Source: https://procedurallytaxing.com/category/return/
Timestamp: 2019-04-19 08:27:11+00:00

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On April 4, 2018, the Eleventh Circuit ruled in Schuster v. Commissioner that a credit applied to a taxpayer’s account is not the same thing as a refund. This was bad news for the taxpayer.
Sometimes the IRS messes up when it applies payments, and mistakenly gives the taxpayer an account credit or a refund that the taxpayer did not deserve. If the error is discovered many years later, it can get complicated to figure out where the parties stand and which remedies are available to each.
In 2011, the IRS discovered its mistake and reversed the erroneous credit. Mr. Schuster had made payments (apart from the $80,000) that satisfied his tax liabilities for 2004 and 2005, but not for 2006. So, after the credit was reversed the IRS sent Mr. Schuster a bill for his 2006 balance due. The case came before the Tax Court on a CDP appeal of a notice of intent to levy.
The government has many mechanisms it can use to collect from taxpayers who owe money to the Treasury. One of these mechanisms is an erroneous refund suit under section 7405. An erroneous refund suit must be brought within 2 years of the refund, except in cases of fraud. IRC 6532(b). Mr. Schuster argued that the $80,000 credit applied in 2005 was an erroneous refund that started the 2-year clock running. He argued that the IRS effectively created an end-run around 7405 by using its administrative collection powers, and it should not be permitted to do that. For its part, the IRS argued that the error at issue was a “credit transfer” which did not implicate section 7405 at all. In the IRS’s view, the appropriate statute of limitations is found in section 6502, providing for a 10-year collection period following assessment of tax. Both the Tax Court and the Eleventh Circuit sided with the IRS.
From a taxpayer’s perspective one can understand how unfair this feels. The $80,000 would have been refunded to the taxpayer had he not elected to have it credited to his 2005 (and then 2006) liability. I imagine Mr. Schuster thought he was doing a good deed as a taxpayer by making that election. If he had received a refund check and then sent an estimated tax payment to the IRS, section 7405 would apply. Economically the taxpayer would be in the same position. But the tax code does not run on fairness or logic. Also, there are complications beyond the distinction between a refund and a credit.
In the 1990s there were seven circuit court cases that addressed whether the government could treat erroneous refunds as unpaid tax, and thereby use its administrative collection powers to recover the funds. The government lost those cases. The courts of appeals held that once a taxpayer has paid their assessed taxes, a subsequent erroneous refund does not re-open the liability, and therefore the erroneous refund cannot be treated as an unpaid tax liability to be collected administratively under the original assessment. See O’Bryant v. United States, 49 F.3d 340, 346 (7th Cir. 1995); Mildred Cotler Trust v. United States, 184 F.3d 168, 171 (2d Cir. 1999); Stanley v. United States, 140 F.3d 1023, 1027-28 (Fed. Cir. 1998); Singleton v. United States, 128 F.3d 833, 837 (4th Cir. 1997); Bilzerian v. United States, 86 F.3d 1067, 1069 (11th Cir. 1996); Clark v. United States, 63 F.3d 83, 87 (1st Cir. 1995); United States v. Wilkes, 946 F.2d 1143, 1152 (5th Cir. 1991). For example, in the O’Bryant case, the taxpayers fully paid their liability but the IRS accidentally credited the payment twice, and issued a refund check. The Court held that the IRS could not use its administrative lien and levy procedures to recoup the erroneous refund.
Unfortunately for Mr. Schuster, he had not actually paid all of his assessed taxes for 2006. The Tax Court opinion (by Judge Chiechi) cites the Clark and Wilkes cases for the proposition that a tax assessment can only be extinguished by a payment tendered by the taxpayer, and not by an IRS clerical error. (Refunds resulting from clerical errors are often referred to as nonrebate refunds.) Therefore, the court holds that the 2006 assessment was not extinguished by the $80,000 credit, and the IRS could use its administrative collection powers to pursue the balance. The Court further found that the erroneous credit was not a refund for purposes of section 7405, so the two-year time limit did not apply.
The Eleventh Circuit affirmed the Tax Court, under different (though not inconsistent) reasoning. The per curiam opinion is short and to the point. The court notes that the Code distinguishes between a refund and a credit in several places, and section 7405 specifically only refers to refunds. Therefore, following basic statutory interpretation principles, the Eleventh Circuit holds that section 7405 does not apply to erroneous account credits.
