IRS Releases Update on Frequently Asked Questions Part 1

Last week the IRS issued a news release and fact sheet discussing its use of frequently asked questions. The IRS’s practice of using FAQs has been the subject of many Procedurally Taxing blog posts. This week we will run a series with different practitioners offering their perspective on the development. Today, we hear from frequent guest contributor Monte A. Jackel, Of Counsel at Leo Berwick. Les

In The Proper Role of FAQs, I discussed certain aspects of the use of FAQs in the tax system. I also wrote a short note in Tax Notes on the same topic at around the same time. See A Question of Two About FAQs (March 2, 2020).

The IRS very recently published an announcement on October 15, 2021 on the subject of FAQs, following up on its earlier promise to provide a more structured institutional approach to the use of FAQs in the federal tax system. See IRS Announcement On FAQs. A Tax Notes story on this announcement followed the next day. Tax Notes Story On FAQs. The announcement explains how the IRS plans to maintain information about when versions of FAQs have been released, as well as whether and how taxpayers can rely on those FAQs.

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As noted in the Tax Notes Story On FAQs, the announcement doesn’t go so far as to actually update the very much out of date accuracy related penalty regulations (particularly reg. sections 1.6662-4 and 1.6664-4), “but it does state that FAQs published in fact sheets will satisfy both the reasonable cause defense to tax penalties that allow it and can be part of a taxpayer’s assertion of substantial authority on a tax return. It also says that the FAQs and any resulting changes to them will be announced in news releases.”

I have a few questions about this FAQ announcement. First, does it matter that the pertinent regulatory list of authorities references “press releases” at reg. section 1.6662-4(d)(3)(iii), whereas this IRS announcement references those FAQs which can provide penalty protection as “news releases” that will incorporate the fact sheets published on IRS.gov? This should be clarified. However, it is believed that the two terms are intended to mean the same thing.

Second, the so-called “minimum legal justification” for tax shelters under reg. section 1.6664-4(f) requires the use of authorities at a MLTN basis as a minimum standard to establish reasonable cause and good faith when a tax shelter is involved. (The regulations expressly deal with corporate tax shelters because the statute was amended later on to apply to all tax shelters and the regulations do not reflect the statutory change.)

The extent to which this particular provision will be affected by the announcement is unclear given that a fact sheet FAQ issued in the future under the designated news release process could encompass a transaction that could be treated as a tax shelter under section 6662(d)(2)(C). This outdated regulation would have to control over the announcement and so, what now given that the term “tax shelter” as amended in 1997 remains undefined in the regulations to date.

Third, the disclaimer referenced in the announcement is only mandatory for the new FAQs (new legislation and emerging issues) but the reliance as reasonable cause and good faith, or as an authority, applies to all other FAQs, even those previously issued, but those other FAQs need not have a disclaimer. Why not?

Fourth. Why are the new FAQs (called fact sheet FAQs) limited expressly to new tax legislation with the possible expansion to so-called “emerging issues” (which is not a defined term)? It is understandable that new legislation would most often have a compelling need for immediate guidance but aren’t the chances for error on the part of the IRS equally great in this instance?

And what of the so-called “emerging issues”? Perhaps the thought there is that new topical and time pressure items can be showcased as a fact sheet FAQ because the IRS wants initial feedback on the approach it may want to later take in regulations and using FAQs in this manner could easily bypass the Administrative Procedure Act (APA)?

Speaking of the APA. There is currently a dispute in the Sixth Circuit Court of Appeals relating to two opposing district court opinions in that circuit on whether the APA requirement of advance notice and comment for legislative rules applies to IRS notices issued pursuant to regulations under section 6011 with respect to listed transactions. Update on CIC Services: The Scope of Relief Available if A Court Finds That An Agency’s Rulemaking Violates the APA

If the Sixth Circuit decides that such notices violate the APA, then even though it would just be one circuit, confusion would then surely resurface with respect to fact sheet FAQs.

Even though this announcement is not being issued pursuant to regulations granting such authority to the IRS, the question that arises is this; why shouldn’t that be done?  After all, we would not be talking about a long regulation to do this. Is the IRS worried about the result of an adverse Sixth Circuit opinion that would certainly carry over to FAQs?

We shall see.

