Leslie Book

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Summer Reading: Tax Compliance And Small Business Taxpayers

The Wall Street Journal ran an interesting article last week, Number of Americans Caught Underpaying Some Taxes Surges 40% [$]. The main point in the story is that with the increase in the gig economy many more Americans are left on their own to pay estimated taxes. Many are not complying. The WSJ reported that from 2010 to 2015 there was an increase of about 40% in the number of people penalized for underpaying estimated taxes.

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It is easy to understand why. Without the benefit of withholding that comes with traditional paychecks and in many cases also without information reporting that can remind people that Uncle Sam is looking, there are many challenges to staying on the right side of the tax law.

A report last year from the American University Kogod Tax Policy Center called Shortchanged: Tax Compliance Challenges of Small Business Operators Driving the On-Demand Platform Economy gives the issue a deep dive.

The Kogod Report is terrific. It is well researched. It provides background on the rapid growth of this segment of the economy, with companies like Uber, Airbnb, Etsy and many others pushing Americans into the uneasy tax perch of small business owners. One of the main points in the study is that the tax code is a 20th century code poorly matched with the 21st century economy. Add to the mix a 20th century mode of tax administration and many Americans are ill-equipped to keep records and understand how the law applies to their situation. This all leads to a major tax administration headache.

What I found most interesting in the report is the survey it conducted of about 50 small business owners. While the survey is not meant to be a statistically reliable sample (and in fact may reflect a greater sophistication as all responders were in the National Association of Self Employed) it did provides some insight into many challenges this group faces:

At best, these small business owners are shortchanged when filing their taxes; at worst, they fail to file altogether. Approximately one- third of our on-demand platform operator survey respondents didn’t know whether they were required to pay quarterly-estimated payments and almost half were unaware of any available deductions, expenses or credits they could claim to offset their tax liability. These taxpayers face potential audit and penalty exposure for failure to comply with filing rules that are triggered by relatively low amounts of earned income. Compounding this problem is inconsistent reporting rule adoption that results in widespread confusion among taxpayers

I tip my cap to one of the headings in the report (They Got 1099 Problems and Withholding Ain’t One). The Report and the WSJ article tell of one of the main shortfalls in the US tax reporting system for platform players. Essentially reporting is only required if payments are made via credit card or debit card, and the aggregate number of transactions to one service provider exceeds 200 and the payments exceed $20,000. Absent exceeding both requirements then companies that process credit card payments on behalf of individuals in the gig economy are not required to issue a 1099. Of course, the absence of a 1099 does not mean that the service provider does not have to report income but the absence of reporting leads to either mistakes or intentional non reporting.

Some of the platform players in the economy, like Uber, issue a 1099 even if the service provider does not meet both the 200/20K tests (an earlier WSJ article talks about this; see The Blind Spot in a Sharing Economy: Tax Collection $).

As the report discusses, employment and income tax liabilities, with penalties, can snowball. Not surprisingly, the National Taxpayer Advocate has been on this issue; for example, her testimony last year before the House Committee on Small Business touches on these issues, and lots more, including employee classification issues. She also adds a number of proposals to increase compliance, including changing estimated tax and backup withholding rules for taxpayers with poor compliance history and an increase in IRS education efforts to get people on the right path.

Tax administrators, scholars and legislators have taken note. IRS has put up the Sharing Economy Tax Center on its web page, and there are legislative proposals to change the 200/20,000 rule to trigger mandatory reporting at lower thresholds. UC Hastings Law Professor Professor Manoj Viswanathan has a new article called Tax Compliance in a Decentralizing Economy that addresses some of these issues (I have not yet read though am looking forward to it). Our blogging colleague BC Law Prof Diane Ring at Surly Subgroup also discusses the sharing economy in a post today highlighting worker classification issues. With her BC colleague Shu-Yi Oei Diane co-authored Can Sharing Be Taxed, an article that was in Wash U Law Review last year that also looked at the sharing economy, including reviewing some of the compliance problems implicated in today’s post.

As the Kogod Center reports, it is likely that this part of the economy will grow rapidly in the next few years so one can expect a great deal more attention on the issue.

