Debtors Still Trying to Fight Against One Day Rule

The case of In re Kriss, 2019 Bankr. LEXIS 3039, (Bankr. D. N.H. 2019) shows that debtors in the First Circuit (and undoubtedly the 5th and the 10th) still struggle with the one-day rule interpretation of their circuits.  I have not written about this issue in some time but it still haunts those living in the wrong places.

As a quick reminder of the issue for those who may have forgotten or who have not read about it previously, three circuits have interpreted the language added to the unnumbered paragraph at the end of B.C. 523(a) in 2005 to mean that if a debtor files a tax return even one day late the debtor can never discharge that liability.  The IRS does not agree with that interpretation of the bankruptcy code and the circuits looking at the issue most recently have not agreed with the issue; however, until the Supreme Court takes up the issue, Congress decides to clarify the language in the bankruptcy code or the circuits reverse themselves, taxpayers in these three circuits can obtain no relief of the tax debts through bankruptcy if they file their returns late.  For a detailed discussion of the issue, see the prior posts here, here and here.

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Mr. Kriss did not file his tax returns for 1997 and 2000 timely.  The IRS prepared substitute for returns for these years and made relatively substantial assessments.  Mr. Kriss later filed returns which the IRS treated as claims for abatement and used as a basis for reducing his liability.  Mr. Kriss also did not timely file returns for 2008 through 2011.  He filed a chapter 13 bankruptcy petition on June 19, 2012, and filed the late returns for 2008 through 2011 in July, 2012 as required by B.C. 1308(a) which provides:

Not later than the day before the date on which the meeting of the creditors is first scheduled to be held under section 341(a), if the debtor was required to file a tax return under applicable nonbankruptcy law, the debtor shall file with appropriate tax authorities all tax returns for all taxable periods ending during the 4-year period ending on the date of the filing of the petition.

The timing of his bankruptcy filing made the liabilities for 2009-2011 priority claims under B.C. 507(a)(8)(A)(i) and the status of the taxes for these years as priority claims required that Mr. Kriss provide for full payment of these liabilities in his chapter 13 plan.  The older periods did not have priority status but rather were classified as general unsecured claims and did not require full payment in the plan.  As in many chapter 13 cases general unsecured claims received little or nothing.

This case picks up after Mr. Kriss has completed his plan.  As with the situation described in the recently blogged case of In re Widick, the post discharge receipt of a bill from the IRS for taxes he thought had disappeared moved Mr. Kriss into action.  In this case the post discharge action of the IRS results in three issues addressed by the bankruptcy court: 1) the one day rule discussed above; 2) the collection of post discharge interest addressed in the Widick post; and 3) damages for wrongful collection.

With respect to the one-day rule issue as it applies to the general unsecured claims for 1997 and 2000, the IRS not only sent Mr. Kriss the first notice of liability, it sent him a seriously delinquent notice (meaning the non-payment of this debt would impact his passport), and it filed suit against him to reduce the liability to judgment.  In response he admitted that:

the Late Filed Returns were untimely and does not contest that under the “one-day late rule” set forth in Fahey, the tax debts from those years are nondischargeable. Instead, the Debtor urges this Court to reconsider Fahey, reject the “one day late rule,” and adopt an alternate analysis set forth by the United States Tax Court in Beard v. Commissioner of Internal Revenue, 82 T.C. 766 (1984). The Debtor suggests that if the analysis in Beard were adopted, the Late Filed Returns may qualify as returns and, if so, any debts relating to the corresponding tax years were discharged.

Not surprisingly, Mr. Kriss does not get anywhere with the bankruptcy court on this argument.  The bankruptcy court’s hands are tied by the circuit decision.  It goes through the motions of explaining the Fahey decision and his argument before stating the obvious – that it cannot change the applicable precedent.  If he wants to make this argument, he has only just begun and must pass through the district court on his way to the First Circuit to try to pursued that court to reconsider its decision.  The bankruptcy court notes that he is not the first person to seek a reconsideration of the First Circuit’s decision in Fahey.  As I have written before, the Fahey decision does not make good sense to me (or to the IRS), but the IRS easily wins this issue.  It can continue to collect on the 1997 and 2000 liabilities and Mr. Kriss’ inability to file his returns on time will haunt him for decades once the IRS obtains a judgment.

Next, the court turns to the liability for the priority liabilities that the IRS seeks to collect after bankruptcy.  Mr. Kriss paid the priority tax claim in full during the bankruptcy case.  Because he did not timely file the returns for the three priority periods on the claim, the debt for these three years is non-dischargeable.  As discussed in the Widick post, a debtor does not pay interest during a bankruptcy case except in situations of fully secured claims.  Here, Mr. Kriss did not pay interest on the priority claims and the IRS wants that interest from him after discharge.

