Not Quite The Informal Claim Doctrine

 

I am looking at a district court opinion from Illinois.

I find the discussion of the numbers a bit confusing. It happens sometimes.

But there something here we should talk about.

We have recently discussed the tax concept of a “claim.” In normal-person-speak, it means you want the government to refund your money. The classic claim is an amended income tax return, but there can be claims for other-than-income taxes. It is its own niche, as using the wrong form can result in having your claim rejected.

Let’s look at the American Guardian Holdings case.

AGH filed its 2015 tax return on September 19, 2016.

Here are the numbers on the original tax return:     

	Original
Revenues	152,092,338
Taxable income	4,880,521
Tax	1,327,806

 The accountant found an error and amended the return on June 6, 2019.

			First
	Original		Original	Amended
Revenues	152,092,338		152,092,338	154,808,792
Taxable income	4,880,521		4,880,521	11,084,397
Tax	1,327,806		1,327,806	148,243
Refund				(1,179,563)

Let me see: The 2015 return would have been extended to October 15, 2016. The amended return was prepared June 6, 2019. Yep, we are within the statute of limitations.

Problem: AGH never sent the amended return.

Answer: AGH hired a new accountant.

The new accountant filed an amended return on September 19, 2019.

COMMENT: Still a few days left on the statute.

For some reason, the accountant incorporated the first amended (even though it had not been filed) into the second amended, resulting in the following hodgepodge:

		First		Second
		Original	Amended	Original	Amended
Revenues		154,808,792	141,773,572	154,808,792	?
Taxable income		11,084,397	7,446,746	11,084,397	?
Tax		1,327,806	148,243	1,327,806	0
Refund			(1,179,563)		(148,243)
Total refund					(1,327,806)

Huh? I would find that second amended confusing. On first impression it appears that AGH is filing a claim for $148,243, but that is incorrect. AGH was stacking the second amended on top of its first. AGH is filing a claim for $1,327,806, which is the entire tax on the original return.

Not surprisingly, the IRS also responded with “huh?” It could not process the second amended return because the “Original” numbers did not match its records.

AGH responded by filing yet another amended return (third amended). Mind you, at this point it was after October 15, 2019, and the statute of limitations was in the rear view mirror.

AGH did the following:

(1)  AGH explained that the new and shiny (third) amended return incorporated the previously (non-filed) first amended return and the second (actually filed) amended return. As a consequence, the “previously-filed amended return for 2015 should be discarded.”

COMMENT: NO! 

(2)  AGH further explained that it was filing Form 1120-PC (a specialized tax form for property and casualty insurance companies) as its third amended return rather than the Form 1120 originally filed because it had received permission to change its method of accounting.

COMMENT: NO!!

I am somewhat shocked at how deep a hole AGH had dug, and more shocked that it kept digging.

Let’s go through the wreckage:

(1)  AGH filed its (second) amended return/claim within the statute of limitations.

(2)  This creates an issue if the claim is imperfect, as one would be perfecting the claim AFTER the statute expires. Fortunately, there is a way (called the informal claim doctrine) that allows one to perfect a claim after the original filing date and still retain the benefit of that original date. 

(3)  The IRS immediately seized on the “previously-filed amended return for 2015 should be discarded” statement to argue that AGH had violated the informal claim doctrine.  If the second amended return was discarded, there was no timely-filed return to which the informal claim doctrine could attach. Fortunately, the Court decided that the use of the word “discard” did not actually mean what it sounded like. AGH dodged a bullet, but it should never have fired.

(4)  That leaves the third amended return, which was filed after the statute expired. AGH of course argued informal claim, but it had committed a fatal act by changing its method of accounting. You see, the informal claim allows one to clarify, document and explain whatever issue is vague or in dispute within the claim at issue. What one is not allowed to do is to change the facts. AGH had changed the facts by changing its method of accounting, meaning its third amended return could not be linked to the second via the informal claim doctrine.

(5)  Standing on its own, the third amended of course failed as it was filed after the statute had expired.    

This case is a nightmare. I am curious whether there was a CPA or law firm involved; if so, a malpractice suit is almost a given. If the work was done in-house, then … AGH needs to tighten up its hiring standards. The case reads like there were no adults in the room.

All is not lost for AGH, however.

Remember that AGH filed its second amended return within the statute of limitations.  The matter then went off the rails and the Court booted the third amended return.

