Unpacking the Collection Due Process Case of Melasky v. Commissioner Part 2: The Payment

As discussed in two prior posts, the Tax Court issued two opinions in the Collection Due Process (CDP) case involving the Melaskys. In 151 T.C. No. 8 it issued a precedential opinion holding that a challenge to the crediting of payment is reviewed pursuant to an abuse of discretion standard and not de novo. In 151 T.C. No. 9 it issued a fully reviewed precedential opinion addressing the collection issues raised in the case before sustaining the determination of the Appeals employee and allowing the IRS to move forward toward levy. See our prior posts on the case here and here.  In this second post on the second opinion, the issue discussed concerns the attempt to make a voluntary payment. The majority decided that the attempt fails leaving the taxpayers with outstanding debt on more recent, but still old, years.

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The Melaskys owe taxes for many years dating back to 1995. Over the years from 1996 until they filed their CDP request in 2011, they made various attempts to settle the debt through offers in compromise (OIC) and installment agreements (IA). They had also made at least one designated payment of a lump sum to one of their more recent tax years.

On Thursday, January 27, 2011, the Melaskys hand-delivered a check for $18,000 to the IRS office in Houston handling their case, directing the IRS to apply the check against their 2009 income tax liability. On Monday, January 31, 2011, the IRS Campus Collection function in Philadelphia issued a levy to the same bank on which the check was drawn. The levy caused the bank to place a 21 day hold on their account and the hold occurred prior to the payment on the January 27th check.

Regular readers of this blog know that a taxpayer can make a voluntary payment and direct the IRS where to apply the check; however, if the IRS collects funds involuntarily the IRS can decide where to apply the levy proceeds and it does so in a manner that best protects the government. We have discussed the general issue of the voluntary payment rule here, here and here.

There are many reasons for a taxpayer to want to make a voluntary payment. In the employment tax context, a corporate taxpayer will almost always want to designate a payment to outstanding trust fund portion of the liability in order to protect corporate officers from the trust fund recover penalty found in IRC 6672. For individual income taxes such as the ones at issue here, taxpayers almost always want to designate payments to the most recent tax years, or the most recently assessed tax years, in order to obtain the possible benefit of older periods falling off the books due to the statute of limitations on collection or due to positioning for a bankruptcy petition in which the priority rules of bankruptcy will allow discharge of older tax years. Whatever was motivating the Melaskys, their strategy followed the normal pattern for taxpayers with multiple periods of outstanding tax liabilities.

The abnormal aspect of this case results from the timing of the levy vis a vis the voluntary payment. While I imagine that this fact pattern may occur in other cases, it would not occur often. The fact pattern also raises the question of whether the IRS sought to levy quickly after receiving a check in order to reorder the application of payments. The court addresses whether the voluntary submission of the check prior to the levy on the bank account permits the Melaskys to designate the application of the payment here or whether the fact that the payment to the IRS actually comes via the levy rather than the check allows the IRS to post the payment to the earliest outstanding liability.

On the same day that the IRS issued the levy to the Melaskys bank, it also sent them a CDP Notice for the years 2002-2003, 2006, 2008 and 2009. They timely requested a CDP hearing and subsequently petitioned the Tax Court upon receiving an adverse determination letter from Appeals. The Tax Court found two issues in the CDP case: (1) did the IRS abuse its discretion in not treating the check as a voluntary payment and (2) did the IRS abuse its discretion in rejecting a proposed installment agreement. Part 3 of this series will focus on the installment agreement aspect of the case while this post focuses on the voluntary payment issue.

The court notes that “a payment by check is a conditional payment because it is subject to the condition subsequent that the check be paid upon presentation to the drawee.” It also notes that delivery of a check does not discharge a debt. Anyone who has ever received a bad check can easily identify with that rule. If, however, a check is honored the payment relates back to the time of delivery of the check.