IRS Violates Taxpayer Bill of Rights by Unilaterally Terminating Installment Agreements Entered into with Private Collection Agencies

On October 14, 2021, National Taxpayer Advocate Erin Collins posted a blog entitled The IRS and Private Collection Agencies:  Four Contracts Lapsed and Three New Ones Are in Place: What Does That Mean for Taxpayers?  The blog contains a number of interesting pieces of information about the Private Debt Collection program, but it also brings to mind many questions.

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I have written extensively about the IRS use of private debt collectors.  You can read a few highlights here and here and here.  By way of background, IRC § 6306 requires the IRS to “enter into one or more qualified collection contracts for the collection of all outstanding inactive tax receivables.”   An “inactive tax receivable” is a tax debt

  • that is removed from active inventory because of lack of resources or inability to locate the taxpayer;
  • that has not been assigned for collection to an IRS employee after two years from the date of assessment; or
  • that has been assigned for collection but more than one year has passed “without interaction with the taxpayer or a third party for purposes of furthering the collection of such receivable.”

There are exceptions to the required assignment, including where the taxpayer has income below 200% federal poverty level or is receiving Social Security disability or supplemental security income benefits.  Private debt collectors, under the contracts, are only allowed to locate and contact the taxpayer; ask for full payment or enter into an installment agreement (IA) for a period up to 7 years; or obtain financial information.

On September 22, 2021, the IRS announced that the four existing Private Collection Agency (PCA) contracts expired and it had issued three new contracts – two to “continuing” PCAs (CBE and ConServe) and one to a new PCA (Coast Professional).  Thus, the IRS did not continue contracting with Performant and Pioneer.  The NTA reports the immediate consequence of these contract terminations is that 1,255,541 accounts will be returned to the IRS, and Performant and Pioneer will send a letter to taxpayers who have payment agreements through these two PCAs , saying “we will no longer be collecting this debt on behalf of the IRS.”  (The NTA Blog quotes this language, so I am assuming this is the language in the letter.)

I understand why the IRS has to retrieve these taxpayer accounts from the discontinued PCAs – this is taxpayer and tax return information and with the discontinuation of the contract there is no exception under IRC § 6103 to share this information with those PCAs.  What I don’t understand is why the IRS terminated the streamlined IAs these taxpayers have entered into.  In all the years (decades) I have worked on the PCA program, at no point did anyone say that the agreement to pay was with the PCA; rather, the PCA was collecting on behalf of the IRS.  The PCA was acting as an agent of the IRS and entering into a payment arrangement by standing in the shoes of the IRS.  Thus, even if the agency relationship terminates, there is no basis for the underlying agreement to terminate.  Otherwise, there is no real agency at all if the principal can abrogate a contract just because of a substitution of agent.  Why would I, as a taxpayer, ever enter into an agreement with the agent/PCA if such were the case?   Here, the taxpayer hasn’t breached the Streamlined IA; in fact, the taxpayer has made arrangements to pay their tax debt; and now they are told, “Well, you thought your affairs were taken care of, but they aren’t.”  This is a violation of the taxpayer’s right to finality in the Taxpayer Bill of Rights and IRC § 7803(a)(3)(F).

Perhaps it is technologically difficult for the IRS to recall these accounts and then reissue them to the existing PCAs so the PCAs can continue to “service” the payment arrangements.  But that makes no sense.  In 2013, when the IRS terminated the second round of PCA usage (the first round was in the 1990s), the IRS recalled all of the accounts placed with the PCAs.  At that time it did not terminate any of the IAs that the PCAs had entered into “on behalf of the IRS.”  The IAs remained in force and the IRS continued to collect the payments.  So we know it is technologically possible for the IRS to recall accounts and continue servicing the existing IAs.

Why, then, would the IRS terminate the IAs?  Could it possibly be the IRS doesn’t want to spend any resources “servicing” these IAs?  It would rather have the PCAs do the monitoring and collect their 25% commissions and costs?  If that is the case, then maybe under IRC § 6306 the IRS needs to terminate the existing IAs in order to “assign” them to its new PCA agents.  It would be nice if the IRS would issue its legal opinion or other rationale for why this is so.  Regardless, it begs the question of why the IRS should assign a perfectly valid and performing IA to a new PCA.  Why isn’t the IRS retaining that IA and collecting the proceeds itself?  Recall that the IRS is able to retain 25% of collections by PCAs for its own “special compliance personnel;” and that PCAs can receive up to 25% of their collections for commissions and costs.  It appears the IRS would rather pocket 25% from these IAs itself, and send 25% to PCAs who had nothing to do with these IAs, than to pay over that 50% of collections to the Treasury General Fund.  The lack of an explanation for the decision to terminate the IAs is troubling, indeed, and as a taxpayers who are footing the bill for these payments, we deserve that explanation.

