A Light Week at the Court Shines the Light on Pro Se Taxpayers Designated Orders: 11/12 – 11/17/2018

We welcome Professor Patrick Thomas from Notre Dame who brings us this week’s designated orders. Keith 

The Tax Court designated three orders this week—another very light week for the Court. Judges Thornton, Gustafson, and Leyden handled some common pro se taxpayer issues. Judge Gustafson, with a very detailed chronology of a petitioner’s unresponsiveness, ordered dismissal of a pro se taxpayer’s case. The cases from Judge Thornton and Judge Leyden are discussed in more detail below. 

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Docket No. 21411-17L, Dail v. C.I.R. (Order Here)

Judge Thornton grants Respondent’s motion for summary judgment nearly in full. This CDP case with a tax protestor flavor arose from returns that Mr. Dail filed for 2010, 2011, and 2012.

In April 2015, Mr. Dail filed amended returns for each year, in addition to 2009 and 2013. These amended returns reported $0 of taxable income, notwithstanding wages reported on a W2. He also attached to the returns a Form 4852 (a substitute for a Form W2 or 1099), which also reported $0 of wages. The Forms 4582 claimed that the wages are not taxable under sections 3401 and 3121 (which define “wages” for federal income and FICA tax withholding purposes, respectively). Mr. Dail also attached various documents that purported to exempt his wages from taxation, arguing that he was a “private sector citizen (non-federal employee) employed by a private sector company (non-federal employer).”

The Service did not take kindly to these amended returns. It rejected the returns and assessed frivolous return filing penalties under section 6702 of $5,000 per return. An original return filed for 2014 also earned Mr. Dail a $5,000 penalty under section 6702, along with a Notice of Deficiency for the underreported tax and an accuracy penalty under section 6662(a).

 

Subsequently, Mr. Dail received a Notice of Federal Tax Lien and Notices of Intent to Levy for each year in February 2017 and timely field a CDP hearing request—noting again that he’s not liable for any taxes of any sort, and that the IRS didn’t send him a summary record of assessment. He did not seek any collection alternative, but did ask for withdrawal of the NFTL.

The Settlement Officer in the CDP hearing found that he only raised frivolous issues as to the underlying liability, and issued a Notice of Determination sustaining both the NFTL and the levies. Mr. Dail timely petitioned the Notice of Determination to the Tax Court.

Respondent eventually filed the present motion for summary judgment. Mr. Dail didn’t respond; this means that Judge Thornton could have granted the motion solely on that basis under Tax Court Rule 121(d).

But as Tax Court judges often do, Judge Thornton evaluates the merits in this case. Regarding the income tax debts, because Mr. Dail only presented frivolous arguments regarding his underlying liability, section 6330(g) provides that the Tax Court could not consider them (though Judge Thornton cites 6330(c)(2)(B)). Judge Thornton also upheld the section 6702 penalties; he could consider them in a CDP case because Mr. Dail had had no prior opportunity to dispute the liability, given that the Service may assess such penalties directly. He found that the penalties were appropriate because (1) Mr. Dail filed documents purporting to be returns, (2) his claims that his wages were not taxable was substantially incorrect on its face, and (3) his conduct was based on a position that the Service previously identified as frivolous. Finally, Judge Thornton finds no abuse of discretion in the Settlement Officer’s analysis of the collection issues in the CDP Hearing. He also warns Mr. Dail of a section 6673 penalty if he persists in these sorts of arguments.

Respondent, however, doesn’t quite get to a full resolution of the case. For tax year 2014, the Service issued a Notice of Deficiency as to this frivolous return seeking to assess the proper amount of tax on Mr. Dail’s wages. The Notice included a small accuracy penalty. Judge Thornton held that Mr. Dail was also barred from challenging 2014 because he received the Notice of Deficiency and had the opportunity then to petition the Tax Court, but did not.

Nevertheless, Judge Thornton denies summary judgment as to the 6662(a) penalty, because Respondent’s counsel promised, but did not deliver, documents supporting the managerial approval of the penalty required under section 6751.

It seems, at first blush, odd that Judge Thornton could and did deny summary judgment on this issue. He could have simply ruled in Respondent’s favor under Rule 121(d). Mr. Dail was barred from challenging the underlying 2014 liability under section 6330(c)(2)(B) because he’d had a prior opportunity to do so. He was also potentially barred under section 6330(g), because the issues he raised were frivolous.

So how did Judge Thornton reach this result? First, the Tax Court Rules are not ironclad; Tax Court judges often waive harshness under the Rules for pro se taxpayers. Judge Thornton certainly has the discretion to do so here. Further, the particular issue—managerial approval under 6751—isn’t a frivolous issue at all. So the bar under section 6330(g) probably doesn’t apply. Moreover, while Mr. Dail is barred from raising the issue under section 6330(c)(2)(B), the Service must consider, under section 6330(c)(1), whether the requirements of any applicable law or administrative procedure have been met. The Court has authority to review the Service’s analysis under an abuse of discretion analysis. Failure to consider the requirement under 6751 would constitute an abuse of discretion, and so the Court may order the Service to consider the issue. If Respondent’s counsel has the goods, then the Court may resolve this case without a remand to Appeals. If not, then a remand may theoretically be appropriate; more likely, however, Respondent’s counsel will conclude that the approval documents do not exist, and—to expedite their and Appeals’ workload—will concede the issue to fully resolve the case.

Docket No. 307-18L, Chang v. C.I.R. (Order Here)

In Chang, Respondent filed a motion to dismiss for lack of jurisdiction in this CDP case. Petitioner challenged years 1999 through 2010 and 2014 in the Tax Court. Respondent countered that, as to years 2003 and 2008, the Service sent a Notice of Intent to Levy on January 12, 2016 and received a CDP request on February 16. (The other years were more clearly barred from a Tax Court challenge, stemming as they did from an NFTL, for which Petitioner requested a CDP hearing four months late, rather than four days. He’d also challenged 1999 to 2002 in a prior CDP case in the Tax Court).

Petitioner’s CDP request for 2003 and 2008 “[did] not bear a postmark”. Therefore, Judge Leyden ordered Respondent (and later Petitioner) to research and present to the Court evidence on the mailing time between Petitioner’s home and the address on the CDP notice, which appear to both be in Hawai’i. Respondent filed a declaration from customer service manager of the “Downtown Station of Hawaii” (I’m not really sure where “Downtown Hawaii” is…), indicating that the letter was necessarily mailed on February 13, due to intervening weekends and holidays.

Petitioner filed an objection to Respondent’s declaration, noting that it can take up to two days for mail to be delivered between zip codes 96813 and 96816. For those curious, both zip codes are located near downtown Honolulu, Hawai’i, so interisland mailing (which might reasonably take longer than one day), is not in play.

So, Judge Leyden gave Petitioner an opportunity to submit similar information as did Respondent, ordering that Petitioner should present evidence about “when an envelope, properly addressed to the IRS requesting a CDP hearing would ordinarily have been received at the IRS and attach as an exhibit any statement by a U.S. Postal Service employee that petitioner obtains in support of his assertion that the CDP hearing request was timely mailed.”

A few questions that remain for me: how was the mailing delivered without a postmark? I originally thought that Respondent should simply argue that Petitioner cannot rely on the mailbox rule of section 7502, because under the applicable regulations at 26 C.F.R. 7502(c)(1)(iii), the envelope was not properly posted. But of course, the envelope did arrive at the Service, so it must have borne some postmark. The U.S. Postal Service is, after all, not in the business of delivering unposted envelopes. Hopefully Judge Leyden will designate a future order in this matter, so that we can discover the rest of the story.

