Using a Refund Suit to Remedy Identity Theft of Return Preparer Fraud

Today, we welcome guest blogger, Robert G. Nassau.  Professor Nassau teaches at Syracuse University College of Law and directs the low income taxpayer clinic (LITC) there.  Today, he discusses twin problems that have plagued my taxpayers, identity theft and preparer fraud.  He has employed refund suits before to resolve cases in which the IRS has frozen a taxpayer’s earned income tax credit and in the post today he explains how he used a refund suit to solve a seemingly intractable identity theft/preparer fraud issue.  His pioneering and innovative use of refund suits to craft favorable results for his clients is probably what caused him to become the author of the chapter on refunds in the book “Effectively Representing Your Client before the IRS.”  The book is gearing up for its seventh edition in 2017 and Professor Nassau has signed on for another update of the refund chapter.  Keith

As all tax professionals know, tax-related identity theft and return preparer fraud are widespread, and trying to assist a victim of these crimes – despite significant procedural improvements made by the Internal Revenue Service – can make one envy Sisyphus and his Boulder Problem.  Recently, the Syracuse University College of Law Low Income Taxpayer Clinic successfully resolved one such taxpayer’s ordeal – and did it by filing a refund suit in Federal District Court.  This is his story.

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The Taxpayer.

Prior to 2011, John Doe (not his real name) had traditionally prepared and filed his own tax returns, and had never had any problems.  When he was working on his 2011 return, his calculations were not leading to his accustomed refund.  When he mentioned his dilemma to a friend, she suggested that he contact Bonnie Parker (not her real name), who, according to the friend, was very knowledgeable in all things tax.  John went to Bonnie, showed her his W-2, and gave her some additional personal information.  Bonnie said she would look into it and get back to him, but she never did.  John never saw her again.  John himself did not timely file his 2011 return, because he was considering filing for bankruptcy, and thought he had three years to file the return.

The Crime Perpetrated.

Unbeknownst, at the time, to John, Bonnie submitted a fraudulent return using John’s identity and some of his legitimate information, and received a refund of about $5,000.

The Crime Discovered.

In early 2013, John realized that something was amiss, as he started to get collection notices regarding “his” 2011 tax return.  The Service had audited John’s “return” on the basis of both automated underreporting and child-based benefits.  Because the audit was ignored, John now found himself assessed close to $6,000.

The Failure of Traditional Remedies.

Having “put two and two together,” John filed his real 2011 return in the summer of 2013, claiming a refund of about $2,000.  This return was not processed.  In early 2014, John went to his local Taxpayer Assistance Center, where he was encouraged to submit an Identity Theft Affidavit (IRS Form 14039), which he did.  This did not solve the problem.  Later in 2014 he was told to submit a Tax Return Preparer Fraud or Misconduct Affidavit (IRS Form 14157-A), and a Complaint: Tax Return Preparer (IRS Form 14157).  John submitted both of these Forms.  He also filed a police report with the Syracuse Police Department.  None of this solved his problem.  In fact, while he was trying to solve his 2011 problem, his refunds for 2012 and 2013 (and, later 2014) were all offset and applied to his 2011 “debt,” reducing it to around $2,000.  In early 2015, John sought help from the Taxpayer Advocate Service, which, despite diligent efforts by his Case Advocate, was unable to fix the problem.  Apparently, the Service was confused by whether this was an Identity Theft case or a Return Preparer Fraud case.  In addition, the Service was suspicious of John and his “relationship” with Bonnie.  Ultimately, his Case Advocate suggested that he contact the Syracuse LITC.

Commencement of the Refund Suit.

Concluding that it would be fruitless to try to solve John’s problem administratively (that train had left the station and was not coming back), the Syracuse LITC decided to file a refund suit on John’s behalf in Federal District Court, which it did in November 2015.  The Complaint sought a recovery of John’s claimed refunds on his actual 2011, 2012, 2013 and 2014 returns. In our view, because each of those returns had claimed a refund; six months had passed since each return had been filed; and it was not more than two years from John’s receipt of a notice of disallowance with respect to any of his claims (there had been no such notices), the District Court had jurisdiction to hear his case.  (Section 6532(a)(1) of the Code.)

The Department of Justice Answers.

In his Answer, the attorney for the Department of Justice raised two interesting points (while denying most of the factual assertions for lack of knowledge): (1) the refunds for 2012, 2013 and 2014 had actually been granted – they had just been offset to 2011, therefore, there was no issue for those years; and (2) there might be a jurisdictional issue regarding 2011, because there was currently a balance due for 2011, and, pursuant to United States v. Flora, one cannot bring a refund suit if one still owes any part of the taxes assessed for that year.  While this first point is not without a good deal of merit, the second point creates a fascinating potential Catch-22 (fascinating from a tax law perspective, not from a solve-the-problem perspective).  If the DOJ attorney were correct, the Court would implicitly have to conclude that the fraudulent return was the real return, when the case is premised on the fact that the fraudulent return is fraudulent and the real return shows a refund (hence no Flora issue).  Effectively, if the DOJ attorney were correct, one might never get his “day in court” to prove that he was the victim of identity theft or return prepare fraud.

How It Played Out.

While reserving his Flora argument, the DOJ attorney flew to Syracuse to depose John.  Having listened to John’s story in person, and having done some independent sleuthing of his own, the DOJ attorney concluded that John was telling the truth.  He arranged to have the fraudulent 2011 return (and its liability) purged from the system, and John’s actual 2011 return respected and processed.  Interestingly, that actual 2011 return wound up showing a small liability, but it was more than offset by John’s 2012, 2013, 2014 and 2015 refunds, so he received a significant check.  It took thirteen months from the time John filed his refund suit until the time his account was rectified and he received his proper refund.

Lessons and Observations.

Given John’s – and even TAS’s – inability to solve his tax problem administratively, a refund suit seemed his best, if not only, resort.  While it took over a year to reach the correct result, the refund suit brought with it an intelligent, diligent and dedicated DOJ attorney who, to his credit, seemed more concerned with reaching the correct result than with trying to set a new jurisdictional precedent.  It also brought a Judge who seemed to believe John from the “get-go,” and who prodded the parties toward settlement.  While we would certainly recommend fully exhausting one’s administrative avenues of relief first, where those have proven unsuccessful, we would encourage taxpayers to file refund suits to get the result they deserve.

 

How Does the IRS Decide Which Amended Returns to Examine

A report of the Treasury Inspector General for Tax Administration (TIGTA) from May 16, 2016, entitled “Improvements are Necessary to Ensure That Individual Amended Returns with Claims for Refunds and Abatements of Taxes are Properly Reviewed” provides significant insight into the handling of refund claims by the IRS.  The report itself follows the typical TIGTA style of reviewing actions by the IRS and finding fault with those actions; however, in describing what the IRS does with amended returns, the reports offers a detailed view of what happens once the amended return arrives at the IRS.  For that reason, the report may interest readers who want to know more about that process.  In this post, I will talk about the process and also about why auditing amended returns may matter more than auditing original returns.

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Why the IRS Should Audit More Amended Returns

The report criticizes the IRS for accepting certain amended returns without auditing them or providing any explanation for making the decision not to audit.  The report acknowledges that some of the decisions may result from resource limitations but still decries the lack of documentation surrounding the decision.  It details the reasons for its concerns but does not discuss the collection criteria applicable to audits.  I see a link between this report and the report I discussed in a recent post concerning the requirement that the IRS make a collectability determination prior to starting an examination.

In the amended return context, the taxpayer has made the collectability determination for the IRS.  The IRS holds the taxpayer’s money, which the taxpayer wants back.  If the IRS audits this return and makes adjustments, the collection division never becomes involved.  For this reason alone, amended returns should receive more scrutiny in a world where collectability provides a finger on the decision making scale of which returns to examine.  The reasons for filing amended returns vary greatly and do not by any means involve bad motives.   I could even argue that because practitioners generally, and I think correctly, believe that filing an amended returns brings scrutiny to the return that filing an original return does not, that amended returns have a greater likelihood of accuracy than original returns.  Since I believe that the IRS should take collectability into account in making audit determinations, I think the IRS should audit a higher percentage of amended returns than original returns since the collectability factor will always support auditing the amended return, but, other factors matter as well and I am not arguing for the audit of all amended returns.

