Posted by: Robert Horwitz | September 9, 2016

Gambling with the FBAR Penalty by Robert S. Horwitz

Most tax professionals (and many taxpayers) are by now familiar with the FBAR penalty: It is a penalty imposed on a person who is required, but fails, to report offshore financial accounts to the IRS.  If the failure to report is not willful, the maximum penalty is $10,000.  If it is willful, the maximum penalty is the greater of $100,000 or 50% of the balance in the account “at the time of the violation.”

One type of account that a person can have offshore is with an internet gaming site. In United States v. Hom (July 26, 2016), the Ninth Circuit recently addressed the issue of whether accounts the taxpayer set up with two UK-based internet poker sites were “financial accounts” for purposes of the FBAR penalty.  Although this was a case of first impression, it is an unpublished decision.

Hom had accounts at two online poker sites that were located in the U.K. and with “Fire Pay,” a company that was in the business of transmitting funds between various entities. The IRS assessed FBAR non-willful penalties totaling $40,000, based on his use of these three accounts in 2006 and one account in 2007.  In proceedings before the district court, the Government took the position that each of the accounts was a “bank, securities and other financial account” located in a foreign country.  The district court ruled for the Government and the taxpayer appealed.

The Ninth Circuit held that the Fire Pay account was a “financial account” because Fire Pay was a “licensed sender of money,” which was by definition a financial institution under the FBAR regulations.

It held, however, that the accounts at the poker sites were not foreign “financial accounts.” There was no evidence in the record that the funds maintained with either poker site served any purpose other than to play poker.  Lacking evidence in the record that the accounts were used for any purpose other than to play poker, neither offshore poker site fit the definition of the bank.  The Ninth Circuit therefore reversed the district court as to these two accounts.

The Government went for broke and lost because of its litigating position in district court. Before the district court, the Government relied solely on the argument that the poker sites were banks.  In a footnote, the Ninth Circuit noted that the Government attempted to argue on appeal that the poker sites were casinos, but that it would not consider this issue on appeal.  This was because the Government explicitly disclaimed any reliance on the FBAR regulations that include casinos within the definition of “financial institution” in district court.  It would not be allowed to argue for affirmance on a theory that was not raised before the district court.  Because in future cases the Government might not eschew the claim that offshore gambling sites are not casinos, the case may of no precedential value, which could explain why it was a “Not for Publication” decision.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at

In a decision that highlights the importance of both knowing and being able to prove mailing dates, the Tax Court recently issued new precedent on the issue of how to determine the date of an IRS Final Notice of Intent to Levy and Notice of Your Right to a Hearing, where there is a mismatch between the date the notice was mailed and the date printed on the letter. This notice triggers a taxpayer’s right to a collection due process (“CDP”) hearing, which must be requested within 30 days of the date of the IRS notice.  This general question more commonly arises where a taxpayer is trying to prove that his submission was timely.  However, in Weiss v. Commissioner, 147 T.C. No. 6 (August 17, 2016), the taxpayer was trying to prove that his request for a collection due process hearing was untimely.

Collection Due Process Hearing vs. an Equivalent Hearing. Before the IRS can levy a taxpayer’s property, the IRS is required to issue a notice informing taxpayers of the Service’s intent to levy and notifying taxpayers of their right to a hearing.[i]  Within 30 days of the date of the notice, the taxpayer has a right to request a CDP hearing to have the intended levy activity reviewed by IRS Office of Appeals.[ii]  During a CDP hearing, the taxpayer can raise (1) innocent spouse defense; (2) challenges to the appropriateness of the collection actions at issue; and (3) offers of collection alternatives, which may include the posting of a bond, the substitution of other assets, an installment agreement, or an offer-in-compromise.[iii] A taxpayer may also dispute the merits of the underlying tax liability, if the taxpayer did not receive a statutory notice of deficiency for the liability or otherwise did not have an opportunity to dispute the liability.[iv]

If the taxpayer does not resolve the collection issue with Appeals, the Taxpayer then has the right to judicial review by the Tax Court of the IRS’s decision.[v]  While this process is pending, collection activity is suspended and the statute of limitations on collection is tolled.[vi]

If a taxpayer does not file a timely request for a CDP hearing, the taxpayer has the option to request an “equivalent hearing” instead, within 1 year of the notice.[vii]  An equivalent hearing allows the taxpayer to have the Office of Appeals review the collection activity within their discretion, but the Tax Court does not have jurisdiction to review the decision of IRS Appeals.  Unlike a CDP hearing, an equivalent hearing does not prevent the IRS from continuing to collect the underlying tax liability while review by IRS Appeals is pending and it does not toll the running of the statute of limitations for collecting a tax liability.[viii]

The key issue in Weiss was whether the taxpayer’s request for a CDP hearing was filed within the statutorily prescribed 30 days for filing the request – if it was timely, the statute of limitations would have been tolled; if it was untimely, the statute of limitations would have run, preventing the IRS from pursuing any further collection activity, including levying the taxpayer’s assets.

Date on Notice vs. Date of Mailing. The dispute in Weiss resulted from a mismatch between the date printed on the notice to the taxpayer and the date the notice was mailed.  Although the Taxpayer had not indicated on the Form 12153 (Request for a Collection Due Process or Equivalent Hearing) that he was requesting an equivalent hearing, the Taxpayer’s position in the Tax Court was that he intentionally filed the CDP hearing request a day late, based on the date printed on the letter.[ix] The IRS argued that the notice was in fact mailed two days after the date on the letter, causing the taxpayer’s request to be timely.  The IRS did not dispute the Petitioner’s position that if the request was filed within the 30-day period, the statute of limitations would not have been tolled.

Even though the taxpayer had not saved the envelope from the IRS and had not been aware that the letter had been mailed two days after the date shown on the notice, the Tax Court held that the 30-day period to request a CDP hearing began on the date the notice was mailed, not the date printed on the notice. Relying on other Tax Court decisions addressing whether a taxpayer’s petition to the Tax Court was timely, the Tax Court explained that a mismatch between a date on an IRS notice and the date the notice was mailed is resolved in favor of the outcome that provides the taxpayer with the greater period for seeking judicial review.  That is, if the date printed on the IRS notice is before the date of mailing, the date of mailing is considered to be the date of the notice; if the date printed on the IRS notice is after the date of mailing, the date appearing on the notice is considered to be the date of the notice.[x]  The court noted that for many years, the Tax Court “[has] reached the same conclusion regarding notices of deficiency” and has done so “ regardless of whether the taxpayer was aware of the actual mailing date.”[xi]

Although it was not the outcome sought by the taxpayer in this case, the Tax Court applied that principle and held that the date of mailing would begin the 30-day period for filing a timely CDP request, because it was after the date printed on the notice. This case is an important reminder to taxpayers of the importance of looking at and saving envelopes received from the IRS where the date of the notice may be relevant.

Proving the Date of Mailing. After holding that the date of mailing would control if the date of mailing was after the date shown on the letter, the Tax Court had to determine the date the IRS’s notice was mailed.  Because the IRS had used a private postage meter for mailing the certified mail, there was no postmark by the USPS on the envelope.  Instead, Respondent introduced testimonial and documentary evidence to establish that the revenue officer left the levy notice in the outgoing mail bin on February 13, that  that an IRS staff person collected the notice from the mail bin and ran it through a private postage meter, which imprinted February 13as the date; then the IRS staff placed a notice in to a postal box outside the IRS office.

