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There are Ways to Prove that a Refund Claim was Timely Filed
The Tax Code imposes several artificial deadlines and consequences for not meeting those deadlines. Tax cases often come down to whether a taxpayer can prove that he met these deadlines. In Chan v. United States, No. 2:15-cv-739-DN-BCW (D. Utah 2016), the court considered whether an Adobe PDF file was sufficient to prove that a refund claim was timely filed.
Facts and Procedural History
The facts and procedural history in Chan case are simple. The case involved the taxpayer’s 2008 income tax return. The taxpayer’s 2008 tax return was due on April 15, 2009. The taxpayer filed his 2008 tax return on or about October 15, 2009. He then filed a refund claim on or about October 15, 2012.
The question for the court was whether the taxpayer’s refund claim was timely filed. This in turn depended on whether the taxpayer requested an extension of time to file his 2008 return.
Refund Claim and Extension Rules
Refund claims must be filed within the later of three years of the date the tax return was filed or two years of the date the tax was paid. So if a tax return was due on April 15, 2009, the taxpayer would be able to file a refund claim anytime before April 15, 2012. The taxpayer could also pay the tax in 2015 and still file a refund claim in 2016 for the amount paid in 2015.
These dates are extended if the taxpayer makes a valid request to extend the time for filing his tax return. Taxpayers can file a Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, to request a six month extension of time to file their income tax returns. The Form has to be mailed to the IRS by the original due date for the tax return (which is normally April 15th for individual taxpayers). So a taxpayer who extended their 2008 tax return due date from April 15, 2009 to October 15, 2009 could file a refund claim anytime before October 15, 2012.
The Taxpayer’s Proof that he Requested an Extension
Had the taxpayer filed an extension for his 2008 return, his time for filing a refund claim would have been extended to October 15, 2009. So his refund claim would have been timely. If he did not file an extension, his refund claim would not have been timely.
The IRS’s records did not show that a request for an extension was received. However, the taxpayer claimed that he requested an extension of time to file and that he sent it to the IRS on or before the April 15, 2009 filing deadline.
Most taxpayers make this showing by providing the court with copies of certified mail receipts, etc. Apparently the taxpayer did not keep this type of proof of mailing. Instead, the taxpayer provided the court with an Adobe PDF version of the photograph of the extension to file form. He claimed that the photo was dated April 15, 2009. The court made this observation about this evidence:
After closely examining .pdf copies Chan provided per the Magistrate Judge’s requests and the hard copy provided with this objection, no date or time could be found. Chan did not submit a digital file from which any date or time could be determined or expert testimony regarding such a file. And, more importantly, there is simply no indication that he actually filed the application. In short, Chan does not provide usable evidence needed to meet the Commissioner’s challenge and gain subject matter jurisdiction.
So it appears that the court was prepared to accept the electronic document, but it was not able to do so without additional evidence to establish the date of the electronic file.
Are Electronic Records Sufficient
If the taxpayer had submitted additional evidence, such as testimony from an expert in computer data and Adobe PDF documents, there would still be a question as to whether the Adobe PDF document would be sufficient proof. This gets to the question as to whether electronic records are ever really sufficient, which is an important topic given the increased reliance on electronic records these days.
Had the taxpayer submitted expert testimony, it would show that the taxpayer completed the form timely, but it would not actually show that the taxpayer took steps to put the IRS form in the mail. Compare this to copies of certified mail receipts. The mail receipts would not show that the taxpayer even completed the IRS form (or even what, if anything, was included in the envelope), but they would show that something was mailed to the IRS within the specified time.
This issue is not limited to refund claims. Taxpayers rely on Adobe PDF files to prove that other tax deadlines are met too. For example, taxpayers typically keep Adobe PDF files to show that tax returns were eFiled. This comes up when the eFiled return is not processed by the IRS. The Adobe PDF files would show that the button was pushed to submit the return and the computer attempted to transmit the return, but it would not show that the computer was actually capable of sending the return. If confirmation of receipt was received, it would no doubt be saved as an Adobe PDF file.
