IRS Campaign Season Begins

Today we welcome first-time guest poster Tom Greenaway. Tom is a principal in KPMG’s Tax Controversy Services practice. He is a former senior attorney in the IRS Office of Chief Counsel’s then-Large and Midsize Business Division. Tom has written on a variety of tax procedure issues and is in the process of updating the chapter on examinations in the 7th edition of Effectively Representing Your Client Before the IRS. We are fortunate to gain his insights as he describes the rollout of IRS changes in its enforcement strategies relating to our nation’s largest taxpayers. Les

For several years, the Large Business & International Division of the IRS (LB&I) has been shifting its approach to its enforcement priorities in light of prolonged budget constraints and reduced staffing. LB&I leadership is trying to better select returns for examination, and to swiftly address noncompliance issues when they find them, all in the name of efficiency and increased productivity.

Productivity in the context of IRS enforcement usually means generating and sustaining meaningful adjustments (though individual revenue agents and managers are not evaluated on this basis). For decades, however, the “no-change” rate for LB&I corporate examinations has been stuck above 20 percent, and the “no-change” rate is more than double that—almost 50%—for LB&I examinations of pass-thru entities and foreign corporations. In IRS jargon, a “no-change” means an audit did not generate any adjustments to the tax return as filed—thus no return on this significant investment of IRS resources. Corporate taxpayers and pass-thrus with more than $10 million in assets on their balance sheets are LB&I taxpayers.

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IRS enforcement serves as a vital backstop to our system of voluntary income tax compliance. But the current trend of fewer examinations owing to budget cuts and increased non-income tax enforcement responsibilities, combined with perennially high no-change rates, is a bad mix. This is a prime reason LB&I is fundamentally changing its process and structure.

One element of LB&I’s new process is to risk assess taxpayers centrally and develop nationwide compliance “campaigns.” According to IRS, a campaign will be developed when LB&I decides, centrally, that an issue requires a response across an identified population of taxpayers in the form of one or multiple “treatment streams.” This centralized risk assessment will include the use of data analytics to identify issues and taxpayers that pose the highest risk to sound tax administration and compliance. LB&I announced this shift in approach more than a year ago, and in response more than 600 campaign ideas were submitted for consideration, mostly from internal IRS sources. Andrew Velarde, Some Complex Issues Won’t Be Part of Initial LB&I Campaigns, Tax Notes Today, (Nov. 15, 2016) available at 2016 TNT 221-3.

On January 31, 2017 IRS released the initial rollout of 13 different LB&I’s campaigns. Each campaign is assigned to an LB&I practice area and executive who will serve as the lead.

Here’s the list of the initial 13 campaigns:

  • Section 48C Energy Credits
  • OVDP Declines-Withdrawals
  • Section 199 Domestic Production Activities Deduction – Multichannel Vide Program Distributors & TV Broadcasters
  • Micro-Captive Insurance
  • Related Party Transactions
  • Deferred Variable Annuity Reserves & Life Insurance Reserves Industry Issue Resolution (IIR)
  • Basket Transactions
  • Land Developers – Completed Contract Method (CCM)
  • TEFRA Linkage Plan Strategy
  • S Corporation Losses in Excess of Basis
  • Repatriation
  • Form 1120-F (Foreign Corporation) Non-Filer Campaign
  • Inbound Distributors

The initial campaigns cover a wide range of topics. They range from technical tax issues affecting multiple industries (e.g., transfer pricing by inbound distributors, cash repatriation strategies), to industry-focused issues (e.g., variable annuity reserves IIR for insurers and completed contract method for land developers), to procedural compliance issues (e.g., OVDI withdrawals, practical workarounds of TEFRA partnership linkage limitations, and foreign corporate non-filers). Some campaigns that have been promised, like Chapter 3 withholding, were not included in this initial rollout.

As promised, the recommended “treatments” for each campaign vary, although all of the campaigns (except the insurance IIR) will involve examinations to some degree or another.

Some of the campaigns already have well-established treatments in place. For instance, IRS has already identified basket transactions as listed transactions and transactions of interest, and recently issued a related Practice Unit. Practice Units on inbound distributors have been available to the public since December 2014. Treatments of other issues, on the other hand, like the Insurance Industry IIR and TEFRA linkages, have been stalled for years.

Large business taxpayers—and their LB&I examination teams—will need to learn how to adapt to IRS campaigns. IRS officials have said that if a return selected for a campaign examination does not fit the targeted facts or concerns, LB&I wants to release the taxpayer and potentially refine the campaign. Amy Elliott, First LB&I Campaign List to Include Inbound and Outbound Issues, Tax Notes Today, (Dec. 19, 2016) available at 2016 TNT 243-3. Practitioners will play an important role in helping examiners understand whether the targeted concern is actually an issue on the returns selected.

On properly selected campaign examinations, the transparency and commitment to collaboration that are hallmarks of the new LB&I generally and the campaign process specifically should lead to faster issue identification, development, and resolution on campaign cases—all of which should be shared goals of both taxpayers and the IRS. Planned ongoing feedback from this process should further help IRS refine or even end a treatment, or a campaign, if the treatments succeed, or do not work.

Another key for practitioners will be to maintain the team’s focus on pre-identified campaign issues. Traditionally, LB&I examination teams enjoyed wide latitude to identify and develop issues for examination. That is all changed now. A shift towards centrally-developed campaigns necessarily comes at the expense of the field teams’ discretion to raise issues. According to at least one official, examination teams working campaign cases may raise other, non-campaign issues “that they feel they cannot walk away from,” but that standard sets a high bar for overloaded examination teams to clear. Andrew Velarde, Some Complex Issues Won’t Be Part of Initial LB&I Campaigns, Tax Notes Today, (Nov. 15, 2016) available at 2016 TNT 221-3.

_______________________________________________________

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP.

©2017 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

 

 

IRS Examination Division’s Requirement to Consider Collectibility of Potential Assessment

On September 7, 2016, the Treasury Inspector General for Tax Administration (TIGTA) issued a report, entitled Examination Collectibility Procedures Need to be Clarified and Applied Consistently, looking at the failure of the Examination Division to consider collection in making decisions on who it should examine.  It found that the Examination Division did not follow its own collectibility procedures in 56% of the cases it sampled.  TIGTA pointed out in the report that the failure to follow these procedures led to collection closing 50% of all exam cases that came into the hands of field collection offices and 19% of all exam cases that came into the Automated Collection System (ACS).  At a time when the IRS examination resources have dropped by about 30% over the past six years and collection resources have dropped by almost 40% over that period, does it make sense to go after taxpayers at the examination stage who will turn into uncollectible accounts, or would it make more sense to look on the shelf at cases needing examination where the taxpayer has the ability to pay the liability in the event of an additional assessment.

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IRM 4.20.1.5.1 (February 26, 2013) provides that the Examination function of stovepipe SBSE “must strive for quality assessments and promote and increased emphasis on early collections in the continuing effort to reduce the Collection function’s inventory and currently not collectible (CNC) accounts.”

