Leslie Book

About Leslie Book

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

Perkins Case Raises Variance and Issue Preclusion In Context of Taxation of Native Americans

The case of Perkins v United States raises interesting procedural issues, including collateral estoppel (also known as issue preclusion) and variance. Earlier this month a federal district court judge adopted the magistrate judge’s recommendation to deny the government’s motion for summary judgment in a refund suit involving a Native American tribe member who along with her husband ran a trucking and gravel extraction business. 

The magistrate’s recommendation situates the dispute: 

The federal income taxation of American Indians is not a sexy topic.” John Lentz, When Canons Go to War in Indian Country, Guess Who Wins? Barrett v. United States: Tax Canons and Canons of Construction in the Federal Taxation of American Indians, 35 Am. Indian [pg. 2018-5250] L. Rev. 211, 211 (2011). Neither is gravel. Yet the two topics have come together in this case to present a question that no prior case has had to answer directly. When Indians extract gravel from Indian land through an Indian-owned sole proprietorship, is the resulting income exempt from federal income tax based on treaties that promise the “free use and enjoyment” of land or protection from “all taxes”? And even if the Court answers in the affirmative, have plaintiffs Fredrick Perkins (“Fredrick”) and Alice J. Perkins (“Alice”) made enough of a showing of business income and expenses that treaty protection would make a practical difference on their 2010 federal income tax return? 


The substantive issues relate to the Canandaigua Treaty and the Treaty of 1842. Native Americans, like other citizens, are subject to tax on income unless a treaty provides otherwise.  The Perkins and the IRS have been fighting about whether the treaties exempt income they earned in their gravel business in 2008, 2009 and 2010. The 2008 and 2009 years were the subject of a deficiency case in Tax Court. In 2018 the Tax Court, in a reviewed opinion that generated a dissent by Judge Foley, held that the treaties did not exempt their income from the gravel business from US income tax. The Perkins have appealed that decision to the Second Circuit. 

The 2010 year is the subject of a refund suit in federal court in New York. The magistrate’s recommendation, adopted by the district court judge last month, explicitly disagrees with the Tax Court’s analysis and finds that the treaties do provide an exemption for the income though the taxpayers’ entitlement to a refund awaits a jury trial that would establish the amount of tax exempt gravel income and allocable expenses. 

This creates the somewhat odd situation where two different courts have reached differing views on the same substantive issue with respect to the same taxpayer. 

Rather than dig into the substantive treaty issue in this post I will discuss the procedural issues that last month’s federal district court opinion raises.

Issue Preclusion (Collateral Estoppel)

In federal district court, the government pointed to the Tax Court decision in its favor. In doing so, the government argued that the taxpayers should be prevented from relitigating the same issue, basing its argument on collateral estoppel. That doctrine prevents parties from relitigating an issue that has been previously litigated and subject to a final determination. The district court disagreed, noting that there has yet to be a final decision, given that the Perkins appealed the Tax Court decision and that the decision “does not become final until a petition for certiorari is denied, the time to file such a petition expires, or the Supreme Court issues a mandate.”

In addition, the district court noted that the magistrate’s recommendation preceded the Tax Court opinion, and collateral estoppel prevents litigation in a subsequent case.


One other procedural issue in the case warrants highlighting.  In objecting to the magistrate’s report, the government raised variance. The variance issue arose because during discovery the government established that the Perkins’ failed to report fully gross receipts from the part of the business that the parties agreed was not covered by the treaties’ exemption.  The Perkins responded by acknowledging the underreporting but also establishing that they underclaimed expenses relating to the taxable portion of the business.

As a refresher, the variance doctrine means that the argument raised in a refund suit must have been made in the claim. As the district court noted, the “variance doctrine does not require exact precision; if the issue raised in court is derived from or is integral to the ground timely raised in the refund claim, it `may be considered as part of the initial ground.” (internal cites omitted).

The refund claim the Perkins submitted focused on the application of the treaties and whether the treaties exempted a portion of their income from the gravel business: 

As enrolled members of the Seneca Nation of Indians (the “Nation”), the taxpayers have been given permission by the Nation to sell gravel from [the] property on the Nation’s territory, in exchange for royalty payments made to the Nation. Under the Supremacy Clause, the [IRS] may not tax income derived directly from the land protected by federal treaties. The taxpayers correctly reported these sales as exempt from federal taxation. The IRS, however, determined the income to be taxable. Taxpayers have paid the taxes and now seek a refund.

In rejecting the government’s variance argument, the district court emphasized that the Perkins’ were not basing their claim to a refund on their entitlement to deduct expenses, and they had properly teed up the treaty issue in their claim:

Cutting through all the back and forth, the crux of the plaintiffs’ claim is that their gravel income was improperly taxed. That issue was fully presented in their refund claim to the IRS. The IRS had a full opportunity to investigate all aspects of their claim for a refund; as the plaintiffs observe, however, the IRS chose not to “examine the 2010 income or business expenses, and did not request or review any receipts, statements, workpapers, or other records.” 

Because the plaintiffs’ theory as to why they are entitled to a refund has not changed, their claim is not barred by the variance doctrine. And the fact that the IRS has now come up with a new reason why the plaintiffs were taxed in the correct amount (or even less than they should have been) does not change that.

While the Perkins’ claim did not identify their entitlement to deduct expenses, the expenses themselves were not the reason why the Perkins’ claimed to have made an overpayment:

Stated another way, the plaintiffs are not now alleging a new reason why they are entitled to a refund; rather, they are responding to the defendant’s argument why they are not. The plaintiffs claimed that they were due a refund for reason A. The defendant responded that even if the plaintiffs were correct about A, they had no claim because of B. The plaintiffs then said that the defendant was wrong about B because of C. That does not mean that the plaintiffs are raising A and C in support of their claim; rather, they are raising A and using C as a response to defense argument B. That is not a variance by any definition.


The longstanding dispute for the 2010 year now moves to trial.  For the 2008 and 2009 years, the Second Circuit heard oral argument earlier this spring. The earlier years involved deficiencies of hundreds of thousands of dollars. The 2010 year involves just under $7,000.  The disparity in amounts at issue likely explains why the Perkins decided to bifurcate the cases, as the Flora full payment rule likely left Tax Court as the only forum for 2008 and 2009.  As a practical matter, the outcome of the live Second Circuit case will control whether the treaties promise of the “free use and enjoyment” of land insulates the Perkins from income tax on the earnings from their gravel extraction business.

Oakbrook Land Holdings v Comm’r: A Follow-Up Post Exploring the Impact of Administrative Law on Validity of Tax Regulations

Oakbrook Land Holdings v Commissioner is the latest salvo in the Tax Court’s effort to apply administrative law to the process and substance of tax regulations. Concerning the validity of Reagan-era tax regulations, the opinion eats up 128 pages and includes concurring and dissenting opinions that squarely reject the majority’s approach to evaluating whether the regulations comport with requirements under the Administrative Procedure Act (APA). 

Guest contributor Monte Jackel discussed the case and its multiple opinions a couple of weeks ago. In this post, like Monte’s excellent post, I focus on whether IRS/Treasury (hereinafter just IRS) failed to do what is required under the APA’s notice and comment process. I am choosing to omit nuance, including 1) the relationship between procedural challenges and substantive challenges to regulations embodied in Step Two of the Chevron analysis, a topic I explore in detail in Chapter 3 in Saltzman and Book, and 2) whether the concurring opinion is correct in its view that the statute alone is enough to put the kibosh on the deduction without getting into the muddy administrative law issues that the case raises.

This post is a follow up to Monte’s post. My goal is to situate the issue within the APA, and in particular its discussion as to what is required when there are challenges to legislative rules.


At ultimate issue in Oakbrook is whether the taxpayer was entitled to a charitable deduction under Section 170 (the accompanying memorandum decision concludes no).  To set the stage I will summarize the main statutory and regulatory concepts.  I will conclude today’s post by discussing the case’s possible significance for future procedural challenges to regulations and potentially other IRB guidance that may in fact be a legislative rule.

