Taxpayer Finds Another Way Not to File a Return

Whether a taxpayer has filed a return impacts not only the statute of limitations and penalties but also bankruptcy discharge.  In December I wrote about whether a taxpayer had filed a return in the Coffey and Quezada cases each involving a situation in which the taxpayer did not file a tax return but where the taxpayer argued that what was filed with the IRS or, in the case of the Coffeys, with the Virgin Island tax authorities, constituted the filing of the return in question.  For those with a Tax Notes subscription, you can see an expanded discussion of the cases here.

Another case has come out addressing the issue of whether a return was filed.  In Harold v. United States, (E.D. Mich. 2021) the district court affirms a bankruptcy court’s order denying discharge to a debtor who sent a revenue officer (RO) his tax return for the year at issue prior to the due date of the return but never filed the return with the IRS at the appropriate service center.  The court determines that delivery of the return to the revenue officer under the circumstances of this case did not satisfy the requirement of the taxpayer to file the return.  The case demonstrates, yet again, the importance of following the correct procedures for submitting a return and the trouble that can follow if the taxpayer colors outside of the lines.

read more...

 Mr. and Mrs. Harold requested the automatic extension of time to file their 2008 return.  Because they were engaged in collection issues with the IRS about that time, they hired a tax resolution company to negotiate an installment agreement.  On June 2, 2009, well before the extended due date for their 2008 return, their representative faxed materials to the RO assigned to the case and included in the package the first two pages of their 2008 return together with the statement that the 2008 return “was sent to the IRS for filing on June 1, 2009.”  On June 16, 2009, the representative faxed a full, signed copy of the 2008 return to the RO.  At a subsequent deposition the representative described this second sending as a courtesy copy.  The representative testified that he did not remember sending the 2008 return to the service center but that if he had done so, his practice would have been to send it by regular mail.

The Harolds did enter into an installment agreement (IA) in July of 2009.  This IA did not cover 2008 and the letter transmitting the IA made no mention of 2008.  The RO testified that she did not require the filing of post IA returns with her.  She also testified that she regularly directed taxpayers to file future returns with the IRS service center in accordance with normal filing procedure.

Fast forward to 2016 when a new RO enters the scene looking for outstanding returns from the debtors.  The debtors go back to the representative and request a copy of their 2008 return.  The rep provides a copy and says it was filed with the first RO on June 16, 2009.  The IRS assesses the liability for 2008 in 2016 when the second RO obtains the return and five days later Mrs. Harold files a chapter 7 petition.

The IRS filed an adversary proceeding seeking a determination, inter alia, that the 2008 tax liability is not discharged.  The relevant discharge provision is in BC 523(a)(1)(B).  This section excepts from discharges the taxes on a return filed late and filed within two years of the filing of the bankruptcy petition.  Here, the IRS will win, and prevent the discharge of the 2008 taxes, if the submission to the first RO fails to qualify as the filing of a return, since the submission in 2016 immediately prior to the filing of the bankruptcy petition would then become the time of the return filing.

The court notes that the Internal Revenue Code does not define the term “filed.”  It then looks to Sixth Circuit precedent found in the case of Miller v. United States, 784 F.2d 728 (6th Cir. 1986).  In Miller, the court defines the filing of a federal tax return as the time when it “is delivered and received.”  That definition, commonly known as the “physical delivery rule,” may not provide the most helpful guidance here as it relates to mailing of a return.  Mrs. Harold argues that the faxing of the return should count if the court does not believe that her representative sent the return by regular mail.

On appeal she abandoned the argument that her representative mailed the return.  Given his tepid testimony on this point, this concession makes sense.  She pins her hopes on the faxing of the return to the RO.  The IRS does not dispute the fact of the faxing of the return but only disputes the consequence.  She argues not only did faxing the return constitute filing but that doing so met a precondition to acceptance of the IA.  So, the acceptance of the IA validates the faxing of the return as a filing.

This argument sends the court to look at the Internal Revenue Manual to find the IRS internal guidance regarding the requirement for filing past due returns as a precondition to acceptance of an installment agreement.  IRM 5.14.1.2, 5.14.1.3, 5.14.1.4.2 as in effect at the time required the filing of past due returns prior to the acceptance of an IA.  The parties agreed that the IRS would not have entered into an IA if delinquent returns existed; however, the IRS argued the 2008 return was not delinquent in June of 2009 since Mrs. Harold and her husband had validly requested an extension until October 15, 2009.

Mrs. Harold makes a technical point concerning the extension in arguing that it lacked validity.  She argues the extension not only required a timely and proper request but also an extension of time for payment.  Since the time for payment had not been extended and since she owed taxes on the 2008 return, the extension was invalid and her return was delinquent in June of 2009.  Taxpayers who request an extension should pay the anticipated tax liability at the time of the request.  The failure to make a necessary payment with the request could allow the IRS to invalidate the request and treat a return filed after the statutory due date (April 15, 2009) as late.  In this case, however, the IRS transcript showed that the due date had been extended until October 15, 2009.  The RO would have looked at the transcript to determine if a delinquency existed and would have found none.  So, the filing of the 2008 return prior to the acceptance did not create an obstacle for the RO in creating the IA.  The district court followed the bankruptcy court in finding that the 2008 return was not delinquent in June of 2018.

The court then addressed whether the IRS should have accepted the fax of the return to the RO as a filing.  Everyone agreed that giving the return to the RO did not meet the IRS rules governing the proper place to file a return.  The court rejects the faxing of the return as a filing for two reasons.  First, it says it cannot presume Mrs. Harold intended the faxing as a filing in light of the language in the fax stating that the 2008 Form 1040 sent by her representative was a “courtesy copy.”  Second, the faxed return did not go to the proper place.

In rejecting the filing for the second reason, the district court disagreed with the bankruptcy court.  The bankruptcy court found that sending a return to the designated service center is not the only way to properly file a return noting that in Chief Counsel Advice 199933039 the IRS had acknowledged that if a RO requested a return they have the authority to “request and receive hand-carried delinquent returns.”  The district court says relying on the CCA is misplaced because it has no precedential value. 

I disagree with the district court’s conclusion on that point.  Giving the return to a RO or a Revenue Agent who requests a delinquent return has been and should be a recognized way to file a delinquent return.  Unless a taxpayer were given a clear caveat that an RO or RA who requested and received a delinquent return did not consider the transmittal of a return in that circumstance to constitute filing, many taxpayers would be deceived into thinking that they had filed.  The bankruptcy court got this right; however, the district court went on to say that the RO did not solicit the return here and that even if delivery to an RO who solicited a delinquent return could constitute filing, delivery without request does not.  I agree with the district court that delivery without request would not in ordinary circumstances meet the filing requirement, although even in this situation actions by the RO or RA could create an impression of acceptance as filing.

