The Tacit Consent Doctrine May Extend Far Beyond Signing a Joint Return

We welcome back my colleague, Audrey Patten for a discussion of a recent case providing an expansive view of the tacit consent doctrine.  Audrey has developed a significant docket of innocent spouse cases and is currently working with Christine to write the third edition of A Practitioner’s Guide to Innocent Spouse Relief.  Look for their book coming out later this year.  Keith 

For those of us with many innocent spouse cases, it is common for clients to point out that they may not have actually signed a joint return.  Such clients’ position is that they should therefore be absolved of any joint liability derived from the return.  It is well established case law, however, that a missing spousal signature does not automatically negate the validity of a joint return.  While the burden will be on the IRS to prove a return with a missing signature is valid, the doctrine of tacit consent holds that if the facts and circumstances show that a non-signing spouse intended to file a joint return, a return the taxpayer did not actually sign can still meet the criteria for a valid joint return.  But how far can the doctrine of tacit consent go? On December 1, 2021, the Tax Court issued a memorandum opinion in Soni v. Commissioner that extends the tacit consent doctrine beyond the joint tax return context to encompass tax matters handled by the other spouse, including powers of attorney and extensions of the statute of limitations. The application of tacit consent in areas beyond the validity of a joint return is what makes the Soni case significant.

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Soni is not an innocent spouse case.  Rather, Om Soni and his wife, Anjali Soni, filed a tax court petition that challenged the validity of a Notice of Deficiency issued on a joint return they filed for tax year 2004 (for clarity, the parties’ first names will be used throughout).  Two questions presented in the case were whether the joint return was valid and whether the limitations period for assessment of tax had expired before the notice issued.  (The other two questions were challenges to the imposition of penalties under I.R.C. §6501 and §6651 and are beyond the scope of this discussion). The Court found that tacit consent on the part of Anjali was dispositive of both issues.

Om was a businessman who engaged in a variety of ventures.  Anjali was a homemaker and, aside from some marginal passive income, did not make any money.  By her own testimony, the marriage was very traditional and she expected her husband to handle all financial matters, including the couple’s taxes.  She lived an affluent lifestyle.  There were no allegations of any domestic abuse. Om for his part, often delegated personal business, including handling IRS related mail, to his employees.  The couple also had a grown son who would discuss his parents’ tax matters with his father and assist with preparing documents.  Anjali, again by her own testimony, never reviewed any tax returns because such documents made her nervous.  She also never signed any returns herself.  She even testified that she left documents “for days and days. Because I don’t feel like reading papers like this.”  She also testified, regarding her husband, that “I trust him with everything…whatever he does, I do trust him. I never discuss his business with him.”  Anjali would sometimes collect mail left at the house, but only sort out her magazines.  Any IRS correspondence she would immediately pass to Om or her son without opening it.

For the 1999 through 2004 tax years, an accounting firm prepared all of the couple’s joint income tax returns. Om would review the returns, but not Anjali.  For the 2004 return, the couple’s son physically signed his mother’s name onto the return, without first showing her the return.

Om’s businesses suffered losses during 2004. In 2006, the IRS began auditing the 2004 return.  In 2008, the IRS received a Form 2848, authorizing a representative named Mr. Grossman to act on behalf of the Sonis.  The signatures on the form were dated in 2006.  Anjali did not sign the Form 2848 authorizing Mr. Grossman to represent her, but her signature was present.  It later turned out that Mr. Grossman was in the habit of signing his clients’ names onto Forms 2848 for them.  In 2015, the IRS received a set of two Forms 2848, authorizing the couple’s son to represent Om and Anjali.  Om signed his Form 2848.  Anjali did not personally sign her Form 2848.

Over the next several years, a total of eight Forms 872 (including one Form 872-I), “Consent to Extend Time to Assess Tax,” were filed with the IRS.  The first two were signed by Mr. Grossman as the representative.  The remaining six were signed by Om for himself and by the son on behalf of Anjali.  Neither Om nor his son ever discussed Form 872 or 872-I with Anjali.   The extensions ultimately extended the period of limitations for assessment of tax to December 31, 2015.  As a result of the extensions, the IRS argued it was still within its limitations period when in March 2015 it mailed a Notice of Deficiency of $642,629 for tax year 2004.

The first argument raised by the Sonis was that the 2004 tax return itself was invalid as a joint return because, not only did Anjali not sign the return, but her signature was placed on the return by her son.  The Court provides a useful review of the rules for establishing the validity of a joint return.  First, it points out that if a spouse does not sign a return, the burden is on the IRS to prove it was valid.  However, the lack of signature can be overcome by showing that the parties intended to sign a joint return.  Even if the non-signing spouse did not explicitly state that she wanted to file a joint return, the facts and circumstances can lead to a finding of validity under the tacit consent doctrine.  Since tacit consent is a facts and circumstances analysis, the fact that the signature was written by the son also does not, by itself, negate the validity of the return.  Common factors in the tacit consent doctrine include whether the non-signing spouse had filed a separate return, whether there was a prior history of filing joint returns, whether the non-signing spouse had objected to the return after it was filed, and whether there was a pattern of one spouse handling the financial matters.

All of these factors weighed in favor of tacit consent in this case.  Anjali repeatedly testified that she did not review the returns by choice because she expected her husband to handle them.  She did not file any returns on her own and there is no record of her contacting the IRS to object to the joint filing.  The couple had also been consistently filing joint returns for the prior five years. These facts were supplemented by Anjali’s admissions that she chose not to review the returns.  The Court was able to confidently find that the 2004 joint return was valid via the tacit consent doctrine.

However, the opinion moves into more complicated territory when determining whether the extended time periods for the IRS to assess the return were valid.  To do this, the Court first reviews whether the Form 2848 appointing Mr. Grossman as a representative was valid as to each of the Sonis and then it discusses whether the eight Forms 872 were also valid as to each spouse.  As the Court acknowledges, “[t]he Code treats married taxpayers who file jointly as one taxable unit; however, it does not convert two spouses into one single taxpayer.  Spouses filing a joint return are separate taxpayers, and each spouse has an absolute right to extend or not extend the time within which to assess…A waiver to extend the period to assess a deficiency is valid only as to the spouse who signs the waiver.”

The Court first finds that Om’s signature on the Form 2848 was valid.  It then uses common law agency principles to find that, as to the first two extensions signed by Mr. Grossman, Om had delegated that authority because he treated Mr. Grossman as his representative throughout the time period in question.

But how does this extend to Anjali?  Common law agency principles would not work here because there is no evidence of Anjali directing Mr. Grossman to act as her representative.  Instead, the Court states, because Anjali gave Om “tacit consent to handle tax matters…we might be able to rely on that authority to conclude Om authorized Mr. Grossman’s representation of Anjali.”  The only further analysis the Court makes on this point is to note that Anjali remained silent as to the representation, thus allowing the IRS the impression that Mr. Grossman represented both parties, and therefore making his signatures on the first two Forms 872 valid. The Court’s conclusion is that “[b]ecause Om authorized Mr. Grossman’s representation, Anjali also tacitly consented, through Om’s agency.”

The Court takes this position a step further by then finding that the next six Forms 872 signed by Om and by his son signing on behalf of Anjali, without her direct knowledge, were also valid on the basis that Anjali had tacitly consented to letting Om handle all financial matters and that she never showed any due diligence in becoming involved in resolving the couple’s tax matters.  The Court found that “[w]hile Anjali may not have expressly given her husband authority to sign specific forms, it was well understood that Anjali gave him implied authority to act on her behalf.”

The specific facts in this case, particularly Anjali’s own testimony that she did not want to deal with any tax matters and trusted her husband to handle them, convinced the Court that she had given Om a blank check for any decisions made regarding taxes.  In doing so, however, the Court took the specific doctrine of tacit consent as applied to confirming the validity of joint returns and converted it into a general concept of “tacit consent to handle tax matters,” with only limited further analysis.  This expansion of the doctrine raises concerns, especially as to cases that may not have such clear spousal testimony as to the consent.  If a spouse has indeed given tacit consent to a joint return, it does not automatically follow that they have tacitly consented to each and every decision the other spouse later makes regarding that return.  The consequences of a broad reading of the tacit consent doctrine could be quite severe to a taxpayer’s individual rights and rigorous analysis should be required to justify such conclusions.

A reason that does support this decision concerns the impact of the documents on the IRS.  The IRS relied on the signed document to extend the statute and, in the case of the return, to assess the liability.  If one taxpayer can come back later after the statute has expired and say I did not sign this and did not consent to filing this, then the IRS is put in a bad position.  Here, the Court seemed to find that the burden to undo the potential harm of having the statute extended should fall on Anjali.  That does not necessarily seem wrong on the facts in the Soni case, but this presents a difficult situation that can also come up in other contexts, such as the filing of joint Tax Court petitions in situations where one spouse is claiming they have the other spouse’s authority to file a joint petition. 

