Source: https://procedurallytaxing.com/category/earned-income-credit/
Timestamp: 2019-04-18 22:54:28+00:00

Document:
We welcome back guest blogger Bob Probasco. Bob tells a disaster story with a happy ending but we must keep in mind that the happy ending only occurred because the low income taxpayer had found her way to a clinic where she received free and highly competent representation. Other stories similar to this one exist in the system without the happy ending provided here.
There is a film genre often referred to, because of the primary plot device, as “disaster movies.” The golden age was the 1970s, with films like Airport, The Poseidon Adventure, and The Towering Inferno. Minor actions or problems interact in ways that create huge challenges. Each time the characters survive one obstacle, losing a few members of the group in the process, a new threat arises. How many, and which, characters will eventually survive?
The tax administration equivalent is the earned income tax credit (EITC) ban.
The EITC ban process is seriously flawed, as has been pointed out frequently. Les discussed it here on Procedural Taxing in blog posts in January 2014 and July 2014. National Taxpayer Advocate Nina Olson has been complaining about it for years, with the most detailed coverage in her 2013 Annual Report to Congress. Patrick Thomas made a presentation on it (outline available on the LITC Toolkit website, if you have access) at the December 2016 LITC Grantee Conference. Les and William Schmidt addressed the specific issue of Tax Court jurisdiction over the ban in 2016 and 2018 respectively. I strongly recommend a thorough review of all of the above – including comments to the blog posts! – to anyone who deals with taxpayers who claim the EITC.
This post discusses the IRS administrative process for applying (and correcting?) the ban. It also points out how the interaction of the EITC ban process with problems elsewhere in the tax administration process can turn a serious issue into an absolute disaster. This is the story of one such disaster.
If there is a final determination that the taxpayer’s claim of credit was due to fraud, the disallowance period is 10 taxable years instead.
In the case of a taxpayer who is denied credit under this section for any taxable year as a result of the deficiency procedures under subchapter B of chapter 63, no credit shall be allowed under this section for any subsequent taxable year unless the taxpayer provides such information as the Secretary may require to demonstrate eligibility for such credit.
Denial of the EIC as a result of the deficiency procedures occurs when a tax on account of the EIC is assessed as a deficiency (other than as a mathematical or clerical error under section 6213(b)(1)).
And Treas. Reg. section 1.32-3(c) specifies Form 8862 as the information required to demonstrate eligibility. The instructions make clear that the taxpayer should not file Form 8862 during the years that a ban applies, but it will be required if the EITC is disallowed, even absent a final determination of fraud or reckless or intentional disregard of rules and regulations, to claim the EITC in any other years. If the form is properly completed and the IRS determines the taxpayer is eligible for the EITC, then the taxpayer is re-certified and need not submit Form 8862 again – unless the EITC is denied again.
Under Section 6213(g)(2)(K), the IRS can adjust the tax return by math error correction, rather than the deficiency procedures, if the taxpayer claims the credit during the ban period or without providing the required information for recertification. Nina Olson fought against that idea for years but it was eventually enacted in the Protecting Americans from Tax Hikes Act of 2015.
Our LITC client – let’s call her “Maria” – was originally audited with respect to her 2014 return. She did a very good job of responding to the audit before even coming to our clinic. Most often, issues in an EITC audit concern proving relationship to the qualifying child or that the child lives with the taxpayer. Maria resolved those to the satisfaction of Exam/Appeals but one stumbling block remained: filing status. She filed her return as “single,” which of course should have been “Head of Household,” but the IRS insisted that she was married. Section 32(d) specifies that married taxpayers can claim the EITC only if they file joint returns. The IRS reclassified her filing status as “Married Filing Separately.” That was where the resolution bogged down, because Maria was adamant that she was not married.
Unfortunately, Maria lives in Texas, one of only ten states (plus the District of Columbia) that recognize common law marriage. She didn’t know that and she didn’t realize what the IRS was arguing from the correspondence she received. Maria doesn’t speak English and the “common law” part got lost in the translation by her son, who may not be familiar with the concept either. When she came to our clinic, we were able to explain the problem to her. We also determined that she had two arguments for claiming the credit.
First, she arguably did not meet the requirements under Texas law for a common law marriage. She had lived with her putative husband – let’s call him “Jose” – but she did not intend to be married and did not hold herself out to others as being married. We were persuaded as to the absence of intent by her obvious surprise when we explained what the IRS was saying. While corresponding with Exam/Appeals, before she came to the clinic, she submitted proof that she was not married: a certificate from the county clerk’s office that there was no record of a legal marriage between Maria and Jose. That’s not the type of evidence you’re likely to submit if you are aware of the existence of common law marriage. And if you’re not aware, that certainly suggests that you lacked the intent.
The more difficult aspect was the “holding out” requirement, because Maria and Jose had filed joint tax returns for several years prior to 2014. Jose may have held himself out to the IRS as married to Maria but I don’t think she did. She didn’t realize what the tax returns she signed meant. She thought Jose was claiming her as a dependent, not that she was presenting herself as his spouse. But it was always going to be difficult, if not impossible, to prevail on the first argument.
Our second argument was better. Under Section 7703(b), Maria could file her return as Head of Household, even though married, if (a) she maintained a household for a child who lived there and (b) she and Jose lived apart for at least the last six months of the year. Under Reg. 1.32-2(b)(2), such a return is not subject to the limitation of Section 32(d). Jose had moved out in 2013; he was working in the oil fields in South Texas and living in his truck to save money to start a business. When he moved out, she even began paying him rent.