The problem the IRS faces stems from its form letters, which do not mention interest but state that Mr. Kriss has unpaid taxes.  Any attempt to collect taxes violates the discharge injunction while the effort to collect interest after the discharge is permitted because of his late filing of the taxes.  The bankruptcy court holds for the IRS to the extent it seeks to collect taxes but finds that it cannot rule on the summary judgment motion of either party until it has more facts regarding whether the IRS seeks only to collect interest or, as stated in its notices, it also seeks to collect tax. 

The IRS could fix this problem going forward by rewriting its form letters.  The collection of post discharge interest on priority claims arises in only a small percentage of its collection cases, but it needs to acknowledge that these cases represent a special situation and adjust its collection practices accordingly.  By sending out its normal collection letters in these situations, it causes confusion for the debtors and the courts.  The situation already confuses debtors if their bankruptcy attorneys have failed to alert them to this issue.  The IRS should not compound the confusion by using letters with inappropriate descriptors of the liability.

The last issue concerns the liability of the IRS for violating the discharge injunction.  The IRS argues that it has no liability, no matter how the second issues turns out, because Mr. Kriss did not seek to mitigate his damages.  The court quickly agrees with the IRS to the extent that he seeks damages for emotional distress but fails to grant summary judgment to the extent that Mr. Kriss has actual damages, saving the decision on that issue until further factual development occurs.  The court notes that the topic of exhaustion of administrative remedies has been the subject of much litigation stating:

[L]ess conclusive is the IRS’s argument that the Debtor is not entitled to attorney’s fees and costs, actual damages and/or sanctions resulting from the IRS’s post-discharge collection activities because he failed to comply with the exhaustion of administrative remedies requirement found in both 26 U.S.C. § 7430(b)(1) (awarding costs and certain fees) and 7433(d)(1) (governing civil damages for certain unauthorized collection actions). While the IRS admits that this issue has not been definitively decided by the First Circuit, it cites to cases such as Kuhl v. United States, 467 F.3d 145, 148 [98 AFTR 2d 2006-7379] (2d Cir. 2006), for the proposition that administrative exhaustion is jurisdictional in an adversary proceeding seeking attorney’s fees, and that failing to exhaust administrative remedies divests this Court of jurisdiction per 26 C.F.R (Treas. Reg.) § 301.7430-1.
 
Many other courts have “painstakingly” considered the issue of administrative exhaustion with repect (sic) to motions for awards of attorney fees, actual damages, and sanctions relating to discharge injunction violations, arriving at various and differing conclusions utilizing different statutory provisions and treasury regulations for their decisions. See In re Langston, 600 B.R. 817, 825 [123 AFTR 2d 2019-1262] (Bankr. E.D. Cal. 2019) (providing an extensive review of cases addressing this issue from multiple jurisdictions with varying outcomes). For example, in contrast to the Kuhl case cited by the IRS, the court in In re Graham, No. 99-26549-DHA, 2003 WL 21224773 [91 AFTR 2d 2003-2142] (Bankr. E.D. Va. Apr. 11, 2003) found that it had jurisdiction to award damages in the form of litigation costs to debtors who alleged IRS violations of § 524, even where they had not exhausted their administrative remedies, holding that: “26 U.S.C. § 7433(e)(2)(A) states that the exclusive remedy for recovering damages for violations of the Bankruptcy Code is to petition the bankruptcy court,” and within that section “there is no mention … of the need to exhaust administrative remedies.” Id. at *2. The Graham court held that 26 U.S.C. § 7433(e) was “quite clear” that the “bankruptcy court is the exclusive remedy for the violation of Bankruptcy Code provisions.” Id. (emphasis in original).

The ability to obtain damages for a stay violation is something we discuss at some length in IRS Practice and Procedure at 16.11[2].  You might look there if you face this issue.  Here, Mr. Kriss will not receive damages if he cannot show that the IRS has violated the discharge injunction and that may turn on whether the IRS seeks to collect anything more than interest in the priority claims.  Even if the IRS has tried to collect more than interest on the priority claims, he may have trouble showing actual damages the IRS has created by sending the post-discharge bill.  This will leave him seeking attorney’s fees for fending against the wrongful collection and trying to convince the court to impose sanctions.

Filing Form 1040 did not Extend Statute for Filing Form 945

Last year I wrote about the case of Quezada v. IRS. In the aspect of the case decided last summer, the bankruptcy court refused to grant summary judgment to the IRS regarding the statute of limitations for the taxpayer to file Form 945. The taxpayer argued that his Form 1040 provided the IRS with the information necessary and started the statute of limitations. The taxpayer needed the Form 1040 to serve as a surrogate Form 945 in order to discharge the liabilities it should have reported on Form 945. Now, the court has ruled on the issue and found for the IRS in Adv. Proc. No. 16-01101 (Bankr. W.D. Tex. 2018). The court provides a thoughtful analysis for its decision.

