Another Jurisdictional Issue in Pfizer

Today we welcome Bob Probasco in his first guest appearance on Procedurally Taxing. Bob directs the Low-Income Taxpayer Clinic at Texas A&M University School of Law in Fort Worth. He has had a long and varied career in the tax world, having moved from accounting to tax law and most recently to teaching. In this post Bob describes the pending dispute over which forum a taxpayer can use to sue for overpayment interest. Christine

Carl Smith blogged earlier this year about the Pfizer case. The attention on Procedurally Taxing, and the amicus briefs filed by Carl and Keith in several cases, focused on an issue that could affect a large number of tax controversies: whether filing deadlines are “claim-processing” rather than “jurisdictional” rules and therefore can be equitably tolled. It’s an interesting and very important issue.

But there’s also a smaller issue Carl alluded to briefly, in an area with which some readers may not be familiar, that hasn’t received as much attention. The issue arises in lawsuits seeking overpayment interest under section 6611. The procedural differences might be of interest while we’re waiting for Second Circuit’s decision in Pfizer.

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Underpayment interest under section 6601, owed by taxpayers to the government on taxes and penalties that have not yet been paid, is explicitly treated as equivalent to the underlying tax for most purposes by section 6601(e)(1). (The exception is that underpayment interest is not subject to deficiency procedures.) Treating underpayment interest as equivalent to tax makes sense – assessment of additional tax will often result in assessment of underpayment interest and an abatement of tax will often result in abatement of previously assessed underpayment interest. But overpayment interest under section 6611 has no provision equivalent to section 6601(e)(1) and additional overpayment interest is “allowed” and paid rather than assessed.

If a taxpayer does not receive the overpayment interest to which it is entitled, how can the taxpayer challenge the IRS in court? If the tax overpayment was determined as part of a Tax Court case, the taxpayer can seek the court’s review of an erroneous determination of associated interest under Rule 261. But if the underlying tax overpayment was claimed on the original return (as in Pfizer) or a refund claim that is resolved administratively rather than in court, how does the taxpayer seek judicial review of an erroneous determination of overpayment interest?

Pfizer filed its suit under the jurisdiction (concurrent to district courts and the Court of Federal Claims) to hear tax refund suits, 28 U.S.C. § 1346(a)(1). But it’s not at all clear that provision applies to a stand-alone claim for additional overpayment interest. The jurisdictional provision applies to

Any civil action against the United States for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected, or any penalty claimed to have been collected without authority or any sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws.

With an action for additional overpayment interest, there was no assessment or collection – simply a failure to “allow” and pay.

The Sixth Circuit, in E.W. Scripps Co. v. United States, 420 F.3d 589 (6th Cir. 2005), concluded that courts do have jurisdiction under § 1346(a)(1) to hear a stand-alone claim for overpayment interest. It looked to the last part of the provision: “any sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws.” You may be wondering how the court concluded that a failure to allow and pay interest equates to overpayment interest that is “excessive” or “wrongfully collected.” The answer: “If the Government does not compensate the taxpayer for the time-value of the tax overpayment, the Government has retained more money than it is due, i.e., an ‘excessive sum.’”

I’ve never found Scripps very convincing, and to the best of my knowledge no other Circuit has reached the same conclusion. The government disagrees with Scripps and continues to challenge efforts to bring stand-alone claims for overpayment interest under § 1346(a)(1). That doesn’t mean taxpayers are without recourse, of course. Suit can be brought under the Tucker Act, which provides jurisdiction to both district courts and the Court of Federal Claims for

any claim against the United States . . . founded either upon the Constitution, or any Act of Congress or any regulation of an executive department, or upon any express or implied contract with the United States, or for liquidated or unliquidated damages in cases not sounding in tort.

Even better, the six-year statute of limitations under 28 U.S.C. §§ 2401 or 2501 applies to Tucker Act suits and there is no requirement to file a refund claim first.

So why didn’t Pfizer just claim jurisdiction under the Tucker Act, to avoid any question about jurisdiction? As you might expect, this was probably a case of forum shopping. The Tucker Act jurisdiction for the Court of Federal Claims, at 28 U.S.C. § 1491(a)(1), is not limited as to the amount of the claim. Pfizer wanted to bring suit in district court instead, where the Tucker Act jurisdiction (sometimes referred to as the “little Tucker Act”), at 28 U.S.C. § 1346(a)(2), adds a limitation: “not exceeding $10,000 in amount.” (Judges in the Court of Federal Claims have more experience with claims against the federal government than typical district court judges; the jurisdictional provisions funnel most large and complex disputes there instead of to district court.) But Pfizer was seeking more than $8 million. If there is any way to do that in district court, it would have to be § 1346(a)(1).

The district court in Pfizer followed Scripps and ruled for the taxpayer in a preliminary motion to dismiss based on whether jurisdiction was proper under § 1346(a)(1). But Pfizer’s suit was filed beyond the two-year limit of section 6532 and the court granted the government’s second motion to dismiss because the suit was not filed timely. On appeal, the government is challenging the first ruling and the taxpayer is challenging the second ruling.

In addition to the argument based on equitable tolling, the taxpayer is also making a second argument: no refund claim was required at all, and therefore section 6532 doesn’t apply. That seems odd when suit was brought under the jurisdictional provision we think of as governing refund suits, Section 7422, which requires a refund claim be filed first for any suit

for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected.

The language is almost identical to that in § 1346(a)(1) but the taxpayer argues the two provisions should not be interpreted the same way.

