A Snow Holiday? Not if the IRS Can Help It.

Today we welcome guest blogger, Amanda Klopp.  Amanda is a student in the Harvard Federal Tax Clinic.  This semester she participated in drafting the amicus brief filed by the Harvard Federal Tax Clinic in the Guralnik case.  After graduation she plans to flee the snow of New England and work in sunny Florida with the firm of Akerman LLP.  Keith

In Bing Crosby’s classic Christmas movie White Christmas everyone pitches in to save the hotel run by their former company commander.  In Guralnik, a case in which Tax Court Special Trial Judge Armen issued a tentative opinion finding that a snow day in DC satisfies the holiday rule of IRC 7503, read our blog post on the case here, the IRS is not pitching in to save the holiday.  Instead, in Grinch-like fashion, it goes to great lengths in its response to the Tax Court to explain why a snow day should not be treated as a holiday.  This post will examine the arguments the IRS makes in its response.

In full disclosure, the Harvard Federal Tax Clinic has filed an amicus brief in this case arguing that the Court should use equitable tolling to find that it has jurisdiction to hear this case.


First, it is helpful to explain the procedural posture of the case. As previously discussed in a blog post, Special Trial Judge Armen issued a Recommended Findings of Fact and Conclusions of Law pursuant to Tax Court Rule 182(e). Within forty-five days of a Special Trial Judge issuing recommended findings of fact and conclusions of law, all parties may file objections to such recommended findings of fact and conclusions of law under Rule 183(c). This procedure of publishing the Special Trial Judge’s recommended opinion and allowing the parties to comment was the Tax Court’s response to Ballard v. Commissioner.  Previously, the Special Trial Judge’s report was not issued to the parties and instead was issued only to the Regular Judge. The two judges would engage in a collaborative revision process, which resulted in a final, published opinion. Ballard rejected this collaborative approach, and found that the Regular Judge should merely adopt, modify, or reject the Special Trial Judge’s report. Furthermore, Ballard held that the Tax Court was required to serve a copy of the Special Trial Judge’s report to the parties. In Guralnik, the IRS filed objections to the Special Trial Judge’s report pursuant to Rule 183(c), and the rest of this blog post analyzes these objections.

The IRS’s objections begin with a textual argument, tracking Section 7503’s definition of “legal holiday,” Treasury Regulation 301.7503-1, which interprets Section 7503, D.C. Code Ann. 28-2701, which lists legal holidays in D.C., and dictionaries, which define legal holiday, to argue for why the snow day at issue does not constitute a “legal holiday” under Section 7503. From the IRS’s argument, it is clear that “snowstorm” never has been included as a “legal holiday” in any statute or regulation, and the particular snowstorm at issue was not declared by any executive or mayoral order to be a legal holiday. The IRS probably viewed these arguments as necessary because they establish that snowstorm is not within the legislative definitions or even the plain meaning of a “legal holiday” under 7503, but these arguments are not counter to the reasoning in the recommended opinion issued by Special Trial Judge Armen. This question was a difficult one in the first place because the contingency of an office-closing snowstorm was not provided for in the statute or regulations. Thus from the start, it almost seems like the IRS is talking past the court, because the recommended opinion’s reasoning was based on legislative history which explained the rationale of the statute.

Special Trial Judge Armen’s recommended opinion was supported in no small part by the legislative history of Section 7503. The recommended opinion reasoned that when Congress added Saturdays and Sundays to 7503 to prevent those days from being counted as the last day in a filing period, it did so because the Tax Court was closed on those days. When the IRS does address the legislative history of 7503, it still does not contradict the recommended opinion’s interpretation that the rationale behind each carve out in 7503 was based on the Tax Court’s inaccessibility. Instead, the IRS argues that the incremental nature of the carve outs evince an intent by Congress to not add any other types of days not named. The IRS cites case law in which courts refused to extend the statutory rationale of the Tax Court’s inaccessibility to holidays or Saturdays, before such days were included in the statute. In essence, the IRS is just countering the recommended opinion’s use of legislative history to expand 7503 based on the statutory rationale, with case law in which courts refused to do the same. But this seems less like an argument based in legislative history, and more like an argument to use a strict textual reading rather than relying on legislative history.

What was missing in the legislative history argument that would have strengthened the IRS’s position? Perhaps some history supporting the IRS’s statement that “Congress knows how to add language that would include days when the Tax Court is inaccessible.” The IRS did not show that Congress had enacted inaccessibility provisions in other parts of the Tax Code, which would have been helpful to properly analogize to the cited case, Omni Capital Int’l v. Rudolf Wolff & Co., 484 U.S. 97, 106 (1987). In Omni, the Supreme Court found Congress’s exclusion of a nationwide service of process provision in Section 22 of the Commodity Exchange Act was significant because Congress had included nationwide service of process provisions in other sections of the Act.

The IRS also did not support the proposition that Congress had ever considered an amendment that would provide broadly for the inaccessibility of the clerk’s office. The IRS cited Southern California Loan Ass’n v. Commissioner, 4 B.T.A. 223 (1926), in which the Board of Tax Appeals (the predecessor to the Tax Court) analyzed a subsequently enacted Congressional amendment that tolled the time period for filing a petition with the BTA if the last day to file was a Sunday. In Southern California, the BTA refused to apply this Sunday tolling provision retroactively to a taxpayer whose final filing day was a Sunday. The BTA reasoned that the addition of a Sunday carve out in a subsequent amendment evidenced that Sundays were not intended to be tolled in the previous version of the statute. Thus, Southern California does not quite support the proposition that the rationale behind a statute should not be extended to trump the explicit statutory language – which seems to be what the IRS intended. Clearly, the IRS wants the Tax Court to prioritize the explicit statutory language. However, unlike Southern California, the IRS did not show that Congress ever considered an amendment to the Tax Code that would provide for the contingency of inaccessibility of the clerk’s office.

Special Trial Judge Armen’s recommended opinion also noted that the Tax Court rules are silent as to the tolling of a filing period due to the inaccessibility of the clerk’s office. FRCP 6(a)(3) tolls filing periods due to inaccessibility of the clerk’s office. The silence in the Tax Court rules regarding this FRCP provision implicates Tax Court Rule 1(b), which provides, “Where in any instance there is not applicable rule of procedure, the Court or the Judge before whom the matter is pending may prescribe the procedure, giving particular weight to the Federal Rule of Civil Procedure to the extent that they are suitably adaptable to govern the matter at hand.” The IRS countered this argument in three ways. First, the IRS stated that Tax Court rule 1(b) did not apply, because there were applicable rules of procedure, namely Tax Court Rule 25, Section 7502 and Section 7503, which specify methods of computing timely filing. Second, the IRS argued that while the FRCP and other court rules of procedure have been amended in the past thirty years to add an inaccessibility provision, the Tax Court rules have not been similarly amended. Of course, the IRS does not provide a reason for this because it is impossible to comment on why such a provision has not been adopted.  We can imagine that this issue just has not previously provided such a compelling case to cause the court to address the need for an inaccessibility provision in the Tax Court Rules. Third, the IRS argues precedent: that the court has not relied on FRCP 6(a)(3) to fill gaps in the Tax Court rules in three recent unpublished cases with similar facts.

A previous blog post has discussed the IRS’s use of unpublished cases in unrelated Tax Court cases. The three unpublished cases, Fitzpatrick v. Commissioner, Docket No. 4416-15S; Colabella v. Commissioner, Docket No. 1034-14S; and McCoy v. Commissioner, Docket No. 25941-13S, seem to hold the opposite of the recommended opinion. These cases were all decided by Chief Judge Thornton, which perhaps reveals the reason that Special Trial Judge Armen issued recommended findings of fact and conclusions of law, rather than an opinion. The IRS acknowledges that these cases are not “to be treated as precedent,” but states that “they are illustrative with respect to how the Court has handled identical and similar cases in the past.” In Fitzpatrick and Colabella, which both dealt with Tax Court closings due to inclement weather, Chief Judge Thornton held that the one day late hand delivered petition should be dismissed for lack of jurisdiction. The facts of McCoy involve late filing due to the inability to hand deliver a petition to the Tax Court, which was closed due to a government shutdown. McCoy is less comparable to the facts in Guralnik, due to the Tax Court’s website notice which informed the public of how to file timely petitions during the government shutdown and the necessity to timely file.

These three cases are deficiency cases rather than CDP cases.  The IRS does not note that distinction in its brief or address the equitable differences between deficiency proceedings and CDP proceedings.  Although that distinction may not seem relevant when considering that Section 7503 governs computation of time for both deficiency and CDP jurisdiction, the distinction is relevant for purposes of the amicus brief which only focuses on the equitable tolling of Section 6330(d)(1). In Section 6330(d)(1) considerations of equity have been more prevalent, compared to deficiency jurisdiction.

