Be Careful What You Ask For

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In Showalter v Commissioner, T.C. Memo 2022-114, the pro se petitioner went to the Tax Court to contest the deficiency resulting from the IRS preparing a substitute return (SFR) following his failure to fulfill his return filing obligation.  He found out that going to Tax Court is not a one way street when the Chief Counsel attorneys uncovered income the IRS had not found in computing his tax liability using the substitute for return procedures.

I end the post with a suggestion for taxpayers like Mr. Showalter to reduce his exposure but also for a suggestion regarding the penalty regime for taxpayers who force the IRS into preparing an SFR.


I don’t know the statistics on how many people fail to file returns each year who should.  The number is huge.  My sympathy for this group of individuals is low.  They put a lot of pressure on the tax system.  Some have a good excuse for not filing, at least for one year, but many lack what I consider to be a good excuse.

The failure to file causes the IRS, in many instances, to prepare a return for the non-compliant taxpayer using the substitute for return procedures set out in IRC 6020.  My experience is that most of the time the IRS prepares returns under this procedure it overstates the taxpayer’s liability because it does not make elections the taxpayer might make in order to reduce the liability; however, the IRS also misses income when it uses this system to prepare a return because it relies exclusively on third party reporting information which will not always capture all of a taxpayer’s income.

Because the IRS needs some form of taxpayer or statutory consent in order to assess, it ends up sending a notice of deficiency (SNOD) to taxpayers who do not agree with its calculation of income in the substitute for return process.  Taxpayers who engage with the IRS in this process can usually file their own return during the process or provide deduction information to the IRS to reduce tax computed by the IRS.  Taxpayers who do not engage in the process need to file a petition in Tax Court or use audit reconsideration at a later point in order to reduce the amount computed by the IRS.

Mr. Showalter appears not to have engaged with the IRS during the process of its preparation of the SFR but the Court does not explicitly say that and I may be drawing an incorrect inference.  He did, however, respond to the SNOD by filing a timely petition with the Tax Court.  He contended that the IRS overstated his income by failing to allow him certain business deductions.  In the Tax Court case he worked with the IRS to determine his business expenses and Schedule A deduction.  In the course of determining his expenses, the parties gathered bank records the IRS would not have reviewed in preparing the SFR.  Those records showed that the SNOD understated his income by $102,885.

The IRS sought summary judgment on this additional amount.  The Court goes through the requirements for obtaining summary judgment relief noting that the petitioner failed to respond to the Motion for Partial Summary Judgment and that it could have granted the motion on that basis alone.  The Court, however, decides to put the IRS through its paces even though the Petitioner did not engage with this process.

First, the Court notes that the IRS has the burden of proof on this additional amount of income because it was not included in the SNOD.  To do so it must establish a “minimal evidentiary showing” connecting the taxpayer and the income producing activity.  The Court finds that the bank account records attached to the motion accomplish this purpose.

Here, the IRS used the bank deposits method to establish the additional income.  The IRS needs to show that funds deposited into a taxpayer’s bank account are income and not non-taxable amounts.  The Petitioner had raised a concern about some of the money deposited into the account and the IRS addressed that concern.  Based on the information before it, the Court granted the IRS motion sustaining the determination that Petitioner had the additional income alleged by the IRS.

At the conclusion the Court orders a Rule 155 computation.  Based on the business and personal deductions allowed, the Petitioner in this case may end up with a reduced liability from the amount in the SNOD even with the inclusion of an additional $100,000+ of income.  So, the decision to go to Tax Court in this case may provide the taxpayer with a net benefit.

The case, however, points out that going to Tax Court opens the door for the IRS to allege additional liabilities and does not just provide the taxpayer with the opportunity to reduce the amount initially determined by the IRS.  Each taxpayer making the decision to go to Tax Court needs to carefully consider the downside of the petition as well as the upside.  A taxpayer in Mr. Showalter’s position may have obtained a more favorable result, though not a more correct result, by seeking audit reconsideration rather than petitioning the Tax Court. 

Suggestion for Taxpayers with exposure not reflected in the SNOD

Audit reconsideration involves asking the IRS to look at an assessed liability to abate it because the IRS assessed too much after an audit.  The provision is described in IRM 4.13.1.  We have mentioned the process in many prior blog posts, but I could not find one explicitly addressing the process.  I have mostly written about it in the context of prior opportunity in Collection Due Process cases.  A taxpayer seeking audit reconsideration goes into a black hole by sending in the request because the IRS does not acknowledge receipt.  The process can take months or, in pandemic time, more than one year.  The case goes back to the source asking the office that originated the assessment process to consider new evidence the taxpayer failed to present during the audit and, on the basis of that new information, reduce or eliminate the tax assessment.  This is an entirely administrative process with administrative appeal rights but no right to judicial review.  Yet, the IRS is generous with its time by giving assessments a second look even though it is not required to do so and even though I wish it was more communicative in the process.

Audit reconsideration sends the case back to auditors and not into the hands of attorneys.  The chances that the auditors would pick up on the additional income using a bank deposits method are low.  The individuals looking at the audit reconsideration request are much more likely to focus on the basis for the request than the whole picture.  While audit reconsideration does not bring the same safeguards as judicial review, it also does not bring the same scrutiny.  Someone in Mr. Showalter’s position might have achieved a net benefit from going the audit reconsideration route rather than exposing himself to having additional income found. 

Suggestion for Penalizing Taxpayers Who Force the IRS to Prepare SFRs

As a taxpayer who wants others to pay their rightful amount of tax, I am glad Mr. Showalter went to Tax Court and glad that the Chief Counsel attorneys found the additional income that the IRS did not pick up during the SFR stage.  Trying to get someone’s income right through the SFR process puts a lot of pressure on the IRS as well as a lot of additional costs on the system that is unnecessary if people comply with their return filing obligations.  I would put more of a late filing penalty on non-filers who force the IRS to go this route and be more generous to late filers with a good excuse.  Our current one size fits all penalty probably doesn’t capture the true cost of the taxpayers who force the IRS into the SFR process and is not always generous enough to taxpayers who miss the filing deadline for an excusable reason.  Maybe the IRS has data on its costs of chasing after people who do not comply.  That information would be useful in determining if my suggestion is a reasonable one.


  1. Jerry Borison says

    Keith – I agree audit reconsideration is one route but, as you say, it is purely administrative and not statutory and one sometimes waits and waits. I have also used OIC – Doubt as to Liability. Administratively, I believe the IRS does the same thing as audit reconsideration, i.e. send it back to exam. I like this approach as it just feels a bit more formal. Your thoughts? Jerry

    • Jerry – Making a doubt as to liability OIC is a good alternative to audit reconsideration and maybe a better one. I don’t have enough personal information on the difference in the handling of the two processes to say one is better than the other but concur with your instinct that the additional formality of the OIC process may make it better than audit reconsideration. Keith

    • It also requires a filing fee and a one-time payment or monthly payments in most cases, right? It works for those who have the means to pay what they agree they owe. But it doesn’t work for those who owe $60,000 and want it reduced to $10,000, when they can’t pay that much either but would still like to have a passport, and maybe avoid a lien filing.

  2. Jerry Borison says

    Bob – An OIC Doubt as to Liability does not require a fee or any payment. You just need to offer at least $1.00. Jerry

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