I have blogged before about the myth that our system of taxation is one of “self-assessment.” Our system is better described as one of self-reporting. It depends on taxpayers properly reporting their items of income and deductions. The IRS can do the rest.
Section 6011 requires taxpayers to self-report on “a return or statement according to the forms and regulations prescribed by the Secretary.” The most common return is the Form 1040. Taxpayers who fail to file returns or who file fraudulent or frivolous returns are subject to various consequences. For example, the three year statute of limitations on the IRS to audit a tax year is only triggered when the taxpayer files a return. §6501(c). If what is filed is not a return, then the IRS can assess the penalties imposed by §6651(a) for the failure to file a return.
It thus becomes important to know: what constitutes a “return”?
Two recent Tax Court cases teach that a “return” is not simply a form but is a form which serves a function. In Seaview Trading, LLC v. Commissioner, T.C. Memo. 2019-122 (Sept. 16, 2019) Judge Ruwe held that a copy of a return sent to a Revenue Agent could not function as a “return.” In George J. Smith and Sheila Ann Smith v. Commissioner, T.C. Memo. 2019-111 (Sept. 3, 2019) Judge Halpern held that taxpayers who filed a completely frivolous Form 1040 had still filed a “return.” Details below the fold.
Despite the importance of returns to tax administration, the Tax Code does not define the term "return." And perhaps this is just as well for, as I have written here and here, returns serve different purposes and what may serve for one purpose may not serve for another. The Tax Court did a bang-up job in synthesizing prior law in the seminal case of Beard v. Commissioner, 82 T.C. 766 (1984), aff’d, 793 F.2d 139 (6th Cir. 1986). There the Court consolidated decades of disparate Supreme Court doctrine into four requirements a document must generally meet to qualify as a "return":
"First, there must be sufficient data to calculate tax liability; second, the document must purport to be a return; third, there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and fourth, the taxpayer must execute the return under penalties of perjury."
Most courts follow the Beard formulation. See e.g. In re Hindenlang, 164 F.3d 1029 (6th Cir. 1999)(collecting cases). But one should keep in mind that it is just a restatement of the general requirements; each requirement has its exceptions. One should also note each requirement stems from different fact patterns.
The primary function of a return is to satisfy the legal obligation imposed on taxpayers, by §6011, to self-report their financial transactions. A document that does not satisfy the §6011 purpose does not constitute a return—regardless of its form. At the same time, the law requires forms for the excellent reason that the IRS must process hundreds of millions of returns. If taxpayers could fulfill their §6011 responsibility using just any old scrap of paper, “the business of tax collecting would result in insurmountable confusion.” Parker v. Commissioner, 365 F.2d 792, 780 (8th Cir. 1966). That is why §6011 and its regulations require taxpayers to use the “prescribed return forms.” Treas.Reg. 1.6011-1(b). The forms are necessary for the IRS to perform its return processing function.
That was the tension in the Beard case itself. It involved a taxpayer who cleverly (he thought) altered the lines in Form 1040. For example, he altered the wording of one of the deduction lines to read “Non-Taxable Receipts” and put the same number there as he put in the gross income line. Thus, while the taxpayer properly reported his income, he did so on an altered form that required the IRS to use separate procedures to process the document. The IRS refused to treat the document as a return and imposed failure to file penalties. The Beard majority thought that the taxpayer’s alterations caused the Form 1040 to fail in its purpose and so upheld the imposition of penalties for failure to file a “return.”
Judge Chabot dissented from that position, pointing out that the taxpayer had, after all, filed the right “form” and had properly reported his income on the proper line. The altered deduction lines were immaterial because an improper deduction would be disallowed no matter how reported. In Judge Chabot’s view, the Tax Court was so pissed off at the taxpayers that it went beyond what was necessary to decide the case. He wrote: “I understand and share the majority's frustration at having to deal with frivolous arguments such as the "equal exchange" theory. However, this Court should not confuse the law as to what is a tax return, just to punish a particular individual or even a class of individuals. The Congress has given the courts more effective tools.” Among those tools were §6673.
