Source: https://procedurallytaxing.com/category/notice-of-deficiency/
Timestamp: 2019-04-22 17:06:54+00:00

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In a precedential opinion in the case of Gregory v. Commissioner, 152 T.C. No. 7 (2019), the Tax Court has held that sending a power of attorney (POA) form to the IRS with a new address for the taxpayer does not put the IRS on notice with respect to the change of address such that it must use that address in corresponding with the taxpayer in a notice required to be sent to the taxpayer’s last known address. Bryan Camp has a nice write up of the case on the Tax Prof blog if you want an expanded take on the case and you have an interest in knowing how Bryan met his wife.
Before going into an explanation of the basis for the Court’s opinion and why it issued a precedential opinion on this issue, I found it worth noting what was not discussed in this case. Since it was not discussed, I do not know why and would welcome comments from any reader who might know. Because the issue in the case is whether the POA form can change a taxpayer’s address, I would guess that a valid POA existed at the time the notice of deficiency at issue in this case was mailed. If a valid POA existed at the time of the issuance of the notice, why didn’t the POA receive the notice in time to file the Tax Court petition?
The IRS position is that its failure to send a copy of the notice of deficiency to the POA does not invalidate the notice and does not save the taxpayer who files late. See IRM 4.8.9.11.4 (providing that notice may be invalid if not mailed to last known address of taxpayer or if not mailed by certified or registered mail) and IRM 4.8.9.11.2 (providing that copies of the notice are sent to the POA via regular mail). Here, it is not clear if there was a valid POA at the time of the notice, if the POA was timely notified or if the IRS failed to send a copy to the POA. If a POA existed and the IRS timely sent a copy to the POA, maybe this was really a case seeking to protect the POA from exposure. If a POA existed and the IRS did not send a timely notice to the POA, I am surprised that the taxpayer did not at least make an argument regarding that failure. If the notice were a notice of determination in a CDP case, IRC 6304 might come into play if the IRS failed to timely notice the POA. See IRC 6304(a)(2); but cf. Bletsas v. Commissioner, T.C. Memo 2018-128 (2018) (rejecting taxpayer’s argument that IRC 6304 required the IRS to mail a notice of lien to her POA).
The Gregorys filed their return for 2014 after they moved from Jersey City, New Jersey to Rutherford, New Jersey in 2015; however, on the 2014 return they put their Jersey City address. The opinion did not provide an explanation for why they did this but right off the bat they have created a problem for themselves. During the course of the examination, the Gregorys submitted two POAs to the IRS and each POA listed their new address in Rutherford. During the examination, they also filed a request for extension of time to file their 2015 return and that request also listed their Rutherford address. When the IRS issued the notice of deficiency on October 13, 2016, it had not yet received their 2015 return and it had not received a formal change of address notification from the Gregorys.
The IRS sent the SNOD to Jersey City. The Gregorys did not receive it until after 90 days had run. They filed their Tax Court petition immediately upon receipt of the SNOD. The IRS moved to dismiss the petition as untimely. Both parties agreed it was untimely and that the Tax Court case became one that would decide whether the notice was sent to their last known address and not one which would determine the merits.
The Court here relies on the statute, the regulations under the statute and the Rev. Proc. promulgated in furtherance of the regulations. Bryan Camp’s post does an excellent job walking through those provisions and I will not duplicate it here. The result of the application of the statute, the reg and the Rev. Proc., as well as the language on the POA form and the application for extension form, is that these forms are not returns. Putting a new address on these forms does not provide the type of notice requiring the IRS to adjust its records. Because the POA form and the application for extension form do not require the IRS to adjust its record of a taxpayer’s address, the sending of the SNOD to the Jersey City address met the statutory requirement of sending the notice to the taxpayer’s last known address. Since it met that requirement, the SNOD provided a valid basis for the IRS to assess the liability shown thereon. The taxpayers can still litigate about the underlying liability. They must fully pay first and file a refund claim in order to litigate the issue through the refund process. Alternatively, since they did not receive the SNOD, they can litigate the merits in a Collection Due Process case once the IRS sends notice of intent to levy or files a notice of federal tax lien. Depending on whether a copy of the SNOD was timely sent to a representative, they may find their representative anxious to assist them in obtaining an opportunity to litigate the merits.
The decision here suggests to practitioners that they should take the opportunity of sending in a POA to review the client’s last known address and the practitioner should consider including with the POA a formal notice of the change of address where appropriate.
The case does not address the situation of conversations with the IRS. When I speak with someone at the IRS and I am confirming my ability to represent the taxpayer, I frequently get quizzed about the POA. One part of the quiz is the taxpayer information. If the POA does not contain the taxpayer’s phone number, I get quizzed about their phone number and sometimes about their address. If a representative talks to a human at the IRS about the taxpayer’s address on a POA, I wonder if that might change the outcome here. The issue of last known address has many permutations. In the book Effectively Representing Your Client before the IRS an entire chapter is devoted to this topic. No one wants to be relying on a last known address argument but this issue comes up with frequency.
What happens when IRS wishes to issue stat notice to taxpayers who filed joint returns? Section 6212(b)(2) provides that the notice may be a single joint notice, except if the IRS has been notified that the spouses live separately. IRS Restructuring Act of 1998 in an off-Code provision states that IRS is required, “whenever practicable,” to send “any notice” relating to a joint return separately to each spouse. When taxpayers file joint returns, and IRS issues a stat notice, IRS policy is to send duplicate notices to each spouse even if they live at the same address.
Parson v Commissioner is a recent undesignated Tax Court order that highlights the risks to the IRS when it does not strictly follow its procedures for issuing separate notices.
