When Does the Period Begin for Filing a CDP Request?

I previously blogged the case of Weiss v. Commissioner in which the taxpayer argued that the date on the Collection Due Process (CDP) Notice controlled the period for making a CDP request. Les provided an update on the case that included the oral argument and the briefs. The D.C. Circuit issued its opinion, an unpublished per curiam, on May 22, 2018, affirming the decision of the Tax Court but not without some criticism of both parties.

As a reminder about the case and to set up the language of the Circuit decision, the taxpayer owes a substantial amount of tax for many periods. Three bankruptcy cases suspended the statute of limitations on collection. Near the end of the statute of limitations, a revenue officer made a personal visit to the home of Mr. Weiss to deliver the CDP Notice. The RO dated the notice he expected to deliver during the visit; however, the RO did not go up to the door and deliver the notice because a dog of sufficient size and ferocity made him think better of personal delivery. Instead, the RO returned to his office and mailed the notice. He did not get around to mailing the notice until two days after the date on the notice.

Mr. Weiss filed a CDP request within 30 days of the date on which the notice was actually mailed but more than 30 days after the date on the notice. He argued that his request should be treated as a request for an equivalent hearing which does not suspend the statute of limitations on collection and the IRS argued that the actual date of mailing controls which meant that his request for a CDP hearing was timely and suspended the statute of limitations on collection. The consequence of a statute suspension was that a suit brought by the IRS was timely filed. The Tax Court agreed with the IRS that the date of actual mailing controls but had some sharp words for both parties.

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When requesting a CDP hearing or an equivalent hearing, the IRS asks that the taxpayer file a Form 12153. The form contemplates that if filed within 30 days of the CDP notice the taxpayer will receive a CDP hearing with full rights and if filed after that time but within one year of the CDP notice the taxpayer will receive an equivalent hearing. Although the form does not contemplate the option, it seems possible that a taxpayer could make a request for an equivalent hearing during the first 30 days by stating that request. Because of the suspension of the statute of limitations that accompanies a CDP hearing and because of the low likelihood of success in court on those cases, good reason exists to want an equivalent hearing in some circumstances.

Here, the taxpayer argues that he wanted an equivalent hearing and he thought he would get one based on the timing of his request. In my experience the IRS regularly puts dates on its letters, not just CDP notice letters, that do not correspond to the date on which the IRS mails the letter. Weiss tells you not to rely on the date of the letter as the meaningful date. For taxpayers seeking an equivalent hearing in this context, it would seem that a clear statement that an equivalent hearing is sought plus waiting for a couple of weeks after the 30 day period ends from the date on the CDP notice would be the best practice. The D.C. Circuit, while agreeing that the language of the statute dictates using the date of mailing rather than the date on the letter, had some pretty sharp words for the IRS and its practice of putting a date on the letter that was not the actual date of mailing:

Nonetheless, in spite of the unappealing proposition that we must side either with a taxpayer deliberately attempting to manipulate the Code to prevent paying his own taxes or a government agency that seems not to care whether it provides the citizenry with notice of their rights and liabilities, we must decide whether the date on the notice or the date of mailing governs. The taxpayer’s position has the advantage of common sense. But the government’s position has the insurmountable advantage of compliance with the language of the statute. That is to say, what the statute requires is “the notice . . . shall be . . . sent by certified or registered mail, return receipt requested . . . not less than thirty days before the date of the first levy. . . .” (emphasis added). In this case, the undisputed evidence is that the notice was “sent,” that is mailed, no more than thirty days before Weiss’s March 14 mailing. Therefore the statute was tolled.

We note in parting the court’s hope that few taxpayers will be as anxious as Weiss to manipulate the law in order to attempt to extinguish tax liabilities. We further hope that few agencies will be as careless with dates and especially with the rights of the citizens as the IRS in this case. Nonetheless, unattractive as the position of the IRS may be, it does comport with the language of the statute and the apparent meaning of the word “send.” We therefore affirm the decision of the Tax Court.

Congress could fix this problem, and others regarding CDP notices, by requiring the IRS to put a date on the letter by which the taxpayer should file the request and providing that the taxpayer could rely on that date or on the later date of actual mailing. There were enough problems with notices of deficiency that Congress addressed the situation in that context in 1998 at the same time it created the CDP process; however, it failed to give taxpayers seeking CDP relief the same benefit as those seeking relief in the deficiency context.

 

Designated Orders: 5/28 – 6/1/2018

Patrick Thomas brings us the designated order posts this week. He is writing separately on the Krug whistleblower case and we will publish his write up with the designated orders for a later week. The Webert case, discussed here, provides a good lesson on different types of assessments and covers material we have not previously addressed. Keith 

Memorial Day week is, apparently, a fairly inactive one at the Tax Court. Only three orders were designated this week, though all have something interesting. We’ll cover Judge Halpern’s order in a whistleblower case in an upcoming post that looks at a later designated order in that case.

Summary vs. Deficiency Assessments in Section 6213(a)

Docket No. 15981-17, Webert v. C.I.R. (Order Here) 

This order from Judge Panuthos very nicely distinguishes a summary assessment from a deficiency assessment—and the resulting ability of the Service to collect on the former, though not the latter, while a Tax Court proceeding is pending.

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The Service sent these joint taxpayers Notices of Deficiency for 2010 through 2015 proposing over $300,000 in tax and penalties, as the taxpayers hadn’t yet filed returns for those years. Two days later, the Service received tax returns for all of these years and filed them. These returns reported substantially less tax for each year and claimed a refund for a number of years. For 2010 through 2013, they’d owe about $11,000; for 2014 and 2015, they claimed a refund, which they elected to apply to the subsequent tax year.

They then filed a 2016 return, which claimed a $10,000 refund (owing largely to their election with respect to the 2015 tax year). In turn, they wanted this refund applied to 2017.

That didn’t happen. Instead, the Service first issued a math error notice for 2016, removing the $7,000 overpayment from 2015, leaving a $2,875 refund. Then, after processing the old returns, the Service took that refund and applied it to the 2010 and 2011 debts.

In the meantime, the Service sent a notice for 2010 through 2015, reducing the proposed assessments in the Notice of Deficiency (though the Court doesn’t say by how much). Presumably, these reductions exceeded the Weberts’ own calculations, as the examining agent “did not accept the figures on the returns as substantially correct.”

The Weberts filed a Tax Court petition, and before the Respondent answered, Mr. Webert filed a motion to restrain assessment or collection last September. This motion argued that the 2016 to 2010/2011 refund offset violated section 6213(a), which prohibits collection of a deficiency until after a Tax Court decision becomes final. The Court has since issued four substantive orders asking for additional detail from Respondent, ultimately resulting in this order denying Mr. Webert’s motion. (Mrs. Webert apparently retained counsel and clarified that she did not join in his motion).

Judge Panuthos denied the motion, principally because he found that the petitioners did not challenge the portion of the deficiency representing the taxes listed on their filed tax returns. He explained that, under Meyer v. Commissioner, 97 T.C. 555 (1991), the Service is authorized to assess and collect tax reported on original or amended tax returns, along with any additions to tax such as the failure to file penalty. Further, he notes that under section 6213(a) itself, the Court has jurisdiction to enjoin collection as to part of a deficiency only if the Tax Court petition disputes that part of the deficiency.

However, Judge Panthuos needs to distinguish the Powerstein case—a case he himself wrote more than 25 years ago! There, the petitioners filed amended returns for multiple years during a Tax Court proceeding that, under the logic of Meyers, would constitute summary assessments and were otherwise collectible by the Service during a Tax Court case. But Judge Panuthos held in Powerstein that these returns did not authorize the Service to assess or collect the tax they reported.

What’s the difference? In Powerstein, petitioners filed their return after their petition was filed, specifically referencing the ongoing Tax Court proceeding. Indeed, the returns were filed after Respondent’s answer proposing additional deficiencies and after petitioner’s reply thereto. The returns were also submitted at once—some claiming a large refund, others reporting tax, in what Judge Panuthos characterized as a “misguided attempt to generate a net refund for the years at issue.”

While Powerstein doesn’t explicitly state this principle, the core inquiry seems to be whether, based on all facts and circumstances, it was clear that the Powersteins were still disputing a portion of the deficiency the Service was seeking to assess or collect. That squares with the text of section 6213(a), which deprives the Court of jurisdiction otherwise. In other words, it doesn’t necessarily matter when the returns were filed, but that timing can be relevant to the inquiry.

