Enjoining Pyramiding Taxpayers

Over the past 10-15 years, the Department of Justice Tax Division has become much more aggressive about bringing injunction actions against taxpayers who fail to pay their employment taxes over an extended period of time. The IRS calls the repeated failure to pay employment taxes “pyramiding” and views this as one of the most serious types of bad tax behavior, following such other types of bad behavior as evasion and tax shelter promotion. While the IRS has a long history of prosecuting tax evasion and a pretty solid record of getting legislation to root out and aggressively pursuing tax shelter promoters, it has suffered for a long time with the issue of how to stop pyramiding. We are adding some material on injunctions to Chapter 14 of Saltzman and Book, IRS Practice and Procedure which led us to pay more careful attention to the recent cases coming out on this issue. As you will see from the discussion below, the rules governing the enjoining of taxpayers from continuing a business have not been uniformly developed and applied.

The most recent former Acting Assistant Attorney General in charge of the Tax Division, Caroline Ciraolo, made it one of her signature enforcement efforts to prosecute and/or enjoin taxpayers who engaged in pyramiding. Some of the DOJ press releases on this effort provide a flavor for what they have done in this area: general discussion; injunction in Texas; injunction in Pennsylvania; injunction in Iowa; and injunction in New York. Prosecution has long been a desired effort by the folks in collection at the IRS, and I am sure they were delighted with this effort. The civil action that parallels prosecution for failure to pay employment taxes is an injunction action. Like prosecution, this is a labor intensive effort both on the part of the IRS and DOJ. A pair of cases this summer tell some of the story of the effort to root out pyramiding through suits to enjoin the taxpayers engaged in the activity. Usually, these types of suits are coupled with other actions such as reducing the liability to judgment and foreclosing the tax lien on some property.


Under the general authority granted by Section 7402(a), the Service can bring an injunction action in certain circumstances in order to stop a taxpayer from taking or continuing certain actions. The Service uses its injunctive authority, and this is authority that it uses sparingly, to seek to stop taxpayers from pyramiding employment taxes in circumstances in which the taxpayer has demonstrated a long term pattern of failing to pay employment taxes. Courts have not provided clear guidance on exactly what the Service must show in order to obtain injunctive relief. Because granting injunctive relief will generally result in the taxpayer losing the right to engage in business, courts carefully look at the request. While seeking criminal prosecution against the responsible officer(s) of a business that has a long history of pyramiding employment taxes provides an alternative to seeking injunctive relief to stop a business from operating and continuing to pyramid, each type of relief places a high burden of proof on the Service as well as a high cost in time and effort.

In United States v. Padron, the court granted injunctive relief in a decision entered in May, 2017. In the Padron case, the Service brought suit against both the individual responsible for running the business and the business itself. The defendants did not vigorously defend the action. The business defaulted and the individual agreed to enter into a consent judgment that included the injunction. Nonetheless, the court saw the need to carefully review the case in order to determine if injunctive action was appropriate including whether the claim of the Service for injunctive relief had merit. The court found the claim for injunctive relief had merit only after looking at the standard it should apply, and noting that the 5th Circuit had not ruled on the issue.

The court stated that the issue of what constitutes a sufficient basis for a permanent injunction under Section 7402(a) has created a split in authority among the courts that have addressed it. Some courts require the Service to show the traditional factors for use of the equitable remedy of injunction. As we discuss in more detail in the Saltzman chapter, the majority of courts permit an injunction under Section 7402(a) if the government shows “that an injunction is appropriate for the enforcement of the internal revenue laws, without reference to the traditional equitable factors.” Having determined that it had a sufficient basis for entering a permanent injunction against the business, the court had little trouble finding that it had a basis for entering one against the individual responsible officer of the business.

Reflecting the split of authority on the issue, in US v Moore, the district court in New Jersey reached the opposite conclusion, a case in which the taxpayer did not contest the imposition of an injunction. The Service sought a default judgment, including an injunction against a taxpayer running a dental practice. The principal of the business failed to pay employment taxes over a 20-year period. The Service clearly proved the long term failure to pay; however, the court found that it must determine if “this relief is necessary and proper ‘in light of the public interest involved.’” Similar to the court in the Padron case, the court in the Moore case found no controlling circuit authority and looked for authority from the other district courts in its circuit.

Even though it quoted language stating that the standard included the totality of the circumstances such as the reasonable likelihood that the taxpayer would violate federal tax laws again, the court in Moore found that “applying that standard, the injunction sought by the United States is overbroad and premature. It would force a shutdown of Dr. Moore’s dental practice and stop him from practicing dentistry entirely until the tax liabilities are paid. Such a harsh result is not only unprecedented but also premature given that no efforts or supplemental proceedings have been taken to satisfy this judgment.” At the same time it sought the injunction, the Service obtained a judgment against Mr. Moore for his failure to pay taxes over a substantial period.

While the Service has the ability to obtain an injunction, the Moore case shows that courts have split in a fairly significant manner on the appropriateness of this remedy or the proof that the Service must provide in order to obtain an injunction. The Moore case involves a very long period of non-payment and high amounts of non-payment. Much of the non-payment of employment taxes no doubt got credited to Mr. Moore when he filed his own individual tax return each year. I proposed in a law review article many years ago that responsible officers should not get withholding credit on their own returns when the business does not pay over the withheld taxes to the IRS. Mr. Moore seems like a poster child for that recommendation. Though the district court in Moore was concerned that he would not be able to repay the taxes if he can no longer practice dentistry, I do not think the injunction prohibits him from practicing dentistry as an employee of another dentist. It just seeks to keep him from running his own business and not paying his taxes. The facts in his case convince me that he should be an employee and not a business owner.

