Imperfect Petitions in Tax Court

The Tax Court has a practice of taking letters, notices of deficiency with handwritten notes and other documents and treating these documents as petitions.  It does so in order to aid petitioners by giving them a greater chance to meet the deadline for filing a petition in the Court.  I looked back over our seven years of blog posts for a post on imperfect petitions and could not find one directly examining this Tax Court practice (but see these two posts for related discussions). 

Chief Counsel, IRS in its portion of the Internal Revenue Manual discusses imperfect petitions here; however, it deems the discussion so sensitive that it prevents the public from seeing its views on this subject.  I am a bit surprised that the whole of the discussion on imperfect petitions would be of such a sensitive nature that it is protected from public view.  I would think that all or almost all of the discussion would be material that would not need such protection. So, I thought I would write about these special petitions for anyone who wondered what they were or wondered what the Tax Court was doing when it ordered the filing of a perfected petition.

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Tax Court Rule 13(c) provides:

(c) Timely Petition Required: In all cases, the jurisdiction of the Court also depends on the timely filing of a petition.

Readers of the blog know that we do not adhere to this statement about the Court’s jurisdiction and, indeed, the D.C. Circuit has specifically said that the time period for filing is not jurisdictional and equitable tolling can apply in whistleblower cases.  After the decision in Myers, the government did not seek Supreme Court review of the decision.  The fact that the jurisdiction for all whistleblower cases lies in the D.C. Circuit coupled with Golsen rule of the Tax Court requires the Court to follow the decision in every whistleblower case.  Nonetheless, moving past those technical points, the general requirement of Court and the Tax Court’s view of the applicable statutes is that taxpayers must file by the date listed in the provision giving the court jurisdiction over a matter.  Except for the Myers case, the Tax Court’s view of jurisdiction has been upheld by the circuit courts ruling on this issue thus far.  This narrow view of the role of time frames and the Court’s otherwise generally kind view toward petitioners causes the Court to seek to treat documents filed, even if they do not look like petitions, as potential petitions. This is a way to get past the jurisdictional barriers that could arise if the Court tried to correspond with a petitioner in an effort to obtain a “normal” petition by the due date.

Tax Court Rule 20(a) provides:

(a) General: A case is commenced in the Court by filing a petition with the Court. See Rule 13.

Tax Court Rule 34(a)(1) provides:

(a) General: (1) Deficiency or Liability Action: The petition with respect to a notice of deficiency or a notice of liability shall be substantially in accordance with Form 1 shown in Appendix I, and shall comply with the requirements of these Rules relating to pleadings. Ordinarily, a separate
petition shall be filed with respect to each notice of deficiency or each notice of liability. However, a single petition may be filed seeking a redetermination with respect to all notices of deficiency or liability directed to one person alone or to such person and one or more other persons or to a husband and a wife individually, except that the Court may order a severance and a separate case to be maintained with respect to one or more of such notices. Where the notice of deficiency or liability is directed to more than one person, each such person desiring to contest it shall file a petition, either separately or jointly with any such other person, and each such person must satisfy all the requirements of this Rule in order for the petition to be treated as filed by or for such person. The petition shall be complete, so as to enable ascertainment of the issues intended to be presented. A petition may be filed electronically under the electronic filing procedures established by the Court, or a petition may be
filed by properly mailing or hand delivering it to the Court. No paper will be recognized as a petition if it is submitted to the Court in any other way. The address to be used to mail or hand deliver a petition is set forth in Rule 10(e). Petitions may be hand delivered to the Court only during business hours, see Rule 10(d). Failure of the petition to satisfy applicable requirements may be ground for dismissal of the case. As to the joinder of parties, see Rule 61; and as to the effect of misjoinder of parties, see Rule 62. For the circumstances under which a timely mailed petition will be treated as having been timely filed, see Code section 7502.

Tax Court Rule 34(b) provides:

(b) Content of Petition in Deficiency or Liability
Action:
The petition in a deficiency or liability action shall
contain (see Form 1, Appendix I):
(1) In the case of a petitioner who is an individual, the petitioner’s name and State of legal residence; in the case of a petitioner other than an individual, the petitioner’s name and principal place of business or principal office or agency; and, in all cases, the petitioner’s mailing address and the office of the Internal Revenue Service with which the tax return for the period in controversy was filed. The mailing address, State of legal residence, principal place of business, or principal office or agency shall be stated as of the date of filing the petition. In the event of a variance between the name set forth in the notice of deficiency or liability and the correct name, a statement of the reasons for such variance shall be set forth in the petition.
(2) The date of the notice of deficiency or liability, or other proper allegations showing jurisdiction in the Court, and the City and State of the office of the Internal Revenue Service which issued the notice.
(3) The amount of the deficiency or liability, as the case may be, determined by the Commissioner, the nature of the tax, the year or years or other periods for which the determination was made; and, if different from the Commissioner’s determination, the approximate amount of
taxes in controversy.
(4) Clear and concise assignments of each and every error which the petitioner alleges to have been committed by the Commissioner in the determination of the deficiency or liability. The assignments of error shall include issues in respect of which the burden of proof is on the Commissioner. Any issue not raised in the assignments of error shall be deemed to be conceded. Each assignment of error shall be separately lettered.
(5) Clear and concise lettered statements of the facts on which petitioner bases the assignments of error, except with respect to those assignments of error as to which the burden of proof is on the Commissioner.
(6) A prayer setting forth relief sought by the petitioner.
(7) The signature, mailing address, and telephone number of each petitioner or each petitioner’s counsel, as well as counsel’s Tax Court bar number.
(8) A copy of the notice of deficiency or liability, as the case may be, which shall be appended to the petition, and with which there shall be included so much of any statement accompanying the notice as is material to the issues raised by the assignments of error. If the notice of deficiency or liability or accompanying statement incorporates by reference any prior notices, or other material furnished by the Internal Revenue Service, such parts thereof as are material to the issues raised by the assignments of error likewise shall be appended to the petition. A claim for reasonable litigation or administrative costs shall not be included in the petition in a deficiency or liability action. For the requirements as to claims for reasonable litigation or administrative costs, see Rule 231.

Nothing in the Tax Court Rules talks about accepting a letter that says something to the effect of “I disagree with the IRS.”  Yet, the Tax Court will take that letter, stamp it as an imperfect petition and send the taxpayer a letter requesting that the taxpayer file a petition using the Tax Court’s form petition package.  In sending out the letter to the taxpayer, the Court will generally give the petitioner 30 days but it sometimes extends that period.  If the person sending in the letter files the petition that substantially conforms to the form petition within the allotted time period, the Tax Court will treat the case as timely filed, even though it may take much more than 30 or 90 days to get the petition package into the Court.  The Court may also allow the addition of another individual on the case in a situation in which H mailed the letter that the Court treats as an imperfect petition, but W signs onto the later filed form petition.

