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.

 

Tax Court Jurisdiction and the EITC Ban

We welcome William Schmidt who is normally one of our regular designated order blogging. William’s post today results from a request for help from another designated order blogger, Patrick Thomas, who asked for assistance from his colleagues to do an in-depth analysis on a specific designated order from the week of July 23 to 27. During that week the Tax Court issued a heavy load of designated orders that Patrick turned into a three part series without including the case which is the subject of today’s post. William writes about Docket No. 20967-16, Katrina E. Taylor & Avery Taylor, v. C.I.R. (Order here). He focuses on the Taylor case because it brings back a jurisdictional issue for Tax Court regarding the earned income tax credit (EITC) ban that Les has written about before as is cited below. Keith

To begin with some background on the EITC ban, there have been issues through the years regarding fraud on tax returns claiming the EITC. In response, Congress provided the Taxpayer Relief Act of 1997. Its purpose, according to the Joint Committee on Taxation: “The Congress believed that taxpayers who fraudulently claim the EIC or recklessly or intentionally disregard EIC rules or regulations should be penalized for doing so.” The Act provided for an EITC ban under Internal Revenue Code (IRC) section 32(k). The ban disallows a taxpayer to claim the EITC for 10 years when there claim of the credit was due to fraud (or 2 years for reckless or intentional disregard of rules and regulations, though not due to fraud). There have been issues on how fairly the IRS administers the ban. One example is that it was identified as one of the “Most Serious Problems” in the National Taxpayer Advocate’s 2013 Report to Congress.

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The IRS issued a notice of deficiency to the Taylors regarding the 2013 tax year, listing a deficiency of $14, 186 and an IRC section 6662(a) accuracy-related penalty of $2,837.20. The deficiency results from disallowance of car and truck expenses the Taylors claimed on the Schedule C filed with their Form 1040.

The Taylors timely filed their Tax Court petition and the IRS filed their answer. The IRS followed up with an amended answer, raising two affirmative defenses. First, they raise an IRC section 6663 civil fraud penalty of $10,639.50, asserting the petitioners falsely claimed business-related car and truck expenses to reduce their income to make them eligible to claim the EITC. Second, the IRS raises the 10-year EITC ban pursuant to IRC section 32(k)(1)(B)(I) for improperly claiming the EITC.

To complete the procedural history, the Taylors did not participate further in their Tax Court case, which was to their detriment. They did not respond to the amended answer and the IRS followed with a “Motion for Entry of Order that Undenied Allegations be Deemed Admitted Pursuant to Rule 37(c).” The Court issued an order granting that motion, meaning the Taylors are deemed to have admitted all the statements in the amended answer, including the affirmative allegations with respect to the civil fraud penalty and the 10-year ban on claiming the EITC.

Next, the IRS filed a “Motion to Take Judicial Notice,” which requested the Court take judicial notice of the distances between the Taylors’ home and the various addresses Katrina Taylor reported driving during 2013 for her business activities. The motion asserts that the Taylors’ travel logs are unreliable and overstate the travel distances. The IRS provided Google Maps documents that show the distance and driving times for the routes Mrs. Taylor reported for the business destinations. Since the Taylors did not respond, the Court’s order granted the IRS motion, taking judicial notice of that information as facts, the accuracy of which cannot reasonably be questioned.

The IRS prepared a joint stipulation of facts that the Taylors refused to sign. The IRS filed a “Motion for Order to Show Cause Why Proposed Facts and Evidence Should not be Accepted as Established Pursuant to Rule 91(f).” The Court ordered the Taylors to respond to the motion. Since they failed to respond, the Court issued its order making the Order to Show Cause absolute, meaning the facts and evidence set forth in the proposed stipulation of facts was deemed to be established for the purposes of the case.

