X. Tax Procedure
A. Interest, Penalties, and Prosecutions
1. The Tax Court has provided guidance on what constitutes the Service’s “initial determination” to impose penalties for purposes of the supervisory approval requirement of section 6751(b).
In Belair Woods, LLC v. Commissioner, the petitioner, Belair Woods, LLC, was classified as a partnership for federal tax purposes. On its partnership tax return for its taxable year ending December 31, 2009, Belair Woods claimed a $4.78 million charitable contribution deduction for a conservation easement on land in Georgia. On December 18, 2012, the Service revenue agent auditing the partnership’s return sent petitioner a Letter 1807 inviting the tax matters partner (TMP) and other partners to a closing conference to discuss the government’s proposed adjustments, which were set forth in an attached summary report. The letter “indicated that ‘[a]ll proposed adjustments in the summary report will be discussed at the closing conference’ . . . .” The summary report proposed to disallow the $4.78 million charitable contribution deduction, “proposed a ‘gross overvaluation’ penalty under section 6662(h), and in the alternative proposed penalties for negligence and substantial understatement of income tax under section 6662(c) and (d), respectively.” On September 2, 2014, the revenue agent’s supervisor signed a Civil Approval Penalty Form approving the penalties listed on the form. On March 9, 2015, the Service issued a “TMP 60-Day Letter” (60-day letter) that “formally communicated to petitioner the Examination Division’s decision to assert the tax adjustments determined in the examination and the three penalties listed on the Civil Penalty Approval Form.” Following the petitioner’s unsuccessful appeal to the IRS Office of Appeals (IRS Appeals), the Service issued a notice of final partnership administrative adjustment (FPAA) disallowing the $4.78 million charitable contribution deduction and determining a gross valuation misstatement penalty or certain other penalties in the alternative.
The main issue in the case was whether the Service had complied with the requirement of section 6751(b)(1) that the initial determination of the assessment of a penalty be “personally approved (in writing) by the immediate supervisor of the individual making such determination.” The Tax Court (Judge Lauber) reviewed the court’s prior decisions interpreting section 6751(b) and reasoned:
In a deficiency context such as this, we conclude that the “initial determination” of a penalty assessment—the “consequential moment” of IRS action, as the Second Circuit put it in Chai . . . is embodied in the document by which the Examination Division formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties.
In this case, the court concluded that the Letter 1807 inviting the TMP to a closing conference—which informed the petitioner of both the penalties the Service was considering and the defenses that might be available to the petitioner—was not the initial determination of the penalties because it merely advised Belair Woods of the penalties that might be imposed. Instead, the court held, the 60-day letter represented the Service’s initial determination of penalties because it was in this letter that the Service formally notified Belair Woods that the Examination Division had completed its work and that the Service “had made a definite decision to assert penalties.” Because the revenue agent’s supervisor had signed the Civil Penalty Approval Form before the 60-day letter was sent to the taxpayer, the court held the Service had complied with the supervisory approval requirement of section 6751(b) as to the three penalties described in the 60-day letter. In contrast, the court concluded, the Service had not complied with the section 6751(b) supervisory approval requirement as to a fourth penalty that was not mentioned in the 60-day letter and instead was asserted in the FPAA.
2. Former Service revenue agent who prepared tax returns for decades gets the Tax Court to clarify the burden of production with respect to the requirement of section 6751(b) that the individual initially determining accuracy-related penalties obtain written supervisory approval.
In Frost v. Commissioner, Mr. Frost’s poor efforts in substantiating his deductions for 2010–2012 resulted in the Service imposing accuracy-related penalties under section 6672 for each year. The Tax Court (Judge Pugh) held that Mr. Frost, who was a Service revenue agent for 15 years and who prepared tax returns as an enrolled agent for 25 years, failed to substantiate his deductions on his Schedule C, Profit or Loss from Business, and failed to establish his basis in a partnership interest to deduct his share of partnership losses, on his Schedule E, distributive share of partnership losses. However, the court held that the Service had failed to meet its burden of production with respect to accuracy-related penalties for 2010 and 2011 and therefore declined to uphold the penalties.
a. Facts. As a result of the disallowance of Mr. Frost’s deductions, the Service determined penalties under section 6662(a), (b)(1), and (2) for both negligence and substantial understatements of income for the years 2010, 2011, and 2012. The examining agent prepared a Civil Penalty Approval Form (Form) on April 22, 2014. The Form included an electronic signature dated May 20, 2014, approving the substantial understatement penalty but pertained only to Mr. Frost’s 2012 return. The examining agent did not similarly prepare or obtain approval for any penalties in relation to Mr. Frost’s 2010 or 2011 returns. It has long been settled that the Service has the initial burden of production with respect to a taxpayer’s liability for any penalty to come forward with sufficient evidence indicating that the imposition of penalties is appropriate. As part of that burden, the Service must produce evidence that it complied with section 6751(b)(1), which requires that the initial determination of the assessment of a penalty be personally approved in writing by the immediate supervisor of the person making the determination. However, this case presents an issue of first impression for the Tax Court, which has not addressed the point in time when the burden shifts to the taxpayer to show otherwise.
b. Analysis of 2010–2012. The Service failed to offer evidence that it had complied with the supervisory approval requirement of section 6751(b)(1) with respect to the penalties asserted for 2010 and 2011. Because the Service had failed to meet its burden of production, the court held that the Service was precluded from imposing those penalties. In contrast, the Service introduced a signed penalty approval form in relation to Mr. Frost’s 2012 return. The issue then became whether the form supported a finding that a supervisor approved Mr. Frost’s penalty prior to formally communicating it to Mr. Frost in the notice of deficiency and whether the form was sufficient to satisfy the Service’s initial burden of production. If it was, the burden would shift to Mr. Frost to come forward with evidence to the contrary, for example, that the penalty had been communicated to him before the supervisor’s approval was obtained. The court held that the penalty approval form reflected approval of the 2012 substantial underpayment penalty prior to formal communication of it to the taxpayer. Therefore, the form was held sufficient to carry the Service’s initial burden of production under section 7491(c), including the supervisory approval requirement of section 6751(b)(1).
With respect to the 2012 negligence penalty, however, the Service was not able to provide similar evidence, and therefore the Service failed to satisfy its burden of production as to supervisory approval of the negligence penalty. Because the Service had met its burden of production with respect to the 2012 substantial understatement penalty, the court held that the burden shifted to Mr. Frost to offer evidence that the Service’s approval of the substantial understatement penalty was untimely. If he had done so, the court would have been left to weigh the evidence to determine whether the Service had satisfied the supervisory approval requirement of section 6751(b)(1) prior to formally communicating the substantial understatement penalty to the taxpayer. Mr. Frost, however, did not claim and the court found no evidence indicating that the Service communicated any penalty determination to Mr. Frost before the penalty approval form was signed. Accordingly, the court held that, because the Service had complied with the requirements of section 6751(b)(1), Mr. Frost was subject to the substantial understatement penalty determined by the Service.
c. Policy. The court’s holding protects the requirement that the Service come forward initially with evidence of written penalty approval as required by section 6751(b)(1). Shifting the burden to the taxpayer after the Service makes the initial showing avoids requiring the Service to prove a negative, that is, that no formal communication of the penalty took place before supervisory approval of the penalty was obtained. Thereafter, if the taxpayer introduces evidence to contradict the Service’s initial showing, then the Service can respond with additional evidence leaving the court to weigh the evidence. Note further that any evidence of prior formal communication should have been received by the taxpayer. The taxpayer could introduce it to prove the untimeliness of the supervisory approval of the penalty.
3. Is the Service ever going to learn that the section 6751(b) supervisory approval requirement is not met unless the required supervisory approval of a penalty occurs before the initial determination that formally communicates the penalty to the taxpayer?
In Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, the taxpayer, a C corporation, failed to disclose its participation in a listed transaction as required by section 6011 and Regulation section 1.6011-4(a). The Service revenue agent examining the taxpayer’s return issued a 30-day letter to the taxpayer offering the opportunity for the taxpayer to appeal the proposal to IRS Appeals. The 30-day letter proposed to assess a penalty under section 6707A for failing to disclose a reportable transaction. Approximately three months after the 30-day letter was issued, the revenue agent’s supervisor approved the penalty by signing a Civil Penalty Approval Form. Following unsuccessful discussions with IRS Appeals, the Service assessed the penalty and issued a notice of levy.
The taxpayer requested a collection due process (CDP) hearing with IRS Appeals, following which IRS Appeals issued a notice of determination sustaining the proposed levy. In response to the notice of determination, the taxpayer file a petition in the Tax Court. In the Tax Court, the taxpayer filed a motion for summary judgment on the basis that the Service had failed to comply with the supervisory approval requirement of section 6751(b). Section 6751(b)(1) requires that the “initial determination” of the assessment of a penalty be “personally approved (in writing) by the immediate supervisor of the individual making such determination.”
The Tax Court (Judge Gustafson) granted the taxpayer’s motion. The court first concluded that the supervisory approval requirement of section 6751(b) applies to the penalty imposed by section 6707A. Next the court concluded that the supervisory approval of the section 6707A penalty in this case was not timely because it had not occurred before the Service’s initial determination of the penalty. The parties stipulated that the 30-day letter issued to the taxpayer reflected the Service’s initial determination of the penalty. The supervisory approval of the penalty occurred three months later and therefore, according to the court, was untimely.
The Service argued that the supervisory approval was timely because it occurred before the Service’s assessment of the penalty. In rejecting this argument, the court relied on its prior decisions interpreting section 6751(b), especially Clay v. Commissioner, in which the court held in a deficiency case “that when it is ‘communicated to the taxpayer formally . . . that penalties will be proposed,’ section 6751(b)(1) is implicated.” In Clay, the Service had issued a 30-day letter when it did not have in hand the required supervisory approval of the relevant penalty. The Service can assess the penalty imposed by section 6707A without issuing a notice of deficiency. Nevertheless, the court observed “[t]hough Clay was a deficiency case, we did not intimate that our holding was limited to the deficiency context.”
The court summarized its holding in the present case as follows: “Accordingly, we now hold that in the case of the assessable penalty of section 6707A here at issue, section 6751(b)(1) requires the IRS to obtain written supervisory approval before it formally communicates to the taxpayer its determination that the taxpayer is liable for the penalty.” The court therefore concluded that it had been an abuse of discretion for IRS Appeals to determine that the Service had complied with applicable laws and procedure in issuing the notice of levy. The court accordingly granted the taxpayer’s motion for summary judgment.
4. The trust fund recovery penalty imposed on responsible persons by section 6672(a) is a “penalty” subject to the supervisory approval requirement of section 6751(b), says the Tax Court.
In Chadwick v. Commissioner, the taxpayer was the sole member of two different LLCs, both of which failed to pay employment taxes for several calendar quarters. Different revenue officers were assigned to each LLC. Each revenue officer completed Service Form 4183, Recommendation re: Trust Fund Recovery Penalty Assessment, recommending that the Service hold the taxpayer responsible for total penalties equal to nearly $114,000 of the business’ unpaid employment taxes pursuant to section 6672(a). Each revenue agent’s supervisor electronically signed the appropriate Form 4183 approving the recommendation. On the same day that each Form 4183 was approved by the supervisor, the Service sent to the taxpayer a Letter 1153 (notice of proposed assessment) for each LLC informing him that the Service intended to hold him responsible for a penalty equal to the unpaid employment taxes pursuant to section 6672(a). The Service assessed the penalties and issued a notice of levy. The taxpayer requested a CDP hearing with the Service Office of Appeals, following which IRS Appeals issued a notice of determination sustaining the proposed levy. In response to the notice of determination, the taxpayer file a petition in the Tax Court. In the Tax Court, the Service filed a motion for summary judgment.
The Tax Court (Judge Lauber) granted the government’s motion. In reviewing for abuse of discretion the determination of IRS Appeals to uphold the proposed collection action, the court considered whether the requirement of section 6751(b) that the “initial determination” of the assessment of a penalty be “personally approved (in writing) by the immediate supervisor of the individual making such determination” applies to the penalty imposed by section 6672(a). The court held that the penalty imposed by section 6672(a) on responsible persons who willfully fail to collect or pay over any tax due (commonly referred to as the trust fund recovery penalty) is a “penalty” subject to the supervisory approval requirement of section 6751(b). Further, the court held that the Service had complied with the supervisory approval requirement because the Letters 1153 that the Service had issued to the taxpayer constituted the “initial determination” of the penalty and the appropriate supervisor had approved the penalties on the same day the Letters 1153 were sent to the taxpayer.
5. Taxpayer again escapes penalties where supervisory approval to impose penalties is not obtained until after imposition of the penalties.
In Kroner v. Commissioner, the taxpayer, Mr. Kroner, had an incredibly successful relationship with a benefactor, Mr. Haring, with whom he had worked for years. Notwithstanding that Mr. Kroner submitted into evidence a letter purportedly from Mr. Haring indicating that more than $24 million in transfers over several years to Mr. Kroner were gifts, the transfers were held not to qualify as excludable from gross income under section 102(a) as gifts. Instead, the Tax Court (Judge Marvel) applied the U.S. Supreme Court’s analysis in Commissioner v. Duberstein and held that the transfers were included in Mr. Kroner’s income because he had failed to prove that the transfers were made with detached, disinterested generosity. In short, despite the court’s strong recommendation during trial, Mr. Kroner failed to offer any testimony from Mr. Haring that he had anything more than a business relationship with Mr. Haring. The court found the taxpayer’s story concerning the transfers and the testimony of the taxpayer, his attorney, and a third witness not to be credible.
a. Accuracy-Related Penalties Under Section 6662. The more significant aspect of Kroner relates to Judge Marvel’s denial of the Service’s imposition of accuracy-related penalties under section 6662 based on substantial understatement of income. The issue before the court was whether the Service had complied with the requirement of section 6751(b)(1) that the initial determination of the assessment of a penalty be “personally approved in writing by the immediate supervisor of the individual making such determination.” In Graev v. Commissioner, the Tax Court held that compliance with section 6751(b)(1) is properly a part of the Service’s burden of production under section 7491(c). Further, in Chai v. Commissioner, the Court of Appeals for the Second Circuit held that “the written-approval requirement of § 6751(b)(1) is appropriately viewed as an element of a penalty claim, and therefore part of the IRS’s prima facie penalty case.” The Tax Court has held that the initial determination of a penalty occurs in the document through which the Service Examination Division notifies the taxpayer in writing that the examination is complete and a decision to assert penalties has been made.
