NTA Blog: IRS Should Identify Potentially Frivolous Positions in the Letters It Mails to Taxpayers

October 25, 2017

The IRS Should Specifically Identify Potentially Frivolous Positions in the Letters It Mails to Taxpayers, So As to Give Them a Better Opportunity to Correct the Positions and Comply with the Tax Laws

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In the early 1980s, Congress became concerned with the rapid growth of deliberate defiance of the tax laws by taxpayers objecting to the payment of tax on frivolous grounds or through reliance on obviously unsupportable tax positions. As a result, Congress passed Internal Revenue Code (IRC) § 6702, which, as currently formulated, generally imposes an immediately assessable $5,000 penalty on tax returns adopting a position that the IRS has identified as frivolous or reflecting a desire to delay or impede the administration of Federal tax laws. This penalty, however, was primarily intended to address “protest” returns and was not aimed at taxpayers who were unintentionally noncompliant, such as in the case of innocent mathematical or clerical errors. The goal was to establish a regime that discouraged obstructive returns, but not one that adopted punitive measures against potentially good-faith taxpayers.

To illustrate the distinction, TAS has seen cases in which an unrepresented taxpayer accidentally transposed two lines from a Form W-2 when completing the taxpayer’s return. This innocent error results in an overreporting of withholding that generates a refund and, based on the standards of the IRS, triggers the IRC § 6702 penalty. Nevertheless, this tax position, albeit certainly incorrect, was adopted in good faith and was completely free of any motive to pursue a position previously identified by the IRS as frivolous or to delay or impede the administration of Federal tax laws.

For this reason, among others, Congress has consistently been concerned with protecting the due process rights of taxpayers adopting potentially frivolous positions in tax returns or tax submissions. To avoid stigmatizing taxpayers and to protect against prejudicial IRS treatment of their cases, Congress, as part of the IRS Restructuring and Reform Act of 1998 (RRA 98), enacted legislation prohibiting the IRS from labeling taxpayers as illegal tax protesters or adopting similar terminology. The Treasury Inspector General for Tax Administration (TIGTA) conducts annual audits of the IRS to verify that these potentially destructive characterizations are not placed on taxpayer accounts or otherwise used by the IRS.

To help achieve the desired balance between fairness on the one hand and preventing truly frivolous tax positions on the other hand, Congress also enacted a number of measures to mitigate the harshness of the frivolous return penalty. For example, Congress required the IRS to provide taxpayers individual notice that a position they adopted constitutes an IRC § 6702(b) specified frivolous submission and furnish the opportunity to avoid application of the penalty if the position is withdrawn within 30 days. The IRS now issues these letters in the case of potential IRC § 6702(a) frivolous tax returns as well as IRC § 6702(b) frivolous submissions.

I have previously commended both Congress and the IRS for allowing taxpayers to avoid application of the frivolous return penalty if they withdraw and correct their frivolous position within 30 days of receiving notice from the IRS. This approach allows taxpayers to self-correct unintentional errors without experiencing the stigma and the burden of the penalty for frivolous tax submissions. It has the additional advantage of using IRC § 6702 as an opportunity to educate taxpayers and encourage their future compliance, while reducing the government’s collection and enforcement efforts.

The benefits of this policy, however, are substantially diluted by the IRS’s failure to specifically identify the frivolous position in the letters that are issued. In the case of frivolous returns, Wage & Investment (W&I) generally sends Letter 3176C to provide the requisite 30-day notice. Based in part on TAS recommendations, W&I has agreed to use selectable paragraphs to identify the frivolous position adopted by the taxpayer. The revisions to Letter 3176C, however, which have yet to be implemented by W&I, do not go far enough. The selectable paragraphs would describe the frivolous position in only general terms, such as, “You included a position that has no basis in the law. You’re attempting to avoid or reduce tax liabilities or to secure a refund that you’re not entitled to.”  Even another possible selectable paragraph reading, “You reported correct income, but deducted all or part of the income as a loss or an itemized deduction on the Schedule A,” is vague because the taxpayer has to search through at least two to four schedules and many items in order to identify what, precisely, the IRS has identified as frivolous.