 

 

Recent Tax Court Case Explores Tax Matter Partner SOL Extensions

TEFRA is still with us. Despite the coming launch of new partnership procedures in the Bipartisan Budget Act (BBA), TEFRA will remain relevant, as old cases work their way through the courts and also likely continuing to inform interpretations of many statutory holes in BBA. A recent Tax Court case, BCP Trading and Investments v Commissioner, explores whether alleged conflicts of interest taint what was an otherwise valid extension to the SOL on assessment.

I will skip the sordid details, but the case involves Son of Boss transactions implicating asset transfers to partnerships, with liabilities attaching to the assets in an effort to increase basis in the partnership and thus produce super sized partner tax losses. (Judge Holmes’ opinion describes the transactions for those who like that sort of thing).

The main procedural issue in the case involved claims that the consents to extend to the SOL on assessment that the tax matters partner (TMP) executed were invalid. The argument focused on how the TMP, Bolton, was under the influence of E&Y. E&Y was under criminal investigation for its role in structuring the transactions. That control, according to the argument, meant that the TMP had a conflict of interest, which invalidated the SOL extensions.

There is precedent for invalidating a TMP consent to extend the SOL. Transpac is a Second Circuit case which held that a TMP’s SOL extension did not have effect when IRS turned to a TMP who himself was under criminal investigation, when the partners individually would not extend the SOL.

The BCP Trading opinion (citations removed) describes Transpac further:

The TMP [in Transpac] s were, unsurprisingly, more receptive to the Commissioner’s request. They had “a powerful incentive to ingratiate themselves to the government,” and worked with the IRS in a criminal prosecution of the Transpac promoter because their immunity or suspended sentence depended on it. The TMPs signed the extensions right about the time they were especially trying to coax the government into granting them immunity or agreeing to lighter sentences.

The Second Circuit in Transpac held that the Commissioner couldn’t use these consents to bind the partners because he knew the TMPs had a strong incentive to cooperate with the government and had conflicting interests with the partners.

As BCP discusses, the issue is “very fact dependent.” The opinion distinguishes Transpac for two main reasons: 1) in BCP many of the individual partners did not turn IRS down in the face of individual requests to extend the SOL and 2) the TMP was not under criminal investigation when the IRS turned to him to sign the original extension.

BCP also argued that the E&Y role in the transactions should bring its actions into the lens as to whether the TMP had an impermissible conflict. One of the partnership employees, who started out working at the slippery sounding E&Y group with the acronym VIPER (which stood for Value Ideas Produce Extraordinary Results) went to BCP as a BCP employee to be a liaison with E&Y. BCP argued that the TMP was in effect controlled by the former E&Y/VIPER employee. The opinion gives that pretty short shrift, noting that the former E&Y employee left for messy reasons and that in any event the individual partners also signed consents to extend the SOL.

E&Y’s conduct, beyond its former employee’s role in the partnership, was not irrelevant to a related issue, however. BCP argued that the consents to extend were not valid because E&Y breached its fiduciary duty and exercised undue influence in getting the TMP to sign the consents. The opinion notes that while the consents to extend are not contracts (and should be treated as a waiver of a defense, rather than as a contract itself), contract principles are key to this inquiry. In light of those principles, the argument fell short, looking at contract principles to define undue influence:

Undue influence is unfair persuasion by a person who dominates a party or when, because of their relationship, a party justifiably assumes the person won’t do anything against his welfare.

It was here that the sophistication and extent of the partners’ other advisors worked against the undue influence argument. The opinion details the parade of high-profile advisors other than E&Y that were involved in looking over the shoulder of E&Y. In light of that, the opinion concludes that the evidence did not support a finding that E&Y manipulated the TMP to sign the consents to extend.

Conclusion

As we have discussed before it is difficult to argue against a signed consent to extend. The argument in BCP was a long shot, especially given the partners’ sophistication and the less than appealing atmosphere of a reviled tax shelter.

Attorney’s Fees Awarded in Penalty Case Arising From Late Payment of Excise Taxes

As in Keith’s post yesterday, today’s post also involves attorney’s fees, though the subject of toady’s post, C1 Design Group v US, involves a qualified offer and whether the awarding of fees justifies a rate higher than the statutory cap of $200/hour. C1 Design Group is a magistrate’s order from a federal district court in Idaho, and as I describe below is a helpful case for practitioners wanting insights into recovering attorney’s fees under Section 7430.

