Biden Administration Floats Refundable Pet Tax Credit Idea to Boost Child Tax Credit

Readers know that last year’s comprehensive tax legislation did not make it through Congress. In the Administration’s FY 23 proposed budget the Biden Administration has brought back one of last year’s more innovative tax policy proposals. In today’s post we revisit that proposal. Les

Last week, Assistant Secretary for Tax Policy nominee Lily Batchelder floated the latest in the Biden Administration’s efforts to provide tax relief to the nation’s millions of people suffering due to the pandemic: a $250 refundable tax credit for families with children under the age of 18 who have pets in their household.

President Biden with his dog, Major
Photo by Stephanie Gomez/Delaware Humane Association, via NY Times/Associated Press

In speaking at the Tax Policy Center webinar entitled “Thinking Outside the Box Tax Policy Ideas”, Batchelder cited the overwhelming research showing that the presence of certain family pets has a strong correlation with positive outcomes in children, including health, education and lifetime earnings. (See, for example this recent research study by Robert Matchock, Pet Ownership and Physical Health)

Insisting that the Biden Administration will continue its evidence based approach to good governance, current Assistant Secretary Mark Mazur noted that evidence has tied positive outcomes to only certain pets-namely dogs and cats. As such, the Treasury officials expected that the legislative language they would support would not extend to other household friends. Mazur acknowledged that the research to date has not studied other animals nearly as much as dogs and cats although there is preliminary research showing that larger rodents (such as chinchillas) have had a positive impact on mental health across age ranges.

Facing questions about whether this might be expanded to older Americans, as the data strongly correlates pet ownership with positive health outcomes among seniors, Mazur was noncommittal, though he emphasized that the Administration’s focus in the near term was on improving conditions for families with children.

“It might be the camel’s nose in the tent,” said Mazur, “but for now we are tying this to our proposals to make permanent the expanded child tax credit that Congress enacted last month.”

Needless to say the proposal generated quite a stir in the webinar. Former NTA and current Executive Director of the Center for Taxpayer Rights Nina Olson asked if Treasury expected IRS to expand its nonfiler portal to allow nonfiling taxpayers to enter pet information alongside their children. Commissioner Rettig, also on the panel, in noting that he is the first Commissioner in IRS history to own not one but two adopted retired Greyhound racers, suggested that Congress should allocate an additional $100 million to its proposed upgrade of technology in order to allow it to build the pet database. 

Panelist and Tax Notes’ tax historian Joseph Thorndike noted that many of these pets may be the direct descendants of pets removed from being claimed as dependents in 1986 when Congress began requiring taxpayers to list the social security number of dependents which caused almost seven million dependents to disappear in one year.  He noted that the ancestors of today’s household pets would no doubt be smiling down as pets once again returned to the 1040.

While not on the panel, former Treasury Secretary Larry Summers, who was slated to speak on a separate panel with former Commissioner Rossotti about the Rossotti/Sarin/Summers tax gap proposal, interrupted Batchelder, stating that the “last thing poor people need is more money in their pockets. I worry about the inflationary impact in the important pet sector.”

As with any proposed credit expansion, there are lots of ancillary issues. PT’s own Keith Fogg notes that “in the 1860s in the predecessor to Section 6334 Congress allowed as part of the property exempt from levy one cow, three pigs, five sheep and the wool thereon. Although that was changed to livestock in 1954 it’s good to see animals formally entering the code again.”

Click here for a link to a video of the webinar.

Oh Mann: The Sixth Circuit Holds IRS Notice Issued in Violation of the APA; District Court in CIC Services Finds Case is Binding Precedent

Preface: This discussion of Mann Construction v US discusses the possible implications of the opinion on the remanded case of CIC Services v IRS, mentioned in the conclusion of this post. Last night in CIC Services v IRS, a federal district court in Tennessee held that the opinion in Mann Construction “is binding on this Court and applies equally to the arguments advanced by the IRS regarding Notice 2016-66 in this case. Accordingly, and for the same reasons previously stated by the Court in granting CIC’s motion for preliminary injunction…, Notice 2016-66 is a legislative rule that is invalid because the IRS failed to observe notice-and-comment procedures required by the APA. ” The district court also held that the notice was “set aside under the APA because the IRS acted arbitrarily and capriciously in issuing the Notice.” In finding that the IRS acted arbitrarily and capriciously, the court explained that the IRS insufficiently examined the relevant data and failed to articulate a satisfactory explanation for its decision to designate micro-captive transactions as a “transaction of interest” based on the potential for tax avoidance or evasion. In fashioning relief, the court decided to vacate the notice in its entirety, resolving the debate discussed below as to the appropriate remedy. We will discuss CIC Services v IRS more in a later post. Les

In reversing a federal district court opinion, the Sixth Circuit in Mann Construction v US held that the IRS’s issuance of a 2007 notice including certain employee-benefit plans featuring cash-value life insurance policies as listed transactions was invalid because the IRS issued it without providing notice or the opportunity for comment. The case is significant; it is a forceful repudiation of the IRS’s penchant for sidestepping the normal regulatory process and yet another circuit court opinion that views IRS action through the same administrative law prism that applies to other agencies.


