regard to the Schneider scheme in 2004 or 2007. See Zinn, 885 F.Supp.2d at 874 (“The court agrees with Defendant, and finds that there is insufficient evidence from which a reasonable jury could find Plaintiffs had no reasonable prospect of recovery at the close of 2004. More specifically, Plaintiffs have not provided evidence to rebut the inference that the filing of ODC v. Schneider litigation at the close of 2004 presented a reasonable prospect of recovery.”); Cramer, 885 F.Supp.2d at 866 (“Plaintiffs have presented no evidence that as of December 31, 2007, their chances of recovery from [the] third-party litigation was nebulous or remote.”).

Further, there is no material dispute of fact as to whether Elsass and FRG acted willfully and/or recklessly or intentionally disregarded rules and regulations in violation of § 6694(b) by claiming Schneider theft losses using either 2004 or 2007 as the year of discovery. As with the ABFS claims, in making the Schneider claims, Elsass and FRG ignored critical information and the precedent and law surrounding theft-loss deductions, and continued to file claims even in the face of frequent IRS disallowances. Elsass, who was in communication with Fornshell, was aware that recovery efforts were merely beginning or remained ongoing during the 2004 through 2007 timeframe, and was also attuned to the specific details of Fornshell’s efforts. (See Gov. Ex. 89, Doc. 214-20.) In a February 23