Examining the Interaction between Section 6020(b) and Deficiency Assessments

Today we welcome first time guest blogger Jeffrey Sklarz. He practices with the firm of Green and Sklarz in New Haven, CT with a practice focused heavily on the intersection of tax and bankruptcy law.  Jeffrey writes today about a recent full Tax Court opinion where the taxpayer attacked the sufficiency of the substitute for return prepared by the IRS.  The substitute for return in this case differs from most because the IRS used the bank deposits method in calculating the income.  The taxpayer has the type of small business not susceptible to an easy determination of unreported income.  Nonetheless, the case does not focus on the amount of unreported income the taxpayer had during his many years of nonfiling but rather the method used by the IRS in documenting it through the substitute for return process.  While this self-represented taxpayer wanders over into constitutional arguments with sufficient force to draw the IRC 6673 penalty for delaying the proceeding, and while the taxpayer may not have presented the arguments in the most articulate manner, the Court nonetheless uses this case to closely examine the substitute for return process.  

Les briefly discussed the substitute for return process last year in a post. The issue comes up with frequency in bankruptcy cases after the assessment of the liability and we have posted several times on impact of failing to file a return and failing to work with the IRS in filing a return on the ability to obtain a discharge in bankruptcy.  See A Cogent Look at the “What is a Return?” Question (Sept. 26, 2014); Willful Attempt to Evade or Defeat the Payment of Tax (Sept. 8, 2014); What Constitutes an Attempt to Evade or Defeat Taxes for Purposes of Section 523(a)(1)(C) of the Bankruptcy Code: The Ninth Circuit Parts Company with Other Circuits (Part 1),(Part 2) (Sept. 2014); What is a Return – The Long Slow Fight in the Bankruptcy Courts (Dec. 4, 2013)Jeffrey will focus on the importance of this decision for taxpayers later facing bankruptcy. Keith

When analyzing whether a bankruptcy filing can discharge income tax debts, the taxpayer’s IRS account transcript are a practitioner’s most important tool. IRS transcripts can be very confusing.  One particularly vexing set of entries occur when the IRS begins investigating a non-filer.  The transcript reflects a code of “150” followed by the designation “substitute for return” (“SFR”) with an amount due of “$0.00.”  It appears that this is simply the opening of the investigation, not the actual “filing” of an SFR or assessment, even though the IRS explains a 150 code as “return filed and tax liability assessed.”  IRS Transaction Codes Pocket Guide, IRS Document 11734 (Rev. 2012).  Thereafter, when an assessment is made, a “290” code will be entered, meaning an additional tax has been assessed; but, has the IRS actually filed any document that constitutes an SFR?  What the transcript reflects, and the IRS actually does, is highly relevant when considering the efficacy of a bankruptcy filing to resolve a client’s tax debts.


The case of Radar v. CIR provides a helpful discussion of the interplay between SFR procedures and the deficiency assessment process.  This explanation is particularly important when considering whether taxes may be dischargeable for bankruptcy purposes, since 11 U.S.C. § 523(a)(*) states that a return filed by the IRS on behalf of a taxpayer pursuant to § 6020(b) is not a “return” for purposes of discharge.  This leads to the question of whether there is a qualitative difference between an income tax deficiency assessed through the standard deficiency procedure versus an assessment following the IRS filing a § 6020(b) return. Radar helps to answer the above question by holding that the two work in tandem.

The taxpayer in Radar was a self-employed plumber who did not file tax returns for several years.  Following an audit, the examiner, using third-party sources, pieced together income information and issued notices of deficiency to both the taxpayer and his wife as “single” people.  The taxpayer and his wife timely filed a petition in Tax Court seeking redetermination arguing, among other things, that (a) the SFRs were deficient and, therefore, the notices of deficiency were invalid, and (b) the taxpayer’s wife was not the recipient of any income.  The IRS agreed that the taxpayer’s wife did not receive any income and amended its answer acknowledging the tax treatment would be “married filing separately.”

The Court considered the validity of the SFRs. The taxpayer (representing himself pro se) argued that the SFRs were invalid because the IRS failed “to cite a deficiency statute and/or a tax statute from which the deficiency and penalties could arise.”  The taxpayer also claimed that the IRS’s filing of a “nearly blank SFR 1040” was not a valid SFR.

Analyzing the validity of the SFR, the Court looked to § 6020 of the Tax Code, which authorizes the IRS to prepare and file returns for non-filers. The Court held that the IRS properly followed the non-filer procedures for assessing a deficiency and that the SFR was valid under § 6020(b).  The Court reasoned that the IRS issued a 30-day letter and revenue agent report (Form 4549, Income Tax Examination Changes) and the “combination of documents is sufficient to constitute a valid SFR under section 6020(b).”  (Emphasis added.) See also, IRM §  Thereafter, the IRS issued a statutory notice of deficiency.  Accordingly, the Court held there was a valid SFR filed under § 6020(b) by the IRS, followed by a notice of deficiency.

Turning back to § 523(a)(*) of the Bankruptcy Code, returns filed by the IRS pursuant to § 6020(b) of the Tax Code render related taxes nondischargeable. However, § 523(a)(*) of the Bankruptcy Code provides two safe harbors: (1) if the taxpayer agrees to the audit report and signs the Form 4549, which following the logic of Radar, means that the audit report is treated as an SFR and would constitute a “§ 6020(a) return” and be dischargeable, and (2) if the “return” is pursuant to a “written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal,” such as Tax Court.  In re Kemendo, 516 B.R. 434 (Bankr. S.D. Tex. 2014) (return was considered a “§ 6020(a) return” and related taxes were dischargeable).  Therefore, Mr. Radar’s taxes may be dischargeable as the “return” came into existence by way of a Tax Court order, however, other conduct of the taxpayer would likely render the taxes nondischargeable, such as his willful tax avoidance.

Radar provides clarity to the SFR process and when the SFR actually arises for dischargeability purposes. SFRs arise when the 30-day letter and audit report are issued, which constitute “§ 6020(b) returns” for purposes of dischargeability, unless the taxpayer agrees to the audit report or files in Tax Court.  While this is a highly technical point, Radar provides much needed guidance when analyzing transcripts and advising clients about SFRs and their impact on a potential bankruptcy filing.  Most importantly, Radar stands for the proposition that SFRs in income tax cases are “§ 6020(b) returns” under § 523(a)(*) of the Bankruptcy Code.