Unfortunately, there was no documentary evidence that Jose no longer lived there. He still received mail at the address where Maria lived and continued to use that address on subsequent tax returns he filed. You can’t get mail addressed to a truck and you can’t use the truck as your address on a tax return. There was no rental agreement or utility bill for the truck either, so the IRS could find no records showing a different address for him. So as far as Exam and Appeals were concerned, he still lived with Maria.
The IRS also was not satisfied with the substantiation for the agreement to pay rent. Maria and Jose documented that arrangement with a very formal rental agreement. (How many taxpayers would think to do that?) Unfortunately, Maria’s copy of the agreement was unsigned and it was only for a term of one year, which did not cover all of 2014. Maria continued paying rent after that but they did not think to prepare a new agreement until she was audited. Also, Maria didn’t have records of the payments to Jose, because she paid him in cash.
Maria’s case stumbled over what appears to be a larger problem with correspondence audits. During my limited time at the LITC, Exam and Appeals both appear to rely exclusively on documentary evidence. That may be understandable, given drastic reductions in staffing and the absence of face-to-face meetings in correspondence audits, but I don’t think it’s reasonable – particularly on something like this that had huge potential consequences. We offered to arrange a telephone conference (including translator) with Maria and could have put together an affidavit if they preferred that. But they just rejected the idea of testimony. Luckily, Counsel can and does accept testimonial evidence, so we were still hopeful. Unfortunately, this meant that we had to go to Tax Court, when we encountered another obstacle.
Shortly after we filed the Tax Court petition for the 2014 tax year, the IRS sent an audit notice for 2015. The same process repeated with the same result – Exam and Appeals rejected our explanations due to a lack of documentary evidence and Maria received a notice of deficiency. The IRS had frozen the refund for 2015 during the audit, so further delay did create some financial hardship.
Once Appeals returned the docketed case for 2014 to Counsel, we submitted a declaration by Maria setting forth what her testimony would be. Within a week, the IRS attorney agreed to concede the case in full. The stipulated decision for 2014 was filed a day after we filed the petition for 2015. And in less than three months, we had a full concession from Counsel for 2015 and another stipulated decision. So, great results for Maria, right? Alas, here’s where we ran into an unrelated issue that had a very unfortunate interaction with the EITC ban.
I had never given much thought to the question of how Exam and Appeals proceed after issuing a notice of deficiency. I should have, although I’m not sure I could have avoided this problem. Internal Revenue Manual (IRM) sections 4.8.9.25 and 4.8.9.26 set forth the process when the taxpayer petitions and when the taxpayer defaults, respectively, after a notice of deficiency. It seems to be an elaborate process with many safeguards – a tax litigation counsel automated tracking system, a related docketed information management system, and checking the Tax Court website if not in those systems to confirm that the taxpayer defaulted. There is even a follow-up process for the occasional situation when the responsible employee receives the docket list after tax was assessed.
no assessment of a deficiency . . . shall be made, begun, or prosecuted until such notice [of deficiency] has been mailed to the taxpayer, nor until the expiration of such 90-day or 150-day period, as the case may be, nor, if a petition has been filed with the Tax Court, until the decision of the Tax Court has become final.
This is a disaster story, though, so you’ve undoubtedly guessed (correctly) that for both years the IRS assessed tax and reversed the EITC, while there was a pending Tax Court case. The IRS imposed the EITC 2-year ban in both cases and issued Notice CP 79A.
I reported the issue of premature assessments from these cases in the Systemic Advocacy Management System (SAMS) last year, and I suspect other people have done so as well. It’s always a problem, but the consequences can be worse when the EITC ban is put into play.
Notwithstanding the provisions of section 7421(a), the making of such assessment or the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court, including the Tax Court, and a refund may be ordered by such court of any amount collected within the period during which the Secretary is prohibited from collecting by levy or through a proceeding in court under the provisions of this subsection.
It doesn’t provide for enjoining the imposition of the EITC ban, though. In addition, IRM 4.13.3.17 provides that errors concerning an EITC assessment can be resolved through the audit reconsideration process, although presumably this is intended to apply when the taxpayer provides additional documentation after a legitimate assessment.
Perhaps foolishly, we tried to resolve the problem for 2014 informally. I gave the IRS attorney assigned to the case a copy of the notices issued by the IRS and asked if she could have it corrected. Because she had already referred the docketed case to Appeals, she passed that documentation along to the Appeals Officer. I followed up with the Appeals Officer twice, with no response. But the problem was eventually resolved; the assessment was reversed, and the IRS mailed Notice CP 74, recertifying Maria for EITC. Problem solved, and since the Tax Court case was still pending, no harm, no foul.
For 2015, I responded directly to the assessment and Notice CP 79A. That notice presents the ban as a fait accompli; there was no reference to what the taxpayer should do if she disagreed with the IRS action. As noted above, the recertification process applies only after the ban period. The accompanying Notice CP 22E for the assessment suggested the taxpayer call if she disagreed with the changes. Instead, I wrote a letter – remarkably polite under the circumstances – pointing out that the assessment and imposition of the ban were illegal because of the pending Tax Court case and requesting the IRS “take all necessary corrective actions immediately.” Exactly one month later (which qualifies as “immediately” in any large bureaucracy), the assessment was reversed. We had filed the stipulated decision in the meantime and finally, almost six months after our letter and five months after the stipulated decision, the IRS issued a refund. This was a long time for a low-income taxpayer to wait for a refund, but better late than never.
