Bankruptcy Court Limits Prior Supreme Court Decision on Equitable Tolling

Regular readers of the blog know that the tax clinic at Harvard has been pushing to break down jurisdictional barriers and have equitable tolling applied to allow taxpayers to get into court in situations in which the government has caused, or partially caused, them to miss the filing deadline. The IRS vigorously opposes our requests just as it vigorously opposed the equitable tolling request in the cases leading to the Supreme Court’s decision in Brockamp v. United States, 519 U.S. 347 (1997).

Sometimes the IRS wants to use equitable tolling. In 2002, it won a major victory in the Supreme Court in the case of Young v. United States, 535 U.S. 43 in which the court found that the time period for an income tax liability to have priority status could be tolled by a prior bankruptcy case. The decision significantly expanded the possible life of priority status for claims of the IRS. Priority status not only assists the IRS in recovering from the bankruptcy estate but makes the tax non-dischargeable because of the interplay of the priority and discharge provisions. In Clothier v. IRS, No. 18-00104 (Bankr. W.D. Tenn. 2018) the bankruptcy court held that Young no longer applies because of changes to the law in 2005.

I feel confident that the IRS will appeal this decision; however, the decision has nationwide implications and will no doubt cause enterprising bankruptcy lawyers, who previously did not think that the changes to the bankruptcy law in 2005 changed the outcome in the Young case, to litigate this issue around the country. When coupled with Internal Revenue Service v. Murphy, a case of first impression from the First Circuit issued on June 7, 2018, this might keep the IRS and the U.S. Attorneys representing the IRS busy at the end of a high number of bankruptcy cases obtaining rulings from the bankruptcy court regarding discharge. Our post on Murphy can be found here.

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Bankruptcy code section 507(a)(8)(A) has three subparts describing the income taxes that achieve priority status in a bankruptcy case. Subpart (i) describes income taxes for which the tax return is due within three years, including extensions, of the bankruptcy petition. This subpart would make a debtor’s taxes for the years 2017, 2016 and 2015 entitled to priority status if the debtor filed bankruptcy today because the returns for those years were due on April 15, 2018; April 15, 2017 and April 15, 2016, and each due date is within three years of today’s date. If the debtor obtained an extension to file the 2014 tax return, the due date for that return would have been October 15, 2015 and that due date is also with three years of today’s date. If the debtor did not obtain an extension to file the 2014 return, the due date of April 15, 2015 is more than three years from today’s date and any liability for that year would not meet the priority test imposed by subpart (i).

Because the ability to assess income taxes, and therefore to collect income taxes, involve the deficiency procedure which allows the taxpayer to delay the timing of the assessment by failing to file a return or declining to accept a proposed increase, Congress added two additional subparts to BC 507(a)(8)(A) to cover the eventuality that an assessment would not occur at or near the original due date for filing the return. The thinking behind the provisions for priority status for taxes was that the IRS should have a reasonable time to collect before a tax loses its priority status. It picked three years as the generally reasonable time but knew that the three year rule could be frustrated by certain taxpayer actions which is why it created subparts (ii) and (iii).

Subpart (ii) provides priority for taxes assessed within 240 days of the bankruptcy petition. I will come back to talk about the exceptions to subpart (ii) which form the basis for this decision but first want to explain how it works. A typical case in which subpart (ii) would apply involves a liability assessed after a Tax Court case or an extended examination. If the IRS audited the debtor’s 2013 return, it might be April 1, 2018 before the Tax Court rendered a decision regarding additional taxes for that year and the IRS made an assessment based on the decision. If the taxpayer filed bankruptcy today, the income tax liability for 2013 would not receive priority status based on subpart (i) because more than three years have passed since the due date of the return; however, today’s date is less than 240 days after the making of the additional assessment for 2013 causing subpart (ii) to bring this liability into priority status. Note that if the debtor had an outstanding liability stemming from the filing of his return because he did not include sufficient remittance, the liability related to the return would not have priority status because it would fail the tests of both (i) and (ii). It would be a general unsecured claim while the liability for the same tax period assessed as a result of the Tax Court decision would have priority status.

Subpart (iii) applies to those taxes which the IRS can still assess. Building on the prior example, assume that the debtor filed a Tax Court petition for 2013 but the Tax Court has not yet rendered a decision. The IRS cannot yet assess the taxes in the notice of deficiency. It has a priority claim for those taxes based on subpart (iii). It would not have priority status based on subpart (i) since more than three years has passed since the due date of the return nor would it have priority status based on subpart (ii) since there has been no assessment within 240 days of the filing of the bankruptcy petition. While subpart (iii) would appear to grant priority status for unfiled or fraudulent returns since the assessment period would remain open in those instances, an exception prevents the IRS from gaining priority status if the reason the statute of limitations on assessment remains open is due to an unfiled or fraudulent return. The discharge provisions will allow the IRS to continue collecting from the debtor after bankruptcy on this type of debt but the priority provisions prevent the IRS from gaining an advantage over other creditors from the property of the estate when the debtor’s bad actions with respect to taxes created the problem.

Circling back to subpart (ii) and the issue in Clothier it is necessary to look at the exceptions that exist in that subpart. Prior to 2005, it contained an exception in the case of a pending offer in compromise which extended the 240 day period if an offer was pending during that time period for the period the offer was pending plus 30 days. In the 2005 bankruptcy legislation, Congress added a second exception which provides “any time during which a stay of proceedings against collections was in effect in a prior case under this title during that 240 day period, plus 90 days…”

The bankruptcy court here finds that the passage of this subsection, passed after the decision in Young, shows Congressional intent to overrule Young and to limit the application of the tolling of the priority period to the circumstance prescribed in the new subsection in subpart (ii). If correct, this means that the tolling permitted by Young would not apply to extend the time in subpart (i) which is the time period on which the IRS was relying in Clothier.

Here, the debtors filed the bankruptcy case at issue in the opinion on September 4, 2013. The tax years at issue in the discharge proceeding are 2008 and 2009 for which the debtors had extensions to file until October 15 of year of the respective years. Debtors filed a prior bankruptcy petition on January 19, 2012 which was dismissed on June 5, 2013.

The bankruptcy court quickly and correctly found that the 2009 liability was entitled to priority status under BC 507(a)(8)(A)(i) because the filing of the current bankruptcy fell within three years of the extended due date for the 2009 return, viz., the return was due on October 15, 2010 which was less than three years prior to September 4, 2013. (The bankruptcy filing was ill timed if motivated by eliminating this tax debt absent consideration of the effect of Young.)

