Doc 2006-3459 (6 pgs)

Author: Raby, William L.;

Raby, Burgess J.W., Tax Analysts
The Schedule D instructions for the 2005 Form 1040 state in no
uncertain language that each disposition of a capital asset must be
reported on a separate line on the Schedule D (or Schedule D-1 if there
were so many that Schedule D required a continuation). Phoenix CPA Ed
Zollars said of the instructions that it was difficult to come to a
conclusion that an attachment [other than Schedule D-1] would ever be
acceptable. See Crystal Tandon, IRS Clarifies Schedule D
Instructions, Tax Notes, Jan. 16, 2006, p. 208. The practitioner
annoyance reflected in Zollarss comment led to an IRS clarification
that taxpayers could continue to provide detail in the form of
transaction summaries issued by their brokers, and presumably other
attachments as well, as long as the attachment contained four pieces of
information for each transaction - date of acquisition, date of
disposition, basis, and proceeds less transaction costs. Doc 2006-561,
2006 TNT 7-12. Thus, one of the ways in which voluminous Schedule D data
were being handled by tax preparers was blessed: The use of see
schedule attached. The IRS clarification also noted, however, that
merely inserting summary totals on Schedule D and stating, Details of
each transaction will be provided upon request, is not sufficient. Not
sufficient? Sufficient? Not sufficient or sufficient for what?
From both a taxpayer and a practitioner viewpoint, returns are
certainly not sufficient if they trigger failure-to-file penalties. They
certainly are not sufficient if they fail to start the running of the
statute of limitations. They are not sufficient, but to a lesser degree,
if the IRS is unwilling to process them but they still manage to avoid
failure-to-file penalties and to start the statute of limitations
running. They may be viewed as not sufficient by practitioners if there
is danger that the practitioners themselves would be exposed to preparer
penalties. Those four concerns - failure-to-file penalties, failure to
start the running of the statute of limitations, IRS unwillingness to
process, and possible preparer penalties - are the subjects of this
article.
Returns Insufficient to Avoid Failure-to-File Penalties
Section 6651(a)(1) imposes the familiar 5 percent per month
penalty, capped at 25 percent, for failure to file any return
required. Neither the statute nor the regulations, however, provide a
definition of return. Section 6011(a) comes close:
when required by regulations . . . any person made liable for any
tax imposed by this title, or with respect to the collection
thereof, shall make a return or statement according to the forms
and regulations prescribed. . . . Every person required to make a
return or statement shall include therein the information required
by such forms or regulations.
Robert D. Beard v. Commissioner, 82 T.C. 766 (1984), affd per
curiam, 793 F.2d 139 (6th Cir. 1986), tested whether a taxpayer could
include the required information but modify the prescribed forms and
still have a return sufficient to avoid penalties for failure to file.
Beard was essentially a tax protester trying to test how far he could
go. The main substantive step he took on his 1981 Form 1040 was to
deduct his wages as being in exchange for his labor and thus a type of
receipt on which he realized no gain. To facilitate that deduction, he
changed line item headings on the return.

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When Is a Return Sufficient? And What Does 'Sufficient' Mean?

Doc 2006-3459 (6 pgs)

Congress has given discretion to the Commissioner to prescribe by

regulation forms of returns and has made it the duty of the
taxpayer to comply. It thus implements the system of self
assessment which is so largely the basis of our American scheme of
income taxation. The purpose is not alone to get tax information
in some form but also to get it with such uniformity,
completeness, and arrangement that the physical task of handling
and verifying returns may be readily accomplished.
321 U.S. at 223.
Judge Whitaker also quoted from Parker v. Commissioner, 365 F.2d
792 (8th Cir. 1966), although he noted that the facts of that case were
distinguishable from the Beard case:
Taxpayers are required to file timely returns on forms established
by the Commissioner. * * * The Commissioner is certainly not
required to accept any facsimile the taxpayer sees fit to submit.
If the Commissioner were obligated to do so, the business of tax
collecting would result in insurmountable confusion.
365 F.2d at 800.
Where does the line get drawn between acceptable and unacceptable
modifications to the instructions and forms? The appeals court in United
States v. Moore, 627 F.2d 830, 835 (7th Cir. 1980), said of tax
protester cases: In our self-reporting tax system the government should
not be forced to accept as a return a document which plainly is not
intended to give the required information. That was a conclusion that
Judge Whitaker not only embraced in his Beard opinion but emphasized
when he concluded that Beard failed to meet [t]he critical requirement
that there must be an honest and reasonable attempt to satisfy the
requirements of the federal income tax law.
Statute of Limitations and the Fifth Amendment
The idea of an honest and reasonable attempt is embraced within
the concept of substantial compliance, as it has developed regarding
tax return preparation and filing. In ILM 200547012, Doc 2005-23912,
2005 TNT 227-6, the IRS dealt with the sufficiency of Forms 1040 to
start the running of the statute of limitations. The taxpayer, under
criminal investigation, had essentially put asterisks (******) where the
form called for amounts and it was reasonable to expect that he would
have had income of that sort. The returns explained the failure to
provide specific information by citing the Fifth Amendment privilege
against self-incrimination. The IRS dealt with that by pointing out
that:
the Taxpayer is not making an honest and reasonable attempt to
comply with the tax law, because he has submitted documents
purporting to claim a Fifth Amendment privilege he cannot validly
exercise. The Fifth Amendment does not shelter a taxpayer from
filing a return. [Citations omitted.] Pending criminal
investigations do not excuse a failure to file a return, United
States v. Malquist, 791 F.2d 1399 (9th Cir. 1986), even if the
taxpayer is asserting his Fifth Amendment privilege against selfincrimination, see Kirschbaum v. Commissioner, T.C. Memo. 1989526. The Fifth Amendment privilege against self-incrimination does

