Some Facts About the Walquist Case, Along with Some Nuance

Frequent guest blogger Bob Kamman put his formidable investigative skills to work to bring us an in-depth look behind the Walquist opinion. Christine

“Everyone is entitled to his own opinion, but not to his own facts.”
–Daniel Patrick Moynihan

“Facts, sir, are nothing without their nuance.”
–Norman Mailer

The Tax Court is certainly entitled to its opinion in Walquist v. Commissioner, 152 T.C. No. 3, which Keith Fogg blogged here. But a review of the record and other public documents yields facts that may contradict those cited in the opinion, or at least provide some meaningful nuances. Serious questions are therefore raised about its precedential value.

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 Here are what the Tax Court found to be some of the facts:

R through his Automated Correspondence Exam system determined, for Ps’ 2014 tax year, a deficiency in tax and a penalty for an underpayment attributable to a substantial understatement of income tax. R’s computer program generated a 30-day letter inviting Ps to reply and submit relevant information. When Ps declined to respond, the program generated and issued to them a notice of deficiency in the form of a Letter 3219. This letter again invited Ps to contact R, but they did not do so.

Here is what actually happened:

Petitioners filed their 2014 Form 1040 with a paper return that was received by the Fresno Service Center on April 2, 2015. It must have been placed in the “Funny Box” (see Internal Revenue Manual 3.10.73.3.4) because it was stamped “Frivolous Return Program – Internal Revenue Service – Fresno CA” on that day. The next stop in its processing was April 13, 2015, when it was stamped “Received – FRP 306.”

The taxpayers had added to the jurat (declaration under penalty of perjury, just above their signatures), “This return is in accordance with 12 USC 411, 12 USC 95(a)(2), [illegible].” Those sections are used by tax protesters who claim income is not taxable unless paid or measured by Federal Reserve notes, or something like that.

They also wrote “Demand for Lawful Money Reduction” on Line 21, with a bracketed amount of $87,647.96 to indicate a loss. The pretrial memorandum correctly transcribes the first word as “Demand” but a later pleading erroneously changed it to “Remand.”

The next we see of the return is an internal IRS Form 8278, “Assessment and Abatement of Miscellaneous Civil Penalties,” dated July 27, 2015 and signed by “Ms. Bluemel” as originator and Krista Decaria as manager and reviewer. (They work not in Fresno, but at the IRS Ogden Service Center.) It assesses a $5,000 penalty for a frivolous tax return. Assessment of this penalty is not subject to deficiency procedures. In its “Remarks” section, the Form 8278 states “Argument 29.” IRM 25.25.10.2 explains this as “Any other position deemed frivolous.”

The Walquists filed a joint return. Both spouses had W-2 income. Craig Walquist earned $20,113 from two employers, with $624 federal income tax withheld. Maria Walquist earned $59,840 from one employer, with $5,105 withheld. The total withholding from W-2 forms was $5,729 but their return claimed $5,730.69. In August 2015, IRS grabbed the $5,000 penalty from this amount. That left $730.69, which was applied to taxes they owed for 2008. Then IRS allowed $54.12 interest from April 15 on the “overpayment.” That amount went to 2008, also.

All of these facts come from IRS pleadings in the Tax Court case. To find out what happened between August 2015 and August 2017, when the Notice of Deficiency was issued, we must look elsewhere. Did IRS just throw the fishy 1040 back in the sea of returns, only to have the audit commence again because of some unreported income? Fortunately, the taxpayer attached some IRS correspondence to the lawsuit he filed in the District Court for Minnesota. But first, let’s look at some more facts from the Tax Court opinion.

Alerted to petitioners’ underreporting by computer document matching, the IRS processed the examination of their return through its Automated Correspondence Exam (ACE) system, employing its Correspondence Examination Automated Support (CEAS) software program. This software is designed to process cases ‘with minimal to no tax examiner involvement until a taxpayer reply is received.’ Internal Revenue Manual (IRM) pt. 4.19.20.1.1 (Dec. 18, 2017).

On July 26, 2017, the CEAS program generated and issued to petitioners a Letter 525, General 30-Day Letter. In cases such as this–where the understatement of income tax calculated by the program exceeds the greater of $5,000 or 10% of the tax required to be shown on the return–the program systematically includes in the letter a substantial understatement penalty. See sec. 6662(b)(2), (d)(1)(A). The program accordingly calculated a penalty of $2,766.40, or 20% of the proposed deficiency of $13,832. See sec. 6662(a).

What Walquist attached to his District Court complaint, though, is a Letter 525 dated June 30, 2017. It says, “We’re auditing your 2014 Form 1040, and need a response from you.” Attached to the letter is a computation showing a balance due of $18,003. This included $13,832 tax; $2,766 Section 6662 penalty; and $1,405 interest. In a box on the Letter 525 for “Examiner’s Signature,” there is printed “Tax Examiner”; and in the box for “Employee ID,” the number 1000099771.

The Letter 525 adds, “let us know by July 30, 2017 if you agree or disagree with our proposed changes.” The Walquists both signed a two-page, single-spaced letter dated July 26, 2017, asserting tax-protester arguments based on Federal Reserve notes. (There is no proof it was mailed, but no reason to believe it was not. It would not have accomplished anything, anyway). IRS responded with the August 30, 2017 Notice of Deficiency.

In addition to his $20,113 of W-2 income, Walquist received $14,159 in “non-employee compensation” reported on Forms 1099-MISC, which IRS determined was subject to $2,001 self-employment tax. He also received $1,215 in unemployment compensation.

As IRS stated in a November 26, 2018 filing, “respondent’s determinations are chiefly based on a misclassification of income rather than underreporting of income by petitioners.” In other words, the $14,159 of self-employment income should not have been reported as wages, but instead shown on Schedules C and SE.

The Notice of Deficiency shows the same employee identification number as the Letter 525. It is attributed to Christine L. Davis, from Ogden’s “Return Integrity and Compliance Services, Integrity and Verification Operation.” That IRS office “detects, evaluates and prevents improper refunds.”

As it turned out, the software that IRS relied on to figure the tax did not produce an accurate result. It was only after the Tax Court petition was filed that IRS Counsel reduced the $13,832 amount to $12,220, and the $2,766 Section 6662 penalty to $2,444. A $60 filing fee saved the taxpayers $1,934 plus interest. They should have quit while they were ahead. The Tax Court also corrected its error in ordering them to pay the filing fee, before it found that it had already been received. Perhaps it was paid in Federal Reserve notes which caused some accounting problems.

Some more facts from the Tax Court:

Whether an accuracy-related penalty determined by an IRS computer program is a ‘penalty automatically calculated through electronic means’ does not appear to have been decided in any published Opinion of this Court. . . .The penalty at issue was calculated and instantiated in letter form by a computer software program. Because the computer did this without human intervention, no ‘individual making such determination’ appears to exist.

Yes, “instantiated” is a word. But that part about human intervention?

In its pretrial motion dated October 5, 2018, the IRS attorney informed the Court:

Respondent determined that petitioners were liable for an I.R.C. §6662 accuracy-related penalty for their 2014 tax year. I.R.C. § 6662 (a). Respondent is able to satisfy its burden of production with respect to this penalty. I.R.C. § 6751 requires respondent to furnish evidence of managerial approval of the accuracy-related penalty prior to the issuance of the notice. As an exhibit to respondent’s September 5, 2018 motion to dismiss, respondent submitted a signed Declaration and Case History demonstrating managerial approval of the accuracy-related penalty in this case prior to issuance of the notice. As such, respondent is able to meet its burden of production.

