IRS Treatment of Penalties Following a Substitute for Return

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Today’s guest blogger is Professor Joni Larson of Thomas M. Cooley Law School where she teaches tax courses and serves as Assistant Director of the Graduate Tax Program. Prior to entering her teaching career, she clerked for Tax Court Judge Irene Scott and worked for the Office of Chief Counsel, IRS. She writes today on an issue of proof in a penalty case which tailors nicely with her book “A Pracitioner’s Guide to Tax Evidence” which is published in 2013 by the ABA Section of Taxation. She has also published a book entitled “Federal Tax Research” with her colleague Dan Sheaffer. We welcome Joni to our wonderful cadre of guest bloggers. Keith 

In Robertson v. Commissioner (T.C. Memo. 2014-143) the Tax Court continues it’s now-we-see-it-now-we-don’t treatment of the Commissioner’s substitute for return (SFR). This varied treatment arises when the court considers the additions to tax (often referred to as penalties) applied in a notice of deficiency, penalties routinely included in every notice, for a taxpayer who did not file a return.   

Three penalties are almost always applied together. The first penalty is based on timing and applies when the taxpayer files his return late (without having filed an extension request). The second penalty is based on not paying the tax. It applies when the taxpayer fails to pay the tax shown on his return. The third penalty is for not making necessary tax payments. Each taxpayer has an obligation to estimate his total tax liability for the year and make estimated tax payments, usually making no fewer than four payments. If no installment payments have been made, or they are insufficient in amount so that there is a tax deficiency at the end of the year, a penalty may apply. 


The facts in Robertson are those of a typical taxpayer who fails to file a return. Mr. Robertson did not file, nor pay taxes beyond what his employer withheld, for his 2009 year. The Commissioner calculated the amount of additional tax he owed and, to this amount, applied the three penalties and sent him a notice of deficiency. Mr. Robertson filed a petition with the Tax Court, contesting the deficiency and applicability of the penalties. 

Procedurally, there is an order for how contesting the penalties will play out in court. First, the taxpayer must put the penalties at issue. Usually he does this in the petition. Because Mr. Robertson questioned all the penalties in his petition, the Tax Court moved to the next step.   (If he had failed to put them at issue, he would have been deemed to have conceded the penalties and the argument would have been over and the penalties would have been applicable.) 

Next, the Commissioner must come forward with evidence it was appropriate to impose the penalty. This is referred to as the burden of production and is where the Commissioner ran into some trouble. 

In its summary of the facts, the Tax Court held that Mr. Robertson had failed to file an income tax return for 2009. It also found the IRS prepared an SFR, that the notice of deficiency was based on the SFR, and that the parties stipulated to an IRS transcript of the taxpayer’s account referencing the SFR. 

In its analysis the Tax Court quickly agreed there was a deficiency then turned to the issue of the penalties. The court was willing to consider the transcript (referencing the SFR) and find the Commissioner had met his burden of going forward for two of the penalties, the penalty for late filing and the penalty for failing to make estimated tax payments. 

With respect to the penalty for late filing, Mr. Robertson could have escaped liability if he could have shown the failure was due to reasonable cause and not willful neglect. He wasn’t able to do so, so the penalty applied. (Except in very limited circumstances, there is no reasonable cause exception for the failure to make estimated tax payments.) 

Even though the Tax Court had considered the transcript, and its reference to the SFR, for the first and third penalties, it balked at relying on the transcript when considering the penalty for failure to pay the tax shown on the return. For this penalty to apply, it wanted to actually see the SFR – it wanted to see a return that showed a tax liability due. And to be such a return, it had to be a valid return, or in Mr. Robertson’s case, a valid SFR. The court had addressed the issue of what constitutes a valid SFR several times in previous court opinions. 

In the distant past, the IRS would prepare SFRs that showed nothing more than the taxpayer’s address and social security number. These returns otherwise contained just zeros – no income reported and no tax liability due. The Court held such SFRs to be invalid. It tied this holding to the failure of the IRS to meet the requirements of Section 6020(b), the code section allowing the IRS to prepare an SFR. 

In Mr. Robertson’s case, there was plenty of evidence that the SFR existed and the parties agreed an SFR had been prepared. But, no actual SFR had been offered into evidence (nor did the Commissioner demonstrate it met the requirements of Section 6020(b)). When pointed in the direction of the transcript as evidence of the amount of tax Mr. Robertson had failed to pay, the Tax Court called it a mere “summary reference” and insufficient for the Commissioner to satisfy his burden of going forward. The Tax Court stuck to its literal reading of the statute, imposing the penalty based only on a tax shown on a return, and not the tax due but not unpaid. In sum, if no valid SFR was offered into the record, there would be no penalty for failing to pay the tax due. (This is not the first time the court has come to this conclusion. For prior cases see, for example, Wheeler v. Commissioner, 127 T.C. 200 (2006), aff’d, 521 F.3d 1289 (10th Cir. 2008) and Gardner v. Commissioner, T.C. Memo. 2013-67.) 

