Preparer “Doctors” the Return Adding Phantom Income: Court Sustains Preparer Penalties

Tax return preparers have heightened requirements when preparing returns claiming many refundable credits. While the IRS lost the battle over regulating unlicensed preparers, it does have tools to examine and sanction preparers who violate those rules. There have been very few opinions considering whether a preparer’s conduct justifies the imposition of civil penalties. Last week in Foxx v US the Court of Federal Claims held that a preparer was subject to a civil penalty under Section 6694(b) for his willful or reckless conduct relating to his failure to make reasonable inquiries into income from taxpayer’s purported auto-detailing business. The IRS claimed that the taxpayer did not in fact earn the income in question. The Foxx case presents the what frequent guest poster Carl Smith has referred in a guest post to as the topsy-turvy world of earned income tax credit (EITC) cases because the creation of the phantom income fueled a refundable EITC that exceeded the taxpayer’s income and self-employment tax liability.

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George Foxx came to the attention of the IRS after it audited the tax return of Shakeena Bryant. Bryant had claimed an EITC; almost all of the earned income on the return was from an auto-detailing business she reported on Schedule C. Foxx referred to himself as the tax doctor and claimed to have 37 years of tax return prep experience. Bryant went to the tax doctor with a friend of hers, Herman James. On audit of Bryant’s return, the IRS disallowed the credit. During the audit, she agreed that she did not have the income necessary to justify her claiming the credit. In correspondence, Bryant claimed that she was instructed by Foxx to report the income to justify the refund.

IRS then examined Dr. Foxx and assessed a $5,000 penalty under Section 6694 for his willful or reckless conduct in preparing the return (note there is a separate $500 penalty under Section 6695(g) for violating the due diligence rules; that penalty was not at issue in the case). After an administrative appeal of his penalty IRS reduced it to $2500. Foxx paid and sued for refund.

The government deposed Bryant’s friend (James) who accompanied her to Dr. Foxx when the Tax Doctor prepared her return.

The case on the surface turned on whether the preparer George Foxx 1) facilitated the improper claiming of the credit by instructing the taxpayer how to goose the credit and make it look legitimate by applying for a business license even in the absence of the actual business or 2) prepared the return based on what Bryant told him about her business.

A bad fact for the Tax Doctor in this case was that James on deposition supported Bryant’s version of the facts. Both Bryant and James stated that she obtained a business license the same day the return was prepared pursuant to Dr. Foxx’s instruction. James also stated that Dr. Foxx “explained that such a license would allow him to obtain more money for Ms. Bryant, and Dr. Foxx, not Ms. Bryant, created the false business income that appeared on Ms. Bryant’s tax return.”

According to the opinion, Foxx clamed that in preparing the return he relied upon Bryant’s business license and two pages of his notes that outlined expenses associated with the business.

What was potentially a he said/they said case evolved into the court concluding that it did not matter which version was true. Even if Bryant did tell the preparer about her income the court concluded that Foxx had an affirmative obligation under the specific EITC due diligence regulations to dig deeper:

Dr. Foxx argued before the IRS that his reliance on Ms. Bryant’s alleged statements regarding her business was reasonable because Ms. Bryant otherwise would have only earned approximately $15 in 2007 based on the W-2 she provided to Dr. Foxx. Such an argument is misplaced; Ms. Bryant’s financial situation did not relieve Dr. Foxx of his obligation to make reasonable inquiries into any auto detailing business purportedly conducted by Ms. Bryant after she did not provide adequate documentation. His failure to do so was an intentional or reckless disregard of relevant Treasury Regulations [referring to the due diligence regulations under Section 6695]

Schedule C and Compliance Generally

As the Foxx case illustrates, the EITC creates the odd incentive for the creation of phantom income that could fuel a tax refund. That phantom income could also create a record of social security benefits that could generate Social Security benefits.

While noncompliance with the EITC generates significant attention, the absence of information reporting that ties much income to self-employed taxpayers contributes to those taxpayers in general comprising the largest source of the individual tax gap. EITC noncompliance among self-employed taxpayers is a small but significant part of the tax gap that is associated with self-employed taxpayers. Despite the EITC comprising a small portion of the tax compliance problem among the self-employed, there are special due diligence obligations imposed on preparers who prepare EITC returns with Schedule C’s that do not apply to other Schedule C returns.

On the IRS’s EITC web page for professionals it has a special training section discussing Schedule C. The training states that preparers “generally can rely on the taxpayers’ representations, but EITC due diligence requires the paid preparer to take additional steps to determine that the net self-employment income used to calculate the amount of or eligibility for EITC is correct and complete.”

