Information Return Cannot Be Relied Upon By IRS in Proceeding After Taxpayer Reasonably Disputed Amount Reported

The IRS was reminded by the Tax Court in the case of Perez v. Commissioner, TC Summary Opinion 2009-94 of the existence of §6201(d) when it attempted to rely upon only a Form 1099-R and a life insurance application to sustain a tax assessment against a taxpayer who had let lapse a life insurance policy.

In the case in question, two 1099-Rs were issued in consecutive years by a life insurance company to Dr. Perez, the taxpayer in this case. Dr. Perez, upon receipt of the 1099-R for the first year reporting a taxable distribution related to his policy did not report the amount as income, but rather entered into a series of contacts with the IRS, but via telephone and written exchanges, each time hearing from a different person at the IRS and never apparently getting a complete answer. While waiting for clarification from the IRS about the tax status of that 2003 distribution, the IRS issued a CP2000 that related to the 1099-R income. Dr. Perez paid the tax shown as due on that notice, but continued to dispute its taxation and noted such on the form he returned with his check.

While this saga continued, the life insurance company issued another Form 1099-R for the following year (2004). As Dr. Perez was still waiting for clarification on 2003, he did not include this amount in income and, this time, did not end up paying the tax the IRS eventually demanded he pay.

The IRS introduced at trial only the Forms 1099-R and an application that Dr. Perez initially made for coverage. The Tax Court held that was insufficient, as Dr. Perez had cooperated with the IRS throughout his ordeal, and had raised a reasonable dispute as to the taxable status of the amounts reported by the insurance company. Under §6201(d), once that took place, the IRS was required to make reasonable inquiries into the validity of the information report issued—and they failed to do so.

The Tax Court contrasted the facts here with those in Atwood v. Commissioner, T.C. Memo. 1999-61, a case the IRS looked to as controlling in this matter. The Court noted that in Atwood it had information related to the policies and its terms. In this case, by contrast, the court complained that it did not have an actual policy in evidence, did not have any evidence about why the policies lapsed or any information upon which to determine the consequences to Dr. Perez of such a lapse. The court points out that once a reasonable disput was raised, the IRS is not justified in merely showing a 1099-R was issued and that it properly recorded the amounts the insurance company had reported.

The IRS computers certainly tend to believe in the inerrancy of information reports but it’s important to note to remind the IRS that the mere existence of the information reporting form is not necessarily conclusive evidence of taxable income. Similarly, it’s important that we understand that to invoke §6201(d) our clients must be able to raise a reasonable dispute regarding the taxable status.

As this case showed, such a dispute does not mean proving the amount was not taxable—rather, it simply means that, given the knowledge and sophistication of the taxpayers and his advisers, did the taxpayer have reason to believe the amount might not be taxable and did the taxpayer take reasonable steps to obtain clarification on the matter. The opinion never mentions Dr. Perez asking the insurance company about the 1099-R—but the court did not appear to hold that against him, likely due to his expertise (or lack thereof) on tax matters. But the Court did specifically take the IRS to task for not making inquiries there.