Statutes of Limitations and the Substitute for Return Procedures

We have written quite a few blog posts on the substitute for return (SFR) process but not one specifically addressing the statute of limitations regarding the returns prepared using this process.  Guest blogger Michelle Drumbl wrote about the procedures involved in preparing these returns. Guest blogger Jeffrey Sklarz wrote a post on the interaction between IRC 6020(b) and deficiency assessments.  I wrote about the IRS suspending the SFR program when it was over burdened in 2017 (imagine what’s happening to the program post pandemic.)  We have written many posts about the impact of failure to file a return on bankruptcy discharge and the impact of an SFR in bankruptcy.  One sample from these posts is linked here.

This post focuses on what happens with respect to the statute of limitations on assessment and collection when the IRS makes a substitute for return assessment.

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Just to back up slightly before answering those questions in order to make sure everyone understands what we are talking about, it is necessary to quickly cover what makes an SFR an SFR.  Typically, the case starts with the IRS receiving information returns which suggest that a taxpayer has a return filing obligation and a tax liability, but the IRS can find no return on its system.  It then sends the taxpayer a letter requesting information from the taxpayer on the information returns, asking if the taxpayer has filed, asking if the taxpayer would like to file now if he or she has not previously filed, and asking if the taxpayer agrees to the liability the IRS has computed based on the information returns.  Upon receipt of that letter, and not having previously filed a return for the period at issue, the taxpayer typically does nothing.  There are variations on the theme, but continued inactivity and procrastination usually underlie the reaction to this letter. 

After the requisite amount of time, the IRS eventually sends a notice of deficiency.  It needs to do this because, lacking the taxpayer’s explicit consent to assess, the IRS needs statutory consent to assess which it will get with the notice of deficiency process.  Since only about 3% of persons receiving a notice of deficiency petition the Tax Court, it’s safe to say that the vast majority of taxpayers receiving the notice of deficiency, which has computed the taxpayer’s liability based on third party returns, do not petition the Tax Court, allowing the IRS to assess the proposed liability because of the default.  Based on these facts, we look at the statutes of limitation. 

Assessment

When someone does not file a return, the statute of limitations on assessment does not run.  The fact that the IRS goes through the SFR procedures and makes an assessment based on the information reported to it from third parties does not count as the filing of a return by the taxpayer and does not start the clock ticking on the time the IRS has to make an assessment. IRM 4.12.1.5.4(2).  If the IRS decided that it did not assess the proper amount as a result of the SFR, it could assess an additional amount at any time.  Because the taxpayer did not submit a return stating the correct amount of the liability under penalty of perjury, the determination by the IRS in the SFR is imperfect.  Usually, an SFR overstates a taxpayer’s liability, but that outcome does not hold true if the taxpayer has income not reported to the IRS on a third-party information return.  For that reason, the IRS should continue to have the right to assess indefinitely.

If the taxpayer files a petition in Tax Court in response to the notice of deficiency setting forth the proposed liability stemming from an SFR, the Tax Court case will close out the tax year and the statute of limitations will no longer be meaningful.  Even though the taxpayer has never filed a return under penalty of perjury, the finality afforded by a Tax Court decision ends the ability of either the IRS or the taxpayer to seek a change in the liability after the conclusion of the Tax Court case.

There is some dissonance in the way I describe the effect of an SFR on the taxpayer’s ability to start the clock running on assessment and the way bankruptcy courts have viewed the subsequent filing of a tax return after an SFR assessment.  If the IRS issues an SFR notice of deficiency and the taxpayer does not petition the Tax Court (the 97% likelihood), and if the taxpayer subsequently files a Form 1040 under penalty of perjury, most bankruptcy courts say that the filing of the Form 1040 in those circumstances does not start the two-year period for achieving discharge set forth in B.C. 523(a)(1)(B)(ii) because the filing of the Form 1040 at that point is not the filing of a return.  The IRS has successfully pushed this argument over the past two decades following the decision in Hindenlang

Even though the filing of a Form 1040 signed under penalties of perjury does not start the two-year period for achieving discharge, it should start the three-year statute of limitations on assessment. This conclusion is bolstered by IRM 25.6.1.9.4.5(2), which states that when a taxpayer files a signed tax return after the Service has processed an unsigned SFR, the assessment statute period will begin with the received date of the taxpayer’s signed return. The IRS has not obtained an opinion that the filing of a return after an SFR assessment is the same as the filing of a good return after a fraudulent return, which the Supreme Court decided in Badaracco does not start the period of limitations.  I am not aware that the IRS has ever argued that the same rationale in Badaracco applies to the SFR situation, and with the language from IRM 25.6.1.9.4.5(2), I’m not sure they ever would make this argument.  So, the filing of a Form 1040 signed under penalties of perjury starts the statute of limitations on assessment even if it will not, under most case law in the bankruptcy courts, start the running of the discharge clock. IRM 4.12.1.5.4(1) also supports this conclusion.