If anything, the Chan case serves as a reminder that we cannot rely on Adobe PDF or other electronic records without considering exactly what the records substantiate and what records would be needed to document tax positions–particularly tax positions that are likely to be challenged by the IRS.
IRS Agents can Contact Third Parties and Must Maintain Confidentiality
We often get questions as to whether IRS agents can contact various third parties during the course of an IRS audit. The general rule is that IRS agents can in fact contact third parties. And they frequently do. The ability to do this is limited and it does not exempt IRS agents from the confidentiality rules.
IRS Agents Typically Do Not Contact Third Parties
As a practical matter, the IRS directs its agents to avoid third party contacts where possible. In fact, IRS agents usually do not have an incentive to make inquiries of third parties. Setting aside the nuances, taxpayers generally have the burden to show that their tax tax positions are correct. So the lack of information can and often does help the IRS’s position on audit.
The General Third Party Contact Rule
If you are reading this article, you are probably more interested in the rules that come into play when the third party has harmful information that the IRS agent would like to obtain or it is thought that the third party has this information.
Again, the general rule is that the IRS agent may contact any person other than the taxpayer with respect to the determination or collection of the taxpayer’s tax liability.
IRS agents may not do so unless the agent gives the taxpayer reasonable notice in advance that such contacts may be made. IRS agents usually satisfy this notice requirement by providing the taxpayer with Publication 1, which, among other things, says that third party contacts may be made. The publication is typically provided to taxpayers at the start of the IRS audit and it does not list the individuals who will or who may be contacted. The IRS may also use Letter 3164 or provide the notice verbally.
The rules go on to say that upon request, IRS agents have to provide the taxpayer with a record that identifies the persons who are contacted. IRS agents are supposed to record this information on a form in their case files (on Form 12175), so it can be provided upon request. While required, it is common for IRS agents not to create this record unless it is requested by the taxpayer.
Third Party Contacts
These rules only apply to third party contacts. Not every contact is considered a “third party contact.” There are five elements for determining whether a contract is considered a “third party contact.” These elements say that a third party contact is a communication:
- Initiated by the IRS;
- Made to a person other than the taxpayer, another IRS employee, the taxpayer’s employees/fiduciaries, or any computer database or website;
- Made with respect to the determination or collection of the tax liability of such taxpayer;
- That discloses the identity of the taxpayer being investigated (either directly or by implication); and
- That discloses the association of the IRS employee with the IRS (either directly or by implication).
All of these elements must be met in order for the contact to be a “third party contact.”
When Advance Notice is Not Required
Even if the contact is a third party contact, there are several exceptions to these rules that allow IRS agents to contact third parties without providing the taxpayer with advance notice. These exceptions include communications made:
- To the taxpayer or their representative.
- When there is a good faith belief that providing the taxpayer with either a general pre-contact notice or a record of the specific person contacted may jeopardize the collection of any tax.
- When the IRS agent has good cause to believe that providing the taxpayer with either a general pre-contact notice or a specific record of the person being contacted may cause harm to any person in any way, physically, economically, emotionally or otherwise (a statement by the third party that harm may occur to any person is sufficient to constitute good cause).
- Made during criminal investigations or any inquiry to determine whether to open a criminal investigation.
- Made to governmental entities, including any office of any local, state, Federal or foreign governmental entity, except for contacts concerning the taxpayer’s trade or business with that government office, such as the taxpayer’s contracts with or employment by the office.
- Made to confidential informants if the IRS agent has good cause to believe that providing either the precontact notice or the record of the person contacted would identify a confidential informant whose identity would be protected under Section 6103(h)(4).
- Made in the course of a pending court proceeding.
If any one of these exceptions are met, IRS agents can contact the third party without providing the taxpayer with advance notice.
Confidentiality and Section 6103
The IRS agent will still have to comply with the confidentiality rules in Section 6103. Section 6103(a) provides that returns and return information shall be confidential.