Legal and Factual Background

When donating property other than money, the charitable deduction is equal to the property’s fair market value at the time the donor makes the gift.  When donating noncash property, the Code generally prohibits a charitable contribution deduction when the donor fails to donate the entire interest in the property. 

There is a statutory exception to the requirement that a donor transfer the entire interests for “qualified conservation contributions” like easements over a portion of land involved in this case. One of the statutory requirements for qualified conservation contributions is that the done uses the contributed property exclusively for conservation purposes. In discussing that requirement, the Code provides that a donation will not be treated as made exclusively for conservation purposes unless “unless the conservation purpose is protected in perpetuity” (the “perpetuity rule”).

Now that we have situated the broad statutory scheme let’s focus on how IRS put some flesh on the perpetuity rule. Three years after the statutory rules for conservation easements came about in 1980 in the Tax Treatment Extension Act, IRS proposed regulations. One of the items in the proposed regulations addressed how to satisfy the perpetuity rule with the reality that circumstances may change and prevent a property’s use for conservation purposes. Recall that conservation purpose is not perpetual if the donee organization that holds the easement is unable to carry on the conservation purpose.

To allow satisfaction of the perpetuity rule, the proposed regulations and final regs required that the contract between the donor and donee provide that the proceeds of a sale of be used in a manner consistent with the conservation purposes and that the proceeds split in a way that reflected the proportionate fair market value of the easement relative to the whole property at the time of the donation. The proposed regulations, and the final regulations which essentially adopted the proposed regs’ approach to divvying up sale proceeds after a judicial extinguishment of the easement, did not take into account any investments or improvements that the donor could have made following the contribution, notwithstanding that the donor’s actions might account for post-contribution changes in market value.

After issuing the proposed regulations, IRS received over 90 comments.  As the regulations addressed issues other than the perpetuity rule only one commenter criticized the proposed regs’ failure to address how a donor’s improvements might account for increasing the value of the land. In finalizing the regulation, the preamble stated that IRS considered all of the comments it received but did not specifically address the critical comment that addressed donor improvements. IRS made some minor tweaks to the perpetuity rule regulations (that is the way the regs required a proportionate division in a sale following a judicial extinguishment) and made other changes to other provisions in the final regs, which it discussed in the regulations’ preamble published in a Treasury Decision.

What Does the APA Require For Issuing Tax Regulations?

Before I discuss the opinion, I quote from Saltzman and Book, IRS Practice & Procedure ¶3.02[2][a], Historical Classification of Regulations, where treatise Contributing Author Greg Armstrong and I discuss how the APA intersects with the tax regulation process:

Before embarking on a consideration of the categorization of Treasury Regulations….the only types of rules that are specifically referred to in the APA are interpretative rules, policy statements, and rules of agency organization and practice. Those categories are not defined, but rather are listed as exceptions to the notice and comment procedures (discussed at IRS Practice & Procedure ¶ 3.02[3] The Drafting Process).

In the treatise, we discuss how the APA does not mention the term legislative rules. For many years, the IRS and most in the tax academy (including one of my mentors and the original author of IRS Practice & Procedure, Michael Saltzman) have generally thought of tax regulations that were issued pursuant to the general authority to issue rules under Section 7805 as interpretative (or the more modern interpretive) rules that did not require agency to use the APA’s notice and comment process under 5 USC § 553. (For an even deeper dive into this see Bryan Camp’s Duke Law Journal article A History of Tax Regulation Prior to the Administrative Procedure Act; Leandra Lederman’s 2012 article on fighting regs and judicial deference also has an excellent discussion of the historical classification of regs).

As we discuss in the treatise, the understanding that most tax regs were interpretative was rooted in part on the notion that Congress could not delegate its constitutional duty to make law to the executive. In time, the nondelegation doctrine lost force (though is on the comeback trail), and, as academics like Kristin Hickman have emphasized, the consequences for failing to comply with Treasury regulations include sanctions and have both practical and legal effects. In part due to the persuasive writing of Professor Hickman, the consensus has shifted and the modern view shared by most but not all is that Treasury regulations, whether promulgated under the Code’s general authority or a specific grant within a substantive statute, are legislative rules that require the IRS to comply with the notice and comment requirements in the APA (as I mentioned the term legislative rule has no home in the APA but over time courts and commentators began referring to them as such because of their reputation to carry the force of law).

What are the APA’s notice and comment requirements? As the opinion summarizes, to “issue a legislative regulation consistently with the APA an agency must: (1) publish a notice of proposed rulemaking in the Federal Register; (2) provide “interested persons an opportunity to participate * * * through submission of written data, views, or arguments”; and (3) “[a]fter consideration of the relevant matter presented,* * * incorporate in the rules adopted a concise general statement of their basis and purpose.”

The primary procedural issue in Oakbrook was whether the IRS satisfied the third requirement, which I will refer to as the consideration requirement though it is best thought of as two related requirements, that the agency a consider the comment and show its consideration by explaining the choices it made. 

What are the consequences if a court finds that the IRS failed to satisfy the notice and comment requirements? Under the APA a court is required to invalidate agency action if the agency failed to satisfy them because it would be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” Whether IRS satisfied the consideration requirement is, as Monte discussed, where the majority, concurring and dissenting opinions parted ways.  All the opinions agreed that the regs at issue were legislative (As an aside, I note and expand in the treatise that the issue of whether an agency rule, including IRS IRB guidance, is legislative involves dense administrative law case law. The majority opinion in this case adds a slightly different gloss on that issue compared to what the Tax Court said in its last major opinion on the issue, SIH Holdings v Comm’r, with the emphasis in this opinion on the regulations imposing a requirement that is “not explicitly set forth in the statute”).

The Majority Opinion’s Approach to Whether the IRS Considered Comments and Explained Itself Adequately

The opinion’s discussion of the consideration requirement notes that while the court itself cannot provide an agency explanation for the agency’s choices it will “uphold a decision of less than ideal clarity if the agency’s path may reasonably be discerned.” (citing Bowman Transp., Inc. v. Ark.-Best Freight Sys., Inc., 419 U.S. 281, 285 (1974)). This sweeps in the Supreme Court’s 1983 State Farm decision: for agency action to satisfy the arbitrary and capricious standard, the agency action “must be the product of ‘reasoned decision-making,’ and the agency must, at the time it takes the action being reviewed, provide a reasoned explanation for why it made the particular decision it did.”

In finding that the IRS’s actions were adequate in this case, the majority notes that the preamble discussed the IRS’s efforts at effectuating Congressional policy choices and that the preamble flagged “that ‘[t]he most difficult problem posed in this regulation was how to provide a workable framework for donors, donees, and the * * * [IRS] to judge the deductibility of open space easements,’ inviting public comments on this and other points.”

Finding the general statement in the preamble that it considered all comments important, the opinion also notes that the preamble discussed the seven groups of comments it received and that it was not required to address all of the comments. The opinion also notes that IRS clearly considered the judicial extinguishment rule, pointing to the changes in the final regs in response to some of the comments IRS received.  

What about the absence of specific discussion of the comment on donor improvements? In the majority’s view, that was insufficient find invalidate the reg. It gets to that conclusion by framing the one comment as essentially insignificant:

Only one of the 90 commenters mentioned donor improvements, and it devoted exactly one paragraph to this subject. That commenter, NYLC, was concerned about facade easements on historic structures, as opposed to “perpetual open space easements,” with which Treasury was chiefly concerned

Moreover, the majority opinion suggests that a comment may be considered significant (and thus likely requiring the agency to address to pass muster) if the comment offers proposed remedies and in this case the commenter “offered no suggestion about how the subject of donor improvements might be handled; it simply recommended “deletion of the entire extinguishment provision.”

In finding that the IRS also complied with its requirement to provide a concise general statement of the regulation’s basis and purpose, the opinion notes that the failure to discuss its rationale in not changing the final regs to reflect value issues stemming from donor improvements was not grounds for invalidating the reg: 

[That] provision represented one subparagraph of a regulation project consisting of 10 paragraphs, 23 subparagraphs, 30 subdivisions, and 21 examples. No court has ever construed the APA to mandate that an agency explain the basis and purpose of each individual component of a regulation separately.

