We welcome back guest blogger Bob Probasco. Bob tells a disaster story with a happy ending but we must keep in mind that the happy ending only occurred because the low income taxpayer had found her way to a clinic where she received free and highly competent representation. Other stories similar to this one exist in the system without the happy ending provided here.
As we have written before, the time for contesting the EITC ban in Tax Court is unclear. Another possible avenue for taxpayers in the position of Bob’s client is to seek orders regarding the ban from the Tax Court. I cannot say whether the taxpayer would have obtained relief in the Tax Court but the existence of the prohibited assessments would provide a basis for an injunction which might have gotten the client to the right place. Keith
There is a film genre often referred to, because of the primary plot device, as “disaster movies.” The golden age was the 1970s, with films like Airport, The Poseidon Adventure, and The Towering Inferno. Minor actions or problems interact in ways that create huge challenges. Each time the characters survive one obstacle, losing a few members of the group in the process, a new threat arises. How many, and which, characters will eventually survive?
The tax administration equivalent is the earned income tax credit (EITC) ban.
The EITC ban process is seriously flawed, as has been pointed out frequently. Les discussed it here on Procedural Taxing in blog posts in January 2014 and July 2014. National Taxpayer Advocate Nina Olson has been complaining about it for years, with the most detailed coverage in her 2013 Annual Report to Congress. Patrick Thomas made a presentation on it (outline available on the LITC Toolkit website, if you have access) at the December 2016 LITC Grantee Conference. Les and William Schmidt addressed the specific issue of Tax Court jurisdiction over the ban in 2016 and 2018 respectively. I strongly recommend a thorough review of all of the above – including comments to the blog posts! – to anyone who deals with taxpayers who claim the EITC.
This post discusses the IRS administrative process for applying (and correcting?) the ban. It also points out how the interaction of the EITC ban process with problems elsewhere in the tax administration process can turn a serious issue into an absolute disaster. This is the story of one such disaster.
Background
Section 32(k)(1), added by the Taxpayer Relief Act of 1997, establishes that the EITC shall not be allowed for
the period of 2 taxable years after the most recent taxable year for which there was a final determination that the taxpayer’s claim of credit under this section was due to reckless or intentional disregard of rules and regulations (but not due to fraud)
If there is a final determination that the taxpayer’s claim of credit was due to fraud, the disallowance period is 10 taxable years instead.
This is an absolute ban but there is also an indefinite potential disallowance, in Section 32(k)(2):
In the case of a taxpayer who is denied credit under this section for any taxable year as a result of the deficiency procedures under subchapter B of chapter 63, no credit shall be allowed under this section for any subsequent taxable year unless the taxpayer provides such information as the Secretary may require to demonstrate eligibility for such credit.
Treas. Reg. section 1.32-3(b) explains that
Denial of the EIC as a result of the deficiency procedures occurs when a tax on account of the EIC is assessed as a deficiency (other than as a mathematical or clerical error under section 6213(b)(1)).
And Treas. Reg. section 1.32-3(c) specifies Form 8862 as the information required to demonstrate eligibility. The instructions make clear that the taxpayer should not file Form 8862 during the years that a ban applies, but it will be required if the EITC is disallowed, even absent a final determination of fraud or reckless or intentional disregard of rules and regulations, to claim the EITC in any other years. If the form is properly completed and the IRS determines the taxpayer is eligible for the EITC, then the taxpayer is re-certified and need not submit Form 8862 again – unless the EITC is denied again.
Under Section 6213(g)(2)(K), the IRS can adjust the tax return by math error correction, rather than the deficiency procedures, if the taxpayer claims the credit during the ban period or without providing the required information for recertification. Nina Olson fought against that idea for years but it was eventually enacted in the Protecting Americans from Tax Hikes Act of 2015.
First obstacle: Location and language
Our LITC client – let’s call her “Maria” – was originally audited with respect to her 2014 return. She did a very good job of responding to the audit before even coming to our clinic. Most often, issues in an EITC audit concern proving relationship to the qualifying child or that the child lives with the taxpayer. Maria resolved those to the satisfaction of Exam/Appeals but one stumbling block remained: filing status. She filed her return as “single,” which of course should have been “Head of Household,” but the IRS insisted that she was married. Section 32(d) specifies that married taxpayers can claim the EITC only if they file joint returns. The IRS reclassified her filing status as “Married Filing Separately.” That was where the resolution bogged down, because Maria was adamant that she was not married.
Unfortunately, Maria lives in Texas, one of only ten states (plus the District of Columbia) that recognize common law marriage. She didn’t know that and she didn’t realize what the IRS was arguing from the correspondence she received. Maria doesn’t speak English and the “common law” part got lost in the translation by her son, who may not be familiar with the concept either. When she came to our clinic, we were able to explain the problem to her. We also determined that she had two arguments for claiming the credit.