In other words, in a case where the Tax Court saw no human intervention in a tax-protester audit, the IRS itself saw the need for managerial approval of a Section 6662 penalty, and confirmed it was done.

But maybe that is not the precedent the Court intended to establish with this case. Maybe the message is the $12,500 penalty it assessed under Section 6673, for taking a position in Tax Court that was frivolous or groundless.

The maximum penalty that could have been assessed is $25,000. It might not be coincidence that $12,500 nearly matches the amount of tax, $12,220, that should have been shown on the Walquists’ frivolous return. That does not include the $5,000 penalty they had already paid to IRS.

The Tax Court penalty can now be collected from either spouse. In 2014, Mrs. Walquist was the primary breadwinner, responsible for 63% of the income. Filing separately, she still would have owed more than $3,000 tax. But there is little evidence that she is the primary tax protester. She was not a plaintiff in the District Court case. An IRS notice attached to that complaint indicates that for 2016 her husband filed separately, and was again penalized $5,000. It is the husband who has self-published a book that asks such questions as, “Have American Christians erred in assuming our country is Biblically on the side of good?”

I searched Tax Court opinions from 2017 to date for cases involving joint returns where the Section 6673 penalty was considered. Most such cases during this period involved taxpayers who are unmarried or filing separately.

I found two cases involving joint returns. In one of them, Henry and Kathy Jagos, TCM 2017-202, the taxpayers had income of $544,167 in 2012. They denied owing tax because they “are private-sector citizens (non-federal employee) employed by a private-sector company (non-federal entity) as defined in 3401(c)(d).”

From the Court’s opinion:

At trial the Court encouraged the Jagoses to abandon their frivolous arguments and cited specific authorities for them to consider. The arguments raised in their 70-page brief were a rehash of the very same arguments that were dispatched in those cases. And the Jagoses have raised frivolous arguments at every stage of this process from their 2012 income tax return to their closing brief. For disregarding the cases cited to them and wasting the Court’s resources with their frivolous arguments, we impose a sanction under section 6673 . . .

The Court found that they owed $155,149 in tax – but assessed only a $1,000 penalty under Section 6673.

In the other case, Michael Wells and Lynn Kirchner-Wells, TCM 2018-188, the Court noted:

Petitioners also attached Forms 4852, Substitute for Form W-2, Wage and Tax Statement, to each of the returns indicating zero wages and the same amounts of tax withheld as was shown on each Form W-2. The Forms 4852 included the following tax protester statements: I am a private-sector worker, not an ‘employee’ as defined in IRC 3401(c) and IRC 3121. I worked with a private-sector company, not a federal employer as defined in IRC 3401(d). I did not engage in a ‘trade or business’ as defined in USC Section 7701(a)(26).

The tax deficiency was $52,051, but no Section 6673 penalty was assessed. “The Court may on its own determine whether to impose a penalty not to exceed $25,000 when it appears to the Court that a taxpayer’s position is frivolous or groundless. Sec. 6673,” Judge Gerber wrote. “We did not find in the record that petitioners have made these or similar frivolous claims in the Court before or that they have been previously forewarned. Thus we will not impose one here, nor does respondent seek a section 6673 penalty in this case.”

Has the Tax Court now announced an end to leniency for tax protesters? At least the Walquist case suggests that those with frivolous arguments (and their spouses) should stick to the facts, and keep their opinions to themselves.

Five Things to Know About FedEx and the Tax Court

Today Bob Kamman explores FedEx issues in Tax Court and brings us several interesting findings. The bottom line for practitioners (as always) is to be aware of the jurisdictional perils that await those who cut it close without carefully checking the list of designated private delivery services. Christine

Inspired by Keith Fogg’s post about the Tax Court petition that could not be delivered by FedEx during the January 2019 government shutdown, I searched recent Tax Court orders for similar cases. Here are five things I learned.

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1) You can’t always trust word searches on the Tax Court website.

I searched for orders with the word “FedEx” from October 1, 2018 through May 28, 2019.  The search returned three hits.  Then I searched for “FedEx” from April 30, 2019 through May 28, 2019.  That search returned ten hits.  So I searched for “FedEx” from only November 1 through December 31, 2018.  That search returned five hits, none of which were in my first search.

My conclusion, or at least hypothesis, is that the search “times out” after a certain number of orders are searched.  Results will be more accurate if done by month, rather than for longer periods. 

2) The case described in Keith’s post is not unique.

In the Awad case, in response to an earlier order the Court writes

The petition, filed January 30, 2019, arrived at the Court in an envelope with a FedEx ship date of January 29, 2019. . . . petitioners indicated that the petition was originally mailed to the Tax Court on January 16, 2019, (2) petitioners provided respondent a copy of the envelope in which the petition was originally sent to the Tax Court on January 16, 2019, a copy of which was attached to the Response, and (3) petitioners also provided respondent a copy of the envelope in which the petition was returned to them, a copy of which was attached to the Response.

It is not clear whether the first attempt was through the U.S. Postal Service, or through FedEx.

And then there is the unfortunate petitioner in Chicas, whose deadline for filing was December 31, 2018 – a date the government was closed.  He used UPS Ground to send his petition on January 3, 2019.  It was returned by UPS, and he sent it again by UPS Ground on February 22, 2019.  He was late the first time, and UPS Ground is not an acceptable service anyway. 

3) IRS does not always question jurisdiction.  Sometimes it needs help from the Tax Court.

That is what happened in Powerhouse Mortgage Corporation.  In dismissing the case on November 29, 2018,  Judge Foley explained,

Attached to the petition was a notice of determination concerning collection action dated July 17, 2018 . . .The petition had been received by the Court in an envelope sent by FedEx Express Standard Overnight and bearing a ship date of August 17, 2018. An answer to the petition followed on October 9, 2018, but did not address jurisdictional matters. Nonetheless, because review of the record suggested a fundamental jurisdictional defect, the Court by Order dated October 12, 2018, directed the parties, on or before November 2, 2018, to show cause in writing why this case should not be dismissed for lack of jurisdiction, . . .Shortly thereafter and in lieu of a response, respondent on October 17, 2018, filed a Motion To Dismiss for Lack of Jurisdiction on the identical ground of an untimely petition.. . .petitioner was afforded additional time, until November 9, 2018, to object to respondent’s motion as well. 

The petitioner did not respond, and the motion to dismiss was granted.

See also Jones, dismissed by Judge Foley on December 3, 2018.  IRS didn’t notice that the petitioners not only were late, but used the wrong FedEx service.  However, the Court did:

The petition in the above-docketed proceeding was filed on September 4, 2018. Therein, petitioners alleged dispute with a notice of deficiency dated June 1, 2018, issued with respect to the 2015 and 2016 taxable years. The petition had been received by the Court in an envelope sent by FedEx Express Saver and bearing a ship date of September 1, 2018. Unexpectedly, respondent thereafter on September 21, 2018, filed an answer to the petition, not addressing the matter of timeliness.

Nonetheless, because review of the record continued to suggest a fundamental jurisdictional defect, the Court at that juncture issued an Order To Show Cause dated October 24, 2018, directing the parties to show cause in writing why this case should not be dismissed for lack of jurisdiction, on the ground that the petition was not filed within the time prescribed by section 6213(a) or 7502. . . . In particular, the Order To Show Cause noted, first, that the date of the notice of deficiency underlying this proceeding indicated a statutory deadline for filing a petition pursuant to section 6213(a) . . .that expired on August 30, 2018, and, second, that FedEx Express Saver is not a designated private delivery service for purposes of the section 7502 . . . timely mailing provisions.