The Sixth Circuit agreed, in Scripps. The taxpayer had filed a refund claim timely but the court addressed section 7422 anyway. The government had cited a case suggesting a link between section 7422 and § 1346(a)(1). If so, since section 7422 and related provisions apply most naturally to refunds of “tax,” arguably § 1346(a)(1) also should be limited to “tax.” Certainly some requirements associated with section 7422, such as the “look-back” provision in section 6511(b)(2) and the Flora rule, would seem nonsensical for a stand-alone claim for overpayment interest. But the Sixth Circuit simply distinguished these two provisions that use virtually identical language:

. . . the two provisions serve different functions and thus have their own independent meanings. . . . Thus, even though a claim for statutory interest on an overpayment of tax might not fall within the scope of § 7422(a), this does not prevent statutory interest from being included with the ‘‘any sum’’ clause of § 1346(a)(1).

Will the Second Circuit rule for the taxpayer by following Scripps and also by concluding that the section 6532 statute of limitations either doesn’t apply or can be equitably tolled? If so, with two Circuits now giving an expansive reading to § 1346(a)(1), will more taxpayers be likely to file these claims – and other, non-tax claims – in district court instead of the Court of Federal Claims?

Or will the Second Circuit rule for the government? Will it conclude that Pfizer was “in the right place but it must have been the wrong time” (agreeing with Scripps that jurisdiction is proper in district court under § 1346(a)(1) but dismissing the suit as not filed timely) and/or “in the wrong place but it must have been the right time” (timely filing for a suit under the Tucker Act, but plaintiff didn’t claim that as jurisdiction and also needed to be in the Court of Federal Claims)? Pfizer might wind up in the Court of Federal Claims after all.

Designated Orders 12/18/2017 – 12/22/2017: Basis, Discretion to Reject Offers and Restitution Interest

Regular DO guest poster Professor Samantha Galvin of the University of Denver catches us up on some interesting designated orders during a busy pre-holiday week at the Tax Court. Les

The Tax Court issued seventeen designated orders the week ending December 22. Prior to reviewing them closely, I assumed it was a push to get a lot accomplished before the holidays and the end of the year, but nine of the seventeen designated orders (including three consolidated dockets) were issued in light of the Graev decision and many were discussed as part of Keith’s post here.

I discuss three of the eight non-Graev designated orders below. The five remaining orders not discussed involve: 1) a petitioner’s motion for reconsideration relating to a 6621(c) penalty (here and discussed briefly below); 2) a denial of a petitioner’s motion for summary judgment and motion to compel discovery (here); 3) a grant of respondent’s motion for summary judgment in a CDP case where petitioners’ failed to propose a collection alternative (here); 4) a denial of petitioner’s motion for reconsideration on a consolidated docket (here); and 5) a grant of respondent’s motion for summary judgment in a CDP case where a petitioner improperly attempted to raise an underlying liability (here).

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The issues discussed below include an interesting basis computation question when a seller transfers a partial interest in property to a taxpayer that improved the property prior to a subsequent sale to a third party, Appeals’ discretion to reject offers in compromise, and restitution interest abatement and res judicata.

Court Corrects Computations to Basis When There is an Interim Sale of an Interest in Property

Docket No. 021378-03, Stephen M. Gaggero v. C.I.R. (Order here)

It is rare for the Tax Court to grant a petitioner’s motion for reconsideration but it happened, in part, in two different cases two weeks ago. I only discuss this case. The other case involves a section 6621(c) penalty, but the motion is granted only to change certain phrases in the original opinion to reflect the Court’s intended meaning.

To be successful with a motion for reconsideration a petitioner must show that the Court made more than a harmless error pursuant to Rule 160. In this case the error in the original opinion, according to the Court, was a failure to understand that the sale of a share of property to a construction company in exchange for the construction company’s improvements made to the property should have been reflected in petitioner’s adjusted basis when he and the construction company jointly sold the property to a third party in a subsequent transaction. In essence the petitioner sought to add the FMV of the services he received from the constriction company to the basis for purposes of both the initial transfer of a partial interest to the construction company and on the subsequent third party sale.

This error could have been corrected using Rule 155 computations, but the parties cannot agree on the correct numbers. Pursuant to Rule 155(b) if the parties cannot agree, the Court has the discretion to grant them an opportunity to present arguments about the amounts so that the Court can determine the correct amount and enter its decision accordingly.

In this designated order, the Court looks to the closest analogous case which is Hall v. Commissioner, 65 T.C.M. 2575 (1993). In Hall it was held that, “the value of the carpenter’s services did not increase the sellers’ basis in the property for the sale to the carpenter but would increase the basis in the remaining share of the property on any later sale to a third party.” The parties cannot agree about the way the rule in Hall should apply to petitioner’s case. Petitioner argues that the portion of the property exchanged for the construction company’s services should increase his basis on both the partial sale to the construction company and the joint sale to the third party; whereas Respondent argues that the increase in basis should only apply on the joint sale to the third party.

The Court finds that respondent’s application of Hall is correct and the amount determined in the original opinion is not correct. The Court proceeds to go through a calculation using what it has now determined to be the correct amount.

The other findings and holdings from the original opinion are unchanged but require another attempt at Rule 155 computations, however, with the Hall-related dispute laid to rest hopefully the parties will agree going forward.

Offers and IRS Discretion

Docket No. 25587-15SL, Randolph and Jennifer Jennings v. C.I.R. (Order here)

In this designated order the Court is ruling on cross-motions for summary judgment. The case originates from a notice of determination issued after a timely requested CDP hearing on a proposed levy. Petitioners indicated that they wished to submit offer in compromise in their CDP request, but submitted the offer prior to the IRS acknowledging the CDP request and prior to the hearing. The settlement officer learned that the offer had already been submitted and waited for a decision from the offer unit before evaluating the proposed collection alternative.

The offer unit determined petitioners’ reasonable collection potential was higher than the amount of their offer, in part due to the cash surrender value of a life insurance policy. Following the offer unit’s reasoning, the settlement office also rejected the OIC but first allowed petitioners to increase the amount of their offer which would have required them to surrender the life insurance policy. Petitioners were not willing to surrender the policy, so the settlement officer issued a notice of determination sustaining the proposed levy.

