IRS Releases Update on Frequently Asked Questions Part 4: The Low-Income Taxpayer Perspective

Today we welcome back guest blogger Ted Afield, Professor of Law at Georgia State University, with the fourth installment in our mini-series on IRS FAQ.

The IRS’s mission, in its own words, is to “Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.” Taxpayers reading this mission statement are not being unreasonable in believing that fulfilling the service side of this mission includes at least some obligation to explain to taxpayers what the tax laws are and how taxpayers are expected to comply with them. Indeed, a service-focused mission would also suggest that, to the extent that the IRS does provide an explanation of the tax laws that turns out to be incorrect, the IRS would make at least some effort to mitigate the impact of its mistake, such as through acknowledgement and correction of the error and through ensuring that taxpayers are not penalized for relying on an IRS explanation.

As has been noted numerous times on this blog and elsewhere, however, this has sadly not been the case in the context of one of most commonly utilized IRS methods of explaining the tax law: the FAQ.  Rather, historically, the IRS has taken the position that it would do its best through FAQs to provide quick and clear guidance to taxpayers, but that essentially taxpayers should rely on those FAQs at their peril, as there would be no relief if the guidance turned out to be incorrect.

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As Professors Joshua Blank and Leigh Osofsky have pointed out in an upcoming article in the Vanderbilt Law Review titled, The Inequity of Informal Guidance, that the approach that the IRS taken to this type of informal guidance is “a social justice issue. . . [because] the two tiers of formal and informal tax law systematically disadvantage taxpayers who lack access to sophisticated advisors.”  As Professors Blank and Osofsky correctly observe:

This imbalance occurs irrespective of whether the IRS’s tax guidance contains statements that, if taxpayers followed them, would be taxpayer favorable or unfavorable.  When the guidance contains taxpayer-favorable positions the IRS is not legally bound by these positions and, during an audit, can contradict or ignore them.  When the guidance contains taxpayer-unfriendly positions, taxpayers who rely on them are bound to these interpretations as a practical matter.  Worse yet, these taxpayers have almost no protection against tax penalties for incorrect positions that they claimed based on the IRS’s tax guidance.

While these inequities can of course be experienced by taxpayers at a variety of income levels, they are most acutely felt by the most economically vulnerable members who interact with the tax system.  Furthermore, the inequity is exacerbated by the fact that Congress increasingly uses the tax system to distribute economic relief in periods of economic crisis. This means that new areas of tax law in which the IRS is attempting to provide FAQ guidance as quickly as possible are areas of the law that are specifically designed to provide critical social safety-net benefits to vulnerable taxpayers who are most in need of a clear explanation that shows them what they must do to receive these benefits.  The National Taxpayer Advocate described the extent of this problem as just as it related to the COVID-19 relief provisions here:

The Coronavirus relief provisions provide a good example of the useful role of FAQs. There is no end to the questions that have arisen under the Families First Coronavirus Response Act, the Coronavirus Aid, Relief, and Economic Security Act, and the IRS’s People First Initiative. It would not have been feasible for the IRS to address most of those questions through published guidance, at least not quickly. By our count, the IRS has posted nearly 500 COVID-19-related FAQs on its website, including 94 on the employee retention credit, 93 on the Families First Coronavirus Response Act (via a link to the Department of Labor website), 69 on Economic Impact Payments, 67 on COVID 19-related tax credits, and 40 on filing and payment deadlines.

For a more specific example, see here for a discussion of how the IRS provided incorrect FAQ guidance for the eligibility of incarcerated and non-resident taxpayers for economic impact payments during the first round of COVID-19 stimulus).  This approach represented more than just poor service—it violated at least four of the Taxpayer Bill of Rights: the right to be informed; the right to quality service; the right to pay no more than the correct amount of tax; and the right to a fair and just tax system.  Indeed, as Professors Alice Abreu and Richard Greenstein have noted, given that the IRS would remove and replace FAQs without warning and without an archive, it “may also violate the taxpayers “Right to Challenge the IRS’s Position and Be Heard,’” which would cause it to violate half of the listed taxpayer rights in TBOR.

Thankfully, the IRS last week took a significant step in rectifying this inequity, with the publication of IR-2021-202 (October 15, 2021).  Through this notice, the IRS has indicated that it will make the following changes to its FAQ practices:

  1. Publishing FAQs as separate Fact Sheets that will be dated so that taxpayers will know when FAQs are modified.
  2. Allowing taxpayers who reasonably rely on FAQ guidance in good faith to have a “reasonable cause” defense against negligence or accuracy related penalties if the FAQ is incorrect as applied to that taxpayer

This notice represents an important change from the “heads, the IRS wins; tails, the taxpayer loses” historical approach to FAQs and is a welcome development for all taxpayers, but particularly so for those taxpayers who lack the resources to pay for professional tax guidance and nevertheless rely on benefits administered through the tax code for their economic security.  Inevitably, however, commentators will turn their attention to the question of whether this fix solves the problem or whether it only represents the first step towards an even more equitable solution.

