Next Month’s Symposium Highlighting Relationship Between Tax and Race

I am writing to share information about an upcoming Symposium to be held on February 24, 2023 in Washington, D.C. on “The Federal Income Tax: Racially Blind But Not Racially Neutral.”  The symposium is free and open to the public. 

There are in-person and Zoom attendance options, with pre-registration here and a flyer with more information here. The program is sponsored by the American Tax Policy Institute and co-sponsored by the American College of Tax Counsel, the ABA Tax Section, Skadden Arps Meagher & Flom LLP, the Center for Tax Law and Public Policy at Temple University Beasley School of Law, the Elisabeth Haub School of Law at Pace University, and the Pittsburgh Tax Review.  The symposium comes at a time of increased attention concerning the relationship between tax law and racial justice. Professor Dorothy Brown’s book, The Whiteness of Wealth, has justifiably received wide recognition for shining a bright light on how the tax system disproportionately favors White Americans, reinforcing our country’s racial wealth gap.

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On his first day in office, President Biden signed Executive Order 13985, Advancing Racial Equity and Support for Underserved Communities Through the Federal Government. And this past week, Treasury has released a working paper estimating the distribution of certain tax breaks by race and ethnicity. There is a Treasury blog post highlighting the main take aways from this important paper.

As the Treasury blog post notes,

The IRS does not collect information on race and ethnicity on tax returns, so to facilitate analysis of disparities in tax policy, the Treasury Department has developed an approach to impute race and ethnicity in tax data, which it will continue to refine. Using this approach, the Department has conducted a first-of-its-kind analysis of the impact of tax expenditures on racial and ethnic disparities, which will increase transparency and improve our understanding of how existing tax policies work.

In the study, Treasury found that preferential rates for capital gains and dividends, deduction for pass-through income, charitable deduction, home mortgage interest deduction, and deduction for employer-provided health insurance disproportionately benefit White families.

In contrast, Treasury notes that “Black and Hispanic families, who make up a disproportionate share of low-wage workers, disproportionately benefit from the Earned Income Tax Credit” And “Hispanic families, who have comparatively low rates of employer-sponsored health insurance, also disproportionately benefit from the Premium Tax Credit, which provides assistance for the purchase of health insurance through the Marketplaces. Finally, Hispanic families disproportionately benefit from the Child Tax Credit.” 

The Feb 24th Symposium thus comes at an important inflection point for scholars and others interested in how the tax system relates to issues of racial justice, and includes panels on the following:

• Race, History, and Taxation

• Tax Systems and Privileged Choices

• Systemic Inequalities Undergirding Facially Neutral Tax Laws

• Discrimination through Non-Discrimination

I am thrilled to participate, as I will discuss the relationship between tax administration and racial justice, an especially important topic given how, for better or for worse, Congress increasingly tasks the IRS to play a main role in distributing benefits relating to poverty relief, creating work incentives, and subsidizing health care, housing, and energy efficient consumption. The Center For Taxpayer Rights will explore these themes further in the fall of 2023 as part of its successful Reimagining Tax Administration series. The Center’s first Reimagining Tax Administration series in 2021 addressed running social programs through the Internal Revenue Code, and the 2022 series explored taxpayer rights at the state level. With its upcoming series Racial Impact of Tax Administration, the Center will follow up on many of the themes likely to be explored in the February 24th Symposium.

While virtual and in person attendance for the February 24th Symposium is free, there are limited spaces, so I encourage those of you interested to register asap.

Getting Refunds in Collection Proceedings: Why CDP Matters

In my last two posts (see here and here) I have tried to put into perspective how a taxpayer is and isn’t constrained by the Tax Court’s lack of “refund” jurisdiction in CDP cases. In my posts I have tried to explain that the Tax Court may (1) functionally determine an “overpayment,” so long as it pertains to the propriety of a collection action, and (2) order the IRS to return money to the petitioner, so long as it is not a “rebate” refund (i.e. money representing an overpayment).

In this post I want to expand on the ability to get a refund in CDP a bit more, with a focus on how even if what you’re really after is the determination of an overpayment with a (rebate) refund, CDP may still be of use. To get there, we need to think a bit more holistically about how the CDP process really works, rather than just focusing on the (occasional) end-product of a Tax Court order.

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So you think the IRS should give you money and you have the opportunity for a CDP hearing… Returning to my wrongful state tax levy example may help illustrate the problems with throwing up one’s hands and cursing Greene-Thapedi for CDP’s futility.

As a refresher, in my earlier post I stated that if I had a case where the IRS took a state tax refund without giving the (legally required) prior notice, I would demand that money back in a CDP hearing. In the comments, Carl noted that every court thus far has found that the Tax Court does not have refund jurisdiction. Carl also compared the statutory language of Tax Court CDP jurisdiction (IRC § 6330(e)(1)) with that of the Tax Court’s refund jurisdiction in deficiency cases (IRC § 6213(a)). On his reading (and having no small amount of knowledge on the area of all things jurisdictional), Carl speculated that the Tax Court also likely wouldn’t find it had the injunctive grant of power to return the improperly levied state refund.

Perhaps.

In my prior two posts I think I’ve explained why I don’t think that’s the case. But let’s leave that alone for now. Instead, let’s focus on everything that would happen before actually getting to the Tax Court.

How CDP Cases Actually Play Out – Multiple Chances for Remedy

If the facts are abundantly clear that the IRS did not send the proper, legally required notice prior to levying on my state tax refund, it is possible that the CDP hearing will end without ever needing Tax Court involvement. Perhaps you get a reasonable Settlement Officer who takes seriously their statutory obligation to investigate that “the requirements of any applicable law or administrative procedure have been met.” IRC § 6330(c)(1). Clearly, they were not followed in my hypo.

Admittedly, it is an open question of whether the IRS should necessarily have to give back the state tax refund just because the applicable rules were not followed. Perhaps the IRS could make some sort of harmless error argument, if I really don’t have a good alternative to levy. But it is also pretty easy to come up with facts where the IRS’s own policies would suggest that they shouldn’t have levied -for example, if the levy would cause (or exacerbated) economic hardship.

