Pursuing Non-Filers

We regularly write about non-filers in the blog because non-filing often pairs with non-payment and other issues involving tax procedure.  Today, I write about non-filers from the perspective of the IRS as portrayed in a recent report  prepared by the Treasury Inspector General for Tax Administration (TIGTA).  The unflattering report exposes some of the dysfunction of the IRS and how that dysfunction, in this case, benefits high income non-filers.  Essentially, the TIGTA report finds that in 2012 the IRS modified its program for identifying non-filers and in doing so excluded individuals who requested an extension and then failed to follow up by filing a return.


Individuals who file an extension generally have higher income than the average taxpayer.  The TIGTA report goes into this somewhat but it also seems intuitive that persons requesting an extension would generally have higher income and, often, more sophisticated returns needing additional time.  That fact has nothing to do with why the IRS program for 2012 failed to pick up non-filers requesting an extension.  It does, however, impact the decision on whether to go back and fix the problem.  The IRS resists the suggestion in the report that it should go back and pursue this target rich group because of resource issues.  TIGTA rightly takes the IRS to task for this decision.

I note as an aside that Congress has required the IRS to turn over to private debt collectors accounts it cannot collect.  While I think this is a bad idea for reasons discussed in a prior post, these private debt collectors will supplement the strained collection resources of the IRS.  If the IRS does not use its automated resources to make an assessment, however, these accounts never go into the collection stream for the IRS or private collectors to work.

The problem started in 2012 return cycle when the IRS created the computer code to use for going after non-files for that cycle.  The code somehow left off non-filers who requested an extension before failing to file.  Apparently, the IRS normally does a check on the code to see if any anomalies exist.  At the time that it would have run its check, Congress had shut down the Government and the people who would have run the check never got back to it.  So, for the cycle of 2012 returns, filing an extension got you a pass from the non-filer correspondence normally sent.  Many of these non-filers may have received a nudge to file the late return from a state taxing authority, from bankruptcy court or from other sources but they never received one from the IRS.  The TIGTA report shows the amount of relatively easy dollars to assess that the IRS lost as a result of this programming error.

In 2013 the IRS duplicated the error in 2013.  Between the two years, TIGTA estimated that the IRS failed to identify 1.9 million returns.  Because these non-filers typically produce a much higher rate of return than non-filers who never requested an extension, TIGTA estimated that the IRS lost $2-3 billion each year.  By not pursuing these individuals even though it has the computer capability to easily identify them and target them with correspondence requiring almost no human effort, the IRS promotes these individuals failing to file again the following year and makes collection of the late taxes more difficult to achieve.

I will not relay all of the findings and all of the excuses provided by the IRS for not fixing the problem now but one excuse has popped up before and demonstrates the dysfunction happening there at this point.  Since non-filing creates an unlimited statute of limitations for the IRS to assess, nothing legally stops the IRS from pursuing these taxpayers today.  TIGTA writes in the report about how little time and effort it would take for the IRS to generate the correspondence to these individuals that should spur compliance in a healthy percentage.  The IRS concern in response takes the focus away from the work it would take to send the notices and moves it to the work it would take to handle the phone calls and the downstream work for the IRS that these notices would present.

The IRS has raised this issue before with respect to levies.  It slowed down its process of sending levies because of concerns about handling the downstream work levy notices present.  The concern raised by the IRS with respect to the downstream work is legitimate and goes right to the core of problem with cutting its funding for six years.  At the same time, not pursuing high dollar non-filers shows that the wheels have come off of its compliance function if it cannot even proceed with enforcement against easily identifiable cheaply pursued tax scofflaws.  Going after these individuals would seem about as essential to compliance as any work the IRS might do yet it is reluctant or unwilling to do so.  This especially hurts those of us who represent low income taxpayers when we try to address or mitigate problems our clients have with the IRS collection machinery which can grind down a person because we know that the IRS has decided not to bother even attempting to collect returns and taxes from high income individuals who decided not even to file a return.

Proving You Filed a Return

Sometimes taxpayers and the IRS just disagree on whether the taxpayer filed a return. The taxpayer faces a daunting task to prove the filing of a return.  In a recent bankruptcy case, McGrew v. Internal Revenue Service, the court held that the taxpayer proved her case.  Her success provides some insight into how a taxpayer might win this argument.  I have some other thoughts based on cases I have seen over the years.

Last year we “celebrated” the 30th anniversary of the famous incident at the Philadelphia Service Center in which IRS employees who had too many cases to process and too little time to do it decided to take matters into their own hands and flush the returns down toilets, hide them in ceiling tiles and otherwise find creative things to do with tax returns.  For stories and investigations concerning the little problem with returns the IRS had in 1985 see here, here, here and here.  Thirty years is a long time and only a small percentage of IRS employees working today worked at the IRS in 1986.  The Philadelphia Service Center has moved locations.  The institutional memory of IRS workers concerning this incident seems no longer to exist.  I had a conversation with two young attorneys from the Boston office this past year, neither of whom could even seem to contemplate the possibility that the IRS transcript could contain inaccuracies.  The IRS employee testifying in the McGrew case, stated that she had no knowledge of the IRS ever losing a tax return.  I find this amazing.


The IRS does a great job of keeping track of millions of pieces of paper with a focus on tax returns; however, anyone who thinks that the IRS never loses tax returns is naive. On the flip side, many taxpayers have a similar naiveté because they seem to think they can just waltz into court and assert the IRS has lost their returns and the court will easily buy that story.  In the vast majority of cases, courts will reject such an argument, which makes the McGrew case interesting and instructive.  Before I get to the facts of the McGrew case, I want to detour to my practice for testing for lost returns when I tried these cases for the IRS and to the bankruptcy issue lurking in this case.