This opinion generated some good discussion among a handful of practitioners with whom I correspond on tax related bankruptcy matters.  Bob Pope noted the absence of a discussion of the one-day rule by the court.  That’s a good catch.  For anyone not familiar with the one-day rule read blog post on it here (citing to many earlier posts.)  Ken Weil notes that before filing bankruptcy Ms. Harold should have checked the IRS transcripts to make sure the 2008 liability was assessed in 2009, which would have allowed her to properly consider her risk before filing the bankruptcy petition.  He also notes he could not find a delegation of authority for an RO to accept a return, although the CCA suggests such a delegation exists.  Lavar Taylor provided an interesting war story involving a similar issue and the practices of ROs regarding returns received after requests.  Bryan Camp noted that the RO’s job has involved “collecting” delinquent returns going back to the 1860s but that he did not think the return would be considered filed until it made it to the office that made the assessment.

You do not want your client to test these waters.  Don’t give a delinquent return to an RO or an RA and expect that delivery to constitute filing.  Send a signed original to the proper service center.  Be aware of the arguments available if your client has delivered a delinquent return to an RO or RA but save those arguments for situations where you are cleaning up after someone else.

Eighth Circuit Spills Coffey Decision

Well, in a case that fractured the Tax Court about as badly as it can be fractured, the Eighth Circuit, after initially projecting harmony and uniformity in its decision, initially appeared to have fractured as well, reversing the decision it rendered a couple months ago overturning the Tax Court’s fully reviewed and fractious opinion.  This latest action briefly reopened the door on the question of adequate filing of a return for purposes of triggering the statute of limitations, before reinstating the original holding through a new opinion by the panel. That new panel opinion can be found here  Our most recent prior post on this case can be found here.  It contains links to prior posts on the Coffey case, the Tax Court opinion and the Eighth Circuit’s original opinion. We anticipate the Coffeys will file a new motion for reconsideration.

read more...

To briefly recap the facts in Coffey, the taxpayers claimed that they were residents of the US Virgin Islands in 2003 and 2004 and filed returns with the Virgin Island tax authority.  That taxing authority has a symbiotic relationship with the IRS and sent to the IRS some of the documents it received.  The IRS took the documents it received and concluded that M/M Coffey should have filed a US tax returns.  Based on that conclusion, it sent to the Coffeys a notice of deficiency.  The Coffeys argued that the notice of deficiency was sent beyond the statute of limitations on assessment since their filing with the US Virgin Islands tax authority also served as a filing with the IRS starting the normal assessment statute.  The government argued that because the Coffeys did not file a return with the US, no statute of limitations on assessment existed.  After only eight years, the Tax Court sided with the Coffeys.  A mere three years later, the Eighth Circuit reversed in a unanimous three judge panel.  –

On February 10, 2021, the Eighth Circuit granted a panel rehearing but denied a rehearing en banc.  Disagreements with the outcome of a circuit court usually result in a request for a rehearing en banc rather than a rehearing with the very panel that entered the decision.  So, this is a bit of an unusual twist in a case with many twists. After the vacating of the original opinion, the same panel issued a new opinion with some minor differences.

Since the original opinion, the Virgin Islands tax authority had filed its own petition for rehearing, supporting the position of the Coffeys that a return filed with the Virgin Islands acts as a trigger for the starting of the statute of limitations on further assessments by the IRS. The petition focused in part on “a seemingly minor factual mistake” in the panel opinion, namely that the Virgin Islands tax authority “chooses” to use Form 1040 rather than being statutorily required to do so. It is this observation that appears to have encouraged the Eighth Circuit to vacate the original opinion. In the new opinion, the panel clarified this, observing that the Virgin Islands taxing authority “uses the same forms” as the IRS and clarifying that the original holding — that returns filed with the Virgin Islands authority are not returns — applies only to non-residents like the Coffeys.

The result of the Eighth Circuit’s decision allows the IRS to come in many years later to challenge residence of individuals claiming Virgin Islands residence.  If the Coffeys had succeeded in this case, the procedural issue would have turned into a substantive victory, since the IRS would not have been able to make an assessment against them for the years at issue.

TIGTA Audit Flags Inconsistency in IRS Treatment of E-filed Returns

A recent report from TIGTA highlights the IRS’s inconsistent treatment of millions of e-filed returns that have errors.  IRS e-file processes consider an e-filed tax return as “filed” when the IRS accepts the return for processing, not when the IRS originally receives the return. The TIGTA report reveals that IRS does not have the  “the ability to use the date an e-filed return was initially received as the return filing date.” This is a problem because under the commonly used Beard test the IRS routinely rejects legally sufficient returns, triggering delinquency penalties and uncertainty as to the statute of limitations on assessment, a topic that Keith discussed in Rejecting Returns that Meet Beard. That post covered Fowler v Comm’r, which held that a rejected an e-filed return the return still triggered the 3-year limitation period on assessment. The TIGTA report suggests that there are systemic issues stemming from the IRS practice of rejecting e-filed returns, issues that will likely require a legislative fix or a significant change to internal IRS practices.

read more...

Unlike submitting a return by snail email, when e-filing a return it generates the possibility of the IRS rejecting a return (so called validation problems). Even if an e-filed return is validated, as with paper returns sent via regular mail, the IRS may notice errors that trigger Error Resolution System (ERS) scrutiny. TIGTA notes that there were about 26 million ERS issues on 2019 individual returns, with over 24 million of those errors attributable to “when the tax liability, balance due amount or refund computed is incorrect, or when information on the return does not match the information on a supporting form or schedule.” Not surprisingly the numbers of these types of errors are much higher on paper returns, (appx 15.3 million to 8.9 million).

For some errors, the IRS process for ERS scrutiny generally involves a tax return examiner contacting a taxpayer to correct the error; if over 40 business days elapse without a response the return is often released for processing, though is still tagged with the error code that delayed the processing.

All of this background gets us to the problem that TIGTA flagged, namely inconsistent IRS processes on e-filed returns with errors:

Our review found that IRS processes do not consistently provide taxpayers the opportunity to self-correct errors on e-filed tax returns. For example, some e-filed returns with a missing form are rejected to provide the taxpayer the opportunity to self-correct the error (i.e., attach the missing form and resubmit the e-file return) while others are accepted and sent to the ERS for manual correction by an IRS tax examiner, which suspends the return and holds the refund until the error condition is resolved.

This inconsistency can leads to later problems, as the statutory filing date of a tax return is, as TIGTA notes, “the date the IRS receives a legally valid tax return from the taxpayer.” Yet despite the statutory filing date, which is key for issues like delinquency penalties and the start date for determining when the statute of limitations on assessment expires  “e-file processes do not consider a rejected e-file tax return to be “received” until the taxpayer resubmits the rejected return and the IRS accepts it for processing.”

