Avoiding the Federal Tax Lien Securing Penalties in a Bankruptcy Case

The case of Hutchinson v. United States [No. 17-01076] (E.D. Cal. 2017) involves an effort by taxpayers in bankruptcy to avoid a federal tax lien securing the payment of penalties. The bankruptcy court denies the effort by the taxpayers to avoid the lien while acknowledging that the bankruptcy trustee could have avoided the lien had the trustee sought to do so. As discussed below, the reason that the bankruptcy court allows one party, the trustee, to avoid a federal tax lien securing penalties but not another party, the debtor, results from the benefit Congress sought to confer in allowing avoidance of the federal tax lien securing penalties in a chapter 7 case.

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The taxpayers owed $162,690 in penalties at the time they filed their bankruptcy petition. Prior to the filing of the petition, the IRS had filed a notice of federal tax lien in the city or county in which their residence was located. In their bankruptcy schedules, taxpayers indicated that the value of their home was $185,000 and that it was encumbered by a first deed of trust in the amount of $87,000. They claimed a personal exemption of $100,000. Because they lived in California, which has a generous exemption provision for personal residences, this was possible. Not all states have such a large exemption for personal residences.

Taxpayers’ problem with the exemption was that it removed the property from the bankruptcy estate allowing them to keep the property and the home equity; however, the federal tax lien continued to attach to the property after bankruptcy putting them in the position of going through the bankruptcy only to find that on the other side they had not obtained the relief they needed. Because the federal tax lien still attached to the home, the IRS had/has the ability to sell the home either administratively or through a foreclosure proceeding. The taxpayers presumably sought to avoid the lien in their case in a post bankruptcy discharge action in order to keep the IRS from taking their home and using the equity in excess of their first mortgage to satisfy the tax debt.

Before discussing the Hutchinsons’ case further I stop to note that the IRS is generally very reluctant to take taxpayers’ homes. Before 1998 it did not take taxpayers’ home frequently, but after the Restructuring and Reform Act of 1998 the IRS very rarely takes taxpayers’ homes or other tangible property. The situation gets a little stickier for the IRS in the post bankruptcy situations. Absent bankruptcy, the IRS can simply take no collection action operating under the fiction that the statute of limitations on collection is still open and it might collect from the taxpayers through some mechanism other than seizure and sale of property. No one at the IRS is forced to make a decision concerning collection and the general practice of only seizing tangible assets in rare circumstances usually results in a decision to do nothing which is different than an affirmative decision to walk away from the only property that could satisfy the liability.

When a taxpayer obtains a bankruptcy discharge and before the filing of the bankruptcy petition the IRS  a filed federal tax lien for the discharged taxes discharged, someone at the IRS must make an affirmative determination whether to pursue collection from any assets the taxpayer brought into the bankruptcy estate to which the federal tax lien attached. The equity available in a debtor’s property such as the home equity available in the Hutchinsons’ case is the only thing from which the IRS can collect to satisfy the discharged liability because the bankruptcy discharge turned what was an in personam liability into an in rem liability.  The rem, or the thing securing the debt, in the Hutchinsons’ case, their house, is the only asset the IRS has from which it can satisfy the liability. Someone at the IRS must make an affirmative determination to release the lien.  In this situation the IRS employee assigned to the case cannot rely on the fiction that the IRS might later collect the liability from future earnings or a voluntary payment. The IRS employee knows that if they release the lien they are walking away from $100,000 in equity and that the only way to collect the $100,000 is to enforce the lien on the property. Here, it becomes more likely that the IRS will take action against the property to obtain the equity to which its lien attaches than if the taxpayer had not sought bankruptcy relief.

So, the Hutchinsons would like to eliminate the IRS lien in order to eliminate the possibility that the IRS would take their home. Because the lien at issue here is a lien in which the underlying liability is a penalty and not a tax and because the taxpayers filed a chapter 7 petition, the trustee could have avoided the lien using the powers available in Bankruptcy Code sections 724(a) and 726(a)(4). The Hutchinsons brought this action to avoid the penalty under Bankruptcy Code section 522(h). Section 522 is the section that addresses exempt property. The IRS responded to the action by arguing that 522(c)(2)(B) specifically allows it to assert its lien against exempt property and that only the trustee has standing to assert the lien avoidance provisions of 724(a).

The court acknowledged that the trustee could have avoided the tax lien and then found that if the trustee does not do so debtors can avoid liens under section 522(h) but not tax liens. Citing the earlier Ninth Circuit case of In re DeMarah, 62 F.3d 1248,1250 (9th Cir. 1995) the court holds that “where the lien sought to be avoided secures back taxes, 522(c)(2)(B) eviscerates the debtors’ 522(h) powers.” The court noted that the fact that the debtor could exempt property from the estate does not mean that the debtor can remove the lien “or that portion of it which secures the penalty.” The purpose for allowing the trustee to avoid the tax lien securing penalties in a chapter 7 case is to allow the trustee to obtain a greater recovery for the benefit of the other creditors of the bankruptcy estate. The purpose of the provision allowing avoidance was not to allow the debtor to gain relief.

This case does not break new ground but presents a bankruptcy issue we had not previously discussed on the blog. The penalty avoidance powers in chapter 7 are strong and represent an effort by Congress to clear up some equity for other creditors who should not be penalized themselves by the debtors’ bad tax behavior. The provision allows the removal of the lien on penalties as an impediment to the payment of a creditor with no lien interest or an inferior lien interest and avoids having limited estate funds go to satisfy a debt based on bad behavior towards the IRS.  Those avoidance powers were not intended to allow the debtor to use bankruptcy to escape from their bad tax behavior. In the absence of a filed federal tax lien and if the penalty is not for fraudulent behavior, bankruptcy serves as an excellent mechanism for discharging penalties more than three years old but the existence of the filed federal tax lien changes the game and gives the IRS the opportunity to pursue available equity in a debtor’s property to collect penalty claims if it has the desire to do so.

 

 

Designated Orders, January 29 – February 2: Holmes Continues Plumbing the Depths of Graev

Regular contributor Professor Caleb Smith continues on our theme of discussing the long reach of Graev and related issues.  Les

There were five designated orders last week, but only one worth going into much detail on. Of course, it involved Judge Holmes once more considering some implications of Graev. The other orders involved a taxpayer erroneously claiming the EITC with income earned as an inmate (here); and three orders by Judge Gustafson working with pro se taxpayers: two of which are in the nature of assisting the taxpayer (how file a motion to be recognized as next friend here, and clarifying how to enter evidence here) and one granting summary judgment to the IRS (here). Note parenthetically that in the latter order Judge Gustafson goes out of his way to mention that the IRS approved a 6662(a) penalty in compliance with IRC 6751 [erroneously cited as 7651]. IRC 6751, of course, is the issue du jour, and the focus of today’s post.

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Rajagopalan & Kumar, et al. v. C.I.R., Dkt. # 21394-11, 21575-11 [here]

Supervisory Approval: Is it Needed for Every “Reason” Behind the Penalty?

For those that need to catch up, the Procedurally Taxing team has provided a wealth of analysis and insight on the Graev/Chai case developments. For “Graev III” fallout readers are encouraged to visit this, this and this post (to name a few). Judge Holmes in particular has been at the forefront of raising (if not quite resolving) unanswered questions that lurk in the aftermath of Graev III. In Judge Holmes’s most recent order, we see two questions bubble to the surface. One of those issues should only provide a temporary headache to the IRS: the procedural hurdle for the IRS to introduce into evidence that they complied with IRC 6751 if the record has been closed. The other issue, however, could well create a lasting migraine for the IRS: whether the IRS form showing supervisor approval also sufficiently shows approval for the rationale of the penalty. That problem isn’t directly answered in the order, but I think it is the most interesting (and most likely to remain a lasting problem) so we will begin our analysis with it.

