Is It Time To Reconsider When IRS Guidance Is Subject to Court Review?

I have been working on an essay that looks at the possible way that Congress could breathe more life into the 2015 codification of the taxpayer bill of rights. My essay Giving Taxpayer Rights a Seat at the Table, which is in draft form and up on SSRN, makes a relatively simple claim: before IRS issues guidance it should be statutorily required to consider whether in its view the guidance is consistent with the taxpayer rights that the IRS adopted in 2014 and that Congress codified in 2015. In making my claim, I acknowledge the limits of the current statutory taxpayer rights framework, which arguably provides no direct way to hold the IRS accountable for actions that violate taxpayer rights unless the right relates to a separate specific cause of action for its violation.*

In researching my article on taxpayer rights, I came back to a stubborn problem with the IRS guidance process and for taxpayers and third parties who believe that the IRS guidance violates a procedural requirement under the Administrative Procedure Act:  there are at times insurmountable obstacles to challenging IRS guidance for procedural adequacy. That problem has led me to think about some interesting and important articles that have addressed this issue in the past few years.

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In the tax world, unlike other areas of federal law, statutes like the Anti-Injunction Act and the Declaratory Judgment Act, have proven formidable barriers to test the adequacy of IRS fidelity to for example the notice and comment requirements under the APA until well after the rule has been in place. In other words, a taxpayer or third party often has to wait for a refund or deficiency case (i.e., an enforcement proceeding) to argue that there was a procedural infirmity that would result in the court’s possibly invalidating the regulation or possibly subregulatory guidance.

This has contributed to some calling for a careful look at the Anti-Injunction Act, with Professor Kristin Hickman and her co-author Gerald Kerska arguing in Restoring the Lost Anti-Injunction Act in the Virginia Law Review (reviewed here by Sonya Watson) that history supports a reading of the AIA that would generally allow pre-enforcement challenges to IRS guidance. The article takes as a starting point that IRS has not always been faithful to APA requirements and not every possible challenge neatly fits into an enforcement proceeding. On top of that, as Professor Hickman has highlighted in prior work as well, it is questionable that there would be an adequate remedy in certain instances even if a court were to find a procedural infirmity in the context of a challenge that arises in a deficiency or refund case.

Despite my sympathy with a reading of current law that would allow for greater pre-enforcement challenges, there are strong legal and policy arguments against courts on their own extending the circumstances when there will be challenges to the procedural adequacy of IRS guidance. For example, expanding the opportunity for procedural challenges will naturally soak precious agency resources.  As Professor Daniel Hemel, in The Living Anti-Injunction Act in the Virginia Law Review online edition argues in an essay responding to Hickman and Kerska’s article, it would be best institutionally for Congress rather than the courts to open the door to pre-enforcement challenges.

Professor Stephanie Hunter McMahon in a 2017 Washington Law Review article Pre-Enforcement Litigation Needed for Taxing Procedures also takes up the subject of challenging IRS guidance. In her article, she sizes up the current landscape:

While Congress only permits procedural challenges late in the tax collection process, this offers little to most taxpayers. The delay in litigating procedural complaints reduces what is challenged and affects taxpayer behavior throughout the period from its promulgation until someone, eventually, challenges the procedures. In the process, delayed litigation requires that taxpayers plan their affairs under the spectre of guidance that might not survive a procedural challenge. Moreover, in deciding whether to follow the tax guidance, taxpayers must not only assess its substance but also the procedures used to create it under procedural requirements that are not consistently interpreted by the courts.

Professor Hunter McMahon drills deeper on the disincentives associated with challenging tax guidance in enforcement proceedings:

Disincentives are increased because, unlike in other areas of law that permit pre-enforcement litigation, people are not suing in post- enforcement tax litigation simply to perfect the agency’s procedures. Instead, they are suing over their own tax obligations. The personal nature of the result and that the costs are already imposed likely changes the way people perceive the litigation. With pre-enforcement litigation, a judge remanding a case to the agency to correct the procedures would be a victory. In a tax refund or deficiency case, remand is insufficient to accomplish the goal of reducing the taxes owed. If courts are likely to remand procedural matters without vacating the rule, the taxpayer has little incentive to challenge the rules because the personal outcome remains the same.

These issues are even more pernicious when the rules in question relate to lower income or marginalized taxpayers, who are less likely to be able to get to court and as Professor Hunter McMahon aptly points out may not have the means or resources to influence the guidance process in the first instance. (That latter point is indirectly highlighted by the draft article “Beyond Notice-and-Comment: The Making of the § 199A Regulations” by Shu-Yi Oei and Leigh Osofsky that Keith discussed recently).

Professor Hunter McMahon proposes a legislative fix. That fix would be to allow an amendment to the Anti-Injunction and Declaratory Judgment Act to allow for a limited time period challenges to the procedural adequacy of the guidance:

[T]his proposal would permit pre- enforcement litigation of procedural requirements and a judicial evaluation of whether the process used, including the clarity of the statement and the comment period, suffices for APA purposes.

