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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Conclusion

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

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

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

Review of 2019 (Part 2)

In the last two weeks of 2019 we are running material which we have primarily covered during the year but which discusses the important developments during this year.  As we reflect on what has transpired during the year, let’s also think about how we can improve the tax procedure process going forward.

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2017 Tax Legislation

The Tax Cuts and Jobs Act (TCJA) has already had significant effects on taxpayers in the first two years since its enactment. The law almost doubles the standard deduction for taxpayers, while mostly eliminating personal exemptions and limiting or eliminating certain personal deductions. Of particular relevance in the LITC context, the Child Tax Credit (CTC) was doubled from $1,000 to $2,000 per qualifying child (though only $1,400 is refundable). While the elimination of the personal exemption for dependents largely makes this a wash for many taxpayers, low income taxpayers may actually be advantaged by the change, since the CTC is partially refundable, and exemptions are of less benefit to those with low marginal rates. Finally, beginning in 2019, the TCJA eliminates the shared responsibility penalty assessed on taxpayers who fail to enroll in qualified health insurance plans under the Affordable Care Act.

The TCJA has also led to another potentially unintended consequence for some taxpayers seeking ITINs for their dependents. Since the dependency exemption is now worth $0 and because (almost) all tax benefits attributed to an ITIN dependent requires that they physically live in the United States (see e.g. IRC 24(h)(4)(B)), the IRS is now reluctant to issue ITINs to dependents outside of the US unless a specific tax benefit is demonstrated. (See W7 Instructions, “What’s New”). This causes serious problems for taxpayers that live in “non-conforming” states (like Minnesota) where a dependency exemption is still worth something on the state return, but their dependent lived in Mexico the whole year. These taxpayers can’t get an ITIN for the dependent because there is arguably no federal tax reason, and they can’t put their dependent on the state return because they don’t have a federally issued ITIN. The University of Minnesota LITC has dealt with this issue and had some success by working with a VITA site that issues ITINs. In at least one instance, the clinic was able to get an ITIN issued based on an issued position letter that argued that there was a federal benefit to an ITIN.

Leslie Book, Suggestions to Get Up to Speed on (Some) Issues With the New Tax Law, Procedurally Taxing (Dec. 17, 2017), https://procedurallytaxing.com/suggestions-to-get-up-to-speed-on-some-issues-with-the-new-tax-law/

Third party contacts

Until the TFA was enacted, a 9th Circuit case, J.B. v. United States, represented anew obstacle for IRS making contact with third-parties during an audit. During the course of the audit of the petitioner and his wife, the IRS issued a summons to a third-party (incidentally, the California Supreme Court), seeking information on compensation issued to the petitioner. The petitioner then moved to quash the summons, on the basis that the IRS failed to give reasonable advance notice of the third-party contact (in accordance with IRC § 7602(c)(1)) when it sent Publication 1, a pamphlet included with the initial notice of audit. Publication 1 is a generic publication that broadly gives advance notice of the possibility that the IRS will make contact with a third party.

The 9th Circuit held that the publication was insufficient as not reasonably calculated to inform the taxpayer of the contact. The court based its decision on a number of factors, including the two-year length between the issuing of Publication 1 and the contact, the possibility of privileged information being included in the summons, and the extensive contact between the taxpayers and IRS. Perhaps most relevantly, the court suggested in a footnote that Publication 1 alone may never be sufficient to provide reasonable notice due to its broad language and lack of certainty regarding the chance of contact.  But see, High Desert Relief, Inc. v. United States, 917 F.3d 1170, 1193 (10th Cir. 2019) (assuming, without deciding after J.B., that Publication 1, in substance, did provide sufficient notice under section 7602(c)(1)). 

Following a 2017 National Taxpayer Advocate report discussion of TPCs, Section 1206 of the Taxpayer First Act (TFA) amended IRC § 7602(c) by repealing the requirement for the IRS to provide “reasonable notice,” making J.B. less relevant.  It clarified that the IRS may provide this third-party contact (TPC) notice only if it intends to make a TPC during the period specified in the notice, which may not exceed one year.  Generally, the IRS must send the notice at least 45 days before making the TPC.  TAS has been advocating that an IDR be included with the TPC notice so that the taxpayer has a realistic opportunity to avoid a TPC that seeks new information by providing the information requested.

See Leslie Book, Ninth Circuit Rejects IRS’s Approach to Notifying Taxpayers of Third Party Contacts, Procedurally Taxing (Mar. 4, 2019), https://procedurallytaxing.com/ninth-circuit-rejects-irss-approach-to-notifying-taxpayers-of-third-party-contacts/

EITC

Special Report to Congress

Before leaving her post as National Taxpayer Advocate, Nina Olson issued a Special Report on the Earned Income Tax Credit as part of her annual report to Congress. The report makes a number of recommendations to improve administration of the EITC, notably including that the IRS develop an examination process for EITC bans and that Congress legislate whether the Tax Court has jurisdiction over EITC ban cases. Under the current situation, taxpayers are left with little recourse or due process opportunity when the IRS imposes such a ban.

See Bob Probasco, The EITC Ban – Further Thoughts, Part One, Procedurally Taxing (Sep. 27, 2019), https://procedurallytaxing.com/the-eitc-ban-further-thoughts-part-one/

Leslie Book, EITC Ban: NTA Report Recommends Changes and IRS Advises on its Application to Partial Disallowances, Procedurally Taxing (Aug. 8, 2019), https://procedurallytaxing.com/eitc-ban-nta-report-recommends-changes-and-irs-advises-on-its-application-to-partial-disallowances/

Earned Income for EITC but not for Income Taxes

Feigh v. Commissioner involved a novel issue of law: the interplay between the exclusion of Medicaid Waiver Payments from income (a change made via notice in 2014) and the EITC. The petitioners in Feigh would have been able to exclude these received payments from their income, but it actually would have made them worse off by removing the “earned income” necessary for them to qualify for the EITC and Child Tax Credit (“CTC”). The IRS rationale was that it was preventing the provision of a double tax benefit not intended by Congress. The Tax Court applied Skidmore deference to the IRS notice changing the waiver treatment and found that the notice was not persuasive that payments were excludible under IRC 131. The court then held that the IRS could not reclassify the status of the payments via notice as a means to eliminate the benefits of the EITC and CTC.

See Caleb Smith, Invalidating an IRS Notice: Lessons and What’s to Come from Feigh v. C.I.R., Procedurally Taxing (June 17, 2019), https://procedurallytaxing.com/invalidating-an-irs-notice-lessons-and-whats-to-come-from-feigh-v-c-i-r/

Innocent Spouse

Jurisdiction of District Court to hear refund

The question of whether taxpayers can bring an innocent spouse claim as part of a refund suit is an increasingly litigated issue. Under the long-time rule of Flora v. United States, taxpayers must pay their assessment first in order to bring a refund claim in federal district court. But whether such taxpayers could litigate the merits of their innocent spouse claims in such an action has been unclear. In 2018, a Texas district rejected the argument that an innocent spouse claim could proceed in a refund suit in Chandler v. United States. But in the more recent case of Hockin v. United States, an Oregon district court allowed a refund suit involving such a claim to proceed. Hockin is set for trial in early 2020 and may prove an interesting test case for this issue.  Ms. Hockin was represented by the tax clinic at Lewis & Clark and the tax clinic at the Legal Services Center of Harvard Law School filed an amicus brief in this case on behalf of Ms. Hockin.

See Sarah Lora & Kevin Fann, Innocent Spouse Survives Motion to Dismiss in Jurisdictional Fight with the IRS, Procedurally Taxing (Sep. 18, 2019), https://procedurallytaxing.com/innocent-spouse-survives-motion-to-dismiss-in-jurisdictional-fight-with-the-irs/

Carlton Smith, Another District Court Holds It Lacks Jurisdiction to Consider Innocent Spouse Refund Suits – at Least for Section 6015(f) Underpayment Cases, Procedurally Taxing (May 3, 2019), https://procedurallytaxing.com/another-district-court-holds-it-lacks-jurisdiction-to-consider-innocent-spouse-refund-suits-at-least-for-section-6015f-underpayment-cases/

Carlton Smith, Update: Can District Courts Hear Innocent Spouse Refund Suits?, Procedurally Taxing (Dec. 24, 2018), https://procedurallytaxing.com/update-can-district-courts-hear-innocent-spouse-refund-suits/

Innocent Spouse and Rev Proc.

Under Rev. Proc. 2013-34, actual knowledge of a spouse’s omission of income does not preclude equitable innocent spouse relief under IRC 6015(f). A recent case litigated by the tax clinic at the Legal Services Center of Harvard Law School has sought to reinforce the availability of equitable relief to such taxpayers. In Jacobsen v. Commissioner in the 7th Circuit, the petitioner has challenged the Tax Court’s denial of his appeal of an innocent spouse determination. The petitioner had four positive factors for relief under the statute, but the Tax Court found that his actual knowledge of embezzled income outweighed those factors thus not entitling him to relief. Oral argument was held in September 2019, and the case is currently pending.  Since the oral argument in Jacobsen two additional Tax Court cases have ruled against individuals claiming innocent spouse status where there was three positive factors and knowledge was the sole negative factor.  The Tax Court seems to be placing a heavy thumb on the scale when knowledge exists.

