Is Sending A Form Taxpayer Self-Assessment?

 

There are times we need to remember that we are working with law.

Words in law can have very specific meanings.

Let’s look at three Code sections.

Code § 6201 - Assessment authority

(a) Authority of Secretary 

 

The Secretary is authorized and required to make the inquiries, determinations, and assessments of all taxes (including interest, additional amounts, additions to the tax, and assessable penalties) imposed by this title, or accruing under any former internal revenue law, which have not been duly paid by stamp at the time and in the manner provided by law. Such authority shall extend to and include the following:

(1)  Taxes shown on return

The Secretary shall assess all taxes determined by the taxpayer or by the Secretary as to which returns or lists (or payments under section 6225(c)(2)(B)(i) are made under this title.

Code § 6211 - Definition of a deficiency

(a) In general

For purposes of this title in the case of income, estate, and gift taxes imposed by subtitles A and B and excise taxes imposed by chapters 41, 42, 43, and 44 the term "deficiency" means the amount by which the tax imposed by subtitle A or B, or chapter 41, 42, 43, or 44 exceeds the excess of—

(1) the sum of

(A) the amount shown as the tax by the taxpayer upon his return, if a return was made by the taxpayer and an amount was shown as the tax by the taxpayer thereon, plus

(B) the amounts previously assessed (or collected without assessment) as a deficiency, over—

(2) the amount of rebates, as defined in subsection (b)(2), made.

Code § 6213 - Restrictions applicable to deficiencies; petition to Tax Court

(a) Time for filing petition and restriction on assessment

Within 90 days, or 150 days if the notice is addressed to a person outside the United States, after the notice of deficiency authorized in section 6212 is mailed  (not counting Saturday, Sunday, or a legal holiday in the District of Columbia as the last day), the taxpayer may file a petition with the Tax Court for a redetermination of the deficiency. Except as otherwise provided in section 6851, 6852, or 6861 no assessment of a deficiency in respect of any tax imposed by subtitle A, or B, chapter 41, 42, 43, or 44 and no levy or proceeding in court for its collection shall be made, begun, or prosecuted until such notice has been mailed to the taxpayer, nor until the expiration of such 90-day or 150-day period, as the case may be, nor, if a petition has been filed with the Tax Court, until the decision of the Tax Court has become final. Notwithstanding the provisions of section 7421(a), the making of such assessment or the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court, including the Tax Court, and a refund may be ordered by such court of any amount collected within the period during which the Secretary is prohibited from collecting by levy or through a proceeding in court under the provisions of this subsection. The Tax Court shall have no jurisdiction to enjoin any action or proceeding or order any refund under this subsection unless a timely petition for a redetermination of the deficiency has been filed and then only in respect of the deficiency that is the subject of such petition. Any petition filed with the Tax Court on or before the last date specified for filing such petition by the Secretary in the notice of deficiency shall be treated as timely filed.

Let’s talk about Ken and Juli Walker.

They filed a joint tax return for 2018.They reported adjusted gross income of approximately $110 grand, requesting a federal refund of approximately $2,100.

They left something out, however: Marketplace insurance for which they had received advance premium payments of $20,904.

COMMENT: The Marketplace refers to the Affordable Care Act, also known as Obamacare. One guesstimates his/her income for the upcoming year, and - if income is low enough - one is entitled to a subsidy. The subsidy can be handled one of two ways: first, as a monthly reduction of any premium otherwise due; second, as additional tax paid-in when filing the return next year. The advantage to the first is immediate reduction of premiums due now. The advantage to the second is dry powder in case one is over-subsidized. I do not immediately recall a client electing the second option.   

There is a potential problem, though. The subsidy is based on your income, and you are guessing at your income when you request the subsidy. Eventually you have to settle-up this guess by attaching a reconciliation to your tax return - Form 8962 – calculating what your subsidy should have been had you used the actual, final numbers on your tax return. If actual income is lower, you probably have a refund coming. If actual income is higher, you are probably writing a check to the IRS.

In September 2019 the IRS sent a notice requesting Form 8962.

In December 2019 the Walkers sent the 8962.

The IRS processed the form and in March 2020 sent a notice of assessment for $20,904, fully attributable to the ACA subsidy.

By October 2021 interest and penalties had swelled the balance to $27,297. The IRS issued a Notice of Intent to Levy.

The Walkers requested a Collection Due Process hearing.

COMMENT: The Notice of Intent to Levy starts a 30-day calendar on the taxpayer’s ability to stop the lien, which the Walkers did by requesting a CDP hearing.  Mind you, a CDP hearing is not an end-all. For example, one generally cannot contest the existence of the liability itself in a CDP. One would have gone through numerous notices to get to this point, and the IRS would have lost patience. If the taxpayer wants to contest the liability, he/she will have to consider alternatives such as audit reconsideration or an offer in compromise. The IRS wants a payment program as the product of a CDP hearing.

