Lesson From The Tax Court: Don’t Confuse Dummy Returns With Substitutes For Returns

October 13, 2022 by Leave a Comment

We welcome back Professor Bryan Camp, the George Mahon Professor of Law at Texas Tech School of Law, who offers guidance on the §6020 SFR process and the §6212 deficiency process. Every Monday, Professor Camp publishes posts like this one in his “Lesson From The Tax Court” series on the TaxProf blog. This post is a cross post that originally appeared on the TaxProf blog on October 3rd.

The act of filing a return is central to tax administration. Section 6011 sets out the general requirement: “any person made liable for any tax imposed by this title” must file a return “according to the forms and regulations prescribed by the Secretary.”  Section 6012 gets more granular and gives more specific requirements and exemptions from filing.

When a taxpayer fails to file a return, even after being reminded to do so, the IRS can simply send the taxpayer a Notice of Deficiency (NOD), and let the taxpayer either agree to the proposed tax liability or petition Tax Court.  Or the IRS can follow the §6020 Substitute For Return (SFR) process whereby it creates a return for the taxpayer either with or without the taxpayer’s cooperation.

Regardless of how the IRS deals with the non-filer, an IRS employee first needs to create an account in the computer system for the relevant tax period.  They do that by inputting the proper Transaction Code and preparing what is called a “dummy return” to support it.  But there is one important difference between dummy returns used to set up the NOD process and dummy returns used to set up the SFR process: the §6651(a)(2) failure to pay penalties only apply to the failure to pay taxes shown on a “return.”  Thus, the penalties do not apply to bare NODs.  They do apply to SFRs.  That’s why today’s lesson is useful.

In William T. Ashford v. Commissioner, T.C. Memo. 2022-101 (Sept. 29, 2022) (Judge Vasquez), we learn what to look for in the IRS files to see whether a dummy return used by the IRS leads to a proper SFR or not.  We also learn why you cannot always trust the advice you see on the IRS website.  Details below the fold.

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The IRS has a choice of two ways to proceed when it determines a taxpayer has failed to file a required return: the §6020 SFR process or the §6212 deficiency process.  Let’s take a quick look at both.

    A.  The §6020 SFR Process

Section 6020 has two subsections.  Section 6020(a) permits the IRS to prepare the taxpayer’s return with the cooperation of the taxpayer.  I call that the friendly SFR because that return will be treated as the return of the taxpayer for all purposes.  For example, it starts the §6501 assessment limitation period.  It counts as triggering the various bankruptcy discharge clocks. 11 U.S.C. §523(a) (flush language).  It means the taxpayer cannot be tagged as a non-filer.  That’s not really on the plate for today’s lesson, although the difference between what constitutes a 6020(a) and 6020(b) SFR is very interesting and not entirely intuitive.  See Bryan T. Camp, “The Never-Ending Battle,” 111 Tax Notes 373 (Apr. 17, 2006).

Section 6020(b) is the unfriendly SFR.  It provides that when the taxpayer does not cooperate, the IRS is authorized to “make such return from [its] own knowledge and from such information as [it] can obtain through testimony or otherwise.”  Unlike §6020(a), §6020(b) SFRs are not always treated as returns of the taxpayer.  Generally, it’s a heads-I-win, tails-you-lose proposition.

On the one hand, for example, almost all courts refuse to construe a §6020(b) SFR as the taxpayer’s return when to do so would permit the taxpayer to discharge of a tax liability in bankruptcy.  See generally Ken Weil’s excellent post on the exception that proves the rule: “Rare Discharge in Bankruptcy for Taxpayers with a Return Filed After an SFR Assessment,” Procedurally Taxing Blog (May 22, 2022).

On the other hand, §6651(g) provides that such a return will count as the return of the taxpayer for purposes of computing the §6651(a)(2) penalty for failure to pay the tax owed. That’s an important point for today’s lesson.  Until 1996, a §6020(b) SFR was not deemed to be a “return” within the meaning of §6651(a)(2).  See generally Rev. Rul. 76-562, 1976-2 C.B. 430.  That is because §6651(a)(2) imposes the failure to pay penalty only as to what is “shown as tax on any return.” Before 1996, both courts and the IRS interpreted that to mean the return of the taxpayer.  That perverse situation rewarded obstreperous taxpayers and penalized cooperative ones.  Congress fixed the problem (at the urging of the IRS and Treasury) by adding §6651(g).  Section 6651(g) now properly aligns the consequences with the behavior.

Construing a §6020(b) SFR against a taxpayer this way makes sense, if you view it as a result of taxpayer noncompliance with the §6011 filing duty.  To treat it the same as voluntary returns would undermine compliance.  That is what happened before 1996 as to the §6651(a)(2) failure to pay penalties.  But it is not always clear that a 6020(b) SFR results from bad-acting taxpayers, because the process is almost entirely automated and relies upon taxpayers responding to automated notices.  As we all know, a notice properly sent is not always actually received.  A taxpayer’s failure to respond thus may or may not be due to bad faith.

The §6020(b) SFR process is pretty much run by computers with minimal human oversight in a system called the Automated Substitute for Return (ASFR) process.  See generally IRM 5.18.1 (Automated Substitute for Return (ASFR) Program)(March 11, 2020).  The ASFR draws from the Information Return Program (IRP) where the IRS collects and stores everything received on third party information returns such as W-2s and 1099’s.  The ASFR creates an SFR package and sends it to the taxpayer’s last known address giving the taxpayer 30 days to respond.  The 30-Day Letter package is fully automated.  See generally, IRM 5.18.1.6.5, Letter 2566. If the taxpayer makes no response, the computers then generate an NOD, giving the taxpayer the usual time to petition Tax Court.  For a more complete description of the ASFR process, see TIGTA Report 2017-30-078, “A Significantly Reduced Automated Substitute for Return Program Negatively Affected Collection and Filing Compliance,” (Sept. 29, 2017). 

Note too that the traditional TC 150 used to open a Tax Module using a dummy return seems to have now been changed to TC 971 with Action Code (AC) 143.  Whenever you see a TC 971 on a transcript you have no idea what it means unless you look carefully at the associated AC because the TC 971 is the Swiss Army knife of transactions codes: it’s used for a wide variety of situations unanticipated when the Automated Data Processing system was first constructed long, long, long ago.

Back to the SFR.  If the IRS chooses to use the SFR process, it thus needs to be sure to create an SFR.  Otherwise, the NOD it sends out will not be treated as resulting from an SFR but will instead be treated as arising from the second way the IRS can deal with non-filers.  Let’s take a look at that first before we get to the lesson on how to tell whether the IRS has created an SFR.

    B. The Deficiency Process

From 1862 to 1924, the SFR process was the only way for the IRS to deal with non-filers.  And once it prepared the SFR it could immediately assess the tax.  There was no deficiency process.  See e.g. Revenue Act of 1913, 38 Stat. 114, at 178 (mandating immediate assessment).

The Revenue Act of 1924, 43 Stat. 253, 296 created the deficiency procedures now codified in §6211 et. seq.  That worked a profound change in tax administration.  While the law had long allowed taxpayers who disagreed with proposed increases to tax a right to conferences within the IRS, the 1924 Act now forbade the IRS from assessing an income, estate or gift tax against a non-consenting taxpayer until after the taxpayer had the chance for pre-payment review by an independent quasi-judicial body.  That body started out as the Board of Tax Appeals (BTA) and morphed over time to its current status as the Tax Court.

In the early days the IRS tried to argue that it did not have to use the deficiency procedures to assess the tax it created on a §6020(b) SFR, but the BTA quickly rejected that position. See Taylor v. Commissioner, 36 B.T.A. 427 (1937) (requiring IRS to follow deficiency procedures when it had prepared return without consent or cooperation of the taxpayer).

Thus the IRS must issue an NOD even after it creates an SFR.  But it does not have to create an SFR in order to issue an NOD to a non-filer.  Courts have long rejected taxpayer arguments that the IRS was limited to the SFR process and that an NOD was invalid against a non-filer unless the IRS’s first prepared an SFR.  See United States v. Harrison, 72-2 USTC ¶ 9573 (S.D.N.Y. 1972)(I cannot find free link, but Judge Weinstein gives an excellent discussion of legislative history); see also Hartman v. Commissioner, 65 T.C. 542, 545 (1975)(taxpayer’s failure to file a return and IRS decision not to prepare a substitute for the return under §6020 did not invalidate the NOD).

So the IRS can choose how to address a non-filer.  However, even though the IRS has the option to forgo the SFR process, it generally chooses the SFR route, for several reasons.  First, perhaps most importantly, encouraging and helping taxpayers prepare and file their own returns has long been recognized as an important part of the IRS mission.  It makes sense administratively to use upstream resources to get as many taxpayers into compliance as possible before using downstream resources for enforced collection.  See e.g. Policy Statement P-5-133, IRM 1.2.1.6.18 (08-04-2006).  Before a taxpayer’s account goes into the ASFR program, the IRS will have sent the taxpayer at least two “soft” notices asking the taxpayer to file.  Again, however, that sending does not ensure actual receipt.

Second, preparing a §6020(b) return betters serves compliance purposes because §6020(b) SFRs now trigger the §6651(a)(2) addition to tax for failure to pay the amount shown on the “return.”  No such addition can be proposed if the IRS simply sends an NOD.