First, she arguably did not meet the requirements under Texas law for a common law marriage. She had lived with her putative husband – let’s call him “Jose” – but she did not intend to be married and did not hold herself out to others as being married. We were persuaded as to the absence of intent by her obvious surprise when we explained what the IRS was saying. While corresponding with Exam/Appeals, before she came to the clinic, she submitted proof that she was not married: a certificate from the county clerk’s office that there was no record of a legal marriage between Maria and Jose. That’s not the type of evidence you’re likely to submit if you are aware of the existence of common law marriage. And if you’re not aware, that certainly suggests that you lacked the intent.
The more difficult aspect was the “holding out” requirement, because Maria and Jose had filed joint tax returns for several years prior to 2014. Jose may have held himself out to the IRS as married to Maria but I don’t think she did. She didn’t realize what the tax returns she signed meant. She thought Jose was claiming her as a dependent, not that she was presenting herself as his spouse. But it was always going to be difficult, if not impossible, to prevail on the first argument.
Our second argument was better. Under Section 7703(b), Maria could file her return as Head of Household, even though married, if (a) she maintained a household for a child who lived there and (b) she and Jose lived apart for at least the last six months of the year. Under Reg. 1.32-2(b)(2), such a return is not subject to the limitation of Section 32(d). Jose had moved out in 2013; he was working in the oil fields in South Texas and living in his truck to save money to start a business. When he moved out, she even began paying him rent.
Second obstacle: Exam/Appeals and evidence
Unfortunately, there was no documentary evidence that Jose no longer lived there. He still received mail at the address where Maria lived and continued to use that address on subsequent tax returns he filed. You can’t get mail addressed to a truck and you can’t use the truck as your address on a tax return. There was no rental agreement or utility bill for the truck either, so the IRS could find no records showing a different address for him. So as far as Exam and Appeals were concerned, he still lived with Maria.
The IRS also was not satisfied with the substantiation for the agreement to pay rent. Maria and Jose documented that arrangement with a very formal rental agreement. (How many taxpayers would think to do that?) Unfortunately, Maria’s copy of the agreement was unsigned and it was only for a term of one year, which did not cover all of 2014. Maria continued paying rent after that but they did not think to prepare a new agreement until she was audited. Also, Maria didn’t have records of the payments to Jose, because she paid him in cash.
Maria’s case stumbled over what appears to be a larger problem with correspondence audits. During my limited time at the LITC, Exam and Appeals both appear to rely exclusively on documentary evidence. That may be understandable, given drastic reductions in staffing and the absence of face-to-face meetings in correspondence audits, but I don’t think it’s reasonable – particularly on something like this that had huge potential consequences. We offered to arrange a telephone conference (including translator) with Maria and could have put together an affidavit if they preferred that. But they just rejected the idea of testimony. Luckily, Counsel can and does accept testimonial evidence, so we were still hopeful. Unfortunately, this meant that we had to go to Tax Court, when we encountered another obstacle.
Shortly after we filed the Tax Court petition for the 2014 tax year, the IRS sent an audit notice for 2015. The same process repeated with the same result – Exam and Appeals rejected our explanations due to a lack of documentary evidence and Maria received a notice of deficiency. The IRS had frozen the refund for 2015 during the audit, so further delay did create some financial hardship.
Third obstacle: Error in a ministerial or administrative action
Once Appeals returned the docketed case for 2014 to Counsel, we submitted a declaration by Maria setting forth what her testimony would be. Within a week, the IRS attorney agreed to concede the case in full. The stipulated decision for 2014 was filed a day after we filed the petition for 2015. And in less than three months, we had a full concession from Counsel for 2015 and another stipulated decision. So, great results for Maria, right? Alas, here’s where we ran into an unrelated issue that had a very unfortunate interaction with the EITC ban.
I had never given much thought to the question of how Exam and Appeals proceed after issuing a notice of deficiency. I should have, although I’m not sure I could have avoided this problem. Internal Revenue Manual (IRM) sections 4.8.9.25 and 4.8.9.26 set forth the process when the taxpayer petitions and when the taxpayer defaults, respectively, after a notice of deficiency. It seems to be an elaborate process with many safeguards – a tax litigation counsel automated tracking system, a related docketed information management system, and checking the Tax Court website if not in those systems to confirm that the taxpayer defaulted. There is even a follow-up process for the occasional situation when the responsible employee receives the docket list after tax was assessed.
For both 2014 and 2015, we filed Tax Court petitions timely. As we all know, Section 6213(a) states in unequivocal terms that
no assessment of a deficiency . . . shall be made, begun, or prosecuted until such notice [of deficiency] has been mailed to the taxpayer, nor until the expiration of such 90-day or 150-day period, as the case may be, nor, if a petition has been filed with the Tax Court, until the decision of the Tax Court has become final.
