Reliance on the Return Preparer, Too Good to Be True?

We welcome back guest blogger James Creech. Today James discusses a recent opinion by Judge Goeke examining a taxpayer’s reasonable cause defense. Reasonable cause is a frequent topic on PT, but this case involves a provision we rarely discuss: the ASED extension for failure to notify the government of certain foreign transfers. Christine

On June 28 the Tax Court released a 71 page decision in Kelly v Commissioner T.C Memo 2021-76. In Kelly, the IRS sought 6 years of income tax deficiencies and Section 6663 fraud penalties, with accuracy-related penalties in the alternative. For three of the years, the IRS needed an expanded statute of limitations to make its assessments. As an alternative argument as to why the expanded statute of limitations was appropriate for 2008 and 2009, even if there was not fraud, on the eve of trial the IRS raised the issue that the Taxpayer had not timely filed Forms 5471 for KY&C, a corporation he owned that was in part owned by another controlled entity based in the Cayman Islands.

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How does the failure to file Form 5471 extend the ASED for Mr. Kelly’s personal income taxes? Section 6501(c)(8)(A) provides:

In the case of any information which is required to be reported to the Secretary pursuant to an election under section 1295(b) or under section 1298(f), 6038, 6038A, 6038B, 6038D, 6046, 6046A, or 6048, the time for assessment of any tax imposed by this title with respect to any tax return, event, or period to which such information relates shall not expire before the date which is 3 years after the date on which the Secretary is furnished the information required to be reported under such section.

Luckily for Mr. Kelly, the extension is much narrower if 6501(c)(8)(B) applies:

If the failure to furnish the information referred to in subparagraph (A) is due to reasonable cause and not willful neglect, subparagraph (A) shall apply only to the item or items related to such failure.

As Judge Goeke explains, “ if reasonable cause for the failure to file Forms 5471 exists, then under section 6501(c)(8)(B) only the adjustments related to KY&C would remain open under the statute of limitations.”

While the facts are complicated, and involve a company named after Dr. Evil’s company from the Austin Powers movies, the Tax Court held that the fraud assertions were not sustained. The Court then evaluated if the failure to file the 5471’s held the statute open or if, as the Taxpayer claimed, there existed reasonable cause for the failure to file because he had reasonably relied upon his CPA.  

The three-prong test to see if Taxpayer had a reliance defense is

  1. the adviser was a competent professional with sufficient expertise
  2. the taxpayer provided necessary and accurate information to the adviser, and
  3. the taxpayer relied in good faith on the adviser’s judgment.

Applying this test, the Court found that Mr. Kelly had reasonable cause based upon reliance on his tax return preparer. In a rather detailed analysis, the Court referenced the return preparer’s impartiality and lack of disciplinary record, contemporaneous emails where the Taxpayer disclosed the existence of the Caymen ownership to his preparer, and most interestingly the level of imputed knowledge the Taxpayer should have had about the return:

Respondent contends that it was not enough for Mr. Kelly to inform [his tax preparers] S&C that KY&C was a foreign entity, and he implies that Mr. Kelly should have advised Mr. Scott [of S&C] that Form 5471 was required.

The Court rejected this position.

The failure to file the Forms 5471 does not present an obvious tax obligation which was negligently omitted from information that a taxpayer provided to the return preparer. Mr. Kelly, through his staff, provided the necessary information to S&C, identified KY&C as a foreign corporation, and stated that he was unsure of the reporting requirements. Having done this, Mr. Kelly reasonably relied on S&C to prepare his returns properly. While it could be argued that S&C should have done more to ascertain Mr. Kelly’s filing obligations, it was reasonable for Mr. Kelly to rely on S&C do so. A taxpayer need not question the advice provided, obtain a second opinion, or monitor the advice received from the professional. Boyle, 469 U.S. at 251.

The Court’s citation of United States v. Boyle here, in a taxpayer victory, is an ironic twist. As Les discussed in a recent post,

Boyle essentially stands for the position that taxpayers have a nondelegable duty to be aware of tax deadlines. An agent’s incompetence or willful misconduct will not excuse the taxpayer from delinquency penalties.

Here, the Court seemed to impose a catchy “too good to be true” standard when it came to the Taxpayer’s knowledge:

At trial, Mr. Scott credibly described the reasons that his firm failed to prepare Form 5471 for KY&C. No facts suggest that the failure was the result of a conflict of interest or a “too good to be true” situation for either year. … We hold that Mr. Scott’s lack of prior experience with Form 5471 was not fatal to a finding of Mr. Kelly’s reasonable reliance on him or S&C.