Importantly, it is also clear that the IRS “can” give a state refund back to the taxpayer. The IRM suggests that there are a number of situations where it may be appropriate to return a state tax refund levy (see IRM 5.19.9.3.7). The IRM also suggests returning the refund if there was a finding of economic hardship. See IRM 5.1.9.3.5.1(8).

So with the right facts and a reasonable Settlement Officer the IRS just might agree to give you back the improperly levied proceeds in their (favorable) determination letter. Obviously, being provided the relief you sought, you would petition the Tax Court thereafter, and no Tax Court involvement would ever take place.

The system (in this case, buoyed by a truly “Independent Office of Appeals”) works!

Indeed, this is precisely what I suggested in my post on the CP504 Notice, where I mentioned the value of CDP while also (in the same sentence) mentioning the limitations on refund jurisdiction in Tax Court. Simply put, you can get a refund in an administrative CDP hearing that you may never get “ordered” in CDP litigation.

But what if the Settlement Officer issues an unfavorable notice of determination? Good news: you still don’t (yet) need the Tax Court to order a refund. You just need reasonable IRS Counsel after your petition.

Believe it or not, even huge bureaucracies like the IRS are ultimately made up of people -most of whom want to do the right thing. I’ve had multiple petitions on CDP determinations where there is a plain error made by IRS Appeals. On the egregious cases I’ve had, when IRS Counsel gets the petition they ask me, “what can we do to fix it?” Sometimes IRS proposes a fix that the Tax Court would not be able to order on its own. As an example, I had a CDP case where IRS Counsel proposed removing penalties as a fix, even though (in our posture) there was no possible way of the Tax Court providing that remedy.

Of course, the obvious next question is “but what if IRS Counsel doesn’t agree with you?” Well, then you just may get to a Tax Court order. But even still, I think the Tax Court can play an important role without directly ordering a refund.

Doing the Right Thing, With the Right Motivation

Back to the Schwartz opinion from my first post…

In Schwartz the Tax Court found that the petitioner didn’t owe for two years (2006 and 2007) but did owe for others. Accordingly, the conclusion of the opinion states that the Tax Court does “not sustain the proposed levy for those years.” What are the consequences of this opinion?

I suppose you could read it extremely narrowly: the IRS cannot levy for 2006 and 2007. That’s it.

Or you could read it more accurately: the IRS cannot levy and should adjust their accounts to show no balance due for those years.

There is a subtle difference between the two.

Theoretically, if the order didn’t require the IRS to adjust the account balance but only said “the IRS cannot levy” for 2006 and 2007 the IRS could still maintain that there is a balance due, and even offset against it, effectively collecting while not running afoul of the Tax Court order. This would read an opinion (and order) as only pertaining to the propriety of a levy, and not addressing the underlying rationale.   

But it is unthinkable to me that the IRS would fail to adjust the accounts, not least of all because the opinion makes explicit that the Tax Court has found no balance due. So it shouldn’t really matter if the ensuing order tacks that on… but therein lies the rub.

As I said before, Tax Court opinions matter. And this is why remands aren’t a useless remedy. I ended my first post with the hypo where the Tax Court finds that the IRS erred in failing to credit the taxpayer’s account with $5,000 on a $3,000 liability. Conceptually, not that different from Schwartz or even the issue in Melasky… albeit in my hypo, the Tax Court has a favorable finding for the taxpayer.

What happens next?

The Tax Court opinion finds that the IRS erred in failing to credit money to the taxpayer’s account. But the Tax Court order only remands the case to IRS Appeals to address this error in a supplemental hearing: it does not “order” a refund.

The opinion, frankly, should be enough to get you where you want to go. When the Tax Court kicks the case back to Appeals, the IRS should get the (literal and figurative) memo. It will either make the adjustments required of the opinion’s reasoning or be stuck in a doom-loop of remands for errors of law in its supplemental determinations.

In my experience, this is actually a pretty non-controversial understanding of how the Tax Court works in CDP, even on “vanilla” collection issues. The Tax Court almost never “orders” specific relief (e.g. “the IRS must accept this Offer,”), but rather remands solely on abuse of discretion (e.g. “the IRS abused its discretion in rejecting this Offer,”). Where taxpayers ask for more, they usually don’t get it, even when they clearly win on abuse of discretion. See, for example, Antioco v. Commissioner, T.C. Memo. 2013-35 (Judge Holmes finding abuse of discretion, but not ordering the IRS to enter into an installment agreement).

Conclusion: Maybe You Don’t Need an Order of Refund, or Even Refund “Jurisdiction”

The IRS’s mission isn’t to cling tightly to as much money as it can that comes through its doors. And the IRS attorneys I’ve worked with likewise don’t tend to see this as their job. I am confident that if I had a court opinion saying “IRS you were wrong to take this money,” the IRS wouldn’t say “But we’re keeping it until you can find a judge to specifically order us to give it back.”

It is, perhaps, a hassle that the Tax Court can’t or won’t act as a one-stop shop to order these refunds, and that a particularly recalcitrant IRS employee could force the taxpayer to seek redress in federal district court. But I don’t think this is what happens in most instances.

At the administrative level, the IRS can surely make the changes to its accounts “behind the scenes” in CDP, and without the Tax Court expressly ordering them to do so. I expect that’s how most CDP cases resolve.

But even at the Tax Court level, it is important to recognize that the parties can enter decisions that provide more detail and more protection than just “the Notice of Determination is (or is not) sustained” without running into jurisdictional traps. Indeed, going beyond the limited jurisdictional issues before the Tax Court judge is what negotiating “below the signature” stipulations is all about (PT posted a helpful IRS guide on that issue here).

And while it might not be a Tax Court “order,” having stipulations dealing with the future actions of the parties (e.g. “the IRS will credit Petitioner’s account with $x”) is not too shabby.  

Getting a Refund in CDP: Don’t Call it a (Rebate) Refund

In my previous post I discussed how the Tax Court can effectively find there was an “overpayment” in CDP jurisdiction, even if it doesn’t (or can’t) order a “refund” thereafter. This, I argued, is essentially what happened in the recent case of Schwartz v. Commissioner. In this post I’ll take things a step further by arguing that the Tax Court can (effectively) order a refund in CDP, even if it can’t quite use those exact words.