It thus remains an open question as to how far the tacit consent doctrine can be expanded in future cases.  Specifically, if one party is passive in the circumstances surrounding a tax liability, how far should the IRS or the Tax Court go to make sure that the other party is on board?  In the interim, the major takeaway from this case is that spouses will not get very far in arguing that they are absolved by having taken a head in the sand approach to joint tax matters.

Goldring Is Back – With a Circuit Split

Last year, I wrote a couple of blog posts (here and here) about an order by the Eastern District of Louisiana: Goldring v. United States, 2020 U.S. Dist. LEXIS 177797, 2020 WL 5761119 (E.D. La. Sept. 28, 2020).  A significant amount was at issue, so the Goldrings appealed to the Fifth Circuit, which issued its decision recently: Goldring v. United States, 2021 U.S. App. LEXIS 29832, 2021 WL 4520343 (5th Cir. Oct. 4, 2021). 

The primary issue in the case was the proper treatment of a settlement award resulting from a 1997 cash-out merger of a privately held corporation in which Ms. Goldring owned shares.  Instead of taking the offered amount, she sued the company and its directors, asserting claims of unfair dealing and breach of fiduciary duty and seeking either the fair value of those shares or to retain her 15% stake.  The state court held that her shares were worth more than twice the amount she was offered in the merger. 

In 2010, she received a total award of almost $41 million, including $13,684,800 for the fair value of her shares, $26,252,741 for pre-judgment and post-judgment interest (“Interest Award”), and various other fees and costs.  The taxpayers reported the entire award on their 2010 tax return as a long-term capital gain.  The IRS audited the return, concluded that the Interest Award should have been reported as ordinary income, and assessed a deficiency of $5,250,549 plus interest in 2017.  The taxpayers challenged that deficiency in a refund suit, but both the district court and the Fifth Circuit ruled for the government on this issue.

But that’s not what I’m here to tell you about.  I’m here to talk about the procedural issue of how underpayment interest should be computed on that deficiency.

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The underpayment interest issue involved the treatment of “credit-elect transfers.”  The rule for this is relatively unknown, as it is set forth only in caselaw and a Revenue Ruling, rather than in the Code.  The plaintiffs in this case sought to expand the rule (a) beyond the situations in which it was first applied and (b) in a way that the only Circuit Court to have ruled on the question had rejected.  That earlier decision was FleetBoston Fin. Corp v. United States, 483 F.3d 1345 (Fed. Cir. 2007).  The district court in Goldring followed the majority decision in FleetBoston and granted summary judgment to the government.  The Circuit Court overruled the district court on this issue and ruled consistently with some lower court cases and the dissent in FleetBoston.

More details are available at the earlier blog posts, but for now here’s a simplified version of facts that would raise the issue:

  • Taxpayer files tax return for Year 1 (after requesting extension) on October 15th, showing tax liability of $220,000 and payments (withholding or estimated tax payments) of $270,000, for a net overpayment of $50,000. 
  • Taxpayer elects to have the $50,000 applied to estimated taxes for Year 2, instead of getting a refund.
  • IRS audits the Year 1 tax return and determines that the proper tax liability was $260,000 instead of $220,000, a $40,000 deficiency.

Section 6601(a) says that underpayment interest is imposed if the “amount of tax imposed . . . is not paid on or before the last date prescribed for payment.”  As of that last date prescribed, April 15th of Year 2, Taxpayer had paid $270,000 against the re-determined tax liability of $260,000.  Under a literal reading of the statute, the government can’t impose deficiency interest at all.  However, courts decided to interpret section 6601(a) to mean that interest started running when the tax was “due and unpaid.”  This itself was, of course, a favorable result for the government, which otherwise couldn’t collect any interest at all.

The tax became “unpaid” not on April 15th of Year 2, but when the $50,000 was applied to a different tax year.  On the effective date of the credit – equivalent to a refund for Year 1 and payment for Year 2 – the $50,000 left the account for Year 1 and was moved to Year 2.  At that point, the tax liability as redetermined is $260,000 and the payments, net of the credit, are only $220,000.  At that point, the tax is “due and unpaid” and underpayment interest starts running.

But what was the effective date of that credit to Year 2?  The date that the return for Year 1 was filed, making that election to apply the overpayment shown on the return to Year 2’s estimated taxes?  The date of the specific installment of Year 2’s estimated taxes that Taxpayer chose as where the overpayment should be applied?  Something else?  Eventually, the courts and the IRS reached a taxpayer-favorable rule, which was recorded in Revenue Ruling 99-40 :

When a taxpayer elects to apply an overpayment to the succeeding year’s estimated taxes, the overpayment is applied to unpaid installments of estimated tax due on or after the date(s) the overpayment arose, in the order in which they are required to be paid to avoid an addition to tax for failure to pay estimated income tax under sections 6654 or 6655 with respect to such year. 

. . .

When a taxpayer reports an overpayment on its income tax return, interest will be assessed on that portion of a subsequently determined deficiency for the overpayment return year that is less than or equal to the overpayment as of: (1) the date on which the Service refunds the overpayment without interest; or (2) the date on which the overpayment is applied to the succeeding year’s estimated taxes.

The assumption was that, if the transfer from Year 1 were not needed because Taxpayer’s other payments were sufficient to cover the Year 1 tax liability, the remainder would be refunded.  But what if it weren’t?  Let’s revisit that simple example.

  • Taxpayer files tax return for Year 1 (after requesting extension) on October 15th, showing tax liability of $220,000 and payments (withholding or estimated tax payments) of $270,000, for a net overpayment of $50,000. 
  • Taxpayer elects to have the $50,000 applied to estimated taxes for Year 2, instead of getting a refund.
  • Taxpayer doesn’t need the $50,000 to meet its obligations for estimated taxes in Year 2.  It is part of an overpayment for Year 2 that Taxpayer elects to have applied to estimated taxes for Year 3, instead of getting a refund.
  • Taxpayer doesn’t need the $50,000 to meet its obligations for estimated taxes in Year 3, either.  It is part of an overpayment for Year 3 that Taxpayer elects to have applied to estimated taxes for Year 4, instead of getting a refund.
  • IRS audits the Year 1 tax return and determines that the proper tax liability was $260,000 instead of $220,000, a $40,000 deficiency.
  • Taxpayer doesn’t need the $50,000 to meet is obligations for estimated taxes in Year 4, either.  It is part of an overpayment for Year 4 and the government applies $40,000 of the overpayment to pay the deficiency in Year 1.

That, in simplified form, is what the Goldrings did.  They anticipated that the IRS might conclude that the Interest Award was ordinary income, so they left money with the IRS to cover any eventual deficiency and avoid interest on that deficiency.  Making a deposit would have been a more certain way to avoid interest on the eventual deficiency, but that’s not what they did.

The caselaw and Revenue Procedure didn’t address this situation.  A few lower courts, and the dissent in FleetBoston, concluded that underpayment interest for the Year 1 deficiency wouldn’t start running until it was applied to Year 4 effective as of April 15th, 2015 – the last date prescribed for payment.  Under that approach, the amount of interest Taxpayer had to pay on the $40,000 deficiency was minimal.  The majority in FleetBoston, however, said once Taxpayer decides to transfer the $50,000 from Year 1 to Year 2, that amount should be treated as leaving the account for Year 1 and moving to the account for Year 2 no later than the date prescribed for payment for Year 2.  The district court in Goldring agreed with FleetBoston, but the Fifth Circuit didn’t.

The Fifth Circuit’s reasoning was not entirely clear.  I argued in the earlier blog posts on the district court decision that a ruling contrary to FleetBoston might be reasonable.  For example, a court might conclude that the previous line of rulings – a one-time application of the overpayment to estimated taxes for the following years – could be extended to situations when a taxpayer continuously rolls the amount forward for several years.  The earlier courts determined that the overpayment moved to Year 2 as of the date the taxpayer would receive a benefit (avoiding the penalty for failure to pay estimated taxes) in Year 2. If there was no benefit in Year 2, because it is neither used for estimated tax obligation nor refunded, the IRS treats the transfer from Year 1 as effective on the unextended filing date for Year 2.  Would the same principle apply to cover rollovers to Year 3, Year 4, etc.?  That is, is the money treated as remaining in the account for Year 1 – and the tax liability there is not “due and unpaid” – until the taxpayer receives a benefit in a future year, either by application to estimated taxes or refund?  Possibly, although that is not consistent with how these amounts are reported on Form 1040 for Year 1, Year 2, Year 3, etc.  But the Fifth Circuit did not rule narrowly in that way. 

The court focused on a broad statement of the purpose of interest.  “Under the use-of-money principle, a taxpayer is liable for interest only when the Government does not have the use of money it is lawfully due.”  Mentioning “use-of-money” is guaranteed to raise the hackles of DOJ Tax Division, which rejects taxpayer arguments to treat this as a broad equitable principle rather than a limited tool of statutory interpretation. 