It is unclear why the Commissioner failed to introduce the SFR into the record. If the SFR was unavailable, he could have satisfied his burden by introducing evidence that the requirements of Section 6020(b) had been met. Or, if such evidence was not available, he might have turned to the Federal Rules of Evidence for help. 

The Tax Court applies the Federal Rules of Evidence (FRE). Under FRE Rule 1002, sometimes called the best evidence rule, the original writing generally is required to prove the contents of the document. (It is a rule of admissibility and does not determine the weight of the evidence admitted.) FRE Rule 1004 allows secondary evidence to be offered when the original has been lost or destroyed. To establish that the original is lost, the party must establish that a diligent but unsuccessful search for the document occurred. If the SFR had in fact been, say, lost, the Commissioner could have turned to the exception in FRE Rule 1004. If the Commissioner had shown a diligent search had been made for the SFR but it could not be located, might the court then have been willing to consider the transcript of account? 

Until a transcript of account is offered as secondary evidence of an SFR, it is not possible to know whether the court would consider relying on such evidence to impose the penalty for failure to pay the tax shown on the return. Accordingly, as the law currently stands, a transcript of account will be considered sufficient for imposition of the tax for failing to timely file the return and failing to make estimated tax payments but insufficient for imposition of the penalty for failing to pay the tax shown on the return. 




  1. Carl Smith says

    Professor Larson writes something that I am litigating, so I want to alert people. She writes:

    “Procedurally, there is an order for how contesting the penalties will play out in court. First, the taxpayer must put the penalties at issue. Usually he does this in the petition. Because Mr. Robertson questioned all the penalties in his petition, the Tax Court moved to the next step. (If he had failed to put them at issue, he would have been deemed to have conceded the penalties and the argument would have been over and the penalties would have been applicable.) ”

    What Professor Larson states is what the Tax Court has held as to the interaction of section 7491(c) (putting the initial burden of production on penalties on the IRS) with Tax Court Rule 34(b)(4) (providing that any issue not pleaded is conceded). In Funk v. Commissioner, 123 T.C. 213 (2004), and Swain v. Commissioner, 118 T.C. 358 (2002), the Tax Court held that the failure to mention penalties in the petition or later in the case constitutes a concession of all penalties, excusing the IRS from meeting any burden of production on penalties under 7491(c).

    In posts here in March and June, I have discussed the follow-up to the Rand case, where it appears many Tax Court judges are fixing the penalty base (per Rand) in cases where the petitions did not even mention penalties — thus, perhaps ignoring or in their minds, sub silencio, distinguishing Funk and Swain. Further, Judge Gale explicitly held, in unpublished orders in three such cases, that Funk and Swain do not apply where evidence in the record indicates that the penalty was miscomputed. Thus, sua sponte, he reduced or eliminated penalties that improperly included disallowed refundable tax credits, even though the petitions in the cases never even mentioned the penalties.

    There are two companion cases in the 9th Circuit in which I am litigating the issue of the Tax Court’s refusal to fix the Rand computational issue where the taxpayers raised a contest to penalties generally, but not as to the specific lack of underpayment issue posed in Rand, Morales v. Commissioner (discussed in these prior two posts). In Morales, the briefs are all in and we are awaiting oral argument. One of our arguments, however, is that the Tax Court’s Funk and Swain holdings are wrong. Pro se taxpayers rarely mention penalties in their Tax Court petitions. We think that Congress knew this when it enacted 7491(c) and meant 7491(c) to put the burden of production on the IRS with regard to penalties any time an individual taxpayer attaches a notice of deficiency containing penalties to her Tax Court petition — even though she does not mention the penalties in her petition. We think section 7491(c) trumps Tax Court Rule 34(b)(4)’s pleading rules. After all, section 7491(c) applies “notwithstanding any other provision of this title”, and only section 7453 of Title 26 allows for the Tax Court to promulgate rules of practice and procedure. No court of appeals has ruled on this pleading question. When the 9th Cir. does rule, I will send another post to be put up here.

  2. Bob Kamman says

    Has anyone actually seen a Substitute for Return? All I have seen — but this is not recent — is a transcript showing return filed with zero tax (150 transcript code) and then a subsequent assessment, in the amount of the Notice of Deficiency computation (the transcript code is in the 300 series). I think this has more to do with the decrepit IRS computer system, than anything that actually is backed up by paper documents. In fact, the Intenal Revenue Manual explanation of the Automated Substitute for Return program states: (05-19-2009)
    Preparing and Processing ASFR Dummy Return

    ASFR generates a TC 971 AC141 which triggers a dummy return to post to the module. No paper return exists. Do not attempt to request the DLN from files or try to associate anything with it.

