Leslie Book

About Leslie Book

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

EITC Ban: NTA Report Recommends Changes and IRS Advises on its Application to Partial Disallowances

The following brief post discusses two recent developments relating to the EITC ban. The first is a report that the recently retired NTA submitted to Congress that contained administrative and legislative recommendations to improve the penalty. The second is informal IRS advice concerning its application to partial EITC disallowances.

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Report to Congress Proposes Changes to Ban Procedures

We have written frequently about problems with the authority that the IRS has to ban taxpayers from claiming the EITC (and now CTC and AOTC) following improper claims. Just last fall guest poster Bob Probasco in The EITC Ban—It’s Worse Than You Realizedaptly equated one of his client’s experiences in navigating the ban process to victims of 1970’s Hollywood disaster movies. I spent much of this past spring at IRS TAS as a Professor in Residence working on a report recommending improvements to the EITC that Nina Olson as NTA submitted in her final report to Congress.  The report, Making the EITC Work for Taxpayers and Government: Improving Administration and Protecting Taxpayer Rightsbecame Volume 3 of the FY 2020 Objectives Report to Congress. 

Part V of the report addresses the problematic ban provision. After detailing the process the IRS uses for imposing the ban we concluded on page 45 that the current system raises serious concerns and jeopardizes taxpayer rights: 

The processes described above are complicated for even seasoned tax lawyers much less unrepresented EITC recipients. The IRS path during the ban proposal and imposition period is marked by a series of notices with limited explanation. No rules or notices pertaining to the effect on a taxpayer who files jointly with a banned taxpayer exist, and there may be limited opportunities for audit reconsideration where a significant amount of time has passed since the ban was imposed. Adding to this confusion, there is some uncertainty as to whether, and when, the Tax Court has jurisdiction to consider the ban 

To address the risks to taxpayer rights, we provide two key recommendations. First, we recommend that the IRS develop a ban examination process that is separate from the audit process. That process should focus on whether the taxpayer’s conduct justifies the IRS to impose the ban. Second, we suggest that Congress clarify when the Tax Court has jurisdiction over the ban and require that the burden is on the IRS to prove that imposing the ban was appropriate.

While the IRS has imposed the ban relatively infrequently over the past few years, Congress recently expanded the opportunities for IRS to impose the ban by giving the IRS to exercise its authority for improper child tax credit and American Opportunity Tax Credit claims. Unfortunately Congress did so without addressing any of the issues we discuss in the report to Congress. This only exacerbates the problems Bob and others have identified when taxpayers are potentially subject to the ban. 

IRS Email Advice Discusses How Ban Can Apply to Partial Disallowances

A recent IRS informal opinionaddresses the possibility of the IRS imposing the ban when there is only a partial disallowance of the EITC:

[Taxpayer] claims 3 children, 1 child disallowed. TP continues to claim the 1 child for consecutive years when they know that they are not entitle[d] to claim the child. Can the TP be subject to the 2-year ban, even though they are entitled to the EIC for the other 2 kids? 

 The opinion concludes that the ban can apply in this situation:

Section 32(k)(1) states that no credit shall be allowed under § 32 for any taxable year during the disallowance periods, which are 2 years for reckless and intentional disregard and 10 years for fraud. Section 32(k)(1)(B)(ii), regarding the 2-year ban for reckless or intentional disregard of rules and regulations, does not prohibit imposition of the ban for partial disallowances. Accordingly, if any taxpayer’s claim for the EIC is partially disallowed because of reckless or intentional disregard of rules and regulations, the IRS may asset the 2-year ban under § 32(k)(1)(B)(ii) on the taxpayer claiming any EIC during the 2 years.

Technically, this conclusion makes sense yet I have concerns with the IRS’s ability to make fair and accurate determinations of taxpayers’ intentions. Family lives are complex. It is difficult for taxpayers to reach the IRS during the correspondence examination process. Getting through to IRS by phone requires persistence, patience and time. Many of the taxpayers who the IRS has imposed or asserted a ban used paid preparers, further complicating questions of intent.  

As we discuss in the report, the correspondence the IRS uses when it has imposed the ban does not adequately discuss how taxpayers can challenge the IRS ban determination. To be sure, improper claims are a problem with the EITC and other credits. Yet basic fairness suggests that before the IRS imposes the ban there is a straightforward and clear path to challenge the ban. 

In CIC Sixth Circuit Sides With IRS in Major Anti Injunction Act Case

Earlier this summer there were two major circuit court opinions examining the validity of guidance. First, there was Altera v. Commissioner, where the Ninth Circuit again reversed the Tax Court and upheld the validity of regulations under Section 482. The second opinion is CIC Services v IRS. That case generated a little less fanfare than Altera, but it is significant and it highlights fundamental differences in the interpretation of the Anti Injunction Act (AIA). In CIC, the Sixth Circuit found that the AIA barred an APA challenge to an IRS notice that required the reporting of micro captive insurance companies as transactions of interest under Section 6011.