I think the caselaw for the most part is consistent with DOJ Tax Division’s viewpoint.  Some of the so-called use-of-money cases have made broad statements such as that, but their actual holdings have been much narrower.  They involved either (a) determining the effective date of changes in tax liability, as later than when underpayment interest generally starts or (b) determining the effective date of changes in the amount paid.  Category (a) revolves around whether the change is due to “subsequent operational events”; category (b) involves crediting an overpayment to the following year’s estimated taxes, the first simplified example above.  Courts have for the most part used the principle to interpret specific statutory provisions in unusual circumstances, rather than as an all-purpose argument for equitable results.

The court did not think much of the government’s argument.  “Further, like the FleetBoston majority, the Government’s argument in this case fixates on theoretical migration of credit-elect overpayment funds from one tax year to another.”  I think describing it as “theoretical” is a bit much.  One of the long-standing, fundamental principles of tax administration is that tax liabilities and payments are accounted for separately by taxpayer, type of tax, and tax period.  Movement of funds, from one tax period to another, is subject to specific procedures and restrictions.  This treatment of credit-elect transfers is no more “theoretical” than applying any funds received from a taxpayer to the tax period the taxpayer specifies.

As support for its conclusion, the court stated that the government “completely ignores the simple, undisputed fact that the IRS was never deprived of its use of the money the Goldrings lawfully owed it at any point during the five-year underpayment interest assessment period.”  I think the court is effectively asserting a broad “netting” principle – that an overpayment in any tax year can be used to offset an underpayment in another tax year to reduce interest on the latter.

The problem with this argument is that the netting provision enacted by Congress has a narrower scope and arguably prohibits what the Fifth Circuit did in Goldring.  Section 6621(d) states:

To the extent that, for any period, interest is payable under subchapter A and allowable under subchapter B on equivalent underpayments and overpayments by the same taxpayer of tax imposed by this title, the net rate of interest under this section on such amounts shall be zero for such period.

This only applies, based on its literal terms, when interest is payable on the underpayment and allowable on the overpayment.  But the amounts transferred to Year 2, then Year 3, then Year 4 never would have accrued overpayment interest, under the regulations for such transfers.  (Second 6621(d) is really for the benefit of corporations, who for the same period might pay a higher interest rate on underpayments than the interest rate they receive on overpayments.)  You can argue for a broader application of netting between tax periods than provided by section 6621(d), but that conclusion is not necessarily easy to reach.  The question you have to answer:  If Congress didn’t intend to exclude that possibility, why did they include the limitation that interest must be payable on the underpayment and allowable on the overpayment?

I’m not opposed to the result per se, but I’m not convinced by the opinion.  I would prefer to see a more analytical approach along one or both of these lines – narrow expansion of the previous line of cases; or broad netting between tax periods.  I would prefer that the decision recognize and address the difficulties and limitations in reaching that answer, rather than rely on a broad equitable principle.  However, the courts decide these issues, not me, and the judges are normally generalists, rather than tax experts.  As the Fifth Circuit said in Cornelius v. Commissioner, 494 F.2d 465 (5th Cir. 1974):

Ours has been the more mundane assignment of contouring the codified curlicues of Subchapter S to the Code’s synoptic minutiae. Being mere mortals unendowed with cosmic tax wisdom, we have performed our task as well as our fallible mentalities and compositions will permit.

Where do we go from here?  The government filed a petition for a rehearing en banc on November 18th.  Based on the DOJ Tax Section’s opinion of “use-of-money,” I wasn’t at all surprised.  There is, of course, no guarantee that the court will grant a rehearing or that the en banc court would reach a different decision.

So, assuming the decision is not reversed by an en banc rehearing, we have a new circuit split.  In recent years we’ve seen a lot of activity with respect to a different interest issue for which a circuit split developed.  I doubt that we’ll see the same swift development here that we saw there; there are fewer of these “rolling credit-elect transfer cases” than taxpayers seeking to bring stand-alone suits for overpayment interest in district court.  But we’ll see.

The Fifth Circuit Parts Ways with the Ninth Circuit Regarding the Non-Willful FBAR Penalty

We welcome guest blogger Andy Weiner today to provide insight on a very important case decided last year.  Professor Weiner teaches at Temple Law School where he directs their LLM program in Tax and, starting this fall, also directs their low income taxpayer clinic.  Prior to arriving at Temple, Professor Weiner spent more than a decade as an attorney in the Tax Division of the Department of Justice, initially in the Appellate Section, where he briefed and argued approximately 50 cases throughout the United States Courts of Appeals, and then at the trial level in the Court of Federal Claims Section. He received numerous distinguished service awards during his tenure.  Keith

In United States v. Bittner, the Fifth Circuit reckons with the crack down on hiding wealth offshore. At issue is the non-willful penalty in 31 U.S.C. § 5321(a)(5)(A) for failing to report interest in foreign financial accounts on an annual Report of Foreign Bank and Financial Accounts known as an FBAR. The statute provides the Secretary of the Treasury “may impose a civil monetary penalty on any person who violates, or causes any violation of, any provision of section 5314 . . . not [to] exceed $10,000.” As explained by the Fifth Circuit, the case “hinges on what constitutes a ‘violation’ of section 5314: the failure to file an FBAR (as urged by Bittner) or the failure to report an account (as urged by the government).” Slip Op. at 13. On the surface, it’s a straightforward question of statutory interpretation, and not a particularly close one at that. It becomes more complicated, however, when you consider questions of purpose and fairness, which may help to explain why the Fifth Circuit and the Ninth Circuit split on the issue.

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Bittner has spent most of his life in Romania. Between 1982 and 1990, he lived in the United States and became a citizen. He then returned to Romania and made a fortune as an investor. Through holding companies, Bittner controlled dozens of bank accounts in Romania, Switzerland and Liechtenstein. He did not file timely FBARs for 2007 to 2011 disclosing these accounts. The IRS imposed the maximum non-willful penalty of $10,000 regarding each account for each year. Bittner’s total penalty liability came to $1.77 million.

Bittner argued his liability should be capped at $50,000 based on his failure to file an FBAR for each of five years. As mentioned, that depends on what qualifies as a violation of 31 U.S.C. § 5314 subject to a penalty. Section 5314 states that the Secretary “shall require a resident or citizen of the United States . . . to keep records, file reports, or keep records and file reports, when the . . . person makes a transaction or maintains a relation for any person with a foreign financial agency.” By the Fifth Circuit’s reading, a person violates the statute according when he or she fails to report “a relation . . . with a foreign financial agency.” Bittner pointed out that the statute is not self-effectuating and that the implementing regulations require filing one FBAR that reports all applicable accounts. But that does not affect the meaning of the statute, as the Fifth Circuit explained: “Streamlining the process in this way, . . . cannot redefine the underlying reporting requirement imposed by section 5314.” Slip Op. at 17.

The Fifth Circuit also looked to the surrounding penalty provisions. Section 5321(a)(5) includes both a non-willful and a willful penalty, and the latter unquestionably treats each failure to report an account as a violation. Specifically, 31 U.S.C. § 5321(a)(5)(C) provides that “any person willfully violating, or willfully causing any violation of, any provision of section 5314” is subject to a maximum penalty equal to the greater of $100,000 or 50% of “the balance in the account at the time of the violation.” The reasonable cause exception to the non-willful penalty at 31 U.S.C. § 5321(a)(5)(B)(ii) likewise treats each failure to report an account as a violation, excusing “such violation” if “due to reasonable cause” and “the balance in the account at the time of the transaction was properly reported.” The same word in the definition of the non-willful penalty presumably bears the same meaning as it does in these related provisions.

The Fifth Circuit presents a compelling case based on the text of the statute that each failure to report a foreign bank account is a violation subject to a non-willful FBAR penalty. But why should Bittner, who maintained many foreign accounts ostensibly for legitimate business reasons and who did not willfully fail to report them on an FBAR, owe $1.77 million? Given the unintentional nature of the conduct, there’s little, if any, deterrence value to be gained. What then is the point of such significant penalty liability? The history of the non-willful penalty raises the prospect that it has outlived some of its usefulness.

The original FBAR reporting requirement in the Bank Secrecy Act of 1970 was enforced only by a willful penalty up to $100,000. In 2004, following a report by Treasury that perhaps hundreds of thousands of taxpayers were hiding wealth offshore and not filing FBARs, Congress increased the maximum willful penalty to 50% of the balance in an account not properly reported and added a non-willful penalty up to $10,000. Congress sought to make getting caught prohibitively expense and installed the non-willful penalty as a floor on the cost of non-compliance. Then, in 2010, Congress enacted the Foreign Account Tax Compliance Act, which required foreign banks to report account information of U.S. taxpayers. Bank reporting has proven much more efficient and effective at enforcing FBAR compliance and weakened the justification for the maximum non-willful penalty.