Is the lesson for taxpayers to eschew line 77 and always request their refund? This does not guarantee a windfall for the taxpayer as the government may act within the 2 years or it may be able to use other mechanisms to collect the funds, but it makes the government’s task more difficult especially if the taxpayer takes care to remit legitimate payments covering their assessment.
We have had many posts on the myriad of consequences of filing late tax returns. One we have not discussed results when a self-employed taxpayer files more than three years late. In that situation, the individual must still pay the self-employment tax; however, the individual receives no social security benefits as a result of those payments. As the economy drives more and more individuals into jobs in which they have independent contractor status, the importance of filing on time increases in order to preserve future benefits available to those who qualify for social security.
When a non-filer shows up, sometimes we triage their return for the year in which the refund statute of limitations will soon expire. If it appears that the taxpayer will receive a refund, a last minute push occurs to send that return in before the expiration of the statute of limitations which is generally three years from the due date of the return. If it appears that the taxpayer owes money, the same last minute push may not occur. Because filing the return before three years from the original due date could preserve for the individual the ability to get credit for self-employment earnings for purposes of calculating the amount of social security they will receive, or even whether they will qualify for social security, the practitioner who has the chance to file the return before three years from the due date of the original return should make every effort to do so.
In order to receive social security benefits based on age, an individual must accumulate 40 quarters of earnings. To receive social security disability benefits, the individuals needs 32 quarters. In 2017, an individual receives credit for a quarter of social security earnings if they have $1,300 of qualified earnings. Anyone earning more than $5,200 in 2017 will receive four quarters of credit – the most quarters it is possible to earn in a single year. In addition to meeting the number of quarters necessary to obtain benefits, an individual receives social security benefits based on the amount of their earnings. While the formula skews towards individuals at the lower end of the earnings spectrum by giving a higher return on those earnings in calculating the benefits, the more a person earns the higher their social security benefits.
Here are the directions from Social Security on how to calculate your projected benefit. You can find Column A and B here. I include this primarily to show how valuable the lower earnings are to someone compared to the earnings over $5,336 and how the benefit skews to provide the greatest assistance to those who will likely have the greatest need.
Step 2: Multiply the amounts in Column B by the index factors in Column C, and enter the results in Column D. This gives you your indexed earnings, or the estimated value of your earnings in current dollars.
The aged based benefit is calculated based on the highest 35 years of earnings. Some of my earnings from the 1960s and 1970s when I worked summer jobs while going to school and a quarter of earnings could accumulate for $250 will not do much to push up my high 35 years of earnings, but these quarters did provide a benefit to me in reaching the 40 quarters because all of my earnings when working for the federal government involved no social security taxation and therefore no buildup of earnings or quarters. Federal employees hired starting in the mid-1980s do pay social security, but some state and local government employees may still be outside of the social security system from their primary earnings. Some of my clients have not yet earned enough quarters to receive any social security benefits. Making sure that they understand the importance of earning enough quarters and the link between filing their tax return and earning quarters is something we try to impart.
(2) Have already been included on the individual’s Social Security record.
(2) Requested a revision of his or her earnings record for a year(s).
The time limit can also be extended if an investigation was in progress. Because of the manner in which social security benefits work, it may not be the taxpayer who wants or needs to correct the social security records. It could be a spouse or a child or someone else who can obtain benefits derivatively from the individual with the earnings.
Some sources for correcting the social security statement can be found here, here and here.
On October 16 TIGTA issued the press release copied below. The release includes a link to the full report. The release and the report make clear that putting the Substitute for Return program on hold represents a significant compliance hole in the IRS system. Persons who do not file their returns, of whom there are many, may now receive a pass because of the lack of resources at the IRS.
WASHINGTON — Due to resource considerations, the Internal Revenue Service (IRS) has significantly curtailed the Automated Substitute for Return Program (ASFR), which it uses to address taxpayers who have failed to file a tax return, according to an audit report that the Treasury Inspector General for Tax Administration (TIGTA) issued today.
The program seems to be more effective at assessing, rather than collecting tax. The TIGTA report’s Figure 6 on Page 14 shows that more than 28% of unpaid assessments in FY 2016 are from ASFR/Section 6020(b) returns. That compares to about 29% of unpaid assessments from returns filed with a balance due.