Finally, a §6020(b) SFR will almost always preclude the taxpayer from obtaining a discharge of the taxes in bankruptcy. See e.g. In Re: Payne, 431 F.3d 1055 (7th Cir. 2005), and cases cited therein.

In contrast to the SFR, if the IRS just sends out an NOD, the well-advised non-filer will promptly file returns to minimize penalties, set up a potential bankruptcy discharge, and start the §6501 limitations period running.  I’m not saying that will always work, but the taxpayer certainly has a better shot than if the IRS has sent the NOD based on a §6020(b) SFR. See e.g. Mendes v. Commissioner, 121 T.C. 308 (2003) (Form 1040 reporting zero tax liability filed 48 months after receiving a notice of deficiency and 22 months after Tax Court petition was not a valid for §6654(d)(1)(B) safe harbor purposes).

    C. The Dummy Return Problem: How To Tell Which Process The IRS Is Using?

So how do you tell whether the NOD being issued is based on an SFR or just a bare NOD?  After all, both processes result in an NOD.  And yet they have some very different consequences for taxpayers.

Part of the problem is that the IRS initiates both the 6020(b) process and the notice of deficiency process the same way:  it opens what is called a Tax Module on the computer system in order to process documents and track the work done.  Because of various and ancient computer design decisions dating back to the 1950’s, the IRS employee who creates a Tax Module needs a return to do so.  If there is no taxpayer-prepared Form 1040 to use (for income taxes), the employee will use what is basically a fake 1040 to support opening the module.  That fake form is often called a “dummy return.” In the ASFR program, the Tax Module often opens before the IRS pulls enough information from third parties together to come up with a proposed tax liability.

But while that dummy return helps create the Tax Module it cannot, in and of itself, create an SFR.  The Tax Court has held that dummy returns do not serve as a §6020(b) return.  They need something more.  Only when the IRS also creates records which support an assessment, properly associates those documents contemporaneously, and some authorized IRS employees signs off on the package will the dummy return caterpillar transform into a beautiful §6020(b) butterfly.  Millsap v. Commissioner, 91 T.C.  926 (1988).  For example, in Cabirac v. Commissioner, 120 T.C. 163 (2003), the Court denied the §6651(a)(2) failure to pay penalties because it decided that while the revenue agent’s report dated May 31, 2000, “contained sufficient information from which to calculate petitioner’s tax liability” it was not sufficiently contemporaneous with the dummy return used to open the Tax Module on February 23, 2000.

For years there was litigation over whether and when the IRS had properly created an SFR.  In 2008 Treasury issued final regulations to try and create more certainty.  See 73 Fed. Register 9188.  As you might expect, the regulations make it pretty easy for the IRS.  For example, while the regulations say that the SFR must be “signed” by an authorized official, they are very generous on what meets that requirement, providing that an SFR “may be signed by the name or title of an Internal Revenue Officer or employee being handwritten, stamped, typed, printed or otherwise mechanically affixed to the return” and that the “signature may be in written or electronic form.”  Treas. Reg. 301.6020-1(b)(2) (emphasis supplied).

The regulations also give the IRS flexibility as to what documents to associate together in a package, but what the regulations also require is some form to forge the documents together into an SFR.  Typically, the IRS will associate a Revenue Agent’s Report (often on a Form 886 series), and a Form 4549.  But it seems that the key document to look for is “Form 13496, IRC Section 6020(b) Certification.” That Form is what forges all those other documents into an SFR. See e.g. IRM 4.25.8.5.3.2 (07-08-2021)(“All SFRs having tax adjustments that follow deficiency procedures with the failure to pay (FTP) penalty applied under IRC 6651(g) must have a Form 13496, IRC Section 6020(b) Certification, completed.”).  See generally IRM 4.19.17.1.2 (01-05-2010) (Form 13496 Certification Procedures).  In fact, I would not be surprised if that Form—mentioned specifically in the regulation—becomes the bright-line test for the proper creation of an SFR, even though the regulation generously says it is not the exclusive form the IRS must use.

Facts and Lesson

The tax years at issue are 2013 and 2014.  In those years Mr. Ashford received self-employment income for services provided to Aviation Managed Solutions, earning just about $90,000 in 2013 and $100,000 in 2014.  Although he had filed returns for prior years, it appears that at some point in 2013 Mr. Ashford unintelligently came to believe that he was not required to file returns or pay taxes.

Eventually the IRS caught the error—likely through IRP—and sent NODs to Mr. Ashford in 2018.  The NODs asserted taxes and failure to file penalties, and also asserted the §6651(a)(2) failure to pay penalty.  Mr. Ashford petitioned Tax Court arguing, in part, that the NODs were not based on proper SFRs because the IRS had used dummy returns to open the Tax Module.  He argued that the use of dummy returns resulted in no SFRs and that, in turn, invalidated both the asserted deficiencies and the asserted penalties.

As to the deficiencies, Judge Vasquez explains that the mere use of a dummy return does not affect the validity of the proposed deficiencies.  Op. at 6. That is because the IRS has a choice in how to proceed against non-filers.  It can issue its NOD based either on an SFR it prepares or simply on the basis of an examination.

As to the §6651(a)(2) penalties, however, is does matter whether the NOD was based on an SFR.  Again, however, the use of dummy returns is irrelevant.  Here, Judge Vasquez explains that the NODs in this case were indeed based on an SFR and recites how each one contained the magic Form 13496.  Op. at footnote 9.

Bottom line: The IRS had properly transformed the dummy returns to create §6020(b) SFRs.

Comment:  Misleading IRS Website?  I am not clear on what soft Notices or Letters the IRS uses to ask for unfiled returns before it sends out a 6020(b) SFR package.  It appears that if you or your client gets the CP2566, then you must really be careful to prevent an unfriendly SFR.  The CP2566 is the 30-day letter sent out by the ASFR, as part of the 6020(b) SFR package.  And the IRS takes the position that once a taxpayer is presented with that package, the taxpayer is helpless to prevent a 6020(b) SFR if the taxpayer simply signs the accompanying Form 4549.  In a reversal of prior rulings, the IRS now says the taxpayer’s consent to the proposed deficiencies on Form 4549 does not result in a 6020(a) SFR.  See Rev. Rul. 2005-59.  For details and critiques on why this is one of the most inane Rev. Rules ever, see Bryan Camp, “The Function of Forms in the Substitute-for-Return Process,” 111 Tax Notes 1511 (June 26, 2006).  But there it is.  As best I can tell, it’s only been discussed by one court, a bankruptcy court in Texas in 2017, where the debtor had many other problems.

But the IRS website ignores the Rev. Rule!  It thus gives bad advice to taxpayers.  It says that taxpayers who receive the CP2566 can either “File your tax return immediately” or “Accept our proposed assessment by signing and returning the Response Form.”  Well, gosh, that’s pretty misleading if signing the forms included in the CP2566 create a §6020(b) SFR!  That is definitely not the same as properly filling in a Form 1040, signing it and filing it!  So it would be useful to know what CPs get issued before the taxpayer’s account gets loaded into the ASFR system and it becomes too late to create a friendly SFR.  BTW, CP stands for “Computer Paragraph,” meaning that any notice containing a “CP” before the number is a totally automated notice. I welcome any comments to address my confusion here.

Coda: There is some weirdness in this case.  In 2019 Mr. Ashford received a notice from the Social Security Administration that it was reducing his 2013 self-employment income from the amounts reported on the Form 1099 to zero.  That may have resulted from the IRS’s premature assessment of the deficiency while the case was pending in Tax Court, and then its abatement of that assessment.  That’s kind of a rough justice for Mr. Ashford, especially if he was arguing to the effect that “I don’t have to pay self-employment taxes on the income but I still get to use it to generate Social Security benefits.”  Now he’s got to figure out how to straighten out the SSA records. 

Filed Under: Notice of deficiency, Substitute for return, Tax Court Tagged With:

Prior Opportunity and Receipt of the Notice of Deficiency

August 12, 2022 by 2 Comments

In Chinweze v. Commissioner, TC Memo 2022-56 the Tax Court finds that the petitioner received his statutory notice of deficiency even though he stated that he did not.  Proof of non-receipt is generally tricky.  Here, the Court did not need to find that he did not receive the notice in order to deny his request to have the merits of his liability considered during the Collection Due Process (CDP) case.  Mr. Chinweze presents a disorganized and unsympathetic case but the decision could make it tougher for others who make a similar argument of non-receipt.  Perhaps the case relies on the facts and does not set any precedent but it provides a cautionary tale for others seeking to argue non-receipt in order to gain access to the opportunity to argue the merits of their liability in a CDP case.

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Mr. Chinweze is a tax lawyer admitted to practice before the Tax Court.  He apparently practiced as a sole practitioner during the years at issue – 2008 to 2010.  He did not file his federal tax returns for those years.  I imagine that this makes the Tax Court a little nervous that one of its bar members falls into the non-filer category.  I have not seen it discipline a practitioner for non-filing in looking at prior disciplinary actions.  It does not take the same tack as the IRS Office of Professional Responsibility nor am I suggesting that it should; however, a Tax Court bar member who fails to file would generally not get a case off on the best footing from a sympathy perspective.