See Carlton Smith, Seventh Circuit to Hear First Case about Applying Latest Innocent Spouse Equitable Rev. Proc., Procedurally Taxing (July 30, 2019), https://procedurallytaxing.com/seventh-circuit-to-hear-first-case-about-applying-latest-innocent-spouse-equitable-rev-proc/

Cracks in the Flora Rule? Definition of a “Tax” and the New World of Refundable Credits

This year, the Notre Dame Tax Clinic litigated a case in the U.S. District Court for the Northern District of Indiana, which sought a refund of taxes claimed on our clients’ amended tax return. Alexander Ingoglia, a 3L at the Notre Dame Law School and a student in the Clinic, worked on this case last spring, and composed our response to the government’s motion to dismiss for lack of jurisdiction. Alex describes the case and the cracks it might show in the Flora rule.  – Patrick  

In 1960, the United States Supreme Court decided United States v. Flora and established the full-payment rule.  The rule requires plaintiffs to pay their entire tax deficiency before obtaining jurisdiction to sue the government for a tax refund in federal district court or the Court of Federal Claims.  However, we encountered a case in the Notre Dame Tax Clinic this year that presented facts that challenged the Flora rule.  While the case came to an end before the court considered its jurisdiction with respect to the facts, several unique facts established a credible distinction from Flora’s full-payment rule.  As a student attorney in the clinic, I had the opportunity to research Flora’s progeny and the statutory meaning behind the underlying jurisdictional hurdle while representing our client.

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Factual and Legal Background

Our clients, Mr. and Mrs. Burns, originally filed a timely 2014 tax return, which properly claimed their two grandchildren as dependents.  The Burns’ tax return preparer, however, failed to claim the Burns’ deserved Child Tax Credit (“CTC”) and Earned Income Tax Credit (“EITC”) with respect to the grandchildren.  Pursuant to the Burns’ 2014 tax return, the couple received a $617 tax refund.

When the Burns switched tax preparers, their new preparer realized the mistake and filed an amended return on their behalf in April 2016.  At the time the Burns filed their amended return, they owed no taxes to the IRS.  The Burns reported a $1,889 decrease in adjusted gross income and claimed the EITC and CTC in the amounts of $5,430 and $1,588, respectively.  The Burns’ new tax preparer also noticed a $70 understatement in the Burns’ self-employment tax and reported the increase on the amended return.  In total, the Burns sought to receive a $6,948 refund after combining the additional credits with the increased self-employment tax assessment.

The IRS received the return, but rather than sending the Burns their nearly $7,000 refund, the IRS only assessed the additional $70 self-employment tax.  The IRS sent nothing denying the credits or even a request for additional information to substantiate the claimed credits. The Burns never received a right to challenge the denial of credits administratively or otherwise.

The Notre Dame Tax Clinic filed a complaint in district court on the Burns’ behalf.  The complaint stated that the Burns timely claimed a refund in their 2014 tax return, but that they never received any indication that their claims were insufficient or denied.  Instead, the claimed credits were selectively ignored while the IRS recognized the increased self-employment tax in the same 1040X.  The complaint sought relief in the form of the Burns’ $6,948 refund.

In response, the Department of Justice (“DOJ”) filed a Motion to Dismiss for lack of jurisdiction.  The DOJ asserted that the district court lacked jurisdiction to hear the case, pursuant to 28 U.S.C. § 1346(a)(1), which states that the district courts have original jurisdiction over civil actions “for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected . . . .”  This section serves as a limited waiver of sovereign immunity, allowing plaintiffs to sue the government in federal court. 

Although the section allows plaintiffs to sue the government to obtain their allegedly deserved refunds, the Supreme Court interpreted the limited waiver to include a “pay first and litigate later” requirement.  Flora v. United States, 362 U.S. 145 (1960).  Without a plaintiff fulfilling the “pay first and litigate later” requirement, the district court lacks jurisdiction to hear the case.  The Seventh Circuit reiterated the full payment rule, holding that “[f]ull payment is a jurisdictional prerequisite imposed by Congress.”  Univ. of Chicago v. United States, 547 F.3d 773, 785 (7th Cir. 2008) (citing Flora, 362 U.S. 64–65, 75, 78).  This interpretation of 28 U.S.C. § 1346(a)(1) prevents taxpayers from paying only a small portion of their tax bill to obtain district court jurisdiction. 

Of course, § 1346(a)(1) only dictates jurisdiction in the District Courts and the Court of Federal Claims.  Taxpayers retain the ability to bring cases in tax court without full payment (or any payment) of an alleged tax liability.  However, to sue for a refund in district court, Supreme Court and lower courts’ precedent has long held that a plaintiff must fully pay their tax bill before utilizing the limited waiver of sovereign immunity in § 1346(a)(1). What “fully pay” means, though, is not always clear.

In Flora, the case that established the full payment rule, the facts were simple.  The petitioner claimed ordinary losses.  The Commissioner treated the reported losses as capital, resulting in a $28,908.60 deficiency.  The petitioner paid $5,058.54 of the alleged deficiency and filed a refund claim for that amount with the IRS.  Once denied, the petitioner sued in district court for a refund of the $5,058.54 and a judgment abating the remainder of the assessment.  Recognizing a circuit split and a need for uniform treatment of similar district court suits, the Supreme Court agreed to hear the case.  In the interest of saving “the harmony of our carefully structured . . . system of tax litigation,” the Court ruled that in order to obtain jurisdiction, a tax liability must be fully paid before commencing a refund suit in district court.  The petitioner lost because he had paid only the $5,058.54 portion of the $28,908.60 deficiency.

Flora, at its core, is a decision about statutory interpretation.  Faced with ambiguous language, the Court resorted to legislative history to determine the meaning of “any internal-revenue tax.” 28 U.S.C. § 1346(a)(1).  That history, the Court determined, made it more likely that Congress intended the language to mean that the entirety of a tax must be paid for jurisdiction to arise.  In Flora’s case, this meant paying the entire deficiency assessment relevant to the dispute at hand.

The Burns’ case presented complicated facts.  At the time the Burns filed their 1040X, they owed nothing to the IRS.  In fact, they already collected a refund when originally filing the return.  While the Burns reported a $70 self-employment tax on their amended return, the nearly $7,000 in credits drowned the small self-assessment.  The IRS failed to deny the claimed credits or request additional documentation.  Instead, the IRS ignored the credits, assessed the $70 self-employment tax, and hid behind Flora to attempt to dismiss the refund suit, despite failing to deny or request additional information pertaining to the credits that swallowed the assessment.

The Clinic filed a response to the DOJ’s Motion to Dismiss.  The response differentiated the Burns’ case from Flora and its subsequent progeny on two bases: first, the Burns solely disputed the denial of rightfully claimed credits of the “tax” imposed under IRC § 1.  They did not dispute the unpaid self-employment tax assessment under § 1401.  Second, the Burns had already fully paid the $70 self-employment tax with their $7,000 of deemed refundable credits.

The First Distinction: The Owed Tax and the Refundable Tax are Different “Taxes” under § 1346(a)(1)

Our response argued that the statute’s use of the words “any internal-revenue tax” allows a petitioner to file a refund suit for one type of “internal-revenue tax,” while owing another type of “internal-revenue tax.”  Our argument pointed to several different types of internal-revenue taxes throughout Title 26 of the United States Code, such as §§ 1 (individual income tax), 11 (corporate income tax), 59A (base erosion and anti-abuse tax), etc. Similarly, Flora and the language of § 1346(a)(1) does not bar tax refund suits for a given year where a taxpayer has fully paid one tax period, but owes the government on another tax period.  By the same logic, the statutory language should not bar a petitioner from refund suits where the taxpayer has fully paid one “internal-revenue tax,” but not a separate, undisputed tax. 

Looking first to the text of 28 U.S.C. § 1346(a)(1), we argued that “[t]he term ‘any’ should be given [a] broad construction under the settled rule that a statute must, if possible, be construed in such fashion that every word has some operative effect.” Jove Eng’g, Inc. v. I.R.S., 92 F.3d 1539, 1554 (11th Cir. 1996) (citing United States v. Nordic Village, 503 U.S. 30, 36 (1992) (internal citations omitted)).  Assuming a broad construction of the term “any,” we contended that the contested credits were analytically distinct from the uncontested self-employment taxes.  The two taxes come from different chapters in Title 26 of the United States Code (“IRC”), with separate analyses and calculations.  The CTC and EITC fall under Chapter 1, whereas the self-employment tax falls under Chapter 2.

Flora, on the other hand, completely concerned an IRC § 1 tax.  Flora and its progeny do not contemplate jurisdiction when the petitioner challenges an entirely separate tax than the one creating the alleged deficiency.  Further, the tax creating the alleged deficiency would be eliminated if the Burns succeeded in their case and received their refundable CTC and EITC.  In Flora, the petitioner only paid a portion of his § 1 taxes, then sought a refund for those § 1 taxes paid, with a large § 1 tax deficiency outstanding.  The Burns paid the entirety of the § 1 tax disputed in the lawsuit, which was statutorily distinct from the unpaid, undisputed § 1401 (self-employment) taxes.

We focused primarily on two cases to deliver this point.  The first, Moe v. United States, No. CS-96-0672-WFN, 1997 WL 669955 (E.D. Wash. June 30, 1997), directly took on this distinction, stating that requiring payment of both § 1 and § 1401 taxes “places form over substance,” when the taxes pertinent to the disputed issue were paid.  In Moe, the taxpayer sought a refund with respect to his § 1401 (self-employment) taxes, while he owed taxes under § 1.  While the court granted the defendant’s motion to dismiss on other grounds, it clearly found the plaintiff’s argument persuasive, stating “[p]laintiff[s] should arguably not be required to prepay the uncontested income tax portion of her 1991 tax deficiency in order to litigate the contested 1991 self-employment tax.”  We also relied on Shore v. United States, 9 F.3d 1524 (Fed. Cir. 1993), which allowed the Court of Federal Claims to hear a refund suit even though interest on the underlying tax had not been paid.  The Shore court reasoned that because the interest was not itself disputed in the refund claim or in court, it need not be fully paid prior to filing suit.

