Clients are untrustworthy.  As a tax controversy attorney, this is my experience.

I have heard that other types of law deals with more honorable sorts, but I’ll believe it when I see it.  When a client comes to you and says “whoopsie, I forgot to report [insert absurdly large number here] on my return, what should I do?” what should you tell him?  What if the IRS has already discovered the understatement?  Is he under the obligation to file an amended return?  Are you required to tell him to file one?

In this brief article, Briefly Taxing examines amended returns in general, whether filing them is required, and whether a CPA and tax attorney must advise their client to file an amended return.

Quick Rules

• • An amended return filed by a taxpayer reporting an underpayment is an admission by that taxpayer of an underpaid tax liability.[1]
  • The taxpayer has no obligation to amend a return.[2]
  • A tax professional does not have the legal, ethical, or professional obligation to advise the client to file an amended return.[3]

Assessing Tax on Original Return

Pursuant to IRC § 6331, the IRS is authorized to collect all taxes imposed under the Code. An assessment of tax is the first step in that process. Assessments come in two flavors – summary assessments and, more commonly, deficiency assessments.[4]

Pursuant to the deficiency procedures, before any assessment can be made, the IRS must send a notice of deficiency to the taxpayer by certified or registered mail regarding its determinations.[5] If the taxpayer timely petitions the Tax Court for redetermination of the deficiency, the IRS may not further assess the deficiency (or any additions to tax and penalties thereto) while the case is before the Tax Court.[6]

Summary Assessments on Returns (Original and Amended)

The IRS may summarily assess the amount of tax shown on a taxpayer’s original return.  Critically, the IRS may (and will) assess summarily any amount of any additional tax shown on a subsequently filed amended return.[7] The IRS may also summarily assess and collect certain civil penalties.[8] The preconditions for making such an assessment are a valid filed—original or amended—return and, most importantly, the taxpayer’s unconditional admission of liability for the tax shown thereon.[9]

In a Tax Court memorandum opinion from early last year,[10] the taxpayer (whether out of guilty conscience, an effort to avoid more substantial penalties) filed an amended return reporting an additional amount of tax (an “understatement”).  Because the taxpayer had included the amount on his amended return, the IRS appropriately treated this reporting as an admission of tax due.  As a consequence, the IRS summarily assessed the failure to pay penalty under IRC § 6651(a)(3).  It should be noted that summary assessments are not subject to the deficiency procedures, no notice of deficiency is required to be sent to the petitioner.[11] nonetheless, if a penalty is asserted and/or assessed, the individual asserting the penalty must obtain prior supervisory approval in writing for such penalty.[12]

Is a Client Required to Amend its Return?

We get the question a lot whether a taxpayer is required to amend a return that they later realize is incorrect. Let’s take a step back for a moment and look at the requirements for filing a tax return in general.

With some specific exceptions, generally income based, every red-blooded American must file a Federal income tax return each and every year.[13] Any individual. who willfully fails to file an income tax return may be guilty of a misdemeanor and fined up to $25,000.[14] A short stint in the hoosegow (one year) is also a possibility, if the Department of Justice is feeling especially frisky.

Income tax returns must be filed under penalty of perjury.[15] How important is a statement that the tax return was filed under penalty of perjury? Very important. The Supreme Court and other federal courts have held that if a taxpayer fails to comply with IRC §6065 by submitting a return without a signed statement, made under penalties of perjury, that the tax return is accurate to their knowledge, the return itself is a “nullity.”[16] Once again, any person that willfully files return under the penalties of perjury believing that the return was untrue or incorrect as to any material matter may be guilty of a felony—and may be fined up to $100,000 and imprisoned for up to three years.[17]

Understanding Badaracco

Before we get to the Badaracco case, let’s look at Treas. Reg. 1.451-1(a).

If a taxpayer ascertains that an item should have been included in gross income in a prior taxable year, he should, if within the period of limitation, file an amended return and pay any additional tax due.

Clear as day, right?

If a taxpayer realizes that an understatement has been made on an original return, he “should…file an amended return.”  In 1984, the Supreme Court (in the Badaracco case) looked at this regulation and other regulations that mention amended returns and found that none of those regulations required the filing of an amended return.[18]

In Badaracco, the petitioners conceded that the income tax returns they filed for five years were complete and utter malarkey and were, they supposed, if you want to get picky, fraudulent. [19] Soon after being indicted on 15 counts of filing false or fraudulent returns under IRC § 7206(1), the petitioners filed nonfraudulent amended income tax returns for each of the taxable years.  The taxes reported were paid with the returns, but the IRS eventually asserted the civil fraud penalty against the petitioners…six years later.[20]

The petitioners cried foul and sought redetermination in the Tax Court of the asserted deficiencies, contending that the IRS’s action was barred by IRC § 6501(a) (general three-year statute of limitations on assessment). They claimed that IRC § 6501(c)(1) (the fraud exception to the general three-year) did not apply because the 1971 filing of nonfraudulent amended returns caused the general three-year period of limitations specified in IRC § 6501(a) to operate from the date the amended returns were filed. The case wound its way from the Tax Court to the Second Circuit and ultimately to the Supreme Court, which was less than sympathetic to the Badaraccos.

