The Unspotted Issue in an Audit; Ethics and Crimes (7/24/20)

In an ABA Tax Section Court Procedure Virtual meeting on Wednesday, there was a one-hour discussion of ethical issues in handling a matter in the Tax Court.  The participants in the discussion were:

• Judge L. Paige Marvel, United States Tax Court, Washington, D.C.
• Elizabeth G. Chirich, Chief, Branch 1, Procedure & Administration, IRS Office of Chief Counsel, Washington, D.C.
• Guinevere Moore, Moore Tax Law Group, LLC, Chicago, IL
• Kandyce Korotky, Covington & Burling, Washington, D.C. (Moderator)
• Mitchell I. Horowitz, Buchanan Ingersoll & Rooney P.C., Tampa, FL

The discussion was excellent.  I highly recommend those who can access the recording of the event on the ABA web site to do so.  (I would provide a link but have not yet located the link, perhaps because the recording has not yet been put up.)
During the discussion I posted two questions which, apparently because of time, the participants did not respond to.  I offer the questions and some comment here.  The questions were:

1.        Question : What if the IRS sets up only one issue in the notice of deficiency and the IRS never spotted a big issue involving omitted income. There is no real gray area in the unspotted issue; the taxpayer clearly would owe tax if the unspotted issue were fully litigated (indeed taxpayer’s counsel did not think she could even make a nonfrivolous argument that the omitted income should not have been included). After filing the petition, IRS Counsel offers to concede that one issue (the spotted issue in the NOD) and sends a stipulated decision document saying that the deficiency is $0. Because the taxpayers’ counsel knows that stipulation that there is no deficiency is not true, can the taxpayers’ counsel sign the stipulated decision?
2.        Question: This may be a philosophical question rather than one you can answer here:  What good are ethical rules when they don’t provide answers — i.e., when different ethical lawyers acting ethically can reach different conclusions — does that simply reward the aggressive attorney (who may even be a lawyer who charges for the benefit offered to the taxpayer by being aggressive within the ambiguities — even creative ambiguities — in the ethical rules) and the taxpayer engaging this ethically aggressive attorney?  And would about the more conservative ethical attorney and his client?  Is the ethically conservative attorney providing less than ethically aggressive representation then not zealously representing the client?  There is more but I’ll stop there?

The second question is more philosophical, so I will focus on the first question.  Here is the key background:

1.      As I note in my Federal Tax Procedure Book, § 6211(a) defines a deficiency in part here relevant as:  “the taxpayer’s correct tax liability less the amount the IRS has previously assessed.”  

2.     Decision documents in a deficiency case state either that “there is a deficiency in income tax due from petitioner” in a stated amount for a taxable year(s) or “there is no deficiency in income tax due from petitioner” for the taxable year.

The first question above asks the practitioner’s response when the practitioner knows that the decision document recitation that there is no deficiency is not correct.  The same issue would arise if the decision document stated a deficiency amount for a year(s) without considering the unspotted issue.
I have only had one case that I recall presented this issue in a draft decision document.  I discussed the issue with my client and the real decision maker for the client (a lawyer, one of the smartest lawyers I ever met, in business with the client).  That lawyer and, at his recommendation, the client stepped up and authorized me to discuss the issue with IRS counsel.  That was the end of the client discussion (very short, no back and forth about what to do); I raised the issue with IRS counsel; and the decision document was revised to state the correct deficiency (a substantial amount).  Fortunately, I had a good client who had good counsel and I did not have to chase down my ethical responsibilities that would have been required had the client instructed me not to discuss the issue with IRS counsel and to sign the decision document as proffered.
I do not discuss this specific issue in my Federal Tax Procedure Book in Chapter 18 on Ethics.  I will likely revise the book to include the example in my 2020 editions that will be posted to SSRN in August 2020.  But I do discuss a similar dilemma involving a claim for refund timed to avoid the assessment statute of limitations on new assessments, thus, in the refund claim and resulting suit if necessary, to avoid the unspotted issue.

            Let me illustrate in an example.  Let’s say that the taxpayer is audited and the IRS sets up a single issue that results in a notice of deficiency for $100,000.  You counsel the taxpayer that, in your best judgment as a seasoned tax litigator, you can win that issue in whichever court the taxpayer chooses to litigate it.  However, since you handled that audit, you also know that the auditing agent did not spot an even larger issue that, in your judgment, the taxpayer would lose in any court that the taxpayer chooses to litigate it.  That issue would create a tax liability larger than the dollars that would be saved on the issue that you believe the taxpayer could win.  One of the traditional gambits is to preserve the refund statute of limitations, let the assessment statute expire, and the file the claim for refund.  For example, assume that the Year 01 return was filed on April 15 of Year 02, the audit deficiency was proposed on September 1 of Year 04, your client signs a Form 870 waiver of the restrictions on assessment for Year 01 on September 5 of Year 04, the IRS assesses the tax on February 1 of Year 5, the taxpayer pays on February 10 of Year 05, and the statute of limitations on further assessment expires on April 15 of Year 5.  You will recall that, although the statute of limitations on further assessment has expired, the taxpayer still has 2 years from the date of the February 10 payment to claim a refund. So, on June 1 of Year 05, the taxpayer files a claim for refund alleging that the IRS erred on the one audit issue (the only issue the IRS knows about).  In that claim for refund, the taxpayer does not mention the issue the IRS did not audit and is not otherwise aware of, despite the fact that, in his attorney’s judgment, he would lose that issue and his taxes for the year are therefore not overpaid.  Can the taxpayer lawfully sign the amended return (the claim for refund) with the jurat?  Can the attorney counsel or otherwise assist the taxpayer in filing the return?

I don’t know what other practitioners would or should do.  I can state what I would do.  I would not participate in the filing of the claim for refund and advise the taxpayer / client not to do so either.  The reasons I would marshal for the client are:  First, Section 6672 provides a 20% penalty for filing a claim for refund in an excessive amount without reasonable cause.  Second, there could be criminal penalties – perhaps tax evasion (§ 7201), perhaps tax perjury/false statement (§ 7206(1)), perhaps false, fictitious or fraudulent claim (18 USC 287).  Third, it is wrong.  (I don’t think stating this reason is inconsistent with the duty of zealous advocacy for the client.)  And those are just the risks for the client.  For the professional participating — dare I say enabling — the conduct there are professional ethics as well as potential criminal liability.
Now the play in the joints come if the unspotted issue is not certain to be resolved against the taxpayer if the IRS were to discover the issue and fully litigate it.  What level of confidence as to the issue is required for the taxpayer and the professional to avoid the problem?  Certainly, the taxpayer could likely avoid the criminal penalties with some level of assurance, such as perhaps reasonable basis or substantial authority or maybe just nonfrivolous position that the taxpayer could prevail if litigated.  But, what about the professional, particularly one who knows the vagaries and uncertainties in the statements of position (what really is reasonable basis of reasonable cause or nonfrivolous)?  And what if the professional is willing to permit assisting the client do something wrong to cloud his judgment as to whether the client has a defensible position on the unspotted issue?
I would appreciate anyone wanting to engage on the issues presented by these fact patterns either by comment on the blog or by email to me at
This blog is cross-posted on my Federal Tax Procedure Blog, here.