The Court also recognized that when it came to filing Mr. Kelly’s tax return, informational returns do not impact the economics of the return. After all, most taxpayers only know how much money they made during the year, whether that be $35,000 or $3,500,000. If the only thing missing is an informational Form or a Statement, taxpayers, especially taxpayers who do not have a tax background, do not have the requisite knowledge to recognize such an error and insist the return preparer correct the return.

Time will tell if the “too good to be true” standard catches on as the knowledge requirement for a taxpayer’s review a return for correctness. As even simple returns grow more complex it would be useful to have a more definable standard that taxpayers can use to frame their standard of care when it comes reviewing returns and reliance on return preparers.

Getting Perspective on DAWSON

Today guest blogger James Creech brings a series of articles to our attention which illuminate the Tax Court’s case management transition from a different point of view. Whatever your thoughts about DAWSON, considering the transition from an internal point of view is a good exercise. Previous PT coverage of DAWSON can be found here, and the Court’s DAWSON User Training Guides are here.

One of the practitioner challenges of the transition has been learning about new features. The Court maintains a page on its website with DAWSON release notes, which indicates that improvements were deployed just two days ago. Perhaps the Court could consider an announcement system that would alert users to upcoming features as well as new features. Of course, the Court must manage staff workload and it may have bigger fish to fry. Christine

Much has been written about the Tax Court’s new case management system from the practitioner’s point of view. While most of the articles focus on the shortfalls of the new system, such as a search function that has been “coming soon” for months on end, and the change in the way orders are published, not much has been published about how DAWSON was created from a technical point or internal Tax Court staff point of view.

A recently published set of blog posts from 18F changes that. 18F is an internal US Government technology and design consultancy group that worked on developing and implementing DAWSON. As part of 18F’s outreach they have published a three part series on the Tax Court’s case management modernization project. The first article is more of an overview of the Tax Court and the shift from the old case management system to DAWSON and the second and third articles are interviews with Jessica Marine, the Deputy Clerk of Court who oversaw the project, and Mike Marcotte the technical lead.

The articles are technology focused and at times paint an overly rosy picture of DAWSON’s success. Being technical there are numerous references to bugs and minimal viable products (MVP) but not a single reference to the Internal Revenue Code. Despite this, there are still several items of interest to those of us who regularly use DAWSON. Some tidbits include that more than 1 million cases containing more than 1 terabyte of data have been transferred over to the new system, DAWSON is built on an open source framework (which is considered more secure), and at least according to Mike Marcotte there is some internal optimism that the initial problems with the launch have been resolved and that new features can be confidently deployed.

These articles are also a good reminder of all the hard work that went into creating DAWSON. Migrating 30 years of legacy computer systems and 70 years of Tax Court cases does not happen without significant planning, technical skill, and bug fixes. Getting a glimpse into these issues, including one ruined Thanksgiving, is a reminder that building and deploying software is difficult.

FinCEN Moves To Include Convertible Virtual Currency On FBAR Form

We welcome back guest blogger James Creech, who describes an interesting development in the government’s efforts to track and tax virtual currency. Christine

Recently FinCEN has declared its intention to require convertible virtual currency (aka Bitcoin) to be reported on the FBAR. In order to begin the formal rulemaking process FinCEN published Notice 2020-2 stating that it intends to modify 31 C.F.R. 1010.350.

While not a formally a tax provision, filing delinquent FBAR’s and the IRS counterpart FATCA reporting were a main stay of the tax practice during the heyday of the offshore voluntary account disclosure program in the early to mid 2010s. As a result many practitioners would be well served by taking a second look at these proposed changes as more details become available.

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One issue that has always appeared to be a challenge for reporting virtual currency on both the FBAR and the 8938 is identifying where the asset is held. The blockchain that stores the data on virtual currency is hosted on a decentralized network stored upon tens of thousands of computers all across the globe. The keys (analogous to a password) that control the underlying virtual currency could be anywhere as well. While it was generally accepted that keys stored on a desktop in the United States were not held in a foreign account, there were a number of edge cases that became much tricker to administer. For example how do you report a UK based exchange that might hold custodial assets in a server in Iceland? Or if bitcoin is stored locally on a phone does it become a foreign account if the taxpayer travels (with their phone) to Portugal for 9 months?

