Seeking Disclosure of Return Information in Tax Court Case

On April 5, 2017, the Tax Court rendered a fully reviewed T.C. opinion in the case of Mescalero Apache Tribe v. Commissioner, 148 T.C. No. 11.  We do not often have two disclosure cases in one week.  It doesn’t get much better than this.

After President Nixon tried to run roughshod over the tax information of his enemies and Congress reacted with the new, extremely beefed up section 6103 in 1976, Chief Counsel, IRS soon thereafter created the Disclosure Division.  As you might imagine, new attorneys did not flock to that Division as their first (or second or third) choice.  So, Chief Counsel’s office created a rule that if you worked in the Disclosure Division for three years, you got first choice on any opening in the country.  That rule suggests how sought after a career focused on the disclosure laws was, at least with lawyers in Chief Counsel’s office; however, the disclosure provisions, despite their non-glamorous reputation, contain many important policy issues a number of which have split the circuits.  The Mescalero Apache Tribe case demonstrates one of the interesting issues that can lurk in the disclosure provisions.

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Before I move on to the disclosure issue, I want to pause and discuss an issue that the Court discusses in a footnote – appellate venue in cases brought by Indian tribes.  The issue of appellate venue in Tax Court cases has importance to the outcome of the case at the trial level because of the Golsen rule under which the Tax Court will follow the law of the circuit to which the case will be appealed.  The failure to update the appellate venue rules in 1998 when Congress created several new ways to obtain Tax Court jurisdiction led to some interesting issues we have blogged here and here.  In this case the Tax Court notes that the rules of appellate venue discuss individuals and corporations but not Indian tribes which have a sovereign nation like status.  So, the appellate venue for a Tax Court case involving a tribe put the court in uncharted waters.  It defaulted to looking to the law of the 10th Circuit which is the circuit where the tribal lands of the tribe appearing before the court are located.  I suspect that most readers will have few cases in which they represent an Indian tribe in Tax Court but the case points out in yet another context a hole that exists in the appellate venue of the Tax Court and how that hole can impact the resolution of the case when a circuit split exists on an issue.

The taxpayer is an Indian tribe that hired workers.  At issue in the Tax Court case is the classification of those workers as independent contractors or employees.  The tribe classified the works as independent contractors and the IRS seeks in the case to obtain a determination that the workers were employees.  If the IRS wins this argument, the tribe would owe the taxes on the workers under the theory that its failure to properly classify the workers and consequent failure to withhold taxes with each payment caused the non-payment of the taxes.  Section 3402(d) allows a company deemed to have employees rather than independent contractors to avoid the additional liability to the extent that the company can show that the workers independently paid the taxes to the IRS.  This offers a significant way out of what could be a heavy tax liability; however, there is one catch – the payment by the employees of their taxes is return information under IRC 6103 and return information, like tax returns themselves, comes under the broad umbrella of the protection from disclosure.

The structure of 6103 basically sets out the broad general rule at the outset that returns and return information is covered by the disclosure provisions and cannot be disclosed by the IRS.  The lengthy code section then has a multitude of exceptions.  At issue in this case is the application of one or more of the exceptions.  The case is a slightly unusual disclosure case in that both the IRS and the taxpayer before the court know the names of all of the individuals who worked for the tribe.  So, the tribe does not want taxpayer identity information but simply whether the identified individuals paid their taxes for the years at issue so that the tribe knows if the defense available in 3402(d) protects it.  Before seeking the information in discovery in the Tax Court case, the tribe sought to gather the information from the individuals who previously worked with it.  Because of time and mobility of the work force and maybe because some of the former workers did not want to provide the information, the tribe was unable to get information about all of its former workers.  So, it sent a discovery request to the IRS seeking to obtain information about a group of identified former workers and whether they paid taxes on the compensation they received.  The IRS objected to the request citing the general rule that it may not disclose this return information.  The tribe brought an action to enforce discovery citing to an exception in 6103(h) and the Tax Court, in a fully reviewed, unanimous opinion, holds that the tribe is entitled to the information through discovery.

This is a big deal for taxpayers who need information from the IRS in order to defend themselves in a tax matter.  The decision here will not open the IRS records in every case but it does provide a model for seeking information in Tax Court cases.  Because the Tax Court had not previously addressed this issue, it did so here through court conference.