So, I suspect that a return filed even during a Tax Court proceeding itself could still allow the Service, under Judge Panuthos’ logic in Powerstein and Webert, to assess and collect that debt where there’s no other indication that the taxpayer still dispute that portion of the liability. Conversely, any tax reported on a return filed before the Service issues a Notice of Deficiency would be summarily assessed and collectible.

The Weberts fall into a grayer area, given that the Service determined a deficiency, but they had not yet filed a Tax Court petition. Ultimately, however, they did not show either through the returns themselves, their petition, or through the many rounds of previous orders and responses any intent to challenge that portion of the purported deficiency. That being so, the assessment was properly made under section 6201(a) and the Tax Court lacks jurisdiction to enjoin collection under section 6213(a).

A Cautionary Tale of Stipulations, Admissions, and Delay

Docket No. 17507-14, Trilogy, Inc. & Subsidiaries v. C.I.R. (Order Here)

To conclude, a foray into relief from stipulations by Judge Gustafson. Before getting to this order—which grants Respondent’s motion to strike under Rule 91(e)—some context is necessary.

At issue is whether Petitioner can deduct legal fees for 2009 through 2011. An apparently key analysis underlying this claim is why Trilogy sought to increase its stock ownership percentage in another company, Selectica. The Supreme Court of Delaware affirmed a ruling that concluded Trilogy did so to “intentionally impair corporate assets, or else coerce Selectica into meeting certain business demands under the threat of such impairment,” rather than to conduct a hostile takeover. Versata Enterprises, Inc. v. Selectica, Inc., 5 A.3d 586 (Del. 2010).

In the Tax Court, Trilogy filed requests for admissions in November 2017 that asked Respondent to admit matters that were contrary to that 2010 holding. Nevertheless, Respondent admitted them in January 2018. The Court previously relieved Respondent of those admissions in an order on April 12.

In the meantime, Respondent and Petitioner signed a stipulation of facts on March 19, 2018, and filed it on March 26. This stipulation also contained the offending provisions and so Respondent filed its motion to strike under Rule 91(e)—on April 20, 2018. Anyone see a problem yet?

Judge Gustafson granted Respondent’s present motion, as under the standards for evaluating such a motion, Trilogy could not show unfair prejudice, given it knew about Respondent’s dispute as to this issue when the motion to withdraw the admissions was filed on March 20—and indeed, of the larger factual controversy since 2010.

Judge Gustafson, however, is not indulging IRS counsel’s delay and unnecessary motion practice. Looking at the dates above, IRS counsel clearly knew about this factual dispute when the motion to withdraw the admission was filed on March 20—and likely for some time before. Yet counsel signed the stipulation containing similar language one day prior (and filed it a few days after that). Worse still, counsel took a whole month to file a motion to correct the stipulations.

I certainly respect that both petitioner’s and respondent’s counsel bear significant time pressures in Tax Court litigation. In this case, however, the Court itself had to expend additional time and resources on this motion, which if the issue had been caught before the stipulations were filed, could have been avoided. Not wanting to deal with this again in this litigation, Judge Gustafson concludes: “we do not condone the Commissioner’s inefficient handling of this issue. Absent truly extraordinary circumstances, we do not expect to allow the Commissioner to make any further correction of his admissions or stipulations in this case.” Consider yourself warned.

 

Does the Mailbox Rule Survive a 2011 Reg. Under Section 7502?

We welcome back frequest guest blogger Carl Smith who discusses important forthcoming arguments regarding the mailbox rule.  This seemingly simple procedural provision gives rise to its fair share of litigation because it can make or break a case.  The cases that Carl flags are worth watching for those in need of the mailbox rule to preserve the timeliness of a submission.  Keith

 Before section 7502 was added to the Internal Revenue Code in 1954, courts determined the timeliness of various filings required under the Internal Revenue Code under a common law mailbox rule under which, if there was credible extrinsic evidence of timely mailing via the U.S. mails, then a document was presumed to have been delivered (despite denials of receipt), and if the mailing was made before the filing date, the mailing effected a timely filing. Of course, the use of certified or registered mail was excellent proof of timely mailing under the mailbox rule, but testimony about timely use of regular mail could be believed by the court, as well.

Over the years, some Circuits have faced the issue of whether the enactment of the statutory timely-mailing-is-timely-filing provision of section 7502 preempted or supplemented the mailbox rule. Compare Anderson v. United States, 966 F.2d 487 (9thCir. 1992)(mailbox rule still valid); Estate of Wood v. Commissioner, 909 F.2d 1155 (8th Cir. 1990)(same); withMiller v. United States, 784 F.2d 728 (6th Cir. 1986)(mailbox rule preempted by section 7502); Deutsch v. Commissioner, 599 F.2d 44 (2d Cir. 1979)(same). See alsoSorrentino v. Internal Revenue Service, 383 F.3d 1187 (10th Cir. 2004)(carving out a middle position).

In 2011, a Treasury Regulation under section 7502 was amended to specifically provide, in effect, that the common law mailbox rule no longer operated under the Code.  Since then, a few district courts have faced the question of the validity of this regulation.  Two courts have held the regulation valid under the deference rules of Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984).  McBrady v. United States, 167 F. Supp. 3d 1012, 1017 (D. Minn. 2016);Jacob v. United States, No. 15-10895, 2016 WL 6441280 at *2 (E.D. Mich. Nov. 1, 2016).  Another district court, in an unpublished opinion in a tax refund suit, followed Andersonand applied the mailbox rule, without discussing the regulation.  Baldwin v. United States, No. 2:15-CV-06004 (C.D. Cal. 2016).

While no court of appeal has yet ruled on the validity of the regulation, on August 31, 2018, the Ninth Circuit will hear oral argument both on the government’s appeal of Baldwinand the taxpayers’ allegedly late appeal from an unrelated Tax Court Collection Due Process (CDP) case.  Both cases squarely present the issue of whether the Ninth Circuit should hold that its Andersonopinion has been superseded by a Treasury regulation abolishing the mailbox rule – a regulation that must be considered valid under Chevrondeference.

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Baldwin

Baldwin is a tax refund suit.  There, the taxpayers reported a loss on their 2007 income tax return, filed on or before the extended due date of October 15, 2008.  They wished to file an amended return for 2005, carrying back the 2007 loss to generate a refund in 2005.  Under section 6511(d), this had to be done by filing the amended return within three years of the due date of the return generating the loss – i.e., by October 15, 2011.  The taxpayers, while living in Connecticut, had properly filed their original 2005 return with the Andover Service Center, but by 2011, original returns of Connecticut residents needed to be filed at the Kansas City Service Center.  In 2011,Reg. § 301.6402-2(a)(2)provided that “a claim for credit or refund must be filed with the service center serving the internal revenue district in which the tax was paid.” That would be Andover.  But, instructions to the 2010 Form 1040X (the one used by the taxpayers) told Connecticut taxpayers to file those forms with Kansas City, where original Forms 1040 for 2010 were now being filed.  (In 2015, the regulation was amended to provide that amended returns should be filed where the forms direct, not where the tax was paid.)

The taxpayers introduced testimony by one of their employees that the employee mailed the 2005 amended return by regular mail on June 21, 2011 from a Hartford Post Office to the Andover Service Center.  But, the IRS claimed it never received the Form 1040X prior to October 15, 2011, and that the filing was in the wrong Service Center.

The district court credited the testimony of mailing, citing the Anderson Ninth Circuit opinion that allowed for the common law mailbox rule to apply.  The Baldwincourt’s opinion does not mention the August 23, 2011 amendment to the regulation under section 7502 (quoted below) that purports to preempt use of the mailbox rule.  The court went on to find that, given the conflict between the regulation under section 6402 and the form instructions, a taxpayer was then “simply required . . . [to] mail his amended return in such a way that it would, as a matter of course, be delivered to the proper service center to handle the claim within the statutory period.”  Finding that this was done here, the court held the refund claim timely filed.  The Court also observed:  “The fact that the IRS routinely forwards incorrectly addressed refund claims as a matter of course also suggests that the IRS does not consider an address problem to be fatal to a refund claim.”

Then, the Baldwin court, over the government’s objections, found that a net operating loss had been incurred in 2007 and could be carried back to 2005, resulting in a refund due the taxpayers of $167,663.  To add insult to injury, the court also held that the government’s litigating position in the case, after a certain point, was not substantially justified, so the court imposed litigation costs payable to the taxpayers under section 7430 of $25,515.