  3. The IRS’s “Substitute for Return” is a misnomer. In fact, its existence violates the law.

    No law allows the IRS to create a mere “Substitute for Return.” Indeed, the very nomenclature is nonsensical. The taxpayer files no return. That means nothing exists for which something else can act as a “substitute.”

    In any event, if a person fails to file a required return (or files a false or fraudulent one), the IRS “shall make such return” from its own knowledge and the information it can obtain. I.R.C. § 6020(b). Cf. I.R.C. § 6012(a)(certain persons “shall” make income tax returns).

    Despite the command (or even the authorization) of 6020(b), however, the IRS NEVER makes an individual income tax return for a non-filer. I have never been able to figure out why. What the IRS does, as Professor Larson indicates, is place the individual’s name and address on a Form 1040 and make a few “0” entries. That “Substitute for Return” shows no tax at all. If a tax protester filed such a return, then the IRS would declare it frivolous.

    To answer Bob Kamman’s query, yes, I have seen many SFRs. His IRM reference, however, is only to the ASFR, i.e. the “Automated” Substitute for Return. The ASFR is the SFR’s equally bogus cousin.

    The IRS’s deliberate failure to make an actual individual income tax return on Form 1040 for a non-filer has fueled tax protesters’ beliefs for decades. They say if the federal income tax was mandatory, then the IRS would actually make a 6020(b) return for the non-filer. And the tax protesters have a point. For all taxes, except for the federal income tax, the IRS makes a return for a non-filer that it calls a “6020(b) return.” In contrast, for the federal income tax alone, the IRS calls its creation a “Substitute for Return.” It may sometimes add in “under 6020(b),” but the point is the same: why does the IRS not make full federal income tax returns for non-filers?

    To approach Professor Larson’s specific point, the courts say the presence or absence of an SFR is irrelevant to a deficiency determination. In 1996, however, it became very relevant to deficiency cases. That year, Congress enacted what is now I.R.C. § 6651(g). That section requires that the IRS make an I.R.C. § 6020(b) return before a non-filer can be liable for the I.R.C. § 6651(a)(2) addition to tax, which applies to a failure to “pay a tax shown on a return.” And as Carl Smith points out, I.R.C. § 7491(c) places the burden of producing evidence in support of that tax addition on the IRS. But the IRS still produces only the largely blank Form 1040, an examination report, and a “certification” that the whole paper pile (somehow) constitutes an actual 6020(b) return.

    Full disclosure: I am well versed on this subject for a good reason. I assisted the taxpayer in the Spurlock 6020(b) cases, 118 T.C. 155 (2002) and TC Memo. 2003-124.
    The latter Spurlock case compelled the IRS to stop asserting the I.R.C. § 6651(a)(2) addition to tax in all non-filer cases for nearly a year. In that time, the IRS scrambled to figure out how it could still assert that addition to tax—without, again for whatever reason, completing a Form 1040. So it added to its conglomeration of papers two “certification” forms; one for SFRs, one for ASFRs. According to the IRS, and now the Tax Court, either form produces a real 6020(b) return. Nonsense.

    If the Professor, or anyone else, wishes to learn more about why the IRS approaches the 6020(b) return/6651(a)(2) issue in the way it does, then please read the Spurlock cases first. After you do that, please read Chief Counsel Notices CC-2003-019, CC-2004-009, and CC-2007-005. At least in part, Spurlock inspired each Chief Counsel Notice.

    In closing, I must say I am alarmed at Professor Larson’s implication that the IRS should be able to rely on secondary evidence to meet its I.R.C. § 6651(a)(2) production burden. The failure to file a return and the failure to pay estimated tax additions are much different from a failure to pay a tax shown on a return addition. The first two tax additions require the IRS to show it possesses neither the person’s return nor any of his estimated tax payments. As applied to non-filers, however, I.R.C. section 6651(a)(2), is much different. That addition to the tax arises only when the IRS has made a return under I.R.C. section 6020(b). Without that return, though, how is the Court to determine (a) the return exists, (b) a tax is shown on that return, and (c) the exact tax amount shown on that return?

    In short, evidence that an event occurred must be stronger than the evidence that an event did not occur. Account transcripts do not make the grade. As I see it, the IRS has made its “Substitute for Return” bed; now it must “lie” in it.

