What happens if the IRS makes a mistake when drafting a waiver of the SOL on assessment and puts the wrong taxable year in the waiver? In Kunkel v Commissioner the Seventh Circuit took up the issue, with the taxpayer arguing that the IRS’s mistake resulted in a blown statute of limitation. This week the Seventh Circuit affirmed the Tax Court (original TC opinion here, modified on unrelated issue at TC Memo 2015-37) and held that courts have the power to reform the waiver and to correct the IRS’s mistake if a preponderance of the evidence shows that the true intent differed from the language in the agreement. The opinion is interesting as there are not many cases where the courts step in and fix a mistake in a waiver form.
I will discuss the case and the court’s holding below.
The case arose due to an IRS audit for the years 2008, 2009 and 2010 for Integra Engineering and its principal owners, Craig and Kim Kunkel. The tax at issue for all three years was about $456,600 from the Kunkels and $322,800 from Integra. In addition, IRS included an accuracy-related 20% accuracy-related penalty.
IRS asked for extensions on all the years. The taxpayers eventually conceded the 2009 and 2010 years, but they claimed the IRS blew the statute of limitations on assessment for 2008 for both the business and individual returns.
On what basis did the taxpayers argue that the 2008 statute was blown? IRS had sent across waivers on Form 872-A for both the individuals and Integra. The taxpayers’ rep signed the 872-A waivers, and though they agreed that the rep had the authority to sign the waivers they argued that the language on the waivers was directed to the 2011 tax year and not the 2008 year, resulting in the IRS failing to assess the 2008 taxes within the three-year assessment period.
Normally IRS is careful about its language in the 872-A. Not with the Kunkels. The IRS and the taxpayers’ rep at exam signed a Form 872-A that contained nonsense dates for the tax year being extended:
The amount of any Federal Income tax due on any return(s) made by or for the above taxpayer(s) for the period(s) ended February 15, 2012 may be assessed at any time on or before December 31, 2012.” The date “February 15, 2012” had been typed into a blank for Integra (and April 15, 2012, for the Kunkels). But February 15, 2012, and April 15, 2012, did not designate the “period ended” for any tax year; they designated the end of the limitations periods for 2008 taxes. Whoever filled in the blanks at the IRS had typed the wrong year (2012 instead of 2009) and missed the fact that Integra’s 2008 tax year ended on November 30, 2008, which was the appropriate “period ended” for the purpose of this form. The date a return is filed affects the statute of limitations but not the “period ended.”
Although neither party introduced testimony as to what the parties to the Form 872 actually intended, the Tax Court concluded that there was a mutual mistake of facts and that it had the power to reform the Form 872 to reflect the parties’ true intent, as manifested by “clear and convincing evidence.”
The Tax Court agreed that courts can use the equitable power of reformation to modify the 872-A to reflect the parties’ true intent (referring to some older cases holding that the Tax Court though a court of limited jurisdiction can exercise those powers, an issue we discuss in SaltzBook Chapter 5). The Seventh Circuit likewise agreed and was “confident that 2012 was the wrong year because no one thought that the IRS was agreeing to a reduction in the time it had to assess taxes for 2011. The point of this exercise had been to allow the IRS more time to decide what to do for the 2008 tax year.” (emphasis added)
In finding for the IRS, the Seventh Circuit’s analysis differed somewhat from the Tax Court, which leaned heavily on Buchine v Commissioner, another case where the facts where arguably stronger for the IRS (e.g., there was a cover letter in Buchine with the correct year) and where the court used its reformation powers to correct what it believed was a clear mutual mistake of fact. The Kunkels on appeal argued that courts could reach a result different from the language in the waiver only if “only if clear and convincing evidence shows the taxpayer’s true intent.” That was the standard that the Tax Court applied in finding for the IRS below. Using that standard, the Kunkels argued that “since neither Taxpayers nor the IRS offered evidence from the persons who filled in the blanks and signed the forms, it is impossible to meet that standard.”
The Seventh Circuit disagreed with the taxpayer (and Tax Court’s) view of the standard, noting that the appropriate standard is based on a preponderance of the evidence:
None of these opinions [cited by the taxpayer] evinces awareness of the Supreme Court’s decisions holding that, in civil litigation over money, the appropriate standard is the preponderance of the evi- dence. See, e.g., Herman & MacLean v. Huddleston, 459 U.S. 375, 387–90 (1983); Grogan v. Garner, 498 U.S. 279, 286 (1991); Octane Fitness, LLC v. ICON Health & Fitness, Inc., 134 S. Ct. 1749, 1758 (2014). Preponderance of the evidence therefore is the right standard for reforming a waiver of a statute of limitations in a tax case.
Moreover, without discussing whether the 872-A is a contract (the Tax Court has held that it is not a contract but a unilateral waiver of a defense) the Seventh Circuit held that the matter turns on principles of federal contract law, with federal contract law relying on an objective test and not the subjective intent of the parties:
This means that the parties’ intents matter only to the extent that they are expressed to each other. When considering parol evidence a court looks to documents, and sometimes to oral exchanges, but never considers either side’s private thoughts and hopes.
Framed that way, the court had an easy time reaching its conclusion:
The Tax Court thought reform of the waivers appropriate because only the 2008 tax year had periods of limitations expiring in spring 2012. The forms could not have served any purpose other than extending the time to file assessments for 2008—and you can’t beat something with nothing…
The best way to understand what happened is the way the Tax Court did: A typist misread the file, entering the dates on which limitations periods would expire rather than the dates on which the tax years ended, and then everyone else missed that error. We see no clear error or abuse of discretion in that conclusion.
The opinion discounts the taxpayer view of the events with the brief on appeal speculating that the practitioner at exam in signing the 872-A “thought that he was playing a practical joke on the IRS by signing without alerting it to the scrivener’s error.” The court took a dim view of that explanation:
This seems unlikely; the adverse effect on Bastian’s [the CPA/attorney rep at exam] professional reputation could have been substantial. If the IRS came to conclude that Bastian had tried to hoodwink it, he might find his credentials as a tax representative pulled.
Some Parting Thoughts
The Seventh Circuit noted that it was “conscious of the irony in allowing the IRS to collect a 20% penalty for the errors in the Kunkels’ 2008 return, when the IRS has made an error of its own. But the Kunkels have not asked us to compare the degrees of fault or to set aside the penalty, if the assessment was timely.”
Kunkel shows us that not all errors are created equal. While the IRS mistake was a scrivener’s error the mistake for which the taxpayer was being penalized was a knowing decision that was different in kind. If a taxpayer makes a scrivener’s error, the IRS does not usually hit the person with a tax penalty. Moreover, Kunkel shows that while it is generally true that the IRS takes the risk of defects in documents upon which it relies as waivers courts can step in and use their equitable powers to reach a conclusion that the parties likely intended even when the language states differently.