IRS Chief Counsel Advises Its Attorneys to Concede Rand Issue

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We have previously reported on Rand v. Commissionerhere, here, here, here and here.  On July 31, 2014, IRS Chief Counsel’s office, issued Notice CC-2014-007 entitled “Application of the Accuracy-Related or Fraud Penalty in Tax Court Cases involving Disallowed Refundable Credit.” In the Notice Chief Counsel’s office provides guidelines for handling Tax Court cases involving certain penalties with respect to disallowed refundable credits based on Rand. In Rand type cases Chief Counsel attorneys are advised to concede these penalties based upon the analysis in the Tax Court’s decision.

The Notice is great news for taxpayers litigating this issue in Tax Court. It still leaves open several issues regarding these penalties. This post seeks to highlight some of the outstanding issues.

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I contacted Andy Roberson at McDermott, Will, and Emery to get his take on the notice. Andy tried the Rand case pro bono and currently serves as the ABA Tax Section Chair of the Pro Bono and Tax Clinics Committee. He commented as follows:

“I am pleased to see that the Service is accepting and will follow the Tax Court’s opinion in Rand, and has accepted that its reasoning applies equally to all refundable credits and to penalties under both section 6662 and section 6663. ­­ That said, the Chief Counsel Notice leaves open the possibility that the Service may change its mind in the future, as indicated by the qualifier “Pending any future guidance.” This raises the question of whether the Service may be considering a project to amend the regulations or whether to issue some other guidance in the future. There is no mention in the Chief Counsel Notice of whether the Service may be pursuing the 20% penalty under section 6676, but that may be because that penalty does not appear to be subject to the deficiency procedures and the Notice is directed toward Tax Court litigation. Additionally, the Notice does not advise on other situations where the penalty issue may arise; for example, CDP cases where the taxpayer has already had the opportunity to dispute the underlying deficiency or section 6015 cases where the liability is not at issue. The ABA Section of Taxation Pro Bono & Tax Clinics Committee is currently exploring ways to gain relief for taxpayers who have been erroneously assessed penalties under the Service’s pre-Rand position, and we will keep you updated on any future developments.”

Andy’s response highlights the major issues still pending and I will briefly discuss each in turn.

Pending Future Guidance

This statement in the Notice along with the opening caveat in the document “Effective until further notice” that the issue is not dead. While I doubt that the IRS will reopen this precise issue in the future, it certainly leaves that possibility open. When Chief Counsel’s Office issues a Notice the reason for doing so is to quickly get out guidance that it follows up with changes to its manual as well as with more substantive forms of guidance that take longer to work their way through the review process. This Notice comes not very long after the end of the appeal period and the decision not to appeal the Tax Court in this case. Clearly, the IRS still wants to chew on this a bit before issuing broader guidance.

Pursuing Penalties Under 6676

One of the sub-plots in this litigation and in the IRS approach to penalizing taxpayers receiving refundable credits is its failure to use 6676 which seems targeted to this circumstance yet does not currently apply to earned income credit cases. The failure to mention 6676 in the Notice appears to signal that the IRS is not ready to announce a change to its heretofore extremely rare use of 6676. This Notice only applies to Chief Counsel attorneys handling cases in Tax Court. The Notice does not address how the IRS will apply penalties in refundable credit cases in the future and does not bind the IRS regarding a continuation of its past practice. While it is hard to imagine that the IRS would continue to assess penalties on refundable credits in the same manner it did before Rand when its attorneys will not defend that position in Tax Court, the Notice does not provide answers to the direction of the IRS on this issue.

For many low income taxpayers who owe little or no taxes, the returns they file serve as refund claims for refundable credits and not mechanisms for self reporting a tax liability. While any return with a credit balance serves as a refund, the refunds generated by refundable credits create the refund in a different manner than defined in 6664(a). If the IRS is to penalize taxpayers for overclaiming refundable credits, the use of 6676 appears the appropriate way as the statutes currently exist. This may require some training of its staff and rewriting of its programs. Will those overclaiming refundable credits get a penalty holiday while the IRS retools?

Application of the Penalty in Past Cases

While I can speculate on what the IRS might do in the future, the bigger immediate issue concerns the past. Only a very small percentage of taxpayers receiving a notice of deficiency go to Tax Court. This means that the vast majority of cases with this issue have an assessed penalty just sitting there on the IRS books. The Notice does not address what the IRS might do with these cases if it acknowledges that its application of penalties in refundable credit cases was wrong.

In the “normal” tax procedure principles to this situation, it is incumbent upon the taxpayer to come forward to contest an incorrect assessment or to catch the result of subsequent litigation or policy change that makes a prior assessment subject to abatement. The individuals impacted by the Rand issue, however, are, by and large, low income taxpayers. They do not have tax advisors looking for issues of this type and advising them on how to get the assessment abated or obtain a refund if they have already paid. In circumstances such as this, does the IRS, knowing that the persons assessed this situation have a very low likelihood of coming forward to seek a refund or an abatement have a special responsibility to seek to identify them and reach out to them.

As someone who represents low income taxpayers, I hope that the IRS does feel that responsibility. I know the administrative issues present challenges to the IRS to roll back these penalties, but I also know that without action by the IRS, these penalty assessments will stay on the books for 10 years. Money will be collected from some who should not owe it and others, even if they do not pay will, worry about it and perhaps have the notice of lien filed because of it. Figuring out a way to unwind an action that causes incorrect assessments to remain on the books is a difficult but important part of administering the tax laws. The assessments occurred in good faith. Removing them now, if it can be done without significant administrative difficulty, would demonstrate great tax administration.

