A Tax Refund When The IRS Fails To Process A Return

I am looking at a case involving a tax refund. The IRS bounced it, and I am having a hard time figuring out what the IRS was thinking.

Let’s talk about it.

James Willetts filed an extension for his 2014 individual tax return. He sent a $8,000 payment and extended the return from April 15 to October 15, 2015.

Standard stuff.

He did not file the return by October 15, 2015.

Oh well.

He finally filed the 2014 return on April 14, 2018.

April 15, 2015 to April 14, 2018 is less than three years, and that is not even including the six-month extension on the 2014 return.

The IRS rejected the return because of potential identity theft.

I presume that the IRS sent a notice, but Willetts did not respond. The Court goes on to observe that it was unclear whether Willetts even knew there was an identity issue before bringing suit.

COMMENT: That struck me as odd, as one of the first things a tax professional would do is obtain a transcript of Willett’s tax account. I then noted that Willetts brought suit as “pro se,” generally interpreted as going to Court without professional representation. Technically, that is incorrect, as one can go to Court with a CPA and still be considered “pro se,” but, in Willetts’ case, I am inclined to believe he was truly pro se.

The issue before the Court was straight-forward: did Willetts file his return in time to get his refund?

Let’s go tax nerd for a moment:

(1)  A taxpayer may recoup a tax overpayment by filing a claim within a statutorily-prescribed period of time.

(2)  That period of time is:

a.    Three years from when the return was filed, if the return was filed within three years of when the return was due; otherwise

b.    … two years from when the tax was paid.

(3)  The three years in (2)(a) extends with a valid tax extension.

Let’s parse this.

(1) Willetts' 2014 tax return was due April 15, 2015.

(2) He had a valid extension until October 15, 2015.

(3) His three-year period for filing a refund claim would run – at a minimum - until April 15, 2018. Since he also had a valid extension, the extension period gets tacked-on. He therefore had until October 15, 2018 to file a refund claim within the three-year lookback period.

You can see where the IRS was coming from. It did not have a tax return in its system until after October 15, 2018.

However, Willetts filed - or at least attempted to file - a return on April 14, 2018. It wasn’t his fault that the IRS held up processing.

The Court made short work of this.

A tax return is deemed filed the day it is received by the IRS, regardless of whether it is accepted, processed, ignored or destroyed by the IRS. The IRS’ own records showed Willetts' return as received on May 2, 2018, well within the period ending October 15, 2018.

The return was filed timely. Willetts was due his refund.

I have a couple of observations:

(1)  I do not understand why the IRS pursued this. The rules here are bright-line. The IRS did not have a chance of winning; in fact, the case strikes me as borderline harassment. 

What concerns me is the mountain of paper returns – especially amended returns – waiting unopened and unprocessed at the IRS as I write this. Are we going to see Willetts-like foot-dragging by the IRS on those returns? Is the IRS going to force me to file with the Tax Court to get my clients their refunds?   

(2)  Let’s play what-if.  

Say that Willetts had filed his return on November 1, 2018, so that all parties would agree that he was outside the three-year lookback period. Once that happened, his refund would be limited to any taxes paid within the previous two years. His 2014 taxes would have been deemed paid on April 15, 2015, meaning that none, zero, zip of his 2014 taxes were paid within two years of November 1, 2018. There would be no refund. This, by the way, is the how-and-why people lose their tax refunds if they do not file their returns within three years.   

Our case this time was Willetts v Commissioner, Tax Court November 22, 2021.

Data Security And Your Tax Preparer

I annually reflect on what was unique about every tax season, other than this is a difficult profession. I can understand why accounting graduates increasingly dismiss public accounting as a career choice.

I am concerned with the increasing concentration of confidential information in an accounting office.

We have always had your name, address, birthdate and social security number.

Right there is big bucks to an Eastern European identity thief.

Riding the best-intentions train, you now have states – Tennessee comes to mind – that will not allow you to pay their (Hall) tax with a check. No sir, you have to have that bad boy drafted against your bank account. I understand Tennessee’s position – it is cheaper than handling a check – but I do not care about their position. How dare they coerce you to make it convenient for them to Soprano your money. If it is so much trouble, then stop taking the money!