The government appealed, arguing not only that there was no valid net operating loss in 2007 to be carried back (and so the litigation costs, as well, should not have been imposed), but that the district court lacked jurisdiction because the refund claim was not filed within the time set forth in section 6511(d).

Waltner

The Waltners are a couple who have been to the Tax Court may times, and even have been sanctioned under section 6673for making frivolous arguments (even their attorney has sometimes been sanctioned thereunder).  Their Tax Court case at Docket No. 8726-11L involved an appeal by them of multiple CDP notices of determination involving multiple years of income tax and frivolous return penalties under section 6702.  In an unpublished orderon April 21, 2015, Judge Foley granted the IRS’ motion for summary judgment with respect to some of the notices of determination, but not as to all notices.  The parties later reached a settlement on the other notices, which was embodied in a stipulated decision entered by the court on January 21, 2016.  Under section 7483, this started a 90-day window in which the Waltners had to file any notice of appeal.

An August 9, 2016 unpublished order of then-Chief Judge Marvel describes what happened next:

On August 4, 2016, petitioners electronically filed a Statement Letter to the Clerk of the U.S. Tax Court (With Ex.).  Among other things, in that Statement petitioners assert that: (1) on April 15, 2016, petitioners sent by regular U.S. mail to the Tax Court a notice of appeal in this case to the U.S. Court of Appeals for the Ninth Circuit; and (2) that notice of appeal (a) either may have been lost by the U.S. Postal Service, or (b) may have been lost after delivery to the Tax Court.  Attached to the Declaration of Sarah V. Waltner as Exhibit A, is a copy of Petitioners’ Notice of Appeal to the Court of Appeals for the Ninth Circuit.  Because this case is closed, petitioners’ Statement Letter to the Clerk of the U.S. Tax Court (With Ex.) may not be filed.

On August 15, 2016, the Waltners then admittedly filed a proper notice of appeal with the Tax Court.   But, the Ninth Circuit questioned whether the appeal was timely and sought briefing on this issue.  The DOJ argued that the appellate court lacked jurisdiction because the notice of appeal was untimely.

DOJ Argument

 Here are the links to the Baldwin Ninth Circuit appellant’s brief, appellees’ brief, and the reply brief.  Also, here are the links to the Waltner Ninth Circuit appellants’ brief, appellee’s brief, and the reply brief in the Ninth Circuit.  Although the two cases are not consolidated with each other, they have been scheduled to be argued one after the other before the Ninth Circuit in Pasadena on August 31, 2018.  And the DOJ briefs are clearly coordinated in their argument.

The DOJ arguments are predicated on the Treasury’s section 7502 regulation, Chevron, and Nat’l Cable & Telecomms. Ass’n v. Brand X Internet Servs., 545 U.S. 967 (2005).

As amended by 76 Fed. Reg. 52561-01 (Aug. 23, 2011), Reg. § 301.7502-1(e)(2)(i)provides, in relevant part:

Other than direct proof of actual delivery, proof of proper use of registered or certified mail, and proof of proper use of a duly designated [private delivery service] . . . are the exclusive means to establish prima facie evidence of delivery of a document to the agency, officer, or office with which the document is required to be filed.  No other evidence of a postmark or of mailing will be prima facie evidence of delivery or raise a presumption that the document was delivered.

The DOJ argues that section 7502, when enacted (and still today) is ambiguous as to whether it preempts the common law mailbox rule.  The DOJ contends that there is thus a gap to fill, which, under Chevron, can be filled by a reasonable regulation. The Circuit split over whether the mailbox rule has been preempted is evidence of two reasonable interpretations of section 7502.  The regulation is valid because it chooses one of those two reasonable interpretations.

In Brand X, the Supreme Court held that Chevron deference must even apply to a regulation that takes a position that has been rejected by a court, so long as the court opinion did not state that it found the statute unambiguous.  If the statute was unambiguous, then there can be no gap under ChevronStep One to fill.  PT readers may remember the extensive discussion of Brand X in the section 6501(e) Treasury Regulation case of United States v. Home Concrete & Supply, LLC, 566 U.S. 478 (2012).

The DOJ argues that Anderson did not describe its interpretation of section 7502 to still allow the mailbox rule as one required by an unambiguous statute.  Accordingly, under Brand X, the 2011 amendment to the section 7502 regulation is entitled to Chevron deference, in spite of Anderson.

We’ll see in Baldwin and Waltner if the government can effectively overrule Anderson by its regulation.

Observations

I will not needlessly extend this post by explaining my beef with the DOJ’s other arguments that compliance with the filing deadlines for refund claims under section 6511 and for notices of appeal under section 7483 are “jurisdictional” conditions of the courts.  I don’t think that either deadline is jurisdictional under current Supreme Court case law that makes filing deadlines now only rarely jurisdictional.  And, sadly, none of the taxpayers in these two cases made an argument that the filing deadlines are not jurisdictional – probably because it makes no difference in the outcome of their cases whether the filing deadlines are jurisdictional or not.  The taxpayers are not arguing for equitable tolling, just the mailbox rule (which is not an equitable doctrine that would be precluded by a jurisdictional deadline).  I only regret that I did not learn of either of these two cases earlier, when I could have filed amicus briefs raising the issue of whether the two filings deadlines are really jurisdictional.  At least the courts, then, might have noted that it is a debatable question whether these two filing deadlines are jurisdictional.

Recent Tax Court Case Highlights CDP Reach and Challenges With Collection Potential (and a little Graev too)

I read with interest Gallagher v Commissioner, a memorandum opinion from earlier this month.  The case does not break new ground, but it highlights some interesting collection issues and also touches on the far-reaching Graev issue.

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First the facts, somewhat simplified.  The taxpayer was the sole shareholder of a corporation whose line of business was home building and residential construction.

The business ran into hard times and was delinquent on six quarters of employment taxes from the years 2010 and 2011. IRS assessed about $800,000 in trust fund recovery penalties under Section 6672 on the sole shareholder after it determined he was a responsible person who willfully failed to pay IRS. IRS issued two notices of intent to levy including rights to a CDP hearing. The taxpayer timely requested a hearing, and the request stated that he sought a collection alternative.

After the taxpayer submitted the request for a CDP hearing the matter was assigned to a settlement officer (SO). There was some back and forth between the SO and the taxpayer, and the taxpayer submitted an offer in compromise based on doubt as to collectability for $56,000 to be paid over 24 months. After he submitted the offer, IRS sent a proposed assessment for additional TFRP for some quarters in the years 2012 and 2014.

The SO referred the offer to an offer specialist. Here is where things get sort of interesting (or at least why I think the case merits a post). The specialist initially determined that the taxpayer’s reasonable collection potential (RCP) was over $847,000. That meant that the specialist proposed to reject the offer, as in most cases an offer based on doubt as to collectability must at least equal a taxpayer’s RCP, a figure which generally reflects a taxpayer’s equity in assets and share of future household income.

Before rejecting the offer, the specialist allowed the taxpayer to respond to its computation of RCP. The taxpayer submitted additional financial information and disputed the specialist’s computation of the taxpayer’s equity in assets that he either owned or co-owned.  That information prompted the offer specialist to revise downward the RCP computation to about $231,000 after the specialist took into account the spouse’s interest in the assets that the taxpayer co-owned and also considered the impact of the spouse on his appropriate share of household income.

Following the specialist’s revised computations, the taxpayer submitted another offer, this time for about $105,000. Because it was still below the RCP (at least as the specialist saw it), she rejected the follow up offer, which led the IRS to issue a notice of determination sustaining the proposed levies and then to the taxpayer timely petitioning the Tax Court claiming that IRS abused it discretion in rejecting his offer and sustaining the proposed levies.

So what is so interesting about this? It is not unusual for taxpayers to run up assessments and to then disagree with offer reviewers on what is an appropriate offer and to differ on RCP. RCP calculations are on the surface pretty straightforward but in many cases, especially with nonliable spouses, illiquid assets and shared household expenses (as here) that calculation can be complex and lead to some differences in views.

In addition, the opinion’s framing of the limited role that Tax Court plays in CDP cases that are premised primarily on challenges to a collection alternative warrants some discussion. The opinion notes that the Tax Court’s function in these cases is not to “independently assess the reasonableness of the taxpayer’s proposed offer”; instead, it looks to see if the “decision to reject his offer was arbitrary, capricious, or without sound basis in fact or law.” That approach does not completely insulate the IRS review of the offer (or other alternative) from court scrutiny, and in these cases it generally means that the court will consider whether the IRS properly applied the IRM to the facts at hand. While that is limited and does not give the court the power to compel acceptance of a collection alternative, it does allow the court to ensure that the IRS’s rejection stems from a proper application of the IRM provisions in light of the facts that are in the record and can result in a remand if the court finds the IRS amiss in its approach (though I note as to whether the taxpayer can supplement the record at trial is an issue that has generated litigation and differing views between the Tax Court and some other circuits).

