Be Careful What You Ask For

In Showalter v Commissioner, T.C. Memo 2022-114, the pro se petitioner went to the Tax Court to contest the deficiency resulting from the IRS preparing a substitute return (SFR) following his failure to fulfill his return filing obligation.  He found out that going to Tax Court is not a one way street when the Chief Counsel attorneys uncovered income the IRS had not found in computing his tax liability using the substitute for return procedures.

I end the post with a suggestion for taxpayers like Mr. Showalter to reduce his exposure but also for a suggestion regarding the penalty regime for taxpayers who force the IRS into preparing an SFR.


I don’t know the statistics on how many people fail to file returns each year who should.  The number is huge.  My sympathy for this group of individuals is low.  They put a lot of pressure on the tax system.  Some have a good excuse for not filing, at least for one year, but many lack what I consider to be a good excuse.

The failure to file causes the IRS, in many instances, to prepare a return for the non-compliant taxpayer using the substitute for return procedures set out in IRC 6020.  My experience is that most of the time the IRS prepares returns under this procedure it overstates the taxpayer’s liability because it does not make elections the taxpayer might make in order to reduce the liability; however, the IRS also misses income when it uses this system to prepare a return because it relies exclusively on third party reporting information which will not always capture all of a taxpayer’s income.

Because the IRS needs some form of taxpayer or statutory consent in order to assess, it ends up sending a notice of deficiency (SNOD) to taxpayers who do not agree with its calculation of income in the substitute for return process.  Taxpayers who engage with the IRS in this process can usually file their own return during the process or provide deduction information to the IRS to reduce tax computed by the IRS.  Taxpayers who do not engage in the process need to file a petition in Tax Court or use audit reconsideration at a later point in order to reduce the amount computed by the IRS.

Mr. Showalter appears not to have engaged with the IRS during the process of its preparation of the SFR but the Court does not explicitly say that and I may be drawing an incorrect inference.  He did, however, respond to the SNOD by filing a timely petition with the Tax Court.  He contended that the IRS overstated his income by failing to allow him certain business deductions.  In the Tax Court case he worked with the IRS to determine his business expenses and Schedule A deduction.  In the course of determining his expenses, the parties gathered bank records the IRS would not have reviewed in preparing the SFR.  Those records showed that the SNOD understated his income by $102,885.

The IRS sought summary judgment on this additional amount.  The Court goes through the requirements for obtaining summary judgment relief noting that the petitioner failed to respond to the Motion for Partial Summary Judgment and that it could have granted the motion on that basis alone.  The Court, however, decides to put the IRS through its paces even though the Petitioner did not engage with this process.

First, the Court notes that the IRS has the burden of proof on this additional amount of income because it was not included in the SNOD.  To do so it must establish a “minimal evidentiary showing” connecting the taxpayer and the income producing activity.  The Court finds that the bank account records attached to the motion accomplish this purpose.

Here, the IRS used the bank deposits method to establish the additional income.  The IRS needs to show that funds deposited into a taxpayer’s bank account are income and not non-taxable amounts.  The Petitioner had raised a concern about some of the money deposited into the account and the IRS addressed that concern.  Based on the information before it, the Court granted the IRS motion sustaining the determination that Petitioner had the additional income alleged by the IRS.

At the conclusion the Court orders a Rule 155 computation.  Based on the business and personal deductions allowed, the Petitioner in this case may end up with a reduced liability from the amount in the SNOD even with the inclusion of an additional $100,000+ of income.  So, the decision to go to Tax Court in this case may provide the taxpayer with a net benefit.

The case, however, points out that going to Tax Court opens the door for the IRS to allege additional liabilities and does not just provide the taxpayer with the opportunity to reduce the amount initially determined by the IRS.  Each taxpayer making the decision to go to Tax Court needs to carefully consider the downside of the petition as well as the upside.  A taxpayer in Mr. Showalter’s position may have obtained a more favorable result, though not a more correct result, by seeking audit reconsideration rather than petitioning the Tax Court. 

Suggestion for Taxpayers with exposure not reflected in the SNOD

Audit reconsideration involves asking the IRS to look at an assessed liability to abate it because the IRS assessed too much after an audit.  The provision is described in IRM 4.13.1.  We have mentioned the process in many prior blog posts, but I could not find one explicitly addressing the process.  I have mostly written about it in the context of prior opportunity in Collection Due Process cases.  A taxpayer seeking audit reconsideration goes into a black hole by sending in the request because the IRS does not acknowledge receipt.  The process can take months or, in pandemic time, more than one year.  The case goes back to the source asking the office that originated the assessment process to consider new evidence the taxpayer failed to present during the audit and, on the basis of that new information, reduce or eliminate the tax assessment.  This is an entirely administrative process with administrative appeal rights but no right to judicial review.  Yet, the IRS is generous with its time by giving assessments a second look even though it is not required to do so and even though I wish it was more communicative in the process.

Audit reconsideration sends the case back to auditors and not into the hands of attorneys.  The chances that the auditors would pick up on the additional income using a bank deposits method are low.  The individuals looking at the audit reconsideration request are much more likely to focus on the basis for the request than the whole picture.  While audit reconsideration does not bring the same safeguards as judicial review, it also does not bring the same scrutiny.  Someone in Mr. Showalter’s position might have achieved a net benefit from going the audit reconsideration route rather than exposing himself to having additional income found. 

Suggestion for Penalizing Taxpayers Who Force the IRS to Prepare SFRs

As a taxpayer who wants others to pay their rightful amount of tax, I am glad Mr. Showalter went to Tax Court and glad that the Chief Counsel attorneys found the additional income that the IRS did not pick up during the SFR stage.  Trying to get someone’s income right through the SFR process puts a lot of pressure on the IRS as well as a lot of additional costs on the system that is unnecessary if people comply with their return filing obligations.  I would put more of a late filing penalty on non-filers who force the IRS to go this route and be more generous to late filers with a good excuse.  Our current one size fits all penalty probably doesn’t capture the true cost of the taxpayers who force the IRS into the SFR process and is not always generous enough to taxpayers who miss the filing deadline for an excusable reason.  Maybe the IRS has data on its costs of chasing after people who do not comply.  That information would be useful in determining if my suggestion is a reasonable one.

Lesson From The Tax Court: Don’t Confuse Dummy Returns With Substitutes For Returns

We welcome back Professor Bryan Camp, the George Mahon Professor of Law at Texas Tech School of Law, who offers guidance on the §6020 SFR process and the §6212 deficiency process. Every Monday, Professor Camp publishes posts like this one in his “Lesson From The Tax Court” series on the TaxProf blog. This post is a cross post that originally appeared on the TaxProf blog on October 3rd.

The act of filing a return is central to tax administration. Section 6011 sets out the general requirement: “any person made liable for any tax imposed by this title” must file a return “according to the forms and regulations prescribed by the Secretary.”  Section 6012 gets more granular and gives more specific requirements and exemptions from filing.

When a taxpayer fails to file a return, even after being reminded to do so, the IRS can simply send the taxpayer a Notice of Deficiency (NOD), and let the taxpayer either agree to the proposed tax liability or petition Tax Court.  Or the IRS can follow the §6020 Substitute For Return (SFR) process whereby it creates a return for the taxpayer either with or without the taxpayer’s cooperation.

Regardless of how the IRS deals with the non-filer, an IRS employee first needs to create an account in the computer system for the relevant tax period.  They do that by inputting the proper Transaction Code and preparing what is called a “dummy return” to support it.  But there is one important difference between dummy returns used to set up the NOD process and dummy returns used to set up the SFR process: the §6651(a)(2) failure to pay penalties only apply to the failure to pay taxes shown on a “return.”  Thus, the penalties do not apply to bare NODs.  They do apply to SFRs.  That’s why today’s lesson is useful.