Let’s summarize the timeline, because this is getting confusing.
Just when we thought Maria’s problems were over, on 7/2/2018 she received Notice CP 12, a math error adjustment denying EITC, for her 2016 tax return. We either didn’t notice or didn’t realize the significance at the time, but when the IRS reversed the premature assessment for her 2015 tax year, it did not issue Notice CP 74 recertifying her for EITC.
There had been an assessment of tax, on account of the EITC, as a deficiency for 2015, so it met the requirements of Treas. Reg. section 1.32-3(b) and Section 32(k)(2). Of course, that assessment for 2015 was illegal and had been reversed. The stipulated decision in the Tax Court case meant there never was and never would be a legitimate final assessment or determination of reckless or intentional disregard of rules or regulations for 2015. Because there is no process to confirm the validity of the EITC ban first, the failure to recertify automatically resulted in issuance of the math error adjustment.
Luckily, although a math error adjustment can be assessed without judicial review, taxpayers can simply request that the adjustment be reversed within 60 days, although – if appropriate – it can be re-asserted through the deficiency process. Section 6213(b)(1) and (2). That’s exactly what we requested for the 2016 tax year, by letter on 7/24/2018.
And, of course, since this is a disaster story, you know that Maria also received Notice CP 12 for her 2017 tax return.
Sixth obstacle: Further delay for an audit?
If you contact us in writing within 60 days of the date of this notice, we will reverse the change we made to your account. However, if you are unable to provide us additional information that justifies the reversal and we believe the reversal and we believe the reversal is in error, we will forward your case for audit. This step gives you formal appeal rights, including the right to appeal our decision in the United States [Tax] Court before you have to pay additional tax. After we forward your case, the audit staff will contact you within 5 to 6 weeks to fully explain the audit process and your rights. If you do not contact us within the 60-day period, you will lose your right to appeal our decision before payment of tax.
That’s consistent with Section 6213(b) as well as IRM 21.5.4.5.3 to 21.5.4.5.5 (general math error procedures) and IRM 21.6.3.4.2.7.13 (EITC math errors specifically). A substantiated protest can result in just reversing the math error adjustment; an unsubstantiated protest will result in referral to Exam.
The IRS treated our protest of the math error adjustment for 2016 as an unsubstantiated protest and referred it to Exam. Perhaps they misclassified our protest because they expect a substantiated EITC protest to provide documentation regarding relationship or residence or SSNs. Our protest was based on a premature assessment and assertion of the ban, and the failure to reverse the ban imposed as a result of the audit of 2015. We certainly had substantiated our basis for that. But when you provide a type of substantiation that they’re not anticipating . . .
So we received an audit letter dated November 9th. Further delay before Maria will receive her refund. To add insult to injury, the notification of what was happening was inadequate and would have been confusing to an unrepresented taxpayer. There was no response to the protest, telling us that they were referring the case to Exam for review. That might have provided an opportunity to clarify the nature of our protest before initiation of the audit. The audit letter did not explain the connection with the math error adjustment. For that matter, the IRS did not – as specified in the IRM – abate the disputed adjustment.
I have a sneaking suspicion that the same thing would have happened when we protested the math error adjustment for 2017 as well. Luckily . . .
The rescue party arrives! Maria makes it to safety!
Our efforts hadn’t met with much success, so we contacted our Local Taxpayer Advocate office in mid October. The case advocate spent a lot of time and effort, chasing from one office to another on Maria’s behalf. He pointed out the premature bans, the decisions by the Tax Court, and the IRS policy against auditing an issue that were examined in either of the two preceding years with no change or a nominal adjustment. Even after he elevated the discussion to managers in the operating units, there was still a lot of resistance. I’m not sure he would have succeeded without the gentle reminder of the possibility of a Taxpayer Assistance Order. Just as I was finishing this post, he called us with the good news. The 2-year ban is being lifted, the two math error adjustments are being reversed, and the examination of 2016 is being closed. Soon Maria will be getting the remainder of the refunds she requested on her 2016 and 2017 tax returns.
I’m getting used to the unfortunate difficulty of convincing Exam/Appeals that our clients are entitled to the EITC. I didn’t worry that much about the EITC ban because most of the time either we prevail or our clients aren’t entitled to the EITC and won’t claim it in the future anyway. I certainly didn’t anticipate how much trouble the EITC ban can cause even when we win the battle over the EITC itself.
TAS Systemic Advocacy also continues to look at these issues. They approached me after hearing about the case, before I even got around to reporting it in SAMS. Nina Olson has been fighting the problems with the EITC ban for years but still meets with resistance. Maybe this example of how much can go wrong will help in that fight. We can only hope.
The positive part of any ordeal like this is that, amid all the mindless adherence to byzantine and flawed processes, you can still encounter the IRS working the way it should: getting the right result, protecting the government fisc while also protecting taxpayer rights. In Maria’s case, those bright spots were Counsel, the case advocate at LTA, and the folks at TAS Systemic Advocacy. Without people like them, these tax issues can be devastating, not just for Maria but also for a lot of other taxpayers in similar situations.