But that leaves the second amended. Can AGH resuscitate it, as technically the Court dismissed the third claim but not necessarily the second?  It would likely require additional litigation and associated legal fees, and I would expect the IRS to fight tooth and nail. AGH would have to weigh the cost-benefit.

Our case this time was American Guardian Holdings, Inc v United States of America, No. 1:2023cv 01482, Northern District of Illinois.

Incorrect Submission Leads to Dismissal of Refund Claim

 

You should be able to talk with someone at the IRS and work it out over the phone.”

I have lost track of how many times I have heard that over the years.

I do not disagree, and sometimes it works out. Many times it does not, and we recently went through a multi-year period when the IRS was barely working at all.

There are areas of tax practice that are riddled with landmines. Procedure - when certain things have to be done in a certain way or within a certain timeframe – is one of them. Ignore those letters long enough and you have an invitation to Tax Court. You do not have to go, but the IRS will – and automatically win.

I was looking at a case recently involving a claim.

Tax practitioners generally know claims under a different term – an amended return. If you amend your individual tax return for a refund, you use Form 1040X, for example.

There are certain taxes, including penalties and interest, however, for which you will use a different form. 

Frankly, one can have a lengthy career and rarely use this form. It depends – of course – on one’s clients and their tax situations.

And yes, there is a serious procedural trap here – two, in fact. If you use this form but the IRS has instructed use of a different form, the 843 claim will be invalid. You will be requested to resubmit the claim using the correct form. By itself it is little more than an annoyance, unless one is close to the expiration of the statute of limitations. If that statute expires before you file the correct form, you are out of luck.

There is another trap.

Let’s look at the Vensure case.

Vensure is a professional employer organization, or PEO. This means that they perform HR, including payroll responsibilities, for their clients. They will, for example, issue your paycheck and send you a W-2 at the end of the tax year.

Vensure had a client that stiffed them for approximately $4 million. As you can imagine, this put Vensure in a precarious financial situation, and they had trouble making timely payroll tax deposits in later quarters.

I bet.

Vensure did two things:

(1)  They filed amended payroll tax returns (Forms 941X) for refund of payroll taxes remitted to the IRS on behalf of their deadbeat client.

(2)  They submitted Forms 843 for refund of penalties paid over the span of six quarters (payroll taxes are filed quarterly).

Notice two things:

(1)  The claim for refund of the payroll taxes themselves was filed on Form 941X, as the IRS has said that is the proper form to use.

(2)  The claim for refund of the penalties on those taxes was filed on Form 843, as the IRS has said that is the proper form for the refund or abatement of penalties, interest, and other additions to tax.

Vensure’s attorney prepared the 843s. Having a power of attorney on file with the IRS, the attorney signed the forms on behalf of the taxpayer, as well as signing as the paid preparer. He did not attach a copy of the power to the 843, however, figuring that the IRS already had it on file.

Makes sense.

But procedure sometimes makes no sense.

Take a look at the following instructions to Form 843:

You can file Form 843 or your authorized representative can file it for you. If your authorized representative files Form 843, the original or copy of Form 2848, Power of Attorney and Declaration of Representative, must be attached. You must sign Form 2848 and authorize the representative to act on your behalf for the purposes of the request.” 

The IRS bounced the claims.

The taxpayer took the IRS to court.

The IRS had a two-step argument:

(1) For a refund claim to be duly filed, the claim’s statement of the facts and grounds for refund must be verified by a written declaration that it is made under penalties of perjury. A claim which does not comply with this requirement will not be considered for any purpose as a claim for refund or credit. 

(2)  Next take a look at Reg 301.6402-2(c):  

Form for filing claim. If a particular form is prescribed on which the claim must be made, then the claim must be made on the form so prescribed. For special rules applicable to refunds of income taxes, see §301.6402-3. For provisions relating to credits and refunds of taxes other than income tax, see the regulations relating to the particular tax. All claims by taxpayers for the refund of taxes, interest, penalties, and additions to tax that are not otherwise provided for must be made on Form 843, "Claim for Refund and Request for Abatement."

Cutting through the legalese, claims made on Form 843 must follow the instructions for Form 843, one of which is the requirement for an original or copy of Form 2848 to be attached.

Vensure of course argued that it substantially complied, as a copy of the power was on file with the IRS.