The full text of this IRM provision states:

  1. Examination may need to suspend collection activity on a taxpayer’s account. Examiners can suspend collection activity using Transaction Code (TC) 470 with Closing Code (cc) 90 or by using “STAUP” procedures.
  1. The use of TC 470 with cc 90 is restricted to those situations where it is expected that an adjustment will fully pay the tax for the suspended tax year. For example, if the IRS discovers that an obvious error created a balance-due condition in one tax year, and an adjustment will reduce the balance due to zero, the IRS can request the necessary tax adjustment and also request that this collection suspension code be entered for the specific tax year. This will ensure collection action is suspended while the adjustment is made and overpayments for other tax years will not be used to pay the tax in question.
  1. It is imperative that TC 470 with cc 90 is used correctly and only in those instances that meet the criteria outlined above. If TC 470 cc 90 is used incorrectly when adjustments may not be appropriate or when an adjustment does not eliminate the balance due, credits from a taxpayer’s other tax years will be refunded to the taxpayer rather than being used to satisfy the amount still owed for the suspended tax period. See IRM 5.1.15, Abatements, Reconsiderations and Adjustments.
  1. In instances where the TC 470 cc 90 criteria is not met, Collection activity can be suspended for a fixed period of time using Command Code “STAUP.” For example, an examiner encounters the situation where the suspension of collection activities is necessary when one or more of the following is expected to reduce the balance due to zero:
    1. Claims
    2. Net operating loss (NOL) carryback
    3. Credits carried back

In these instances, examiners can request a suspension with Command Code “STAUP.” Command Code STAUP is an IDRS command code used to accelerate, omit, or delay the issuance of an IDRS balance due notice. A STAUP will stop any notice from being issued or destroy a printed notice not yet mailed. See IRM 2.4.28, Command Codes STAUP, STATI, and STATB.

To achieve that goal, IRM 4.20.1.2 (February 26, 2013) provides that Exam employees should consider collectibility during the pre-contact, audit and closing phases of an examination.  In fiscal year 2015 approximately 75% of the accounts receivable owed to the IRS was listed as uncollectible.  The IRM provisions seek to keep the IRS from building more and more inventory in the uncollectible category.

I wrote about this issue previously in the context of the trust fund recovery penalty (TFRP).  Since the collection function handles TFRP investigations it sits in the best place to determine whether to work the case and does not need to refer the matter to anyone in order to make that determination.  Despite language directing the IRS to only pursue TFRP investigations on taxpayers able to pay, the comments received to that post almost uniformly took the view that the collection function did not make a determination on collectibility prior to initiating TFRP investigations.  If collection is not doing this, it is easy to believe that Exam would not follow the requirement to select cases that will result in collection of the resulting assessment.

TIGTA has some good stats in its report.  One is the information that between 2011 and 2015 Collection received an average of 707,789 new delinquent accounts each year as a result of an examination assessment.  TIGTA determined that if the examination division had focused on auditing taxpayers with the ability to pay the IRS “could have assessed approximately $109 million on cases that were more collectible.”  The IRS must balance the use of its enforcement tools such as an examination as a basis for generating revenue against the need to ensure a fair and just tax system.  The idea that taxpayers with a low potential for collection should get a free pass from collection does not sit well.  Yet, neither does the idea that the IRS spends a significant percentage of its examination resources generating assessments that merely sit on the books for 10 years without any resulting collection.

The IRM provisions do not require that the IRS examiners guarantee the collection function will collect on the assessments they generate, but the IRM does suggest that considering the collectibility of an assessment should factor into the decision to pursue an examination.  TIGTA stated that it planned to “review a sample of Examination cases closed as surveyed due to doubt of collectibility; however, the IRS does not systemically track these cases.”  So, TIGTA had no way to determine if the IRS had declined to audit cases, “survey” them in IRS parlance, in circumstances in which the taxpayers had even a less chance of collection than the ones the IRS chose to audit.

TIGTA interviewed examination employees during this course of its study and these employees “told us that they rarely or never survey a return due to collectibility.”  These employees cited the potential adverse impact on voluntary compliance as a reason for not surveying cases due to a lack of collectibility.  TIGTA cited to the language in the IRM which speaks in absolutes about the ability to collect rather than in degrees.  It seems very logical to conclude that the IRS should not exam returns where the chance of collection is absolutely zero.  I have watched it do that on many occasions in the assessment of individuals following a criminal prosecution.  The 2010 changes allowing assessment based on the restitution order removes the need for the IRS to devote examination resources to those cases in most criminal cases, though I do not know whether it walks away from the assessment of additional taxes in all criminal cases in which collection has a near zero chance.

TIGTA recommends that the IRS change the IRM to provide “clear instruction on documenting collectibility determinations, including examples of when cases should be given consideration for being surveyed….”  The IRS agreed with this recommendation and stated that it will update the IRM.  The IRS response also stated that the broader goal of examination in promoting voluntary compliance must enter into the decision and that collectibility should not drive the decision of who to examine.  The IRS response hits the right tone.  Whether the IRS will make changes that meaningfully change the role of collectibility in the choosing of cases to exam is something to watch as the IRS updates this IRM and implements the suggestions made by TIGTA.

The recommendations section of the report contains a discussion of the need for the examination division to coordinate with the collection division in making the collectibility determination.  The response suggests that the examination division has concerns about that proposal.  Based on the comments received in my earlier post about the collection division’s ability to incorporate collectibility into its own TFRP determinations, I cannot fault the examination division for their concerns.  The issue of how to incorporate collectibility into workload decisions requires a deep policy look by the IRS.  The TIGTA report exposes the issue but cannot resolve the policy issues that underlie the correct approach.  The same policy issues presented here also exist as the cases move forward into litigation and the difference in approaches between the litigators in Chief Counsel’s office and the Department of Justice also cry out for a uniform policy that takes into account the need to have a tax oversight system that promotes uniformly fair laws but does not waste limited resources chasing uncollectible accounts.

Because I represent low income individuals, a high percentage of the cases in which I represent individuals in Tax Court involve assessments the IRS will probably never collect.  I tell my clients that the fight in Tax Court represents a skirmish.  Even if we lose that skirmish, we can win the overall battle by obtaining an offer in compromise.  We do not send our clients away after the Tax Court phase, and post-trial work on those cases is often more important than the pre-trial or trial work because we settle the matter for a very low payment.  Knowing that the case will get resolved for a nominal payment makes me sad at all of the resources that Exam, Counsel, and the Tax Court put into the case so that my client will pay $50 and keep current on their filing obligations for the next five years.  I do not have the answer but it lies in a policy that avoids spending significant resources on uncollectible cases.

