Federal Circuit Upholds Deficiency Assessment Without Issuance of 90-Day Letter as Harmless Error

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By Theodore Peyser, Esq.

Roberts & Holland, LLP, Washington, D.C., and New York, N.Y.

In Bush v. U.S.,1   decided on March 31, 2010, the Federal Circuit applied the doctrine of harmless error to uphold a deficiency assessment made without the issuance of a 90-day letter.  Taxpayers were members of partnerships that instituted partnership proceedings in the Tax Court and while these cases were pending the taxpayers entered into closing agreements with the IRS. The IRS then made adjustments to taxpayers' returns and assessed deficiencies without issuing a 90-day letter. The taxpayers paid the assessments, filed claims for refund, and filed suits for refund in the Court of Federal Claims. That court held in favor of the IRS, and the Federal Circuit affirmed.

The Federal Circuit panel issued a majority opinion and a concurring opinion. The majority held that the assessments did not meet the definition of computational adjustments on the ground that the settlements stated that there was no change in "partnership items" and the assessments involved a change in a partner-level item, the imposition (in accordance with the settlement) of a $50,000 cap on the at risk capital of each taxpayer in each partnership.  In the view of the majority, the fact that there was no need for an individual partner-level factual determination failed to make the assessments into ones involving a computational adjustment. There being no computational adjustment, the assessments involved deficiencies and the IRS clearly violated the §6213 requirement that it issue notices of deficiency prior to making these assessments.

The majority went on to hold that this failure of the IRS to comply with the statute was insufficient to warrant a refund on the ground that it was harmless error. The majority invoked the federal harmless error statute, 28 USC §2111, directing courts to give judgment without regard to errors or defects which do not affect the substantial rights of the parties. The majority concluded that there was no showing that litigating the issues in question in the Tax Court as opposed to the Court of Federal Claims could have resulted in a different outcome. The language in §6213 permitting the enjoining of collection of such an assessment and the refund of amounts collected during the period of prohibited collection was rejected as inapplicable for the reason that the taxpayers here chose not to resist collection and voluntarily paid the tax.

The concurring opinion would affirm the judgment below in favor of the IRS on the ground that the assessments involved computational adjustments for which no notice of deficiency is required under §6230(a)(1). Because the assessments reflected how the taxpayers had to report certain partnership losses on their returns, they involved computational adjustments, as determined by the Court of Federal Claims.

The concurring opinion went on to charge that the majority erred "by inventing a harmless error exception for `procedural' errors by the IRS" and that "the implications of this new rule are sweeping." Taxpayers will rarely, if ever, be able to satisfy the majority's test that the litigating in the Tax Court will produce a different outcome. Finally, the concurring opinion argues that the majority's new rule "has no textual basis in the tax code."

If the taxpayers file a petition for rehearing en banc, it might very well be granted in view of the majority's unprecedented application of the harmless error statute to the right to litigate in the Tax Court, the importance of the computational adjustment issue, and the fact the decision involves test cases. Moreover, it will be interesting to see if on rehearing the Department of Justice supports the majority's application of the harmless error doctrine.

 For more information, in the Tax Management Portfolios, see Mather, 624 T.M., Audit Procedures for Pass-Through Entities,  and in Tax Practice Series, see ¶3855, Partnership Audit Procedures.


105 AFTR2d 2010-1687 (Fed. Cir. 2010).