Petitioners argue the settlement officer abused her discretion by not considering their poor health and limited employment opportunities, but the Court finds the offer unit considered these things. Petitioners did not propose a different collection alternative other than the offer.

The Court denies petitioners’ motion for summary judgment and grants respondent’s motion. The Court highlights the fact that accepting or rejecting an offer is within the IRS’s discretion and the Court does not interfere with that discretion unless it finds the decision is arbitrary. In this case it is not arbitrary for the IRS to sustain the levy because petitioners’ offer was rejected, petitioners refused to increase the offer amount, and they did not propose any other collection alternatives.

Restitution Res Judicata

Docket No. 12358-16, Debra J. Ray v. C.I.R. (Order here)

This case involves petitioner’s arguments that the IRS improperly assessed interest on her District Court ordered restitution and that the restitution had already been paid in full. Both parties have moved for summary judgment.

Petitioner was ordered by the District Court to make restitution payments after being convicted of criminal tax fraud for filing a false tax return. In that case, the District Court agreed to waive interest and applied a $250 credit toward the restitution. A few months after the District Court decision was made, petitioner paid the restitution in full and the U.S. Attorney filed a satisfaction of judgment with the District Court.

Then several things happened around the same time, the IRS: assessed liability for tax year 2000, assessed restitution and interest finding that petitioner had not fully paid the restitution, and applied her restitution payment toward the tax year 2000 liability.

The IRS issued a Notice of Tax Lien Filing on the restitution amount and interest. Petitioner timely requested a CDP hearing.

Petitioner claimed she had paid restitution in full. After clearing up confusion about whether the lien was filed on the restitution or liability amount, but instead of looking into underlying issue, the settlement officer agreed to withdraw the lien and placed petitioner’s account into currently not collectable status. The interest on the restitution was not abated and petitioner’s claim that she did not owe restitution was not considered.

Petitioner then appealed the CDP determination. The appeals officer examined petitioner’s case and determined that interest abatement was not appropriate since there were not any substantial ministerial or managerial acts that would warrant an abatement of interest. The appeals officer also determined that petitioner still owed $250 of restitution.

As for the interest component, the Tax Court had decided a similar issue in Klein v. Commissioner, 149 T.C. No. 15 (2017); Les discussed Klein in a post here, where he noted that Klein was an important case and one of first impression. The Klein opinion came out after the petitioner filed her petition but before her trial date. In Klein, after a thorough analysis, the Court held it did not have the ability to charge interest on restitution payments under section 6601. As a result of Klein, respondent concedes that petitioner should not be liable for interest on the restitution amount, but whether she still owes any restitution is at issue.

Since petitioner did not have an opportunity to raise the underlying restitution liability previously, the Tax Court’s review is de novo. The Court looks to the doctrine of res judicata which requires that: 1) the parties in the current action must be the same or in privity with the parties of a previous action; 2) the claims in the current action must be in substance the same as the claims in the previous action; and 3) the earlier action must have resulted in a final judgment on the merits.

The Court finds the requirements are met: 1) the parties are the same as both cases involve the petitioner and the government (albeit different agents of the government); 2) the claims in substance both involve whether petitioner paid the restitution required by the judgment; and 3) the satisfaction of judgment filed by the District Attorney is a final judgment which binds the IRS and extinguishes the IRS’s right to collect any additional restitution.

 

As a result, the Court grants petitioner’s motion for summary judgment and respondent is ordered to abate the restitution assessment and corresponding interest.

When Does Underpayment Interest Begin When IRS Retroactively Revokes Corporation’s Tax Exempt Status

A recent case in Tax Court, CreditGuard of America v Commissioner, considers how interest on underpayments applies when there is a retroactive revocation of a corporation’s tax exempt status. In so doing it walks us though the provisions that impose interest on underpayments.

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I will simplify the facts to get to the issue. IRS began examining CreditGuard of America’s Form 990 for 2002 back in late December 2003. Fast forward (or slow forward) 9 years or so to February of 2012, and IRS retroactively revoked its tax exempt status for years starting January 1, 2002.

In revoking its status, IRS informed CreditGuard of America (CreditGuard) that it was obligated to file corporate income tax returns for years starting in 2002. When CreditGuard did not file its corporate income tax return for 2002, IRS helpfully filed a substitute for return and a statutory notice of deficiency. CreditGuard eventually petitioned the Tax Court and agreed to a stipulated decision for a deficiency of about $216,000. The stipulaion stated that “interest will be assessed as provided by law on the deficiency in income tax due from petitioner.”

IRS assessed the tax and interest of about $142,000 on the deficiency. In calculating the interest, the IRS used the start date of the underpayment interest as March 17, 2003, the due date of the 2002 corporate income tax return.

When CreditGuard did not pay the tax or interest, IRS commenced administrative collection and filed a notice of federal tax lien. In response, CreditGuard filed a CDP request seeking an offer in compromise, but also challenging the interest computation. According to CreditGuard, interest should have only run from 2012– the date of the IRS’s revocation of its tax exempt status.

The CDP case allowed the court to get to the merits of the interest issue. As a threshold issue, the court held that there was no prior opportunity to consider the interest calculation; while the Tax Court had limited jurisdiction to order a refund if the party in a case believes it has overpaid interest that does not give the court the power to determine the correct amount of interest in the first instance.

Once clearing that hurdle, the court turned to the interest issue, one of first impression in the Tax Court, leading to this being a division opinion. The taxpayer’s essential argument was straightforward: it had no obligation to file a corporate tax return in 2003; in fact that obligation only arose 9 years later when IRS revoked its status.

