Damages for Lost Tax Documents = Refund Claim?

We welcome back guest blogger Sarah Lora, Supervising Attorney of the Statewide Tax Project of Legal Aid Services of Oregon. Today Sarah (with the help of 3L Katelynn Clements of Lewis and Clark Law School) examines a recent federal district court decision from Colorado. She argues that the court wrongly categorized a tort claim against the Transportation Security Administration as a tax refund claim, and so should not have dismissed the case for lack of jurisdiction. As we have discussed before on PT, the prerequisites to a successful tax refund suit are insurmountable for many taxpayers. Sarah points out that the taxpayer here may actually have a chance with the IRS. The record does not tell us if he’s tried that route yet. Christine

If the TSA removes from luggage and negligently misplaces tax papers that are essential to prove your claim for refund, sorry friend, you are out of luck. This, according to the federal district court in Schlieker v. Transportation Safety Administration, is the state of the law.

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On February 17, 2016, Mr. John Schlieker flew from Phoenix to Denver on Southwest Airlines. According to his complaint and documents attached to it, Mr. Schlieker checked luggage that contained “a multitude of green hanging files containing manila folders filled with documenting receipts, paperwork, check registers, charitable contribution receipts, medical and dental receipts, property interest confirmation; all the things needed to appropriately file [his 2015] tax return.” When he arrived in Denver, instead of those documents, Mr. Schlieker found a TSA notice of bag inspection stating that his bag “was among those selected for physical inspection.”

On May 19, 2016, Mr. Schlieker filed a claim for damage with the TSA for $5,000, representing the amount of refund he estimated he could have obtained had the TSA not misplaced his papers. TSA sent Mr. Schlieker a letter on December 1, 2016 denying his claim “after careful evaluation of all the evidence” and directing him to file a lawsuit in U.S. District Court if he was dissatisfied with the denial. Mr. Schlieker was dissatisfied. He then filed a lawsuit in the U.S. District Court for the District of Colorado against the TSA under the Federal Tort Claims Act for $5,000.

The court dismissed the lawsuit holding it lacked subject matter jurisdiction because Mr. Schlieker did not claim the refund with the IRS first. Assuming that the allegations in his complaint are true, as the law requires when considering a motion to dismiss, the papers that the TSA lost were necessary to file a claim for refund. Mr. Schlieker stated in his complaint that he could not “completely, honestly, and truthfully” sign a return claiming the refund without the papers the TSA took. How could he file a claim for tax refund when the TSA took the very documents he needed to assert the claim?

Mr. Shlieker’s actions are not unique. In many cases, even for sole proprietorships, a taxpayer may not keep any “books” detailing their profits, losses, or expenses. Instead, the taxpayer will save receipts and other records throughout the year which they then give to their tax preparer every April. This is not ideal, but it happens routinely.

Citing I.R.C. § 7422(a) and a long list of cases dismissing suits based on that statute, the court reasoned that Mr. Schlieker’s lawsuit was really a claim for a tax refund and should therefore be dismissed. The statute reads:

No suit or proceeding shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected . . . or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Secretary [of the Treasury], according to the provisions of law in that regard, and the regulations of the Secretary established in pursuance thereof.

The cases the court cites, which cite this statute as the reason for their decision to dismiss, fall into two inapposite categories. The first are cases in which a third party, either an employer or an airline, is acting as an agent of the IRS to collect and pay over taxes. In those cases, the courts have held that § 7422(a) protects those agents, who are required by statute to collect taxes for the government under threat of criminal penalty for failure to do so, from civil lawsuits relating to the collection of those taxes. Sigmon v. Southwest Airlines (dismissing class action against Southwest for improperly charging excise taxes to passengers); see also Kaucky v. Southwest Airlines (same); Chalfin v. St. Joseph’s Healthcare Sys. (dismissing case against employer who improperly withheld FICA from medical residents working at a hospital).

In Mr. Schlieker’s case, the TSA was not acting as an agent of the IRS to collect and pay over taxes. It did not confiscate Mr. Schlieker’s documents in order to perform some duty it believed it owed to the IRS. Assuming the allegations in the complaint are true, the TSA committed a tort, plain and simple, when it took Mr. Schlieker’s documents out of his luggage and did not return them. For that reason, those agency cases are not persuasive.

The second group of cases hold that plaintiff must timely exhaust administrative remedies, by filing a claim for refund, prior to filing suit for the refund of taxes. See United States v. Clintwood Elkhorn Mining Co; United States v. Dalm; Strategic Hous. Fin. Corp. v. United States. The court misses the mark with this line of cases as well. TSA, by means of tortious conduct, took the means for filing a claim for refund away from Mr. Schlieker. To require Mr. Schlieker to file a return without supporting documents violates the letter of IRC §7206(1):

any person who . . . [w]illfully makes and subscribes any return, statement or other document which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe true and correct as to every material matter . . . shall be guilty of a felony. . . .

