Collection from Retirement Accounts Part 3 – IRS Pushes Hard to Collect from F. Lee Bailey

The bankruptcy court in Maine has granted relief from the automatic stay to allow the IRS to collect from Mr. Bailey’s pension accounts and Social Security benefits. While the IRS has the power to go after these accounts, its exercise of this power is governed by the issues discussed in the first two parts of this series. This is another defeat for Mr. Bailey in his efforts to protect his assets from the collection of federal taxes. I wrote previously about Mr. Bailey’s filing of the bankruptcy petition after suffering a massive loss in Tax Court.

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In my earlier post regarding Mr. Bailey’s Tax Court loss, I speculated that Mr. Bailey might achieve relief in bankruptcy because his Tax Court case resulted in the imposition of an accuracy related penalty rather than the fraud penalty. That may still be true; however, the type of penalty does not stop the IRS from pursuing his assets and that is what it is doing with a vengeance. The bankruptcy court starts off the opinion stating “This bankruptcy case is another chapter in the decade long struggle between the Internal Revenue Service and Mr. Bailey over taxes.” We have not previously written much about the ability of the IRS to take a taxpayer’s social security payments and pension accounts. In addition to the first two posts in this series, I briefly touched on it recently in a post about military pensions where I discussed the federal payment levy program. Mr. Bailey’s case provides the opportunity to discuss how and when the IRS will take these assets as the policies apply to a specific individual rather than the group of individuals studied by TIGTA.

Based on the pursuit of these assets in the bankruptcy case, it seems clear that the IRS has determined that Mr. Bailey meets its definition of having committed flagrant conduct regarding the payment of his taxes. I discussed, and linked to, the IRS definition of flagrant conduct in the first post in this series. Cases where the IRS makes the determination that the taxpayer’s conduct is flagrant are the ones in which you see the IRS using its collection tools to their full effect. You should always seek to have your clients behave in a way that keeps them from fitting into the flagrant criteria or, should their conduct fall into the flagrant criteria, have them work quickly to mitigate that behavior because that type of behavior can cause the IRS to use some tools at its disposal that it might otherwise keep holstered.

The IRS will routinely go after 15% of a taxpayer’s social security payments through the federal payment levy program. As discussed in the post referenced above, the IRS has filters that it applies, thanks to the National Taxpayer Advocate, which exclude from the FPLP taxpayers whose income appears to be less than 250% of poverty. Section 6343 requires that the IRS not levy on taxpayers when the levy would put the taxpayer into a hardship situation and the filters the IRS applies in the FPLP program recognize that a high percentage of the individuals with income below 250% of poverty would end up in a hardship situation if the IRS levied on 15% of their Social Security payments. Of course, individuals whose income exceeds 250% of poverty can come into the IRS and show that the levy places them in hardship status if the IRS takes 15% through this program. For a detailed description of FPLP, see part two of this series.

The IRS need not limit itself to 15% of a taxpayer’s Social Security payments and it can levy on the entire amount of the payments if it chooses and if doing so does not place the taxpayer into hardship status. The opinion does not say whether the IRS plans to take only 15% of his Social Security payments or all of them; however, I would be surprised if it is not planning to take them all. When it seeks to take all of a taxpayer’s Social Security payments, the discussion in the last part of part two of this series becomes important. Mr. Bailey’s case is or was prior to bankruptcy in the hands of a revenue officer. Now that he is in bankruptcy, there will also be a bankruptcy specialist working on his case and probably an attorney at the Office of Chief Counsel. These individuals will apply the policy decisions set out in the manual in deciding to take his social security payments. The only legal impediment, aside from the automatic stay, is IRC 6343 setting out the hardship exception to levy.

As discussed previously, taking social security payments does not stop when the statute of limitations on collection ends. The IRS lien attaches to the taxpayer’s right to the stream of payments. Because the taxpayer’s right to this stream is fixed, once the IRS levies on the taxpayer’s interest in the social security payments the levy attaches to the right to receive all of the payments. So, as long as the taxpayer lives and the tax debt remains outstanding, the IRS can continue to receive the social security payments.

From part one of this series you know that the IRS can also levy on interests that taxpayers have in IRAs or pension plans. Even though ordinary creditors cannot reach assets in pension plans because of restrictions put in place by ERISA, these restrictions do not apply to the IRS. The IRS has policies that cause it to pause and obtain approvals and certain levels within the agency in order to levy on pension plans but the law places basically no restrictions that prevent the IRS from levying on these plans. A levy on a pension plan does not accelerate payment from the plan, but just like the levy on the taxpayer’s Social Security payments, the levy on the pension plan does attach to all of the rights the taxpayer has in the plan even if those rights include future and not present payments. I can only assume that prior to seeking to lift the stay in Mr. Bailey’s bankruptcy case, the IRS and its lawyers have already made a determination that neither the policies in the manual or the provisions in IRC 6343 prevent levies upon his pension plan or social security payments.

These IRS rights to pursue Social Security and pension plan payments play out in Mr Bailey’s bankruptcy case in the context of the automatic stay. The automatic stay comes into existence the moment a debtor files a bankruptcy case and works to prevent creditors from taking most assets of the debtor and of the estate. Bankruptcy code section 362(a) lists eight separate matters covered by the automatic stay; however, creditors can apply to the bankruptcy court to lift the automatic stay to permit the creditor to go after an asset otherwise protected by the stay. That is what the IRS has done in Mr. Bailey’s case. The bankruptcy court must then determine whether to lift the automatic stay to permit the IRS to collect from these assets while the bankruptcy case proceeds.

The concern of the IRS is that if Mr. Bailey receives these payments he might spend them. Each time he spends the payments from Social Security and the pension plan, he dissipates an asset on which the IRS has a lien interest and allowing him to receive the payments can only occur if he provides adequate protection to the IRS that its lien interest will not be harmed by his receipt of these payments. The bankruptcy court notes that he has the burden of proof on all issues connected with the motion of the IRS to lift the stay except on the issue of the equity in the Social Security and pension benefits. The IRS must show these assets have equity to which the federal tax lien has attached. Showing that equity exists in social security and pension plan payments is very simple.

By the time the IRS filed the motion to lift the automatic stay, Mr. Bailey had already received his chapter 7 discharge. The discharge lifted the automatic stay with respect to collection against him personally but the stay would continue with respect to assets of the bankruptcy estate until the estate was closed. The claims of the IRS survived the discharge in the chapter 7 case according to the bankruptcy court but the court does not provide specific information as to why they survived. It appears that even if some or all of the IRS claims were not excepted from discharge under bankruptcy code 523, the federal tax lien continued to attach to property belonging to Mr. Bailey which he kept after the chapter 7. After the conclusion of the chapter 7 case, Mr. Bailey filed a chapter 13 bankruptcy case. This maneuver is sometimes called a chapter 20.

The court finds that the IRS lien interest in the Social Security and pension payments is not adequately protected. Mr. Bailey said he needed to use the payments from these sources to fund his chapter 13 case and therefore he should get to keep them; however, that is exactly what the IRS fears since in using them to fund the plan he will spend the money from these plans and as he does so he destroys the lien interest of the IRS. The court points out that though it rules for the IRS in this summary type proceeding, Mr. Bailey can challenge the lien claim of the IRS in another proceeding should he seek to do so.

Mr. Bailey continues in his second bankruptcy case to do what many taxpayers before him have tried to do and use bankruptcy to wriggle free from federal tax debt. While it is possible to do that in certain circumstances, where the IRS has perfected its lien, debtor has assets to which the lien attaches, and the IRS is diligent in protecting its rights, the debtor will basically always lose. That does not mean the IRS will ultimately collect the $5 million dollars owed to it, but it does mean that while some or all of that debt remains due and owing, the IRS will continue to have open season on his assets including his Social Security and pension assets.

