The Rules of the Game: Burden of Proof in Tax Disputes

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irs burden of proof

Every relationship has rules, whether informal or formal. Every human interaction has them too.

One can easily see this in forced relationships. Take organized sports, for example. Organized sports are essentially pre-planned interactions governed by specific rules that all parties agree to follow. The effectiveness of the rules hinges on proper enforcement, which often requires judgment calls. For many sports, this requires a referee–the critical overseer who interprets and applies the rules.

This is very similar to our legal system, and, with taxes, how tax disputes are handled. The tax code serves as the rulebook (along with other sources of tax law), taxpayers and the IRS are the players, and the courts often act as the referee. The referee uses the concept of “burden of proof” to administer the proceeding and make the provisions of the tax code work.

Despite its importance, the concept of the “burden of proof” in tax cases isn’t as clear as one might think. The recent Cotroneo v. Commissioner, T.C. Memo. 2024-70, provides an opportunity to consider the burden of proof rules in practice.

Facts & Procedural History

The case involved a married couple who filed a joint tax return for the 2012 tax year. The primary issue in the case was the taxability of IRA distributions totaling $122,500 that were not reported on the couple’s tax return.

The taxpayers filed their Form 1040 for 2012, reporting an IRA distribution of only $10.

On audit by the IRS, the IRS determined that the taxpayers had failed to report taxable IRA distributions. This resulted in a proposed tax deficiency and tax penalties.

The taxpayers disagreed with the IRS’s determination and filed a petition with the U.S. Tax Court to challenge the proposed deficiency.

Section 7491 Burden of Proof

Congress enacted Section 7491 to clarify the burden of proof. To understand the court’s decision in Cotroneo, we must first consider Section 7491 and its legislative history.

When Congress enacted this provision in 1998, its intent was to make it easier for taxpayers to shift the burden of proof to the IRS in certain situations and provide a rule that could be consistently applied across different cases.

With Section 7491, Congress essentially codified the general rules that the courts were already applying.

Section 7491 generally says that absent a specific rule in the tax statutes for a particular issue, such as a tax deduction, taxpayers have the burden of proof (the opposite is true for items of unreported income and constructive dividends). This burden shifts to the IRS if the taxpayer presents credible evidence. The IRS then has to produce evidence to rebut the taxpayer’s showing, and, if the IRS cannot do so or if the evidence is essentially a tie, the taxpayer is to prevail. This tie-breaker provision is not technically found in Section 7491. It is found in the legislative history for Section 7491.

Section 7491(a) provides that if, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer, the burden of proof with respect to such issue shall be on the IRS.

There are other nuances that apply to shift the burden of proof. For example, the burden shift only occurs if the taxpayer has:

  1. Complied with all substantiation requirements.
  2. Maintained all required records.
  3. Cooperated with reasonable IRS requests for information, meetings, and interviews.

This leads to the question as to how the rule is to be applied. The answer is that it is applied based on “credible evidence.”

The “Credible” Evidence Standard

Section 7491 does not explain what evidence is to be presented or what evidence is considered “credible.” This is a determination that is left to the courts.

The legislative history for Section 7491 provides guidance, however. It describes “credible evidence” as: “the quality of evidence which, after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted (without regard to the judicial presumption of IRS correctness).” The legislative history also states that a taxpayer has not produced credible evidence if they “merely make implausible factual assertions, frivolous claims, or tax protestor-type arguments.”