That led the court to directly address one of the main contentions that the taxpayer made, namely that the specialist grossly overstated his RCP due to what the taxpayer claimed was an error in assigning value to his share of an LLC that owned rental properties.  This triggers consideration of whether it is appropriate to assign a value for RCP purposes to an asset that may in fact also be used to produce income when the future income from that asset is also part of the RCP. The IRM addresses this potential double dipping issue but the Gallagher opinion sidesteps application of those provisions because the rental properties did not in fact produce income, and the offer specialist rejection of the offer, and thus the notice of determination sustaining the proposed levies, was not dependent on any income calculations stemming from the rental properties.

The other collection issue worth noting is a jurisdictional issue. During the time the taxpayer was negotiating with the offer specialist, IRS proposed to assess additional TFRP for quarters from different years that were not part of the notice of intent to levy and subsequent CDP request:

Those liabilities [the TFRP assessments from quarters that were not part of the CDP request] were not properly before the Appeals Office because the IRS had not yet sent petitioner a collection notice advising him of his hearing rights for those periods.  In any event, the IRS had not issued petitioner, at the time he filed his petition, a notice of determination for 2012 or 2014. We thus lack jurisdiction to consider them. [citations omitted]

Yet the taxpayer in amending his offer included those non CDP years in the offer. The Gallagher opinion in footnote 5 discusses the ability of the court to implicitly consider those non CDP years in the proceeding:

We do have jurisdiction to review an SO’s rejection of an OIC that encompasses liabilities for both CDP years and non-CDP years. See, e.g., Sullivan v. Commissioner, T.C. Memo. 2009-4. Indeed, that is precisely the situation here: the SO considered petitioner’s TFRP liabilities for 2012 and 2014, as well as his TFRP liabilities (exceeding $800,000) for the 2010 and 2011 CDP years, in evalu- ating his global OIC of $104,478. We clearly have jurisdiction to consider (and in the text we do consider) whether the SO abused his discretion in rejecting that offer. What we lack jurisdiction to do is to consider any challenge to petitioner’s underlying tax liabilities for the non-CDP years.

This is a subtle point and one that practitioners should note if in fact liabilities arise in periods subsequent to the original collection action that generated a collection notice and a consideration of a collection alternative in a CDP case. Practitioners should sweep in those other periods to the collection alternative within the CDP process; while those periods are not technically part of the Tax Court’s jurisdiction they implicitly creep in, especially in the context of an OIC which could have, if accepted, cleaned the slate.

The final issue worth noting is the opinion’s discussion of Graev and the Section 6751(b) issue. While acknowledging that it is not clear that the TFRP is a penalty for purposes of the Section 6751(b) supervisory approval rule, the opinion notes that in any event the procedures in this case satisfied that requirement, discussing and referring to the Tax Court’s Blackburn opinion that Caleb Smith discussed in his designated orders post earlier this month:

We found no need to decide that question because the record included a Form 4183 reflecting supervisory approval of the TFRPs in question. We determined that the Form 4183 was suffic- ient to enable the SO to verify that the requirements of section 6751(b)(1) had been met with respect to the TFRPs, assuming the IRS had to meet those requirements in the first place.

Here, respondent submitted a declaration that attached a Form 4183 showing that the TFRPs assessed against petitioner had been approved in writing by …. the [revenue officer’s] immediate supervisor…. In Blackburn, we held that an actual signature is not required; the form need only show that the TFRPs were approved by the RO’s supervisor. Accordingly, we find there to be a sufficient record of prior approval of the TFRPs in question.

Supreme Court Holds that SEC ALJs are “Officers” Who Need Constitutional Appointment

Frequent guest blogger Carlton Smith brings us an important development in Appointments Clause litigation that could have implications for employees of the IRS Office of Appeals. Christine

In Lucia v. Securities and Exchange Commission (June 21, 2018), in a 6-3 ruling, the Supreme Court held that Securities and Exchange Commission (SEC) Administrative Law Judges (ALJs) are “Officers of the United States” under the Constitution’s Appointments Clause (Art. II, Sec. 2, cl. 2), so need to be properly appointed by the SEC, not merely hired by SEC staff. In an opinion authored by Justice Kagan that was joined by all five Conservative Justices on the Court, the Court said that its holding was simply one required as a result of the holding in Freytag v. Commissioner, 561 U.S. 868 (1991), that Tax Court Special Trial Judges (STJs) are constitutional officers who need to be appointed pursuant to the Appointments Clause.

Since September 2015, I have been doing posts on the litigation leading up to the Lucia ruling (in chronological order, here, here, here, here, here, here, and here). In those posts, I have pointed out that the litigation leading to Lucia might have a significant impact on the ALJs that the Treasury uses to conduct Circular 230 violation hearings. Although I am not sure, I suspect that only Treasury staff, and not the Secretary of the Treasury (or any other Secretary) has hired those ALJs and that none has been appointed. I also noted that a ruling holding that SEC ALJs need to be appointed may cause the revisiting of the Tax Court’s holding in Tucker v. Commissioner, 135 T.C. 114 (2010), affd. on different reasoning, 676 F.3d 1129 (D.C. Cir. 2012), that Appeals Settlement Officers and their Team Managers conducting Collection Due Process (CDP) hearings need not be appointed.

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In Freytag, the Court held that STJs are “Officers of the United States” who need to be appointed and that the Tax Court Chief Judge was one of “the Courts of Law” to which Congress could delegate this power, since the STJs were “inferior Officers” under the Clause. In making its ruling in Freytag, the Court noted numerous powers of STJs that were similar to those of district court judges (who everyone conceded were officers under the Clause).

However, the Court created confusion in Freytag by also noting that Tax Court judges could enter final decisions in certain Tax Court cases, without review by a regular Tax Court judge. See section 7443A(c). This led to a split by lower courts as to whether SEC ALJs had to be appointed, since the SEC ALJs lacked power to make final decisions. An SEC ALJ’s ruling becomes final only if the SEC declines to hear an appeal from the ruling. In the Lucia case, the D.C. Circuit had followed its ruling in Landry v. FDIC, 204 F.3d 1125 (D.C. Cir. 2000), concluding that Freytag held that STJs needed to be appointed only because they entered final decisions in some cases. In Lucia, the Supreme Court (in footnote 4) called the finality mention in Freytag an “alternative holding”, with the primary holding being that STJs needed to be appointed based on their other powers. The Lucia footnote states that Freytag’s “primary analysis explicitly rejects JUSTICE SOTOMAYOR’s theory that final decision making authority is a sine qua non of officer status.” Thus, the Lucia Court rejected Landry’s interpretation of Freytag.

This point is important, since in its opinion in Tucker, the Tax Court held that Appeals Settlement Officers and their Team Managers conducting CDP hearings need not be appointed because they do not (in the Tax Court’s view) have the power to enter final decisions, as required by Landry’s interpretation of the holding of Freytag. The D.C. Circuit in Tucker, however, disagreed with the Tax Court and stated that the IRS personnel had effective final ruling authority in CDP. Instead, the D.C. Circuit in Tucker held that the Appeals personnel need not be appointed because the collection matters they ruled on were not important enough to need a constitutional officer and the tax liability determinations that they made were so restricted by Counsel’s supervisory authority that little discretion was exercised by Appeals personnel in CDP.

In Buckley v. Valeo, 424 U.S. 1 (1976) (per curiam) (involving the Federal Election Commission), the Supreme Court had held that an “Officer” under the Appointments Clause is one who exercises “significant authority” on behalf of the United States. The Lucia Court acknowledged that the “significant authority” standard provides little concrete guidance for how to decide other cases, and the Court did not want to provide more general guidance in Lucia as to what “significant authority” encompassed.

Instead, the Court in Lucia held that the SEC ALJs were so like Tax Court STJs that the holding of Freytag inevitably extended to make SEC ALJs Officers under the Clause. The Court in Lucia noted four powers of the SEC ALJs that were similar to those of Tax Court STJs: (1) taking testimony, (2) conducting trials, (3) ruling on the admissibility of evidence, and (4) having the power to enforce compliance with discovery orders. The Court held that these four powers alone were enough to make the ALJs constitutional officers, without deciding whether each of those four powers was necessary to a determination of officer status. The Court acknowledged that there were some differences between the two types of adjudicators (e.g., the STJs can enforce their discovery orders by contempt, whereas the ALJs can enforce those orders only by lesser means – such as barring the person from the hearing), but did not find these differences of constitutional significance.

