SCOTUS Reports

Tag: Section 7605(b)

  • Richard Essner v. Commissioner of Internal Revenue, T.C. Memo. 2020-23: Taxation of Inherited IRA Distributions and Section 7605(b) Examination Limits

    Richard Essner v. Commissioner of Internal Revenue, T. C. Memo. 2020-23 (U. S. Tax Court 2020)

    In Richard Essner v. Commissioner, the U. S. Tax Court upheld the IRS’s determination of tax deficiencies and penalties against Essner, a California cancer surgeon, for failing to report income from inherited IRA distributions in 2014 and 2015. The court rejected Essner’s claim that the IRS conducted an unnecessary second examination of his 2014 tax year, clarifying the scope of section 7605(b). This ruling underscores the necessity for taxpayers to accurately report inherited IRA distributions as income and the limited protections against IRS examinations under section 7605(b).

    Parties

    Richard Essner, the petitioner, represented himself pro se. The respondent, the Commissioner of Internal Revenue, was represented by Mark A. Nelson and Sarah A. Herson. The cases were consolidated under docket numbers 7013-17 and 1099-18 for trial and opinion.

    Facts

    Richard Essner, a cancer surgeon residing in California, inherited an IRA from his late mother, who had inherited it from his father. Essner received distributions from the IRA of $360,800 in 2014 and $148,084 in 2015. He researched the tax implications of these distributions on the IRS website and concluded they were not taxable. Essner engaged a return preparer for his 2014 and 2015 returns but did not inform the preparer of the IRA distributions. Consequently, Essner did not report these distributions as income on his tax returns. The IRS, having received Forms 1099-R reporting the distributions, initiated two separate processes to address the discrepancies: the Automated Underreporting (AUR) program and an individual examination by Tax Compliance Officer Hareshkumar Joshi.

    Procedural History

    The IRS’s AUR program identified a discrepancy in Essner’s 2014 return and issued a notice of deficiency on January 3, 2017, for $117,265, which Essner contested by filing a timely petition with the U. S. Tax Court under docket No. 7013-17. Concurrently, Officer Joshi examined Essner’s 2014 and 2015 returns, focusing on other issues but not the IRA distributions. On October 23, 2017, the IRS issued another notice of deficiency for Essner’s 2015 tax year, determining a deficiency of $101,750 and an accuracy-related penalty under section 6662(a) of $20,350, which Essner also contested under docket No. 1099-18. The Tax Court consolidated the cases for trial and opinion.

    Issue(s)

    Whether Essner failed to report distributions from an inherited IRA as income for 2014 and 2015?

    Whether the IRS subjected Essner to a duplicative inspection of his books and records relating to his 2014 tax year in violation of section 7605(b)?

    Whether Essner is liable for the accuracy-related penalty under section 6662(a) for tax year 2015?

    Rule(s) of Law

    Section 61(a) of the Internal Revenue Code defines gross income as “all income from whatever source derived”, including income from pensions under section 61(a)(11). Section 7605(b) limits the IRS to one inspection of a taxpayer’s books of account per taxable year, unless the taxpayer requests otherwise or the Secretary notifies the taxpayer in writing of the need for an additional inspection. Section 6662(a) authorizes the imposition of a 20% accuracy-related penalty for substantial understatements of income tax, which can be excused if the taxpayer shows reasonable cause and good faith.

    Holding

    The Tax Court held that Essner failed to report the IRA distributions as income for 2014 and 2015, sustaining the IRS’s deficiency determinations. The court also held that the IRS did not violate section 7605(b) by conducting a second examination of Essner’s 2014 tax year, as the AUR program’s actions did not constitute an examination of Essner’s books and records. Finally, the court held Essner liable for the accuracy-related penalty for tax year 2015, finding that he did not act with reasonable cause and good faith.