As Professor Hunter McMahon notes, the benefit of allowing a limited time to challenge to procedural adequacy is that it could focus attention on procedural issues early in the life of the guidance, which would allow for consistency in application of the substantive rules. A second part of Professor Hunter McMahon’s legislative fix is for Congress to delineate more specifically which forms of guidance are required to go through notice and comment—she focuses on guidance that is intended to change taxpayer behavior rather than define prior action as the candidate for a default requirement to go through the notice and comment process.

Conclusion

I believe that Professor Hunter McMahon’s approach merits serious consideration. I am reflecting further on my proposal about ways to give the taxpayer rights provisions more teeth -my proposal relies heavily on the Taxpayer Advocate Service and enhancing its institutional role in the guidance process, including giving the National Taxpayer Advocate specific authority to comment on regulations (something that the NTA herself as recommended in both Purple Books that accompanied the last two annual reports). As Congress signals a further willingness to take on IRS reform issues, I believe that it should directly address the current reach of the Anti-Injunction Act and the issue of when and to what extent taxpayers and third parties should be able to test the adequacy of IRS guidance conforming to APA requirements.

As part of this approach I am intrigued by the possibility of tying in the IRS’s fidelity to taxpayer rights principles in the rulemaking process. I would be grateful for comments on my draft article or reactions to any of the issues raised in this post.

*An example of how a taxpayer right relates to a specific cause of action is taxpayer right number 7, the right to privacy, and Section 7213, which authorizes a suit for unauthorized disclosure of a taxpayer’s any tax return or return information. An example of a taxpayer right that does not so relate to a cause of action is right number 5, the right to appeal an IRS decision in an independent forum, which as we discussed last year in connection with the Facebook case does not seem to carry with it a direct way to challenge IRS action that arguably conflicts with that right.

 

 

IRS Still Ignores Allocation of Underpayment Mandated by 2011 Pullins Opinion in Computing Section 6015(f) Relief

I came back out of retirement to become the acting director of the Harvard Federal Tax Clinic for the first six months of this year, while Keith is on sabbatical.  One of the depressing things I just discovered is that the IRS is still ignoring the method for computing innocent spouse relief in underpayment cases under section 6015(f) that the Tax Court adopted (at least for some cases) in Pullins v. Commissioner, 136 T.C. 432 (2011).  In a nutshell, the IRS computers take the joint tax return liability as reported and allocate it between the spouses based on each’s relative proportion of total reported taxable income.  But, in Pullins, the court said that, at least in that case, relief should be to eliminate all tax except that which would be paid by the requesting spouse had she filed a married filing separately return.

I dealt with this issue when I was the director of a tax clinic at Cardozo School of Law some years ago, and every time I saw the allocation the IRS had done of the spouse’s taxes for purposes of underpayments cases, I had to ask the IRS to recompute the relief consistently with Pullins.  The IRS always did so at my request, increasing the amount of relief.  But, I shouldn’t have had to ask.  And I wondered about all the thousands of pro se requesting spouses out there who were seeking (f) relief in underpayment cases.  They would never have known to challenge the IRS computations of their relief the way I knew to make the challenge.

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Last week, I consulted with a taxpayer who had reached a resolution of a Tax Court section 6015(f) underpayment case and who asked me to look at the IRS settlement computations.  Once again, the computations ignored Pullins.  The amount by which the taxpayer was being cheated was $300.  However, after I pointed this out to her, she decided not to make a fuss about this – not wanting to possibly jeopardize the settlement that she had already achieved on the major issue of getting relief at all.

But, I want to alert everyone to what is going on, and I hope the National Taxpayer Advocate will look into this matter.  After all, it is now almost 8 years since Pullins rejected the way the IRS computers are programmed to calculate section 6015(f) relief in underpayment cases.

The goal of the innocent spouse provisions (at least where there has been no abuse) is to relieve a requesting spouse only of the tax on the nonrequesting spouse’s income, not the tax on the requesting spouse’s income.  But, implementing this goal can be tricky.

If the tax as to which innocent spouse relief is sought is a “deficiency” – i.e., attributable to an audit adjustment increasing reported tax (a situation involving an “understatement”) – then relief may be available to the taxpayer under section 6015(b), (c), or (f).  Congress provided rules for calculating relief under section 6015(c) that provide, as a general rule, that “[t]he portion of any deficiency on a joint return allocated to an individual shall be the amount which bears the same ratio to such deficiency as the net amount of items taken into account in computing the deficiency and allocable to the individual under paragraph (3) bears to the net amount of all items taken into account in computing the deficiency.”  Section 6015(d)(1).  In a simple example, if the deficiency were $30,000, and the underlying adjustments to income were $80,000 of unreported income of the husband and $20,000 of unreported income of the wife, and the wife requested section 6015(c) relief, she could be relieved, at most, of 80% of the $30,000 deficiency – or $24,000.

The IRS uses this allocation system for subsection (c) relief also when computing relief from deficiencies under subsections (b) and (f).  And I take no issue with the IRS doing so.