This led to the question of remedy: The SEC has since appointed the various ALJs (including the one who decided Lucia’s case) and has purported to ratify all prior rulings entered by ALJs before they were appointed. But, the Court held that a person who brings a successful Appointments Clause challenge is entitled to a remedy, which, it in the past, the Court had held was a trial before an appointed officer. The Lucia Court wanted to make the remedy here one that encourages the brining of successful Appointments Clause challenges. Accordingly, the Court expanded on its prior case law and ordered a new hearing by either a now-appointed ALJ or the SEC itself, but not by the ALJ who originally decided Lucia’s case. The Court thought that the ALJ who decided Lucia’s case, whose underlying rulings had never yet been even criticized in a judicial opinion, would be too likely to simply reissue his opinion unchanged.

Justices Thomas and Gorsuch had joined the majority opinion, but Justice Thomas wrote a concurrence, joined in by Justice Gorsuch, in which he rejected Buckley’s significant authority test. He would have a less restrictive test: Anyone who held a continuing position in the government should be an officer, since that would have been the understanding of the drafters of the Constitution in 1787 as to what they meant by “Officer”.

Justice Breyer wrote a partially dissenting opinion in which he refused to decide the constitutional Appointment Clause issue. He thought that the language of the Administrative Procedure Act that authorized the SEC to appoint ALJs was simply enough to decide the case and that the SEC had not complied with its statutory mandate to appoint, rather than have the staff hire, the ALJs. Justice Breyer felt he could not decide the Appointments Clause issue without also deciding whether, in the event appointment was required, there would be another constitutional issue created concerning the limited for cause removal powers of those ALJs that the SEC possessed. The SG, when he changed the government’s Lucia position to argue that the SEC ALJs need to be appointed, had asked the Court to also decide whether a removal power issue was created if the ALJs needed appointment. The Court explicitly declined to write on removal power issues that might have been created by its ruling. The Court desired that lower courts consider any removal power issue before the Supreme Court is asked to consider it.

It is not clear to me that the Appointments Clause powers need to mesh constitutionally with removal power issues. However, in Kuretski v. Commissioner, 755 F.3d 529 (D.C. Cir. 2014), as counsel for the taxpayers, I had argued that another holding of Freytag – that the Tax Court exercised a portion of the Judicial Power of the United States – means that a for cause removal power applicable to regular Tax Court judges at section 7443(f) violates the separation of powers doctrine and so should be eliminated. There is clearly a reason for harmonizing the appointment and removal power questions, but it is not a foregone conclusion that anyone who exercises a portion of the Judicial Power of the United States, and so who needs to be appointed, cannot be removed by the President under a for cause removal power.

Justice Breyer also disagreed with the majority’s holding that the remedy should be a rehearing by an appointed ALJ or the SEC, but not by the ALJ who ruled after the original hearing. He thought that the remedy chosen by the Court was excessive. A rehearing before any appointed officer, he thought, would be enough of a remedy.

Justice Sotomayor wrote a dissent in which she was joined by Justice Ginsburg. Those two Justices also joined that part of Justice Breyer’s dissent that descried the remedy as excessive. But, Justice Sotomayor, in her dissent, also argued that the ability to render a final decision was a sine qua non of constitutional officer status under her reading of Freytag (which matched that of the D.C. Circuit both in Landry and Lucia). She wrote:

In Freytag, the Court suggested that the Tax Court’s special trial judges (STJs) acted as constitutional officers even in cases where they could not enter final, binding decisions. In such cases, the Court noted, the STJs pre­sided over adversarial proceedings in which they exercised “significant discretion” with respect to “important func­tion,” such as ruling on the admissibility of evidence and hearing and examining witnesses. 501 U. S., at 881–882. That part of the opinion, however, was unnecessary to the result. The Court went on to conclude that even if the STJs’ duties in such cases were “not as significant as [the Court] found them to be,” its conclusion “would be un­changed.” Id., at 882. The Court noted that STJs could enter final decisions in certain types of cases, and that the Government had conceded that the STJs acted as officers with respect to those proceedings. Ibid. Because STJs could not be “officers for purposes of some of their duties . . . , but mere employees with respect to other[s],the Court held they were officers in all respects. Ibid. Freytag is, therefore, consistent with a rule that a prerequisite to officer status is the authority, in at least some instances, to issue final decisions that bind the Government or third parties.

As noted above, though, the Lucia majority rejected this interpretation of Freytag.

As to the direct impact of Lucia on pending Tax Court cases, in my last post on Lucia on January 19, 2018, I noted that Florida attorney Joe DiRuzzo is again raising the Tucker issue (i.e., whether CDP Appeals personnel need to be appointed) in multiple Tax Court cases that would be appealable to other Circuits. Rulings on this issue have in essence been postponed (though not officially) pending the ruling of the Supreme Court in Lucia. Those rulings are now ready for the Tax Court to make.

I don’t know if there are any Circular 230 adjudications going on, so I can’t tell whether or how the Lucia opinion will affect current Circular 230 matters. I am not sure that future Circular 230 sanctions litigants will want to raise issues concerning the ALJs and Appointments Clause. And, of course, it is too soon for the Treasury to have decided whether to change its procedures and appoint its ALJs.

IRS Office of Chief Counsel Gives Direction on Graev Compliance in Litigation

The IRS issued Chief Counsel Notice 2018-006 advising its attorneys how to address compliance with section 6751’s requirement for supervisory approval of penalties in light of the Tax Court’s decision in Graev III. The notice covers a lot of ground in a short number of pages. It reviews several different ways an IRS attorney might encounter Graev issues in litigation and instructs the attorney how to proceed in each situation. I will not review each issue covered by the notice; I encourage readers to read it in full. This blog post discusses two of the items mentioned in Notice 2018-006: the application of section 6751 to the trust fund recovery penalty and the exception in subsection 6751(b)(2) for penalties automatically calculated through electronic means. 

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IRS asserts supervisory approval is not required before imposition of a Trust Fund Recovery Penalty 

Section 6751(b) begins, “No penalty under this title shall be assessed unless…” In a brief paragraph, Chief Counsel Notice 2018-006 directs IRS attorneys to argue that the trust fund recovery penalty (TFRP) under section 6672 is a tax, rather than a penalty. Therefore, the argument goes, supervisory approval for assertion of a TFRP is not required by section 6751. The Notice also flags this issue generally, noting “there may be other taxes that taxpayers will contend are penalties.”  

In support of the IRS position the Notice cites United States v. Rozbruch, 28 F. Supp. 3d 256 (S.D.N.Y. 2014), aff’d on other grounds, 621 Fed. Appx. 77 (2d Cir. 2015). In Rozbruch the government had filed suit under section 7403 to reduce its tax assessments to judgment and to foreclose on property owned by the Rozbruchs. The taxpayers defended in part by arguing that the TFRP assessments were invalid for failure to comply with section 6751’s supervisory approval requirement.  

The Rozbruchs pointed out that section 6672 explicitly calls the TFRP a penalty. Penalties may not be imposed on top of the TFRP. (I have not read the case documents apart from the court’s decision; the taxpayers may have made additional points not mentioned in the decision.) On the other side, the government pointed out that individuals who make payments towards a TFRP are really paying the underlying trust fund taxes; liability for a TFRP is co-extensive with the employment taxes that remain to be paid over. The district court in Rozbruch agreed with the government, citing an Eighth Circuit decision and several Second Circuit district court cases finding the TFRP to be a tax.  

However, the government’s position is not yet established in the Tax Court. The court declined to decide the issue in its April 2018 decision in the CDP case of Blackburn v. Commissioner, 150 T.C. No. 9. (The case was first noted on PT in a Designated Order post by Professor Caleb Smith.) In Blackburn Judge Goeke found that it was unnecessary to decide whether supervisory approval is required for TFRPs because the IRS had satisfied the requirement in any event. The IRS had a Form 4183, Recommendation re: Trust Fund Recovery Penalty Assessment, bearing the approval of the recommending Revenue Officer’s immediate supervisor, the Acting Group Manager. This was enough to support the Settlement Officer’s finding under section 6330(c)(1) that IRS had complied with administrative procedures in making the assessment. Judge Goeke rejected the taxpayer’s argument that the Settlement Officer should have looked beyond the form to investigate whether the supervisor’s review was “meaningful.” As the opinion points out, Tax Court “caselaw acknowledges that reliance upon standard administrative records is acceptable to verify assessments.” Blackburn, slip op. at 10 (citing Nestor v. Commissioner, 118 T.C. 162, 266 (2002); Davis v. Commissioner, 115 T.C. 35, 41 (2000)).  