Here are the facts. Parson involved married taxpayers who lived at the same address. In 2014, the husband filed a MFS return and the wife did not file a return; in 2015 they filed a joint return. IRS examined the husband’s 2014 MFS return and the 2015 joint return. IRS issued and sent a single stat notice that covered the husband’s 2014 MFS return and the joint return. The letter portion of the stat notice was addressed only to the husband. The waiver allowing immediate assessment only listed the husband as the sole taxpayer. Accompanying the letter were two separate Forms 4549 A, Income Tax Examination Changes, one for 2014 in the husband’s name and the other for 2015 that referred to both husband and wife.
The Parsons together filed and signed a single petition; the petition swept in both years. For 2014, IRS moved to dismiss the case for the wife, which the Tax Court granted, given that in 2014 the examination pertained to the husband’s MFS return.
Special Trial Judge Armen on his own raised the issue of a jurisdiction for the wife for 2015 given that the stat notice letter only listed the husband’s name. IRS claimed that the Tax Court had jurisdiction over the wife for 2015 because the Income Tax Examination Change Form 4549 A for 2015 also had her name on it and that she was not misled or confused—after all she did file a petition the Tax Court.
However, the Court views the matter differently. First and foremost, it is clear that the . . . notice of deficiency was addressed solely to [husband]. See I.R.C. sec. 6212(a) and (b). Second, the Commissioner is obliged, “wherever practicable, [to] send any notice relating to a joint return under section 6013 of the Internal Revenue Code of 1986 separately to each individual filing the joint return.” Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, sec. 3201(d), 112 Stat. at 740. This was not done in the present case.
The order thus dismissed the wife’s case for lack of jurisdiction; the order goes on to state that of course IRS could issue a separate stat notice to the wife and that if she wishes to challenge that in Tax Court she will have to timely file a new petition.
RRA 98’s off Code provision requiring “wherever practicable” that IRS issue separate notices related to a joint return is an important protection from abusive or controlling spouses that may not share correspondence (IRS by the way interprets “any notice” relating to a joint return as only notices required by statute). The separate notice requirement is not an absolute directive and Section 6212 allows a single joint notice when IRS does not know that spouses live separately. The order in Parson highlights the risk to IRS when its stat notice itself fails to explicitly list both spouses’ names, and IRS fails to send separate letters. Parson also is a reminder to practitioners to review carefully IRS correspondence to make sure that IRS complied with its notice requirements. Query how Judge Armen would have ruled if the IRS had sent a duplicate copy of the stat notice addressed to the wife that failed to include her name on the letter portion of the notice.
Hat tip to Lew Taishoff who flagged this order on his blog.
Who Can Issue a Notice of Deficiency?
Two years ago the Eighth Circuit reversed a Tax Court decision in a case involving a tax protestor because the IRS did not prove that the person signing the notice of deficiency had the authority to do so. I blogged about it here and predicted that the case would return to the Eighth Circuit after the Tax Court saw to it that the person issuing the notice had the delegated authority to do so. On May 16, 2018, the Eighth Circuit issued an opinion upholding the Tax Court’s decision on remand that the person signing the notice of deficiency had the authority to do so. The outcome is exactly what I predicted in my prior post but worthy of mention to close the loop. Because of the post-Graev challenges to penalty approval, it is possible that there will be an uptick in other challenges to IRS action. The Muncy case serves as a reminder that the IRS must follow a prescribed process in issuing the notice of deficiency (and other similar notices), that taxpayers can challenge the authority of the person issuing the notice and that the IRS must go through the steps to prove that it followed the rules even though going through those steps is burdensome. It also serves as a reminder that these challenges will generally not prevail.
Mr. Muncy tried to cheat on his taxes, got caught and was convicted of a willful attempt to evade and defeat his taxes for 2004. The IRS sent him a notice of deficiency dated September 7, 2011 signed on behalf of the IRS Commissioner by Ms. Miller who was a Technical Services Territory Manager at the time. She signed the notice pursuant to Delegation Order 4-8, as set out in IRM 1.2.43.9 (February 10, 2004). There are many delegations orders in the IRM which are constantly being updated. The IRS does a good job of following the IRM with regard to the delegation orders but it is certainly possible that it could make a foot fault. A mistake in signing notices of deficiency could have a broad impact on the validity of assessments since the person signing the notices usually signs a large number of them.
In the initial visit of this case to the Eighth Circuit, as described in the prior post, the Eighth Circuit was unconvinced that the IRS had provided the necessary proof that the person who signed the notice of deficiency had the authority to do so. The opinion did not suggest that the IRS had made a mistake but simply that the appropriate level of proof was lacking. So, it sent the case back to allow the IRS to put on proof that the person signing the notice was properly authorized to do so and the IRS put on that proof.
Petitioner contends that respondent’s deficiency determinations for tax years 2000 through 2005 are “null and void” because the notice of deficiency was not “issued and sent by a duly authorized delegate of the Secretary.” Petitioner’s argument regarding the authority of IRS employees is similar to those we have previously rejected, held to be without merit, and characterized as frivolous. See e.g., Roye v. Commissioner, at *15, *16 n.6; Cooper v. Commissioner , T.C. Memo. 2006-241, 2006 WL 3257397, at *2. We nonetheless address petitioner’s contention in accordance with the U.S. Court of Appeals for the Eighth Circuit’s instructions that we establish jurisdiction over the present matter.
Statutory notices of deficiency are valid only if issued by the Secretary of the Treasury or his delegate. Kellogg v. Commissioner, 88 T.C. 167, 172 (1987); see secs. 6212(a), 7701(a)(11)(B), (12)(A)(i). The technical services territory manager position is part of the Small Business/Self-Employed (SB/SE) division of the IRS. SB/SE territory managers were specifically delegated the authority to send notices of deficiency in Delegation Order No. 77 (Rev. 28), 61 Fed. Reg. 30937 (June 18, 1996) (effective May 17, 1996). See, e.g., Tarpo v. Commissioner, T.C. Memo. 2009-222, 2009 WL 3048627, at *4 (holding an IRS employee with the title “Technical Services Territory Manager” had the authority to sign and issue notices of deficiency, thus conferring jurisdiction on this Court). That delegated authority was reauthorized without substantive changes in Delegation Order 4-8, IRM pt. 1.2.43.9. Ms. Miller undoubtedly has the authority to sign and issue notices of deficiency. See, e.g., Batsch v. Commissioner, T.C. Memo. 2016-140, at *9 (stating a valid notice of deficiency was signed by the “Technical Services Territory Manager,” pursuant to Delegation Order 4-8). We therefore hold that we have jurisdiction.