Other factors may override collectability but on that one factor, the decision is clear.  While not clearly articulated in the IRS guidance or in this report, this factor has always played a role in making the scrutiny of amended returns higher than that of original returns.  Just reading the process of review of amended returns, whether or not selected for audit, provides plenty of support for the conclusion that the IRS guards the money it already has more than it looks for money it might obtain through an audit.

The Process of Reviewing Amended Returns

The report gives a fairly detailed walk through of the procedures that the IRS uses to pipeline an amended return.  The report suggests that tax examiners manually review each claim.  That process obviously provides greater scrutiny than original returns receive.  Claims that the initial reviewers list as Category A go on to additional review and possible audit, while claims that avoid Category A in the initial screening apparently move forward for acceptance.  Figure 1 of the report provides a flow chart of the processing of amended returns that receive the Category A classification.  I.R.M. 4.4.4.5.3 provides guidance to the IRS employees processing amended returns.  The initial review also checks for timeliness of the claim which could result in a denial of the claim at the initial review if the claim is deemed untimely.

The report does not talk about how long after the filing of the amended return this initial screening takes place.  The IRS now has a handy track my amended return feature on its web site.  I have not yet used that feature to track a refund and do not have a sense of how quickly someone can obtain a refund.  The TIGTA report reads as though the refund could occur relatively quickly if the initial screeners do not put the amended return into Category A.

For amended returns falling into Category A, the IRS sends them to field or campus exam depending on the type of case.  The chart suggests that all Category A claims going to campus exam get audited, while cases going to field exam get another level of review once they reach the field.  The written report does not make this distinction.

For field exam cases, two additional levels of review occur after the initial screening has designated the case as Category A.  The case first goes through the Planning and Special Programs (PSP) office and then, potentially, to the field exam group.  PSP could survey the return if it determines that an audit of the amended return would not result in a material change.  In reviewing the amended return, PSP should also review the original return and other relevant case file material.  If PSP does not survey the case – survey meaning accept the amended return after the PSP review – then it goes to the group manager of the group assigned to the case.

The group manager gives the amended return another review, which includes the review done by PSP for risk analysis, but the group manager must also “plan, monitor, and direct the input of work to accomplish program priorities and effectively utilize resources….”  This means that the group manager’s decision to assign the amended return for examination not only includes a determination of the need for examination of the amended return, but balances that need against other workload priorities with the group.  The group manager could conclude that the risk analysis does support examination of the amended return but still survey the return because of other priority work within the group.

The report does not talk about time frames but they will enter into the equation.  The statute does not require the IRS to examine the amended return within any set time.  The IRS can simply sit on an amended return forever if it chooses to do so and need not act.  Of course, sitting on amended returns forever would be a bad practice for the IRS to adopt, but when a group manager considers priorities, the statute of limitations for making an assessment provides a bright line for decision making about auditing original returns, while the absence of such a bright line for amended returns slightly changes the equation.  The group manager will have internal guidance driving the decision but has a bit more leeway with amended returns.

The system established by the IRS provides three cut points for the amended return headed to field exam, i.e., those amended returns with larger and more complicated refund claims, to get sent for acceptance without an audit.  TIGTA’s concerns about the IRS process for surveying amended returns focuses on the cases getting sent for acceptance because the IRS did not adequately document that decision.  The further the case gets into the process, the greater the concern because the more likely that an audit of the amended return would result in adjustments.  Because the acceptance of an amended return means handing over money, TIGTA wants more documentation of the decision to accept the refund claim without an audit.

Timing of Refund and Choices between Original and Amended Returns

Of course, a very high percentage of original returns also involve handing over money, meaning that these returns are also refund claims, yet the system does not require the same type of review and documentation for handing over money as the result of an initial return.  When taxpayers file the initial return, the IRS, as with the amended return, has no statutory time pressure within which it must accept the return.  Mild pressure exists in both circumstances based on interest which will accrue.  Stronger pressure exists with original return based on social expectations that have developed over decades and systems the IRS has created to send back refunds as quickly as possible, but the statute does not require that the IRS race to refund money with original returns yet carefully scrutinize refund requests on amended returns.

With the PATH Act, Congress signaled that it wanted to slow down the payment of refunds on certain original returns and stop the race that happens at the opening of filing season.  The PATH Act concerns focus on refundable credits which cause the same concerns in many ways as amended returns.  Yet, the biggest part of the tax gap does not exist because of amended returns or refundable credits.  It exists with self-employed.  TIGTA’s concerns about documentation of amended returns being surveyed has a legitimate basis because of the likelihood that amended returns surveyed after making the cut to Category A probably contain mistakes.  It makes sense, if resources permit, for the IRS to internally explain why it allows the payment of a refund in those cases.  Except for the distinction concerning collection, it would also make sense to explain why the IRS does not examine original returns with an equal likelihood of adjustable mistakes, but the TIGTA report focuses only on amended returns and not original ones.

Wrongful Incarceration Claims

On December 11, 2016, I posted an 11th hour plea for assistance with a project to file refund claims for individuals who had received monetary awards resulting from wrongful incarceration.  A provision of the December 2015 PATH Act, amending IRC 139F, allowed the exclusion of qualifying payments for wrongful incarceration and provided a one-year window to claim federal tax refunds for those individuals who had previously received such an award and paid taxes on it before the passage of the exclusion.  Thank you to those who responded to the plea for assistance.

Kelley Miller, the leader from the group making the plea for assistance, the Exonerees Tax Assistance Network, told me that several PT readers stepped forward to help.  At the time of the plea the clock was about to run for making the refund requests.  In addition to trying to submit all of the refund claims before the deadline established by the PATH Act, an effort was underway to get an extension of time within which individuals with the refund possibility might make their requests.  Kelley also told me that “the extender legislation got through the House on the consent calendar but time ran out in the Senate—the bill got to Committee and never got out.  Ironic, sadly, as Senator Schumer was one of the original main supporters of the legislation.  There may be efforts to re-introduce before the end of the month.”

A recent case interpreting the legislation and an FAQ on the issue from the IRS give me the opportunity to discuss the issue further in case you have a client who has made one of these claims or you have a client who would like to make one of these claims should the time get extended.

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The IRS published an FAQ on June 16, 2016 explaining the circumstances in which someone would qualify for the refund. It explained that the exclusion applied to compensatory or statutory damages and restitution received by a wrongfully incarcerated individual in connection with the covered offense. It set out three requirements for qualification one of which must be met: 1) receipt by the taxpayer of a pardon, grant of clemency or grant of amnesty for the covered offense due to innocence of the charge; 2) reversal or vacation of the judgment of conviction for the covered offense and dismissal of the indictment, information, or other accusatory instrument; or 3) reversal or vacation of the covered offense and a finding of not guilty after a new trial. The legislation allowed for an exclusion from federal taxes for any payment received by the taxpayer even if received in a prior year which essentially opened up the statute of limitations for claiming refunds during the window created by Congress in the PATH Act. The FAQ also explains the way the taxpayer should make the claim, where it should be sent and the time limit for making the claim which was December 19, 2016. In addition, it states that an award received by a spouse, child, parent, or other individual for a derivative claim can also qualify for the exclusion. This last issue presented itself in the case of Elkins v. United States (N.D. Ohio December 16, 2016).

In Elkins, the district court heard an appeal from the bankruptcy court in which the wife and child of the individual incarcerated brought an action for a refund based on the derivative loss of consortium due to wrongful incarceration. The Circuit Court considering an earlier phase of the case provided a detailed discussion of the underlying facts concerning the wrongful incarceration. Elkins v. Summit County, Ohio, 614 F.3d 671 (6th Cir. 2010).  Because thinking about the way criminal cases can go wrong is important to understanding why excluding monetary awards to exonerees is important, I provide some of those details here.

In 1998, Mr. Elkins’ mother-in-law was raped and murdered in her home in Ohio.  Mr. Elkins’ six-year-old niece was also assaulted and raped.  Based on the six-year-old’s statement, the perpetrator looked like her uncle, Mr. Elkins, and the police arrested him.  Shortly afterward, Mr. Elkins was indicted on charges of aggravated murder, attempted aggravated murder, rape, and felonious assault.

