August 24, 2019

Tenth Circuit: Form 1040s Filed After IRS Tax Assessments Not “Returns” for Bankruptcy Dischargeability Purposes

The Tenth Circuit Court of Appeals issued its opinion in In re Mallo: Mallo v. Internal Revenue Service on Monday, December 29, 2014.

In these consolidated appeals, the debtors did not file tax returns timely and the IRS issued statutory notices of deficiency. The debtors in both cases eventually filed tax returns for the years at issue, changing their tax liabilities. The debtors in both cases later were subject to bankruptcy court orders discharging their debts but excluding their tax liabilities. They filed adversary proceedings against the IRS, seeking determinations that their tax debts had been discharged, and the IRS answered, denying that the debts had been discharged. The parties filed cross-motions for summary judgment on the legal question of whether the debtors’ tax debts were excepted from discharge under 11 U.S.C. § 523(a)(1)(B). In the Mallo case, the bankruptcy court granted the IRS’s motion for summary judgment based on the court’s conclusion that the Mallos had not filed a return and therefore their debt was not dischargeable. In the Martin case, the bankruptcy court reached the opposite conclusion. Both cases were appealed to the U.S. District Court for the District of Colorado, where they were consolidated. The district court concluded the late-filed returns were not “returns” for purposes of § 523(a)(1)(B) because they served no tax purpose. The debtors then appealed, and the appeals were consolidated.

The Tenth Circuit found the plain language of § 523(a) unambiguous, and found that the late-filed returns were not returns for purposes of § 523(a) and therefore their tax liabilities were excepted from the bankruptcy courts’ general orders of discharge. The Tenth Circuit noted that the district court in this case utilized the long-established Beard test to determine whether a filing is a return, focusing on the third prong of the test, i.e., whether a Form 1040 filed after the IRS assesses tax penalties evinces “an honest and reasonable attempt” to comply with tax law. The district court in this case adopted the reasoning of several other courts to consider the issue and determined that because the IRS has no use for the Form 1040 after it has calculated tax liability, the late-filed returns have no valid purpose and therefore are not “honest and reasonable attempts” to follow tax law. The Tenth Circuit took a different approach, instead applying a plain language analysis to § 523(a). The Tenth Circuit found the phrase “applicable filing requirements” to include time limits for filing. Because the debtors did not file their returns by the deadline, an applicable filing requirement, they were not “returns” as required by the Bankruptcy Code.

The Commissioner of the Internal Revenue Service proposed a different approach, instead relying on the official IRS position, which is that “a debt assessed prior to the filing of a Form 1040 is a debt for which [a] return was not ‘filed.’” In essence, the Commissioner argued that focusing on the meaning of the word “return” was not necessary, and would impermissibly work a “major change” in bankruptcy practice. The Tenth Circuit rejected this approach, relying instead on the plain and unambiguous statutory language and finding that Congress intended the result achieved by the Tenth Circuit because the language it chose was unambiguous. It would not create a “major change” in bankruptcy practice because the language the Tenth Circuit interpreted was part of the Bankruptcy Code.

The district court’s rulings were affirmed.

Tenth Circuit: Entrapment By Estoppel Instruction Inappropriate Where Defendant Unreasonably Concluded Government Consent

The Tenth Circuit Court of Appeals issued its opinion in United States v. Rampton on Friday, August 8, 2014.

April Rampton learned of a tax refund scheme involving filing 1099-OID forms claiming interest income on debts she owed others, such as her mortgage. She filed her 2007 tax return but subsequently amended it based on the 1099 scheme. She received a refund check from the IRS for $228,967.28 and took that to mean that the tax scheme was legitimate. Subsequently, she told several friends about the scheme and helped them file similar false returns. She charged for her help, even though she was not an accountant or tax professional. In January 2009, an IRS agent met with one of the people Rampton had assisted in the tax scheme. The agent informed Rampton’s friend that she could be fined or imprisoned for her false use of the forms. The friend called Rampton and reported what the agent had said. Rampton told the friend the agent was using a “scare tactic” and continued the scheme. She assisted nine other people in filing false tax returns using the 1099 scheme after the IRS agent visited the friend. Eventually, she was indicted by a grand jury of one count of using a false tax return for herself (Count 1) and 14 counts of helping others file false returns (Counts 2 through 15). She moved to dismiss Counts 2 through 15 before trial based on entrapment by estoppel, averring that the refund check issued by the IRS was an affirmative demonstration that her conduct was legal. The motion failed, but during trial she proposed a jury instruction on the defense of entrapment by estoppel, which was similarly rejected. The jury could not reach a verdict on the first six counts, but convicted her on the remaining nine counts relating to the nine people Rampton assisted after learning the scheme was fraudulent.