As the Tax Court examined the issue of whether 6103(h)(4) provides an exception to the general rule of nondisclosure, it found the circuits were split.  The 5th Circuit held that this subsection applied to disclosures to certain federal officers because of the title of the section; however, the 10th Circuit held the 6103(h)(4), unlike earlier subparagraphs of the subsection,” speaks specifically of disclosure in a judicial or administrative tax proceeding with no indication that disclosure should be limited to officials.”  The Tax Court found that most courts had followed the 10th Circuit; however, the fact that (h)(4) created an opportunity for disclosure in a court proceeding did not mean that its language required or allowed disclosure in this circumstance.  So, the Tax Court had to look further at the statute.  Subparagraph (h)(4)(B) refers to returns and return information and another part refers only to returns.  Without getting into a significant discussion of returns and return information, it is important to understand that these are two different classes of information protected by 6103 and the tribe wants return information.  Two circuits found the subsequent reference to returns which omitted the phrase return information to create a limitation on the disclosure of return information.  The 10th Circuit had two opinions which, in different contexts, did not impose that limitation.

The Tax Court avoided that issue by looking at 6103(h)(4)(C) which allows for disclosure of both returns and return information; however, it limits disclosure to situations in which “return or return information directly relates to a transactional relationship between a person who is a party to the proceeding and the taxpayer which directly affects the resolution of an issue in the proceeding.”  So, the Tax Court needed to decide if the employer/worker relationship is a transactional relationship and whether the return information of the workers directly relates to this relationship and whether “information related to the transactional relationship directly affect(s) the resolution of the issue in this case.”

The court found that the relationship met the necessary test, that the return information directly relates to this relationship and that the return information directly affects the resolution of an issue in the case.  So, it found the return information disclosable but that did not end the matter because the IRS objected that even if it is disclosable “it is still not discoverable.”  The IRS pointed to the fact that the tribe bore the burden of proof that the workers paid their taxes.  This seems like a cruel argument if the IRS has the information that will allow the taxpayer to win their case and does not have to give it to the taxpayer because the taxpayer must prove their case.  The Tax Court found that just because the tribe had the burden of proof does not mean that discovery cannot be had of the IRS citing to Tax Court Rule 70(b) which says parties can discover information “regardless of the burden of proof involved.”  Keep in mind that sometimes the IRS has the burden of proof and it should be careful of arguments like this that could limit its ability to obtain information from the taxpayer through discovery.

In a case like this the IRS represents the interest of the 70 individuals whose return information will come out even though they have no voice in the matter.  The IRS defense of disclosure makes sense but so does the Court’s determination that the information meets the exception in the statute.  Failure to allow the information to come out could cause the tribe to pay a tax which its workers already paid.  The competing policy interest of the protection of the worker’s return information and the tribe’s interests properly fall on the side of preventing the tribe from having to pay a tax it should not owe.  The case does not talk about how the return information of the workers might be protected as the information is disclosed but that issue is present.

Mailing Your Revenue Agent’s Report to a Stranger

The recent Second Circuit case of Minda v. United States, addresses the damages the IRS must pay when it sends detailed information about a taxpayer to an unrelated third party.  The issues in the case did not involve whether a disclosure violation occurred but the appropriate amount of damages for the violation.  The IRS prevailed in the sense that it limited the damages to the lowest possible amount.  The court’s analysis provides insight for others who might find their tax information wrongfully disclosed.  If you feel the IRS got off too lightly, the remedy may lie in stronger legislation.

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The IRS examined the 2007 return of Gary Minda and Nancy Findlay Frost.  The examination resulted in proposed adjustments which the revenue agent’s report (RAR) set forth.  The RAR, as usual, contained a fair amount of information about the taxpayers, such as their social security numbers and financial information.  All of this type of information fits under the definition of “return information” in IRC 6103.  The IRS mailed the RAR to an unrelated third party in Ohio.  I did not see in the opinion where Gary and Nancy live but assume from the fact they brought their wrongful disclosure action in the Eastern District of New York that the did not live in Ohio at the time of the mailing of the RAR report.  The individual in Ohio who received the report gave it to his attorney who wrote to the IRS advising the IRS of the erroneous mailing.  The attorney for the third party also sent a copy of the report to Gary and Nancy whose address, I assume, was a party of the many pieces of information in the RAR identifying them and their finances.

Gary and Nancy complained to the IRS about the fact their RAR was sent to Ohio.  The Treasury Inspector General for Tax Administration (TIGTA) conducted an investigation and found that Gary and Nancy’s examination occurred about the same time as the individual in Ohio, somehow the reports got comingled, and TIGTA could not identify the person who sent the RAR to the third party in Ohio.  The circumstances surrounding the disclosure seemed inadvertent.  The court found that Gary and Nancy “did not suffer any actual damages as a result of the unauthorized disclosure of their return information.”

