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Notice of Deficiency in Substitute for Return Setting

Posted on Dec. 5, 2013

Earlier this week, a Tax Court Order to Show Cause in the case of Edward and Cherilyn Jackson v Commissioner raised the question as to whether a notice the IRS has been issuing to taxpayers who have failed to file a return constitutes a statutory notice of deficiency. The Order, which can be found here, arose because the IRS had filed a motion to dismiss for lack of jurisdiction with respect to Cherilyn, Edward’s wife, and to change the caption to reflect only Edward’s name. In its motion, the IRS attached IRS Notice 3219N (or most of it anyway; it left out a page), which was only addressed to Edward. I suspect IRS was surprised that in response to its motion, Judge Armen did not rule but rather raised broad concerns about the IRS’s form for issuing statutory notices to taxpayers who have not filed tax returns. What makes the Order unusual is that Judge Armen ordered the IRS to explain how the Notice in its generic form came into existence, and whether it was reviewed by Chief Counsel. That request reflects deep unease with the way IRS communicates with nonfiling taxpayers.

I’ll explain a bit more and give some context.

Brief Context

When taxpayers fail to file a return and the IRS receives third party income information, IRS often will contact a taxpayer asking the taxpayer to prepare a return. It is fairly common that the taxpayer not respond, and the IRS will prepare a substitute for return (SFR) based on information it has in its possession. IRS generally cannot assess tax based upon the liability in the SFR until it issues a statutory notice of deficiency giving the taxpayer the right to petition the Tax Court (unless the taxpayer consented to the assessment or there was jeopardy, for example). If the taxpayer does not file a petition, the IRS can assess the tax as reflected in the statutory notice, as well as interest and certain applicable penalties.

As Keith’s post what is a return points out, most SFRs arise pursuant to Section 6020(b), rather than 6020(a), which requires an exchange of information from the taxpayer to the IRS:

IRC 6020(b) describes situations in which the taxpayer submits no return, provides no information or fraudulent information, refuses to sign a return after the IRS prepares it requiring the IRS to send a notice of deficiency based on the best information it can collect independently.  Usually, these returns are based upon the wage and income transcripts reported to the IRS by third parties but occasionally they result from independent fact gathering.  Because the taxpayer has not consented, the IRS does not make elections for the taxpayer such as joint return filing status or itemized deductions, etc., that might reduce the tax liability.  Usually, these returns overstate the liability because the IRS does not (cannot) make elections that might reduce the taxes; however, these returns might understate the liability because the IRS is unaware of income sources not reported to it by third parties.

In Jackson, the IRS sent its SFR under Section 6020(b) to Edward in a 3219N Notice.  Unlike many taxpayers who fail to file a return, apparently Edward and Cherilyn filed a petition in response to the 3219N, even though it was issued only in Edward’s name.  

I did not see the 3219 that IRS sent to Edward, but the IRS website entitled Understanding Your CP3219N Notice describes that notice and has a redacted sample. The sample on the IRS website is hard to read, but Judge Armen’s displeasure with the 3219 is attributable to the sloppy language in the Notice as well as the small font typeface of the term “Notice of Deficiency” relative to the Notice’s command to file a “2010 Form 1040 to avoid our assessment.” (Judge Armen said the phrase notice of deficiency “is dwarfed” by the command to file which “appears in bold and prominent typeface that dominates the IRS Notice 3219N.”)

The Order reflects further its displeasure at the Notice:

IRS Notice 3219N also announces how “We’ve calculated the assessment”, and it cautions that “If all your income is not listed here, you must file a tax return. You can’t agree to the amount due.”

IRS Notice 3219N appears designed to cajole (one might say, pressure) a taxpayer into filing a return upon threat of assessment. And, remarkably, IRS Notice 3219N admonishes the taxpayer that he or she may not acquiesce in the assessment “[i]f all your income is not listed here” but that the taxpayer “must file a tax return”, apparently upon pain of some unspecified penalty.

Also noteworthy is the fact that neither the Commissioner nor an authorized delegate purports to “determine” any “deficiency” in IRS Notice 3219N. Indeed, IRS Notice 3219N does not disclose the name (much less the signature) of the IRS official or employee who caused the notice to be issued and only reveals the issuing office as an IRS post office box in Fresno, California. Further, there is no “determination” of a “deficiency”, but only the proclamation that “We have determined that you owe taxes”.  

The Order asks “[i]f IRS Notice 3219N is not a notice of deficiency, might it be a collection notice?”