Looking at State Tax Returns to Prove Federal Filing – or Lack Thereof

Taxpayers regularly asserted that the IRS lost their return when I worked for Chief Counsel’s office. I knew the possibility existed but doubted most of the taxpayers making the assertion.  Because I practiced primarily in Virginia and because Virginia has a state tax scheme that mirrors the federal one, even requiring taxpayers to attach a copy of their federal return to their state one, my go-to place for checking on lost tax returns was the state.  I figured the loss of one return by the IRS was low but possible.  The loss of two or more returns, each allegedly timely filed, got much lower.  The loss of the federal returns by the IRS and the state returns by an entirely different agency made the story one that was unbelievable.  So, the first thing I did when a taxpayer said the IRS lost a tax return was ask if the taxpayer filed a state tax return with Virginia.  If the taxpayer answered affirmatively, the state tax records were requested.  In every case I can remember, the state tax records matched the IRS records.  Taxpayers who alleged that the IRS lost their tax returns had to allege that the state also lost their returns for the same periods.  That basically ended the inquiry into the allegedly missing returns.  Courts found this coincidence too powerful to ignore.  No discussion of the parallel state tax return filings exist in the McGrew case, and I do not know if that is because the taxpayer had no state filing obligation or no one checked on those returns.

One aspect of the McGrew case that makes the lost return story more believable is that the lost return was one of multiple late returns filed many years after the due date.  When a taxpayer files a late return, the IRS may set that return to the side so that it can continue timely processing returns filed during the current cycle.  My experience suggests that late-filed returns have a higher incidence of getting lost in the system.  The post I wrote earlier this year about a friend and family client seeking an installment agreement involved two late returns that the IRS lost.

Special Rule for Late Returns in 8th Circuit

The other issue presented in this case is the bankruptcy issue of unfiled and late filed returns we have written about several time previously here, here and here. This case arises in the 8th Circuit and that is very fortunate for Ms. McGrew.  The basic IRS position is that if it goes to the trouble of filing a substitute for return for a taxpayer, sends the notice of deficiency on which the taxpayer defaults, and later the taxpayer files a Form 1040, the Form 1040 filed in that circumstance does not satisfy the Beard test and does not trigger the two year rule in B.C. 523(a)(1)(B).  The only circuit in which the IRS has lost that argument is the 8th Circuit.  Because of the loss in the Colsen case in the 8th Circuit and because the IRS decided not to try to take that loss before the Supreme Court, taxpayers living in the 8th Circuit can file a Form 1040 after an SFR assessment and start the two year period running.  That’s what happens in this case.  So, do not get excited if you read this case and think filing returns after an SFR assessment will help your client.  Unless you live in the 8th Circuit, you will face stiff opposition from the IRS if you try that and the courts elsewhere have almost uniformly ruled for the IRS.  The IRS hoped that the 2005 amendment, which has caused so much consternation, would fix the Colsen problem, but it has only created additional problems.

Proving You Filed a Missing Return

Ms. McGrew did not file returns for many years. Her testimony mirrors the testimony of so many people who get into a pattern of non-filing.  She did not have enough money to pay her taxes for 2000 so she did not file for fear of the consequence of non-payment, not realizing the problem of non-filing was worse.  Then, having not filed in 2000 and not having the money to fix that problem, her non-filing snow-balled into a multi-year event.  The IRS prepared SFRs establishing the liability for many of the missing years.  After it probably sent her a multitude of letters over the period of a decade, it levied on her wages in 2010.  The wage levy usually serves as a wake-up call in these situations and did for Ms. McGrew as well.

Motivated by the loss of about 80% of her wages each week and probably wanting to eat, she asked the IRS to stop the wage levy and allow her to pay her liability of many years through an installment agreement. The IRS told her she first needed to file the back returns before it would work with her on a collection alternative.  So, she finally had the motivation she needed to fill out the back returns.  She filled them out and sent them in batches to two different service centers.  Most of the back returns she sent to the IRS were processed; however, the return for 2006 was never processed and that is the return at issue in this case.

Her case consisted of her testimony regarding the mailing of the back tax returns. Her testimony contained many details about the mailing.  She also relied on two other facts.  First, the IRS granted her an installment agreement in 2010 suggesting that it had the return because if the 2006 return were missing at that time the IRS should have denied the installment agreement request based on the missing return.  Second, the IRS initially questioned her failure to file not only 2006 but also 2007.  Then the IRS said it had found the 2007 return.  The IRS relied on the testimony of a bankruptcy specialist who interpreted the IRS transcript.  This specialist explained how the IRS records regarding the 2006 year showed that the IRS had not received the 2006 return.  The bankruptcy specialist also testified that she had never known the IRS to lose a return.

The Court weighed the evidence and determined that Ms. McGrew did submit the 2006 return to the IRS and did wait more than two years after doing so before filing the bankruptcy petition. Therefore, Ms. McGrew received a discharge of her liability for 2006 together with the remaining years for which she late-filed her returns.


The 11th Circuit Bypasses the Chance to Rule of the Late Return Issue

In Justice v. United States, the 11th Circuit had the chance to become the fourth Circuit Court to rule on the impact of the unnumbered paragraph, aka (*) paragraph, at the end of B.C. 523(a).  It passed on the opportunity and went back to the roots of this issue before siding with the majority of Circuit Courts that addressed this issue based on the pre-2005 law.  Mr. Justice loses because the majority of Circuit Courts deciding the issue prior to 2005 held that debtors filing a Form 1040 in circumstances similar to his were not filing a tax return under the Beard test.  I think everyone loses because the opinion just defers to another day the resolution of the (*) paragraph problem.  I have written about this issue on numerous occasions and the last post has links to the earlier ones.


The Justice case provides a nice review of the law as it existed when Congress tried to fix the problem in 2005. Because the Court essentially ignores, or leaves for another day, the 2005 legislation, those following this issue simply have another opinion that follows the way the case law was developing prior to the legislative change. By deciding the case based on pre-2005 law, the 11th Circuit did a disservice to those concerned about this issue including debtors and the various taxing authorities trying to decide how to deal with this discharge provision. Both sides need a speedy resolution to a problem that has persisted for 18 years since the Sixth Circuit decided Hindenlang.

Resolution of the issue is important for debtors because so many individuals fail to timely file their returns. These individuals need to know if their failure to timely file the return means that they are forever barred from using bankruptcy to discharge the taxes or have some hope for relief that seems to exist in B.C. 523(a)(1)(B)(ii). The taxing authorities need to know because every day they must make a decision on whether to discharge a debtor in these circumstances. The longer the uncertainty lingers, the more debtors that have what may ultimately turn out to be a wrongful discharge determination and the more trouble the taxing authorities will have unwinding the situation. The IRS continues to resist applying the harsh discharge rule as interpreted by three Circuit Courts but it has no obligation to continue to do so in the face of continuing uncertainty and given the certainty that the harsh rule provides.

