Suspending the Priority Claim Period and an Update on Clothier v. IRS

On August 17, 2018, I wrote about the bankruptcy case of Clothier v. IRS which held that a debtor’s prior bankruptcy did not suspend the time period for the IRS to retain priority status. I will come back to that case in a postscript to this post. Clothier involved the issue of whether a taxpayer’s prior bankruptcy case tolled the time for the IRS to claim priority status. The case of Tenholder v. United States, No. 3-17-cv-01310 (S.D. Ill. 2018) looks at the same issue but examines a different basis for tolling – a Collection Due Process (CDP) request. The district court, affirming the decision of the bankruptcy court, concludes that taxpayers’ CDP request did toll the time period for claiming priority status.


Debtors filed a chapter 7 petition on December 30, 2015. At issue in this discharge litigation is tax year 2011. Debtors requested an extension of time to file their 2011 return making the return due date October 15, 2012. That extended due date falls more than three years before the date of their bankruptcy petition. As such, the priority claim provision of BC 507(a)(8)(A)(i) did not apply nor did the other two rules that allow the IRS to file a priority claim for assessments within 240 days of the bankruptcy petition and for taxes not yet assessed but still assessable. So, the IRS sought to hold open the three years from the extended due date for filing by resorting to the flush language added to the end of 507(a)(8) in the 2005 legislative changes.

That language provides:

An otherwise applicable time period specified in this paragraph shall be suspended for any period during which a governmental unit is prohibited under applicable nonbankruptcy law from collecting a tax as a result of a request by the debtor for a hearing and an appeal of any collection action taken or proposed against the debtor, plus 90 days; plus any time during which the stay of proceedings was in effect in a prior case under this title or during which collection was precluded by the existence of 1 or more confirmed plans under this title, plus 90 days.

Applying this language suspends the three year period for 207 days in the debtors’ case because that was the time between their CDP request on July 22, 2013, and the end of the CDP hearing on February 14, 2014. In addition to the 207 days, the flush language also tacks on an additional 90 days. Adding 297 days to the end of the period three years from the extended due date of October 15, 2015, yields a date of August 7, 2016. Since debtors filed their bankruptcy petition prior to August 7, 2016 the IRS filed its claim for 2011 as a priority claim. Based on its claim of priority status for 2011, the IRS argued that the debt was excepted from discharge by BC 523(a)(1)(A).

Debtors disagreed with the application of the flush language because the language of the paragraph says taxes for “which a governmental unit is prohibited under applicable non-bankruptcy law from collecting a tax.” Debtors acknowledge that the IRS could not levy while their CDP case was pending but argued that the IRS could offset or could bring a collection suit while the CDP case was pending and, since it was not totally prohibited from collecting, the flush language does not apply to suspend the priority period.

Debtors were not the first to make this argument. At least three prior cases addressed the same issue but the district court did its own analysis of the provision. It found IRC 6330, the CDP provision, was a non-bankruptcy law prohibiting collection. The court disagreed with debtors’ argument that the language provided a clear statement requiring broad prohibition of any type of collection and agreed with the argument of the IRS that the statute does not say all collection and it clearly covers the collection prevented by a CDP hearing. In holding for the IRS the court found the language of the statute ambiguous but the legislative history clear in its intent to cover the CDP situation. As a result it found that debtors filed within the period during which the IRS could claim priority status. This decision aligns with the prior decisions interpreting the language of this paragraph.

The harsh result here points to the care that a debtor must take in choosing the timing of a bankruptcy petition where discharge of a tax for a specific year serves as the goal of the filing of the bankruptcy petition. Had the debtor realized the impact of the filing of the CDP request, and assuming no other factors drove the timing of the filing of the petition, the debtor could have realized the discharge of this tax debt by simply waiting a little longer to file.

This brings us back to the Clothier case which raised a similar issue of timing but did not discuss the flush language of 507(a)(8) added in 2005. As I mentioned in the earlier post about Clothier, the Court’s decision essentially overturned the Supreme Court’s decision in Young v. United States, 519 U.S. 347 (1997).

Following the post, I received an email from Ken Weil in Seattle who specializes in bankruptcy and tax matters citing me to the hanging paragraph at the end of 507(a)(8). Ken’s cite to this part of 507 is perfect because in this hanging paragraph Congress codified the decision in the Young case. I am getting too rusty on bankruptcy and should have questioned in my post why the government did not vigorously argue this language.

Coincidentally, I had a conversation with someone familiar with the case who informed me that the case was argued by an assistant United States Attorney rather than a Department of Justice Tax Division attorney. The AUSA would not be as familiar with tax issues in bankruptcy and did not cite the court to the hanging paragraph. So, the judge missed it as well.

We have not yet confirmed that the IRS appealed the Clothier decision. I expect that it will and that the outcome of the decision will change. We will see.



Proper Treatment of Earned Income tax Credit in Calculating Disposable Income

In Marshall v. Blake, 885 F.3d 1065 (7th Cir. 2018) the Seventh Circuit accepted a certified appeal from the bankruptcy court and ruled that taxpayer’s earned income credit refund (EIC) could be prorated over the year. Both the procedure for certification of bankruptcy appeals and the method for calculating disposable income provide useful procedural information.