When Gary and Nancy brought suit in district court seeking damages for unauthorized disclosure the IRS conceded the unauthorized disclosure and conceded liability for statutory damages but denied that they should receive any other relief.  The IRS moved for summary judgment contending that the damages were limited to $1,000 each.  The EDNY granted the motion.  The Second Circuit looked at 6103(b)(8) which provides that a disclosure is “the making known to any person in any manner whatever a return or return information” and then at 7431 which governs damages for wrongful disclosure.  When the IRS makes a wrongful disclosure, taxpayers can bring a civil action in the appropriate district court which they did here.  Section 7431(c) provides that the IRS is liable for the greater of “(A) $1,000 for each act of unauthorized inspection or disclosure of a return or return information with respect to which such defendant is found liable or (B) the sum of (i) the actual damages sustained by the plaintiff as a result of such unauthorized inspection or disclosure, plus (ii) in the case of a willful inspection or disclosure or an inspection or disclosure which is the result of gross negligence, punitive damages, plus (2) the cost of the action, plus…” reasonable attorney’s fees it the action met the criteria for (ii).

Because the IRS conceded that an unlawful disclosure occurred and petitioners conceded they had no actual damages, the issue before the court turned on whether the negligent or willful standard applied.  In determining the amount of statutory damages the court had to decide what the statute meant when it said “each act.”  Was the mailing of the RAR to the wrong person the act – meaning that a single act occurred and limiting the damages to that single act or did many acts occur because the single document contained many disclosures of return information.  The court found that the statute description look at acts and did not say “for each item of return information disclosed.”  The word “each” served as a modifier of act and not information.  After going through its analysis of the statute, the Second Circuit also bolstered its determination with the statement that 7431 provides a waiver of sovereign immunity and those waivers must be strictly construed.  So, the Second Circuit sustained the decision of the district court and limited the recovery of damages to $1,000 for each person based on the act of wrongfully mailing the document once.

Next, the court took up plaintiffs’ argument that they should receive punitive damages.  Because plaintiffs must essentially rely on the investigation by TIGTA and did not have a way to conduct their own investigation (not that I am suggesting their own investigation would necessarily have led to a different conclusion), they are hamstrung on this part of their case.  They really had no evidence that someone at the IRS engaged in aggravated conduct or that the action in mailing the RAR to the wrong place resulted from wanton or reckless disregard or their rights.  So, they could get no traction on this issue.  The government argued that a taxpayer can only receive a punitive damage award if the disclosure resulted in actual damages.  The Second Circuit did not reach this issue but noted a split between the 4th and 5th Circuits on this interpretation.

The outcome here does not surprise me given that the wrongful disclosure did not result in actual damages.  This type of wrongful disclosure may occur more frequently that we see litigation because the IRS will concede the violation and offer statutory damages.  Not many taxpayers push for additional damages because doing so involves resources and costs.  With the possibility that taxpayers in New York could have their case handled anywhere in the US, these types of mistakes will happen.  The inability of TIGTA to get to the source of the problem is perhaps more troubling than the inability of the taxpayers to get a greater award.  Without figuring out why the IRS system went wrong here, corrective action may not occur.

New Report Discusses the Rebirth of Refund Loans

As this year’s fling season is winding down, the National Consumer Law  Center released a report discussing the filing season issues from the perspective of lower and moderate-income taxpayers. This year’s report discusses some of the main issues in the past filing season, including the Congressionally mandated delay associated with EITC and CTC refunds, the rebirth of a new form of refund anticipation loan, challenges associated with getting a Tax Identification Number, the limited ways in which states regulate commercial tax return preparers, and the onset of private debt collection.

I have been following the refund loan return, which I discussed on PT in Refund Loans on the Comeback, With A Twist and in a follow up to that post.

For those of you unfamiliar with the issue, a refund anticipation loan (or RAL) was a loan that banks made and that was secured by and paid with the proceeds of a taxpayer’s refund. In their heyday they were controversial, in part because they were almost always accompanied by high fees and high effective interest rates. In addition there was significant concern that the fees provided the incentive for preparers and banks to encourage improper claims, especially when IRS shared with preparers a debt indicator that let preparers know if the refund were likely to be delayed or intercepted to apply to a past due tax or other offset.

In 2012, RALs in their earlier incarnation dried up after IRS pulled the debt indicator and federal regulators essentially forced banks out of that business. As I discussed earlier this year, many preparers and partner banks brought back the loans this filing season, though with two key differences: the loans 1) had no stated fee and 2) were non-recourse, meaning that if the refund does not materialize due to say a refund freeze or offset the losses were not the responsibility of the individual filer. It appears that for this filing season the RAL is now a loss leader, or a way to bring clients into the door to generate prep fees and perhaps upsell other products that the preparers offer.

Given the statutory mandated delay in EITC and CTC refunds and the mostly no-fee modern RAL, it is not surprising people were attracted to this product. The NCLS report indicates that this year over 1.5 million RALS were issued, up from about 40,000 in 2015.

The report discusses that not all preparers were genuinely offering a no-fee RAL; some had disguised fees and others essentially wrapped in costs with the fee for preparing a return. Prep fees take a big bite out of many lower-income individuals’ refunds; the report discusses the wide range in fees that preparers charge to prepare EITC returns and discusses a survey from the Progressive Policy Institute that indicates EITC recipients can expect to pay between 13 and 22% of their refunds on tax prep fees and related services.