The IRS makes a good point about the implications of expanding Section 7503. Section 7503 covers not only filing of petitions, but numerous other events such as filing of tax returns and refund claims. The IRS points out that the scope of filings and acts affected by this decision will be broad, and that the decision could be even further expanded to local inclement weather events.   The scope of a ruling under Section 7503 and its impact on tax administration will cause the IRS to fight this case beyond the Tax Court.

Although the IRS makes good textual arguments, and with strong supporting case law, explaining why a snowstorm should not be considered a legal holiday under 7503, the IRS did not address the recommended opinion’s concern with the equities of the situation, beyond stating that the Tax Court lacks equity jurisdiction to prevent harsh results, and that the taxpayer might have avoided this result by using a designated delivery service under 7502. The recommended opinion stated “we find it inconceivable that Congress would have intended, absent a specific statutory provision requiring otherwise, to bar a taxpayer who fails to anticipate on a Friday that the Government will decide to close a filing office on the first workday of the following week on account of a snowstorm.” Instead of arguing that it was conceivable, the IRS has advocated for an approach that would leave the taxpayer literally out in the cold.

The next development in Guralnik is expected by January 8, 2016, the date by which parties may file a memorandum in response to the Amicus Memorandum. We expect the IRS’s response will argue the jurisdictional nature of Section 6330(d)(1), and that it is not subject to equitable tolling.

Is A Claimed Refund the Taxpayer’s Property? Tax Court Holds Yes in the Estate Tax Context

Earlier this month in Estate of Badgett v Commissioner, the Tax Court had occasion to consider whether over $400,000 in an unpaid refund attributable to a 2011 tax return was considered part of Russell Badgett’s estate when he died in March 2012, prior to the filing of Badgett’s 2011 individual income tax return. The case raises an important estate tax issue, and I will describe it below. However it caught my attention because of its possible implications when IRS holds refunds without notifying or explaining its actions, a practice we have heard about in past posts such as Freezing the Refunds of Our Guests. In this post I will describe the Badgett case and also explain why its rationale may have significance in areas removed from the estate tax context, including ensuring fair treatment for individuals who claim refunds.


In Badgett the taxpayer died in March 2012, prior to filing his 2011 individual return. When the executor filed the 2011 individual return, it reflected a substantial overpayment and requested a refund of over $400,000, and also applied a small amount of the overpayment to Badgett’s estimated individual income taxes for 2012. After the executor filed the 2011 individual return in May 2012, the IRS issued the $400,000 plus refund to the estate, and applied a small portion of the overpayment to the 2012 year. When the estate filed its estate tax return in December of 2012, it did not include the refund from Badgett’s 2011 1040 as part of the estate’s gross value, nor did the estate tax return reflect the small amount of refund attributable to Badgett’s 2012 1040. IRS examined the estate, and proposed a deficiency attributable to the estate’s not including the refunds in the gross estate.

The Tax Court decided that the estate should have included the refunds attributable to both the 2011 and 2012 individual returns as part of the estate’s gross estate. In so doing it worked its way through the thicket of Kentucky state law and some cases which on the surface appear to support the estate’s position that the refund should not be part of the gross estate.

The Issue: Estate Tax and Overpayments

To start the Tax Court framed the estate tax issue. It noted that Section 2031(a) provides that “[t]he value of the gross estate of the decedent shall be determined by including to the extent provided for in this part, the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated.”

It then looked to Section 2033, which provides that “[t]he value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death.”

This teed up the issue: was the claimed but unpaid refund part of Badgett’s property at the time of his death?

The estate looked to Kentucky law (Badgett’s residence), which provided that “property must be in existence on the tax assessment date to be subject to tax and cannot be a mere possibility or expectancy.” To that end, its view was that the “overpayment does not create a right to an income tax refund” and that “there is no property interest until the refund has been declared by the Government.”

As further support, the estate looked to cases that considered the issue in light of the offset powers of Section 6402, which provides as follows:

In the case of any overpayment, the Secretary, within the applicable period of limitations, may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall, subject to [ offsets for past due child support, state tax and certain other federal debts] refund any balance to such person.

There were two cases that relied in part on Section 6402’s offset powers in finding that an overpayment did not constitute a property interest, one in the bankruptcy context and the other in the estate tax context. The bankruptcy case was In re Piggot, a bankruptcy case in which the “IRS sought to offset an unpaid dischargeable tax debt of the debtors (husband and wife) incurred in 1996 and 1998 against a “potential” tax overpayment they made in 2004.”

In that case, the bankruptcy court found that the debtors’ tax overpayment was not a property interest, stating: “[T]he court is convinced that the tax law that holds that an overpayment is not the same as a refund is correct. Since an overpayment is not credited to the debtor until after offsets have occurred, if the IRS chooses to make such offset, there is no property interest in a debtor until the refund has been declared.”

In the estate tax context there was a Third Circuit case affirming the Tax Court which likewise found that the overpayment was not property. Estate of Bender v. Commissioner, 827 F.2d 884 (3d Cir. 1987), aff’g in part, rev’g in part 86 T.C. 770 (1987):

[Bender] was an estate tax case in which the testator had unpaid Federal tax liabilities for years other than those involving the tax overpayments. The Court of Appeals for the Third Circuit concluded that the testator did not have a property interest in the tax overpayments for purposes of calculating his gross estate. The court held that the IRS’ discretionary power to offset the testator’s tax overpayments against his unpaid liabilities meant that the estate could not compel the IRS to issue a tax refund for the years for which the testator overpaid his taxes; therefore, the tax overpayments “never attained the status of independent assets for estate tax purposes.”

In Badgett the Tax Court distinguished Bender and Piggot because of the presence in those cases of “undisputed and unpaid tax liabilities.” This is where tax procedure enters the picture. Under Section 6402 IRS has discretion to apply the overpayment to satisfy the debt or issue a refund; absent the liabilities the statute says the IRS “shall” issue the refund. Looking to Section 6402 as the key to the case, the Tax Court noted it “reached a different conclusion in another case where a deceased taxpayer had no tax liabilities to which a tax overpayment could be offset. Estate of Chisolm v. Commissioner, 26 T.C. 253 (1956). As such, in Chisolm it found “that the full value of the deceased taxpayer’s viable but unasserted income tax refund claim was an asset of the estate”:

The entire taxes on the income of Harvey [the deceased taxpayer] and his wife for 1950, as disclosed on the return filed for that year, were paid by Harvey. He was dead at the time the return was filed and of course did not join in filing it. However, the type of return that was filed for that period is immaterial as is the crediting of the overpayment as requested on that return. The fact is that Harvey had overpaid not only his own taxes but those of himself and his wife. The resulting overpayment was really his. It was valuable property and a part of his estate at the time he died. It was includible in his estate under section 811(a) [a precursor to the current section 2033], and incidently would have been includible in his estate even if it represented jointly held property since he had supplied the entire consideration therefor. * * *

There were a couple of other post-Chisolm Tax Court cases where there was no offsetting liability when the Tax Court also held that the refund was part of the gross estate. To the Tax Court, Chisolm and those cases controlled:

We believe it proper to herein follow the holdings in these cases. Simply stated, if no offsetting liability exists, section 6402(a) is clear: The statute mandates that the IRS “shall” refund any balance to the taxpayer. In the matter herein, there is no indication that decedent was subject to any liability or obligation against which the IRS could offset his overpayments. The status of the tax refund is more than a mere expectancy; the estate has the right to compel the IRS to issue a refund for the years for which decedent overpaid his tax. Thus, we hold that the overpayments in question attained the status of independent assets for estate tax purposes; they constitute decedent’s property for estate tax purposes.

When is an Overpayment Property of the Taxpayer? Other Contexts

The estate tax issue is interesting enough, and that alone would warrant a PT post. What tipped the scales for me, however, is the discussion in the opinion concerning the nature of the taxpayer’s interest in the overpayment. The estate argued that “a taxpayer has ‘no legal right’ to a tax refund unless and until the taxpayer files a successful suit within the permitted statutory periods against the IRS for that tax refund after meeting all conditions precedent.” The estate cited to a number of cases that it alleged supported its view, including the 1996 Lundy Supreme Court case where the Court held that the Tax Court lacks jurisdiction to award a refund of tax paid more than two years prior to the IRS mailing a taxpayer a deficiency notice where the taxpayer failed to file a  return. The Tax Court in Badgett was not persuaded that those cases supported the estate’s argument:

These cases do not support the estate’s contention. Rather, they merely discuss the requirements imposed on a taxpayer of prosecuting a tax refund action.