    Reasoning

    The court reasoned that Essner’s failure to report the IRA distributions as income was not supported by any evidence that a portion of the distributions represented a non-taxable return of his late father’s original investment. Essner’s inability to substantiate his claim due to lack of records from financial institutions did not relieve him of his burden of proof. Regarding section 7605(b), the court narrowly interpreted the statute, concluding that the AUR program’s review of third-party information and Essner’s filed tax returns did not constitute an examination of his books and records. Therefore, no second examination occurred, and the IRS’s actions were not unnecessary. For the accuracy-related penalty, the court found that Essner’s failure to consult his return preparer about the IRA distributions, despite his professional background and the size of the distributions, demonstrated a lack of reasonable cause and good faith.

    Disposition

    The Tax Court entered decisions sustaining the IRS’s determinations of tax deficiencies for 2014 and 2015 and the accuracy-related penalty for 2015.

    Significance/Impact

    This case reaffirms the IRS’s authority to require taxpayers to report inherited IRA distributions as income and clarifies the limited scope of section 7605(b) in protecting taxpayers from multiple examinations. It also highlights the importance of taxpayers seeking professional advice to ensure accurate tax reporting, particularly in complex situations involving inherited assets. The decision may influence future cases involving similar issues of tax reporting and IRS examination practices, emphasizing the need for clear communication and coordination within the IRS to avoid confusing taxpayers.

  • Burlage v. Commissioner, T.C. Memo. 1993-448: When IRS Can Reexamine Tax Years Without Notice

    Burlage v. Commissioner, T. C. Memo. 1993-448

    The IRS may reexamine a tax year without providing notice under section 7605(b) if the reexamination arises from an examination of a different tax year using the same records.

    Summary

    In Burlage v. Commissioner, the IRS reexamined the petitioners’ 1987 tax year after examining their 1988 amended return, using the same records related to a subchapter S corporation’s losses. The court held that this reexamination did not violate section 7605(b) as it was not an “unnecessary examination” and did not constitute a “second inspection” of the 1987 records. The decision emphasized that the IRS may reexamine a year without notice if the same records are examined in connection with a different tax year, and highlighted the annual nature of tax assessments, allowing for independent examinations of each year.

    Facts

    Petitioners resided in Englewood, Colorado. Revenue Agent Burlage examined petitioners’ 1987 tax year, allowing a loss from Digby Leasing based on a draft Schedule K-1 and a memorandum provided by petitioners’ representative. Later, Agent Chase examined petitioners’ 1988 amended return, which included a similar loss from Digby Leasing. Upon reviewing the 1988 records, Agent Chase determined that petitioners lacked sufficient basis for the claimed losses in both 1987 and 1988. He then reexamined the 1987 tax year, leading to a notice of deficiency for 1987 without providing written notice to petitioners.

    Procedural History

    The IRS issued notices of deficiency for petitioners’ 1987, 1988, and 1989 tax years, which were consolidated for trial. The parties resolved all substantive issues except whether Agent Chase’s reexamination of the 1987 tax year violated section 7605(b) by being an unnecessary examination or a second inspection without notice.

    Issue(s)

    1. Whether Agent Chase’s reexamination of petitioners’ 1987 tax year constituted an “unnecessary examination” under section 7605(b).
    2. Whether Agent Chase conducted a “second inspection” of petitioners’ 1987 records without providing written notice as required by section 7605(b).

    Holding

    1. No, because the reexamination was necessary as it was based on information obtained from the 1988 examination and was not barred by the prior examination or agreement.
    2. No, because the reexamination of the 1987 tax year using the same records as the 1988 examination did not constitute a second inspection under section 7605(b).

    Court’s Reasoning

    The court applied section 7605(b), which aims to limit unnecessary examinations and second inspections without notice. It found that Agent Chase’s reexamination of the 1987 tax year was not unnecessary because it was based on new information from the 1988 examination, and the statute does not limit the number of examinations for the same year. The court also determined that there was no second inspection of the 1987 records since the same records were examined in connection with the 1988 tax year, and each tax year is treated as a separate matter. The court cited cases like United States v. Powell and Curtis v. Commissioner to support its interpretation of section 7605(b). The court noted that the purpose of section 7605(b) is to curb the investigating powers of low-echelon revenue agents, but it does not restrict the IRS from examining subsequent years using the same records.

