Muhammad Zulfiqar & Shazia Zulfiqar v. Commissioner

The Unsettled Settlement: When a Stipulated Decision Leaves Liability in Limbo

The Zulfiqars paid over $93,000 to the IRS, believing their 2015 tax liabilities were settled. Now, they are back in Tax Court fighting the IRS, which continues to pursue penalties related to that year. At the heart of the dispute is a Stipulated Decision stating there would be "no addition to tax." The question is: Did this agreement wipe out all penalties, or only those specifically addressed in the original deficiency notice? The Tax Court found the settlement language ambiguous and denied both the Zulfiqars' and the IRS's motions for summary judgment, setting the stage for a trial to determine whether there was a 'mutual mistake' in the settlement.

From Late Filing to 'Final' Decision

The dispute stems from the Zulfiqars' 2015 tax liability and how a subsequent settlement impacted the additions to tax. After requesting an extension to file their 2015 return until October 15, 2016, the Zulfiqars failed to meet the extended deadline. As a result, the IRS prepared a Substitute for Return (SFR) on September 3, 2018, leveraging its authority under Section 6020(b). This section empowers the IRS to create a return based on available information when a taxpayer fails to file.

The Zulfiqars eventually filed their 2015 Form 1040 on May 20, 2020. The IRS, treating it as an amended return due to the prior SFR, then made assessments on July 20, 2020. These summary assessments, distinct from deficiency procedures, included $282,637 in tax, a $61,243 addition to tax under Section 6651(a)(1) for failure to timely file, and a $4,881 addition to tax under Section 6654 for failure to make sufficient estimated tax payments. Section 6651(a)(1) imposes a penalty for failing to file a tax return on time, calculated as a percentage of the unpaid tax liability.

Subsequently, the IRS conducted an examination and, on September 29, 2020, mailed the Zulfiqars a Notice of Deficiency. This notice determined a $201,644 deficiency in income tax, a $53,886 addition to tax under Section 6651(a)(1), and a $40,329 accuracy-related penalty under Section 6662(a). Section 6662(a) allows the IRS to impose a penalty on underpayments of tax if they are due to negligence or disregard of rules or regulations. The Zulfiqars petitioned the Tax Court in December 2020 (Docket No. 14881-20), contesting the late-filing penalty, arguing they were not liable for any penalties, and asserting "reasonable cause."

While the Tax Court 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. Section 6651(a)(2) imposes a penalty for failing to pay the tax shown on a return by the due date. This assessment was based on the unpaid tax reported on the Zulfiqars’ 2015 Form 1040. The parties eventually resolved the case, filing a Proposed Stipulated Decision on May 16, 2023, which the Tax Court entered on May 18, 2023. The key provision stated "there is no addition to tax under I.R.C. § 6651(a)(1) due from [the Zulfiqars] for taxable year 2015." Critically, the Stipulated Decision lacked a "below-the-line" stipulation addressing the assessed additions to tax, nor did it mention the previously assessed Section 6651(a)(2) penalty.

The Collection Clash: 'We Paid' vs. 'You Owe'

Following the Tax Court's entry of the Stipulated Decision, the IRS proceeded with collection efforts. On May 31, 2023, the Commissioner mailed the Zulfiqars a Final Notice of Intent to Levy, known as Letter 1058. This notice indicated an unpaid amount of $202,932 for the 2015 tax year, a figure seemingly encompassing the original tax per Form 1040, additions to tax under Section 6651(a)(1) for failure to file, Section 6651(a)(2) for failure to pay, Section 6654 for underpayment of estimated tax, the agreed deficiency of $2,443, prior payments, and interest.

The Zulfiqars responded by making a designated payment of $93,100, covering tax and interest, based on computations previously provided by the Commissioner. Simultaneously, they submitted Form 12153, Request for a Collection Due Process (CDP) Hearing, asserting that the entire 2015 tax liability had been satisfied via the Stipulated Decision. They checked boxes on the form indicating they were not liable for the tax, had made payments not properly applied, and included an addendum explaining their understanding of the Stipulated Decision as a final resolution.

The Independent Office of Appeals assigned Settlement Officer Megan Velasco (SO Velasco) to the case. Separate CDP hearings were scheduled for Mr. and Mrs. Zulfiqar. During Mr. Zulfiqar's hearing on October 17, 2023, his representatives reiterated their belief that the Stipulated Decision finalized the 2015 tax liability. SO Velasco, unconvinced, sought an opinion from the IRS Office of Chief Counsel.