In reality, even if Mr. Schlieker’s claim survived the initial motion to dismiss, he still might have lost or received only limited damages. In a case like this, TSA may argue that its seizure of the records was not the proximate cause of Mr. Schlieker’s loss. After all, with today’s technology, could he not have reconstructed his records well enough to file his tax return? Copies of bank records, dental and medical bills, mortgage interest paid, etc. are likely readily available online. I do not see much in the multitude of green hanging files that he could not replace with some headache and hassle. It is possible he could still get those documents and file his claim for refund before April 15, 2019. Perhaps the damages in a case like this should be measured by the cost to replace the documents, a reasonable estimate of the lost refund attributable to any irreplaceable documents, and perhaps any non-economic damages such as emotional distress.

Claiming Refunds for Veterans Where Disability Severance Pay Was Improperly Withheld

Today we welcome guest blogger Sarah Lora. Sarah has been the Supervising Attorney of the Statewide Tax Project of Legal Aid Services of Oregon since April 2016.  Prior to that that, she worked for 13 years as an attorney in Legal Aid’s Farmworker Program where she concentrated her practice on employment litigation and tax controversy. Sarah is also a vice-chair of the pro bono and tax clinics committee of the ABA Tax Section. At the most recent Tax Section meeting she participated in a panel presenting on the issue of obtaining tax refunds for veterans. The blog has previously brought attention to the special extended time frame for filing refund claims by exonerees, here and here. In a similar fashion to exonerees, who needed to file refund claims long after the normal statute of limitations had expired, many veterans face the same issue because of a mistake by the Department of Defense that went unnoticed. Sarah explains the problem and the efforts being made to assist veterans in getting back the money they overpaid to the Treasury. With exonerees the need was for people to assist in filing the claims. For the veterans, perhaps the biggest need is identifying the individuals entitled to the refunds. While the Department of Defense is seeking to notify the veterans, it has lost contact with many of the individuals. Keith

Over 130,000 veterans have the right to a refund of over $717 million. So far only 26,000 have made claims and the time period for making claims for many of those veterans in nearly over. The NTA blogged about this issue last November here. In this post I will summarize the issues discussed by the NTA, as we seek to reach all affected taxpayers, and to provide resources for outreach efforts.

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Summary of Issue: Since 1991 the Department of Defense has been improperly withholding federal income taxes and issuing information returns for disability severance payments, also known as “DSP.” A DSP is a one-time lump sum payment made to service members separated due to medical disability. DOD’s withholding of federal income taxes from DSP was improper because the payments are excluded from income under Section 104(a)(4). See St. Clair v. United States. According to the IRS, the DOD improperly withheld approximately $717 million from over 130,000 veterans. These numbers would be higher if they included veterans who served in the military reserves.

To recoup the wrongfully withheld funds, veterans must file an amended tax return with the IRS. However, many taxpayers missed the 3-year deadline for claims for refund under Section 6511(a). To remedy this, Congress passed a law called the Combat-Injured Veterans Tax Fairness Act in 2016, which allows veterans to file an amended return within 1 year after the Department of Defense provides the taxpayer with a letter describing their right to a refund of improperly withheld amounts. As of October 2018, according to TAS, 13,000 letters have been returned as undeliverable. The IRS has advised that the 1-year time period does not begin to run on undeliverable letters. According to TAS, as of October 26, 2018, only 26,000 of the 130,000 veterans had made refund claims for the improperly withheld taxes.

What You Can Do: Reach out to your community partners, veterans groups, and other allies to make sure we help all qualified veterans get the refunds they deserve. Some ideas: post information to your facebook page, send information to your community partners, set up a table at a Stand Down event in your area, or request to give a presentation at your local Purple Heart chapter.

Resources Available: The resources below, created by TAS, are available for dissemination.

For any readers who have already engaged in an effort to obtain refunds for these veterans, we welcome your comments on how the effort is going or your advice on how to make the effort more effective.

 

Trials and Tribulations in the ITIN Unit

We welcome first time guest blogger Sarah Lora. Sarah is a supervising attorney in Legal Aid Services of Oregon located in Portland, Oregon. She is also a vice chair of the ABA Tax Section Pro Bono and Low Income Taxpayer Committee. She represents a high percentage of immigrant taxpayers. Today, she discusses the problems encountered by one of her clients trying to file a proper tax return. The process led to frustration and points to the need for a system that allows clients to have a further hearing when things go wrong. She cites us to the Taxpayer Bill of Rights and to administrative law in her discussion of the search for a clear answer. Julie Preciado, Willamette Law School 2L, helped edit this piece. Keith

Our clinic represents a U.S. legal permanent resident who supports his teenage daughter who resides in Mexico. Our clinic helped the client file his 2015 return tax return. The client rightfully included his daughter as a dependent on the return. The daughter qualifies as a dependent under Section 151 of the code, except that she does not have a TIN as required by Section 151(e). To satisfy that requirement, we helped prepare the W-7 application pursuant to Section 6109(i)(1) with supporting documents of an original birth certificate and school record as allowed by the W-7 instructions. A few weeks passed and we received a notice that stated that the supporting documents submitted were insufficient, without further explanation.

