Revisiting Craft

It has been almost four years since I wrote a post on United States v. Craft, 535 U.S. 274 (2002). At the time I wrote the last post, a circuit split existed on how to value the interest of the spouses in a tenancy by the entirety. The IRS argues for a 50/50 valuation whereas some taxpayers argue for a valuation based on the actuarial interest of each of the spouses. The issue has been quiet recently, perhaps because of the lack of IRS activity in the area based on its diminished capacity or perhaps because the cases that have moved forward have all involved situations in which the 50/50 split favors the spouse who does not owe the tax. In United States v. Gerard, 121 AFTR 2d 2018-640 (N.D. Ind. April 9, 2018), another court voiced an opinion on how to split the proceeds.

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Robert and Cynthia Gerard bought a home in Indiana in 1990 as tenants by the entirety. Over 90% of the purchase of the property has been paid by Robert. From 2003 to 2008, Cynthia owned a business treated as a sole proprietorship and incurred employment taxes which remain unpaid. In 2012, following in the footsteps of the Crafts, Robert and Cynthia conveyed, by gift, the property to Robert individually. I am guessing they had not read the Supreme Court’s opinion at the time they decided to make this transfer and they may have thought that it would magically remove the federal tax lien from the property.

They argue that at the time of the transfer her interest was worth much less than his because he had contributed the lion’s share toward the purchase of the property and her business had been a net drain on the family finances. They further claim that the property was transferred due to her health and the need for Robert to manage her affairs.

The case involves a fight about the amount owed as well as the extent of the federal tax lien on the property. With respect to the amount owed, the Court found that Cynthia owed $60,969.04 plus statutory accruals, resolving that aspect of the case and then turned to the lien.

The Gerards argued that Robert was a purchaser when the property was transferred to him from joint ownership. That argument flies in the face of the statute. IRC 6323(h)(6) defines a purchaser as:

“a person who, for adequate and full consideration in money or monies worth, acquires an interest (other than a lien or security interest) in property which is a valid under local law against a subsequent purchaser without actual notice.”

Despite the deed of gift, the Gerards argue that Cynthia’s use of joint marital assets in connection with her business formed the basis for meeting the full and adequate consideration test. The IRS argued that the deed itself stated it was transferred “without any consideration other than love and affection.” It further argued that even if the language of the deed prepared by the Gerards does not control the transfer, the consideration they offer is past consideration which is insufficient to meet the test of adequate consideration. The Court agreed with the IRS on the issue of past consideration and determined that Robert was not a purchaser.

Having determined Robert did not purchase the property from the joint tenancy, the remaining dispute centered on the extent to which the liens attached to the property. The Gerards contend that Cynthia’s interest in the property was something less than half of the property and the federal tax lien only attached to her smaller interest. The arguments regarding who has what interest in the property usually stem from an application of the actuarial tables and usually occur when the husband owes the money and the actuarial tables show that the wife has the greater life expectancy. Here, the argument builds around the husband’s contribution toward the purchase of the property. The IRS argues that they each have a 50% interest and that’s what the court found that Indiana law supports. The court cites Indiana case law in support of the position that husband and wife each become owner of half of the property.

In addition to the several cases involving Indiana law, the court cited the earlier Craft decisions from the Third and Sixth Circuits, supporting a 50/50 split of the value of the property.  So, the court concludes that the lien against Cynthia attaches to her 50% interest in the property.  I was curious that I had not seen the Craft issue in some time and felt there must be cases decided since my last post.  My research assistant found the following cases which may benefit someone concerned with this issue: United States v. Tannenbaum, 2016 WL 4261755 (E.D.N.Y. 2016)United States v. Bogart, 715 Fed. Appx. 161 (3d Cir. 2017); United States v. Cardaci, 856 F.3d 267 (3d Cir. 2017); In re Conrad, 544 B.R. 568 (Bankr. D. Md. 2016); and United States v. Born, 2016 WL 1239219 (D. Alaska 2016).

The third issue in the case involves whether the court should allow the IRS to foreclose its lien and sell the property giving Robert a monetary amount equal to his interest in the property based on the sale. Although it initially sought summary judgment on this issue, the IRS backed away from that request and argued that the decision to foreclose required the gathering of facts. Such facts would be necessary in order to make a United States v. Rogers, 461 U.S. 677 (1983) determination that foreclosure properly serves the interests of all parties in this situation. So, the amount of the liability is now known, the extent of the lien in the property is known, and all that remains to learn is whether the court should order foreclosure or defer it based on the Rogers factors.

 

 

Innocent Spouse Status versus the Federal Tax Lien

The case of United States v. Kraus, No. 3:16-cv-5449 (W.D. Wash. April 3, 2018) demonstrates the problems that can occur when your spouse engages in tax protestor action even if you were “innocent.” The result here for the wife is the loss of her home, even though she has no personal liability for the unpaid tax. She argues that such a result renders her innocent spouse status somewhat meaningless; however, the court points out that innocent spouse status relieves the individual of personal liability but does not destroy the federal tax lien or the remedies available in connection with the lien.

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Ms. Lao married Mr. Kraus in 1988. At the time of the decision, they had three children ages 16, 24, and 27. During almost all of the marriage, Mr. Kraus earned the money used by the couple and she took care of the family. He handled all of the family finances, including tax filing, and gave her an allowance for household expenses. He stopped filing taxes in 1999, claiming that only federal employees need file tax returns. He ran a jewelry business with his brother. When the IRS audited the business and him individually, he did not engage in the audit, causing the agent to determine taxable income without the benefit of his assistance. As a result, the agent determined a huge liability because of the lack of expenses to offset the income. In addition to owing taxes for the years of non-filing, Mr. Kraus had numerous frivolous filing penalties for his tax protestor submissions to the IRS in response to its correspondence.

The couple sold their prior residence in 2003 and purchased a new home. At the time of the suit to foreclose, they had almost completely paid off the home. Mr. Kraus had also “transferred” the home to a trust though the couple and their children continued to live in the home, make all decisions related to the home, and pay all of the bills. Mr. Kraus told Ms. Lao that the transfer to the trust was for estate planning purposes and to protect the property from frivolous suits.