A very different result, however, applies with respect to 2008. The due date for the 2008 return, as extended, clearly falls outside of the three year period in BC 507(a)(8)(A)(i). Here, the IRS filed a priority claim relying on Young which tolled the time period due to the prior bankruptcy filing. The prior bankruptcy existed long enough to cause the new bankruptcy to fall within the three year period. Because of the apparent codification of the Young decision in BC 507(a)(8)(A)(ii), the bankruptcy court finds that Young no longer helps the IRS when it relies on subpart (i). Since the IRS does not receive the additional tolling, the 2008 tax debt does not achieve priority status and since it was not classified as a priority debt it was discharged in the bankruptcy case.

I have not looked at the brief filed by the IRS in this case to discover what arguments it makes that equitable tolling should continue in the face of the statue change. The statute change was driven by the bankruptcy commission created in the 1994 bankruptcy legislation. That commission created a tax advisory panel which recommended several changes to the bankruptcy code to make it better align with the tax code. The recommendations of the tax advisory panel and the bankruptcy commission were wrapped up a few years before the decision in the Young case but, after the IRS victory in Young no one went back to the proposed legislation to remove the change to subpart (ii). Now we will find out if the bankruptcy court’s seemingly logical interpretation of the statutory change effectively overrules Young and limits the IRS to the new statutory provision.

The reason for tolling the time period still exists when the IRS relies on subpart (i) to achieve priority status. The tax clinic at Harvard has some experience with arguing equitable tolling. We will be thinking about filing an amicus brief on behalf of the IRS. Given our track record on this issue, it would be the kiss of death.

 

In Major Victory for IRS DC Circuit Upholds IRS Annual Filing Program

In a major victory for IRS, in AICPA v IRS, the DC Circuit upheld the voluntary annual filing season program. The annual program allows unenrolled preparers to take a competency test and satisfy continuing education requirements in exchange for limited representation rights before Exam and publication in the IRS’s database of preparers, along with enrolled agents, CPAs and attorneys. The opinion reaches the merits of the IRS’s authority to create the annual program. In a prior opinion, the district court had found that AICPA did not have standing to bring the action that challenged the program. The DC Circuit, by reaching the merits of AICPA’s challenge, analyzed the reach of Loving and whether the program was a legislative rule that should have been issued via regulations rather than via a revenue procedure.

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To get to the merits of the dispute the DC Circuit reversed the lower court on statutory standing.  The lower court held that AICPA did not have standing to bring the challenge. The DC Circuit felt that the additional supervisory responsibilities of CPAs and other licensed preparers, and the concomitant possibility that failing to supervise those preparers may bring sanctions under Circular 230, meant that AICPA had enough skin in the game to challenge the program.

The real importance of this decision is twofold:  first, the majority opinion takes a somewhat limited read of Loving, and second, in finding that the program is not a legislative rule for APA purposes and thus was not required to be issued under the APA notice and comment regime, the opinion provides cover for other IRS actions that the IRS may argue are merely interpretive and thus not subject to notice and comment.

As to the AICPA view that the annual program was a backdoor way to avoid Loving and regulate return preparation, the court disagreed, emphasizing that the rules allow for establishing competence in representing taxpayers in the exam process rather than regulate return prep per se:

We see nothing in the Program that attempts to resurrect regulations of the type enjoined in the Loving decisions. Unenrolled tax preparers who participate in the program “consent to be subject to the duties and restrictions relating to practice before the IRS in [certain sections of] Circular 230,”id. § 4.05(4); they do not consent to be governed by Circular 230 insofar as they are engaged in the business of tax preparation.

The Program also ties violations of Circular 230 to the limited practice right, not to the preparation of tax returns: Record of Completion holders “who violate Circular 230 during the course of [their] representation [before the IRS]will have their Record of Completion and ability to represent a taxpayer before the IRS under this revenue procedure revoked.” Id. § 7.01(2). When seen in this light, it is clear that the participants’ commitment to follow Circular 230 is coextensive with the IRS’s authority under § 330(a) to regulate practice before it.

The issue that generated a spirited dissent was whether the program required notice and comment. This case is another in a line of cases where courts (mostly in the nontax context) have struggled to define what in fact is a legislative rule which, under the APA, requires notice and comment, as compared to an interpretive rule that is not required to be issued through notice and comment. Here, that was a crucial issue because the IRS served up these rules via a revenue procedure, rather than via regulations. AICPA argued that the program was in fact a legislative rule and the IRS failure to comply with notice and comment meant that it was improperly established.

The majority’s view that the rules were not legislative stemmed mostly from the voluntary nature of the program:

In this case the Revenue Procedure and associated Program do not bind unenrolled preparers at all; the Program merely provides an opportunity for those unenrolled preparers who both choose to participate and satisfy its requirements.

As to the argument that the rules imposed new burdens on supervisors (more akin to a legislative rule), the majority noted that supervisors had responsibilities under Circular 230 prior to the program, and that the opt in to Circular 230 for the unlicensed preparers who take the annual program does not extend to additional supervisory responsibilities pertaining to return preparation:

Nor does it impose any new or different requirement upon supervisors or unenrolled agents; Circular 230 bound supervisors and unenrolled agents before the Program took effect and continues to bind them now. [note omitted]

In further finding that the rule was interpretive, the majority took a dig at IRS for not being clearer in its revenue procedure that it meant to illustrate the meaning of the statutory term competence:

The AICPA also argues the Revenue Procedure cannot be an interpretive rule, and in its view therefore must be a legislative rule, because it “contains not a word of the reasoned statutory interpretation … that typifies an interpretative rule.” We disagree, although we acknowledge the agency could have been more clear. By clarifying how an unenrolled preparer seeking to practice before the IRS may “demonstrate … necessary qualifications … and competency” within the meaning of § 330(a), the Revenue Procedure “reflects an agency’s construction of a statute that has been entrusted to the agency to administer.” Syncor Int’l Corp. v. Shalala, 127 F.3d 90, 94 (D.C. Cir. 1997); see Interport Inc. v. Magaw, 135 F.3d 826, 828-29 (D.C. Cir. 1998) (holding a rule interpretive where “it explains more specifically what is meant” in another authority, in that case a legislative rule). As stated above, the Program requires unenrolled preparers who want to participate to complete a set number of hours of instruction, on specific topics, and pass a test before gaining the limited practice right. See REV. PROC. 2014-42 §§ 4, 6. Those requirements are the agency’s interpretation of what § 330(a) means by “competency” and the other criteria it lists. [footnote omitted]

The dissent focused on two main issues: first, it noted that the IRS power to allow unenrolled preparers limited rights in examinations initially arose via regulations that were issued with notice and comment, and changes to those rules likewise had to follow from notice and comment. Second, it argued that the majority opinion failed to appreciate the reach of Circular 230 and its possible imposition of monetary sanctions for violations of the annual program.

