IRS Treatment of Penalties Following a Substitute for Return

In Robertson v. Commissioner (T.C. Memo. 2014-143) the Tax Court continues it’s now-we-see-it-now-we-don’t treatment of the Commissioner’s substitute for return (SFR). This varied treatment arises when the court considers the additions to tax (often referred to as penalties) applied in a notice of deficiency, penalties routinely included in every notice, for a taxpayer who did not file a return.
3 penalties (FTF, FTP, FTD) are almost always applied together. The first penalty is based on timing and applies when the taxpayer files his return late (without having filed an extension request). The second penalty is based on not paying the tax. It applies when the taxpayer fails to pay the tax shown on his return. The third penalty is for not making necessary tax payments. Each taxpayer has an obligation to estimate his total tax liability for the year and make estimated tax payments, usually making no fewer than four payments. If no installment payments have been made, or they are insufficient in amount so that there is a tax deficiency at the end of the year, a penalty may apply. The taxpayer can escape liability if he/she could have shown the failure was due to reasonable cause and not willful neglect. 
Procedurally, there is an order for how contesting the penalties will play out in court. First, the taxpayer must put the penalties at issue. Usually he does this in the petition. Next, the Commissioner must come forward with evidence it was appropriate to impose the penalty. This is referred to as the burden of production. Even though the Tax Court had considered the transcript, and its reference to the SFR, for the first and third penalties, it balked at relying on the transcript when considering the penalty for failure to pay the tax shown on the return. For this penalty to apply, it wanted to actually see the SFR – it wanted to see a return that showed a tax liability due. And to be such a return, it had to be a valid return, or in Mr. Robertson’s case, a valid SFR. The court had addressed the issue of what constitutes a valid SFR several times in previous court opinions.


The IRS’s “Substitute for Return” is a misnomer. In fact, its existence violates the law.
No law allows the IRS to create a mere “Substitute for Return.” Indeed, the very nomenclature is nonsensical. The taxpayer files no return. That means nothing exists for which something else can act as a “substitute.” 
In any event, if a person fails to file a required return (or files a false or fraudulent one), the IRS “shall make such return” from its own knowledge and the information it can obtain. I.R.C. § 6020(b). Cf. I.R.C. § 6012(a)(certain persons “shall” make income tax returns). Despite the command (or even the authorization) of 6020(b), however, the IRS NEVER makes an individual income tax return for a non-filer. I have never been able to figure out why. What the IRS does, is place the individual’s name and address on a Form 1040 and make a few “0” entries. That “Substitute for Return” shows no tax at all. If a tax protester filed such a return, then the IRS would declare it frivolous. The “Automated” Substitute for Return is the SFR’s equally bogus cousin.
The IRS’s deliberate failure to make an actual individual income tax return on Form 1040 for a non-filer has fueled tax protesters’ beliefs for decades. They say if the federal income tax was mandatory, then the IRS would actually make a 6020(b) return for the non-filer. And the tax protesters have a point. For all taxes, except for the federal income tax, the IRS makes a return for a non-filer that it calls a “6020(b) return.” In contrast, for the federal income tax alone, the IRS calls its creation a “Substitute for Return.” It may sometimes add in “under 6020(b),” but the point is the same: why does the IRS not make full federal income tax returns for non-filers ?
The courts say the presence or absence of an SFR is irrelevant to a deficiency determination. In 1996, however, it became very relevant to deficiency cases. That year, Congress enacted what is now I.R.C. § 6651(g). That section requires that the IRS make an I.R.C. § 6020(b) return before a non-filer can be liable for the I.R.C. § 6651(a)(2) addition to tax, which applies to a failure to “pay a tax shown on a return.” And as Carl Smith points out, I.R.C. § 7491(c) places the burden of producing evidence in support of that tax addition on the IRS. But the IRS still produces only the largely blank Form 1040, an examination report, and a “certification” that the whole paper pile (somehow) constitutes an actual 6020(b) return.
I am alarmed at the implication that the IRS should be able to rely on secondary evidence to meet its I.R.C. § 6651(a)(2) production burden. The failure to file a return and the failure to pay estimated tax additions are much different from a failure to pay a tax shown on a return addition. The first two tax additions require the IRS to show it possesses neither the person’s return nor any of his estimated tax payments. As applied to non-filers, however, I.R.C. section 6651(a)(2), is much different. That addition to the tax arises only when the IRS has made a return under I.R.C. section 6020(b). Without that return, though, how is the Court to determine (a) the return exists, (b) a tax is shown on that return, and (c) the exact tax amount shown on that return?
In short, evidence that an event occurred must be stronger than the evidence that an event did not occur. Account transcripts do not make the grade. As I see it, the IRS has made its “Substitute for Return” bed; now it must “lie” in it.
http://www.procedurallytaxing.com/irs-treatment-of-penalties-following-a-substitute-for-return/