The IRS And Lack Of A Postmark

The IRS botches things every now and then.

I walked in Friday morning to a botch.

And before leaving Friday I was reading a near-botch that a taxpayer was able to rescue.

Let’s talk about it.

I received a client collection notice for approximately $25 grand. The entire amount represents penalties, and we are appealing the penalties. Generally speaking, an appeal puts a stay on collection activity.

I did what you would do: I called the phone number.

About an hour and a half later (seriously, IRS?) I spoke with an IRS representative.

I explained what happened and inquired about the stay. He asked for a few minutes while he investigated.

He found our appeal arriving in Memphis and then transferring to Kansas City. The file then went cold.

Got it: Kansas City never opened the file. Once Memphis closed, the IRS collection machinery went back online.

This was easy to resolve: I faxed him the appeal while on the phone; he forwarded the appeal; he then granted a stay on collection activity.

Point is: the IRS makes mistakes. Protect yourself.

One of the easiest ways to protect yourself is to certify your mailings. Granted, I would not certify an estimated tax payment, but I would certify more significant transactions with the IRS, such as (paper) filings, responding to correspondence audits or entering the procedural carousel.

Some procedural steps (think notices) have defined response periods. Miss them and you make your advisor’s job much more difficult – if not near impossible.

The granddaddy of defined response periods is the Statutory Notice of Deficiency, sometimes called a “NOD” or a “SNOD” and also known as the 90-day letter.

The 90-day letter means that the IRS intends to assess, a necessary procedural step (generally, there is always an exception) before the IRS can bring its full Collections weaponry to bear. If you want to contest the assessment without paying it first, you had better file with the Tax Court. 

You have 90 days.

Not 91.

Let’s talk about Seely v Commissioner.

The IRS audited Michael and Nancy Seely’s 2013, 2014 and 2015 tax returns. The IRS issued the SNOD. The last day to respond was June 26, 2017.

The taxpayers’ attorney prepared and mailed a Tax Court petition in response to the SNOD.

The Tax Court received the petition on July 17, 2017.

Oh, oh.

Like night follows day, the IRS motioned to dismiss.

The taxpayer will lose this argument 999 times out of 1,000.

But there was something peculiar about the Seely’s petition. It had all the necessary postage but had no discernable postmark. For all practical purposes, it was like it was never mailed.

There is a special rule for this unlikely occasion: the Court looks at extrinsic evidence, and both parties (the taxpayer and IRS) are allowed to present such evidence.

The Seelys came out strong: their attorney filed a declaration with the Court that his office had mailed the petition on June 22, 2017 at a specified mail location.

The IRS came with their argument:

(1)  It takes approximately 8 to 15 days for the Postal Service to deliver mail from the Seeley’s city to Washington, D.C.

(2)  If mailed on June 26, then it would have arrived at the Tax Court no later than Friday, July 14.

(3)  It didn’t. It arrived instead on Monday, July 17.

This argument is standard IRS play.

But the Court allowed for one more factor: unusual volumes of mail or staffing issues due to the intervening July 4^th  holiday.

The Court reasoned that might explain the one day the IRS was disallowing.

The Court decided for the Seelys.

This is a rare taxpayer win.

You know what else would constitute extrinsic evidence and have also handcuffed the IRS?

Certify the mailing with the Post Office.

Use Certified Mail With The IRS

I am looking at Baldwin v U.S., at least as much as I can between the September and October 15^th due dates.

In the blog equivalence of cinematic foreboding, the case comes out of the Ninth Circuit.

The Baldwins filed a 2007 joint tax return showing an approximate $2.5 million loss from a movie production business.

They filed to carry the loss back to 2005 for a refund.

They had three years to file the refund claim. The three years started with the filing of their 2007 return – that is, the year that showed the loss. They filed their 2007 return on extension, so three years later would be October 15, 2011.

They filed the refund claim on June 21, 2011.

Seems plenty of time.

They filed using regular mail.

The IRS said they never received the refund claim.

Problem.

The three years expired. Sorry about your luck, Baldwins, purred the IRS.

You know this went to court.

It went to a California district court.

And we get to talk about the mailbox rule.

There is a provision in the tax Code that timely-mailing-equals-timely filing with the IRS. That is the reason you hear (not as much now in the era of electronic filing) of people heading to the post office on April 15^th. Folks want to get that “April 15” stamped on the envelope, as that stamp means the return is considered timely filed with the IRS.

By the way, that provision did not enter the Code until 1954.

What did folks do before 1954?

They relied on common law.