Not good enough, said the Court:

The court agrees with the defendant that the signature and verification requirements for Form 843 claims for refund are statutory.”

Vensure lost on grounds of procedure.

Is it fair?

There are areas in tax practice where things must be done in a certain way, in a certain order and within a certain time.

Fair has nothing to do with it.

Our case this time was Vensure HR, Inc v The United States, No 20-728T, 2023 U.S. Claims.

Why You Always Use Certified-Mail For A Paper-Filed Return

Just about all tax returns are moving to electronic filing.

It makes sense. Our server sends a return to the government server, starting the automated processing of the return. Minimal manpower, highly automated, more efficient.

COMMENT: Electronic filing however does allow states and other filing authorities to include filing “bombs,” which can be very frustrating. We had a bomb recently with the District of Columbia. It could have been resolved – should have, in fact – but that would have required someone in D.C.  to answer our e-mail request or telephone call. Belatedly realizing this was a bar too high, we called the client to inform them of a change in plans. We would be paper filing instead.

Sometimes a state will say they never received a return. Our software maintains log events, such as electronic transmission of returns and their acceptance by the taxing authority. Tennessee has done this over the last few years as they updated some of their systems. Fortunately, the matter generally resolves when we present proof of electronic filing.

Do you remember when – not too many years ago – standard professional advice was to send tax returns using either certified or registered mail? That was that era’s equivalent of today’s electronic filing. We used to, back in the Stone Age, send our April 15^th individual extensions as follows:

·      Include multiple extensions per envelope. There could be several envelopes depending on the number of extensions.

·      Include a cover sheet detailing the extensions included in the envelope.

·      Certify the mailing of the envelope.

The problem with this procedure is that it could be abused. One could mail an empty envelope to the IRS, certifying the same. If any question came up, one could point to that envelope as “proof” of whatever. I do not know how often this happened in practice, but I recall having this very conversation with IRS representatives.

This reminds me of a recent case dealing with an issue arising from putting a paper-filed return in the mail. As we move exclusively to electronic filing, this issue will transition to history – along with rotary phones and rolodexes.

Let’s talk about the Pond case.

The IRS audited Stephen Pond’s return and made a mistake, concluding that Pond had underpaid his taxes. Pond paid the notice for tax due and interest on the 2012 tax year. The matter also affected 2013, so Pond overpaid his taxes for that year also. Pond’s accountant caught the mistake and filed for a refund for both years.

The accountant did the following:

(1)  He mailed the 2012 and 2013 tax refund claims in the same envelope to Holtsville, New York.

(2) He mailed a claim for refund of overpaid 2012 interest to Covington, Kentucky, which in turn forwarded the matter to Andover, Massachusetts.

Andover responded first. It wanted proof of the underlying 2012 filing (as the overpaid interest was for 2012). It took a while, but Pond eventually received his 2012 refund, including interest.

Time passed. There was no word about 2013. Pond contacted the IRS and was told the IRS never received the 2013 amended return.

COMMENT: While not said, I have a very good guess what happened. The IRS has had a penchant for stapling together whatever arrives in a single envelope. For years I have recommended separate envelopes for separate returns, as I was concerned about this possibility. It raised the cost of mailing, but I was trying to avoid the staple-everything-together scenario.

Pond sent a duplicate copy of his 2013 amended return.

Months went by. Crickets.

Pond contacted Holtsville and was informed that the IRS had closed the 2013 file.

Oh, oh.

A couple of weeks later Pond received the formal notice that the IRS was denying 2013 because it had been filed after statute of limitations had run.

Pond filed a formal protest. He filed with Appeals. He eventually brought suit in district court. The district court held against Pond, so he is now in Appeals Court.

This is tax arcana here that we will summarize.

     (1)  The general way to satisfy a statutory filing requirement is physical delivery.

(2)  Mail can constitute physical delivery.

a.    However, things can happen after one drops an envelope into the mailbox. The post office can lose it, for example. It would be unfair to hold someone responsible for a post office error, so physical delivery has a “mailbox” subrule:

If one can prove that an item was mailed, the subrule presumes that the item was timely delivered.

NOTE: Mind you, one still must prove that one timely put the item in the mail.

(3)  Congress codified the mailbox rule in 1954 via Section 7502. That section first included certified and registered mail as acceptable proof of filing, and the rule has been expanded over the years to include private delivery services and electronic filing.