Turning to the facts established through the orders, the Taylors reported $105,914 in wages on their 2013 Form 1040, with $55,033 earned by Mrs. Taylor as an employee. The attached Schedule C listed financial data on Mrs. Taylor’s business, which reports no business income. It instead reports advertising expenses of $290 and car and truck expenses of $73,740, resulting in a net loss of $74,030. Also included are a Form 4562, Depreciation and Amortization (Including Information on Listed Property), which states the Taylors represent they used two vehicles for business purposes, with a total of 130,513 business miles. Vehicle 1 was driven 65,212 miles and vehicle 2 was driven 65,301 miles. In response to line 24a, “Do you have evidence to support the business/investment use claimed?” their response was to check the box for “no.” Those business expenses reduced their adjusted gross income to $30,690. Since they had three minor children in 2013, they qualified for an earned income credit of $4,417 based on that income.

The IRS audited the Taylors, focusing on their car and truck expenses. The Taylors supplied two versions of a log purporting to show business miles driven for Mrs. Taylor’s business. The logs were not provided contemporaneously with her travel and state she drove the 130,513 miles on business, driving a 2004 Cadillac truck 41,483 miles and a 2006 BMW 89,030 miles. The Court states these logs are demonstrably unreliable because petitioners traded in the 2004 Cadillac truck with Mrs. Taylor signing an odometer disclosure statement reporting the odometer at time of sale as 102,345 miles while according to the provided logs the December 23, 2013 year end odometer reading was 154,990 miles. Similarly, the BMW’s trade-in odometer disclosure statement was 91,333 miles while the purported logs stated the December 17, 2013, reading to be 186,880 miles.

The Court also believed the log mileage to be inflated. The logs stated Mrs. Taylor drove the Cadillac 1,376 miles and the BMW 701 miles (totaling 2,077 miles) on September 22, 2013. The IRS points out the driving distance from Manhattan to Los Angeles is approximately 2,800 miles and “[a]t a constant speed of 70 miles per hour (“MPH”) it would take 29.7 hours to drive 2,077 miles.” The logs also report trips of 1,200 miles to 1,800 miles for other days.

The Court’s discussion within the order itself focuses on how the petitioners have not been responsive. They failed to plead or otherwise proceed within Rule 123(a). Because of the deemed established facts, the Court grants the IRS Motion for Default Judgment and enters a decision against the Taylors.

In the decision, Judge Jacobs ordered and decided that for 2013 there is a deficiency of $14,186 and an IRC section 6663 civil fraud penalty of $10,639.50 (the IRS sought an IRC section 6662 accuracy-related penalty in the alternative so that is denied as moot). Additionally, Judge Jacobs orders and decides “that the 10-year ban for claiming the earned income credit, pursuant to section 32(k)(1)(B)(I), is imposed as sought in respondent’s amended answer.”

There is no analysis regarding the 10-year ban and whether the Court has jurisdiction to impose it. The closest is a prior mention of the affirmative allegations that “petitioners…should be subject to the 10-year ban on claiming the earned income credit.”

We come back to a jurisdictional issue for the Tax Court. In the Taylor case, the Court had the 2013 tax return at issue. The jurisdictional issue is what authority the Court has with regard to the EITC ban in a case like this. Is the jurisdiction for the year in which the ban arises (2013) or for the years in which the ban will take effect (10 following years, presumably starting with 2014)?

The Tax Court is a court of limited jurisdiction. IRC section 6214(a) states that Tax Court has jurisdiction to redetermine the correct amount of a deficiency at issue. The disallowed refundable credit banned through the EITC ban affects future years that are not before the Tax Court. In fact, IRC section 6214(b) states that the Court “shall have no jurisdiction to determine whether or not the tax for any other year…has been overpaid or underpaid.”