 

The Federal Tax Lien and the Homestead Exemption

The case of In re Selander, No. 16-43505 (Bankr. W.D. Wash. Oct. 19, 2018) pits the bankruptcy trustee against the IRS. The trustee attempts to use a provision in Chapter 7 to take from property secured by the federal tax lien in order to pay his fees and other administrative costs. The IRS argues that when its lien attaches to property claimed by the debtor as a homestead, the provision allowing the trustee to use an asset secured by the federal tax lien does not apply. The case allows for an explanation of B.C. 724(b), in which Congress allows the use of money that would otherwise come to the government because of its secured position to pay unsecured priority creditors, and the interplay between the federal tax lien and the homestead exemption. The bankruptcy court here gets the law right and does a good job of explaining it.

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Mr. Selander filed a Chapter 7 petition on August 22, 2016. The Umpqua Bank filed a claim for over $5 million and the IRS filed one for over $700,000. The bank had liens against the debtor that predated the IRS’s federal tax lien. The debtor owned a ½ interest as a tenant in common of a home in the Seattle area. Other assets may have existed, but the house occupied the attention of the court.

The trustee of the bankruptcy estate found a buyer for the house for a gross sales price of $825,000. After paying off the mortgage, closing costs and the other owner, about $200,000 came to the bankruptcy estate. Washington is one of the states that allows debtors to choose between the federal bankruptcy exemptions in B.C. 522, or its own state-level exemptions, including a pretty generous homestead exemption of $125,000. The debtor elected to receive that amount as his homestead exemption.

The homestead exemption seeks to allow debtors something to get going after bankruptcy as part of their fresh start. While some states provide generous homestead exemptions and other states provide very little, the exemption in all states comes to the debtor subject to the federal tax lien. So, debtors owing federal taxes do not get the benefit of the homestead exemption that the state might intend since the state homestead law lacks the ability to pass property to the debtor in a way that overrides federal law. The operation of the federal tax lien vis-à-vis the homestead exemption has frustrated many debtors and provides one of many reasons to pay down federal tax debt prior to bankruptcy rather than to pay ordinary creditors.

The trustee ordinarily cannot use the homestead amount to pay his fees or to pay the claims of creditors of the estate. B.C. 522 carves the homestead amount out of the estate and gives it to the debtor as property exempt from the estate.

B.C. 724(b) allows the trustee to take an amount that would ordinarily go to the IRS because of the federal tax lien and use that amount to pay unsecured creditors of the bankruptcy estate entitled to priority status. The trustee is one of the creditors entitled to priority status. In the B.C. 724 analysis of Mr. Selander’s bankruptcy estate, nothing would go to the IRS because of the higher priority lien of Umpqua. That higher priority lien and the value of the assets in the estate prevents the IRS from having a secured claim against the estate. Without a secured claim held by the IRS, the trustee could not use B.C. 724(b) to carve out money to pay priority claimants.

Even though the IRS could not take from the estate, it stood to receive the homestead amount. The trustee argued that the payment of the homestead amount should allow the B.C. 724(b) carve out to occur even though the basis for the payment occurred from money not a part of the bankruptcy estate.

The court rejects the trustee’s argument, citing to relevant case law and finding:

There is no conflict between § 724(b) and § 522(k) because those two sections speak to different kinds of property. Section 724(b) involves property of the estate where the IRS holds a valid lien. In this scenario, Congress has made the decision that the bankruptcy trustee may subordinate the secured tax claim to pay administrative expenses. What § 724(b) does not address is the property a debtor removes from the estate by exemption, but still subject to a continuing lien of the IRS. This property is not covered by the plain language of § 724(b), which provides that it only applies to property ‘in which the estate has an interest….’ Exemptions remove property, or a certain value of that property, from the estate. Alsberg v. Robertson (In re Alsberg), 68 F.3d 312, 315 (9th Cir. 1995). Debtor’s Homestead Exemption removed the value of $125,000 from the estate but such exemption was powerless to eliminate the interest of the IRS in those funds claimed with the exemption.

The court noted that in the absence of the federal tax lien, the trustee’s attempt here would be a naked effort to take exempt funds to pay his fees, and that B.C. 522(k) prohibits that action. The bankruptcy court found that by claiming the homestead exemption, the debtor removed the property from both the estate and the application of B.C. 724(b).   It further found that the IRS need not bring a separate action to seize the money in the debtor’s bank account, but that the trustee should remit the $125,000 to the IRS. This victory by the IRS may benefit the debtor if the taxes were excepted from discharge. If the taxes would have been discharged by the bankruptcy, the debtor loses as well as the trustee since the debtor’s homestead exemption turns out to provide him with no benefit. Prior to filing bankruptcy, debtors should check the impact of a federal tax lien if they hope that bankruptcy will allow them to take certain assets with them. Mr. Selander’s case leaves him with a bankruptcy discharge but no major asset to take with him as he leaves bankruptcy.

 

IRS Digital Communication Pilot: Digital Divide and Tax Administration

Last week Bloomberg reported that IRS officials are expanding the Taxpayer Digital Communications pilot, which was launched in late 2016. The pilot program allows taxpayers to respond to correspondence audits electronically through a secure portal rather than by regular mail or fax. According to Bloomberg[$paywall], IRS has tested the program with audit correspondence from the Philadelphia Service Center and will add the Brookhaven Service Center to the pilot program next year.

The IRS has noted that there was over an 80% satisfaction rate among taxpayers who used the digital communications tool. The take up rate was relatively low, however, with 3,000 taxpayers opting in out of 28,000 invited. On the other hand, the default rate is quite high for correspondence examinations; it is not clear how many taxpayers who chose not to opt in continued participating in the audit process.

The brief Bloomberg article notes that the pilot actually added about an hour of IRS employee time to resolve a case; to me that is an interesting metric but key questions left unaddressed include whether the program will facilitate IRS and the taxpayer getting to the correct outcome, and the amount of time saved in closing the case from start to end.

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The same week that the Bloomberg story came out the New York Times reported that Microsoft has released a study showing the digital divide is much worse than the government has previously reported.  Access to broadband, according to Microsoft, is unavailable to over 168 million Americans, while the FCC claims that broadband is unavailable to only 24.7 million. The Microsoft study relied on actual speeds of people using its products.

To be sure, Microsoft has a vested interest in this discussion, as greater access to broadband makes its products and services more likely to be purchased. Yet, independent researchers have documented the difference in access to broadband and also detailed differing preferences and abilities for use of differing technologies (a good place to look at this research is the Pew Research Center on Internet & Technology). Access varies greatly by region; for example as of about a year ago Cleveland.com reported that about 1/3 of city residents had no access at all to internet in any form. New census data shows a stark digital divide within the city of Philadelphia, where neighborhood broadband access rates range from a shocking 37% to a high of 89%.

When it comes to use of technology, the IRS is playing catch up compared to many other tax administrators and the private sector. My sense is that the agency’s reflexive starting point with the adoption of technology is the possibility of efficiency gains. This is especially important to an agency that has faced serious funding shortfalls. To that end see this week’s  terrific piece in Pro Publica by Paul Kiel and Jesse Eisinger that highlights some of the recent IRS budget history and steep decline in many enforcement metrics. A companion Pro Publica piece quotes clinicians and guest posters Michelle Drumbl and Mandi Matlock discussing the burdens that EITC recipients face in light of the continued drumbeat for EITC audits while audit rates for all but the very rich continue to plummet. No doubt that for the IRS the allure of doing more with less is hard to resist.

