At the end of last summer, the Tax Court issued a TC opinion on the issue of imposing the frivolous return penalty of IRC 6702. In that opinion it also discussed, inevitably, the impact of Graev on this particular penalty. We should have covered this case closer to the time it came out. Several subsequent opinions have cited to it. This post seeks to correct the omission and make you all aware of Kestin v. Commissioner, 153 T.C. No. 2 (2019).
This case provides yet another example of how friendly the Tax Court is to petitioners. Of course, statistically, the Tax Court rules most of the time for the IRS; however, it generally gives the taxpayers ample opportunities to make their case. Mrs. Kestin did not appear for the trial of her case but that did not stop the court allowing her to participate in post-trial briefing and for holding, in part, in her favor despite the position she took on her amended return.
Mrs. Kestin got off to a good start, from a tax perspective, in 2014. She timely filed a joint return with her husband reporting her wages of over $155,000 from which she was withheld. Something happened there after that caused her to lose faith with the tax system. In September 2015 she submitted an amended return which the Tax Court describes as frivolous and which the IRS identified as frivolous for purpose of imposing the IRC 6702 penalty. The amended return reported a zero liability accompanied by a narrative that I would describe as tax protestor language, together with a request for a refund of all of the money withheld from her in 2014.
The IRS sent her correspondence pointing out that her amended return could result in the imposition of the IRC 6702 penalty and giving her a chance to avoid the penalty by correcting the frivolous filing. Unfortunately, she doubled down on her newfound position by sending a letter pointing out the IRS was wrong and attaching a copy of the original amended return. She did not stop there but sent five more letters to the IRS explaining her position, each one attaching a copy of the amended return. The IRS imposed a new penalty assessment each time it received one of her missives.
To assist in collecting the sizable liability resulting from the imposition of all of these $5,000 penalties, the IRS filed a notice of federal tax lien and that provided her with the opportunity to request a Collection Due Process (CDP) hearing which she did. In the CDP hearing she sought, inter alia, to contest the imposition of the penalty on the merits. Faithful readers know it is hard to raise merits issues regarding assessable penalties because taxpayers have typically had a prior opportunity to go to Appeals before the imposition of the assessable penalty at issue; however, Appeals will not hear frivolous arguments, so she got to raise the merits in her CDP case.
The court imposed the 6702 penalty on the original filing of the amended return and says that Mrs. Kestin agrees with that penalty except for some procedural differences. The focus then turns to the six times she mailed a copy of the frivolous return to the IRS and it imposed additional penalties. In a 6702 case, the issue is not what is a return – as the court has discussed many times going back to the Beard case – but what purports to be a return. When she mailed in the additional six documents she marked them as copies. The court found that because these documents were marked as copies they did not purport to be returns. The court points out that the statute does not address whether copies might trigger the penalty and neither do the regulations or prior case law. On the facts here, it holds that the six copies she sent in her follow up correspondence did not purport to be returns and cannot form the basis for imposition of the penalty. While the decision is important, and certainly important for Mrs. Kestin, the fact pattern here may be a narrow one although a couple of subsequent opinions discussed below may suggest otherwise.
Having removed all but one of the penalties based on the lack of the filing of documents purporting to be a return, the court then moved to the now inevitable inquiry concerning supervisory approval. The IRS conceded that the penalty here was not calculated by electronic means and required supervisory approval. Next, the court turned to Letter 3176C sent by the IRS to Mrs. Kestin warning her that if she did not correct the amended return asserting the frivolous position, the IRS intended to impose the 6702 penalty. Was this letter the “initial determination” of the penalty that required supervisory approval prior to mailing? The court finds that the sending of this letter did not mark an initial determination because at the time of sending this letter it remained to be seen whether the penalty would apply.
After acknowledging the strange language of the statute that does not fit the situation, the court found this letter served to warn the taxpayer rather than to determine the penalty liability. Because it gave the taxpayer the opportunity to avoid the penalty by correcting the submission, the initial determination could not occur until after the proffered period of retraction. The actions of the IRS did not seek to use the letter as a bargaining chip but rather as an opportunity to avoid imposition. Kestin is one of several cases decided in the past few months on the issue of initial determination including the severely split decision in Belair Woods, LLC v. Commissioner, 154 T.C. No. 1 (2020) (though Judge Gustafson dissents in Belair Woods after penning Kestin because he perceives a distinction between the situations.) The decision here appears generally consistent with the other decisions and in some respects foreshadows their outcome.
In the short time since the Kestin opinion the Tax Court has had several additional opportunities to address the issue of frivolous penalties and taxpayer submissions. In Smith, the taxpayer sent an objectionable original return. She sent at least one copy of that return with later correspondence (can’t tell yet how many). Her case was tried (without her showing up) and post-trial briefs were filed. Then, both Graev III and Kestin came down. In an order from August 30, 2019, Judge Halpern invited additional briefing from the parties by mid-September concerning the application of both opinions. Only the pro se taxpayer filed a supplemental brief. The case is awaiting decision, which may be further held up pending the Kestin appeal (see discussion below.) In Luniw, a bench opinion from Judge Carluzzo served Nov. 20, 2019, the taxpayer was hit with three 6702 penalties. One was for his original return. Then the IRS wrote back proposed changes to the return causing the taxpayer to generate essentially the same return and sent it again to the IRS. Later the taxpayer sent a second copy of the return to the IRS. Judge Carluzzo applies Kestin and holds that only the last document is not subject to a penalty. Finally, in Jaxtheimer, the taxpayer filed his 2013 return three separate times, reporting zero wages and zero tax owed. Upon each instance, the IRS assessed 6702 penalties. Judge Pugh upheld only the first instance of the penalty assessment, citing Kestin and finding that there was insufficient evidence to determine that the two later-filed returns were not copies.
Mrs. Kestin raised a few other issues which the court brushed away with relatively little fanfare. The most important of these lesser issues concerns the adequacy of the notice of determination. She argues that the notice fails because it describes two occasions of frivolous action when the IRS sought to impose seven penalties. Citing to its earlier opinion in First Rock Baptist Church Child Dev. Ctr. v. Commissioner, 148 T.C. 380, 387 (2017), blogged here, the court holds that if the notice contains enough information to allow the taxpayer to understand the matter at issue and does not mislead it satisfies the statutory requirement.
We blogged about the Kestin case prior to its decision here, here, and here. This may not be the last time we blog about it. The IRS filed a notice of appeal in the 4th Circuit on Wednesday, January 8. I am mildly surprised that it is appealing this case because the circumstances seem pretty narrow; however, the three subsequent opinions citing to Kestin suggest my view of the universe of frivolous cases may just be too limited. From the perspective of the IRS, the amount of effort to handle a copy of a frivolous document probably closely equals the amount of time it takes to handle a document that purports to be a return. So, it may want to argue that the decision does not follow the intent of the statute. It seems like it could get where it wants to go with a regulation, but I do not know what drives this decision. To my knowledge Mrs. Kestin continues to pursue this matter pro se. If anyone has a significant interest in the issue and feels the Tax Court got it right, perhaps an amicus brief would be of assistance to her.