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Imagine that the IRS levied on your state tax refund when it has not properly followed the procedures (that is, the law) prior to doing so. Fortunately, under IRC § 6330(f) you are provided a CDP hearing after the levy. You are pretty upset: indeed, you want the money back for the IRS’s improper levy.

Months ago, I wrote about this exact scenario with the IRS CP504 “Notice of Intent to Levy.” I argued if the IRS does not properly send the CP504 (for example, it isn’t sent to the “last known address”), the IRS should have to return the levied proceeds to the taxpayer. I suggested that this be done at the CDP hearing.

Carl Smith noted in the comments section that you probably wouldn’t be able to get these proceeds returned in CDP because the Tax Court does not (believe itself to) have “refund jurisdiction.” See Greene-Thapedi. And I completely agree with Carl that if you ask the Tax Court to “order” a “refund” in CDP it isn’t going to happen.

But I don’t think that ends the inquiry or addresses the actual hypothetical I laid out. And it is important to understand why.

It is fair to say that the Tax Court has tended to take a rather narrow view of its ability to order refunds in CDP litigation. The posts here and here detail multiple cases where the Tax Court (and affirming appellate courts) say “sorry, but if you’re asking for a refund you’re in the wrong place.”

One could therefore be excused for looking at these decisions and saying “if you’re asking for money back, it isn’t going to happen in CDP.” In a likely ill-advised effort of providing a mnemonic device, I’m going to refer to this approach as being a “Thapedi-Thumper,” since a broad reading of Greene-Thapedi really forms the backbone of this belief.

I see two fundamental problems with the Thaepdi-Thumper approach. The first problem is focusing too much on the need for the Tax Court’s jurisdictional power to order a refund. The second, related problem, is a failure to focus on the actual people and actual processes that resolve the bulk of CDP controversies.

I will cover the second problem in my next post. For now, let’s look at if and when you really need “refund jurisdiction” in CDP to get the remedy you’re asking for.

Overpayments and Refunds – Keep Them Separate

In my previous post I noted the distinction between an “overpayment” and a “refund.” Namely, that an “overpayment” is what happens when you have more credits/payments than tax, and a “refund” is when the IRS actually sends that excess money to you. It is important to keep those notions separate.

Let’s start with the Tax Court and overpayments in CDP. I think it’s clear that the Tax Court is actually less averse to making determinations about the existence or amount of overpayments than Thapedi-Thumpers may believe. Indeed, Greene-Thapedi itself suggests this in the oft-cited and tantalizing “Footnote 19,” which provides:

We do not mean to suggest that this Court is foreclosed from considering whether the taxpayer has paid more than was owed, where such a determination is necessary for a correct and complete determination of whether the proposed collection action should proceed. Conceivably, there could be a collection action review proceeding where (unlike the instant case) the proposed collection action is not moot and where pursuant to sec. 6330(c)(2)(B), the taxpayer is entitled to challenge “the existence or amount of the underlying tax liability”. In such a case, the validity of the proposed collection action might depend upon whether the taxpayer has any unpaid balance, which might implicate the question of whether the taxpayer has paid more than was owed.

To me, the footnote suggests that the Tax Court may consider overpayments when relevant to a proposed (i.e. not mooted) collection action. The Schwartz case is consistent with this: there was still outstanding tax on multiple years (i.e. no refund would result), but the “validity of the proposed collection action” on the years where there was an overpayment would obviously not be upheld. That’s why Judge Vasquez said it didn’t matter if he looked at the issue from abuse of discretion or de novo: the levy wouldn’t be sustained either way.

The problem is that so many taxpayers (understandably) want to take it a step further: they have an overpayment, so why not also order a refund? That’s what the taxpayer in McLane v. Commissioner (T.C. Memo. 2018-149) wanted, and that’s what the Tax Court resisted. As far as collection went, the “overpayment” tax year at issue (2008) was already fixed by the parties, with the IRS abating the assessment.

So let’s move to when, if ever, you might get a refund in CDP litigation. On that question I’d say that it is clear the Tax Court will not order a refund of an overpayment. But the Tax Court may order a refund of other ill-gotten funds.

What does that mean? It means that if you are saying you “paid more tax” than you have due (i.e. an overpayment) you are out of luck in CDP litigation. But if instead you are saying the IRS took money they shouldn’t have (say, by failing to follow proper procedures), you may just get your money back.

If you want to put a technical spin on it, I’d say that the Tax Court is averse to ordering “rebate refunds,” and perhaps less averse to “non-rebate refunds.” Again, I commend Professor Camp’s article to those who want to learn more about the distinction between the two. For present purposes (and possibly in contravention of what Professor Camp himself would agree to), I’m going to classify any disbursement of money to the taxpayer that doesn’t result from an overpayment as a “non-rebate refund.”

You may say I’m a dreamer, but I’m not the only one: Chocallo v. C.I.R., T.C. Memo. 2004-152.

The Chocallo opinion involves a disgruntled pro se petitioner asking the Tax Court to exercise all sorts of powers it does not have in CDP: namely, criminal prosecution of IRS employees and other monetary compensation. The Tax Court pretty easily determines it doesn’t have jurisdiction to do so. But you might ask why the petitioner was so upset in the first place…

And that’s where things get interesting.

The Tax Court found that the IRS had levied on Chocallo’s bank account (for approx. $23,000) prior to offering her a statutorily required CDP hearing. (The IRS later discovered that the underlying assessment was invalid too… oops.) Because the levy improperly occurred prior to being offered a CDP hearing the Tax Court, in Judge Ruwe’s words, “ordered that the amount collected by levy be returned to petitioner with interest.”

Wow. Ordering money being returned in a CDP hearing… How are we to unpack this?

The Chocallo opinion was issued before Greene-Thapedi, which is important. The Tax Court was aware of Chocallo when it gave its opinion… and in approximately three paragraphs discussing Chocallo, gave no indication that it disagreed with the return of the improperly levied proceeds. Indeed, the court thought it an important distinction that Chocallo dealt with an improper levy rather than offset, as was the case in Greene-Thapedi.

This is all to suggest that Chocallo is in fact consistent with Greene-Thapedi. The Court doesn’t find it necessary to explain why Chocallo is consistent, but I can think of a couple reasons it might have latched on to.