Technology access and the skills to use new technology, like other resources, are unevenly distributed in America.  While the new technology holds great promise for the IRS and taxpayers, some of the greatest challenges the IRS face in the next decade include evaluating how the adoption of new technology relates to fundamental taxpayer rights as well as traditional tax procedure principles that have their origin in a paper-based tax system.

The National Taxpayer Advocate has been focusing on this for years, including her series of public hearings gathering information to inform IRS as it plans its Future (soon to be present) State and on more technical issues like the need to think about how the mailbox rule of Section 7502 intersects with digital communication. We are just scratching the surface on these issues.

I hope that the IRS and Congress consider all taxpayers’ perspectives, including the many low and moderate income taxpayers who increasingly rely on the safety net now increasingly found within the tax code, when evaluating and developing any IRS technology roll out. That will require a holistic view of taxpayers, and one that focuses on more than IRS employee hours per case resolution as compared to whether the technology facilitates reaching the correct outcome. In considering taxpayer service the IRS should understand the key role that taxpayer rights play in ensuring sound tax administration.  Relying on the supposed efficiency gains of technology can lead to a two track system of tax administration, and one that will exacerbate inequalities and unfairness associated with being poor.

Should the Tax Court Sua Sponte Continue a Case When Taxpayer Would Benefit from Representation

I saw the headnote of Ford v. Commissioner, 122 AFTR 2d xxxx, No. 18-1524 (6th Cir. 2018) and decided it was a case about hobby loss. It is; however, fellow blogger Peter Reilly pointed out to me that in the Sixth Circuit, Ms. Ford also raised as a ground for overturning the opinion the failure of the Tax Court to sua sponte continue her case when it was called at the Nashville calendar call of the Tax Court. You can find Peter’s post on the case here.

The idea that the failure to grant a continuance that the taxpayer never requested could form the basis for a successful appeal seemed a bit far-fetched to me. I guess it did to the Sixth Circuit as well since it found against Ms. Ford on that issue. Despite the difficult stretch to get to where Ms. Ford wanted the Sixth Circuit to go, the facts of the case regarding the need for some help from the court are worth discussing as a lesson for future litigants.

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Ms. Ford ran a restaurant and venue for emerging music artists in Nashville. From reading the opinion, I came away with the impression that the business had helped to launch the careers of some artists who had performed there. I also came away with the impression that the business had not produced a profit for many years and only continued to exist because of Ms. Ford’s generosity. The IRS audited her return and disallowed losses generated by the business, arguing that Ms. Ford did not engage in the business for profit but rather was motivated by something other than profit. The IRS sent Ms. Ford a notice of deficiency and she petitioned the Tax Court.

At calendar call, she appeared with her return preparer who is an enrolled agent. Enrolled agents can study and take the Tax Court test to practice before the court. I have written about the test before. Many have passed the test but the vast majority have not taken the test because Tax Court representation is not something they want to do. Most of the enrolled agents I have encountered are very knowledgeable about taxes and very diligent in representing their clients. I regularly recommend that individuals seeking the services of our clinic who do not qualify for our services seek advice from an enrolled agent in their neighborhood because I think the test to become an enrolled agent and the ongoing training they pursue generally makes them a reasonably priced, well-trained option for the types of individuals who my clinic must turn away.

Because representing someone in Tax Court falls pretty far outside the scope of what most enrolled agents do for their clients, going to the Tax Court with the client as happened in Ms. Ford’s case puts the EA, the client and the court in an awkward position. The EA cannot speak to the court on behalf of the client unless the EA has passed the Tax Court’s admission test. The client is left having to speak to the court and often the EA is not in a position to provide much, if any, guidance on the procedural aspects of the case even though they may know the substantive aspects of the case very well. The court can speak to the EA and provide direction. Judge Foley did that in this case but ultimately the taxpayer must be the one to talk to the court and the one to decide what to do.

Ms. Ford did not know how to best present her case and the EA she brought with her either did not know how to do it through her or did not know how to do it either. As a result she did a poor job of presenting her case. It’s hard to say whether she might have won with a good lawyer guiding the introduction of evidence. It would be expensive for her to hire a good lawyer to represent her but maybe not as expensive as losing the case. The EA may have advised her to obtain a lawyer and may have suggested lawyers she could use. The case does not get into those facts.

The case does bring out another facet of the dynamic at calendar call, which is that at almost every Tax Court calendar call, there are tax lawyers there as volunteers willing to meet with unrepresented taxpayers and provide advice. If you want to read more about the calendar call program, here is an article about a successful representation of someone encountered at calendar call. In Ms. Ford’s case, she was fortunate to meet with an excellent tax lawyer, Mary Gillum, who runs the tax clinic at Legal Aid Society of Middle Tennessee & the Cumberlands. Mary has been running the tax clinic there for almost two decades and is a fierce litigator, but Mary is hamstrung in helping someone like Ms. Ford. First, she is hamstrung because she has only a short time to size up the situation. Second, she is hamstrung because Ms. Ford is over the income guidelines of IRC 7526, which makes it difficult for Mary to take on full representation of the case. Lastly, Mary may have been hamstrung by the existence of the EA. Although the court suggested that Ms. Ford speak with Mary who was there to volunteer and assist unrepresented taxpayers, a taxpayer who brings a representative, even one not qualified to represent someone in the Tax Court, can create a barrier to effective counseling. The dynamic here is not one that the court discusses because it would have no way of knowing what happened. The program of volunteers at Tax Court calendars has helped many people but does not appear to have helped Ms. Ford in this situation.

Ms. Ford hired an attorney to handle her appeal but by then it was too late. The attorney handling the appeal is stuck with the record below. He wrote a brief arguing that the Tax Court erred in not deciding on its own that Ms. Ford’s case should have been continued and arguing that she had proved the business purpose of the venture. With respect to the first argument, it is difficult to believe that the attorney had a realistic expectation of success at the appellate level. With respect to the second argument, he did not have enough to work with based on the record at trial. He copied into his brief portions of the trial transcript regarding the back and forth between the court and Ms. Ford at calendar call as part of his effort to show a continuance should have been granted. I copy those below so you can see the difficult spot Ms. Ford had placed herself in by not coming to court with someone authorized to represent her. This also puts the court in an awkward spot but if the Tax Court granted a continuance every time someone appeared before it who did not have their act together, it would be granting multiple continuances at every calendar.

THE COURT: An option from the Court is to push this later on in the week to give you a little more time to gather that information. We could proceed Wednesday. What’s your position about proceeding to trial on this matter? Or would you still like some time to see if you could settle this?

  1. FORD: I really am confused about all of this.

THE COURT: Okay. Okay.

  1. FORD: I’ve never been to court like this.

THE COURT Okay.

  1. FORD: So I’m trying to learn.

THE COURT: I don’t know if – you may not meet the guidelines for Ms. Gillam. I don’t know. But if you do, then – well, you’ve been working with your CPAso in consultation with him, I think we should decide what the most prudent way to proceed is, whether you should proceed to trial or whether you should try and work something out or if you think you have a good case and you’re ready to go to trial then we’ll have a trial in this matter on Wednesday, but that would give you a couple more days to gather more information and also any other documentation that you think would support your position. It’s the Government’s position that this case is – that Ms. Ford didn’t have the requisite intent to make a profit?