The couple was divorced in 2010 and she began working at a retail store. Mr. Kraus continued to live in the marital home and they split the bills. When the tax situation arose, she applied for and received innocent spouse status under IRC 66, since Washington is a community property state. Despite her innocent spouse status, the IRS sought to foreclose its lien on the property owned by the couple. The court quickly brushed aside the fraudulent transfer and determined that the lien attached to the property. Ms. Lao argued that allowing the IRS to foreclose on the house would render her IRC 66 relief “an empty shell of false security.” The court responded that IRC 66 relief does not entitle her to prevent foreclosure. “While innocent spouse relief prevents the assessment of a tax against Lao individually in any separate property she may possess, it does not affect the ability of the Government to pursue collection remedies against Lao’s interest in community property.” Under Washington law, “all debts of each spouse that are acquired during the marriage attach to the marital community as a whole and one spouse’s tax liabilities are presumed to be community debts if they are incurred during the marriage.”

Even if she obtained a separate property interest after the divorce, she took that interest subject to the preexisting liens or mortgages. “Any separate interest that Lao possesses in the subject property must lie in the equity that exceeds the preexisting mortgage and liens.”

The court finds an open question of whether the lien could continue to grow after her interest in the property separated from the marital community. The court said that interest accruing after the divorce may only attach to his separate property and requested additional briefing on this point. It appears that the IRS will obtain permission to foreclose on the entire property and sell it, leaving her with money from the sale but no home where she and the children, one of whom is a minor, have lived for 15 years. I was surprised that the court did not apply the equitable factors in United States v. Rogers, 461 U.S. 677 (1983) to decide whether selling the home under these circumstances was appropriate. Applying the factors in that case might cause the court to pause in making the decision to sell the property at this time – at least until the youngest child reaches the age of majority.

The case demonstrates the limits of innocent spouse status. Being an innocent spouse does not stop the IRS from taking collection action that can have a negative impact on the innocent spouse where property interests of the non-liable spouse remain intertwined with the liable spouse. While she will receive some equity from the sale of the home, this situation causes her to lose her home despite being innocent of the actions causing the liability.

For those interested in the power of the federal tax lien, the Pro Bono & Tax Clinics committee of the ABA Tax Section will host a panel discussing Kraus and other lien cases at the May Meeting in D.C. next week. Christine

 

New Rock Baptist Church Continues Development of Collection Due Process Law

Located not too far from the Tax Court’s building in D.C., New Rock Baptist Church and its nursery school provided the setting for an interesting full TC opinion looking at who can bring a Collection Due Process (CDP) case as well as when does the case become moot.  The Court finds that only the real taxpayer can bring a CDP case even if the IRS lists the wrong taxpayer in its notice of federal tax lien and that fixing the lien problem by withdrawing the notice does not end the CDP case for the taxpayer seeking to adjudicate their collection issue.

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It’s not unusual for a church to host a nursery school.  It’s not unusual for the church and the nursery school to exist as two separate entities despite the close relationship they have in sharing a building and often other matters as well.  In this case, the church and the school did have separate identities and separate EINs and even separate addresses.  The nursery school ran into trouble with its payroll taxes.  The IRS eventually assessed a decent sized liability of over $400,000 against the nursery school and decided that it needed to file a notice of federal tax lien in order to protect its interest.

Unfortunately, when the IRS filed the notice of federal tax lien, it did not file it in the name of the New Rock Baptist Church Child Development Center but rather filed it in the name of New Rock Baptist Church.  Although the NFTL correctly identified the address and EIN of the nursery school, the church did not appreciate having a NFTL filed in its name rather than the name of the nursery school and took the opportunity to join in filing a CDP request.  The person receiving the CDP notice at the nursery school seems to have shared the notice with the church, and one might even imagine some discussions occurring regarding the nature and the existence of the NFTL, because the nursery school also filed a CDP request.

The CDP requests of the church and the school were consolidated in the hands of one settlement officer.  I base my comments on the opinion and not the underlying documents.  Based on the opinion, it appears that the CDP requests filed by both entities focused on obtaining an installment agreement for the nursery school instead of focusing on the separate issue of the correctness of the NFTL.  The SO, perhaps unaware of the incorrectness of the NFTL, rejected the proposed installment agreement stating “no collection alternative can be approved.”  The Court notes that the SO did not make the basis for rejection clear.  I would speculate that the basis was a failure of the nursery school to keep current with its filing requirements or payment requirements.  Surprisingly, although perhaps attributable to neither party raising the issue, the SO further determined that “the NFTL was correctly and properly filed.”  Even if neither the church nor the nursery school mentioned the incorrect name on the NFTL, the existence of CDP requests from both entities should have served as at least a mild clue that something was amiss.

On June 20, 2014, the IRS issued a notice of determination.  The Court’s choice of words makes me think that only one notice of determination was issued.  It was sent, like the NFTL to the correct address, with the correct EIN and the wrong taxpayer name.  The nursery school and the church jointly petitioned the Tax Court from the notice of determination requesting that the IRS should withdraw the NFTL.  Chief Counsel’s office requested a remand of the case to Appeals for it to: 1) give further consideration into withdrawing the NFTL, and 2) provide greater explanation regarding why it rejected the IA.  The Court granted the motion of the IRS for a remand.

On remand the IRS assigned a new SO.  The new SO, perhaps alerted to the issue by the Chief Counsel attorney, determined that the NFTL was ambiguous (this is the Court’s word; it is possible to conclude that the NFTL was simply wrong or that it violated disclosure laws by wrongfully naming a taxpayer with no liability and telling the world that it had a whopping liability) and that the NFTL should be withdrawn.  The new SO determined that the nursery school did not qualify for an IA because it was not in compliance with all return filing requirements.  Despite having identified the problem with the lien, the new SO sent the supplemental notice of determination to the correct address for the nursery school, with the correct EIN and with the name of the church rather than the nursery school.  Some things die hard.  Once the IRS has used the wrong name, getting it to switch and use the right name can require an act of God, or at least a Tax Court judge, and here again the IRS misidentifies the taxpayer even after recognizing the problem of misidentification.