Practitioners and academics will be digging in deeper on the spirited disagreement between the dissent and majority on whether the program is in fact the product of a legislative rule. The disagreement between the majority and dissent over the reach of Circular 230 (and whether the program imposes the possibility of newer sanctions on supervisors)  reminded me of Karen Hawkins’ insightful 2017 Griswold lecture, where she discussed how “because it has not been amended to reflect current case law, legislation or clarifications….” parts of Circular 230 have “become vague, ambiguous, outdated and, in some instances unadministrable.”

My quick takeaway of the case is that there is significant uncertainty in the reach of Circular 230 and the contours as to what is a legislative rule. IRS should tread carefully when establishing new programs as significant as this. IRS could have benefitted from the input that notice and comment provides, as well as perhaps given it more time to think through how the program could be more effectively administered.

Requesting Information about IRS Collection Activity on a Spouse or Former Spouse

We recently celebrated the 20th anniversary of the Restructuring and Reform Act of 1998 (RRA 98). That legislation requires the Treasury Inspector General for Tax Administration (TIGTA) to perform a number of annual audits to determine if the IRS complies with specific provisions of the Internal Revenue Code. One of the matters that TIGTA must review and report on each year concerns compliance by the IRS with the requirement that the IRS provide information to spouses about collection from the other spouse or former spouse on an account resulting from a joint return. TIGTA has recently issued its 20th annual report on this topic which shows that 22 years after enactment of the law requiring disclosure to the other spouse and 20 years after requiring an annual review a high percentage of IRS employees do not understand the law and the guidance in the Internal Revenue Manual (IRM) does not adequately guide.

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For anyone who has asked the IRS for information about a spouse or former spouse regarding a liability stemming from a joint return, the TIGTA report will not come as a surprise. Maybe the civil and criminal penalties IRS employees face for making a wrongful disclosure, in addition to the employee sanctions, should cause us to expect that if you ask for information about someone other than yourself the IRS employee’s knee jerk reaction will be no since not providing the information will almost never get the employee into trouble but providing it when they should not has a high likelihood of creating a personal problem for the employee. The IRS generally does a good job of not disclosing. Ask President Trump who should be a big fan of the IRS and its compliance with disclosure laws. We have not seen his returns despite a lot of curiosity about them. The lack of a leak speaks highly of the IRS ability to follow the disclosure provisions.

When Congress has created an exception to the general rule of non-disclosure, the IRS does not get high marks. Part of the problem stems from the complexity and length of IRC 6103. Anyone taking the time to read that statute from end to end knows that it is not only one of the longest sections in the code but is also quite complex. Still, the subsection added in 1996 to allow one spouse to find out what is happening regarding collection from the other spouse (or former spouse) should not create too difficult a technical barrier to compliance. Yet, a relatively high percentage of the employees at the IRS cannot get it right.

One of the issues that regularly tripped up IRS employees was mirrored accounts. We recently discussed the misinformation delivered by IRS regarding a mirrored account and that case did not involve the disclosure exception in IRC 6103(e)(7) or (8). The TIGTA report shows that when the IRS creates mirrored accounts, as it will do when there is an innocent spouse request or a Tax Court or bankruptcy petition by just one party to a joint return, IRS employees become even more reluctant to disclose information about the other party to the joint return. For anyone not familiar with the term mirrored account discussed in the TIGTA report, read our post here, which provides a brief explanation of the IRS master file system and the non-master file, or mirrored system of accounts, created in certain circumstances where the accounts of taxpayers on one master file assessment, typically a joint return assessment, move in different directions and require special handling.

The TIGTA report not only shows that IRS employees do not understand how to respond when the IRS creates a mirrored account but also that the IRS has done a poor job of writing the IRM to guide its employees on how to handle requests for information from one spouse about another. Helpfully, the IRS does not require the request to be made in writing; however, in far too many cases taxpayers requesting information about their spouse or former spouse simply get turned away and told they do not have access to such information. Anyone trying to obtain this information on behalf of a client may not be able to convince the IRS employee by citing them to an IRM provision – the normal place to start any discussion with an IRS employee – since the IRM has not provided clear guidance.

In March, the IRS attempted to address this problem by putting a number of examples in the IRM to guide its employees to the right answer. Look at IRM 5.19.5.4.11.1 (Mar. 9, 2018). Perhaps the new IRM provisions will help to clear up the problem either by making IRS employees more informed in the first place or making them comfortable when the taxpayer or the representative cites the IRS to the new IRM provision in support of releasing the information. Anyone who has sought to convince an IRS employee of the law knows that citing to the Code is a waste of breath. The only thing that matters to 99% of IRS employees is the guidance in the IRM. The TIGTA report did not test IRS employees after the release of the new IRM provisions. Perhaps spouses seeking information in the future will have better luck. My guess is that they will not but with the new IRM provisions perhaps knowledgeable representatives will have more success in citing to the IRM.

 

Jurisdiction in the Court of Federal Claims and FBAR Cases

Yesterday, in Paying the Full FBAR Penalty, Keith discussed the Court of Claims opinion in Norman v US, which upheld an FBAR penalty and disagreed with district court opinions in Colliot and Wadhan concerning the intersection of the FBAR regs and the statute.  Keith’s post flags an important split in views concerning the intersection of regs, which cap the penalty at $100,000, and the later-enacted statute, which provides that the maximum penalty “shall be increased” to the greater of $100,000 or 50% of the account.

Keith notes that the case was tried in the Court of Federal Claims; most of the cases concerning FBAR penalties have arisen in federal district courts. There is a side jurisdictional issue in the case, and one of the reasons for the delay between the complaint being filed and the outcome Keith discussed is that the government initially argued in Norman that only federal district courts could hear FBAR cases.

Here is the statutory context of the dispute.