First, one could argue that what the Tax Court did in Chocallo was not to order a “refund” or even to determine an “overpayment.” Instead, it ordered the IRS to “return” certain levy proceeds. Note, importantly, that as I define it, these would be “non-rebate refunds.” The return of money in this case has nothing to do with whether there was an “overpayment” or not: it just has to do with the propriety of the collection action.

(As an aside, note that this is exactly the remedy I’d be asking for in the hypothetical involving an invalid CP504 Notice and levy on state tax refund I posted on, which Carl seemed to disagree with me about. Because I can’t let it go, more on why, regardless of Chocallo, I think I’d have a good chance of getting the levied proceeds back in CDP in my next post.)

Second, one could read Chocallo as merely addressing a procedural wrong (levy prior to CDP hearing), that in a very real sense has nothing to do with the “underlying liability” of the tax, and everything to do with the levy action itself. And what exactly is the Tax Court given jurisdiction over if not a review of the propriety of levy actions?

Indeed, PT has covered something quite similar before in Cosner v. Commissioner. Strangely enough, the Tax Court seems to care when the IRS improperly levies in CDP litigation reviewing the propriety of levy actions…

Reasons to Doubt My Optimism

Yet despite everything I’ve written, one could still be excused for wondering how much a “non-precedential” (reasons for scare quotes in this post) memorandum opinion from 2004 can really open the door to getting money back in CDP. Similarly, is the Tax Court really going to be swayed by arcane (and questionable) distinctions between “rebate” and “non-rebate” refunds?

I think the issue has yet to be determined. The case that actually worries me the most isn’t Greene-Thapedi or any of the other “please give me a refund of overpayment” cases. Rather, it is the much-maligned Brown v. Commissioner saga (as written about here, here and here among other places).

It appears that the litigious Mr. Brown asked the Tax Court to provide a refund of his TIPRA payment on his returned Offer in Compromise… and the Tax Court said it has no such jurisdiction. That would very plainly be a “non-rebate” refund. A big strike against the distinction I’ve attempted to draw, albeit in a non-precedential opinion. I’ve also previously complained about the Brown’s case failure to raise administrative law arguments, and I seriously doubt that it raised the rebate/non-rebate distinction here, so perhaps the argument could still persuade a judge. But the existence of this opinion makes the fight a little more uphill.

Nonetheless, I’d note that Brown had relatively bad facts for the taxpayer. I’d also note that Greene-Thapedi, McLane, and others tend to have extremely convoluted fact patterns. It is possible that when the issue is a bit more clear-cut (IRS didn’t follow proper procedures) the Tax Court may be willing to order appropriate relief, short of a “rebate refund.” The Tax Court does, I believe, want to fix obvious wrongs so long as it has the jurisdictional “power” to do so.

So long as there is an obvious inequity and the remedy doesn’t violate refund jurisdiction, the Tax Court can help. Note that Greene-Thapdedi references (without criticizing) Chocallo’s return of the improperly levied proceeds as an exercise of the “Tax Court’s inherent equitable powers.” The precedential case Zapara v. Commissioner (126 T.C. 215 (2006)) is also a very clear exercise of inherent equitable powers. And again in 2006 (albeit in the non-precedential Sampson-Gray v. Commissioner, T.C. Summ. Op. 2006-19), the Tax Court (1) references its inherent equitable powers, (2) cares about whether there was a procedural defect to be remedied, and (3) “expects” the IRS to do the right thing and credit the taxpayer with the money that is due to them (see footnote 5).

Put together, this means that you may not be out of luck in Tax Court during CDP litigation when you’re asking for money back, so long as you aren’t asking for an “order” of a (rebate) “refund.” But beyond that, as I’ll detail in my next post, even if what you want is undeniably a rebate refund, CDP may still help get you where you want to go.

“Refunds” and CDP Review

In a post months ago, I wrote that if the IRS improperly levied on a state tax refund by failing to give required notice, I would ask for the money back in the CDP hearing. In the comments to my post, I was promptly reminded of the Tax Court’s lack of “refund jurisdiction” as well as its (possible) lack of injunctive power to order a return of the improperly levied funds.

In response, I started writing about why I don’t think that the lack of refund jurisdiction or lack of injunctive power ends the conversation or dooms my argument: in other words, that even without a Tax Court order, I still think I’d have a decent chance of getting my money back if the IRS (clearly) improperly levied and I raised that issue in a CDP hearing. Then life happened and the post got put on the back burner. In the interim, however, another CDP case caught my eye: Schwartz v. Commissioner, T.C. Memo. 2022-125. The opinion is interesting for a number of reasons, but for me it really drives home two points: the power of framing the issue, and the functional ability of the Tax Court to fix problems in CDP even if it cannot “order” certain relief from the IRS. More below the fold:

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The Power of Framing

In CDP review, quite a lot hinges on how you frame the issue (and your proposed relief) to the Tax Court. Frequently this comes up in the context of disputing the underlying liability. Depending on exactly how you frame your issue (more accurately, how the Tax Court interprets the issue), you may get de novo review instead of abuse of discretion: that’s the crux of the precedential Melasky case covered here (with links to additional coverage therein). (Note also that if it is a pure merits issue you may not even be able to raise it at all (see, for example posts here and here).

Context matters in determining the proper way to frame an issue. I’ve posted on this previously, with regards to summary judgment motions. But I’ve also posted about how in CDP the seemingly straightforward argument “I don’t owe the tax” can be framed in different ways. The Tax Court could look at that as a “merits” argument (disagreeing with the calculation of the tax) or a “procedure” argument (disagreeing with the IRS books for continuing to show an outstanding liability).

Which brings us to Schwartz, which is something of a hybrid between the two.

In Schwartz, the taxpayer (led by estimable counsel Karen Lapekas) essentially argued that they “don’t owe” for the years at issue because they had a credit-elect under IRC § 6402(b) that would wipe out each liability. For more on the many nuances of credit-elects, see posts here, here, and here. For our purposes, all that you need to know is that the taxpayer claimed they overpaid for 2005, applied that overpayment to the next year (i.e. the “credit elect”), and that resulting overpayment for 2006 was applied to the next year… and so on and so on in a cascade, that effectively resulted in no balance due for any of the years before the Tax Court.