As Professors Abreu and Greenstein have argued here, perhaps the IRS should be encouraged to go beyond simply allowing reliance for the purposes of penalty protection and should be encouraged to “stand by its [sic] all of its written, publicly announced, positions until it announces that it has changed positions, and it should do so for all purposes, not just for penalty protection.”  There is considerable appeal to this argument, but part of me wonders whether this could potentially backfire on economically vulnerable taxpayers. Requiring that the IRS stand by all written guidance for all purposes until the guidance is changed could end up having the counter-effect of making the IRS more hesitant to release the guidance in the first place.  Even if the IRS did continue to release guidance, allowing taxpayer reliance over and above penalty protection could incentivize the IRS to release guidance in a more taxpayer unfriendly manner, which, as Professors Blank and Osofsky have observed, could cause taxpayers to rely on unfriendly FAQ guidance that puts them in an unfavorable tax position that their reliance causes them not to realize.

While that concern does give me pause in wishing that the IRS had adopted a position that taxpayers are entitled to reliance on FAQs for all purposes, I do find myself still wishing that the IRS had moved more toward the Abreu/Greenstein proposal.  But, perhaps the IRS could have found a middle ground between penalty defense and complete reliance for all taxpayers.  For me, this middle ground would recognize that the service obligations that the IRS owes the economically vulnerable are, frankly, higher than the obligations owed to more sophisticated taxpayers.  It would also recognize that, in addition to failing these taxpayers on the service side, the IRS has also failed these taxpayers on the enforcement side by auditing them at much higher rates than their incomes or percentage of the taxpaying population would justify.

Therefore, while it might be too chilling for the IRS to have to stand behind all written guidance in effect for all taxpayers, is it that unreasonable to ask the IRS to stand behind this guidance for all purposes for taxpayers who are the most likely to depend on FAQ guidance to educate them about social safety-net benefits?  To be specific, I would have liked to have seen the IRS adopt the Abreu/Greenstein model for taxpayers whose incomes for the tax year at issue were below 250 percent of that year’s federal poverty guidelines (the same eligibility standard for LITC representation).  I also would have liked to see the IRS adopt the National Taxpayer Advocate’s recommendation of refusing to assess a penalty for a position taken in reliance on an FAQ in effect for the year in which the return was filed, at least for this subset of taxpayers.  Should the IRS balk at providing this relief towards low-income taxpayers, I would have an extra wrinkle that I would propose—I would give the IRS a way out of having to allow for this heightened level of reliance for these taxpayers by tying it to the IRS’s approach to enforcement against low-income taxpayers. 

My added wrinkle is that the IRS should permit low-income taxpayers to have a higher level of reliance protection for FAQs for as long as the IRS chooses to subject them to heightened levels of enforcement.  As Kim Bloomquist has persuasively demonstrated, “the IRS audits EITC filers at a rate four times higher than non-EITC filers with similar incomes.”  That disparity in audit rates is uncontroversially unjustifiable, and allowing low-income taxpayers to have a higher degree of reliance on all published IRS guidance for as long as this enforcement disparity persists would be a small step towards IRS perhaps recognizing that it in fact has its priorities exactly backwards when it provides more enforcement and less service towards the economically vulnerable.

The IRS took an important step last week towards making its use of FAQ’s much fairer to all taxpayers, and the IRS deserves to be celebrated for this.  Nevertheless, I do hope like other commentators that this might represent the first step towards a more just use of FAQs and, specifically, an acknowledgement that, if the IRS is going to provide heightened enforcement scrutiny of low-income taxpayers, it should be providing heightened service that it stands behind as well.

IRS Recent Guidance on FAQs: Too Little, Too Narrow

Today we welcome back guest bloggers Alice Abreu and Richard Greenstein, Professors of Law at Temple’s Beasley School of Law in Philadelphia, with the third installment in our mini-series on IRS FAQ.

On Friday, October 15, 2021, the IRS finally issued guidance addressing the controversial issue of taxpayer reliance on positions the agency announces in FAQs, which are published on its website (IR-2021-202, IRS updates process for frequently asked questions on legislation and addresses reliance concerns). Acting Chief Counsel William Paul foreshadowed this development at the NYU Tax Controversy Forum back on June 24, as Nathan Richman reported in Tax Notes. Importantly, the new guidance accepts two of the three recommendations made by the National Taxpayer Advocate Erin Collins in her July 7, 2020 blogpost. But, unfortunately, the new guidance suffers from the same shortcomings that attended the NTA’s recommendations.

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As we observed in a PT post a few days after NTA Collins posted her recommendations, those recommendations did not go far enough to address the problem of taxpayer reliance on IRS informal guidance, and protect taxpayer rights. NTA Collins began by positing a taxpayer who wants to know whether an expense is deductible and finds an FAQ on the IRS website saying it is, only to discover when audited that the IRS has changed its position and the examining agent not only denies the deduction but imposes a penalty. As we explained,