Sometimes a bit of confusion to the IRS can occur at the beginning of a case when the Court seeks to obtain a perfected petition.  Remember that the filing of a petition stops assessment of the liability proposed in the deficiency.  The IRS gets notified of the imperfect petition and must seek to stop the assessment.  Sometimes it seeks to do so with a very small amount of information about the person filing the imperfect petition.  Sometimes the attorney for the IRS does not know exactly when to file an answer.

The practice of accepting imperfect petitions extends back for as long as I can remember, which takes it back into the 1970s.  I do not know when it started or what rules may exist in the Tax Court for what makes an imperfect petition, how much leeway to give an imperfect petitioner or other questions that might exist about this practice.  The Tax Court bends over backwards to help petitioners who send something into the Court before the filing deadline to have a chance.  There are a pair of 5th Circuit cases,  Crandall v. Comm’r, 650 F.2d 659 (5th Cir. 1981) and United States v. Jenkins, 780 F.2d 518 (5th Cir. 1986)(affirming the decision in Crandall and not directly speaking to the Tax Court) admonishing the Tax Court to give taxpayers plenty of opportunity to explain their reasons for delay in responding to court orders to perfect.  There is also an Action on Decision following the Crandall case in which the IRS recommends not seeking cert because of a lack of a circuit split on the issue.  My observation is that the Tax Court generally follows the guidance provided in Crandall and gives taxpayers ample opportunities to explain once they are in the door.

You will see the orders in docketed cases if you peruse through them regularly.  Even petitioners whose cases get off to a slow start because of the imperfect nature of their petition still have every opportunity going forward for success and for defeating the proposed assessment if they have a good case.  I hope to do a study of imperfect petitions at some point to gather some empirical data on the ultimate outcomes of these special cases.

Why a Win for CIC Services Would Be a Win for Tax Shelters

We welcome a group of guest bloggers who filed an amicus brief in CIC Services earlier this week.  Professors Susie Morse, Clint Wallace and Daniel Hemel and attorneys at Gupta Wessler filed a brief on behalf of former government officials Lily Batchelder, Mark Mazur, Eileen O’Connor, Leslie Samuels, Stephen Shay and George Yin.  Today, they provide us with an explanation of why the Supreme Court should uphold the decision of the 6th Circuit, which held that the Anti-Injunction Act bars CIC Services’ suit.  The Supreme Court has now scheduled this argument for December 1, 2020.  Keith

This week, a group of former government officials filed an amicus brief in support of the government in CIC Services v. IRS, the Anti-Injunction Act case before the Supreme Court this term. The case involves a tax shelter promoter that seeks to prevent the IRS from imposing penalties on the promoter and its clients if they fail to comply with tax-shelter reporting requirements. A ruling for CIC Services would, as the Solicitor General emphasizes in its brief, go a long way toward gutting the 153-year-old Anti-Injunction Act. It would also—as our brief demonstrates—deal a serious blow to the IRS in the agency’s decades-long battle to combat abusive tax shelters.

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Ever since the first wave of abusive tax shelters gathered momentum in the 1960s, Congress has taken a series of actions to give the IRS tools to fight back. Those include the at-risk rules in the Tax Reform Act of 1976, the passive activity loss limitations in the Tax Reform Act of 1986 and, at issue here, the reportable transaction disclosure regime in the American Jobs Creation Act of 2004. Specifically, in the 2004 law, Congress required tax shelter promoters and their clients to disclose certain large-dollar shelter transactions to the IRS, and it enacted new penalties so that those disclosure requirements had teeth. Of particular importance to this case, Congress placed those penalties in Subchapter 68B of the Code, which means that they qualify as “taxes” for purposes of the AIA.

The disclosure regime was, by most accounts, a resounding success. Prior to the disclosure rules, the IRS often found itself “looking for the tax shelter needle in the haystack of a complicated business tax return.” By requiring parties who arrange and participate in specific potentially abusive transactions to identify themselves to the IRS or face stiff penalties, Congress made it possible for the IRS to find the needle. To be sure, taxpayers still have the opportunity to argue that their transactions claim legal tax benefits. What they can’t do any more is keep their transactions outside the IRS’s view.

The reportable transaction scheme is designed to be agile. Congress wanted the IRS, upon learning of a new shelter, to require disclosure from promoters of the shelter and their clients. Congress specifically blessed the IRS’s practice of issuing reportable-transaction designations under already-existing authority (section 6011). That regime provides for issuance of designations by the IRS via notice in the Internal Revenue Bulletin—backed by penalties under the AJCA for failure to comply. Indeed, the IRS has designated dozens of transactions in this way, starting before Congress enacted the penalties for failure to report in the AJCA and continuing in recent years. CIC Services’ substantive argument is that the IRS should promulgate these notices through Administrative Procedure Act rulemaking rather than relying on the section 6011 framework. We think the AJCA endorsed the IRS’s approach. But in any event, the only issue here is whether CIC Services can obtain a pre-enforcement injunction that would block the IRS from imposing penalties for nondisclosure.

Allowing pre-enforcement challenges to these penalties—i.e., allowing taxpayers to challenge reportable transaction designations and to delay revealing to the IRS their participation in such transactions—would have severe consequences for the effort to fight abusive tax shelters. As we detail in our brief, injunctions of the sort that CIC Services seeks would yield three specific effects. First, they would prevent the IRS from detecting many abusive transactions. Second, when injunctions delayed detection, it would be likelier that the statute of limitations would lapse before the IRS could assess taxes that are rightfully owned. Third, in cases where the IRS is able to assess taxes before the statute of limitations runs out, delaying assessments would increase the risk of non-collection. The longer the delay, the likelier it is that taxpayers will have spent down their assets or moved their wealth beyond the IRS’s reach.

The petitioner wants to cast its effort in a different light. By its telling, the case has nothing to do with tax shelters at all. Petitioner tells the Court in its brief that its micro-captive products allow for “customized” risk management and a “more seamless claims process,” though it advertises itself to clients as a provider of a “legal tax shelter” that “can often double a business owner’s wealth.”

As readers of Procedurally Taxing know, petitioner’s argument received support from Professors Fogg and Book, who joined with the Center for Taxpayer Rights in an amicus brief opposing the Sixth Circuit’s interpretation of the AIA. Their brief argues that low-income taxpayers are especially disadvantaged when forced to rely on the AIA’s required remedy of post-enforcement judicial review. As Professor Fogg has written, under the Flora full-payment rule, in practice this can mean that post-payment judicial review for low-income taxpayers who face failure-to-report penalties is out of reach. And as Professor Book has written, the government’s approach to enforcing the tax law applicable to low-income taxpayers may excessively target taxpayers who make unintentional mistakes and lack access to constructive government guidance about how to comply.