The Burns never owed tax under § 1 for 2014.  They claimed refundable credits, causing an overpayment, which they claimed as a refund.  They were never audited or received a deficiency assessment.  Indeed, they never became subject to a tax assessment until the Government ignored their claimed refundable credits in the amended return.  While the Burns owed a tax under § 1401, this was a separate “internal-revenue tax,” which the Burns did not dispute in court.  We argued that, following the statutory interpretation in cases such as Moe and Shore, the Burns passed the statutory hurdles to jurisdiction.

Second Distinction: The Refundable Credits Claimed on the Amended Return Exceed the Tax Reported on the Return

The gist of this distinction is simple: there is no deficiency that needs to be fully paid because the credits claimed outweigh the increased self-employment assessment.  Flora preceded refundable credits in general, let alone the specific CTC and EITC at issue in the Burns’ case.  Thus, Flora could not contemplate the facts in the Burns case.  However, such refundable credits should, reasonably construed, constitute payments of tax that can, in circumstances such as in this case, provide jurisdiction for a District Court to adjudicate a substantive dispute as to the taxpayer’s entitlement to those credits.

In our response, we analogized the refundable EITC and CTC to withholding credits.  By example, we described a situation where a taxpayer neglects to include a W-2 in their tax return, notices it, then attempts to file an amended return to correct the error. If the W-2 produced additional tax of $150, but reported withholdings of $200, the Government surely could not assess the $150 tax, ignore the $200 withholding, and seek dismissal of a refund suit because the taxpayer failed to fully pay the associated tax assessment.  In that example, the government already has $50 owed to the folks amending their return.  Similarly, the government already owed nearly $7,000 to the Burns.  How could the government seek dismissal based on a $70 self-employment assessment when the government owes that same taxpayer nearly $7,000 for the same tax period?  We argued that the withholding credits and the credits in our case were analogous, and thus considering these claimed refundable credits, the tax was fully paid.

Conclusion

After the court received our response, the DOJ contacted us to offer a compromise.  The DOJ proposed a stay in the case while the IRS investigated the authenticity of the claimed credits.  The Burns agreed, and the IRS ultimately agreed that the Burns qualified for the claimed CTC and EITC.  The IRS’s issuance of the refund marked the end of the Burns’ district court case, leaving the unique distinctions in the case unaddressed.  The Burns case demonstrates the ambiguity that remains nearly 60 years after the Supreme Court interpreted 28 U.S.C. § 1346(a)(1) to require full payment in order to establish district court jurisdiction with respect to tax refund claims.

The EITC Ban – Further Thoughts, Part Three

Guest blogger Bob Probasco returns with the third and final post on the ban for recklessly or fraudulently claiming refundable credits. Part Three tackles the ban process.

The first two parts of this series (here and here) addressed judicial review of the EITC ban. The National Taxpayer Advocate’s Special Report on the EITC also made several recommendations about improvements during the Exam stage. The report is very persuasive (go read it if you haven’t already). In Part One, I quoted Nina’s preface to the report, which says that she is “hopeful that it will lead to a serious conversation about how to advance the twin goals of increasing the participation rate of eligible taxpayers and reducing overclaims by ineligible taxpayers.” Part Three is my small contribution to the conversation, concerning the ban determination process.

About that “disregard of rules and regulations” standard

The ban provision refers to a final determination that the taxpayer’s claim of credit was due to “reckless or intentional disregard of rules and regulations.” This standard seems to have been imported from section 6662, although there it covers not only reckless or intentional disregard but also negligent disregard. It seems a strange standard in this context, though.

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The accuracy-related penalty regulations, § 1.6662-3(b)(1), state that disregard of rules and regulations is not negligent, let alone reckless or intentional, if there is a reasonable basis for the return position. But the definition of reasonable basis, § 1.6662-3(b)(3), cross-references the types of authority, § 1.6662-4(d)(3)(iii), applicable to determining whether there was substantial authority for a return position. And those are legal authorities. Arguably, the “disregard of rules and regulations” standard – for the EITC ban as well as the accuracy-related penalty – carries with it an unexamined implication that the facts are known and indisputable; only the application of the law to those facts is at issue.

Such a standard may make a lot of sense with respect to the accuracy-related penalty, at least for sophisticated taxpayers with good records. Those of us who deal a lot with low-income taxpayers and the EITC, however, know that often the credit is disallowed because the taxpayer’s proof is not considered sufficient. It’s a factual dispute, rather than a dispute as to what the law means.

Osteen v. Commissioner, 62 F.3d 356 (11th Cir. 1995) has some interesting discussion of this distinction in the context of the substantial understatement penalty. The very first sentence of the case mentions “certain tax deductions attributable to their farming and horse breeding operations,” so we know that section 183 is going to be the focus. The taxpayers, both of whom were employed full-time, were breeding and raising Percheron horses with the expressed intent to train them, show them, use them to operate a horse-powered farm, and then sell them. The Tax Court opinion, 66 T.C.M. 1237 (1993), determined that the taxpayers did not have “an actual and honest objective of making a profit,” and the Eleventh Circuit concluded that the court’s determination was not clearly erroneous.

The penalty discussion took much longer than the analysis of the profit objective issue. The Tax Court had rejected the petitioners’ penalty defense, which was based on substantial authority, and that puzzled the Eleventh Circuit:

The application of a substantial authority test is confusing in a case of this kind. If the horse breeding enterprise was carried on for profit, all of the deductions claimed by the Osteens would be allowed. There is no authority to the contrary. If the enterprise was not for profit, none of the deductions would be allowed. There is no authority to the contrary. Nobody argues, however, not even the Government, that because the taxpayers lose on the factual issue, they also must lose on what would seem to be a legal issue.

The court reversed on the penalty issue and said that “substantial authority” for a factual issue is met if a decision in the taxpayers’ favor would not have been clearly erroneous:

If the Tax Court was deciding that there was no substantial authority because of the weakness of the taxpayers’ evidence to establish a profit motive, we reverse because a review of the record reveals there was evidence both ways. In our judgment, under the clearly erroneous standard of review, the Tax Court would be due to be affirmed even if it had decided this case for the taxpayers. With that state of the record, there is substantial authority from a factual standpoint for the taxpayer’s position. Only if there was a record upon which the Government could obtain a reversal under the clearly erroneous standard could it be argued that from an evidentiary standpoint, there was not substantial authority for the taxpayer’s position.
 
If the Tax Court was deciding there was not substantial legal authority for the deductions, we reverse because of the plethora of cases in which the Tax Court has found a profit motive in the horse breeding activities of taxpayers that were similar to those at hand.

For those interested in the “factual issue versus legal authority” question, there was also an interesting article by Bryan Skarlatos in the June-July 2012 issue of the Journal of Tax Practice & Procedure: “The Problem With the Substantial Authority Standard as Applied to Factual Issues.”

This is not directly applicable to the EITC ban but a similar approach seems reasonable. A determination in Exam to disallow the EITC often merely means “the taxpayer didn’t prove that she met the requirements,” rather than “the taxpayer didn’t meet the requirements.” But I suspect that some or many of those who make the ban determination proceed with an assumption, implicit if not explicit, that the former is the equivalent of the latter. If the taxpayer doesn’t meet her burden of proof, that may suffice for denying the credit in the conduct year but may not be enough to impose the ban for future years.

For example, one of the three scenarios in IRM 4.19.14.7.1 (7), used as a starting point to help determine whether the ban is appropriate, addresses situations in which the taxpayer provided insufficient documentation but “indicates they clearly feel they are eligible, and is attempting to prove eligibility and it is clear they do not understand.” In those circumstances, the technician is supposed to “[c]onsider the taxpayer’s lack of understanding” before asserting the ban. There is no reference to the relative strength or weakness of the support offered. That formulation strongly supports an assumption by the technician that (understanding the rules + insufficient documentation), rather than (understanding the rules + not meeting the requirements), is sufficient to assert the ban. If so, that’s a problem.

Recommendations for a revised ban recommendation process

The Office of Chief Counsel issued Significant Service Center Advice in 2002 (SCA 200245051), concluding that neither the taxpayer’s failure to respond to the audit nor a response that fails to provide adequate substantiation is enough by itself to be considered reckless or intentional disregard of rules and regulations. That conclusion is also set forth in IRM 4.19.14.7.1 (1): “A variety of facts must be considered by the CET [correspondence examination technician] in determining whether the 2-Year Ban should be imposed. A taxpayer’s failure to respond adequately or not respond at all does not in itself indicate that the taxpayer recklessly or intentionally disregarded the rules and regulations.”

But, as the Special Report points out, the guidance in IRM 4.19.14.7.1 (7) is erroneous and/or woefully inadequate for the CET’s. And research described in the National Taxpayer Advocate’s 2013 Annual Report to Congress showed an incredibly high error rate in the ban determination. The Special Report recommends that the IRS develop a ban examination process independent from the audit process, modeled on other means-tested programs, to improve accuracy and provide adequate due process protections. The report also mentions several recommendations from earlier annual reports. For example, in the 2014 Annual Report to Congress, the NTA recommended (again) that a single IRS employee be assigned to work any EITC audit in which the taxpayer calls or writes to respond.

The Special Report didn’t, and couldn’t, define the appropriate process in depth. That is something that the IRS, in consultation with TAS, will have to develop, and it may take a significant amount of time. But while we’re waiting for that, here are suggestions for some specific parts of a revised process that would be on my wish list.