Title 28 Section 1355 states that “district courts shall have original jurisdiction, exclusive of the courts of the States, of any action or proceeding for the recovery or enforcement of any fine, penalty, or forfeiture, pecuniary or otherwise, incurred under any Act of Congress, except matters within the jurisdiction of the Court of International Trade under section 1582 of this title.”

The Tucker Act is also found within Title 28 and waives the federal government’s sovereign immunity from suit and authorizes monetary claims “founded either upon the Constitution, or any Act of Congress, or any regulation of an executive department, or upon any express or implied contract with the United States, or for liquidated or unliquidated damages in cases not sounding in tort.”  The Court of Federal Claims has trial court jurisdiction over “Big” Tucker Act claims against the United States; district court and the Court of Federal Claims have concurrent jurisdiction over claims for $10,000 (so-called Little Tucker Act claims)

In 2016, the government argued in effect that the Tucker Act was preempted by Section 1355 and sought to dismiss Norman’s complaint; the Court of Federal Claims disagreed, finding that 1355 was not meant to give district courts jurisdiction in all penalty cases and also finding that the FBAR penalties in Title 31 did not reflect a “specific and comprehensive scheme for administrative and judicial review” which could also displace its jurisdiction under the Tucker Act.

The 2016 Norman opinion discusses a handful of cases applying 1355 that limit the Court of Federal Claims’ jurisdiction; ultimately it distinguished those cases from Norman as relating to either forfeiture cases or criminal cases.  There is a bit more to the issue, including a 9thCircuit case that suggests that 1355 is only meant to apply when the government is reducing a penalty to judgment. The 2016 Norman opinion did note that there was tension between Section 1355 and the Tucker Act, and substantial ground for difference of opinion in its view that the CFC had jurisdiction, leading it to conclude that the government could file an interlocutory appeal on the jurisdictional issue, which would have allowed for an appellate opinion on that issue before a trial on the merits.

That appeal never came, as the government abandoned its jurisdictional defense. While the government lost the battle in 2016, as Keith discussed, it won the war of the case—at least for now. One expects that Mrs. Norman may try her luck for an appellate review on the merits of the penalty, and see if the panel agrees with the two district court judges that have capped the penalty in line with the regulations. In addition, if Norman appeals one suspects that the circuit court may take a fresh look at the jurisdictional issue.

 

Paying the Full FBAR Penalty

Few penalties have the bite of the FBAR penalty. As the IRS obtained more information and more sophistication in locating foreign bank accounts, it offered taxpayers who had used such accounts the opportunity to limit their civil and criminal exposure through a series of Offshore Voluntary Disclosure Initiatives (OVDI and its cousin OVDP). We have discussed OVDI and OVDP in previous posts here and here. Les wrote about a non-wilful FBAR case here.

The Court of Federal Claims recently rendered an opinion in Norman v. United States, No. 1:15-cv-00872 (July 31, 2018) finding the taxpayer liable for the 50% penalty imposed by 31 U.S.C. 5314. The 50% penalty means that Ms. Norman owes the IRS half of the money in her foreign bank account which makes the FBAR penalty one with an enormous bite. Jack Townsend’s blog covers FBAR issues extensively and is a much better source than PT on this issue. As usual, he wrote about this case the day after it came out and his post can be found here. The Norman case has importance not only because the court finds her conduct willful but also because the court addresses the application of the regulations. For that reason, it deserves mention in PT where we spend relatively little time writing about foreign bank accounts.

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In October, 2013, the IRS assessed an FBAR penalty against Ms. Norman in the amount of $803,530 for willfully failing to report her foreign bank account. After unsuccessfully contesting the penalty administratively, she paid it and brought a suit for refund. The IRS tried to win the case on summary judgment but the court found that the issue of willfulness required the gathering of facts in a manner not possible through summary judgment. So, a three hour trial took place in Brooklyn on May 10, 2018.

A couple of things about the trial deserve note. First, the location of the trial shows that the Court of Federal Claims regularly travels around the country for its trials to a site near the taxpayer. This is not news for those familiar with the Court of Federal Claims but for those not familiar with this court it may come as a surprise.   Second, the timing of the decision in this case vis a vis the trial stands in stark contrast to the normal time for a decision from the Tax Court. Unless decided by a bench opinion, I would not expect a Tax Court decision following a trial of this type for about a year instead of less than three months; however, it did take almost three years after the filing of the complaint in the Court of Federal Claims before the case came to trial.

In short, the court did not believe the testimony of Ms. Norman. It found her memory quite selective. It went through the elements necessary to prove a willful failure to report a foreign bank account, then through the facts she did and did not prove in order to reach the conclusion without much difficulty that Ms. Norman knew about the account and knew she should have reported it. It’s not worth going through all of the factual findings here but for those representing individuals with foreign accounts the details might matter. As Les mentioned in his post, the number of opinions coming out on this issue is relatively low. The IRS settlement initiative doubtless has resolved the vast majority of cases without litigation.

Having found a willful violation, the court then had to deal with the amount of the penalty. The taxpayer argued that the court should cap her penalty based on regulation 31 C.F.R. 1010.820 which was written under the previous version of the Bank Secrecy Act and which capped the penalty at $100,000 which would be quite a reduction from the assessment here. Taxpayer requested that the court adopt the reasoning set forth in Colliot v. United States, 2018 U.S. Dist. LEXIS 83159 (W.D. Tex. 2018), and in Wadhan v. United States, 122 AFTR2d 2018-5208 (D. Colo. 2018). In 2004 Congress amended the law to increase the penalty. Colliot and Wadhan held that the new law did not supersede the regulation promulgated under the prior statute. The Colliot district court reasoned that:

[The amendment] sets a ceiling for penalties assessable for willful FBAR violations, but it does not set a floor. Instead, 5321(a)(5) vests the Secretary of the Treasury with discretion to determine the amount of the penalty to be assessed so long as that penalty does not exceed the ceiling set by 5321(a)(5)(C).

The Court of Federal Claims found that the statement in Colliot “mischaracterizes the language of 5321(a)(5)(C), by ignoring the mandate created by the amendment in 2004.” The revised statute provided that the maximum penalty “shall be increased” to the greater of $100,000 or 50% of the account. Because Congress used the imperative, the amendment did not merely permit a higher ceiling on penalties based on the decision of the Secretary it “removed the Treasury Secretary’s discretion to regulate any other maximum.” It found Congress superseded the regulations.

