TIGTA Audit Flags Inconsistency in IRS Treatment of E-filed Returns

A recent report from TIGTA highlights the IRS’s inconsistent treatment of millions of e-filed returns that have errors.  IRS e-file processes consider an e-filed tax return as “filed” when the IRS accepts the return for processing, not when the IRS originally receives the return. The TIGTA report reveals that IRS does not have the  “the ability to use the date an e-filed return was initially received as the return filing date.” This is a problem because under the commonly used Beard test the IRS routinely rejects legally sufficient returns, triggering delinquency penalties and uncertainty as to the statute of limitations on assessment, a topic that Keith discussed in Rejecting Returns that Meet Beard. That post covered Fowler v Comm’r, which held that a rejected an e-filed return the return still triggered the 3-year limitation period on assessment. The TIGTA report suggests that there are systemic issues stemming from the IRS practice of rejecting e-filed returns, issues that will likely require a legislative fix or a significant change to internal IRS practices.

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Unlike submitting a return by snail email, when e-filing a return it generates the possibility of the IRS rejecting a return (so called validation problems). Even if an e-filed return is validated, as with paper returns sent via regular mail, the IRS may notice errors that trigger Error Resolution System (ERS) scrutiny. TIGTA notes that there were about 26 million ERS issues on 2019 individual returns, with over 24 million of those errors attributable to “when the tax liability, balance due amount or refund computed is incorrect, or when information on the return does not match the information on a supporting form or schedule.” Not surprisingly the numbers of these types of errors are much higher on paper returns, (appx 15.3 million to 8.9 million).

For some errors, the IRS process for ERS scrutiny generally involves a tax return examiner contacting a taxpayer to correct the error; if over 40 business days elapse without a response the return is often released for processing, though is still tagged with the error code that delayed the processing.

All of this background gets us to the problem that TIGTA flagged, namely inconsistent IRS processes on e-filed returns with errors:

Our review found that IRS processes do not consistently provide taxpayers the opportunity to self-correct errors on e-filed tax returns. For example, some e-filed returns with a missing form are rejected to provide the taxpayer the opportunity to self-correct the error (i.e., attach the missing form and resubmit the e-file return) while others are accepted and sent to the ERS for manual correction by an IRS tax examiner, which suspends the return and holds the refund until the error condition is resolved.

This inconsistency can leads to later problems, as the statutory filing date of a tax return is, as TIGTA notes, “the date the IRS receives a legally valid tax return from the taxpayer.” Yet despite the statutory filing date, which is key for issues like delinquency penalties and the start date for determining when the statute of limitations on assessment expires  “e-file processes do not consider a rejected e-file tax return to be “received” until the taxpayer resubmits the rejected return and the IRS accepts it for processing.”

This rejection can lead to problems, especially if someone is e-filing at or close to the filing deadline.  To be sure this problem is mitigated by the resubmission policy that IRS has adopted. Publication 1345 discusses that process, which allows for sending a snail mail return within 10 calendar days of an e-file rejection:

If the taxpayer chooses not to have the electronic portion of the return corrected and transmitted to the IRS, or if the IRS cannot accept the return for processing, the taxpayer must file a paper return. To timely file the return, the taxpayer must file the paper return by the later of the due date of the return or ten calendar days after the date the IRS gives notification that it rejected the electronic portion of the return or that the return cannot be accepted for processing. Taxpayers should include an explanation in the paper return as to why they are filing the return after the due date.

As TIGTA suggests, the rejection of e-filed returns that satisfy the Beard test is common. If a taxpayer fails to correct the return (or corrects after the 10-day period) there is the likelihood that a return that would qualify as a return under Beard is not treated by the IRS as filed. IRS desire to maximize taxpayer self-correction of returns makes sense; it can reduce burden, speed up refunds, and avoid possible downstream costs. Yet it seems that millions of e-filed returns that IRS rejects are likely to constitute validly filed tax returns. When facing possible delinquency penalties or there are questions about the SOL on assessment it is important to consider whether the IRS previously rejected an attempted e-filed return.

Padda v Comm’r: Possible Opening in Defending Against Late Filing Penalty When Preparer Fails to E-file Timely

Courts have generally not excused taxpayers from late filing penalties when the taxpayer defense is that that the return preparer was responsible for the delinquency.  Decades ago the Supreme Court in Boyle 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.”  We have previously discussed how Boyle seems incongruent with e-filing. As I noted last year in Update on Haynes v US: Fifth Circuit Remands and Punts on Whether Boyle Applies in E-Filing Cases “the basic question is whether courts should reconsider the bright line Boyle rule when a taxpayer provides her tax information to her preparer and the preparer purports to e-file the return, but for some reason the IRS rejects the return and the taxpayer arguably has little reason to suspect that the return was not actually filed.”

So far taxpayers have not been successful in arguing that courts should distinguish BoylePadda v Commissioner is the latest case applying Boyle in these circumstances. Like other cases where the taxpayer’s late filing was due to a preparer’s mistake the court did not relieve the taxpayer from penalties. What is unusual though is that in rejecting the defense Padda implicitly acknowledges that differing circumstances might lead to a taxpayer win.

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I will summarize the facts and discuss the slight opening the opinion suggests.

The opinion nicely summarizes what went wrong:

Padda and Kane’s 2012 federal individual income tax return was due October 15, 2013. On October 15, 2013, Padda and Kane signed IRS Form 8879, “IRS e-file Signature Authorization” to authorize Ehrenreich’s accounting firm to electronically file their 2012 Form 1040, “U.S. Individual Income Tax Return”. On October 15, 2013, Ehrenreich’s accounting firm was electronically filing several tax returns just before midnight. Ehrenreich’s accounting firm created an electronic version of Padda and Kane’s return on October 15, 2013, at 11:59 p.m. It transmitted the electronic version to the IRS on October 16, 2013, at 12 a.m. On October 16, 2013, the IRS rejected the return as a duplicate submission. Ehrenreich’s accounting firm electronically resent the return on October 25, 2013, and it was received and accepted by the IRS the same day.