In William T. Ashford v. Commissioner, T.C. Memo. 2022-101 (Sept. 29, 2022) (Judge Vasquez), we learn what to look for in the IRS files to see whether a dummy return used by the IRS leads to a proper SFR or not.  We also learn why you cannot always trust the advice you see on the IRS website.  Details below the fold.

read more…

The IRS has a choice of two ways to proceed when it determines a taxpayer has failed to file a required return: the §6020 SFR process or the §6212 deficiency process.  Let’s take a quick look at both.

    A.  The §6020 SFR Process

Section 6020 has two subsections.  Section 6020(a) permits the IRS to prepare the taxpayer’s return with the cooperation of the taxpayer.  I call that the friendly SFR because that return will be treated as the return of the taxpayer for all purposes.  For example, it starts the §6501 assessment limitation period.  It counts as triggering the various bankruptcy discharge clocks. 11 U.S.C. §523(a) (flush language).  It means the taxpayer cannot be tagged as a non-filer.  That’s not really on the plate for today’s lesson, although the difference between what constitutes a 6020(a) and 6020(b) SFR is very interesting and not entirely intuitive.  See Bryan T. Camp, “The Never-Ending Battle,” 111 Tax Notes 373 (Apr. 17, 2006).

Section 6020(b) is the unfriendly SFR.  It provides that when the taxpayer does not cooperate, the IRS is authorized to “make such return from [its] own knowledge and from such information as [it] can obtain through testimony or otherwise.”  Unlike §6020(a), §6020(b) SFRs are not always treated as returns of the taxpayer.  Generally, it’s a heads-I-win, tails-you-lose proposition.

On the one hand, for example, almost all courts refuse to construe a §6020(b) SFR as the taxpayer’s return when to do so would permit the taxpayer to discharge of a tax liability in bankruptcy.  See generally Ken Weil’s excellent post on the exception that proves the rule: “Rare Discharge in Bankruptcy for Taxpayers with a Return Filed After an SFR Assessment,” Procedurally Taxing Blog (May 22, 2022).

On the other hand, §6651(g) provides that such a return will count as the return of the taxpayer for purposes of computing the §6651(a)(2) penalty for failure to pay the tax owed. That’s an important point for today’s lesson.  Until 1996, a §6020(b) SFR was not deemed to be a “return” within the meaning of §6651(a)(2).  See generally Rev. Rul. 76-562, 1976-2 C.B. 430.  That is because §6651(a)(2) imposes the failure to pay penalty only as to what is “shown as tax on any return.” Before 1996, both courts and the IRS interpreted that to mean the return of the taxpayer.  That perverse situation rewarded obstreperous taxpayers and penalized cooperative ones.  Congress fixed the problem (at the urging of the IRS and Treasury) by adding §6651(g).  Section 6651(g) now properly aligns the consequences with the behavior.

Construing a §6020(b) SFR against a taxpayer this way makes sense, if you view it as a result of taxpayer noncompliance with the §6011 filing duty.  To treat it the same as voluntary returns would undermine compliance.  That is what happened before 1996 as to the §6651(a)(2) failure to pay penalties.  But it is not always clear that a 6020(b) SFR results from bad-acting taxpayers, because the process is almost entirely automated and relies upon taxpayers responding to automated notices.  As we all know, a notice properly sent is not always actually received.  A taxpayer’s failure to respond thus may or may not be due to bad faith.

The §6020(b) SFR process is pretty much run by computers with minimal human oversight in a system called the Automated Substitute for Return (ASFR) process.  See generally IRM 5.18.1 (Automated Substitute for Return (ASFR) Program)(March 11, 2020).  The ASFR draws from the Information Return Program (IRP) where the IRS collects and stores everything received on third party information returns such as W-2s and 1099’s.  The ASFR creates an SFR package and sends it to the taxpayer’s last known address giving the taxpayer 30 days to respond.  The 30-Day Letter package is fully automated.  See generally, IRM, Letter 2566. If the taxpayer makes no response, the computers then generate an NOD, giving the taxpayer the usual time to petition Tax Court.  For a more complete description of the ASFR process, see TIGTA Report 2017-30-078, “A Significantly Reduced Automated Substitute for Return Program Negatively Affected Collection and Filing Compliance,” (Sept. 29, 2017). 

Note too that the traditional TC 150 used to open a Tax Module using a dummy return seems to have now been changed to TC 971 with Action Code (AC) 143.  Whenever you see a TC 971 on a transcript you have no idea what it means unless you look carefully at the associated AC because the TC 971 is the Swiss Army knife of transactions codes: it’s used for a wide variety of situations unanticipated when the Automated Data Processing system was first constructed long, long, long ago.

Back to the SFR.  If the IRS chooses to use the SFR process, it thus needs to be sure to create an SFR.  Otherwise, the NOD it sends out will not be treated as resulting from an SFR but will instead be treated as arising from the second way the IRS can deal with non-filers.  Let’s take a look at that first before we get to the lesson on how to tell whether the IRS has created an SFR.

    B. The Deficiency Process

From 1862 to 1924, the SFR process was the only way for the IRS to deal with non-filers.  And once it prepared the SFR it could immediately assess the tax.  There was no deficiency process.  See e.g. Revenue Act of 1913, 38 Stat. 114, at 178 (mandating immediate assessment).

The Revenue Act of 1924, 43 Stat. 253, 296 created the deficiency procedures now codified in §6211 et. seq.  That worked a profound change in tax administration.  While the law had long allowed taxpayers who disagreed with proposed increases to tax a right to conferences within the IRS, the 1924 Act now forbade the IRS from assessing an income, estate or gift tax against a non-consenting taxpayer until after the taxpayer had the chance for pre-payment review by an independent quasi-judicial body.  That body started out as the Board of Tax Appeals (BTA) and morphed over time to its current status as the Tax Court.

In the early days the IRS tried to argue that it did not have to use the deficiency procedures to assess the tax it created on a §6020(b) SFR, but the BTA quickly rejected that position. See Taylor v. Commissioner, 36 B.T.A. 427 (1937) (requiring IRS to follow deficiency procedures when it had prepared return without consent or cooperation of the taxpayer).

Thus the IRS must issue an NOD even after it creates an SFR.  But it does not have to create an SFR in order to issue an NOD to a non-filer.  Courts have long rejected taxpayer arguments that the IRS was limited to the SFR process and that an NOD was invalid against a non-filer unless the IRS’s first prepared an SFR.  See United States v. Harrison, 72-2 USTC ¶ 9573 (S.D.N.Y. 1972)(I cannot find free link, but Judge Weinstein gives an excellent discussion of legislative history); see also Hartman v. Commissioner, 65 T.C. 542, 545 (1975)(taxpayer’s failure to file a return and IRS decision not to prepare a substitute for the return under §6020 did not invalidate the NOD).

So the IRS can choose how to address a non-filer.  However, even though the IRS has the option to forgo the SFR process, it generally chooses the SFR route, for several reasons.  First, perhaps most importantly, encouraging and helping taxpayers prepare and file their own returns has long been recognized as an important part of the IRS mission.  It makes sense administratively to use upstream resources to get as many taxpayers into compliance as possible before using downstream resources for enforced collection.  See e.g. Policy Statement P-5-133, IRM (08-04-2006).  Before a taxpayer’s account goes into the ASFR program, the IRS will have sent the taxpayer at least two “soft” notices asking the taxpayer to file.  Again, however, that sending does not ensure actual receipt.

Second, preparing a §6020(b) return betters serves compliance purposes because §6020(b) SFRs now trigger the §6651(a)(2) addition to tax for failure to pay the amount shown on the “return.”  No such addition can be proposed if the IRS simply sends an NOD.

Finally, a §6020(b) SFR will almost always preclude the taxpayer from obtaining a discharge of the taxes in bankruptcy. See e.g. In Re: Payne, 431 F.3d 1055 (7th Cir. 2005), and cases cited therein.