We therefore hold that decedent had property interests in the values of his 2011 and 2012 Federal income tax refunds and consequently the refunds are included in the value of decedent’s gross estate for Federal estate tax purposes.

In the International Taxpayer Rights Conference two weeks ago I gave a talk on a paper I am writing considering both legal on nonlegal ways to counter agency actions that deprive taxpayer rights. On the legal side, I pointed to three main areas, administrative law, constitutional law and organic agency statutes. Constitutional law and in particular procedural due process have at times been like the red-headed stepchild in this list, though perhaps that may change.  The presence of a property interest is essential when one considers what protections are due when the government takes actions that may deprive access to that property right. Procedural due process under the 5th Amendment generally requires that individuals receive adequate notice and the opportunity for a hearing prior to the deprivation of a protected interest. It is always an uphill struggle when arguing that IRS procedures may trigger a procedural due process challenge, in part because the Supreme Court in cases stemming from the 19th century has held that in certain exceptional areas (including tax) a postdeprivation hearing may be sufficient process when essential government needs must be satisfied. In addition, there is some uncertainty as to when a property interest arises in the context of applications for benefits in the nontax context, though recent cases suggest that applications for benefits where the government does not exercise meaningful discretion in determining eligibility may trigger a property inteterest worthy of constitutional protection. Those cases have bearing in considering procedural protections that should attach to returns claiming refundable credits.

The Badgett distinction between cases where the IRS knows about undisputed and unpaid liabilities and other scenarios may be important not just for the estate context in which it arises. Badgett suggests that absent undisputed liabilities to which the Service can use its offset powers, taxpayers have a property interest in the receipt of refunds claimed on returns. We have discussed in PT how on occasion IRS sits on refunds or fails to adequately explain why it chooses to not issue a refund. In addition, the National Taxpayer Advocate has on multiple occasions (such as here in a 2013 report) criticized IRS for failing to issue refunds when the taxpayer’s return preparer may have engaged in abusive and illegal behavior and altered a return to ensure that the preparer rather than the taxpayer gets funds that rightfully belong to the taxpayer. Relatedly I have criticized the lack of adequate explanation or defined standards and process to challenge the IRS’s imposing a ban on individuals who IRS has claimed have recklessly or fraudulently claimed an EITC, actions that may inhibit taxpayers from receiving and even claiming refunds to which they may be entitled to receive.

In past papers I have criticized the rationale in older Supreme Court cases that take a narrow view of procedural due process in the tax context, in part due to those cases’ overstatement of the government interest and failure to consider the individual interest in prompt payment and procedures to help ensure that the government does not erroneously deprive people of property. The individual interest is even more enhanced when Congress for better or worse uses the Code to deliver benefits in the form of refundable credits. I think recent examples of IRS sitting on refunds and freezing them without adequately explaining itself raise at a minimum fairness concerns and may in fact trigger a relook at some of the constitutional underpinnings of IRS procedures. While the IRS has a strong interest in ensuring integrity, minimizing overclaims and detecting fraud, framing as Badgett does overpayments as property of the taxpayer should remind the IRS in other contexts that it needs to more carefully consider individuals’ interests. If it does not the courts will likely force the issue.



Happy Thanksgiving!


New, Additional Proposed Innocent Spouse Regulations Issued (Part 2)

My introduction to the first post by Carl yesterday, created some confusion about the regulations just issued. While the IRS has not finalized the 2013 proposed regulations (and so has not responded to the comments that Carl, Jamie Andree, Kathryn Sedo and I submitted in response to those regulations), it has just issued additional proposed innocent spouse regulations that, for the most part, deal with different issues than the 2013 proposed regulations.  As Carl discusses, they do some good things and offer the opportunity to comment further. Today’s post will analyze the new proposed regulations.  Keith

This is the second part of a two-part post on proposed regulations under sections 66 and 6015 issued by the Treasury on November 20, 2015. In the first part of this post, I gave the long, tortuous background that has led up to these new proposed regulations. In this second part of the post, I will discuss the actual proposed changes and note some requested changes not made.

To repeat my summary from the first part of this post, the new proposed regulations largely do four things:  (1) make changes necessary to conform the existing regulations to the 2006 statutory amendments to subsection (e) concerning subsection (f) equitable relief, (2) adopt positions previously taken by the IRS in Rev. Proc. 2013-34, 2013-2 C.B. 397, that expanded the instances in which a requesting spouse could get a refund from post-return payments applied to the liability, (3) provide detailed new rules and examples concerning when a spouse, under section 6015(g)(2), “participated meaningfully” in a prior litigation such that the spouse is precluded by res judicata from later relitigating the right to section 6015 relief, and (4) provide detailed rules and examples concerning allocation of deficiencies among spouses in situations where one spouse’s unreported income or improper deductions changed adjusted gross income (AGI) such that a portion of the deficiency is attributable to a phase-out of tax benefits on the return.


New Proposed Regulations

The new proposed regulations do not replace the 2013 proposed regulations, so they do not state that they address comments made on the 2013 proposed regulations.  However, there is some overlap in the new proposed regulations in that, in two instances, they take positions that commenters on the 2013 proposed regulations opposed.  The notice of proposed rulemaking for the new regulations is 57 pages in length on a double-spaced release. I won’t discuss every proposed change, but I will identify the most significant changes made and the most significant changes requested that were not made.

One Request for All Relief

One thing the new proposed regulations do is conform the 2002 regulations to the statutory changes wrought by the 2006 amendment to section 6015(e) to make that subsection also apply to requests for equitable relief under subsection (f). This is accomplished in several ways:

First, since 2007, the IRS has informally treated the filing of any Form 8857 as an election of relief under subsections (b) and (c) and a request for relief under subsection (f). The new proposed regulations enshrine this practice at Prop. Reg. sec. 1.6015-1(a)(2). Although the statute refers to elections for relief under subsections (b) and (c) and requests for relief under subsection (f), the regulations abandon the cumbersome terminology difference, which has no practical effect anymore, and henceforward use the simpler terminology of “request” to apply to seeking relief under any of the three subsections. I applaud this change, which has the side benefit of making the regulations easier to read because of shorter sentences.

A conforming change is made at subsection (b) of Prop. Reg. sec. 1.6015-7 on Tax Court review, which will provide that the Tax Court can consider review of any denial of a request for relief (effectively including consideration of subsection (f) relief in section 6015(e) stand-alone Tax Court cases).

Prop. Reg. sec. 1.6015-7(c) provides rules for the suspension of collection activities and the tolling of the collection statute of limitations under the amended subsection (e) that now accompany a request for relief under any of the three subsections. Prior to 2006, the suspension and tolling provisions only kicked in for elections under subsections (b) and (c).

The new proposed regulations do not change the prior rule – by the way, nowhere stated in the statute — that (with one minor exception relating to electing subsection (c) relief for which one belatedly qualified) only one Form 8857 may be filed. See Prop. Reg. sec. 1.6015-1(h)(5).

One of the comments made to the 2013 proposed regulations by LITC people (who included Keith and me) was that we wished the IRS to change the rule that a taxpayer could only file one Form 8857. While we acknowledged the improvement in the 2013 proposed regulations of creating an audit reconsideration process, we proposed that a taxpayer who had already filed a Form 8857, but who had never petitioned the Tax Court in response to a notice of determination denying relief, be allowed to file a second Form 8857 if, as one example, the factors considered for (f) relief in Rev. Proc. 2013-34 substantially changed (e.g., divorce, financial hardship, health, and/or abuse).  If the taxpayer had never petitioned the Tax Court with respect to a prior notice of determination, we thought the taxpayer should be allowed to petition the Tax Court with respect to the notice of determination rejecting the later Form 8857.

The need for a right to a second or subsequent Form 8857 is much greater now that the period in which one can file a Form 8857 encompasses the entire collections statute of limitations. That period will be at least 10 years, and it may be longer if certain events (such as a request for an installment agreement or an offer in compromise) caused a tolling of the period.  Sadly, there is no discussion in the preamble to the new proposed regulations of the comments that the LITC people made about the benefit of having additional chances to file Forms 8857 as equity factors change over the lengthy collection period.

Election Timing and Refund Issues

The new proposed regulations make amendments to allow requests for relief under subsection (f) to be made in the time frames set out in Notice 2011-70 – i.e., during the entire collection statute of limitations at section 6502 or the entire refund claim statute of limitations at section 6511, as is relevant.

