A basic lesson I teach students is that clients often have choices in where to obtain judicial review of a Notice of Deficiency (NOD). The usual choices are (1) file a petition in Tax Court and get pre-payment review or (2) pay the proposed deficiency in full and follow the procedures to, eventually, sue for a refund in either federal district court or the U.S. Court of Federal Claims. The downside of Tax Court is that interest keeps accruing so, if you lose, you lose more than if you had paid and gone the refund route.
We find a more sophisticated lesson in Robert J. Peacock and Bonita B. Peacock v. Commissioner, T.C. Memo. 2020-63 (May 19, 2020) (Judge Vasquez). There, at the end of the audit the taxpayers sent the IRS a check for more than the deficiency proposed in the later-issued NOD. They even wrote “payment” in the memo line. Yet they were allowed to contest that later-issued NOD in Tax Court. How can that be? The answer is below the fold.
Law: Deficiency Jurisdiction
Today’s case involves the Court’s oldest and most commonly invoked jurisdiction, commonly called “deficiency jurisdiction.” When the IRS determines there is a deficiency of tax, it sends a taxpayer an NOD and §6213 gives the taxpayer either 90 or 150 days to petition the Tax Court. If they do that, §6214 gives the Tax Court jurisdiction to “redetermine the correct amount of the deficiency” even if that is more or less than the deficiency proposed in the NOD. Additionally, once a taxpayer gets into Tax Court through the deficiency jurisdiction door, §6512 gives the Tax Court jurisdiction to determine an overpayment and order a refund.
Thus the Tax Court routinely says, as Judge Vasquez did here, that “we have jurisdiction to redetermine a deficiency if a valid notice of deficiency is issued by the Commissioner and if a timely petition is filed by the taxpayer.” (Op. at 6). That disarmingly simple statement conceals a metaphysical confusion about what a deficiency is. Is the Court’s power to hear a petition keyed to an actual deficiency or just keyed to an assertion of deficiency by the IRS?
The Tax Court has not always given a clear answer. On the one hand, it has said: “it is not the existence of a deficiency but the Commissioner's determination of a deficiency that provides a predicate for Tax Court jurisdiction.” Hannan v. Commissioner, 52 T.C. 787, 791 (1969)(emphasis in original). The Court there explained that if the rule were otherwise, then the Tax Court would lose jurisdiction the very moment it redetermined a proposed deficiency to be zero. On the other hand, it has also said: “It is the existence of a deficiency at the date of the sending of the notice of deficiency that confers jurisdiction upon this Court.” Paccon v. Commissioner, 45 T.C. 392, 396 (1966) (emphasis supplied).
The statements can be reconciled by the idea of timing. When I teach the concept of deficiency jurisdiction I emphasize the timing aspect: the IRS cannot issue a valid NOD unless, at the time it issues the NOD, there exists a disagreement between what the taxpayer believes to be the correct tax and what the IRS believes to be the correct tax. In that sense the NOD is like a pleading, a Complaint: it alleges a dispute and sets out the scope of the dispute. If there is no dispute, there is no jurisdiction. In other words, a valid NOD must plead a dispute as of the date the NOD is sent.
That is why payments made after an NOD is issued do not affect the Court’s deficiency jurisdiction. Section 6213(b)(4) explicitly allows the IRS to accept payments and made a corresponding assessment of the amounts received and provides that “where such amount is paid after the mailing of a notice of deficiency under section 6212, such payment shall not deprive the Tax Court of jurisdiction over such deficiency determined under section 6211 without regard to such assessment.” (emphasis added)
In contrast, payments made before an NOD issues might well render an NOD invalid if those payments remove the implied allegation of a dispute. Bendheim v. Commissioner, 214 F.2d 26 (2nd Cir. 1954) illustrates the concept. There the taxpayer received a 30-day letter proposing a deficiency in tax of $17,583. The taxpayer took it to Appeals and about a year later deliberately sent in a slightly smaller payment of $17,500, plus accrued interest. That left just a little bit of the alleged deficiency in dispute. The taxpayer planned to use that to open the deficiency jurisdiction door and get to Tax Court. However, after the taxpayer sent in the money Appeals allowed the taxpayer “certain credits based upon information in the various papers submitted,” and so Appeals ended up issuing an NOD that proposed a deficiency of only $17,420. When the taxpayer petitioned Tax Court, the Tax Court dismissed for lack of jurisdiction. The Circuit Court upheld the dismissal, finding that the NOD was not valid, writing: “as the additional tax in dispute had already been paid there was no ‘deficiency.’” Id at 28.
It has long been true, however, that taxpayers can send money to the IRS during the course of an examination (and before the NOD) just to stop the running of interest. Those remittances won't be treated as payments. When taxpayers send money to stop interest and not for the purpose of discharging the asserted deficiency, the NOD will still validly assert a dispute. Remittances made to stop interest and not to pay the asserted deficiency are called deposits.
The difference between deposits and payments has a long and complex history, which I won’t go into here. Suffice to say that it stems from an inherent tension in a system that since 1918 has required payments to be made before liability is assessed. It pre-dates the creation of the statutory overpayment rules in §6401 in 1943. The foundational case is still Rosenman v. United States, 323 U.S. 658 (1945) which involved the payment/deposit distinction for refund SOL purposes but which is used in all situations where there payment v. deposit issue arises.