Such vague statements often will be insufficient to allow good faith taxpayers, particularly those who are unrepresented, to determine the nature of the position the IRS thinks is frivolous and correct it within the 30-day period. This determination is made all the more difficult by the circumstance that Notice 2010-33, on which most of these penalties are based, lists over 50 sometimes complex and obscure frivolous positions and further complicates matters by allowing the IRS to treat a position as frivolous if it is “the same as or similar to” those positions. Accordingly, the five broad selectable paragraphs currently contemplated for inclusion in Letter 3176C, while a step in the right direction, fall short of the clarity needed to be of real benefit to either taxpayers or the IRS.

The IRS Office of Appeals (Appeals) is even less forthcoming regarding positions characterized as frivolous submissions in Collection Due Process (CDP) proceedings. In Letters 4380 and 3846, Appeals, at most, tells taxpayers that they have adopted a frivolous position identified by the IRS in Notice 2010-33; a reason not specified in Notice 2010-33 but reflecting a desire to delay or impede federal tax administration; or a moral, religious, political, constitutional, conscientious, or similar objection to the imposition or payment of federal taxes that reflects a desire to delay or impede the administration of federal tax laws. If, after receiving this meager information, taxpayers fail to withdraw their frivolous submission within 30 days, they lose their CDP appeal rights with respect to the position and may incur the frivolous submission penalty. Appeals makes no effort in either letter to provide a particularized description of the frivolous position involved.

Further support for the inadequacy of the letters can be found in Thornberry v. Comm’r. In this case, the United States Tax Court, in dicta, expressed concern that Letter 4380 fails to meaningfully relay the nature of the frivolous position to taxpayers and stated that the “use of boilerplate forms has undermined the purposes of section 6330(g) and 6702(b).” The court explained its belief that the letters are insufficient by observing: “a taxpayer who is notified that an unspecified portion of [his or her] request... reflects a desire to delay or impede the administration of Federal tax laws may not be able to identify and withdraw that portion without further explanation.” While this case looked only at Letter 4380, Letter 3846 has nearly identical “boilerplate” language, and therefore the Tax Court’s statement should be equally applicable.

The failure on the part of both W&I and Appeals to specifically identify frivolous positions jeopardizes taxpayer rights. It not only impedes taxpayers’ ability to avail themselves of the 30-day correction window, but it can also cause taxpayers to lose their CDP appeal rights with respect to these issues. Further, the IRS’s unwillingness to simply tell taxpayers what they have done wrong in the IRC § 6702 context hinders good faith taxpayers from complying with the tax laws. This compliance obstacle harms taxpayers and is counterproductive to the IRS, as it only makes things harder for taxpayers who may already be doing their best to pay the correct amount of tax liability. Moreover, where a taxpayer has taken an unreasonable position, specifically identifying that position and the serious consequences of maintaining it, may be a wake-up call and persuade the taxpayer to withdraw that position.

I appreciate the steps that Congress and the IRS have taken to implement a 30-day notice period providing affected taxpayers with an opportunity to withdraw or correct a frivolous position and avoid the IRC § 6702 penalty. This approach is good for everyone in that it encourages compliance while educating taxpayers. The notice’s beneficial impact, however, is limited by the failure of both W&I and Appeals to tell taxpayers which of their positions is potentially frivolous.

In order to assert the IRC § 6702 penalty in the first place, IRS personnel must know why the position in question is frivolous. As a result, and in the interests of taxpayers’ right to be informed, right to challenge the IRS’s position and be heard, and right to a fair and just tax system, the IRS should pass along that information to taxpayers so as to facilitate quick and efficient withdrawal and correction.

The views expressed in this blog are solely those of the National Taxpayer Advocate. The National Taxpayer Advocate is appointed by the Secretary of the Treasury and reports to the Commissioner of Internal Revenue. However, the National Taxpayer Advocate presents an independent taxpayer perspective that does not necessarily reflect the position of the IRS, the Treasury Department, or the Office of Management and Budget.