Prior to trial, the IRS and spouses Padda and Kane stipulated that the return was filed on October 25, 2013. The IRS had proposed late filing penalties under Section 6651, which trigger a 5% penalty of the amount required to be shown on the return if the failure to file is under a month, as the case here. In arguing that they had exercised reasonable care and prudence, the taxpayers explained that “1) Ehrenreich’s accounting firm pressed a button only a few seconds late, (2) they relied on Ehrenreich’s accounting firm to timely file the return, and
(3) they themselves could not have pressed the button to timely file the return.”

In rejecting the defense, the Padda opinion cites to Boyle and other cases which provide that taxpayers cannot delegate their filing obligation other than in circumstances where the advice pertains to whether a return needs to be filed at all. 

What I find interesting is that the opinion could have just cited Boyle and stopped there. Instead, it suggested that a relationship with a preparer who had history with the taxpayer of submitting e-filed returns on time might have led to a different outcome:

Even if sometimes it might be reasonable for a taxpayer to rely on his or her accountant to timely file his or her returns (contrary to the caselaw), it was not reasonable in this particular case for Padda and Kane to rely on Ehrenreich’s firm to timely file their return. Padda and Kane have relied on Ehrenreich’s firm to file their returns every year since at least 2006. And every year since then, except for 2011, their return was filed late. Yet they have continued to use Ehrenreich’s firm to file their return year after year. Padda and Kane’s failure to ensure that Ehrenreich’s firm timely filed their 2012 return demonstrates a lack of ordinary business care, particularly in the light of the firm’s history of delinquent filings.

Given the the firm’s delinquent filing history, the opinion concluded that the taxpayers failed to establish that they had reasonable cause for the late filing.

Conclusion

We wait for perhaps better facts for a court to distinguish Boyle. The Boyle-blanket rule seems out of place in today’s world where there may be little way to monitor preparers who taxpayers should be able to expect can meet a deadline. Padda suggests, though does not explicitly embrace, that some reliance may be reasonable, but when there is a long past history of delinquency, even if the taxpayer was not in a position to monitor the particular filing, it will be difficult to find that the taxpayer has a winning reasonable cause defense.

Senate Investigation Concludes IRS Free File Program is Not Meeting Eligible Taxpayers’ Needs

Today we welcome first time guest blogger Evan Phoenix. Evan is an ABA Tax Section Christine Brunswick Public Service Fellow with Bet Tzedek in Los Angeles. In this post Evan describes a recent senate subcommittee memo on the IRS Free File program. The memo and this post are quite critical of the IRS’s oversight of the program and of certain program members. Needless to say, the Free File Alliance (FFA) and its members likely have a different take. Intuit, for example, points out that the memo “acknowledges Intuit’s voluntary investment in paid advertising of Free File, our email communication with customers beyond what is required, and reiterates findings by the previously published MITRE report and recommendations Intuit has supported, many of which are already enacted in the new MOU between FFA and IRS.” Christine

A recent memorandum by staff of the Senate’s Permanent Subcommittee on Investigations (“PSI Memo”) concludes that deficient IRS oversight of the Free File Program has resulted in the program struggling to meet its mission to provide free tax preparation and e-filing services to economically disadvantaged populations. 

The IRS Free File program has been discussed in previous posts here and here.

The PSI Memo highlights the fact that multiple independent entities have reviewed the Free File program since 2018 and provided clear recommendations for improvement with respect to observed issues. For example, the PSI memo notes that in 2018 the Internal Revenue Service Advisory Council (IRSAC) concluded that “the IRS’s deficient oversight and performance standards for the Free File program put vulnerable taxpayers at risk, and make it difficult to ensure that FFA members are upholding their obligation …”

The need to ameliorate deficiencies in the Free File Program has been exacerbated by the COVID pandemic as many private tax prep businesses and VITA sites have been closed during the tax filing season. Given the uncertainty of the situation, it is incumbent on the IRS to concentrate on protecting economically disadvantaged taxpayers by future-proofing the Free File Program to meet the needs of the vulnerable in our communities. Delays in filing taxes means delays in receiving desperately needed refunds—such as the refundable EITC, which is the largest anti-poverty initiative  in the country—for economically disadvantaged taxpayers fighting to survive the devastating effects of COVID-19. The EITC and the Child Tax Credit greatly reduce poverty for working families. These working family credits lifted an estimated 8.9 million people out of poverty in 2017, more than half of whom were children. However, “paid tax preparer fees are diminishing the EITC” with fees between 12% to 22%, and as high as 25% of the EITC.    

The PSI Memo covers five topics—a brief history of the Free File Program, a summary of IRS oversight of the program, a discussion of the importance of online search engines in taxpayers’ selection of tax preparation software, the IRS’s Free File Program marketing strategy, and recent IRS changes to strengthen the program. I will discuss these issues under three headings—(1) Brief History, (2) Recent Improvements to Free File Program, and (3) Future-Proofing Free File Program Benefits.  

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BRIEF HISTORY

Topic one of the PSI Memo discusses the Free File Program history. In 1998, Congress directed the IRS to work with the tax preparation industry to ensure at least 80% of all federal tax returns were electronically filed by 2007. In 2002, the IRS entered into the Free Online Electronic Tax Filing Agreement with several electronic tax prep companies that had banded together as the Free File Alliance (“FFA”).  Under this agreement, FFA members committed to offering free online tax prep and filing services, known as Free File. The IRS and FFA also agreed to coordinate for the marketing of these free offerings to “provide uniformity and maximize public awareness.” In 2005, the IRS and FFA also developed a Memorandum of Understanding (“MOU”) to identify the service standards for Free File members and the procedures for resolving disputes.  The most recent version of the MOU runs through October 31, 2021.