We agree with NTA Collins that “[i]f the Taxpayer Bill of Rights is to be given meaning, this scenario violates ‘The Right to Informed’ and ‘The Right to a Fair and Just Tax System.’”  We also emphatically agree that “[i]t is neither fair nor reasonable for the government to impose a penalty against a taxpayer who follows information the government provides on its website.” But we think that by focusing on the penalty, NTA Collins understates the unfairness faced by the taxpayer in this scenario.  Of course it is unfair for a taxpayer to be penalized for doing what the IRS itself said she could do, in a document specifically intended to guide taxpayer actions. And it is also unfair for the IRS to take down the document so that the taxpayer cannot offer it in support of a claim that she had “reasonable cause” for the position that resulted in the alleged underpayment, as provided by IRC § 6664(c)(1), which should allow her to avoid the penalty without reaching the question of whether the FAQ constitutes substantial authority for the taxpayer’s position. Indeed, removing an FAQ from the IRS website after a taxpayer has relied on it may also violate the taxpayer’s “Right to Challenge the IRS’s Position and Be Heard” because the IRS is thereby interfering with the taxpayer’s ability to provide adequate documentation for her position.  We therefore heartily endorse the NTA’s recommendation that the IRS create and maintain an archive of all FAQs issued.

Because the IRS’s recent announcement follows two of the NTA’s recommendations, both our endorsement and our criticisms of those recommendations apply to the announcement as well. First, the announcement does too little, because it respects taxpayer reliance for penalty purposes only. As we develop in a forthcoming article, the argument that a taxpayer who relies on statements made by the IRS in a writing issued for the purpose of guiding taxpayers should not be penalized for so doing, is so robust that to state it is to win it. While it is nice for the IRS to confirm that, in a document on which taxpayers can rely, it is hardly something that taxpayers should be popping champagne corks over.

Second, despite its positive movement on the penalty issue, by refusing to stand by the words it has written to guide taxpayers, the IRS is continuing to behave like the Peanuts character Lucy, who entices Charlie Brown to kick the football, only to pull it away just as he is about to do it. Its behavior violates the taxpayer’s rights to be informed and to a fair and just tax system and impugns the legitimacy of both the agency and the tax system it administers. While we would have preferred that the NTA had recommended that “examining agents not retain the authority . . . to challenge taxpayer return positions if an FAQ has been changed,” we welcomed her recommendation that such authority be retained “in limited circumstances” only (emphasis in original), and that, in such cases “examining agents should be required to consider previously issued FAQs.” We therefore wish the recent announcement had followed that recommendation as well. For us, that recommendation was too tentative, but for taxpayers, the IRS’s following it would have been an improvement over its continuing to behave like Lucy.

The IRS’s recent announcement is also too narrow: it applies only to written statements the IRS makes in FAQs, whereas the fundamental problem addressed by the NTA—taxpayers relying on IRS written information intended for their guidance—extends far beyond FAQs. FAQs captured the limelight because the onslaught of pandemic-relief legislation effective upon enactment led to the need to issue interpretive guidance as close to immediately as possible, causing FAQs to multiply exponentially. But the same reliance problem raised by FAQs arises whenever a taxpayer relies on a statement the IRS makes in one of its publications, instructions to forms, Fact Sheets, and even in correspondence or other documents addressed specifically to the taxpayer.

Despite the recent proliferation of FAQs, the amount of all of this other informal guidance must be greater than the number of FAQs. The scant comfort provided by the recent announcement should have applied to other forms of informal guidance as well. Despite the foregoing criticisms, the recent announcement does make progress toward increasing the legitimacy of the IRS: it shows the IRS as capable of responding to criticism even in the absence of a specific NTA recommendation. In her July 7, 2020 blog post NTA Collins criticized the disclaimers included in some FAQs, which stated that “These FAQs are not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.” See, e.g. IRC § 199A FAQ. As NTA Collins pithily observed in her blog post, “Why should taxpayers even bother reading and following FAQs if they can’t rely on them and if the IRS can change its position at any time and assess both tax and penalties?” Even though the blog post did not make any specific recommendation regarding disclaimers, the IRS’s recent announcement retreats from the arrogant “we’ve said it but it won’t help you in court” stance of current disclaimers. Henceforth, the IRS will include a “legend” in Fact Sheet FAQs explaining that the FAQ

may not address any particular taxpayer’s specific facts and they may be updated or modified upon further review. Because these FAQs have not been published in the Internal Revenue Bulletin, they will not be relied on or used by the IRS to resolve a case. Similarly, if an FAQ turns out to be an inaccurate statement of the law as applied to a particular taxpayer’s case, the law will control the taxpayer’s tax liability.

The change from “it won’t help you” to “we won’t use it against you” may be subtle, but it is not insignificant. Although we would have preferred a change to “you may rely on it,” and perhaps NTA Collins would have as well, by not dismissing reliance in its entirety, the new language is a step in what we think is the right direction. Thank you, Acting Chief Counsel Paul.

IRS Releases Update on Frequently Asked Questions Part 2

Today guest blogger James Creech brings us his take on the recent IRS news release and fact sheet announcing important changes in the agency’s use of frequently asked questions. Part One in this series can be found here. Christine

As an extended filing day surprise the IRS has released a news release on the role Frequently Asked Questions (FAQ) play in tax administration.  Anyone who has been following the expanded role FAQs have been playing over the last few years, especially in the areas of the Employee Retention Credit and Virtual Currency, will not be surprised by the conclusions the IRS reaches in the press release.