First, the ban determination process should incorporate the concept of the strength of evidence for and against eligibility. The ban should be asserted only when the evidence against eligibility is significantly stronger than evidence for eligibility. The inability to provide evidence for eligibility is not equivalent to deemed evidence against eligibility. And some types of evidence against eligibility will be stronger or weaker than other types.

Second, the process for determining eligibility for the credit should expand the types of evidence that can be submitted and considered, which in turn will affect the relative strength of evidence to be considered during the ban determination phase. The standard audit request and the IRM 4.19.14-1 list focus on third-party documents. Third-party documents are strong evidence but they’re not the only evidence; they’re just the only evidence Exam seems to accept. The IRS experimented with allowing third-party affidavits in test cases from 2010-2013. Starting with tax year 2018, taxpayers can submit third-party affidavits (signed by both the taxpayer and the third party) to verify the residency of qualifying children (IRM 4.19.14.8.3). Why not for other aspects of the eligibility determination? Why not talk directly with the taxpayer and assess credibility?

This is a pet peeve of mine. It’s frustrating to receive a notice of deficiency (because the technician did not accept other types of evidence) and then get a full concession by the government in Tax Court (because the IRS attorney understands the validity of testimony as evidence). I like getting the right result but would prefer to avoid the need to go to Tax Court, delaying the resolution. As the Special Report points out, the IRS cannot properly determine whether to assert the ban without talking to the taxpayer. If a technician/examiner is talking to the taxpayer for that, and assessing their understanding of the rules and regulations, why not also accept verbal testimony (or statements by neighbors and relatives) and evaluate credibility, to accurately evaluate the strength of the evidence for eligibility and therefore the propriety of imposing the ban?

Conclusion

The Special Report would, if its recommendations were implemented, transform a critically important benefit to low-income taxpayers. Nina, Les, and the rest of the team did a fantastic job. It will be a long, hard fight to achieve that transformation but it will be worth it.

The EITC Ban – Further Thoughts, Part Two

Guest blogger Bob Probasco returns with the second of a three-part post on the ban for recklessly or fraudulently claiming refundable credits. In today’s post Bob looks at legislative solutions to the issue of Tax Court jurisdiction.

My last post summarized previous arguments by Les and Carl Smith that the Tax Court lacks jurisdiction to review the proposed imposition of the EITC ban and then examined what the Tax Court is actually doing.  Some cases have ruled on the ban, but some cases have expressed uneasiness about this area and have declined to rule at all.  Congress has clearly stated its intent that judicial review would be available, but it’s appropriate to clarify that by an explicit grant of jurisdiction – preferably in a deficiency proceeding for the year in which the alleged conduct – the taxpayer intentionally or recklessly disregarded rules and regulations – occurred.  The National Taxpayer Advocate’s Special Report on the EITC recommended that Congress provide an explicit grant of jurisdiction to the Tax Court to review the ban determination.  This post offers suggestions – some sparked by Tax Court decisions and/or previous posts here on PT – about exactly how that should be implemented.  The point at which recommendations turn into legislation is a danger zone where flawed solutions can create problems that take years to fix.

Grant Tax Court jurisdiction in a deficiency proceeding for the “conduct year,” not the “ban years”

Les explained the benefits of this approach in his “Problematic Penalty” blog post.  Ballard saw the “attractiveness,” as do I.  It’s even more attractive today.  Although challenging the ban in a proceeding with respect to the conduct year is a better solution, back in 2014 taxpayers at least would have the opportunity to challenge the ban in a proceeding with respect to the ban year. (The “conduct year” is the year for which the taxpayer recklessly or intentionally disregarded rules or regulations to improperly claim the EITC and the “ban year” is a subsequent year for which the taxpayer cannot claim the EITC.)  As Les pointed out, and the Office of Chief Counsel explained in 2002 guidance (SCA 200228021), summary assessment procedures were available for post-ban years (for failure to re-certify) but the IRS would have to issue a notice of deficiency to disallow EITC in a ban year.  But since then, summary assessment authority for the ban years was added by the PATH Act of 2015, in section 6213(g)(2)(K), and the IRS is using it.  There is still an opportunity for judicial review after a summary assessment, but that opportunity has a lot of problems, as described in the Special Report.

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The Special Report, Part IV, also recommends changes in summary assessment authority, under which some adjustments are not subject to the deficiency procedures, for an initial determination in the conduct year that the taxpayer is not entitled to the EITC.  Although I’m not entirely sure, I think the report is not recommending any change to the summary assessment authority under section 6213(g)(2)(K) for automatic disallowances in the ban year.  That’s understandable, as normally the correct application of the ban will be straight-forward and not require a separate examination in the ban year.  But there may some instances where the ban shouldn’t be applied automatically.  I’ll return to that below in the discussion of the application of the determination in the ban year.

Require that the proposed ban be set forth in a notice of deficiency for the conduct year

Of course, judicial review will be difficult if not impossible unless imposition of the ban is explicitly asserted and at issue in a case for the conduct year.  In all seven of the Tax Court cases discussed in my last post, the ban was explicitly asserted in an amended answer (Taylor) or the NOD itself (the other cases).  But that doesn’t always happen.

Carl Smith mentioned, in comments to the “Ballard” blog post, seeing a lot of cases where the ban was imposed by letter (presumably Notice CP79) rather than NOD.  I’ll quote his final sentence:

I wonder why some 32(k) sanctions are imposed by a simple letter and others (though apparently very few) are imposed in notices of deficiency.

My answer might be along the lines of: “Because the IRS thinks it can do that, unless Congress explicitly says otherwise, and it’s easier.”  My experiences with the EITC ban have made me more cynical.

My experience is consistent with Carl’s.  In just the past couple of years, my clinic has had four cases in which the IRS imposed the ban and issued Notice CP79.  Only one of the NOD’s explicitly stated the intent to impose the EITC ban.  In the other three cases, there was no indication whatsoever. 

In fact, in one case, there was an indication that an examiner had decided not to impose the ban.  After the NOD was issued, the taxpayer provided additional information and received a response from the IRS declining to change the proposed tax increase.  The letter included Form 886-A Explanation of Items that, again, did not propose the ban.  It also included a separate attachment, explaining why the additional information provided was insufficient.  That attachment stated at one point (emphasis added):

For future reference on the EITC BAN (Earned Income Tax Credit Ban) – The ban was considered.  If you continue to claim XXXXXXX for the credit and disallowed for no relationship, you could be subject to a 2-year earned income tax ban if you are found reckless and intentionally disregard the tax laws, rules and regulations.  You must meet the relationship test, residency test, age test and support test to be eligible for the credits.

That certainly sounds as though the determination required for the ban had not been made when the NOD was issued.  Nevertheless, when the taxpayer failed to file a petition timely, the IRS imposed the ban.

Given all the evidence that the IRS is asserting the ban without ever mentioning it in a notice of deficiency, the grant of jurisdiction to the Tax Court should be carefully crafted.  It should include not just jurisdiction to review the determination but also incorporate safeguards like those found in Section 6213(a) for tax assessments:

  • The determination required by section 32(k) is not a final determination until: (a) a notice of deficiency setting forth the determination has been properly mailed to the taxpayer; and (b) the expiration of the 90-day or 150-day period or, if a petition is filed in Tax Court, the decision of the Tax Court has become final.
  • Any disallowance of the credit in subsequent years based on the ban, before the determination is final, can be enjoined by a court proceeding, including in the Tax Court, despite the Anti-Injunction Act.

Applying the ban in the ban year

The cases I discussed in the last post suggested some specific issues that may need to be addressed when legislation is drafted to grant Tax Court jurisdiction to review the ban.  The first is obvious and fairly straight-forward.  Congress may need to modify section 7463(b) to specify that the determination in a small case with respect to the ban will be treated as binding for a proceeding in a future ban year.

How do we address the problem (discussed in Ballard and Griffin) that the court may not know yet whether the ban even had an effect in the ban years, because (for example) the taxpayer may not yet have filed returns claiming the credit for those years?  I don’t consider this concern an insurmountable obstacle.  Consider an analogy to the TEFRA partnership rules.  Under those rules, the court makes a redetermination of proposed adjustments on one return (the partnership’s).  The effect of that adjustment on other returns (the partners’) is authorized by provisions for computational adjustments.  The redetermination might turn out to have no effect on the partners’ returns, but the court doesn’t have to consider that in making its ruling in the partnership proceeding.

Currently, any credit claimed in the ban years can be disallowed automatically through the summary assessment authority in section 6213(g)(2)(K).  I don’t like that solution and think that instead Congress and/or the IRS should consider an approach similar to that in TEFRA: providing for some assessments without requiring a notice of deficiency in the ban year, but in other circumstances requiring a notice of deficiency because new fact determinations are needed.

Why might new fact determinations be needed?  Primarily because some exceptions or limitations should be carved out.  An all-or-nothing approach simply doesn’t make sense all the time.  What if:

A. The credit was reduced, but not disallowed, because some of the taxpayer’s earned income was disallowed.

B. The credit was claimed for 3 children and was only disallowed with respect to one.

C. The credit was disallowed because Husband’s earned income could not be verified.  Husband later married Wife, who has earned income and children from a previous marriage, and filed a joint return.  (See page 48 of the Special Report.)

Should we consider for future years, in situations like those: (A) allowing the credit but solely with respect to the taxpayer’s earned income from a Form W-2; (B) allowing the credit solely with respect to the children who qualified in the conduct year; or (C) allowing the credit but solely with respect to Wife’s earned income and qualifying children?

