Seventh Circuit Reverses in King Interest Abatement Case

Last week the Seventh Circuit reversed the Tax Court in King v Commissioner, holding that the Tax Court was incorrect in concluding that the Service abused its discretion in not abating the late Mr. King’s interest that accrued on employment tax liabilities. We have discussed the case before, most recently with Carl reviewing the oral argument in Interest Abatement Based on “Unfair” Assessment and Stephen discussing the Tax Court opinion in A Pro Se King Royally Wins Interest Abatement on Employment Taxes

I will excerpt heavily from our prior posts and the Seventh Circuit opinion and offer a few observations.

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The Issue and Tax Court Resolution

As Carl and Stephen discussed, this was an odd interest abatement case, arising through CDP and applying Section 6404(a) rather than the explicit interest abatement provision found in Section 6404(e). The dispute centered on interest that the IRS charged that was attributable to unpaid employment taxes and in part erroneous information that the IRS had given King. An IRS employee told King it would grant him an installment agreement; it later decided that King’s collection potential was too high to warrant an installment agreement. King paid the tax but argued that he should not have paid the interest that ran from the date of the erroneous information about the installment agreement until his later payment as he would have paid earlier had he known he was not going to be given an installment agreement.

Carl discussed how the employment tax context took this case out of the explicit interest abatement regime in Section 6404(e) and how it came to Tax Court via CDP:

King is an employment tax Collection Due Process (CDP) case based on a notice of federal tax lien (NFTL).  The only issue left in the case on appeal is interest abatement under IRC § 6404(a).  That’s not a typo for § 6404(e).  § 6404(e) allows abatement of interest with respect to taxes that are deficiencies (income, estate, and gift), not employment taxes, where there have been unreasonable IRS errors or delays.  By contrast, § 6404(a) provides: “The Secretary is authorized to abate the unpaid portion of the assessment of any tax or any liability in respect thereof, which–(1) is excessive in amount, or (2) is assessed after the expiration of the period of limitation properly applicable thereto, or (3) is erroneously or illegally assessed.” While § 6404(a) abatement clearly authorizes abating tax, the IRS agrees that “any liability in respect” of the tax includes interest.

Stephen set out King’s argument and the Tax Court’s resolution of the case:

Mr. King claimed that the interest was excessive because of the various delays created by the IRS.  The Service position on this matter is that “excessive” is essentially a restatement of the third option of “erroneously or illegally assessed.”  The Service has lost on this matter before in the Tax Court in H&H Trim & Upholstry v. Commr, TC Memo 2003-9, and Law offices of Michael BL Hepps v. Comm’r, TC Memo 2005-138, so this is not breaking new ground, but good reinforcement of a taxpayer friendly ruling.  The Tax Court in the previous cases had interpreted “excessive” to “include the concept of unfairness under all of the facts and circumstances.”  A bit broader than simply erroneously or illegally assessed.   In H&H Trim, the taxpayer was able to show the interest would not have accrued “but for” the Services dilly-dallying.  In King, the Service argued that the prior case law was incorrect, but also argued that the taxpayer could have made a voluntary payment to stop the interest and was requesting an installment agreement, which would have incurred interest.  The Court essentially held that the taxpayer showed he would have perfected the installment agreement and paid it the underlying amount more quickly but for the IRS taking its sweet time and failing to follow its own IRM procedures in responding to the taxpayer’s IA request (albeit imperfect), and abatement was therefore appropriate.  As to the voluntary payment, the Tax Court stated that Section 6404(a) has no language barring abatement when a portion of the error or delay could have been attributable to the taxpayer (Section 6404(e) has that language).  Even if the taxpayer could have made the payment, the failure to do so did not alleviate the IRS’s requirement to abate

Seventh Circuit Reverses

In a relatively brief opinion, after getting over a mootness hurdle (King died shortly after the appeal was lodged) the Seventh Circuit reversed the Tax Court, giving three reasons:

The first is the vagueness of “unfairness” as a criterion for abatement; the word is an invitation to arbitrary, protracted, and inconclusive litigation.

Second, extending as it does an invitation to taxpayers to delay paying taxes, the nebulous standard of “unfairness” could result in a significant loss of tax revenues.

And third, we’ll see that the Tax Court’s approach is inconsistent with a valid regulation promulgated by the Treasury Department.

Judge Posner, no fan of vague standards or multiple factors, was explicit in his dislike of using unfairness as a standard and Tax Court precedent that so allowed:

Elaborating the first point briefly, we note the embroidery that the Tax Court, quoting from its earlier opinion in H & H Trim & Upholstery Co. v. Commissioner, T.C. Memo. 2003‐9, at *2, wove into its opinion in the present case on the basis of its touchstone of “unfairness under all of the facts and circumstances”—its belief that the “word ‘excessive’ takes into account the concept of what is fair, or more appropriate here, unfair,” and its approving references to a dictionary’s definition of “excessive” as “whatever notably exceeds the reasonable, usual, proper, necessary, just, or endurable” (what on earth is “endurable” doing in this list?) and to “just” as meaning “equitable” and “equitable” as meaning “fair.” This terminological potpourri can provide no guidance to taxpayers, their advisers, IRS agents, or the Tax Court. It’s a monkey wrench tossed into the machinery of tax collection.

The opinion also has a nod to Chevron and agency deference, as Judge Posner explains in discussing the third reason why the Seventh Circuit thought the Tax Court was wrong:

The Supreme Court has said that “filling gaps in the Internal Revenue Code plainly requires the Treasury Department to make interpretive choices for statutory implementation at least as complex as the ones other agencies must make in administering their statutes.” Mayo Foundation for Medical Education & Research v. United States, 562 U.S. 44, 56 (2011). The interpretive choice in this case is found in the regulation defining the statutory term “excessive in amount” to mean “in excess of the correct tax liability.” 26 C.F.R. § 301.6404–1(a), Treas. Reg. § 301.6404–1(a). As there is no indication that the IRS is misinterpreting its regulation, there is no need for us to consider the possible inroads that recent Supreme Court decisions have made into “Auer deference” (judicial deference to agencies’ interpretations of their own regulations), inroads discussed for example in Michael P. Healy, “The Past, Present and Future of Auer Deference: Mead, Form and Function in Judicial Review of Agency Interpretations of Regulations,” 62 Kansas Law Review 633 (2014).

Some Brief Thoughts

This was a case that mattered a lot to IRS for the broader precedent, as the amount of interest at issue was minimal. As Carl discussed, this case went up to the Seventh Circuit without the benefit of a taxpayer brief or oral argument. Some background on the interest abatement provisions makes this perhaps not as clear as Judge Posner concludes. In 1986, where Congress enacted the first interest abatement provision, Congress wrote then that it intended the provision at subsection (e) to be used in situations where an error or delay in performing a ministerial act resulted in the imposition of interest, and the failure to abate interest “would be widely perceived as grossly unfair”.  S. Rep. 99-313, 1986-3 (Vol. 3) C.B. 1, 208.  Later in 1998, Congress inserted the word “unreasonable” before “error or delay” to provide a judicial review standard, but did not say that the prior legislative history language about unfairness was now obsolete.  Indeed, in King, Judge Posner quoted from H & H Trim, which quoted a dictionary definition of “excessive” as including “whatever notably exceeds the reasonable” (i.e., is unreasonable).