 

Levies on Retirement Accounts – Part 2 of 3 Social Security

In Part 1 of this series of posts on levies, I wrote about the ability of and the restrictions on levies on retirement plans by the IRS. In this post, I will discuss the ability of the IRS to levy upon a taxpayer’s social security payments, the choice the IRS has in how to do that, and the restrictions the IRS places upon itself as it decides to impose these levies. The big difference between levying on retirement accounts and on social security derives from the source of the funds. Retirement accounts rest with private parties while it is the government itself that makes the social security payments while at the same time being the party owed the unpaid taxes. In many ways, taking all or a part of a taxpayer’s social security payments is a form of offset; however, the Code does not treat it as an offset the same way it treats the offset of a refund in one year and a liability for a prior period.

IRC § 6331(h)(2)(A), as prescribed by the Taxpayer Relief Act of 1997, Pub. L. No. 105-34, § 1024, authorizes the IRS to issue continuous levies on certain federal payments. The Bureau of the Fiscal Service (BFS) (formed from the consolidation of the Financial Management Service and the Bureau of the Public Debt) is the Department of Treasury agency that processes payments for various federal agencies. Payments subject to FPLP include any federal payments other than those for which eligibility is based on the income or assets of the recipients. With a regular offset, the IRS simply programs its computers to check for any liabilities before it sends the refund to BFS for payment to the taxpayer. With social security, the IRS sends notice of the liability to BFS and the taking of the funds occurs at that level outside of the IRS since the funds, although coming from the federal government, come from another agency.

IRC Section 6334(a)(11) exempts from levy certain needs based payments such as Supplemental Security Income payments to the aged, blind, and disabled as well as State or local government public assistance or public welfare programs for which eligibility is determined by a needs or income test. The exemptions in section 6334 do not apply to regular social security payments since they are based on contributions and not based on need. Some taxpayers receiving social security do not need their social security payments to meet basic needs but many do. The IRS knows that many social security recipients will face hardship if all or a part of their social security payments are taken to satisfy tax liabilities. The debate concerns how to take the money of the taxpayers who do not need it while identifying the taxpayers who need it in order to avoid hardship.

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As with the discussion on retirement accounts, this discussion is built upon a report issued by the Treasury Inspector General for Tax Administration (TIGTA). On June 30, 2016, TIGTA issued “Revenue Officer Levies of Social Security Benefits Indicate That Further Modification to Procedures Is Warranted” in which it discusses in detail the rules governing the IRS levy upon social security benefits and reviews how the IRS has done in following those rules. The discussion starts with a reminder of the federal payment levy program (FPLP). For the publication on FPLP created by the Taxpayer Advocate’s office look here.

Federal Payment Levy Program and Social Security

The TIGTA report describes the FPLP as follows:

“The FPLP is an automated program that includes taxpayers in both the Automated Collection System and the Collection Field function along with inventory that is currently not being worked by either Automated Collection System or the Collection Field function….

Through the FPLP, the IRS can issue a continuous levy of 15 percent on Social Security benefits. During Fiscal Year 2014, the majority of revenue collected by the FPLP program was from Social Security benefits. Between Calendar Years 2002 and 2006, the IRS had a low-income filter for Social Security benefits levied through the FPLP, but that particular filter was found to be inaccurate by the Government Accountability Office. The Government Accountability Office’s recommendation advised the IRS to eliminate the exclusion until a more accurate criterion could be developed. “

The IRS reinstated the filter in 2011, and it causes taxpayers whose income presents itself to the IRS as under 250% of poverty to bypass the FPLP in order that they can receive their full payment.

IRM 5.11.7.2 contains the description of all of the automatic offset programs operated between the IRS and Treasury. While the offset of funds from social security payments is the largest of these programs, it is only one of several including many designed to capture past due taxes from federal employees. According to IRM 5.11.7.2.3.4.2, the IRS sends the name of social security recipients with past due taxes over to the IRS after sending out a notice of intent to levy letter:

“For Social Security payments matched, a FPLP levy will be transmitted to BFS at least eight (8) weeks but no more than twenty-six (26) weeks from when the CP 91 or 298, Intent to seize up to 15% of your Social Security benefits, was issued (indicated by the unreversed TC 971 AC 169 posting cycle). A FPLP levy TC 971 AC 662 will post on the module with the literal “SSA” displayed in the Miscellaneous Field and TIN in the XREF TIN field.”

The NTA has written extensively on social security levies and particularly on the issue of the filters imposed to allow certain accounts to bypass the social security levy. For background, an interested reader might want to check out her report found here from the 2014 annual report to Congress. The discussion in the report focuses heavily on the decision of the IRS to exclude from its filters those taxpayers with unfiled returns. This discussion which also gets some play in the TIGTA report focuses on the reason for these levies and whether levies on retirement accounts and social security payments where taxpayers are known to be especially vulnerable should be used for general enforcement. The IRS has long used the levy as a means of promoting compliance because it wakes up the taxpayer by moving the IRS from its status as “pen pal” by sending many letters requesting payment, to the status of law enforcement when the taxpayer feels the pain of lost funds.

Collection by Revenue Officers

The TIGTA report focuses on the collection by revenue officers of social security payments. As discussed previously, the cases in the hands of revenue officers, the IRS field collection agents, will primarily be accounts in which a large amount of tax is due. TIGTA points out that revenue officers have no special instructions regarding pursuit of collection from social security payments. It made the following diverse findings from its interviews of 26 collection employees at various levels:

When making Social Security levy determinations, revenue officers are not required to consider whether the taxpayers’ income level is below 250 percent of the Federal poverty level . Field Collection procedures require that they determine if the FPLP process will be part of their strategy to resolve the case. Some other observations made in our audit interviews include:

  • Some Field Collection group managers require that all other taxpayer resources be levied before attempting to levy Social Security benefits, while others do not.
  • Some group managers believed that, in upwards of 90 percent of their cases in which paper levies are made on taxpayers, the taxpayer possesses no other source of income.
  • Some group managers stated that the case had to be “egregious” before Social Security Benefits would be levied above the 15 percent FPLP levy.
  • Some group managers indicated that Social Security levies were used to get a taxpayer’s attention, while others believed such use of a levy is not appropriate.
  • Some revenue officers use Form 668-W, Notice of Levy on Wages, Salary, and Other Income, which ensures that levied taxpayers receive the exemptions to which they are entitled, while others use Form 668-A, Notice of Levy, to maximize the levy.
  • Most interviewees indicated that most cases involving Social Security benefits already have an FPLP levy on the case when the case is assigned.
  • In one territory, the territory manager indicated that the groups in that territory never levy 100 percent of Social Security benefits. A revenue officer within that same territory indicated that he had issued as many as five Social Security levies in the past year and used Form 668-A to levy the maximum amount.
  • All interviewees indicated that a financial analysis should be performed on a Collection Information Statement to assess the taxpayer’s ability to pay the tax, and all stated that the“250 percent above Federal poverty level” criterion is not factored into their analysis.

In most of the cases in which the revenue officers were assigned, the IRS had already begun collecting 15% through the FPLP process and the question for the revenue officer was whether to take the entire social security payment. The median amount owed of the accounts sampled by TIGTA was over $80,000. TIGTA found that in 85% of the cases in which the revenue officer decided to levy, the decision fell within the guidance; however, in 15% of the cases the levy exacerbated or caused hardship. TIGTA noted that in the cases in which it determined the levy caused hardship the notes of the revenue officer usually supported the conclusion reached by TIGTA. TIGTA recommended better guidance for revenue officers on when to pursue a taxpayer’s social security and the IRS management agreed.