The Walkers requested an installment agreement. The reason they gave was as follows:

Taxpayers do not believe that they agreed to this assessment and do not understand it. If the assessment is correct, taxpayers dispute the penalties because of the IRS’s inactivity on the matter during the pandemic. If there is a liability, taxpayers request an installment agreement.”

There was back and forth, and in January 2024 the (IRS) Settlement Officer decided that the Walkers owed the tax. She did allude to the need for the taxpayers to do something more if they wanted to contest the tax liability itself:

Beside your general statement, you did not submit an amended return or a substantive reconsideration request.”

The taxpayers – surprisingly – withdrew their request for an installment agreement.

At this point, I would normally lose hope for the Walkers. I do not see an immediate way to avoid repaying the excess subsidy, but I nonetheless would have pressed for a payment plan. I would also have requested penalty abatement, as you won’t receive one without asking.

But there is a major technical issue here: had the IRS checked all the boxes to be able to collect the tax?

Let’s go back to the Code sections at the beginning of this post.

Section 6201 addresses what happens when you send in a return showing a tax liability: the system self-assesses. The IRS will ride piggyback on that assessment. Easy. Makes sense.

That is not what happened with the Walkers. The return as originally filed showed a refund, not a liability. The Walkers never filed a return that showed a liability. The Walkers sent a Form (8962) to the IRS, which the IRS processed and somehow generated a liability.

Question: did sending that 8962 create a liability that could be assessed?

We need to be careful with words here. No question the 8962 created a number that – when combined with other numbers on the return – resulted in a liability. What it did not do is show a liability on its own power. Somebody had to do math.

Here is an example: what if the taxpayer had inadvertently omitted estimated tax payments exceeding the subsidy recapture shown on Form 8962? There would be no additional tax, and there would be an additional refund instead.

Here is the Court:

However, we reject respondent’s additional contention that petitioners’ completion of Form 8962 reflects additional tax due which may be assessed under section 6201.”

If this is not an assessment under Section 6201, what is it?

It is a deficiency under Section 6211.

So what?

Look at the italicized portion of Section 6213 above.

… no levy or proceeding in court for its collection shall be made, begun, or prosecuted until such notice has been mailed to the taxpayer,….

A deficiency presumes that the IRS is matching, changing, moving, eliminating numbers. The IRS is doing math.

And the Code wants a notice mailed to the taxpayer alerting him/her of what the IRS is doing.

There are procedures for enforcing a deficiency, and one is key. We have called it many names over the years - a statutory notice of deficiency, a NOD, a SNOD, a 90-day letter. These are all terms for the following notice:

Code section 6213 requires the IRS to issue a SNOD before it can enforce a deficiency.

What did the IRS fail to do with the Walkers?

Yep, it failed to send a SNOD.

Here is the Court:

With respect to the proposed levy action before us - and having determined the IRS failed to issue a Notice of Deficiency despite … being legally required to do so - we hold that the IRS may not proceed with the collection of the Assessment.”

Howaboutthat?

The Walkers won their case on an especially narrow technical point. Still, a win is a win.

Our case this time was Walker v Commissioner, T.C. Memo 2026-4.

Sweat Equity Tries To Deduct Losses

 It was the last two sentences that caught my attention:

P was a sweat equity partner.

The idea is simple: the income-only (IO) partner participates only if there is a profit. If there are losses, then the losses pass over the IO and are allocated to the other partner(s).

So, an IO partner would generally only report partnership income.

We continue: the IO also participates in cash distributions.

This might be simple. Let’s say the IO is allocated $100 in profits and receives a $75 distribution. The IO has reported (and paid tax) on $100 and received $75 cash. The IO is still positive (by $25) taxwise. The tax concept here is called “basis,” and it is critical in partnership taxation.

Basis is the amount of money a partner has invested in the partnership. Basis goes up and down with normal partnership activity.

         Increase basis

·      Contribute money into a partnership

·      Report partner share of partnership income

·      Increase partner share of partnership debt

Decrease basis

·      Receive distributions from partnership

·      Report partner share of partnership loss

·      Decrease partner share of partnership debt

Basis is fundamental: a partner can report losses only to the extent of basis (mind you, there are special rules and subrules here, but let’s keep this conversational). Once basis gets to zero, the partner stops deducting losses. The term here is “suspended,” and the losses wait until basis is restored. The losses can wait until the following tax year or they can wait forever - it depends on what happens with the partnership.

This is not a problem with the usual sweat equity, as the IO would not receive losses.

Mind you, distributions can create a problem - for example, distributions in excess of basis will create income. If you think about it, this makes sense. If you are an IO, receive zero allocation of income and a $100 distribution, that $100 is income - it is an increase in your wealth, you have no obligation to repay it, and it arrives with all the usual tax qualifiers.

Let’s further expand: you are sweat equity but can be allocated losses.