In this post I will discuss the CIC case. We may return to Altera – that case in its multiple permutations remains the most blogged about case on PT; in my read the recent Altera opinion follows the approach of the prior panel, with the majority and dissents authored by the same judges. Jack Townsend’s overview and comments are worth reading, here.

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The AIA is codified at IRC § 7421(a). It provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.” While the language is straightforward, recent opinions have struggled to apply its reach, especially in the context of challenges to information reporting requirements backstopped by the possible imposition of penalties.

CIC is a case we discussed previously when a district court in Tennessee dismissed the suit. CIC, a manager of captives, and an individual who also managed captives and provides tax advice to them, sued claiming in part that the Notice imposed substantial costs and that the IRS in the Notice effectively promulgated legislative rules without complying with the APA’s mandatory notice and comment requirements. The plaintiffs sought an injunction prohibiting the IRS from enforcing the Notice and a declaratory judgment claiming that the notice was invalid.

The district court and now the Sixth Circuit held that the AIA prohibited the suit. The AIA landscape when considering challenges to reporting requirements is somewhat in flux as a result of the Supreme Court’s discussion of the related Tax Injunction Act (TIA) in the Direct Marketing case from a few years ago. As you may recall, Direct Marketing involved a Colorado law that required out-of-state retailers to provide the state with information reports on their sales to residents of the state. In Direct Marketing, the Supreme Court held that the requirements were not sufficiently connected with the collection or assessment of tax for the challenge to be barred by the Tax Injunction Act, legislation that is similar to though slightly different from the AIA in that it imposes restrictions on cases involving taxes imposed by the states rather than the federal government.

Shortly after Direct Marketing, in Florida Bankers the DC Circuit (in an opinion by then Judge Kavanaugh) held that the AIA prevented bankers from challenging heightened reporting requirements when the failure to comply would lead to civil tax penalties under Subchapter 68B of the Code. In Florida Bankers the DC Circuit, relying in large part on the ACA case Nat’l Fed’n of Indep. Bus. v. Sebelius, held that the civil penalty for violating the reporting requirements was a tax and thus subject to the AIA’s reach.

Not surprisingly the plaintiffs in CIC attempted to situate the case within Direct Marketing and focused their arguments on the challenge to the IRS’s implicit regulatory regime rather than a challenge to the assessment or collection of any tax.

The Sixth Circuit in CIC disagreed, and adopted the Florida Bankers rationale in finding that the AIA prevented the suit challenging the IRS Notice. In so doing it focused on the consequences to failing to comply with the reporting requirements; that is, the civil penalties for failing to compile and maintain records relating to reportable transactions:

Plaintiff argues that the “information gathering” and “records maintenance” requirements of the Notice are focused on the act of reporting to the taxing authority information used to determine tax liability, not the discrete, subsequent acts of assessment or collection of that liability. This argument misses the mark.

While it is true that information reporting is a separate step in the taxation process that occurs before assessment or collection, see Direct Marketing, 135 S. Ct. at 1130, Plaintiff’s argument presupposes that the relevant taxes in this AIA analysis are the third-party taxes the collection of which the Notice is designed to facilitate. As previously discussed, that is incorrect. Like the challenged regulation in Florida Bankers, the Notice is indeed “two or three steps removed” from any third-party taxes. 799 F.3d at 1069. But once it is established that the relevant tax is the penalty imposed for violation of the Notice’s requirements, it becomes clear that Plaintiff’s suit is focused on that tax’s assessment or collection. Plaintiff’s suit seeks to invalidate the Notice, which is the entire basis for that tax. If successful, Plaintiff’s suit would “restrain (indeed eliminate)” it. Id. at 1067.

After finding that the matter was covered by the AIA, the majority opinion concluded that the narrow “no alternative remedy” exception to the AIA  did not apply because there was the opportunity to challenge the notice by failing to comply with its requirements, paying the associated penalties and then pursuing a refund suit.

Conclusion

The majority opinion (as does the dissent) extensively cites the Hickman and Kerska article Restoring the Lost Anti-Injunction Act, 103 Va. L. Rev. 1683, 1686 (2017), an article PT has reviewed and I discussed earlier this year. In the opinion’s conclusion, there is an explicit acknowledgement (in part based on that article and related scholarship) that there may be legitimate grievances associated with limits on challenging the IRS’s purported failure to comply with the APA.  As I said earlier this year in PT and in an upcoming article in Temple Law Review, perhaps it is time for a fresh legislative look at ways taxpayers can challenge IRS guidance – an idea that I adopt from a 2017 article from Professor Stephanie Hunter McMahon (blogged by PT here), also cited by the dissent (as is Pat Smith, who has written about these issues for PT too).

One final point. This brief blog post does not dive deeply into the argument that Florida Bankers is wrongly decided. The dissent believes that to be the case.