Rampton appealed, asserting she was deprived of a fair trial because the jury was not informed of her defense of entrapment by estoppel. The Tenth Circuit disagreed because she was not entitled to the instruction. The Tenth Circuit found no reasonable basis for Rampton to have believed the refund check was a symbol of her conduct’s legality. Rather, it was unreasonable for Rampton to believe the tax scheme was legal.

The Tenth Circuit affirmed Rampton’s convictions.

Tenth Circuit: IRS Notices are Untimely if IRS Does Not Follow Administrative Requirements of Internal Revenue Code

The Tenth Circuit Court of Appeals issued its opinion in Jewell v. United States on Monday, April 28, 2014.

The IRS issued four summonses to banks in the Eastern and Western Districts of Oklahoma for records involving nursing homes owned by Mr. Sam Jewell. Under federal law, the IRS had to notify Mr. Jewell at least 23 days before the examination date. The IRS failed to timely provide notice to Mr. Jewell, and he filed petitions to quash the summonses in the district courts for the Eastern and Western Districts of Oklahoma. The Eastern District granted Mr. Jewell’s motion to quash, while the Western District denied it.

The Tenth Circuit, creating a circuit split, ruled that the U.S. Supreme Court’s decision in United States v. Powell, 379 U.S. 48 (1964), required it to rule in favor of Mr. Jewell because the plain language of 26 U.S.C. § 7609(a)(1) mandated 23 days’ notice by the IRS prior to enforcing its summonses. The ruling of the Eastern District of Oklahoma was affirmed and the ruling of the Western District was reversed.

U.S. District Court Strikes Down IRS’s Registered Tax Return Preparer Regulations

TramLeBy Tram Le

On Jan. 18, 2013, the U.S. District Court for the District of Columbia issued a decision enjoining the IRS from enforcing its new registered tax return preparer program. See Loving v. IRS, No. 12-385, 2013 WL 204667 (D.D.C. Jan. 18, 2013).

In 2011, the IRS issued final regulations requiring all paid tax return preparers, who were not otherwise regulated by the IRS, to comply with Circular No. 230. Specifically, the regulations required tax return preparers who are not attorneys, CPAs or enrolled agents to pass a qualifying exam, pay an annual fee, and take 15 hours of continuing education courses each year.

In promulgating the regulations, the IRS relied on 31 U.S.C. Sec. 330, which gave them the authority to regulate individuals who “practice” before it.

Factual and Procedural History

Three paid tax return preparers, who were not previously regulated, filed suit against the IRS in federal court. The individuals argued that the IRS had no authority under 31 U.S.C. Sec. 330 to regulate tax return preparers who only prepare and sign tax returns, and file claims for refund and other documents with the IRS.

The tax return preparers claimed that the new IRS regulations would likely cause them to lose customers and close their business due to the increased costs and burdens associated with compliance. Therefore, they sought for injunctive and declaratory relief and moved for summary judgment.

Issue and Decision

The issue before the court was whether all paid tax return preparers are “representatives” who “practice” before the IRS under 31 U.S.C. Sec. 330 and therefore, are properly subject to the new IRS regulations. In deciding the case, the court applied the two prong Chevron test. Chevron U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984). The first step asks whether “the intent of Congress is clear.” Under this test, if the intent is clear, then the court “must give effect to the unambiguously expressed intent of Congress” and does not need to address the second step.

In this case, the court found that the intent of Congress was clear under 31 U.S.C. Sec. 330 and preparers who are limited to preparing and signing tax returns and claims for refund, and other documents to the IRS are not “representatives” who “practice” before the IRS.

The court reasoned that under 31 U.S.C. Sec. 330(a)(2)(D), the definition of “practice of representatives” does not include tax return preparation. The court equates “practice” as advising and assisting taxpayers in presenting their cases. The court stated that merely filing a tax return would never in its normal usage be described as “presenting a case.”

The court also reasoned that the IRS’s interpretation of 31 U.S.C. Sec. 330 would displace an existing statutory scheme that regulates penalties on tax return preparers. The court referred to Title 26 of the U.S. Code, which provides for a “careful, regimented schedule of penalties for misdeeds by tax-return preparers.” For example, a tax return preparer would be subject to a fine of $50 (with an annual maximum of $25,000) for failing to sign a return without reasonable cause under 26 U.S.C. Sec. 6695(c). If tax return preparers were subject to 31 U.S.C. Sec. 330, the IRS would have a considerable amount of discretion to impose penalties ranging from $0 and the “gross income derived (or to be derived) from the conduct giving rise to the penalty.”

Furthermore, the court stated that a federal penalty provision pursuant to 26 U.S.C. Sec. 7407, which remedies abusive practice by tax return preparers, would be irrelevant under the IRS’s interpretation.