Relying on taxpayers to find and timely raise this issue as might occur when a corporate tax issue is reversed seems to flow against the recently announced taxpayer bill of rights and the right to pay no more than the correct amount of tax and the right to a fair and just tax system. One place to start on the right path is the known overassessment of penalty; as guest blogger Carl Smith discussed in his post last month the DOJ is arguing in some cases that the penalty should stand if the taxpayer (even a pro se taxpayer) failed to specifically raise the Rand issue in pleadings. No issues of administrative inconvenience prevent conceding a case already identified. A statement from the IRS on this issue rather than just a statement of Chief Counsel’s litigation position will set this issue on the right path and offer an early demonstration that the taxpayer bill of rights has meaning to those taxpayers who are the least among us.

 

Comments

  1. Carl Smith says

    I represent two taxpayers who are currently in court challenging penalties computed inconsistently with Rand. I have mixed news to report.

    One case, Cheyenne Johnson v. U.S., EDNY Docket no. 1:14-cv-1285, is a refund lawsuit over tax deductions and ACTC and EITC allegedly wrongly claimed by the taxpayer with respect to three dependents. In that case, the IRS also imposed the accuracy-related penalty on the entire deficiency — including on the disallowed refundable credits — in violation of Rand. The penalty refund claim that we made on a Form 843 last year was based both on reasonable cause and, in part, on Rand. The claim had not been ruled on at the time last month when the DOJ indicated that it was challenging Rand’s correctness in the case. But, effective as of Aug. 11 (in a post-dated notice I have just received), the IRS Examination Division, without contacting me, just granted a full penalty refund. It is not clear to me that this was done in response to the IRS’ new position on Rand. But, I know this was a complete surprise to the DOJ attorneys.

    I have blogged before on two companion cases named Morales v. Commissioner, 9th Cir. Docket No. 13-72483 and 13-72484. In both cases, the Tax Court refused to implement the Rand holding in response to motions for reconsideration that I filed after I made pro bono appearance in the cases. The Tax Court said that the taxpayers had not raised the Rand issue in their pleadings, so were barred from raising it in a motion for reconsideration. In its brief filed in the 9th Circuit in late June, the DOJ did not argue that Rand was wrongly decided, and it noted the DOJ’s concession of its protective appeal in Rand. But, the DOJ still sought to keep the improperly-computed penalties on the grounds of the taxpayers’ alleged failure to comply with Tax Court pleading rules. In a reply brief filed last month, among other things, we excoriated the DOJ for violating the IRS’ new Taxpayer Bill of Rights providing the taxpayer should only have to pay the correct tax and several Manual provisions stating that penalties should be corrected when later evidence indicates they were incorrect. After the Chief Counsel notice, earlier this week, I e-mailed the DOJ attorneys to see whether the DOJ is still going to contest the Morales cases. Ominously, I have gotten no response to that e-mail. So, I assume, the DOJ is still fighting to keep penalties computed inconsistently with Rand in the cases.

  2. Carl Smith says

    Well, the DOJ in Morales just filed a Rule 28(j) letter giving its views on whether the Chief Counsel notice applies to the Moraleses. In a word, the DOJ says that the Chief Counsel notice does not apply because the Rand case was not binding precedent at the time the Morealeses’ cases were originally decided — even though the decisions in the cases have never become final because of timely motions for reconsideration and timely appeals. The DOJ seems not to realize that Tax Court decisions do not become final under 7481(a) until all timely motions form reconsideration and appeals have been heard — even though we pointed this out to the DOJ in our reply brief.

    An FRAP Rule 28(j) letter is submitted to a court to inform it of new developments since the briefs were filed. The DOJ letter was in response to my Rule 28(j) letter bringing the Chief Counsel notice to the 9th Circuit’s attention earlier this week. The DOJ letter reads, in full:

    Pursuant to Fed. R. App. P. 28(j), we submit this response to the Rule 28(j) letter submitted by taxpayers Robert Perez Morales and Ronda Kay Morales (“taxpayers”) on August 5, 2014, regarding I.R.S. Notice CC-2014-007 (July 31, 2014).

    Notice CC-2014-007 informs attorneys in the Office of Chief Counsel, Internal Revenue Service, that the current practice of that office is to ensure that underpayment penalties in open Tax Court cases are decided consistently with Rand v. Commissioner, 141 T.C. No. 12, 2013 WL 6063566 (Tax Ct. Nov. 18, 2013) (en banc), appeal dismissed by stipulation, No. 14-1753 (7th Cir. June 10, 2014). As we explained in our answering brief (at pp. 52-54), Rand is now binding precedent for all open Tax Court cases. Cases in which no final decision had been entered by November 18, 2013, when Rand was issued, have been decided consistently with that precedent.

    In asserting that this Notice somehow created “Equal Protection” issues (Rule 28(j) Ltr. at 2), taxpayers ignore critical differences between their cases and the cases remaining undecided after Rand that are addressed in Notice CC-2014-007. The Tax Court issued final decisions and denied reconsideration in taxpayers’ cases before November 18, 2013, when Rand was handed down. (Ans. Br. at p. 3.) Prior to that date, there was no precedent requiring the Tax Court to provide the relief sought by taxpayers in this case. (Id. at p. 54.) And, unlike the situation in Rand, taxpayers here failed to raise the underpayment-penalty issue prior to final decision being entered. (Id. at p. 55.)

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