Common law allows one to presume that a properly-mailed envelope will arrive in the ordinary time required to get from here to there. One would have to prove that one mailed the envelope, of course, but once that was done the presumption that the mail arrived in normal time would kick-in.

In 1954 Congress added the following:

§ 7502 Timely mailing treated as timely filing and paying.

(a)  General rule.

(1)  Date of delivery.

If any return, claim, statement, or other document required to be filed, or any payment required to be made, within a prescribed period or on or before a prescribed date under authority of any provision of the internal revenue laws is, after such period or such date, delivered by United States mail to the agency, officer, or office with which such return, claim, statement, or other document is required to be filed, or to which such payment is required to be made, the date of the United States postmark stamped on the cover in which such return, claim, statement, or other document, or payment, is mailed shall be deemed to be the date of delivery or the date of payment, as the case may be.

Section (c) is important here:

(c)  Registered and certified mailing; electronic filing.

(1)  Registered mail.

For purposes of this section , if any return, claim, statement, or other document, or payment, is sent by United States registered mail-

(A)  such registration shall be prima facie evidence that the return, claim, statement, or other document was delivered to the agency, officer, or office to which addressed; and

(B)  the date of registration shall be deemed the postmark date.

Section (c) is why accountants encourage the use of certified mail with tax returns.

But the Baldwins did not certify their mailing.

They instead argued that they met the common-law standard for timely filing.

Seems a solid argument.

The IRS went low.

There are Court cases out there (Anderson, for example) that decided that the common law standard continued to exist even after the codification of Section 7502. It makes sense – at least to me - as that is what common law means.

The IRS argued that Section 7502 did away with the common-law standard, and the cases deciding otherwise were decided erroneously.

Sounds like a truckload of fine-cut bull manure to me.

Let’s load the truck.

There was a case in 1984 called Chevron. From it came the Chevron doctrine, an administrative law principle that a government agency’s interpretation of an ambiguous or unclear statute should be respected by a court.

I get the concept.

The first thing the agency has to do is show that the statute is ambiguous or unclear.

Does Section 7502 appear ambiguous or unclear to you?

We are going to need a jump to get this truck going.

Let’s introduce National Cable & Telecommunications Association v Brand X. That case has to do with the internet and whether it is an information service or a telecommunication service.

Sounds boring.

Let’s look at the Ninth Circuit’s take-away from Brand X:

But [a] court’s prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion.”

Let me translate that word salad:

Since the prior Court decisions (let’s use Anderson as an example) did not specifically say that the statute was unambiguous, the statute is therefore ambiguous.

Huh?

So, if I do not make clear that I am not a Robert Howard sword-and-sorcery, skilled, powerful and fearless giant weapon-wielding barbarian, then it can be deduced that I am that very said barbarian?

Cool!

Brand X lets me say that Section 7502 is ambiguous, at which point Chevron kicks-in and allows me to argue that the underlying statute means anything I want it to say.

There is an aisle for this at Borders. It is called “Fiction.”

The Baldwins did not get to rely on common-law. Since they could not meet requirements of Section 7502(c), they lost out altogether. No carryback refund for them.

Depression And Disability

I am reading a Tax Court case where the taxpayer represented himself. This is referred to as “pro se.” Technically, it does not mean that you cannot have an attorney or advisor with you; it rather means that the attorney or advisor is not admitted to practice before the Tax Court. If I was your CPA, for example, I would field the questions-and-answers on your behalf while you sat there silent and forlorn. You would still be considered to be “pro se,” as I do not practice before the Court. Had I practiced in the D.C. area or with the national tax office of a large firm, I might have been more interested in pursuing admission to practice.

The taxpayer’s name is Walter Kowsh, and he had an incredible string of misfortune. Walter lived in New York. His wife died at age 53, leaving him with two teenage children and an elderly parent.

Then he lost several friends on the 9/11 attacks on the World Trade Center. Some of those friends had gone to his wife’s funeral.

By 2002 he could longer work because of depression and anxiety attacks.

He started taking prescriptions, including Wellbutrin and Paxil.

His depression became debilitating.

He started collecting on his private disability insurance.

He did not however apply for Social Security disability. Too bad, as there is a case (Dwyer) that accepts social security as proof of disability.

He took an early distribution from his 401(k) or IRA in 2003. He did not however file a tax return for 2003.

So the IRS tentatively prepared one for him.

After a string of IRS notices, he finally prepared and filed his 2003 return.

The IRS next wanted penalties for late filing as well as the 10% penalty on the early distribution.