In contrast to the SFR, if the IRS just sends out an NOD, the well-advised non-filer will promptly file returns to minimize penalties, set up a potential bankruptcy discharge, and start the §6501 limitations period running.  I’m not saying that will always work, but the taxpayer certainly has a better shot than if the IRS has sent the NOD based on a §6020(b) SFR. See e.g. Mendes v. Commissioner, 121 T.C. 308 (2003) (Form 1040 reporting zero tax liability filed 48 months after receiving a notice of deficiency and 22 months after Tax Court petition was not a valid for §6654(d)(1)(B) safe harbor purposes).

    C. The Dummy Return Problem: How To Tell Which Process The IRS Is Using?

So how do you tell whether the NOD being issued is based on an SFR or just a bare NOD?  After all, both processes result in an NOD.  And yet they have some very different consequences for taxpayers.

Part of the problem is that the IRS initiates both the 6020(b) process and the notice of deficiency process the same way:  it opens what is called a Tax Module on the computer system in order to process documents and track the work done.  Because of various and ancient computer design decisions dating back to the 1950’s, the IRS employee who creates a Tax Module needs a return to do so.  If there is no taxpayer-prepared Form 1040 to use (for income taxes), the employee will use what is basically a fake 1040 to support opening the module.  That fake form is often called a “dummy return.” In the ASFR program, the Tax Module often opens before the IRS pulls enough information from third parties together to come up with a proposed tax liability.

But while that dummy return helps create the Tax Module it cannot, in and of itself, create an SFR.  The Tax Court has held that dummy returns do not serve as a §6020(b) return.  They need something more.  Only when the IRS also creates records which support an assessment, properly associates those documents contemporaneously, and some authorized IRS employees signs off on the package will the dummy return caterpillar transform into a beautiful §6020(b) butterfly.  Millsap v. Commissioner, 91 T.C.  926 (1988).  For example, in Cabirac v. Commissioner, 120 T.C. 163 (2003), the Court denied the §6651(a)(2) failure to pay penalties because it decided that while the revenue agent’s report dated May 31, 2000, “contained sufficient information from which to calculate petitioner’s tax liability” it was not sufficiently contemporaneous with the dummy return used to open the Tax Module on February 23, 2000.

For years there was litigation over whether and when the IRS had properly created an SFR.  In 2008 Treasury issued final regulations to try and create more certainty.  See 73 Fed. Register 9188.  As you might expect, the regulations make it pretty easy for the IRS.  For example, while the regulations say that the SFR must be “signed” by an authorized official, they are very generous on what meets that requirement, providing that an SFR “may be signed by the name or title of an Internal Revenue Officer or employee being handwritten, stamped, typed, printed or otherwise mechanically affixed to the return” and that the “signature may be in written or electronic form.”  Treas. Reg. 301.6020-1(b)(2) (emphasis supplied).

The regulations also give the IRS flexibility as to what documents to associate together in a package, but what the regulations also require is some form to forge the documents together into an SFR.  Typically, the IRS will associate a Revenue Agent’s Report (often on a Form 886 series), and a Form 4549.  But it seems that the key document to look for is “Form 13496, IRC Section 6020(b) Certification.” That Form is what forges all those other documents into an SFR. See e.g. IRM (07-08-2021)(“All SFRs having tax adjustments that follow deficiency procedures with the failure to pay (FTP) penalty applied under IRC 6651(g) must have a Form 13496, IRC Section 6020(b) Certification, completed.”).  See generally IRM (01-05-2010) (Form 13496 Certification Procedures).  In fact, I would not be surprised if that Form—mentioned specifically in the regulation—becomes the bright-line test for the proper creation of an SFR, even though the regulation generously says it is not the exclusive form the IRS must use.

Facts and Lesson

The tax years at issue are 2013 and 2014.  In those years Mr. Ashford received self-employment income for services provided to Aviation Managed Solutions, earning just about $90,000 in 2013 and $100,000 in 2014.  Although he had filed returns for prior years, it appears that at some point in 2013 Mr. Ashford unintelligently came to believe that he was not required to file returns or pay taxes.

Eventually the IRS caught the error—likely through IRP—and sent NODs to Mr. Ashford in 2018.  The NODs asserted taxes and failure to file penalties, and also asserted the §6651(a)(2) failure to pay penalty.  Mr. Ashford petitioned Tax Court arguing, in part, that the NODs were not based on proper SFRs because the IRS had used dummy returns to open the Tax Module.  He argued that the use of dummy returns resulted in no SFRs and that, in turn, invalidated both the asserted deficiencies and the asserted penalties.

As to the deficiencies, Judge Vasquez explains that the mere use of a dummy return does not affect the validity of the proposed deficiencies.  Op. at 6. That is because the IRS has a choice in how to proceed against non-filers.  It can issue its NOD based either on an SFR it prepares or simply on the basis of an examination.

As to the §6651(a)(2) penalties, however, is does matter whether the NOD was based on an SFR.  Again, however, the use of dummy returns is irrelevant.  Here, Judge Vasquez explains that the NODs in this case were indeed based on an SFR and recites how each one contained the magic Form 13496.  Op. at footnote 9.

Bottom line: The IRS had properly transformed the dummy returns to create §6020(b) SFRs.

Comment:  Misleading IRS Website?  I am not clear on what soft Notices or Letters the IRS uses to ask for unfiled returns before it sends out a 6020(b) SFR package.  It appears that if you or your client gets the CP2566, then you must really be careful to prevent an unfriendly SFR.  The CP2566 is the 30-day letter sent out by the ASFR, as part of the 6020(b) SFR package.  And the IRS takes the position that once a taxpayer is presented with that package, the taxpayer is helpless to prevent a 6020(b) SFR if the taxpayer simply signs the accompanying Form 4549.  In a reversal of prior rulings, the IRS now says the taxpayer’s consent to the proposed deficiencies on Form 4549 does not result in a 6020(a) SFR.  See Rev. Rul. 2005-59.  For details and critiques on why this is one of the most inane Rev. Rules ever, see Bryan Camp, “The Function of Forms in the Substitute-for-Return Process,” 111 Tax Notes 1511 (June 26, 2006).  But there it is.  As best I can tell, it’s only been discussed by one court, a bankruptcy court in Texas in 2017, where the debtor had many other problems.

But the IRS website ignores the Rev. Rule!  It thus gives bad advice to taxpayers.  It says that taxpayers who receive the CP2566 can either “File your tax return immediately” or “Accept our proposed assessment by signing and returning the Response Form.”  Well, gosh, that’s pretty misleading if signing the forms included in the CP2566 create a §6020(b) SFR!  That is definitely not the same as properly filling in a Form 1040, signing it and filing it!  So it would be useful to know what CPs get issued before the taxpayer’s account gets loaded into the ASFR system and it becomes too late to create a friendly SFR.  BTW, CP stands for “Computer Paragraph,” meaning that any notice containing a “CP” before the number is a totally automated notice. I welcome any comments to address my confusion here.

Coda: There is some weirdness in this case.  In 2019 Mr. Ashford received a notice from the Social Security Administration that it was reducing his 2013 self-employment income from the amounts reported on the Form 1099 to zero.  That may have resulted from the IRS’s premature assessment of the deficiency while the case was pending in Tax Court, and then its abatement of that assessment.  That’s kind of a rough justice for Mr. Ashford, especially if he was arguing to the effect that “I don’t have to pay self-employment taxes on the income but I still get to use it to generate Social Security benefits.”  Now he’s got to figure out how to straighten out the SSA records. 

Rare Discharge in Bankruptcy for Taxpayers with a Return Filed After an SFR Assessment

We welcome back guest blogger Ken Weil. Ken is one of the top national experts on the intersection of personal bankruptcy and taxation, and today we are fortunate to publish his analysis of an unusual loss for the government on the issue of dischargeability following a substitute for return assessment. Keith covered a previous case on the issue here. Christine

In Golden v. United States (In re Golden), Bankr. E.D. Cal. Adv. Proc. No. 21‑2012, Docket No. 60 (Golden), the taxpayer‑debtors Nicole Golden and Stephen Alter (the Taxpayers) argued successfully that their return was an honest and reasonable attempt to satisfy the requirements of the tax law.  The bankruptcy court discharged their tax obligation even though the Taxpayers had filed their return after the IRS initiated the substitute‑for‑return process, issued a notice of deficiency (NOD), and assessed tax based on the NOD.  This note calls that type of an assessment an “SFR assessment.”

