Is A Zero-Return Partnership A Valid Tax Filing?

 

I remember when they were called Chief Counsel Advices. IRS employees – think revenue agents or officers in the field – would reach out to their employer – the IRS – for guidance on an issue.

I am looking at something called a Chief Counsel Email.

Everything changes.

It caught my eye because I was talking with a CPA last week on the very same issue.

And the IRS position is initially disturbing.

Let’s go over this.

A revenue agent (commonly called an auditor) wanted to know if an initial partnership return showing partner information but zeros for activity would constitute a valid tax return.

COMMENT: I have seen this situation many times, including last week. Someone obtains a federal EIN, putting the entity on the IRS radar. The entity then goes on to do … nothing. It never starts or starts a year or two later. Meanwhile the entity is on the IRS Christmas card list. Fail to file a return and the IRS may send a letter asking why you did not file. In response, practitioners usually file an initial return but show zeros as activity because… well because there has been no activity.

Here is the Email:

We agree with the RA’s memo that the initial return showing ownership information, but containing all 0s would most likely be considered invalid under application of the Beard test.

Not good.

To be fair, however, I do not think that it is difficult to work with this Email.

Let’s first talk about Beard.

Beard was a tax protestor.

He found himself in Tax Court over his 1981 return. He received a Form W-2, which he reported on the form 1040. He then inserted a line he described as “Non-taxable receipts” and subtracted his W-2. The result was that he owed – according to him – no taxes and was entitled to a full refund of his withholding.

The IRS wanted tax, of course, and also wanted penalties for failure to file a return. He filed something, but tampering with the forms voided the filing.

Beard responded that he obviously filed a return. The IRS was out of line saying that he had not.

The issue before the Court was: what is a tax return?

The Court presented a four-part test:

1. Does it purport to be a tax return?
2. Is it signed under penalties of perjury?
3. Does it include enough information to calculate a tax?
4. Does it represent an honest effort to satisfy the tax laws?

Beard – a protestor – missed the third test by altering the form.

Here was the Court on the fourth test:

The tampered form here is a conspicuous protest against the payment of tax, intended to deceive respondent’s return-processing personnel into refunding the withheld tax. Since such intentional tampering could go undetected in computer processing, respondent was forced to develop and institute special procedures for handling such submissions. The critical requirement that there must be an honest and reasonable attempt to satisfy the requirements of the Federal income tax law is clearly not met."

Back to our Email.

Numerous tax court decisions have found that a return (typically a 1040) containing all zeros, even if filed on an official IRS form, does not constitute a valid tax return.”

True, but …

However, these are all in the tax protestor context and other cases have held that a zero return may be valid if there is reason to believe that it is an accurate reflection of the taxpayer’s activity.”

Got it.

I will start including a schedule or attachment to the partnership tax return stating the following:

XXX Partnership/LLLC was formed on XX/XX/XX and no business operations occurred during its initial tax year ending XX/XX/20XX.”

Easy.

But it is a trap for a non-tax specialist.

This time we discussed CCA 2026030612260600 a/k/a Chief Counsel Email 202634014.

 

A Failed E-Filed Return Hit With Penalties

 

I have noticed something about electronic filing of tax returns, especially state returns: there is a noticeable creep to demanding more and more information. I can understand if we are discussing tax-significant information, but too often the matter is irrelevant. We received a bounce from Wisconsin, for example, simply because there was a descriptor deep in the state return without an accompanying number.

How did this happen? Perhaps there was a number last year but not one this year. Could an accountant have scrubbed it out? Yes, in the same way that I could have played in the NFL. Work on a return of several hundred pages, add a few states in there for amusement, tighten the screws by closing in on a 15^th deadline and you might miss a description on a line having no effect on the accuracy of the return.

Why is this an issue?

Because if a state – say Wisconsin - bounces a return, then it is the same as never having filed a return. The penalties for not filing a return are more severe than – for example - filing a return but not paying the tax. Does it strike you as a bit absurd for a state to argue that one never filed a return when an accountant prepared (and charged one for) that state return?

The US Tax Court has reviewed the issue of what counts as a federal tax return in a famous case called Beard v Commissioner. The Court looks at four items, each of which has to be met:

·      It must purport to be a return;

·      It must be signed under penalty of perjury;

·      It must contain sufficient information to allow the calculation of the tax; and

·      It must be an honest and reasonable attempt to satisfy the requirements of the tax law.

Let’s look at a case involving the Beard test.

John Spottiswood (let’s call him Mr S) filed a joint 2012 tax return using TurboTax. He made a mistake when entering a dependent’s social security number. He submitted the electronic return through TurboTax on or around April 12. Within a short period, TurboTax sent him an e-mail that the IRS had rejected the return.

Problem: The e-mail was sitting in TurboTax. Mr S needed to log back in to TurboTax to see the e-mail. A professional would know to check, but an ordinary individual might not think of it.

Another Problem: Mr S owed almost $400 grand with the return. Since the return was never accepted, the bank transfer never happened. He did not pay the tax until almost 2 years later.

The IRS tagged him over $40 grand for late payment of tax.

I have no issue with this. Think of the $40 grand as interest.

The IRS also tagged him over $89 grand for late filing of the return.

I have an issue here. Mr S did try to file; the IRS rejected his return. I see a significant difference between someone trying and failing to file a return and someone who simply blew off the responsibility to file. It strikes me as profoundly unfair to equate the two.

Mr S protested the late filing penalty.

He had two arguments:

(1)  He did file (per the Beard standard).

(2)  Failing that, he had reasonable cause to abate the penalty.

I like the first argument. I would advise Mr S to provide a copy of the return to the Court and request Beard.

COMMENT: I suppose the issue is whether the return would meet the third test – sufficient information to calculate the tax. I would argue that it would, as the IRS could deny the dependency exemption and recalculate the tax accordingly. If Mr S objected to the loss of the exemption, he could investigate and correct the social security number.

FURTHER COMMENT: The IRS argued that it could not calculate the tax because it had rejected the return. I consider this argument sophistry, at best. The IRS could simply reject a return ... some returns … all returns … and make the same argument.

But Mr S could not provide a copy of the return.

Why not? Who knows. I suppose he never kept a copy and later lost the username and password to the software.

The Court cut him no slack. To conclude that the return met the Beard standard, the Court had to … you know … look at his return.

That left his second argument: reasonable cause.

The Court again cut him no slack.

The Court said that he should have logged back into TurboTax and yada yada yada.

Seems severe except for one thing: how could Mr S fail to realize that he never got dinged with an almost-$400 thousand bank transfer? I get that he carried a large bank balance, but reasonable people would pay attention when moving $400 grand.

Mr S could not provide a copy of his return nor could he explain how he could blow-off $400 grand. The Court was not buying his jibe.

There was no Beard for Mr S, nor was there reasonable cause to abate the penalty.

OBSERVATION: It occurs to me that Mr S may have received no advantage from the dependency exemption. This case involves a 2012 tax return, and for 2012 it is very possible that the alternative minimum tax (AMT) applied to this return. The AMT serves to disallow selected tax attributes to higher-income taxpayers – attributes such as a dependency exemption (I am not making this up, folks). The Court did not say one way or the other, but I am left wondering if he was penalized for something that did not affect his ultimate tax.

Our case this time was Spottiswood v US.