IRS Releases Update on Frequently Asked Questions Part 4: The Low-Income Taxpayer Perspective

Today we welcome back guest blogger Ted Afield, Professor of Law at Georgia State University, with the fourth installment in our mini-series on IRS FAQ.

The IRS’s mission, in its own words, is to “Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.” Taxpayers reading this mission statement are not being unreasonable in believing that fulfilling the service side of this mission includes at least some obligation to explain to taxpayers what the tax laws are and how taxpayers are expected to comply with them. Indeed, a service-focused mission would also suggest that, to the extent that the IRS does provide an explanation of the tax laws that turns out to be incorrect, the IRS would make at least some effort to mitigate the impact of its mistake, such as through acknowledgement and correction of the error and through ensuring that taxpayers are not penalized for relying on an IRS explanation.

As has been noted numerous times on this blog and elsewhere, however, this has sadly not been the case in the context of one of most commonly utilized IRS methods of explaining the tax law: the FAQ.  Rather, historically, the IRS has taken the position that it would do its best through FAQs to provide quick and clear guidance to taxpayers, but that essentially taxpayers should rely on those FAQs at their peril, as there would be no relief if the guidance turned out to be incorrect.

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As Professors Joshua Blank and Leigh Osofsky have pointed out in an upcoming article in the Vanderbilt Law Review titled, The Inequity of Informal Guidance, that the approach that the IRS taken to this type of informal guidance is “a social justice issue. . . [because] the two tiers of formal and informal tax law systematically disadvantage taxpayers who lack access to sophisticated advisors.”  As Professors Blank and Osofsky correctly observe:

This imbalance occurs irrespective of whether the IRS’s tax guidance contains statements that, if taxpayers followed them, would be taxpayer favorable or unfavorable.  When the guidance contains taxpayer-favorable positions the IRS is not legally bound by these positions and, during an audit, can contradict or ignore them.  When the guidance contains taxpayer-unfriendly positions, taxpayers who rely on them are bound to these interpretations as a practical matter.  Worse yet, these taxpayers have almost no protection against tax penalties for incorrect positions that they claimed based on the IRS’s tax guidance.

While these inequities can of course be experienced by taxpayers at a variety of income levels, they are most acutely felt by the most economically vulnerable members who interact with the tax system.  Furthermore, the inequity is exacerbated by the fact that Congress increasingly uses the tax system to distribute economic relief in periods of economic crisis. This means that new areas of tax law in which the IRS is attempting to provide FAQ guidance as quickly as possible are areas of the law that are specifically designed to provide critical social safety-net benefits to vulnerable taxpayers who are most in need of a clear explanation that shows them what they must do to receive these benefits.  The National Taxpayer Advocate described the extent of this problem as just as it related to the COVID-19 relief provisions here:

The Coronavirus relief provisions provide a good example of the useful role of FAQs. There is no end to the questions that have arisen under the Families First Coronavirus Response Act, the Coronavirus Aid, Relief, and Economic Security Act, and the IRS’s People First Initiative. It would not have been feasible for the IRS to address most of those questions through published guidance, at least not quickly. By our count, the IRS has posted nearly 500 COVID-19-related FAQs on its website, including 94 on the employee retention credit, 93 on the Families First Coronavirus Response Act (via a link to the Department of Labor website), 69 on Economic Impact Payments, 67 on COVID 19-related tax credits, and 40 on filing and payment deadlines.

For a more specific example, see here for a discussion of how the IRS provided incorrect FAQ guidance for the eligibility of incarcerated and non-resident taxpayers for economic impact payments during the first round of COVID-19 stimulus).  This approach represented more than just poor service—it violated at least four of the Taxpayer Bill of Rights: the right to be informed; the right to quality service; the right to pay no more than the correct amount of tax; and the right to a fair and just tax system.  Indeed, as Professors Alice Abreu and Richard Greenstein have noted, given that the IRS would remove and replace FAQs without warning and without an archive, it “may also violate the taxpayers “Right to Challenge the IRS’s Position and Be Heard,’” which would cause it to violate half of the listed taxpayer rights in TBOR.

