IRS Check Shouldn’t Nullify Crypto Tax Suit, 6th Circ. Told

By Anna Scott Farrell
Via Law360

Law360 (February 14, 2023, 4:30 PM EST) — A taxpayer advocacy group asked the Sixth Circuit to overturn a decision that a check sent by the Internal Revenue Service to a Tennessee couple rendered their challenge to taxes on cryptocurrency they obtained moot, saying a decision favoring the couple could help low-income taxpayers.

If the court upholds a ruling that the agency quashed Joshua and Jessica Jarrett’s lawsuit seeking a refund by writing them a check midway through litigation, there’s nothing stopping the agency from similarly blocking suits from recipients of the earned income tax credit, the Center for Taxpayer Rights said Monday.

“Allowing the United States to do so will hamper the pursuit of justice in tax controversy cases and abrogate taxpayer rights in refund suits, which will particularly burden low- and middle-income taxpayers seeking correction of wrongful IRS collection practices,” the advocacy group said in an amicus brief.

In the underlying case, the Jarretts obtained 9,000 Tezos tokens via a process known as staking, by which some blockchains verify transactions, and paid $3,800 in taxes on the tokens for 2019. When the IRS didn’t respond to their refund request, the Jarretts sued in a Tennessee federal court, which said their request was made moot by an IRS check for the refund amount.

The Jarretts told the appellate court last week that they never cashed the check and, just as a defendant in a class action is not allowed to block a suit by trying to pay off the damages of the class leader, the IRS should not be allowed to block their suit by writing a check they rejected.

Neither the IRS, with its unexplained check, nor the Tennessee district court, in dropping the suit, indicated whether the tokens generated through staking are taxable as income — creating an untenable and recurring situation for them as business owners, they said.

Other taxpayers could be left in a similar lurch if the appellate court agrees to uphold the lower court’s ruling, the Center for Taxpayer Rights said, and EITC recipients whose tax credits hung in the balance would be hit particularly hard.

The tax credits are a vital poverty-reduction tool that helped 31 million taxpayers for 2021, the center said, with families with three or more children receiving up to $7,400. The money can be used to catch up on back rent, avoid eviction or pay down medical debt, the group said.

If a suit seeking a decision on an EITC issue was similarly mooted by an IRS check, a low-income taxpayer could be in jeopardy of losing their ongoing rights to claim the credit, the group argued. Rulings help taxpayers avoid repetitive harm, the group said. For example, if no judgment was rendered, facts needed as evidence to claim the credit could go unresolved, causing the IRS to deny the credit again and again in future years.

Because four out of every 10 audits of individuals in 2021 were of EITC recipients, and because such taxpayers are already vulnerable to the disruptions of poverty, a decision preventing them from receiving rulings in refund suits would have a disproportionately negative effect, the advocacy group argued.

Counsel for the Center for Taxpayer Rights, Audrey Patten of the Legal Services Center of Harvard Law School, told Law360 that the right to bring a refund suit in district court can be one that middle- and low-income taxpayers have trouble accessing. Notably, to request a refund in district court, the taxpayer must first pay the bill.

“But once they’re in there, it’s a forum where people should be able to have their cases heard,” she said.

The Jarretts’ case — where the couple remained undeterred from seeking a court decision despite getting a refund check — presented an unusual situation, she said.

“There’s not really any binding precedent on this exact fact pattern in the Sixth Circuit and probably not elsewhere,” she said.

The U.S. Department of Justice declined to comment.

The case is Jarrett et al. v. U.S., case number 22-6023, in the U.S. Court of Appeals for the Sixth Circuit.