Based on the evidence introduced, the Tax Court concluded that the IRS notice was mailed at least two days after the date printed on the letter. The Tax Court noted that “While it seems plausible that USPS personnel collected the notice from the IRS postal box on February 13, the evidence does not conclusively establish that they deposited it into the U.S. mail that same days.”[xii]  The Tax Court held that it was not necessary for the IRS to prove the exact date of mailing in this situation, because ascertaining the notice’s exact mailing date would not affect the outcome.[xiii]

From a taxpayer’s perspective, it is important to note that the Tax Court in this case could not conclude based on the IRS’s evidence that the notice was in fact mailed on the date claimed by the IRS, notwithstanding the fact the notice was sent by certified mail, return receipt requested. This conclusion demonstrates the problem with using private postage meters for certified mailings where a taxpayer intends to rely on the timely mailed rule under Section 7502.  If the Tax Court had instead been trying to determine, for examples, the date a taxpayer’s CDP request was mailed for purposes of deciding whether it was timely, evidence proving the earliest date that the request could have been mailed may not be sufficient to prove that the request was in fact mailed timely.

Moreover, the Tax Court regulations specify that for Section 7502 to apply, there are specific mailing requirements that must be satisfied and a taxpayer may have a challenge proving a document was timely mailed if it was sent using a private postage meter and there was a delay in the delivery. Treasury Regulation Section 301.7502-1 provides that a taxpayer can eliminate the risk that the document or payment will not be postmarked on the day that it is deposited in the mail by the use of registered or certified mail.  However, a taxpayer may only rely on certified mail if the sender’s receipt is postmarked by the postal employee to whom the document or payment is presented.[xiv]  Alternatively, taxpayers have the option under the regulations of sending by approved private delivery services, such as certain delivery services offered by UPS and FedEx.[xv]

LACEY STRACHAN – For more information please contact Lacey Strachan at Ms. Strachan is a senior tax attorney at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere in complex civil tax litigation and criminal tax prosecutions (jury and non-jury). She represents U.S. taxpayers in litigation before both federal and state courts, including the federal district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the Ninth Circuit Court of Appeals. Ms. Strachan has experience in a wide range of complex tax cases, including cases involving technical valuation issues.  She routinely represents and advises U.S. taxpayers in foreign and domestic voluntary disclosures, sensitive issue civil tax examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise, and in defending criminal tax fraud investigations and prosecutions. Additional information is available at


[i] IRC § 6330(a).

[ii] IRC § 6330(a)(3)(B), (b)(1).

[iii] IRC § 6330(c)(2)(A).

[iv] IRC § 6330(c)(2)(B).

[v] IRC § 6330(d)(1).

[vi] IRC § 6330(e).

[vii] Instructions to IRS Form 12153.

[viii] Although the IRS has the right to continue collection activity, IRS policy is generally to not seize assets while the equivalent hearing is pending.  Publication 594: The IRS Collection Process; Instructions to Form 12153.

[ix] Checking the box to request an “equivalent hearing” is a requirement under the Instructions to the Form 12153.

[x] “When considering the timeliness of notices of deficiency under section 6213, we have encountered situations where the date on the notice did not match the date on which the notice was successfully mailed to the taxpayer. Where the date on the notice was earlier than the date of mailing, we have held that ‘[t]he critical date is the date the deficiency notice was “’mailed.”’ August v. Commissioner, 54 T.C. 1535, 1536 (1970); see, e.g., Lundy v. Commissioner, T.C. Memo. 1997-14, 73 T.C.M. (CCH) 1693, 1695 (ruling that the date of mailing is generally ‘the date that the Commissioner actually places the notice of deficiency in the mail’); United Tel. Co. v. Commissioner, 1 B.T.A. 450 (1925). By contrast, when the date appearing on the notice of deficiency is later than the date of mailing, we have held that the former date controls. See Loyd v. Commissioner, T.C. Memo. 1984-172, 47 T.C.M. (CCH) 1450, 1453-1454; Jones v. Commissioner, T.C. Memo. 1984-171, 47 T.C.M. (CCH) 1444.” Weiss v. Comm’r, 147 T.C. No. 6 (Aug. 17, 2016).

[xi] Weiss v. Commr, 147 T.C. No. 5 (Aug. 17, 2016).

[xii] Id.

[xiii] Id.

[xiv] Treas. Reg. § 301.7502-1(c)(2).

[xv] Treas. Reg. § 301.7502-1(c)(3).  The list of approved delivery services is currently available here:

The following Statement was presented by Robert S. Horwitz (of Hochman, Salkin, Rettig, Toscher & Perez, PC), Chair of the California State Bar Taxation Section, at the August 22 IRS National Taxpayer Service public forum in Los Angeles.

The Internal Revenue Service has a simple Mission Statement: “Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.”

In my experience over the past several years it has had increasing difficulty accomplishing its mission. When I first began practicing law with the U.S. Department of Justice, Business Week magazine reported that a poll of business executives rated the IRS was the top agency in the Federal Government in terms of professionalism, competence and honesty. Unfortunately the IRS could not rank so high today. . The view of the IRS by tax professionals and individuals who interact with the agency on a regular basis has fallen greatly.

As an attorney represents taxpayers who have problems with the IRS, there four IRS functions that I routinely deal with:

1. Examination. The IRS has moved towards remote audits that are conducted from the IRS Service Centers. The IRS sends a letter to a taxpayer asking for the taxpayer to provide documents to support a deduction or credit claimed on a tax return or information on why it failed to report income that a third party claimed it paid the taxpayer. If the taxpayer does not respond on time, the IRS issues a notice of deficiency to the taxpayer. Taxpayers are often not represented in these exams and thus do not understand how to respond or the potential consequences of failing to respond to the IRS request by the due date. Even where a taxpayer is represented by a tax professional, it is difficult to find anyone at the IRS to speak with about the audit and IRS employees who conduct these audits are trained to treat the cases on an assembly-line basis.

Where an examination is conducted by a local IRS revenue agent, the results can be frustrating. In many instances, IRS examiners have not received adequate training. This is not always the case, but from my perspective and that of other tax attorneys, too many agents who conduct taxpayer examinations are not sufficiently trained.

2. Collection. Automated collection systems may work for taxpayers who owe modest sums that they can pay over time through an installment agreement. For anyone else, it can be a nightmare. The centralization of the IRS offer in compromise program, which processes offers on an assembly-line basis, is problematic.

3. Appeals. Appeals was for many years a place where a taxpayer could resolve a dispute with the IRS in a rational manner— in many respect it exemplified what was best about the IRS. That is no longer the case. Like most of the IRS, Appeals has suffered from hiring freezes, a cut back in personnel and a lack of adequate training. Cases are routinely assigned to Appeals Officers in cities far from the taxpayer and his or her representative. This means that the taxpayer cannot have a face to face conference with the Appeals Officer unless he or she is willing to spend the time and money to travel. Even where the case is assigned to an Appeals Officer in the same area, it is difficult to get more than one meeting. These problems are increased due to the adoption of the Appeals Judicial Approach and Culture (AJAC) initiative, under which Appeals sends the case back to exam for comment if the taxpayer submits new information. To paraphrase Shakespeare, “AJAC is their fool.”

