9th Circuit Reverses District Court in Case Involving Exceptions to SOL For Failing to Disclose a Listed Transaction

We have often discussed statutes of limitation. Yesterday’s post discussed the government’s unlimited time period to assess civil penalties that are not based on the filing of a tax return. Today’s post discusses the consequences of a taxpayer failing to file a form that it is supposed to file when it engages in a listed transaction. In an opinion that surprised me, in May v US, (an unpublished opinion) the 9th Circuit reversed and held that the taxpayer’s failure to file the form resulted in the application of an extended SOL on assessment even when the IRS admitted that it had knowledge of the information that the form itself would have contained.

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First some background: Section 6707A imposes a civil penalty for failing to include information pertaining to a listed transaction on a tax return. Under Section 6707A a listed transaction is “a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of [Section] 6011.”

Section 6501(c)(10) is an exception the general SOL rules and addresses a taxpayer who “fails to include on any return or statement (that Section 6011 requires to be included in the return or statement) for any taxable year any information with respect to a listed transaction.” If this information is omitted, the time for the assessment of any tax imposed by the Code arising out of the transaction, “shall not expire before the date which is [one] year after the earlier” of (A) the date the Service receives the information required to have been filed, or (B) the date that a material advisor complies with the Service’s request for the list the material advisor is required to maintain on the transaction in which the taxpayer has participated.

Treasury promulgated regs under Section 6011 that specify how a taxpayer is to disclose the transaction. Regulation § 1.6011-4 provides that “[a] taxpayer required to file a disclosure statement under this section must file a completed Form 8886, ‘Reportable Transaction Disclosure Statement’ … , in accordance with … the instructions to the form” and that “[t]he Form 8886 … is the disclosure statement required under this section.”

May involved a transaction that the taxpayer failed to disclose on his 2004 tax return, which he filed in 2005. The transaction at issue that he failed to include on his 2004 tax return was about $165,000 in pass through income. May eventually agreed that the transaction that gave rise to the omitted income was a listed transaction. At the district court, the Service argued that only the taxpayer’s filing of Form 8886 triggered the statute of limitations for purposes of Section 6501(c)(10)(A). The Service admitted that it had knowledge of the information that the taxpayer was supposed to report in the form but that May’s failure to file Form 8886 meant that the statute of limitation was still open (the trial court and appellate opinion do not specify how the IRS got the information but IRS conceded that it had it). May argued that the Service’s knowledge of the information in the form, rather than his filing the form, was the starting point for the one-year period.

 At the district court, May won, with that opinion stating that “common sense confirms that the statute of limitations does not open or close based on which piece of paper a taxpayer chooses to employ.”

Over a brief but spirited dissent, the 9th Circuit reversed. In finding for the government, the 9th Circuit tied the 6501(c)(10) exception to what it viewed as clear directive under the 6011 regulations to submit the 8886:

6501(c)(10)(A)’s reference to “the information so required” under § 6011 functions as an incorporation by reference of the disclosure requirements of Treasury Regulation § 1.6011-4(d), which requires that a taxpayer disclosing a listed transaction do so on Form 8886 and send a completed copy of that disclosure to the OTSA[Office of Tax Shelter Analysis]. It is undisputed that May neither filed a Form 8886 nor sent it to the OTSA. For that reason, May failed to do what was required to start the running of the § 6501(c)(10)(A) statute of limitations. Thus, the one-year limitations period of § 6501(c)(10)(A) did not commence, and the IRS’s assessment of the penalty was timely.

As support, the majority felt that looking to 6501(c)(10) in isolation was not coherent with the overall scheme, and it repeated the maxim from the 1984 Supreme Court case Badaracco v Comm’r that statutes of limitations “barring the collection of taxes otherwise due and unpaid are strictly construed in favor of the Government.”