While there is a superficial appeal to CreditGuard’s argument, the Tax Court held that the statute mandates that interest ran from 2003:

Under section 6601(a), interest runs from the “last date prescribed for payment.” Under section 6151(a), the “last date prescribed for payment” is the date “fixed for filing the return.” Because the date fixed for filing petitioner’s 2002 Form 1120 was March 17, 2003, these provisions indicate that petitioner must pay interest on the unpaid tax “for the period from such last date to the date paid.” See sec. 6601(a).

To deflect that statutory reading, CreditGuard argued that the interest provisions that apply to “taxes not otherwise prescribed” under Section 6601(b)(5) applied to revocations. That section applies to taxes “payable by stamp and in all other cases in which the last date for payment is not otherwise prescribed.” For those taxes, the “last date for payment” is the date the liability for tax arises, a date that CreditGuard argued pushed the interest start date to 2012.

The Tax Court disagreed, holding that the corporate income tax was otherwise prescribed with a deadline (as per Section 6072(b)), and in any event, even if it were not, the liability for the tax arose during 2002, not when the IRS revoked its status or when it agreed to the stipulated decision in the Tax Court.

The part of the opinion addressing when the tax arose is a little like a dog chasing its tail, but as our good friend Professor Bryan Camp discusses in a thoughtful blogpost on Taxprof  it highlights the difference between a liability and an assessment. The liability arose back in the year the corporate income tax return should have been filed; the assessment that followed the Tax Court’s decision did not alter the essential time when the liability arose.

The opinion’s statement that retroactivity has real consequences is important. Its citation to Bergerco Can. v. U.S. Treasury Dep’t, Office of Foreign Assets Control, 129 F.3d 189, 192 (D.C. Cir. 1997) and its discussion of those consequences situate the nature of the court’s view of the issue and why the IRS position was right as policy matter:

To be sure, “until we devise time machines, a change can have its effects only in the future.” …. But the purpose of making a change retroactive is to suspend reality and invoke a counterfactual premise. Here, the premise is that petitioner was not in fact tax exempt during 2002 but rather was a corporation subject to the regular corporate income tax. Because petitioner did not actually pay that tax on the date prescribed for payment, it is liable for interest beginning on that date.

After the language cited above, the opinion does drop a footnote to Section 6501(g)(2), which provides that for sol purposes a corporation’s good faith filing of a Form 990 “shall be deemed the return of the organization” for purposes of starting the period of limitations on assessment.” That is an important point, as IRS cannot revoke status for stale tax years (absent the sol remaining open for other reasons). Yet, as the opinion notes, the interest provisions are designed to compensate the government for the use of money. By agreeing with the IRS that it should not have been tax exempt back in 2002, CreditGuard essentially agreed that it did not pay what it was required to pay had it properly reported its status in the first place. As a result, the court’s approach to make the government whole is consistent with the underlying purpose of the interest provisions.

As If: Tax Court Holds that Restitution Assessment Does Not Attract Late Payment Penalties or Interest

This week in Klein v Commissioner the Tax Court in a division opinion held that assessments of restitution do not generate underpayment interest or late payment penalties. This is an important holding and a case of first impression.

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Section 6201(a)(4) gives the Service to power to assess restitution “in the same manner as if such amount were such tax.” Following a restitution assessment, Internal Revenue Manual provisions and Service policy has been to impose underpayment interest and late payment penalties on amounts that are unpaid similar to other unpaid tax.

To the facts at hand. In Klein, after some delay, the taxpayer fully paid the restitution, as well as interest that accrued pursuant to the statute in Title 18 that allowed for restitution. The taxpayer did not pay the separate Title 26 interest and late payment penalties that the Service imposed and assessed.

The IRS commenced administrative collection with respect to the unpaid interest and penalties. In a CDP proceeding the taxpayer challenged the Service’s right to impose underpayment interest and civil penalties, having claimed that it fully paid what was due.

The taxpayer had to clear the hurdle that she could challenge the Service’s imposition of penalties and interest in the CDP proceeding. The Court found that it was possible, noting that in a CDP proceeding, “underlying tax liability refers to the assessed liabilities that the IRS is seeking to collect via the challenged lien or levy.”

The opinion then considered the Service’s interest and penalty procedures in place for restitution assessments under the Internal Revenue Manual. The Tax Court held that the statutory language that gives IRS the power to assess restitution “as if” it were a tax does not transform the assessed restitution into a tax for purposes of the penalty and interest provisions. In doing so, the opinion discusses how the statute is drafted in the subjunctive mood.

For those who may have forgotten their Latin, the opinion explains what that means:

This clause is drafted in the subjunctive mood. Clauses of this type are commonly used to express a counterfactual hypothesis. See, e.g., Andrea A. Lunsford, The St. Martin’s Handbook 633 (5th ed. 2003) (describing the subjunctive mood as expressing “a wish, suggestion, requirement, or a condi- tion contrary to fact”). For example, assume a statute providing that certain per- sons (green card holders, perhaps) shall be treated “in the same manner as if they were citizens.” In such a statute, Congress would necessarily presume that such persons were not in fact citizens, providing merely that they should be accorded the treatment which citizens receive.

So as Alicia Silverstone in Clueless can attest, “as if” is an important phrase. As the opinion explains, the “as if” in the statute provides “the counterfactual hypothesis that restitution is a tax for the limited purpose of enabling the IRS to assess that amount, thus creating an account receivable on the taxpayer’s transcript against which the restitution payment can be credited.” It is treated like a tax but is not a tax.

In addition to parsing the statute, the opinion notes that the criminal concepts of tax loss and restitution do not neatly equate with the concepts of civil tax liability. In 2010 when Congress gave the IRS the power to assess (and collect) restitution it did not alter the fundamental distinction between the separate criminal and civil concepts.