Imagine the IRS asserts that a taxpayer understated their tax due by $5500 (with that amount being more than 10% of the total tax due). The IRS issues a Notice of Deficiency that throws the book at the taxpayer with an IRC 6662(a) penalty because of this substantial understatement of income tax and because the taxpayer was negligent. In so doing, the IRS is relying on two separate subsections of IRC 6662 as their legal basis for the penalty’s application: subsections (b)(1) and (b)(2).

Imagine further that the IRS did the right thing and had a supervisor sign-off on the penalty prior to issuing the Notice of Deficiency. Does the supervisor need to approve of both rationales (i.e. (b)(1) and (b)(2))? Or is the fact that the penalty, to some degree, got supervisory approval enough on its own? What if the Tax Court finds that this same taxpayer only understated $4500 in tax on their return? Now only negligence could get the IRS to a 6662(a) penalty: do we need to have proof that the supervisor approved of that ground for raising the penalty?

These are questions that Judge Holmes has raised before, in his concurrence of Graev III. Judge Holmes lays out a parade of horribles beginning on page 45 of the opinion, one of which deals with approval of one, but not two, grounds for an IRC 6662(a) penalty (on page 46, point 4). This made me wonder exactly what the supervisory approval form looks like, and if it sets these points apart. With the sincerely appreciated assistance of frequent PT blogger Carl Smith and lead Graev III attorney (also PT contributor) Frank Agostino, I was able to gaze upon this fabled supervisory approval form, which can be found here. And, sure enough, the form does break down 6662 penalties (to a degree). It breaks down IRC 6662 into four categories: (1) Negligence, (2) Substantial Understatement, (3) all other 6662(b) infractions, and (4) 6662(h). The neatly delineated checkboxes certainly make it seem like a supervisor is only “approving” whichever specific penalty rationale they check yes next to.

Looking to the statute at issue provides little guidance on what “amount” of supervisory approval is needed, only that the “initial determination” is personally approved before making the determination. Taking the above accuracy penalty as an example, one could argue that the penalty needing approval is only IRC 6662(a), so that is all that need be approved broadly. The supervisor has agreed that the penalty should apply and the worry of it being used as a bargaining chip is lessoned. The statute isn’t intended to provide a through legal review of all penalty theories, but only to be sure that they aren’t being applied recklessly as “bargaining chips.”

However, one could just as reasonably argue that the nature of the penalty’s application requires some degree of specificity: the penalty is only applied to the amount of the underpayment attributable to that rationale. If our hypothetical taxpayer understated by $5500, but only $1,000 of it is due to negligence, then you would have two potential penalty values: $1,110 (20% of substantial understatement) or $200 (20% for the portion attributable to negligence). Yes, the penalties arise under the same code section (broadly: 6662(a)), but their calculation depend on the rationale (narrowly: 6662(b)(1) or (2)). Since that leads to two different potential penalty amounts, it would seem (in a sense) to be two different penalties. Certainly, one would think two separate approvals were needed if the penalties were IRC 6662(a) or IRC 6662(h), as they apply two different penalty percentages. Why should it be different if they potentially apply against two different amounts of understatement?

Questions I’m sure Judge Holmes looks forward to in future briefs. Though the intent of IRC 6751 is laudable, the language certainly leaves much to be desired.

In the interest of taxpayer rights, however, I think it is important to note that the IRS has created at least some of these problems on their own. From my perhaps biased perspective, accuracy penalties under IRC 6662(a) are most troublesome when applied “automatically” or with little thought against low-income taxpayers that may simply have had difficulty navigating complicated qualifying child rules. In my practice I deal less with the “bargaining chip” and more with the “punitive” aspect of penalties. We have already seen how reflexively the IRS will slap EITC bans without proper approval or documentation here. There may be reason to believe the IRS is just as reflexive with these IRC 6662(a) penalties. Consideration of the relevant IRM is illustrative:

IRM section 20.1.5.1.4 details “Managerial Approval of Penalties.” It lays out the general requirement of IRC 6751 that supervisory approval is required for assessment of a penalty, and then details two important exceptions (one of which I’ll focus on): there is no need for supervisory approval on penalties that are “automatically calculated through electronic means.”

This, by the IRS interpretation, includes IRC 6662(a) penalties for both negligence and substantial understatement if so determined by AUR… so long as no human employee is actually involved in that AUR determination. In other words, we are to trust that no safeguard is needed when the (badly outdated) computers of the IRS determine that there was negligence on the part of the taxpayer. I would note that it appears that this also applies for campus correspondence exams though that is not immediately clear. IRM 20.1.5.1.4(2)(b) implies as much by referring to IRM 20.1.5.1.4(4) (the exception to human approval provision), but that latter provision only mentions the AUR function.

But wait, there’s more. Per that same IRM, if the taxpayer responds to the letter (or notice of deficiency) proposing the penalty then the IRS needs supervisory approval because now it is out of the realm of machines and into the realm of humans. This would seem to imply that taxpayers only have the protection of IRC 6751 if they are noisy. If they aren’t noisy, the IRS hasn’t violated a right of the taxpayer they failed to assert: the right never existed by virtue of failing to assert it. (Apologies for getting metaphysical on that one.)

Bringing it back to the realm of legal/statutory analysis, this still doesn’t seem quite right. Wasn’t the “initial” determination of the penalty already done prior to the taxpayer responding? Or is that irrelevant because at the computer stage it was not an “initial determination of such assessment” (whatever that means)? Judge Holmes, again, has signaled what he believes to be a coming storm on the “initial determination” question. I have no doubt that, given the sloppiness of the statute and the rather poor procedures in place for the IRS, that question is likely to be litigated.

Other Temporary Problems Addressed in Rajagopalan

Though I have devoted the bulk of this post to the issue of “types” of supervisory approval, most of the designated order actually dealt with a different issue. Luckily it is an issue that should be less of a problem moving forward: the IRS scrambling to get evidence of supervisory approval into the court record when the record’s already closed.

As the docket numbers indicate, these consolidated trials have been going on for quite some time: a child born when the Rajagopalan petition was filed would probably be learning their multiplication tables right now. The supervisory approval requirement of IRC 6751 was in effect well before the Rajagopalan trial and record was closed… so how could the IRS possibly have an excuse to reopen the record at this later date?

Obviously, because of the brave new post-Graev III world we now live in. Judge Holmes notes that the IRS had some reason to anticipate the IRC 6751 issue, but doesn’t seem to fault the IRS too much for that failure. Instead, Judge Holmes lays out the requirements to reopen the record: the late evidence must be (1) not merely cumulative or impeaching, (2) material to the issues involved, and (3) likely to change the outcome of the case. In other words, it must be very important towards proving what is at stake (not simply disproving other evidence). But even if it is all of these things, if the diligence of the party trying to reopen the record has to be weighed against the prejudice reopening the record will do to the other party. This final weighing test demonstrates the high importance we place on parties being able to question and examine evidence in a usual proceeding.