If interpreting “excessive” in 6404(a) as “unfair” would be unworkable, it seems odd that “unfair” is exactly what Congress thought the courts should be looking to as a standard for review of interest abatement cases under Section 6404(e).  If he is correct that “the vagueness of ‘unfairness’ as a criterion for abatement; [is that] the word is an invitation to arbitrary, protracted, and inconclusive litigation”, then perhaps the opinion should discuss how such a criteria has operated for 30 years without a problem to tax administration in Section 6404(e).

It is possible that this is not the last of time we will see this issue. I am aware that practitioners have used an H&H Trim unfairness argument successfully at times with counsel to generate abatements, even on case involving income taxes. We will see whether the Tax Court will stick to its guns on this issue. The Service appeal and victory in this case is a pretty good indicator that the Service is now focused on and opposed to such arguments.

 

Using 20th Century Technology in a 21st Century World: IRS Stops Initiating Contact By Phone on Failure to Deposit Cases

There was a great scene from the TV show Black-ish last season when the stylish and trendy older daughter Zoey (played by Yara Shahidi) decides she has had enough of her brothers’ using her trend-setting ways as a way to get ideas on the next big thing to make money in the stock market. She decides to thwart her brothers’ plans and shun new technology; we see her sitting in a chair reading a print newspaper and making a phone call on a rotary phone. (as an aside, video of this generation of kids trying to use a rotary phone is a good way to spend a few minutes).

The antithesis of successful integration of technology for communication is the IRS. When one looks at tax administration, we see a world where the IRS for the most part operates in a 20th century model. To be sure, IRS has achieved success in getting Americans to e-file (in partnership with the private sector), but as the recent Electronic Tax Administration Advisory Committee report indicated the IRS is “mired in a manual taxpayer service delivery model that relies on interactions using people, paper and phones.” The IRS needs to change the meet the expectations of those who expect to seamlessly communicate while at the same time be sensitive to the needs of those who rely on and may in fact prefer the opportunity for a more personal way to communicate with the IRS.

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The next few years will be important as the IRS tries to shift away from paper and phones and begin providing resources for real time communications with taxpayers (see NTA Objectives Report Focuses on IRS Future State: Some Thoughts on Technology, Participation and Tax Administration). This possible shift is one of the most important developments in tax administration. No doubt it has animated the National Taxpayer Advocate in her efforts to get the IRS to balance its needs for efficiency and the public’s expectation that it can communicate with its citizens in a manner similar to other business interactions with the realities that among other things there is a deep digital divide in our country. This complicates IRS measures to rely heavily on technology for all the programs it administers, especially those like refundable credits where many Americans who claim various credits do not have ready internet access.

One complicating feature that all businesses (and IRS) have come to address is the possibility that bad guys are out to get personal information that would facilitate identity theft and just plain theft. We have discussed identity theft and IRS imposter scams many times as well. In a speech earlier this year the Commissioner said that IRS would not initiate phone calls to taxpayers; that was a big deal because as TIGTA and others have reported there has been a proliferation of IRS imposter phone schemes that have separated many innocents from their money.

Well, it turned out that in some instances IRS did initiate phone calls with Americans. One area was when employers are delinquent with depositing employee income and employment taxes. IRS has been pulling back from that practice, and earlier this month in an IRS Small Business and Self-Employed Division (SB/SE) legal memorandum the Director of Collections Policy indicated that “[i]n response to the continuing threat of phone scams, phishing and identity theft, we are changing our practice of making initial contact on FTD (Failure to Deposit) Alerts by telephone.”

The memorandum provides some additional information, including some templates for letters to use and how the process should work generally:

Field contact is the preferred method of contact on assigned FTD Alerts. However, Revenue Officers retain the discretion to determine the best method of effective initial contact on a case-by-case basis. Effective immediately, all anticipated telephone initial contacts on FTD Alert taxpayers can proceed AFTER a notice is sent to the taxpayer informing them that a Revenue Officer (RO) will contact them by phone within 15- calendar days of receipt of the FTD Alert.

Parting Thoughts

It is not easy trying to administer compliance with FTD penalties, which require a real time interactive experience to prevent the possibility of cascading liabilities. It is even more difficult for an agency stuck in 20th century technology and at the same time combatting 21st century scams. I suspect in about ten years the way the IRS communicates with taxpayers in 2016 will remind us of Lily Tomlin playing Ernestine the telephone operator trying to collect an unpaid phone bill.

Op-Ed: Congress Reaches New Low in Proposed Censure of IRS Commissioner

In today’s post we feature an Op-Ed from Professor Bryan Camp, the George H. Mahon Professor of Law at Texas Tech University School of Law. Professor Camp discusses a proposed Censure resolution pending in the House against IRS Commissioner John Koskinen. While the Republicans have a party platform plank urging impeachment, and while there is an impeachment resolution currently in Committee, the proposed Censure resolution is what is up for action and so is the subject of Camp’s post. Les

This post originally appeared on the Forbes PT site on July 19, 2016.

Procedurally Taxing Op-Ed

Congress Reaches New Low in Proposed Censure of IRS Commissioner

Among the pile of work waiting for Congress to take up in September is a real stinker. It is H. Res. 737, a proposal to censure the current IRS Commissioner John Koskinen. It was voted out of committee on June 15, 2016. Still pending in Committee is a resolution of impeachment, H. Res. 494. Lynnley Browning at Bloomberg has a very interesting review of these measures. And Leandra Lederman has a great summary of the events leading up to them over at Surly Subgroup.

Those who voted for H. Res. 737 are like my son who, when younger, would throw objects across the house in his fits of frustration. The difference, however, is that at least my son was careful to hurl objects that would not do much damage or break. In contrast, H. Res. 737 seeks to throw Commissioner Koskinen across the House and so risks doing great damage to a decent man and risks further breakage to a tax collection agency already weakened by relentless and mindless budget cuts.

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Look, I’m a law professor. I try to teach my students more than just an understanding of the rules relating to taxation. I want them to respect the law-giving authorities, both the Congress that writes the laws and the agency that must administer the laws as written, the IRS.

H. Res. 737 undermines my teachings. The resolution is permeated with pettiness, putrid with peevish odors. In case you think I just like alliteration, let’s take a look at some of the “charges” in the document and you will see what I mean.

The fourth and fifth “Whereas” clauses assert that Mr. Koskinen “failed to live up to the promise” he made at one hearing to “be transparent” because he did not inform the Senate Finance Committee about potentially missing Lerner emails until, at most, four months after he might have known about that particular problem.

In fact, the White Paper attached as Appendix 3 to Mr. Koskinen’s June13, 2014, letter to the Finance Committee spends 9 pages of text and 11 pages of attachments explaining the multiple problems the IRS encountered in recovering emails. To any reasonable person, that’s transparency. There is no accusation that the White Paper lied, or hid information about the problems. And no one contests the basic truths of the White Paper: responding to the Finance Committee’s myriad demands sucked up millions and millions of dollars and human work time that had to be diverted from the agency’s mission. So these particular accusations do not even attempt to accuse Mr. Koskinen of deliberately lying or covering up or hiding or destroying the relevant emails. They cannot. They just accuse him of not being “transparent.”