By statute, refunds attributable to section 6015 relief are only available under subsections (b) and (f), not (c). In section 4.04 of Rev. Proc. 2003-61, 2003-2 C.B. 296, the IRS had set rather severe limits on refunds under subsection (f) relief. First, no refunds could be made of payments made with the joint return or from joint payments later made, say, as a result of the IRS’ taking a joint overpayment from a later tax year and offsetting it against the tax liability addressed by section 6015(f). In the case of deficiencies, refunds were limited basically to amounts paid by the requesting spouse under an installment agreement after the Form 8857 was filed.

In section 4.04 of Rev. Proc. 2013-34, the IRS substantially liberalized the refund rules for subsection (f) refunds (both for underpayment and deficiency cases), making refunds available for amounts taken and applied by offset from a later-year joint return overpayment to the extent the taxpayer can establish (basically, under the injured spouse tracing rules) the extent to which the later-year overpayment was attributable to the requesting spouse.

The new proposed regulations adopt the salutary changes made by Rev. Proc. 2013-34 to refunds under subsection (f) and, quite logically, extend such rules to refunds under subsection (b) by creating a new subsection (k) at Prop. Reg. sec. 1.6015-1. And for the first time, subsection (k)(4) adopts the existing IRS practice of treating the filing of a Form 8857 requesting relief as the administrative refund claim for purposes of section 6511 and 7422 refund litigation, even though the Form 8857 (1) states nothing in it about seeking a refund or (2) doesn’t state an amount sought to be refunded. Kudos for new subsection (k)(4)!

Another comment that the LITC people made in response to the 2013 proposed regulations was to ask that the period in which to claim refunds be allowed to be extended by the IRS where the other spouse’s abuse or control of the requesting spouse prevented the requesting spouse from filing within the normal 2- and 3-year periods in section 6511(a).  Our request was analogous to asking for a regulatory form of section 6511(h) financial disability tolling of the 6511(a) periods in abusive situations.  Sadly, the new proposed regulations do not address or discuss the LITC comment about putting in a tolling provision.

Res Judicata Issues 

In 1998, Congress was concerned that taxpayers might be precluded from receiving section 6015 relief if they had been a party to a prior court proceeding that involved, or could have involved, section 6015 relief. Accordingly, Congress enacted what is now at section 6015(g)(2), providing:

In the case of any election under subsection (b) or (c) or of any request for equitable relief under subsection (f), if a decision of a court in any prior proceeding for the same taxable year has become final, such decision shall be conclusive except with respect to the qualification of the individual for relief which was not an issue in such proceeding. The exception contained in the preceding sentence shall not apply if the court determines that the individual participated meaningfully in such prior proceeding.

In a section 6015(e) stand-alone innocent spouse proceeding in the Tax Court, the question sometimes comes up whether the requesting spouse “participated meaningfully” in a prior suit – say a deficiency suit in the Tax Court or a collection suit brought against the spouse by the United States under sections 7402 or 7403. Current Reg. sec. 1.6015-1(e) largely repeats the statutory res judicata rules, but gives no examples.

Since 1998, the Tax Court has generated a number of opinions in which it has decided whether a spouse’s actions in a prior suit constituted meaningful participation. See, e.g., Harbin v. Commissioner, 137 T.C. 93 (2011); Deihl v. Commissioner, 134 T.C. 156 (2010). The new proposed regulations greatly expand this regulatory provision and, with one minor exception that I won’t get into, the IRS adopts the various activities that the Tax Court looked to as evidence in deciding the question of meaningful participation and the Tax Court’s holdings in this area. The proposed regulations also give examples.

In addition, the IRS, in the proposed regulations, adds a new exception to res judicata if the requesting spouse, in the prior suit, performed any of the activities indicating meaningful participation only because the non-requesting spouse abused or maintained control over the requesting spouse, and the requesting spouse did not challenge the non-requesting spouse for fear of the non-requesting spouse’s retaliation.  Once again, I applaud this IRS innovation.

Less laudable is the IRS’ failure to deal with the government’s conflicting litigation positions regarding res judicata that puts taxpayers in an untenable situation.  As Keith noted in a recent post on United States v. Stein, a suit to reduce a tax assessment to judgment, the Department of Justice has, in about a dozen district court cases since 1998, convinced those courts that they lack jurisdiction to consider section 6015 relief as a defense in a tax collection suit under section 7402 or 7403, and that only the Tax Court or district court judges entertaining a refund lawsuit under 28 U.S.C. sec. 1346(a)(1) have jurisdiction to provide section 6015 relief.

For years, Nina Olson, in a series of her reports to Congress, has deplored the lack of legal reasoning in these district court opinions.  For her most recent report complaints, with which I agree, see 2013 NTA Annual Report to Congress at Vol. 1, pp. 416-417. At least three times she has called for a legislative fix, if the courts, at the urging of the Department of Justice, continue to get this wrong.  Her proposed fix would confirm that section 6015 relief can be raised as a defense in a district court collection suit.

But, it is the position of the Tax Court – egged on to this holding by the IRS – that section 6015 relief can be raised as a defense in a district court collection suit, and that a taxpayer who meaningfully participated in such a suit, but who did not ask for section 6015 relief, is precluded by res judicata from raising section 6015 relief in a later suit in the Tax Court under section 6015(e).  Thurner v. Commissioner, 121 T.C. 43 (2003), aff’d on other issues 255 Fed. Appx. 90 (7th Cir. 2007). The proposed regulations provide no resolution or even discussion as to this Kafkaesque res judicata situation faced by taxpayers.

Allocation of Taxes Between Spouses 

Current regulations have no general rule about how to allocate either unpaid taxes or deficiencies between spouses when erroneous items from the spouses create additional AGI, thereby triggering statutory phase-outs (such as of deductions or the earned income tax credit). New Prop. Reg. sec. 1.6015-1(n) provides rules and examples that allocate the amounts of taxes or disallowed credits triggered by the increases in AGI. The amounts are allocated among the spouses in proportion to their erroneous income or deductions reported on the return. For a concrete example that may be of interest to the LITC community, Prop. Reg. sec. 1.6015-1(n)(2) (Example 1), states:

H and W file a joint Federal income tax return. After applying withholding credits there is a tax liability of $500. Based on the earned income reported on the return and the number of qualifying children, H and W are entitled to an Earned Income Tax Credit (EITC) in the amount of $1,500. The EITC satisfies the $500 in tax due and H and W receive a refund in the amount of $1,000. Later the IRS concludes that H had additional unreported income, which increased the tax liability on the return to $1,000 and resulted in H and W’s EITC being reduced to zero due to their adjusted gross income exceeding the maximum amount. The IRS determines a deficiency in the amount of $2,000 – $1,500 of which relates to the EITC and $500 of which relates to H’s erroneous item – the omitted income. If W requests relief under section 6015, the entire $2,000 deficiency is attributable to H because the EITC was disallowed solely due to the increase of adjusted gross income as a result of H’s omitted income.

Final Observations

The 2013 proposed regulations also addressed an issue that is not covered by the new proposed regulations in any way:  when collection activities start for purposes of making an election under (b) or (c).  That election must be made within 2 years of the IRS commencing collection activities. Current regulations provide that, among other things, the issuance of a notice of intention to levy (NOIL) is a collection activity for this purpose. Reg. sec. 1.6015-5(b)(2)(ii).

The 2013 proposed regulations sought to adopt the holding in Mannella v. Commissioner, 132 T.C. 196 (2009), rev’d on other issues 631 F.3d 115 (3d Cir. 2011), that the mailing of an NOIL commences the two years running, even if the NOIL is never received or (as alleged in Mannella) was hidden from the requesting spouse by the nonrequesting spouse.  The LITC comments explain why an NOIL should not be considered a collection activity; rather, an actual levy should be considered such an activity. That was the position that the IRS took in the original regulations it proposed in 2001, then rejected in the final 2002 regulations.  See section 1.6015-5(b)(2) and (4) of the proposed 2001 regulations atREG-106446-98, 2001-1 C.B. 945, 958-959.

In the alternative, the LITC commenters argued that, if an NOIL was to trigger the start of the 2-year period, the period should run from actual receipt of the NOIL because the Mannella holding was incorrect in light of legislative history never considered in the opinion.

Sadly, the new proposed regulations do not involve the portions of the regulations at Reg. sec. 1.6015-5(b)(3) that provide the definition of “collection activities”. Hopefully, the IRS will still keep this issue open for reconsideration when final regulations are adopted under section 6015.

