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.

 

Where Does Designation of Payment Fall in the List of Items Appeals Must Verify in a Collection Due Process Case

The recent case of Au v. Commissioner sort of raises the issue of verification in a Collection Due Process (CDP) case.  I say sort of because I read the case to raise that issue but it does not appear that the parties or the Court viewed the case as raising this issue.  Because of the way the pro se taxpayer presented the case, the Court did not focus on the issue of verification but rather on the taxpayer’s failure to follow through by providing information the IRS requested.

Section 6330(c)(1) requires that Appeals verify that all “requirements of any applicable law or administrative procedure have been met.”  Mr. Au was unrepresented in the Tax Court case and probably in the CDP hearing as well.  The IRS had assessed a trust fund recovery penalty (TFRP) for unpaid employment taxes at a business where he was a principal.  The opinion says that he attached to the Form 12153 requesting the CDP hearing a statement “I request that the equivalent hearing be held in the jurisdiction of Honolulu, Hawaii.”  On the form itself he requested “(1) a CDP hearing or an equivalent hearing; (2) an offer-in-compromise (OIC); and (3) a lien discharge.”  My guess is that Mr. Au did not have a clear picture of what he was requesting.  It appears that he said nothing about application of payments on the TFRP when he submitted the Form 12153.  Despite the conflicting language in his request concerning whether he sought a CDP hearing or an equivalent hearing, the IRS and the Court treated his timely filed request as one seeking a CDP hearing.  The IRS issued a determination letter upholding the proposed levy action, he timely petitioned the Tax Court and it sustained the IRS determination.  In doing so, the Court does not address whether Appeals had a duty to verify the proper application of payments.  This post will explore that duty.

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Part of the opinion deals with the issue of whether he could get a face to face hearing in Hawaii and the opinion finds in essence that he waived his chance for such a hearing by not responding to Appeals offer for such a hearing in a timely fashion.  I will not spend more time on that issue but the case suggests by implication that giving a taxpayer 15 days to make the request for a face to face hearing is sufficient.  That request came early in the case and the time to respond passed before he made his desire clear.  It does not appear that the request to have the hearing in Honolulu contained in his request for a CDP hearing provided any benefit to him in seeking to have the face to face conference.

In his initial correspondence with the Settlement Officer after the submission of the Form 12153, Mr. Au asserted “that he had made voluntary payments of over $300,000 that the IRS should have applied against his TFRPs.”  Appeals issued a determination letter upholding the IRS decision to levy to collect the taxes.  Mr. Au renewed his argument about designation at the CDP hearing before the Tax Court.  The Court found the following:

Generally, a taxpayer must raise an issue at a CDP hearing to preserve it for this Court’s consideration.  Gianelli v. Commissioner, 129 T.C. 107, 115 (2007); sec. 301.6330-1(f)(2), Q&A-F3, Proced. & Admin. Regs.  The merits are not properly raised if the taxpayer mentions an issue but fails to present Appeals with any evidence regarding that issue after being given a reasonable opportunity to do so.  See Delgado v. Commissioner, T.C. Memo. 2011-240; sec. 301.6330-1(f)(2), Q&A-F3, Proced. & Admin. Regs.

There is nothing in the record to show that petitioner provided any evidence to Settlement Officer Cochran in regard to this issue.  Settlement Officer Cochran gave petitioner sufficient time to submit evidence of his alleged designation, but he failed to do so.  Instead, petitioner simply made unsupported statements that he had properly designated the application of voluntary payments against his TFRPs.  Accordingly, we find that petitioner did not properly raise this issue during the CDP hearing, and therefore he cannot dispute this issue before this Court. (emphasis added)

I wrote recently about the concept of variance in CDP cases.  The concept clearly relates to affirmative issues a taxpayer seeks to raise such as collection alternatives to levy, e.g., OIC or Installment agreement, whether the taxpayer can contest the underlying merit of the liability or raise innocent spouse status.  Section 6330(c)(1) is not clear, however, about what must be verified.  Is the proper application of a payment something that the IRS must verify as part of its administrative practice or is it an affirmative matter the taxpayer must properly raise or is it something in the middle?