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Tax Court Judge Meade Whitaker noted that the regulations mandate
the use of the proper official form, a requirement that also has the
approval of the U.S. Supreme Court. He cited Commissioner v. Lane-Wells
Co., 321 U.S. 219 (1944), as having recognized that mandate in stating:

Doc 2006-3459 (6 pgs)

On that point, the memorandum concluded that [t]he privilege against

self-incrimination is not validly exercised where taxpayer does not
provide the financial data on his tax returns; instead, this amounts to
a total failure to file a return. What does constitute sufficient data
so that the substantial compliance test is met? The memorandum also
speaks to that. A return will meet that standard if it lists items of
income, deductions, and credits in compliance with the statutory duty to
report information. It will meet that standard if it provides the
Service with sufficient data from which an income tax liability can be
computed.
As phrased somewhat more broadly by Judge Whitaker in Beard, at
777:
First, there must be sufficient data to calculate tax liability;
second, the document must purport to be a return; third, there
must be an honest and reasonable attempt to satisfy the
requirements of the tax law; and fourth, the taxpayer must execute
the return under penalties of perjury.
Inability to Process
Rather paradoxically, a return may be deemed not processible by
the IRS Service Center to which it has been sent and still be a valid
return for statute of limitations purposes. In ILM 200251013, Doc 200227813, 2002 TNT 246-43, the IRS considered the situation in which a Form
1040-NR return was filed on behalf of a foreign partner but showing a
different taxpayer identification number on the 1040-NR than on the
related Form 8805, Foreign Partners Information Statement of Section
1446 Withholding Tax, which summarized the withholding tax paid on the
partners behalf during the partnerships tax year. The Form 8805 is
intended to be attached to the Form 1040-NR in the same manner as a Form
W-2 is attached to a Form 1040-NR or a Form 1040 and the TINs are
expected to be the same. The request for advice had stated that the
return could not be processed by the IRS until the mismatch in TINs was
resolved.
The ILM concluded that the return still met the substantial
compliance test and was therefore sufficient to start the running of the
statute of limitations. It also constituted a valid refund claim.
However, because the return was not processible, the time for
calculating overpayment interest would not start running until 45 days
after the mismatch was resolved and the return put into processible
form.
Penalties on Practitioners
The sufficiency of returns to start the running of the statute of
limitations, to avoid penalties for failure to file, or even to be
processible is seldom or never seen as an issue for the returns filed by
the tax practitioners with whom we deal. That may be why the IRS
instructions on the Schedule D information seemed to upset so many
people. Heres a sample of the reactions:

o Can they do this?

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not protect a taxpayer from answering all income related

questions, United States v. Russell, 585 F.2d 368, 371 (8th Cir.
1978); United States v. Leiderneker, 779 F.2d 1417, 1418 (9th Cir.
1986), because the privilege protects the taxpayer from disclosing
only the source of the income. Shivers v. United States, 788 F.2d
1046, 1049 (5th Cir. 1986); United States v. Wade, 585 F.2d 573,
574 (5th Cir. 1978, cert. denied, 440 U.S. 928 (1979).