Before finishing the discussion of the case, I want to pause here to make sure everyone understands that the withdrawal of the NFTL does not impact the federal tax lien itself which continues to exist and continues to attach to all property and rights to property owned by the nursery school.  Withdrawal of a NFTL simply removes the notice of the lien but not the lien itself.  Withdrawing the notice has an impact on the security of the lien and its priority vis a vis other creditors, but not the validity of the underlying lien or the liability secured by the lien.  Do not get sucked into thinking that withdrawal of the NFTL fixes the nursery school’s tax problems.  Withdrawal does, however, remove from the public record the erroneous statement that the church has a tax liability.  The church may still need more statements from the IRS to the effect that it never owed any federal taxes giving rise to the NFTL because creditors will, or may, know that the withdrawal does not signal the church no longer owes.

So, back in the Tax Court the IRS moves to dismiss the case as moot since the new SO fixed the problem by withdrawing the NFTL.  The nursery school, however, says not so fast because it still wants to have a hearing on the liabilities it owes.  The Tax Court determines that it has jurisdiction over the CDP case involving the nursery school basically finding that even though the NFTL did not mention the nursery school by its precise name it was close enough to trigger CDP rights; however, with respect to the church the Court finds that it was not a proper party.  It says no valid notice of determination was issued to the church despite the fact that the notice of determination listed the name of the church and not the nursery school.  Maybe this works in an opinion written when the NFTL has already been withdrawn; however, I am troubled that an entity clearly listed on the NFTL and on the notice of determination is denied the opportunity to seek relief from the impact of the NFTL.

Perhaps the Court thinks that the 7432 provisions regarding liens provide sufficient protection but it does not spell out why it thinks an individual or entity listed on an NFTL and listed in the notice of determination as the taxpayer against whom the IRS is taking collection action giving right to a CDP hearing has no right to seek redress through such a hearing.  It says that no valid federal tax lien existed with respect to the church.  True, but CDP protection does not depend on a valid federal tax lien it depends on the filing of an NFTL.  Determining the validity of the NFTL is an integral part of the CDP process.  A taxpayer listed in an NFTL should be able to use the CDP process to contest the validity of the NFTL and the underlying lien.  The Court does not explain why the lack of an underlying federal tax lien has an impact on the jurisdiction of the Court in a CDP case.  Does this mean that if the Court should reach the conclusion in another case that no lien exists, say because the assessment is invalid, it must dismiss the case rather than grant relief.  I cannot follow the logic here.

The Court also says no valid notice of determination was issued.  I have a similar problem.  A notice of determination was issued in the name of the church.  Yes, the IRS made a mistake in sending the notice of determination (as well as the notice of supplemental determination) in the name of the church but that should not prevent the church from receiving relief.  Maybe it would be useful for a taxpayer who wrongfully gets listed on an NFTL and who receives a notice of determination to have a court opinion that says it was wrong so it can show its creditors that it was wrong.

The Court may reach its conclusion because the notice of determination uses the separate address of the nursery school to say that the church did not receive this notice.  It does not make that explicit and the link between the organizations still creates a problem for the church that CDP might resolve.

In the end, after determining that it has jurisdiction to consider the CDP relief requested by the nursery school, the Court finds that the withdrawal of the NFTL did not moot the case.  Even though it has jurisdiction and even though issues regarding liability still exist, the nursery school has problems that prevent it from getting any relief through CDP.  It raised some issues it wanted the Court to address after making its CDP request, and the Court says those issues are not properly before it.  Because the nursery school was not in compliance with its filing requirements at the time of the Appeals determination, the Court sustains the Appeals determination that it is not eligible for an IA.  The nursery school alleges that it is now in filing compliance, and the Court responds correctly that losing a CDP case does not prevent it from entering into an IA at the conclusion of the case.  That’s the nice thing about CDP.  It’s just a skirmish on the road to collection and not the ending point.

 

 

New Estate Tax Lien Discharge Procedures — Give the IRS All the Monies

In early April, the IRS issued updated guidance relating to the processing of the estate tax liens after June of 2016. See SBSE-05-0417-0011.   In June of 2016, various changes were made to the administration of the estate tax, including which groups in SBSE handled requests for the discharge of the estate tax lien.  The changes to the discharge were fairly drastic in some ways, and the Service took a significant amount of time getting around to announcing the changes (which it states is actually just the correct implementation of the law, perhaps implying the prior handling was incorrect).  The new provisions appear to force prepayment of tax, or at least handing over the funds, in exchange for the discharge of the lien in a broader range of situations, potentially creating a significant hardship for estates.  This has caught many estate administration lawyers off guard, altering sales, and angering many in the professional community.

The estate tax lien is somewhat different than other tax liens, and arises in every estate (you just don’t know it most of the time).  Under Section 6324(a), a lien is immediately imposed on all property in the “gross estate” of the decedent.  This includes property passing through the estate, but also most property passing directly to a beneficiary by operation of law, such as property held joint with right of survivorship, and most property passing by beneficiary designation.  As stated in the IRS guidance:

Unlike other tax liens, no assessment, no notice and no demand for payment are necessary to create the estate tax lien. It attaches at the time of the decedent’s death, before the tax is determined, and is security for any estate taxes that may be determined to be due. It is referred to as the “silent lien” and does not have to be recorded to be enforced.

Sneaky stuff, but arguably provides important protection for the Fed.  This lien attaches and remains in place for ten years after the date of death unless discharged.  There are some provisions extending the lien in circumstances where the estate tax is deferred, such as under Section 6166, but otherwise the use-by date is set at ten years.  As a side note, it is possible for a general tax lien to also be imposed under Section 6321, which could be in place longer, so in dealing with a lien estate tax practitioner must determine if one or both are in place.  See IRM 5.5.8.2.  For those looking to learn more about this lien, Keith and Les recently drafted chapter 14A.20 in SaltzBook, which covers the lien in depth, along with the transferee liability, how to request discharge, and various other interesting aspects of the “silent lien.”

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As indicated above, the lien is imposed immediately, while the audit could take months or years to occur, if ever at all.  Various situations would not be audited or do not require returns.  This can create issues, especially for illiquid estates, that need funds for administration costs.  If a fiduciary sought to transfer assets, especially when finicky title insurance and mortgage companies were involved, assurances would be needed that the property could be transferred free and clear.