Pursuant to the FFA agreement, private-sector tax prep providers agree to provide tax prep and e-filing services to vulnerable taxpayers at no cost to the taxpayer or the government; in exchange, the government agrees to not compete with FFA members by refraining from offering free online tax prep or e-filing services. Since its inception in 2002, the IRS reports the Free File Program has produced “more than 53 million free returns e-filed and an estimated $1.6 billion in savings to taxpayers.” Despite each stakeholder’s vested interest in the success of the Free File Program, the PSI Memo highlights that the program has come under scrutiny repeatedly for falling short of its objectives. The PSI Memo finds that “[u]ntil recently, the IRS conducted little oversight of the Free File program.”

Topic two of the PSI Memo provides a summary of IRS oversight of the Free File Program in the last decade. The PSI Memo highlights the fact that “[t]hree different independent entities have reviewed the Free File program since 2018 and provided recommendations for improvement, but the program continues to struggle to serve eligible taxpayers.” The PSI Memo reports that TIGTA’s 2007 review of “the effectiveness of the Free File program […] found that the IRS could improve its efforts to evaluate, promote, and administer the Free File program.”

RECENT IRS IMPROVEMENTS TO FREE FILE

Next, I’ll discuss topic five and three of the PSI Memo together. Topic five is an analysis of recent changes the IRS has made to strengthen the Free File program, and topic three discusses the importance of online search engine results in helping taxpayers choose a tax preparation software.

Prior reports revealed that some FFA members had taken deliberate actions to reduce access to the Free File Program by using coding to prevent the program from being populated in organic online web searches, a practice known as de-indexing. This is particularly troublesome because, as the MITRE 2019 assessment report (“MITRE 2019 Report”) of the program revealed, “[m]ost taxpayers find their preferred tax preparation product through online searches using an online search engine.”

The PSI Memo found:

[f]or the first 15 years of the Free File program, the IRS declined to take a position on whether FFA companies should index Free File websites to appear in online search engines, nor did FFA companies seek guidance from the IRS on whether their indexing practices complied with the MOU. As a result, participating FFA companies took different approaches in deciding whether to code their Free File program.

MITRE found that five of the twelve FFA members engaged in non-indexing their Free File websites. Upon questioning by MITRE, “most [FFA] members” stated that they “believed” this practice complied with the MOU terms. The PSI Memo emphasizes that TIGTA agreed with the IRS that the MOU did not explicitly prohibit de-indexing, but stated “it was against the spirit of the Free File program.” Indeed, this practice seems inconsistent with the FFA’s clear mission of providing low-income taxpayers with tax prep services for free, and its agreement with the IRS to “provide uniformity and maximize public awareness.”

Following public reports exposing the FFA members for using coding in this way, in December 2019, the IRS and FFA members agreed to an addendum to the Free File MOU prohibiting any practice that would exclude Free File websites from organic searches and standardizes the naming of Free File offerings to “IRS Free File program delivered by (Member company name or product name).” The PSI memo notes that FFA executives said that they “discover more program violations than the IRS and believe [the FFA] is tougher on their members than the IRS [… and] added that members do “a lot of self-policing” and report violations by other members.”

Recent news of the departure of one of the FFA members has raised many questions. After being a 20-year member, H&R Block recently announced its withdrawal from the FFA. H&R Block was one of the FFA members that engaged in the de-coding practice aimed at steering taxpayers away from the Free File Program. H&R Block will continue to offer its own free-filing options on its website, but it will remove its return filing software from the IRS’s Free File website after the extended filing season ends on October 15, 2020. Nina Olson, executive director of the Center for Taxpayer Rights, told Tax Notes (subscription required) that the withdrawal “is a perfect storm of things—the cumulative effect of the negative articles, the TFA, the [IRS] nonfiler portal, etc.”  Perhaps H&R Block’s performance of MOU requirements or stated position regarding certain requirements foreshadowed its recent announcement to exit the program.  Specifically, the PSI Memo highlights H&R Block’s position regarding marketing, stating it does not believe it should be marketing the program “in any manner;” therefore, it does not engage in any efforts to market the Free File program. H&R Block sends one reminder email, as required by the MOU, to individuals who used the company’s Free File product the prior year. Whereas, Intuit sends six to eight reminder emails each year to previous Fee File users.  

Although H&R Block will withdraw from the FFA, it will continue to benefit from the collective bargaining benefits of the agreement with the remaining eleven members because the IRS will continue to honor its commitment to not compete against the FFA members. H&R Block will have all of the benefits and none of the oversight or accountability. What is to stop other members from following suit?

The MOU addendum is a great step in the right direction, however, as the PSI memo highlights, there is still much more that needs to be done to ensure the program meets the needs of taxpayers.

FUTURE-PROOFING FREE FILE BENEFITS

The PSI Memo notes that,

[d]espite these challenges, the Free File program continues to provide a valuable service for millions of Americans. To support Free File, the IRS should increase its oversight of FFA members and dedicate funding—including increased funding from Congress, if necessary—to market the Free File program. The IRS should ensure FFA members comply with new guidance that attempts to avoid similarities between Free File branding and branding for commercial tax preparation products that could confuse taxpayers.

These recommendations echo those made previously by TIGTA, MITRE, and the National Taxpayer Advocate.

Increase Member Oversight and Accountability

A February 2020 Treasury Inspector General For Tax Administration Report (TIGTA 2020 Report) concluded that complexity, confusion, and a lack of taxpayer awareness about the Free File program led to low levels of eligible taxpayer participation, and that this was partially due to the IRS’s insufficient oversight of the Free File Program. These findings are consistent with those in the NTA 2019 Annual Report to Congress (“2019 ARC”), presented in a section titled, “Substantial Free File Program Changes Are Necessary to Meet the Needs of Eligible Taxpayers.” 