Not only are these accusations baseless, they’re trashy. The entire reason that Congress even knew about the potentially missing email was because Mr. Koskinen was, in fact, transparent about the email search process and dutifully reported to Congress about several problems in June 2013. He was able to do so, in part, because he consistently attempted to inculcate a sense of duty within the IRS. Rather than hiding problems as the resolution asserts, Mr. Koskinen went to extreme lengths to disclose and explain them.

What seems to affront the sensitive souls of those who voted H. Res. 737 out of committee is that Ms. Lerner’s hard drive crashed in June 2011. They have faith, sure and pure, certain and implacable, that this was no accident and that Lerner was hiding something. I say “faith” because they have no evidence. Even the faith part is shaky: the TIGTA report that started it all (May 14, 2013) shows Lerner had no reason to hide or cover up anything in June 2011. No one was watching or investigating her in June 2011. The entire matter of inappropriate scrutiny of 501(c)(4) applications was still an internal matter. It did not hit the Congressional radar screen (according to the first TIGTA report, on page 3), until the 2012 election cycle. TIGTA began its investigation in June 2012, about a year after Lerner’s hard drive crashed. It sure takes a lot of faith to believe that a hard drive crash in June 2011 was Lerner’s attempt to thwart an investigation that started in June 2012. Gosh, you’d THINK she’d would have at least waited until May 2012 so she could get rid of more stuff…

But those searching for conspiracy have faith. Their faith guides them even a step further into fantasy: since Lerner’s hard drive must have contained incriminating evidence (because it crashed), it follows that the White Paper and Mr. Koskinen’s letter were just covering up the cover-up. You see, a determined and faithful conspiracy theorist is not deterred by a lack of evidence. A lack of evidence just proves a successful cover-up.

So the Senate Finance Committee sent a letter to TIGTA on June 23, 2014, asking TIGTA to (1) try to recover what the IRS could not and (2) investigate whether anyone should be charged for the crime of obstruction of justice.

The result of all this tempest was not even a teaspoon of information.   After more than a year of work, TIGTA issued a report on June 30, 2015. It found no basis for obstruction of justice charges. True, TIGTA found sources overlooked by the IRS, such as loaner laptops, backup tapes stored in weird or forgotten places, and decommissioned email servers stored in closets. In other words, it found that the IRS—big shock here—was a pretty typical government bureaucracy filled with imperfect humans. All told, TIGTA reported that it found some 83 million unsearched emails on these new sources. That sounds like a lot…until you check your spam box. Of those 83 million, TIGTA found only 1,330 emails, linked to Lerner in some way, that were not among the 67,000 Lerner emails the IRS previously provided. Were any of these 1,330 emails from her busted hard drive, or were they emails that had been otherwise overlooked? The report does not specify.

And what did the Committee learn from these 1,330 additional emails? Squat. There was no evidence that any of these missing emails were in any way relevant to the original investigation. That is because the Senate Finance Committee had changed up its demands on the IRS. Up until early 2014, the IRS had worked hard to provide emails and other documents relative to the Committee’s original investigation of inappropriate scrutiny of 501(c)(4) applications from conservative groups. That is what Mr. Koskinen describes in his June 13, 2014, letter. But as the White Paper explains on pages 5-6, in early 2014 the Committee directed the IRS to re-do all the work it had already done and this time bring the committee any and all emails related to Ms. Lerner, regardless of their subject or content. Since what the IRS had produced had not given the Committee a basis for criminal charges, that just meant—to the faithful—that the IRS needed to be more forthcoming. The accusations in H. Res. 737 are all about Mr. Koskinen’s so-called failure to “obey” this expanded search command, issued in the form of a subpoena on February 14, 2014.

So, yea! here were a bunch of emails that IRS missed and TIGTA found. But none of them appear to have been relevant to the Committee’s original investigation; they simply were within the scope of its later demand for all of emails that were either to or from (or merely copied) Lois Lerner.

This does not deter the faithful who voted H. Res. 737 out of committee. Like my petulant son, they want to punish Mr. Koskinen for failing to give them what they were sure existed. He denied their faith. So they accuse him of failing to be “transparent.” It’s a silly, stupid, sad accusation that has no merit.

H. Res. 737 contains more accusations, all equally vapid. Later accusations claim Mr. Koskinen made a “series of false and misleading statements.” Why? Because certain statements he made turn out to be incorrect. The accusations really just accuse Mr. Koskinen of failing to be omniscient. All the statements that H. Res. 737 labels as “lies” and “false statements” are simply the result of normal information limitations in a bureaucracy.   If one put the phrase “to the best of by knowledge” or “to the best of my ability” before each of the alleged false statements, they would no longer be false. The “falsity” of the statements arises only from events beyond Mr. Koskinen’s control or knowledge.

For example, H. Res. 737 accuses Mr. Koskinen of lying when he testified that the IRS had ‘‘confirmed that backup tapes from 2011 no longer existed because they have been recycled, pursuant to the Internal Revenue Service normal policy’’ and that ‘‘confirmed means that somebody went back and looked and made sure that in fact any backup tapes that had existed had been recycled.” If one puts the phrase “to the best of my knowledge” in front of these statements, they are no longer false. TIGTA’s investigation showed the statements to be false only in the sense of being incorrect, not in the sense of Mr. Koskinen being aware at that time that they were incorrect. Yep, some back up tapes did still exist in some closet even as Mr. Koskinen was claiming they did not. So Koskinen was wrong about that, but he was correct in the destruction was, at that time, the IRS normal policy and he was correct in that “somebody” had looked and not found the tapes. That’s what he knew. That’s what he testified to: the best of his knowledge. This is all in the TIGTA report.

So, yeah, Mr. Koskinen was not omniscient. But his statement was to the best of his knowledge and it’s his knowledge that turns out to have been imperfect. In fact, when the Inspector General himself testified in 2015 about his agency’s findings, one Congressman urged him to describe how often IRS employees were not cooperating. The Inspector’s response was “Very rarely, especially, in all candor, under the current Commissioner. He’s been extraordinarily cooperative.”

The Inspector went on to point out that while IRS employees were cooperative in responding to authorized requests, they were not good at sharing information outside the specific boundaries of his investigation. In his words: “so they were not compelled to provide us that information, but they neglected to.” What the Inspector did not say, however, was that IRS employees can be criminally charged under IRC § 7213 if they disclose information outside of a lawful request. Conviction is a felony punishable by up to 5 years in the slammer. If you had THAT hanging over your head, you’d probably make the choice to stick to disclosing the information requested and not volunteer.

H. Res. 737 is a petty product of petulance. I’ve watched Mr. Koskinen testify at several hearings and what I have seen is grace under pressure. He came out of retirement at age 74 to volunteer for his country. I would like to see any one of the yahoos who voted H. Res. 737 out of committee step up and volunteer to manage the IRS when they turn 74. Wait…no…on second thought, given how they have mangled their oversight duties, that is not a sight I hope to see.