  1. HARRIS: That is correct, Your Honor.

THE COURT: And –

  1. HARRIS: Your Honor will remember, we issued discovery on this and attempted to gather documents to show that this is like manner – it was conducted, and the Court does have an order, a standing pretrial order. I’m happy to look at what they have but this has drug on for quite a while.

THE COURT: This case hasn’t been –

  1. HARRIS: No, it hasn’t. I’m sorry. No, it hasn’t but we have been seeking information since last fall.

THE COURT: And is there any reason why that information hasn’t been provided?

  1. FORD: Well, I was sick with pneumonia for a couple of months with pneumonia and bronchitis, and there was a storm that hit the Bell Cove, my place of business. …

THE COURT: Well, Ms. Ford, if we proceed to trial, one thing you have to be aware of is there are specific rules that you’re going to have to meet in order to make your case, and of course you can consult with your CPA. I’m sure your CPA is aware of what the rules under 183 are and what the standards are and exactly what Ms. Ford is going to have to establish in order to meet those rules. And it’s going to be your contention that she meets those standards; is that correct?

  1. KING: Yes.

THE COURT: Well, what I can do is schedule this trial for Wednesday at ten o’clock and that doesn’t mean that the parties can’t sit down and talk prior to Wednesday. I would anticipate that it might make some sense for you guys to talk and to see if something can be worked out. I don’t know what the merits are in this case. I don’t know what evidence you plan to present. Can you give me an idea about what kind of evidence you plan to present?

  1. KING: Well, I think she will be prepared to go through the rules to establish that she was in the business of making money.

THE COURT: Okay. All right. So any witnesses, Ms. Ford, that you plan to call?

  1. FORD: I don’t know. Right now I’m not sure what 183 is even.

THE COURT: Okay. Well consult with your CPA. He’ll know what the rules are and what’s going to be important for you is I’m going to give you the opportunity to testify and when you testify, you just make sur[e] that you hit all the important points. It also helps to have documentation, you know, business licenses and more things that support your contention that you were in this endeavor to make a profit.

  1. FORD: Well I wouldn’t have gone into it if I wasn’t.

THE COURT: Okay.

  1. FORD: That would be silly.

THE COURT: Okay.

  1. FORD: I mean, I’ve generated millions of dollars through the music industry from helping everybody there. There are so many, George Jones, *13John Anderson – I can’t tell you how much people I’ve helped through there. And I didn’t go in there to fail, you know. I would not want to fail.

THE COURT: All right. Well, this is what we’ll do. We will schedule the trial for ten o’clock Wednesday. And do we have a stipulation of facts?

  1. HARRIS: Well, Your Honor, I have one prepared. It is not signed and if I could get some clarification on exactly, is Mr. King a witness? Is he – what role he’s going to play. Ms. Ford didn’t file a ––– I’m somewhat at a loss here.

THE COURT: Okay. Mr. King?

  1. KING: I can only be a witness.

THE COURT: Okay.

  1. KING: I cannot practice.1

THE COURT: So you’ll be a witness. Of course, you can — I’m going to anticipate that you’ll be working with Ms. Ford so that she has a better understanding of what the rules are, and I would also suggest that you meet with Ms. Gillam. Ms. Gillam is right behind you in the first row and talk to her, and then I think she’ll be able to give you a better — you, the two of you, go in one of the counsel’s rooms, talk with Ms. Gillam, so that you can get a better assessment of the strength of your case and just how prudent it is for you to proceed.

[Calendar Transcript, pgs. 6-12 (emphasis added)]

Conclusion

For most people going to Tax Court, proving their case without a qualified representative will be very difficult. In deciding whether to hire someone, the taxpayer has to take into account the amount at issue and the ongoing nature of the matter in dispute. Assuming that Ms. Ford wanted to continue to run the business, she might have found the calculus for hiring a qualified representative in her situation would have led her to hire someone. Because of the complexity of proving a hobby loss case and the potential for the issue to continue on in future years, someone in Ms. Ford’s situation should think hard before proceeding in the Tax Court without qualified representation. Similarly, someone in the position of this EA must also try to steer their client to a qualified representative even if they have a good grasp of the substance of the case.

 

 

Are Alleged Alter Egos, Successors in Interest and/or Transferees Entitled to Their Own Collection Due Process Rights Under Sections 6320 And 6330? Part 5

Lavar Taylor brings us the fifth installment of his series on Collection Due Process and third parties. Today he addresses strategies in litigating the issues. Lavar promises one more post on the topic after this one. When complete his work on this topic will be the equivalent of a law review article but with a very practical bent. For practitioners with clients who have derivative liabilities, Lavar provides significant insight into the law and the practice of representing parties operating in the dark shadows of the code and administrative practice. Although Lavar does not discuss the issue, it is interesting how the Taxpayer Bill of Rights promises of the right to challenge the IRS position and be heard and the right to appeal an IRS decision in an independent forum intersect with the way that these third parties are treated by the IRS. Keith

In Part 4 of this series, I discussed the questions of 1) how a putative alter ego/successor in interest/transferee of a taxpayer might pursue litigation in the Tax Court to raise the questions of whether they are entitled to Collection Due Process (“CDP”) rights under sections 6330 and 6320 of the Code, independent of the rights of the original taxpayer who incurred the liability, 2) whether the government can take administrative collection action against a putative alter ego/successor in interest/transferee without first obtaining a District Court judgment or making a separate assessment, and 3) whether the Tax Court has the ability to address issues 1 and 2 above, given that no notice of determination is ever issued by the IRS in these situations.

This post addresses the question of how a putative alter ego/successor in interest/transferee of a taxpayer might pursue litigation in the District Court to raise the questions of 1) whether they are entitled to Collection Due Process (“CDP”) rights under sections 6330 and 6320 of the Code, independent of the rights of the original taxpayer who incurred the liability, and 2) whether the government is prohibited from taking collection action against a putative alter ego/successor in interest/transferee of the taxpayer without first obtaining a District Court judgment against the putative alter ego/successor in interest/transferee, based on the arguments set forth in Part 3 of this series.

This post also discusses the factors affecting the decision of whether to litigate these issues in Tax Court or District Court. In addition, this post discusses why assertions of “nominee” status by the IRS are treated differently under the CDP rules.

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1. Litigating in District Court

An alleged alter ego/successor in interest/transferee has always had a remedy in District Court to challenge levy action against them in the form of a wrongful levy action brought under §7426. See, e.g., Towe Antique Ford Found. v. IRS, 999 F.2d 1387 (9th Cir. 1993). These lawsuits, however, have focused on whether the alleged alter ego/successor in interest/transferee was substantively liable for the tax liability under state law.

To the best of my knowledge, there are no reported decisions where the alleged alter ego/successor in interest/transferee has argued that the IRS levy action was improper because the IRS failed to send the alleged alter ego/successor in interest/transferee a separate §6330 Notice of Intent to Levy before taking levy action against them. Nor am I aware of any reported cases where the alleged alter ego/successor in interest/transferee brought a wrongful levy action claiming that the IRS cannot take any administrative collection action against a purported alter ego/successor in interest/transferee prior to the government obtaining a District Court judgment they are liable for the taxpayer’s taxes as an alter ego, successor in interest, or transferee of the taxpayer, based on the theory articulated in Part 3 of this series.