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The underlying case involved a refund action that considered whether C1 Design’s failure to timely pay its excise taxes was due to willful neglect. C1 argued that a car crash involving the company’s founder led to financial difficulties, which led to the late excise tax payments. IRS agreed with that excuse for the first four quarters but litigated the effect of the crash on later quarters. The taxpayer argued that the injury triggered financial difficulties, which amounted to reasonable cause for the late payments.

The matter went to trial, with a jury rendering its verdict in favor of the taxpayer for the full amount of the refund, about $28,000. About a year after filing its claim, C1 Design made a qualifying offer, essentially agreeing to accept as a settlement a refund of about half of what the jury found the taxpayer was ultimately entitled to receive.

Following the verdict, C1 Design filed its motion for fees, seeking about $76,000; approximately $50,000 was attributable to the period after it made the qualifying offer.

The court agreed that C1 was entitled to fees for the period after the IRS  rejected the qualifying offer, but found that rejecting the offer was “substantially justified”, thus not warranting fees for the period prior to the qualifying offer. In addition, the court reduced the lead lawyer and his associates’ hourly rate, based on a finding that the taxpayer did not prove that there were special factors that warranted an increase over the statute’s $200 cap. The net result was that the taxpayer was awarded attorneys’ fees of about $33,000, not the $70,000 that the taxpayer sought.

There are some things in the opinion worth highlighting.

One, just because a taxpayer wins on the merits, it does not mean that the government position is not substantially justified, especially on a fact intensive issue like reasonable cause involving late payment penalties. As the opinion discusses, the “United States’ position was substantially justified if it is ‘justified to a degree that satisfies a reasonable person,’” or has reasonable basis in both law and fact. Pac. Fisheries Inc. v. United States, 484 F.3d 1103, 1108 (9th Cir. 2007) (citing Pierce v. Underwood, 487 U.S. 552 (1988). That inquiry, under the statute, has a focus on whether the “United States has lost in courts of appeal for other circuits on substantially similar issues.”

In this case (as in most), the judge deciding the fees motion presided at the trial. She noted that while the taxpayer won, its victory was “no slam dunk” for either side. Pointing out evidence that favored the government, including the taxpayer’s decisions to pay other creditors and pay healthy salaries while not paying Uncle Sam, the magistrate judge emphasized that had the taxpayer’s main witness (the person whose crash caused the taxpayer’s financial spiral) been less credible, the US would have won on the merits.

The order also discusses the lack of circuit court authority on the issue as to whether financial difficulties equate to reasonable cause for late payment of excise taxes; the slim authority the taxpayer relied on was out of the Third Circuit and involved an analogous issue, employment taxes rather than excise taxes.

Finally worth noting is the court’s unwillingness to allow the full hourly rate for the partner and associate’s fees. The statute caps the fees at $200/hour; the taxpayer sought the $300 that the partner charged and that were the bulk of the fees. Section 7430 provides that the $200 cap is what the taxpayer gets “unless the court determines that a special factor, such as the limited availability of qualified attorneys for such proceeding, the difficulty of the issues presented in the case, or the local availability of tax expertise, justified a higher rate.”

To justify the fee, the lead attorney filed an affidavit, stating that he practiced law for over 37 years, that for the last 16 years his main focus was tax resolution and that his fees were equivalent to what other attorneys with similar expertise charged. For good measure he noted that he believed he was only one of a couple of attorneys in the Idaho area that “solely represents” clients in tax controversy matters.

The order found that the affidavit was insufficient:

While Mr. Martelle [the partner] “believes” he is one of few tax attorneys in the Boise, Idaho market, he does not identify in his affidavit who those other attorneys are or the rates charged by those attorneys. Mr. Martelle’s belief, without other evidence to corroborate it, is not sufficient to establish that Boise, Idaho, is lacking in qualified tax attorneys. Moreover, the Court finds the issues presented in this matter were not so difficult as to warrant an upward adjustment of attorney fees. The issues presented were not technical—neither side found it necessary to hire an expert, and the trial (including deliberations) was over in just two days. Finally, while the Court does not doubt Mr. Martelle’s vast experience in tax law, such expertise alone is not a special factor to justify attorney’s fees in excess of the statutory cap. For these reasons, the Court will award attorney’s fees at the maximum statutory rate of $200 per hour for Mr. Martelle.