Finally, earlier this year, the IRS lost Altera Corp. v. Commissioner, 145 T.C. No. 3 (July 27, 2015), in which all 15 judges of the Tax Court who voted in the case held that a regulation under section 482 had to be treated as legislative, and thus covered by the rules of 5 U.S.C. section 553(b) of the Administrative Procedure Act, because the regulation had the force and effect of law.  The regulation was held not to be exempt as an interpretative rule.  It is interesting to see the Treasury go blithely on as if nothing had happened in Altera.  In the preamble to the proposed section 66(c) and 6015 regulations issued on November 20, 2015, the following now-insupportable sentence appears:  “It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.”  I don’t know whether to laugh or cry.

New, Additional Proposed Innocent Spouse Regulations Issued (Part 1)

We welcome back frequent guest blogger, Carl Smith.  Carl worked with me and two other low income tax clinic directors, Jamie Andree and Kathryn Sedo, to prepare comments to the innocent regulations which we submitted in January of 2014.  We were late in submitting the comments but the IRS was nice about letting us submit them after the deadline.  The proposed regulations have finally arrived.  As Carl discusses, they do some good things and they fail to do some things we requested.  Because of the history behind these regulations, Carl breaks his comments into a two part post.  Today’s post will set the scene and tomorrow’s post will analyze the proposed regulations.  Keith

On November 20, the Treasury published a set of proposed regulations under sections 66 and 6015. Section 6015 is the innocent spouse relief provision with respect to liability from joint income tax returns. Section 66(c) is a similar provision, dealing with relief from income tax deficiencies on married filing separate returns that arise from a spouse’s failure to report half of community income received by the other spouse in community property states. The proposed changes to the section 66(c) regulations are minor, and I will not discuss them further. However, the proposed changes to the section 6015 regulations are significant – both in what they do and what they do not do.

These new proposed regulations supplement, but do not retract, other proposed regulations under these sections that were promulgated in 2013.  While the new proposed regulations are intended to deal with different issues than the 2013 proposed regulations, in some cases, the new proposed regulations necessarily overlap with the 2013 proposed regulations.  Unfortunately, where the overlap occurs, and where the 2013 proposed regulations had elicited critical comments, the new proposed regulations neither reflect nor respond to those prior comments.

The new proposed regulations largely do four things:  (1) make changes necessary to conform the existing regulations to the 2006 statutory amendments to subsection (e) concerning subsection (f) equitable relief, (2) adopt positions previously taken by the IRS in Rev. Proc. 2013-34, 2013-2 C.B. 397, that expanded the instances in which a requesting spouse could get a refund from post-return payments applied to the liability, (3) provide detailed new rules and examples concerning when a spouse, under section 6015(g)(2), “participated meaningfully” in a prior litigation such that the spouse is precluded by res judicata from later relitigating the right to section 6015 relief, and (4) provide detailed rules and examples concerning allocation of deficiencies among spouses in situations where one spouse’s unreported income or improper deductions changed adjusted gross income such that a portion of the deficiency is attributable to a phase-out of tax benefits on the return.

This is a two-part post. Today, I will give the long, tortuous background that has led up to these new proposed regulations. In the second part of the post, I will discuss the actual proposed changes and note some requested changes that were not made.



Current regulations under sections 66(c) and 6015 were promulgated in 2003 and 2002, respectively. With respect to section 6015 relief, two very important things have transpired since 2002 that required changing the regulations:

First, there was the issue of whether a Tax Court stand-alone innocent spouse case at section 6015(e) could include a determination of equitable relief under subsection (f). After the Tax Court held that it could consider subsection (f) relief in such a suit in Ewing v. Commissioner, 122 T.C. 32 (2004), the Ninth Circuit reversed this holding at 439 F.3d 1009 (9th Cir. 2006). The Eighth Circuit then agreed with the Ninth Circuit in Bartman v. Commissioner, 446 F.3d 785 (8th Cir. 2006), and the Tax Court changed its position to follow the two appellate courts in Billings v. Commissioner, 127 T.C. 7 (2006).

These rulings displeased Congress, which in December 2006 amended section 6015(e) both (1) to provide that subsection (f) relief can be considered in a subsection (e) stand-alone Tax Court innocent spouse case and (2) to provide that a request for subsection (f) relief prevents the IRS from collecting the liability while the relief request (and any ensuing Tax Court suit) is pending and tolls the collection statute of limitations during that same period. The collection prevention and statute tolling provisions in subsection (e) prior to that amendment applied only in the case of taxpayers electing relief under subsections (b) (regular deficiency relief) or (c) (separation of liability relief as to divorced or separated spouses), not those (such as all taxpayers with underpayments) merely requesting relief under subsection (f). The existing 2002 regulations have never been fixed to reflect this 2006 statutory amendment.

Second, existing Reg. 1.6015-5(b)(1) provides that persons who “elect” relief under subsections (b) or (c) or “request” relief under subsection (f) must do so within 2 years after the commencement of collection activities. After the Tax Court declared that regulation invalid as applied to taxpayers requesting relief under subsection (f) in Lantz v. Commissioner, 13 T.C. 131 (2009), the Seventh Circuit reversed the Tax Court and upheld the validity of the regulation at 607 F.3d 439 (7th Cir. 2010). In early 2011, two other Circuits agreed with the Seventh Circuit.   Mannella v. Commissioner, 631 F.3d 115 (3d Cir. 2011); Jones v. Commissioner, 642 F.3d 459 (4th Cir. 2011). This brought a storm of protest from many members of Congress, who believed that a spouse should be able to request subsection (f) relief at any time while the collection statute of limitations is open. Bowing to the Congressional pressure, the IRS issued Notice 2011-70, providing that the IRS would not enforce the 2-year regulation’s time limit to claim subsection (f) relief and that subsection (f) relief could be requested at any time when either the statute of limitations on collection under section 6502 remained open or the statute of limitations on refund claims under section 6511 remained open.

The controversy over the 2-year election regulation sparked the IRS to reconsider whether it could make relief under subsection (f) easier to obtain. In 2011, the substantive grounds and procedures for electing section 66(c) and 6015(f) equitable relief were set out in Rev. Proc. 2003-61, 2003-2 C.B. 296. At Notice 2012-8, 2012-4 I.R.B. 309, the IRS sent out for public comment a proposed Revenue Procedure to replace Rev. Proc. 2003-61 and liberalize some of its relief provisions. The IRS received extensive comments from the low-income taxpayer clinic (LITC) community on the proposed Rev. Proc. Unfortunately, most of those comments were not incorporated in the ensuing replacement, Rev. Proc. 2013-34, but some were, at least in part.

2013 Proposed Regulations

Around the same time that it issued Rev. Proc. 2013-34, the IRS issued proposed regulations (at REG-132251-11, 78 Fed. Reg. 49242) primarily to update Reg. 1.6015-5 to incorporate the Notice 2011-70 position that subsection (f) relief could be requested at any time when either the statute of limitations on collection under section 6502 remained open or the statute of limitations on refund claims under section 6511 remained open. The proposed regulation also did two other things:

First, it provided for an innocent spouse relief audit reconsideration process. Under the regulations, with one rare minor exception that I won’t get into, a taxpayer can only file one Form 8857 – the form by which a taxpayer requests or elects any relief under sections 66 and 6015. The audit reconsideration process is designed for taxpayers to be able to bring to the IRS’ attention significant changes in the factors that go into equitable relief that happened after the IRS’ previous notice of determination denied relief (e.g., changes in marital status, financial hardship, health, and/or abuse). Under the 2013 proposed regulations, the reconsideration request is not considered an election of section 6015(b) or (c) relief or a request for section 6015(f) relief, so any adverse ruling on audit reconsideration may not be appealed to the Tax Court under subsection (e).

Second, the 2013 proposed regulations provided additional detail on what constitutes collection activity for purposes of the 2-year election period that still applies to subsection (b) and (c) relief. Among its new rules was an adoption of the Tax Court’s holding in Mannella v. Commissioner, 132 T.C. 196 (2009), that the issuance of a notice of intention to levy to the taxpayer’s last known address constitutes collection activity that commences the 2-year election period running — even though the taxpayer never actually receives the notice. In Mannella, the taxpayer’s ex-husband was willing to testify that he hid the notice from the taxpayer.

Again, the LITC community made extensive comments on the 2013 proposed regulations that Tax Notes Today published. To date, no final regulations have been issued with respect to the 2013 notice of proposed rulemaking.

In part 2 of this post, I will discuss the actual proposed changes made by the new proposed regulations and note some requested changes that were, sadly, not made.


Summary Opinions for October 19th through the 30th

Happy Thanksgiving Week! And thank you all for reading, commenting and guest posting!  SumOp this week is full of great tax procedure content that was released or published in the end of October, including updates to many items we previously covered in 2014 and 2015.  In addition, I am pretty confident that I solved all of your holiday shopping needs, so no reason to fight the Black Friday crowds.