Here, the Service supervisor approved the agent’s penalty determination on a Civil Penalty Approval Form dated October 31, 2012. The Service had sent the taxpayer two letters. The first, dated August 6, 2012, was Letter 915 accompanied by Form 4549 (Income Tax Examination Changes), which proposed the penalties and provided the taxpayer with an opportunity to protest the proposed adjustments with IRS Appeals. The second, dated October 31, 2012, was Letter 950 accompanied by Form 4549-A (Income Tax Discrepancy Adjustments), which also offered the taxpayer an opportunity to file a protest with IRS Appeals. According to the court, if Letter 915 was the initial determination to assert accuracy-related penalties, then the Service could not meet its burden to show the required supervisory approval because Letter 915 predated the date on which the Civil Penalty Approval Form was signed. The Service argued that Letter 915 was not the initial determination of the penalties because Letter 915 was not the so-called “30-day letter” giving the taxpayer 30 days within which to file a protest with IRS Appeals and instead was meant only to invite the taxpayer to submit additional information “at a time when it was understood that petitioner would not yet pursue an administrative appeal.” The court rejected this argument.
The court reasoned that Clay had held that a letter offering the taxpayer a right to pursue an administrative appeal and enclosing a revenue agent’s report that proposed a section 6662 penalty was the initial determination within the meaning of section 6751(b), and Letter 915 in this case did just that. The court made clear that the content of the document sent to the taxpayer is the relevant inquiry and not the Service’s subjective intent in mailing the document. The court concluded that the Service made its initial determination of the assessment of penalties no later than August 6, 2012, when Letter 915 was delivered to the taxpayer. Because the initial determination to assert penalties occurred before the Civil Penalty Approval Form was signed on October 31, 2012, the Service had failed to satisfy its burden of production under section 6751(b); the taxpayer, therefore, was not liable for the section 6662(a) accuracy-related penalties.
6. A settlement offer that would have required the taxpayers to pay penalties at a reduced rate was not an “initial determination” of the penalties that required supervisory approval under section 6751(b)(1).
In Thompson v. Commissioner, the taxpayers participated in a distressed asset trust (DAT) transaction, which they disclosed on their returns. The Service revenue agent assigned to examine their returns sent them two letters offering to resolve their tax liabilities associated with the transaction. Each letter proposed that the taxpayers agree to an accuracy-related penalty under section 6662 at a reduced rate. The taxpayers did not accept the settlement offers. The revenue agent then completed his examination of the taxpayers’ returns and concluded that they owed penalties under sections 6662(h) and 6662A. The revenue agent’s acting immediate supervisor signed a memorandum approving the penalties. The Service then sent a notice of deficiency to the taxpayers that reflected both a deficiency and the specified penalties.
The taxpayers argued that the Service had failed to comply with the supervisory approval requirement of section 6751(b)(1). Section 6751(b)(1) requires that the “initial determination” of the assessment of a penalty be “personally approved (in writing) by the immediate supervisor of the individual making such determination.” They argued that the letters sent by the revenue agent offering to settle constituted the Service’s “initial determination” of the penalties and that the supervisor’s approval of the penalties was untimely because it occurred after the revenue agent had sent the letters.
The Tax Court (Judge Greaves) disagreed and granted the Service’s motion for partial summary judgment. The Tax Court’s prior decisions addressing section 6751(b), the court observed, including Belair Woods, provide that “supervisory approval is required no later than (1) the date the IRS issues the notice of deficiency, or, if earlier, (2) the date the IRS formally communicates to the taxpayer Exam’s determination to assert a penalty and notifies the taxpayer of his right to appeal that determination.” In this case, the court concluded,
[t]he offer letters . . . do not reflect an “initial determination” because they do not notify petitioners that Exam had completed its work. Rather than determining that petitioners are liable for penalties of specific dollar amounts, subject to review by Appeals or the Tax Court, each letter offers to settle penalties arising from the DAT transaction on certain terms, including substatutory penalty rates, which are based not on an audit but on Announcement 2005-80.
Because the offer letters did not constitute an initial determination of the penalties, the court reasoned, section 6751(b)(1) did not require supervisory approval of the penalties before the offer letters were sent. The court also rejected the taxpayers’ argument that the supervisory approval requirement was not met because the supervisor who approved the penalties was an acting supervisor and therefore provided “meaningful review” of the penalties.
7. The sole shareholder of a captive insurance company organized as an S corporation escaped penalties because the Service failed to comply with the supervisory approval requirement of section 6751(b).
The issue in Oropeza v. Commissioner was whether the Service was precluded from asserting penalties because it had failed to comply with the requirement of section 6751(b)(1) that the initial determination of the assessment of a penalty be “personally approved (in writing) by the immediate supervisor of the individual making such determination.” The taxpayer was the sole shareholder of a micro-captive insurance company organized as a Subchapter S corporation. The limitations period for assessment of tax for 2011 was nearing expiration, and the taxpayer would not agree to extend it. Accordingly, on January 14, 2015, the Service revenue agent auditing the taxpayer’s 2011 return sent petitioner a Letter 5153 along with the revenue agent’s report on Form 4549-A, Income Tax Discrepancy Adjustments. The revenue agent’s report proposed to increase the taxpayer’s distributive share of income from the S corporation by $1.25 million and his reported capital gain by $650,000.
The report also asserted a 20% accuracy-related penalty under section 6662(a). The report did not state the specific basis for the penalty but instead stated that it was based on a substantial underpayment of tax “attributable to one or more of” four possible grounds: (1) negligence; (2) substantial understatement of income tax; (3) substantial valuation misstatement (overstatement); or (4) transaction lacking economic substance. On January 29, 2015, the revenue agent’s supervisor signed a Civil Penalty Approval Form that authorized the assertion of a 20% penalty for substantial understatement of income tax. In a subsequent memorandum prepared for a Service Chief Counsel attorney and dated May 1, 2015, the revenue agent recommended a 40% penalty pursuant to section 6662(i) for a nondisclosed economic substance transaction based on the taxpayer’s failure to disclose the captive insurance arrangement on either the S corporation’s return or his personal return. The revenue agent’s supervisor signed the memorandum on an unspecified date. The Service issued a notice of deficiency on May 6, 2015, in response to which the taxpayer filed a petition in the Tax Court. The notice of deficiency asserted a 40% penalty under section 6662(i) for a nondisclosed economic substance transaction or, in the alternative, a 20% penalty based on either negligence or substantial understatement of income tax.
In the Tax Court, the Service conceded that it had not obtained supervisory approval of the negligence penalty. The Tax Court (Judge Lauber) held that the Service was precluded from asserting both the 20% penalty based on substantial understatement of income tax or the 40% penalty for a nondisclosed economic substance transaction. With respect to the 20% penalty, the court relied on its prior decision in Belair Woods, in which the court had held that the initial determination of a penalty occurs in the document through which the Service Examination Division notifies the taxpayer in writing that the examination is complete and a decision to assert penalties has been made. In this case, the court held, the initial determination of the penalty was the Letter 5153 that was mailed to the taxpayer on January 14, 2015. Because the required supervisory approval of that penalty did not occur until January 29, 2015, the approval was untimely.
With respect to the 40% penalty, the parties agreed that the first notification to the taxpayer was the notice of deficiency that was issued on May 6, 2015. The Service argued that this penalty received the required supervisory approval when the revenue agent’s supervisor signed the revenue agent’s memorandum dated May 1, 2015, to the Service Chief Counsel attorney. The court first concluded that section 6662(i) does not impose a distinct penalty, but instead “increases the rate of the penalty imposed by section 6662(a) and (b)(6) for engaging in a transaction lacking economic substance.” The relevant questions therefore became whether the revenue agent’s report had asserted a penalty under section 6662(a) and (b)(6) that received the required supervisory approval and, if not, whether the Service can satisfy the section 6751(b) supervisory approval requirement by later determining that section 6662(i) applies because the transaction was not disclosed on the return. The court held that the “boilerplate text” of the Letter 5153 sent to the taxpayer on January 14, 2015, did assert a penalty under section 6662(a) and (b)(6) for engaging in a transaction lacking economic substance but that the revenue agent’s supervisor had not timely approved this penalty because the supervisor did not sign the Civil Penalty Approval Form until January 29, 2015.
The court then turned to the question, which it regarded as one of first impression, of whether the Service can satisfy the section 6751(b) supervisory approval requirement by later determining that section 6662(i) applies because a transaction was not disclosed on the return. The court reviewed the text and legislative history of section 6662 and concluded that the 40% penalty of section 6662(i) is an enhancement of the 20% penalty imposed by section 6662(a) and (b)(6) in situations in which the taxpayer has failed to disclose on the return a transaction lacking economic substance. The court viewed the enhancement as analogous to an “aggravating factor” in the area of criminal law that justifies a harsher penalty for a basic offense. Because the section 6662(i) penalty is an enhancement of the basic penalty imposed by section 6662(a) and (b)(6) and because the Service had failed to obtain supervisory approval of the basic penalty, the court held the Service was precluded from asserting the 40% enhancement of the penalty.
8. Updated instructions on how to rat yourself out.
Revenue Procedure 2020-54 updated Revenue Procedure 2019-42. Revenue Procedure 2020-54 “identifies circumstances under which the disclosure on a taxpayer’s income tax return with respect to an item or a position is adequate for the purpose of reducing the understatement of income tax under section 6662(d) . . . (relating to the substantial understatement aspect of the accuracy-related penalty), and for the purpose of avoiding the tax return preparer penalty under section 6694(a) (relating to understatements due to unreasonable positions) . . . .” There have been no substantive changes. The Revenue Procedure does not apply with respect to any other penalty provisions, including section 6662(b)(1) accuracy-related penalties. “If this revenue procedure does not include an item or position, disclosure is adequate with respect to that item only if made on a properly completed Form 8275 or Form 8275-R, as appropriate, attached to the return for the year or to a qualified amended return.” A corporation’s complete and accurate disclosure of a tax position on the appropriate year’s Schedule UTP, Uncertain Tax Position Statement, is treated as if the corporation had filed a Form 8275 or Form 8275-R regarding the tax position. The Revenue Procedure “applies to any income tax return filed on a 2020 tax form for a taxable year beginning in 2020 and to any income tax return filed on a 2020 tax form in 2021 for a short taxable year beginning in 2021.”
B. Discovery: Summonses and FOIA
There were no significant developments regarding this topic during 2020.
C. Litigation Costs
There were no significant developments regarding this topic during 2020.
D. Statutory Notice of Deficiency
1. ♪♫If you want my love, leave your name and address . . . . ♫♪ A notice of deficiency mailed to the address on the taxpayers’ tax return was mailed to the taxpayers’ last known address despite their filing of a power of attorney and a request for an extension using their new address.
Section 6212(b)(1) provides that a notice of deficiency in respect of a tax imposed by subtitle A shall be sufficient if “mailed to the taxpayer at his last known address.” For this purpose, a taxpayer’s last known address is “the address that appears on the taxpayer’s most recently filed and properly processed Federal tax return, unless the [Service] is given clear and concise notification of a different address.” The taxpayers in Gregory v. Commissioner, a married couple, moved from Jersey City, New Jersey, to Rutherford, New Jersey, on June 30, 2015. They filed their 2014 federal income tax return on October 15, 2015. The return incorrectly reflected their old Jersey City address. In November 2015, a power of attorney on Form 2848 was submitted to the Service that had their new Rutherford address. In April 2016, they filed a request for an automatic extension of time to file their 2015 federal income tax return on Form 4868 that also had their new Rutherford address. The Service sent a notice of deficiency with respect to tax year 2014 by certified mail to the taxpayers’ old Jersey City address on October 13, 2016. The U.S. Postal Service returned the notice of deficiency to the Service as unclaimed; the taxpayers never received it. The taxpayers first became aware of the notice of deficiency on January 17, 2017, and, in response, filed a petition in the Tax Court that same day. The Service moved to dismiss for lack of jurisdiction because the taxpayers had filed their petition late (outside the 90-day time period of section 6213(a)), and the taxpayers moved to dismiss for lack of jurisdiction on the ground that the petition had not been mailed to their last known address and therefore was invalid.
a. The Tax Court’s decision. The Tax Court (Judge Buch) held that the notice of deficiency had been mailed to the taxpayers’ last known address and granted the government’s motion to dismiss. The court first reasoned that neither the Form 2848 nor the Form 4868 submitted by the taxpayers was a “return” within the meaning of the last known address rule of Regulation section 301.6212-2(a). These forms, the court reasoned, are not returns under the four-part test of Beard v. Commissioner. Further, the court explained, Regulation section 301.6212-2(a) provides that additional information on what constitutes a return for purposes of the last known address rule can be found in revenue procedures published by the Service. Revenue Procedure 2010-16 specifically provides that Forms 2848 and 4868 are not returns for this purpose.
The court next concluded that the Forms 2848 and 4868 submitted by the taxpayers had not provided the Service with clear and concise notification of their new address. The instructions to both forms, the court reasoned, explicitly provide that the forms will not update a taxpayer’s address of record with the Service. That these forms do not constitute clear and concise notification of a new address, the court explained, is implicit in Revenue Procedure 2010-16, which provides that Forms 2848 and 4868 are not returns and that they “will not be used to update the taxpayer’s address of record.”