Among other things, TIGTA recommended that IRS management update its testing review guide to ensure adherence to the MOU by FFA members. Increasing member oversight and accountability will help ensure consistency to the FFA mission that will benefit the program. The IRS partially agreed with this recommendation.

Dedicate Funds to Marketing

Topic four in the PSI Memo is a discussion of the IRS marketing strategy for the Free File program. The PSI Memo finds that “[a] lack of investment in marketing by the IRS likely led to a lack of consumer awareness that hampered participation in the Free File program.” The TIGTA 2020 Report explains that in addition to deterring effects of the confusion of the Free File Program, the lack of taxpayer awareness about the operation and requirements contributes to lack of participation by eligible taxpayers.  The TIGTA Report explains that insufficient actions have been taken to educate taxpayers that the only way to participate in the Free File Program is through the IRS website.  “To participate in the Program, taxpayers must access the IRS.gov Free File web page and select a link on this web page directing them to a Free File Inc. member’s website. However, this provision is not in the […] MOU and most taxpayers are unaware of this requirement.” The PSI memo also highlights that the lack of taxpayer awareness is directly related to the fact that the IRS has no budget for marketing the Free File program, and Congress has not appropriated funds for it. 

TIGTA made several recommendations connected to marketing and taxpayer education. First, TIGTA recommended that the IRS “develop and implement a comprehensive outreach and advertising plan to inform eligible taxpayers about the Free File program and how to participate.” (Recommendation 1) The IRS agreed with this recommendation. Second, TIGTA recommended that the IRS.gov Free File page contain comprehensive eligibility criteria for each product. (Recommendation 2) The IRS agreed, but stated this was already the case. Importantly, TIGTA also recommended that the IRS inform taxpayers of their right to be free from cross-marketing or upselling of fee-based services on Free File program software. (Recommendation 7) This practice confuses taxpayers and gives the specious impression of IRS endorsement. The IRS agreed with this recommendation, and in response created a new webpage, Know Your Protections Under the IRS Free File Program. Whether taxpayers will find this information without additional marketing seems doubtful. We will hopefully see the new comprehensive outreach and advertising plan by the next filing season.

CONCLUSION

I personally have used Free File software, and I definitely saw how certain parts can be confusing. Thanks to my experience as a VITA volunteer and coordinator, I was able to work through it, but it is unlikely that most eligible taxpayers have VITA training and experience.

One example of a confusing surprise that confronts taxpayers is the fee for a state tax return. Free File allows eligible taxpayers to file their federal tax return for free, but there can be a fee ranging from $14.99 to $54.95 to prepare your state tax return for some taxpayers. When the payment request popped up for my state return, I backtracked to the first page to double check if there were any disclosures about payments associated with state tax returns or if I had unknowingly navigated away from the Free File program. The main page says “free state return options are available,” but nothing about payments. The payment is disclosed once you choose a product to use. The products generally break down into two groups—the first group says “No free state tax preparation in any states,” and the second group says “Free state return, for some states.” California is not on the list of states eligible for free state tax preparation.

However, I recommend checking the website of your state taxing authority for free state tax preparation software if your state is not eligible for free state tax preparation services. California, for example, provides CalFile to e-file your state tax return directly to the Franchise Tax Board for free. Realistically, I think most eligible taxpayers will eat the costs to avoid going through the daunting task of preparing their state tax return from scratch when the federal tax software can transfer the information over to the state if they pay.

Another point of confusion is the constant upselling gimmicks promising a better refund gives the impression that the Free File program may be inferior to the paid software, giving me cause to think that my refund could be higher if I paid for another product. Thankfully, I know better, but these gimmicks are likely to successfully steer vulnerable taxpayers with little or no understanding of tax preparation away from the beneficial Free File program that will save them a substantial sum of money.

Given the enormous potential of the Free File Program to meet its mission of best serving vulnerable taxpayers’ needs, one can only hope the IRS heeds the constructive criticism outlined in the PSI Memo, which echoes previously reported issues. The IRS has risen to the challenge of meeting taxpayers’ needs many times before, e.g., the implementation of IRS Settlement days and the commendable rapid mobilization and implementation of the EIP initiative in response to COVID-19. I’m confident the IRS can rise to the challenge of making the necessary improvements to the Free File Program to meet the needs of eligible taxpayers. The question is, when?

Claiming a Refund Without Signing the Return

In the refund case of Gregory v. United States, No. 1:19-cv-00386 (Ct. Cl. 2020) the Court of Federal Claims denies the refund claim of a couple because they did not sign the amended return.  The issue of signatures has become more important during the pandemic because of the difficulties of meeting in person.  For the Gregorys the issue probably involved distance because they were working the Australian outback.  Still, the case shows that an actual signature can be an important step in making a request to the IRS.

The outcome for the Gregorys may change for others in their situation in the future.  On August 17, 2020, in IR-2020-182, the IRS announced that ” [m]arking a major milestone in tax administration, the Internal Revenue Service announced today that taxpayers can now submit Form 1040-X electronically with commercial tax-filing software.”  Read on and find out what happened to the Gregorys when electronic filing of amended returns was unavailable.

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The Gregorys are U.S. citizens but during the period at issue they worked as defense contractors at a facility near Alice Springs, Australia starting in 2015.  They timely filed their original 2015 return claiming a small refund.  The IRS sent them a notice of adjustment seeking to assess an additional liability.  I suspect the inquiry caused the Gregorys to ask around about their taxes.  This was their first year in Australia on this contract.  If it was their first year filing a non-resident return, they had many things to learn.  Over the course of the next couple of years they started learning them and they hired an accounting firm to review their return.  That firm determined that they had overpaid their taxes by more than $20,000 and prepared an amended return claiming the exclusion for foreign earned income and the exclusion for employer provided housing.  The amended return was signed by an employee of the preparer of the amended return and not by the Gregorys.