In Florida Bankers, a divided panel of the D.C. Circuit held that the Anti-Injunction Act barred a similar suit challenging the legality of a reporting requirement that the IRS enforced with a tax. See 799 F.3d at 1072. That is because, the court reasoned, the tax is “imposed as a direct consequence of violating the regulation,” and so “[i]nvalidating the regulation would directly bar collection of that tax.” Id. at 1069. For the D.C. Circuit majority, this distinguished the case from Direct Marketing because “the tax . . . is not two or three steps removed from the regulation in question.” Id. In other words, there was no attenuation between the assessment and collection of the tax, on the one hand, and invalidating the regulation on the other.

That misses the mark. Enjoining a reporting requirement enforced by a tax does not necessarily bar the assessment or collection of that tax. That is because the tax does not result from the requirement per se. The only way for the IRS to assess and collect the tax is for a party to violate the requirement. So enjoining the requirement only stops the assessment and collection of the tax in the sense that a party cannot first violate the requirement and then become liable for the tax. Surely, this is the kind of attenuated relationship between “restrain,” “assessment,” and “collection” that Direct Marketing rejected.

Underlying the dissent’s different take on the reach of the AIA is its practical concern for the consequences of the majority’s approach, including the difficult position people find themselves in if they believe that the guidance that the IRS issues is either procedurally or substantively improper:

Under the majority’s decision, CIC now only has two options: (1) acquiesce to a potentially unlawful reporting requirement that will cost it significant money and reputational harm or (2) flout the requirement, i.e., “break the law,” to the tune of $50,000 in penalties for each transaction it fails to report. See 26. U.S.C. § 6707(a)–(b). Only if it (or someone else) follows the latter path—and only when (or if) the Government comes to collect the penalty—will any court be able to pass judgment on the legality of the regulatory action.

The dissent goes on to note that there are possible criminal sanctions under 7203 for willfully failing to keep the records that the Notice required:

In other words, the only lawful means a person has of challenging the reporting requirement here is to violate the law and risk financial ruin and criminal prosecution. That is probably enough to test the intestinal fortitude of anyone. And it leaves CIC in precisely the bind that pre-enforcement judicial review was meant to avoid.

I strongly suspect we will see more circuit opinions and perhaps the Supreme Court weigh in on whether it is possible to reconcile Direct Marketing and the DC Circuit’s approach. For more on these issues and the tension between Direct Marketing and Florida Bankers, including a detailed discussion of how the term “restrain” may differ in the context of the TIA and AIA (including an analysis of the Tenth Circuit’s approach to the issue in the 2017 decision Green Solution Retail which like CIC emphasized the differences between the TIA and the AIA), see the most recent update to IRS Practice and Procedure at ¶ ¶ 1.06[2] Restraining the Assessment or Collection of Tax: The Necessary Nexus to Assessment or Collection.

NTA Releases Subway Map Depicting Complexity of Tax System

We have been running a series of reflections on the career of Nina Olson. I shared some of my thoughts on Nina’s impact, both to me personally and professionally, when she announced her retirement and just prior to my starting work at TAS as a Professor in Residence this past spring. 

The TAS release this past week of a subway map that illustrates a taxpayer’s journey through the tax system highlights some of Nina’s strengths as an advocate and public servant. She has seized upon an incredibly good idea (visualizing complexity to understand the burdens that taxpayers experience and assist taxpayers in exercising their rights) and through energy, passion and a deep understanding of the tax system was able to take a good idea and produce a tangible result.  This specific project began bearing fruit in the 2018 Annual Report to Congress, which included a series of roadmaps that displayed a taxpayer’s journey through the tax system.

This past spring I saw firsthand as Nina brought together dozens of TAS employees to collaborate on expanding the roadmap. Working with the talented team at TAS Communications, Stakeholder Liaison & Online Services (headed by Maryclaire Ramsey) TAS was able to complete a more detailed subway style map that further visualizes a taxpayer’s journey through the tax system.  The idea is to expand this even further, and eventually develop an interactive map that will help taxpayers (and practitioners) who receive correspondence fully understand what a notice means, all with the goal of helping taxpayers exercise their rights in light of their specific place in the system. 

I am a huge fan of this project. There is some interesting and important research being done that incorporates design principles into the access to justice movement, including how images facilitate unrepresented individuals’ exercise of their rights. This fits directly into the work that TAS and broader IRS is doing with respect to designing notices. This project also has the effect of helping policymakers understand just how complex the tax system is. As Nina wraps up her tenure at TAS, this project will have an impact long after she has moved on to her next chapter.  The ability to transform (good) ideas into practical specific policies, proposals and projects has been a key part of the NTA’s work this past 18 years (and even before that with her work at CTLP and in helping Congress see the need to provide funding for tax clinics). That is a powerful legacy.

Some Key Links

To place an order for a hard copy: Call 800-829-3676 beginning July 12 and request Publication 5341.

