An Erroneous Tax Refund Check In The Mail

 

Let’s start with the Code section:

§ 6532 Periods of limitation on suits.

(b)  Suits by United States for recovery of erroneous refunds.

 

Recovery of an erroneous refund by suit under section 7405 shall be allowed only if such suit is begun within 2 years after the making of such refund, except that such suit may be brought at any time within 5 years from the making of the refund if it appears that any part of the refund was induced by fraud or misrepresentation of a material fact.

 

I have not lost sleep trying to understand that sentence.

But someone has.

Let’s introduce Jeffrey Page. He filed a 2016 tax return showing a $3,463 refund. In early May 2017, he received a refund check of $491,104. We are told that the IRS made a clerical error.

COMMENT: Stay tuned for more observations from Captain Obvious.

Page held the check for almost a year, finally cashing it on April 5, 2018.

The IRS – having seen the check cash – wanted the excess refund repaid.

Page wanted to enjoy the spoils.

Enter back and forth. Eventually Page returned $210,000 and kept the rest.

On March 31, 2020, Treasury sued Page in district court.

Page blew it off.

Treasury saw an easy victory and asked the district court for default judgement.

The court said no.

Why?

The court started with March 31, 2020. It subtracted two years to arrive at March 31, 2018. The court said that it did not know when Page received the check, but it most likely was before that date. If so, more than two years had passed, and Treasury could not pass Section 6532(b). They would not grant default. Treasury would have to prove its case.

Treasury argued that it was not the check issuance date being tested but rather the check clearance date. If one used the clearance date, the suit was timely.

The district court was having none of that. It pointed to precedence – from the Ninth Circuit Court of Appeals - and dismissed the case.

The government appealed.

To the Ninth Circuit Court of Appeals, ironically.

The Ninth wanted to know when a refund was “made.”

“within 2 years after the making of such refund …”

Is this when the refund is allowed or permitted or is it when the check clears or funds otherwise change hands?

The Ninth reasoned that merely holding the check does not rise to the threshold of “making” a refund.

Why, we ask?

Because Treasury could cancel the check.

OK. Score one for the government.

The Ninth further reasoned that the statute of limitations cannot start until the government is able to sue.

Why, we again ask?

Had Page shredded the check, could the government sue for nearly half a million dollars? Of course not. Well then, that indicates that a refund was not “made” when Page merely received a check.

Score two for the government.

The Ninth continued its reasoning, but we will fast forward to the conclusion:

… we hold that a refund is made when the check clears the Federal Reserve.”

Under that analysis, Treasury was timely in bring suit. The Ninth reversed the district court decision and remanded the case for further proceedings.

What do I think?

I see common sense, although I admit the Ninth has many times previously eluded common sense. Decide otherwise, however, and Treasury could be negatively impacted by factors as uncontrollable as poor mail delivery.

Or by Page’s curious delay in depositing the check.

Then again, maybe a non-professional was researching the matter, and it took a while to navigate to Section 6532 and its two years.

Our case this time was U.S. v Page, No 21-17083 (9th Cir. June 26, 2024).

IRS Notices And Waiting To The Last Minute

We have been fighting a penalty with the IRS for a while.

What set it up was quite bland.

We have a client. The business had cash flow issues, so both the owner and his wife took withdrawals from their 401(k) to put into the business.

They each took the same amount – say $100,000 for discussion purposes.

OK.

They did this twice.

Folks, if you want to confuse your tax preparer, this is a good way to do it.

At least they clued us that the second trip was the same as the first.

They told us nothing.

The preparer thought the forms had been issued in duplicate. It happens; I’ve seen it. Unfortunately, the partner thought the same.

Oh oh.

Eventually came the IRS notices.

I got it. The client owes tax. And interest.

And a big old penalty.

Here at CTG galactic command, yours truly seems to be the dropbox for almost all penalty notices we receive as a firm. In a way it is vote of confidence. In another way it is a pain.

I talked to the client, as I wanted to hear the story.

It is a common story: I do not know what all those forms mean. You guys know; that is why I use you.