Doc 2006-3459 (6 pgs)

time to do and for which clients are not going to be willing to

pay.

o What is the penalty if we continue providing the information

by photocopying what the brokers provide us?
The decided cases and rulings deal with tax protesters and people
undergoing criminal investigation, not with the nuances of copying
information from one supporting schedule onto another.
What about preparer penalties? The preparer penalties of section
6694 and the penalties of section 6701, like the taxpayer penalties of
section 6662, are triggered only by underpayments of tax. If theres no
underpayment, theres no penalty, no matter the degree to which the
preparation of the return departed from the instructions. If theres an
underpayment, the focus of any contest over a proposed penalty will be
the propriety of the position(s) taken and not, as such, on the
compliance with the IRS instructions for form preparation. Failure to
follow instructions on the form may be viewed as a sign of negligence if
related to the underpayment itself, but not otherwise. By the same
token, scrupulous compliance with the instructions will weigh in the
taxpayers favor when trying to avoid penalties.
Circular 230 also provides standards and penalties, of course.
Section 10.34 provides [s]tandards for advising with respect to tax
return positions and for preparing or signing returns. Nowhere does
section 10.34 mention any requirement of slavish adherence to return
instructions; it generally adopts the section 6694 standards applicable
to return preparers.
Thus, the IRS clarification of the Schedule D instructions
probably stated something that essentially was true even if the
clarification had not been issued. If sufficient detail was attached
supporting the capital gains numbers, the return probably was legally
sufficient even if the detailed information was not on the specific form
approved by the IRS. It would meet the substantial compliance test.
No Penalty for Alteration of Jurat?
The phrase under penalties of perjury was deleted on Roger B.
Morrisons Form 1040 for 1980, although the return was otherwise
properly signed. Unbeknownst to his return preparer, Morrison had simply
taken his pen and struck through the offending words. They were, as he
testified, inappropriate in light of his belief that one could commit
perjury only when testifying in a court of law. Asked to explain why he
had done that on his 1980 return but not on his 1981 return, he
testified that he had by then been informed that you really should not
do that. The reason the IRS challenged the strike-through was probably
more related to the other issues it had with Morrison than it was his
alteration of the jurat. However the issue got raised, it was part of
the case by the time it reached Tax Court Judge Charles R. Simpson.
Morrison argued that section 6651 simply does not provide a penalty for
an individual who alters a jurat but does file a return that is
otherwise adequate. Judge Simpson agreed that that might be literally
true, but pointed out that a return that is not signed under the
penalties of perjury is not a return under the substantial compliance
test. Thus, alteration of the jurat results in a failure to file and it
is that which draws the penalty. He added that on a number of
occasions, this Court has sustained such an addition for the failure to
include the jurat, and we so hold. See, e.g., Cupp v. Commissioner, 65
T.C. 68 (1975), affd 559 F.2d 1207 (3d Cir. 1977); Vaira v.
Commissioner, 52 T.C. 986 (1969), revd. on other grounds 444 F.2d 770
(3d Cir. 1971).

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o This merely creates more paperwork which we do not have the

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A trap for the unwary may lie in wait for a few of the non-U.S.
persons who have U.S. tax withheld from payments to them of dividends,
interest, annuities, and other items of fixed or determinable income. If
their U.S. tax is fully satisfied by way of withholding, those non-U.S.
persons are not required to file a U.S. tax return. But if they perceive
the tax withheld was excessive, they will have to file a U.S. return as
a way of obtaining a tax refund. That was the situation in ICI Pension
Fund v. Commissioner, 112 T.C. 83, Doc 1999-9072, 1999 TNT 44-66.
Withholding tax on ICIs dividend income was more than the zero
tax ICI thought was due, so ICI filed Forms 990-T with the IRS as a
refund claim. In due course, it received a refund. When the IRS then
sought to get the refund returned, ICI argued that whatever the merits
of the IRS case, the statute of limitations had run. The IRS disagreed.
No return had ever been filed, it said, and so the statute of
limitations for those years had never run. The Tax Court agreed with the
IRS that while Form 990-T was sufficient to constitute a claim for
refund, it was not a tax return for statute of limitations purposes. To
the ICI contention that it was excepted under reg. section 1.60121(b)(2)(I) from the requirement that it file a return, the court
responded:
these rules do not apply to the facts at hand. First, the Fund's
tax liability is not "fully satisfied" by amounts that have been
withheld. Although the Fund states correctly that the Fund did
satisfy this requirement at one time, the Fund ceased to meet this
requirement when it requested and received a refund of the
withheld tax. The fact that the Fund claimed a refund of these
withheld amounts also removed it from the regulatory exception.
Section 1.6012-1(b)(2)(i), Income Tax Regs., states specifically
that that exception is not applicable where, as is the case here,
the taxpayer claims a refund of an overpaid tax.
Under normal circumstances, a taxpayer would be filing the tax
return form as the refund claim. For many, if not most, Forms 1040-NR
being filed solely to obtain refunds, the instructions provide a
simplified procedure for claiming those refunds. The question then
arises whether a Form 1040-NR omitting the data permitted to be omitted
is a sufficient return for statute of limitations purposes. We think it
is, for the obvious reason that it complies with the instructions. We
also think that the information provided does constitute substantial
compliance under the circumstances.
Conclusion
Over the years, the increased complexity of both the tax law and
the transactions with which it deals, plus the soaring volume and size
of returns, facilitated by changes in data processing technology, has
resulted in a transition from what was a labor-intensive processing
routine for both taxpayer and tax collector to one in which taxpayer
computers transmit data to IRS computers. The audit process has also
changed, with the vast bulk of taxpayer contacts relative to filed
returns being computer-generated.
In a bygone day, a taxpayer could modify an IRS form to better
accommodate that taxpayers needs. That day is gone. Taxpayers and
practitioners alike must face the reality that, as the Supreme Court
said in 1944, Treasury has the power to mandate use of proper official
forms. In Lane-Wells, the Court emphasized that [t]he purpose is not
alone to get tax information in some form but also to get it with such
uniformity, completeness, and arrangement that the physical task of