As far as the author knows, Golden marked only the second time a court using a subjective‑test analysis discharged tax due on a return filed after an SFR assessment (and was not reversed on appeal).  Golden also extended the IRS’s streak of unsuccessfully arguing that the tax due on a document filed after an SFR assessment is per se nondischargeable.


1. Applicable Law

In the First, Fifth, and Tenth Circuits, the rule is that tax due on a late‑filed return is always nondischargeable, even if the return were filed only one‑day late.  McCoy v. Miss. Tax Comm’n (In re McCoy), 666 F.3d 924 (5th Cir. 2012); Mallo v. IRS (In re Mallo), 774 F.3d 1313 (10th Cir. 2014); and Fahey v. Internal Revenue Service, 779 F.3d  1 (1st Cir. 2015).  The one‑day-late rule has been discussed extensively in Procedurally Taxing.  See K. Fogg, Debtors Still Trying to Fight Against One Day Rule (October 24, 2019), which cites prior discussions.  In shortened form, these three circuits reason that the language in 11 U.S.C. §_523(a)(*) requires that, for a document to be considered a valid return, it must satisfy all applicable nonbankruptcy law requirements, including applicable filing requirements and timely filing is an applicable filing requirement.  This note focuses on Golden and not the propriety of the one‑day‑late rule.

Outside of those three circuits, to determine whether a document filed late will be considered a valid return, the IRS and the other circuits follow the Beard test, which is a four‑part test.  Beard v. Comm’r, 82 T.C. 766, 775‑778 (1984), aff’d, 793 F.2d 139 (6th Cir. 1986).  The Ninth Circuit uses the Beard test.  Smith v. United States Internal Revenue Serv. (In re Smith), 828 F.3d 1094, 1096 (9th Cir. 2016), and United States v. Hatton (In re Hatton), 220 F.3d 1057, 1060-1061 (9th Cir. 2000).  As Golden arose within the Ninth Circuit, it will have no impact on those courts bound by the one‑day‑late rule.

Under the four‑part Beard test, for a late‑filed document to be considered a valid return

  • there must be sufficient data to calculate the tax liability;
  • the document must purport to be a return;
  • there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and
  • the taxpayer must execute the return under penalty of perjury.

The most contentious part of the Beard test is whether the taxpayer made an honest and reasonable attempt to satisfy the requirements of the tax law.  That was the key question in Golden.

The Eighth Circuit stands alone in using an objective test to determine whether the taxpayer made an honest and reasonable attempt to satisfy the tax law.  Colsen v. United States (In re Colsen), 446 F.3d 836 (8th Cir. 2006).  Under the objective test, the inquiry into the validity of the document at issue is limited to the four corners of the document.  The IRS accepts that an objective test is used in the Eighth Circuit.  IRM (12-09-2016).  The other “non-one-day‑late circuits” use a subjective test, and the Golden court used a subjective test.  Golden p.19 (“this court looks to the totality of circumstances”).

2. Factual Background

The tax year at issue in Golden was 2008.  The Taxpayers extended the return’s due date to October 15, 2009.

With the onset of the Great Recession in 2008, the Taxpayers experienced financial difficulties, including loss of a rental property through foreclosure.  In 2010, Golden took over operation of the jointly owned business from Alter.  Golden took an additional, unspecified amount of time to take over the tax responsibilities. 

The financial difficulties led to marital difficulties.  In February 2010, Golden separated from Alter.  At that time, the Taxpayers’ children were aged four and six.

On March 8, 2011, the Taxpayers filed their 2009 tax return.  On March 10, 2011, the Taxpayers’ accountant completed the 2008 return and the Taxpayers signed the return.  This was approximately 15 months after the extended due date for the 2008 return.  Thereafter, the Taxpayers held off filing the 2008 return in hopes of putting together the money to pay off the taxes and to understand the IRS’s position better.

On March 14, 2011, the IRS issued its NOD for 2008.  The NOD asserted a deficiency of $276,506.  The document signed by the Taxpayers asserted a liability of approximately $23,000.  The difference in the two amounts appears to have been primarily expenses incurred in running the Taxpayers’ business that were not accounted for in the NOD.

The Taxpayers did not respond to the NOD, and, on July 28, 2011, the IRS assessed the tax due as reported in the NOD.  From issuance of the NOD to assessment, 136 days elapsed.  On August 10, 2011, the Taxpayers filed a document that they asserted was their 2008 return.  From issuance of the NOD to the filing of the document that purported to be the return, 149 days elapsed.  From assessment to filing, 13 days elapsed.  From the extended due date to filing, approximately one year and ten months elapsed.

On February 11, 2013, the IRS reduced the assessed tax to the $23,000 number reported as due by the Taxpayers.

On April 30, 2014, the Taxpayers filed for relief under Chapter 13 of the Bankruptcy Code.  This was approximately two years and eight months after the Taxpayers filed the document purporting to be their 2008 return.  This was approximately four years and six months after the extended due date of the 2008 return.

The Taxpayers successfully completed their Chapter 13 plan.  They full paid their secured and priority tax claims of over $58,000 and made a small distribution to their unsecured creditors.

3.  Briggs, Sr.

Prior to Golden, the only case known to the author that discharged tax reported on a document filed after the SFR assessment was Briggs, Sr. v. United States (In re Briggs, Sr.), 511 B.R. 707 (Bankr. N.D. Ga. 2014), aff’d, Briggs, Sr. v. United States (In re Briggs, Sr.), N.D. GA. No. 15-2427‑MHC  (June 7, 2017) (“District Court Briggs, Sr.).  In that case, Mr. Briggs thought his business partner had filed his return.  Mr. Briggs had signed the return and sent it back to his business partner, as was his annual custom.  The business partner did not file the return, and an IRS SFR designation ensued.  The IRS mailed the NOD to the business partner’s address and not Mr. Briggs’s address.  Upon learning of the nonfiling and SFR assessment, Mr. Briggs filed a document purporting to be his return, and it was found to be a valid return. 

The United States argued in Briggs, Sr. that any document filed after the SFR assessment is per se not a return under §_523(a)(*).  Yet, in its appeal brief to the district court, the United States conceded that no appellate court had adopted the per se rule.  District Court Briggs, Sr. at p.8.  The District Court Briggs, Sr. opinion is now almost five years old.  In the ensuing five years, the author is unaware of any appellate court that has adopted the per se rule, i.e., an appellate court outside of the one-day-late circuits and the Eighth Circuit.

4. Facts used by the Court to find for the Taxpayers

At Golden p.20‑21, the Court explained why it thought the Taxpayers had made an honest and reasonable attempt to comply with the tax law. 

  • The Taxpayers did not “belatedly” accept responsibility for filing a return, and they did not “attempt to present inaccurate or fabricated information.”
  • Taxpayers “provided solid and accurate information” to the IRS.  Taxpayers used the “assistance of a tax professional” to present accurate information.
  • Taxpayers did not try to “walk away” from the debt.  They spent five years in “bankruptcy purgatory” in order to obtain a discharge.
  • The Taxpayers’ “corrective actions were not merely filing a ‘me too’” 2008 return that “parroted the assessed tax” with a goal of two years later filing for bankruptcy and asserting the tax debt should be discharged.
  • The IRS presented “no identifiable bad faith reason for the failure to file” the 2008 return sooner.
  • Although “beset” with financial and marital problems, the Taxpayers acted properly to substantially pay their tax obligations.