I sincerely hope that when Congress re-convenes in September, the House will treat H. Res. 737 like the garbage it is and throw it away.

Postscript: I very much appreciate the support I received from the following fellow tax profs who were kind enough to review an earlier draft: Richard Winchester (Thomas Jefferson School of Law); Roberta Mann (University of Oregon School of Law); Leandra Lederman (Indiana University Maurer School of Law); Lisa Milot (University of Georgia School of Law); Tracy Kaye (Seton Hall University School of Law). Readers, if you find errors, don’t blame these folks; it’s my fault and not theirs! Finally, please remember that I here express my personal views and am not writing on behalf of Texas Tech University School of Law. -BTC

 

 

On Offsets and Posted Dates

We welcome guest blogger Caleb Smith.  Caleb has worked on tax returns and tax transcript issues for several years.  Before law school he worked for Prepare and Prosper as a Tax Program Manager for their VITA program.  At Lewis and Clark Law School he participated in the excellent low income taxpayer clinic there run by my former colleague, Jan Pierce.  Most recently Caleb has been working at Mid-Minnesota Legal Aid in their tax clinic.  Next month he will join me as the new fellow at the Harvard Tax Clinic.  Keith

When is an offset not a § 6402 offset? After the recent Tax Court memorandum opinion, Luque v. Commissioner, the answer seems to be only “when the offset didn’t actually happen.” And because of the nearly wholesale prohibition on Tax Court review of § 6402 offsets codified at § 6512(b)(4), checking to see if the offset actually happened is about as far as the court will go. The opinion serves as an illustration of the pitfalls many taxpayers face in getting to court, while also offering a look into the arcana of IRS transcript posted dates. Indeed, this latter endeavor appears to be the main objective of Judge Halpern in issuing the opinion.

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The facts of the case are fairly commonplace: taxpayer files a 2011 return showing a refund and the refund is credited in its entirety against a 2009 tax liability. In this instance, after the refund was credited the IRS issued a NOD for 2011, thus allowing the taxpayer into Court to argue (1) that the offset did not arise under § 6402 and (2), even if it did, the offset never actually was credited to 2009.

Prior to issuing the opinion the Court had essentially dashed the hopes that the liability giving rise to the offset, the 2009 liability, could be reviewed (i.e. didn’t arise under § 6402) in an earlier court order. It could be noted that the judge issuing the opinion, Judge Halpern, has been involved with previous cases questioning what is and is not an offset (found here with more insight on the matter provided by the First Circuit in appeal found here). But even though the Tax Court cannot “restrain or review” a § 6402 offset by examining if the taxpayer really owes the taxes being paid through the offset under § 6512(b)(4), Judge Halpern noted that it can look to see if the offset actually happened.

As this is usually a fairly straightforward inquiry (either the taxpayer had funds credited to a prior year or they didn’t), the import of the opinion seems to be elsewhere. Indeed, what appears to motivate the Court was the educational opportunity for tax practitioners in better understanding how IRS official records work. Judge Halpern almost explicitly acknowledges this rationale:

“On March 29, 2016, we issued an order concerning the motions in which we addressed and rejected petitioners’ jurisdictional argument. We, did not, however, dispose of the motions. Instead, we ordered respondent to address seeming anomalies between his representations and entries on the official records he submitted in support of his motion. Because there may be general interest in respondent’s reconciliation of those seeming anomalies […] we use this opportunity to make that reconciliation public.” [Emphasis added.] Luque at *3 – 4.

I’ll admit that as someone who frequently pores over IRS transcripts I counted myself as an enthusiastic member of the “general interest” Judge Halpern referred to. And yet, after reading the opinion, I couldn’t help but feel that the more important aspects of the decision remained elsewhere. But more on that later.

My naïve hope was that the opinion would give more insight on the meaning of IRS transaction codes. In my experience, the codes can be extraordinarily misleading or arbitrary. As one example, the notation “additional tax assessed” often does not mean that additional (i.e. “more”) tax was assessed, or even that any assessment action took place at that time. I have had one IRS employee tell me over the phone that the “additional tax assessed” transaction code is sometimes used as a “placeholder” just to show that some action was taken on the account… even where clearly no assessment action took place because the ASED had run years ago and the balance continued to show $0. The mind fairly boggles.

The opinion did not much address such things. However, if you are looking for insight on posted dates and cycle numbers you are in luck. I won’t spoil you with the mechanics (some may say, minutia) of their complete inner workings. You can read that for yourself at pages *12 – 14. I will, however, provide the general take-away points.

First of all, a “posted date” is the effective date of the transaction, which is either the actual date the transaction processing was finalized or the date it is deemed to have occurred by law (like withholding always being credited as paid on the last day to timely file). Meanwhile, a “cycle number” pertains to the dates the IRS actually processed the transaction. In the transcripts that are readily available to taxpayers and practitioners, the “cycle number” field is often left blank. This has never bothered me much because on the account transcript alone the cycle number is mostly useless: it leads off with a year (e.g. 2012) and ends with a number that appears to mean nothing. In Luque, for example, the cycle number was 201219, which corresponded to transactions taking place in 2012 over the month of… May. The 19, as far as I can tell, only has meaning if you have access to an IRS list of 2012 cycle numbers with their corresponding dates, as the IRS Appeals Officer does. With access to that list, you can then glean when the transaction was actually processed by the IRS: a three-step procedure concluding, in most cases, with the effective “posting date” (see above) unless there is an otherwise designated effective date.

This is all to say that cycle numbers are unlikely to matter much unless you are playing a game of inches (likely in a statute of limitations scenario). It also serves as a reminder that the law has numerous artificial constructs for when something is deemed to have actually taken place (like when you are deemed to have paid in withholding). Reconciling anomalies in these dates on the IRS records (when the return was filed, when the return was processed, and when the withholding was credited) was the reason the Court felt the matter was not resolved simply by saying “it was a § 6402 offset, and we have no jurisdiction to review those.”

Yet I am actually not convinced that the timing matters so much as to warrant much inquiry in this case. If the IRS can show that the 2009 liability on the books is $4,223 less (the amount of the 2011 credit), can a slight discrepancy in dates really do so much as to call into question if an offset actually occurred at all? Judge Halpern almost acknowledges as much, stating “Although the question of whether the overpayment reported on petitioners’ 2011 return was credited to their 2009 account is more important than precisely when that credit was allowed, the ambiguity in the dates […] called into question the reliability of the respondent’s certifications as evidence that the credit was, in fact, allowed.” Luque at *9. [Emphasis in original.] Of course, the exact date matters quite a bit if the liability causing the offset may have had the CSED run (or if the date to file a refund claim is close). But those issues both involve investigating the propriety of the offset: something § 6412(b)(4) does not allow. The date the offset occurred is essentially moot as far as the Tax Court should be concerned. It may matter, but it would presumably be litigated in a refund suit in district court.