However, there is no provision of section 6015 that tells the IRS how to compute relief under subsection (f) in an underpayment case – i.e., where the IRS has no issue with the tax reported on the return except that, when the return was filed, not all of the tax shown thereon was paid.  The IRS has filled this gap only in Manual section 25.15.3.9.2.1(7) (7/29/14), which states, in part:

If liability is attributable to both the RS [requesting spouse] and NRS [nonrequesting spouse], equitable relief will only be considered for the portion attributable to the NRS.

Note:

. . . .  Underpayments of tax are allocated based on each spouse’s pro rata share of the joint taxable income.

Note:

For purposes of determining how much of an underpayment is attributable to each spouse, the EITC and ACTC is allocated to each spouse in proportion to the spouse’s share of the adjusted gross income.

Imagine a case where the total tax shown on the joint return was $6,400 and the return only showed two items of income:  $80,000 of wages of the husband and $20,000 of wages of the wife.  After standard deductions for a married filing jointly return and two personal exemptions, assume that the taxable income is $58,000.  Imagine that the balance unpaid on that return is currently $4,000.  How much the requesting spouse should be relieved of under (f) is determined, in part, by how much of the total $6,400 of tax the requesting spouse already paid – either through income tax withholding, estimated tax payments, and payments made after the IRS commenced collection.  Under the Manual provision, though, the IRS would also say that the $6,400 of total tax should be allocated to the spouses 80% to the husband and 20% to the wife because that is their relative shares of the taxable income reported.  So, the wife would be allocated $1,280 of the reported joint tax liability of $6,400.

Pullins presented a similar fact pattern – i.e., the wife sought relief, and the wife’s income was relatively small compared to the total reported joint taxable income. Judge Gustafson, though, rejected the method the IRS used to determine section 6015(f) relief in that underpayment case.  Instead, he noticed that, had the wife filed a return as married filing separately, she would have had less tax.  That is because, by adding her income to her husband’s to file a joint return, both spouses got taxed at a high bracket.  But, her income alone would have been taxed at a low bracket if she had filed married filing separately.  In my example in the previous paragraph, the wife could have filed a married filing separately return showing only $20,000 of gross income.  Taking a combined standard deduction and personal exemption of, say, $11,000, the wife’s taxable income would have been only $9,000.  All of that $9,000 would be subjected only to the 10% tax bracket, so the tax she would have paid would have been about $900 – $380 less than her proportionate share of the joint liability.

In Pullins (at page 432), the judge wrote:

As we stated above, for purposes of determining the extent of her liability for or overpayment of tax on her own income, we use Ms. Pullins’s computation on the basis of married-filing-separately status, rather than the IRS’s computation that made a pro rata allocation of the reported liability (based on married-filing jointly status). To reckon the amount of tax liability that Ms. Pullins should have to pay because it is fairly attributable to her, we think that on the facts of this case it is reasonable to figure Ms. Pullins’s tax liability separately. The IRS’s method assumes a joint liability and then attributes to her a pro rata share of the joint liability, but the purpose of section 6015 is to grant relief from joint liability.  Under the IRS’s method, if we found Ms. Pullins to be otherwise entitled to section 6015 relief, we would nonetheless leave her liable for a portion of the joint liability.  Our aim here, however, is to figure Ms. Pullins’s own liability apart from joint liability and then ensure that we do not excuse her from paying her own liability.  To accomplish that aim, a determination of her separate liability, rather than an allocation of the joint liability, is most reasonable here. [footnotes omitted]

In footnote 8 on that page, the judge noted that the allocation that he was making was similar to one that would be made if it was determined that there was no joint return at all because the return had been signed under duress.  The footnote reads:

As an analogy, see 26 C.F.R. sec. 1.6013–4(d) (to allocate liability where a supposedly joint return was signed under duress, ‘‘The return is adjusted to reflect only the tax liability of the individual who voluntarily signed the return, and the liability is determined at the applicable rates in section 1(d) for married individuals filing separate returns’’ (emphasis added)). [emphasis in the Pullins original]

I think that Judge Gustafson declined to set down a general rule for all underpayment cases under section 6015(f) because he might want to adopt the IRS system of allocating the reported joint tax in proportion to relative taxable income when the requesting spouse was a person with much higher gross income than the nonrequesting spouse.  Also, there is the problem of the earned income tax credit.  If that credit applies for a married couple, it is only available if they file married filing jointly.  The nonrequesting spouse could not get any earned income tax credit with married filing separately status.  Section 32(d).

The case on which I was recently consulted was one like Pullins, where the requesting spouse had relatively small income compared to her husband’s and her income would have been taxed at a much lower rate had she filed a married filing separately return.  The return also involved no earned income tax credit.  Over the years, I have probably seen a half-dozen of this kind of case.  All presented this fact pattern.  My suspicion is that this is the typical innocent spouse case because, in my experience, the requesting spouse is usually the low earner in the family.