 

Using the IRM to Help Taxpayers During Audits Exploring a Taxpayer’s Unreported Income

Today we welcome first time guest poster David Breen, the Acting Director of Villanova’s Federal Tax Clinic, former Senior Counsel with the IRS Office of Chief Counsel in Philadelphia and longtime adjunct faculty member in Villanova’s Graduate Tax Program. In addition to his Counsel experience, Dave began his career with Exam. He has taught courses in Villanova’s graduate tax program for years, including Tax Procedure and our innovative trial litigation simulation course. While Keith has been visiting at Harvard, Dave has ably directed our tax clinic. In today’s guest post, he discusses some of the IRS’s own rules relating to examinations that focus on unreported income as well as some of the powers practitioners can but rarely do exercise in the context of those examinations. Les

The country is approaching the half way point of the NFL season and during the Eagles games I’ve watched so far, I can’t help but again notice the tendency of coaches to cover their mouths while talking to one another. This practice, which dates back to at least 2000, prevents opposing teams from employing lip readers to intercept the play the opposition is calling. Stealing plays in a game? By professional lip readers? Really? A bit of overkill, don’t you think? But football is not alone in this type of larceny. Less than one month into this year’s baseball season, the Padres were accused of positioning a spy inside the scoreboard with binoculars to telegraph pitches to San Diego batters.

This got me to thinking about the lengths that professional athletes will go to increase ever so slightly an edge over their opponents. And with that in mind, it made me look to my own profession as a tax attorney for whatever edge, legally, of course, that I could exploit as well. I didn’t have to look far.

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When I was an IRS Revenue Agent back in the 1970s, the Internal Revenue Manual was IRS’s playbook, containing well-guarded tips, resources, recommendations, and directions on how to audit taxpayers. As a Senior Counsel in IRS’s Office of Chief Counsel from 1987 to my retirement in 2014, Part 35 of the IRM, also called the CCDM, provided the same practical guidance and advice for IRS attorneys. Today the IRM continues to guide IRS employees in the performance of their duties and thanks to the Freedom of Information Act (FOIA) it can be an invaluable resource for practitioners as well. In my experience, however, I find that many practitioners fail to avail themselves of this resource. In other words, they don’t take advantage of the ability to read IRS’s lips from across the gridiron to see what IRS’s next step will be.

When it comes to an IRS audit, particularly in the SBSE division which includes self-employed Schedule C filers, unreported income is the name of the game. From 2008 – 2010 the average annual tax gap was $458 billion, up from $450 billion in 2006. IRS revenue agents are given discretion in deciding which deductions to scrutinize on a return. Proof for deductions that are LUQ (large, unusual, or questionable) is sure to be requested. Examiners do not, however, have discretion in examining gross income. Unlike deductions, gross income must be examined in all audits. It is one of the relatively few mandatory items examiners must investigate.

This article discusses how a practitioner can utilize the IRM to represent clients more competently during an audit of gross income. I am limiting my comments to IRM Part 4 – Examining Process, but the advantages of being well-versed in IRS’s own procedures applies well beyond this area.

The law is clear on gross income: all income from any source is taxable unless specifically excluded somewhere in the Code. Taxpayers are required to maintain books and records to support items on their returns. If a taxpayer refuses to provide books and records, IRS may issue a summons to the taxpayer and third parties to compel production of documents and to give testimony under oath. Finally, before an examiner may use financial status or economic reality examination techniques to determine the existence of unreported income there must be an indication that there is a likelihood of unreported income.

While the above paragraph would score well on a law school tax final, it provides little insight into how the law is put into action. Let’s put some flesh on the bones by looking at how examiners are taught to audit returns.

To insure that returns are examined within the 3 year statute of limitations, IRM 4.10.2.2.2-1 requires that the examination and disposition of individual income tax returns be completed within 26 months after the due date of the return or the date filed, whichever is later. For example, if an examiner is assigned a timely filed 2015 return, the audit should not be started if it cannot be completed by June 2018 (26 months from April 15, 2016). This includes, however, the time to process the return, select it for examination, ship it to the examination group closest to the taxpayer’s location, assign it to an examiner, and schedule an appointment. To add additional incentive to IRS to examine returns promptly, interest is suspended if the Service fails to notify the taxpayer of a liability within 36 months of the later of the date the return is filed, or the due date for the return without regard to extensions. Like soggy hors d’oeuvres once the main course is served, returns falling short of this timeframe are forgotten about, “surveyed” as excess inventory and replaced by fresher, more current work. The lesson here is that despite the three year statute of limitations on assessment of tax, the likelihood of a return being audited is actually much less than three years after its filing under the 26 month cycle rule.

For those returns that are audited, however, examiners are given specific guidelines for verifying gross income. How does an IRS examiner decide how detailed the gross income investigation must be? To answer, we have to consider one more Code section, IRC § 7602(e), enacted as part of the IRS Structuring and Reform Act of 1998:

(e)Limitation on examination on unreported income

The Secretary shall not use financial status or economic reality examination techniques to determine the existence of unreported income of any taxpayer unless the Secretary has a reasonable indication that there is a likelihood of such unreported income.

Prior to the enactment of IRC § 7602(e) examiners could (and often did) investigate gross income by engaging in intrusive inquiries into a taxpayer’s private life and finances. Interviews of business associates, co-workers, lenders, and even neighbors were conducted, sometimes without the taxpayer’s knowledge. Time consuming, intensive, expensive requests for voluminous records were the norm rather than the exception.

IRC § 7602(e) put the brakes on IRS examiners. Before an examiner may conduct an in-depth, intrusive examination – what the statute refers to as financial status or economic reality techniques – the examiner must first have some reason to suspect that a taxpayer has not reported all gross income. So called “indirect methods” are economic reality techniques. How does an IRS agent determine if there is a likelihood of unreported income to gain entrée into a detailed investigation? The answer is in the IRM.

IRM 4.10.4 sets forth a number of mandatory “minimum income probes” examiners must perform. If the minimum income probes indicate a likelihood of unreported income, the examiner must consult with a group manager. They jointly determine whether to conduct a more in-depth examination of income and document their findings in the workpapers. This more in-depth examination may include, but is not limited to a bank deposits and cash expenditures analysis, a source and application of funds analysis, or a net worth analysis – what IRS calls a formal indirect method of proof. ( Note, however, that IRC § 446(b) allows IRS to use any reasonable method. The high water mark of reasonable may have been IRS’s Atlantic City Tip Income Project back in the 1980s when IRS reconstructed cocktail waitress tip income by placing undercover special agents in casinos to watch how much tip income waitresses typically received during a shift and applying those findings to compute tip income for a “normal waitress.”).

All practitioners want to dissuade examiners from conducting time-consuming, costly, detailed indirect methods. Volumes have been written on defending a client when IRS determines under one of these methods that a taxpayer hasn’t reported all income. But remember, the minimum income probes are the gateway to the use of a formal indirect method of proof. For that reason, they should be the first line of defense in representing clients.

What are these “MIPs”? It depends on the type of taxpayer. The minimum income probes for individual business returns, i.e. Schedule C taxpayers, include: preparing a financial status analysis; conducting an interview with the taxpayer or representative; touring the business; evaluating internal controls; reconciling the income per return to the taxpayer’s books and records; testing gross receipts by tying original source documents to the books; preparing an analysis of the taxpayer’s personal and business bank and financial accounts; preparing an analysis of business ratios; and determining if there is Internet use and e-commerce income activity.