The terms “return” and “return information” are defined broadly. Section 6103(b)(1) defines the term “return” as the actual form filed by the taxpayer, including any supporting schedules, as well as any information return filed by a third party on behalf of or with respect to the taxpayer. Even an item of return information that has its identifier removed is still return information under these rules.
Section 6103(b)(2) defines the term “return information” to include any information gathered by the IRS with regard to a taxpayer’s liability under the Code. It includes, but is not limited to, the taxpayer’s identity, the nature, source, or amount of income, whether the return was, is being, or will be examined or subject to other investigation or processing, and any other data which is received by, recorded by, prepared by, furnished to, or collected by the IRS; with respect to a return or with respect to the determination of the existence or possible existence of liability or the amount of liability under the Code.
There are several exceptions to these rules in Section 6103, which are similar to the exceptions for advance notice of third party contacts described above.
Remedy for the IRS’s Violation of the Confidentiality Rules
Section 7431 provides taxpayers with a civil remedy when their tax return information is disclosed in an unauthorized manner. Specifically, it authorizes a taxpayer to bring a civil cause of action for damages against the U.S. government in district court if a United States officer or employee knowingly or negligently inspects or discloses a taxpayer’s return or return information in violation of Section 6103. Section 7431(c)(3) also allows the taxpayer to recover reasonable attorneys’ fees if he is the prevailing party.
Obtaining Refunds in U.S. Tax Court Cases
There are a number of forums for litigating tax disputes, such as the U.S. Tax Court. There are pros and cons associated with bringing suit in each forum. Taxpayers often pass on litigating cases in the U.S. Tax Court in cases when they are seeking a refund of an amount in excess of the amount reported on their tax returns. This is often based on a belief that the U.S. Tax Court cannot issue refunds.
Federal Tax Litigation
Other than in bankruptcy situations, Federal tax disputes can be litigated in the U.S. Tax Court, U.S. District Courts, or the U.S. Court of Federal Claims. The U.S. Tax Court is generally a preferred choice as taxpayers are allowed to bring suit without having to first pay the IRS’s proposed increase in tax. With the U.S. District Courts, or the U.S. Court of Federal Claims, taxpayers do have to first pay the tax, file a refund claim, and, once the refund claim is denied or more than six months goes by, the taxpayer can bring suit.
An example may help explain the difference. Assume the taxpayer’s tax return shows $100 in tax due. The IRS then conducts an audit and increases the tax by $50 to $150 in total. In many cases the taxpayer may have paid the $100, but not the $50. The taxpayer can bring suit in the U.S. Tax Court before paying the $50. He cannot bring suit in the U.S. District or Court of Federal Claims before paying the $50 and filing a refund claim for $50.
The taxpayer can also pay the $50, file a refund claim for more than the $50, and bring suit in the U.S. District or Court of Federal Claims. To continue the example, the taxpayer could seek a refund of $75 instead of $50. This is the defining characteristic of litigation in the U.S. District and Court of Federal Claims. The term “refund litigation” is what comes to mind when thinking about bringing suit in these courts. Taxpayers and their advisors often forget that they can also obtain a $75 refund in U.S. Tax Court pursuant to Section 6512 in some cases.
Obtaining Refunds in U.S. Tax Court Cases
Section 6512 authorizes the U.S. Tax Court to determine the amount of an overpayment and entitle the taxpayer to a refund. Continuing the prior example, if the taxpayer’s return reported a $100 tax liability and the IRS determined a $150 tax liability, the U.S. Tax Court could agree witht the taxpayer and enter an order granting a $25 refund to the taxpayer.
There are some limits on the U.S. Tax Court’s ability to issue refunds for this type of overpayment. Specifically, the time for filing the refund claim must not have expired at the time the IRS issues the Notice of Deficiency or 90-day letter to the taxpayer. This brings in the refund claim timing rules.
