Program Manager Technical Advice 2011-013
In Program Manager Technical Advice (PMTA), IRS has determined that a purported return on which a return preparer increased the amount of the taxpayer's claimed charitable deduction without the taxpayer's knowledge was a nullity because it was unknown to and unverified by the taxpayer.
Background. In Beard v. Com., (CA 6 6/24/1986) 58 AFTR 2d 86-5290, the Sixth Circuit, affirming the Tax Court, held that for a document to constitute a valid return, it must:
... contain sufficient data to calculate tax liability;
... purport to be a return;
... represent an honest and reasonable attempt to satisfy the requirements of the tax law; and
... be executed under penalty of perjury.
Observation: The above four-part analysis is commonly known as the “substantial compliance” standard or the Beard formulation.
Facts. A certified public accountant (CPA) prepared approximately 700 individual income tax returns for tax year 2002, of which approximately 450 were filed electronically. CPA initially prepared the returns with the information provided by the taxpayer and printed a copy of that return to give to the taxpayer, but then increased the charitable contribution amount without the taxpayer's knowledge in order to increase the amount of the refund.
Additionally, CPA established a refund anticipation loan (RAL) account at a financial institution for that taxpayer, also without the taxpayer's knowledge, that allowed CPA to issue a bank check before the refund was received from IRS. CPA provided the taxpayer with a bank check for the amount of the refund shown on the original tax return, less his $50 preparation fee. The excess refund attributable to the inflated charitable deduction was put into CPA's checking account.
In some cases, IRS froze certain taxpayers' refunds, and the financial institution demanded that they repay the refund amounts. Some taxpayers paid the amount of the check they received, while others paid the entire amount, including the fraudulent portion that CPA received without their knowledge.
CPA also reported fraudulent business expenses for several taxpayers. According to IRS, these fraudulent expenses appeared to have been claimed with their knowledge.
Issues. The questions presented to IRS included:
(1) whether a return on which CPA claimed an inflated charitable contribution without the taxpayer's knowledge is a nullity;
(2) if the return is a nullity, but the taxpayer received a RAL for the correct amount of his refund (less preparation fees), whether the taxpayer will receive another refund when the true return is filed;
(3) whether a return on which CPA claimed an inflated charitable contribution without the taxpayer's knowledge, but also claimed fraudulent business expenses with the taxpayer's knowledge, is a nullity; and
(4) whether affected taxpayers should file new or amended returns.
Conclusion. IRS determined that since the return that was signed and verified by the taxpayer was not the document that was actually sent to IRS, and the taxpayer was unaware of the inflated charitable contribution expenses added by the return preparer, he didn't execute his return under penalties of perjury. Thus, the signature requirement wasn't met, and the document doesn't constitute a return. The result is the same for returns on which fraudulent business expenses were also claimed with the taxpayer's knowledge.
IRS noted that since no return was filed, no accuracy-related or civil fraud penalties could be imposed against the taxpayer. However, criminal fraud penalties under Code Sec. 7206 could potentially apply.
If the taxpayer in fact received a RAL in the correct amount, then there is no overpayment, and IRS thus won't issue a second refund when the taxpayer's true return is filed. However, where the refund was frozen by IRS, and the taxpayer sent the amount of the refund to the financial institution, the taxpayer has overpaid his taxes and IRS should send the correct amount of the refund directly to the taxpayer.
Finally, IRS determined that since the fraudulently altered returns were nullities, affected taxpayers are treated as if no return has been filed. Therefore, taxpayers whose returns were fraudulently altered shouldn't file a Form 1040X. Instead, they should file an accurate Form 1040 (or 1040 series return), and the Criminal Investigation or Small Business/Self-Employed Division should use that information to correct the taxpayers' Master Accounts.
References: For the requirement that a taxpayer execute a return under penalty of perjury, see FTC 2d/FIN ¶S-1401; United States Tax Reporter ¶60,614; TaxDesk ¶570,100 et seq.; TG ¶1960.