To begin with some background on the EITC ban, there have been issues through the years regarding fraud on tax returns claiming the EITC. In response, Congress provided the Taxpayer Relief Act of 1997. Its purpose, according to the Joint Committee on Taxation: “The Congress believed that taxpayers who fraudulently claim the EIC or recklessly or intentionally disregard EIC rules or regulations should be penalized for doing so.” The Act provided for an EITC ban under Internal Revenue Code (IRC) section 32(k). The ban disallows a taxpayer to claim the EITC for 10 years when there claim of the credit was due to fraud (or 2 years for reckless or intentional disregard of rules and regulations, though not due to fraud). There have been issues on how fairly the IRS administers the ban. One example is that it was identified as one of the “Most Serious Problems” in the National Taxpayer Advocate’s 2013 Report to Congress.
The IRS issued a notice of deficiency to the Taylors regarding the 2013 tax year, listing a deficiency of $14, 186 and an IRC section 6662(a) accuracy-related penalty of $2,837.20. The deficiency results from disallowance of car and truck expenses the Taylors claimed on the Schedule C filed with their Form 1040.
The Taylors timely filed their Tax Court petition and the IRS filed their answer. The IRS followed up with an amended answer, raising two affirmative defenses. First, they raise an IRC section 6663 civil fraud penalty of $10,639.50, asserting the petitioners falsely claimed business-related car and truck expenses to reduce their income to make them eligible to claim the EITC. Second, the IRS raises the 10-year EITC ban pursuant to IRC section 32(k)(1)(B)(I) for improperly claiming the EITC.
To complete the procedural history, the Taylors did not participate further in their Tax Court case, which was to their detriment. They did not respond to the amended answer and the IRS followed with a “Motion for Entry of Order that Undenied Allegations be Deemed Admitted Pursuant to Rule 37(c).” The Court issued an order granting that motion, meaning the Taylors are deemed to have admitted all the statements in the amended answer, including the affirmative allegations with respect to the civil fraud penalty and the 10-year ban on claiming the EITC.
Next, the IRS filed a “Motion to Take Judicial Notice,” which requested the Court take judicial notice of the distances between the Taylors’ home and the various addresses Katrina Taylor reported driving during 2013 for her business activities. The motion asserts that the Taylors’ travel logs are unreliable and overstate the travel distances. The IRS provided Google Maps documents that show the distance and driving times for the routes Mrs. Taylor reported for the business destinations. Since the Taylors did not respond, the Court’s order granted the IRS motion, taking judicial notice of that information as facts, the accuracy of which cannot reasonably be questioned.
The IRS prepared a joint stipulation of facts that the Taylors refused to sign. The IRS filed a “Motion for Order to Show Cause Why Proposed Facts and Evidence Should not be Accepted as Established Pursuant to Rule 91(f).” The Court ordered the Taylors to respond to the motion. Since they failed to respond, the Court issued its order making the Order to Show Cause absolute, meaning the facts and evidence set forth in the proposed stipulation of facts was deemed to be established for the purposes of the case.
Turning to the facts established through the orders, the Taylors reported $105,914 in wages on their 2013 Form 1040, with $55,033 earned by Mrs. Taylor as an employee. The attached Schedule C listed financial data on Mrs. Taylor’s business, which reports no business income. It instead reports advertising expenses of $290 and car and truck expenses of $73,740, resulting in a net loss of $74,030. Also included are a Form 4562, Depreciation and Amortization (Including Information on Listed Property), which states the Taylors represent they used two vehicles for business purposes, with a total of 130,513 business miles. Vehicle 1 was driven 65,212 miles and vehicle 2 was driven 65,301 miles. In response to line 24a, “Do you have evidence to support the business/investment use claimed?” their response was to check the box for “no.” Those business expenses reduced their adjusted gross income to $30,690. Since they had three minor children in 2013, they qualified for an earned income credit of $4,417 based on that income.
The IRS audited the Taylors, focusing on their car and truck expenses. The Taylors supplied two versions of a log purporting to show business miles driven for Mrs. Taylor’s business. The logs were not provided contemporaneously with her travel and state she drove the 130,513 miles on business, driving a 2004 Cadillac truck 41,483 miles and a 2006 BMW 89,030 miles. The Court states these logs are demonstrably unreliable because petitioners traded in the 2004 Cadillac truck with Mrs. Taylor signing an odometer disclosure statement reporting the odometer at time of sale as 102,345 miles while according to the provided logs the December 23, 2013 year end odometer reading was 154,990 miles. Similarly, the BMW’s trade-in odometer disclosure statement was 91,333 miles while the purported logs stated the December 17, 2013, reading to be 186,880 miles.
The Court also believed the log mileage to be inflated. The logs stated Mrs. Taylor drove the Cadillac 1,376 miles and the BMW 701 miles (totaling 2,077 miles) on September 22, 2013. The IRS points out the driving distance from Manhattan to Los Angeles is approximately 2,800 miles and “[a]t a constant speed of 70 miles per hour (“MPH”) it would take 29.7 hours to drive 2,077 miles.” The logs also report trips of 1,200 miles to 1,800 miles for other days.
The Court’s discussion within the order itself focuses on how the petitioners have not been responsive. They failed to plead or otherwise proceed within Rule 123(a). Because of the deemed established facts, the Court grants the IRS Motion for Default Judgment and enters a decision against the Taylors.
We come back to a jurisdictional issue for the Tax Court. In the Taylor case, the Court had the 2013 tax return at issue. The jurisdictional issue is what authority the Court has with regard to the EITC ban in a case like this. Is the jurisdiction for the year in which the ban arises (2013) or for the years in which the ban will take effect (10 following years, presumably starting with 2014)?