Still, the maximum penalty has its place, for example, as a proxy for taxes that the account holder avoided. Finding the appropriate balance is a matter of IRS discretion and the penalty mitigation guidelines at IRM 4.26.16-2. A person must cooperate with the examination and have a clean record in terms of prior FBAR penalty assessments, criminal activities, and civil tax fraud in any year of a non-willful FBAR violation. If these criteria are met, examiners are instructed to “limit the total mitigated penalties for each year to the statutory maximum for a single non-willful violation,” unless “in the examiner’s discretion . . . , the facts and circumstances of a case warrant a different penalty amount.” IRM 4.26.16.5.4.1 (06-24-2021). Among the factors an examiner should consider is “the harm caused by the FBAR violation,” i.e., lost tax revenue. IRM 4.26.16.5.2.1 (06-24-2021).

There is no indication why the IRS sought the maximum penalty liability against Bittner. The Fifth Circuit seemed to assume that Bittner’s liability was justified by “Congress’s central goal in enacting the BSA . . . to crack down on the use of foreign financial accounts to evade tax.” Slip Op. at 22. The Ninth Circuit in United States v. Boyd, 991 F.3d 1077 (2021), on the other hand, observed that Boyd amended her return to include income from her foreign bank accounts and proceeded to conclude that her non-willful penalty liability from failing to report 13 accounts in one year could not exceed $10,000. Tax avoidance (or the lack thereof) weighs heavily on courts notwithstanding that the relevant information is not necessarily disclosed in FBAR cases.

The lesson here for foreign account holders is to cooperate with an examination and pay the tax owed on income from foreign bank accounts. If the IRS does not mitigate the non-willful penalty liability, the account holder is in position to seize the higher equitable ground in court. The lesson for the IRS is to follow the mitigation guidelines and consider any departures from those rules carefully. The Supreme Court may take up Bittner to resolve the conflict with the Ninth Circuit, in which case I would expect it to affirm that each failure to report a foreign bank account is a violation of section 5314. But that will not end the debate over the appropriate level of non-willful penalty liability. To the contrary, the more the IRS has discretion, the more likely those disputes will endure.

Diving Beneath the Surface of In re Webb

We welcome back Ken Weil to help us parse a technical bankruptcy issue impacting taxes.  Ken has his own practice in Seattle that focuses on representing individuals with tax debt and resolving that debt through administrative action with the IRS or through bankruptcy. He has written a book on his specialty area, Weil, Taxes and Bankruptcy, (CCH IntelliConnect Service Online Only) (3d ed. 2014). He is one of the top experts at the crossroads of personal bankruptcy and taxes. We are fortunate to have him back with us again. Keith

In Webb v. Internal Revenue Service (In re Webb), Bankr. N.D. W.Va. Adv. Proc. No 21-00014 (November 8, 2021), a Chapter 13 debtor brought an adversary proceeding to hold the IRS in contempt for an improper setoff of a tax refund against a tax debt.  On the IRS’s Rule 12(b)(6) motion to dismiss, the court held for the IRS. 

The court stated that “[a]n order of contempt is a serious reprimand and is appropriate only in the case of a deliberate violation in the face of succinct directions to the contrary.”  Id. at p.3.  Because the debtor’s Chapter 13 plan did not explicitly prevent tax setoffs, the court found that the high standard necessary to hold the IRS in contempt was not met.  In note 2, the court stated that it “need not discuss the legality of the IRS’s actions because the Debtor only alleges the [IRS’s] actions constituted contempt of the confirmation order.”

Because contempt was the only issue before him, Judge Bissett decided the case without diving into the more complicated issues lurking beneath the surface.  What makes this case blog-worthy are the issues that would or could have been before the court if the case had been presented differently.  In particular, because of the IRS’s implicit election to treat its 2019 tax debt to Ms. Webb as a prepetition debt, there are multiple opportunities to discuss an analytical tool that I call deemed versus defined, which I first learned from Professor Harvey Dale almost 40 years ago.

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   1.   Factual background.

          In November 2019, Marie Webb (the Debtor) filed a Chapter 13 petition.  In her schedules, she listed taxes owed for 2013 and 2018.  In April 2020, the IRS filed its proof of claim, which it amended subsequently.  It listed the 2013 tax owed as an unsecured general claim, i.e., nonpriority claim.  It listed the 2018 tax owed as an unsecured priority claim.  In addition to the taxes scheduled by the Debtor, the IRS’s proof of claim listed the 2019 tax year as an unsecured priority claim and estimated the tax due. 

          In her Chapter 13 plan, the Debtor agreed to pay the 2019 tax debt as a priority obligation.  Corrective Order Confirming Chapter 13 Plan, Webb Docket No. 45, p.5, ¶ 10 (February 19, 2021) (Corrective Order).  The Debtor’s Chapter 13 plan left all property the Debtor acquired postpetition in the bankruptcy estate.  Corrective Order p.8, ¶ 10.

          In March 2021, the IRS set off the Debtor’s 2020 tax refund (IRS’s debt) against the 2019 tax obligation (IRS’s claim). In the Bankruptcy Code, setoffs are viewed from the creditor’s perspective.  Thus, the IRS’s refund owed is the debt, and the taxpayer’s unpaid tax obligation is the claim.  The Tax Code and 11 U.S.C. § 553 use the word “offset.”  I use “setoff” when used as a noun or adjective and “set off” when used as a verb. The Debtor objected to the setoff by filing an adversary proceeding seeking to hold the IRS in contempt.

     2.   Applicable law and its application in Webb.

          This paragraph discusses the law that would have been applicable if some of the underlying issues had been raised and argued by the parties.

          a.   I.R.C. §§ 1398-1399. 

          Tax Code §§ 1398 and 1399 provide rules for when a debtor’s tax year in the year of filing can be bifurcated.  The only time an individual’s tax year can be bifurcated is in an asset, Chapter 7 case. Assuming a calendar year-end, if the tax year of filing is bifurcated, a prepetition tax year runs from January 1 to the day before the petition is filed.  A second, postpetition year runs from the day of filing to December 31. See I.R.C. § 1398(d) (rules for taxable years of individual debtors); I.R.C. § 1399 (“Except in any case to which section 1398 applies, no separate taxable entity shall result from the commencement of a case under title 11 ….”); and Hall v. United States, 566 U.S. 506, 516 (2012) (Chapter 13 postpetition taxes are not incurred by the estate; they are a liability of the debtor).

          The Debtor filed for bankruptcy in November 2019.  This means the 2019 tax year ended after the bankruptcy filing and was a postpetition tax year.  The IRS’s proof of claim treated 2019 as a prepetition tax year.

          b.   11 U.S.C. § 1305.

          This paragraph discusses the things we know and do not know about 11 U.S.C. § 1305, and it looks at Webb through a § 1305 lens.

               i.   What we know about § 1305.

          Under 11 U.S.C. § 1305, a governmental unit can elect to file a proof of claim for taxes that [first] become payable while the case is pending.  11 U.S.C. §§ 1305(a)(1) and 1322(b)(6); and see Joye v. Franchise Tax Board Cal. (In re Joye), 578 F.3d 1070, 1075-1077 (9th Cir. 2009) (payable means first becomes payable); and In re DeVries, Bankr. D. Id. No. 13-41591 (April 28, 2015), 2015-1 USTC ¶ 50,287 (only governmental entity may file § 1305 claim).  Internal Revenue Manual guidance is found at IRM 5.9.10.9.2 (08-07-2018).

          Beyond the proof of claim, no special form is needed for a governmental unit to elect § 1305.  The IRM states that IRS personnel should file a proof of claim and add to the proof of claim language stating that the proof of claim is being filed under the authority of § 1305.  IRM 5.9.10.9.2(6) (08-07-2018).  The IRS’s proofs of claim in Webb did not have this language. 

          If the governmental unit so elects and the proof of claim is accepted as filed, the governmental unit’s postpetition claim is treated as if it were a prepetition claim.  In other words, a postpetition claim is deemed to be a prepetition claim.  Beyond this point, the applicable law is murky.

               ii.  The confusing world of § 1305.

          The election to use § 1305 raises a number of confusing issues.

                     I.  Are § 1305 claims entitled to priority?

          The argument that § 1305 claims do not receive priority is based on 11 U.S.C. § 507(a)(8), which has no provision for priority treatment of a deemed prepetition claim under § 1305.  In re Jagours, 236 B.R. 616, 619-620 (Bankr. E.D. Tex. 1999) (postpetition claim treated as filed prepetition but not entitled to priority because such a claim does not fit within the language of § 507(a)(8)(i)).  Cases that allow priority rely on § 1305(b), which states that a § 1305 claim shall be allowed or disallowed the same as if such claim had arisen prepetition.  In re Jagours, 236 B.R. at 616 n.3.  The IRM straddles the fence.  Compare IRM 5.9.10.9.2(8) (08-07-2018) (benefit of filing § 1305 claim is that “Service will be paid as a priority creditor”), with IRM 5.9.10.9.2(9) (08-07-2018) (risk of filing § 1305 claim is that “§ 1305 claims may not be accorded priority status”).