In invalidating the regulations the Court of Federal Claims refused to follow precedent that could have damaged the IRS not just in FBAR cases but in other similar situations in which a revised statute did not immediately trigger a withdrawal or revision of a regulation by the IRS. Of course, the Colliot decision turned on an interpretation of the intent of Treasury in leaving the regulations on the books but it had potentially far reaching consequences for the IRS. The Norman decision does not mean the IRS has won this issue but it does mean that a court of nationwide jurisdiction has not signed on to the interpretation of one district court.  While I agree with the decision in Norman, the IRS could do itself a favor by addressing the regulation.  It seems that it has the power to avoid having to litigate this issue repeatedly.

 

 

TIGTA Criticizes IRS Efforts at Curbing Preparer Misconduct

TIGTA reports are, by their nature, often critical of IRS performance. IRS Lacks a Coordinated Strategy to Address Unregulated Return Preparer Misconduct details TIGTA’s view that IRS is not doing enough to curb preparer misconduct.

There is a lot in this report. It lays out the recent history of IRS efforts; starting in 2009 with the ill-fated plan to regulate unlicensed preparers via compliance and background checks, qualifying examinations and continuing education requirements. When Loving struck down the 2009 rules, IRS pivoted and the TIGTA report discusses in detail the IRS procedures at SB/SE for examining preparers and the sanctions that IRS can bring on unscrupulous or incompetent preparers even in the absence of the direct oversight.

The main takeaway from the report is that IRS does not have a consistent national return preparer strategy. As the report details, IRS stated that its “overall strategy for addressing preparer misconduct was generally to use the tools at the IRS’s disposal as effectively as possible within resource constraints to improve tax compliance by increasing the accuracy of tax returns and holding tax return preparers accountable for misconduct.” Post-Loving, IRS has shifted resources to a relatively undersubscribed voluntary program for unenrolled preparers while the vast majority of unenrolled preparers continues to operate outside direct oversight.

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TIGTA takes direct issue with IRS claims to address the issue “as effectively as possible.” Starting from a macro perspective, TIGTA notes that there is no evidence of a coordinated IRS strategy; and little in writing that could serve as a blueprint for efforts to address unenrolled preparers. While SB/SE has the main responsibility for addressing preparer misconduct, its Business Performance Review documentation in recent years barely mentions the Return Preparer Coordinator functions in the seven main geographic areas; it also has little discussion of Lead Development Centers, which are the hubs for reviewing referrals of preparer misconduct.

The report goes into great detail as to how this lack of strategy manifests itself in particular problems. Here are some of the highlights:

Limited Priority in Exams: TIGTA notes the relative scarcity of focused preparer examinations (called PACS, or Program Action Cases) in recent years; for example in FY 2016 there were only 140 developed PACs compared to Criminal Investigation’s 248 investigations and 204 indictments in the same period.  As TIGTA notes, the lesser number of civil cases “is unexpected given the respective resources of these two IRS functions, as well as the intensive nature of criminal investigations versus civil penalty cases. The SB/SE Division Examination function has approximately 6,500 revenue agents and tax compliance officers compared to Criminal Investigation’s nearly 2,200 special agents.”

Inconsistent Criteria and Limited Impact For PAC Referrals: TIGTA criticized the differing approaches to focused preparer examinations in the seven geographical areas, with some areas focusing on high refund rates and others looking to numbers of taxpayers connected to a preparer. That contributes to a lack of a national approach to the issue of preparer oversight.Furthermore, TIGTA noted that the preparer exam impact  is often limited as IRS often failed to examine all of the identified preparer’s tax returns.

Assessment of Penalties Not Maximized: The report examines the failure to assess penalties when conduct may have warranted them. For example, it discusses a lack of PTIN penalty enforcement. TIGTA notes that “if penalties had been proposed when the invalid PTINs were identified, more than $122,747,250 could have been assessed, yet only 215 penalties were assessed for all of I.R.C. § 6695(a)-(e) penalties, inclusive of § 6695(c) penalties, totaling $1,572,055 which is 1 percent of the potential penalty assessment for just one of the possible violations.”  Of course, assessing more penalties against a group such as bad preparers in no way guarantees collection of the penalties assessed as discussed in the next section.

Collection of Preparer Penalties is Minimal: TIGTA notes that IRS no longer prioritizes collection of return preparer penalties. TIGTA notes that from CY 2012 to CY 2015, the IRS collected just $46.3 million (15 percent) of the $317.2 million of penalties assessed on individual return preparers; the numbers are even worse for penalties assessed against preparers failing to put a PTIN on returns, with IRS collecting just 8% of those penalties in 2016.  Prioritizing collection from this group would not necessarily ensure a higher return.  Collection may have directed their limited resources to persons more likely to have the ability to pay.

RPO Doing Little to Combat Unregulated Preparer Misconduct:The report discusses the efforts of the IRS Return Preparer Office following Loving. It is not a pretty picture.

The Return Preparer Office, which was originally established to lead the now defunct regulatory effort, is still in existence but now primarily focuses its efforts on tax professionals and those few tax return preparers who volunteer to be subject to certain annual training. The Return Preparer Office checks tax compliance for tax professionals but not for most unregulated preparers. More than 26,000 Preparer Tax Identification Number recipients acknowledged being tax noncompliant. Additionally, while preparing tax returns without a Preparer Tax Identification Number is subject to a penalty, the penalties are assessed on a limited ad hoc basis. In Processing Year 2016, the IRS failed to assess $121,175,195 in Preparer Tax Identification Number penalties.

TIGTA notes that a main part of RPO, the Suitability Office, produces limited benefits:

The resources used by the Suitability Office to conduct credentials research are not commensurate with the benefits realized. At best, preparers who have misrepresented themselves will stop after being notified by the Suitability Office. However, if the preparers continue with the behavior, the IRS is not taking additional steps to address it. The Suitability Office takes no further action if the preparer is unregulated. Even when cases are referred to the OPR, nearly all of them are closed upon receipt because the preparers are not currently practicing before the IRS and therefore, the OPR lacks jurisdiction. The appropriate function to report unregulated preparers misrepresenting themselves as tax professionals is TIGTA’s Office of Investigations.

The report notes that “an even more significant problem is that the Suitability Office no longer devotes any resources to unregulated preparers. Ensuring the tax compliance of tax preparers yields benefits to tax administration; however, the Suitability Office is only checking the status of the relatively small number of tax professionals and volunteers for the AFSP, e.g., those who present the least risk to tax administration.”