Judge Holmes also raised the issue in a TFRP CDP case, Humiston v. CommissionerDocket No. 25787-16 L. In Humiston, no Form 4183 was mentioned in the Settlement Officer’s determination or apparent from the record before the court. In a May 24 order denying the IRS’s motion for summary judgment, Judge Holmes notes that the TFRPs “are called penalties under the Code,” and determines that the novelty of the legal issue weighs in favor of permitting petitioner to raise it at calendar call. I do not know whether petitioner did so, but he now has counsel so perhaps the case will result in a decision on the issue. It appears that case would be appealable to the 2d Circuit Court of Appeals, which of course started all this with Chai 

Next up, Judge Lauber may have the intersection of 6751 and the TFRP before him in the Florida case of Kane v. CommissionerDocket No. 10988-17 L (hat tip: Lew Taishoff). Under a recent order, the IRS has until June 28 to file “a Form 4183 or any other relevant documentation concerning supervisory approval of the TFRPs in question.”  

The way a provision is titled or described does not trump its function for constitutional purposes, but it does provide evidence of Congressional intent for purposes of statutory construction. See National Federation of Independent Business v. Sibelius, 567 U.S. 519, 543-546, slip op. at 12-13 (2012) (finding the individual shared responsibility provision a penalty for purposes of the Anti-Injunction Act but a tax for purposes of constitutional validity). Taxpayers arguing this issue before the Tax Court will need to address both form and function of the TFRP.  

Uncertainty continues around penalties automatically calculated through electronic means 

Readers of this blog know that penalties which are “automatically calculated through electronic means” do not require supervisory approval under section 6751(b)(2). For background, see my previous post on the issue. Chief Counsel Notice 2018-006 largely repeats the position taken in prior IRS guidance (linked in the prior post). The 2018 Notice says, in part:  

Penalties appearing in a statutory notice of deficiency as a result of programs such as the Automated Underreporter (AUR) and the Combined Annual Wage Reporting Automated programs will fall within the exception for penalties automatically calculated through electronic means if no one submits any response to the notice, such as a CP2000, proposing a penalty. However, if the taxpayer submits a response, written or otherwise, that challenges a proposed penalty, or the amount of tax to which a proposed penalty is attributable, then the immediate supervisor of the Service employee considering the response should provide written supervisory approval prior to the issuance of any statutory notice of deficiency that includes the penalty. A penalty is no longer automated once a Service employee makes an independent determination to pursue a penalty or to pursue adjustments to tax to which a penalty is attributable.  

This is in line with prior IRS guidance but it does not do a whole lot to clear up unresolved issues. For one thing, the notice does not mention correspondence examinations. It is unclear whether we should read anything into that. Perhaps the IRS is not ready to publicly take a consistent position on correspondence examinations, but it is a shame the issue was not explicitly addressed in Notice 2018-006. The Notice also fails to clarify the issue of timing, and when precisely a taxpayer’s response arrives too late take a penalty out of section 6751(b)(2)’s ambit.   

The prior post on section 6751(b)(2) examined a nondesignated order in Triggs v. Commissioner. Triggs involves a correspondence examination where the taxpayer did not respond during the audit. The IRS argued that the correspondence exam function had automatically asserted the penalties according to its computer programming without the independent intervention of any human IRS employee, and therefore no supervisory approval was required for either the negligence penalty or the substantial understatement penalty. Although penalty assertion in correspondence examinations may be fully automated in practice, several IRM provisions appear to conflict with this view and require examiners to exercise responsibility for penalty assertions. On April 5, 2018 Judge Leyden ordered further submissions to address these IRM provisions.  

The Triggs case is still pending. The IRS filed its supplement in response to the April 5 order, and subsequently Judge Leyden gave the petitioner until June 29 to respond. The court also provided him with a list of local low-income taxpayer clinics. Unfortunately, to date Mr. Triggs remains pro se. 

IRM provisions also muddy the waters for Judge Lauber in the case of Bowse v. CommissionerBowse has a fact pattern similar to Triggs but in it arises from the AUR program rather than correspondence exam. It also deals solely with the substantial understatement penalty rather than both negligence and understatement. Like Triggs, the Bowse case was brought to my attention by Carl Smith.  

In Bowse, Judge Lauber highlights the timing problems that muddle the application of section 6751(b)(2) to a deficiency case in the Tax Court. Remember, it is the “initial determination” of a penalty “assessment” that requires supervisory approval under section 6751. Professor Bryan Camp has an excellent post explaining why the statutory language does not make much sense and inevitably causes courts to engage in interpretive gymnastics. We can clearly see this in Bowse 

Mr. Bowse and his wife Ms. Vaes were picked up by the AUR program, but they did not respond to the IRS’s letters until after the AUR program issued them a statutory notice of deficiency (SNOD). The SNOD included a 20% substantial understatement penalty. At that point, the taxpayers submitted an amended return, and in response the Office of Appeals reduced the proposed deficiency and understatement penalty amounts. The penalty was still 20% of the proposed deficiency; it was reduced in proportion to the deficiency amount. The taxpayer then appealed the SNOD to the Tax Court.  

On those facts, what constitutes the “initial determination” of the penalty “assessment”? Was it the automated proposal by AUR in the SNOD? Or did the individualized review by Appeals take the case out of 6751(b)(2) territory? Does it matter that the proposed penalty amount changed? To answer this question, one needs to consider both what “initial determination” means and what qualifies as the “assessment” under section 6751.  

As Professor Camp explains, in Graev III the Tax Court interpreted the word “assessment” to essentially mean “penalty assertion.” And so Graev III examines whether certain IRS employees had “authority to make the initial determination of a penalty,” among other issues. 149 T.C. No. 23, slip op. at 17. But before Graev III the word “assessment” in section 6751 was taken at its ordinary meaning in the tax context – the official recording of a liability. Because of this, pre-Graev IRS guidance and IRMs are not wholly consistent with the IRS’s current litigating position. The IRMs in particular raise questions for Judge Lauber, as they did for Judge Leyden in Triggs. 

In Bowse, the IRS argued that no supervisory approval was required because the AUR program had automatically proposed the penalty in its SNOD without any human employee review. However, Judge Lauber is not sure it’s that simple and requests further briefing from the parties on several points.  

In his order Judge Lauber quotes several IRM sections, including this one: 

‘…However, if a taxpayer responds either to the initial letter proposing a penalty or to the notice of deficiency that the program automatically issues, an IRS employee will have to consider the taxpayer’s response. Therefore, the IRS employee will have to make an independent determination as to whether the response provides a basis upon which the taxpayer may avoid the penalty. The employee’s independent determination of whether the penalty is appropriate means the penalty is not automatically calculated through electronic means. Accordingly, IRC 6751(b)(1) requires managerial written approval of an employee’s determination to assert the penalty.’ IRM pt. 20.1.5.1.6(9) (Jan. 24, 2012); see also IRM pt. 4.19.3.2.1.4(2) and (3) (Sept. 1, 2012).  

(Emphasis added.) The IRM clearly suggests that the taxpayer can escape automatic penalty calculation by responding to the AUR program’s SNOD. Judge Lauber asks for briefing to address the following five questions: 

(1) By filing a Form 1040X for 2014 after receiving the notice of deficiency, did petitioners “respond * * * to the notice of deficiency that the [AUR] program automatically issue[d],” within the meaning of the IRM provision quoted above?

(2) If so, after considering petitioners’ response, did an IRS employee “make an independent determination as to whether the response provides a basis upon which the taxpayer may avoid the penalty,” within the meaning of the IRM provision quoted above?

(3) By accepting petitioners’ amended return and reducing the deficiency and penalty amounts, did the IRS made a new “initial determination” of the assessment of the penalty?

(4) If so, was that new initial determination of the penalty “automatically calculated through electronic means”?

(5) If not, what IRS officer made the “initial determination” of the reduced penalty, and who was the immediate supervisor of that individual? 