I present two ways for the minimum income probes to be used proactively by representatives.

  1. Lay the groundwork during return preparation. Most return preparers send some form of tax organizer to clients which clients complete (or at least are supposed to complete) as part of having their returns filed. I encourage preparers to include questions concerning the minimum income probes in their client surveys. Gathering information on internal controls, bank accounts, business ratios, and e-commerce activity will serve as reminders to clients on what they records they should be keeping and also identify potential weak areas in the client’s operations. Weaknesses that can be corrected or anticipated in the event of an audit.
  2. Challenge the examiner’s conclusions regarding the use of an indirect method. If early in the audit, say after the initial meeting and taxpayer interview, an examiner issues a detailed, voluminous information document request (IDR) clearly focused on income or personal living expenses, that is a clear indication that the examiner is “ramping up” the examination of gross income. Representatives should not simply shrug and hope for the best. I encourage representatives to ask the examiner in writing, if the examination has extended into IRC § 7602(e) territory. If the examiner answers affirmatively, or doesn’t answer at all, the representative should take the offensive and request a meeting with the group manager, request the examiner’s workpapers detailing the minimum income probe analysis and the discussion with the group manager green-lighting the indirect method, file a FOIA request for the workpapers, or all of the above. A taxpayer should be given an opportunity to respond to an examiner’s determination that the minimum income probes reflect unreported income. If the agent’s analysis is flawed, it is better for IRS and your client to not waste time on needless issues. To date, however, I have yet to find a representative who has taken any of these pre-emptive steps. My suspicions were confirmed when my opinion search of 7602(e) on the Tax Court’s website produced a single case which dealt only with the effective date of the statute.

In summary, as a representative you should adhere to the old adage, “Forewarned is forearmed” and study the IRM as if it were the Cowboys playbook and you were the coach of the New York Giants.

Summary Opinions through 12/18/15

Sorry for the technical difficulties over the last few days.   We are glad to be back up and running, and hopefully won’t have any other hosting issues in the near future.

December had a lot of really interesting tax procedure items, many of which we covered during the month, including the PATH bill.  Below is the first part of a two part Summary Opinions for December.  Included below are a recent case dealing with Section 6751(b)(1) written approval of penalties, a PLR dealing with increasing carryforward credits from closed years , an update on estate tax closing letters, reasonable cause with foundation taxes, an update on the required record doctrine, and various other interesting tax items.

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  • In December, PLR 201548006 was issued regarding whether an understated business credit for a closed year could be carried forward with the correct increased amounts for an open year.  The taxpayer was a partner in a partnership and shareholder in an s-corp.  The conclusion was that the corrected credit could be carried forward based on Mennuto v. Comm’r, 56 TC 910, which had allowed the Service to recalculate credits for a closed year to ascertain the correct tax in the open year.
  • IRS has issued web guidance regarding closing letters for estate tax returns, which can be found here.  This follows the IRS indicating that closing letters will only be issued upon taxpayer request (and then every taxpayer requesting a closing letter).  My understanding from other practitioners is that the transcript request in this situation has not worked well.  And, some states will not accept this as proof the Service is done with its audit.  Many also feel it is not sufficient to direct an executor to make distributions.  Seems as those most are planning on just requesting the letters.
  • Models and moms behaving badly (allegedly).  Bar Refaeli and her mother have been arrested for tax fraud in Israel.  The Israeli taxing authority claims that Bar told her accountant that she resided outside of Israel, while she was living in homes within the country under the names of relatives.  Not model behavior.
  • The best JT (sorry Mr. Timberlake and Jason T.), Jack Townsend, has a post on his Federal Tax Procedure Blog on the recent Brinkley v. Comm’r case out of the Fifth Circuit, which discusses the shift of the burden of proof under Section 7491.
  • PMTA 2015-019 was released providing the government’s position on two identity theft situations relating to validity of returns, and then sharing the return information to the victims.  The issues were:

1. Whether the Service can treat a filed Business Masterfile return as a nullity when the return is filed using a stolen EIN without the knowledge of the EIN’s owner.

2. Whether the Service can treat a filed BMF return as a nullity when the EIN used on the return was obtained by identifying the party with a stolen name and SSN…

4. Whether the Service may disclose information about a potentially fraudulent business or filing to the business that purportedly made the filing or to the individual who signed the return or is identified as the “responsible party” when the Service suspects the “responsible party” or business has no knowledge of the filing.

And the conclusions were:

1. The Service may treat a filed BMF return as a nullity when a return is filed using a stolen EIN without the permission or knowledge of the EIN’s owner because the return is not a valid return.

2. The Service may treat a filed BMF return as a nullity when the EJN used on the return was obtained by using a stolen name for Social Security Number for the business’s responsible person. The return is not a valid return.

  • Back in 2014, SCOTUS decided Clark v. Rameker, which held that inherited IRAs were not retirement accounts under the bankruptcy code, and therefore not exempt from creditors.  In Clark, the petitioners made the claim for exemption under Section 522(b)(3)(C) of the Bankruptcy Code for the inherited retirement account, and not the state statute (WI, where petitioner resided, allowed the debtor to select either the federal exemptions or the state exemptions).  End of story for those using federal exemptions, but some states allow selection like WI between state or federal exemptions, while others have completely opted out of the federal exemptions, such as Montana.  A recent Montana case somewhat follows Clark, but based on the different Montana statute.  In In Re: Golz, the Bankruptcy Court determined that a chapter 7 debtor’s inherited IRA was not exempt from creditors.  The Montana law states:

individual retirement accounts, as defined in 26 U.S.C. 408(a), to the extent of deductible contributions made before the suit resulting in judgment was filed and the earnings on those contributions, and Roth individual retirement accounts, as defined in 26 U.S.C. 408A, to the extent of qualified contributions made before the suit resulting in judgment was filed and the earnings on those contributions.

The BR Court, relying on a November decision of the MT Supreme Court, held that an inherited IRA did not qualify based on the definition under the referenced Code section of retirement account.  I believe opt-out states cannot restrict exemption of retirement accounts beyond what is found under Section 522, but it might be possible to expand the exemption (speculation on my part).   Here, the MT statute did not broaden the definition to include inherited IRAs.