Finally, the court distinguished earlier decisions holding that a Form 2848 filed with the Service does give clear and concise notification of a new address. The court reasoned that the previous decisions were based on prior versions of Form 2848 and that “[s]ince 2004 the Commissioner has issued clear guidance informing taxpayers of what actions will and will not change their last known address with the Commissioner.”
b. The Service knew or should have known of the taxpayers’ new address, says the Third Circuit. The taxpayers in Gregory appealed the Tax Court’s decision to the Court of Appeals for the Third Circuit, the same court that had held that a prior version of Form 2848 did provide clear and concise notification of a taxpayer’s new address. In a brief opinion by Judge Roth, the Third Circuit vacated and remanded the case to the Tax Court. The court first noted that “Form 8822 [the Service’s change-of-address form] has not been consistently required to notify the IRS of an address change.” The court observed that the Tax Court twice had concluded that a power of attorney on Form 2848 filed with the Service did provide the Service with clear and concise notification of a new address. Curiously, the court did not cite its own earlier decision that had reached the same conclusion. The court then emphasized that, “[i]n determining whether the IRS had clear and concise notification of an address change, the proper inquiry is what the IRS knew or should have known.” In this case, the court noted, before the Service issued the notice of deficiency in question, the taxpayers’ CPA had informed the Service agent conducting the audit of the taxpayers’ return that the taxpayers had moved. Based on this actual notice to the Service, combined with the filing of both an extension request on Form 4868 and a power of attorney on Form 2848, both of which reflected the taxpayers’ new address, the court concluded that “the IRS knew or should have known that the Gregorys had changed addresses.”
The Third Circuit’s opinion is not entirely clear as to the basis of the court’s decision. The court’s opinion emphasizes that the taxpayers’ CPA directly informed the Service agent conducting the audit that the taxpayers had moved, but the opinion also relies on the extension request and power of attorney forms filed by the taxpayers. By failing to mention its own earlier decision that a prior version of Form 2848 did provide clear and concise notification of a taxpayer’s new address, the court’s opinion does not directly address the question whether a current Form 2848, by itself, would operate as clear and concise notification of a new address. In light of this uncertainty, advisors whose clients move should either counsel clients to file Form 8822, the Service’s change-of-address form, or file Form 8822 on their behalf.
E. Statute of Limitations
1. Based upon a credible declaration from the taxpayer’s attorney, the Tax Court has held that a petition sent in an envelope that had no postmark was timely filed even though it arrived after the 90-day period for filing.
In general, under section 6213(a), a taxpayer must petition the Tax Court within 90 days after the date the notice of deficiency is mailed. There is, however, a “timely mailed timely filed” rule which provides that if a document is delivered by U.S. mail, it is deemed to be timely mailed (and, therefore, timely filed) if the envelope is properly addressed, postage is prepaid, and the postmark date on the envelope falls on or before the end of the 90-day period for mailing the petition. If all of these conditions are met, then the date of the postmark is deemed to be the date of delivery and date of filing. In Seely v. Commissioner, the Seelys’ attorney prepared a petition and mailed it to the Tax Court. The Seelys and the Service agreed that all the conditions were met except there was no postmark on the envelope containing the petition. The Seelys’ 90-day period for filing the petition expired on June 26, 2017 (a weekday), but the Tax Court received the petition on July 17, 2017, a number of days after the expiration of the 90-day period. The Service filed a motion to dismiss for lack of jurisdiction on the ground that the petition was not timely filed. The Seelys argued that their petition was timely filed because their attorney mailed the petition to the Tax Court on June 22, 2017, before the 90-day period expired. In support of their argument, the Seelys supplied a declaration from their attorney under penalty of perjury indicating that on June 22, 2017, he deposited the petition into a U.S. mailbox.
While regulations prescribe specific rules for postmarks, they provide no rules regarding the situation where the envelope has no postmark whatsoever. In holding in favor of the Seelys, the Tax Court followed its prior precedents indicating that where the postmark is illegible, extrinsic evidence is allowed to ascertain the mailing date. The issue, therefore, narrowly turned on whether the Seelys presented convincing evidence establishing that they timely mailed their petition. The Service argued that it takes only 8 to 15 days for the U.S. Postal Service to deliver an item of mail to Washington D.C. Further, because the petition arrived at the Tax Court (16 as opposed to 15 days) later than expected, the Service argued, the lawyer’s declaration was not credible. Judge Vasquez disagreed that the attorney’s declaration was not convincing evidence due in part to the fact that the Fourth of July holiday fell between the date of the alleged mailing and the delivery date. On the basis of the attorney’s sworn declaration and of the court’s judicial notice of the Fourth of July holiday, the court concluded that, more likely than not, the petition was mailed on June 22, 2017, before the 90-day period had expired. Accordingly, the Service’s motion to dismiss for lack of jurisdiction was denied.
2. Up in Smoke: The period for filing petitions in the Tax Court had expired for these medical marijuana dispensaries. The Lesson: For God’s sake, when you are filing the petition on the last possible day, use registered or certified mail or make sure you are using a designated private delivery service.
In two cases, one involving Organic Cannabis Foundation, LLC, a limited liability company, and the other involving Northern California Small Business Assistants, Inc., a corporation, the Service issued notices of deficiency. Both taxpayers operated or held interests in medical marijuana dispensaries in California. The notices of deficiency disallowed deductions under section 280E, which disallows any deduction or credit otherwise allowable if such amount is paid or incurred in connection with a trade or business “if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances . . . .”
The last day for filing petitions in the Tax Court seeking redeterminations of the deficiencies was April 22, 2015. The law firm representing the taxpayers filed petitions in the Tax Court by sending them on April 21, 2015, using Federal Express’s (FedEx) “First Overnight” delivery service, which should have resulted in the earliest possible delivery on April 22. The petitions, however, were not delivered by Federal Express to the Tax Court until April 23, 2015. The delivery notes made by the Federal Express driver indicated that he or she had attempted delivery on April 22 but “could not get to the door for some plausible reason like construction, or some sort of police action (perhaps the [FedEx] representative said the access was blocked off because of a safety threat).” The Tax Court granted the government’s motion to dismiss for lack of jurisdiction because the taxpayers had not filed the petitions within the 90-day period prescribed by section 6213(a).
On appeal, the Ninth Circuit affirmed the Tax Court’s decision. In an opinion by Judge Collins, the court rejected four arguments made by the taxpayers. First, the taxpayers argued that the filing deadline had been extended to April 23 because the Tax Court clerk’s office was inaccessible on April 22, the last day for filing. The court noted that in a prior opinion, Guralnik v. Commissioner, the Tax Court had concluded that a petition filed on the day after the last day for filing was timely by virtue of Federal Rule of Civil Procedure 6(a)(3)(A), which provides that, if the clerk’s office is inaccessible on the last day for filing, then the time for filing is extended to the first day that is not a Saturday, Sunday, or legal holiday on which the clerk’s office is accessible. In Guralnik, the Tax Court had been closed due to a snowstorm on the last day for filing the petition. In this case, the Ninth Circuit concluded, the Tax Court clerk’s office was not inaccessible on April 22. According to the court, “[a] temporary obstacle that is encountered earlier in the day does not, without more, render the clerk’s office ‘inaccessible’ on ‘the last day for filing.’” For nonelectronic filings such as the petitions in this case, the court held, “a clerk’s office is ‘inaccessible’ on the ‘last day’ of a filing period only if the office cannot practicably be accessed for delivery of documents during a sufficient period of time up to and including the point at which ‘the clerk’s office is scheduled to close.’”
Second, the taxpayers argued that their petitions were timely filed pursuant to the timely-mailed-is-timely-filed rule of section 7502(a). Section 7502(a) provides that the postmark stamped on the cover in which a return, claim, or other document is mailed is deemed to be the date of delivery if the return or claim (1) is deposited in the mail in the United States within the time prescribed for filing in a properly addressed, postage-prepaid envelope or other appropriate wrapper and bears a postmark date that falls within the time prescribed for filing and (2) is delivered by U.S. mail after the prescribed time for filing to the agency with which it is required to be filed. This rule is extended by section 7502(f) to any document sent through a “designated delivery service,” defined in 7502(f)(2) as any delivery service that meets certain requirements and is provided by a trade or business if the service is designated for this purpose by the Secretary of the Treasury. At the time the petitions in this case were filed, the Service had specified which delivery services were designated private delivery services in Notice 2004-83. Although Notice 2004-83 listed several FedEx services as designated private delivery services, FedEx “First Overnight” was not among them. Accordingly, the court held, the taxpayers could not rely on section 7502(a) to establish that their petitions had been timely filed and the Tax Court had correctly dismissed the cases for lack of jurisdiction.
Third, the taxpayers argued that the 90-day period specified in section 6213(a) for filing a petition in the Tax Court seeking redetermination of a deficiency is subject to equitable exceptions such as equitable tolling. The court, however, adhered to controlling Ninth Circuit precedent in which the court previously had held that this 90-day period is jurisdictional and not subject to equitable exceptions. The court rejected the taxpayers’ argument that recent decisions of the U.S. Supreme Court addressing when statutory deadlines should be deemed jurisdictional had undermined the Ninth Circuit’s settled precedent.
Fourth, Organic Cannabis Foundation argued that the notice of deficiency issued by the Service was invalid because it had not been mailed to the taxpayer’s last known address as required by section 6212(b)(1). The court rejected this argument because, although the address to which the notice had been mailed omitted the taxpayer’s P.O. Box number, the nine-digit zip code included in the address indicated both that it was to be delivered to a P.O. Box and the specific number of the box to which it was addressed.
3. Tax Court holds that a rejected e-filed return still triggers the three-year limitations period of section 6501(a) on assessment of tax.
In a unanimous, reviewed opinion by Judge Greaves in Fowler v. Commissioner, the Tax Court has addressed whether an electronically filed return that was rejected for electronic filing triggered the section 6501(a) three-year limitations period on assessment of tax. The Service rejected the return for lack of an Identity Protection Personal Identification Number (IP PIN). An IP PIN is a six-digit number assigned to eligible individuals that must be used on a tax return in addition to the individual’s Social Security Number to verify the individual’s identity. Mr. Fowler properly filed to extend the due date of his 2013 tax return on Form 1040 until October 15, 2014. His CPA prepared and e-signed Mr. Fowler’s Form 1040 with a Practitioner Personal Identification Number. The CPA electronically transmitted or “e-filed” Mr. Fowler’s return with the Service on October 15, 2014. On the same day, the Service rejected the e-filed return for failure to include an IP PIN. Three days later, on October 28, 2014, the CPA again electronically submitted Mr. Fowler’s return and also sent via the U.S. Postal Service a paper version of the return, which was signed for as received by the Service.
Nevertheless, in December 2014 Mr. Fowler received a notification letter indicating that the Service had not received his return. On April 30, 2015, the CPA responded by again electronically refiling Mr. Fowler’s 2013 return with a proper IP PIN. This return was accepted by the Service on the same day. On April 5, 2018, the Service issued a notice of deficiency to Mr. Fowler in relation to his 2013 return, and he filed a petition in the Tax Court raising the three-year limitations period on assessment of tax in section 6501(a) as a defense.
The narrow question before the court was whether either the first e-filed return or the paper tax return, both submitted in October 2014, triggered the running of the section 6501(a) three-year limitations period. The Service generally is required to assess tax within a three-year period that begins when a return is filed. The filing of a return starts the running of this limitations period if the return was (1) “properly filed” and (2) a “required return.”
a. Was Mr. Fowler’s 2013 Form 1040 a “required return”? Judge Greaves first addressed whether Mr. Fowler’s 2013 Form 1040 was a “required return” under the test applied by the court in Beard v. Commissioner. Beard requires that “(1) the document purport to be a return and provide sufficient data to calculate tax liability, (2) the taxpayer make an honest and reasonable attempt to satisfy the requirements of the tax law, and (3) the taxpayer execute the document under penalties of perjury.” Mr. Fowler’s return readily met the first element without much question. With respect to the second element, Judge Greaves concluded that Mr. Fowler’s return was an honest and reasonable attempt to comply with the law because it included the taxpayer’s income, deductions, exemptions, and credits along with supporting documentation. The failure to include a proper IP PIN on the original October 2014 filings was not sufficient to disqualify the return as an honest and reasonable attempt to comply. Judge Greaves reasoned that this is especially true where the Service does not explain why the Service rejects an e-filed return but not a paper return without an IP PIN.
The third element of the Beard test requires a taxpayer to sign or execute the return under penalties of perjury. The Service argued that the October 15 electronic submission failed to satisfy the signature requirement because it did not include an IP PIN. Judge Greaves found this argument unpersuasive because the IP PIN is not a requirement in relation to what constitutes a valid signature. The regulations require only that each individual “shall sign” his or her return. The regulations further direct that a return preparer “electronically sign the return” consistent with guidance provided by the Service. By including his practitioner PIN on the e-filed return, Mr. Fowler’s CPA complied with the Service’s guidance on electronic return signatures. Just because the Service’s software rejects an e-filed return for lack of an IP PIN, the court concluded, does not mean that an IP PIN is part of the signature requirement. Thus, because there was no Service guidance that characterized an IP PIN as part of the signature requirement, Mr. Fowler’s return met the third element of the Beard test. Mr. Fowler’s Form 1040 therefore was a “required return.”
b. Was Mr. Fowler’s Form 1040 a “properly filed” return? Whether a return is “properly filed” does not depend upon whether the Service is informed or what the Service received and understood. Rather, a return is properly filed when the taxpayer’s mode of filing complies with the prescribed filing requirements. Delivery to the correct Service office is when a return is “filed.” A return that is delivered either physically through the U.S. Postal Service or electronically qualifies as “filed” even if the Service does not accept the return. Judge Greaves reasoned that Mr. Fowler’s return was properly filed because his CPA represented that he submitted the return on behalf of Mr. Fowler and he received a 20-digit submission ID as confirmation from the Service. Moreover, the Service acknowledged Mr. Fowler’s return was submitted on October 15.
c. Holding & Afterthoughts. Judge Greaves held that Mr. Fowler had satisfied the requirements for triggering the three-year limitations period on assessment set forth in section 6501(a). Because the limitations had been triggered by the October 2014 filing, the limitations period had expired before the Service issued the notice of deficiency on April 5, 2018. The opinion contains a fair amount of description regarding the machinations of the Service’s software and how the software operates to reject returns. The opinion might be narrowly construed to stand for the proposition that the Service’s rejection of an e-filed return for lack of an IP PIN will not prevent the section 6501(a) limitations from beginning to run. However, Judge Greaves also noted that a signature serves an authentication function and that Service guidance indicates that an element other than just an e-signature may be needed to authenticate an electronically filed return. The IP PIN would appear to have been what the Service needed to distinguish between the true taxpayer and a fraudulent taxpayer. By strictly applying the elements of Beard to conclude it was a properly filed return, the court may be putting the Service in the untenable position of forfeiting the protection of the statute of limitations in an effort to protect taxpayers from fraud. Finally, the opinion might also be broadly interpreted to support the proposition that where an e-filed return is rejected for any number of errors on the return, the limitations period on assessment continues to run.