The problem with the pre-2005 state of the law and the problem that the Justice opinion prolongs is the difficulty of administering a law concerning discharge based on a case by case factual determination of whether the late for 1040 represents a meaningful attempt to file a return under the Beard test, there by resulting in a discharge, or does not represent a good faith attempt to file, thereby resulting in an exception to discharge. The IRS has offered a post-2005 alternative which provides certainty, viz., if the debtor does not file the return until after the IRS makes an assessment based on an SFR then the debt is always excepted from discharge because it is not a return and if the debtor files the late return before an assessment based on an SFR then the two year rule applies. The IRS offered up this outcome to the 11th Circuit but it was not buying what the IRS was selling. So, it sticks the parties with the factual determination test.

To its credit the 11th Circuit seems to choose the “best” of the factual determination cases – Moroney out of the 4th Circuit but Moroney is still a factual determination case at its heart although one in which the debtor will almost always lose making it easy for the IRS to administer and for debtors to predict the outcome. The application of the Moroney rules will almost always create the same result the IRS seeks in its post-2005 argument for a legal test but it does not quite get all the way to the legal test.

Last week I was working on a case in the clinic that demonstrates the problems with the application of the harsh (*) rule and cries out for a simple solution. The individual owes for three years and has a total liability over $60,000. For each of the three years he was running a small business and requested an extension of time to file his return. He clearly filed two of the three returns on time but he may have filed the third year late by a week or two. The year is old and I am trying to get a definitive answer on when the return was filed because it is so critical. The individual has a very low income now but has recently married someone with a good income. Because of her income, I do not think he can obtain an offer in compromise without a very high payment. He is someone who has always filed. With the possible exception of the one year where I am trying to find out if the return was timely filed or filed shortly after the extended due date, he has always filed timely. The IRS did not impose a late filing penalty on him and would have abated the penalty based on its first time abate rules if it had imposed the late filing penalty. Yet, if it turns out he did not timely file, he cannot discharge this debt in bankruptcy because he lives in the First Circuit. Because he got married to someone with a good and stable income, he also cannot obtain an offer unless his new spouse is willing to pay off his long outstanding and substantial tax debt. Understandably, she is not excited about paying off his old tax debts and the situation is putting a strain on their relationship. So, he may end up waiting out the statute of limitations on collection and putting pressure on his marriage.

This is a wasteful policy dilemma. Section 523(a)(1)(B)(ii) set up a system to allow late filers to still obtain a discharge if they waited extra time. In the case of my client, who, if he filed late, did so immediately after the due date, would not even have to wait extra time because of the timing of his filing. Yet, he appears to be prevented from obtaining a discharge for this year. By demurring on the correct interpretation of (*) the 11th Circuit sentences those seeking to know the answer to a longer wait. No matter which way it ruled, having the opinion of the 11th Circuit on (*) would have helped to move the issue to resolution faster.

Les’ post discussing how  filing within 10 days of an e-file rejection will still result in a timely return.  This work around will not present itself often but is worth remembering for those situation where your client has tried and failed to timely file their return electronically.

Summary Opinions for November

1973_GMC_MotorhomeHere is a summary of some of the other tax procedure items we didn’t otherwise cover in November.  This is heavy on tax procedure intersecting with doctors (including one using his RV to assist his practice).  Also, important updates on the AICPA case, US v. Rozbruch, and the DOJ focusing on employment withholding issues.


I’ve got a bunch of Jack Townsend love to start SumOp.  He covered a bunch of great tax procedure items last month.  No reason for me to do an inferior write up, when I can just link him.  First is his coverage of the Dr. Bradner conviction for wire fraud and tax evasion found on Jack’s Federal Tax Crime’s blog.  Why is this case interesting?  Because it seems like this Doc turned his divorce into some serious tax crimes, hiding millions offshore.  He then tried to bring the money back to the US, but someone in the offshore jurisdiction had flipped on him, and Homeland Security seized the funds ($4.6MM – I should have become a plastic surgeon!).  His ex is probably ecstatic that the Feds were able to track down some marital assets.   I am sure that will help keep her in the standard of living she has become accustom to.

  • I know I’ve said this before, but you should really follow Jack Townsend’s blogs.  From his Federal Tax Procedure Blog, a write up of the Second Circuit affirming the district court in United States v. Rozbruch.  Frank Agostino previously wrote up the district court case for us with his associates Brian Burton and Lawrence Sannicandro.  That post, entitled, Procedural Challenges to Penalties: Section 6751(b)(1)’s Signed Supervisory Approval Requirement can be found here.  Those gents are pretty knowledgeable about this topic, as they are the lawyers for the taxpayer. As Jack explains, the Second Circuit introduces a new phrase, “functional satisfaction” (sort of like substantial compliance) as a way to find for the IRS in a case considering the application of Section 6751(b) to the trust fund recovery penalty.
  • The Tax Court in Trumbly v. Comm’r  has held that sanctions could not be imposed against the Service under Section 6673(a)(2) where the settlement officer incorrectly declared the administrative record consisted of 88 exhibits that were supposed to be attached to the declaration but were not actually attached.  The Chief Counsel lawyer failed to realize the issue, and forwarded other documents, claiming it was the record.  The Court held that the Chief Counsel lawyer failed to review the documents closely, and did not intentionally forward incorrect documents.  The Court did not believe the actions raised to the level of bad faith (majority position), recklessness or another lesser degree of culpability (minority position).  Not a bad result from failing to review your file!
  • This isn’t that procedure related, but I found the case interesting, and I’ve renamed the Tax Court case Cartwright v. Comm’r as “Breaking Bones”.  Dr. Cartwright, a surgeon, used a mobile home as his “mobile office” parked in the hospital parking lot.  He didn’t treat people in his mobile home (which is good, because that could seem somewhat creepy), but he did paperwork and research while in the RV.  Cartwright attempted to deduct expenses related to the RV, including depreciation.  The Court found that the deductions were allowable, but only up to the percentages calculated by the Service for business use verse personal use.  I’m definitely buying an Airstream and taking Procedurally Taxing on the road (after we find a way to monetize this).
  • The IRS thinks you should pick your tax return preparer carefully (because it and Congress have created a monstrosity of Code and Regs, and it is pretty easy for preparers to steal from you).
  • Les wrote about AICPA defending CPA turf in September.  In the post, he discussed the actions the AICPA has been taking, including the oral argument in its case challenging the voluntary education and testing regime.  As Les stated:

The issue on appeal revolves whether the AICPA has standing to challenge the plan in court rather than the merits of the suit. The panel and AICPA’s focus was on so-called competitive standing, which essentially gives a hook for litigants to challenge an action in court if the litigant can show an imminent or actual increase in competition as a result of the regulation.