The IRS reviewed the amended return and allowed the refund claim but for $1,039 related to the housing exclusion.  They received a check and no doubt happily paid the preparer of their amended return for setting them on the right path in dealing with the special issues raised when working overseas.  For reasons that do not make economic sense to me, the Gregorys decided to file suit to recover the relatively small disallowed amount.  Instead of filing in district court, they filed in the Court of Federal Claims, an alternate forum for refund suits.

The IRS moved to dismiss the case arguing that the Gregorys did not sign the refund claim making the claim invalid.  The Gregorys countered that the IRS accepted the refund claim and paid them a refund of most of the amount claimed and should not, after doing so, raise the issue of valid signature.

The Court of Federal Claims went through the test of what a taxpayer must do in order to file a valid claim and obtain jurisdiction in a refund suit.  First, a taxpayer must meet the Flora full payment rule.  Second, a taxpayer must file a claim.  Third, the taxpayer must provide “the amount, date, and place of each payment to be refunded, as well as a copy of the refund claim when filing suit in the Court of Federal Claims.”  The Gregorys problem stems from the second requirement – a valid claim.

The court then walked through what makes a valid claim stating, inter alia, that it “must be verified by a written declaration that it is made under the penalties of perjury.”  The court explained why having it signed under penalties of perjury is important.  It also referred to the possibility of having the return signed by someone holding a power of attorney if the POA is attached to the return.  Here, it was not.

Then the court addressed the waiver doctrine raised by the taxpayers in their defense.  The court acknowledged that the IRS can waive compliance with its own regulatory requirements but cannot waive compliance with statutory requirements.  IRC 6061 requires “any return, statement or other document required to be made under any provision of the internal revenue laws or regulations shall be signed in accordance with forms or regulations prescribed by the Secretary.”  IRC 6065 provides “[e]xcept as otherwise prescribed by the Secretary, any return, declaration, statement, or other document required to be made under any provision of the internal revenue laws or regulations shall contain or be verified by a written declaration that is made under the penalties of perjury.”  Regulation 301.6402-2(c) allows for someone other than the taxpayer to sign under penalties of perjury only if a POA form accompanies the return.

The IRS argued that in partially allowing the refund claim it waived the regulation requiring the attachment of the POA but that to the extent it did not agree with the claim, it did not, and could not waive the signature requirement in litigation by allowing a part of the claim.  It pointed out the taxpayers’ argument could allow individuals to avoid the penalties of perjury requirement altogether.  The court agreed and dismissed the case.

Signature issues are becoming more and more important.  Electronic signatures are becoming more prevalent.  We now allow remote notarization in many states.  Individuals in many assisted living facilities that have locked down have no practical means of physically signing documents and often do not have computer capabilities.  Getting signatures or some type of verification on documents that allows the government or the interested party to know the validity of the approval while at the same time addressing the practical difficulties created by the pandemic, requires careful attention.

While the IRS allows individuals to file tax returns electronically, it has not historically allowed the filing of amended returns electronically requiring individuals like the Gregorys who live thousands of miles from their preparer to make arrangements to meet the signature requirements.  I don’t fault the IRS for wanting documents signed under penalties of perjury and requiring proof that the person submitting the claim is really the taxpayer.  Electronic signature tools exist.  New rules are coming out. 

The IRS issued a memo on March 27, 2020 that provides a temporary deviation from IRM signature procedures. The memo allows IRS employees on the collection side to accept images of signatures and e-signatures on a number of documents, including SOL assessment/collection extensions, closing statements, POAs, and generally any document collected “outside of standard filing procedures.”  The Tax Court issued a press release on August 6, 2020 which announces that electronically-filed stipulations with digital signatures will be accepted by the Court.  In Massachusetts, the Supreme Judicial Court issued a rule that authorizes e-signatures for all documents filed with Mass. courts. Numerous federal district courts have issued new rules accepting e-signatures, which can be found on this page.

Maybe next time the Gregorys can move forward in a case like this with the friendlier e-file rules, which could allow them to work with their accountant from thousands of miles away and still file a valid amended return.  I remain curious about their decision to sue for such a small amount and wonder about the decision dynamic that led to this case in a refund posture.

Electronic Trial Sessions in the Tax Court: New Procedures for Expert Witness Reports and Unagreed Exhibits

One of the Designated Orders from the week of March 30 included a short order from Judge Gale. The order raises a specific issue under Rule 143(g), along with some broader issues regarding compliance with Tax Court filing requirements while the Court’s mailroom remains closed due to the COVID-19 pandemic.

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It’s common knowledge, among practitioners at least, that merely because you file something with the Tax Court doesn’t mean the Tax Court will consider it as evidence in the case. Pro se petitioners often run afoul of this rule when they attach various substantive proof to their Tax Court petition. The Court will lightly chide them for doing so, and remind them not to do it again. The substantive rationale is that this evidence must first be presented to the opposing party for objection, and then either stipulated to or moved into evidence

Much like anything else, expert witness reports are subject to this rule. But Rule 143(g)(2) provides that the expert witness reports must be “submitted” to the Court “not later than 30 days before the call of the trial calendar on which the case shall appear . . . .” Ordinarily, this means that a party will mail the expert report to the assigned judge and to opposing counsel.

However, as we all know, the Tax Court’s mailroom has been closed since March. Petitioner’s counsel in this case saw their expert report filing deadline coming up. And while the Guralnik and 7508A extensions apply to Tax Court petitions, they don’t necessarily apply to submission deadlines like this. Ultimately, the judge needs to review the report prior to the trial session (albeit this particular one was cancelled). Harsh consequences follow under Rule 143(g)(2) if a party doesn’t comply: “An expert witness’s testimony will be excluded altogether for failure to comply with the provisions of this paragraph . . . .” There’s an exception for reasonable cause combined with lack of prejudice, but best not to risk it. So, what to do?