While the Elkins investigation was ongoing, another man, Mr. Mann, was arrested.  During the arrest, Mr. Mann – who was drunk – asked an officer, “Why don’t you charge me with the Judy Johnson murder?”  The patrol offer wrote an interdepartmental memorandum, in compliance with his training and protocol, regarding Mr. Mann’s statement which was directed to the department in charge of the Elkins investigation.  However, the memorandum was not disclosed to Elkins or the prosecution, and was never produced.

At trial, the six-year-old identified Mr. Elkins as the perpetrator; however, Mr. Elkins presented substantial evidence that someone else committed the crime. Mr. Elkins’ then-wife testified that Mr. Elkins had been at home with her, forty miles away, at the time of the crime. Other witnesses testified that they had spent time with Mr. Elkins throughout the evening until just before the time the murder occurred.  Moreover, police officers recovered hairs from the scene that did not match Mr. Elkins’ DNA.  The officers were unable to find a match, and a jury convicted Mr. Elkins on all of the charges, sentencing him to life imprisonment without parole.

In 2002, the six-year-old (or, thirteen-year-old) recanted, yet the state did not reverse Mr. Elkins’ conviction.  Mr. Elkins began to suspect that Mr. Mann – who was in the same prison facility – was the person responsible for the murder, and was able to obtain a DNA sample from him.  Subsequent DNA testing revealed that Mr. Mann’s DNA matched the DNA found at the scene.  After an investigation, Mr. Elkins was released from prison, after having served seven years, Mr. Mann pled guilty to the murder, and the case against Mr. Elkins was dismissed.  The Summit County Court of Common Pleas found that Elkins was wrongfully imprisoned, and in a wrongful imprisonment settlement, the State of Ohio awarded him $1,075,000.

In the bankruptcy case in which the debtor’s claim arose, the IRS argued that Mr. Elkin’s wife and son did not qualify for a refund because they claim they sought to exclude from income and on which they based their claim for refund did not meet the definition of the statute because it was based on loss of consortium rather than wrongfully incarceration. The bankruptcy court agreed with the IRS, and the claimants appealed.

The claimants argued that the language of the statute applies to all civil damages and awards related to wrongful incarceration and not just those awards given to the individual wrongfully incarcerated. The district court upheld the determination of the bankruptcy court, finding that the statutory language which stated “in the case of any wrongfully incarcerated individual” defined the person to whom the statute applies and limits the special rule excluding the award from tax to the incarcerated individual and not to derivative claimants. The court reached this determination based on the plain language of the statute.

Alternatively, the claimants argued that because their proof, as derivative claimants, for damages under state law mirrored the proof required by the wrongfully incarcerated individual they should recover for that reason. Since state law did not distinguish between direct and derivative claimants, they argued that the tax law should not treat them differently. The district court pointed out that the tax result at issue here was a federal tax result stemming from a federal statute that had a distinct basis for existence from the underlying state based claim for damages. The court, therefore, rejected this argument as well. The claimants made two more similar arguments which the court rejected as well. The court noted that only one other case mentions IRC 139F. I do not know if the claimants will appeal the district court decision to the circuit.

Unless Congress does extend the statute, all of the claims have now been filed but it could take a couple of years to work out the litigation that will accompany the claims where the IRS issues a denial. Kelley’s group is already working on one case in which the claim was denied. They are waiting to see if the other claims filed will result in refunds or if additional litigation will be necessary. The group is also continuing to seek a statute extension because one year was not enough time for them to reach all of the exonerated individuals and advise them of their right to file a claim

Refund Loans on the Comeback, with a Twist

Tax filing season has kicked off. IRS has a web page dedicated to the filing season, and it includes a lot of helpful information, including information on ITIN changes and this year’s delay in releasing refunds relating to EITC and child tax credit.

The delay in the timing of the refunds is a major change.  New York Times reported last week on the resurrection in refund loans this filing season in Tax Refund Loans are Revamped and Resurrected, with the large tax prep chains offering up to $1300 within a day or so with no direct fees passed on to the individuals for the loan. The article discusses the history of refund loans, which in their earlier form carried heavy fees and attracted a lot of criticism from consumer advocates. They essentially disappeared a few years ago.

Here is why the loans have returned. As we have discussed, Congress in the PATH legislation mandated a delay in remitting refundable-credit-based refunds until mid-February. The start of filing season has traditionally been a time when millions of lower-income refund seeking individuals filed early to get the refunds. To offset the PATH delay, and as a way to stem the flow of individuals to DIY software, the large prep chains have stepped in and essentially offered access to the refund loans as a loss leader.

What happens if the refund never materializes come late February (say there is a set off or examination based refund freeze) and the loan cannot be repaid? The NYT article says the large prep chains are going to eat the loss, though I have not read the fine print on what the consumers are signing when getting the loans.

From a tax compliance perspective, this situation more closely aligns the prep companies with the government’s interest in ensuring that the claimants are in fact eligible when claiming a credit, or at least are able to get past the IRS filters on freezing a refund if there are eligibility concerns.

To be sure, the prep chains have other ways to make money on the transaction, and the prep companies are good at cross-selling. I suspect we will be hearing more from consumer groups on this practice.

 

 

Seventh Circuit Wonders if a Refund Claim is a Jurisdictional Requirement for a Refund Suit

Guest poster Carl Smith brings us up to date on the latest in developments relating to courts reconsidering whether certain time limits in the Internal Revenue Code are jurisdictional. Les

Recently, a panel of the Seventh Circuit hearing the appeal of Tilden v. Commissioner, T.C. Memo. 2015-188, sua sponte, at oral argument raised the question whether a failure to file a deficiency petition in the Tax Court within the 90-day period set out in section 6213(a) is still a jurisdictional defect in light of non-tax Supreme Court case law since 2004 that has generally limited jurisdictional requirements to those involving personal and subject matter jurisdiction, not “claims processing rules”, such as filing timing requirements. My post on the October 6 Tilden oral argument can be found here. In an unpublished opinion issued by another panel of the Seventh Circuit on November 1, in Gillespie v United States, 2016 U.S. App. LEXIS 19604, affg. 2016 U.S. Dist. LEXIS 12891 (E.D. Wisc. 2016), the panel speculated (but did not decide) that the requirement in section 7422(a) to file an administrative refund claim before bringing a refund lawsuit may also no longer be a jurisdictional requirement under that same Supreme Court case law.

This post is to explain the facts of Gillespie and the panel’s non-jurisdictional thinking. It is also to report how the Gillespie opinion scared the DOJ enough into filing, on November 10, a motion for leave to file a supplemental brief in Tilden laying out in detail, for the first time, the government’s reasons for believing that the deficiency filing period is still jurisdictional. The Tilden panel immediately granted this unexpected motion, to which the  proposed brief was attached, and directed the taxpayer to file his own supplemental brief on the jurisdictional question by November 28.

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Gillespie Facts

The Gillespies initially filed a joint income tax return for 2009 reporting $82,499 of wages from a private employer on which they calculated the tax as $5,145, all of which had apparently been withheld. I am not sure why, but by April 2013, the taxpayers had been forced to pay a total of $13,653 in tax, penalties, and interest towards the 2009 year. At that point, the taxpayers filed an amended return for 2009 showing their wages, income, and tax all as $0. They took the position, apparently, that only employees of the U.S. government had reportable wages, not employees of private employers. So, they sought a refund of the entire $13,653.

The IRS refused to process the amended return, so the Gillespies filed suit in district court for the refund. There, the DOJ moved under FRCP 12(b)(1) to dismiss the case for lack of jurisdiction, arguing that no valid refund claim had been filed, and that Congress only waived sovereign immunity under section 7422(a) for refund lawsuits after a taxpayer first files a refund claim.

Gillespie District Court Ruling

The district court held that section 7422(a)’s requirement for a refund claim to have been filed before a refund suit is maintained is not a jurisdictional requirement. It wrote (at footnote 2):

While Congress can create statutory limitations on jurisdiction, such as prerequisites to suit, “when Congress does not rank a statutory limitation on coverage as jurisdictional, courts should treat the restriction as nonjurisdictional in character.” Arbaugh v. Y & H corp., 546 U.S. 500, 516 (2006). The statute at issue here, which waives sovereign immunity in taxpayer suits but requires taxpayers to first file a claim with the IRS, contains no language suggesting that this requirement is jurisdictional. 26 U.S.C. § 7422(a).