You have no choice with those states.

So we have your bank information.

We now have additional “identity theft” safeguards. For example, some states require driver’s license information before you can file your return. Wow, I now have a copy of your driver’s license. And your spouse’s, if you are married.

Seems the government has shifted data protection responsibility to your friendly neighborhood tax preparer.

I did not want your data. I still don’t want it, but there it is - on my server.

Which can be carried away in an instant.

How hard would it be for someone to take down my office door, walk to the server, pull out all the wires and walk out with the thing?

And their goes your name, address, birth date, social security number, bank account information, driver’s license, those of your spouse and children, and who knows what else.

Identity thieves are spending way too much time hacking into Target and other major corporations.

It would be easier to break into CPA offices across the fruited plain. One person. One server. Repeat. You could probably knock out a dozen or two in a day.

Thank heavens our government is standing guard over all CPA firm servers in all the offices in all the cities across the land. 

Otherwise we would have reason to be concerned.

Can The IRS Use A Private Debt Collector Against You?

On December 4, 2015 the President signed into law a five- year $305 billion highway bill.

One of the contentious issues was the 18.4 cents per gallon gasoline tax. You know the politics: one side wanted to increase it and the other did not.  Unable to come to agreement, Congress looked elsewhere for the money.

One place they looked was the use of private debt collectors for IRS debt.

Ohio routinely farms out its tax collection to private agencies. Does it work? Well, let me answer the question this way: I usually request the file be returned to the Ohio Department of Taxation. Why? Because the collection agency could not care less whether the debt is accurate or not, whether the penalties are correctly calculated, or whether there is even a tax case to be collected. I have, for example, seen Ohio farm out collection on cases where the appeal period was still open. Although Ohio is not especially friendly to work with, they are better than dealing with a debt collector. You would be pressed to find too many Ohio tax CPAs that have positive opinions about this arrangement.

Congress has gone down this path before. The most recent collection program started in 2006 and ended in 2009. The program was widely considered a failure, as was its predecessor in 1996-1997. After accounting for commissions paid as well as internal IRS costs to administer, both programs actually caused losses for the Treasury.  

The National Taxpayer Advocate, Nina Olsen, expressed her feelings clearly to Congress:

Based on what I saw, I concluded the program undermined effective tax administration, jeopardized taxpayer rights protections, and did not accomplish its intended objective of raising revenue. Indeed, despite projections by the Treasury Department and the Joint Committee on Taxation that the program would raise more than $1 billion in revenue, the program wound up losing money. We have no reason to believe the result would be any different this time.”

The Federal Trade Commission routinely reports more complaints about debt collectors than any other industry. FTC chairwoman Edith Ramirez stated that over 280,000 federal complaints were filed in 2014 alone.

You know that Congress would not care.

Section 6306 of the highway bill requires the IRS to enter into collection contracts for the collection of certain inactive tax receivables, defined as:

·        A receivable removed from active inventory for lack of resources or because the taxpayer cannot be located;

·         A receivable where at least one-half of the statute of limitations period has expired and no IRS employee has been assigned; or

·        A receivable assigned for collection but at least one year has passed since taxpayer contact

Did you catch the use of the word “requires?” That is quite the departure from pre-existing law, which “authorizes” the IRS to use private debt collection agencies.

There are some exceptions, such as:

·        Pending or active offers in compromise or installment agreements

·        Innocent spouse

·        Deceased taxpayers

·        Minors

·        Taxpayers in designated combat zones

·        Taxpayers in examination or appeal

·        Victims of identity theft

The last one is disconcerting, especially after the Treasury Inspector General for Tax Administration reported in 2014 that it received over 90,000 complaints about scam telephone calls demanding payment from impostors claiming to be the IRS.  IRS Commissioner Koskinen cited the TIGTA report and reminded taxpayers that:

Taxpayers should remember their first contact with the IRS will not be a call from out of the blue, but through official correspondence sent through the mail.”

Well, that used to be true.

What Happens When Hacking Concerns Conflict With A State Electronic Payment Mandate?

Let’s travel to the Bay State for a taxpayer requesting reasonable cause against the imposition of penalties.  