                     II.  Is a § 1305 claim dischargeable?

          In dicta, Jagours stated that § 1305 claims are not dischargeable.  In re Jagours, 236 B.R. at 620 (“rights of the creditor to collect are not impaired by the Chapter 13 plan”).  The IRM appears to disagree.  IRM 5.9.10.9.2(9) (08-27-08) (“Once provided for in the plan, the tax liability may be dischargeable.”)

                     III. Is postpetition interest paid on § 1305 claims? 

          Assuming funds are insufficient to pay interest to unsecured creditors, postpetition interest will not run on a discharged § 1305 claim, regardless of whether the § 1305 claim is paid-in-full.  If the § 1305 claim is not discharged or if it is deemed a postpetition claim, postpetition interest will continue to run.  See Ward v. Bd. of Equalization of Cal. (In re Artisan Woodworkers), 204 F.3d 888 (9th Cir. 2000) (postpetition interest payable on nondischargeable tax debt fully paid through a Chapter 12 plan).

                     IV.  Are penalties paid on § 1305 claims?

          In Webb, what happens to the failure-to-pay penalty (assuming the Debtor filed her 2019 return timely)?  If a prepetition claim, during the bankruptcy, the penalty does not accrue.  I.R.C. § 6658.  If a prepetition claim, the portion of the penalty that accrued prepetition is dischargeable in the bankruptcy, regardless of age.  See 11 U.S.C. § 1328(a)(2) (by omission from the listed exceptions, all penalties discharged regardless of age; this rule is one of the last vestiges of the old Chapter 13 superdischarge that disappeared with the 2005 revisions to the Bankruptcy Code).  If a postpetition claim, the penalty accrues.  

               iii. Webb and § 1305.

          With its proofs of claim in Webb, the IRS implicitly filed a § 1305 claim and took the position that it was entitled to priority.  The Debtor agreed to that treatment.  If the plan is completed, the tax would be paid-in-full.  At that point, only the payment of interest would turn on the dischargeability issue. 

          If postpetition interest and penalties are not paid, this is a sweet deal for the Debtor, as a postpetition tax is paid interest-free over the life of the plan.

          c.   11 U.S.C. §§ 541, 1306, and 1327(b).

          Bankruptcy Code §§ 541 and 1306 tell us what property is included in the bankruptcy estate.  Section 541 broadly defines bankruptcy estate property.  Section 1306(a)(1) provides that property of the estate includes all property that the Chapter 13 “debtor acquires after the commencement of the case but before the case is closed, dismissed or converted ….”  Upon plan confirmation, all property of the estate vests in the debtor.  11 U.S.C. § 1327(b).  Section 1327(b) does not override § 1306.  In re Shay, 553 B.R. 412, 417-418 (Bankr. W.D. Wash. 2016) (Lynch J.).  A priori, it applies to prepetition property that is returned to the debtor upon confirmation.

          The Debtor’s Chapter 13 plan included all property acquired postpetition in her bankruptcy estate, which means it included any potential tax refund in her bankruptcy estate. Whether the refund could even be estate property is also debatable.  Because the right to overpayment arose before the IRS made its setoff, it was most likely estate property.  Copley v. United States, 959 F.3d 118, 122-123 (4th Cir. 2020).  West Virginia is in the Fourth Circuit.  Otherwise, under I.R.C. § 6402(a), a “debtor is generally only entitled to a tax refund to the extent that her overpayment exceeds her unpaid tax liability.”  IRS v. Luongo (In re Luongo), 259 F.3d 323, 335 (5th Cir. 2001); and United States v. Gould (In re Gould), 401 B.R. 415, 424-425 (B.A.P. 9th Cir. 2009) (citing Luongo with approval), aff’d, Gould v. United States (In re Gould), 603 F.3d 1100 (9th Cir. 2010) (adopting BAP opinion).

          d.   11 U.S.C. §§ 327(a), 362(a)(3), (b)(26), and (c)(1).

          The automatic stay protects the debtor from collection action by creditors while a bankruptcy case is pending and before discharge is entered.  In particular, the creditor may not act to obtain possession of estate property.  11 U.S.C. § 362(a)(3).  An exception is that a governmental unit may set off postpetition a prepetition debt (a tax refund) against a prepetition claim (a debtor’s unpaid tax debt).  11 U.S.C. § 362(b)(26).  Here, the 2020 tax refund is a postpetition debt.

          The Debtor’s plan kept all property in the bankruptcy estate, and § 362(a)(3) stayed collection as to that property.  The automatic stay remained in place as long as the property remained bankruptcy estate property.  11 U.S.C. § 362(c)(1); and see also 11 U.S.C. § 362(c)(2) (if property had been returned to debtor, stay would have remained in place until the case was closed, dismissed, or the debtor received a discharge.)

          Judge Bissett stated correctly that the Debtor’s plan failed to address explicitly whether the setoff of a postpetition tax refund was permissible.  Consistent with § 1306, the plan did state that all property acquired postpetition would be property of the bankruptcy estate.  It also provided that the Debtor could keep the first $1,500 of any tax refund and the remainder should be sent to the Chapter 13 trustee.  Corrective Order p.2, ¶ 3.

          Pursuant to 11 U.S.C. § 1327(a), all creditors, including the IRS were bound by the terms of the plan, and the Debtor’s complaint so alleged.  Webb v. Internal Revenue Service (In re Webb), Bankr. N.D. W.Va.Adv. Proc. No. 21-00014, Docket No. 1, Complaint ¶ 23 (June 21, 2021).

          e.   Setoffs, mutuality of obligation, and deemed versus defined.

          This paragraph discusses when setoffs are allowed in bankruptcy and the concept of mutuality of obligation.  It then applies the analytical tool of deemed versus defined to ask whether mutuality of obligation existed when the IRS made its setoff in Webb. For a thorough analysis of setoffs and taxes, see K. Fogg, “The Role of Offset in the Collection of Federal Taxes,” added to SSRN on February 26, 2021 and forthcoming in the Florida Tax Review.

               i. Setoffs and mutuality of obligation.

          As a general rule, the Bankruptcy Code “does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose” prepetition against a claim of the debtor that arose prepetition. One exception is the improvement-in-position test that a bankruptcy trustee can use to claw back into the bankruptcy estate setoffs made in the 90-day prepetition period. 11 U.S.C. § 553(b).11 U.S.C. § 553(a).

          Valid setoffs require a mutual debt, i.e., mutuality of obligation.  The debt and claim must be between the same persons.  Because a bankruptcy filing creates a new entity, i.e., the postpetition debtor, the mutual debt requirement may be flunked while a bankruptcy case is active.  For example, a setoff of a postpetition debt (IRS refund owed to the debtor in bankruptcy) against a prepetition claim owed by the prepetition debtor (IRS’s right to unpaid tax) is not a mutual debt.  After a bankruptcy case closes, this issue disappears.  There is no longer an existing bankruptcy case to force a division between events arising pre and postpetition.

               ii.  Did mutuality of obligation exist in Webb?

          The combination of the IRS’s implicit § 1305 election and its setoff of the 2020 refund against the 2019 claim also puts the deemed versus defined concept in play.  If the IRS’s 2019 tax claim is treated as defined, mutuality of obligation exists because the IRS set off a postpetition obligation against a postpetition claim.  This must be how the IRS viewed the world.  Yet, as long as the Debtor has rights in the overpayment, see n.3, supra, this setoff would violate the automatic stay.  11 U.S.C. §§ 1306 and 362(c)(1).  If the 2019 tax refund is treated as deemed, i.e., prepetition treatment under the Debtor’s Chapter 13 plan, mutuality of obligation does not exist.  The IRS set off its postpetition debt against its prepetition claim.   

     3.   Conclusion.

          Judge Bissett is a wise man.  He found the straight-forward answer to the issue at hand.  He wisely and successfully avoided the difficult issues that were lurking beneath the surface. See Webb at n.2 (“the court need not discuss the legality of the IRS’s actions”).

          In lieu of filing an adversary proceeding alleging contempt and depending on the legal analysis one thinks is correct, the Debtor might have sued the IRS for (i) turnover under 11 U.S.C. § 542(b) for failing to pay the tax refund to the bankruptcy estate, (ii) violation of the automatic stay for exercising control over estate property, or (iii) making a setoff without mutuality of obligation.

Eleventh Circuit Finds Regulation Invalid Under the APA

One of the most significant tax cases of 2020 was Oakbrook Land Holdings, a case involving a challenge to regulations in a conservation easement deduction dispute. In Oakbrook, the Tax Court held that the regulation was properly promulgated under the Administrative Procedure Act. In today’s guest post Monte Jackel of Leo Berwick discusses  Hewitt, an important case out of the 11th Circuit, where the appellate court reached a different conclusion. Les

In a prior post on May 15, 2020 “Conservation Easement Donation and the Validity of Tax Regulations”, I wrote about the Oakbrook Land Holdings Tax Court case (154 T.C. 180 (2020), decided a few days earlier.