Collection

The making of an assessment based on an SFR starts the running of the 10-year period for collection of the liability.  IRM 25.6.1.9.4.5(1). The starting of the clock on the collection period for this SFR-based assessment does not mean that the IRS cannot make another assessment at a later point.  It just means that the fact that the assessment statute of limitations remains open does not mean that the collection statute on the SFR is open ended.  During the course of any one tax year the IRS might make numerous assessments.  While doing so is not normal, it is possible.  Each time the IRS makes an assessment, the statute of limitation on collection starts running with respect to that assessment creating the possibility of several statutory ending dates for one period.

IRS Failure to Process Return Does Not Mean Taxpayer Failed to File A Return

It is all too common for the IRS to fail to process returns that taxpayers submit either electronically or by mail. In Willets v Commissioner, a nonprecedential summary opinion, the Tax Court held that the IRS’s failure to process a return did not equate to the failure to file the return. The legal distinction between processing and filing is significant given that the filing of a return is the jump off point for determining timeliness of assessments and refund claims, and also may determine whether a taxpayer is subject to delinquency penalties. 

Willets involves an original late filed return that reflected an overpayment. That context triggers some dense procedural rules relating to refund claims, so I will discuss the case’s facts, its legal background, and its significance even though it is an S case.

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In Willets, the taxpayer timely filed a request for an extension of time to file his 2014 Federal income tax return. With the extension, the taxpayer sent in an $8,000 payment. He failed to file his return by the extended October 15, 2015 date.  On April 14, 2018, he mailed the 2014 return to the IRS. On May 2, 2018 IRS records indicated that IRS rejected and failed to process the return due to concerns IRS had over identity theft. After the taxpayer failed to respond to the IRS identity theft correspondence, the IRS automated underreporter unit sent a notice of deficiency.  In addition to proposing about $17,000 in additional tax it also proposed approximately $1,000 in delinquency penalties.

The taxpayer filed a Tax Court petition, and in the petition he alleged that he overpaid his 2014 tax by about $1,500. The IRS did not disagree with the amount of the overpayment but alleged that the claim was not timely.

How do the refund claim limitations apply in Willets? Recall that Willets failed to file his original return by the extended October 15, 2015 due date and then mailed his 2014 return on April 14, 2018. That return served dual purpose as a refund claim as it reflected an overpayment.

Willets tees up the refund claim limitations of Sections 6511(a) and 6511(b).

For the purposes of the refund claim SOL, Section 6511(a) provides that the three-year period of limitation for filing a refund claim begins on the filing due date of the relevant return.  For taxpayers whose original return itself serves as the refund claim (like Willets) the key issue concerns the lookback limits of Section 6511(b)(2)(A) and not the general three-year SOL in Section 6511(a) because a refund claim contained in the original return is filed within three years of the filing of the return — in fact the refund claim is filed at the same time as the original tax return.  As a slight tangent, I note that it may be surprising that a late return that contains a refund claim (as in Willets) is automatically timely under the three-year rule of section 6511(a). That position is reflected in Rev. Rul. 76-511, 1976-2 C.B. 428, followed in Omohundro v. United States, 300 F.3d 1065 (9th Cir. 2002) (per curiam).  In Omohumdro, the 9th Circuit overruled its prior precedent of Miller v. United States, 38 F.3d 473 (9th Cir.1994), that had held that in cases of a late original return claiming a refund, the untimely return should not count as a return for purposes of section 6511(a), only a claim, and the taxpayer had to file the claim within two years of payment to be timely under (a). 

Just because a refund claim is timely under 6511(a) does not mean that the taxpayer is home free. The (b)(2)(A) lookback rule generally limits the amount of a refund on a timely filed claim to taxes deemed paid during the period looking back three years plus the six-month extension period from the date the taxpayer files the claim.  

Similar issues have arisen in the past when a taxpayer mails an original return that also has embedded within it a refund claim but arrives to the IRS more than three years after the extended due date. For that issue see Carl Smith’s post District Court Gets Timely Mailing Is Timely Filing Rule of Section 7502 Wrong as Applied to Refund Claim Lookback Period of Section 6511(b)(2)(A) and follow up post District Court Reverses Its Section 6511(b)(2)(A) Ruling and Excoriates IRS and DOJ for Not Citing Relevant Authority .

As Carl discusses in his posts the Second Circuit in Wesibart and eventually the IRS itself conceded that section 7502’s timely mailing rules apply such that the lookback period should begin from the date the return was mailed (not received) if the IRS receives the return outside the three-year plus six month extension time window.

The 7502 issue is not at play in the Willets case, as here the IRS acknowledged receiving the 2014 1040/refund claim in May of 2018 (less than three years from the extended 2014 due date).  The May 2018 delivery of Willets’ 2014 1040 avoids any direct application of the Section 7502 timely mail timely file issue as the IRS received the return before the three-year period (plus extension) of limitation expired on October 15, 2018.

The wrinkle in Willets is that the IRS failed to process the return before the three years had elapsed from the 2014 return’s extended due date of October 15, 2018.  That failure to process the return by October 15, 2018 led to the IRS arguing that the refund claim was barred (I assume under 6511(b) since as I discussed above a late filed return that has an embedded refund claim is timely under 6511(a) though the opinion is not clear on that point).

