Jurisdiction is just a fancy word for “power.” In a speech later published as The Path of The Law, the sainted Justice Holmes said: “in societies like ours the command of the public force is entrusted to the judges in certain cases, and the whole power of the state will be put forth, if necessary, to carry out their judgments and decrees.” To Holmes, and others, courts are an instrumentality of government power. The Tax Court is one such court.
In the tax arena, §6214 gives the Tax Court the power “to redetermine the correct amount of the deficiency even if the amount so redetermined is greater than the amount of the deficiency...” And the whole force of the state---via the IRS---will be put forth, if necessary, to carry out its judgment regarding the correct amount of a deficiency.
Last week’s decision in U.S. Auto Sales, Inc. v. Commissioner, 153 T.C. No. 5 (Oct. 28, 2019), teaches a lesson in how the Tax Court takes a pragmatic approach to exercising its power to “redetermine...the deficiency.” In that case, the IRS sent the taxpayer an erroneous NOD. The error was in the taxpayer’s favor, to the tune of over $6 million. The taxpayer filed a petition, ostensibly asking the Tax Court to wield it’s power to “redetermine...the deficiency.” Un uh. The IRS moved to dismiss the case for lack of jurisdiction because, it claimed, the erroneous NOD was also invalid. Accordingly, there was no deficiency over which the Tax Court could exercise its power of review.
The Tax Court held that the NOD was invalid and so the Court could not exercise its power. But the vote was 9-6, spread over five different written opinions. My take-away is that what splits the majority and dissenting positions are different practical judgments about what parts of an NOD the Court should consider when deciding whether its jurisdiction has been properly invoked. NOD's serve different purposes and different parts of an NOD package contribute to those different purposes. Details below the fold.
Law: The Deficiency Process
Before zooming in on the requirements for a valid NOD, let’s back off and get a wider perspective.
Sections 7601 and 7602 give the IRS wide authority to snoop. Section 7601 authorizes the IRS to “inquire after and concerning all persons...who may be liable to pay any internal revenue tax...” Section 7602 authorizes the IRS to examine any persons or data “for the purpose of...determining the liability of any person for any internal revenue tax...” In more formal terms, this power to snoop is called inquisitorial process. If you care, you can read a big long article I wrote about that called “Tax Administration As Inquisitorial Process & the Partial Paradigm Shift in the IRS Restructuring and Reform Act of 1998,” 56 Fla. L. Rev. 1 (2004). I won't cry if you skip it.
After snooping, the IRS may determine that a taxpayer has a “deficiency” of tax. This really gnarly term is defined in §6211. Don’t worry about the devilish details of that statute. For today’s lesson you can think of a deficiency as the amount by which the IRS asserts the taxpayer’s true tax liability is more than what the taxpayer reported on their return.
When the IRS determines a deficiency of tax, it is then “authorized to send notice of such deficiency to the taxpayer.” §6212(a). That’s the NOD. The taxpayer generally has 90 days from the date of the NOD to petition the Tax Court to ask for a “redetermination of the deficiency.” §6213(a).
The procedures outlined in §§6212 and 6213 carry several important consequences, all triggered by the filing of a timely petition in response to a valid NOD. First, the IRS is prohibited from sending a second NOD for the tax year(s) about which the taxpayer has petitioned. §6212(c)(1). Second, the IRS is prohibited from assessing the proposed deficiency (or from starting separate court proceedings with respect to it) until after the Tax Court has issued a decision and all appeals are exhausted. §6213(a). Third, the statute of limitations for the IRS to make an assessment is suspended for the same period during which the IRS is prohibited from assessing, plus 60 days. §6503(a).
The Tax Court believes that a fourth consequence of the §§6212/6213 procedures is that they form the basis of its jurisdiction. Section 6214(a) provides that the Tax Court has the power to “redetermine the correct amount of the deficiency, even if the amount so determined is greater than the amount of the deficiency.” The Tax Court reads the two statutes preceding §6214 as creating prerequisites for its §6214 powers. It routinely says that “this Court’s jurisdiction requires a valid notice of deficiency and a timely petition.” U.S. Auto Sales at 7. I think the Court is wrong about that. If you care, you can peruse my reasons in the next issue of the Tax Lawyer (coming out next month). I won't cry if you skip it.
