The Effect of Violation of the Statutory Requirements for a Notice of Deficiency (8/15/13)

Leslie Book has a good blog entry titled What Happens When The IRS Violates a Statutory Requirement Relating to Notices of Deficiency? (Procedurally Taxing 8/13/13), here.  His general topic is when courts will treat a failure to meet the statutory requirements for a notice of deficiency as invalidating the purported notice of deficiency.  The statutory requirements for the notice are:

1. The date to file a petition for redetermination in the U.S. Tax Court.
2. Notice of Taxpayer Advocate's Contact Information.
3. Notice sent to Taxpayer's Last Known Address.
4. Explanation of Basis for Deficiency.

I encourage readers to read Professor Book's blog entry for more detail than I offer here (except as to item 4).  The unifying theme is whether the taxpayer has been prejudiced by some IRS footfault in meeting these statutory requirements.  Professor Book discusses that prejudice issue in the context of requirements 1 and 2.  It is also present in #3, for the cases hold that, if, despite not being sent to the last known address, the taxpayer actually receives the notice of deficiency in time to file a petition for redetermination, the notice of deficiency will not be invalidated (so that it will operate to suspend the statute of limitations and support the ultimate assessment if the taxpayer did not petition the Tax Court or even if he did petition the Tax Court and loses the last known address issue).

I would like to address briefly the Scar case (Scar v. Commissioner, 814 F.2d 1363 (9th Cir. 1987)) which Professor Book discusses briefly.  I offer the following from  my book (footnotes omitted):

As noted above, the deficiency notices must describe the basis for the deficiency but failure to do so will not invalidate the deficiency.  Thus, the taxpayer appears to have a statutory right to the information in the notice of deficiency, but no statutory remedy if he does not receive it in the notice of deficiency.  As we shall note, however, there may be some remedies short of invalidity of the notice for failure to meet this requirement of § 7522(a). 

Usually, there will be some explanation.  It may be summary or even cryptic because the determination usually follows an audit in which the taxpayer participated and was aware of the issues the IRS was raising.  Indeed, in such cases, usually the taxpayer will have been provided some type of report (often referred to as a Revenue Agent's Report (“RAR”)) that explains the proposed adjustments.  But again, although the Code provides that the taxpayer be notified of the basis for the deficiency, there is no Code remedy if one is not provided.

Where the IRS satisfies the Code requirement of an explanation, there are some practical pressures to force the IRS to make it a reasonably good explanation.  As noted above, the statute does require that the IRS determine a deficiency.  One court has held that where the notice of deficiency explains the deficiency based on facts that patently do not exist, then the IRS has not met the requirement that it make a deficiency determination.  In that case, Scar v. Commissioner, 814 F.2d 1363 (9th Cir. 1987), the notice of deficiency said that it was disallowing a deduction for certain tax shelter partnership items with respect to a named partnership.  The taxpayer was not a partner in the named partnership.  The taxpayer was a partner in a tax shelter partnership with another name, and it is likely that the IRS just plugged in the wrong name on the notice of deficiency.  Moreover, the notice of deficiency indicated that the IRS had not actually examined the taxpayer’s return but just calculated the tax proposed in the notice at the highest marginal rate rather than the progressive income tax rates.  The Ninth Circuit held that, on these facts on the face of the notice of deficiency, the IRS had made no determination as required by § 6212.  The result was that the notice of deficiency was invalid.  The invalidity of the notice of deficiency meant that the statute of limitations on assessment was not suspended under § 6503 and, by the time the IRS realized the error (i.e., when the Court of Appeals pronounced the notice invalid), the statute of limitations on assessments had likely expired.  Cases since Scar have read the holding narrowly; a notice of deficiency will be not honored “only where the notice of deficiency reveals on its face that the Commissioner failed to make a determination.”  As a result, Scar is an outlier, with its analysis and holding rarely invalidating a notice of deficiency. 

There is still another incentive on the IRS to provide an explanation for the notice of deficiency.  Even where a court is unable to find as the case discussed in the prior paragraph that the notice of deficiency is so deficient (pardon the pun) that the notice is invalid, the IRS's failure to provide an explanation or its providing of a poorly worded explanation may force on the IRS the burden of proof when in the course of Tax Court litigation it sharpens its focus in a way that might be considered “new matter” because the notice of deficiency did not fairly put the taxpayer on notice.  Note that, although this “new matter” issue may put an incentive on the IRS to be inclusive in the notice or perhaps to use broad language that may not be helpful, counterbalancing that incentive is the concern that the IRS may be so inclusive or broad that a Court might hold that it has not made a determination and invalidate the notice of deficiency altogether. 

The Tax Court has held that, although there is no statutory remedy for violating § 7522(a), the Court would in fairness impose a procedural one that any position relied upon by the IRS that is not described in the notice will be treated as new matter upon which the IRS bears the burden of persuasion.  In effect, the Court simply imposed its historic position on new matters raised by the IRS to positions which were taken but not adequately described in the notice of deficiency.

Code Provisions Students Should Review (all of these are important to know for my Tax Procedure Class):

• Section 6212, here.  Subsection (a) requires the IRS to make a determination and subsection (b)(1) requires that the notice of deficiency be sent to the last known address.
• Section 6213, here.  Subsection (a) provides for petitioning for redetermination and, if the taxpayer petitions, prohibits the assessment of the deficiency until the Tax Court decision is final.
• Section 6503, here.  Subsection (a)(1) provides for the suspension of the statute of limitations upon issuance of a notice of deficiency.  The key here is that, upon issuing a notice of deficiency the IRS treats the statute as suspended and does not watch the original statutory expiration date (except to add the remaining time at the date of notice of deficiency when the suspension is then lifted upon "finality" under Section 7481, here.