So, the IRS has the “golden ticket” (i.e. a document that shows actual supervisory approval) but the record is closed. Is that golden ticket enough to reopen or is the petitioner so prejudiced by this inability to confront the evidence that it should remain closed?

Clearly the supervisory approval form is very important to the case, meeting tests (1), (2) and (3) above. Further, the supervisory approval form is admissible as a hearsay exception through the business records rule (FRE 803(6)). However, the IRS supervisor declaration authenticating the supervisory approval form does, potentially, run afoul of the rules of evidence since it is offered after trial without reasonable written notice to the adverse party. See FRE 902(11).

In the end, the petitioners concern with being unable to challenge the supervisory approval forms is given little weight. Cross-exam would likely have done nothing. The issue is supervisory approval, which is shown by a particular form that the IRS is now offering: either the forms “answer those questions or they don’t.”

This seems like a practical way to frame an increasingly thorny issue.

 

 

 

The Next Government Shutdown: A Legal Perspective

We welcome back guest blogger Stuart J. Bassin who writes about a topic recently on everyone’s mind, the government shutdown. Whether you are a government employee who must spend endless hours at the water cooler discussing whether you will come to work or someone impacted by the shutdown or threat of a shutdown because of your work or your vacation or other activity, lots of time gets wasted over something that should never happen in the first place. We have written about different aspects of the government shutdown before, focusing on the Tax Court here and here, and on the special circumstance of the National Taxpayer Advocate here when she sued the government because the Commissioner deemed her non-essential. The NTA lost her legal battle over the authority to declare her non-essential but may have won the war. In the most recent shutdown, Local Taxpayer Advocates were deemed at least partially essential and directed to work parts of the shutdown days checking and processing the mail, and particularly any payments, coming into their office. While we all enjoy talking about how dysfunctional the federal government is and how appreciative we are that the Newt Gingrich strategy to use what was previously the routine vote to increase the debt ceiling to force votes on other issues, a greater understanding of the process and the consequences can help. Stuart seeks to help us understand the consequences of a shutdown. The consequences can be scary. Keith

Many years ago, I was working as a Justice Department attorney during one of the longer Government shutdowns. Having been designated “essential” during the shutdown (but only on some days), I was supposed to continue representing the United States in ongoing civil litigation. During those happy days, I started wondering about the actual law underlying my activities and the shutdown.   Here is what I learned and some speculation about what that means for our near future.

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The Shutdown is Mandated by the Constitution and Statutory Law.

English law has limited the authority of the executive to spend money without the consent of the legislature ever since the Middle Ages. By taking the unregulated “power of the purse” from the monarchy, the English required the executive and legislative branches to come to agreement on taxation and spending, thereby providing the foundation for a parliamentary or representative form of government (as opposed to a monarchy or autocracy). Absent agreement, the system would grind to a halt.

The English tradition is carried forward by the “separation of powers” principles embodied in the United States Constitution. Spending and taxation authority reside in Congress under Article I, Section 8 of the Constitution; the Executive has no independent taxation or spending power. Separately, Article I Section 9 prevents unauthorized spending, providing that “No Money shall be drawn from the Treasury, but in consequence of appropriations made by law.” When a lapse in appropriations occurs, the government necessarily shuts down. Neither the President nor Congress decides to shut down the Government; it happens automatically under the Constitution.

Statutory law develops the constitutional prohibitions and invokes the criminal law to enforce the prohibition. Under Section 1341(a) to Title 31 of the U.S., federal employees “may not make or authorize an expenditure or obligation” or involve the “government in a contract or obligation” absent a lawful appropriation. Similarly, under Section 1342, federal employees “may not accept voluntary services for the government … except for emergencies involving the safety of human life or the protection of property.”   The “emergency” exception is narrowly defined to exclude “ongoing, regular functions of government the suspension of which would not imminently threaten the safety of human life or the protection of property.” Section 1350 makes a knowing violation of either provision a felony punishable by up to two years in prison.

Setting aside some nuances, four basic prohibitions emerge. Absent an appropriation, Federal employees can go to jail if they—

–                 obligate the government to pay for goods or services,

–                 require another government employee to perform his or her job with or without pay,

–                 allow their subordinates to perform their duties as “volunteers” with an understanding that the employees will be paid after the shutdown, or

–                 allow their subordinates to perform their duties as true volunteers if their duties are not required to prevent an imminent threat to the safety of human life.

Even if Congress and the President informally agree that some governmental function is “essential” and should continue absent an appropriation, designation of an employee or their functions as “essential” makes no difference under the statutes; that vague terminology has no basis in the Constitution or the statutory law.

Government operations during the coming shutdown.

There are some special situations involving expenditures from government trust funds and multi-year appropriations which allow certain spending when other appropriations have lapsed.   However, setting aside those exceptions, we should consider how the plain statutory language and the Constitution apply in some commonplace situations—

Can the military pay soldiers to man the borders?   National defense surely involves situations which present an imminent threat to human life. But, that is not enough to allow military commanders to pay soldiers’ salaries. The imminent threat to human life exception would not authorize salary payments to anyone; it only applies where the soldiers “volunteer” to work without pay or promises of future pay. We can all hope that they will volunteer.

Can Veterans Affairs employees pay health care benefits to veterans? In general, government employees cannot issue checks when there is no appropriation. Even if money for the payments was available from some trust fund or unexpired appropriation, the Government cannot pay the employees responsible for issuing the checks. Indeed, even if those employees volunteer to work without pay or any expectation of future payment, their supervisors likely could not allow them to volunteer because issuing payments for veterans’ health care benefits is not required to prevent an imminent threat to the safety of human life.

Can IRS employees receive and deposit checks in the Treasury? Probably no. Even if the employees were volunteers, depositing checks is not required to prevent an imminent threat to the safety of human life.

Can the courts operate?   For civil matters, almost surely no. Even if all involved were volunteers, the conduct of virtually all civil litigation does not implicate any imminent threat to the safety of human life.   Volunteers (and only volunteers) might be able to conduct criminal litigation involving an imminent threat to the safety of human life.

Perhaps some agencies have squirreled away some portion of a prior appropriation to support their activities for a couple days. But, absent an appropriation, these functions of government cannot continue for long absent a new appropriation.

The National Train-Wreck Scenario

Of course, the scenario described above would quickly degenerate into a national train-wreck. And, no one would argue that it is good policy to leave the borders unmanned, veterans unpaid, government funds undeposited, or the courts largely closed. However, the current jury-rigged system where government operations continue (or not) based upon some vague notion of what is essential (probably protecting those functions which would trigger a public outcry) surely is not what the Constitution and the law mandate.

Perhaps the Constitutional fathers had it right. A lapse in appropriations (and a legal government shutdown) should be extremely painful for all involved. The prospect of a true government shutdown ought to hang like a Sword of Damocles over the heads of our elected officials. Regardless of party or ideology, a national train-wreck would produce enough blame to pass amongst all involved and one would hope that none of those involved would survive politically.   One thing for sure; the threat of such a train-wreck ought to focus everyone’s attention.