According to the Court, the returns were filed in 2012 without remittance reflecting small liabilities.  The IRS audited the returns proposing relatively substantial increases and certain penalties.  A notice of deficiency was sent on March 4, 2014, by certified mail to an address he subsequently used in his correspondence with Appeals.  Mr. Chinweze did not petition the Tax Court and the IRS assessed the proposed deficiencies.

The IRS sent a notice of intent to levy on March 6, 2015 at which time he owed over $160,000.  On March 17, 2015 it sent a second CDP notice after filing notice of federal tax lien.  He requested a CDP hearing with respect to the second CDP notice.  Even though the CDP notices were sent only 11 days apart, his failure to request a CDP hearing with respect to the first notice created a bar to the litigation of the merits of his tax liability because it served as a prior opportunity to litigate the merits – an opportunity he passed up.  So, even if he could conclusively prove that he did not receive the notice of deficiency, his effort to litigate the merits was never going to get off the ground.

Despite the fact that his merits argument lacked legs, the Settlement Officer (SO) considering his CDP case asked him to submit information supporting his claim that he did not owe the assessed amount.  Mr. Chinweze did not respond the the SO’s attempts to obtain information.  This also could provide a basis for cutting off his effort to litigate the merits of his liability.

After hearing nothing from Mr. Chinweze, the SO sent out the notice of determination and he filed a petition in Tax Court.  The case was remanded to insure proper verification of the assessments and this may have been when the penalties were dropped by the IRS probably because of Graev problem in the approval.  Because of the time from of the case the IRS was not paying careful attention to penalty approval at that time.

In the supplemental hearing the SO gave Mr. Chinweze four dates to comply with sending information.  He never responded.  He has not built a sympathetic case based on his education and professional background or his lack of responsiveness.  Certainly, that must color the decision of the Court.

The Court finds that the IRS records regarding the mailing of the notice of deficiency are not sufficiently complete to create a presumption of proper mailing.  The case provides a detailed list of cases on this issue.  The Court, however, points out that the Form 3877 still provides probative information upon which the Court could concluded the IRS did mail the notice to Mr. Chinweze.  Again the Court provides a detailed list of cases.

Mr. Chinweze’s only evidence is his statement he did not receive the notice.  The Court says:

We are unconvinced. Mr. Chinweze was an experienced tax lawyer and filed a CDP request setting forth specific challenges to the NFTL filing (i.e., the liability amount and mitigating factors). His failure to contest receipt of the notice of deficiency in his CDP request undermines the credibility of his subsequent claim, particularly in light of the compelling evidence of mailing and the accompanying presumption of delivery.

The Court cites several more cases.  If nothing else, this case provides a good roadmap of the challenges for others who want to argue non-receipt.  Undoubtedly, Mr. Chinweze’s unsympathetic background plays a role in this outcome but you can see that the hill is still a steep one to climb even for taxpayers who would invoke much more sympathy.

Having determined that he received the notice, the Court did not need to further explain that he missed the boat by not seeking a CDP hearing from the levy notice but the Court also explains in one paragraph why he loses his opportunity to raise the merits of the liability for a second reason.

If he wants to fight the merits now, he needs to come up with a fair amount of cash in order to full pay the liability allowing him to satisfy the Flora rule and file a claim for refund.  He can full pay any of the three years at issue and fight over that year.  To the extent the issues are the same in each of the years, he could fight and win one and then seek a claim for abatement.  Still, he has a lot of work ahead to fight the merits of this liability.

Filed Under: Notice of deficiency

Things are Different at the Government

May 20, 2022 by 2 Comments

Everyone graduating from law school these days must take a course in legal ethics aka professional responsibility.  State bars also require persons seeking admittance to take a standardized test designed to ensure that those entering the profession have the requisite knowledge of the ethical rules that govern legal practice. 

In 2007 when I was retiring from the Office of Chief Counsel, IRS and beginning to teach at Villanova, the law school wanted me to become a member of the Pennsylvania bar.  Thankfully, Pennsylvania allowed members of the Virginia bar with the requisite number of years of practice to waive into the bar; however, they stopped my application because I had not passed the ethics exam.  I pointed out to them that when I joined the bar in 1977 there was no ethics exam.  I politely inquired if, given my age and length of service, I might be grandfathered in without need to take this standardized test.  The bar examiners politely let me know I needed to take the test.  So, shortly before retiring from federal service, I sat in a room filled with people 30 years younger than me who no doubt wondered what ethical lapses had caused this very old person to take the test.  Thankfully, I passed.

One of the ethical rules, Rule 1.4(2) of the ABA model rules, concerns settlement and the requirement that an attorney must bring a settlement offer to the client.  The ethical rules prevent the attorney from simply rejecting the settlement because the attorney does not like it.  In Delponte v. Commissioner, 158 T.C. No. 7 (2022), the Tax Court explains how that rule does not apply to the attorneys in the Office of Chief Counsel handling an innocent spouse case.  Taking it from the innocent spouse issue to the broader issue of cases handled by Chief Counsel, the rule does not apply to any of the cases in Tax Court nor does it apply to the Department of Justice Tax Division attorneys.  Once a case moves into the office of Chief Counsel or DOJ Tax Division, the attorneys are in the driver’s seat in deciding when to settle.   While they may consult with their client at the IRS, the relationship of the government attorney to its client differs dramatically from the relationship of the attorney in private practice to the client.  This proves unfortunate for Ms. Delponte.

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The case goes back to years from two decades ago.  The Tax Court docket numbers, of which there are five, go back to 2005.  Way back when, Ms. Delponte was married to Mr. Goddard who the Court described as “a lawyer who sold exceptionally aggressive tax-avoidance strategies with his business
partner David Greenberg and became very wealthy in the process.”  Mr. Goddard not only sold aggressive tax shelters, he also invested in them.  The IRS examined his returns, which were joint returns with Ms. Delponte, and proposed huge liabilities.

Ms. Delponte’s involvement in the Tax Court cases provides an interesting procedural sidelight.  The notices of deficiency were sent to Mr. Goddard’s law office years after the parties had split.  Mr. Goddard filed several Tax Court petitions as joint petitions without consulting or notifying Ms. Delponte.  Even though he filed the petitions in years 2005 through 2009, she did not become aware of the petitions until November of 2010.  At that  point she ratified the petitions.  Allowing her to ratify the petitions and be treated as if she timely filed them is an interesting feature of Tax Court jurisdiction.

The Tax Court, and the IRS, would not have known that she did not agree to the filing of the joint petition.  The IRS would have held off making an assessment against her, thinking that doing so would violate IRC 6213.  By putting her name on the petition even without her permission, Mr. Goddard not only suspended the statute of limitations on assessment for her liability but also preserved for her the opportunity to accept or reject the Tax Court case over five years after its filing.  You can see the awkward position this puts everyone in.  Yet, in many ways this works to the unknowing spouse’s advantage since it preserves the right to litigate in a prepayment forum.  The suspension of the statute of limitations on assessment is the downside of this action on the unwitting spouse.

Mr. Goddard not only filed joint petitions but he also listed her as an innocent spouse.  I do not know why in the five years between 2005 and 2010 the case had not progressed to a point that someone at Chief Counsel had pressed on the innocent spouse issue in a Branerton conference or otherwise, but at the point when she came fully into the case nothing seemed to have occurred regarding the innocent spouse defense. 

When you raise an innocent spouse defense in a deficiency case, the Chief Counsel attorneys ask that you complete a Form 8857, the innocent spouse relief form, and they send the form off for review by the innocent spouse unit of the IRS located in Covington, Kentucky.  This finally happened in Ms. Delponte’s case in April of 2011 only six years after the filing of the first petition in the case.

The Court points out that when Chief Counsel refers the case to the innocent spouse unit it requests that the unit not issue a determination letter as it would do if the request had arrived outside of a Tax Court deficiency proceeding but rather that the innocent spouse unit simply provide the results of its review to the attorney handling the deficiency case.  Here the innocent spouse unit reviewed the submission and determined that Ms. Delponte met the criteria for relief.

At the Harvard Tax Clinic we handle quite a few innocent spouse cases.  We submit what we believe are good applications but receive a favorable determination from the innocent spouse unit on a distinct minority of cases.  We usually gain relief from Appeals or from Chief Counsel. So, the fact that this unit granted Ms. Delponte relief in no way reflects that her success at this stage was routine.  Nonetheless, the Chief Counsel attorney did not accept the advice of its client and pressed forward with the innocent spouse case.

So, unlike an attorney in private practice who would be bound by the decision of its client, the government attorney is not so bound.  Ms. Delponte disagreed with the refusal of Chief Counsel to accept the decision made by its client that she met the criteria for relief.  She refused to meet with the Chief Counsel attorney to discuss the case, arguing that the additional information it sought “would be superfluous because CCISO (the innocent spouse unit) had already decided she was entitled to relief and its decision was binding on Chief Counsel.”

Because she would not meet, her innocent spouse status remained unresolved while the deficiency case moved forward, ultimately resulting in a large deficiency determination that was upheld on appeal.  Once the underlying tax issue was complete, the Court turned back to her innocent spouse request. The next post on this case will discuss how the Tax Court came to the conclusion that Chief Counsel’s office could ignore the decision of its client and what happened on the merits of the innocent spouse relief request.