4. Criminal Investigation. This is the one IRS function that has managed to retain a reasonable level of competence. It is also the one that a taxpayer least wants to hear from. But there has been a large drop of in the investigation of routine criminal tax cases and that is not good for our voluntary compliance system.

These problems are most apparent with taxpayers who are wage earners, owners of small and medium sized businesses and people on a fixed income. For taxpayers who fall under the jurisdiction of the IRS’s Large Business & International Division, the problems are not as great. Only a very small portion of taxpayers are, however, within the jurisdiction of LB&I.

Many of the IRS problems stem from a lack of funding and an ill-conceived reorganization instituted in the late 1990’s. Without funding, it lacks the resources to adequately train its personnel, it cannot replace personnel and, even when it has funds to hire additional personnel, it cannot attract the highest caliber of people. With a move towards increased automation, the outsourcing of collection functions to for-profit companies, as required by Congress, and an increase in its functions (such as the Affordable Care Act) in my view dealing with the IRS will become ever more difficult. Congress and the IRS have to recognize that the nation’s tax collection and enforcement agency is not a credit card company whose primary purpose is profit maximization. If this does not occur, the IRS will have to change its Mission Statement.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at


TaxCon 2016

The 32nd Annual Tax Controversy Institute is a one-day conference that explores the procedures, policies, and strategies that are involved in resolving difficult tax controversy issues. Attorneys, accountants, business and corporate professionals can learn from top tax practitioners in the federal government, judiciary, and private practice.

Our featured speakers include high-ranking government representatives:

  • Caroline Ciraolo, principal deputy assistant attorney general, Tax Division, U.S. Department of Justice, Washington, DC
  • Sandra Brown, chief, Tax Division, United States Attorney’s Office (C.D. Cal.)(invited), Los Angeles, CA
  • Mary Beth Murphy, deputy commissioner, IRS Small Business/Self Employed Division, IRS, Lanham, MD
  • Sherri Wilder, area counsel, IRS Small Business/Self Employed Division, IRS, Laguna Niguel, CA

32nd Annual Tax Controversy Institute Tuesday, Oct. 25, 8AM-5PM Beverly Hills Hotel, 9641 Sunset Blvd. Reg# 264872 Fee: $525

CE Credit This conference has been approved for MCLE, CPE, and Legal Specialist Educational Credit in Taxation Law.

IRS employees, CalCPA, NAEA, and FPA members can receive a special discount on the conference fee. Contact Sam Gomez for more details and to enroll!

For more information, visit or contact Sam Gomez at or (310) 825-4938.

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Posted by: Taxlitigator | August 5, 2016

Qualified Amended Returns and the Civil Fraud Exception

Under any scenario, improved tax compliance requires taxpayers (and those who ought to be taxpayers) to voluntarily come into compliance. When errors are discovered in a filed return, tax practitioners often pave the road to compliance through assurances that the tax-equivalent of water-boarding is not a typical government response to receipt of an amended return. Some assurances are purportedly provided in Treasury Regulation (Treas. Reg.) §1.6664-2(c)(2) relating to the timely filing of a Qualified Amended Return (QAR). Generally, the QAR Regulations are intended to encourage voluntary compliance by permitting taxpayers to avoid accuracy-related penalties if an amended return is filed before the IRS begins an investigation of the taxpayer or the promoter of a transaction in which the taxpayer participated. 

Practitioners have long encouraged taxpayers to get into compliance because it is simply the right thing to do. When advised of an error in a return, most non-compliant taxpayers want to come into compliance although all will inquire about the potential consequences of amending returns that are not otherwise under examination. Some believe that an amended return constitutes a “red flag” assuring the examination of every open tax year. Others are simply reluctant to believe that the government won’t seek out some exception within the QAR regulations as a method of asserting penalties against the now low-hanging fruit identified within the amended return.

Logically, the information set forth in an amended return should be substantially accurate. In fact, since taxpayers would either amend every potentially questionable item in the return or do nothing, most amended returns are substantially bulletproof. A taxpayer desiring to be less than forthright in an amended return would not likely file the return. Practitioners should decline any engagement involving the filing of a less-than-accurate amended return (unless the potentially questionable issues are appropriately disclosed). From the government’s perspective, an amended return setting forth a deficiency represents the preservation of limited enforcement resources and the ability to focus such resources elsewhere. The government should respond with a hearty “Thank you!”… not an aggressive examination attempting to ferret out any potential penalties that may lie between the complexities of the QAR regulations.

Recent IRS examinations of QAR’s in several unrelated situations (not involving previously undeclared foreign accounts) around the country seem to support the contention that the historical reliance by practitioners and taxpayers upon the sanctity of the QAR regulations may now be somewhat misplaced. Practitioners and taxpayers should beware of the QAR Trojan Horse that seems to be appearing more often before the gates of taxpayers coming into compliance through the filing of an amended return. 

Ten Facts about Amended Returns. Amended returns, voluntarily filed with the government, serve as strong support for tax administration in the United States. The government and practitioner communities support taxpayers coming into compliance in advance of any IRS contact. A recent IRS Fact Sheet is designed to encourage the amendment of tax returns by listing the following facts:

  1. If you need to amend your tax return, use Form 1040X, Amended U.S. Individual Income Tax Return.
  2. Use Form 1040X to correct previously filed Forms 1040, 1040A or 1040EZ. The 1040X can also be used to correct a return filed electronically. However, you can only paper file an amended return.
  3. You should file an amended return if you discover any of the following items were reported incorrectly: filing status, dependents, total income, deductions or credits.
  4. Generally, you do not need to file an amended return for math errors. The IRS will automatically make the correction.
  5. You usually do not need to file an amended return because you forgot to include tax forms such as W-2s or schedules. The IRS normally will send a request asking for those documents.
  6. Be sure to enter the year of the return you are amending at the top of Form 1040X. Generally, you must file Form 1040X within three years from the date you filed your original return or within two years from the date you paid the tax, whichever is later.
  7. If you are amending more than one tax return, prepare a 1040X for each return and mail them in separate envelopes to the IRS campus for the area in which you live. The 1040X instructions list the addresses for the campuses.
  8. If the changes involve another schedule or form, you must attach it to the 1040X.
  9. If you are filing to claim an additional refund, wait until you have received your original refund before filing Form 1040X. You may cash that check while waiting for any additional refund.
  10. .If you owe additional tax for 2009, you should file Form 1040X and pay the tax as soon as possible to limit interest and penalty charges. Interest is charged on any tax not paid by the due date of the original return, without regard to extensions.

Penalties Based on “Underpayment” of Tax. Internal Revenue Code (Code) §§ 6662(a) and (b) provide for a 20% penalty on an “underpayment” resulting from negligence, a “substantial understatement of income tax”, a substantial valuation misstatement, a substantial overstatement of pension liabilities, or a substantial estate or gift tax valuation overstatement. Code § 6663 provides for a 75% civil fraud penalty on the portion of any “underpayment” attributable to fraud. For purposes of Code §§ 6662 and 6663, an “underpayment” is defined in Code § 6664 and the regulations as the difference between the correct amount of tax (determined without regard to payments and credits) and the “amount shown as the tax by the taxpayer on his return” (including amounts previously assessed and credits or refunds received).

