Enough is Enough, But An Amended Tax Return is Not

The process for reporting taxes can be more difficult than discerning whether a tax provision applies. This complexity stems from the level of information is required to be reported.

The IRS reporting requirements continue increase every year. The IRS’s decision to require partnership tax capital accounts is an example. Why is that information required and why should taxpayers have to pay tax preparers to report the calculations?

But we comply with the IRS requirements. We use the IRS’s forms. We follow the instructions in the forms. We provide the information requested. We do this to ensure that we do not have to pay taxes we do not owe. But when is enough, enough? How much information has to be provided to the IRS?

If you are concerned about the increase in the reporting requirements or the prying eyes of the IRS, you should be concerned about the Harper v. United States, No. 19-55933 (9th Cir. 2021). The case stands for the proposition that even a simple amended return has to, i.e., this is a requirement, it has to, include hundreds of thousands of pages of documentary support in order for the amended return to be a valid.

Facts & Procedural History

The taxpayers filed amended returns to take research tax credits. They had failed to claim the credits on their originally filed returns.

The IRS conducted a four year audit and then, with what appears to be no explanation, simply disallowed the credits. The taxpayers filed suit against the IRS to recover their tax overpayment.

The government filed a motion to dismiss, arguing that the taxpayer’s amended returns alone were not sufficient to justify having a court hearing. This appeal was the result.

About Refund Claims

There are times when taxpayers overpay their taxes. They may file a tax return that reports too much in taxes and pay the taxes or the IRS may make an adjustment increasing tax in error.

The IRS will usually refund these overpayments if they discover them. For example, one can generally point these issues out to the auditor if their tax return is under audit by the IRS. The IRS auditor will make the adjustment and process the paperwork even if it means that the taxpayer will get cash back from the IRS.

The IRS may not agree that a refund is warranted, however. To preserve the right to recoup an overpayment, one generally has to file a refund claim. This is accomplished by either filing an amended tax return or a Form 843, depending on what type of tax or addition to tax for the overpayment. The Code sets out timing rules for when these claims have to be filed.

The refund claim preserves the right to recoup an overpayment by keeping the door open for suing the government to recoup the funds. In order to bring a refund suit in either Federal District Court or the Court of Federal Claims, the taxpayer must first file a claim for refund. Then, when the IRS denies the fund or the IRS fails to act within six months, the taxpayer can file fie suit.

Amended Return is Not Sufficient

This brings us back to the Harper case. The taxpayers filed amended returns to claim refunds as they failed to originally report their research tax credits.

The IRS audited the claims for four years. This included numerous document requests and the taxpayers providing thousands of pages of documents for their research tax credits.

The taxpayers filed suit in Federal District Court. The government responded with a motion to dismiss. The government argued that the taxpayers only provided copies of the tax schedules with their amended returns and that this information did not fully apprise the IRS of the nature of their claims. The Federal District Court agreed with the government. Thus, the Federal District Court concluded that filing an amended return in accordance with the IRS’s own instructions and using the IRS’s own form for doing so was not enough.

Notice of the Nature of the Claims

The appeals court went on to describe the IRS audit as follows:

Over the course of the four-year audit, the IRS targeted its questioning and document requests specifically on determining Taxpayer’s eligibility for the increased research credit, including, inter alia, Taxpayer’s project accounting practices, the means used to translate that accounting to capture Qualified Research Expenses, the breakdown of its business components, the satisfaction of the “substantially all” rule of 26 U.S.C. § 41(d)(1)(C) and the breakdown of eligible employee salaries.

The appeals court even noted that the taxpayers provided multiple answers and “over a hundred thousand pages of documentary support” for their research tax credits.

On appeal, the appeals court had little difficulty in concluding that the IRS was apprised of the nature of the taxpayers claims: “[t]he IRS’s targeted investigation and final determination unmistakably demonstrates that it understood Taxpayer’s claims.”

The concurring justice decided the case based on the informal refund claim. The court presumed that the amended returns alone were not enough, but that the claims were perfected with the information provided to the IRS on audit.

Shouldn’t an Amended Tax Return Be Sufficient?

While not addressed by the court, the IRS form in question reports quite a bit of detail about the research tax credits. It requires taxpayers set out all of the figures used to compute the research tax credits.

Neither the form the IRS created for the research tax credit nor the instructions for the form, both of which the IRS authored, requires any additional information be submitted in support of a research tax credit. The taxpayers completed the IRS’s forms and complied with the IRS’s instructions. Why would this not be sufficient to put the IRS on notice of the claims?

This is especially true given that the IRS has a long history of auditing R&D credits. It is very aware of the elements for R&D credits and how the elements vary based on industry, etc. We are not talking about a novel multi-step tax shelter designed by smart tax lawyers. It’s a tax credit that has a calculation set out in a statute enacted into law by Congress. How much specificity do you need when the tax code sets out each element and requirement–with just the amounts and nature varying?

The court case also does not address the realities of what the IRS actually knows these days. The IRS computers should be able to calculate the amount of the taxpayer’s R&D credits automatically with a high level of precision without any additional input by the taxpayer.

The IRS sees the business category code on the tax return and it sees the gross receipts and expenses (such as wages, supplies, and contractor costs) on the tax return (and other filings by the taxpayer, such as Forms W-2 and 1099). The IRS has this same data for every year the taxpayer filed tax returns and it has this data for every other taxpayer who took research tax credits since the credit was enacted over 40 years ago. The IRS has a store of historical audit data for all taxpayers. Thus, what may seem like a few entries on an IRS form to a court or judge who does not process tax returns, actually speaks volumes to the IRS. Indeed, the IRS already knows that the taxpayer likely qualifies for the tax credit and even how much they likely qualify for. To say that the IRS is not apprised of the nature of the claim with specificity when it is armed with this information ignores the reality of where data sciences are today.

Worse yet, one is left wondering what the implications are for other cases. If the claims were not audited by the IRS, as in the cases where the IRS simply sends a claim disallowance letter with basically no audit, can the taxpayer not preserve their right to litigate the claim? Is that the right result when a taxpayer fully complied with the IRS’s forms and instructions?

And what does this mean for other tax issues? The IRS form for the research tax credit is substantially more detailed that most other tax positions. Take tax losses for example. Usually tax losses are reported on a single line on an amended return and then a few sentences included as an explanation in the blank provided for the explanation on the tax return or form. Just one entry and a few sentences. This is much less than the information provided for the research tax credit on the Form 6765. This calls into question every refund claim for every tax issue.

The Takeaway

The taxpayers in this case produced “over a hundred thousand pages of documentary support” for their research tax credits. The IRS concluded that this was not sufficient notice. The courts eventually accepted this volume as being sufficient.

Unfortunately, the takeaway from this case is that taxpayers should include “over a hundred thousand pages of documentary support” with their amended tax returns for their research tax credits.

This is a bad answer for taxpayers and for the IRS. The IRS isn’t really set up to receive or process this type of disclosure for every research tax credit and will probably not want to receive such high volume submissions, but that is what this court case says is required.