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.


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. 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.

Superseding Original Returns

As the filing season starts, it is appropriate to think of filing more than one return if the first or second return is incorrect.  This is not the same as voting early and often as Chicago voters were fond of doing during the Mayor Daley era.  The filing of  a more correct return(s) during the filing season allows the taxpayer to get it right before the due date of the return in order to avoid penalties or other consequences that can flow from an incorrect return.  With each new return filed prior to the due date of the return, the newly filed return replaces and supersedes the preceding one(s).  Because of the timing of this post at the beginning of the filing season, we do not mean to suggest that you make anything but the best effort in filing the first return, but knowledge of the availability of the superseding return may come in handy for one of your clients some day.

Usually, April 15th is not an especially busy time for the tax clinic because the work of the clinic is not geared to the filing season but rather to the litigation calendar.  Last year things worked out a little differently because we had some clients with unfiled 2012 returns that generated refunds which would have been lost if the returns were not filed within three years of the original due date and a client who had already filed their 2015 return which was rendered incorrect by a Form 1099 received after the filing of the return.  So, the filing date mattered to our clinic last year.  In filing the second return for 2015 for the client who received the Form 1099 after the original filing for the year, we filed what is known as a superseding return.  Prior to filing this return, we did a bit of research which I share in this post.  If we had not filed a superseding return in the case of the Form 1099, the taxpayer could have filed an amended return after the due date for filing the 2015 return passed or could have waited for contact from the IRS Automated Underreporter Unit and responded at that time to an inquiry about the income reported on the Form 1099 but not reported on the Form 1040.  By filing the superseding return, we hoped that we corrected the situation in the timeliest manner.  Superseding returns are far enough outside filing norms for me to expect that some glitch might occur in doing this so you do not want to do this routinely or declare victory too soon afterwards.


Many people file returns early in the filing season because they want to obtain a refund as quickly as possible or they need to have a filed return for other reasons such as sending it to the people who determine the amount of student loans or financial aid for which their son or daughter qualifies.  Sometimes, after filing a return and before the due date for filing the return, a taxpayer gains additional information that renders the return incorrect in some fashion.   The taxpayer in that situation faces a choice about whether and when to fix the return.  The advantage of fixing the return prior to the due date for filing the return is that fixing it before that date makes the later return the original return for the tax period and eliminates the possibility of penalties or other action based on the missing information.

If a taxpayer learns of the incorrectness of a return after filing but before the due date, they also face a slightly different situation than if they had learned about the incorrectness after the due date.  The regulations provide that a taxpayer should, but not must, file an amended return when they learn that a return filed is incorrect. I co-authored an article with Professor Calvin Johnson on the duty to correct returns if you want to read more on this topic. The regulation which directs taxpayers that they should file an amended return when learning of a mistake seems to address the taxpayer who finds out after the original due date.  If the taxpayer finds the mistake before the original due date and fails to fix it before that date, their responsibility to the system may differ.

The idea of superseding returns receives little attention.  The IRS makes brief mention of it in I.R.M which it last revised on October 1, 2016. The mention in the manual does not imply that the IRS encourages superseding returns.  I suspect that the IRS does not want to encourage superseding returns because it does not want to deal with the processing headaches they will create.  If you do submit a superseding return, you will need to file the return as a paper return and you will want to write on the return “SUPERSEDING RETURN” at the top of the form in hopes that doing so will give a big clue to the person processing the return.  Of course, you could send it with a cover letter but letters often get separated from the tax form during the filing process.

The legal basis for superseding returns traces its roots to Haggar Co. v. Helvering, 308 U.S. 389 (1940).  In Haggar the taxpayer filed a return, realized before the due date that the return contained a mistake, filed an amended return before the due date of the original return and sought to have the IRS accept the amended return.  The return had particular importance in this year because it fixed the corporation’s capital stock account for purposes of a special tax on earnings.  The Court stated “Sections 215 and 216 of the National Industrial Recovery Act impose interrelated taxes on domestic corporations — namely an annual capital stock tax and an annual tax on profits in excess of 12 1/2 percent of the capital stock, calculated on the basis of the value of the capital stock as fixed by the corporation’s return for the first year in which the tax is imposed.”  The return at issue in Haggar was the corporation’s return for the first year.

The IRS refused to accept the second or amended return and issued a notice of deficiency based upon the value of the stock in the tax return originally filed   The taxpayer petitioned the notice arguing that  filing the amended return before the due date allowed it to set the value of the stock.  The Supreme Court agreed stating:

“It is plain that none of these purposes would have been thwarted, and no interest of the Government would have been harmed, had the Commissioner, in conformity to established departmental practice, accepted the petitioner’s amended declaration. It is equally plain that, by its rejection, petitioner has been denied an opportunity to make a declaration of capital stock value which it was the obvious purpose of the statute to give, and that denial is for no other reason than that the declaration appeared in an amended, instead of an unamended, return. We think that the words of the statute, fairly read in the light of the purpose, disclosed by its own terms, require no such harsh and incongruous result.”

Even though most returns do not have the same importance as the return at issue in Haggar, the principle in the case established the concept of superseding returns that carries forward to today. While my description of superseding returns focuses on using them to correct a mistake found before the due date in order to avoid penalties or some other consequence of leaving information off of a return, a couple of former Chief Counsel attorneys, Harve Lewis and Norlyn Miller, have written about how it might be used as a planning tool for timely making certain corporate elections.


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).