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The IRS states that FAQs are not guidance rather they are a form utilized by the Service to quickly communicate general concepts to taxpayers.  From the viewpoint of the IRS, FAQs synthesize authoritative guidance that is binding on the IRS, either through guidance published in the Internal Revenue Bulletin, or the Internal Revenue Code and Treasury Regulations.  The IRS acknowledges that as a general application of the law the statements contained in FAQs may not be perfect and “if an FAQ turns out to be an inaccurate statement of the law as applied to a particular taxpayer’s case, the law will control the taxpayer’s tax liability.”

The most important part of the press release is a statement on what happens if a taxpayer relies on an incorrect FAQ for the purpose of penalty protection.  The press release states “a taxpayer’s reasonable reliance on an FAQ (even one that is subsequently updated or modified) is relevant and will be considered in determining whether certain penalties apply.”  As a practical note the IRS’s reference to updated or modified FAQs is an endorsement of the practice of printing out or saving FAQs that are helpful to a position because once an FAQ is updated the prior version can no longer be found on IRS.gov

Perhaps the most novel point of the press release is that FAQs issued in a press release have more weight than FAQs simply published to IRS.gov without fanfare.  This is an extrapolation of Treasury Regulation 1.6662-4(d)(3)(iii) that lists “Internal Revenue Service information or press releases” as types of authority that can be relied upon for penalty protection even though FAQs are conspicuously absent from the regulation.  Although the IRS as assured practitioners that it does not take positions contrary to FAQs it may be worth saving all of the IRS emails in your inbox in case you ever need to show that certain FAQs were part of an “information or press release”. 

The IRS has stated that in the near future it would begin archiving all FAQs and would release more formal guidance about reliance on FAQs for the purposes of penalty protection.  Until then this press release will have to suffice about the interaction of FAQs, weight of authority, and penalty protection.

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.

The Law Does Not Forbid a Helpful Internal Revenue Policy

Commenter in chief Bob Kamman returns with a colorful story following up on yesterday’s topic of jeopardy assessment.

The Fumo case, of course, is small potatoes.  If you want a real jeopardy assessment involving a real politician, you have to go back to March 13, 1925, when Internal Revenue assessed James Couzens, United States Senator from Michigan, $10.9 million in tax based on his sale in 1919 of Ford Motor Company stock to Henry and Edsel Ford.  Until 1915, Couzens had been vice president and treasurer of Ford Motor.

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The assessment was announced on the Senate floor by Couzens himself, who accused Treasury Secretary Andrew Mellon of initiating the audit to discipline Couzens for his investigation of the Bureau of Internal Revenue.  Couzens was a former mayor of Detroit who had been appointed to a vacant Senate seat in 1922 and then elected for a full term, starting nine days before the jeopardy assessment. 

Couzens (pronounced “cousins”) was one of several minority shareholders in Ford who complained that Ford was not paying dividends even though its profits could support them.  A state court agreed, so the Ford family agreed to buy them out.  The shareholders were reluctant to sell without knowing how much they would owe in income taxes, which were at a post-war high of 73% (with no break for capital gains).

And the shareholders did not know their cost basis because it depended on the value of the stock on March 1, 1913, when the income tax went into effect.  Ford was not publicly traded.  At the time, Internal Revenue would audit a company to determine this amount.  Henry Ford asked for an audit, and the Commissioner authorized it.

That “courtesy audit” placed the value at  $9,489 per share.  Couzens, who sold 2,180 shares for $29.3 million, used this audit result when he filed his 1919 return.  But then, under a later Commissioner, his return was audited under a new Commissioner.  (His return had also been audited in 1920, but for a different issue.)  And this time, the valuation was reduced to $2,634 per share.  A jeopardy assessment was required because the statute of limitations was about to expire on March 15, 1925, five years after the due date of the original return.  

Couzens and the other shareholders negotiated in secret with Internal Revenue lawyers until their lawsuit was filed in December 1925.  When it went to trial in January 1927 before the Federal Board of Tax Appeals (predecessor to the Tax Court), it was the largest income tax case in U.S. history. Government lawyers had reduced the claim by $1.5 million, allowing a value of  $3,548 per share, so only $9.4 million was at stake.

The petitioners argued estoppel required use of the higher valuation, but the BTA disagreed, and explained in terms that might be useful today:

The evidence shows that at the time of the valuation there was in the Bureau of Internal Revenue a policy of being helpful to taxpayers in adjusting them to the new tax law, but that this policy interfered with the administration of the assessment and collection of taxes and was soon restricted. . . .It should not be understood that the law forbids a helpful policy.  There is a public interest in the cooperation by the Bureau of Internal Revenue, and it should be given as freely as efficiency and good administration permit.  But it cannot go so far as to fix a responsibility beyond that contemplated by the statute, and it would be unjustified to stifle a spirit of helpfulness with a caution against binding and irrevocable action.

In May 1928, the three participating judges of the Board decided  the stock was worth $10,000 per share.  Couzens owed nothing, and could collect a refund of the $92,000 in taxes he had paid in 1924, having filed a timely claim, because of the earlier audit on an unrelated issue.  