Conclusion

The ability to determine between a “can’t pay” and a “won’t pay” taxpayer is a difficult decision that requires both training and judgment. Both TIGTA and the NTA have written about the failure of the IRS to train and the failure of revenue officers and their managers to use appropriate judgment. If a revenue officer levies on a client’s social security payments because the client did not cooperate or did not file past due returns, use the decision in Vinatieri v. Commissioner, 133 T.C. 392 (2009) as well as the relevant manual provisions to convince the revenue officer to remove the levy. TIGTA’s report shows that the IRS gets the decision right most of the time but if the 15% error rate is correct, that still leaves a large number of taxpayers, many of whom are unrepresented, losing necessary funds to make ends meet. Providing revenue officers with better training and better oversight requires funds which is a problem we have discussed many times before.

 

 

 

Levies on Retirement Accounts – Part 1 of 3 Pension Plans and IRAs

Thanks to two Treasury Inspector General for Tax Administration (TIGTA) reports and one bankruptcy case, In re F. Lee Bailey, I am inspired to do a three-part series on how the IRS levies on retirement accounts. I note also that the National Taxpayer Advocate has blogged recently on this general topic. The first post will focus on the power of the IRS to levy and the decisions it makes in issuing a levy to obtain either a stream of payments from a retirement account or the retirement account itself. The second post will focus on the levy on social security payments, and the third post will look at the application of those policies in a specific case involving a well-known attorney who has fallen from the heights of the profession and has recently filed his second bankruptcy petition. I issued two posts, here and here, focusing on the levy of military retirement benefits in the past couple of months that also speak to this topic from both a policy and individual perspective.

The levy serves as the calling card for the IRS to taxpayers who have not responded to correspondence requesting payment. As I have discussed before, the IRS often hopes that the levy will cause the taxpayer to begin working with it. When the levy hits the taxpayer’s salary, retirement benefits, or similar stream of payments, it leaves the taxpayer in a position in which the taxpayer must deal with the IRS in some fashion because the loss of the stream of payments does not permit the taxpayer to make the payments necessary for life’s necessities. While it is common for the IRS to levy on wages and put the taxpayer into hardship, the discussion in the manual and the TIGTA reports makes clear that the employee generating the levy on retirement payments should consider this before making the levy rather than just using the levy as an enforcement tool. This is just one way in which the levy on retirement benefits differs from ordinary levies.

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Levy Basics

To set the scene for this discussion of levies, looking at the basics of levy may help in understanding what the IRS can do with this enforcement tool. The levy allows the IRS to step into the taxpayer’s shoes and receive payments to which the taxpayer is entitled or to take control of property that the taxpayer could control. Levy is a provisional remedy and does not give the IRS greater rights to the property than the taxpayer has. Levy can set the scene for a fight over property rights through the wrongful levy process.

In United States v. National Bank of Commerce, 472 U.S. 713 (1985), the Supreme Court said that Congress could not have devised a broader lien than the federal tax lien. The comment about the federal tax lien has relevance to a post about levies because the IRS needs to have a lien on the property it intends to levy. National Bank of Commerce was a levy case in which the taxpayer, Mr. Reeves, had a joint bank account with his wife and mother. Only Mr. Reeves owed the IRS. The IRS levied on the bank account and demanded that the bank turn over all of the money in the account since Mr. Reeves could have walked up to the teller window and made a similar demand. The bank refused, arguing that before it turned over the money it needed the consent of co-owners of the account. In a 5-4 decision, the Court reversed the lower courts and ordered that the bank must turn over the money but made clear that levy is a provisional remedy and that turning over the money to the IRS did not deprive the taxpayer’s wife or mother from recovering the money upon a showing that it belonged to them and not to Mr. Reeves.

After issuing the notices required in IRC 6330 and 6331, the IRS can take a taxpayer’s property without court approval. For the small number of taxpayer’s who seek Collection Due Process relief after receipt of the notice, the Tax Court must bless the use of the levy. For the vast majority of taxpayers, the IRS makes decisions on what and when to levy without interference from any judicial body. In most cases, the levy comes as a surprise to taxpayers who fail to appreciate the meaning of the correspondence warning them of the IRS’s intent to levy and who only appreciate the power the IRS possesses once it takes the levy action.

Basics of TIGTA Report

On September 26, 2017, TIGTA issued a report entitled “Procedures for Retirement Account and Thrift Savings Plan Levies Not Always Followed by Revenue Officers.” The report not only looks at specific levy actions taken by the IRS but does an excellent job of explaining the rules governing collection employees when levying on a retirement account. My discussion here will highlight the rules. If you have a case with this issue or questions not answered by this post, you should carefully read the report and the related Internal Manual Provisions (referred to in this post sometimes as “Manual” and sometimes as “IRM”).

The report breaks up its discussion of retirement account levies essentially into three parts: 1) levies on the income stream from a retirement account; 2) levies on the retirement account itself; and 3) levies on thrift saving accounts. Thrift savings accounts belong only to federal employees, and I am not going to discuss that part of the report because of its limited coverage; however, if you represent a current or retired federal employee with money in a thrift saving account, this discussion is valuable.

If the taxpayer has already retired and receives payment from some type of defined benefit or defined contribution plan or an IRA, the IRS can levy on the stream of payments. It gives broader authority to its employees to levy on a stream of payments than on the retirement account itself. Internal Revenue Manual 5.11.6.1 provides that both revenue officers and employees of the Automated Collection System (ACS) can levy on the stream of payments. If the IRS levies on a stream of retirement payments before the statute of limitations expires, the levy reaches the future stream of payments that comes after the expiration of the statute because the levy has taken over the taxpayer’s defined rights to future payment prior to the expiration of the statute.

Levying on a Stream of Payments from a Retirement Account

The manual gives relatively detailed instructions on when and how collection employees can levy on the stream of payments. Before levying on this stream of retirement payments, ACS employees should check to see that the IRS has properly sent the notice of intent to levy and if the file indicates taxpayer is in a hardship situation. These are basically the same procedures required for regular levies. The difference in process for the stream of levy payments is the requirement that the ACS employee obtain managerial approval. Since the manager has little information to review when making this decision, the report leaves the impression that such approval is fairly routine. The TIGTA review determined that ACS employees followed the required procedures in the cases reviewed.

TIGTA also found that ACS employees were not required to consider the financial situation of the taxpayer before issuing the levy. TIGTA looked closely at the 30 cases it identified and found that in about 25% of those cases the levy on the stream of payments placed the taxpayers in a hardship situation. It recommended that the IRS change it procedures to place more emphasis on determining if the levy would cause hardship. The IRS agreed to emphasize that ACS and managers should pay attention to available data; however, it is not sending the employees out to gather additional data. I do not see a distinction between levying on a stream of payments and levying on someone’s wages but the TIGTA report sends the message that more protection is needed for these payments than wages.

The rules for cases in the hands of revenue officers are slightly different than those for ACS employees. The IRS expects that revenue officers assigned to individual accounts will know more about the taxpayers assigned to them than an ACS employee who does not have individual taxpayers assigned. The manual requires that revenue officers follow all normal levy procedures and to “use discretion” when determining whether to levy on a stream of payments from a retirement account. In addition to normal pre-levy procedures, revenue officers were required to consider the taxpayer’s:

– responsiveness to attempts at contact and collection

– filing and paying compliance history

– effort to pay the tax

– whether current taxes are being paid; and

– financial condition, including information related to economic hardship determinations.

TIGTA’s review of 28 cases found that about 15% of the taxpayers were in a hardship situation. While TIGTA felt the IRS should not have levied if it knew the taxpayer faced hardship, IRS management disagreed and responded that a revenue officer can levy if the taxpayer fails to respond or misses deadlines. TIGTA, sounding like the National Taxpayer Advocate (NTA), recommended changes to the manual to place more emphasis on hardship pointing out that if the IRS simply uses the levy as a wake-up call to the taxpayer without giving thought to hardship it not only places an undue burden on the taxpayer but also causes more work for the IRS as it unwinds the levy.