Walter needed an out from both penalties. Is there way to do it?

Yep.

Disability would do it. Disability is an exception to the 10% penalty and is also reasonable cause to abate a late filing penalty.

Walter argued that he was disabled.

Question is: did Walter’s depression rise to the level of a disability?

Incredible story, said the IRS. Get us a doctor’s letter, and let’s wrap this up.

Walter could not – or would not - get a doctor’s letter. His own doctor refused to provide one.

This was a bad start.

How about a prescription history from the pharmacy? asked the IRS. They might be able to print out your history for the whole year.

Nope, said Walter.

I am already collecting disability, continued Walter. What part of “disability” do you not understand?

Walter could really have used a tax advisor at this point.

You see, collecting disability from an insurance company lends strong credibility to Walter’s claim, but disability is a medical diagnosis. The insurance reinforces the diagnosis but is not a substitute for it.

Rest assured the Court was curious why Walter’s doctor would not provide a letter, or why he refused to have another doctor provide one…

… despite numerous requests from respondent.”

Respondent means the IRS.

And I am curious myself.

I do not doubt that he was depressed. I also do not doubt that he considered himself disabled. What I don’t understand is the big pushback on what appears to be a reasonable request.

It is not personal, Walter. Stop taking it that way.

Walter lost.

You see the downside to a true pro se.

I would have been screaming at Walter for sabotaging his own case. He would have gotten that doctor’s letter or I would have fired him.

But Walter made the tax literature for the point that collecting private disability insurance, by itself and without further substantiation, does not prove disability for purposes of the tax Code.

Tax geeks will remember Walter for decades.

Do You File An Accurate Return Or A Timely Return?

I have alerted the staff here at CTG command center that I prefer and expect to file all business returns, especially passthrough returns, on a timely basis, irrespective of whether we have all required information. Granted, there is some freeplay – we cannot file if we have no information, for example, or if so much information is missing that a filing would not be construed as substantially correct.

The reason?

Penalties for late filing.

Let’s say that you and a partner have an LLC. The return is due in March and can be extended to September. You file an extension but, for whatever reason, do not file the partnership return until December.

What just happened?

(1)  You might think that the return is only 2 months late, as it was extended until September. That is incorrect. You have until September 15 to file the return. Fail to do so, and it is as if you never filed an extension. That return is now late beginning March 16.

(2)  So what? Here is so what: the penalty is $195 per K-1 per month. There are two K-1s: you and a partner. The penalty is $390 per month. Multiply that by the number of months, and you can see how this gets expensive fast.

(3)  You might be able to get out of this penalty. Revenue Procedure 84-35 allows an avenue for small partnerships with 10 or fewer partners, for example. Depending on the facts, however, there may be no easy out. Like fire, you do not want to be playing with this.

There are a hundred variations on the theme. Let me give you one. This one involves an estate tax return. Let’s review the key points, and you decide whether there is cause for a late-filing penalty. 

• The decedent died February 24, 1986.
• On May 6, 1986 the estate was admitted to probate.
• The wife was appointed executrix.
• The estate hired an attorney.
• The estate tax return was due November 24, 1986 (nine months after death). No extension was filed.
• In January, 1987 the executrix filed an inventory with the probate court. Four assets were listed but given no value. One of those assets was an interest in a trust, which asset took on a life of its own. 
• The assets which were valued - that is, excluding the four which were unvalued - were enough the require the filing of a federal estate tax return.
• In 1991 (five years later) the estate filed suit concerning the trust.
• In 1994 the common pleas court entered judgement.
• In 1996 the executrix filed a revised and final accounting with the probate court.
•  In 1997 the estate finally filed a federal estate tax return. 

     The IRS immediately went after late filing penalties. Why wouldn’t it? The tax return was filed more than 10 years after the decedent died.

The gross estate was over $2 million. Those items that could not initially be valued came in around $200 grand.

The IRS charged in and chanted its standard wash-rinse-repeat hymn: the taxpayer cannot escape penalties for the non-extension or late filing of a return pursuant to the Supreme Court’s Boyle decision.

But the estate punched back with reasonable cause: the executrix did not have values for some of the assets that were eventually distributable from the estate. Heck, they had to sue to even get to some of those assets!

What do you think? Is there reasonable cause?

Let me give you a clue: the disputed assets were about 10% of the final estate.

And we come back to a phrase I used early on: “substantially correct.” Tax Regulations require only that the estate return be “as complete as possible.” There are numerous cases where pending litigation – even if the outcome is expected to materially affect the estate’s final tax liability – has not been considered reasonable cause for not filing a return.