The dissent viewed it quite differently, focusing on how Section 6501(c)(10) itself does not require the submission of any particular form and that the regulations under 6011 failed to clearly specify the SOL consequences of failing to submit information on any particular form:

It would have been simple to write a statute that stated that the limitations period starts to run on “the date when the taxpayer provides the information to the Secretary on the form specified by the Secretary,” but that’s not how Congress wrote the statute. Alternatively, it would have been simple for the Secretary to have promulgated a regulation that clearly informed all taxpayers that providing information to the IRS doesn’t count unless the information is provided on the specified form.

I must say I am surprised by the 9th Circuit opinion. As the dissent noted, it might have been appropriate to remand for the trial court to refine its standard to avoid a broad reading of the opinion that would invite questions and litigation in other circumstances as to whether IRS had sufficient knowledge:

I have no quarrel with the Government’s position that the taxpayer should be required to provide the relevant information in a coherent form to the appropriate tax agents. An interpretation that started the limitations period as soon as some IRS office, somewhere, had the information or as soon as IRS agents collectively had the information would be both illogical and open to abuse. I don’t disagree that it might be appropriate to remand this case to the district court to apply a more precise interpretation of the statute. But I am not persuaded by the Government’s interpretation, especially in the context of a civil penalty, and cannot join my colleagues in adopting it.

It seems to me if the IRS admits to knowledge of the information then in appropriate circumstances then to elevate the Form itself as the sole trigger elevates a literal form over substance.

Court Rules Abusive Tax Shelter Penalty Has No SOL; Laches Also Not A Defense

Groves v US involves a taxpayer who was assessed over $2M in penalties for failing to register transactions as tax shelters. The penalties stemmed from conduct in years 2002, 2004 and 2005, but the IRS did not assess the penalties until 2015. Groves argued that the IRS assessments, coming over a decade after the conduct that gave rise to the penalty, was too late. The federal district court for the Northern District of Illinois disagreed.

I will briefly explain the opinion below.

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Under statutory procedures that allow for a refund claim following partial payment of the tax shelter penalty, Groves paid 15%, and filed a refund claim alleging that the penalty was assessed outside the normal three-year statute of limitations under Section 6501(a) or a 5-year SOL under Title 28 that applies to civil penalties. He also alleged in the alternative that the doctrine of laches barred the government from assessing the penalty for conduct that stretched back the better part of a decade.

After IRS denied the claim, Groves filed suit in federal district court. The court agreed with the IRS, holding that the penalty under Section 6700 for failing to register a tax shelter was not subject to the normal statute of limitation scheme and that laches was of no help.

We are in the process of finishing the new chapter in Saltzman and Book on statutes of limitation (SOL); it should be out in the fall (with this chapter will mark the rewriting of all original 18 chapters in the book, with a new 19th chapter on CDP). In the SOL chapter we discuss the odd intersection of civil penalties and SOL issues. Many penalties are not subject to readily observable statutes of limitations. For civil penalties that are not “return-based” penalties, courts have increasingly found that those penalties are not subject to any statute of limitations.

What are non return-based penalties? The key feature is that the conduct that gives rise to the civil penalty is not tethered to the filing of a tax return; in other words, as in Groves, what triggered the liability was the conduct of promoting tax shelters and failing to inform the IRS of his promotion rather than the filing of a return.

Groves argued that because the Code states that the 6700 penalty is to be assessed and collected in the same manner as taxes it should thus be subject to the general SOL rules as per Section 6501(a). The opinion disagreed:

Section 6700 assessments do not depend on the filing of a tax return,” but rather “occur … after the IRS becomes aware that an individual’s activities are prohibited by Section 6700.” The mismatch between the triggering event under § 6501(a)—the taxpayer’s filing a return—and the basis for liability under § 6700—being involved in a tax shelter and making false statements about its benefits—makes the § 6501(a) limitations period an inappropriate fit for the assessment of § 6700 penalties.

Groves countered that there was a return at issue, that is, the individuals who took up his advice and filed returns taking positions consistent with his shelter advice. The court emphasized that the penalty under Section 6700 only looked to whether promoter makes “a statement that falsely touts the shelter’s tax benefits.”