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Regarding school records, the W-7 instructions state:

School records will be accepted only if they are for a school term ending no more than 12 months from the date of the Form W-7 application. The school record must consist of an official report card or transcript issued by the school or the equivalent of a Ministry of Education. The school record must also be signed by a school official or ministry official. The record must be dated and contain the student’s name, coursework with grades (unless under age 6), date of grading period(s) (unless under age 6), and school name and address.

I carefully reviewed the documents and the W-7 instructions and could find no problem with the birth certificate. The only discrepancy I could find with the school record is that it contained a grade point average, and not individual coursework. We submitted a detailed explanation as to why the documents substantially complied with the W-7 instructions. The rejection letter came shortly thereafter, again, without explanation. I started to feel like I had entered Dickens’ Office of Circumlocution.

I posted to the ABA listserv requesting feedback from my fellow practitioners about how to appeal a rejected W-7. All the responses were the same: you cannot. The only recourse is to file another application. However, if I do not understand why the ITIN unit rejected the original application, how can I hope to be successful in a second application? Furthermore, the education record had become stale because, according to the W-7 instructions, the records are only acceptable for 12 months from the end of the school term for which the record pertains. To file another W-7 would mean the time-consuming and arduous task of obtaining other documents from Mexico.

The Taxpayer Bill of Rights guarantees my client the right to: challenge the IRS’s position and be heard; appeal an IRS decision in an independent forum; and pay no more than the correct amount of tax. How could we appeal and where could my client be heard? Several weeks later, we received a math error notice stating that my client had erred in calculating the correct amount of tax because he was denied a dependent exemption due to lack of a valid tax identification number for his dependent. A light bulb went off. We could get to the issue of the wrongly denied ITIN by protesting the math error notice!

Section 6109(i)(1) authorizes the Secretary to issue an ITIN, “if the applicant submits an application, using such form as the Secretary may require and including the required documentation.” Section 6109(i)(2) defines required documentation to include “such documentation as the Secretary may require that proves the individual’s identity, foreign status, and residency.” The implementing regulation is found at Section 301.6109-1(b)(3) and states, in relevant part, that the applicant “must apply for [an ITIN] on form W-7.” An ITIN will be assigned to an individual on the basis of information reported on Form W-7 . . . and any such accompanying documentation that may be required by the Internal Revenue Service. An applicant for an [ITIN] must submit such documentary evidence as the Internal Revenue Service may prescribe in order to establish alien status and identity.

The regulation gives latitude to the IRS to prescribe the types of allowable documents. However, that latitude is limited by the APA. Judicial review under the APA allows a court to examine a final agency action, so long as it is not committed to agency discretion or otherwise precluded from review by statute. Section 706 requires that with respect to any agency action, a reviewing court must “hold unlawful and set aside agency action found to be,” among other things, “arbitrary, capricious, [or] an abuse of discretion.”

The arbitrary and capricious standard requires agencies to engage in reasoned decision making prior to issuing a determination. Motor Vehicle Mfr. Ass’n v. State Farm Auto Mut. Ins. Co., 463 U.S. 29, 52 (1983). Courts will invalidate agency determinations that fail to “examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choice made.” Id. at 43 (internal quotation omitted).

In this case, a reasonable person could make the argument that the denial of my client’s dependent’s ITIN application was arbitrary and capricious under State Farm because the IRS did not articulate a satisfactory explanation for its action, much less show a rational connection between a report card with “coursework and grades” and proving an applicant’s identity. Not only are the W-7 instructions raising barriers for the most vulnerable taxpayers by requiring “coursework” rather than grade point averages, a rational connection with a legitimate state interest is tangential at best. If fraud prevention in supporting documentation is the IRS’s objective, requiring report cards including “coursework with grades” is both under and over inclusive. It excludes more official government issued educational proof documents, such as the one my client submitted with a grade point average, and includes easily falsified commonplace progress reports. The ITIN unit is wrong to offer no explanation for its decisions that create confusion, frustration, and ultimately an inefficient process that wastes taxpayer resources.

Another possibly narrower argument against the ITIN unit’s actions in my case is that the ITIN unit’s interpretation of Treasury Reg. 301.6109-1(b)(3) is “plainly erroneous” as set in Auer v. Robbins, 519 U.S. 452, 461 (1997). Here the ITIN unit’s requirement for specific coursework versus a grade point average (if this is indeed the problem in my case) does not appear to be at all rationally related to the regulation’s requirement that the document show “alien status and identity.”

Creating opaque guidelines for the most vulnerable taxpayers is fundamentally unfair. Administrative agencies have a duty to the public to provide clear guidelines, tied to legitimate state interests. After all, Nina Olson has told us on many occasions that “[a]t their core, taxpayer rights are human rights.”