Without discussion, the Court rejected the per se rule.  Golden at p.3 (where the government argument is set forth) and p.19 (where the Court makes clear that the Hatton rule applies; the Court looked at the totality of circumstances to determine whether the Taxpayers acted honestly and reasonably in the filing of their return).

5. Lagniappes

Golden will be a tough case for the IRS to win on appeal.  Ninth Circuit case law is clear that a subjective test applies so de novo review is unlikely.  The government will need to prove clear error.  See District Court, Briggs, Sr. at p.4 (burden is on the government to show that the bankruptcy court’s findings were clearly erroneous).  The United States might question, even under a “totality of the circumstances” test, how much weight should be given to actions taken after the document is filed, e.g., completing a Chapter 13 plan.  Regardless, sufficient facts exist to support the Court’s holding.  For example, the Court found that “the personal and financial maelstrom is the reason for Plaintiff‑Debtor stumbling with respect to the 2008 federal tax return.”  Golden at p.21.  Kudos to the Taxpayers’ attorney for taking on this battle and winning.

In Golden, the IRS again argued for a per se rule.  Even though such a rule would make life easier for the IRS, the IRS should put that argument to bed.  It has been singularly unsuccessful.  Golden notwithstanding, the IRS still has a de facto per se rule.  It is very difficult for a taxpayer to prove that a document filed after the SFR assessment was an honest and reasonable attempt to comply with the tax law.

One other note, if you represent a client with a non‑filed return and a NOD has been issued and the 90‑day period has not run, strongly consider filing a Tax Court petition.  Section_523(a)(*) of the Bankruptcy Code provides that a return includes “a written stipulation to a judgment or final order entered by a nonbankruptcy tribunal.”  The Tax Court filing and subsequent final order will keep the bankruptcy‑discharge option open, and, perhaps, prevent an expensive discharge litigation.

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.


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. 


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  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, 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, 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 also supports this conclusion.


The making of an assessment based on an SFR starts the running of the 10-year period for collection of the liability.  IRM 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.

District Court Reverses Outlying Bankruptcy Court Decision Regarding Discharge of Taxes Following SFR Assessment

The case of IRS, et al v. Starling, No. 7:20-cv-07478 (S.D.N.Y. 2021) reverses the bankruptcy case discussed here.  The bankruptcy court followed the authority created in the 8th Circuit almost two decades ago.  The 8th Circuit’s position is distinctly in the minority regarding how to treat a taxpayer who fails to timely file a return prior to the time the IRS makes a substitute for return assessment (SFR).  By adopting the 8th Circuit’s position regarding late filed returns, the bankruptcy court found that Mr. Starling discharged his taxes and that the IRS violated the discharge injunction by pursuing collection against him after the granting of the discharge.  The decision of the district court realigns the outcome with the majority of courts that have looked at the issue.  A significant split of authority continues to exist crying out for a legislative or judicial resolution.


Mr. Starling didn’t file his 2002 return.  The IRS followed the substitute for return procedures including a preliminary letter and a notice of deficiency.  He did nothing in response to these letters allowing the IRS to assess the taxes it determined due through the substitute for return procedures.  After the assessment, Mr. Starling submitted a return prepared by him which reflected the same amount of tax as the IRS assessed based on the notice of deficiency.  This fact made his case almost identical to the facts in the Hindenlang case that started this issue almost a quarter century ago. 

Waiting until after the IRS has gone through the notice of deficiency procedure and made the assessment based on a defaulted notice has caused every taxpayer except Mr. Colsen in the 8th Circuit to lose the discharge argument for one reason or another.  The bankruptcy court’s decision surprised me.  The government appealed as I predicted in the prior post.  The outcome here does not surprise me.  Perhaps Mr. Starling will appeal to the 2nd Circuit which does not have circuit decisional law on this issue.  If he does appeal, I expect that he will lose but whether he loses or wins he will create a conflict with one circuit or another.  Perhaps this could be that case that after a quarter of century resolves the issue of when it becomes too late to file a return and still reap the benefit of a discharge.

The district court decision highlights the continued uncertainty which puts the IRS and state taxing authorities in a tough spot.  They must create protocols for discharging taxes.  The IRS has created a protocol that it will not discharge a tax if the taxpayer files the return after the IRS has assessed the liability using the substitute for return procedures (except it cannot safely use that protocol in the 8th Circuit.)  When the bankruptcy court disagreed with the majority of cases reviewing this issue, it then found that the IRS had violated the discharge injunction and imposed sanctions.  The IRS does not want to get sanctioned and it does not want a discharge standard that has too many variables and unknowns.  I am sure it will continue to appeal any adverse decisions similar to Starling.  Its failure to take the Colsen case to the Supreme Court many years ago has proved to have been a mistake.  The IRS believed it could fix the problem created by Colsen with legislation; however, the legislation passed in 2005 has just made the situation more complicated as discussed in the many prior blog posts on this issue.

The additional party in the Starling case was the private debt collection company used by the IRS.  That company essentially violated the discharge injunction as an agent of the IRS.  With the decision that bankruptcy did not discharge this debt, the private debt collection company gets off the hook the same as the IRS.

The district court does a nice job of consolidating the cases decided on this issue and describing the failed legislative fix.  It notes that the bankruptcy court’s decision in Starling goes even further than the 8th Circuit did in Colsen:

But even the Eighth Circuit is unlikely to have regarded Debtor here as having made an honest and reasonable effort. First, there is serious doubt that Colsen‘s reasoning survives the addition of BAPCPA’s hanging paragraph, and at least one bankruptcy court within the Eighth Circuit has instead adopted the one-day-late test. See Kline v. Internal Revenue Serv. (In re Kline), 581 B.R. 597, 604 (Bankr. W.D. Ark. 2018). Second, while Colsen held that “the honesty and genuineness of the filer’s attempt to satisfy the tax laws should be determined from the face of the form itself, not from the filer’s delinquency or the reasons for it,” Colsen, 446 F.3d at 840, the court also noted that the late-filed form in that instance provided the IRS with new information that assisted the agency in determining the taxpayer’s ultimate tax liability, id. at 841. The Eighth Circuit distinguished the facts before it from those in Hindenlang, “where the taxpayer’s forms contained essentially the same information as the substitute forms that the IRS prepared and the calculation of tax did not change substantially.” Id. (citing Hindenlang, 164 F.3d at 1031.) Unlike in Colsen, Starling’s late-filed Form 1040 appears to have simply reiterated the tax assessment the IRS had already performed, and although this effort may have been an “honest” attempt to satisfy his obligations under the tax law, it was hardly “reasonable” to ignore multiple notices and only file years late with the same number the IRS had already come up with on its own. While I do not believe that the Colsen test is the appropriate one to apply here, especially in the wake of BAPCPA, Debtor fails to meet even that most lenient standard for avoiding § 523(a)’s discharge exception.

The statute of limitations on collection has apparently run on Mr. Starling’s debt.  So, the discharge aspect of this case no longer matters to him.  I don’t know if the contempt fees would sufficiently fuel an effort to go to the 2nd Circuit but maybe someone wants another circuit court decision on this issue and another shot at the Supreme Court.  This case breaks no new ground, and puts Colsen back in the 8th Circuit only.  The IRS continues to argue that any document filed after the assessment is automatically not a return.  To date, the IRS has not gotten one court to buy this argument.   In Briggs v. United States (In re Briggs), No. 15-2427-MHC at p.8 (N.D. Ga., June 7, 2017) (government admitted at oral argument that no court of appeals had adopted the per se argument).  The IRS has won every case but one when it argues that the document filed after the SFR assessment was not a return.  So, it has a de facto, if not a de jure, rule.