Conclusion

Keith has previously discussed how qualifying offers are an important tool for taxpayers and practitioners. The qualifying offer in C1 Design was crucial, and allowed for the recovery of some fees. While the order and the underlying refund case is a victory for the taxpayer, it is not the complete victory that it sought. It is expensive to try tax cases. Assuming that the taxpayer is paying the balance of the attorney fees, that amount almost washes out the recovery of the late payment penalties that were the subject of the underlying refund case.

 

Wells Fargo and The Negligence Penalty for A Transaction Lacking Reasonable Basis

Over the last few weeks, Stephen, Keith and I (with some help from others like Jack Townsend who is the lead author on the criminal penalties chapter) are all writing up the next update for IRS Practice and Procedure, and are sorting through and writing about 125 developments from March through early July for addition to the book.

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A few of the developments are major ones we did not address in Procedurally Taxing. One is the Wells Fargo case from earlier this spring. You may recall Wells Fargo v US where Stu Bassin in a post on PT discussed the government’s loss in its efforts to use the economic substance doctrine to disallow interest expense deductions for a transaction that lacked a non tax business purpose. The case also has an interesting and important penalty component involving the government’s assertion of a negligence penalty in connection with Wells Fargo’s claiming of disallowed foreign tax credits.

The issue was teed up for the district court in a somewhat odd manner, with Wells Fargo stipulating that if the foreign credit generating transaction was a sham, it should not be subject to the penalty because “there was an objectively reasonable basis for Wells Fargo’s return position under the authorities referenced in § 1.6662–3(b)(3).”

The court held that the foreign credit generating transaction was a sham. Wells Fargo agreed to the stipulation to limit discovery, but the effect of the stipulation prevented it from arguing that it exercised ordinary and reasonable care in the preparation of its tax return. In other words, Wells Fargo felt that the authority for the position was sufficient to shield it from penalties without regard to any independent effort it made to assess the merits of the transaction prior to taking its position on its tax return. Wells Fargo did so because the regulations insulate from negligence a return position that has a reasonable basis; i.e., the position is reasonable based on one or more authorities (as further defined in the regulations).

In the opinion considering the penalties, the district framed the issue as follows:

Is it enough for Wells Fargo to show that its return position had a reasonable basis under the authorities referenced in § 1.6662–3(b)(3)? Or must Wells Fargo prove that it actually consulted those authorities in preparing its tax return?

The district court held that Wells Fargo was subject to the penalty because it had to prove that it in fact consulted with the authorities before adopting its position on the return. This was the view the government urged under the regulations; the taxpayer argued that the statute and regulatory focus is on an objective analysis, with the taxpayer’s efforts beside the point.

The Court found the regulations to be ambiguous, specifically that Treasury Regulation §1.6662-3(b)(3) states a reasonable basis is satisfied if “a return position is reasonably based on one or more” authorities. That was important, because under administrative law principles (so-called Auer deference) an agency is entitled to deference regarding an interpretation of an ambiguous question relating to the meaning of its own regulations.

At or around the time of the opinion, Jim Malone of Post & Schell wrote a terrific blog post critiquing the district court opinion, suggesting that perhaps Wells Fargo deserved to be penalized but that the court’s approach to the issue was “troubling”. There was also a piece in Bloomberg that quoted Jim and former PT guest poster Andy Grewal, with Andy saying that “it would be more sensible to apply Section 1.6662-3(b)(1) in accordance with its plain meaning and examining all relevant authorities supporting the treatment of a position, whether or not the taxpayer was aware of them.”

The Wells Fargo outcome is a departure from the norm in these cases because it has generally been thought that reasonable basis is an objective inquiry; i.e., if the position is more or less plausible based on an authority, then the taxpayer is free from the penalty. As Jim discusses, there are some cases along the lines suggesting that if a taxpayer had some separate reason to do a bit of digging then more than just objective analysis is warranted, yet the Wells Fargo opinion suggests a differing starting point than what many believed to be the case under the regulations.

