Frequent guest blogger Bob Kamman put his formidable investigative skills to work to bring us an in-depth look behind the Walquist opinion. Christine
“Everyone is entitled to his own opinion, but not to his own facts.”
–Daniel Patrick Moynihan
“Facts, sir, are nothing without their nuance.”
The Tax Court is certainly entitled to its opinion in Walquist v. Commissioner, 152 T.C. No. 3, which Keith Fogg blogged here. But a review of the record and other public documents yields facts that may contradict those cited in the opinion, or at least provide some meaningful nuances. Serious questions are therefore raised about its precedential value.
Here are what the Tax Court found to be some of the facts:
R through his Automated Correspondence Exam system determined, for Ps’ 2014 tax year, a deficiency in tax and a penalty for an underpayment attributable to a substantial understatement of income tax. R’s computer program generated a 30-day letter inviting Ps to reply and submit relevant information. When Ps declined to respond, the program generated and issued to them a notice of deficiency in the form of a Letter 3219. This letter again invited Ps to contact R, but they did not do so.
Here is what actually happened:
Petitioners filed their 2014 Form 1040 with a paper return that was received by the Fresno Service Center on April 2, 2015. It must have been placed in the “Funny Box” (see Internal Revenue Manual 126.96.36.199.4) because it was stamped “Frivolous Return Program – Internal Revenue Service – Fresno CA” on that day. The next stop in its processing was April 13, 2015, when it was stamped “Received – FRP 306.”
The taxpayers had added to the jurat (declaration under penalty of perjury, just above their signatures), “This return is in accordance with 12 USC 411, 12 USC 95(a)(2), [illegible].” Those sections are used by tax protesters who claim income is not taxable unless paid or measured by Federal Reserve notes, or something like that.
They also wrote “Demand for Lawful Money Reduction” on Line 21, with a bracketed amount of $87,647.96 to indicate a loss. The pretrial memorandum correctly transcribes the first word as “Demand” but a later pleading erroneously changed it to “Remand.”
The next we see of the return is an internal IRS Form 8278, “Assessment and Abatement of Miscellaneous Civil Penalties,” dated July 27, 2015 and signed by “Ms. Bluemel” as originator and Krista Decaria as manager and reviewer. (They work not in Fresno, but at the IRS Ogden Service Center.) It assesses a $5,000 penalty for a frivolous tax return. Assessment of this penalty is not subject to deficiency procedures. In its “Remarks” section, the Form 8278 states “Argument 29.” IRM 188.8.131.52 explains this as “Any other position deemed frivolous.”
The Walquists filed a joint return. Both spouses had W-2 income. Craig Walquist earned $20,113 from two employers, with $624 federal income tax withheld. Maria Walquist earned $59,840 from one employer, with $5,105 withheld. The total withholding from W-2 forms was $5,729 but their return claimed $5,730.69. In August 2015, IRS grabbed the $5,000 penalty from this amount. That left $730.69, which was applied to taxes they owed for 2008. Then IRS allowed $54.12 interest from April 15 on the “overpayment.” That amount went to 2008, also.
All of these facts come from IRS pleadings in the Tax Court case. To find out what happened between August 2015 and August 2017, when the Notice of Deficiency was issued, we must look elsewhere. Did IRS just throw the fishy 1040 back in the sea of returns, only to have the audit commence again because of some unreported income? Fortunately, the taxpayer attached some IRS correspondence to the lawsuit he filed in the District Court for Minnesota. But first, let’s look at some more facts from the Tax Court opinion.
Alerted to petitioners’ underreporting by computer document matching, the IRS processed the examination of their return through its Automated Correspondence Exam (ACE) system, employing its Correspondence Examination Automated Support (CEAS) software program. This software is designed to process cases ‘with minimal to no tax examiner involvement until a taxpayer reply is received.’ Internal Revenue Manual (IRM) pt. 184.108.40.206.1 (Dec. 18, 2017).
On July 26, 2017, the CEAS program generated and issued to petitioners a Letter 525, General 30-Day Letter. In cases such as this–where the understatement of income tax calculated by the program exceeds the greater of $5,000 or 10% of the tax required to be shown on the return–the program systematically includes in the letter a substantial understatement penalty. See sec. 6662(b)(2), (d)(1)(A). The program accordingly calculated a penalty of $2,766.40, or 20% of the proposed deficiency of $13,832. See sec. 6662(a).
What Walquist attached to his District Court complaint, though, is a Letter 525 dated June 30, 2017. It says, “We’re auditing your 2014 Form 1040, and need a response from you.” Attached to the letter is a computation showing a balance due of $18,003. This included $13,832 tax; $2,766 Section 6662 penalty; and $1,405 interest. In a box on the Letter 525 for “Examiner’s Signature,” there is printed “Tax Examiner”; and in the box for “Employee ID,” the number 1000099771.
The Letter 525 adds, “let us know by July 30, 2017 if you agree or disagree with our proposed changes.” The Walquists both signed a two-page, single-spaced letter dated July 26, 2017, asserting tax-protester arguments based on Federal Reserve notes. (There is no proof it was mailed, but no reason to believe it was not. It would not have accomplished anything, anyway). IRS responded with the August 30, 2017 Notice of Deficiency.
In addition to his $20,113 of W-2 income, Walquist received $14,159 in “non-employee compensation” reported on Forms 1099-MISC, which IRS determined was subject to $2,001 self-employment tax. He also received $1,215 in unemployment compensation.