Got it. However, we are not talking about forms; we are talking about events – like tapping into retirement accounts four times for the exact amount each time. Perhaps a heads up would have been in order.

But yeah, we should have asked why we had so many 1099s.

So now I am battling the penalty.

Far as I am concerned there is reasonable cause to abate. Perhaps that reasonable cause reflects poorly on us, but so be it. I have been at this for over three decades. Guess what? CPA firms make mistakes. Really. This profession can be an odd stew of technicality, endurance and mindreading.

However, the IRS likes to use the Boyle decision as a magic wand to refuse penalty abatement for taxpayer reliance on a tax professional.

Boyle is a Supreme Court case that differentiated reliance on a tax professional into two categories: crazy stuff, like whether a forward contract with an offshore disregarded entity holding Huffenpuffian cryptocurrency will trigger Subpart F income recognition; and more prosaic stuff, like extending the return on April 15th.

Boyle said the crazy stuff is eligible for abatement but the routine stuff is not. The Court reasoned that even a dummy could “check up” on the routine stuff if he/she wanted to.

Talk about a Rodney Dangerfield moment. No respect from that direction.

So I distinguish the client from Boyle. My argument? The client relied on us for … crazy stuff. Withdrawals can be rolled within 60 days. Loans are available from 401(k)s. Brokerages sometimes issue enough copies of Form 1099 to wallpaper a home office.

I was taking the issue through IRS penalty appeal.

The IRS interrupted the party by sending a statutory notice of deficiency, also known as the 90-day letter.

Class act, IRS.

And we have to act within 90 days, as the otherwise the presently proposed penalty becomes very much assessed. That means the IRS can shift the file over to Collections. Trust me, Collections is not going to abate anything. I would have to pull the case back to Appeals or Examination, and my options for pulling off that bright shiny dwindle mightily.

You have to file with the Tax Court within 90 days. Make it 91 and you are out of luck.

I am looking at a case where someone used a private postage label from Endicia.com when filing with the Tax Court. She responded on the last day, which is to say on the 90^th day. Then she dropped the envelope off at the post office, which date stamped it the following day.

I get it.

That envelope has an Endicia.com postmark. Then it has a U.S. Postal Service postmark dated the following day.

Then there is another USPS postmark 13 days later.

And the envelope does not get delivered until 20 days after the date on the Endicia.com label.

Who knows what happened here.

But there are rules with the Tax Court. One is allowed to use a delivery service or a postmark other than the U.S. Post Office. If the mail has both, however, the USPS postmark trumps.

In this case, the USPS postmark was dated on the 91^st day. 

You are allowed 90.

She never got to Tax Court. Her petition was not timely mailed.

Sheeeessshhh.

BTW always use certified mail when dealing with time-sensitive issues like this. In fact, it is not a bad idea to use certified mail for any communication with the IRS.

And - please - never wait to the last day.

I Filed A Petition With The Tax Court

This week I put in a petition to the Tax Court.

It used to be that I could go for years without this step. Granted, I have become more specialized, but unfortunately this filing is becoming almost routine in practice. A tax CPA unwillingly to push back on the new IRS will have a frustrating career.

Heck, it is already frustrating enough.

The IRS caused this one.

We have a client. They received an audit notice near the end of 2018. They were traveling overseas. We requested and received an extension of time to reply.

Then happened the government shutdown.

We submitted our paperwork.

The client received a proposed assessment.

We contacted the IRS and were told that the assessment had been postdated and should not have gone out. Aww shucks, it was that IRS-computers-keep-churning-thing even though there were no people in the building. The examining agent had received our pack-o’-stuff and we should expect a revised assessment.

Sure. And I was drafted by the NFL in Nashville recently.

We received a 90-day notice, also known as a statutory notice of deficiency. The tax nerds refer to it as a “NOD” or “SNOD.” Believe it or not, it was dated April 15.

Let’s talk this through for a moment, shall we?