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Non-U.S.-Person Refund Claims

Doc 2006-3459 (6 pgs)

One of the strengths of our system is illustrated in situations

like the security account transaction reporting instructions that
triggered practitioner consternation earlier this year. When the IRS
miscalculates or even goes too far, tax practitioners and others have
avenues to voice their unhappiness - and the IRS is usually
conciliatory enough so that it clarifies whatever was said in such a
way as to improve its workability. When the IRS has not seemed flexible
enough to Congress, legislative action has often forced the IRS to
soften its stance. Look at the provisions in the various taxpayer bills
of rights enacted over the past dozen years. Section 7430 is a good
example. When it came to reimbursing taxpayers for their legal fees and
other expenses of tax controversies when they substantially prevailed,
the IRS managed to allow few dollars to squeeze through despite the
provisions of section 7430. In a letter to the editor published in Tax
Notes on Oct. 9, 1995, p. 247, Robert T. Duffy pointed out that during
the first 10 years of its existence, roughly 1983 through 1992, awards
of litigation costs under section 7430 averaged only about $220,000 per
year and $6,300 per award. The General Accountability Office reported
that during fiscal 1993 and 1994 combined, there were 43 attorney fee
awards of more than $10,000, aggregating $1.6 million, charged to the
IRS. Of those, 26 were under section 7430, aggregating $1.1 million. Doc
95-10912, 95 TNT 237-20. So what happened? Congress made repeated
changes to make section 7430 more taxpayer-friendly.
Our point is that the tax practitioner is not powerless in dealing
with IRS actions. That power is one of the checks in the complex system
of checks and balances that manages to keep our system of government
from asserting more regulation than it otherwise would while preventing
the inefficient and expensive chaos that would result if there was no
regulation. Part of the power of the practitioner-taxpayer coalition is
that the IRS really has never been willing to fully assert the power
that it does have. As in the Cold War days, neither side can push too
hard because of the fear of massive retaliation from the other.
The IRS does not know what would happen if, for example, it
decreed that only official forms could be used for attachments and
millions of taxpayer returns came in that contained full information but
with varied attachments. The courts would not back the IRS if it tried
to treat returns containing those attachments
as invalid and proceeded
to impose failure-to-file penalties.1 The IRS could treat the returns as
nonprocessible, but might not even be able to substantiate that claim if
someone wanted interest on a refund to start 45 days after the
nonprocessible return reached the IRS and took that issue to court.
The fact is that the IRS would frustrate its primary goal of tax
collection, increase the costs of achieving that lesser level of
performance, and divert resources to preparing and trying cases that
should never reach that stage. In the end, a congressional committee
would undoubtedly hold hearings and Congress probably would pass a bill
stating that substantial conformity does not require use of only IRSprescribed attachments as long as adequate information is supplied.
1

Note that the courts might or might not uphold the IRS if it treated as invalid the use of only
summary information on a Schedule D that also contained the notation: Details of each transaction will be
provided on request. Certainly, it can be argued that summary information is sufficient to allow the
calculation of the tax, the standard cited in ILM 200547012. The summary totals can even be audited by
the computer in that the IRS can match those numbers against the totals from the information returns it has
received from brokers and dealers.

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handling and verifying returns may be readily accomplished. The courts

so far have not been willing to second-guess IRS decisions about what
that involves. Rather, Congress has given the IRS more authority by
passing legislation enabling the IRS to mandate electronic filing for
filers of larger numbers of returns.