    Practical Implications

    This decision allows the IRS greater flexibility to reexamine tax years without providing notice if the same records are relevant to an examination of a different year. Practitioners should be aware that signing a Form 870 does not preclude further examination of the same year. The ruling reaffirms the principle that each tax year is a separate liability, which may affect how taxpayers and their representatives handle ongoing audits and amended returns. Future cases may reference Burlage when addressing the scope of section 7605(b) and the IRS’s ability to reexamine tax years based on information from subsequent years.

  • Curtis v. Commissioner, 84 T.C. 1349 (1985): IRS Inspections of Partnership Books Not Considered Inspections of Partner’s Books

    Curtis v. Commissioner, 84 T. C. 1349 (1985)

    The IRS’s inspection of a limited partnership’s books does not constitute a second inspection of a partner’s books under section 7605(b) of the Internal Revenue Code.

    Summary

    In Curtis v. Commissioner, the U. S. Tax Court held that the IRS’s examination of a limited partnership’s books did not constitute a second inspection of a partner’s books under section 7605(b), which prohibits unnecessary or multiple inspections of a taxpayer’s books without notice. Leslie Curtis, a partner in Rock Properties, Ltd. , argued that the IRS’s review of the partnership’s books was a second inspection of his books. The court disagreed, stating that a partnership’s institutional identity distinguishes its books from those of individual partners. This decision clarifies that the IRS may inspect partnership records without it counting as an inspection of each partner’s books, thereby not infringing on the protections of section 7605(b).

    Facts

    Leslie C. Curtis, a California resident, held a 9. 5% interest in Rock Properties, Ltd. , a Florida limited partnership. In 1978, the IRS examined Curtis’s 1976 tax return and sent him a “no-change” letter. Later that year, the IRS inspected the partnership’s books without notifying Curtis, leading to a disallowance of some of his claimed distributive share of the partnership’s losses and credits. Curtis argued that this constituted a second inspection of his books in violation of section 7605(b).

    Procedural History

    The IRS issued a statutory notice of deficiency to Curtis for 1976 and 1977. Curtis petitioned the Tax Court, contesting the notice on the grounds of an alleged violation of section 7605(b). The Tax Court heard the case and ruled in favor of the Commissioner, holding that the examination of the partnership’s books did not constitute a second inspection of Curtis’s books.

    Issue(s)

    1. Whether the IRS’s inspection of the books of a limited partnership constitutes a second inspection of a partner’s books under section 7605(b) of the Internal Revenue Code.

    Holding

    1. No, because the inspection of a limited partnership’s books does not equate to an inspection of a partner’s books. The court reasoned that a partnership possesses an institutional identity separate from its partners, and thus, its books are not the same as those of individual partners.

    Court’s Reasoning

    The court applied section 7605(b), which aims to prevent harassment through repetitive investigations but not to severely restrict the Commissioner’s powers. It cited precedent that a partnership, though not a “taxpayer,” can have an institutional identity sufficient to distinguish its books from those of its partners. The court emphasized that recognizing the partnership’s books as those of the partners would unduly hamper the IRS’s ability to evaluate partnerships. The court referenced the Supreme Court’s decision in Bellis v. United States, which acknowledged partnerships as entities for certain purposes, and rejected Curtis’s reliance on Moloney v. United States, noting the significant differences in partnership size and involvement. The court concluded that an inspection of the partnership’s books did not violate section 7605(b).

    Practical Implications

    This ruling clarifies that the IRS can inspect partnership records without such action counting as an inspection of each partner’s books under section 7605(b). This allows the IRS greater latitude in auditing partnerships, particularly larger ones with many partners, without the need to notify each partner of such an examination. The decision impacts how attorneys should advise clients involved in partnerships regarding IRS investigations. It also sets a precedent for distinguishing between corporate and partnership entities in tax law, influencing how similar cases involving entity examinations should be analyzed. Subsequent cases like Williams v. United States have applied this ruling, treating limited partnerships more like corporate investors for inspection purposes.

