Return to Sender

The notice of deficiency provisions in the Internal Revenue Code are not a model of good draftsmanship. As a result, for more than 70 years taxpayers and the Internal Revenue Service have litigated an amazing diversity of issues covering all aspects of the seemingly innocuous notice of deficiency requirement. Under IRC section 6211(a), an income tax deficiency basically is the difference between the correct amount of income tax liability-as determined by the IRS-and the amount shown on a taxpayer’s return.

Most taxpayers who are notified of a deficiency either pay it or otherwise resolve the matter with the IRS at the administrative level. If a taxpayer disputes the deficiency and informal negotiations with the IRS prove fruitless, the agency issues the taxpayer a notice of deficiency-usually a letter stating the amount of the deficiency and how it was computed-that

1. Formally notifies the taxpayer of the impending assessment.
2. Suspends the running of the statute of limitations on assessing and collecting the deficiency.
3. Starts the 90-day (or 150 days if the notice is addressed to a person outside the United States) statutory period within which the taxpayer can petition the Tax Court for a redetermination of the deficiency without first having to pay it.

UNDERSTANDING THE FUNDAMENTALS
Despite the critical role deficiency notices play, the IRC and Treasury regulations do not adequately address several key issues. For example, even though IRC sections 6212(a) and 6212(b) direct the IRS to send a deficiency notice to the taxpayer’s last known address by certified or registered mail, neither the code nor the regulations

• Take account of the consequences of an incorrectly mailed notice.
• Specify whether the notice must be actually received by the taxpayer.
• Suggest how the IRS should go about establishing a taxpayer’s last known address.
• Indicate how a taxpayer can challenge a deficiency notice that is not in conformity with statutory requirements.
• Prescribe a particular format for deficiency notices.

Not surprisingly, these lapses have triggered significant litigation. Besides being a burden on taxpayers and the judicial system, such uncertainty breeds more litigation and increases the IRS’s average cost of collecting revenue. This article examines the deficiency notice requirements and discusses the obligations of taxpayers and of the IRS. Remedies CPAs can suggest to clients receiving invalid notices also are discussed.

THE USE OF CERTIFIED OR REGISTERED MAIL
Section 6212(a) says the IRS is “authorized” to send a taxpayer a notice of deficiency by certified or registered mail. But if the IRS sends the notice by some other method, such as ordinary mail, is it valid? In a long line of court cases addressing this issue, taxpayers repeatedly have taken the position that certified or registered mail is mandatory and because the IRS typically holds taxpayers to a rigid standard of compliance with technical requirements, it, too, should be held to the same standard. (See Tenzer v. Commissioner , 285 F2d 956, 9th Cir., 1960, or Balkisson v. Commissioner , 995 F2d 525, 4th Cir., 1993.)

The original version of section 6212(a), included in the Revenue Act of 1924, said taxpayers “shall be notified” of a deficiency by registered mail, which some courts construed as proscribing any other form of notice. The Revenue Act of 1926 changed the language to its present form, authorizing the IRS to use registered mail (certified mail was added in 1958). Although there is no official explanation for the implied invitation to use other forms of delivery, the courts have consistently interpreted the change as providing the IRS with a safe harbor if it uses certified or registered mail.

Practice tip . If the IRS uses certified or registered mail and the notice is properly addressed, then the running of the statute of limitations on assessing and collecting the deficiency is suspended effective as of the notice’s mailing date. Practitioners should note that the statutory period to petition the Tax Court for a prepayment review (90 days or 150 days) also begins on that date. If the IRS uses some other delivery method and the taxpayer’s ability to petition the Tax Court is thereby impaired, the notice usually is not effective until it is delivered. However, if the taxpayer’s ability to petition the Tax Court is not affected, then the IRS’s failure to use certified or registered mail will likely be viewed as a technical-yet harmless-violation.