Adding some support for its conclusion, the majority notes that context matters, looking to things like the subject matter of the regs and the nature of the comments received: 

The broad statements of purpose contained in the preambles to the final and proposed regulations, coupled with obvious inferences drawn from the regulations themselves, are more than adequate to enable us to perform judicial review. We find that Treasury’s rationale for the judicial extinguishment rule “can reasonably be discerned and * * * coincides with the agency’s authority and obligations under the relevant statute.”

Future Implications

As Monte suggests in his post, the majority opinion provides guidance for those submitting comments on regs, as the “case seems to indicate that a comment letter should state that the issue is material, fully discuss the issue, and propose a practical alternative if one is available.”

What about future courts confronting procedural challenges? Monte’s post does an excellent job of highlighting how the concurring and dissenting opinions approach the issue of a regulation’s procedural validity under the APA. As the concurring and dissenting opinions emphasize, the 2012 Federal Circuit case Dominion Resources is an example of a court invalidating a tax regulation on procedural grounds. Future litigants unhappy with way that regulations apply to their positions will be taking aim at the process and looking at this opinion to help frame their arguments.

One thing that is clear is that cases applying the APA to agency issuance of legislative rules is that an agency need not respond to all comments it receives. The key is whether the comment is significant, a term that is hard to pin down, though the dissenting opinion attempts to provide guidance. Building on the majority opinion’s discussion that a comment is more likely to require agency response if it offers an alternative, the dissent refines that by requiring the comment “identify a specific and objective issue created by the language of the proposed rule and give some explanation for why that language is troublesome.” Framed as the what and why test , i.e., “(1) what is the problem; and (2) why is it a problem?” the dissent notes that agencies are not required to speculate or offer hypotheticals on their own.

It remains to be seen how other courts will address challenges to regulations that predate the more modern Treasury practice of throwing the kitchen sink in preambles, though the SIH Holdings case (also involving decades old regs, though in that case there were no comments as an excellent Tax Prof post from Bryan Camp discussed) suggests that courts are hesitant to apply today’s more exacting standards to regulations that were issued decades earlier. As the majority opinion highlights at times the Tax Court has upheld regulations even in the absence of a stated purpose if the basis and purpose were obvious.

The concurring opinion in Oakbrook emphasized the inadequacy of the preamble to the final reg (e.g., only two pages in the face of hundreds of pages of comments, and hours of public comments at a hearing) and Home Box Office, an important DC Circuit case from the late 1970s, that discussed the benefit to agency rulemaking when there is a dialogue between an agency and commenters making significant points in the rulemaking process. The concurring opinion also rightly notes when promulgating the reg in this case the IRS likely “was simply following its historical position that the APA’s procedural requirements did not apply to these types of regulations.”

In concluding that the reg failed to satisfy the APA’s procedural requirements, the concurring opinion ends by citing language from a Supreme Court case noting that the reasoned explanation requirement is “not a high bar but an unwavering one.” (citing Judulang v Holder).

Oakbrook suggests that the bar may be lower for longstanding tax regulations, and highlights the way that these challenges arise in deficiency cases rather than at a time closer to the rule’s promulgation. Of course that makes no sense, but that takes us to other issues and how perhaps it is time to allow a more orderly challenge to IRS guidance outside the traditional tax controversy process.

Is IRS Too Soft on People Claiming EITC? Treasury Says Yes and Also Suggests No

The pressure on the IRS to deliver the economic impact payment (EIP) highlights some of the general challenges the IRS faces when Congress tasks the IRS to deliver benefits.  With respect to the EIP, faced with a public that needs the money that Congress has earmarked, IRS has had to move quickly. In times like these, when balancing speed with accuracy, IRS should and admirably has erred on the side of speed.  With lives upended and millions of Americans struggling, this is the right call. 

As an administrator that regularly gets taken to task when it comes to its administration of refundable credits like the EITC, IRS faces a similar trade off in its more routine day to day work.  IRS knows that millions of Americans rely on those Code-based benefits. At the same time, about 25% of the EITC is classified as an improper payment, as Congress has been sure to remind Commissioner Rettig when he has been up on the Hill.

Two recent publications highlight the competing pressures the IRS faces as a result of it having responsibility for administering the EITC.  One is a TIGTA report taking the IRS to task for failing to impose civil penalties and bans on individuals who appear to be improperly claiming the EITC. The other is a Treasury Office of Tax Analysis (OTA) working paper that emphasizes that the vast majority of people claiming the EITC have an eligible familial relationship with a claimed qualifying child.

For folks who are looking for differing perspectives on an issue I suggest that you read both, back to back.  If reading TIGTA reports and OTA working papers is not your ideal way of spending an afternoon, in this post I will discuss the highlights of both.


TIGTA: IRS Not Doing Enough to Deter and Punish Improper Claimants

First, the TIGTA Report. TIGTA’s steady drumbeat on EITC and refundable credits is that IRS is not using the enforcement tools that Congress has given to it. 

Congress provided the IRS with tools to address taxpayers identified as submitting fraudulent or reckless refundable credit claims. These tools include the authority to assess the erroneous refund penalty and require taxpayers to recertify that they meet refundable credit eligibility requirements for credits claimed on a return filed subsequent to disallowance of a credit, and the ability to apply two-year or 10-year bans on taxpayers who disregard credit eligibility rules. However, the IRS does not use these tools to the extent possible to address erroneous credit payments. 

What are the consequences of IRS not using its robust power to sanction taxpayers? In TIGTA’s view,

[t]he ineffective use of the various authorities provided in the I.R.C. is a contributing factor in the high rate of improper payments. The IRS estimates that 25 percent ($18.4 billion) of EITC payments made in Fiscal Year 2018 were improper payments. The IRS also estimates that nearly 33 percent ($8.7 billion) of ACTC payments made during Tax Years 2009 through 2011, and more than 31 percent ($5.3 billion) of AOTC payments made during Tax Year 2012, were potentially improper. 

The main gripe TIGTA emphasizes is that the IRS has failed to use its power to impose a 20% erroneous refund penalty under Section 6676, a power that Congress amended a few years ago to specifically apply to individuals erroneously claiming refundable credits like the EITC:

In Years 2015, 2016, and 2017, the IRS assessed the erroneous refund penalty on 3,190 erroneous claims totaling $2.7 million. However, our analysis identified 494,555 withholding and refundable credits disallowed for Tax Years 2015, 2016, and 2017 (as of December 27, 2018). These taxpayers filed 798,504 tax returns that claimed more than $2.6 billion in improper withholding or refundable credits. Applying the 20 percent erroneous penalty rate to the disallowed credits computes to almost $534.7 million in penalties that the IRS potentially could have assessed. 

TIGTA goes on state that IRS has studied the impact of the few cases when IRS has in fact imposed the 6676 penalty, and it appears that IRS is teeing up some recommendations based upon its study (FYI – I have not seen the study nor do I know if IRS is planning on releasing it; it would be interesting as well to see how much tax is collected out of previously assessed penalties—I suspect not much). 

The report also criticizes IRS for failing to systematically impose a two-year ban on taxpayers who in TIGTA’s view are recklessly or intentionally disregarding rules and faulty IRS processes for allowing individuals to recertify eligibility for the EITC (and other disallowed credits). As to the ban, TIGTA notes that in successive years people appear to be incorrectly claiming the EITC. ( Note: as advocates know appearances may be misleading as claimants may be unaware of the rules or simply not able to document meeting eligibility criteria. For more on the ban, see Bob Probasco’s excellent three part series, The EITC Ban-Further Thoughts Part 1Part 2 and Part 3.) In a heavily redacted section, TIGTA suggests that the IRS should impose the ban earlier and more frequently. This would free scarce audit resources to investigate other individuals and prevent erroneous claims.