But for today’s lesson, let’s agree that the Tax Court can only exercise its power to redetermine a deficiency when two conditions exist: (1) the IRS has sent out a valid NOD and (2) the taxpayer has timely petitioned the Tax Court.
The Law: The Functions of an NOD in Deficiency Process
Now let’s zoom in. A critical part of the §§6212/6213 procedures is the NOD. Commentators point out that an NOD serves more than one function. I particularly like this terrific article from Professor Leandra Lederman. You should really care to read it. You may someday cry if you skip it.
First, the NOD serves an access function. It is the document that provides taxpayers access to the Tax Court. This is the famous “ticket to the Tax Court” function. Taxpayers receive lots of documents from the IRS. None of those other documents open the Tax Court’s doors to an unhappy taxpayer who wants judicial review of an IRS determination.
I like to think of the NOD as a key rather than a ticket. It unlocks the next step in processing the taxpayer’s claim that the IRS’s conclusions are wrong. For the Tax Court to process this dispute the taxpayer must use the right key within the prescribed time.
To validly serve this first function, the IRS can give the taxpayer a mere skeleton key. The IRS need not use any particular form or even give an explanation for the basis of the determination. Any document that fairly advises the taxpayer that a deficiency has, in fact, been determined as to a specified year for a specified type of tax will do the trick. Dees v. Commissioner, 148 T.C. 1 (2017). Olsen v. Helvering, 88 F.2d 650, 651 (2d Cir. 1937) ("the notice is only to advise the person who is to pay the deficiency that the Commissioner means to assess him; anything that does this unequivocally is good enough.").
However, there needs to be some assurance that the taxpayer gets the key. To that end, §6212 requires the NOD be mailed to the taxpayer’s “last known address.” There is a large body of law built up over the meaning of this term. But the idea that consistently runs through the cases is this: the IRS should not be able to assess a deficiency unless the taxpayer has a reasonable opportunity to actually invoke the Tax Court's power to redetermine the IRS's decision. The NOD is the key to access.
Second, the NOD serves a pleading function. True, the formal pleading is the petition that the taxpayer files with the Tax Court. But the contents of the NOD help set the scope for that famed presumption of correctness. That is, the Tax Court will presume the IRS's deficiency determination is correct unless and until the taxpayer persuades the Court otherwise. Even if the burden of producing facts gets shifted to the IRS, the burden of persuasion remains with the taxpayer to show the deficiency determination is wrong. See, e.g. Rockwell v. Commissioner, 512 F.2d 882 (9th Cir. 1975)(great discussion on burdens).
Here is where §7522 comes into play. That statute says that the NOD must “describe the basis for” the deficiency determination. However, the statute goes no to say that an “inadequate description...shall not invalidate the notice.” That is an important qualification. It means that one might have an NOD that is valid for the first function---a working key---but inadequate as to the second function.
An NOD that fails this second function is bad news for the IRS because now the IRS has the burden of persuasion, to prove any “new matter” it raises in Tax Court after the petition is filed. Tax Court Rule 142. The Tax Court has relied on §7522 to hold that if “a notice of deficiency fails to describe the basis on which the Commissioner relies to support a deficiency determination and that basis requires the presentation of evidence that is different than that which would be necessary to resolve the determinations that were described in the notice of deficiency, the Commissioner will bear the burden of proof regarding the new basis. To hold otherwise would ignore the mandate of section 7522 and Rule 142(a).” Shea v. Commissioner, 112 T.C. 183 (1999).
In evaluating an NOD’s validity in serving either of these two functions, the Tax Court has traditionally taken a broad view of what documents constitute an NOD and will look not only at the document labeled “Notice”---which is generally a cover letter---but will also consider all attachments to that document that were sent to the taxpayer. See Saint Paul Bottling Co. v. Commissioner, 34 T.C. 1137, 1138 (1960).