As IRS stated in a November 26, 2018 filing, “respondent’s determinations are chiefly based on a misclassification of income rather than underreporting of income by petitioners.” In other words, the $14,159 of self-employment income should not have been reported as wages, but instead shown on Schedules C and SE.
The Notice of Deficiency shows the same employee identification number as the Letter 525. It is attributed to Christine L. Davis, from Ogden’s “Return Integrity and Compliance Services, Integrity and Verification Operation.” That IRS office “detects, evaluates and prevents improper refunds.”
As it turned out, the software that IRS relied on to figure the tax did not produce an accurate result. It was only after the Tax Court petition was filed that IRS Counsel reduced the $13,832 amount to $12,220, and the $2,766 Section 6662 penalty to $2,444. A $60 filing fee saved the taxpayers $1,934 plus interest. They should have quit while they were ahead. The Tax Court also corrected its error in ordering them to pay the filing fee, before it found that it had already been received. Perhaps it was paid in Federal Reserve notes which caused some accounting problems.
Some more facts from the Tax Court:
Whether an accuracy-related penalty determined by an IRS computer program is a ‘penalty automatically calculated through electronic means’ does not appear to have been decided in any published Opinion of this Court. . . .The penalty at issue was calculated and instantiated in letter form by a computer software program. Because the computer did this without human intervention, no ‘individual making such determination’ appears to exist.
Yes, “instantiated” is a word. But that part about human intervention?
In its pretrial motion dated October 5, 2018, the IRS attorney informed the Court:
Respondent determined that petitioners were liable for an I.R.C. §6662 accuracy-related penalty for their 2014 tax year. I.R.C. § 6662 (a). Respondent is able to satisfy its burden of production with respect to this penalty. I.R.C. § 6751 requires respondent to furnish evidence of managerial approval of the accuracy-related penalty prior to the issuance of the notice. As an exhibit to respondent’s September 5, 2018 motion to dismiss, respondent submitted a signed Declaration and Case History demonstrating managerial approval of the accuracy-related penalty in this case prior to issuance of the notice. As such, respondent is able to meet its burden of production.
In other words, in a case where the Tax Court saw no human intervention in a tax-protester audit, the IRS itself saw the need for managerial approval of a Section 6662 penalty, and confirmed it was done.
But maybe that is not the precedent the Court intended to establish with this case. Maybe the message is the $12,500 penalty it assessed under Section 6673, for taking a position in Tax Court that was frivolous or groundless.
The maximum penalty that could have been assessed is $25,000. It might not be coincidence that $12,500 nearly matches the amount of tax, $12,220, that should have been shown on the Walquists’ frivolous return. That does not include the $5,000 penalty they had already paid to IRS.
The Tax Court penalty can now be collected from either spouse. In 2014, Mrs. Walquist was the primary breadwinner, responsible for 63% of the income. Filing separately, she still would have owed more than $3,000 tax. But there is little evidence that she is the primary tax protester. She was not a plaintiff in the District Court case. An IRS notice attached to that complaint indicates that for 2016 her husband filed separately, and was again penalized $5,000. It is the husband who has self-published a book that asks such questions as, “Have American Christians erred in assuming our country is Biblically on the side of good?”
I searched Tax Court opinions from 2017 to date for cases involving joint returns where the Section 6673 penalty was considered. Most such cases during this period involved taxpayers who are unmarried or filing separately.
I found two cases involving joint returns. In one of them, Henry and Kathy Jagos, TCM 2017-202, the taxpayers had income of $544,167 in 2012. They denied owing tax because they “are private-sector citizens (non-federal employee) employed by a private-sector company (non-federal entity) as defined in 3401(c)(d).”
From the Court’s opinion:
At trial the Court encouraged the Jagoses to abandon their frivolous arguments and cited specific authorities for them to consider. The arguments raised in their 70-page brief were a rehash of the very same arguments that were dispatched in those cases. And the Jagoses have raised frivolous arguments at every stage of this process from their 2012 income tax return to their closing brief. For disregarding the cases cited to them and wasting the Court’s resources with their frivolous arguments, we impose a sanction under section 6673 . . .
The Court found that they owed $155,149 in tax – but assessed only a $1,000 penalty under Section 6673.
In the other case, Michael Wells and Lynn Kirchner-Wells, TCM 2018-188, the Court noted:
Petitioners also attached Forms 4852, Substitute for Form W-2, Wage and Tax Statement, to each of the returns indicating zero wages and the same amounts of tax withheld as was shown on each Form W-2. The Forms 4852 included the following tax protester statements: I am a private-sector worker, not an ‘employee’ as defined in IRC 3401(c) and IRC 3121. I worked with a private-sector company, not a federal employer as defined in IRC 3401(d). I did not engage in a ‘trade or business’ as defined in USC Section 7701(a)(26).
The tax deficiency was $52,051, but no Section 6673 penalty was assessed. “The Court may on its own determine whether to impose a penalty not to exceed $25,000 when it appears to the Court that a taxpayer’s position is frivolous or groundless. Sec. 6673,” Judge Gerber wrote. “We did not find in the record that petitioners have made these or similar frivolous claims in the Court before or that they have been previously forewarned. Thus we will not impose one here, nor does respondent seek a section 6673 penalty in this case.”
Has the Tax Court now announced an end to leniency for tax protesters? At least the Walquist case suggests that those with frivolous arguments (and their spouses) should stick to the facts, and keep their opinions to themselves.