The refund claim timing rules basically say that a refund claim can be submitted within the later of (1) three years of the tax assessment date or (2) two years from the date of payment. With Section 6512, the law presumes that a tax refund claim was submitted (even though it was not) on the date the Notice of Deficiency or 90 day letter was issued to the taxpayer.
By way of explanation, the Notice of Deficiency or 90-day letter is issued at the end of the IRS audit. It is the legal notice that allows the IRS to assess or record the increased tax liability on its books. So if the IRS issued a Notice of Deficiency in 2015 for the 2012 tax year, the taxpayer could have still filed a refund claim on the date the Notice was issued. As such, the U.S. Tax Court could order the IRS to issue a refund in this scenario.
If the IRS issued the Notice of Deficiency in 2016 for the 2012 tax year, which could come up if the taxpayer did not timely file his 2012 tax return, the taxpayer may be precluded from filing a refund claim for 2012 at the time the Notice of Deficiency was issued. This would preclude the U.S. Tax Court from ordering the IRS to issue a refund. The exception would be if the tax was paid in the two years prior to the Notice of Deficiency. The U.S. Tax Court could order the IRS to issue a refund for the overpayment.
There are several exceptions and nuances to these rules that are beyond the scope of this writing. The takeaway is that the taxpayer may be able to obtain a refund via litigation in the U.S. Tax Court, which is typically true in situations where the taxpayer timely files its tax returns. The U.S. Tax Court will usually not have the authority to do this when the taxpayer files its tax returns late.
Physical Sickness Not Sufficient to Exclude Settlement Payment
Settlement payments paid to compensate a taxpayer for his physical sickness or injury are not taxable. This rule has been heavily litigated. It often comes down to what proof there is of the physical sickness or injury. In George v. Commissioner, T.C. Memo. 2016-156, the court addressed an argument that the physical sickness or injury could be inferred given that there was no economic damages.
The facts and procedural history are as follows:
- The taxpayer was a car salesman in New York.
- He found a new job and brought suit against his former employer and two former co-workers for discrimination under the Civil Rights Act of 1964 and comparable provisions of the New York Human Rights Law.
- He alleged that he was “constructively discharged” from Dana by virtue of a hostile work environment caused by the alleged discrimination.
- The parties reached a settlement whereby the taxpayer released all claims in exchange for a $45,000 payment.
- The taxpayer paid $15,000 to his attorney.
- The taxpayer did not report the $45,000 as income on his personal income tax returns.
- The former employer issued a Form 1099-MISC to the taxpayer, which was no doubt picked up by the IRS computer matching system and which likely generated an adjustment notice and eventually the court case.
The Exclusion for Physical Injuries or Sickness
The taxpayer’s position was that the $45,000 settlement payment was excluded from gross income under Section 104(a)(2), as damages received “on account of personal physical injuries or physical sickness.” This rule generates considerable amount of controversy between the IRS and taxpayers. The question in many cases involving this rule is whether there was a physical injury or physical sickness or merely emotional distress. Emotional distress is not sufficient to exclude the settlement payment.
The courts often look to the origin of the claim to determine whether there was a physical injury or physical sickness or merely emotional distress. This often involves evaluating the complaint or petition the taxpayer filed in the underlying lawsuit. Absent any indication of whether the claim was for a physical injury or sickness, the courts also consider the settlement agreement terms. Absent this type of evidence, the courts may also consider other evidence that shows that the payor intended to compensate the taxpayer for physical injuries or sickness.
The Lack of Evidence Establishing Physical Injuries or Sickness
In this case, the taxpayer’s original complaint included a general allegation of “psychological and physical harms,” but it did not allege with any specificity that the taxpayer had suffered actual physical injury or physical sickness. Moreover, the settlement agreement also did not reference any physical injuries or sickness. It does not appear that the taxpayer presented evidence that he sought treatment from a licensed professional or other evidence of a physical injury or sickness.