This rejection can lead to problems, especially if someone is e-filing at or close to the filing deadline.  To be sure this problem is mitigated by the resubmission policy that IRS has adopted. Publication 1345 discusses that process, which allows for sending a snail mail return within 10 calendar days of an e-file rejection:

If the taxpayer chooses not to have the electronic portion of the return corrected and transmitted to the IRS, or if the IRS cannot accept the return for processing, the taxpayer must file a paper return. To timely file the return, the taxpayer must file the paper return by the later of the due date of the return or ten calendar days after the date the IRS gives notification that it rejected the electronic portion of the return or that the return cannot be accepted for processing. Taxpayers should include an explanation in the paper return as to why they are filing the return after the due date.

As TIGTA suggests, the rejection of e-filed returns that satisfy the Beard test is common. If a taxpayer fails to correct the return (or corrects after the 10-day period) there is the likelihood that a return that would qualify as a return under Beard is not treated by the IRS as filed. IRS desire to maximize taxpayer self-correction of returns makes sense; it can reduce burden, speed up refunds, and avoid possible downstream costs. Yet it seems that millions of e-filed returns that IRS rejects are likely to constitute validly filed tax returns. When facing possible delinquency penalties or there are questions about the SOL on assessment it is important to consider whether the IRS previously rejected an attempted e-filed return.

Eighth Circuit Finds Coffey Delivery Inadequate to Constitute a Return

Coffey v. Commissioner, No. 18-3256 (8th Cir. 2020) reverses a fully reviewed and heavily fractured decision of the Tax Court.  The case spent approximately eight years in the Tax Court getting to a decision and almost three years in the circuit court.  We wrote about the Tax Court case here, here and here primarily focusing on the heavily split decision and what it means when no clear majority of the Tax Court exists.  Based on the difficulty the Tax Court had in deciding the case, it’s safe to say the issue presents plenty of challenges.

Yesterday, I discussed the Quezada case in which the Fifth Circuit overturned the district court which overturned the bankruptcy court in deciding that the information provided in Mr. Quezada’s Forms 1040 and 1099 sufficiently provided the IRS with the information it needed for backup withholding meaning that these two forms essentially served as the Form 945 Mr. Quezada should have filed to report backup withholding meaning that the statute of limitations on assessment for backup withholding ran by the time the IRS made thee assessment.  Today, we look at whether a return was filed based on an entirely different set of facts but also considering whether information on one return could satisfy the requirements of another.  Like Quezada, the circuit court reverses the lower court but here it reverses a decision holding that the ersatz documents satisfied the requirements and holds that they do not.  Both cases involved the statute of limitations on assessment.

read more...

The Coffeys claimed residence in the US Virgin Islands.  This time of year many of us would like to be residents of the Virgin Islands and not just for tax reasons.  For 2003 and 2004 they filed USVE returns which consisted of complete Forms 1040 and numerous other schedules and forms.  Although they did not file the returns with the IRS, the USVI’s Bureau of Internal Revenue sent to the IRS the first two pages of their return for each year as well as the Virgin Island and “regular” US Forms W-2.  The returns and W-2s were sent to the IRS about five months after receipt of the documents.  These documents were sent to the IRS pursuant to a process which would cause the IRS to send to the Virgin Islands any overpayment that would otherwise have been refunded to the Coffeys.

The IRS did not just send to the Virgin Islands the Coffeys’ refunds for the two years.  It audited the documents it received and issued a notice of deficiency for the two years.  The notice went out in 2009 well more than three years after the years at issue.  The IRS took the position in the notice that Judith Coffey had never qualified as a resident of the Virgin Islands and therefore could not claim the special credit available to VI residents.  The fractured Tax Court decision held that the statute of limitations for assessment of their US taxes began upon receipt of the pages of the Form 1040 sent by VI to the IRS.  Of course, the IRS took the position that receiving a portion of the Form 1040 from the VI taxing authority did not constitute a filing of a tax return with the IRS and consequently did not trigger the running of the statute of limitations on assessment.

Section 932(a)(2) of the Internal Revenue Code requires that Virgin Island non-residents must file their tax return with both the IRS and the VI taxing authority.  The court notes the statute of limitations on assessment does not begin to run until a taxpayer files a return.  The IRS, as in Quezada, argues for strict construction of whether the statute of limitations bars the IRS from assessing.

The Coffeys made two arguments in support of their position that the statute had run.  First, they argued that the sending of a portion of their return to the IRS by the VI taxing authority met the filing requirement.  Second, they argued that the filing in the VI alone met their US tax filing requirement.

As in Quezada, the case of Commissioner v Lane-Wells Co., 321 U.S. 219 (1944) ends up in the first paragraph of the court’s analysis.  The Eighth Circuit says:

Returns are “filed” if “delivered, in the appropriate form, to the specific individual or individuals identified in the Code or Regulations.

Quoting from Commissioner v. Sanders, 834 F.3d 1269, 1274 (11th Cir. 2016) which was quoting from Allnutt v. Commissioner, 523 F.3d 406, 413 (4th Cir. 2008).

The Eighth Circuit also quotes from Lane-Wells:

The purpose of filing requirements “is not alone to get tax information in some form but also to get it with such uniformity, completeness, and arrangement that the physical task of handling and verifying returns may be readily accomplished.

The Eighth Circuit cites to an earlier decision by it in Heckman v. Commissioner, 788 F.3d 845 (8th Cir. 2015) which it describes as a similar case to Coffey.  In Heckman the taxpayers did not report some taxable income and the IRS learned about the failure during an unrelated audit of the taxpayer.  When the IRS issued a notice of deficiency more than three years after the return filing, Heckman argued the statute of limitations barred the notice because of the actual notice of the IRS; however, in Heckman the Eighth Circuit held that even though the IRS knew about the income, that knowledge did not start the running of the statute of limitations on assessment.  In making that holding the court said that the statute started running only when the taxpayer’s return was filed.

Here, the sending of the information from the Virgin Islands did essentially the same thing as the related audit of Mr. Heckman.  It provided the IRS with actual knowledge but not with a filed return.  Here, the Coffeys even made clear they did not intend to file a return with the IRS and they failed to follow the statute for return filing by non-Virgin Island residents.  The court also pointed out that in sending a portion of their return to the IRS, the Virgin Islands did not act as an agent of the Coffeys:

That the IRS actually received the documents, processed and audited them, and issued deficiency notices is irrelevant for statute of limitations purposes. See Heckman, 788 F.3d at 847–48. The IRS’s actual knowledge did not create a filing.  The statute of limitations in section 6501(a) begins only when a return is filed.  Because the Coffeys did not meticulously comply with requirements to file with the IRS, the statute of limitations never began.