Ford v. Commissioner: A step forward in the shadow of Graev III

We welcome back guest blogger Professor Erin Stearns who directs the low income taxpayer clinic at the University of Denver Sturm College of Law, Graduate Tax Program. She writes today about more fallout from Graev III. Professor Stearns co-authored the Penalty chapter in the forthcoming (hopefully next month) Seventh Edition of Effectively Representing Your Client before the IRS. The case she discusses today takes a taxpayer favorable position on proof of the necessary penalty approval. For a discussion of the case that focuses on the substantive law at issue, see the blog post by Professor Bryan Camp. Keith

The Tax Court published the Ford v. Commissioner memorandum decision on January 25, 2018. See T.C. Memo. 2018-8. It is significant not only because the petitioner is a legendary mover and shaker on Nashville’s country music scene, but because it demonstrates how the Tax Court may handle penalty disputes involving I.R.C. § 6751 after Graev v. Commissioner, 149 T.C. No. 23 (Dec. 20, 2017) (“Graev III”).

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I.R.C. § 6751 states that no penalty shall be assessed unless the “initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.” Exceptions from the requirement of supervisory approval are for penalties under § 6651 (failure to pay and file) and §§ 6654 and 6655 (failure to make estimated tax penalties by individuals and corporations). See I.R.C. § 6751(b)(2).

Ford v. Commissioner involves the petitioner, Mrs. Joy Ford, who with her deceased husband, Mr. Sherman Ford, formed a country music label called Country International Records in 1974. They also started the Bell Cove Club in Hendersonville, Tennessee, just outside Nashville, in the late 1980’s. Bell Cove – still in operation – has been an important venue for up and coming country music stars to take the stage and perform before talent scouts and agents in the competitive Nashville music scene.

In each of 2012, 2013, and 2014, Bell Cove sustained significant losses which appear to have been reported on Schedule C of Mrs. Ford’s Form 1040 and which offset her income from other sources. The IRS audited Mrs. Ford’s individual income tax returns and proposed to deny the losses, arguing that Bell Cove was not an activity engaged in for profit under I.R.C. § 183, but rather a hobby for Mrs. Ford. The IRS also sought to deny NOL deductions on two years of tax returns. Finally, it proposed an accuracy-related penalty for negligence under I.R.C. § 6662. Mrs. Ford’s case went to trial before Judge Foley in May 2017.

The seven-page memorandum decision addresses three issues. The first was whether the Bell Cove was an activity engaged in for profit or a hobby in 2012, 2013, and 2014, and the second was whether Mrs. Ford was entitled to net operating losses (NOL) deductions from earlier years. In the decision, Judge Foley quickly disposed of the first two issues. Albeit with an approving nod to the mission and contributions of Bell Cove to the Nashville music scene, he determined that the operation of Bell Cove was “primarily motivated by personal pleasure, not profit, and simply used the club’s losses to offset her [other] income.” T.C. Memo. 2018-8, Slip Op. at 6. He noted that the handwritten ledger did not match business expenses reported on the returns, that Mrs. Ford frequently used her personal bank account to pay Bell Cove’s expenses, and that the amount paid to performers generally exceeded the revenue from ticket sales. Judge Foley also sustained the respondent’s disallowance of NOL deductions for lack of substantiation.

The remaining issue, and the one relevant here, concerns the accuracy-related penalty. The decision states:

We do not, however, sustain the section 6662(a) accuracy-related penalties relating to negligence for the years in issue. Respondent failed to present any evidence that the penalties were “personally approved (in writing) by the immediate supervisor of the individual making such determination.”… Accordingly, he did not meet his burden of production, and petitioner is not liable for the determined penalties.

The IRS has the burden of production under § 7491(c) for certain penalties in a deficiency case, including showing compliance with the requirements of § 6751(b). See Graev III. The penalty at issue in Ford, and a common penalty for many petitioners, is the accuracy-related penalty under § 6662(a).

Over the last year, the Tax Court and Second Circuit Court of Appeals have sought to define what the IRS must show in order to prove the petitioner is liable for penalties, and when the IRS must show it. See Graev v. Commissioner, 147 T.C. No. 16 (November 30, 2016) (“Graev II”), Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017), and Graev III. There have also been a series of excellent posts by Keith (here, here, and here) and Carl Smith (here) about these cases and their impacts on this site. These posts are worth reading and this post will not re-span the ground they cover other than to identify the landscape post-Graev III, and how Ford builds on it.

Graev III, issued December 20, 2017, held that in a deficiency case, the IRS’s burden of production under § 7491(c) for certain penalties includes showing compliance with the requirements of § 6751(b). Graev III was significant in that it overruled the earlier decision in Graev II and rejected that majority’s holding that the written approval may be obtained at any time before the penalty is assessed, and any challenge under § 6751(b) must be made after assessment of the underlying tax liability. This would effectively postpone challenges under § 6751(b) until after the deficiency dispute has been decided, whether by settlement or at trial. The Graev III court seems to adopt the timing standards set forth by the Second Circuit in Chai v. Commissioner. This rule says that the IRS must “obtain written approval of the initial penalty determination no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty.”

Following Graev III, Tax Court judges issued a number of orders asking parties to weigh in on whether and how Graev III affected them. Ford is the first decision issued post-Graev III addressing whether the IRS met its burden of production by showing compliance with the requirements of § 6751(b). As noted above, in Ford Judge Foley held that respondent failed to put on evidence sufficient to meet this burden. This was good for Mrs. Ford and appears to be a good sign for petitioners going forward.

I hesitate to overstate the significance to Ford, but it demonstrates the Court’s willingness to sua sponte require the IRS to show compliance with § 6751(b) in at least some cases involving penalties. We know that Mrs. Joy Ford was represented by counsel, but it’s not clear from the decision to what degree and on what basis her counsel challenged penalties and if the issue of compliance with § 6751(b) ever came up. Therefore, on its own, Ford does not give us clear guidance on what this means for pro se litigants, or even represented petitioners with pending cases involving penalties where § 6751(b) compliance issues were not raised.

If judges increasingly sua sponte require the IRS to show it complied with § 6751(b), then petitioners are likely to prevail on the issue of penalties unless respondent’s counsel immediately anticipates this challenge and puts on evidence that the § 6751(b) requirements were met. Assuming that Ford does not alter the landscape so much as to make it standard for judges to sua sponte require respondent to prove it complied with § 6751(b), another more practical question arises: how should petitioners’ counsel approach penalty challenges in light of the timing rule that respondent must obtain supervisory approval of penalties “until no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty”?

Certainly Graev III and Ford empower petitioners and their counsel to raise the issue that the IRS has the burden of production under § 7491(c) to show compliance with the § 6751(b) procedures, and to argue that penalties at issue should not be sustained absent such a showing. But when is the best time to make this argument? More specifically, is this something petitioners should state in their petitions to Tax Court?

As noted above, the language in Chai which Graev III seems to have adopted, would give the IRS up until the notice of deficiency is issued or the Answer or Amended Answer is filed to obtain supervisory approval of penalties sufficient to comply with § 6751(b). Chai seems to suggest that for penalties asserted in a notice of deficiency, the IRS would need to have obtained approval of the penalties by a supervisor before the notice was issued. It also suggests that in instances where respondent’s counsel may seek to assert penalties not originally asserted in the Notice of Deficiency in the Answer (or Amended Answer), then supervisory approval must be obtained prior to the issuance of the Answer (or Amended Answer). At this point, it’s not clear from Chai or Graev III whether the IRS could go back and obtain supervisory approval of a penalty after a notice of deficiency is issued but before an Answer (or Amended Answer) is filed if the IRS determines that the requirements of § 6751(b) were not met prior to issuance of the notice of deficiency.