This order is interesting coming from Judge Lauber, whose concurrence in Graev III suggests a straightforward approach. He describes the majority opinion as “requiring supervisory approval the first time an IRS official introduces the penalty into the conversation.” Graev III, Lauber, J., concurring, slip op. at 27. That reading of “initial determination” appears narrower than the IRM’s, since under the IRM a taxpayer’s response to a SNOD can take a penalty out of section 6751(b)(2)’s ambit.  

I suspect the conflict between the IRS’s litigating position and the IRM is temporary. The IRMs cited by Judges Lauber and Leyden (like the 2002 Service Center Advice) reflect the IRS’s pre-Graev III understanding of what “assessment” means in section 6751. If assessment meant the official recording of the liability, then naturally a taxpayer’s response after an AUR SNOD but prior to assessment could take the final penalty decision out of the computer’s hands. Now that penalty “assessment” means penalty “proposal,” though, I would expect to see the IRMs on section 6751(b)(2) changing to remove references to taxpayers responding to the SNOD. It is somewhat puzzling, however, that Chief Counsel Notice 2018-006 does not explicitly mention this change or clarify whether, in the IRS’s view, the SNOD is the cut-off point for taxpayers to respond to an automated penalty proposal in order to trigger supervisory review.  

 

Does IRS Bear the Responsibility to Affirmatively Obtain a Ruling from the Bankruptcy Court before Pursuing Collection after Discharge?

We welcome back guest blogger Marilyn Ames. Marilyn is retired from Chief Counsel’s office and works with Les, Steve and me on updates to the treatise “IRS Practice and Procedure” which Les edits. Since her last guest post, she has moved from Alaska back to Texas where she lives much nearer to her grandchildren. She writes today about a recent First Circuit opinion that imposes a liability on the IRS for failing to prove that a debt was excepted from discharge. The failure of proof resulted from an unusual situation; however, the important issue in the case focuses on the responsibility of the IRS at the conclusion of a bankruptcy case. I have written about the fraud exception to discharge on several occasions. Here is a sample post on the topic if you want background on the underlying discharge issue. Keith

Both the Internal Revenue Code and the Bankruptcy Code are statutory schemes of almost mind-numbing complexity, and when the two collide, the results are generally ugly. Such was the case in Internal Revenue Service v. Murphy, a case of first impression from the First Circuit issued on June 7, 2018, which can be found here. The majority opinion, as noted by the dissent, has the result of “hiding an elephant in a mouse hole” and could significantly change the ability of the Internal Revenue Service to collect debts that are otherwise not discharged in a bankruptcy case.

The hiding of the elephant began in 2005, when Mr. Murphy filed a Chapter 7 bankruptcy, listing debts of $601,861.61. Of that amount, $546,161.61 was owed to the Internal Revenue Service for unpaid taxes for a number of years, and to the State of Maine for one year. The bankruptcy court entered Mr. Murphy’s discharge in February of 2006, which provided that the “discharge prohibits any attempt to collect from the debtor a debt that has been discharged.” For those without either personal or professional experience with a Chapter 7 discharge order, it does not list the specific debts that are or are not discharged. The Internal Revenue Service was given notice of the entry of the discharge.

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For three years after the entry of the discharge, the Internal Revenue Service informed Mr. Murphy that it believed his tax debts were not discharged under the provisions of Bankruptcy Code § 523(a)(1)(C), as Mr. Murphy had either filed fraudulent returns or had made some other “attempt to evade or defeat [these] taxes in any manner.” In 2009, the Internal Revenue Service levied on property belonging to Mr. Murphy, which caused him to file suit against the Internal Revenue Service in the bankruptcy court, seeking a declaration that the tax liability had been discharged. Although the IRS continued to take the position that the taxes were nondischargeable as they were due to Mr. Murphy’s fraudulent actions, the AUSA did little to present evidence to show this when Mr. Murphy filed a motion for summary judgment, and the bankruptcy court granted the summary judgment motion, holding that the taxes were discharged. The government did not appeal. The AUSA was subsequently diagnosed with a form of dementia, and had probably been experiencing it when he defended the Internal Revenue Service in the dischargeability case.

Mr. Murphy then filed a complaint under Internal Revenue Code § 7433(e), seeking damages for willful violation of the injunction created by the discharge in the bankruptcy case. After some initial procedural skirmishing over the effects of the earlier discharge litigation and the AUSA’s illness, the Internal Revenue Service agreed that the summary judgment ruling determined that the taxes were discharged, and to the amount of the damages Mr. Murphy had suffered. The only issue remaining was the question of whether the Internal Revenue Service had willfully violated the discharge injunction such that Mr. Murphy was entitled to monetary damages under Section 7433(e).

The bankruptcy court held that Mr. Murphy was entitled to damages, as the term “willfully violates” means that “when, with knowledge of the discharge, [a creditor] intends to take an action, and that action is determined to be an attempt to collect a discharged debt.” The bankruptcy court’s decision was affirmed by the district court, and the Court of Appeals also found in favor of Mr. Murphy, agreeing that the Internal Revenue Service only had to intend to take the actions resulting in collection of the discharged taxes. A good faith belief that the taxes were not dischargeable was not a defense. The Court of Appeals also rejected the IRS argument that because Section 7433(e) is a waiver of sovereign immunity, it must be construed narrowly by permitting a good faith defense. The end result of the Court of Appeals’ opinion is that, for all practical purposes, the Internal Revenue Service must litigate dischargeability before it begins collection of taxes it reasonably believes have not been discharged, or risk having monetary damages imposed against it. This requirement of pre-collection litigation, not contained in the Bankruptcy Code, is the elephant the dissent believes the majority is hiding in a mouse hole.

As noted by Judge Lynch in the dissenting opinion, the majority got this one wrong. In reaching its decision, the majority opinion creates a standard of near strict liability by stripping the government of a reasonable good faith defense, rather than reading this waiver of sovereign immunity narrowly and construing ambiguities in favor of the sovereign, as generally required. Judge Lynch notes that the majority picks and chooses among circuit and lower court opinions in reaching its definition of willful violation, ignoring a Supreme Court opinion issued in Kawaauha v. Geiger, 523 US 57 (1998), a case decided just months before Section 7433(e) was passed. (This is an interesting omission by the majority, given that retired Supreme Court Justice David Souter was one of the two judges signing on the majority opinion.) In Kawaauhau, which interpreted the phrase “willful injury” in connection with another provision of Bankruptcy Code § 523, the Supreme Court held that the word “willful” modified “injury” and required a deliberate or intentional injury, rather than merely a deliberate or intentional act that leads to injury. The same rationale would appear to apply to Internal Revenue Code § 7433(e), leading to the dissent’s conclusion that a “willful violation” requires a deliberate or intentional violation, not just a deliberate or intentional act. If the IRS acts reasonably and in good faith, the violation cannot be willful. Judge Lynch notes that this conclusion is consistent with other Supreme Court decisions construing the phrase “willful violation.”

But Judge Lynch’s most convincing argument is that the majority’s opinion changes the tax collection scheme without an express mandate from Congress. Under the majority’s opinion, the Internal Revenue Service must first go to court and prove the taxes are still owed before instituting any collection action after a discharge, even though not expressly required by Bankruptcy Code § 523. The treatment of tax liabilities under Section 523(a)(1)(C) should be compared to the debts listed in Bankruptcy Code § 523(c)(1). For these types of debts, Congress has provided that they are automatically deemed to be included in the discharge injunction unless the creditor obtains a judicial determination that the debt is not discharged. When Congress wanted a creditor to sue first, then collect, it knew how to provide for it. It did not hide the requirement in a statute allowing for damages that is not even in the Bankruptcy Code, but in a provision of the Internal Revenue Code. An elephant in a mouse hole, indeed.

 

 

Requesting Innocent Spouse Relief: How long is long enough to request relief? Not two years. Another reflection on the NTA’s recent Innocent Spouse blog

We welcome guest bloggers Robert Horwtiz, Hochman Salkin Rettig Toscher & Perez, P.C., and Carolyn Lee, Morgan, Lewis & Bockius LLP. Both Robert and Carolyn practice tax controversy and litigation in California. They each have extensive experience with section 6015 innocent spouse matters – many involving no- or low-income taxpayers. In addition, they each have a history of pro bono service including volunteering with state and county Bars and low-income tax clinics, and assisting taxpayers during the Tax Court Calendar Call. The comments and recommendations in this post are Robert’s and Carolyn’s personally, and do not represent the views of their firms or any Bar Association. 

