The New York State Tax Appeals Tribunal has upheld the validity of a notice of deficiency imposing civil fraud penalties that was issued after an individual taxpayer was found guilty of criminal tax fraud and was required to pay restitution in an amount equal to the tax improperly unreported on her New York State and City personal income tax returns. Matter of Vilma Bautista, LLC, DTA Nos. 827182 (N.Y.S. Tax App. Trib., Mar. 13, 2017).

Facts. Petitioner Vilma Bautista was at one time an assistant to Imelda Marcos, the former First Lady of the Philippines. Ms. Bautista worked for Mrs. Marcos in New York City. In 1995, Ms. Bautista acquired several high-value paintings "that had mysteriously disappeared earlier that year from the walls" of a Manhattan townhouse owned by the Philippine government that was used by Mrs. Marcos when she was in New York City. Ms. Bautista secretly stored the paintings at her own Manhattan apartment for several years and, in 2010, sold one of the missing paintingspainted by Claude Monetfor over $32 million to a private purchaser.

Ms. Bautista filed a 2010 New York State resident personal income tax return on which she: (a) filed as a New York City nonresident and claimed that she did not maintain living quarters in the City during 2010, even though she maintained her Manhattan apartment throughout 2010; and (b) failed to report any income from the sale of the Monet painting.

In November 2013, Ms. Bautista was found guilty of crimes including filing a false instrument and criminal tax fraud. The convictions were premised on the finding that, with deceitful intent, Ms. Bautista filed a fraudulent 2010 tax return because she did not report her receipt of the proceeds and resultant income from the sale of the Monet painting and did not pay personal income taxes due to the State and City of New York.

As a result of her conviction, on January 13, 2014, Ms. Bautista was ordered to pay restitution for the unpaid New York State and City taxes of over $3.5 million, and on March 19, 2014, a warrant to collect such taxes was issued against Ms. Bautista. The tax owed and restitution due was calculated consistent with testimony of an auditor in the Department's Criminal Investigations Division, who had calculated Ms. Bautista's personal income tax deficiency based on the assumption (consistent with the factual conclusions ultimately reached at trial) that Ms. Bautista had come to possess the Monet painting in 1995 either illegally or on behalf of its true owner and subsequently retained the sale proceeds in 2010.

Separately, on January 23, 2014, the Department issued Ms. Bautista a notice of deficiency imposing New York State and City civil fraud penalties of over $7.5 million (representing double the amount of tax unreported on her original 2010 tax return) and interest (the "Civil Penalties Notice"). However, the Civil Penalties Notice did not assert any tax liability, presumably because the actual tax liability was already addressed in the criminal restitution order and subsequent warrant.

Ms. Bautista subsequently protested the Civil Penalties Notice, claiming that it was invalid because the Department did not independently issue a deficiency notice identifying any tax due and instead relied on the tax assessment related to the restitution order to support the penalties identified in the Civil Penalties Notice.

ALJ Decision. At the hearing before an Administrative Law Judge, Ms. Bautista further maintained that the criminal convictions against her did not preclude her from challenging the amount of tax underpaid on her original returns as identified in the Civil Penalties Notice. The ALJ upheld the Civil Penalties Notice, concluding, among other things, that Ms. Bautista was collaterally estopped from disputing the amount of tax referenced in the Civil Penalties Notice. Ms. Bautista subsequently appealed to the Tribunal.

Tribunal Decision. The Tribunal upheld the decision of the ALJ and sustained the validity of the Civil Penalties Notice. First, the Tribunal concluded that the Civil Penalties Notice asserted fraud penalties based on the facts outlined by a Department auditor during Ms. Bautista's criminal tax proceedings and rejected a series of technical arguments by Ms. Bautista that the Department needed to separately confirm that a tax deficiency was present in order to issue the Civil Penalties Notice. Among other things, the Tribunal rejected Ms. Bautista's claim that the fraud penalties were based on a "theoretical deficiency."

Further, the Tribunal concluded that there was no statutory support to impose a requirement that the Civil Penalties Notice must either include an income tax assessment or be based on a prior income tax assessment by the Department. Based on a close reading of the statutes, the Tribunal concluded that penalties may be assessed when a tax deficiency exists, whether or not the tax deficiency is independently assessed, as the statutory language distinguishing between a "deficiency" and a "notice of deficiency" provides the Department with some flexibility in situations like those present, i.e., when an amount equal to the tax liability has already been included within a restitution order and warrant. Tax Law 681(b), (g) & 685(m).

Finally, the Tribunal swiftly dismissed Ms. Bautista's collateral estoppel claim. The Tribunal stated that Ms. Bautista only argued at the Tribunal that she was not collaterally estopped from challenging the validity of the Civil Penalties Notice. The Tribunal pointed out that the ALJ decision did not find that Ms. Bautista was collaterally estopped from making such a challenge, and, in any case, the Tribunal stated that it fully considered the validity of the Civil Penalties Notice in reaching its determination.

Additional insights

From a practical standpoint, it seems sensible that the Tribunal did not require the Department in this case to issue a separate notice asserting a deficiency of tax in order to assert a deficiency of penalties against Ms. Bautista. While the Tribunal states that Ms. Bautista portrayed the fraud penalties as having been based on a "theoretical deficiency," it seems clear that the Department asserted penalties based on an actual tax amount calculated for purposes of Ms. Bautista's criminal trial by one of the Department's auditors.