And there, I think, is the lesson behind the opinion: what would be the victory to the taxpayer if the Court found the records so shoddy as to hold that an offset didn’t occur? I imagine the Court could find that the taxpayer is due that amount… which the IRS could promptly credit as an offset. For the Tax Court to do anything else (that is, compel the IRS not to offset) would be a violation of both § 6512(b)(4) and § 6402 since the choice to offset is committed to the IRS’s discretion. Thus, as Judge Halpern intimated, the greater point of the opinion may well be the education of taxpayers and (more likely) practitioners on the mysteries of IRS transcripts such that the issue can be resolved administratively when errors do arise. Failure to actually credit an offset certainly seems to be in the province of TAS, and a tax practitioner is better able to see when such errors arise (or don’t arise) if they have greater knowledge of the transcripts showing them. Indeed, in most cases it is doubtful that the Tax Court will even be able to review if an offset occurred: Luque was fortuitous in that both offset and NOD (i.e. ticket to tax court) occurred for the same tax year.

And that, in turn, allows us to close on what I believe to be the most important point is lurking behind this all: the difficulties of getting to court at all if you are low-income seeking to challenge an ancient, but sizeable, tax debt. Under § 6512(b)(4) when an offset occurs, the taxpayer better look elsewhere than Tax Court to challenge the propriety of the offset. That “elsewhere” is a refund action in federal district court. At least, it ought to be. The restrictions of Flora’s full-pay rule (discussed, among other times, here and here) and § 6512(b)(4) means that when a taxpayer has a substantial past tax debt that current year refunds will never full pay, the taxpayer can pretty much count on losing a refund they may desperately need for the foreseeable future. (Practitioners, of course, should be aware that the IRS offset for past federal income taxes is discretionary, and would do well to acquaint themselves with Offset-Bypass Procedures, discussed here in cases where the taxpayer is suffering hardship.)

Thus, under Flora and § 6512(b)(4), an offset applied to what may well be an inflated underlying liability will continue to haunt the taxpayer with little chance for judicial review. In such situations, the law seems to give short shrift to the right of the taxpayer to “pay no more than the correct amount.” The statutes as written give the Tax Court no power other than to ensure that at least the offset is properly credited to the earlier year… or give us practitioners the tools to read the transcripts and determine exactly when that happened for ourselves.

 

Federal Circuit takes Wells Fargo Stage Coach Down the Middle Path – “Same Taxpayer” for Interest Netting in Corporate Mergers

Just about two years ago, I wrote about the Court of Federal Claims holding in Wells Fargo v. United States, which can be found here.  The government took the case on appeal to the Federal Circuit, which handed down a very important decision regarding interest netting in the context of corporate mergers.  We discuss the ways the courts and IRS have wrestled with the netting rules in the updated Saltz/Book chapter 6, which  I recently revised and updated to include the latest developments, including the lower court holding (and, imminently, this holding).  A few other online outlets have covered this, but I think it is still worth adding our thoughts, even if a few weeks late.

The Federal Circuit’s holding was not as taxpayer friendly as the Court of Federal Claims holding, but it still is significantly better, and I believe more sound, than the IRS position on the matter.  I’ve recreated a bit of my prior post as background, which will be followed with a discussion of the Federal Circuit’s holding, including some helpful stripped down examples from the holding as to how the netting works:

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The Facts – Together we’ll go far…to get some tax benefits.

So, this case involves bank mergers (and lots of them) that Wells Fargo has been involved with over the last 15 years; all of which were statutory mergers.  Following the actual mergers is a little confusing, and the specifics of those mergers are not that important to the holding [sjo updated note: this statement is less true with the Federal Circuit holding, as you will see below].   What does matter is the issue, as stated by the Court, which was:

It concerns whether plaintiff…Wells Fargo…is entitled to net the interest paid on certain tax underpayments owed by Wells Fargo or its predecessor…First Union…, with the interest owed by the United States to Wells Fargo on overpayments made by First Union or other companies acquired by Wells Fargo through various corporate mergers.

Positions and the law.

Section 6621(d) was enacted in 1998 to allow overpayment and underpayment interest rates to be netted against each other at a zero percent interest rate when the “same taxpayer” has overpayments and underpayments of tax.  Corporate overpayments and underpayments, otherwise, would be at different rates.  The key issue before the court was the definition of “same taxpayer”.

Wells Fargo argued that the “same taxpayer” was both the predecessors and the surviving corporation of statutory mergers, so that the surviving entity could benefit from the tax attributes of all prior corporations.  The IRS argued for a more narrow view of “same taxpayer”, stating that a taxpayer is only the same if it has the same taxpayer identification number before and after the merger.

The Service had previously been successful with this position in Magma Power and Energy East, and had repeatedly taken this position in rulings and Counsel Advice.

And the Court of Federal Claims says…

The Court of Federal Claims took the taxpayer friendly, and I believe correct, approach to the issue, and held that a TIN is not fully determinative of legal status in the merger context.  The Court stated that because Energy East and Magma involved fully separate but affiliated corporations, they did not control the Wells Fargo case.  The Court further stated:

In a merger, the acquired and acquiring corporations have no post-merger existence beyond the surviving corporation; instead, they become one and the same by operation of law, and thereafter the surviving corporation is liable for the pre-merger tax payments of both the acquired and acquiring corporations.

As stated above, this went to the Federal Circuit, which affirmed the Court of Federal Claims in part and reversed in part.  As a brief summary, the Federal Circuit held TINs were not determinative, and neither was the fact that the two entities became one eventually. The key to the Federal Circuit was the timing of when the underpayment and overpayment occurred, which it indicated was the actual holding of Energy East.

The parties to the case agreed to three specific fact patterns, which the Court included in its holding.  I have taken out the specific names, but you can find those names and graphical reproductions of the same in the holding.  I think these will be helpful in explaining the holding.  The examples are:

  1. In 1993, Company A had an overpayment. In 1999, Company B had an underpayment.  In 2001, Companies A and B merged pursuant to a statutory merger under Section 368(a)(1)(A).
  2. In 1993, Company A had an overpayment. Between 1993 and 1999, Company A merged with four other companies under Section 368(a)(1)(A) and (2)(D).  Company A survived in each merger, and in 1999 had an underpayment.
  3. In 1992, Company A had an overpayment. In 1998, Company A merged with Company B under Section 368(a)(1)(A). In 1999, Company B, the surviving company, made an underpayment.

Each party largely advocated the same positions, although Wells Fargo incorporated much of the Federal Claims holding into its arguments.  Based on the TIN argument advanced by the Service, the Service conceded interest netting in example two above, leaving only examples one and three.

The Federal Circuit held that interest netting would not apply in example one, but it would in example three.   The Federal Circuit looked to its holding in Energy East for the analysis of the statute regarding the timing.  It stated the fact that “different corporations” generated the overpayment and underpayment was of less importance…depending on the timing.  Under Section 6621(d) the Court highlighted the language, “for any period…interest is payable…on equivalent underpayments and overpayments by the same taxpayer…”   Meaning, the two entities could not have been separate in the period where the underpayment and overpayment were generated subsequently brought together, but could be different if the sequence was the merger occurring prior to the later underpayment or overpayment.

The Federal Circuit held in example 1 above, Company A and Company B had their overpayment and underpayment each separately prior to the merger, when each was a distinct taxpayer.  In this instance, “the payments were both made before the merger, and thus the payments were made by two separate corporations…[and] do not meet the “same taxpayer” requirement under [Section] 6621(d).”  The subsequent unity does not invalidate the required timing to the Federal Circuit.