IRS has on its EITC due diligence web site a series of scenarios discussing what it believes are examples of when preparers need to take additional steps. One of the scenarios involves a self-employed housecleaner who comes to a preparer claiming exactly $12,000 in earnings with no records and no expenses. A similar example is in the regulations. For the house-cleaner with the rounded off income figures and no expenses the IRS advice states that a preparer should “probably not” prepare the return in the absence of at least a written record of expenses and earnings, though opens the door a bit if the taxpayer “can reasonably reconstruct” the earnings and expenses. To that end the advice suggests that the preparer should ask how much she charges per house, as well questions relating to how many houses she cleaned on average per week and probe as to the reason for the lack of expenses (e.g., the homeowners provided all supplies).

Back to Foxx

One does not need to have a suggestion that a preparer has encouraged the fabrication of phantom income to generate preparer penalties. A cautious reading of the Foxx opinion is when preparing a return with an EITC based on self-employment income the preparer should  require documentary evidence supporting the amount claimed to have been earned and any expenses that are incurred. In the absence of records (a sure bet for many) the preparer should document and retain an explanation as to how he came to the net earnings, tying conclusions to specific information that the client has provided. For a taxpayer with little in the way of documents, it would be a good idea to have the taxpayer in writing affirm the manner that the preparer computed a business’ net earnings and state that the facts that the preparer is relying on are accurate to the best of the taxpayer’s recollection. Absent that the preparer opens himself up to a charge that he has failed to make “reasonable inquiries” in the presence of incomplete information (one of the requirements under the due diligence regulations).

Brief Follow up to Today’s Post on Refund Loans

Today’s post noted that we are likely to hear from consumer groups regarding the return of refund loans. It turns out that yesterday the National Consumer Law Center issued a press release called Tax Time Kick-Off: Delays and Risks Await Many Taxpayers This Year, discussing some of this filing season’s challenges. In the release, the NCLC, which was a leading voice against the earlier use of refund loans, again warns consumers against their use:

Advocates recommend that taxpayers avoid no fee RALs if possible. One risk is that some unscrupulous tax preparers might charge more in their tax preparation fees to “no fee” RAL borrowers. Also, in the last tax season some lenders, such as EPS and River City Bank, appeared to actually impose a price for “no fee” RALs by charging a higher price for a refund anticipation check (RAC) if the preparer was offering these loans.

With RACs, the bank opens a temporary bank account into which the IRS direct deposits the refund. After the refund is deposited, the bank issues the consumer a check or prepaid card, minus tax preparation fees paid to the preparer, and closes the temporary account. RACs do not deliver refunds any faster than the IRS can, yet cost $25 to $60. Some preparers charge additional “add-on” junk fees for RACs, fees that can range from $25 to several hundred dollars.

The NCLC also discusses some of the other challenges this year, including the need for many taxpayers to get a renewed Taxpayer ID number (ITIN), the coming of private debt collectors and the need to select competent and honest preparers.

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Further note: I have updated the link to the IRS web page for this filing season.

Refund Loans on the Comeback, with a Twist

Tax filing season has kicked off. IRS has a web page dedicated to the filing season, and it includes a lot of helpful information, including information on ITIN changes and this year’s delay in releasing refunds relating to EITC and child tax credit.

The delay in the timing of the refunds is a major change.  New York Times reported last week on the resurrection in refund loans this filing season in Tax Refund Loans are Revamped and Resurrected, with the large tax prep chains offering up to $1300 within a day or so with no direct fees passed on to the individuals for the loan. The article discusses the history of refund loans, which in their earlier form carried heavy fees and attracted a lot of criticism from consumer advocates. They essentially disappeared a few years ago.

Here is why the loans have returned. As we have discussed, Congress in the PATH legislation mandated a delay in remitting refundable-credit-based refunds until mid-February. The start of filing season has traditionally been a time when millions of lower-income refund seeking individuals filed early to get the refunds. To offset the PATH delay, and as a way to stem the flow of individuals to DIY software, the large prep chains have stepped in and essentially offered access to the refund loans as a loss leader.

What happens if the refund never materializes come late February (say there is a set off or examination based refund freeze) and the loan cannot be repaid? The NYT article says the large prep chains are going to eat the loss, though I have not read the fine print on what the consumers are signing when getting the loans.

From a tax compliance perspective, this situation more closely aligns the prep companies with the government’s interest in ensuring that the claimants are in fact eligible when claiming a credit, or at least are able to get past the IRS filters on freezing a refund if there are eligibility concerns.