I note that the IRS does have the ability to assert fraud and get facts deemed stipulated in order for the IRS to meet its burden of proof on the issue of fraud. I provide a quote from Console v. Commissioner, T.C. Memo. 2001-32 at *12, aff’d 2003 U.S. App. LEXIS 15535 (3d Cir. 2003): “It is well settled in this Court that the Commissioner may establish fraud by relying upon matters deemed admitted under Rule 90. Marshall v. Commissioner, 85 T.C. 267 (1985); Morrison v. Commissioner, 81 T.C. 644, 651 (1983); Doncaster v. Commissioner, 77 T.C. 334, 336 (1981). The Commissioner may also establish fraud by relying on facts deemed to be stipulated under Rule 91(f). Ambroselli v. Commissioner, T.C. Memo 1999-158.” My thanks to Carl Smith for providing this note and citation.
One case to consider is a prior Tax Court case, Ballard v. Commissioner, which included a Tax Court judge’s reluctance to issue an order regarding a 2-year ban on the EITC. Les Book provided prior commentary in Procedurally Taxing here. In that posting, there are links to other posts, including Carl Smith’s discussion of the jurisdictional issue of the EITC ban in the Tax Court. I agree with Les’s view that the Tax Court does not have authority to apply an EITC ban for a year of fraudulent behavior (or reckless/intentional disregard), which could be called a conduct year.
Specifically for the Taylors, I argue that while the petitioners should potentially be subject to the ban, the only year before the Court was 2013. It was within the Court’s authority to find that there was fraud in 2013, but not within their authority to apply an EITC ban for later years.
I am unsure if the Taylors were outmatched in the courtroom. If all of the allegations against them are true, though, I can understand the claims of fraud the IRS made against them. Whether their goal was to inflate business expenses to claim the earned income tax credit or not, the results are unrealistic business miles and mileage logs that do not match. Even if one does not agree with the EITC ban, the ban is an area the IRS has authority to administer. This case does not provide justification that the Tax Court has jurisdiction to administer the EITC ban for later years when 2013 was the conduct year before the Court so went a step too far in ordering the imposition of the EITC ban for the Taylors.
Last week in Mohamed v Commmssioner, the Tax Court sustained $7,000 of EITC due diligence penalties against a preparer. The preparer, who was a CPA, had an active business preparing individual tax returns, including many EITC returns. The opinion provides a rare court review of the imposition of these penalties.
The EITC due diligence penalty has been on the books for a while; the current penalty is $500 for each failure to comply. Requirements include preparing and retaining forms like the Paid Preparer’s Earned Income Credit Checklist, and the Earned Income Credit Worksheet. In addition, the rules require that tax return preparer must not know, or have reason to know, that any information pertaining to the EITC is incorrect.
This penalty is even more important for preparers, as Congress recently expanded the scope of due diligence penalties to include the child tax credit and the American opportunity tax credit.
There are not many cases involving the penalty, and while Mohamed is a summary opinion, it does provide some insights into the process and limits on Tax Court review of the penalty.
The opinion discusses how IRS examined a number of Mohamed’s clients as part of its EITC due diligence audit program. He was visited by a tax compliance officer, who reviewed 50 of Mohamed’s returns. The audit report proposed a penalty on 20 of the 50 returns; while the penalty is not subject to deficiency procedures, the IRM provides and IRS allowed for Mohamed to challenge the proposed assessment before Appeals.
Mohamed met with an Appeals Officer for 6 hours to discuss the penalty; after the meeting Appeals agreed to remove the penalty from 5 of the returns. Appeals also asked for more information on 4 other returns. Mohamed sent documents to Appeals and also had a follow up phone conversation. The correspondence and phone call led Appeals to remove the penalty from another return, bringing the penalty down to 14 returns, or $7,000.
Appeals sent a closing letter indicating that it was recommending a penalty assessment on 14 of the returns; it also let Mohamed know that he could pay the penalty and file a refund claim and eventually sue in district court or the Court of Federal Claims if he wanted court review of the penalty.
IRS assessed the penalty and issued a notice of intent to levy. Mohamed did not pay and instead filed a CDP request. In the hearing he asked to challenge the underlying assessment. The settlement officer refused that request on the theory that he had a prior opportunity to challenge the penalty in the preassessment Appeals hearing.
Given the Tax Court and appellate courts’ views on this issue, it is not surprising Mohamed had an uphill battle. He gamely attempted to distinguish the adverse authority, arguing that Appeals did not give him a chance to rebut its conclusions and that it terminated the process prematurely.
In sum, the record shows that in 2015 petitioner was provided a full and fair opportunity to challenge the imposition of the disputed penalties before the Appeals Office and he meaningfully participated in that proceeding. Although petitioner would have preferred to continue to dispute his liability, we are satisfied hat the Appeals Office conducted a fair and comprehensive review of the matter and acted properly in concluding the matter by issuing its closing letter.
That the Tax Court looked into the process that Appeals provided in the preasessment hearing is a slight opening for other taxpayers who may not have had the same opportunities with Appeals. Yet Mohamed is another in the growing line of cases that show that CDP is not an avenue for challenging the amount or existence of a liability even if there is no prior opportunity for court review.