Effect of Qualified Amended Return. Under certain situations, a timely filed amended return may reduce or eliminate accuracy-related penalties. The “amount shown as the tax by the taxpayer on his return” includes an amount shown as additional tax on a QAR, except that such amount is not included if it relates to a fraudulent position on the original return. Treas. Reg. § 6664-2(c)(3) provides that a QAR is an amended return, or a timely request under Code § 6227 (regarding a request for an administrative adjustment of partnership items), filed after the due date of the original return for the specific tax year (determined with regard to extensions) and before the earliest of—

(A). The date the taxpayer is first contacted by the IRS concerning any examination (including a criminal investigation) with respect to the return. Note that the contact must be by the IRS; a QAR can be filed if the taxpayers has not been contacted by the IRS even though they were contacted by others. Also, the IRS contact must be “with respect to the return.” An initial IRS contact does not always identify the exact reason for the contact. Also, a contact for one tax year should not bar the filing of a QAR for a different tax year;

(B). The date any person is first contacted by the IRS concerning an examination of that person under Code § 6700 (relating to the penalty for promoting abusive tax shelters) for an activity with respect to which the taxpayer claimed any tax benefit on the return directly or indirectly through the entity, plan or arrangement described in Code § 6700(a)(1)(A). Contacts of a promoter under Code § 6700 must be examined to determine whether such promoter was a “person” contacted concerning the taxpayers’ particular transaction. Consistent with its promoter strategy, the Service has initiated a significant number of promoter examinations to obtain (among other objectives) tax shelter client lists. The IRS frequently conducts examinations under Code § 6707 (failure to register penalty) and Code § 6708 (failure to maintain investor list penalty), not under Code § 6700 (promoting abusive tax shelters);

(C). With respect to a pass-through item, the date the pass-through entity is first contacted by the IRS in connection with an examination of the return to which the pass-through item relates. Practitioners should determine whether any such contacts were “in connection with an examination of the return to which the pass-through item relates.” A contact for one tax year should not bar the filing of a QAR for a different tax year;

(D) The date on which the IRS serves a “John Doe” summons relating to the tax liability of a person, group, or class that includes the taxpayer (or pass-through entity of which the taxpayer is a partner, shareholder, beneficiary, or holder of a residual interest in a REMIC) with respect to an activity for which the taxpayer directly or indirectly claimed any tax benefit on the return. A “John Doe” summons does not identify the specific person with respect to whose liability the summons is issued but must relate to the investigation of a particular person or an ascertainable group. The foregoing applies to any return claiming a direct or indirect tax benefit from the type of activity that is the subject of the John Doe summons, regardless of whether the summons seeks the production of information for the taxable period covered by such return. This represents a distinction from the requirements relating to individual returns and partnership items for particular tax years; and

(E). The date on which the IRS announces by revenue ruling, revenue procedure, notice, or announcement, to be published in the Internal Revenue Bulletin, a settlement initiative to compromise or waive penalties, in whole or in part, with respect to a “listed transaction”. The foregoing only applies to a taxpayer who participated in the listed transaction and for the tax year(s) in which the taxpayer claimed any direct or indirect tax benefits from the listed transaction. Essentially, once the IRS announces an administrative settlement for a listed transaction, the taxpayer can no longer obtain penalty relief through the filing of a QAR

A QAR effectively eliminates accuracy-related penalties, by removing amounts shown on the amended return from the penalty calculation. Significantly, even if timely, an amended return does not qualify as a QAR if the tax deficiencies that are corrected in the amended return relate to a fraudulent position on the original return. Why? Taxpayers should be encouraged to voluntarily amend all returns, even returns that for some reason may be deemed to include fraudulent positions, before the occurrence of any of the events set forth in Treas. Reg. § 6664-2(c)(3).

Historically, the IRS has rarely examined amended returns setting forth a deficiency. The IRS is presently conducting examinations of good faith QARs and is aggressively seeking interviews of the taxpayer, the return preparer and others. What is an appropriate interview response as to the reason a taxpayer decided to amend a return and report an additional tax liability? Patriotism? Sleep therapy? Should we care?

Freedom of Information Act. Practitioners can not effectively represent their clients without knowing the nature and scope of any examination. During every examination involving an amended return (and otherwise), consider submission of a Freedom of Information Act (FOIA) request seeking a copy of the IRS administrative file, which would include the internal memoranda and documents prepared by the examining agent or received from third parties. In the event the IRS Disclosure Office might determine that an exemption applies to some or all of the requested information, the FOIA request should include a request that a privilege log be provided in the form of a Vaughn Index.Also, request information regarding any third parties the IRS may have contacted at any time regarding the examination of the taxpayer.

Filing a Good Faith QAR. Efficient tax administration should seek to encourage, rather than restrict, the filing of QAR in a resource-challenged environment. Taxpayers and practitioners must carefully consider whether submission of a good faith QAR is actually in the best interest of the taxpayer. Code § 6664 and Treas. Reg. § 6664-2 specifically preclude the IRS from asserting the Code § 6662 accuracy-related penalties following the filing of a timely QAR.

The informal IRS voluntary disclosure practice (see Internal Revenue Manual (IRM) mostly precludes a criminal referral to the Department of Justice if a taxpayer has come into compliance in a timely manner. Although the IRS has the burden of proving civil fraud by clear and convincing evidence, taxpayers must now be advised that it can be anticipated that the IRS will use the purported QAR as a roadmap in attempting to determine whether to assert the 75% fraud penalty under Code § 6663. Examinations of QARs for the stated or unstated purpose of determining a civil fraud penalty are simply inappropriate and do anything but promote the desired perception of the fairness of tax administration within the United States. 

QAR Examination. Examinations of amended returns are appropriate if to determine the accuracy of the amended return. However, the current QAR examinations are targeting items reflected on the original return that were changed in the amended return for the sole purpose of determining the possibility of a civil fraud penalty. The government should graciously accept the amended return and payment of the tax and interest deficiencies, determine whether it is substantially accurate, and thank the taxpayer for their contribution to the continued operations of the U.S. government. It is not good policy to shoot the fish in the barrel simply because the others are more difficult to catch.

Burning down the village in an effort to save it is simply bad policy. Inappropriately allocated enforcement resources may only serve to foster future non-compliance. If your neighbor filed a good faith QAR and then had to defend a civil fraud examination (and a 75% penalty) associated with the originally filed return there is little chance you or others would similarly consider filing a QAR. Those who amend returns in a timely and voluntary manner should be treated fairly and with respect.

Importance of Fairness in Tax Enforcement. The complexity found within the Code will long continue to be a significant problem for effective tax administration. We live in a country founded by smugglers and those resisting the exercise of government powers in England. Inappropriately asserting penalties will not improve tax compliance. Penalties only impact those who are actually penalized. Notwithstanding a strong, wide-ranging international enforcement effort and an increasingly significant possibility of detection and potential punishment, enforcement efforts alone will not reduce the Tax Gap. Fairness or at least the perception of fairness in enforcement will have a significant impact on the future of tax compliance in the United States. Compliant taxpayers and supportive practitioners will reduce the Tax Gap.

What to do? Taxpayers who are aware of questionable issues within their returns and are not presently under examination should seriously consider filing a QAR to avoid the exposure to the accuracy-related penalties. Practitioners should proceed with extreme caution when representing a taxpayer following submission of a purported QAR.