The TIGTA report also discusses recertification. For individuals who have had credits denied through deficiency procedures, Section 32(k) provides that “no credit shall be allowed under this section for any subsequent taxable year unless the taxpayer provides such information as the Secretary may require to demonstrate eligibility for such credit.” TIGTA highlights IRS problems with its processes to ensure that taxpayers who recertify are in fact eligible for the claimed credits.

OTA: The “Improper” EITC Claimants Look Like the Proper Claimants

The OTA paper looks at the EITC very a different perspective. While noting the stubborn 25% or so improper payment rate, OTA attempts to study the characteristics of the people who are not eligible or who appear to be overclaiming the credit. The reason for the inquiry is to help frame the debate around improper payment rates. As OTA notes, 

from the social welfare perspective, policymakers might view a case where a child lived with her low-income grandmother for 6 months of the year differently from a case where an unrelated person claimed a child she did not live with at all; but, both cases would be counted equally in computing the EITC error rate.

What the improper payment rates alone fail to tell us is context. 

When a taxpayer fails to meet the qualifying child tests for an EITC claim, it is generally unknown how closely this taxpayer is related to the child and whether another taxpayer could have correctly claimed the child. 

It is possible for more than one taxpayer to have provided some care for the child during the year, but no single taxpayer to be eligible to claim the EITC for that child under the law (e.g., the child does not live with any taxpayer for more than half the year). In other cases, the erroneous claim may have precluded the actual caregiver from claiming the child. 

What OTA does in the paper is to provide more detail to allow for a “more nuanced consideration of EITC qualifying child errors and the associated social welfare implications.”

What kind of nuance did OTA look to identify? Essentially OTA looked to see if there was a family relationship between the adult and the child claimed as a qualifying child:

Specifically, we analyzed the intensity of the familial relationship between the child and the actual claimant as well as the length of the shared residency, providing information about whether the claim, despite being erroneous, might nonetheless have supported a low-income worker caring for a child. In addition, we studied possible reasons why the “wrong” taxpayer may have claimed the child—whether this occurred due to complicated family circumstances, intentional credit-maximizing behavior, or other reasons—to better understand the causes of EITC noncompliance. Finally, we estimated the credit that could have been received by the parent who did not already claim the child and was potentially the actual caregiver. This result offers an insight into the extent to which the EITC improper payment estimates may overstate not only the social welfare loss but also the monetary loss to the government. 

OTA’s study showed that in the overwhelming number of cases, when there was an error, there still was a close familial relationship between the adult and the child or children, though typically the adult was not the child’s biological parent:

Our analysis suggests an intense relationship between the child and the claiming taxpayer in most cases. About 87 percent of the children, despite being claimed with qualifying child errors, had a valid familial relationship (84 percent) or lived with the taxpayer for more than half of the year (7 percent) or both. However, compared to children who met all of the qualifying child tests, the children in our sample were much less likely to be the son or daughter of the taxpayer, and more likely to have other valid familial relationships (e.g., grandchild or nephew/niece) with the taxpayer. 

The whole paper deserves a careful read, but the bottom line conclusion is that the majority of children claimed with qualifying child errors had an eligible familial relationship with their claimants and in a majority of the cases there was no parent who under current eligibility criteria could in fact be eligible to claim a child.

Furthermore, about 60 percent of the children did not appear to have a parent who could be the “right” taxpayer, as stipulated by law, who could file a claim. We conclude that a substantial portion of erroneous EITC claims likely helped support children in low-income families despite those children being claimed in error. Parents of another 4 percent of children were found to have filed a duplicate claim with the taxpayer under audit. For the remaining 36 percent of children, who had a tax-filing parent not already claiming the child, the family members’ filing patterns were consistent with the credit-maximizing motive in 85 percent of cases. We offer a few explanations, including taxpayer confusion about EITC rules or law changes, to account for the claiming pattern of the remaining 15 percent of cases. Finally, we estimate that the forgone credit that could have been received by non-claiming parents amounted to about 10 percent of the total overclaims attributable to qualifying child errors, or 4 percent of all EITC overclaims. Taken together, these results suggest that the official improper payment rate overstates the social welfare loss and monetary loss to the government.  (emphasis added)


At the end of the day, the OTA study and TIGTA report are likely to appeal to differing parts of the trade off I discussed in the introduction. It could very well be that administrators (and readers and Congress for that matter) do not necessarily value social welfare concerns in the same way that I or others do.  People could place a higher value on rule following. After all, Congress is responsible for determining the eligibility criteria, and it could change the criteria to reach some of the adults who are improperly claiming the credit (I and others have suggested this in past papers, most recently from me in the special report to Congress on the EITC that was part of the TAS FY 2020 Objectives Report). 

How does the current pandemic and economic crisis influence this issue? If I were in the IRS now, I would be strongly advocating for the IRS to slow down on the TIGTA recommendation to impose more civil penalties and sanctions on EITC claimants. Context matters. People are struggling. While it should not mean a green light for allowing erroneous claims to go out of the door, OTA helps us understand that the overwhelming majority of Americans who appear to be improperly claiming the credit have a close family relationship with the children identified on their tax return. 

When the current crisis clears, Congress should take a hard look at the EITC and other credits. It could help the IRS by boosting the childless EITC, which in addition to helping millions of working Americans will also likely decrease incentives for people to share children to ensure eligibility. Congress should also reconsider the eligibility requirements that are difficult and expensive for the IRS to verify and which make less sense in today’s world, like pegging eligibility on arbitrary residency rules that 1) may understate the importance of family members who are connected financially and emotionally but who do not live with a child for more than 6 months and 2) do not work well when there are multigenerational families living together.

In Wells Fargo 8th Circuit Holds Reasonable Basis Defense to Negligence Penalty Requires Taxpayers Prove Actual Reliance on Authorities

In an important opinion the 8th Circuit in Wells Fargo v US held that the reasonable basis defense to the negligence penalty requires a taxpayer to prove that they actually relied on relevant legal authority rather than just show that objectively the authority supported the taxpayer’s position. Wells Fargo is the first appellate opinion to hold that reasonable basis for penalty defense purposes is based on a subjective rather than objective standard. The earlier district court opinion had attracted significant interest, and as I discuss below, the court’s holding may force taxpayers to waive attorney client privilege if they want to use the defense to the negligence penalty.


Some Background

Before getting to the 8th Circuit opinion I will give some context.

The transaction at issue involved interest deductions and a complex foreign tax credit generating transaction. At the district court, the government lost in its effort to use the economic substance doctrine to disallow interest expense deductions for a transaction that lacked a non tax business purpose but won on its use of the doctrine to disallow the foreign tax credits arising from a trust structure. The district court also sustained the negligence penalty attributable to the tax due from the disallowed foreign tax credits. 

There are a couple of tangential issues that that I need to address before I get to the main parts of this post. I am not analyzing Wells Fargo’s economic substance issue; for readers looking for more background see Stu Bassin’s post Wells Fargo Decision Answers Economic Substance Question that followed the district court opinion. In addition, the negligence penalty in this case was not asserted on audit but arose as part of the government’s offset defense in the district court litigation. That is important for purposes of a separate Section 6751(b) managerial approval/Graev issue that I do not analyze in this post. Essentially the 8th Circuit in this opinion held that supervisory approval is not required when the government asserts a penalty as an affirmative defense in refund litigation, as done in this case. For readers wanting more on 6751(b), I direct you to many posts on the issue or newly revised ¶ 7B.24 in Saltzman and Book.

To the negligence penalty and reasonable basis. 

Section 6662 imposes a 20 percent penalty on any underpayment of tax that is attributable to the taxpayer’s “negligence or disregard of rules or regulations.” Treasury regulations under Section 6662 provide a defense to the negligence penalty if the taxpayer’s “return position” was “reasonably based on one or more of the authorities set forth in § 1.6662-4(d)(3)(iii) (taking into account the relevance and persuasiveness of the authorities, and subsequent developments).” The Wells Fargo opinion cross references regs under Section 6114 (addressing treaty based return positions) which provide that a “taxpayer is considered to adopt a ‘return position’ when the taxpayer determines its tax liability with respect to a particular item of income, deduction or credit.” 

