Can A Taxpayer Be Responsible For Tax Preparer Fraud?

 

We are familiar with the statute of limitations. In general, the SoL means that you have three years to file a return, information important to know if you are due a refund. Likewise, the IRS has three years to audit or otherwise adjust your return, important to them if you owe additional tax.

The reason for the SoL is simple: it has to end sometime, otherwise the system could not function.  Could it be four years instead of three? Of course, and some states use four years. Still, the concept stands: the ferris wheel must stop so all parties can dismount.

A huge exception to the SoL is fraud. File a fraudulent return and the SoL never starts.

Odds are, neither you nor I are too sympathetic to someone who files a fraudulent return. I will point out, however, that not all knuckleheaded returns are necessarily fraudulent. For example, I am representing an IRS audit of a 2020 Schedule C (think self-employed). It has been one of the most frustrating audits of my career, and much of it is self-inflicted. I know the examiner had wondered how close the client was to the f-word; I could hear it in her word selection, pausing and voice. We spoke again Friday, and I could tell that she had moved away from that thought. There is no need to look for fraud when being a knucklehead suffices.

Here is a question for you:

You do not commit fraud but your tax preparer does. It could be deductions or credits to which you are not entitled. You do not look at the return too closely; after all, that is why you pay someone. He/she however did manage to get you the refund he/she had promised. Can you be held liable for his/her fraud?

Let’s look at the Allen case.

Allen was a truck driver for UPS. He had timely filed his tax return for the years 1999 and 2000. He gave all his tax documents to his tax preparer (Goosby) and then filed the resulting return with the IRS.

Mr. Goosby however had been juicing Allen’s itemized deductions: contributions, meals, computer, and other expenses. He must have been doing quite a bit of this, as the Criminal Investigations Division (CID, pronounced “Sid”) got involved.

COMMENT: CID is the part of the IRS that carries a gun. You want nothing to do with those guys.

Allen was a good guy, and he agreed with the IRS that there were bogus numbers on his return.

He did not agree that the tax years were open, though. The IRS notice of deficiency was sent in 2005 – that is, outside the normal three years. Allen felt that the tax years had closed.

He had a point.

However, look at Section 6501(c):

§ 6501 Limitations on assessment and collection.

(c)  Exceptions.

(1)  False return.

In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.

The Court pointed out that the law mentions a “false or fraudulent return.” It does not say that the fraud must be the taxpayer’s.

The year was open, and Allen owed the additional tax.

I get it. There is enough burden on the IRS when fraud is involved, and the Court was not going to add to the burden by reading into tax law that fraud be exclusively the taxpayer’s responsibility.

The IRS had helped its case, by the way, and the Court noticed.

How?

The IRS had not assessed penalties. All it wanted was additional tax plus interest.

I wish we could see more of that IRS and less of the automatic penalty dispenser that it has unfortunately become.

Allen reminds us to be careful when selecting a tax preparer. It is not always about getting the “largest” refund. Let’s be honest: for many if not most of us, there is a “correct” tax number. It is not as though we have teams of attorneys and CPAs sifting through vast amounts of transactions, all housed in different companies and travelling through numerous foreign countries and treaties before returning home to us. Anything other than that “correct” number is … well, a wrong number.  

Our case this time was Allen v Commissioner, 128 T.C. 4 (U.S.T.C. 2007).

90 Days Means 90 Days

Let’s return to an IRS notice we have discussed in the past: the 90-Day letter or Notice of Deficiency. It is commonly referred to as a “NOD” or “SNOD.”

If you get one, you are neck-deep into IRS machinery. The IRS has already sent you a series of notices saying that you did not report this income or pay that tax, and they now want to formally transfer the matter to Collections. They do this by assessing the tax. Procedure however requires them (in most cases) to issue a SNOD before they can convert a “proposed” assessment to a “final” assessment.

It is not fun to deal with any unit or department at the IRS, but Collections is among the least fun. Those guys do not care whether you actually owe tax or have reasonable cause for abating a penalty. Granted, they might work with you on a payment plan or even interrupt collection activity for someone in severe distress, but they are unconcerned about the underlying story.

