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.

Scamming Taxpayers: 2018 Version

IRS has released information this week about the latest twist on identify theft related tax scams. This scam involves thieves who access personal client information from preparers, and then submit fraudulent tax returns claiming a refund. The funds arrive via direct deposit in a legitimate bank account. The thieves then pounce on the unsuspecting refund recipient, leaving messages detailing how the IRS has issued an erroneous refund and in order to correct the situation the individual must send the cash to a collection agency. Some versions of the scam threaten criminal prosecution; others threaten a so-called blacklisting of the individual’s social security number.

IRS notes that new versions of the scam are appearing; it all stems, however, from thieves compromising personal information from a preparer’s client files. Earlier this month, IRS reminded preparers on ways to secure data.

All of this reminds me about the generational shift in  tax preparation and filing and how technology has changed the dynamics, mostly for the better but in its wake creating 21st century problems and legal issues. We have discussed the effects of this shift, including recently in Delinquency Penalties: Boyle in the Age of E-Filing, where we looked at an amicus brief the ACTC filed in Haynes v US. That case tees up if a taxpayer who uses an authorized e-filer expecting that the return be timely filed can avoid a delinquency penalty if in fact there was an error in the processing of the e-filed return but the IRS or the preparer did not notify the taxpayer of the error in time to fix the glitch.

For more on the changes in tax administration relating to the shift, I recommend a review of the Electronic Tax Administration Advisory Committee (ETAAC) annual reports; recently that group has shifted its focus to more directly include security issues generally and identity theft tax refund fraud in particular. The 2017 report discusses what IRS, working with private sector and other government partners, has done and its progress in recent years. As this week’s IRS news release indicates, IRS efforts to secure the tax system from creative and motivated thieves is a little bit like whack a mole; one scam disappears and a new one pops up in its place.

 

 

Delinquency Penalties: Boyle in the Age of E-Filing

The issue of when a taxpayer can be insulated from the imposition of civil penalties when the taxpayer depends and relies on the advice of a tax professional is an issue that we have discussed many times on PT and which fills many pages in the Saltzman Book treatise IRS Practice and Procedure. This month the American College of Tax Counsel (ACTC) filed an amicus brief in the Fifth Circuit case Haynes v US, which looks at the issue with a modern twist: can a taxpayer who uses an authorized e-filer expecting that the return be timely filed avoid a delinquency penalty if in fact there was an error in the processing of the e-filed return but the IRS or the preparer did not notify the taxpayer of the error until a couple of years passed and penalties accrued?

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As many PT readers know, Boyle creates a bright line that prevents taxpayers from arguing reasonable cause based on good faith reliance on an advisor when it comes to meeting tax-filing deadlines. Boyle is a Reagan era case, well before today’s e-file world. The brief, which is exceptionally well done, explains that many e-file reject returns would clearly be accepted as returns under the Beard test if they were sent in via snail mail. The current e-file regime essentially makes it easy for rejects, as IRS has required taxpayers to identify prior year’s AGI or a special PIN to verify the return (a task not all are up for).

As I have discussed previously when IRS rejects an e-filed individual income tax return that cannot be rectified taxpayers “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.” (as per the Handbook for Authorized E-file Providers of Individual Income Tax Returns). If there is no timely notification and little way for the taxpayer to independently check whether the return was rejected, it seems unfair to apply Boyle in these circumstances.

The ACTC brief (note: Keith and I are ACTC fellows though we did not participate in the drafting of the brief; Peter Connors of Orrick and Professor Jon Forman at Univ of Oklahoma Law School led the charge for ACTC ) makes the case much more forcefully. As the brief discusses, the act of e-filing is not nearly as simple as placing a paper return in the mail. Requiring a taxpayer to independently check to ensure that the return has been accepted, absent major developments in the so-called Future State of tax account information, seems to me unfair. By requiring a taxpayer to double check with the preparer or IRS to ensure that the e-filed return has been accepted places additional burdens on taxpayers using a preparer. If anyone should have that responsibility, it is the preparer, and a preparer who fails to ensure that the IRS has accepted the return should face the penalty music, not the taxpayer.

We will watch this case with interest and keep readers posted.

Can Tax Preparer Recover Damages for Revoked EFIN

The recent decision rendered by the Court of Federal Claims in Snyder & Associates v. United States provides a stark reminder about the perils of building a business based on a government privilege or license – in this case the ability to electronically file tax returns for clients.  It also provides a reminder of the limitations of federal employees to bind the government for which they work.