Substantially the same facts have also led Judge Foley to request both parties in Rodriguez to explain by June 11 why the case should not be dismissed when FedEx Express Saver was used and the petition was not received by the required date.  This May 22, 2019 order is somewhat confusing because it states the FedEx envelope “reflects a ship date of August 25, 2019.

I am sure that will be cleared up in later proceedings.  Maybe it was just another FedEx mistake, as happened in Muramota.  In that case, the petition was “in an envelope indicating that the petition was received and processed by FedEx on May 15, 2018, for delivery by FedEx 2-day mail.”  But when Judge Thornton questioned jurisdiction, because the last date to petition was May 14, 2018, “the parties are in agreement that the petition was delivered to FedEx on May 14, 2018, as evidenced by a receipt provided by petitioners’ counsel, and the petition was therefore timely mailed.”  A stipulated decision was entered the same day.

4) Petitioners continue to use FedEx services that do not qualify for “timely mailed” recognition.

Judge Foley’s four-page order of February 25, 2019,  dismissing the Thompson case explains why FedEx Express Saver service is not a qualified “private delivery service.”  The petitioners had noted that they followed the instructions on the second page of their Notice of Deficiency, which apparently did not explain “private delivery service” limitations.  I looked at a couple Notices of Deficiency from 2018 and did not find a reference to private delivery services on them. 

Similar language was used by Judge Foley in his four-page order of February 4, 2019, dismissing Griffiths.

5) The Tax Court uses FedEx also.

When it absolutely positively has to get there faster than the Postal Service can deliver, or when there may be other benefits, the Tax Court uses FedEx to contact Petitioners.  (It probably gets a discounted government rate.)  

For example, in McPhee,  “On May 7, 2019, the Court was informed of an unsuccessful delivery attempt by FedEx of the Notice of Change of Beginning Date of Session, served on petitioners on May 1, 2019. Petitioners subsequently advised the Court that their address has changed. . . .”

Undesignated Orders: All in a Day’s Work for a Tax Court Judge

Today frequent guest blogger Bob Kamman takes us through a day in the life of a Tax Court judge, as viewed through the non-designated orders that occupy much of the Court’s day-to-day time. Christine

Much can be learned from the Designated Orders selected by Tax Court judges as noteworthy among the hundreds of orders issued each day. But sometimes we may learn just as much from those that are not designated. For examples, let’s shadow Judge David Gustafson for one day, as he works through his in-box to move cases along.

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These are all lessons from May 2, 2019. They include:

  1. A taxpayer (Augustine) hopes to get help from a Low-Income Taxpayer Clinic.
  2. A taxpayer (Pendse) wants a trial later this month because she will be out of the country for more than a year.
  3. Taxpayers (Emanouil) whose co-counsel wants to withdraw, but forgets to sign the motion.
  4. A taxpayer (Miruru) whose case was dismissed with tax deficiency upheld after failure to appear at trial and to respond to an IRS motion.
  5. A taxpayer (Baba) gets a second chance from IRS Appeals but has not confirmed he wants it.
  6. Taxpayers (Reuter and Stovall) have not returned proposed decision documents to IRS after a settlement seems to have been reached.
  7. A partnership (Cross Refined Coal) in whose case IRS has filed a motion to compel.
  8. A taxpayer (Insinga) in a 2013 whistleblower case, whose latest filing needs to be sealed without redactions.
  9. Taxpayers (Houchin) whose 2013 case will be continued again, as they and IRS requested, but not on Judge Gustafson’s calendar. (The docket shows a bankruptcy filing.)
  10. Taxpayers in two cases (Lugo, and Abdu-Shahid) in which IRS Counsel misfiled documents.

Darline Augustine, Docket 12248-18

Pro Se, New York

The Commissioner filed a motion for summary judgment (Doc. 7) in this “collection due process” (“CDP”) case. We ordered petitioner Darline Augustine to file a response by March 1, 2019, and we did our best to explain the nature of the IRS’s motion and what she should state in a response. (See Doc. 9.)

Ms. Augustine requested more time to submit her response (see Doc. 13), so we gave her until April 15, 2019 (see Doc. 14). On that date she filed a one sentence letter (Doc. 15) that did not respond substantively to the motion. By order of April 22, 2019 (Doc. 17), we allowed her to file a supplemental response by no later than May 6, 2019. On April 29, 2019, we received from Ms. Augustine another letter (Doc. 18), which informed us that she is getting the help of a Low Income Tax Clinic, and which states: “With regard to the reply to the summary judgment, I will have to get assistance from a low income legal service. I am not an attorney and legal language is quite opaque to me.” No attorney from an LITC has filed an entry of appearance in this case.

Ms. Augustine’s letters have asserted that she wants to appear before the Tax Court. Trials are conducted, however, to resolve disputes of fact. If there are no material facts that are disputed, then there is no need for a trial. The Commissioner’s motion purports to show that no trial is needed in this case because (the motion says) the undisputed facts show that the IRS is entitled to prevail. To preserve her opportunity for a trial, Ms. Augustine must show why we should not grant the Commissioner’s motion. We will give her one more opportunity to do so. It is

ORDERED that, no later than June 3, 2019, Ms. Augustine shall file any supplemental response to the Commissioner’s motion that she wishes to file. If she intends to obtain the assistance of an LITC, then she will need to obtain it in time to meet that deadline. In the absence of the entry of an appearance by an attorney representing Ms. Augustine, we would not expect to grant her any further extension of this deadline. It is further

ORDERED that, no later than June 24, 2019, the Commissioner shall file a reply to Ms. Augustine’s supplemental response, if she files one; or, if she does not file a supplemental response, then the Commissioner shall file a status report so stating.

Shona Pendse, Docket 25665-17

(Pro Se, Boston before taxpayer relocated)

Now before the Court is petitioner’s motion to calendar this case for trial this month. We will deny the motion.

This case was scheduled to be tried at a Boston session of this Court on April 1, 2019, but at the joint request of the parties, it was continued. The place of trial was changed to Washington, D.C., and the case was thereafter scheduled to be tried at a trial session beginning September 16, 2019. Petitioner wants a more prompt trial, and she says that she must be out of the country from June 2019 through August 2020. She therefore requested that the case be set for trial at a special trial session in Washington beginning May 21, 2019, at which the undersigned judge will coincidentally be presiding. Respondent objects. Counsel states that he received information from petitioner in April that prompted an inquiry by which he learned of a related refund case that is pending in U.S. district court, that involves a different taxpayer, and that is being handled by the U.S. Department of Justice. Counsel states that it is necessary to coordinate the two cases and that he cannot be ready for trial in this case in May 2019. Petitioner does not dispute the relatedness of the cases but maintains that respondent should have known about the related case already and should now be ready to proceed.

Even if we were otherwise inclined to grant petitioner’s motion, it might not be practical to try to fit this case into the special trial session beginning May 21, 2019. A special trial session is set based upon the anticipated situation and needs of the case being scheduled, and in this instance the other case set for that session is likely to use all of the available time in that session. Moreover, respondent’s counsel’s expressed need to coordinate this case with the refund case is plausible, and while perfect coordination of information between Chief Counsel and the various units of the IRS–and between Chief Counsel and the Department of Justice–might bring efficiencies, it would do so at a sometimes great cost, so we do not fault Chief Counsel nor his client agency for counsel’s unawareness of the related case before petitioner disclosed it to him.