4. Forms 1040 and 1099 filed by the taxpayer constituted a “return” that started the running of the limitations period on assessment of amounts the taxpayer failed to backup withhold from payments made to contractors, says the Fifth Circuit. Therefore, the Service was barred from assessing $1.2 million.
In Quezada v. United States (In re Quezada), the taxpayer, a debtor in bankruptcy proceedings, was a stone mason who hired subcontractors that provided their labor. For the years 2005 through 2008, he filed Forms 1099 to report the payments he made to the individuals he hired. Many of these Forms 1099, however, did not have taxpayer identification numbers (TINs) because the individuals had failed to provide them. The failure of these individuals to provide their TINs triggered an obligation on the part of the taxpayer under section 3406(a) to withhold a flat rate for all payments made to these individuals and to remit the withheld amounts to the Service. This is commonly referred to as “backup withholding.” Under Regulation section 31.6011(a)-4(b), the taxpayer was required to file a return on Form 945 to report the amounts withheld through backup withholding. The taxpayer failed to withhold the required amounts and did not file Form 945.
In 2014, more than three years after the taxpayer had filed Forms 1099 and his individual tax return on Form 1040 for 2008, the last year at issue, the Service assessed approximately $1.2 million for the amounts the taxpayer had failed to withhold. The taxpayer subsequently filed a petition in bankruptcy, and the Service filed a proof of claim in the bankruptcy proceeding. The taxpayer asserted that the Service was barred from assessing the amounts in question by the section 6501(a) limitations period on assessment of tax. Section 6501(a) generally requires the Service to assess tax within a three-year period that begins when a return is filed. The issue was whether the Forms 1099 and Forms 1040 that the taxpayer filed for the years in question constituted a “return” that triggered the running of the section 6501(a) three-year limitations period. The Service asserted that only Form 945, the return required by the relevant regulations, could be a “return” for this purpose and that, since the taxpayer had not filed Forms 945, the three-year limitations period on assessment never began to run.
In an opinion by Judge Jolly, the Fifth Circuit agreed with the taxpayer. In reaching its conclusion, the court rejected the government’s argument that the Supreme Court’s decision in Commissioner v. Lane-Wells Co. requires a taxpayer to file the return designated for the tax liability in question in order to start the running of the three-year limitations period. According to the Fifth Circuit, several other Circuit Courts of Appeal—including the Second, Sixth, Ninth, Eleventh, and Federal Circuits—have concluded that a form other than the one prescribed in regulations can constitute a “return” for this purpose. Instead, the court concluded, Lane-Wells stands for the following proposition: “‘the return’ is filed, and the limitations clock begins to tick, when the taxpayer files a return that contains data sufficient (1) to show that the taxpayer is liable for the tax at issue and (2) to calculate the extent of the liability.”
The Forms 1040 and 1099 filed by the taxpayer, the court concluded, met both of these requirements. The first requirement (showing that the taxpayer was liable for the tax) was met because he had filed Forms 1099 that did not contain TINs, which indicated that he was liable for backup withholding. The second requirement (allowing calculation of tax liability) was met because the Forms 1099 filed without TINs indicated that the taxpayer was liable for backup withholding at the statutory flat rate applied to the amount paid, which was, in fact, how the Service had calculated his liability for backup withholding. Because the Forms 1040 and 1099 filed by the taxpayer constituted “returns” that triggered the running of the section 6501(a) three-year limitations period on assessment, the Service was barred from assessing the $1.2 million in backup withholding that the taxpayer had failed to withhold and remit.
F. Liens and Collections
1. The taxpayers’ attempt to pay their federal tax liability went awry when the Service levied on the bank account on which their check was drawn and applied the proceeds to other tax years. Following a CDP hearing, the appropriate standard of review is for abuse of discretion, says the Tax Court.
In Melasky v. Commissioner (Melasky I), the taxpayers hand delivered to the Service at the Service’s office in Houston a check for $18,000 and requested that the check be applied against their 2009 federal income tax liability. The Service accepted the check and initially applied it as the taxpayers had requested. A few days later, however, the Service levied against the bank account on which the check had been drawn and applied the proceeds of the levy to an earlier tax year. The effect of the levy was that the taxpayers’ check bounced. The Service therefore reversed the payment against the 2009 liability and charged a $360 penalty for writing a bad check.
On the same day as the levy, the Service issued to the taxpayers a final notice of intent to levy with respect to certain years, including 2009. In response, the taxpayers requested a CDP hearing. The Service’s settlement officer issued a notice of determination concluding that the proceeds of the levy constituted an involuntary payment, rather than a voluntary payment, and that the Service therefore was free to apply the payment as it wished. In response to the notice of determination, the taxpayers filed a petition in the Tax Court.
The Tax Court (Judge Holmes) held that the appropriate standard of review in the Tax Court was for abuse of discretion. In its earlier decision, Goza v. Commissioner, the court had established that the standard of review in a CDP case is normally for abuse of discretion but that the standard of review is de novo when the underlying tax liability is appropriately before the court. The parties agreed that the standard of review for the 2009 tax year was de novo because the taxpayers contended that they had no tax liability for that year. Nevertheless, the court held that the standard of review was for abuse of discretion because the taxpayers were not challenging the underlying tax liability but rather were challenging whether the Service properly applied a payment:
The question for the Melaskys’ 2009 tax year is about whether the IRS properly applied a check. A question about whether the IRS properly credited a payment is not a challenge to a tax liability; i.e., the amount of tax imposed by the Code for a particular year. It is instead a question of whether the liability remains unpaid. Section 6330(c)(2)(A) allows a taxpayer to raise at a CDP hearing “any relevant issue relating to the unpaid tax,” whereas section 6330(c)(2)(B) says a taxpayer may challenge “the existence or amount of the underlying tax liability” . . . only if he didn’t receive a notice of deficiency or otherwise have an opportunity to do so . . . We therefore hold here that the Melaskys aren’t challenging their underlying liability for 2009.
a. A dishonored check is not a voluntary payment of tax and therefore the Service need not apply the tendered check as directed by the taxpayer, even when the check is dishonored because a Service levy depleted the funds in the bank account. In Melasky v. Commissioner (Melasky II), a separate, reviewed opinion (9–2–2) by Judge Thornton involving the same facts as in Melasky I, discussed above, the Tax Court considered whether it was an abuse of discretion for the Service to decide (1) not to apply against the taxpayers’ 2009 income tax liability the proceeds of the levy on their bank account and (2) to reject the taxpayers’ proposed installment agreement. With respect to application of the levy proceeds, the court noted that the Service’s policy is to apply voluntary payments as directed by the taxpayer but that involuntary payments generally may be applied against whatever unpaid tax liabilities the Service chooses. The court rejected the taxpayers’ argument that the check for $18,000 they hand delivered to the Service’s office in Houston should be treated as a voluntary payment and therefore applied to 2009 as the taxpayers had directed. A payment by check, the court reasoned, is a conditional payment and is subject to the condition subsequent that the check be paid when presented to the drawee (the bank). If the condition subsequent is fulfilled, the court explained, “the payment generally becomes absolute and is deemed to relate back to the time when the check was provided.” According to the court, acceptance of a check is not an absolute payment in the absence of an agreement that the check will be treated as an absolute payment.
In this case, because the check was not honored, and there was no agreement that acceptance of the check would be treated as an absolute payment, the check was not a voluntary payment. The court rejected the taxpayers’ argument that, because the Service’s levy on the bank account led to the check being dishonored, a different result was warranted. It was not unreasonable or inappropriate, the court stated, for the Service to levy after approximately 15 years of collection activity. The proceeds of the levy were an involuntary payment that the Service could apply as it chose. With respect to the second issue, the court held that it was not an abuse of discretion for the Service to reject the taxpayers’ proposed partial-pay installment agreement.
(i) Concurring opinion of Judge Lauber. A concurring opinion by Judge Lauber (joined by Judges Thornton, Marvel, Gustafson, Kerrigan, Buch, Nega, Pugh, and Ashford) is highly critical of and responds to certain arguments in the dissenting opinion by Judge Holmes. Generally, the concurring opinion takes the position that the taxpayers did not raise in the CDP hearing the argument that the $18,000 check, although dishonored, should be treated as a voluntary payment, and therefore “[t]he [settlement officer] did not commit legal error by failing to address an argument petitioners did not make.”
(ii) Concurring opinion of Judges Buch and Pugh. A concurring opinion by Judges Buch and Pugh (joined by Judges Gustafson and Paris) notes that Revenue Procedure 2002-26 requires the Service to apply a voluntary payment as directed by the taxpayer and that the court’s opinion does not “foreclose finding an abuse of discretion if evidence were to show that, through negligence or malfeasance, the Commissioner circumvented his own revenue procedure for designating payments.”
(iii) Dissenting opinion of Judge Holmes. Judge Holmes wrote a lengthy dissenting opinion that Judge Morrison joined. Judge Holmes agreed that the settlement officer did not abuse his discretion in rejecting the taxpayers’ proposed installment agreement, although for different reasons than those set forth in the court’s opinion. Judge Holmes dissented with respect to the treatment of the $18,000 dishonored check. According to the dissenting opinion, the check was a voluntary payment that the Service should have applied as directed by the taxpayers.
b. Agreeing with the Tax Court, the Fifth Circuit reiterates that if other taxpayers do not want to run the same bounced-check risk as the Melaskys, they should use a certified check or money order when making designated, voluntary payments for past years’ tax liabilities. The Fifth Circuit, in an opinion by Judge Owen, agreed with the Tax Court’s prior decisions that the taxpayer’s payment was “involuntary” and that the Service did not abuse its discretion. The Fifth Circuit declined to adopt an “equitable exception to the normal rules” regarding voluntary and involuntary tax payments. According to the Fifth Circuit, the Melaskys had notice of the Service’s intent to levy issued to them in 2001, long before the Service’s actual levy in 2009. Therefore, quoting language from the concurring opinion of Judges Buch and Pugh, the Fifth Circuit reasoned that “[b]y choosing . . . a personal check rather than a certified check or money order, the Melaskys ran [the] risk” that the Service would levy on their bank accounts before the check representing their voluntary payment was presented to the bank by the Service.
2. Congress has codified the waiver of fees for low-income taxpayers submitting an offer in compromise.
Generally, under section 7122(c)(1)(A), a taxpayer making a lump-sum offer in compromise must submit with the offer a payment of 20% of the amount offered. A taxpayer also must pay a user fee for processing the offer in compromise. Through administrative guidance, the up-front partial payment and the user fee are waived for low-income taxpayers. The Taxpayer First Act amends section 7122(c) by adding new section 7122(c)(3), which codifies these waivers. Section 7122(c)(3) provides that the up-front partial payment and user fee do not apply to an offer in compromise submitted by a taxpayer whose adjusted gross income, for the most recent taxable year for which adjusted gross income is available, does not exceed 250% of the applicable poverty level. This change applies to offers in compromise submitted after July 1, 2019, the date of enactment.
a. Final Regulations increase the user fee for processing an offer in compromise by ten percent. The Treasury Department and the Service have finalized, with some changes, Proposed Regulations that set the user fees for processing an offer in compromise. Prior to these Regulations, the general user fee for an offer in compromise was $186. However, no fee was charged for an offer in compromise based solely on doubt as to liability or if the taxpayer was a low-income taxpayer (defined as a taxpayer who has income at or below 250% of the federal poverty guidelines). The Proposed Regulations would have increased the general fee for an offer in compromise to $300 but did not propose a change for offers in compromise based on doubt as to liability or those submitted by low-income taxpayers. Since the Proposed Regulations were issued, Congress codified the waiver of the user fee for low-income taxpayers through amendments to section 7122(c)(3) that apply to offers in compromise submitted after July 1, 2019. The final Regulations increase the general user fee for processing an offer in compromise to $205, which is a ten-percent increase. This fee applies to offers in compromise submitted on or after April 27, 2020. The final Regulations continue to waive the user fee for offers in compromise based solely on doubt as to liability. They also provide a waiver of the user fee for low-income taxpayers that is consistent with amended section 7122(c)(3). The Preamble to the final Regulations provides a great amount of detail on how the increased user fee was determined, including the cost of the services provided.
3. The Government may enforce a tax lien in Federal Court and sell a taxpayer’s property notwithstanding the taxpayer’s right to redemption under state law.