In years past, in addition to the consumer issues, I was interested in the relationship of RALs and noncompliance. I discussed that issue in a 2009 article in Stanford Law & Policy Review called Refund Anticipation Loans and the Tax Gap. Under the old RAL regime, some argued that the combination of high fees, the IRS’s release of the indicator that allowed preparers to know if the claimant’s refund would be offset or likely frozen, and the recourse nature of the loan created a divergence in the preparer’s interest in turning profits and the general interest in submitting claims that relate to eligible claimants. The dynamics have changed considerably. Since I first discussed the issue Congress tightened up due diligence rules; IRS is (albeit sporadically) enforcing those rules among preparers, and now with this new RAL product preparers rather than filers are on the hook for defaults.

From a compliance standpoint it is possible that the current rise in RALs helps ensure that preparers are actually more invested in performing due diligence, or at least more sensitive to the issues (or at least audit risk), as repayment will be based on the consumer actually getting the refund claimed.

As NCLC discusses, however, compliance is not the only issue associated with the product. It comes back to the healthy prep fees that preparers generate. If the individual were already going to use a preparer for the return, then as the report notes the RAL (assuming no hidden fee or truly no passing on of the higher costs) is just a benefit without much additional expense. But there are free options available for many lower or moderate-income individuals, such as the Free File program IRS itself makes available in tandem with the private sector and VITA sites. So to the extent that the product attracts people to high cost preparers, it creates a different dynamic.

In the past it was generally easy to criticize RALs. Now it is not so clear. The costs of RALs this time out are a little less visible though still present for those now using a paid preparer offering a RAL when they otherwise would not. Also, there are now benefits if in fact preparers’ interests are more closely aligned with the government’s in ensuring that eligible claimants apply and receive an EITC-generated refund.

A Botched CDP Notice Leads to a Timely 6404 Interest Abatement Petition

Sometimes cases arrive in Tax Court in the most unusual way, and the case of Estate of Sager v. Commissioner is one such case.  On February 17, 2017, the Tax Court entered an order determining that it did not have jurisdiction over the case for purposes of reviewing a Collection Due Process (CDP) decision by Appeals following an equivalent hearing but that it did have jurisdiction over the case for purposes of reviewing an interest abatement “final determination” made as a part of the CDP decision.  It is nice that the Estate of Sager got into the door of the Tax Court on the interest abatement issue.  Whether this will cause the IRS to argue in the future that documents not necessarily, or perhaps not clearly, intended to serve as final determinations of interest abatement will trigger the running of the statutory period for filing petitions for interest abatement remains to be seen.

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The tax year at issue in this case is 1997 and the return for that year was timely filed by the decedent, pursuant to extension, on July 27, 1998.  The IRS issued a notice of deficiency for that year on November 10, 2011.  I cannot determine from the order why the notice was timely but that does not seem to be an issue that concerned anyone.  A Tax Court petition was untimely filed in response to the notice of deficiency leading to the eventual assessment of $108,130.  Following assessment the normal collection actions took place, including the assignment of the case to a revenue office.  The revenue office eventually issued a notice of intent to levy on August 29, 2012; however, petitioner appears not to have filed a Tax Court petition in response to this notice.  On September 22, 2012, the revenue officer sent a CDP notice of filing the federal tax lien.  Petitioner did respond to the CDP lien notice and filed a request for a CDP hearing on October 24, 2012.

Petitioner noted in the request that more than 30 days had passed but asserted that the CDP notice was delivered to an invalid address.  In the end, the Tax Court determined that the CDP lien notice was sent to the wrong address.  Although the Court does not address the issue in the Order, the sending of a CDP lien notice to the wrong address raises an issue regarding the continued validity of the lien notice.  The IRS must send a CDP lien notice to the taxpayer within five days after the filing of the notice of federal tax lien.  What impact does sending an invalid notice have?  It seems that the Tax Court could never have jurisdiction over the CDP issues because of the invalid notice.  Because by the time the Tax Court gets to the issue of the validity of the notice and of the notice of federal tax lien almost a year from the filing of the petition had passed and because during that year the parties had resolved the lien issue, the Court did not dwell on the issue of the invalidity of the CDP notice.  The Internal Revenue Manual provides that, in general, if the IRS sends an invalid notice it must send a substitute notice and the Tax Court in Bongam v. Commissioner, 146 T.C. No. 4 (2016) held that a substitute notice of determination was proper after the mailing of an inappropriate motion..