Because we will deny the motion to calendar, this case remains on the calendar for the regular trial session in Washington, D.C., beginning September 16, 2019. However, we do not overlook petitioner’s scheduling difficulty with that trial session, and this order is without prejudice to any motion petitioner might make to continue this case from that trial session. We would consider any such motion on its merits. It is

ORDERED that petitioner’s motion to calendar is denied.

Peter C. & Pascale Emanouil, Docket 5089-17

(2-Day Trial in Boston, October 2018)

On April 25, 2019, an unopposed motion to withdraw as counsel of record was filed on behalf of Nicholas F. Casolaro. The motion states that co-counsel Richard M. Stone and Peter D. Anderson will continue as counsel for petitioners in this case. That motion, however, was not signed by Mr. Casolaro in compliance with Tax Court Rule 24(c), which requires that counsel seeking to withdraw his appearance must file a motion with the Court requesting leave to do so. It is therefore

ORDERED that, no later than May 7, 2019, counsel for petitioners shall file an amendment to the unopposed motion to withdraw bearing the signature of Mr. Casolaro in compliance with Rule 24(c).

Mbugua J. Miruru, Docket 25168-17

(New Hampshire, Pro Se)

When this case was called from the calendar for the Court’s March 11, 2019, Boston, Massachusetts, trial session, there was no appearance by or on behalf of petitioner Mbugua J. Miruru. Counsel for the Commissioner appeared and filed a motion to dismiss for lack of prosecution. In that motion, the Commissioner moves the Court to enter a decision with respect to Mr. Miruru in the amount for the tax year 2015 set forth therein. By order dated March 11, 2019 (served March 18, 2019), the Court directed Mr. Miruru to file a response to the Commissioner’s motion to dismiss on or before April 10, 2019. As of this date, the Court has received no response from Mr. Miruru. It is therefore

ORDERED that in addition to regular service, the Clerk of the Court shall serve a copy of this Order of Dismissal and Decision on Mr. Miruru at the additional address (in Bristol, New Hampshire) that appears on the certificate of service attached to the Commissioner’s motion. It is further

ORDERED that the Commissioner’s motion to dismiss for lack of prosecution is granted, and this case is dismissed for lack of prosecution. It is further

ORDERED AND DECIDED that there is a deficiency in income tax due from petitioner Mbugua J. Miruru for the tax year 2015 in the amount of $4,538.

Abu Baba, Docket 13186-18

(Virginia, Pro Se)

On April 26, 2019, the Commissioner filed two motions: (1) a motion for continuance [i.e., for a postponement] of the trial of this case, and (2) a motion for remand, in which it asks the Court to remand the case to the IRS’s Office of Appeals for further consideration. A continuance and remand would be welcome to many petitioners in a case such as this one, but the motions state that the Commissioner does not know whether petitioner Abu Baba objects to the motions. It is therefore

ORDERED that, no later than May 14, 2019, Mr. Baba shall file with the Court and serve on the Commissioner a response to the Commissioner’s two motions filed April 26, 2019.

Janet Ann Reuter & David Stovall, Docket 15641-17

(New York, Pro Se)

On May 1, 2019, the Commissioner filed a motion for entry of decision. The motion alleges that the parties have reached a basis of settlement and that counsel for the Commissioner sent to petitioners a proposed decision document effectuating that settlement, but indicates that petitioners have failed to return the decision document to counsel for the Commissioner. It is therefore

ORDERED that, if petitioners objects to the Commissioner’s motion for entry of decision, then on or before May 15, 2019, petitioners shall file with the Court and serve on the Commissioner a response to the motion, explaining why that motion should not be granted and a decision entered in this case.

Cross Refined Coal, LLC, Docket 19502-17

(Counsel for Both Parties in Chicago; Boston Trial Request)

On April 26, 2019, respondent filed a motion to compel (Doc. 50). It is

ORDERED that petitioner shall file a response by May 10, 2019, and that respondent shall file a reply by May 23, 2019.

Robert J. & Linda C. Houchin, Docket 27654-13

(Nevada; Counsel for Both Parties and Trial in Los Angeles)

In accordance with the parties’ joint recommendation in their status report filed April 29, 2019, it is

ORDERED that the undersigned judge no longer retains jurisdiction over this case and that this case is continued generally.

Joseph A. Insinga, Docket. 9011-13W

(New Jersey; Washington DC Trial)

(Petitioner Counsel in Memphis; IRS Counsel in Detroit)

 On April 26, 2019, petitioner filed a first amended reference list of redacted information (Doc. # 258). It is therefore

ORDERED petitioner’s first amended reference list of redacted information (Doc. 258), is sealed. It is further

ORDERED that the Clerk of the Court shall remove from the Court’s public record the first amended reference list of redacted information (Doc. 258), and that these documents shall be retained by the Court in a sealed file which shall not be inspected by any person or entity except by an Order of the Court.

Wanda M. Lugo, Docket 15028-18

(New York; Pro Se)

On May 1, 2019, the Commissioner mis-filed in this case a motion for extension of time (Doc. 10) that was obviously intended to be filed in another case. It is therefore

ORDERED that the Commissioner’s motion filed May 1, 2019 (Doc. 10), is stricken from the Court’s record in this case and shall not be viewable as part of this case.

Abdu-Shahid May, Docket 11654-18

(New York; Pro Se)

On May 1, 2019, the Commissioner mis-filed in this case a motion for extension of time (Doc. 12) that was obviously intended to be filed in another case. It is therefore

ORDERED that the Commissioner’s motion filed May 1, 2019 (Doc. 12), is stricken from the Court’s record in this case and shall not be viewable as part of this case.

What sort of day was it? “A day like all days, filled with those events that alter and illuminate our times… all things are as they were then, and you were there.” (If you were not a television viewer before 1972, you may not recognize that quotation from Walter Cronkite.) As this review demonstrates, a Tax Court judge in just one day may make a wide range of decisions –- for individuals and businesses disputing large amounts of tax and small ones; in collection due process matters; and even in whistleblower cases. Most of this work will not be found in published opinions and designated orders. What all of the cases have in common, though, is that each is the most important one before the Court, for the petitioner (and counsel, if any) involved.

When A Promise to Pay Is Not A Debt

In this post, frequent guest blogger Bob Kamman provocatively explores possible links between the Thrift Savings Plan, tax refunds, and the federal debt limit. Christine

An army of accountants and lawyers is standing by while its employer cooks the books of their pension plan, but it’s nothing you should expect a special prosecutor to investigate.

That’s because their employer is the federal government, and the consent of IRS professionals along with all of their colleagues in other agencies and the military who participate in the Thrift Savings Plan was never requested. Like a shutdown with mandatory work hours, they have to take it or leave.

This situation arose when the federal debt limit returned on March 2, after being suspended for a year. Congress has told the Treasury not to borrow any more money. However, Congress has also told the government to spend more money than it collects. Treasury has a solution to this paradox, at least for the short term. It makes a side deal, off the books, with the employees who pay into the federal equivalent of a 401(k) retirement savings plan.

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The Thrift Savings Plan (TSP), created in 1986, allows investments in several funds based on the stock or bond markets. The most popular is the “G” fund, which invests in a special variable-rate United States Treasury bond. Last year its rate of return was 2.91%. Today it earns 2.50%.