The IRS returned from the government shutdown on January 28^th.  We had an audit that had not started. Worst case scenario there should have been at least one exchange between the IRS and us if there were questions. There was no communication, but let’s continue. I am supposed to believe that an IRS agent (1) returned from the shutdown; (2) picked-up my client file immediately; (3) wanted additional paperwork and sent out a notice that never arrived requesting the same; (4) allowed time for said notice’s non-delivery, non-review and non-reply; (5) forgot to contact taxpayer’s representative, despite having my name, address, CAFR number, telephone number, fax number, waist size and favorite ice cream; (6) and yet manage to churn a SNOD by April 15^th?

I call BS.

I tell you what happened. Someone returned from the shutdown and cleared off his/her desk, consequences be damned. Forget about IRS procedure. Kick that can down the road. What are they going to do – fire a government employee? Hah! Tell me another funny story.

If you google, you will learn that there are two conventional ways to respond to a SNOD. One is to contact the IRS. The other is to file a petition with the Tax Court.

Thirty-plus years in the profession tells me that the first option is bogus. Go 91 days and the Tax Court will reject your petition. The 90 days is absolute; forget about so-and-so at the IRS told me….

What happens next? The case will return to Appeals and – if it proceeds as I expect – it will return to Examination. Yes, we would have wasted all that time to get back to where the initial examining agent failed to do his/her job.

I wish there were a way to rate IRS employees. Let’s provide tax professionals - attorneys, CPAs and enrolled agents - a website to rate an IRS employee on their performance, providing reasons why. Allow for employee challenge and an impartial hearing, if requested. After enough negative ratings, perhaps these employees could be - at a minimum - removed from taxpayer contact. With the union, it probably is too much to expect them to be fired.

You can probably guess how I would rate this one.

A Rant On IRS Penalties

I am reading that the number one most-litigated tax issue is the accuracy-related penalty, and it has been so for the last four years.

The issue starts off innocently enough:

You may qualify for relief from penalties if you made an effort to comply with the requirements of the law, but were unable to meet your tax obligations, due to circumstances beyond your control.

I see three immediate points:

(1)  You were unable to file, file correctly, pay, or pay in full

(2)  You did legitimately try

(3)  And it was all beyond your control

That last one has become problematic, as the IRS has come to think that all the tremolos of the universe are under your control.

One of the ways to abate a penalty is to present reasonable cause. Here is the IRS:

Reasonable cause is based on all the facts and circumstances in your situation. The IRS will consider any reason which establishes that you used all ordinary business care and prudence to meet your federal tax obligations but were nevertheless unable to do so.

How about some examples?

·       Death

Something less … permanent, please.

·       Advice from the IRS

·       Advice from a tax advisor

That second one is not what you might think. Let’s say that I am your tax advisor. We decide to extend your tax return, as we are waiting for additional information. We however fail to do so. It got overlooked, or maybe someone mistakenly thought it had already been filed. Whatever. You trusted us, and we let you down.

There is a Supreme Court case called Boyle. It separated tax responsibilities between those that are substantive/technical (and reasonable cause is possible) and those which are administrative/magisterial (and reasonable cause is not). Having taken a wrong first step, the Court then goes on to reason that the administrative/magisterial tasks were not likely candidates for reasonable cause. Why? Because the taxpayer could have done a little research and realized that something – an extension, for example - was required. That level of responsibility cannot be delegated. The fact that the taxpayer paid a professional to take care of it was beside the point.

So you go to a dentist who uses the wrong technique to repair your broken tooth. Had you spent a little time on YouTube, you would have found a video from the UK College of Dentistry that discussed your exact procedure. Do you think this invites a Boyle-level distinction?

Of course not. You went to a dentist so that you did not have to go to dental school. You go to a tax CPA so that do not have to obtain a degree, sit for the exam and then spend years learning the ropes.      

·     

• Fire, casualty, natural disaster or other disturbances
• Inability to obtain records
• Serious illness, incapacitation or unavoidable absence of the taxpayer or a member of the taxpayer’s immediate family

I am noticing something here: you are not in control of your life. Some outside force acted upon you, and like a Kansas song you were just dust in the wind.

How about this one: you forgot, you flubbed, you missed departure time at the dock of the bay? Forgive you for being human.