Because of this uncertainty, I question whether raising a § 6751(b) challenge in a petition would invite the IRS to obtain supervisory approval if it appears to be missing before the Answer is filed. While the students and staff in our clinic strive to be as transparent as possible in our dealings with IRS Counsel, we would not want to show all our cards in the petition if doing so could later preclude us from making an argument in our client’s favor. At this point, unless and until judges require the IRS to show it complied with § 6751(b) as a matter of course, it may be safest for petitioner to simply state she disagrees with the IRS’s proposed assessment of penalties in her petition and save any potential § 6751(b) arguments for later negotiations or trial, if necessary.

 

District Court Rules Against Government in Starr International Erroneous Refund Case

Today’s returning guest blogger is Sean Akins. Sean is a partner at Covington & Burling, LLP. His practice includes representing corporations, partnerships, and individuals in tax controversy matters. Sean is a co-author of Kafka, Cavanagh & Akins: Litigation of Federal Civil Tax Controversies and a co-author of Effectively Representing Your Client Before the IRS, Chapter 7, Litigation in the Tax Court. Sean is also a Nolan Fellow (2014-2015) of the Section of Taxation of the American Bar Association, and an Associate Member of the J. Edgar Murdock American Inns of Court (U.S. Tax Court).

In this post, Sean writes about an important district court opinion addressing the time when the government can bring an erroneous refund suit. Les

Taxpayers who have been paid refunds by the IRS can breathe a little easier following last week’s decision in the Starr International case. Prior rulings in Starr have been covered by Les Book here, here, and here. This most recent, and perhaps final, aspect of the case relates to the application of the extended five-year period of limitations in erroneous refund actions brought by the Government.

In Starr’s case, the Government asserted that an erroneous refund action brought four years after a refund was paid to Starr was timely because section 6532(b)’s extended five-year period of limitations applied. The reason? According to the Government, Starr knew or should have known it was not entitled to the refund, and so when Starr filed its refund claim reporting on the face of the return that it was owed approximately $21 million, that representation constituted a misrepresentation of material fact that triggered the extended limitations period. The Government posited that Starr should have instead reported on the face of the return a $0 refund, and then later explained in the attached statement of facts and grounds that it was actually seeking a $21 million refund.

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The district court, citing an amicus brief filed in the case by (shameless plug) Les Book, Fred Murray, and myself [Editor’s note: Sean was the principal drafter], rejected the Government’s argument, and held that no misrepresentation of material fact exists when a taxpayer reports on the face of the tax return the amount of refund to which the taxpayer reasonably believes it is entitled.

Background

In 2007, Starr, a Swiss company, sought from the United States Competent Authority (“USCA”) a determination that it was entitled to a reduced rate of withholding on stock dividends it received. In 2010, the USCA denied that request, which lead Starr to file two claims for refund: one for its 2007 tax year, filed on an amended Form 1120-F, and one for its 2008 tax year, filed on an originally filed Form 1120-F. In 2011, the IRS granted and paid the 2008 refund claim, but took no action on the 2007 refund claim. Rather than seek immediate court review of the 2007 refund claim, Starr waited until 2014 to file suit. By that time, two important statutes of limitations had expired: (i) the three-year period within which the IRS could have assessed a deficiency of tax for the 2008 tax year, and (ii) the two-year period within which the IRS could have initiated an erroneous refund action to claw-back the refund it had previously paid.

After Starr filed suit with respect to the 2007 tax year refund, the Government counterclaimed, seeking a return of the $21 million the Government alleged was erroneously paid. The Government argued that the extended five-year period of limitations applied, rather than the standard two-year period. In order to secure the lengthier period of limitations, the Government was required to show that “the refund was induced by fraud or misrepresentation of a material fact.” Section 6532(b).

The Government asserted that Starr had misrepresented material facts in three ways: (i) Starr reported on line 9 of the Form 1120-F that it was entitled to a $21 million refund; (ii) Starr failed to notify the USCA that it was filing the 2008 refund claim; and (iii) Starr did not expressly notify the IRS service center that the service center lacked jurisdiction to issue a refund.

The district court rightly rejected all three of these as constituting misrepresentations of material fact, but I’ll focus on the first as the most significant of the bunch.

The District Court’s Decision

The district court does a good job of describing the Government’s theory regarding the first alleged misrepresentation (citations to the record omitted):

The Government argues that Starr’s “representation on line 9 of its return that it was due a refund of over $21 million was a misrepresentation of material fact.” In the Government’s view, even if Starr had to file the request to preserve its ability to seek judicial review of the USCA’s treaty benefits determination, it should have either requested $0 or left line 9 of the form blank. According to the Government, taking “this precaution would have allowed [Starr] to litigate the merits of the USCA denial determination in court” without inducing the Ogden Service Center to actually issue the refund.

There are a host of reasons why the Government’s position can’t be the right answer. First and foremost, the Code’s regulations and the Form 1120-F and its instructions require the taxpayer to state the amount of refund to which the taxpayer believes it is entitled. Specifically, Treasury Regulation section 301.6402-3(a)(5) provides that a refund claim must “contain[] a statement setting forth the amount determined as an overpayment.” Moreover, Lines 8 and 9 of the Form 1120-F state that the taxpayer must “enter the amount overpaid” and “that portion” being claimed as a refund. The instructions to Form 1120-F further confirm that an actual amount must be reported, stating that to claim a refund of withheld taxes, the taxpayer must enter on Line 9 “the amount to be refunded to you.” The Court rightly added that “[a]ccepting the Government’s argument would imply that taxpayers—many of whom are less sophisticated as Starr—should ignore this plain instruction, lest they be accused of making a misrepresentation.”

The district court also pointed out that the Government’s position was inapposite to its arguments in many other cases, where the Government has asserted (often successfully) that a taxpayer’s failure to fully inform the IRS of the amount and basis for its refund claim violate the variance doctrine and/or section 6402’s procedural requirement to report the refund amount. Moreover, the district court hypothesized that if Starr were to report that it was owed $0 on the face of its return, one of two untenable situations could arise:

(1) the IRS would ‘grant’ the $0 request, in which case Starr has no further right to seek the $21 million it believes it is owed; or (2) the IRS would deny the refund claim, in which case it could at least argue (as it has in the past) that Starr cannot seek more than it initially requested. Either way, Starr would have risked not being able to receive its $21 million refund . . . .”

Finally, the District Court recognized that the Government’s position would moot the standard two-year period of limitations for erroneous refund actions:

Under the Government’s theory, a taxpayer would be misrepresenting a material fact every time she asked for a refund the Government believed she was not entitled to. And if that were so, there would be no need for an extended limitations period for misrepresentations of material fact because every erroneously issued refund would be the product of a misrepresentation. That cannot be right.”

Based on the foregoing, the Court rejected the notion that Starr had misrepresented a material fact, and found the extended period of limitations for an erroneous refund action inapplicable.

Inducement

Because the district court found that there was no misrepresentation of material fact, it was not required to evaluate whether any such misrepresentations induced the IRS to issue the $21 million refund. Notwithstanding this point, it’s worth noting that the Government claimed to have been induced to issue the refund, at least in part, because Starr’s refund claim was voluminous and the IRS lacked the resources to review such a lengthy tax return. Indeed, the Government had argued that Starr “had no basis to have ‘reasonably expected’ that the Service Center would review the over 100-pages of attachments” to its return. Reply in Support of the United States’ Motion for Summary Judgment on the Counterclaim at p. 7.

This is a troubling argument for the Government to make. Starr not only told the IRS, in its attached statement of facts and grounds, that the USCA had previously considered and rejected Starr’s treaty benefits request, but it also attached to its return the letter from USCA denying those treaty benefits. A review of these materials, even a cursory one, would have informed a service center agent that the refund claim should likely have been denied.

