Faulty Information Returns: A New Frontier

We welcome back my colleague, Caleb Smith, in the Harvard Tax Clinic at the Legal Services Center.  Caleb has the misfortune to sit next to me and have me come over and regularly pose to him guest blog posts he might write.  In today’s post he linked up with Toby Merrill and our amazing colleagues at the Legal Services Center in the Predatory Lending Clinic who have a nationwide project going to assist individuals who fell prey to unscrupulous for profit colleges.  We hope that the Revenue Procedure issued by the IRS that Caleb discusses here might become a model for future rulings in similar circumstances.  Kudos to the IRS and Treasury for identifying and implementing a solution to a problem that could have created a lot of headaches for individuals who were already suffering from their student loan problems.  Keith

A lot has recently been said about the problems that arise when 1099s and other information returns are issued when they shouldn’t be. These earlier posts seemingly run the gamut of 1099 issues: from how to strategically defend against “phantom income” here to insight on how difficult it is to bring action against potentially malicious 1099 issuers (bottom of the post, here). The prior posts focus mostly on what to do when a 1099 was issued that shouldn’t have been. This post focuses on preventing the issuance of the 1099 in the first place.

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As a tax practitioner, it can be easy to lose sight of the forest for the trees. Generally, you work with an individual client to solve their individual tax problem. Sometimes, however, you can’t help but take note that your client’s problem is identical to a pool of other individuals: think, for example, of the Bank of America underreporting of mortgage interest covered here, here and here. The recently issued IRS Rev. Proc. 2017-24 is perhaps an even better example of a systemic fix for a problem that will affect thousands of individual clients. Among other things, it demonstrates the potential of collaboration between tax and disparate fields of law to reach an optimal outcome. For your reading pleasure, it also provides an opportunity to learn a bit more about the sometimes-sordid world of for-profit colleges.

Background of Rev. Proc. 2017-24

In early 2013, a for-profit vocational school called the American Career Institute (ACI) closed suddenly, shutting out thousands of students in Massachusetts and Maryland. Shortly thereafter, the company went into receivership, and the Massachusetts Attorney General sued the company and its principals. After more than two years of contentious litigation, the Attorney General reached a consent judgment with the school in which the corporate defendants admitted significant wrongdoing and violations of state law.

At the same time that the Commonwealth was litigating the case, the U.S. Department of Education was dealing with an influx of applications for loan discharges from borrowers who were cheated by for-profit schools, especially the defunct Corinthian Colleges. Under federal law and the terms of all federal student loan master promissory notes, federal student loan borrowers are entitled to assert such “defenses to repayment” of their federal student loans when their schools violate their rights under state law.

The Department of Education eventually made a finding that certain subsets of former Corinthian Colleges students are presumptively entitled to have their loans discharged under this provision, and invited those borrowers to submit applications for discharge. Before the first discharges were granted or announced, advocates raised the issue with the Departments of Education and Treasury.

This advocacy helped result in the IRS issuing Rev. Proc. 2015-57, in which the IRS held that borrowers with federal loans taken out to attend ACI or Corinthian would not have income upon those loans cancellation. Rev. Proc. 2015-57 was a big win for taxpayers, but didn’t go quite as far as Rev. Proc. 2017-24…

What Rev. Proc. 2017-24 Does

Rev. Proc. 2017-24 essentially says three things: (1) “ACI/Corinthian students, completely disregard your cancelled student loans, (2) also, we want to avoid a bunch of other problems so don’t worry about things like potential ‘tax benefit rule’ issues on having taken education credits in the past, and most importantly (3) Creditor, you don’t have to report the cancelled debt under 6050P -so don’t bother issuing a 1099-C.”  The first two directives are pretty much already handled in Rev. Proc. 2015-57. It is the final point that addresses the most obvious problem that the IRS (and practitioners) could see looming on the horizon.