Like Professors Fogg and Book, the authors of this blog post are concerned about the interaction between tax law enforcement and the situations faced by low-income taxpayers. But we think the remedy is to relax the full-payment rule in cases where it forces hardship for low-income individuals, and not to exempt CIC Services from the Anti-Injunction Act’s plain text.

The immediate result of a ruling for CIC Services would be to make it easier for tax-shelter promoters and their predominantly high-income clients to avoid paying the taxes they owe. That would result in less revenue overall, and more of the federal tax burden would be borne by lower-income taxpayers. The distributive result would be regressive.

Also, a ruling for petitioner is unlikely to provide relief for low-income taxpayers fighting the IRS. Petitioner’s theory is that it is challenging a “regulatory mandate” unrelated to its own tax liability. “Win or lose,” petitioner says in its brief, “the IRS will collect no additional revenue from CIC.” Petitioner accepts that taxpayers litigating about their own liabilities are covered by the Anti-Injunction Act but asks the Court to distinguish tax shelter promoters like CIC Services who are litigating about penalties for failure to disclose other taxpayers’ transactions. 

We agree with the government that the distinction that CIC Services draws is not a valid one. (Whether CIC Services wins or loses will affect the ability of the IRS to collect penalties from CIC Services itself under §§ 6707 and 6708—penalties that Congress has deemed to be taxes.) But let’s imagine that the Court disagrees and accepts CIC Services’ argument. That helps tax shelter promoters, but what does it accomplish for low-income taxpayers seeking to claim the earned income tax credit or the child tax credit? They are arguing about their own taxes and tax credits. 

In addition, a ruling for the government in CIC Services would leave undisturbed any equitable exceptions to the Anti-Injunction Act, which would allow low-income taxpayers to seek prepayment remedies in a case of clear government overreach. In the Bob Jones case, the Court said that such an equitable exception could be available where a plaintiff can show both a “certainty of success on the merits” and “irreparable injury.”  CIC Services has not sought that exception, and as our brief argues, it would not be eligible anyway. But Bob Jones may provide relief for low-income taxpayers in situations like the ones that Professors Fogg and Book highlight.  

The AIA lies at the foundation of federal tax administration and the modern tax shelter disclosure regime. That regime relies on a nimble IRS, backed by the threat of penalties for failure to disclose. Permitting tax shelter promoters to resist disclosure requirements with strategic lawsuits and pre-enforcement injunctions would mean trouble for tax collection.

IRS Expands Digital Signature COVID Response

Today guest blogger James Creech returns with an update to his previous post on IRS acceptance of digital signatures. As James notes, there continues to be confusion over which forms may be accepted with a digital signature, and for what purpose. Christine

The IRS recently made two announcements dated August 28, 2020 and September 10, 2020 expanding the list of documents that are temporary eligible to be filed using electronic signature due to the ongoing pandemic.  These two announcements add 16 forms to the list of documents that can be submitted with electronic signatures. 

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What is notable about these forms, is that they are forms that were previously barred from using an electronic signature because they were subject to standard filing procedures.  Since these forms had standard filing procedures, they were outside of the scope of the March 27, 2020 (and superseded with minor changes on June 12th) internal IRS memo that originally permitted electronic signatures on a number of forms used by the IRS to resolved cases at the exam or collection stages.  A full list of the forms can be found here.

The expanded use of electronic signatures for more routine forms is a welcome development even if, as the memo notes, it does not “represent the full universe of forms filed or retainer on paper that taxpayers and their representatives would like to see covered”.   Some of the forms such as the 706 family of tax returns are particularly useful because they allow an executor who may be at high risk from COVID to sign the return without having to come into contact either with other people by having to travel to the return preparer’s office or without having to physically go into the post office.  

The expanded use of electronic signatures does not change any of the other filing requirements.  Generally speaking most of the document on the expanded electronic signatures list still require that they be physically mailed to the IRS although some of the forms such as Form 3115 are also subject to temporary acceptance by fax.  The current expiration for electronic signature acceptance on both the listed forms as well as for documents provided for exam and collection is December 31, 2020.  In the case of a form filed though normal channels an electronic signature is valid as long as the form is signed and postmarked prior to January 1, 2021. 

These announcements by the IRS are a recognition that while life is returning to normal it is not the normal that existed in January.  Overall the IRS has done a good job of adjusting to our shared existence of social distancing.  The agency’s flexibility with electronic signatures, accepting documents via email, expanding e-filing for forms such as the 1040x are all recognition that the tools for remote work exist and have value. 

While the rollout of the prior electronic signatures has not gone without its hitches, such as continued CAF rejections of 2848’s due to electronic signatures despite the form being specifically identified as eligible for electronic signature is in the March 27th memo, and there are some tradeoffs with security and identity verification, these changes are a net positive.  Hopefully the IRS spends some of the next few months working out ways to reduce these risks to acceptable levels so that when taxpayers and their representatives can safely meet again they will not have to return to signing paper forms. 

 

Designated Orders June 15 – 19 2020 Part II of II: Tax Procedure Final Exams!

The prior designated order post focused heavily on a new issue in the procedural world: whether the Tax Court has jurisdiction to issue a writ of mandamus ordering the IRS to issue a Notice of Determination in a whistleblower case. The remaining orders of that week don’t break such new ground, but do bring up a lot of fun procedural issues. Indeed, one of the orders reads like a potential Tax Procedure Final exam and provides helpful refreshers to practitioners as well.

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Tax Liens and Tax Procedure: A Game of Inches. O’Nan v. C.I.R., Dkt. # 5115-17 (here

Convoluted fact patterns and the importance of dates/timing are hallmarks of law school exams. I still recall my exact thoughts after reading through the prompt for my Wills and Trusts exam: that would never happen. No one in history has ever written their “will” on a cocktail napkin, stepped outside the bar and been hit by a car. [Note: I may be misremembering the exact facts of my final exam, but it wasn’t far off from that.] The facts in O’Nan are not quite so far-fetched, and since it actually happened may serve as a useful template (or rebuke) to stressed out law students complaining about endless hypos. 

In O’Nan, husband and wife had joint liabilities for 2012 and 2013, which were assessed by the IRS on November 18, 2013 and November 17, 2014 respectively. The order doesn’t specify what avenue the IRS took to get to assessment (e.g. deficiency procedures or summary assessment of amounts listed on the returns), but judging from how quickly after the filing deadline these assessments took place, I’d be willing to bet on “summary” assessment. That little implicit fact might just matter… But more on that later.