On its face, Form 8484 is a report that IRS personnel are encouraged to use to convey information to the OPR about questionable practitioner conduct. Although the form does not function to authorize the assessment of a penalty, in this case the TCO’s acting immediate supervisor placed her digital signature on the Form 8484 indicating that she agreed with the referral of the matter to the OPR and that she approved the audit report (attached to the Form 8484) which recommended that 20 section 6695(g) penalties be assessed against petitioner. The audit report included a detailed explanation in support of each of the 20 penalties. Under the circumstances of this case, we conclude that the TCO’s initial determination to assess the penalties in dispute was personally approved in writing by her immediate supervisor within the meaning of section 6751(b).
As this is a summary opinion not subject to further review, there is no chance to in this case see if the IRS’s failure to seek penalty approval in the proper manner amounted to compliance with Section 6751(b). As we have discussed (most recently in Samantha Galvin’s Designated Order post from a few weeks ago), the 6751(b) issue is one that the Tax Court and other courts are increasingly facing.
There are many complexities in the Internal Revenue Code. There are also many nuances in tax procedure. Put the two together and there are ingredients for the need for guidance. Earlier this week the IRS issued a nonacquiesence in a 2016 Tax Court case that had slipped through and I had not noticed.
The case at issue is Tsehay v. Commissioner, T.C. Memo. 2016–200. In Tsehay, the taxpayer, a custodian whose first language was not English, had an on again off again relationship with his spouse. During 2013, the taxpayer testified (credibly, according to the opinion) that he his wife and their children lived with him though by 2014 they had separated. He, using a paid return preparer, filed a 2013 return as head of household and claimed his kids as qualifying children for the EITC and dependency exemptions. HOH status was crucial for purposes of the EITC, as married taxpayers who are not divorced or separated (or who do not live apart from their spouse for the last 6 months of the year and who otherwise generally pay ½ of the household and childcare expenses) cannot claim the EITC unless they file a joint return. There is no similar anti-MFS rule in place for claiming children as dependents.
The opinion concluded that his credible testimony regarding his living with his kids was enough to justify his receiving dependency exemptions and the EITC.
It appears that the judge and IRS counsel may have missed the special rule that prevents MFS taxpayers from claiming the EITC.
Actions on Decisions shall be relied upon within the Service only as conclusions applying the law to the facts in the particular case at the time the Action on Decision was issued. Caution should be exercised in extending the recommendation of the Action on Decision to similar cases where the facts are different. Moreover, the recommendation in the Action on Decision may be superseded by new legislation, regulations, rulings, cases, or Actions on Decisions. Prior to 1991, the Service published acquiescence or nonacquiescence only in certain regular Tax Court opinions. The Service has expanded its acquiescence program to include other civil tax cases where guidance is determined to be helpful. Accordingly, the Service now may acquiesce or nonacquiesce in the holdings of memorandum Tax Court opinions, as well as those of the United States District Courts, Claims Court, and Circuit Courts of Appeal. Regardless of the court deciding the case, the recommendation of any Action on Decision will be published in the Internal Revenue Bulletin.
At times, the AOD that the Service issues has an extensive discussion of the reasoning. Other times, as in AOD 2017-05 on Tsehay, it just states the conclusion that the Service does not acquiesce in the decision. That nonaqciescence makes sense, as it appears that Tsehay is just the result of a counsel and judicial foot fault on the law. It is intended to remind counsel attorneys (and taxpayers) that it is inappropriate to rely on Tsehay for the position that married taxpayers who file an MFS return or who are required to file an MFS return are entitled to the EITC. As a guest post from Andy Grewal discusses a couple of years ago, while Tax Court memo opinions are not supposed to be precedential (and are intended to be used only in clear cut or heavy factual cases), as a practical matter advocates and the court itself often look to and effectively rely on these cases so Counsel wanted to clear the air.
Because AODs give direct insight into Chief Counsel’s litigating position and because understanding that position allows a representative to provide valuable advice about the likelihood a case will go to trial rather than settle, the more AODs the IRS issues the better. Back in the 1970s the IRS issued AODs routinely. Today, issuing an AOD seems to be the exception rather than the rule. Still, the AODs that are issued provide a benefit when trying to understand what will happen with a case and they should not be overlooked.
The Trump Administration released its FY 18 budget, a budget that is generating a great deal of controversy due to unrealistic assumptions and for its slashing many entitlement programs. Since early days on the campaign the President has emphasized the need to control for errors and fraud in transfer programs. IRS has been a poster child for improper payments, and it is no surprise that this budget addresses that issue.
The document entitled Analytical Perspectives to the budget seems to contain most of the context and description of the assumptions and additional detail. Starting at about page 99 is a discussion of the need to ensure greater integrity in federal spending programs. While I have not read line by line the budget materials there are two measures in the budget that stand out for possible impact on tax administration: oversight over tax return preparers and expanded IRS math error powers. The former in my view is a great idea and the latter not so much.
The budget requests “authority to increase [IRS] oversight over paid preparers.” As the Administration states, “[i]ncreasing the quality of paid preparers lessens the need for after-the-fact enforcement of tax laws and increases the amount of revenue that the IRS can collect.” We have discussed this issue numerous times in PT. Increasing accountability and visibility of unenrolled preparers is on balance good for taxpayers and tax administration. The most recent IRS compliance study pegged unenrolled preparers as having the highest error rates on EITC returns, and while regulation is not a panacea, requiring minimum standards and directly bringing those preparers into the Circular 230 fold is a way to discourage preparers and taxpayers from acting as if the tax system is an unwatched cookie jar and to encourage preparers to act as gatekeepers.