Arbaugh is one of the line of recent Supreme Court opinions that has cut back on the use of the word “jurisdictional”. The district court in Gillespie said that a defense of a lack of a waiver of sovereign immunity is a defense on the merits. The court then converted the motion to dismiss into one under FRCP 12(b)(6) to dismiss the case for failure to state a claim on which relief could be granted. The court then cited Seventh Circuit case law (relying indirectly on one of the factors in Beard v. Commissioner, 82 T.C. 766, 779 (1984)) requiring that any refund claim or tax return must evince an honest and genuine endeavor to satisfy the law. Since the legal position taken by the taxpayers on the amended return reflected a long-rejected tax protestor argument, the court held that the amended return did not evince an honest and genuine endeavor to satisfy the law, and, thus, the taxpayers had failed to file a refund claim before bringing suit. The court granted the motion to dismiss.

Gillespie Seventh Circuit Ruling

On appeal, the Seventh Circuit agreed with the district court that no refund claim had been filed before suit had been brought because the purported amended return did not evince an honest and genuine endeavor to satisfy the law. While affirming the district court’s dismissal of the suit for failure to comply with section 7422(a)’s requirement, the court of appeals dodged the issue of whether the dismissal was properly on the merits or should have been for lack of jurisdiction. The Seventh Circuit wrote:

The Gillespies do not respond to the government’s renewed argument that § 7422(a) is jurisdictional, though we note that the Supreme Court’s most recent discussion of § 7422(a) does not describe it in this manner, see United States v. Clintwood Elkhorn Mining Co., 553 U.S. 1, 4-5, 11-12 (2008). And other recent decisions by the Court construe similar prerequisites as claims-processing rules rather than jurisdictional requirements, see, e.g., United States v. Kwai Fun Wong, 135 S. Ct. 1625, 1632-33 (2015) (concluding that administrative exhaustion requirement of Federal Tort Claims Act is not jurisdictional); Reed Elsevier, Inc. v. Muchnick, 559 U.S. 154, 157 (2010) (concluding that Copyright Act’s registration requirement is not jurisdictional); Arbaugh v. Y & H Corp., 546 U.S. 500, 504 (2006) (concluding that statutory minimum of 50 workers for employer to be subject to Title VII of the Civil Rights Act of 1964 is not jurisdictional). These developments may cast doubt on the line of cases suggesting that § 7422(a) is jurisdictional. See, e.g., United States v. Dalm, 494 U.S. 596, 601-02 (1990); Greene-Thapedi v. United States, 549 F.3d 530, 532-33 (7th Cir. 2008); Nick’s Cigarette City, Inc. v. United States, 531 F.3d 516, 520-21 (7th Cir. 2008).

Supplemental DOJ Brief in Tilden

 As I noted in my prior post on Tilden, the DOJ there had not briefed the issue of whether the time period in which to file a deficiency petition in the Tax Court was jurisdictional under recent non-tax Supreme Court case law on the meaning of “jurisdictional”. Counsel had incorrectly assumed that all they had to show was that the filing of the deficiency petition was or was not timely under the timely-mailing-is-timely-filing regulations under section 7502.

But, the panel of the Seventh Circuit in Tilden (which consisted of different judges from the panel in Gillespie), sua sponte, at oral argument, raised the jurisdictional question and was surprised that counsel in the case were not prepared to discuss it. In my prior post, I mentioned that the day after oral argument, the DOJ filed a short letter setting out its position that the deficiency petition filing period is still jurisdictional under the recent Supreme Court case law. I linked to that letter in my post on Tilden. But, this initial letter triggered off three more short letters back and forth between the parties on the issue – all filed after my post.

According to the DOJ, the opinion in Gillespie on November 1 triggered its concern that a fuller explanation of the government’s position as to why the deficiency filing period was jurisdictional was in order. So, without warning (and apparently without even contacting the taxpayer’s attorney), on November 10, the DOJ moved in Tilden to file a 24-page supplemental brief on the issue, a copy of which the DOJ attached to its motion. Without asking the taxpayer’s attorney whether there was an objection to the motion, the Seventh Circuit immediately granted the motion and directed the taxpayer to file a responding supplemental brief by November 28.

In my post on Tilden, I mentioned a couple of things that suggest that the deficiency filing period (unlike the filing periods under sections 6015(e)(1)(A) and 6330(d)(1)) might still be jurisdictional, despite the recent non-tax Supreme Court case law. In particular, I mentioned (1) a possible res judicata problem (if the court would hold otherwise) with the application of section 7459(d) and (2) that Congress in 1998 had, in Committee reports, called the deficiency time period “jurisdictional”. It may be that the DOJ lawyers read my Tilden post, since their brief makes these two points — though the DOJ lawyers also present a few other arguments that I did not articulate.

Interestingly enough, in its supplemental brief, the DOJ does not argue that the first sentence of section 6213(a) that contains the filing period contains a “clear statement” that Congress wants the time period to be jurisdictional. Rather, the DOJ points to other sentences in section 6213(a) and other Tax Court provisions that suggest that the time period must be jurisdictional. I won’t belabor this post with the details of and possible responses to what the DOJ argues, but suffice it to say that I can construct some responses that I suspect Mr. Tilden will present. I don’t consider this a slam dunk issue for either side.

Finally, once again, the DOJ, in its supplemental Tilden brief (as the Tax Court did in its opinion in Guralnik v. Commissioner, 146 T.C. No. 15 (June 2, 2016)), put great weight on the long history of the Tax Court and Courts of Appeals holding that the deficiency filing period is jurisdictional. In one of Mr. Tilden’s short post-argument letters, he had written:

One of the issues in Guralnik was whether the 30-day period in 26 U.S.C. § 6330(d)(1) to file a Collection Due Process Tax Court petition is jurisdictional. The Tax Court’s primary reasoning for not abandoning its prior holdings indicating that §6213 is jurisdictional is the long history of the Tax Court’s own interpretation of the §6213(a) time period as jurisdictional, which the Tax Court thought it was entitled to follow under the stare decisis exception to the current jurisdictional rules set out in John R. Sand. But, that exception only applies for a long history of Supreme Court opinions, not opinions of lower courts. See Reed Elsevier, Inc. v. Muchnick, 559 U.S. 154, 173-174 (Ginsburg, J., concurring, joined by Stevens and Breyer, JJ.) (“[I]n Bowles and John R. Sand & Gravel Co. . . . we relied on longstanding decisions of this Court typing the relevant prescriptions ‘jurisdictional.’ Amicus cites well over 200 opinions that characterize § 411(a) as jurisdictional, but not one is from this Court. . . .”; emphasis in original; citations omitted). Thus, the Tax Court’s reliance on stare decisis in Guralnik was misplaced.

In its Tilden supplemental brief, the DOJ responds:

But even if Justice Ginsburg’s concurring opinion supports the broad proposition taxpayer advances (and it is not clear that it does), the fact remains that a concurring opinion expressing the views of three justices does not represent a holding of the Court.

In the situation presented here, we think that the reasoning of the Court in John R. Sand & Gravel Co. supports our contention that I.R.C. § 6213(a)’s time limit is jurisdictional. As the Court explained in John R. Sand & Gravel Co., “re-examin[ing] … well-settled precedent” holding that a limitations period is jurisdictional would “threaten to substitute disruption, confusion, and uncertainty for necessary legal stability.” 552 U.S. at 139. Here, more than 35 years ago, the Fifth Circuit aptly described the state of the decisional law, observing that “[i]t cannot now be seriously questioned that the timely filing of the petition for redetermination is jurisdictional.” Johnson v. Commissioner, 611 F.2d 1015, 1018 (5th Cir. 1980). And, the absence of Supreme Court precedent confirming the decisional law of the courts of appeal only reflects the fact that the Supreme Court has had no reason to address the matter. As noted above, since the enactment of I.R.C. § 6213(a) in 1954, the twelve circuit courts that have jurisdiction to review decisions of the Tax Court have held that the statute’s time limit is jurisdictional. In these circumstances, there is no meaningful difference between the disruption that would occur from overturning this long-standing appellate court precedent and the disruption that would occur from overturning a Supreme Court precedent. Accordingly, under the Court’s reasoning in John R. Sand & Gravel Co., the long-standing and unanimous treatment of I.R.C. § 6213(a)’s time limit by the courts of appeals as jurisdictional should be sustained.