I note that the IRS does have the ability to assert fraud and get facts deemed stipulated in order for the IRS to meet its burden of proof on the issue of fraud. I provide a quote from Console v. Commissioner, T.C. Memo. 2001-32 at *12, aff’d 2003 U.S. App. LEXIS 15535 (3d Cir. 2003): “It is well settled in this Court that the Commissioner may establish fraud by relying upon matters deemed admitted under Rule 90Marshall v. Commissioner, 85 T.C. 267 (1985)Morrison v. Commissioner, 81 T.C. 644, 651 (1983)Doncaster v. Commissioner, 77 T.C. 334, 336 (1981). The Commissioner may also establish fraud by relying on facts deemed to be stipulated under Rule 91(f)Ambroselli v. Commissioner, T.C. Memo 1999-158.” My thanks to Carl Smith for providing this note and citation.

One case to consider is a prior Tax Court case, Ballard v. Commissioner, which included a Tax Court judge’s reluctance to issue an order regarding a 2-year ban on the EITC. Les Book provided prior commentary in Procedurally Taxing here. In that posting, there are links to other posts, including Carl Smith’s discussion of the jurisdictional issue of the EITC ban in the Tax Court. I agree with Les’s view that the Tax Court does not have authority to apply an EITC ban for a year of fraudulent behavior (or reckless/intentional disregard), which could be called a conduct year.

Specifically for the Taylors, I argue that while the petitioners should potentially be subject to the ban, the only year before the Court was 2013. It was within the Court’s authority to find that there was fraud in 2013, but not within their authority to apply an EITC ban for later years.

I am unsure if the Taylors were outmatched in the courtroom. If all of the allegations against them are true, though, I can understand the claims of fraud the IRS made against them. Whether their goal was to inflate business expenses to claim the earned income tax credit or not, the results are unrealistic business miles and mileage logs that do not match. Even if one does not agree with the EITC ban, the ban is an area the IRS has authority to administer. This case does not provide justification that the Tax Court has jurisdiction to administer the EITC ban for later years when 2013 was the conduct year before the Court so went a step too far in ordering the imposition of the EITC ban for the Taylors.

 

Recent Tax Court Case Sustains Preparer EITC Due Diligence Penalties

Last week in Mohamed v Commmssioner, the Tax Court sustained $7,000 of EITC due diligence penalties against a preparer. The preparer, who was a CPA, had an active business preparing individual tax returns, including many EITC returns. The opinion provides a rare court review of the imposition of these penalties.

The EITC due diligence penalty has been on the books for a while; the current penalty is $500 for each failure to comply. Requirements include preparing and retaining forms like the Paid Preparer’s Earned Income Credit Checklist, and the Earned Income Credit Worksheet. In addition, the rules require that tax return preparer must not know, or have reason to know, that any information pertaining to the EITC is incorrect.

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This penalty is even more important for preparers, as Congress recently expanded the scope of due diligence penalties to include the child tax credit and the American opportunity tax credit.

There are not many cases involving the penalty, and while Mohamed is a summary opinion, it does provide some insights into the process and limits on Tax Court review of the penalty.

The opinion discusses how IRS examined a number of Mohamed’s clients as part of its EITC due diligence audit program. He was visited by a tax compliance officer, who reviewed 50 of Mohamed’s returns. The audit report proposed a penalty on 20 of the 50 returns; while the penalty is not subject to deficiency procedures, the IRM provides and IRS allowed for Mohamed to challenge the proposed assessment before Appeals.

Mohamed met with an Appeals Officer for 6 hours to discuss the penalty; after the meeting Appeals agreed to remove the penalty from 5 of the returns. Appeals also asked for more information on 4 other returns. Mohamed sent documents to Appeals and also had a follow up phone conversation. The correspondence and phone call led Appeals to remove the penalty from another return, bringing the penalty down to 14 returns, or $7,000.

Appeals sent a closing letter indicating that it was recommending a penalty assessment on 14 of the returns; it also let Mohamed know that he could pay the penalty and file a refund claim and eventually sue in district court or the Court of Federal Claims if he wanted court review of the penalty.

IRS assessed the penalty and issued a notice of intent to levy. Mohamed did not pay and instead filed a CDP request. In the hearing he asked to challenge the underlying assessment. The settlement officer refused that request on the theory that he had a prior opportunity to challenge the penalty in the preassessment Appeals hearing.