As background, Congress added Section 6707A to the Code to help fight shelters and abusive transactions. The statute permits the IRS to penalize the failure to provide information concerning “reportable” and “listed” transactions. While reportable and listed transactions are statutorily defined, over the years the IRS has issued notices, rather than regulations after notice and comment, to identify reportable and listed transactions that in the absence of recordkeeping and reporting can generate hefty civil penalties.

Mann Construction, and its owners, failed to comply with the reporting obligations for its investment in the employee-benefit plan that was identified in the 2007 notice.

The IRS assessed penalties, and Mann Construction filed a refund claim and eventually a suit that after some preliminary procedural skirmishes was narrowed to considering whether the 2007 notice was a legislative rule under the APA that was improperly issued without public notice and comment.

At the district court, the IRS argued that its notice was an interpretive rule, such that it was not required to issue and promulgate the rule only after notice and comment.

In the alternative, the IRS argued that Congress excepted the IRS from the normal notice and comment requirements when it came to fighting the scourge of tax shelters. That alternative argument brings into sharp focus 5 USC § 559, which limits the ability of a subsequent statute (like IRC § 6707A) to modify or supersede the APA’s procedures “except to the extent that it does so expressly.” 

The district court opinion rejected the government’s primary argument that the notice was an interpretive rule, but still held in favor of the government because it agreed with the government’s alternative argument.

At the district court, the opinion referred to the 2004 addition of Section 6707A, which defined “reportable transactions” by reference to Treasury regulations that had been issued following notice and comment and permitted the IRS to identify those transactions through “notice, regulation, or other form of published guidance.”

In summary, the district court found that in adding Section 6707A, and in subsequent legislative amendments to the statute, Congress expressed a clear intent to deviate from the norm of notice and comment rulemaking.  In essence, the district court found that there was enough evidence to find an express legislative directive for the IRS to skip notice and comment when it came to identifying reportable and listed transactions.

On appeal, the Sixth Circuit panel reversed. First, like the district court below, it rejected the government’s primary argument that the rules themselves were interpretive and not required to be issued after notice and comment:

The Notice has the force and effect of law. It defines a set of transactions that taxpayers must report, and that duty did not arise from a statute or a notice-and-comment rule. It springs from the IRS’s own Notice. Taxpayers like Mann Construction had no obligation to provide information regarding listed transactions like this one to the IRS before the Notice. They have such a duty after the Notice. Obeying these new duties can “involve significant time and expense,” and failure to comply comes with the risk of penalties and criminal sanctions, all characteristics of legislative rules.

(Citing Kristin Hickman’s article Unpacking the Force of Law, 66 Vand. L. Rev. 465, 524 (2013))

I will not dig deeper into the legislative versus interpretive muddy waters other than to note that not everyone agrees with the Sixth Circuit’s approach; see Jack Townsend, Sixth Circuit Invalidates Notice Identifying Listed Transaction Requiring Reporting and Potential Penalties:

There is no question that the Treasury made a rule by regulation that, under any fair reading, permits Treasury to identify listed transactions subject to the reporting requirement by guidance documents, such as Notices, without notice-and-comment regulations. Since Congress clearly intended Treasury to have law-making authority as to reporting transactions within the scope of § 6011(a) and, as a result, permitting penalties for failure to meet the requirements, it seems to me that the “law” is (or should be) that persons subject to the reporting requirement in the regulation by identification in the Notice is sufficient to sustain the penalties.

(For those wanting a deeper dive from Jack, see The Report of the Death of the Interpretive Regulation Is an Exaggeration, which is up on SSRN).

Where the Sixth Circuit parted with the court below is that it held that Congress’s actions did not amount to an express repudiation of the APA’s notice and comment requirements.  In finding that Congress in Section 6707A did not disrupt the APA’s requirement for an agency to issue a legislative rule using notice and comment, the Sixth Circuit held that the statute did not expressly deviate from that norm:

Note to begin the absence of any express variation of the APA’s notice-and-comment procedures. The statutes do not say anything, expressly or otherwise, that modifies the baseline procedure for rulemaking established by the APA. Id. §§ 6011, 6707A. Nor did Congress expressly displace those requirements by creating a new procedure for these regulations. The statutes do not provide any “express direction to the” agency “regarding its procedure” for identifying reportable and listed transactions, let alone procedures “that cannot be reconciled with” notice-and-comment requirements or any other indication within the statutory text that “plainly expresses a congressional intent to depart from” the normal APA procedures. Asiana Airlines, 134 F.3d at 398. The statutes merely establish a disclosure and penalty regime for the IRS to administer. As to the statutory text, Congress did not change the background procedural requirements of the APA or otherwise indicate an exemption from those requirements in a “clear” or “plain” way that would make the APA’s procedures inapplicable to the IRS. See Lockhart, 546 U.S. at 145–46.

The opinion acknowledged that Congress was aware of the regulatory directive giving IRS the power to identify listed transactions using notices issued without notice or comment, like in this case. Yet Congressional awareness of those regulations and even subsequent acquiescence after amendments to IRC 6707A was not tantamount to the express exemption from the APA’s rules that 5 USC 559 requires.