Posted by: Taxlitigator | July 20, 2016

CA Residents May Exclude Aliso Canyon Gas Leak Reimbursements

In IRS Announcement 2016-25, the IRS confirmed that residents who were living near and affected by a natural gas leak discovered at Southern California Gas Co.’s Aliso Canyon storage field may exclude from gross income amounts that the company paid or reimbursed for some relocation and cleaning expenses incurred between November 19, 2015, and May 31, 2016.

For nearly four months, the northern Los Angeles community of Porter Ranch suffered from the largest natural gas leak in U.S. history.  More than 7,000 families were displaced from their homes and forced to relocate. Schools in the area were also closed. This announcement came at the urging of Congressman Brad Sherman (D-Porter Ranch), who worked with the Treasury Department and the IRS over the last six months to reach this result.

On October 23, 2015, Southern California Gas Company (SoCal Gas) discovered a natural gas leak at the Aliso Canyon storage field, which was sealed on February 18, 2016. Residents of nearby areas complained of numerous adverse health effects as a result of the gas leak, including nausea, dizziness, vomiting, shortness of breath, and headaches. Because the gas leak caused significant symptoms for area residents, the Los Angeles County Department of Public Health directed SoCal Gas to offer free, temporary relocation to affected residents. Pursuant to the directive and subsequent court orders, SoCal Gas is required to either pay on behalf of or reimburse affected residents for certain relocation and cleaning expenses incurred generally for the period beginning November 19, 2015 through May 31, 2016. These expenses include:

º Hotel expenses, including meal reimbursement ($ 45
per day for an individual age 18 and older; $ 35
per day or $ 25 per day for a child based on age),
mileage reimbursement, parking expenses, pet boarding
fees, internet fees, electric vehicle charging fees,
and laundry fees;

º Expenses of staying with friends or family at the
rate of $ 150 per day, and mileage reimbursement;

º Expenses of renting another home for a lease term
(including a lease term extending beyond May 31,
2016) as approved by SoCal Gas, including expenses
of housewares, appliances, pet fees, furniture rental,
utility fees, and moving expenses;

º Mileage allowances or alternative transportation
for a resident whose child or children attended the
relocated area schools until the date the resident
exited the relocation program. If, however, a resident
enrolled a child in a school outside of the affected
area, SoCal Gas must pay the mileage allowance until
the child no longer attends the reenrolled school
or the school year ends, whichever occurs first;

º Expenses of cleaning the interior of an affected
individual’s home prior to returning home according
to protocols established by the Los Angeles County
Department of Public Health;

º Air filtration and purification expenses;

º Expenses of cleaning residue from the exterior of
an affected individual’s home, outdoor fixtures,
and exterior furniture and appliances;

º Expenses of a vehicle detailing treatment; and

º Other expenses not specifically described in the
relocation plan based on SoCal Gas’s evaluation of
the expenses.

Questions have been raised concerning the taxability of these expenses paid on behalf of or as reimbursements to affected area residents. Existing guidance does not specifically address these questions.

The IRS will not assert that an affected area resident must include these payments or reimbursements in gross income. However, family and friends who received payments under the relocation plan for housing affected area residents must include these payments in gross income under section 61 of the Internal revenue Code unless these amounts are properly excludable from gross income under section 280A (relating to the exclusion for rental income from a taxpayer’s residence for less than 15 days during the taxable year).



What is so surprising about a court holding that a tax return for nonbankruptcy purposes is a tax return for bankruptcy purposes? Three federal appeals courts that have considered the question have held that a late filed return that is treated as a return for nonbankruptcy purposes is not a return for purposes of the bankruptcy discharge rules.  Fahey v. Massachusetts Dep’t of Revenue (In re Fahey), 779 F.3d 1, 4-5 (1st Cir. 2015); Mallo v. IRS (In re Mallo), 774 F.3d 1313, 1325-27 (10th Cir. 2014); McCoy v. Miss. State Tax Comm’n (In re McCoy), 666 F.3d 924, 928, 932 (5th Cir. 2012) . The reason given by these courts was a 2005 amendment to the Bankruptcy Code’s discharge rules.  The amendment states that a “return” means a return that satisfies the requirements of nonbankruptcy law, including applicable filing requirements.  According to these courts, the date for filing a return is an “applicable filing requirement.”  Thus, a person who files a return even one day late would not be able to discharge the unpaid tax in bankruptcy.

In Smith v. IRS, decided July 13, Mr. Smith failed to file his 2001 tax return. The IRS issued a notice of deficiency based on a “substitute for return.”  When he did not file a Tax Court petition, the IRS assessed the tax.  In 2009, Mr. Smith filed a return for 2001 reporting more income than the IRS had determined.  The IRS increased the assessment by the additional tax due.  Mr. Smith made some monthly payments.  In 2013 he filed a bankruptcy petition.  He sought to have his tax debt discharged.

Consistent with its position that taxes based on a substitute for return are not dischargeable, the IRS conceded that the additional tax based on Mr. Smith’s return was discharged. It argued that the original assessment was not discharged.  Mr. Smith claimed that the entire liability was discharged and the bankruptcy court agreed.  The district court reversed.  The Ninth Circuit affirmed the district court.

Unlike the First, Fifth and Tenth Circuits, the Ninth Circuit refused to interpret the 2005 amendment as requiring that a return be filed by the due date to be a “return” for bankruptcy purposes. Instead, it adhered to the four part test that the Tax Court has consistently used: to be a return, a document 1) must purport to be a return, 2) must be signed under penalty of perjury, 3) must contain sufficient data to allow tax to be calculated and 4) must be “an honest and reasonable attempt to satisfy the requirements of the tax law.”  Both the IRS and Mr. Smith this was the test that should be applied.

The Ninth Circuit held that Mr. Smith did not make an honest and reasonable attempt to satisfy the requirements of the tax law. The “return” he filed was 7 years late and three years after the IRS assessment.  Mr. Smith’s claim that “honest and reasonable” requires the court to look only at the face of the return was rejected.

The Ninth Circuit did not discuss the three circuit cases holding that the 2005 amendment requires a return to be filed on time in order to be a return for purposes of bankruptcy. The Ninth Circuit cited two circuit courts as supporting its interpretation.  In one, In re Justice, 817 F.3rd 728 (11th Cir. 2016), the court expressly avoided deciding the issue and assumed, for the sake of argument, that the four part test applied.  It held, on facts similar to those in Mr. Smith’s case, that the tax was not dischargeable.  In the other, In re Ciotti, 638 F.3rd 276 (4th Cir. 2011), the debtor failed to notify Maryland of a federal adjustment to a tax return.  The question before the court was whether Maryland’s requirement that notice be given of federal adjustments was the equivalent of a return.  There was no issue as to whether a late filed “return” is a return.

The Ninth Circuit’s decision in Smith v. IRS creates a direct conflict between the circuits.  Will either side seek certiorari?  No.  Both the IRS and the debtor agree that the four-part test applies and that the 2005 amendment does not impose a timeliness requirement.  Neither wants the Supreme Court to hold that the 2005 amendment requires a return to be filed on time in order to be dischargeable.  We will have to wait for the question to be decided by the Supreme Court.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at

Posted by: Taxlitigator | June 12, 2016

IRS Methods of Indirectly Determining Taxable Income

There are various audit and investigative techniques available to corroborate or refute a taxpayer’s claim about their business operations or nature of doing business. IRS audit or investigative techniques for a cash intensive business might include an examiner determining that a large understatement of income could exist based on return information and other sources of information. The use of indirect methods of proving income, also referred to as the IRS Financial Status Audit Techniques (FSAT), is not prohibited by Code Section 7602(e) .