Unless you agree with the proposed IRS adjustment, you must respond to that SNOD.

That means you are in Tax Court.

Well, sort of.

The IRS will return the case to the IRS Appeals with instructions and the hope that both sides will work it out. The last thing the Tax Court wants is to hear your case.

This week I finally heard from Appeals concerning a filing back in March.

Here is a snip of the SNOD that triggered the filling.

Yeah, no. We are not getting rolled for almost $720 grand.

I mentioned above that this notice has several names, including 90-day letter.

Take the 90 days SERIOUSLY.

Let’s look at the Nutt case.

The IRS mailed the Nutts a SNOD on April 14, 2022 for their 2019 tax year. The 90 days were up July 18, 2022. The 18^th was a Monday, not a holiday in fantasy land or any of that. It was just a regular day.

The Nutts lived in Alabama.

They filed their Tax Court petition electronically at 11.05 p.m.

Alabama.

Central time.

90 days.

The Tax Court is in Washington, D.C.

The Tax Court received the electronic filing at 12.05 a.m. July 19^th.

Eastern time.

91 days.

The Tax Court bounced the petition. Since it had to be filed with the Tax Court - and the Tax Court is eastern time - the 90 days had expired.

A harsh result, but those are the rules.

Our case this time was Nutt v Commissioner, 160 T.C. No 10 (2023).

A Current Individual Tax Audit

 

We have an IRS audit at Galactic Command. It is of a self-employed individual. The self-employeds have maintained a reasonable audit rate, even as other individual audit rates have plummeted in recent years.

I was speaking with the examiner on Friday, lining up submission dates for records and documents. We set tentative dates, but she reminded me that Congress was going into budget talks this weekend.  Depending on the resolution, she might be furloughed next week. No prob, we will play it by ear.

This is a relatively new client for us. We did not prepare the records or the tax returns for the two years under audit. We requested underlying records, but there was little there for the first year and only slightly more for the second. We then did a cash analysis, knowing that the IRS would be doing the same.

COMMENT: The IRS will commonly request all twelve bank statements for a business-related bank account. The examiner adds up the deposits for the twelve months and compares the total to revenues reported on the tax return. If the tax return is higher, the IRS will probably leave the matter alone. If the tax return is lower, however, the IRS will want to know why.

We had a problem with the analysis for the first year: our numbers had no resemblance to the return filed. Our numbers were higher across the board: higher deposits, higher disbursements, higher excess of deposits over disbursements.

Higher by a lot.

The accountant asked me: do you think …?

Nope, not for a moment.

Implicit here is fraud.

There are two types of tax fraud: civil and criminal. Yes, I get it: if you have criminal, you are virtually certain to have civil, but that is not our point. Our point is that there is no statute of limitations on civil fraud. The IRS could go back a decade or more - if they wanted to.

I do not see fraud here. I do see incompetence. I think someone started using a popular business accounting software, downloading bank statements and whatnot to release their inner accountant. There are easy errors to one not familiar: you do not download all months for an account; you do not download all the accounts; you fail to account for credit cards; you fail to account for cash transactions.

OK, that last one could be a problem, if significant.

The matter reminded me of a famous tax case.

It is easy to understand someone committing fraud on his/her tax return. Put too much in, leave too much out. Do it deliberately and with malintent and you might have fraud.

Question: can you be responsible for your tax preparer’s fraud?

Vincent Allen was a UPS driver in Memphis. He used a professional preparer (Goosby) for 1999 and 2000.  Allen did the usual: he gave Goosby his W-2, his mortgage interest statement, property taxes and whatnot. Standard stuff.

Goosby went to town on miscellaneous itemized deductions; He goosed numbers for a pager, computer, meals, mileage and so forth. He was creative.

The IRS came down hard, understandably.

They also wanted fraud penalties.

Allen had an immediate defense: the three-year statute had run.

The IRS was curt: the three years does not apply if there is fraud.

Allen argued the obvious:

How was I supposed to know?

Off to Tax Court they went.

The Court looked at the following Code section:

 § 6501 Limitations on assessment and collection

(c)  Exceptions.

