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.

Taxpayer Wins Refund Despite Using Wrong Form

Let’s look at a case that comes out of Cincinnati.

E. John Rewwer (Rewwer) had a professional practice which he reported on Schedule C (proprietorship/disregarded entity) of his personal return.

He got audited for years 2007 through 2009.

The IRS disallowed expenses and assessed the following in taxes, interest and penalties:

           2007            $  15,041

           2008            $137,718

           2009            $ 55,299

Rewwer paid the assessments.

He then filed a claim for refund for those years. More specifically his attorney filed and signed the refund claims, including the following explanation:

The IRS did not properly consider documentation of my expenses during my income tax audit. I would ask that the IRS reopen the audit, reconsider my documentation, and refund the amounts paid as a result of the erroneous audit adjustments, including any penalty and interest that may have accrued.”

I am not certain which expense categories the IRS denied, but I get it. I have a similar (enough) client who got audited for 2016. IRS Holtsville disallowed virtually every significant expense despite being provided a phonebook of Excel schedules, receipts and other documentation.  We took the matter to Appeals and then to Tax Court. I could see some expenses being disallowed (for example, travel and entertainment expenses are notoriously difficult to document), but not entire categories of expenses. That told me loud and clear that someone at IRS Holtsville could care less about doing their job properly.

Wouldn’t you know that our client is being examined again for 2018? Despite taking the better part of a day faxing audit documentation to IRS Holtsville, we are back in Tax Court.  And I feel the same way about 2018 as I did about 2016: someone at the IRS has been assigned work above their skill level.

Back to Rewwer.

The attorney:

(1)  Sent in claims for refund on Form 843, and

(2)  Signed the claims for refunds.

Let’s take these points in reverse order.

An attorney or CPA cannot sign a return for you without having a power of attorney accompanying the claim. Our standard powers here at Galactic Command, for example, do not authorize me/us to sign returns for a client. We would have to customize the power to permit such authority, and I will rarely agree to do so. The last time I remember doing this was for nonresident clients with U.S. filing requirements. Mail time to and from could approach the ridiculous, and some of the international forms are not cleared for electronic filing.

Rewwer’s claims were not valid until the signature and/or power of attorney matter was resolved.

Look at this Code section for the second point:

§ 301.6402-3 Special rules applicable to income tax.

(a) The following rules apply to a claim for credit or refund of income tax: -

(1) In general, in the case of an overpayment of income taxes, a claim for credit or refund of such overpayment shall be made on the appropriate income tax return.

(2) In the case of an overpayment of income taxes for a taxable year of an individual for which a Form 1040 or 1040A has been filed, a claim for refund shall be made on Form 1040X (“Amended U.S. Individual Income Tax Return”).

Yep, there is actually a Code section for which form one is supposed to use. The attorney used the wrong form.

For some reason, the IRS allowed 2008 but denied the other two years.

The IRS delayed for a couple of years. The attorney, realizing that the statute of limitations was about to expire, filed suit.

This presented a window to correct the signature/power of attorney issue as part of the trial process.

To which the IRS cried foul: the taxpayer had not filed a valid refund claim (i.e., wrong form), so the claim was invalid and could not be later perfected. Without a valid claim, the IRS claimed sovereign immunity (the king cannot be sued without agreement and the king did not so agree).

The IRS had a point.

But the taxpayer argued that he had met the “informal claim” requirements and should be allowed to perfect his claim.

The Supreme Court has allowed imperfect claims to be treated as informal claims when:

(1) The claim is written

(2)  The claim adequately tells the IRS why a refund is sought, and

(3)  The claim adequately tells the IRS for what year(s) the claim is sought.

The point to an informal claim is that technical deficiencies with the claim can be remedied – even after the normal statute of limitations - as long as the informal claim is filed before the statute expires.

As part of the litigation, Rewwer refiled years 2007 and 2009 on Forms 1040X, as the Regulations require. This also provided opportunity to sign the returns (and power of attorney, for that matter), thereby perfecting the earlier-filed claims.

Question: did the Court accept Rewwer’s informal claim argument?

Answer: the Court did.

OBSERVATION: How did the Court skip over the fact that the claims – informal or not – were not properly signed? The IRS did that to itself. At no time did the IRS deny the claims for of lack of signatures or an incomplete power of attorney. The Court refused to allow the IRS to raise this argument after-the-fact to the taxpayer’s disadvantage: a legal principle referred to as “estoppel.”  