Anyway, the O’Nans had liabilities assessed for both 2012 and 2013 as of November 17, 2014. On that same day the IRS mailed a CP14 letter to the O’Nans for 2013 demanding payment. It is unclear when the 2012 demand for payment was mailed, though one would assume it was earlier than that: the remainder of the order focuses predominantly on 2013. 

Sadly, only eight days after the notice and demand letter was sent (November 25, 2014) Mr. O’Nan passed away. Months pass, and people focus on things more important than taxes for the remainder of 2014.

On March 11, 2015, Ms. O’Nan records a “Survivorship Affidavit” in the county where the marital home is located. This effectively means that she has an undivided property interest in the home, whereas before it was a joint tenancy. Shortly thereafter (April 28, 2015), the IRS filed a Notice of Federal Tax Lien in that same county, though the order does not specify for which tax year (i.e. 2012, 2013, or both) or for which taxpayer (i.e. Ms. O’Nan, Mr. O’Nan, or both). More facts a discerning student may underline.

Possibly spooked by that Notice of Federal Tax lien, Ms. O’Nan filed an Innocent Spouse request on May 6, 2015. A little over a month after filing the Innocent Spouse request, Ms. O’Nan sold the marital home for (at least) a gain of $123,200… which promptly goes to the IRS in full satisfaction of the 2012 and 2013 joint liabilities.

An unhappy result for Ms. O’Nan I’m sure, but (maybe?) not the end of the story. After all, the Innocent Spouse request is still outstanding, and a couple years later (February 2017) the IRS issues the following determination: “Good news: you are granted full relief for 2013 and partial relief for 2012! Bad news: you are entitled to $0 in refund for either of those years.”

Apparently Ms. O’Nan wasn’t happy with a piece of paper from the IRS effectively saying “We’ve relieved you from the joint tax debt that was paid through the sale of your home, but you aren’t getting any of it back.” So she filed in Tax Court, bringing us to the present day and this order. And, just to add a little more procedure in the mix, this order is only on a motion for partial summary judgment by the IRS on the question of when the federal tax lien (FTL) arose under IRC § 6321.

That narrow question actually has a pretty easy answer. The broad (“secret”) federal tax lien arises at the date of assessment, so long as notice and demand for payment is made within 60 days of assessment. See IRC § 6303. If the notice and demand is properly made within those 60 days, the effective FTL date “relates back” to the date of assessment. 

Looking only at the 2013 tax year (the order is mostly silent about 2012) the assessment took place on November 17, 2014 and the notice and demand for payment was mailed on the same day. Accordingly, in this instance there isn’t even the need to “relate back” to the assessment date from a later-mailed notice and demand. The federal tax lien arose on November 17, 2014. Easy answer on the main issue, I’d say, but let’s look at some wrinkles:

Bonus points to students for those who advised putting the IRS mailing of the Notice and Demand at issue. If the Notice and Demand for payment were severely defective (or never actually mailed), it is possible (but by no means guaranteed) that in certain circuits the federal tax lien would not arise on November 17, 2014. Frankly, I think you could write a whole test question just on what the effects of failing to properly mail a Notice and Demand for payment are. It isn’t always clear or consistent.

Extra-special bonus points to students (or practitioners) that note potential evidentiary issues with the Notice and Demand for payment. The IRS provided transcripts as proof of proper mailing, but the IRS gets things wrong all the time -particularly with dates on notices (see Keith’s post here for an instance where the IRS effectively decided it was OK to send notices with bad dates). Judge Panuthos notes, however, that petitioners did not raise any arguments challenging the presumptively correct mailing record, so the argument essentially falls by the wayside. 

Note, however, that in this instance the Petitioner actually does raise an argument about the Notice and Demand. But it is a purely legal argument about the notice being untimely because it was issued too early after assessment. This legal argument is quickly and correctly dismissed as being a strained and improper reading of the statute. In my experience, I would say that a law student is more likely to raise that (doomed) legal argument than the more promising factual one: law school tends to focus on laws more than facts, after all.

Ok, so we’ve solved the narrow issue before Judge Panuthos here, which is when as a matter of law the federal tax lien came into existence. (It just so happens that Judge Panuthos worked extensively on collection matters as an attorney with Chief Counsel before becoming a Tax Court Judge, so he is likely better suited than most to wade through these tricky lien issues. Thanks to Keith for alerting me to this bit of information.) Partial summary judgment granted. But what remains to be disposed of in this case? What other Federal Tax Procedure Final Exam prompts might we take from this order? 

First off, consider whether and why the precise date of the federal tax lien even matters in this instance. Recall that the IRS filed a Notice of Federal Tax Lien (NFTL) before the property was sold, and also that Ms. O’Nan was liable for the entire 2012 and 2013 debt. Recall that unlike a “secret” tax lien, an NFTL takes priority over a for-value purchaser. See IRC § 6323(a). Wouldn’t the IRS be entitled to the proceeds regardless of the notice and demand issue?

I think the answer is “yes,” but a little more analysis is helpful to tie up potential loose ends. Those loose ends only really exist since the IRS granted innocent spouse relief, effectively cutting ties that otherwise bind Ms. O’Nan to joint and several liability.

As is frequently mentioned on this blog and elsewhere, the reach of the federal tax lien (FTL) is exceedingly broad. It is certainly broad enough to attach to Mr. O’Nan’s interest in the marital home before he passed away… so long as it arose before he passed away (i.e. when he still had an interest). Just as important as the breadth of the FTL is its resilience -that it sticks with real property that changes ownership through gift or, in this case inheritances. (See IRC 6323(h)(6), defining “purchaser” (one of the categories that otherwise defeats an FTL) but would not include a conveyance by inheritance.) 

Putting it all together, Ms. O’Nan needs to show that at the time the FTL came to exist her late-spouse had no interest in the marital property that the FTL could “attach” to. If that is the case, Ms. O’Nan still owes the tax liabilities but (critically) when the home is sold the proceeds going to the tax debts could only be attributable to her. That sets us up for her innocent spouse claim: the payments are solely attributable to Ms. O’Nan, who the IRS concedes doesn’t owe the tax (i.e. granted relief from liability). Unless the IRS can say “actually, the payments that fully eliminated the (previously) joint tax debt were attributable to the lien from your late spouse” it certainly seems like a refund would be in order.

Which gets to the final prompt: the circumstances for getting refunds in innocent spouse cases. For ultra-special-bonus-points we go all the way back to why the method of assessment matters. If the liability was from a summary assessment (i.e. tax reported on the return) then the only “type” of innocent spouse relief available under IRC § 6015 is “equitable” relief (IRC § 6015(f)) because it must be an “underpayment” and not an “understatement.” If it is an understatement you (potentially) get into other factually thorny issues about whether (b) or (c) relief is available.