To be sure, if the Service gets around to a civil examination, it can potentially generate an assessment that would be based on deficiency procedures. (for readers who would like more background on the interplay of the deficiency assessment procedures and the relatively new restitution assessment procedures see Keith’s post from this past spring discussing the issue here). If the Service were to conduct a civil examination and the amount assessed under deficiency procedures is both unpaid and exceeds what has previously been collected, it will be possible for Title 26 interest and civil penalties to start running.

 

Why Would the Service Stop Me From Paying Someone Else’s Taxes?

That is an incredibly misleading title.  You obviously can pay someone else’s taxes.  And, its fairly common to do so.  Executives often have their taxes on certain compensation paid by their employer.  I am sure it is also common for a relative to pay taxes for someone if they cannot pay it themselves.  Depending on the circumstances, this may create additional tax issues to work through.  For instance, if an employer pays tax for an employee, it will give rise to additional taxable income, on which you must pay tax…and if the employer pays that tax, it will give rise to taxable income, on which you must pay tax…and so on.  Here is an old Slate article discussing just this in the context of a Survivor winner Richard Hatch.  I vaguely recall he was sort of a jackass, and got dinged for tax evasion.   If a family member pays your taxes, it is likely a gift, giving rise to potential gift tax issues.

So, why the B.S. misleading post title?  Tax procedure.  The government released Legal Advice issued by Field Attorneys (LAFA) 20171801F earlier this month, which considered two questions:

  • May a person making a deposit under I.R.C. § 6603 for a potential transferee liability direct the Service to apply all or a portion of its deposit against the liability of another person liable for the same underlying liability?

  • If a person making a deposit is permitted to apply all or a portion of the deposit to the liability of another person liable, under these facts, may an attorney-in-fact for a person making a deposit under I.R.C. § 6603 direct the Service to transfer the deposit to pay another person’s tax liability?

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Based on the title you can probably guess the IRS position on this.  First, though, it might be worth a quick note on what a LAFA is, since this is probably the first time we have devoted a full post to one and perhaps the first time we have discussed them in general. This is advice written by field counsel for local field employees.  As it was not issued by the National Office, it is not Chief Counsel Advice (“CCA”).  We touch on CCAs somewhat frequently.  As defined by the Code, for disclosure purposes, CCAs are:

written advice or instruction, under whatever name or designation, prepared by any national office component of the Office of Chief Counsel which (i) is issued to field or service center employees of the Service or regional or district employees of the Office of Chief Counsel; and (ii) conveys… any legal interpretation of a revenue provision; any Internal Revenue Service or Office of Chief Counsel position or policy concerning a revenue provision; or any legal interpretation of State law, foreign law, or other Federal law relating to the assessment or collection of any liability under a revenue provision.

As such, CCAs often indicate the official IRS position on a matter.  Under the above definition, most field counsel advice is not required to be released, but sometimes the field counsel will seek review by the National Office.  The review probably (definitely?) still does not make the field advice a CCA, but it is generally released to the public anyway.

In the LAFA, the Service determined that no, the depositor could not direct the deposit to be used to pay the liability of another person liable for the tax underlying debt. Although that effectively answers both questions, since the second is contingent on the first, the LAFA also stated the transfer of a deposit could not be done by a POA if it were possible to transfer deposits.

So, what is going on here?  The LAFA is short on facts.  Those two pages are completely redacted.  It appears that there was transferee liability under Section 6901 from a transferor to a transferee (transferee 1), and then to another transferee (transferee 2).  I believe this was a subsequent transfer of the same assets, and transferee 2 was attempting to transfer its deposit to transferee 1. Section 6901 is a procedural provision that allows collection from a transferee based on liability under another federal or state law, so the liability could be for any number of reasons, and I am not sure what it was in this case.  The subsequent transferee, transferee 2, made a deposit for the potential tax outstanding under Section 6603, which allows for deposits to be made on potential outstanding tax.

In making the deposit, transferee 2 stopped interest from running on the potential tax debt, and potentially generated some interest payable to transferee 2 if the amount was returned (it also keeps things out of the refund procedures and statute of limitations).  Transferee 2 apparently was not the person who was going to end up paying the outstanding tax, and sought to transfer the deposit to the transferee 1, who presumably was going to pay the tax.  And, presumably had not made a deposit (or had not deposited sufficient funds).  Since transferee 2 could pay transferee 1’s tax debt, it seems conceivable that transferee 2 should be able to transfer its deposit to transferee 1.

The LAFA’s position, however, was that:

While a person making a deposit may direct the Service to use the deposit as payment of other of his liabilities, Rev. Proc. 2005-18 does not authorize a person to direct the Service to apply a deposit to pay another person’s liability.

Section 6603, which allows for deposits, states a “taxpayer may make a cash deposit…which may be used by the Secretary to pay any tax imposed…which has not been assessed at the time of the deposit.  Such a deposit shall be made in such manner as the Secretary shall prescribe.”  This language doesn’t necessarily preclude the transfer of the deposit to another taxpayer.

In the LAFA, the Service reviewed Rev. Proc. 2005-18 for the Service’s self-prescribed procedural rules under Section 6603.  The Rev. Proc. does have language that treats Section 6603 as allowing deposits for the taxpayer’s tax debts, and not that of others, or potentially shared debts.  It also states that the deposit does not constitute a payment until it is applied against an “assessed tax of the taxpayer.”  But, the Rev. Proc. does also allow the taxpayer to allocate deposit amounts against other assessments, and does not specify the assessments must be that of the taxpayer in other language.