IRS Failing to Use Its Information: One of the key benefits of a uniform preparer identification number is the greater ease that the number affords the IRS to track preparer behavior. The report notes that PTINs “allow the IRS to keep track of preparers’ behavior, such as the number of returns they prepare and file, the number of returns by filing method (paper or electronically filed), returns filed with refunds, and returns filed with balances due.”

All of the IRS’ information on preparers is consolidated in the Return Preparer Database. Despite the presence of the information, TIGTA notes that IRS has failed to maximize its potential:

IRS has not yet taken full advantage of its capabilities. Much of the analyses and resulting corrective actions could be performed systemically, with minimal need for employees’ direct involvement. Expansion of the database’s capabilities could allow the IRS to identify and deter additional preparer misconduct, while also freeing employees who are currently performing manual tasks that could be performed systemically by the database.

Given the resources reductions over the past several years, it is particularly important for the IRS to continue developing and taking full advantage of its available systemic capabilities.

Conclusion

No doubt the IRS could improve its police role for return preparers.  Many of the recommendations presented by TIGTA could assist the IRS in improving this role.  The IRS has continued to push for a legislative fix to Loving – a fix that would have come quickly in past decades but not in the Congress since 2010.  The hope for a legislative fix that would allow the IRS to go back to the strategy it had finally decided to employ coupled with the diminution of resources may have something to do with the sluggish action TIGTA perceives coming out of the IRS.  Collection from bad preparers will never be easy.  The IRS will not fix the problem of bad preparers by assessing more penalties.  It needs strong tools to stop them from preparing.  Getting the return right at the outset saves the IRS and taxpayers from time consuming efforts to reconstruct a correct tax assessment.  TIGTA is right to keep reviewing IRS efforts on this important issue.  The IRS is right to keep pushing for legislation to allow it to robustly regulate preparers.  While waiting for Congressional approval, the IRS should look carefully at those suggestions from TIGTA that will allow it to shut down bad tax preparers and pay little attention to the suggestions that cause it to assess large amounts of penalties it will struggle to collect and that may not stop the bad action.

 

 

 

 

 

 

IRS Updates Guidance on How to Handle Premature Petitions

The work that the IRS must perform at the beginning of a Tax Court case requires more effort than readily meets the eye and results in issues easily overlooked. Bob Kamman wrote earlier this year about the answers the IRS files in Tax Court cases in which the taxpayer has yet to pay the filing fee (and in some cases never does so.) That discussion raises questions concerning the filing of an answer before a case has properly come before the court.

In another issue involving answers in Tax Court case, the IRS has been trying for over a decade to reverse a 2007 decision of the Tax Court to require answers in small tax cases. Since approximately 50% of the petitions filed in the Tax Court request small case status, this issue has a huge impact on the effort the IRS must expend at the beginning of the case. The attachment to the IRS submission on the issue, attached to our post, discusses that impact on the IRS. I see no change coming on that front in the near future. The IRS will continue to file answers in small tax cases. The answers will continue to provide almost no useful information since the IRS denies everything in the vast majority of cases including matters it could admit if it took the time to look in its file. The answers will confuse pro se taxpayers. The answers will provide the taxpayer with the name of the IRS attorney and that, at least, will keep, or at least reduce the numbers, taxpayers from contacting the Tax Court to find out the status of their case. Filing the answer also should cause the IRS attorney to pay attention to jurisdictional issues at the outset of the case although that does not always happen.

Today’s post discusses another issue that the IRS faces at the outset of the Tax Court case – identifying and addressing petitions filed prior to the time the taxpayer receives the notice of deficiency. (The issue can arise in other types of Tax Court jurisdiction such as notices of determination in CDP and innocent spouse cases or whistleblower cases but the Chief Counsel notice discussed today focuses on deficiency cases.) It is important that the IRS identify cases filed prematurely since the filing can have an impact on the statute of limitations on assessment and collection.

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Notice CC-2018-008, issued on July 6, 2018, alerts Chief Counsel attorneys to revisions in their manual regarding Tax Court petitions filed prior to the issuance of the notice giving the taxpayer the right to petition. The Notice makes clear that the suspension of the statute of limitations on assessment provided by IRC 6503 does not apply when someone petitions the Tax Court in a situation in which the IRS did not issue a notice of deficiency. Of course, Chief Counsel attorneys are not the only part of the IRS that play a role in these cases. They must coordinate with exam and with appeals as they tie down the facts to show that no notice of deficiency was sent. The information regarding the absence of a notice of deficiency needs to be gathered quickly so that the Chief Counsel attorney handling the case can notify the Tax Court before the case gets too far along and so that it does not impair the examination division in its review of the case.

Although the Tax Court rules and the instructions printed on the form petition require that the taxpayer attach a copy of the notice of deficiency to the petition, many petitioners do not attach the notice.   If the taxpayer attaches a valid notice of deficiency, the case becomes easy to work. Once the IRS attorney receives the administrative file, the IRS can file an answer or file any other appropriate responsive pleading. In the relatively high percentage of cases in which a notice of deficiency is not attached to the petition, then the Service must run down the notice of deficiency before it knows what to do. While it may seem like a simple task to run down a notice of deficiency, the IRS sometimes has problems finding the administrative file. The task becomes more difficult if the IRS has not recently been handling the case. Some taxpayers file petitions based on almost any document they receive from the IRS and some do not mention the year(s) at issue. Determining the reason for the petition can involve a fair amount of detective work in some cases.

The notice informs Chief Counsel attorneys that internal guidance is changing regarding the handling of these cases and that their manual will soon change. One change provides that:

If no notice of deficiency is attached to the petition, the attorney should determine whether a notice of deficiency has in fact been issued. If a notice of deficiency has not been issued because the tax year is still under examination, the petition is premature…. For any such year, the attorney should file a motion to dismiss for lack of jurisdiction… also remind Examination personnel that the statute of limitations on assessment is not tolled by premature petition and the ASED must be protected by extending the statute of limitations with Form 872….

Further in the Notice Chief Counsel attorneys are advised that:

If the petition is premature, attorneys should move to dismiss the case for lack of jurisdiction. In this instance, the motion should make out a prima facie case that the petition is based upon a 30-day letter, notice of rejection of a claim for refund, or other similar notice, or not based on any communication from the Service at all… If Field counsel does not receive a Form 15022 (a form the IRS has devised to certify to the attorneys that a notice of deficiency was NOT issued), Field Counsel must conduct a search to verify that a notice of deficiency or other determination letter that would confer jurisdiction on the Tax Court has not been issued to the taxpayer for the tax/period at issue….