What Willets adds, and what Keith previously discussed when addressing the Fowler case in Rejecting Returns That Meet Beard and what I discussed in TIGTA Audit Flags Inconsistency in IRS Treatment of E-filed Returns is that when IRS fails to process a return it does not mean the rejected return was not in fact filed.  The Willets opinion discusses the Beard test and easily concludes that Willets’ 1040 satisfies Beard’s requirements. As such, as Willets notes,  “a valid return is deemed filed on the day it is delivered, regardless of whether it is accepted by the Commissioner.”

In holding that Willets’ return was filed even though IRS failed to process it due to ID theft concerns, the opinion notes that the return/claim was deemed filed as of the date of delivery, May 2, 2018.  That filing date meant that the refund claim was both timely under 6511(a) and not limited by the lookback rules of 6511(b).

Conclusion

Willets holds appropriately that the IRS rejection or failure to process a return or refund claim does not mean that a taxpayer has failed to file a return or claim. The distinction between processing and filing is significant, and even more so these days as IRS has had and continues to have a backlog of returns and claims that it has failed to process. As Willets holds, returns that are not processed due to delay or other reasons may in fact be deemed filed so long as they satisfy the Beard requirements. Practitioners need to be alert to consider whether a taxpayer has in fact filed a return, even if IRS transcripts fail to reflect that the taxpayer has in fact filed the return. As IRS may be sitting on a significant number of unprocessed returns that request a refund for well more than six months after their filing date, I would not be surprised to see some taxpayers bringing refund suits off of filed but unprocessed returns.

Hat tip to Ed Zollars whose Current Federal Tax Developments post flagged the Willets case. Ed’s work on that blog is outstanding, and I encourage readers to check it out.

Briefs in the Boechler Case

The Boechler case involves the issue of whether the time period for filing a Tax Court petition in a Collection Due Process case is jurisdictional or a claims processing rule.  Last week I provided a link to the excellent brief written on behalf of the petitioner.  Also last week, the Supreme Court set the oral argument in this case for January 12, 2022.

Yesterday, seven days after the filing of the petitioner’s brief, amicus briefs were due in support of the petitioner.  Four amicus briefs were filed in support of petitioner’s position that the time period is not jurisdictional.  For those following this issue, the briefs are provided here.

The Tax Clinic at the Legal Services Center of Harvard Law School filed an amicus brief on behalf of the Center for Taxpayer Rights and the National Consumer Law Center.  This brief focuses on the issue of equitable tolling.

Skadden Arps filed a brief on behalf of Federal Tax Clinics, Legal Aid Groups and Tax Professors.  This brief argues that treating the time period as jurisdictional undermines Congressional intent and disproportionately harms low income taxpayers.

The National Taxpayer Union Foundation and National Federation of Independent Business Small Business Legal Center filed an amicus brief arguing that tax exceptionalism is an anachronism and that even if tax law is special the result should be greater tax protection through doctrines such as equitable tolling.

Regular Guest Blogger and procedural expert Lavar Taylor filed an amicus brief arguing that tax exceptionalism should not prevent equitable tolling, the IRS has argued for and received equitable tolling beneficial to it, and many statutory deadlines in the Code are amenable to equitable tolling and CDP especially so.  Lavar also spends time pointing out the impact of the lack of equitable tolling on individuals living abroad given the extremely short time for filing the petition in CDP cases and the mailing issues for those overseas.

Proving the Liability – The Presumption of Regularity

I am not sure, but I don’t think we have written about a case from Guam since Les cited one in a post during our first month of existence as a blog.  The case of Government of Guam v. Guerrero, No. 19-16793 (9th Cir. 2021) gives us a chance to make up for lost time regarding tax law and Guam.  Perhaps the first issue to address concerns why we care about Guamanian tax issues.  We care because their tax code essentially mirrors our, similar to other territories, and procedural issues regarding their tax issues decided by the 9th Circuit could impact similar issues arising from the U.S.

At issue in the Guerrero case is whether the government of Guam kept adequate records to prove the liability it asserted and to prove that the statute of limitations remained open for it to act.  The court makes a decision regarding the presumption of regularity that could easily apply to the IRS.  For that reason, this circuit court opinion matters.

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Guam’s Department of Revenue and Taxation (DRT) determined that Mr. Guerrero owes about $3.7 million in unpaid taxes for 1999-2002.  He filed his returns late for those years.  The dispute concerns when the taxes were assessed.  The court states:

the official records are missing, likely due to water, mold, and termite damage at the storage facility where they were housed.

This suggests that Guam does not maintain its tax records on a computer system.  That’s surprising.  Maybe the antiquated IRS system is not the worst system in the world.

The court says that after assessment the DRT filed tax liens (I assume the court meant to say the DRT filed notices of federal tax liens) on various parcels of real property (I assume the DRT simply filed notices against Mr. Guerrero and the liens attached to his real property along with his other property.)  After filing the liens, DRT brought this case to foreclose the liens on the real property to which the liens attached.