Since the enactment of Section 7491, courts have grappled with defining and applying the “credible evidence” standard. Several key cases have shaped the interpretation of this provision:

  1. Higbee v. Commissioner (2001) – In Higbee, the Tax Court provided one of the earliest interpretations of Section 7491. The court emphasized that Section 7491 does not override specific substantiation requirements in the tax code. This means that if a particular deduction or credit requires specific documentation, the taxpayer must still provide that documentation to meet the “credible evidence” standard. The court stated: “Nothing in the provision shall be construed to override any requirement under the Code or regulations to substantiate any item.” This interpretation set a precedent that “credible evidence” must still comply with existing tax law requirements.
  2. Griffin v. Commissioner (2003) – The Eighth Circuit Court of Appeals in Griffin provided a definition of credible evidence that closely mirrors the legislative history. The court stated that “credible evidence” is “the quality of evidence which, after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted (without regard to the judicial presumption of IRS correctness).” This case is significant because it emphasized that courts should consider the taxpayer’s evidence in isolation, without regard to any contrary evidence presented by the IRS. This interpretation seemed to align closely with the legislative intent of Section 7491.
  3. Blodgett v. Commissioner (2005) – In Blodgett, the Eighth Circuit made a statement that has had a significant impact on subsequent interpretations of Section 7491. The court stated that the burden shift under Section 7491 is only significant in the “rare event of an evidentiary tie.” This interpretation has been widely cited and has arguably limited the practical impact of Section 7491. It suggests that in most cases, the outcome will be determined by the preponderance of evidence, regardless of which party bears the burden of proof.
  4. Knudsen v. Commissioner (2008) – The tax court in Knudsen further reinforced the Blodgett approach, stating: “In a case where the standard of proof is preponderance of the evidence and the preponderance of the evidence favors one party, we may decide the case on the weight of the evidence and not on an allocation of the burden of proof.” This line of cases has effectively narrowed the circumstances in which the burden shift under Section 7491 might make a difference in the outcome of a case.

What is Credible Evidence?

This brings us back to the Controneo case. In Cotroneo, the Tax Court had to determine whether the taxpayers had presented credible evidence sufficient to shift the burden of proof to the IRS regarding the unreported IRA distributions.

The court noted that the taxpayer testified about her lack of knowledge regarding the unreported income and her reliance on her husband and their accountant for tax matters. However, the court did not even acknowledge this testimony as evidence. Instead, it seems to have focused only on the records that the taxpayer presented, and concluded that this evidence did not support the taxpayer’s position.

The court stated: “We find that petitioner has not introduced credible evidence with respect to the factual issue of whether Mr. Cotroneo received taxable IRA distributions of $122,500 for 2012 that were not reported on the couple’s joint return. Petitioner’s evidence consisted mostly of unreliable estimates and insufficient explanations.”

This interpretation appears to set a higher bar for “credible evidence” than what might be inferred from a strict reading of the legislative history. The court seems to require more than just plausible testimony; it appears to demand some form of corroborating evidence or detailed explanation to meet the credible evidence threshold.

The court’s approach in Cotroneo seems to align more closely with the Higbee and Blodgett type of court case interpretations, emphasizing the importance of substantiation and suggesting that the burden shift may not be significant in most cases. This stands in contrast to the more taxpayer-friendly interpretation in cases like Griffin.

The Impact of Substantiation Requirements

The Cotroneo case also highlights the importance of substantiation requirements in tax disputes. The tax court emphasized that Section 7491 does not override the need for taxpayers to comply with specific recordkeeping and documentation requirements set forth in the tax code.

In this case, the taxpayer’s failure to provide adequate documentation to support their position weighed heavily against them. The court noted: “The comprehensive Morgan Stanley records that document Mr. Cotroneo’s withdrawal of $122,500 from a traditional IRA during 2012 — including the 2012 Form 1099-R issued to Mr. Cotroneo from Morgan Stanley — is reasonable and probative information concerning the deficiency respondent determined.”

Thus, the court’s interpretation of “credible evidence” can be influenced by the quality and completeness of the documentation provided.

The Takeaway

As this case shows, while Section 7491 was intended to level the playing field for taxpayers, its practical impact has been limited by court interpretations. Winning a tax case often comes down to successfully navigating the burden of proof regime. The burden of proof comes down to documentation. Documentation is the best defense. Anything short of perfect documentation opens the door for the court to interpret “credible evidence” more stringently than the legislative history suggests.

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