District Court Holds That Taxpayer With Rejected E-Filed Return Subject to Late Filing Penalties

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Last week, in Spottiswood v US, Docket No. 3:17-cv-00209 [link not yet available], the District Court for the Northern District of California held that a taxpayer who attempted to e-file his return a few days before the filing deadline but who incorrectly entered his child’s Social Security number was responsible for a late filing penalty. The case is the latest in I am certain to be a growing number of cases attempting to apply a 20thcentury approach to tax administration to the realities of 21stcentury tax return filing.

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Here are the facts.

Taxpayer John Spottiswood used Turbo Tax to prepare his federal return and California return. The federal return was submitted to Intuit for the software provider to then submit to IRS for electronic filing. Also using the Turbo Tax software, Spottiswood printed out his state return and mailed the State return via old-fashioned snail mail.

Here comes the problem. On the federal return his child’s Social Security number differed from information IRS had when it crosschecked the numbers with its databases. IRS notified Intuit, which sent an email to Spottiswood telling him IRS failed to accept the return.

Spottiswood failed to notice the email and he had no idea that all was not kosher until months later:

When I was investigating the issue, I discovered the following by logging back into my Turbo Tax 2012 software. [] I discovered that my return, which I thought had been successfully e-filed, had actually been rejected. If I had realized that there was a chance of rejection I would have mailed in my return, but e-filing seemed like an easier option and it was free with the software. Intuit may have informed me in the fine print that I needed to log back in to make sure that my return had not been rejected, but if so I did not read this fine print. Had I logged back in a few days later I would have realized that the return had been rejected. But I did not log back in until 18 months later.

Eventually Spottiswood got around to fixing the error and resubmitting the return.  IRS, however, assessed a late filing penalty of about $89,000.

Spottiswood paid the interest on the penalty and filed a claim for abatement and refund claim, which IRS rejected, leading to a suit (an aside: not clear how this gets around Flora as it does not appear based on the order that Spottiswood paid the penalty). In his motion for summary judgment, he had two main arguments: 1) the rejected return should have been considered a return and therefore no late filing penalty was appropriate and 2) in the alternative he had reasonable cause for the late filing.

The court held for the government and granted its cross-motion for summary judgment.

As to the first issue, the taxpayer’s main argument revolved around how if he had sent the precise information contained in the attempted e-filed return via old fashioned paper return, IRS would have accepted it and the information contained qualified as a return under the Beard standard as to whether a document is a return for federal income tax purposes.

I am sympathetic to this argument, as the IRS’s current approach essentially creates an additional burden for e-filers who, if they had just mailed the return in the old fashioned way, would not have found themselves facing a late filing penalty.

The court sidestepped the argument though because Spottiswood failed to establish that in fact IRS would have treated the information in a paper return differently than the e-filed return:

Plaintiffs argue that the IRS would have accepted a paper-filed return containing the same error, and that the IRS unlawfully applied a more stringent standard to their electronically- submitted return. Pls.’ Mem. at 7-8. Plaintiffs’ only support for this argument is a document entitled “Internal Revenue Manual Part 3. Submission Processing Chapter 11. Returns and Documents Analysis Section 3. Individual Income Tax Returns.” See Pls.’ Opp’n at 1 (“Plaintiffs submit Exhibits 1 through 3”); id., Ex. 2. This document is not authenticated, and Plaintiffs establish no foundation for the document. The document shows a transmittal date of November 17, 2017, and Plaintiffs do not establish any foundation showing the IRS followed the procedures described therein when Plaintiffs attempted to submit their tax return more than four years prior to that date. Plaintiffs also establish no foundation to show their interpretation of the procedures described in the document is correct. Plaintiffs fail to create a triable issue that the same mistake contained in their submission would have been treated differently if it had been presented as a paper filing, and that the IRS’ rejection of their submission because it contained an erroneous Social Security number was not lawful.

The order continued with its critique of the way the taxpayer argued that the information it submitted should have been enough to constitute a return for tax purposes:

Plaintiffs’ assertion that the document “contained sufficient data to calculate the couple’s tax liability” (Pls.’ Mem. at 7) is purely conclusory. Their support for this argument is based entirely on an unauthenticated copy of a document faxed by the IRS to an unidentified recipient on May 23, 2016. Id. (citing Pls.’ Opp’n at 1 (“Plaintiffs submit Exhibits 1 through 3”); id., Ex. 1). Plaintiffs do not set out facts showing the document is a true and correct copy of the data they submitted to the IRS in 2013; indeed, it does not appear to be, given that the document displays information received on January 26, 2015. See, e.g., Pls.’ Opp’n, Ex. 1, passim (“TRDB-DT- RCVD:2015-01-26”). Nor do they set out facts showing the information contained in this document would be sufficient to calculate their tax liability. They thus have not created a triable issue of fact that the document they attempted to submit to the IRS in 2013 qualifies as a tax return under Beard, such that the IRS should have accepted it for filing under their theory of the case. The United States does not actually challenge this point, arguing only that the first Beard factor was not met because the IRS could not calculate Plaintiffs’ tax liability because the return had not been accepted for filing.

With a better foundation, the court would have had to address this issue head on, and I think it is a close case and requires courts and IRS to apply some fresh thinking on the issue.

The court also summarily rejected the taxpayer’s argument that reasonable cause should excuse the penalty, looking to the taxpayer’s failure to check his email account that he provided Intuit and the taxpayer’s failure to look at the “check e-file status” on his software to confirm that everything went well with the e-filing. For good measure, although the court did not emphasize this in the order, IRS also failed to debit the $395,000 that Spottiswood designated as a payment with the  purportedly e-filed return, and he failed to notice this due to as he described the high balance in the account. That failure to confirm that in fact IRS accepted the payment cuts against the argument that he had reasonable cause for failing to file on time.

