Zulfiqar v. Commissioner

When 'No Penalty Due' Might Not Mean Zero

The stakes are high for Muhammad and Shazia Zulfiqar, who believed they had settled their 2015 tax liability with the IRS, including "zero" penalties. Now, the IRS is seeking to collect over $65,000 in additions to tax. At issue is the effect of a prior Stipulated Decision entered in 2023. Judge Copeland denied cross-motions for Summary Judgment from both the Zulfiqars and the IRS, finding a factual dispute over whether the settlement document contained a 'mutual mistake' regarding the penalties.

A Timeline of Two Assessments

Following the Zulfiqars' failure to file their 2015 return by the extended deadline of October 15, 2016, the IRS prepared a substitute for return (SFR) on September 3, 2018, relying on third-party information reports. Authority for SFRs is found in Section 6020(b), which allows the IRS to create a return for a taxpayer who fails to file.

The Zulfiqars eventually filed their 2015 Form 1040 on May 20, 2020. The IRS treated this as an amended return, even though it was not accompanied by Form 1040-X, Amended U.S. Individual Income Tax Return. On July 20, 2020, the IRS made a summary assessment of tax, additions to tax, and penalties totaling $282,637. This assessment included a Section 6651(a)(1) addition to tax of $61,243 for failure to timely file and a Section 6654 addition to tax of $4,881 for failure to make sufficient estimated tax payments. Critically, this assessment was based on the Zulfiqars' own late-filed return.

Subsequently, the IRS conducted an examination of the Zulfiqars' 2015 tax year. On September 29, 2020, the IRS mailed a Notice of Deficiency. Deficiency procedures, outlined in Sections 6211 through 6213, require the IRS to issue this notice when it determines that the amount of tax due exceeds the amount shown on the taxpayer's return. The notice determined a deficiency in income tax of $201,644, an additional Section 6651(a)(1) addition to tax of $53,886, and an accuracy-related penalty of $40,329 under Section 6662(a), which imposes a penalty on underpayments attributable to negligence or disregard of rules.

On December 23, 2020, the Zulfiqars petitioned the Tax Court for redetermination of the deficiency, initiating the case at Docket No. 14881-20. While this case was pending, on April 12, 2021, the IRS automatically assessed a Section 6651(a)(2) addition to tax of $65,849 for failure to timely pay the amount reported on their return. Section 6651(a)(2) imposes a penalty for failure to pay the tax shown on the return.

The Tax Court case (Docket 14881-20) concluded with a Stipulated Decision entered on May 18, 2023. This decision stated "there is no addition to tax under I.R.C. § 6651(a)(1) due from [the Zulfiqars] for taxable year 2015; and [t]hat there is no penalty under I.R.C. § 6662(a) due from [the Zulfiqars] for taxable years 2015 and 2016." The Stipulated Decision did not explicitly address the previously assessed Section 6651(a)(2) penalty or the Section 6654 penalty, nor did it contain any "below-the-line stipulation" addressing those penalties.

The Jurisdiction Trap: IRS Arguments

The IRS argued that the prior Stipulated Decision, which seemingly absolved the Zulfiqars of penalties for the 2015 and 2016 tax years, only applied to the deficiency penalties, not the summary assessment penalties. This argument hinged on the Tax Court's jurisdictional limitations.

The IRS pointed out that certain penalties, such as those under Section 6651(a)(2) (failure to pay) and Section 6654 (failure to pay estimated tax), can be immediately assessed and collected if they are based on the amount of tax shown on the taxpayer's self-filed return. Such an immediate assessment is called a "summary assessment." According to the IRS, summary assessments are not subject to the deficiency procedures typically required before the IRS can assess and collect taxes. Deficiency procedures, governed by Sections 6211 through 6213, require the IRS to issue a Notice of Deficiency before assessing additional taxes, giving taxpayers the opportunity to petition the Tax Court before payment.