The Oakbrook court dealt with the same regulation as the Hewitt case (No. 20-13700, 11th Cir. 2021) that is the subject of this follow up commentary.

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The issue presented is whether, as required by the Administrative Procedure Act (APA), the IRS considered and responded in the final regulations to all “significant” comments to the proposed regulations relating to the extinguishment rule under the conservation easement deduction regulation that requires a proportion of the extinguishment proceeds to include donor improvements to the property. The IRS and Treasury in the final regulations did not address comments that addressed this rule in its “concise general statement of its [the regulation’s] basis and purpose”. This concise general statement is supposed to allow one to see the objections made to the proposed rule and why the agency, in this case the IRS, reacted to those comments as it did. The IRS, just like any other federal agencies, is required to give adequate reasons for its decisions and it is required to rebut vital relevant or significant comments. All the IRS is to state in the final regulation preamble that it “considered all comments” but the IRS did not respond specifically to the comment.

The Tax Court in Oakbrook Land Holdings ruled that either the comment not specifically responded to was not significant or, if it was significant, it was adequately responded to by the general statement that it considered all comments and by taking into account the administrative record. The Tax Court in that case gave the IRS the benefit of the doubt. However, the Eleventh Circuit Court of Appeals in Hewitt required a specific response to the comments made on the issue and put the burden on the IRS to show that it had adequately responded. Since the latter court held that the response was not adequate, the court held that the regulation was arbitrary, capricious, and/or an abuse of discretion under APA 706(2)(A) and was thus invalid.

And so, what does this all mean? There appear to be two choices. Either the taxpayer has the burden to establish that the comment made was significant and that it was not adequately addressed and the administrative record can be used to justify the IRS action. That is Oakbrook Land Holdings. The other approach is that the IRS must establish why the comment was not significant and why its response was adequate. That is Hewitt. And the reviewing court has the last word on whether the comments made were or were not significant-a huge dose of second-guessing.

What does this all mean for the future? The Hewitt case was an Eleventh Circuit opinion and so, under the Golsen rule, the Tax Court does not have to follow that case for taxpayers not within that circuit. But given the circuit court opinion, will this opinion effectively require the IRS to respond to almost every comment made and give a reason directed to that comment or otherwise risk invalidation of the regulation? That seems to be the risk the IRS will be taking if it does not act conservatively and respond to everything. The very recent foreign tax credit regulations seem to have taken the respond to everything approach and that does add pages and pages onto the regulation and become repetitive in a number of cases.

To make matters worse, the reviewing court will have the final say on what was significant and whether it was adequately responded to. Trying to avoid this issue by saying that a regulation was not a legislative rule does not seem to be a favored position in the courts. Can the OIRA review process help avoid mis-steps by the IRS in this area? That also remains to be seen but as I understand it that is where the burden of compliance should be in the current regulation process.

Will this process eat up precious IRS resources better spent elsewhere? Yes it will. Is it good for the tax system? That remains to be seen. The door is now wide open for taxpayers to step in and test the waters.

TIGTA Report on EITC Audit Procedures Suggests Room for Improvement in IRS Communication and Education Strategy

Today we welcome back guest blogger Anna Gooch. Anna highlights ongoing discussions of the IRS’s communication and education strategy between TIGTA, the IRS, and stakeholder groups. This topic is particularly timely following the President’s executive order on improving customer experience across the federal government, which states in part, that

Agencies should continually improve their understanding of their customers, reduce administrative hurdles and paperwork burdens to minimize “time taxes,” enhance transparency, create greater efficiencies across Government, and redesign compliance-oriented processes to improve customer experience and more directly meet the needs of the people of the United States.

The Secretary of the Treasury is specifically directed to

design and deliver new online tools and services to ease the payment of taxes and provide the option to schedule customer support telephone call-backs.  The Secretary of the Treasury should consider whether such tools and services might include expanded automatic direct deposit refunds based on prior year tax returns, tax credit eligibility tools, and expanded electronic filing options.

Creatively re-thinking taxpayer communication and education will help ensure that the agency’s new online tools and services make a meaningful difference in the taxpayer experience. Christine

In a report issued on September 2, 2021, the Treasury Inspector General for Tax Administration (TIGTA) released a report reviewing the IRS’ EITC audit practices and providing recommendations for improvement. In the report, TIGTA explained:

The IRS’s EITC examination strategy is not part of a larger IRS examination strategy that encompasses all examinations by which resources devoted to EITC examinations can be more easily assessed in the context of other challenges to taxpayer noncompliance. Also, due to IRS processing limitations, the IRS does not prioritize certain high-risk EITC claims for examination. Lastly, the IRS’s examination rates for EITC claims appear disproportionate with respect to certain Southern States; however, the examinations are aligned with tax returns flagged by IRS compliance filters.

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Based on these findings, TIGTA made the following recommendations designed to improve the processes by which the IRS selects EITC claims for audit:

1. [C]onsider how refundable credits, including the EITC, would be examined to a different extent if the claims are considered for compliance purposes closer to the proportion that they contribute to the Tax Gap.

2. Evaluate the current programming for the prerefund selection process to ensure that cases identified by both [Questionable Refund Program (QRP)] and [Dependent Database (DDb)] selection pools are prioritized for DDb prerefund selection.

3. Evaluate and revise the scoring process to ensure that the cases with the highest risk are scored as such.  This process should include adding weight to cases with higher QRP and DDb scores and [duplicate TIN filing] repeaters.

4. [T]ailor EITC-related educational efforts for the States with disproportionate error rates.

Of these four recommendations, three are focused on the IRS’ role as a revenue collector. The fourth recommendation, the only recommendation that the IRS did not agree to adopt, concerns the IRS’ role as benefits administrator. In rejecting that recommendation, the IRS relied on its belief that “it already has extensive outreach and education strategy in place,” including EITC Awareness Day and Refundable Credits Summit.

Although this report focuses solely on EITC audits, it provides an opportunity to explore the nature of current IRS outreach and education programs in the context of refundable credit compliance. The Refundable Credits Summit and EITC Awareness Day provide a window into such efforts.

On November 2 and 3, 2021, the IRS held its annual Refundable Credits Summit, a two-day conference hosted by the Wage & Investment Division and Return Integrity & Compliance Services. Commendably, the IRS has been holding these summits for several years now and invites various stakeholders – academics, nonprofits serving the target community, representatives of tax professional groups, LITCs, and tax preparation and VITA entities – to hear presentations from senior IRS leaders on topics relevant to refundable credits and to discuss concerns. The first day of the Fall 2021 Summit provided a summary of legislative and procedural developments regarding the Child Tax Credit and the Earned Income Credit, as well as progress made on advance payments of credits and the various portals associated with those credits. On the second day of the Summit, the IRS hosted a four-hour brainstorming session, requesting suggestions on ways to raise awareness of the availability of refundable credits. During this session, Summit participants offered ways in which the IRS can reach more Americans – posters in laundromats, billboards along highways, ads on local radio stations. There were seemingly endless ideas offered, and while raising awareness of refundable credits is undoubtedly important, this discussion highlighted the IRS’ limited view of “outreach.”

First, based on what was discussed during the Summit (and what was not discussed), it is clear that raising awareness is where the IRS’ plan ends. Reaching as many taxpayers as possible is admirable, but as several participants pointed out during the summit, the lack of a follow up education strategy from the IRS creates a risk that taxpayers will not understand how refundable credits apply to them and their circumstances, nor will they have resources to consult when they encounter a problem.  

Second, it seems the IRS views itself as an information provider and not as the entity that would communicate directly with taxpayers. Rather, though aware of geographic, cultural, and demographic differences among eligible populations, the IRS did not appear to envision any role for itself in communicating with these populations. Instead, the IRS looked to the attendees to conduct community-based outreach using IRS-provided resources. Understandably, the IRS is proud of increasing its stakeholders and the number of eligible individuals it reaches; however, the IRS has no effective way of analyzing whether its materials and efforts are useful or effective because it delegates this responsibility to stakeholders.  

Finally, the IRS failed to consider the importance of using data in its outreach campaigns. There exist data breaking down which areas are most at risk for failing to claim the expanded CTC, even if families in these areas are eligible. These areas should have not only a different, targeted outreach strategy, as TIGTA suggests, but also an intensive education campaign focusing on the communities where specific types of noncompliance occur.  The IRS also doesn’t seem to use data in analyzing its efforts after the fact. As one participant stated during the Summit, the IRS cannot just throw several campaigns out and hope that something sticks. If the IRS wants outreach and education to be effective, it must analyze what works and what doesn’t.