The Court pointed out two things:

(1)  The executrix knew (or should have known) early on that the estate was large enough – even excluding the disputed items – to require filing a return.

(2)  She could have paid at least the tax on that amount, or estimated and also included tax on the disputed items.

a.     The Court pointed out that disputed assets were only 10% of the estate.

The executrix did not have reasonable cause. She should have filed and paid something, even if she later had to amend the estate tax return.

My thoughts?

I agree with the Court. I believe the estate was ill-advised. 

There is a sub-story in here concerning the attorney (who thought the accountant was taking care of the estate tax return) and the CPA (who was never told to prepare an estate tax return, at least not until years after the return would have been due). Why didn’t the attorney reach out earlier to the CPA, at least for peace of mind? Who knows? Why didn’t the long-standing CPA – who would have known the decedent - ask about an estate return? Again, who knows?

Our case this time was Estate of Thomas v Commissioner.

COMMENT: I am looking (translation: I printed but have not yet read) a case where a taxpayer did use estimates but still got nailed with penalties. We may come back to that one in the near future.

When The IRS Does Not Believe You Filed An Extension

I have a certain amount of concern whenever we approach a major due date. Let’s use your personal tax return as an example. It is due on April 15; an extension stretches that out to October 15. 

What is the big deal?

Penalties. Fail to extend the return, for example.

How does this happen?

A client moves to another city. A client was unhappy with your fees last year, and you are uncertain if the client is staying with you. A client’s kid starts working, prompting a tax return for the first time. A client gets involved with some business, and the first time you hear about it is when his/her information comes in. A client does business in a new state.

Or – let’s be frank here – you just miss it.

There are two common penalties; think of them as the salt and pepper of penalties:

·      Failure to file

·      Failure to pay

We associate the IRS with taking our money, so one would easily assume that the more onerous penalty is failure to pay. It is not. Owe money past April 15 and the IRS will charge a penalty of ½% per month.

Fail to file, however, and the penalty is 5% per month.

Yep, 10 times as much.

And when does the penalty start?

Miss that extension and it starts April 16.

Huh? Don’t you have until October 15 to file that thing?

Yes, IF you file an extension.

You do not want to miss that extension.

I was reading a case about the Laidlaw brothers. They sold Harley Davidson motorcycles, and they got pulled into Court for a welfare benefit plan that went awry.

There was one issue left: did their accountant file extensions for the two brothers by April 15? If not, those penalties included 5 zeroes. We are talking enough-to-buy-a-house money.

To add to the stress, the trial occurred about a decade after the tax year in question.

The accountant’s name was Morgan, and he presented extensions showing zero tax due for each brother. The IRS said it never received any extensions. Morgan did not send the extensions certified mail, but he recalled sending both extensions in the same envelope. He remembered taking the envelope to the post office and checking for proper postage. He took pride that the Post Office had never returned an extension request for insufficient postage.

He pointed out that there was no question about an extension for the year before, and the year before that, and so forth. The brothers were significant clients to his firm, and he went the extra mile.

The IRS was having none of it. They pointed out that Morgan had many clients, and the likelihood that he could remember something that specific from a decade ago was dubious. Additionally, any memory was suspect as self-serving.

Sounds like Morgan needed to present well in front of the Court.

And there is the rub. The Laidlaw case went Rule 122, meaning that depositions were submitted to the Court, but there was no opportunity for face-to-face questioning.

Here is the Court:

… we had no opportunity to observe Mr. Morgan’s credibility as a witness. The reliability of a witness’ testimony hinges on his credibility. We were not provided a full opportunity – so critical to our being able to find the witness reliable – to evaluate Mr. Morgan’s credibility on the issue of timely filing because petitioners never offered his live testimony in a trial setting. While we can learn much from reading the testimony, it is not the same as a firsthand observation of the witness’ demeanor and sincerity, both essential aspects of credibility and reliability.

The brothers lost, and the IRS collected a sizeable penalty amount.

Back in the day, we used to log all extensions going to the IRS. We would certify each envelope and then attach the receipt to a log detailing each envelope’s contents. Granted, that log could not prove that a given envelope contained a given extension, but it did show our attention to policies and procedures. I recall getting out of at least one sizeable penalty by arguing that point to the IRS.

Those were different times, and many (including me) would say that today’s IRS is less forgiving of basic human error

And, to some extent, we are talking ancient history with extension procedure. Today’s practices, our included, has moved to electronic filing. Our software tracks and records our extensions and returns and their receipt by the IRS. I do not need to keep a mail log as my software does it for me.