What could be safer than Treasury bonds, right? But right now the Treasury can’t issue those bonds, because of the pesky debt limit. So Treasury simply promises to sell them to TSP just as soon as Congress allows. Meanwhile, accounts are credited with interest as if these phantom bonds really existed. For those who want to withdraw their funds or take out an allowable loan, the account value includes this phantom interest.

On March 5, the Thrift Savings Plan assured federal employees that the TSP money in their “G” spot was safe. It issued a statement:

As of Tuesday, March 5, 2019, the U.S. Treasury was unable to fully invest the Government Securities Investment (G) Fund due to the statutory ceiling on the federal debt. However, G Fund investors remain fully protected and G Fund earnings are fully guaranteed by the federal government. This statutory guarantee has effectively protected G Fund investors many times over the past 30 years. G Fund account balances will continue to accrue earnings and will be updated each business day, and loans and withdrawals will be unaffected.

Further details on this scheme are provided in an article on the Govsmith website.

Why does this matter to tax law practitioners? Maybe it doesn’t. But in my mind, it’s a useful reminder that federal government employees, including those at IRS with whom we occasionally interact, face different challenges from many of the rest of us.

More importantly, the future of the IRS depends on recruiting qualified professionals to protect the Treasury’s revenue without violating taxpayer rights. The IRS “brain drain” is a real problem. The GAO recently reported that attrition is causing a serious risk to the IRS mission:

IRS officials told GAO that resource constraints and fewer staff with strategic workforce planning skills due to attrition required IRS to largely abandon strategic workforce planning activities. …

IRS staffing has declined each year since 2011, and declines have been uneven across different mission areas. GAO found the reductions have been most significant among those who performed enforcement activities, where staffing declined by around 27 percent (fiscal years 2011 through 2017). IRS attributed staffing declines primarily to a policy decision to strictly limit hiring. Agency officials told GAO that declining staffing was a key contributor in decisions to scale back activities in a number of program and operational areas, particularly in enforcement, where the number of individual returns audited from fiscal years 2011 through 2017 declined by nearly 40 percent.

While reduced budgets and government shutdowns bear most of the responsibility for the IRS brain drain, underfunding the Thrift Savings Plan can only make matters worse. Imagine a Chief Counsel recruiter at a law school campus, trying to answer questions about this make-believe bookkeeping.

On the other hand, the Thrift Savings Plan might be easier to sell because it is guided by BlackRock, one of the world’s largest money managers with nearly $6 trillion of assets under supervision. BlackRock recently disclosed  that its funds have an $11 million stake in Curaleaf Holdings, a Massachusetts-based medical cannabis company.

TSP does not yet have a W fund, for investments in the marijuana industry. But to my knowledge, no one has yet ruled it out.

Meanwhile, I am still wondering whether a record $45 billion in tax refunds was paid out on February 27, as I reported here, because the new debt limit was based on how much the federal government owed on March 1. Did Treasury tell IRS to clean out the bank account because the balance sheet needed to show as little cash as possible?

My suspicions grew when I saw the refund check my clients received that was dated March 1, based on an amended return they had filed in August. The explanation for the refund (“this is what you asked for with the amended return”) was not dated and mailed until March 11. Checks seldom arrive at the same time as the notices that explain them, but a ten-day lag seems unusual.

But I digress. At some point federal employees’ tolerance for TSP shenanigans may grow thin. Congress cannot afford to worsen the already critical brain drain at our nation’s revenue collection agency.

Refund checks, and other “news” inspired by the IRS

We welcome back guest blogger Bob Kamman. Today Bob delves into the “real-time” tax return statistics available during the filing season. Christine

You might remember February 27, 2019 as the day of a House committee hearing in Washington, or a summit meeting in Hanoi. But for millions of Americans, it was Jackpot Wednesday, when the Treasury made, in one day, seventeen percent of the Form 1040-related payments it will issue all filing season.

The news media have been fascinated more than usual this year by IRS refund checks. They simply disregard that in many cases they are not refunds, and in most cases they are not checks.

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So let’s agree that when we read about “refund checks,” we know what the journalists and IRS itself mean are largely electronic deposits to individual bank accounts, often representing credits claimed by people who pay no federal income tax.

For actual taxpayers, 2019 refund amounts may be more or less than those of previous years because of changes both to tax law, and to the way that wage and pension withholding is calculated. There is anecdotal evidence, and nothing else, that many are receiving smaller amounts.

But for those whose annual budget relies on the earned income credit or the child tax credit, the annual concern is whether IRS will question eligibility and sequester payments until it is sure that there is no fraud or mistake involved. That’s why the February 27 mass payout of $45 billion was good news for the poor and for those who help them with tax procedure.

Last filing season, IRS paid out about $265 billion in “refunds” through April 20. IRS will tell you once a week, how many returns it had processed cumulatively through the previous week. But Treasury will tell you by this afternoon, how much tax money it collected and how much in IRS payouts it made yesterday; so far this month; and to date this fiscal year. The data can be found online in the Daily Treasury Statement.

There is a lag between when IRS counts a refund return, and when Treasury makes the payment. That’s why the IRS weekly report for Friday, February 22, showed a huge increase in refunds, while the Treasury report for February 22 still showed a lag. The following week’s $45-billion payout explained the IRS calculation.

Treasury does not report the number of payments, just the amount. So we must rely on IRS for the “average refund” figure, which answers the question: “Of those who get refunds, what is the average amount?” This figure does not attempt to answer the question: “Of those who file returns, how many owe nothing or must pay?”

However, the March 1, 2019 IRS report shows that the number of refunds was 81.6% of the total returns processed. This was down slightly from 82.1% in the comparable report from March 2, 2018. Half a percentage point is not that much unless you filed one of the 650,000 or so returns which that number represents. Elections have been decided by smaller margins.

IRS does not tell us, until much later this year or next, how many returns showed no tax owed. Nor does it report the average payment with balance-due returns. What we do know from the Daily Treasury Statement is how much money was deposited into its account at the Federal Reserve. (This number also includes employment taxes not paid through the “Federal Tax Deposit” system, but those are mostly from small employers.)

Through March 7, the total “individual income and employment taxes, not withheld” for the fiscal year that began October 1 was $125.3 billion. The comparable amount for the previous year was $123.7 billion. But keep in mind that IRS offers a “file now, pay later” option for electronic filers. Taxpayers can request the balance due be withdrawn from their account on a certain date – for example, April 15. Last year, tax returns were due on Tuesday, April 17. The one-day count on that date for this category was $28.1 billion. The next three days, the checks continued falling out of the envelopes: $11.6 billion on Wednesday, $11.8 billion on Thursday, and $15.2 billion on Friday.

While the weekly IRS reports shed little light on collections, they raise a couple of interesting questions about tax administration. For example:

1) Where have all the practitioners gone?

Through March 1, 2019, the returns prepared by tax professionals had dropped by 1.7 million, or 5.8%. Meanwhile, self-prepared returns had increased by about 371,000. Does this mean the new 1040 forms, and higher standard deduction, have made do-it-yourself an option for more people? Are improvements in commercial software responsible? Are more kitchen-table preparers just refusing to sign off on their work because of the Form 8867 “due diligence checklist” interrogatories?

2) Why did direct-deposit become so popular?

Last year, about 84% of refunds were deposited directly to taxpayer accounts. So far this year, the rate is about 93%. Do Americans trust the financial-services industry more, or the Post Office less?