The court also addressed 28 USC § 2462, a non-tax law based SOL that applies to civil penalties. That statute states that “[e]xcept as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued ….”

The opinion concluded (as have other courts) that the IRS assessment of a 6700 penalty does not arise from “an action, suit or proceeding” because the IRS assessment arises from in the court’s view an ex parte act rather than an adversarial adjudication. Adjudicative action is a prerequisite to the 28 USC § 2462 SOL applying. As support, the court emphasized that Groves had no right to any pre-assessment administrative adjudication of the penalty, and a number of courts have held that the assessment itself was agency conduct not in the nature of an action or suit for these purposes. Groves served up a number of other creative § 2462 arguments, but the court rejected them, largely on the grounds that the IRS imposition of the penalty was not in any way based on a hearing or other adversarial procedures.

Finally, the court considered whether laches applied. Laches is an equitable defense that gives the court the power to hold that a legal right or claim will not be enforced if a party unreasonably delays in bringing the claim and the delay prejudices the other party. There is uncertainty as to whether a laches claim can be made against the government in tax cases. A Fifth Circuit case, Sage v US, after concluding that no SOL applied to the 6700 penalty, stated in dicta that the doctrine was the only curb on IRS assessment power.

Groves is appealable to the 7th Circuit, and the district court noted that the circuit had not held whether laches is available as a defense to a government tax suit. (for an interesting discussion of laches, including its history, see Judge Posner’s discussion in the 7th Circuit Lantz case from 2010). Groves concluded that laches is probably not a defense in tax cases, and that even if laches were an available defense it only applied in narrow circumstances that were not present in the case. One of the circumstances is when there is an egregious delay. On that point  the court pointed to a 2005 Second Circuit case, Cayuga Indian Nation v Pataki. In Cayuga, the US intervened on behalf of the tribe in an ejectment action that stemmed from conduct over 200 years old and pertained to actions surrounding a treaty signed in 1795. Unlike Cayuga, “this case, by contrast, involves a delay of just over ten years. Although ten years is not an instant, the difference between a ten-year delay and a 200-year delay is one in kind, not of degree.” Another circumstance where laches may apply is when the government action pertains to an adjudication of private rights. As to that circumstance, the court noted that “few areas of government activity are more canonically sovereign than taxation.”

Parting Thoughts

It does to me seem odd that the government has no limits on when it can assess these (and some other) penalties. Over the last couple of decades there has been a vast increase in the number of civil penalties in the Code. When Congress gets around to revising the civil penalty regime, it would be well served to look at these non return based penalties and impose some outside limits on when the government can  assess these penalties.

 

Oral Argument This Week on State Qui Tam Action Involving Citigroup

Readers may recall from fall of 2015 a post by Professor Eric Rasmusen discussing a New York State False Claim complaint he filed in connection with allegations that the government’s purchase of Citigroup stock should have triggered Section 382 to apply to limit the bank’s net operating losses. The matter has been removed to New York State court and is scheduled for oral argument this Wednesday. Professor Rasmusen has posted lots of useful information (including briefs) about the case here.

The main issues before the court are the following:

1. Does Citigroup owe the taxes?
2. Should Citigroup know it owes the taxes? (scienter)
3. Is the qui tam suit based on information “publicly disclosed in the news media and government reports”?
We will keep you posted.

ABA Tax Section Preview: Panels of Interest, Appeals Comments and Olson Wins Distinguished Service Award

Keith and I are off to the ABA Tax Section meeting in DC this week. We will report back on some of the highlights; both Keith and I are speaking. Keith is on a panel today discussing issues small businesses confront when things do not go well, including trust fund recovery and bankruptcy issues.

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I am moderating a panel tomorrow that will feature two former PT guest posters, David Vendler and Caleb Smith. David and Caleb will be focusing on information reporting issues; David will be looking at interest reporting arising from transactions relating to homeownership (e.g., loan modifications, short sales). As David has discussed here before, the issue is timely: it is part of the recent IRS guidance priority and David is lead attorney in a class action suit that alleges banks are systematically underreporting interest to millions of consumers. Caleb will be looking at systemic approaches to information reporting, looking at student loan discharge as a case study, a topic he has also discussed in PT here.