Filed Under: Innocent Spouse, Notice of deficiency, Settlement, Tax Court

What Happens After Boechler – Part 3:  The IRS Argues that IRC 7459 Requires that IRC 6213(a) Treat the Time for Filing a Tax Court Petition as Jurisdictional

April 27, 2022 by Leave a Comment

After Congress created the predecessor statute to IRC 6213 in 1924 (and created the Board of Tax Appeals – the predecessor to the Tax Court) it came back in 1926 and 1928 to create a separate statute which is now IRC 7459.  Section 7459 provides that a dismissal from a Tax Court case on jurisdictional grounds does not prevent the taxpayer from paying the tax and suing for refund.

When Carl Smith and I began making the argument that time periods for filing a Tax Court petition are not jurisdictional time periods, we initially confined our arguments to Collection Due Process (CDP) and innocent spouse cases out of concern that succeeding in deficiency cases might harm taxpayers because of 7459.  As we thought about this further over time, we could not remember a single incidence of a taxpayer being dismissed from the Tax Court on jurisdictional grounds and subsequently full paying the tax and suing for refund.  Of course, this does not mean it has never happened, but it does suggest it happens rarely.

This post will explain why IRC 7459 should not factor into the decision of whether IRC 6213 is a jurisdictional provision or a claims processing rule.  That conclusion results from both the language of the two statutes as well as the goal to protect taxpayers.

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In the prior two posts we have explained why the Supreme Court’s decision in Boechler knocks out all of the arguments that IRC 6213 is a jurisdictional provision previously made by the IRS, the Tax Court, and other courts, including the 9th Circuit in Organic Cannabis.  This post looks at the arguments regarding IRC 7459 and the cases the Tax Court dismisses in order to provide an explanation for removing the last argument from consideration.

In Organic Cannabis the 9th Circuit explained the various types of suits a taxpayer could bring to contest a tax liability and pointed out that:

if the taxpayer does file a petition in the Tax Court, then a decision “dismissing the proceeding shall be considered as its decision that the deficiency is the amount determined by the [IRS],” id. § 7459(d), and such decision as to “amount” is entitled to preclusive effect in subsequent proceedings between the taxpayer and the IRS, see Malat v. Commissioner, 302 F.2d 700, 706 (9th Cir. 1962). [emphasis added]

We have written before about the effect of a Tax Court dismissal, and we have explained that petitioners to the Tax Court cannot voluntarily dismiss a Tax Court case once jurisdiction has attached.  After setting up the general rule, the 9th Circuit went on to explain the exception in IRC 7459(d) when the Tax Court dismisses a case because it lacks jurisdiction:

there is no such “decision” as to “amount,” and no preclusive effect, if the Tax Court’s “dismissal is for lack of jurisdiction.” 26 U.S.C. § 7459(d) (emphasis added)

Then the 9th Circuit used as one of its bases for finding IRC 6213 to be a jurisdictional provision with regard to the time of filing the problem that would attach if it were not jurisdictional:

Under Appellants’ non-jurisdictional reading of § 6213(a), the Tax Court’s dismissal of a petition as untimely could potentially have the perverse effect of barring the taxpayer from later challenging the amount in a refund suit—ironically yielding precisely the sort of “harsh consequence[]” that the Supreme Court’s recent “jurisdictional” jurisprudence has sought to avoid.  Kwai Fun Wong, 575 U.S. at 409.  That peculiar outcome is avoided if § 6213(a) is read as being jurisdictional, because then dismissals for failure to meet its timing requirement would fall within § 7459(d)’s safe-harbor denying preclusive effect to Tax Court dismissals “for lack of jurisdiction.” 

So, the 9th Circuit used what it thought would be a negative effect of finding IRC 6213 to be a claims processing rule as a basis for justifying its decision.  This is wrong both as statutory interpretation and wrong in thinking that keeping IRC 6213 as a jurisdictional provision would not harm taxpayers, while making that deadline non-jurisdictional would harm taxpayers.

With respect to statutory interpretation, IRC 7459 simply has no role to play.  The argument for the role of IRC 7459(d), at least based on the IRS argument, is that interpreting the jurisdictional dismissal exception of that subsection to exclude dismissals for late filing would render the exception superfluous.  The IRS has argued that the only dismissals that are currently jurisdictional (other than those when no notice of deficiency was issued and so the amount of a deficiency cannot be set out in the dismissal order) are from late filing. This argument fails because many reasons exist why a petition may be dismissed for lack of jurisdiction other than merely late filing or the lack of a notice of deficiency.  The most obvious situation occurs when the Tax Court dismisses a petition for lack of jurisdiction due to an invalid notice of deficiency because the IRS did not send the notice to the taxpayer’s last known address.  See, e.g., Crum v. Commissioner, 635 F.2d 895 (D.C. Cir. 1980).  Another example occurs when the automatic stay in bankruptcy bars the filing of a Tax Court petition, see, e.g., Halpern v. Commissioner, 96 T.C. 895 (1991).  Another example occurs when a corporation lacks capacity to file the petition, see, e.g., Vahlco Corp. v. Commissioner, 97 T.C. 428 (1991) (Texas law).  The biggest reason for dismissal from Tax Court for lack of jurisdiction occurs for failure to pay the filing fee – almost 2/3rds of the dismissals occur for this reason.  So, the IRS is wrong when it argues that determining IRC 6213 is a claims processing rule renders IRC 7459(d) superfluous.

The legislative history of IRC 7459(d) also does not support the conclusion that Congress enacted the statute to preserve the rights of taxpayers who file late in the Tax Court to avoid res judicata in a subsequent refund suit involving the same deficiency.  There is no such legislative history.  There is also nothing in the language of IRC 7459 that speaks to the time frame for filing a Tax Court petition as a jurisdictional time frame.  There is simply no language to parse.

After you leave the legal arguments that have no merit, you move to the apparent presumption by the 9th Circuit that somehow IRC 7459 helped taxpayers.  First, there’s the problem that Congress gave no indication it sought that result, either in the language of the statute or its legislative history. Second, the actual effect of the 9th Circuit’s take on the statute hurts far more taxpayers than it helps.

Carl Smith looked at the dismissals for lack of jurisdiction due to late filing in February and March of 2022 searching DAWSON using the search words “lack of jurisdiction and timely.”  He found 103 cases which suggests 618 dismissals over the entire year or some similar number.  Each of those individuals could theoretically be adversely impacted if section 7459(d)’s exception for jurisdictional dismissal could not apply, so that res judicata would prohibit their filing later refund suits.

To know how the loss of 7459(d) protection could adversely impact this group, it’s necessary to know how many taxpayers in this group paid the tax and filed a suit for refund.  For this fiscal year ending September 30, 2020, 188 refund suits in total were brought in the Court of Federal Claims and the district courts.  Not all of the 188 complainants filed after a prior Tax Court dismissal for late filing and perhaps none of them did.  Indeed, Carl looked at all district court and CFC opinions issued in 2021 using the search terms “refund and (Tax Court) and dismiss!” and could not find a single refund suit in which it was clear that the IRS had issued a notice of deficiency, the taxpayer had then late-filed a Tax Court suit, and, after the suit’s dismissal, the taxpayer sued for a refund. 

Carl did come across one 2021 opinion where a taxpayer’s Tax Court deficiency suit had been dismissed for lack of jurisdiction, purportedly for late filing, and a CFC refund suit ensued — see my post of June 4, 2021 on the case, Jolly.  However, in that case, it was unclear whether the IRS had ever issued a notice of deficiency, with the IRS arguing in the Tax Court that a notice of deficiency had been issued, but arguing in the CFC that the IRS had never issued one and that the Tax Court dismissal was wrong for saying there had been a late-filed petition rather than a petition lacking an underlying notice of deficiency.  And, in Jolly, the taxpayer did not fully pay the tax before bringing the CFC suit.    Reading the 2021 opinions, Carl also found a citation to a pre-2021 opinion in a refund suit where a taxpayer brought a CFC suit after his Tax Court deficiency suit was dismissed for lack of jurisdiction for late filing and where there was no dispute that a notice of deficiency had been issued, Wall v. United States, 141 Fed. Cl. 585 (2019), but the taxpayer in the suit was only seeking relief from liens, not a refund, and, in any event, had not fully paid the deficiency before bringing the suit.

It’s probable that no refund suits resulted from the Tax Court dismissals for failure to timely file the petition because a very high percentage of the petitioners dismissed were pro se taxpayers who lack knowledge of tax procedure and funds to full pay.  Only in a rare cases does the taxpayer benefit from IRC 7459(d), and not one that we know of.  Yet, we know there are cases in which taxpayers could benefit from the interpretation of IRC 6213 as a claims processing rule.

Petitioners who would especially benefit from the interpretation of IRC 6213 as a claims processing rule are petitioners with a good basis for equitable tolling.  While this is not a large number, the individuals with a good reason for filing late present very sympathetic cases in which the petitioners deserve the chance to have the merits of their case heard.  The next post will talk about the equitable tolling rules and who these petitioners might be. 

In addition, petitioners who would benefit are the petitioners dismissed because the Tax Court spent the time and effort to carefully review each case to determine if it had jurisdiction and issued an order to show cause when it had concerns about its jurisdiction even though Chief Counsel did not raise an issue.  In February and March of 2022, Carl searched for this type of order to show cause and found 34 cases.  This means that about 204 petitioners a year might benefit if the Tax Court did not need to spend time carefully scouring each case to check on its jurisdiction.  This would not only give these taxpayers a chance to have the merits of their argument heard but would save the Tax Court all of the time it currently spends looking at each case to determine if it has jurisdiction. 