In recent days FinCEN has been laying the groundwork for a potentially wide application of FBAR reporting requirements.  On December 23, 2020 FinCEN published a notice of proposed rule making that would require virtual currency transactions from self custodial or unhosted wallets (wallets that do not use a financial institution to store the virtual currency) to be reported on Currency Transaction Reports (CTR) if the amount transferred to or from a financial institution was more that $3,000. Part of this proposed rule making was to expand the definition of unhosted wallets as having a high risk of money laundering similar to bank accounts held in Iran or North Korea. And while this is even further removed from tax, administrative law devotees will be interested in the fact that FinCEN’s comment period for these proposed rules was only 14 days which included Christmas and New Years. (If you would like to read comments I submitted they can be found here and they expand on the risk of loss concerns contained below)

Based upon how aggressive FinCEN has been towards unhosted wallets and CTR reports it will be interesting to watch how they treat unhosted wallets for purposes of FBAR reporting, and if the IRS follows suit by amended the requirements for FATCA reporting via Form 8938. It may be that FinCEN takes a hard line and definitionally declares that all unhosted wallets are foreign assets and as such need to be reported on a taxpayer’s FBAR. Those that fail to do so may be subject to the same draconian penalties of $10,000 (non willful) or 50% of the highest account balance (willful) as those who fail to report a Swiss bank account.

A Word of Caution

While FinCEN does have legitimate reasons for potentially using the broadest definition of unhosted wallets possible, such a mandate may cause security and liability issues for tax practitioners. Beyond the technological aspects, the biggest difference between virtual currencies and traditional assets is that virtual currencies users have a 100% risk of loss if the private keys used to transfer the underlying virtual currency are lost or stolen. There is no way for a user to recover compromised keys after a hack or to undo a fraudulent transfer that is a result of a phishing attack. For those reasons, high value virtual currency users have relied on a combination of robust data security using an unhosted wallets, coupled with personal anonymity to protect their assets. The logic behind anonymity is simple. Unless a thief knows that a particular user has enough virtual currency to steal they are not a target. Sophisticated attacks are costly and security developers can quickly fix exploits once they become known or widely used. As such criminals chose there targets carefully.

Why this matters to tax practitioners is that the information required to file the FBAR would also provide a roadmap for bad actors to target and steal virtual currency from your clients. Hacking a law firms internal system would mean that bad actors would have access to a list of clients along with where they lived, their contact information, what their net worth was, and in the case of any voluntary disclosures a narrative of their dealings in virtual currency. Such information could be used to then target the end user directly.

This informational burden would exponentially raise the stakes on tax practitioner data security. Having virtual currency information stored on a firm’s computer would be the digital equivalent of having large amounts of cash stored in the office in perpetuity. It would also significantly raise the need for specialized malpractice insurance because filing a FBAR for someone with $50 million in virtual currency is completely unlike filing an FBAR with someone with $50 million in a Swiss bank account. If the bank account information gets hacked there are still several layers of institutional security that might prevent the attacker from successfully gaining access to the assets, not to mention bank deposit insurance that would compensate for lost funds. If the firm’s virtual currency FBAR client list was hacked, and the information was used to successfully target the client, then the firm would be responsible for an uncompensated $50 million loss.

Given how anonymity is synonymous with criminality in the eyes of law enforcement it is likely that FinCEN will seek to require significant information when drafting the virtual currency FBAR rules. If this does happen tax practitioners need to be aware that simply going back to the old FBAR playbook will not be sufficient, and that there are very real second order consequences for both legitimate virtual currency users and the professionals that they use to comply with the law.

Coinbase Switches From 1099-K to 1099-MISC: A Better Mousetrap or Prelude to Litigation?

Welcome back to guest blogger James Creech. Today James looks into a recent announcement by Coinbase that they are changing their method of tax reporting. When I saw this (in a Law360 article by Joshua Rosenberg) I wondered how such a dramatic shift was possible under the tax laws. We are fortunate that James agreed to investigate the matter and illuminate us. Christine

Former Netscape CEO Jim Barksdale once said, “There are only two ways to make money in business: one is to bundle; the other is unbundle.”   Of the two options, virtual currency exchange Coinbase has chosen to go the bundling route.  At its beginning in 2012 Coinbase supported only a small number of virtual currencies and has steadily expanding its offerings over the last eight years.  Recently Coinbase has dramatically expanded its offerings to include tokens such as the stable coin DAI (don’t worry the technical side does not make a difference to this article) which offers rewards to its holders that functionally resemble interest.

These expanded offerings have caused Coinbase to rethink its third party tax reporting.  Prior to 2020 Coinbase reported transactions to the IRS using Form 1099-K.  The issuance of a 1099-K was due in large part to litigation between Coinbase and the IRS over the issuance of a John Doe Summons that asked for all information Coinbase had regarding US Taxpayers. (Les wrote about the litigation for PT, most recently here.) While the matter was decided in favor of the Government, Coinbase was able to limit the request to information that mirrored the 1099-K and has stuck with that reporting standard since 2017. 