To be sure, the prep chains have other ways to make money on the transaction, and the prep companies are good at cross-selling. I suspect we will be hearing more from consumer groups on this practice.

 

 

Grab Bag: Posts and Articles of Note on EITC, Compliance, IRS Guidance, Alimony, Private Debt Collectors and Tax Return Simplification

Today’s extra post looks to some other blog posts and articles that may be of interest for people looking for some weekend reading.

EITC and Compliance

We have been reading and enjoying many of the posts on the Surly Subgroup Blog. Francine Lipman’s 2015 Poverty Measures Released: Antipoverty Relief Delivered through the IRC = EITC & CTC discusses the anti-poverty effects of refundable credits such as the Earned Income Tax Credit. While not a procedure post, the intersection of tax procedure and administration and refundable credits is a major issue. While I am plugging away on my article on EITC compliance (as Steve discussed last week) there are some really good articles on that topic that have come out in the last few months. Two of the articles that stand out are Steve Holt’s The Role of the IRS as a Social Benefits Administrator and Michelle Drumbl’s Beyond Polemics: Poverty, Taxes and Noncompliance.  For those interested in how recent trends in family life complicate tax administration, and administering refundable credits in particular, I recommend the Tax Policy Center’s report Increasing Family Complexity and Volatility: The Difficulty in Determining Child Tax Benefits. I will be appearing on a panel with Elaine Maag, one of the authors of the Family Complexity paper, at next week’s ABA Tax Section meeting, where we will discuss some of the report’s implications for tax administration as well as some of my research on EITC compliance.

Speaking of noncompliance and more from Surly Subgroup Blog, Shu-Yi Oei in Does Enforcement Reduce Compliance? discusses Leandra Lederman’s draft paper and presentation on that topic at the Boston College Law School Tax Colloquium. I look forward to reading that paper.

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Alimony and Tax Compliance Again

Last week I discussed the procedural issues that spun out of Leslie v Commissioner in African Diamond Scam and Millions in Alimony: (and Some Reasonable Cause and Chenery). My Villanova colleague Jim Maule in Mauled Again discusses the alimony issue in his post on the case. As usual, Jim clearly describes the issue and offers some practical advice for practitioners. For good measure, and while relating back to compliance, I recommend Jim’s thought-provoking post from September 2 where he discusses a Washington Post op-ed piece by Catherine Rampell  that offered six reasons why cheating on taxes is likely to increase. Jim’s take, as with many of his posts, takes the reader outside the tax world:

It is the increase in self-focus, the increase in greed, and the increase in harsh economic conditions that coalesce to tempt people to cheat on their taxes. It is the weakening of concerns for integrity and responsibility that make it possible for increasing numbers of people to succumb to that temptation. These are problems that will not go away with a simplified tax law and adequate IRS funding, as Rampell advocates. Of course I support simplifying the tax law and adequate funding of the IRS, but I also support increased attention to tax education in middle and high schools, and a broader dissemination and explanation of what happens with tax revenue. And somehow, some way, the sense of integrity and responsibility that was once a core value of the culture needs to be reinvigorated. That, however, is more than just a tax compliance problem.

IRS Guidance

Former PT guest poster Andy Grewal has a post on Notice & Comment discussing a recent GAO report called Treasury and OMB Need to Reevaluate Long-standing Exemptions of Tax Regulations and Guidance. Andy hits some important points in his post, including his highlighting that “[t]he GAO recognizes that the IRS puts out many forms of guidance, but notes that the IRS’s procedures for choosing one method of guidance (e.g., regulations) as opposed to another (e.g., Revenue Rulings, Announcement, Procedures) is a bit of a mess.”

Litigants are likely to continue to press the adequacy of IRS guidance and the choice IRS makes in issuing that guidance. We discussed this briefly in our latest review of the AICPA litigation challenging the IRS’ voluntary testing and education program for tax return preparers (IRS Wins Latest Battle on Voluntary Return Preparer Testing and Education Though Other Battles Likely Remain). In that case, the district court opinion, while finding against AICPA, suggests that a different litigant could challenge the IRS’s use of a revenue procedure to create the voluntary program.

Private Debt Collectors

Keith has discussed private debt collection a few times, including his most recent this past February Private Debt Collection which noted problems with prior two versions and raised concerns with the new legislation mandating its use. The IRS asked for permission to push back the deadline on implementing the new debt collection program so it has not yet gone live. Last week Accounting Today ran a post Here Come the Private Tax Debt Collectors…Again by H&R Block’s Jim Buttonow, where he discusses how the IRS will select the collectors and the plan is set go live in 2017. In his post, he highlights seven things about the new program, including how IRS and the collectors themselves will be letting people know by snail mail if they have the golden ticket and private debt collectors will be working their accounts. No doubt we will be hearing more about the program in the months ahead.