The Daily Treasury Statement provides some interesting information about tax-related issues, as well. For example:

  • Customs “and certain excise taxes” collected for the fiscal year through March 7 were $35.3 billion, up from $20.3 billion for the same period last year. What could the Treasury do with an extra $15 billion? Well, corporation income tax FTD receipts were down from $94.1 billion to $73.5 billion.
  • FTD’s for “withheld income and employment taxes” are holding steady at $1.108 trillion through March 7, about the same as $1.120 trillion last year.
  • The “Treasury Offset Program” collected nearly $3 million in February from tax refunds that would otherwise have been paid to people who owe federal, state or child-support debts. The amount for February 2018 was $2.4 million.
  • Social Security benefit payments increased from $72.35 billion in February 2018 to $76.83 billion in February 2019. Some of that 6.2% growth can be explained by the 2.8% “cost of living adjustment” this year.
  • “Business” tax refunds so far this fiscal year total $28.9 million, and more than half of them were paid by check, not direct deposit. The comparable amount for FY 2018 is $35.4 million.

How reliable are any of these reports? My confidence was somewhat shaken by the Daily Treasury Statement for Friday, March 8, which showed a negative $32 million for “IRS Tax Refunds Individual (EFT).” A footnote explained, “reported as a negative amount due to a return/reversal of $32 million.”

Well, I suppose if some economists can advocate a negative income tax, others can support a negative income tax refund.

IRS Updates Contingency Plan

Frequent contributor Bob Kamman discusses the IRS’s updated lapsed appropriations contingency plan for the filing season. Les

The first thing to realize about the IRS Filing Season Contingency Plan is that it is already outdated. As the Overview states,

“The IRS Lapse in Appropriations Contingency Plan describes actions and activities for the first five (5) business days following a lapse in appropriations. The plan is updated annually in accordance with guidance from the Office of Management and Budget (OMB) and the Department of Treasury. While we do not anticipate using the plan, prudent management requires that agencies prepare for this contingency.”

Although the cover sheet is dated January 15, 2019, that excerpt from Page 5 is dated January 11, 2019.  Filing season, it states, runs from January 1 through April 30, 2019.  What happens after the first five days?

“In the event the lapse extends beyond five (5) business days, the Deputy Commissioner for Operations Support will direct the IRS Human Capital Officer to reassess ongoing activities and identify necessary adjustments of excepted positions and personnel.”

In lay terms, this is known as “flying by the seat of your pants.”

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The general rule is that all IRS employees must stay home because they are not essential and there is no money to pay them.  (Of course, history tells us that they will be paid when the shutdown ends.)  The exception to the rule is that they must work, without pay, if they fall into one of several “excepted” categories.

Category “A” includes activities that (A1) are already funded, like those related to TCJA implementation and disaster relief; activities (A2)  “authorized by statutes that expressly permit obligations in advance of appropriations; and the catch-all (A3) “authorized by necessary implication from the specific terms of duties that have been imposed on, or of authorities that have been invested in, the agency.”  Until anyone objects, this A3 means what any given lawyer says it means on any given day.

Then there are “excepted” employees (remember, these are the ones who must show up to work) in Category B.  Their jobs are necessary to safeguard human life (see Police Officers, below) and, more often, to protect government property.

To understand this category, note that “tax revenues constitute Government property which the Service must safeguard.”  But not just money is involved:

 “…the Service may continue processing tax returns to ensure the protection of those returns that contain remittances. Activities necessary to protect other types of Government property, including computer data and Federal lands and buildings, may continue during a shutdown as well.”

In fact, not just money, buildings, and computers are at stake.  It is the IRS reputation itself.  The agency must “maintain the integrity of the federal tax collection process.” (This mostly seems to come under A3, not B, for those keeping score at home.)

Finally, there is the “turn out the lights” Category C, for activities that “provided for the orderly termination of those functions that may not continue” during a shutdown.

Those are the rules.  Here are some examples of how they are being applied.

Category A1: This includes “Income Verification Express Service (IVES) and Revenue & Income Verification Service (RAIVS) Photocopy Programs.”  These allow mortgage lenders  to verify taxpayer incomes.  It was recently determined that this was “excepted” work, perhaps because it is funded by user fees.

Category A2: This one is easy.  IRS does not have any.  It just shows up in the report because Treasury needs it for other reports.

Category A3: “Maintaining minimum staff necessary to handle budget matters related to the lapse in appropriations.”  Presumably these employees will have other work to do, when the lapse ends.

Category A3 also includes “Activities necessary for the payment of refunds, including processing electronic returns through issuance of refunds; processing “Paper Refund Tax Returns” through issuance of refunds; and processing “1040X Amended Refund Returns Adjustments including Carrybacks, Amended Returns, Duplicate Filed Returns (DUPF), Correspondence, Injured Spouse Claims, Disaster Claims, F843 Claim for Refund and Request for Abatement in support of issuing refunds.”

Issuing those refunds is necessary, not because they are government property, but because they are part of a system that maintains IRS integrity.

For Category B, there is a long list of activities necessary for the protection of human life or government property.  “The risk to life or property must be near at hand and demand an immediate response. To ensure that employees only perform functions that meet this requirement, each business unit will conduct regular meetings throughout a lapse in appropriations to identify actual imminent threats and activate excepted personnel only as required to perform related excepted activities.”   Here are just some of these examples:

  • Completion and testing of the upcoming Filing Year programs
  • Processing Remittances including Payment Perfection
  •  Responding to taxpayer filing season questions (call sites)
  • Continuing the IRS’ computer operations to prevent the loss of data
  • Protection of statute expiration, bankruptcy, liens and seizure cases
  •  Protecting Federal lands, buildings, and other property owned by the United States
  • Upcoming Tax Year forms design and printing
  • Maintaining criminal law enforcement and undercover operations

(You might find it odd that designing next year’s forms has at least the same priority as criminal law enforcement.  You will agree, however, once you see this year’s forms.)

Those are the activities that are necessary.  Here are some examples of work that is not:

  •  Non-automated collections
  •  Legal counsel
  • Taxpayer services such as responding to taxpayer questions (call sites) (But only during Non-Filing Season.  During Tax Season, they hope to operate.)
  • All audit functions, examination of returns, and processing of non-electronic tax returns that do not include remittances

So let’s not call it a shutdown.  When audit and collection work is suspended, let’s call it a holiday.  Were it not for the staff trying to prevent statute expirations, we could almost call it amnesty.

Here are some details from the latest plan:

Chief Counsel

“Chief Counsel’s primary responsibility during a lapse is to manage pending litigation, the time-sensitive filing of motions, briefs, answers and other pleadings related to the protection of the government’s material interests. Due to Counsel’s separate litigation function, the number of excepted Counsel positions will not align with excepted activities authorized in other IRS business units. Counsel’s plan assumes that the Federal and District Courts will be open, and that litigation will continue uninterrupted. The plan excepts, on an as needed basis, those personnel assigned to litigation that is scheduled for trial or where there is a court-imposed deadline during the first five days of a lapse. Personnel are not generally excepted to perform litigation activities where a trial or other court-imposed deadline is scheduled more than five days after the start of the lapse. Personnel assigned to those cases should seek continuances as part of an orderly shutdown. If a continuance is denied, the case will be reviewed to determine if work on the case may be excepted. . . .

“Chief Counsel personnel are also excepted, on an as needed basis to provide required legal advice necessary to protect statute expiration, and the government’s interest in bankruptcy, lien, and seizure cases.”

