Tenth Circuit Hook Opinion: Interest and Penalties Must Also Be Paid to Satisfy Flora Full Payment Rule

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We welcome back frequent guest blogger Carl Smith writing today on a surprising issue.  The surprise could be that the Flora rule still has open questions at this stage of life or that the circuit court opinion deciding the issue came out as unpublished and non-precedential.  Either way, this is an important development that bears watching.  Keith

This is just a brief update to part of a post that I did on February 4, 2015.  In that post, I noted that Flora v. United States, 362 U.S. 145 (1960), held that for a court to have jurisdiction of a tax refund suit, the taxpayer must, before bringing suit, fully pay the tax as billed by the IRS.  In a footnote in Flora – one that was arguably dicta – the Supreme Court wrote that “the statute lends itself to a construction which would permit suit for the tax after full payment thereof without payment of the interest”. Id., at 170 n.37. You would think that over the half century since Flora was decided, the Circuit courts would have resolved the question of whether the Flora rule requires full payment of interest and penalties, as well, but the issue has only been discussed (prior to last week) in two conflicting appellate court opinions. This post is to report that the Tenth Circuit just weighed in on this question in Hook v. United States, 2015 TNT 161-11 (10th Cir. Aug. 19, 20-15), an unpublished, non-precedential opinion.

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In Magnone v. United States, 902 F.2d 192 (2d Cir. 1990), the Second Circuit wrote that “the full payment rule requires as a prerequisite for federal court jurisdiction over a tax refund suit, that the taxpayer make full payment of the assessment, including penalties and interest”.  Id., at 193. Several years later, without noting Magnone, the Federal Circuit in Shore v. United States, 9 F.3d 1524, 1527-28 (Fed. Cir. 1993), expressed a different view, citing the Flora footnote and holding that payment of the tax alone was sufficient to commence a refund suit, so long as the taxpayer was not making any argument specific to interest (such as its being wrongly computed) or penalties (reasonable cause).  The court wrote that “only if the taxpayers assert a claim over assessed interest or penalties on ground not fully determined by the claim for recovery of the principal must they prepay such interest and penalties as well as the assessed tax principal.”  Id.

I find the Shore caveat as to when interest and penalties must be paid a bit odd and hard to read out from the statute. But, in a Cardozo Tax Clinic case where the taxpayer made no independent arguments about penalties and interest, I took advantage of the Shore holding to go to district court after only having paid the tax – i.e., sooner than I might have under Magnone. I couldn’t wait for the taxpayer to pay the roughly $2,000 in interest and late-payment penalties because she was then retired, and I had no idea if she would ever have the money to pay the interest and penalties that she currently couldn’t afford to pay. In response, the DOJ made no objection to jurisdiction, since the IRS agrees with the taxpayer-friendly Federal Circuit Shore interpretation. However, the government reserves the right to continue to pursue collection of the unpaid interest or penalties either by way of levy or counterclaim in the suit.  1996 FSA LEXIS 476 (Mar. 15, 1996). If the EDNY district court judge sua sponte had raised a jurisdictional objection in my case, citing Magnone, I was prepared to first try to distinguish Magnone, but if necessary go to the Supreme Court, citing the Court’s footnote in Flora and a Circuit split on this issue. In any event, in short order, the government conceded that my client was due a full refund of what she had paid, and the judge never brought up the possible jurisdictional objection to my suit.

In Hook, the taxpayers were lawyers (married to each other) who were extremely litigious over their back taxes. They brought suit in district court raising various grounds for relief. Among the grounds was that the court had jurisdiction of their suit as a tax refund suit under 28 U.S.C. § 1346(a)(1). They alleged that they satisfied the full payment rule for all tax years. But, the district court disagreed. The Tenth Circuit affirmed, writing that Ms. Hook’s

contention that the amended complaint shows all amounts were paid, including interest and penalties, is conclusory. And she fails to identify any error in the district court’s determination that Ms. Tibbs’s declaration and supporting exhibits established that the accounting in the amended complaint was faulty in omitting substantial statutory interest and penalties, both of which are treated as taxes under the Internal Revenue Code. See 26 U.S.C. section 6601(e)(1) (interest is treated “in same manner as taxes” for assessment and collection purposes); id. section 6671 (same with respect to penalties); Magnone, 902 F.2d at 193 (same with respect to interest and penalties).

The Tenth Circuit had previously cited the above-quoted sentence from Magnone providing that full payment included paying all interest and penalties.  The Tenth Circuit opinion does not mention Shore or the footnote in Flora seemingly contradicting the Tenth Circuit’s holding.

I checked the briefs in the Tenth Circuit, and none cites or discusses Magnone, Shore, or the footnote in Flora.  The district court did a better job – citing Magnone, but worrying about the footnote in Flora.  The district court wrote:  “The Court recognizes that under Flora, 362 U.S. at 170 n.37, an issue may be raised as to whether the payment of interest is also required. As Plaintiffs are challenging not only the tax but also the interest and ‘penalties/additions to tax,’ without further explanation as to the bases, the Court finds the full payment rule requires payment of all amounts challenged.”  (Slip op. at 14 n.11)

Personally, I think this is a pretty weak footnote, and the courts (both the district court and Tenth Circuit) should have discussed Shore when citing Magnone, as there was no Tenth Circuit precedent on the issue.

Somehow, because of all the other problems in the case, I doubt the Supreme Court will grant cert. on this jurisdictional issue if this very litigious couple seeks cert. after discovering the Shore opinion.  This case is just too messy on the facts.  And, as far as I can see, it really has no chance of success on the merits, even if the court had jurisdiction.

Considering how long this Circuit split over Flora has been in existence, I think it high time for Congress to step in and clarify it legislatively, and adopt the Shore rule.  But, I prefer even a broader carve-out of the Flora rule from § 1346(a)(1).  See my article “Let the Poor Sue for a Refund Without Full Payment”, 125 Tax Notes 131 (Oct. 5, 2009).

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