For tax year 2020 that is all changing.  Coinbase is no longer going to issue 1099-K’s and will instead only issue 1099-MISC forms.

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The switch from a 1099-K to a 1099-MISC could be dramatic for a large number of Coinbase users.  Form 1099-K reports gross transactions to the IRS if the taxpayer exceeds 200 transactions or a $20,000 threshold.  The standards for Form 1099-MISC reporting are much lower.  A 1099-MISC is required to be issued if a taxpayer receives more than $600 in payments during the year.  This switch could potentially provide the IRS the names of tens of thousands of taxpayers who thought that they could avoid paying tax on virtual currency gains because they fell under the $20,000 reporting threshold.

Coinbase’s decision to switch from Form 1099-K to Form 1099-MISC could be for a number of reasons.  First is that 1099-MISC is a more appropriate form to report payments akin to interest and that Coinbase decided it was more efficient only to issue one type of 1099.  The second could be that Coinbase made an internal decision that the shortcomings of the 1099-K were too great to ignore.  Since the 1099-K only reports gross transactions and not basis, many taxpayers who actively traded virtual currencies would have a very high dollar amount of transactions reported on the 1099-K but may only have small gains or could potentially have losses.  The responsibility of tracking basis and reporting gains and losses still falls on the taxpayer but now that the IRS is issuing CP2000’s based upon virtual currency exchange third party reporting they might have to spend time, effort, and resources rebutting an incorrect 1099.

The bigger unanswered question after this switch is does Coinbase even intend to report sales or other transactions to the IRS in 2020 and beyond?  The webpage announcing the switch to a 1099-MISC reporting standard states: “1099-MISC Eligibility To be eligible for a 1099-MISC, you must: 1. Be a Coinbase customer, 2. Have received $600 or more in cryptocurrency from Coinbase Earn, USDC Rewards, and/or Staking in 2020 and 3. Be subject to US taxes.”  Nowhere in this announcement are transactions such as sales or purchases mentioned. 

One reading of this press release is that Coinbase is beginning a taxpayer revolt against virtual currency third party reporting.  Recently Coinbase has acquired a reputation of being one of the more conservative technology companies.  For example, the company reaction to the Black Lives Matter protest over the summer was to simply ban its employees from speaking out on the matter or using BLM emblems as part of their internal communications.  This reaction was starkly different from most companies that put out a politely worded statement offering some sort of recognition of the importance of the events.  A further shift into libertarianism vis a vis refusing to provide information to the IRS might play well with the virtual currency community which tends to have an aversion towards any sort of government interaction.  Not to mention it would seem to offer a business advantage for any frustrated virtual currency user who had to spend significant time resolving issues based upon 1099-K’s lack of basis reporting.

If Coinbase does stop reporting transactions to the IRS it sets the stage for a reprise of the John Doe Summons litigation from a few years ago.  The IRS has made tax compliance in the virtual currency space a priority.  It has significantly upgraded its technical understanding of virtual currencies and dedicated significant resources to cracking down on unreported virtual currency income.  A resistant firm like Coinbase, and its users, would be the ideal target for the IRS to showcase their significant ability to identify virtual currency tax noncompliance just as it was in the original litigation.  Only time will tell what will happen, but the only sure thing at the moment is that there is not an ideal form for virtual currency third party reporting.

IRS Expands Digital Signature COVID Response

Today guest blogger James Creech returns with an update to his previous post on IRS acceptance of digital signatures. As James notes, there continues to be confusion over which forms may be accepted with a digital signature, and for what purpose. Christine

The IRS recently made two announcements dated August 28, 2020 and September 10, 2020 expanding the list of documents that are temporary eligible to be filed using electronic signature due to the ongoing pandemic.  These two announcements add 16 forms to the list of documents that can be submitted with electronic signatures. 

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What is notable about these forms, is that they are forms that were previously barred from using an electronic signature because they were subject to standard filing procedures.  Since these forms had standard filing procedures, they were outside of the scope of the March 27, 2020 (and superseded with minor changes on June 12th) internal IRS memo that originally permitted electronic signatures on a number of forms used by the IRS to resolved cases at the exam or collection stages.  A full list of the forms can be found here.

The expanded use of electronic signatures for more routine forms is a welcome development even if, as the memo notes, it does not “represent the full universe of forms filed or retainer on paper that taxpayers and their representatives would like to see covered”.   Some of the forms such as the 706 family of tax returns are particularly useful because they allow an executor who may be at high risk from COVID to sign the return without having to come into contact either with other people by having to travel to the return preparer’s office or without having to physically go into the post office.  

