United States: Tax Court In Brief | Clarkson v. Comm'r | Frivolous Return Penalties And "Zero Returns"

The Tax Court in Brief – September 5th – September 9th, 2022

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Tax Litigation: The Week of September 5th, 2022, through September 9th, 2022

Clarkson v. Comm'r, T.C. Memo 2022-22| September 7, 2022 | Lauber, Judge | Dkt. No. 16804-21L

Short Summary: This is a collection due process opinion addressing frivolous return penalties assessed against taxpayer Eric Clarkson for submissions he made to the IRS for tax years 2003-2016. Clarkson failed to file returns for every year 2003-2016. So, the IRS prepared substitutes for return for each year and issued notices of deficiencies, totaling about $250,000. Clarkson then prepared and filed Forms 1040 for each year 2003-2016. For 2003, he attached Form 4852, Substitute for Form W-2, showing $0 income in 2003 and he created and attached his own Form 1099-MISC. He claimed a refund for 2003. Clarkson did the same for years 2004-2016, except for each year he claimed $0 wages, $0 adjusted income, $0 federal income tax withheld, and $0 overpayment and refund request. The IRS's examining agent proposed $5,000 frivolous return penalty ("FRP") for each Form 1040. Those were approved by the agent's supervisor. After assessing the penalties, the IRS sought to collect via a levy notice. Clarkson stood fast claiming that his returns were not frivolous and claimed that his compensation from a "non-governmental, for-profit, private sector business," were not taxable. He petitioned the Tax Court to determine that his returns were not frivolous and that the FRPs were not proper. The IRS moved for summary judgment on the issue.

Key Issues:

Whether, as a matter of law, Clarkson was liable for the FRPs?

Primary Holdings:

Yes. Clarkson's submissions satisfy all three conditions specified in 26 U.S.C. § 6702(a) for a "frivolous return." Each return was submitted, unequivocally, as a return of tax. Each return contained information which, on its face, indicated that the self-assessment was substantially incorrect. And, Clarkson's conduct was based on a position that the IRS has identified as frivolous – submission of "zero returns" constitutes a frivolous position.

Key Points of Law:

Standard of Review. Section 6330(d)(1) does not prescribe the standard of review that the Tax Court should apply in reviewing an IRS administrative determination in a CDP case. Pursuant to Tax Court precedents, where the taxpayer's underlying tax liability is properly at issue, the Tax Court reviews the IRS determination de novo. A taxpayer may challenge his underlying liability at a CDP hearing if he did not receive a statutory notice of deficiency for that liability or did not otherwise have a prior opportunity to dispute it. IRC § 6330(c)(2)(B). Where the taxpayer's underlying liability is not properly in dispute, the Tax Court reviews the IRS decision for abuse of discretion only. See Jones v. Commissioner, 338 F.3d 463, 466 (5th Cir. 2003); Sego v. Commissioner, 114 T.C. 604, 610 (2000); Goza v. Commissioner, 114 T.C. 176, 181–82 (2000). Abuse of discretion exists when a determination is arbitrary, ca[1]pricious, or without sound basis in fact or law. See Murphy v. Commissioner, 125 T.C. 301, 320 (2005), aff'd, 469 F.3d 27 (1st Cir. 2006).

Frivolous return penalties imposed under section 6702(a) are "assessable penalties" not subject to deficiency procedures. See 26 U.S.C. § 6703(b). Clarkson did not receive, and could not have received, a statutory notice of deficiency that would have enabled him to petition the Tax Court for re-determination of the penalties. He was thus entitled to challenge his underlying liabilities for the penalties during his CDP hearing. So, the review of this issue de novo.

Underlying Liability – Factors for Frivolous Tax Return Penalties. 26 U.S.C. § 6702(a) imposes a civil penalty of $5,000 for filing "frivolous tax returns." The IRS bears the burden of proof. Id. at § 6703(a); see Osband v. Commissioner, T.C. Memo. 2013-188, 106 T.C.M. (CCH) 124, 128.

Frivolous Return. A frivolous return penalty applies where three conditions are met. 1. The taxpayer must have filed a document that "purports to be a return of a tax imposed by this title." § 6702(a)(1). 2. The purported return must be a document that either "does not contain information on which the substantial correctness of the self-assessment may be judged" or "contains information that on its face indicates that the self-assessment is substantially incorrect." § 6702(a)(1). 3. The taxpayer's conduct must either be "based on a position which the Secretary has identified as frivolous" or must "reflect[] a desire to delay or impede the administration of Federal tax laws." § 6702(a)(2). Courts generally look to the face of the document to determine whether a purported return is "frivolous." If a purported return reflects a position that the IRS has identified as "frivolous," then the taxpayer's belief in the correctness of his position cannot serve as a defense to the penalty. See Hudson v. United States, 766 F.2d 1288, 1291 (9th Cir. 1985) (per curiam); Alexander v. Commissioner, T.C. Memo. 2012-75, 103 T.C.M. (CCH) 1405, 1407; Lindberg v. Commissioner, T.C. Memo. 2010-67, 99 T.C.M. (CCH) 1273, 1278; Vaughn v. United States, 589 F. Supp. 1528, 1532 (W.D. La. 1984).

Zero Returns = Frivolous Return. The IRS has identified "zero return" arguments as "frivolous positions." Notice 2010-33, 2010-17 I.R.B. at 609. And the courts have repeatedly done the same. See, e.g., Walker v. Commissioner, T.C. Memo. 2022-63; Briggs v. Commissioner, T.C. Memo. 2016-86; Lovely v. Commissioner, T.C. Memo. 2015-135, aff'd per curiam, 642 F. App'x 268 (4th Cir. 2016).

Judicially-Assessed Frivolous Return Penalty. Section 6673(a)(1) authorizes the Tax Court to require a taxpayer to pay to the U.S. a penalty, not in excess of $25,000, "[w]henever it appears to the Tax Court that—(A) proceedings before it have been instituted or maintained . . . primarily for delay, [or] (B) the taxpayer's position in such proceeding is frivolous or groundless." See also Coleman v. Commissioner, 791 F.2d 68, 71–72 (7th Cir. 1986); Salzer v. Commissioner, T.C. Memo. 2014-188, 108 T.C.M. (CCH) 284, 287. "Frivolous and groundless claims divert the Court's time, energy, and resources away from more serious claims and increase the needless cost imposed on other litigants . . . ." Kernan v. Commissioner, T.C. Memo. 2014-228, 108 T.C.M. (CCH) 503, 512, aff'd, 670 F. App'x 944 (9th Cir. 2016).

Insights: Submission of a "zero return" is likely a frivolous return, which can result in the assessment of frivolous return penalties. In addition to those statutory penalties, the Tax Court may assess up to $25,000 in additional penalties. If the Tax Court has not had an occasion to warn a taxpayer about these risks of the judicially-assessable penalty, the Tax Court may decide to not impose the addition to tax. But, that decision is solely within the purview of the Tax Court.

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