Simplified Return Filing

Finally, ABA Tax Times this past August has a fascinating point /counterpoint with longtime tax return simplification protagonist (and my former law school professor) Joe Bankman discussing his views on how technology can make tax filing time less painful and my Villanova colleague Jim Maule offering thirteen reasons why he believes Professor Bankman’s proposals make for bad tax policy.

Happy reading and enjoy the weekend.

 

 

 

Professor Book Presents at Loyola (LA) on Taxpayer Rights, Social Psychology, and the EITC

Les is out on the West Coast today presenting at Loyola Law School’s Tax Policy Colloquium.  Les is the first presenter this year, and the other speakers cover a broad range of topics.  Les’ talk is based on research and a paper he is currently working on, some of which is based on his prior writing and a number of Procedurally Taxing posts where he discusses the EITC, compliance, and criticism of the IRS in relying on sanctions like the Section 32(k) ban.   He also weaves in his interest in viewing these issues through the social science and behavioral economics lenses.

Some of Les’ recent PT posts that he pulls from for the talk and paper are:

Legislative Language Directs IRS to Make Self-Prepared EITC Claims More Burdensome

Warren Buffet Calls For Expanding EITC: Tax Administration Impact Highlights There is No Free Lunch

IRS Issues New Report on EITC Overclaims (Title A)

H&R Block CEO Asks IRS To Make it Harder to Self-Prepare Tax Returns and Why That is Good for the Tax System

The paper will likely not be finalized until later this fall, but the abstract for the paper and talk is as follows:

Thinking About Taxpayer Rights and Social Psychology to Improve Administration of the EITC

 Abstract

The IRS is a reluctant but key player in delivering social benefits to the nation’s working poor.  The earned income tax credit (EITC) is generally praised for its role in reducing poverty and incentivizing low-wage work. While the EITC has generally received bipartisan support, the IRS faces strong criticism over EITC compliance issues. Opponents focus on headline-generating reports of improper payments and a characterization of errors as likely due to fraud. Advocates look to the intersection of legal complexity and the characteristics of recipients as the main driver of error and the relatively low share of the tax gap that is attributable to refundable credits in general and the EITC in particular.

The current compliance challenge presents an opportunity to think about the compliance problem differently than before. In prior research, building off the work of sociologists Kidder and McEwen, I applied a typology of noncompliance to EITC claimants. That typology suggests that the problem of EITC overclaims is not a single problem but best thought of as many different compliance problems, some of which reflect intentional taxpayer misconduct and others which reflect problems that are more directly connected to the characteristics of the claimants (such as transiency or literacy challenges), perceived unfairness of eligibility rules, or actions attributable to third parties, such as return preparers who play an important role in the delivery of the EITC. In this article, I build on that typology by integrating recent compliance studies, current research on the increased complexity of American family life and two approaches that may present an opportunity for the IRS to improve the likelihood that claimants will voluntarily comply. One approach is based on research that suggests tax agencies can enhance voluntary compliance by an appropriate mix of power and measures that will enhance greater trust in the IRS. The other is based on social psychology research that has shown that by increasing psychological costs and the perceived likelihood of detection through changes in forms, disclosure statements and a more personalized communication approach people may be more inclined to be truthful in the first instance.

By explicitly tying in how possible administrative and legislative solutions relate to the complex structure of today’s American family life, trust in the tax administration, and social psychology research, this article takes the small but I believe important step of recognizing that IRS and Congress cannot principally rely on detecting and deterring noncompliance through audits, penalties and expanded summary tax return adjustment powers. While there is no silver bullet that Congress and IRS can turn to, and audits and penalties are and should remain an important part of a tax agency’s approach, the article provides insights from tax compliance researchers and offers specific administrative and legislative proposals that may improve administration of the EITC.

 

DOJ Cracking Down on Preparers Using its Injunction Powers and Requiring Preparer to Disgorge Illicit Profits

The government has lots of tools at its disposal when it comes to going after the effects of crooked preparers. Last week I wrote about how the fraud of a preparer can have consequences for the taxpayer and indefinitely extend a taxpayer’s SOL on assessment.   DOJ often goes after the illicit preparer as well, sometimes using its vast civil remedies, including injunctions, as Keith discussed in Return Preparer Shenanigans.

This past month the DOJ has been busy releasing information trumpeting its efforts to get civil injunctions against prepares as well as requiring those preparers to disgorge their profits. Preparers that submit returns with phony refundable credits seem to be getting a great deal of attention.

