Tax Court in Brief | Decrescenzo v. Comm’r | Challenge to Notice of Deficiency and Penalties for Frivolous Arguments

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The Tax Court in Brief – January 9th – January 13th, 2023

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Tax Litigation:  The Week of January 9th, 2022, through January 13th, 2023

Decrescenzo v. Comm’r, T.C. Memo. 2023-7| January 12, 2023 | Halpern, J. | Dkt. No. 16784-18

Summary: Taxpayer and petitioner, Joseph Decrescenzo (“Petitioner”) belatedly filed returns of income for seven years at issue (2007-2013). The IRS determined various differing deficiencies as to the years at issue and notified Petitioner of the determinations. The notice of proposed changes included total adjustments on Form 5278 and two sub forms; Form 4549B, Income Tax Examination Changes, Form 886–A, Explanation of Items. The notice contained calculations in support of the determinations for each year, although the calculation method differed some among the years at issue.  Petitioner appealed the determinations to the IRS Office of Appeals (Appeals). During the evaluation of Petitioner’s returns, Petitioner and an Appeals officer signed two separate IRS Forms 872, Consent to Extend the Time to Assess Tax, extending the time to assess tax for the years at issue. Within that limitations period, the IRS mailed the notice of deficiency to Petitioner. The Notice included, “We have determined that you owe additional tax or other amounts, or both, for the tax year(s) identified above. This letter is your NOTICE OF DEFICIENCY as required by law. The enclosed statement shows how we figured the deficiency.” The notice letter and enclosures consisted of 70 pages that unambiguously identified Petitioner. Petitioner claimed that the notice was deficient based on process failures by the IRS in determining the alleged deficiencies and additions to tax.

Key Issues:  Whether the notice of deficiency was valid, and whether Petitioner should be liable for sanctions for making frivolous arguments?

Primary Holdings: Yes and yes. The notice of deficiency is valid. The letter was addressed to Petitioner and sets forth the amounts of the deficiencies in tax and the taxable years involved. And, the notice passed muster under Campbell, Scar, and Dee, being three Tax Court opinions that combine to provide the current framework for review of a challenge to a deficiency notice. And, Petitioner’s arguments as to jurisdiction, statute of limitations, and validity of the notice of deficiency were meritless such that the Tax Court assessed a $5,000 penalty against Petitioner.

Key Points of Law:

Authority to Tax. The authority for the IRS to determine a deficiency in income tax and send notice thereof to a taxpayer is beyond dispute. See 26 U.S.C. § 6301; id. at § 6211(a).

Period of Limitations. Although section 6501(a) requires that “the amount of any tax imposed . . . shall be assessed within 3 years after the return was filed,” section 6501(c)(4) provides that the period may be extended by agreement of the parties.

Jurisdiction. If the IRS fails to issue a valid notice of deficiency, the Tax Court will dismiss the case for lack of jurisdiction on that ground. E.g., Keeton v. Commissioner, 74 T.C. 377, 379 (1980). Section 6212(a) authorizes the Secretary (i.e., the IRS Commissioner or his delegate) to send a notice of deficiency when he determines a deficiency in a taxpayer’s tax. Section 7522(a) provides that the notice must “describe the basis for, and identify the amounts (if any) of, the tax due, interest, additional amounts, additions to the tax, and assessable penalties included in such notice.” The essential purpose of a deficiency notice is to provide a formal notification that a deficiency in taxes has been determined. Pietz v. Commissioner, 59 T.C. 207, 213–14 (1972). Even an inadequate description does not invalidate a notice. Dees v. Commissioner, 148 T.C. 1, 4 (2017).

Scar, Campbell, and Dees. Three cases mark the evolution of deficiency notice: (1) Scar v. Commissioner, 81 T.C. 855 (1983), rev’d, 814 F.2d 1363 (9th Cir. 1987) — “The requirements of section 6212(a) are met if the notice of deficiency sets forth the amount of the deficiency and the taxable year involved.”; (2) Campbell v. Commissioner, 90 T.C. 110 (1988) — “Where the notice of deficiency does not reveal on its face that the Commissioner failed to make a determination, a presumption arises that there was a deficiency determination.”; and (3) Dees v. Commissioner, 148 T.C. 1, 4 (2017) – Applying a two-prong approach to the question of the validity of a notice of deficiency.

Additions to Tax and PenaltiesA. Failure to File Timely Tax Return. Section 6651(a)(1) imposes an addition to tax for failure to file a timely tax return. The addition equals 5% of the amount required to be shown as tax on the delinquent return for each month or fraction thereof during which the return remains delinquent, up to a maximum addition of 25% for returns more than four months delinquent. Id. The addition to tax does not apply if the failure to file timely is due to reasonable cause and not to willful neglect. Id. When the taxpayer is an individual, the IRS has the initial burden of production as to additions to tax, penalties, and other additional amounts, meaning he must make a prima facie case that imposing liability is appropriate. See id. at § 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446–47 (2001). If the Commissioner carries his burden, normally the taxpayer has the burden of proving that any affirmative defenses apply, such as that the taxpayer acted with reasonable cause and in good faith.