Thankfully, the IRS last week took a significant step in rectifying this inequity, with the publication of IR-2021-202 (October 15, 2021).  Through this notice, the IRS has indicated that it will make the following changes to its FAQ practices:

  1. Publishing FAQs as separate Fact Sheets that will be dated so that taxpayers will know when FAQs are modified.
  2. Allowing taxpayers who reasonably rely on FAQ guidance in good faith to have a “reasonable cause” defense against negligence or accuracy related penalties if the FAQ is incorrect as applied to that taxpayer

This notice represents an important change from the “heads, the IRS wins; tails, the taxpayer loses” historical approach to FAQs and is a welcome development for all taxpayers, but particularly so for those taxpayers who lack the resources to pay for professional tax guidance and nevertheless rely on benefits administered through the tax code for their economic security.  Inevitably, however, commentators will turn their attention to the question of whether this fix solves the problem or whether it only represents the first step towards an even more equitable solution.

As Professors Abreu and Greenstein have argued here, perhaps the IRS should be encouraged to go beyond simply allowing reliance for the purposes of penalty protection and should be encouraged to “stand by its [sic] all of its written, publicly announced, positions until it announces that it has changed positions, and it should do so for all purposes, not just for penalty protection.”  There is considerable appeal to this argument, but part of me wonders whether this could potentially backfire on economically vulnerable taxpayers. Requiring that the IRS stand by all written guidance for all purposes until the guidance is changed could end up having the counter-effect of making the IRS more hesitant to release the guidance in the first place.  Even if the IRS did continue to release guidance, allowing taxpayer reliance over and above penalty protection could incentivize the IRS to release guidance in a more taxpayer unfriendly manner, which, as Professors Blank and Osofsky have observed, could cause taxpayers to rely on unfriendly FAQ guidance that puts them in an unfavorable tax position that their reliance causes them not to realize.

While that concern does give me pause in wishing that the IRS had adopted a position that taxpayers are entitled to reliance on FAQs for all purposes, I do find myself still wishing that the IRS had moved more toward the Abreu/Greenstein proposal.  But, perhaps the IRS could have found a middle ground between penalty defense and complete reliance for all taxpayers.  For me, this middle ground would recognize that the service obligations that the IRS owes the economically vulnerable are, frankly, higher than the obligations owed to more sophisticated taxpayers.  It would also recognize that, in addition to failing these taxpayers on the service side, the IRS has also failed these taxpayers on the enforcement side by auditing them at much higher rates than their incomes or percentage of the taxpaying population would justify.

Therefore, while it might be too chilling for the IRS to have to stand behind all written guidance in effect for all taxpayers, is it that unreasonable to ask the IRS to stand behind this guidance for all purposes for taxpayers who are the most likely to depend on FAQ guidance to educate them about social safety-net benefits?  To be specific, I would have liked to have seen the IRS adopt the Abreu/Greenstein model for taxpayers whose incomes for the tax year at issue were below 250 percent of that year’s federal poverty guidelines (the same eligibility standard for LITC representation).  I also would have liked to see the IRS adopt the National Taxpayer Advocate’s recommendation of refusing to assess a penalty for a position taken in reliance on an FAQ in effect for the year in which the return was filed, at least for this subset of taxpayers.  Should the IRS balk at providing this relief towards low-income taxpayers, I would have an extra wrinkle that I would propose—I would give the IRS a way out of having to allow for this heightened level of reliance for these taxpayers by tying it to the IRS’s approach to enforcement against low-income taxpayers. 

My added wrinkle is that the IRS should permit low-income taxpayers to have a higher level of reliance protection for FAQs for as long as the IRS chooses to subject them to heightened levels of enforcement.  As Kim Bloomquist has persuasively demonstrated, “the IRS audits EITC filers at a rate four times higher than non-EITC filers with similar incomes.”  That disparity in audit rates is uncontroversially unjustifiable, and allowing low-income taxpayers to have a higher degree of reliance on all published IRS guidance for as long as this enforcement disparity persists would be a small step towards IRS perhaps recognizing that it in fact has its priorities exactly backwards when it provides more enforcement and less service towards the economically vulnerable.

The IRS took an important step last week towards making its use of FAQ’s much fairer to all taxpayers, and the IRS deserves to be celebrated for this.  Nevertheless, I do hope like other commentators that this might represent the first step towards a more just use of FAQs and, specifically, an acknowledgement that, if the IRS is going to provide heightened enforcement scrutiny of low-income taxpayers, it should be providing heightened service that it stands behind as well.