Look however at the work it took to get the IRS to consider/reconsider Rewwer’s exam documentation for 2007 and 2009. Seems excessive, I think.

Our case this time was E. John Rewwer v United States, U.S. District Court, S.D. Ohio. 

COMMENT: If you are wondering why the “United States” rather than the usual “Commissioner, IRS,” the reason is that tax refund litigation in federal district courts is handled by the Tax Division of the Department of Justice.

A CPA’s Signature And The Informal Claim Doctrine

 

I am looking at case where the CPA signed a return on behalf of a client.

Been there and done that.

There is a hard-and-fast rule when you do this.

Let’s go through it.

The Mattsons were working in Australia for the Raytheon Corporation.

In April, 2017 they timely filed their 2016 individual tax return, paying $21,190 in federal taxes.

COMMENT: This immediately strikes me as odd. I would have anticipated a foreign income exclusion. Maybe they were over the exclusion limit, meaning that some of their income was exposed to U.S. tax. Even so, I would then have expected a foreign tax credit, offsetting U.S. tax by taxes paid to Australia.

Turns out they had signed a closing agreement when they went to Australia. The agreement was with the IRS, and they waived their right to claim the foreign income exclusion.

Ahh, that answers my first question.

Why would they do this?

In return for agreeing not to claim the 911 exclusion, the government of Australia has entered into an agreement with the United States Government not to subject the income earned by the taxpayer to Australian taxes."

Yep, there are advantages to working with the big company. It also answers my second question.

Seems to me that we are done here. Taxpayers paid taxes on their Australian wages solely to the United States. In exchange they forwent the foreign income exclusion. Makes sense.

The Mattsons changed CPA firms. The new firm prepared an amended 2016 return for – you guessed it – the foreign income exclusion.

COMMENT: I presume the new firm did not know about the closing agreement.

A CPA at the firm signed the amended return on behalf of the Mattsons.

No problem, but she did not attach a power of attorney authorizing the CPA to sign the return.

Not good, but there is time to fix this.

The IRS held the amended return and sent a letter wanting to know why the Mattsons had taken a position contrary to the closing agreement.

Me too.

In May, 2019 the CPA firm requested an Appeals hearing.

OK.

In July, 2019 the IRS sent a letter that they were disallowing the refund.

The taxpayers filed suit in Court.

To me, the controversy was done with discovery of the closing agreement. There is a Don Quixote quality to this story once that fact came to light.

There is a requirement in the tax Code and a list of cases as long as my arm that taxpayers have to sign a return, especially a claim (that is, a return requesting a refund). A CPA can sign the return on behalf of a client, but the CPA is charged with attaching a copy of a power of attorney to the return.

Hold on, argued the CPA. We sent a power of attorney to the IRS in November, 2018.

This is new information.

And it introduces the “informal claim” doctrine to our discussion.

The idea is that the taxpayer can correct the defect in a claim. That is what “informal” means in this context – think of the first claim as a placeholder until it is perfected. The CPA firm had failed to initially attach a power of attorney, but it subsequently corrected this error in November, 2018.

Issue: the claim has to be perfected BEFORE the start of a lawsuit.

Fact One: the lawsuit was filed in July, 2019.

Fact Two: the power was sent to the IRS in November, 2018.

Reasoning: the dates work.

Question: did the taxpayer correct their claim in time?

I sign powers of attorney all the time. I doubt I go a week without filing at least one with the IRS. I like to explain to clients (unless they have been through the process before) what the limitations are to a standard tax power of attorney. I can call the IRS, request and/or agree to adjustments or stays, and so forth.

However, what our standard power does not do is allow me to sign the return. A client can give me that authority, true, but is has to be separately stated on the power. Our routine powers here at Galactic Command, for example, do not include the authority to sign a return on behalf of a client. In truth, unless there are exceptional circumstances, I do not want that authority. I don’t want to receive a client’s refund check, either.

I can almost visualize what happened.

The CPA signed the return. She knew that she needed a power, so she – or a staff accountant – generated one from their software. It was a default power, the one they – like we – use in almost all cases. No one paused to consider that the default power was not appropriate in this instance.

There was still time to fix this. The firm could revise the power to allow the CPA authority to sign, collect the appropriate signatures and record the power with the IRS.

But they had to do this before bringing suit.

Which they did not.

The informal claim doctrine did not apply, because the placeholder claim was not perfected before filing suit.

Our case this time was Mattson v U.S., 2021 PTC 110 (Fed Cl 2021).