The court held that the statute was not ambiguous based on the plain language and does not clearly cover individuals who prepare and sign tax returns, file claims for refund and other documents to the IRS. Since the regulations failed under the first prong of the Chevron test, the court did not consider the second prong. As such, the court granted a declaratory judgment and permanent injunctive relief, enjoining the IRS from enforcing its new regulations.

Appeal of Ruling

In response to the district court’s decision, the IRS filed a motion to suspend the permanent injunction against the tax return preparer regulations. On Feb. 1, 2013, the court denied the IRS’s motion. However, the court agreed to modify the ruling to clarify that IRS could continue its Preparer Tax Identification Number (PTIN) program and was not required to close its testing and continuing-education centers.

Tram Le, CPA, Esq., LL.M. – SALT Consultant – Golden, CO – With more than six years of government financial and forensic auditing experience, Tram has developed and implemented audit procedures for forensic audits and assisted in investigations of fraud, waste and abuse such as improper payments. Tram is a CPA and a licensed attorney.  She received a joint JD/LL.M. in taxation from the University of Denver. Tram is currently developing knowledge and expertise in State and Local Tax (SALT). She focuses on variety of state and local sales and income/franchise tax issues and assists with protesting and the representation of clients at administrative appeals and appeals meetings. She writes for the CBA Taxation Section newsletter, where this article originally appeared.

The opinions and views expressed by Featured Bloggers on CBA-CLE Legal Connection do not necessarily represent the opinions and views of the Colorado Bar Association, the Denver Bar Association, or CBA-CLE, and should not be construed as such.

Internal Revenue Service to Provide Relief to Homeowners with Corrosive Damage Due to Toxic Imported Drywall

The Internal Revenue Service (IRS) is offering relief to taxpayers who have incurred property loss caused by the presence of toxic imported drywall that was installed in their homes between 2001 and 2009.

Revenue Procedure 2010-36 (pdf) enables qualified taxpayers to claim as a casualty loss any damage to homes and provides a “safe harbor” method for calculating the loss amount.

Eligible corrosive drywall must be identified by a two-step process described by the U.S. Department of Housing & Urban Development: first, there must be visual evidence of blackened copper electrical coilings and/or air conditioning evaporator coils; and second, the drywall must have been installed between 2001 and 2009. Additional corroboration of the property’s eligibility for special tax treatment will follow when these two criteria have been met.

According to an IRS news release, the revisions provide:

  • Individuals who pay to repair damage to their personal residences or household appliances resulting from corrosive drywall may treat the amount paid as a casualty loss in the year of payment.
  • Taxpayers who have already filed their income tax return for the year of payment generally have three years to file an amended return and claim the deduction.The amount of a loss that may be claimed depends on whether the taxpayer has a pending claim for reimbursement (or intends to pursue reimbursement) of the loss through property insurance, litigation or otherwise.
  • In cases where a taxpayer does not have a pending claim for reimbursement, the taxpayer may claim as a loss all unreimbursed amounts paid during the taxable year to repair damage to the taxpayer’s personal residence and household appliances resulting from corrosive drywall.
  • If a taxpayer does have a pending claim (or intends to pursue reimbursement), a taxpayer may claim a loss for 75 percent of the unreimbursed amount paid during the taxable year to repair damage to the taxpayer’s personal residence and household appliances that resulted from corrosive drywall.

Homeowners who suspect they have corrosive drywall should file a report with the U.S. Consumer Product Safety Commission by calling (800) 638-2772 or visiting www.cpsc.gov/cgibin/drywall.aspx.

The issue of toxic imported drywall, typically of Chinese manufacture, came light in 2009 amidst widespread reports of electrical failure, sulphuric fumes emissions, and respiratory problems experienced by owners of newly built homes constructed during last decade’s housing boom.

(image source: Wikimedia Commons)

IRS Reminds Small Nonprofits to Satisfy Filing Requirements to Preserve Tax-Exempt Status; One-Time Relief Offer Expires October 15

Small nonprofit organizations that did not file returns for 2007, 2008, and 2009 will be given a one-time reprieve and the opportunity to maintain their tax-exempt status if they file their returns by October 15, according to the Internal Revenue Service (IRS).

IRS Commissioner Doug Shulman said, “We are doing everything we can to help organizations comply with the law and keep their valuable tax exemption. So if you do not have your filings up to date, now’s the time to take action and get back on track.”

Organizations at risk of losing their nonprofit status are listed by state here, along with more information about the relief program and available remedies.

The IRS will revoke tax-exempt status of all small nonprofit organizations that fail to submit their returns by October 15.

Ed. Note: For more on this, take a look at this post by Jim Thomas, who also recommends this CBA article by Peter Nagel.