Indirect Methods of Determining Income. Indirect methods include a fully developed Cash T, percentage mark-up, net worth analysis, source and application of funds or bank deposit and cash expenditures analysis. However, examiners must first establish a reasonable indication that there is a likelihood of underreported or unreported income. Examiners must then request an explanation of the discrepancy from the taxpayer. If the taxpayer cannot explain, refuses to explain, or cannot fully explain the discrepancy, a FSAT may be necessary. Common FSATs include:

• The Source and Application of Funds Method is an analysis of a taxpayer’s cash flows and comparison of all known expenditures with all known receipts for the period. This method is based on the theory that any excess expense items (applications) over income items (sources) represent an understatement of taxable income. Net increases and decreases in assets and liabilities are taken into account along with nondeductible expenditures and nontaxable receipts. The excess of expenditures over the sum of reported and nontaxable income is the adjustment to income. The Source and Application of Funds Method is typically used when the review of a taxpayer’s return indicates that the taxpayer’s deductions and other expenditures appear out of proportion to the income reported, the taxpayer’s cash does not all flow from a bank account which can be analyzed to determine its source and subsequent disposition, or the taxpayer makes it a common business practice to use cash receipts to pay business expenses.

Sources of funds are the various ways the taxpayer acquires money during the year. Decreases in assets and increases in liabilities generate funds. Funds also come from taxable and nontaxable sources of income. Unreported sources of income even though known, are not listed in this computation since the purpose is to determine the amount of any unreported income. Specific items of income are denoted separately. Specific sources of funds include the decrease in cash-on-hand, in bank account balances (including personal and business checking and savings accounts), and decreases in accounts receivable; increases in accounts payable; increases in loan principals and credit card balances; taxable and nontaxable income, and deductions which do not require funds such as depreciation, carryovers and carrybacks, and adjusted basis of assets sold.

Application of funds are ways the taxpayer used (or expended) money during the year. Examples of applications of funds include increases in cash-on-hand, increase in bank account balances (including personal and business checking and savings accounts), business equipment purchased, real estate purchased, and personal assets acquired; purchases and business expenses; decreases in loan principals and credit card balances, and personal living expenses. Determining the beginning amount of cash-on-hand and accumulated fund for the year is important. See IRM for possible defenses the taxpayer might raise regarding the availability of nontaxable funds.

• The Bank Account Analysis compares total deposits with the reported gross income. for all accounts, whether designated as personal or business. The examiner will review the taxpayer’s business and personal bank accounts (including investment accounts); i.e., statements, deposit slips, and canceled checks, etc. looking for unusual deposits (size or source), the frequency of deposits, deposits of cash, specific deposits that do not follow the taxpayer’s normal routine or pattern, nontaxable deposits such as loans and transfers, commingling of personal and business activities, and cash-backs when a deposit occurs.

The examiner will attempt to total the deposits and reconcile deposits of nontaxable funds and transfers between accounts focusing on transfers in, out, and between accounts as previously unknown accounts may be identified. Checks deposited by the taxpayer but later returned by the bank (e.g., the maker of the check did not have sufficient funds in the account to pay the check) are categorized as nontaxable transactions. Nontaxable funds, transfers-in, and returned deposits need to be subtracted from total deposits to get “taxable deposits.” The examiner will determine disbursements by adding the opening bank balance to the total deposits and then subtracting out the ending balance. To the extent possible, cancelled checks will be reviewed to determine whether nondeductible expenditures (personal expenses, investments, payments on asset purchases, etc.) are included with business expenses and if so, the amount. If cancelled checks are unavailable, transactions will be traced from the bank statement to the check register and the original document. Significant commingling of accounts may warrant a more in-depth analysis by the examiner. When nondeductible expenditures are deducted from the total disbursements the remainder should approximate the deductible business expenses on the tax return (other than non-cash expenses such as accruals and depreciation).

If the analysis results in the identification of excess deposits over the reported gross income, the excess represents potential unreported income. If specific transactions or deposits can be identified as the source of the understatement, the examiner may assert a specific item adjustment to income supported by the direct evidence of excess deposits. If the specific transactions or deposits creating the understatement are not identified, an adjustment to taxable income may be made based on the circumstantial evidence. If the business expenditures paid by check are less than the deducted business expenses on the return, then the taxpayer may be overstating expenses, paying expenses by cash (unreported income), or paying expenses from an undisclosed source of funds. If the analysis indicates significant commingling of funds, then the internal controls are weak and the books and records may be unreliable.

• The Bank Deposits and Cash Expenditures Method is distinguished from the Bank Account Analysis by the depth and analysis of all the individual bank account transactions, and the accounting for cash expenditures, and a determination of actual personal living expenses. The Bank Deposits and Cash Expenditures Method computes income by showing what happened to a taxpayer’s funds based on the theory that if a taxpayer receives money it can either be deposited or it can be spent . This method is based on the assumptions that proof of deposits into bank accounts, after certain adjustments have been made for nontaxable receipts, constitutes evidence of taxable receipts; expenditures as disclosed on the return, were actually made and could only have been paid for by credit card, check, or cash. If outlays were paid by cash, then the source of that cash must be from a taxable source unless otherwise accounted for and it is the burden of the taxpayer to demonstrate a nontaxable source for this cash.

The examiner will consider whether there are unusual or extraneous deposits which appear unlikely to have resulted from reported sources of income? The examiner may limit the examination to large deposits or deposits over a certain amount. However, the identification of smaller regular deposits may be indicative of dividend income, interest, rent, or other income, leading to a source of investment income. An item of deposit may be unusual due to the kind of deposit, check or cash, in its relationship to the taxpayer’s business or source of income. An explanation may be required if a large cash deposit is made by a taxpayer whose deposits normally consist of checks. Also, a bank statement noting only one or two large even dollar deposits, in lieu of the normal odd dollar and cents deposits, would be unusual and require an explanation.

Many taxpayers, due to the nature of their business or the convenience of the depository used, will follow a set pattern in making deposits. Deviation from this pattern may be reason for more in depth questioning. Bank statements or deposit slips which indicate repeat deposits of the same amount on a monthly basis, quarterly or semi-annual basis may indicate rental, dividend, interest or other income accruing to the taxpayer.

The examination of deposit slips may indicate items of deposit which appear questionable due to the location of the bank on which the deposited check was drawn. It is common practice when preparing a deposit slip to list either the name of the bank, city of the bank or identification number of the bank upon which the deposited check was drawn. If an identification number is used, the name and location of the bank can be determined by reference to the banker’s guide. In all cases, if the location of the bank on which the check for deposit was drawn bears little relation to the taxpayer’s business location or source of income, it may indicate the need for further investigation.

The examiner should identify all loan proceeds, collection of loans, or extraneous items reflected in deposits. If loan proceeds are identified, the examiner may request the loan application documents to verify the source and amount of the nontaxable funds and attempt to determine whether such information is consistent with other information; i.e., cash flows, assets, anticipated gross receipts, etc.

If repayments of loans are identified, the examiner will request the debt instruments to establish that a loan was made, the terms of the debt, and the repayment schedule. Before an examiner can reach any conclusion about the relationship between deposits and reported receipts, transfers and redeposits must be eliminated. For example, if a taxpayer draws a check to cash for the purpose of cashing payroll checks and then redeposits these payroll checks, the examiner would be incorrect if total deposits were compared to receipts reported without adjusting for this amount. The taxpayer has done nothing more than redeposit the same funds in the form of someone else’s checks.

