There are some taxpayers who have a propensity for finding themselves featured in Procedurally Taxing. While those taxpayers, unlike our guest bloggers, do not get a Procedurally Taxing coffee mug, they do get the satisfaction of a PT home page appearance. John Hom is one of those taxpayers, giving me the chance to pay homage to my colleague Steve.
Early on I wrote about Mr. Hom in What Happens When IRS Violates a Statutory Requirement Relating to Notices of Deficiency. Steve wrote about Hom’s district court case holding that an online poker account was a bank account for FBAR purposes. Steve also wrote IRS Says Hom Gonna Getchya on FBAR Too, where the district court held that that the Service could allow its employees to share the return and return information it collected in its income tax audit to other employees who would investigate the FBAR issue.
Last week, the Tax Court in John Hom & Associates v Commissioner, a summary opinion, held that Hom and Associates was not responsible for intentional disregard penalties associated with failing to file Forms W-2 and W-3 with the Social Security Administration. In this post, I will discuss some of the procedural issues in the case, including the effect of a prohibited ex parte communication and the ability to beat the penalty using credible testimony.
First some background.
Mr. Hom was the sole engineer at his self named Marin County-based “geotechnical engineering firm specializing in soil testing services and providing geotechnical consulting.” According to the opinion, “Mr. Hom performed geotechnical investigations for various projects, such as parking lots and retaining walls. Mr. Hom explored the subsurface conditions of proposed jobsites and analyzed the results of fieldwork to provide recommendations for construction.”
Hom became a professional poker player in the early 2000s, though he still did some engineering work and had employees. For 2004 and 2006, he filed his W-2s with the employees but failed to send those and the transmittal W-3 into Social Security.
IRS assessed intentional disregard penalties under Section 6721(e) for both years in the amounts of about $2,000 and $8,000 respectively. IRS filed a NFTL and Hom submitted a Form 12153 challenging the liability.
He testified that he believed he had filed the forms with SSA and therefore the penalty should not apply because his failure was unintentional:
After mailing the forms to the SSA, Mr. Hom would save copies of the Forms W-2 and W-3 on his computer. Because Mr. Hom retained copies of the 2004 and 2006 Forms W-2 and W-3 on his computer, he believed that he had completed the previous step of filing those forms with the SSA.
The issue was teed up for trial, though before getting to the merits the opinion dealt with a preliminary matter, Appeals’ violation of the ex parte rules.
Ex Parte Rules Violated Yet No Remedy at Hand
The IRS had previously filed a motion for summary judgment, which the court denied; in the motion was a declaration by the Settlement Officer (SO) in the case that had as an attachment a letter that an IRS Revenue Officer (RO) had written to the SO. That letter included statements that “He is difficult to deal with.” and “He is very argumentative and unwilling to listen.” IRS conceded that the Revenue Officer’s statements were ex parte communications. As per RRA 1998, Appeals is prohibited from ex parte communications (Keith wrote about that and more in Expanding Ex Parte).
The opinion addresses what consequences if any should flow from the breach of the ex parte rules. In some cases, the Tax Court has remanded a case back to Appeals with an order that a fresh Appeals employee conduct a new hearing. In this case, the Tax Court declined to do that, in large part because the case come up on de novo review of the underlying liability with little prejudice to Hom flowing from the RO’s characterizations and Appeals’ violating the ex parte rules:
Respondent urges that, because the proper level of scrutiny in this case is de novo review and we have already conducted a trial on the merits, we are in a better position to adjudicate petitioner’s challenge of the underlying tax liabilities than a different settlement officer. If we remand the case to respondent’s Appeals Office, the case will potentially come before us again when respondent issues a new notice of determination. Since we have already held a trial on the merits, we conclude that remand of this case to the Appeals Office for a new section 6330 hearing would unnecessarily burden petitioner and respondent with a second hearing and possibly with a second trial on the merits. Since we review the matter de novo, we will not remand this case to the Appeals Office.