After the Tax Court went to the trouble to address the delegation order, the Eighth Circuit expended little effort in affirming the Tax Court the second time around. It found Mr. Muncy relied on an overly technical reading of the delegation order and that the IRS had complied with the delegation order in having Ms. Miller sign the notice of deficiency. So, Mr. Muncy now has a big assessment and we have a roadmap for how the Tax Court approaches cases in which the taxpayer challenges the proof of delegation order to the person signing the notice.
Today we continue our reporting on designated orders. Guest blogger Samantha Galvin reports on three cases. Professor Galvin teaches and represents low income taxpayers in the tax clinic at the Sturm College of Law at the University of Denver – one of the oldest and best tax clinics for low income taxpayers. Keith.
Two out of three of last week’s designated orders involved the IRS moving to dismiss the case, in part, for lack of jurisdiction because the taxpayers did not petition the Tax Court on a Notice of Deficiency but ended up in Tax Court after walking down a different procedural path. In these types of cases, the IRS wants to ensure that all parties understand which issue(s) is in front of the Court.
The first case is a fairly common scenario, but it is a scenario in which new practitioners (and pro se petitioners) should be careful. Petitioners’ original 2013 tax return showed a balance due of approximately $44,000, but they did not make any payments. They received a Final Notice of Intent to Levy and timely requested a collection due process (CDP) hearing asking for an installment agreement or an offer in compromise.
As part of the normal process, the IRS Appeals Office requested that the taxpayers submit a financial form and substantiation but taxpayers did not respond, nor did they participate in their CDP hearing phone conference. In October of 2015 (mistakenly referred to as 2016 in the Order and Decision), the taxpayers finally submitted a financial form, but again did not submit any substantiation. In December of 2015, the taxpayers received a statutory Notice of Deficiency (NOD) for tax year 2013 proposing to assess an additional $7,058 in tax and penalties. Taxpayers’ failed to timely petition the Tax Court for a redetermination pursuant to the NOD.
On January 22, 2016 (less than a week after the deadline to petition the Tax Court on the NOD had passed), the IRS Appeals Office issued a notice of determination concluding the CDPhearing in which it sustained the proposed levy because the taxpayers did not submit any substantiation and because they had sufficient assets to pay the balance. This time the taxpayers petitioned the Tax Court claiming the IRS unfairly assessed penalties and seeking review of the NOD.
The IRS moved to dismiss the case for lack of jurisdiction to the extent the matter related to the NOD and the Tax Court granted the motion. Additionally because the taxpayer did not raise the issue of penalties during the administrative process, the Court held they were precluded from doing so in Tax Court.
The IRS’s motion to dismiss not only prevented the taxpayers from disputing the underlying liability, but also impacted the standard of review used by the Tax Court. On a deficiency case, the standard of review is “de novo” which generally means the Court will review the case without being bound by what the IRS or taxpayer has done to resolve the case prior to coming to Court. On a CDP hearing case, such as this when the underlying liability is not properly at issue, the Court reviews the case for an “abuse of discretion” which is whether the exercise of discretion by IRS Appeals was without sounds basis in fact or law.
The court reviewed the notice of determination for abuse of discretion and found that Appeals did not abuse its discretion in sustaining the proposed levy, since the taxpayers failed to participate in the CDP hearing and did not submit financial information or substantiation. As a result, the Court granted the IRS summary judgment.
Be cognizant of the procedural path down which you are walking. It can get confusing especially if the taxpayer is in collections for a portion of liability, but another portion has not yet been assessed. If you want to dispute the underlying liability, then petition the Tax Court on an NOD rather than a notice of determination. It is rare that liability disputes can be raised in a collection due process hearing and it can really only be done if a taxpayer did not receive an NOD or did not otherwise have an opportunity to dispute the liability, an issue PT has covered extensively; see Keith’s post from this past March, for example. This is true even if a practitioner begins representing a client after the right to petition Tax Court pursuant to an NOD has expired.
Penalty abatement can be raised in a CDP hearing, but if it is not raised it may be precluded from being raised in Tax Court.
If a dispute to liability exists but the right to go to Tax Court on an NOD has expired, a practitioner or taxpayer should dispute the liability through audit reconsideration or a doubt as to liability offer in compromise instead.
Don’t petition Tax Court on a CDP hearing unless the IRS abused its discretion, which means it did not consider the facts or law in an appropriate way.
Similar to the Schwartz case (above) this is another case where the taxpayers did not petition the Tax Court on a Notice of Deficiency (NOD), but unlike the Schwartz case it seems like the taxpayers did not intend to dispute the underlying liability. In this case taxpayer wife and taxpayer husband ended up in Tax Court after the taxpayer wife’s request for innocent spouse relief was denied by the IRS (presumably this means the case involves taxpayer ex-wife and taxpayer ex-husband). Taxpayer husband intervened, which is permissible in an innocent spouse case and allows the non-requesting spouse the opportunity to testify about why the requesting spouse should not be granted relief. When an intervening spouse is successful, both spouses remain jointly and severally liable for the deficiency.
The IRS filed a motion to dismiss for lack of jurisdiction as to the NOD, stating that the Tax Court only had the jurisdiction to determine whether petitioner (taxpayer wife) should be relieved of liability.