This gets us to back to those initially innocuous string of words:

          … due to circumstances beyond your control.”

When one does what I do, one might be unimpressed with what the IRS considers to be under your control.

Let me give you an example of a penalty appeal I have in right now. I will tweak the details, but the gist is there.

·   You changed jobs in 2015 

·   You had a 401(k) loan when you left

·   Nobody told you that you had to repay that loan within 60 days or it would be considered a taxable distribution to you. 

·   You received and reviewed your 2015 year-end plan statement. Sure enough, it still showed the loan.  

·   You got quarterly statements in 2016. They also continued to show the loan. 

·    Ditto for quarter one, 2017. 

·   The plan then changed third-party administrators. The new TPA noticed what happened, removed the loan and sent a 1099 to the IRS.

o   Mind you, this is a 1099 sent in 2017 for 2015.

o   To make it worse, the TPA did not send you a 1099.     

•  The IRS computers whirl and sent you a notice.
•  You sent it to me. You amended. You paid tax and interest.
•  The IRS now wants a belt-tightening accuracy-related penalty because ….

Granted, I am a taxpayer-oriented practitioner, but I see reasonable cause here. Should you have known the tax consequence when you changed jobs in 2015? I disagree. You are a normal person. As a normal you are not in thrall to the government to review, understand and recall every iota of regulatory nonsense they rain down like confetti at the end of a Super Bowl. Granted, you might have known, as the 401(k)-loan tax trap is somewhat well-known, but that is not the same as saying that you are expected to know.  

I know, but you never received a 1099 to give me. We never discussed it, the same as we never discussed Tigris-Euphrates basin pottery. Why would we?

Not everything you and I do daily comes out with WWE-synchronized choreography. It happens. Welcome to adulthood. I recently had IRS Covington send me someone else’s tax information. I left two messages and one fax for the responsible IRS employee – you know, in case she wanted the information back and process the file correctly – and all I have heard since is crickets. Is that reasonable? How dare the IRS hold you to a standard they themselves cannot meet?

I have several penalty appeals in to the IRS, so I guess I am one of those practitioners clogging up the system. I have gotten to the point that I am drafting my initial penalty abatement requests with an eye towards appeal, as the IRS has  convinced me that they will not allow reasonable cause on first pass - no matter what, unless you are willing to die or be permanently injured. 

I have practiced long enough that I remember when the IRS was more reasonable on such matters. But that was before political misadventures and the resulting Congressional budget muzzle. The IRS then seemed to view penalties as a relief valve on its budget pressures. Automatically assess. Tie up a tax advisor’s time. Implement a penalty review software package in the name of uniformity, but that package's name is “No.” The IRS has become an addict.

Phone Call About The Statute Of Limitations

Recently I received a call from another CPA. 

He is representing in a difficult tax audit, and the IRS revenue agent has requested that the client extend the statute of limitations by six months. The statute has already been extended to February, 2016, so this extension is the IRS’ second time to the well. The client was not that thrilled about the first extension, so the conversation about a second should be entertaining.

This however gives us a chance to talk about the statute of limitations.

Did you know that there are two statutes of limitations?

Let’s start with the one commonly known: the 3-year statute on assessment.

You file your personal return on April 15, 2015. The IRS has three years from the date they receive the return to assess you. Assess means they formally record a receivable from you, much like a used-car lot would. Normally – and for most of us – the IRS recording receipt by them of our tax return is the same as being assessed. You file, you pay whatever taxes are due, the IRS records all of the above and the matter is done.    

Let’s introduce some flutter into the system: you are selected for audit.

They audit you in March, 2017. What should have been an uneventful audit turns complicated, and the audit drags on and on. The IRS knows that they have until April, 2018 on the original statute (that is, April 15, 2015 plus 3 years), so they ask you to extend the statute.

Let’s say you extend for six months. The IRS now has until October 15, 2018 to assess (April 15 plus six months). It buys them (and you) time to finish the audit with some normalcy.