I highly recommend reading the opinion for details both on the metaphysics of credit-elects, and the “informal claim doctrine” (see posts here and here). Those were the substantive issues that Judge Vasquez spent most of his time wrestling with. I’m going to largely ignore them to focus on a procedural issue that Judge Vasquez… didn’t quite ignore, but definitely sidestepped.

When a taxpayer says “I don’t owe” in a CDP case, and the reason they “don’t owe” is a credit elect, what is the standard of review? There are definite undertones of merits issues/challenges to the liability (it is a “credit” that is claimed on a tax return after all) and procedure (that “credit” happens to be in Subtitle F, which covers procedure and it really is just the application of a payment).

The Tax Court hasn’t quite made up its mind on how that works with credit-elects. Judge Vasquez notes that in one case (Landry v. Commissioner, 116 T.C. 60 (2001)) the Tax Court applied de novo review to a credit elect issue. However, later in the aforementioned Melasky case, the Tax Court applied abuse of discretion review to the dispute over whether a payment was properly credited to the taxpayers account -which is pretty fundamentally similar to a credit elect. What to do here…

Fortunately, Judge Vasquez determined that he didn’t need to reach that question because the IRS would lose on abuse of discretion or de novo review… that tends to happen, I suppose, where the judge finds that IRS Appeals erred on a consequential matter of law.

Ultimately, Judge Vasquez finds that Mr. Schwartz had a valid credit-elect for some years (2006 and 2007) but that the record wasn’t sufficient to show that the carryforward “cascaded” to later years (2010 – 2012). Because of this, the IRS proposed levy action is “not sustained” for 2006 and 2007, but is for 2010 – 2012.

Why Schwartz Matters: A Refund By Any Other Name?

I think it is important to consider what the Tax Court functionally did in this case. Effectively, it determined an overpayment for multiple years. I really don’t think you can get around that conclusion for the concept of a cascading credit-elect to make any sense.


Maybe that’s no big deal: the Tax Court even hinted as much in Greene-Thaepedi that it might determine overpayments in some circumstances (see footnote 19). Also, one could say that in Schwartz the Tax Court was only looking at the timing of an overpayment, and didn’t determine the amount. Further, in Schwartz, the Tax Court didn’t order a “refund,” which is what we really care about.

(It’s also worth highlighting that it was Judge Vasquez (with Judge Swift joining) who dissented in Greene-Thapedi, believing that the Tax Court did, in fact, have something akin to refund jurisdiction. In that regard, Schwartz may have had had a “good draw” on the judge deciding his case.)

But Schwartz definitely doesn’t conflict with Greene-Thapedi, and I’d suggest the most important reason why is this: a refund is different from a determination of overpayment. An “overpayment” is a determination that the taxpayer had more credits/payments than tax. A “refund” occurs when the excess is sent to the taxpayer. See IRC § 6402(a). A lot of people have “overpayments” but still don’t end up with “refunds.” That’s because they owe other back taxes, child support, student loans… or perhaps choose a credit-elect rather than a refund.

(For more on the contours of overpayments and refunds, I would recommend an older article from Professor Bryan Camp found here. I have returned to it again and again when dealing with the metaphysics of refunds, assessments, and all other forms of tax procedure geekery ordinary people dare not dream of.)

But even if there was only the determination of an “overpayment” and not the order of a “refund,” in Schwartz, I think it holds another important lesson. And that lesson is this:

Court opinions have consequences.


Well duh, you reply. But what I’m getting at is that an “opinion” can carry consequences even if it isn’t followed by a particularly useful “order.”  In other words, even if the Tax Court doesn’t have “refund jurisdiction” in CDP to “order” refunds, it may nonetheless have a functionally equivalent power when it determines that the IRS erred as a matter of law.

To illustrate, imagine that the Tax Court issues an opinion finding that the IRS erred in failing to credit $5,000 to a taxpayer’s $2,000 liability. As we’ve seen in Schwartz, even in CDP cases the Tax Court can clearly make such a determination. What the Tax Court (arguably) cannot do is follow that opinion with an order that the IRS refund the taxpayer $3,000. But the Tax Court can remand for abuse of discretion on proposed collection of a non-existent liability.

And what happens next?

In my next two posts I’ll explore that question and dive again into just how close to getting a “refund” you can get in CDP even without “refund jurisdiction” in Tax Court.

Now is the Time for IRS to Enhance Digital Services

Today’s guest post features first time contributor Jessica L. Jeane, who is the VP of Tax Policy & Strategic Partnerships, at Western CPE. In this post, Jessica discusses the state of the IRS’s digital services offerings, a key theme in the recently issued  National Taxpayer Advocate’s Annual Report to Congress. As Jessica discusses, the IRS has made some progress for both taxpayers and tax pros, but there is lots of room for improvement. Les

It likely comes as no surprise to readers that the IRS isn’t winning any awards in the digital services realm. A few old adages come to mind when thinking about the long-awaited improvement needed for the IRS’s digital communications or more formally digital tax administration services. Maybe something along the lines of: there’s no time like the present, seize the day, or even in the words of Elvis Presley, “it’s now or never.”

Okay, the last one is probably a little dramatic, but the overarching point here is that now is the time for the IRS to enhance its digital communications tools for taxpayers and tax professionals. But don’t take my word for it, just ask the National Taxpayer Advocate (NTA) Erin M. Collins.

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Seize the Day (Or the Funding)

Indeed, the need for improved digital services in both the areas of customer service and compliance has been a consistent concern of Collins’. And she again reiterates the importance of ramping up these digital communications efforts in the Online Access for Taxpayers and Tax Professionals section of the 2022 NTA Annual Report to Congress released earlier this month.

In fact, of all the steps the IRS could take to improve the taxpayer experience, creating robust online accounts should be the highest priority and will prove the most transformational, according to Collins. “Providing tax information and services accessible through a robust online account and seamlessly integrated digital communication tools are essential for taxpayers, their representatives, and IRS employees,” she wrote.

And why is now the time for the IRS to expand its digital services, you may ask. I’ll give you 5 billion reasons. I won’t, but the IRS’s recent funding boost of nearly $80 billion under the Inflation Reduction Act (IRA) (P.L. 117-169) serves as a good one. Specifically, the IRA provided $4.74 billion to the IRS for business systems modernization.