Before discussing the issues raised in the opinion, I would like to point out a related issue that bothers me in offer in compromise (OIC) submissions. The IRS pre-printed OIC contract permits the IRS to retain the debtor’s refund for the year in which the IRS accepts the OIC. This includes the EIC refund. In many cases, even if the IRS allowed taxpayers to keep their refunds and added the prorated amount to a taxpayer’s monthly income, monthly expenses will still exceed projected income.  The EIC refund seeks to lift the taxpayer out of poverty. It is not a refund of funds withheld. Taking the refund hurts the children of the taxpayer as much as or more than the taxpayer. Many families rely on the EIC to purchase everyday items, as indicated by a recent Federal Reserve analysis. The analysis tracked retail sales following the 2017 congressionally mandated delay in tax refunds for EIC claimants. It noted that retail sales were much lower than previous years during the period in which refunds are typically issued, but peaked once the EIC was finally released. For a more detailed analysis, see Elaine Maag’s recent blog post. I think the IRS should not require offset of the taxpayer’s refund generated by EIC where the debtor’s schedules show allowable expenses in excess of income but should allow a refund recoupment bypass as cryptically described in IRM  Allowing the taxpayer to retain future refunds under these circumstances, makes economic sense because of the purpose of the credit. Taking the EIC portion of a taxpayer’s refund where the schedules demonstrate its need to meet basic living expenses just seems wrong. The Seventh Circuit shows a better way.


The trustee in the chapter 13 bankruptcy case seeks to have debtor turn over her entire refund each year to fund the plan. The debtor, a low-income wage earner, single mom living in subsidized housing with three dependent children, argues that the court should allow her to retain the portion of her refund attributable to the earned income tax credit allocating a portion of the credit each month to offset her reasonably necessary expenses. Her annual income of $30,000 falls well below the median income for a family of four in Illinois. In her schedules she included a pro rata share of her anticipated EIC. Doing this and subtracting payroll deductions and allowable expenses created for her the ability to pay $120 a month toward her chapter 13 plan.

The chapter 13 plan explicitly laid out her proposed use of the refund each year attributable to the EIC. The trustee filed a motion to dismiss the case for failing to correctly list her income and expenses. The trustee argued that the court should not confirm the plan because it failed to commit all of the debtor’s projected disposable income since it called for her to retain a portion of her annual refund. The debtor argued that the EIC should not count as income under the bankruptcy code. The bankruptcy court allowed the debtor to confirm a plan with a prorated version of annual income that would have her offset expenses throughout the year in a manner that would have her keep most or all of the EIC portion of the refund.

The court noted in its confirmation order that the debtor sought to purchase beds and furniture for her two 19 year old sons who had previously slept on air mattresses. The plan also proposed purchasing dressers for their bedroom which they previously did not have. These types of purchases created “a pretty skinny budget overall.”

The trustee moved for a direct appeal to the circuit court. The debtor objected. The normal path to the circuit court would involve a stop at the district court or a bankruptcy appellate panel; however, a direct appeal can occur in certain circumstances and the majority of the panel at the 7th Circuit citing 28 USC 158(d)(2)(A)(i) agreed that certification to the circuit “was appropriate because there is no controlling decision from the Supreme Court or the Seventh Circuit as to whether tax credits are disposable income under the Bankruptcy Code.”

Although the parties had argued in the bankruptcy court about whether to characterize the EIC credits as income, the circuit court recast the issue by focusing on the language of the bankruptcy statute. It looked at BC 1325(b)(1) which defines disposable income and BC 101 which defines “current monthly income.” It found that current monthly income includes the monthly income from all sources that the debtor receives “without regard to whether such income is taxable income.” The Seventh Circuit also looked at case law in reaching the conclusion that “Congress intended for the [EIC] to be included in the calculation of income.”

More importantly, however, the court found that just because current monthly income includes the EIC refund received by the debtor, that does not mean that the debtor must pay the entire refund to the trustee because the real issue in this case involves how the EIC works when calculating projected disposable income. The court noted that several bankruptcy courts in its circuit used the same calculus used by the bankruptcy court and allowed debtors to prorate future expense on which the debtor would spend the refund as long as such expenses met the reasonably necessary test.

The Seventh Circuit found that the holding here fits with the Supreme Court’s interpretation of projected disposable income. In Hamilton v. Lanning, 560 U.S. 50 (2010) the Court adopted a forward-looking approach to the question. It provided several reasons for approaching this issue with flexibility. It looked to the ordinary meaning of projected. The Supreme Court found that the mechanical approach adopted by the trustee in that case clashed with the provisions of BC 1325 and would produce senseless results in cases in which the debtor’s income during the six month lookback period was “substantially lower or higher than the debtor’s disposable income during the plan period.” Here, the bankruptcy court’s flexible approach aligned with the approach used by the Supreme Court.

The trustee argued that prorating the annual refund to a monthly amount artificially inflated the debtor’s income; however, the Seventh Circuit found that nothing in the bankruptcy code requires that current monthly income “is limited to income that is received on a monthly basis.” Rather, the bankruptcy code defines current monthly income as “the average monthly income from all sources that the debtor receives’ during the six-month lookback period.” The court describes the trustee’s objection to the plan as one driven by the fact that it allows the debtor to deduct reasonable expenses which reduces the amount that the debtor could use to fund plan payments.

The Seventh Circuit also found that allowing confirmation of this plan meets the good faith requirement of BC 1325(a)(3), that it meets the feasibility requirement in 1325(a)(6), and that it promotes the purposes of chapter 13. The dissenting opinion on the circuit court did not object to the holding on the merits but expressed concern that the case did not meet the criteria for direct appeal from the bankruptcy court.

The opinion avoids rigid treatment of the EIC just because it comes once a year. Though the court did not mention this, the EIC was available throughout the year prior to 2010 when Congress discontinued that option apparently because of the low uptake on the monthly option and the higher cost to employers. The impact allows debtors to project the true cost of their expense on an annual basis rather than treating the once a year payment as some sort of special payment that does not relate to the annual expenses. I would like to see the IRS adopt this approach in the treatment of OICs which have very similar considerations.