Frequently, the previously unannounced levy action against the alleged alter ego/successor in interest/transferee financially destroys them and deprives them of the resources needed to challenge the IRS’s assertion of liability. Under the law as interpreted by the IRS, the playing field is decidedly tilted in favor of the IRS. While there are undoubtedly many meritorious assertions of liability by the IRS, I am aware of a number cases in which the issue of liability as an alter ego/successor in interest/transferee was at best questionable or debatable. In our now-settled Tax Court case, for example, there was a state Supreme Court decision which made clear that, based on the undisputed facts in our case, it was not possible for our client to be an alter ego of the taxpayer. Yet the IRS, without properly investigating the facts, pursued levy action against our client, with the blessing of Area Counsel’s Office, based on the unsound premise that our client was an “alter ego” of the taxpayer.

Even where a third party is conceding that they are liable as an alter ego, successor in interest, or transferee of the taxpayer under state law, they can bring a wrongful levy action to challenge the procedural validity of the levy action, based on the failure of the IRS to issue a §6330 Notice of Intent to Levy to the third party prior to taking levy action against the third party.  The mere opportunity to seek administrative collection alternatives, such as an installment agreement, or even an offer in compromise based on doubt as to liability, without having to deal with unannounced levy action may often be the difference between financial life and death for an alleged alter ego/successor in interest/transferee.

For these reasons, any alleged alter ego/successor in interest/transferee, even if they agree that they are liable for the taxes assessed against the taxpayer can bring suit, either in District Court or in Tax Court to challenge the failure of the IRS to issue a separate §6330 Notice of Intent to Levy to them prior to taking levy action.   In such a suit they can also challenge the underlying ability of the government to ever take administrative collection action against an alleged alter ego/successor in interest/transferee prior to obtaining a District Court judgment in favor of the government (or prior to making a separate assessment), based on the theory articulated in Part 3 of this series.

Similar options exist to challenge the validity of an alter ego/successor in interest/transferee notice of federal tax lien. A petition can be filed with the Tax Court, although care should be taken to file the petition promptly after the filing of the lien notice, to minimize the risk that such a petition might be deemed untimely by the Court. Such a petition will be subject to the same jurisdictional challenges as a levy petition.

Alleged alter egos/successors in interest/transferees likewise have always had the opportunity to file a quiet title action in District Court, pursuant to 28 U.S.C. §2410 in order to challenge the validity of the tax lien. See Spotts v. United States, 429 F.3d 248 (6th Cir. 2005). There is no reason why an alleged alter ego/successor in interest/transferee could not file a quiet title action in District Court based on the grounds that 1) the IRS failed to give them their own lien CDP rights as required by section 6320 after the filing of the notice of federal tax lien, and 2) the government is not permitted to take collection action against them in the absence of a separate assessment against them or a District Court judgment imposing liability as an alter ego, successor in interest, or transferee of the taxpayer, for reasons outlined in Part 3 of this series.

2. Tax Court or District Court: Making a Choice

If an alleged alter ego/successor in interest/transferee wishes to pursue litigation to challenge the ability of the IRS to levy without first issuing a separate §6330 Notice of Intent to Levy to challenge the ability of the IRS to take administrative collection action against a purported alter ego/successor in interest/transferee, choosing between Tax Court and District Court as a litigation forum can be difficult. District Court offers a forum where the court clearly has jurisdiction to rule on the issues at hand. District Court also is much quicker than Tax Court. Indeed, in our now-settled case, at the time of the settlement, the IRS’s motion to dismiss the petition for lack of jurisdiction had been pending with the Tax Court for over 12 months without any opinion being issued.

District Court Judges, however, often lack even basic familiarity with tax laws in general and with CDP laws in particular. Tax Court Judges have significant expertise in tax law and regularly deal with CDP procedures in their cases. They certainly have more expertise in determining the extent of their own jurisdiction than do District Court Judges. Page limitations on filings in District Court may hamper the ability of an alleged alter ego/successor in interest to fully brief all of the issues, which are complex and arcane, even to the most dedicated tax procedure junkies.

In addition, once the Department of Justice acquires jurisdiction over a case, settling that case can become much more difficult. There can be a dramatic difference in the levels of approval needed to settle a case with the Office of Chief Counsel and the levels of approval needed to settle a case with the Department of Justice.   See the Department of Justice Tax Division Settlement Reference Manual. Furthermore, the differences between the rules governing discovery in Tax Court and the rules governing discovery in the District Court generally make it far more expensive to litigate in District Court than in Tax Court.

An alleged alter ego/successor in interest/transferee who ventures into District Court in a wrongful levy action or a quiet title action also faces the possibility that the Department of Justice will seek an affirmative judgment against them, including a judgment for the foreclosure of real property owned by the alleged alter ego/successor in interest/transferee which the government contends can be reached in an effort to satisfy the taxes owed by the taxpayer. No such counterclaims can be filed by the government in Tax Court litigation; IRS must refer the matter to the Department of Justice for a separate lawsuit.

Yet, until the Tax Court has issued an opinion in this area, anyone who chooses Tax Court as their litigation forum currently faces the possibility that the Tax Court will eventually dismiss their petition for lack of jurisdiction in a way that fails to resolve the underlying question of whether alleged alter egos/successors in interest/transferees are entitled to their own independent CDP rights or whether the IRS may ever pursue administrative collection action against an alleged alter ego/successor in interest/transferee without first obtaining a District Court judgment. And however the Tax Court rules on this issue, the Tax Court’s ruling can be appealed to the relevant Court of Appeals.

The specific facts in each case will also be an important factor, as will the proclivities of the local District Court Judges. The rulings of the District Courts can also be appealed to the relevant Court of Appeals, but there will never be any appeal on the issue of whether the District Court lacks jurisdiction over such a suit, as long as the suit is brought within the applicable statute of limitations for wrongful levy actions and quiet title actions. (The statute of limitations for wrongful levy actions is now two years. 26 U.S.C. §6532(c). The statute of limitations on quiet title actions is six years. See Nesovic v. United States, 71 F.3d 776 (9th Cir. 1995). )

3. The Long, Hard Road Ahead

Given the circumstances described in this series of posts, it is likely to be quite some time before there is a definitive answer to the questions of whether alleged alter egos/successors in interest/transferees are entitled to their own independent CDP lien and levy rights and whether the IRS may ever take administrative collection action against a putative alter ego/successor in interest/transferee without first obtaining a District Court judgment or making a separate assessment. The speed at which the case law develops will depend in large part on how the Tax Court rules in its first published opinion on these issues. If the Tax Court rules that it has jurisdiction, that holding will drive litigation of these issues to the Tax Court. The IRS will then likely appeal the Tax Court’s holding(s) to multiple Courts of Appeal, possibly leading to a split in the Circuits and Supreme Court review of the issue(s) that split the Circuits.

If the Tax Court holds that it lacks jurisdiction but refuses to follow Adolphson and holds adversely to the government on the procedural issues in dismissing the petition for lack of jurisdiction, this holding will also drive litigation to the Tax Court. This will likely be followed by government appeals to multiple Courts of Appeal and possibly an eventual Supreme Court ruling in this area.

If the Tax Court holds that it lacks jurisdiction and follows Adolphson, a few brave hardy souls may continue to litigate in Tax Court, with the idea of taking their cases to the relevant Courts of Appeal But most litigation involving these issues will be driven to the District Courts, many of which may be reluctant to second guess the Tax Court’s holding on the jurisdictional issue. But the District Courts will still be able to rule on the substantive CDP issue, as well as on the issue of whether the government is required to obtain a District Court judgment (or make a separate assessment) against purported alter egos/successors in interest before the government can take collection action against them.