This matters mostly in the context of getting a refund. You can only get 6015(f) relief if you are not entitled to relief under 6015(b) or (c). This is important because refunds are available under (f), whereas they are not available under (c) which is generally the easiest variety of relief to get. And if the only reason you can’t get (c) is because you want a refund, the Treasury Regulations provide that you are out of luck (see Treas. Reg. § 1.6015-4(b)). As blogged on previously here, the IRS also sometimes appears to default to “c” relief causing exactly these sorts of problems (it doesn’t appear to me that simply checking the “I’d like a refund” box on Form 8857 fixes the problem)

The IRS used to take a much stingier line on when you could get a refund under IRC 6015(f). Current IRS guidance (Rev. Proc. 2013-34), however, has liberalized such that refunds are generally available if there is a timely claim and the amounts paid are attributable to the requesting spouse. Which neatly brings us all the way back to why the FTL timing matters so much… determining which spouse the payment could be attributable to. After all, both spouses legitimately owed the tax at the time the IRS swooped in on the sale proceeds.

There are, undoubtedly, other questions and prompts one can pull from this scenario. In particular, the order provides look at the intersection of state law for determining “property rights” and federal law for how the FTL attaches to those rights. But those are prompts for another day.  

Theft Loss Issues with a Side of Tax Procedure. Bruno v. C.I.R., Dkt. # 15525-18 (here)

The fact-intensive nature of “theft losses,” as well as its interplay with other code sections (itemized deduction limitations, net operating losses, etc.) tends to make for good Federal Income Tax test prompts. And this order is no different, involving an alleged theft loss of roughly $2.5 million(!). The facts in this case are also sordid enough to keep students interested: the “theft” at issue arises from a divorce and supposed conspiracy of the ex-husband to hide assets from petitioner through a series of entities owned by the ex-husband’s family. 

Plenty of interesting stuff on the substantive question of whether (and critically, when) a theft loss may have occurred. But since this is a Tax Procedure blog, it seems fitting to focus on the procedural issue at play giving rise to the order at hand. 

The order from Judge Lauber tells the parties to file a supplemental stipulation of facts. Why not just parse out the facts that are needed in trial, you ask? Because the parties filed a motion to submit the case under Tax Court Rule 122 (i.e. “fully stipulated”). Judge Lauber is basically saying “What you’ve stipulated to isn’t enough for me to know if/when the theft loss is appropriate. Give me more.”

And here is where we get to tax procedure. Recall that the burden of proof is generally on petitioner, challenging the Notice of Deficiency, to prove that she is entitled to the theft loss. (See Welsh v. Helvering, 290 U.S. 111 (1933)) This does not change under Rule 122 submissions: subparagraph (b) of Rule 122 pretty specifically states as much. If the stipulations aren’t enough to show one way or another if the theft loss deduction is appropriate, shouldn’t the default be “petitioner loses?” 

Probably yes, but that doesn’t mean the Tax Court has to jump to that conclusion. And power to Judge Lauber for not doing so. As noted before (see post here), the Tax Court generally wants to get things right, and not to decide based on foot faults. Ruling based on insufficient stipulated facts, particularly where the parties may well end up agreeing on the facts that matter, may not quite be a foot-fault, but certainly seems unfair without first giving the parties a chance to fix the issue. If they don’t agree to the stipulated facts, however, I think there are problems for Petitioner. Until then, however, Judge Lauber seems to take the best approach. (Also (in my humble opinion) I think the Tax Court may be more willing than usual to accept and work with Rule 122 cases during this time of “virtual trials.”) 

Remaining Designated Orders – Conservation Easements That Sound Too Good to be True (Little Horse Creek Property, LLC v. C.I.R., Dkt. # 7421-19 (here) and Coal Property Holdings, LLC v. C.I.R., Dkt. # 27778-16 (here)

Finally a brief note on a couple of designated orders that arose from conservation easement cases. I recall at one of the first tax conferences I ever attended in 2012, practitioners (focusing on tax planning, not controversy) crowing about conservation easements. Now, interestingly enough, these years later conservation easements are still a topic frequently being discussed in the tax world, though now mostly by litigators… usually a bad sign for the planners. 

Coal Property Holdings pretty well illustrates the general state of affairs, with the taxpayers now arguing only over whether they should get hit with a 40% penalty for gross valuation misstatement under IRC § 6662(h). Post-script: in the time since this order was issued, the Tax Court entered a stipulated decision (here) where the parties agreed to the 40% penalty, and reducing the charitable contribution from $155,558,162 (on the return) to a slightly-less-magnanimous $58,162. Ouch.

Rejecting Returns That Meet Beard

The IRS rejects a lot of e-filed returns for reasons that seemingly have nothing to do with whether the taxpayer filed a valid return. (see these posts) It has done this for years, decades even.  This disparity between the way it treats e-filed returns and the way it treats returns mailed by snail mail catches up with it in Fowler v. Commissioner, 155 T.C. No. 7 (2020) a fully reviewed opinion with no concurrences or dissents (see also Bryan Camp’s informative post on Fowler from a different perspective). I don’t know if the Fowler case will serve as a wake-up call to the IRS to change its practices of rejecting returns with issues having nothing to do with whether the taxpayer actually filed a return, but it should.  The opinion seems so clearly correct that I wonder if, even given the administrative importance of the issue, the IRS will bother to appeal.  It would be interesting to be a fly on the wall in the Room of Lies when the IRS tries to sell this case to DOJ to appeal, if it does.

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Mr. Fowler requested an automatic extension to file his 2013 return extending the due date from April 15 to October 15, 2014.  Pursuant to the extension, Mr. Fowler timely e-filed his 2013 return; however, the IRS rejected his return because he failed to attach an IP-PIN, something the IRS wants some taxpayers who have had issues with identity theft to file with their return.  When the e-filed return rejected, Mr. Fowler’s preparer created a paper return which Mr. Fowler signed using DocuSign and filed on October 28.  Although the preparer received a signed certified mail slip indicating that the IRS received the paper return, in December, 2014, the IRS notified Mr. Fowler that he had not filed a return.

A third attempt to file the return occurred in April of 2015 and this attempt succeeded.  For some reason, the IRS waited to send Mr. Fowler a statutory notice of deficiency until April of 2018.  The notice date fell within three years of the third return but outside the three years of the first two documents Mr. Fowler sent in as returns for 2013.  He filed a summary judgment motion arguing that the IRS blew the statute of limitations by not sending the notice with three years of the originally filed or the second return.  The IRS filed a cross motion for summary judgment on the statute of limitations issue, arguing that the failure to include the IP PIN with the original return caused it to fail the Beard test.  Similarly, it argued that signing the paper return via DocuSign caused the second return to fail the Beard test, making the third return the original filing of a return for 2013 and the timing of the notice of deficiency appropriate.

