In a recent decision filed on April 11, 2016, the Tax Court ruled that the IRS can amend its answer to assert new grounds upon which its disallowance is based. In its initial disallowance, the IRS provided that they were disallowing certain deductions for insurance premium payments because the taxpayer “did not establish that the amount show was (a) [an] insurance expense, and (b) paid.” After filing its initial answer, the IRS filed the present motion to amend its answer. Specifically, the IRS wants to amend its answer in order to argue that (1) the taxpayers’ captive insurance arrangement lacked economic substance and (2) the premium payments were not deductible as “necessary and ordinary” expenses.
In its response, the taxpayers asserted the Administrative Procedures Act (APA) forbade the court from granting the IRS leave to amend its answer, arguing that the Service’s attempt to bolster its disallowance must be rejected as the Supreme Court itself turned down the opportunity to extend such “tax exceptionalism” to the IRS in Mayo Foundation for Med. & Educ. Research v. U.S. The judge found this argument unpersuasive, relying upon a number of IRC code sections that establish the Tax Court’s jurisdiction. In particular, the court cites IRC §§ 6214(a) and 6215(b), which provide that the Tax Court can redetermine whether there is a deficiency or overpayment, respectively, regardless of the amount initially determined by the IRS. The court also stated that Mayo Foundation was inapplicable in the present case as the APA distinguishes between circumstances involving judicial review explicitly authorized by statute and those that do not involve statutorily authorized judicial review.
Secondly, the taxpayers asserted that granting the commissioner leave to amend its answer would unfairly prejudice them. The taxpayers also contend that the amended answer does not meet the requirement under Tax Court Rule 142 because the amended answer does not contain any supporting facts for this “new matter.” However, the court agreed with the commissioner on the former issue, relying on the fact that the no trial date has been set and that no discovery had taken place. The court also disagreed with the taxpayers on their third contention as the concept of “ordinary and necessary” was implicit within the assertion that the premium payments to the captive insurance company did not constitute an insurance expense.
This case is a good reminder that petitioning the Tax Court can result in a review that extends beyond those asserted in the Notice of Deficiency, and that practitioners must carefully weigh the value of filing suit in Tax Court against the possibility of an expanded look at a taxpayer’s return.
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