The LAFA concludes though that while transferee liability is derivative of the transferor’s liability, multiple transferees may be liable for different debts, which it believed was evidence that transferees should not be able to transfer deposits.  Further, the Service’s own current guidance does not allow for such a transfer, which it deemed was sufficient reason to preclude the deposit transfer.  The guidance essentially says transferee 2 needs to request the deposit back, and then use the funds to pay the debt of transferee 1.  This does not, however, stop the underpayment interest of transferee 1 from accruing (although transferee 2 might be entitled to overpayment interest, if certain requirements were met – the overpayment and underpayment rates, however, are not necessarily the same.  For those who wish to learn more about deposits, payments, and interest rates, Chapter 6.06 and Chapter 11.05 of SaltzBook were recently updated and they cover these topics in great detail).

As to the POA issue, the guidance indicates that, even if a deposit could be transferred, the Form 2848 does not specifically allow for that action, and therefore would not be authorized.

So, what does this mean?  You clearly can pay someone else’s taxes, but the Service position is that a deposit cannot be shifted between taxpayers.  The reasoning is based on the Service’s own guidance, and not the statute.  For multiple parties potentially responsible for the same tax, to stop interest from running each will need to make a deposit of his, her, or its own maximum liability amount.

A Botched CDP Notice Leads to a Timely 6404 Interest Abatement Petition

Sometimes cases arrive in Tax Court in the most unusual way, and the case of Estate of Sager v. Commissioner is one such case.  On February 17, 2017, the Tax Court entered an order determining that it did not have jurisdiction over the case for purposes of reviewing a Collection Due Process (CDP) decision by Appeals following an equivalent hearing but that it did have jurisdiction over the case for purposes of reviewing an interest abatement “final determination” made as a part of the CDP decision.  It is nice that the Estate of Sager got into the door of the Tax Court on the interest abatement issue.  Whether this will cause the IRS to argue in the future that documents not necessarily, or perhaps not clearly, intended to serve as final determinations of interest abatement will trigger the running of the statutory period for filing petitions for interest abatement remains to be seen.

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The tax year at issue in this case is 1997 and the return for that year was timely filed by the decedent, pursuant to extension, on July 27, 1998.  The IRS issued a notice of deficiency for that year on November 10, 2011.  I cannot determine from the order why the notice was timely but that does not seem to be an issue that concerned anyone.  A Tax Court petition was untimely filed in response to the notice of deficiency leading to the eventual assessment of $108,130.  Following assessment the normal collection actions took place, including the assignment of the case to a revenue office.  The revenue office eventually issued a notice of intent to levy on August 29, 2012; however, petitioner appears not to have filed a Tax Court petition in response to this notice.  On September 22, 2012, the revenue officer sent a CDP notice of filing the federal tax lien.  Petitioner did respond to the CDP lien notice and filed a request for a CDP hearing on October 24, 2012.

Petitioner noted in the request that more than 30 days had passed but asserted that the CDP notice was delivered to an invalid address.  In the end, the Tax Court determined that the CDP lien notice was sent to the wrong address.  Although the Court does not address the issue in the Order, the sending of a CDP lien notice to the wrong address raises an issue regarding the continued validity of the lien notice.  The IRS must send a CDP lien notice to the taxpayer within five days after the filing of the notice of federal tax lien.  What impact does sending an invalid notice have?  It seems that the Tax Court could never have jurisdiction over the CDP issues because of the invalid notice.  Because by the time the Tax Court gets to the issue of the validity of the notice and of the notice of federal tax lien almost a year from the filing of the petition had passed and because during that year the parties had resolved the lien issue, the Court did not dwell on the issue of the invalidity of the CDP notice.  The Internal Revenue Manual provides that, in general, if the IRS sends an invalid notice it must send a substitute notice and the Tax Court in Bongam v. Commissioner, 146 T.C. No. 4 (2016) held that a substitute notice of determination was proper after the mailing of an inappropriate motion..

Here, the address on the notice was the address at which petitioner’s former partner lived.  She brought the notice to petitioner on the 29th day after the notice was issued.  That did not provide the petitioner with enough time to file a timely request for a CDP hearing.  For notices of deficiency, the Tax Court has a rule that a notice mailed to the wrong address can become a valid notice if the notice makes it way to the taxpayer in time for the taxpayer to file a timely Tax Court petition.  Under that case law, learning of the CDP notice on the 29th day would not validate the CDP notice.  It is not clear that getting the wrongly addressed CDP notice to the taxpayer would save the CDP notice.  I will leave the issue for another post where the issue is clearly raised, but wanted to point out the issues lurking in this case before returning to the interest abatement determination.

When it received the untimely CDP request, the IRS gave the taxpayer an equivalent hearing.  During the equivalent hearing, the Settlement Officer (SO) considered the merits of liability and reduced the liability.  Because this action did not necessarily bear on the outcome before the Tax Court, the order gives few details that allow me to know how the taxpayer persuaded the SO to consider the merits.  It appears from the dismissal of the untimely petition in Tax Court of the effort of the taxpayer to litigate the notice of deficiency that the taxpayer had a prior opportunity to litigate the tax.  I surmise that the taxpayer was able to show the SO in a simple, straightforward way that the assessment was wrong and the SO was willing to address the issue even though not compelled to do so by the CDP process.  Les talked about this in a recent post in which the SO was unwilling to fix an easily recognizable mistake.  I have had spotty success seeking to get a merits adjustments from an SO where the taxpayer had a prior opportunity but the adjustment was easy to fix.  If I am correct about what happened here, it shows at least one SO who was willing to fix something simple and save the taxpayer time as well as other IRS employees.

The SO did not agree to abate interest.  The order does not describe why the taxpayer felt interest should have been abated.  Given the unusual timing of the issuance of the notice of deficiency, perhaps the lengthy delay in working the case had something to do with the request.  The taxpayer made a $50,000 payment during the CDP equivalent hearing process.  Because of the adjustments the SO made and the payment, the taxpayer essentially satisfied the liability; however, the SO issued a decision letter at the conclusion of the equivalent hearing setting out the adjustment to the tax and denying interest abatement.