In their second argument, that filing with the Virgin Islands counts as a filing with the IRS, the Coffeys were aided by an amicus brief filed by the Virgin Islands.  This argument turns on the Coffeys’ genuine belief that they met the residence requirements of the Virgin Islands.  They argue that if they had a good faith belief they were VI residents filing their return with VI satisfies the return filing requirement and starts the statute of limitations within the US.  Not so says the Eighth Circuit:

The taxpayer’s “subjective intent is irrelevant” in determining what is an honest and genuine return. Citing In re Colsen, 446 F.3d 836, 840 (8th Cir. 2006).

Colsen involved a taxpayer who filed a late return and waited two years before filing bankruptcy seeking to obtain a discharge.  In the bankruptcy world the Colsen case involves the minority view of whether a taxpayer can file a return after the IRS has made an assessment pursuant to the substitute for return procedures.  I have written glancingly about Colsen on many occasions and most recently here.  The Eighth Circuit explains that Colsen dealt with whether a document met the test to be a return and had nothing to do with whether a document was filed.  Applying that logic to the Coffeys’ situation the Eighth Circuit finds that the honesty and genuineness of their returns has no bearing on whether the returns were filed.

The Eighth Circuit judges decided the case without the fracturing that occurred at the Tax Court.  Maybe non-tax lawyers have the advantage of being a bit removed from the law on which they are ruling.  They seemed to have none of the angst present in the Tax Court’s decision in Coffey and set out a bright line rule relying heavily on prior circuit precedent. 

The creation of a bright line rule certainly benefits the IRS in administration.  It can argue that if a taxpayer does not follow the rules it creates with regard to return submission do not constitute the filing of a return and benefit from all of the downstream effects of that result.  The IRS would have the knowledge of the return and be able to react to the return at its leisure.  Situations may exist where the IRS knowledge and its practice with regard to acceptance of a return may make a closer case or make another court less comfortable with the outcome.

Fifth Circuit Says 1040 plus 1099 equals 945, Reversing District Court’s Calculation of What is a Return

In Quezada v. IRS, No. 19-51000 (5th Cir. 2020) the Fifth Circuit determined that the Form 1040 filed by the Quezadas and the Forms 1099 issued by his business to its workers started the running of the statute of limitations for backup withholding. The decision reverses the district court which had reversed the bankruptcy court. We discussed those decisions here and here, respectively. You can read the prior posts for background on what is a hotly contested matter with significant monetary implications for the Quezadas as they seek to emerge from bankruptcy and for the IRS as it tries to prevent consequential adverse precedent regarding what constitutes a return.

I plan to follow this post tomorrow with a victory for the IRS in another circuit rendered just a few days after Quezada.  I don’t know if this decision has enough administrative importance for the IRS to warrant consideration of a cert petition or if there is a sufficient conflict in the circuits but I expect the IRS and DOJ will give the matter more than glancing thought.  The IRS very much wants a per se rule because of its desire for ease of administration.  It does not want to triangulate documents on the wrong forms or submitted to the wrong place in order to make a judgment whether a taxpayer has effectively filed a return.  Decisions like Quezada act like sand in the efficient running of its return processing machinery.  The decision also raises questions concerning why the IRS took so long to act on what were clearly deficient Forms 1099.

read more...

The issue presented here arises as a statute of limitations question. Did Mr. Quezada file a return that started the running of the statute of limitations, or rather, since we know he did not file the specific return at issue, did he file other returns or other documents that could take the place of the required return? In some ways this case takes the court into the type of analysis it would use in an informal claim case. Although Mr. Quezada makes no claim for a refund, he argues that he provided the IRS with enough information to trigger a running of the statute of limitations, just as an informal claim would trigger a satisfaction of the statute of limitations for filing a claim without actually using the process prescribed by the IRS.

Mr. Quezada ran a stone mason business.  He had a number of individuals working for him at various times during the years at issue.  These individuals were treated as subcontractors and not as employees and the case does not question that designation.  In 2014 the IRS assessed deficiencies against him dating back to 2005 for his failure to backup withhold for 2005 through 2008.  The court explains why the IRS made the backup withholding assessment:

A Form 1099 shows the name and address of the payee and how much he was paid. Each payee for whom a payor files a Form 1099 must provide a “Taxpayer Identification Number” (TIN). See 26 U.S.C. § 3406(a). A personal identifying number, like a social security number, can serve as a TIN. 26 C.F.R. § 301.6109-1(a)(1)(i). The payor must list the payee’s TIN on the Form 1099. Id. § 301.6109-1(c). If “the payee fails to furnish his TIN to the payor in the manner required,” the payor must withhold a flat rate for all payments to the payee and send the withholdings to the IRS. 26 U.S.C. § 3406(a). This is called “backup withholding”; the flat rate the payor withholds acts as a “backup” in case the payee fails to pay taxes on the underlying payments.

Mr. Quezada reported the payments he made to subcontractors working for his business but almost all of the Forms 1099 he filed reporting those payments failed to include the individuals TIN as required by the statute and regulations. In each of the years almost all of the Forms 1099 he issued were deficient in this way. For reasons not explained, the IRS did not make an assessment against Mr. Quezada for the failure to engage in backup withholding with respect to the deficient Forms 1099 until more than three years after the filing of his income tax returns and the Forms 1099 for the four years in question. At issue concerns an assessment against him of over $1.2 million.

The purpose of backup withholding is to prevent individuals the IRS cannot identify from the Form 1099 from avoiding payment of their taxes with no practical way for the IRS to check whether they paid or not.  Here, it is unknown whether the subcontractors actually paid their taxes meaning that the assessment against Mr. Quezada would result in a windfall to the IRS or whether the assessed amount would allow the IRS to recover taxes it would otherwise lose because of the poor quality of the Forms 1099.

In his bankruptcy case Mr. Quezada contested the timeliness of the assessment of backup withholding. The Fifth Circuit sets out its view of the IRS argument:

Form 945 is thus the “return required to be filed by” a taxpayer who, like Quezada, is required to backup withhold. 26 U.S.C. § 6501(a). Quezada failed to file a Form 945. So, the argument goes, he never filed “the return,” and the limitations period never began to run under § 6501(a)‘s “[g]eneral rule.” The IRS thus contends the analysis ends here: Form 945 is the only document that can constitute “the return,” and Quezada failed to file it. Appeal concluded. In support of its argument, the IRS invokes Lane-Wells, which the IRS construes to create a per se rule requiring the taxpayer to file the return designated for the tax liability at issue; if the taxpayer does not file that specific return, the limitations clock never begins to run.

The court rejects the per se rule finding that Lane-Wells did not create such a rule not only finding that Lane-Wells did not create the per se rule the IRS argues that it held but citing to several circuit court decisions it says support the filing of a return based on other returns or documents.  The Fifth Circuit says it aligns itself with these other circuits and holds that:

‘the return’ is filed, and the limitations clock begins to tick, when the taxpayer files a return that contains data sufficient (1) to show that the taxpayer is liable for the tax at issue and (2) to calculate the extent of that liability.