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Mr. Quezada operates a masonry company that builds projects for general contractors. He hires subcontractors to perform some of the work and provided to the subcontractors Forms 1099. The problem occurred because the Forms 1099 contained missing or incorrect TINs of the subcontractors. A missing or inaccurate TIN prevents the IRS from effectively using the Form 1099 to check on the reporting by the subcontractor. So, the IRS sent Mr. Quezada a notice in September 2006 that the 1099s had missing or inaccurate information and that if he did not correct the situation he had to start backup withholding. The IRS sent the same notice in 2007 and twice in 2009.

In 2008 the IRS began examining Mr. Quezada regarding his backup withholding liability for the subcontractors. This ultimately led to the recommendation of an assessment of $600,000 plus penalties of over $300,000. He eventually filed bankruptcy in which the IRS filed a claim for over $1.2 million. He brought an action to determine dischargeability arguing that the IRS waited too long to make its assessment. Mr. Quezada argued that his timely filed Forms 1040 and 1099 started the running of the statute of limitations on assessment while the IRS countered that he had an obligation to file Form 945 and his failure to file that form meant the statute never began running.

When a business pays an independent contractor, it must deduct backup withholding if the independent contractor fails to provide its TIN or if the IRS notifies the business that the TIN is incorrect. In addition to the backup withholding, the business must also file Form 945. Mr. Quezada argued that he had all of the TINs in a notebook but did not provide a record to the court and he had previously signed a sworn statement that he “did not obtain Social Security numbers (SSN) OR Taxpayer identification numbers (TIN) from all of [his] subcontractors.” The failure of proof in the trial coupled with the admission against interest caused the court to find that he had an obligation to file Forms 945.

Having found he had a duty to file the Forms 945, the court then looked at whether his failure to do so could somehow be excused. In Commissioner v. Lane-Wells, 321 U.S. 219 (1944) the Supreme Court analyzed whether a taxpayer who had filed a Form 1120 satisfied the requirement for filing a Form 1120H for holding companies. It found that Lane-Wells did not meet its statutory requirement for filing a return with respect to the holding company liability. The bankruptcy court found that Mr. Quezada, like Lane-Wells, had a separate liability requiring him to file two returns and preventing him from relying on the Form 1040 to satisfy his backup withholding liability.

The court also addressed his argument that he provided sufficient data to meet the Beard test. Beard v. Commissioner, 82 T.C. 766 (1984), aff’d 793 F.2d 139 (6th Cir. 1986) establishes the well-recognized test for what constitutes a return. Even though the bankruptcy court found that he had a responsibility to file the Form 945 return, if he could convince the court that his submissions on the Form 1040 essentially provided the information needed for the Form 945 he could meet the filing requirement. Beard has four tests: 1) sufficient data to calculate the tax liability; 2) document must purport to be a return; 3) honest and reasonable attempt to satisfy the tax law requirements; and 4) execution of the return under penalties of perjury.

The court found that he failed the second and fourth tests. He argued that missing TINs are “not relevant to his tax liability.” The court rejected this argument pointing out that the IRS needs to have the TINs in order for the Form 1099 to have meaning. The data provided did not meet the needs of the IRS and could not be considered sufficient. With respect to the third test the court explained that the IRS told him on several occasions of his failure and need to correct. His failure to correct over an extended period of time negates any argument that he acted in good faith and reasonably attempted to satisfy his tax law requirements.

This type of case provides a horrible result for a taxpayer such as Mr. Quezada if the subcontractors actually paid their taxes. Earlier this year we blogged about a case involving the misclassification of workers. We also posted a response from the National Taxpayer Advocate to our blog post. The situation faced by Mr. Quezada has similarities with the misclassification cases. The goal of backup withholding is ensuring that the third parties report their income to the IRS. If Mr. Quezada could show that his independent contractors actually reported their taxes, there should be some way to relieve him of at least a part of his liability. By failing to follow the rules, he causes the IRS to expend a fair amount of effort and for that he should be penalized. At the same time it seems he should have a path to reduce this crushing liability if he can prove that his independent contractors reported and paid the proper amount of tax. Maybe they did not pay and maybe, even if they did, he could not prove it but it seems a shame he does not have a chance to show that his failure did not result in loss to the IRS.

 

How a Credit is not the Same as a Refund

We are still working out logistics to get Christine Speidel full access to the blog site. In the meantime I introduce her most recent post which focuses on the distinction between giving a taxpayer credit and giving the taxpayer a refund. Keith

On April 4, 2018, the Eleventh Circuit ruled in Schuster v. Commissioner that a credit applied to a taxpayer’s account is not the same thing as a refund. This was bad news for the taxpayer.

Sometimes the IRS messes up when it applies payments, and mistakenly gives the taxpayer an account credit or a refund that the taxpayer did not deserve. If the error is discovered many years later, it can get complicated to figure out where the parties stand and which remedies are available to each.