  • Ballantine v. Commissioner, 74 T.C. 516 (1980): Timely Filing of Motions and IRS Second Examination Notices

    Ballantine v. Commissioner, 74 T.C. 516 (1980)

    Mailing a motion to the Tax Court within the prescribed time limit constitutes timely filing, even if service on opposing counsel is slightly delayed; furthermore, a taxpayer’s demand for a second examination letter from the IRS is not a valid defense against a notice of deficiency when no second examination of taxpayer’s books occurred.

    Summary

    In this Tax Court case, petitioners challenged a motion to strike filed by the Commissioner, arguing it was untimely and that the Commissioner erred by not issuing a second examination letter before issuing a notice of deficiency. The court held that the Commissioner’s motion to strike was timely because it was mailed to the court within the 45-day limit, even though service on petitioners’ counsel was slightly delayed due to an incorrect address. The court also ruled that the Commissioner was not required to issue a second examination letter under Section 7605(b) because no second examination of the petitioners’ books actually took place. The court granted the Commissioner’s motion to strike a portion of the petition and denied the petitioners’ motion to dismiss.

    Facts

    The IRS served the petition on December 12, 1977. On January 26, 1978 (45 days later), the Commissioner mailed a motion to strike to the Tax Court. On the same day, a copy was mailed to petitioners’ counsel at a former address and was returned as undeliverable. Upon return, the Commissioner immediately re-mailed the motion copy to the correct address of petitioners’ counsel. Petitioners argued the motion to strike was untimely because service on their counsel was delayed. Petitioners also argued that the Commissioner erred by issuing a deficiency notice without issuing a second examination letter after petitioners refused to provide further access to their books without such a letter.

    Procedural History

    Petitioners filed a motion to dismiss the case or, alternatively, to dismiss the Commissioner’s motion to strike, arguing the motion to strike was untimely under Tax Court Rules. The Commissioner had filed a motion to strike paragraph 4(e) of the petition, arguing it failed to state a claim upon which relief could be granted. The Tax Court consolidated these motions for hearing and ruling.

    Issue(s)

    1. Whether the Commissioner’s motion to strike was timely filed with the Tax Court, considering a delay in serving petitioners’ counsel.
    2. Whether the Commissioner’s failure to issue a second examination letter under Section 7605(b) before issuing a notice of deficiency constitutes a valid claim upon which relief can be granted, when no second examination occurred.

    Holding

    1. Yes, because timely mailing the motion to the Tax Court constitutes timely filing under Section 7502 and Tax Court Rules, and the minor delay in service on petitioners’ counsel did not prejudice them or invalidate the timely filing.
    2. No, because Section 7605(b) is intended to protect taxpayers from unnecessary examinations, and since no second examination occurred, the failure to issue a second examination letter does not invalidate the notice of deficiency or provide grounds for relief.

    Court’s Reasoning

    The court reasoned that under Section 7502 and Tax Court Rules, timely mailing to the court is considered timely filing. The motion to strike was mailed to the Tax Court within the 45-day deadline. The delay in serving petitioners’ counsel was inconsequential and did not prevent timely filing with the court. The court emphasized its discretion to allow pleadings out of time in the interest of justice, although it found the motion was indeed timely. Regarding the second issue, the court distinguished cases where a second examination had occurred without proper notice. Here, no second examination took place; petitioners merely requested a second examination letter before allowing further access to their books, which the court found was not required for the deficiency notice to be valid. The court cited precedent like United States Holding Co. v. Commissioner and Rose v. Commissioner, which held that refusing access and issuing a deficiency notice based on existing information without a second examination does not violate Section 7605(b).

