Exam or no exam, taxpayers must file on time

The U.S. Tax Court delivered a firm reminder to taxpayers and practitioners alike in Fussell v. Commissioner, T.C. Memo 2025-131: an ongoing IRS examination does not relieve a taxpayer of the fundamental duty to file a return. The case, decided on Dec. 18, 2025, underscores a principle that tax professionals know well, but clients sometimes resist.

Mark L. Fussell failed to file a federal income tax return for 2018, arguing that delays and unresolved issues from prior IRS examinations justified his waiting. The court soundly rejected this position, sustaining not only the income tax deficiency of $38,662 but also a trio of penalties for failure to file, failure to pay and failure to pay estimated tax, totaling over $18,800.

Background of the long-running dispute

Mr. Fussell's tax troubles originated nearly two decades earlier with his software development company, Velidom, Inc. He claimed to have lent the "tightly held" corporation $420,000 in 2005. After the business failed, he sought to claim these advances as a business bad debt loss.

In 2015, he filed amended returns for 2012, 2013 and 2014 to claim portions of this loss. While the IRS initially processed a refund for 2012, it subsequently audited the 2013 and 2014 returns. That audit culminated in a prior Tax Court case, which the parties settled with a stipulated decision resulting in no additional tax liability or refunds due for Fussell. Despite this outcome, Fussell continued to believe the losses would eventually be allowed.

He did not file a return for 2016 or 2018. For the 2018 tax year, the IRS prepared a substitute for return (SFR) under its §6020(b) authority, using third-party information returns that showed over $130,000 in gross income. At trial, Fussell conceded he had received the income but argued that deductions from the old Velidom loans and anticipated refunds would entirely offset his 2018 liability. The court rejected his arguments and sustained the notice of deficiency. 

The court’s rejection of the filing argument

Under §6651(a)(1), penalties apply when a taxpayer fails to file a return by the due date unless they can show the failure was due to reasonable cause and not willful neglect. Fussell argued that his ongoing dispute with the IRS constituted reasonable cause.

The court found this argument unpersuasive, citing long-standing precedent that a taxpayer's dissatisfaction with the IRS or unresolved disputes over other tax years does not excuse a failure to file. The duty to file a timely and accurate return for each year is independent. Because Fussell didn’t file and didn’t show reasonable cause, the court upheld the failure-to-file penalty and the related failure-to-pay penalty under §6651(a)(2).

The anatomy of a failed deduction

The case also serves as a masterclass in the substantiation required for the bad debt and net operating loss (NOL) deductions.

First, the court found Fussell failed to prove the advances to Velidom were bona fide debt rather than capital contributions. Applying the Ninth Circuit's multi-factor test for distinguishing debt from equity, the court noted the absence of formal documentation. There were no promissory notes, no stated interest rate, no maturity date and no evidence of repayment attempts. The funds were advanced to a thinly capitalized company, and repayment appeared entirely dependent on its future success; these are hallmarks of an equity investment, not a loan.

Second, even if a valid debt had existed, to take the deduction a taxpayer must prove the specific year in which the debt became wholly worthless. Fussell failed to do so. The court pointed out that worthlessness could have occurred as early as 2008 when the company "functionally dissolved" or in 2013 when it formally dissolved, but the taxpayer could not definitively establish the timing.

Third, the court dismantled the taxpayer's NOL argument. Even if a $420,000 loss had been allowed in a prior year, creating an NOL, that loss would have been fully absorbed by Fussell's own reported income in the intervening years (2012-2017), leaving nothing to carry forward to 2018. A taxpayer cannot simply reserve an NOL for a future year of their choosing; the loss must be carried to the earliest year allowed and then applied successively to later years until it’s fully used.

Why Fussell v. Commissioner matters

For tax professionals, Fussell v. Commissioner reinforces three core compliance lessons. First, disputes with the IRS do not pause tax filing obligations. Clients must be advised that the belief they are owed a refund or are waiting on the IRS is not an acceptable defense against failure-to-file penalties. Second, deductions for advances to closely held corporations, especially bad debts, require meticulous documentation establishing a clear debtor-creditor relationship. Substance, not just intent, is paramount. Third, the mechanics of net operating loss carryovers are rigid. Hoping that past losses will conveniently offset future income is a disallowed strategy that courts consistently reject.

The takeaway is simple and timeless: File the return, even if certain figures are being disputed. Filing protects clients from compounding penalties, starts the statute of limitations and preserves options for resolution. As this case demonstrates, waiting to file only makes the problem harder and more expensive to fix.