Notes from Last Week’s ABA Tax Section Meeting in Atlanta

Christine, Les and I attended the ABA Tax Section meeting in Atlanta from October 4-6. We did a little speaking and a lot of listening. One of the benefits of the meeting is to hear the government speakers to obtain insights on their world. Here is a short post coming from a meeting in which government speakers provided updates.

Comments from Chief Judge of the Tax Court

The Tax Court is developing a new case management system and has signed a contract with the vendor to build the system. No date on when it might be launched.

The Tax Court currently has 175 cases with over $10 million in dispute

The ABA Tax Section submitted a proposal to the Tax Court to allow limited scope representation. The Chief Judge has submitted the proposal to the Court’s Rules Committee, Pro Bono Committee and Admissions Committee for review and a report back. [These comments resulted from remarks by Chief Special Trial Judge Lewis Carluzzo at the Tax Court’s judicial conference back in March of this year. Note that PT’s own Christine Speidel was one of the primary persons responsible for the comment. The ABA comment recommends that the Tax Court adopt limited practice rules especially to cover lawyers assisting with calendar call. This is a positive development that has been discussed for many years.]

There were over 27,000 cases filed in the Tax Court last year and over 29,000 cases closed.

Comments from the Office of Chief Counsel

The comments focused on the implementation of IRC 7345 and the passport revocation program. As of August 31, 2018, 272,656 taxpayers have been certified by the IRS to the State Department. Of those taxpayers, slightly over 17,000 have been decertified or reversed.

A taxpayer cannot just pay the debt under $51,000 and have the passport revocation lifted. Once a taxpayer is selected and referred, full payment must be made to have the IRS decertify the debt.

The Tax Court has chosen to use the letter “P” after the docket number to indicate that a case is a passport case.

The Tax Court is not the exclusive forum for contesting the passport revocation. Chief Counsel takes the position that: 1) a taxpayer cannot raise the merits of the underlying liability in the passport revocation case; 2) an equivalent hearing does not stop a passport revocation from moving forward the same way a CDP hearing would; 3) the scope of review is the administrative record; 4) the standard of review is abuse of discretion; 5) Chief Counsel will not refer these cases to Appeals after the filing of a Tax Court petition; and 6) the appellate venue in these cases is the DC Circuit. The Chief Counsel initial positions on passport revocation can be found in CC-2018-5.

It is not clear how to figure out what the State Department is doing with the information that the IRS sends over. The taxpayer generally will not hear from the State Department unless it revokes the passport or rejects an application for a passport. If a taxpayer applies and the State Department rejects the application because of an IRS certification, the State Department will hold open the application for 90 days for the individual to get the IRS to withdraw the referral. Thereafter, the individual will need to reapply for the passport.

The IRS has no control over what the State Department does with the referrals. It is not clear that an individual has a path to talk to someone in the State Department. It has not yet published procedures for handling these cases. The State Department is held harmless by the statute for the actions it takes (or fails to take) in these cases. The State Department may issue a passport for humanitarian or emergency reasons but does not have a requirement to do so.

Comments from DOJ, Tax Division

It is focusing on three matters this year:

  • Offshore
  • Return Preparer Injunctions – it has brought 40 complaints so far this year
  • Employment taxes – it has obtain 100 permanent injunctions against individuals and businesses pyramiding liability since 2016

Comments from Treasury

It is working hard to publish regulations as quickly as possible. It is not giving commenters additional time to submit comments generally because of the push to get out the regulations. The goal is to publish all of the regulations within 18 months of enactment so that the government gets the benefit of the relation back to the date of enactment rule.

Tax Court Reiterates That It Lacks Refund Jurisdiction in Collection Due Process Cases

In McLane v. Commissioner, TC Memo 2018-149, the Tax Court followed its prior precedent in Greene-Thapedi v. Commissioner, 126 T.C. 1 (2006) holding that it lacked jurisdiction in a Collection Due Process (CDP) case to grant petitioner a refund. Carl Smith blogged about the issue here when the McLane case was pending and he earlier blogged about the issue here when the DC Circuit affirmed the outcome in Greene-Thapedi in its holding in Willson v. Commissioner, 2015 U.S. App. LEXIS 19389 (Nov. 6, 2015). We have discussed other cases with this issue such as VK&S Industries v. Commissioner; ASG Services, LLC v. Commissioner; and Allied Adjustment Services v Commissioner (see post here) in which the court issued a designated order rather than an opinion. These cases serve as another reminder of the importance of orders, and particularly designated orders as a source of substantive rulings from the Tax Court even if these orders do not have precedential value.

Carl assisted the University of the District of Columbia Tax Clinic in filing an amicus brief in the McLane case. A link to the amicus brief, substantially written by Jacqueline Lainez’s student at UDC Roxy Araghi is here. A copy of the taxpayer’s brief and the IRS brief are here and here, respectively. The outcome is disappointing but not surprising given the prior precedent. In the opinion Judge Halpern provides a detailed explanation regarding why the Tax Court should not exercise jurisdiction to grant refunds in CDP cases but does not change the reasoning or outcome of Greene-Thapedi which is no doubt why the Tax Court marked this as a memorandum opinion.


On October 19, 2009, Mr. McLane timely filed his 2008 income tax return pursuant to a 6-month extension to file and the mailing rules of section 7502. The return showed a balance due, and so he paid $957 toward that balance between December 2009 and October 2010 and another $800 between October 2010 and October 2012.   In August 2012, the IRS mailed a notice of deficiency to Mr. McLane disallowing various Schedule C deductions and seeking a deficiency with respect to his 2008 taxes. But, he never got the notice of deficiency. Some of the $800 had been paid after the IRS mailed the notice of deficiency. The IRS later filed a notice of federal tax lien (NFTL) against him, and he sought a CDP hearing in which he contended that the assessment was invalid because no notice of deficiency had been mailed. He also argued in the hearing that he could prove sufficient deductions, but he did not ask for a refund of any amount that he had paid.