As Collins noted, most taxpayers have been conducting business with various financial institutions digitally for at least the last two decades, and it’s high time the IRS offers online accounts with comparable functionality. Importantly, doing so would eliminate the need for calling the IRS (good luck there) or mailing paper correspondence (the IRS’s Achilles heel).

In that vein, the IRS has been working on (or working toward working on) expanding its digital services for years, and most recently in accordance with statutory requirements since 2019 pursuant to the Taxpayer First Act (TFA) (P.L. 116-25). Under the TFA, the IRS was required to provide Congress a report on its “comprehensive customer service strategy.” And starting on page 41 of the TFA Report to Congress (2021), the IRS details its goals for expanding digital services. Yet as Caleb Smith noted in his Procedurally Taxing post last year, the report contains a lot of aspirational buzzwords rather than a clear path forward. And what’s more, fast forward over two years later (okay, and a pandemic), the IRS is missing the mark. To the IRS’s credit, however, it has made some meaningful advancements in its digital services lineup over the last few years, but it still has a long way to go. Just take a look at the Treasury Inspector General for Tax Administration’s (TIGTA) audit report released last November detailing its less than stellar review of the IRS’s Taxpayer Digital Communications (TDC) program. In case you haven’t read it, I’ll save you the suspense and tell you that TIGTA weighed and measured the IRS’s implementation of the TDC program and it was found wanting.

Generally, the TDC program is intended to enable taxpayers and practitioners to better communicate and securely share information with the IRS. Best laid plans, am I right? Except in this case, the plans weren’t laid out too well, according to TIGTA’s findings, which note that the IRS failed to proactively identify IRS functions or operations for which digital communication may have provided sizable benefits for both taxpayers and IRS employees. TIGTA’s evaluation further concludes that the IRS’s management of the TDC program was more focused on completing various program installations than actually maximizing the IRS’s ability to communicate digitally with taxpayers.

Tax Pros’ Efforts are Instrumental in Effective Tax Administration

While we often focus on the taxpayer implications of various tax procedure and administration issues, it is important to note the impact on the tax professional, as well as not discount that impact’s effect on the taxpayer. Plainly put, the important role tax professionals play in effective tax administration and compliance while minimizing taxpayer burdens cannot be overstated.

And as our tax pros know better than anyone, and let’s just call a spade a spade, communicating with the IRS ain’t easy. During 2022, the IRS answered only 11 percent of calls – an “all-time low.” And 52 percent of correspondence currently remains unprocessed in the IRS’s backlog of inventory that goes beyond standard processing timeframes.

“Taxpayers or their representatives wanting to interact online need and deserve quality service options and quick responses from the IRS,” Collins wrote in the 2022 NTA Annual Report to Congress. “Today, most taxpayers and tax professionals can’t depend on receiving either, causing dissatisfaction that can lead to distrust in tax administration.”

In a solid effort to increase its digital tax services, the IRS rolled out the Tax Pro Account feature in 2021, which at the time was called a “groundbreaking step” by former Commissioner Chuck Rettig. “This is the first, basic step toward a more fully integrated digital tax system that will benefit taxpayers, tax professionals, and the IRS,” Rettig said.

And while the Tax Pro Account certainly received a warm welcome from practitioners, it hasn’t lived up to industry expectations. In fact, Collins refers to its name as a “misnomer,” because it offers only very basic functions for tax pros, such as digitally signing and transmitting a Form 2848, Power of Attorney and Declaration of Representative.

What it fails to provide, however, is secure messaging and the ability to upload documents. According to Collins, needed upgrades to the Tax Pro Account should include practitioners’ ability to:

  • view all clients’ Online Accounts through their Tax Pro Account portal;
  • view all changes and new information posted in the taxpayer’s account;
  • view all notices and letters mailed to the taxpayer;
  • view the status of pending refunds and requests;
  • view information on digital payment options;
  • upload requested documents relating to notices or correspondence on a tax issue; and
  • send messages to an IRS employee working their client’s case.

“Tax professionals are key to a successful tax administration.  The challenges of the past three filing seasons have pushed tax professionals to their limits, raising client doubts in their abilities and creating a loss of trust in the system – often through no fault of the tax professional.”- Collins

Good News

While the digital services situation remains dreary today, the good news is that the IRS not only states that it is committed to expanding digital services, it now has the funding to do it. “The Inflation Reduction Act affords the IRS the funding and opportunity to implement numerous improvements to the online services offered to taxpayers and tax professionals,” the IRS said in its comments included within Collins’ report.

Additionally, the IRS said it is planning expansion of certain digital services available through the Tax Pro Account and has developed a list of enhanced features based directly on feedback from the tax professional community. We’ll cheers to that. 

A Quick Hobby Loss Refresher: Why These Losses Are Useless (At Least Until 2026)

Today’s post veers slightly from procedure. If one takes seriously the promise that the coming uptick in IRS will fall on those with incomes over $400,000, we might see an increase in hobby loss/ Section 183 cases. When wealthy taxpayers try their hand at boat chartering in the Caribbean, dressage, running a vineyard, or writing a travel guide premised on finding the best sushi in Japan, and the activities generate losses that the taxpayer would like to use to offset other income, the IRS may carefully scrutinize the taxpayer’s profit intent.

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As I teach my students, Section 183 is technically a deduction allowance provision. Taxpayers may have some gross income from the hobby. Section 183 allows taxpayers to deduct some of the expenses from the activity, even if the taxpayer does not establish the profit intent to merit the activity qualifying as a trade or business.

If a taxpayer cannot establish the needed profit intent, Section 183 is supposed to allow taxpayers to deduct the expenses associated with the hobby activity to the extent that the hobby has kicked off some income. But for 183, the expenses would be considered personal nondeductible expenses under Section 262. That means that, theoretically at least, as a result of Section 183 taxpayers are not going to have an increase in tax liability due to their likely pleasurable but unprofitable activity. So Section 183 throws a small bone to taxpayers who, but for 183, would face an increase in tax liability from an otherwise personal activity that would not generate any deductible expenses.