Having decided that Mr. Quezada need not have filed Form 945 in order to start the clock ticking, in order words that there exists an “informal return” doctrine, the court then looks at what he did file to determine if the returns filed sufficiently met the test it stated.  The court decides that the Forms 1040 and 1099 did provide the IRS with enough information to create an informal Form 945.  The forms filed contained enough data to show he had a backup withholding liability.  The Forms 1099 showed the amount paid and the person paid thus allowing the IRS to calculate the amount of backup withholding that Quezada should have made.  Case over.

The case obviously matters to businesses that fail to make proper backup withholding when they lack the payees TIN. Does the test adopted by the Fifth Circuit create principles that will assist taxpayers in other circumstances? If so, what are those circumstances and how broadly could this test apply.? No doubt, there will be taxpayers out there willing to test the limits of this opinion.

Tomorrow, in a different context but with the same ultimate question of whether a return was filed, we will look at a case that came out the other way.

Rejecting Returns That Meet Beard

The IRS rejects a lot of e-filed returns for reasons that seemingly have nothing to do with whether the taxpayer filed a valid return. (see these posts) It has done this for years, decades even.  This disparity between the way it treats e-filed returns and the way it treats returns mailed by snail mail catches up with it in Fowler v. Commissioner, 155 T.C. No. 7 (2020) a fully reviewed opinion with no concurrences or dissents (see also Bryan Camp’s informative post on Fowler from a different perspective). I don’t know if the Fowler case will serve as a wake-up call to the IRS to change its practices of rejecting returns with issues having nothing to do with whether the taxpayer actually filed a return, but it should.  The opinion seems so clearly correct that I wonder if, even given the administrative importance of the issue, the IRS will bother to appeal.  It would be interesting to be a fly on the wall in the Room of Lies when the IRS tries to sell this case to DOJ to appeal, if it does.

read more...

Mr. Fowler requested an automatic extension to file his 2013 return extending the due date from April 15 to October 15, 2014.  Pursuant to the extension, Mr. Fowler timely e-filed his 2013 return; however, the IRS rejected his return because he failed to attach an IP-PIN, something the IRS wants some taxpayers who have had issues with identity theft to file with their return.  When the e-filed return rejected, Mr. Fowler’s preparer created a paper return which Mr. Fowler signed using DocuSign and filed on October 28.  Although the preparer received a signed certified mail slip indicating that the IRS received the paper return, in December, 2014, the IRS notified Mr. Fowler that he had not filed a return.

A third attempt to file the return occurred in April of 2015 and this attempt succeeded.  For some reason, the IRS waited to send Mr. Fowler a statutory notice of deficiency until April of 2018.  The notice date fell within three years of the third return but outside the three years of the first two documents Mr. Fowler sent in as returns for 2013.  He filed a summary judgment motion arguing that the IRS blew the statute of limitations by not sending the notice with three years of the originally filed or the second return.  The IRS filed a cross motion for summary judgment on the statute of limitations issue, arguing that the failure to include the IP PIN with the original return caused it to fail the Beard test.  Similarly, it argued that signing the paper return via DocuSign caused the second return to fail the Beard test, making the third return the original filing of a return for 2013 and the timing of the notice of deficiency appropriate.

To get to the bottom of the case the Tax Court analyzed the facts using the Beard test – a test developed in the 1980s before e-filing existed.  The problem the IRS has stems from its effort to shoehorn a post-Beard practice into the language of Beard.  As it developed and refined e-filing, it let programmers define acceptable e-filing, but the programmers did not keep their eye on the Beard test because it has rather elegant simplicity designed to provide guidance in a different time.  Either by statute, regulation or an updated version of Beard, the IRS must change the underlying law if it wants to stick with the tests it seeks to impose on e-filing that go well beyond Beard’s requirements.  The Tax Court judges unanimously, and correctly, determine that IRS practices in rejecting e-filed returns for matters not covered by Beard’s test fail. 

The Tax Court said it was not going to bother looking at the second return because it could decide the case based on the first one. Let’s look at the Beard test and how it lines up with rejecting a return for failure to include an IP PIN. The Court noted “We first consider whether the October 15 submission was a “required return” and “properly filed”.”

It looked at the concept of required return and explained what the Beard test requires:

The Beard test requires that: (1) the document purport to be a return and provide sufficient data to calculate tax liability, (2) the taxpayer make an honest and reasonable attempt to satisfy the requirements of the tax law, and (3) the taxpayer execute the document under penalties of perjury.

Here, the original 1040 purported to be a return and provided sufficient data to calculate the liability. The IRS did not object to this conclusion.

Having determined that the document met the first test, the Court moved on to the second test which it described as follows:

We next consider whether petitioner made an honest and reasonable attempt to comply with the tax law. A taxpayer need not file a perfect return to start the limitations period.

The Court determined that Mr. Fowler’s document met this test because he did try to file a correct return that complied with the tax law. The Court notes that the only difference between the original return and the one filed in April was the addition of the IP PIN on the April return. It further noted that the IRS did not file any response that would lead the Court to the conclusion that the original return did not provide an honest and reasonable attempt to comply with tax law.

Having concluded the taxpayer met the first two tests it moved onto the test involving the need to sign the return under penalties of perjury. On this point the IRS strenuously objected that Mr. Fowler complied. To win, the IRS had to argue that including the IP PIN constituted an integral part of his signature. The problem with this argument, or at least a major problem with this argument, is that even the IRS own descriptions don’t say that. Here’s what the Court says on this subject:

Under the heading “IRS e-file: Electronic Return Signatures!”, the instructions state that the taxpayer “must sign the return electronically using a personal identification number (PIN)”, either a Self-Select PIN or a Practitioner PIN. 2013 Form 1040 Instructions, at 73 (emphasis added). Here, Mr. Call included a Practitioner PIN on petitioner’s efiled return in accordance with the instructions.
Notwithstanding the foregoing instructions, respondent now argues that the IP PIN is part of the signature requirement. Because we find no IRS guidance characterizing an IP PIN as a signature, we disagree.

The IRS instructions for electronic filing explicitly required Mr. Fowler to use a PIN and his practitioner to use a PIN but did not require that he use the IP PIN. Because the programmers at the IRS decided that certain individuals must submit an IP PIN so the IRS can satisfy itself that the person is who they say they are, the programmers added the additional requirement regarding the IP PIN just as they have added other requirements which do not conform to the Beard test. The Court noted that the IRS regularly rejects returns that meet the Beard test:

the Modernized e-File (MeF) system, which the IRS uses to process
efiled returns, see infra Part II.B, rejects returns for numerous errors that may not cause a return to fail the Beard test.