  • In August, we covered US v. Chabot, where the 3rd Circuit agreed with all other circuits in holding the required records doctrine compels bank records to be provided over Fifth Amendment challenges.  SCOTUS has declined to review the Circuit Court decision.
  • PLR 201547007 is uncool (technical legal term).   The PLR includes a TAM, which concludes reasonable cause holdings for abatement of penalties are not precedent (and perhaps not persuasive) for abating the taxable expenditure tax on private foundations under Section 4945(a)(1).  The foundation in question had assistance from lawyers and accountants in all filing and administrative requirements, and those professionals knew all relevant facts and circumstances.  The foundation apparently failed to enter into a required written agreement with a donee, and may not have “exercised expenditures responsibly” with respect to the donee.  This caused a 5% tax to be imposed, which was paid, and a request for abatement due to reasonable cause was filed.  Arguments pointing to abatement of penalties (such as Section 6651 and 6656) for reasonable cause were made.  The Service did not find this persuasive, and makes a statutory argument against allowing reasonable cause which I did not find compelling.  The TAM indicates that the penalty sections state the penalty is imposed “unless it is shown that such failure is due to reasonable cause and not due to willful neglect.”  That language is also found regarding Section 4945(a)(2), but not (1), the first tier tax on the foundation.  That same language is found, however, under Section 4962(a), which allows for abatement if the event was due to reasonable cause and not to willful neglect, and such event was corrected within a reasonable period.  Service felt that Congress did not intend abatement to apply to (a)(1), or intended a different standard to apply, because reasonable cause language was included only in (a)(2).  I would note, however, that Section 4962 applies broadly to all first tier taxes, but does specify certain taxes that it does not apply to.  Congress clearly selected certain taxes for the section not to apply, and very easily could have included (a)(1) had it intended to do so.

I’m probably devoting too much time to this PLR/TAM, but it piqued my interest. The Service also stated that the trust cannot rely on the lack of advice to perform certain acts as advice that such acts are not necessary.  I am not sure how the taxpayer would know he or she was not receiving advice if it asked the professionals to ensure all distributions were proper and all filings handled.  I can hear the responses (perhaps from Keith) that this is a difficult question, and perhaps the lawyer or accountant should be responsible.  I understand, but have a hard time getting behind the notion that a taxpayer must sue someone over missed paperwork when the system is so convoluted.  Whew, I was blowing so hard, I almost fell off my soapbox.

  • This is more B.S. than the tax shelters Jack T. is always writing about.  TaxGirl has created her list of 100 top tax twitter accounts you must follow, which can be found here. Lots of great accounts that we follow from writers we love, but PT was not listed (hence the B.S.).  It stings twice as much, as we all live within 20 miles of TaxGirl, and we sometimes contribute to Forbes, where she is now a full time writer/editor.  Thankfully, Prof. Andy Gerwal appears to be starting a twitter war against TaxGirl (or against CPAs because Kelly included so many CPAs and so few tax professors).  We have to throw our considerable backing and resources behind Andy, in what we assume will be a brutal, rude, explicit, scorched earth march to twitter supremacy.  We are excited about our first twitter feud, even if @TaxGirl doesn’t realize we are in one.
  • This doesn’t directly relate to tax procedure or policy, but it could be viewed as impacting it, and we reserved the right to write about whatever we want.  Here is a blog post on the NYT Upshot blog on how we perceive the economy, how we delude ourselves to reinforce our political allegiances (sort of like confirmation bias), and how money can change that all.

Deciding Whether to Pursue a Liability – The Differing Standard between Trust Fund Recovery Penalty Cases and Examination Cases

 

As we have mentioned before, Les, Steve and I are engaged in updating IRS Practice and Procedure by Saltzman and Book.  Last year I wrote a number of posts on Collection Due Process as I prepared to update that part of the book.  I have now created an entire chapter on CDP cases which will come out with the 3rd Edition of the book.  Now, I am beginning to update Chapter 17 which covers both transferee liability and the trust fund recovery penalty (TFRP).  So, look for more posts on those topics.  In this post I will examine a unique facet of the TFRP with respect to the when the IRS makes a decision to assess that liability.

In TFRP cases the IRS has decided that it has the ability to look at a taxpayer’s collection potential in deciding whether to set up a tax liability in the first place.  This post will examine the policy behind the decision that the IRS can use collection as a basis for not pursing a liability in TFRP cases yet it pays no attention to collection in ordinary examination cases particularly the cases involving low income taxpayers with little or no collection potential.

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The determination to purse TFRP is made under IRM 5.7.4.1, which is made as soon as possible after the initial contact (IRM 5.1.10.3) with the taxpayer and within 120 days of being assigned to a revenue officer.  IRM 5.7.4.1.1 lists the factors to consider when determining the amount of the TFRP.  After the initial contact, collectability will be determined.  IRM 5.7.5.3.1 gives the IRS the option of non-assertion based on collectability.  To assert non collectability the IRS will look to the factors listed in IRM 5.7.5.1(1).  Those factors include:

  • Current financial condition
  • Involvement in a bankruptcy proceeding
  • Income history and future income potential
  • Asset potential (likelihood of increase in equity in assets and taxpayer’s potential to acquire assets in the future

More guidelines on the impact of collectability in making the TFRP assessment follow in IRM 5.7.5.1(2) and (3), which includes:

If responsible person financial analysis shows. . . Then. . .
Any present or future ability to pay Assess the penalty and take the appropriate collection action based on an analysis of the taxpayer’s financial condition.
No present, but future ability to pay Assess the TFRP based on future income potential and possible refund offset. Prepare a pre-assessed Form 53 and file lien if appropriate.
The responsible person cannot be located or contacted but internal research identifies assets or income sources Assess the TFRP since there is a good possibility of some collection from the assets/income sources that were located.
No present or future income potential exists over the collection statute period Do not assess the TFRP since the financial analysis shows there is little prospect that the taxpayer will receive any increase in income or acquire assets that will enable the Service to collect any of the penalty.

 

The TFRP will normally not be assessed when:

  • There is no present or future collection potential.
  • Neither the responsible person nor their assets/income sources can be located

IRM 5.7.4.8 discusses whether to pursue the TFRP in Installment Agreement or Bankruptcy Situations, while IRM 5.7.4.9 analyzes TFRP in offer in compromise situations.

The focus on collectability before making the assessment in the TFRP situation stands in stark contrast the approach of the IRS in making an assessment in other situations.  The use of collection in the TFRP situation creates difficulties in reconciling the policy here regarding assessment with the Congressional policy on this type of liability expressed in the bankruptcy code.  The TFRP stands as the only tax liability incapable of getting discharged no matter how old the period for which the taxpayer owes the tax or how long ago the assessment took place.  Bad actions such as filing a fraudulent return, late return or no return can also result in a liability excepted from discharge but in those situations it is the action of the taxpayer with respect to the tax rather than the tax itself.

Given that the taxpayer cannot discharge the TFRP and the IRS has a guaranteed 10 years to collect the liability if it wants to have that period, why would the IRS choose this debt among all others to exercise a collectability determination as part of deciding whether to assess.  Why would it not save this type of determination for low income taxpayers and dependency exemption cases like the taxpayer Les wrote about on Mother’s Day?

I think that the IRS makes a distinction for TFRP taxes because this is the one tax that gets assessed by the collection division.  Employees of the collection division approach assessment with a pragmatism employees of the examination division do not.  While the IRS does not evaluate employees based on metrics (see Restructuring and Reform Act of 1998 Sec. 1204) such as how many dollars they have assessed or collected, exam employees generally measure their worth by the number and amount of assessment with little care for whether the assessment will ever be collected.  Collection officers, however, hate the thought of going through the assessment process for nothing.  As a consequence, they built into the portion of the assessment process they control a look at collection.  Nothing stops the IRS from applying this same logic to all assessments it makes.  If it did, probably a decent percentage of the assessments against low income taxpayers would go unmade.  That might be good for a system in which the IRS has limited resources.