PT readers are likely familiar with the legal issue; namely whether a prior opportunity to dispute the amount or existence of the liability includes for these purposes an administrative preassessment Appeals hearing. Taxpayers have lost in Tax Court and circuit courts on this issue (For more see Keith’s discussion Continued Developments in Taxpayer Attempts to Litigate the Merits in CDP Cases.)

Given the Tax Court and appellate courts’ views on this issue, it is not surprising Mohamed had an uphill battle. He gamely attempted to distinguish the adverse authority, arguing that Appeals did not give him a chance to rebut its conclusions and that it terminated the process prematurely.

The Tax Court disagreed, emphasizing that he participated fully in the examination process, had a long in-person meeting with Appeals and follow up conversations and correspondence:

In sum, the record shows that in 2015 petitioner was provided a full and fair opportunity to challenge the imposition of the disputed penalties before the Appeals Office and he meaningfully participated in that proceeding. Although petitioner would have preferred to continue to dispute his liability, we are satisfied hat the Appeals Office conducted a fair and comprehensive review of the matter and acted properly in concluding the matter by issuing its closing letter.

That the Tax Court looked into the process that Appeals provided in the preasessment hearing is a slight opening for other taxpayers who may not have had the same opportunities with Appeals. Yet Mohamed is another in the growing line of cases that show that CDP is not an avenue for challenging the amount or existence of a liability even if there is no prior opportunity for court review.

There is one other aspect of the case worth noting. Mohamed also challenged the penalty under Section 6751(b) which requires that no IRC penalty “shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate…”

The court considered this issue on the merits and found that the compliance officer had prepared a Form 8484, which is used to refer preparers for possible discipline to the Return Preparer Office. That form was where the compliance officer proposed the penalties, and the supervisor signed that form and approved referral.   Interestingly the record did not include a Form 8278, which is what IRS typically uses to propose preparer penalties. The lack of that form did not trouble the Tax Court:

On its face, Form 8484 is a report that IRS personnel are encouraged to use to convey information to the OPR about questionable practitioner conduct. Although the form does not function to authorize the assessment of a penalty, in this case the TCO’s acting immediate supervisor placed her digital signature on the Form 8484 indicating that she agreed with the referral of the matter to the OPR and that she approved the audit report (attached to the Form 8484) which recommended that 20 section 6695(g) penalties be assessed against petitioner. The audit report included a detailed explanation in support of each of the 20 penalties. Under the circumstances of this case, we conclude that the TCO’s initial determination to assess the penalties in dispute was personally approved in writing by her immediate supervisor within the meaning of section 6751(b).

As this is a summary opinion not subject to further review, there is no chance to in this case see if the IRS’s failure to seek penalty approval in the proper manner amounted to compliance with Section 6751(b). As we have discussed (most recently in Samantha Galvin’s Designated Order post from a few weeks ago), the 6751(b) issue is one that the Tax Court and other courts are increasingly facing.

IRS Expresses Disapproval of Tax Court Case Allowing EITC for Separated But Married Taxpayer

There are many complexities in the Internal Revenue Code. There are also many nuances in tax procedure. Put the two together and there are ingredients for the need for guidance. Earlier this week the IRS issued a nonacquiesence in a 2016 Tax Court case that had slipped through and I had not noticed.

The case at issue is Tsehay v. Commissioner, T.C. Memo. 2016–200. In Tsehay, the taxpayer, a custodian whose first language was not English, had an on again off again relationship with his spouse. During 2013, the taxpayer testified (credibly, according to the opinion) that he his wife and their children lived with him though by 2014 they had separated. He, using a paid return preparer, filed a 2013 return as head of household and claimed his kids as qualifying children for the EITC and dependency exemptions. HOH status was crucial for purposes of the EITC, as married taxpayers who are not divorced or separated (or who do not live apart from their spouse for the last 6 months of the year and who otherwise generally pay ½ of the household and childcare expenses) cannot claim the EITC unless they file a joint return. There is no similar anti-MFS rule in place for claiming children as dependents.