Furthermore, the Court in John R. Sand & Gravel also took into account the fact that “‘Congress remains free to alter what [the Court] ha[s] done.’” 552 U.S. at 139 (citation omitted). Here, Congress has had ample opportunity to amend I.R.C. § 6213(a) if it disagreed with the unanimous decisions of the judiciary. That it has not done so speaks volumes as to the correctness of those decisions.

All I can say is that I am grabbing a bowl of popcorn and, from the peanut gallery, I will be watching how the deficiency petition filing period jurisdictional fight comes out. Fascinating.

Editor’s Update: Carl’s comment to this post references Duggan v. Commissioner, which involves an appeal of a Tax Court dismissal of a CDP petition for lack of jurisdiction for being mailed to the Tax Court one day late. Here is the DOJ brief that Carl references in his comment.

Requesting an Offset Bypass Refund and Tracing Offsets to Non-IRS Sources

Under the right circumstances the IRS will apply administrative procedures to override the general rule required by IRS 6402 to offset the refund of a taxpayer to satisfy an outstanding liability.  This administrative process, known by the catchy name of offset bypass refund or OBR can provide significant assistance to a taxpayer struggling with a financial hardship.  Even though not required to do so by the code, the IRS will step back from taking the refund and allow it to go to the taxpayer despite outstanding tax liabilities.  While this is not the season for OBR activity at the IRS — the normal season is tax filing season, particularly the early part — this may provide the best time for a discussion of the topic since the season will be upon us shortly.  When requesting an OBR, it is critical to know whether the client has other debts subject to offset since the client generally does not achieve the goal of OBR if they do not receive the refund due to other offsetting debts.  This post will explain OBR: the procedures for making the request and the offset rules that can apply to thwart such a bypass.

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When someone owes federal taxes, section 6402 authorizes the IRS to offset a refund due to that person to pay for the outstanding balance.  While governed by statute, the concept of an offset has ancient roots and provides a logical method for a creditor to recover a debt.  Every year the clinic is contacted by taxpayers complaining that they did not receive their tax refund.  When we obtain the transcript of their account, we can see that the IRS did allow the refund, but the refund was applied against an outstanding tax debt or, in some cases, against an outstanding debt owed to a third party authorized to receive a federal tax refund.  When the IRS makes an offset to pay an outstanding federal tax debt, it notifies the taxpayer it has done so.  This correspondence may not be sufficiently clear for some individuals or they may have changed their addresses and not received it.  If the IRS applies 6402 to use the refund to pay a debt other than a federal tax debt, the taxpayer usually does not get a notice until September of the year the return is filed and that notice does not come from the IRS but from the Bureau of Fiscal Service described below.

Sometimes a taxpayer with past due federal tax obligations faces a severe financial hardship at the time of filing a return claiming a refund.  The hardship may be a pending cut-off of electricity, eviction, foreclosure, need for heating oil, or other basic life needs. The taxpayer could use the tax refund to avert these crises, but the tax refund will not come to them because of the outstanding liability.  In these circumstances, the IRS can override, or “bypass,” the offset and send the taxpayer the refund.  In order to have the IRS override the refund, the taxpayer must contact the IRS and set up the bypass before filing the tax return.  Failure to receive approval for a “bypass” before the posting date of the original return forecloses the opportunity to bypass the offset.  See IRS Clarifies Procedures for Issuing Offset Bypass Refunds.  If the tax refund has already been applied to the prior tax obligation, the IRS will not reverse the offset unless there was a clerical error. See IRM 3.17.79.3.21(5) (Note).

OBR is governed by IRM 21.4.6.5.11.1.  In order to request an offset bypass refund, the taxpayer, or representative, should make the request when the return is filed.  The request must occur prior to assessment.  The request needs to demonstrate the financial hardship the taxpayer faces.  The amount of the offset limits the amount of the OBR.  For example, if the taxpayer would receive a $1,000 refund and the taxpayer demonstrates a $600 hardship in order to pay the rent and avoid eviction, the OBR will be $600 and not the entire amount of the refund available.  The balance of the refund will go to pay the past due tax liability under the normal offset rules.  Although the Taxpayer Advocate Service is usually associated with OBR the OBR need not go through TAS.  If the IRS fails to make the properly requested OBR before assessment, the IRS can reverse the offset and pay the taxpayer the amount it would have paid based on the taxpayer’s demonstrated hardship.

Going back to the clinic’s case that I mentioned at the outset, we found that the client had not filed tax returns for the past few years.  However, when a taxpayer requests the IRS to permit a collection process other than the one normally taken, the IRS generally requires that the taxpayer be compliant with their return filing obligations.  The only broad exception to this rule is the hardship exception to having the account placed in currently not collectible status discussed in Vinatieri v. Commissioner. However, since we intended to file an Offer in Compromise for this particular client, we needed to prepare the old returns.  These returns, if filed, would generate about a $1300 refund for the taxpayer.  This refund amount was enough to satisfy the client’s federal tax obligation and eliminate the need for an offer in compromise. However, the client’s financial situation was so dire that we decided the best option for him involved submitting the returns, requesting an OBR and then submitting an OIC afterwards. This way, the client would both get the refund and clear his federal tax debt.  However, in contacting TAS about using this procedure, we learned that the client had other outstanding debts subject to the Treasury Offset Procedure (TOP).  These other debts prevented the IRS from granting the OBR since the IRS also forbids “bypasses” if the taxpayer also has a TOP debt (i.e., federal agency nontax debt, state income tax obligations, unemployment compensation debt, or child support). See IRM 3.17.79.3.21(2)(Note) and IRM 21.4.6.5.5.

We then needed to learn the nature and amount of the debts subject to the TOP offset in order to determine how to move forward with his case. We hoped that we would be able to resolve these debts before trying again for a “bypass.”  The IRS transcript of account, which provides a picture of a taxpayer’s status for federal tax debts, does not show how much debt a taxpayer owes to the parties entitled to obtain an IRS refund through the procedures of 6402 nor does it identify those parties.  To find out this information, you need another type of power of attorney, one for the Bureau of the Fiscal Service an agency of the Treasury Department.  You can contact this Bureau via a toll free number 800-304-3107 but if you represent a taxpayer you need a signed Authorization for Release of Information from your client.  Once you have the release form for the Bureau, you can contact it and find out what other parties have “dibs” on your client’s refund.  However, the Bureau can only tell you identity of the other parties; it does not have any information regarding the amount owed or the reason for the debt.  Each individual party would then need to be contacted to find out the specifics for the debt owed.

Our research led us to the conclusion that three other agencies had placed a marker on our client’s refund.  One of the other parties was the state taxing authority.  We thought we might be able to work with that debt to reduce or eliminate it through a state procedure.  However, another one of the debts was child support and the amount of the debt was significant.  Although there may be a mechanism for addressing past due (or way past due) child support, a quick consultation with a supervising attorney at the Legal Services Center of the clinic handling those types of cases convinced us that accomplishing a reduction of that debt would be very difficult and would place us way outside the comfort zone of our practice area.  So, we concluded that a refund bypass would serve no purpose here.  Because the refunds generated by the returns we had prepared would eliminate his federal tax liabilities, we returned to the simple plan of filing the returns and knocking one creditor off of his list.

