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).

Penalty Abatement For Preparer Errors

 

I was looking over a law review article weighing the pros and cons of different types of Tax Court decisions.

Nerd train, I admit.

But there is something here to talk about.

There are several types of Tax Court opinions. Some have precedential value, and some do not. Precedence means that a Court applies the law in the same manner to cases with the same facts.

One type is a Memorandum opinion. These tend to be heavily factual, and they involve relatively well-settled law.

Another is the Summary (or S) opinion. These involve a relatively modest amount of tax (currently $50 grand) and use a streamlined set of procedures.

The reason for different types of opinion is grounded in practicality. Memo opinions allow the Court to process more clear-cut cases without worrying about establishing unanticipated precedent. The S opinions allow taxpayers a forum without having to hire an attorney to navigate cumbersome Tax Court procedural rules.

I am looking at a case decided as a bench opinion. 

Think about the judge issuing an oral opinion right there and then and you have a bench opinion.

And these types can be combined. A judge may, for example, issue a bench opinion in a memo or S case.

I am looking at something I know all too well.

Mr. Trammer was an IT consultant.

Mrs. Trammer was a social worker.

Mr. Trammer worked primarily from home. Depending upon, he was paid as a W-2 employee or as a 1099 gig worker. He had an office-in-home and all that.

Mrs. Trammer was a W-2 employee. She drove around Michigan visiting childcare and foster care locations. She at times would purchase gifts for the kids.

She sounds like a good person.

They reported all kinds of deductions on their 2019 and 2020 returns: business deductions for the gig, employee business deductions for the social work, charitable deductions for the church.

If you recall, many itemized deductions were reduced or eliminated altogether beginning in 2018.

No surprise, the IRS disallowed a swath of deductions. Some – like employee business deductions – simply did not exist for the tax year at issue. Others – like office-in-home for the gig – had calculation errors.

Got it. They need to dig up documentation. They should immediately concede on the calculation error and employee expenses. The matter should be resolved as routine in correspondence exam.

Off to Tax Court they went.

Huh?

Upon reflection, this makes sense. The IRS and Covid did not play well together. They were not answering the phones over there. Faxing supporting documentation to the AUR Unit was often a joke. I suspect this matter went to Court by default.

Here we go:

The Trammers relied on a paid return preparer to prepare their returns for the years at issue. Although the individual return preparers identified on the 2019 and 2020 returns differed, the Trammers used the same preparation firm for both years.”

That does not sound like a CPA firm. Granted, I prepare only a fraction of returns I sign - staff accountants generally prepare - but I do review all returns before signing. 

Each year, they brought their records … who decided what items to report on the Trammers’ return and where.”

Yep.

The returns contained obvious errors such as reporting the same expense in multiple places.”

The old list-the-same-thing-over-and-over routine. Often these returns are not complex, but the preparer must be diligent when moving numbers. It consequently is common to give these returns to more experienced staff. Ideal would be to give the return to the same experienced staff every year.

The Court made short work of the returns.

Schedule C/Gig work

They failed to demonstrate the amount of expenses that they incurred or the business purposes for those expense, and they did not provide sufficient evidence from which the Court could formulate an estimate.”

Form 2106/employee business expenses

… the Trammers failed to substantiate the expenses Mrs. Trammer incurred in the conduct of her social work.”

Schedule A/Itemized Deductions

The Trammers failed to substantiate itemized deductions in excess of the standard deduction amounts that the Commissioner allowed…”

The IRS wanted penalties. They always do.

Not his time. Here is the Court:

The Trammers relied on a return preparer to whom they had been referred. They supplied the return preparer with necessary and accurate information each year, and the return preparer decided what to do with that information. The Trammers reasonably relied in good faith on their return preparer’s judgement. Accordingly, the section 6662 accuracy-related penalty does not apply for the years in issue.”

I am impressed, as I was expecting a rubber stamp.

What was different this time?

For one thing, Mr. Trammer showed up for the trial, and Mrs. Trammer participated via conference call. This gave them a chance to humanize their situation. While not conceding the errors, the Court did believe them when they said they tried. The Court, however, was not as kind to the preparer.

And remember: the next person cannot use this case (technically) as precedent in a future penalty. The Court had room to be lenient.

Our case this time was Trammer v Commissioner, TC Bench Order March 14, 2023.

You Have To Look At Your Return

I am looking at a case that covers relatively well-trod ground. It did however remind me of a client from around 20 years ago. I got a different result than the taxpayer did in this case, but I suspect part of the reason is the IRS becoming noticeably more overbearing with penalties over the last two decades.

Anna Walton is a psychologist. In 2014 the firm where she worked informed her that their interests had diverged. This of course is jargon for termination, and she transitioned to her own firm with multiple clients, including Brown University and the National Geographic Society.

 Having multiple clients meant that she received multiple Forms 1099 at the end of the year. It is a poor idea to blow these off, as the IRS uses the 1099s for computer matching of reported income. Report less income than the 1099s on file and you can anticipate an automated notice from the IRS.

Let’s roll to January, 2016 and Ms Walton was looking at her 2015 records. She e-mailed her accountant of approximately 20 years that the practice had approximately $525 grand in revenues. The accountant used that number to arrive at an estimated tax payment.

So far there is no big deal.

She later sent her tax stuff in. A staff accountant working at the firm noted that the 1099s she remitted only added-up to approximately $351 grand. Cross-referencing the $525 grand e-mail, the accountant asked whether Ms Walton had or was expecting other 1099s. She also asked about other stuff, such as contributions, tuition plans and whatnot going into the tax return.

COMMENT: In case you are wondering, it is quite unlikely that your accountant personally prepares your tax return. It is more likely that he/she hires someone to prepare your return, including questions, and then reviews the draft return once fully or mostly prepared. I for example prepare very few returns, but I review a ton. There are not enough hours in the day for me to work with as many returns as I do if I also had to prepare them.

Ms Walton responded to the accountant but blew-off the 1099 question.

The accountant asked again.

Ms Walton blew her off again.

I think you get the drift.

The accountant prepared the return with the information available. The IRS caught the underreporting of 1099 income. The IRS wanted tax. It also wanted penalties.

Ms Walton agreed to the tax, but she did not think she should owe penalties.

Off to Tax Court they went

Her argument was easy: she relied on her accountant.

Folks, there are prerequisites to the reliance argument. For example, one has to provide all necessary information to the accountant. Secondly, that reliance is moot if even the most cursory review of the return would alert the average person to errors on the return.

The Court was quite curious why Ms Walton did not inquire why the return showed approximately one-third less revenues than she herself had previously told the accountant.

I also suspect that the Court did not take kindly to Ms Walton repetitively blowing-off the staff accountant. The repeated questioning would have/should have alerted a reasonable person that more attention was required on the matter.

The Court decided that she did not have reasonable cause to abate the penalty.

I agree.

My client back in the antediluvian days?

He left $3.5 million off his return.

The IRS wanted tax and penalties.

I argued the penalties.

What was my argument?

The client reported so much income from so many sources that $3.5 million could reasonably have been overlooked on that year’s return.

I wish I had a personal tax return like that.

I got penalty abatement, by the way.

Our case this time was Walton v Commissioner, T.C. Memo 2021-40.