  • From Professor Bryan Camp, a review of Effectively Representing Your Client Before the IRS (which was edited by Keith) can be found here.  This article was originally published in Tax Notes.  I have not read the article, so I suppose he could be bashing the book; however, knowing Keith and the book, I’m pretty confident that isn’t the case (perfect holiday gift for that tax procedure nut in your life; you can pick it up here).  Completely unrelated, unless you are looking for holiday gift ideas for me, I’ve always wanted a Lubbock or Leave It t-shirt to go with my Ithaca is Gorges t-shirt.  At that point, it would become a bad pun t-shirt collection….How did I make this bad transition – Professor Camp teaches at Texas Tech, which is located in Lubbock, TX.
  • Keith forwarded this article to me from the AICPA newsletter regarding ten things to do while on hold with the IRS.  I say just sit back and enjoy the music…wait, we already discussed how that music seems to have been designed to slowly drive you insane (see Keith’s post, A Systemic Suggestion – Change the Music).  I sort of feel terrible admitting this, but I make my assistant sit on hold and then transfer the calls to me.   Wait times do not appear to be getting much better, but, since misery loves company, I would suggest checking #onholdwith.com/irs while waiting, or post your own.  Everyone loves complaining.
  • Kearney Partners Fund has generated a lot of tax procedure litigation over the last few years, which continues with the Eleventh Circuit affirming the GA District Court in Kearney Partners Fund, LLC v. United States.  At issue in this case was whether one particular participant was responsible for the accuracy related penalties.  The Eleventh Circuit agreed with the District Court that the transaction was in fact a tax shelter, but that the participant had disclosed the tax shelter in a voluntary disclosure program under Announcement 2002-2.  The Service argued that the participant only made disclosure in his individual capacity, not on behalf of the partnerships involved.  The Courts, relying on the doctrine of nolite jerkus, found it was disingenuous for the Service to attempt to collect the penalties on a shelter it was notified about through a disclosure program (I know that actually isn’t Latin, or a court doctrine).
  • In Notice 2015-73, the Service has identified additional transactions as “of interest” or as listed, including Basket Option Transactions.
  • In US v. Sabaratnam before the District Court for the Central District of California , a taxpayer lost his attempt to toss a Section 6672 TFRP assessment as untimely, which was made more than three years after the deemed filing date of the returns.  Although normally this would have not been timely as there is a three year statute for assessment, the taxpayer made a timely protest thereby tolling the time for assessment under Section 6672(b)(3).  The taxpayer actually argued his protest was not timely, thereby allowing the statute to run, and, in the alternative, that it wasn’t valid because it failed to contain the required information and because his representative did not tell him the letter was filed.  The Court disagreed, and found the filing was valid and timely.  Interestingly, in the letter, the representative stated that he did not “know personally whether the statements of fact…[were] true and correct. However…[he] believe[d] them to be true and correct,” which the taxpayer argued was damning because no one was attesting to the allegations.  The Court found that since the IRS instructions only required the representative to indicate if the facts were true, his statement was sufficient, as opposed to requiring that the representative actually state the facts were true.
  • The Senate is apparently checking up on Big IRS Brother.  In a hearing regarding the handling of the Tea Party applications, the Senate inquired about news that the Service would be using a high-tech gadget that could locate cell phones and collect certain data (couldn’t listen in on conversations though).  The Service indicated this was going to be used in criminal matters to help locate drug dealers and money launderers.  The Senate was nervous that Louis Lerner would target Republicans the Service would abuse this power (which twelve other agencies are currently using).  Don’t all drug dealers solely use burners?  And, aren’t the ones who don’t in jail already?  Looks like this will be moving forward, hopefully for tax crimes not thoughtcrimes.
  • In December, guest blogger Jeffrey Sklarz blogged about Rader v. Comm’r, a Tax Court case discussing substitutes for returns and when those have been validly issued under Section 6020(b).  In October, Mr. Rader was in court again, where the Tenth Circuit affirmed the Tax Court’s treatment of the SFRs and the imposition of sanctions by the Tax Court for frivolous arguments.
  • I’m in the process of working with Les on a rewrite of Chapter 5 of SaltzBook, which contains a discussion of the mitigation provisions for the statute of limitations.  One case dealing with those mitigation provisions that has been interesting to us over the last few years was Karagozian v. Commissioner, where the Tax Court and then Second Circuit held the mitigation provisions could not provide relief where a taxpayer overpaid employment taxes in one year, only to have income taxes imposed for that year after a worker reclassification.  SCOTUS did not find it as interesting as we did, and will not be granting cert.
  • From Jack Townsend’s incomparable Federal Tax Crimes Blog in early November was a post about nonresident aliens failing to pay US estate tax.   Jack offers some thoughts on how to start chipping away at that tax gap in his post.
  • The Eastern District of Pennsylvania in Giacchi v. United States decided another dischargeability of late returns case.   EDPA held in line with recent cases that the tax due on the late returns was not dischargeable.  Keith’s has written a fair amount on this topic, and I think the most recent was in June and can be found here.
  • Do you ever wonder if those companies claiming to give a % of their revenue to charity ever actually give the funds to charity?  I can proudly say PT will be donating 100% of its proceeds to charity, but deductibility and follow through won’t be an issue (it’s zero, we just do this for the love of the game; well maybe a hope that some publisher buys us out for millions).  Is there a watchdog group that tracks this?  Well, apparently some are actually donating the funds just out of charitable inclination, and the IRS has issued guidance on the deductibility of those payments.  In CCA 201543013, the advice concludes that the company taxpayer and not its customers are entitled to the deduction.  It also goes through the deductibility of payments to various types of entities, including exempt and non-exempt.

Important New Partnership Audit Rules Change Taxation of Partnerships

Today’s guest post is written by attorneys from the San Antonio office of Strasburger & Price LLP, a Texas based firm with a strong tax practice area. Farley P. Katz is a partner at Strasburger who focuses his practice on civil and criminal tax controversies. He has written a variety of tax articles including The Art of Taxation: Joseph Hémard’s Illustrated Tax Code, 60 Tax Lawyer 163 (2007) and The Infernal Revenue Code, 50 Tax Lawyer 617 (1997). Joseph Perera represents clients on a variety of federal and state tax matters. Before joining Strasburger, he worked in the National Office of the Office of Chief Counsel. Katy David is a partner at Strasburger who counsels clients on tax matters, including federal income taxation and state margin and sales taxation.  We welcome these first time guest bloggers who provide an explanation of the new law impacting partnership tax procedures.  I always hoped that if I waited long enough I would not have to learn TEFRA.  Keith 

On November 2, 2015, the Bipartisan Budget Act of 2015 (BBA) became law. Buried in the BBA are new rules replacing the long-standing Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and the Electing Large Partnership rules that previously governed partnership audits. These new rules turn established partnership tax law on its head.

Under BBA rules, if a partnership understates its income or overstates its deductions, it is subject to income tax. Not only can the partnership owe income tax, the tax will not be based on the income for the year in question, but instead on one or more prior years’ income. Consequently, the economic burden of the tax could be borne by partners who had no interest in the partnership when the income was generated. Conversely, if a partnership overstated its income in a prior year, the benefit of correcting that overstatement will accrue to the current partners, not those who were partners in the earlier year. Finally, if a partnership elects out of the new provisions (assuming it is eligible), the IRS will no longer be able to conduct a centralized audit controlling each partner’s distributive share, but will instead have to audit each partner individually.

The BBA rules apply to partnership returns filed after 2017, although a partnership may elect to have these rules apply to returns filed before 2018. Not only will these new rules vastly complicate the audit of partnerships that elect out, but they will also require that virtually every partnership in existence consider electing out or revising its partnership agreement to address BBA.


Who is subject to BBA?

All partnerships are subject to the new rules unless they elect out. Although TEFRA excluded partnerships with 10 or fewer individual (excluding NRAs), C corporation or estate partners, BBA has no such automatic exception. As a result, all partnerships are now covered: even those with as few as two individuals, family limited partnerships, LLCs treated as partnerships for tax purposes, and tiered partnerships. The only excluded partnerships are those that are eligible to elect out and do so on a timely basis.

What does BBA do?

BBA is similar to TEFRA in many respects. Like TEFRA, it requires that all items of income, loss, deduction or credit be determined at the partnership level. Like TEFRA, BBA provides that a partner’s tax return is consistent with the K-1 the partnership issued, unless the partner files a notice of inconsistent treatment. If a partner fails to file the notice, the IRS may treat any underpayment of tax resulting from the partner taking an inconsistent position as a mere mathematical or clerical error and assess the tax without issuing a deficiency notice.