    Practical Implications

    Ballantine v. Commissioner clarifies the procedural aspects of timely filing motions in Tax Court, emphasizing that mailing to the court is the key action for timeliness, not necessarily immediate service on opposing counsel. It also reinforces the IRS’s ability to issue notices of deficiency based on available information without conducting a second examination if the taxpayer refuses to cooperate without a second examination letter. This case is important for understanding the limitations of taxpayer defenses based on Section 7605(b) when no actual second inspection of books has occurred. It highlights that Section 7605(b) is meant to prevent burdensome repeat examinations, not to impede the IRS from issuing deficiency notices based on existing records when taxpayers become uncooperative.

  • Ballantine v. Commissioner, 70 T.C. 558 (1978): The Effect of IRS Noncompliance with Section 7605(b) on Deficiency Notices

    Ballantine v. Commissioner, 70 T. C. 558 (1978)

    The IRS’s failure to issue a second examination letter under section 7605(b) does not invalidate a notice of deficiency or shift the burden of proof if no second examination occurred.

    Summary

    In Ballantine v. Commissioner, the Tax Court ruled that the IRS’s failure to issue a second examination letter under section 7605(b) did not invalidate the notices of deficiency issued to the taxpayers. The court held that since no second examination took place, there was no violation of section 7605(b). The taxpayers argued that the IRS’s actions were arbitrary and excessive, but the court found that the IRS’s deficiency determinations were based on available information, and thus, the burden of proof remained with the taxpayers. This decision clarifies that the IRS’s noncompliance with section 7605(b) does not automatically void a notice of deficiency or shift the burden of proof in the absence of a second examination.

    Facts

    Robert A. Ballantine and Inez V. Ballantine, along with their related corporations, were audited by the IRS from August 8, 1975, to February 10, 1977. During the audit, the IRS requested the taxpayers to execute “Slush Fund Affidavits,” which they refused on Fifth Amendment grounds. Subsequently, the IRS sought further access to their books and records, but the taxpayers, advised by counsel, refused to allow further access without a second examination letter under section 7605(b). The IRS issued deficiency notices without further inspection, leading the taxpayers to challenge these notices on the grounds that the IRS violated section 7605(b) by not issuing a second examination letter.

    Procedural History

    The taxpayers filed a petition with the Tax Court challenging the IRS’s deficiency determinations. The IRS moved to strike paragraph 4(e) of the petition, which alleged a violation of section 7605(b), claiming it failed to state a claim upon which relief could be granted. The taxpayers cross-moved to dismiss the case or, alternatively, the IRS’s motion to strike, arguing that the IRS failed to timely move with respect to the petition. The Tax Court heard arguments on both motions and ultimately adopted the opinion of the Special Trial Judge.

    Issue(s)

    1. Whether the IRS’s failure to issue a second examination letter under section 7605(b) renders the notices of deficiency null and void?
    2. Whether the IRS’s failure to issue a second examination letter shifts the burden of proof to the IRS by rendering the deficiency notices arbitrary and excessive?

    Holding

    1. No, because no second examination occurred, and thus, there was no violation of section 7605(b).
    2. No, because the deficiency notices were based on available information and not deemed arbitrary and excessive solely due to the lack of a second examination letter.

    Court’s Reasoning

    The court applied section 7605(b), which limits the IRS to one inspection per taxable year unless the taxpayer requests otherwise or the IRS provides written notice of an additional inspection. The court reasoned that since no second examination took place, there was no violation of section 7605(b). The court cited United States Holding Co. v. Commissioner and Rose v. Commissioner, where similar facts led to the same conclusion. The court also distinguished Reineman v. United States, noting that it involved a second examination without notice, unlike the present case. The court emphasized that the taxpayers’ refusal to allow further inspection did not compel the IRS to issue a second examination letter, and the IRS’s decision to issue deficiency notices based on existing information did not render them arbitrary and excessive. The court also noted that the taxpayers’ claim regarding the second examination letter was intertwined with other allegations of arbitrary and excessive determinations, but striking paragraph 4(e) would not prejudice their case.