Under the old rules, release or discharge was handled by different groups depending on whether a return was filed or audit was occurring.  If no return was filed or a return was under audit, Exam reviewed the request. This used to be outlined in IRM 4.25.14.2, which has subsequently been updated to indicate Exam will no longer be handling discharge requests.  Specialty Collection Advisory used to handle all other requests relating to the estate tax lien, which was covered under IRM 5.5.8 and IRM 5.12.10.

The prior procedures would allow the fiduciary to request a discharge of the lien on the property to be sold by filing a Form 4422, Application for Certificate of Discharging Property Subject to the Estate Tax Lien. This was fairly routine in the past and occurred quickly, allowing property to be sold and estates to obtain the proceeds.  This was allowed under Section 6325 if the lien was “fully satisfied or provided for.”  Presumably, the “provided for” language was what was relied upon prior to payment and the issuance of a closely letter.  The regulations added some additional requirements regarding “necessity” of the estate.

In SBSE-05-0417-0011, the Service outlined the new procedures for requesting discharge, and it appears the conditions for obtaining discharge have become a bit more strict.  Beginning in June of 2016, responsibly for all discharge applications of the estate tax lien were shifted to Advisory to be handled by its “Estate Tax Lien Group.”   Information about requesting the discharge, including the address to send such requests, is found on the IRS webpage here.  The directions provide that such requests must be filed “at least 45 days before the transaction date”, which is roughly a month or more longer than such requests used to take.  This is irksome, but not as problematic as some other changes that have been made.

After noting discharge is completely discretionary, the advice indicates considerations that Advisory may take into account, including situations where Advisory does not need to consult with Exam prior to issuing a discharge, stating:

In many instances, decisions concerning the discharge application can be made from the information provided on the Form 706 (if applicable) and the Form 4422 without the need to coordinate with Examination Estate & Gift. For example, if based on the information provided with the Form 4422 and internal account records you are able to determine that the estate tax liability has been paid, or the estate is not subject to a Form 706 filing requirement, or the value of other property disclosed on the Form 4422 that will remain subject to the estate tax lien is more than ample to protect the government’s interest in the payment of the estate tax, coordination with Examination Estate &Gift is not ordinarily necessary (emph. added).

The advice goes on to cover situations where Advisory will need to coordinate with Exam or Chief Counsel when considering discharge.  I emphasized some language in the above quote, because that language would seem to indicate discharge is appropriate where there is clearly more than sufficient other assets to timely pay the estate tax, which historically occurred.  Other language would give the same impression:

In many instances, in determining whether to grant an estate tax lien discharge, the issue you will need to consider is whether the estate tax liability is adequately provided for, meaning that the government’s interest in collecting the estate tax is secured… In determining whether an estate tax liability is adequately provided for, you have discretion and should exercise your judgment in making that decision based on the particular circumstances…[and] you may also consider the criteria in IRC § 6325(b) as a guideline in making your decision as the estate tax liability will generally be adequately provided for when one or more of the IRC § 6325(b) criteria set forth below is satisfied. In addition, there may be other circumstances where you and your manager determine that the estate tax liability has been adequately provided for under the particular circumstance involved.

This again would indicate payment at the time of discharge is not required, although gets a little thornier perhaps by reference to Section 6325(b), which allows for discharge in various circumstances, such as having double the potential liability available, partial payment, substitution of proceeds at sale, substitution of other assets (deposits, bonds, etc.).

The advice then covers some common scenarios.  For instance, if no Form 706 is required to be filed, no discharge is offered, and instead  Letter 1352 is issued indicating no return must be filed.  When a return is required, but no tax is due, the advice indicates escrow may not be needed.  But, if there are questions as to the veracity of the claim, additional research may be needed, and perhaps escrow.

Then  it starts to get problematic, stating:

if the Form 4422 shows an estimated estate tax greater than the net proceeds from the property being sold, and no estimated payment has been made, then the net proceeds should be paid or escrowed before granting the discharge.

For an estate that is illiquid, holding only real property or closely held business interests, this could be very problematic.  And, anecdotally, it appears some estates are running into this issue.  Although the estate tax is a priority claim, there are various other administration costs that can be paid first (my fave, attorneys’ fees).  It could also impact the payment of state death taxes, the timing of which can be more important that federal taxes.  In Pennsylvania, for instance, prepayment of inheritance tax at the three month mark will provide a five percent discount off the tax bill.  At least one tax practitioner has requested some type of hardship request from having to pay over the funds, and been rebuffed.

It also brings into question what will happen for someone who would have requested an extension to pay tax under Section 6161 or Section 6166.  I suppose the funds could be escrowed until the return is filed, but the funds may have been needed to run a closely held company or pay another debt.

I do not necessarily begrudge the IRS attempting to ensure payment, but this seems like an attempt to solve a problem that may not have existed.  I would be interested in seeing whether or not the IRS often gets stiffed on federal estate tax by people who request a discharge and have indicated tax may be due (my suspicion is no, but I could be wrong).  If this is not a problem, it seems like this change that can drastically and negatively impact estate administration (and potentially the value of estate assets) is misguided.  It would also be good if the IRS became a bit more flexible on a case by case basis – there cannot be that many of these per year — which the guidance seems to still allow.  From the anecdotal evidence, it would seem that the factors in Section 6325(b) may have been applicable in having assets worth double the tax debt still under the lien, but funds have still had to be paid or escrowed.

The take away for now is that 1) you have to apply much more in advance from closing and 2) if you need the proceeds from the sale, you probably need to make a compelling argument under Section 6325(b) why the fisc would be lighter for it.

District Court Blesses Sale of Marital House to Satisfy Other Spouse’s Tax Liability

What happens when a spouse or other third party co-owns a house with someone who has a sizable federal tax liability? IRS seizures to satisfy an assessment are relatively rare. IRS attempts to enforce a lien and foreclose on a home are even rarer. And forced sales of homes when one of the co-owners of the house owes none of the taxes probably occurs only a handful of times a year.

We are in the process of reviewing cases and other developments that we have read over the past few months as we gear up to complete the last of the three updates we do annually for the Thomson Reuters treatise IRS Practice and Procedure. Earlier this year I read US v Tannenbaum, a case out of the Eastern District in New York where the IRS sought to enforce its lien and foreclose and sell upon a marital home in Brooklyn that was shared by the Tannenbaums, Sarah and Gershon. I flagged Tannenbaum for inclusion in our discussion of the government’s authority to force the sale of co-owned property under Section 7403.