The facts in Briggs offer a good argument for the non per se rule but the IRS will continue to push for a per se rule because that’s what it needs in order to comfortably administer a provision, the discharge rule, that has significant adverse consequences when the creditor gets it wrong.  Because of their desire for a clear rule, taxing authorities would benefit from a visit to the Supreme Court in order to seek an administrable rule they can follow without fear even if the rule is not as favorable to them as the current situation.  Debtors might prefer the current state of affairs unless they live in the 1st, 5th or 10th Circuits where the current rules create a crushing situation for them.  We’ll see if Starling is the case that brings the issue to a head.

Discharge of Late Filed Return Takes a Turn in Taxpayer’s Favor – Has the Objective Test of Colson Migrated Out of the 8th Circuit?

In the case of In re Starling, 125 AFTR2d 2020-2587 (Bankr. S.D.N.Y 2020) the bankruptcy court holds against the IRS in a case involving the filing of a Form 1040 after an assessment based on a substitute for return.  The case runs contrary to lots of case law but none at the Second Circuit level.  I anticipate the IRS will appeal this aspect of the case and maybe others.  Thanks to Christine Speidel for bringing the case to my attention and Ken Weil for providing me with background research as we discussed the case.  I have posted many times on this issue but not since the beginning of 2020.  Look here for a collection of the posts.

The case also involved a claim for damages under IRC 7433.  The bankruptcy court determined that the debtor could not obtain damages from the IRS because he failed to exhaust administrative remedies; however, it determined that the private debt collector who sent notices to the debtor after a referral of the debt from the IRS did owe damages, since it lacked the immunity available to the IRS on this issue.


Mr. Starling failed to file his 2002 individual income tax return despite notices from the IRS requesting that he do so.  Eventually, the IRS prepared a substitute for return and made an assessment of tax for 2002 in 2005.  Two years later, the taxpayer filed a Form 1040.  Six years after filing the Form 1040, Mr. Starling filed a chapter 13 bankruptcy petition.  After completion of the plan payments Mr. Starling received a discharge in May 2016.  Although he had paid the priority claim of the IRS through his plan, Mr. Starling found that the IRS did not consider the 2002 year discharged.  In the chapter 13 case the 2002 taxes would have been classified as general unsecured claims because of their age and as general unsecured claims would generally have been eliminated when Mr. Starling received his discharge.  This seems to have been his expectation.

The IRS did not believe the 2002 taxes were discharged because it made its assessment based on an SFR.  I am almost certain that the IRS instructions coded into its computer and given to its bankruptcy employees would treat the 2002 debt in this manner everywhere in the country except in the 8th Circuit.  Because it believed that the 2002 debt survived the bankruptcy discharge and because it remained unpaid, the IRS referred the debt to one of the private debt collectors (PDC) with whom it has a contract, and the PDC sent Mr. Starling letters seeking payment on the outstanding liability.  Sending those types of collection demand letters regarding a discharged debt would violate the discharge injunction in BC 524.

Because Mr. Starling felt that his chapter 13 discharge eliminated the 2002 liability, he brought a contested matter seeking a determination regarding discharge and seeking contempt against the IRS for violating the discharge injunction.  The IRS defended the action arguing that the exception to discharge in BC 523(a)(1)(B)(ii) applied to the 2002 liability because Mr. Starling filed the Form 1040 for 2002 after the IRS had processed a substitute for return and made an assessment based on the substitute.  Since the IRS had already processed a return for Mr. Starling for 2002, it argued that the subsequent submission of the Form 1040 for that year failed the Beard test and, therefore, did not trigger the late filed exception in B.C. 523(a)((1)(B).

The issue here has existed for over 20 years since the 6th Circuit’s decision in the Hindenlang case.  In that case the court decided that the filing of a Form 1040 after the assessment of the liability could serve to trigger a discharge but the late return must have been filed prior to an IRC 6020(b) assessment triggered by the IRS.  Most courts look at the issue agreed with Hindenlang but the 8th Circuit in Colson did not.  The split in authority and the uncertainty resulting from the split caused the IRS to push for and Congress to adopt an amendment to B.C. 523 in 2005 intended to resolve this situation.  Unfortunately, the 2005 amendment did not resolve the uncertainty but injected more uncertainty into the situation.  Instead of two theories regarding what should happen in this situation, the amendment created a third without resolving the original dispute.

The three possible outcomes, in order of likelihood from least likely to most likely, are 1) the debtor’s objective filing of the Form 1040 after the IRS makes the SFR assessment begins the two year period described in B.C. 523(a)(1)(B) allowing debtor to obtain a discharge by waiting two years after filing the delinquent Form 1040 before filing a bankruptcy petition – the Colson view which is the prevailing view in the 8th Circuit; 2) the debtor’s filing a return late, even one day late, prevents the debtor from ever obtaining a discharge for the taxes related to the late return based on an interpretation of the flush language of the 2005 amendment to BC 523(a) in the unnumbered paragraph at the end of that provision – the one day late rule which is the prevailing view in the 1st, 5th and 10th Circuits and most recently repudiated by the 11th Circuit in In re Shek, 937 F.3d 770, 776 (11th Cir. 2020) (providing a definition of applicable to overcome the one day rule).; and 3) the debtor can file a late return and discharge it by waiting two years before filing bankruptcy after the filing of the late return but the late return must be filed prior to an IRC 6020(b) assessment triggered by the IRS – the Hindenlang view.

The bankruptcy court in Starling chooses the path less travelled and essentially follows Colson.  This potentially presents large problems for the IRS if it stands because it requires the IRS to reprogram its computers and issue supplemental instructions to its bankruptcy staff for all bankruptcies in the Southern District of New York.  For that reason and for the reason that the Colson theory has not caught on elsewhere, I expect an appeal to the district court on this issue.  Because the IRS does not agree with the one-day rule, it will appeal arguing that a subjective test should apply and that Mr. Starling knew when he filed the Form 1040 that the IRS had already assessed his taxes for 2002, causing his Form 1040 not to meet the Beard test based on his knowledge of the circumstances. 

So far, there may only be one case applying the subjective test in which a debtor has prevailed on the Beard test that has not been reversed on appeal.  That case is Briggs, Sr. v. United States (In re Briggs, Sr.), 511 B.R. 707 (Bankr. N.D. Ga. 2014).  At trial, the tax was found dischargeable.  The District Court affirmed.  Briggs, Sr. v. United States (In re Briggs, Sr.), N.D. GA. No. 15-2427 (June 7, 2017).  In Briggs, the debtor thought his business partner had filed his return.  Their custom was for the business partner to prepare the return, the debtor to sign it, and the business partner to file it.  The business partner did not file the return.  The IRS’s notice of deficiency was mailed to the business partner’s address and not the debtor’s, so the debtor did not know the return was nonfiled.  As part of a lawsuit, the debtor had done a forensic accounting to determine revenue and expenses.  Upon learning of the nonfiling and SFR assessment, taxpayer filed a return, which was found to be a valid return.

I previously wrote a post on Shek here.  Although Shek is an 11th Circuit case it involves state income taxes owed to Massachusetts.  Massachusetts convinced the 1st Circuit in the Fahey case that the flush language added to the end of BC 523 in 2005 means that a return filed one day late prevents it from ever receiving a discharge.  Shek did not involve an intervening substitute for return but a clean question of the application of the one-day rule.  Thanks to an amicus brief by University of Michigan law professor John Pottow, the 11th Circuit rejected the one day rule argument, finding that the language added in 2005 did not require this result.  

The Massachusetts Department of Revenue wisely, in my opinion, chose not to seek cert from the Supreme Court based on the direct split between the 1st (and 5th and 10th) Circuits and the 11th Circuit.  Because almost all of the Massachusetts Department of Revenue cases exist in the 1st Circuit, it had much to lose by taking the case to the Supreme Court and little to gain.  So, we must wait for another circuit decision before the Supreme Court will have the opportunity to fix the problem.  Of course, Congress could step in and try again to fix the problem without creating a fourth split in possible outcomes.  I know there are some debtor’s attorneys in the 1st Circuit looking for another chance to take on the Fahey decision.  Maybe the 1st Circuit will take another look at this issue and the next split will come there.