To get to the bottom of the case the Tax Court analyzed the facts using the Beard test – a test developed in the 1980s before e-filing existed.  The problem the IRS has stems from its effort to shoehorn a post-Beard practice into the language of Beard.  As it developed and refined e-filing, it let programmers define acceptable e-filing, but the programmers did not keep their eye on the Beard test because it has rather elegant simplicity designed to provide guidance in a different time.  Either by statute, regulation or an updated version of Beard, the IRS must change the underlying law if it wants to stick with the tests it seeks to impose on e-filing that go well beyond Beard’s requirements.  The Tax Court judges unanimously, and correctly, determine that IRS practices in rejecting e-filed returns for matters not covered by Beard’s test fail. 

The Tax Court said it was not going to bother looking at the second return because it could decide the case based on the first one. Let’s look at the Beard test and how it lines up with rejecting a return for failure to include an IP PIN. The Court noted “We first consider whether the October 15 submission was a “required return” and “properly filed”.”

It looked at the concept of required return and explained what the Beard test requires:

The Beard test requires that: (1) the document purport to be a return and provide sufficient data to calculate tax liability, (2) the taxpayer make an honest and reasonable attempt to satisfy the requirements of the tax law, and (3) the taxpayer execute the document under penalties of perjury.

Here, the original 1040 purported to be a return and provided sufficient data to calculate the liability. The IRS did not object to this conclusion.

Having determined that the document met the first test, the Court moved on to the second test which it described as follows:

We next consider whether petitioner made an honest and reasonable attempt to comply with the tax law. A taxpayer need not file a perfect return to start the limitations period.

The Court determined that Mr. Fowler’s document met this test because he did try to file a correct return that complied with the tax law. The Court notes that the only difference between the original return and the one filed in April was the addition of the IP PIN on the April return. It further noted that the IRS did not file any response that would lead the Court to the conclusion that the original return did not provide an honest and reasonable attempt to comply with tax law.

Having concluded the taxpayer met the first two tests it moved onto the test involving the need to sign the return under penalties of perjury. On this point the IRS strenuously objected that Mr. Fowler complied. To win, the IRS had to argue that including the IP PIN constituted an integral part of his signature. The problem with this argument, or at least a major problem with this argument, is that even the IRS own descriptions don’t say that. Here’s what the Court says on this subject:

Under the heading “IRS e-file: Electronic Return Signatures!”, the instructions state that the taxpayer “must sign the return electronically using a personal identification number (PIN)”, either a Self-Select PIN or a Practitioner PIN. 2013 Form 1040 Instructions, at 73 (emphasis added). Here, Mr. Call included a Practitioner PIN on petitioner’s efiled return in accordance with the instructions.
Notwithstanding the foregoing instructions, respondent now argues that the IP PIN is part of the signature requirement. Because we find no IRS guidance characterizing an IP PIN as a signature, we disagree.

The IRS instructions for electronic filing explicitly required Mr. Fowler to use a PIN and his practitioner to use a PIN but did not require that he use the IP PIN. Because the programmers at the IRS decided that certain individuals must submit an IP PIN so the IRS can satisfy itself that the person is who they say they are, the programmers added the additional requirement regarding the IP PIN just as they have added other requirements which do not conform to the Beard test. The Court noted that the IRS regularly rejects returns that meet the Beard test:

the Modernized e-File (MeF) system, which the IRS uses to process
efiled returns, see infra Part II.B, rejects returns for numerous errors that may not cause a return to fail the Beard test.

In a footnote to this sentence the Court also noted that although the Internal Revenue Manual says that the IRS should reject e-filed returns failing to contain a IP PIN when the IRS had sent one to the taxpayer, the same provision does not provide for the IRS to return the paper filed return with the same problem. Because the IRS provided no authority for the fact that its programmers injected into the system a requirement that the taxpayer must attach the IP PIN, the Court found that the original return Mr. Fowler filed constituted a valid return, making the notice of deficiency one sent after the statute of limitations had expired.

The Court went on to explain why an IP PIN did not need to serve as the only line of defense here to avoid a problem of validating Mr. Fowler’s identity. It also provided some history on e-filing to show that his return went into the IRS system the way it should.

Assuming Fowler stands, what does it mean? It can mean that the IRS completely loses a case. as in this situation where the notice of deficiency bears a date more than three years after the valid initial filing. The Fowler case will not stand alone in reaching this result for certain taxpayers, but the more common situation will involve penalties. The IRS will seek to impose late filing penalties on electronic filers like Mr. Fowler, whose electronically filed returns fail to meet the rules created by the IRS programmers. We discussed the issue of the disconnect between the electronic filing rules and paper rules in this regard several times in the last few years, and the ABA Tax Section tried to get the IRS to react to the problem at that time.

The problem here results from the IRS using different rules for electronically filed returns than the case law allows. It deserved to lose. It needs to take a hard look at how to treat taxpayers equally in the electronic and paper context. If it persists in wanting more protection or more tests for a valid electronic return than Beard requires, it needs to find some authority for that. The Tax Court got it right that the emperor has no clothes on this issue.

Death of Taxpayer Extinguishes Claims for Wrongful Collection and Failure to Release Lien

The recent case of Pansier v United States addressed whether a taxpayer’s death extinguishes claims for improper collection and failure to release a lien. In deciding that the taxpayer’s death extinguished the claims, a federal district court focused on the text of Section 7432 and 7433 and the analogous statue applicable to damages for improper IRS disclosures of tax return information, as well as the principle that waivers of sovereign immunity are narrowly construed.

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A summary of the facts tees up the issue in the case. In 2017, the US sued in federal court and sought a judgment for Gary Pansier’s unpaid 1995 through 1998 assessed federal tax liabilities and for Joan and Gary Pansiers’ 1999 through 2006 and 2014 assessed federal tax liabilities. The Pansiers then filed for bankruptcy. The Pansiers then filed a separate lawsuit alleging that the statute of limitations on Gary’s 1996-98 liabilities had expired prior to the government’s collection suit. In that suit they sought approximately $28,000 in damages under Section 7432 for the IRS failure to release a federal tax lien and under Section 7433 for the IRS’s alleged unauthorized collection activities, both of which related to Gary’s separate 96-98 liabilities. 

While the Pansiers’ suit under Sections 7432 and 7433 was pending, Gary passed away. Joan filed a motion to substitute claiming that she as the surviving spouse was the sole representative and proper party in the action. The government filed a motion to dismiss, claiming that she was not the proper party, given that the alleged improper collection actions and failure to release the tax lien only pertained to Gary’s sole tax liabilities, even though some of the collection action reached marital property under Wisconsin law. 