It seems especially unsatisfactory that the one tax Congress chose to single out for the worst treatment in bankruptcy, the one tax based on the taxpayer’s breaching the trust to hold public funds for payment to the IRS, the one tax where the taxpayer responsible for non-payment nevertheless receives full credit for the unpaid withheld taxes on their individual income tax return and on the calculation of their social security benefits would be the tax that the IRS gives a break to deciding to make an assessment by looking first to its ability to collect the tax after assessment.  To limit this pragmatic approach to individuals engaged in behavior we otherwise view as reprehensible seems not to make sense.  Perhaps, the IRS should take another look at why it adopted the policy and why it only applies this beneficial approach to responsible officers who owe the TFRP.

 

Summary Opinions for the week of 05/01/15

Happy Memorial Day weekend!  We won’t be posting on Monday, but will probably be back in full force on Tuesday.  I know we have a handful of guest posts coming up on really interesting topics and I’m certain Keith and Les have some insightful things to add following ABA.

In the week of May the 1st, we welcomed first time guest poster, Marilyn Ames, who wrote on NorCal Tea Party Patriots v. IRS and disclosure of return information.

Here are the other procedure items from that week:

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  • A recent Tax Court decision brought back the analysis used by the Supreme Court almost 20 years ago on a similar but slightly distinct fact pattern.  The situation can be tough to follow at first because it plays out at the intersection of Sections 6511 and 6512.  It also involves reliance on the earlier Supreme Court decision which caused a change to Section 6512 after it was decided.  In Butts v. Comm’r, the Tax Court denied taxpayers’ request for refund as being untimely.  The taxpayers failed to file in ’07 and ’08.  In 2011 (and 2012), SNODs were issued for 2007 and 2008, and later that year the taxpayer filed for review in the Tax Court.  In 2013, taxpayers filed joint returns, claiming overpayment due to employer withholdings.  The Court stated SCOTUS reviewed an almost identical case in Lundy v. Comm’r.   The issue in both cases was if the refund amount was allowed under Section 6512(b)(3), which allows refunds of any amount paid:

(A) after the mailing of the notice of deficiency;

(B) within the period which would be applicable under section 6511(b)(2), (c), or (d), if on the date of the mailing of the notice of deficiency a claim had been filed (whether or not filed) stating the grounds upon which the Tax Court finds that there is an overpayment; or

(C) within the period which would be applicable under section 6511(b)(2), (c), or (d), in respect of any claim for refund filed within the applicable period specified in section 6511 and before the date of the mailing of the notice of deficiency.

Based on the facts in Butts and Lundy, (A) and (C) do not apply.  In Lundy, SCOTUS stated it considered:

the look-back period for obtaining a refund of overpaid taxes in the…Tax Court under 26 USC 6512(b)(3)(B), and decide[d] whether the Tax Court can awarded a refund of taxes paid more than two years prior to the date on which the [IRS] mailed the taxpayer a notice of deficiency, when, on the date the notice of deficiency was mailed, the taxpayer had not yet filed a return.  We hold that in these circumstances the 2-year look-back period in 6513(b)(3)(B) applies, and the Tax Court lacks jurisdiction to award a refund.

One difference in Butts and Lundy is that in Lundy the taxpayer made its request within three years of the filing date, whereas in Butts the request was made more than three years after the filing date.  Based on a prior version of the statute, Lundy was precluded from obtaining a refund because it was outside of two years and there was not a reference to the three year statute applicable. Section 6512(b)(3) was modified in 1997 by Congress, and now the minimum statute of limitations would be the three years from the filing date.

In Butts, under Section 6512(b)(3)(B), the Court stated it must look to the mailing date of the SNOD as a hypothetical claim date and determine if a timely claim could have been made then based on Section 6511.  This requires a review of the two year statute from the date of taxes paid, and three years from the due date of the return.  The withholdings for 2007 were treated as having been paid on April 15, 2008, while the initial SNOD was issued in June of 2011.  Since both statutes had passed, no claim for refund could be allowed.  There was a similar issue with the 2008 return.

  • Peter Hardy and Carolyn Kendall, attorneys from Post & Schell, and prior guest bloggers here at PT, have posted on Jack Townsend’s Federal Tax Crimes blog (two-timers!) on the Microsoft appeal in In re Warrant to Search a Certain E-mail Account.  The guest post can be found here, and Jack’s summary of related materials on the Stored Communications Act can be found here.  Although the post deals with a drug case, the impact could be far reaching regarding subpoena power over electronic communications in the cloud (including datacenters outside of the US).  Peter and Carolyn tie in the Service’s review of foreign accounts nicely.
  • It’s like speed dating, but it might cost more and you only get lucky if you don’t get picked.  The NY Times has an op-ed on the IRS speed audit, with agency cut backs causing reduced response time for taxpayers, which if not promptly responded to could result in important collection due process rights being forfeited.  The op-ed indicates that the IRS may be sending out follow up letters the same day as the initial letter, which the author argues is in violation of the updated taxpayer bill of rights issued last year.  When you are on the op-ed, check out the comments the NY Times has picked as important.  Carl Smith was highlighted for indicating a few other ways the tax system is failing taxpayers.  This practice may save time for the Examination Division of the IRS but pushes more cases into the collection stream which also impacts the IRS resources.
  • On April 20th, the Tax Court issued a decision in Yuska v. Comm’r, holding the automatic stay invalidated a Notice of Determination Concerning Collection Actions regarding a tax lien that was issued after the bankruptcy petition.  Importantly, the Court declined to follow the IRS’s suggestion that the Court distinguish this case from Smith v. Comm’r, which had similar facts but pertained to a levy.  The timing of events were very important in following Smith, and the Service also argued that the Court should instead follow Prevo v. Comm’r, which was a lien case where the collection action occurred before the BR petition.  In Smith, the Serviced began collection actions, and then the taxpayer filed a bankruptcy petition, followed by the Service issuing a notice of determination concerning the levy, and then the taxpayer petitioning the Tax Court for review of the levy action.  The Court held the continuance of the collection action violated the stay under 11 USC 362(a)(1).  In Prevo, the sustaining of the lien occurred before the BR petition.  As to differentiating between a lien and levy case, the Court found the administrative review of a lien was clearly part of the administrative collection process and subject to the ruling in Smith, even if future administrative review was possible. Although the Court declined to differentiate between the two in this case, Keith noted that if the stay stopped the CDP case there can be important differences.  In a lien case, the NFTL remains valid (if not enforceable) until after the stay is lifted.  In a levy case, the stay prevents the IRS from moving forward with the levy completely.  Keith didn’t read the case, and still came up with something much more insightful and helpful to add.
  • This is becoming a little like an advertisement for Jack Townsend’s Criminal Tax Crimes Blog.  Jack posted on the recent 7th Circuit case, US v. Michaud, which reviewed whether or not the IRS had authority to issue a summons in a criminal matter prior to a DOJ referral.  The statute in question is Section 7602(b) & (d), which was modified after US v. LaSalle Nat’l Bank to make it clear the IRS did have this authority.  The 7th Circuit had some additional thoughts on when the IRS couldn’t issue the summons.  Check out the post for a discussion of that point, and Jack’s always helpful thoughts on the matter.
  • Context is always important.  For instance, being suspended can be very good (we took our daughters rock climbing this weekend, and being suspended by the rope was really helpful), but it can also be pretty bad in the school, professional or corporate context.  Such was the case in Leodis C. Matthews, APC, a CA Corp. v. Comm’r, where the Tax Court held that it lacked jurisdiction  over a deficiency petition brought be a corporation (law firm) that California had suspended its corporate privileges for due to failure to pay state taxes.  Interesting point of law.  Can someone bring the petition on behalf of the corporation so it does not lose its ability to contest the tax?  Timing is also interesting.   Corp is suspended May 1, 2013, and 90 day letter is issued June 30, 2014.  Taxpayer petitions court Oct. 1, 2014 (presumably timely), and had its corporation reinstated November 26, 2014.  You would guess he was trying to deal with his state tax issue during the 90 day period.  I also wonder if there is a way to get limited rights reinstated, so that the corporation could have petitioned the Tax Court.
  • We all hear the scare tactics on the radio about how if you owe more than $10,000, the IRS is going to come and take your assets, steal your children, put you in jail, shoot your dog, etc.  We are lucky enough to know this is BS, and an effort to garner business.  Sometimes, however, the IRS can show up at your premises (probably armed), and take your stuff.  You have to owe a bit more than $10k, and the Service has to jump through a lot of hoops.  In re: The Tax Indebtedness of Voulgarelis is one such writ of entry case.  In Voulgarelis, the taxpayer apparently owed around $300k, possibly more, and ignored six notices of intent to levy.  The Service sought an order authorizing it to enter the premises and levy the tangible property, which was granted in accordance with GM Leasing Corp. v. United States, 429 US 338 (1977).
  • The Service has updated its list of private delivery services that count for the timely mailing is timely filing rules under Section 7502.  The update can be found in Notice 2015-38.  As we’ve discussed before, failure to file these rules can result in harsh results.  These results can be seemingly arbitrary when a taxpayer selects a quicker FedEx/UPS delivery method that isn’t approved, and cannot rely on the rule.
  • In information notice 2015-74, the IRS has reminded businesses of the temporary pilot penalty relief program for small businesses that have failed to properly comply with administrative and reporting requirements for retirement plans.  That program ends June 2nd.