On Saturday I will be on a panel moderated by former guest poster, current Tax Court clerk (and Villanova Law alum) Lany Villalobos with the National Taxpayer Advocate Nina Olson, EITC expert Steve Holt, and Congressional Research Service staffer Margot Crandall-Hollick; the panel will focus on tax benefits for working families, with an eye toward future reform proposals.  I will look at two recent cases as a platform to show how the current EITC often entraps individuals, contributing to the high improper payment rate. This is a topic of a brief essay I am finishing and hope to discuss in more detail in PT once it is done.

In addition to hosting meetings, the Tax Section submits many comments. Earlier this week, the Section submitted a set of comments looking at recent Appeals changes and suggesting improvements. Those comments are quite good and are linked here.

Finally, the ABA Tax Section is recognizing National Taxpayer Advocate Nina Olson this weekend with its Distinguished Service Award in honor of her service to the ABA Tax Section, the government and the tax system generally. Former ABA Tax Section Chair Michael Hirschfeld wrote a brief article discussing some of Nina’s career highlights. In it he shares a terrific story involving Keith and Nina meeting years ago to discuss Nina’s prescient idea to have tax clinics help the unrepresented in tax disputes.

District Court Grounds NetJets’ Refund Suit

NetJets Large Aircraft v US, a recent case out of the Southen District of Ohio, [free link not available], illustrates some of the nooks and crannies that taxpayers must navigate in refund suits. Being right on the merits is not enough. Filing a timely claim for refund is a jurisdictional requirement, even when the circumstances are clear that the government knows that a taxpayer wants its money back. Most of the times when there is a dispute about timeliness of a claim the issue revolves around a taxpayer filing a claim too late. Sometimes, as in this case, a claim for refund can also be too early.

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IRS assessed NetJets and related entities air transportation excise taxes on a variety of fees that the fractional jet company collected from its customers. For a court to have jurisdiction over a refund suit, taxpayers must under the Flora rule fully pay the tax, file a refund claim, and if the Service denies the claim, file a refund suit in federal court. As a divisible tax, under Flora, NetJets only needed pay the amount of excise tax due on an individual transaction for each tax quarter at issue to gain standing to challenge the entirety of the assessment.

NetJets payed a representative amount of tax, and then filed a claim for refund on the amounts it paid.(As to whether an amount is considered representative to meet the Flora divisible payment exception see an earlier two-part guest post by Rachael Rubenstien here ). After the Service denied the claim, it filed a suit seeking 1) a refund of the amounts it paid and 2) an abatement of the unpaid amounts the IRS had assessed for other transactions that IRS felt were subject to the excise tax.

Here is where it got tricky for NetJets.

During the pendency of the suit, IRS applied overpayments from other periods to the unpaid assessments that were at issue in the refund suit.  NetJets won on the merits in the refund suit and then filed a motion to make sure that the district court’s final judgment included an order that directed the Service to pay back the tax that were originally listed in the complaint as well as the overpayments that the IRS had applied during the pendency of the suit.

For support for its motion, NetJets relied in part on Fed R Civ Proc 54(c), which states that ‘[e]very . . . final judgment [other than a default judgment] should grant the relief to which each party is entitled, even if the party has not demanded that relief in its pleadings.'”

The Service disagreed, and in opposing the motion argued that the US had not waived sovereign immunity with respect to the overpayments it had applied to the unpaid assessments during the pendency of the refund suit. In particular, the government leaned on the jurisdictional requirement in Section 7422 that a tax refund suit cannot be brought until a claim has been filed and the rule in Section 6511(b)(2) that “no credit or refund shall be allowed or made after the expiration of the period of limitation prescribed in [Section 6511(a)] for the filing of a claim for credit or refund, unless a claim for credit or refund is filed by the taxpayer within such period.”

