What to Do After Receiving a Notice of Claim Disallowance

The National Taxpayer Advocate wrote a blog post last month highlighting a potential trap for the unwary who receive a notice of claim disallowance and think that they have worked out or are working out a resolution.  In oversized bolded letters, she stated:

If you are working with the IRS or the IRS Independent Office of Appeals (“Appeals”), do not make the mistake and assume that working toward a resolution equates to the IRS’s ability to pay a refund or allow a credit once the IRC § 6532 statute has expired.

The NTA made this statement because IRC 6514(a)(2) “prohibits the IRS from paying the refund or allowing the credit” if more than two years has passed from the notice of claim disallowance.  In order to preserve the right to obtain payment beyond the two-year period, the taxpayer must either file suit or ensure that they and an authorized IRS employee sign a Form 907, Agreement to Extend the Time to Bring Suit.


The NTA felt it necessary to write the post highlighting this issue because of the significant and unusual delays the pandemic has caused.  Taxpayers might think they have worked something out with the IRS to resolve an issue after the notice of claim disallowance, but unless the IRS actually takes action within the two years to pay the refund or allow the credit, the taxpayer can lose out.  In the current climate, matters can take more than two years to resolve.

The advocate lays out the problem in stark terms as she describes the administrative process of contesting a claims disallowance letter:

Once the notice of claim disallowance is received, a taxpayer needs to send a protest to the issuing office contesting the disallowance. This assumes the taxpayer understands the notice and the requirements, as these notices are not always clear. (See the National Taxpayer Advocate 2014 Annual Report to Congress, Refund Disallowance Notices Do Not Provide Adequate Explanations.) With the delays in processing correspondence, these protests may sit for many, many months before being addressed. Once assigned, the IRS employee assigned to the case needs to obtain the administrative file, bundle it with the taxpayer’s protest, and send it to Appeals for consideration. Unfortunately, the backlog adds more delays to this process. Once a protest is assigned to Appeals, it still needs to be assigned to an Appeals Officer and worked, which could be an additional six to 12 months. If the issue involves whether the claim was timely, and the Appeals Officer concludes that it was, the case may be transferred back to Exam for a determination on the merits of the refund claim. If the IRS and the taxpayer do not agree on the merits, the taxpayer can file another protest with Appeals to contest the merits of the underlying claim and the process starts all over. It is not surprising that this process may take over two years to be resolved, exceeding the two-year period in which a refund could have been issued (or a credit allowed).

While the Form 907 extension exists to remove the pressure of the two-year time period in this circumstance, executing that form may not always solve the problem.  The blog also points out that representatives must ensure that their power of attorney designates the Form 907 as an act within their scope of representation.  Of course, the IRS must agree to the Form 907.  A taxpayer cannot unilaterally execute a binding extension agreement.  Look to IRM to find the reasons that will cause the IRS to agree to extend the time.

The NTA also points out that sometimes no one at the IRS has the case under assignment.  In that situation the taxpayer will struggle to find someone at the IRS willing and authorized to sign Form 907.  For this reason, the NTA suggests starting the process of getting the Form 907 filed 4-6 months before the running of the two-year period. 

If a taxpayer cannot obtain the necessary signature as the two-year period approaches, filing a refund suit may provide the taxpayer’s only option.  The NTA states the IRS could extend the time period by exercising its authority under IRC 7508 as it has done for several pandemic-related matters; however, it has not done so for the two-year period for refund.

Be aware that filing a refund suit has slightly different timing rules than the filing of a petition in Tax Court.  The timely mailing is timely filing rule of IRC 7502 does not apply.  Carl discussed this in a post a few years ago.  A recent unpublished opinion of the Federal Circuit also addresses this issue.  In Weston v. United States, No. 22-1179 (Fed Cir. 2022), an unpublished opinion [appearing in Tax Notes Federal on April 14, 2022], the Fed. Circuit affirmed the dismissal of a pro se complaint for Lack of Jurisdiction for late filing under the 2-year rule of 6532(a).  No new law was made, and there was no way the taxpayer could have won her case under 6511, anyway.  The taxpayer filed joint 2012 and 2013 returns with her deceased husband in mid-2017 – more than 3 years late.  The returns showed overpayments.  The claims were timely under 6511(a) (filed on the same day as the returns), but would be limited to zero under 6511(b)(2)(A).  The IRS sent her notifications of claim disallowance on April 4, 2018 (for 2013) and April 11, 2018 (for 2012).  She mailed a complaint to the Court of Federal Claims on April 11, 2020, which arrived at the CFC and was filed on April 20, 2020.  Of course, the 2013 disallowance 2-year period ran before she mailed.  But, she argued for timely filing for the 2012 year because of timely mailing of the complaint.  She lost because 7502 applies to filings with the IRS and the Tax Court, but not with any other court. 