One or more of these issues are likely to end up being argued before the Supreme Court, absent any future legislative action by Congress. But it is likely to be a number of years before that happens.

4. “Nominee” Liens and Levies- Why The CDP Rules Are Different

In writing this series of posts, I have purposefully avoided including “nominee” liens and levies within the scope of my discussion of the extent to which the CDP provisions may be invoked by third party non-taxpayers against whom the IRS is pursuing collection action to collect taxes owed by the original taxpayer. Putative “nominees” are different from putative alter egos/successors in interest/transferees in that “nominees” are not themselves personally liable for the tax liability. Rather, a true nominee holds “property or rights to property” of a taxpayer as the agent of the taxpayer.   They are not personally liable for the tax. This distinction is critical for purposes of determining the rights of putative “nominees” under the CDP procedures.

In Part 1 of this series I noted that there are important differences between §§6320 and 6330, and their counterparts, §§ 6321 and 6331. Section 6321 imposes a lien against all “property and rights to property” of a person who is “liable for the tax.” Thus, there must be a personal liability for a tax obligation before a lien can arise against a person’s “property or rights to property” under §6321.

The language of §6320 makes clear that a lien CDP notice is only required to be sent to the “the person described in section 6321,” i.e., a person who is personally liable for the tax. Thus, a putative nominee of the taxpayer is not entitled to notice under §6320 and cannot invoke the lien CDP procedures if the IRS files a “nominee” notice of federal tax lien. Note, however, that a true “nominee” notice of federal tax lien should make clear that the IRS lien only attaches to the specific property, real or personal, which the putative nominee is supposedly holding as an agent of the taxpayer. As I will discuss in Part 6 of this series, virtually all “nominee” notices of federal tax lien flunk this test.

Section 6331, on the other hand, authorizes the IRS to levy on all “property and rights to property” of a person who is personally liable for a tax and to levy on all property on which there is a tax lien. Thus, it is possible that the IRS could levy on property that is possessed or owned by a third party which the IRS claims is encumbered by a tax lien, even though the person who possesses or owns that property is not personally liable for the tax.

Section 6330 provides that “[n]o levy may be made on any property or right to property of any person” unless notice is given to “such person” under §6330. Importantly, §6330 uses the phrase “any person,” not the phrase “person liable for the tax.” Section 6330 also does not refer specifically to the “person” described in §6331(a). I personally believe that this a distinction with a difference, and that Congress intended for any person who has a facially recognizable possessory or ownership interest in property under state law upon which the IRS intends to levy is entitled to notice under section 6330 and thus is entitled to invoke the collection due process procedures.

But the IRS thinks otherwise, and issued regulations which define the term “person” in §6330 as the “person liable for the tax.” Treasury Regulation §301.6330-1(a)(3), Question and Answer 1. If this regulation is valid, only persons who are personally liable for the tax are entitled to notice under §6330 and may invoke the CDP levy procedures. No true “nominees” can invoke CDP levy procedures under the IRS’s interpretation of the law.

If the cited Treasury Regulation is struck down as being inconsistent with the statute, however, true nominees would be entitled to notice under §6330 and would be entitled to avail themselves of the CDP levy appeal process. I believe this regulation is inconsistent with the statute. The phrase “any person” is about as broad as you can get, and the contrasting language of §6320 supports the conclusion that Congress’ use of the phrase “any person” in section 6330 was deliberate. Limiting the availability of the levy CDP appeal procedures to persons who are personally liable for the tax is contrary to the language of the statute.

I leave a more detailed analysis of why I believe that this regulation is not valid for another day. Suffice to say that anyone who is the subject of true nominee collection action, where the IRS merely claims that the property held by or ostensibly belonging to a third party on which the IRS has levied is being held by the third party putative nominee for the benefit of the taxpayer and is not asserting that the third party is personally liable for the taxes owed by the taxpayer, will have to convince the Court that this regulation is invalid should they bring an action in Tax Court or District Court to challenge the IRS “nominee” levy action on the grounds that the IRS failed to issue a §6330 Notice of Intent to Levy to the third party prior to levying on property owned or held by the third party.

Because alleged “nominees” are in a more perilous legal position than alleged alter egos/successors in interest/transferees when it comes to invoking the CDP procedures, It may be that the IRS will, in the future, show a greater interest in pursuing “nominee” collection activity as opposed to pursuing “alter ego/successor in interest/transferee” collection activity.   I have seen some evidence of this here in southern California, after the IRS read our pleadings in our now-settled case.

My experience is that many people in the IRS throw around the terms “alter ego,” “transferee,” and “nominee” like these terms are interchangeable body parts. Of course, nothing could be further from the truth. Alter egos and transferees are personally liable for the taxpayer’s taxes, based on applicable state law. Under California law, for example, the legal test for holding a third party liable as an alter ego is different from holding a third party liable as a transferee. The legal test for holding a third party liable as a successor in interest is likewise distinct from the tests for imposing liability as an alter ego or transferee. Nominees are not personally liable for the taxpayer’s tax liability.

Private practitioners should be prepared to call out the IRS if it attempts to sidestep efforts to hold the IRS accountable under the CDP provisions by improperly labeling all third party collection action as “nominee” collection action.

I have one more post to add to this series of posts. In Part 6, I will explain why virtually all IRS “nominee” notices of federal tax lien are improper in a way which can cause legal detriment to the alleged nominees. I have also seen a “transferee” notice of federal tax lien with this same impropriety. In addition to explaining the impropriety, I will offer a suggestion to the IRS on how it can cure this impropriety.

 

When Does Interest Start Running on a Transferee Liability

We welcome back guest blogger Marilyn Ames. Marilyn is retired from Chief Counsel’s office but works with us on IRS Practice and Procedure assisting with many chapters because of the breadth of her knowledge. She has done a lot of writing on transferee liability and provides insight on a recent case in that area. Keith

When a taxpayer has an unpaid income tax liability, the Internal Revenue Code is clear that interest on the unpaid tax accrues from the original due date of the return. However, when the Internal Revenue Service attempts to collect liability under Internal Revenue Code § 6901, the transferee liability section, questions arise as to the ability of the IRS to collect interest on the unpaid tax debt.  Because Section 6901 is merely a procedural law, the Internal Revenue Service must look to state law or other federal law for the substantive provisions that allow collection of taxes from a person who receives property from the taxpayer. The Internal Revenue Code provides that a transferee is liable for interest on the unpaid tax debt after the Internal Revenue Service issues a notice of transferee liability, but does state law govern the collection of interest before this date? The Ninth Circuit addressed this in the recent case of Tricarichi v. Comm’r, 122 AFTR2d 2018-6634 (9th Cir. Nov. 13, 2018). 

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The transferee in this case, Michael Tricarichi, was the sole shareholder of West Side Cellular, Inc., which received a $65 million settlement in 2003. Before its return for 2003 was due, Mr. Tricarichi, who was then a resident of Ohio, sold his West Side stock in a “Midco” tax-shelter transaction, leaving West Side Cellular with insufficient assets to pay its corporate income taxes for 2003. Mr. Tricarichi received about $35.2 million in the transaction, and then moved to Nevada to enjoy the fruits of his labors. (The workings of the Midco transaction, which have been the subject of frequent litigation in the recent past, are outlined in Diebold Foundation, Inc. v. Comm’r, 736 F3d 172 (2d Cir. 2013)).

