Question

4. Brian’s sister, Diana, filed a valid timely return for 2015, and paid tax of $10,000 for that year. Since then, she read a book that explained that the Federal income tax system does not apply unless you sign a contract agreeing to perform military service for the government. She now believes that she should have owed no tax for 2015 and is due a refund. On July 1, 2017, she filed a refund claim for 2015 claiming that she is a “free person of the independent republic of California” and is due a refund of $10,000.  

a. Can the IRS assert any penalties against Diana based on her 2015 refund claim? If so, what is the amount of the penalty?

b. Will the IRS have to issue a Notice of Deficiency before assessing any such penalty?

Answer 1

A). A penalty may be imposed, per I.R.C. §6695(f), on a return preparer who endorses or negotiates a refund check issued to any taxpayer other than the return preparer. The prohibition on return preparers negotiating a refund check is limited to a refund check for returns they prepared.

A preparer that is also a financial institution, but has not made a loan to the taxpayer on the basis of the taxpayer’s anticipated refund, may

cash a refund check and remit all of the cash to the taxpayer

accept a refund check for deposit in full to a taxpayer’s account provided the bank does not initially endorse or negotiate the check, or

endorse a refund check for deposit in full to a taxpayer’s account pursuant to a written authorization of the taxpayer.

A preparer bank may also subsequently endorse or negotiate a refund check as part of the check-clearing process through the financial system after initial endorsement. Under Treas. Reg. 1.6695-1(f), a tax preparer, however, may affix the taxpayer's name to a check for the purpose of depositing the check into the account in the name of the taxpayer or in joint names of the taxpayer and one or more persons (excluding the tax return preparer) if authorized by the taxpayer or the taxpayer's recognized representative. The IRS may sanction any income tax return preparer that violates this provision.

In addition to the above-specified provisions, the IRS reserves the right to assert all appropriate preparer and non-preparer penalties against a Provider as warranted.

B.). A notice of deficiency is also known as a statutory notice or a statutory notice of deficiency because tax laws require the Internal Revenue Service (IRS) to issue a notice of deficiency before assessing additional income tax, estate tax, gift tax and certain excise taxes unless the taxpayer agrees to the additional assessment. Although its language says the IRS is proposing a change, the notice of deficiency is a legal determination of tax deficiency that is presumptively correct.

A notice of deficiency is issued when the IRS proposes a change to a tax return because they found that the information reported on a return does not match their records. A notice of deficiency is usually triggered by tax information received from a third party filer such as an employer or a financial institution that does not match information reported by the taxpayer.

A notice of deficiency is triggered by a taxpayer’s failure to timely respond to or to successfully appeal a pre-assessment letter known as a 30-day letter.  

A notice of deficiency is also known as an IRS Notice CP2319A - Notice of Deficiency & Increase in Tax. It explains any adjustments and how the amount of any deficiency was calculated. It explains the taxpayer’s options to either 1) agree to the additional tax liability by signing a Waiver Form 4089-A or 2) challenge it in U.S. Tax Court.

A notice of deficiency is sometimes referred to as a 90-day letter because it gives the taxpayer 90 days to dispute the tax assessment in the Tax Court. The 90-day period within which a petition may be filed is prescribed by statute and cannot not be extended. The 90-day period is counted from the date the notice of deficiency is mailed to the taxpayer’s last known address. The IRS is required by law to include the last day a petition may be filed directly on the notice of deficiency. Until 90 days expire or a Tax Court decision is final, whichever is later, the IRS is barred from any assessment or collection activity.