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Mr. Schuster’s case stems from an IRS error in 2005, when it applied an $80,000 check meant for his mother’s taxes to Mr. Schuster’s 2004 income tax account. If Mr. Schuster had requested a refund when he filed his 2004 tax return, the case would be very different and the outcome might have changed. Instead, Mr. Schuster’s tax returns for 2004 through 2007 asked that his refunds be applied to the following year’s estimated tax. (Line 77 on the current Form 1040)

In 2011, the IRS discovered its mistake and reversed the erroneous credit. Mr. Schuster had made payments (apart from the $80,000) that satisfied his tax liabilities for 2004 and 2005, but not for 2006. So, after the credit was reversed the IRS sent Mr. Schuster a bill for his 2006 balance due. The case came before the Tax Court on a CDP appeal of a notice of intent to levy.

The government has many mechanisms it can use to collect from taxpayers who owe money to the Treasury. One of these mechanisms is an erroneous refund suit under section 7405. An erroneous refund suit must be brought within 2 years of the refund, except in cases of fraud. IRC 6532(b). Mr. Schuster argued that the $80,000 credit applied in 2005 was an erroneous refund that started the 2-year clock running. He argued that the IRS effectively created an end-run around 7405 by using its administrative collection powers, and it should not be permitted to do that. For its part, the IRS argued that the error at issue was a “credit transfer” which did not implicate section 7405 at all. In the IRS’s view, the appropriate statute of limitations is found in section 6502, providing for a 10-year collection period following assessment of tax. Both the Tax Court and the Eleventh Circuit sided with the IRS.

From a taxpayer’s perspective one can understand how unfair this feels. The $80,000 would have been refunded to the taxpayer had he not elected to have it credited to his 2005 (and then 2006) liability. I imagine Mr. Schuster thought he was doing a good deed as a taxpayer by making that election. If he had received a refund check and then sent an estimated tax payment to the IRS, section 7405 would apply. Economically the taxpayer would be in the same position. But the tax code does not run on fairness or logic. Also, there are complications beyond the distinction between a refund and a credit.

In the 1990s there were seven circuit court cases that addressed whether the government could treat erroneous refunds as unpaid tax, and thereby use its administrative collection powers to recover the funds. The government lost those cases. The courts of appeals held that once a taxpayer has paid their assessed taxes, a subsequent erroneous refund does not re-open the liability, and therefore the erroneous refund cannot be treated as an unpaid tax liability to be collected administratively under the original assessment. See O’Bryant v. United States, 49 F.3d 340, 346 (7th Cir. 1995); Mildred Cotler Trust v. United States, 184 F.3d 168, 171 (2d Cir. 1999); Stanley v. United States, 140 F.3d 1023, 1027-28 (Fed. Cir. 1998); Singleton v. United States, 128 F.3d 833, 837 (4th Cir. 1997); Bilzerian v. United States, 86 F.3d 1067, 1069 (11th Cir. 1996); Clark v. United States, 63 F.3d 83, 87 (1st Cir. 1995); United States v. Wilkes, 946 F.2d 1143, 1152 (5th Cir. 1991). For example, in the O’Bryant case, the taxpayers fully paid their liability but the IRS accidentally credited the payment twice, and issued a refund check. The Court held that the IRS could not use its administrative lien and levy procedures to recoup the erroneous refund.

Unfortunately for Mr. Schuster, he had not actually paid all of his assessed taxes for 2006. The Tax Court opinion (by Judge Chiechi) cites the Clark and Wilkes cases for the proposition that a tax assessment can only be extinguished by a payment tendered by the taxpayer, and not by an IRS clerical error. (Refunds resulting from clerical errors are often referred to as nonrebate refunds.) Therefore, the court holds that the 2006 assessment was not extinguished by the $80,000 credit, and the IRS could use its administrative collection powers to pursue the balance. The Court further found that the erroneous credit was not a refund for purposes of section 7405, so the two-year time limit did not apply.

The Eleventh Circuit affirmed the Tax Court, under different (though not inconsistent) reasoning. The per curiam opinion is short and to the point. The court notes that the Code distinguishes between a refund and a credit in several places, and section 7405 specifically only refers to refunds. Therefore, following basic statutory interpretation principles, the Eleventh Circuit holds that section 7405 does not apply to erroneous account credits.

Is the lesson for taxpayers to eschew line 77 and always request their refund? This does not guarantee a windfall for the taxpayer as the government may act within the 2 years or it may be able to use other mechanisms to collect the funds, but it makes the government’s task more difficult especially if the taxpayer takes care to remit legitimate payments covering their assessment.

 

 

 

 

 

 

 

 

 

 

 

Paying for but not Receiving Your Social Security Benefits – The Consequence of Filing Late

We have had many posts on the myriad of consequences of filing late tax returns. One we have not discussed results when a self-employed taxpayer files more than three years late. In that situation, the individual must still pay the self-employment tax; however, the individual receives no social security benefits as a result of those payments. As the economy drives more and more individuals into jobs in which they have independent contractor status, the importance of filing on time increases in order to preserve future benefits available to those who qualify for social security.