In 2012, the Internal Revenue Service issued a notice of transferee liability to Mr. Tricarichi, which was duly litigated in the Tax Court, the result being that the Tax Court determined that Mr. Tricarichi was liable for the full amount of West Side’s tax deficiency and the associated penalties and interest in the tidy total sum of about $35.1 million. In a separate opinion, the Ninth Circuit affirmed the Tax Court’s conclusion that Mr. Tricarchi was liable as a transferee under Internal Revenue Code § 6901 and the Ohio Uniform Fraudulent Transfer Act, leaving the question of when and whether a transferee is liable for the amount of interest due on the transferor’s tax liability before the notice of transferee liability is issued to this opinion.

Mr. Tricarichi, the transferee, argued that Ohio law determined his liability for any interest before the notice of transferee liability was interested. Under Ohio law, Mr. Tricarichi would have owed nothing instead of the nearly $13.9 million that accrued between the due date for the 2003 return and the issuance of the notice of transferee liability in 2012. He cited the Supreme Court’s decision in Commissioner v. Stern, 357 US 39 (1958), for the proposition that state law should determine the existence and extent of transferee liability, including the amount of the interest that can be collected on the underlying claim – which in Mr. Tricarichi’s view would be the tax and penalties owed by the taxpayer, but not the interest that accrued between the due date of the taxpayer’s 2003 return and June of 2012 when the IRS issued the notice of transferee liability.

The Ninth Circuit disagreed, holding that Internal Revenue Service’s claim is computed under the Internal Revenue Code, and will include statutory interest. The extent of the liability to be determined under state law is actually a question of the amount of the claim that can be recovered from the assets transferred. When the taxpayer transfers sufficient assets to pay the underlying claim, including the interest that has been accruing under the Internal Revenue Code for the unpaid tax liability, it is unnecessary to look to state law for the creation of a right to interest. It is only necessary to look to state law for interest when the assets transferred are insufficient to satisfy the total claim for the liability of the transferor/taxpayer. In that case, the relevant state law determines whether the Internal Revenue Service may recover any prejudgment interest beyond the value of the assets transferred. The Ninth Circuit adopted the “simple rule” formulated by the First Circuit in Schussel v. Werfel, 758 F3d 82 (1st Cir. 2014) that “the IRS may recover from [the transferee] all amounts [the transferor] owes to the IRS (including section 6601 interest accruing on [the transferor’s] tax debt), up to the limit of the amount transferred to [the transferee], with any recovery of prejudgment interest above the amount transferred to be determined in accord with [state] law.”

Under this relatively simple rule, because West Side’s tax deficiency, including interest and penalties was $35.1 million, and Mr. Tricarichi received $35.2 million in assets from West Side, an amount in excess of West Side’s tax liability, Mr. Tricarichi was liable for the full amount of the $35.1 million. The fact that Mr. Tricarichi will also be liable for interest as a transferee from the issuance of the notice of transferee liability in 2012 is irrelevant to the determination that he received more from West Side in assets than the tax claim against West Side. As a resident of Nevada, Mr. Tricarichi should understand that his attempt to break the bank in his litigation with the IRS has left him busted.

 

 

 

 

Filing a Tax Court Petition Late for Purposes of Determining if the Notice of Deficiency Was Mailed to the Last Known Address

In Sadek v. Commissioner, T.C. Memo 2018-174 the Court decided the issue of a taxpayer’s last known address at the time of the mailing of the notice of deficiency. These cases occur regularly. We have not written about one recently and this one is interesting because no one seemed to know the taxpayer’s last known or current address including his lawyer. The taxpayer did not file the Tax Court petition until more than four years had passed from the issuance of the notice of deficiency. The only reason that the taxpayer filed the petition in Tax Court was to obtain from the court a ruling regarding last known address. From the outset of the case the Tax Court lacked jurisdiction to hear the merits of the underlying liability but could in dismissing the case determine whether the assessment based on the default in filing a timely Tax Court petition could stand. For another take on this case with greater detail see the post by Bryan Camp in his lessons from the Tax Court series.

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The amounts at issue are eye popping. The IRS assessed Mr. Sadek over $30 million in income tax and penalties for 2005 and 2006. Prior to making the assessments, the IRS sent a notice of deficiency to him at an address in California and one in Nevada. The IRS mailed the notice of deficiency on August 25, 2011. At the time it mailed the notice, the last correspondence it had from Mr. Sadek appeared on his 2005 individual income tax return which he filed on May 21, 2009. It showed a California address and the IRS sent one copy of the notice to that address. In October of 2009 Mr. Sadek filed bankruptcy in Nevada. The IRS sent a second copy of the notice to the address in Nevada that Mr. Sadek used in filing the bankruptcy petition. At the time the IRS mailed the notice Mr. Sadek actually resided in Beirut, Lebanon; however, the IRS did not send a notice to him in Beirut.

Prior to the issuance of the notice, Mr. Sadek had appealed the proposed audit adjustments. The Appeals Officer asked Mr. Sadek’s representative where Mr. Sadek resided. The court found that :

During the pendency of petitioner’s appeal, AO Zhou and Mr. McGinnis communicated about petitioner’s location. Mr. McGinnis informed AO Zhou that petitioner was out of the country, but AO Zhou was unable to get a new address from Mr. McGinnis despite repeated attempts. AO Zhou never spoke directly with petitioner, and Mr. McGinnis represented to AO Zhou that petitioner had cut off contact with him as well.

Anyone who has represented a client before the IRS and had the client go missing knows the uncomfortable feeling that Mr. McGinnis must have felt over not knowing the location of his client. Representing low income taxpayers, I do regularly lose touch with clients. Although the clinic does not have fee issues creating concerns about lost clients, we have plenty of other issues and try hard to reestablish contact if possible. Of course, the Appeals Officer would also have been uncomfortable. She knew the importance of sending the notice of deficiency to the correct address. She seems to have diligently pursued the address and defaulted to the best information in the IRS system when the taxpayer’s current address was not forthcoming. I hope that the IRS also sent a copy of the notice of deficiency to Mr. McGinnis. Maybe that did not help here since Mr. McGinnis had lost touch with his client but the copy of the notice sent to the representative will often keep the client from defaulting on a notice sent to the “last known address” which is not the actual address.

Mr. Sadek resided in Beriut from September 2010 through May 2014. While the IRS did not know where he resided, the FBI investigator assigned to his case did have conversations with him and knew that Mr. Sadek was out of the country even though he did not have a specific address for Mr. Sadek.

Mr. Sadek argues in this case that the IRS had ample notification that he did not reside in California or Nevada at the time it sent the notice. First, he argued that the file in the bankruptcy case showed that the bankruptcy court lifted the automatic stay to allow creditors to foreclose upon his California and Nevada homes. The IRS argued that the bankruptcy files did not show that the foreclosure actually took place and also did not show where he actually lived. The controlling regulation also makes clear that information a taxpayer provides to a third party “is not clear and concise notification of a different address.”

Next, Mr. Sadek argued that “[v]irtually the entire federal government knew where” he was. The Court rejected this argument as well because the evidence showed the FBI knew he had left the US and spent some of his time in Lebanon but did not have a specific address. Further, even if the FBI had known precisely where he lived, it could not have shared that information with the civil arm of the IRS. Similarly, Mr. Sadek’s argument regarding the State Department failed. He argued that he provided his specific address in Lebanon to the State Department in connection with a request for a renewed passport. He did not, however, put evidence into the record of the hearing on this matter of the address provided to the State Department. Had he put on evidence that he provided a specific address to the State Department, providing the updated address to the State Department would not cause his address to change with the IRS. The regulation provides that “change of address information that a taxpayer provides to … another government agency, is not clear and concise notification of a different address.”