As PT readers are likely aware, this is not the only high profile case involving a challenge to the IRS’s issuance of a notice to identify transactions subject to the 6707A reporting regime. The CIC Services case, currently on remand to a district court in Tennessee in a case that is appealable to the Sixth Circuit, involves another APA challenge. Unlike Mann Construction, which comes from a refund suit, CIC Services involves a pre-enforcement challenge to a 2016 notice. As you may recall CIC Services generated an important Supreme Court decision on the scope of the AIA, which allowed its pre-enforcement proceeding to survive. We now await a merits determination following cross motions for summary judgment after the district court granted a request for a preliminary injunction.

Tax Notes’ Kristen Parillo reported last week ($$) that both the government and the CIC Services have filed documents with the district court on the impact of Mann Construction. CIC Services argues that the case is fully dispositive of the issues and the Justice Department cautions the district court that there is time for the government to decide whether to seek en banc review or file a petition for certiorari with the Supreme Court.

The Justice Department response to CIC Services’ filing also highlights an issue I have previously discussed, namely the scope of a court’s remedial powers if it finds that the IRS’s notice (or other rule) was improperly issued without notice and comment or otherwise in violation of the APA.  In Mann Construction, the Sixth Circuit stated in conclusion that the notice should be “set aside”. In its letter to the CIC Services district court, the DOJ referred to the “set aside” conclusion as dicta given that the only cause of action was a refund suit and thus should not be controlling precedent. That distinction seems, at least on the surface, to matter because in Mann Construction the court was specifically applying its analysis in the context of the individualized request for relief in the form of a refund and not injunctive relief.

The skirmish on the scope of a court’s remedy should it find that the IRS acted in violation of the APA in a pre enforcement challenge is a hot issue generally in administrative law. See my post from last year, Update on CIC Services: The Scope of Relief Available if A Court Finds That An Agency’s Rulemaking Violates the APA.  We will be closely watching for further developments as APA litigation continues to make inroads in the tax realm.   

The Passing of Michael Mulroney

Michael Mulroney, a dear former colleague of Keith and mine at Villanova Law School, has passed away at the age of 90.  Michael had a zest for life, dry sense of humor and deep commitment to his family, colleagues and students.

Remembrances by Les

His passion for cars was legendary at Villanova: as head of the (one manned) Phlexed Sphincter Racing Team he competed in his 1962 British Morgan in about 150 races over almost 20 years. Michael was a very hard worker-you would find his old funky cars, including a cool Karmann Ghia that I envied, in the Villanova parking lot no matter when you came to the law school. Before he joined Villanova he had a successful career in DC, first as an attorney advisor for the Tax Court, then at the Appellate Section of the DOJ and then ultimately as a partner at a boutique tax firm. At Villanova he wrote about and taught a variety of subjects. He had keen interest in legal ethics, and I was fortunate to co-teach a seminar with him for a couple of years.

Michael displayed immense kindness and concern for his junior colleagues. Indulge me a couple of anecdotes. Along with the late Jim Fee Sr, Michael was directing the Villanova Clinic before I arrived in 2000. Jim and Michael stayed on as advisors; Jim more formally and Michael informally. In my first year as Clinic Director at Villanova, we had a mix up with the grant application for federal funding (a long and sad story). This was the sort of thing that could torpedo a first-year professor. Michael came to my office and said that “he was taking the grenade” and he took full responsibility for a gaffe that was mostly mine (we wound up getting the funding anyway). Fast forward a few years, and when a client at the Clinic submitted doctored documents that we inadvertently passed on to Counsel (another long and sad story), Michael was the trusted senior counsel with grey hair and good judgment who I turned to in crisis.

Remembrances by Keith

When Michael took emeritus status, Les followed him as the director of the graduate tax program and moved from the clinic to the podium.  That left an opening in the tax clinic which I was fortunate to fill.  Michael welcomed me to Villanova with open arms and was always available to assist with any problem in the clinic.  We regularly debated which of us was the oldest person ever to obtain tenure at Villanova since we both left our prior careers at the age of 55 to join the faculty.  He generously prepared the tax returns each year of just about every international student on the Villanova campus.  In doing so he used his deep knowledge of international taxes and treaties to benefit the students in ways I doubt students anywhere else in the United States received. 

Each year Villanova held an auction for public interest so that law students could spend their summers providing assistance in jobs for which they would otherwise receive no compensation.  Michael would often donate rides in his collection of antique vehicles as a way to raise funds.  One year I won the bid for such a ride, and he decided to bring out the “chicken” Morgan so that we could bring our wives on the ride.  While Michael drove and I sat in the very low front seat, our wives sat in the space Michael said the manufacturer designed so that his wife could bring chickens to market.  They wore scarves to keep their hair from blowing in the wind and we toured the Pennsylvania countryside before stopping at an Irish pub for lunch.  A memorable day with an unforgettable colleague.


We are fortunate that about fifteen years ago Paul Caron ran a series where tax profs wrote about their lives. You can get a sense of Michael’s sense of humor and joy for life in his brilliant write up here.

Rest in peace Michael.

