The IRS is required to send taxpayers a notice of deficiency before it can assess additional tax. The notice itself has to put the taxpayer on notice that the IRS made a determination that there was a tax deficiency (i.e., an amount owed), the tax year, and the amount. A notice that does not include one or more of these items may be invalid and, if enough time has passed, can prevent the IRS from lawfully assessing the tax. The U.S. Tax Court set out a two-prong test in Dee v. Commissioner, 148 T.C. No. 1 (2017), that may make it more difficult for taxpayers to challenge invalid notices.
The Facts and Procedural History
The facts and procedural history are as follows:
- The taxpayer filed his 2014 tax return.
- The IRS disallowed the premium tax credit reported on the return in 2015 by mailing a notice of deficiency to the taxpayer.
- The notice of deficiency reflected $0.00 as the deficiency amount.
- The notice also included tax calculations and indicated that “[a] decrease to refundable credit results in a tax increase.”
- The taxpayer filed a petition with the U.S. Tax Court to challenge the disallowance of the premium tax credit.
The court asked the IRS to explain how the court had jurisdiction over the case if there was a tax deficiency in the amount of $0.00. The IRS responded that this was a clerical error and that it did not invalidate the notice of deficiency.
The Majority Opinion
The court said this two-prong test is to be used to determine whether a notice of deficiency is valid:
We have often addressed questions regarding the validity of notices of deficiency. We have at times characterized our review of the sufficiency of a notice as an objective test. But our caselaw shows that an objective review is used to establish prima facie validity of a notice of deficiency. When that objective review has led us to conclude that a notice was ambiguous, we have looked beyond the notice to determine whether the Commissioner made a determination and whether the taxpayer knew or should have known that the Commissioner determined a deficiency.
The court viewed the objective test as a “should have known” test and the subjective test as a “knew” test.
The court explained the objective test as follows:
we look to see whether the notice objectively put a reasonable taxpayer on notice that the Commissioner determined a deficiency in tax for a particular year and amount. If the notice, viewed objectively, sets forth this information, then it is a valid notice. … Accordingly, if the notice is sufficient to inform a reasonable taxpayer that the Commissioner has determined a deficiency, our inquiry ends there; the notice is valid.
The court explained the subjective test in light of a prior court case where the taxpayer asserted that he was not mislead by the error in the notice of deficiency. The taxpayer in this prior court case made this admission to allow the court to have jurisdiction. The court also cited another prior court case in which the court concluded that the taxpayer was not misled by the error given the taxpayer had filed a petition with the court contesting the deficiency.
In this case, the court determined that the taxpayer was not misled by the error given the taxpayer had filed a petition with the tax court contesting the deficiency. As such the court concluded that the notice of deficiency was valid and it had jurisdiction over the case.
The Concurring Opinions
One justice issued a concurring opinion to agree with the court’s conclusion, but not its two-prong test for reaching the conclusion:
I disagree that our caselaw supports a test that looks, in part, to whether the taxpayer knew or should have known that the Commissioner determined a deficiency or was misled. The references to a taxpayer’s knowledge or intent and/or to whether a taxpayer was misled in the cases on which the opinion of the Court relies are dicta reinforcing the Court’s conclusion in each case that the Commissioner made a determination in the notice of deficiency that passes jurisdictional muster. We should not elevate those references into a test that has no place in resolving the real jurisdictional issue—whether the Commissioner in the notice of deficiency made a determination with respect to the taxpayer that confers jurisdiction on this Court.
A second justice also issued a concurring option to agree with the court’s conclusion, but not its two-prong test for reaching the conclusion:
The opinion of the Court delineates a two-prong approach (with both objective and subjective elements) to determining our deficiency jurisdiction that is, at best, unnecessary, and is, at worst, improper.
The Dissenting Opinion
A third justice issued a dissent to disagree with the court’s conclusion:
The existence of a deficiency is a notice’s most fundamental requirement. The Commissioner is not required to give the correct deficiency amount, but he is required to determine an amount, and $0 is not a deficiency. The opinion of the Court cites a myriad of cases referencing notices dating back to 1919, see op. Ct. pp. 6-13, yet none of those cases hold valid a notice which informs the taxpayer that he does not have a deficiency.
The Problem with the Result
In a footnote in the dissenting opinion, the justice explained the problem with the court’s two-prong test:
While the notice in this case related to a refundable tax credit, the precedent here will extend to notices issued to increase tax liabilities. Some taxpayers receiving those notices will petition the Court. Their ticket to the Tax Court will also be a ticket to the gallows. Other taxpayers will not file petitions and may ultimately seek relief (i.e., pursuant to sec. 6320 or 6330) when the IRS attempts to collect. If we invalidate $0 deficiency notices, taxpayers would typically prevail in collection proceedings. Instead, our determination of whether the taxpayers were misled will now determine their fate.
The second justice who issued a concurring opinion (as described above), explained it this way:
Even in cases in which the Commissioner sends an inadequate notice of deficiency, the taxpayer does not petition us for redetermination, and tax is subsequently assessed, the taxpayer is not completely out of luck. The taxpayer has the option to pay the assessed tax and pursue a refund claim, after which he or she is entitled to file a suit for refund in a U.S. District Court or the U.S. Court of Federal Claims. Or, if the taxpayer does not become aware of the assessment until receiving a collection notice, the taxpayer can seek relief in a collections due process hearing, after which he or she is entitled to petition this Court for review. Although our caselaw probably would not allow us to find that a taxpayer who receives an inadequate notice of deficiency was not issued a notice of deficiency and thus is entitled to challenge his or her underlying liability under section 6330(c)(2)(B) (as Judge Foley correctly notes in his dissent, see Foley op. note 2, but which is true regardless of the outcome of this case), we could instead find that the Commissioner, in issuing an inadequate notice, failed to fulfill the necessary administrative procedures, including those in the Internal Revenue Manual, under section 6330(c)(1).
What this means is that by filing a petition in tax court, the taxpayer may lose the ability to contest the notice of deficiency in tax court. Even if the case was brought as part of a collection due process hearing, all the taxpayer would get was the case remanded to appeals for further consideration by a settlement officer. To have their day in court, the taxpayer may have to file a refund claim, pay the tax first, sue for a refund and contend with the higher burden imposed on taxpayers in refund litigation.