On October 30th, the Court of Appeals for the District of Columbia reversed the lower court, and held that the AICPA had standing to challenge the IRS’s Annual Filing Season Program, where the IRS created a voluntary program to somewhat regulate unenrolled return preparers.  The Court found the AICPA had “competitive standing”, which Les highlighted in his post as the argument the Court seemed to latch on to.   For more info on this topic, those of you with Tax Notes subscriptions can look to the November 2nd article, “AICPA Has Standing to Challenge IRS Return Preparer Program”.  Les was quoted in the post, discussing the underlying reasons for the challenge.

  • Service issued CCA 201545017 which deals with a fairly technical timely (e)mailing is timely (e)filing issue with an amended return for a corporation that was rejected from electronic filing and the corporation subsequently paper filed.  The corporation was required to efile the amended return pursuant to Treas. Reg. 301.6011-5(d)(4). Notice 2010-13 outlines the procedure for what should occur if a return is rejected for efiling to ensure timely mailing/timely filing, and requires contacting the Service, obtaining assistance, and then eventually obtaining a waiver from efiling.  There is a ten day window for this to occur.  The corporation may have skipped some of the required steps and just paper filed.  The Service found this was timely filing, and skipping the steps in the notice was not fatal.  The Service did note, however, that efiling for the year in question was no longer available, so the intermediate steps were futile.  A paper return would have been required.  It isn’t clear if the Service would have come to the same conclusion if efiling was possible.
  • Sticking with CCAs, in November the IRS also released CCA 201545016 dealing with when the IRS could reassess abated assessment on a valid return where the taxpayer later pled guilty to filing false claims.   The CCA is long, and has a fairly in depth tax pattern discussed, covering whether various returns were valid (some were not because the jurat was crossed out), and whether income was excessive when potentially overstated, and therefore abatable.  For the valid returns, where income was overstated, the Service could abate under Section 6404, but the CCA warned that the Service could not reassess unless the limitations period was still open, so abatement should be carefully considered.



Failed Attempt to File a Joint Return and the IRS Practice of Returning the Original Return

The case of Reifler v. Commissioner recounts a simple mistake that got very costly for the taxpayers but also raises the issue of how should both the IRS and the taxpayers act when something about an original return requires fixing.  On the facts here Judge Laro finds that the petitioners did not timely file their return for 2000.  That failure became costly because of deficiencies determined by the IRS concerning the return during an audit.


Both petitioners worked and had business backgrounds. They relied on an accountant to prepare their return.  The accountant prepared the return during the extended due date period and provided it to Mr. Reifler.  Mr. Reifler signed the return and brought it home for his wife to sign.  They had a practice of filing joint returns and the accountant had prepared a joint return.  For an unknown reason she did not sign the return but he mistakenly or absent-mindedly thought she had.  He mailed in the return with only his signature.  The IRS sent them back the original return because of the lack of her signature.  When they received the original return back from the IRS, petitioners did not, according to their testimony, receive correspondence with it explaining that the IRS sent it back for lack of a signature.  They did not pay attention to the fact that the document return had red marks all over it and was the original return Mr. Reifler had sent to the IRS.  They filed away the return and did nothing to address the unsigned return issue.

Several months later, petitioners received a notice from the IRS that they had not filed their 2000 return. In response to this notice, they printed and signed a copy of the original return and sent it to the IRS.  The IRS treated this document as the original return and treated it as a late filed return.  Two years later the IRS began an audit of 2000 and other years.  For the first time during the audit the petitioners realized that the IRS had treated the copy as the original return.  Petitioners still had the original return.  They introduced the original return at trial although with some alterations.

Petitioners made two arguments concerning the validity of the original filed return while acknowledging that it omitted Mrs. Reifler’s signature. First, they argued that the original return substantially complied with the requirements for a valid return and should be treated as a valid and timely return.  Second, they argued tacit consent, an argument usually reserved for circumstances where one spouse signs for both.  The Tax Court rejected both arguments because of the lack of Mrs. Reifler’s signature but went into significant detail in discussing both bases for its possible validity.  This discussion offers useful insight into these theories.

Substantial Compliance

Taxpayers relied on three Supreme Court cases, Florsheim, Zellerback and Badaracco.  The Tax Court looked to its own decision in Beard.  Beard has a four part test one of which is that a return must be signed under penalty of perjury.  The Court cited to numerous cases decided in the Second Circuit, the circuit to which the appeal of this case lies, in support of the proposition that a valid return requires a signature.  In addition to the three old, if not ancient Supreme Court cases, petitioners also cited to two comparatively recent Tax Court decisions in which the IRS returned the original return to the taxpayers and the Tax Court allegedly found reasonable compliance as a basis for not finding the returns were late.  In Blount, the IRS sent back a return because the taxpayer failed to attach a Form W-2.  In that case the taxpayer had signed the return and did promptly return the return with the missing form.  The Tax Court found the return was timely filed but nothing about the missing Form W-2 really implicates the Beard test.  In White, a Summary Opinion, the IRS sent back a return missing both the spouse’s signature and a Form W-2.  The taxpayers promptly signed and returned the Form 1040 with the Form W-2.  The IRS conceded the validity of the joint return not forcing the Tax Court to decide the issue even in this non-binding opinion.  The Tax Court stated that “it would be inappropriate for this Court to use its power to create a potentially unlimited exception to a well-established and fairly simple rule.”  Finding nothing to support the application of the substantial authority rule as a basis for providing the taxpayers relief, it moved on to their arguments concerning tacit consent.