The Lack of Economic Harm is Not Sufficient
The taxpayer argued that he must have been compensated for a physical injury or sickness as he was not compensated for an economic harm. The taxpayer based this argument on the fact that he earned more money from his new job than he did at his prior job. So the taxpayer argued that the court could infer that the payment was for physical injury or sickness because it was not for economic harm.
The court did not agree that this had a bearing on the intent of the payor. It concluded that it showed that the payor compensated the taxpayer for discrimination and not a physical injury or sickness. So the court reasoned that it was not limited to just physical injury or sickness or economic harm. Discrimination was a third option–and one that the court found to be the most appropriate option given the facts.
How to Deduct Attorney’s Fees
The court also addressed whether the $15,000 attorney’s fees were deductible above or below the line. This issue has also generated quite a bit of controversy between the IRS and taxpayers.
Attorney’s fees deducted above the line are not subject to phase outs or otherwise limited, as in the case of Schedule A itemized deductions.
The IRS argued that the attorney’s fees in this case were Schedule A itemized deductions.
The court did not agree with the IRS. It concluded that the attorney’s fees were above-the-line deductions pursuant to Section 62(a)(20). This section provides that payments for discrimination under the Civil Rights Act of 1964 are above-the-line deductions. As noted by the court, the settlement agreement here specifically stated that it applied to claims for compensation “with respect to the employment relationship and termination thereof.” Given this language, the court concluded that the taxpayer paid legal fees to secure a settlement of his claim for unlawful employment discrimination and that Section 62(a)(20) entitled him to an above-the-line deduction of $15,000 for his legal fees.
IRS Cannot Group Nonpassive Activities to Trigger Loss Limitation for Taxpayer
Taxpayers are often surprised to learn that some losses may not be netted against gains in the current tax year. This is often due to the passive activity loss and material participation rules. The IRS National Office addressed these rules in TAM 201634022, in the context of whether two businesses should be grouped together and trigger these loss limitation rules.
The facts and procedural history are as follows:
- The taxpayer was an otolaryngologist (an ear, nose, and throat doctor).
- The taxpayer and several other doctors invested in a partnership.
- The partnership in turn owed an an interest in a second partnership.
- The second partnership provided outpatient surgery facilities for qualified licensed physicians.
- The facilities were used by a number of other doctors and their patients–including the taxpayer and his patients.
- Patients would often choose to have surgeries at these facilities as it was cheaper than having the surgeries at a hospital.
- The taxpayer also had losses from a rental condo.
- The taxpayer netted the losses from the condo with the income from the hospital facility partnership on his individual income tax returns.
- The IRS apparently audited the taxpayer’s returns and concluded that the losses were not allowable. It appears that the IRS auditor concluded that the taxpayer’s income from the partnership had to be grouped with his income from his medical practice.
- On appeal, the IRS Office of Appeals asked the IRS National Office to weigh in on the issue.
The Passive Activity Loss Rules
This ruling addresses the passive activity loss and material participation rules. These rules suspend otherwise deductible losses until the taxpayer has income from passive activities or disposes of the passive activity that generated the loss.
This requires a determination as to whether an item of income or loss is passive or nonpassive. Income and losses from rental activities are considered to be passive. Income and losses from business activities in which the taxpayer materially participates are considered to be nonpassive. Thus, passive rental losses normally cannot be netted against nonpassive business income.
The Passive Activity Loss Grouping Rules
The regulations also provide grouping rules. These rules allow taxpayers to group activities for purposes of the passive activity loss rules. They generally ask whether the activity grouping represents an appropriate economic unit. The regulations focus on these factors in evaluating whether grouping is appropriate:
- Similarities and differences in types of trades or businesses;
- The extent of common control;
- The extent of common ownership;
- Geographical location;
- Interdependencies between or among the activities (for example, the extent to which the activities purchase or sell goods between or among themselves, involve products or services that are normally provided together, have the same customers, have the same employees, or are accounted for with a single set of books and records).