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For example, last week the DOJ press release Federal Court Bars Florida Man from Preparing Tax Returns for Others and Enters $1 Million Disgorgement Judgment discusses how a district court in Florida entered an injunction and disgorgement order stemming from the facts as alleged below:

In September 2014, the United States filed a civil injunction complaint against Pierre-Louis alleging that he and his employees prepared fraudulent tax returns for customers.  The complaint alleged that return preparers in Pierre-Louis’s business targeted primarily low- to moderate-income customers with deceptive and misleading advertisements; prepared and filed fraudulent tax returns to increase their customers’ refunds; and profited through unconscionable, exorbitant and often undisclosed fees—all at the expense of their customers and the U.S. Treasury.  According to the complaint, Pierre-Louis and his employees prepared federal tax returns on which they falsely claimed earned income and education credits, reported improper filing statuses, concocted phony businesses, claimed bogus income and expenses related to the non-existent businesses and fabricated job-related expenses.  The complaint also named Jehoakim Victor and Lauri Rodriguez, allegedly former managers at Pierre-Louis’s tax preparation stores, as defendants.  In February 2015, the court permanently enjoined Victor and Rodriguez from preparing tax returns for others and from owning or operating a tax return preparation business.  Victor and Rodriguez agreed to entry of the injunction without admitting the allegations in the complaint.

The order itself is interesting and details just how far-reaching the government’s powers reach under those provisions, enjoining the preparer from preparing or assisting in preparing returns for others and essentially prohibiting him from having any commercial activity related to the preparation of tax returns, including getting a PTIN or EFIN.

The order also requires the preparer to turn over the identities of all people whose returns were prepared by the defendant and his related businesses, all the employees of the defendant and the related entities and also prohibits the defendant from selling any customer list. That customer list can lead to the issue I discussed last week, as it is likely that the IRS will systematically go after those individuals whose returns were prepared by this preparer.

In addition to the injunction, the order requires the defendant to cough up $1 million as a “for the disgorgement of the proceeds that Kerny Pierre-Louis received for the preparation of tax returns making or reporting false or fraudulent claims, deductions, credits, income, expenses, or other information resulting in the understatement of taxes.”

I have not focused much on the government’s use of general disgorgement powers to go after preparers. Disgorgement is an equitable remedy that has its roots in undoing enrichment rather than punishing and is meant to force the preparer to return profits from the improper activity. That disgorgement is not punitive may have significant consequences as to the deductibility of any such payments, as discussed in this McGuire Woods blog post discussing how the IRS in Field Service Advice opined that a Food and Drug Administration disgorgement order was not a non deductible fine or penalty under Section 162(f).

I have seen a number of disgorgement orders in return preparer cases recently and I suspect that they are now part and parcel of the government’s tool kit.

Some Observations

I am in DC this week attending a summit that the Commissioner has convened on the Earned Income Tax Credit. I have been interested in the EITC, and its administration, for years, starting with my time as a director of a low income taxpayer clinic.  I saw early on in my time as director claimants who used a return preparer that was either incompetent or unscrupulous, or both. Assigning blame between claimants or preparers and getting at the root cause of the source of the incorrect claim is a tricky business, and there have been very few meaningful qualitative studies that identify the extent of demand (claimant) or supply (preparer) driven noncompliance. As I have written previously, there is an interesting and complex relationship between preparers and claimants, and government efforts both before the fact (though regulation and oversight, including due diligence) and after the fact (including injunctions and preparer penalties, both civil and criminal) attempt to change the dynamics in that relationship.

In the blog and in other articles I have written about the various ways that the government has sough to change this dynamic. I am working on a longer paper that looks at compliance issues in some more detail. Most of what Congress has done in this area over the past decade has been to increase penalties and allow IRS to detect and unwind erroneous credits through the use of a more automatic reportable error that dispenses with traditional deficiency procedures(though IRS wants even more of that power). I am interested in learning from others at the summit, as this is a problem that is in need of solutions from many differing perspectives, not just increasing penalties and removing barriers to assessment.

UPDATE 7/1 After initially posting I learned that IRS last month has issued a CCA that held that certain disgorgement payments made to the Securities and Exchange Commission for violating the Foreign Corrupt Practices Act were not deductible. There is a lot of commentary on that substantive issue. For example, see Lawrence Hill from Shearman in the FCPA Report.