Without Rev. Proc. 2017-24 there is the serious risk that creditors would issue 1099-Cs to former students of Corinthian or ACI even though most of those students wouldn’t have discharge of indebtedness income under the disputed debt doctrine. The creditor would have impetus to avoid potential IRC § 6050P compliance problems by erring on the side of issuing 1099-Cs. This in turn would create an information reporting nightmare. To the IRS computers, it would look as if former students simply forgot to report the 1099-C on their returns. In fact, under the disputed debt doctrine there is no streamlined “form” for the former student to file “showing their work” as to why they did not include the 1099-C on their return (as they could on Form 982 for the insolvency exclusion). At best the taxpayer could attach a Form 8275 disclosure statement to their return explaining their disputed debt doctrine position. I have my doubts that this would ever be done. (As a side-note, low-income taxpayers seeking free tax assistance through VITA cannot file Form 982 for insolvency and very likely cannot file Form 8275, as it is “out-of-scope” of the VITA guidelines.)

But there is another issue that the IRS seems to acknowledge, albeit indirectly. After detailing the defense to repayment argument as a reason much of the debt wouldn’t be taxable, the IRS casually drops one more reason why much of the cancelled debt shouldn’t be included in income: the insolvency exclusion (see Section 2.03 of Rev. Proc. 2017-24). The IRS doesn’t say why it has reason to believe many of these individuals are insolvent (I don’t doubt that many are). It is just one more potential reason listed as to why we should treat ALL of the affected individuals as not having cancellation of debt income. Since the insolvency exclusion requires a reduction of tax attributes (and therefore properly requires a step beyond just “not reporting” the cancelled debt as income, see IRC § 108(b)), I think the IRS is actually mentioning insolvency for a different reason. Namely, that the IRS recognizes that many of these individuals would be very hard to collect from in the first place. And although it might seem unfair to administer assessment of tax based on collection criteria, to an extent this already happens all the time. Collectability is already cited as a factor in determining whether to pursue an examination of a taxpayer (see IRM 4.20.1.2). Treating collectability as a factor in the exam stage (which can be thought of, in a sense, as the assessment phase) is even cited with approval by TIGTA, as covered by Procedurally Taxing here.

The New Normal: Why Collectability and Efficiency Matters

The quote “an ounce of prevention is worth a pound of cure” is attributed to the great American statesman Ben Franklin. Given current budget issues, it could serve just as well as the IRS guiding principle.  Think of the downstream costs without Rev. Proc. 2017-24. Thousands of taxpayers, generally low-income and with the least access to competent tax advisors, would receive 1099s. My bet is that many would ignore them when they filed their returns. This, in turn, would lead to a flurry of activity from the Automated Under-Reporter function of the IRS, leading to the usual split of taxpayers that respond to the notices and those that do nothing until their paychecks are on the verge of getting levied. Those that wait to respond would, most likely, have an excellent argument on the merits that they shouldn’t have cancelled debt income… but good luck finding a venue to make that argument in the collection stage. Instead, out of expediency, many of these individuals would likely look to (and be eligible for) collection alternatives. The outcome? Skewed tax rolls, about an extra billion trees chopped down for IRS notices, and little to no more money taken in by the Treasury.

Of course, the IRS shouldn’t make decisions purely out of administrative efficiency concerns: the proper application of the tax law should govern. But where both equity and the law bend strongly towards broad strokes (that just so happen to carry significant efficiency gains as well), I for one find it hard to work up too much moral outrage. (A similar example can be found in the IRS administration of the PATH Act ITIN expiration statutes. The law plainly says all pre-2008 ITINs expire January 1, 2017 (See IRC 6109(i)(3)(c). The IRS plainly says (at page 5) all ITINs with 78 or 79 as the middle digit expire January 1, 2017… but that’s it. Don’t worry if your ITIN was actually issued before 2008, as it would be a nightmare to track those all down.)

And this leads to the final point: that the “new normal” of an under-funded IRS may provide greater opportunity for systemic advocacy and innovative alternatives to the usual procedures. As a recently publicized example, one may consider the educational letters sent out by TAS to EITC recipients that likely over-claimed their credit but weren’t audited. The IRS may have a greater appetite for a Rev. Proc. 2017-24 type solution when the argument is advanced that, on the whole, tax administration is better served by painting with a broad brush. Cancelled debts stemming from lawsuits are not the only area where this approach is being taken. But seeing where these opportunities are, and effectively advocating for them, requires collaboration and an eye to the non-tax world.

