My last post was devoted to a CCA, which inspired me to pull a handful of other CCAs to highlight from the last few months. The first CCA discusses the suspension of the SOL when a petition is filed with the Tax Court before a deficiency notice is issued (apparently, the IRM is wrong on this point in at least one spot). The second touches on whether failing to disclose prior years gifts on a current gift tax return extends the statute of limitations for assessment on a gift tax return that was timely filed (this is pretty interesting because you cannot calculate the tax due without that information). And, finally, a CCA on the imposition of the fraud penalty in various filing situations involving amended returns.
CCA 201644020 – Suspension of SOL with Tax Court petition when no deficiency notice
We routinely call the statutory notice of deficiency the ticket to the Tax Court. In general, when a taxpayer punches that ticket and heads for black robe review, the statute of limitations on assessment and collections is tolled during the pendency of the Tax Court case. See Section 6503(a). What happens when the petition is filed too soon, and the Court lacks jurisdiction? Well, the IRM states that the SOL is not suspended. IRM 22.214.171.124.2(4) states, “If the petition filed by the taxpayer is dismissed for lack of jurisdiction because the Service did not issue a SND, the ASED is not suspended and the case must be returned to the originating function…” But, Chief Counsel disagrees. Section 6503(a) states:
The running of the period of limitations provided in section 6501 or 6502…shall (after the mailing of a notice under section 6212(a)) be suspended for the period during which the Secretary is prohibited from making the assessment or from collecting by the levy or a proceeding in court (and in any event, if a proceeding in respect of the deficiency is placed on the docket of the Tax Court, until the decision of the Tax Court becomes final), and for 60 days thereafter. (emph. added).
Chief Counsel believes the second parenthetical above extends the limitations period even when the Tax Court lacks jurisdiction because no notice of deficiency was issued. The CCA further states, “Any indication in the IRM that the suspension does not apply if the Service did not mail a SND is incorrect.” Time for an amendment to the IRM. I think this is the correct result, but the Service likely had some reason for its position in the IRM, and might be worth reviewing if you are in a situation with the SOL might have run.
The issue in CCA 201643020 was whether the three year assessment period was extended due to improper disclosure…of prior gifts properly reported on prior returns. In general, taxpayers making gifts must file a federal gift tax return, Form 709, by April 15th the year following the gift. The Service, under Section 6501(a) has three years to assess tax after a proper return is filed. If no return is filed, or there is not proper notification, the service may assess at any time under Section 6501(c)(9).
In the CCA, the Service sought guidance on whether a the statute of limitations was extended where in Year 31 a gift was made and reported on a timely filed gift tax return. In previous years 1, years 6 through 9, and 15 prior gifts were reported on returns. On the year 31 return, however, those prior gifts were not reported. That information was necessary to calculate the correct amount of tax due.
Section 6501(c)(9) specifically states:
If any gift of property the value of which … is required to be shown on a return of tax imposed by chapter 12 (without regard to section 2503(b)), and is not shown on such return, any tax imposed by chapter 12 on such gift may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time. The preceding sentence shall not apply to any item which is disclosed in such return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature of such item.
Chief Counsel concluded that this requires a two step analysis. Step one is if the gift was reported on the return. If not, step two requires a determination if the item was adequately disclosed. Counsel indicated it is arguable that the regulations were silent on the omission of prior gifts, but that the statutory language was clear. Here, the gift was disclosed on the return, and the statutory requirements were met. The period was not extended. I was surprised there was not some type of Beard discussion regarding providing sufficient information to properly calculate the tax due.
Earlier this year, the Service also released CCA 201640016, which is Chief Counsel Advice covering the treatment of fraud penalties in various circumstances surrounding taxpayers filing returns and amended returns with invalid original issue discount claims. The conclusions are not surprising, but it is a good summary of how the fraud penalties can apply.