As I discussed following the district court opinion in Wells Fargo and The Negligence Penalty for A Transaction Lacking Reasonable Basis, the penalty issue was “teed up for the district court in a somewhat odd manner, with Wells Fargo stipulating that if the foreign credit generating transaction was a sham, it should not be subject to the penalty because ‘there was an objectively reasonable basis for Wells Fargo’s return position under the authorities referenced in § 1.6662–3(b)(3).’  In finding that the transaction was a sham, the district court also held that Wells Fargo was subject to the penalty because it had to prove that it in fact consulted with the authorities before adopting its position on the return. 

In my 2017 post I noted that the penalty aspect of the opinion was controversial:

At or around the time of the opinion, Jim Malone of Post & Schell wrote a terrific blog post critiquing the district court opinion, suggesting that perhaps Wells Fargo deserved to be penalized but that the court’s approach to the issue was “troubling”. There was also a piece in Bloomberg that quoted Jim and former PT guest poster Andy Grewal, with Andy saying that “it would be more sensible to apply Section 1.6662-3(b)(1) in accordance with its plain meaning and examining all relevant authorities supporting the treatment of a position, whether or not the taxpayer was aware of them.”

Practitioners have been closely following the case. For example, a February 2020 article in Tax Notes co-written by my old Davis Polk colleague Mario Verdolini and Christopher Baratta The Objectivity of the Reasonable Basis Defense to Tax Penalties (subscription needed) criticized the district court opinion and urged the 8th Circuit to adopt an objective approach in applying reasonable basis.

The 8th Circuit Majority Opinion on Reasonable Basis

The 8th Circuit, in affirming the district court, disagreed, finding that reasonable basis requires evidence that a taxpayer actually relied on relevant legal authority in support of its positions taken on tax returns. In so doing the 8th Circuit sidestepped the possible thorny administrative law issue concerning whether IRS is entitled to deference regarding an interpretation of its own regulations because it concluded that the regs were not ambiguous. (Aside: Deference to an agency’s interpretation of its own ambiguous regulations is the so-called Auer issue I discussed in my earlier post on the case. Last year the Supreme Court addressed Auer in Kisor v. Wilkie, where it tightened the standard under which courts are to defer to agency interpretations of their own regulations. For those wanting more on this, see Saltzman and Book IRS Practice & Procedure ¶ 3.6, where Greg Armstrong and I recently added a revised discussion of the importance of Auer deference in light of Kisor; I discuss this a bit more below in reviewing the dissent.  See also an earlier post discussing Kisor.)

Citing Black’s Law Dictionary, the opinion stressed that the “plain or common usage of the word “base” suggests that one is relying on particular information in order to form an opinion or a position about something.”

As the district court noted, “[i]t is difficult to know how a taxpayer could ‘base’ a return position on a set of authorities without actually consulting those authorities, just as it is difficult to know how someone could ‘base’ an opinion about the best restaurant in town on Zagat ratings without actually consulting any Zagat ratings.” Indeed, the regulation does not require the taxpayer’s position to be simply “consistent with” or “supported by” the relevant legal authority. If it did, then it might be sufficient that the relevant authorities supported the taxpayer’s position, regardless of whether the taxpayer relied upon them. But in order for a taxpayer to “base” its position on relevant authority, it must have actually known about those authorities and actually relied upon them when forming its return position. (emphasis added though citations omitted, including cites to some district court opinions taking a contrary view of the issue)

In addition to its use of a plain language analysis, the opinion also notes that the subjective approach to the reasonable basis defense is “sensible in light of the broader context of the statute and accompanying regulatory definition.” In reaching that conclusion, the opinion looks to the underlying issue relating to a penalty, and how that suggests some foundation in actual taxpayer behavior:

Again, the government is seeking to impose a “negligence penalty,” which suggests that the focus of the inquiry must be, at least in part, on the taxpayer’s actual conduct—whether it met the requisite standard of care in preparing its tax return and considering its return position—rather than simply determining whether its legal position finds support in the relevant legal authority. See 26 U.S.C. § 6662(c) (defining “negligence” as “any failure to make a reasonable attempt to comply with the provisions of this title”). 

In support of its view that considering actual conduct is at least part of the inquiry, the opinion notes that in a 1996 case, Chakales v Comm’r, the 8th Circuit stressed that “the burden is on the taxpayer to prove that he did not fail to exercise due care or do what a reasonable and prudent person would do under similar circumstances.” 

The opinion does spend time directly addressing the arguments that Wells Fargo offered, including that other regulations directly require taxpayers or third parties to analyze authorities or facts and circumstances (recall that the reasonable basis regs employ the passive voice “is based” approach rather than directly requiring that the taxpayer base its position on authorities):

That other statutory provisions or regulations use different language in creating an actual reliance requirement does not mean that the provision at issue in this case requires only that the taxpayer’s position be objectively reasonable with respect to the relevant legal authorities. 

While it brushed that away the passive voice argument, the opinion noted that Wells Fargo’s concern that a subjective standard “would likely require a taxpayer to waive attorney-client privilege in order to prove that it actually relied on the relevant legal authority” had more “appeal.” Despite that appeal, the opinion noted that other defenses (like actual reliance) trigger similar concerns and that this argument “standing alone” was insufficient to carry the day.

As a final matter, Wells Fargo argued that policy issues supported its view of the regulations and that it should not matter if a taxpayer gets to a reasonable position by luck or design. The opinion disagreed:

[T]here is a sound policy reason underlying a subjective or actual reliance requirement—it incentivizes taxpayers to actually conform to the requisite standard of care rather than simply taking the chance that there may be a reasonable basis for their underpayment of tax. It also reflects the understanding that a taxpayer who carefully studies the relevant legal authorities but arrives at an incorrect conclusion of law, albeit with a reasonable basis for its position, is perhaps less blameworthy or culpable than a taxpayer which simply ignored the existing authorities in forming its tax position and attempts to generate a reasonable basis as a post-hoc justification for its underpayment.

The Dissent

There is a brief but powerful dissenting opinion by Judge Grasz. The dissent disagrees with the majority opinion’s finding that the regulation was unambiguous. In so doing, the dissent is persuaded by Wells Fargo’s argument that the reasonable basis regulations on their face do not impose a reliance argument, and is cast in “objective terms”, unlike the reasonable belief defense, which directly requires that taxpayers “analyze the pertinent authorities.”

The Supreme Court has explained that when “Congress includes particular language in one section of a statute but omits it in another section of the same Act, it is generally presumed that Congress acts intentionally and purposely in the disparate inclusion or exclusion.” Russello v. United States, 464 U.S. 16, 23 (1983) (quotation omitted). I see no reason why the same canon of statutory construction would not apply when interpreting the regulation here. See Black & Decker Corp. v. C.I.R., 986 F.2d 60, 65 (4th Cir. 1993) (“Regulations, like statutes, are interpreted according to canons of construction.”). If the IRS wanted to require actual reliance on the specified authorities to satisfy the reasonable-basis defense, it could have expressly said so, as it did in setting forth eligibility for the reasonable-belief defense. Its failure to do so indicates actual reliance is not required. 

Judge Grasz also returns to the Zagat’s restaurant review analogy (i.e., it is difficult to know how someone could ‘base’ an opinion about the restaurant in town on Zagat ratings without actually consulting any Zagat ratings) in the original district court opinion that the majority also used. While Judge Grasz notes that the analogy is “incisive and colorful” it in his view is based on the faulty premise that the consulting has to be done before the taxpayer takes a position on the return: 

It assumes the taxpayer must base its position on the specified authorities before the return is filed. The regulation makes no such demand. Instead, 26 C.F.R. § 1.6662-3(b)(3) simply provides that a return position will generally be considered — presumably by the agency or the courts — to have a reasonable basis if it is based on one of the authorities designated in 26 C.F.R. § 1.6662-4(d)(3)(iii). And § 1.6662- 4(d)(3)(iii) further indicates that the agency or courts should consider only such designated authority to make its determination. Reading these regulations together, I believe the agency and/or the courts — not the taxpayer — are to make the determination whether there was a reasonable basis for a return position based on the specified authorities. 