TIGTA Report Makes (Incomplete) Case For Expanded Math Error Authority

An earlier version of this post appeared on the Forbes PT site on May 20, 2016

TIGTA just released a report called Without Expanded Error Correction Authority, Billions of Dollars in Identified Potentially Erroneous Earned Income Credit Claims Will Continue to Go Unaddressed Each Year. The report is sure to generate headlines, as it details some eye popping numbers about EITC improper payment rate and the IRS’s failure to take action on EITC-claiming returns it knows are likely to contain errors. On the surface TIGTA makes a compelling case but I do not understand why the default solution TIGTA proposes is one that effectively treats EITC claiming individuals as a suspect class that is not entitled to the same due process protections as other individuals who file income tax returns. Our tax system is built on individuals having procedural protections in the form of pre-assessment Tax Court review rights through deficiency procedures. TIGTA’s proposals amount to a possible rejection of protections for millions of individuals least likely to be in a position to protect themselves against IRS overreaching.

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A snapshot of the numbers from the TIGTA report shows that the improper payment rate hovering between 23 and 27% for the past six years, with 2015 estimates looking at about IRS improperly paying out $15.6 billion out of a total $62.3 billion claimed for a 24% improper payment rate. TIGTA also notes that the IRS has identified millions of EITC returns which it believes are likely erroneous but due to resource constraints (and perhaps other reasons) IRS fails to take action and prevent the outflow of improper credits. For example, for 2014 TIGTA estimates that IRS identified over 5.7 million EITC returns with over $20 billion claimed that were likely containing improper claims but due to resource issues IRS only “systematically corrected” about 166,000 of the returns:

We continue to report that IRS compliance resources are limited. Consequently, the IRS does not address the majority of potentially erroneous EITC claims despite having established processes that identify billions of dollars in potentially erroneous EITC payments. For example, the IRS identified approximately 5.7 million potentially erroneous EITC claims totaling approximately $20.7 billion in Tax Year 2014 for which it does not have error correction authority to address.

The TIGTA solution is one that the President has proposed in recent budget proposals, an expanded ability to use summary math error assessment procedures to disallow the credits without allowing people the same pre-assessment right to notice and Tax Court review that everyone else enjoys.

It has been a couple of years since I have discussed TIGTA math error proposals, but the TIGTA discussion brings to mind a post from December 2014 Annual TIGTA Review of IRS Erroneous Payments and The Possible Expansion of Math Error Powers. In that post I go into some more detail regarding the efficiency issues that the government points to in making the case for expanded math error procedures (it is on the surface way cheaper to use math error powers than to give taxpayers a stat notice and full blown deficiency rights). Back in 2014 I referred to TIGTA’s dollars and cents discussion:

While the IRS has the authority to audit potentially erroneous EITC claims for which it does not have math error authority, doing so is more costly than the math error process. The IRS estimates that it costs $1.50 to resolve an erroneous EITC claim using math error authority compared to $278 to conduct a prerefund audit. In addition, the number of potentially erroneous EITC claims the IRS can audit is further reduced by its need to allocate its limited resources among the various segments of taxpayer noncompliance to provide a balanced tax enforcement program. As a result, billions of dollars in potentially erroneous EITC claims go unaddressed each year.

The TIGTA report both now and in 2014 fails however to address some of the criticism of the proposals for expanded powers. In my 2014 post I argued for caution in this area:

If the administration is successful in getting its expanded summary assessment procedures, I hope that IRS carefully studies its impact (as it seems to have done with child support data), establishes clear guidelines for employees, and drafts simple understandable correspondence to allow taxpayers to unwind the assessment and get back in line for deficiency procedures. Some lower-income taxpayers may be less equipped to contest erroneous assessments; telephone wait times are long, and taxpayers who are lower-income are often more transient and less likely to receive correspondence. Add to the mix language and literacy obstacles and you have a potential recipe for real harm.

Congress’ continued use of the Internal Revenue Code to deliver social benefits combined with pressure on IRS to reduce error rates may lead to the IRS taking additional compliance steps without an ability to serve taxpayers who may be inadvertently caught in the compliance crosshairs. Even an agency intent on balancing competing interests must reflect the budget realities that are likely going to jeopardize those taxpayers least likely to be able to withstand erroneous IRS determinations.