(1)  False return.

In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.

The Court noted there was no requirement that the “intent to evade” be the taxpayer’s.

The statute was open.

Allen owed tax.

The IRS - in a rare moment of mercy - did not press for penalties. It just wanted the tax, and the Court agreed.

The Allen decision reminds us that there is some responsibility when selecting a tax preparer. One is expected to review his/her return, and – if it seems too good …. Well, you know the rest of that cliche.

Do I think our client committed fraud?

Not for a moment.

Might the IRS examiner think so, however?

It crossed my mind. We’ll see.

Our case this time was Allen v Commissioner, 128. T.C. 37.

Substantially Disclosing A Gift To The IRS

Take a look at this memorable prose:

         Sec 6501(c) (9) Gift tax on certain gifts not shown on return.

If any gift of property the value of which (or any increase in taxable gifts required under section 2701(d) 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.

I get it: if you never disclose the gift, the IRS can come after you until the end of time. The reverse is what concerns us today: if you disclose the gift “in a manner adequate,” then the IRS does not have until the end of time.

Gift tax cases can be … idiosyncratic, to be diplomatic. All tax is personal, but gift tax can be Addams Family idiosyncratic.

Ronald Schlapfer (RS) was a Swiss-born businessman. He had ties to both Switzerland and the United States. He owned a life insurance policy issued in 2006.The policy in turn owned all the stock in EMG, a Panamanian company previously owned by RS.

It was 2006 and RS was a nonresident of the U.S. He gifted his interest in EMG to his mother, aunt and uncle.

He obtained U.S. citizenship in 2008.

Got it: he gifted before he became subject to U.S. gift tax.

In 2013 – and after obtaining his citizenship – RS decided to play it safe and submitted an offshore voluntary disclosure filing with the IRS. It included a gift tax return for 2006, which informed the IRS of the gift to his family. The return included the following:

“A protective filing is being submitted. On July 6, 2006, taxpayer made a gift of controlled foreign company stock valued at $6,056,686 per U.S. Treasury Regulation 25.2501-1(B). The taxpayer is not subject to U.S. gift tax as he did not intend to reside permanently in the United States until citizenship was obtained in 2008.”

COMMENT: In this situation, a protective filing means that the taxpayer is unsure if a filing is even required but is submitting one, nonetheless. It is an attempt to backstop penalties and other bad things that could happen from a failure to file.

COMMENT: International practice has become increasingly paranoid for many years now. The IRS seems convinced that every UBER driver has unreported foreign accounts, and one’s failure to follow arbitrary and obscure rules are a per se admission of culpability. In this case, for example, there was technical doubt whether the gift was reportable as the transfer of a life insurance policy or as the transfer of a company owned by that policy. Why was there doubt? Well, the IRS itself created it. Rest assured, whichever way you chose the IRS would fall the other way.

The IRS disagreed that the gift occurred in 2006. There was a hitch in the transfer, and the attorney did not resolve the matter until 2007. RS in turn argued that 2007 was but a scrivener’s error. According to well-trod ground, a scrivener’s error is considered administrative, not substantive, and does not mark the actual date of the underlying transaction.

Sometime in here RS agreed to extend the limitations period.

In 2019 the IRS issued the statutory notice of deficiency (SNOD). That is also called a 90-day letter, and it meant that the next step was Tax Court - if RS wanted to further pursue the matter.

Off to Tax Court they went.

RS’ argument was simple: the statute of limitations had expired.

The IRS argued that the gift was not adequately disclosed.

The IRS argued that disclosure requires the following:

·       Description of the property gifted, and any consideration received by the donor.

·       The identity and relationship between the parties.

·       There is additional disclosure for property is transferred in trust.

·       A detailed explanation of how one arrived at the fair market value of the property gifted.

·       Whether one has taken a position contrary to any Regulations or rulings

The IRS was trying to catch RS in the first requirement above: a description of the property gifted.

Was it an insurance policy, ownership in a company, or something else?

Here is the Court:

While Schlapfer may have failed to describe the gift in the correct way, he provided enough information to identify the underlying property that was transferred.”

RS won his case. The IRS had blown the statute of limitations.