The Tax Court gave the petitioner (taxpayer wife) and intervenor (taxpayer husband) an opportunity to respond and neither did, but later in a telephone conference taxpayer husband had no objections and taxpayer wife’s counsel affirmatively consented to the Court granting the IRS’s motion.
Once all parties were made aware that a dispute to the liability was not before the Tax Court, the Court allowed the innocent spouse relief question to proceed to trial.
In this case it is unclear if a dispute to the liability was raised in the petition, or if IRS always requests a motion to dismiss for lack of jurisdiction in these case just so the taxpayers (and perhaps, the Court) are clear about what is really at issue.
The IRS is required to send separate original notices of deficiency to each spouse at their last known address (pursuant to I.R.M. 4.8.9.8.2.7), so even if taxpayers were divorced or separated at the time both taxpayers would have had the opportunity to petition the Tax Court on the NOD.
This case involves a taxpayer/petitioner who is currently an inmate in the Texas prison system, but the deficiency arose from tax years 2009 and 2010 (only 2009 was still at issue, because IRS had been granted summary judgment for 2010). In those years, the taxpayer was not yet in prison and he was a school teacher. The IRS sent him a Notice of Deficiency (NOD) after he began serving time and he timely petitioned the Tax Court asking for the deficiency to be redetermined. The deficiency arose from the taxpayer’s failure to substantiate gross receipts on his Schedule C and expenses on his Schedule C and Schedule A.
The Tax Court prefers to resolve cases expeditiously, even when a taxpayer is in prison. In this case, the taxpayer petitioned the Tax Court in 2012 and the decision was issued in 2017 so this case had been going on for a while. The Court worked with the taxpayer through the stipulation and summary judgment process (presumably for 2010) but then ordered the taxpayer to file written testimony stating his disagreement of the NOD for 2009 but the taxpayer failed to do so.
The Tax Court used its Rule 123(a) power which allowed the Court to default the taxpayer’s case, and pursuant to that rule, enter a decision against him.
Taxpayers without substantiation are a common phenomenon even when they are not in prison, so it was likely nearly impossible for the petitioner in this case to retrieve old records – but to view this as just another lack of substantiation case may be incorrect, because the Court took the time to describe the difficulties involved in resolving cases when a taxpayer/petitioner is in prison.
The Court referenced the BTK serial killer’s Tax Court case (in which the Court allowed the BTK killer to participate in trial via phone pursuant to Tax Court Rule 143). The Court also discussed that writs of habeaus corpus ad testificandum, which is an order from the court that a prisoner be brought to court to testify, are difficult to manage and security concerns make transportation difficult. Those concerns allow the Court to weigh the amount at issue with the need to find economical solutions for resolving the case.
If a practitioner has a client in prison, the Tax Court may use Rule 143 in order to resolve the case without requiring the petitioner to be there in person.
These types of cases present potential substantiation-related issues and may require some creativity on the part of the practitioner.
Yesterday the Second Circuit decided a very important decision in favor of the taxpayer pertaining to the Section 6571 requirement that a direct supervisor approve a penalty before it is assessed. In Chai v. Commissioner, the Second Circuit reversed the Tax Court, holding the Service’s failure to show penalties were approved by the immediate supervisor prior to issuing a notice of deficiency caused the penalty to fail. In doing so, the Second Circuit explicitly rejected the recent Tax Court holdings on this matter, including Graev v. Commissioner, determining the matter was ripe for decision and that the Service’s failure prevented the imposition of the penalty. Chai also has interesting issues involving TEFRA and penalty imposition that will not be covered (at least not today), and is important for the Second Circuit’s rejection of the IRS position that the taxpayer was required to raise the Section 6571 issue. It is lengthy, but worth a read for practitioners focusing on tax controversy work.
PT regulars know that we have covered this topic on the blog in the past, including the recent taxpayer loss in the very divided Tax Court decision in Graev v. Commissioner. Keith’s post on Graev from December can be found here. For readers interested in a full review of that case and the history of this matter, Keith’s blog is a great starting point, and has links to prior posts written by him, Carlton Smith, and Frank Agostino (whose firm handled Graev and also the Chai case). Graev was actually only recently entered, and is appealable to the Second Circuit, so I wouldn’t be surprised if the taxpayer in that case files a motion to vacate based on the Second Circuit’s rejection of the Tax Court’s approach in Greav.
That paragraph from Keith’s post regarding the holding doesn’t cover the lengthy and nuanced discussion, but his full post does for those who are interested. The Second Circuit essentially rejected every position taken by the majority and concurrence in Graev, and almost completely agreed with the dissenting Tax Court judges (with a few minor differences in rationale).
For its Section 6751(b) review, the Second Circuit began by reviewing the language of the statute. It highlighted the fact that the Tax Court did the same, and found the language of the statute unambiguous, a conclusion with which the Second Circuit disagreed.
The Tax Court found the lack of specification as to when the approval of the immediate supervisor was required allowed the immediate supervisor to approve the determination at any point, even after the statutory notice of deficiency was issued or the Tax Court reviewed the matter.
The Second Circuit, however, found the language ambiguous, and the lack of specification as to when the approval was required problematic. The Second Circuit stated “[u]understanding § 6751 and appreciating its ambiguity requires proficiency with the deficiency process,” and then went through a primer on the issue. To paraphrase the Second Circuit, the assessment occurs when the liability is recorded by the Secretary, which is “essentially a bookkeeping notation.” It is the last step before the IRS can collect a deficiency. The Second Circuit stated the deficiency is announced to the taxpayer in a SNOD, along with its intention to assess. The taxpayer then has 90 days to petition the Tax Court for review. If there is a petition to the Court, it then becomes the Court’s job to determine the amount outstanding. As it is the Court’s job to determine the amount of the assessment, the immediate supervisor no longer has the ability to approve or not approve the penalty. The Second Circuit agreed with the Graev dissent that “[i]n light of the historical meaning of ‘assessment,’” the phrase “initial determination of such assessment” did not make sense. A deficiency can be determined, as can the decision to make an assessment, but you cannot determine an assessment.
