Agreeing to Disagree: the 6707A Penalty and Extensions of the SOL

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In my first post on the May case yesterday, involving the 6707A penalty for failing to disclose participation in a listed transaction, I discussed why the IRS lost its on its principal argument, namely that the special statute of limitations under Section 6501(c)(10) for failing to disclose participation does not require the taxpayer to submit a Form 8886. So long as the IRS has the information that the taxpayer otherwise would have provided in the Form, the IRS is on the clock to assess within the one-year period under Section 6501(c)(10).

Of course, the special statute of limitations operates in conjunction with the general statute of limitations under Section 6501(a). Just because IRS lost on its main argument, if the statute were otherwise open, IRS could still assess the 6707A penalty (a penalty that is not subject to deficiency procedures, by the way).

In this post, I will discuss the IRS’s alternative argument in the case, which involved the taxpayer (May) signing a series of Form 872s, Consent to Extend the Time to Assess Tax. IRS argued that May had extended the statute of limitations on assessment for the 6707A penalty so that even absent the 6501(c)(10) period being triggered off the receipt of the Form, the assessment was timely. The issue in the alternative argument was whether an 872 which did not specifically identify the 6707A penalty was broad enough to include that penalty when the context strongly suggested that when IRS wanted to extend the sol for 6707A purposes it would draft the consent to extent the statute in such a way as to clearly specify its intent.

Let’s consider the facts, and then turn to the legal issues.

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Facts

The taxpayer (May) filed his 2004 federal income tax return on July 22, 2005. In September 2011, May “acknowledged.. that he had neglected to include in that return $165,000 of pass-through income from Tornado Alley, Inc., a corporation with which he was “affiliated.” Specifically, May did not file an IRS Form 8886 disclosing one of Tornado Alley’s transactions for that year; that transaction both parties stipulated was in fact a listed transaction.”

On May 23, 2010, May executed his first IRS Form 872, “Consent to Extend the Time to Assess Tax.” The particular language on the form is important.

That form provided that the “amount of any Federal Income & Excise tax due on any return(s) made by or for [May] for the period(s) ended December 31, 2003 and December 31, 2004 may be assessed at any time on or before December 31, 2011.”

Context to the language is also important. From the opinion (throughout I delete references/citations to the record):

The IRS agent who prepared this form—whom the parties, for confidentiality reasons, have agreed to refer to simply as Julie testified during discovery that she was not relying on it to extend the § 6707A statute of limitations for tax year 2004; rather, she believed that statute of limitations could be extended merely by the operation of 26 U.S.C. § 6501(c)(10)…

The opinion also discussed what Julie (the IRS agent) thought the language should be in the 872 to ensure that it covered the 6707A penalty:

When she intended to extend a § 6707A statute of limitations, Julie testified, she would ensure the Form 872 referenced that provision expressly. Indeed, at the same time that she obtained the Form 872 described above, she also procured May’s signature on a second Form 872 that contained the following language: “The amount of any IRC section 6707A penalty due with respect to any return(s) made by or for [May] for the period(s) ended December 31, 2005 and December 31, 2006 may be assessed at any time on or before December 31, 2011.”

There were two other Form 872s as well that also suggested the scope of the extensions. Here is the third:

On May 2, 2011, May’s representative signed a third Form 872, also prepared by Julie, allowing the “amount of any IRC section 6707A penalty due with respect to any return(s) made by or for [May] for the period(s) ended December 31, 2005 and December 31, 2006” to “be assessed at any time on or before September 30, 2012.”

And the fourth, which did not identify the 6707A penalty:

A fourth Form 872, signed by May’s representative on June 2, 2011, stipulated that the “amount of any Federal Income and Excise tax due on any return(s) made by or for [May] for the period(s) ended December 31, 2003, December 31, 2004, December 31, 2005 and December 31, 2006 may be assessed at any time on or before December 31, 2012.” Again the context for the 872 is important.

As the opinion discusses, the IRS agent who prepared that fourth 872 was not Julie, the agent who prepared the first three:

Mary Linda Hosler, the IRS agent who prepared that latter form, was involved in seeking unpaid income taxes from May but had no involvement in assessing—or seeking an extension of the statute of limitations for— any § 6707A penalty. Although she was somewhat evasive during her deposition, the only fair reading of Hosler’s testimony is that it was not her purpose, in obtaining the 2011 Form 872, to extend the statute of limitations for May’s § 6707A penalty. She was interested only in extending the limitations period for the assessment of other taxes.

Bringing it Back to the IRS Assessment of the 6707A Penalty

With the background of the 872s, the opinion also discusses the IRS’s assessment of the 6707A penalty:

The Government acknowledges that by March 2010 it had sufficient information from which to determine that May had engaged in a listed transaction. On March 10, 2010, the IRS sent May a “30-day letter” informing him that it would assess a § 6707A penalty relating to the Challenged Transaction if he did not object in writing within thirty days. The Government also concedes that “there was no information necessary to assess a penalty pursuant to Internal Revenue Code § 6707 A that the IRS did not have in its possession prior to February 6, 2011.” Nevertheless, it was not until February 6, 2012, that the Government assessed May a $18,563 penalty under § 6707A for failing to disclose his participation in the Challenged Transaction.

When the dust cleared, given that the IRS lost on its principal argument under 6501(c)(10) that I discussed yesterday, the only way that the sol on assessment for the 2004 6707A penalty was timely was if the court could conclude that the first and fourth 872 applied to extend the time to assess the 6707A penalty for 2004, even though they both did not specifically identify the penalty.

The Law

The opinion, citing established law, discusses how the 872 is not technically a contract but is “an agreement on the part of a taxpayer (consented to by the IRS) to waive the running of the normal statutory limitations period.” Part and parcel of that is that the agreement reflect mutual assent to extend the statute. Here is where the IRS came up short again:

Here, there was no “mutual assent” to extend the limitations period for May’s § 6707A penalty via a Form 872. May executed two Forms 872 on March 23, 2010. The first extended the limitations period for income and excise taxes for tax years 2003 and 2004; the other extended the limitations period for § 6707A penalties arising out of tax years 2005 and 2006. Both forms were signed by the same IRS agents on the same day. The execution of these documents at the same time, by the same parties, is “objective” evidence that “Income & Excise tax” and “IRC section 6707A penalty” did not have the same meaning in the parties’ minds. If, as the Government insists, the word “tax” on Form 872 “include[d] additions to tax and penalties provided by Chapter 68 of the Code (sections 6501 through 6751)” there would have been no reason to execute two different forms. May and the IRS could simply have signed a single document extending the limitations period for any and all “Income & Excise taxes”—or even any and all “taxes”—for years 2003 through 2006. But they did not do so. Julie’s deposition testimony confirms that the IRS did not intend the first 2010 Form 872 to extend the statute of limitations on the § 6707A penalty for tax year 2004. If that had been Julie’s intent, she testified, she would have explicitly so provided (emphasis added).

Conclusion

May’s tenacity on the sol resulted in his entitlement to a full refund of the $18,563 6707A penalty. The opinion is a useful reminder that when IRS prepares consents to extend the statute of limitation on assessment, especially when there are multiple issues and multiple extensions, the specific language matters a great deal. I suspect that if there were not separate 872s addressing the 6707A penalty and the underling tax liabilities, the court would have found the broadly worded 872 sufficient to have extended the statute. Kudos to May’s counsel on a well-argued and hard-fought sol victory.

About Leslie Book

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

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