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Including interest and penalties Gershon unfortunately had run up a couple of million dollars in income tax liabilities. I am not sure if he filed MFS or if Sarah were relieved of the liabilities via Section 6015; the opinion is silent but Sarah was not on the hook for those assessments. Since 1977, the Tannenbaums jointly owned a house in Brooklyn that had an appraised value of over $1.2 million (a far cry from the Brooklyn home values when I was born and lived there in the days of Mayor Lindsay).

While the tax assessment only related to Gershon, both had some history with the government. In the mid 90’s both Sarah and Gershon had been indicted for conspiracy to defraud or commit an offense against the US and for false statements made to the IRS. Gershon pleaded guilty to the conspiracy charges and Sarah entered into a deferred prosecution agreement and all charges were dropped against her. Gershon had been sentenced to a year and a day and supervised release.

That background takes us to the case at hand and likely matters in terms of how the government approached this case. IRS sought to enforce the assessment against Gershon by foreclosing on and forcing the sale of their Brooklyn house. Both lived in the house, where they raised their children and also now lived with Sarah’s disabled mom. The house was specially set up to accommodate Sarah’s mom, who was in her 80’s and bound to a wheelchair.

This takes us to an issue that we discuss heavily in the Saltz/Book treatise, courtesy of Keith who has taken the lead oar as primary author on the revised collection chapters. Under Section 7403, a federal district court can “determine the merits of all claims to and liens upon the property, and, in all cases where a claim or interest of the United States therein is established, may decree a sale of such property,…, and a distribution of the proceeds of such sale according to the findings of the court.

Yet that power to force a sale and distribution of the proceeds is limited. In the 1983 case US v Rodgers the Supreme Court said that while the government has broad discretion to force a sale, “Section 7403 does not require a district court to authorize a forced sale under absolutely all circumstances, and that some limited room is left in the statute for the exercise of reasoned discretion.” Keith has discussed the application of Rodgers in prior posts here and here

To assist courts in exercising that discretion, Rodgers identifies factors:

1) “the extent to which the Government’s financial interests would be prejudiced if it were relegated to a forced sale of the partial interest actually liable for the delinquent taxes[;]”

(2) “whether the third party with a nonliable separate interest in the property would, in the normal course of events (leaving aside § 7403 and eminent domain proceedings, of course), have a legally recognized expectation that that separate property would not be subject to forced sale by the delinquent taxpayer or his or her creditors[;]”

(3) “the likely prejudice to the third party, both in personal dislocation costs and … practical undercompensation [;]” and

(4) “the relative character and value of the nonliable and liable interests held in the property ….”

The Tannebaum opinion applies these factors to the case at hand. While I will not discuss all the factors here, usually the most interesting part of these cases considers the prejudice to the non liable party if there is a forced sale. Of course, when the government comes in and kicks you out of your marital residence (and one that here was the marital home for close to 40 years) there is going to be prejudice.

What is too much in terms of prejudice? Sarah starts off at an atmospheric disadvantage because of her (and Gershon’s) prior history with the government. It did not help that Gershon’s mother had bequeathed a condo to Sarah and Gershon’s sister in what looks like an attempt to transfer assets outside the reach of creditors, including Uncle Sam. In addition, the opinion suggests that Sarah had other assets at her disposal and upon sale of the Brooklyn house, she would be entitled to about $600,000, as the government offered to split the sale proceeds of the Brooklyn house equally.

Those facts led the court to conclude that there was little prejudice to Sarah if the government would go ahead with the sale, as Sarah could find somewhere else to live.

Despite those facts that were stacked up against Sarah I did find one aspect of her prejudice argument to be interesting. She emphasized that in thinking about prejudice the court should “consider intangible factors” and “other common sense special circumstances.” In particular, Sarah noted that the forced sale would also impact her elderly and disabled mom, who lived with Gershon and Sarah in Brooklyn. She also pointed to the unique character of the neighborhood, which was predominantly Orthodox Jewish, as were the Tannenbaums. To top it off, she included in her papers an affidavit from a local real estate broker who noted that there was little market turnover in the neighborhood and that the house had additional value to elderly residents due to its proximity to a hospital.

The court agreed with Sarah on the principle that intangible factors matter but in the end concluded that the mom’s presence and the neighborhood’s character did not tip the scales on prejudice. First, on the mom:

The Court sympathizes with Sarah Tannenbaum concerning the care of her mother. But the evidence does not support Sarah Tannenbaum’s argument that she is short on resources. First, her financial resources are not limited to her salary, an amount that she has not disclosed.

The opinion then discussed that she and her sister in law sold the condo they inherited from Gershon’s mom and that all things considered Sarah (and her mom) would be ok if the IRS sold the marital home given the assets she had at her disposal:

Nonetheless, her share of the Condo sales proceeds, $350,000, plus the approximately $600,000 that she is anticipated to receive from the sale of the Home, mean that Sarah Tannenbaum will have $950,000 to lease or buy another home that can accommodate the Tannenbaums and Sarah Tannenbaum’s mother. Although neither side presented any evidence of the cost of leasing or buying an apartment or house in this neighborhood, the Court finds that $950,000 should suffice where the Tannenbaums can look for a smaller home, and the amount is not far off from the $1.2 million estimated market value of the Home. The Court is not aware of any controlling law, nor does Sarah Tannenbaum bring any to the Court’s attention, holding that a non-liable party is prejudiced if that party has to lease rather than buy a home.

The opinion noted that there were other Orthodox communities even if there were few alternates in the specific neighborhood. At the end of the day, however, while the court acknowledged the relevance of Sarah’s special circumstances, her resources were enough to tip that factor in favor of the government.

Conclusion

After applying all the Rodgers factors, the district court held that IRS had the right to force the sale of the Brooklyn house. Interestingly, the government argued that one of the factors in its favor was the prejudice to the government if it did not permit the forced sale. It is hard to force a sale of half a house, so there is always some prejudice if a court does not permit the sale of the entire property.