NTA Olson Testifies Today on the Filing Season and Some Personal News From Me

Today at 10 AM EST  National Taxpayer Advocate Nina Olson will be testifying before the House Ways and Means Oversight Subcommittee on the filing season. For those interested, the testimony will be live-streamed; the landing page for the hearing has a link that you can use.

This will be the last filing season that will feature Nina Olson testifying in her capacity as National Taxpayer Advocate. As many of our readers have likely heard, she announced her retirement, effective July 31, 2019. Nina has received countless accolades over the years, including the ABA Tax Section’s Distinguished Service Award and the Spragens Pro Bono Award, and has won recognition from many scholars both inside and outside tax who have looked to her work as a model for a successful ombuds office.

Nina has had a huge impact on my career. In 1997, after attending an ABA Tax Section panel on the importance of clinics that featured her and the late great Janet Spragens, I decided to explore the possibility of directing a tax clinic. I can draw a direct line from that panel presentation to me directing a low-income taxpayer clinic for over ten years. Her writing on issues over the years has also been the single greatest influence on how I think about tax administration.

Underlying her work has been a fierce commitment to give voice to taxpayers, whom Nina has always emphasized are human beings deserving dignity.

It can be easy sometimes to lose sight of that basic insight in the maze of procedural rules and the challenges the IRS faces in administering a complex tax system at a time when there have been (and continue to be) great pressures on the agency. Yet, that theme of recognizing the humanity of taxpayers is a constant chord through the eighteen annual reports she submitted, dozens of appearances before Congress, and in her writings and speeches.  For example, consider her 2013 Woodworth Memorial Lecture:

At their core, taxpayer rights are human rights. They are about our inherent humanity. Particularly when an organization is large, as is the IRS, and has power, as does the IRS, these rights serve as a bulwark against the organization’s tendency to arrange things in ways that are convenient for itself, but actually dehumanize us. Taxpayer rights, then, help ensure that taxpayers are treated in a humane manner.

One essential part of Nina’s legacy will be the constant reminder that taxpayers are human beings, with failings, needs, and most of all an inherent right to be treated with respect.

One final point. As of next week as part of my sabbatical from Villanova I will be working with TAS as a Professor in Residence at the IRS in DC, working on a variety of projects including those involving taxpayer rights and the EITC.  I know in this position I will continue to learn a great deal from Nina, just as I did when I attended that ABA panel over twenty years ago, and just as I will in the future when I reflect back on the lessons of her tenure.

Ninth Circuit Rejects IRS’s Approach to Notifying Taxpayers of Third Party Contacts

Under Section 7602(c)(1), IRS must provide the taxpayer with “reasonable notice in advance” before it summons records from financial institutions, employers or other third parties. The IRS has argued that Publication 1, its Your Rights as a Taxpayer publication, suffices for these purposes. There had not been a published circuit court opinion on the issue until last week’s Ninth Circuit opinion in JB v United States. While the JB opinion is careful to note that its holding is context specific, it holds that Publication 1 did not constitute reasonable advance notice in the case at issue. The opinion also questions whether Publication 1 could constitute reasonable notice in any context.

I will summarize the facts and the court’s approach, and also suggest why this opinion has broad implications.

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The taxpayers JB and PB are an elderly couple; JB is an attorney who as state-appointed counsel represented capital defendants in California. In 2013, they were lucky enough to be selected for a National Research Project (NRP) IRS audit for the 2011 tax year. The NRP audits are extensive line by line reviews of all items on a tax return. The letter that notified the taxpayers that they were selected for audit described the NRP audit process and asked the taxpayers to contact a revenue agent. The packet also included Publication 1.

The taxpayers requested to be excused from the NRP audit due to JB’s age and poor health. In particular they passed on declarations from a doctor that the audit would “worsen his hypertension and contribute to hypertensive retinopathy, a deteriorating eye condition, as well as his serious hearing loss.” (I am no doctor and am not sure how hearing loss connects to the audit but that is not really relevant for this opinion).

IRS refused and the taxpayers filed suit to stop the audit. In the meantime the NRP audit went forward and two years later in 2015 the IRS issued a summons to the California Supreme Court seeking “copies of billing statements, invoices, or other documents . . . that resulted in payment to” J.B. In seeking that information, IRS did not separately notify the taxpayers about its contacting the court.

JB and PB filed a suit in district court to quash the summons arguing that IRS failed to give them reasonable advance notice. The government essentially argued that IRS did comply with its notice requirements, pointing to the Publication 1 that IRS had sent to the taxpayers two years before when it notified them of the NRP audit. That publication included the following:

Potential Third Party Contacts

Generally, the IRS will deal directly with you or your duly authorized representative. However, we sometimes talk with other persons if we need information that you have been unable to provide, or to verify information we have received. If we do contact other persons, such as a neighbor, bank, employer, or employees, we will generally need to tell them limited information, such as your name. The law prohibits us from disclosing any more information than is necessary to obtain or verify the information we are seeking. Our need to contact other persons may continue as long as there is activity in your case. If we do contact other persons, you have a right to request a list of those contacted. Your request can be made by telephone, in writing, or during a personal interview.