In addition to the issue of discharge, the bankruptcy court in Starling also addressed the issue of damages.  Mr. Starling sought damages from the IRS for seeking to collect the tax liability after discharge.  The bankruptcy court found that he could not obtain damages from the IRS, because he did not exhaust administrative remedies by making a request to the IRS before bringing the action.  If he had made a request to the IRS, he likely could have recovered damages, because the IRS would have told him his position on the discharge issues was wrong.

Although the bankruptcy court could not award damages against the IRS because the waiver of sovereign immunity required exhaustion of administrative remedies, it decided that it could award damages against the PDC, which lacked the same sovereign immunity protection cloaking the IRS.  While I am not a fan of PDCs, I expect this aspect of the decision will also be appealed, both because of the argument regarding the applicability of the exception to discharge and the argument of the PDC’s relationship to the IRS and reliance on the IRS.

Procedure Grab Bag – Foreign Tax Credits

Two cases dealing with foreign tax credits, with very different litigation records; one being denied cert by SCOTUS (Albemarle, which we’ve covered before) and one tossed on summary judgement in the District Court (Estate of Herrick) with the taxpayer prevailing on making a late election where no late election was permissible.  The second case has pretty interesting regulatory interpretation.


The first has been covered here on PT before on at least two occasions.  SCOTUS has denied cert in Albemarle Corp. v. US.  When the Federal Circuit reviewed the case, I wrote the following in a SumOp:


Hopping in the not-so-wayback-machine, in October of 2014, SumOp covered Albemarle Corp. v. US, where the Court of Federal Claims held that tax accruals related back to the original refund year under the “relation back doctrine” in a case dealing with the special statute of limitations for foreign tax credit cases.   As is often the case in SumOp, we did not delve too deeply into the issue, but I did link to a more robust write up.  It seems the taxpayers were not thrilled with the Court of Federal Claims and sought relief from the Federal Circuit.  Unfortunately for the taxpayer, the Fed Circuit sided with its robed brothers/sisters, and affirmed that the court lacked subject matter jurisdiction because the refund claim had not been made within the ten year limitations period under Section 6511(d)(3)(A).   This case deserves a few more lines.  The language in question states,  “the period shall be 10 years from the date prescribed  by law for filing the return for the year in which such taxes were actually paid or accrued.”   When the tax was paid or accrued is what generated the debate.

In the case, a Belgium subsidiary and its parent company, Albemarle entered into a transaction, which they erroneously thought was exempt from tax, so no Belgian tax was paid.  Years in question were ’97 through ‘01.  In 2002, Albemarle was assessed tax on aspects of the transaction in Belgium, and paid the tax that was due.   In 2009, Albemarle filed amended US returns seeking about $1.5MM in refunds due to the foreign tax credit for the Belgian tax.  Service granted for ’99 to ’01, but not ’97 or ’98 because those were outside the ten year statute for claims related to the foreign tax credit under Section 6511(d)(3)(A).  Albemarle claimed that the language “from the date…such taxes were actually…accrued” means the year in which the foreign tax liability was finalized, which would be 2002 instead of the year the tax originated.  Both the lower court and the Circuit Court found that the statute ran from the year of origin.  The Circuit Court came to this conclusion after a fairly lengthy discussion of what “accrue” and “actually” mean, plus a trip through the legislative history and various doctrines, including the “all events test”, the “contested tax doctrine”, and the “relation back” doctrine.  The Court found the “relation back” doctrine was key for this issue, which states the tax “is accruable for the taxable year to which it relates even though the taxpayer contests the liability therefor and such tax is not paid until a later year.” See Rev. Rul. 58-55.  This can result in a different accrual date for crediting the tax against US taxes under the “relation back” test and when the right to claim the credit arises, which is governed by the “contested tax” doctrine.

At that time, McDermott, Will and Emery posted some “Thought Leadership” (I’ve hated that term for a long time, but the summary is extensive and helpful), which can be found here.  The final paragraph of their advice is right on the mark, indicating there is no circuit split, so there likely would be no SCOTUS review.  It also provides great additional parting advice, stating:

Taxpayers in similar situations wishing to take positions contrary to the Federal Circuit’s decision, and without any option other than litigation, may want to file suits in local district court to avoid the negative precedent. Taxpayers may also want to consider filing protective refund claims in situations where it does not appear that a tax payment to a foreign jurisdiction will actually be made (and there will be enough time to file a formal refund claim with the IRS) within 10 years from the date the U.S. federal income tax return was filed to avoid the situation in Albemarle.

Not so late election

The second foreign tax credit case is the Estate of Herrick v. United States from the District Court for the Central District of Utah, where an estate filed late income tax returns seeking a refund for a decedent who had resided and worked in the Philippines for a number of years.  The taxpayer failed to file income tax returns during that period, under the mistaken belief that no income tax would be due because of credits for the foreign tax he was paying (not how that works).  The Service created SFRs, and assessed and collected over a $1MM in tax for the years in question.  The taxpayer sought summary judgement on its refund claim, which the IRS was contesting, arguing the taxpayer was not entitled to the credit or exclusion for foreign income taxes or that there were insufficient facts to establish that he was entitled to the same.

Under Section 911, some taxpayers living and working abroad in some circumstances can exclude a portion of the foreign earned income, and under Section 901, there is a credit for foreign tax that is paid, which can be applied against US income tax (as most of our readers know, under Section 61, the United States generally treats all income of its citizens, wherever earned, as being taxable income—these provisions help to reduce the potential for double taxation with the other jurisdictions).

As to the second claim, that insufficient evidence was available regarding the credits, the IRS position largely applied to one year.  For all other years, the taxpayer had showed copies of its returns, copies of his employer’s information related to him for the years in question, and the taxing authority in the Philippines verified all the information, including payment.  For one year, only a copy of the return and the employer’s information was available.  The Court found this was sufficient evidence to show proof of payment.

The second argument the Service made was that the taxpayer could not obtain the foreign earned income exclusion under Section 911 because the taxpayer had not made the election on a timely filed return or within one year of a timely filed return.  See Treas. Reg. 1.911-7(a)(2)(i).  Seems damning.

The Court, however, stated that the Service was only looking to subsections (A) through (C), and not giving consideration to subsection (D) in the Regulations allowing for elections to made when:

(D) With an income tax return filed after the period described in paragraphs (a)(2)(I) (A), (B), or (C) of this section provided –

(1)  The taxpayer owes no federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached either before or after the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion; or

(2)  The taxpayer owes federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached before the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion.

The Court found the first prong under (D) did not apply.  The taxpayer claimed that it did not owe any federal income tax, because the IRS had already assessed and collected an amount over the total amount outstanding.  The Court stated, however, the fact that no tax was due at the time of filing was not the question, and the determination was whether any tax was due for the year, which had been the case but the Service had already collected that amount via levy.

The Court, however, held that the second prong did apply.  The Court found the Service had not discovered the failed election.  The Court found the Service had determined the taxpayer failed to file returns for the years in question, but that was not the same as discovering the taxpayer failed to make the election (would anyone be surprised if the Service doesn’t concede this point in other jurisdictions?).  This allowed the taxpayer to make the election on the late filed returns.

The Automated Substitute for Return Procedures

Today we welcome guest blogger Michelle Drumbl.  Professor Drumbl teaches tax at Washington and Lee University School of Law and runs the low income taxpayer clinic there.  She thanks clinic student Hollie Floberg for her assistance in writing this post.  One of Professor Drumbl’s suggestions concerns the use of the substitute for return procedures to pursue returns with little collection potential.  I wrote about the IRS policy of taking collection into account in the TFRP context.  That policy may have some play here.  Keith

The automated substitute for return (ASFR) procedure, authorized by section 6020(b) of the Internal Revenue Code, provides the Internal Revenue Service with a mechanism by which to use third-party information reporting to assess a tax liability for nonfilers. This enforcement mechanism is a relatively easy way for the Service to narrow the so-called “tax gap,” defined as “the amount of true tax liability faced by taxpayers that is not paid on time.” In the context of closing the tax gap, income that is subject to information reporting is low-hanging fruit. Unsurprisingly, studies show that taxpayer compliance rates are higher when income is subject to “substantial information reporting” (and highest if subject to both information reporting and withholding).