RECEIPT OF THE NOTICE
According to section 6212(b)(1), a deficiency notice is sufficient if it is mailed to a taxpayer’s last known address. Legislative history suggests this section’s purpose is to protect the IRS when a taxpayer fails to notify the IRS of an address change. When this occurs, the notice is sufficient if it is mailed to the taxpayer’s last known address. What, however, constitutes a taxpayer’s last known address? Is a notice’s validity predicated on its actual receipt? Neither the IRC nor the regulations answer these questions. Consequently, numerous court cases have resulted, their number matched only by their amazing diversity. Consider these examples:

• A notice is correctly addressed but not received by the taxpayer.
• A notice is incorrectly addressed but received by the taxpayer.
• A notice is incorrectly addressed and not received by the taxpayer.
• A notice is incorrectly addressed and not received by the taxpayer, but a copy of the notice is correctly addressed to and received by the taxpayer’s accountant.
• A notice is incorrectly addressed, correctly forwarded by the U.S. Postal Service but refused by the taxpayer.
• A taxpayer files a return showing a new address, but the IRS sends a notice to the taxpayer’s old address.
• A taxpayer offers evidence to suggest the deficiency notice was not even mailed by the IRS.

Practice tip. In general, the prevalent judicial view is that a deficiency notice mailed to the taxpayer’s last known address is valid from the date of its mailing, whether or not the taxpayer actually receives it (King v. Commissioner , 857 F2d 676, 9th Cir., 1988). Thus, the running of the statute of limitations is suspended and the 90-day or 150-day statutory period to petition the Tax Court begins from the mailing date. The only condition is that the notice be sent to the taxpayer’s last known address .

LAST KNOWN ADDRESS
Against the backdrop of an increasingly mobile American society, the last known address clause has caused considerable litigation. Generally, a taxpayer’s last known address means the address to which the IRS reasonably believes-in light of all the circumstances-the taxpayer wishes the notice to be sent. (See Cyclone Drilling, Inc. v. Kelly , 769 F2d 662, 10th Cir., 1985.) The IRS is entitled to treat the address shown on the return for which the deficiency notice is being issued as the taxpayer’s last known address unless it receives clear and concise notice that the taxpayer has moved. Thus, if the taxpayer wants to hold the IRS accountable for using a different address, the taxpayer has to prove that he or she furnished the IRS with clear and concise notification of the different address. Nonetheless, if the IRS becomes aware before mailing a deficiency notice that the address on file is incorrect, it must exercise reasonable diligence based on all surrounding circumstances to determine the taxpayer’s correct address ( Teong-Chan Gaw v. Commissioner , 45 F3d 461, D.C. Cir., 1995).

Practice tip . An incorrectly addressed notice that is not received by the taxpayer at all is null and void and will not suspend the running of the statute of limitations. If the taxpayer actually receives the notice despite an address error, then relief will be granted only if the taxpayer’s ability to petition the Tax Court is impaired because of the address error. For example, a taxpayer’s ability would be considered impaired when an incorrectly addressed notice is received just 8 days before expiration of the 90-day period to petition the Tax Court ( Sicker v. Commissioner , 815 F2d 1400, 11th Cir., 1987). The Tax Court may then grant a motion to dismiss, thus preventing collection. Absent such impairment, the notice ordinarily will suspend the running of the statute of limitations and start the running of the 90-day or 150-day statutory period from the date of its mailing.

NOTIFICATION OF AN ADDRESS CHANGE
As noted earlier, a taxpayer is responsible for providing the IRS with clear and concise notification of an address change. Does a subsequently filed return with a new address constitute clear and concise notice? In Williams v. Commissioner (935 F2d 1066, 9th Cir., 1991), the taxpayer filed a subsequent return bearing a new address before the IRS mailed the deficiency notice. Nevertheless, the court held that there was no clear and concise notice of an address change since the notice was mailed before information on the return was processed and transferred to the IRS central computer system.

Taxpayer computer files are maintained at the IRS national computer system in Martinsburg, West Virginia. According to revenue procedure 90-18, a return ordinarily is considered properly processed after a 45-day period that begins after the date the return is received. However, because of the high volume of returns received during filing season, if a taxpayer provides new address information on a tax return received by the IRS after February 14 and before June 1, the return is considered properly processed on July 16. Thus, the mere filing of a tax return bearing a new address does not constitute clear and concise notification of an address change.