Section 6402 creates a hierarchy of payment of refunds similar to the hierarchy for payment of unsecured claims in section 507 of the bankruptcy code.  Refunds of federal taxes first go to satisfy federal tax debt.  Only when that debt no longer exist, does money go to other parties entitled to receive the federal tax refund before the taxpayer. The statutory scheme in section 6402 first pays the refunds to the agency seeking money for child support.  In that way, the Internal Revenue Code now also mirrors the bankruptcy code.  If you look at the priority payment hierarchy of bankruptcy code 507, you see that the number one priority-unsecured-claim is child support and alimony.  However, it was not always this way.  In 1978 when the current bankruptcy code was passed, no priority was given to child support and alimony.  “Deadbeat dads” filing bankruptcy generally discharged these unsecured claims with little or no payment.  In 1994, when the first major bankruptcy reform act occurred with respect to the new bankruptcy code, child support and alimony made it into the code section creating priority claims but only as the seventh priority.  In 2005, when the last major bankruptcy reform occurred, alimony and child support moved to the number one spot.  It is interesting to see how this particular type of debt moved up over the course of one generation from an afterthought to the top priority.  It is also interesting to note that it moved to the number one spot in section 6402.  This says a lot about our social priorities and how they have changed.

If a taxpayer due a refund does not have the refund taken by the IRS or by a child support agency, then it must next pass the gauntlet of other federal debts.  The statute does not list the federal debts able to be offset by the federal government but you can find it on Page 3 of this GAO Report.  The one I see the most often is student loan debt.  After federal debt, comes state debt.  The list of state obligations varies by state.  You can find a list here. Only after the IRS fails to find any debts from these lists does it send a taxpayer the requested refund.  Anyone actually receiving the full amount of their refund should feel some sense of financial well-being vis-a-vis a broad spectrum of the government because it means they have a clean bill of health for many agencies.

Many times OBR will not help taxpayers in financial hardship because of their non-tax debts.  This seems a little counterintuitive and counterproductive because the IRS is the senior creditor in this situation and it is generating the refund.  As the senior creditor, it should have the ability to decide if the person has sufficient need for the refund and to send the refund even if other creditors exist lower in the 6402 queue.  As a practical matter, convincing both the IRS and the other creditors, many of whom have a different process or no process for allowing the demonstration of hardship, is a task neither the taxpayer nor a representative can accomplish.  So, the person with a hardship ends up fully paying or reducing their debt to the one party that would have waived this payment while the other parties who force the failure of the refund bypass still receive little or nothing on their debt.  Perhaps the IRS should receive authority to speak for the queue.

Willson v. Comm’r: D.C. Cir. Holds Tax Court Lacks Refund Jurisdiction in Collection Due Process Cases

We welcome back frequent guest blogger, Carl Smith.  Carl writes on the first circuit court opinion to address the issue of obtaining a refund in a CDP case.  Keith

Regular Tax Court practitioners are aware that in a case brought in the Tax Court in response to a notice of deficiency, the Tax Court has jurisdiction not just to find no deficiency, but to find an overpayment and, if necessary, to order the IRS to pay the overpayment as a refund.  The Tax Court’s refund jurisdiction, and that jurisdiction’s various limitations, can be found at section 6512(b).

Tax Court Collection Due Process (CDP) cases start with Appeals Office hearings in response to a notice of intention to levy (NOIL) or a notice of federal tax lien (NFTL) in which multiple other issues can be raised beyond merely the propriety of the NOIL or NFTL.  Section 6330(d)(1) gives jurisdiction to the Tax Court the hear appeals of notices of determination issued at the end of the Appeals Office CDP hearings.  What if, during the Tax Court appeal, the IRS takes an overpayment from a later tax year and offsets it against the year involved in the NOIL or NFTL such that the tax is now fully paid and the IRS is no longer seeking to collect it?  What happens in such a case if the offset more than fully pays the assessment, such that the taxpayer now wants a refund?  Can the Tax Court order a refund as part of its CDP jurisdiction?

In Greene-Thapedi v. Commissioner, 126 T.C. 1 (2006), the Tax Court held that once the IRS notifies the court that, since the liability has been fully paid, the IRS is no longer seeking to collect the liability set out in the NOIL or NFTL, the case is moot and should be dismissed — even if the taxpayer is now arguing that she overpaid the tax assessment.  The Tax Court held that it had no overpayment jurisdiction in its CDP appeal jurisdiction.

Surprisingly, in the nearly 10 years since the Greene-Thapedi opinion was issued, the question of whether the Tax Court lacks refund jurisdiction in its CDP proceedings has never been considered by a Court of Appeals.  But, the D.C. Circuit, in its recent opinion in Willson v. Commissioner, 2015 U.S. App. LEXIS 19389 (Nov. 6, 2015), has finally considered the issue and agreed with the Tax Court that the Tax Court lacks refund jurisdiction in its CDP appeals proceedings.

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Byers Prequel

I am not greatly surprised by the Willson holding, as part of it was foreshadowed in the opinion in Byers v. Commissioner, 740 F.3d 668 (D.C. Cir. 2014).  Although ProcedurallyTaxing has done a number of blog posts on Byers, see here and here, the posts have all focused on the Byers’ case’s CDP venue on appeal issue.  One of the non-venue issues in Byers, however, concerned an assessment that the IRS abated during the Tax Court CDP appeal. The Byers Tax Court appeal involved a notice of determination that upheld an NOIL covering five taxable years.  During the course of the Tax Court proceeding, at the taxpayer’s request, the IRS lawyers went searching for the notice of deficiency that supposed underlay the assessment for the last taxable year, but the lawyers found no such notice.  Accordingly, the IRS abated the assessment for that year and moved in the Tax Court to dismiss this one year from the suit as moot.  Byers objected to the dismissal, noting that the year that was abated represent over 30% of the total unpaid liability set forth in the NOIL, and it was the large total liability for all five years together that may have motivated the Settlement Officer (SO) to have upheld the levy; had the liability been smaller, the SO might have, say, worked with him to give him an installment agreement. Despite this argument, both the Tax Court and D.C. Circuit held that the Tax Court should dismiss from its CDP proceeding any tax year as to which the IRS was no longer seeking collection. Id. at 679.  In Byers, however, the taxpayer had paid nothing towards this abated assessment, so there was no request from the taxpayer for the Tax Court to find an overpayment and order a refund.

Willson Holding

In Willson, the taxpayer filed his 2006 income tax return showing an overpayment of over $13,000, but he elected to carry that amount forward to his 2007 taxes.  After the carryforward, on his 2007 taxes, he still showed a large overpayment, and he asked that $10,000 of such overpayment be sent to him as a refund while the rest should be carried forward again to 2008.  The IRS not only sent him the $10,000 for 2007, but it issued a check to him for 2006 in the amount of the $13,000 overpayment credit.  Realizing its error, the IRS — more than 2 years after sending the check for 2006 — improperly assessed the taxpayer’s 2006 year for $13,000 and began collection actions.  It was improper of the IRS to try to recover its erroneous refund by assessment.  Instead, the IRS should have filed a suit for erroneous refund under section 7405 within 2 years of the refund, though it never did, so it could not now.  The taxpayer, understanding the IRS’ error, sent a check to the IRS for $5,000, suggesting that he be allowed to pay back the rest of the 2006 overpayment in installments.  Another roughly $2,000 was taken from an overpayment for the taxpayer’s 2009 year and applied to the 2006 assessment by offset.  An NOIL was then issued for the 2006 assessment, and the taxpayer had a CDP hearing.  The notice of determination upheld the NOIL.

In the course of the Tax Court proceeding, the IRS lawyers recognized that the assessment for 2006 was improper and had it reversed.  This left a credit balance in the 2006 account of over $7,000, but the IRS did not send a check for that amount to Mr. Willson.  Rather, the IRS sent Mr. Willson a check to cover the 2009 offset that was taken (less $100 that Wilson had apparently sent as an estimated tax payment for 2009 in March 2010), and the IRS lawyers moved for the Tax Court to dismiss the 2006 year case as moot.  But, the taxpayer argued that the year was not moot, since he wanted to get his $5,100 overpayment credit refunded to him and he was now alleging various other damages.  Apparently, the IRS kept the $5,100 because it was voluntarily paid within 2 years of the erroneous refund check.  In a one-page unpublished order, the Tax Court granted the IRS’ motion and dismissed the case as moot.