The taxpayer filed a petition in Tax Court within 30 days of the issuance of the decision letter.  The IRS moved to dismiss since it had not issued a determination letter.  Essentially, it argued that the late filing of the request for a CDP hearing precluded the Tax Court from having jurisdiction.  The low income taxpayer clinic at Rutgers Law School entered the scene at this point and argued that the Tax Court had jurisdiction over the interest abatement aspect of the case.  The IRS conceded that the Tax Court “may” have jurisdiction over the interest abatement request while continuing to argument that it did not have jurisdiction over the CDP request.  The taxpayer argued that his case met the unusual conditions for treating a decision letter as a notice of determination and that the Tax Court did have jurisdiction over his case.  The Tax Court disagreed and distinguished this case from the very short line of cases holding that the Tax Court has jurisdiction over a CDP matter after the issuance of a decision letter.

While disagreeing with petitioner on the issue of jurisdiction over the CDP aspect of the case, the Tax Court held that the decision letter could serve as a final determination with respect to interest abatement.  In Gray v. Commissioner, the Tax Court previously held that a CDP determination letter could serve as the basis for a final determination regarding interest abatement.  The order in Sager takes the next logical step and holds that a decision letter can also serve that purpose.  The petition filed here came well within the 180 period after the notice of final determination.  The Court finds that “Respondent has not asserted nor proven that the decision letter was not meant to be a final determination on Mr. Sager’s interest abatement request.”  Therefore, the Court found it had jurisdiction to hear the interest abatement request and ordered the parties to file status requests regarding the interest abatement issue.

The order follows the Tax Court’s longstanding practice of finding jurisdiction in those situations in which the petitioner comes to the Court within the established time frames in the applicable statutes.  Not only had the Court made a similar holding regarding a CDP determination letter in the Gray case, but it has made similar decisions in other contexts as well.  I wrote recently about one in the whistleblower context.  The decision here allows the petitioner to move forward for a determination on interest abatement without going the more ordinary route of filing a Form 843.  This is good news for this taxpayer and good news generally unless the IRS can argue that this type of informal final determination precludes the taxpayer from seeking interest abatement if the taxpayer does not realize that the informal final determination closes the door when it goes unrecognized and the taxpayer does not act quickly in response to it.

Tax Court Holds that Points Paid on Interest Only Refinancing Not Deductible

This week in Singh v Commissioner the Tax Court in a summary opinion held that a taxpayer was not entitled to deduct the amounts paid in respect of points on a refinancing of a principal residence. Determining whether interest on a home is deductible is complicated by the reality that for many taxpayers information returns or settlement statements may not completely or accurately indicate the amount that can be deducted.

One such issue relates to when consumers are paying interest on a modified mortgage; as we have discussed before (see. e.g. a guest post by Dave Vendler discussing the issue and related litigation) the Form 1098 that most financial institutions issue does not reflect the amounts that were attributable to the accrued but unpaid interest at the time of the modification. This is an issue that is currently the subject of an IRS guidance project (a copy of the American Bankers Association and Mortgage Bankers Association comments on the proposed guidance can be found here). [As an aside I will moderate a panel discussion on that topic at the ABA Tax Section May meeting in DC as part of the Individual and Family Committee].

Singh does not involve a modified mortgage though does spin off of some of the challenges that many Americans faced following the great recession. In Singh the taxpayer refinanced two mortgages on his principal residence with an interest only loan that was for an indefinite period.

Part of the costs that Singh paid included points on the interest only refinancing. To the extent that the points represent interest taxpayers may deduct the points over the course of the loan (assuming of course that the interest is otherwise deductible). This sweeps in Section 461(g), which requires a cash basis taxpayer to amortize prepaid interest over the life of the loan, just as if the taxpayer were on the accrual method of accounting. Section 461(g)(2) provides an exception to the amortization requirement in 461(g)(1) and allows a taxpayer to deduct the payment of certain points if they were paid “in connection with the purchase or improvement of, and secured by, the principal residence of the taxpayer.”

For taxpayers who seek to refinance years after the original purchase or who do not use proceeds of a refinancing to substantially improve the residence, the immediate deduction exception in Section 461(g)(2) provides no help. When is a refinancing close enough to the original purchase to be eligible for the 461(g)(2) immediate deduction? There is a well-known 8th Circuit case from 1990, Huntsman v Commissioner, that provides guidance for taxpayers seeking a deduction for points. In Hunstman, the 8th Circuit allowed an immediate deduction, emphasizing that the taxpayer refinanced to extinguish short-term loans from the original purchase, rather than just seeking to get a lower interest rate or accomplish other financial goals. That connection in Hunstman allowed the taxpayer to take advantage of the Section 461(g)(2) exception on the points paid on the refinancing.

This brings us back to Singh. A refinancing arising (and points paid on that refinancing) many years after the original purchase differs from Huntsman. In addition, the Tax Court noted that Singh could not deduct the points even under the general Section 461(g)(1) authority, which treats the points as amortized over the life of the loan, as Singh’s loan was for an interest only loan for an indefinite period.

The upshot for Singh was no deduction, and accuracy-related penalties for good measure. This is a a good reminder that the deductibility of interest on residences is sometimes not just a matter of plugging in information off a form 1098 or settlement document.  I suspect there is a great deal of confusion and error in this area of the tax law.