To determine how many of the cases in which the Tax Court show cause orders resulted in a dismissal, Carl went back to April and May of 2021 expecting that most of those cases would have cleared through the system by now, offering a percentage of cases dismissed after a show cause order.  His research suggests that about 75% of the cases identified were dismissed as untimely.  The 9th Circuit’s effort to “help” taxpayers by citing to IRC 7459(d) instead created a misguided view of the system.  The actual cases show that few, if any, taxpayers receive a benefit from IRC 7459(d) but quite a few taxpayers might benefit from a claims processing rule, either because they have a basis for equitable tolling or, more likely assuming the Chief Counsel attorneys continue to fail to identify issues of timely filing, because taxpayers will no longer face orders to show cause for dismissal for lack of jurisdiction on account of late filing.

Filed Under: Collection Due Process, Equitable tolling, Federal Courts - Jurisdiction, Notice of deficiency, refund claim, Tax Court

You Call That “Notice”? Seriously?

March 24, 2022 by 1 Comment

Last April, I wrote (see here and here and here) about the Federal Circuit’s decision in General Mills, Inc. v. United States, 957 F.3d 1275 (Fed. Cir. 2020), aff’g 123 Fed. Cl. 576 (2015).  The briefs on appeal are available here: the taxpayer’s opening brief, the government’s answering brief, and the taxpayer’s reply brief.  This was a complex case, involving the intersection of TEFRA partnership audit procedures and the “large corporate underpayment” (LCU interest, or “hot interest”) provisions of the Code.

There was one argument made by the plaintiff on the TEFRA issue that I addressed rather briefly, because the Federal Circuit simply swatted it away.  That argument really warrants more discussion because it’s a serious problem that goes beyond just this specific context, one that we need to continue challenging: the adequacy of notices to taxpayers.  So let’s talk about that case a bit more.

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The Background

This is a very abbreviated version of the facts, because I want to focus on that one argument General Mills raised and the court rather perfunctorily swatted down.  Interested in more?  Check the opinions or prior blog posts.

The General Mills consolidated group (“GMI”) filed corporate tax returns for the 2002-2003 and 2004-2006 tax years, and General Mills Cereals, LLC (“Cereals”) filed partnership tax returns for the same years.  Various members of the GMI consolidated group were partners in Cereals, so the tax returns—and any audit adjustments—for Cereals flowed through to GMI.  The IRS audited both sets of tax returns for all these years.  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Deficiencies were identified for both the corporate and the partnership tax returns.  As this was back in the days before the Bipartisan Budget Act of 2015, the TEFRA audit procedures were still in effect.  For the remainder of this post, references to Code sections in the 62xx range will be the old, pre-BBA versions, which have been replaced in the current Code by the new BBA procedures.

TEFRA “Computational Adjustments”

TEFRA required “partnership items” to be resolved at a partnership-level proceeding.  After that proceeding ended, the effects of the adjustments to partnership items were translated into partner-level tax liabilities by means of “computational adjustments.”  Notices of deficiency at the partner level are required only if a partner-level “determination” is required; otherwise the IRS can assess immediately.  (Penalties can be assessed immediately even though a partner might raise partner-level defenses in a refund claim/suit.)  Immediately assessable computational adjustments also include “any interest due with respect to any underpayment or overpayment of tax attributable to adjustments to reflect properly the treatment of partnership items.”  Treas. Reg. § 301.6231(a)(6)-1(b).

TEFRA also provided a mechanism for taxpayers to challenge computational adjustments that did not require a deficiency proceeding, in section 6230(c).  The taxpayer must file a refund claim “within 6 months after the day on which the Secretary mails the notice of computational adjustment to the partner.”  Thereafter, a refund suit can be brought within the period specified in section 6532(b) for refund suits.  Section 6511(g) provides that section 6230(c) applies, rather than the two-year period specified in section 6511(a), with respect to tax attributable to partnership items.

You guessed it.  The partners (individual members of the GMI consolidated group) paid the assessed liabilities and then filed refund claims.  Those refund claims were timely under the two-year period in section 6511, but not under the six-month period in section 6230(c).  So GMI had to argue that the longer period applied.

There were a lot of different arguments by GMI that I discussed at length last April.  Here, I want to focus on GMI’s argument that the six-month period never commenced, because none of the communications from the IRS qualified as a “notice of computational adjustment.”

A Brief Pause to Consider Other Types of Notices

A notice of deficiency clearly identifies the tax year, the amount of the deficiency, and the reasons for the deficiency.  The IRS sends it by certified mail.  It clearly identifies what the taxpayer must do to challenge it – file a petition with the Tax Court – and the period within which the taxpayer must do that.  It even calculates the deadline and states it explicitly on the first page, and the taxpayer can rely on that even if the IRS erroneously calculates the date.  Stat notices are not without their flaws, but this is about as good as you could hope for – the “gold standard.”

A notice of determination denying innocent spouse relief can be pretty good too.  The most recent we received, by Letter 3288, was sent by certified mail and clearly identified the tax year(s) at issue and a (too) brief explanation of why relief was denied.  (A request for the administrative file is definitely in order!)  It clearly specified, at the top of page two, the taxpayer’s right to challenge the determination by filing a petition in Tax Court and the period within which the taxpayer must do that.

A notice of intent to levy is, frankly, horrible.  They’re too long and poorly written, hard to understand for a layperson; even for some students at an academic LITC.  They muddle the message by combining requests to pay with notifying the taxpayer of her rights.  The next-to-last notice (CP504) is misleading, as discussed below.  The final notice (LT11, CP90, etc.) explains the right to a CDP hearing reasonably well, including the period within which the taxpayer has to request a CDP hearing, but the message can be drowned out by the scare tactics elsewhere within the notice.  On the positive side, both these notices at least specify their statutory basis – sections 6331(d) and 6330(a) respectively, and both must be delivered personally or by certified mail.  There are other problems with collection notices, but those will do for a start.

Keith has a great blog post here about the distinction between the 6331(d) notice (CP504) and the 6330(a) “final notice” providing the right to a CDP hearing (LT11, CP90, etc.) and the history.  It also points out how misleading, if not knowingly false, the 6331(d) notice is.  Go read Keith’s post now if you haven’t already/lately.  I like to think of the difference as that the 6331(d) notice by itself only allows the limited categories of levy described in section 6330(f), most notably state tax refunds or jeopardy collections.  For those categories, a CDP hearing is available only post-levy.  For all other categories, a CDP hearing is available pre-levy but the IRS must first send the 6330(a) “final notice” to allow the taxpayer to request a hearing.  It’s a bit of a mess procedurally.

Math error notices are . . . well, look at this post by Keith (including the comments and the NTA blog post he links to) for some of the many defects of math error notices. 

Multiple Communications

GMI, on the other hand, was dealing with a notice of computational adjustment.  The Court of Federal Claims and the Federal Circuit considered several of the communications from the IRS to GMI as possible notices of computational adjustment, either separately or collectively, that would have started the statute of limitations running.   

First, on August 27, 2010, the IRS sent a letter with Form 5278, “Statement—Income Tax Changes” enclosed. That form included a line for “Balance due or (Overpayment) excluding interest and penalties” with a corresponding dollar amount, the additional tax owed by the partners from the settlement of the partnership audit.  No amount was shown for interest, but the cover letter stated that the IRS “will adjust your account and figure the interest.” 

The Court of Federal Claims quoted a statement in the earlier Form 870-LT (AD) settlement agreement for the Cereals audit that the taxpayer consented to the immediate assessment of deficiencies in tax and penalties “plus any interest provided by law.”  I emphasized that last phrase because the court did.  Three times, once for each place that phrase occurred on Form 870-LT (AD).  Pause for a moment and consider the reaction if a settlement agreement or notice of deficiency had not specified the exact amount of tax and penalties and merely said “the amount of additional tax and penalties provided by law.”  And here, there was enough ambiguity about what the law provided regarding “hot interest” that “provided by law” was not sufficient anyway.

Second, the IRS assessed the adjustments to GMI’s returns, flowing through from the partnership audit and including interest, on September 3, 2010.  The assessment, of course, would have just shown up as a lump sum.  I defy anyone to reverse engineer the calculations underlying an interest assessment on a large corporate return, including flow-through adjustments from a partnership.  It can be done, but anyone in their right mind would give up long before they reached a solution.  GMI proceeded to pay the assessed amounts on April 11, 2011. 

Finally, on April 18, 2011, the IRS sent GMI detailed interest computation schedules.  As described, those were probably sufficient to identify the IRS application, which GMI disputed, of the “hot interest” provisions.  (This discussion focuses on the 2002-2003 tax years.  For the 2004-2006 tax year, the IRS sent two different sets of interest computation schedules, the first one of which implied that “hot interest” wouldn’t apply at all.)