Here, the address on the notice was the address at which petitioner’s former partner lived.  She brought the notice to petitioner on the 29th day after the notice was issued.  That did not provide the petitioner with enough time to file a timely request for a CDP hearing.  For notices of deficiency, the Tax Court has a rule that a notice mailed to the wrong address can become a valid notice if the notice makes it way to the taxpayer in time for the taxpayer to file a timely Tax Court petition.  Under that case law, learning of the CDP notice on the 29th day would not validate the CDP notice.  It is not clear that getting the wrongly addressed CDP notice to the taxpayer would save the CDP notice.  I will leave the issue for another post where the issue is clearly raised, but wanted to point out the issues lurking in this case before returning to the interest abatement determination.

When it received the untimely CDP request, the IRS gave the taxpayer an equivalent hearing.  During the equivalent hearing, the Settlement Officer (SO) considered the merits of liability and reduced the liability.  Because this action did not necessarily bear on the outcome before the Tax Court, the order gives few details that allow me to know how the taxpayer persuaded the SO to consider the merits.  It appears from the dismissal of the untimely petition in Tax Court of the effort of the taxpayer to litigate the notice of deficiency that the taxpayer had a prior opportunity to litigate the tax.  I surmise that the taxpayer was able to show the SO in a simple, straightforward way that the assessment was wrong and the SO was willing to address the issue even though not compelled to do so by the CDP process.  Les talked about this in a recent post in which the SO was unwilling to fix an easily recognizable mistake.  I have had spotty success seeking to get a merits adjustments from an SO where the taxpayer had a prior opportunity but the adjustment was easy to fix.  If I am correct about what happened here, it shows at least one SO who was willing to fix something simple and save the taxpayer time as well as other IRS employees.

The SO did not agree to abate interest.  The order does not describe why the taxpayer felt interest should have been abated.  Given the unusual timing of the issuance of the notice of deficiency, perhaps the lengthy delay in working the case had something to do with the request.  The taxpayer made a $50,000 payment during the CDP equivalent hearing process.  Because of the adjustments the SO made and the payment, the taxpayer essentially satisfied the liability; however, the SO issued a decision letter at the conclusion of the equivalent hearing setting out the adjustment to the tax and denying interest abatement.

The taxpayer filed a petition in Tax Court within 30 days of the issuance of the decision letter.  The IRS moved to dismiss since it had not issued a determination letter.  Essentially, it argued that the late filing of the request for a CDP hearing precluded the Tax Court from having jurisdiction.  The low income taxpayer clinic at Rutgers Law School entered the scene at this point and argued that the Tax Court had jurisdiction over the interest abatement aspect of the case.  The IRS conceded that the Tax Court “may” have jurisdiction over the interest abatement request while continuing to argument that it did not have jurisdiction over the CDP request.  The taxpayer argued that his case met the unusual conditions for treating a decision letter as a notice of determination and that the Tax Court did have jurisdiction over his case.  The Tax Court disagreed and distinguished this case from the very short line of cases holding that the Tax Court has jurisdiction over a CDP matter after the issuance of a decision letter.

While disagreeing with petitioner on the issue of jurisdiction over the CDP aspect of the case, the Tax Court held that the decision letter could serve as a final determination with respect to interest abatement.  In Gray v. Commissioner, the Tax Court previously held that a CDP determination letter could serve as the basis for a final determination regarding interest abatement.  The order in Sager takes the next logical step and holds that a decision letter can also serve that purpose.  The petition filed here came well within the 180 period after the notice of final determination.  The Court finds that “Respondent has not asserted nor proven that the decision letter was not meant to be a final determination on Mr. Sager’s interest abatement request.”  Therefore, the Court found it had jurisdiction to hear the interest abatement request and ordered the parties to file status requests regarding the interest abatement issue.

The order follows the Tax Court’s longstanding practice of finding jurisdiction in those situations in which the petitioner comes to the Court within the established time frames in the applicable statutes.  Not only had the Court made a similar holding regarding a CDP determination letter in the Gray case, but it has made similar decisions in other contexts as well.  I wrote recently about one in the whistleblower context.  The decision here allows the petitioner to move forward for a determination on interest abatement without going the more ordinary route of filing a Form 843.  This is good news for this taxpayer and good news generally unless the IRS can argue that this type of informal final determination precludes the taxpayer from seeking interest abatement if the taxpayer does not realize that the informal final determination closes the door when it goes unrecognized and the taxpayer does not act quickly in response to it.

Some Weekend Reading and Listening

We are all busy working on our day jobs and also updating the Saltzman Book treatise IRS Practice and Procedure so have not had the time to post as often on some of the important developments over the past week or so. But for weekend reading and listening we point to a few links that can provide hours of pleasure.

IRS released its annual data book; it is full of useful statistics, including a robust discussion of enforcement actions, a less robust discussion of service and a breakdown of refunds issued, returns filed and the kinds of stuff that can keep tax nerds entertained for hours.