The holding in example 3 provided the most interesting analysis.  The question boiled down to whether pre-merger A was the “same taxpayer” as post-merger B,  more akin to Wells Fargo’s general position.  This analysis followed somewhat the Court of Federal Claims’ holding.  The Federal Circuit found that the legislative history, tax treatment in similar situations, and general laws of mergers leaned in favor of treating the acquired corporation being “absorbed” by the continuing one and stepping into its shoes.  This allowed the treatment as the same taxpayer for later underpayments/overpayments.  Company A had an underpayment, was then absorbed by Company B, which then had an underpayment – same taxpayer due to merger.

This is a very technical argument, and it will be interesting to see if the Service continues the TIN argument in other courts, as it has not met with much success and the Federal Circuit is fairly influential.  It is also interesting why, based on the holding in three, the eventual unity doesn’t cause the netting from the time of merger forward but not prior periods (perhaps it does, and I misunderstood the holding).  In any event, all corporations that have engaged in mergers should be going through and making sure interest netting has occurred in a minimum under examples two and three above (and possibly one if you are in a different circuit and like litigating).

Passing of the Honorable Howard Dawson, Jr.

Our condolences to the family and friends of Tax Court Judge Howard Dawson, who passed away on July 15th. Judge Dawson devoted a substantial portion of his career and life to the administration of the tax system, and was the longest serving Tax Court Judge.  Judge Dawson was appointed in 1962 by JFK, and was amazingly still hearing and deciding cases this year.

The entire Tax Court announcement regarding Judge Dawson’s  illustrious career can be found here.  We are grateful for his service and many, many contributions and achievements.

Administrative Law Grab Bag: Chevron and State Farm Developments

Last week’s post Treasury on the Right Side of the APA in Altera highlighted the importance of administrative law generally as well as some landmark cases such as Chevron and State Farm. In today’s post I offer some general developments on both Chevron and State Farm, one in the form of proposed legislation that if enacted would overrule Chevron and shift the power to interpret statutes from agencies to courts. The other is a Supreme Court decision from late June that elaborated on State Farm in a way that may have specific relevance for challenges to Treasury regulations when parties allege that Treasury has failed to adequately explain its reasons for promulgating regulations.

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First some background. As most tax people know in the post-Mayo world, Chevron provides a two-step inquiry for reviewing agency interpretations of statutes that is easy to state but challenging to apply. Under Chevron the court first (under Step 1) determines if Congress directly spoke to the question at issue. If a court finds that Congress did, then the court defers to the statute and the agency’s interpretation falls if it is inconsistent with the statutory language. If Congress did not address the issue in question in the statute itself or if the language is ambiguous then the inquiry (under Step 2) is whether the agency’s answer is based on a “permissible” construction of the statute. A permissible construction is one that is not “arbitrary, capricious, or manifestly contrary to the statute.” If it is permissible then the court defers to the agency.

In PT we have also discussed principles relating to State Farm, issues that are front and center in the Altera dispute. As Pat Smith discussed for us in his post discussing the IRS’s Altera defeat, “[u]nder the Supreme Court’s landmark 1983 State Farm decision, in order for agency action to satisfy the arbitrary and capricious standard, the agency action must be the product of “reasoned decision-making,” and the agency must, at the time it takes the action being reviewed, provide a reasoned explanation for why it made the particular decision it did.”

Proposed Legislation on Chevron

Last week the House passed the Separation of Powers Restoration Act, a bill that if enacted would overturn Chevron and amend the APA to provide that courts review “de novo all relevant questions of law, including the interpretation of constitutional and statutory provisions and rules.” The legislation is the product of efforts of the Article I Project, a network of House and Senate legislators that describes itself as working on a “new agenda of government reform and congressional rehabilitation.” The Article I Project Web Page states that its mission is to “develop, advance, and ultimately enact an agenda of structural reforms to strengthen Congress by reclaiming its constitutional legislative powers that today are being improperly exercised by the Executive Branch.”

Republican Congressman John Ratcliffe of Texas is the sponsor of the legislation in the House. He has a post in the Hill Separation of Powers Restoration Act Key to Rebalancing Government describing the legislation:

This critical measure reverses the 1984 Supreme Court decision that established the “Chevron doctrine,” placing the power to determine ambiguous laws back into the hands of the Judiciary. This would help stop future abuse of power by preventing administrative agencies from establishing regulations with the intent of leveraging the “Chevron doctrine” to implement them however they so choose, fully free from judicial review. Instead, agencies will be forced to adhere to the courts’ interpretation of the laws they implement – keeping them from “grading their own papers,” as they’re allowed under the “Chevron doctrine.”

There is also a Senate version of the bill (co-sponsored by Senators Hatch, Lee and Grassley) though that has yet to move out of committee. An article in the Dallas Morning News indicates that the President would veto this bill if it came to his desk.

Does Chevron Make a Difference?

Does Chevron deference make a difference in agency outcomes in court? In a working paper called Chevron Deference and the Courts Professor Kent Barnett of University of Georgia Law School and Professor (and former PT guest blogger) Christopher Walker from Ohio State Moritz College of Law suggest that it does. They looked at every published decision citing Chevron in a ten year period and “found that the circuit courts overall upheld 71% of interpretations and applied Chevron deference 75% of the time. But there was nearly a twenty-five percentage-point difference in agency-win rates when the circuit courts applied Chevron deference than when they did not.”

The study found differences across circuits and a difference between Supreme Court and circuit court outcomes, with the authors concluding that Chevron may not have as much of an effect on agency outcomes at the Supreme Court but that it may be “an effective tool to supervise lower courts’ review of agency statutory interpretations.”

Supreme Court Developments on State Farm

So while there are some rumblings in Congress to overturn Chevron, there are some preliminary questions that arise before one gets into the Chevron inquiry. For example, what has been called Chevron Step Zero asks whether Congress intended to defer to agencies in the first place. To that end if issues implicated are extraordinary and of great importance, as in King v Burwell last year (involving the IRS’s regulatory definition of exchanges for purposes of tax credits), the courts may conclude that the issue is one that Congress did not intend for agencies to play a role in filling statutory gaps. The upshot in those cases is that courts take a de novo crack at the statute in the manner that the Separation of Powers Act legislation proposes.

Another of those preliminary questions presents itself in the Supreme Court case Encino Motorcars v Navarro, decided this past June. Bloggers and law profs Michael Pollock and Daniel Hemel at the Notice & Comment blog discuss the Encino Motorcar case and its relationship to general administrative law principles in the post Chevron Step .5 Their post is terrific. I highly recommend that readers with an interest in the area read the whole post, though I hit some of the high points here.

The Encino case involved Labor Department rules that provided that service employees at car dealers were entitled to overtime pay. The service employees sued the car dealers asking for overtime; the dealers claimed that Department of Labor failed to adequately explain why it changed its mind and promulgated rules that said that service employees at car dealers were not exempt from overtime pay (a statute exempts overtime for “any salesman, partsman, or mechanic primarily engaged in selling or servicing automobiles, trucks, or farm implements, if he is employed by a nonmanufacturing establishment primarily engaged in the business of selling such vehicles or implements to ultimate purchasers.”). The Labor Department had gone back and forth on the issue for decades and in 2011 took the view that service employees were not exempt from overtime.