The district court held that the IRS’s sending Publication 1 did not adequately give notice and concluded that “the advance notice procedure cannot be satisfied by the transmission of a publication about the audit process generally.”  As the Ninth Circuit summarized, the district court “instructed that ‘advance notice should be specific to a particular third party,’ reasoning that ‘the implementing regulations contemplate notice for each contact, not a generic publication’s reference that the IRS may talk to third parties throughout the course of an investigation.’”

The Ninth Circuit affirmed the lower court but ostensibly charted a more nuanced course. In so doing, it explored case law rooted in procedural due process jurisprudence that considers what constitutes notice; that law generally requires a context-specific inquiry that is inconsistent with the IRS position in this case:

We reject a categorical approach to this question. We conclude that “reasonable notice in advance” means notice reasonably calculated, under all the relevant circumstances, to apprise interested parties of the possibility that the IRS may contact third parties, and that affords interested parties a meaningful opportunity to resolve issues and volunteer information before third-party contacts are made.

The opinion then goes on to explain why in this case Publication 1 was insufficient:

In this case, the sole notice that the government provided J.B. and P.B. that it might contact the California Supreme Court is Publication 1. The IRS sent J.B. and P.B. Publication 1 as part of its initial, introductory letter to the couple explaining that they had been selected for an audit; an audit the couple sought to stop. The Publication did not accompany a specific request for documents, nor is there any evidence that the IRS revisited the notice later in the audit when it knew that J.B. and P.B. had requested an exemption from the research audit and had not provided documents for the audit. More than two years elapsed between when the IRS sent Publication 1 to J.B. and P.B., and when the IRS subpoenaed the billing records and invoices from the California Supreme Court. We do not think that an agency that actually desired to inform a taxpayer of an impending third-party contact would consider Publication 1 adequate notice in these circumstances.

In rejecting the IRS position the court staked out a position that requires the IRS to deliberate and weigh the government’s interest with the individual’s privacy interests, including whether the taxpayer has a reasonable opportunity to give the information the IRS wants so as to avoid the potential embarrassment and loss of privacy that accompanies third-party notifications.

In the context of this case it was easy for the court to conclude that the IRS came up short:

  • This was an NPR audit that is intended to assist the government with its understanding of the tax gap,
  • There was a two-year delay between the audit notice and the summons,
  • The information requested from the court might include privileged information relating to the taxpayer’s legal work representing capital defendants, and
  • The taxpayers and IRS had extensive contact that could have been a vehicle for additional notice by virtue of the lawsuit that the taxpayers brought to stop the audit.

This opinion has implications that go to heart of the IRS’s approach to all third party contacts. Buried in footnote 15 is the following:

Although we limit our holding to the facts of this case, we are doubtful that Publication 1 alone will ever suffice to provide reasonable notice in advance to the taxpayer, as the statute requires. We think it unlikely that the broad and colloquial language in the “Third-Party Contacts” paragraph of Publication 1, which states that the IRS may “sometimes talk with other persons,” gives the taxpayer reasonable advance notice that the IRS intends to subpoena, under threat of penalty, third-party documents.

Thus, the Ninth Circuit strongly suggests that the IRS revisit its approach to third party contacts on a systemic basis. In setting out its views the Ninth Circuit was mindful that this might add significant time and expense, but in its view this is an issue for Congress, not the courts:

We understand that one result of adopting a context- specific rule may be to make it more difficult for IRS officers, and district courts, to determine whether § 7602(c)(1)’s advance notice requirement is satisfied in any given case. But, to the extent such an administrability problem develops, the responsibility lies with Congress, not the courts. We cannot ignore the text of a statute that hinges the adequacy of notice on a determination of reasonableness. Nor can we ignore the congressional mandate to provide taxpayers faced with a potential third-party summons with a meaningful opportunity to respond with the relevant information themselves so as to maintain their privacy and avoid the potential embarrassment of IRS contact with third parties, such as their employers.

The upshot was the Ninth Circuit affirmed the quashing of the summons. The opinion will likely prompt changes to IRS practice, at least in Alaska, California, Hawaii and Arizona, and perhaps an effort to get Congress to revisit the issue.

Is It Time To Reconsider When IRS Guidance Is Subject to Court Review?

I have been working on an essay that looks at the possible way that Congress could breathe more life into the 2015 codification of the taxpayer bill of rights. My essay Giving Taxpayer Rights a Seat at the Table, which is in draft form and up on SSRN, makes a relatively simple claim: before IRS issues guidance it should be statutorily required to consider whether in its view the guidance is consistent with the taxpayer rights that the IRS adopted in 2014 and that Congress codified in 2015. In making my claim, I acknowledge the limits of the current statutory taxpayer rights framework, which arguably provides no direct way to hold the IRS accountable for actions that violate taxpayer rights unless the right relates to a separate specific cause of action for its violation.*

In researching my article on taxpayer rights, I came back to a stubborn problem with the IRS guidance process and for taxpayers and third parties who believe that the IRS guidance violates a procedural requirement under the Administrative Procedure Act:  there are at times insurmountable obstacles to challenging IRS guidance for procedural adequacy. That problem has led me to think about some interesting and important articles that have addressed this issue in the past few years.