The court agreed with the government. In reaching its decision the court looked to both statutes and their reference to the particular taxpayer:

Section 7432 provides that, when an officer or employee of the IRS “knowingly, or by reason of negligence, fails to release a lien . . . on property of the taxpayer, such taxpayer may bring a civil action for damages against the United States.”  (emphasis added). And Section 7433 states that, when an officer or employee of the IRS recklessly or intentionally, or by reason of negligence, “disregards any provision of [ Title 26], or any regulation promulgated under [ Title 26], such taxpayer may bring a civil action for damages against the United States.”  (emphasis added).

A the court notes, there is longstanding law where courts have routinely dismissed Section 7432 and 7433 claims where a party claims that improper IRS collection activities were undertaken to satisfy a spouse’s tax liability. 

The somewhat more difficult issue was whether Gary’s claims survived his death, and would allow the court under the Federal Rules of Civil Procedure to substitute Joan for Gary.  FRCP 25 provides the following: 

If a party dies and the claim is not extinguished, the court may order substitution of the proper party. A motion for substitution may be made by any party or by the decedent’s successor or representative. If the motion is not made within 90 days after service of a statement noting the death, the action by or against the decedent must be dismissed.

Pointing to the narrow language in 7432 and 7433 that allows claims only for “such taxpayer” the government opposed the motion. In deciding against Joan, the court noted that there were no cases it found that directly addressed the issue, but that courts have applied similar language in 7431 and refused to allow a substitution when the claim involved an alleged improper disclosure of tax return information. That statute also restricts suits for improper disclosure and provides:

If any officer or employee of the United States knowingly, or by reason of negligence, inspects or discloses any return or return information with respect to a taxpayer in violation of any provision of Section 6103 such taxpayer may bring a civil action for damages against the United States in a district court of the United States.

There is case law on the survivability of 7431 claims. For example, in US v Garrity,  a district court case from 2016, the government sought to collect a civil penalty from the estate of a taxpayer (as an aside whether a penalty survives death and can be collected is an important issue, one I discussed years ago in Death, Taxes and Civil Penalties: Does the Taxpayer’s Death End IRS’s Ability to Collect Penalties?, which Stephen Olsen and I discuss further in Saltzman & Book ¶7B. That issue has gotten lots of attention in recent years due in part to FBAR and other potentially large penalties). The estate in Garrity counterclaimed and sought damages under 7431 due to alleged improper IRS disclosure of return information. In deciding against the estate, the court stated that “[g]iven the clear text of the statute and the strict construction of waivers of sovereign immunity,” …”the private cause of action in Section 7431 is limited to claims brought by taxpayers whose return information has been disclosed.”

In deciding against allowing a substitution, the district court in Pansier looked to the case law under Section 7431 as well as the longstanding principle that waivers of sovereign immunity are to be narrowly construed against the government.  As such, the court granted the government’s motion to dismiss. While the government may pursue the estate for any tax liability, and even for possible civil penalties, this case shows that the government enjoys special status and is free from any consequences from alleged misconduct in collecting those taxes when the taxpayer was alive.

For 2020, IRS Offers Spanish Speakers a “Diez Cuarenta”

We welcome back frequent commenter and occasional guest blogger Bob Kamman with a glimpse of a new Spanish language version of Form 1040 the IRS has tested before as Bob tells us from his research into the history of the form.  He also refers to the music the IRS might add to its call line and that reminded me of a post I wrote in the second year of the blog.  Keith

The idea was rejected by IRS in 1971 and tested with little success in 1994.  But IRS has announced an “aggressive step” that for the next tax season, Form 1040 will be available in Spanish.   According to the IRS press release:

“As part of a larger effort to reach underserved communities, the Internal Revenue Service is taking a number of aggressive steps to expand information and assistance available to taxpayers in additional languages, including providing the Form 1040 in Spanish for the first time.”

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Will the numerous schedules and forms that must be attached to some Ten Forty (Diez Cuarenta) returns also be available in Spanish?  How about the 1040 instructions?  IRS does not tell us.  But the press release notes:

“Other changes include Publication 1, Your Rights as a Taxpayer, is now available in 20 languages. The 2020 version of Publication 17, Your Federal Income Tax, will be available early next year in seven languages – English, Spanish, Vietnamese, Russian, Korean and Chinese (Simplified and Traditional).”

It’s accurate for IRS to claim that this is the first time for Form 1040 to have an official translation, although the Form 1040-PR is in Spanish.  (That form is used by some residents of Puerto Rico to report self-employment income and to claim the additional child tax credit.)

However, in 1994 IRS tested Spanish versions of Form 1040A in Southern California and Florida.  That “simplified” IRS form no longer exists.   The purpose was described then as “aimed at increasing tax revenue.”

An IRS spokesperson in California told the Los Angeles Times, in an article published January 28, 1994:

“Most people want to comply but they don’t know how to and can’t understand the forms.  The IRS isn’t concerned about [which language a person speaks or] legal or illegal status . . . We just want the taxes.”

A spokesperson for the Mexican American Legal Defense and Education Fund (MALDEF) of Orange County, California, saw the Spanish forms as a way to decrease tax-preparer fraud.  “It may minimize the exploitation of the immigrant community by those who file their taxes,” he said.  The Times article reported that “it will also give immigrants, who are often accused of feeding off the public welfare system, a chance to ‘pay their fair share of taxes,’ [the MALDEF spokesperson] said.”

Two members of Congress from Orange County objected, however. Representative Ron Packard, who served from 1983 to 2001, criticized the $100,000 cost of the test, claiming the forms were a waste of money that would just make tax collection more confusing.  “Will the United States government print forms . . . for all of the thousands of different languages spoken and written by people in this country?” he asked.  “At a time when the federal government faces unprecedented fiscal constraints, this does not represent a prudent use of taxpayer funds.” 

Meanwhile, a spokesperson for Representative Dana Rohrabacher, who retired in 2019 after 20 years,  said the Congressman  believed   all government business should be conducted in English and all forms should be printed in English.

What conclusions did IRS draw from the 1994 trial of Spanish tax returns?  A July 27, 1994 article in the South Florida (Fort Lauderdale) Sun Sentinel reported that the program cost taxpayers about $157 per completed return:

“The IRS printed about 500,000 Spanish-language 1040A forms and distributed them in districts in South Florida and the Los Angeles area.  The translation, printing and distribution of the forms cost about $113,000.  As of the middle of May, a total of 718 Americans had filed their tax returns on the forms, called 1040A Espanol, the IRS said.”

Well, at least they tried.  In 1971, Representative Henry B. Gonzalez of Texas, ten years into his 38-year career in Congress, asked IRS to provide a Spanish translation of Form 1040.  IRS wrote him back that “practical difficulties” prevented this.  James N. Kinsel, described as “IRS tax forms chairman,” wrote that “one of these difficulties is the number of different languages which might have to be given this treatment.  Another difficulty stems from our processing and audit activities, and the possible need to employ large numbers of bilingual technicians.” 