Utah state law allows the owner of real property to redeem or purchase back foreclosed property that has a mortgage debt associated with it. At common law, the property owner’s equitable right of redemption ended upon foreclosure. In contrast, Utah law provides a statutory right to redeem after foreclosure. The general policy behind redemption is to protect the property holder’s right to redeem the property to insure against a foreclosure sale that is well below fair market value. Carving out a federal exception to this rule, the Tenth Circuit has held in Arlin Geophysical Co. v. United States that the Utah right of redemption does not apply to properties that are sold to satisfy a taxpayer’s federal tax lien. In general, under section 6321, when a taxpayer fails to pay a tax liability after receiving a notice and demand for payment, a statutory federal tax lien arises automatically by operation of law and attaches to all of the taxpayer’s property. After proper notification, the government can enforce such tax liens in a federal district court. Pursuant to section 7403, the federal district court in a tax lien foreclosure action may determine the merits of all claims on the property and decree a sale of the property. According to 28 U.S.C. section 2001(a), the sale must be transacted “upon such terms and conditions as the court directs.”
In Arlin Geophysical Co., the taxpayer, Mr. John Worthen, owed the United States more than $18 million. In connection with this liability, the Service filed a notice of federal tax lien that encumbered 15 properties owned by, among others, Arlin Geophysical Company (Arlin). Arlin was owned by Mr. Worthen and his wife. Arlin brought an action to quiet title to these properties. The federal district court held that Worthen was liable for the $18 million plus interest and held in favor of the government in relation to 13 of the 15 properties. Properties 14 and 15 remained at issue with the U.S. government, Fujilyte (a company owned by Worthen), and several others claiming rights to these two properties. Initially concluding that Worthen’s nominee, Arlin, held title to properties 14 and 15, the federal district court granted summary judgment to the government and ordered that the two properties be sold.
On appeal to the Tenth Circuit, Mr. Worthen argued that neither section 7403 nor 28 U.S.C. section 2001 expressly address Mr. Worthen’s redemption rights under Utah state law, and, therefore, he had a right of redemption in the properties. He further argued that this statutory silence supports the conclusion that Congress did not intend to usurp his state-created right of redemption and he should be able to redeem the properties. Stated in other words, he argued that the statutory silence indicates congressional intent that his state right of redemption should operate as the rule of decision governing the federal court.
The Tenth Circuit declined to adopt Mr. Worthen’s argument and instead affirmed the district court’s denial of Mr. Worthen’s right to redeem the property. The Tenth Circuit held that state-created rights are not the rules of decision to be applied by a federal court where the government seeks to enforce a federal tax lien. Rather, the question of whether a state-law right constitutes “property” or “rights to property” is a matter of federal law. According to the court, congressional silence in section 7403 and 28 U.S.C. section 2001 should be distinguished from other Code sections and federal procedural rules that specifically provide for redemption. For example, certain statutes provide that redemption is specifically authorized within a period of time after the sale of property subject to a lien or on which the government has levied. Thus, when Congress intends to provide redemption rights, it does so explicitly and not by silence.
In the current case, the court observed, redemption is not appropriate when taxpayers have had procedural protections such as the right to an administrative appeal of a lien under section 6326 and the right to a CDP hearing upon filing of the lien under section 6320(a). Statutes such as section 6331 provide redemption rights when a taxpayer is entitled to only summary administrative proceedings. In the area of federal tax liens, the court reasoned, procedures providing for the “punctilious” protection of the rights of the parties in interest—such as the requirement that interested third parties receive notice and be made parties to the action—adequately protect the interests of delinquent taxpayers. The court therefore was not persuaded that Congress’s silence regarding redemption rights in section 7403 should allow delinquent taxpayers to reclaim their properties through state-provided redemption rights. Accordingly, the court held, Mr. Worthen had no right to redeem property sold pursuant to section 7403 by a federal district court.
4. The Tax Court has held that audit reconsideration followed by a conference with IRS Appeals was a prior opportunity to challenge the taxpayers’ underlying tax liability and therefore they were barred by section 6330(c)(2)(b) from challenging the liability in a CDP hearing.
While Lander v. Commissioner is a factually complex case with a lengthy set of dates and numerous communications and meetings between the Service and the taxpayer, the salient elements revolve around two copies of the notice of deficiency (NOD) that were mailed by the Service to the taxpayers (a married couple) at their last known address and also to the address of the federal prison in which the husband, Mr. Lander, was incarcerated. The dispute began in April 2009, when the Landers filed a late initial 2005 income tax return and, shortly thereafter, an amended return. In July of 2011, the Service sent the Landers a letter notifying them of two adjustments that substantially increased their 2005 tax liability. Several weeks later, in August 2011, the Landers formally protested the adjustments and requested that the Service send any future questions or information to the address of the federal correctional institution where Mr. Lander was incarcerated.
The Service later informed the Landers that the large adjustments resulted in additions to tax and an accuracy-related penalty. The Service then sent the two copies of the NOD mentioned previously to the Landers’ home and the prison. However, in sending the NOD to each place, the Service examiner recorded the two certified mail numbers improperly. He switch the number for each parcel in the recorded documentation in the Service file. Regardless, each parcel was recorded by the U.S. Postal Service as having reached its destination. However, because Mr. Lander had been moved to another correctional facility and because Mrs. Lander had moved out of their home, the Landers did not receive either NOD.
In July 2012, the Service sent a notice and demand for payment. The taxpayers asked for reexamination of their tax liability. The Examination Division reaffirmed the adjustments to their tax liability, following which the taxpayers requested and received a conference with IRS Appeals, which abated a substantial amount of the originally assessed tax but continued to demand a portion of the originally assessed amounts. In January 2015, the Service sent the taxpayers a Notice of Federal Tax Lien Filing (NFTLF). The taxpayers timely requested a CDP hearing and maintained their assertion that the Service’s underlying assessment of tax was invalid because they did not receive either copy of the original NOD. Following the CDP hearing, IRS Appeals concluded that the NOD had been properly mailed to the last known address of the taxpayers and sustained the NFTLF.
Tax Court’s Analysis. The Tax Court addressed whether IRS Appeals erred in determining that the Landers were barred from challenging the assessed tax liability in the CDP hearing. Section 6330(c)(2)(B) permits a taxpayer to challenge the existence or amount of the taxpayer’s underlying tax liability in a CDP hearing only “if the person did not receive any NOD for such tax liability or did not otherwise have an opportunity to dispute such tax liability.” The court concluded that, although the Service had mailed the NOD to the taxpayers’ last known address and therefore was not barred by section 6213(a) from assessing the tax, the taxpayers had not received the NOD. However, the court declined to accept the Landers’ argument that they were not given an opportunity to dispute their tax liability. In reaching this conclusion, the Tax Court relied on its decision in Lewis v. Commissioner, in which the court reasoned:
[W]hile it is possible to interpret section 6330(c)(2)(B) to mean that every taxpayer is entitled to one opportunity for a precollection judicial review of an underlying liability, we find it unlikely that this was Congress’s intent. As we see it, if Congress had intended to preclude only those taxpayers who previously enjoyed the opportunity for judicial review of the underlying liability from raising the underlying liability again in a collection review proceeding, the statute would have been drafted to clearly so provide. The fact that Congress chose not to use such explicit language leads us to believe that Congress also intended to preclude taxpayers who were previously afforded a conference with the Appeals Office from raising the underlying liabilities again in a collection review hearing and before this Court.
Consistent with this reasoning, the Tax Court turned to whether the Landers were afforded a conference with IRS Appeals and whether they had an opportunity to dispute their tax liability. The court found that the Landers had received a post-assessment conference in the form of the audit reconsideration process. The reconsideration process provided for an independent review of the Landers’ underlying tax liability by IRS Appeals, which resulted in significantly reducing their tax liability. Under these circumstances, the court held that the Landers had a prior opportunity to dispute their tax liability within the meaning of section 6330(c)(2)(B) and that they were therefore barred from challenging the amount of their underlying liability.
5. Following a CDP hearing, the Tax Court held that it had jurisdiction to consider the taxpayer’s underlying tax liabilities because the taxpayer did not have a prior opportunity to contest them.
In Amanda Iris Gluck Irrevocable Trust v. Commissioner, the taxpayer, the Amanda Iris Gluck Trust (the Trust), was a direct and indirect partner in partnerships subject to the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) audit procedures. The taxpayer allegedly omitted from its income $48.6 million of its distributive share of partnership income on its 2012 federal income tax return. Because this income allegedly was reflected on the Schedule K-1 received by the taxpayer and the taxpayer did not notify the Service of its inconsistent reporting of income by filing Form 8082 (Notice of Inconsistent Treatment or Administrative Audit Request), the Service was permitted to make a “computational adjustment” to the Trust’s 2012 income tax return to include the omitted income without issuing a NOD.
The adjustment had the effect of eliminating the net operating loss the Trust had reported for 2012, which also eliminated the NOL carryforwards the Trust had claimed in 2013–2015. The Service sent letters (Letter 4735) to the Trust indicating that it would have to pay the resulting liabilities and file for a refund. Upon the Trust’s failure to pay, the Service assessed liabilities for 2013–2015 and issued a notice of intent to levy. The Trust timely requested a CDP hearing for 2012–2015, even though the notice of levy related only to 2013–2015.
In the hearing, the IRS Settlement Officer (SO) confirmed that the 2013–2015 tax liabilities had been properly assessed but that the 2012 liability was not a subject of the levy notice. The SO therefore concluded he had no jurisdiction over the Trust’s 2012 year. The SO did not address the Trust’s underlying challenge of the liabilities imposed in relation to 2013–2015 in the hearing.
Following the CDP hearing, the Service issued a notice of determination sustaining the levy. The notice explained that, because the taxpayer could have paid the underlying tax liabilities and filed a claim for refund, it had neglected to take advantage of a prior opportunity to dispute its 2013–2015 liabilities and therefore was precluded from contesting the underlying liabilities in the CDP hearing. In response to the notice of determination, the taxpayer filed a petition in the Tax Court. The Service moved to dismiss as to 2012 and 2013 on the basis that 2012 was not properly before the court and the 2013 liability had been fully satisfied by tax credits applied from other years.
The Tax Court (Judge Lauber) initially held that it lacked jurisdiction to consider any challenge for 2012 because the Service had not issued a notice of determination in relation to that year. Further, because the Trust conceded that the 2013 tax liability was satisfied and there no longer existed any liability upon which collection action could be based for 2013, the court concluded that any proceeding in relation to 2013 was moot. Accordingly, the court granted the Service’s motion to dismiss as to 2012 for lack of jurisdiction and as to 2013 on grounds of mootness.
The remaining two years, 2014 and 2015, remained at issue for the court to decide whether the Service’s motion for summary judgment should be granted. Section 6330(c)(2)(B) permits a taxpayer to challenge the existence or amount of the taxpayer’s underlying tax liability in a CDP hearing only “if [the person] ‘did not receive any statutory NOD for such tax liability or did not otherwise have an opportunity to dispute such tax liability.’” The SO concluded that the taxpayer had such a prior opportunity because it could have paid the underlying tax liabilities and filed a claim for refund. The Service conceded that the SO’s reason for not considering the Trust’s underlying tax liabilities for 2014 and 2015 was erroneous.
Because the Trust did not have a prior opportunity to dispute its 2014 and 2015 liabilities, the court held that it had jurisdiction to review the liabilities for those years. The court noted that, although it generally lacks jurisdiction to review computational adjustments in deficiency cases, it does not have a similar lack of jurisdiction in CDP cases. The court referred to prior decisions in which it similarly had concluded that it had jurisdiction to review liabilities in CDP cases despite the fact that it would have no jurisdiction to review them in deficiency proceedings. The court concluded that the Trust had properly raised its underlying tax liabilities for 2014–2015 during the CDP hearing and that these liabilities were properly before the court. The taxpayer raised several arguments as to why it was entitled to the NOL carryforward deductions for 2014 and 2015. Because these arguments and the Service’s responses raised genuine issues of material fact, the court denied the Service’s motion for summary judgment.
6. The 30-day period for requesting review in the Tax Court of a notice of determination following a CDP hearing is jurisdictional and not subject to equitable tolling.
In Boechler, P.C. v. Commissioner, the Service had issued a notice of determination upholding a proposed collection action following a CDP hearing. The notice informed the taxpayer that, if he wished to contest the determination, he could do so by filing a petition with the Tax Court within a 30-day period beginning the day after the date of the letter. The Service mailed the notice on July 28, 2017. The 30-day period expired on August 27, 2017, but because this date fell on a Sunday, the taxpayer had until the following day, August 28, to file a petition. The taxpayer mailed his petition to the Tax Court on August 29, 2017, which was one day late. The Tax Court (Judge Carluzzo) granted the government’s motion to dismiss for lack of subject matter jurisdiction.
On appeal, the taxpayer argued that the 30-day period specified in section 6330(d)(1) for filing his Tax Court petition should be equitably tolled. In an opinion by Judge Erickson, the Court of Appeals for the Eighth Circuit affirmed the Tax Court’s decision. The court held that the 30-day period specified in section 6330(d)(1) is jurisdictional and therefore is not subject to equitable tolling. In reaching this conclusion, the court relied on the plain language of section 6330(d)(1), which provides: “[a] person may, within 30 days of a determination under this section, petition the Tax Court for review of such determination (and the Tax Court shall have jurisdiction with respect to such matter).” This provision, the court reasoned, “is a rare instance where Congress clearly expressed its intent to make the filing deadline jurisdictional.” According to the court, the parenthetical expression regarding the Tax Court’s jurisdiction “is clearly jurisdictional and renders the remainder of the sentence jurisdictional.” Because the 30-day period specified in section 6330(d)(1) is jurisdictional, the court concluded, it is not subject to equitable tolling.
In reaching this conclusion, the Eighth Circuit found persuasive the reasoning of the Court of Appeals for the Ninth Circuit in Duggan v. Commissioner, in which the Ninth Circuit similarly held that the 30-day period specified in section 6330(d)(1) is jurisdictional and therefore not subject to equitable tolling. Conversely, the court found unpersuasive the taxpayer’s reliance on Myers v. Commissioner, in which the D.C. Circuit held that a similarly worded 30-day limitations period in section 7623(b)(4) for filing a Tax Court petition to challenge an adverse Service determination regarding entitlement to a whistleblower award was not jurisdictional and was subject to equitable tolling.