I am not sure that other courts will follow this approach but it is something that advisers should be aware of when considering the effect of a stipulation as well as what may be necessary to put in the record if one is looking to rely on this defense to penalties.

 

 

Villanova Law School Seeks Faculty Member to Direct Tax Clinic

Keith’s departure for Harvard this year means that Villanova Charles Widger School of Law is looking to hire a full time faculty member to run our tax clinic. The posting for the position is here.

It is a great opportunity. Villanova has an excellent Clinical Program and an innovative Graduate Tax Program. Prior to Keith, I directed the Tax Clinic, and Stephen also cut his teeth there as a student many moons ago. The Law School provides significant support to faculty members and expects that the new Tax Clinic Director will continue the Clinic’s place as a national leader in the tax clinic community.

A PT Anniversary and Court Finds IRS Summons on Coinbase Suggests an Abuse of Process

Today marks the 4th anniversary of Procedurally Taxing. Our first post, Welcome to Procedurally Taxing, discusses our goals for the blog. As I discussed in that initial post, we hoped to become a source for developments and to act as a filter to allow readers to hone in on some key issues relating to tax administration and tax procedure. When we started we had no idea how much work was involved in writing and editing. We also did not anticipate how much we would benefit from our readers, many of whom contact us, offer comments and become guest posters. So thanks to our readers for inspiring us to remain engaged.

Enough of the mush and on to some tax procedure.

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We have previously discussed the IRS issuance of a John Doe summons on Coinbase. The case has been proceeding and last week an order from a magistrate judge out of the Northern District in California held that an anonymous customer could intervene in the summons enforcement proceedings. This brief posts highlights some of those developments.

Coinbase is an exchange that deals in convertible virtual currency. It operates a bitcoin wallet. It is a big player in the virtual currency market. IRS has been concerned that parties using bitcoin are not complying with their tax obligations. Recall that in 2014 IRS issued Notice 2014-21, where IRS opined that virtual currencies are property for tax purposes, potentially triggering a gain or loss on sale or exchange of a virtual currency.

Flash forward a few years and IRS serves up its John Doe summons on Coinbase. The requested information was voluminous, including:

Account/wallet/vault registration records for each account/wallet/vault owned or controlled by the user during the period stated above including, but not limited to, complete user profile, history of changes to user profile from account inception, complete user preferences, complete user security settings and history (including confirmed devices and account activity), complete user payment methods, and any other information related to the funding sources for the account/wallet/vault, regardless of date.

At the recent ABA Tax Section meeting there was lots of talk about how the IRS summons was overbroad, potentially sweeping up small transactions and people whose information would likely be of no interest to the IRS.

Following service of the summons a number of parties, including Coinbase, sought to intervene to quash the summons. Coinbase also sought to narrow the scope of the summons.

This summer there was oral argument on the motions and IRS informed the court that it has narrowed the scope of the summons. The CA district court order on the motions describes that narrowing:

In particular, [IRS] now seeks information for users with at least the equivalent of $20,000 in any one transaction type (buy, sell, send or receive) in any one year during the 2013-2015 period. Further, the IRS does not seek records for users for which Coinbase filed Forms 1099-K during this period or for users whose identity is known to the IRS.

The order does a nice job laying out the procedures for IRS to get enforcement of a John Doe summons, highlighting that it (as with a generic third party or taxpayer summons) is not self-enforcing and also reviewing the special protections Congress set out in Section 7609(f) before the government can get records when it does not know the identity to whom the records belong.

As with any summons enforcement proceeding, the government has to show that it is issuing its summons in good faith and in pursuit of a Congressionally authorized purpose.

The interesting part of the recent order is the District Court considering whether one of the Coinbase customers has the right to intervene under the Federal Rules of Civil Procedure. There is a bit more to the issue than I describe but whether a party has a right to intervene in the absence of a privilege claim mostly turns on whether the IRS procedures amounted to an abuse of process.