Petitioner adopts a somewhat innovative solution: rather than mailing the report to the Court, knowing that no one will review it, he decided to submit the expert’s report electronically by filing it as an attachment to Petitioner’s status report.  Ordinarily, this would run afoul of the same prohibition mentioned above—and indeed, as the Court acknowledges, it does. However, Judge Gale understands the parties’ predicament due to the mailroom’s closure. So he directs the Clerk to re-characterize the filing as the “Report of Brent M. Longnecker, Petitioners’ Proffered Expert” and to serve a copy of the report on Respondent. And, like those ordinary orders directed to pro se petitioners, he notes that that the report is not received into evidence. Finally, he prospectively permits Respondent to file their own expert report in a similar manner.

What should practitioners do in a similar situation? The course of action in Smith seems to be a model that works in the face of ambiguity. I think it’s important for practitioners to fully disclose (1) the requirements that the Tax Court rules impose and (2) the limitations that the Tax Court’s closure and technological limitations impose upon the normal manner of proceeding. Ordinarily though, there are few other situations where a party must disclose substantive proffered evidence to the Court before trial.

The Court, however, in its recently enacted electronic trial session procedures, has indicated that parties planning to call an expert should file “a Motion for Leave to File an Expert Report, with the expert report attached (lodged)”. Rule 143 doesn’t contemplate this motion, so I suspect it’s a new one.  Indeed, this language is different than the ordinary language in the Standing Pretrial Order, which centers on the language of Rule 143 and requires submission of the proffered expert report directly to the assigned judge.

Moreover, as the Tax Court moves its trial sessions online in response to the COVID-19 pandemic, this situation does raise broader concerns for how the Court will handle proffered evidence moving forward. How will the Court allow for Petitioners, especially pro se Petitioners, to present evidence to the Court? How will Chief Counsel allow for the electronic transmission of proposed evidence? (Potentially Chief Counsel will have less of an issue with mailroom closures, thereby mooting this problem to some extent).

Certain initiatives may help. The Court already relies heavily on stipulations, and electronic hearings will likely only give it stronger reasons to do so. Indeed, the electronic trial session procedures reinforce this idea.  Additionally, while the Court ordinarily suspends e-filing during the trial session (a lesson I first learned the hard way!), the Court indicates in the procedures that it will not do so for remote trial sessions. So, perhaps the Court can provide a mechanism to lodge evidence electronically.

Indeed, the electronic trial session procedures indicate that unagreed trial exhibits not in the stipulation of facts should be “marked and filed as Proposed Trial Exhibits.” This is again in contrast to the Court’s previous standing pretrial order that requires only an exchange of such documents with opposing counsel. So how do we lodge the documents with the Court? Helpfully, on the Court’s electronic filing system, a new option now exists called “Proposed Trial Exhibits.”

It seems like the Court has done quite a bit of work to implement technology and policy changes to accommodate taxpayers and the IRS alike. It should be commended for its relatively nimble planning in response to a fast-moving global pandemic. It will be interesting to see how these changes play out in practice, as well as contemplate how the Court might improve access to justice through implementing some of these procedures after this crisis abates.

Reliance on Preparer Does Not Excuse Late E-Filing of Return

The case of Intress v. United States, No. 3:18-cv-00851 (M.D. Tenn. 2019) again raises the question of Boyle in an electronic era.  Does e-filing have the ability to change the outcome in Boyle?  According to the district court in this case, it does not. 

We have traveled this road before.  Last year Les wrote an excellent post on the Spottiswood v United States case in which the District Court for the Northern District of California held that a taxpayer who attempted to e-file his return a few days before the filing deadline but who incorrectly entered his child’s Social Security number was responsible for a late filing penalty.  That post contains links to a couple of other relevant posts and to submissions I helped to draft on behalf of the ABA Tax Section as part of its annual meeting with the Commissioner in which Tax Section raised this issue to the IRS because people are being penalized for filing electronically in situations in which the IRS would not impose penalties for paper filing.  That post also contains a link to the amicus brief filed in the Haynes case, discussed below, by the American College of Tax Counsel (ACTC).  Since the IRS has encouraged people to e-file for the past two decades, it seems odd that it would impose stricter penalties and cite to Boyle if it really wants to encourage e-filing.  Seems like it’s time for rethinking the situation.

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According to the decision Kristen Intress and Patrick Steffen are a “marital community” in Tennessee.  They brought a refund action seeking to recover a late filing penalty imposed on them with respect to their 2014 return.  The penalty amount here, $120,607.27, makes it worth the fight.  At the time of the filing deadline for their 2014 return taxpayers were out of the country.  Their preparer sought to file a request for an automatic extension and queued up the extension document using her e-file software; however, she failed to hit send.  The taxpayers, and the preparer, did not discover the error until October.  Of course, by that time the return had already amassed the maximum failure to file penalty.

They paid the penalty, and requested a refund arguing that they met the dual requirements for abatement – reasonable cause and lack of willful neglect.  They argued that reliance on their return preparer to make the request for the automatic extension was reasonable; however, that argument runs right into Boyle.  So, they additionally argued that Boyle in its stark black and white view of the world should not apply to an e-filing situation in the same way it did in the 1980s.

The district court finds their position at odds with Boyle and states that their argument that Boyle does not govern e-filed returns “presents a novel legal question – one not previously addressed squarely by the federal courts.” Citing Haynes v. United States, 760 F. App’x 324, 326 (5th Cir. 2019)Haynes squarely raised a Boyle question but did not decide it.

In Haynes, the 5th Circuit described the facts as follows:

“On October 17, 2011, the last day of a six-month filing extension, John Dunbar, a certified public accountant and paid tax preparer, electronically transmitted the Hayneses’ Form 1040 income tax return, which he had prepared, to Lacerte Software Corporation for filing with the IRS. Later that day, Dunbar notified Mr. Haynes that the 2010 return had been timely filed. Ten months later, however, on August 20, 2012, the Hayneses received an overdue-return notice from the IRS for the 2010 tax year.