GMI’s Argument

What was missing from all these communications?  The August 27, 2010, letter didn’t state the amount of the computational adjustment.  The September 3, 2010, assessment gave the total amount of interest assessed, which did not break out the portion attributable to the increased tax and penalties included in the computational adjustment and was insufficient to identify how the IRS calculated that amount.  The April 18, 2011, interest computation schedules did provide sufficient information to identify what GMI considered in error.  None of them were explicitly identified as a “notice of computational adjustment.”  None of them specified the applicable statutory provision.  None of them specified the deadline for filing a refund claim, a deadline that was different from the normal statute of limitations for filing refund claims.

When I compare this notice of computational adjustment (at least with respect to the interest amount) to other notices described above, it seems: (a) significantly worse than the notice of deficiency and an innocent spouse notice of determination; (b) arguably worse than collection notices; and (c) at least as bad as some of the worst examples of math error notices.  Being “no worse than math error notices” is not a good standard for the IRS to strive for.

GMI argued that

a notice of computation adjustment must (1) contain the amount of adjustments, (2) contain a statement of the increased rate of interest that will apply, and (3) provide the partner with some indication that the document is intended to be a notice of computational adjustment that triggers a 6-month period of limitations under § 6230(c)(2)(A).

It cited McGann v. United States, 76 Fed. Cl. 745 (2007) as establishing that standard.

The Federal Circuit Was Not Convinced

The court noted GMI’s arguments but rejected them because those asserted requirements went beyond the statutory text.

GMI contends that the notices were defective for various reasons. First, GMI says that the IRS was required to give notice that “a jurisdictional period was being triggered,” and the schedules failed to mention § 6230(c) or the six-month limitations period. GMI also argues that the schedules were tainted by the failure to mention the Partnership proceedings and the failure to separate the accrued interest on underpayments resulting from the corporate proceedings from that of the Partnership proceedings. These contentions lack merit. The Court of Federal Claims stated that the notice of computational adjustment need not be in any particular form, and we agree. Indeed, the Internal Revenue Code does not define what a notice of computational adjustment should contain.

(citations omitted)  At most, the court would have required “the information [GMI] needed to assess whether the IRS may have erroneously computed the computational adjustment,” but it concluded the various communications provided that.

The court’s apparent conclusion that a notice, unless it is misleading, need only comport with statutory requirements is disturbing.  McGann stands for the proposition that there is a minimum requirement of due process that may exceed statutory requirements.  The Federal Circuit distinguished McGann as involving a misleading notice of computational adjustment and concluded the notices sent to GMI were neither misleading nor contradictory.  It didn’t mention the statement from McGann that “the notice of balance due bears no indication that it is to be taken as a notice of computational  adjustment, nor does it disclose that Mr. and Mrs. McGann would have had to contest any amounts said to be due within a six-months’ period thereafter.”  The McGann court also pointed out that “neither the Form 4549A nor the accompanying Form 886-A previously sent to Mr. and Mrs. McGann contained such an advisory.”  The McGann court also looked to cases involving notices of deficiency as “instructive” in determining whether a notice of computational adjustment was adequate.

Conclusion

I can understand why Congress and the IRS might not specify, and courts might be reluctant to impose, rigorous requirements for notices of computational adjustment.  With respect to additional tax and penalties, the amount of the aggregate adjustment was already determined in the TEFRA proceeding.  The partner-level adjustments seem merely mechanical and unlikely to be in error.  But it doesn’t make sense with respect to complex interest computations, which were not addressed in the TEFRA proceeding.  That rationale is probably also the unstated reason for why the IRS treats math error notices so cavalierly.  But we know those math error notices also increasingly include adjustments that go far beyond the simple mechanical adjustments that have an extremely high likelihood of being correct.

Not only math error notices but also notices of computational adjustments require improvement, beyond the statutory requirements, to protect taxpayer rights.  We can and should work with the IRS and Congress to achieve better notices.  But pushing for the courts to recognize and enforce higher standards is also a worthy fight, even if it may feel like tilting at windmills.

Filed Under: Math error, Notice of deficiency, TEFRA Tagged With:

IRC 7459(d) and the Impact of Dismissal

June 4, 2021 by 2 Comments

On May 20, 2021, the Court of Federal Claims decided the case of Jolly v. United States, Dk. No. 20-412.  Ms. Jolly pursued the case pro se.  The court lists the opinion as not for publication. The case involves a refund suit covering four tax years.  The court decided not to dismiss her complaint rejecting the government’s motion.  Carl Smith noticed this decision and in his email forwarding the opinion he provided much of the substance of this post. 

In amicus briefs filed by the tax clinic at Harvard in the cases of Organic Cannabis and Northern California, the clinic argued that the court should not be concerned about turning late filing of a deficiency petition into a merits issue, rather than a jurisdictional one.  The counter-argument (which the 9th Cir. accepted in Organic Cannabis) was that, if a deficiency petition is dismissed for late filing and that is a merits dismissal, then it upholds the deficiency under 7459(d), and so the Tax Court decision could present a res judicata bar to a person seeking to litigate the deficiency later by paying and suing for a refund.  In our cert. amicus brief in Northern California, we acknowledged that that was a theoretical possibility.  We noted in our brief that neither Carl Smith nor I could recall any case where a person who was dismissed from the Tax Court for late filing later full-paid the deficiency and sued for refund.  We acknowledged that it is possible such rare cases existed, but said they must be a very few since it could arise in the traditional refund context or when there is no balance due but a disallowed refundable credit and a late filed petition. 

Because of the possibility, Nina Olson, when she was the National Taxpayer Advocate made a legislative proposal to fix the jurisdiction issue, and it contains a modification to 7459(d) that would except untimely filed petition dismissals from the rule upholding the deficiency. 

The Jolly case presents the fact pattern we said we did not recall ever seeing. 

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In Jolly, for the 2016 year, the IRS issued a notice of deficiency.  Jolly, pro se, late-filed a Tax Court petition, which was dismissed for lack of jurisdiction.  The IRS applied overpayments from 2018 and 2019 that were shown on the returns to the 2017 deficiency, still leaving a partial balance due for 2017.  The IRS did not apply any of the overpayments to 2016.  This is unusual because normal procedure at the IRS applies payments to the earliest period to tax, then penalty and then interest.  It is unclear why the payments were posted in this manner in the Jolly case. 

Jolly, again pro se, then filed suit in the Court of Federal Claims seeking a refund for each of the years 2016 through 2019.  The DOJ moved to dismiss all four years, though on different grounds.  It wanted the court to dismiss 2016 and 2017 for failure to full pay and wait 6 months after a refund claim to bring suit – i.e., lack of jurisdiction.  It wanted the court to dismiss 2018 and 2019 because the overpayments from those years had been applied to 2017 – i.e., failure to state a claim since she received the refund she requested on her returns for those years.  Pro se taxpayers commonly misunderstand what it means when the IRS offsets a liability.  Clinic clients regular arrive at the door complaining of one year when the IRS has granted the requested refund for the year identified by the taxpayer but taken the refund to an earlier year where the problem exists.  In somewhat confusing rulings, the court denied  the government’s motions for all years.

For 2016 and 2017, the court thinks it is important to decide whether notices of deficiency were issued for each year.  It’s not clear why it feels this way.  The court finds that a notice of deficiency was issued for 2016, but not 2017.  The court notes the IRS has lost the 2017 administrative file, and the court won’t accept at this time only circumstantial evidence of mailing.  The court says that the credits from 2018 and 2019 might have full-paid the 2016 liability and part-paid the 2017 alleged liability based on the evidence in the record at this time.  This approach seems confused.  It is implicit in the court’s ruling that if a notice of deficiency was not sent for 2017, the Flora rule doesn’t apply to the erroneous assessment of the deficiency and the credits from 2018 and 2019 can be moved from the 2017 year to the 2016 year to meet Flora.  I would have thought Flora requires full payment of an assessment, even if the assessment was not made correctly procedurally, though I have never researched case law on that issue, if any. 

In addition to this argument, what about the government argument that the taxpayer had to file a refund claim and wait six months?  Clearly, a 2019 overpayment used to finish paying the 2016 year could only have been applied as a credit in 2020, and suit here was brought in 2020.  It is very unlikely that the taxpayer filed a refund claim for 2017 between the time that the 2019 credit was posted to 2017 and then waited six months to bring suit.  In denying the motion, the court doesn’t discuss this issue.  Here’s the last paragraph of the opinion as relates to the motion for 2016 and 2017:

If Ms. Jolly’s 2017 deficiency of $6,371.76 does not exist, the math follows: applying Ms. Jolly’s 2018 and 2019 tax refund ($1,947.00 and $1,255.00, respectively) to only her 2016 assessment of $2184.81 results in a residual amount of around $1017.19.2 As there is a factual dispute underlying the jurisdictional allegation in the government’s Rule 12(b)(1) motion, the Court “weigh[s] evidence” and “find[s] facts” while “constru[ing] all factual disputes in favor of [Ms. Jolly].” Knight, 65 Fed. Appx. at 289; see also Cedars-Sinai Medical Center, 11 F.3d at 1583–84, James, 887 F.3d at 1373. Accordingly, based on the record before the Court, specifically the government’s failure to locate Ms. Jolly’s 2017 IRS administrative file, the Court finds Ms. Jolly may have paid her full tax liability before filing this lawsuit, and thus the Court has subject matter jurisdiction over her 2016 and 2017 tax refund claims. See Flora, 362 U.S. at 150.