Basis now becomes an issue, as losses can only be deducted to the extent of basis. You can create basis by having allocable income and leaving it in the partnership. You will not have basis by contributing capital, however, because that is what “sweat equity” means.

Great. You can create basis by reporting (and paying tax) on partnership income, but you must leave (all or some) of the income in the partnership.

Probably not what you were thinking when you got involved.

Is there another way?

Yep.

Notice that your share of partnership debt can increase or decrease your basis.

We have to somehow allocate some of that debt to you.

Once again, this is not customary. Sweat equity partners are not normally allocated partnership debt.

Let’s look at someone who tried.

His name was Andrew West.

He owned three single member LLCs that he reported as sole proprietorships on his personal tax return. He also had a business relationship with a businessman (Oscar Quintanilla) spanning cattle, oil and gas, and real estate development activities. West served a president and CEO for several Quintanilla entities, and he was entitled to a 6% “operating bonus.”

I see potential sweat equity.

In 2014 West and Quintanilla formed a joint venture to manage commodity trading accounts.

Well, we do need losses somewhere to continue this discussion, and commodity trading will do it.

The two draw up a Commodity Trading Allocation Agreement (think of it as a partnership agreement), a secured Promissory Note (up to $5 million), and an Asset Security Agreement for all of West’s assets.

No surprise: Quintanilla contributed 100% of the capital. Both profit and losses, however, were allocated 50:50 between Quintanilla and West.

Losses will be a problem for West.

They however thought of this: any losses allocated to West will be deemed borrowed from Quintanilla via that (up to $5 million) promissory note.

Ah, clever.

The trading partnership lost over $11 million over two tax years.

Half of that loss went to West.

Who got booted out in 2016.

COMMENT: Let’s be fair, if you cost me over $11 million over two years, we probably are - at a minimum - exchanging words.

Enter the IRS into West’s 2015 and 2016 tax returns.

There were several issues in this case: the IRS used bank deposit analysis to reconstruct income, it reviewed documentation for (disallowed) business expenses, and so on. The only area we will discuss today are the partnership losses.

West wanted $6.8 million in losses.

The IRS allowed zero.

The parties stipulate that Mr. West and Mr. Quintanilla formed a partnership for Federal income tax purposes, pursuant to section 761(a), in taxable year 2014 when they signed the CTA, the CTA Note, and the CTA Security Agreement creating a new joint venture. Neither party disputes that gains and losses from the trading accounts would be partnership gains and losses; neither disputes that the termination of the partnership in February 2016 would have been a proper occasion for Mr. West’s recognition of such losses; and neither disputes that Mr. West received no distribution of any kind from the partnership upon its termination. However, as Mr. West seems to acknowledge, he can claim losses from the partnership only to the extent of his tax “basis” in the partnership; but it was Mr. Quintanilla who contributed all of the securities, and Mr. West was to contribute his effort; so Mr. West made no monetary contribution to the partnership that would have granted him any basis at its formation.”

West argued he had basis via the Promissory Note. He was personally liable for millions of dollars.

He had a point.

The IRS argued otherwise.

Here is byzantine: a partner cannot create basis by contributing his own promissory note to a partnership.

EXAMPLE: You and I form a partnership. You put in $25 grand. I put in a personal $25 grand promissory note. You have immediate basis of $25 grand. I have … nothing. Can I eventually match your $25 grand? Sure, as I put money in pursuant to the note. Contributing my own promise to pay accomplishes nothing taxwise until I actually pay.

Wait, wait you say. West was borrowing under the Promissory Note, which was a third-party note. How did we get from a third-party to a personal promissory note?

Because the note was between West and Quintanilla - not between West and the partnership.

Still, wouldn’t West have basis if Quintanilla loaned money to the partnership (via the note) on West’s behalf?

Yes, if Quintanilla had loaned money to the partnership (via the note) on West’s behalf.

OK, let’s try this another way. Could West have created basis by contributing his promissory note to Quintanilla to the partnership?

Nope. Quintanilla could have created basis (as he was collecting on the note), but West could not (as he was paying on the note). You cannot create basis by contributing your liability.

COMMENT: Contributing a note may have worked if this were an incorporation (which is a different area), but we are discussing partnership – not corporate – tax law.

The Tax Court decided that West had zero basis in the partnership and could not deduct the losses.

This beggars the question: will West ever be able to deduct the losses?

I doubt it.

The losses are suspended until West establishes basis. West will likely never establish basis, and therefore the losses will never release. They will mummify and be eventually lost to time.

And West’s story reminds me of my usual advice with sweat-equity arrangements: don’t get fancy. This thing is basically a bonus by another name. Have the sweat equity pay tax if there is income to share. Leave the losses with the wallet. An IO is an excellent incentive partnership tool, but any tool has its limitations. Do not overreach.

Our case this time was West v Commissioner, T.C. Memo 2026-105.