While the government agreed that NetJets had filed a refund claim, it filed its claim before the Service had applied the later overpayments to the assessments that were at issue in the case. According to the government, its earlier claim was not a claim with respect to the later amounts. The evidence in the record did not indicate that NetJets filed a formal claim for those other applied amounts; nor did it amend its pleadings to specifically allege a return of those funds. While the government agreed to abate the unpaid assessments, it would not refund any of the amounts that were applied to the assessment after NetJets filed its original refund claim because there was no separate claim filed with respect to those latter amounts.

The district court agreed with the government, looking primarily to the statutory language in Section 6511(b)(2). To get around that statute’s rather clear language that tethers the government issuing a refund to a taxpayer filing a claim, NetJets argued that a plain language approach to the issue failed to effectuate legislative intent (preventing the litigation of stale claims) and produced an absurd result. The court disagreed, initially noting that Section 6511(b)(2) had no exception for divisible taxes and that the broad language of the statute suggested perhaps an intent that was not so clear to discern.

As to the absurdity of requiring a taxpayer to file a separate claim when litigation was already pending, the court disagreed with NetJets:

Plaintiffs point to the apparent absurdity of filing a new refund claim when the Court has already determined that the underlying tax assessment cannot be collected. The application of § 6511(b)(2) in this case is, admittedly, tedious. But it is hardly absurd. Where the IRS retains overpayments and applies them toward a divisible tax liability for which a claim has already been filed, the taxpayer, to comply with § 6511(b)(2), must take a simple action: file a new refund claim. And contrary to Plaintiffs assertion, a refund claim is not only a “challenge [to] the lawfulness of an underlying tax assessment.” More mundanely, and as relevant here, a refund claim is a formal request to the IRS for the return of a taxpayer’s money. See 26 C.F.R. 301.6402-2. Filing a refund claim does not become a superfluous task simply because the lawfulness of the underlying assessment has already been determined.

Conclusion

This is a harsh result for NetJets but the opinion suggests that all is not lost. While it is too late to file claim now, the opinion states that the government “hinted” that previously NetJets may indeed have filed another formal claim for some of the amounts. Moreover, the opinion discusses that NetJets may have submitted informal refund claims, though there was insufficient evidence in the record on that point, and a party who files an informal claim must also perfect that informal claim with a formal claim in order for a court to have jurisdiction.

While NetJets may be able to salvage some of its refund the lesson of this case is clear: if litigating a divisible tax refund suit taxpayers should be on the lookout for IRS applying any overpayments to the dispute that is at issue in the suit. Even if the taxpayer wins on the merits, absent a specific refund claim for those amounts, taxpayers are vulnerable to the government’s argument that it has not waived sovereign immunity.

NetJets Large Aircraft v US, 119 AFTR2d 2017-1246 (SD Ohio 2017)

Ways and Means Committee Hearing on 2017 Tax Season Highlights Progress and Challenges

Last week the Oversight Subcommittee of the House Ways and Means Committee held its annual hearing to examine the IRS’s filing season performance. The testimony included opening statements from Chair Vern Buchanan and ranking minority member John Lewis, as well as testimony from IRS, TIGTA and GAO.

For those interested in the testimony itself, this link will take you to Committee’s landing page, with video and the written testimony. Here are some highlights.

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Chair Buchanan emphasized the IRS’s efforts to combat fraud, looking to specific programs that in his mind are characterized by high error rates; not surprisingly, the EITC was the poster child (“we are taking about big money here”) though the Chair did note that it was not clear how much of the error was due to fraud and how much due to mistakes.

Representative Lewis, after commenting on the upward trajectory in customer service this filing season, used most of his introductory remarks to criticize private debt collection, noting that he has introduced legislation to overturn its adoption.