Honest Mistakes Happen, But a Two Million Dollar Difference in Mortgage Interest Will Likely Trigger An Accuracy-Related Penalty

Busch v Commissioner, a small tax case issued as a bench opinion, involves a couple who claimed to have made an honest mistake on their self-prepared tax return.  According to the Busches, when using their tax return prep software, the software did not allow them to enter cents when recording the mortgage interest paid in a year. The Busches paid $21,201.25 in deductible mortgage interest and entered $21,201.25 line for their mortgage interest, but the software, kicking out the cents, recorded the deduction as $2,120,125 instead. The couple of million dollar difference led IRS to likely discover the error automatically via document matching.

What followed was likely mismatch virtual audit, a notice of deficiency that adjusted for the underpaid tax, and for good measure, a proposed 20 per cent substantial understatement accuracy related penalty under Section 6662(a). The Busches filed a petition, conceding the extra tax but challenging the penalty.


The issue in the case was whether the taxpayers could establish that they acted with reasonable cause and in good faith under Section 6664(c) and thus be excused from the penalty.

The brief opinion notes that the taxpayers urged the court to find that the error was an “honest” mistake, and, as such, they should not be penalized for that mistake. The opinion shows some sympathy for the taxpayers and more generally to how it is possible that taxpayers may foot fault when using software:

[The taxpayers] ask the Court to recognize, as they point out that honest mistakes are sometimes made. As a general proposition of life, we agree with petitioners on the point, and we further agree with petitioners’ suggestion that not every mistake made on a Federal income tax return should result in the imposition of an accuracy-related penalty. A person preparing a return might understandably get distracted while doing so and enter the wrong amount for an item, or if not distracted, when transferring numbers from one document to another, transpositions often occur. If a computer-based software program is being used in the process, the limitations and requirements of a software program might not be fully appreciated by the user. Any number of situations could cause an “honest” mistake to be made when amounts are incorrectly reported on a Federal income tax return. 

The problem with the taxpayers’ argument though was that the taxpayers had an obligation to review the return. The two-million dollar difference between the deduction on the return and interest actually paid should have triggered greater inquiry into the matter:

But petitioners’ focus on the erroneous entry as the “mistake”, and their explanation describing how the mistake occurred, misses the point. The mistaken entry is not the real problem. Their mistake was failing to review the return carefully enough to have recognized the erroneous entry before the return was filed. After all, it should go without saying, that a taxpayer’s obligation to prepare and file a Federal income tax return includes the duty to review that return to ensure that the information reported or shown on the return is accurate before the return is filed.

The opinion notes that the “deduction for mortgage interest shown on the return occupies at least two additional columns” on the same page as where the deduction appears on the return:

Looking up and down the columns showing other items reported on the return, the mortgage interest deduction sticks out, as the saying goes, “like a sore thumb”. A careful review of the return after it was prepared would most certainly have caught the error; actually, even as little as a quick glance at the return probably would have done so.


This is another in the line of cases that holds that the use of tax software by itself is not sufficient to establish a defense to an accuracy-related penalty. As Bryan Camp noted in Lesson From The Tax Court: The Turbo-Tax Defense in Tax Prof a few years ago, there is dicta in a Tax Court opinion that suggests that the use of software can help establish reasonable cause/good faith. But hiding behind “the software made me do it” is not enough to insulate all taxpayers from penalties.

To succeed in blaming the software, taxpayers will generally achieve better results if the software issue involves a question of the proper tax treatment of the item as opposed to a clerical type mistake any taxpayer could pick up by reviewing the return.  The taxpayers discussed in post by Bryan Camp were sophisticated yet the Tax Court, in dicta, expressed sympathy with their plight.  Similarly, former Treasury Secretary Timothy Geithner had a problem reporting his income from the World Bank that he blamed on the tax prep program.  His excuse worked to get him out of a confirmation pickle.  Where the defense of the computer made me do it fails is in cases in which any reasonable taxpayer should recognize the mistake if they took care.

Taxpayers can generally rely on a paid preparer to insulate them from the penalty when taxpayers give the paid preparer all of the information necessary and the preparer makes a mistake; however, just having a paid preparer doesn’t necessarily insulate a taxpayer from the duty to review the return and catch obvious mistakes.  Taxpayers could not easily escape penalty where a return contained an obvious mistake just by saying they relied on the accountant to add the numbers properly and if the accountant said 1 + 1 + 3 the taxpayer had no duty to correct the mistake. 

Courts seek to build on decades of case law involving human paid preparers as they analyze situations in order to decide the appropriateness of penalizing someone relying on digital paid preparers.  Taxpayers choosing the do it yourself route can put some blame on their digital preparer but must assume some responsibility to check to make sure the resulting return makes sense.  Had the taxpayers here checked, they would have concluded the return did not reflect the correct tax result.  The Busches bore responsibility to at least check for a return that made sense.

11th Circuit Remands Willful FBAR Penalty Case Back to IRS Due to APA Violation

Taxpayers who fail to disclose overseas accounts with more than $10,000 face hefty penalties under the Bank Secrecy Act. For willful violations the IRS can impose a penalty of up to the greater of $100,000 or 50% of the balance in each undisclosed account at the time of the violation (for a discussion of whether the non-willful penalty is computed per account or per form, see The Fifth Circuit Parts Ways with the Ninth Circuit Regarding the Non-Willful FBAR Penalty).