If nothing else, the value of Rev. Proc. 2017-24 may be as a reminder to tax practitioners on the value of stepping outside of the tax bubble (or even just noticing that you may be in one).

Form 2848: The First Hurdle

Today we welcome back guest blogger Caleb Smith.  Caleb is a fellow this year in the Harvard Federal Tax Clinic.  We have seen some interesting power of attorney issues in our clinic recently and Caleb provides some insight on problems that arise in this area.  Keith

The IRS is planning to implement new security measures (originally set for October 24 target date, but since pushed back) for its online services. In anticipation of these changes (and potential complications) it seems timely to devote some thought to one particularly important gateway for information gathering activities with the IRS: the Form 2848.

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Sometimes you just can’t avoid calling a general number of the IRS, especially if the 2848 hasn’t been processed by CAF yet or when there is an ID Theft Indicator on the account. When contacting such a call center, one of the first questions asked is whether you have POA on file for the entity you are calling about. The IRS employee will usually offer a personal fax number for you to send the 2848 (if you have one) so that they can continue to assist you. Once the 2848 is received what happens next can be downright Kafka-esque depending on the reticence and training of the IRS employee on the other line.

Recent calls to the IPSU unit of the IRS have yielded these Halloween-worthy responses:

1). We can’t speak to you because there is no signature from the taxpayer on your 2848. The signature you have is from the previous attorney [that was granted the power to substitute or add-in new representatives]

My charitable take on this is that the IRS employee was misunderstanding the core concept of the taxpayer granting their representative the power to substitute other attorneys. Who can sign a 2848 has been dealt with here before. The continued misunderstanding of certain IRS employees, unfortunately, is not an unusual occurrence for me. The idea that someone the taxpayer specifically said could substitute attorneys for them is now substituting an attorney for them somehow smacks of foul-play. In one instance, I directed an IRS employee to the 2848 instructions specifically stating that the taxpayer doesn’t need to sign the 2848 for a subbed-in representative. The IRS employee referred to that as a “loophole.” Further attempts to explain that requiring the taxpayer to sign my 2848 would obviate the whole point of granting representatives authority to substitute attorneys were fruitless. Perhaps I should have referred the employee to IRM 21.3.7.5.4, which reads in relevant part “Only the taxpayer can grant a recognized representative the additional authority to substitute or delegate authority. The notice of substitution or delegation must be signed by the representative appointed on the power of attorney.”

2). We can’t speak to you because a 2848 automatically expires after 45 days(!)

My charitable take on this is that the IRS employee was misunderstanding the rule that a 2848 is invalid if the taxpayer signature is dated more than 45 days before the representative’s (See IRM 21.3.7.5.1.4). As that wasn’t the case, my less charitable take is that the IRS employee just wanted to cut the call short. I am inclined to this less charitable take in part because the employee only brought up the 2848 issue after already speaking to me for several minutes about the client in a case where the IRS behavior looked somewhat bad.

 

All of this is to say that if an IRS employee wants to challenge your Power of Attorney they can put up a pretty big and pretty immediate roadblock. Yes, you can call back and almost certainly get a different person on the phone, but wait-times often make that impractical. During a recent visit from our local taxpayer advocate, our clinic (Harvard Legal Services Center) voiced concern about IRS employees that didn’t seem to understand how Form 2848 works and the barrier this caused for providing services. When such problems arise we were advised to request to be escalated to the employee’s manager, and that TAS would look into making sure that employees were well trained on 2848 issues. This is about as good as can be hoped for, but I’m not sure it is enough to provide a whole lot of relief. (A few weeks after that advice I attempted to put it into action and asked to be escalated to the manager on two separate occasions. On the first one, I was cut off after being put on hold. On the second, I was told (after being put on hold) that the manager wasn’t available.)

Of course, much of this can be avoided if your 2848 is on file with CAF, in which case, the main hurdle is submitting a 2848 that will be accepted and processed in the first place. Though this seems like it should be a fairly easy task (and generally it is), complications do arise.