The amount in dispute is $100.

Yes, you read that correctly.

Our protagonist is Jonathan Haar, and he lives in Massachusetts. On April 15, 2011 he had the audacity to file a paper extension and include a $19,517 check for his tax year 2010 state return. The paper extension and payment

“… did not comply with the requirements set forth in Technical Information Release (“TIR”) 04-30 (“TIR 04-30”), which states that if a payment accompanying an extension application equals $5,000 or more, such extension application and payment must be submitted electronically.”

Got it. The state says that it is less expensive to process electronic than paper tax filings and payments. Seems reasonable. How do we get people to follow along, however? One way is to make whatever the state wants mandatory.

Our protagonist unfortunately had travelled this path before, and he had been warned for tax year 2005 and penalized for year 2006.  Massachusetts had a tax recidivist! They assessed the above-mentioned $100 penalty on our ne-er-do-well.

If you were my client, I would have told you to pay the $100 and move on. Mr. Haar is not my client, and he refused to pay. He instead filed an appeal, which appeal went to the Massachusetts Appellate Tax Board.

His argument?

“Mr. Haar maintained that the Commissioner’s electronic payment mandate is a ‘serious invasion of both [his] privacy and [his] personal business practices,’ as it exposes his finances to risk of cyber attack.”

 “I intentionally do no electronic banking nor direct bill paying, I have none of my credit cards linked to my bank accounts directly and I think anyone who does any of the above is exposing themselves to multiple risks of cybercrime and identity theft.”

Mr. Haar further expressed doubts as to the security of the computer systems used by the Department of Revenue (“DOR”), noting that "if the Pentagon can be hacked," he had little confidence that DOR could protect his – or anyone’s – personal data from theft.

Massachusetts argued that it had the authority to mandate electronic filing and payment, as well as assess penalties if a taxpayer failed to comply with their filing and payment mandates. Massachusetts does recognize exceptions for reasonable cause, but its own Administrative Procedure 633 (“AP 633”) provides that

… the fact that a taxpayer does not own a computer or is uncomfortable with electronic data or funds transfer will not support a claim for reasonable cause.”

COMMENT: Call me quaint, but I would say that someone not having a computer is prima facie reasonable cause for not being able to file an electronic return or transfer funds electronically. The issue I see with AP 633 is its absolutism: the language “will not support” leaves no room. Why not say instead “generally will not support,” if only to allow space for unexpected fact patterns? 

In support of its position, the DOR trotted out two officials: the first was Robert Allard, a tax auditor. He pointed out that Mr. Haar filed an electronic return, presumably through a professional preparer. I suppose that Mr. Allard felt that if one could electronically file then one should be able to electronically pay. 

The second was Theresa O’Brien-Horan, a 26-year employee and Deputy Commissioner, who testified that

… the mandate at issue in this appeal – requiring individual taxpayers who apply for an extension with an accompanying payment of $5,000 or more to file and pay electronically – is helpful to DOR because it maximized up-front revenue intake.”

… the $5,000 threshold was chosen because it would ‘impact 17% of the taxpayers, but … get the money banked for 84% of the revenue.”

You can virtually feel the customer service vapor emanating from Ms O’Brien- Horan.

When asked whether reasonable cause was the Massachusetts equivalent of an ”opt out,” Ms. O’Brien-Horan answered “yes.”

OBSERVATION: The IRS, for example, prefers that one file an electronic return. The IRS however did not put the burden on the taxpayer; rather it put the burden on the preparer. If a preparer prepares more than a minimal number of returns annually, the preparer is required to file the returns electronically. This is awkward, as the return belongs to the taxpayer and not to the preparer. The preparer is not allowed to release any return – even to the IRS – without the taxpayer’s approval. What does the preparer do if the taxpayer does not grant approval? The preparer includes yet-another-form with the return indicating that the taxpayer has “opted out.” This prevents the IRS from penalizing the preparer for not filing electronically.

If Mr. Haar’s position was reasonable, then Mr. Haar could “opt out,” irrespective of any self-serving Massachusetts Administrative Procedure.

Ms. O’Brien-Horan just didn’t think that Mr. Haar was being reasonable.

But the Board did.