Two other Ford shareholders involved in the case were the estates of John and Horace Dodge, also well known in the automobile industry. Another of the shareholders, John W. Anderson, was represented by E. Barrett Prettyman, who later became an Appeals Court judge and had a D.C. courthouse named after him.

IRS Did Not Appeal This Tax Court Decision. They Just Ignored It.

We welcome back commenter in chief Bob Kamman writing today about his experience in a Tax Court case.  One of the benefits of going to Tax Court is getting an attorney from Chief Counsel’s Office assigned to the case.  While not everyone will have a perfect encounter with the attorneys from Chief Counsel’s Office, dealing with them to fix a problem beats almost any other option offered in trying to fix a problem with the IRS.  Sometimes, paying the $60 to get to a Chief Counsel attorney can be worth the cost of admission.  If something goes wrong with the client’s case that relates to a year in Tax Court, don’t try to fix it by calling the place at the IRS that made the mistake or contacting the Taxpayer Advocate’s office, go straight to the Chief Counsel attorney, who will almost always be able to fix the problem with a lot less effort than it would otherwise cost you.  Keith


I’m Nobody! Who are you?

Are you – Nobody – too?

Emily Dickinson

About 20 months and one pandemic ago, I complained here about how IRS did not timely answer a Tax Court petition I had filed.

I feel better now. I’m not the only one IRS ignores. They ignore Tax Court orders also.

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The tardy IRS answer was filed shortly after the blog post appeared. Judge Gustafson initially rejected it because it was not accompanied by a motion to request late filing. IRS Counsel filed a “motion for leave to file out of time answer,” it was granted, and the case proceeded two weeks later.

This case arose from a CP-2000 notice dated July 22, 2019, involving omitted income from a 2017 return. IRS initially proposed an assessment of $4,761 plus interest. On August 6, 2019, we provided documents showing the actual amount owed was only $2,847.

Two months later, the response from IRS was to issue a notice of deficiency dated October 15, 2019, for the same $4,761 shown on the CP-2000. This happened shortly after the end of the fiscal year, but I’m just guessing that timing had something to do with it.

My experience has been that IRS never rescinds a notice of deficiency, even though they have a form (8626) for agreeing to that. As Janet Hagy, a CPA in Austin wrote here, “obtaining a rescission is not an easy process. In most cases, it is probably more expedient to just file a Tax Court petition and use the Appeals process to resolve the case.”

So, in November 2019, my clients sent a check for $2,847 to IRS, identifying it as an advance payment under Section 6603. At the same time, we bought the $60 ticket to Tax Court and filed a petition. Chief Counsel’s January 2020 answer was late, but after that, they were quick to agree with us and stipulate to the $2,847 amount already paid.

On March 3, 2020, Chief Judge Foley signed the stipulated decision that the tax due was $2,847. This was one of his last actions before Covid-19 shut down the Tax Court building and then trials everywhere, within weeks.

My clients had paid the tax, but I told them to wait for a final bill from IRS before paying the exact amount of interest owed. They received a bill and paid it. I should have told them to let me review the bill, but what could go wrong?

What went wrong is that IRS in Ogden, Utah issued a revised CP-2000 five months later, on August 17, 2020, proposing an assessment of $3,057. A tuition tax credit was still being disallowed, although we had addressed that issue with them a year earlier. Then on September 14, 2020, like computer clockwork, a CP-22A first collection notice demanded payment of this amount, less the advance payment of $2,857. My clients paid the additional $210, along with $297 interest, and I did not discover the error until I heard from them again in April 2021 to prepare their 2020 returns.

By then it was a year into the pandemic. I mailed a letter on April 7, 2021, to the Counsel attorney who had handled the case, explaining what had happened and enclosing copies of relevant documents. There was no response.

So, on May 20, 2021, I filed a Form 911 asking my local Taxpayer Advocate for assistance with correcting the error. There was no response to that, either. Such has been my experience in other requests for Taxpayer Advocate help. I attribute it to my lack of academic or tax-clinic credentials.

Surely, I thought, the Tax Court must have some rule governing enforcement of its decisions when IRS ignores them. All I could find, though, was Rule 260, which deals with a “proceeding to enforce an overpayment determination.” There had not been an overpayment determination; my clients had agreed there was a deficiency. They had paid the exact amount ordered by the Tax Court decision. Our problem was with the IRS decision, which was to ignore the case history and demand more tax.

Fortunately, an unexpected development allowed me to suspend my search for possible Tax Court relief. The letter I had sent to the Counsel attorney at his last known address was returned to me as undeliverable, several months later. I checked the Tax Court docket online, and physical addresses no longer appear there. The only contact information is an email address.

So, I emailed my request for help. A couple weeks later, a paralegal specialist called and left a message that they are working on fixing the problem.

Maybe I’m not such a nobody, after all.

Complications from Extensions and Unprocessible Returns

Bob Probasco returns today with an important alert on overpayment interest. Christine

A few months ago, Bob Kamman flagged a number of surprising phenomena he’d observed recently, one of which related to refunds for 2020 tax returns.  Normally, when the IRS issues a refund within 45 days of when you filed your return, it doesn’t have to pay you interest.  That’s straight out of section 6611(e)(1).  Yet, taxpayers were getting refunds from their 2020 returns within the 45 day period and the refunds included interest.  As Bob explained, that was a little-known benefit of COVID relief granted under section 7805A.  Not only were filing and payment dates pushed back but also taxpayers received interest on refunds when they normally would not have.