Because summary assessments bypass these deficiency procedures, the IRS asserted that the Tax Court lacked jurisdiction over the Section 6651(a)(2) and Section 6654 penalties in the prior proceeding. The original Notice of Deficiency did not include these penalties, and the penalties were calculated based on the Zulfiqars' 2015 Form 1040. Therefore, according to the IRS, the prior Stipulated Decision, which only addressed penalties within the Tax Court's jurisdiction at that time, could not have extinguished the Zulfiqars' liability for these separately assessed penalties.

Contractual Silence and Mutual Mistake

The previous section concluded that the Tax Court lacked jurisdiction over the Section 6651(a)(2) and Section 6654 penalties in the prior proceeding. The original Notice of Deficiency did not include these penalties, and the penalties were calculated based on the Zulfiqars' 2015 Form 1040. Therefore, according to the IRS, the prior Stipulated Decision, which only addressed penalties within the Tax Court's jurisdiction at that time, could not have extinguished the Zulfiqars' liability for these separately assessed penalties.

The Zulfiqars, however, argued that the prior proceeding settled the addition to tax under Section 6651(a)(1), which imposes a penalty for failure to file a return, without elaborating on the other additions to tax at issue. The Zulfiqars emphasized that they negotiated, drafted, and executed the Stipulated Decision; that they paid $93,011.19 to fully settle their 2015 liability; and that the payment amount was based on the settlement computations provided in the prior proceeding. The taxpayers invoked their rights to a Collection Due Process hearing, asserting that no liability was due.

The Tax Court, in its analysis, acknowledged that a settlement stipulation is essentially a contract where each party concedes rights for consideration. Citing Saigh v. Commissioner, 26 T.C. 171, 177 (1956), the court noted its reluctance to set aside a stipulated decision absent fraud, mutual mistake of fact, or similar cause.

The court observed that while the Stipulated Decision stated, "there is no addition to tax under I.R.C. § 6651(a)(1) due from petitioners for taxable year 2015," it omitted any mention of the previously assessed Section 6651(a)(2) penalties (for failure to pay) and Section 6654 penalties (for underpayment of estimated tax) that were still at issue in the Collection Due Process (CDP) proceeding. The court further noted that the document did not distinguish between the Section 6651(a)(1) penalty subject to deficiency procedures in the prior docket and the previously assessed Section 6651(a)(1) penalty, which, like the other penalties, might have been jointly omitted from consideration.

The Zulfiqars highlighted the absence of a "below-the-line" stipulation clarifying that the prior assessed Section 6651(a)(1) addition remained. In Tax Court parlance, "below the line" refers to items in a decision document that are agreed upon by the parties but are not part of the court's formal order, often because the court lacks jurisdiction to rule on them directly in that specific proceeding. The court acknowledged that the lack of such a modification could suggest a mistake of fact, meaning the parties shared a misunderstanding about the terms of the settlement. The court reasoned that the lack of a "below-the-line" stipulation was not dispositive but rather raised the possibility of a mutual mistake of fact as to what the parties intended to settle. These unresolved factual issues precluded a summary adjudication of the case.

Drafting Lessons: The Danger of Ambiguity

The court's decision serves as a stark warning regarding the importance of precision in drafting stipulated decisions, particularly in the Tax Court. This case highlights the potential pitfalls of ambiguity when dealing with different types of tax assessments. The presence of a potential summary assessment, authorized under Section 6201, which allows the IRS to immediately assess certain tax liabilities, demands explicit attention in the decision document.

Specifically, the decision document should clearly address any summary assessments "below-the-line" if they exist. As background, in Tax Court practice, the "line" refers to the Judge’s signature on the final decision document. Items "below the line" represent matters the parties have agreed upon that are not part of the Court’s formal order. The court’s order contains the official determination of the deficiency and penalties. Failing to do so can lead to protracted litigation.

The court here found it lacked sufficient information to rule on the existence of a mutual mistake. As such, the case will proceed to trial to resolve the factual dispute regarding the penalties and their proper assessment.