Court case highlights taxpayers’ duty of consistency

In Squeri et al. v. Commissioner, T.C. Memo 2016-116 (June 16, 2016), the Tax Court ruled that the IRS had the authority to make adjustments to the taxpayers’ closed tax year based on the taxpayers’ duty of consistency in reporting items of income.

The taxpayers in Squeri were the owners of Preferred Building Services, Inc. (PBS), an S corporation.  From 2008 to 2010, PBS was a cash basis taxpayer that determined its gross receipts reported on Form 1120S, “U.S. Income Tax Return for an S Corporation,” using the deposits made into its bank accounts during the calendar year. However, the IRS alleged that PBS deposited certain payments that were received in 2008 into its bank account in January 2009, certain payments received in 2009 into its bank account in January 2010 and certain payments received in 2010 into its bank account in January 2011. The IRS determined that the taxpayers improperly computed their gross income by excluding the checks that were received during the last quarter of each tax year at issue. The IRS examined the taxpayers’ 2009 and 2010 tax years.

In calculating the adjustment to each taxpayer’s gross receipts for 2010, the IRS included the checks that were received in the year at issue but deposited by PBS in January of the following year, and excluded the checks that were deposited in January of the tax year at issue but were received in the prior year. For 2009, the IRS argued that under the equitable doctrine of the duty of consistency, the taxpayers must include on their 2009 returns the amounts of 2008 income, as the taxpayers had originally reported. The taxpayers argued, however, that because 2008 was a closed year, the IRS didn’t have the authority to make adjustments.

The Tax Court ruled that the IRS did have the authority to make the adjustments under the equitable doctrine of the duty of consistency. The duty of consistency has three elements, all of which must be proved by the party asserting the duty. Those elements are:
  1. A representation or report by the taxpayer
  2. Reliance by the IRS
  3. An attempt by the taxpayer after the statute of limitations has run to change the previous representation or to recharacterize the situation in such a way as to harm the IRS. See Estate of Ashman v. Commissioner, 231 F.3d 541 (9th Cir. 2000), aff’g T.C. Memo 1998-145, aff’g T.C. Memo 2004-117.

In Squeri, the Tax Court held that the taxpayers made a clear representation to the IRS when they reported on the 2009 Form 1120S that PBS had received certain gross receipts in 2009. The IRS also relied on the taxpayers’ representation when it accepted the taxpayers’ 2008 tax returns and allowed the statute of limitations to expire for that year. Finally, the Tax Court held that the third prong of the test had been met because allowing the taxpayers to recharacterize their 2009 income as belonging in 2008 would harm the IRS. Accordingly, the IRS was able to make adjustments to the taxpayers’ previously closed tax year under the equitable doctrine of the duty of consistency.

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