How To Prove You Filed a Tax Return, If The IRS Says You Didn't

Tuesday, October 25, 2016

Sometimes taxpayers and the IRS just disagree on whether the taxpayer filed a return. The taxpayer faces a daunting task to prove the filing of a return.  In a recent bankruptcy case, McGrew v. Internal Revenue Service, the court held that the taxpayer proved her case.  Her success provides some insight into how a taxpayer might win this argument.  I have some other thoughts based on cases I have seen over the years.

Last year we “celebrated” the 30th anniversary of the famous incident at the Philadelphia Service Center in which IRS employees who had too many cases to process and too little time to do it decided to take matters into their own hands and flush the returns down toilets, hide them in ceiling tiles and otherwise find creative things to do with tax returns.  For stories and investigations concerning the little problem with returns the IRS had in 1985 see here, here, here and here.  Thirty years is a long time and only a small percentage of IRS employees working today worked at the IRS in 1986.  The Philadelphia Service Center has moved locations.  The institutional memory of IRS workers concerning this incident seems no longer to exist.  I had a conversation with two young attorneys from the Boston office this past year, neither of whom could even seem to contemplate the possibility that the IRS transcript could contain inaccuracies.  The IRS employee testifying in the McGrew case, stated that she had no knowledge of the IRS ever losing a tax return. 

The IRS does a great job of keeping track of millions of pieces of paper with a focus on tax returns; however, anyone who thinks that the IRS never loses tax returns is naive. On the flip side, many taxpayers have a similar naiveté because they seem to think they can just waltz into court and assert the IRS has lost their returns and the court will easily buy that story.  In the vast majority of cases, courts will reject such an argument, which makes the McGrew case interesting and instructive.  Before I get to the facts of the McGrew case, I want to detour to my practice for testing for lost returns when I tried these cases for the IRS and to the bankruptcy issue lurking in this case.

Taxpayers regularly asserted that the IRS lost their return when I worked for Chief Counsel’s office. I knew the possibility existed but doubted most of the taxpayers making the assertion.  Because I practiced primarily in Virginia and because Virginia has a state tax scheme that mirrors the federal one, even requiring taxpayers to attach a copy of their federal return to their state one, my go-to place for checking on lost tax returns was the state.  I figured the loss of one return by the IRS was low but possible.  The loss of two or more returns, each allegedly timely filed, got much lower.  The loss of the federal returns by the IRS and the state returns by an entirely different agency made the story one that was unbelievable.  So, the first thing I did when a taxpayer said the IRS lost a tax return was ask if the taxpayer filed a state tax return with Virginia.  If the taxpayer answered affirmatively, the state tax records were requested.  In every case I can remember, the state tax records matched the IRS records.  Taxpayers who alleged that the IRS lost their tax returns had to allege that the state also lost their returns for the same periods.  That basically ended the inquiry into the allegedly missing returns.  Courts found this coincidence too powerful to ignore.  No discussion of the parallel state tax return filings exist in the McGrew case, and I do not know if that is because the taxpayer had no state filing obligation or no one checked on those returns.

One aspect of the McGrew case that makes the lost return story more believable is that the lost return was one of multiple late returns filed many years after the due date.  When a taxpayer files a late return, the IRS may set that return to the side so that it can continue timely processing returns filed during the current cycle.  My experience suggests that late-filed returns have a higher incidence of getting lost in the system. 

By Keith Fogg for Forbes Magazine

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