Like the Tax Matters Partner under TEFRA, BBA’s “Partnership Representative” (who does not have to be a partner) is the point of contact for the IRS and can bind the partnership. Unlike TEFRA, however, BBA provides that all tax attributable to adjustments (called the “imputed underpayment”) is assessed against and collected from the partnership, along with interest (determined from the due dates for the reviewed years) and penalties. Also unlike TEFRA, BBA provides that penalties are exclusively determined at the partnership level; there is no partner-level defense. 

How does BBA calculate an underpayment?

Under BBA the years audited are called the “reviewed years,” and the year in which an audit becomes final is called the “adjustment year.” The imputed underpayment is determined by adding together or “netting” all adjustments to items of income, gain, loss and deduction and multiplying the result by the highest tax rate in effect for the reviewed years under section 1 (individuals) or section 11 (corporations). The imputed underpayment is calculated without regard to the nature of the adjustments; all positive or negative adjustments to capital gains, losses, whether long or short term, items of ordinary income or other types of income or loss, are netted. Nor does it appear to matter that items might be subject to restrictions on deduction at the partner level such as the “at risk” or “passive activity” limitations. If the audit adjusts tax credits, those adjustments are taken into account.

Changes in partners’ distributive shares are treated differently and are not netted. For example, if an audit reallocates income from one partner to another, BBA counts only the increase in income, not the decrease, and adds the increase to the partnership underpayment. This treatment will result in phantom income and tax to the partnership even though it does not change the net income reported on the Form 1065.

What if there would be less tax if the adjustments flowed through to the partners?

In many circumstances, the imputed underpayment will be less overall if the adjustments flowed through to the partners. For example, a partner might have a net operating loss that could absorb an adjustment. BBA provides that Treasury shall issue procedures allowing partners to elect to file amended returns for the reviewed years (i.e., the audited years). If the amended returns take into account all adjustments made, and if the tax is paid, then the adjustments will be removed from the partnership level adjustment. Reallocations of distributive shares will be removed only if all the partners affected file amended returns.

Treasury also will issue rules to reduce the partnership level tax rate without requiring amended returns from the partners in certain situations, such as where there are tax-exempt partners. A similar rule will apply lower tax rates if the adjustment includes ordinary income to a C corporation partner (which would pay a lower tax than an individual partner would) or if the adjustment includes capital gain or qualified dividends to an individual partner. Finally, Treasury may issue regulations that make other modifications to the imputed underpayment in similar circumstances.

A partnership seeking to reduce its imputed underpayment under this provision must supply supporting documentation to the IRS within 270 days of issuance of a Proposed Partnership Adjustment.

Can a partnership elect to make the partners liable for the adjustments?

A partnership may elect to have the adjustments shown in a Final Partnership Adjustment (FPA) flow through to its partners. The partners’ tax for the year of the election will be increased by the amount their tax in the reviewed years would have increased based on their distributive share of the adjustments made. In addition, the tax will include any tax that would have resulted from those adjustments in the years after the reviewed year and before the election year. All tax attributes, such as basis, will be affected by these adjustments.

The partnership must elect this flow-through within 45 days of issuance of the FPA. If it makes the election, the partnership will not be liable for any tax. Although the statute is unclear, it appears that the partnership can still contest the FPA in court.

The effect of this election is similar to a TEFRA adjustment, but instead of actually imposing tax in the earlier years, it imposes a tax in the year of the election. In addition to the tax, partners will liable for any penalties and interest, but the interest rate is increased by two percentage points and runs from the earlier years that generated the liability.

What if an audit reduces the tax reported?

If a partnership audit reduces the income originally reported or increases the net loss originally reported, these changes will constitute adjustments for the adjustment year (audit year) and will flow through to the partners for that year.

As under TEFRA, partnerships that have over reported their income may file an Administrative Adjustment Request (AAR), but the IRS will treat any decrease in income or increase in loss as occurring in the year the AAR is filed. If the partnership determines it underpaid its tax, it may file an AAR, but payment of tax is due on filing.

TEFRA provided that the Tax Matters Partner could file an AAR on behalf of the partnership or that any other partner could file an AAR on the its own behalf. However, under BBA, only the partnership can file an AAR; a partner no longer may file its own AAR.

Who can elect out? 

Partnerships with 100 or fewer partners can elect out, if the partners are all individuals (including NRAs), C corporations, foreign entities that would be treated as C corporations if they were domestic, or estates of deceased partners. An S corporation also may qualify, if it identifies all of its shareholders to the IRS. In that event, each of the S corporation’s shareholders counts as a partner for purposes of the “100 or fewer partners” test. A partnership that has even one partner that is itself a partnership cannot elect out, nor does it appear that a partnership could elect out if it has a trust as partner. Although TEFRA contained a provision that a husband and wife counted as one partner for the similar “10 or fewer” rule, BBA contains no such exception. 

How does a partnership elect out?

An election applies to one year only and must be made in a timely filed return for that year. The partnership must identify all the partners to the IRS and give the partners notice of the election.

What happens if a partnership elects out?

If a partnership elects out of BBA, the consistency provisions no longer apply. As a result, each partner may take an inconsistent position regarding partnership items reported on its K-1, without providing notice to the IRS of the inconsistent position.

If a partnership elects out, the IRS still could audit the partnership, but it must make all tax adjustments at the partner level. Accordingly, it would have to issue 30-day letters or notices of deficiency to the individual partners. We expect many partnerships that were subject to TEFRA to elect out of BBA, which will put the IRS in a bind. If the IRS issues a taxpayer a notice of deficiency and the taxpayer petitions the Tax Court, the IRS ordinarily is barred from issuing another deficiency notice if it later discovers additional adjustments. Accordingly, if a partnership elects out of BBA and the IRS makes adjustments on audit, it will have to decide whether to fully audit the returns of the partners (significantly increasing its workload) or issue notices of deficiency and thereby risk losing the opportunity to make further adjustments to those returns.

What are the procedural rules for audits? 

The procedural rules are similar to those under TEFRA. The IRS must give notice of the beginning of the audit. The IRS, however, is required to give notice of any Proposed Partnership Adjustment and then must wait at least 270 days before issuing a FPA. The 270 days gives the partnership time to produce documentation supporting lower tax rates for an imputed underpayment. The IRS must wait 90 days after issuing the FPA before assessing, and—if the partnership timely petitions in court—the IRS must wait until the decision is final to assess. Petitions in Tax Court do not require pre-payment, but a partnership filing in district court or the Claims Court requires payment of the estimated imputed underpayment.

There are, however, a number of procedural differences between BBA and TEFRA. For example, BBA requires that the IRS issue a Proposed Partnership Adjustment, which has legal consequences, whereas TEFRA did not require that an analogous 60-day letter be issued. TEFRA also provided that any partner could participate in the audit and many could bring suit, whereas BBA provides that only the partnership may take those actions. TEFRA also provided procedures by which the IRS or a partner could convert partnership items to partner-level items, effectively opting out of TEFRA, but BBA contains no such provisions. TEFRA provided that if an AAR is filed and the IRS did not act on it, the taxpayers could bring a suit in court, whereas BBA provides for such suit only if the IRS issues an FPA, apparently leaving taxpayers without remedy.

Statute of limitations 

BBA provides that an adjustment generally must be made (presumably “assessed”) within 3 years from the later of (1) the date the partnership return for the reviewed year was filed, (2) the due date for that return, or (3) the date the partnership filed an AAR for the year. However, if the partnership timely submitted documentation to support a reduced tax rate, the adjustment may also be made within 270 days of the date all such documentation was submitted, plus any extensions of time given to submit. Finally, even if the partnership did not request a reduced tax rate, an adjustment also will be timely if made within 270 days of the date a Proposed Partnership Adjustment was issued. An adjustment made within any of these periods is timely, and the partnership can extend the time to make the adjustment. The periods also are extended in other situations. If the amount of unreported income exceeds 25 percent of the gross income of the partnership for the reviewed year, the IRS has 6 years to make the adjustment. Moreover, if the partnership did not file a return or filed a fraudulent return, there is no limitation.

Will there be guidance? 

The BBA rules make fundamental changes in the tax treatment of partnerships and raise a multitude of new questions. Treasury has been directed to issue regulations, and the IRS is expected to issue additional guidance. Nevertheless, the rules undoubtedly will result in much confusion and litigation in the coming years.

What should partnerships do now? 