Nothing is present in [IRC § 6501] that can be construed to suspend its operation in the light of a fraudulent filer’s subsequent repentant conduct. Neither is there anything in the wording of IRC § 6501(a) that itself enables a taxpayer to reinstate the section’s general three-year limitations period by filing an amended return. Indeed…the Internal Revenue Code does not explicitly provide either for a taxpayer’s filing, or for the Commissioner’s acceptance, of an amended return; instead, an amended return is a creature of administrative origin and grace. Thus, when Congress provided for assessment at any time in the case of a false or fraudulent “return,” it plainly [meant] by this language a false or fraudulent original return.

Quick Lessons from Badaracco

Badaracco teaches us three important lessons:

• • First, once a fraudulent return has been filed, the case remains one “of a false or fraudulent return,” regardless of the taxpayer’s later revised conduct, for purposes of criminal prosecution and civil fraud liability under IRC § 6653(b).[21]
  • Second, an amended return may constitute an admission of substantial underpayment.[22]
  • Third, and most importantly for this article, nothing in the Code or the Treasury Regulations requires a taxpayer to file an amended return.[23]

When is Amendment a Good Idea?

There are two primary reasons for filing amended return: avoiding accuracy-related penalties, and avoiding criminal prosecution. The IRS tends to appreciate voluntary disclosure, especially when such disclosure means that they don’t have to go through the deficiency procedure rigmarole. It should be noted that the voluntary disclosure that comes with the filing of an amended return creates no substantive or procedural rights for taxpayers, nor will it automatically guarantee immunity from prosecution. In general, however, unless the underlying fraud was really, really bad, the filing of an amended return may result in prosecution not being recommended.

When is Amendment a Patently Bad Idea?

If the taxpayers are currently under audit (or investigation by CI) for the year for which they want to file an amended return, this is generally a terrible idea. Taxpayers under audit or investigation should generally avoid filing an amended return because, as discussed above, it is considered an admission by the taxpayer and will be used as Exhibit A against said taxpayer in court.

Must Tax Attorneys and CPAs Advise Clients to File Amended Returns?

The IRS publishes Circular 230, and, aside from certain recent court cases that have found that the IRS oversteps their authority in certain cases under Circular 230, it governs the practice of tax professionals before the IRS, including CPAs and tax attorneys.[24]  As much as the IRS may love amended returns because of the ease of assessment, the Supreme Court has spoken on the matter.  Thus, although it is a common misconception that a tax professional must advise or compel the client to file an amended return, such language does not appear in Circular 230.

Circular 230 provides only that a tax professional must (a) advise the client promptly of any error that the tax professional discovers and (b) advise the client about the consequences of the noncompliance, error, or admission.[25] The tax professional must inform the client of any opportunity to avoid any consequences and of the requirements for adequate disclosure.[26]  The tax professional may not advise the taxpayer to file a false or fraudulent document or return with the IRS.[27] Otherwise, the decision to file an amended return ultimately rests with the client.

As such, CPAs and tax attorneys are well within their ethical and legal rights and duties (including under Circular 230) to advise a client against filing an amended return, if such amended return is not in the client’s best interest.

 

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Footnotes:

[1] See Badaracco v. Commissioner, 464 U.S. 386, 399 (1984); Cooley v. Commissioner, T.C. Memo. 2004-49, *17.

[2] Id.

[3] Circular 230, § 10.21. However, as discussed below, the attorney must advise the taxpayer about the potential consequences of filing and non-filing, including any penalties.

[4] Yes, yes, there are jeopardy and termination assessments, too, but for purposes of this analysis there are two. Got it? Good.

[5] IRC § 6212(a); IRC § 6213.

[6] IRC § 6213(a).

[7] IRC § 6201(a)(1); Meyer v. Commissioner, 97 T.C. 555, 559 (1991).

[8] See Meyer, 97 T.C. at 559; IRC § 6665(b).

[9] See Powerstein v. Commissioner, 99 T.C. 466, 474-475 (1992); Estate of Brourman v. Commissioner, T.C. Memo. 2013-99, at *4-*5.

[10] Mei Productions v. Commissioner, T.C. Memo. 2020-11.

[11] See IRC § 6211; IRC § 6212; IRC § 6213; Meyer 97 T.C. at 560.

[12] IRC § 6751(b)(1).

[13] IRC § 6001 (returns, generally); IRC § 6011 (income tax returns).

[14] IRC § 7203. The fine is $100,000 in the case of a corporation.

[15] IRC § 6065; Treas. Reg. § 1.6065-1(a).

[16] Lucas v. Pilliod Lumber Co., 281 U.S. 245 (1930); Hettig v. United States, 845 F.2d 794 (8th Cir. 1988) (finding taxpayer’s return a nullity when the taxpayer struck through the words “under penalties of perjury”).

[17] IRC § 7206. The fine is $500,000 in the case of a corporation.

[18] Badaracco v. Commissioner, 464 U.S. 386 (1984).

[19] The petitioners also filed fraudulent partnership information returns (Forms 1065) and amended these as well.

[20] The civil fraud penalty was under IRC § 6653 in 1984, but is not contained in IRC § 6663.

[21] 464 U.S. at 394.

[22] Id. at 399.  Note, however, that an amended return will not ordinarily constitute an admission of fraud.

[23] Id. at 397.

[24] Ridgeley v. Lew, 55 F.Supp.3d 89 (D.D.C. 2014) (prohibition on contingent fees); Sexton v. Hawkins, 2017 WL 1042464 (D. Nev. 2017) (same).

[25] Circular 230, § 10.21 (generally); § 10.34(c) (advising clients on penalties).

[26] Id. at § 10.34(c)(2).

[27] Circular 230, § 10.34 (generally).

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