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In the tax world, unlike other areas of federal law, statutes like the Anti-Injunction Act and the Declaratory Judgment Act, have proven formidable barriers to test the adequacy of IRS fidelity to for example the notice and comment requirements under the APA until well after the rule has been in place. In other words, a taxpayer or third party often has to wait for a refund or deficiency case (i.e., an enforcement proceeding) to argue that there was a procedural infirmity that would result in the court’s possibly invalidating the regulation or possibly subregulatory guidance.

This has contributed to some calling for a careful look at the Anti-Injunction Act, with Professor Kristin Hickman and her co-author Gerald Kerska arguing in Restoring the Lost Anti-Injunction Act in the Virginia Law Review (reviewed here by Sonya Watson) that history supports a reading of the AIA that would generally allow pre-enforcement challenges to IRS guidance. The article takes as a starting point that IRS has not always been faithful to APA requirements and not every possible challenge neatly fits into an enforcement proceeding. On top of that, as Professor Hickman has highlighted in prior work as well, it is questionable that there would be an adequate remedy in certain instances even if a court were to find a procedural infirmity in the context of a challenge that arises in a deficiency or refund case.

Despite my sympathy with a reading of current law that would allow for greater pre-enforcement challenges, there are strong legal and policy arguments against courts on their own extending the circumstances when there will be challenges to the procedural adequacy of IRS guidance. For example, expanding the opportunity for procedural challenges will naturally soak precious agency resources.  As Professor Daniel Hemel, in The Living Anti-Injunction Act in the Virginia Law Review online edition argues in an essay responding to Hickman and Kerska’s article, it would be best institutionally for Congress rather than the courts to open the door to pre-enforcement challenges.

Professor Stephanie Hunter McMahon in a 2017 Washington Law Review article Pre-Enforcement Litigation Needed for Taxing Procedures also takes up the subject of challenging IRS guidance. In her article, she sizes up the current landscape:

While Congress only permits procedural challenges late in the tax collection process, this offers little to most taxpayers. The delay in litigating procedural complaints reduces what is challenged and affects taxpayer behavior throughout the period from its promulgation until someone, eventually, challenges the procedures. In the process, delayed litigation requires that taxpayers plan their affairs under the spectre of guidance that might not survive a procedural challenge. Moreover, in deciding whether to follow the tax guidance, taxpayers must not only assess its substance but also the procedures used to create it under procedural requirements that are not consistently interpreted by the courts.

Professor Hunter McMahon drills deeper on the disincentives associated with challenging tax guidance in enforcement proceedings:

Disincentives are increased because, unlike in other areas of law that permit pre-enforcement litigation, people are not suing in post- enforcement tax litigation simply to perfect the agency’s procedures. Instead, they are suing over their own tax obligations. The personal nature of the result and that the costs are already imposed likely changes the way people perceive the litigation. With pre-enforcement litigation, a judge remanding a case to the agency to correct the procedures would be a victory. In a tax refund or deficiency case, remand is insufficient to accomplish the goal of reducing the taxes owed. If courts are likely to remand procedural matters without vacating the rule, the taxpayer has little incentive to challenge the rules because the personal outcome remains the same.

These issues are even more pernicious when the rules in question relate to lower income or marginalized taxpayers, who are less likely to be able to get to court and as Professor Hunter McMahon aptly points out may not have the means or resources to influence the guidance process in the first instance. (That latter point is indirectly highlighted by the draft article “Beyond Notice-and-Comment: The Making of the § 199A Regulations” by Shu-Yi Oei and Leigh Osofsky that Keith discussed recently).

Professor Hunter McMahon proposes a legislative fix. That fix would be to allow an amendment to the Anti-Injunction and Declaratory Judgment Act to allow for a limited time period challenges to the procedural adequacy of the guidance:

[T]his proposal would permit pre- enforcement litigation of procedural requirements and a judicial evaluation of whether the process used, including the clarity of the statement and the comment period, suffices for APA purposes.

As Professor Hunter McMahon notes, the benefit of allowing a limited time to challenge to procedural adequacy is that it could focus attention on procedural issues early in the life of the guidance, which would allow for consistency in application of the substantive rules. A second part of Professor Hunter McMahon’s legislative fix is for Congress to delineate more specifically which forms of guidance are required to go through notice and comment—she focuses on guidance that is intended to change taxpayer behavior rather than define prior action as the candidate for a default requirement to go through the notice and comment process.