Yet it is these very documents the Government points to when arguing that Starr had buried a strained service center in voluminous detail, thereby inducing it to pay a $21 million refund rather than examine the return. Ironically, had Starr failed to make those disclosures, and had the service center paid the refund, Star would likely have faced a stronger argument from the Government that it had misrepresented material facts by failing to include those disclosures.

In short, the Government’s argument that Starr’s disclosures contributed to the service center issuing a refund is a troubling one, as it seeks to punish a taxpayer for over-disclosing, rather than under-disclosing, a return position.

Why Does IRS File Answers Before Petition Fees Are Paid?

We welcome back guest blogger Bob Kamman. As mentioned before, Bob practices in Phoenix and does a great job of providing comments to our blog posts, often filling in the “rest of the story.” For those immersed in the filing season, here is an oldie but goody article featuring Bob and the impairment of his eyesight caused by the minuscule entries on the Forms 1099 he must decipher. He has lately been paying a lot of attention to the Tax Court’s orders and he noticed an anomaly – the IRS regularly files answers to petitions that have not been perfected by the petitioner.

There can be several reasons for a petition to be “imperfect” in the language of the Tax Court. Perhaps the most common results from the failure to pay the filing fee. When a taxpayer fails to pay the filing fee, or in some other way files an imperfect petition, the Court does not consider the case perfected until the taxpayer fixes the imperfection, e.g., pays the fee or obtains a fee waiver. The Court’s practice is very taxpayer friendly because the Court treats the receipt of the imperfect petition as the time for calculating whether the taxpayer meets the 90 day period within which to file but also keeps taxpayers who fail to perfect from having the tax periods in the notice deemed resolved by the provisions of IRC 7459. I wrote about this a couple of years ago in an unintentionally suggestive post that does not convey the importance of not gaming the Tax Court’s generosity.

Bob’s post raises, but does not answer, the question of why Chief Counsel attorneys file answers to imperfect petitions. I cannot say why they do in the percentage of cases Bob has tracked. Filing an answer takes resources and even though all too often the Chief Counsel attorneys do not carefully review petitions to admit facts not in dispute, I would expect the Chief Counsel attorneys and paralegals to wait until perfection before filing. The Court issues an order when the case is perfected. It seems that Chief Counsel’s office should do a better job of tracking that order and not the 60 day period from the filing of the petition. Keith

The average price last year for a ticket to a Cleveland Browns football game was $108. NFL fans know, of course, that the Browns did not win a game all season. By comparison, the price of a ticket to the Tax Court is still just $60 — and has stayed the same since the early 1980s, although the “small tax case” filing fee of $10 was eliminated back then.

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So filing a Tax Court petition costs next to nothing for most petitioners, and the filing fee can be waived on application and good cause shown. Nevertheless, some petitions don’t include the $60 fee. The Tax Court is remarkably tolerant of these unpaid cases, sending at least one notice and often two to remind petitioners of their debt.

One consequence is that petitions are assigned a docket number and copies are sent to IRS Chief Counsel upon filing, not upon payment. And in many cases, it seems that IRS attorneys file an answer, only to discover later that it was wasted effort. Many observers agree that the IRS has more work every year and not enough resources to do the best possible job. So why are these answers necessary?

For example, in the week ending January 19, 2018 there were eight cases dismissed for failure to pay the filing fee. The orders of dismissal are all the work of Chief Judge L. Paige Marvel, who signs hundreds of orders involving cases that have not yet been assigned for further proceedings to another Tax Court judge. In six of these eight cases, the IRS had filed an answer. Here are the chronologies (all dates are 2017 except dismissal date, and where noted):

 

Docket: 7257-17

Petition Filed: March 31

Order for Filing Fee: April 5; pay by May 22

IRS Answer: May 2

Second Order for Filing Fee: November 29; extended date December 20

Case Dismissed: January 18 (This case also involved an unsigned petition.)

 

Docket: 16014-17S

Petition Filed: July 27, with application for fee waiver

Order for Filing Fee: July 31, application denied (no reason stated); pay by September 14

IRS Answer: August 18

Second Order for Filing Fee: November 29; extended date December 20

Case Dismissed: January 18 (This case also involved an unsigned petition.)

 

Docket: 16917-17

Petition Filed: August 8

Order for Filing Fee: August 15; pay by September 29

IRS Answer: September 1Second Order for Filing Fee: November 29; extended date December 20Case Dismissed: January 18

 

Docket: 11527-17

Petition Filed: May 22

Order for Filing Fee: May 26; pay by July 10

IRS Answer: June 19, with request for place of trial

Second Order for Filing Fee: November 29; extended date December 20

Case Dismissed: January 18

 

Docket: 19697-17

Petition Filed: September 18

Order for Filing Fee: September 25; pay by November 9

Amended Petition Filed: October 27

IRS Answer to Amended Petition: November 14

Second Order for Filing Fee: November 30; extended date December 21

Case Dismissed: January 18

 

Docket: 20587-17

Petition Filed: October 2

Amended Petition Filed: October 4

Order for Filing Fee: October 4; pay by November 20.

IRS Answer to Amended Petition: November 21.

Second Amended Petition Filed: December 4

On December 4, 2017, Judge Marvel ordered IRS to file an answer to the amended petition by January 4, 2017 (sic).

On December 21, IRS filed a motion for more definite statement pursuant to Rule 51 (apparently stating there is no objection by petitioner).

On January 12, 2018, petitioner filed a motion to dismiss.

Case Dismissed: January 16, for failure to pay filing fee. IRS motion for more definite statement and petitioner’s motion to dismiss are denied as moot.

 

Tax Court Rule 20(d) requires that the filing fee be paid “at the time of filing a petition.” However, this is one of those rules that the court does not consider jurisdictional. It allows more time for payment of the fee, even giving petitioners a second chance to pay if they ignore the first deadline.

The filing fee is authorized by Code Section 7451, but Congress did not provide instructions on when it must be paid: “The Tax Court is authorized to impose a fee in an amount not in excess of $60 to be fixed by the Tax Court for the filing of any petition.”

Meanwhile, Rule 21(b) requires the Clerk of the Court to serve petitions on the IRS. It does not say when this should be done, but apparently a docket number is assigned immediately and the papers are sent (physically, or electronically?) right away.

Rule 36(a) requires that IRS file an answer within 60 days “from the date of service of the petition.”

 

Or, the IRS has “45 days from that date within which to move with respect to the petition.”

Rule 36 then provides:

(b) Form and Content: The answer shall be drawn so that it will advise the petitioner and the Court fully of the nature of the defense. It shall contain a specific admission or denial of each material allegation int he petition; however, if the Commissioner shall be without knowledge or information sufficient to form a belief as to the truth of an allegation, then the Commissioner shall so state, and such statement shall have the effect of a denial. If the Commissioner intends to qualify or it as is true and shall qualify or deny only the remainder. In addition, the answer shall contain a clear and concise statement of every ground, together with the facts in support thereof on which the Commissioner relies and has the burden of proof. Paragraphs of the answer shall be designated to correspond to those of the petition to which they relate.

(c) Effect of Answer: Every material allegation set out in the petition and not expressly admitted or denied in the answer shall be deemed to be admitted.