Army Veteran Seeking to Avoid Levy Loses Battle

In the week in which we remember the veterans who have served our country, it seems an appropriate time to post a case involving intersection of service in the military and taxation of the financial benefits of military service.  For those more interested in this topic, there is a chapter entitled Assisting Military Clients in the ABA Tax Section publication “Effectively Representing Your Client before the IRS” and the chapter on military issues is available as a standalone section of the book. The 7th Edition of that book will be coming out with the next couple of months.

In a Collection Due Process (CDP) case a taxpayer can raise certain defenses and cannot raise certain other defenses. The case of Bruce v. Commissioner, T.C. Memo 2017-172 involves a veteran who seeks to stop the IRS from levying on his pension. In some ways it seems that the CDP issues concerning merits litigation gets caught up in a case that partially implicates the exemption from levy under 6334(a)(10). We have spilled a lot of ink discussing merits litigation in CDP cases but with the exception of a post on a bank levy which seemed to hit a Veteran Disability Payment we have spent little time talking about levy exemptions.

At the Legal Services Center of Harvard within which the Harvard Tax Clinic is located, there is also a veteran’s clinic. As a result of that and a grant we receive from a veteran’s organization enabling us to represent any veteran needing assistance, the Harvard Tax Clinic sees a fair number of veterans needing tax assistance. While most of the issues we see with veterans do not turn on some of the special tax provisions related to that group, some of the issues are impacted by special provisions for veterans. In the Bruce case, he seeks to cloak his income with the protective coating of a non-taxable disability military pension. He loses but the effort is worth a look.  There is a link between the non-taxable nature of a military pension and the exemption from levy.


Mr. Bruce is a disabled Army veteran who retired on January 31, 2000 at the rank of chief warrant officer 3. The Department of the Army classified his retirement as regular but the “Department of Veterans Affairs subsequently assigned him an overall 80% disability rating retroactive to February 1, 2000 and individual unemployability resulting in a disability compensation at a 100% rate retroactive to December 19, 2002.”

Mr. Bruce argues that because of the retroactive determination, his retirement “should have been classified by the [Army] as a disability retirement.” He asked the Army to reclassify his retirement and it denied his request. He brought suit against the Army based on the denial and his case was dismissed. H appealed to the 11th Circuit which sustained the dismissal. He indicated to the Tax Court that he planned to go to the Supreme Court. Perhaps some of these actions have prevented him from focusing on his tax obligations and perhaps some of these actions made him take tax positions in anticipation of a different outcome.

Mr. Bruce alleged that the Army should have granted him a disability retirement rather than a regular retirement, citing as evidence the VA rating.  I am told that a veteran can seek to have his record corrected in order to switch from a regular retirement to a disability retirement through an application to the relevant Board for Correction of Military (or Naval) Records (which are the same Boards that handle some discharge upgrades). If the Board did grant him relief, it could potentially do so retroactively, I believe, which could affect tax liability.  It is unclear to me if his request to the Army to reclassify his retirement is the same type of request I describe in this paragraph.  If it is, perhaps his only path to having the retirement reclassified at this time is through a successful petition to the Supreme Court.

Because the Army did not reclassify his pension, it gets reported to the IRS as taxable. In 2011 he also received Social Security payments.  Based on the formula for taxing Social Security payments and his taxable pension payments, a fractional part of his Social Security payment amount was classified as taxable. In that year he received a gross distribution on his military pension of $28,822 which was entirely classified as taxable but he only had $20 of withhold. He did not file a 2011 return.

Back in 2011 the IRS would send taxpayers substitute returns when they did not file and the IRS has third party information indicating a taxable return. Of course, we know that today, Mr. Bruce might not receive anything from the IRS. As is typical in substitute for return cases, the IRS sent Mr. Bruce correspondence in which it calculated his 2011 liability based on the information available to it, waited for him to respond and when he did not it sent a notice of deficiency. Since he did not file a Tax Court petition, the IRS assessed the liability and began sending him collection notices culminating in the CDP notice giving him a right to talk to Appeals about the proposed levy action the IRS intended to take on the almost $6,000 he owed in taxes, penalties and interest for 2011.

Mr. Bruce, now alert to the imminent danger, timely filed a CDP request stating that he did not have the funds to pay the balance and that it was his position that the pension was not-taxable.  He argued that the non-taxable nature of the pension payments mooted the collection case by eliminating the basis for the assessment. In addition to 2011, he had many other unfiled returns which Appeals sought before it wanted to talk to him about his levy problem. Appeals also told him a merits discussion was off the table because he had the chance to go to Tax Court regarding his 2011 liability when the IRS sent the notice of deficiency and he chose not avail himself of that opportunity. Eventually, Appeals issued a notice of determination denying Mr. Bruce relief from the levy.  He timely filed a Tax Court petition and the IRS filed a motion for summary judgment.

The Court goes through a pretty standard analysis of his failure to petition the Tax Court upon receipt of the notice of deficiency and how that precludes Mr. Bruce from challenging the merits of his tax liability at this time. I totally agree with the analysis and the outcome denying him a merits determination in his CDP case.

I was left wondering, however, about how his pension fits into levy side of the equation. I wondered what would have happened if Mr. Bruce had raised IRC 6334(a)(10) as a defense to levy against his pension during the CDP case. If he had done so it should not have changed the outcome of the case which would have allowed the IRS to levy because a CDP case is not an exemption from levy case. Even if his pension is exempt from levy, the IRS could still propose levy action, which is not a proposal against specific funds or income streams, and the Court would have, on these facts, sustained the determination. It is still possible, however, that depending on the nature of his pension it might restrict the funds upon which the IRS can levy. Does the taxable nature of the pension as it stands today waiting for his Supreme Court challenge automatically mean that the pension does not qualify for the levy exemption?