On September 26, at a New York County Lawyers Association seminar entitled “Nontraditional Tax Advocacy”, Matthew Weir, the Assistant Inspector General of the office of the Treasury Inspector General for Tax Administration (TIGTA) spoke. Among other things, he announced that the IRS had, for lack of sufficient financial resources, suspended its Automated Substitute for Return (ASFR) program. This is shocking news!
Mr. Weir said that TIGTA internally debated whether to disclose to the public the ASFR program’s suspension because, normally, TIGTA does not like to disclose information that taxpayers could use to evade enforcement. But, TIGTA decided that the suspension of the ASFR program was too important to keep from the public. He said a TIGTA report on the suspension would be issued shortly.
The ASFR program was employed for individuals who did not file an income tax return but who had enough gross income reported by third parties to the IRS on information returns (such as on Forms W-2 and 1099) to have had an obligation to file an income tax return. In the ASFR program, computers (without human involvement) (1) detected the need to file and the lack of filing, (2) prepared substitutes for returns under section 6020(b) based on the third-party gross income information, and (3) issued a letter to the taxpayer showing the proposed deficiency and balance due based on that substitute for return (essentially, a 30-day letter). The computer would automatically tack on late-filing and late-payment penalties to the tax balance due. A taxpayer who did not respond to the computer’s letter or who did respond, but did not convince the IRS that no tax or penalties were due, would later get a notice of deficiency – a ticket to the Tax Court.
Under the ASFR program, many taxpayers wrote back to the IRS and pointed out either errors in the gross income calculation or claimed entitlement to fully- or partially-offsetting deductions or credits that the IRS had no knowledge about, such as dependency exemptions and earned income tax credits. Human IRS employees needed to respond to such taxpayer letters. Although Mr. Weir did not say so, I assume that the big expense in running the ASFR program was employee time responding to the taxpayer correspondence. I also assume that, given the frequently-available offsetting deductions and credits, the ASFR program may not have generated enough enforcement revenue to justify the use of the scarce resource, human IRS employee time.
A report of the Treasury Inspector General for Tax Administration (TIGTA) from May 16, 2016, entitled “Improvements are Necessary to Ensure That Individual Amended Returns with Claims for Refunds and Abatements of Taxes are Properly Reviewed” provides significant insight into the handling of refund claims by the IRS. The report itself follows the typical TIGTA style of reviewing actions by the IRS and finding fault with those actions; however, in describing what the IRS does with amended returns, the reports offers a detailed view of what happens once the amended return arrives at the IRS. For that reason, the report may interest readers who want to know more about that process. In this post, I will talk about the process and also about why auditing amended returns may matter more than auditing original returns.
The report criticizes the IRS for accepting certain amended returns without auditing them or providing any explanation for making the decision not to audit. The report acknowledges that some of the decisions may result from resource limitations but still decries the lack of documentation surrounding the decision. It details the reasons for its concerns but does not discuss the collection criteria applicable to audits. I see a link between this report and the report I discussed in a recent post concerning the requirement that the IRS make a collectability determination prior to starting an examination.
In the amended return context, the taxpayer has made the collectability determination for the IRS. The IRS holds the taxpayer’s money, which the taxpayer wants back. If the IRS audits this return and makes adjustments, the collection division never becomes involved. For this reason alone, amended returns should receive more scrutiny in a world where collectability provides a finger on the decision making scale of which returns to examine. The reasons for filing amended returns vary greatly and do not by any means involve bad motives. I could even argue that because practitioners generally, and I think correctly, believe that filing an amended returns brings scrutiny to the return that filing an original return does not, that amended returns have a greater likelihood of accuracy than original returns. Since I believe that the IRS should take collectability into account in making audit determinations, I think the IRS should audit a higher percentage of amended returns than original returns since the collectability factor will always support auditing the amended return, but, other factors matter as well and I am not arguing for the audit of all amended returns.
Other factors may override collectability but on that one factor, the decision is clear. While not clearly articulated in the IRS guidance or in this report, this factor has always played a role in making the scrutiny of amended returns higher than that of original returns. Just reading the process of review of amended returns, whether or not selected for audit, provides plenty of support for the conclusion that the IRS guards the money it already has more than it looks for money it might obtain through an audit.