In Lee v. Commissioner, a full T.C. opinion decided earlier this year, Judge Wells confronted the issue of verification in a TFRP case. Les wrote about this case. The Lee case does not specifically address the designation issue and whether it is a matter subject to verification but it does give some additional definition concerning verification in the TFRP context. The discussion of verification in Lee supports the view that Appeals has an affirmative responsibility to verify in these cases even if it left open all of the possible issues included in the verification process.

Designation of payment comes up frequently in TFRP cases because the responsible person making payments to the IRS on their own behalf or through the entity wants to have the payments applied to the portion of the liability for which the responsible person bears personal responsibility in order to eliminate or reduce their personal exposure. Most TFRP cases involve unpaid employment taxes and that appears true in Mr. Au’s case. When a corporation fails to pay its employment taxes, the unpaid taxes include both withheld income and social security taxes owed by the individual employees of the business as well as the employer portion of the employment taxes (basically half of the social security and Medicare taxes.) The TFRP imposes a personal liability on responsible persons of the corporation only for the withheld taxes that the corporation holds for the IRS in trust and not for the employer portion of the employment taxes. Frequently, responsible persons, or potentially responsible persons, will individually pay or cause the corporation to pay a portion of the outstanding employment tax liability and will designate that the IRS apply the payment to the trust fund portion of the outstanding liability in order to reduce or eliminate the TFRP. The IRS position of designation resides in Revenue Procedure 2002- 26 where IRS states that it will apply a voluntary designation from taxpayer in the manner requested by the taxpayer. Issues concerning designation usually turn on whether the payment was voluntary or the designation was clear. The Revenue Procedure and the process for designation suggests that the issue of designation makes the case more clearly a verification issue than a merits issue.

Judge Vasquez treats designation of payment as a merits issue and applies the regulation to deny the taxpayer the opportunity to raise the issue before the Court since he raised but did not pursue the issue before Appeals.  I find the issue a close one.  I would not necessarily advocate that Appeals should have to verify in each case whether the taxpayer designated the application of his payments and whether the IRS properly followed the designation request; however, if the taxpayer raises that the IRS has improperly followed an administrative practice, it seems that the IRS should have the duty to at least take a look and go as far as it can on this issue.  Without help from the taxpayer in the form of a copy of the correspondence or other indicia of designation, the IRS may not be able to determine if its administrative procedures were properly followed but it could take a look.  The statute may require it to do so.

This was not a small matter or a case where designation had no impact.  If the responsible officer has paid $300,000 on a trust fund or employment tax debt, it should be possible for the Appeals employee to go into the system of the IRS and take a look at those payments.  With that amount of money at issue, it is also possible that a revenue officer was involved in the collection of the tax.  Should the Appeals employee affirmatively charged with verifying the correctness of the IRS in following its administrative procedures have a duty in a CDP case to look to see if the IRS properly applied the payments where the taxpayer alleges it did not do so?

I think the Appeals employee did have some responsibility to verify that the IRS properly followed administrative procedures regarding the application of payments as a part of the verification process.  Therefore, is seems that the Court should have looked at that verification rather than simply denying the taxpayer any review of this issue because he did not provide sufficient information to the Appeals employee.  The Court may well have ended up back at the same result because the Appeals employee could not find any designation by the taxpayer in the IRS records and therefore verified that the IRS followed procedures based on the information available; however, that would seem a better result under the statute than treating this as a merits issue on which the taxpayer bears complete responsibility.  Because the issue of designation may require something more than just looking at IRS records, it straddles a line between the duty of the IRS and the duty of the taxpayer leaving an unclear picture of the responsibility of each.

The Au case appears to present an issue of first impression, but the Court delivers it in a non-precedential memo opinion.  Because the taxpayer was pro se, both Appeals and the Court were at a disadvantage in dealing with the issue.  Congress did not clearly define the scope of section 6330(c)(1).  This opinion does nothing to clear the waters.  Since the opinion does not bind the judges on the Court by setting precedent, others arguing that IRS has not properly posted designated payments should raise the argument that the Appeals employee has a duty to verify the proper posting of payments pursuant to section 6330(c)(1).  Providing information and assistance to Appeals in verifying the proper application would help in reaching the correct result.