Lopez (situation A) suggested that there might be an exception for a partial disallowance:

It would appear that our findings will result in the reduction of petitioner’s claimed earned income tax credit for each year, but we expect that the credit will not be entirely disallowed for either year.  Consequently, we make no comment in this proceeding regarding the application of section 32(k).

A recent CCA (situation B) mentioned in Les’s blog post, however, concluded that partial disallowance was enough to trigger the ban.  The CCA’s reasoning was that section 32(k) doesn’t prohibit imposition of the ban for partial disallowances; thus, any disallowance is enough to trigger the ban.  “Disallowance” is not explicitly restricted to “total disallowance.”

Fair enough, but that doesn’t seem to be how Lopez interpreted the statute.  I don’t think it is entirely clear under current law.  Section 32(k) doesn’t refer to a disallowance (without explicitly specifying “total”) in the conduct year; it refers to the taxpayer’s “claim of credit” due to disregard of rules and regulations.  If the taxpayer could not legitimately claim any credit at all, that could meet the requirement (if done intentionally or recklessly).  In Lopez, was the “claim of credit” contrary to rules and regulations?  Or was the “claim of [at least some amount of] credit” consistent with rules and regulations but the amount excessive?  Lopez suggests the latter.  Does the answer depend on the reason for the excessive amount?  These questions deserve more thought.  The conclusion in the CCA may not be the best answer.

Another wrinkle came up in Griffin.  The court found the taxpayer was not entitled to EITC at all for 2013 because the taxpayer did not establish that any of the claimed dependents met the necessary tests.  However, the court found the taxpayer might be entitled to EITC for 2014, subject to applicable AGI limitations and thresholds after adjustments, because one of the two dependents claimed as qualifying children did meet all of the tests.  Should the ban be imposed if the taxpayer is not entitled to the EITC at all for one year but is entitled to at least some EITC in another year included in the same NOD, particularly if it’s the latest year included in the NOD?

Even if the CCA above is correct, current law is not immutable.  Congress should consider carving out exceptions or limitations to the ban.  If it doesn’t, we can try to change the law by persuading a court concerning the proper interpretation of the statute.  If the law changes, either through Congress or a court decision, we may want to use a more nuanced approach, like that in TEFRA, rather than blanket summary assessment authority.

Conclusion

This finishes my discussion of judicial review.  Establishing robust judicial review with all the flourishes will provide significant protection to low-income taxpayers who claim the EITC.

Some protection but, given current IRS practices, not enough.  Not all cases even go to Tax Court, so our primary goal should be to reduce the need for judicial review by improving the ban determination process in Exam.  The Special Report offered several suggestions along those lines.  I have some additional thoughts, coming up in Part Three of this series.

The EITC Ban – Further Thoughts, Part One

Guest blogger Bob Probasco returns with the first of a three-part post on the ban for recklessly or fraudulently claiming refundable credits. In today’s post Bob looks at how the Tax Court has addressed the ban. Part Two will suggest legislative solutions to the issue of Tax Court jurisdiction. Part Three tackles the ban process.

As Bob mentions, in the recent Special Report to Congress on the EITC that I helped write, we flagged the ban as an issue that potentially jeopardizes taxpayer rights. The Senate Appropriations Committee in a committee report accompanying the IRS funding for FY 2020 directs the IRS to “make the elimination of improper payments an utmost priority.” S. Rep. No. 116-111, at 26-27. At the recent Refundable Credits Summit at the IRS National Office that I attended IRS executives explored ways to reduce overpayments (in addition to increasing participation and improving administration more generally). The ban is part of the IRS toolkit. As Bob highlights today, there are fundamental questions concerning the path that taxpayers can employ to get independent review of an IRS determination. Les

One of Nina Olson’s last acts as National Taxpayer Advocate was the release of the Fiscal Year 2020 Objectives Report to Congress.  Volume 3 was a Special Report on the EITC; Les discussed it in a recent post.  If you are interested in issues affecting low-income taxpayers, you’ve probably already read it.  It’s definitely worth your time.  Kudos to Nina and to Les and the rest of the team that worked on the Special Report.  There are a lot of innovative, creative suggestions, backed up by thorough research, that would not just improve but transform how the IRS administers this program.

Nina’s preface to the report says that she is “hopeful that it will lead to a serious conversation about how to advance the twin goals of increasing the participation rate of eligible taxpayers and reducing overclaims by ineligible taxpayers.”  In that spirt, I’d like to offer my small contribution to the conversation, with additional thoughts about some of their suggestions.  The entire Special Report is important, but after a client’s recent “close encounter of the worst kind” with the EITC ban of section 32(k)(1), I have a particular interest in Part V.  This post will address the need for judicial review and what the Tax Court is actually doing.  Part Two will provide some further thoughts about how the Tax Court’s jurisdiction (when clarified by Congress) should be structured.  Part Three will address suggested changes to the ban determination process.

Does the Tax Court have jurisdiction to review the imposition of the ban?

Congress clearly envisioned the opportunity for pre-payment judicial review.  According to the legislative history for the Taxpayer Relief Act of 1997, “[t]he determination of fraud or of reckless or intentional disregard of rules or regulations are (sic) made in a deficiency proceeding (which provides for judicial review).”  H. Conf. Rpt. 105-220, at 545.  But there is no jurisdictional statute that clearly and unequivocally covers this, at least not until the ban is actually imposed in a future year.

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The question of Tax Court jurisdiction has been discussed here on Procedurally Taxing several times: 

I will follow Les’s terminology and refer to the year in which the taxpayer recklessly or intentionally disregarded rules and regulations by claiming the EITC as the “conduct year,” and to the subsequent years in which the taxpayer is not allowed to claim the credit because of the ban as the “ban years.”

Les and Carl Smith advanced arguments, in the “Problematic Penalty” and “Ballard” blog posts, that the Tax Court does not have jurisdiction to review an EITC ban in a deficiency proceeding for the conduct year.  The Tax Court has jurisdiction to redetermine the amount of a deficiency stated in a notice of deficiency as well as accuracy-related penalties applicable to the understatement, but explicitly does not have jurisdiction to determine any overpayment or underpayment for other years.  Although the EITC ban looks somewhat like a “penalty,” it does not fall within the scope of penalties that are treated like taxes, which are limited to Chapter 68.  Ruling on whether the ban was valid, in a deficiency proceeding for the conduct year, would therefore be a declaratory judgement for which the court has no jurisdiction.  The ban years will only be subject to the court’s deficiency jurisdiction if/when a notice of deficiency is issued with respect to them.

What has the Tax Court actually been doing?

I’m persuaded by Les’s and Carl’s arguments.  The Tax Court may not be, though.  It has addressed the issue of the ban in seven cases to date: Campbell v. Commissioner (2011 decision concerning 2007-2009 tax years), Garcia v. Commissioner (2013 decision concerning 2008 tax year), Baker v. Commissioner (2014 decision concerning 2011 tax year), Ballard v. Commissioner (2016 decision concerning 2013 tax year), Lopez v. Commissioner (2017 decision concerning 2012-2013 tax years), Griffin v. Commissioner (2017 decision concerning 2013-2014 tax years), and Taylor v. Commissioner (2018 decision concerning 2013 tax year).  All were either summary opinions, bench opinions, or orders granting a decision for the government when the taxpayer did not participate.

I’m not going to go into a lot of detail here concerning the cases.  The PT blog posts above have already discussed Campbell (in the blog comments only),Garcia, Baker, Ballard, and Taylor – only Lopez and Griffin appear to be new here.  (The Lopez case was actually discussed here, but that was with respect to an earlier order dealing with a different issue.)  But I do want to summarize how the Tax Court responded to the issue, with a couple of additional observations.

Campbell and Taylor imposed the ban, when the taxpayers did not respond to a Motion to Dismiss for Lack of Prosecution and a Motion for Default Judgment respectively, without any discussion of jurisdiction to do so.  In addition to the jurisdictional issue, it’s noteworthy that there was – or could have been – evidence supporting a determination of intentional or reckless disregard of regulations.  In Taylor, as previously noted in William Schmidt’s blog post, the court granted a motion to deem Respondent’s allegations, including those relevant to civil fraud and the ban, as admitted when the Petitioners did not respond to the amended answer.  (Because the ban was apparently not proposed in the notice of deficiency but was instead asserted in the notice of deficiency, the government would have the burden of proof.)  In Campbell, Respondent filed a motion to show cause why statements in a proposed stipulation of facts should not be deemed admitted.  The court granted the motion, Petitioners did not respond, and the court could have deemed those statements (which presumably would have covered the ban) as admitted.  Instead, the court simply granted the motion to dismiss for lack of prosecution.

These decisions to impose the ban demonstrate an interesting quirk.  The Office of Chief Counsel issued Significant Service Center Advice in 2002 (SCA 200245051), concluding that neither the taxpayer’s failure to respond to the audit nor a response that fails to provide adequate substantiation is enough by itself to be considered reckless or intentional disregard of rules and regulations.  That conclusion is also set forth in IRM 4.19.14.7.1 (1): “A variety of facts must be considered by the CET [correspondence examination technician] in determining whether the 2-Year Ban should be imposed. A taxpayer’s failure to respond adequately or not respond at all does not in itself indicate that the taxpayer recklessly or intentionally disregarded the rules and regulations.”  In these cases, and assuming the taxpayers were equally uncooperative during the audit, arguably the IRS should never have asserted the ban.  But that’s during the audit.  If the IRS does assert the ban, challenging that in Tax Court (if the taxpayer remains uncooperative) opens the door for deemed admissions supporting the ban.  It’s better to cooperate.