G. Innocent Spouse
1. Congress has clarified the scope and standard of review in the Tax Court of determinations with respect to innocent spouse relief and has specified limitations periods for seeking equitable innocent spouse relief under section 6015(f).
The Taxpayer First Act amended section 6015(a) to clarify the scope and standard of review in the Tax Court of any determination with respect to a claim for innocent spouse relief, that is, any claim for relief under section 6015 from joint and several liability for tax liability arising from a joint return. Pursuant to the amendment, the Tax Court’s scope of review is limited to the administrative record and “any additional newly discovered or previously unavailable evidence.” The standard of review in the Tax Court is de novo. Prior to the amendment, the Tax Court had held that both the standard and scope of review were de novo. The amendment’s specification that the standard of review is de novo is consistent with the Tax Court’s holding in Porter, but its limitation of the scope of review departs from the holding in Porter. New section 6015(e)(7) resolves conflicting decisions in cases in which the taxpayer sought equitable innocent spouse relief under section 6015(f), some of which had held that the Tax Court’s review is limited to the administrative record and that the Tax Court’s standard of review is for abuse of discretion.
The legislation also amended section 6015(f) by adding new section 6015(f)(2), which specifies the time within which a taxpayer can assert a claim for equitable innocent spouse relief under section 6015(f). With respect to any unpaid tax, a taxpayer can assert such a claim within the limitations period provided in section 6502 on collection of tax (generally within ten years after assessment). With respect to any tax that has been paid, the taxpayer can assert a claim for equitable innocent spouse relief within period within which the taxpayer could have submitted a timely claim for refund. Generally, this period is set forth in section 6511(a)–(b). All of these amendments apply to petitions or requests for innocent spouse relief filed or pending on or after July 1, 2019, the date of enactment.
a. What does “filed or pending” mean? In Sutherland v. Commissioner, a unanimous, reviewed opinion by Judge Lauber, the Tax Court has held that section 6015(e)(7), which limits the scope of the Tax Court’s review to the administrative record (except for any newly discovered or previously unavailable evidence), applies only to petitions filed in the Tax Court on or after July 1, 2019, the date of enactment of the 2019 provision. The provision does not apply to petitions filed before that date that might still be pending on July 1, 2019.
H. Miscellaneous
1. The Tenth Circuit stirs the previously muddied water on whether a late-filed return is a “return” that will permit tax debt to be discharged in bankruptcy proceedings.
In an opinion by Judge McHugh in Mallo v. IRS (In re Mallo), the Tenth Circuit held, with respect to taxpayers in two consolidated appeals, that a late return filed after the Service had assessed tax for the year in question was not a “return” within the meaning of Bankruptcy Code section 523(a), and, consequently, the taxpayers’ federal tax liabilities were not dischargeable in bankruptcy. The facts in each appeal were substantially the same. The taxpayers failed to file returns for the years 2000 and 2001. The Service issued notices of deficiency, which the taxpayers did not challenge, and assessed tax for those years. The taxpayers subsequently filed returns, based on which the Service partially abated the tax liabilities. The taxpayers then received general discharge orders in Chapter 7 bankruptcy proceedings and filed adversary proceedings against the Service seeking a determination that their income tax liabilities for 2000 and 2001 had been discharged. Importantly, section 523(a)(1) of the Bankruptcy Code excludes from discharge any debt for a tax or customs duty
(B) with respect to which a return, or equivalent report or notice, if required—
(i) was not filed or given; or
(ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of filing of the petition . . . .
An unnumbered paragraph at the end of Bankruptcy Code section 523(a), added by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, provides that, for purposes of Bankruptcy Code section 523(a):
the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared under section 6020(a) of the Internal Revenue Code . . . but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code . . . .
In Mallo, the Tenth Circuit examined a line of conflicting cases in which the courts had applied a four-factor test, commonly known as the Beard test, to determine whether a late-filed return constitutes a “return” for purposes of Bankruptcy Code section 523(a) and concluded that it did not need to resolve that issue. Instead, the court concluded that, unless a late return is prepared by the Service with the assistance of the taxpayer under Code section 6020(a), it is not a “return” because it does not satisfy “the requirements of applicable nonbankruptcy law (including applicable filing requirements)” within the meaning of the language added to the statute in 2005. In reaching its conclusion, the court agreed with the analysis of the Fifth Circuit in McCoy v. Miss. State Tax Comm’n (In re McCoy), in which the Fifth Circuit concluded that a late-filed Mississippi state tax return was not a return within the meaning of Bankruptcy Code section 523(a).
The Tenth Circuit’s interpretation of Bankruptcy Code section 523(a) is contrary to the Service’s interpretation, which the Service made clear to the court during the appeal. The Service’s interpretation, reflected in Chief Counsel Notice CC-2010-016, is that “[Bankruptcy Code] section 523(a) does not provide that every tax for which a return was filed late is nondischargeable.” However, according to the Chief Counsel Notice, a debt for tax assessed before the late return is filed (as in the situations before the Tenth Circuit in Mallo) is not dischargeable because “a debt assessed prior to the filing of a Form 1040 is a debt for which [a] return was not ‘filed’” within the meaning of Bankruptcy Code section 523(a)(1)(B)(i).
a. The First Circuit aligns itself with the Fifth and Tenth Circuits and applies the same analysis to a late-filed Massachusetts state income tax return. In Fahey v. Mass. Dep’t of Revenue (In re Fahey), in an opinion by Judge Kayatta, the First Circuit aligned itself with the Fifth and Tenth Circuits and concluded that a late-filed Massachusetts state income tax return was not a “return” within the meaning of Bankruptcy Code section 523(a). In a lengthy dissenting opinion, Judge Thompson argued that the majority’s conclusion was inconsistent with both the language of and policy underlying the statute: “The majority, ignoring blatant textual ambiguities and judicial precedent, instead opts to create a per se restriction that is contrary to the goal of our bankruptcy system to provide, as the former President put it in 2005, ‘fairness and compassion’ to ‘those who need it most.’”
b. A Bankruptcy Appellate Panel in the Ninth Circuit disagrees with the First, Fifth, and Tenth Circuits. The Ninth Circuit now might have an opportunity to weigh in. In United States v. Martin (In re Martin), in an opinion by Judge Kurtz, a Bankruptcy Appellate Panel in the Ninth Circuit disagreed with what it called the “literal construction” by the First, Fifth, and Ninth Circuits of the definition of the term “return” in Bankruptcy Code section 523(a). The court emphasized that the meaning of the language in the unnumbered paragraph at the end of Bankruptcy Code section 523(a), which provides that “the term ‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements),” must be determined by taking into account the context of the surrounding words and also the context of the larger statutory scheme. Taking this context into account, the court reasoned, leads to the conclusion that the statutory language does not dictate that a late-filed return automatically renders the taxpayer’s income tax liability nondischargeable. “Why Congress would want to treat a taxpayer who files a tax return a month or a week or even a day late—possibly for reasons beyond his or her control—so much more harshly than a taxpayer who never files a tax return on his or her own behalf [and instead relies on the Service to prepare it pursuant to Internal Revenue Code section 6020(a)] is a mystery that literal construction adherents never adequately explain.”
The court also rejected the Service’s interpretation, reflected in a Chief Counsel Notice that, although not every tax for which a return is filed late is nondischargeable, a debt for tax assessed before the late return is filed (as in the situation before the court) is not dischargeable because the tax debt is established by the assessment and therefore arises before the return was filed. Instead, the court concluded that binding Ninth Circuit authority predating the 2005 amendments to Bankruptcy Code section 523(a) requires applying the four-factor Beard test to determine whether a late-filed return constitutes a “return” for purposes of Bankruptcy Code section 523(a). The court concluded that the bankruptcy court, which had held that the taxpayers’ late-filed returns were “returns” within the meaning of the statute, had relied on a version of the Beard test that did not reflect the correct legal standard. Accordingly, the court remanded to the bankruptcy court for further consideration.
c. The Eleventh Circuit declines to decide whether a late-filed return always renders a tax debt nondischargeable in bankruptcy. In Justice v. United States (In re Justice), in an opinion by Judge Anderson, the Eleventh Circuit declined to adopt what it called the “one-day-late” rule embraced by the First, Fifth, and Tenth Circuits because it concluded that doing so was unnecessary to reach the conclusion that the taxpayer’s federal income tax liability was nondischargeable in bankruptcy. The taxpayer filed his federal income tax returns for four tax years after the Service had assessed tax for those years and between three and six years late. The court concluded that it need not adopt the approach of the First, Fifth, and Tenth Circuits because, even if a late-filed return can sometimes qualify as a return for purposes of Bankruptcy Code section 523(a), a return must satisfy the four-factor Beard test in order to constitute a return for this purpose, and the taxpayer’s returns failed to satisfy this test. One of the four factors of the Beard test is that there must be an honest and reasonable attempt to satisfy the requirements of the tax law. The Eleventh Circuit joined the majority of the other circuits in concluding that delinquency in filing a tax return is relevant to whether the taxpayer made such an honest and reasonable attempt. “Failure to file a timely return, at least without a legitimate excuse or explanation, evinces the lack of a reasonable effort to comply with the law.” The taxpayer in this case, the court stated, filed his returns many years late, did so only after the Service had issued notices of deficiency and assessed his tax liability, and offered no justification for his late filing. Accordingly, the court held, he had not filed a “return” for purposes of Bankruptcy Code section 523(a) and his tax debt was therefore nondischargeable.
d. The Ninth Circuit holds that a taxpayer’s tax debt cannot be discharged in bankruptcy without weighing in on the issue whether a late-filed return always renders a tax debt nondischargeable. In Smith v. United States (In re Smith), in an opinion by Judge Christen, the Ninth Circuit held that the tax liability of the taxpayer, who filed his federal income tax return seven years after it was due and three years after the Service had assessed the tax, was not dischargeable in bankruptcy. The government did not assert the “one-day-late” rule embraced by the First, Fifth, and Tenth Circuits. Accordingly, the Ninth Circuit looked to its prior decision in United States v. Hatton (In re Hatton), issued prior to the 2005 amendments to the Bankruptcy Code on which the First, Fifth, and Tenth Circuits relied. In Hatton, the Ninth Circuit had adopted the four-factor Beard test to determine whether the taxpayer had filed a “return” for purposes of Bankruptcy Code section 523(a). The fourth factor of the Beard test is that there must be an honest and reasonable attempt to satisfy the requirements of the tax law. The Ninth Circuit concluded that the taxpayer had not made such an attempt:
Here, Smith failed to make a tax filing until seven years after his return was due and three years after the IRS went to the trouble of calculating a deficiency and issuing an assessment. Under these circumstances, Smith’s “belated acceptance of responsibility” was not a reasonable attempt to comply with the tax code.
The court noted that other circuits similarly had held that post-assessment filings of returns were not honest and reasonable attempts to satisfy the requirements of the tax law but refrained from deciding whether any post-assessment filing could be treated as such an honest and reasonable attempt.
e. The Third Circuit also declines to consider whether a late-filed return always renders a tax debt nondischargeable and instead applies the Beard test. In Giacchi v. United States (In re Giacchi), in an opinion by Judge Roth, the Third Circuit held that the tax liability of the taxpayer, who filed his federal income tax returns for 2000, 2001, and 2002 after the Service had assessed tax for those years, was not dischargeable in bankruptcy. The court declined to consider whether the “one-day-late” rule embraced by the First, Fifth, and Tenth Circuits is correct. Instead, the court applied the four-factor Beard test to determine whether the taxpayer had filed a “return” for purposes of Bankruptcy Code section 523(a). The fourth factor of the Beard test is that there must be an honest and reasonable attempt to satisfy the requirements of the tax law. The court stated:
Forms filed after their due dates and after an IRS assessment rarely, if ever, qualify as an honest or reasonable attempt to satisfy the tax law. This is because the purpose of a tax return is for the taxpayer to provide information to the government regarding the amount of tax due . . . Once the IRS assesses the taxpayer’s liability, a subsequent filing can no longer serve the tax return’s purpose, and thus could not be an honest and reasonable attempt to comply with the tax law.
f. The Eleventh Circuit has rejected the one-day late approach to determining whether a late-filed return renders a tax debt nondischargeable in bankruptcy. In Mass. Dep’t of Revenue v. Shek (In re Shek), in a very thorough opinion by Judge Anderson, the Eleventh Circuit held that a tax debt reflected on a late-filed Massachusetts tax return was discharged in bankruptcy. In reaching this conclusion, the court rejected the “one-day-late” rule embraced by the First, Fifth, and Tenth Circuits. The taxpayer filed his 2008 Massachusetts income tax return seven months late. The return reflected a tax liability of $11,489. Six years later, he filed for Chapter 7 bankruptcy in Florida and received an order of discharge in January 2016. When the Massachusetts Department of Revenue subsequently sought to collect the tax debt, the taxpayer filed a motion to reopen his bankruptcy case to determine whether his tax debt had been discharged. The bankruptcy court held that his tax debt had been discharged.
In affirming this conclusion, the Eleventh Circuit focused on the definition of the term “return” in Bankruptcy Code section 523(a), which provides that, for purposes of Bankruptcy Code section 523(a):
the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code . . . but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code . . . .
The court emphasized that canons of statutory construction dictate the need to give effect to every word of a statute when possible and that the term “applicable filing requirements” must mean something different than all filing requirements. Further, the court reasoned, adopting the “one-day-late” approach and holding that the tax liability reflected on every late-filed return is not dischargeable would render a near nullity the language of Bankruptcy Code section 523(a)(1)(B)(ii), which contemplates that the tax liability on a late-filed return can be discharged as long as the late return is not filed within the two-year period preceding the filing of the bankruptcy petition.