NTA comments on this levy issue can be found here, here and here. This recommendation also mirrors a recommendation TIGTA made with respect to levies on social security payments which I will discuss in the next post in this series. The IRS agreed to make changes to IRM 5.11.1.3.1 to reflect this dialogue. Notice that in the new IRM provision a reference to Taxpayer Bill of Rights is baked right into the directions on what the revenue officer should do. In this report, TIGTA recommended that the IRS change this newly drafted IRM provision to make it even clearer that the financial condition of the taxpayer is a primary consideration in making the levy and the IRS agreed to make that revision.

Levying on the Retirement Account Itself

Only revenue officers can levy on a retirement account. Because revenue officers are primarily assigned to cases in which the taxpayer owes a fair amount of money, in some geographic locations this means more than $100,000, many taxpayers whose accounts remain in ACS will not face the prospect of having their retirement account levied even though the ACS employee might levy any stream of payment that exists. The manual creates four discrete rules that govern levy upon the retirement account itself and create barriers to the use of such a levy as a tool:

  • Revenue officers must consider “all alternatives” before issuing a levy on a retirement or IRA account.
  • Revenue officers must determine if the taxpayer’s conduct has been flagrant. Look here for a detailed explanation of flagrant behavior. It includes such things as making voluntary contributions to retirement accounts while asserting an inability to pay past due taxes; demonstrating a pattern of uncooperative or unresponsive behavior; being convicted of tax evasion; being assess the fraud penalty; assisting others in evading taxes and incurring a tax liability based on illegal income. This requirement means that otherwise cooperative taxpayers may get a pass on having their retirement funds levied.
  • Revenue officers must determine whether the taxpayer depends on the money in the retirement account or will depend on it in the near future for necessary living expenses; and
  • Revenue officers must prepare a memorandum summarizing the taxpayer’s compliance history and reason for the levy and obtain approval from the Area Director. This type of requirement creates a bureaucratic barrier that will stop many cases because the revenue officers do not have the time or the inclination to do this type of work and expose themselves to criticism from their group manager or the area director. Whenever you find this higher level approval provisions in the manual, they serve as a signal to the employee that except in extreme cases this is something to be avoided.

Conclusion

Retirement accounts receive special consideration. Giving too much deference to money in retirement accounts generally favors higher income taxpayers over lower income taxpayers because of who is most likely to have money built up in retirement plans. The IRS must carefully balance its enforcement in this area to pursue these accounts when the taxpayer has the ability to pay while holding back from enforced collection against these accounts where a levy would create economic consequences for the taxpayer that would engender hardship. This balance is often made harder for the IRS because taxpayers do not always respond quickly or completely concerning their financial situation. TIGTA rightly seeks to have the IRS not blindly use the levy as it might ordinarily do to spur taxpayer cooperation but to look within its database for information regarding the hardship that might occur if the levy takes place. This is a good dialogue. TIGTA does a nice job in this report laying out the issues and the rules.

 

Applying the Federal Payment Levy Program to Veterans

The National Taxpayer Advocate has recently written a couple of blog posts on the application of the Federal Payment Levy Program (FPLP) to veterans which can be found here and here. The posts provide significant detail and insight into the application of the program to veterans and argue persuasively that the IRS has applied the program too broadly by failing to use filters that it has adopted for other similar FPLP programs. If you are not generally familiar with FPLP the first post provides a good deal of background into the program generally.

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In May, 2017, the Service expanded it application of the FPLP to include military retirement payments paid by the Defense Finance and Accounting Service. The decision to expand FPLP to these payments makes good sense. It stems from a recommendation in an audit by the Treasury Inspector General for Tax Administration (TIGTA). This seems to be one of those situations in which the auditors of the IRS did an excellent job of noticing a hole in the collection system, the IRS relatively quickly followed up to implement a program which will collect money from people receiving federal payments who have not fulfilled their tax obligations at little cost to the Treasury.

If the program is so good, why is the NTA complaining and why do I think her complaint is valid? The problem is not the program itself but the scope of the program. In implementing this program, the Service made a decision not to exclude from the levy program military retirees whose incomes fall below 250 percent of the federal poverty level. The decision to apply the FPLP to all military retirees means that money will be taken from the pensions of many retirees who are quite vulnerable. The second post goes into details about the numbers of military retirees whose income falls below 250% of poverty. When the IRS levies on a person whose income is that low, it almost always comes into the prohibition on levy when the taxpayer is in a hardship situation. A high percentage of the military retirees whose income falls below 250% of poverty will have allowable expenses that exceed their income. This qualifies them to have the IRS remove the levy. Many of the military retirees, like many of the recipients of Social Security payments, lack familiarity with IRC 6343. So, they will not raise it. For those that do raise the hardship issue, with or without knowing the statutory basis, the IRS will expend its precious resources undoing the levy and probably cost itself more in that process than it obtains from several others. For these reasons the IRS has chosen not to levy on similarly situated individuals in other settings.

The Service developed a filter to the FPLP which it uses to screen out low income taxpayers receiving Social Security old age or disability benefits and Railroad Retirement Board benefits. I applaud the use of this filter because applying the FPLP to the vast majority of taxpayers with income under 250% of poverty would implicate the hardship restriction on levy imposed by IRC 6343. It does not make good business sense or good policy to levy on these individuals with a high likelihood that hardship exists and require them to raise the hardship exception to levy.

For the same reasons that it makes good business sense and policy not to impose the FPLP on recipients of federal payments under the Social Security or Railroad Retirement Board, it also makes sense to extend the application of the exclusion to military retirement payments made to military retirees whose income is less than 250% of poverty. Military retirees, having served our country in such an important way, do not deserve to be discriminated against in this way. They have the same financial constraints as non-military retirees whose income is less than 250% of poverty. We should not honor their service by making it harder for them to receive the hardship relief granted by the Internal Revenue Code. The same presumptions that they would qualify for such relief should apply to this group as well.

The expansion of the FPLP to military retirement payments followed an internal audit criticizing the Service for failing to capture these payments under the FPLP. The internal audit, however, did not suggest that the same exclusions offered to individuals in the lowest economic strata of our society should be ignored when those individuals were recipients of a military pension based on their long and honorable service to the country. Many military retirees fall into the low income category and should receive the same treatment with regard to the low income filter as other recipients of federal benefits.

The NTA has marshalled the data showing that the levy will fall hard on the low income military retirees just as it falls hard on other persons receiving federal payments. The IRS should reconsider its decision not to apply the filter. The removal of the filter does not give the group with less than 250% of poverty in earnings a free pass and the decision is not a static decision that applies for the 10 year statute of limitations. If the IRS has information about the military retiree’s assets or other sources of support suggesting that imposition of the levy would not produce a hardship, nothing prevents the IRS from imposing FPLP or other collection remedies at any time.