The expanded use of electronic signatures does not change any of the other filing requirements.  Generally speaking most of the document on the expanded electronic signatures list still require that they be physically mailed to the IRS although some of the forms such as Form 3115 are also subject to temporary acceptance by fax.  The current expiration for electronic signature acceptance on both the listed forms as well as for documents provided for exam and collection is December 31, 2020.  In the case of a form filed though normal channels an electronic signature is valid as long as the form is signed and postmarked prior to January 1, 2021. 

These announcements by the IRS are a recognition that while life is returning to normal it is not the normal that existed in January.  Overall the IRS has done a good job of adjusting to our shared existence of social distancing.  The agency’s flexibility with electronic signatures, accepting documents via email, expanding e-filing for forms such as the 1040x are all recognition that the tools for remote work exist and have value. 

While the rollout of the prior electronic signatures has not gone without its hitches, such as continued CAF rejections of 2848’s due to electronic signatures despite the form being specifically identified as eligible for electronic signature is in the March 27th memo, and there are some tradeoffs with security and identity verification, these changes are a net positive.  Hopefully the IRS spends some of the next few months working out ways to reduce these risks to acceptable levels so that when taxpayers and their representatives can safely meet again they will not have to return to signing paper forms. 

 

Oversharing on Social Media Reaches the Tax Court

Today guest blogger James Creech brings us a cautionary tale of social media undermining a taxpayer’s credibility. After reading this post, practitioners may want to read this article by Marie V. Lim of the ABA Section of Litigation, on how to use social media at trial.

As James notes, social media also brings up ethical concerns for lawyers. In addition to the issues discussed below, attorneys must be careful as they investigate their opponents. The issue is not so much “who” can be investigated but “how”. Under Rule 8.4 it is professional misconduct for a lawyer to engage in conduct involving dishonesty, deceit, or misrepresentation. If an opponent’s social media account is not public, how can one go about accessing the incriminating posts that are certain to exist? Before engaging in any schemes, practitioners would be well advised to research the applicable ethics opinions. The Philadelphia Bar Association, for example, has advised that attempting to “friend” a witness to gain access to information on Facebook or Myspace is pretextual and violates Rule 8.4(c), even if there is no fake name or falsehood used. However, the State Bar of Oregon came out the other way. Christine

Most of us know social media is a double-edged sword. It allows us to share events and thoughts in real time regardless of the substance. Sometimes those thoughts are genius and inspire others, other times those thoughts are inane, banal, or outright stupid. Occasionally these posts cost (or make) people real money. One of these situations where social media posts perhaps cost a taxpayer real money is the recently decided Tax Court case of Brzyski v. Commissioner, T.C. Summary Opinion 2020-25 released on August 27.

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The facts of Brzyski are complicated and highly factual. Mr. Brzyski claimed the children of his significant other as qualifying children for the dependency exemption. The IRS disallowed the dependency exemption because Mr. Brzyski was not formally married to the children’s mother and without a marriage the children cannot be qualifying stepchildren. Mr. Brzyski claims that while not formally married in his home state of California, one night while he and his significant other were in Missouri they crossed the border into Kansas for dinner and declared themselves married. Thus, according to Mr. Brzyski, they were legally common-law married in Kansas and the children met the relationship test. To provide support for this Mr. Brzyski testified to this effect and produced affidavits from family members to the same effect.

While the facts might be unusual, even more unusual is how the taxpayer’s version of events was discredited. At trial social media posts were entered into evidence (presumably by Chief Counsel) that showed Mr. Brzyski referring to his significant other as his fiancée after the date of their alleged common law marriage. This plus a host of other inconsistencies (which were probably enough to carry the day for the respondent without mention of the social media post) were enough to satisfy Judge Copeland that the testimony regarding a Kansas common law marriage was unreliable and not enough for the taxpayer to carry their burden of proof. As a result the dependency deduction was denied.

From a quick search it appears that Brzyski may be the first Tax Court decision in which social media posts are cited to as direct evidence of a taxpayer’s lack of credibility. It also appears to be the first decision where the social media posts introduced into evidence could have only come from Chief Counsel’s office.

To get a sense of just how novel this is, it is worth looking at the totality of social media in Tax Court decisions. Tax Court decisions do not cite to social media frequently. Excluding Brzyski, a keyword search using the Tax Court’s website for even a single mention of “social media” returns six cases. A search using the term “Facebook” as a proxy for social media returns eight cases and of those eight cases two of the “Facebook” cases refer to Facebook’s Taxpayer Bill of Rights litigation. This leaves a grand total of twelve cases that cite to social media.