Mr. McLane did not get satisfaction at Appeals, so he petitioned the Tax Court. The Tax Court concluded that a notice of deficiency had been properly mailed, but he simply had not received it. After a remand to Appeals, a trial was had in the Tax Court in September 2016, and post-trial briefs were later filed. The failure to receive the notice of deficiency allowed the Tax Court to decide de novo his challenge to the underlying tax liability set out therein. Neither in his pretrial nor post-trial briefs did Mr. McLane seek a refund. Before the Tax Court’s ruling on the merits, the IRS later conceded that, for the 2008 tax year, Mr. McLane had proved enough business expenses at trial to not only fully eliminate any deficiency and abate the NFTL, but to also produce an overpayment. In a conference call among the parties and Judge Halpern in February 2018, Mr. McLane first asked for a refund of the overpayment that the IRS now conceded had occurred.

In an order issued on March 13, 2018 — one that did not mention Greene-Thapedi — Judge Halpern asked for memoranda of law from the parties on whether he had jurisdiction to find an overpayment under these facts. UDC filed an amicus memorandum, as well.

In Greene-Thapedi the Tax Court reviewed a CDP case where the IRS had been trying to collect a deficiency arising from a stipulated decision of the Tax Court in an earlier deficiency case involving 1992 income taxes. The dispute in the CDP hearing was only over the amount of interest charged on the stipulated deficiency. But, the IRS offset an overpayment of taxpayer’s 1999 liability to fully pay the 1992 liability pending before the court in the CDP matter. The taxpayer in that CDP case then sought a refund of interest accrued before the notice of intent to levy. The court found that the dispute over the interest was a challenge to the underlying liability, but once the levy became moot by virtue of the offset of the 1999 liability the opportunity to challenge the liability vanished together with any claim for refund. The court also noted in the case that IRC 6330 does not expressly give the Tax Court jurisdiction to determine overpayments and to order refunds. The case contains no discussion of whether the refund claim was timely filed under section 6512(b)(3), which gives the Tax Court the power to find an overpayment under its deficiency jurisdiction under several scenarios.

In the Greene-Thapedi opinion at footnote 19 the Tax Court mentioned the possibility that although not present in that case the determination of an overpayment might be “necessary for a correct and complete determination of whether the proposed collection action should proceed.” Thus, the court gave Mr. McLane some hope that his case might fit within the exception mentioned by the court as a possibility. Both Mr. McLane and the amicus also argued that the Greene-Thapedi case was legally distinguishable, since it involved a dispute over interest on a deficiency that had already been stipulated, whereas the McLane CDP case was the first time the merits of the deficiency were being litigated. Both memoranda argued that a taxpayer who had not received a notice of deficiency should be put in the same position in a CDP challenge to that liability in Tax Court as he would have been had he received the notice of deficiency. The amicus pointed out that one could still apply the Tax Court’s overpayment jurisdiction rules of section 6512(b)(3) by limiting the amount of the refund to both (1) the amount paid in the 3-year (plus extension) period before the notice of deficiency was mailed (a deemed paid claim) and (2) the amount paid after the notice of deficiency. The $957 and $800 payments would fall within those descriptions. Another factor giving Mr. McLane some hope was the dissenting opinion of Judge Vasquez in Greene-Thapedi which invoked the need to broadly construe the court’s jurisdiction because of the remedial nature of CDP. Judge Vasquez also pointed out that the decision created a trap for the unwary:

Taxpayers who choose to litigate their section 6015 [innocent spouse] and section 6404 claims as part of a section 6330 proceeding cannot obtain decisions of an overpayment or refund in Tax Court. If those same taxpayers had made claims for section 6015 relief or interest abatement in a non-section 6330 proceeding, we could enter a decision for an overpayment and could order a refund.

In McLane the court acknowledges that it must revisit Greene-Thapedi to determine if it has overpayment jurisdiction on the facts presented here; however, it concludes that it has no reason to depart from the earlier precedent.

In response to the narrow argument that Mr. McLane and UDC made that the Tax Court has overpayment jurisdiction in a Tax Court case only where the underlying tax liability is at issue because of “the non-receipt of a mailed notice of deficiency,” the court states that:

We see no reason why the issuance of a notice of deficiency that petitioner never received should allow him to pursue a claim for refund that would otherwise have become time barred long before he manifested any awareness of it.

The court reasons that he had plenty of time to notice that he had more expenses than he originally claimed on his 2008 return and he did not act to raise a refund claim until a conference call with the parties in the CDP litigation in February of 2018. By 2018, the normal statute of limitations to file a claim for refund had long since passed. The court expresses concern that providing refund jurisdiction in this context would allow a taxpayer to make an end run around the refund time frames established in the Code. It is unclear how much this late request for a refund may have impacted the outcome of the case. The court does not directly address the argument made by UDC that section 6512(b)(3)’s overpayment jurisdiction filing deadlines (which cover payments made in periods both before and after the notice of deficiency was mailed) could be treated as obviating the need for any amended return in order to seek a refund in the Tax Court CDP case.

