Regarding Notices of Deficiency
AS DISCUSSED AT THE END OF PART II in CtC, a "deficiency" is a statutorily-defined term, with a very limited meaning. The term refers to the difference between the tax shown on a filed return and what the tax should be if the proper rate of tax is accurately applied to net "income" which has been properly calculated by the accurate and appropriate application of any claimed and legitimately-available deductions and other adjustments to the amount of gross "income" reported on the return, and after factoring in amounts previously assessed and/or "rebated". Here's how Congress puts it:
26 USC § 6211 - Definition of a deficiency
(a) In general
For purposes of this title in the case of income, estate, and gift taxes imposed by subtitles A and B and excise taxes imposed by chapters 41, 42, 43, and 44 the term “deficiency” means the amount by which the tax imposed by subtitle A or B, or chapter 41, 42, 43, or 44 exceeds the excess of—
(1) the sum of
(A) the amount shown as the tax by the taxpayer upon his return, if a return was made by the taxpayer and an amount was shown as the tax by the taxpayer thereon, plus
(B) the amounts previously assessed (or collected without assessment) as a deficiency, over—
(2) the amount of rebates, as defined in subsection (b)(2), made.
(b) Rules for application of subsection (a)
For purposes of this section—
(1) The tax imposed by subtitle A and the tax shown on the return shall both be determined without regard to payments on account of estimated tax, without regard to the credit under section 31, without regard to the credit under section 33, and without regard to any credits resulting from the collection of amounts assessed under section 6851 or 6852 (relating to termination assessments).
(2) The term “rebate” means so much of an abatement, credit, refund, or other repayment, as was made on the ground that the tax imposed by subtitle A or B or chapter 41, 42, 43, or 44 was less than the excess of the amount specified in subsection (a)(1) over the rebates previously made.
(3) The computation by the Secretary, pursuant to section 6014, of the tax imposed by chapter 1 shall be considered as having been made by the taxpayer and the tax so computed considered as shown by the taxpayer upon his return.
(4) For purposes of subsection (a)—
(A) any excess of the sum of the credits allowable under sections 24 (d), 25A by reason of subsection (i)(6) thereof, 32, 34, 35, 36, 36A, 36B, 53(e), 168(k)(4), 6428, and 6431 over the tax imposed by subtitle A (determined without regard to such credits), and
(B) any excess of the sum of such credits as shown by the taxpayer on his return over the amount shown as the tax by the taxpayer on such return (determined without regard to such credits),
shall be taken into account as negative amounts of tax.
(c) Coordination with subchapters C and D
In determining the amount of any deficiency for purposes of this subchapter, adjustments to partnership items shall be made only as provided in subchapters C and D.
I know. You're saying, "What the h***?!"
As well you might. This statute is a mare's nest of near-gibberish, which a cynical person might imagine to have been specifically designed to confuse the unwary, create clients for tax attorneys and CPAs, and represent so much choking undergrowth as to allow corrupt tax agencies and judges to exceed their jurisdiction by exploiting the ignorance of their prey, while still retaining plausible deniability of chargeable malfeasance.
In fact, this is a classic example of the difference between what must be dealt with by those within the ambit of the tax law, and those without (and why it's so important to know which you are at any given time).
Happily, breaking it down makes it easy (assuming a return has been properly completed and filed):
1. A return shows an amount of gross "income" (which might be $0).
2. That amount of "income" has been reduced by the application of deductions, adjustments, credits, exemptions, and so forth (if any are claimed, and if reduction is even possible).
3. The resulting net ("adjusted gross") "income" (aka "taxable income")-- which might be $0-- has been multiplied by a given rate of tax, which resulted in an amount showing as "tax due" (which might be $0).
4. A "deficiency" is the difference between the amount shown as "tax due", and what that amount should be if everything in steps 2 and 3 was properly done (minus amounts previously assessed and "rebate" adjustments, if any).
So, the jurisdiction of Tax Court regarding "deficiencies" is over everything in steps 2 and 3. Significantly, it has nothing to do with step 1. As said in the statutory definition (consolidated for easier intake, but feel free to check my parsing...):
“[D]eficiency” means the amount by which the tax imposed by subtitle A or B, or chapter 41, 42, 43, or 44 exceeds the sum of the amount shown on the return plus amounts previously assessed (or collected without assessment as a deficiency) minus the amount of rebates (as defined in subsection (b)(2)) which have been made.
Nothing in this definition purports to involve debate, challenge or determinations concerning the amount of "income" that is the starting point for all "tax due" calculations. And how could it, after all? Neither the "deficiency" alleger nor the tax court judge has any personal competency concerning that subject; further, don't lose sight of the fact that tax agencies and "tax courts" are really nothing more than accounting and collection operations. In any event, "income" is not the issue addressed by "deficiency" proceedings. The only thing addressed is the difference between the amount of tax shown and the amount properly calculated in light of the data already in consideration.
Of course, we all know that the tax agencies like to pretend that a deficiency is the difference between the amount shown on a return and what they would rather see the filer end up paying as tax-- even if that means pretending that their authority extends to deciding that the filer didn't start with a big enough gross "income" figure. At times like that, we all have to remember:
“Persons dealing with the government are charged with knowing government statutes and regulations, and they assume the risk that government agents may exceed their authority and provide misinformation.”
Lavin v. Marsh, 644 F.2d 1378 (9th CA, 1981);
“Whatever the form in which the government functions, anyone entering into an arrangement with the government takes the risk of having ascertained that he who purports to act for the government stays within the bounds of his authority.”
Federal Crop Ins. Corp. v. Merrill, 332 U.S. 380 (USSC, 1947).
WE SHOULD ALSO CONSIDER THAT a Notice of Deficiency MIGHT get sent in the face of an educated, accurate filing based on the pretense that a return was never filed. One might also be sent on the pretense that the filed return is "frivolous" and therefore invalid (meaning "effectively never filed at all"). This pretense would be used to calculate a "deficiency" from a "module", under the doctrine that non-filing amounts to an agreement with the "income" assertions on unanswered "information returns"-- W-2s or 1099s, for instance-- and allows the "service" to treat the self-assessment as $0 for purposes of calculating a deficiency:
In such a case responding with proof of one's filing, or definitively rebutting a "frivolous" pretense, respectively, would likely be appropriate and important in such circumstances. See here and here for a number of case studies involving CtC-educated Americans and "notices of deficiency" (found throughout the postings on those pages). Also see various related legal notes here.