The taxpayer participated in an “Original Issue Discount (OID) scheme” for multiple tax years. The position take for the tax years was frivolous. For tax year 1, the Service processed the return and issued a refund. For tax year 2, the Service did not process the return or issue a refund. For tax year 3, the return was processed but the refund frozen. The taxpayer would not cooperate with the Service’s criminal investigation, and was indicted and found guilty of various criminal charges. Spouse of taxpayer at some point filed amended returns seeking even greater refunds based on the OID scheme, but those were also frozen (the dates are not included, but the story in my mind is that spouse brazenly did this after the conviction).
The issues in the CCA were:
- Are the original returns valid returns?
- If valid, is the underpayment subject to the Section 6663 fraud penalty?
- Did the amended returns result in underpayments such that the penalty could apply, even though the Service did not pay the refunds claimed?
The conclusions were:
- It is likely a court would consider the returns valid, even with the frivolous position, but, as an alternative position, any notice issued by the Service should also treat the returns as invalid and determine the fraudulent failure to file penalty under Section 6651(f).
- To the extent the return is valid, the return for which a refund was issued will give rise to an underpayment potentially subject to the fraud penalty under Section 6663. The non-processed returns or the ones with frozen refunds will not give rise to underpayments and Section 6663 iis inapplicable. CC recommended the assertion of the Section 6676 penalty for erroneous claims for refund or credit.
- The amended returns did not result in underpayments, so the Section 6663 fraud penalty is inapplicable, but, again, the Service could impose the Section 6676 penalty.
So, the takeaway, if a taxpayer fails to file a valid return, or there is no “underpayment” on a fraudulent return, the Service cannot use Section 6663. See Mohamed v. Comm’r, TC Memo. 2013-255 (where no valid return filed, no fraud penalty can be imposed). In the CCA, Counsel believed the return was valid, but acknowledged potential issues with that position. Under the Beard test, a return is valid if:
four requirements are met: (1) it must contain sufficient data to calculate tax liability; (2) it must purport to be a return; (3) it must be an honest and reasonable attempt to satisfy the requirements of the tax law; and (4) it must be executed by the taxpayer under penalties of perjury. See Beard v. Comm’r, 82 T.C. 766 (1984). A return that is incorrect, or even fraudulent, may still be a valid return if “on its face [it] plausibly purports to be in compliance.” Badaracco v. Comm’r, 464 U.S. 386 (1984).
The only prong the CCA said was at issue was the third prong, that the return “must be an honest and reasonable attempt to satisfy the requirements of the tax law.” As the taxpayer had been convicted of Filing False Claims with a Government Agency/Filing A False Income Tax Return, Aiding and Abetting, and Willful Attempt to Evade or Defeat the Payment of Tax, it is understandable why you would question if the returns were “an honest and reasonable attempt to satisfy the requirements of the tax law.” Further, the Service had imposed the frivolous filing penalty under Section 6702, which only applies when the return information “on its face indicates that the self-assessment is substantially incorrect.”
The CCA notes, however, it is rare for courts to hold returns as invalid solely based on the third prong of Beard, but clearly there would be a valid argument for the taxpayers in this situation. The CCA acknowledges that by stating “[t]o guard against the possibility that the returns are not valid, the Service should include the Section 6651(f) fraudulent failure to file penalty as an alternative position,” so the taxpayer could pick his poison.
As to the underpayment, Counsel highlighted that overstatements of withholding credits can give rise to an underpayment under the fraud penalty. The definition was shown as a formula of Underpayment = W-(X+Y-Z). W is the amount of tax due, X is the amount shown as due on the return, Y is amounts not shown but previously assessed, and Z is the amount of rebates made. Where the refund was provided, the penalty could clearly apply. In “frozen refund” situations, the Service has adopted the practice of treating that amount as a sum collected without assessment, which can cancel out the X and Y variables so no underpayment for the fraud penalty will exist.
But, as shown above, even if the fraud penalty may not apply, the Section 6651 penalty will likely apply if the return is invalid, or the frivolous position penalty under Section 6702 may apply.