Practice tips. T o facilitate notifying the IRS of address changes, the IRS issued Form 8822, Change of Address , and revenue procedure 90-18, which explains how a taxpayer should inform the IRS of an address change. Generally, notification of a change should be sent by certified or registered mail, return receipt requested, to the IRS center serving the taxpayer’s old address or to the chief of the taxpayer service division in the local district office. The notification should contain a signed statement that includes the taxpayer’s full name, new address, old address and Social Security or employer identification number. Since the IRS maintains separate records for income, gift, estate and generation skipping transfer taxes, the notification should say what type of tax is affected by the address change. If after a joint return is filed either taxpayer establishes a separate address, each taxpayer should send an update.

An address change notification is considered properly processed after a 45-day period that begins after the date it is received. Since a taxpayer may want a temporary address to be the last known address, any instruction to the IRS to use a temporary address must include all of the details above as well as a clear statement of the time period during which the IRS is to use the temporary address. As an added precaution, taxpayers who change their addresses should request the U.S. Postal Service to forward all mail.

REASONABLE DILIGENCE
Notwithstanding the absence of clear and concise notification of an address change, when the IRS becomes aware before mailing a deficiency notice that a taxpayer’s last known address is incorrect, it must exercise due diligence to determine an address where the taxpayer will receive the notice. The degree of effort required to meet the due diligence requirement varies depending on the facts and circumstances of the case.

For instance, in Mulder v. Commissioner , (855 F2d 208, 5th Cir., 1989), the IRS perfunctorily mailed a deficiency notice to the same address from which the post office had already returned two previous IRS mailings as undeliverable. The court held that the deficiency notice was defective because when the IRS knows or should know that the taxpayer has moved, reasonable diligence requires the IRS to make an effort to ascertain an address at which the taxpayer will receive the notice.

Similarly, in Teong-Gaw v. Commissioner , the IRS apparently was aware that the notice it sent to the taxpayer’s Hong Kong address would not be received in time. Yet the agency made no effort to respond to numerous communications it had received about the taxpayer’s whereabouts. The court held that the IRS failed to satisfy its obligation to use reasonable diligence to ascertain the taxpayer’s correct address. Accordingly, the court concluded that the 150-day period to file a petition with the Tax Court did not begin to run until the taxpayer actually had received the notice.

NOTICE FORMAT
Although the statute does not prescribe any particular format for a deficiency notice, the notice must at a minimum advise the taxpayer that his or her tax return is deficient for a particular year and specify the amount of deficiency or provide information sufficient to determine the deficiency ( Scar v. Commissioner , 814 F2d 1363, 9th Cir., 1987). For example, in Abrams v. Commissioner (814 F2d 1356, 9th Cir., 1987), the IRS sent the taxpayer a letter-commonly known as a prefiling notification-advising him that the tax shelter in which he had invested was not a proper basis for tax deductions or credits and that his return would be audited. Since the letter failed to say the IRS had made a determination of the taxpayer’s tax deficiency, the Ninth Circuit Court of Appeals held that the letter was not a notice of deficiency.

UNENVIABLE TASK
The IRS has broad authority to assess and collect income taxes. This authority is moderated by the general requirement that the IRS mail taxpayers a notice of deficiency every time an income tax deficiency is asserted. The notice is not an assessment. Rather, it is a proposed deficiency that starts the time clock for petitioning the Tax Court for a prepayment redetermination.

Despite the pervasiveness of the notice of deficiency requirement, it has not been properly legislated. As a result, the government has found itself litigating a number of cases and losing significant revenue. Many of the disputes focus on whether or not the IRS mailed notices to the taxpayer’s correct address. Given the mobility of the American society, the IRS’s task of locating taxpayers before sending deficiency notices is both unenviable and administratively difficult. At the same time, however, it is relatively easy for taxpayers to notify the IRS of address changes and thereby help avoid costly litigation.