The dissent extends the analogy to show why he believes that the majority’s view strays from the regulations:

To illustrate this distinction [that is that the agency or the courts and not the taxpayer are to make the determination under the regs], let us alter the district court’s restaurant analogy. Suppose three friends try to decide where to go for dinner. Two of the friends, Friend A and Friend B, offer differing suggestions, each claiming his suggestion is the best restaurant in town. Tasked with resolving the dispute, Friend C consults Zagat to see which of the two recommended restaurants is indeed “the best,” and, after doing so, sides with Friend A. Friend C’s decision was indeed based on the Zagat ratings. But Friend A did not rely on the Zagat ratings when taking his position. In other words, Friend C’s determination was based on Zagat, regardless of whether Friend A ever relied on the service. 

Once establishing that there is at least ambiguity in the regs, that tees up the Auer/Kisor issue.  Kisor essentially looks to see if five additional factors are present before a court is to give an agency’s view greater deference. Here, according to Judge Grasz, three of those factors were absent, that the interpretation must be the agency’s authoritative or official position; the interpretation must in some way implicate the agency’s substantive expertise; and the interpretation must reflect fair and considered judgment. 

In light of his view that the regulations did not require a subjective standard and in light of Kisor, Judge Grasz felt that the court effectively improperly gave deference to the IRS’s own view of the regulation. That did not mean necessarily mean that Wells Fargo established that it had reasonable basis. He would have remanded it to the district court to see if in the court’s view Wells Fargo’s foreign tax credit had a reasonable basis in the authorities. (Those few readers still with me might wonder what exactly is reasonable basis? Well that is for another day but most observers peg a position as having a reasonable basis if it has a 20% or more probability of winning).


This case is sure to attract attention and is a powerful tool in the government’s arsenal to penalize aggressive tax positions, or at least put taxpayers in a bind of waiving privilege claims to successfully assert a reasonable basis defense.

I do believe that the majority opinion perhaps overstates its position that the broader context of the statute and regulations support the conclusion that the regs require a taxpayer to show that it actually relied on the authorities. For example, as the Verdolini & Baratta article in Tax Notes earlier this year notes, the reasonable basis regulations take into account subsequent developments. If, as Verdolini and Baratta note,  “a taxpayer had to rely on the authorities when filing a return, it would be impossible for the taxpayer to rely on any developments after the filing of the return.”  

I anticipate that this will not be the last appellate word on this issue.

Court Grants Compassionate Release to High Profile Tax Felon Morris Zukerman

COVID-19 is spreading throughout prisons. The first federal prisoner died of the virus on March 28th. A week later Attorney General Barr ordered the federal Bureau of Prisons to prioritize the release of vulnerable inmates. In today’s post I will explore the impact of COVID-19 on one high profile tax felon.


In 2016, wealthy investor Morris Zukerman pled guilty to one count of tax evasion and one count of corruptly endeavoring to obstruct and impede the administration of the internal revenue laws. He was sentenced to 70 months in prison for evading $45 million in federal income and state taxes. His crime included a phony $1 million charitable donation which actually funded his purchase of land on tony Block Island, providing fake documents to his accountants and lawyers representing him during the IRS audit, and funneling corporate funds to pay personal expenses.

In sentencing Zukerman, Federal District Court Judge Analisa Torres said that “Zukerman’s crimes were driven by unmitigated greed,” and that he “thought himself to be above the law.”

Zukerman reported to federal prison in Otisville New York in June of 2017. 

Fast forward to 2020. Prison populations are especially vulnerable to COVID-19, with prisoners living and eating in close quarters, and much of the prison population elderly and suffering from pre-existing health conditions. This has led to the early release of some high profile felons, including President Trump’s former fixer Michael Cohen, a fellow inmate of Zukerman’s at Otisville, who left prison last week to serve the balance of his term in home confinement.

On March 27th, the day before the first reported death in federal prisons, Zukerman filed a request with his warden asking for compassionate release. Three days later and prior to any response from the warden, Zukerman filed a motion in federal district court asking that the court grant his request. The government opposed the motion, and the same judge who sentenced Zukerman granted his request. Zukerman is now finishing his term in home incarceration. 

Under what authority can federal prisoners like Cohen or Zukerman seek early release? The First Step Act of 2018 amended Title 18 USC § 3582 and provides that a court may modify a sentence “upon motion of the Director of the Bureau of Prisons, or upon motion of the defendant after the defendant has fully exhausted all administrative rights to appeal a failure of the Bureau of Prisons to bring a motion on the prisoner’s behalf…” The statute grants the court power to reduce a sentence or impose supervised release if the court finds that  “extraordinary and compelling reasons warrant such a reduction … and that such a reduction is consistent with applicable policy statements issued by the Sentencing Commission.”

Under normal circumstances, a prisoner seeking compassionate release is required to present an application to the BOP and then either (1) administratively appeal an adverse result if the BOP does not agree that his sentence should be modified, or (2) wait for 30 days to pass and then appeal.  

On March 27, 2020, Zukerman submitted a request for compassionate release to his warden. Three days later, after not receiving a response, Zukerman filed a motion in court to modify his sentence in light of the COVID-19 pandemic. The motion included information about Zukerman’s risk factors for getting COVID-19 in light of his age, health and Otisville’s dorm-like living arrangements:

Zukerman is 75 years old and suffers from diabetes, hypertension, and obesity. He is currently serving his sentence at Otisville, where, as of March 27, 2020, at least one inmate has tested positive for COVID-19…. At Otisville, 120 inmates eat elbow-to-elbow at the same time, share one large bathroom with a handful of stalls and a handful of showers, and sleep together in bunks beds only a few feet apart that are divided principally between two dormitories (as opposed to individual cells). The two dormitories are separated only by the shared bathroom.

As Zuckerman’s motion describes, the dorm like setting makes it impossible to isolate. The response at the prison has been to quarantine all prisoners to their dorms or other common areas (Otisville, as one might surmise from the description, is a minimum security federal “camp”–for more on Otisville, see this New York Times article from a year or so ago). 

Zukerman’s doctor wrote in support of the motion that based on the Centers for Disease Control and Prevention guidelines for COVID-19, Zukerman is in “the highest risk category for complications and death from the disease.” 

The government’s opposed the motion on two grounds. First, it argued that Zukerman failed to exhaust the administrative process, a process that the statute seems to mandate. Second, it argued that the severity of Zukerman’s crimes warranted against finding that there were extraordinary and compelling reasons to grant the request.

The Exhaustion Requirement

In finding that Zukerman could bypass the requirement that prisoners exhaust the administrative process, the court noted that while it is strictly construed, there are circumstances when courts could waive it:

 “Even where exhaustion is seemingly mandated by statute … , the requirement is not absolute.”… There are three circumstances where failure to exhaust may be excused. “First, exhaustion may be unnecessary where it would be futile, either because agency decisionmakers are biased or because the agency has already determined the issue.” . Second, “exhaustion may be unnecessary where the administrative process would be incapable of granting adequate relief.” Id. at 119. Third, “exhaustion may be unnecessary where pursuing agency review would subject plaintiffs to undue prejudice.” 

In light of the potential harm of the virus, the court concluded that “requiring [Zukerman] to exhaust administrative remedies, given his unique circumstances and the exigency of a rapidly advancing pandemic, would result in undue prejudice and render exhaustion of the full BOP administrative process both futile and inadequate.”

The court’s brush off of the exhaustion requirement warrants a bit more discussion. I note that in the block quote above there is a footnote I omitted discussing a recent Supreme Court case where the Supreme Court seemed to make it very clear that in considering exhaustion “Congress sets the rules” and “courts have a role in creating exceptions only if Congress wants them to.”, citing Ross v. Blake , 136 S. Ct. 1850, 1857 (2016). Despite that admonition, the district court stated that some times the claimant’s interest is so great that courts can sidestep strictly following the rules so long as the person has made some request to the agency, citing the 1976 Supreme Court case Mathews v Eldridge and Washington v Barr, a 2019 Second Circuit opinion discussing how that in extraordinary circumstances the courts can relax the exhaustion requirements. As Zukerman did submit a release request to the warden three days before he filed his motion in court, and in light of the risks to his health, the court found that Zukerman need not go through normal channels. 