Enter the 2021 Tax Court case of Gregory v Commissioner T.C. Memo. 2021-115. I came across it an article on Section 183 by Leila Carney, Entrepreneur or Hobbyist: Turning Losses Into A Win, 110 Practical Tax Strategies 10 (January 2023). And back in 2021 Bryan Camp has a really nice write up of the case in his weekly Tax Prof series, where he provides some helpful historical context for our tax system’s distinction between above the line and below the line deductions.

Gregory involved taxpayers who had a Caribbean-based boat chartering business. Gregory confirms that a taxpayer whose activity is deemed not for profit will not be able to take any deductions from that activity, save expenses (like local taxes) that would otherwise be deductible.

For those still with me here is the roadmap getting to that outcome. The Code does not specifically identify Section 183 as an above the line deduction used in computing AGI. To get to taxable income, taxpayers can elect to take their itemized deductions or take the standard deduction. Section 67 defines itemized deductions as deductions other than (i) those allowable in computing AGI and (ii) the deduction for personal exemptions allowed under Section 151.

Section 67(b) identifies a number of itemized deductions that are not considered miscellaneous itemized deductions (like, for example, home mortgage interest).

Unfortunately, Section 67(b) does not list Section 183 losses in the category of itemized expenses that are not miscellaneous itemized deductions.

Why is that unfortunate? Well, prior to 2018, miscellaneous itemized deductions were deductible only if they were greater than 2% of a taxpayers AGI. And, as part of what is referred to as the Tax Cuts and Jobs Act, from the years 2018-25, the Code suspends deduction of all miscellaneous itemized deductions. Until 2025, all expenses from the 183 hobby activity will be disallowed, (except expenses that would otherwise be deductible), even while income from the activity remains taxable “other income”..

In Gregory, the taxpayer argued that Section 183, as a more specific statutory provision, should in effect preempt Section 67, with the result that the allowance of expenses under 183 means that those expenses could be deducted above the line to establish AGI.

The Tax Court disagreed, finding that the statutes were not in conflict; rather it just “assumes there is conflict between these two provisions of the Code when in fact each provision may be given effect without precluding or otherwise undermining application of the other.”

The bottom line for the Gregorys is not pretty: the income from their boat chartering activities (totaling $342,173 and $313,825 for the respective years at issue) is taxed as “other income,” but the lion’s share of their corresponding expenses ($341,423 and $313,699) are MIDs. (Payments totaling $750 and $126 categorized as taxes.) Then, “because the Gregorys’ total miscellaneous itemized deductions for both years at issue were less than 2 percent of their adjusted gross income (AGI), no deductions for the [boat chartering] expenses (with the exception of the tax expenses) [are] permitted pursuant to section 67(a).”

The Gregorys have appealed this to the 11th Circuit; there was oral argument last week.

Conclusion

A couple of years ago IRS published guidelines for Section 183 audits. Given the temporary disallowance of all miscellaneous itemized deductions, the stakes are even higher when a taxpayer is deemed to not have the requisite profit intent. I suspect that we may see more of these fact-intensive cases in the years to come.

Public Records Exception to IRC 6103

The case of McGowan v. United States, No. 3:19-cv-01703 (N.D. Ohio 2022) explores the prohibitions in the disclosure provisions and wrestles with whether those prohibitions prevent disclosure of material that is tax return information but also information previously made public.  The case comes down on the side that the material previously made public is not shielded by the disclosure provisions in a discovery dispute in which the plaintiff in a refund suit seeks testimony and information from the government’s expert regarding prior cases in which he served as an expert.  The IRS opposed questioning of the expert regarding prior cases arguing that such testimony is prohibited by IRC 6103.  The dispute centers on the application of the public records exception to 6103 an issue that has a long history.

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In his expert report, the expert witness writes:

I have been retained by the United States to provide testimony as to the nature of various life insurance products, particularly whole-life insurance contracts and term life contracts, and how such contracts operate and are administered. I have also been asked to analyze the particular insurance contract at issue in this case, and to provide an actuarial analysis as to the amount required to provide the death benefits offered to Plaintiffs in connection with the transaction at issue. Additionally, I have been asked to provide testimony as to employee welfare benefit plans and how such arrangements make use of life insurance policies.

In my experience, I have seen that designers and promoters of these purported EWBPs have put a great deal of effort into designing programs that would permit the use of cash value life insurance products on a tax deductible basis. This has been done by attempting to fit within particular Internal Revenue Code subsections regarding sharing of risk among companies by concealing the build-up of cash value through the use of special policies, or by the use of trusts to hold the insurance policies and to temporarily limit the ability of either the company or the insured individual to access the case value.

DeWeese’s [the expert] CV lists 27 prior cases in which he served as an expert.

Plaintiffs have some concern that his experience in 27 previous cases impacted his opinion in their case and they want information so they can pursue that theory.

The three Tax Court cases on which Plaintiffs sought testimony from DeWeese are Booth v. Comm’r of Internal Revenue, 108 T.C. 524 (1997); Neonatology Assoc., P.A. v. Comm’r of Internal Revenue, 115 T.C. 43 (2000); and V.R. DeAngelis M.D.P.C. v. Comm’r of Internal Revenue, 94 T.C.M. (CCH) 526 (2007).

The opinion lists the questions plaintiff sought to ask and the objections based on 6103 made by the IRS.  In analyzing whether the expert can answer the questions asked, it cites to the general prohibition on disclosure in 26 U.S.C. §6103(b)(2) as well as to the exceptions provided in 26 U.S.C. §6103(h)(4).  Plaintiffs argue their questions do not address tax return information but rather the structure of the insurance plans at issue.

The court cites to the conflicting opinions regarding the public records exception to disclosure:

The §6103 definition of return information is broad, and confidential return information “remains such even when it does not identify a particular taxpayer” — that is, even if a taxpayer’s identity can be redacted, the return information still cannot be disclosed. Church of Scientology of Calif. v. I.R.S., 484 U.S. 9, 10 (1987). But the Sixth Circuit has held “once a taxpayer’s return information becomes part of the public domain through the filing and recording of a judicial lien, it loses its confidentiality and is not protected by Section 6103 if republished by the Internal Revenue Service for tax administration purposes.” Rowley v. U.S., 76 F.3d 796, 801 (1996). When information is “clearly already a part of the public domain”, it is no longer confidential.