In fact, the NTA reports that through September 30, 2020, the IRS has assigned about $32 billion and 3.5 million accounts to PCAs since April, 2017, when the third PCA initiative began.  Since that time, PCAs have collected only 2 percent of the debt assigned to them (about $580 million).  The IRS, through its “special compliance personnel,” has collected about $345 million in non-PCA debt.  Further, the taxpayers voluntarily paid $43 million within 10 days of receiving a letter from the IRS saying their debt would be sent out to a PCA.  That is, for the price of a stamp (not 50% of the payments), the IRS collected $43 million within 10 days.  I will say this again, as I have been saying for about 20 years:  if the IRS sent monthly bills out to taxpayers like every other credit card company, revolving account, lender, insurance company, and landlord, it would regularly collect something on almost every past due account.  The IRS response to this usually is that it doesn’t have the resources to answer the phone calls that will come in response to the letters.  And my answer to that is to paraphrase former Commissioner Charles Rossotti: Why would you not pick up the phone when someone is calling to pay you money?

At any rate, since its inception the current PCA initiative has apparently collected about $969 million, or 3%, of the total $32 billion in inventory transferred to the PCAs.  Now, the IRS estimates that the gross underpayment tax gap for 2008 to 2010 was $39 billion.  A raw calculation shows PCAs are now holding 82% of the underpayment tax gap.  If we adjust for inflation, the $39 billion in gross underpayment tax gap from 2010 would be about $48.81 billion today, which means the PCAs are now holding about 65% of the underpayment tax gap inventory.  And they are only collecting 2% of that inventory.  All we have done, with the PCA program, is shift the IRS collection queue to the PCAs.  We have not reduced the collection queue in any meaningful way.

And now the IRS is burdening taxpayers who thought they had resolved their debts, including taxpayers who have entered into direct debit agreements to pay their installments.  The letter the terminated PCAs are sending out states, “…your payment arrangement and pre-authorized direct deposit payment schedule (if applicable) has ended, effective [date].  We encourage you to contact the Internal Revenue Service to resolve your account.” That assumes the taxpayer can get through to the IRS on the phone.  And, if the taxpayer does get through to the IRS and enters into the IA through the IRS, the taxpayer will be charged a user fee.  Taxpayers entering into IAs with PCAs aren’t charged a user fee.  (I don’t know how the IRS justifies that; I’d love to see the legal opinion on that one, too.)  At any rate, the taxpayer had an IA that didn’t include a user fee; the PCA/IRS cancelled it, and now to get another IA, the taxpayer has to pay a user fee.  Or, the taxpayer can wait and get sent back to a PCA.  Of course, by then additional interest and penalties accrue.

The NTA explains that if the IRS decides these recalled accounts still meet the PCA criteria, the TPs will be sent out to yet another PCA again, who will contact the taxpayer and try to get payment in full or enter into yet another installment agreement.  If I were a taxpayer who had entered into an IA with one PCA, and now I get another contact from another PCA, (1) I’d be really suspicious this was a scam; (2) I’d want to know why they couldn’t just re-enter me into the IA I had before; and (3) I’d want to know why they were creating this burden on me, since I had already entered into an IA.  Finally, the whole thing looks like the IRS doesn’t know what it is doing – contacting me to tell me the agreement is terminated and then contacting me to tell me I need to make payments and arrange another IA.

None of this bodes well for increasing trust in the IRS.

What should the IRS do to right this violation of the Taxpayer Bill of Rights?  Five things:

  1. Personally contact each of the taxpayers whose IAs through Pioneer/Performant have been terminated;
  2. Apologize profusely;
  3. Reinstate the IA and direct debit agreement (where applicable) waiving the user fee;
  4. Abate any penalty and interest that accrued between when the IA was terminated and the reinstatement; and
  5. Apologize profusely again.

