Today’s guest blogger is Professor Joni Larson of Thomas M. Cooley Law School where she teaches tax courses and serves as Assistant Director of the Graduate Tax Program. Prior to entering her teaching career, she clerked for Tax Court Judge Irene Scott and worked for the Office of Chief Counsel, IRS. She writes today on an issue of proof in a penalty case which tailors nicely with her book “A Pracitioner’s Guide to Tax Evidence” which is published in 2013 by the ABA Section of Taxation. She has also published a book entitled “Federal Tax Research” with her colleague Dan Sheaffer. We welcome Joni to our wonderful cadre of guest bloggers. Keith
In Robertson v. Commissioner (T.C. Memo. 2014-143) the Tax Court continues it’s now-we-see-it-now-we-don’t treatment of the Commissioner’s substitute for return (SFR). This varied treatment arises when the court considers the additions to tax (often referred to as penalties) applied in a notice of deficiency, penalties routinely included in every notice, for a taxpayer who did not file a return.
Three penalties are almost always applied together. The first penalty is based on timing and applies when the taxpayer files his return late (without having filed an extension request). The second penalty is based on not paying the tax. It applies when the taxpayer fails to pay the tax shown on his return. The third penalty is for not making necessary tax payments. Each taxpayer has an obligation to estimate his total tax liability for the year and make estimated tax payments, usually making no fewer than four payments. If no installment payments have been made, or they are insufficient in amount so that there is a tax deficiency at the end of the year, a penalty may apply.
The facts in Robertson are those of a typical taxpayer who fails to file a return. Mr. Robertson did not file, nor pay taxes beyond what his employer withheld, for his 2009 year. The Commissioner calculated the amount of additional tax he owed and, to this amount, applied the three penalties and sent him a notice of deficiency. Mr. Robertson filed a petition with the Tax Court, contesting the deficiency and applicability of the penalties.
Procedurally, there is an order for how contesting the penalties will play out in court. First, the taxpayer must put the penalties at issue. Usually he does this in the petition. Because Mr. Robertson questioned all the penalties in his petition, the Tax Court moved to the next step. (If he had failed to put them at issue, he would have been deemed to have conceded the penalties and the argument would have been over and the penalties would have been applicable.)
Next, the Commissioner must come forward with evidence it was appropriate to impose the penalty. This is referred to as the burden of production and is where the Commissioner ran into some trouble.
In its summary of the facts, the Tax Court held that Mr. Robertson had failed to file an income tax return for 2009. It also found the IRS prepared an SFR, that the notice of deficiency was based on the SFR, and that the parties stipulated to an IRS transcript of the taxpayer’s account referencing the SFR.
In its analysis the Tax Court quickly agreed there was a deficiency then turned to the issue of the penalties. The court was willing to consider the transcript (referencing the SFR) and find the Commissioner had met his burden of going forward for two of the penalties, the penalty for late filing and the penalty for failing to make estimated tax payments.
With respect to the penalty for late filing, Mr. Robertson could have escaped liability if he could have shown the failure was due to reasonable cause and not willful neglect. He wasn’t able to do so, so the penalty applied. (Except in very limited circumstances, there is no reasonable cause exception for the failure to make estimated tax payments.)
Even though the Tax Court had considered the transcript, and its reference to the SFR, for the first and third penalties, it balked at relying on the transcript when considering the penalty for failure to pay the tax shown on the return. For this penalty to apply, it wanted to actually see the SFR – it wanted to see a return that showed a tax liability due. And to be such a return, it had to be a valid return, or in Mr. Robertson’s case, a valid SFR. The court had addressed the issue of what constitutes a valid SFR several times in previous court opinions.
In the distant past, the IRS would prepare SFRs that showed nothing more than the taxpayer’s address and social security number. These returns otherwise contained just zeros – no income reported and no tax liability due. The Court held such SFRs to be invalid. It tied this holding to the failure of the IRS to meet the requirements of Section 6020(b), the code section allowing the IRS to prepare an SFR.
In Mr. Robertson’s case, there was plenty of evidence that the SFR existed and the parties agreed an SFR had been prepared. But, no actual SFR had been offered into evidence (nor did the Commissioner demonstrate it met the requirements of Section 6020(b)). When pointed in the direction of the transcript as evidence of the amount of tax Mr. Robertson had failed to pay, the Tax Court called it a mere “summary reference” and insufficient for the Commissioner to satisfy his burden of going forward. The Tax Court stuck to its literal reading of the statute, imposing the penalty based only on a tax shown on a return, and not the tax due but not unpaid. In sum, if no valid SFR was offered into the record, there would be no penalty for failing to pay the tax due. (This is not the first time the court has come to this conclusion. For prior cases see, for example, Wheeler v. Commissioner, 127 T.C. 200 (2006), aff’d, 521 F.3d 1289 (10th Cir. 2008) and Gardner v. Commissioner, T.C. Memo. 2013-67.)
It is unclear why the Commissioner failed to introduce the SFR into the record. If the SFR was unavailable, he could have satisfied his burden by introducing evidence that the requirements of Section 6020(b) had been met. Or, if such evidence was not available, he might have turned to the Federal Rules of Evidence for help.
The Tax Court applies the Federal Rules of Evidence (FRE). Under FRE Rule 1002, sometimes called the best evidence rule, the original writing generally is required to prove the contents of the document. (It is a rule of admissibility and does not determine the weight of the evidence admitted.) FRE Rule 1004 allows secondary evidence to be offered when the original has been lost or destroyed. To establish that the original is lost, the party must establish that a diligent but unsuccessful search for the document occurred. If the SFR had in fact been, say, lost, the Commissioner could have turned to the exception in FRE Rule 1004. If the Commissioner had shown a diligent search had been made for the SFR but it could not be located, might the court then have been willing to consider the transcript of account?
Until a transcript of account is offered as secondary evidence of an SFR, it is not possible to know whether the court would consider relying on such evidence to impose the penalty for failure to pay the tax shown on the return. Accordingly, as the law currently stands, a transcript of account will be considered sufficient for imposition of the tax for failing to timely file the return and failing to make estimated tax payments but insufficient for imposition of the penalty for failing to pay the tax shown on the return.