The D.C. Circuit opinion cites both its prior opinion in Byers and the Tax Court’s opinion in Greene-Thapedi for its holding that the Tax Court properly dismissed the case as moot and that the Tax Court lacks refund jurisdiction in a CDP proceeding.  In the opinion’s final full paragraph, the D.C. Circuit wrote:

No unpaid tax liability remains on Willson’s 2006 tax account. The IRS no longer seeks to levy on his property. This is, in fact, the very relief Willson ostensibly sought when he requested a CDP hearing to challenge the proposed levy in the first place. Willson has received all the relief that section 6330 authorizes the tax court to grant him; if he is entitled to any other relief—with regard to the disputed $5,100 or otherwise—he must seek it in district court or in the Court of Federal Claims. See 28 U.S.C. § 1346(a)(1) (granting federal district court and Court of Federal Claims original jurisdiction over actions for “recovery of any internal-revenue tax”); 26 U.S.C. § 7422 (setting out procedure for taxpayer refund suits); id. § 7433(a)-(b) (granting right to bring suit against government for damages if IRS collection action is unlawful). “With no levy being placed upon [Willson’s] property[,] . . . there was no actual case in controversy regarding [his] appeal of such a levy action.” See Byers, 740 F.3d at 679. Accordingly, “[t]here was no appropriate course of action for the Tax Court to take but to dismiss as moot” Willson’s case. See id.

In a footnote to this paragraph, the D.C. Circuit wrote:

The same is true of Willson’s claims that the IRS violated his constitutional rights, the Ex Post Facto Clause and the constitutional principle of separation of powers in pursuing a levy against him; because the tax court has granted him all the relief to which he is entitled under section 6330, those claims likewise belong in district court or in the Court of Federal Claims.

Willson also contends that the case is not moot because he has a claim for costs and attorney’s fees, but a plaintiff’s attorney’s fees claim cannot of its own accord keep alive any merits claim that would otherwise be moot. See Lewis v. Continental Bank Corp., 494 U.S. 472, 480 (1990); accord Johansen v. United States, 506 F.3d 65, 70 (1st Cir. 2007).

I’m not too sanguine that Mr. Willson will ever get back his $5,100.  It likely is too late for him to bring a section 7433 suit for damages for wrongful collection, as the time in which to bring such a suit is 2 years from the date that he became aware of the wrongful collection action.  And I doubt he will get that money back through a district court tax refund suit, since earlier in the opinion, the D.C. Circuit also wrote:

The IRS retained the $5,100 not to satisfy a tax liability but to recover an erroneous refund sent as a result of a clerical error. The debt created by such an erroneous refund is not a tax liability. See, e.g., O’Bryant v. United States, 49 F.3d 340, 347 (7th Cir. 1995) (“[E]rroneous refunds and tax liabilities are simply not of the same ilk.”); Pac. Gas & Elec. Co. v. United States, 417 F.3d 1375, 1383 (Fed. Cir. 2005) (refunds sent due to clerical error “are owed to the government by reason of unjust enrichment” instead of “statutory obligation under the tax code to pay the government”).

Observations

For some reason, the D.C. Circuit’s opinion in Willson never mentioned the Tax Court’s jurisdiction at section 6512(b) to find overpayments.  I know that Frank Agostino has represented several people in the Tax Court where Frank has argued that section 6512(b) is not limited to deficiency cases, but applies, as well, to CDP cases.  Frank tells me he raises this issue challenging the holding in Greene-Thapedi often in the Tax Court, but the cases all have so far all settled out (and the one case he has pending is likely to settle), so he is not yet in a position to take any appeal to a Circuit court so as to create, if possible, a Circuit split with the D.C. Circuit.  As I noted in the post on Byers from July 22, 2015, the IRS and DOJ are not objecting to taxpayers taking appeals of their CDP cases from the Tax Court to the Circuits of residence.  So, a person with a Tax Court CDP case is free to avoid the D.C. Circuit holding in Willson, even though the D.C. Circuit might have held in Byers that the person’s type of CDP case (i.e., one not involving a challenge to the underlying liability) can only properly be appealed to the D.C. Circuit.

Mr. Willson, according to the Tax Court website, lives in Washington state.  (I hope this is not a mistake for his being a resident of D.C.)  If this is true, then Mr. Willson is another one of a number of taxpayers who have, since the Byers opinion, deliberately chosen to take their appeals from the Tax Court in CDP cases to the D.C. Circuit under the flush language at the end of section 7482(b)(1), rather than to their Circuit of residence.  Mr. Onyango of Onyango v. Commissioner, 142 T.C. 425 (2014), who lives in Illinois, also has brought his CDP appeal from the Tax Court in the D.C. Circuit, where it is pending (mid-briefing) at docket number 14-1280.  You can find Keith’s post on the Onyango Tax Court opinion here.

District Court Hands IRS Loss in its Bid to Exclude Discretionary Treaty Benefits From Judicial Review

Last month’s Starr v US involves a $38 million 2007 refund suit in the DC district court brought by Starr International (Starr), the then-largest shareholder in American Insurance Group (AIG). In most refund suits there is little question that a district court has the power to conduct a de novo review of the IRS’s decision to deny a refund claim and determine whether a taxpayer is entitled to a refund. Why did the IRS view the case differently?

The issue involves the IRS’s failure under the US-Swiss income tax treaty to grant Starr a discretionary reduction in withholding on US-sourced AIG dividends. IRS argued that its decision to not grant Starr the discretionary treaty-based withholding relief was for it alone to make, and that its decision was not subject to judicial review. The district court rejected the IRS position, and in so doing discussed an aspect of the Administrative Procedure Act that the IRS claimed applied (at least in principle) to the proceedings.

In this post I will summarize the dispute and offer my view as to why as a policy matter IRS should be reluctant to argue for absolute discretion over most substantive decisions it makes, especially one that goes to the merits of a tax liability such as in this case.

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What is the APA provision at issue? The APA states that agency action is generally reviewable “except to the extent that . . . [it] is committed to agency discretion by law.” 5 U.S.C. § 701(a) (note that another statute such as the Anti-Injunction Act may also remove an IRS decision from court review; that was not at issue in this case). Starr did not bring an action under the APA, however, as it brought a refund suit under Section 7422 and 28 U.S.C.
§ 1346(a)(1). As such, Starr argued that the “committed to agency discretion” rule did not apply because it did not bring an APA claim.

The district court rejected Starr’s position and essentially provided that even if the claim itself were not brought under the APA (and by implication even if the APA did not apply to agency determinations of this type), the principle of nonreviewability in 5 USC § 701(a) applies to all agency actions because the APA merely codified traditional principles of nonreviewability. In other words, if the IRS could establish that the decision to grant treaty benefits at issue in the case were committed solely to the IRS’s discretion, then its decision would be unreviewable despite the fact that there was no APA cause of action.

How does an agency establish that something is solely in its discretion and this not subject to court review? The legal inquiry asks generally if there are judicially manageable standards for a court to review. While that seems a somewhat vague principle, it is safe to say that courts are reluctant to let agency actions escape judicial scrutiny.

That limitation on nonreviewability is for good reason, as many administrative law scholars have claimed and common sense dictates. In an article I wrote awhile back on CDP (around page 1167) I have discussed both the legal and policy reasons why unreviewability of agency action should be the rare exception. In that piece I quote extensively from a 1990 article by Ronald Levin in the Minnesota Law Review called Understanding Unreviewability in Administrative Law. Professor Levin summed up the policy reasons nicely:

Scrutiny of administrative action by an independent judiciary is an integral part of the American checks and balances system—a powerful deterrent to abuses of power and an effective remedy when abuses occur. By helping maintain public confidence that government officials remain subject to the rule of law, judicial review also bolsters the legitimacy of agency action. . . . Finally, judicial review can enhance the quality of administrative action by exposing partiality, carelessness, and perverseness in agencies’ reasoning.

Despite the policy reasons against doing so, over the years, in addition to being able to put an invisibility cloak around its actions due to the Anti-Injunction Act, IRS has claimed unreviewability based on the “committed to agency discretion” defense over a wide range of agency decisions. For example, prior to legislation, it argued with success that decisions to not abate interest and to not grant equitable relief from joint and several liability were exempt from court review, and it continues to assert unreviewability when taxpayers seek judicial review of IRS denials of collection alternatives outside of CDP.