In finding that there was an abuse, the court emphasized that the original summons was far too broad in relation to the government’s legitimate interest in seeking information that may pertain to potential evaders. It is worth honing in on the government’s position and the court’s rebuke:

As of 2014, Coinbase had one million users; thus, the IRS seeks broad data on likely hundreds of thousands of users. These records include complete user profiles including user payment methods, records of Coinbase’s due diligence on their customers, powers of attorney, complete user security settings and history (including confirmed devices and account activity), among other documents. The IRS offers no explanation as to how the IRS can legitimately use most of these millions of records on hundreds of thousands of users; instead, it claims that as long as it has submitted a declaration from an IRS agent that the IRS “is conducting an investigation to determine the identity and correct federal income tax liabilities of United States persons who conducted transactions in a virtual currency during 2013-2015” the Court must find that the Summons does not involve an abuse of process. It contends that “there seems to be a substantial gap between the number of people transacting in virtual currency (for which tax consequences might attach) and those that are reporting such transactions.”

(emphasis added)

The order pushes back on the government’s perspective, claiming that it “proves too much”:

Under that reasoning the IRS could request bank records for every United States customer from every bank branch in the United States because it is well known that tax liabilities in general are under reported and such records might turn up tax liabilities. It is thus no surprise that the IRS cannot cite a single case that supports such broad discretion to obtain the records of every bank-account holding American. While the narrowed Summons may seek many fewer records, the parties agreed to have the Court decide the motion on the original record, and so it has.

The order is also interesting for its rebuke of the government’s position that a customer (unlike Coinbase itself) did not have a protected interest that would allow it to intervene. There is little law in this area, bit the court order distinguishes between enforcement and issuance proceedings. The court holds that a customer who learns of the John Doe summons through some other means can intervene in an enforcement proceeding but not on the issuance of the summons itself:

There is nothing in the John Doe summons procedure adopted by Congress to provide protections to those to whom the IRS could not give notice that suggests that when the John Doe nonetheless learns of a summons from other means the John Doe has no interest in challenging the enforcement of that summons. The government’s assertion that to do so would place an undue burden on the IRS’s legitimate use of John Doe summons makes no sense. All that is being addressed here is the proposed intervenor’s right to intervene in a proceeding that is already taking place. Moreover, as the IRS concedes, if it knew of the applicant’s identity, it would have to give the applicant notice and the applicant would have the opportunity to challenge enforcement. It is thus unsurprising that the one case to have discussed the issue, at least that the parties have cited, assumed that a subject of a John Doe summons could challenge its enforcement.

That the direct interests of the other parties are now involved in this proceeding is as the court implies a good development. Allowing information from customers to be directly introduced provides an opportunity for the court to be better informed. While the government has a clear view as to what it believes Coinbase customers are up to, the strong reaction to the IRS efforts and the IRS’s narrowing of the summons itself suggest that the IRS worldview may be a bit narrow.

Stay tuned, as the court will now likely address the merits of challenges to the summons itself.

Important DC Circuit Opinion on Anti-Injunction Act and Offshore Disclosure Regime

We have previously briefly discussed the challenge that a group of noncompliant taxpayers brought against the IRS decision to disallow participation in the so-called Streamlined Procedures of the offshore disclosure program. Last year, a district court held that the Anti Injunction Act (AIA) barred the taxpayers from challenging the IRS decision. Last week the DC Circuit Court of Appeals in Maze v IRS upheld the district court.

Maze is the latest in a series of important Anti Injunction Act decisions and reflects the statute’s ability to insulate IRS decisions from judicial review until a taxpayer fits squarely within deficiency, refund or CDP procedures.

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The main issue that the Maze opinion considers whether the AIA is a bar to preventing the court from considering the taxpayer’s argument that the IRS should have used streamlined disclosure procedures rather than transition streamlined procedures. Streamlined procedures allow for no payment of accuracy related penalties; transition rules required payment of up to eight years of those penalties. (Readers looking to learn more on the offshore disclosure program can look to our colleague Jack Townsend over at Federal Crimes Blog; Jack is also the primary author in the criminal tax penalty chapter in the Saltzman Book treatise, and we discuss the IRS offshore disclosure policies in detail in the treatise).

The importance of Maze for our purposes is its consideration of the AIA and in particular Maze’s efforts to get court review of the IRS decision to shoehorn her into the Transition Streamlined procedures rather than the regular Streamlined disclosure procedures.