IRS Recent Guidance on FAQs: Too Little, Too Narrow

Today we welcome back guest bloggers Alice Abreu and Richard Greenstein, Professors of Law at Temple’s Beasley School of Law in Philadelphia, with the third installment in our mini-series on IRS FAQ.

On Friday, October 15, 2021, the IRS finally issued guidance addressing the controversial issue of taxpayer reliance on positions the agency announces in FAQs, which are published on its website (IR-2021-202, IRS updates process for frequently asked questions on legislation and addresses reliance concerns). Acting Chief Counsel William Paul foreshadowed this development at the NYU Tax Controversy Forum back on June 24, as Nathan Richman reported in Tax Notes. Importantly, the new guidance accepts two of the three recommendations made by the National Taxpayer Advocate Erin Collins in her July 7, 2020 blogpost. But, unfortunately, the new guidance suffers from the same shortcomings that attended the NTA’s recommendations.

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As we observed in a PT post a few days after NTA Collins posted her recommendations, those recommendations did not go far enough to address the problem of taxpayer reliance on IRS informal guidance, and protect taxpayer rights. NTA Collins began by positing a taxpayer who wants to know whether an expense is deductible and finds an FAQ on the IRS website saying it is, only to discover when audited that the IRS has changed its position and the examining agent not only denies the deduction but imposes a penalty. As we explained,

We agree with NTA Collins that “[i]f the Taxpayer Bill of Rights is to be given meaning, this scenario violates ‘The Right to Informed’ and ‘The Right to a Fair and Just Tax System.’”  We also emphatically agree that “[i]t is neither fair nor reasonable for the government to impose a penalty against a taxpayer who follows information the government provides on its website.” But we think that by focusing on the penalty, NTA Collins understates the unfairness faced by the taxpayer in this scenario.  Of course it is unfair for a taxpayer to be penalized for doing what the IRS itself said she could do, in a document specifically intended to guide taxpayer actions. And it is also unfair for the IRS to take down the document so that the taxpayer cannot offer it in support of a claim that she had “reasonable cause” for the position that resulted in the alleged underpayment, as provided by IRC § 6664(c)(1), which should allow her to avoid the penalty without reaching the question of whether the FAQ constitutes substantial authority for the taxpayer’s position. Indeed, removing an FAQ from the IRS website after a taxpayer has relied on it may also violate the taxpayer’s “Right to Challenge the IRS’s Position and Be Heard” because the IRS is thereby interfering with the taxpayer’s ability to provide adequate documentation for her position.  We therefore heartily endorse the NTA’s recommendation that the IRS create and maintain an archive of all FAQs issued.

Because the IRS’s recent announcement follows two of the NTA’s recommendations, both our endorsement and our criticisms of those recommendations apply to the announcement as well. First, the announcement does too little, because it respects taxpayer reliance for penalty purposes only. As we develop in a forthcoming article, the argument that a taxpayer who relies on statements made by the IRS in a writing issued for the purpose of guiding taxpayers should not be penalized for so doing, is so robust that to state it is to win it. While it is nice for the IRS to confirm that, in a document on which taxpayers can rely, it is hardly something that taxpayers should be popping champagne corks over.

Second, despite its positive movement on the penalty issue, by refusing to stand by the words it has written to guide taxpayers, the IRS is continuing to behave like the Peanuts character Lucy, who entices Charlie Brown to kick the football, only to pull it away just as he is about to do it. Its behavior violates the taxpayer’s rights to be informed and to a fair and just tax system and impugns the legitimacy of both the agency and the tax system it administers. While we would have preferred that the NTA had recommended that “examining agents not retain the authority . . . to challenge taxpayer return positions if an FAQ has been changed,” we welcomed her recommendation that such authority be retained “in limited circumstances” only (emphasis in original), and that, in such cases “examining agents should be required to consider previously issued FAQs.” We therefore wish the recent announcement had followed that recommendation as well. For us, that recommendation was too tentative, but for taxpayers, the IRS’s following it would have been an improvement over its continuing to behave like Lucy.