For people with multiple accounts and multiple years of willful violations, the maximum willful penalty can be crippling. The draconian impact has led to 8th Amendment excessive fine challenges, as well as arguments that its punitive nature should lead to the penalty not surviving the death of the violator.

All this leads to United States v Schwarzbaum, a case that has generated a great deal of attention. The case involves a wealthy German-born naturalized U.S. citizen who starting in the early 2000’s had multiple bank accounts in Costa Rica and Switzerland. Schwarzbaum self-filed an FBAR in 2007 and listed only one account. He did not file any FBAR in 2008, and in 2009 he filed an FBAR that only listed three accounts. IRS assessed over $12 million in penalties, and brought suit to collect.


There is a lot to the case, including a discussion of the appropriate willfulness standard and the possible impact of the opinion on the statute of limitations when an original penalty assessment is timely but a court finds that the IRS computed the penalty improperly and needs to start over. My colleague Jack Townsend, who, in addition to writing a terrific blog on criminal tax matters, is the principal author of the criminal penalties chapter and FBAR subchapter in Saltzman and Book IRS Practice and Procedure, covers the case in 11th Cir. Remands For IRS To Re-Determine FBAR Penalties After Affirming Original Calculation Was Arbitrary And Capricious.

For purposes of this post, I just want to highlight one aspect of the opinion: the relationship of the Administrative Procedure Act (APA) to the appropriate amount of willful penalty.

On appeal, Schwarzbaum argued that the IRS’s actions in calculating the penalties were “not in accordance with the law” under 5 U.S.C. § 706(2)(A). This inquiry into what and why the IRS did in computing the penalty differs from what courts do in reviewing Title 26 penalties; for the most part, in IRC-based tax penalty cases the APA does not provide the means to examine the IRS’s conduct. In typical tax penalty cases, courts can take a fresh look at both the propriety of imposing the penalty and the amount of the penalty, assuming that they conclude that the penalty is warranted in the first instance.

Title 31 FBAR penalties differ. The APA shines a light on agency conduct, and reviewing courts are generally empowered to examine whether the agency acted rationally and provided a reasoned contemporaneous explanation based on the record at the time of the original agency action. (for an early discussion of the intersection of APA and FBAR see District Court Punishes IRS For Failing to Justify or Explain Itself in FBAR Case )

All of this gets back to the IRS actions in assessing over $12 million in willful FBAR penalties on Schwarzbaum. As Jack notes, to soften the possible impact of the FBAR penalty the IRS in the Internal Revenue Manual “has a formula that determines the maximum willful penalty that it will assess at 50% of the highest amount in the accounts in all willful years. The IRM then allocates that penalty in equal portions over the willful years.”

The problem with that IRM is that the statute itself pegs the maximum penalty to each account’s balance as of the date that the taxpayer failed to file the FBAR, a date that IRM formula neglects and one that the IRS did not use in calculating Schwarzbaum’s penalty.

As Jack discussed, Schwarzbaum “held that, since the allocation formula was based on the high amounts during the reporting year rather than the amounts on the reporting dates, the allocation was arbitrary and capricious and could not be sustained.” (my emphasis).

In the words of the Eleventh Circuit, the IRS botched its calculations from the start:

In calculating Schwarzbaum’s FBAR penalties, the IRS took a wrong fork in the road by starting with the wrong numbers. Recall that, for each tax year and for each account, the statutory maximum penalty for a willful FBAR violation is the greater of $100,000 or 50% of the account’s June 30 balance. See 31 U.S.C. § 5321(a)(5)(C)(i), (D)(ii); 31 C.F.R. § 1010.306(c). By using the wrong account balances, the IRS calculated the wrong statutory maximums for Schwarzbaum’s penalties, and from there, mitigated the penalties across the board. The IRS’s error, it appears, flowed through its calculations from beginning to end.

This led the Eleventh Circuit to conclude that the district court should have remanded the matter back to the IRS to determine the appropriate penalty amount:

When a party challenges agency action under the APA, “the district court does not perform its normal role but instead sits as an appellate tribunal.” Cnty. of L.A. v. Shalala, 192 F.3d 1005, 1011 (D.C. Cir. 1999) (quotation omitted). And when an agency action is unlawful, the APA directs a reviewing court to “hold [it] unlawful and set [it] aside.” 5 U.S.C. § 706(2). The APA does not, however, direct the court to do the agency’s job for it.

The opinion goes on to cite the the Supreme Court in SEC v. Chenery Corp for the principle that a reviewing court is to examine the grounds that the agency used in making its determination, and it is not the court’s role to “affirm the administrative action by substituting what it considers to be a more adequate or proper basis.”


In vacating the district court’s judgment, the Eleventh Circuit instructed the district court to remand the matter back to the IRS to recalculate the penalties.

While I have problems with the draconian nature of the FBAR penalty (an issue that Congress should take up or perhaps one that can have an impact on courts considering the survivability of the FBAR penalty at death), the Eleventh Circuit’s approach seems formalistic.