Most recently, I’ve seen 2848s rejected for:

  1. Appearing to have a “stamp or electronic” signature of the representative (it wasn’t: it just looked that way because the form had been faxed so many times). See IRM 21.3.7.5.1.4.
  2. Having the taxpayer signature dated more than 45 days before the representative’s (it was, but only because the client signed with the wrong year) IRM 21.3.7.5.1.4 again. Note that the problem doesn’t arise if the taxpayer’s signature is more current than the representative’s.
  3. Form was illegible (a product of the Form 2848 being faxed multiple times, and perhaps my poor penmanship)
  4. Student Authorization Form missing for LITC Student Attorney (These generally result only in the student being unable to call the IRS: as an attorney, my authorization has generally still been processed.)

The first time I ever submitted a Form 2848 I was under the impression that the CAF fax basically fed into an enormous scan-tron type machine that checked for initial processing requirements. My belief in that was based (1) on the sheer volume of 2848s that must be sent and (2) the fact that the Treasury Regulations provide that a substitute for Form 2848 can be used (problem for the scan-tron theory), but an actual 2848 must be attached if submitted to CAF (see Treas. Reg. 601.503(b)(2)). In fact, actual humans do process and input the Form 2848, although the number of these dedicated souls may not be sufficient for the task (see TAS report here). Beyond just taking the IRS’s word on this, other evidence of a human touch can be found in the handwritten “OK” marked next to certain areas and practically undecipherable scribbles marked next to others on 2848s that have been sent back to me from CAF.

One problem is obviously the turn-around time for figuring out whether CAF is going to process the 2848 sent. Usually, the practitioner has no way of knowing the 2848 isn’t processed until either (1) weeks pass and they are still unable to access accounts via e-services, or (2) the taxpayer receives a letter from the IRS mentioning the unprocessed 2848 (a letter which also generally serves to freak out the taxpayer). Might this be an area for the IRS “Future State” (see post on Future State here) to bring in a greater degree of automation to speed up the process? On the one hand, the sensitive data at play may warrant keeping a greater human touch. On the other hand, I’m not really sure how humans do much of anything to prevent ID theft in this context: I am fairly confident that the person at CAF isn’t comparing signatures of the taxpayer and representative to a signature database.

Another problem has less to do with the time it takes to process the 2848, and more to do with the actual processing. I have seen numerous rejection notices for 2848s supposedly lacking the proper student authorization page, when it appears from the fax records that such authorization was in fact sent. Several comments on the ABA LITC listserv have also mentioned this issue. One commenter suggested creating a “2848 Sandwich” with the student authorization page placed between page 1 and 2 of the 2848, the rationale being that it is much harder to miss the authorization page in those circumstances. I have never tried this, and cannot vouch for its efficacy, but am always a fan of creative solutions.

One area that I HAVE had experience with and can vouch is in submitting Form 2848 as a substitute representative for the original attorney of the taxpayer. As mentioned above, a taxpayer may grant their attorney the power to substitute or add representatives (see line 5a of Form 2848). Doing so, obviously, gets rid of the need for the taxpayer to sign a new 2848 for the substituted representative. The instructions (and logic) make this clear: the new attorney “can send in a new Form 2848 with a copy of the Form 2848 you [the taxpayer] are now signing, and you do not need to sign the new Form 2848.” [emphasis added.] Reading the instructions literally, one might think that all the new attorney need do is fill out a new 2848 and include a copy of the old one with it. But IRM 21.3.7.5.4 requires a little more. For CAF to process the new 2848 you will need to send (1) the original 2848 signed by the taxpayer, and (2) a new 2848 signed by the original attorney. I usually have the original attorney sign on line 7 along with listing their CAF number. I have not found anywhere in the IRM that says this is the proper way to include the signature of the appointing attorney. But it has worked with CAF, and that is good enough for me.

When you need to speak with someone at the IRS about a client and the validity of your power of attorney is put at issue, you are essentially confronted with a brick wall. Systemic changes to how 2848s are processed by the IRS may be ideal, but in the absence of that practitioners are generally left with trading war-stories and tricks-of-the-trade. I invite anyone with such advice or stories to post below.