Extraordinary and Compelling 

Given that Zukerman was able to convince the court to waive the exhaustion rules, it also is not surprising that the judge found that his motion presented extraordinary and compelling reasons for his release.  In discussing this issue, the opinion notes that the statute gives the US Sentencing Commission  (USSC) authority to define what is extraordinary and compelling. USSC comments on the standard focus on whether “[t]he defendant is … suffering from a serious physical or medical condition … that substantially diminishes the ability to provide self-care within the environment of a correctional facility and from which he or she is not expected to recover.”

The opinion discusses a number of cases in the last month where other courts have looked at the health, age and prison conditions, and concluded that the pandemic justified early release from prison.

Yet the government also argued that the severity of Zukerman’s tax crimes warranted against finding that the reasons for early release were extraordinary and compelling. While acknowledging Zukerman’s offenses, the court noted however that the pandemic was a game changer: 

The Court does not disagree that Zukerman’s misconduct was egregious. As the Court observed at sentencing, “Zukerman evaded taxes totaling millions of dollars. He was driven not by need, but by unmitigated greed. He entangled himself in a web of lies and deceit, lying to his tax preparer, and then hiring lawyers to defend his lies. He went to such extraordinary lengths in order to cheat. These frauds were deliberate and calculated. Zukerman thought himself to be above the law.” The severity of Zukerman’s conduct remains unchanged. What has changed, however, is the environment where Zukerman is serving his sentence. When the Court sentenced Zukerman, the Court did not intend for that sentence to “include incurring a great and unforeseen risk of severe illness or death” brought on by a global pandemic.  Citing United States v. Rodriguez , 03 Cr. 271-1, 2020 WL 1627331, at *12 (E.D. Pa. Apr. 1, 2020) (emphasis added)


The upshot of the opinion is that Zukerman was able to leave prison at least a year before he was otherwise eligible to do so. I do not have any special expertise in requests to modify prison sentences. The Zukerman opinion and order highlights just one of the many ways that the pandemic is having an impact on tax administration. With many well-heeled felons like Zukerman able to afford the costs of getting a motion for early release before a court, one hopes that the BOP takes a proactive approach with other inmates who do not have the same resources. While the pandemic should not necessarily amount to a get out of jail card for all felons, it should not amount to a pass for only those who can pay for their freedom.

Boyle and the AWOL Return Preparer: No Excuse for Late Filing

A recent case out of the Northern District of California, Willett v United States, illustrates the difficulty taxpayers face when trying to base a reasonable cause defense to the late filing of tax returns on the conduct of their return preparer.

I will summarize the facts and the court’s analysis.


The Willetts had filed an extension for the 2014 year. In August of 2015, they delivered their K-1s, W-2s and 1099’s to their longtime preparer, who was a CPA. After dropping off the documents, for about three months their preparer did not respond to their phone calls. In October, the preparer contacted the Willets and told them that she had been seriously ill, would prepare the returns upon her release from an extended care facility, and would pay any penalties and interest associated with the late filing.

After another month or so of not hearing from the accountant, in November Mrs. Willett visited her preparer’s house to get an update. The preparer assured Mrs. Willett that she would complete the return. Unfortunately, despite the Willetts’ repeated efforts to contact her, that was the last that time that they heard from her (she in fact passed away in early 2017).  

The Willetts alleged that by December of 2015 they actively sought a replacement but were unable to get someone until June of 2016 due to other preparers claiming that (1) they were too busy or (2) the return was too complex. By June of 2016, they found someone and hired another CPA, and they filed the return in September of 2016. 

When the Willetts filed the delinquent return, IRS assessed over $34,000 and $6,000 of late filing and late payment penalties. The Willetts paid the penalties and filed a timely refund claim, alleging that their late filing should be excused based on their reasonably relying on their longtime accountant to prepare and file the returns on their behalf.  The IRS rejected the claim, and the Willetts filed suit in federal court. 

In response to the complaint, the government filed a motion to dismiss based on Boyle.  In response to the motion to dismiss, the Willetts amended their complaint and included even greater detail about the efforts they made to contact their longtime preparer after they dropped their tax documents off in August of 2016.   

The additional facts did not help: 

The Willetts’ allegations do not sufficiently plead reasonable cause entitling them to a refund for the late-filing penalties. Their allegations illustrate that they relied on their CPA, Ms. Goode, who possessed the original copies of their tax documents, became seriously ill, and was unable to complete their 2014 tax return on time.  In their Amended Complaint, the Willetts attempt to salvage their claims by providing a detailed timeline of the failed attempts to contact Ms. Goode. However, this timeline fails to demonstrate ordinary care, because it merely illustrates the numerous attempts to contact Ms. Goode.  But those allegations plead no excuse for the late-filing other than reliance on the Willetts’ agent, which is not “reasonable cause” under Boyle.

The Willett opinion does not break new ground. It refers to a couple of cases where the Tax Court held that a nonresponsive or ill accountant does not constitute reasonable cause for late filing. 

It also distinguishes Conklin Brothers of Santa Rosa, a post Boyle 1993 Ninth Circuit case which “held, in the case of a corporate-taxpayer, that reliance on an agent can establish reasonable cause if the taxpayer shows that “it was disabled from complying timely”—e.g., where its agent’s conduct was beyond the taxpayer’s control or supervision.” In distinguishing Conklin the opinion notes  (unpersuasively) that no court has extended it to individuals. More persuasively, the opinion explains that even if Conklin’s limited exception did apply to individuals, the facts as alleged did not support a finding that the Willetts were disabled from complying with their filing responsibilities:

The Willetts seem to imply that Ms. Goode’s possession of the original tax documents “disabled” them from filing their taxes themselves, and prevented them from hiring another CPA. They allege that they made attempts to contact other CPAs, and that those other CPAs would not take them as clients. The insufficiency of these allegations is apparent when compared to other cases holding that the disability exception did not apply. In Conklin, the agent in charge of Conklin’s tax obligations, the corporation’s controller, failed to timely file Conklin’s returns.  For over two years the controller also “intercepted and screened the mail,” “altered check descriptions and the quarterly reports,” and “concealed the deficiencies by undertaking the performance herself of all payroll functions.”  Although the controller’s concealment meant that Conklin’s officers were not aware of the IRS’s penalty assessments, the Ninth Circuit held that the controller’s “intentional misconduct” was not enough to establish that Conklin was disabled from timely complying.  The Willetts’ allegations do not suggest that their agent’s misbehavior was remotely comparable to the controller’s misconduct in Conklin.

(emphasis added; citations omitted)


Willett is a reminder that Boyle generally will prevent a reliance defense in the context of missing a return filing deadline. While there are grounds to challenge Boyle in the context of e-filing (as we have discussed before), Boyle casts a long shadow over taxpayers seeking to escape the hefty civil penalties for late filing. While the Willetts were mightily inconvenienced by their preparer’s failure to prepare the returns and the absence of their K-1s, W-2s and 1099s, the circumstances did not excuse the tardy filing.

As Willett demonstrates, the responsibility to file rests on the taxpayer. One of the barriers that the Willetts faced was that their old preparer had their tax information returns. To be sure the government could make it easier for taxpayers to comply by, for example, seamlessly providing taxpayers access to all information returns they receive from third parties. Last summer, I signed up for an online tax account from the IRS-one of its virtues is that by the time I got around to filing last October I was able to see in one spot the information returns that the IRS had on record for my 2018 year. Of course, most financial institutions and many employers provide access to the information returns if a taxpayer no longer has the original. At some point I suspect that the IRS will make a central portal more readily available for all taxpayers, thereby reducing the burdens of compiling (or retrieving) the returns that are necessary to file.

CIC: Supreme Court Review?

