Just Give Me a Reason: Tax Court Ignores Frivolous Arguments

As part of the Taxpayer Bill of Rights, taxpayers must pay only the amount of tax legally due, including interest and penalties. They can also raise objections and receive a response if the IRS doesn’t agree with their position.

But those rights aren’t unlimited: The taxpayer must take a reasonable position. That’s the finding in a recent Tax Court case.

In Sun River Financial Trust, the taxpayer filed delinquent returns for 2010 and 2011, reporting no tax due and claiming a refund for the withholding. Attached to the returns were several bogus forms, including Form 1099-OID, Original Issue Discount. That combination of factors proved to be a red flag.

The IRS and courts have penalized taxpayers for filing improper zero returns to avoid tax liability or obtain a false refund. As support for these returns, taxpayers may, for example, attach a “corrected” Form W-2 or another information return that misrepresents income and withholding. The IRS has repeatedly warned against advancing these schemes.

Form 1099-OID may also be linked to a frivolous position. Normally, the difference between a bond’s issue price and its redemption value is the OID. That’s most commonly treated as interest and reported on Form 1099-OID, which is a real tax form. But some taxpayers have developed schemes that treat Form 1099-OID like a personal IOU from the government.

By manipulating the form, taxpayers either purport to access a secret Treasury account in exchange for payment, or significantly overstate withholding to claim an inflated tax refund. The IRS and courts have consistently discredited these claims, making it clear that taxpayers who pursue them may be subject to civil and criminal tax penalties.

When the IRS reviewed the taxpayer’s 2010 and 2011 tax returns in Sun River, it called the positions frivolous. The IRS mailed the taxpayer a letter warning of the potential consequences and offering an opportunity to file correct returns. The taxpayer didn’t change the returns. Instead, the taxpayer doubled down, raising more arguments that the IRS considered frivolous and meritless. Among them, the taxpayer asserted that IRS agents can’t determine whether a return is frivolous because they are “not lawyers and do not regularly read legal texts.”

As a result, the IRS assessed a $5,000 Section 6702 penalty for each frivolous tax return and sent a bill. The taxpayer didn’t respond to the assessment and didn’t pay the penalties. The IRS subsequently issued a Letter 1058, Final Notice—Notice of Intent to Levy and Notice of Your Right to a Hearing, and a Notice of Federal Tax Lien Filing (NTFL) and Your Right to a Hearing Under IRC 6320.

In response, the taxpayer filed a request for a Collection Due Process, or CDP, hearing. As support for the challenge, the taxpayer cited reports issued by the U.S. Government Accountability Office alleging that the IRS’s computers are “unreliable, inaccurate, untrustworthy and lack proper security.” That means, the taxpayer argued, that the computers are “unable to produce a believable result.” The taxpayer demanded “proof that the mathematical calculations * * * [were] correct” but didn’t offer any additional arguments to support the position or request collection alternatives.

A settlement officer was assigned to the case. The SO scheduled a telephone hearing, but the taxpayer requested that the conference be done by written correspondence. The SO agreed and proceeded to review the record. The taxpayer didn’t raise any new challenges or offer additional evidence.

Frivolous Arguments

The SO found that the proposed collection activities against the taxpayer were proper and sent notices of determination to the taxpayer sustaining the filing of the NTFL and the proposed levy. In response, the taxpayer filed for relief in the Tax Court. Notably, the taxpayer didn’t challenge the underlying tax assessments but instead advanced a series of frivolous legal arguments. The court rejected all of them.

By statute, the court could have slammed the taxpayer with a penalty up to $25,000 for making frivolous arguments that “have been instituted or maintained by the taxpayer primarily for delay.” The court didn’t do that (yet) but did warn the taxpayer against continuing to pursue such arguments because doing so could result in additional penalties.

The court noted that the taxpayer had an opportunity to dispute the liability at the CDP hearing but didn’t do so. The taxpayer’s sole argument was that the IRS’ computers weren’t reliable.

The court can consider a taxpayer’s challenge in a CDP case only if it is properly raised at the CDP hearing (Giamelli v. Commissioner). Since the taxpayer didn’t raise any meaningful challenges, the court didn’t need to consider those arguments further. Instead, the only question was whether the IRS abused discretion in sustaining the filing of the NFTL and the levy for the unpaid penalties.

An abuse of discretion occurs when an SO acts “arbitrarily, capriciously, or without sound basis in fact or law” (Woodral v. Commissioner). If the SO follows the rules and provides a reasoned, balanced decision, the court won’t substitute its judgment (Link v. Commissioner).

The taxpayer “did not introduce any credible evidence or persuasive arguments” to convince the court that the proposed collection activities were arbitrary, capricious, or without foundation. Additionally, the taxpayer didn’t prove there was any irregularity in the SO’s assessment procedure.

In contrast, the court found that the SO considered the issues raised by the taxpayer and balanced the need for efficient collection of taxes with a concern that any collection action is no more intrusive than necessary. There was “no abuse of discretion in any respect” that would require overturning the proposed levy and the filing of the NFTL, the judge said. With that, the court ruled in favor of the IRS.

What’s the takeaway? Taxpayers absolutely have the right to disagree with the IRS, but the arguments must be reasonable and have a legal or factual basis. Advancing frivolous positions is a waste of IRS and court resources, and can backfire on the taxpayer.

This is a weekly column from Kelly Phillips Erb, the TaxGirl. Erb offers commentary on the latest in tax news, tax law, and tax policy. Look for Erb’s column every week from Bloomberg Tax and follow her on Twitter at @taxgirl.