The BBA raises a number of issues that taxpayers should consider. Among them is whether partnership agreements need to be revised to address the BBA. Some partnerships, for example, might consider provisions that require electing out of the BBA (if that is possible). Under the BBA, the economic consequences of a tax audit of a given year or years will accrue in a subsequent year when the partnership might have different partners. Taxpayers might consider provisions addressing such possibilities and providing for appropriate tax sharing or allocation provisions. In any event, taxpayers using partnerships for businesses or investments and persons buying or selling partnership interests need to be aware of these provisions and should consult with their tax advisors.

Enforcing the Summons against Microsoft

This post by Keith Fogg was originally published on the Post & Shell Tax Controversy Blog, found here.

The IRS is auditing Microsoft.  Ordinarily, we do not know when the IRS is auditing a person or a business but the audit of Microsoft has provided, for the last year, a pretty detailed look at the process of auditing Microsoft and, by implication, many large corporations.  The Microsoft audit has repeatedly made it to the front pages of the “regular” press.  Microsoft is challenging the manner in which the IRS has gone about the audit.  The challenge to the IRS audit process first went public when Microsoft brought a FOIA suit to obtain information about the contract the IRS entered into with a private law firm in connection with the audit.  Shortly thereafter on December 11 and 19, the IRS filed petitions in the United States District Court for the Western District of Washington seeking to enforce summonses it had issued on October 30, 2014.  The publicity continued when Senator Hatch weighed in on the use of private contractors in the manner being used in the Microsoft case and as the court granted Microsoft permission to hold an evidentiary hearing in the summons cases on June 17, 2015.  It is now coming to a crescendo with the filing of briefs and the making of oral arguments on November 6, 2015.


With the briefs submitted by both Microsoft and the United States and oral argument completed, soon District Court Judge Ricardo S. Martinez will render an opinion directing Microsoft to comply with the summons or denying enforcement of the summons.  Given the amount of effort that has gone into the case to this point, an appeal by the losing party seems like a forgone conclusion.  The amount of time and effort that has gone into this information gathering case that is generally a summary proceeding demonstrates why the IRS fought so hard in the Clarke case to prevent summons cases from turning into proceedings with evidentiary hearings and other trappings of fully contested matters.  Despite its recent Supreme Court victory in Clarke limiting the scope of the litigation in summons cases, Microsoft’s case represents an exception to the general rule.  The full-fledged fight here, while unfortunate and unusual in a summons case, reflects the unusual nature of the case and the tack the IRS has taken in the audit.

The issue at the core of the fight over enforcement of the summons issued to Microsoft concerns the use by the IRS in the audit of a law firm, Quinn Emanuel, to assist the IRS.  The fight does not concern the use of a third party to assist with the audit of a large corporation, such use is common, but rather how the IRS uses Quinn Emanuel.  Rather than merely using Quinn Emanuel to assist the examiners in determining what questions to ask or providing expert advice on some aspect of the case, the IRS seeks to use Quinn Emanuel to examine Microsoft employees under oath and to provide other assistance that makes the law firm look much more like the lawyer for the IRS and much less like an expert.  As the facts portray Quinn Emanuel as a lawyer rather than an expert, the issues get stickier.

At some point in the audit of Microsoft, the IRS decided it needed more legal muscle than provided by attorneys from Chief Counsel, IRS or the Department of Justice Tax Division.  It wrote a Temporary Regulation changing the rules on who could participate in an examination of the witness under oath in a summons case to allow a third party to do so.  The temporary regulation seems to have been written specifically to allow Quinn Emanuel to participate in the audit of Microsoft.  Before the issuance of the temporary regulation only a duly authorized “officer or employee or an agency of the Treasury Department could take testimony under oath to investigate a tax liability pursuant to section 7602(a)(1)-(3) and 7701(a)(11)(B).  The IRS hired the law firm of Quinn Emanuel about the same time the temporary regulation was issued.

The first thing Microsoft had to do in the summons case, aside from failing to appear at the time appointed in the summons, was to convince the Court that this was an extraordinary case and the Court should hold an evidentiary hearing concerning the validity of the summons.  To do that it essentially argued that the hiring of a private law firm to participate in and ask questions of the witnesses under oath improperly passed a government function to a private party and may have improperly delegated aspects of a tax audit to a private firm.  Though the IRS argued that these were legal issues that did not require evidence, the Court granted the evidentiary hearing because Microsoft has pointed to sufficient facts to raise an “inference of impropriety.”  As mentioned above, courts allow evidentiary hearings in summons cases only in unusual circumstances and the Supreme Court has emphasized the summary nature of the proceedings.

The evidentiary hearing itself also sparked disagreement between the parties.  Microsoft wanted to have its attorneys testify.  The IRS thought this was inappropriate under the Washington state rules of conduct which generally prohibit a lawyer from serving as both the advocate and the witness.  The Court again allowed Microsoft to proceed with witnesses in the manner it proposed.

After the evidentiary hearing Microsoft filed an opening brief, the IRS filed a reply brief and Microsoft filed a reply to the brief of the IRS.  Now the case has reached the point of decision.  Microsoft’s opening brief in the summons matter and the reply brief filed by the Government frame the issues.  I will focus my discussion here on Microsoft’s reply brief because it raises some interesting issues.

Microsoft argues first that contractors may not take testimony.  It argues that section 7602 limits how the IRS can conduct the taking of testimony following a summons and that the limitation prohibits the IRS from using a contractor for this function.  The IRS argues that asking questions of a witness under oath in a summons setting is not necessarily taking testimony.  Because Microsoft argues that asking questions under oath is taking testimony and that only the IRS can take testimony in a summons case, Microsoft further argues that the temporary regulation violates the statute and should be struck down.  Here, Microsoft goes into a Chevron argument concerning the validity of the temporary regulation and it cites to Dominion Res., Inc. v. United States, and SEC v. Chenery Corp.  The issue of the appropriateness of a regulation has been extensively discussed in procedurallytaxing.com here and here.  The attack on the temporary regulation is interesting and certainly not frivolous.  After the big loss this past summer in the Tax Court in the Altera case another loss would certainly set the IRS back with respect to its rule making process.  Because the temporary regulation at issue here was out of the ordinary both in the way it was created and what it created, Microsoft has a chance on this argument.

Microsoft next argues that the IRS issued the summonses for the improper purpose of extending the statute of limitations.  It spends little effort making this argument and the argument has little chance of success.  The IRS does not need to explain everything about its audit plans in seeking a statute extension from a taxpayer.  Its failure to discuss how it planned to use Quinn Emanuel can hardly provide too much fodder for undoing the agreement to extend.

Microsoft’s third argument is that the summons should not be enforced because it is just a veiled attempt to allow Quinn Emanuel to conduct pre-trial discovery.  By their nature summonses seek to gather information prior to trial.  The participation of Quinn Emanuel does not change the dynamic much as I see it on this issue.  Chief Counsel lawyers were going to be involved in the summons matter in any event.  Having a different set of lawyers involved does not make much difference with respect to the purpose of gathering the information.

Microsoft’s fourth argument goes back to the heart of the problem created by using Quinn Emanuel in the manner anticipated by the IRS.  Microsoft argues that the participation of this private law firm in the questioning of the witnesses places the firm in an impermissible position of conducting the examination.  In addition to the arguments about Quinn Emanuel’s role in the audit and whether that role exceeds the role permitted by statute, Microsoft also makes an argument, in response to replies it received from the IRS about the role of Quinn Emanuel that “QE’s admitted role in providing the IRS with a “legal assessment” of its case is contrary to Section 7803(b)’s requirement that legal advice to the IRS be provided by the Office of Chief Counsel, which resides under a separate branch of the Treasury Department from the IRS.”  The 7803 raises a different statutory argument than Microsoft raised in its attack on the regulation.  Here, the argument centers on who is the lawyer for the IRS.  Can the IRS go out and hire new or additional lawyers if it does not find it is getting the service or expertise it needs from its own lawyers or does the statute limit it to using the government lawyers mentioned in the statute?  In its responses to Quinn Emanuel’s role, the IRS seems to move them away from assisters to the revenue agents to the role of attorney.  That may help in arguing that the role does not take away the government function of examination but does it create an opening that if the role is really that of lawyer the role now runs afoul of another provision of the code.

The case presents an interesting look at the proper role of the government and of those assisting the government.  Congress decided it wanted whistleblowers to assist the IRS in finding taxpayers it might not otherwise find.  Congress seems poised to try for a second time to foist private debt collectors off on the IRS.  Has Congress given the IRS the authority to allow contractors to perform something very close to a function reserved for government employees or is this contract just a simple hiring of a contractor in the ordinary (except for the need for the temporary regulation) course of business?