It is also unclear why the court did not dismiss the 2018 and 2019 years for failure to state a claim.  The government argued that the claims (shown on original returns) had been paid by application of the overpayments to 2017.  A taxpayer should not be able to bring a refund suit for the year in which overpayments occurred that were used as credits against earlier-year balances due.  Such a suit could only be brought for the earlier years to which the credits had been applied.  The court seems to think that because it determines that the 2017 assessment was improper, the IRS must be deemed not to have made the credits of the refund claims shown on the 2018 and 2019 returns.  But, even if so, why didn’t the court say that the 2018 overpayment should be deemed to partly pay the 2016 deficiency, so at least there can be no overpayment suit relating to 2018?  Here’s the entire discussion of why the court denies the DOJ 21(b)(6) motion for 2018 and 2019:

The government further contends Ms. Jolly is not entitled to any recovery for 2018 and 2019 since Ms. Jolly received her 2018 and 2019 refunds as payments towards her 2017 balance. Gov’t MTD at 9–10. As discussed supra, the absence of a notice of deficiency bars the IRS from assessing a tax deficiency against Ms. Jolly in 2017, thus, the record before the Court compels a finding that the IRS possibly owes Ms. Jolly a residual amount after applying her 2018 and 2019 tax credit towards her 2016 balance. Accordingly, “accept[ing] well-pleaded factual allegations as true and . . . draw[ing] all reasonable inferences in favor of [Ms. Jolly],” the Court finds Ms. Jolly alleges “enough facts to state a claim to relief [regarding her tax refund of 2018 and 2019] that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007); see also Athey v. U.S., 908 F.3d 696, 705 (Fed. Cir. 2018) (quoting Call Henry, Inc. v. U.S., 855 F.3d 1348, 1354 (Fed. Cir. 2017)) (When deciding a Rule 12(b)(6) motion to dismiss, the Court “must accept well-pleaded factual allegations as true and must draw all reasonable inferences in favor of the claimant.”).

Jolly will struggle to win this case, but perhaps the court’s ruling will allow her to prove to the Tax Division attorney handling the case that she should not have been assessed in 2016 and that she is entitled to a refund, even if she is not entitled to bring a refund suit for four years.  Since much confusion seems to surround the 2017 year and how the assessment came to exist for that year and why the IRS offset the later refunds to 2017 instead of 2016 perhaps this pause will allow time for clearing up that issue as well. The judge seems to misunderstand the basis for refund litigation but that will no doubt be worked out over time.  The case is most notable because it represents an example of someone who missed their chance to go to Tax Court but followed through in seeking a return of the tax through the filing of a refund suit.  Although Carl and I said we did not know of a case with those facts, perhaps we should have remembered the case of Flora which had those very facts and raised the question of what happens when you miss your chance to go to Tax Court.  In the Flora case we know that the Supreme Court held, in the fact of an unclear statute and contradictory prior case law, that the taxpayer can only bring the refund suit by first fully paying the tax, making a timely refund claim, waiting for the claim disallowance letter (or the passage of six months) and then coming to court.  If you want to read more about Flora and the parallels with the Jolly case, here is an article I wrote about Flora.

Filed Under: Flora, Notice of deficiency

Incapacitation, Death and the End of an Era, Designated Orders November 16 – 21, 2020, Part II

February 17, 2021 by 1 Comment

The week of November 16, 2020 was the week preceding Thanksgiving and the Tax Court’s transition to Dawson was looming, which meant orders would no longer be “designated” on a daily basis. The judges knew it may be one of their last opportunities to alert the public (and Procedurally Taxing) to an order. Many lengthy, novel and diverse orders were designated. As a result, my week in November warranted two parts, and this second part is my last post on designated orders ever. I’ve learned a lot over the last three and a half years, and I hope you all have too.

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Answering Interrogatories while Incapacitated

In consolidated Docket No. 26812-12, 29644-12, 26052-13, 27243-15, 5314-16, 5315-16, 5136-16, 5318-16, Deerco, Inc., et al. v. CIR, the case involves the acquisition of a corporation and the subsequent removal of substantial plan assets (over $24 million) from the acquired corporation’s pension plan in 2008.

The petitioner who is the focus of this order was the President of the acquiring corporation and the trustee for the pension plan of the acquired corporation in control of the disposition of assets, so naturally, the IRS is very interested in what he has to say. Unfortunately, he is incapacitated. His counsel answered some of the IRS’s interrogatories on behalf of all the petitioners (individuals and entities) in this consolidated case by stating that they lack information or knowledge.

The IRS and Court find petitioners’ counsel’s answers to be insufficient for a couple reasons:

1) Rule 71(b) requires the answering party to make reasonable inquiry and ascertain readily available information. A party cannot simply state they lack the information without explaining the efforts they have made to obtain the information. Even though the petitioner is incapable of responding, the Court thinks he should have documents or records that would enable his counsel to answer the substance of the interrogatories. Petitioner also had an attorney and accountant assisting him during the transaction at issue, and those individuals may have useful information, documents, or records.

2) The Court also finds the answers are procedurally defective. The procedures, found in Rule 71(c), differ depending on whether an individual or an entity is providing the answer. In this case, petitioners’ counsel has signed under oath the answers on behalf of all petitioners. Counsel is permitted to answer and sign under oath for entities, but not for individuals. Individuals must sign and swear under oath themselves. The petitioner in this case can’t do that, but his wife has been appointed as his guardian, so she can.

There are other issues raised (such attorney-client privilege concerns), but the prevailing message is that the Court thinks petitioner’s counsel can do better and outlines the ways in which they can provide more adequate answers.

We Cannot See A Transferee

In consolidated Docket No. 19035-13, 19036-13, 19037-13, 19038-13, 19058-13, 19171-13, 19232-13, 19237-13,  Liao, Transferees, et al. v. CIR, the IRS tries several avenues to prove that petitioners, who consist of the estate and heirs of a taxpayer who owned a holding company, called Carnes Oil, should be liable as transferees when an acquisition company ultimately sold the company’s assets and tried to use a tax shelter to offset the capital gains.

In this case, initially, a company called MidCoast offered to buy Carnes Oil’s shares. MidCoast has a history of facilitating a tax shelter known as an “intermediary transaction.” In another post for PT (here), Marilyn Ames covers a Sixth Circuit decision in Hawk, which involved MidCoast, intermediary transactions, and some implications under section 6901. In Hawk, the Court affirmed the Tax Court’s decision and held that petitioners’ lack of intent or knowledge cannot shield them from transferee liability when the substance of the transaction supports such a finding.

In this case, petitioners have moved for summary judgment, and their lack of knowledge is one of the factors the Court uses to ultimately determine petitioners should not be held liable as transferees. Petitioners’ case is distinguishable from Hawk, because the Court determines, in substance, the transaction was a real sale.  

Petitioners didn’t accept MidCoast’s offer, but instead accepted an offer from another company called ASI. More details are fleshed out below, but long story short- the IRS argues an “intermediary transaction” occurred. In support of this the IRS insists that the economic substance doctrine (a question of law) and substance over form analysis (a question of fact) show that what looked like a sale of stock for money was really the sale of Carnes Oil’s assets followed by a liquidating distribution directly from the company to petitioners. The IRS seeks to reclassify the estate and heirs from sellers to transferees to hold them liable.

Even viewing the facts in a light most favorable to the IRS, the Court disagrees under both analyses. The heirs reside in different states, so the appellate jurisdiction varies. The Court acknowledges that they may have to contend with subtle conflicts among the jurisdictions, but regardless of the jurisdiction, whether a transaction has economic substance requires a close examination of the facts.

The facts show that when petitioners sold their stock the company still had non-cash assets, and those assets weren’t liquidated until after ASI controlled it. Petitioners also weren’t shareholders of the dissolved corporation, because it continued to exist for over a year after they sold it.

The facts are not clear as to where ASI got the money to pay petitioners, but after tracing the funds from relevant bank accounts, the Court determined it did not come from Carnes Oil, or a loan secured by their shares.

Neither the petitioners nor their advisers had actual knowledge of what ASI was planning to do. The IRS says there were red flags and petitioners should have known, but the Court finds Carnes Oil was a family company using local lawyers in a small town, and the shareholders reasonably accepted the highest bid.

It was a real sale. The company got an asset-rich corporation and petitioners got cash. The Court grants petitioners’ motion for summary judgment – a win for petitioners in an increasingly pro-IRS realm.

Gone and Abandoned

In Docket No. 23676-18, Miller v. CIR, the Court dismisses a deceased petitioner’s case for lack of prosecution despite his wife being appointed as his personal representative. Petitioner died less than a month after petitioning the Tax Court in 2018 and after some digging the IRS found information about petitioner’s wife.

The Court reached out to her and warned that if she failed to respond the case was at risk of being dismissed with a decision entered in respondent’s favor. The Court did not receive a response.

Rule 63(a) governs when a petitioner dies and allows the Court to order a substitution of the proper parties. Local law determines who can be a substitute. The Court’s jurisdiction continues when someone is deceased, but someone must be lawfully authorized to act on behalf of the estate. If no one steps up the prosecution of the case is deemed to be abandoned.

The Court finds petitioner is liable for the deficiency amount, but it’s not a total loss for the estate, because IRS can’t prove they complied with section 6751(b) so the proposed accuracy-related penalty is not sustained.