The IRS’s recent announcement is also too narrow: it applies only to written statements the IRS makes in FAQs, whereas the fundamental problem addressed by the NTA—taxpayers relying on IRS written information intended for their guidance—extends far beyond FAQs. FAQs captured the limelight because the onslaught of pandemic-relief legislation effective upon enactment led to the need to issue interpretive guidance as close to immediately as possible, causing FAQs to multiply exponentially. But the same reliance problem raised by FAQs arises whenever a taxpayer relies on a statement the IRS makes in one of its publications, instructions to forms, Fact Sheets, and even in correspondence or other documents addressed specifically to the taxpayer.

Despite the recent proliferation of FAQs, the amount of all of this other informal guidance must be greater than the number of FAQs. The scant comfort provided by the recent announcement should have applied to other forms of informal guidance as well. Despite the foregoing criticisms, the recent announcement does make progress toward increasing the legitimacy of the IRS: it shows the IRS as capable of responding to criticism even in the absence of a specific NTA recommendation. In her July 7, 2020 blog post NTA Collins criticized the disclaimers included in some FAQs, which stated that “These FAQs are not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.” See, e.g. IRC § 199A FAQ. As NTA Collins pithily observed in her blog post, “Why should taxpayers even bother reading and following FAQs if they can’t rely on them and if the IRS can change its position at any time and assess both tax and penalties?” Even though the blog post did not make any specific recommendation regarding disclaimers, the IRS’s recent announcement retreats from the arrogant “we’ve said it but it won’t help you in court” stance of current disclaimers. Henceforth, the IRS will include a “legend” in Fact Sheet FAQs explaining that the FAQ

may not address any particular taxpayer’s specific facts and they may be updated or modified upon further review. Because these FAQs have not been published in the Internal Revenue Bulletin, they will not be relied on or used by the IRS to resolve a case. Similarly, if an FAQ turns out to be an inaccurate statement of the law as applied to a particular taxpayer’s case, the law will control the taxpayer’s tax liability.

The change from “it won’t help you” to “we won’t use it against you” may be subtle, but it is not insignificant. Although we would have preferred a change to “you may rely on it,” and perhaps NTA Collins would have as well, by not dismissing reliance in its entirety, the new language is a step in what we think is the right direction. Thank you, Acting Chief Counsel Paul.

IRS Releases Update on Frequently Asked Questions Part 2

Today guest blogger James Creech brings us his take on the recent IRS news release and fact sheet announcing important changes in the agency’s use of frequently asked questions. Part One in this series can be found here. Christine

As an extended filing day surprise the IRS has released a news release on the role Frequently Asked Questions (FAQ) play in tax administration.  Anyone who has been following the expanded role FAQs have been playing over the last few years, especially in the areas of the Employee Retention Credit and Virtual Currency, will not be surprised by the conclusions the IRS reaches in the press release.

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The IRS states that FAQs are not guidance rather they are a form utilized by the Service to quickly communicate general concepts to taxpayers.  From the viewpoint of the IRS, FAQs synthesize authoritative guidance that is binding on the IRS, either through guidance published in the Internal Revenue Bulletin, or the Internal Revenue Code and Treasury Regulations.  The IRS acknowledges that as a general application of the law the statements contained in FAQs may not be perfect and “if an FAQ turns out to be an inaccurate statement of the law as applied to a particular taxpayer’s case, the law will control the taxpayer’s tax liability.”

The most important part of the press release is a statement on what happens if a taxpayer relies on an incorrect FAQ for the purpose of penalty protection.  The press release states “a taxpayer’s reasonable reliance on an FAQ (even one that is subsequently updated or modified) is relevant and will be considered in determining whether certain penalties apply.”  As a practical note the IRS’s reference to updated or modified FAQs is an endorsement of the practice of printing out or saving FAQs that are helpful to a position because once an FAQ is updated the prior version can no longer be found on IRS.gov

Perhaps the most novel point of the press release is that FAQs issued in a press release have more weight than FAQs simply published to IRS.gov without fanfare.  This is an extrapolation of Treasury Regulation 1.6662-4(d)(3)(iii) that lists “Internal Revenue Service information or press releases” as types of authority that can be relied upon for penalty protection even though FAQs are conspicuously absent from the regulation.  Although the IRS as assured practitioners that it does not take positions contrary to FAQs it may be worth saving all of the IRS emails in your inbox in case you ever need to show that certain FAQs were part of an “information or press release”. 

The IRS has stated that in the near future it would begin archiving all FAQs and would release more formal guidance about reliance on FAQs for the purposes of penalty protection.  Until then this press release will have to suffice about the interaction of FAQs, weight of authority, and penalty protection.