Mr. Guerrero asserts that DRT cannot prove that it timely assessed the taxes against him.  DRT acknowledges that it does not have the original certificates of assessment, but invokes the presumption of regularity relying on the DRT procedures:

Guam’s evidence that the Department timely assessed Leon Guerrero’s taxes instead consists only of the Department’s internal documents rather than the certificates of assessment. Guam argues that these internal documents are sufficient evidence that the Department assessed Leon Guerrero’s unpaid taxes in January 2006 and sent the relevant notices before the three-year statute of limitations expired. Guam relies on the Department’s internal registers (record lists of delinquent taxpayers) known as TY53 and TY69 registers, as well as an internal transmittal sheet sent to the collections branch after the TY53 and TY69 notices were sent to Leon Guerrero, to demonstrate both that it followed standard procedure for purposes of the presumption of regularity and to show the assessment dates.

At a meeting on March 10, 2006, DRT learned that the notices of assessment did not reach Mr. Guerrero but instead went to his ex-wife’s address.  During the meeting, DRT gave Mr. Guerrero final demand and notice of intent to file a lien and he signed an acknowledgment.  This meeting took place about two weeks before the expiration of the assessment statute of limitations.  The court describes the testimony of the DRT officials who testified at the two-day trial explaining the system for making assessments and notifying taxpayer.  The statutory scheme, and much of the system, mirrors the system in the U.S. used by the IRS.

Because the assessment certificate itself is missing, DRT seeks to prove that it timely made the assessments in question by some other means, here the presumption of regularity.  The court notes:

We have held that a public actor is entitled to the presumption of regularity where there is some evidence that the public actor properly discharged the relevant official duties, which an opposing party must rebut with clear, affirmative evidence to the contrary….

As previously observed, whether the presumption applies or has been rebutted with clear and affirmative evidence to the contrary are mixed questions of law and fact that may be reviewed for clear error. The clear error standard is significantly deferential, and clear error is not to be found unless the reviewing court is “left with the definite and firm conviction that a mistake has been committed.”

Here, the 9th Circuit is not deciding the case as an initial matter but as a reviewing court.  It finds that the district court did not make clear error but it also finds that the district court’s opinion was “opaque and did not adhere to the proper steps of the analysis.”  So, the 9th Circuit sets out to explain the proper steps for making a presumption of regularity determination.

First, it should have considered if some evidence existed to support timely assessment of the taxes.  Instead, the district court determined the presumption was automatically available.  Despite this misstep, the testimony of the DRT officials did provide evidence in support of a timely assessment.  The district court should have explicitly stated that it relied upon the credibility of the DRT witnesses.

Next, the court should have examined whether Mr. Guerrero rebutted the presumption that could be drawn from the testimony.  At the trial level, he did not argue that the records presented were inaccurate.  Therefore, he waived that argument.  He failed to build the type of record he needed to build at the trial level.  The arguments he does make that are not waived by his prior actions are insufficient to cast adequate doubt on the records of the DRT.

The opinion leaves the impression that no one had a good idea what they were doing at the trial level but that DRT had enough on the ball to put into the record evidence supportive of a conclusion that a timely assessment occurred.  The presumption here is one on which the IRS may need to rely if its records are destroyed or it otherwise suffers a degradation of its system.  The court provides a bit of a roadmap for someone trying to attack a record like an assessment.  Certainly, the attack should be straightforward and clearly done at the trial level.  Mr. Guerrero should have sought the testimony of individuals who could talk about the impact of the lost records and how it cast doubt on the correctness of the entire system.  The importance of an expert testifying on this point to counteract the testimony of the government officials cannot be overstated.  Unless the government officials were destroyed on cross, Mr. Guerrero needed to give the court something to cause it to pause before presuming DRT handled the case correctly.  He gave the court nothing to go on and the 9th Circuit finds that significant.

The dissent picks up on some of the errors by DRT and offers a roadmap for how Mr. Guerrero might have attacked the validity of the assessment.  The dissent provides good lessons for those who find themselves in this situation trying to combat a presumption of this nature.  The case leaves me a little concerned about the use of the presumption of correctness in this situation to prove the timeliness of the assessments.  Like the dissent, I felt the majority made some leaps to get to the favorable result for the DRT.

BC 507(a)(8)(C) Priority Prevents Discharge under BC 523(a)(1)(A)

Last week I wrote about the case of Lufkin v. Commissioner, T.C. Memo 2021-71, in which the Tax Court ruled on the impact of filing bankruptcy on the statute of limitations.  In that post, I mentioned that Bryan Camp wrote about the case as part of his Lessons from the Tax Court series, which alerted me to the decision.  In that same post Bryan also wrote about Barnes v. Commissioner, T.C. Memo. 2021-49, which Judge Lauber decided on May 4, 2021.  As with the Lufkin case, Bryan has a good write-up, and he provides good bankruptcy background information.  I will try to add a little additional color to the case.

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The Barnes case shows what happens when a taxpayer goes into bankruptcy while still contesting a liability.  As taxpayers learn, the result does not favor the taxpayer in a situation in which the unresolved liability gets resolved after the bankruptcy filing and the resolution allows the IRS to assess an additional amount.  The Tax Court must work through the bankruptcy provisions to get to the correct result which it does as it demonstrates again that bankruptcy discharge issues can find their way into Tax Court decisions requiring the Tax Court judges to understand bankruptcy law as they rule on tax collection issues.