After almost 8 years since the issuance of Pullins, I think it high time that the IRS modify its Manual provision to reflect the Pullins system for calculating section 6015(f) relief in underpayment cases.  The IRS can adopt exceptions to deal with (1) the unusual situation of tax on a married filing separately return basis exceeding the allocation of the joint return tax in proportion to relative taxable income and (2) earned income tax credit returns.  I like the idea of allocating that credit between the spouses, though I would modify the allocation to be based on relative shares of the total earned income, not adjusted gross income.  After all, the tables for the earned income tax credit are computed with respect to combined earned income.

NTA Issues 2018 Annual Report to Congress

Yesterday, National Taxpayer Advocate Nina Olson released the 2018 Annual Report to Congress. In an accompanying news release and in the report’s preface, she highlights the impact of the government shutdown on taxpayer rights, and also emphasizes the crucial need for IT modernization to replace antiquated systems at the IRS.

We will be highlighting issues of interest to readers in forthcoming posts. I look forward to reading the report.

Will the IRS Take My Home?

LITC practitioners hear recurring worries from taxpayers with IRS problems: will I go to jail? will the IRS take my home? For the vast majority of people who owe taxes, the answer to both questions is no. Someone who simply owes a tax debt usually does not need to worry about going to jail or having their home taken by the IRS. However, this is not to say it never happens. There are perhaps one or two cases per month reported on daily tax news services, and the National Taxpayer Advocate’s 2017 Annual Report to Congress identified 60 opinions in that fiscal year involving section 7403Recent cases illustrate the steps the government must take and the factors courts consider when evaluating a request to foreclose. 

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The government has two separate legal mechanisms to seize a taxpayer’s home in order to collect a tax debt. The National Taxpayer Advocate explains in her 2017 ARC Purple Book: 

The IRS has two options, which cannot be used concurrently, to collect against the principal residence of a taxpayer or a residence that is owned by the taxpayer but occupied by the taxpayer’s spouse, former spouse, or minor child. One option is to obtain a court order allowing administrative seizure of a principal residence under IRC § 6334(e)(1). … The other option is a suit to foreclose the federal tax lien against a principal residence under IRC § 7403.

The IRS makes use of both options, by way of making a recommendation and referral to the Department of Justice Tax Division, which represents the IRS in Federal District Court. The IRM explains that  

[s]uits should still be brought to foreclose the federal tax lien and reduce the tax liability to judgment in lieu of bringing a section 6334(e)(1) proceeding whenever it is determined that such suits would be optimal. A lien foreclosure suit may be preferable to a section 6334(e)(1) proceeding when there are questions regarding title or lien priority that create an unfavorable market for administrative sale. See 35.6.3.2 for discussion of lien foreclosure suits. A lien foreclosure suit may also be a specific option when the collection statute of limitations is about to run.  

34.6.2.5.1 (06-12-2012), Procedures for Instituting a 6334(e)(1) Proceeding.  So, taxpayer representatives should be familiar with the requirements for both actions.

Administrative seizure with judicial approval 

In August of 2018, Keith blogged about an Eighth Circuit decision under section 6334United States v. Brabant-Scribner, No. 17-2825 (8th Cir. Aug. 17, 2018). Keith explains: 

The 1998 Restructuring and Reform Act added IRC 6334(e)(1)(A) to require that prior to seizing a taxpayer’s principal residence the IRS must obtain the approval of a federal district court judge or magistrate in writing. Before the passage of this provision, the IRS could seize a taxpayer’s home with the same amount of prior approval needed to seize any other asset owned by the taxpayer. No approval was necessary to seize any asset of the taxpayer.

The government has adopted Treasury Regulation 301.6334-1(d) incorporating additional procedures and standards. Keith summarizes: 

To convince the court to allow the sale of a personal residence, the IRS must show compliance with all legal and procedural requirements, show the debt remains unpaid and show that “no reasonable alternative” for collection of the debt exists. 

… the taxpayer has a right to object after the IRS makes its initial showing and “will be granted a hearing to rebut the Government’s prima facie case if the taxpayer … rais[es] a genuine issue of material fact demonstrating … other assets from which the liability can be satisfied.”  

Also, the regulation provides for written notice to family members and occupants of the property.  

Unfortunately for taxpayers, judicial approval may not be difficult for the IRS to obtain despite the above standards and procedures. In Brabant-Scribner, the court reasoned that an alternative “for collection” must provide for payment of the debt; therefore, it held that the IRS was not required to consider the taxpayer’s offer in compromise. Similar reasoning has been followed by other courts. E.g. United States v. Gower, No. 3:16-cv-01247 (M.D. FlaJul. 10, 2018). Nevertheless, the administrative collection statutes and regulations provide some procedural protections for the taxpayer and certain family members living in a home owned by the taxpayer. IRM procedures also provide significant safeguards, which the National Taxpayer Advocate has recommended that Congress codify in section 7403

Suit to foreclose judgment lien 

The government’s second option, if it seeks to seize a taxpayer’s home, is to foreclose the federal tax lien by filing suit pursuant to section 7403Les has discussed section 7403 previously, and I will borrow his summary:

Under Section 7403, a federal district court can “determine the merits of all claims to and liens upon the property, and, in all cases where a claim or interest of the United States therein is established, may decree a sale of such property,…, and a distribution of the proceeds of such sale according to the findings of the court. 