Robert and Carolyn reached out to us after the recent post providing statistics on the timing of innocent spouse relief. They are promoting a legislative change to the innocent spouse provisions that eliminates the time limitation for requesting relief. Their proposal, as explained in detail in the post and attachment below, would eliminate a restriction on requesting relief that does not follow the spirit of the statute. In a recent post regarding time frames and notice, Carl Smith discussed Mannella v. Commissioner, 132 T.C. 196, 200 (2009), rev’d and remanded on other issue, 631 F.3d 115 (3d Cir. 2011) as well as the regulation comments that he and I and others made in response to the proposed “new” regulations for 6015 resulting from the IRS pull back of the two year rule formerly applicable by regulation to section 6015(f). Robert and Carolyn take a broader view of the problem and seek legislation to eliminate the time period entirely. Doing so lines up with the goal of innocent spouse relief. For a host of reasons, discussed below, discussed in our regulation comments, discussed by the NTA and highlighted by cases like Mannella, individuals caught up in domestic break ups need time to sort through the resulting problems in their lives. I have not met clients who postponed dealing with their tax issue out of a desire to inconvenience the IRS. Any delay usually results from factors outside the control of the applicant or factors related to the necessity to secure basic human needs such as safety, shelter, food, and employment (recall Maslow’s hierarchy of needs) before getting to the tax problem. By thinking big to address the problem, Robert and Carolyn may convince Congress to set the statute right. Keith  

Recently Procedurally Taxing commented upon the May 23, 2018 National Taxpayer Advocate (NTA) blog discussing current trends in innocent spouse (§6015) determinations of relief. Another feature of the NTA blog was her observation about the effect on application volume of the IRS’s 2011 decision to accept requests for §6015(f) equitable relief through the end of the §6502 statutory collection period – typically at least ten years. The request period for equitable relief is significantly longer than the statutory two-year request period for the other two avenues to §6015 relief, §6015(b) (traditional relief) and §6015(c) (allocated relief). We believe this is a mistake. The §6015 request period should be the same for qualifying requesting spouses regardless of the avenue to relief, and it should extend through the end of the §6502 collection period.

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The NTA noted that extending the equitable relief period from two years to at least ten years did not result in a tsunami of requests. Both the NTA and Procedurally Taxing blogs describe the judicial and legislative route to the longer period to request equitable relief. They observed that §6015(b) and §6015(c) were enacted in 1998 with a two-year request period. Also relevant to the discussion is that the earliest statutory versions of relief from joint and several liability for innocent spouses did not include a two-year limitation on the request period. Inexplicably, the two-year period was included with other, more beneficially expansive revisions to innocent spouse relief with the enactment of §6015 in 1998. The legislative history is silent about the selective limitation. Legend has it there was a concern the Agency would be overwhelmed with requests if the application period were longer. Thanks to the NTA’s research, we know this concern was unfounded.

We see no valid reason to maintain the two-year statutory period to request traditional or allocated relief. A person claiming relief as an innocent spouse under §6015(b), §6015(c) or §6015(f) should be allowed to elect relief at any time during which the IRS has authority to collect the tax underpayment. A truncated period to request relief under two of the three §6015 subsections is at odds with the character of the statute, which is to make the benefits of §6015 relief available to taxpayers who qualify on the merits of their facts and circumstances. A longer statute of limitations acknowledges the complexities of marital relations. Congress enacted three distinct legal remedial forms of §6015 relief. The two-year period to request the benefits of traditional or allocated relief effectively nullifies two §6015 subsections for many requesting spouses.

Last May, as part of the 2018 Washington DC delegation sponsored by the Taxation Section of the California Lawyers Association and the Taxation Committee of the Los Angeles County Bar, we spoke with representatives of the IRS, Treasury, and National Taxpayer Advocate, as well as House and Senate Tax committee staff members about such a change. We advocated for an amendment to §6015 to extend the period of time to request relief for §6015(b) and §6015(c) through the end of the §6502 collection period, as under §6015(f). In a happy coincidence, the Taxpayer First Act, HR 5444, had recently passed the House of Representatives without opposition and was pending in the Senate. The Taxpayer First Act is an ideal legislative vehicle to effect the proposed amendment, including as it does §11303 to codify the extended §6015(f) period to request relief through the end of the §6502 collection period. It is a noncontroversial – dare we say nonpartisan – matter to change §11303 to codify the same extended request period for all three avenues to relief.

Enactment of this simple statutory amendment will bring consistency and increased fairness relative to the statute’s first gate; i.e., the period for requesting relief. The amendment will make relief pursuant to §6015(b) and §6015(c) available to the taxpayers whom these separate forms of relief were intended to benefit, and whose requests are rejected because the two-year application period closed and they cannot qualify for equitable relief pursuant to §6015(f). The change will not increase stress on the IRS or the Tax Court, which have been administering and deciding §6015 matters for almost two decades. Any concern about an overwhelming volume of applications for relief may be assuaged based on data the NTA analyzed. (Please note that the NTA has not commented on the proposal to extend the statutory period of time to request relief from joint and several liability pursuant to §6015(b) and §6015(c).) All the other existing, rigorous requirements to qualify for relief remain the same. This proposal is not a liability give-away. It is no easy task to obtain relief.

The longer request period will make a material difference for requesting spouses who merit relief. Some clients may make a dash for a low-income tax clinic. For those clients, one might conclude the §6015(f) request period could have remained two years. No one is suggesting the NTA’s findings support that argument. However, in our experience, the current two-year request period is too short for most taxpayers dealing with unexpected erroneous tax items, typically during times of family, financial and emotional distress. We find that for every client who acts quickly on IRS collection correspondence there are many dozens more who cannot bring themselves to even open the envelope. Or the second envelope. Paralyzing panic sets in.

The two-year period for seeking relief under §6015(b) and §6015(c) can result in unduly harsh consequences for taxpayers too late to satisfy the statutory two-year period. This is especially true where the spouses do not divorce or become legally separated until after the two-year period, or begin living in separate households more than one year after collection activity begins. In addition, pro se taxpayers – the vast majority of taxpayers who might qualify for relief – likely find the two-year statute a trap for the unknowing. The unintentional adverse collateral consequences of the truncated statute of limitations to request relief pursuant to §6015(b) and §6015(c) have emerged as the law has been applied.

It is important to highlight that §6015(f) equitable relief is not a safety net for requesting spouses after the §6015(b) and §6015(c) gate shuts. Like §6015(b) and §6015(c), equitable relief under §6015(f) serves its own legal purpose, with its own raft of eligibility factors to consider. As applied, §6015(f) is not an avenue to liberally granted relief for requesting spouses who could qualify for traditional or allocated relief but for missing the two-year request period. In fact, §6015(f) expressly is intended to apply when the requesting spouse fails to qualify based on the merits of §6015(b) and §6015(c). For example, requesting spouses may fail to qualify for equitable relief because the requesting spouse has financial resources, which is a factor weighing against equitable relief. Or, the requesting spouse may satisfy the §6015(c) “actual” knowledge test regarding the erroneous item, but fall short on the highly subjective and seemingly all-embracing equitable test for “reason to know” of the erroneous item. There are many circumstances when §6015(f) would not offer a safe harbor to requesting spouses who would qualify for traditional or allocated relief if only they had applied in time.

In addition, §6015(f) as applied by the IRS often fails to serve requesting spouses. The Service simply gets the equitable analysis wrong. As recent examples, two applications for relief were rejected by the IRS Innocent Spouse unit because the requesting spouses failed to establish they suffered abuse. There is no basis in any of the guidance provided by the IRS or the courts to apply a requirement of abuse in order to obtain equitable relief. To the contrary, Revenue Procedure 2013-34 describing factors to consider when determining eligibility for §6015(f) relief expressly expanded the factual parameters pertaining to physical and emotional abuse to make relief more available in such circumstances. Unrepresented taxpayers confronted with incorrect administrative rejections may not have the wherewithal to rebut these determinations, including undertaking the next – potentially remedial but perhaps overwhelming – step of petitioning for Tax Court review.

As another collateral consequence, if the government brings an action to reduce to judgement joint liabilities against a taxpayer who may be eligible for innocent spouse relief after the two-year period for requesting relief, the taxpayer would be unable to defend based upon being an innocent spouse.

We could go on, and did go on during the DC Delegation meetings. We continue to monitor the Taxpayer First Act, with the hope that the legislation will be amended to extend the period of time to request §6015 relief for each of the three avenues to relief to be coterminous with the period of time to collect the tax. Doing so is only fair, and better serves Congress’s wish to put innocent spouses first, thus permitting the IRS to collect tax on erroneous items from the taxpayer responsible for them.