Instead, Rep. Gonzalez was told that IRS puts Spanish-speaking workers in income tax assistance offices in areas of the country with high Mexican-American population, and was working on a Spanish-language pamphlet concerning income tax.

Of course, in the Internet era, most of the printing and distribution costs of translated forms are gone.  But as IRS becomes increasingly dependent on private enterprise, will software providers like TurboTax and the coalition that sponsors Free File make it easier for taxpayers to prepare returns in a language other than English?  And how many states will translate their income tax forms and instructions?

Optimistically, IRS tells us that it will allow taxpayers to indicate their choice of language when IRS contacts them.  As the press release notes:

“In addition to being available in English and Spanish, the 2020 Form 1040 will also give taxpayers the opportunity to indicate whether they wish to be contacted in a language other than English. This is a new feature available for the first time this coming filing season.”

It might be more useful if taxpayers were given a choice of music for listening on hold.  Mariachi, Salsa or K-pop?

By the way, the Taxpayer Advocate is called the “Defensor” in Spanish, which translates to “Defender.”  This may remind some of the 1961-65 television series starring E.G. Marshall and Robert Reed, and others of the recent Netflix series starring the Marvel Comics heroes Daredevil, Jessica Jones, Luke Cage, and Iron Fist.

Lien Interest in Insurance Proceeds Differs from Interest in Property Itself

In the case of Wolinsky v. Frye, No. 19-01009 (Bankr. D. Vt. 2020) the holder of a second mortgage competes against the IRS for the insurance proceeds resulting from a fire at the taxpayers’ home.  Even though the IRS had subordinated its lien to the second mortgage holder on the home, it argues that with respect to the insurance proceeds, the federal tax lien and the equitable lien of the mortgage holder attach simultaneously, giving the IRS a victory over the insurance proceeds.  The bankruptcy court agrees.

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This case involves more than one lien issue.  The first issue presented by the case is the subordination of the federal tax lien to the second mortgage.  This does not often happen.  The opinion gives few facts about the subordination but states that the IRS agreed to subordinate its lien for a payment of $120,000.  Between the time the taxpayers purchased the house and the time they sought a second mortgage, they incurred significant federal tax debt and the IRS filed notices of federal tax lien.  Very few second mortgage companies seek subordination of the federal tax lien in this situation, and we do not know why it happened here.  By agreeing to subordinate the federal tax lien, in return for a payment, the IRS gave away its priority position in the home to the second mortgage lender.

Sometime after the creation of the second mortgage, a home fire occurred.  Although the second mortgage lender required that the taxpayers insure their home for fire, it did not have itself named as the beneficiary of the insurance proceeds.  Only the first mortgage lender was named on the policy.  Because it was not named on the policy, the second mortgage lender held an equitable lien in the proceeds.

Prior to the fight over the insurance proceeds, taxpayers filed a chapter 13 petition in bankruptcy and subsequently converted the case to chapter 7.  The insurance proceeds from the fire became property of the estate against which the IRS and the second mortgage company each claimed an interest.  The parties filed cross motions for summary judgement seeking payment of the insurance proceeds.  The parties did not dispute that liens of each attached to the proceeds but only who had the superior priority.

The second mortgage holder argued first that its equitable lien on the insurance proceeds resulted directly from its lien on the property to which the federal tax lien was subordinate.  The IRS countered that though its lien was subordinate to the second mortgage holder’s lien on the home itself, that did not make its lien subordinate with respect to the insurance proceeds.  It argued that the court must look to the timing of the attachment of the respective liens to the proceeds, in other words their choateness with respect to the proceeds.  The second mortgage company, knowing that if the court framed the argument in this manner it might lose, argued that its claim was statutorily excepted from the choateness requirement pursuant to IRC 6323(c), a provision rarely litigated.

The court agreed with the IRS that the case involved the timing of the attachment of the liens to the insurance proceeds.  It found that the liens attached simultaneously to the insurance proceeds.  Based on V.J. Processors, Inc. v. Fireman’s Fund Ins. Cos., 679 F. Supp. 399, 401 (D. Vt. 1987), the court finds that the tie goes to the IRS in this situation.  That result matches the result of a fight between the IRS and a judgment lien creditor as decided by the Supreme Court in United States v. McDermott, 507 U.S. 448 (1993).

The court explains that the second mortgage holder’s argument regarding IRC 6323(c) does not work because a home mortgage is not a commercial financing security.  The purpose of IRC 6323(c) is to allow lenders to provide a line of credit.  A line of credit would not work if the filing of a federal tax lien immediately gave the IRS priority over the lender, since the lender could not watch for the filing of a notice of federal tax lien every moment of the day.  Essentially, this provision gives the lender a 45-day window to discover the filing of the federal tax lien and shut off the line of credit.  The court correctly decides that this commercial lending provision does not apply to the circumstances of this case.

While holding for the IRS, the court notes the unfairness of the result to the lender resulting strictly because of the change in the interest securing the property from the real estate to insurance proceeds.  Had the property been sold instead of destroyed, the second mortgage holder would have won any priority dispute.  The court says:

While the statute does not offer relief to the non-governmental creditors in this case, from an equitable perspective there is something troubling about this commercial transaction, in which the facts indicate (i) the IRS subordinated its interest in the real property to induce the Joint Bank Lienholders to make mortgage loans to debtors in financial distress, (ii) the Joint Bank Lienholders paid $120,000 in consideration of that subordination, (iii) the Joint Bank Lienholders each then made a mortgage loan, apparently in reliance on the subordination agreement, and (iv) when the property that was collateral for their loans was destroyed, the IRS declared its subordination agreement did not apply to the proceeds of the collateral and proclaimed its lien usurped the Joint Bank Lienholders’ interest in those proceeds. This seems inconsistent with the Remaining Parties’ expectations and intentions, and creates a result dependent on whether the Oneida Property was reduced to proceeds or was in existence at the time the Remaining Parties sought to enforce their respective rights against it, and whether the Debtors fulfilled their contractual duties to the Joint Bank Lienholders. The Joint Bank Lienholders ask this Court to do equity by turning over the Insurance Proceeds to them. The IRS responds that federal law controls and establishes very clear criteria, which the Joint Bank Lienholders simply have not met, in order to have priority over the IRS’ federal tax liens.

Cold comfort for the lender whose mistake here was not to be named on the insurance proceeds but to rely on its equitable lien.  The case demonstrates the sometimes peculiar results that lien law can produce, as property interests create outcomes that logic might not have dictated.  Because of the financial situation of the taxpayers, the insurance proceeds may provide the only source of recovery, leaving the second mortgage lender out in the cold.