As Title 31 gives IRS discretion to impose a penalty up to the maximum of 50% of the account balance as of the violation date, it seems that the IRS approach in the IRM, and any mitigated penalty it wishes to impose on Schwarzbaum or anyone else for that matter, should likely just start with a new first step in its calculations. That step should take into account half of the highest account balance and allocate it across all willful years, with any amount in a given year capped at 50% of that year’s aggregate account balances on the reporting date. Once that step is taken, documented internally, and communicated to taxpayers clearly, I suspect that it will be difficult to mount an APA challenge to the penalty.

Villanova Graduate Tax Program Looking To Hire A Professor of Practice/Faculty Director

At the end of this academic year, my longtime colleague at Villanova Professor Joy Mullane will be returning to the faculty after a successful stint as Faculty Director of Villanova’s Graduate Tax Program.

Villanova has launched a national search for a new Faculty Director, who will also serve as a Professor of Practice. The announcement for the position is here.

Joy has done an outstanding job in her tenure, having expanded the number and diversity of distinguished adjunct faculty, grown its international tax offerings, and built on the Program’s considerable strengths in state and local tax, business tax and online offerings.

The tax program at Villanova is vibrant. Our students are terrific, with most classes catering to full time practitioners, both lawyers and accountants. In addition to Joy, we have four other full time tax faculty: Procedurally Taxing’s Christine Speidel, Michael Semes, Dick Harvey and me. Supplementing the FT faculty and adjunct faculty, the Graduate Tax Program has professional dedicated Grad Tax staff that works tirelessly with students, faculty and employers.

The job is a great opportunity for someone with extensive practical experience who wants to work in a supportive atmosphere and help manage and build a strong academic program.

No Reasonable Cause When Tax Return Preparer Fails to E-file Extension

A recent district court opinion addresses the inability to establish reasonable cause for a late filing penalty even if a longtime preparer promised but failed to e-file an extension of time to file a 1040.  The case, Oosterwijk v United States, brings in interesting reasonable cause issues and highlights the limits of the IRS First Time Penalty Abatement policy.

In 2017, taxpayers Erik and Aspasia Oosterwijk sold for many millions of dollars a Baltimore based wholesale meat business that they had run for decades. When it came time to file their 2017 tax return on Tuesday April 17, 2018 (Monday April 16, 2018 was Emancipation Day in DC), the taxpayers expected their longtime preparer to e-file an extension and instruct IRS to apply a payment of about $1.8 million in taxes.  The taxpayers made sure they transferred money to their checking account, and kept looking to see when the tax payment would hit the account.

By April 25, when the money was still not debited from their account, the taxpayers emailed their longtime CPA tax return preparer, who told them to wait until April 30, and if the money were still in their checking account at that date he would follow up with the IRS.

On April 29 the now concerned taxpayers emailed their CPA again saying that the money was still in their account. The preparer checked his records and……


You guessed it. The preparer realized that that he failed to e-file the extension and had not given instructions to IRS to debit the payment.

What happens next compounds the original problem.

The preparer advised the Oosterwijks that if they immediately filed a six-month Extension Request on Form 4868, they would have until October 15, 2018, to file their tax return, and the penalties for late filing would stop accruing..
The taxpayers followed the advice and immediately mailed in the Form 4868 and a check for $1.8 million, which IRS processed on May 4, 2018.

On June 29, 2018 the Oosterwijks’ CPA e-filed their 2017 return. Upon processing the return, IRS assessed failure to pay penalties of about $8,860 for the one month non payment delinquency period that ran April 17 to May 4, 2018. IRS assessed failure to file (FTF) penalties of about $259,000 for the three month late filing period that ran from April 17 to June 29th 2018, the date that Oosterwijks’ CPA e-filed their return on their behalf.

The Oosterwijks (and their CPA) were surprised that the IRS assessed a FTF penalty for the two-month period that ran from May 15 to June 29th. Based on their CPA’s advice, the taxpayers had incorrectly believed that by paying their taxes, submitting the Extension Request on May 4 (during the first month), and filing the return before October 15, they would halt the accrual of any FTF penalties beyond the first monthly delinquency.
Well, as you likely know, the CPA and his clients were mistaken. A late filed extension to file does not excuse FTF penalties for any subsequent filing.

In November 2018, after the IRS assessed both delinquency penalties, the taxpayers’ CPA requested penalty relief based on reasonable cause. The IRS denied the relief, and the CPA appealed administratively on behalf of his clients. The Appeals Officer agreed to abate about 50% of both delinquency penalties.
Despite the 50% abatement, the taxpayers were not happy with the result. By March of 2019, the taxpayers sent in another letter to IRS stating that they believed they should be relieved of all the penalties, raising the issue of their reasonable cause for late filing due to their CPA’s failure to e-file the extension and his incorrect substantive advice about how to halt the FTF penalty’s accrual.

IRS did not respond, and the taxpayers paid the balance due and filed a refund claim. After six months passed they then filed a refund suit in federal district court, claiming that they had reasonable cause for the delinquency due to both the mistaken belief that the extension were filed and the reliance on substantive advice that a late filed extension excused a portion of the FTF penalties.

Following the complaint, the government filed a motion to dismiss, which the court treated as a motion for summary judgment.