In a footnote to this sentence the Court also noted that although the Internal Revenue Manual says that the IRS should reject e-filed returns failing to contain a IP PIN when the IRS had sent one to the taxpayer, the same provision does not provide for the IRS to return the paper filed return with the same problem. Because the IRS provided no authority for the fact that its programmers injected into the system a requirement that the taxpayer must attach the IP PIN, the Court found that the original return Mr. Fowler filed constituted a valid return, making the notice of deficiency one sent after the statute of limitations had expired.

The Court went on to explain why an IP PIN did not need to serve as the only line of defense here to avoid a problem of validating Mr. Fowler’s identity. It also provided some history on e-filing to show that his return went into the IRS system the way it should.

Assuming Fowler stands, what does it mean? It can mean that the IRS completely loses a case. as in this situation where the notice of deficiency bears a date more than three years after the valid initial filing. The Fowler case will not stand alone in reaching this result for certain taxpayers, but the more common situation will involve penalties. The IRS will seek to impose late filing penalties on electronic filers like Mr. Fowler, whose electronically filed returns fail to meet the rules created by the IRS programmers. We discussed the issue of the disconnect between the electronic filing rules and paper rules in this regard several times in the last few years, and the ABA Tax Section tried to get the IRS to react to the problem at that time.

The problem here results from the IRS using different rules for electronically filed returns than the case law allows. It deserved to lose. It needs to take a hard look at how to treat taxpayers equally in the electronic and paper context. If it persists in wanting more protection or more tests for a valid electronic return than Beard requires, it needs to find some authority for that. The Tax Court got it right that the emperor has no clothes on this issue.

For 2020, IRS Offers Spanish Speakers a “Diez Cuarenta”

We welcome back frequent commenter and occasional guest blogger Bob Kamman with a glimpse of a new Spanish language version of Form 1040 the IRS has tested before as Bob tells us from his research into the history of the form.  He also refers to the music the IRS might add to its call line and that reminded me of a post I wrote in the second year of the blog.  Keith

The idea was rejected by IRS in 1971 and tested with little success in 1994.  But IRS has announced an “aggressive step” that for the next tax season, Form 1040 will be available in Spanish.   According to the IRS press release:

“As part of a larger effort to reach underserved communities, the Internal Revenue Service is taking a number of aggressive steps to expand information and assistance available to taxpayers in additional languages, including providing the Form 1040 in Spanish for the first time.”

read more...

Will the numerous schedules and forms that must be attached to some Ten Forty (Diez Cuarenta) returns also be available in Spanish?  How about the 1040 instructions?  IRS does not tell us.  But the press release notes:

“Other changes include Publication 1, Your Rights as a Taxpayer, is now available in 20 languages. The 2020 version of Publication 17, Your Federal Income Tax, will be available early next year in seven languages – English, Spanish, Vietnamese, Russian, Korean and Chinese (Simplified and Traditional).”

It’s accurate for IRS to claim that this is the first time for Form 1040 to have an official translation, although the Form 1040-PR is in Spanish.  (That form is used by some residents of Puerto Rico to report self-employment income and to claim the additional child tax credit.)

However, in 1994 IRS tested Spanish versions of Form 1040A in Southern California and Florida.  That “simplified” IRS form no longer exists.   The purpose was described then as “aimed at increasing tax revenue.”

An IRS spokesperson in California told the Los Angeles Times, in an article published January 28, 1994:

“Most people want to comply but they don’t know how to and can’t understand the forms.  The IRS isn’t concerned about [which language a person speaks or] legal or illegal status . . . We just want the taxes.”

A spokesperson for the Mexican American Legal Defense and Education Fund (MALDEF) of Orange County, California, saw the Spanish forms as a way to decrease tax-preparer fraud.  “It may minimize the exploitation of the immigrant community by those who file their taxes,” he said.  The Times article reported that “it will also give immigrants, who are often accused of feeding off the public welfare system, a chance to ‘pay their fair share of taxes,’ [the MALDEF spokesperson] said.”

Two members of Congress from Orange County objected, however. Representative Ron Packard, who served from 1983 to 2001, criticized the $100,000 cost of the test, claiming the forms were a waste of money that would just make tax collection more confusing.  “Will the United States government print forms . . . for all of the thousands of different languages spoken and written by people in this country?” he asked.  “At a time when the federal government faces unprecedented fiscal constraints, this does not represent a prudent use of taxpayer funds.” 

Meanwhile, a spokesperson for Representative Dana Rohrabacher, who retired in 2019 after 20 years,  said the Congressman  believed   all government business should be conducted in English and all forms should be printed in English.

What conclusions did IRS draw from the 1994 trial of Spanish tax returns?  A July 27, 1994 article in the South Florida (Fort Lauderdale) Sun Sentinel reported that the program cost taxpayers about $157 per completed return:

“The IRS printed about 500,000 Spanish-language 1040A forms and distributed them in districts in South Florida and the Los Angeles area.  The translation, printing and distribution of the forms cost about $113,000.  As of the middle of May, a total of 718 Americans had filed their tax returns on the forms, called 1040A Espanol, the IRS said.”

Well, at least they tried.  In 1971, Representative Henry B. Gonzalez of Texas, ten years into his 38-year career in Congress, asked IRS to provide a Spanish translation of Form 1040.  IRS wrote him back that “practical difficulties” prevented this.  James N. Kinsel, described as “IRS tax forms chairman,” wrote that “one of these difficulties is the number of different languages which might have to be given this treatment.  Another difficulty stems from our processing and audit activities, and the possible need to employ large numbers of bilingual technicians.” 

Instead, Rep. Gonzalez was told that IRS puts Spanish-speaking workers in income tax assistance offices in areas of the country with high Mexican-American population, and was working on a Spanish-language pamphlet concerning income tax.

Of course, in the Internet era, most of the printing and distribution costs of translated forms are gone.  But as IRS becomes increasingly dependent on private enterprise, will software providers like TurboTax and the coalition that sponsors Free File make it easier for taxpayers to prepare returns in a language other than English?  And how many states will translate their income tax forms and instructions?

Optimistically, IRS tells us that it will allow taxpayers to indicate their choice of language when IRS contacts them.  As the press release notes:

“In addition to being available in English and Spanish, the 2020 Form 1040 will also give taxpayers the opportunity to indicate whether they wish to be contacted in a language other than English. This is a new feature available for the first time this coming filing season.”

It might be more useful if taxpayers were given a choice of music for listening on hold.  Mariachi, Salsa or K-pop?

By the way, the Taxpayer Advocate is called the “Defensor” in Spanish, which translates to “Defender.”  This may remind some of the 1961-65 television series starring E.G. Marshall and Robert Reed, and others of the recent Netflix series starring the Marvel Comics heroes Daredevil, Jessica Jones, Luke Cage, and Iron Fist.