Rolling the Beds and Wheelchairs to the Curb – Applying the Hardship Provision of IRC 6343 to Corporations

Starting in March the Tax Court has issued several Collection Due Process opinions involving nursing homes: Lindsay Manor Nursing Home, Inc. v. Commissioner, 148 T.C. No. 9 (March 23, 2017); Lindsay Manor Nursing Home, Inc. v. Commissioner, T.C. Memo. 2017-50 (March 23, 2017); Crescent Manor, Inc. v. Commissioner, T.C. Memo. 2017-94 (May 31, 2017); Sulphur Manor, Inc. v. Commissioner, T.C. Memo. 2017-95 (May 31, 2017); Silvercrest Manor Nursing Home, Inc. v. Commissioner, T.C. Memo. 2017-96 (May 31, 2017); Hennessey Manor Nursing Home, Inc. v. Commissioner, T.C. Memo. 2017-97 (May 31, 2017); Seminole Nursing Home, Inc. v. Commissioner, T.C. Memo. 2017-102 (June 5, 2017). For good measure, there was a 10th Circuit case during this same span – United States v. Hodges, 684 Fed. Appx. 722 (10th Cir. April 10, 2017).  When I worked for Chief Counsel it was my opinion that the worst types of collection cases to encounter were the cases involving nursing homes that were not paying their employment taxes.  Even though the IRS could potential seize the assets of the business or levy on the Medicare or other stream of funds, taking these types of actions would shut down the nursing home leaving a number of relatively helpless people homeless.  Closing down a nursing home had very little upside except for stopping an entity from pyramiding taxes.  So, seeing several of these cases in a short span made me wonder if something had changed at the IRS.  Nothing I read about these cases makes me think that a magic solution has occurred.  I would like to know the IRS strategy for these cases because closing down these businesses without a plan would seem unwise.

The first case decided, Lindsay Manor Nursing Home, breaks new ground by addressing the issue of hardship in IRC 6343.  As discussed below, the Court upholds the interpretation of hardship in the applicable regulation finding that a corporation cannot suffer economic hardship and so cannot use the prospect of economic hardship as a basis for arguing that the IRS cannot levy on corporate assets no matter how dire the corporation’s financial situation.  This important decision has a domino effect on the outcome of the CDP cases of the related nursing homes.

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In defending these cases in the CDP process, taxpayer’s attorney made a couple of arguments that failed.  I want to focus on those arguments even though in the back of my mind I am still wondering what will happen now that the nursing homes have lost their CDP cases.  The first argument concerns the hardship exception to levy and the second argument, which I have difficulty understanding, concerns the meaning of prior involvement.

The nursing homes in the recent decisions all operated as corporations.  They argued that the levy action proposed by the IRS in its Notice of Intent to Levy would create havoc and financial ruin for these corporations.  The petitioner in Lindsay Manor attacked Treas. Reg. 301.6343-1(b)(4)(i) which limits hardship to individual taxpayers.  Petitioner argued that the regulation should be declared invalid because it is inconsistent with IRC 6343(a)(1)(D).  The statute does not specify that it applies only to individual taxpayers.  Petitioner argued that the term “taxpayer” in section 6343 is a defined term in IRC 7701(a)(14) and the definition is broad including corporate taxpayers.  This is a logical, statute based argument that seems to be made here for the first time.  Even though the taxpayer ultimately loses, the argument was certainly worth making.

The Court responds to the argument by finding that it must look at the term in the context used included other instances of use of the term in IRC 6343, the meaning of the phrase “economic hardship” in IRC 6343(a)(1)(D) , and the grammatical structure of the statute.  The Court finds that the term taxpayer was used seven times in IRC 6343.  Twice its meaning clearly related to individuals and five times the meaning could have related to individuals or corporations.  So, the Court continues its search for the meaning of the term in this context.

The Court finds that the term “economic hardship” appears nowhere in the IRC.  Although the IRS argued that the answer lay in the use of this term the Court does not find the answer here and moves on with its inquiry.

The Court finds that the statute is “simply silent or ambiguous with respect to the meaning of taxpayer; the relationship between ‘hardship’ and a taxpayer’s ‘financial condition,’ and whether congress intended to require prospective relief.”  So, the Court looked at the legislative history.  In 1988, in the Taxpayer Bill of Rights I, Congress added (1)(E) which talks about necessary living expenses – something clearly related to individuals.  However, other aspects of legislative history left the Court uncertain of the applicability to individuals only.  Since the statute is unclear, the Court moved to Step 2 of the Chevron analysis to determine if the regulation is a permissible interpretation of the statute.

The Court finds that the interpretation of the statute chosen by the regulation is permissible because 1) the statute might be interpreted in a manner argued by either party; 2) choosing to apply hardship only to individuals is not inconsistent with IRC 6343(a)(1)(D); and 3) the regulation provides greater relief than the statute and does not limit the statute.

In addition to the argument concerning the meaning of hardship, petitioner also argued that the Settlement Officer had prior involvement in its case and this involvement barred her from making the determination.  Petitioner did not argue that the Settlement Officer had worked on a matter involving it prior to her assignment to this CDP case but rather that “she reviewed petitioner’s documents before the CDP hearing.”  Wow.  Petitioner’s hardship argument presented an innovative and thoughtful attack on the regulation.  This argument, at least as described by the Court, makes no sense to me and undercuts the validity of the first argument because it makes no sense.  Petitioner seems to argue that in a CDP hearing, which will almost always occur by phone, the call should take place and then the petitioner should sit silently by the phone while the Settlement Officer for the first time cracks open the file and begins to look at the documents in the case.  Depending on the size of the case, the silent portion of the CDP hearing could last quite a long time.  The Court took only four paragraphs to describe and resolve this argument.  This may have been three paragraphs too many.

As a result of the determination that the regulation validly interpreted the statute and that the Settlement Officer had the requisite impartiality, the Court denies the summary judgment motion filed by petitioner.  This opinion only addressed petitioner’s motion.

On the same day it ruled on petitioner’s motion for summary judgment, the Tax Court issued a second opinion in the case at T.C. Memo 2017-50, ruling on the motion for summary judgment filed by the IRS.  In this opinion, the court grants the IRS request for summary judgment.  The Court points out the long history of non-compliance by the taxpayer including many breached installment agreements.  Because another installment agreement was the collection alternative sought by the taxpayer and because of the failure of prior installment agreements coupled with nothing suggesting a new agreement would succeed, the Court found that the Settlement Officer did not abuse her discretion in denying an installment agreement as an alternative to levy.  The Settlement Officer determined that the taxpayer could satisfy the outstanding liability by liquidating or borrowing against its accounts receivable.  Another factor that tipped the scales against the taxpayer in the decision concerned the taxpayer’s current state of non-compliance.  As with almost any employment tax liability case where the taxpayer cannot keep current while seeking relief from levy, the Court finds this fact an important one in denying relief.

The other cases in the group followed the same script as the TC Memo opinion in Lindsay Manor even though they come out over a period of time following the release of that opinion.  All grant the motion for summary judgment requested by the IRS.  Although the IRS won these cases, the ability to potentially close these nursing homes by levying on their accounts receivable puts the IRS in a tough spot.  It does not want to condone pyramiding of employment taxes but it also does not want to negatively impact the lives of many vulnerable senior citizens.

An appeal has been filed with the 10th Circuit in Lindsay Manor.  Here is the docket sheet in the appeal:

05/23/2017 — [10469270] TAX CASE DOCKETED. DATE RECEIVED: 05/23/2017. DOCKETING STATEMENT DUE 06/06/2017 FOR LINDSAY MANOR NURSING HOME, INC.. NOTICE OF APPEARANCE DUE ON 06/06/2017 FOR COMMISSIONER OF INTERNAL REVENUE AND LINDSAY MANOR NURSING HOME, INC. TAX COURT RECORD DUE 07/03/2017 FOR ROBERT R. DITROLIO, CLERK OF COURT. [17-9002] [ENTERED: 05/23/2017 12:31 PM]

05/24/2017 — [10469509] TAX COURT RECORD FILED. NUMBER OF VOLUMES FILED: 6. [17-9002] TC [ENTERED: 05/24/2017 09:13 AM]

05/24/2017 — [10469551] MINUTE ORDER FILED – APPELLANT’S BRIEF DUE ON 07/03/2017 FOR LINDSAY MANOR NURSING HOME, INC. (TEXT ONLY – NO ATTACHMENT) [17-9002] [ENTERED: 05/24/2017 10:09 AM]