The court provides an extensive discussion regarding the arguments of the amicus brief which follow closely the arguments made by Judge Vasquez in his dissent in Greene-Thapedi and the court pushes back on each one of those arguments. I will not repeat them here but I came away with the impression that the length of the opinion may have been influenced by the desire to take this opportunity to refute Judge Vasquez’s dissent in more detail than was done in the majority opinion in Greene-Thapedi and perhaps was done with an eye toward the possible appeal of the McLane case. Of the appellate courts, only the D.C. Circuit (in Willson, a case also with unusual facts not involving a challenge to the underlying liability) has ever discussed or followed Greene-Thapedi. McLane could appeal his case to the Fourth Circuit. In any event several pages of the opinion explain in detail why none of the issues raised by Judge Vasquez provide a basis for Tax Court jurisdiction.

For anyone interested in fighting this issue, the opinion provides a detailed roadmap of what the court thinks of the arguments made to this point. While it appeared that Greene-Thapedi may have left a crack in the door for a taxpayer to come in with different facts and succeed in obtaining a refund in a CDP case, the McLane decision signals that the crack is closed. Any success on this issue must come from persuading a circuit court to interpret the statute differently or for Congress to make clear that its jurisdictional grant goes further than it currently appears to do.



What is a Prior Administrative Hearing?

In Loveland v. Commissioner, 151 T.C. No. 7 (2018) the Tax Court answered a previously unanswered question necessary in some Collection Due Process cases for determining the scope of the hearing. The court determined that a prior administrative hearing means a hearing before Appeals and that meeting with a revenue officer (and presumably a revenue agent) does not satisfy the language of IRC 6330(c)(4)(A)(i) or Treasury Regulation 301.6320-1(e)(1). The court issued the case in a precedential opinion because of this aspect but it contains other interesting issues as well. The taxpayers brought their case pro se. The court reaches its opinion in the context of a motion for summary judgment.


The Lovelands present a factual situation quite similar to many clients of low income taxpayer clinics. He retired from working as a boilermaker and she retired after a career as a teacher. The Great Recession significantly impacted their finances in a negative way and each has had a major health issue to deal with. Because of the negative financial and health issues happening in their lives, the Lovelands stopped paying taxes during the years 2011-2014 and accumulated about $60,000 in federal tax debt.

The opinion does not say exactly what they did to accumulate the debt but the fact pattern reminded me of so many formerly middle class clients I saw following the recession who had to dip into their retirement funds to keep afloat. These individuals ended up at the Villanova tax clinic with significant tax liabilities similar to the Lovelands’ and often by that point had lost their jobs, their houses, their cars and had little prospect of repaying the taxes. We saw so many of these cases for a few years that my students threw me a 72(t) party on the day I turned 59 and ½ because they had come to appreciate the significance of all of the exceptions to the 10% excise tax imposed by that Code section.

The IRS sent the Lovelands a notice of intent to levy. They entered into negotiations with a collections officer and sought an offer in compromise. The description in the opinion leads me to believe that they submitted a complete offer package and that they sought a special circumstances offer which would allow them to pay less than what the IRS would calculate as their reasonable collection potential. I suspect that they did this because they had a house or some other asset of value they sought to keep because their health issues would prevent them from borrowing on the house.

The collection officer rejected the OIC finding that they had the ability to fully repay the taxes. They initially appealed the decision; however, they also sought to pursue discussions about an installment agreement (IA). The IRS told them that if they appealed the rejection of the OIC they could not simultaneously negotiate an IA, so they withdrew the appeal of the OIC rejection and continued negotiations with the collection officer about an IA.

While they discussed the IA, the Lovelands sought to borrow about $11,500 against real estate they owned in order to reduce their tax liability below $50,000 so they could qualify for a streamlined IA. On the day they submitted the loan application, the IRS filed a notice of federal tax lien (NFTL) which killed the loan application. They requested a CDP hearing with respect to the filing of the NFTL and requested release of the NFTL so they could obtain the financing to pay the IRS.

The Appeals employee assigned to the CDP case sent them a letter asking for a Form 433-A to support their requested collection alternative. They responded by asking the Appeals employee to take a second look at the OIC which included a completed 433-A (OIC). The Appeals employee declined to consider the OIC or a partial pay IA but she was kind enough to calculate a full pay IA in 84 months which would cost them $853 per month.

The court found that:

On April 7, 2017, the Appeals officer closed the Lovelands’ appeal. On April 11, 2017, a notice of determination was sent to the Lovelands informing them of the Commissioner’s determination and their right to appeal the decision to the Tax Court. The notice states that the Lovelands’ requested the withdrawal of the lien and an installment agreement. The notice also states that the Appeals officer did not consider their proposed installment agreement because the Lovelands ‘did not provide any financial information.’ Neither the notice of determination nor the case history notes discussed Mr. Loveland’s medical condition or the effect of his disability on the Lovelands’ ability to pay the tax liability.

In response to the motion for summary judgment, the Lovelands argued that in giving the Form 433-A (OIC) to the Appeals employee they did submit financial information and they also argued that the NFTL was causing financial hardship.

The court states that:

We are faced with a unique question here: whether negotiations with a collections officer constitute a previous administrative proceeding under section 6330(c)(4)(A)(i)….The Lovelands made an offer-in-compromise in a separate collection proceeding that is not before us. Then, in the CDP hearing underlying this case, they renewed their offer-in-compromise.

The statute says that an issue cannot be raised if “the issue was raised and considered at a previous hearing under section 6320 or in any other previous administrative or judicial proceeding.” In this case the issue does not turn on whether there was a prior opportunity for a hearing as many cases have litigated but rather whether there was a prior proceeding. The court points out that the standard for a prior opportunity differs from whether a prior proceeding occurred. The applicable regulation, 301.6320-1(e)(3), Q&A-E7 explicitly provides that a prior opportunity to dispute the underlying liability precludes consideration of the underlying liability in a subsequent CDP hearing. We have written extensively on that issue here, here and here.