Facts of the Case: IRS Goof-up Results in Two NODs
The taxpayer in this case is U.S. Auto Sales, Inc. (“Sales Inc.”). On May 15, 2012, the IRS sent it an NOD that consisted of several documents. First was a cover letter stating, in no uncertain terms, that the IRS had determined a deficiency of $24,000 for 2003 and of $30,000 for 2007 and zero for 2008. Second was a Form 4089. That is a form that permits a taxpayer to waive its right to petition Tax Court and authorizes the IRS to immediately assess the proposed deficiencies. See IRM 184.108.40.206. Third was a Form 5278. This is the form that the IRS uses to show the computation of the deficiency. See IRM 220.127.116.11. Fourth was Form 886-A. This is the form that the IRS uses to explain the adjustments listed on the Form 5278. See IRM 18.104.22.168.
Here is how the IRS goofed up. The first two documents were addressed to the taxpayer, Sales Inc. But the second two documents related to a different taxpayer, U.S. Auto Finance., Inc. (“Finance, Inc.”). That is, the Forms 5276 and 866-A both explained how the IRS had determined deficiencies for Finance, Inc. They did not explain how the IRS had determined the stated deficiencies for Sales. Inc., the taxpayer. Here’s the kicker: the deficiencies for Finance, Inc. that were explained in the last two documents were the same amounts as were listed as the deficiencies for Sales, Inc.
So what would YOU do if you represented the taxpayer and the IRS had sent you an NOD that massively understated the deficiency? Would you sign the waiver and let the IRS assess? No, you would not. That is because once you sign the waiver, you won’t get the §6212 restriction on the IRS’s power to assess additional amounts or issue additional NODs. See e.g. Goff v. Commissioner, 18 BTA 283 (1929).
What you would do is quick-like-a-bunny (of the Br’er Rabbit kind) file a Tax Court petition to “contest” the deficiency. You would do this so you could actually trigger the §6212(c)(1) prohibition on further NODs. That prohibition serves a claim preclusion function. For the gory details see Zackim v. Commissioner, 887 F.2d 455 (3rd Cir. 1989) (reading the plain language and legislative history of §6212(c) to mean that, once a taxpayer files a Tax Court petition, the IRS is precluded from asserting any further deficiencies relating to the years and taxes encompassed by the petition unless the IRS discovers fraud).
The taxpayer here did just that. It filed a Tax Court petition on August 10, 2012. Bwahahaha.
However, the IRS figured out its goof before the taxpayer had filed it petition. On August 2, 2012---8 days before the taxpayer filed its Tax Court petition---it sent a second NOD to the taxpayer in this case, Sales Inc. The new NOD proposed deficiencies of $3.3 million for 2007 and $3.0 million for 2008. This time, the IRS attached the correct supporting documents. The taxpayer also filed a petition for review of that NOD.
The IRS then moved to dismiss the taxpayer’s petition of the first NOD. In last week’s decision, the Tax Court did just that.
Opinions and Lesson: The Practical Function of an NOD
Nine Tax Court judges agreed that the Tax Court did not have the power to hear the taxpayer’s petition as to the first NOD. Judge Marvel wrote for the court. She also wrote a separate concurrence, as did Judge Buch. Bottom line for the majority: if, taken together, the documents in an NOD create an ambiguous NOD, then it is an invalid NOD.
Six Tax Court judges thought the Tax Court had the power to adjudicate the taxpayer’s petition. Judges Foley and Urda wrote one of the dissents. Judge Ashford wrote the other. Bottom line for the dissents: if any part of the NOD, taken alone, is valid, the Court can take care of the rest through the pleadings.
What if find useful here is how the opinions focus on the different functions of the NOD and evaluate those functions using different conceptions of what constitutes "the" NOD. This is very similar to split you see in the Scar cases, as Professor Lederman very nicely explains in her article.
The majority of judges find that the first NOD was invalid because they focus on the notice function of an NOD and they treat the entire set of four documents as “the” NOD. The statute and case law all assume that an NOD is sent to a single taxpayer and concerns the deficiency of a single taxpayer. For example, to serve this notice function, §6212(b)(1) requires the NOD must be mailed to “the” taxpayer’s last known address. Here, nine Tax Court judges look at all the documents and find that, taken together, the documents create such confusion as to which taxpayer was supposed to be put on notice here that the NOD utterly fails this function.