 

 

On Offsets and Posted Dates

We welcome guest blogger Caleb Smith.  Caleb has worked on tax returns and tax transcript issues for several years.  Before law school he worked for Prepare and Prosper as a Tax Program Manager for their VITA program.  At Lewis and Clark Law School he participated in the excellent low income taxpayer clinic there run by my former colleague, Jan Pierce.  Most recently Caleb has been working at Mid-Minnesota Legal Aid in their tax clinic.  Next month he will join me as the new fellow at the Harvard Tax Clinic.  Keith

When is an offset not a § 6402 offset? After the recent Tax Court memorandum opinion, Luque v. Commissioner, the answer seems to be only “when the offset didn’t actually happen.” And because of the nearly wholesale prohibition on Tax Court review of § 6402 offsets codified at § 6512(b)(4), checking to see if the offset actually happened is about as far as the court will go. The opinion serves as an illustration of the pitfalls many taxpayers face in getting to court, while also offering a look into the arcana of IRS transcript posted dates. Indeed, this latter endeavor appears to be the main objective of Judge Halpern in issuing the opinion.

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The facts of the case are fairly commonplace: taxpayer files a 2011 return showing a refund and the refund is credited in its entirety against a 2009 tax liability. In this instance, after the refund was credited the IRS issued a NOD for 2011, thus allowing the taxpayer into Court to argue (1) that the offset did not arise under § 6402 and (2), even if it did, the offset never actually was credited to 2009.

Prior to issuing the opinion the Court had essentially dashed the hopes that the liability giving rise to the offset, the 2009 liability, could be reviewed (i.e. didn’t arise under § 6402) in an earlier court order. It could be noted that the judge issuing the opinion, Judge Halpern, has been involved with previous cases questioning what is and is not an offset (found here with more insight on the matter provided by the First Circuit in appeal found here). But even though the Tax Court cannot “restrain or review” a § 6402 offset by examining if the taxpayer really owes the taxes being paid through the offset under § 6512(b)(4), Judge Halpern noted that it can look to see if the offset actually happened.

As this is usually a fairly straightforward inquiry (either the taxpayer had funds credited to a prior year or they didn’t), the import of the opinion seems to be elsewhere. Indeed, what appears to motivate the Court was the educational opportunity for tax practitioners in better understanding how IRS official records work. Judge Halpern almost explicitly acknowledges this rationale:

“On March 29, 2016, we issued an order concerning the motions in which we addressed and rejected petitioners’ jurisdictional argument. We, did not, however, dispose of the motions. Instead, we ordered respondent to address seeming anomalies between his representations and entries on the official records he submitted in support of his motion. Because there may be general interest in respondent’s reconciliation of those seeming anomalies […] we use this opportunity to make that reconciliation public.” [Emphasis added.] Luque at *3 – 4.

I’ll admit that as someone who frequently pores over IRS transcripts I counted myself as an enthusiastic member of the “general interest” Judge Halpern referred to. And yet, after reading the opinion, I couldn’t help but feel that the more important aspects of the decision remained elsewhere. But more on that later.

My naïve hope was that the opinion would give more insight on the meaning of IRS transaction codes. In my experience, the codes can be extraordinarily misleading or arbitrary. As one example, the notation “additional tax assessed” often does not mean that additional (i.e. “more”) tax was assessed, or even that any assessment action took place at that time. I have had one IRS employee tell me over the phone that the “additional tax assessed” transaction code is sometimes used as a “placeholder” just to show that some action was taken on the account… even where clearly no assessment action took place because the ASED had run years ago and the balance continued to show $0. The mind fairly boggles.

The opinion did not much address such things. However, if you are looking for insight on posted dates and cycle numbers you are in luck. I won’t spoil you with the mechanics (some may say, minutia) of their complete inner workings. You can read that for yourself at pages *12 – 14. I will, however, provide the general take-away points.

First of all, a “posted date” is the effective date of the transaction, which is either the actual date the transaction processing was finalized or the date it is deemed to have occurred by law (like withholding always being credited as paid on the last day to timely file). Meanwhile, a “cycle number” pertains to the dates the IRS actually processed the transaction. In the transcripts that are readily available to taxpayers and practitioners, the “cycle number” field is often left blank. This has never bothered me much because on the account transcript alone the cycle number is mostly useless: it leads off with a year (e.g. 2012) and ends with a number that appears to mean nothing. In Luque, for example, the cycle number was 201219, which corresponded to transactions taking place in 2012 over the month of… May. The 19, as far as I can tell, only has meaning if you have access to an IRS list of 2012 cycle numbers with their corresponding dates, as the IRS Appeals Officer does. With access to that list, you can then glean when the transaction was actually processed by the IRS: a three-step procedure concluding, in most cases, with the effective “posting date” (see above) unless there is an otherwise designated effective date.

