Tax Return Photocopies Aren't Subject to Frivolous Return Penalties

(Parker Tax Publishing September 2019)

The Tax Court held that six photocopies of a Form 1040X, which were submitted by a taxpayer and which the court determined were frivolous submissions under Code Sec. 6702(a), did not purport to be returns for purposes of the frivolous return penalty and thus the IRS could not assess additional $5,000 penalties on each of the photocopies. The court found that the photocopies did not meet the requirement of purporting to be tax returns because the taxpayer did not request action on them but rather asked the IRS to process and honor the original return. Kestin v. Comm'r, 153 T.C. No. 2 (2019).

Background

In 2014, Gwendolyn Kestin received $155,702 in wages. In April 2015, she and her husband filed a 2014 Form 1040 reporting a tax liability arising from her wage income. However, in September 2015, the Kestins submitted to the IRS an amended 2014 tax return on Form 1040X that reported a zero tax liability and which the IRS determined was a frivolous tax return. Two one-page letters, one from each of the Kestins, accompanied the Form 1040X. Mrs. Kestin's letter stated that she did not receive taxable wages in 2014 and sought a refund of all of her withheld income tax.

In February 2016, the IRS sent the Kestins a Letter 3176C advising that the position reflected on their 2014 Form 1040X return was frivolous and that a $5,000 penalty under Code Sec. 6702 would be applied unless they corrected their frivolous filing. The Kestins responded with a letter that argued against the IRS's position and listed, as an attachment, "Reference copy of previously-submitted tax return." The IRS received the letter and attachment in March 2016. The attached photocopy of the Form 1040X was stamped "photocopy - do not process."

In May 2016, the IRS assessed two frivolous return penalties totaling $10,000, one for the original Form 1040X and the other for the copy that the Kestins submitted with their February 2016 letter. The Kestins then sent five letters to various IRS offices repeating their request for a refund, each with a copy of their Form 1040X attached that was expressly stated to be a copy of the Kestins' original Form 1040X. In September 2016, the IRS assessed five more $5,000 penalties, totaling $25,000, for the Kestins' five additional submissions that included copies of their Form 1040X.

The IRS filed a notice of federal tax lien (NFTL) stating an amount due of $33,842 ($35,000 for the seven penalties minus a credit for an overpayment from an earlier year). The IRS sent Mrs. Kestin a notice of the NFTL and of her right to a collection due process (CDP) hearing. Mrs. Kestin requested a hearing. At the hearing, she advanced largely frivolous arguments and did not propose a collection alternative. The IRS Appeals office issued a notice of determination (NOD) in July 2017 sustaining the assessment of the penalties and the NFTL. Mrs. Kestin appealed the NOD in the Tax Court.

Under Code Sec. 6702(a), the $5,000 frivolous tax return penalty applies only if a taxpayer files "what purports to be a return." In the view of the Tax Court, there was no question that Mrs. Kestin's original Form 1040X purported to be a return and that a $5,000 frivolous submission penalty applied to that filing. The issue before the court was whether the six copies of the Form 1040X submitted by Mrs. Kestin purported to be returns.

The IRS cited Grunsted v. Comm'r, 136 T.C. 455 (2011), in which two Code Sec. 6702 penalties were sustained against a taxpayer who, after being told the IRS would not accept two purported tax returns he had filed, resubmitted substantially identical purported returns for the same two years. The IRS also cited Whitaker v. Comm'r, T.C. Memo. 2017-192, in which the Tax Court held that, if a taxpayer files multiple frivolous returns for a single year, the IRS can assess multiple frivolous return penalties. Finally, the IRS referred to an Internal Revenue Manual (IRM) provision which instructs IRS employees to assess Code Sec. 6702 penalties without regard to whether the claim is a copy or an original, whether the signature on the claim is a copy or an original, or whether there has been a Code Sec. 6702 penalty previously assessed for the same period.

Analysis

The Tax Court held that Mrs. Kestin's inclusion of copies of her original Form 1040X as attachments to her letters asking the IRS to process and honor her original amended return did not constitute filing what purports to be a return for purposes of Code Sec. 6702(a)(1), and Mrs. Kestin was therefore not liable for the $5,000 penalties on the six photocopies. The court found that when Mrs. Kestin submitted photocopies of her Form 1040X to the IRS, she did not request action on the photocopy itself. Rather, she asked the IRS to process and honor her original Form 1040X.

The Tax Court rejected the IRS's reliance on Grunsted, noting that in that case there was no suggestion that the later returns were mere copies or labeled as such. On the contrary, the court noted that in Grunsted the later documents were again seeking a refund and each document purported to be an income tax return filed to obtain tax refunds. As to the Whitaker decision, the court observed that its holding in that case was based on the later-filed document having been submitted on Form 1040, with the taxpayers' original signatures, in an effort to obtain a refund. According to the court, no penalty was sustained against a mere copy. Rather, the second penalized document was not labeled a copy, was not in fact a copy, was instead a signed original, and sought a refund as opposed to merely arguing that the IRS should process a previously filed original document.

With respect to the provision of the IRM cited by the IRS, the court noted that the IRM does not have the force of law and concluded that, if the IRS interpreted Code Sec. 6702 to call for a penalty even where a copy is labeled as such and does not seek an additional refund, it was incorrect because it failed to distinguish a purported tax return from a mere copy of a purported tax return.

Observation: The court clarified that it was not holding that a copy of a purported return could never be subject to a penalty under Code Sec. 6702(a). The court said that, for example, the IRS may have received information about an individual's income or withholding and yet have no record of having received a return from the individual. According to the court, if the IRS notified the individual that no return has been received, and if the individual responded with a copy of a purported return that he claimed to have previously filed and on which copy he relied to report his income, the copy might constitute a purported return for purposes of imposing a frivolous return penalty.

The court also held that the IRS complied with the supervisory approval requirement of Code Sec. 6751(b)(1). The court found that Letter 3176C was not an initial determination of the penalty that required supervisor approval because, although the letter gave a stern warning about the IRS's intention to impose a penalty, its purpose was actually to invite Mrs. Kestin to make a correction that, if made, would have caused the IRS not to assess the penalty. The court also noted that when the Letter 3176C was issued, it was not possible to determine the penalty because it remained to be seen, depending on the Kestins' actions, whether they would be liable for the penalty.

For a discussion of penalties relating to frivolous tax submissions, see Parker Tax ¶262,145. For a discussion of the procedural requirements for computing penalties, see Parker Tax ¶262,195.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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