We have discussed CIC Services v IRS on the blog numerous times. As readers may recall, CIC involves an IRS Notice that imposes additional reporting obligations on captive insurance companies and their advisors. CIC, a manager of captives, and an individual who also managed captives and provides tax advice to them, sued. The suit claimed 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 Sixth Circuit, affirming the district court, held that the Anti-Injunction Act (AIA) barred an APA challenge to the Notice.

In August the Sixth Circuit denied a petition for rehearing (see here for my prior blog post discussing that denial). Judge Sutton in his concurring opinion accompanying the rehearing denial strongly encouraged that the Supreme Court grant cert to resolve open questions concerning the reach of the Anti-Injunction Act. 

Since that time CIC filed a cert petition. The Harvard Tax Clinic (through Keith, Carl and students Tyler Underwood, Lauren Hirsch and Oliver Roberts), Meagan Horn (at Thompson and Knight in Dallas serving as pro bono counsel to the clinic) and I have filed an amicus brief flagging the importance of the issue. In our amicus brief we emphasize that the implications of the case extend to low and moderate-income taxpayers. The amicus brief, as well as an amicus from the American College of Tax Counsel and the cert petition itself, can be found on the SCOTUSblog cite.  The government originally was supposed to respond by February 24th but it has asked the Court for a one- month extension.

As an aside, I, along with one of  my colleagues on the Saltzman/Book IRS Practice and Procedure treatise, Contributing Author Marilyn Ames, have posted on SSRN The Morass of the AIA: A Review of the Cases and Major Issues. The article will be published in the Summer 2020 issue of the Tax Lawyer and is based on the heavily rewritten Chapter 1.6 of the Saltzman Book treatise which likewise discusses and analyzes the AIA.  As the article is in draft form I encourage readers to offer comments. This, and other developments such as the Silver case Keith discussed here, suggest that the reach of the AIA is a very hot issue in tax procedure. Stay tuned.

Unreal and Real Audits: Surgeon Finds No Relief From IRS’s “Byzantine” Exam Procedures

The recent Tax Court case of Essner v Commissioner highlights a problem when the IRS conducts both a traditional examination of taxpayer’s books and records while simultaneously contacting the taxpayer under its automated underreporter program.

Here is a simplified version of the still somewhat messy Essner facts. In 2013, Essner, a surgeon, inherited an IRA from his mother, who in turn had inherited the IRA from her husband (Essner’s father).  In 2014 Essner took a distribution of over $360,000 from the IRA.  He researched on his own the tax treatment of the distribution and concluded that the distribution was not gross income because it reflected his father’s original investment in the account. Despite Essner’s belief that the IRA reflected a nontaxable distribution, the financial institution that held the IRA issued an information return both to the IRS and Essner reflecting the distribution as taxable. Essner’s 2014 return, however, did not include the distribution as gross income.


In March and May of 2016, Essner received letters generated from the IRS automated underreporter (AUR) program essentially noting the discrepancy between the income reported on Essner’s return and the income reported by third parties. That discrepancy was attributable to the IRA distribution that Essner did not include as income on his return. In late June of 2016 Essner sent a handwritten letter to the AUR unit saying that he disagreed with the proposed changes. The next letter Essner received from the AUR unit was a January 3, 2017 notice of deficiency reflecting the full amount of the IRA distribution as gross income.

Here is where things get even messier. After Essner sent his letter in response to the AUR notices, but before the IRS sent the notice of deficiency, Essner received a letter from IRS Tax Compliance Officer Joshi saying that the IRS was examining his 2014 federal income tax return.  The letter Joshi sent mentioned that IRS was looking into Essner’s business expenses but did not mention the IRA distribution that the AUR unit had flagged.

The opinion states that Joshi was not aware of the AUR contact and continued with his examination, focusing on expenses. On January 10, 2017, a week after IRS sent Essen a notice of deficiency, Joshi sent an examination report and proposed adjustments. A month later, in February, Joshi sent a revised exam report for 2014. Neither the original or revised report included any income from the IRA distribution. 

On March 10, 2017 Essner sent a letter to Joshi requesting that Joshi send the report to confirm that the IRA distribution was not taxable. Essner received another report and it too did not include the IRA distribution as gross income.

Recall however that the AUR office generated a notice of deficiency reflecting the IRA distribution as gross income. Essner filed a timely pro se petition, arguing initially that the distribution was not gross income. Unfortunately for Essner, at trial he was unable to secure proof of the alleged nondeductible contributions, as well as any prior distributions or withdrawals of those contributions, so he was unable to carry his burden of proof on the issue.

At trial, he also alleged that the IRS actions amounted to a duplicative examination of the same year and tax. While IRS has broad powers to examine tax returns to ensure that the return reflects a taxpayer’s liability, Section 7605(b) contains a general statutory protection against unnecessary or repeat taxpayer examinations for the same tax year. The idea behind 7605(b) is to limit burdens on taxpayers, including time and expense associated with responding to multiple requests for information.

Essner’s argument was that because the AUR contacts and Joshi’s examination ran concurrently, taken together they violated the duplicate exam restriction of Section 7605(b). In addition, he argued that the correspondence showed that “Joshi’s examination was unnecessary (given that it extended past the date when the AUR program generated the notice of deficiency with respect to 2014) and that it required an unauthorized second inspection of petitioner’s books and records (given that Officer Joshi’s examination ran parallel to and appears to have come to positions at odds with the AUR adjustments that underlie the IRS’ position taken in the notice).” 

The IRS argued, as it has in the past, that any contact stemming from AUR is not an examination for purposes of 7605(b) because it derives from a review of third-party records and not the taxpayer’s books and records.

The opinion sympathized with Essner but held that 7605(b) provided no basis for relief on this case:

At the outset, we note that petitioner’s interactions with the IRS–both through the AUR program and his correspondence with Officer Joshi–would be confusing to an ordinary taxpayer. Various offices of the IRS contacted petitioner without coordination, without clarity as to what the other parts were doing, and without providing petitioner a clear explanation as to why the IRS was speaking out of many mouths. A taxpayer ought not to have been subjected to such a byzantine examination. However, we are not empowered to police what ought to have occurred in an examination; we are limited to considering whether section 7605(b), as written, was violated. See Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324, 327 (1974). (emphasis added)

The opinion continues and notes that 7605(b) does not address contacts that stem from the IRS’s receipt of information returns:

Under section 7605(b), the AUR program’s matching of third-party-reported payment information against petitioner’s already-filed 2014 tax return is not an examination of petitioner’s records. See Hubner, 245 F.2d at 38-39. Therefore, no second examination of petitioner’s books and records could have occurred, regardless of the concurrent actions of Officer Joshi. Additionally, as we have found above, petitioner failed to properly report income from the 2014 distribution from the retirement account, and he has conceded other adjustments for tax year 2014. Therefore, respondent’s examination of petitioner’s 2014 tax return was not unnecessary. While we understand petitioner’s frustration with the process of this examination, we cannot say that a failure to communicate and coordinate within the IRS–standing alone–violates section 7605(b). We therefore agree with respondent. 


The IRS’s failure to coordinate its communications as typified in Essner is likely to generate confusion. It is inconsistent with the right to finality, impinges on a taxpayer’s right to be informed and is in tension with a taxpayer’s right to a fair and just tax system. Carving out from 7605(b) protection “unreal” audits like AUR contacts is an issue that the Taxpayer Advocate Service has repeatedly flagged in its annual reports as a most serious problem. (For some more on the TAS view and IRS disagreement with TAS see the FY 2019 Objectives Report at page 38). 

The opinion in Essner rightly reflects concern with the IRS practice. IRS should revisit the limited rights taxpayers are afforded in unreal audits like AUR correspondence (including no right to Appeals review prior to the issuance of a 90-day letter), and should at a minimum strive to ensure that a concurrent examination sweeps in any issues that are raised in AUR correspondence.  Subjecting taxpayers to inconsistent and uncoordinated communication is far from best practice and creates burdens that are inconsistent with a taxpayer rights–based tax administration and the concerns that underlie Section 7605(b). Absent IRS policing itself perhaps it is time for a legislative fix that more directly addresses the growing importance of unreal audits and the burdens they impose.