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Snyder & Associates engaged in return preparation in the Los Angeles area.  It had a symbiotic relationship with a lender that funded refund anticipation loans (RALs).  Even though RALs ended several years ago, at least in their first decade of the 21st Century form, this case relates back to that era.  The same person owned both the return preparation firm and the lender.  Nothing in the opinion suggests that the businesses or the owner of the businesses engaged in inappropriate activity; however, one of the associates of the business, Nancy Hilton, who prepared returns there in the capacity of an independent contractor, did engage in fraudulent activity.

Ms. Hilton approached the IRS criminal investigators and advised them of the scheme in which she participated.  The scheme used stolen identities to seek benefits through tax filing.  After she brought the scheme to the IRS, Special Agents sought to use her to set up a sting.  For the sting to work, the IRS wanted Ms. Hilton’s co-conspirators to cash the checks written as refund anticipation loans.  Cashing those checks meant pulling money out of the lender side of the business.  The owner initially balked at the plan because of concerns of losing the money.  One of the special agents directly stated or implied that the IRS would make the lender whole.  The sting went forward.  In the end, the IRS declined to make the lender whole and, to add insult to injury, it terminated the EFIN license held by Snyder & Associates – an act which effectively terminated the return preparation business.

The business sued to recover the funds lost through the sting operation and to restore its EFIN privileges.  It lost on both counts.

With respect to the money lost in the sting, the issue turned on the authority of the special agent to bind the government.  I am probably oversimplifying this, but my experience working in the federal government for over 30 years suggests that first line employees like special agents, revenue agents, revenue officers, attorneys, etc., have extremely limited ability to bind the government.  Almost everything that they do which might create a monetary liability for the government must first be approved by their supervisors.  The principle extends beyond contracting for repayment of a sting obligation or other monetary obligations to matters such as settlement authority or referral authority.  There is a fairly elaborate system of delegation orders granting authority for certain acts.  The system generally does not go lower than the front line manager and frequently does not go that low.

Snyder & Associates ran full force into this system.  The special agent who told it that the money used to pay the fraudulent RALs would be repaid to the business by the government simply did not have the authority to bind the IRS.  The Court expended little effort in denying this claim for relief because the IRS had not committed itself to repayment of losses.  Based on my experience, the special agent who made the representation will receive counseling about their scope of employment which will include a discussion about not doing this again.  Such counseling will be cold comfort to the business that has lost the money with little or no hope of recovering it from the participants in the fraudulent scheme who will also owe the IRS and whose debt to the IRS will generally have a higher priority than the debt to the business.

Having lost the money spent to support the sting, the business then sought to reobtain the right to electronically file returns which the IRS pulled at approximately the same time the business cooperated with the sting operation.  The business argued that the termination of the EFIN rights was an improper taking of a property interest.  The Court points out that the IRS did not take the business or in any way deny the business use of the business.  The termination of the EFIN certainly impacted the business but the business had “no cognizable property interest in their EFIN in the first place.”  Citing Mitchell Arms v. United States, the Court stated that “when a party receives a permit to engage in an activity ‘which, from the start, is subject to pervasive Government control,’ no cognizable property interest capable of supporting a takings claim ever arises in that permit.”

Although the Mitchell Arms case involved the import and sale of assault rifles rather than electronic filing of returns, the Court found the action of ATF in that case exactly paralleled the action of the IRS in this one.  Because no property interest attached to the EFIN, the termination of the right to electronically file could not constitute a taking under the constitution.

Conclusion

The decision here, though harsh, does not cover new ground.  The business had good reason to expect the IRS would make it whole for assisting with the sting operation based on the representations of the special agent.  Not everyone knows of the limitations governing federal employees.  The case reminds us to take care in contracting or thinking we have contracted with the federal government.  Authority is critical.  Here, the special agent did not have proper authority to bind the IRS and the actions of other IRS officials did not act to ratify the actions of the special agent.

Similarly, licenses like EFINs do not come with a guarantee or with special protections.  When a business relies on the EFIN for its financial life, it must take extreme care to avoid actions that can result in its removal.  Even though the actions here appear to be those of an independent contractor working with the business, the concern of the IRS about fraudulent return filing schemes ends up punishing the business as well as the individual perpetrator in an effort to keep the system clean.  The result here reaches a much different result for the preparer than the D.C. Circuit in Loving because of the difference in the nature of the fight.  In Loving, the IRS sought to assert its authority over a previously unregulated matter – tax return preparation.  Here, the IRS exercised control over use of its electronic filing procedures something which it has carefully regulated from the start.  The challenge was not to the IRS ability to regulate electronic filing but whether the business had a property interest in the ability to electronically file.