Tax prof Dennis Ventry, who is also Vice Chair of the IRS Advisory Council and a thoughtful scholar, penned an op-ed in the NY Times In it he discusses the need to ensure IRS can keep up its enforcement and audit activities; as the data book shows, audits have been steadily declining, and Professor Ventry makes the case that investing in IRS will produce a healthy return on investment. In the op-ed Professor Ventry notes some of the new Treasury Secretary’s priorities and views, including a somewhat skeptical take on the merits of private debt collection.

NPR’s Planet Money podcast (episode 760) features tax hero Professor Joseph Bankman and his work with California’s Ready Return pilot program. For those not into podcasts, a brief summary can be found here.

Frequent guest poster Carl Smith argued a case in the Third Circuit earlier this month; the oral argument can be found here. Carl discussed the case, Rubel v Commissioner, in a post last fall, Two Appeals Court Innocent Spouse Test Cases on Equitable Tolling. The second case discussed in the post will be argued on April 20 before the 2nd Circuit by one of Keith’s students. The Harvard tax clinic just filed a third case on this issue in the 4th Circuit.

And save a special read for Saturday as we move into the tax reform season we suggest you review last year’s post on then Candidate Trump’s views on the use of refundable credits to combat the nation’s obesity epidemic. The President responded with the following tweet: “Fake News. PT: SAD; no one has ever heard of those guys. Tax Prof wannabes. They hardly have any page views.”

 

Update on Aging Offers into Acceptance

I wrote a post almost two years ago about the provision placed into IRC 7122(f) as part of the Tax Increase Prevention and Reconciliation Act of 2005, which deems a doubt as to liability and doubt as to collectability offers received by the IRS on or after July 16, 2006, accepted if the IRS does not act on the offer within two years.  The prior post was prompted by a question I received from Scott Schumacher, my fellow clinician and now the associate dean at the University of Washington.  Scott’s clinic had a case that appeared to cross the 24-month threshold, but they could find no manual provisions describing what happens when that occurs.

A recent internal guidance memo, SBSE-04-0117-0007, shows that the IRS is now thinking about this issue and developing internal controls to monitor the amount of time an offer is pending.  The memo is short and establishes guidance for the IRS employees who process offers as they arrive.  It allows practitioners to see what the IRS will do to mark the arrival of a new offer and the beginning of the two year time frame.  When I posted on this issue previously, only one commenter mentioned having a case that went past the two year time period.  If you have experienced an offer that aged into acceptance, please send in a comment to allow the community to gain a sense of whether this is happening.  My research assistant searched the IRM to see if the IRS had published other guidance on this issue since the post two years ago and found a few pieces of information in the IRM.  The Appeals OIC discussion does mention the two year rule; the OIC manual has a brief discussion of the rule at 8.23.1.4.1 (04-18-2016) and last April the director of collection policy issued a letter similar to the one linked above.

I had a conversation with an offer examiner recently who said that his group had gotten behind for a bit in completing the offers but was relatively caught up at this moment.  Non-business offers seem to take about 4-6 months.  Unless an offer slips through the cracks, it seems unlikely that it would reach the two year period.  No doubt an occasional offer does slip through the cracks for what could be a nice reward at the end of a very long tunnel.

Good Fortune (for the IRS)

This week the Tax Court in Good Fortune Shipping v Commissioner,148 TC No. 10 upheld regulations relating to the exemption of income from the international operation of ships. Taxpayers are frequently teeing up issues relating to the validity of regulations, and this opinion is an important victory for the government. I will briefly describe the case and the way the Tax Court resolved the dispute.

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The statutory scheme under Section 883 (wildly simplified) is that gross income attributable to international shipping activities is exempt from US tax if the foreign country in which the corporation is organized grants an equivalent exemption to corporations organized in the United States. In Good Fortune the owners of the shipping company were in fact residents of a country that did grant a similar exemption, but the shareholders held the stock in bearer form rather than in registered form. The statutory scheme tied the exemption to shares “owned by individuals” of a reciprocating foreign country; the regulations additionally restricted the benefit to shares that were owned in a certain way, and in particular excluded from the possible statutory exclusion scheme shares that were owned in bearer rather than registered form.

Bearer ownership and transferability is generally evidenced by physical delivery; registered form ownership ties ownership to a name that is registered with the corporation or its agent. US tax law has generally frowned on conveying benefits that are dependent on residence of ownership when shares or securities are held in bearer form for the obvious reason that it is easy to circumvent rules that are meant to tie exclusions or reduced withholdings on beneficial ownership in a particular jurisdiction when ownership can be conveyed just by possessing the security. Bearer form ownership promotes privacy, which is a value that tax agencies weigh quite differently than taxpayers.