The testimony of the IRS executive, Kristen Wielobob, emphasized that this filing season has been generally successful, pointing to reduced telephone wait times and implementation of PATH changes (like accelerating the receipt of W-2’s and delaying EITC and CTC-fueled refunds until February 15 to theoretically allow a match before release of those credit-based refunds).

The GAO testimony, while also noting many of the IRS successes such as reduced telephone wait time, looked to the challenges, including the somewhat surprising statement that even with the PATH acceleration of W-2 filing deadlines, IRS did not verify the wage information on about 2/3 of the EITC returns it received. That was due in part to limits IRS had in processing information it received from third parties (including the challenges of digesting paper rather than electronic W-2s). GAO did note however that the PATH changes led to an early identification of about $863 million in additional refunds as being possibly fraudulent.

The TIGTA testimony indicates that it is studying and will report soon on IRS compliance with the PATH requirements. It also highlights the IRS shift away from in-person service to alternative ways to communicate with taxpayers, (or in its parlance “technology-based assistance services”). The TIGTA testimony also highlights the ongoing identity theft challenges IRS has faced, the IRS efforts to assist identity theft victims and the challenges associated with private debt collection. On the latter point, most worrisome to me is the TIGTA warning that in an initial audit it felt that IRS seems to be setting itself up for major problems in administering the PDC program. According to TIGTA,

[w]e have identified numerous concerns during our audit, including the IRS’s lack of commitment to assist taxpayers concerned that the PCAs [private collection agencies] are part of an impersonation scam as well as our concerns related to the IRS’s process for receiving taxpayer complaints about PCAs.

Parting Thoughts

I am far removed from DC and do not have a good feel about the prospects for tax reform this year. The current administration’s proposals will, at least in the short-term, cost a great deal of revenue. While there is always a drumbeat to reduce the tax gap, those beats get louder when a legislature looks hard to find revenue offsets.

The opening statements of the Chair and ranking minority member of the Oversight Subcommittee to a large extent focused on tax gap issues. I suspect that there will be an increasing focus on ways to reduce the tax gap. While much of the individual tax gap is associated with small business income underreporting, small business taxpayers have powerful voices.  That suggests an increased focus on reducing errors associated with refundable credits, which, relatively speaking, account for little of the overall tax gap but credit claimants typically do not have the same clout with representatives. I would not be surprised if Congress expands the PATH model of delaying credit-based refunds to allow IRS more time to verify eligibility. In addition, TIGTA (as it has in years past) discussed the supposed benefits of allowing IRS to use math error authorities to disallow refundable credits in additional circumstances. I have previously raised concerns with expanding IRS math error powers  (which essentially deprives claimants of the usual pre-assessment notice and hearing rights), but I suspect that there may be increased interest in that approach.

 

 

Tax Court Holds That Veteran’s Submission of Election to Exclude Foreign Earned Income is Too Late When Submitted After Service Issues a Substitute Return

This week’s Redfield v Commissioner illustrates the harsh and sometimes unfair results that sometimes attach when a taxpayer misses a deadline. The taxpayer in this case was a disabled 12-year Marine veteran who served in Afghanistan; he was suffering from PTSD and memory loss. After leaving the Marines he returned in 2010 to accept a civilian position at an airfield in Kandahar. Unfortunately his physical and mental condition worsened and he returned back to the States later in 2010. The case illustrates perhaps a gap in our tax system: the Service is required to enforce most deadlines without regard to whether the taxpayer’s disability contributed to the taxpayer’s delinquency.

Redfield’s tax troubles arose from his failing to file a tax return for the 2010 year, the year in which he had some foreign source income from the time he was working as a civilian in Kandahar. In 2014, IRS eventually prepared a substitute for return under Section 6020(b). Redfield did not respond to the stat notice that accompanied the SFR; instead he filed a delinquent 2010 return, which attempted to exclude the foreign source income from his shortened civilian gig in Kandahar.