The audit concludes and you owe them $10 thousand. They will send you a notice of the audit adjustment and taxes due. If you ignore the first notice, the IRS will keep sending notices of increasing urgency. If you ignore those, the IRS will eventually send a Statutory Notice of Deficiency, also known as a SNOD or 90-day letter.

That SNOD means the IRS is getting ready to assess. You have 90 days to appeal to the Tax Court. If you do not appeal, the IRS formally assesses you the $10 thousand.

And there is the launch for the second statute of limitations: the statute on collections. The IRS will have 10 years from the date of assessment to collect the $10 thousand from you.

So you have two statutes of limitation: one to assess and another to collect. If they both go to the limit, the IRS can be chasing you for longer than your kid will be in grade and high school.

What was I discussing with my CPA friend? 

• What if his client does not (further) extend the statute?

Well, let’s observe the obvious: his client would provoke the bear. The bear will want to strike back. The way it is done – normally – is for the bear to bill you immediately for the maximum tax and penalty under audit. They will spot you no issues, cut you no slack. They will go through the notice sequence as quickly as possible, as they want to get to that SNOD. Once the IRS issues the SNOD, the statute of limitations is tolled, meaning that it is interrupted. The IRS will then not worry about running out of time - if only it can get to that SNOD.

It is late August as I write this. The statute has already been extended to February. What are the odds the IRS machinery will work in the time remaining?

And there you have a conversation between two CPAs.

I myself would not provoke the bear, especially in a case where more than one tax year is involved. I view it as climbing a tree to get away from a bear. It appears brilliant until the bear begins climbing after you. 

I suspect my friend’s client has a different temperament. I am looking forward to see how this story turns out.

The 6707A Tax Penalty Is Outrageous

I have attached a penalty notice to this blog. Take a look . The IRS is assessing $14,385 for the 2008 tax year, and the description given is a “Section 6707A” penalty.

This is one of the most abusive penalties the IRS wields, in my opinion. As too often happens, it may have been hatched for legitimate reasons, but it has degenerated into something else altogether.

Let’s time travel back to the early aughts. The IRS was taking a new direction in its efforts against tax shelters: mandatory disclosure.  There was a time when tax shelters involved oil and gas or real estate and were mostly visible above the water line, but the 1986 changes to the tax Code had greatly limited those schemes. In their place were more sophisticated – and very hard to understand – tax constructions. The planners were using obscure tax rules to separate wealth from its tax basis, for example, with the intent of using the orphaned basis to create losses. 

The IRS promulgated disclosure Regulations under Section 6011. At first, they applied only to corporations, but by 2004 they were expanded to include individual taxpayers. The IRS wanted taxpayers to disclose transactions that, in the IRS’ view, were potentially abusive. The IRS quickly recognized that many if not most taxpayers were choosing not to report. There were several reasons for this, including:

·       Taxpayers could consider a number of factors in determining whether a transaction was reportable

·       The gauzy definition of key terms and concepts

·       The lack of a uniform penalty structure for noncompliance

The IRS brought this matter to Congress’ attention, and Congress eventually gave them a new shiny tax penalty in the 2004 American Jobs Creation Act. It was Section 6707A.

One of the things that the IRS did was to disassociate the penalty from the taxpayer’s intent or purpose for entering the transaction. The IRS published broad classes of transactions that it considered suspicious, and, if you were in one, you were mandated to disclose. The transactions were sometimes described in broad brush and were difficult to decipher. Additionally, the transactions were published in obscure tax corners and publications. No matter, if the IRS published some transaction in the Botswana Evening Cuspidor, it simply assumed that practitioners – and, by extrapolation, their clients – were clued-in.

If the IRS decided that your transaction made the list, then you were required to disclose the transaction on every tax return that included a tax benefit therefrom. If the IRS listed the transaction after you filed a tax return but before the statute of limitations expired, then you had to file disclosure with your next tax return. You had to file the disclosure with two different offices of the IRS, which was just an accident waiting to happen. And the disclosure had to be correct and complete. If the IRS determined that it was not, such as if you could not make heads or tails of their instructions for example, the IRS could consider that the same as not filing at all. There were no brownie points for having tried.

There’s more.