The 9th Circuit applied a traditional two step Chevron inquiry and found that the statute was ambiguous (Step 1) and the agency’s interpretation was reasonable (Step 2). In Encino Motorcars the Supreme Court stated that the Labor Department failed to explain its reasons in coming up with its 2011 rules, remanding the case back to the 9th Circuit to interpret the statute:

One of the basic procedural requirements of administrative rulemaking is that an agency must give adequate reasons for its decisions. The agency “must examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choice made.” Motor Vehicle Mfrs. Assn. of United States, Inc. v. State Farm Mut. Automobile Ins. Co., 463 U. S. 29, 43 (1983) . . . .

Applying those principles here, the unavoidable conclusion is that the 2011 regulation was issued without the reasoned explanation that was required in light of the Department’s change in position and the significant reliance interests involved. In promulgating the 2011 regulation, the Department offered barely any explanation. . . . This lack of reasoned explication for a regulation that is inconsistent with the Department’s longstanding earlier position results in a rule that cannot carry the force of law. See 5 U.S.C. § 706(2)(A); State Farm, supra, at 42-43. It follows that this regulation does not receive Chevron deference in the interpretation of the relevant statute.

How does this relate to Chevron and State Farm? Using a helpful example, bloggers Pollock and Hemel suggest that there is a preliminary step that arises prior to the two-step Chevron test and after Step Zero, a Chevron “.5” step:

To put the point starkly, imagine an agency had been granted the authority to engage in notice-and-comment rulemaking and wrote a new regulation (on a matter within its jurisdiction and expertise) on the back of a napkin nailed to a signpost outside the White House. The regulation contains an interpretation of an ambiguous statutory provision, again within the agency’s jurisdiction. If that agency then claimed its interpretation written on that napkin was entitled to Chevron deference, it would (we think) be laughed out of court. But why? Congress intended for the agency to fill gaps in the statute (Chevron step zero) and the statute is indeed ambiguous (Chevron step one). Suppose, too, that the interpretation adopted by the agency on the napkin is entirely reasonable (indeed, maybe even the best reading of the statute), and that the agency actually explained its reasoning quite thoroughly despite the napkin’s surface-area limits. So the interpretation should pass muster at Chevron step two—and would even satisfy State Farm’s reason-giving requirement. But no one (we don’t think) believes that an agency can get Chevron deference for a position taken on a napkin. Why not? Because the agency failed to follow the proper procedure for exercising its gap-filling authority. The napkin rule flunks at Chevron step 0.5.

The post goes on to explain why it is likely that winning a Step .5 challenge does not automatically result in a victory, as agency interpretations will still be given heightened (though not quite Chevron) deference under Skidmore, where the weight of an agency interpretation “depend[s] upon the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control.” Skidmore, 323 U.S. 134, 140 (1944)).

Moreover, using some administrative law acrobatics, the post explains why in many other challenges involving a party bringing an action against an agency (except tax cases), courts generally resolve procedural defects such not under this type of Step .5 analysis but under the APA itself.

Some Parting Thoughts

A decade or so ago there were only a handful of tax cases that leaned on administrative law principles. Now, litigants look to administrative law and its complexities as a principal means of attacking IRS and Treasury actions. No doubt that Treasury and IRS are deeply aware of the administrative law sharks circling agency actions; the extensive discussion of comments in the preamble to Treasury’s recently promulgated regulations under Section 7602 addressing the use of private contractors to assist in interviewing summoned witnesses reflects that sensitivity (note Keith commented on those regs last week in Tax Notes; a free link is not available).

With Altera and other cases teeing up an application of some basic administrative law principles in the tax context, and many other cases in the pipeline where litigants are looking to administrative law principles to challenge IRS rulemaking and other practices we will likely see many more cases and posts in PT struggling to come to terms with how tax cases fit in with the many nuances of administrative law.

UPDATE 7.18 10:30 PM: Florida State’s Steve Johnson has written a taxprof blog Op-Ed on the proposed legislation. It raises some questions in the event of passage (unlikely at least for now as Steve acknowledges) and is full of good references to other works and Steve’s prolific writings on Chevron and related topics over the years. It does a nice job as well situating Steve’s support for dispensing with Chevron.

Ninth Circuit Reenters the Late-Filed-Return Field

On Wednesday I quickly put up a copy of the opinion in Smith with the promise of further discussion.  Today, we are fortunate to have commentary on the case by guest blogger Ken Weil.  Ken blogged with us earlier this year on George Washington’s birthday.  Ken has his own practice in Seattle that focuses on representing individuals with tax debt and resolving that debt through administrative action with the IRS or through bankruptcy. He has written a book on his specialty area, Weil, Taxes and Bankruptcy, (CCH IntelliConnect Service Online Only) (3d ed. 2014). He is a one of the top experts at the crossroads of personal bankruptcy and taxes. We are fortunate to have him back with us again. Keith

Case law continues percolating in the late-filed-return field.  On July 13, the Ninth Circuit decided Smith v. United States (In re Smith), No. 14-15857, Pacer Docket Entry 51. (9th Cir. 2016).  In Smith, the Ninth Circuit reaffirmed its position that, even after the bankruptcy law changed in 2005, a subjective test is still applied to determine whether a document filed by a taxpayer is an honest and reasonable attempt to comply with the tax law.  Smith, supra at p.7; and see, Beard v. Comm’r, 82 T.C. 766, 775-778 (1984), aff’d, 793 F.2d 139 (6th Cir. 1986) (four-part test used to determine whether the document in question is a valid tax return; one of the four parts is whether the taxpayer made an honest and reasonable attempt to comply with the tax law).  This blog piece discusses the subjective and objective tests as methods for determining whether a taxpayer made an honest and reasonable attempt to comply with the law, the previous confusion surrounding the Ninth Circuit’s leading case in the area, the Smith decision, and the interaction of Smith with an earlier 2016 Ninth Circuit Bankruptcy Appellate Panel (BAP) case that rejected application of the one-day-late rule.

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Subjective and objective tests.

Mr. Smith filed his 2001 tax document seven years after it was due and three years after the IRS assessed tax due.  Smith, supra at p.7.  In affirming the district court’s determination that Mr. Smith had not made an honest and reasonable attempt to comply with the tax law, the Ninth Circuit held that United States v. Hatton (In re Hatton), 220 F.3d 1057 (9th Cir. 2000) still applied even after the 2005 Bankruptcy Code amendments.  Smith, supra at p.7.  Hatton used a subjective test and not an objective test to determine whether a document would pass the honest and reasonableness prong of the Beard test.  Under the subjective test, one looks beyond the four corners of the document to determine whether the taxpayer has made an honest and reasonable attempt to comply with the law.  Prior to Smith, the most recent circuit court to look beyond the four corners of the document was the Eleventh, which was blogged hereJustice v. United States (In re Justice), 817 F.3d 738 (11th Cir. 2016).  The objective test limits the applicable inquiry to the four corners of the filed document to determine whether it qualifies as a return.  The leading case in support of the objective test remains Colsen v. United States, 446 F.3d 836 (8th Cir. 2006).  The use of the terms “subjective test” and “objective test” are co-opted, at least in part, from Martin v. United States (In re Martin), 542 B.R. 479, 482 (9th Cir. B.A.P. 2015)(blogged here)(Hindenlang is broad in scope and takes at least a partially subjective focus; the test used by the bankruptcy court was narrow in scope and exclusively objective in focus) and Colsen, 446 F.3d at 840.