All’s Fair in Love and SNOD

In consolidated Docket No. 7671-17 and 10878-16, Roman et. al. v. CIR, a pro se married couple with separate, but consolidated Tax Court matters moves the Court to reconsider its decision to deny petitioners’ earlier motions to dismiss for lack of jurisdiction. The motions were disposed of by bench opinion.

The Court reviews the record and determines that petitioner made objections that have yet to be ruled on.

First, however, it explains that there are two procedural reasons for why petitioner motions could be denied. Petitioners filed the present motion under Rule 183, but that rule only applies to cases tried before a Special Trial Judge. Petitioners in this case have not yet had a trial, the bench opinion only exists to dispose of petitioners’ motions to dismiss, so Rule 183 is not applicable. Additionally, the motions for reconsideration were filed more than 30 days after the petitioners received the transcripts in their case, so they were not timely under rule 161.

Even though the motions could be denied for those reasons, the Court goes on to consider the merits of petitioners’ arguments.

Petitioners’ argue that the Court lacks jurisdiction because their notices of deficiency were invalid because they were not issued under Secretary’s authority as required by section 6212(a).   

Petitioner wife argues her notice of deficiency is invalid because it originated from an Automated Underreported (AUR) department and was issued by a computer system, which is not a under a permissible delegation of the Secretary’s authority.  

Petitioner husband’s notice of deficiency was issued by a Revenue Agent Reviewers about a year later. He argues that his notice is invalid because the person who signed the notice was not named on the notice and she did not have delegated authority to issue the notice. The IRS was not sure who issued the notice, but there were three possibilities. Petitioner husband says not knowing who specifically issued the notice constitutes fraud.

After reviewing the code, regulations, extensive case law, and the Internal Revenue Manual the Court concludes both notices were issued under permissible delegations of the Secretary’s authority and the case can proceed to trial.

Orders not discussed:

  • In Docket No. 25660-17, Belmont Interests, Inc. v. CIR, the Court needs more information from the IRS about how it plans to use the exhibits which petitioner wants deemed inadmissible. According to IRS, the exhibits support the duty of consistency related to representations made by petitioner. Petitioner states the exhibits include representations made in negotiations directed toward the resolution of prior cases involving the same or very similar issues and the F.R.E. 408(a) bars their admission.  
  • Docket No. 10204-19, Spagnoletti v. CIR (order here) petitioner moves to vacate or revise the decision in his CDP case based on arguments made in the original opinion which the Court found were not raised during in the CDP hearing nor supported by the record, so the Court denies the motion.
  • Docket No. 11183-19, Bright v. CIR and Docket No. 18783-19, Williams v. CIR, two bench opinions in which petitioners were denied work-related deductions primarily due to lack of proper proof.  
Filed Under: Designated Orders, Notice of deficiency, Tax Court, Transferee Liability

When the “Routine” Morphs into a “Ticket to Tax Court”

February 9, 2021 by 6 Comments

We welcome guest blogger Steve Jager.  Steve is a regular reader of PT with a commercial and a pro bono tax practice.  He devotes a lot of time to the LITC at California State University Northridge [known as the Bookstein LITC], serving as one of their “Tax Court Advisors”  and regularly working with clinic staff/students and clients in resolving issues. He is also a partner in private practice with the firm of Fineman West & Company, LLP.  Although licensed as a CPA, he has passed the test to practice before the Tax Court which a small percentage of practitioners pass each time the Court offers the test.

Steve brings us the story of one of his clients driven to Tax Court by the pandemic and the inability of the IRS to process its mail.  Steve’s case probably represents one of many in this situation where taxpayers receive a notice of deficiency (or notice of determination) not through any fault of their own or of the IRS but because the significant delays in processing mail cause the IRS system to move the case into the deficiency procedure process rather than allowing resolution at the administrative stage.  This by-product of the pandemic certainly occurred in pre-pandemic times but not to the extent of the current level of cases caused by the failure to match correspondence which could resolve the case with the taxpayer’s file.  This causes extra work for the practitioner which is not compensated in the current attorney fee structure, extra anxiety for the taxpayer (and costs) and extra work for Chief Counsel attorneys forced to work on cases that would have been resolved at a lower level.  Taking the case to Tax Court does buy a taxpayer the personal service of an attorney or paralegal rather than the impenetrable correspondence unit of a Service Center but at a high price for all.  Hopefully, the cost here will obtain for Steve’s client the desired result.  Because the client paid the tax prior to the mailing of the notice of deficiency, I expect the IRS will file a motion to dismiss.  Keith

I feared it could happen, but prayed it would not.  I knew the cogs in the IRS machinery were still churning out Notices, and I also knew that the IRS was not keeping up with all the correspondence it was creating with these Notices and I wondered what would happen IF an IRS failure to quickly process a reply to Notice CP2000 occurred…   And then it did. 

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Most of us are probably already familiar with the CP2000 Notice – that Notice that the IRS uses when a “routine matching” of the W2’s and 1099’s are matched up against the tax returns that are filed, and when there is a “mismatch,” the letter that is sent out to the Taxpayer is the CP2000, which assumes that the “mismatch” is unreported income (or an incorrectly deducted interest expense amount), and the IRS gives the taxpayer the opportunity to either pay the calculated tax or otherwise offer explanations as to why the “mismatches” are already reported or not taxable or correctly deducted, as the case may be.  So the possible responses from the Taxpayer (or his/her practitioner) would be either: (i) concession of the amount requested, with or without payment of the additional tax; or (ii) partial concession with a full explanation as to why the concession was only partial – i.e., agreeing with one or more, but not all of the adjustments proposed by the IRS; or (iii) no concession due to a full explanation as to why the proposed adjustments are not correct.    Under “normal” conditions [read that as prior to the pandemic], any of those responses made within 30 days would be considered and at least acknowledged by the IRS.  This, of course, would mean that someone at the Service Center has opened the mail, read the response and within those 30 days, has generated a reply letter back to the Taxpayer.  

But what happens now when the IRS is behind in opening mail, reading the correspondence and writing replies?

Well, it would appear that under the current conditions the CP2000 “machinery” is assuming there has been no response and “pulling the trigger” by issuing the Statutory Notice of Deficiency!  Yikes!  Once the IRS has issued a Statutory Notice of Deficiency, it is really hard to convince the IRS to rescind the Notice (made especially hard, once again, by the fact that the IRS is not running at full capacity), so the Taxpayer has little choice except to file a petition with the United States Tax Court.  Let me relate my own clients’ story.  

Let’s call these clients, Mr. and Mrs. Taxpayer.  When I prepared their 2018 income tax return, I was unaware that Mr. Taxpayer had begun receiving social security income during that tax year, and he did not give me the 1099 from the Social Security Administration, and I certainly did not know to ask him for it.  Therefore, that income was omitted from the tax return.  The IRS computer, however, when matching the social security administration payments against the tax returns, realized a “mismatch,” and a CP2000 was issued last October.  My client received the Notice and contacted me, whereupon we quickly figured out that the income should have been reported, but was not, so I instructed my client to write a check for the tax and the interest as calculated by the IRS.  My client wrote that check IMMEDIATELY, and mailed it with the correct payment stub to the address, as instructed by the IRS.    The IRS cashed the check within 7 days of its receipt, so we know they are still opening the mail quickly, but then things obviously break down.  Notwithstanding the fact that I have had to elevate this to the Tax Court (more on that in a moment), the truly insidious part of this now all-too-common saga, is that the IRS had apparently not credited the payment to the account for Mr. and Mrs. Taxpayer, which resulted in the Statutory Notice being issued!  Once the check was noted as received, I must ask why the IRS machinery wasn’t stopped?

Regardless of why this has happened despite Mr. and Mrs. Taxpayer’s compliance, the reality is that I have had to file a Petition in the Tax Court.  This was certainly not my first petition filed with the Court, but it is my first which was filed electronically, pursuant to the new DAWSON system which the Tax Court has been so excited to roll out.  Preparing the petition was exactly the same as before – that is to say that the Petitioner or practitioner still drafts the Petition as before, and merely uploads the petition as a pdf file, which is a fairly simple process.  Paying the $60 filing fee, which in the past would have been paid by writing a check out of my Client Trust Account, was fairly easy to do by establishing an account with Pay.gov.

Now that the Petition is filed and the IRS is “served,” relatively expensive IRS resources are going to be needed.  Since I have asked for the Trial to be conducted in Los Angeles, I believe that at least a paralegal will need to be conscripted into drafting the Answer to the Petition.   Once that has happened and the Commissioner and my clients are “at issue,” only then will I be able to offer the copy of Mr. and Mrs. Taxpayer’s canceled check to prove that they timely paid the tax that they conceded as soon as they were notified, plus interest.

In this case, my clients, Mr. and Mrs. Taxpayer, are fortunate.  They are being represented and I expect to resolve this case easily.   But how many other folks are there who are compliant, law-abiding taxpaying citizens who will also need to go through a similar ordeal on their own…  unless, of course, they find their way (and are eligible for services) by one of the many LITC clinics.  And for those who do not qualify for LITC Service?   How much will those folks need to pay a professional lawyer or qualified Tax Court practitioner if they wish to be represented?

Filed Under: Notice of deficiency, Tax Court Tagged With:
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