[W]ith this new authority, the IRS could deny a tax credit that a taxpayer had claimed on a tax return if the taxpayer did not include the required paperwork, or where government databases showed that the taxpayer-provided information was incorrect.
I understand the reasoning behind this proposal. EITC exams already hover at about 40% of all IRS exams and while IRS does these exams mostly on the cheap through correspondence, TIGTA has estimated that it still costs IRS on average about $400 for each correspondence exam. Yet the problem with the proposal is that the underlying information in many of the federal databases is not reliable enough to justify dispensing with the normal due process protections of pre-assessment notice and defined right to Tax Court review. For example, HHS maintains database on child custody but millions of lower income individuals do not have formal custody arrangements or even if they do the databases are not reliable enough to warrant automatic rejection. In addition, GAO and others have criticized past IRS administration of its math error powers, an issue that is particularly pressing if individuals rely on the claimed credit to meet basic needs.
While IRS is still an efficient administrator of refundable credits (even accounting for program error costs per $ of benefit are very low relative to other means-based benefit programs), Congress would be better served recognizing the limits of IRS ability to verify eligibility and provide additional resources to do its job properly rather than look for ways to do its job on the cheap and on the backs of the beneficiaries.
While many observers have labeled this budget dead on arrival, tax proposals and tax administration proposals often have nine lives. The theme of reducing errors and saving money through increased compliance will be recurring over the next few years, and that will likely lead to proposals like these that if enacted could mean significant tax administration changes.
As this year’s fling season is winding down, the National Consumer Law Center released a report discussing the filing season issues from the perspective of lower and moderate-income taxpayers. This year’s report discusses some of the main issues in the past filing season, including the Congressionally mandated delay associated with EITC and CTC refunds, the rebirth of a new form of refund anticipation loan, challenges associated with getting a Tax Identification Number, the limited ways in which states regulate commercial tax return preparers, and the onset of private debt collection.
I have been following the refund loan return, which I discussed on PT in Refund Loans on the Comeback, With A Twist and in a follow up to that post.
For those of you unfamiliar with the issue, a refund anticipation loan (or RAL) was a loan that banks made and that was secured by and paid with the proceeds of a taxpayer’s refund. In their heyday they were controversial, in part because they were almost always accompanied by high fees and high effective interest rates. In addition there was significant concern that the fees provided the incentive for preparers and banks to encourage improper claims, especially when IRS shared with preparers a debt indicator that let preparers know if the refund were likely to be delayed or intercepted to apply to a past due tax or other offset.
In 2012, RALs in their earlier incarnation dried up after IRS pulled the debt indicator and federal regulators essentially forced banks out of that business. As I discussed earlier this year, many preparers and partner banks brought back the loans this filing season, though with two key differences: the loans 1) had no stated fee and 2) were non-recourse, meaning that if the refund does not materialize due to say a refund freeze or offset the losses were not the responsibility of the individual filer. It appears that for this filing season the RAL is now a loss leader, or a way to bring clients into the door to generate prep fees and perhaps upsell other products that the preparers offer.
Given the statutory mandated delay in EITC and CTC refunds and the mostly no-fee modern RAL, it is not surprising people were attracted to this product. The NCLS report indicates that this year over 1.5 million RALS were issued, up from about 40,000 in 2015.
The report discusses that not all preparers were genuinely offering a no-fee RAL; some had disguised fees and others essentially wrapped in costs with the fee for preparing a return. Prep fees take a big bite out of many lower-income individuals’ refunds; the report discusses the wide range in fees that preparers charge to prepare EITC returns and discusses a survey from the Progressive Policy Institute that indicates EITC recipients can expect to pay between 13 and 22% of their refunds on tax prep fees and related services.
In years past, in addition to the consumer issues, I was interested in the relationship of RALs and noncompliance. I discussed that issue in a 2009 article in Stanford Law & Policy Review called Refund Anticipation Loans and the Tax Gap. Under the old RAL regime, some argued that the combination of high fees, the IRS’s release of the indicator that allowed preparers to know if the claimant’s refund would be offset or likely frozen, and the recourse nature of the loan created a divergence in the preparer’s interest in turning profits and the general interest in submitting claims that relate to eligible claimants. The dynamics have changed considerably. Since I first discussed the issue Congress tightened up due diligence rules; IRS is (albeit sporadically) enforcing those rules among preparers, and now with this new RAL product preparers rather than filers are on the hook for defaults.
From a compliance standpoint it is possible that the current rise in RALs helps ensure that preparers are actually more invested in performing due diligence, or at least more sensitive to the issues (or at least audit risk), as repayment will be based on the consumer actually getting the refund claimed.
As NCLC discusses, however, compliance is not the only issue associated with the product. It comes back to the healthy prep fees that preparers generate. If the individual were already going to use a preparer for the return, then as the report notes the RAL (assuming no hidden fee or truly no passing on of the higher costs) is just a benefit without much additional expense. But there are free options available for many lower or moderate-income individuals, such as the Free File program IRS itself makes available in tandem with the private sector and VITA sites. So to the extent that the product attracts people to high cost preparers, it creates a different dynamic.
In the past it was generally easy to criticize RALs. Now it is not so clear. The costs of RALs this time out are a little less visible though still present for those now using a paid preparer offering a RAL when they otherwise would not. Also, there are now benefits if in fact preparers’ interests are more closely aligned with the government’s in ensuring that eligible claimants apply and receive an EITC-generated refund.