When a non-filer shows up, sometimes we triage their return for the year in which the refund statute of limitations will soon expire. If it appears that the taxpayer will receive a refund, a last minute push occurs to send that return in before the expiration of the statute of limitations which is generally three years from the due date of the return. If it appears that the taxpayer owes money, the same last minute push may not occur. Because filing the return before three years from the original due date could preserve for the individual the ability to get credit for self-employment earnings for purposes of calculating the amount of social security they will receive, or even whether they will qualify for social security, the practitioner who has the chance to file the return before three years from the due date of the original return should make every effort to do so.

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In order to receive social security benefits based on age, an individual must accumulate 40 quarters of earnings. To receive social security disability benefits, the individuals needs 32 quarters.   In 2017, an individual receives credit for a quarter of social security earnings if they have $1,300 of qualified earnings. Anyone earning more than $5,200 in 2017 will receive four quarters of credit – the most quarters it is possible to earn in a single year. In addition to meeting the number of quarters necessary to obtain benefits, an individual receives social security benefits based on the amount of their earnings. While the formula skews towards individuals at the lower end of the earnings spectrum by giving a higher return on those earnings in calculating the benefits, the more a person earns the higher their social security benefits.

Here are the directions from Social Security on how to calculate your projected benefit. You can find Column A and B here. I include this primarily to show how valuable the lower earnings are to someone compared to the earnings over $5,336 and how the benefit skews to provide the greatest assistance to those who will likely have the greatest need. 

Step 1: your earnings in Column B, but not more than the amount shown in Column A. If you have no earnings, enter “0.”

Step 2: Multiply the amounts in Column B by the index factors in Column C, and enter the results in Column D. This gives you your indexed earnings, or the estimated value of your earnings in current dollars.

Step 3: Choose from Column D the 35 years with the highest amounts. Add these amounts. $_________

Step 4: Divide the result from Step 3 by 420 (the number of months in 35 years). Round down to the next lowest dollar. This will give you your average indexed monthly earnings. $_________

Step 5:

  1. Multiply the first $885 in Step 4 by 90%. $_________
  2. Multiply the amount in Step 4 over $885, and less than or equal to $5,336, by 32%. $_________
  3. Multiply the amount in Step 4 over $5,336 by 15%. $_________

Step 6: Add a, b, and c from Step 5. Round down to the next lowest dollar. This is your estimated monthly retirement benefit at … your full retirement age. $_________

The aged based benefit is calculated based on the highest 35 years of earnings. Some of my earnings from the 1960s and 1970s when I worked summer jobs while going to school and a quarter of earnings could accumulate for $250 will not do much to push up my high 35 years of earnings, but these quarters did provide a benefit to me in reaching the 40 quarters because all of my earnings when working for the federal government involved no social security taxation and therefore no buildup of earnings or quarters. Federal employees hired starting in the mid-1980s do pay social security, but some state and local government employees may still be outside of the social security system from their primary earnings. Some of my clients have not yet earned enough quarters to receive any social security benefits. Making sure that they understand the importance of earning enough quarters and the link between filing their tax return and earning quarters is something we try to impart.

What can you do if your client has failed to file their return within the normal time period for having their earnings count toward social security? Several exceptions apply to individuals in these circumstances; however, the exceptions are narrow:

After the time limit has passed, earnings records can only be revised under the conditions described below and in §1425:

1. To correct an entry established through fraud;

2. To correct a mechanical, clerical, or other obvious error;

3. To correct errors in crediting earnings to the wrong person or to the wrong period;

4. To transfer items to or from the Railroad Retirement Board (if reported to the wrong agency), or to add railroad earnings to Social Security earnings records when the law permits;

5. To add wages paid in a period by an employer who made no report of any wages paid to the worker in that period, or if the employer is increasing the originally reported amount for the period;

6. To add or remove wages in accordance with a wage report filed by the employer with IRS; or, if a State or local governmental employer, with SSA if the report is filed within the time limitation specified for assessment, refund, or credit under a State’s coverage agreement;

7. To add self-employment income in a taxable year if an individual or the individual’s survivor establishes that:

(1) A self-employment tax return for that year was filed before the time limit ran out; and

(2) Either no self-employment income for that year has been recorded in the individual’s earnings record, or the recorded self-employment income for that year is less than the amount reported on the self-employment tax return; or

8. To add self-employment income for any taxable year up to the amount of earnings that were wrongly recorded as wages and later deleted. This can be done only if a tax return reporting such self-employment income is filed within three years, three months, and 15 days after the taxable year in which the earnings wrongly recorded as wages were deleted. The self-employment income must:

(1) Be for the same taxable year as the year in which the wages were removed; and

(2) Have already been included on the individual’s Social Security record.

9. Prior to the expiration of the time limit the worker or the worker’s survivor has:

(1) Applied for benefits and stated that the earnings for a year(s) were incorrect; or

(2) Requested a revision of his or her earnings record for a year(s).

The time limit can also be extended if an investigation was in progress. Because of the manner in which social security benefits work, it may not be the taxpayer who wants or needs to correct the social security records. It could be a spouse or a child or someone else who can obtain benefits derivatively from the individual with the earnings.