Morgan needed something like a log. It would have given the Court confidence in and support for his recollection of acts occurring a decade earlier, even without him being present to testify in person.

A Baseball Player Gets Hit By A Penalty

I have a question for you: let’s say you are a professional athlete. You have hired a financial advisor and an accountant. You give the financial advisor a durable power of attorney, allowing him/her to pay your bills, manage your money and grow your investments. You ask your accountant to prepare tax returns as necessary keep you out of trouble.

These services are not cheap. They cost you an upfront fee of $150,000 and an ongoing $360,000 annually.

            COMMENT: I am available and open to relocation.

You get robbed for millions of dollars. Tax returns do not get filed.

The IRS now wants big penalties from you.

QUESTION: Do you have “reasonable cause” to have the IRS remove those penalties?

We are talking about Mo Vaughn, who played baseball with the Red Sox, the Anaheim Angels and the New York Mets in the nineties and aughts.  He was the American League MVP in 1995.

In 2004 he hired Ra Shonda Kay Marshall to handle his money matters. She wound up leaving her employer, Omni Elite, and set up her own company, RKM Business Services, Inc. He also hired David Krebs with CPA Advisory Group, Inc. for the preparation of his tax returns.

Something happened, and in 2008 he fired both of them. Vaughn was going through his bank statements when he realized that Marshall had been embezzling. He hired forensic accountants, who determined that from 2004 to 2008 she had embezzled more than $2.7 million.

He then learned that his 2006 taxes were not paid.

Even that was better news than 2007, when his taxes were not even filed, much less paid.

He sued Marshall and RKM Business Services.

He hired new CPAs to get him caught up. The IRS – in that show of neighborliness that we have come to expect – hit him with penalties of $1,037,158 for 2006 and $102,106 for 2007. He had filed and/or paid late, and there were penalties for both.

He owed the tax, of course, but he had to contest the penalties. He went the administrative route – meaning appealing and working within the IRS itself. Striking out, he then took his case to court. He went to district court and then to appeals.

His main argument was simple: he was paying people to keep him out of tax problems. There was a lot of money leaving his account, so he had every reason to believe that a good chunk of it was going to the IRS. He was robbed. The IRS was robbed. Surely robbery is reasonable cause.

The IRS and the court pretty much knew his story at this point, and they knew that he was suing to get his millions back. The court however decided the government was due its money. There was no reasonable cause.

How is this possible?

There is a tax case (Boyle) where the Supreme Court addressed the issue of penalties assessed a taxpayer for his/her agent’s failure to file and pay taxes. The Court stated:

“It requires no special training or effort to ascertain a deadline and make sure that it is met. The failure to make a timely filing of a tax return is not excused by the taxpayer’s reliance on an agent, and such reliance is not ‘reasonable cause’ for a late filing under [Section] 6651(a)(1).”

The Court was addressing deadlines, and it set a fairly high standard. The Court distinguished relying on an attorney or accountant for advice from relying on an attorney or accountant to actually file the return itself. Reliance on an agent did not relieve the principal of compliance with statutory deadlines, except in extremely limited circumstances.

Vaughn could not clear this standard. He had delegated too much when he turned over responsibility for both preparing and filing his taxes to Marshall and Krebs.

Vaughn had a backup argument: the malfeasance of his agents rendered him unable to pay. He did not have enough money left to pay taxes by the time Marshall was done with him.

He was referring to a tax case (American Biomaterials Corp) where two corporate officers defrauded their corporation, including failing to file and pay taxes. Those two were the only officers with the responsibility to file returns and make payment. The Court held that the corporation was not vicariously liable for the acts of its officers and therefore was not liable for penalties.

There is a limit on American Biomaterials, though: a corporation is not entitled to relief if – by act or omission – its internal controls are so lax that that there was no reasonable expectation that malfeasance would be detected in the ordinary course of business. In other words, the corporation cannot willfully neglect normal checks and balances and expect to be relieved of penalties.

Vaughn got smacked on his second argument. The Court noted the obvious: in American Biomaterials there was no one left in the company to file and pay the taxes. This was not Vaughn’s situation. While he had delegated responsibility, there was someone left who could and should have stepped in: Mo Vaughn himself. He did not. That was his decision and provided both reason and cause to impose penalties.

And so Vaughn lost both in the district and the appeals courts. He owed the IRS enough penalties to allow either you or me to retire. He lost because he delegated the one thing the tax Code does not allow one to delegate, except in the most extreme cases: the duty to file the return itself.