Confusion with Hatton.

Hatton had made for somewhat confusing precedent.  In Hatton, the taxpayer flunked two prongs of the Beard test.  The document purporting to be a return was not filed under penalty of perjury and it was filed very late and only after collection pressure from the IRS so that it flunked the subjective test.  Did this dual failure mean that there was still room for the objective test in the Ninth Circuit, especially since the Ninth Circuit BAP had previously applied the objective test?  United States v. Nunez (In re Nunez), 232 B.R. 778 (9th Cir. B.A.P. 1999) (applying the objective test).  Martin, 542 B.R. at 490 swept away any remaining confusion.  It stated clearly that both Hatton reasons for rejecting the document as a return had to be given equal consideration:  “When alternate grounds are given for a holding, neither ground constitutes non-binding dicta.”  Id. (citation omitted).  Martin then applied the subjective test and found the document in question was not an honest and reasonable attempt to comply with the law.  The alternate-grounds rule is also helpful in understanding Smith.  As will be seen in the following paragraphs, the Ninth Circuit was careful to limit its holding to one reason.

The decision in Smith, and, the Court’s refusal to address ancillary arguments.

Like Martin, Smith applied the subjective test.  It held “that Hatton applies to the bankruptcy code as amended….”  Id. at p.7.  The court observed that two Circuit courts, the Tax Court, and both parties all agreed the four-factor Beard test still applied after that the new definition of return in § 523(a)(*) was added to the Bankruptcy Code.  Id. at p.5.  Mr. Smith’s delay in filing made it an easy decision for the court to affirm the district court’s ruling that the tax was nondischargeable.  See, id. at p.6 (“these are not close facts”).  Although it agreed with Martin, Smith never cited Martin.  The failure to cite Martin is an interesting choice, and, this omission is discussed again under the one-day-late rule below.

In Smith, the government argued, as it almost always does, for a per se rule.  The per se rule states that any document filed after the IRS assessment is not a document that will qualify as a return.  The leading case supporting the per se rule is United States v. Hindenlang (In re Hindenlang), 164 F.3d 1029 (6th Cir. 1999).  The Smith Court felt the facts before it were overwhelming, and, it did not need to answer the government’s per se argument.  “We need not decide the close question of whether any post-assessment filing could be ‘honest and reasonable’ because these are not close facts.”  Smith, supra, at p.6 (emphasis in original).  Thus, the government’s per se argument was set aside for now.

Because it held the purported document was not a return, the Court also declined to address the government’s argument that the tax was not associated with a return.  The government had argued that a return was not filed when it assessed the deficiency.  Id. at p.7, n.1; and see, 11 U.S.C. § 523(a)(1)(B) (tax for respect to which a return is made).  Martin addressed this issue, basically stating that the government’s argument proves too much.  Tax debt arises under bankruptcy law at the end of the applicable tax year and almost always exists before an assessment is made and even before a return is filed.  Martin, 542 B.R. at 491.

Impact of Smith on the one-day-late rule in the Ninth Circuit.

The facts in Martin are similar to the facts in Smith, i.e., tax documents filed only after an IRS audit and assessment.  Unlike Smith, Martin addressed the one-day-late rule, and, it rejected the one-day-late rule with a persuasive attack on its underpinnings.  Martin, 542 B.R. at 483-489.

Practitioners in the Ninth Circuit should be acutely aware of the First, Fifth, and Tenth Circuit decisions in support of the one-day-late rule.  McCoy v. Miss. State Tax Comm’n (In re McCoy), 666 F.3d 924 (5th Cir. 2012); Mallo v. IRS (In re Mallo), 774 F.3d 1313 (10th Cir. 2014); and Fahey v. Mass. Dep’t of Rev. (In re Fahey), 779 F.3d 1 (1st Cir. 2015).  Those cases apply the “applicable filing requirements” language of 11 U.S.C. § 523(a)(*) to mean that a return filed late, even by one second, is not a valid return for bankruptcy purposes.  It is clear that the Smith panel purposely side-stepped the one-day-late rule.  The one-day-late rule is never mentioned in the opinion.  This also means Martin’s persuasive attack on the one-day-late rule is also not mentioned.  (And, yes, I understand that the government did not advocate for it.)

In the Ninth Circuit, although BAP decisions are not binding, they are persuasive and generally held in high regard.  State Compensation Ins. Fund v. Zamora (In re Silverman), 616 F.3d 1001, 1005, n.1 (9th Cir. 2010) (Ninth Circuit has never held that bankruptcy courts are bound by BAP decisions, but, BAP opinions are treated as persuasive authority and promote uniformity of bankruptcy law throughout the Circuit); and see, B. Camp, “Bound by the BAP:  The Stare Decisis Effects of BAP Decisions,” 34 San Diego L. Rev. 1643 (1997) (yes, that is Bryan Camp, who posts here).  For all practical purposes, assuming the Smith case goes no further, whether by a request for an en banc hearing or a petition for certiorari, the one-day-late rule will not apply in the Ninth Circuit, at least for now.  It will take a state-court tax case to undo the one-day-late rule.  And, then, the case will need to be before a bankruptcy judge who does not feel bound by BAP decisions or an independent-thinking district court judge.

What happens if the Third Circuit in Davis follows the First, Fifth, and Tenth Circuits and accepts the one-day-late rule?  Keith posted on this recently.  Will the IRS capitulate?  If so, what happens in the Ninth Circuit?  Will the IRS feel strongly enough to litigate the issue in the face of Martin?

Mr. Smith’s counsel must feel that the subjective test is wrong and the Ninth Circuit should have reversed Hatton.  Although the objective test is very much the minority position, there are strong arguments in its favor.  Those arguments are well-stated in Colsen, 446 F.3d at 840-841, and, they do not need to be restated here.  But, from the perspective of containing the one-day-late rule, further appeals, whether a request for an en banc hearing or a petition for certiorari, could easily do more harm than good.  This is doubly so because the IRS still is not pressing the one-day-late rule.  One need look no further than Mallo to see what could happen.  Every case that asks an appeals court to look at the subjective versus objective test is another opportunity for a court to rule in favor of the one-day-late rule.  It is relatively easy for a judge to say that the literal language of § 523(a)(*) must be applied and timeliness is an applicable filing requirement.  It takes much more work to do what Judge Kurtz did and systematically explain why the one-day-late rule does not make sense.  While Mr. Smith and his counsel might disagree, in general, delinquent taxpayers in the Ninth Circuit are very fortunate that the Martin and Smith courts ruled as they did.

Trivia.

Here is one final piece of trivia.  The taxpayer’s first name in Smith is Martin.