But there is more. Here the government pointed out that under NY law if Gershon were to die the US would not have the right to collect because its lien would be extinguished. Earlier this year and in fact prior to the court order setting the sale Gershon in fact did pass away (See Brooklyn, NY – Jewish Community Mourns The Sudden Loss Of Rabbi Gershon Tannenbaum ). The court was not aware of his passing when it wrote the opinion as the opinion noted Gershon failed to file any responsive papers. I suspect that the rabbi’s passing may then have extinguished the government’s interest in the residence, which would allow Sarah to remain in the house and give her the relief she sought. After the court issued its opinion, Sarah in fact filed a motion effectively asking the court seeking relief from a final judgment; the government has yet to respond and last week filed a motion seeking additional time to respond.

 

 

 

 

Two Notices of Deficiency, One Abatement, One Lien Release – Taxpayer Still Owes

The recent bankruptcy case of Lewis v. IRS  caught my eye for the number of procedural gears in motion.  The focus of the case is on the impact of the release of the federal tax lien, but much more happens in the case and following the action plus, wondering why the IRS chose a certain path makes for an interesting discussion of what happens when the IRS makes a mistake and how it goes about correcting that mistake.

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Mr. Lewis had a business installing water lines for the city of Haynesville, Alabama. Apparently, the city did not have its own public works department with the capacity to do this and it contracted with Mr. Lewis to get this done.  In 2004, he installed enough water lines to earn $429,251.50.  Unfortunately, Mr. Lewis did not have time to file a federal tax return for that year.  The IRS prepared a substitute for return for him and issued a notice of deficiency.  He defaulted on the notice of deficiency, allowing the IRS to assess.  Based on the assessed liability, the IRS filed a notice of federal tax lien in 2010.  This fact pattern repeats itself all too often and presents nothing unusual.  Mr. Lewis has a case much like that of several clients of the Harvard Tax Clinic.

At almost the same time the IRS decided to file the notice of federal tax lien, Mr. Lewis “got religion” and decided to file his 2004 tax return. He did not get a whole lot of religion, however, because the Form 1040 that he sent to the IRS did not include the $429,251.50 he received for installing water lines and reported no income tax due.  When I first read that he filed the Form 1040 after the SFR assessment, I thought that perhaps he was trying to set the year up for a discharge in bankruptcy; however, he would not leave off the income from the installation of water lines if bankruptcy drove the filing of this return.  So, I cannot speculate why he filed this very late return and why he reported no tax liability on it.  Nonetheless, the IRS processed the return and abated the liability assessed as a result of the SFR.  The IRS routinely processes returns filed after SFRs and abates the SFR assessments down to the amount on the late filed return; however, the IRS usually gives some thought to the information reported on the SFR.  Here, the IRS appears to have given no thought to the late return before abating the assessment based on the SFR.

The abatement of the assessment created a zero balance on the account which triggered the release of the notice of federal tax lien as well as the refund of some of the money the IRS has collected to that point. The following year, the IRS awoke from its slumber on this case and began an audit of the 2004 return that failed to report any of the money on the Form 1099 issued by the city.  Not surprisingly, the IRS determined that he should have reported that amount and issued him a new notice of deficiency offering him what must have been at least his third chance to go to the Tax Court (the filing of the notice of federal tax lien would have given him a chance as well as the first notice of deficiency and I do not know if he also received a CDP notice for intent to levy though I would expect that he did.)  Mr. Lewis again chose not to go to Tax Court and the IRS again assessed the tax.  On January 23, 2015, the IRS filed a second notice of federal tax lien for 2004 and, I assume, gave him another CDP notice since this was a separate assessment.

Mr. Lewis filed a Chapter 13 petition on March 18, 2015 and eventually objected to the large proof of claim filed by the IRS. Mr. Lewis argued that the release of the federal tax lien had the effect of “extinguish[ing] any and all tax liability stemming from the tax period 2004.”  Mr. Lewis is not the first person against whom the IRS has improvidently released the federal tax lien.  A long list of cases exists deciding essentially the same argument he makes in this case – that the statute absolves him from all future liability for the period.  Unfortunately for taxpayers making this argument, that is not exactly what the statute says.  Section 6325(a)(1)(A) says that

“If a certificate is issued pursuant to this section by the Secretary and is filed in the same office as the notice of lien to which it relates… such certificate shall have the following effect:

(A)  In the case of a certificate of release, such certificate shall be conclusive that the lien referred to in such certificate is extinguished.”

Having the lien extinguished and having the liability extinguished are obviously not the same thing, and the Court walked through several cases making that point. I did not read all of those cases but suspect that few of them involved the fact pattern here in which the IRS actually went to the trouble to reassess the liability and file a new notice of federal tax lien.  A footnote in the opinion states that the IRS briefed the issue of whether the lien release barred the IRS from issuing a second notice of deficiency but the Court found it did not need to reach that issue.

Because the IRS not only released the first lien but abated the assessment, I think the court reached the right result using the wrong analysis. The first lien no longer mattered by the time Mr. Lewis filed bankruptcy.  The IRS might have tried to reverse the abatement – something it can do under the right circumstances – and revoke the release of the first lien but it did not.  Instead, it used its authority to issue another notice of deficiency.  The lien on which the IRS based its claim in the bankruptcy case had never been released.  Unless the court found that the release of the first lien barred the IRS from taking any further action with respect to the tax year 2004, which is the argument advanced by Mr. Lewis, the court did not need to cite to the line of cases holding that the release of the tax lien only extinguishes the lien but not the underlying liability.

Sometimes, a mistake by the IRS prevents it from collecting the tax at issue. Here, it had several avenues to use to continue pursuing collection of the tax.  It lost the priority position it held based on the original lien.  Several years passed before it filed the second lien.  The case does not provide enough facts to allow me to determine if other creditors benefited from the loss of the lien position.  The case also does not provide enough details to make it clear whether the IRS will collect on the outstanding liability, but it is clear that the claim filed by the IRS will withstand a challenge simply trying to argue that a mistaken release bars the IRS from further collection for the year at issue.

 

Procedure Grab Bag – Making A Grab for Attorney’s Fees and Civil Damages

Your clients love the idea, and always think the government should pay, but it isn’t that easy.  Below are a summary of a handful of cases highlighting many pitfalls, and a few helpful pointers, in recovering legal fees and civil damages from the government (sorry federal readers) that have come out over the last few months.