This takes us into the AIA itself, which is codified at Section 7121. The AIA provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person . . . .”  The key in the case is whether the lawsuit would have the effect of restraining the assessment or collection of any tax. There is a current ambiguity as to whether restrain for these purposes is defined broadly or narrowly. Not surprisingly the government argued for a broad application, urging that the term includes “litigation that completely stops the assessment or collection of a tax but also encompasses a lawsuit that inhibits the same.” Maze urged a more narrow reading, arguing restrain refers “solely to an action that seeks to completely stop the IRS from assessing or collecting a tax.”

The scope of the term “restrain” is a hotly contested issue in AIA litigation; proponents of the narrow reading have pointed to the analogous Supreme Court discussion of the term in the Direct Marketing opinion from a couple of years ago. Earlier this year, the Tenth Court of Appeals in Green Solutions carefully distinguished Direct Marketing and held that the broader reading of restrain is the more appropriate reading in the context of federal AIA litigation.

The DC Circuit in Maze sidestepped this definitional issue; in resolving the opinion in favor of the government the court assumed that the more narrow reading that the taxpayers urged was correct. Using that narrow reading, the DC Circuit still found that the taxpayers came up short.

To get there it first concluded that for these purposes accuracy related penalties are taxes for purposes of the AIA (as the Court discussed not all penalties are taxes for these purposes). After reaching that decision, it was fairly easy to get to the government’s view:

As participants in the 2012 [Offshore Voluntary Disclosure Program], the plaintiffs are required to pay eight years’ worth of accuracy-based penalties. These penalties are treated as taxes under the AIA and any lawsuit that seeks to restrain their assessment or collection is therefore barred…. This lawsuit, in which the plaintiffs seek to qualify to enroll in the Streamlined Procedures, does just that; to repeat, the Streamlined Procedures do not require a participant to pay any accuracy-based penalties for the three years covered by the program. Thus, their lawsuit would have the effect of restraining—fully stopping—the IRS from collecting accuracy-based penalties for which they are currently liable. We believe this fact alone manifests that the AIA bars their suit. See 26 U.S.C. § 7421(a).

To shift the focus away from the lawsuit’s impact on a possible assessment or collection, Maze emphasized that its efforts concerned a desire to apply to Streamlined procedures, which in and of itself alone was not a determination that there were no penalties due. The DC Circuit rejected that view:

They note that their eligibility to enroll alone, viewed in vacuo, has no immediate tax consequence. But we have never applied the AIA without considering the practical impact of our decision. Rather, we have recognized our need to engage in “a careful inquiry into the remedy sought . . . and any implication the remedy may have on assessment and collection.” Cohen, 650 F.3d at 724 (emphasis added). And here, the plaintiffs concede that they will enroll in the Streamlined Procedures if they are deemed eligible, see Oral. Arg. Rec. 3:10-3:15, thereby stopping the IRS from collecting the 2012 OVDP accuracy-based penalties.

The taxpayer noted that the Streamlined procedures would not have resulted in a more favorable treatment if the IRS determined that there was willful noncompliance or a foot fault with the Streamlined procedures. That too was not enough:

But the fact that their attempt to take advantage of the Streamlined Procedures’ more lenient tax treatment might be thwarted by the possibility of an adverse IRS determination does not make their lawsuit one that is not brought “for the purpose of restraining the assessment or collection of any tax.” 26 U.S.C. § 7421(a).

Conclusion

There are still important definitional questions that the courts are wrestling with as the IRS and Treasury get dragged kicking and screaming into the 21st Century post Mayo world. Using its centuries old shield of tax exceptionalism that is the AIA, the IRS still enjoys powerful procedural protections that essentially shoehorn procedural challenges to IRS rulemaking decisions to traditional tax litigation. The DC Circuit in Maze was careful to note (and the DOJ attorney conceded at oral argument) that Maze could have challenged the IRS position in a refund suit. This concession is important because there is an exception to the AIA if there is no other remedy for the alleged wrong. Of course, a traditional tax refund suit generally requires full payment, and that is a considerable bar and practical limit on taxpayers who do not like the rules of the game. Cases like Maze suggest that while the IRS is less special than it used to be the IRS still enjoys a limit on court inquiry into its decisions.