In terms of education, as noted in the recent TIGTA report, the IRS relies on its existing EITC Awareness Day to provide sufficient education to EITC claimants. According to the IRS website, “Awareness Day is an event organized by the IRS and its partners to educate the public about the EITC and requirements to claim the credit. The goal is to raise awareness of EITC to ensure every qualified worker claim and receive [sic] their EITC. We also ask you to join us in getting the right message out about the CTC/ACTC and the AOTC to the right people who deserve the credits” (emphasis added). Despite the IRS’ apparent goal to reach “every qualified worker,” the reach of Awareness Day is quite limited. In 2020, via its 1,500 “supporters,” the IRS reached 2 million individuals on EITC Awareness Day. While the IRS does state that “other activities such as news releases and articles for EITC Awareness Day” were conducted, it is silent as to what exactly these activities are or what their reach is, especially because the IRS relies so heavily on its “partners.” In 2020, 25 million taxpayers claimed the EITC on their return. Two million is 8% of 25 million – not exactly “every qualified worker.” The IRS does not publish much data on EITC Awareness Day, so it’s not entirely clear who is targeted, what the message is, or if there is any follow up, much less what communities the education actually occurred in.  The information that is published suggests that there is room for improvement of EITC (and other refundable credit) education efforts, particularly those targeted toward the 5 million taxpayers who are potentially eligible for the EITC but do not claim it.

The TIGTA report is just one example of where the IRS is failing to embrace its dual role as both revenue collector and benefits administrator, and outreach and education are just a small part of adopting that role. The IRS could begin to improve its educational programs by starting with small pilot programs targeting communities with high noncompliance or nonparticipation, as TIGTA suggests. From these programs, the IRS would be able to test and analyze multiple strategies and approaches to determine the best approach for larger markets. Among other changes, the IRS could revise its mission statement, create a specialized unit dedicated to benefits administration, adjust administrative processes, and improve communications to better reflect the role it has in administering some of the nation’s largest anti-poverty programs. Of course, all of this cannot happen overnight, but as Congress continues to place benefit administration in the IRS, the IRS must adapt accordingly.

Was Your Tax Court Petition Due December 7, 2021? Maybe it’s now due December 21!

We welcome back Guest Blogger Charles Markham who last posted on an issue I discussed earlier this week.  Charles practices in the Boston area and has been a volunteer with the Harvard tax clinic over the years.  He is both an Enrolled Agent and a United States Tax Court Practitioner based on having passed the test from the Tax Court.  He raises an interesting issue posed by the recent legislation creating a window of additional time to petition the Tax Court.  The issue here was one I remember discussing when the Guralnik v. Commissioner, 146 T.C. 230 (2016) (en banc) case caused a closure of the Tax Court several years ago due to snow.  If the Tax Court closes for part of a day but not all of a day how does not impact the timing of the filing of a petition.  Maybe we will soon have answers.  Keith

I received a Notice from Taishoff Law’s blog that Dawson was down on December 7, 2021.  I hadn’t been on Dawson in a while but as of 7:45 pm on December 7, 2021, while I was able to search cases, I was unable to log into the website to access my own cases or file a petition. 

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The Tax Court left a series of status messages on the website:

DAWSON OUTAGE

Investigating – We are currently observing issues of users unable to log into DAWSON and handling cases. We are currently investigating the issue.
Dec 7, 12:37 EST

Update – Our service provider is reporting issues with some of the services that DAWSON relies upon. We are working to get DAWSON back online.
Dec 7, 12:40 EST

Identified – Our service provider has reported that they have “identified the root cause and are actively working towards recovery.”
Dec 7, 12:44 EST

Monitoring – Our service provider has indicated that they are starting to see signs of recovery, but do not have an ETA for a full recovery. We are continuing to monitor the situation.
Dec 7, 13:34 EST

Update – Our service provider reports “We have executed a mitigation which is showing significant recovery in the US-EAST-1 Region. We are continuing to closely monitor the health of the network devices and we expect to continue to make progress towards full recovery. We still do not have an ETA for full recovery at this time.”
Dec 7, 17:20 EST

Update – We have been able to restore the public access enabling Case Search and Today’s Orders and Today’s Opinions. We are continuing to work towards a full recovery.
Dec 7, 17:25 EST

Update – It appears systems are recovering and users are able to login and access DAWSON. We are continuing to monitor to ensure the outage is resolved.
Dec 7, 19:49 EST

Update – Still observing some failures with the API. We are continuing to monitor the situation.
Dec 719:57 EST

Resolved – This incident has been resolved. Users can now log back into DAWSON.
Dec 720:36 EST

Actually, a few minutes after I started to write this, I checked again (around 8 pm EST) and I can now file a Tax Court petition–so the crisis appears to have passed.  Although the official website status report did not report full functionality until 8:36 p.m.

Interestingly, the Infrastructure Investment and Jobs Act, which was signed by President Biden into law (PL 117-58) on November 15, 2021 includes a new provision that appears directly on point to this situation:

SEC. 80503. TOLLING OF TIME FOR FILING A PETITION WITH THE TAX COURT.

a) IN GENERAL.—Section 7451 of the Internal Revenue Code of 1986 is amended […] by adding at the end the following new subsection:

‘‘(b) TOLLING OF TIME IN CERTAIN CASES.— ‘

“(1) IN GENERAL.—Notwithstanding any other provision of this title, in any case (including by reason of a lapse in appropriations) in which a filing location is inaccessible or otherwise unavailable to the general public on the date a petition is due, the relevant time period for filing such petition shall be tolled for the number of days within the period of inaccessibility plus an additional 14 days.

“(2) FILING LOCATION.—For purposes of this subsection, the term ‘filing location’ means—

“(A) the office of the clerk of the Tax Court, or

‘‘(B) any on-line portal made available by the Tax Court for electronic filing of petitions.’’.

“(c) EFFECTIVE DATE.—The amendments made by this section shall apply to petitions required to be timely filed (determined without regard to the amendments made by this section) after the date of enactment of this Act.

Note that the filing location in the new Internal Revenue Code Section 7451(b)(2) is the office of the clerk of the Tax Court or (author’s emphasis)“any on-line portal made available by the Tax Court for the electronic filing of petitions”.  That refers of course to DAWSON.  While the author believes this legislative provision was in response to Boechler and ongoing concerns about government funding shutdowns as well as significant weather events, it appears to be more far ranging.

IRC 7451(b)(1) states (author’s emphasis) that “in any case…in which a filing location [note—DAWSON] is inaccessible or otherwise unavailable to the general public on the date a petition is due…the relevant time period shall be tolled for…an additional 14 days”.

The author argues that if a Tax Court petition was due on December 7th that the eight hour downtime would trigger this two week tolling event.

Will the Tax Court see it this way?  Time will tell.  There will likely be some filings that find themselves in this fact pattern.  There may even be other cases:  petitions due today but inadvertently get postmarked late that will unintentionally get the windfall of this reprieve. 

But this does beg the question, how long does DAWSON need to be offline to trigger this provision.  DAWSON was offline for at least eight hours today and arguably most of the business day, but it is available now.  What about an hour offline?  The Tax Court should probably develop a bright line test for when 7451(b) applies and when it won’t.

When Is a Late Return Not Really “Late”?? – Part 2

Bob Probasco picks up from his post last week and continues discussing the tricky issue of when interest starts to accrue on refunds when the taxpayer may not have known that they had a return filing obligation on the due date of the return. Les

And now some observations and questions about that recent IRS legal memo on an overpayment interest issue.  The memo relied substantially on two cases addressing similar situations: MNOPF Trs. Ltd. v. United States, 123 F.3d 1460 (Fed. Cir. 1997) and  Overseas Thread Indus. v. United States, 48 Fed. Cl. 221 (2000).  (The Overseas Thread scenario is virtually identical to that in the memo.)  Normally, taxpayers receive overpayment interest from the filing due date of the return, if all payments that make up the overpayment were made by then.  These cases involved a statutory provision, Section 6611(b)(3), under which if the return is filed late, taxpayers do not receive overpayment interest before the date the return was filed. 

MNOPF established the principle that a return cannot be “late” if the taxpayer was not required to and did not file a tax return.  Overseas Thread addressed the situation of a foreign corporation that did not have a U.S. trade or business and therefore was not required to file an income tax return – but had to do so to claim a refund of excessive withholding tax on dividends from a U.S. source.  The court in that case determined that the tax return filed to claim a refund of an overpayment was only required by the normal filing date, and therefore late if not filed by then, if the taxpayer knew of the overpayment before the prescribed filing date.  Part I provided background on those two cases and the legal memo.  I think Overseas Thread and the memo leave a lot of questions, and they may be incomplete or even wrong.  Those rulings also could be applied much more broadly than the specific fact pattern they address. 

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What About Delays After Discovery?

Neither Overseas Thread nor the memo directly mentioned another obvious question.  Is the lack of knowledge, by the return due date, of a filing obligation a “blank check” for filing the return at a much later date?  In Overseas Thread, the delay between discovery of the filing obligation and filing the return was relatively short – at most from early October to mid-February.  What if TFI and OTI had waited another year or two to accrue additional interest?

