The following is a case update written by Maggie E. Schroedter analyzing a recent case of interest:
The three-year limitations period for an assessment of tax liability set forth in Internal Revenue Code section 6501(a) begins to run from the date the “return” is filed. In Matter of Quezada, 982 F.3d 931, 931–33 (5th Cir. 2020), the U.S. Court of Appeals for the Fifth Circuit analyzed the question of what constitutes a “return” under the Internal Revenue Code. The lower courts held that because Quezada never filed the return applicable to the tax liability at issue, the limitations period never began to run.
The Fifth Circuit disagreed and vacated the judgment in favor of the Internal Revenue Service. It held that Quezada filed “the return” when he filed forms containing data sufficient to (1) show that he was liable for the taxes assessed and (2) calculate the extent of his tax liability. Id.at 933.
To read the full published decision, click here.
The debtor James Quezada owned a masonry business and hired subcontractors to perform the labor. In tax years 2005-2008, Quezada filed Forms 1099 to report payments to his subcontractors, but many of the forms lacked the required Taxpayer Identification (“TIN”) numbers. Pursuant to the Internal Revenue Code, because the Form 1099s did not contain the required TIN numbers, Quezada was required to backup withhold from each payment to the subcontractors. He failed to do so and also failed to file the requisite Form 945 indicating the backup withheld.
In 2014—more than three years after Quezada filed forms 1040 and 1099 for 2008— the IRS assessed approximately $1.2 million against Quezada for amounts he failed to backup withhold for 2005-2008, plus penalties and interest.
In 2016, Quezada filed for bankruptcy. The IRS filed a proof of claim for the missing backup withhold. In an adversary proceeding, Quezada contended that the Forms 1099 and 1040 combined constituted a “return” and therefore that the assessment was barred by the three-year limitations period. See 26 U.S.C. § 6501(a).
The bankruptcy court disagreed. It held that Quezada never filed the “return” and that the limitations period never commenced. The bankruptcy court entered judgment in favor of the IRS. The district court affirmed.
Disagreeing with the lower courts, the Fifth Circuit adopted Quezada’s reasoning and vacated the district court’s judgment in favor of the IRS.
Citing Badaracco v. Comm’r, 464 U.S. 386 (1984), the Fifth Circuit first observed that because Quezada sought to apply the limitations period against the IRS, it must be strictly construed in the IRS’s favor.
The court then analyzed the meaning of “return” as set forth in the Internal Revenue Code, Title 26 of the United States Code, section 6501(a). The “general rule” under section 6501(a) requires the IRS to assess a tax “within 3 years after the return was filed.” 26 U.S.C. § 6501(a). “[T]he return” means “the return required to be filed by the taxpayer[.]” Id. If the taxpayer fails “to file a return,” the IRS may assess the tax “at any time.” 26 U.S.C. § 6501(c)(3).
This “[g]eneral rule” “rests on a pragmatic consideration associated with ‘the system of self-assessment which is so largely the basis of our American system of … taxation. The purpose is not alone to get tax information in some form but also to get it with such uniformity, completeness, and arrangement that the physical task of handling and verifying returns may be readily accomplished.’ ”
Quezada, 982 F.3d at 935 (citing Law Office of John H. Eggertsen, P.C. v. Comm’r, 800 F.3d 758, 763 (6th Cir. 2015) (quoting Comm’r v. Lane-Wells Co., 321 U.S. 219, 223 (1944))).
The IRS argued that the treasury regulations require a taxpayer to report backup withholding on a Form 945. The Form 945 is therefore the “return” required to be filed under section 6501(a). Because the Form 945 is the only document that can constitute a return, the limitations clock never began to run. In support of its position, the IRS relied on Lane-Wells, contending it created a per se rule requiring the taxpayer to file the specific return designated for the tax liability at issue.
The Fifth Circuit disagreed with the IRS’s interpretation of Lane-Wells. There, the taxpayer filed corporate returns, but not personal holding company returns. The IRS assessed the tax more than three years after the taxpayer filed the corporate returns. The Supreme Court ruled in favor of the IRS, emphasizing that the “the returns did not show the facts on which liability would be predicated.” Id.at 223. The Fifth Circuit construed Lane-Wells not as prescribing “so inflexible a rule,” but rather that “the wrong form can be ‘the return’ so long as the form shows the facts on which liability could be predicated.” Id.at 223; Quezada,982 F.3dat 935. The court further observed that the IRS’s reading of Lane-Wells conflicts with the opinions of the Sixth, Ninth, Eleventh and Federal Circuits. See Springfield v. United States,88 F.3d 750, 753 (9th Cir. 1996).
The court therefore held that “‘the return’ is filed, and the limitations clock begins to tick, when the taxpayer files a return that contains data sufficient (1) to show that the taxpayer is liable for the tax at issue and (2) to calculate the extent of that liability.” Quezada, 982 F.3d at 936. Ultimately, the court determined that the “Forms 1040 and 1099 contained data sufficient (1) to show that Quezada was liable for the backup-withholding taxes assessed and (2) to calculate the extent of Quezada’s backup-withholding liability, those forms constitute ‘the return’ that triggers the Internal Revenue Code’s three-year assessment limitations period.” Id. at 936. Because the assessment occurred more than three years after Quezada filed the forms, the limitations period barred the assessment.
This opinion is interesting as it underscores the circuit courts’ inclination to show taxpayers leniency with respect to compliance with the Internal Revenue Code, even though the IRC limitations period is to be construed strictly in the IRS’s favor—an extraordinary burden to overcome. Like the Ninth Circuit in Springfield, 88 F.3d at 753, the Fifth Circuit’s holding places the burden on the IRS to ultimately determine and assess the tax, even if the taxpayer failed to file the requisite form.
These materials were written by Maggie E. Schroedter of Robberson Schroedter LLP in San Diego, California (maggie@theRSfirm.com). Editorial contributions were provided by the publications committee of the ILC. Ms. Schroedter is a member of the Insolvency Law Committee.