Judge Nims felt compelled to respond by re-emphasizing the functional problem:
“I write this concurring opinion only to expressly dissociate myself from the views expressed [by Judge Chabot] in support of petitioner's travesty tax return. I find it impossible to suppose that the Supreme Court intended...to give intellectual aid and comfort to petitioner and others like him, whose so-called returns on their face make clear a concerted effort to disrupt the tax system.” 82 T.C. at 783.
Lesson From Seaview: A Copy is Not a Return
This opinion deals with one issue in long-running (since 2005) controversy between a sophisticated taxpayer (who can afford to hire Armando Gomez) and a large amount in controversy (disallowance of a $35.5 million deduction generated by a tax shelter in 2001).
In 2005 the IRS started its audit of Seaview’s 2001 tax year. The Revenue Agent told Seaview’s accountant that the IRS had never received Seaview's 2001 return (Form 1065). The accountant responded by sending the RA a certified mail receipt showing that something was mailed to the IRS on July 3, 2002. Along with the certified mail receipt, the accountant sent a Form 1065 and said it was a copy of what had been mailed in 2002. In 2007, Seaview’s attorney did something similar by sending IRS Chief Counsel a Form 1065 with a cover letter that basically said “here is a copy of Seaview’s 2001 Form 1065.”
The IRS eventually issued a Final Notice of Partnership Adjustment against Seaview in October 2010. The IRS said its FPAA was timely because Seaview had never filed a return.
Seaview petitioned the Tax Court, and raised two separate arguments on why the FPAA fell outside the three year limitation period. First, Seaview said it had indeed filed its return timely, in July 2002. Second, Seaview said that even if it had not filed in 2002, it had filed its “return” both in the 2005 fax to the RA and then in the 2007 letter to the IRS Chief Counsel attorney. Judge Ruwe’s opinion addresses only the second argument. He says Seaview can raise the first argument if it loses the second.
Seaview lost. Judge Ruwe sensibly finds that sending a return to either the Examination function of the IRS or to the Chief Counsel function is not the act of “filing.” That, however, is not the lesson for us today. The lesson is what Judge Ruwe says after that. He goes on to hold that by designating what was sent as a “copy” of what had been filed, the taxpayer failed the second Beard factor: the copy did not purport to be a return. Therefore, the IRS employee receiving the copy cannot be charged with a duty to do the taxpayer’s filing for it.
Simply put: a copy is not a return. This is more than wordplay, or abstract formalism. A copy does not serve the reporting function. It serves an information function. By identifying the document as a copy, the taxpayer is telling the IRS employee that the document was already filed. The copy is just FYI, to show the filing. Judge Ruwe relies on Friedman v. Commissioner, T.C. Memo 2001-207, an analogous case. There, an RA requested copies of the taxpayer’s returns for 1989 and 1990 and the taxpayer provided them, without telling the RA they had not been, actually, filed. The Tax Court held those copies were not “returns” because the RA had no reason to think the taxpayer was asking the RA to treat them as returns.
Lesson From Smith: Chabot’s Ghost --- A Frivolous Return Can Still Be a Return
In contrast to Seaview, there is no question that the Smiths actually filed their returns for both the 2013 and 2014 tax years. The 2014 return was timely; the 2013 return was a year late. The IRS proposed the late filing penalty for the 2013 return, but did not propose any such penalty for the 2014 return.
Both returns, however, were highly problematic. The Smiths did not alter the Form 1040 like Mr. Beard did. But they refused to report as income the money they had received from their respective employers (Staples, Inc., and Fife Marine, Inc.), saying that money did not constitute “wages” and, besides, the income tax is really an excise tax on transactions they did not engage in. So they reported zero income for 2013 and asked for full refund of their tax withholding. For 2014 they reported some unemployment compensation as income but not their wages.