Tacit Consent

The IRS regularly uses this argument to hold that a return meets the joint return requirements where one spouse argues that their signature on the return was placed there by their spouse. The problem for the Reiflers concerning this theory is that the cases they cited were cases with two signatures.  The theory behind tacit consent generally supports the position the Reiflers sought to present; however, the facts turn on consent to a signature placed on the return and not the failure to place a signature on the return.  Here the IRS never argued that the return met the joint return requirements and had consistently argued it did not.  In contrast to the consistency of the IRS position, petitioners had behaved neither consistently nor appropriately after receiving the original return back from the IRS.  They had not signed and returned it as the IRS requested (though they disputed receipt of that request).  They altered the original return before presenting it to the Court.  They did not follow their stated procedures with the return.  Their actions just did not support their later argument.  The Court also addresses the administrative issue here for the IRS and finds that “using the tacit consent doctrine, in cases when a tax return is rejected by the Commissioner for lack of compliance with the most basic requirements would only create chaos.”

The return processing part of the IRS handles millions of returns. It needs straight forward rules to administer.  It receives such a ruling from this case which is good.

Because I have seen the mischief that sending back the original return can cause, I long for a different procedure. Sometimes the IRS sends back returns, like the one in the White case, that meet the Beard test.  That seems wrong.  The system of processing returns is too complicated for me to arm chair quarterback.  The IRS ability to process as many documents as it does is impressive but sending back original documents that purport to be returns can cause problems in unwinding the original mistake.  The decision here gives the IRS a clear rule for unsigned returns and that should be an easy rule for it to follow in identifying Forms 1040 that do not make it to “return” status.

In our quick research for this post, we did not find Internal Revenue Manual sections providing instructions on what to keep, if anything, when sending back a return.  I am not sure what record the IRS has of this transaction and the taxpayers attempt to comply with the return filing requirement.  I would prefer to have the IRS retain the original version of the Form 1040 and send back a copy with its explanation.  This leaves the IRS with evidence of what the taxpayer(s) sent and a record that something was sent.  Sending back the original and having no record of the taxpayer’s submission seems to lead to problems.  I also wish it would not send back returns that meet the Beard test but do not comply with the IRS desires for a return.  Sending back the returns in those situations can lead to significant problems, particularly for low income taxpayers in getting the case back to the right point.


Summary Opinions through 02/20/15

A special thanks to our frequent guest blogger, Carlton Smith, who over the last few weeks has provided us with quite a few posts.  Les, Keith and I have been extremely busy with various projects, which Carl knows, and he offered to do some extra writing to ensure the blog had quality content over that period. The posts have all been wonderful, and we are indebted to him for that.

Before getting to the other tax procedure, we wanted to provide an interesting update on a case we have been following.  Frequent readers of our blog are familiar with our coverage of the Kuretski case, which questioned the President’s power to remove Tax Court judges under Section 7443(f). As Mr. Smith stated in his December 2nd post on the topic,

This past June, the D.C. Circuit ruled that there was no separation of powers issue because (1) the Tax Court, while defined as an Article I (Congressional) court in section 7441, was really, for most constitutional purposes, an Article II Executive Agency exercising executive functions, and (2) there is no problem in the President, who heads the Executive Branch, ever having the power to remove officers of an Executive Agency.

The taxpayer has filed for cert., which has not yet been reviewed.   Miami attorney, Joe DiRuzzo (who seems to get his hands on cases with most interesting procedure issues), in late December and early January, filed Kuretski-like motions in various Tax Court cases appealable to various Circuits asking the Tax Court to declare the 7443(f) removal power unconstitutional.  In a couple of those cases, the Service was given a healthy amount of time to respond, until March 9th.  The Service has requested another sixty days to coordinate its response at the highest levels of Counsel’s office (not a direct quote, but pretty close–we can provide a copy of the motion, if you are interested).  That is a lot of time to coordinate a response, and it would be reasonable to assume this has something to do with what is or is not happening with the Kuretski.  I’m sure we will have continuing coverage as this moves forward (or doesn’t move forward).

To the other procedure:

  • Agostino & Associates have published their February 2015 Newsletter.  It is great, as normal, and congrats to Jairo Cano on being named a Nolan Fellow!  I particularly liked the first part of the article regarding the “Service’s Duty to Foster Voluntary Compliance Through IRC Sections 6014(a) and 6020(a).”
  • Do you hate it when your clients fail to pay your bills? Want to stick it to them, and force them to pay tax on the discharge of that indebtedness by issuing a Form 1099-C.  OPR thinks that might reflect negatively on your character and fitness to practice before the Service.  OPR did not provide an opinion, but found that only an “applicable entity” had to file such a form, which is defined as various government entities, “applicable financial entities” or other organizations that engage in lending.  Further, whether a debt can be discharged is a question of fact, and it “generally occurs when a taxpayer receives funds that are not includible in income, because the taxpayer is obligated to repay the obligation,” not when there is a disagreement about fees for services owed.  OPR stated that if a practitioner was not following these substantive rules, that could be problematic for the practitioner under Circular 230, as the practitioner would have a duty to know those laws before issuing an IRS form.  See in particular Circ. 230, Section 10.22(a).
  • The District Court for the Western District of North Carolina, in Carriker v. United States, has partially dismissed an accountant’s attempt to collect attorney’s fees for the accountant defending his CPA license before a state board that he claimed was related to an IRS controversy.  The Court found these were not proceedings “by or against” the United States under Section 7430.  Similarly, the Code did not provide for fees for the accountant’s time helping his lawyer on the project.  The claims related to fees for the underlying IRS controversy were not dismissed.
  • The Service issued a taxpayer favorable PLR on seeking discretionary relief for late recharacterization of a Roth IRA conversion back to a normal IRA in PLR 201506015.  Under the PLR, the taxpayer converted his IRA to a Roth, and a few weeks later invested in a company on his financial advisor’s advice.  That company, through other investments, either stole or lost the money, and fraudulent provided incorrect statements regarding the investment’s value.  Because of this, the taxpayer had no reason to recharacterize his IRA back to a Roth.  After the period for making such an election, the taxpayer found out about the fraud.  Taxpayers are, under certain circumstances, allowed to convert their traditional IRA to a Roth IRA.  This requires the taxpayer to pay the income tax due on the distribution, but no penalty.  If the value of the account decreasing significantly immediately after the conversion, taxpayers may want to recharacterize and obtain a refund of the tax due.  There are certain time limits within which the election must be made.   Under Treas. Reg. § 301.9100-3(b)(1), the Service has discretion to allow late relief in certain circumstances.  One of which is when the taxpayer “failed to make an election because, after exercising due diligence, the taxpayer was unaware of the necessity for the election.”  The Service found the fraud caused the taxpayer to be “unaware of the necessity for the election” and allowed the late election.  This is arguably a broad, taxpayer friendly, view of when a taxpayer will be aware of something and what is a necessity.
  • The Service has issued its internal guidance regarding Letter 5262-D in estate and gift audits.  This guidance discusses how the auditor should handle a case that was not settled based on how cooperative the taxpayer was.  It covers when a 30 day letter can be issued, how additional information must be requested, and when a 90 day letter must go out.  If you don’t respond to those IDRs, you are probably getting a ticket to Tax Court.
  • Next time the ABA Tax Section meets in San Francisco, we may need to take a field trip to the bar from this next case.  In Estate of Fenta v. Comm’r, the Tax Court found the taxpayer was not entitled to litigation and administrative costs, as the IRS was substantially justified (too bad, because I think the fees would have gone to a low income taxpayer clinic).   The action in this case surrounded the Lakeside Lounge, which might be this joint.  The Lounge appears to be a dive bar, that earned a substantial portion of its income from the sale of booze, largely in cash transactions.  In a fact pattern that would not be surprising to any IRS agent, it was believed that the bar was not reporting all of its income.  Below is a quick note on how the Service calculated the deficiency and on why no costs were awarded.

The taxpayer wasn’t excited to hand over the books and records, and after a few summonses, the Service determined the business was not keeping adequate books and records.  Using the invoices for the alcohol purchased by the bar, the Service applied the “percentage-markup” analysis (which the California taxing authority had previously used) to determine the under reporting of the income.  This is one of the methods used by the IRS during audits of cash intensive businesses – here is a portion of the IRS’ audit guide on the topic.  For bars, this is calculated by taking “liquor purchases divided by average drinks per bottle times average price per drink with allowance for spillage.”  There are a lot of things practitioners and the Service can quibble about in this calculation.  The Service issued its notice of deficiency, and the taxpayer petitioned the court.  Prior to a hearing, the matter was largely settled and a stipulated settlement was filed with the court.

In the instant case, it does not appear a qualified offer was made, so the Tax Court did a Section 7430(c)(4)(A) review to determine if the taxpayer substantially prevailed.  In this case, the Service largely argued that it was substantially justified in its position because Mr. Fenta failed to provide various receipts until after he filed his petition.  Once the Service received those items, it settled.  The Court agreed with the Service.  Interestingly, the Court did not indicate whether the Service argued that the settlement precluded fees.  I was too lazy (busy) to pull the briefs to see if the Service did not argue the same or if the Court found it more appropriate to only discuss the substantially justified argument.

  • The First Circuit, in In Re: Brian S. Fahey, consolidated four cases, all with the same question, which was:

whether a Massachusetts state income tax return filed after the date by which Massachusetts requires such returns to be filed constitutes a “return” under 11 U.S.C. § 523(a) such that unpaid taxes due under the return can be discharged in bankruptcy.

The Court, joining a recent Tenth Circuit decision, held “we conclude that it does not.”  The Court found persuasive the holding in Mallo v. Internal Revenue Service, where the Tenth Circuit held late filed returns were not returns for the applicable paragraph in the bankruptcy code.  Keith had a great write up of Mallo found here (comments are worth a review also).

  • From the Federal Tax Crimes Blog, Jack Townsend discusses the DOJ press release regarding another plea deal for a UBS client.  Jack quotes the release and then covers his thoughts, which are insightful, as always.  Great point about the taxpayer’s lie to the Service in a meeting potentially extending the statute on the underlying crime (and being a crime itself).

Summary Opinions for 10/10/14

Summary Opinions only touches on a few items this week, but they are all interesting and somewhat important.  More jurisdiction questions, both in the whistleblower context and on failure to exhaust administrative remedies.  Plus interest abatement, penalty abatement, and more on the Elkins case and the Yari case.

  • Whistleblower cases are sort of like the IRS’s version of the Beatles’ Ringo songs.  Sort of quirky and entertaining, but not their best work.  If you have frequently read the Whistleblower opinions over the last few years, I think it would be understandable if you thought the Service was intentionally trying to thwart the program (were the Beatles trying to stop Ringo’s continued singing by giving him garbage?), or perhaps just incompetent (see Ringo’s singing), or nowhere near sufficient assets are allocated to the program (seems like the Beatles mailed a few of those Ringo songs in).  A recent Tax Court jurisdiction case, Ringo v. Comm’r, can be added to those prior cases.  In Ringo, the Service’s Whistleblower Office sent the petitioner a letter stating he was ineligible for an award under Section 7623, and not much else.  Petitioner disagreed, and appealed the determination to the Tax Court.  A few months later, the IRS sent a second letter saying, “just kidding, we are considering your claim”.  The Service then responded to the petition by filing a motion to dismiss for lack of jurisdiction, which Ringo did not oppose.  The Court, however, relying on law related to stat notices found that its jurisdiction is based on the facts at the time of the petition, and jurisdiction continues “unimpaired” until a decision is entered. (contrast this with CDP cases, which as Keith discussed here the parties can dismiss without the need for a decision) The Court found that the letter constituted a determination under Section 7623(b)(4), providing it with jurisdiction.