When Mr. and Mrs. Barnes entered bankruptcy, they were still waiting for the Tax Court to make a decision on their 2003 liability.  They filed the Tax Court petition in 2008 and tried the case in June 2009.  They had submitted their briefs in the case when, on July 26, 2010, before the issuance of an opinion, they filed a chapter 11 petition.  The filing of the bankruptcy petition stayed the Tax Court proceeding and would have caused the Tax Court judge working on the opinion in their case to hold onto the opinion.  While the automatic stay stops the Tax Court proceeding, I don’t know if Tax Court judges interpret it as stopping them and their clerks from working on the case, or if it just stops them from issuing an opinion.  My guess is the latter, but I have not spoken with a Tax Court judge about how strictly the Tax Court interprets the stay.  Perhaps the Tax Court judges interpret the stay to require them to completely stop working on the opinion until the stay lifts, or perhaps there is a split among the judges regarding how they interpret the stay when it comes into existence during the opinion-writing stage of a case.

In any event, the existence of the unresolved Tax Court case means that as to the liability at issue in the Tax Court, the debt in the bankruptcy court for that unresolved liability would receive priority status under BC 507(a)(8)(A)(iii) because the liability was not yet assessed but was assessable. Here, the Barnes filed a chapter 11 case, which requires in BC 1129 that they commit in their plan to fully pay all priority claims.  The IRS participated in the plan and filed a proof of claim; however, it failed to include in its claim the 2003 liability.  The Barnes could have filed a claim on behalf of the IRS for 2003 or could have included 2003 in their plan, but the plan did not include the 2003 liability.  It’s hard to know whether this was oversight by one or both of the parties or a calculated decision.  The Barnes may not have wanted to commit to paying the $50K or so the IRS thought was due and may have been stretched to come up with a plan that would have paid it over time.  The IRS may have preferred to collect outside of bankruptcy and not lose the interest it would lose if paid through bankruptcy.  In any event, 2003 was not addressed.

Note that chapter 11 cases for individuals occur relatively infrequently.  If this were a chapter 11 filed by an entity, an oversight of this type could have ended the IRS’s hopes for any recovery on 2003 because of the super discharge available in chapter 11 to entitles.  That super discharge is not, however, available to individuals who must look to BC 523(a) for the discharge provisions and that’s where the Barnes lose their case with respect to the tax.

The chapter 11 plan, silent as to 2003, was confirmed.  The Tax Court says the automatic stay remained in place while the debtors made their plan payments.  In November 2011, the IRS filed a motion to lift the stay to allow the Tax Court case to move forward, which the bankruptcy court granted.  On April 2, 2012, the Tax Court entered its opinion.  Although the Barnes appealed the Tax Court opinion to the D.C. Circuit, they, like 99.9% of Tax Court petitioners who appeal, did not post a bond to stay assessment.  The IRS assessed on August 1, 2012.  The IRS eventually filed a notice of federal tax lien which allowed the Barnes to make a collection due process (CDP) request, which eventually led to the second Tax Court opinion regarding 2003 – this one only 18 years after the tax year, though the delay was not due to the Tax Court, which had acted reasonably expeditiously in both cases.

The Barnes’ first argument in the CDP case was that the 10-year statute of limitations on collection had ended before the IRS filed the notice of federal tax lien.  This argument makes absolutely no sense given that the assessment date for the 2003 liability is in 2012.  The Tax Court was gracious in noting that the collection statute remained open.

Next, the Barnes made another argument that made no sense – that the 2003 liability was discharged by the bankruptcy case.  Again, the Tax Court graciously pointed out that the liability was entitled to priority because it was not yet assessed but still assessable at the time of the bankruptcy petition.  Since they were represented, I am surprised by both arguments.

The Barnes requested an offer in compromise, but the IRS determined they had the ability to fully pay the debt.  Since they did not agree with that determination or did not want to pay the debt in full, the IRS determined the filing of the notice of federal tax lien was valid and the lien did not need to be released or withdrawn.  The Tax Court sustained this determination by ruling for the IRS in response to a motion for summary judgment.

Tax and penalty liability do not travel on the same discharge path in BC 523.  The penalty for late filing and the penalty for accuracy were discharged because they are governed by BC 523(a)(7) rather than 523(a)(1).  The provision for penalties essentially allows their discharge if three years has passed from the due date of the return at the time of the bankruptcy filing.  The Tax Court notes that these two penalties were discharged.  The interest on the penalties would likewise be discharged just as the interest in the tax would not.

Note that if the Barnes had owed taxes based on their return and not their deficiency case, the taxes owed which were shown on their return would have been discharged subject to an argument regarding the one-day rule, which the IRS would not raise and which the D.C. Circuit has not decided.  It’s possible for a taxpayer having liabilities that arise at different points in time to achieve different discharge results based on the timing of the liability vis a vis the timing of the filing of the bankruptcy petition.

If you have not read one of the many posts regarding the one-day rule, you can read one here which links to others.  The late filing of the 2003 return could itself have posed a basis for losing the ability to discharge any taxes due on 2003 had they filed bankruptcy in the 1st, 5th or 10th Circuits.  No one raised that argument in this case, and I mention it just because there was a late filing penalty assessed.