In order to resolve my questions about Mr. Bruce’s pension on the levy, I consulted with someone more expert than me and received the following advice about his situation as it interplays with military pensions.

In Mr. Bruce’s situation, the pension would not be exempt from levy under 6334(a)(10) because his pension results from his time of service in the military and not his disability and this will never change no matter what happens at the Veteran’s Administration. The situation is not, however, entirely straightforward and this is probably what has confused Mr. Bruce. To achieve the result that he seeks he needed to have gone through a disability review by the Army before he retired or seek a retroactive review from the Army separate and apart from the review received from the VA. Because the review was done by the VA after retirement, he falls into a different scheme and his “regular” military pension remains taxable and subject to levy for the rest of his life. He does, however, receive other benefits that are not taxable and that are exempt from levy.

If a service member receives disability payments from the VA, his “regular” military retirement pay is reduced by the amount of his VA disability compensation (referred to as an “offset”). This happens if the service member’s disability rating falls between 10% and 49%. This offset portion of the ‘regular” pension would not be taxed under those circumstances but the other portion would still be taxed and still be subject to levy.

If a retired service member receives a “regular” pension from Defense Finance Accounting Service (DFAS) as well as disability pay from the VA at a disability rating of 50% or higher, the disability payment is added to his military retirement pay. This is called “Concurrent Retirement and Disability Pay (CRDP). This CRDP is exempt from levy under 6334(d)(10).


Retired service member “A” receives monthly retirement pension of $1,000, and has no disability rating. The entire $1,000 is taxable.

Retired service member “B” receives monthly retirement pension of $1,000, but has a disability rating of 30%. His disability compensation through the VA is $100. The DFAS pays him $1,000, but only $900 of it is taxable; $100 is not taxable.

Retired service member “C” receives monthly retirement pension of $1,000, but has a disability rating of 75%.  His disability compensation through the VA is $100.  The DFAS pays him $1,000, and the VA pays him $100.  He receives $1,100, of which $100 is not taxable.

From the available information it would appear that Mr. Bruce receives CRDP because his disability rating greater than 50%.

It also appears that Mr. Bruce would receive the Individual Unemployability benefit, which allows the VA to pay certain veterans at the 100-percent disability rate even though their service-connected disabilities are not rated as 100-percent disabling. Veterans may be eligible for this rating increase if they are either unemployed or unable to maintain substantially gainful employment as a result of their service-connected disability. It is meant to compensate veterans unable to work because of service-connected disability or disabilities that do not meet the VA rating requirements for a total evaluation at the 100-percent rate.


So, Mr. Bruce’s regular military pension is now in the IRS crosshairs. The IRS may take 15 percent of it through the Federal Payment Levy Program as discussed in a recent post and it may take 15 percent of his Social Security pension.   Because his income level causes the IRS filters to stay away from the Social Security payments but those filters do not apply to his military pension even if he is low income, in his situation the IRS may only take from his “regular” military pension but not his Social Security Pension.

The CRDP payments and the Individual Unemployability benefit increase the funds available to veterans in a way that makes them a little different from Social Security recipients and other persons for whom the IRS has applied income filters. The complexity of military benefits may be what caused the IRS not to make an initial decision to apply its filters to these payments.  I have waded into deep water on the military pension issues and others more expert than me may be posting comments that will shed further light on this situation.



Getting Convicted of Tax Evasion Means No Discharge of the Tax in Bankruptcy

I wrote last spring about how a conviction for filing a false tax return, IRC 7206(1), provided a basis for denying a bankruptcy discharge on the basis of collateral estoppel. The recent decision in United States v. Wanland provides an example of a conviction for tax evasion, IRC 7201, which creates the same result.

At issue in the Wanland case is only the unpaid taxes and not the fraud penalties. The civil fraud penalty, like all tax penalties, can be discharged in a bankruptcy case when it becomes three years old, as discussed here. The IRS does not argue that anything keeps the fraud penalty from discharge but it does make good use of an argument regarding its levy to extend the years in which Mr. Wanland was charged with criminal behavior to earlier years to also prevent their discharge.


Mr. Wanland was an attorney. The recently decided case seeks to obtain a judgment against him for $1,065,493.30. He is representing himself in this litigation. On September 26, 2013, he was convicted of 28 counts of criminal tax violations. One count of 7201 evasion of payment, 24 counts of concealment of property subject to levy and three counts of 7203 failing to file tax returns.

Before he was convicted of the criminal tax violations, Mr. Wanland filed bankruptcy and received a discharge of his debts on June 8, 2011. Because of the bankruptcy discharge, Mr. Wanland argues that the IRS is collaterally estopped from raising the issue of his liabilities since it did not bring an action in the bankruptcy case to except his liabilities from discharge. The issue presented is one of first impression in the 9th Circuit though other courts have addressed it. Must the IRS affirmatively seek a determination regarding the discharge of taxes or does the exception to discharge of 523(a)(1), except the described taxes from discharge without the need for affirmative action.

The IRS takes the position that it does not affirmatively need to bring an action in each bankruptcy case to have the bankruptcy court make a determination regarding which taxes are and which taxes are not discharged. At the conclusion of each bankruptcy case the IRS makes its own determination regarding the impact of the discharge on the taxpayer’s liabilities. If the IRS determines that the taxes or penalties, were discharged, it will write them off its books and the taxpayer does not need to do anything to request that the IRS do so. If the IRS determines that the taxes are not discharged, it sends them back into the collection stream. If a taxpayer thinks that the IRS decision to send the taxes back into the collection stream is wrong, the taxpayer can sue the IRS for violating the discharge injunction and cause the write-off of the taxes if it wins.