In response to the Hayneses’ resulting inquiry, Dunbar ultimately determined that, on October 17, 2011, Lacerte accepted the electronically submitted return and timely transmitted it to the IRS. Nevertheless, the IRS rejected the return because Ms. Haynes’s Social Security Number erroneously appeared on the line designated for an employment-identification number. For reasons unknown, the Hayneses did not receive a rejection notice from the IRS, Dunbar, or Lacerte prior to the August 2012 notice of nonpayment.”

Haynes pushes the problem of the mistake further down the line because of the way e-filing works.  Haynes handed off to the CPA who handed off to the transmitter who handed off to the IRS.  Somewhere between the transmitter and the IRS the problem occurred but no one got back to either the CPA or the Hayneses to notify them of the botched handoff.  What responsibilities do the parties bear to insure that the document made it successfully to the IRS in the absence of notice that it did not arrive?  Once they learned of the failure of transmittal the Hayneses immediately filed a paper return; however, because this occurred 10 months after the extended due date the IRS hit them with the late filing penalty.

Under the facts here the 5th Circuit sidesteps the decision regarding the application of Boyle in an e-filing era stating;

“While the e-filing issue is an interesting one, it is one that we need not decide today. Even if the Government is right that Boyle should apply to e-filing, another genuine dispute of material fact—laid out in the next section— still defeats summary judgment. Consequently, we take no position on whether a taxpayer’s reliance on a CPA to e-file a tax return, by itself, constitutes reasonable cause.”

The case arrived at the 5th Circuit after the lower court granted summary judgment to the IRS; however, the 5th Circuit said this case presents a different factual situation than Boyle.  In Boyle, the preparer put the wrong due date on his calendar and everyone agreed that the mistake belonged to the preparer.  Here, the preparer timely and properly filed the return but did not follow up when he did not receive a notice confirming receipt.  The fact, the duty to follow up after an electronic transmission, creates a different situation than Boyle, requiring the trier of fact to determine, after testimony, whether the duty to follow up has the same consequence as the duty to get the date right in the first place.

After the 5th Circuit’s opinion the Department of Justice Tax Division sent a letter to the court notifying the court that the case was moot because the government conceded the case and refunded the money paid by the Hayneses to them.  Of course, the letter does not provide details of why the government conceded this case but it is clear from subsequent events it has not conceded the issue.  Thereafter, the Hayneses sought attorneys’ fees but that effort failed, though the government did pay court costs.

In addition to citing Haynes, the district court also cited to the National Taxpayer Advocate’s 2018 annual report to Congress where she discussed this issue.  Having looked at the relevant cases and discussions swirling around the issue of Boyle’s continued viability in very different e-filing world that now exists, the court holds for the IRS and applies Boyle to prevent relief but states that its “conclusion is neither axiomatic nor self-evident, and is worthy of analysis.”

While agreeing that the landscape for filing returns has changed drastically since the Boyle decision, the district court finds commonality between petitioners’ situation and Boyle in that “taxpayers are not obligated to use tax preparation services.”  The taxpayer controls which preparer to hire and the decision of whether to file using a paper return.  While the IRS has encouraged e-filing and while most taxpayers do e-file, taxpayers may still file using paper just as they could when the Supreme Court decided Boyle.  The court states that if the IRS gets to the point of requiring everyone to e-file taxpayers’ argument would become more plausible.

The court then finds that even if taxpayers could get past the Boyle issue, they would still need to show reasonable reliance on the return preparer.  They should show they took reasonable steps to check to make sure the extension was received but they showed nothing of this sort.  The record did not indicate that the taxpayers made any effort to verify the filing of the extension request.

This will not be the last case on late e-filing and the Boyle case.  Last month ACTC wrote a letter to the IRS Chief Counsel urging him to revise the rules that apply to e-filing.  The letter does an excellent job of setting out three possible solutions to the application of the bright line rule in Boyle to the e-filing situation:  1) the IRS should not apply the bright line test to e-filed returns; 2) the IRS should require the ERO to notify the taxpayer of the acceptance or rejection of the e-filed return within a reasonable time after the e-filing and 3) the IRS should implement a systemic first time abatement program.  (The Intress case does not discuss first time abatement which is an administrative program rather than a basis for courts to grant relief.

The situation needs to change.  The IRS understandably does not want to go back to the slippery slope that existed before Boyle with taxpayers (and their representatives/preparers who are themselves frequently on the line for malpractice in these cases) pleading for relief because of the special circumstances that caused the late filing of the return.  It’s a lot easier to send them away with the bright line rule of Boyle.  Yet, the notification issues and the mismatch issues that really do not impact the viability of the document as a return need recognition.  In Intress, the facts are not as favorable to the taxpayers as in Haynes and some of the other situations.  Here, the preparer screwed up by not pressing send.  No part of the fault for the late return lies at the doorstep of the IRS.  Yet, even here, the situation cries out for relief.  The ACTC has made some good proposals, the NTA has made some good proposals, and the ABA Tax Section has made some good proposals.  It’s time for the IRS to make some decent counterproposals to try to work out this problem administratively with new procedures and regulations.  It’s time for Congress to step in to help them by passing laws governing the imposition of penalties in the e-filing setting that match the circumstances.  Both taxpayers and practitioners need to know their responsibilities as we continue to encourage e-filing.

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

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

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

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

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

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

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

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

Conclusion

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

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

 

 

District Court Holds That Taxpayer With Rejected E-Filed Return Subject to Late Filing Penalties

Last week, in Spottiswood v US, the District Court for the Northern District of California held that a taxpayer who attempted to e-file his return a few days before the filing deadline but who incorrectly entered his child’s Social Security number was responsible for a late filing penalty. The case is the latest in I am certain to be a growing number of cases attempting to apply a 20thcentury approach to tax administration to the realities of 21stcentury tax return filing.

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Here are the facts.