I do not know what prompted the Notice. It’s possible that the IRS blew the statute of limitations on assessment in one or more case because it failed to pay careful attention to the running of the statute while it sorted out a prematurely or improperly filed petition. In any event, the IRS seems to seek to catch these issues with renewed vigor. Because of the high volume of cases handled by correspondence examination providing low income taxpayers with no person to really talk to about their case, it’s not surprising that many taxpayers get confused about when to file their Tax Court petitions. The fact that the IRS publishes this Notice suggests that representatives should look closely at the statute of limitations on assessment for clients they represent who may have prematurely petitioned the Tax Court so that a decision can occur regarding the timeliness of the proposed assessment.

 

Designated Orders 7/16 – 7/20

Caleb Smith from the University of Minnesota brings us this week’s designated orders. The parade of orders involving Graev continues and Professor Smith explains the evidentiary issues present when the IRS seeks to enter the necessary approval form after reopening the Tax Court record. Professor Smith also provides advice, based on another order entered this week, on how to frame your CDP case. A non-procedural matter that might be of interest to some readers is ABA Resolution 102A passed this week, urging Congress to repeal the repeal of the alimony deduction. For those interested in this issue, the resolution contains much background on the deduction.  Keith

Submitting Evidence of Supervisory Approval Post-Graev III

Last week, William Schmidt covered three designated orders that dealt with motions to reopen the record to submit evidence of supervisory approval under IRC 6751. I keep waiting for this particular strain of post-Graev III clean-up to cease, but to no avail: the week of July 16 two more designated orders on issues of reopening the record were issued. Luckily, there are important lessons that can be gleaned from some of these orders on issues that have nothing to do with reopening the record (something that post-Graev III cases shouldn’t have to worry about). Rather, these cases are helpful on the evidentiary issues of getting supervisory approval forms into the record in the first place.

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Choosing the Right Hearsay “Exception” Fakiris v. C.I.R., dkt. # 18292-12 (here)

In Fakiris, the IRS was once again confronted with the issues of (1) reopening the record to get supervisory approval forms into it, and (2) objections to those forms on hearsay grounds. At the outset (for those paying attention to docket numbers), one may be forgiven for wondering how it is even possible that this case was not decided well before Graev III. The briefing in Fakiris was completed in August, 2014 with no apparent court action until June, 2017. Judge Gale walks us through the procedural milestones in a footnote: although a decision was entered for the IRS about a year ago in T.C. Memo. 2017-126, the IRS filed a motion to vacate or revise (surprisingly, since they appear to have won on all fronts). The decision that the IRS sought to vacate includes a footnote (FN 20) providing that because petitioner did not raise a 6751 issue, it is deemed conceded. At the time, there was some uncertainty about whether the taxpayer had to affirmatively raise the issue, or whether it was a part of the IRS’s burden of production under Higbee. See earlier post from Carl Smith.

In any event, and no matter how old the case may be, it is still before the Court and the record must still be reopened for the IRS to succeed on the IRC 6751 issue. After the usual explanation of why it is proper for the Court to exercise its discretion to reopen the record, we arrive at the evidentiary issue: isn’t a supervisory approval form hearsay? At least so objects petitioner.

Where petitioners object to IRS supervisory approval forms as “hearsay” it appears to be the standard operating procedure of IRS counsel to argue the “business records” exception (see FRE 803(b)). Generally, the IRS prevails on this theory, but this theory creates potentially needless pitfalls. Fakiris demonstrates those pitfalls, noting that under the business record exception the IRS has certain foundational requirements it must meet “either by certification, see 902(11), Fed. R. Evid. [here], or through the testimony of the custodian or another qualified witness, see Rule 803(6)(D), Fed. R. Evid.” Without that foundation, the business records exception cannot hold -and indeed, in Fakiris the IRS lacks this foundation and is left spending more time and resources to go back and build it as their proffered evidence is excluded from the record.

So how does one avoid the time-consuming, perilous path of the “business exception?” Judge Gale drops a rather large hint in footnote 9: “We note that Exhibits A and B [the actual penalty approval forms] might also constitute “verbal acts”, i.e., a category of statements excluded from hearsay because ‘the statement itself affects the legal rights of the parties or is a circumstance bearing on conduct affecting their rights.’” If it is a “verbal act” it is categorically not hearsay (and not an “exception” to the hearsay rule). I have made exactly this argument before, although I referred to verbal act as “independent legal significance.” I am surprised that the IRS does not uniformly advanced this argument. In the instances that the IRS used it, the IRS has prevailed (as covered in the designated orders of the previous week). Judge Gale also refers to the advisory committee’s note to bolster the argument that the supervisory approval form is not hearsay: “If the significance of an offered statement lies solely in the fact that it was made, no issue is raised as to the truth of anything asserted, and the statement is not hearsay.” Advisory Committee Note on FRE 801(c) [here]. To me, that is what appears to be happening here. The IRS is simply trying to prove that a statement was made (i.e. a supervisor said “I approve of this penalty.”) The penalty approval form is that statement. It is absurd to think that the form is being offered for any other purpose (e.g. as evidence that the taxpayer actually was negligent, etc.).

If you don’t believe me (or Judge Gale), perhaps Judge Holmes will change your mind? In a designated order covered last week in Baca v. C.I.R., the IRS prevails on a theory that the supervisory approval form is a verbal act, without relying on the business exception. In reaching that determination, Judge Holmes references not only the FRE advisory committee note on point, but also Gen. Tire of Miami Beach, Inc. v. NLRB, 332 F.2d 58 (5th Cir. 1964) providing that a statement is a nonhearsay verbal act if “inquiry is not the truth of the words said, merely whether they were said.”

If you just aren’t sold on the “verbal acts” argument, Judge Gale’s Footnote 9 has yet more to offer. As a second possible avenue for getting the penalty approval form into evidence, Judge Gale suggests the public records exception of FRE 803(8). This exception to hearsay requires proper certification, but apparently has been successfully used by the IRS in the past with Form 4340 (See U.S. v. Dickert, 635 F. App’x 844 (11th Cir. 2016)).

