A tax deficiency is a statutorily defined concept that is essential to planning and proceeding with tax litigation. Specifically, a deficiency is defined as the amount by which the correct tax exceeds the excess of:
- If a tax return was filed and a tax amount was reported on the return, then the sum of the amount reported on the return plus any amounts previously assessed as a deficiency; or
- The amount of any rebate. (1)
The Tax Court has interpreted this concept in mathematical terms as well, where the deficiency equals the correct tax minus the sum (tax on return + prior assessments – rebates), or where the deficiency equals the correct tax minus the tax on the return minus the prior assessments plus the rebates. Despite the many different interpretations of how to calculate a deficiency, in most cases it is simply defined as the amount by which the taxpayer’s correct tax liability exceeds the amount reported on the tax return.
Prior assessments and rebates sometimes factor into the calculation of a deficiency in the tax litigation arena. However, this takes place only infrequently and when it does, it is because a prior assessment has been made through the course of the first two examinations of the tax return. Along a similar vein, a rebate is defined as an abatement, refund, credit or other repayment that was made to the taxpayer on the grounds that the correct amount of tax was less than the tax reported by the taxpayer as defined in IRC § 6211(a)(1). (2)
Caselaw Related to Assessments and Rebates in a Tax Deficiency
Baldwin v. Commissioner is an example of how assessments and rebates may play a role in tax deficiency litigation. In that case, the taxpayers received a tentative refund on Form 1045 from a carryback resulting from a Net Operating Loss reported on an earlier tax return. The refund was applied, in the form of a credit, against the unpaid tax liability reported on the earlier tax return. The IRS subsequently disallowed the refund and assessed a deficiency in the amount of the previously allowed credit. In response, the taxpayer argued that their credit could not be considered a “rebate” under IRC § 6211(b)(2) because they correctly reported income on their tax return, and thus there could be no “deficiency”. The Tax Court disagreed, and held that a credit allowed as a result of an NOL carryback could be considered as a rebate under IRC § 6211(b)(2).
Sometimes, the IRS makes adjustments to income on the tax return which are offset by other adjustments for the same taxable year. When these other adjustments are equal to or greater than the IRS adjustments, there is no deficiency. In calculating the “correct tax” for these purposes, interest on underpayments are not included, even though underpayments typically constitute a deficiency, and withholding and estimated tax payments are also disregarded.
The IRS can Assess a Deficiency when No Return is Filed
The IRS can assess a deficiency even when no tax return is filed by the taxpayer. In order to calculate the deficiency, the IRS simply assumes that the taxpayer filed a tax return with the amount of tax owed at zero. The IRS also may treat the amount of tax on a tax return as zero if the taxpayer files a statement or letter denying responsibility for the amount of the assessment. In Penn Mutual Indemnity Co. v. Commissioner, the taxpayer filed a tax return with the correct amount of tax indicated on the return, but also included a letter stating his belief that the tax was invalid and unconstitutional. The taxpayer also included a statement that he would not pay the tax on the advice of counsel. According to the IRS, the tax return included the correct amount of tax, so no deficiency existed and the Tax Court was without jurisdiction over the matter. Ultimately, however, a deficiency was found to exist due to the recitations on the taxpayer’s transmittal letter. Because the taxpayer denied responsibility for the assessment and stated his belief that it was invalid, the return was held to actually report no tax, so a deficiency existed for the entire amount of the tax disputed. (3)
The IRS can Assess a Deficiency Based on an Amended Return
Typically, the filing of an amended return will have no impact on assessment and collection process. However, the filing of an amended return may impact the deficiency process. Taxpayers can file amended returns only in certain limited circumstances, and the right to file one is not absolute. The right exists where:
- The amended return is filed prior to the due date of the original return;
- The taxpayer treats a contested item consistently on the original and amended return; and
- The taxpayer treated an item incorrectly on the original item but chose to employ a permissible alternative treatment for the item on the amended return.
When the taxpayer files an amended return reporting a lesser amount than what was reflected on the original return, no deficiency will exist, provided the IRS maintains its position that the original return reflected the correct amount of tax. In that case, the taxpayer is not entitled to receive a statutory notice of deficiency from the IRS. In contrast, when the taxpayer’s amended return shows a greater amount of tax than the original return, the tax amount reported on the amended return is considered the tax reported for deficiency purposes. Thus, the amended return can often be an important starting point for determining the taxpayer’s deficiency.
How a Tax Attorney Can Help with Your Tax Litigation
If you are contemplating a deficiency litigation, then you must consult with an experienced tax attorney. San Diego Tax Attorney William D. Hartsock has been successfully helping clients with tax issues since the early 1980s. Mr. Hartsock offers free consultations with the full benefit and protections of attorney client privilege to help people clearly understand their situation and options based on the circumstances of their case. To schedule your free consultation simply fill out the contact form found on this page, or call (858) 481-4844.
Tax Law References:
- IRC § 6211(a).
- IRC § 6211(a)(1).
- 277 F2d 16 (3d Cir. 1960), aff’g 32 TC 653 (1959).