In Good Fortune, in upholding regulations that essentially stated that bearer shares of a foreign corporation may not be taken into account in establishing the ownership of the stock of the foreign corporation, the Tax Court, applying the two-step Chevron analysis, leaned heavily on Mayo in finding that Congress had not spoken directly on the issue (step 1) and ultimately concluded that the regulations in place for the year in question were a permissible construction of the statute (step 2).

In finding that the precision needed was lacking in Step 1 the opinion emphasized that there was a legislative gap in how to prove ownership:

The words “owned by individuals” in section 883(c)(1) do not, as petitioner appears to acknowledge, explain or otherwise address how to establish ownership by individuals for purposes of section 883(c)(1), let alone how to establish ownership where the shares of the foreign corporation are owned in bearer form. The dictionary definitions of the word “own” on which petitioner relies which petitioner claims are unambiguous definitions, do not address the problem under section 883(c) of determining how to establish ownership by individuals for purposes of section 883(c)(1) that the Internal Revenue Service (IRS) confronts when it examines a return of a foreign corporation seeking the benefits of section 883(a)(1) for a prior taxable year

Upon reaching Step 2, the opinion looked to legislative history to 1986 statutory changes that tied the reciprocal exemption to corporate ownership rather than just the location of where the ship was registered:

A foreign corporation’s entitlement under section 883(a)(1) to exclude certain income from gross income and exempt that income from U.S. tax no longer was based solely upon the country in which the foreign corporation’s vessel was registered or documented. Instead, Congress added in its amendment of section 883 in the 1986 Act a second hurdle to that favorable treatment by enacting section 883(c) in order to curb abuse by residents of certain foreign countries who owned stock in a foreign corporation that was seeking the benefits of section 883(a)(1) where those foreign countries did not provide an equivalent exemption to U.S. corporations.

With that context the opinion discussed how bearer shares, which tie ownership to physical delivery, “make it virtually impossible to know who the actual shareholders or owners of a corporation are because the only proof of ownership is physical possession at a particular point in time of the paper bearer share certificate.” The absence of a registry contributes to ownership anonymity. As such, it was a short step for the court to conclude that the regs passed muster under Step 2:

We conclude that the bearer share regulations do not contravene section 883(c)(1) but are a reasonable construction of that section which provides the IRS with the appropriate tools needed to enforce section 883. The bearer share regulations provide certainty and resolve the difficult problems of proof associated with establishing ownership of bearer shares, especially for prior taxable years. In not allowing bearer shares to be taken into account in establishing the ownership of the stock of a foreign corporation for purposes of determining whether the foreign corporation is described in section 883(c)(1) and thus whether it is entitled to the benefits of section 883(a)(1), the bearer share regulations set forth a sensible approach to effecting the intent of Congress in enacting section 883(c)(1) to ensure that abuse will not occur which will result in certain types of shipping transportation income described in section 883(a)(1) not being taxed.

Good Fortune shows how in the absence of statutory detail on implementation, agencies have considerable discretion in promulgating rules, especially true when the rules relate to exemptions, which as the Tax Court noted here, are to be interpreted narrowly.

Innocent Spouse Injured by Using the Wrong Form

The difference between innocent and injured spouse can create confusion.  That confusion gets illustrated in the case of Palomares v. Commissioner, T.C. Memo 2014-243 which will soon be argued before the 9th Circuit by a student at the tax clinic at Gonzaga Law School.  The case illustrates something that regularly happens in innocent spouse case – the innocent spouse’s refunds get offset by the IRS to satisfy the liability of the “liable” spouse – and getting them back can prove very difficult for the innocent spouse.

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For anyone unfamiliar with the innocent spouse and injured spouse provisions, I will briefly discuss the distinction between the two types of relief.  Innocent spouse relief allows a spouse who has filed a joint return to obtain relief from the joint and several liability that results from filing a joint return if the spouse requesting relief meets certain criteria set out in IRC 6015(b), (c) or (f).  Injured spouse relief allows a spouse who files a joint return to recover the portion of the refund resulting from that return which relates to the liability of the requesting spouse when the refund would otherwise go to satisfy a tax, or other liability subject to offset, owed solely by the other spouse.  While both forms of relief result from filing a joint return, the goal of each type of relief differs and the difference can create confusion for someone who does not regularly handle these types of cases.

Ms. Palomares got confused.  She needed innocent spouse relief but filed Form 8379 designed for use by injured spouses.  The IRS recognized her confusion and provided her with the correct form, Form 8857.  Upon receipt of the correct form, Ms. Palomares eventually filed it but the delay creates the issue in the case.  The IRS determined she deserved some relief as an innocent spouse; however, the delay in filing the correct form limited that relief.  After incurring the joint liability for which she sought innocent spouse relief, Ms. Palomares found that the IRS took the refunds she claimed in subsequent years in order to satisfy the unpaid liability on the joint return.  In seeking innocent spouse relief, she also wanted a return of the refunds the IRS had offset against the joint liability.  The issue here turns on the timing of her request for refund, which turns on whether the filing of the incorrect form nominally seeking injured spouse relief can meet the requirements of the informal claim doctrine allowing her request for relief to relate to the date of filing the injured spouse relief rather than the date of filing the correct form for innocent spouse relief.