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3rd Party Rights

The Ninth Circuit, in US v. Optional Capital, Inc., held that a third party holding a lien on property could not obtain attorney’s fees for an in rem proceeding to determine its rights in real estate that had also been subject to government liens pursuant to the Civil Asset Forfeiture Reform Act, 28 USC 2465(b)(1)(A), or Section 7430.  The Court determined the 3rd party was not the prevailing party “in any civil proceeding to forfeit property,” as required by CAFRA.  The government had lost in a related hearing regarding the lien, but the 3rd party had “not pointed to any work it performed that was ‘useful’ or ‘necessary to secure’ victory against the Government,” so it was not the prevailing party.  It would seem, however, this leaves open the possibility of other 3rd parties prevailing, if meaningful work was done in the underlying case.  This case is a good reminder of another potential option under CAFRA in attempting to claim fees in certain collection matters.

As to Section 7430, the Court found, contrary to the 3rd party’s claims, it had not actually removed the government’s liens from the property, and therefore could not be considered the prevailing party, which is required under Section 7430 to obtain fees.

When You Are Rich Is Important

In Bryan S. Alterman Trust v. Comm’r, the Tax Court held that a trust could not qualify to recover litigation costs under Section 7430 because its net worth was over $2MM.  Section 7430 references 28 USC 2412(d)(2)(B), which states an individual must have under $2MM in net worth in order to recover litigation costs.  That is extended to trusts by Section 7430(c)(4)(D).  The taxpayer argued the eligibility requirement should be as of the time the deficiency notice was issued or the date the petition was filed.  That “reading” of the statute was found incorrect, as Section 7430(c)(4)(D)(i)(II) states the provision applies to a trust, “but shall be determined as of the last day of the taxable year involved in the proceeding.”  At that time, the trust had over $2MM in net worth, saving the IRS from potentially having to shell out capital.  And, that’s why I always keep my trust balances below $2MM…and right around zero dollars.

Key Questions: Are you the Taxpayer?  Did you Exhaust the Administrative Remedies?

The District Court for the Northern District of Illinois dismissed the government’s motion for summary judgment in Garlovsky v. United States on fees under Section 7433, but also gave clear indication that the claim is in danger.  In Garlovsky, the government sought collection on trust fund recovery penalties against an individual for his nursing home employer that allegedly failed to pay employment taxes.  Prior to that collection action, the individual died, and notices were sent to his surviving spouse (who apparently was some type of fiduciary and received his assets).  The taxpayer’s wife paid a portion, and then sued for a refund.  As to damages, the Court found that the taxpayer’s wife failed to make an administrative claim for civil damages before suing in the District Court, which is required under Section 7433.

In addition, although the surviving spouse received the collection notices, none were addressed to her and the Service had not attempted to collect from her.  Section 7433 states, “in connection with any collection of…tax…the [IRS] recklessly or intentionally, or by reason of negligence, disregards any provisions of this title…such taxpayer may bring a civil action…”  The Court found that the spouse was not “such taxpayer”, and likely did not have a claim.  Although I have not researched this matter, I would assume the estate of the decedent could bring this claim (unlike Section 7431, pertaining to claims for wrongful disclosure of tax information, which some courts have held dies with the taxpayer – see Garrity v. United States –a case I think I wrote up, but never actually posted).

Qualifying as a Qualified Offer

The 9th Circuit held that married taxpayers were not entitled to recover attorney’s fees under Section 7430 in Simpson v. Comm’r, where the taxpayer did not substantially prevail on its primary argument, even though they did prevail on an alternative argument.  In Simpson, the wife received a substantial recovery in an employment lawsuit.  The Simpsons only included a small portion as income, arguing it was workers comp proceeds (not much evidence of that).  The Tax Court held 90% was income.  This was upheld.  The 9th Circuit held that the taxpayer was clearly not successful on its primary claim.  They did raise an ancillary claim during litigation, which the IRS initially contested, but then conceded.  The Court held the Service was substantially justified in its position, as the matter was raised later in the process and was agreed to within a reasonable time.  Finally, the Court held that the taxpayer’s settlement offer did not qualify as a “qualified offer”, since the taxpayers indicated they could withdraw it at any time.  Qualified offers must remain open until the earliest of the date it is rejected, the date trial begins, or the 90th day after it is made.  Something to keep in mind when making an offer.

Making the Granite State Stronger – No Fees For FOIA

Granite seems pretty sturdy, but Citizens for a Strong New Hampshire are hoping for something even sturdier.  The District Court for the District of New Hampshire in Citizens for a Strong New Hampshire v. IRS has denied Strong New Hampshire’s request for attorney’s fees under 5 USC 552(a)(4)(E)(i) for fees incurred in bringing its FOIA case.  That USC section authorizes fees and litigation costs “reasonably incurred in any case under [FOIA] in which the complainant has substantially prevailed.”  The statute defines “substantially prevailing” as obtaining relief through “(I) a judicial order, or an enforceable written agreement or consent decree; or (II) a voluntary…change in position by the agency…”

Strong New Hampshire requested documents through a FOIA request regarding various New Hampshire politicians.  It took the IRS a long time to get back to Strong New Hampshire, and it withheld about half the applicable documents as exempt under FOIA.  Strong New Hampshire continued to move forward with the suit, and the Service moved for summary judgement arguing it complied.  Aspects remained outstanding, but the Court held that the Service had not improperly withheld the various documents.  The IRS did a second search, moved for summary judgement, and Strong New Hampshire did not contest.

The Court held that the voluntary subsequent search by the Service did not raise to the level of substantially prevailing by Strong New Hampshire.  As required by the statute, there was not a court order in favor of Strong New Hampshire, and the actions taken by the Service unilaterally in doing the second search was not sufficient to merit fees.