Here, the bank never honored the check because by the time it went to clear the account had no funds. Since the check did not clear, it could not constitute payment and since it did not constitute payment, any instructions regarding what to do with the payment because irrelevant. The court found that “taxpayers may direct the application of a payment only if payment occurs.” This seems like a rather straightforward application of the law but the petitioners want equity and not law. They argued that the Tax Court should create an equitable exception for situations in which the check does not clear due to that actions of the IRS.

The Melaskys cited no authority for the adoption of such an equitable rule which is not to say they cited no authority. The court finds no reason to create an equitable exception to the normal rule of allowing designation only if a payment occurs. The IRS levy appears procedurally sound in its execution and logical in its use given the long history of non-payment. The court states that “Respondent did not cause petitioners’ check to bounce; petitioners’ check bounced because they owed and have chronically failed to pay various taxes, a portion of which was collected by levy after respondent’s man attempts at compromise failed to reach a voluntary resolution.”

On this point Judge Homes raises a vigorous dissent; however, he makes clear in footnote 6 that his dissent is not grounded in equity.  One could almost get the feeling equity is a bad word here. As an aside, you may be wondering how Judge Holmes can even participate in a fully reviewed opinion since his term as an appointed Tax Court judge ended on June 29, 2018, causing him to assume senior status while Congress works through its amazingly quick appointment process to approve his reappointment. Because he is the trial judge in this case, he is allowed to participate in court conference on this case and to have his voice heard in the fully reviewed opinion.

Judge Holmes has concerns that the majority’s failure to create an equitable rule in this situation stems from the incredibly bad tax payment behavior exhibited by the Melaskys across the decades leading up to this opinion. On the point of his dissent, Judge Lauber writes a spirited concurring opinion in which he is joined by several judges. Judges Buch and Pugh write a narrow concurring opinion pointing out that on the facts of this case it appears the IRS followed all procedures but on similar facts it might be possible to find that the levy interfered with the attempted voluntary payment. All in all, the opinion gets very long because of the depth of the disagreement and the Tax Court shows more fractures in its personal relationships than we might normally observe. For this inside glimpse, you might read the entire opinion.

In footnotes, Judge Holmes raises interesting points about the IRS hitting the Melaskys with a bad check penalty. He expresses concerns about whether in doing so it followed the requirement of IRC 6751(b) to obtain proper approval and why it would impose such a penalty when IRC 6657 has a good faith and reasonable cause exception. It’s hard to imagine how this penalty would apply on these facts when they tendered payment with sufficient funds in the account and had no reason to know of the impending levy. Because the amount is small relative to the overall liabilities and maybe because of the timing of the imposition of the penalty vis a vis the CDP case, the Melaskys did not raise an objection to the imposition of this penalty. So, that issue will wait for another day.

Judge Holmes finds that the Appeals employee handling the CDP case did not provide an adequate explanation of the basis for concluding the payment did not meet the voluntary payment rules and, therefore, the court should remand the case. The primary concern raised by Judge Homes brings in the Chenery doctrine which binds the agency to the reasons expressed for its decision. He provides a detailed analysis of federal tax cases regarding the timing of application of payment when made by check. The concurring opinion does not spend much time addressing this collection of cases but focuses on Judge Holmes analysis of contract law and the interference the levy created with the ability of the Melaskys to complete performance of the payment of their check.

While Judge Holmes acknowledges that the parties had no express contract he points to the Melaskys’ reliance on Rev. Proc. 2002-26. He proposes a bright line rule that if the IRS causes a check to bounce the taxpayers should receive the benefit of the voluntary payment rule. The concurring opinion pushes back hard on the use of contract principles, the application of the Chenery doctrine in the way described by Judge Holmes and in the idea that the Appeals employee did anything wrong in making his decision. As always I learned a lot by reading Judge Holmes dissent but I am persuaded here that the majority got it right. Whether the IRS inadvertently caused the attempted voluntary payment to fail or the cause had been some third party, the failure of the check to clear keeps a taxpayer from gaining the benefits of the voluntary payment rule. As the concurrence points out, the Melaskys could have obtained a cashier’s check had they wanted to make sure the funds were in the account when the IRS sought to cash the check. That may be the greatest lesson for those seeking to make a voluntary payment and who want to avoid unpleasant surprises.