This is a disaster story, though, so you’ve undoubtedly guessed (correctly) that for both years the IRS assessed tax and reversed the EITC, while there was a pending Tax Court case. The IRS imposed the EITC 2-year ban in both cases and issued Notice CP 79A.
Why did this happen? I really don’t know. While I was writing this post, out of curiosity I reviewed the limited number of Tax Court deficiency cases our clinic handled in our two years of existence. For all the non-EITC cases, transaction code 520 “bankruptcy or other legal action filed” was posted to the transcript consistently in less than a month after the date the petition was posted to the Tax Court online docket. But for three of our six EITC cases in Tax Court, including Maria’s cases for 2014 and 2015, transaction code 520 was posted to the transcript significantly later: 64, 212, and 221 days after the respective petition was posted to the Tax Court docket. Every process is only as strong as its weakest link – in this case, human error or delay. Someone somewhere didn’t realize that we had challenged the notice of deficiency and didn’t get the information into the computer, so the assessments – and EITC bans – proceeded for those three cases. (Our other client made it to safety relatively early in the process.)
I reported the issue of premature assessments from these cases in the Systemic Advocacy Management System (SAMS) last year, and I suspect other people have done so as well. It’s always a problem, but the consequences can be worse when the EITC ban is put into play.
Fourth obstacle: The difficulty of reversing an illegitimate assessment and EITC ban
Section 6213(a) provides a remedy if the IRS assesses or takes collection actions while a Tax Court case is pending:
Notwithstanding the provisions of section 7421(a), the making of such assessment or the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court, including the Tax Court, and a refund may be ordered by such court of any amount collected within the period during which the Secretary is prohibited from collecting by levy or through a proceeding in court under the provisions of this subsection.
It doesn’t provide for enjoining the imposition of the EITC ban, though. In addition, IRM 4.13.3.17 provides that errors concerning an EITC assessment can be resolved through the audit reconsideration process, although presumably this is intended to apply when the taxpayer provides additional documentation after a legitimate assessment.
Perhaps foolishly, we tried to resolve the problem for 2014 informally. I gave the IRS attorney assigned to the case a copy of the notices issued by the IRS and asked if she could have it corrected. Because she had already referred the docketed case to Appeals, she passed that documentation along to the Appeals Officer. I followed up with the Appeals Officer twice, with no response. But the problem was eventually resolved; the assessment was reversed, and the IRS mailed Notice CP 74, recertifying Maria for EITC. Problem solved, and since the Tax Court case was still pending, no harm, no foul.
For 2015, I responded directly to the assessment and Notice CP 79A. That notice presents the ban as a fait accompli; there was no reference to what the taxpayer should do if she disagreed with the IRS action. As noted above, the recertification process applies only after the ban period. The accompanying Notice CP 22E for the assessment suggested the taxpayer call if she disagreed with the changes. Instead, I wrote a letter – remarkably polite under the circumstances – pointing out that the assessment and imposition of the ban were illegal because of the pending Tax Court case and requesting the IRS “take all necessary corrective actions immediately.” Exactly one month later (which qualifies as “immediately” in any large bureaucracy), the assessment was reversed. We had filed the stipulated decision in the meantime and finally, almost six months after our letter and five months after the stipulated decision, the IRS issued a refund. This was a long time for a low-income taxpayer to wait for a refund, but better late than never.
Let’s summarize the timeline, because this is getting confusing.
2014 tax year
- Notice of deficiency – 11/30/2016
- Tax Court petition filed (timely) – 2/24/2017
- Assessment/ban – 4/17/2017
- “Bankruptcy or other legal action” posted per transcript – 5/3/2017
- Clinic contacts Counsel and Appeals regarding the premature assessment – 6/5/2017, 6/21/2017, 7/24/2017
- Assessment reversed – 11/13/2017
- Tax Court stipulated decision – 1/23/2018
2015 tax year
- Notice of deficiency – 10/16/2017
- Tax Court petition filed (timely) – 1/16/2018
- Assessment/ban – 2/26/2018
- Clinic letter to IRS – 3/2/2018
- Assessment reversed – 4/2/2018
- Tax Court stipulated decision – 4/5/2018
- Refund issued – 8/3/2018
- “Bankruptcy or other legal action” posted per transcript – 8/29/2018
Fifth obstacle: Enter the math error adjustment
Just when we thought Maria’s problems were over, on 7/2/2018 she received Notice CP 12, a math error adjustment denying EITC, for her 2016 tax return. We either didn’t notice or didn’t realize the significance at the time, but when the IRS reversed the premature assessment for her 2015 tax year, it did not issue Notice CP 74 recertifying her for EITC.