 

Summary Opinions for 11/21/14 to 12/5/14

Once again, trying to catch up and cover a few weeks in one SumOp post.  Before getting to the new items from the last three weeks, I wanted to give a short update on Hawkins v. Franchise Tax Board.  In September, A. Lavar Taylor wrote a two part guest post on the 9th Circuit’s holding, which can be found here and here.  The case deals with, as the guest post title indicates, “What Constitutes An Attempt to Evade or Defeat Taxes for Purposes of Section 523(a)(1)(C) of the Bankruptcy Code,” and a split found between the recent holding and other Circuits.  Carlton Smith shared with us last week that the Government sought en banc review, the debtor has responded, and the petition is now before the entire 9th Circuit to decide whether the review is appropriate or not.  Either way, some court may be reviewing soon, and we will let you know if we hear more.

GC

I also want to highlight some really strong guest posts over the last three weeks, and thank all of our guest posters again!  The aforementioned Carlton Smith wrote on the Lippolis Tax Court jurisdiction case relating to the $2MM Whistleblower amount limitation.  Professor Andy Grewal covered the recent Petaluma FX Partners oral argument in the DC Circuit, regarding the scope of TEFRA jurisdiction when the underlying partnership is a sham.

A few first time guest posters also contributed over the last few weeks.  Rachel Partain, an attorney at Caplin & Drysdale, wrote on the LB&I policy restricting informal refund claims for taxpayers in exam.  And, finally, Jeffrey Sklarz, of Green and Sklarz, touched on the interaction between Section 6020(b) and Deficiency Assessments in the recent Radar case.

To the other procedure.

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  • PWC provided a fairly comprehensive overview regarding the new information document request process.  The document outlines the history behind the changes, how the process works, and what occurs if the IDR is not responded to in a manner the IRS finds acceptable.
  • As I mentioned above, Carlton Smith had a write up on PT regarding the Lippolis case.  Tax Litigation Survey has added its thoughts here.
  • Two weeks ago, Jack Townsend on his Federal Tax Crimes Blog posted about a FOIA information dump regarding FBAR audits found on Dennis Brager’s web page.  You can find Jack’s post about it here.  The FOIA request resulted in over 6,500 pages of info.  Jack’s page has some good comments and responses.
  • Chief Counsel has taken the position that a company which acquired, pursuant to Section 381, another company that had taken TARP funds was subject to the same restrictions as the TARP company regarding NOL carrybacks.
  • Tax Girl has a well written story on Forbes about the Whistleblower case brought against Vanguard.  Vanguard is a huge financial company located in Chester County (same as me), which is known for its low cost investing options.  A prior in house tax attorney, David Danon, has brought an action under the New York False Claims Act regarding its internal transfer pricing for investment services, which he claims caused Vanguard to underpay its taxes substantially.  The New York statute was expanded in 2010 to include tax claims.  Last year, this expanded statute was discussed on the whistleblower panel at the VLS Shachoy symposium, although this case was under seal at that time (if it had been filed), and was not discussed.  There is probably a IRS and SEC action moving forward, although those were not highlighted in the story.
  • This story deals with a few Golden Corral restaurants.  Apparently the slogan there is “Help Yourself to Happiness,” which is a reference to its all you can eat buffet.  The one time I went to the Corral, that didn’t summarize my experience, but it seems like a popular chain, so others would probably disagree with me.  Also interesting, there is a lot of internet debate out there about the fact that Golden Corral no longer allows people to bring guns into its establishments.  This really pisses people off.

In Erwin v. United States, 114 AFTR2d 2014-6630 (MD NC), a general manager (a gent named Pintner) of a company that owned five GC restaurants (these are franchises) was found to be a responsible person for the TFRP.  He clearly handled day to day operations, oversaw payroll, could hire and fire, and could write checks.  The fact that the owners and officers indicated they would take care of the issue did not mitigate the responsibility.  There was an argument about whether he knew of the debt in June or October of the year in question, but the Court directed that did not matter, which is somewhat interesting because he left the company two months after finding out about the issue.  Tough holding for the manager, as the amount was substantial, and his knowledge may have been less than 60 days.  Should have left the Corral sooner.  Keith had a good post a few months ago about postponing the assessment of the TFRP when others might be liable (and hopefully pay), which can be found here.  I bet most folks in the manager’s position would be surprised to know this is how the law works.