Conclusion

I believe that Professor Hunter McMahon’s approach merits serious consideration. I am reflecting further on my proposal about ways to give the taxpayer rights provisions more teeth -my proposal relies heavily on the Taxpayer Advocate Service and enhancing its institutional role in the guidance process, including giving the National Taxpayer Advocate specific authority to comment on regulations (something that the NTA herself as recommended in both Purple Books that accompanied the last two annual reports). As Congress signals a further willingness to take on IRS reform issues, I believe that it should directly address the current reach of the Anti-Injunction Act and the issue of when and to what extent taxpayers and third parties should be able to test the adequacy of IRS guidance conforming to APA requirements.

As part of this approach I am intrigued by the possibility of tying in the IRS’s fidelity to taxpayer rights principles in the rulemaking process. I would be grateful for comments on my draft article or reactions to any of the issues raised in this post.

*An example of how a taxpayer right relates to a specific cause of action is taxpayer right number 7, the right to privacy, and Section 7213, which authorizes a suit for unauthorized disclosure of a taxpayer’s any tax return or return information. An example of a taxpayer right that does not so relate to a cause of action is right number 5, the right to appeal an IRS decision in an independent forum, which as we discussed last year in connection with the Facebook case does not seem to carry with it a direct way to challenge IRS action that arguably conflicts with that right.

 

 

Update on Haynes v US: Fifth Circuit Remands and Punts on Whether Boyle Applies in E-Filing Cases

One of the foundational principles in tax procedure is that reliance on an accountant or lawyer to file a tax return cannot in and of itself constitute reasonable cause to avoid a late-filing penalty. The Supreme Court said as much in the 1985 case United States v Boyle. Over the last few years taxpayers and practitioners have started to challenge Boyle in the e-filing context. The basic question is whether courts should reconsider the bright line Boyle rule when a taxpayer provides her tax information to her preparer and the preparer purports to e-file the return, but for some reason the IRS rejects the return and the taxpayer arguably has little reason to suspect that the return was not actually filed.

Sometimes the preparer may fail to receive a rejection notice from the IRS; sometimes the preparer gets the reject notice and fails to tell the client. In either situation, the client then gets a surprise letter from the IRS months or maybe years later, leading to late filing penalties.

In the case of the Hayneses, the taxpayers heard from their accountant/preparer that on the last day for filing their 2010 tax return he had in fact e-filed the return. But for some reason the Social Security Number erroneously appeared on the line designated for an employment-identification number, and the IRS rejected the return. The preparer did not get a reject notice and neither he nor his clients took any steps to confirm that the IRS processed the supposedly e-filed return. After eventually receiving IRS correspondence the taxpayers filed their return and paid a late filing penalty. They sought a refund for the penalty, first with the IRS and then after the IRS denied the claim in federal district court. The district court granted the government summary judgment, concluding that as a matter of law under Boyle the taxpayers could not rely on their accountant to satisfy a return filing obligation even if the return filing process in the 21st century differs in kind from what was done back in the Reagan years.

In last month’s brief opinion, the Fifth Circuit took a different approach to the dispute. While noting that the application of Boyle in the 21stcentury world of e-filing is an “interesting” issue, it remanded the case back to the district court. It did so because it believed that there was a factual dispute that the lower court needed to resolve before it could even get to the legal issue:

Whether it was reasonable for Dunbar [the accountant] to assume, based on the IRS’s silence, that it had accepted the Hayneses’ return or whether ordinary business care and prudence would demand that he personally contact the IRS to ensure acceptance is a genuine question of material fact for the jury to decide. Because Dunbar is the Hayneses’ agent, if a jury determines that his actions meet the reasonable-cause standard, it must find the same to be true for the Hayneses—barring any determination of independent negligence by them.   After all, principals are not only bound by their agents’ failures, as in Boyle, but also by their diligence.

If, as a matter of fact, it was reasonable for the accountant to assume that the IRS accepted the return without seeking confirmation, then the penalty does not stand. If, however, the jury finds it was not reasonable, then the 21st century Boyle issue is teed up:

It is this question of material fact that makes it unnecessary for us to decide whether a broad e-filing exception to Boyle exists. That complex question need only be answered if Dunbar, in fact, acted negligently in filing the Hayneses’ tax return. Only then would the Hayneses be relegated to relying solely on their reliance on Dunbar to meet the reasonable-cause standard, thereby teeing up the Boyle question.

Conclusion

We will closely follow this case, as well as the handful of other cases that are percolating in the courts that raise the issue.

For prior PT coverage on this issue, see our post on the lower court opinion in the Haynes case and our post discussing a similar issue in the Spottiswood case. Those posts generated thoughtful comments and also link to some other useful sources.