Oh yes, and (6) stop treating taxpayers so cavalierly.

Update on CIC Services: The Scope of Relief Available if A Court Finds That An Agency’s Rulemaking Violates the APA

Following the Supreme Court decision in CIC Services, the matter was remanded back to the district court. Last month the district court granted CIC Services’ motion for preliminary injunction, finding that the Notice 2016-66 was a legislative rule and its issuance violates the notice-and-comment provisions of the APA.  Following CIC Services’ victory, however, it filed a motion to reconsider.

Why would CIC file a motion for reconsideration? Last month’s district court’s opinion narrowly enjoined the IRS from enforcing the Notice against CIC Services. In its motion, CIC Services has requested that the court broaden the relief and issue a national outright injunction that would prevent the IRS from enforcing it against anyone.

Readers may recall that in CIC Services: Now that AIA Issue Resolved, On to Some Meaty Administrative Law Issues I discussed the lurking issue as to the extent of any relief that a court could grant if it were to find that the IRS issuance of the notice violated the APA. In that piece I pointed to an excellent Notice & Comment blog post, Do you C what I C? – CIC Services v. IRS and Remedies Under the APA. In the post Professor Mila Sohoni provides context on the debate within administrative law. She argues that a district court has the power to set aside the Notice for everyone and should not be constrained to focus only on the application of the Notice to the plaintiff.

In the motion CIC Services acknowledges that there is uncertainty as to the scope of relief but argues that the court’s power to vacate the notice is broad (citing to the Notice & Comment blog). It also discusses the particular harm that CIC Services faces in the absence of a national injunction, including how it must incur costs to assist its nationwide clients who still have to comply and how the order “does not explicitly relieve CIC Services of the on-going and compulsory record-keeping that Notice 2016-66 requires.”

This is an important issue not only for tax administration. It has wide implications for administrative law.

Third Time is the Charm for CDP Case

In Dodd v. Commissioner, T.C. Memo 2021-118, the Tax Court decides the merits of petitioner’s case, having twice remanded the case previously.  In the end, Ms. Dodd lost the merits of her case and owes a large tax liability.  The case shows what happens when the IRS fails to properly conduct the Collection Due Process (CDP) hearing and then what happens when it does.  Ms. Dodd, although an administrative assistant at a law firm, went through CDP process for over four years pro se.  We discussed this case during its previous trip from Appeals to the Tax Court here.

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Starting in 2013, Ms. Dodd became an investor in Cadillac Investment Partners, LLC (Cadillac).  She was the managing member of this real estate partnership with a 35.5% share of its profit, loss, and capital account.  In 2013 Cadillac sold some property generating a large IRC 1231 gain.  She received a K-1 from the partnership and reported on her return $1,073,312 in 1231 gain, $1,909 in ordinary business income, ($100,739) net real estate income and $201,601 in distributions.  She reported all of these items from her K-1 on her 2013 return which showed a liability of $169,882, that she did not pay with her return.  This self-reported liability leads to the CDP hearing.  Because the amount at issue stems from a liability reported on her return, the CDP provision, as interpreted by the Tax Court, allows her to contest the correctness of her own return reporting.

While she was not a model CDP citizen, Appeals also had trouble dealing with her case.  As discussed in the previous post, it twice assigned the same settlement officer who did not seem well equipped to resolve the proper reporting of a partnership distribution.  On the third trip, referred to by the Tax Court as the second supplemental hearing, Appeals assigned a new settlement officer and paired the SO with an appeals officer who had experience dealing with partnership issues.  This team determined that Ms. Dodd correctly reported the liability on her return.  That determination ending remand number three brought the case back to the Tax Court where this time the court has the tools to make a decision.

In the Tax Court the parties agreed to the necessary facts and submitted the case fully stipulated.  Looking at the facts, the court concludes that she correctly reported the liability on her return.  Thus, no merits relief in CDP.  This merits decision occurred after a de novo review of the facts.

Next, the Tax Court looks at whether Appeals abused its discretion in denying her collection relief from the proposed levy.  It concludes that Appeals did not abuse its discretion based on the information Ms. Dodd provided – which was very sparse.  So, four years and three remands after she began her case, she ends up back where she started.  She now has a determination that her return correctly reported the partnership income and expenses.  The IRS has permission to levy upon her and she may need some relief from levy, but she failed to request that relief in a meaningful way during the CDP process.