It asks that last question because the notice “boldly announces to the taxpayer both the amount of “Tax you owe” and the net “Amount due” after factoring in “Payments you made”, multiple penalties, and “Interest charges”. Presumably, however, IRS Notice 3219N is not a notice of determination, because (for example) there is nothing within the four corners of the notice to suggest that it was issued by the IRS Office of Appeals.”

What is Required to be in a Notice of Deficiency?

What to make of the IRS’s 3219? Our colleague over at the blog Federal Tax Procedure, Jack Townsend, has a good post from last summer discussing the statutory requirements for 90-day letters:

As Jack stated, the four requirements that are statutorily required are:

  1. The date to file a petition for redetermination in the U.S. Tax Court
  2. Notice of Taxpayer Advocate’s contact information
  3. Notice sent to a taxpayer’s last known address
  4. Explanation of basis for deficiency

I described the first two requirements in a post from this past summer addressing what happens if the IRS whiffs on including the filing date or TAS contact info (summary: not much, though I argue that in some cases if a taxpayer can show prejudice maybe the omission should trigger a notice’s invalidity).  There is much law on last known address. I will not get into that here.  For those interested, we recently rewrote the content on last known address in Saltzman and Book—it can be found in revised Chapter 10.03[d], coming out next month. The Notice 3219 presumably satisfies the first three of the requirements; at least the sample on the IRS website suggests as much on the filing date and TAS info; and nothing in the Order is suggestive of a last known address problem.

As to the fourth requirement, Section 7522 requires that the IRS adequately explain the basis for the deficiency; failure to do so does not, however, invalidate the notice. As we describe in revised Saltzman 10.3[b], “Scar v. Commissioner provides that the notice must contain sufficiently accurate information to establish that the Service has made a “determination” about the taxpayer’s return. Where the notice of deficiency reveals on its face that the Service has failed to make a determination about the return of the named taxpayer, the notice has been held to be a “naked assessment, and thus invalid.” (citations omitted). Yet, as Jack Townsend has described this past summer, Scar is “an outlier, with its analysis and holding rarely invalidating a notice of deficiency.” (A good example describing its limited application is in Cross v Comm’r, a 2012 Tax Court case which Jack nicely describes in a separate post).

The Order questions whether there is a determination in the Notice 3219. Yet, while there is lots of sloppy language (e.g., stating “we’ve calculated the assessment” when no assessment has been made, and the assessment is a term that refers to the recording of the liability), and inadequate emphasis on the notice functioning as a deficiency notice (e.g., small font-size and lack of prominence in relation to other content), there presumably is a connection between Edward’s items of income that he failed to report and the amount that the notice says is due. The generic Notice states that it “has determined that there is a deficiency (increase) in your [tax year] income tax. “ (this language is from the page 2 sample on the IRS web site).

In the context of a notice of deficiency generated from a failure to file a tax return, it follows that the IRS has not examined the tax return to generate the notice. IRS’s reliance on third party income information to generate the Notice 3219 like that in Jackson is likely sufficient connection to the taxpayer for a court to conclude that a determination has been made. Yet, the Order rightfully reflects an unease with the possible lack of consequences with the IRS’ sloppy and potentially misleading information in the notice itself.

What the Future Holds

I am not sure what we will learn from the IRS response (which is due December 20). In addition to asking the IRS about how the Notice 3219 came into existence, the Order asks parties to show in writing why the Court should not dismiss the case for want of a notice of deficiency. I suspect IRS will point to the fairly liberal statutory requirements and case law gloss to justify treating this notice as a valid stat notice. Its explanation of the origins of the 3219 will also likely be interesting for tax procedure fans.

Going forward, the IRS should perhaps separate the SFR from the issuance of the notice of deficiency, and, at a minimum, fix the misleading aspects of the 3219. That Edward apparently filed a petition (though mistakenly with Cherilyn) suggests no prejudice in terms of protecting the right to pre-payment court review, though I am sure that other taxpayers are mightily confused by the letter and do not understand where they are in the process. Good tax administration requires better communication, and even if there is no remedy for bad notices, that should not insulate IRS from taking corrective measures. If it does not, perhaps Congress should step in even if the court’s hands are tied.

In the meantime, as Keith reminds me and as his post yesterday on what is a return for bankruptcy purposes highlights, to preserve possible discharge, anyone receiving one of these notices should immediately file the return or immediately start working with the IRS to provide information and consent to a 6020(a) assessment to avoid the problems he describes.  Allowing this to go forward to assessment sets the taxpayer up for the inability to discharge the debt incurred.

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