The regulation is “noticeably silent” with regard to “spousal defenses, challenges to the appropriateness of the NFTL filing, and offers of collection alternatives” leaving open the opportunity for taxpayer to raise these issues in a CDP hearing if they did not have a previous administrative hearing. The court then finds that in refusing to consider the OIC requested by the Lovelands the IRS abused its discretion. Similarly, the court finds that it abused its discretion in refusing to consider the partial pay installment agreement and the court took pains to point out that the record did not show any failure on the part of the Lovelands to provide requested information.

The court also found that the Lovelands used words in their communication with the Appeals employee that she should have interpreted as economic hardship giving rise to the consideration of an effective tax administration offer in compromise. Because the Appeals employee never evaluated this claim, the IRS abused its discretion in failing to consider this as well. The court remanded the case to Appeals. One hopes that Appeals can find a way to work with the Lovelands and that their case will not return to the Tax Court.

The case creates new law for taxpayers not arguing the merits of the tax liability by making clear that only a prior administrative hearing and not a prior opportunity for an administrative hearing has a preclusive effect on the collection issues such as spousal defenses, collection alternatives and lien filing that a taxpayer may want to raise in a CDP hearing. It will be interesting to see if the IRS agrees with this legal conclusion by the court or seeks to appeal the issue.


Unsuccessful Constitutional Challenges to the Collection Treaty Provision in the Tax Treaty between Canada and the United States

This summer I visited Canada twice, Montreal and Toronto. Canada and the United States have long seemed like best friends. I wondered if I would be treated any differently now that our government policies do not seem to treat Canada as our best friend. Happy to report the Canadians remain as friendly as ever on the personal level. They do, however, want to collect the taxes due to them and that results in the case of Retfalvi v. United States, No. 5:17-cv-00468 (E.D.N.C. Aug., 15, 2018).

I have written before about the collection language that exists in two of the five tax treaties that have this special language, France and Denmark. Canada, along with the Netherlands and Sweden, is one of the other three countries that have the collection provision in their tax treaty with the United States. The Canadians invoked the treaty to ask the Unites States, specifically the IRS, to collect some unpaid Canadian taxes from an individual who at one point was a Canadian citizen but who had become a citizen of the United States. The taxpayer raised a number of constitutional arguments regarding the treaty to collect taxes. Most individuals raising constitutional arguments bring the phrase ‘tax protestor’ to mind but these were legitimate and well-argued constitutional arguments. In the end, the taxpayer lost but we gain insight regarding the constitutional underpinnings of the collection treaty provisions.


Mr. Retfalvi moved from Hungary to Canada and became a citizen in 1993. He later moved to the United States and obtained permanent resident status in 2005 followed by citizenship in 2010. In 2006 he sold a pair of condominiums he had purchased earlier in Vancouver before he knew he was moving to the United States. He and his wife reported the sales on their Canadian tax returns; however, the returns were selected for audit. The audit resulted in a proposed increase in tax of over $100,000. He did not petition the Canadian Tax Court to fight the assessment of this additional tax. After the assessment became final, Canada invoked the treaty to secure the assistance of the IRS in collecting the taxes.

As the treaty requires, the IRS sprang into action. In November of 2015 it sent to Mr. Retfalvi a “Final Notice – Notice of Intent to Levy” giving him a chance to pay the liability before the IRS took administrative collection action against him. He objected to the notice of intent to levy and let the IRS know that he did not owe the tax. The IRS let him know that he had no ability to contest the tax in the United States. He filed a Form 12153 seeking a Collection Due Process (CDP) or equivalent hearing. The IRS let him know that he could not use the CDP process but could seek a CAP appeal. The IRS subsequently denied his CAP appeal because he tried to use the CAP process to challenge the underlying liability.

After failing to obtain a CDP hearing and losing the CAP appeal, Mr. Retfalvi filed suit in the United States District Court for the Eastern District of North Carolina seeking declaratory and injunctive relief from the collection action. The IRS moved to dismiss for lack of subject matter jurisdiction and failure to state a claim. The court dismissed the case citing the anti-injunction statute. Mr. Retfalvi then paid the tax and filed a suit for refund. The IRS rejected his claim for refund and he filed this suit because of alleged constitutional infirmities with the collection treaty provisions. He cited to nine specific constitutional problems with the treaty:

  • Article 26A [the collection provision of the treaty] violates the Origination Clause because it is a bill to raise revenue that did not originate in the House of Representatives:
  • Article 26A is invalid because it is not self-executing;
  • Article 26A violates the Taxing Clause because Congress has the exclusive authority to lay and collect taxes;
  • Article 26A violates the Taxing Clause because Congress cannot use its taxing power to levy or collect taxes of a foreign country;
  • Article 26A violates the Taxing Clause because it purports to amend the Internal Revenue Code;
  • The IRS is not authorized to assess and collect taxes imposed by Canadian laws;
  • Article 26A denies taxpayers due process;
  • Article 26A denies taxpayer equal protection of the law that is available to taxpayers who have had taxes assessed under the Internal Revenue Code; and
  • Article 26A creates an impermissible sub-classification of United States taxpayers.

The court addressed each of the nine alleged grounds for striking the treaty provision. It found as to each that a basis existed for the provision to be deemed constitutional. As a result, it struck his refund suit. I do not know if he has the ability to bring a refund suit in Canada but that is where he must go next if he wants the return of his money.

I am not going to go through each of the separate reasons that the court found the treaty provision constitutional but anyone with an interest in treaties and in constitutional law may find the opinion interesting. It provides a fair amount of detail with respect to each of the claimed bases for unconstitutionality including case citations and, in some instances, analysis of the treaty language as it relates to the constitution. The case also provides a good discussion of what is a tax bill that must originate in the House of Representatives and what is not.