Garcia and Baker disallowed the EITC but concluded that claiming the credit was not due to a reckless or intentional disregard of rules and regulations and therefore that the taxpayers were not subject to the ban for following years.  Reliance on a paid return preparer was significant for both decisions.  Neither case discussed the court’s jurisdiction to rule on the validity of the proposed ban.

Ballard and Griffin declined to rule on the ban.  Both made the same argument: there was no information in the record as to whether returns had been filed, and whether the EITC had even been claimed, for the ban years.  Further, both pointed out that any ruling in an S-case is not precedential in any other case.  It was questionable whether a ruling in a proceeding with respect to the conduct year would have any effect at all in the ban years.  Ballard seemed to suggest that this factor was the most critical:

Respondent made that determination for the year in dispute here, but the determination obviously has no consequence to the deficiency determined in the notice – the consequences of the determination take effect in years other than the year before us.  Normally, in a deficiency case the Court is reluctant to make findings or rulings that have no tax consequences in the period or periods presently before us.  Nevertheless, we can see the attractiveness in making the determination in the same year that the earned income credit is disallowed albeit on other grounds and we have addressed the issue in other non-precedential opinions, see
Section 7463(b).
 
In this case not only does the application of section 32(k) have no tax consequence to Petitioner’s Federal income tax liability for the year before us, the record does not reveal whether a finding or ruling on the point would have any Federal tax consequence in either 2014 or 2015.

The court “is reluctant,” rather than “has no jurisdiction,” and even that is qualified as “normally.”  The court’s concern may have been jurisdiction but the language in the opinion suggests that the court might have been willing to rule if the record included appropriate information about the future years.  As far as I know, though, Campbell, Taylor, Garcia, and Baker also did not have such information in the record.

Ballard did, however, rule that the petitioner (who relied on a paid return preparer) was not liable for an accuracy-related penalty for negligence.  That strongly suggested that the ban should not apply; if the taxpayer was not negligent with respect to erroneously claiming the EITC, how would the IRS demonstrate the higher culpability of “reckless or intentional”?

Lopez also declined to rule on the ban, for a slightly different stated reason.  The IRS had disallowed the total gross receipts reported on Schedule C, eliminating the earned income required for claiming EITC.  The court allowed gross receipts in an amount less than the taxpayer had claimed.  With respect to the ban, it said:  “It would appear that our findings will result in the reduction of petitioner’s claimed earned income tax credit for each year, but we expect that the credit will not be entirely disallowed for either year.  Consequently, we make no comment in this proceeding regarding the application of section 32(k).”

Thus, in four cases the court ruled on the ban – two upholding it and two rejecting it – apparently without considering the jurisdictional issue.  Although Ballard, Griffin, and Lopez all declined to rule on the ban, none of them simply stated that the court had no jurisdiction with respect to the proposed ban.  Ballard and Griffin pointed out that a decision would not be precedential in an S-case.  The court, however, explained the primary justification not as lack of jurisdiction but what appears to be more like a concern about ripeness.  Lopez, on the other hand, did not mention that a summary opinion has no precedential effect for any other case.  Although far from clear, that decision sounds as though it assumed an implicit requirement for the ban – that it applies only when the credit was improperly claimed, not when it was properly claimed but in an excessive amount.  (I’ll return to that point in my next post.)

Despite the court (sometimes) being willing to rule on the issue, it would be better if the court’s jurisdiction to do so were firmly established.  The lack of explicit jurisdiction creates a serious problem.  What happens if the IRS asserts the ban in a notice of deficiency, the court disallows at least a portion of the EITC, but the court does not rule on the ban?  I suspect that the IRS will impose the ban in the future years.  It would be interesting to know what happened to Mr. Ballard, after the strong hint in the bench opinion. 

The taxpayer could still contest the validity of the ban in a deficiency proceeding for a ban year; that clearly would come within the scope of section 6214.  But the “Problematic Penalty” blog post pointed out pragmatic problems with that solution, which lead Les to conclude that it wouldn’t make sense from a policy perspective.  Since that blog post, an additional problem has arisen, making that solution even worse.  Summary assessment authority for the ban years was added by the PATH Act of 2015, in section 6213(g)(2)(K), and the IRS is using it.  Although the taxpayer still has an opportunity for judicial review after a summary assessment, the opportunity is less obvious than with a notice of deficiency and may be missed by unrepresented taxpayers.  It also comes with a shorter time to respond.

Thus, we are left with two alternatives for Tax Court review of the assertion of the ban.  Doing so in a deficiency proceeding for the conduct year is by far the best alternative and is consistent with Congress granting summary assessment authority for the ban years.  I suspect that is what Congress had in mind, but if so, it forgot to clearly grant jurisdiction.  Reviewing the assertion of the ban in a deficiency proceeding for a ban year has the advantage of fitting within the Tax Court’s existing jurisdiction but is a horrible solution for a number of reasons. 

Even if the court were willing to rely on the legislative history as implicit jurisdiction to address the ban in a deficiency proceeding for the conduct year, it would still be worthwhile to establish appropriate guidelines.  There are some obvious questions about exactly how the entire process should work.  Setting those guidelines proactively in legislation or regulation would also be helpful for the vast majority of these cases that never make it to Tax Court. 

The Special Report recommends a ban determination process independent of the audit process.  That is a great idea that would go a long way in solving some of the problems the report points out.  But for simplicity, and in case the IRS is reluctant to implement the Special Report’s recommendation, Part Two will discuss how Tax Court jurisdiction could be structured within the framework of a deficiency proceeding for the conduct year.

EITC Ban: NTA Report Recommends Changes and IRS Advises on its Application to Partial Disallowances

The following brief post discusses two recent developments relating to the EITC ban. The first is a report that the recently retired NTA submitted to Congress that contained administrative and legislative recommendations to improve the penalty. The second is informal IRS advice concerning its application to partial EITC disallowances.

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Report to Congress Proposes Changes to Ban Procedures

We have written frequently about problems with the authority that the IRS has to ban taxpayers from claiming the EITC (and now CTC and AOTC) following improper claims. Just last fall guest poster Bob Probasco in The EITC Ban—It’s Worse Than You Realizedaptly equated one of his client’s experiences in navigating the ban process to victims of 1970’s Hollywood disaster movies. I spent much of this past spring at IRS TAS as a Professor in Residence working on a report recommending improvements to the EITC that Nina Olson as NTA submitted in her final report to Congress.  The report, Making the EITC Work for Taxpayers and Government: Improving Administration and Protecting Taxpayer Rightsbecame Volume 3 of the FY 2020 Objectives Report to Congress. 

Part V of the report addresses the problematic ban provision. After detailing the process the IRS uses for imposing the ban we concluded on page 45 that the current system raises serious concerns and jeopardizes taxpayer rights: 

The processes described above are complicated for even seasoned tax lawyers much less unrepresented EITC recipients. The IRS path during the ban proposal and imposition period is marked by a series of notices with limited explanation. No rules or notices pertaining to the effect on a taxpayer who files jointly with a banned taxpayer exist, and there may be limited opportunities for audit reconsideration where a significant amount of time has passed since the ban was imposed. Adding to this confusion, there is some uncertainty as to whether, and when, the Tax Court has jurisdiction to consider the ban 

To address the risks to taxpayer rights, we provide two key recommendations. First, we recommend that the IRS develop a ban examination process that is separate from the audit process. That process should focus on whether the taxpayer’s conduct justifies the IRS to impose the ban. Second, we suggest that Congress clarify when the Tax Court has jurisdiction over the ban and require that the burden is on the IRS to prove that imposing the ban was appropriate.

While the IRS has imposed the ban relatively infrequently over the past few years, Congress recently expanded the opportunities for IRS to impose the ban by giving the IRS to exercise its authority for improper child tax credit and American Opportunity Tax Credit claims. Unfortunately Congress did so without addressing any of the issues we discuss in the report to Congress. This only exacerbates the problems Bob and others have identified when taxpayers are potentially subject to the ban. 

IRS Email Advice Discusses How Ban Can Apply to Partial Disallowances

A recent IRS informal opinionaddresses the possibility of the IRS imposing the ban when there is only a partial disallowance of the EITC:

[Taxpayer] claims 3 children, 1 child disallowed. TP continues to claim the 1 child for consecutive years when they know that they are not entitle[d] to claim the child. Can the TP be subject to the 2-year ban, even though they are entitled to the EIC for the other 2 kids? 

 The opinion concludes that the ban can apply in this situation:

Section 32(k)(1) states that no credit shall be allowed under § 32 for any taxable year during the disallowance periods, which are 2 years for reckless and intentional disregard and 10 years for fraud. Section 32(k)(1)(B)(ii), regarding the 2-year ban for reckless or intentional disregard of rules and regulations, does not prohibit imposition of the ban for partial disallowances. Accordingly, if any taxpayer’s claim for the EIC is partially disallowed because of reckless or intentional disregard of rules and regulations, the IRS may asset the 2-year ban under § 32(k)(1)(B)(ii) on the taxpayer claiming any EIC during the 2 years.

Technically, this conclusion makes sense yet I have concerns with the IRS’s ability to make fair and accurate determinations of taxpayers’ intentions. Family lives are complex. It is difficult for taxpayers to reach the IRS during the correspondence examination process. Getting through to IRS by phone requires persistence, patience and time. Many of the taxpayers who the IRS has imposed or asserted a ban used paid preparers, further complicating questions of intent.  