05/25/2017 — [10470153] NOTICE OF APPEARANCE FILED BY MS. KATHLEEN E. LYON FOR CIR. CERT. OF INTERESTED PARTIES: Y (ALREADY LISTED). SERVED ON 05/25/2017. MANNER OF SERVICE: EMAIL [17-9002] [ENTERED: 05/25/2017 01:55 PM]

05/25/2017 — [10470135] NOTICE OF APPEARANCE SUBMITTED BY KATHLEEN E. LYON (LEAD COUNSEL) FOR APPELLEE CIR FOR COURT REVIEW. CERTIFICATE OF INTERESTED PARTIES: YES. SERVED ON 05/25/2017. MANNER OF SERVICE: EMAIL. [17-9002]–[EDITED 05/25/2017 BY KLP TO DELETE THE ATTACHMENT; ENTRY FILED.] KEL [ENTERED: 05/25/2017 01:06 PM]

06/05/2017 — [10472178] NOTICE OF APPEARANCE FILED BY MR. DAVID JOSEPH LOOBY FOR LINDSAY MANOR NURSING HOME, INC. CERT. OF INTERESTED PARTIES: N. SERVED ON 06/05/2017. MANNER OF SERVICE: EMAIL. [17-9002] [ENTERED: 06/05/2017 11:36 AM]

06/05/2017 — [10472180] DOCKETING STATEMENT FILED BY LINDSAY MANOR NURSING HOME, INC.. SERVED ON 06/05/2017. MANNER OF SERVICE: EMAIL. [17-9002] DJL [ENTERED: 06/05/2017 11:40 AM]

06/05/2017 — [10472174] NOTICE OF APPEARANCE SUBMITTED BY DAVID J. LOOBY FOR APPELLANT LINDSAY MANOR NURSING HOME, INC. FOR COURT REVIEW. CERTIFICATE OF INTERESTED PARTIES: NO. SERVED ON 06/05/2017. MANNER OF SERVICE: EMAIL. [17-9002]–[EDITED 06/05/2017 BY KLP TO DELETE THE ATTACHMENT; ENTRY FILED.] DJL [ENTERED: 06/05/2017 11:25 AM]

 

IRS Takes Pugnacious Attitude toward Mr. Mayweather

On July 5, 2017, well-known boxer Floyd Mayweather filed a Tax Court petition seeking Collection Due Process (CDP) relief.  Mr. Mayweather’s petition uses the Tax Court’s form petition and parts of the petition are handwritten.  My clinic uses the form petition but most of our cases do not involve $22 million.  The use of the petition for a case of this dollar amount shows the ability of the form to serve taxpayers at all ends of the income spectrum.  The form gets the job done and wastes little energy.

The petition attaches the determination from Appeals as the instructions provide.  The determination offers a couple of interesting side notes to discuss.  First, the notice of determination sent to a taxpayer, like a statutory notice of deficiency, contains the Social Security Number of the petitioner.  Petitioners receive instruction from the Tax Court in the form package to redact the SSN.  The Court will get the SSN on the special form it has devised for that purpose and putting the SSN on that form keeps the number from the public eye.  Leaving it on the determination letter without redacting it opens the petitioner up to things that happen when the SSN gets in the wrong hands.  We try to be diligent in the clinic to find and redact the social security information of the taxpayer on every page of the notice we attach.  Programs exists that will allow you to perform the redaction in a cleaner form than might be available if you just use a marker.  Don’t miss this important step in filing a petition.

In addition to the redaction issue which is present in every case, the CDP notice of determination contains the misleading guidance on when to file the Tax Court petition that we have discussed previously.  Carl Smith has carefully tracked Tax Court orders over the past two years.  Because of his work, we know of seven cases in which the language in the CDP notice of determination has caused taxpayers to petition on the 31st day which has caused them to be dismissed for lack of jurisdiction.  With Carl’s help, the Harvard clinic is litigating some of these cases and arguing that the notice has misled the petitioner in to filing late.  We have blogged about this before.  Look carefully at the wording in the second paragraph.  The IRS should change this wording and avoid misleading taxpayers into losing their Tax Court opportunity.

Enough diversions, let’s talk about Mr. Mayweather’s little $22 million dollar problem.

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Maybe you and I wish we earned enough to have a $22 million tax problem.  It’s hard to imagine.  We know the amount because the IRS filed a notice of federal tax lien (NFTL).  The NFTL provides an exception to the normal rules regarding disclosure of a taxpayer’s information.  In order for the IRS to protect and secure its interest in a delinquent taxpayer’s property, Congress authorized the IRS to make the liability public.  When the IRS does file a NFTL against a celebrity, the news media usually picks it up and the celebrity is held up to a mild form of public shaming or at least notoriety.  Several news outlets, here, here, here, and here together with many others did the honors in covering the NFTL filed against Mr. Mayweather.

In 2015, Mr. Mayweather made a lot of money in a fight.  When a foreign fighter gets paid in the United States, 30% is paid to the IRS.  When a US citizen fights, the fighter gets the entire purse with no withholding so it is up to the fighter to make the appropriate estimated payments.  I presume that insufficient estimated payments were made on the $100 million paid to Mr. Mayweather for his fight in 2015, but I do not know that for certain.  I am told that a fighter earns the money in one of these fights as soon as the opening bell rings and that the money is frequently paid on the night of the fight.  The payments to Mr. Mayweather go to a corporation that he controls which would then distribute money to him.  I am also told that someone from the IRS attends these major fights in an effort to ensure that the IRS gets its take from the purse.  The fact that Mr. Mayweather does not seek to contest the liability in the CDP context suggests that he agrees with the amount.  Now, the question is how will he pay the tax and what will the IRS do about it if he does not.

I assume without knowing that some breakdown in communication between Mr. Mayweather and the IRS may have occurred before the IRS sent the notice of intent to levy.  It is also possibly based on their respective positions taken in the CDP case that what I am calling a breakdown was an offer from Mr. Mayweather to fully pay the liability with a short term installment agreement following certain liquidity events with the IRS rejecting that proposal and demanding immediate payment by liquidating assets or borrowing money.  The notice of determination speaks only about sustaining the levy action and not about the NFTL.  The newspaper stories would only know the amount of the liability because of the filing of a NFTL.  I cannot tell why the NFTL was not a part of the CDP case.

With the focus on levy, the parties each took their respective corners in the CDP hearing.  From the IRS corner came a pronunciation that Mr. Mayweather had sufficient income and equity in assets to fully satisfy the liability.  From the Mayweather corner came the position that although he did have enough assets to satisfy the liability, it did not make financial sense to liquidate or borrow on those assets when he would soon have a liquidity event and was about to have another fight with a proposed payday that would more than satisfy the outstanding liability.  The proposed purse for Mr. Mayweather from the upcoming fight is purported to be between $100 and $200 million.  Mr. Mayweather offered to fully pay the liability with a short term installment agreement.  Without knowing more, it’s hard for me to argue with the logic of a short delay in these circumstances.

In pre-CDP days, the IRS would simply have issued a levy on the fight promoter or whoever makes payment of the purse to the fighters after a fight.  I doubt the Revenue Officer in pre-CDP days would have exhausted too much effort trying to persuade Mr. Mayweather to liquidate his assets because the RO could tie up the purse and doing so would solve the problem in the easiest, most efficient manner.  Because the timing of the CDP notice and the upcoming fight allow Mr. Mayweather to keep the IRS from levying on the purse unless it can show jeopardy, the statute gives him the upper hand while the CDP matter awaits final disposition.  By filing a relatively simple form (Form 12153) followed by the filing of the Tax Court petition (using the simple form provided by the Court), Mr. Mayweather wins this fight for the low cost of $60 and some attorney’s fees.