The NTA’s post provides a good reminder of yet another hurdle created by the pandemic.  Don’t let this hurdle prevent your client from obtaining a refund.

Summary Opinions for the week ending 3/27/15

How could I not start with John Oliver and Michael Bolton singing about the IRS.  This link is not really great for work, and to say it is sophomoric may overstate the sophistication and maturity.  Sexy singing is at the end of a fairly long clip, which is all pretty funny (on the IRS, “it combines two things we hate, people taking our money and math”).  This is probably the funniest Michael Bolton clip from the month, which is really impressive since it is about the IRS and he recently recreated the Office Space scenes with the character sharing his name – if you liked that movie, you should find the clip.  Equally as entertaining and enlightening were our guest posters during the week ending March 27, 2015.  Peter Hardy and Carolyn Kendall of Post & Schell did a two part post (found here and here) regarding the definition of willfulness in civil offshore enforcement cases.  First time guest poster, Bob Nadler, posted on the recent Sanchez case dealing with an interesting innocent spouse issue that hinged on whether a joint return was actually filed.  Thank you again for the great content.

I also need to thank our guest posters from the last week and a half.  Carlton Smith provided two of the three posts on the Godfrey case, the last of which can be found here and links to the first two.  Godfrey is an interesting case raising a couple issues regarding appropriate notice with collection actions.  We were also pleased to have Prof. Bryan Camp with a three part post on Eight Tax Myths, the last of which can be found here and links the first two.  Both sets of posts were very well received, and both generated a fair amount of discussion.  I would encourage everyone who has not read both sets to do so, and, for those who have, you might consider going back and reading the comments and responses.

To the other procedure: 


  • In a FOIA dump, the Service has released PMTA 2014-015, which discusses the erroneous refund penalty under Section 6676.  The following points are discussed in the memo:

1. Does the Section 6676 penalty apply to refund claims made on Form 1040 and Form 1040X and does it matter whether the Service has paid the claim?

2. Does the nature of the item to which the excessive amount is attributable have any bearing on the penalty?

3. Is the Section 6676 penalty subject to deficiency procedures?

4. Are there any specific taxpayer notifications required for the penalty to apply?

5. Does the ‘reasonable basis’ exception to the Section 6676 penalty have the same general meaning as the reasonable basis exception to negligence found in Reg. 1.6662-3(b)(3)?

 I’m not sure there are any earth-shattering realizations to be found in the IRS response, but some points seem worth noting.  As to the first point, the Service stated the penalty can be imposed even when the IRS does not actually refund the amount requested.  For the second point, the Service discussed the various situations where other penalties would apply (reportable transactions, EIC, etc.).  As to the third question, the Service stated the general rule that the penalty is not subject to the deficiency procedures, but stated that for some refundable credit cases the penalty will have to be assessed pursuant to the procedures.  No court has apparently addressed either point.  The last thing that jumped out at me was that the Service stated the reasonable basis exception under Section 6676 has the same meaning as under the accuracy related penalty provisions found in Section 6662, which is not news, but good reinforcement of the prior position.