This case continues the general theme of the collection treaty cases both here and in the other treaty countries. That theme, succinctly stated, is that if you want relief you must seek it in the country in which the liability arose. The country to whom the liability is sent pursuant to the treaty provision simply goes out and collects the money with basically no questions asked about the correctness of its origins.


Filing Form 1040 did not Extend Statute for Filing Form 945

Last year I wrote about the case of Quezada v. IRS. In the aspect of the case decided last summer, the bankruptcy court refused to grant summary judgment to the IRS regarding the statute of limitations for the taxpayer to file Form 945. The taxpayer argued that his Form 1040 provided the IRS with the information necessary and started the statute of limitations. The taxpayer needed the Form 1040 to serve as a surrogate Form 945 in order to discharge the liabilities it should have reported on Form 945. Now, the court has ruled on the issue and found for the IRS in Adv. Proc. No. 16-01101 (Bankr. W.D. Tex. 2018). The court provides a thoughtful analysis for its decision.


Mr. Quezada operates a masonry company that builds projects for general contractors. He hires subcontractors to perform some of the work and provided to the subcontractors Forms 1099. The problem occurred because the Forms 1099 contained missing or incorrect TINs of the subcontractors. A missing or inaccurate TIN prevents the IRS from effectively using the Form 1099 to check on the reporting by the subcontractor. So, the IRS sent Mr. Quezada a notice in September 2006 that the 1099s had missing or inaccurate information and that if he did not correct the situation he had to start backup withholding. The IRS sent the same notice in 2007 and twice in 2009.

In 2008 the IRS began examining Mr. Quezada regarding his backup withholding liability for the subcontractors. This ultimately led to the recommendation of an assessment of $600,000 plus penalties of over $300,000. He eventually filed bankruptcy in which the IRS filed a claim for over $1.2 million. He brought an action to determine dischargeability arguing that the IRS waited too long to make its assessment. Mr. Quezada argued that his timely filed Forms 1040 and 1099 started the running of the statute of limitations on assessment while the IRS countered that he had an obligation to file Form 945 and his failure to file that form meant the statute never began running.

When a business pays an independent contractor, it must deduct backup withholding if the independent contractor fails to provide its TIN or if the IRS notifies the business that the TIN is incorrect. In addition to the backup withholding, the business must also file Form 945. Mr. Quezada argued that he had all of the TINs in a notebook but did not provide a record to the court and he had previously signed a sworn statement that he “did not obtain Social Security numbers (SSN) OR Taxpayer identification numbers (TIN) from all of [his] subcontractors.” The failure of proof in the trial coupled with the admission against interest caused the court to find that he had an obligation to file Forms 945.

Having found he had a duty to file the Forms 945, the court then looked at whether his failure to do so could somehow be excused. In Commissioner v. Lane-Wells, 321 U.S. 219 (1944) the Supreme Court analyzed whether a taxpayer who had filed a Form 1120 satisfied the requirement for filing a Form 1120H for holding companies. It found that Lane-Wells did not meet its statutory requirement for filing a return with respect to the holding company liability. The bankruptcy court found that Mr. Quezada, like Lane-Wells, had a separate liability requiring him to file two returns and preventing him from relying on the Form 1040 to satisfy his backup withholding liability.

The court also addressed his argument that he provided sufficient data to meet the Beard test. Beard v. Commissioner, 82 T.C. 766 (1984), aff’d 793 F.2d 139 (6th Cir. 1986) establishes the well-recognized test for what constitutes a return. Even though the bankruptcy court found that he had a responsibility to file the Form 945 return, if he could convince the court that his submissions on the Form 1040 essentially provided the information needed for the Form 945 he could meet the filing requirement. Beard has four tests: 1) sufficient data to calculate the tax liability; 2) document must purport to be a return; 3) honest and reasonable attempt to satisfy the tax law requirements; and 4) execution of the return under penalties of perjury.

The court found that he failed the second and fourth tests. He argued that missing TINs are “not relevant to his tax liability.” The court rejected this argument pointing out that the IRS needs to have the TINs in order for the Form 1099 to have meaning. The data provided did not meet the needs of the IRS and could not be considered sufficient. With respect to the third test the court explained that the IRS told him on several occasions of his failure and need to correct. His failure to correct over an extended period of time negates any argument that he acted in good faith and reasonably attempted to satisfy his tax law requirements.

This type of case provides a horrible result for a taxpayer such as Mr. Quezada if the subcontractors actually paid their taxes. Earlier this year we blogged about a case involving the misclassification of workers. We also posted a response from the National Taxpayer Advocate to our blog post. The situation faced by Mr. Quezada has similarities with the misclassification cases. The goal of backup withholding is ensuring that the third parties report their income to the IRS. If Mr. Quezada could show that his independent contractors actually reported their taxes, there should be some way to relieve him of at least a part of his liability. By failing to follow the rules, he causes the IRS to expend a fair amount of effort and for that he should be penalized. At the same time it seems he should have a path to reduce this crushing liability if he can prove that his independent contractors reported and paid the proper amount of tax. Maybe they did not pay and maybe, even if they did, he could not prove it but it seems a shame he does not have a chance to show that his failure did not result in loss to the IRS.


Recognizing Pat Mullarkey

This afternoon in the Great Hall of the Department of Justice people will gather to recognize and celebrate Pat Mullarkey who has served for almost four decades as the Chief of the Northern Trial Section of the Civil Section of the Tax Division.  He retires after working over 52 years at the Department of Justice.  I had the pleasure to work with Pat on several occasions.  He is a great lawyer and a great section chief who has mentored hundreds of trial lawyers over the course of his career.  You can find an interview of Pat about his career here on PT. More recently Pat was interviewed by Paul Merrion for MLex US Tax Watch (Lexis subscription required).