  • Foundation was granted reasonable cause relief to abate first-tier excise taxes under Section 4943 by the Service.  The TAM found that the foundation had reasonably relied on a memorandum that incorrectly determined the attribution rules regarding excess business holdings, and how the percentage applied.  The memorandum was made by a qualified tax preparer.  The foundation realized the error and fixed the issue.  The Service determined there was not willful neglect, and the error was due to reasonable cause.
  • The Service issued Announcement 2014-34 discussing the realignment of technical work between TE/GE and Chief Counsel to shift authority for preparing revenue rulings, revenue procedures, announcements, notices, technical advice, and certain letter rulings relating to exempt orgs and certain qualified plans.
  • Occasionally, a nice woman from accounting-degree.org sends me a link to infographics they have created, which are usually interesting.  This one is a fairly simple chart regarding entity choice, including the tax impacts.  Unlike most similar lists, this one covers cooperatives…which are useful if you want to be a snooty building or start an organic farm in a vacant lot.

IRS May Restrict Informal Refund Claims for LB&I Taxpayers Under Exam

Today’s guest poster is Rachel Partain.  Rachel is of counsel at Caplin & Drysdale, Chtd. in New York, NY and her practice involves tax controversy matters for corporations, partnerships, and individuals.  Rachel was formerly an associate at Dewey & LeBoeuf LLP and a 2012-2013 Nolan Fellow of the ABA Section of Taxation.  In this post, Rachel explores a proposed change relating to refund claims for LB&I taxpayers.  Steve.

LB&I is considering sharply curtailing the ability of LB&I taxpayers under examination to submit informal refund claims and will be seeking comments on a claim cutoff from external stakeholders.  As informal claims are very common in LB&I (and other) examinations, there likely will be significant feedback to LB&I’s proposal.

On November 10, 2014, the IRS made available a draft of Publication 5125 dated as of July 2014 relating to the LB&I quality examination process.  See 2014 TNT 217-62 (Nov. 10, 2014).  Among other things, the publication indicates that LB&I is considering reducing the period in which taxpayers may submit informal claims to within 30 days after the examination opening conference.  After the expiration of the 30 day period, LB&I taxpayers would be required to submit documented and supported formal refund claims on Forms 1120X or 843 and, presumably, administrative adjustment requests for TEFRA partnerships and Form 1040X for Global High Wealth taxpayers.  Currently, LB&I asks that taxpayers submit refund claims, formal or informal, as soon as possible.  See I.R.M. 4.46.3.2.3.2.  In practice, it is common for exam to establish a deadline for the submission of informal claims.  LB&I’s proposal would apply an informal claim period uniformly to all LB&I taxpayers.

The Code furnishes the time in which refund claims must be filed.  See I.R.C. § 6511. The regulations provide additional requirements that refund claims must satisfy, including that claims must be filed on a tax return or Form 843.  See Treas. Reg. §§ 301.6402-2, -3.  Numerous court decisions have held that informal claims constitute valid refund claims, despite the requirements in the regulations.  An informal claim is any written document that provides the IRS with notice that the taxpayer is claiming a refund and the grounds for the taxpayer’s claim, and generally is not submitted with tax computations.  See Mobil Corp. v. Unites States, 67 Fed. Cl. 708 (2005).  There is precedent addressing informal claims in the context of an exam-imposed cutoff.  For example, in Mobil, the exam team set a date certain by which informal claims were to be filed.  The court held that the IRS has the ability to require taxpayers to follow the refund claim regulations, with the result being that one of the taxpayer’s informal claims submitted after the informal claim deadline did not constitute a valid refund claim.  As a result, under the proposed change and Mobil, LB&I taxpayers would be precluded from asserting that a submission to exam after the period for filing informal claims has elapsed constitutes an informal refund claim.

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The draft publication states that the purpose of informal claim end point is to “deploy resources efficiently.”  LB&I’s industry director of natural resources and construction stated that LB&I taxpayers submit a significant number of informal claims and that the informal claims impede the examination of issues identified on LB&I exam plans.  See 222 DTR G-2 (Nov. 18, 2014).  The publication indicates that LB&I wants taxpayers to submit fully documented and supported refund claims, which would enable exam teams to make determinations on refund claims without engaging in a lengthy examination process.  In fact, the LB&I Commissioner has publicly stated that exam will no longer be developing refund claims and instead will reject claims that are not fully developed.  See 2014 TNT 217-2 (Nov. 10, 2014).

Also, the LB&I document states, without explanation, that late informal refund claims “may result in unnecessary refund litigation.”  Perhaps the later an informal claim is filed, the more likely exam is to reject the claim in order to focus on wrapping up the examination.

It has been suggested that another purpose for LB&I’s proposed informal claim window may relate to the section 6676 penalty for erroneous refund claims.  However, the IRS’s position is that the penalty applies to both formal and informal claims.  See I.R.M. 20.1.5.16.  Therefore, the penalty may not be a driving factor behind LB&I’s proposal to require the filing of formal claims that otherwise would have been submitted as informal claims.

The LB&I Commissioner also announced that refund claims will be risk assessed, which means that claims will be preliminarily reviewed to determine whether to allow the claim or to initiate an examination of the issues raised in the claim.  See 2014 TNT 217-2.  LB&I’s considerations during risk assessment include the materiality of the issues in the claim, the time and resources needed to examine the issues and whether the issues in the claim may affect future years.  See I.R.M. 4.46.3.2.2.2.

The effect of an informal claim cutoff would be to shift the development and computation of claims more fully to taxpayers.  If implemented, the policy may result in an LB&I taxpayer delaying the filing of a formal claim until the end of the examination.  This would permit the submission of a comprehensive claim covering all of the taxpayer’s issues and their grounds and alternative grounds, and would require the taxpayer to prepare tax computations only once.  Where taxpayers submit formal claims towards the end of the refund limitations period, taxpayers will be under greater pressure, given the variance doctrine, to submit full and complete claims explaining all possible grounds for the taxpayer’s recovery as taxpayers will have a shorter window within which they can timely correct defective claims with amended or superseding claims.  Further, a formal claim requirement may deter taxpayers from filing smaller dollar amount claims if the time and expense of amending the return is more than the value of the refund claim.

Also, a policy limiting the period in which taxpayers may submit informal refund claims may lead to less collaboration between taxpayers and exam, which relationship has already become more formalized as a result of the recent changes to the LB&I information document request procedures.  See., e.g., LB&I-04-0214-004 (Feb. 28, 2014).

Given the IRS’s resource limitations resulting from budget constraints and exam’s objective of adhering to the LB&I exam timeline, it seems likely that LB&I will adopt an informal claim window.  However, many practitioners feel that 30 days is too short of a period.  I would expect an enlargement of the period in which LB&I taxpayers will be permitted to submit informal claims.  A more reasonable period would be at least 90 days, and perhaps a longer timeframe for TEFRA partnerships as opposed to other LB&I taxpayers.

Although the publication is in draft form and LB&I has not issued a notice announcing the proposed changes, it appears that LB&I has already determined that action should not be taken on late-raised informal refund claims.  I have seen LB&I exam respond to informal claims by directing the taxpayers to submit formal refund claims, or an administrative adjustment request in the case of a TEFRA partnership.