Our case this time was Schlapfer v Commissioner, T.C. Memo 2023-65.

Becoming Personally Liable For An Estate’s Taxes

 

I had lunch with a friend recently. He is executor for an estate and was telling me about some … questionable third-party behavior and document discoveries. I left the conversation underwhelmed with his attorney and recommending a replacement as soon as possible. There are two other beneficiaries to this estate, and he has a fiduciary responsibility as executor.

Granted, all are family and get along. The risk - it seems to me - is minimal.

It is not always that way. I have a client whose family was ripped apart by an inheritance. I shake my head, as there was not enough money there (methinks) to spat over, much less exact lifelong grudges. However, he was executor and so-and-so received such-and-such back when Carter first started making liver pills and he should have offset someone for … oh, who knows.

Being executor can be a thankless job.

It can also get one into trouble.

Let’s take a look at the Lee estate.

Kwang Lee died testate in September, 2001.

         COMMENT: Testate means someone died with a will.

A municipal court judge was named executor.

The judge filed the estate return in May, 2003.

COMMENT: The return was late, but there was some complexity as both spouses died within six months. There was language in the will about a-spouse-is-considered-to-survive-if that created some confusion.

COMMENT: It doesn’t matter. You know the IRS is coming in with penalties.

The IRS audited the return.

 In April 2006 the IRS issued a Notice of Deficiency for over $1,000,000. 

COMMENT: The IRS also wanted a penalty over $255 grand for late filing.

The executor filed with the Tax Court.

 In February, 2007 the executor distributed $640,000 to the beneficiaries.

COMMENT: Pause on what happened here. The IRS wanted additional tax and penalties. The executor was contesting this in Tax Court. The issue was live when the executor distributed the money.

Is there a risk?

You bet.

What if the estate lost its case and did not have enough money left to pay the tax and penalties?

The Tax Court gave the executor a partial win: the estate owed closer to a half million dollars than a million. The Court also waived the penalties.

The estate did not have a half million dollars. It did have $182,941.

The estate submitted an offer in compromise to the IRS for $182,941.

The IRS looked at the offer and said: are you kidding me? What about that $640,000 you distributed before its time?

The IRS pointed out this bad boy:

31 U.S. Code § 3713.Priority of Government claims

(a)

(1) A claim of the United States Government shall be paid first when—

(A) a person indebted to the Government is insolvent and—

(i) the debtor without enough property to pay all debts makes a voluntary assignment of property;

(ii) property of the debtor, if absent, is attached; or

(iii) an act of bankruptcy is committed; or

(B) the estate of a deceased debtor, in the custody of the executor or administrator, is not enough to pay all debts of the debtor.

(2) This subsection does not apply to a case under title 11.

(b) A representative of a person or an estate (except a trustee acting under title 11) paying any part of a debt of the person or estate before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government. 

The effect of Section 3713 is to make the executor personally liable for a debt to the U.S. when: 

o  The estate was rendered insolvent by a distribution, and

o  The executor had knowledge or notice of the government’s claim at the time of the distribution.

The judge/executor did the only thing he could do: he challenged the charge that he had actual knowledge of a deficiency when he distributed the $640,000.

The executor was hosed. I am not sure what more of a wake-up-call the executor needed than an IRS Notice of Deficiency. For goodness’ sake, he filed a petition with the Tax Court in response.

Maybe he thought that he would win in Tax Court.

He did, by the way, but partially. The tax was cut in half, and the penalties were waived.

Notice that the estate would not have had enough money had it lost the case in full. The tax would have been over a million, with additional penalties of a quarter million. Under the best of circumstances, the estate would have had cash of approximately $822 thousand and unable to pay in full.

In that case I doubt Section 3713 would have applied. The estate would have conserved its cash upon receiving a Notice of Deficiency.

But the estate did not conserve its cash upon receiving a Notice of Deficiency.

The executor became personally liable.

Mind you, this may work out. Perhaps the beneficiaries return the cash; perhaps there is a claim under a performance bond.

Still, why would an executor – especially a skilled attorney and municipal judge – go there?