(4) The question before the Court was whether Section 7502 supplanted prior common law (physical delivery, mailbox rule) or rather was supplementary to it.

a.    Believe it or not, the courts have split on this issue.

b.    What difference does it make? Let me give an example.      

There is an envelope bearing a postmark date of October 5, 20XX (that is, before the October 15^th extension deadline). The mail was not certified, registered, or delivered by an approved private delivery service.

If Section 7502 supplanted common law, then one could not point to that October 5 date as proof of timely filing. The only protected filings are certified or registered mail, private delivery service or electronic filing.

If Section 7502 supplemented but did not override common law, then that October 5 date would suffice as proof of timely mailing.

Let’s fast forward. The Appeals Court determined that Pond did not qualify under the safe harbors of Section 7502, as he did not use certified or registered mail. He could still prove his case under common law, however. Appeals remanded the case to the District Court, and Pond will have his opportunity to prove physical delivery.

My thoughts?

If you are paper filing – especially for a refund - always, always certify the mailing. Mind you, electronic filing is better, but let’s assume that electronic filing is not available for your unique filing situation. Pond did not do this and look at the nightmare he is going through.

Our case this time was Stephen K Pond v U.S., Docket No 22-1537, CA4, May 26, 2023.

 

A Firefighter Sues

The taxation of legal settlements can be maddening.

The general rule is found in IRC Section 61, which can be colloquially summarized as:

If it breathes, moves, or eats, it is taxable.

Then come the exceptions.

The Code begins with a broad rule, and then you must find and fit into an exception to avoid taxability. A big exception for legal settlements is Section 104(a)(2):

        § 104 Compensation for injuries or sickness.

(a)  In general.

Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include-

(1)  amounts received under workmen's compensation acts as compensation for personal injuries or sickness;

(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;

What can we learn here?

(1) The Code does not care whether the judge decides or if the parties instead come to an agreement.  

(2)  It does not care if one gets paid in a lump sum or in a series of payments.

(3) It cares very much that the settlement is for something physical – whether injury or sickness.  

What about something nonphysical, such as mental or emotional distress?

Reviewing the history of the Code helps here, as we learn that the Code was changed in 1996 to clarify that mental and emotional injury settlements are excludable from income only if they arose from physical injury or sickness.

This gives the following rule of thumb:

          Physical               =       nontaxable

          Nonphysical        =       taxable      

The attorney must be aware of the above demarcation and wordsmith accordingly if some or all the settlement is for nonphysical damages. 

Can it be done?

Let’s look at the Montes case.

Suzanne Montes wanted to be a firefighter since she was a little girl. She was one of the few women to pass the exam to get into the San Francisco Fire Academy. She then was one of the few women to graduate from the program.

Good for her.

In 2016 she received a sweet assignment to a firehouse in downtown San Francisco.

You may know that firefighters work as a team and in 24-hour shifts. There are about 10 shifts per month, so they spend a LOT of time together. Suzanne was a woman. The remainder of the team were men. Many did not welcome her. First came the disparaging comments, then sabotaging her equipment, then doing - I do not know what specifically and I do not want to know – “disgusting and extremely unsanitary” things to her personal property and effects.

Thanks, guys, for painting men as knuckle-dragging Neanderthals. Way to represent the team.

She complained.

She sued.

She won approximately $380 grand.

Good.

She went to a CPA when it was time to file. The CPA advised that the $380 grand was not taxable.

Even better.

You know the IRS balked, as we are looking at a Tax Court case.

The IRS’s first argument?

Start with the complaint, which claimed sex discrimination and retaliation, including the intentional infliction of emotional distress.

There are no allegations of physical disease or harm to her in the complaint.”

We are not seeing the magic words here: physical injury, physical sickness or micrato raepy sathonich.

Hopefully her attorney salvaged this in the settlement agreement.

Here is the Court:

Our detective work here begins and ends with the settlement agreement.”

Oh oh.

There are no allegations of physical injury …, and indeed, in the summary of the complaint it says, ‘She has lost compensation for which she would have been entitled. She has suffered from emotional distress, embarrassment, and humiliation and her prospects for career advancement have been diminished.’”

No magic words.

Yep, she lost her case. The settlement was taxable.

The Court did hand her a small victory, though. Penalties did not apply because she took a reasonable position based on the advice of a CPA.

Our case this time was Montes v Commissioner, Docket No. 17332-21, June 29, 2023.