It is hard to refute that noncompliance undermines the tax system, or to deny the appropriateness of the Service pursuing assessment of unreported income it can easily verify. However, in her recently released 2015 Annual Report to Congress, National Taxpayer Advocate (NTA) Nina Olson identifies the selection criteria for cases in the ASFR program as Most Serious Problem #17. Olson insightfully identifies a number of ways in which the ASFR process, while easy for the Service, is imperfect for the taxpayer. Olson’s critique of the current ASFR selection criteria includes three points: 1) the IRS has a poor collection rate on these assessments; 2) the IRS has a high abatement rate on amounts assessed through ASFR; and 3) the ASFR program has a low return on investment.

I will address some of these points and the NTA’s recommended solutions from my perspective of a practitioner representing low-income taxpayers, and add some observations of my own. 

When Using its Third-Party Documentation, the IRS Should Take into Account Deductions and Credits, Not Just Income

In describing the abatement rate on ASFR assessments, Olson notes that the program could increase efficiency and return on investment if, as part of its case selection, it more carefully considered third-party documentation consistent with possible deductions and credits. She notes that selection of cases likely to result in abatement causes “rework for the IRS and potential harm for the taxpayer”. She suggests that the IRS refine its selection process by “considering third-party documentation that supports deductions or credits when determining which cases to select for the program”.

Olson’s point is well taken. The ASFR assessment process takes into account all income reported as earned by the taxpayer, but it ignores reported items that would reduce taxable income. For example, mortgage interest is reported to the IRS on Form 1098, state income tax withholding is reported on Form W-2, and student loan interest is reported on Form 1098-E. All of these reported payments potentially reduce a taxpayer’s liability.

I agree with Olson that the failure of the IRS to use or acknowledge this readily accessible information is inefficient, but the burden must remain on the taxpayer to claim these deductions. These deductions cannot be accurately calculated by the IRS during the ASFR process because the IRS has imperfect information. For example, the student loan interest deduction phases out at a certain income level, and it is possible that the taxpayer has additional income not subject to information reporting. Thus, it would be premature to propose the deduction based only on the income information reported by third parties. Accordingly, it is not unreasonable for the IRS to omit these deductions in calculating its proposed ASFR assessment. After all, the taxpayer sat on his or her rights by not filing a return; appropriately, the burden of filing and claiming deductions or credits rests with the taxpayer. But as I describe in my recommendation below, the IRS can and should communicate these possibilities to the taxpayer when known. Another issue the IRS should address more clearly in its communications is filing status.

Filing Status Presents Challenges for Taxpayers beyond What the NTA Report Describes

Olson is absolutely correct that filing status matters. Married taxpayers who file a joint income tax return are entitled to a number of potential benefits that are denied to married taxpayers who file separately. Most notably for low-income individuals, the earned income tax credit is not available to married taxpayers filing separately. But because joint filing is at the taxpayers’ election, an ASFR assessment must be based upon a filing status of single or married filing separately. Olson addresses this issue, but she does not describe the limitations that section 6013(b)(2) impose on married taxpayers who wish to file a joint return after filing separate returns.

Professor Kathryn Sedo has blogged here and here about one possible “procedural trap for unrepresented taxpayers” that arises under section 6013(b)(2)(B), namely that married taxpayers cannot amend from a separate return to a joint return once either spouse has filed a petition in Tax Court with respect to such tax year.

Another limitation, set forth in section 6013(b)(2)(A), is that if one of the spouses has filed a separate return, the taxpayers are prohibited from amending to file a joint return after the expiration of three years from the due date of the return for such tax year.

As I write about in a forthcoming article, in my low-income taxpayer clinic I commonly encounter married couples in which one spouse is a wage earner subject to information reporting and withholding and the other spouse receives nonemployee compensation subject to self-employment tax and no withholding. If a low-income couple with dependent children files a joint return, it may result that the personal exemptions, the standard deduction, the earned income credit, and the child tax credit combine to offset (in part or whole) the self-employment tax and the lack of withholding. However, a couple who lacks proper information and tax advice does not realize this; fearing a tax bill because of the self-employment tax and the absence of withholding, the taxpayers make a decision to file separate returns (or, quite commonly, a decision for one to file a separate return and one not to file).

Assuming the self-employed individual receives a Form 1099-MISC, the IRS will eventually discover the nonfiler and may pursue an assessment through the ASFR procedure. But this does not necessarily happen within three years of the due date of the return; as Olson describes, ASFR criteria require, among other things, that the module be “not older than five years prior to the current processing year.” But because of section 6013(b)(2)(A), the spouse who files a separate return has a limited window in which to amend and file jointly. Thus the nonfiler who comes into compliance more than three years late (perhaps in response to a proposed ASFR assessment) will have no choice but to file as married filing separately for those years if his or her spouse filed a separate return.

The IRS should (but currently does not) advise a nonfiler receiving a proposed ASFR of the time limitations imposed by section 6013(b)(2)(A) for amending to file jointly.

My Recommendation: Advise Taxpayers More Clearly of their Rights and Options, and Do So Sooner

The IRS can and should be much clearer in its communications with the taxpayer during the ASFR assessment process. My recommendation would be for the IRS to contact nonfilers within one year of the missed deadline and to include a letter explaining their rights and responsibilities more clearly. Currently, the 30-day proposed assessment letter lists the details of income reported by others. This letter should include all information received from third parties, not just income reported; it should notify (or remind, as the case may be) the taxpayer of any information reporting it received relating to possible deductions or credits. The letter could state clearly that the reported information may or may not be relevant in determining certain deductions or credits, note explicitly that the IRS has not included any deductions or credits in its calculation of the proposed assessment, and remind the taxpayer that it is his or her responsibility to affirmatively claim any deductions or credits on the return.

Moreover, the 30-day letter should be used as a reminder that the taxpayer may be eligible to use a more favorable filing status and is entitled to claim any qualifying dependents, either of which may reduce the proposed assessment. Specifically, it should notify the taxpayer that if he or she is married, there remains the option to file jointly with a spouse; it should further provide the deadline by which the taxpayer would need to file if the taxpayer’s spouse previously filed a separate return and wishes to amend and file a joint return.

Finally, the notice should recommend that the taxpayer visit a low-income taxpayer clinic if income eligible. 

In Conclusion: A Word About Those Low Collection Rates

Olson notes that the ASFR program has poor collection rates, citing statistics that the Service collected less than one-third of the amount assessed through ASFR in fiscal years 2011-2014. She suggests that the poor collection results are evidence of inefficient selection criteria, and notes that the ASFR program has a low return on investment relative to other IRS programs.

I feel strongly that the IRS should not simply choose to ignore nonfilers who represent a poor “return on investment” just because the program has “low collection rates”. Nonfilers degrade the tax system. They undermine the faith of the general public in a fair system, and they should not be given a pass because the relative dollar amounts are small or because they likely cannot afford to pay the liability. Olson speaks of the right to a fair and just tax system, but this concept cuts both ways. Compliant taxpayers expect the IRS to enforce filing requirements in an even-handed manner. Taxpayers who cannot afford to pay their tax liabilities have many avenues of relief available to them, including financial hardship status, a variety of installment agreement options, and the offer in compromise process. Taxpayers whose income exceeds the filing threshold must be expected to file a timely return and report their income, even if it is unlikely that the IRS will ever collect from them.

While the ASFR process can be modified in ways that would make it a more taxpayer-friendly (and perhaps a more efficient) procedure, it should not use collection likelihood (or the lack thereof) as part of its selection criteria.