First, on that issue, I offer the relevant portion of the working draft of my Federal Tax Procedure Book will be published on SSRN in early August 2019 (footnotes omitted):
New Matters [In the Tax Court].
The IRS can raise new issues in its answer that seek to increase the amount of the deficiency on a basis not asserted in the notice of deficiency or to justify the deficiency asserted (or part thereof) on some basis not asserted in the notice of deficiency. Jurisdictionally, the Tax Court case is a case to redetermine the correct amount of tax liability for the year(s) involved, thus permitting it to determine a higher deficiency amount or an overpayment. § 6214(a) & 6512(b). So the IRS can seek additional taxes and penalties not previously asserted. The statute of limitations will be open because, to reprise what we learned earlier, the statute is suspended during the period the Tax Court case is pending. §§ 6213(a) and 6503(a). This is one of the dangers in proceeding in the Tax Court where the IRS has not previously spotted an issue. Since the statute of limitations is suspended upon issuance of the notice of deficiency (§ 6503(a)), all new matters may be raised, assuming that the statute of limitations did not bar the notice of deficiency in the first place.
The IRS's ability to raise new issues after its original answer is, however, limited by rules of fairness. If the IRS does assert new matters after filing its original answer, it will formally do so by moving to amend the original answer. The Tax Court rules, like the Federal Rules of Civil Procedure applicable in district courts and the Court of Federal Claims' Rules, permit amended pleadings, usually requiring the approval of the Court which is liberally granted to promote justice on the underlying merits. New issues cannot be inserted too late in the process so as to deny the taxpayer the effective opportunity to respond. And, as to “new matters,” the IRS bears the burden of persuasion. (Of course, if the new matter is the civil fraud penalty not asserted in the notice of deficienty, the IRS would have the burden of persuasion anyway to prove civil fraud by clear and convincing evidence, so asserting civil fraud as a new matter has no affect on the burden of persuasion.)
The IRS is allowed to raise a new theory or ground in support of an issue raised in the notice of deficiency without the theory or ground being a new matter. Depending upon how much variance the new theory or ground has with the notice of deficiency, the variance might be considered a new matter subject to the foregoing new issues discussion. Certainly, if it is raised so late that the taxpayer cannot fairly respond with evidence addressing the new issue, the Court should deny the IRS’s attempt to assert the new issue.
If the IRS asserts an affirmative defense (such as estoppel), it will be deemed denied and the taxpayer need not file a responsive pleading, which is usually called a “reply.” If, however, the IRS raises “new matter” either in an answer or an amended answer, the taxpayer should file a reply providing the IRS notice as to the taxpayer's position on the new matter. This is frequently done via a simple denial of the various matters pled with respect to the new matter.
I think it would be helpful to illustrate the new matter issue. Recall that § 6662 provides a 20% substantial understatement penalty that is then increased to 40% if the understatement is attributable to a gross valuation misstatement. If the notice of deficiency asserted the 20% penalty but, in its answer, the IRS asserts the 40% penalty, the IRS will have the burden of proof on the increase in the penalty. That seems to be the straight-forward reading of the rule shifting the burden of proof to the IRS. But, let’s focus on one issue raised in this setting. The taxpayer can avoid the accuracy related penalties if there was reasonable cause for the position on the return. This is like an affirmative defense to the penalty. Thus, as to the 20% penalty asserted in the notice and contested in the petition, the taxpayer bears the burden of proving reasonable cause even after the IRS meets its production burden under §7491(c); as to the increased 40% penalty, however, the IRS bears the burden of proof, including establishing absence of reasonable cause.
Finally, an even worse case for the taxpayer who improvidently petitions for redetermination is that the IRS can raise as new matter a civil fraud penalty. Say in the above example, the notice of deficiency asserted either the 20% or 40% accuracy related penalty in § 6662 and then in the answer (or amended answer), the IRS asserts the 75% civil fraud penalty in § 6663. Note in this regard that, if the IRS raises the civil fraud penalty as a new matter, its burden of proof is not affected because, as to civil fraud, the IRS bears the burden of persuasion by clear and convincing evidence anyway, just as it the civil fraud penalty had been asserted in the notice of deficiency. So, if the IRS prevails, the taxpayer will be even worse off for having filed a petition for redetermination. Thus, taxpayers and practitioners should think carefully about unspotted potential issues before filing a petition for redetermination in the Tax Court.Now let's work this a little more. This IRS favorable result works because the statute of limitations is still open in Tax Court proceedings.