  • Harper Int’l Corp v. US is a case we (I) missed in January (see page 13 of this PDF for a more robust recitation of facts and holding).  In the case, the IRS denied a refund request.  On May 2, 2012 the IRS issued a Notice of Disallowance, which stated the taxpayer had two years to challenge the determination.  About a month later, another notice was received by the taxpayer, stating the claim was rejected and another formal Notice of Disallowance would be issued – but it never was.  Taxpayer petitioned the Court of Federal Claims in June of 2014, more than two years after the first letter, but less than two years after the second letter.  The Court of Federal Claims held that although equitable provisions might apply, it was not reasonable for the taxpayer to rely on the second notice (and they failed to comply even if using the date of the second notice because timely mailing was not timely filing for CFC).
  • Another sham(wow) partnership case in CNT Invest., LLC v. Comm’r, where the Tax Court has held that gain recognized in a collapsed step of a multi-step transaction was gross income for determining the extended statute of limitations under Section 6501(3)(1)(A).  Case also confirmed limitations period was the longer of the period found under Section 6229 or Section 6501.
  • Businessweek thinks the IRS sucks.  The reasons are largely outlined by the John Oliver video above.  I’m sure this has generated a lot of scoffs, but I honestly do try to keep this in mind as I sit on hold for 90 minutes.  Maybe it helps me from being a complete jerk to the person who eventually picks up.  Solid chance that person’s day is worse than mine. How much longer before this all implodes? Is that the goal?  Might work.
  • Kardash v. Commissioner was decided by the Tax Court on the 18th, and has a good discussion of transferee liability but a difficult result for taxpayer minority shareholders in a company where the Service found transferee liability for tax due that was the result of theft by the majority shareholders.  This is going to get a little longwinded, sorry.  In Kardash, a concrete company was largely owned by two shareholders, who controlled all aspects of the business.  Two other minor shareholders oversaw sales and operations; neither had any control over the overall management or finances of the company.  During the early 2000s, the company was very successful and the minority shareholders received huge additional compensation.  Unfortunately, during this time, the majority shareholders were plundering the coffers and not paying any taxes ( one of whom is in the clink and the other is no longer with us).  Here is some more background on that sad story.  The finances of this company were apparently open for the taking, as two other employees were jailed for stealing over $5.5MM from it before the IRS got involved.  On audit, for 2003 to 2007, the Service assessed over $120MM in tax, penalties and interest.  The company was insolvent at that point, payment was not possible, and the company and the Service entered into an installment agreement to pay $70,000 a year until the end of time.  The Service reached agreements with the two majority shareholders, but substantial amounts of tax were still outstanding.  The Service then attempted to recoup a portion of the remaining amount from the minority shareholders pursuant to Section 6901(a).  For Kardash, the amount was around $4MM.  There were a host of questions before the Court regarding the IRS’s collection actions against the company and majority shareholders cutting off liability, but what I found interesting was the issue about whether, under state law, the minority shareholders were responsible for the tax due to fraudulent transfers to them by the majority shareholders.

For the fraud, the Court looked to Florida law to determine the extent of the potential transferee liability.  As an initial point, the Court did not aggregate the transfers with those of the majority shareholders (contrary to the Service argument), and instead looked at each payment to the minority shareholders to determine constructive or actual fraud of each payment.  The FL statute provides that if the company did not receive “reasonably equivalent value” for the payments, they may be fraud if: “(1) the debtor was engaged…in a business…for which the remaining assets of the debtor were unreasonably small…;(2) the debtor intended to incur…debts beyond his ability to pay as they became due; and (3) the debtor was insolvent at the time of the transfer or became insolvent as a result of the transfer.”  Kardash argued his work for the company was reasonably equivalent value, and the Court agreed for certain “loans” in 2003 and 2004, which were really advanced on compensation.  For 2005 through 2007, the funds were provided to Kardash in the form of a dividend from the Company.  The Court noted the conflict in cases regarding the treatment of dividends as “reasonably equivalent value” as compensation for work done.  The Court seems to indicate the general position is that dividends are not compensation for services rendered and therefore not an exchange for value.  In the limited cases holding the opposite, the dividend has been directly tied to work provided.  See In re Northlake Foods, Inc., 715 F3d 1251 (11th Cir.) (holding dividend made as tax distribution to pay tax due on s-corp shares); In re TC Liquidations, LLC 463 BR 257 (ED NY 2011) (dividend made to shareholder to repay loans taken out to expand business).  Although I have not read these cases, this seems like a point that could be open to other interpretation in this case.  The dividends here effectively replaced a prior bonus program.  The program was stopped and the company made the loan/advances to the minority shareholders because the company knew the minority shareholders needed that level of compensation.  This was a temporary solution until the dividends were to start.  Since at least a portion was compensation provided in a different form, a finding that it was received in exchange for equivalent value would not seem unreasonable in this case.  The Court did address this by stating the company did not benefit from the dividends as clearly as in the above two cases, but I am not sure I agree.  Had the dividends not be issued to take the place of the prior bonus program and advances, the minority shareholders may have left.  During the period in question, the company was very successful, arguably because of the minority shareholders.  The second reason is that the company and shareholders treated it as dividend income and not compensation.  Although a factor worth consider, I am not sure it has to be dispositive.