Writes Judge Marvel for the Court: “We start our inquiry by asking whether the May notice, on its face, would unambiguously put a reasonable taxpayer on notice that the Commissioner determined a deficiency in tax for a particular year and amount.” Op. at 9. She concludes the NOD does not meet the test, writing “Though the May notice is consistent throughout as to the amounts of the deficiencies and the years at issue, it is fatally inconsistent as to the identity of the taxpayer against whom the deficiencies are determined.”
Under this view, the taxpayer is not at all prejudiced by being forced to litigate the second NOD. Writes Judge Marvel in her concurrence: “This is not a case where a taxpayer is being unfairly forced to litigate an allegedly invalid notice. This is not a case where the Commissioner is being favored over the taxpayer. The IRS made a processing error, and petitioner admitted in its petition that the notice reflected adjustments to the returns of a different but related taxpayer. Regardless of the decision reached with respect to the validity of the notice in this case, petitioner will still have the opportunity to litigate adjustments that respondent made against it, which were set forth and described in the [second] notice of deficiency.”
Well...yeah, but what about that presumption?? The taxpayer would really, really, prefer that the IRS take on the burden of proving up the $6 million deficiency rather than the taxpayer having to disprove it. That practical consideration is what I see driving the dissent.
The dissent says that the first NOD properly served the notice function because only part of the NOD counts for that purpose: the cover notice, or letter. All the rest, the attachments, are just bad pleading. The IRS can fix the bad pleading by amending its Answer to the petition and asserting a deficiency greater than the amount in the first NOD.
Thus, Judge Ashford said that she would hold “that we have jurisdiction in the instant case because respondent made a determination in relation to petitioner’s Federal income tax and issued a notice of deficiency dated May 15, 2012, to petitioner informing it of that determination--the notice is unmistakably addressed to petitioner and states on its first page that respondent ‘determined that you have a deficiency in your tax account(s)’--and from that May notice petitioner timely filed a petition in this Court.” She then relies on Shea v. Commissioner (cited above) for the proposition that the IRS would have to fix its error by amending its pleadings and assuming the position...of having to prove up the $6 million.
Similarly, Judges Foley and Urda are concerned about the practical consequences of the majority’s approach for future taxpayers. They urge that the notice function of an NOD should be construed so as to permit the widest number of taxpayers to contest petitions. They even title one section of their dissent “We Should Not Raise the Code’s Low Jurisdictional Bar.” They then write “The notice--that oft-described ticket to the Tax Court--is not meant to be mysterious or to require deciphering (by us or the taxpayer) in order for us to punch the ticket. The IRS here sent the taxpayer a notice stating that a deficiency had been determined.”
Well...yeah, but what about that presumption?? The IRS would really, really prefer that the taxpayer here bears the burden that taxpayers usually bear: disproving the determination of a $6 million deficiency.
I think the dissents have the better technical argument here. I get there by imagining the shoe on the other foot. What if the taxpayer had been the party moving to dismiss its own first petition, claiming that the NOD was invalid because two of the documents attached to the letter were about the tax liabilities of a different taxpayer? I don’t think the Court would buy it. The Court would say “too bad, so sad.”
I think that by explicitly distinguishing the notice function from the pleading function of NODs, the dissent arrives at the more reasonable conclusion. The disagreement here is over what documents actually constitute “the” NOD for purposes of evaluating the NOD’s compliance with its notice function. I happen to think that is the cover letter document. But this is a question over which reasonable minds can, and here in fact did, disagree.
However, I think the majority gets to the right result. I would get to the majority’s result by a different path. Sure, the first NOD in this case is a working key---it serves the notice function---and the Tax Court has the power to redetermine the proposed deficiency. But the second NOD serves the pleading function: it is a corrected (amended, if you like) pleading that forms the basis for deciding which party has what burdens going forward. If the taxpayers had filed their petition more quickly, the IRS would have been locked in. §6212(c)(1). But as it was, the IRS slipped in the corrected NOD in a timely fashion. In Civil Procedure we call that an amendment as a matter of right. The taxpayer suffered absolutely no prejudice. And any other result gives the taxpayer a huge break.