Taxpayer Advocate Service

There are now two “excepted” Category B employees allowed in each local office: The local TA, and either a group manager or a “lead case advocate.”  Their jobs are to “Check mail to comply with the IRS’s requirement to open and process checks during a shutdown while also complying with the statutory requirements that TAS maintain confidential and separate communications with taxpayers and that TAS operate independently of any other IRS office . . .Screen the mail for incoming requests for Taxpayer Assistance Orders and notify the appropriate Business Unit that a request has been made tolling any statute of limitations.”

It doesn’t sound like they are allowed to answer the phone or work cases.  Protecting IRS integrity doesn’t extend this far?

Small Business / Self Employed

In this operating division, 2,614 of the 2,938 Category B employees are in Collection and another 264 are in Examination. But wait – what happened to that  holiday?

Most of them are Collection Representatives who “carry out revenue protection activities that include responding to taxpayers who have received a collection notice through the Automated Collection System and clarifying the payment process; assisting taxpayers with setting up installment agreements for tax payments; assist taxpayers with general collection processes; serve as the gateway for transferring taxpayers to Accounts Management for appropriate filing season inquiries;  and provide assistance with releasing levies and liens as required by law.” In other words, you can contact them but they won’t contact you.

Those in Examination “protect statute expiration/assessment activities, bankruptcy or other revenue generating issues.   Open incoming mail to identify documents required to be processed to protect the government’s interest during shutdown. Complete computer operations required to determine necessary actions, prevent data loss and route documents associated with imminent statutes.”

Wage And Investment

These are the workers at 10 Service Centers and 15 call sites,  most of whom are in Category A3.  IRS hopes that 12,961 show up for Submission Processing, and 17,520 show up for Accounts Management, which includes call sites.

From other sources, I find that at least 6,600 of these employees are seasonal.  Would you take a temporary job with IRS in January, with the hope of being paid by April? It might make a difference if you needed to pay for daycare.

How many in W&I “Refundable Credits Policy & Program Management” will work on “Pre-refund case selection to protect improper payments from being released to ineligible taxpayers and perfect refunds to verify the refund is appropriate”?  An army of 51.

Compare that with the 469 needed for the IVES and RAIVS programs.  IVES “provides express return transcript, W-2 transcript, and 1099 transcript delivery services to mortgage lenders and others within the financial community to confirm the income of a borrower during the processing of a loan application. RAIVS services taxpayer request for copy of tax return.”

Online Services

In Category B, 25 employees are needed because “Online Services (OLS) is responsible for the development and continuity of operations for IRS.gov, which is the agency’s exclusive external facing website servicing the public. IRS.gov is the means in which taxpayers may continue to file returns and submit remittances online. OLS anticipates that 9 employees will be needed for the duration of the shutdown to maintain the IRS.gov website.”

Facilities Management

Did you know IRS has Police Officers?  There are nine of them kept on duty who along with 13 Security Specialists and five Safety Officers “support general security services that increase as the IRS population escalates in excepted employees during the Filing Season.   Additionally, security and emergency response actions are influenced by other external activities such as bomb threats, suspicious packages and threats to employees. Situational Awareness Management Center/Threat Incident Reporting is operational 24/7 during a shutdown.”

Leave (Not Brexit) Policy

Finally, current and former IRS employees should find this interesting.  I am not sure it  is how the situation was handled in previous shutdowns, but maybe I am thinking of snow days.

“Managers should advise employees who are scheduled to be on annual, sick, court, or military leave that, if a lapse in appropriations occurs while they are on leave, their leave will be canceled, and they will be placed in a furlough status. According to 5 CFR § 752.402, a furlough means ‘the placing of an employee in a temporary status without duties and pay because of lack of work or funds or other non-disciplinary reasons.’”

What IRS Taught Me about Building Barriers

During the IRS and Tax Court shutdown, we have less material to work with and more time for observations and reminiscences from readers.  Chronic contributor Bob Kamman assures us that there must be others who can do better than this. 

I have stories about shutdowns that I could tell from my time at the government but mostly my impression of shutdowns is that they are an incredible waste. I feel it would not take much to find a better way to fight over disagreements about the budget.  

Bob tells us a story about barriers and Service Centers. Having been at several Service Centers, I can say that the barriers to entry there pale by comparison to entry to the Martinsburg Computing Center where the IRS stores the masterfile information and creates significant barriers to entry. Keith

Before I get to that story, here is something to watch for when this “partial government shutdown” finally ends.

In November 1995, the IRS was shut down for only four days. Some of the rest of the government then closed again for 22 days, when negotiations between President Clinton and Speaker Gingrich failed, but IRS was spared.

The White House was not reluctant to place blame on Congress, so it released a report showing how much tax was not assessed or collected during the brief furlough of examination and collection employees. The Treasury Department calculated that $400 million was lost by lack of enforcement action by IRS over a four-day period. That round number of $100 million a day translates to $165 million in today’s dollars, or about a billion dollars for every six working days.

This estimate was confirmed in a White House report on the costs of the October 2013 federal government shutdown. “IRS enforcement and other program integrity measures were halted,” it stated. “IRS was unable to conduct most enforcement activities during the shutdown, which normally collect about $1 billion per week.” (Emphasis in original.)

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Will similar numbers be provided this time? Or maybe there will be a compromise. Most federal budget analysts agree that every dollar IRS spends on enforcement brings in about $10 of revenue. The Democrats have offered $1.6 billion for border security. The President could refuse such a large sum. “Just give me $500 million more for IRS,” he could say. “Then let me spend the $5 billion it produces, how I want.”

(Much of that half billion would be paid in salaries and come back to the government anyway. IRS employees are notorious for paying their income taxes.)

But the current impasse reminds me of my IRS days, in the mid-1970s, when I was an intern in the National Office’s Taxpayer Service division. Interns were not unpaid college students brought in for the summer (like my son in 2003, at the White House photo office). We were full-time permanent employees, recruited nationally for training that would create the next generation of IRS leadership. The assignment lasted for a year, followed by placement in some essential program.

There were only three of us in Taxpayer Service, but there were more than 20 “Admin” interns who rotated among what were then the four divisions of the Administration function (if I remember them correctly): Personnel; Facilities Management; Training; and Fiscal.

There were occasional “classes” for interns when senior executives would lead discussions of IRS problems and how they had been solved. When it was the turn for Facilities Management, the topic for discussion was whether a rather large sum should be spent to build fences around Service Centers.

I doubt any of us had ever considered this question. Service Centers are huge buildings on large parcels of real estate. For example, the one in Ogden, Utah, is a single-story brick building with 504,741 gross square feet located on a 60-acre site. It operates 24 hours a day, 7 days a week, and provides work space for approximately 2,500 federal employees.

 

That would require a lot of chain link, we agreed. Of course, security is an important issue for all government buildings, but especially IRS work locations. Who would argue with fencing them off?

But fences are meant either to keep people in (not an issue at IRS) or to keep people out. So whom were we trying to exclude?

This was before daily headlines about terrorist threats. But there have always been angry taxpayers, including some with mental-health issues. And by then the “Anarchist Cookbook” had instructions for building bombs. So fences were necessary.

Or were they? The class was asked to imagine a potential bomber driving past the Service Center, noticing a fence around it, and therefore deciding it was not worth the effort to penetrate. If this person existed, then the cost of the fence would justify discouraging the “casual bomber.” But of course, someone intent on bombing IRS could probably figure out a way to get over, under, around or through that fence.

The point was: The fence is not there for security. It is there to create the appearance of security. The otherwise-determined bomber, it was hoped, would decide that “if there is that much security on the perimeter, there must be a lot more of it inside.” So according to the cost/benefit analysis of the day, the fences were built and the contractors paid.