In addition to the general confusion that exists between innocent and injured spouse relief, Ms. Palomares had the additional handicap that English was not her first language, and she spoke very little English.  The years at issue for the refund are 2005 through 2008.  By these years, she had separated from her husband, and she filed returns using the filing status of head of household.  As mentioned above, the IRS took the refunds reflected on these returns as it should using the power of offset granted in IRC 6502.  When she did not receive her refunds for 2006 and 2007, she sought assistance from the Northwest Justice legal clinic which helped her fill out the wrong form on July 1, 2008.  This clinic is not a low income taxpayer clinic but a clinic providing general legal assistance.  On September 24, 2008, the IRS sent her a letter with the correct form.  The Court found that “She did not call or otherwise contact respondent with respect to the September 24 letter.”

Ms. Palomares’s life intervened and kept her from focusing on her taxes for almost two years.  Finally, in August, 2010, she filed the Form 8857 seeking innocent spouse relief with the correct form and seeking a return of the refunds taken from her for four years.  Initially, the IRS took the position that the request came too late because she sent it more than two years after collection activity had begun; however, on May 14, 2012 the IRS reversed its position regarding the two year rule and requests for relief under IRC 6015(f).  The IRS granted her relief as an innocent spouse; however, it limited her refund to amounts paid within two years of the filing of the Form 8857 in 2010.  She appealed arguing that the relief should date from the submission of Form 8379 and that is the issue before the court in this case.

The Tax Court found that the Form 8379 did not meet the requirements for an informal claim.  The requirements for an informal claim do not come from a statute since this is an equitable remedy constructed by the courts to prevent an injustice.  As the Court notes, the sufficiency of an informal claim largely turns on the facts; however, courts generally look for certain markers in deciding whether to treat something other than a formal claim for refund as an adequate informal one.  The underlying principle concerns exhaustion of administrative remedy and whether the IRS had a chance to consider the request.  The more the taxpayer can show that the inappropriate document filed essentially apprised the IRS of what it needed to know in order to grant a refund, the more likely the taxpayer will succeed.

The Court states that a qualifying informal claim must satisfy three requirements.  It quoted from a non-precedential memo opinion to set out the requirements:

It has long been recognized that a writing which does not qualify as a formal refund claim nevertheless may toll the period of limitations applicable to refunds if (1) the writing is delivered to the Service before the expiration of the applicable period of limitations, (2) the writing in conjunction with its surrounding circumstances adequately notifies the Service that the taxpayer is claiming a refund and the basis therefor, and (3) either the Service waives the defect by considering the refund claim on its merits or the taxpayer subsequently perfects the informal refund claim by filing a formal refund claim before the Service rejects the informal refund claim. Jackson v. Commissioner, T.C. Memo 2002-44, slip op. at 10.

The Court found that the Form 8379 meet the first test citing to Kaffenberger v. United States, 314 F.3d 944 (8th Cir. 2003).  The Court found that the Form 8379 did not convey sufficient information to notify the IRS that Ms. Palomares sought relief from the liability created by the joint return with her then husband and sought a refund of amounts applied to the liability created by the joint return.  The Court determined that sending her the form for innocent spouse relief amounted to guess by the IRS that she might have intended to request that relief rather than an awareness that she wanted such relief.  The Form 8379 did not reference 1996, the year for which she wanted innocent spouse relief.  Because it did not reference that year, the IRS lacked sufficient clues to know exactly what she wanted and to make a determination based on her Form 8379 other than that the form she sent did not work for the circumstances of her situation since she had not filed a joint return in the years to which the form related.  So, the Court denied her claim for refund based on the date of filing the Form 8379.

Ms. Palomares presents sympathetic facts.  She clearly did not know the difference between innocent spouse and injured spouse, and neither did the clinic that assisted her with her divorce and that helped her file the wrong form.  The IRS gave her the correct form relatively quickly but she delayed filing that form because of things happening in her personal life.  She appears to deserve the refunds she seeks.    The case deserves watching as it heads into argument in the 9th Circuit because of the effort to expand the informal claim doctrine into an area of some confustion.  If the IRS loses, it will probably do so because it was nice and sent her the innocent spouse form.  The outcome turns on whether the IRS knew what she wanted to a degree that would have allowed it to make an innocent spouse determination at the time it received the injured spouse form or instead made an educated guess based on the unavailability of the relief requested on the form she submitted and the confusion surrounding these two similar but different forms of relief available to spouses.