Of the twelve cases that remain for social media, nine of the cases involve the petitioner introducing social media as evidence of a for profit enterprise or as part of a business plan, one case discusses the business expense of a computer that was also used for work and personal social media usage, one opinion from Judge Holmes mentions the company Facebook to set the stage for discussing a petitioner’s career in technology, and one case memorializes a laundry list of the taxpayer’s grievances including the notion that social media websites were conspiring against his vaporizer business.

One common thread that Brzyski shares with the other nine relevant cases is that each of the social media cases is about mindset. Posts on social media are generally inadmissible hearsay if offered by the declarant for the truth of the matter asserted. A part time horse breeder cannot claim a Facebook post stating “We are now a legitimate stable conducting a for profit enterprise” is substantive evidence in his favor for purposes of section 183.

However, as an indicator of mindset social media posts can be useful. The low threshold for publication and our cultural habit of oversharing and introspection mean that they are probably a fairly accurate indicator of the declarant’s mental state. (See FRE 803(3)). One could also imagine social media posts that might plausibly qualify for the  excited utterance exception to the hearsay rules under the Federal Rules of Evidence Rule 803(2). Present sense impression is a third exception that might apply. (FRE 803(1)). As a result, social media posts have been useful in the past for practitioners to reconstruct the mindset of a client. For instance, one could learn a lot from the social media posts of a struggling small business owner who has lost money four straight years.

Now that the Tax Court is on the record giving more weight to a spontaneous social media post that hurts the taxpayer than to the taxpayer’s actual testimony at trial, practitioners should beware that these posts cut both ways. As a result of Brzyski, due diligence as to a client’s social media should be conducted if the case relies heavily on the petitioner’s credibly on the witness stand. However, this potentially opens up the Pandora’s box of what to do if practitioner learns prior to trial that the petitioner’s version of events does not match the story social media tells. This can lead to conflicts between Model Rule 3.3’s Duty of Candor Towards the Tribunal vs Model Rule 1.6’s Duty of Confidentiality. As with many social media issues today, solving one problem invariably leads to another.

FAQ Disclaimers: Balancing the Need for Guidance and Taxpayer Reliance on FAQs

Today we follow up on Alice G. Abreu and Richard K. Greenstein‘s post discussing the recent NTA blog on IRS FAQ with some additional thoughts from guest blogger James Creech. As yesterday’s post noted, IRS FAQs have grown more important since the coronavirus hit, as the IRS responded to the urgent need for a high volume of guidance by increasing its use of website FAQs in place of IRB guidance.

While IRS FAQs are particularly voluminous and consequential right now, recent observations build on years of criticism. For example, in 2012 Robert Horwitz and Annette Nellen authored a policy paper for the State Bar of California’s Taxation Section. This paper recounts the evolution of the IRS’s use of website FAQs and proposes solutions to concerns, including “(1) the lack of transparency, (2) the lack of accountability, (3) the lack of input by the public, (4) the difficulty in finding specific FAQs on the IRS website, (5) whether FAQs are binding on IRS personnel, and (6) the extent to which FAQs can be relied upon by taxpayers and tax practitioners.” I recommend reading this paper not only for the history of IRS website FAQs but for the authors’ proposals to address these concerns without scrapping the practice or reducing its utility as a quick method of communication to taxpayers.

Former NTA Nina Olson also addressed IRS FAQ in reports to Congress and in Congressional testimony, as discussed and linked in this 2017 blog post.

In addition to her recent blog post discussed yesterday, NTA Erin Collins addressed FAQ in several sections of her 2021 Objectives Report to Congress. The report discusses the pros and cons of informal guidance “in the face of widespread closures of core IRS functions as well as the enactment of the FFCRA and CARES Act,” and notes that by June 10, the IRS had issued 273 FAQ relating to pandemic tax relief. That number has continued to grow in the last four weeks. Due to the uncertainties facing taxpayers, the NTA argues that “if the IRS continues issuing and relying on FAQs, the regulations under IRC § 6662 need to be amended to clarify that FAQs can be used to establish reasonable cause for relief from the accuracy-related penalty.” I wholeheartedly agree. Christine

The IRS has routinely used FAQs as a way inform the public about some of the nuances of tax administration. However as part of the COVID-19 FAQs something new has emerged. The IRS has started to put disclaimers at the beginning of some recently issued FAQs. For example the preamble to the Employee Retention Credit FAQs states:

This FAQ is not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.

and the preamble to the COVID Opportunity Zone FAQs states:

These Q&As do not constitute legal authority and may not be relied upon as such. They do not amend, modify or add to the Income Tax Regulations or any other legal authority.