Some sources for correcting the social security statement can be found here, here and here.

 

 

 

 

Update on the Substitute for Return Issue

On October 16 TIGTA issued the press release copied below. The release includes a link to the full report. The release and the report make clear that putting the Substitute for Return program on hold represents a significant compliance hole in the IRS system. Persons who do not file their returns, of whom there are many, may now receive a pass because of the lack of resources at the IRS.

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October 16, 2017
TIGTA-2017-27
Contact: Karen Kraushaar, Director of Communications
Karen.Kraushaar@tigta.treas.gov
(202) 622-6500

A Significantly Reduced Automated Substitute for Return Program Negatively Affected Collection and Filing Compliance

WASHINGTON — Due to resource considerations, the Internal Revenue Service (IRS) has significantly curtailed the Automated Substitute for Return Program (ASFR), which it uses to address taxpayers who have failed to file a tax return, according to an audit report that the Treasury Inspector General for Tax Administration (TIGTA) issued today.

From June 2010 through July 2011, the ASFR program collected over $3 billion, whereas from June 2015 through July 2016 the program’s collections were down to approximately $430 million.  IRS management has mainly used the ASFR program to focus on “Refund Hold” cases where the IRS holds a refund on one tax year to secure an unfiled return in another year.  If the IRS refocused priorities away from small Refund Hold cases and focused on high net tax due cases, the IRS could collect $843 million over the next five years.  If the IRS worked Refund Hold cases differently, it could have collected $45 million in unpaid taxes by applying refunds to amounts owed from prior years in which no tax return was filed.

When a taxpayer who has a tax filing requirement fails to file a tax return, the IRS is authorized to use third-party information to determine and assess a tax liability.  The IRS handles these cases primarily through the ASFR Program, which enforces filing compliance on taxpayers who have not filed individual income tax returns but appear to owe a significant tax liability.  TIGTA initiated this review to evaluate the effect of the ASFR Program on enforcement yield and nonfiler compliance and determine whether the program effectively processed its workload.

Refund Hold inventory includes income tax refunds that are withheld from taxpayers to cover any potential tax liability on an unfiled return.  Refund Hold cases are considered the highest priority work for the ASFR Program, because refunds are held for only six months.  High net tax due cases in the ASFR Program are those in which the potential tax liability from an unfiled return is $100,000 or more.

TIGTA’s analysis of 21,533 Refund Hold cases worked in the ASFR Program between June 2011 and November 2016 identified 12,872 cases (60 percent) that were not resolved within six months, and a refund was released to the taxpayer in 8,115 cases.  If the IRS held these refunds until the ASFR process was completed, it could have potentially applied $45 million to the taxpayers’ accounts.

However, TIGTA also estimates that if the IRS had worked the same number of high net tax due cases it closed in the period July 2010 through June 2011 in the most current period, July 2015 through June 2016, it would have potentially increased revenue by about $169 million dollars, which is approximately $843 million over the next five years.  Specifically, replacing nine percent of the Refund Hold cases the ASFR Program closed during FY 2016 with high net tax due cases would achieve these results.

In addition, TIGTA’s analysis of 103 randomly sampled ASFR cases determined that nine percent of ASFR inventory could be eliminated if previously filed tax return and other information was considered during the inventory selection process.  Finally, ASFR Program performance measures are generally limited to the amount of direct time employees spend on the Program, types and numbers of closures, and closure rates.  Additional comparative measures such as the rates of reduction in tax assessments after taxpayers file their own returns and collection of tax dollars for ASFR cases would provide management with information to make informed strategic decisions.

“The IRS needs to bring noncompliant taxpayers into compliance to ensure fairness and reduce the burden on the vast majority of taxpayers who fully pay their taxes on time,” said J. Russell George, the Treasury Inspector General for Tax Administration.  “An effective Automated Substitute for Return Program is an important part of its efforts to bring those who do not file tax returns into compliance,” he added.

TIGTA made seven recommendations in the report.  IRS management plans to take corrective actions relating to five of them, but disagreed with two of them.  In one instance, they did not agree to reassess the suspension of the ASFR Program due to limited resources, and in the other instance, management disagreed with extending the refund hold period due to its view that the hold period is sufficient when the ASFR Program is operating as intended.  Read the report here

Follow up to Yesterday’s Post on Suspension of ASFR Program

Longtime reader and frequent commenter Bob Kamman provides additional history and context for the ASFR suspension Carl Smith discussed yesterday. Les

This is not the first time the ASFR program has been halted, according to the September 11, 2017 report from TIGTA, “Trends In Compliance Activities Through FY 2016.” According to the report,

“IRS management halted ASFR issuances completely from September 2015 through May 2016 due to resource constraints and the assignment of resources to other collection activities that were deemed a higher priority. Although the ASFR is one of the IRS’s primary tools used to enforce filing compliance, the IRS reported in the FY 2016 Data Book that there were $542.8 million of additional assessments in FY 2016. This represents a substantial decline compared to the $6.7 billion of additional assessments that were reported for FY 2012.”