The Second Circuit then looked to the legislative history, and found the requirement was meant to force the supervisor to approve the penalty before it was issued to the taxpayer, not simply before the bookkeeping function was finalized. The Court further stated, as I noted above, if the supervisor is to give approval, it must be done at a time when the supervisor actually has authority. As the Court noted, [t]hat discretion is lost once the Tax Court decision becomes final: at that point, § 6215(a) provides that ‘the entire amount redetermined as the deficiency…shall be assessed.” The supervisor (and the IRS generally) can no longer approve or deny the imposition of the penalty. The Court further noted, the authority to approve really vanishes upon a taxpayer filing with the Tax Court, as the statute provides approval of “the initial determination of such assessment,” and once the Court is involved it would no longer be the initial determination. Continuing this line of thought, the Second Circuit stated that the taxpayer can file with the Tax Court immediately after the issuance of the notice of deficiency, so it is really the issuance of the notice of deficiency that is the last time where an initial determination could be approved.
This aspect of the holding is important for two reasons. First, the Second Circuit is requiring the approval at the time of the NOD, and not allowing it to be done at some later point. Second, this takes care of the ripeness issue. If the time is set for approval, and it has passed, then the Court must consider the issue.
Of potentially equal importance in the holding is the fact that the Second Circuit stated unequivocally that the Service had the burden of production on this matter under Section 7491(c) and was responsible for showing the approval. It is fairly clear law that the Service has the burden of production and proof on penalties once a taxpayer challenges the penalties, with taxpayers bearing the burden on affirmative defenses. The case law on whether the burden of production exists when a taxpayer doesn’t directly contest the penalties is a little more murky (thanks to Carlton Smith for my education on this matter). The Second Circuit made clear its holding that the burden of production was solely on the Service, and the taxpayer had no obligation to raise the matter nor the burden of proof to show the approval was not given. The Service had argued the taxpayer waived this issue by not bringing it up earlier in the proceeding, which the Second Circuit found non-persuasive.
As to the substance of the matter, the Second Circuit held the government never once indicated there was any evidence of compliance with Section 6751. Since the Commissioner failed to meet is burden of production and proof, the penalty could not be assessed and the taxpayer was not responsible for paying it. A very good holding for taxpayers, and we would expect a handful of other case to come through soon. Given the division within the Tax Court, and the various rationales, it would not be surprising to see other Circuits hold differently.
In a fully reviewed case, the Tax Court holds, in a very fractured vote, that an IRS Notice of Deficiency stating the taxpayer owes $.00 is a valid notice of deficiency conferring jurisdiction on the Court. The decision in Dees v. Commissioner, 148 T.C. 1 (2017) finds the judges engaged in a debate about just how bad a Notice of Deficiency can be and still meet the standard of a Notice of Deficiency. In upholding the notice as valid, the split vote came out seven judges in favor of the notice in an opinion by Judge Buch, two judges in favor of the notice in a concurring opinion by Chief Judge Marvel, one judge in favor of the notice in a lengthy concurring opinion by Judge Ashford (for a total of 10) versus seven judges in a dissent by Judge Foley and six of those same judges signing onto a separate dissent written by Judge Gustafson. The result almost reminds you of a presidential election and makes me feel better that the Harvard tax clinic was able to unify the Court in a jurisdictional case last year, Guralnik discussed here, in which it voted 16 to 0 against a position espoused by the clinic.
When the IRS makes a mistake in the Notice of Deficiency and the Tax Court nonetheless holds that the notice meets the minimum standard to satisfy the statutory definition of a Notice of Deficiency, the IRS still faces some hurdles in most cases because the burden of proof often shifts to it to prove the basis for the poorly described adjustment. In the Dees case, the various opinions supporting the notice discussed the burden shifting aspect of the Court’s jurisprudence with respect to poorly drafted notices. The judges in the dissent noted the many ways a bad notice can still constitute a valid notice but reached a tipping point with a notice that on its face said that the taxpayer had a $.00 deficiency. I cannot do a great job of distilling all of the arguments presented in the five separate opinions in a blog post but I will try to briefly describe the points made by each opinion.
Judge Buch’s opinion follows a long line of Tax Court opinions holding that various problems with the Notice of Deficiency do not invalidate the notice. In this regard, the opinion here represents just another small step in a 90-year march to save notices whenever possible while imposing other consequences on the IRS for the failures in its notice. In order to save this notice, Judge Buch looks at the notice as a whole and does not stop on the first page of the notice where the notice states quite clearly that it finds no deficiency. Judge Buch, as the Court has done in many prior opinions, goes into the back pages of the notice to figure out that the IRS really did find something wrong with the taxpayer’s return and that what it found wrong really did result in a deficiency in the taxes reported on the return. This opinion finds that in making the determination to validate a notice a Court looks at both objective and subjective facts. The objective facts include the “package” of the notice as a whole. When read together what does the IRS really say? Here, it found, as is common in the opinions reviewing the validity of notices, that when considered as a whole, the notice made sufficiently clear that the IRS did find the taxpayer had claimed a refundable credit he should not have claimed, the IRS intended to disallow that claim, and that in disallowing that claim the tax result created a liability that meets the definition of deficiency. Judge Buch’s opinion goes on to look at the subjective effect of the notice in order to determine its validity. Here, he found that not only did the notice as a whole evince a deficiency determination but the taxpayer realized what the IRS intended to say even though the IRS drafted an inartful notice. Because this notice met both prongs of the test for a valid notice, Judge Buch and six other judges determined that this notice conferred jurisdiction on the Tax Court.
