My daughter worked part-time this past year for a woman who paid her about $500 cash. My daughter was not happy to learn from me that she has to report that as gross income. My daughter says “but my employer is not giving me a W-2 or 1099!” I am sure many of us have heard that from clients. Last week, the Tax Court issued an opinion that may give unintended support for my daughter’s assertion that there is no obligation to report income unless there is a concomitant obligation to file a related information return.
In 2010 Congress enacted the Hiring Incentives to Restore Employment Act (HIRE), 124 Stat. 71. Subtitle A of HIRE (§501 et. seq.) implemented what had been a separate bill called the Foreign Account Tax Compliance Act (FATCA). FATCA requires many individuals to report their foreign financial assets under certain circumstances. Violation of the reporting requirements carries several consequences, including monetary penalties and an extension of the limitation period for the IRS to audit a return. That’s the issue in last week’s case of Mehrdad Rafizadeh v. Commissioner, 150 T.C. No. 1 (January 2, 2018). In Rafizadeh, the IRS seemed to try and use that latter consequence to crack open otherwise closed years. At least that is what the Tax Court appears to believe. The sticking point was that the years at issue were years before the FATCA reporting requirements took effect. See below the fold for why the IRS thought that the FATCA provisions extending the limitation period applied, and why the Tax Court held otherwise.
The statutory construction issue in this case involves the interplay of two sections of the HIRE Act and how they were drafted. First, §511(a) codified the new FATCA reporting requirements in IRC §6038D and §511(d) made the effective date of those reporting requirements the same as the effective date of the statute, which was March 10, 2010. Second, §513(a), (b), and (c) modified the existing rules for when the general three-year limitations period on assessment in IRC 6501(a) is extended.
It is useful here to pause and remember that §6501 contains two sets of extensions to the general three year limitation period. The first set is found in §6501(a)(8). Those rules modify the trigger for the general three year limitation period. Normally, the trigger for the three year limitation period is the taxpayer filing the return. But §6501(8) says that if a taxpayer fails to meet certain reporting requirements, the trigger for the three year period is changed to be “the date on which the [IRS] is furnished the information required to be reported...” The second set of extensions is found in §6501(e). Those extensions still key off filing, the same trigger as §6501(a), but extend the assessment limitations period from three to six years.
Section 513(a), (b), and (c) of the HIRE act modified both sets of extensions in 6501. And §513(d) contained statutory language that established the effective date of the SOL modifications made by the rest of §513. It is worth quoting in full:
(d) The amendments made by this section [§513] shall apply to—
(1) returns filed after the date of the enactment of this Act; and
(2) returns filed on or before such date if the period specified in section 6501 of the Internal Revenue Code of 1986 (determined without regard to such amendments) for assessment of such taxes has not expired as of such date.
The IRS audited Mr. Rafizadeh’s 2006, 2007, 2008 and 2009 returns and issued a Notice of Deficiency on December 8, 2014. The parties stipulated that (1) the assessment period for all these years was still open as of date of the HIRE Act’s enactment, in March 2010, and that (2) the NODs were timely only if the IRS could get the six year limitation period in §6501(e).
The IRS argued that it was entitled to the six limitation period because enactment language in §513(d)(2) meant that the modifications to §6501(e) made by §513(a) applied to prior years that were still open years. The §513(a) modifications provided, in relevant part, that the IRS could get the six year period “if the taxpayer omits from gross income an amount properly includible therein and...(ii) such amount (I) is attributable to one or more assets with respect to which information is required to be reported under section 6038D...and (II) is in excess of $5,000.” The IRS said that Mr. Rafizadeh’s omissions from his 2006, 2007, 2008 and 2009 returns met this test.
Mr. Rafizadeh argued that the IRS position made no sense when one considered the interplay of HIRE Act §513 with §511. Section 511 created a new reporting requirement (codified in §6038D) and the §513 modification to §6501(e) that the IRS relied upon depended on a violation of that new reporting requirement. Since Mr. Rafizadeh had not been subject to the §6038D reporting requirement for the years 2006, 2007, 2008, and 2009, then §6501(e) could not possibly apply.
The Tax Court bought Mr. Rafizadeh’s argument. It held that because the six year period in §6501(e) “applies only to omissions from gross income of amounts attributable to assets with respect to which the reporting requirement of IRC sec. 6038D is applicable....it is effective only for tax years with respect to which the reporting requirements of IRC sec. 6038D is effective.”
I confess I am puzzled by that result. The Tax Court goes into a long discussion of why its interpretation does not render §513(d)(2) meaningless. The thrust of that discussion is that §513(d)(2) can apply to other pre-2010 tax returns because §513(b) and (c) modify other parts of §6501, notably that first set of extensions found in §6501(a)(8).
But the Tax Court seems to conflate a substantive reporting requirement with a procedural reporting requirement.
Taxpayer are required to report their gross income “from whatever source derived.” §61. If their failure to do so is substantial enough, then the IRS gets six years. That’s the idea of §6501(e). It describes the basic rules for when the failure to report gross income is substantial enough to warrant a six year limitation period rather than a three year. And generally, that is when the taxpayer’s omission amounts to 25% or more of what the taxpayer did report. But the HIRE Act modified §6501(e) to say for certain types of income---the income that is notoriously difficult for the IRS to discover---what counts as “substantial” is much less. And what is that kind of income that is notoriously difficult for the IRS to discover? Why, it’s the income “attributable to one or more assets with respect to which information is required to be reported under section 6038D.”
Taxpayers are also under various obligations to report different kinds of information to the IRS. That’s all those sections creating various types of information returns. And §6038D is one of those information return statutes. It requires taxpayers to report the existence of certain assets.
But regardless of whether one must report the information about the existence of assets, one must always report income from those assets!
This difference between reporting income and information reporting is reflected in the two sets of §6501 extensions to the normal three year limitation period. If the IRS were here relying on the first set of extensions, in §6501(a)(8), the Court’s opinion would make sense: Mr. Rafizadeh was not under a reporting obligation with respect to the years at issue. But the IRS was not trying to use Mr. Rafizadeh’s reporting obligation to get the longer SOL. It was trying to use his failure to report a substantial enough amount of income.
The lesson here comes down to interpreting the phrase “such amount...is attributable to one or more assets with respect to which information is required to be reported under section 6038D...” The Tax Court thought that phrase could not apply to amounts attributed to assets if the taxpayer was not also under an obligation to report the existence of those assets.
I’m not telling my daughter.