Yet that power to force a sale and distribution of the proceeds is limited. In the 1983 case US v Rodgers the Supreme Court said that while the government has broad discretion to force a sale, “Section 7403 does not require a district court to authorize a forced sale under absolutely all circumstances, and that some limited room is left in the statute for the exercise of reasoned discretion.” Keith has discussed the application of Rodgers in prior posts here and here. 

To assist courts in exercising that discretion, Rodgers identifies factors: 

1) “the extent to which the Government’s financial interests would be prejudiced if it were relegated to a forced sale of the partial interest actually liable for the delinquent taxes[;]” 

(2) “whether the third party with a nonliable separate interest in the property would, in the normal course of events (leaving aside § 7403 and eminent domain proceedings, of course), have a legally recognized expectation that that separate property would not be subject to forced sale by the delinquent taxpayer or his or her creditors[;]” 

(3) “the likely prejudice to the third party, both in personal dislocation costs and … practical undercompensation [;]” and 

(4) “the relative character and value of the nonliable and liable interests held in the property ….”

Once the government has decided to sue for foreclosure, the taxpayer and others hoping to prevent that outcome face an uphill battle. The government prevailed in 58 of the 60 cases identified by TAS in the 2017 Annual Report to Congress, and one case resulted in a split decision. The taxpayer prevailed in only one case. These lopsided statistics are consistent with prior years’ reports.  

At times courts’ analysis of the Rodgers factors is cursory or nonexistent, but sometimes the factors do make a difference and judicial discretion is exercised. In United States v. Kwitney, No. 6:18-cv-1366-Orl-37TBS (M.D. Fla. Feb. 8, 2019), the district court rejected a magistrate’s recommendation in favor of foreclosure, because the interests of a third party had not yet been adjudicated.  

A less happy outcome for the interested third party occurred on January 30 in United States v. Jackson, No. 3:16-cv-05096 (W.D. Mo. Jan. 30, 2019). Mr. Jackson’s wife jointly owned properties with him, but she was not liable for the tax debt. Unfortunately for her, Mrs. Jackson came to the court with unclean hands, having previously collaborated with Mr. Jackson in what the court found were fraudulent transfers of the property. The court nevertheless examined the Rodgers factors: 

With respect to the first factor, the Court finds Plaintiff’s financial interests would be prejudiced if it were relegated to the forced sale of only Phil Jackson’s interest in the Properties. As a practical matter, if Plaintiff foreclosed on Phil Jackson’s interests only, Sharon Jackson retains her interests in the Properties. Thus, the sale of Phil Jackson’s interests would not decrease the judgment amount Phil Jackson owes to Plaintiff. 

Translation: it will be hard, perhaps impossible, to find a buyer for Mr. Jackson’s half-interest in the property. The government is likely to collect nothing under this alternative.  

With respect to the second factor, Sharon Jackson lacks an expectation that the Properties would not be subject to sale. Sharon Jackson, as owner with Phil Jackson, participated in the fraudulent transfers (since disclaimed) of the Properties. In the Court’s view, this conduct “tilts the balance of legal expectation against” her under this factor. United States v. Bierbrauer, 936 F.2d 373, 376 (8th Cir. 1991). 

With respect to the third factor, Sharon Jackson will receive full compensation for her interests in the Properties. … 

Finally, with respect to the fourth factor, because Phil Jackson’s and Sharon Jackson’s interests in the Properties are equal, forced sale could net Plaintiff as much as half the value of each of the properties to apply to the tax judgment against Phil Jackson. Under these circumstances, the Plaintiff is likely to recover more than “a fraction of the value of the property.” Bierbrauer, 936 F.2d at 375. 

Mrs. Jackson also argued that if the properties were sold, she should receive half of the sale price before any of the sale expenses were deducted and before certain property tax liens were paid. The Court held against her on both counts. As co-owner Mrs. Jackson was equally liable for the property taxes, and the court reasoned that her legal interest in the property is subject to those liens. Regarding the administrative costs of sale,  

[The Jacksons] cite no legal authority for the premise that the sale costs for the Properties should be borne by Plaintiff. Thus, the Court relies on “the Government’s paramount interest in prompt and certain collection of delinquent taxes” to conclude that Plaintiff net proceeds from the sale of the Properties should be distributed to PALS first. Rodgers, 461 U.S. at 712. 

The government’s “paramount interest” certainly makes these cases very difficult for taxpayers and their family members to win.

The bottom line 

The case numbers are low: the government probably won’t try to seize your home for back taxes. However, it’s in taxpayers’ interests to resolve their collection disputes rather than ignore the IRS. And certainly, don’t try any funny business with fraudulent transfers.

Update on Haynes v US: Fifth Circuit Remands and Punts on Whether Boyle Applies in E-Filing Cases

One of the foundational principles in tax procedure is that reliance on an accountant or lawyer to file a tax return cannot in and of itself constitute reasonable cause to avoid a late-filing penalty. The Supreme Court said as much in the 1985 case United States v Boyle. Over the last few years taxpayers and practitioners have started to challenge Boyle in the e-filing context. The basic question is whether courts should reconsider the bright line Boyle rule when a taxpayer provides her tax information to her preparer and the preparer purports to e-file the return, but for some reason the IRS rejects the return and the taxpayer arguably has little reason to suspect that the return was not actually filed.