 

TIGTA Report Shows IRS Has a Long Way to Go On Employment Related Identity Theft

The other day I wrote about the Electronic Tax Administration Advisory Committee and its annual report showcasing many successes and improvements IRS made when it came to identity theft. Part of the success ETAAC discussed included a major drop in identity theft receipts, which the report suggests is the product of better detection at the front end of the return filing process. TIGTA, in a report from last month, highlights a different story when it comes to employment related identity theft. Essentially TIGTA found that IRS materially understates the number of employment-related identity theft cases and has had major systemic flaws in informing victims.

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What is employment related identity theft? As most readers know, to gain employment one must have valid Social Security number. Individuals who are not authorized to work in the US sometimes use other peoples’ Social Security numbers to secure employment. They then file a individual income tax return using an Individual Taxpayer Identification Number (ITIN). Individuals whose SS numbers are used by someone else can be in for a surprise after they file a tax return (or do not file due to not having an obligation to file) when IRS may send an Automatic Underreporting (AUR) notice reflecting the income that was earned by someone else who illegitimately used their SS number.

IRS procedures are supposed to catch returns that are submitted by an ITIN user that reflect someone else’s SS # associated with wages. In IRS speak, that is known as an ITIN/SSN mismatch. When all works well, IRS places an identity theft marker on the victim’s account, and prevents victims from getting an AUR notice.

TIGTA found that all does not work well, with a number of systemic issues associated with placing markers on accounts. It examined over a million e-filed returns that had an SS/ITIN mismatch and found that in about 51.8% of the time IRS put the appropriate identity theft marker on the account. The IRS did not place markers on the remaining 48%; that was because many in that 48% group did not have a tax account (Note IRS defines tax account as an active account as one “for which the taxpayer’s Master File account, which contains the taxpayer’s name, current addresses, and filing requirements, etc., exists on the IRS computer system capable of retrieving or updating stored information.”).

Of the e-filed returns, there were another 60,000 or so victims who did have a tax account but still did not have an id theft marker placed; IRS noted various reasons, including its placing only one marker per return even if the return filed has multiple incorrect SS# associated W-2s and that some of the victims were minors and IRS did not have procedures in place to inform minors.

TIGTA sensibly recommended that IRS take steps to improve its process of placing id theft markers on all e-filed returns. IRS generally agreed with the recommendations and said it would monitor progress “and determine, by July 2018, the requisite programming changes needed to ensure that identity theft markers are properly applied when the potential misuse of an individual’s SSN becomes evident.”

In addition to e-filing issues, TIGTA noted major problems that the IRS has had in placing identity theft markers when a return reflecting an ITIN/SS mismatch is not e-filed:

Specifically, guidelines state that a Form W-2 is not required for Line 7 (Wages, Salaries, Tips, etc.) of Form 1040. As such, the IRS has no way to identify ITIN/SSN mismatches associated with paper tax returns. In addition, if the ITIN filer voluntarily attaches a Form W-2 with an SSN, IRS internal guidelines do not require employees processing these returns to place an employment identity theft marker on the SSN owner’s tax account.

TIGTA recommended that IRS require ITIN filers to attach W-2s with their 1040’s; IRS rejected that recommendation because it noted that “wages constitute taxable income under Internal Revenue Code Section 61 and are reportable even when a Form W-2 is not provided or is otherwise unavailable at the time of return filing.” IRS did, however, agree to put better procedures in place when a paper filed ITIN return does in fact include W-2s that reflect a mismatch.

Conclusion

The TIGTA report shows that IRS has a lot of room for improvement. People need to be vigilant, as IRS in many cases does not take action even if it has information that reflects a high likelihood that someone is improperly using a Social Security number. As TIGTA notes, if IRS fails to place an identity theft marker on an account, “victims can be subjected to additional burden when the IRS processes their tax returns.” It may trigger confusing and stressful notices and limit the ability for IRS and others to help victims unwind the effects of the identity thief. IRS needs to do a better job here, as the costs for victims in time, stress and potentially dollars are likely very significant.