As we discuss in the report, the correspondence the IRS uses when it has imposed the ban does not adequately discuss how taxpayers can challenge the IRS ban determination. To be sure, improper claims are a problem with the EITC and other credits. Yet basic fairness suggests that before the IRS imposes the ban there is a straightforward and clear path to challenge the ban. 

The EITC Ban – It’s Worse Than You Realized

We welcome back guest blogger Bob Probasco. Bob tells a disaster story with a happy ending but we must keep in mind that the happy ending only occurred because the low income taxpayer had found her way to a clinic where she received free and highly competent representation. Other stories similar to this one exist in the system without the happy ending provided here.  

As we have written before, the time for contesting the EITC ban in Tax Court is unclear. Another possible avenue for taxpayers in the position of Bob’s client is to seek orders regarding the ban from the Tax Court. I cannot say whether the taxpayer would have obtained relief in the Tax Court but the existence of the prohibited assessments would provide a basis for an injunction which might have gotten the client to the right place. Keith

There is a film genre often referred to, because of the primary plot device, as “disaster movies.” The golden age was the 1970s, with films like Airport, The Poseidon Adventure, and The Towering Inferno. Minor actions or problems interact in ways that create huge challenges. Each time the characters survive one obstacle, losing a few members of the group in the process, a new threat arises. How many, and which, characters will eventually survive?

The tax administration equivalent is the earned income tax credit (EITC) ban.

The EITC ban process is seriously flawed, as has been pointed out frequently. Les discussed it here on Procedural Taxing in blog posts in January 2014 and July 2014. National Taxpayer Advocate Nina Olson has been complaining about it for years, with the most detailed coverage in her 2013 Annual Report to Congress. Patrick Thomas made a presentation on it (outline available on the LITC Toolkit website, if you have access) at the December 2016 LITC Grantee Conference. Les and William Schmidt addressed the specific issue of Tax Court jurisdiction over the ban in 2016 and 2018 respectively. I strongly recommend a thorough review of all of the above – including comments to the blog posts! – to anyone who deals with taxpayers who claim the EITC.

This post discusses the IRS administrative process for applying (and correcting?) the ban. It also points out how the interaction of the EITC ban process with problems elsewhere in the tax administration process can turn a serious issue into an absolute disaster. This is the story of one such disaster.

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Background

Section 32(k)(1), added by the Taxpayer Relief Act of 1997, establishes that the EITC shall not be allowed for

the period of 2 taxable years after the most recent taxable year for which there was a final determination that the taxpayer’s claim of credit under this section was due to reckless or intentional disregard of rules and regulations (but not due to fraud)

If there is a final determination that the taxpayer’s claim of credit was due to fraud, the disallowance period is 10 taxable years instead.

This is an absolute ban but there is also an indefinite potential disallowance, in Section 32(k)(2):

In the case of a taxpayer who is denied credit under this section for any taxable year as a result of the deficiency procedures under subchapter B of chapter 63, no credit shall be allowed under this section for any subsequent taxable year unless the taxpayer provides such information as the Secretary may require to demonstrate eligibility for such credit.

Treas. Reg. section 1.32-3(b) explains that

Denial of the EIC as a result of the deficiency procedures occurs when a tax on account of the EIC is assessed as a deficiency (other than as a mathematical or clerical error under section 6213(b)(1)).

And Treas. Reg. section 1.32-3(c) specifies Form 8862 as the information required to demonstrate eligibility. The instructions make clear that the taxpayer should not file Form 8862 during the years that a ban applies, but it will be required if the EITC is disallowed, even absent a final determination of fraud or reckless or intentional disregard of rules and regulations, to claim the EITC in any other years. If the form is properly completed and the IRS determines the taxpayer is eligible for the EITC, then the taxpayer is re-certified and need not submit Form 8862 again – unless the EITC is denied again.

Under Section 6213(g)(2)(K), the IRS can adjust the tax return by math error correction, rather than the deficiency procedures, if the taxpayer claims the credit during the ban period or without providing the required information for recertification. Nina Olson fought against that idea for years but it was eventually enacted in the Protecting Americans from Tax Hikes Act of 2015.

First obstacle: Location and language

Our LITC client – let’s call her “Maria” – was originally audited with respect to her 2014 return. She did a very good job of responding to the audit before even coming to our clinic. Most often, issues in an EITC audit concern proving relationship to the qualifying child or that the child lives with the taxpayer. Maria resolved those to the satisfaction of Exam/Appeals but one stumbling block remained: filing status. She filed her return as “single,” which of course should have been “Head of Household,” but the IRS insisted that she was married. Section 32(d) specifies that married taxpayers can claim the EITC only if they file joint returns. The IRS reclassified her filing status as “Married Filing Separately.” That was where the resolution bogged down, because Maria was adamant that she was not married.

Unfortunately, Maria lives in Texas, one of only ten states (plus the District of Columbia) that recognize common law marriage. She didn’t know that and she didn’t realize what the IRS was arguing from the correspondence she received. Maria doesn’t speak English and the “common law” part got lost in the translation by her son, who may not be familiar with the concept either. When she came to our clinic, we were able to explain the problem to her. We also determined that she had two arguments for claiming the credit.

First, she arguably did not meet the requirements under Texas law for a common law marriage. She had lived with her putative husband – let’s call him “Jose” – but she did not intend to be married and did not hold herself out to others as being married. We were persuaded as to the absence of intent by her obvious surprise when we explained what the IRS was saying. While corresponding with Exam/Appeals, before she came to the clinic, she submitted proof that she was not married: a certificate from the county clerk’s office that there was no record of a legal marriage between Maria and Jose. That’s not the type of evidence you’re likely to submit if you are aware of the existence of common law marriage. And if you’re not aware, that certainly suggests that you lacked the intent.

The more difficult aspect was the “holding out” requirement, because Maria and Jose had filed joint tax returns for several years prior to 2014. Jose may have held himself out to the IRS as married to Maria but I don’t think she did. She didn’t realize what the tax returns she signed meant. She thought Jose was claiming her as a dependent, not that she was presenting herself as his spouse. But it was always going to be difficult, if not impossible, to prevail on the first argument.

Our second argument was better. Under Section 7703(b), Maria could file her return as Head of Household, even though married, if (a) she maintained a household for a child who lived there and (b) she and Jose lived apart for at least the last six months of the year. Under Reg. 1.32-2(b)(2), such a return is not subject to the limitation of Section 32(d).  Jose had moved out in 2013; he was working in the oil fields in South Texas and living in his truck to save money to start a business. When he moved out, she even began paying him rent.

Second obstacle: Exam/Appeals and evidence

Unfortunately, there was no documentary evidence that Jose no longer lived there. He still received mail at the address where Maria lived and continued to use that address on subsequent tax returns he filed. You can’t get mail addressed to a truck and you can’t use the truck as your address on a tax return. There was no rental agreement or utility bill for the truck either, so the IRS could find no records showing a different address for him. So as far as Exam and Appeals were concerned, he still lived with Maria.

The IRS also was not satisfied with the substantiation for the agreement to pay rent. Maria and Jose documented that arrangement with a very formal rental agreement. (How many taxpayers would think to do that?) Unfortunately, Maria’s copy of the agreement was unsigned and it was only for a term of one year, which did not cover all of 2014. Maria continued paying rent after that but they did not think to prepare a new agreement until she was audited. Also, Maria didn’t have records of the payments to Jose, because she paid him in cash.

Maria’s case stumbled over what appears to be a larger problem with correspondence audits. During my limited time at the LITC, Exam and Appeals both appear to rely exclusively on documentary evidence. That may be understandable, given drastic reductions in staffing and the absence of face-to-face meetings in correspondence audits, but I don’t think it’s reasonable – particularly on something like this that had huge potential consequences. We offered to arrange a telephone conference (including translator) with Maria and could have put together an affidavit if they preferred that. But they just rejected the idea of testimony. Luckily, Counsel can and does accept testimonial evidence, so we were still hopeful. Unfortunately, this meant that we had to go to Tax Court, when we encountered another obstacle.

Shortly after we filed the Tax Court petition for the 2014 tax year, the IRS sent an audit notice for 2015. The same process repeated with the same result – Exam and Appeals rejected our explanations due to a lack of documentary evidence and Maria received a notice of deficiency. The IRS had frozen the refund for 2015 during the audit, so further delay did create some financial hardship.

Third obstacle: Error in a ministerial or administrative action

Once Appeals returned the docketed case for 2014 to Counsel, we submitted a declaration by Maria setting forth what her testimony would be. Within a week, the IRS attorney agreed to concede the case in full. The stipulated decision for 2014 was filed a day after we filed the petition for 2015. And in less than three months, we had a full concession from Counsel for 2015 and another stipulated decision. So, great results for Maria, right? Alas, here’s where we ran into an unrelated issue that had a very unfortunate interaction with the EITC ban.

I had never given much thought to the question of how Exam and Appeals proceed after issuing a notice of deficiency. I should have, although I’m not sure I could have avoided this problem. Internal Revenue Manual (IRM) sections 4.8.9.25 and 4.8.9.26 set forth the process when the taxpayer petitions and when the taxpayer defaults, respectively, after a notice of deficiency. It seems to be an elaborate process with many safeguards – a tax litigation counsel automated tracking system, a related docketed information management system, and checking the Tax Court website if not in those systems to confirm that the taxpayer defaulted. There is even a follow-up process for the occasional situation when the responsible employee receives the docket list after tax was assessed.