Unless the IRS wants to find that jeopardy exists, its hands are tied.  The championship fight will occur even before the answer is due in the Tax Court CDP case.  The Settlement Officer must have known this yet did not want to enter into an agreement allowing for a short term installment agreement.  Now, Mr. Mayweather can make the installment payments he proposed while the CDP case is pending in Tax Court without having to pay the fee for an installment agreement.  The savings in the installment agreement fee will more than make up for the $60 fee he paid to file his petition.  I would like to know what the SO thought would happen with the issuance of this notice of determination.  The taxpayer couched his request as a short term installment agreement.  It sounds similar to a forbearance request because it essentially requests the IRS to wait to a date certain for full payment.  A short term installment agreement or a forbearance request provides a type of resolution where the taxpayer has the ability to full pay upon the occurrence of an event sometime in the near future.  The IRS gains little by forcing a taxpayer to sell or lien assets when a big payday is coming up.  There may be more than meets the eye here but agreeing to take the taxes through a short term installment agreement seems in everyone’s interest.

Although the filing of the CDP petition essentially allows Mr. Mayweather to win this fight over the timing of the payment and structure the payment in a manner convenient to him, the IRS does not lose here if it gets the $22 million.  I hope the purse is large enough to fully pay the 2015 liability and the tax on the new winnings.  I wish Mr. Mayweather well in his upcoming fight with a person other than the tax man.  If his tax issues cause him to want to assist others at a different end of the income spectrum in their fights with the tax man, I know a clinic willing to accept a share of the purse and put it to use providing representation.

 

 

Tenth Circuit Raises Possible Defense to IRS Levying Bank Account with Veteran’s Disability Payments

Thanks to celebrity shills such as Alan Thicke even non-tax experts know the reach of IRS’ collection powers. That power extends to allow it to levy on a taxpayer’s property unless that property is subject to a specific exemption in Section 6334(a). Included in that exemption list are things like workers’ compensation and unemployment benefits. Veterans’ disability payments are also on that list.

Last week’s 10th Circuit’s Maehr v Koskinen involved an IRS levy on a bank account that had received the taxpayer’s VA disability deposits. Maehr had challenged the IRS assessment and intention to levy on some of his assets. Maehr appears to be a serial tax protestor, and the order dispenses with the frivolous arguments quickly though not the issue of the levy on the bank account that held his VA payments.

That issue requires a bit more context and analysis. Maehr had an account at Wells Fargo that received his VA disability payments. Under Section 6334(a)(10), IRS is precluded from directly levying on certain armed force connected disability benefits. Maehr argued that Section 6334(a)(10) should protect the assets in the bank account since the funds were comprised of VA disability benefits that are exempt from levy.

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The government raised two arguments against Maehr’s challenge to that levy:

(1) the IRS did not place a direct levy on any exempt VA disability payments; and (2) even if the IRS is improperly levying exempt disability payments, the only remedy available to the taxpayer would be full payment of the assessment of his tax liability followed by a suit for refund in district court.

The arguments are closely related. The second of the arguments relates to the Anti-Injunction Act (AIA), which, is codified at Section 7421 and provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed.” In other words, taxpayers unhappy with IRS enforced collection actions are generally unable to get a court to enjoin the IRS from going forward with its collection powers, including levy. We have discussed the AIA on numerous occasions, as courts in the past few years have been poking holes in that restriction. Even before some of the recent exceptions, then Chief Justice Warren in the Williams Packing case crafted a two-pronged common law exception to the AIA: 1) that under no circumstances could the Government ultimately prevail and 2) that equity jurisdiction otherwise exists. Courts have generally looked at that last part of Williams Packing as requiring the taxpayer to prove irreparable injury stemming from the IRS’s proposed collection action.

Taxpayers subject to collection action for excise and employment taxes that were outside the deficiency procedures have often faced the AIA’s reach when IRS sought to collect even while a refund proceeding was in the works. In a 1977 case called Marvel v US the 10th Circuit used the AIA to dispense with a taxpayer trying to challenge the IRS’s levying of business’s assets during a district court refund suit following a partial payment of employment taxes. In Maehr, the 10th Circuit distinguished Marvel on the facts, noting that Maehr also had a cause of action in addition to injunction (I assume a wrongful collection claim as well).

Despite the distinction, the 10th Circuit addressed the broader AIA issue and found that Maehr satisfied the Williams Packing narrow exception allowing the suit to continue:

If the IRS had placed a direct levy on Appellant’s VA disability benefits, we have little doubt that Appellant would have been able to satisfy the Williams Packing test and obtain injunctive relief. We see no possibility of the government prevailing on the merits in such a case, and a disabled veteran will likely be able to show that he will suffer irreparable injury if the government is not enjoined from illegally levying the VA benefits on which he relies for his maintenance and survival. See Comm’r v. Shapiro, 424 U.S. 614, 627 (1976)…

What about the government’s argument that the IRS was not directly going after the VA disability benefits, since the funds were sitting in a bank account? The Tenth Circuit briefly addressed that:

However, here the government has not directly levied Appellant’s VA benefits, and it suggests that it may do indirectly what it may not do directly—that it may wait until exempt VA disability benefits have been directly deposited into Appellant’s bank account and then promptly obtain them through a levy on all funds in the bank account, despite their previously exempt status. The government cites no authority to support this argument, and the few cases we have found adopting such a rule, see, e.g., Calhoun v. United States, 61 F.3d 918 (Fed. Cir. 1995) (unpublished table decision); United States v. Coker, 9 F. Supp. 3d 1300, 1301–02 (S.D. Ala. 2014); Hughes v. IRS, 62 F. Supp. 2d 796, 800–01 (E.D.N.Y. 1999), have not considered whether this result is consistent with the Supreme Court’s opinion in Porter Aetna Casualty & Surety Co., 370 U.S. 159 (1962), or with 38 U.S.C. § 5301’s prohibition against the levy of veterans’ benefit payments either before or after receipt by a beneficiary.

I was not familiar with either the Porter case or 38 U.S.C. § 5301, and this opinion nudged me to look at both. Porter v Aetna Casualty involves a private creditor and not the IRS but it held that VA disability benefits paid to an incompetent veteran and deposited in a federal savings and loan association were exempted from attachment by 38 U.S.C. § 3101(a) [now codified at 38 USC 5301(a)(1)]. That statute provides that payments administered by the VA “shall be exempt from taxation, shall be exempt from the claim of creditors, and shall not be liable to attachment, levy, or seizure by or under any legal or equitable process whatever, either before or after receipt by the beneficiary. The preceding sentence shall not apply to claims of the United States arising under such laws nor shall the exemption therein contained as to taxation extend to any property purchased in part or wholly out of such payments.” (emphasis added).

So Title 38 has its own protection of VA disability benefits that goes beyond the Internal Revenue Code. As I said, Porter did not involve an IRS levy (instead it involved a private creditor) but it did directly consider the reach of the Title 38 protection when the disability benefits were held after payment. The savings and loan rules at issue in Porter treated the depositor as a shareholder, requiring a 30-day demand before the S&L shareholder could reach the proceeds. Porter considered whether the deposit of the VA disability payments in a savings and loan essentially constituted after-acquired property that was no longer protected by Title 38. Porter discusses the earlier case of Lawrence v. Shaw, 300 U. S. 245 (1937), where the Court held that “bank credits derived from veterans’ benefits were within the exemption, the test being whether, as so deposited, the benefits remained subject to demand and use as the needs of the veteran for support and maintenance required.” On the other hand, the Court had held in a prior case that a veteran’s purchase of bonds with the VA proceeds removed the protection of the statute and those bonds constituted an after-acquired investment.