Senate Investigation Concludes IRS Free File Program is Not Meeting Eligible Taxpayers’ Needs

Today we welcome first time guest blogger Evan Phoenix. Evan is an ABA Tax Section Christine Brunswick Public Service Fellow with Bet Tzedek in Los Angeles. In this post Evan describes a recent senate subcommittee memo on the IRS Free File program. The memo and this post are quite critical of the IRS’s oversight of the program and of certain program members. Needless to say, the Free File Alliance (FFA) and its members likely have a different take. Intuit, for example, points out that the memo “acknowledges Intuit’s voluntary investment in paid advertising of Free File, our email communication with customers beyond what is required, and reiterates findings by the previously published MITRE report and recommendations Intuit has supported, many of which are already enacted in the new MOU between FFA and IRS.” Christine

A recent memorandum by staff of the Senate’s Permanent Subcommittee on Investigations (“PSI Memo”) concludes that deficient IRS oversight of the Free File Program has resulted in the program struggling to meet its mission to provide free tax preparation and e-filing services to economically disadvantaged populations. 

The IRS Free File program has been discussed in previous posts here and here.

The PSI Memo highlights the fact that multiple independent entities have reviewed the Free File program since 2018 and provided clear recommendations for improvement with respect to observed issues. For example, the PSI memo notes that in 2018 the Internal Revenue Service Advisory Council (IRSAC) concluded that “the IRS’s deficient oversight and performance standards for the Free File program put vulnerable taxpayers at risk, and make it difficult to ensure that FFA members are upholding their obligation …”

The need to ameliorate deficiencies in the Free File Program has been exacerbated by the COVID pandemic as many private tax prep businesses and VITA sites have been closed during the tax filing season. Given the uncertainty of the situation, it is incumbent on the IRS to concentrate on protecting economically disadvantaged taxpayers by future-proofing the Free File Program to meet the needs of the vulnerable in our communities. Delays in filing taxes means delays in receiving desperately needed refunds—such as the refundable EITC, which is the largest anti-poverty initiative  in the country—for economically disadvantaged taxpayers fighting to survive the devastating effects of COVID-19. The EITC and the Child Tax Credit greatly reduce poverty for working families. These working family credits lifted an estimated 8.9 million people out of poverty in 2017, more than half of whom were children. However, “paid tax preparer fees are diminishing the EITC” with fees between 12% to 22%, and as high as 25% of the EITC.    

The PSI Memo covers five topics—a brief history of the Free File Program, a summary of IRS oversight of the program, a discussion of the importance of online search engines in taxpayers’ selection of tax preparation software, the IRS’s Free File Program marketing strategy, and recent IRS changes to strengthen the program. I will discuss these issues under three headings—(1) Brief History, (2) Recent Improvements to Free File Program, and (3) Future-Proofing Free File Program Benefits.  

read more...

BRIEF HISTORY

Topic one of the PSI Memo discusses the Free File Program history. In 1998, Congress directed the IRS to work with the tax preparation industry to ensure at least 80% of all federal tax returns were electronically filed by 2007. In 2002, the IRS entered into the Free Online Electronic Tax Filing Agreement with several electronic tax prep companies that had banded together as the Free File Alliance (“FFA”).  Under this agreement, FFA members committed to offering free online tax prep and filing services, known as Free File. The IRS and FFA also agreed to coordinate for the marketing of these free offerings to “provide uniformity and maximize public awareness.” In 2005, the IRS and FFA also developed a Memorandum of Understanding (“MOU”) to identify the service standards for Free File members and the procedures for resolving disputes.  The most recent version of the MOU runs through October 31, 2021.

Pursuant to the FFA agreement, private-sector tax prep providers agree to provide tax prep and e-filing services to vulnerable taxpayers at no cost to the taxpayer or the government; in exchange, the government agrees to not compete with FFA members by refraining from offering free online tax prep or e-filing services. Since its inception in 2002, the IRS reports the Free File Program has produced “more than 53 million free returns e-filed and an estimated $1.6 billion in savings to taxpayers.” Despite each stakeholder’s vested interest in the success of the Free File Program, the PSI Memo highlights that the program has come under scrutiny repeatedly for falling short of its objectives. The PSI Memo finds that “[u]ntil recently, the IRS conducted little oversight of the Free File program.”

Topic two of the PSI Memo provides a summary of IRS oversight of the Free File Program in the last decade. The PSI Memo highlights the fact that “[t]hree different independent entities have reviewed the Free File program since 2018 and provided recommendations for improvement, but the program continues to struggle to serve eligible taxpayers.” The PSI Memo reports that TIGTA’s 2007 review of “the effectiveness of the Free File program […] found that the IRS could improve its efforts to evaluate, promote, and administer the Free File program.”

RECENT IRS IMPROVEMENTS TO FREE FILE

Next, I’ll discuss topic five and three of the PSI Memo together. Topic five is an analysis of recent changes the IRS has made to strengthen the Free File program, and topic three discusses the importance of online search engine results in helping taxpayers choose a tax preparation software.

Prior reports revealed that some FFA members had taken deliberate actions to reduce access to the Free File Program by using coding to prevent the program from being populated in organic online web searches, a practice known as de-indexing. This is particularly troublesome because, as the MITRE 2019 assessment report (“MITRE 2019 Report”) of the program revealed, “[m]ost taxpayers find their preferred tax preparation product through online searches using an online search engine.”

The PSI Memo found:

[f]or the first 15 years of the Free File program, the IRS declined to take a position on whether FFA companies should index Free File websites to appear in online search engines, nor did FFA companies seek guidance from the IRS on whether their indexing practices complied with the MOU. As a result, participating FFA companies took different approaches in deciding whether to code their Free File program.

MITRE found that five of the twelve FFA members engaged in non-indexing their Free File websites. Upon questioning by MITRE, “most [FFA] members” stated that they “believed” this practice complied with the MOU terms. The PSI Memo emphasizes that TIGTA agreed with the IRS that the MOU did not explicitly prohibit de-indexing, but stated “it was against the spirit of the Free File program.” Indeed, this practice seems inconsistent with the FFA’s clear mission of providing low-income taxpayers with tax prep services for free, and its agreement with the IRS to “provide uniformity and maximize public awareness.”

Following public reports exposing the FFA members for using coding in this way, in December 2019, the IRS and FFA members agreed to an addendum to the Free File MOU prohibiting any practice that would exclude Free File websites from organic searches and standardizes the naming of Free File offerings to “IRS Free File program delivered by (Member company name or product name).” The PSI memo notes that FFA executives said that they “discover more program violations than the IRS and believe [the FFA] is tougher on their members than the IRS [… and] added that members do “a lot of self-policing” and report violations by other members.”