Here, the IRS has gotten to the point in the collection of the liabilities against Mr. Wanland that it is bringing a suit to reduce the liabilities to judgment. That will cause the liabilities to hang around his neck basically forever, as we have discussed here. In his effort to ward off the suit, he argues that the IRS missed the time to object to the discharge of his tax liabilities and it cannot seek to collect them at this point.

The district court rejects his arguments citing to the decisions of other courts that have faced this issue.

“Debts listed in sections 523(a)(2), (a)(4) and (a)(6) are automatically discharged in bankruptcy unless a creditor objects to their dischargeability by fiing an adversary proceeding. Fed. R. Bankr. P. 4007 (advisory committee notes). A creditor who wishes to object to the dischargeability of a debt under sections 523 (a)(2), (a)(4) or (a)(6), must file a complaint within sixty (60) days of the first scheduled meeting of creditors. Fed. R. Bankr. P. 4007(c)… Those debts excluded from discharge not listed in sections 523 (a)(2), (a)(4) or (a)(6), including certain tax debts, are automatically excepted from discharge… As a result, a complaint to determine the dischargeability of a debt, other than a debt listed in sections 523(a)(2), (a)(4) or (a)(6), may be filed at any time. Fed. R. Bankr. P. 4007(b)”

Quoting In re Walls, 496 B.R. 818, 825-26 (N.D. Miss. 2013)(citation omitted); see also In re Range, 48 Fed. App’s 103 at 5 & n.2 (5th Cir. 2002)(unpublished).

There are 19 subparagraphs of Bankruptcy Code section 523. Only three of them have been singled out in the Bankruptcy Rules to require the creditor to affirmatively bring an action early in the case to determine discharge. The first two deal with types of fraudulent activity by the debtor and the third with willful and malicious action that causes harm. Because the particular provision that prevents Mr. Wanland’s discharge is a type of fraud, there is some basis for looking at taxes excepted from discharge under 523(a)(1)(C) to determine if they create a different situation that “ordinary” taxes. It would create an enormous burden on the IRS and the bankruptcy court to have the IRS objecting to discharge in every bankruptcy case in which the debtor’s taxes are excepted from discharge because the volume would be enormous. The IRS has historically been a creditor in about 40% of all bankruptcy cases meaning that these types of motions would be filed in hundreds of thousands of cases each year.

The number of cases in which the IRS excepts the taxes from discharge under 523(a)(1)(C), however, is quite small. It would not place a big burden on the IRS or the bankruptcy court if the IRS were required to come into those cases with a motion similar to the motion made in the cases of the three provisions cited. Nonetheless, the general rule regarding tax debts prevails here and the district court finds with the other courts looking at the issue that the IRS need not affirmatively file an objection to the discharge of this debt.

The decision does not surprise me. Once the IRS gets past the issue of whether it should have raised the issue during the proceeding, the court has no trouble finding that the debtor’s conviction serves to estop the debtor from arguing that the liability is excepted from discharge for the years of the 7201 criminal conviction which were 2000-2003. The court finds it a closer question whether the IRS can use offensive collateral estoppel to the 1996-1998 tax liabilities which were not included in the criminal case. The IRS presented evidence that it served a levy to collect taxes for 1996-1998 and 2000-2003. That levy was the levy upon which the criminal case was based because he concealed his assets to keep the IRS from receiving payment on that levy. Under the circumstances, the court finds that affirmative collateral estoppel works to prevent Mr. Wanland from arguing that the taxes for all of the years are not excepted from discharge. This is an interesting extension of the collateral estoppel effect of the bankruptcy case. The court could have reached the same conclusion without the need for collateral estoppel if it found that he was trying to evade the payment of his taxes for the non-criminal years.


Filing a Collection Due Process Petition Based on Denial of a Doubt as to Liability Offer

In Crim v. Commissioner, the Tax Court dismissed a case in which the petitioner sought to obtain Tax Court review of the rejection of the denial of an offer in compromise for doubt as to liability. The Tax Court dismisses the case because the petitioner did not have the statutory predicate for jurisdiction – a collection due process (CDP) determination letter. Petitioner argued that the offer rejection letter, which came from the examination division because the offer was a doubt as to liability offer “reflects a ‘determination’ sufficient to invoke the Court’s jurisdiction.” Petitioner sought to use the decision of the Tax Court in Craig v. Commissioner, 119 T.C. 252, 257 (2002), which held that a wrongly issued decision letter could form the basis for a timely petition where the IRS should have issued the taxpayer a determination letter, as a hook for similar treatment of the rejection letter he received from the IRS. The Court did not accept this argument.


The IRS rejected the doubt as to liability offer because the IRS does not have the ability in that process to compromise a liability previously determined by the Tax Court, other courts, or in a closing agreement. The liability petitioner asked the IRS to review was a restitution order for $17,242,806.57 issued by the United States District Court for the Eastern District of Pennsylvania resulting from Mr. Crim’s criminal conviction for conspiracy to defraud the United States under 18 U.S.C. 371 and the corrupt interference statute in IRC 7212(a). The IRS cannot compromise restitution orders whether the request comes in a doubt as to liability or a doubt as to collectability offer because the amount has been ordered by the district court. Mr. Crim’s underlying complaint concerns the timing of the change in the manner in which the IRS can collect on restitution orders. His criminal acts occurred prior to 2010, but in 2010 Congress changed the law to permit assessment of the restitution amount as if it were a tax and collection on that assessment as we have discussed here, here, and here. Mr. Crim views the change in the law as applied to him as violating the ex post facto clause of the constitution. The Third Circuit rejected his argument twice, here and here, as premature because the IRS had not tried to collect at that point.