Update on Issues Relating to Financial Institutions Underreporting Mortgage Interest to Millions of Consumers

One of the most viewed posts on Procedurally Taxing in the last year or so was one that discussed a lawsuit alleging that Bank of America intentionally and systematically understated millions of dollars in homeowners’ mortgage interest payments following loan modifications. Earlier this year the lead attorney on that lawsuit, David Vendler of Morris Polich & Purdy, wrote a two-part post An Update on the Lawsuit Against Bank of America for Failing to Issue Accurate Interest Information Statements. When we last heard about the issue the IRS was seeking input through the Industry Issue Resolution program. Today David tells us that that the IRS has terminated that IIR project and added it to its list of guidance priorities for 2016-17. The issue is one with major implications for millions of consumers. The bankers are obviously well-represented in the guidance process. As David discusses there is a strong need for IRS and Treasury to hear how financial institutions should be required to report the payment of interest payments following loan modifications and other transactions like short sales when consumers are effectively paying substantial amounts of interest but not receiving information from banks that would allow them to determine whether the interest is deductible. Les

To all of you tax professionals reading this, I need your help.  Some of you may recall my two-part post regarding whether 26 U.S.C. section 6050H requires lenders and mortgage servicing entities to report payments of “capitalized” mortgage interest they receive from borrowers on IRS Form 1098 so that the borrowers can then deduct those payments.  The issue literally involves billions and billions of dollars in mortgage interest deductions that millions of American homeowners are losing because of the failure of their mortgage servicers to properly report.  As described in my prior posts, the situation arises in the contexts of negative amortization/Option Arm loans as well as loan modifications.  It also, however, arises with short sales, which was not discussed in my prior posts.  (Basically, if you look at the 1099-C that the consumer receives following a short sale, you will note that box 2 (which requires the reporter to indicate how much of the debt being cancelled is mortgage interest) is generally left blank.  This means that all of the cancelled debt is principal.  This is correct since mortgage notes generally require allocation of payments to interest before principal.  But in the short sale context, while the banks and mortgage servicers are correctly reporting the amounts of debt being cancelled, they are not reporting the other side of the transaction on Form 1098, which is the amount of interest being paid from the sales proceeds.  This amount can be in the tens of thousands of dollars)

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Anyway, following my bringing lawsuits against certain banks arising from their failure to properly report their customers’ interest payments, the American Bankers Association and the Mortgage Bankers Association requested the IRS to address the issue.

In late December 2016 the IRS responded that it would address the issue via its Industry Issue Resolution (“IIR”) program.  This program, however, does not provide for public comment and I was afraid that the banks and the IRS would simply arrive at “guidance” that would conclude that section 6050H was ambiguous as to whether it required payments of capitalized interest to be reported.  This way, even if the IRS concluded that I was correct about the reportability of the interest, the banks could then use the “guidance” announcing that there was an ambiguity to “prove” that they did nothing wrong in not previously reporting  payments of capitalized interest.

In fact, however, there really is no ambiguity.  The law is very clear and can be stated in a single paragraph.  21 U.S.C. section 6050H unambiguously requires banks and mortgage servicers to report on Form 1098 the “aggregate” of all mortgage interest they receive in a year (if that amount is over $600).  The Supreme Court has held that “interest” unambiguously refers to money that has been charged for the use of money.  Deputy v. DuPont, 308 U.S. 488 (1940).  Case law further uniformly holds that payments of capitalized mortgage interest (whether in the loan modification context or the negative amortization loan context) are payments of mortgage interest that can be deducted in the year of payment.  See Copeland v. C.I.R., T.C. Memo. 2014-226, (capitalized pre-loan modification interest held deductible as mortgage interest in the year of payment); Smoker v. C.I.R., 2013 WL 645265 *6 (Tax Ct. 2013) (same holding in the negative amortization loan context) [note Les discussed Copeland on PT  here].  Since capitalization of interest does not change its character as interest (Motel Corporation v. Commissioner of Internal Revenue, 54 T.C. 1433, 1440 (1970)), payments of capitalized mortgage interest are part of the “aggregate” mortgage interest that banks and mortgage servicers “receive” and thus are required to be reported on Form 1098 by the plain and unambiguous language of section 6050H.  Indeed, it was for this very same reason why 26 CFR § 1.6050S-3(b)(1) specifically requires that payments of capitalized student loan interest be reported on Form 1098-S.  There is simply no logical distinction that can be made between the reportability of payments of capitalized student loan interest and capitalized mortgage interest.

After a bunch of submissions on my part to the IRS requesting to be included in the IIR process, the IRS has just last week declared that it is terminating the IIR process and will address the issue of the reportability of capitalized interest on Form 1098 by formal rulemaking.  I see this as very good news insofar as the public, including you, will have an opportunity to comment.  I further fully expect that whatever rule the IRS eventually publishes will be consistent with all of the law above since this was the conclusion the IRS reached on the reportability of student loan interest way back in 2004.  That said, I expect that there will be heavy pressure from the banks and mortgage servicing entities to push for a rule that is “prospective-only” as was done with the student loan interest rule back in 2004.  This will hurt consumers tremendously.  Banks should instead be required to issue corrected Forms 1098 to all consumers which will (retrospectively) inform them of the interest that was not reported to them and allow them to file an amended return (if the statute of limitations has not expired) to recover his/her deduction.  Further, if consumers are really to be helped, the IRS should include in its rule an exception to the statute of limitations (based on the fact that because of the bank’s misreporting, the consumer was unaware of the potential for amendment previously), or allow consumers to take the prior deductions in the current tax year.    There simply is no justification for a prospective-only rule precisely because the question of the reportability of payments of capitalized interest has already answered.  The mortgage industry just ignored that answer for the sake of reporting convenience.

So, what I would like from anyone who feels equipped to do so is to write to the IRS (prior to the official public comment period which comes after a proposed rule is formally announced) and let them know your thoughts.   Comments can be sent directly to Thomas.West@treasury.gov prior to the formal public comment period.  Further, if any of you have any questions, please address them to me at dvendler@mpplaw.com