Sometimes the preparer may fail to receive a rejection notice from the IRS; sometimes the preparer gets the reject notice and fails to tell the client. In either situation, the client then gets a surprise letter from the IRS months or maybe years later, leading to late filing penalties.

In the case of the Hayneses, the taxpayers heard from their accountant/preparer that on the last day for filing their 2010 tax return he had in fact e-filed the return. But for some reason the Social Security Number erroneously appeared on the line designated for an employment-identification number, and the IRS rejected the return. The preparer did not get a reject notice and neither he nor his clients took any steps to confirm that the IRS processed the supposedly e-filed return. After eventually receiving IRS correspondence the taxpayers filed their return and paid a late filing penalty. They sought a refund for the penalty, first with the IRS and then after the IRS denied the claim in federal district court. The district court granted the government summary judgment, concluding that as a matter of law under Boyle the taxpayers could not rely on their accountant to satisfy a return filing obligation even if the return filing process in the 21st century differs in kind from what was done back in the Reagan years.

In last month’s brief opinion, the Fifth Circuit took a different approach to the dispute. While noting that the application of Boyle in the 21stcentury world of e-filing is an “interesting” issue, it remanded the case back to the district court. It did so because it believed that there was a factual dispute that the lower court needed to resolve before it could even get to the legal issue:

Whether it was reasonable for Dunbar [the accountant] to assume, based on the IRS’s silence, that it had accepted the Hayneses’ return or whether ordinary business care and prudence would demand that he personally contact the IRS to ensure acceptance is a genuine question of material fact for the jury to decide. Because Dunbar is the Hayneses’ agent, if a jury determines that his actions meet the reasonable-cause standard, it must find the same to be true for the Hayneses—barring any determination of independent negligence by them.   After all, principals are not only bound by their agents’ failures, as in Boyle, but also by their diligence.

If, as a matter of fact, it was reasonable for the accountant to assume that the IRS accepted the return without seeking confirmation, then the penalty does not stand. If, however, the jury finds it was not reasonable, then the 21st century Boyle issue is teed up:

It is this question of material fact that makes it unnecessary for us to decide whether a broad e-filing exception to Boyle exists. That complex question need only be answered if Dunbar, in fact, acted negligently in filing the Hayneses’ tax return. Only then would the Hayneses be relegated to relying solely on their reliance on Dunbar to meet the reasonable-cause standard, thereby teeing up the Boyle question.

Conclusion

We will closely follow this case, as well as the handful of other cases that are percolating in the courts that raise the issue.

For prior PT coverage on this issue, see our post on the lower court opinion in the Haynes case and our post discussing a similar issue in the Spottiswood case. Those posts generated thoughtful comments and also link to some other useful sources.

 

 

Restitution Order, IRA Account, Community Property = Unfortunate Result for Non-Liable Spouse

It’s never a good thing for your spouse to be the subject of a $2,165,126 restitution order. You know when that comes out in the first few sentences of an opinion that things do not look good for the non-liable spouse. That proves true in United States v. Berry, No. 4:17-cr-00385 (S.D. Tex. 2018).

From the perspective of the IRS, this case presents the not always available situation of a wayward party who still has assets after a criminal prosecution. Here, the asset takes the form of an IRA. An IRA generally does not provide the best place to hold assets if you seek to protect them from creditors. Here, the court mentions the general rule that ERISA does not govern IRAs as a shorthand way to state that the substantial protections from creditors afforded to individuals holding assets in an account covered by ERISA do not apply when the retirement account instead exists in an IRA. The court does not make mention of the fact that ERISA’s protections do not insulate a taxpayer from the collection tools available to the IRS. Because of the way this case arises, I am unsure if the IRS tools are available here. So, the fact the account existed in an IRA could make a crucial difference not always present in federal tax collection cases.

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The Berrys live in Texas although I am unsure where Mrs. Berry is serving her 51 month sentence for wire fraud, mail fraud and filing a false tax return in violation of IRC 7206. In this case the government seeks to obtain 100% of Mrs. Berry’s retirement account and 50% of Mr. Berry’s account. The Berrys make four legal arguments and one equitable argument in an effort to protect their accounts. I will go through the arguments in the order presented by the court. Spoiler alert – none of the arguments work for the Berrys.

Federal Pre-emption

They argue that retirement funds are not community property. The retirement accounts are IRAs. The court finds that because the funds are held in IRAs and not ERISA protected retirement accounts, no pre-emption of state community property laws exists.

