TAX COURT "WHACK-A-MOLE" by Steve Mather

         It can be a good move strategically to force an audit to a conclusion to get IRS’s position established in the notice of deficiency (“NOD”). Pursuant to I.R.C. §6212(a), an NOD is only authorized if IRS “determines” a deficiency.

         The vast majority of contested NODs are petitioned to Tax Court.  The reasons for the IRS determination are beyond the scope of Tax Court’s review. Greenberg’s Express v. Commissioner, 62 T.C. 324 (1974). The Court will not “go behind” the NOD to determine the reasons the notice was issued even if IRS issued multiple self-contradictory notices. Bedrosian v. Commissioner, 940 F.3d 467, 473 (9th Cir. 2019). The NOD therefore determines the issues in the Tax Court case before the case is filed.

         The typical “reward” that IRS receives for clearly determining a deficiency is that the burden of proof in the Tax Court proceeding is generally imposed on the taxpayer for those determinations. Tax Court Rule 142. When IRS wants to increase the deficiency or raise a new issue that requires different evidence, however, the new issue is considered to be a “new matter.” Shea v. Commissioner, 112 T.C. 183, 191 (1999). IRS assumes the burden of proof on any new matter IRS raises. Tax Court Rule 142. For new matters on which IRS has the burden of proof, IRS must seek to file an amended answer and affirmatively plead “a clear and concise statement of every ground, together with the facts in support thereof on which [IRS] relies.” Tax Court Rules 36(b), 41(a).

         In several recent cases, IRS tried to change positions shortly before trial. This change of position occurred during trial preparation when IRS Counsel apparently felt there was a “better” position than the position taken in the NOD.  Examples include:  (1) IRS asserting for the first time in the pretrial memo that the real issue in the case was a change of accounting method from accrual to cash rather than the taxpayer’s eligibility to use the cash method in the first place as determined in the NOD; (2) IRS arguing for the first time in the pretrial memo that the challenge to the character of an amount as debt in the NOD should be expanded to include whether the debt was worthless; and (3) IRS seeking leave to amend its answer two months before trial to raise a profit motive issue not stated in the NOD.

These attempted changes must be resisted at the first instance. Otherwise, Tax Court is likely to allow the new position to be tried and briefed. The Court will typically find that the taxpayer consented to try the new issue and will allow IRS to later conform the pleadings to the proof, if need be. Tax Court Rule 41(b). Often the taxpayer may be unaware of this “implied consent.”

         In the three examples above, IRS Counsel felt entitled to raise the new issue whenever IRS wanted. The Court allowed the new position in the accounting method case, but refused to let IRS to raise the new issue in the other two cases.  Even after the Court rejected IRS’s effort to raise the new issue in the latter two cases, however, IRS tried again after trial, ultimately without success.

         Committing IRS to a position in the NOD is a useful strategy. Immediate and emphatic objection is required to avoid letting IRS push up a new “mole” once the original position has been “whacked,” however.