This is all to say that cycle numbers are unlikely to matter much unless you are playing a game of inches (likely in a statute of limitations scenario). It also serves as a reminder that the law has numerous artificial constructs for when something is deemed to have actually taken place (like when you are deemed to have paid in withholding). Reconciling anomalies in these dates on the IRS records (when the return was filed, when the return was processed, and when the withholding was credited) was the reason the Court felt the matter was not resolved simply by saying “it was a § 6402 offset, and we have no jurisdiction to review those.”

Yet I am actually not convinced that the timing matters so much as to warrant much inquiry in this case. If the IRS can show that the 2009 liability on the books is $4,223 less (the amount of the 2011 credit), can a slight discrepancy in dates really do so much as to call into question if an offset actually occurred at all? Judge Halpern almost acknowledges as much, stating “Although the question of whether the overpayment reported on petitioners’ 2011 return was credited to their 2009 account is more important than precisely when that credit was allowed, the ambiguity in the dates […] called into question the reliability of the respondent’s certifications as evidence that the credit was, in fact, allowed.” Luque at *9. [Emphasis in original.] Of course, the exact date matters quite a bit if the liability causing the offset may have had the CSED run (or if the date to file a refund claim is close). But those issues both involve investigating the propriety of the offset: something § 6412(b)(4) does not allow. The date the offset occurred is essentially moot as far as the Tax Court should be concerned. It may matter, but it would presumably be litigated in a refund suit in district court.

And there, I think, is the lesson behind the opinion: what would be the victory to the taxpayer if the Court found the records so shoddy as to hold that an offset didn’t occur? I imagine the Court could find that the taxpayer is due that amount… which the IRS could promptly credit as an offset. For the Tax Court to do anything else (that is, compel the IRS not to offset) would be a violation of both § 6512(b)(4) and § 6402 since the choice to offset is committed to the IRS’s discretion. Thus, as Judge Halpern intimated, the greater point of the opinion may well be the education of taxpayers and (more likely) practitioners on the mysteries of IRS transcripts such that the issue can be resolved administratively when errors do arise. Failure to actually credit an offset certainly seems to be in the province of TAS, and a tax practitioner is better able to see when such errors arise (or don’t arise) if they have greater knowledge of the transcripts showing them. Indeed, in most cases it is doubtful that the Tax Court will even be able to review if an offset occurred: Luque was fortuitous in that both offset and NOD (i.e. ticket to tax court) occurred for the same tax year.

And that, in turn, allows us to close on what I believe to be the most important point is lurking behind this all: the difficulties of getting to court at all if you are low-income seeking to challenge an ancient, but sizeable, tax debt. Under § 6512(b)(4) when an offset occurs, the taxpayer better look elsewhere than Tax Court to challenge the propriety of the offset. That “elsewhere” is a refund action in federal district court. At least, it ought to be. The restrictions of Flora’s full-pay rule (discussed, among other times, here and here) and § 6512(b)(4) means that when a taxpayer has a substantial past tax debt that current year refunds will never full pay, the taxpayer can pretty much count on losing a refund they may desperately need for the foreseeable future. (Practitioners, of course, should be aware that the IRS offset for past federal income taxes is discretionary, and would do well to acquaint themselves with Offset-Bypass Procedures, discussed here in cases where the taxpayer is suffering hardship.)

Thus, under Flora and § 6512(b)(4), an offset applied to what may well be an inflated underlying liability will continue to haunt the taxpayer with little chance for judicial review. In such situations, the law seems to give short shrift to the right of the taxpayer to “pay no more than the correct amount.” The statutes as written give the Tax Court no power other than to ensure that at least the offset is properly credited to the earlier year… or give us practitioners the tools to read the transcripts and determine exactly when that happened for ourselves.