On July 2, 2021, the IRS issued PMTA 2021-06, which raised two new wrinkles—one related to returns that were not processible; the other related to returns for which taxpayers had filed extensions.  How do those factors affect the results Bob described?

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Interest on Refunds Claimed on the Original Return

The general rule is that the government will pay interest from the “date of the overpayment” to the date of the refund.  Normally the “date of the overpayment” will be the last date prescribed for filing the tax return, without regard to any extension—April 15th for individuals—unless some of the payments shown on the return were actually made after that date.  But there are three exceptions applicable to refunds claimed on the original return: 

  • Under section 6611(b)(2), there is a “refund back-off period” of “not more than 30 days” before the date of the refund, during which interest is not payable.  In practice, this period is significantly less than 30 days.  See Bob Kamman’s post and the comments for details.
  • Under section 6611(b)(3), if a return is filed late (even after taking into account any extension), interest is not payable before the date the return was filed.
  • Under section 6611(e)(1), no interest is payable if the refund is made promptly—within 45 days after the later of the filing due date (without regard to any extension) or the date the return was filed.

Section 6611(b)(3) and (e)(1) affect when overpayment interest starts running, while section 6611(b)(2) affects when it ends.

Other Code provisions, however, may adjust this further.

When Is the Return Considered Filed?

This is where “processible” comes in.  Section 6611(g) says that for purposes of section 6611(b)(3) and (e), a return is not treated as filed until it is filed in processible form.  As the PMTA explains, a return that is valid under Beard v. Commissioner, 82 T.C. 766 (1984), may not be processible yet, because it omits information the IRS needs to complete the processing task.  IRM 25.6.1.6.16(2) gives an example of a return missing Form W-2 or Schedule D.  Those are not required under the Beard test, but the return cannot be processed “because the calculations are not verifiable.”  The PMTA also mentions a return submitted without the taxpayer identification number; still valid under the Beard test but the IRS needs the TIN to process it.

As a result, under normal conditions, if a valid but unprocessible return is filed timely, and a processible return is not filed until after the due date, the latter is treated as the filing date for purposes of section 6611(b)(3) and (e).  The return is late, so the taxpayer is not entitled to interest before the date the (processible) return was filed.  And the 45-day window for the IRS to issue a refund without interest doesn’t start until the (processible) return was filed.

And Now We Add COVID Relief

The previous discussion covered normal conditions, but today’s conditions are not normal  As we all recall, the IRS issued a series of notices in early 2020 that postponed the due date for filing 2019 Federal income tax returns and making associated payments from April 15, 2020, to July 15, 2020.  The IRS did the same thing for the 2020 filing season, postponing the due dates from April 15, 2021, to May 17, 2021.  (Residents of Oklahoma, Louisiana, and Texas received a longer postponement, to June 15, 2021, as a result of the severe winter storms.)

This relief is granted under authority of section 7508A(a)(1), responding to Presidential declarations of an emergency or terroristic/military actions.  For purposes of determining whether certain acts were timely, that provision disregards a period designated by Treasury—in effect, creating a “postponed due date.”  The acts covered are specified in section 7508(a) and potentially, depending on what relief Treasury decides to grant, include filing returns and making payments.  For the 2019 filing season, the IRS initially postponed the due date for payments and then later expanded that relief to cover the due date for filing tax returns.

(Yes, the section 7508A provision for Presidentially declared emergencies piggybacks on the section 7508 provision for combat duty.  As bad as the disruptions caused by COVID have been, I prefer them to serving in an actual “combat zone.”  Hurricane Ida, which I am also thankful to have missed, may be somewhere in between.  All get similar relief from the IRS.)

Section 7508A(a)(2) goes beyond determining that acts were timely.  It states that the designated period, from the original due date to the postponed due date, is disregarded in calculating the amount of any underpayment interest, penalty, additional amount, or addition to tax.  No penalties or underpayment interest accrue during periods before the postponed due date, just as they don’t accrue (in the absence of a Presidentially declared emergency) before the normal due date. 

That’s the right result, and section 7508A(a)(2) is necessary to reach it.  Section 7508A(a)(1) simply says that the specified period is disregarded in determining whether acts—such as payment of the tax balance due—are timely.  It doesn’t explicitly modify the dates prescribed elsewhere in the Code for those acts.  The underpayment interest provisions, on the other hand, don’t focus on whether a payment was timely.  Section 6601(a) says underpayment interest starts as of the “last date prescribed for payment” and section 6601(b) defines that without reference to any postponement under section 7508A.

What about overpayment interest on a refund?  Section 7508A(c) applies the rules of section 7508(b).  That provision tells us that the rule disregarding the period specified by Treasury “shall not apply for purposes of determining the amount of interest on any overpayment of tax.”  Great!  We won’t owe interest for that designated period—April 15, 2020 to July 15, 2020 for the first emergency declaration above—on a balance due, but we can potentially be paid interest for that period on a refund.