Our case this time was Estate of Lee v Commissioner, T.C. Memo 2021-92.

What Does It Mean To File A Return?

 

The IRS generally has three years to examine a return and assess additional taxes after it has been filed.

This can put pressure on whether what was filed is a “return.”

I am looking at a case involving this issue.

Mr Quezada (Q) ran a stonemasonry business. He had a number of people working for him over the years. Like many a contractor, he treated these individuals as subcontractors and not employees.

OK.

He filed Form 1099s.

OK.

Most of these 1099s did not include social security numbers.

Oh oh.

This is a problem. If a payor requests a social security number and an individual refuses to provide it, the tax Code requires the payor to withhold “backup withholding.” The same applies if an individual provides a bogus social security number.

Say that you are supposed to pay someone $1,000 for stone masonry work, but they refuse to provide a social security number.

COMMENT: Let’s be honest: we know what is going on here.

You are required to withhold 24% and send it to the IRS. You should pay the person $860 and send $240 to the IRS.

QUESTION: what are the odds that anyone will ever claim the $240?

FURTHER QUESTION: And how could one, since there is no social security number associated with the $240?

Mr Q was supposed to file the following forms with the IRS:

·      Form 1099

·      Form 1096 (the summary of the 1099s)

·      Form 945 (to remit the $240 in our example)

He filed the first two. He did not file the third as he did not withhold.

Mr Q filed for bankruptcy in 2016. The creditors had a chance to file their claims.

In the spirit of bayoneting the dead, the IRS wanted backup withholding taxes from 2005 onward.

It filed its claim – for over $1.2 million.

QUESTION: how could 2005 (or 2006? or 2007?) still be an open tax year?

The IRS gave its argument:

1.    The liability for backup withholding is reported on Form 945.

2.    Mr Q never filed Form 945.

3.    The statute of limitations never started because Mr Q never filed the return.

The IRS was alluding to the Lane-Wells case.

In Lane-Wells the taxpayer filed one type of corporate tax return rather than another, mostly because it thought that it was the first type and not the other. The distinction meant money to the IRS.

The Supreme Court agreed with the IRS.

The IRS likes to consider Lane-Wells as its trump card in case one does not file a return, unintentionally leaves out a schedule or files the wrong form altogether. The courts have fortunately pushed back on this position.

Mr Q had a problem. He had not filed Form 945. Then again, from his perspective there was no Form 945 to file. He was between a rock and a hard spot.

The Appeals Court hearing Mr Q’s case realized the same thing.

The Court reasoned that the issue was not whether Mr Q filed the “magic” form. Rather, it was whether Mr Q filed a return that:

·      Showed the liability for tax, and

·      Allowed calculation of the amount of tax

Here is the Court:

The IRS could determine that Q[uezada] was liable for backup-withholding taxes by looking at the face of his Forms 1099; if a particular form lacked a TIN, then Q[uezada] was liable for backup withholding taxes applied to the entire amount …”

There is the first test.

For each subcontractor who failed to supply a TIN, the IRS could determine the amount that Q[uezada] should have backup withheld by multiplying the statutory flat rate for backup withholding by the amount Q[uezada] paid the subcontractor.”

There is the second test.

The Court decided that Q had filed returns sufficient to give the IRS a heads-up as to the liability and its amount. The IRS could but did not follow up. Why not? Who knows, but the IRS was time-barred by the statute of limitations.

Our case this time was Quezada v IRS, No 19-51000 (5^th Cir. 2020).

IRS Collection Statute Expiration Date (CSED)

 I consider it odd.

I have two files in my office waiting on the collection statute of limitations to expire.

It is not a situation I often see.

Audits, penalty abatements, payment plans, offers and innocent spouse requests are more common.

Let’s talk about the running of the collection statute of limitations.

COMMENT: I do not consider this to be valid tax planning, and I am quite reluctant to represent someone who starts out by intending to do the run. That said, sometimes unfortunate things happen. We will discuss the topic in the spirit of the latter.

Let’s set up the two statutes of limitations:

(1) The first is the statute on assessment. This is the familiar 3-year rule: the IRS has 3 years to audit and the taxpayer has 3 years to amend.