Last, Mr. Sadek argues that the IRS knew the two addresses to which it sent the notices were wrong and so the notice could not be valid. The Tax Court holds that the burden falls on the taxpayer to keep the IRS informed of his address and not on the IRS to find exactly where someone lives. The IRS tried to find his correct address and even Mr. Sadek’s own representative could not tell the IRS where to send the notice. The case shows that the IRS must make an effort when it knows that the address it has is wrong but that effort need only be reasonable. The taxpayer bears the burden to keep the IRS informed. When your own representative does not know how to find you, you will have an uphill battle convincing a court that the IRS should have known your address. Most cases do not have the personal involvement of an Appeals Officer prior to the issuance of the notice of deficiency and an Appeals Officer who directly questions the representative regarding the proper address. In the face of that type of questioning, taxpayer’s failure to provide the IRS with the proper address causes the outcome here.

Mr. Sadek owes a lot of money. That kind of money makes it worthwhile trying to set aside the assessment for an improperly filed notice. Since his case was dismissed for lack of jurisdiction because of an untimely petition and not because of a wrongly addressed notice of deficiency, the IRS assessment stands. If he wants to contest the underlying liability now, he must find the money to pay for at least one of the two years in order to meet the requirements of Flora.

 

Calculating Insolvency: A Technical Minefield for Taxpayers

We welcome first-time guest blogger Krzysztof Wendland of the Legal Aid Society of Northeastern New York, who writes about a recent insolvency case he litigated before the Tax Court. We have discussed cancellation of debt and the insolvency exclusion a few times recently on PT, including a post in May and two in July here and here. Christine 

Taxpayers who receive 1099-C forms informing them of debts that have been cancelled and reported to the IRS face the challenge of calculating the value of their assets and liabilities at a time immediately before the debt was cancelled.  This requires taxpayers to not only gather financial information from many financial institutions, but also try to calculate fair market values of their property.  An issue that most taxpayers do not often consider is whether debts that they list as a liability qualify as a liability for insolvency purposes.  Additionally, taxpayers who don’t receive the forms from the creditor and first learn of the cancelled debt after receiving a notice from the IRS, face a much larger burden as they must now gather financial information, often from years ago, and face higher scrutiny on the assets and liabilities they include in their calculation. 

Our LITC recently had the opportunity to represent otherwise Pro Se petitioners during this year’s Albany Trial calendar.  The clients received a statutory notice from the IRS Automated Underreporter Unit (AUR) proposing to increase their income based on unreported cancellation of debt income.  Three credit card companies had cancelled debt on their own.   Predictably, all three 1099-C forms were mailed to an outdated address, hence the taxpayer was unaware that any of the debt had been cancelled and that cancellation of debt should be included on his return.  After petitioning the U.S. Tax Court, the taxpayer attempted to exclude this income by claiming insolvency.  One of the largest debts in his liability column, and the only disputed issue in this case, was the balance of an agreement owed to his New York State pension.  

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The taxpayer had returned to employment with the State of New York after an absence of many years.  When reentering the Civil Service, rather than being returned to his previous retirement tier, he was instead placed in the less advantageous retirement tier that was then available to all new State employees enrolling for the first time.  This tier required a perpetual contribution of 3% by the employee towards their retirement plan, rather than capping contributions at 10 years as his original tier had done.  The taxpayer was later informed that he could opt into his previous and more beneficial tier.  In order to opt in and be relieved of this ongoing expense, he was required to agree to repay the funds that were originally distributed from his retirement account, plus the interest that would have accrued.  The agreement contained a contingency that the repayment would cease if and when his employment was terminated. 

At the time immediately preceding the cancellation of debt events, the outstanding amount owed by the taxpayer to the New York State Local Employee Retirement System (NYSLRS) was over $50,000. If this amount was a liability under section 108 of the I.R.C., the taxpayer would have been considered insolvent and all cancellation of debt income would have been excluded.  Neither section 108 of the I.R.C nor the regulations related to the provision define the term “liabilities”.   Chief Counsel objected to allowing this liability to be considered in the insolvency equation, and Judge Guy ultimately agreed.  In this case, Judge Guy took issue with three peculiarities of the agreement between the taxpayer and NYSLRS.

  1. The agreement resulted in an immediate and ongoing benefit to the taxpayer; 
  2. The calculation for insolvency would be distorted if the agreement would be considered a liability, without regard to the taxpayer’s increased future benefit; and 
  3. The payments were contingent on the taxpayer’s continued state employment

I agree that the agreement the taxpayer entered into was financially sound and did substitute a debt for an ongoing expense.  However, I believe that the reclassification of the taxpayer’s retirement contributions should not affect the legal reality that an ongoing expense has been extinguished and a new liability created.

I agree that the agreement the taxpayer entered into was financially sound and did substitute a debt for an ongoing expense.  However, I believe that the reclassification of the taxpayer’s retirement contributions should not affect the legal reality that an ongoing expense has been extinguished and a new liability created. 

I also agree that allowing including the balance owed on this agreement would distort the net asset analysis; however, I do not believe it does so improperly.  The insolvency exclusion serves to determine the accession to wealth at the time of an identifiable event.  When determining the value of assets and liabilities in a snapshot of time, there can be many distortions.  Here, the taxpayer’s agreement resulted in a balance that was owed to NYSLRS.  Correspondingly, his interest in a future defined benefit pension was increasing.  However, due to the structure of this pension, any contributions to the pension would not result in a corresponding increase in the value of the asset.  In Schieber v. Commissioner, TC Memo 2017-32, the court determined that a State pension that did not allow the beneficiary to “convert their interest in the plan to a lump-sum amount, sell the interest, assign the interest, borrow against the interest, or borrow from the plan,” was not available to pay income tax that resulted from cancellation of debt and was therefore not an asset within the meaning of section 108(d)(3).  The difference between this taxpayer’s pension and the Schiebers’ was that the NYSLRS pension would allow the taxpayer to borrow against their interest.  However, since a loan would result in a corresponding liability, I do not believe this difference would matter.   

The most difficult hurdle in this case was whether this agreement resulted in a bona-fide debt or whether the debt was illusory, overly contingent, or non-recourse.  The agreement required that the agreed upon repayment amount be drawn from taxpayer’s bi-weekly paycheck.   While the agreement was irrevocable and the consequences for non-payment of the periodic payments did exist, the agreement did not include an event that could trigger an acceleration of the amount owed.   

While the contingency of the debt alone did not doom this agreement; the totality of the circumstances resulted in a determination that this obligation should not be considered for the purposes of I.R.C. section 108.    

While this is a small tax court case and does not have precedential value, it highlights some of the hurdles a taxpayer may have a duty to overcome.  In this case, the taxpayer worked diligently with IRS chief counsel to ascertain his liabilities and assets at the time of the debt cancellation.  Several days before trial, the taxpayer believed that the sole issue remaining in this case was the correct valuation of the pension as an asset.  Taxpayers who claim insolvency may be required to prove, not only the correct value of assets and liabilities at the time immediately before the cancellation of debt, but also that the liabilities qualify as liabilities for insolvency purposes.    

I expect insolvency cases to become more frequent, particularly as student loan debtors begin to experience debt forgiveness that has not been statutorily excluded from cancellation of debt income.