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As discussed in some detail in a previous post by Monte Jackel, these disclaimers are necessary because of the lack of weight given to these otherwise official sounding pronouncements. Technically speaking, FAQs are considered unpublished guidance because they are not printed in the Internal Revenue Bulletin like Notices and Revenue Rulings. They are not binding on the IRS. They are not binding on the taxpayer and cannot be used by a taxpayer as substantial authority when taking a legal position or penalty protection. FAQs are subject to change at any time (which is why practitioners should print any on point FAQs instead of bookmarking the webpage) and are frequently revised based upon real world feedback.

Yet despite these limitations, FAQs have real value because they allow the IRS to push out guidance faster without the worry of unintended consequences. For taxpayers they can offer some comfort that their interpretation of how to approach a murky situation is not at odds with the IRS’s approach. The trouble is that for many taxpayers there is no recognizable difference between FAQs published on IRS.gov and a Notice (published in the Internal Revenue Bulletin) done in FAQ format and also published on IRS.gov.

While including disclaimers on some of the COVID guidance is a good start, it is a little disappointing that the disclaimers are not uniform and are not part of every set of FAQs regardless of when they were issued. Recognizing, of course that this is not the right time for the IRS to start new projects, even the COVID specific FAQs are haphazard. Surprisingly the FAQs regarding the Economic Impact Payments (at the time this article was written) do not have a disclaimer. This is despite the target audience being individual taxpayers who may be less able to parse statutory language when compared to sophisticated opportunity zone investors.

For an FAQ disclaimer to be effective for all taxpayers it should be written in plain English in a manner understandable to all taxpayers. The Employee Retention Credit disclaimer for example does not make it clear that the FAQs are not binding on the IRS. Unless the reader knows the importance of publication in the Internal Revenue Bulletin, the statement that the FAQs “cannot be used to support a legal argument in a court case” could seem to indicate that a taxpayer could cite to the FAQ during an administrative dispute regarding the credit.

A better disclaimer might read “These FAQs are informational purposes only and are subject to change at any time. Taxpayers cannot rely on these FAQs as the official position of the IRS and cannot be cited as legal authority. FAQs do not change the Internal Revenue Code or Treasury Regulations. For more information on FAQs click here”

Effective FAQs are an important element of agency communication and like it or not they are here to stay. However getting them right means not only drafting answers that reflect the law but giving taxpayers the tools to understand exactly what they can and cannot rely on.

The IRS Cracks Open the Door to Electronic Communications

In 2016 the IRS released its Future State vision, featuring seamless electronic interactions between the agency and taxpayers or their representatives. Progress towards this vision has been slow, as IRSAC noted in its 2018 and 2019 reports. (Les also wrote several posts on the Future State, its implications, and related developments.) Today the IRS remains far behind lenders, brokers and banks in the digital customer interactions it offers. While the IRS’s privacy concerns with electronic communications have not abated, faced with the coronavirus pandemic the agency adapted quickly, recognizing the need for digital communications if taxpayers’ matters are to progress as people shelter in place. In today’s post, guest blogger James Creech describes important new IRS parameters for email correspondence and electronic signatures. Christine

On March 27, 2020 as part of the IRS’s response to COVID-19 the IRS issued an internal memorandum temporarily modifying the existing prohibitions against the acceptance of electronic signatures and use of email to send and receive documents. For the Service these modifications were a necessary adjustment to the realities of remote work. It allows many of the cases in progress prior to the People First Initiative to continue to move forward even if it is just to avoid a statute of limitations expiring. It is also an acceptance that many taxpayers who must interact with IRS employees are sheltering in place and may lack access to any technology beyond a smartphone. It is interesting to note that the memorandum does not specify an end date for these temporary procedures unlike many of the other aspects of COVID-19 that expire on July 15, 2020.

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Electronic Signatures

The most important part of the IRS accepting electronic signatures is not how they accept them but rather what types of documents have been approved for electronic signatures. Electronic signatures are temporarily permitted on documents required to extend a statute of limitations or to close an agreed upon matter such as Forms 870 and 872. Beyond those forms, the memorandum only lists a few specific forms by number but it appears that it should be interpreted broadly. As a catch all, it states that long as the form is not normally subject to standard filing procedures, ie a 1040x or 8832, an electronic signature is permitted and the document can be submitted electronically. An IRS employee can request further guidance from their internal policy office on the specific email acceptance policy. Given that the internal guidance is vague it might be incumbent on a practitioner to remind an IRS employee that this option is available should there be some hesitation about accepting particular form.