The Parties Positions
The taxpayer treated his medical practice, partnership, and rental activities as separate activities. He did not make an election to group them together. Since he did not materially participate in the partnership, not electing to group the partnership with his medical practice allowed the partnership income to be passive and be netted against the taxpayer’s passive real estate losses.
With the IRS auditor’s position, that the taxpayer’s income from the partnership had to be grouped with his income from his medical practice, the income from the partnership would be nonpassive as the taxpayer materially participated in the medical practice. This would mean that the partnership income could not be netted against the taxpayer’s passive rental losses.
The IRS National Office
The IRS national office considered the examples in the regulations whereby a taxpayer carves out a part of their business to create passive income, which would allow them to net the income against their passive rental losses.
The regulations provide an example of this in which doctors create a separate business that leases medical equipment back to the doctors. The doctors do not materially participate in the equipment rental business, so its income is nonpassive income for the doctors. The regulations say that this is not permissible given that the doctors formed the equipment rental business to avoid the passive activity loss rules. The rules allow the IRS to regroup the activities to prevent taxpayers from circumventing the passive activity loss rules.
The IRS national office concluded that it was not appropriate for the IRS to try to re-group the taxpayer’s medical practice with the partnership. It reached this conclusion by determining that the taxpayer did not enter into the partnership to circumvent the passive activity loss rules and that the taxpayer’s grouping was reasonable given the grouping rules.
As a result, the taxpayer will likely be allowed to net his passive rental losses with his nonpassive partnership income.
Court Addresses IRS Audit Adjustments that are Really Accounting Method Changes
Given the potential for the adjustments to trigger extremely large tax liabilities, accounting method changes made by the IRS on audit can be doomsday scenarios for unwary taxpayers. In Nebeker v. Commissioner, T.C. Memo. 2016-155, the court addressed a common situation where the IRS makes an adjustment on audit that is an accounting method, but it does not follow the accounting method change rules.
The facts and procedural history in Nebeker are as follows:
- The taxpayer operated a Schedule C business that provided project management consulting primarily for aerospace and defense companies.
- The taxpayer employed a number of independent contractors who provided services to his clients.
- The taxpayer paid his independent contractors every two weeks for labor and travel expenses they incurred, regardless of whether the his clients had paid the invoices associated with the subcontractors’ labor and expenses. The taxpayer would then invoice and collect on the invoices at a later time.
- Beginning in 2004 and running through 2009, the taxpayer claimed the income tax deduction for outside labor associated with payments made to his contractors for the year in which the he received payment for the contractor expense, regardless of whether he paid the subcontractor in a prior year.
- So the taxpayer deducted $1,373,309 and $392,210 for 2006 and 2009, respectively, even though he only paid $1,087,551.72 and $180,665.62.
- The IRS audited the tax returns and proposed to disallow the difference between the amount deducted and paid in each year.
Accounting method changes are timing issues. They include changes in the overall plan of accounting for gross income or deductions or changes in the treatment of any material item used in such overall plan.
They usually require the taxpayer (or the IRS, if the IRS is making the change) to make a catch-up adjustment in the current year to account for the treatment of the item in prior years.
Accounting method changes can result in either favorable adjustments that result in a reduction of taxes in the current year or unfavorable adjustments that increase the amount of tax in the current year. The adjustments are usually quite large if they change the tax treatment for several years or for several decades.
For example, a taxpayer who changes their method of accounting for depreciation on a building that has been held for a number of years may be able to make a catch-up adjustment in the current year to account for depreciation that was not taken in the prior years. This can result in the taxpayer being entitled to a large depreciation deduction in the current year. This adjustment can reduce the taxpayer’s tax liability in the current year by allowing the missed depreciation deductions from the prior year to all be taken in the current year.
In Nebeker, the IRS only disallowed the taxpayer’s 2006 and 2009 deductions. It did not make a catch-up adjustment in 2006 to account for the same items in the 2004 and 2005 tax years.
