TAX COURT RULES DEFICIENCY NOTICE VALID DESPITE IRS NOT FOLLOWING THE LAW
By Larry Jones
In the recent case of Smith v. Commissioner">
| Tax Court Rules Improper Deficiency Notice Valid |
| Tax Court Gerrymanders the Unified Partnership Proceedings Rules |
| Houston IRS Adopts Fast Track Mediation |
TAX COURT RULES DEFICIENCY NOTICE VALID DESPITE IRS NOT FOLLOWING THE LAW
By Larry Jones
In the recent case of Smith v. Commissioner, 114 T.C. No. 29 (June 8, 2000), the Tax Court held that even though a statutory notice of deficiency was missing a date for the letter and the last date to file a petition, the notice was still valid. The facts in this case are relatively simple. The IRS mailed a statutory notice of deficiency and failed to date the letter or place on the notice the last date to file a petition with the Tax Court. The Tax Court found that even though Congress "provided that the IRS ‘shall include' the petition date on each notice, Congress failed to prescribe what consequences result from such failure to include the date." The Tax Court has not hesitated in other cases to find notices invalid without specific remedies from Congress.
Section 6212(a) of the Internal Revenue Code ("Code") provides for the sending of a notice of deficiency by the IRS if a deficiency in taxes is determined against a taxpayer. A taxpayer can petition to the United States Tax Court within 90 days after a notice of deficiency is mailed. The IRS may not assess a tax until a notice of deficiency has been sent to the taxpayer. Code Section 6213(a).
Section 3463 of the IRS Restructuring and Reform Act of 1998, supra, states as follows:
SEC. 3463. NOTICE OF DEFICIENCY TO SPECIFY DEADLINES FOR FILING TAX COURT PETITION.
(a) In General: The Secretary of the Treasury or the Secretary's delegate shall include on each notice of deficiency under section 6212 of the Internal Revenue Code of 1986 the date determined by such Secretary (or delegate) as the last day on which the taxpayer may file a petition with the Tax Court. [Emphasis added.]
(b) Later Filing Deadlines Specified on Notice of Deficiency To Be Binding: Subsection (a) of section 6213 (relating to restrictions applicable to deficiencies; petition to Tax Court) is amended by adding at the end the following new sentence: "Any petition filed with the Tax Court on or before the last date specified for filing such petition by the Secretary in the notice of deficiency shall be treated as timely filed."
(c) Effective Date: Subsection (a) and the amendment made by subsection (b) shall apply to notices mailed after December 31, 1998.
The notice of deficiency now includes an item to be completed by the IRS titled "Last Day to File a Petition With the United States Tax Court:". This item was not completed on the notice of deficiency sent to the Smiths, and no date was specified by which to file a petition with the Tax Court. However, the attorney for the Smiths called the IRS and advised them of the error and a timely petition was filed by the Smiths. After informing the IRS of the error and before the filing of the petition, the IRS sent a new notice of deficiency which included the dates. The result in Smith may be correct due to the fact that a timely petition was filed. However, we disagree with the Tax Court's determination that the missing date did not invalidate the petition.
The House Committee Report (H.R. No. 105-364, pt. 1) states that the reason the law was changed was because the Committee believed–
* * * taxpayers should receive assistance in determining the time period within which they must file a petition in the Tax Court and that taxpayers should be able to rely on the computation of that period by the IRS.
In explaining this provision, the House Committee Report stated:
The bill requires that the IRS include on each deficiency notice the date determined by the IRS as the last day on which the taxpayer may file a petition with the Tax Court. It is expected that the last day on which a taxpayer who is outside the United States may file a petition with the Tax Court will be shown as an alternative. The bill provides that a petition filed with the Tax Court by this date shall be treated as timely filed. [Emphasis added.]
The failure of the IRS to comply with Section 6213 of the Code makes a notice of deficiency invalid. Section 3463 of the IRS Restructuring and Reform Act of 1998, supra, does not give the IRS an option in specifying a date on the notice of deficiency by which the petition must be filed with the Tax Court. The language in the Act is clear and mandatory that the IRS shall specify the date on the notice of deficiency.