The Tax Court performed its normal jurisdictional analysis. In addition, it looked at the Craig decision to determine if its decision in Craig could stretch to cover a letter from the examination division. The Tax Court determined that the letter sent to Mr. Crim rejecting his offer in compromise for doubt as to liability could not be construed to be a determination letter and that it lacked jurisdiction over his case. The Court provided several reasons: 1) the letter did not come from Appeals; 2) the letter did not purport to sustain a notice of Federal tax lien or a proposed levy; 3) the record does not suggest Mr. Crim had requested a CDP hearing at the time the letter was issued; and 4) the record does not suggest the IRS had issued a levy or filed a NFTL. The Court went on to apply Craig to this situation and point out that in Craig, the Appeals Office made a mistake in a “real” CDP case and issued the wrong letter, but here there is no CDP case which would allow the Court to construe the letter sent to Mr. Crim as a mistake.

Finally, the Tax Court addressed Mr. Crim’s argument that the 3d Circuit told him that he could raise his ex post facto argument if the IRS seeks to collect from him and that the statement by the 3d Circuit should allow him to come to Tax Court to make that argument. The Tax Court pointed out that the 3d Circuit did not, and could not, open the doors of the Tax Court for him to bring a case at any time. He needed to have the proper prerequisite in order to do so, and he did not have it yet.

Nothing about the decision is surprising. The nine page order goes into greater detail explaining why the Tax Court lacks jurisdiction than I might have expected, but the case is one that may be one of first impression at the Court. Mr. Crim may be back if at some point the IRS takes the type of collection action that would allow him to invoke jurisdiction. At that time, he will have the chance to argue that individuals who committed their crimes prior to the change in the law in 2010 regarding assessment of restitution orders should not apply in his circumstance. In the meantime, maybe others in his situation will make the argument and establish precedent on this issue.


Trying to Limit a Federal Tax Lien through Confirmation of a Chapter 13 Plan

A Chapter 13 plan usually gets confirmed with 60 to 90 days after a debtor files bankruptcy. It often involves fairly boilerplate language, but it is binding on the debtor and the creditors. Because of the relatively high volume of these plans and their relatively routine nature, the IRS does not always pay sufficient attention to these plans. In Nomellini v. United States, the debtor pointed to his plan language and argued that it limited the federal tax lien filed against him. The district court affirmed a bankruptcy court determination holding that the plan did not disrupt the federal tax lien. The decision does not break new ground but does point to the potential power of confirmation to impact tax debts even if the discharge does not eliminate them.


Mr. Nomellini owed taxes for several years and the IRS filed a notice of federal tax lien before he filed bankruptcy. In the bankruptcy case, the IRS filed a claim listing only $10,000 of its almost $200,000 claim as secured because the IRS adopted the values listed in debtor’s schedules showing his property and his secured creditors. The plan stated that “the valuations shown above will be binding unless a timely objection to confirmation is filed. Secured claims will be allowed for the value of the collateral or the amount of the claim, whichever is less…. The remainder of the amount owing, if any, will be allowed as a general unsecured claim paid under the provisions of paragraph 2(d).”

The plan made no mention of the IRS lien nor did it state that the IRS lien would be avoided. Although the debtor filed motions to value and avoid the liens of two other creditors, he did not do so with respect to the IRS lien. The plan provided that the real property owned by the debtor would re-vest to him at the time of the discharge or dismissal of the case. At the time of filing the bankruptcy case, the debtor valued his property at $950,000. Two years into the plan, the debtor asked for permission to employ a real estate agent and list the property for $1,800,000. Not long thereafter, the debtor obtained a contract for $2,175,000. I pause here to mention that this has never happened to me and I am jealous.

The debtor proposed that after paying off other debts based on their priority, over $1M of the sale proceeds would come back to the debtor. At this point, the IRS amended its claim to file a fully secured claim for $214,552 based on the NFTL it filed prior to the bankruptcy petition. The debtor objected to this amendment, arguing that the IRS was stuck with the plan language quoted above which limited its lien interest in the property.

The court found that the plan did not alter the lien rights of the IRS. While the plan binds the parties, the issue of what the plan covers still exists. It stated that a plan “should clearly state its intended effect on a given issue. Where it fails to do so, it may have no res judicata effect for a variety of reasons: any ambiguity is interpreted against the debtor, any ambiguity may also reflect that the court that originally confirmed the plan did not make a final determination of the matter at issue, and claim preclusion generally does not apply to a claim that was not within the parties’ expectations of what was being litigated, nor where it would be plainly inconsistent with the fair and equitable implementation of a statutory or constitutional scheme.” Citing In re Brawders, 503 F.3d 856, 867 (9th Cir. 2007).

The court also found that the debtor should have brought an adversary proceeding in which the IRS would receive adequate notice of the attempt to limit its lien if that was the debtor’s intention. Because the debtor did not make clear that his intention was to limit the IRS lien, the court would not allow him to limit the in rem rights of the IRS with respect to the property to which its lien had attached. Creditors should receive adequate notice of efforts to limit their liens. Putting cursory language in the plan is not an adequate method for providing notice. The court pointed to the court rules that the debtor should have followed if he wanted to limit the lien. These types of rules not only protect creditors with large numbers of claims like the IRS, but also protect creditors who only occasionally have a matter in bankruptcy.

The debtor also argued that the court valued the secured claim of the IRS at confirmation in order to determine the feasibility of the plan. The court finds that the claim was valued but not the lien interest and rejected this argument as well.