The issue of insolvency was reviewed next, with a few pages devoted to the debts and income stream.  The Court relied on the IRS’s expert’s opinion that since there were no tax returns, no buyer would ever pay more than the gross value for the land and tangibles, and the company had no intangibles.  Based on that, the company was insolvent most of, if not the entire time.  Interestingly, the opinion includes the gross revenue, but I don’t think it includes the asset values.  Ignoring the various other ways to value a company, I think this is also open to other interpretation.  I am not sure the conclusion that no one would be willing to buy the company is correct—obviously that would be a substantial risk, but business people often take risk if the reward appears sufficient.  I am also not sure the value of the intangibles was $0, since the revenue for the years in question was north of $100MM, which was substantially more than the hard assets.  Clearly, the company, as a going concern, had some value that exceeded hard assets.  The company may have still been insolvent, I just wasn’t sold on those particular points.  An interesting case, and what seems to be a tough result for some transferees who were screwed by their employer.

  • The Service has issued internal guidance indicating that it will no longer allow taxpayers to enter into installment agreements for post-petition liabilities when the taxpayer has filed for Chapter 13 bankruptcy.  The guidance indicates that this was previously allowed in some jurisdictions, but that the Service believes this potentially violates the BR stay.
  • 2014 data book has been issued by the Service in electronic form, and can be found here.  Lots of interesting stuff.  Looks like 40% of penalties were abated in terms of amount.  Less business returns, but more individual in 2014 than 2013.
  • Barry and Michelle paid an effective tax rate of 18.8% (maybe slightly higher –I’m finding some conflicting reports and too lazy to do the math) for federal income tax purposes.  I think that is a little higher than mine…although we made slightly different amounts.

What good is your right to challenge the IRS’s position if you have no idea what it is?!

Today we welcome first time guest blogger Mandi Matlock. Mandi splits her time between private practice where she is an associate at Mondrik & Associates and Texas RioGrande Legal Aid where she founded the low income taxpayer clinic. I know Mandi through her work in the clinic.  Because she has a significant background in consumer law, she brings a perspective to tax law issues informed by her other practice knowledge.  In addition, she is the chapter author in Effectively Representing Your Client before the IRS of the chapter on the special tax issues faced when disaster strikes.  This post picks up on an issue identified by the National Taxpayer Advocate in her annual report and examines the problems created when the IRS fails to explain why it is disallowing a claim for refund.  Keith

National Taxpayer Advocate Nina Olson released her Annual Report to Congress this January expounding on her oft-repeated mantra that the continued erosion of taxpayer service does not bode well for future tax compliance or for public trust in the fairness of the tax system. In this blog post, we take a look at the Annual Report’s Most Serious Problems #17, which focuses on how deficient refund disallowance notices are harming taxpayers.

The Service’s specific problem here starts with that tiny little subsection endcapping Section 6402. It says that when the Service disallows a refund claim, it “shall provide the taxpayer with an explanation for such disallowance.” IRC 6402(l). How hard could that be, right?

Well, scrutinizing the Service’s efforts closely through the lens of the Taxpayer Bill of Rights, as the National Taxpayer Advocate did in her Annual Report, it turns out the Service has more than a little trouble complying.


How Does the Service try to Meet its Obligations?

The Service uses of a patchwork of over 50 different claim disallowance notices, some of which are required by statute, to notify taxpayers of its decision to deny or partially deny a refund claim. In an obvious attempt to comply with 6402(l), various subsections of the IRM require these claim disallowance notices to contain specific reasons for the disallowance and an IRC section where possible.

The Annual Report categorizes the claim disallowance notices it reviewed as either statutory or non-statutory. The statutory notices are those the Service is required by statute to send by certified or registered mail to commence the two-year statute of limitations for challenging the denial by filing a refund suit in a United States District Court or the Court of Federal Claims. They include stand-alone notices such as Letters 105C and 1364 as well as any number of so-called combo-notices, such as Letter 3219 or even a Statutory Notice of Deficiency issued during an examination in which a refund claim is pending.

The non-statutory notices alert the taxpayer that a refund claim was denied, but have no effect on the statute of limitations for filing a refund suit. They include Letter 569 (SC), the initial letter from Examination proposing to deny or partially deny a claim for refund, and Letters 2681 and 2683 from Appeals sustaining a prior decision to deny a refund claim. Non-statutory notices may be sent before or after a statutory notice a statutory notice of claim disallowance. For example, Appeals may issue a non-statutory notice informing a taxpayer of its decision to sustain the denial of a refund where Examination has already sent a statutory notice of claim disallowance. There are some instances where the non-statutory notice is the only notice ever sent (i.e., cases where the taxpayer has signed a waiver of his or her right to statutory notice of claim disallowance).