Treasury Inspector General Report on Timeliness of Lien Notices

On July 7 the Treasury Inspector General for Tax Administration (TIGTA) issued a report on the timeliness of the IRS in sending out notice to taxpayers and to their representatives after it files the notice of federal tax lien (NFTL).  Section 6320, creating Collection Due Process (CDP) rights following the filing of the NFTL, requires that the IRS send notice of the filing of the NFTL within 5 business days after the filing of the NFTL.  IRS procedures and seemingly Section 6304  require that notice of the NFTL also go to the taxpayer’s representative.  If the IRS fails to send out the notice of the NFTL to the taxpayer who is the subject of the lien or to the taxpayer’s representative, the failure can have consequences to the taxpayer in the effort to pursue rights.

During the past year, I had two cases in which I represented taxpayers against whom the IRS filed an NFTL. In those cases, the notice of the filing was not sent to me until several days after it was mailed to the taxpayer.  By the time I received the notice, 10 days or more of the 30 day period to request a CDP hearing had run.  Because of my experience, I read the TIGTA report with interest.  As discussed below, the Tax Court has held that the failure to notify the representative does not extend the time period within which the taxpayer must exercise their CDP rights.  This makes the study of the IRS effectiveness in providing notice to representatives all the more important.

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TIGTA found that of a sample of “162 undelivered lien notices identified nine cases for which lien notices were not timely sent to the taxpayers last known addresses because the lien notices were sent to the taxpayers’ old addresses even though IRS systems reflected their new addresses.” With respect to the notice sent to representatives, TIGTA found that for “six of the 37 sample cases for which the taxpayer had an authorized representative, the IRS did not notify the taxpayers’ representatives of the NFTL filings.  TIGTA estimated that 22,866 taxpayers may have been adversely affected.”

What happens when the representative does not receive a copy of the Notice of Deficiency and the taxpayer fails to timely petition the Tax Court? The failure to send the notice to the representative does not give the taxpayer a basis for getting into the Tax Court after the 90-window has closed, see McDonald v. Commissioner, Bond v. Commissioner (a CDP case refusing to allow taxpayers to raise the merits of a liability based on the failure of the IRS to send the statutory notice of deficiency to petitioner’s representative), Houghton v. Commissioner, and Allen v. Commissioner.

What happens when the representative does not receive a copy of the CDP notice? Unlike the Notice of Deficiency which deals with examination issues, the CDP notice concerns collection.  In 2015, the Tax Court in Godfrey said the failure to provide notice to the authorized representative in a CDP case has the same consequences as the failure to provide notice when sending the notice of deficiency, which is to say that no consequences to the IRS result from that failure.  We posted on Godfrey here, here, and here.  Godfrey does not appear to have appealed the decision.

IRC 6304(a)(2) provides that the IRS “Without the prior consent of the taxpayer given directly to the Secretary or the express permission of a court of competent jurisdiction, the Secretary may not communicate with a taxpayer in connection with the collection of any unpaid tax . . . if the Secretary knows the taxpayer is represented by any person authorized to practice before the Internal Revenue Service with respect to such unpaid tax and has knowledge of, or can readily ascertain, such person’s name and address, unless such person fails to respond within a reasonable period of time to a communication from the Secretary or unless such person consents to direct communication with the taxpayer…”

In a 2001 Chief Counsel Advisory opinion discussed in the Godfrey post, Chief Counsel’s office takes the position in footnote 7 that the 6320 (or 6330) notice must go to the taxpayer by statute and that Section 6304 prohibition on communication with the taxpayer without the consent of the representative does not does not alter that requirement.  A more nuanced argument exists concerning the impact of using the IRS power of attorney form and whether the language of the POA form gives the Service additional rights.

The TIGTA report contains a chart of NFTL filings in the five year period running from 2011 through 2015. NFTLs have dropped by almost half during that period.  The biggest drop resulted from the change in the threshold for filing as a result of the Fresh Start initiative from $5,000 to $10,000.  That change is not hard and fast, as the IRS can file the NFTL at any dollar level and it is not required to file the NFTL at any dollar level; however, in general, IRS employees will follow the manual guidance to the extent they have the ability to work a case.  The dropoff in the most recent years probably reflects some reduced enforcement action due to the reduced staff.

The TIGTA report on providing notice to taxpayers after the filing of the NFTL is one of a number of reports Congress required TIGTA to perform on an annual basis in the Restructuring and Reform Act of 1998 (RRA 98).  TIGTA notes that over the past five years it has found that the IRS almost always complies with the requirement to provide timely notice to the taxpayer but has not always met internal guidelines with respect to practitioner notice.  The report does not address the legal requirement provided in IRC 6304 concerning practitioner notice probably because of the Chief Counsel guidance that IRC 6304 does not create a requirement here.

The error rate for providing notice to authorized representatives in 2016 was consistent with the error rate over the past five years and shows that one in five notices of the filing of the NFTL does not get sent to the authorized representative despite internal guidance and a statute that specifically provide that the notice must be sent to the representative. TIGTA did not make any recommendations concerning the failure to notify authorized representatives this year because it had made them in the past and the IRS system for fixing the problem did not get implemented until after the sample period.  TIGTA indicated that it would revisit the issue next year.

If you do not receive notice as a representative on any collection case in which you have a power of attorney on file with the IRS and have checked the box that you want copies of correspondence, then the IRS has failed to meet its statutory, not internal, requirement. We have posted about IRC 6304 before here, here, and here.  Given the relatively high percentage of cases in which the IRS has not sent out the notice to the POA, a number of these cases should exist.  TIGTA does not address the timeliness of sending out the copy of the notice to the representative.  My impression from the report was the significantly delayed notices I received would count toward the 84% of the cases in which the IRS complied and were not measured by TIGTA as a form of IRS non-compliance.  Yet, a significant delay when the taxpayer has only 30 days to act can have a significant influence on the outcome of a matter.

If you are concerned about receipt of the notice of the filing of an NFTL either by yourself as the representative or by your client, you may want to read this report and possibly some of the prior reports. If Congress is going to require TIGTA to provide us with this information, we should find ways to use it in situations in which the IRS fails to comply with the requirements.  The failure to comply with notice requirements in collection cases may eventually lead to a different outcome than the failure to comply in examination cases.  Godfrey may not be the final word in this litigation.  IRC 6304 does not come with any directions about the remedy for failure to comply with its provisions and little litigation exists in the tax context.  If you seek a remedy because of a violation of IRC 6304, you might look to litigation in the consumer debt collection area after which the statute is patterned.