The report gives a fairly detailed walk through of the procedures that the IRS uses to pipeline an amended return. The report suggests that tax examiners manually review each claim. That process obviously provides greater scrutiny than original returns receive. Claims that the initial reviewers list as Category A go on to additional review and possible audit, while claims that avoid Category A in the initial screening apparently move forward for acceptance. Figure 1 of the report provides a flow chart of the processing of amended returns that receive the Category A classification. I.R.M. 4.4.4.5.3 provides guidance to the IRS employees processing amended returns. The initial review also checks for timeliness of the claim which could result in a denial of the claim at the initial review if the claim is deemed untimely.
The report does not talk about how long after the filing of the amended return this initial screening takes place. The IRS now has a handy track my amended return feature on its web site. I have not yet used that feature to track a refund and do not have a sense of how quickly someone can obtain a refund. The TIGTA report reads as though the refund could occur relatively quickly if the initial screeners do not put the amended return into Category A.
For amended returns falling into Category A, the IRS sends them to field or campus exam depending on the type of case. The chart suggests that all Category A claims going to campus exam get audited, while cases going to field exam get another level of review once they reach the field. The written report does not make this distinction.
For field exam cases, two additional levels of review occur after the initial screening has designated the case as Category A. The case first goes through the Planning and Special Programs (PSP) office and then, potentially, to the field exam group. PSP could survey the return if it determines that an audit of the amended return would not result in a material change. In reviewing the amended return, PSP should also review the original return and other relevant case file material. If PSP does not survey the case – survey meaning accept the amended return after the PSP review – then it goes to the group manager of the group assigned to the case.
The group manager gives the amended return another review, which includes the review done by PSP for risk analysis, but the group manager must also “plan, monitor, and direct the input of work to accomplish program priorities and effectively utilize resources….” This means that the group manager’s decision to assign the amended return for examination not only includes a determination of the need for examination of the amended return, but balances that need against other workload priorities with the group. The group manager could conclude that the risk analysis does support examination of the amended return but still survey the return because of other priority work within the group.
The report does not talk about time frames but they will enter into the equation. The statute does not require the IRS to examine the amended return within any set time. The IRS can simply sit on an amended return forever if it chooses to do so and need not act. Of course, sitting on amended returns forever would be a bad practice for the IRS to adopt, but when a group manager considers priorities, the statute of limitations for making an assessment provides a bright line for decision making about auditing original returns, while the absence of such a bright line for amended returns slightly changes the equation. The group manager will have internal guidance driving the decision but has a bit more leeway with amended returns.
The system established by the IRS provides three cut points for the amended return headed to field exam, i.e., those amended returns with larger and more complicated refund claims, to get sent for acceptance without an audit. TIGTA’s concerns about the IRS process for surveying amended returns focuses on the cases getting sent for acceptance because the IRS did not adequately document that decision. The further the case gets into the process, the greater the concern because the more likely that an audit of the amended return would result in adjustments. Because the acceptance of an amended return means handing over money, TIGTA wants more documentation of the decision to accept the refund claim without an audit.
Of course, a very high percentage of original returns also involve handing over money, meaning that these returns are also refund claims, yet the system does not require the same type of review and documentation for handing over money as the result of an initial return. When taxpayers file the initial return, the IRS, as with the amended return, has no statutory time pressure within which it must accept the return. Mild pressure exists in both circumstances based on interest which will accrue. Stronger pressure exists with original return based on social expectations that have developed over decades and systems the IRS has created to send back refunds as quickly as possible, but the statute does not require that the IRS race to refund money with original returns yet carefully scrutinize refund requests on amended returns.
With the PATH Act, Congress signaled that it wanted to slow down the payment of refunds on certain original returns and stop the race that happens at the opening of filing season. The PATH Act concerns focus on refundable credits which cause the same concerns in many ways as amended returns. Yet, the biggest part of the tax gap does not exist because of amended returns or refundable credits. It exists with self-employed. TIGTA’s concerns about documentation of amended returns being surveyed has a legitimate basis because of the likelihood that amended returns surveyed after making the cut to Category A probably contain mistakes. It makes sense, if resources permit, for the IRS to internally explain why it allows the payment of a refund in those cases. Except for the distinction concerning collection, it would also make sense to explain why the IRS does not examine original returns with an equal likelihood of adjustable mistakes, but the TIGTA report focuses only on amended returns and not original ones.