COMMENT: I do not want to include the word “generally” every time, as it will get old. Please consider the modifier “generally” as unspoken but intended.

(2)  The second is the statute on collections. This period is 10 years.

We might conversationally say that the period can therefore go 13 years. That would be technically incorrect, as there would be two periods running concurrently. Let’s consider the following example:

·      You filed your individual tax return on April 15, 2020. You owed $1,000 above and beyond your withholdings and estimates.

·      The IRS audited you on September 20, 2022. You owed another $4,000.

·      You have two periods going:

o  The $1,000 ends on April 15, 2030 (2020 + 10 years).

o  The $4,000 ends on September 20, 2032 (2022 + 10 years).

Alright, so we have 10 years. The expiration of this period is referred to as the “Collection Statute Expiration Date” or “CSED”.

When does it start?

Generally (sorry) when you file the return. Say you extend and file the return on August 15. Does the period start on August 15?

No.

The period starts when the IRS records the return.

Huh?

It is possible that it might be the same date. It is more possible that it will be a few days after you filed. A key point is that the IRS date trumps your date.

How would you find this out?

Request a transcript from the IRS. Look for the following code and date:

                  Code          Explanation

                    150           Tax return filed

Start your 10 years.

BTW if you file your return before April 15, the period starts on April 15, not the date you filed. This is a special rule.

Can the 10 years be interrupted or extended?

Oh yes. Welcome to tax procedure.

The fancy 50-cent word is “toll,” as in “tolling” the statute. The 10-year period is suspended while certain things are going on. What is going on is that you are probably interacting with the IRS.

OBSERVATION: So, if you file your return and never interact with the IRS – I said interact, not ignore – the statute will (generally – remember!) run its 10 years.

How can you toll the statute?

Here are some common ways:

(1)  Ask for an installment payment plan

Do this and the statute is tolled while the IRS is considering your request.

(2)  Get turned down for an installment payment plan

                  Add 30 days to (1) (plus Appeals, if you go there).

(3)  Blow (that is, prematurely end) an installment payment plan

Add another 30 days to (1) (plus Appeals, if you go there).

(4)  Submit an offer in compromise

The statute is tolled while the IRS is considering your request, plus 30 days.

(5)  Military service in a combat zone

The statute is tolled while in the combat zone, plus 180 days.

(6)  File for bankruptcy

The statute is tolled from the date the petition is filed until the date of discharge, plus 6 months.

(7)  Request innocent spouse status

The statute is tolled from the date the petition is filed until the expiration of the 90-day letter to petition the Tax Court. If one does petition the Court, then the toll continues until the final Court decision, plus 60 days.

(8)  Request a Collections Due Process hearing

The statute is tolled from the date the petition is filed until the hearing date.

(9)  Request assistance from the Taxpayer Advocate

The statute is tolled while the case is being worked by the Taxpayer Advocate’s office.

Unfortunately, I have been leaning on CDP hearings quite a bit in recent years, meaning that I am also extending my client’s CSED. I have one in my office as I write this, for example. I have lost hope that standard IRS procedure will resolve the matter, not to mention that IRS systems are operating sub-optimally during COVID. I am waiting for the procedural trigger (the “Final Notice. Notice of Intent to Levy and Notice of Your Rights to a Hearing”) allowing the appeal. I am not concerned about the CSED for this client, so the toll is insignificant.

There are advanced rules, of course. An example would be overlapping tolling periods. We are not going there in this post.

Let’s take an example of a toll.

You file your return on April 15, 2015. You request a payment plan on September 5, 2015. The IRS grants it on October 10, 2015. Somethings goes wobbly and the IRS terminates the plan. You request a Collection Due Process hearing on June 18, 2019. The hearing is resolved on November 25, 2019.

Let’s assume the IRS posting date is April 15, 2015.

Ten years is April 15, 2025.

It took 36 days to approve the payment plan.

The plan termination automatically adds 30 days.

The CDP took 161 days.

What do you have?

April 15, 2025 … plus 36 days is May 21, 2025.

Plus 30 days is June 20, 2025.

Plus 161 days is November 28, 2025.