Until 2004, deposits would stop the running of interest but since they were not “payments” of tax, they could not become “overpayments” for the purpose of earning overpayment interest as provided by §6611. In the American Jobs Creation Act of 2004, 118 Stat 1418, Congress added §6603 to the Code to provide for some limited payment of interest on deposits. The Conference Committee Report explains some other difficulties taxpayers encountered with deposits and how the new §6603 addressed those problems as well. See H.R. 108-755 at 646-649.
The IRS issued procedural guidance for §6603 in Rev. Proc. 2005-18. Section 4.01 of the Rev. Proc. says that if taxpayers want to send in a deposit they need to include “a written statement designating the remittance as a deposit” and, if they want the interest now provided by §6603, they must follow other specific rules contained in a different part of the Rev. Proc. Section 4 further provides that if taxpayers do not adequately specify their intent, the “undesignated remittance” will be treated as a payment and not a deposit. And if that undesignated remittance comes in before an NOD is issued and “is in the full amount of a proposed liability, such as an amount proposed in a revenue agent’s or examiner’s report, the undesignated remittance will be treated as a payment of tax, a notice of deficiency will not be mailed and the taxpayer will not have the right to petition the Tax Court for a redetermination of the deficiency.” Rev. Proc. 2005-18 §4.02
The IRS selected Mr. and Ms. Peacock’s 2013 return for examination. In April 2016, at the end of the examination, the Revenue Agent (RA) followed the standard practice and presented the proposed deficiency to the taxpayer in what is known as a 30-day letter package. That is a package where the Revenue Agent’s Report (RAR) explains the proposed adjustments, and a cover letter with forms tells the taxpayer than an NOD will issue in 30 days if the taxpayer takes no action, and offers the taxpayer two actions to take: elevate the matter to Appeals or sign a consent to immediate assessment of the proposed deficiency, thus waiving the opportunity to go to Tax Court.
Here, the RA ended up proposing a deficiency of $6,761. Most of the deficiency was based on the disallowance of a deduction item. Mr. and Ms. Peacock did not agree to the proposed adjustments. On April 8, 2016, Mr. P. hand-delivered a 4-page letter to the RA disputing the RA’s conclusions and asking for a conference with Appeals. Along with the letter Mr. Peacock handed the RA a check for the full amount of the proposed deficiency, plus accrued interest of $431.43 for a total of $7,192.43. In the memo line of the check Mr. Peacock had written “payment 2013 Federal Income Tax.” In the cover letter, Mr. Peacock referenced the check as “enclosed” and then immediately followed that sentence with this: “I do, however, respectfully disagree completely with your determination.” His letter also said he wanted to go to Appeals, and he did. In his October 2016 protest letter to Appeals, Mr. Peacock wrote that he had given a check to the RO and had “made it crystal clear that this payment was made in protest, and that I completely disagreed with the IRS determination.” Mr. Peacock asked for a face-to-face hearing.
The opinion does not tell us what happened in Appeals. It says only that Appeals issued an NOD in March 2017 and the Peacocks timely petitioned the Court. The NOD issued by Appeals was for $6,544, less than what the RA had proposed and less than the amount in Peacocks' 2016 check.
The IRS moved to dismiss the petition for lack of jurisdiction because, it argued, the check was a payment. Mr. Peacock had never identified it as a "deposit" and had even explicitly designated the pre-NOD check as a “payment” right in the memo line. Thus the NOD was not valid because there was no disputed tax. The IRS argued that Mr. Peacock's disagreement with the proposed deficiency expressed in his letter was not enough to override the check’s memo line designation. The Peacocks argued that the letter accompanying the check made it “crystal clear” that the check was given in protest and not in fulfillment of their tax obligations. That is one of the main ideas in the Rosenman case.
Lesson: Learn Your Client's Facts
Judge Vasquez held that the check was a deposit despite the notation on the check itself. That made the NOD valid, thus allowing the Tax Court jurisdiction to hear the dispute.
Two facts appear key to his decision. The first key fact that Mr. Peacock’s letter expressed more than just a disagreement; it expressed “a desire to dispute a liability in prepayment forums.” Judge Vasquez explicitly noted that he was not going to “decide today whether a written expression of disagreement by itself is sufficient to indicate that a remittance is a sec. 6603 deposit.” (Op. at note 14). He did not need to because Mr. Peacock’s letter went beyond simply disputing the amount by asking for prepayment relief in Appeals and following that up with protest to Appeals.
The second key fact was that the IRS appears to have actually treated the check as a deposit and not a payment. It did not, for example, use its assessment authority to assess the $7,192.43 check as a payment of tax. And the IRS did, after all, issue an NOD, which it’s own regulations says it won’t do when it treats a remittance received prior to an NOD that fully pays what would otherwise be in the NOD. See Treas. Reg. 301.6213-1(b)(3) (“if such a payment satisfies the taxpayer’s tax liability, no notice of deficiency will be mailed and the Tax Court will have no jurisdiction over the matter.”).
This would not have been a lesson worth blogging about if Mr. Peacock had not written “payment” on the check. I am sure that if he had a competent tax professional advising him he would not have done that and I am sure that most tax professionals will know how to instruct their clients to properly designate a remittance as a deposit. But we don't always get a chance to help our clients ex ante, before they commit errors.
Learning what the two key facts were in this case will help readers figure out ex post whether they have an argument that any particular remittance was a deposit or a payment. That can not only be important for Tax Court jurisdiction but it can also be important for the §6511 limitations periods on recovering refunds.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School Thereof