Additions to Tax and PenaltiesB. Section 6662(a) Accuracy-Related Penalties.  Section 6662(a) and (b)(1) provides for an accuracy-related penalty of 20% of the portion of an underpayment of tax required to be shown on a return attributable to negligence or disregard of rules and regulations (without distinction, negligence). Section 6662(a) and (b)(2) provides for the same penalty on the portion of an underpayment of tax attributable to any substantial understatement of income tax. In the case of an individual, there is a substantial understatement of income tax for a year if the amount of the understatement exceeds the greater of (1) 10% of the tax required to be shown on the return for the tax year or (2) $5,000. 26 U.S.C. § 6662(d)(1)(A). The amount of an understatement is reduced if there is substantial authority for the taxpayer’s treatment of an item on his return. See id. at § 6662(d)(2)(B)(i). The amount of the understatement is reduced for any item that is adequately disclosed in the taxpayer’s return, or in an attached statement, if there is reasonable basis for the taxpayer’s treatment of the item. Id. at § 6662(d)(2)(B)(ii).

Reasonable Cause Exception. Section 6664(c)(1) provides a reasonable cause exception to imposition of the section 6662(a) accuracy-related penalty on that portion of an underpayment for which it is shown that there was reasonable cause for the underpayment and the taxpayer acted in good faith. Only one accuracy-related penalty may be applied with respect to any given portion of an underpayment even if that portion is subject to the penalty on more than one of the grounds set out in section 6662(b). Treas. Reg. § 1.6662-2(c).

Burden of Production. The IRS’s burden of production with respect to the accuracy-related penalty includes making a prima facie case that the section 6751(b)(1) requirement for written supervisory approval has been met. E.g., Ball v. Commissioner, T.C. Memo. 2020-152, at *12. Section 6751(b)(1) provides: “No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher-level official as the Secretary may designate.” The amount of tax petitioner was required to show was, with a minor increase for 2010, the amount of the deficiency in tax shown in the first paragraph of this report. For each year at issue, petitioner reported zero tax liability on the return he filed for that year. Thus, for each year, his understatement of income tax was both equal to (100% of) the tax required to be shown on the return and more than $5,000. In other words, a substantial understatement of income tax. See id. at § 6662(d)(1)(A).

Reasonable Cause and Good Faith. Section 6664(c)(1) excepts from imposition of the accuracy-related penalty that portion of an underpayment for which the taxpayer both had reasonable cause and acted in good faith. The determination of reasonable cause and good faith is made considering all relevant facts and circumstances. See Higbee, 116 T.C. at 448; Treas. Reg. § 1.6664-4(b)(1). A taxpayer has reasonable cause for a portion of an underpayment if the taxpayer exercised ordinary business care and prudence with respect to the portion. An honest misunderstanding of fact or law that is reasonable considering the taxpayer’s experience, knowledge, and education may indicate reasonable cause and good faith. See Higbee, 116 T.C. at 449; Barnes v. Commissioner, T.C. Memo. 2016-79, at *11–12.

Section 6673(a)(1) Sanction for Instituting a Proceeding Primarily for Delay or Where the Taxpayer’s Position Is Frivolous or Groundless. Section 6673(a)(1) allows the Tax Court to impose a penalty of up to $25,000 if (1) the taxpayer has instituted or maintained proceedings before the Tax Court primarily for delay or (2) the taxpayer’s position in the proceeding is frivolous or groundless. “Groundless” means lacking a basis or a rationale. The Tax Court may impose the penalty even where taxpayers have raised some issues that were neither frivolous nor groundless, along with issues that were frivolous or groundless. And, a taxpayer who ignores warnings that an argument is meritless is deserving of a greater penalty. See Leyshon v. Commissioner, T.C. Memo. 2015-104, at *25, aff’d, 649 F. App’x 299 (4th Cir. 2016).

Insights: The construct of this Decrescenzo opinion illustrates the judicial and administrative resources wasted by Petitioner’s frivolous arguments and challenges. The Tax Court went to great lengths to essentially over-explain all the shortcomings and frivolity engaged in by Petitioner. While the IRS failed to prove certain accuracy-related penalties, the Tax Court assessed additional sanctions against Petitioner for his frivolous arguments and wasteful litigation tactics. From a more practical position, this opinion provides a great roadmap for requirements of a deficiency notice and the analysis the Tax Court will take when a taxpayer challenges a notice of deficiency.