The Chief Counsel opinion, received on November 7, 2023, proved pivotal. It asserted that the $65,849 addition to tax under Section 6651(a)(2) – the penalty for failure to pay, calculated at 0.5% per month up to a maximum of 25% of the unpaid tax – was based on the Zulfiqars' filed return and had been assessed in 2020, predating the Tax Court case. The opinion emphasized that the Stipulated Decision addressed only the deficiency stemming from the notice of deficiency, not the earlier assessed penalties. It stated that Section 6651(a)(2) should not be abated. SO Velasco conveyed this information to the Zulfiqars' representatives, who maintained their disagreement. Ultimately, the IRS issued a Notice of Determination sustaining the levy, stating that the Stipulated Decision pertained only to the notice of deficiency and not to the separately assessed Section 6651(a)(1) penalty for failure to file. Mrs. Zulfiqar's CDP hearing and subsequent Notice of Determination mirrored this reasoning.

Ambiguity and the Missing 'Below-the-Line' Stipulation

As detailed above, the IRS sustained the levy, arguing the Stipulated Decision only addressed the notice of deficiency, not the separately assessed penalty under Section 6651(a)(1). Mrs. Zulfiqar's CDP hearing and subsequent Notice of Determination mirrored this reasoning.

The Tax Court, however, saw the matter differently when considering the parties' cross-motions for summary judgment. The court emphasized that while it entered the Stipulated Decision in Docket No. 14881-20, rendering it final under Section 7481(a), it had to determine the effect of that decision on the current proceeding. Section 7481(a) states that the decision of the Tax Court becomes final upon the expiration of the time allowed for filing a notice of appeal, if no such notice has been duly filed within the statutory deadline.

The court reiterated the established principle that "a settlement stipulation is in all essential characteristics a mutual contract," citing Saigh v. Commissioner, 26 T.C. 171, 177 (1956). As such, it carries the sanctity of any other contract. The Tax Court is typically reluctant to set aside a stipulated decision absent fraud, mutual mistake of fact, or similar cause.

Here, the court found that while there was no evidence of fraud, a "mutual mistake of fact" was possible. While the IRS may immediately assess and collect additions to tax under various sections, this action, also known as a summary assessment, is not subject to deficiency procedures and is beyond the Tax Court’s jurisdiction. Section 6665(b) states that "Procedure for Assessing Certain Additions to Tax" dictates that additions to tax can be assessed immediately if determined by the amount of tax shown on the taxpayers' self-filed return.

The court noted that the Zulfiqars contended they negotiated and executed the Stipulated Decision, paid $93,011.19 to settle their 2015 liability, and that the payment was based on settlement computations omitting the penalties at issue. The IRS countered that the prior proceeding couldn't have addressed the previously assessed additions to tax.

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 additions to tax for underpayment of estimated tax, which were at issue in the CDP proceeding.

Crucially, the court highlighted the absence of a "below-the-line" stipulation. The Zulfiqars emphasized that the Stipulated Decision contained no such stipulation to clarify that the prior assessed Section 6651(a)(1) addition remained. A below-the-line stipulation is a specific term of art in Tax Court decision documents, referring to stipulations that appear physically below the Judge’s signature, which the court has clarified are agreements only between the parties and do not constitute a "finding" or "decision" by the Tax Court. The absence of such a stipulation, the court reasoned, suggested that the omission "may have been a mistake of fact." The court suggested that without this language, the taxpayers might have reasonably believed they were settling all outstanding liabilities for the year. These unresolved factual questions prevented the court from granting summary judgment to either party.

Impact: The Cost of Contract Precision

As the court denied both motions for summary judgment, the case is headed for trial to determine the scope of the original settlement. This case serves as a potent reminder of the importance of precision in drafting stipulated decisions, a lesson applicable to all tax practitioners navigating settlements with the IRS. The Tax Court's decision underscores the danger of ambiguous language, particularly when dealing with previously assessed additions to tax that fall outside the typical deficiency procedures.

This case highlights that if the IRS intends to retain the ability to collect on prior assessments of penalties like those under Section 6651(a)(2), which imposes a penalty for failure to pay tax, specific language clarifying the continued liability is crucial. Absent such explicit "below-the-line" stipulations – agreements between the parties that appear physically below the judge’s signature, which the court has clarified are agreements only between the parties and do not constitute a "finding" or "decision" by the Tax Court – the IRS risks creating ambiguity that could jeopardize collection efforts. Conversely, if taxpayers seek a truly global settlement encompassing all potential liabilities for a given tax year, they must ensure the stipulated decision's language explicitly covers all assessments, including those already made by the IRS, not just the initial deficiency stemming from the notice of deficiency. The Zulfiqar case illustrates how a lack of clarity can lead to protracted litigation and a forced trial, all to determine the parties' original intent.