I think this is the correct result, and a good policy.  There could be negative implications in the Whistleblower context, and perhaps others, if the Court held the Service could divest the Court of jurisdiction simply by stating it was actually still reviewing the matter.  First, the Service could use this to prolong matters.  Second, and more troubling, the Service could start issuing such letters in all close situations, or even more broadly, so it wouldn’t have to deal with the matter until the taxpayer proved it was willing to go to court, or to attempt to thwart valid claims, only to retract the letter once the matter goes to court. In Ringo, none of this seems to have mattered much, because the petitioner appears to not have objected to the dismissal of the case, but other’s may want to force the issue, and it is better to not have a holding stating the Tax Court lacks jurisdiction.  For a far more succinct recitation of the facts and holding, check out Prof. Tim Todd’s write up on the Tax Litigation Survey blog.  Lew Taishoff also has a good post on the case found here.

  • The Tax Court had an interesting interest abatement holding in Larkin v. Comm’r.  I found two aspects interesting, and the case a little challenging to work through.  The quick facts; an incorrect overpayment in a later year was due to an incorrectly carried forward NOL, which should have been carried back.  The taxpayer amended the returns, resulting in a liability in the later year, and a larger overpayment in the prior carryback NOL year. Initially, my mind jumped to interest netting, which gets to the first interesting aspect of the case.  One argument the taxpayer made was that the Service failed to credit the prior year overpayment against the later year liability, as requested, and instead issued a refund, which it thought would have negated interest on the later year’s underpayment.  The Court found this argument moot, although the Service did not.  The Court stated, “[i]t appears that both parties may have assumed that a credit…would, no matter when it was administratively credited against the [later] liability, have been treated as if it had been paid at least as early as the due date of the [later return] and would therefore have precluded the accrual of any interest…But that is not the case.”  The Court looked to Section 6601(f) relating to the satisfaction of tax by credit, which it found precluded the erroneous assumption.  I have not had time to review this, so I am not saying the Court was correct on this point.  The main text of the holding does not fully flesh the point out, but I think Footnote 8 helps to explain the Section 6601(f) issue, stating:

Under section 6611(f)(1), for interest purposes the overpayment of 2003 tax was “deemed not to have been made prior to the filing date for” the loss year (2005), i.e., not before April 2006; and under subsection (f)(4)(B)(i)(I), the 2003 overpayment was “treated as an overpayment for the loss year”, i.e., for 2005. However, under subsection (f)(4)(B)(i)(II), the return for the loss year (2005) was treated as if “not filed before claim for such overpayment is filed”, i.e., in May 2008. That is, the 2003 overpayment was deemed to arise in April 2006, when the 2005 return was due; but the 2005 return (due in April 2006) was treated as not filed before May 2008 (and therefore as late), and the refund was made less than 45 days thereafter on July 9, 2008.

 The second major point I found interesting was the Court’s review of ministerial acts for abatement under Section 6404.  The taxpayers claimed that the IRS gave them erroneous advice regarding amending a different year, which was incorrect and the return was not processed.  The taxpayers claimed this caused delay in proper filing, resulting in interest.  The Court noted some evidentiary issues that made the taxpayers’ claim fail, but also stated that direction regarding amending prior returns, at least in this case, were “providing an interpretation of Federal tax law” which was not a ministerial or managerial act subject to Section 6404 abatement.

  • I’m not certain who is the “Chief Idea Guy” at Procedurally Taxing; probably Keith, maybe Les, definitely not me.  If we had such a position, our ideas would generally be tax related – at least the good ones.  In Suder v. Comm’r, that was not the case for Mr. Eric Suder who was CEO and CIG of his company Estech Systems.  His good ideas had something to do with telephones.  Not tax planning. Estech did some incorrect research credit tax planning, which resulted in an underpayment, which the Service assessed accuracy related penalties on.  The taxpayer argued reliance on a professional, and honest misunderstanding of law.  The reliance holding was fairly straightforward.  It is, however, less frequent that you see a misunderstanding of the law argument successfully made.  The Court held that the taxpayer had an honest misunderstanding of the tax law related to reasonable compensation under Section 174(e), which was reasonable under the facts and circumstances, and that this area was very complex.  It did seem like some of the pertinent facts and circumstances were that they relied on their longtime accountant to provide them with their misunderstanding, which makes it overlap with professional reliance.
  • In US v. Appelbaum the District Court for the Western District of North Carolina had the opportunity to review various procedural issues in a case involving Section 7433 damages claim following the Service attempting to claim Section 6672 penalties for not paying over a bankrupt company’s taxes.  Mr. Appelbaum, like almost all applicants for damages under this Section, failed to exhaust the administrative remedies under Section 7433, which allowed the District Court to provide its opinion on whether or not that requirement was jurisdictional.  Following Galvez and Hoogerheide, the Court found it was not a jurisdictional requirement, but failing to comply with the statute resulted in the taxpayer failing to state a claim upon which relief could be granted.  Regarding the counterclaim, it appears the taxpayer alleged latches, but not as some sort of equitable argument regarding the Section 7433.   I was initially excited to see “equitable” language following a determination that failure to exhaust administrative remedies was not jurisdictional (Courts don’t usually get to whether an equitable argument could prevail).  Unfortunately, it was a separate claim, which makes sense, since latches would not be the first equitable argument you would think should apply in that context.
  • Jack Townsend’s thoughts on the Elkins’ art valuation case can be found here.  We touched on that in the last SumOp, and this case is popping up everywhere.  Jack has a great discussion regarding burden of proof, which should be reviewed.  I’m thrilled that my family has a way to discount the value of our Star Trek commemorative plates.  The estate tax on those was going to be a bear when my folks died.
  • More on the Yari case, which considers the 6707A penalty in the context of an amended return; Les previously blogged on the case here.  This content is from David Neufeld, and was reproduced from the Leimberg Information Services, Inc. tax newsletter. In the post, Neufeld takes aim at the Tax Court holding in the case, and makes a spirited argument in favor of the taxpayer’s view that the penalty should be pegged to the amended return, and not the original filed return.

A Cogent Look at the “What is a Return?” Question

In Briggs v. United States, 511 B.R. 707 (Bankr. N.D. Ga. 2014), Bankruptcy Judge Wendy Hagenau carefully examined the facts of the case and the applicable law in concluding that a Form 1040 filed after the IRS assessed taxes based on a substitute for return procedures met the requirements for filing a return. I previously blogged about the mess created by the litigation and legislation in this area. Judge Hagenau worked her way through existing precedent and arrived at a conclusion that offers hope to many taxpayers who fail to timely file their return and later seek relief through bankruptcy. 