Appeals correctly dealt with her merits issue on the third try.  I cannot guess what went wrong the first two times.  As discussed in the prior post, the SO initially assigned to the case moved it quickly both times but seemed incapable of addressing the correctness of the reporting of the partnership items.  That an SO would have difficulty determining the correctness of partnership items comes as no surprise, but the failure on the first two tries to line up someone to help with that aspect of these case seems like a failure of the system.  Perhaps the correct handling of the case on the third try signals a better understanding of the way to handle a merits claim or perhaps it just means that in this case Appeals’ eyes finally opened to the problem presented.

Failure to Timely Raise Financial Disability Argument

We have written on several occasions about the exception to the two and three-year lookback periods of IRC 6511 that exist as a possibility if the taxpayer can show financial disability.  You can find posts on the subject here, here and here.  This year my clinic represented someone making the financial disability argument in Tax Court, where petitioners can make refund claims but do so less frequently than through district court litigation.  We succeeded in obtaining a concession of the refund despite the client’s primary use of providers not described in Rev. Proc. 99-21; however, the case of Schmidt v. Internal Revenue Service, No. 2:20-cv-02336 (E.D. CA. 2021) provides another example in the government’s streak of victories against individuals seeking to extend the statute of limitations through financial disability.  Like the majority of litigants raising this issue, she proceeded pro se.

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Ms. Schmidt filed her 2013 return late on February 22, 2015.  On December 15, 2017, she filed an amended return seeking a refund of $31,904.  The IRS sent her a letter informing her that it intended to disallow her claim due to lateness.  She wrote back, obviously confused by the somewhat confusing construct of IRC 6511, arguing that she filed her amended return timely within three years of the filing of her tax return.  She did file the amended return within three years of filing her original return for 2013; however, the filing of the return within three years was not the important fact here.  Most important, as the IRS pointed out, was the three-year lookback rule of IRC 6511(b)(2), which limited her refund to payments with three years.  Since the payments occurred on the original due date of the return because withholding credits get credited on that date, she filed her amended return too late to recover any money even though she filed her amended return within three years of filing the original return.

Once Ms. Schmidt understood the lookback rule, she pivoted and began arguing that she missed the time period for timely filing the amended claim due to financial disability.

Plaintiff acknowledges the Refund Claim did not demonstrate financial disability to the IRS and argues it would have been illogical to submit the information at that time because she was still sick and still meeting the requirements for financial disability for all of 2017.1 In addition, when plaintiff received notice of the IRS’s intent to disallow the Refund Claim, plaintiff believed the IRS was rejecting the Refund Claim for a reason other than the time limits of 26 U.S.C. § 6511(b)(2).  Plaintiff asks the court to consider the evidence submitted with her complaint of her financial disability based on the special circumstances of her case, including the fact that the IRS issued a Private Letter Ruling (PLR) declaring the 2013 disability income tax-exempt.

Now, she hits another roadblock for those seeking a refund – variance.  While I think the court imposes the variance rule against her, it does not use that term, but instead discusses how her refund claim fails to meet the onerous requirements of Rev. Proc. 99-21.  It lists the requirements set forth in the Rev. Proc. and notes that she met none of them.  She submitted no information about financial disability with her amended return.  The court does not offer her a chance to submit it at this point.  Some of the prior cases in which IRC 6511(h) has been raised did allow the taxpayer to supplement their submissions, though in those cases the taxpayer may have engaged in more signaling about the possibility of financial disability than Ms. Schmidt did in filing her amended return.

She appears to have disability issues.  The information in the opinion does not provide a basis for deciding if she might have succeeded had she submitted her request with the amended return.  It also does not make clear whether she has a valid refund claim.  I don’t blame the court for these omissions since that information has nothing to do with the basis for denial of her claim; however, the result is harsh.  A pro se individual will struggle to take the correct procedural steps.  A disabled and sick pro se individual will struggle even more.  The law does not need to require such precision that she must file with her claim a full blown statement as required by the Rev. Proc. and the Rev. Proc. does not need to make the requirements as draconian as it does.

I have sympathy for Ms. Schmidt but the financial disability provision designed to assist people struggling to make life work offers little sympathy.  The mismatch between the purpose for the law and the administration of the law continues.