One other routine document specifically listed by the memorandum is a power of attorney. On the surface the inclusion of the 2848 seems of limited utility. The CAF units are located in service centers that are currently closed, new matters are not being assigned to the field, and adding a power of attorney midway through working through an issue with a Revenue Agent is relatively rare. However for tax clinics and taxpayers who need to either add or change a representative mid stream specifically stating a power of attorney can be filed with an electronic signature is a useful inclusion.

If a document is eligible for an original electronic signature, the signature itself can be submitted in a number of widely used file formats including pdf and jpeg file types.

The real value for practitioners in the modification is the ability to send in photographs of a signature, or to have a client electronically sign a document on smartphone without the need to print the document at all, and still have it accepted by the IRS. Without this ability many taxpayers could potentially have to either have to physically meet their representative in order to sign a document, or worse yet many pro se taxpayers could be unable to meaningfully participate in moving cases forward because they lack access to a printer or a scanner.

Emailed Documents

The IRS now allows employees to both send and receive emails, including emails with attachments. For practitioners receiving emails the procedures are similar to receiving a physical copy of information from the IRS. The attachment is sent as a standalone email in an encrypted SecureZip. The 12 character password is then relayed to the practitioner over the phone, or by some other means than email, and the attachment can then be opened.

Sending documents to the IRS is a little more complicated. In order to protect the IRS, incoming email is not being accepted without an established relationship between the taxpayer or their representative. The IRS employee must also first request that the documents be sent through the normal e-fax channels prior to offering the use of email.

If the taxpayer is unable to send an e-fax or wishes to use email the employee must still take steps to dissuade them from doing so. They must advise the taxpayer that email is not secure. They must request that all attachments should be encrypted to the best of the taxpayer’s ability and baring that any information must be in a valid format. Links to files in the cloud are not accepted. Finally they should advise the body and subject line of the email must not contain any sensitive or identifying information. All of these steps are perfectly reasonable for security purposes but may be intimidating to some taxpayers.

If the taxpayer is sending a document that contains an electronic signature the taxpayer must attest to the signature by including a statement similar to “The attached [name of document] includes [name of taxpayer]’s valid signature and the taxpayer intends to transmit the attached document to the IRS.” It is worth noting that if there are technical issues with the .gov email address, IRS employees are prohibited from using personal email addresses as a back up.

Privacy Concerns

Part of the reluctance on behalf of the Service to accept emailed documents in the past has been a well-founded worry about introducing viruses into a secure system. From the IRS’s point of view requiring a known taxpayer to opt in to email, and follow the required procedures and formats, should greatly reduce this risk.

Email for the practitioner has its own set of privacy concerns. From a technical perspective sending an email to the IRS is no different than an e-fax. E-faxes are routed to IRS employees’ email addresses so the only difference is the terms of service for the e-fax vs the email provider.

Slightly different is what happens to the data once it is on a laptop in the IRS employee’s home. Fortunately for taxpayers the IRS has a robust set of data privacy protections that can be found in Section 6103. Generally speaking the IRS has done a good job of training employees on the importance of Section 6103. Without going into much detail, Section 6103 prohibits the disclosure or inspection of sensitive taxpayer information by anyone who is not authorized to view the material. The punishment for violations of Section 6103 can range from potential criminal charges for willful disclosures to administrative sanctions, including termination, for less serious breaches. Violations of Section 6103 also give taxpayers a right to a civil cause of action against the United States under IRC Section 7431.

Section 7431 was given additional teeth in the Taxpayer First Act of 2019 that is especially relevant right now given that all IRS employees are working remotely. Even though the IRS has safeguards in place to protect taxpayer information, such as requiring that laptops containing sensitive data are encrypted, accidents do happen.

Prior to the Taxpayer First Act taxpayers were only notified of a Section 6103 disclosure violation if the violation resulted in criminal charges. This left many taxpayers in the dark if return information was disclosed in a non willful manner. The Taxpayer First Act significantly broadened this disclosure to impacted taxpayers, including when IRS “proposes an administrative determination as to disciplinary or adverse action against an employee arising from the employee’s unauthorized inspection or disclosure of the taxpayer’s return or return information” and it requires that the IRS affirmatively inform taxpayers of the civil cause of action against the government. It remains to be seen whether there will be an uptick in Section 6103 violations but if expanded use of email does not trigger a wave of taxpayer notifications, then privacy may not be such a barrier to making this modification permanent.

While the limited acceptance of electronic signatures and use of email was expanded to benefit IRS employees during this difficult time, it is impossible to see this as anything but beneficial for taxpayers. Even with the required hurdles it makes engagement with the IRS easier, quicker, and more approachable to anyone who does not have a scanner and an e-fax service.