I explain my reasoning in the next section, if you care to read it. I won't cry if you skip it.
Commentary: The Idea of A Superseding NOD
I confess I am confused. It seems both parties to the suit, and the entire Tax Court, believe only one of the two NODs can be valid. Thus, if the first NOD is the valid NOD, then the IRS will bear the burden to produce evidence and persuade the Tax Court as to any additional deficiencies beyond the paltry sums given in that first NOD. But if the IRS can get the Tax Court to nuke the first NOD and consider the second NOD as “the” NOD it is reviewing, then the IRS can enjoy that powerful presumption of correctness for the entire $6 million.
Here is my confusion. Even if the Court can exercise jurisdiction over the petition disputing the first NOD, I do not see why that means the Court cannot "count" the second NOD by consolidating the cases. After all, the taxpayer did timely file a petition as to the second NOD as well. Key for me is that the second NOD was issued before the taxpayer filed its Tax Court petition. That makes it, in my mind, a valid superseding NOD. Because the IRS acted before the taxpayer filed its first petition, the claim preclusion provisions in §6212(c)(1) would not seem to apply. That is how I read the plain language of the statute. Shoot, if taxpayers can file superseding returns, why cannot the IRS issue a superseding NOD when it goofs up the first one? I don’t see why the Court could not consolidate the two petitions under Tax Court Rule 141 and then proceed to hear the consolidated cases with the second NOD valid as to the pleading function.
I take this idea of a superseding NOD from the ancient case of Goff v. Commissioner, 18 BTA 283 (1929). There, the IRS had sent the taxpayer an NOD and the taxpayer had failed to petition the Tax Court. The IRS later sent a second NOD for the same tax periods asserting a larger deficiency. The Board of Tax Appeals said that because the taxpayer had not filed a petition, the prohibition on further deficiencies in what is now §6212(c)(1) did not apply: "we find no reason for holding that the Commissioner may not issue a second deficiency notice for the same taxable year where the taxpayer has failed or declined to appeal from the first notice."
The Tax Court has used this idea of a superseding NOL more recently in Gmelin v. Commissioner, T.C. Memo. 1988-338, aff'd without published opinion, 891 F.2d 280 (3d Cir.1989). There, the first NOD went out October 31, 1984, and the second NOD was mailed on November 30, 1984. The taxpayer filed a petition in the Tax Court contesting the November 30 notice only, contending that it was invalid under § 6212(c)(1). The Tax Court disagreed. Citing to Goff, the court found that §6212(c)(1) “was intended to restrict [the Commissioner] from issuing a second notice of deficiency only if the taxpayer has filed a Tax Court petition with respect to the first notice of deficiency.” It concluded that the second NOD was valid because the taxpayers "had not filed a Tax Court petition with respect to the first notice of deficiency prior to respondent's issuing the second statutory notice." The Gmelin court distinguished a prior Tax Court case which appears to come to the opposite conclusion. Appellate courts to have considered the matter since follow the Gmelin reasoning. See, e.g., Jones v. United States, 889 F.2d 1448 ( 5th Cir. 1989).
True, these cases are not directly on all fours. But I would think it would be worth at least some discussion? Since absolutely no one mentioned this in any of the opinions, however, I am obviously missing something important here! I welcome enlightenment in the comments from more savvy practitioners or professors.
Coda: The dissents all express horror, horror, that the IRS goofed, calling out the IRS for “sloppiness” and “slapdash gobbledygook” and accusing the majority of bending over backward to “clean up the IRS mess.” To that I just say: chillax. The majority and dissenting opinions are both reasonable. One can have a legit disagreement without getting all huffy about it. Besides, this was not some poor taxpayer lured into the wrong procedure or screwed by IRS errors. It was a savvy taxpayer trying to take advantage of a bureaucratic bungle, a bungle that was actually fixed pretty quickly.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law