For both 2014 and 2015, we filed Tax Court petitions timely. As we all know, Section 6213(a) states in unequivocal terms that

no assessment of a deficiency . . . shall be made, begun, or prosecuted until such notice [of deficiency] has been mailed to the taxpayer, nor until the expiration of such 90-day or 150-day period, as the case may be, nor, if a petition has been filed with the Tax Court, until the decision of the Tax Court has become final.

This is a disaster story, though, so you’ve undoubtedly guessed (correctly) that for both years the IRS assessed tax and reversed the EITC, while there was a pending Tax Court case. The IRS imposed the EITC 2-year ban in both cases and issued Notice CP 79A.

Why did this happen? I really don’t know. While I was writing this post, out of curiosity I reviewed the limited number of Tax Court deficiency cases our clinic handled in our two years of existence. For all the non-EITC cases, transaction code 520 “bankruptcy or other legal action filed” was posted to the transcript consistently in less than a month after the date the petition was posted to the Tax Court online docket. But for three of our six EITC cases in Tax Court, including Maria’s cases for 2014 and 2015, transaction code 520 was posted to the transcript significantly later: 64, 212, and 221 days after the respective petition was posted to the Tax Court docket. Every process is only as strong as its weakest link – in this case, human error or delay. Someone somewhere didn’t realize that we had challenged the notice of deficiency and didn’t get the information into the computer, so the assessments – and EITC bans – proceeded for those three cases. (Our other client made it to safety relatively early in the process.)

I reported the issue of premature assessments from these cases in the Systemic Advocacy Management System (SAMS) last year, and I suspect other people have done so as well. It’s always a problem, but the consequences can be worse when the EITC ban is put into play.

Fourth obstacle: The difficulty of reversing an illegitimate assessment and EITC ban

Section 6213(a) provides a remedy if the IRS assesses or takes collection actions while a Tax Court case is pending:

Notwithstanding the provisions of section 7421(a), the making of such assessment or the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court, including the Tax Court, and a refund may be ordered by such court of any amount collected within the period during which the Secretary is prohibited from collecting by levy or through a proceeding in court under the provisions of this subsection.

It doesn’t provide for enjoining the imposition of the EITC ban, though. In addition, IRM 4.13.3.17 provides that errors concerning an EITC assessment can be resolved through the audit reconsideration process, although presumably this is intended to apply when the taxpayer provides additional documentation after a legitimate assessment.

Perhaps foolishly, we tried to resolve the problem for 2014 informally. I gave the IRS attorney assigned to the case a copy of the notices issued by the IRS and asked if she could have it corrected. Because she had already referred the docketed case to Appeals, she passed that documentation along to the Appeals Officer. I followed up with the Appeals Officer twice, with no response. But the problem was eventually resolved; the assessment was reversed, and the IRS mailed Notice CP 74, recertifying Maria for EITC. Problem solved, and since the Tax Court case was still pending, no harm, no foul.

For 2015, I responded directly to the assessment and Notice CP 79A. That notice presents the ban as a fait accompli; there was no reference to what the taxpayer should do if she disagreed with the IRS action. As noted above, the recertification process applies only after the ban period. The accompanying Notice CP 22E for the assessment suggested the taxpayer call if she disagreed with the changes. Instead, I wrote a letter – remarkably polite under the circumstances – pointing out that the assessment and imposition of the ban were illegal because of the pending Tax Court case and requesting the IRS “take all necessary corrective actions immediately.” Exactly one month later (which qualifies as “immediately” in any large bureaucracy), the assessment was reversed. We had filed the stipulated decision in the meantime and finally, almost six months after our letter and five months after the stipulated decision, the IRS issued a refund. This was a long time for a low-income taxpayer to wait for a refund, but better late than never.

Let’s summarize the timeline, because this is getting confusing.

2014 tax year

  • Notice of deficiency – 11/30/2016
  • Tax Court petition filed (timely) – 2/24/2017
  • Assessment/ban – 4/17/2017
  • “Bankruptcy or other legal action” posted per transcript – 5/3/2017
  • Clinic contacts Counsel and Appeals regarding the premature assessment – 6/5/2017, 6/21/2017, 7/24/2017
  • Assessment reversed – 11/13/2017
  • Tax Court stipulated decision – 1/23/2018

2015 tax year

  • Notice of deficiency – 10/16/2017
  • Tax Court petition filed (timely) – 1/16/2018
  • Assessment/ban – 2/26/2018
  • Clinic letter to IRS – 3/2/2018
  • Assessment reversed – 4/2/2018
  • Tax Court stipulated decision – 4/5/2018
  • Refund issued – 8/3/2018
  • “Bankruptcy or other legal action” posted per transcript – 8/29/2018

Fifth obstacle: Enter the math error adjustment

Just when we thought Maria’s problems were over, on 7/2/2018 she received Notice CP 12, a math error adjustment denying EITC, for her 2016 tax return. We either didn’t notice or didn’t realize the significance at the time, but when the IRS reversed the premature assessment for her 2015 tax year, it did not issue Notice CP 74 recertifying her for EITC.

There had been an assessment of tax, on account of the EITC, as a deficiency for 2015, so it met the requirements of Treas. Reg. section 1.32-3(b) and Section 32(k)(2). Of course, that assessment for 2015 was illegal and had been reversed. The stipulated decision in the Tax Court case meant there never was and never would be a legitimate final assessment or determination of reckless or intentional disregard of rules or regulations for 2015. Because there is no process to confirm the validity of the EITC ban first, the failure to recertify automatically resulted in issuance of the math error adjustment.

Luckily, although a math error adjustment can be assessed without judicial review, taxpayers can simply request that the adjustment be reversed within 60 days, although – if appropriate – it can be re-asserted through the deficiency process. Section 6213(b)(1) and (2). That’s exactly what we requested for the 2016 tax year, by letter on 7/24/2018.

And, of course, since this is a disaster story, you know that Maria also received Notice CP 12 for her 2017 tax return.

Sixth obstacle: Further delay for an audit?

The IRS mis-handled our protest of the math error adjustment for 2016. Of course. Notice CP 12 states:

If you contact us in writing within 60 days of the date of this notice, we will reverse the change we made to your account. However, if you are unable to provide us additional information that justifies the reversal and we believe the reversal and we believe the reversal is in error, we will forward your case for audit. This step gives you formal appeal rights, including the right to appeal our decision in the United States [Tax] Court before you have to pay additional tax. After we forward your case, the audit staff will contact you within 5 to 6 weeks to fully explain the audit process and your rights. If you do not contact us within the 60-day period, you will lose your right to appeal our decision before payment of tax.

That’s consistent with Section 6213(b) as well as IRM 21.5.4.5.3 to 21.5.4.5.5 (general math error procedures) and IRM 21.6.3.4.2.7.13 (EITC math errors specifically). A substantiated protest can result in just reversing the math error adjustment; an unsubstantiated protest will result in referral to Exam.

The IRS treated our protest of the math error adjustment for 2016 as an unsubstantiated protest and referred it to Exam. Perhaps they misclassified our protest because they expect a substantiated EITC protest to provide documentation regarding relationship or residence or SSNs. Our protest was based on a premature assessment and assertion of the ban, and the failure to reverse the ban imposed as a result of the audit of 2015. We certainly had substantiated our basis for that. But when you provide a type of substantiation that they’re not anticipating . . .

So we received an audit letter dated November 9th. Further delay before Maria will receive her refund. To add insult to injury, the notification of what was happening was inadequate and would have been confusing to an unrepresented taxpayer. There was no response to the protest, telling us that they were referring the case to Exam for review. That might have provided an opportunity to clarify the nature of our protest before initiation of the audit. The audit letter did not explain the connection with the math error adjustment. For that matter, the IRS did not – as specified in the IRM – abate the disputed adjustment.

I have a sneaking suspicion that the same thing would have happened when we protested the math error adjustment for 2017 as well. Luckily . . .

The rescue party arrives! Maria makes it to safety!

Our efforts hadn’t met with much success, so we contacted our Local Taxpayer Advocate office in mid October. The case advocate spent a lot of time and effort, chasing from one office to another on Maria’s behalf. He pointed out the premature bans, the decisions by the Tax Court, and the IRS policy against auditing an issue that were examined in either of the two preceding years with no change or a nominal adjustment. Even after he elevated the discussion to managers in the operating units, there was still a lot of resistance. I’m not sure he would have succeeded without the gentle reminder of the possibility of a Taxpayer Assistance Order. Just as I was finishing this post, he called us with the good news. The 2-year ban is being lifted, the two math error adjustments are being reversed, and the examination of 2016 is being closed. Soon Maria will be getting the remainder of the refunds she requested on her 2016 and 2017 tax returns.

Final thoughts

I’m getting used to the unfortunate difficulty of convincing Exam/Appeals that our clients are entitled to the EITC. I didn’t worry that much about the EITC ban because most of the time either we prevail or our clients aren’t entitled to the EITC and won’t claim it in the future anyway. I certainly didn’t anticipate how much trouble the EITC ban can cause even when we win the battle over the EITC itself.

TAS Systemic Advocacy also continues to look at these issues. They approached me after hearing about the case, before I even got around to reporting it in SAMS. Nina Olson has been fighting the problems with the EITC ban for years but still meets with resistance. Maybe this example of how much can go wrong will help in that fight. We can only hope.

The positive part of any ordeal like this is that, amid all the mindless adherence to byzantine and flawed processes, you can still encounter the IRS working the way it should: getting the right result, protecting the government fisc while also protecting taxpayer rights. In Maria’s case, those bright spots were Counsel, the case advocate at LTA, and the folks at TAS Systemic Advocacy. Without people like them, these tax issues can be devastating, not just for Maria but also for a lot of other taxpayers in similar situations.