The penalty applied regardless of whether taxpayer’s underlying tax treatment was ultimately sustained. In fact, the IRS was publishing reportable transactions BEFORE proving in Court that any of the transactions were illegal or abusive. If you took the IRS to Court and won, the IRS said it could still apply the penalty. There was no exception to the imposition of the penalty, even if you could demonstrate reasonable cause and good faith.  

But there was some mercy. Although you could not take the penalty to Court, you could request the IRS Commissioner for rescission if it would “promote compliance … and effective tax administration.” Oh please.

Can this get worse? You bet.

Let’s decouple the penalty from any possible tax benefit you may have gotten. If the transaction was particularly suspicious (termed “listed’), the penalty was $100,000. Double that if you were a company. What if the transaction occurred in your S corporation and then on your personal income tax return because of the K-1 pass-through? Well, add $200,000 plus $100,000 for a penalty of $300,000. Per year. What if the tax benefit was a fraction of that amount? Tough. 

This was a fast lane to Tax Court. Wait, the penalty could not be appealed. Think about that for a moment. The IRS has a penalty that cannot be appealed. What if the system failed and the IRS assessed the penalty abusively or erroneously?  Too bad.  

The Taxpayer Advocate publicly stated that the 6707A penalty should be changed as it “raises significant constitutional concerns, including possible violations of the Eight Amendment’s prohibition against excessive government fines and due process protections.”

In response to public clamor and pressure from Congress, the IRS issued moratoriums on 6707A enforcement actions. It wound up reducing the penalty for years after 2006 to 75% of the decrease in tax resulting from the transaction. There was finally some governor on this runaway car.

My client walked into Section 6707A long before I ever met him/her. How? By using a retirement plan.

Yep, a retirement plan.

The plan is referred to as a 412(i), for the Code section that applies. A company would set up a retirement plan and fund it with life insurance. Certain rules relaxed once one used life insurance, as it was considered a more reliable investment than the stock market. I was a fan of these plans, and I once presented a 412(i) plan to a former client who is (still) a sports commentator at ESPN.

Then you had the promoters who had to ruin 412(i)) plans for everyone else. For example, here is what I presented to the ESPN person. We would set up a company, and the company would have one employee and one retirement plan. The plan would be funded with life insurance. The plan would have to exist for several years (at least five), and - being a pension plan - would have to be funded every year. Because life insurance generally has a lower rate of return than the stock market, the IRS would allow one to “over” fund the plan. After five years or more, we would terminate the plan and transfer the cash value of the insurance to an IRA.

The promoters made this a tax shelter by introducing “springing” life insurance. They were hustling products that would have minimal cash value for a while – oh, let’s say … the first five years. That is about the time I wanted to close the plan and transfer to an IRA. Somehow, perhaps by magic, all that cash value that did not previously exist would “spring” to life, resulting in a very tidy IRA for someone. Even better, if there was a tax consequence when the plan terminated, the cost would be cheap because the cash value would not “spring” until after that point in time.

I thought a 412(i) plan to be an attractive option for a late-career high-income individual, and it was until the promoters polluted the waters with springing insurance nonsense. It then became a tax shelter, triggering Section 6707A.

My client got into a 412(i). From what I can tell, he/she got into it with minimal understanding of what was going on, other than he/she was relying on a professional who otherwise seemed educated, sophisticated and impartial. The plan of course blew up, and now he/she is facing 6707A penalties – for multiple tax years.

And right there is my frustration with penalties of this ilk. Perhaps it makes sense if one is dealing with the billionaires out there, but I am not. I am dealing with businesspeople in Cincinnati who have earned or accumulated some wealth in life, in most cases by their effort and grit, but nowhere near enough to have teams of attorneys and accountants to monitor every fiat the government decides to put out. To say that there is no reasonable cause for my client is itself abusive. He/she could no more describe the tax underpinnings of this transaction any more than he/she could land a man on the moon.

What alternative remains to him/her? To petition the Commissioner for “rescission?” Are you kidding me? That is like asking a bully to stop bullying you. I have ten dollars on how that exercise will turn out.