The court also rejected the Massachusetts Department of Revenue’s argument that the taxpayer’s return did not constitute a return under Massachusetts law (which the court viewed as included among “the requirements of applicable nonbankruptcy law”). After rejecting the one-day late approach, the court held that the taxpayer’s return was a “return” whether the relevant test is the four-factor Beard test or instead the definition of a return under Massachusetts law. Accordingly, the court held, the taxpayer’s tax liability had been discharged.
2. Micro-Captive insurance transactions are “transactions of interest” that might be on their way to being listed.
Notice 2016-66 identifies certain captive insurance arrangements, referred to as “micro-captive transactions,” as transactions of interest for purposes of Regulation section 1.6011-4(b)(6) and sections 6111 and 6112. Generally, these arrangements involve a person who owns an insured business and that same person, or a related person, also owns an interest in the insurance company providing coverage. The insured business deducts the premiums paid to the insurance company, and the insurance company, by making the election under section 831(b) to be taxed only on taxable investment income, excludes the premiums from gross income. An insurance company making the section 831(b) election can receive up to $2.2 million in premiums annually (adjusted for inflation after 2015). The Notice describes the coverage under these arrangements as having one or more of the following characteristics:
- the coverage involves an implausible risk;
- the coverage does not match a business need or risk of Insured;
- the description of the scope of the coverage in the Contract is vague, ambiguous, or illusory; or
- the coverage duplicates coverage provided to Insured by an unrelated, commercial insurance company, and the policy with the commercial insurer often has a far smaller premium.
The Treasury Department and the Service believe these transactions have a potential for tax avoidance or evasion but lack enough information to determine whether the transactions should be identified specifically as a tax avoidance transaction. Transactions that are the same as, or substantially similar to, the transaction described in section 2.01 of the Notice are identified as “transactions of interest” for purposes of Regulation section 1.6011-4(b)(6) and sections 6111 and 6112 effective November 1, 2016. Persons entering into these transactions after November 1, 2006, must disclose the transaction as described in Regulation section 1.6011-4.
a. Participants in micro-captive insurance transactions have until May 1, 2017 to disclose their participation in years for which returns were filed before November 1, 2016. Notice 2017-08 extends the due date for participants to disclose their participation in the micro-captive insurance transactions described in Notice 2016-66. Generally, under Regulation section 1.6011-4(e)(2)(i), if a transaction becomes a transaction of interest or a listed transaction after a taxpayer has filed a return reflecting the taxpayer’s participation in the transaction, then the taxpayer must disclose the transaction for any year for which the limitations period on assessment was open on the date the transaction was identified as a listed transaction or transaction of interest within 90 calendar days after the date on which the transaction was identified. This meant that, for open years for which returns already had been filed on November 1, 2016 (the date on which Notice 2016-66 was issued), disclosures were due on January 30, 2017. In Notice 2017-08, the Service has extended the due date from January 30 to May 1, 2017.
b. Sixth Circuit sides with the Service against micro-captive advisor’s attack on Notice 2016-66 and “reportable transactions.” In CIC Services, LLC v. IRS, in a 2–1 decision reflected in an opinion by Judge Clay, the Court of Appeals for the Sixth Circuit affirmed the district court’s dismissal of a lawsuit against the Service challenging the Service’s categorization of certain micro-captive insurance arrangements as “reportable transactions” in Notice 2016-66. The plaintiff, CIC Services, LLC, advises taxpayers with respect to micro-captive insurance arrangements. Generally, these arrangements involve a taxpayer who owns an insured business while that same taxpayer or a related person also owns an interest in an insurance company providing coverage to the business. The insured business deducts the premiums paid to the insurance company, and the insurance company, by making the election under section 831(b) to be taxed only on taxable investment income, excludes the premiums from gross income. In 2019, an insurance company making the section 831(b) election could receive up to $2.3 million in excludable premiums. Back in 2016, the Service issued Notice 2016-66, which identified certain of these micro-captive insurance arrangements as abusive and thus “transactions of interest” for purposes of the “reportable transaction” rules of sections 6111 and 6112 and Regulation section 1.6011-4(b)(6). Significant penalties can be imposed upon taxpayers and their material advisors for failing to comply with the “reportable transaction” rules.
The plaintiff took offense at the Service’s position regarding micro-captives and filed suit in the District Court for the Eastern District of Tennessee to enjoin enforcement of Notice 2016-66. The plaintiff alleged that the Service had promulgated Notice 2016-66 in violation of the APA, and the Congressional Review Act. The Service countered that the plaintiff’s complaint was barred by the Anti-Injunction Act and the tax exception to the Declaratory Judgment Act (together, the AIA). Generally, the AIA bars lawsuits filed “for the purpose of restraining the assessment or collection of any tax” by the Service. Responding to the Service, the plaintiff characterized its suit as one relating to tax reporting requirements, not tax assessment and collection. Plaintiff therefore contended that its lawsuit was not barred by the AIA. The Service, on the other hand, argued that the case ultimately was about tax assessment and collection because the penalties imposed under the “reportable transaction” regime are treated as taxes for federal income tax purposes. The plaintiff cited as support for its argument the Supreme Court’s decision in Direct Marketing Ass’n v. Brohl, which allowed a lawsuit to proceed against Colorado state tax authorities despite the Tax Injunction Act (TIA). The TIA, which protects state tax assessments and collections, is modeled on the AIA. The Service, on the other hand, argued that the decision of the Court of Appeals for the D.C. Circuit in Florida Bankers Ass’n v. U.S. Dep’t of the Treasury, which distinguished Direct Marketing, reflected the proper analysis. The court in Florida Bankers Ass’n held that the AIA applied to bar a suit seeking to enjoin the Service’s enforcement of certain penalties. The suit was barred by the AIA, according to the court in Florida Bankers Ass’n, because the penalties at issue in that case were treated as federal income taxes for assessment and collection purposes, unlike the action challenged in Direct Marketing.
Writing for the majority, Judge Clay rejected the plaintiff’s Direct Marketing argument and agreed with the Service’s Florida Bankers Ass’n argument. Judge Clay reasoned that, like the penalties at issue in Florida Bankers Ass’n, the “reportable transaction” penalties are located in Chapter 68, Subchapter B of the Code and thus are treated as taxes for federal income tax purposes. Therefore, the decision of the D.C. Circuit in Florida Bankers Ass’n is directly on point. Judge Clay also ruled that the plaintiff’s lawsuit did not fall within any of the exceptions to the AIA. Hence, the AIA barred the plaintiff’s lawsuit because the plaintiff, by seeking to enjoin enforcement of Notice 2016-66, is indirectly attempting to thwart the Service’s assessment and collection of a tax.
Judge Nalhandian dissented and would have held that the suit was not barred by the AIA. He reasoned that the suit involved a challenge to a tax reporting requirement, albeit one with a penalty attached for noncompliance, and that the AIA does not bar challenges to tax reporting requirements.
c. The Service is making time-limited settlement offers to those with micro-captive insurance arrangements. The Service has announced that it has begun sending time-limited settlement offers to certain taxpayers with micro-captive insurance arrangements. The Service has done so following three recent decisions of the Tax Court that disallowed the tax benefits associated with these arrangements. The terms of the offer, which must be accepted within 30 days of the date of the letter making the offer, generally are as follows: (1) the Service will deny 90% of any deductions claimed for captive insurance premiums; (2) the captive insurance company will not be required to recognize taxable income for received premiums; (3) the captive must already be liquidated, will be required to liquidate, or agree to a deemed liquidation that results in dividend income for the shareholders; (4) accuracy-related penalties are reduced to a rate of ten percent and can be reduced to five percent or zero percent if certain conditions are met; (5) if none of the parties to the micro-captive insurance transaction disclosed it as required by Notice 2016-66, a single penalty of $5,000 will be applied under section 6707A (Penalty for Failure to Include Reportable Transaction Information with Return); and (6) additions to tax for failure to file or pay tax under section 6651 and failure to pay estimated income tax under sections 6654 and 6655 may apply.
d. Approximately 80% of taxpayers receiving micro-captive insurance settlement offers accepted them. The Service is establishing 12 new examination teams that are expected to open audits related to thousands of taxpayers. The Service previously announced that it had begun sending time-limited settlement offers to certain taxpayers with micro-captive insurance arrangements. The Service has now announced that “[n]early 80% of taxpayers who received offer letters elected to accept the settlement terms.” The announcement also informs taxpayers that “the IRS is establishing 12 new examination teams that are expected to open audits related to thousands of taxpayers in coming months.” Finally, the announcement reminds taxpayers that Notice 2016-66 requires disclosure of micro-captive insurance transactions with the IRS Office of Tax Shelter Analysis and that failure to do so can result in significant penalties.
The Authors understand that, in March 2020, the Service issued Letter 6336 to thousands of taxpayers seeking information about their participation in micro-captive insurance transactions. The letters initially asked for a response by May 4, 2020, which subsequently was extended to June 4, 2020.
e. The Supreme Court will consider a taxpayer’s challenge to Notice 2016-66. The Supreme Court has granted the taxpayer’s petition for a writ of certiorari in CIC Services, in which the Court of Appeals for the Sixth Circuit dismissed a lawsuit challenging the Service’s categorization of certain micro-captive insurance arrangements as “reportable transactions” in Notice 2016-66. According to the Court’s grant of the writ, the question presented is: “Whether the Anti-Injunction Act’s bar on lawsuits for the purpose of restraining the assessment or collection of taxes also bars challenges to unlawful regulatory mandates issued by administrative agencies that are not taxes.”
3. You Say “FBAR.” We say “FUBAR.” Although Treasury has failed to update relevant FBAR regulations, the penalty for willful violations is not capped at $100,000 per account, says the Federal Circuit.
One of the issues in Norman v. United States was whether substantial foreign bank account reporting (FBAR) penalties assessed by the Service should have been reduced. Under 31 U.S.C. section 5321(a)(5)(A), the Secretary of the Treasury “may impose” a penalty for FBAR violations, and pursuant to administrative orders, the authority to impose FBAR penalties has been delegated by the Secretary to the Service. Further, under the current version of 31 U.S.C. section 5321(a)(5)(B)(i), the normal penalty for an FBAR violation is $10,000 per offending account; however, the penalty for a willful FBAR violation “shall be increased to the greater of” $100,000 or 50% of the balance in the offending account at the time of the violation. These minimum and maximum penalties for willful FBAR violations were changed by the American Jobs Creation Act of 2004 (AJCA). The prior version of 31 U.S.C. section 5321(a)(5) provided that the penalty for willful FBAR violations was the greater of $25,000 or the balance of the unreported account up to $100,000. Treasury regulations issued under the pre-AJCA version of 31 U.S.C. section 5321(a)(5), reflecting the law at the time, capped the penalty for willful FBAR violations to $100,000 per account.
In Norman, the government assessed a penalty of $803,500 for failure to file an FBAR in 2007 with respect to a Swiss bank account. The taxpayer argued that the “may impose” language of the relevant statute, 31 U.S.C. section 5321(a)(5), provides the Secretary of the Treasury with discretion to determine the amount of assessable FBAR penalties and that, because the outdated regulations had not been amended to reflect the AJCA’s increase in the minimum and maximum FBAR penalties, the Service’s authority was limited to the amount prescribed by the existing regulations. The court reasoned that the amended statute, which provides that the penalty amount for willful FBAR violations shall be increased to the greater of $100,000 or 50% of the account value, is mandatory and removed the Treasury Department’s discretion to provide for a smaller penalty by regulation. According to the court, the statute gives the Treasury Department discretion whether to impose a penalty in particular cases, but not discretion to set a cap on the penalty that is different than the cap set forth in the statute. Several federal district courts and the Court of Federal Claims have considered this issue and reached different conclusions.
a. And another BIG government victory in the FBAR-FUBAR war; however, an appeal to the Eleventh Circuit was filed almost before the ink was dry on the District Court’s decision. In United States v. Schwarzbaum, a significant FBAR case, the District Court for the Southern District of Florida (Judge Bloom) upheld the Service’s imposition of almost $13 million in penalties for willful FBAR violations across the years 2007–2009, although the court also ruled that no penalties should be imposed for 2006. The taxpayer, a German and U.S. citizen, owned multiple foreign bank accounts across the years in issue. The largest accounts were given to the taxpayer by his German father and were held in Switzerland. The taxpayer also had a smaller account that he had established at a bank in Costa Rica. The taxpayer credibly testified that for the years 2006–2009 he had been erroneously advised by his tax return preparers that he did not need to report foreign held bank accounts provided the accounts had no U.S. connection. For this reason, Judge Bloom found that the taxpayer’s alleged FBAR violations for 2006 were not willful.
In 2007, however, the taxpayer self-prepared an FBAR disclosure for his account in Costa Rica. The Costa Rican account had been funded with money accumulated by the taxpayer in the United States. The taxpayer testified that he thus believed the Costa Rican account had a “U.S. connection” and, accordingly, was the only account subject to FBAR reporting obligations. The Service argued, though, that the 2007 instructions to the FBAR disclosure clearly state that all foreign bank accounts of taxpayers should be reported. The instructions do not condition a taxpayer’s FBAR disclosure obligation on a “U.S. connection” to the account. Therefore, the Service argued, and Judge Bloom agreed, that despite the (erroneous) advice of his tax return preparers, the taxpayer’s FBAR violations for the years 2007–2009 were willful. Judge Bloom reasoned that after 2006 the taxpayer either had constructive knowledge that his tax return preparer’s advice was erroneous, or the taxpayer recklessly disregarded his FBAR obligations. In either case, Judge Bloom held that a willfulness finding was appropriate and that the Service’s imposition of roughly $13 million (approximately) in FBAR penalties against the taxpayer for the years 2007–2009 was justified.