Porter resolved the issue as to whether the S&L account was more like the bank deposit case or the after-acquired investment:

Since legislation of this type should be liberally construed… to protect funds granted by the Congress for the maintenance and support of the beneficiaries thereof… we feel that deposits such as are involved here should remain inviolate. The Congress, we believe, intended that veterans in the safekeeping of their benefits should be able to utilize those normal modes adopted by the community for that purpose — provided the benefit funds, regardless of the technicalities of title and other formalities, are readily available as needed for support and maintenance, actually retain the qualities of moneys, and have not been converted into permanent investments.

Back to Maehr and the IRS’s Collection Powers

The Tenth Circuit remanded the case back to the District Court to consider whether the reach of Porter and whether the “IRS has improperly levied exempt VA disability benefits by placing a levy on all funds in the bank account where Appellant’s disability benefits are deposited.” It left open the question of remedy, expressing “no opinion on the ultimate resolution of this claim or on the unresolved questions regarding the availability of the types of relief Appellant has sought or may seek in an amended Complaint.”

This is an interesting opinion and raises a possible defense to collection on a certain kind of asset, i.e., a bank account that holds veteran’s disability payments. It seems that IRS at the district court should emphasize Section 6334(c), which provides that “[n]otwithstanding any other law of the United States (including section 207 of the Social Security Act), no property or rights to property shall be exempt from levy other than the property specifically made exempt by subsection (a).” Likewise the regulations under Section 6334 provide that “no other property or rights to property are exempt from levy except the property specifically exempted by section 6334(a).”

IRS has a longstanding position that once the funds move from the excepted payor to the taxpayer, the funds lose their exemption. The Porter case and Maehr’s unearthing it suggest a possible barrier to the vast collection powers that IRS generally has when there is a bank account that has solely as the source of its deposits disability payments the IRS would be unable to reach directly. Given the explicit language in Section 6334(c) and IRS’s longstanding view that the exempted property loses its character when the funds reach the taxpayer I would expect a vigorous challenge to extending Porter to include protection from the reach of an IRS levy. In addition, even if that protection were extended, there could be some interesting second order questions. Query for example  the tracing problems if the account has other funds beyond the disability payments or if the IRS were to show that the taxpayer had other funds that he used to meet his necessities beyond the disability payments.

Collecting Partnership Debt from General Partners

The 9th Circuit recently sustained the district court which sustained the bankruptcy court in the case of Pitts v. United States.  The taxpayer sought a determination that the taxes claimed against her in the bankruptcy proceeding were discharged.  The courts determined that the taxes were not discharged, rejecting various arguments that she presented.  The case breaks no new legal ground but serves to highlight how the IRS collects from general partners.  If you have this issue, you might look at IRM Part 5, specifically 5.1.21, 5.17.7, and 5.19.14.

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Ms. Pitts was the general partner of DIR Waterproofing. DIR failed to pay its employment taxes including both trust fund and non-trust fund portions. The IRS would typically make some effort to collect from the partnership and then seek to collect from the partners. The opinion does not describe the efforts made here, but the IRS did issue a notice of federal tax (NFTL) against Ms. Pitts. In these situations the IRS does not go through a separate assessment process for Ms. Pitts but uses the assessment made against the partnership in order to pursue collection against her. The NFTL would reference the partnership debt although it would make clear that the lien is against her. Because the debt arose through the partnership, she argued that it was a state law debt and the IRS was limited to collect as a state law creditor. The 9th Circuit made three separate explanations of why her arguments failed.

First, the court pointed out that under IRC 6321 Ms. Pitts was a person liable to pay any tax and, as such a person, a lien arises under federal law which attaches to all of her property and rights to property once the IRS makes demand for payment and payment is not made. This is federal law and not state law creating the lien. The court cited several cases in support of its position.

Next, the court found that the IRS can use all of its administrative enforcement tools because she is secondarily liable on this debt. The court cited to a Supreme Court decision, United States v. Galletti, 541 U.S. 114 (2004) that may have caused Ms. Pitts to make the arguments she made here but which should also have suggested to her that these arguments would likely fail. In Galletti, similarly situated taxpayers to Ms. Pitts went into bankruptcy where the IRS filed a proof of claim based on the assessment against the partnership in which they were general partners. The Gallettis argued that no debt existed against them because the IRS had not made an assessment against them (and the statute of limitations on assessment of the partnership debt had run by the time of the bankruptcy.) In that case, the bankruptcy court, the district court, and the 9th Circuit agreed with the Gallettis. These opinions relied upon the definition of ‘taxpayer’ in IRC 7701 and looked to the separate nature of the partners as taxpayers from the partnership. The IRS pushed the case to the Supreme Court, which held that the IRS did not need to make a separate assessment because the Gallettis were liable under state law as general partners of the partnership.

Writing for a unanimous Court, Justice Thomas said:

“Under a proper understanding of the function and nature of an assessment, it is clear that it is the tax that is assessed, not the taxpayer. See §6501(a) (“the amount of any tax … shall be assessed”); §6502(a) (“[w]here the assessment of any tax”). And in United States v. Updike, 281 U. S. 489 (1930), the Court, interpreting a predecessor to §6502, held that the limitations period resulting from a proper assessment governs “the extent of time for the enforcement of the tax liability,” id., at 495. In other words, the Court held that the statute of limitations attached to the debt as a whole. The basis of the liability in Updike was a tax imposed on the corporation, and the Court held that the same limitations period applied in a suit to collect the tax from the corporation as in a suit to collect the tax from the derivatively liable transferee. Id., at 494-496. See also United States v. Wright, 57 F. 3d 561, 563 (CA7 1995) (holding that, based on Updike‘s principle of “all-for-one, one-for-all,” the statute of limitations governs the debt as a whole).

Once a tax has been properly assessed, nothing in the Code requires the IRS to duplicate its efforts by separately assessing the same tax against individuals or entities who are not the actual taxpayers but are, by reason of state law, liable for payment of the taxpayer’s debt. The consequences of the assessment–in this case the extension of the statute of limitations for collection of the debt–attach to the tax debt without reference to the special circumstances of the secondarily liable parties.”

Ms. Pitts wants the courts to recognize that the assessment only applies to her because of the operation of state law and since it is the operation of state law causing her to become liable she wants the debt treated as state law debt and not tax debt with the exceptions to discharge applicable to tax debts. The 9th Circuit, perhaps still remembering the Galletti outcome, does not allow her to split hairs in this manner. State law plays an important role in creating the liability but her liability is for a federal tax debt.

The 9th Circuit rejects her argument that state law creates the statute of limitations. It also rejects her argument that the continuation by the IRS of its efforts to collect this debt violates the discharge injunction. I did not go back and read the earlier opinions to see the age of the debt. The trust fund portion of the partnership’s unpaid employment taxes will always be excepted from discharge because B.C. 507(a)(1)(C) will always make this a priority debt in bankruptcy and that will always make it excepted from discharge under B.C. 523(a)(1)(A). The non-trust fund portion of the partnership employment tax debt should become dischargeable for bankruptcy petitions filed more than three years after the employment tax return due date, assuming it timely filed the returns. The court engages in no analysis of this issue making me think that she is not entitled to a discharge of the non-trust fund portion; however, depending on the timing of the debt and the bankruptcy petition, this portion of her debt could potentially be discharged in her bankruptcy just as in the bankruptcy of the partnership itself.

This case demonstrates how the IRS will proceed to collect from a general partner. It simply uses the assessment against the partnership to open the full range of administrative collection tools given to it under the Code. The effort by Ms. Pitts to use the Galletti opinion to argue that the operation of state law which lets the IRS go after the general partners without a separate assessment should also limit the IRS in its ability to collect. The 9th Circuit rejects that limitation on the power of the IRS in this situation and, I think, its decision is correct. The issue brings up in another context the interplay between state law which creates certain rights and obligations and the federal tax collection law which builds upon the state created rights and obligations.