The Briggs case presents a classic set of facts. The taxpayer did not file his 2002 return by the due date as extended. Eventually, the IRS calculated his liability using IRC 6020(b) procedures and sent him a statutory notice of deficiency. He did not petition the Tax Court within 90 days. The IRS assessed the tax (over $200,000) and began collection. He eventually filed a Form 1040 showing that his correct tax liability was $149,870 rather than the $226, 536 assessed. The IRS accepted the Form 1040 as a claim for abatement and abated his tax to the lower amount. The IRS partially collected the lower liability through levy and offset but he still owed a substantial liability for 2002 when he filed bankruptcy on March 23, 2013. 

The IRS made two arguments in support of its position that BC 523(a)(1)(B)(i) excepts the 2002 taxes from discharge. First, it argued that the tax “debt” arose from the IRS assessment and not from the late filed Form 1040, making the debt one from which the debtor had an unfiled return at the time it arose. This argument represents later thinking by the Government than its original position on this issue and seeks to create a bright line test not available through the Beard test. Second it made its original argument slightly modified by the passage of BC 523(a)(*), that an untimely return filed after assessment does not qualify as a “return” under applicable non-bankruptcy law. 

The Court first addressed the “debt” argument and used bankruptcy definitions to reject it. My guess is that the IRS will appeal the case because it has had several successful outcomes with this argument and it represents a clear path to victory. Judge Hagenau, citing Rhodes v. United States (In re Rhodes), 498 B.R. 357 (Bankr. N.D. Ga. 2013), rejected this argument because the term “debt” in bankruptcy focuses “on the nature and source of debt . . . not on the mechanism to determine debt.” Under bankruptcy law the debt to the IRS arises at the end of the tax period and not when assessment occurs. The assessment or non-assessment of a tax does not “change the fact that the right to payment existed.” So, Judge Hagenau placed no importance on the assessment as creating the debt before the later filed return since the debt for bankruptcy purposes arose long before either of these events. Her interpretation makes the most sense given the bankruptcy definition of debt. The IRS will continue making this argument because of its ability to create a clear statement regarding discharge. 

The Court next addressed whether the late-filed Form 1040 qualifies as a return. This is the original issue on which the IRS won in In re Hindenlang, 164 F.3d 1029 (6th Cir. 1999), although now with the overlay of BC 523(a)(*) adopted in 2005. Remembering the peculiar facts of Hindenlang provides important background information. Like Briggs, Mr. Hindenlang did not timely file his return and the IRS made an assessment after using the substitute for return procedures and issuing a notice of deficiency from which he did not petition the Tax Court. Mr. Hindenlang’s subsequent Form 1040, however, merely mirrored the substitute for return prepared by the IRS. He did not report any more tax or, like Mr. Briggs, any less tax than the IRS determined from its examination. That unusual fact pattern must have influenced the 6th Circuit as it reviewed the Hindenlang case. 

The late filed Form 1040 submitted by Mr. Briggs reported a tax liability over $75,000 less than the amount assessed by the IRS using the substitute for return procedures. The IRS accepted his Form 1040 and abated the liability down to the amount shown on the form. Mr. Briggs’ form had meaning while Mr. Hindenlang’s form really added nothing to the situation. A Form 1040, such as the one Mr. Hindenlang filed, really does not seem like an honest attempt to file a return under the circumstances; however, a return like the one Mr. Briggs filed had meaning and the IRS abated his liability based on that meaning. Judge Hagenau drew from that fact. Before simply applying the facts in the Briggs case to the Beard test she analyzed BC 523(a)(*) to determine what new requirements the 2005 changes imposed, if any, since the Hindenlang decision started the inquiry regarding late filed returns. 

Judge Hagenau’s analysis of the requirements led to a discussion of the cases decided after 2005. A line of cases, led by McCoy v. Miss. State Tax Comm’n (In re McCoy), 666 F.3d 924 (5th Cir. 2012), interprets the 2005 amendment to encompass a timeliness element that makes any untimely filed Form 1040, even if only one day late, something other than a return for purposes of the discharge provisions. The IRS does not agree with this interpretation but the Court here looked at this line of cases before concluding – correctly in my opinion – that the term applicable non-bankruptcy law in BC 523(a)(*) “does not incorporate the timeliness requirements of the tax code.” Judge Hagenau explained that the interpretation in McCoy and its progeny does violence to the overall workings of the bankruptcy code. 

Judge Hagenau then turned at last to the Beard test, which requires that a document must meet four tests to be a return: (1) purport to be a return, (2) be executed under penalty of perjury, (3) contain sufficient data to allow calculation of tax, and (4) represent an honest and reasonable attempt to satisfy the requirements of tax law. In these cases the focus is almost always on the fourth test. Remember that Hindenlang’s Form 1040 really served no purpose except to seek to start the two year period for discharge. Here, the Court agreed with the minority view of cases lead by In re Colson that a return such as the one Mr. Brigg’s filed does meet the Beard test. Therefore, the Court determined that the remaining 2002 taxes were discharged. 

This issue bears careful watching. The IRS chose not to file a petition for cert when it lost Colson in 2006. If its new argument that the debt arose before the late filed return fails and it does not adopt the McCoy argument, it is left with the fact specific Beard argument. Without a bright line legal argument the IRS takes on a lot of administrative risks with this issue because it is not discharging taxes in these situations. It leaves these liabilities on its books and restarts collection action after bankruptcy. If it ultimately must concede this issue, fifteen years or more of post-discharge taxes will exist on its books that it must address. Similar to the situation that now exists in the post-Rand concession, the IRS will need to clean up its assessment records and with the discharge injunction hanging over its head the burden will clearly be on the IRS and cannot be pushed off to the taxpayer. The path it has taken on post-Hindenlang is a risky path and one that is difficult to administer. It tried to fix the problem in 2005 but got language that has proven inadequate. Keep an eye on this issue if you have clients with late filed returns who may need bankruptcy as a refuge.