In the 2015 NTA Report to Congress a section called Authorize the IRS to Summarily Assess Math and “Correctable” Errors Only in Appropriate Circumstances makes a systematic case for at least some more caution in this area before giving IRS expanded math error powers. That report suggests that before giving IRS expanded powers the following must take place:

  1. There is a mismatch between the return and unquestionably reliable data (rather than the IRS’s estimate about the mere probability of an error).
  2. The IRS’s math error notice clearly describes the discrepancy and how taxpayers may contest the proposed change.
  3. The IRS has researched all of the information in its possession (e.g., information provided on prior- year returns) that could reconcile the apparent discrepancy.
  4. The IRS does not have to analyze facts and circumstances or weigh the adequacy of information submitted by the taxpayer (e.g., whether sufficient documentation is attached) to determine if the return contains an error.
  5. The abatement rate for a particular issue or type of inconsistency is below a specified threshold for those taxpayers who respond.
  1. For any new data or criteria, the Department of Treasury, in conjunction with the National Taxpayer Advocate, has evaluated and publicly reported to Congress on the reliability of the data or criteria for purposes of assessing tax using math error procedures The report should analyze the burdens and benefits of the proposed use of math error authority, considering downstream costs
    to taxpayers (e.g., time, paperwork, representation) and the IRS (e.g., processing taxpayer calls and letters, requests for audit reconsideration, amended returns, appeals, and TAS intervention).

Parting Thoughts

I recognize that there is a compelling interest in reducing error rates for programs such as the EITC. Underlying the NTA suggestion for caution is that with expanded math error powers comes the distinct likelihood that millions of Americans who may claim the credit are the same Americans who need the procedural protections that come with the regular right to Tax Court pre-assessment review. Due process at its core reflects a balancing of interests between the government and its legitimate right to ensuring program integrity and the general right to protect against erroneous government determinations that deprive people of protected property rights. The NTA proposal to carefully study and consider the effect of expanded math error powers reflects a respect for the individual.  Congress has increasingly given IRS special powers when it comes to trying to nudge down the improper payment rate for the EITC. Congress would be well-served from stepping back and rather than continuing to add piecemeal provisions study individual noncompliance more generally and consider what is likely to work and what are the full consequences of additional IRS powers.

 

Summary Opinions Catch Up Part II

Second part of the catch up.  These materials are largely from February.  One more installment coming shortly.  We may be renaming SumOp.  Although I loved the name (thanks Prof. Grewal), this keeps getting linked as a summary of all Tax Court summary opinions.  Feel free to suggest names, although it may just fall under the Grab Bag title from now on.  And, if you work at a law firm that is taxed as a C-corporation, check out the Brinks, Gibson discussion below.  Might be a little scary.

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  • Most of you probably heard that the Form 8971 was issued for basis reporting in estates.  Form can be found here and instructions here.  First set will (probably, although it has been extended a couple times already) be due June 30th.  Pretty good summary can be found here.  Lots of complaints so far.
  • The Fourth Circuit had a recent Chapter 7 priority case in Stubbs & Perdue, PA v. Angell (In re Anderson).  In Stubbs (great name), S&P were lawyers who represented Mr. Anderson.  Initially, the case was a Chapter 11 case, and S&P racked up $200k in legal fees.  Priority, but unsecured.  There was also over $1MM in secured tax debt.  The bankruptcy converted to a Chapter 7, and S&P were tossed in with the unsecured debtors, which they took exception with.  The Court looked to the current version of section 724(b)(2) of the bankruptcy code.  That section allows certain unsecured creditors to “step into the shoes” of secured creditors, and recover before other creditors.  Due to perceived abuses, that section had been amended in 2010 to limit the expenses that were given super priority, including Chapter 11 administrative expenses when the case was converted to a Chapter 7 case.  The amended provision was in place when the conversion occurred, and the Fourth Circuit relied on that version of the law, disallowing the legal fees super priority.  The law firm argued the prior version of the statute should apply, as it was the applicable statute when the originally filing occurred, but the Fourth did not agree.  Why does this really matter? It is the federal tax liability supported by the federal tax lien that gets subordinated to pay these priority claims.  So, the fight in this insolvent estate boiled down to whether the lawyers, who may have waited too long to convert the case to Chapter 7, or the IRS get paid (of course, the decision to convert is a client decision which puts the lawyer’s ability to get their fees at the mercy of the rationality of the client’s decision. A bad place to be) (thanks to Keith for giving me a quick primer on this subject).
  • The Tax Court in Brinks, Gilson & Lione, PC v. Commissioner has probably caused quite a bit of concern for quite a few law firms – or should (which reminds me, I have something to discuss with the Gawthrop management committee).  McGuire Woods has a good write up, and some insight into planning around the issue, which is found here.  The facts are that the firm would provide partners with a salary, and then at year end it would take all the profits and provide year-end bonuses to the partners, who would treat the amounts as W-2 wages.  This would wipe out the profits, so the c-corporation law firm would have no tax due (sounds familiar to a lot of you in private practice, doesn’t it?).  This firm had close to 300 non-lawyer employees who generated profits, and the IRS said that treating the bonus amount as w-2 income on to the partners on what those other folks generated was improper.  The corporation should have paid tax, and then dividends should have been issued to the partners, who would also then pay tax.  Yikes!  That is interesting enough, but the Court also found that the firm lacked substantial authority for its positions and there was no reasonable cause under Section 6662(d)(2)(B), so substantial penalties were also due on the corporate income tax due (the regulations do not allow for an “everyone else is doing it” defense).
  • Sometimes you go into court just knowing you are going to look like an @s$ for one reason or another.  I may have felt that way walking in to argue Estate of Stuller for the government before the Seventh Circuit.  Not because I would have been wrong, but, based on the opinion, the taxpayer was having a pretty bad year.  In Stuller, the Court held that the penalties for failure to timely file returns were proper when a restaurant business owner (who was a widow) missed the filing deadline.  In the year in question, the husband died in a tragic fire, which also injured the widow.  In addition, a key employee was embezzling from her businesses and she had difficulty tracking down aspects of the probate proceedings.  The Court found all required info could have been found in her records, and she did not exercise ordinary business care and prudence to fulfill the requirements of the reasonable cause exception (it probably didn’t help that she was taking questionable deductions related to her “horse” business that lost like $1.5MM in the preceding years).
  • We have covered Rand pretty extensively here on the blog, including the reversal of it by section 209 of the PATH Act and the Chief Counsel advice that followed, which can be found here.    In February, additional guidance was released stating there are no longer any situations where the Section 6676 penalty is subject to deficiency procedures, which was the same conclusion our (guest) blogger, Carlton Smith, came to in his post discussing the Kahanyshyn case.  Carl, however, reflected upon this more, and concluded there may, in fact, be a situation where the deficiency procedures might apply to a Section 6676 penalty.  I’m somewhat quoting Carl (via email) here.  All intelligent comments are Carl’s, while any errors are assuredly mine:

If you recall from prior posts, in PMTA 2012-016…the IRS changed its position and held that where it had frozen the refund of a refundable credit, there was no “underpayment” for purposes of section 6664(a) because the freezing of the refund should be considered as “an amount so shown [on the tax return] previously assessed (or collection without assessment)” under section 6664(a)(1)(B). So, there can be no assessment of a section 6662 or 6663 penalty in that circumstance.

However, section 6676′s penalty on excessive refund claims can apply even if the refund is never paid. Accordingly, within the PMTA, the IRS states (I think correctly) that where it freezes a refund of a disallowed refundable tax credit, it can assert a section 6676 penalty instead.

The PATH Act did two significant things to section 6676: It removed the previous exception to applying the penalty with respect to EITC claims. It changed the defense to the penalty from the troublesome proof of “reasonable basis” (an objective test) to the easier “reasonable cause” (a subjective one).

So, we may see section 6676 assessments in the future where refundable credits were improperly claimed, but the refund was frozen.…If a taxpayer improperly claimed, say, an EITC, but the refund was frozen, the IRS would later issue a notice of deficiency to permanently disallow the EITC.  The IRS could also assess a section 6676 penalty (assuming no reasonable cause), since it is the claiming of an improper refund that triggers the section 6676 penalty, not its payment.

It is still an open question whether or not the section 6676 penalty on disallowed frozen refundable credit claims will be asserted by the deficiency procedures or the straight-to-assessment procedures usually involved in the assessable penalties part of the Code.

  • In United States v. Smith, the District Court for the Western District of Washington reviewed a community spouse’s argument that her portion of the community property house could not be used to satisfy her husband’s tax debt from his fraud.  I found this write up of the case from a law firm out west, Miles Stockbridge.  The Court upheld the foreclosure, finding the wife did not show that she was entitled to the exception of collecting against community property under Section 66(c), nor did she show that the debt was not a community property debt by clear and convincing evidence, as required under Washington law.
  • Nothing too novel in US v. Wallis, from the District Court of the Western District of Virginia in February of 2016, but a good review of suspension provisions to collection statute.  In Wallis, the Service  took collection actions after the ten year period found under Section 6502 for penalties under Section 6722.  The Court found collection was not prohibited, as the statute was tolled due to the taxpayer’s bankruptcy and OIC/CDP hearings.  Sorry, couldn’t find a free version.
  • The folks over at The Simple Dollar have asked that we provide you with links to some of their content.  This post is about the best tax software for nonprofessionals to use for doing their own taxes.  This site is geared to the general public, but has some basic finance and tax info.  These are usually in the form of listicles, which are completely click bait, but are hard to hate.