The court concluded that the IRS’s audit adjustments were in fact an accounting method change. As noted by the court, this requires a catch-up adjustment in 2006. The court did not provide the facts to say with any certainty, but it would seem like this adjustment would essentially nullify the IRS’s adjustments in 2006 and 2009.
Duty of Consistency in Suit to Collect Unpaid Taxes
Many tax cases are won or lost based on tax procedure issues. The U.S. v. Holmes, Civil Action No. 4:15-cv-00626 (S.D. Texas 2016), case serves as a reminder of this. The case involved a lawsuit filed by the government in the eleventh hour and the duty of consistency doctrine.
The Holmes case involved an estate tax return filed for the 1997 tax year. The IRS assessed the tax in July of 2004. The IRS did not make any effort to collect the tax liability until 2013–nine years after the tax was assessed by the IRS.
The taxpayer submitted a Form 12153 to the IRS on October 5, 2013, to request a Collection Due Process (“CDP”) hearing. The IRS lost the CDP hearing request due to the federal government shutdown from October 1, 2013 to October 16, 2013. The taxpayer then sent a letter to the IRS on June 2, 2014, to withdraw its request for a CDP hearing. The government then brought suit to collect the tax on March 10, 2015–more than ten years after the tax was assessed by the IRS.
The dispute in the case was whether the IRS’s lawsuit was timely filed. The IRS generally has ten years from the date a tax is assessed to bring suit to try to collect the tax. This time period is extended when the IRS receives the taxpayer’s request for a CDP hearing. This extended time period ends when the IRS receives the taxpayer’s written request to withdraw the CDP hearing request or the IRS issues a Notice of Determination in the CDP hearing.
Since the IRS lost the October 5, 2013 CDP hearing request, the taxpayer argued that the request was not received by the IRS until the taxpayer re-submitted the prior request to the IRS on May 2, 2014. So the taxpayer was arguing that the CDP hearing request only extended the ten year time to file suit by one month–from May to June of 2014. This would mean that the government’s time for filing suit expired in 2014 and the lawsuit was not timely filed.
The court did not agree. It applied the consistency doctrine, which it described as follows:
The elements of the duty of consistency are: (1) a representation or report by the taxpayer; (2) on which the Commission has relied; and (3) an attempt by the taxpayer after the statute of limitations has run to change the previous representation or to recharacterize the situation in such a way as to harm the Commissioner.” Herrington v. C.I.R., 854 F.2d 755, 758 (5th Cir. 1988). “If this test is met, the Commissioner may act as if the previous representation, on which he relied, continued to be true, even if it is not. The taxpayer is estopped to assert the contrary.” Id.
The court dismissed the taxpayer’s argument that the duty of consistency only applies to situations where a taxpayer adopts a factual representation for one tax year and adopts a different factual representation for a different tax year. The court said that the duty of consistency doctrine applies in cases where a taxpayer has taken one position, garnering a tax benefit over many years, and attempts to change its position to garner another benefit.
The court said that the taxpayer had “garnered the benefit of avoiding the tax deficiency for many years, and now change their factual representation in an attempt to garner a judicial shield of protection from liability.”
The court noted that the taxpayer had “aggressively demanded a CDP hearing” with the IRS by writing a letter to the IRS that noted that its original CDP hearing request had in fact been received by the IRS timely. According to the court, the IRS relied on this letter and treated the hearing as a CDP hearing. Thus, the court concluded that the taxpayers were precluded from arguing that the CDP hearing request was not received by the IRS timely. This lead the court to the conclusion that the time the government had to file suit was extended by the CDP hearing request and this extension was sufficient to make the lawsuit filing timely.
This case serves as a reminder that taxpayers should be wary of filing CDP hearing requests when the ten collection statute is about to expire. When they do submit these requests, if they are not going to litigate the CDP hearing if it is not successful, taxpayers should be ready to submit a written request to the IRS to withdraw the CDP hearing as soon as they have a sufficient basis to believe that the outcome will not be favorable. This will help minimize the time that the collection statute is extended.