If answers are being filed less than a month after an unpaid petition, it is likely that they will consist of specific denials, general denials, and assertions of “without knowledge or information sufficient to form a belief.” So, are answers even necessary? Whether the fee is paid or unpaid, perhaps the rule should be that the IRS acknowledge the petition has been received and that the case will be assigned to an Appeals officer and a lawyer when they get around to it, but not until the fee is paid. This is clerical work, and although the IRS shortage of clerks is probably just as severe as its shortage of lawyers, it would be less expensive.

Such a change would not be needed, though, if Rule 20 required that the fee be paid (or a waiver application filed and approved) before the petition is sent to IRS. The original filing date could still be used for purposes of the 90-day rule.

In a civil case, the party demanding money is usually the plaintiff, and the party not wanting to pay it is usually the defendant. A tight deadline for filing an answer prevents delay by the unwilling party. In Tax Court, it is the IRS that wants money, and therefore has greater urgency to move things along. Answers are required because, I suppose, that’s the way it has always been done.

While changing Rule 20, why not order that in all cases, the Clerk of the Court notify the petitioner that the case will not be docketed until payment is made, or waived, within 30 days? It should not require an order signed by a judge to remind petitioners that payment is required. Of course, if the Tax Court and Chief Counsel want statistics to back up claims of increasing workload, it is better to count cases that are easily and quickly dismissed. That’s part of what bureaucrats call “empire building.” It’s not the type of thing that enters the mind of Tax Court or IRS administrators, I’m sure.

 

Spotlight on IRS Guidance: A Look at Recent Blog Posts on How Agencies Communicate

Subtitle: And a Nudge to Look at the National Taxpayer Advocate Purple Book’s Proposal to Formalize the NTA in the Rulemaking Process

Last week I attended an outstanding presentation on the recently enacted tax legislation that Tal Tigay, Brian Volz, Cuyler Lovett, Brian Thaler, and Howard Gavin (all from PWC) gave for the Villanova Graduate Tax Program. The Power Point presentation  summarizes the new legislation’s main individual, corporate, and international provisions. The presentation included review of the legislative process that led to a number of substantive decisions in the legislation and covered how any technical changes legislation will not be able to rely on a simple majority in the Senate to pass, but instead will need 60 votes for cloture to avoid a likely filibuster.

There are  numerous areas where the legislation is in need of further clarification. My colleague Professor Ed Liva, Director of the Villanova Graduate Tax program, noted in his introductory remarks that in today’s charged environment in DC, it may be difficult to get the 60 votes in the Senate to get a technical corrections bill passed, putting even greater pressure on IRS and Treasury to get guidance out in the form of regulations or less formal guidance.

The pressing need for tax guidance in light of the legislation leads me to a fascinating series of posts from our blogging colleagues at Notice & Comment, which last week hosted an online symposium on how agencies communicate.

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As part of that series, there are three posts sweeping in IRS: one by Professor Andy Grewal called Involuntary Rulemaking that discusses IRS use of less formal guidance like Chief Counsel Advice, a post by Professors Susan Morse and Leigh Osofsky called How Agencies Communicate: Introduction and an Example, discussing how IRS sometimes fills the gap in regulations and less formal advice by using examples, and Interim-Final or Temporary Regulations: Playing Fast and Loose with the Rules (Sometimes), a post by Professor Kristin Hickman discussing Treasury’s use of temporary regulations. All of the posts are worth a careful read, as does Professor Bryan Camp’s outstanding post a couple of weeks ago in Tax Prof called Treasury Regulations and the APA that looks at the Tax Court’s opinion in SIH Partners v Commissioner involving an APA challenge to longstanding regulations under Section 965. (Bryan’s post is part of a series of posts he regularly places on Tax Prof called Lessons from the Tax Court; for tax procedure types the series is a must read).

Today I will focus on Professor Hickman’s Notice & Comment post. In her post she notes how Treasury has skirted pre-promulgation APA notice and comment requirements with what she believes is an excessive use of temporary regulations (an issue we have discussed on PT in the context of the Chamber of Commerce challenge to the temporary anti-inversion regs). Calling the practice short-sighted, Professor Hickman laments that “post-promulgation notice and comment are an inadequate substitute for pre-promulgation procedures that themselves are already a second-best proxy for the legislative process.” Adding to the concern, Professor Hickman notes that social science research suggests that once a decision has been made and Treasury is administering a regulation it is less likely to change gears and respond to comments.

Professor Hickman’s comments have broad appeal, especially among  administrative law scholars who might find Treasury’s use of temporary regulations (or interim final regulations in admin law speak) to be an outlier agency practice. The argument also finds a soft landing spot among those who may not like the IRS, for both legitimate and perhaps less legitimate reasons.

Perhaps because I come at the issue more from the perspective of thinking about agency rulemaking as it applies to individual taxpayers, and especially lower income taxpayers, when reading Professor Hickman’s post I thought of the recent National Taxpayer Advocate (NTA) Report and its Purple Book. The Purple Book is a concise summary of suggestions that the NTA believes will strengthen taxpayer rights and improve tax administration. One of the NTA’s recommendations is that Congress should amend Section 7805 to require that IRS/Treasury should be required to solicit comments from the NTA when it promulgates regulations. And for good measure, the NTA proposes that Treasury should have to address those comments in the preamble to the final rules.

This mirrors a proposal I made when I last wrote a longish article about Treasury’s rulemaking process, in the 2012 Florida Tax Review’s A New Paradigm for IRS Guidance: Ensuring Input and Enhancing Participation.  I made a similar suggestion to amend Section 7805, drawing on Section 7805(f), which requires Treasury to solicit input from the Small Business Administration when proposed rules were likely to have an impact on small business taxpayers. I noted that the absence of participation is particularly troubling for rules that have a likely impact on those the agency is less likely or able to consider in the first instance (such as low income taxpayers or other taxpayers without much voice), and that the tax system would be better if there were a more formalized role for proxies like the NTA that could ensure all voices and views are before the agency.

The NTA proposal is a bit more nuanced than mine, as in my article I pegged the requirement to Treasury promulgation of final regs, while the Purple Book proposal adds that the requirement should also apply when Treasury is contemplating issuing temporary regulations.

The increasing attention around IRS’s rulemakng practice is likely to be intensified given the pressing need for guidance following the passage of the sweeping tax legislation. While it seems unlikely that Congress can in a bipartisan way approach the issue from an agency best practices perspective, perhaps the tax legislation’s passage will nudge the IRS to reflect further not just on the public’s need for guidance but also think about the process it uses get that guidance to the public.

 

 

Designated (and other) Orders from January 15 through January 26

The past two weeks of designated orders have been light which allows us to combine two weeks of orders and get back on schedule. Samantha wrote up the first set of orders and William wrote up the second set. They continue to do a great job combing through Tax Court orders to allow us to see what the Tax Court thinks is important and to provide a discussion of cases that generally go unobserved in the tax press. Included in the designated orders is more fall out from Graev. Keith

Designated Orders 1/15 – 1/19

In stark contrast to my pre-holiday week post, during the week of January 15 the Tax Court only found four orders worthy of “designated” status and three of the four were very brief. I discuss two below, the other two were: 1) another motion for summary judgment is scheduled for a hearing so respondent can address how the Graev III decision may impact the motion and the case (here); and 2) an order granting a hearing on a motion to dismiss for lack of prosecution (here).