    • Joni Larson says

      It is noteworthy that nothing in Robertson v. Commissioner suggests that whether a substitute for return can or cannot exist was at issue. The Court simply noted that one had not been entered in evidence. (However, by suggesting the IRS needed to have one in evidence to have the penalty imposed seems to suggest the court had no issue with the idea that one could exist.)
      There also seems to be some confusion about the rules of evidence versus the burden of proof or burden of persuasion. FRE Rule 1004 provides a means for having secondary evidence admitted into evidence when the original writing is not available. It is an evidentiary rule. It in no way impacts or alters a party’s burden of proof or burden of persuasion.

      • In I.R.C. § 6651(a)(2) cases, FRE 1004 is irrelevant. Professor Larson merely assumes “the original writing is not available.” Her assumption is the IRS actually made a “Substitute for Return” (the purported 6020(b) return), but it could not locate it. In Robertson, the Commissioner made no such claim. In fact, I don’t know of one case since 1996, the enactment year for I.R.C. section 6651(g), in which the Commissioner made that claim.

        The IRS simply failed to complete the required 6020(b) certification. Bob Kamman alludes to the reason: the IRS computed Robertson’s deficiency automatically, based on information returns others filed with respect to him; it did nothing else. See Robertson at *3.

        I’m still mystified why Professor Larson thinks it good tax practice to weaken the taxpayer’s protection that I.R.C. § 7491(c) embodies.

  4. On a tangential but related matter while I.R.C. § 6651(a)(2) which applies to a failure to pay a tax shown on a return and other code section refer to “addition to tax”, I have noticed the IRS Chief Counsel attorney in her/his Answer filed to my recent Petitions is “Denying” that there is an addition to tax and pleading instead there is a “penalty” pursuant to whatever section is listed on the Stat Notice and suggesting they will file a 37(c) Motion if I do not file a Reply to the Answer. Regardless whatever nomenclature is given to this, so long as it placed at issue in the Petition I do not see this as changing a party’s burden of proof or burden of persuasion. Has anybody seen a different outcome?

    • Carl Smith says

      7491(c) puts the burden of production on the IRS “in any court proceeding with respect to the liability of any individual for any penalty, addition to tax, or additional amount imposed by this title”. So, it shouldn’t matter whether an item is a penalty or addition to tax for 7491(c) to apply.

    • I can’t imagine that the “addition to tax” v. “penalty” distinction alone would warrant a reply, let alone a Rule 37(c) motion to compel one. As Carl Smith points out, under 7491(c), the distinction makes no difference to the production burden.

      In my experience, when a SNOD asserts a 6651(a)(2) amount, that notice shows it as an “addition to tax.” You do not, though, expressly state that your SNOD mentions 6651(a)(2).

      I suspect, then, that you are disputing either a 6662 (accuracy-related) or 6663 (fraud) amount(s). The Code does denominate each of those impositions as a “penalty,” rather than as an addition to tax. Again, though, it makes no difference to the Commissioner’s burden of producing evidence to support an accuracy-related penalty. On any fraud penalty, however, the Commissioner bears the burden of proving it by clear and convincing evidence.

  5. Bob Kamman says

    I admit that in the tax seas where I swim, automated SFR’s are the only fish. I suspect that’s true of cases that come to taxpayer clinics, also. Do field and ACS collection employees actually prepare any of these manually?

    • I have seen ROs prepare actual 6020(b) returns, i.e. on completed Forms 940, 941. Examiners prepare manual SFRs, generally in “high income non-filer” cases. The Examiner will correspond with the reported payor(s) to verify the accuracy of the filed information returns (because of the 6201(d) burden of production requirement). The amount(s) the payor(s) verify results in the starting point for the Substitute for Return. But you’ll never see an amount shown on the Examiner’s Form 1040 that he or she supposedly “makes” for the taxpayer under 6020(b). To me, that omission renders the resulting 6651(a)(2) failure to pay addition to tax invalid….no tax shown on a return = no addition to tax for failure to pay a tax shown on a return.

  6. While some SFRs are prepared automatically, others are prepared manually. In my experience as an IRS Revenue Agent, taxpayers under examination frequently refused to file certain subsequent year tax returns fearing the imposition of a fraud penalty. If the year(s) under audit were adjusted for such issues as overstatement of expenses and under statement of income and it was determined the same issues would continue to exist in subsequent years, the taxpayer was often advised by his or her attorney not to file an unfiled subsequent year return. Consequently, an SFR was created and the taxpayer presented with the proposed tax. Often, it took the form of an examination report. If the taxpayer refused to agree, the case was often closed to the 90-Day Statutory Notice of deficiency. After the allowable time had passed, if the taxpayer continued to ignore the proposed deficiency, the taxes were assessed. How would a situation like this play out in court if failure to pay penalties and other penalties were assessed?

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