This case demonstrates that in the 9th Circuit, and I think in most circuits, debtors will not be allowed to attack a lien without giving a creditor specific notice of the attack. This is good news for creditors, and especially creditors like the IRS who have a lien interest on all of the debtor’s property and will not have a realistic mechanism for valuing all of that property within the tight time frames of a chapter 13 confirmation. If a debtor puts the IRS on notice that it wants to attack its lien interest, then the IRS can gear up for a fight in an adversary proceeding and decide whether the fight is worth the effort. Losing a lien interest based on the language of a plan puts the IRS and many other creditors in a tough spot.

The case also shows that sometimes debtors can come out of bankruptcy in good shape. This is certainly unusual, but I have seen other cases in which the value of debtor’s property jumped or was improperly valued at the outset. Here, the bankruptcy allowed the debtor some breathing room with respect to his property and he reaped the benefit of appreciation rather than a foreclosing lienholder. Even though the debtor lost the fight with the IRS, the debtor still made out very well in this case.


Working Hard to Get Penalized

The case of Whitaker v. Commissioner, T.C. Memo. 2017-192 provides another example of a taxpayer who works hard to make sure that the IRS penalizes him. In the process, he drains resources at the IRS and the Tax Court. I have no great sympathy for the behavior, but it is a generally sad process to watch. In this case, it is especially sad because it appears that if the Whitakers had filed a proper return claiming the retirement distribution, they would have received back all of the withholding. They do not appear to have enough income to be taxed since their standard deduction and personal exemptions exceeded the amount of the pension. Unless there was other taxable income not reflected in the report of the case, they traded a $3,600 refund for a $10,000 penalty.

The opinion involves the imposition of the frivolous tax return penalty of IRC 6702(a). This is one of over 50 assessable penalties found in Chapter 68, Subchapter B of the Internal Revenue Code. Section 6702 entered the Code in 1982. Taxpayers making frivolous tax returns or frivolous submissions get hit with a $5,000 penalty. I have written about this penalty before here, here, here and here. What interests me about this case, and what has interested me before because it is hard to tell, is why Mr. Whitaker was permitted to litigate the merits of his 6702 penalty in a Collection Due Process (CDP) case. I believe taxpayers should have the right to litigate the merits of assessable penalties in CDP cases because they do not have the right to a prepayment forum; however, the IRS generally objects and the Tax Court sustains the objection based on the IRS regulations. I will discuss the issue further below, but I cannot tell why the IRS did not object to the litigation in this case. As an outside observer without all of the information driving the decision not to object, it is unclear to me why the IRS objects in some cases and not in others.

Additionally, the IRS can reject frivolous arguments in CDP cases; however, it can only reject cases based on frivolous submissions and not frivolous returns. Because Mr. Whitaker’s case involves a frivolous return described in 6702(a) rather than a frivolous submission described in 6702(b), the bar to making an argument in a CDP case does not preclude him from making his type of frivolous argument in this CDP case.


The Court lays out the three bases for the 6702 penalty: 1) “the taxpayer must have filed a document that ‘purports to be a return of a tax imposed by’ title 26;” 2) “the purported return must be a document that either ‘does not contain information on which the substantial correctness of the self-assessment may be judged’ or ‘contains information that on its face indicates that the self-assessment is substantially incorrect:’” and 3) “the taxpayer’s conduct must either be ‘based on a position which the Secretary has identified as frivolous’ or must ‘reflect a desire to delay or impede the administration of Federal tax laws.’”

The Court explains why Mr. Whitaker’s, and the actions of his deceased wife, meet the criteria of the statute. Basically, they kept submitting documents purporting to be returns that showed zero income and zero tax, but withholding which they wanted to use as a basis for obtaining a refund (a refund it looks like they were entitled to, had they properly listed their income.) The IRS conceded the penalty for one of the returns during the Tax Court case which may have influenced the Tax Court not to impose the 6673 penalty, which it had done in a prior case involving frivolous submission penalty, but the imposition of the penalty itself breaks no new ground. The Tax Court may have been influenced not to impose a 6673 penalty because of the apparent lack of a tax liability on the return had it been correctly filed and the sadness of the case.

We have written extensively on the efforts to litigate the merits of a tax liability before the Tax Court of individuals faced with large assessable penalties who have no easy, and sometimes no realistic, way to pay the penalty and bring a refund suit. The Whitaker case contains no explanation of why the taxpayer did or did not have an opportunity to bring the merits of the assessed penalty to Appeals at the time of the assessment and why that opportunity did not foreclose the opportunity to raise the merits of the penalty at the CDP stage of the case. Did the IRS fail to offer an Appeals hearing at the time it imposed this penalty? Did the IRS simply fail to object to raising the merits during the CDP process and allow a tax protestor to go forward with the merits litigation in Tax Court, tying up the resources of the Court and three Chief Counsel attorneys on what seems like a fairly wasteful case (though the concession of one of the three penalties suggests the existence of a partially meritorious suit)? Does the fact that the IRS allowed Mr. Whitaker to bring a merits case on his assessable penalty mean that other taxpayers should at least try to bring merits litigation in the CDP context hoping that they will be allowed to do so? I would like to know why the merits litigation was allowed here, and in other cases I occasionally see where I would have expected the taxpayer to have the opportunity to go to Appeals at the time of the imposition of an assessable penalty, when most taxpayers get turned away. The answer may lie in a simple failure to offer a conference with Appeals at the time of assessment, but it is unclear.