Contrary to the cases mentioned above, the taxpayer apparently did not argue that the Service’s assessed FBAR penalties conflicted with the Treasury Department’s outdated regulations. Instead, the taxpayer argued that even if his FBAR violations for 2007–2009 were found to be willful, the $13 million (approximately) penalty assessment violated the Eighth Amendment to the U.S. Constitution. The Eighth Amendment provides that “[e]xcessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” The taxpayer argued that the FBAR penalties imposed upon him by the Service were “fines” and were “excessive.”
In response to the taxpayer’s Eighth Amendment argument, Judge Bloom ruled that the FBAR penalties, like most tax penalties, are remedial, not punitive, in nature. In other words, the FBAR penalties are designed to safeguard the revenue of the United States and to reimburse the Service and the Treasury Department for the expense of investigating and uncovering the taxpayer’s circumvention of U.S. tax laws. Therefore, Judge Bloom held, the FBAR penalties imposed upon the taxpayer are not “fines” subject to the Eighth Amendment. Because the court held that the FBAR penalties are not “fines,” the court did not rule on whether the approximately $13 million in penalties imposed upon the taxpayer were “excessive.” The taxpayer has filed an appeal with the Eleventh Circuit.
4. The Service has extended many filing and payment deadlines to July 15, 2020.
Following the national emergency declared in response to the COVID-19 pandemic, the Service previously had exercised its authority under section 7508A, which authorizes the Secretary of the Treasury to postpone the time for performing certain acts in federally declared disaster areas, to extend several filing and payment deadlines. In Notice 2020-23, the Service announced that all persons with a federal tax payment obligation or form filing obligation due to be performed on or after April 1, 2020 and before July 15, 2020 are considered affected by COVID-19 for purposes of section 7508A. The Notice extends specified filing and payment obligations to July 15, 2020, including the deadline to file Form 1040 series returns (individuals), Form 1120 series returns (corporations), Form 1065 (partnerships), Form 1041 (income tax return of trusts and estates), Form 706 (estate and generation-skipping transfer tax return), Form 709 (gift and generation-skipping transfer tax return), and Form 990-T (unrelated business income of tax-exempt organizations). It also extends to July 15, 2020, the payment deadline for payments of income tax, estate tax, gift tax, Generation-Skipping Transfer tax, Unrelated Business Income Tax, and quarterly estimated tax payments. This includes the quarterly estimated tax payment due on June 15, 2020. The Notice goes further, however, and extends to July 15, 2020, the time for taking specified time-sensitive actions, including filing a claim for refund (e.g., 2016 refund claims), bringing suit for a refund, and filing a petition with the Tax Court. Finally, the Notice extends the time for the Service to perform time-sensitive acts by 30 days if the act must be performed on or after April 6, 2020 and before July 15, 2020, such as assessment of tax.
5. Tax Court retains jurisdiction in a Section 7345 passport revocation case to review the Service’s certification of a taxpayer’s “seriously delinquent” tax liability, but finds case is moot.
Section 7345, which addresses the revocation or denial of passports for seriously delinquent tax debts, was enacted in 2015 in section 32101(a) of the Fixing America’s Surface Transportation Act. It provides that, if the Service certifies that an individual has a “seriously delinquent tax debt,” the Secretary of the Treasury must notify the Secretary of State “for action with respect to denial, revocation, or limitation of a passport.” In general, a seriously delinquent tax debt is an unpaid tax liability in excess of $50,000 for which a lien or levy has been imposed. A taxpayer who seeks to challenge such certification may petition the Tax Court to determine if it was made erroneously. If the Tax Court finds the certification was either made in error or that the Service has since reversed its certification, the court may then notify the State Department that the revocation of the taxpayer’s passport should be cancelled.
In Ruesch v. Commissioner, a case of first impression, the Tax Court interpreted the requirements of section 7345. Under the facts of the case, the Service had assessed $160,000 in penalties against Ms. Ruesch under section 6038 for failing to file proper information returns for a period of years. Thereafter, the Service sent a final notice of intent to levy, and Ms. Ruesch properly appealed the penalty amounts with the IRS’s Collection Appeals Program (CAP). In a series of errors, the Service mistakenly misclassified the CAP appeal as a CDP hearing. Committing yet further errors, the Service failed to properly record Ms. Ruesch’s later request for a CDP hearing and never offered Ms. Ruesch her CDP hearing. The Service then certified Ms. Ruesch’s liability to the Secretary of State as a “seriously delinquent tax debt” under section 7345(b). Discovering their many errors as well as the oversight of Ms. Ruesch’s timely requested a CDP hearing, the Service determined her tax debt was not “seriously delinquent” and reversed the certification. The Service then notified the Secretary of State of its reversal.
The Tax Court (Judge Lauber) held that, while the Tax Court had jurisdiction to review Ms. Ruesch’s challenge to the Service’s certification of her tax liabilities as being a “seriously delinquent tax debt,” the controversy was moot because the Service had reversed its certification as being erroneous. Under section 7345, the Tax Court’s jurisdiction in passport revocation cases is limited to reviewing the Service’s certification of the taxpayer’s liabilities as “seriously delinquent.” Thus, the only relief the Tax Court may grant is to issue an order to the Service to notify the Secretary of State that the Service’s certification was in error. Since the Service had already notified the Secretary of State of the error, the Tax Court could not offer any additional relief. Judge Lauber, therefore, found the controversy was not ripe to be heard and the issues were moot.
6. Sixth Circuit reverses District Court holding that the government was barred by the doctrine of judicial estoppel from challenging the taxpayer’s method of calculating its R&D credit.
The main issue in Audio Technica U.S., Inc. v. United States was whether a District Court for the Northern District of Ohio had erred in holding that the Service was judicially estopped from challenging the fixed-base percentage that Audio Technica used in calculating its research and development (R&D) credit under section 41. In general, under section 41(a)(1), the R&D credit is equal to 20% of the excess of the taxpayer’s annual qualified research expenses over the “base amount.” The base amount is generally equal to the taxpayer’s average gross receipts over the previous four years multiplied by a “fixed-base percentage.” This percentage is arrived at by adding up the total qualified research expenses for the relevant five-year period and then dividing that amount by aggregate gross receipts for the same period. The lower the fixed-base percentage, the higher the R&D credit. Audio Technica claimed an R&D credit for several years prior to the years in issue. With respect to those previous years, the Service twice agreed to stipulated settlements of litigation in the Tax Court in which Audio Technica used a fixed-base percentage of 0.92%. For the later tax years at issue in this case, Audio Technica reported R&D credits again using a fixed-base percentage of 0.92%. However, the Service disallowed the credits for these years. Audio Technica paid the tax that the Service asserted was due, filed a claim for refund, and ultimately brought a refund action in federal district court.
At trial, Audio Technica asserted that, because the Service had twice agreed with the 0.92% fixed-base percentage in previous years, the doctrine of judicial estoppel applied to estop or prevent the Service from challenging the fixed-base percentage used by Audio Technica in the years at issue. The trial court agreed with Audio Technica on the basis that the Tax Court had approved the previous settlement agreements in which the parties had stipulated that a fixed-base percentage of 0.92% applied.
In an opinion by Judge Clay, the Court of Appeals for the Sixth Circuit disagreed and held that the Tax Court’s orders memorializing the settlement agreements did not constitute judicial acceptance of the facts to which the parties had stipulated in the settlement agreements. In general, the doctrine of judicial estoppel prevents a litigant from asserting a legal position that is contrary to a legal position that the same litigant asserted under oath in a prior proceeding and that was accepted by the court. Applying this principle, the Sixth Circuit held that the doctrine of judicial estoppel did not bar the government from challenging Audio Technica’s fixed-base percentage because the previous litigation in the Tax Court had been resolved through settlements in which there had been no judicial acceptance of the Service’s position. The court emphasized that a settlement agreement, even in the form of an agreed order, does not constitute judicial acceptance of the terms contained in the agreement.
The court also declined to accept Audio Technica’s additional argument that judicial estoppel should apply pursuant to the court’s prior holding in Reynolds v. Commissioner, in which the court had applied the doctrine when the parties previously had entered into a settlement agreement approved by the bankruptcy court. The court rejected this argument on the basis of the unique nature of bankruptcy settlements. In bankruptcy proceedings (as opposed to an ordinary civil proceeding), a compromise between a debtor and his or her creditors must be carefully examined by the bankruptcy court to protect the interests of third parties and must be determined to be fair and equitable before the bankruptcy court will approve it. The bankruptcy court has an affirmative obligation to apprise itself of the underlying facts before it can approve a compromise. Here, the court reasoned, the Tax Court did not have the same obligation and, because the Tax Court proceedings ended with a settlement between the Service and Audio Technica that did not require the Tax Court to accept the parties’ litigating positions, judicial estoppel did not apply.
Finally, the court noted that, even if judicial estoppel could apply, the Tax Court never relied on or approved the 0.92% fixed-base percentage. The stipulated decisions entered in the prior proceedings referred only to total dollar amounts and did not refer to the 0.92% fixed-base percentage. Based on this reasoning, the Sixth Circuit held that the Service was not judicially estopped from redetermining Audio Technica’s fixed-base percentage for the years at issue.
7. The Service has announced that individuals can e-file amended returns on Form 1040-X for 2019.
Individuals who wish to amend a federal income tax return by filing Form 1040-X historically have had to mail the form to the Service. The Service has announced that individuals now can e-file Form 1040-X using available software products to amend Forms 1040 or 1040-SR for 2019. Whether the ability to e-file amended returns will be expanded to other years is not entirely clear. The announcement states that “[a]dditional improvements are planned for the future.” Taxpayers still will have the option to mail a paper version of Form 1040-X.
XI. Withholding and Excise Taxes
A. Employment Taxes
1. Whether it’s a good idea or not, no penalty will be imposed for failing to deposit the employer’s share of Social Security tax.
In general, employers must withhold taxes due under the Federal Insurance Contributions Act (FICA). FICA taxes are a combination of Social Security taxes and Medicare taxes which are deducted or withheld by an employer from an employee’s pay. Such withheld funds are remitted by the employer to the Service on behalf of the employee. Correspondingly, an employer is responsible for paying its share of FICA taxes to the Service including Social Security taxes and Medicare taxes. These employer payments generally are due to be remitted to the Service on a semi-weekly or monthly basis by electronic funds transfer. The CARES Act provides that remittance of the employer’s share of both the Social Security portion of FICA tax and of the Social Security portion of Railroad Retirement Act tax incurred in 2020 may be deferred. Thus, FICA payments previously due between March 27, 2020, and before January 1, 2021, may now be paid in two equal installments. The first half of the payment may be deferred until December 31, 2021, and payment of the second half of the liability may be deferred until December 31, 2022. It is important to note that this deferral is not available to employers that have had debt forgiven with respect to the loans made available through the Small Business Administration pursuant to the CARES Act.
a. Employers whose PPP loans are forgiven can defer depositing the employer’s Share of Social Security tax. The Paycheck Protection Program Flexibility Act of 2020 (PPP Flexibility Act) amended the CARES Act to remove the rule that employers whose loans authorized by the CARES Act and made through the Small Business Administration (commonly referred to as PPP loans) are forgiven cannot defer depositing the employer’s share of Social Security tax. Therefore, an employer that receives a PPP loan can defer the payment and deposit of the employer’s share of Social Security tax, even if the loan is forgiven. This rule is effective as if it had been included in the CARES Act.
b. The Service has issued guidance on deferring the deposit and payment of the employer’s share of Social Security tax in the form of FAQs on its website. The Service has issued guidance on deferring the deposit and payment of the employer’s share of Social Security taxes in the form of FAQs on its website. Among other guidance, the FAQs clarify that self-employed individuals can defer paying 50% of the Social Security tax on net earnings from self-employment income for the period beginning on March 27, 2020, and ending December 31, 2020.
B. Self-Employment Taxes
There were no significant developments regarding this topic during 2020.
C. Excise Taxes
There were no significant developments regarding this topic during 2020.
XII. Tax Legislation
A. Enacted
1. A families second coronavirus response act just wouldn’t do. Congress has enacted the Families First Coronavirus Response Act.
The Families First Coronavirus Response Act was signed by the President on March 18, 2020. Among other features, the legislation provides businesses with tax credits to cover certain costs of providing employees with required paid sick leave and expanded family and medical leave, for reasons related to COVID-19, from April 1 through December 31, 2020.
2. The Coronavirus Aid, Relief, And Economic Security Act might just prove that Congress really CARES.
The Coronavirus Aid, Relief, And Economic Security Act (CARES Act), enacted on March 27, 2020, in response to the coronavirus (COVID-19) pandemic, is economic stimulus legislation that provides, among other things, targeted tax relief for individuals and businesses including (1) a one-time rebate to taxpayers; (2) modification of the tax treatment of certain retirement fund withdrawals and charitable contributions; (3) a delay of employer payroll taxes and taxes paid by certain corporations; and (4) other changes to the tax treatment of business income, interest deductions, and net operating losses. Another important aspect of the CARES Act is that it reverses or temporarily suspends certain of the more significant changes to the Code enacted by the TCJA.
3. Congress has enacted the Paycheck Protection Program Flexibility Act of 2020.
The Paycheck Protection Program Flexibility Act of 2020 (PPP Flexibility Act), enacted on June 5, 2020, modifies several aspects of the forgivable Paycheck Protection Program loans authorized by the CARES Act and made available through the Small Business Administration (commonly referred to as PPP loans), including a repeal of the rule that precluded employers whose PPP loans are forgiven from deferring deposits of the employer’s share of Social Security tax.
4. The 2021 Consolidated Appropriations Act makes some provisions permanent and temporarily extends others.
The Consolidated Appropriations Act, 2021 was signed by the President on December 27, 2020. This legislation made permanent several Code provisions that previously had been temporarily extended for many years, temporarily extended several expiring provisions, and provided tax relief to those in areas affected by certain natural disasters.
