Larson Part  2: Absence of Prepayment Judicial Review Is Not a Constitutional Defect

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Carl Smith’s earlier post on Larson v United States discussed Larson’s argument that the Flora rule should not apply to immediately assessable civil penalties under Section 6707. Larson also argued that the absence of prepayment judicial review violated his 5th Amendment procedural due process rights.

I will briefly describe the procedural due process issue and the Second Circuit’s resolution of the issue in favor of the government.

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Larson’s argument Larson was straightforward: the absence of judicial prepayment review of the 6707 penalty violated his right to procedural due process, a right embedded in the 5thAmendment. The 5thAmendment provides that no person shall be . . . deprived of life, liberty, or property, without due process of law . . . .”  Stated differently, Larson argued that the right to challenge the penalty prior to payment at Appeals was not enough to meet constitutional due process standards. Taking the constitutional gloss off of it, as the opinion states, Larson felt that the process “just wasn’t fair.”

The Second Circuit disagreed in a fairly brief discussion of the issue, and in so doing reminds us that while courts have pushed back on tax exceptionalism in many areas, when it comes to viewing the adequacy of IRS procedures in a due process framework tax is different.

At its heart, the protections associated with procedural due process, notice and hearing, are about minimizing the risk of the government making a mistake and depriving a person of a protected interest—in this case property. In finding that the process adequate, the Larson opinion leaned on caselaw that had its pedigree in 17thcentury England which had established that when assessing and collecting taxes the sovereign is entitled to rely on summary pre-payment and assessment procedures backstopped by the right to post payment judicial review.

That case law was based on the notion that potentially interposing a hostile judiciary between the taxpayer and the fisc was just too risky; taxes, after all, are the lifeblood of the government, and if the government makes a mistake in assessing a tax, a taxpayer can get justice by bringing a refund suit.

Of course, in our modern tax system, Congress has repeatedly stepped in and provided statutory protection to allow prepayment review in many cases. The US Tax Court exists in large part to soften the impact of the lack of meaningful due process protections associated with a determination of liability. The ability to pay a divisible portion of a tax and sue for refund, as well as CDP’s opportunity to challenge a liability in certain circumstances, all soften the blow of the exceptional view of tax cases.

As Carl mentioned the 6707 penalty is not divisible, and we have discussed the limits of CDP providing a forum for challenging the penalty.

This brings us to Larson’s constitutional challenge.  As Larson and others have argued, much has happened since the Supreme Court first blessed the assess first pay later constitutionality of the US tax system in the latter part of the 19thand early part of the 20thcentury. A number of meaningful Supreme Court cases, such as Goldberg v Kelly, provided that in most instances, the norm should be more defined pre-deprivation review. Most creditors are no longer entitled to rely on post payment judicial protections to ensure that a debtor’s interests are protected. In Mathews v Eldridge, the Supreme Court instructed courts to consider three factors when faced with a due process claim: (1) “the private interest that will be affected by the official action”; (2) “the risk of an erroneous deprivation of such interest through the procedures used, and the probable value, if any, of additional or substitute procedural safeguards”; and (3) “the Government’s interest, including the function involved and the fiscal and administrative burdens that the additional or substitute procedural requirement would entail.

In concluding that Larson did not have a successful procedural due process claim, the court did acknowledge that the Mathews factors were instructive and did in fact apply those factors to Larson’s facts. That  is more than some courts have done with tax cases, where some opinions state that since the time of King Charles the sovereign is entitled to rely on summary assessment procedures, and leave it at that.