As mentioned above, another interesting feature of this case is that the IRS could have turned this case away from CDP consideration under the provision of IRC 6330((c)(4)(B) if his frivolous position were a “submission” rather than a “return.” This section precludes the taxpayer from raising an issue at a CDP hearing if the issue meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A). The bar to raising frivolous positions in CDP cases is intended to keep persons from using the CDP process to promote such positions. This case shows how the CDP process can still be used to promote a frivolous position as long as the taxpayer takes the position on a tax return, as Mr. Whitaker did, rather than on another type of document such as a CDP request. The case also points out the terrible result that can happen when tax protestor arguments are pursued.

Tolling the Statute of Limitations on Collection

I have written before about the ability of a Collection Due Process (CDP) request to toll the statute of limitations on collection and hold it open for the IRS to bring a suit to foreclose or to reduce the assessment to judgment. In the Holmes case, it was the request itself that held open the statute of limitations with some discussion of the failure of the IRS to timely act upon the request. The court there found that the request held open the statute of limitations even though the IRS did not act on the request within its ordinary time period.

In the case of United States v. Giaimo, No. 16-2479 (8th Cir. 4-17-2017), a similar issue arises, but here the concern is Tax Court petition she filed following the receipt of a CDP determination. The issue arises in a lien foreclosure case with the taxpayer arguing, similar to the taxpayer in Holmes, that the IRS did not bring the suit within the 10-year period of the collection statute of limitations. In order for the IRS to win, it had to show that Ms. Giaimo timely brought a CDP suit which tolled the statute of limitations on collection. She argued that she never intended to bring the suit and that the Tax Court petition was untimely filed. The 8th Circuit finds otherwise in an opinion that determines her CDP petition kept open the statute of limitations on collection.


How do you not realize that you are bringing a suit? Maybe a better way to frame the question in this case would be how do you make it clear why you brought a suit? The facts make it clear that Ms. Giaimo filed a Tax Court petition after receiving a notice of determination. She argues that her suit did not extend the statute of limitations on collection. The 8th Circuit, affirming the lower court, holds that it did.

Ms. Giaimo received a CDP lien notice and a CDP levy notice in 2005 with respect to her income taxes for 1992-1994. The assessment of the liabilities for these years was delayed by a bankruptcy and did not occur until 1999. The levy notice arrived first, in February 2005, which is normal and the lien notice arrived in April of 2005. She sent the IRS Form 12153, seeking to assert her right to a CDP hearing. The form was timely only with respect to the lien notice. The IRS treated the CDP hearing with respect to the levy as an equivalent hearing. At the conclusion of her discussions with Appeals, it decided that she should not receive the relief she wanted. Appeals issued a notice of determination with respect to the CDP lien notice, but a decision letter with respect to the levy because it treated that hearing as an equivalent hearing. She timely petitioned the Tax Court based on the notice of determination and eventually the Tax Court granted summary judgment to the IRS in 2007. The effect of requesting the CDP hearing with respect to the lien notice is to suspend the statute of limitations on collection from the time of the request until the conclusion of the Tax Court case – approximately two years.

Flash forward to 2011 and the IRS initiates a suit to enforce its lien and foreclose upon certain real property. Ms. Giaimo argues that the statute of limitations on collection expired in 2009, ten years after assessment, while the IRS argues that the statute of limitations on collection expires two years later because of the CDP hearing and Tax Court petition. To avoid the problem of having the statute suspended as a result of the Tax Court case, Ms. Giaimo argues that she brought the Tax Court case to contest the levy and not to contest the lien. The 8th Circuit suggests that her argument arises because of the interplay of IRC 6320 (the CDP lien statute) and 6330 (the CDP levy statute). If you look at the two statutes, you find that they do not mirror each other but rather 6320 borrows from 6330. Many of the CDP provisions reside in 6330, and 6320 basically says to go look at 6330 and follow the directions there. Picking up on the differences in the statutes, Ms. Giaimo argues that her Tax Court suit was based on the levy. Since it did not involve a challenge to the notice of federal tax lien, the statute of limitations on collection was not tolled by the Tax Court case.

The 8th Circuit does not buy what she was selling. It looks at the two statutes, it looks at her Tax Court petition, and it determines that the petition sought to challenge the only thing it could challenge – the CDP lien determination. Her Tax Court petition did reference the tax levy, but the 8th Circuit finds that “regardless of what other issues Giaimo impermissibly might have attempted to raise in her Tax Court appeal, she placed a challenge to the lien before the Tax Court….”

Additionally, she argued that her Tax Court petition was untimely. The IRS argued that the fact of the Tax Court jurisdiction is res judicata because of the decision in the case and cannot be collaterally attacked. The 8th Circuit does not accept this argument but looks at the case. It finds that the “presumption of regularity applies to a long-closed proceeding.” It says that Ms. Giaimo has a heavy burden to show that jurisdiction did not exist. Here, she signed the petition four days before the deadline, the Tax Court deemed the petition timely, she failed to challenge jurisdiction while the case was pending, she did not appeal the decision and she failed to collaterally attack the decision for many years. The court found that she did not carry her heavy burden.

She argued that the Tax Court entered her petition on its docket on the third day after the deadline for filing the petition. The 8th Circuit points to the mailbox rule to swat away this argument. She also argued that the IRS had the burden to come up with her envelope to show the timely mailing. The 8th Circuit finds that the IRS does not have such a burden in a case in which she raises the issue many years after the event.

There is nothing remarkable about the decision. Her arguments were somewhat unique. She argues on the opposite side of the argument most petitioners make, because she is trying to undo something that she set in motion. The case points again to a downside in bringing a CDP case without a plan. When a taxpayer makes a CDP request and files a CDP petition, their only plan at the time might be to delay the collection of the liability. If that is the plan, the request and the petition will work, but it comes with a price. She pays the same price as the petitioners in the Holmes case, which is that she keeps open the statute of limitations for the IRS to bring suit. In another recent post, Mr. Mayweather filed a CDP petition to delay collection but with a plan to use that time to collect his fight purse and pay off the liability. Filing the CDP request and petition can have many beneficial aspects but it has consequences, and thinking about those consequences before initiating the proceeding matters.