Tolling the Statute of Limitations by Filing Bankruptcy

The case of Lufkin v. Commissioner, T.C. Memo 2021-71, puts the Tax Court in a position to rule on the impact of filing bankruptcy on the statute of limitations.  The taxpayers raise arguments not only regarding the collection statute of limitations but also the validity of the underlying assessment, which gives me the opportunity to discuss the impact of bankruptcy on the collection statute, which is significant, and on assessment, which after 1994 is rather small.  Bryan Camp wrote about the case as part of his Lessons from the Tax Court series which alerted me to the decision.  He provides some general background on bankruptcy which may also be helpful.

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The important IRC sections when working out these statute of limitations issues are (1) §6501(a) which provides the general three year time period for assessment after the return filing date; (2) §6502(a) which provides the general rule that the IRS has 10 years to collect after assessment: and (3) §6503(h) which “suspend[s] [the period of limitations] for the period during which the Secretary is prohibited by reason of such case [a bankruptcy case and the automatic stay] from making the assessment or from collecting and—(1) for assessment, 60 days thereafter, and (2) for collection, 6 months thereafter.” 

Assessment

Before 1994, the tolling in 6503(h) created a significant issue.  BC 362(a)(6) prohibits assessment during the period that the automatic stay is in effect.  A literal reading of this provision prohibits the IRS from assessing a self-reported tax on a return which would also prohibit the IRS from issuing refunds to debtors in bankruptcy while the automatic stay remained in effect.  This could prevent a debtor in a chapter 13 case from receiving a refund for five years absent a court order lifting the stay.  The language of BC 362(a)(6) provides an example of legislation that fails to consider the functional role of assessment.

For the 16 years from the passage of the Bankruptcy Code in 1978 until the change to 362(b) in 1994, the IRS arguably violated the automatic stay millions of times because it decided that Congress could not have intended to keep it from assessing returns where an overpayment existed.  So, it made the assessment of tax shown on the return and refunded to the taxpayer the overpayment resulting from the excess credits.  After almost two decades, the IRS, with significant assistance from the Tax Division of the Department of Justice, which had contacts in the Judiciary Committee, persuaded Congress to allow it to assess.  Congress did not, however, remove the restriction on assessment from 362(a)(6).  It still exists.  Instead, it neutered it by expanding the exception to the stay in 362(b)(9).

There exists one remaining area in which bankruptcy can suspend the statute of limitations on assessment.  It results from BC 362(a)(8), which prohibits taxpayers from commencing or continuing a Tax Court proceeding while the stay is in effect.  This provision can suspend the statute of limitations on assessment if the taxpayer has received a notice of deficiency and files a bankruptcy petition prior to the 90th day and prior to filing a Tax Court petition.  In this situation, the combination of the prohibition on filing the Tax Court petition, which suspends the 90-day period for timely filing a Tax Court petition, and the suspension of the statute of limitations on assessment caused by the notice of deficiency suspends the statute of limitations on assessment.  The suspension could be lengthy.  This suspension can also easily cause confusion since it operates through the intermediary of the notice of deficiency suspension.

For bankruptcy petitions filed after October 20, 1994, when the amendments to the bankruptcy statute occurred, the only way the automatic stay suspends the statute of limitations on assessment is through this two-step procedure triggered by the notice of deficiency.

Collection

The suspension of the statute of limitations on collection operates in a much more straightforward manner.  BC 362(a)(6) stays collection of pre-petition liabilities as well as assessment.  This prohibition on collection triggers the suspension of the statute of limitations on collection and lasts for the period during which the automatic stay exists plus, pursuant to IRC 6503(h), an additional six months.  To calculate the impact of the stay on collection, you must know when the stay begins and when it ends.  The beginning part is easy.  The stay begins the moment the debtor files the bankruptcy petition.  The ending of the stay creates more challenges.  It depends on the type of bankruptcy.  Generally, the stay will come to an end when the debtor receives a discharge or when the bankruptcy case comes to an end.  This could be several years in a chapter 13 case with a five-year plan.  Some debtors, like the Lufkins, file multiple bankruptcy cases, which can make the calculation trickier.

Before getting to the facts of the case, note that the docket here was interesting and different from the typical pro se case.  This was Mr. Lufkin’s second Tax Court CDP case.  He filed one in 2013 which he settled on a basis not available to see on the electronic Tax Court docket sheet.  He filed the current case in 2017.  In both cases, he took the offensive, filing his own motions for summary judgment and for other reasons.  Unlike his first case, which resulted in a settlement of some type, in this case, he went to trial.  The trial occurred before Judge Ruwe in June of 2019; however, Judge Ruwe retired in November 2020 before rendering an opinion.  So, the case was reassigned to Judge Greaves.

The taxes at issue in this case were employment taxes filed on Form 941.  Mr. Lufkin is a lawyer and the taxes arose from his law practice for the third and fourth quarters of 1998.  With taxes that old, which were assessed in 1998 and 1999, it’s easy to understand why Mr. Lufkin would argue that the statute of limitations had expired.  He also argued that he was not liable for these taxes.

Applying the assessment and collection statute suspensions to the Lufkin’s facts, Judge Greaves found that because Mr. Lufkin filed multiple bankruptcy petitions between 2000 and 2011, the statute of limitations on collection was suspended for a sufficiently long period to allow it to remain open when the IRS issued the notice of intent to levy.  Since Mr. Lufkin responded to that notice by requesting a Collection Due Process (CDP) hearing, he further suspended the statute of limitations on collection.