The Discretionary Relief in the Swiss Treaty

As the opinion describes, Starr relocated its corporate headquarters to Switzerland from Ireland. It did so because of a highly-publicized split between former AIG CEO Ace Greenberg and AIG, and disputes over Starr funding AIG’s compensation plans. It alleged that its move to Switzerland was done to “protect its assets from an AIG lawsuit claiming that Starr was contractually obligated to fund the plan.”

That was significant because the US –Ireland treaty automatically provided that the rate on withholdings on dividends was 15% rather than the normal 30%. The US-Swiss treaty on the other hand provided for a reduced 15% rate if certain conditions were satisfied.

Because it failed to satisfy the conditions for the non-discretionary Swiss treaty benefit Starr did not qualify for the automatic reduction under the US-Swiss treaty. In the absence of qualifying for the automatic reduction, the US –Swiss treaty allowed for the discretionary relief that is at the heart of this dispute. The relief provision provides that a taxpayer “may, nevertheless, be granted the benefits of the Convention if the competent authority of the State in which the income arises so determines after consultation with the competent authority of the other Contracting State.” US Swiss Treaty, Art. XXII(6).

As the opinion explains, Treasury has published a Technical Explanation of the US-Swiss treaty; the Technical Explanation is as the opinion mentions roughly analogous to legislative history. That explanation provides that the reason for the limitation on benefits (that is, the reason why not every Swiss taxpayer was entitled to the reduced withholding) was to prevent “treaty shopping.” As the opinion sets out, treaty shopping is the practice of 
”moving … specifically to benefit from the lower U.S. tax rate offered by the U.S.-Swiss tax treaty.”

In 2007, Starr sent a request for discretionary reduced withholding as per the treaty to the US Competent Authority. Having not received a response in early 2010 it filed a protective refund claim. Starr forwarded the claim to the IRS analyst working the competent authority request. Shortly thereafter the competent authority denied the 2007 request for discretionary withholding relief, though interestingly it granted relief for the 2008 year.

Starr then sued for a refund in the fall of 2014. The complaint Starr brought claimed that the IRS abused its discretion for three reasons:

  1. Starr was not treaty shopping when it relocated to Switzerland,
  2. the IRS failed to consult with the Swiss Competent Authority before denying Starr’s request, and
  3. the IRS had no legal basis for issuing Starr a 2008 refund while denying its 2007 request based on the same material facts.

IRS filed a motion to dismiss on the grounds that its decision was unreviewable because it was committed to agency discretion. (alternatively, it also argued that the challenge raised an unreviewable political question, an issue that I will not discuss in this post but which the court found also did not apply to restrict court review).

How Did the Court Determine Whether the Matter Was Solely in the IRS Discretion?

As I discuss above, the court first disposed of Starr’s argument that only APA claims themselves are subject to the committed to agency discretion exception to judicial review. That IRS victory however was only short-lived though because the rest of the opinion discusses why in this case there was enough law for the court to apply, leading the court to the conclusion that it had the power to review the IRS’s decision to not grant Starr discretionary treaty relief. How does it get there? I suggest interested readers look at the opinion as there is lots there but I will hit a few of the highlights.

The court’s opinion goes through the black letter I also briefly describe above that generally asks if the applicable provision 
of law “is drawn so that a court would have no meaningful standard against which to judge the agency’s exercise of discretion,” or “in those rare instances where ‘statutes are drawn in such broad terms that in a given case there is no law to apply.’” (citations omitted).

In a footnote (note 7), the court notes the “strong presumption” that “Congress intends judicial review of administrative action” but also acknowledges that this case differs from many others given it was based not in a statute but a treaty provision. Despite the difference, it extends that presumption of reviewability to treaty provisions:

Federal courts “should normally apply the [background] presumptions supplied by American law” when ascertaining treatymakers’ intent in assessing entitlement to relief under a federal statute. One such presumption—an especially strong one—is that Congress intends for agency action to be reviewable. (citations omitted).

To look at the issue in question the court considered the prototypical agency matters that do get exempted from review, agency decisions whether to enforce or prosecute, and contrasted them with the IRS decision in this case. Despite accepting that distinction, IRS argued nonetheless that the treaty benefits’ decision warranted unreviewability because it implicated “complicated foreign policy matters” and courts have on occasion extended unreviewability to agency decisions sweeping in foreign policy.

The opinion distinguished a tax treaty’s benefits’ provision from those cases where courts found that the complex considerations in foreign policy matters rendered unreviewable, such as the State Department’s decisions to deny a consular visa or delegate a decision to control arms exports, noting that “reviewing a denial of benefits under the discretionary provision does not involve “second-guessing executive branch decision[s] involving complicated foreign policy matters.”

After disposing of the IRS argument that treaty benefit decisions were inherently nonreviewable the opinion undertook the task of discerning whether the “language, structure and history” of the benefits provision in the treaty supported nonreviewability. I hit some of the highlights of the opinion below.

The opinion started with a focus on the treaty language itself I quoted above, which provides permissively that the taxpayer “may” be granted relief. At first blush the use of the permissive “may” cuts in favor of absolute agency discretion, but the opinion notes that many cases have held that permissive language such as may was not determinative, leading the court to look to sources other than the text itself.

Its next stop was the treaty’s Technical Explanation, which as I mention above is like legislative history. Prepared by Treasury to assist the Senate in the ratification process, it reflects Treasury’s view and explanation of the treaty. That explanation includes a statement on the discretionary provision, stating that the Treasury would “base [its] determination . . . on whether the establishment, acquisition, or maintenance of the person seeking benefits under the Convention, or the conduct of such person’s operations, has or had as one of its principal purposes the obtaining of benefits under the convention.”

The opinion looked to testimony of Treasury officials, which like the explanation puts some context on the decision to grant discretionary benefits. For example, the Treasury Assistant Secretary stated that in determining eligibility for discretionary relief IRS would look for a “a substantial non-treaty-shopping motive for establishing themselves in their country of residence.”

While not part of the treaty itself, the explanation and testimony suggested a standard by which the IRS would evaluate requests for treaty relief. In fact, in denying Starr’s claim, the IRS applied that standard, informing Starr that it could not “conclude that obtaining treaty benefits was not at least one of the principal purposes for moving Starr’s management, and therefore its residency, to Switzerland.”

What was the IRS’s rebuttal? It pointed to Senate report accompanying the treaty ratification which stated that “the Secretary of the Treasury may, in his sole discretion, treat a foreign corporation as a qualified resident of a foreign country[.]” Tax Convention with Switzerland, S. Exec. Rep. No. 105-10, at 54 (1997). The opinion notes that this “does not explicitly discuss judicial review, but it nonetheless provides some evidence of an intent to preclude such review.” Despite what the opinion felt were the mixed messages, it felt that the report was not enough for the IRS to prevail:

IRS has not presented clear and convincing evidence that the discretionary provision was intended to preclude judicial review. Indeed, the structured guidance set forth in the Technical Explanation—a long with the lack of any express preclusion of judicial review—renders the issue sufficiently ambiguous that the presumption of reviewability controls?

IRS also argued that the “principal purpose” standard was too vague to afford a court meaningful review:

The IRS claims that this standard is not specific enough to permit review. What, asks the IRS, does it mean to conclude that a company’s “principal purpose” is to obtain the benefits of a tax treaty?

The opinion likewise finds this argument unavailing and notes that unlike IRS it was “not so daunted by the prospect of reviewing the IRS’s determinations. Courts routinely face somewhat amorphous and open-ended standards…. At the margins, it may be difficult to determine whether a company moved to Switzerland principally to lower its tax rate. But this does not mean there are no manageable standards to apply.”

Conclusion

Having survived a motion to dismiss, the case now will proceed to the merits. While the presence of the treaty provisions complicates the analysis, I think the district court got this one right on the law and on the policy. Courts are pushing back against IRS claims that its process or decisions should be insulated from judicial review. For the reasons Professor Levin succinctly mentions in his 1990 law review article, courts are rightfully skeptical of agency blanket calls for unreviewability. IRS has faced plenty of allegations of abuse of power, and it is rocked still by questions pertaining to its politicized review of applications for exemption. For an agency like the IRS, which administers a law which depends in part on continued public respect for the integrity of the tax system, IRS needs to choose its battles on this issue carefully.