The program seems to be more effective at assessing, rather than collecting tax. The TIGTA report’s Figure 6 on Page 14 shows that more than 28% of unpaid assessments in FY 2016 are from ASFR/Section 6020(b) returns. That compares to about 29% of unpaid assessments from returns filed with a balance due.

The decline in ASFR assessments appears to be part of a five-year strategy:

“IRS officials attributed the significant decline in the CSCO TDAs [Compliance Services Collection Operations Taxpayer Delinquent Accounts] to the decline in Automated Substitute for Return assessments that are issued as part of the nonfiler program, which have decreased 86 percent since FY 2012.”

The TIGTA report (76 pages) is here

 

 

Automated Substitute for Return (ASFR) Program Suspended

Thanks to frequent guest blogger Carl Smith for this news from a tax conference this morning. Keith

On September 26, at a New York County Lawyers Association seminar entitled “Nontraditional Tax Advocacy”, Matthew Weir, the Assistant Inspector General of the office of the Treasury Inspector General for Tax Administration (TIGTA) spoke. Among other things, he announced that the IRS had, for lack of sufficient financial resources, suspended its Automated Substitute for Return (ASFR) program. This is shocking news!

Mr. Weir said that TIGTA internally debated whether to disclose to the public the ASFR program’s suspension because, normally, TIGTA does not like to disclose information that taxpayers could use to evade enforcement. But, TIGTA decided that the suspension of the ASFR program was too important to keep from the public. He said a TIGTA report on the suspension would be issued shortly.

The ASFR program was employed for individuals who did not file an income tax return but who had enough gross income reported by third parties to the IRS on information returns (such as on Forms W-2 and 1099) to have had an obligation to file an income tax return. In the ASFR program, computers (without human involvement) (1) detected the need to file and the lack of filing, (2) prepared substitutes for returns under section 6020(b) based on the third-party gross income information, and (3) issued a letter to the taxpayer showing the proposed deficiency and balance due based on that substitute for return (essentially, a 30-day letter). The computer would automatically tack on late-filing and late-payment penalties to the tax balance due. A taxpayer who did not respond to the computer’s letter or who did respond, but did not convince the IRS that no tax or penalties were due, would later get a notice of deficiency – a ticket to the Tax Court.

Under the ASFR program, many taxpayers wrote back to the IRS and pointed out either errors in the gross income calculation or claimed entitlement to fully- or partially-offsetting deductions or credits that the IRS had no knowledge about, such as dependency exemptions and earned income tax credits. Human IRS employees needed to respond to such taxpayer letters. Although Mr. Weir did not say so, I assume that the big expense in running the ASFR program was employee time responding to the taxpayer correspondence. I also assume that, given the frequently-available offsetting deductions and credits, the ASFR program may not have generated enough enforcement revenue to justify the use of the scarce resource, human IRS employee time.

How Does the IRS Decide Which Amended Returns to Examine

A report of the Treasury Inspector General for Tax Administration (TIGTA) from May 16, 2016, entitled “Improvements are Necessary to Ensure That Individual Amended Returns with Claims for Refunds and Abatements of Taxes are Properly Reviewed” provides significant insight into the handling of refund claims by the IRS.  The report itself follows the typical TIGTA style of reviewing actions by the IRS and finding fault with those actions; however, in describing what the IRS does with amended returns, the reports offers a detailed view of what happens once the amended return arrives at the IRS.  For that reason, the report may interest readers who want to know more about that process.  In this post, I will talk about the process and also about why auditing amended returns may matter more than auditing original returns.

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Why the IRS Should Audit More Amended Returns

The report criticizes the IRS for accepting certain amended returns without auditing them or providing any explanation for making the decision not to audit.  The report acknowledges that some of the decisions may result from resource limitations but still decries the lack of documentation surrounding the decision.  It details the reasons for its concerns but does not discuss the collection criteria applicable to audits.  I see a link between this report and the report I discussed in a recent post concerning the requirement that the IRS make a collectability determination prior to starting an examination.

In the amended return context, the taxpayer has made the collectability determination for the IRS.  The IRS holds the taxpayer’s money, which the taxpayer wants back.  If the IRS audits this return and makes adjustments, the collection division never becomes involved.  For this reason alone, amended returns should receive more scrutiny in a world where collectability provides a finger on the decision making scale of which returns to examine.  The reasons for filing amended returns vary greatly and do not by any means involve bad motives.   I could even argue that because practitioners generally, and I think correctly, believe that filing an amended returns brings scrutiny to the return that filing an original return does not, that amended returns have a greater likelihood of accuracy than original returns.  Since I believe that the IRS should take collectability into account in making audit determinations, I think the IRS should audit a higher percentage of amended returns than original returns since the collectability factor will always support auditing the amended return, but, other factors matter as well and I am not arguing for the audit of all amended returns.