There had been an assessment of tax, on account of the EITC, as a deficiency for 2015, so it met the requirements of Treas. Reg. section 1.32-3(b) and Section 32(k)(2). Of course, that assessment for 2015 was illegal and had been reversed. The stipulated decision in the Tax Court case meant there never was and never would be a legitimate final assessment or determination of reckless or intentional disregard of rules or regulations for 2015. Because there is no process to confirm the validity of the EITC ban first, the failure to recertify automatically resulted in issuance of the math error adjustment.
Luckily, although a math error adjustment can be assessed without judicial review, taxpayers can simply request that the adjustment be reversed within 60 days, although – if appropriate – it can be re-asserted through the deficiency process. Section 6213(b)(1) and (2). That’s exactly what we requested for the 2016 tax year, by letter on 7/24/2018.
And, of course, since this is a disaster story, you know that Maria also received Notice CP 12 for her 2017 tax return.
Sixth obstacle: Further delay for an audit?
The IRS mis-handled our protest of the math error adjustment for 2016. Of course. Notice CP 12 states:
If you contact us in writing within 60 days of the date of this notice, we will reverse the change we made to your account. However, if you are unable to provide us additional information that justifies the reversal and we believe the reversal and we believe the reversal is in error, we will forward your case for audit. This step gives you formal appeal rights, including the right to appeal our decision in the United States [Tax] Court before you have to pay additional tax. After we forward your case, the audit staff will contact you within 5 to 6 weeks to fully explain the audit process and your rights. If you do not contact us within the 60-day period, you will lose your right to appeal our decision before payment of tax.
That’s consistent with Section 6213(b) as well as IRM 21.5.4.5.3 to 21.5.4.5.5 (general math error procedures) and IRM 21.6.3.4.2.7.13 (EITC math errors specifically). A substantiated protest can result in just reversing the math error adjustment; an unsubstantiated protest will result in referral to Exam.
The IRS treated our protest of the math error adjustment for 2016 as an unsubstantiated protest and referred it to Exam. Perhaps they misclassified our protest because they expect a substantiated EITC protest to provide documentation regarding relationship or residence or SSNs. Our protest was based on a premature assessment and assertion of the ban, and the failure to reverse the ban imposed as a result of the audit of 2015. We certainly had substantiated our basis for that. But when you provide a type of substantiation that they’re not anticipating . . .
So we received an audit letter dated November 9th. Further delay before Maria will receive her refund. To add insult to injury, the notification of what was happening was inadequate and would have been confusing to an unrepresented taxpayer. There was no response to the protest, telling us that they were referring the case to Exam for review. That might have provided an opportunity to clarify the nature of our protest before initiation of the audit. The audit letter did not explain the connection with the math error adjustment. For that matter, the IRS did not – as specified in the IRM – abate the disputed adjustment.
I have a sneaking suspicion that the same thing would have happened when we protested the math error adjustment for 2017 as well. Luckily . . .
The rescue party arrives! Maria makes it to safety!
Our efforts hadn’t met with much success, so we contacted our Local Taxpayer Advocate office in mid October. The case advocate spent a lot of time and effort, chasing from one office to another on Maria’s behalf. He pointed out the premature bans, the decisions by the Tax Court, and the IRS policy against auditing an issue that were examined in either of the two preceding years with no change or a nominal adjustment. Even after he elevated the discussion to managers in the operating units, there was still a lot of resistance. I’m not sure he would have succeeded without the gentle reminder of the possibility of a Taxpayer Assistance Order. Just as I was finishing this post, he called us with the good news. The 2-year ban is being lifted, the two math error adjustments are being reversed, and the examination of 2016 is being closed. Soon Maria will be getting the remainder of the refunds she requested on her 2016 and 2017 tax returns.
Final thoughts
I’m getting used to the unfortunate difficulty of convincing Exam/Appeals that our clients are entitled to the EITC. I didn’t worry that much about the EITC ban because most of the time either we prevail or our clients aren’t entitled to the EITC and won’t claim it in the future anyway. I certainly didn’t anticipate how much trouble the EITC ban can cause even when we win the battle over the EITC itself.
TAS Systemic Advocacy also continues to look at these issues. They approached me after hearing about the case, before I even got around to reporting it in SAMS. Nina Olson has been fighting the problems with the EITC ban for years but still meets with resistance. Maybe this example of how much can go wrong will help in that fight. We can only hope.
The positive part of any ordeal like this is that, amid all the mindless adherence to byzantine and flawed processes, you can still encounter the IRS working the way it should: getting the right result, protecting the government fisc while also protecting taxpayer rights. In Maria’s case, those bright spots were Counsel, the case advocate at LTA, and the folks at TAS Systemic Advocacy. Without people like them, these tax issues can be devastating, not just for Maria but also for a lot of other taxpayers in similar situations.