I reached out to one of his assistants, Henry Riordan, who provided me with the following details about about Pat’s career:

In 1966, Mr. Mullarkey joined the Tax Division as a civil trial attorney.  In recognition of his exceptional talent, he was promoted to an Assistant Chief for the Civil Trial Section’s Western Region in 1977, and then to a Special Litigation Counsel position in early 1979.  Mr. Mullarkey became the Chief of the Civil Trial Section’s Northern Region in July of 1979 and has served continuously in that capacity since his appointment, except for two periods, one for six months and the other for two years, when he served as the Tax Division’s Acting Deputy Assistant Attorney General for Civil Litigation.

Mr. Mullarkey is a 1962 graduate of Marquette University with a B.S. in Accounting.  He received his J.D. from the Georgetown University Law Center in 1965, and an LL.M. in Taxation from that same institution in 1967.  After law school, Mr. Mullarkey was a judicial law clerk for a federal district court judge in the District of Columbia.

Mr. Mullarkey is a legend in the Department, as well as the federal tax bar.  He has been the recipient of a number of governmental awards including the President’s Meritorious Executive Award (twice), the Attorney General’s John Marshal Award for Outstanding Legal Achievement and, most recently, the Attorney General’s Mary C. Lawton Lifetime Service Award. Mr. Mullarkey has been a member of the J. Edgar Murdock Inns of Court of the Tax Court for thirty years.  He has served as an instructor at the Department’s National Advocacy Center and bankruptcy schools sponsored by the Office of Chief Counsel, Internal Revenue Service.  He has been a panelist at tax law conferences sponsored by the Federal Bar Association, sessions presented by the Tax Section of the American Bar Association and programs presented by other groups.  In February 2018, he received the Kenneth H. Liles Award from the Taxation Section of the Federal Bar Association.

Mr. Mullarkey has counseled many attorneys and is well known for his intellect and common sense.  He has supervised and mentored generations of attorneys, who have uniformly recognized their tutelage as the best experience in their careers.  Mr. Mullarkey’s enthusiasm for tax litigation has been infectious and his expertise and institutional knowledge will be greatly missed.

Section Chiefs in the Civil Trial Section play a critical role in developing tax litigation.  Because they serve as the lawyers for the IRS in district and bankruptcy courts, they interact regularly with the attorneys in Chief Counsel’s office where I worked.  Pat worked closely with the Chief Counsel attorneys served by the Northern Trial Section which primarily handles cases in the Northeast and he also worked closely with the Procedure and Administration Division of the National Office of Chief Counsel, IRS.  I reached out to Drita Tunuzi, currently the Deputy Chief Counsel (Operations) who previously served as the head of Procedure and Administration and who started her career in an office in the Northeast.  She had this to say about Pat:

Pat Mullarkey has seen many generations of DOJ and Chief Counsel lawyers over his years and they are all better for having worked for and with him.  He has provided outstanding service and wise counsel to the IRS over his career.  We wish him well in his retirement. 

I also received these comments made by John DiCicco, a colleague of Pat’s at DOJ and a former Acting Assistant Attorney General of the Tax Division:

I am not going to spend time telling you what a great lawyer Pat is.  That is indisputable.  Suffice it to say I learned more from Pat than any other lawyer I worked with. 

Instead, I want to talk about what a fine man Pat is.                 

I relied on Pat from the time I started working in the Division in 1974.  He always patiently answered my questions no matter how stupid they were.  He did the same for all the other lawyers who sought him out.  And seek him out they did.  No matter how busy he was, he would give his time to help the rest of us.               

Inclusive- I remember when I first started with the Division and Pat was a Senior Trial Attorney.  Every morning he would walk by and ask lawyers, especially the new lawyers if they wanted to go next door for breakfast or for coffee.  It made all of us feel we were part of a team working together toward a common goal.  Pat really fostered a sense of camaraderie.  

As an aside, unfortunately, the only place around that served breakfast was something called the “Kitchateria”.  How the Board of Health allowed that place to stay open was always a source of wonderment.   But we went with Pat. Not only to learn about our cases, but to learn about each other.  He made us feel we were working with top people, and maybe more importantly, that the work we did was important.  (Too, we always marveled at how Pat could hold down the “Kitchateria” food.) 

Pat was unceasingly fair and loyal.  He cared about all of his staff, not just his lawyers. And he cared about them not just professionally but personally. He always stood up for and supported his troops.  I remember once he even quit drinking a brand of beer because I had a case (no pun intended) with the Brewery and was always complaining about that piece of litigation. (Of course that I would complain about something was something of a rarity.) 

Pat was one of the four Division employees that I worked with who I always thought were irreplaceable—Pat, Steve Csontos, Bob Markham and Tommy Thompson.  The rest of us were fungible, but not Pat. 

Pat helped me immeasurably when I was the acting AAG. He agreed to serve as my deputy.  I knew that being a deputy was not his first choice (or second choice for that matter), and that he really loved being a section chief. He had little interest in the deputy position, else he would have had it years before.  Nonetheless, he willingly agreed to help, and as always, his help was superb. 

In sum, I owe a debt of deep gratitude for all Pat did for me.  But more importantly, the American people owe him a huge debt of gratitude.  It is outstanding, selfless and unstinting civil servants like Pat, who make our Government function.        

Pat, thank you for all that you have done, and all the best in your new “career”.  I hope it lasts as long as last one. 

For over half a century Pat has impacted tax procedure because of the large role he has played in shaping the litigation strategies at the Tax Division.  The next chief of his section has very large shoes to fill.