Why should the IRS not be penalized for making a mistake? The answer is they should. Taxpayers who receive such notices and do not know the rules and fail to timely file a petition would apparently be penalized by the Tax Court. Such a result is unfair. If the IRS is required by law to advise a taxpayer of the last date on which a timely petition shall be filed, and it fails to do so, then the petition shall be invalid.
Tax Court Gerrymanders the Unified Partnership Proceedings Rules
By Jack Townsend
The Tax Court has entered a remarkable pair of court reviewed decisions. GAF corp., et al v. Commissioner, 114 T.C. No. 33 (6/29/2000); and Rhone-Poulenc Surfactants and Specialities v. Commissioner, 114 T.C. No. 34 (6/29/2000). The decisions involve partnership level proceedings and partner level proceedings arising out of the proper tax treatment for the same transactions.
The Partnership Audit Background
The Code's partnership audit provisions (Sections 6221 ff.) generally provide that the audit of a partnership's tax liability will occur only at the partnership level. If the IRS determines that the results were different than reported by the partnership, the IRS will issue a "final partnership administrative adjustment" (commonly referred to acronymically as an "FPAA"). The partnership and the partners will then have the right to pursue a unified litigation proceeding in an appropriate court. If the partnership and partners do not bring the litigation, the IRS will then allocate the results to and among the partners, as appropriate and send them a notice of deficiency. If the partnership and the partners do bring the litigation, upon conclusion of the litigation, the IRS will then allocate the results to and among the partners consistent with the litigation.
Since concluding the audit and any litigation may occur substantially beyond the statute of limitations that might apply at the partner level, Section 6229 provides that there is a statute of limitations at the partnership level. That statute of limitations substantially parallels the general statute of limitations under Section 6501. But, for example, if the partnership extends the partnership level statute of limitations, the determinations at the partnership level can be made after the partners' statute under Section 6501 had otherwise expired. Then, so long as the IRS issues an FPAA within the partnership level statute of limitations, the partners' statute of limitations for the results is then opened up so that consistent adjustments can be made to the partners.
This explanation deals with the generally applicable circumstance when the partnership level proceedings (audit and any litigation that may ensue) occurs after the partners' statutes of limitation had otherwise expired. Addressing that phenomenon seems to have been what was on Congress' mind in adopting the partnership audit rules.
The issue in these new cases is what happens if a partner's generally applicable statute under Section 6501 had not expired after the special partnership audit statute of limitations in Section 6229 had expired. The partnership unified audit provisions seem not to address that issue. That was the problem.
Facts
Two subsidiaries of GAF Corp. were partners in a limited partnership, Rhone-Poulenc Surfactants and Specialties, L.P. ("the Partnership"). Those subsidiaries will be referred to as "GAF Partners." In 1990, the GAF Partners transferred substantial business properties to the Partnership. For tax purposes, the Partnership and the GAF Partners treated the transfer as a nontaxable contribution to the capital of the Partnership. The Partnership and the GAF Partners (as members of a consolidated group) so reported the transfers on the 1990 tax returns, both filed on 9/15/91. (The Partnership's return may have been filed on 9/17/91, but that is not relevant here.)
The IRS determined that the transfers were sales of the properties rather than contributions to the capital of the Partnership. The IRS's position was "based on two sometimes independent hypotheses: (1) There was no partnership, and (2) the transferor[s] of the property received no partnership interest in exchange therefor." On 9/12/97, the IRS issued an FPAA to the partnership taking that position. On 9/12/97 the IRS also issued a notice of deficiency to the GAF Partners. Both the Partnership, by GAF as non-tax matters partner, and the GAF Partners brought proceedings in the Tax Court in response to the FPAA and notice of deficiency, respectively..
The Partnership Level Proceeding
The problem for the IRS was the statute of limitations. As we shall develop, reading the potentially applicable Code provisions (§§ 6501 and 6229(a)) literally left a hiatus that would prevent the IRS from making the assessment if the IRS were correct in its characterization of the transaction. The applicable Code provisions are probably well-known to you, but are in any event relatively straight-forward.