Clawback from IRS of Payment by Ponzi Schemers

In the case of Zazzali v. United States, the 9th Circuit has affirmed a lower court decision allowing the trustee in a bankruptcy of company that ran a Ponzi scheme to require the IRS to pay the money paid to it for taxes back to the bankruptcy estate for distribution to other creditors of the estate. The case involves Idaho’s Uniform Fraudulent Transfer Act as applicable through Bankruptcy Code section 544(b)(1), as well as the sovereign immunity provision of Bankruptcy Code section 106(a)(1). To win, the trustee needed to show that outside of bankruptcy an unsecured creditor could avoid the same transfer and that the sovereign immunity provision in the bankruptcy code did not prevent the ordering of a repayment from the government.


The company that engaged in the Ponzi scheme was set up as an S Corporation. While operating and while running the Ponzi scheme, it made tax payments on behalf of its shareholders. It paid the IRS over $17 million during the years of the scheme and the primary beneficiaries of the payments were the two principal officers of the corporation. The IRS ultimately refunded to these two men over $3.6 million in claimed overpayments on their individual returns.

When the corporation filed bankruptcy and a trustee was appointed, the trustee began bringing fraudulent transfer actions to bring money into the estate for the benefit of the unsecured creditors. In addition to pursuing the company insiders, the trustee went after the IRS and 25 states to whom taxes were paid. The appeal only involves the IRS.

The trustee used both the fraudulent transfer provisions of Bankruptcy Code 544(b)(1) and 548. Section 548 is broader in scope but more limited in time. Under that provision, the trustee recovered $58,000 from the IRS paid within two years of the filing of the petition and the IRS did not contest that claim. Section 544(b)(1), which relies on the state provision for fraudulent transfers, allows the trustee to go back four years from the petition, and that was where the high dollar transfers occurred.

The IRS argued that Congress had not waived sovereign immunity with respect to the 544(b)(1) claim. The Seventh Circuit, in an almost identical case, ruled for the IRS in the case of In re Equipment Acquisition Resources, Inc., 742 F.3d 743 (7th Cir. 2014). The 9th Circuit reaches a different conclusion.

Section 106 lists the bankruptcy code sections for which sovereign immunity is waived. Section 544 is one of those sections. The 9th Circuit holds that the waiver in section 106 is absolute and gets past the IRS concern that the type of fraudulent conveyance at issue here is one derived from a state statute. The view of the IRS is that because the trustee here relied on 544(b)(1), and through it Idaho’s Uniform Fraudulent Transfer Act, the government’s sovereign immunity precludes a claim based on state law. To get past the IRS argument, the 9th Circuit, affirming the decisions of the district court and bankruptcy court below, looks at the bankruptcy code as a whole and how the two provisions at issue here fit into the overall scheme.

The sovereign immunity provision at issue here was enacted after the enactment of section 544. This suggests that Congress knew what it was doing when it put 544 into the list of provisions for which sovereign immunity was waived and did not back into this situation.

The 9th Circuit also found that the IRS interpretation of section 106 and the interplay of the sovereign immunity provision there with the fraudulent transfer provision in 544 would nullify a portion of the statute. Using a rule of statutory construction, the 9th Circuit found that this interpretation should be avoided if possible, and here it is possible if the waiver of sovereign immunity is read broadly.

The 9th Circuit acknowledged that its opinion is at odds with the only other circuit court opinion and it writes further to explain why its interpretation is the better one. (Perhaps anticipating that the circuit split will result in Supreme Court review.) The 7th Circuit rests its opinion in the Equipment Acquisition case, upon the ground that private creditors could not use the state fraudulent conveyance statute to pry money out of the federal government. It viewed the trustee as standing in the shoes of the state creditors and did not believe that the broad statement in section 106 was intended to change non-bankruptcy law in such a way that allowed the trustee to have state law powers no private creditor had outside of bankruptcy.

The 9th Circuit finds that this is exactly what Congress intended when it passed the broad waiver of sovereign immunity. It recognized the unique position of the bankruptcy trustee and the need to recover money for the bankruptcy estate in a federal proceeding, albeit one based upon state law.

In addition to the argument regarding sovereign immunity, the IRS also argued, in line with the reasoning of Equipment Acquisition, that the 9th Circuit’s interpretation ran afoul of the Appropriations Clause and the Supremacy Clause. These provisions would potentially stop a private creditor outside of bankruptcy even if sovereign immunity did not. The 9th Circuit says no Appropriation Clause violation exists because the trustee is not taking money out of the Treasury but rather recovering money where a transfer is “voidable under applicable law.” With respect to the Supremacy Clause concerns, the 9th Circuit finds that because bankruptcy is a federal cause of action, this situation is not a state wielding power over the federal government.

I do not know if the IRS will pursue this issue into the Supreme Court but would not be surprised if it did. There is a fair amount of money in this case and these types of cases sadly come up with some regularity. The result here is not one that bothers me from an equitable standpoint. It does not seem right for the IRS to keep money stolen from individuals where the tax is essentially a tax on the ill-gotten gains. I feel better if the money goes back to the individuals who suffered the loss and the IRS does not receive what amounts to a type of windfall. Sometimes victims or agencies representing the victims make constructive trust arguments in these types of situations. Whatever the argument, it makes sense to try to get the money back to the victims if possible. I hope that the litigation does not cause all of the money to end up in the hands of the lawyers to the exclusion of the victims.