TAS also included in its review what it called “no consideration” letters, which notify a taxpayer IRS will not consider his or her refund claim because it is somehow deficient. It makes sense to include these no consideration letters in the review because they work to deny refund claims in cases where the no consideration letter itself is so deficient the taxpayer has inadequate information with which to respond and remedy the defects in the original refund claim.

The Treasury Inspector General for Tax Administration found in a recent report that half of IRS letters and nearly two thirds of IRS Notices were not clearly written and did not provide sufficient information. Need we invoke the horror of the old CP-2000 Notices that rambled on with multiple pages of irrelevant and confusing explanations for items of income and equally irrelevant and confusing exceptions to the irrelevant items of income? You get the picture. But do refund claim disallowance notices suffer from similar logorrhea?

The Annual Report Gives Appeals and Examination an “F”

The IRS falls short in its efforts to comply with the letter and spirit of Section 6402, according to the Report, thereby interfering with at least two of the rights guaranteed under the Taxpayer Bill of Rights: the right to be informed and the right to challenge IRS’s position and be heard. The Taxpayer Advocate Service reviewed a sample of refund disallowance notices and found shortcomings running the gamut from notices providing no explanation at all(!) to notices providing lengthy, confusing explanations that nevertheless failed to supply adequate specific information from which a taxpayer could determine how to respond. Oh my!

What good is the gleaming new guaranteed right to challenge the IRS’s position if you have no idea what that position is?! How will you prepare your reply and exercise your right to be heard if you can’t figure out what the issue is in the first instance? Don’t even think about calling IRS for clarification. IRS projects it will be able to answer fewer than half of taxpayer calls in FY 2015. Those taxpayers who do manage to get through will be speaking with an IRS employee who most likely has no access to a copy of the correspondence because IRS does not keep copies of the most frequently used claim disallowance letters.

What specifically did the Annual Report find with respect to refund claim disallowance notices? Letters 105C and 106C variously failed entirely to state the specific reason for the disallowance, failed to state clearly and understandably the specific reason for the disallowance, failed to provide information adequate to permit a taxpayer to dispute the disallowance, or some combination of the three. TAS determined 92% of 105C letters reviewed failed to satisfy the purpose of 6402(l). 65% did not provide information necessary to respond. More than half did not adequately explain the reason for the disallowance. Almost a third contained sections that were not written in clear, plain language. The Report also finds fault with Appeals’ use of Letters 2681 and 2683, neither of which is designed to provide an explanation at all.

Specific examples cited in the report include notices that provided inapposite information, failed to identify which item of income was being disallowed, failed to identify which dependent, credit, or other tax benefit was being disallowed, and failed to correctly state the amount of the claim being denied.

How Far Should the Service Go?

But how much disclosure is too much disclosure? This is the perennial struggle of consumer rights advocates. Have you tried to struggle through your Cardholder Agreement for one of your credit cards lately? How about your home loan closing documents? Now consider that these documents are the streamlined – yes streamlined – products of decades of legislation and regulation intended to benefit consumers by mandating clear and conspicuous information in a format that consumers can understand. In short, as disclosure experts lament, better writing on its own cannot simplify complex concepts.

While proponents of increased disclosure view it as a means to empower consumers and increase market transparency, detractors complain disclosures are inaccessible to uneducated consumers in any event, and still other commentators take the cynical view that businesses gleefully agree to increased disclosure to avoid substantive reform and lull consumers into complacency with white noise. A recent New York Times piece sheds some light on that interesting debate.

Thank goodness the issue of disclosure in this context presents a much simpler paradigm. For example, while the Annual Report highlights certain notices’ “complicated descriptions” of refund statutes, the criticism remains largely on the Service’s failure to provide the underlying dates the Service relied on to deny the refund claims as untimely. Thus a recipient of one of these notices who may understand the Service’s complex description of the law still cannot adequately respond because he or she doesn’t know what basic facts IRS relied on. While the underlying legal issue can at times be so complex as to frustrate efforts to explain it in clear language accessible to all taxpayers, the Service can start by always including the taxpayer’s specific facts that were operative in the IRS’s decision-making process.

The Report heaps praise on the Innocent Spouse Unit and holds up its denial and no consideration letters as models of clarity the Service should look to in revising the Examination and Appeals correspondence and procedures. I think we can all agree the innocent spouse law is complex. And yet the IS Unit manages to explain it while also providing adequate information for taxpayers to understand its decision and how to respond. A great example of the Service striking the right balance!

We agree with the NTA that IRS can get refund claim disallowance notices right the first time. In view of the statutory mandate and the equally important Taxpayer Bill of Rights, it must!