• The Markup Method produces a reconstruction of income based on the use of percentages or ratios considered typical for the business under examination in order to make the actual determination of tax liability. It consists of an analysis of sales and/or cost of sales and the application of an appropriate percentage of markup to arrive at the taxpayer’s gross receipts. By reference to similar businesses, percentage computations determine sales, cost of sales, gross profit, or even net profit. By using some known base and the typical applicable percentage, individual items of income or expenses may be determined. These percentages can be obtained from analysis of Bureau of Labor Statistics data or industry publications. If known, use of the taxpayer’s actual markup is required.

The Markup Method is similar to how state sales tax agencies conduct audits. The cost of goods sold is verified and the resulting gross receipts are determined based on actual markup. The Markup Method is often used when inventories are a principal income producing factor and the taxpayer has nonexistent or unreliable records or the taxpayer’s cost of goods sold or merchandise purchased is from a limited number of sources such that these sources can be ascertained with reasonable certainty, and there is a reasonable degree of consistency as to sales prices.

 • The Net Worth Method for determining the actual tax liability is based upon the theory that increases in a taxpayer’s net worth during a taxable year, adjusted for nondeductible expenditures and nontaxable income, must result from taxable income. This method requires a complete reconstruction of the taxpayer’s financial history, since the government must account for all assets, liabilities, nondeductible expenditures, and nontaxable sources of funds during the relevant period.

The theory of the Net Worth Method is based upon the fact that for any given year, a taxpayer’s income is applied or expended on items which are either deductible or nondeductible, including increases to the taxpayer’s net worth through the purchase of assets and/or reduction of liabilities. The taxpayer’s net worth (total assets less total liabilities) is determined at the beginning and at the end of the taxable year. The difference between these two amounts will be the increase or decrease in net worth. The taxable portion of the income can be reconstructed by calculating the increase in net worth during the year, adding back the nondeductible items, and subtracting that portion of the income which is partially or wholly nontaxable.

The purpose of the Net Worth Method is to determine, through a change in net worth, whether the taxpayer is purchasing assets, reducing liabilities, or making expenditures with funds not reported as taxable income. The use of the Net Worth Method of proof requires that the government establish an opening net worth, also known as the base year, with reasonable certainty; negate reasonable explanations by the taxpayer inconsistent with guilt; i.e., reasons for the increased net worth other than the receipt of taxable funds. Failure to address the taxpayer’s explanations might result in serious injustice; establish that the net worth increases are attributable to currently taxable income, and; where there are no books and records, willfulness may be inferred from that fact coupled with proof of an understatement of taxable income. But where the books and records appear correct on their face, an inference of willfulness from net worth increases alone might not be justified. The government must prove every element beyond a reasonable doubt, though not to a mathematical certainty.

Summary. Circumstances that might support the use of an indirect method include a financial status analysis that cannot be easily reconciled – the taxpayer’s known business and personal expenses exceed the reported income per the return and nontaxable sources of funds have not been identified to explain the difference; irregularities in the taxpayer’s books and weak internal controls; gross profit percentages change significantly from one year to another, or are unusually high or low for that market segment or industry; the taxpayer’s bank accounts have unexplained deposits; the taxpayer does not make regular deposits of income, but uses cash instead; a review of the taxpayer’s prior and subsequent year returns show a significant increase in net worth not supported by reported income; there are no books and records (examiners should determine whether books and/or records ever existed, and whether books and records exist for the prior or subsequent years. If books and records have been destroyed, the examiner will attempt to determine who destroyed them, why, and when); no method of accounting has been regularly used by the taxpayer or the method used does not clearly reflect income as required by Code section 446(b).

When considering an indirect method, the examiner will look to the industry or market segment in which the taxpayer operates, whether inventories are a principle income producing activity, whether suppliers can be identified and/or merchandise is purchased from a limited number of suppliers, whether pricing of merchandise and/or service is reasonably consistent, the volume of production and variety of products, availability and completeness of the taxpayer’s books and records, the taxpayer’s banking practices, the taxpayer’s use of cash to pay expenses, expenditures exceed income, stability of assets and liabilities, and stability of net worth over multiple years under audit.

When the Internal Revenue Service audits a taxpayer, it requests the taxpayer to voluntarily provide documents and information. Where a taxpayer fails or refuses to provide the information, the IRS often issues summonses to the taxpayer or third parties.  Failure to comply with a summons can be costly. As two recent appeals court cases make clear, it is very hard for a taxpayer to get an evidentiary hearing to challenge a summons. United States v. Clarke (11th Cir. 3/15/2016), on remand from 573 U.S. ___, 134 S. Ct. 2361 (2014) and Gangi v. United States (1st Circuit, 3/30/2016).

First, some background on the IRS’s summons power. Internal Revenue Code (IRC) §7602(a) authorizes the IRS to issue a summons for the purpose of “ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax . . ., or collecting any such liability.”  Unlike an IDR, the IRS can obtain a court order enforcing a summons. A taxpayer can also seek a court order to quash a summons.  Where this occurs, the IRS will usually ask the court to enforce the summons.

To obtain a court order enforcing a summons, the IRS must establish that (1) the investigation is being conducted for a legitimate purpose, (2) the information sought may be relevant to the purpose, (3) the information sought is not already in the IRS’s possession, and (4) all administrative steps required by the Code have been followed. United States v. Powell, 379 U.S. 48, 57-58 (1964).  The IRS normally makes this showing through a declaration signed by the IRS agent conducting the audit.  A person contesting enforcement must then either disprove one of the four elements or establish that enforcement of the summons would constitute an abuse of the court’s process. However, a court reviewing an enforcement petition “may ask only whether the IRS issued a summons in good faith, and must eschew any broader role of ‘oversee[ing] the [IRS’s] determinations to investigate.'” Clarke, 573 U.S. at ___, 134 S. Ct. at 2367 (alterations in original).

The Supreme Court’s decision in Clarke clarified what a taxpayer must show to get an evidentiary hearing in which he can examine IRS agents about their motives for issuing a summons. A “taxpayer is entitled to examine an IRS agent when he can point to specific facts or circumstances plausibly raising an inference of bad faith.” Id. at ___, 134 S. Ct. at 2367.  As discussed in a prior blog, in Microsoft v United States, the court granted an evidentiary hearing only to find that the IRS did not abuse its summons power.  See

In Clarke, the IRS was auditing a partnership, DHLP.  During the audit, DHLP twice extended the statute of limitations.  After it refused to extend the statute a third time, the IRS issued five summonses to third parties, all of whom failed to comply.  Instead of seeking enforcement, the IRS issued a Final Partnership Administrative Adjustment (FPAA).  The partnership petitioned the Tax Court to challenge the FPAA.

After the IRS filed its answer in Tax Court, the Government filed petitions in U.S. district court to enforce the summonses, together with a declaration from the IRS agent establishing the four Powell elements.  DHLP opposed enforcement on the grounds that the summonses were issued in retaliation for its refusal to extend the statute and to circumvent the Tax Court’s discovery rules.  It requested an evidentiary hearing.  The district court denied the request for an evidentiary hearing and ordered the summons enforced.  On appeal, the Eleventh Circuit reversed, holding that DHLP was entitled to an evidentiary hearing.