 

Unpacking the Collection Due Process Case of Melasky v. Commissioner Part 1: The Delay

The Tax Court issued two opinions in the Collection Due Process (CDP) case involving the Melaskys. In 151 T.C. No. 8 it issued a precedential opinion holding that a challenge to the crediting of payment is reviewed pursuant to an abuse of discretion standard and not de novo. See our post on the case here. In 151 T.C. No. 9 it issued a fully reviewed precedential opinion addressing the collection issues raised in the case before sustaining the determination of the Appeals employee and allowing the IRS to move forward toward levy. As discussed more fully below, this case took way too long to resolve. We suggest that it serve as a sign that the process needs to change in order to go back to its original design.

I acknowledge that by suggesting the system move more quickly some low income taxpayers who gather information slowly may be disadvantaged.  The IRS already closes cases based on lack of taxpayer responsiveness – and it should.  Except for taxpayer who seek to use CDP to delay, I think that quicker movement by Appeals and the Court actually benefits most low income taxpayers because they stay engaged in the process.  When their case goes on the shelf for six months or a year, they disengage.  At the Appeals stage taxpayers generally have a relatively short time to reengage and that hurts low income taxpayers.  I would rather see early engagement with a slightly longer time to respond.

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The Melaskys filed their Tax Court petition on May 21, 2012. The Tax Court rendered its opinion on October 10, 2018. That’s way too long. When Congress created CDP it only gave taxpayers 30 days to file their request for a CDP hearing after the mailing of the CDP notice and only gave taxpayers 30 days to file their Tax Court petition after mailing of the CDP determination. The extremely short time frame provided to taxpayers in CDP cases reflected Congressional intent that these cases move quickly because delay in collection often proves fatal to successful collection. Congress placed no time limits on either Appeals or the Tax Court even though it placed these tight time frames on taxpayers. Carl Smith and I wrote about the disparity in a pair or articles, here and here, back in 2009 and 2011 analyzing that both Appeals and the Tax Court took longer to resolve CDP cases than deficiency cases. This could not have been what Congress intended. Since our articles, my non-empirical observation is that CDP cases may be moving faster in Tax Court because IRS counsel is filing more motions for summary judgment, the court rules require that they be filed earlier and the Tax Court disposes of most of the cases slightly quicker. The Melasky case shows the opposite side of the coin.

The Tax Court has decided not to adopt procedures that would move CDP cases on a faster track than deficiency cases. This case provides a perfect demonstration of why Bryan Camp calls CDP the 11th Taxpayer Bill of Rights provision – the right to delay. Appeals also has not created procedures that fast track CDP cases. Maybe it’s time to rethink the process and move these cases through the system with the speed Congress anticipated. Congress would not have anticipated it created a process that caused a case to take almost six and ½ years to work its way through the Tax Court to the point of an opinion.

Can it be so hard to move CDP case quickly through the system of Appeals and Tax Court review? In addition to the six plus years this case has spent in Tax Court to this point, the case spent 14 months in Appeals. Taxpayers filed their CDP request on February 9, 2011. Appeals held the initial hearing over six months later on August 25, 2011. The hearing occurred back in a bygone era when taxpayers could obtain a face to face hearing. I read that part of the opinion with nostalgia wondering how they received a face to face meeting until I looked at the dates. Appeals issued the notice of determination on April 20, 2012.

These taxpayers were no strangers to collection by the time they made their CDP request. They have liabilities going back to 1995 with multiple proposals for offers in compromise and installment agreements strewn along the way. Maybe it took six months just to send their undoubtedly voluminous collection file over to the Appeals Office but it seems that Appeals could create a system of moving these cases quickly into hearing. CDP was loosely modeled on CAP appeals which are to take place within five business days after the request. That time frame would not allow Appeals to perform the verification required by the statute but it should not take months to engage in the verification and the evaluation of taxpayer’s collection proposal.