The potential for a taxpayer to “park” money with the IRS at long as possible, earning interest at rates higher than the taxpayer could earn otherwise, may seem very counter-intuitive to those of us who deal with low-income taxpayers.  Their primary objective is getting a refund quickly, not the amount of interest payable.  But Treasury/IRS has expressed a similar concern in some contexts in the past.  (Perhaps that’s what Section 6611(b)(3) is all about – preventing such actions.  An alternative interpretation might be that it’s the flip side of the penalty of Section 6651(a) for filing a return late, which has no teeth when there was no balance due on the return.  I don’t think I’ve ever looked at the legislative history, and that might not explain it anyway.)

The analysis in Overseas Thread seems to allow this very behavior.  If the taxpayer didn’t know of the filing obligation by the normal return due date, Section 6611(b)(3) won’t apply.  Perhaps in another case with a longer delay between discovery of the filing obligation and filing the return, a court might impose a requirement to file within a reasonable time – but it might not.  If it did, that would further complicate the administration of Section  6611(b)(3).

Should The Determination of Whether a Return Was “Late” Depend on the Taxpayer’s Knowledge?

Les pointed out in his post that a knowledge standard – when the taxpayer realized there was an overpayment for that tax period – is extremely difficult to administer and a bright line rule would be much better.  I agree as a practical matter, but I also question whether a knowledge standard is appropriate from a theoretical perspective.  How exactly did Overseas Thread come up with the knowledge standard?

Essentially, it comes down to two provisions of a regulation, that the court was trying to reconcile.  The general rule under Section 6012 is that all corporations are required to file income tax returns “regardless of whether it has taxable income or regardless of the amount of its gross income.”  Treas. Reg. § 1.6012-2(a)(1).  One relevant provision in the regulation, Treas. Reg. § 1.6012-2(g)(2)(i)(a), creates an exception to the general rule:

A foreign corporation which at no time during the taxable year is engaged in a trade or business in the United States is not required to make a return for the taxable year if its tax liability for the taxable year is fully satisfied by the withholding of tax at source under chapter 3 of the Code.

But there’s an exception to the exception in Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2), which states that the preceding exception does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

The court came up with the knowledge standard in an attempt to reconcile those two provisions without creating preposterous or odd results.  The odd result the court saw was that these foreign corporations would have to: (1) always file income tax returns, just because they might later determine that they had an overpayment; or (2) risk not maximizing the overpayment interest they receive.  Of course, taxpayers frequently face the question of whether to file protective claims as a deadline approaches.  And taxpayers often face consequences from delays.

As you read Part 1, you probably were thinking of United States v. Boyle, 469 U.S. 241 (1985), weren’t you?  The Court there held the taxpayer, who relied on an attorney to file an estate tax return, liable for a penalty for late filing.  Reliance on an advisor was not “reasonable cause” to avoid the penalty when the issue was the filing date for the return, as “[i]t requires no special training or effort to ascertain a deadline and make sure that it is met.”  But the Court also mentioned that reliance on a tax adviser might constitute reasonable cause, when the advice was that it was unnecessary to file a return.  I’ve made an argument like that in the context of gift tax.  It might apply here, where the issue was whether part of the distribution was a return of capital rather than a dividend.

But Boyle involved the failure to pay penalty, which has a reasonable cause exception.  There is no such statutory defense to interest.  (The taxpayer in Boyle conceded the interest assessed.)  The taxpayer’s knowledge or intent is very, very rarely relevant to the application of interest provisions.  Perhaps the temporary higher interest rate for a “tax motivated transaction,” or the distinction between a deposit and a payment, but what else?  There’s a good reason for this – interest is not a penalty, it’s simply a payment for the use of the other party’s money.  It’s based on objective criteria rather than the taxpayer’s state of mind.

Thus, I’m not sure whether the knowledge standard really makes sense in Overseas Thread (and by extension, in the legal memo).  I understand the court trying to reach an equitable result, but creating a difficult-to-administer standard is not an ideal solution.

What would a bright-line rule be?  Well, one straight-forward answer would be that Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) explicitly nullifies the exception to the filing requirement; therefore, the return was required, was late, and Section 6611(b)(3) applies.

Of course, that’s not the only possible bright-line rule.

Filing Obligation versus . . . ???

Take another look at Treas. Reg. § 1.6012-2(g)(2)(i)(a) and (b)(2).  I think the Overseas Thread court may have been thinking that they meant something along the lines of:

Normally, you don’t have to file a return under your circumstances but if we owe you money, you’d better file a return and you’d better do it timely!  We want to make sure we get the return by the usual deadline so that we can get your refund to you sooner!

Does that sound like the IRS to you?  Me neither (except when Congress is pushing for quick payments, such as with the economic impact statements and the Advance Child Tax Credit).  If your taxes withheld exceed your tax liability, the IRS is glad to refund that but their feelings aren’t hurt if you don’t ask for it.  And indeed, some taxpayers in that situation don’t bother with filing a return if the overpayment was relatively minor, and as far as know the IRS won’t follow-up to ask about it.

Arguably, Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) is better read as a claims submission rule.  It says that the exception to filing an income tax return for that foreign corporation does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

Not “To a foreign corporation with an overpayment.”  Instead, “To a foreign corporation making a claim . . . for the refund of an overpayment.”  That suggests the proper interpretation would be, paraphrased broadly:

Normally, you don’t have to file a return under your circumstances, because as defined in the exception of § 1.6012-2(g)(2)(i)(a), your tax liability has been fully satisfied. If you choose to file a refund claim – the subject of § 301.6402-3 – though, you must do it on an income tax return form instead of Form 843.

That sounds more like the IRS, doesn’t it?  They won’t insist on a refund claim, but if you file one, please do it on the form for an income tax return or amended return, rather than Form 843.  Indeed, Treas. Reg. § 301.6402-3 allowed refund claims for income tax to be made on Form 843 for many years; that possibility was only eliminated for claims filed after 6/30/76.  Check out T.D. 7410, 1976-1 C.B. 384.  A technical memorandum from the IRS to the Assistant Secretary of the Treasury on 1/21/76, transmitting the T.D., made that purpose explicit.  Case law allowed taxpayers broad discretion regarding what would be considered a valid refund claim; that itself is further support for the conclusion that an income tax return on Form 1120-F was not required in Overseas Thread.  But the IRS could issue regulations to “encourage” taxpayers to file refund claims on tax returns rather than Form 843. 

As noted in Part 1, in the MNOPF case, the taxpayer originally claimed the refund on Form 843.  The IRS rejected that, stating: “A return must be filed to claim the refund, even if in past years you have received refunds by filing only Form 843 without a return.”

If Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) is only about how the refund claim is submitted, but not a requirement to file an income tax return, and caselaw recognizes refund claims that aren’t on income tax returns, arguably there is no obligation to file an income tax return.  Whether a refund claim is filed late is defined by Section 6511 rather than Section 6072.  The “return” therefore was not filed late and Section 6611(b)(3) does not apply. 

That seems like a plausible interpretation of the regulation, and personally I prefer it to that implied by Overseas Thread

Note that this wouldn’t apply broadly to any Form 1040 showing an overpayment.  There is a general obligation to file income tax returns that would apply unless Congress has explicitly stated an exception under which taxpayers need not file, such as Treas. Reg. § 1.6012-2(g)(2)(i)(a).  So, if I file my income tax return (requesting a refund) late, I’m still subject to Section 6611(b)(3) and won’t receive interest for the period before the return is received.

Is This Just About Foreign Corporations With No U.S. Trade or Business?

If it were, Overseas Thread and this legal memo would have relatively little impact.  But there are other situations in which taxpayers are excused from filing an income tax return, but still must do so to claim a refund.  Most common: an individual or married couple whose gross income is less than the sum of the basic standard deduction and exemption amount – unless they have at least a minimum amount of earnings from self-employment.  Sections 6012(a)(1) and 6017 set forth the filing obligations; unlike (domestic) corporations, individuals with no taxable income or self-employment income are excused from filing.  But they may file refund claims, because of withholding and/or refundable credits, and the IRS wants those to be filed on Form 1040. 

These taxpayers will usually know that they have an overpayment.  Most, particularly if they have large refundable credits, will file well before the normal filing deadline.  But if the overpayment is from a small amount of withholding, some may not bother until after the normal filing deadline, perhaps well after.  They would likely to lose under the knowledge standard of Overseas Thread, but under the alternative plausible interpretation above, they wouldn’t. 

How is the IRS handling these now?  I don’t know, but a bright-line rule based on whether the return was filed by the normal filing deadline would be much easier to program.  Of course, the amount of interest lost in these circumstances will be minimal in individual cases.  But I’m curious.  The next time one of my clinic clients has filed a tax return after the normal filing deadline, I may check the calculation of interest.