 

Electronic Tax Administration Advisory Committee Report to Congress: Updates on E-Filing, Refund Fraud and Identity Theft

Last month the Electronic Tax Administration Advisory Committee issued its annual report to Congress. ETAAC was born in the 98 Restructuring Act; it is an advisory committee that is made up of a number of volunteers from the private sector, consumer advocacy groups and state tax administrators. As I discuss below, the report considers e-filing and refund fraud and identity theft issues.

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When formed in 98, ETAAC’s mission was principally directed at IRS reaching an 80% rate of electronic return filing; this year’s report details the substantial progress in meeting that target, though there is a range in e-filing that is based on type of return. For example individual income tax returns are e-filed at around 88%; exempt org returns are in the mid-60% range. ETAAC projects this year that the overall electronic filing for all returns will exceed 80%.

A Shifting Focus to Refund Fraud and Identity Theft

With ETAAC essentially fulfilling its primary mission, last year its charter was amended to include the problem of Identity Theft Tax Refund Fraud (ITTRF), which, as the report states, threatens to undermine the integrity of our tax system:

America’s voluntary compliance tax system and electronic tax filing systems exist, and succeed, because of the trust and confidence of the American taxpayers (and policy makers). Any corrosion of trust in filing tax returns electronically would result in reverting back to the less-efficient and very costly “paper model.” That option is neither feasible any longer nor desirable.

The report discusses the IRS’s convening of a Security Summit and last year’s special $290 million appropriation to “improve service to taxpayers, strengthen cybersecurity and expand their ability to address identity theft.” The main goals relating to ITTRF include educating and protecting taxpayers, strengthening cyber defenses and detecting and preventing fraud early in the process.

The report discusses a number of ITTRF successes in the past year:

  • From January through April 2016, the IRS stopped $1.1 billion in fraudulent refunds claimed by identity thieves on 171,000 tax returns; compared to $754 million in fraudulent refunds claimed on 141,000 returns for the same period in 2015. Better data from returns and information about schemes meant better filters to identify identity theft tax returns.
  • Thanks to leads reported from industry partners, the IRS suspended 36,000 suspicious returns for further review from January through May 8, 2016, and $148 million in claimed refunds; twice the amount of the same period in 2015 of 15,000 returns claiming $98 million. Industry’s proactive efforts helped protect taxpayers and revenue.
  • The number of anticipated taxpayer victims fell between/during 2015 to 2016. Since January, the IRS Identity Theft Victim Assistance function experienced a marked drop of 48 percent in receipts, which includes Identity Theft Affidavits (Form 14039) filed by victims and other identity theft related correspondence.
  • The number of refunds that banks and financial institutions return to the IRS because they appear suspicious dropped by 66 percent. This is another indication that improved data led to better filters which reduced the number of bad refunds being issued.
  • Security Summit partners issued warnings to the public, especially payroll industry, human resources, and tax preparers, of emerging scams in which criminals either posed as company executives to steal employee Form W-2 information or criminals using technology to gain remote control of preparers’ office computers.

E-file Signature Verification

While ETAAC shifts its focus to include security and fraud detection, it still examines how IRS is doing in the e-file arena. One area in the report that I think warrants further reflection is ETAAC’s recommendation that IRS improve its ability to allow taxpayers to verify an e-filed return. The report discusses the history of signing and verifying an e-filed return, which now requires that the taxpayer have access to the prior year’s AGI or a special PIN.  While most software will allow for those numbers to carry over from last year’s returns, at times taxpayers may not know last year’s AGI or the PIN (e.g., when there is a switch in software) and ETAAC tells us that this has triggered many taxpayers abandoning e-filing and reverting to paper filing.

The report discusses how the IRS Get Transcript online tool ostensibly could facilitate taxpayers getting access to their last year’s AGI but that access has a clunky authentication process that has led to a very high fail rate for users (the Report also discusses the compromising of a prior iteration of the Get Transcript online tool and other data breaches).

As IRS works out the kinks with its “Future State” platform, authentication and ease of taxpayer access will be crucial. Of course, given the backdrop of dedicated and as the report notes nimble and dedicated criminals who continue to probe for weaknesses this will continue to be a challenge for IRS and its partners.