This reminds me a bit of my first post on Hom in 2013, where I discussed the lack of consequences from the IRS’ failure to include information about TAS in the stat notice. Not every IRS statutory violation triggers a remedy. That is somewhat unsatisfying, as one should assume that when Congress tells IRS to do something it generally means what it says and that if IRS fails to comply there should be some consequences. While I agree with the Tax Court’s approach here, I point this out because I find this still somewhat unsatisfying.
Maybe an IRS apology is in order? While there is no apology as best as I can tell, and that seems unlikely given the amount of litigation between IRS and Hom, Hom has to be pleased with the case’s outcome on the penalties, which I discuss below.
Intentional Disregard Penalty
After shooing away the ex parte issue, the opinion turns to the penalties.
The regulations under Section 6721 provide that intentional disregard is determined on the facts and circumstances, which include but are not limited to:
(i) Whether the failure to file timely * * * is part of a pattern of conduct by the person who filed the return of repeatedly failing to file timely * * *;
(ii) Whether correction was promptly made upon discovery of the failure;
(iii) Whether the filer corrects a failure to file * * * within 30 days after the date of any written request from the Internal Revenue Service to file * * *; and
(iv) Whether the amount of the information reporting penalties is less than the cost of complying with the requirement to file timely ** *
In addition, the Tax Court cited a bunch of cases where the courts have found that there was no intentional disregard:
In Gerald B. Lefcourt, P.C. v. United States, 125 F.3d 79, 83 (2d Cir. 1997), the Court of Appeals defined “intentional disregard” in the context of section 6721(e) as voluntary, conscious, and intentional conduct. In other words, the penalty applies when the failure was not accidental, unconscious, or inadvertent. See id. In American Vending Group, Inc. v. United States, 103 A.F.T.R.2d (RIA) 2009- 2181(D. Md. 2009), the District Court concluded that the taxpayer did not act with intentional disregard and the failure to file was accidental where the Forms W-2 and W-3 were prepared but were likely misplaced on a messy desk and not filed.
Another case the Tax Court discussed was a 2004 bankruptcy case, In re Flanary & Sons Trucking, Inc. which held “that the taxpayer did not act with intentional disregard where an officer testified that he had mailed the Forms W-2 and W-3 and that if they had not been received by the Service, it was not because of intentional disregard on his part.” As the Hom opinion summarized, in Flannery, “the bankruptcy court noted that “[w]hile a taxpayer’s testimony as to the mere mailing of the return may be insufficient as a matter of law to establish actual filing, such testimony is clearly pertinent when ascertaining whether the taxpayer knowingly or willfully disregarded its filing obligations.”
The opinion applies the regulatory factors as well as applies the cases that give taxpayers some slack to Hom’s circumstances. Hom’s testimony was believable (well one would expect a skilled poker player to have a good testimony face), and the court found in Hom’s favor:
Mr. Hom testified convincingly that he believed that he filed the 2004 and 2006 Forms W-2 and W-3 because he had retained copies of the forms on his computer and he was in the habit of storing the copies on his computer after the forms were filed. In addition, there was no pattern of conduct that would indicate that petitioner consistently failed to file Forms W-2 and W-3 since the forms were unfiled only for 2004 and 2006. We conclude that while the evidence is insufficient to establish actual filing, the evidence does establish that petitioner did not intentionally disregard its filing obligation for Forms W-2 and W-3.
I have not read many of the cases where the IRS has sought penalties for relatively few nonfilings such as this. Hom is getting a lot of IRS attention, which undoubtedly led to these troubles. One factor I found interesting is the court’s discussion of the cost of complying versus the amounts of the penalties (one of the regulatory factors):
Since no payment is required with the filing of Forms W-2 and W-3, there is no cost of complying with the provision other than the time taken to prepare the Forms W-2 and W-3 and the cost of postage. The section 6721(e) penalties assessed are $2,070.30 for 2004 and $8,018.75 for 2006. Any rational taxpayer would comply with the reporting requirement and avoid the risk of assessment of his penalty. Therefore, this factor favors petitioner.
For penalties associated with filing the W-2 and W-3 that is always the case though the time associated with complying may lead to fairly significant compliance costs if the numbers of employees are high. In any event, while this opinion is nonprecedential, it is useful as a way to think about the difficulties IRS may face in imposing intentional disregard penalties, especially for small employers such as Hom.