The IRS processed both returns, then used the associated W-2’s and 1099-INT’s to create Notices of Deficiency. Oh, and the IRS not only hit the Smiths with the usual negligence penalties, but also slapped ‘em with §6702 penalties for filing frivolous returns. That’s how stupid their positions were.
Unrepentant and unrepresented, these two hobbyists persisted in their protestor arguments to Judge Halpern. He warned ‘em. But they pressed on. He then imposed an additional §6673 penalty of $2,500. That is one of the tools Judge Chabot suggested to use.
In addition to their tax protestor bleatings, the Smiths raised a procedural argument. They argued that because their return was so deficient, §6020(b) required the IRS “to create and subscribe its own contrary returns.” Judge Halpern nicely explains why that’s a pretty flagrant misreading of §6020. Section 6020 does not require the IRS to do anything. Instead, that statute permits the IRS to create a processing document called a “substitute for return" (SFR). If the taxpayer cooperates, the SFR is deemed the taxpayer’s return for all purposes. §6020(a). Importantly, that means the IRS can just assess the liability reported on the return under §6201(a)(1). If, however, the taxpayer does not cooperate, §6020(b) permits the IRS to prepare the SFR using its “own knowledge and from such information as [it] can obtain through testimony or otherwise.”
Unlike a §6020(a) return, a §6020(b) return is not treated as the taxpayer’s “return” within the meaning of §6201(a)(1). The IRS must follow the deficiency procedures before assessing the tax shown on a § 6020(b) return. See e.g. Taylor v. Commissioner, 36 B.T.A. 427 (1937)(dealing with predecessor statute to §6020).
Thus, the Smith’s procedural argument that the IRS was supposed to have prepared a §6020(b) SFR would make no difference to the procedure used to determine their correct tax liability. Either procedure gives them the same ticket to the Tax Court.
Yet these two blind squirrels actually got close to a nut. Or maybe a land mine. You be the judge. To me, their argument raises this interesting question: why did the IRS treat the Form 1040s they filed as “returns”? After all, if the returns were so frivolous as to justify the §6702 frivolous return penalty, does not that not disqualify them under the Beard’s third factor? That is, how can the Smiths be said to have made “an honest and reasonable attempt to satisfy the requirements of the tax law” when they pull a stunt like they pulled?
That brings us to the lesson from Smith: a frivolous return is still a return. The Beard factors are just that: factors. The Forms were unaltered and purported to be returns; they were signed under penalty of perjury; the IRS could calculate the tax due from the amounts reported. In essence, both the IRS and Judge Halpern adopted Judge Chabot’s views as expressed in his Beard dissent: there were plenty of other tools to punish the Smiths and so no need to say they did not file returns. And boy, did the IRS and the Tax Court use those tools! To say that these were not returns, and to thus impose a larger failure to file penalty on the Smiths would serve no purpose. Their returns did not “disrupt” the tax system to prevent it from functioning the way the Beard majority thought Mr. Beard's altered return did.
Coda 1: If Seaview was able to prove it had timely filed its Form 1065 in 2002, one would think that it would not have wasted everyone’s time with the argument that later-provided copies constituted returns. It makes me wonder if Seaview has a Boyle problem. In United States v. Boyle, 469 U.S. 241 (1985), the Supremes held that reliance on an agent does not relieve a taxpayer from the responsibility to timely file a return. Thus, if Seaview’s return preparer failed to secure the proper receipt to prove timely filing, Seaview could be up the proverbial creek. The Boyle issue is a huge one now in electronic filing. The IRS rejects many electronically submitted returns that would be accepted as returns under the Beard test if they were sent in via snail mail. The good folks over at Procedurally Taxing are on top of this. I recommend this post by Keith Fogg and this post by Les Book.
Coda 2: Currently, the IRS is messing around with the most commonly used form, the Form 1040. As I have written before, the 2018 format changes hark back to the mid-1950’s formatting (read Coda 2 in this blog post). But look at this Draft Form 1040 for 2019, posted as of September 11, 2019. It looks more like what most of us are used to.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law