In Summons Dispute IRS Entitled to Confidential Emails Between Insurance Companies and State Regulator

In US v Delaware Department of Insurance a federal district court ordered the Delaware Department of Insurance (DDOI) to turn over emails associated with micro-captive promoters.  In tax cases it is somewhat unusual that the federal government finds itself in court with state attorneys as adversaries. The case flags tension between the vast information-gathering powers of the IRS versus state and non tax specific federal law designed to provide state law with exclusive responsibility for regulating insurance companies. In this post I will briefly describe the case and highlight how federal law preempts Delaware confidentiality provisions.

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IRS had previously investigated Artex Risk Solutions, Inc. (“Artex”) and Tribeca Strategic Advisors, LLC (“Tribeca”) (which is owned by Artex) in transactions involving micro-captive insurance plans. As part of its investigation into possibly abusive micro-captive insurance transactions, IRS served an administrative summons on DDOI asking for a wide range of information relating to Artex and Tribeca. DDOI turned over thousands of pages of documents but refused to turn over client specific information.

As justification for its refusal, DDOI relied on Section 6920 of the Delaware Insurance Code, which provides for confidential treatment of materials and information that captive insurers submit to the state tax commissioner, either directly or through DDOI, as part of the application and licensing process.

In response to the IRS’s seeking client specific information, DDOI contacted the parties and asked for consent to comply with the IRS summons. A handful agreed but most did not. DDOI then sought to enforce the summons and DDOI filed a petition to quash, relying on Section 6920 of the Delaware Insurance Code.

As a general matter, when there is a conflict between a federal statute and a state statute, the state statute yields under the doctrine of preemption. The McCarran-Ferguson Act (“MFA”) creates an exception to this general rule.  The MFA generally provides that states are entitled to regulate the business of insurance and that “no Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance, or which imposes a fee or tax upon such business, unless such Act specifically relates to the business of insurance.”

MFA thus sets out a reverse preemption principle. State law cedes to federal law but not when the state law pertains to the state’s role in regulating the business of insurance. The opinion discusses the policy underlying the MFA:

“Congress was mainly concerned with the relationship between insurance ratemaking and the antitrust laws, and with the power of the States to tax insurance companies.” S.E.C. v. Nat’l Sec., Inc. , 393 U.S. 453, 458-59 (1969) (citing 91 Cong. Rec. 1087-1088). The MFA attempted “to assure that the activities of insurance companies in dealing with their policyholders would remain subject to state regulation.” Nat’l Sec., 393 U.S. at 459.

While the language in the MFA is broad, the opinion notes that It did not “purport to make the States supreme in regulating all the activities of insurance companies; its language refers not to the persons or companies who are subject to state regulation, but to laws ‘regulating the business of insurance.’ Insurance companies may do many things which are subject to paramount federal regulation; only when they are engaged in the ‘business of insurance’ does the [MFA] apply.” 

The opinion gets into some detailed discussion about how cases have applied the MFA and its reach but essentially the magistrate and ultimately the district court held that the MFA “simply does not apply – i.e., the MFA only allows for reverse preemption when the conduct at issue is the “business of insurance,” which was found missing here. “

DDOI asserted that the conduct “is more properly characterized as “receiving, maintaining and restricting dissemination of application and licensing information of captive insurers,” which it argues is fundamental to insurance regulation.”

The magistrate and district court judge disagreed, framing the state’s conduct as akin to maintaining records rather than actual regulation:

Here, the Court finds no error in the Report’s conclusion that the challenged conduct itself is fairly characterized as “record maintenance” and, more specifically, the dissemination and maintenance of information, documents, and communications maintained by the state. In the Court’s view, this is a fair characterization because it flows directly from the language of Section 6920, which is what DDOI argues protects it from complying with the Summons. Section 6920 protects from disclosure broad swathes of information, not merely application and licensing information of captive insurers (as DDOI suggests). See, e.g. , 18 Del. C. § 6920 (“ … all examination reports, preliminary examination reports, working papers, recorded information, other documents, and any copies of any of the foregoing, produced or obtained by or submitted or disclosed to the Commissioner that are related to an examination pursuant to this chapter … ”). Given the broad scope of documents and information covered by Section 6920, the Report committed no error in characterizing the conduct at issue.