State Law

They argue that the retirement accounts are governed by Pennsylvania law because the custodial agreement says that the funds are governed by the law of that state which happens to be the state where Vanguard is located. Mrs. Berry argues that Pennsylvania law (and Texas law if PA law does not apply) waives her rights in the accounts and removes them from community property. She did not sign a specific waiver of her community interest in the property. Because she did not waive her interest in community property, the court finds that the retirement accounts are community property allowing the restitution liens to attach. The court cites United States v. Elashi, 789 F.3d 537, 551 (5th Cir. 2015) in support of its position. Since Mrs. Berry had a ½ interest in Mr. Berry’s solely managed community property, the government can seek to obtain her half interest in that account.

Consumer Credit Protection Act

The Berrys argue that even if the government can reach half of Mr. Berry’s retirement account despite the previous two arguments, its ability to reach Mrs. Berry’s community property interest in Mr. Berry’s property is limited to no more than 25% pursuant to section 30 of the Consumer Credit Protection Act. This Act limits the maximum garnishment to 25% of the earnings for that week. The court finds that the weekly limitation imposed by this act depends on whether Mr. Berry is limited to receiving periodic payments or has the ability to cash out. Because he has the ability to take out the entire amount at any time, the government is not limited in the amount of Mrs. Berry’s interest that it can obtain.

Facially Invalid

The Berrys argue that the writ of garnishment issued in this case overstates the amount due because it includes a future debt to the IRS not currently due. The court finds that the amount listed does not invalidate the writ of garnishment.

Equity for Mr. Berry

The Berrys argue that even if their legal arguments do not prevail it would be a significant strain on Mr. Berry to allow the government to take half of his retirement account. The case does not make clear how his finances would be impacted by the taking of half of this account. Certainly taking half of funds in his IRA limits his future ability to take distributions but what that does to his finances is unclear. Perhaps the court does not go into this type of detail because the court finds this type of equitable argument to be unavailing where the government has the legal right to take the property. It seems that the Berrys were essentially asking for the court to create something akin to the Rodgers factors and apply them to this situation.

I think that something could be made of the Rodgers factors in a case like this if the facts support Mr. Berry’s need for the funds in order to avoid seeking benefits from the state. The equitable portion of the opinion is too short to provide an adequate description of the arguments made by the Berrys or the thought process of the court.

Conclusion

Similar to the result in bankruptcy, holding funds in an IRA provides little more protection from creditors than holding funds in an ordinary bank account. Because the government is collecting pursuant to a restitution order rather than a tax assessment, its ability to use the powerful collection tools of the IRC may be limited but that does not matter here. The court does not discuss whether the restitution order would allow the IRS to assess all of part of the amount in the order. If some or all of the restitution order covered taxes, then it could have gone about collection by first assessing the taxes and then pursuing normal federal tax collection alternatives as discussed here.

 

Misclassified “Independent Contractor” Succeeds in Using Tax Code to Get Damages from Employer

We have nearly finished information return filing season. This is the time of year when Americans get their W-2s and 1099s, stuff them in folders and drawers, and hope that when it comes time to prepare their tax return they remember where the papers are. Information returns often lie forgotten until it’s time to answer questions from software prompts or from long-suffering preparers who play detective to ferret out a taxpayer’s economic life.  Some taxpayers can access their information returns seamlessly, but for most this is still a 20th century process that contributes to the huge costs of filing compliance. To be sure, information returns are the backbone of “voluntary” compliance—it is no surprise that when income is not subject to reporting taxpayers have a tendency to not include those items on their 1040s—and that will be true whether the 1040 is postcard size or in the form of a Hallmark Valentine’s Day card professing the IRS’s undying love for taxpayers who file and pay timely.

I digress—today’s post is about people who intentionally file incorrect information returns.

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We have discussed this issue before, and Stephen and I have just heavily tweaked this issue in the Saltzman and Book IRS Practice and Procedure treatise. The cases tend to crop up when someone seeks to make someone else’s life miserable by fling a phony return to generate IRS attention in the form of underreporting letters and possible tax assessments. What could be more middle-finger flipping then sending the IRS an information return showing a former partner or significant other with all kinds of income supposedly but not really earned?

To deal with this, Congress added Section 7434 which provides that

[i]f any person willfully files a fraudulent information return with respect to payments purported to be made to any other person, such other person may bring a civil action for damages against the person so filing such return.

There are a surprising number of interesting legal issues that spin off this provision. One of the issues concerns whether the statute provides a remedy for someone who is truly an employee but is treated as an independent contractor and who then receives a 1099-MISC rather than a W-2. The cases are split, some saying that the statute only provides a remedy when an improper amount is reported, and other courts holding that the statute provides a remedy for any fraudulent action in connection with the information return, including filing the wrong form. Another key issue that the courts are wrestling with is whether liability is limited to the person who was required to file the information return under federal law. For example, some courts have declined to find personal liability if the filer was not the party required to file the information return. See e.g., Vandenheede v. Vecchio, a 2013 case from a federal district court in Michigan declining to hold liable two co-trustees who prepared and caused a false information return to be filed on another’s behalf.