IRS Releases Update on Frequently Asked Questions Part 1

Last week the IRS issued a news release and fact sheet discussing its use of frequently asked questions. The IRS’s practice of using FAQs has been the subject of many Procedurally Taxing blog posts. This week we will run a series with different practitioners offering their perspective on the development. Today, we hear from frequent guest contributor Monte A. Jackel, Of Counsel at Leo Berwick. Les

In The Proper Role of FAQs, I discussed certain aspects of the use of FAQs in the tax system. I also wrote a short note in Tax Notes on the same topic at around the same time. See A Question of Two About FAQs (March 2, 2020).

The IRS very recently published an announcement on October 15, 2021 on the subject of FAQs, following up on its earlier promise to provide a more structured institutional approach to the use of FAQs in the federal tax system. See IRS Announcement On FAQs. A Tax Notes story on this announcement followed the next day. Tax Notes Story On FAQs. The announcement explains how the IRS plans to maintain information about when versions of FAQs have been released, as well as whether and how taxpayers can rely on those FAQs.

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As noted in the Tax Notes Story On FAQs, the announcement doesn’t go so far as to actually update the very much out of date accuracy related penalty regulations (particularly reg. sections 1.6662-4 and 1.6664-4), “but it does state that FAQs published in fact sheets will satisfy both the reasonable cause defense to tax penalties that allow it and can be part of a taxpayer’s assertion of substantial authority on a tax return. It also says that the FAQs and any resulting changes to them will be announced in news releases.”

I have a few questions about this FAQ announcement. First, does it matter that the pertinent regulatory list of authorities references “press releases” at reg. section 1.6662-4(d)(3)(iii), whereas this IRS announcement references those FAQs which can provide penalty protection as “news releases” that will incorporate the fact sheets published on IRS.gov? This should be clarified. However, it is believed that the two terms are intended to mean the same thing.

Second, the so-called “minimum legal justification” for tax shelters under reg. section 1.6664-4(f) requires the use of authorities at a MLTN basis as a minimum standard to establish reasonable cause and good faith when a tax shelter is involved. (The regulations expressly deal with corporate tax shelters because the statute was amended later on to apply to all tax shelters and the regulations do not reflect the statutory change.)

The extent to which this particular provision will be affected by the announcement is unclear given that a fact sheet FAQ issued in the future under the designated news release process could encompass a transaction that could be treated as a tax shelter under section 6662(d)(2)(C). This outdated regulation would have to control over the announcement and so, what now given that the term “tax shelter” as amended in 1997 remains undefined in the regulations to date.

Third, the disclaimer referenced in the announcement is only mandatory for the new FAQs (new legislation and emerging issues) but the reliance as reasonable cause and good faith, or as an authority, applies to all other FAQs, even those previously issued, but those other FAQs need not have a disclaimer. Why not?

Fourth. Why are the new FAQs (called fact sheet FAQs) limited expressly to new tax legislation with the possible expansion to so-called “emerging issues” (which is not a defined term)? It is understandable that new legislation would most often have a compelling need for immediate guidance but aren’t the chances for error on the part of the IRS equally great in this instance?

And what of the so-called “emerging issues”? Perhaps the thought there is that new topical and time pressure items can be showcased as a fact sheet FAQ because the IRS wants initial feedback on the approach it may want to later take in regulations and using FAQs in this manner could easily bypass the Administrative Procedure Act (APA)?

Speaking of the APA. There is currently a dispute in the Sixth Circuit Court of Appeals relating to two opposing district court opinions in that circuit on whether the APA requirement of advance notice and comment for legislative rules applies to IRS notices issued pursuant to regulations under section 6011 with respect to listed transactions. Update on CIC Services: The Scope of Relief Available if A Court Finds That An Agency’s Rulemaking Violates the APA

If the Sixth Circuit decides that such notices violate the APA, then even though it would just be one circuit, confusion would then surely resurface with respect to fact sheet FAQs.

Even though this announcement is not being issued pursuant to regulations granting such authority to the IRS, the question that arises is this; why shouldn’t that be done?  After all, we would not be talking about a long regulation to do this. Is the IRS worried about the result of an adverse Sixth Circuit opinion that would certainly carry over to FAQs?

We shall see.