The IRS appealed to the Supreme Court, which reversed the Eleventh Circuit and remanded the case for further proceedings to determine whether DHLP was entitled to an evidentiary hearing in light of the standard enunciated by the Court. The Eleventh Circuit sent the case back to the district court to “determine, in light of all of the evidence and the affidavits highlighted by the Supreme Court, whether Appellants pointed to specific facts or circumstances plausibly raising an inference of improper purpose …. [and] whether the improper purposes alleged by Appellants . . . are improper as a matter of law.”

After remand, the district court allowed further briefing but denied DHLP’s request to submit additional evidence. To support their allegations of retaliation, DHLP and the summoned parties stressed the timeline of the IRS’s decision to seek enforcement, which was six months after the summonses were issued, four months after the FPAA was issued, and in the same month that the IRS answered the Tax Court petition. They also pointed out that the FPAA was signed prior to the date the summonses were issued, to support the inference that the summonses were retaliatory.

To support the allegation that the IRS sought enforcement of the summonses to evade more stringent Tax Court discovery rules, DHLP pointed to the fact that a summoned person who complied was examined by the attorney who was representing the IRS in Tax Court and not by the IRS agent.

The district court held that none of the grounds alleged were improper as a matter of the law and that no facts were submitted that gave rise to a plausible inference of improper motive regarding the issuance of the summons. It denied the request for an evidentiary hearing and ordered the summonses enforced.  On appeal, the Eleventh Circuit affirmed the district court.

Although it affirmed the district court’s order denying an evidentiary hearing and enforcing the summonses, it rejected two of the district court’s determinations. First, the Eleventh Circuit concluded that issuing a summons for the sole purpose of retaliation against a taxpayer would be improper as a matter of law.  Second, the Eleventh Circuit concluded issuing a summons in bad faith for the sole purpose of circumventing Tax Court discovery would be an improper purpose as a matter of law.

Addressing the district court’s denial of the request to submit additional evidence, the Eleventh Circuit held that in light of the summary nature of a summons enforcement proceeding, the district court did not abuse its discretion.

The Eleventh Circuit also found that while DHLP made a number of allegations, the evidence it presented did not give rise to any plausible inference of improper motive. First, the submission that the timeline of the issuance of the summonses supports an inference of retaliation by the IRS requires substantial conjecture that is both implausible and unsupported by the record. Further, none of the’ submissions suggest that the summonses were issued in bad faith anticipation of Tax Court proceedings rather than in furtherance of the audit. Thus, DHLP and the summoned parties were not entitled to an evidentiary hearing.

The Eleventh Circuit also pointed out that the validity of a summons is tested at the date of issuance. Thus, neither the subsequent issuance of an FPAA nor the initiation of Tax Court proceedings affected the IRS’s summons authority or the summoned parties legal obligation to comply.

Prior to the Supreme Court’s decision in Clarke, the Eleventh Circuit was alone in holding that a bare allegation of improper purpose was sufficient to entitle a person challenging a summons to an evidentiary hearing. In Gangi, the taxpayer filed a petition to quash summonses.  The district court denied the petition and ordered the summonses enforced.  Shortly afterwards, the Supreme Court issued its decision in Clarke.  The taxpayer moved to reopen the case and obtain an evidentiary hearing on the ground that Clarke set a new standard for determining when a taxpayer can get an evidentiary hearing.  The district court denied the motion.  The First Circuit affirmed.  In doing so, it held that the Supreme Court’s requirement that a taxpayer must allege “specific facts and circumstances” sufficient to raise a plausible inference of bad faith was virtually identical its standard that a taxpayer needs to allege specific facts and evidence supporting a claim of bad faith in order to obtain an evidentiary hearing.

Based on these two cases and the district court decision in Microsoft, it has become even more difficult after the Supreme Court’s Clarke decision to quash a summons than it was pre-Clarke if the IRS meets the four-part Powell test.  And if the taxpayer petitions to quash a third-party record keeper summons, or intervenes in a proceeding to enforce a summons, the statute of limitations on assessment is suspended until the conclusion of the proceeding and any appeals.  Thus, a taxpayer’s challenging a summons can result in giving the IRS more time to gather information and examine the return.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at


Since the Supreme Court in Mayo Foundation v. U.S., 562 US 44 (2011)’ held that IRS regulations are subject to the same standard of review as are regulations of other agencies, several prominent attorneys have kicked around the idea that IRS notices of deficiency were subject to review under the Administrative Procedures Act (APA) just like the adjudicative determinations of other agencies. After all, the Tax Court and federal appeals courts have turned to the APA to decide whether a tax regulation was procedurally valid.   The taxpayers raised a claim that the APA applies to deficiency proceedings in Ax v Commissioner, 114 TC No. 10 (April 11, 2016), only to have the claim felled by the Tax Court.

The taxpayers owned a S corporation that had set up a captive insurance company. After audit, the IRS issued a deficiency notice disallowing deductions for payments to the captive insurer on the ground that a) the arrangement was not insurance and b) the taxpayers failed to substantiate the payments.   Seven months after it answered, the IRS moved to amend its answer to raise 2 new claims: a) that the transactions lacked economic substance and b) that the payments were not ordinary and necessary business expenses.  The taxpayers opposed the motion on the grounds that allowing amendment would violate the APA and Chenery Corp. v SEC, 318 US 80 (1943).   They also argued that granting the motion would cause undue prejudice.

The taxpayers’ argued that under the APA and Chenery an agency adjudication can only be reviewed on the grounds articulated in the agency’s determination.   The Tax Court explained that, under Chenery, a court can review an action left to the agency’s sole discretion only on the grounds articulated by the agency in its decision.   A reviewing court cannot “perform a pseudo-review” of a decision that the court may have reached if it were the agency.  This is not the situation in a deficiency case.  While the IRS makes the initial determination that there is a deficiency, the Tax Court is authorized to “redetermine” the deficiency and also has the authority to determine that more is owed than claimed in the deficiency notice or that the taxpayer is owed a refund for the years under review.  Further, while the notice of deficiency must describe the basis for the deficiency determination, an inadequate description does not affect the validity of the notice.

Turning to the APA, the Tax Court noted that under the APA, review of agency action “is the special statutory review proceeding relevant to the subject matter in a court specified by statute,” in this case the Tax Court. Deficiency procedures were in existence 20 years before the APA was enacted and the APA was not meant to supplant these procedures.  In deficiency cases, the IRS had always been allowed to raise new matters, for which it had the burden of proof. Mayo Foundation did not affect deficiency procedures, since it only dealt with the deference to be accorded IRS regulations.

A motion to amend can be defeated by showing that granting the motion will cause undue prejudice.   Since the case had not been set for trial, the taxpayers had adequate time to prepare to meet the IRS’s new contentions.  Thus, the motion to amend was granted.

The taxpayers in this case wanted to have their cake and eat it to, in a sense. Under the Administrative Procedures Act, a reviewing court not only is limited to considering the grounds upon which the administrative agency based its determination, it is also normally limited to reviewing the agency record to determine whether the agency’s determination was an abuse of discretion.  This is the standard used in collection due process cases.  A case in which a court applied the Administrative Procedures Act was Moore v. United States, the non-willful FBAR case we will revisit in the near future.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at

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