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Designated Orders, 10/9 – 10/13

Posted on Oct. 20, 2017

This week’s designated orders were written by Caleb Smith who directs the tax clinic at the University of Minnesota. Today the lessons from the orders concern the importance of the tax return itself. Keith

There were only four designated orders last week, three of which came from Judge Gustafson in Collection Due Process cases, and one from Judge Buch in a deficiency action. I won’t elaborate much on the Buch order, as it deals largely with tax protestor arguments. For those who remain interested, it does offer a look into “current trends” of tax protesting arguments (now apparently including Administrative Procedure Act claims). If nothing else, the sixth footnote of the order may also bring some levity to your day. The order can be found here.

The two Gustafson orders that I will focus on highlight, once more, the important lesson of getting your tax return right the first time. They also provide a look at what sorts of errors the IRS filters can and cannot easily pick up.

Perils of Our Self-Reporting Tax System

Taylor v. C.I.R., Dk # 19243 -16L (order here)

The basics of Taylor are simple: taxpayer reported roughly $120,000 in tax liability with only about $8000 in withholding. No further payments were made, so the IRS began collection procedures. The gulf between the self-reported tax liability and withholding credits certainly catches the eye, and Judge Gustafson elucidates exactly what is at play. This is, quite frankly, a tax return that the taxpayer mangled almost beyond recognition, but not quite enough to keep from reporting a massive amount due.

Judge Gustafson does his best to get into both the mind of the taxpayer at the time of preparation, and what the real transactions seem to be. This is not an easy task. The basics are that the taxpayer prepared Form 1099-A (generally used for abandoned property transactions) listing himself as the lender and USAA Federal Savings Bank as the borrower on a note worth $358,031 with a balance of $190,403 remaining outstanding. If this is mistakenly based off of an actual transaction is anyone’s guess. How the taxpayer reported this (self-prepared) 1099-A on his tax return was to include the $358,031 as “other income,” thus generating a substantial liability. In a later, amended return the taxpayer continued to include the $358,031 as income, but also included the outstanding balance of $190,403 as a withholding credit. It appears that on the original return Mr. Taylor may have forgotten to include that withholding credit: in any event, the IRS did not allow it.

Who knows what motivated the taxpayer to report the transaction as he did, or if there even was a real transaction he was trying to faithfully report. It is hard to doubt that whatever transpired, it was reported incorrectly and very likely resulted in an incorrectly inflated tax liability. In any event, it is noteworthy that, but-for the case law holding that self-reported tax does not constitute “a prior opportunity to dispute” the liability under IRC § 6330(c)(2)(B), there would be effectively NO chance for judicial review when trying to fix these errors. Obviously there will be no notice of deficiency on self-reported tax, and paying the erroneous tax to sue for refund is almost certainly out of the question in most of these instances. I trust that 99% of the time working administratively with the IRS will resolve the problem when it is a clear typo. The bigger issue, to me, is the amount of time it may take for the IRS to resolve the problem (and the intervening events that can take place) when there is no judicial pressure. In the above case it was the taxpayer’s own fault for not meaningfully participating in the CDP hearing or the ensuing litigation to fix what was a clear mistake: the CDP procedures otherwise did what they are supposed to do.

Parikh v. C.I.R., Dk # 19875-16L (order here)

So we have seen that an error on income leading to an inflated, self-reported tax can be hard to unwind since it leads to immediate assessment. What about a typo on a social security number?

In Parikh, the taxpayer self-reported tax liabilities for 2009 – 2011. The IRS then increased those liabilities after disallowing a dependent exemption for each year, presumably after sending a notice to the taxpayer. The reason for the IRS disallowing the exemption is critically important: it isn’t that the IRS was auditing the return and concluding that the taxpayer didn’t meet the IRC § 152 tests. Rather, it was because the dependents Social Security number was incorrect. The first rationale would require a notice of deficiency; the latter may be a “math or clerical error” under IRC 6213(b), and accordingly does not require an NOD unless the taxpayer responds to the notice requesting abatement. If the taxpayer does not respond (as appears to be the case here), the IRS can assess the additional tax.

This is important because the lack of NOD issuance (may) open the door for the taxpayer to argue the underlying liability at a later CDP hearing under IRC § 6330(c)(2)(B) –the same provision that could have assisted Mr. Taylor in the first case had he properly engaged the process. Mr. Parikh, it seems, was slightly more involved and thus gets a slightly better outcome: he provided information for correcting the SSN of the dependent (that the IRS thereafter allowed, thus reducing his liability) but he did not provide financial information or other delinquent tax returns (thus tying the hands of the IRS for providing any variety of collection alternative).

If there is one lesson to be gleaned from the above orders, it’s that if you have a typo on your tax return make sure that it isn’t on an item of income. More specifically, make sure that it doesn’t inflate your actual income by an order of magnitude (say, by adding a couple extra zeros to your wages on line 7). While that isn’t exactly what happened in Taylor, it is the power of the of IRC § 6201(a)(1) that moves the problem forward. The IRS will take you at your word when you say you have a lot of income, even if third party sources don’t back up that claim. With an SSN typo you at least get a math error notice prior to assessment.

Short of a new, “friendly” version of the common CP 2000 notice (i.e. “Our computers think you may have over-reported income: can you explain the discrepancy between your return and our 3rd party sources?”) it is difficult to fault the IRS for treating the two typos differently. Over-reporting gross income is not a “math error,” and it is very difficult for the IRS to reasonably guess that the taxpayer DIDN’T have that income short of further examination. Further, if you are preparing your tax return with most commercial software there will be about a million blinking red lights before you file warning that you owe significant money… usually that is enough to have people take a second look before clicking “submit.” But if you file by PAPER and do not calculate the tax due there is no such warning. In fact, in some instances as a courtesy the IRS will figure the tax for you and either send a bill or refund thereafter (See Page 41, 2016 Form 1040 Instructions and Page 208, IRS Publication 17). It is unclear to me in the Taylor case whether the taxpayer listed an amount due (even by paper, handwriting a huge liability is a warning of its own), or whether the IRS “fixed” that missing information later. By whatever means the point remains: a self-reported liability is hard to erase.

Correct Liability, Incorrect Argument

Karim v. C.I.R., Dk # 17407-15L (order here)

The final Gustafson order also involves self-assessed liabilities, but with a twist: this time, it appears, the liability was correctly reported. Instead the case revolves around what remedy the taxpayer wants: either a double-check that he has had payments credited to the liability, or removal of the lien.

It is increasingly easy to be sympathetic to the taxpayer’s claim that the IRS has misapplied payments that should be credited to an outstanding liability (see posting here). In this case, the taxpayer didn’t really pursue the argument that there had been misapplied payments: the cursory IRS response “our records show” thus carried the day.

This case also provides an example of the difference in remedies when one is contesting a lien rather than a levy. Here the taxpayer was placed in CNC (usually, a good outcome for a levy action), but did not make a persuasive argument why the lien should be withdrawn.

Lastly, some may find the order interesting for the brief analysis of whether the administrative CDP request was on time. Here, the IRS apparently put a date on the Notice of Intent to Levy that did not match the reality of when the letter was actually sent: see previous orders calling into question the veracity of IRS notice dates here).

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