The Appeals employee working this case gave the taxpayers months to liquidate their assets. As will be discussed in Part 3, taxpayers failed to liquidate all of their assets and that ultimately led to the determination to sustain the levy. The taxpayers here were able to actively delay the case because Appeals lacks a triage system. Appeals needs to adopt a triage system that gets to the taxpayer quickly to engage in a conversation about what is expected and necessary for a successful outcome. Then it can perform its verification and balancing while the taxpayer provides the necessary information to support its request. Treat the initial hearing like a CAP hearing to get the process going. By waiting six months just to hold the initial hearing, the CDP process will necessarily move slowly. In our article from nine years ago Carl and I made the following proposals:

To carry out the intent of the creators of CDP for an expedited process, the authors propose that the tolling of the statute of limitations on collection end six months after the CDP notice is sent if the taxpayer makes a timely CDP request. However, the authors would not propose altering one current protection of the CDP statute that in no event can the collection period expire before the 90th day after the date on which there is a final determination by the IRS or the courts) in that hearing….

To address the issue of mounting interest and time sensitive penalties, another possible avenue for revision of the statue is to adopt a provision similar to section 6404 (b) to stop the further accrual of interest and penalties once the administrative portion of the hearing exceeds six months.

The Tax Court also could adopt procedures to move these cases faster. It could give the IRS 30 days to file the answer instead of 60 days. It does not take very long to deny everything. It could schedule a telephonic conference within 30 days of the case coming at issue and encourage summary judgment motions from the parties at that point. In our article seven years ago Carl and I made the following proposals:

We recommend that the Tax Court amend its rules and adopt procedures that foster the early movement of CDP cases through the court. Under a new rule in Title XXXII of the Tax Court Rules (perhaps Rule 335) Chief Counsel should be required to file within 14 days after the case is at issue (1) the administrative record and (2) a current literal transcript of the taxpayer’s account for the years at issue.

Following this filing, the court should either issue an order to show cause or an order for the filing of a report by the parties. This would require the taxpayer to state how the administrative record might be inaccurate or incomplete, and it would require both parties to state why the case should not be decided on the administrative record. This order should also note that supplementing the administrative record may be possible on a party’s request and any needed discovery should be raised with the court at that time. The parties should be given a relatively short time to identify any additional evidence they think is needed to supplement the record or to convince the court that additional discovery is necessary We recommend that the period for the parties to respond to the Court’s order be no more than 30 days.

This case should be a wake-up call that the CDP process is broken and that in 20 years the players have not taken steps to avoid making it Collection Delay Process instead of Collection Due Process. Of course a fraction of the cases will take more time to resolve but none should take six and ½ years and the vast majority should be resolved within months and not years allowing collection to proceed when needed and stop when appropriate. Cases involving a merits or an innocent spouse determination would obviously move on a slower track more in line with regular cases of those types while pure collection cases would get resolved quickly to allow the process to work as intended.

 

Upcoming Appellate Arguments on Cases PT Has Blogged

Frequent guest blogger Carl Smith keeps us up to date with many items that he tracks. Carl is headed to Hawaii for a well-deserved vacation from his busy retirement but before he left he provided us with an update on a number of cases on which we have previously reported. Because we usually pick cases of some importance on which to write, it is not surprising that many of them continue on past the initial decision. For those interested in knowing what is happening on some of the cases on which we have blogged, Carl has left us with a guide to the cases moving forward to oral argument on appeal in the next couple of months.