Section 7508(b) also states that if a postponement with respect to a return applies “and such return is timely filed (determined after the application of [the postponement]), subsections (b)(3) and (3) of section 6611 shall not apply.”  That certainly sounds reasonable with respect to 6611(b)(3); it’s a de facto penalty of sorts for filing late, but if you filed your 2019 tax return by July 15, 2020, that should be treated as though you had paid by the original due date of April 15, 2020. 

Section 6611(e)(1) is a little bit different.  It’s not a de facto penalty for late filing; it’s essentially (1) a recognition that processing returns and issuing refunds takes some minimal amount of time and (2) possibly a small incentive for the IRS to do that expeditiously.  But when Treasury grants relief after a Presidentially declared emergency, any refund issued from a timely return will include interest, unless some other provision overrides it.  That’s what Bob Kamman’s Procedurally Taxing post pointed out and explained. 

And Now, the PMTA

It appears that the PMTA is correcting earlier analysis.  I haven’t been able to track down any earlier guidance, but the PMTA refers to “our previous conclusions” and those differed from the conclusions in the PMTA.  The conclusions in the PMTA seem correct.  Summarized:

  1. If the IRS determined a postponed due date under section 7508A, a return filed by the postponed due date means section 6611(b)(3) and (e) do not apply.  The return need only be valid under the Beard test to be timely and trigger the provisions of section 7508A; it doesn’t need to be processible.  This is what the “previous conclusions” got wrong, apparently thinking that whether a return was timely for purposes of section 7508A depended on whether it was processible.  But section 6611(g) defines “timely” only for purposes of section 6611(b)(3) and (e), not section 7508A.  It doesn’t matter whether the return was timely filed for purposes of 6611(b)(3) and (e); section 7508A negated them.  The default rules below don’t apply.  Interest will run from the date of the overpayment and there is no exception for a prompt refund.
  2. If the IRS determined a postponed due date under section 7508A, but a valid return is not filed by the postponed due date, it doesn’t meet one of the requirements for sections 7508A(c)/7508(b)—that the return is timely filed by the postponed due date—so the default rules below apply. 

Default rules, if there was no section 7508A relief from Treasury, or the taxpayer did not file a valid return by the postponed due date.  Sections 7508A(c)/7508(b) have no effect, so sections 6611(b)(3) and (e) are in effect and the return is “filed” only when it is processible pursuant to section 6611(g).  Thus:

  • If a processible return is filed by the original due date (or extended due date if applicable) it is not late under section 6611(b)(3), so interest runs from the date of the overpayment.  If it is filed after the original due date (or extended due date if applicable) it is late under section 6611(b)(3), so interest runs from the date the processible return was filed.
  • Whether or not the processible return is filed late, no interest is payable at all if the IRS makes a prompt refund under section 6611(e).  The 45-day grace period starts at the later of the original due date (even if the taxpayer had an extension) or the date the return is filed. 

Note that a return filed after the postponed due date (July 15, 2020) but on or before the extended due (October 15, 2020, if the taxpayer requested an extension) is not timely for purposes of section 7508A.  As a result, sections 6611(b)(3) and (e) are not disregarded.  But it is timely for purposes of 6611(b)(3).  Interest runs from the date of the overpayment rather than the date the return is filed, but the taxpayer may still lose all interest if the IRS issues the refund promptly.

Although the PMTA doesn’t mention it, the “refund back-off period” of section 6611(b)(1) will apply in all cases.  That rule is not dependent on whether a return is processible or filed timely, and it is not affected by a Presidentially declared emergency.

Two Final Thoughts

First, I think the PMTA is clearly right under the Code.  That the IRS originally reached the wrong conclusion, in part, is a testament to the complex interactions of the different provisions and the need for close, attentive reading.  I double-checked and triple-checked when I worked my way through the PMTA.  This was actually a relatively mild instance of a common problem with tax.  Code provisions are written in a very odd manner.  They’re not intended to be understandable by the general public; they’re written for experts and software companies, and sometimes difficult even for them.  I suspect that people who work through some of these complicated interpretations would fall into two groups: (a) those who really enjoy the challenging puzzle; and (b) those who experience “the pain upstairs that makes [their] eyeballs ache”.  My bet is that (b) includes not only the general public and most law school students but also a fair number of tax practitioners.  Which group are you in?

Second, that (relative) complexity leads to mistakes.  I assume that these interest computations have to be done by algorithm.  There are simply too many returns affected to have manual review and intervention for more than a small percentage.  An algorithm is feasible but will require re-programming every time there’s a section 7508A determination, with changes from year to year.  Even when the law is clear, there is a lot of opportunity for mistakes to creep in.  (We’re seen some of those recently in other contexts, e.g., stimulus payments and advanced Child Tax Credit.)  Whether by algorithm or manual intervention, particularly given the change from the original conclusions, there’s a good chance that some refunds were issued that are not consistent with the correct interpreation and may not have included enough interest.  Is the IRS proactively correcting such errors?  If the numbers are big enough, it might be worth re-calculating the interest you received—it’s easier than you may think—and filing a claim for additional interest if appropriate.

Reliance on the Return Preparer, Too Good to Be True?