    Practical Implications

    This decision clarifies that the IRS’s noncompliance with section 7605(b) does not automatically invalidate a notice of deficiency or shift the burden of proof unless a second examination occurs without proper notification. Attorneys should advise clients that refusing further IRS access to records without a second examination letter does not provide a defense against a notice of deficiency. Practitioners should focus on proving that deficiency notices are arbitrary and excessive based on the information available to the IRS, rather than relying solely on procedural noncompliance. This ruling has been followed in subsequent cases, reinforcing the principle that the IRS’s procedural errors do not necessarily undermine its substantive determinations.

  • Rose v. Commissioner, 70 T.C. 558 (1978): Validity of Notice of Deficiency When Taxpayer Refuses Second Examination

    Rose v. Commissioner, 70 T. C. 558 (1978)

    A notice of deficiency is not void when the IRS uses an alternative method to determine income after a taxpayer refuses a second examination of their records.

    Summary

    In Rose v. Commissioner, the IRS examined the taxpayers’ records for eight months before returning them upon request. When the IRS later sought to reexamine the records, the taxpayers refused, citing Section 7605(b). The IRS then used the bank deposits plus expenditures method to determine deficiencies, which the taxpayers contested. The Tax Court held that the IRS did not violate Section 7605(b) by not reexamining the records and that the notice of deficiency was valid, even though it was not based on the taxpayers’ records.

    Facts

    Albert E. and Edwina Rose, residents of Helena, Montana, were audited by the IRS for their 1970 and 1971 tax years. The IRS initially examined their records for eight months before returning them at the taxpayers’ request. Later, the IRS sought to reexamine these records, but the Roses refused, relying on Section 7605(b), which prohibits a second examination without written notice. The IRS then used the bank deposits plus expenditures method to determine deficiencies, which the Roses stipulated were correct in amount.

    Procedural History

    The Roses filed a petition in the United States Tax Court contesting the notice of deficiency issued by the IRS. The Tax Court addressed whether the IRS violated Section 7605(b) by not reexamining the records and whether the notice of deficiency was void because it was determined using an alternative method.

    Issue(s)

    1. Whether the IRS violated Section 7605(b) by not reexamining the taxpayers’ records after their initial return.
    2. Whether a notice of deficiency determined by an alternative method (bank deposits plus expenditures) is void when taxpayers maintain adequate records.

    Holding

    1. No, because the IRS did not reexamine the records, there was no violation of Section 7605(b).
    2. No, because the notice of deficiency is not void even when determined by an alternative method when taxpayers refuse a second examination.

    Court’s Reasoning

    The Tax Court relied on United States Holding Co. v. Commissioner, which held that no second examination occurred when taxpayers refused to provide records for reexamination. The court emphasized that the notice of deficiency was not arbitrary or void, as the IRS was not required to reexamine the records to issue a valid notice. The court distinguished cases that dealt with the determination of income from those addressing the validity of the notice of deficiency, noting that the notice’s validity is a jurisdictional issue. The court also referenced Suarez v. Commissioner, where a notice based on inadmissible evidence was upheld, reinforcing that the notice’s validity is separate from the evidence used to determine income. The court concluded that even if the IRS’s method was arbitrary, the taxpayers’ stipulation that the deficiencies were correct in amount shifted the burden of proof, which the IRS met.

    Practical Implications

    Rose v. Commissioner clarifies that the IRS can issue a valid notice of deficiency using alternative methods when taxpayers refuse a second examination of their records. This ruling allows the IRS flexibility in audits, reinforcing its authority to determine deficiencies based on available information. For taxpayers, it underscores the importance of cooperating with IRS requests for records, as refusal may lead to determinations based on alternative methods. The decision also impacts legal practice by clarifying that the validity of a notice of deficiency is distinct from the method used to determine income. Subsequent cases have applied this ruling in similar contexts, reinforcing the IRS’s procedural authority in tax audits.