Tax return preparers have heightened requirements when preparing returns claiming many refundable credits. While the IRS lost the battle over regulating unlicensed preparers, it does have tools to examine and sanction preparers who violate those rules. There have been very few opinions considering whether a preparer’s conduct justifies the imposition of civil penalties. Last week in Foxx v US the Court of Federal Claims held that a preparer was subject to a civil penalty under Section 6694(b) for his willful or reckless conduct relating to his failure to make reasonable inquiries into income from taxpayer’s purported auto-detailing business. The IRS claimed that the taxpayer did not in fact earn the income in question. The Foxx case presents the what frequent guest poster Carl Smith has referred in a guest post to as the topsy-turvy world of earned income tax credit (EITC) cases because the creation of the phantom income fueled a refundable EITC that exceeded the taxpayer’s income and self-employment tax liability.
George Foxx came to the attention of the IRS after it audited the tax return of Shakeena Bryant. Bryant had claimed an EITC; almost all of the earned income on the return was from an auto-detailing business she reported on Schedule C. Foxx referred to himself as the tax doctor and claimed to have 37 years of tax return prep experience. Bryant went to the tax doctor with a friend of hers, Herman James. On audit of Bryant’s return, the IRS disallowed the credit. During the audit, she agreed that she did not have the income necessary to justify her claiming the credit. In correspondence, Bryant claimed that she was instructed by Foxx to report the income to justify the refund.
IRS then examined Dr. Foxx and assessed a $5,000 penalty under Section 6694 for his willful or reckless conduct in preparing the return (note there is a separate $500 penalty under Section 6695(g) for violating the due diligence rules; that penalty was not at issue in the case). After an administrative appeal of his penalty IRS reduced it to $2500. Foxx paid and sued for refund.
The government deposed Bryant’s friend (James) who accompanied her to Dr. Foxx when the Tax Doctor prepared her return.
The case on the surface turned on whether the preparer George Foxx 1) facilitated the improper claiming of the credit by instructing the taxpayer how to goose the credit and make it look legitimate by applying for a business license even in the absence of the actual business or 2) prepared the return based on what Bryant told him about her business.
According to the opinion, Foxx clamed that in preparing the return he relied upon Bryant’s business license and two pages of his notes that outlined expenses associated with the business.
As the Foxx case illustrates, the EITC creates the odd incentive for the creation of phantom income that could fuel a tax refund. That phantom income could also create a record of social security benefits that could generate Social Security benefits.
While noncompliance with the EITC generates significant attention, the absence of information reporting that ties much income to self-employed taxpayers contributes to those taxpayers in general comprising the largest source of the individual tax gap. EITC noncompliance among self-employed taxpayers is a small but significant part of the tax gap that is associated with self-employed taxpayers. Despite the EITC comprising a small portion of the tax compliance problem among the self-employed, there are special due diligence obligations imposed on preparers who prepare EITC returns with Schedule C’s that do not apply to other Schedule C returns.
IRS has on its EITC due diligence web site a series of scenarios discussing what it believes are examples of when preparers need to take additional steps. One of the scenarios involves a self-employed housecleaner who comes to a preparer claiming exactly $12,000 in earnings with no records and no expenses. A similar example is in the regulations. For the house-cleaner with the rounded off income figures and no expenses the IRS advice states that a preparer should “probably not” prepare the return in the absence of at least a written record of expenses and earnings, though opens the door a bit if the taxpayer “can reasonably reconstruct” the earnings and expenses. To that end the advice suggests that the preparer should ask how much she charges per house, as well questions relating to how many houses she cleaned on average per week and probe as to the reason for the lack of expenses (e.g., the homeowners provided all supplies).
One does not need to have a suggestion that a preparer has encouraged the fabrication of phantom income to generate preparer penalties. A cautious reading of the Foxx opinion is when preparing a return with an EITC based on self-employment income the preparer should require documentary evidence supporting the amount claimed to have been earned and any expenses that are incurred. In the absence of records (a sure bet for many) the preparer should document and retain an explanation as to how he came to the net earnings, tying conclusions to specific information that the client has provided. For a taxpayer with little in the way of documents, it would be a good idea to have the taxpayer in writing affirm the manner that the preparer computed a business’ net earnings and state that the facts that the preparer is relying on are accurate to the best of the taxpayer’s recollection. Absent that the preparer opens himself up to a charge that he has failed to make “reasonable inquiries” in the presence of incomplete information (one of the requirements under the due diligence regulations).
Advocates recommend that taxpayers avoid no fee RALs if possible. One risk is that some unscrupulous tax preparers might charge more in their tax preparation fees to “no fee” RAL borrowers. Also, in the last tax season some lenders, such as EPS and River City Bank, appeared to actually impose a price for “no fee” RALs by charging a higher price for a refund anticipation check (RAC) if the preparer was offering these loans.
With RACs, the bank opens a temporary bank account into which the IRS direct deposits the refund. After the refund is deposited, the bank issues the consumer a check or prepaid card, minus tax preparation fees paid to the preparer, and closes the temporary account. RACs do not deliver refunds any faster than the IRS can, yet cost $25 to $60. Some preparers charge additional “add-on” junk fees for RACs, fees that can range from $25 to several hundred dollars.
The NCLC also discusses some of the other challenges this year, including the need for many taxpayers to get a renewed Taxpayer ID number (ITIN), the coming of private debt collectors and the need to select competent and honest preparers.
Further note: I have updated the link to the IRS web page for this filing season.

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