As a threshold matter, why didn’t the taxpayers avoid having to file a suit and request administrative relief under the IRS’s First Time Abatement policy? To add insult to injury the Oosterwijks were not eligible, because their decades long history of tax compliance was tainted by a $7 late payment penalty from the 2014 tax year and the first time abatement for delinquency penalties requires a clean past three years of tax compliance.

With that out of the way the opinion first addressed a variance issue because the formal refund claim addressed reasonable cause relating to the mistaken belief that the extension was filed and did not mention the advice the CPA gave about limiting penalty accrual by filing a 4868 after the due date of the return. The opinion concluded that the claim and communications with IRS were sufficient to put IRS on notice about the full extent of the reasonable cause argument. (as an aside the opinion also seems to mix up the SOL issues in 6511 and 6532).

That gets to the merits of the reasonable cause defense. The taxpayers argued that the FTF penalties should be completely excused because they had reasonable cause for filing late, specifically that their accountant failed to e-file their extension request and their personal e-filing access was limited.

Boyle and Non Delegable Duties

This of course brings in the Boyle case and its applicability to failures to e-file, which we have discussed in Delinquency Penalties: Boyle in the Age of E-Filing and more recently in Possible Opening in Defending Against Late Filing Penalty When Preparer Fails to E-file Timely. To date, even when a taxpayer is relying on an agent to e-file, courts have been unwilling to distinguish Boyle and have held that reliance on a third party to file a return does not establish reasonable cause because “[i]t requires no special training or effort to ascertain a deadline and make sure that it is met.”

The Oosterwijk opinion cites to the opinion in Boyle, and also to Justice Brennan’s concurring opinion, where he “stressed that the ‘ordinary business care and prudence’ standard applies only to the “ordinary person.” That is, the standard exempts individuals with disabilities or infirmities that render them physically or mentally incapable of knowing, remembering, and complying with a filing deadline.”

The Oosterwijks argued that “Boyle does not apply to electronic filing, because a taxpayer cannot personally confirm that an accountant has e-filed as promised.”

The Oosterwijks essentially argued that the placement of a third party (the preparer) “between the taxpayer and the IRS, and the Oosterwijks’ inability either to e-file on their own or to confirm the e-filing’s transmission put the filing beyond their control according to Justice Brennan’s concurrence.”

The opinion disagreed, noting that the taxpayers were free to paper file an extension (and in fact did so):

The specialized technology and professionals-only availability of e-filing need not have been a barrier to the filing of an Extension Request; the same means available to the Boyle taxpayer in 1979 were available to the Oosterwijks in 2017, even if the IRS encourages e-filing.

Moreover, the opinion notes that Justice Brennan’s Boyle concurrence “contemplates differently abled taxpayers who are physically or mentally incapable of meeting filing deadline. The Oosterwijks do not fall under this exception.”

What About The CPA’s Substantive Advice?

Boyle does not prevent a finding of reasonable cause when a taxpayer’s non or late filing was due to erroneous substantive legal advice as compared to just an agent’s failure to file a return or extension. To that end, the Oosterwijks argued that the penalty period after the first month should be excused because their preparer mistakenly believed and advised them that if they mailed an extension after the due date of the return so long as they paid any balance due and filed the 2017 return by October 15, 2018 they would only be subjected to one-month FTF penalty. This, they argued, amounted to substantive legal advice.

A. Is The Penalty Divisible

As I mentioned above, that advice was wrong; the FTF penalty is based on the net tax due as of the due date of the return, and the delinquent extension provided no benefit. But should the taxpayer be expected to second-guess their preparer?

The court’s inquiry focused on timing. Does it matter if the substantive advice arises after the due date of the return? The opinion notes that the reasonable cause inquiry looks to the due date, and while the due date (and thus inquiry time) could be extended if the taxpayer timely filed an extension, actions beyond the due date are not determinative.

To be sure, the opinion notes that reasonable cause at the due date does not mean that there is reasonable cause for the entire delinquency period, citing to the Federal Circuit Court of Appeals case from 2013, Estate of Liftin v US.

The government argued that any advice that the Oosterwijks’ preparer gave after the April 17 due date was irrelevant if as of the original due date the taxpayer did not establish that it had reasonable cause (and as discussed above there was no reasonable cause as of April 17).

The taxpayers essentially argued that the FTF penalty was divisible, or that whether a taxpayer has reasonable cause should be evaluated on a monthly basis given that the penalty amount is triggered by each monthly delinquency period:

To the Oosterwijks, the core issue is whether reasonable cause arose as to parts of the penalty incurred in later months when, after the deadline had already passed, they relied on their tax professional’s bad substantive advice about what actions would stop the accrual of a tax penalty. They say that this would leave intact the April 2018 penalty but would require removal of the penalties for May and June 2018, the months after [the CPA’s] incorrect April 30 advice. The Oosterwijks focus on the distinction between relying on a tax professional to perform the ministerial (and non-delegable, under Boyle) duty of filing an extension return, as compared to the tax professional’s erroneous substantive advice about what actions would halt the penalty’s accrual.

On divisibility, the court examined case law which suggested that the FTF penalty was divisible but distinguished those circumstances. Those cases mostly involved erroneous “legal advice about the availability of second extensions after the taxpayer had already timely filed and obtained a first extension.”