Judge Ashford writes alone but also writes the longest of the opinions. At the risk of distilling her argument too far, she seems to say that the title of the document is what really matters. If the IRS sends a letter entitled Notice of Deficiency, the IRS has sent a Notice of Deficiency and the rest of the discussion concerns other issues. She looks hard at the relevant statutes more than prior law. She too disagrees with Judge Buch’s opinion concerning the importance of the taxpayer’s subjective intent. On this point she writes that “we will never find that we lack jurisdiction under it, because we will never be faced with a case in which a taxpayer has not filed a petition.” While it is true that the Tax Court will never be faced with a case in which the taxpayer has not filed a petition, it may be faced with a case in which the taxpayer files a petition long after the 90 days passes and after the statute of limitations on assessment passes in which the taxpayers argues that a timely petition was not filed because the taxpayer did not believe that the document entitled Notice of Deficiency that said the taxpayer owed $.00 was really a Notice of Deficiency. In such a case, the Tax Court would face the intent issue under the view of the Buch opinion.
Judge Foley and the other six judges joining in the dissent choke on the notion that a Notice of Deficiency can exist where the notice says $.00 on its face because the notice “does not fairly advise the taxpayer that the Commissioner has, in fact, determined a deficiency and … specify the year and amount.” His opinion points out that the existence of a deficiency represents the most fundamental requirement of a Notice of Deficiency. His opinion finds that “only taxpayers with counsel at the ready and pro se taxpayers with extrasensory perception will be able to divine the meaning of these misleading missives.” Because the Notice of Deficiency is designed to satisfy certain fundamental rights and because a notice that on its face says that the taxpayer owes nothing seems not to satisfy those rights, it is hard to argue with the concerns expressed by the dissent. The dissent is short and does not spend much time with prior precedent because it seems to view that the line crossed here is not one that can be patched up by flipping through the back pages of the notice or relying on the taxpayer understanding the true meaning of what the IRS intended. I interpret the bottom line of this opinion as saying that even though the Tax Court has a long history of precedent looking at the back pages of the Notice of Deficiency to ascertain what it really means or looking at other documents, as Chief Judge Marvel points out, that precedent does not support crossing the line to uphold a notice which on its face says the taxpayer owes $.00. Once the notice says that, it does not warrant further inquiry but simply fails to satisfy a necessary condition.
Judge Gustafson writes a separate dissent in which all of the judges joining in Judge Foley’s dissent also join except for Judge Gale. Judge Gustafson further articulates the importance of putting the $.00 amount on the face of the Notice of Deficiency. He points out that the notice twice states that the deficiency is $.00. “A notice that reports such a zero is not a notice of a deficiency; it is a notice of no deficiency.” (emphasis in original) He looks to the requirement that the IRS mail a Notice of Deficiency. Here it mailed a notice of disallowance and of no deficiency. This meant that the notice lacked a statutory predicate and the Court should dismiss the case.
The Tax Court bends over backwards to determine it has jurisdiction when a taxpayer files something within the time frame set out by the relevant statute – usually 90 days. It treats many types of documents filed by petitioners as petitions, or imperfect petitions, allowing taxpayers to perfect their filing as long as the original document arrives at the Court on time. As pointed out by all of the prior opinions cited in Judge Buch’s opinion, the Court has similarly bent over backwards as it determines jurisdiction when a taxpayer timely files a petition in response to a Notice of Deficiency containing defects by allowing the IRS to repair the damage caused by the inadequacy of its notice.
The Dees case presents a factual situation the Court had not previously faced – a notice that literally says no deficiency exists but which when you dig deeper shows that the IRS really did mean to say a deficiency did exist. The majority views the poorly drafted notice as just one more example of a notice that requires peeking behind the first page and they have plenty of case support for that view. The dissent says there must be some line over which the IRS cannot cross and still have a valid notice and that this notice crosses that line. Because I do not have to vote, I will stop there except to say that to the extent the majority is correct, I think the concurring opinion of Chief Judge Marvel places a reasonable limit on the inquiry to which the Court should go in making its determination. It seems tough enough to determine what the IRS means with the written notice without having to try to figure out what the taxpayer thought the IRS meant and how that matters for purposes of granting the Court jurisdiction.
One of the main issues in tax procedure over the next few years will be the relationship of IRS actions with the Administrative Procedure Act. Last week in Taking a Hard Look at Court Review of Treasury Regulations I discussed an article that considered rulemaking in light of 5 USC § 706(2)(A), which empowers a court to invalidate a rule that is “arbitrary” and “capricious.” That issue is front and center in the Altera case involving the validity of regulations under Section 482. That case is currently on appeal in the Ninth Circuit.
A close cousin of the Altera issue is teed up in the context of IRS adjudications in QinetiQ v Commissioner, a case on appeal in the Fourth Circuit. In QinetiQ, well-represented taxpayers are arguing that the IRS’s poorly explained notice of deficiency should be set aside for its arbitrariness. (for previous PT posts on QinetiQ see here and here).
In QinetiQ the taxpayer is arguing that by violating the APA the notice should lose its validity and IRS would have to issue a properly detailed notice to generate a possible deficiency. A side issue would be whether the SOL on assessment would be tolled while the parties fought over the validity of the original notice, an issue I am certain that IRS and taxpayers would disagree over.
In Ax v Commissioner, the Tax Court has not embraced the position that the APA imposes additional obligations on the IRS’s issuance of stat notices, as we explained in Tax Court Rules that APA and Administrative Law Principles Do Not Bar IRS From Amending Answer and Asserting New Grounds for Deficiency. Professors Stephanie Hoffer and Chris Walker followed up and gave additional context on this issue in A Few More Words on Ax and the Future of Tax Exceptionalism.
Petitioners’ submissions make it abundantly clear that they disagree with the Court’s position that the issuance of a notice of deficiency is not subject to the Administrative Procedures Act (APA). But this Court has repeatedly adhered to that position in the past, and most recently in Ax v.Commissioner, 146 T.C.__ (April 11, 2016). Petitioners have presented no authority to the contrary. Their reliance upon Altera Corp. v. Commissioner, 145 T.C. 91 (2015) is misplaced as that case addresses the applicability of the APA to the Commissioner’s regulation promulgation authority.