Taxpayer John Spottiswood used Turbo Tax to prepare his federal return and California return. The federal return was submitted to Intuit for the software provider to then submit to IRS for electronic filing. Also using the Turbo Tax software, Spottiswood printed out his state return and mailed the State return via old-fashioned snail mail.

Here comes the problem. On the federal return his child’s Social Security number differed from information IRS had when it crosschecked the numbers with its databases. IRS notified Intuit, which sent an email to Spottiswood telling him IRS failed to accept the return.

Spottiswood failed to notice the email and he had no idea that all was not kosher until months later:

When I was investigating the issue, I discovered the following by logging back into my Turbo Tax 2012 software. [] I discovered that my return, which I thought had been successfully e-filed, had actually been rejected. If I had realized that there was a chance of rejection I would have mailed in my return, but e-filing seemed like an easier option and it was free with the software. Intuit may have informed me in the fine print that I needed to log back in to make sure that my return had not been rejected, but if so I did not read this fine print. Had I logged back in a few days later I would have realized that the return had been rejected. But I did not log back in until 18 months later.

Eventually Spottiswood got around to fixing the error and resubmitting the return.  IRS, however, assessed a late filing penalty of about $89,000.

Spottiswood paid the interest on the penalty and filed a claim for abatement and refund claim, which IRS rejected, leading to a suit (an aside: not clear how this gets around Flora as it does not appear based on the order that Spottiswood paid the penalty). In his motion for summary judgment, he had two main arguments: 1) the rejected return should have been considered a return and therefore no late filing penalty was appropriate and 2) in the alternative he had reasonable cause for the late filing.

The court held for the government and granted its cross-motion for summary judgment.

As to the first issue, the taxpayer’s main argument revolved around how if he had sent the precise information contained in the attempted e-filed return via old fashioned paper return, IRS would have accepted it and the information contained qualified as a return under the Beard standard as to whether a document is a return for federal income tax purposes.

I am sympathetic to this argument, as the IRS’s current approach essentially creates an additional burden for e-filers who, if they had just mailed the return in the old fashioned way, would not have found themselves facing a late filing penalty.

The court sidestepped the argument though because Spottiswood failed to establish that in fact IRS would have treated the information in a paper return differently than the e-filed return:

Plaintiffs argue that the IRS would have accepted a paper-filed return containing the same error, and that the IRS unlawfully applied a more stringent standard to their electronically- submitted return. Pls.’ Mem. at 7-8. Plaintiffs’ only support for this argument is a document entitled “Internal Revenue Manual Part 3. Submission Processing Chapter 11. Returns and Documents Analysis Section 3. Individual Income Tax Returns.” See Pls.’ Opp’n at 1 (“Plaintiffs submit Exhibits 1 through 3”); id., Ex. 2. This document is not authenticated, and Plaintiffs establish no foundation for the document. The document shows a transmittal date of November 17, 2017, and Plaintiffs do not establish any foundation showing the IRS followed the procedures described therein when Plaintiffs attempted to submit their tax return more than four years prior to that date. Plaintiffs also establish no foundation to show their interpretation of the procedures described in the document is correct. Plaintiffs fail to create a triable issue that the same mistake contained in their submission would have been treated differently if it had been presented as a paper filing, and that the IRS’ rejection of their submission because it contained an erroneous Social Security number was not lawful.

The order continued with its critique of the way the taxpayer argued that the information it submitted should have been enough to constitute a return for tax purposes:

Plaintiffs’ assertion that the document “contained sufficient data to calculate the couple’s tax liability” (Pls.’ Mem. at 7) is purely conclusory. Their support for this argument is based entirely on an unauthenticated copy of a document faxed by the IRS to an unidentified recipient on May 23, 2016. Id. (citing Pls.’ Opp’n at 1 (“Plaintiffs submit Exhibits 1 through 3”); id., Ex. 1). Plaintiffs do not set out facts showing the document is a true and correct copy of the data they submitted to the IRS in 2013; indeed, it does not appear to be, given that the document displays information received on January 26, 2015. See, e.g., Pls.’ Opp’n, Ex. 1, passim (“TRDB-DT- RCVD:2015-01-26”). Nor do they set out facts showing the information contained in this document would be sufficient to calculate their tax liability. They thus have not created a triable issue of fact that the document they attempted to submit to the IRS in 2013 qualifies as a tax return under Beard, such that the IRS should have accepted it for filing under their theory of the case. The United States does not actually challenge this point, arguing only that the first Beard factor was not met because the IRS could not calculate Plaintiffs’ tax liability because the return had not been accepted for filing.

With a better foundation, the court would have had to address this issue head on, and I think it is a close case and requires courts and IRS to apply some fresh thinking on the issue.

The court also summarily rejected the taxpayer’s argument that reasonable cause should excuse the penalty, looking to the taxpayer’s failure to check his email account that he provided Intuit and the taxpayer’s failure to look at the “check e-file status” on his software to confirm that everything went well with the e-filing. For good measure, although the court did not emphasize this in the order, IRS also failed to debit the $395,000 that Spottiswood designated as a payment with the  purportedly e-filed return, and he failed to notice this due to as he described the high balance in the account. That failure to confirm that in fact IRS accepted the payment cuts against the argument that he had reasonable cause for failing to file on time.

Additional readings on this and related issues:

For more on this issue, see a prior PT post discussing the Haynes case on appeal in the Fifth Circuit, Boyle in the Age of E-Filing(linking an amicus brief from the ACTC) and a PT post on e-file rejections.

In December of 2017 and January of 2018 ABA Tax Section submitted letters to IRS asking IRS to reconsider its approach to timeliness of e-filed returns after a failed transmission; see here and here. (Note: Keith was the initial drafter of these letters, and he was part of the ABA Tax group that called on Counsel to change its policies on this issue).

A 2012 Journal of Tax Practice and Procedure article by Bryan Skarlatos and Christopher Ferguson making the persuasive case for a new approach to Boyle in the age of e-filing.