Additional readings on this and related issues:

For more on this issue, see a prior PT post discussing the Haynes case on appeal in the Fifth Circuit, Boyle in the Age of E-Filing(linking an amicus brief from the ACTC) and a PT post on e-file rejections.

In December of 2017 and January of 2018 ABA Tax Section submitted letters to IRS asking IRS to reconsider its approach to timeliness of e-filed returns after a failed transmission; see here and here. (Note: Keith was the initial drafter of these letters, and he was part of the ABA Tax group that called on Counsel to change its policies on this issue).

A 2012 Journal of Tax Practice and Procedure article by Bryan Skarlatos and Christopher Ferguson making the persuasive case for a new approach to Boyle in the age of e-filing.

Leslie Book About Leslie Book

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

Comments

  1. Bryan Camp says:

    Great post, Les. The best argument for the IRS is that e-filings that are rejected are, by definition not a return because they could not be processed. But sometimes the rejection is for a substantive reason and not because the return could not be processed. Keith’s letter gives one example: where there is a duplication of a dependent’s SSN. So perhaps the Service could distinguish those types of rejections from other types and treat those rejections as an inquiry made on a filed return. I don’t know the coding involved. But ultimately, I think we need a legislative fix to revise the penalty provisions to create a different penalty regime for e-filed returns.

  2. Bob Kamman says:

    According to the Complaint in this case, which involves a 2012 return, the taxpayers did not file their 2013 return until early 2015 – after they had filed 2012. On that return, though, there was a refund due them. The refund of $130,654 paid the accumulated penalties on 2012. (These penalties also included $26,217 for late payment.)

    The Schedule K-1 attached to the Complaint as an Exhibit shows Mr. Spottiswood received a distribution of nearly $3 million in 2012 and was required to report a $3.7 million capital gain. If this case arose anywhere but Silicon Valley – where, incidentally, the taxpayers live on a street that translates from Spanish as “Avenue of the Fleas” – my credulity would be strained by their claim that they did not notice their bank balance remained $395,000 more than expected, for more than a year.

    Ironically, because of the amount of the AGI there was probably no federal tax benefit to claiming a dependent, even with a correct SSN.

    The following story crossed my desk last week, about a not-so-similar e-file rejection:

    “He tried to file 2017 electronically, and somehow it wouldn’t go through. After spending hours on the phone (most of it on hold), he learned that it was rejected because he entered his previous year AGI according to what his records showed, but IRS told him his return for 2016 was never filed. And his return for 2016 failed because his AGI for 2015 was rejected, given that his return for 2015 was never filed. After some further conversation, IRS told him there was some evidence that he had tried to file for 2015 and 2016—it just never went through. In both cases, he owed no money, but was due a small refund. He never noticed that the refund never showed up, and IRS never notified him that his electronic filing failed. So now he must write a letter and send his hard copies of 2015 and 2016 returns. Supposedly, that will take care of the problem.”

    • Thanks for the additional information Bob. Very helpful

      • I have more sympathy for Mr. Spottiswood, having examined the (redacted) Form 1040 attached as an exhibit to his Complaint and discovered that he and his co-Plaintiff wife have four children under the age of 17.

        And he’s trying to prepare his own tax return, in his spare time? Even though it involves an NOL carryover and Schedule K-1 items from more than one source.

        Meanwhile, the return shows that he paid $48,643 in alternative minimum tax. So I place some of the blame on Intuit, for not adding this diagnostic to TurboTax:

        “By the way, it doesn’t really matter whether you have zero dependents, or four, or eight. There are no exemptions for dependents when calculating AMT. So consider saving yourself some potential problems, like garbled SSN’s, by leaving them off this year’s Form 1040. They won’t help on your California return, either.”

  3. Ted Leibowitz says:

    I had a reject this year because the EIN of a new W-2 was entered incorrectly. (Actually one number off, but still, correctly, unidentifiable). However instead of disallowing the amount of tax withholding, until a notice could be generated, as a CP-2000, it was rejected. I did notice it and corrected it for the client filing.

    But the fact remains that all was rejected for what could be called a minor error. But of course not as minor as the above case whereby the exemption for the child was -0- because of the income involved and did in no way prevent the proper calculation of the proper tax. Just a vengeful act by the IRS for no apparent reason.

    I would like to see an IRS response that is not, in your words above, “obnoxious, mean spirited, or violates your sense of decency.”

  4. Norman Diamond says:

    https://scholar.google.co.jp/scholar_case?case=8143437654702197844&q=Spottiswood&hl=en&as_sdt=4,323

    Spottiswood is quoted: “If I had realized that there was a chance of rejection I would have mailed in my return”

    That wouldn’t help. He could send registered mail but the IRS might refuse to sign for it, or the IRS might hide it in a ceiling or whatever. Or the IRS might sign for it but months later the IRS would reply that they refuse to accept the return and years later the IRS would delete administrative records of the IRS originally filing the original return.

    Furthermore, since the IRS doesn’t participate in this kind of court case, even if the IRS accepted the original return the DOJ could invent all kinds of reasons to overturn the IRS and the court would accept them.

  5. Ted Leibowitz says:

    Already did.

  6. ” Just a vengeful act by the IRS for no apparent reason.”

    Completely agree. This case is a joke. Of course the IRS can’t compute a tax if they turn their back on an original return. The IRS could have denied the dependency exemption just as easily as they can correct routine math errors. The Beard Test, as we know it, was totally satisfied in this case. What the IRS rejected, was a return that it received. And if the IRS received it, it was filed. And if they say they didn’t receive it, then how could they reject it?

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