Section 911 provides that citizens and residents living and working outside the US can exclude some of that earned income (the cap is adjusted for inflation and is about $100,000 these days). I will not spend much time on the nuances of the foreign earned income exclusion but Section 911 states that a taxpayer wishing to avail himself of the exclusion has to elect its application. The statute also directs the Treasury to issue regs to implement the regime. Treasury issued regs under Section 911 that fill in the details of that election: the when and the how are spelled out in detail.

The case considers whether Redfield satisfied the regulation’s timing requirement. The regs establish 4 methods of making the election 2 of them require the election to be made either with or in response to a timely filed return; a third requires that the election be made within one year of a timely filed return. That did not happen here.

The main issue revolved around the fourth method. It allows a taxpayer to file the election if it is made before the Service “discovers that the taxpayer failed to elect the exclusion.” In particular, the Tax Court considered whether the Service’s SFR amounted to its discovering that Redfield did not elect to exclude the wages he earned while working in Afghanistan.

Unfortunately for Redfield, in McDonald v. Commissioner, T.C. Memo. 2015-169 the Tax Court held that the Service discovers the failure to make the election no later than the issuance of the substitute for return. Redfield’s election was submitted years after the SFR, and the Tax Court held that he was out of luck.

The Tax Court acknowledged the harshness of the outcome, but felt that its hands were tied:

We acknowledge petitioner’s military service to this country and recognize that he emerged far from unscathed from his tours of duty in Afghanistan. We understand that the procedural requirements for making a timely [foreign earned income exclusion] election are not exactly intuitive and that the scars petitioner incurred during his military service may have contributed to the tax delinquency at issue.

While these facts may be relevant to the penalty and additions to tax that the IRS determined, they do not alter the requirement of a timely election. As to that requirement we must give effect to the regulations that the Secretary has issued under his delegated authority from Congress and to this Court’s prior construction of those regulations. That being so, we unfortunately have no alternative but to hold that petitioner did not make a timely and valid [foreign earned income exclusion] election for 2010. He is therefore not entitled to exclude from gross income any foreign earnings under section 911.

Some Parting Thoughts

Keith has written extensively on the impact of disability and time deadlines in the Code. An article he co-wrote a few years ago suggests that Congress should more directly apply the concepts of financial disability to other deadlines that taxpayers may not meet.

Deadlines by their nature may at times work and produce an unfair substantive result. The Service administers a complex tax system and processes many million tax returns. Yet it seems that for taxpayers who suffer from mental and physical disabilities, especially for veterans whose injuries arose in service for our country, there should be a safety valve for the Service or the court to provide relief when the failure to meet a deadline  is connected to the taxpayer’s disability.

Whistleblower Who Prompted Voluntary Compliance Not Entitled to Reward

One of the more interesting Tax Court opinions of the last month is Whistleblower 16158-14W v Commissioner. The opinion concludes that a whistleblower who provides information that exposes taxpayer misconduct and brings about a voluntary change in a taxpayer’s behavior in future years is not entitled to receive a reward.

The case involves an employee/whistleblower who told the Service about his employer, a corporation (perhaps a financial institution) that failed to withhold on payments of interest and dividends to foreign persons. (As background, US persons paying US source payments to foreign persons are generally required to withhold at a 30% rate unless the foreign person establishes that it is subject to an exemption or lesser rate).

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The noncomplying corporation was already under audit for the 2006-08 years for unrelated issues. After the Whistleblower Office received the information about the corporation’s withholding noncompliance, it provided the information to LB&I and Criminal Investigation, and LB&I expanded the audit to include the withholding issues.

At the conclusion of the 2006-08 examination, the Service issued a no-change letter to the corporate taxpayer. After the exam, an employee of the Whistleblower Office and an employee of LB&I completed an evaluation of the whistleblower claim on Form 11369. The opinion discusses that evaluation:

The explanation attached to the Form 11369 stated that the whistleblower was correct that the taxpayer had made errors but the cause of the errors was an “honest mistake” made while updating its reporting systems. The explanation went on to say that “[i]t appears the * * * [taxpayer] has been convinced by its close call to become fully compliant with its withholding tax responsibilities and further examination is not warranted.”