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  1. The first case is one on which Les blogged here and here over two years ago. The issue in the case concerns the effect of fraud on the return by a third party and whether that fraud can hold open the statute of limitations even if the taxpayer did not commit fraud in filing the return. On Nov. 8, the 11th Cir. will hear the appeal of Finnegan v. Commissioner, T.C. Memo. 2016-188, in which the Tax Court held that the fraudulent conduct of a return preparer extended the SOL of 6501 indefinitely (per its Allen opinion).  The Tax Court refused to follow the Fed. Cir.’s BASR’s holding to the contrary, but which is possibly distinguishable as a TEFRA partnership case.  Frank Agostino will do oral argument for the taxpayers.  The DOJ argues that the Tax Court’s interpretation of 6501 is correct and that the taxpayers waived raising any argument that the Tax Court’s position in Allen is wrong. The briefs are here: Appellant; Appellee; Reply. We note in our earlier posts that fellow bloggers Jack Townsend and Bryan Camp think Allen is wrong. I happen to think it is right. Aside from obviously turning on the language of the statute, the issue is one of where should the focus lie. Should the IRS receive an unlimited time period within which to make an assessment because of the deceit on the return or should the taxpayer have a normal statute of limitations since the taxpayer did not engage in fraud even if the taxpayer benefited from the action. It would not be surprising to find that this issue eventually ended up in the Supreme Court.
  2. On Nov. 9, the 9th Cir. will hear oral argument in Crim v. Commissioner, one of the cases in which Joe DiRuzzo is arguing the Kuretski issue.  Carl blogged about the case here mentioning the forthcoming oral argument and providing links to the briefs. The Kuretski issue for those of you not following it closely involves the power of the President to remove Tax Court judges which raises issues of separation of powers depending on where the Tax Court lands inside the government. Is it a part of the executive branch as the D.C. Circuit determined in Kuretski making the removal provision constitutional sound or is it a part of one of the other two branches of government as signaled by the Supreme Court in an earlier case not involving the removal provision. Should the 9th Circuit decide to place the Tax Court in the Judicial or Legislative branch, this case to could end up in the Supreme Court.
  1. Any regular reader of PT knows that the most blogged about issue in 2018 involves the Graev decision and its many permutations. On April 4, 2018, Carl blogged about the RERI case which involves the application of IRC 6751(b) to penalties imposed on partnerships. On Nov. 9, the D.C. Cir. will have oral argument in this TEFRA partnership case, among whose arguments are that the IRS did not prove compliance with 6751(b).  This may result in getting a Court of appeals to accept the Tax Court’s holding in Dynamo Holdings that 7491(c) does not put the burden on the IRS to prove compliance with 6751(b) because TEFRA partnerships are not “individuals”.
  1. On Nov. 13, the 2d Cir. hears oral argument in Borenstein v. Commissioner. I blogged about this case here. The Federal Tax Clinic at the Legal Services Center of Harvard Law School together with the tax clinic at Georgia State filed an amicus brief in the Tax Court and again in the Second Circuit.  This case has to do with the Tax Court’s overpayment jurisdiction under 6512(b) in an odd fact pattern in which the taxpayer filed a late return seeking a refund. The timing of the refund falls into a legislative donut hole because she requested an extension of time to file her return.  The case will not have broad applicability though it is possible that others could fall into this potential trap. The issue requires parsing the language of the statute and discerning its meaning in the overall context of filing a late tax return which contains a refund claim.
  1. On Dec. 4, the D.C. Cir. will hear oral argument from Joe DiRuzzo (again) in the whistleblower case of Myers v. Commissioner. Carl blogged this case on May 21, 2018 in which he linked to the appellants brief and to the brief filed by the Federal Tax Clinic at the Legal Services Center of Harvard, but not the later-filed appellee and reply briefs).  The issue in this case concerns whether the IRS sent a valid determination letter to the whistleblower. In whistleblower cases the statute does not make clear exactly what must be sent to provide a ticket to the Tax Court. The IRS sent him by regular mail a series of letters, none of which said that he should file in the Tax Court if he disagreed.  After many months contacting various other people in government for help with his claim, Mr. Myers eventually took a flyer on filing a Tax Court petition.  The Court decided that each letter in the series had been a ticket to the Tax Court, and Mr. Myers had filed late — dismissing his case for lack of jurisdiction. Because Congress has created new jurisdictional bases for the Tax Court in whistleblower and in passport revocation without setting out the type and formality of correspondence that the IRS must send to provide the ticket to court, these types of cases are needed in order to sort out when to come to court. Because Mr. Meyers is pro se, he may be one of many unrepresented individuals who will struggle to pick the right correspondence if the correspondence does not clearly alert him to its importance as a ticket to court.

 

 

 

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.

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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 5.19.7.2.21.  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.

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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.

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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.

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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.