Supplemental assessment due to IRS error is proper

The Tax Court held that a supplemental assessment made to remedy a material IRS error in the calculation of an original assessment was proper.

Background

Hough Beck & Baird Inc. (HB&B) is a landscape architecture firm based in Seattle. HB&B timely filed a Form 941, Employer’s Quarterly Federal Tax Return, for the first quarter of 2021, properly reporting a tax liability of $121,003 and reporting a corresponding amount paid in three deposits. HB&B did not claim a credit on the Form 941.

In June 2021, the IRS assessed HB&B’s employment tax liability for the first quarter of 2021 as zero by treating the company as entitled to a credit. Because HB&B had made $121,003 of employment tax deposits, the IRS considered HB&B to have made an overpayment of that amount. As a result of its mistaken assessment, the IRS refunded HB&B the $121,003 of deposits it made, plus interest.

HB&B’s accountant, after learning of the unexpected refund, called the IRS. An IRS representative told the accountant that HB&B was entitled to the refund because of “COVID Employee Retention Credits” given to certain employers to provide relief during the COVID–19 pandemic.

However, two years later, in May 2023, the IRS sent HB&B a Letter 6552, stating that the company had received a refund to which it was not entitled. The letter proposed an adjustment to HB&B’s employment tax liability for the first quarter of 2021. HB&B did not respond to the letter or pay the balance the IRS claimed was due. In July 2023, the IRS reversed the credit that caused the erroneous refund and made a supplemental assessment of $121,003 for HB&B’s employment taxes for the first quarter of 2021. It also assessed an interest charge for late payment of $12,582.

After issuing a notice of balance due, which HB&B did not pay, the IRS issued the company a Letter 1058, Final Notice, Notice of Intent to Levy and Notice of Your Rights to a Hearing. In response, HB&B requested a Collection Due Process hearing, claiming in its request that it was not liable for the tax the IRS was attempting to collect. The hearing was conducted, but ultimately, the IRS Independent Office of Appeals sustained the proposed levy.

In December 2024, HB&B challenged the IRS’s determination in Tax Court. The parties filed cross–motions for summary judgment, asking the court to determine whether the IRS’s supplemental assessment was proper. HB&B argued that because the original assessment of its employment tax liability for the first quarter of 2021 was perfect and complete in all material respects, the IRS’s supplemental assessment under Sec. 6204 was improper. The IRS argued that its original assessment was imperfect in a material respect and thus its supplemental assessment was proper under Sec. 6204.

Supplemental assessments

Sec. 6204 allows the IRS to make a supplemental assessment whenever it is ascertained that any assessment is imperfect or incomplete in any material respect, within three years after a return was filed (see also Sec. 6501(a)). Under Sec. 6502(a)(1), the IRS may collect the tax by levy within 10 years after a timely reassessment.

The Tax Court’s holding

The Tax Court granted the IRS’s motion for summary judgment and denied HB&B’s. It held that when the IRS incorrectly calculates the amount of the original assessment and the mistaken calculation is material, the original assessment is imperfect in a material respect and the IRS may make a timely supplemental assessment to remedy the mistaken calculation.

As the Tax Court explained, neither the Code nor the regulations define “imperfect” or “incomplete” as used in Sec. 6204(a), and it had not previously addressed when, as the result of the IRS’s error, an assessment is imperfect. It therefore looked to circuit court decisions on the issue for guidance.

The Tax Court identified three circuit courts that had found an assessment to be imperfect or incomplete in a material respect due to the IRS’s error and upheld the IRS’s supplemental assessment under Sec. 6204 to correct the error. In Brookhurst, Inc., 931 F.2d 554 (9th Cir. 1991), the Ninth Circuit held that where the IRS mistakenly assessed the taxpayer’s liability as less than $1,000 instead of almost $200,000, the assessment was imperfect and a supplemental assessment was allowable. In Johnson, 123 F.3d 700 (2d Cir. 1997), the Second Circuit held that the IRS could make a supplemental assessment where the original assessment was invalid. In Frontone, 383 F.3d 656 (7th Cir. 2004), the Seventh Circuit held that because the IRS understated the taxpayers’ tax liability by more than $5,000, the initial assessment was imperfect or incomplete in a material respect and a supplemental assessment was justified.

With this case law as a backdrop, the Tax Court analyzed whether the supplemental assessment against HB&B was proper. The Tax Court found that the original assessment in HB&B’s case was “strikingly similar to those in Frontone and Brookhurst.” In Frontone, the IRS issued a refund to the taxpayers after miscalculating their tax liability. In Brookhurst, the IRS assessed a smaller employment tax liability amount than what the taxpayer had paid and reported on its return, and that mistaken assessment resulted in an overpayment that the IRS refunded to the taxpayer. In each case, the court concluded that the original assessment was imperfect or incomplete in a material respect. The Tax Court concluded that the two cases, particularly Brookhurst, were almost directly on point and highly persuasive. Accordingly, the court held that the original assessment against HB&B, which misstated HB&B’s liability by the entire amount of its employment tax liability, was imperfect in a material respect and that the IRS had the authority to make a timely supplemental assessment under Sec. 6204 to support its collection efforts.

Reflections

As HB&B argued, if the Tax Court had held that the original assessment was proper, the IRS would only have been able to recover the amount it incorrectly refunded to the company through a Sec. 7405 civil erroneous–refund suit. However, such a suit must generally be begun within two years after the refund is made. Because the IRS had not brought a Sec. 7405 suit within two years of making the refund to HB&B, if the court had found that the original assessment was proper, the IRS would have been unable to recover any of the amount it had refunded.

Hough Beck & Baird, Inc., 167 T.C. No. 2 (2026)

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.