In applying Mathews, the opinion stated that on balance while Appeals might not have afforded a perfect process the taxpayer did get a major reduction in the penalty assessment, and, in any event, the government interest in tax cases is “singularly significant”:

Larson’s interest is not insignificant; the IRS has imposed onerous penalties that Larson claims he cannot pay. But, as we previously noted, the IRS Office of Appeals review resulted in a substantial reduction of Larson’s penalties. No review is perfect and Larson offers no record‐based criticism of how the appeal was conducted. We are satisfied that the current procedures effectively reduced the risk of an erroneous deprivation and gave Larson a meaningful opportunity to present his case. Indeed, the Seventh Circuit recently observed that the IRS Office of Appeals “is an independent bureau of the IRS charged with impartially resolving disputes between the government and taxpayers,” and that “Congress has determined that hearings before this office constitute significant protections for taxpayers.” Our Country Home Enters., Inc., 855 F.3d at 789. Lastly, the governmental interest here is singularly significant due to the careful structuring of the tax system and the Government’s “substantial interest in protecting the public purse.” Flora II, 362 U.S. at 175. Considering all three factors, our Mathewsanalysis weighs in the Government’s favor. Therefore, application of the full‐payment rule to Larson’s § 6707 penalties does not result in a violation of Larson’s due process rights.

Observations and Conclusion

The opinion leans heavily on Appeals’ role, both in terms of how Congress has emphasized Appeals’ importance to the tax system (an issue front and center in the Facebook litigation we have discussed) and how Appeals reduced the penalties at issue in the case by $100 million.  The opinion heavily weighs the government’s interest without thinking on a more granular level as to what the government interest is. For example, what is the government’s interest in summary process for this penalty? What additional burdens or risks would the government face by allowing for judicial review of the penalty? I also would have liked to have seen a more robust discussion of the individual’s interest and a bit more on the structural deficiencies with Appeals as a resolution forum relative to a judicial forum.

To be sure, due process is not a one size fits all analysis. And as a comment to Carl’s post notes perhaps Larson is not the most sympathetic of taxpayers. Yet, over time, our tax system has changed to reflect an increased sense that taxpayers should have the right to challenge an IRS assessment without having to full pay the liability. Congress has also added significant civil penalties that are immediately assessable; that progression has been piecemeal and could stand to use some reform that might also consider the procedural aspects of challenging those penalties.

Norms with respect to individual protections and taxpayer rights are changing as well. Perhaps the appropriate remedy here is a statutory fix to CDP that would allow for Tax Court review of the penalty and possible refund of any amount paid in a CDP proceeding. That would more closely align collection due process with the 5thAmendment notion of due process.

 

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. Jim Malone says:

    Initially, I was very much taken with the due process issue in this case: The penalty is over 60 million, the taxpayer says it should be 7 million and cannot pay. It struck me as fair game for the taxpayer to say there was a due process violation.
    Prior tax cases are different than this penalty regime, which can yield “taxes” subject to summary collection procedures that are actually multiples of a taxpayer’s income, not a portion of it.
    I think it is a hard type of due process issue to sell to a court because it is asking for line-drawing: How big a penalty is so large that the taxpayer should not have to pay.
    The other thing that occurs to me that if (as I believe to be the case) the taxpayer can file a bankruptcy petition and litigate the penalty there, what I thought was a good due process argument may not be very good at all, as judicial review is available.
    None of which is to suggest that the result here is good or that taxpayers should be forced to file for bankruptcy to obtain review of tax determinations. Plainly this should be fixed through legislation.
    Thanks for a thoughtful piece on this case.

  2. Lavar Taylor says:

    As the attorney who lost the Our Country Homes case in the 10th Circuit, I’d like to apologize for that opinion and for the the fact that the Court in Larson relied on the Our Country Homes opinion to reject Larson’s due process argument. Our reply brief in Our Country Homes cited to many of the National Taxpayer Advocate’s Annual Reports which criticized the Office of Appeals as doing an inadequate job of protecting the rights of taxpayers. It seems that the 10th Circuit Judges forgot to read that portion of our reply brief.

    I wish that the Judges who write these opinions could personally experience the same “careful, considerate” treatment that many of our clients receive from the Office of Appeals, particularly the Appeals employees working at the campuses, before writing these opinions.

  3. Bob Kamman says:

    “…some opinions state that since the time of King Charles the sovereign is entitled to rely on summary assessment procedures, and leave it at that.”

    Really? Do you think any of these judges know enough history to add (off the top of their head, so to speak) what happened to King Charles?

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