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Statutory Notice Language and the Administrative Procedure Act

Posted on Apr. 13, 2016

Yesterday, Les posted about the Tax Court decision in Ax v. Commissioner holding that the APA did not prevent the IRS from amending its answer to add additional bases for supporting its deficiency determination.  Last year, we failed to write about the case of QinetiQ U.S. Holdings v. Commissioner, T.C. Memo 2015-123 which seeks to significantly change statutory notices issued by the IRS.  Guest blogger Sean Akins, one of petitioner’s counsel at the Tax Court level, made brief mention of the case in his post on sealing the records in the Tax Court but did not address the major procedural issue in the case.  Although the case may significantly change the way the IRS must issue statute notices of deficiency, it only has importance if the petitioner wins the novel argument.  Because the government won in the Tax Court, the case remains obscure.  Due to its potential significance, it bears watching, with other APA cases seeking to change Tax Court practice, as it moves forward.  Petitioner appealed the case to the 4th Circuit where the parties have recently filed their briefs.

Petitioner timely filed a petition in Tax Court and then moved to dismiss the case for lack of jurisdiction arguing that the notice of deficiency was invalid.  The invalidity of the notice, according to petitioner, resulted from the failure of the notice to provide an adequate description of the issues causing the IRS to send the notice.  While other cases (see here, here and here) over the years have attacked the validity of the notice of deficiency on the grounds of insufficiency and the Tax Court has upheld some notices that must have caused it to hold its nose, no petitioner prior to QinetiQ argued that the notice of deficiency lacked validity because it failed to follow the Administrative Procedure Act (APA).

We have published several posts (see here, here and here) on the APA and its impact on tax regulations.    We have not, however, written about the impact of the APA on more day to day notices issued by the IRS and how, if at all, the APA impacts what the IRS must put in those notices.  That is the issue QuinetiQ takes on.  The IRS argument is essentially that the APA does not apply to things such as a notice of deficiency and the Tax Court agreed.  The taxpayer will make its arguments again before the 4th Circuit.  While the taxpayer may have a low chance of success, big changes in the notice process will occur if it does succeed.

The IRS position is that the IRC does not required detailed reasoning in a notice of deficiency and that the specific language of the IRC regarding the notice of deficiency trumps the provisions of the APA.  The IRS points to IRC 7522 which requires only that the notice briefly inform the taxpayer concerning the proposed deficiency for a specific year and amount.  Section 7522(a) also contains a statement that an inadequate description does not invalidate the notice.  This creates a tough hurdle for the taxpayer to overcome in attacking the validity of a notice of deficiency.

With respect to the “reasoned explanation” requirement petitioner argues that the APA imposes on notices of deficiency, the IRS argues that this misinterprets the APA requirement.  Such an explanation must support agency action in the context of formal rulemaking but not in the context of a notice of deficiency which acts more like an informal rulemaking determination.  The Supreme Court has held that the notice of deficiency does not require a detailed explanation although not necessarily in response to an argument such as petitioners make in this case.

Whether the 4th Circuit reverses the Tax Court or simply lets stand a decision that continues with the same rules for the notice of deficiency to which we have become accustomed, the case bears watching if you have interest in what a notice of deficiency should say.  When I started working on tax cases in the 1970s every case on which the IRS sought to issue a notice of deficiency went through the review staff of the examination division.  The revenue agents had a strong dislike for the review staff because it regularly caught their mistakes and required them to redo their work.  The review staff carefully crafted notices of deficiency.  The effort that the IRS put into the notices at that time seems amazing today as I look back on the procedure then and now.  Revenue agent reports were transformed from sometimes loose language about a proposed change to much more descriptive language that had a better chance of standing up to a challenge.  We have come a long way from the days when a review staff crafted the notice of deficiency and from what may have been expected when the statutory provisions and early case law were written.

Today, the vast majority of notices get issued using the 30 day letter attached to the formal notice letter.  Little, if any, review of the notice occurs and most notices concern small cases handled by the correspondence unit.  Even in larger cases the amount of review is quite small given the amount of money at stake.  Because the change over to the notices of deficiency without review and careful language has now existed for over two decades, we are accustomed to notices that do not provide a great deal of notice in many cases.  Whether or not Quinetiq wins the case for APA level descriptions in notices of deficiency, it might be appropriate to think about how we arrived at the current state of “notice” in these notices and whether a better level of notice should exist.  We have posted now on several occasions about correspondence from the IRS that does not adequately advise the taxpayer of what is happening or what will happen.  Poorly written notices of deficiency raise many of the same issues and place on taxpayers the burden of proof in Tax Court cases concerning matters that sometimes contain inadequate or incorrect descriptions.  Of course, if we want the IRS to spend the time to provide better notice, we must also make the commitment to provide adequate staffing.

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