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Disallowing Extension is Not Abuse of Discretion

Docket No. 16456-17 L, John Lucian v. C.I.R. (Order here)

This designated order was the lengthiest of the group and is somewhat unique because the petitioner is represented by counsel, however, the mistake made by petitioner’s counsel is one pro se petitioners frequently make. Petitioner’s counsel did not provide the IRS with a financial statement, and thus, foreclosed the possibility of a collection alternative in a CDP hearing.

This order decides respondent’s motion for summary judgment to which petitioner’s counsel had an opportunity to respond, but did not.

Petitioner had requested an extension to file the tax returns for the years at issue, but never actually filed so the IRS prepared substitute for returns and assessed the balances, interest and penalties. The petitioner did not make any payments and eventually received a notice of intent to levy. Petitioner’s counsel requested a CDP hearing stating that petitioner could not pay the balance and that health issues had caused the petitioner to cash out his savings and retirement.

As usual in these types of cases, the settlement officer requested a collection financial statement. The settlement officer also requested a 2015 tax return and proof that petitioner had made estimated tax payments for the current year. Petitioner’s counsel filed the 2015 return but did not have a financial statement completed by the hearing date and requested more time which the settlement officer granted. The extended deadline date came, and petitioner’s counsel still did not have the financial statement completed, so he requested yet another extension. The settlement officer denied the request for a second extension and instead directed petitioner’s counsel to contact the collection unit once he had the information. Then the settlement officer issued a notice of determination sustaining the proposed levy.

It is not clear if the reason petitioner’s counsel was unable to comply with deadlines was due to the petitioner not supplying counsel with information in a timely manner, however, the Court reprimanded petitioner’s counsel by stating, “[Petitioner’s counsel], as an attorney, understands the importance of filing due dates and has a professional responsibility to exercise due diligence.”

The Court also pointed out that the Appeals Office will attempt to conduct a CDP hearing “as expeditiously as possible under the circumstances” but there is no time frame mandating when the Appeals Office must issue a notice of determination nor is there a time frame for when they must keep a case open despite not receiving requested information.

The Court finds the settlement officer did not abuse her discretion by not allowing a second extension for the financial statement, because she is not required to give extensions. The settlement officer was ultimately unable to determine an appropriate collection alternative due to the lack of information, which is also not an abuse of discretion, so the Court grants respondent’s motion for summary judgment.

No Jurisdiction Over Petitioner’s Requests

Docket No. 9661-16, Pankaj Mercia v. C.I.R. (Order here)

In this designated order the Court has already entered a stipulated decision, but the petitioner files a motion which the Court treats as a motion to revise pursuant to rule 162.

The Court denies the petitioner’s motion to revise. The case is a deficiency case concerning 2009, 2010, and 2011, but the petitioner’s motion requests relief for earlier years, later years and for collection-related issues. The petitioner also requested relief from credit reporting agencies. The Court does not have the authority to assist the petitioner with nearly all the issues he raised.

The one issue the Court may be able to address is petitioner’s allegation that the IRS assessed more tax than what the Court had determined he owed at the end of his Tax Court case. The Court can review claims of excessive interest, but that type of claim is not raised by the petitioner. The Court amount assessed is correct and consists of the amount decided in Tax Court plus the amount petitioner self-reported when he filed his tax return.

This is another good example of the Court trying to understand a pro se petitioner’s arguments and assist him through the process, while also being bound by subject matter jurisdiction.

Designated Orders: 1/22/18 to 1/26/18 by William Schmidt

In continuing the theme of light weeks for designated orders from the Tax Court, there were 2 orders this week.

The first, Charles Asong-Morfaw v. Commissioner, is a denial of petitioner’s motion for reconsideration of a denial of deductions for his vehicle. Since the Court did not believe he used it exclusively for business, he was only allowed to deduct mileage.

The second order, Cecil K. Kyei v. Commissioner, is from a Tax Court case filed in 2012 that has been delayed due to multiple stays from the petitioner’s bankruptcy proceedings. The parties came to a settlement, prompting the Court to enter a decision. After entry of the decision, the Court learned that the automatic stay of B.C. 362(a)(8) deprived the Court of jurisdiction. The existence of the automatic stay required the Court to vacate that decision. This situation happens occasionally when a taxpayer files a petition while the automatic stay is still in existence (which deprives the Tax Court of jurisdiction over the case) or, as here, files a bankruptcy case while the Tax Court case was pending (which stops the Tax Court from taking any action on the case until the stay is lifted.) Once the stay was lifted, the IRS filed a motion for entry of decision on January 12, 2018, but based it on that previously vacated decision. The judge did not realize the motion was based on the vacated decision and had ordered that arguments on the motion would be heard on January 22, 2018. The petitioner did not appear and respondent renewed his motion for entry of decision, with the judge stating he expected to grant the motion.

At the time of this current order, the judge noted the omission and the motion’s reliance on the alleged agreement entered into during the automatic stay. The judge then ordered that the motion is denied without prejudice unless there is a complete motion that addresses how the agreement was not void by virtue of the automatic stay. Each of the parties are to make a filing as to their recommendation for further proceedings no later than February 16.

Non-Designated Orders

Since there is a low showing of designated orders, I am going to turn to two non-designated orders brought to the attention of the Procedurally Taxing brain trust by Bob Kamman (the titles are his also).

  • Don’t Show Up For Trial; Win Graev Penalty Issue Anyway

Docket # 6993-17S, Clay Robert Kugler v. Commissioner (Order of Dismissal and Decision Here).

Petitioner did not appear for trial in Fresno on December 11, 2017. The Court directed the IRS to file a supplement to their motion to dismiss, showing that it is appropriate to impose a penalty under IRC section 6662(a) in that case. On January 18, 2018, the IRS filed their supplement, stating they concede the petitioner is not liable for the penalty. Petitioner failed to respond to respondent’s motion. The order decides that petitioner is not liable for the accuracy related penalty under IRC section 6662(a) for tax year 2014.

Despite the fact that the petitioner did not show up for trial and did not respond to respondent’s motion, the Tax Court’s focus on Graev led to the removal of a 6662(a) accuracy related penalty!

  • Oops!

Docket # [Redacted for Reasons Cited Below].

One Tax Court order last week had an attached copy of the petition, with the statement of taxpayer identification number included, potentially revealing social security numbers for the petitioners to others in the world with internet access. The Court immediately corrected the order when the problem was brought to their attention. Just like all of us the Court occasionally makes mistakes. Sometimes it is worth double checking the electronic footprint of your case to make sure what goes up is what you intended to go up. We mention this case to set the scene for the following practitioner’s tips.

Takeaways:

  • The statement of taxpayer identification number is regularly used by the Tax Court to keep a record of the social security number of the petitioner(s). It is not scanned and uploaded as part of the public file accessible by others. Quickly alert the Court in the unusual event this document is mistakenly scanned and made a part of the public record.
  • Before sending documents to the Court make sure to review the every document submitted to the Tax Court as part of the petition package. Carefully review the notice of deficiency or other IRS documents in order to redact the social security number of the petitioner(s).
  • Check all of the numbers on the IRS correspondence thoroughly before sending to Tax Court. Innocent-looking barcodes that have a sequence of numbers beneath them can contain a petitioner’s social security number. It is worth comparing the social security numbers of the petitioners to all of the number sequences in order to make sure the redacting is complete.
  • If your client files a bankruptcy petition while a Tax Court case is pending, alert the Court immediately. The Court will then issue an order placing the case in suspense and order the parties to file periodic status reports alerting the Court to the lifting of the stay so that the case could once again move forward.