Other factors may override collectability but on that one factor, the decision is clear.  While not clearly articulated in the IRS guidance or in this report, this factor has always played a role in making the scrutiny of amended returns higher than that of original returns.  Just reading the process of review of amended returns, whether or not selected for audit, provides plenty of support for the conclusion that the IRS guards the money it already has more than it looks for money it might obtain through an audit.

The Process of Reviewing Amended Returns

The report gives a fairly detailed walk through of the procedures that the IRS uses to pipeline an amended return.  The report suggests that tax examiners manually review each claim.  That process obviously provides greater scrutiny than original returns receive.  Claims that the initial reviewers list as Category A go on to additional review and possible audit, while claims that avoid Category A in the initial screening apparently move forward for acceptance.  Figure 1 of the report provides a flow chart of the processing of amended returns that receive the Category A classification.  I.R.M. 4.4.4.5.3 provides guidance to the IRS employees processing amended returns.  The initial review also checks for timeliness of the claim which could result in a denial of the claim at the initial review if the claim is deemed untimely.

The report does not talk about how long after the filing of the amended return this initial screening takes place.  The IRS now has a handy track my amended return feature on its web site.  I have not yet used that feature to track a refund and do not have a sense of how quickly someone can obtain a refund.  The TIGTA report reads as though the refund could occur relatively quickly if the initial screeners do not put the amended return into Category A.

For amended returns falling into Category A, the IRS sends them to field or campus exam depending on the type of case.  The chart suggests that all Category A claims going to campus exam get audited, while cases going to field exam get another level of review once they reach the field.  The written report does not make this distinction.

For field exam cases, two additional levels of review occur after the initial screening has designated the case as Category A.  The case first goes through the Planning and Special Programs (PSP) office and then, potentially, to the field exam group.  PSP could survey the return if it determines that an audit of the amended return would not result in a material change.  In reviewing the amended return, PSP should also review the original return and other relevant case file material.  If PSP does not survey the case – survey meaning accept the amended return after the PSP review – then it goes to the group manager of the group assigned to the case.

The group manager gives the amended return another review, which includes the review done by PSP for risk analysis, but the group manager must also “plan, monitor, and direct the input of work to accomplish program priorities and effectively utilize resources….”  This means that the group manager’s decision to assign the amended return for examination not only includes a determination of the need for examination of the amended return, but balances that need against other workload priorities with the group.  The group manager could conclude that the risk analysis does support examination of the amended return but still survey the return because of other priority work within the group.

The report does not talk about time frames but they will enter into the equation.  The statute does not require the IRS to examine the amended return within any set time.  The IRS can simply sit on an amended return forever if it chooses to do so and need not act.  Of course, sitting on amended returns forever would be a bad practice for the IRS to adopt, but when a group manager considers priorities, the statute of limitations for making an assessment provides a bright line for decision making about auditing original returns, while the absence of such a bright line for amended returns slightly changes the equation.  The group manager will have internal guidance driving the decision but has a bit more leeway with amended returns.

The system established by the IRS provides three cut points for the amended return headed to field exam, i.e., those amended returns with larger and more complicated refund claims, to get sent for acceptance without an audit.  TIGTA’s concerns about the IRS process for surveying amended returns focuses on the cases getting sent for acceptance because the IRS did not adequately document that decision.  The further the case gets into the process, the greater the concern because the more likely that an audit of the amended return would result in adjustments.  Because the acceptance of an amended return means handing over money, TIGTA wants more documentation of the decision to accept the refund claim without an audit.

Timing of Refund and Choices between Original and Amended Returns

Of course, a very high percentage of original returns also involve handing over money, meaning that these returns are also refund claims, yet the system does not require the same type of review and documentation for handing over money as the result of an initial return.  When taxpayers file the initial return, the IRS, as with the amended return, has no statutory time pressure within which it must accept the return.  Mild pressure exists in both circumstances based on interest which will accrue.  Stronger pressure exists with original return based on social expectations that have developed over decades and systems the IRS has created to send back refunds as quickly as possible, but the statute does not require that the IRS race to refund money with original returns yet carefully scrutinize refund requests on amended returns.

With the PATH Act, Congress signaled that it wanted to slow down the payment of refunds on certain original returns and stop the race that happens at the opening of filing season.  The PATH Act concerns focus on refundable credits which cause the same concerns in many ways as amended returns.  Yet, the biggest part of the tax gap does not exist because of amended returns or refundable credits.  It exists with self-employed.  TIGTA’s concerns about documentation of amended returns being surveyed has a legitimate basis because of the likelihood that amended returns surveyed after making the cut to Category A probably contain mistakes.  It makes sense, if resources permit, for the IRS to internally explain why it allows the payment of a refund in those cases.  Except for the distinction concerning collection, it would also make sense to explain why the IRS does not examine original returns with an equal likelihood of adjustable mistakes, but the TIGTA report focuses only on amended returns and not original ones.