At the partner level, section 6501 provides that, for taxpayers generally, the statute of limitations normally expires three years after the return is filed. Section 6501(e)(1)(A) provides an exception in the case of a 25% omission of income. The partnership, however, is a separately auditable entity. Section 6229(a), which roughly parallels Section 6501, provides that the partnership audit period is generally three years. Like Section 6501, Section 6229 provides exceptions. Thus, just as Section 6501(e)(1)(A) extends a taxpayer's statute of limitations for a 25% omission, so Section 6229(c)(2) extends the partnership statute to six years for a partnership 25% omission. Section 6229(c)(2) was not applicable because the partnership had not omitted income under the IRS's theory that the GAF Partners had a taxable transaction which would mean that the GAF Partners, not the Partnership, omitted income. Just as Section 6503(a) suspends the statute of limitations in Section 6501 upon the issuance of a notice of deficiency, Section 6229(d) suspends the statute of limitations provided in Section 6229(a) upon the issuance of an FPAA (which acts somewhat like a notice of deficiency to allow the taxpayer prepayment access to the courts to litigate the partnership level items). At the risk of oversimplification in this case, the IRS could prevail only by having the reference in Section 6229(d) to refer to both Section 6229(a) and Section 6501 (Section 6501(e)(1)(A) specifically). Let's deal more specifically with what the problem was and how the Court resolved the issue.
The parties agreed that, under the expansive definition of a partnership item that must proceed through the unified partnership level track, the treatment of the transactions in question was a partnership item, meaning that it should be determined at the partnership level and then contested by a only upon issuance of the FPAA.The partnership argued, not surprisingly, that the three year period provided in Section 6229(a) was the exclusive period in which the IRS could make an adjustment of a partnership item. Here, no Section 6229 exception applied, so, the partnership argued, the period was a three year period and had expired by the time the IRS issued the FPAA. That argument had support in the statute.
The IRS argued that the three year period was an alternative period to the general period provided in Section 6501. In other words, the IRS urged that Section 6229 was intended and operated to give the IRS the period provided in Section 6229(a) even if the partner level statute of limitations had expired. But, the IRS argued, if the partner's statute of limitations extended beyond the period provided in Section 6229(a), the IRS could still institute a Partnership level audit and issue an FPAA within the partner's statute of limitations that would then suspend the partner's statute of limitations under Section 6229(d). The problem is that Section 6229(a) by its terms suspends only the Section 6229(a) limitations period, not the Section 6501 limitations period upon which the IRS relied because the Section 6229(a) limitations had already expired.
With the issue thus set up, the Court described generally the Code's dual personality treatment for partnerships (the entity and aggregate personalities, depending upon Code context) and the reasons for the TEFRA partnership rules. As respects the specific issue before it, the Court held that Section 6229(a) is not the exclusive limitations period provision but that it is an additional one (i.e., in addition to the normal rule of Section 6501), so that an FPAA could issue until the later of the two periods to expire. Specifically, in the case of a partnership, this means that the IRS can invoke the FPAA procedure as to a particular partner even after the period described in Section 6229(a) so long as that partner's period of limitations is otherwise open under Section 6501. For example, assume that the partnership and the partner both file their year 1 tax returns on April 15 of year 2, that the period is governed by the three years in Section 6229(a) because no partnership exception applies), but that the partner has given a two year extension on the partner's statute of limitations. As to that partner, the holding is that IRS can invoke the unified partnership procedures through the 5 year extended period because Section 6229 is just an alternative that does not supplant the normal statute of limitations. This is true even if the other partners' statute of limitations has expired (because, remember, Section 6229's three year statute had expired and I have not assumed that the other partners gave extensions to the statute of limitations or otherwise were subject to a longer statute of limitations). Similarly, if a partner had a nonpartnership item on the return attributable to fraud, the partner's return would be open forever, and presumably under the holding the IRS could at any time perform a partnership auditing for items having nothing to do with the partner's fraud.