Eventually, the Service issued a denial of the request for an award because the information that the whistleblower provided did not turn into “collected proceeds” under the whistleblower statute.

Section 7623(b)(1) provides that a whistleblower will “receive as an award at least 15 percent but not more than 30 percent of the collected proceeds (including penalties, interest, additions to tax, and additional amounts)”.

Section 7623(b)(1) also predicates the award on the Secretary’s proceeding with “any administrative or judicial action described in subsection (a)” There was no dispute that there was an administrative action in 2006-08, the original years under audit. Yet the taxpayer received a no change letter for those years.

What about future years, when the whistleblower alleged (and the Service did not dispute) that the taxpayer became voluntarily compliant, resulting in the Service collecting substantially more revenue than it otherwise would have absent the whistleblower coming forward?

This tees up the legal issue that the opinion addressed: can a whistleblower’s information that prompts a taxpayer’s voluntary compliance in future years serve as the basis of an award? In particular, does the additional revenue that the Service collects due to a taxpayer’s voluntary compliance amount to “collected proceeds” under Section 7623(b)(1)?

As this case was resolved on summary judgment, the opinion assumed that the whistleblower’s factual allegations were correct, i.e, that in fact his spilling the beans on the withholding noncompliance did in fact contribute to the corporation becoming compliant in future years.

The opinion concludes essentially that without the Service taking administration action in future years the information that the whistleblower provides cannot justify the payment of an award. The opinion gets there first by noting how prior opinions have addressed the scope of the term “collected proceeds”:

Section 7623(b)(1) provides that a whistleblower will “receive as an award at least 15 percent but not more than 30 percent of the collected proceeds (including penalties, interest, additions to tax, and additional amounts)”. Therefore, an award is predicated on the collection of proceeds. “Collected proceeds” is not defined in the statute. In Whistleblower 21276-13W v. Commissioner, we relied on the canons of statutory construction to define collected proceeds. We defined it as “all proceeds collected by the Government from the taxpayer”. We explained that “collected proceeds” is an “expansive and general term” a “sweeping term”, and “not limited to amounts assessed and collected under title 26”… (citations omitted).

Despite the expansive language in Whistleblower 21276-13W  v. Commissioner, it held against the taxpayer, primarily based on a policy concern about the difficulty of establishing a connection between the information that the whistleblower has provided to the Service and a taxpayer’s future conduct:

Collected proceeds do not include self-reported amounts collected when a taxpayer changes its reporting for years that are not part of the action. The Commissioner argues, and we agree, that because of the significant costs and heavy administrative burden, collected proceeds cannot include amounts collected for years after examination years on account of a taxpayer’s changing its reporting. (emphasis added)

In language that I found a bit harsh, the opinion states that the whistleblower’s argument takes the Whistleblower 21276-13W discussion of collected proceeds to an “irrational extreme to argue that self-assessed amounts collected for future years are proceeds collected by the Government. Indeed, many, if not all, of the Commissioner’s examinations will have some influence on a taxpayer’s reporting. However, any determination of an award based on additional amounts collected for years following examination years would be based on speculation.”

There is more to the opinion, including a discussion of how the regulations under Section 7623 in limited and different circumstances tether collected proceeds to future years’ positions if “adjustments to tax attributes made in the year of the action have direct carryover consequences for other years”; its discussion of how if the Tax Court accepted the taxpayer’s position it would effectively require the Court to impermissibly order the Service to conduct an examination of the taxpayer’s future years; and how the Service discussion in Form 11369 of the taxpayer’s future compliance at the end of the 2006-08 audit did not amount to an “implied settlement” for those future years.

This is a very tough outcome for the whistleblower. There are strong policy reasons to want to reward a person whose conduct causes future tax compliance. Given the limited statutory definition of the term “collected proceeds”, and the competing policy concerns that the opinion did not fully address (such as the benefit of information prompting voluntary compliance). I suspect that this is not the last word on some of these issues.