We welcome back guest blogger James Creech. Today James discusses a recent opinion by Judge Goeke examining a taxpayer’s reasonable cause defense. Reasonable cause is a frequent topic on PT, but this case involves a provision we rarely discuss: the ASED extension for failure to notify the government of certain foreign transfers. Christine

On June 28 the Tax Court released a 71 page decision in Kelly v Commissioner T.C Memo 2021-76. In Kelly, the IRS sought 6 years of income tax deficiencies and Section 6663 fraud penalties, with accuracy-related penalties in the alternative. For three of the years, the IRS needed an expanded statute of limitations to make its assessments. As an alternative argument as to why the expanded statute of limitations was appropriate for 2008 and 2009, even if there was not fraud, on the eve of trial the IRS raised the issue that the Taxpayer had not timely filed Forms 5471 for KY&C, a corporation he owned that was in part owned by another controlled entity based in the Cayman Islands.

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How does the failure to file Form 5471 extend the ASED for Mr. Kelly’s personal income taxes? Section 6501(c)(8)(A) provides:

In the case of any information which is required to be reported to the Secretary pursuant to an election under section 1295(b) or under section 1298(f), 6038, 6038A, 6038B, 6038D, 6046, 6046A, or 6048, the time for assessment of any tax imposed by this title with respect to any tax return, event, or period to which such information relates shall not expire before the date which is 3 years after the date on which the Secretary is furnished the information required to be reported under such section.

Luckily for Mr. Kelly, the extension is much narrower if 6501(c)(8)(B) applies:

If the failure to furnish the information referred to in subparagraph (A) is due to reasonable cause and not willful neglect, subparagraph (A) shall apply only to the item or items related to such failure.

As Judge Goeke explains, “ if reasonable cause for the failure to file Forms 5471 exists, then under section 6501(c)(8)(B) only the adjustments related to KY&C would remain open under the statute of limitations.”

While the facts are complicated, and involve a company named after Dr. Evil’s company from the Austin Powers movies, the Tax Court held that the fraud assertions were not sustained. The Court then evaluated if the failure to file the 5471’s held the statute open or if, as the Taxpayer claimed, there existed reasonable cause for the failure to file because he had reasonably relied upon his CPA.  

The three-prong test to see if Taxpayer had a reliance defense is

  1. the adviser was a competent professional with sufficient expertise
  2. the taxpayer provided necessary and accurate information to the adviser, and
  3. the taxpayer relied in good faith on the adviser’s judgment.

Applying this test, the Court found that Mr. Kelly had reasonable cause based upon reliance on his tax return preparer. In a rather detailed analysis, the Court referenced the return preparer’s impartiality and lack of disciplinary record, contemporaneous emails where the Taxpayer disclosed the existence of the Caymen ownership to his preparer, and most interestingly the level of imputed knowledge the Taxpayer should have had about the return:

Respondent contends that it was not enough for Mr. Kelly to inform [his tax preparers] S&C that KY&C was a foreign entity, and he implies that Mr. Kelly should have advised Mr. Scott [of S&C] that Form 5471 was required.

The Court rejected this position.

The failure to file the Forms 5471 does not present an obvious tax obligation which was negligently omitted from information that a taxpayer provided to the return preparer. Mr. Kelly, through his staff, provided the necessary information to S&C, identified KY&C as a foreign corporation, and stated that he was unsure of the reporting requirements. Having done this, Mr. Kelly reasonably relied on S&C to prepare his returns properly. While it could be argued that S&C should have done more to ascertain Mr. Kelly’s filing obligations, it was reasonable for Mr. Kelly to rely on S&C do so. A taxpayer need not question the advice provided, obtain a second opinion, or monitor the advice received from the professional. Boyle, 469 U.S. at 251.

The Court’s citation of United States v. Boyle here, in a taxpayer victory, is an ironic twist. As Les discussed in a recent post,

Boyle essentially stands for the position that taxpayers have a nondelegable duty to be aware of tax deadlines. An agent’s incompetence or willful misconduct will not excuse the taxpayer from delinquency penalties.

Here, the Court seemed to impose a catchy “too good to be true” standard when it came to the Taxpayer’s knowledge:

At trial, Mr. Scott credibly described the reasons that his firm failed to prepare Form 5471 for KY&C. No facts suggest that the failure was the result of a conflict of interest or a “too good to be true” situation for either year. … We hold that Mr. Scott’s lack of prior experience with Form 5471 was not fatal to a finding of Mr. Kelly’s reasonable reliance on him or S&C.

The Court also recognized that when it came to filing Mr. Kelly’s tax return, informational returns do not impact the economics of the return. After all, most taxpayers only know how much money they made during the year, whether that be $35,000 or $3,500,000. If the only thing missing is an informational Form or a Statement, taxpayers, especially taxpayers who do not have a tax background, do not have the requisite knowledge to recognize such an error and insist the return preparer correct the return.

Time will tell if the “too good to be true” standard catches on as the knowledge requirement for a taxpayer’s review a return for correctness. As even simple returns grow more complex it would be useful to have a more definable standard that taxpayers can use to frame their standard of care when it comes reviewing returns and reliance on return preparers.