As I have explained previously, taxpayers are swimming upstream on this issue though there is an atmospheric problem with IRS issuing notices that may be wrong on their face or at best failing to explain much about why IRS is proposing a deficiency. Yet taxpayers generally have the right to de novo review of a stat notice. There are other remedies and specific provisions addressing inadequate stat notices, and taxpayers enjoy the right to meaningful prepayment review of IRS actions. While the courts are pushing IRS toward the mainstream of administrative law in some areas I suspect that this is one issue where tax procedure may stay somewhat outside APA norms.
I am a firm believer that it is better to give than to receive, but I find buying presents to be overwhelming. I can never find the right mix of thoughtfulness and pizzazz, so I usually put it off far too long and then end up doing most my shopping at RiteAid. My wife does all of our holiday shopping, which means I only have to shop for her. Clearly a lucky woman getting all of those fine convenient store items (if you all wanted to comment and provide suggestions as to what I should buy my wife, it probably wouldn’t be a bad thing. What I know after 15 years about her gift preferences are that she would rather they not come from RiteAid, and she doesn’t think tax related gifts are awesome—takes all kinds).
The taxpayers in Cavallaro v. Commissioner did not have similar problems. Their gift was much more complex, but everyone loves huge amounts of wealth. The burden in this case was not what to get or how much to spend. Here, it was the burden of proof (more specifically, which party had the burden and what that burden of proof actually was). The Tax Court and First Circuit both held the taxpayers were unable to shift the burden to the Service, but, interestingly, the First Circuit determined the Tax Court had misapplied the taxpayers’ burden as having to prove their proper tax liability instead of simply proving the Service’s assessed tax was incorrect, which some are suggesting is a significant taxpayer friendly holding.
The Facts –Merging Companies, Giving Gifts.
So, what did the Cavallaros get their sons? A merger, resulting in a gift worth about $29,670,000 (that is on my list, but probably not going to be under my tree). The Cavallaros had a successful company (“Knight”) that made custom tool and machine parts. Husband owned 49%, and wife had 51%. At some point, they tried to expand into a liquid dispensing system manufacturer, but it initially failed. One of the sons asked if he could continue to try to develop the system under a new entity (“Camelot”), and the parents agreed. That son and two other sons owned Camelot. Ten or so years later, the Cavallaros brought in lawyers and accountants to review their estate plan. The accountants felt the now successful other line of business (“newtech”) was part of, or owned by, Knight. This was how it was treated by Knight and how it was kept on the books. The lawyers, however, felt it should be treated as having already passed to Camelot, which was marketing and selling the technology, and which would have already transferred the value to the three sons.
The lawyer, in trying to convince the accountant of this, stated, “[h]istory does not formulate itself, the historian has to give it form without being discouraged by having to squeeze a few embarrassing facts into the suitcase by force.” Facts can be the worst. The lawyer eventually convinced the accountant and family, and then had affidavits, memos, and a confirmatory bill of sale evidencing newtech in Camelot.
The family had a valuation of the two companies post merger, which the valuation expert valued at $70MM to $75MM, with the Knight portion worth about $13MM to $15MM (less than 20% of the total company). Camelot, with the ownership of newtech, was valued at over 80%. After the merger, Mr. C got 18 shares of the merged company, Mrs. C got 20 shares, and each son got 54 shares. Shortly thereafter, the company was sold, with the Cavallaros getting $10.8MM total, and each son receiving $15.4MM.
Later, the IRS examined the two companies, and disagreed about the ownership of newtech, leading it to investigate the transaction for potential gifts from the merger. The Service eventually issued a notice of deficiency for the gifts from the Cavallaros to their sons. The IRS’ initial position, without an appraisal, was that Camelot had no value, resulting in a roughly $46MM gift from the merger, with $12.6MM in tax due. The service also imposed penalties for the failure to file the return and for fraud under Sections 6651(a)(1) and 6663(a).
The Cavallaros took the matter to the Tax Court, and during discovery found that the Service had a valuation done after the deficiency was issued, which had been done by an accountant named Bello, and the appraisal indicated Knight had a value of $22.6MM prior to the merger (not $0). The Cavallaros used the valuation to make two arguments against the Service, both of which could have shifted the burden of proof to the Service. First, the Cavallaros argued that the original deficiency was arbitrary and excessive. Second, the Cavallaros argued the Service had initially taken the position that Camelot was a shell corporation used for a sham transaction, which was used solely for making a disguised gift. The Cavallaros argued that the Service’s new position that the Cavallaros had grossly understated the value of Camelot was a “new matter” under Tax Court Rule 142. Based on this, the taxpayers sought to shift the burden of proof to the Service.
The Tax Court denied the Cavallaros’ renewed motion to shift the burden of proof to the Commissioner. While noting that it was “evidently true that the Commissioner did not obtain an appraisal before issuing the notices” of deficiency, the Tax Court found that there was a sufficient basis for issuing the notices and, thus, that they were not arbitrary. Further, the court found unpersuasive the Cavallaros’ argument that the Commissioner’s litigating position was a “new matter” and stated that the Commissioner’s “partial concessions as to Camelot’s non-zero value” did not require a new theory or change the issues for trial.
On appeal, the Cavallaros renew their claim that the Tax Court erred by failing to shift the burden of proof to the Commissioner for two independent reasons: because (1) the original notices of deficiency were arbitrary and excessive, and (2) the Commissioner relied on a new theory of liability. They make two additional arguments. First, they claim that the Tax Court improperly concluded that Knight owned all of the [newtech] related technology. Second, they contend that the Tax Court erred by misstating their burden of proof and subsequently failing to consider alleged flaws in Bello’s valuation of the two companies.