 

 

Misclassified “Independent Contractor” Succeeds in Using Tax Code to Get Damages from Employer

We have nearly finished information return filing season. This is the time of year when Americans get their W-2s and 1099s, stuff them in folders and drawers, and hope that when it comes time to prepare their tax return they remember where the papers are. Information returns often lie forgotten until it’s time to answer questions from software prompts or from long-suffering preparers who play detective to ferret out a taxpayer’s economic life.  Some taxpayers can access their information returns seamlessly, but for most this is still a 20th century process that contributes to the huge costs of filing compliance. To be sure, information returns are the backbone of “voluntary” compliance—it is no surprise that when income is not subject to reporting taxpayers have a tendency to not include those items on their 1040s—and that will be true whether the 1040 is postcard size or in the form of a Hallmark Valentine’s Day card professing the IRS’s undying love for taxpayers who file and pay timely.

I digress—today’s post is about people who intentionally file incorrect information returns.

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We have discussed this issue before, and Stephen and I have just heavily tweaked this issue in the Saltzman and Book IRS Practice and Procedure treatise. The cases tend to crop up when someone seeks to make someone else’s life miserable by fling a phony return to generate IRS attention in the form of underreporting letters and possible tax assessments. What could be more middle-finger flipping then sending the IRS an information return showing a former partner or significant other with all kinds of income supposedly but not really earned?

To deal with this, Congress added Section 7434 which provides that

[i]f any person willfully files a fraudulent information return with respect to payments purported to be made to any other person, such other person may bring a civil action for damages against the person so filing such return.

There are a surprising number of interesting legal issues that spin off this provision. One of the issues concerns whether the statute provides a remedy for someone who is truly an employee but is treated as an independent contractor and who then receives a 1099-MISC rather than a W-2. The cases are split, some saying that the statute only provides a remedy when an improper amount is reported, and other courts holding that the statute provides a remedy for any fraudulent action in connection with the information return, including filing the wrong form. Another key issue that the courts are wrestling with is whether liability is limited to the person who was required to file the information return under federal law. For example, some courts have declined to find personal liability if the filer was not the party required to file the information return. See e.g., Vandenheede v. Vecchio, a 2013 case from a federal district court in Michigan declining to hold liable two co-trustees who prepared and caused a false information return to be filed on another’s behalf.

This takes us to a case from last year that I read as I prepare the updates for the next round of the treatise. The case is Czerw v Lafayette Moving and Storage. In the case, a federal district court in NY considered the claims of Joseph Czerw, who worked over twenty years as a mover for the same employer. In prior years, Czerw received W-2s and was treated as an employee, which was consistent with his actual arrangement with the employer. In 2015 his employer had major financial difficulties, with checks bouncing. Unlike in past years, when he got W-2s, for that year Czerw received a 1099-MISC for over $5,000. Not only was the information return the wrong type, but Czerw had only been paid about $4,000. Even though Czerw contacted his employer to get him to treat him as an employee and reflect the proper amount he was paid, his employer declined to fix things.

Czerw sued his corporate employer and Matthew Ferrentino, the corporation’s sole owner and president, alleging that his employer and Ferrentino had actual knowledge that a W-2 form was the correct form to submit and that the 1099-MISC reflected the wrong amount he received. Czerw alleged that the defendants willfully, purposely, and fraudulently filed the false Form 1099-MISC as part of a scheme “to defraud state and federal taxing authorities . . . by lessening [] Lafayette’s tax obligations and the amount of its worker’s compensation insurance premiums.” The complaint sought $5,000 in damages—the statutory amount provided in the absence of actual damages or discretionary legal fees.

The defendants defaulted, but before the court granted damages it had to explore whether the statute provided for relief in Mr. Czerw’s situation. The first issue the court considered was whether liability extended not only to the corporation but also to Ferrentino individually. The order briefly explores the split in cases on the issue, and lines up squarely with the cases that extend liability “on any person who willfully causes a fraudulent information return to be filed.” Thus it found that Ferrentino in his individual capacity was also potentially on the hook for damages.

As to whether section 7434 can be used in misclassification cases in the absence of an incorrect amount reported, the order notes that the law is developing on this issue. The court was able to avoid coming down on any side because the 1099-MISC that was filed overstated the amount that Czerw received:

As Plaintiff concedes, however, some courts have held that “§ 7434(a) creates a private cause of action only where an information return is fraudulent with respect to the amount purportedly paid to the plaintiff.” Liverett v. Torres Advanced Enter. Solutions LLC, 192 F. Supp. 3d 648, 653 (E.D. Va. 2016) (emphasis added). Under that interpretation, the statute “provides no remedy for a person incorrectly classified as an independent contractor.” Tran, 239 F. Supp. 3d at 1298. But because Plaintiff alleges that the Form 1099-MISC incorrectly states the amount paid to him, the second element is satisfied regardless, and the Court need not address whether the alleged misclassification supports a claim under § 7434.

Conclusion

Employee misclassification is a major issue. Employers who misclassify employees are failing to provide unemployment insurance and workers’ compensation. Those employers can also leave workers with large employment tax liabilities. Advocates who work in this field have Section 7434 as a possible mechanism to ensure fair treatment for workers and punish those who do the wrong thing. The Czerw order is helpful but as briefly reflected in this post there are some key legal issues that await further development.