This anecdote may have nothing to do with current affairs, but for me there are always reminders.   For example, I thought of it when I saw this April 2018 story about what happened to a fence at the Fresno Service Center – which, however, was breached from the inside out.

 

Section 6662: Owe A Little Tax? Pay The Penalty. Owe A Lot More? Maybe Not.

Frequent commenter/guest blogger Bob Kamman brings us a post about the weird way the IRS is choosing to impose the substantial understatement penalty. He brought a couple of Tax Court cases seeking to establish some precedent in the area but the Chief Counsel attorneys handling the cases conceded and prevented him from obtaining court review of the IRS practice in this area. Because the fact pattern he has identified usually involves a relatively small amount of money, taxpayers will struggle to find representation in these cases and may find it easier to concede than to fight.  A case in which the taxpayer contests all or part of the underlying tax may provide the more likely vehicle for a test.  If you see this issue in your client’s case, consider following Bob’s example and seek to set precedent. Even if Chief Counsel’s office continues to concede the issue, maybe someone in that office will speak to the IRS about the bad practice that may be a result of computer programming or maybe just an unusual view of the type of behavior that should be penalized. Keith

I won a couple of Tax Court cases in 2018 that I had expected to lose. My clients are happy that IRS settled. But I’m disappointed, because I hoped a Tax Court opinion would at least highlight the issue. At least along the way I learned a few things. For example, there is the Doctrine of Absurdity.

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But first, some background. Suppose that you are a Member of Congress and on a committee that oversees tax laws and IRS. You think penalties are sometimes needed to encourage tax compliance. You consider two cases:

 

Taxpayer A, in a 15% bracket, wins $32,000 on a slot machine, has no tax withheld when the casino issues Form W-2G, and does not report the income on Form 1040. The IRS computer-matching system eventually discovers the omission and assesses $4,800 tax.

Taxpayer B, in a 25% bracket, withdraws $20,000 from a retirement account, requests federal tax withholding at a 20% rate, and thinking like many others that “I already paid tax on it,” does not report the income on Form 1040. IRS document matching catches this error also, and sends a bill for $1,000 because the withholding is not sufficient to cover the additional tax.

Not as someone with a sense of fairness and logic, but as a Member of Congress you would reach the same result that according to IRS was enacted nearly thirty years ago. Taxpayer A pays $4,800 but no penalty. Taxpayer B pays not only $1,000 but an additional $200 penalty.

That’s how Section 6662, together with Section 6664, operates. These Internal Revenue Code penalty provisions come up frequently, and deserve a closer look. They require findings of an “underpayment” and an “understatement,” which IRS tells us are not the same thing.

Section 6662 assesses a 20% penalty on several varieties of “underpayment.” The two seen most frequently are those due to “negligence or disregard of rules or regulations,” and to “any substantial understatement of income tax.”

IRS computers, lacking human interaction with taxpayers, don’t yet have the intelligence to make accusations of “negligence or disregard.” So the “substantial understatement” clause is invoked when proposed assessments are based only on matching information returns to a Form 1040.

And acknowledging the legal maxim de minimis non curat lex – “the law does not deal with trifles” – Section 6662(d)(1)(A) adds that on individual returns, a “substantial understatement” occurs only if the amount exceeds the greater of—

(i) 10 percent of the tax required to be shown on the return for the taxable year, or

(ii) $5,000.

In most cases, the $5,000 minimum rule applies. So you might ask, why will IRS assess a penalty to our Taxpayer A, who only owed $1,000? The answer is that no credit is given for withholding, when determining if there is an “understatement,” even though the withholding is considered when figuring the “underpayment” amount on which the 20% penalty is calculated.

At least, that is how IRS interprets the Regulations to these two sections. I am not sure the IRS understands the Regulations, nor am I confident the Regulations correctly describe what Congress enacted. Some day perhaps a Tax Court judge will reach the same conclusions.

Here is an example from a Tax Court case in which IRS decided it was not worth arguing with me. My client withdrew money from a retirement account, and had tax withheld. Because she thought the taxes had already been paid, she did not mention it to her tax preparer or report it on her return. The additional tax was $9,158. The withholding was $7,325. The difference was $1,833, which when contacted by IRS she gladly paid with interest. But IRS still wanted $367 “substantial tax understatement penalty.”

(Had the return been filed late, a penalty of $458 would also have been proposed, but under the IRS “one time free pass” policy, it could be abated.)

My client is not a low-income taxpayer but she had a high-respect government career. I did not charge a fee for filing the Tax Court petition, or for several phone conversations with a Chief Counsel paralegal (in Phoenix) who handled settlement of the case in our favor. I did furnish reasons that this case might qualify under the “reasonable cause” exception of Section 6664(c) because my client had acted “in good faith.” These arguments seldom prevail at IRS administrative levels. The settlement process took more than four months, from petition filing to stipulation signing.

And here is another example from a Tax Court case. My clients unintentionally omitted some W-2 income from their joint return. They and their preparer had rushed to meet the April 15 deadline after receiving a complex, high-dollar Schedule K-1 on April 10. The additional tax was $6,230 and the withholding only $2,012. The difference of $4,218 was not quite as substantial as the $5,000 minimum contemplated by Section 6662(d)(1)(A). Nevertheless, IRS proposed a “substantial understatement” penalty of $844, because the deficiency before withholding exceeded $5,000.

This case was settled by a Chief Counsel attorney (in Dallas) in less than six weeks after the petition was filed. I did not earn a fee on this case either, but as the preparer I avoided reimbursing my clients for an error for which I shared responsibility.

I did not have to ask the Dallas attorney for a copy of the signed managerial approval now required for such assessments. It might not have existed. In Phoenix, the paralegal showed me what the Service Center considers adequate.   I thought it was ambiguous.

In researching these cases, I came across the “Doctrine of Absurdity,” which is discussed in a 2017 Tax Court opinion, Borenstein, in which Keith Fogg of the “Harvard Clinic” filed an amicus brief. (The opinion does not state whether he supported the anti-absurdity argument, which was just one of several.) The opinion explains:

The “anti-absurdity” canon of construction dates back many years. See Rector of Holy Trinity Church v. United States, 143 U.S. 457, 460 (1892) (“If a literal construction of the words of a statute be absurd, the act must be so construed as to avoid the absurdity.”); Scalia & Garner, supra, at 234-239 (“A provision may be either disregarded or judicially corrected as an error * * * if failing to do so would result in a disposition that no reasonable person could approve.”); 2A Sutherland Statutes and Statutory Construction, sec. 46:1 (7th ed.).

The “anti-absurdity” canon, while of ancient pedigree, is invoked by courts nowadays quite rarely. In order for a party to show that a “plain meaning” construction of a statute would render it “absurd,” the party must show that the result would be “so gross as to shock the general moral or common sense.” Crooks v. Harrelson, 282 U.S. 55, 60 (1930); see Tele-Commc’ns, Inc. & Subs. v. Commissioner, 95 T.C. 495, 507 (1990) (citing Harrelson as supplying the relevant standard but upholding the plain language construction of the statute), aff’d, 12 F.3d 1005 (10th Cir. 1993).

Of course the application of the “substantial understatement” penalty to taxpayers who owe small amounts is absurd. But is it more so than many other IRS procedures? Eventually a Tax Court judge may decide that question, if Chief Counsel stops conceding before trial.

Otherwise, it’s unlikely that Congress will revisit the Section 6662 penalty procedures and make sense of a rule where now there is none.