As the filing season starts, it is appropriate to think of filing more than one return if the first or second return is incorrect. This is not the same as voting early and often as Chicago voters were fond of doing during the Mayor Daley era. The filing of a more correct return(s) during the filing season allows the taxpayer to get it right before the due date of the return in order to avoid penalties or other consequences that can flow from an incorrect return. With each new return filed prior to the due date of the return, the newly filed return replaces and supersedes the preceding one(s). Because of the timing of this post at the beginning of the filing season, we do not mean to suggest that you make anything but the best effort in filing the first return, but knowledge of the availability of the superseding return may come in handy for one of your clients some day.
Usually, April 15th is not an especially busy time for the tax clinic because the work of the clinic is not geared to the filing season but rather to the litigation calendar. Last year things worked out a little differently because we had some clients with unfiled 2012 returns that generated refunds which would have been lost if the returns were not filed within three years of the original due date and a client who had already filed their 2015 return which was rendered incorrect by a Form 1099 received after the filing of the return. So, the filing date mattered to our clinic last year. In filing the second return for 2015 for the client who received the Form 1099 after the original filing for the year, we filed what is known as a superseding return. Prior to filing this return, we did a bit of research which I share in this post. If we had not filed a superseding return in the case of the Form 1099, the taxpayer could have filed an amended return after the due date for filing the 2015 return passed or could have waited for contact from the IRS Automated Underreporter Unit and responded at that time to an inquiry about the income reported on the Form 1099 but not reported on the Form 1040. By filing the superseding return, we hoped that we corrected the situation in the timeliest manner. Superseding returns are far enough outside filing norms for me to expect that some glitch might occur in doing this so you do not want to do this routinely or declare victory too soon afterwards.
Many people file returns early in the filing season because they want to obtain a refund as quickly as possible or they need to have a filed return for other reasons such as sending it to the people who determine the amount of student loans or financial aid for which their son or daughter qualifies. Sometimes, after filing a return and before the due date for filing the return, a taxpayer gains additional information that renders the return incorrect in some fashion. The taxpayer in that situation faces a choice about whether and when to fix the return. The advantage of fixing the return prior to the due date for filing the return is that fixing it before that date makes the later return the original return for the tax period and eliminates the possibility of penalties or other action based on the missing information.
If a taxpayer learns of the incorrectness of a return after filing but before the due date, they also face a slightly different situation than if they had learned about the incorrectness after the due date. The regulations provide that a taxpayer should, but not must, file an amended return when they learn that a return filed is incorrect. I co-authored an article with Professor Calvin Johnson on the duty to correct returns if you want to read more on this topic. The regulation which directs taxpayers that they should file an amended return when learning of a mistake seems to address the taxpayer who finds out after the original due date. If the taxpayer finds the mistake before the original due date and fails to fix it before that date, their responsibility to the system may differ.
The idea of superseding returns receives little attention. The IRS makes brief mention of it in I.R.M 21.6.7.4.10 which it last revised on October 1, 2016. The mention in the manual does not imply that the IRS encourages superseding returns. I suspect that the IRS does not want to encourage superseding returns because it does not want to deal with the processing headaches they will create. If you do submit a superseding return, you will need to file the return as a paper return and you will want to write on the return “SUPERSEDING RETURN” at the top of the form in hopes that doing so will give a big clue to the person processing the return. Of course, you could send it with a cover letter but letters often get separated from the tax form during the filing process.
The legal basis for superseding returns traces its roots to Haggar Co. v. Helvering, 308 U.S. 389 (1940). In Haggar the taxpayer filed a return, realized before the due date that the return contained a mistake, filed an amended return before the due date of the original return and sought to have the IRS accept the amended return. The return had particular importance in this year because it fixed the corporation’s capital stock account for purposes of a special tax on earnings. The Court stated “Sections 215 and 216 of the National Industrial Recovery Act impose interrelated taxes on domestic corporations — namely an annual capital stock tax and an annual tax on profits in excess of 12 1/2 percent of the capital stock, calculated on the basis of the value of the capital stock as fixed by the corporation’s return for the first year in which the tax is imposed.” The return at issue in Haggar was the corporation’s return for the first year.
Even though most returns do not have the same importance as the return at issue in Haggar, the principle in the case established the concept of superseding returns that carries forward to today. While my description of superseding returns focuses on using them to correct a mistake found before the due date in order to avoid penalties or some other consequence of leaving information off of a return, a couple of former Chief Counsel attorneys, Harve Lewis and Norlyn Miller, have written about how it might be used as a planning tool for timely making certain corporate elections.

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