Mr. Lufkin made two arguments in the CDP hearing.  First, he argued that he was not liable for the taxes because another entity had assumed the debt.  The court does not spend much time with this argument and it shouldn’t.  Even if another entity assumed the debt, it would not relieve Mr. Lufkin of his liability for the debt.  Since he offered no evidence on this issue, the decision was easy.  It’s worth noting that the court did allow him to raise the merits of his employment tax liability since it would have been assessed without the issuance of a notice of deficiency.  The court did not perform any analysis regarding his ability to raise the merits.  So, I assume that the IRS did not object to the procedural issue of his raising this debt.

With respect to the statute of limitations argument, the court notes that its precedent regarding review of this type of challenge is ambiguous.  This might be considered a merits challenge in which the court would review the evidence de novo or it might be considered something the court reviews on an abuse of discretion standard.  Because the court finds it does not matter here which standard applies, it does not stop to sort out the correct answer.

The court does not perform an analysis of the impact of each of Mr. Lufkin’s bankruptcy petitions during the 11-year period between the assessment and the notice of intent to levy but states “even under a conservative calculation, more than 10 years had not elapsed” on the statute.  Probably, the IRS brief performed the analysis based on each bankruptcy petition.  It’s easy to believe that the court was correct if there were multiple petitions and this is one downside of going into bankruptcy repeatedly, since each filing triggers, at a minimum, a six-month extension of the statute of limitations on collection, even if the stay in bankruptcy is quite short.

In addition to challenging the statute of limitations, Mr. Lufkin challenged the verification by Appeals.  He argued that they had destroyed records regarding the assessment and this “amounted to a violation of procedural due process under the Thirteenth Amendment to the Constitution.”  For those of you who specialize in tax and not constitutional law, the Thirteenth Amendment abolished slavery and involuntary servitude.  It will not surprise you to learn that this argument failed with the court, which stated that Mr. Lufkin had failed to establish a nexus between the Thirteenth Amendment and his tax case.

As Bryan mentions in his post, the primary lesson here regards the impact of filing bankruptcy petitions on the statute of limitations.  Several actions can suspend the statute of limitations on collection.  I wrote recently that the IRS is having trouble correctly calculating the statute of limitations on collection primarily related to installment agreements.  Here, the IRS has plenty of cushion and easily turns back an argument based on the limitations period.

IRS Whiff on Timeliness of Refund Claim Prevents Payment of Refund If Taxpayer Fails to File Suit Within Two Years

What happens if a taxpayer timely files a refund claim, IRS denies the claim because it mistakenly believes that the claim is untimely and the taxpayer fails to files a refund suit within two years? To top it off, IRS, outside the two-year window for filing suit, realizes that it made an initial mistake in rejecting the claim on SOL grounds?

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A recent email released as Chief Counsel Advice describes this scenario. As the email notes, that the IRS later acknowledges the claim as timely does not grant the IRS the power to reconsider its earlier denial if the two year period for filing suit in federal court has passed. 

A quick statutory background on refunds. As to filing a suit, Section 7422 authorizes a suit for refund for taxpayers who believe they have overpaid taxes (or are entitled to an excess of refundable credits). Section 7422 authorizes such a suit only once the taxpayer has submitted an administrative claim for refund with the Service. Section 6532 prevents suits 1) until at least six months have passed after filing the claim (unless there is an earlier denial) or 2)  “after the expiration of 2 years from the date of mailing by certified mail or registered mail by the Secretary to the taxpayer of a notice of the disallowance of the part of the claim to which the suit or proceeding relates.”

The email/advice does not provide the underlying facts but as many readers (and my suffering procedure students learn) is that the 6511(a) and 6511(b) SOL refund rules and limitations on amount can be tough.  The email flags that the timeliness of the claim issue in question relates to Section 7503, which provides rules for when the last day for performing an act falls on a weekend or holiday.  The advice acknowledges that the  refund claim was in fact timely when taking into account Section 7503.

As the advice notes, if a taxpayer has not in fact filed suit, under Section 6514(a)(2) a refund issued after the two-year period in 6532 is considered erroneous. As such, the taxpayer is out of luck unless there was some procedural defect with the IRS’s denial of the refund, such as a failure to be sent to the proper address or a failure to send by certified or registered email. 

What would happen if the IRS had issued the refund after the two-year period had lapsed?  Then the payment would be an erroneous refund, allowing the IRS to recover under erroneous refund procedures, leading to yet another complex set of rules that delight tax professors and annoy students and taxpayers alike.

The situation highlights the at times unfairness of the SOL rules. Whether the time period for an action is jurisdictional or generally subject to equitable exceptions is a topic we have discussed frequently. Bryan Camp has thoroughly discussed these issues in a recent Tax Lawyer article where he explores why he believes the refund suit rules in Section 7422 and Section 6532 are not jurisdictional.  To that end see also a PT post from Carl Smith discussing a district court case from the ED of Washington where the court equitably tolled the 6532(a) filing deadline, citing the Volpicelli case from the 9th Cir. holding that the 6532(c) wrongful levy suit filing deadline is not jurisdictional and is subject to equitable tolling. The brief CCA does not go down this rabbit hole, but I note that IRS does not accept Volpicelli, and this topic is one courts will continue to address.