There is a follow-through question which the Court addressed next. Did the issuance of the FPAA suspend the statute of limitations that might then still be open at the partner level under Section 6501(e)(1)(A)? Section 6229(d) clearly suspends the Section 6229(a) statute of limitations upon issuance of an FPAA. Section 6229(d) refers only to the period described in Section 6229(a) which had already expired in this case and not to the period that applied at the partner level under Section 6501(e)(1)(A). If the Court literally read Section 6229(d), the IRS would have had only 3 to 5 days after the FPAA was issued to make the assessment and yet, because it issued an FPAA, it was prohibited from making the assessment beyond that period because the partnership provisions contemplate that the FPAA when finalized will then have the results applied to the partners through a notice of deficiency. A construction of Section 6229(d) that it did not apply to the Section 6501 period would eviscerate the Court's earlier holding that the statute was still open under Section 6501(e)(1)(A) at the time the FPAA was issued. In order to avoid that absurd result (absurd, assuming the correctness of the first holding), the Court held that the suspension in Section 6229(d) applied to Section 6501 at the partner level.
In summary, therefore, the Court held that the treatment of the transfer was a partnership item or affected item, that the statute of limitations was still open if the facts supported the six-year statute of limitations under Section 6501(e)(1)(A) at the GAF Partners level, and that, upon issuance of the FPAA, the GAF Partners' statute of limitations then remained open under the unified partnership procedures.
The Partner Level Proceeding
In response to the notice of deficiency issued to the GAF Partners contemporaneously with the FPAA, the GAF Partners filed a petition for redetermination and then asked the Court to dismiss the case. The basis for the request was that, even if the IRS were correct that the transactions were sales, it was still a partnership item or affected item under the expansive definition of the Regulations which were the law in this case. The Court agreed with the taxpayer, citing principally the theory of the unified partnership audit rules and the Court's prior precedents that had quashed the portions of notices of deficiency addressing partnership items that had not gone through the FPAA procedure. The Court therefore directed that petition be dismissed.
Dissents
In short, crisp dissents written separately by Judges Foley and Parr, Judges Foley, Chabot and Parr dissented as to the main holding that Section 6229(d) suspends the statute of limitations under Section 6501. They felt that the plain language of the statute did not support the result and further felt that the statutory command for unified partnership proceedings that would then affect all partners commanded that there be only one applicable statute of limitations (the one at the partnership level) rather than potentially multiple ones that can apply under the majority's holding.
Judge Halpern, joined by Judges Whalen and Beghe, agreed that the period in Section 6501 applied if it extended beyond the additional period set forth in Section 6229(a). He disagreed with the conclusion that Section 6229(d) suspended the Section 6501 period that was otherwise applicable. The problem with this, as noted above, is that the statute of limitations had only a few days to run when the partner level petition was filed. The result of dismissal of the petition commanded by the majority would be to cause the suspension to lift under Section 6503(a) and cause the assessment period to expire before the partnership level proceeding would become final. In order to avoid the obvious anomaly, Judge Halpern would overrule prior Tax Court precedent holding or seeming to hold that a notice of deficiency as to a partnership item was invalid. Judge Halpern would then stay the partner level case pending the resolution of the partnership level proceeding. Thus, the suspension of the period of limitations provided in Section 6503(a) would provide the proper result. Judge Halpern felt that this practical fix was preferable to gerrymandering Section 6229(a) and (d) to mean something that the language did not appear to mean.T&J Comments
It seems to us that the dissents got this one right. What the majority did was to fill a gap based on its subjective notion of how the majority judges think Congress would have filled the gap. Congress did not, however, give courts license to fill gaps, and it seems to us that the holding does violence to the letter and theory of the unified partnership rules.
IRS WILL TEST FAST TRACK MEDIATION IN HOUSTON
By Larry Jones
The following is a summary from an IRS e-mail from the Houston District.
Fast track mediation was a major topic presented at the May 18 Tax Alliance Conference held in Houston, prompting some good questions from those in attendance. Following, in Q&A format, is additional information on the upcoming mediation test in Houston that starts July 1.
The initial FTM announcement issued over the Houston IRS News Service is repeated after the Q&As, for your reference.
#1 Question: How does one initiate the process?
The taxpayer merely has to request Fast Track mediation and complete the Agreement to Mediate form. Both parties must sign the form, and Compliance does have the right to refuse - but only with second level concurrence (This is a non-appealable decision.) Only compliance has to submit a brief summary of the issue(s) to the mediator; however, should the taxpayer/representative care to provide such information they are free to do so. Submission of extensive data is discouraged as it is not the job nor expectation of the mediator to be fully cognizant of all the technical factors involved; but the mediator is there to determine where there are areas of disagreements.