BTW there are situations where one might extend the CSED separate and apart from the toll. Again, we are not going there in this post.

Advice from a practitioner: do not cut this razor sharp, especially if there are a lot of procedural transactions on the transcript. Some tax practitioners will routinely add 4 or 5 weeks to their calculation, for example. I add 30 days simply for requesting an installment payment plan, even though the toll is not required by the Internal Revenue Manual.  I have seen the IRS swoop-in when there are 6 months or so of CSED remaining, but not when there are 30 days.

Faxing A Return To The IRS

We recently prepared a couple of back California tax returns for a client.

The client had an accounting person who lived in California – at least on-and-off -for part of one year. The client itself is located in Tennessee and had little to do with California other than perhaps shipping product into the state. It is long-standing tax doctrine that having an employee in a state can subject a company to that state’s income tax, so I agreed that the client had to file for one year.

The second year was triggered by a one-off Form 1099 issued by someone in Los Angeles. The dollar amount was inconsequential, and I am still at a loss how California obtained this 1099 and why they burned the energy to trace it back to Tennessee. I am not convinced the client sold anything into California that second year. One could sell into Texas, for example, but have the check issued by corporate in Los Angeles.

The client did not care about the details. Just get California off their back.

California requested that we fax the returns to a unit rather than sending them through the regular system

And therein can exist a tax trap.

Let’s talk about it.

Seaview Trading LLC got itself into Tax Court for transacting in a tax shelter. The tax-gentle term is “listed transaction,” but you and I would just call it a shelter. At issue was a $35 million tax deduction, so we are talking big bucks.

The transaction happened in 2001.  The examination started in 2005. On July 27, 2005 the IRS sent Seaview a letter stating that it had never received its 2001 return.

Oh, oh.

This was a partnership, and for the year we are talking about there existed rather arcane audit rules. We will not need to get into the weeds about these rules, other than to say that failing to file a return was bad news for Seaview.

In 2005 Seaview’s accountant faxed a copy of the 2001 tax return to the IRS agent, stating that the return had been timely filed and that Seaview was providing a copy of what it had filed in 2002. He also included a certified mail receipt for the return.

The IRS maintained its position that it had never received the 2001 return. In 2010 the IRS issued its $35 million disallowance.

Fast forward to the Tax Court.

$35 million will do that.

The Court decided to review the case in two steps:

(1)  Did faxing the return to the agent in 2005 constitute “filing” the return?

(2)  If not, does the certified mail receipt constitute evidence of timely filing?

Personally, I would have reversed the order, as I consider certified mailing to be presumptive evidence of timely filing. That is why accountants recommend certified mail. It is less of an issue these days with electronic filing, but every now and then one may decide – or be required – to paper file. In that situation I would still recommend that one use certified mail.

The Court held that faxing the return to the agent did not constitute the filing of a return.

The tax literature observed and commented that faxing does not equal filing.

But there is a subtlety here: Seaview’s accountant indicated that he was supplying the agent a copy of a timely-filed 2001 return. By calling it a copy, the accountant was saying – at least indirectly – that the agent did not need to submit the return for regular processing. That said, it would be unfair for Seaview to later reverse course and argue that it intended for the agent to submit the return for processing.

The IRS won this round.

Now they go to round two: does the certified mail receipt provide Seaview with presumptive proof of timely mailing?

Seaview presents issues that we do not have with our client. We are not playing with listed transactions or obscure audit rules. California just wants its $800 minimum fee for a couple of years. They do not really care if our client actually owes. They want money.

Our administrative staff tried to fax the returns this past Friday but had problems with the fax number. I called the unit in California to explain the issue and discuss alternatives, but I never got to speak with an actual human being. I will try again (at least briefly; I have other things to do) on Monday. If California blows me off again, we will mail the returns.

I fear however that mailing the returns to general processing will cause issues, as the unit will probably issue some apocalyptic deathnote before gen pop routes the returns back to them. We will mail the returns to the specific unit and cross our fingers that not everyone there is “busy serving other customers.”

How I wish I had one of those jobs.

BTW, you can bet we will certify the mail.