In those cases there was reasonable cause at the original due date but not later:

These second-extension cases are distinct from the Oosterwijks’. The taxpayers in these cases were erroneously advised by their attorneys before their (first extended) deadlines had passed, meaning they could still have had reasonable cause under § 6651. The fact that they received erroneous advice after their original deadlines is immaterial, because their reasonable cause evaluation was governed by their first extended deadline. In contrast, the Oosterwijks received their erroneous advice after the deadline had passed and therefore after the door had closed on reasonable cause for late filing.

Similarly, the opinion distinguished Estate of Liftin, where a taxpayer had reasonable cause at the date of filing based on erroneous advice about not needing  to file an estate tax return until after the taxpayer’s spouse had become a citizen.  In Liftin, the reasonable cause defense did not apply to the FTF penalty when circumstances changed and the spouse became a citizen, but there was still an additional 9-month delinquency prior to filing:

Liftin shows that although the penalty is not entirely indivisible for the purposes of the reasonable cause exception, it is not divisible in the way the Oosterwijks hope. They, unlike the Liftin taxpayer, failed to meet the initial requirements of reasonable cause. The purpose of encouraging timely filing is best served by reading the statute to allow reasonable cause to expire based on a change in circumstances at some point in the delinquency but not allowing it to materialize where the taxpayer had none at the time of filing.

B. Even if the Penalty Were Divisible the Advice Was Not Reasonable

For good measure, the opinion notes that even if the penalty were divisible in the way the Oostwerwijks argued they still would not qualify for relief because the advice they received was not reasonable given the explicit text of Form 4868. In so concluding the opinion cites to Baer v US, a 2020 Court of Federal Claims opinion that considered a CPA’s failure to file a 4868 because he believed that any extension had to be accompanied by a taxpayer payment. While Baer held that the CPA’s actions were not advice and thus could not justify a taxpayer’s reliance, it also held that if it did amount to advice it was not based on a “reasonable factual or legal assumption.” That was because the text of the extension form directly contradicted the CPA’s mistaken belief, that it could not file a 4868 a scenario analogous to the Oosterwijk’s situation where the form itself stated that the taxpayer must file the 4868 by the due date to receive the extension.

In contrast in La Meres v Commissioner, one case where a taxpayer was able to establish that mistaken advice as to an extension was reasonable cause, the opinion notes that the advice concerned the advisor’s mistaken belief that the taxpayer was entitled to two extensions of time to file an estate tax return, an issue not addressed in the form itself but only  “toward the end of the relevant estate tax regulation” and one in which the IRS actions misled the taxpayer into thinking a second extension was valid.

Concluding Thoughts

The court signs off by acknowledging that it is “sympathetic to the Oosterwijks, who were not willfully neglectful but rather appear to have relied on the advice of a trusted professional, intending to fulfill their obligations under the tax laws.”

Yet the court also acknowledges that the government was not at fault and did in fact abate about half of the penalties. 

I am not sure I accept that there is no government fault here.  Even though I suspect the taxpayers’ longtime preparer will likely reimburse the taxpayers in light of a possible malpractice suit (though maybe Congress should consider directly penalizing the preparer rather than forcing the taxpayer to seek reimbursement from the preparer), the case leaves a bad taste in my mouth.

Apart from my belief that courts (and the IRS) should distinguish Boyle when e-filing makes it difficult to monitor an agent’s actions, the policy underlying the imposition of civil penalties and the first time abatement policy itself suggest that the IRS should have exercised discretion and abated the FTF penalty in full.

Recall that the taxpayers had a long history of tax compliance, save for a 2014 $7 delinquency penalty. Under the First Time Abatement policy, the IRS will abate a delinquency penalty if a taxpayer

  • Didn’t previously have to file a return or have no penalties for the 3 tax years prior to the tax year in which the taxpayer received a penalty;
  • Filed all currently required returns or filed an extension of time to file; and
  • Has paid, or arranged to pay, any tax due.

As the IRS acknowledges, “penalties should relate to the standards of behavior they encourage. Penalties best aid voluntary compliance if they support belief in the fairness and effectiveness of the tax system.” IRM (11-25-2011) Encouraging Voluntary Compliance.

While perhaps the IRS has the power to penalize taxpayers like the Oosterwijks, the taxpayers’ de minimis $7 delinquency penalty is all that stood in the way of a full abatement. The IRS should apply the First Time Abatement policy by ignoring a de mininimis assessment during the three-year period. Even if the policy were not changed to have a deminimis carveout, when a taxpayer has a long history of compliance and the delinquency is directly attributable to preparer error, perhaps the government should show mercy. After all, as Shakespeare wrote, mercy can have an effect that is “twice blest.” It is needed more so these days as trust in our public institutions and IRS in particular seems to be eroding.

Sometimes doing the right thing means the IRS looking the other way. Even if the law is on its side.

Washington Post Editorial With Suggestions for Immediate Ways to Help IRS

Groundhog Day seems like a good opportunity to think how the IRS might avoid some of the problems it faced last year (and the year before). In today’s Washington Post, Nina Olson has written Five Ways to Fix the IRS, Starting With A Halt to Most Audits. It is short, so I will not summarize other than to say it is worth a read.