All of this is to say, I think the IRS has ample grounds for getting the supervisory approval form properly into evidence. For petitioners, though it is likely a losing argument, if there are actual evidentiary concerns you must be sure to properly raise those objections -even if in the stipulation of facts. A second designated order issued the same week as Fakiris (found here) does not even get to the question of whether the forms are hearsay after reopening the record -presumably because the objections were never raised (the docket does not show a response by petitioner to the IRS’s motion to reopen the record).

Setting Yourself Up for Favorable Judicial Review on CDP Cases: Jackson v. C.I.R., dkt. # 16854-17SL (here)

Taxpayers that are unable to reach an agreement with the IRS on collection alternatives at a Collection Due Process (CDP) hearing generally have an uphill battle to get where they want to go. Yes, they can get Tax Court review of the IRS determination, but that review is under a fairly vague “abuse of discretion” standard. Still, there are things that petitioners can do to better situate themselves for that review.

At an ABA Tax Section meeting years ago, a practitioner recommended memorializing almost everything that is discussed in letters to IRS Appeals. Since the jurisdiction I practice in is subject to the Robinette “admin record rule,” it is especially important to get as much as possible into the record. Conversely, one may argue that the record is so undeveloped that it should be remanded because there is nothing for the Court to even review: see e.g. Wadleigh v. C.I.R., 134 T.C. 280 (2010). The order in Jackson provides another lesson: how to frame the issue before the Court.

In Jackson, the taxpayers owed roughly $45,000 for 2012 – 2015 taxes due to underwithholding. After receiving a Notice of Intent to Levy, the Jacksons timely requested a CDP hearing, checking the boxes for “Offer in Compromise,” “I Cannot Pay Balance,” and “Installment Agreement” on their submitted Form 12153. Over the course of the hearing, however, the only real issue that was discussed was an installment agreement -albeit, a “partial pay” installment agreement (PPIA). A PPIA is essentially an installment agreement with terms that will not fully pay the liability before the collection statute expiration date (CSED) occurs.

Obviously, the IRS is less inclined to accept a PPIA than a normal installment agreement, because a PPIA basically agrees to forgive a part of the liability by operation of the CSED. Sensibly, IRS Appeals required a Form 433-A from the Jacksons to determine if a PPIA made sense.

The Form 433-A submitted by the Jacksons appears to have pushed the envelope a bit. Most notably, the Jacksons claimed $740 for monthly phone and TV expenses (the ultra-deluxe HBO package?) and $629 per month in (voluntary) retirement contributions as necessary expenses. The settlement officer downwardly adjusted both of these figures (and possibly others) pursuant to the applicable IRM, and determined that the Jacksons could afford to pay much more than the $300/month they were offering. Going slightly above and beyond, the settlement officer proposed an “expanded” installment agreement (i.e. one that goes beyond the typical 72 months) of $1,100 per month. The Jackson’s rejected this, but appear to have proposed nothing in its stead. Accordingly, the settlement officer determined that the proposed levy should be sustained.

Judge Armen notes that with installment agreements (as with most collection alternatives under an abuse of discretion standard of review), “the Court does not substitute its judgment for that of the Appeals Office[.]” Sulphur Manor, Inc. v. C.I.R., T.C. Memo. 2017-95. If the IRS “followed all statutory and administrative guidelines and provided a reasoned, balanced decision, the Court will not reweigh the equities.” Thompson v. C.I.R., 140 T.C. 173, 179 (2013).

The Thompson and Sulphur Manor, Inc. cases provide, in the negative, what a petitioner must argue for any chance on review. Starting with Sulphur Manor, Inc., the petitioner must strive to present the question as something other than a battle of who has the “better” idea. In other words, don’t frame it as a battle of bad judgment (IRS Appeals) vs. good judgment (petitioner). If it must be a question of judgment, then Thompson gives the next hint on how to frame the issue: not that the IRS exercised “bad” judgment, but that they didn’t provide any reasoning for their decision in the first place (i.e. that they did not “provide a reasoned, balanced decision”). A lack of reasoning is akin to an “arbitrary” decision, which is by definition an abuse of discretion.

Better than framing the determination as lacking any reasoning, however, is where the petitioner can point to “statutory and administrative guidelines” that the IRS did not follow. Of course, this is difficult in collection issues because there are generally fairly few statutory guidelines the IRS must follow in the first place. But administrative guidelines do exist in abundance, at least in the IRM. Of course, this cuts both ways: the IRM can also provide cover for the IRS when it is followed, but appears to get to an unjust outcome.

Returning to the facts of Jackson, the petitioner faced an extremely uphill (ultimately losing) battle. It is basically brought before the Court as a request for relief on the grounds that the taxpayer just doesn’t like what the IRS proposes. As Judge Armen more charitably characterizes the case, by failing to engage in further negotiations with Appeals on a proper amount of monthly installment payments, “petitioners framed the issue for decision by the Court as whether the settlement officer, in declining to accept their offer of a partial payment installment agreement in the monthly amount of $300, abused her discretion by acting without a reasonable basis in fact or law.” This is asking for a pretty heavy lift of the Court, since there is no statute that provides the IRS must accept partial pay agreements, and the facts show the IRM was followed by the IRS. Not surprisingly, the Court declines to find an abuse of discretion.

Odds and Ends: Remaining Designated Orders

End of an Era? Chapman v. C.I.R., Dkt. # 3007-18 (here)

The Chapmans appear to be Tax Court “hobbyists” -individuals that enjoy making arguments in court more than most tax attorneys, and generally with frivolous arguments. The tax years at issue (going back to 1999) have numerous docket numbers assigned to them both in Tax Court and the 11th Circuit, all with the same general take-away: you have no legitimate argument, you owe the tax. But could this most recent action be the secret, silver bullet? Could this newfound argument, that they are not “taxpayers” subject to the Federal income tax when the liability is due to a substitute for return, be their saving grace?

Nope. All that argument does is get them slapped with a $3,000 penalty under IRC 6673(a). One hopes this is the end of the saga.

The Vagaries of Partnership Procedure: Freedman v. C.I.R., dkt. # 23410-14 (here)

Freedman involves an IRS motion to dismiss for lack of jurisdiction the portion of an individual’s case that concerns penalties the IRS argues were already dealt with in a prior partnership-level case. For a fun, late-summer read on the procedures under TEFRA for assessment and collection against a partner, after a partnership-level adjustment, this order is recommended.