This takes us to a case from last year that I read as I prepare the updates for the next round of the treatise. The case is Czerw v Lafayette Moving and Storage. In the case, a federal district court in NY considered the claims of Joseph Czerw, who worked over twenty years as a mover for the same employer. In prior years, Czerw received W-2s and was treated as an employee, which was consistent with his actual arrangement with the employer. In 2015 his employer had major financial difficulties, with checks bouncing. Unlike in past years, when he got W-2s, for that year Czerw received a 1099-MISC for over $5,000. Not only was the information return the wrong type, but Czerw had only been paid about $4,000. Even though Czerw contacted his employer to get him to treat him as an employee and reflect the proper amount he was paid, his employer declined to fix things.

Czerw sued his corporate employer and Matthew Ferrentino, the corporation’s sole owner and president, alleging that his employer and Ferrentino had actual knowledge that a W-2 form was the correct form to submit and that the 1099-MISC reflected the wrong amount he received. Czerw alleged that the defendants willfully, purposely, and fraudulently filed the false Form 1099-MISC as part of a scheme “to defraud state and federal taxing authorities . . . by lessening [] Lafayette’s tax obligations and the amount of its worker’s compensation insurance premiums.” The complaint sought $5,000 in damages—the statutory amount provided in the absence of actual damages or discretionary legal fees.

The defendants defaulted, but before the court granted damages it had to explore whether the statute provided for relief in Mr. Czerw’s situation. The first issue the court considered was whether liability extended not only to the corporation but also to Ferrentino individually. The order briefly explores the split in cases on the issue, and lines up squarely with the cases that extend liability “on any person who willfully causes a fraudulent information return to be filed.” Thus it found that Ferrentino in his individual capacity was also potentially on the hook for damages.

As to whether section 7434 can be used in misclassification cases in the absence of an incorrect amount reported, the order notes that the law is developing on this issue. The court was able to avoid coming down on any side because the 1099-MISC that was filed overstated the amount that Czerw received:

As Plaintiff concedes, however, some courts have held that “§ 7434(a) creates a private cause of action only where an information return is fraudulent with respect to the amount purportedly paid to the plaintiff.” Liverett v. Torres Advanced Enter. Solutions LLC, 192 F. Supp. 3d 648, 653 (E.D. Va. 2016) (emphasis added). Under that interpretation, the statute “provides no remedy for a person incorrectly classified as an independent contractor.” Tran, 239 F. Supp. 3d at 1298. But because Plaintiff alleges that the Form 1099-MISC incorrectly states the amount paid to him, the second element is satisfied regardless, and the Court need not address whether the alleged misclassification supports a claim under § 7434.

Conclusion

Employee misclassification is a major issue. Employers who misclassify employees are failing to provide unemployment insurance and workers’ compensation. Those employers can also leave workers with large employment tax liabilities. Advocates who work in this field have Section 7434 as a possible mechanism to ensure fair treatment for workers and punish those who do the wrong thing. The Czerw order is helpful but as briefly reflected in this post there are some key legal issues that await further development.

 

 

 

 

 

 

Commenting on Regulations

A recent paper shines a light on the fascinating process of commenting on regulations. This year Tax Notes recognized the regulation writers at the IRS Office of Chief Counsel and the Treasury Department as the most significant tax players. Because of the 2017 legislation and the downsizing of Chief Counsel’s office due to the budget reductions over the past eight year, the attorneys there did a tremendous job under very difficult circumstances. They are very deserving of the recognition given by Tax Notes.

The recent paper, entitled “Beyond Notice-and-Comment: The Making of the § 199A Regulations” was written by Shu-Yi Oei of Boston College Law School and Leigh Osofsky of the University of North Carolina at Chapel Hill. The authors focus on the comments made to Treasury and the IRS regarding just one provision of the 2017 legislation. This provision resulted in a high volume of comments because of its nature. The paper not only looks at the volume and the substance of the comments but takes a hard look at the timing and how the timing of comments plays into the final product.

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Although I have limited experience in writing regulations and in commenting on regulations, the article was eye opening in its detail of the process of submissions. In addition to formal submission, the article also comments on the informal ways that parties can influence regulations through the scholarly and popular press, including blogs.

The authors spent a fair segment of the article chronicling the comments on section 199A made prior to the call for formal comments. They detail their effort to find the early comments. These comments do not have the same type of recordkeeping that attaches to formal comments made during the notice and comment period. Their efforts to find these comments is interesting in itself. Also interesting is the impact the early comments had on the proposed regulation. The authors note the number of times the proposed regulations refer to the comments receiving during the period prior to the call for notice and comments. This section had the greatest impact on me because it told me that players with early access have influence at the most critical time. Certainly, parties making comments on the proposed regulation have an influence but having an influence in the formation of the regulation seems even more meaningful.

Because low income taxpayers have no ability to hire lobbyists or attorneys to make their case during the process of creation of a regulation, the Pro Bono and Tax Clinic Committee of the ABA Tax Section tries to comment on legislation and other notices when the IRS puts out a call for comments. At some low income taxpayer clinics around the country, there is also an effort to comment. The article makes me wonder if we are missing an opportunity to more proactively provide our voice on the formation of rules because we generally wait for the IRS to make a request.

If you have ever participated in making comments or wondered about the process, this article will open your eyes. Thanks to the authors for great work.