I am giving somewhat short shrift to the MFA arguments that DDOI made, including a disagreement on the standard relating to how to define the business of insurance, but they will be of interest more to a small group of practitioners. Not only does the case highlight the IRS appetite to challenge captive insurance arrangements, but it also resonates n light of the recent Pandora Papers scandal. The Pandora Papers release reveals how at times states’ trust laws are designed to shield information from taxing authorities and other creditors. Many state laws, such as in the DDOI case, present formidable but not insurmountable barriers to engaged and inquisitive IRS employees. Tax havens are not only located outside the US. We will likely see government efforts to obtain information that is potentially subject to state laws that are meant to make it difficult, though not impossible, to attract the eyes of the federal government.

Informal Refund Claim Allowed

In Johnson v. United States, No. 2:19-cv-01561 (E.D. Cal. 2021) the district court finds that taxpayers’ correspondence with the case advocate in the Local Taxpayer Advocate’s (LTA) office provided a sufficient basis for determining that an informal claim existed.  The taxpayers sought to have the correspondence serve as an informal claim for both 2009 and 2010; however, the court only found that it served as an informal claim for 2009. Some recent posts we have written on the informal claim doctrine can be found here and here.

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Taxpayers seeking a refund must file a claim within the time frames set out in IRC 6511.  The Johnsons did not file a formal refund claim for 2009 and 2010 before the time for filing a claim expired.  For some time, however, they worked with the local LTA office in an effort to resolve a number of account discrepancies.  One piece of correspondence with the LTA office focused on 2009.  The discussions about the situation and related correspondence gave the district court comfort in determining that taxpayers had put the IRS on notice of their claim for 2009.  These informal claim cases require scrutiny of the facts surrounding taxpayers’ interaction with the IRS.  The claim process exists to provide the IRS with an opportunity to consider a taxpayer’s request before litigation begins. The court framed the arguments of the parties:

The Government argues the January 28, 2015 fax is insufficient for an informal claim for a tax refund because Plaintiffs have not met the statutory requirements to invoke this Court’s jurisdiction. The Government contends Plaintiffs fail to allege their counsel requested a refund of any specific amount for the 2010 tax year, the January 28, 2015 fax is regarding the 2009 tax year but is not signed under penalty of perjury, and Plaintiffs’ conversations with TAS do not sufficiently inform the IRS of the factual basis for their tax refunds for 2009 and 2010. The Government maintains Plaintiffs’ failure to do either “deprives this Court of subject matter jurisdiction to hear the lawsuit.”

In opposition, Plaintiffs appear to argue the January 28, 2015 fax meets the requirements for the informal claim doctrine because the claim was submitted to Arndt (the case advocate in the LTA office who was working on the case), the amounts listed by year were specific, the TAS is a part of the IRS that works with all of the agency’s components, and Arndt was specifically working with account services to attempt to resolve Plaintiffs’ case.

We wrote a few years ago about a 9th Circuit case, the controlling circuit here, in which the taxpayer filed an informal claim by making an injured spouse request.  I was a little surprised that the court in the Johnson’s case did not cite to the Palomares case but it did cite to numerous other cases involving the informal claim doctrine.

Courts have held that an “informal claim” is sufficient to meet the requirements of 26 U.S.C. §§ 6511 and 7422(a) and generally have allowed the taxpayer to file suit for a tax refund if the claim: (1) gives notice to the Commissioner of the IRS that the taxpayer is asserting a right to a credit or refund; (2) states the legal and factual basis for the claim or at least indicate the grounds for the claim; and (3) must be in writing or have a written component. Rhodes v. United States, 552 F. Supp. 489, 492 (D. Or. 1982) (“[T]he focus is on the claim as a whole, not merely the written component . . . the only essential is that there be available sufficient information as to the tax and the year to enable the [IRS] to commence, if it wishes, an examination of the claim.” (citing American Radiator & Std. San. Corp. v. United States, 318 F.2d 915, 920 (Fed. Cl. 1963))); Glodowski v. United States, No. CV-N-89-414-HDM, 1990 WL 54831, at *1-2 (D. Nev. Feb. 23, 1990), aff’d, 928 F.2d 1136 (9th Cir. 1991) (finding Plaintiff’s letter to the IRS requesting the return of his money insufficient for an informal written claim as it “appears to be a general indictment of the tax system” and lacks “specific allegations which alert the IRS to commence an examination into a claim for refund”); Roman v. United States, No. C 94-3269 TEH, 1995 WL 463669, at *3 (N.D. Cal. July 27, 1995) (finding plaintiff’s attempt, without explanation, to offset the alleged 1985 overpayment against her 1986 tax return was insufficient to inform the IRS she sought a refund for the payment made in 1985). “There are no hard and fast rules for determining the sufficiency of an informal claim, and each case must be decided on its own facts with a view towards determining whether under those facts the Commissioner knew, or should have known, that a claim was being made.” Schlachte v. U.S., No. C 07-6446 PJH, 2008 WL 3977901, at *5 (N.D. Cal. Aug. 26, 2008) (internal quotations and citation omitted).