#2 Question: Are agreements reached in Fast Track mediation binding?
NO. Normal compliance procedures apply, and agreements are no more binding than those reached during a regular audit. The forms 4549, 1902, 656 etc. are still prepared and controlling. Claims, audit reconsideration's or other options are still available to the taxpayer. Likewise, such files and closings are still reviewable by management and functional review staffs, and there is the possibility they could be returned. The point here is that compliance still has control of the case, and the mediator is only there to assist in coming to a factual resolution of the issues being raised. Both parties are still obligated to follow existing revenue laws and established IRS procedures.
#3 Question: Is Fast Track Mediation available for ACS cases?
Not at this time. While the issue itself is appropriate for mediation, current processing of these cases does not ensure managerial involvement nor availability to the mediation process. Sheer volume of these cases makes it impossible to offer mediation on these cases at this time. It was however, pointed out that this is a pilot and the program could be expanded to other issues, contingent on its success. It was also pointed out that should an ACS case be referred to the district office where an IRS employee and a local manager became involved, such a case/issue would be acceptable for Fast Track Mediation. The key point on this is the need for managerial involvement.
#4 Question: Whereas confidentiality provisions are restricted due to the use of IRS employees as mediators, was any thought given to using external mediators?
Yes; however there were compelling cost, technical and timing factors. Especially cost–hiring of outside mediators on a case by case basis would not be practical. Also, their knowledge of existing revenue laws and procedures may make it difficult to assist in resolving issues. It is important to remember that this is not a settlement process, and the compliance functions must justify in their work papers any resolution that is reached.
#5 Question: Is information provided during the mediation session available for use by compliance (revenue agent/revenue officer) should the case go to Appeals/Court?
Fast track mediation is not mediation in the truest sense of the word because the mediator and the compliance employees are IRS employees governed by various other code sections and laws. Without going into specific case law it was pointed out that oral information provided in caucus to the mediator would remain confidential. However, written communication, documents, and information of any type provided in a joint session would be available to compliance in the development of their case/issues, or in the determination of any resolution.
It was also explained that under 7214(a)(8) any information received concerning a violation of a revenue law would require appropriate referral and action. Also, any allegations received from the taxpayer concerning a Section 1203 violation would also have to be handled in accordance with established procedures.
It is expected that IRS field personnel will make taxpayers or their representatives aware of FTM in situations needing resolution, to ensure that taxpayers and/or their representatives are aware of this resolution option. Julia Whithed, Associate Chief, Appeals, in Houston may be contacted for additional information as needed, at 281-721-7260.
Following is the text of the prior FTM announcement:
Taxpayers will soon have a way to try to settle certain disputes that appear to be bogged down. Starting July 1, they will be able to request a mediator to help resolve certain factual issues while the case is still in the examination or collection division.
The new program, called Fast Track Mediation, will be tested in four IRS districts nationwide, including Houston. It will be available to taxpayers with disputed exam, OIC, or trust fund recovery penalty issues. In general, mediation will be available in cases with a proposed deficiency of $100,000 or less and not docketed in any court. OIC cases generally must be less than $50,000 to be mediated under this process.
The mediator, a specially trained IRS appeals officer will not make any decisions, but will facilitate communication between parties to reach mutually satisfactory agreements. The process is designed to expedite case resolution without the need for the traditional appeals hearing.
Participation in the mediation process will be completely voluntary. To begin the process the taxpayer and manager of the IRS case agent will enter into an agreement. A mediator will be assigned, meet with the taxpayer and IRS manager to explain the process, and schedule the mediation session. The mediator may conduct both separate and joint
conferences with the taxpayer and the manager. The mediator will have no authority to require either party to accept any resolution.The mediation process should be completed within 20 to 30 days. No fees will be charged and participants may withdraw at any point and retain full appeal rights.
Fast track mediation will also be tested in the Connecticut/Rhode Island, North Florida, and Rocky Mountain IRS Districts.
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