“Given his reference to the hacking of the Pentagon’s computer system, and in light of the many well-publicized instances of large-scale thefts of financial information following computer breaches at businesses and other institutions, and the appellant’s consistent practice of avoiding electronic payment of all his bills, including his tax obligations, the Board found that the appellant’s failure to utilize the Commissioner’s mandated electronic tax payment to be reasonable.”

Two things strike me immediately.

The first is the cause for concern comprising Mr. Haar’s argument. It had not occurred to me to off-grid all of one’s banking transactions, but he gives one pause. I recently read the following on www.marketwatch.com, for example:

A Russian gang has stolen 1.2 billion user names and their passwords as well as more than 500 million email addresses, the New York Times reports.

The information came from more than 400,000 websites, according to the Times, which says researchers at Milwaukee-based Hold Security discovered the cyber heist.

Mr. Haar is highly cautious. His position is somewhat eccentric but not unfounded. A reasonable tax collection agency would have granted him this one and moved on.  

The second is the inanity of Massachusetts DOR. Rather than abate a $100 penalty, it preferred to pursue the matter, at who knows what cost to state and citizens. We know that cost would include Mr. Allard and Ms O’Brien-Horan’s payroll, not to mention that of their superiors, legal counsel and who-knows-what else. I can understand not wanting to set a precedent, but … really? My take is that the DOR is too well-funded if they have the time and money to pursue nonsense like this. Perhaps DOR budgets cutbacks are in order for Massachusetts.

State Tax Refunds And Debit Cards

I have noticed that more and more states are increasingly requiring individual income tax refunds to be electronically deposited or received on a debit card.

What got me thinking about this is Virginia’s decision to require electronic refunds, beginning with the 2013 tax season.  One can have his/her refund electronically deposited or loaded onto a debit card. There will be no physical checks.

Virginia is joining Louisiana and Oklahoma with its electronic refund/debit card policy.

I find myself recalling IRS issues with identity theft and debit cards this past filing season. The IRS has estimated that more than $5 billion was refunded to identity thieves in 2011.   A majority of these cases used direct deposits, including debit cards. Thieves prefer debit cards to a paper check, which may require a photo ID matching the taxpayer’s name to cash it. Makes sense.

So what does the identity thief need? He needs a name and social security number, preferably from someone who will not be filing a tax return. An address would also be nice. Find a foreclosed house. Maybe put a new mailbox on it. The thief fills out a tax return, making up the wages, withholdings and so on. As long as he is the first person using the identity for the tax year, it is – as one U.S. Attorney phrased it – a “remarkably simple crime to commit.” Couple this with a hard-to-trace debit card, and the IRS is almost sending cash through the mail.

Do you find yourself wondering how it is cheaper for a state to issue debit cards rather than a physical check? Say that Kentucky issues 1,200,000 refunds using physical checks. Kentucky has the cost of the checks, plus equipment, personnel costs and postage. If Kentucky associates with a debit-card-issuing institution (I am thinking the to-be-formed Hamilton Bank of the Bluegrass, as an example), they instead send one transfer to The Hamilton Bank, as well as a data base of the individual refunds. No mess, no fuss. One can see the savings to Kentucky.

I would – I mean The Hamilton Bank of the Bluegrass would – issue the debit cards. How does The Hamilton Bank make money? First, there would be the float while the debit cards carry balances. Second, there could be merchant fees upon use of the card. Third, The Hamilton Bank would allow one to withdraw cash, but only at conveniently-located-Hamilton-Bank-ATM locations in greater Cincinnati, northern Kentucky and the Bluegrass. Any other ATM’s would trigger a fee. Fourth, The Hamilton Bank would charge fees for inactivity, replacement cards and etc.  I am thinking this could be a sweet deal for me, er… I mean The Hamilton Bank of the Bluegrass.

Kidding aside, I do understand the states’ interest in moving tax administration to an all-electronic format. Practitioners have already seen some of the advantages of electronic processing: verification of receipt and filing, record of filings and payments, transcript deliveries and etc. Electronic refunds fit into this structure. However, the government cannot electronically refund to someone who does not have a bank account, which is how we wind up talking about preloaded debit cards.