Recent news of the departure of one of the FFA members has raised many questions. After being a 20-year member, H&R Block recently announced its withdrawal from the FFA. H&R Block was one of the FFA members that engaged in the de-coding practice aimed at steering taxpayers away from the Free File Program. H&R Block will continue to offer its own free-filing options on its website, but it will remove its return filing software from the IRS’s Free File website after the extended filing season ends on October 15, 2020. Nina Olson, executive director of the Center for Taxpayer Rights, told Tax Notes (subscription required) that the withdrawal “is a perfect storm of things—the cumulative effect of the negative articles, the TFA, the [IRS] nonfiler portal, etc.”  Perhaps H&R Block’s performance of MOU requirements or stated position regarding certain requirements foreshadowed its recent announcement to exit the program.  Specifically, the PSI Memo highlights H&R Block’s position regarding marketing, stating it does not believe it should be marketing the program “in any manner;” therefore, it does not engage in any efforts to market the Free File program. H&R Block sends one reminder email, as required by the MOU, to individuals who used the company’s Free File product the prior year. Whereas, Intuit sends six to eight reminder emails each year to previous Fee File users.  

Although H&R Block will withdraw from the FFA, it will continue to benefit from the collective bargaining benefits of the agreement with the remaining eleven members because the IRS will continue to honor its commitment to not compete against the FFA members. H&R Block will have all of the benefits and none of the oversight or accountability. What is to stop other members from following suit?

The MOU addendum is a great step in the right direction, however, as the PSI memo highlights, there is still much more that needs to be done to ensure the program meets the needs of taxpayers.

FUTURE-PROOFING FREE FILE BENEFITS

The PSI Memo notes that,

[d]espite these challenges, the Free File program continues to provide a valuable service for millions of Americans. To support Free File, the IRS should increase its oversight of FFA members and dedicate funding—including increased funding from Congress, if necessary—to market the Free File program. The IRS should ensure FFA members comply with new guidance that attempts to avoid similarities between Free File branding and branding for commercial tax preparation products that could confuse taxpayers.

These recommendations echo those made previously by TIGTA, MITRE, and the National Taxpayer Advocate.

Increase Member Oversight and Accountability

A February 2020 Treasury Inspector General For Tax Administration Report (TIGTA 2020 Report) concluded that complexity, confusion, and a lack of taxpayer awareness about the Free File program led to low levels of eligible taxpayer participation, and that this was partially due to the IRS’s insufficient oversight of the Free File Program. These findings are consistent with those in the NTA 2019 Annual Report to Congress (“2019 ARC”), presented in a section titled, “Substantial Free File Program Changes Are Necessary to Meet the Needs of Eligible Taxpayers.” 

Among other things, TIGTA recommended that IRS management update its testing review guide to ensure adherence to the MOU by FFA members. Increasing member oversight and accountability will help ensure consistency to the FFA mission that will benefit the program. The IRS partially agreed with this recommendation.

Dedicate Funds to Marketing

Topic four in the PSI Memo is a discussion of the IRS marketing strategy for the Free File program. The PSI Memo finds that “[a] lack of investment in marketing by the IRS likely led to a lack of consumer awareness that hampered participation in the Free File program.” The TIGTA 2020 Report explains that in addition to deterring effects of the confusion of the Free File Program, the lack of taxpayer awareness about the operation and requirements contributes to lack of participation by eligible taxpayers.  The TIGTA Report explains that insufficient actions have been taken to educate taxpayers that the only way to participate in the Free File Program is through the IRS website.  “To participate in the Program, taxpayers must access the IRS.gov Free File web page and select a link on this web page directing them to a Free File Inc. member’s website. However, this provision is not in the […] MOU and most taxpayers are unaware of this requirement.” The PSI memo also highlights that the lack of taxpayer awareness is directly related to the fact that the IRS has no budget for marketing the Free File program, and Congress has not appropriated funds for it. 

TIGTA made several recommendations connected to marketing and taxpayer education. First, TIGTA recommended that the IRS “develop and implement a comprehensive outreach and advertising plan to inform eligible taxpayers about the Free File program and how to participate.” (Recommendation 1) The IRS agreed with this recommendation. Second, TIGTA recommended that the IRS.gov Free File page contain comprehensive eligibility criteria for each product. (Recommendation 2) The IRS agreed, but stated this was already the case. Importantly, TIGTA also recommended that the IRS inform taxpayers of their right to be free from cross-marketing or upselling of fee-based services on Free File program software. (Recommendation 7) This practice confuses taxpayers and gives the specious impression of IRS endorsement. The IRS agreed with this recommendation, and in response created a new webpage, Know Your Protections Under the IRS Free File Program. Whether taxpayers will find this information without additional marketing seems doubtful. We will hopefully see the new comprehensive outreach and advertising plan by the next filing season.

CONCLUSION

I personally have used Free File software, and I definitely saw how certain parts can be confusing. Thanks to my experience as a VITA volunteer and coordinator, I was able to work through it, but it is unlikely that most eligible taxpayers have VITA training and experience.

One example of a confusing surprise that confronts taxpayers is the fee for a state tax return. Free File allows eligible taxpayers to file their federal tax return for free, but there can be a fee ranging from $14.99 to $54.95 to prepare your state tax return for some taxpayers. When the payment request popped up for my state return, I backtracked to the first page to double check if there were any disclosures about payments associated with state tax returns or if I had unknowingly navigated away from the Free File program. The main page says “free state return options are available,” but nothing about payments. The payment is disclosed once you choose a product to use. The products generally break down into two groups—the first group says “No free state tax preparation in any states,” and the second group says “Free state return, for some states.” California is not on the list of states eligible for free state tax preparation.

However, I recommend checking the website of your state taxing authority for free state tax preparation software if your state is not eligible for free state tax preparation services. California, for example, provides CalFile to e-file your state tax return directly to the Franchise Tax Board for free. Realistically, I think most eligible taxpayers will eat the costs to avoid going through the daunting task of preparing their state tax return from scratch when the federal tax software can transfer the information over to the state if they pay.

Another point of confusion is the constant upselling gimmicks promising a better refund gives the impression that the Free File program may be inferior to the paid software, giving me cause to think that my refund could be higher if I paid for another product. Thankfully, I know better, but these gimmicks are likely to successfully steer vulnerable taxpayers with little or no understanding of tax preparation away from the beneficial Free File program that will save them a substantial sum of money.

Given the enormous potential of the Free File Program to meet its mission of best serving vulnerable taxpayers’ needs, one can only hope the IRS heeds the constructive criticism outlined in the PSI Memo, which echoes previously reported issues. The IRS has risen to the challenge of meeting taxpayers’ needs many times before, e.g., the implementation of IRS Settlement days and the commendable rapid mobilization and implementation of the EIP initiative in response to COVID-19. I’m confident the IRS can rise to the challenge of making the necessary improvements to the Free File Program to meet the needs of eligible taxpayers. The question is, when?