In general, there is a presumption of correctness of an IRS notice of deficiency, and the taxpayer must prove by a preponderance of the evidence that the Service erroneously assessed tax (which isn’t necessarily the same as showing the taxpayer’s correct tax liability). It is worth noting that this examination began prior to the enactment of RRA98, which amended Section 7491 dealing with burdens of proof. Those changes made it easier, in certain circumstances, for taxpayers to shift the burden to the Service, but those provisions were not available to the Cavallaros (although I’m not sure that would have mattered in this case).
As indicated above, the first argument the Cavallaros made was that the deficiency notice was excessive and arbitrary. Not much text was devoted to this argument, and the First Circuit noted this was a limited doctrine. Essentially, a taxpayer must argue that the assessment has “no factual relationship to the taxpayer’s liability…” Zuhone v. Comm’r, 883 F2d 1317 (7th Cir 1989). The Court said its question was “whether the [taxpayers] have carried their burden of producing evidence from which it can [conclude] that their deficiency assessments utterly lacked rational foundation.” Although the Service initially used no formula, and had no valuation, the Court found that did not result in a conclusion that the initial assessment lacked a rational foundation. As the Service had seen statements about “squeezing a few embarrassing facts into a suitcase,” and other information about aggressive planning, the Court found sufficient evidence to conclude the Camelot substantially less, and perhaps no, value.
The policy behind this makes sense. The taxpayer has all the information, and may not have been cooperating, but the Court was fairly dismissive of this argument, when there were some negative facts for the Service (obtaining a valuation shortly after assessment, which showed substantial value – hard to imagine it had none of that information when assessing).
[Under Section 2511,] donor’s merger of Knight Tool Co. into Camelot Systems, Inc. in return for 19% of the stock of Camelot Systems, Inc. resulted in a gift of $23,085,000.00 to the other shareholders of Camelot Systems, Inc. Accordingly, taxable gifts are increased $23,085,000.00.
The Court stated that the “clear implication was that, because Knight was undervalued, the…merger allowed for a disguised gift…” The Court found that when the IRS subsequently changed its position on the value from $0 to around $22.7MM, it was “simply a refinement”, which it held was in line with its position that, “if a deficiency notice is broadly worded and the Commissioner later advances a theory not inconsistent with the language, the theory does not constitute a new matter…” The Court also found that the notice clearly informed the Cavallaros that the Service was questioning their valuation. This holding, again, makes sense, but I have conflicted feelings about incentivizing the Service to issue notices that are overly broad and vague.
The most interesting aspect of the holding came from the application of the burden of proof in relation to challenging the IRS’s valuation of the entities. The Cavallaros, before the Tax Court, had attempted to challenge the valuation report by Bello that was relied upon by the Service and the Court, believing it to have substantial flaws. The Tax Court disallowed this challenge, believing it to be unnecessary. The Tax Court stated that the Cavallaros had “the burden of proof to show the proper amount of their tax liability.” The Tax Court had found that the Cavallaros’ valuations were incorrect, because they assumed full ownership of newtech in Camelot and the Tax Court had held the technology was owned by Knight. The Tax Court further held that without valuations, the Cavallaros could not prove their correct tax liability, and therefore lost the case, so challenging the Bello valuation wasn’t necessary. The Cavallaros, however, argued that their burden was not to show the proper amount of tax, but to prove that the alleged deficiencies by the Service were erroneous. One avenue of doing this was to address the flaws in the Bello valuation.
[a]lthough the Tax Court did not misallocate the burden of proof at trial, we agree with the [taxpayers] that the Tax Court misstated the content of that burden. The Commissioner’s deficiency notices enjoyed a presumption of correctness, and the [taxpayers] had the burden of proving by a preponderance of the evidence that they were erroneous.
The First Circuit held this was a clear error, and the Cavallaros should have had the opportunity to show the valuation was arbitrary and excessive, which could have then indicated the Service assessment was incorrect. The First Circuit remanded the case to the Tax Court to determine the evidentiary value of the Bello valuation, stating that if it was not valid the Tax Court would be responsible for determining the correct valuation and amount of tax due.
This procedural misstep by the Tax Court was a bit of a gift for the taxpayers, allowing them another shot at reducing their tax burden. I would note, the Tax Court did state the burden correctly in the text of the holding, which it stated in multiple places as the petitioner having to show the deficiency notice was incorrect, and indicating “where the Commissioner has made a partial concession of the determination in the notice of deficiency, the petitioner has the burden to prove the remaining determination wrong” (quoting Silverman v. Comm’r, 538 F2d 927 (2d Cir. 1976)). However, in the discussion of the review of the valuations, it did state, “[i]t is the Cavallaros who have the burden of proof to show the proper amount of their tax liability, and neither of the expert valuations they provided comports with our fundamental finding that Knight owned [newtech]…” This did lead to the Tax Court not reviewing the valuations.
This was a good catch by the litigating attorneys, and goes to show that you need to pay close attention to every aspect of a holding, because even though a Court may correctly state the rules, it still can drift from those rules in coming to its holding. At least one other commentator, Dominick Schirripa at Bloomberg BNA, believes this could be a substantial holding for taxpayers. He indicates it is fairly common for the Court to require the taxpayer to show the correct liability in order to prove the Service’s assessment is incorrect. Mr. Schirripa may be correct, but I think my expectation from the case is a little more tempered (which Mr. Schirripa also notes in his post). It would seem for many income tax cases, and gift and estate, showing the correct tax is really the only way to show that the Service assessment was incorrect. In this case, where a valuation is at question, there are various ways to attack the Service’s valuations without presenting evidence of the correct tax due. Since it may be limited circumstances where this is the case, this holding may not broadly impact how cases are handled before the Tax Court, but it is worth keeping in mind when reviewing a potential case.

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