Here, the court finds that the letter the taxpayers sent to the LTA meets the requirements for an informal claim because

The letter also notes Plaintiffs “are plagued by phantom interest and penalty charges for 2009” after they “in good faith, borrowed money and paid off all outstanding balances due” and that “the penalties and interest assessed against Gail Johnson and entered on her 2009 [Individual Master File] have no basis in any late balance due.” (Id. at 2-3.) The Court finds this language is sufficient to put the Government on notice of Plaintiffs’ claim for a refund, sufficiently states the legal and factual basis for the claim, and has a written component.

Because the taxpayers only mentioned 2009 in the critical letter and not 2010, the court only finds they made an informal claim for 2009 and not for 2010. 

These cases are difficult for taxpayers to win but the win here and in cases such as Palomares point to the possibility.  Persons seeking to make an informal claim argument must examine their contacts with the IRS looking for contacts which can support an argument that they have adequately apprised the IRS of the period and the problem.  No one wants to rely on the informal claim doctrine to win their case.  Always pay attention to the rules governing the timing of claims but if a failure has occurred don’t overlook the possibility of making this argument.

Transcript Updates

The IRS has recently made some updates to the format of transcripts.  The National Taxpayer Advocate describes the updates in a two part blog series you can find here and here.  If you have been wondering why the transcript appearance you have grown accustomed to viewing is different, read the posts to gain a better understanding of the format changes the IRS has adopted.  If you do not regularly read transcripts, you might read the posts in order to understand what is available to you on the various transcripts that the IRS offers.  In my clinic transcripts provide the basic building block for any collection case and often provide useful information on cases involving a contest on the merits.

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The blog posts also describe the path to obtaining transcripts which has changed recently for the better.  We went through a period where I felt we were operating almost in the dark because it became so difficult to obtain transcripts.  The change over the last several months to electronic submission of transcript requests has significantly improved the process and should take pressure off of the IRS since the inability to obtain transcripts going through the Centralized Authorization File (CAF) unit causes practitioners to tie up precious phone lines trying to obtain transcripts.  The description in the post includes a description for individuals seeking to obtain their own transcripts.  For individuals with computer access, computer skills and the proper identification, this can provide an easy means to gaining information about their status with the IRS.

One of the changes described in the NTA’s posts concerns masked and unmasked wage and income transcripts.  I asked for clarification on the terminology which I did understand after reading the first post.  Here is the explanation:

The new transcript partially masks personally identifiable information, leaving only a portion of this information visible.  The new format is referred to as a masked transcript, while transcripts that fully show all personally identifiable information are referred to as unmasked transcripts.  The following information is visible on a masked transcript:

● Last four digits of any SSN on the transcript: XXX-XX-1234
● Last four digits of any EIN on the transcript:  XX-XXX1234
● Last four digits of any account or telephone number
● First four characters of first name and first four characters of the last name for any individual (first three characters if the name has only four letters)
● First four characters of any name on the business name line (first three characters if the name has only four letters)
● First six characters of the street address, including spaces
● All money amounts, including wage and income, balance due, interest and penalties

Working at the IRS Chief Counsel’s Office I had the luxury for many years of having access to individuals with deep expertise in reading the IRS transcripts.  Because I read them for many years and had numerous tutorials while working there, I have a head start on someone unfamiliar with the way the IRS records transactions.  Learning how to read transcripts can unlock many secrets.  We should probably have more CLE training on this “art” because there is much to learn.  Kudos to the NTA for aiding in this process.