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The opinion concluded that his credible testimony regarding his living with his kids was enough to justify his receiving dependency exemptions and the EITC.

It appears that the judge and IRS counsel may have missed the special rule that prevents MFS taxpayers from claiming the EITC.

This takes us to earlier this month when the IRS announced that it did not acquiesce in the case. We have not discussed this form of guidance in the blog. The Internal Revenue Bulletin nicely describes the IRS policy on commenting on case law, which comes in the form of acquiescence, acquiescence in result only, or nonacquiescence:

It is the policy of the Internal Revenue Service to announce at an early date whether it will follow the holdings in certain cases. An Action on Decision is the document making such an announcement. An Action on Decision will be issued at the discretion of the Service only on unappealed issues decided adverse to the government. Generally, an Action on Decision is issued where its guidance would be helpful to Service personnel working with the same or similar issues. Unlike a Treasury Regulation or a Revenue Ruling, an Action on Decision is not an affirmative statement of Service position. It is not intended to serve as public guidance and may not be cited as precedent.

Actions on Decisions shall be relied upon within the Service only as conclusions applying the law to the facts in the particular case at the time the Action on Decision was issued. Caution should be exercised in extending the recommendation of the Action on Decision to similar cases where the facts are different. Moreover, the recommendation in the Action on Decision may be superseded by new legislation, regulations, rulings, cases, or Actions on Decisions. Prior to 1991, the Service published acquiescence or nonacquiescence only in certain regular Tax Court opinions. The Service has expanded its acquiescence program to include other civil tax cases where guidance is determined to be helpful. Accordingly, the Service now may acquiesce or nonacquiesce in the holdings of memorandum Tax Court opinions, as well as those of the United States District Courts, Claims Court, and Circuit Courts of Appeal. Regardless of the court deciding the case, the recommendation of any Action on Decision will be published in the Internal Revenue Bulletin.

The recommendation in every Action on Decision will be summarized as acquiescence, acquiescence in result only, or nonacquiescence. Both “acquiescence” and “acquiescence in result only” mean that the Service accepts the holding of the court in a case and that the Service will follow it in disposing of cases with the same controlling facts. However, “acquiescence” indicates neither approval nor disapproval of the reasons assigned by the court for its conclusions; whereas, “acquiescence in result only” indicates disagreement or concern with some or all of those reasons. “Nonacquiescence” signifies that, although no further review was sought, the Service does not agree with the holding of the court and, generally, will not follow the decision in disposing of cases involving other taxpayers. In reference to an opinion of a circuit court of appeals, a “nonacquiescence” indicates that the Service will not follow the holding on a nationwide basis. However, the Service will recognize the precedential impact of the opinion on cases arising within the venue of the deciding circuit.

At times, the AOD that the Service issues has an extensive discussion of the reasoning. Other times, as in AOD 2017-05 on Tsehay, it just states the conclusion that the Service does not acquiesce in the decision. That nonaqciescence makes sense, as it appears that Tsehay is just the result of a counsel and judicial foot fault on the law. It is intended to remind counsel attorneys (and taxpayers) that it is inappropriate to rely on Tsehay for the position that married taxpayers who file an MFS return  or who are required to file an MFS return are entitled to the EITC. As a guest post from Andy Grewal discusses a couple of years ago, while Tax Court memo opinions are not supposed to be precedential (and are intended to be used only in clear cut or heavy factual cases), as a practical matter advocates and the court itself often look to and effectively rely on these cases so Counsel wanted to clear the air.

Because AODs give direct insight into Chief Counsel’s litigating position and because understanding that position allows a representative to provide valuable advice about the likelihood a case will go to trial rather than settle, the more AODs the IRS issues the better. Back in the 1970s the IRS issued AODs routinely. Today, issuing an AOD seems to be the exception rather than the rule. Still, the AODs that are issued provide a benefit when trying to understand what will happen with a case and they should not be overlooked.