Additional OIC Comments Not Specifically Related to the Mason Case

When Bryan was writing his post, we had an exchange about OICs.  Some of the comments I provided to him I might have provided in posts over the years, but I will state them here in case we have new readers or old readers with memories like mine.  Most of these comments relate to the history of OIC provisions or the IRS administration of the OIC.

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The Current OIC Program

Although Congress authorized the IRS to compromise collection cases in the 1860s, the IRS very rarely did so.  In Virginia when I started working in Chief Counsel’s office in 1980, one RO in the state was assigned to work offers.  He would travel the state working the offers and reject every offer after careful consideration.  I think what was happening in Virginia was happening across the US.  Then in 1990, Congress extended the statute of limitations on collection from 6 to 10 years.  I was working in the National Office at the time in the group of attorneys specializing in collection matters.  I watched firsthand the reaction to the change in the statute of limitations, which came as a surprise to the IRS.

The extension from 6 to 10 years was an idea that Congress had to collect more money without having to say they raised taxes.  They could score this as something which would bring in dollars and use that score to reduce taxes elsewhere or spend more money and have it look as though the event was revenue-neutral.  We see the same discussion today as Congress debates whether to give the IRS more money so it can collect billions of additional dollars.  While I think the IRS could use more money, the amount it will collect as a result of receiving more money is tricky to predict.

When Congress changed the statute of limitations on collection in 1990, it did not consult with Treasury or the IRS.  Had they been consulted, Congress would have learned that the IRS collects very little money after the first two years.  The bill got passed at a time when Congress, and therefore the IRS, was very concerned with the Accounts Receivable due to the IRS and was asking lots of questions about how the IRS could reduce the ARDI (I can’t remember all of the acronym.)  The IRS even had an executive whose only job was to reduce accounts receivable. 

The IRS knew that the extended statute of limitations was going to cause the ARDI to balloon because of the uncollectable accounts that were going to stay on the books four years longer.  So, it started casting about looking for fresh ideas to reduce it and one of them was to actually accept offers instead of rejecting them.  It was the wild west for the first few years as the IRS tried to get its policy completely lined up.  In the mid-1990s an excellent attorney, now an IRS executive, Carol Campbell, created the income and expense guidelines as well as the exempt asset guidelines based on IRC 6334.  In 1998, Congress came behind and codified some of the things going on, including requiring the IRS to have income and expense guidelines which it had already created.  So, the current OIC program is less than 30 years old and resulted not from a change in the statute but from a change in administration because Congress gives the IRS almost complete discretion in OICs.

OICs for Low-Income Taxpayers

One of the few restrictions placed upon the IRS as the IRS codified additional OIC provisions in 1998 was the requirement that it not reject OICs simply because the taxpayer did not offer some minimum amount.  This restriction is located in IRC 7122(c)(3).  You can give credit for that code section primarily to Nina Olson and partially to me.  Nina had a Tax Court case with my office back when she directed the Community Tax Law Project in Richmond, Virginia.  The IRS had determined that the taxpayer owed a lot of money.  The case had a messy factual background that was going to require a lengthy and difficult trial. 

If the IRS won, it was unlikely to collect anything from the taxpayer, whose business had ended and who had spent time in prison.  I suggested that, instead of a trial, she concede the liability and we compromise the debt.  Nina liked the idea, but we fought over the compromise because I wanted a minimum amount to make the effort worthwhile.  Subsequent to the case but not long thereafter, Nina was asked to testify before Congress.  In her testimony to Congress leading up to the 1998 changes, she convinced Congress that requiring a minimum amount to compromise the debt of a low-income taxpayer was wrong.  Her testimony resulted in the passage of IRC 7122(c)(3), for which I claim partial credit since I was the person at the IRS who “inspired” her testimony.

OIC Stats

For those who can peek behind the paywall, David Van Den Berg recently wrote an article for Law 360 building on the current National Taxpayer Advocate’s comments regarding OICs in the mid-year report.  In her report, she provides stats on the declining number of OICs over the past decade. According to the NTA, fiscal year 2020 marked the seventh consecutive year of decline in OIC receipts, and total OIC receipts for FY 2020 were the lowest they had been since 2008.  She states that TAS is looking for ways to increase the number of successful OICs.  Unemployment is a big driver of receipts.  Perhaps the unemployment situation caused by the pandemic will cause many more OICs. 

In his article, David mentions that the IRS is considering investing in robotics and exploring digitization of the OIC forms as well as creating an ability to submit the OIC online.  I mentioned to him when he contacted me about the article that I would like to see the IRS articulate its goals for the OIC program as part of deciding whether it has too many or too few OICs.  It started the modern program over 30 years ago as a reaction to a surprise change in the statute.  It started the program to reduce accounts receivable rather than to necessarily benefit collection or benefit taxpayers as a whole.  With a tightly crafted goal for the program, it would be easier to determine if it was meeting the goal for accepting offers rather than just saying a goal exists to increase the number of offers.