The court finds that if the expert answers the questions about the insurance plans it would:

almost certainly comprise “the nature, source, or amount of [a taxpayer’s] income, payments, receipts, deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax withheld, deficiencies, overassessments, or tax payments,” and would therefore be confidential return information. 26 U.S.C. §6103(b)(2)(A). Though Plaintiffs insist their questions deal “solely with the structure and operation of the plan[s] at issue” (Doc. 87, at 5), the Court finds the structure and operation of such plans — as income, payments, and deductions — are return information under the §6103 definition.

Having found that the questions would elicit tax return information covered by the disclosure prohibitions in 6103, the court goes on to find that the return information is already public and was disclosed in Tax Court opinions.  It finds:

While the publication of this return information did not occur under precisely the same circumstances as in Rowley, the information within these three cases is “clearly already a part of the public domain”; the return information at issue has not been confidential for more than twenty years. Rowley, 76 F.3d at 801. The protection of this information under §6103 is therefore futile.1 Testimony from DeWeese regarding his experience with and analysis of this return information would speak to his qualifications without revealing additional return information.

From a discovery standpoint, the court finds the information sought part of a legitimate inquiry.  It ends by placing a limitation on the scope of his testimony:

As long as Plaintiffs do not elicit — and DeWeese does not reveal — factual information not made public by the texts of the Booth, Neonatology, and DeAngelis opinions, their questioning of DeWeese on his impressions and experiences with the information in the opinions does not violate §6103 and is permitted.

I don’t know if the IRS will appeal this decision.  The scope or even the existence of the public records exception is something not well settled.  This causes consternation for IRS employees and others dealing with return information that has made its way into the public domain.  I agree with the decision here but would like more definition regarding the limitations on use of information in the public domain, if any.

For more on the public records exception to disclosure see IRS Practice and Procedure at ¶ 4.08[1][b][ii][D]. 

Avoiding the Federal Tax Lien in Bankruptcy

In United States v. Warfield (In re Tillman), No. 21-16034 (9th Cir. 2022) the Ninth Circuit reversed the lower courts and determined that the chapter 7 trustee could not avoid the federal tax lien on the debtor’s homestead.  The trustee filed a motion for rehearing en banc and the 9th Circuit has ordered a response from Appellant by December 4.  A copy of the response is attached here.  So, the discussion below may not be the end of the story.

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Ms. Tillman purchased a house in Prescott, Arizona.  Prior to the filing of the bankruptcy petition the IRS filed a notice of federal tax lien on the property stemming from a penalty she owed.  Ms. Tillman claimed a $150,000 homestead exemption in the house under Arizona law.  The trustee sued to avoid the tax lien on the exempt property in order to obtain the benefit of the lien for the bankruptcy estate.  At the time of the bankruptcy, she had paid off the underlying taxes set out in the lien notice but owed about $25,000 in penalties.

The issue pits different bankruptcy codes sections against each other that deal with exemptions and with the treatment of penalties in chapter 7 cases.

BC 522 generally permits a debtor to claim certain property as exempt.  The amount of property is almost always dictated by the state in which the debtor lives at the time of filing bankruptcy.  Arizona has a generous homestead provision which Ms. Tillman claimed.  Under almost all circumstances a debtor gets to keep the exempt property which cannot be used to satisfy the claims of creditors in the bankruptcy case; however, claiming property as exempt protects it from the claims of unsecured creditors not those who have a security interest in the property claimed as exempt.

BC 522(c)(2)(B) holds that exempting property does not protect it from a tax lien where the IRS has properly filed the notice before the bankruptcy petition.  The notice of federal tax lien would not specifically mention a taxpayer’s real estate but attaches to all property and rights to property belonging to the taxpayer.  To perfect the lien against a taxpayer’s real estate, the IRS would need to file the lien in the locality in which the property was located.  If, prior to the filing of a bankruptcy case, the IRS filed the notice in the city or county in which the property was located and if the notice properly identified the taxpayer, the IRS would have a perfected lien that would survive the debtor’s attempt to claim the property as exempt.  It would not receive payment for its lien in the bankruptcy case but would have the ability to pursue the property after bankruptcy.  Because the IRS is reluctant to administratively or judicially take taxpayer’s homes, sometimes taxpayers get to keep their homes safe from other creditors because of the federal tax lien’s priority, and then the IRS never pursues the property allowing some lucky taxpayers to walk away from both their tax obligations and their other debts.

Chapter 7 trustees do not have the same reluctance or policies regarding debtor’s homes that the IRS does.  The trustees carefully review debtor’s schedules and other available information to determine if selling the debtor’s home or other assets would bring a benefit to the unsecured creditors of the bankruptcy estate (as well as a commission to the trustee.)  Here, the trustee sought to use the existence of the tax lien combined with BC 724 and 726(a)(4) to sell the property for the benefit of the unsecured creditors.

BC 724(a) says that a chapter 7 trustee can avoid a “lien that secures a claim of a kind specified in section 726(a)(4)” for the benefit of the estate.  BC 726 describes how property in a chapter 7 case should be distributed to creditors, providing first for claims listed in BC 507 which would include the unsecured claims to which Congress has given priority, second to unsecured claims with no priority, third to unsecured claims filed late, and fourth to claims for penalties, whether secured or unsecured.

The trustee reasoned that because the underlying tax had been paid, the IRS’s claim (secured by the notice of federal tax lien) was merely a claim for a “penalty” within the meaning of BC 726(a)(4), and therefore under BC 724 the lien could be avoided.  The bankruptcy code disfavors penalty tax claims allowing the avoidance of the liens for these claims through the procedures described in BC 724 and 726.

However, the trustee had one more hoop to jump through: under BC 551 the property preserved must be property of the estate. This requirement was key to the government’s argument.  Section 551 comes immediately after the bankruptcy code provisions allowing for the avoidance of certain transfers.  It seeks to preserve the property avoided for the bankruptcy estate unless the property would not have met the definition of property of the estate described in in BC 541.  In other words, the avoidance provisions cannot transform property that would otherwise have remained outside the estate into property of the bankruptcy estate.

The bankruptcy and district courts held that the trustee could avoid the federal tax lien, rejecting:

The government’s argument that the court’s holding would cause inequitable results for the Debtor, because the Debtor’s exemption could be reduced twice as a result of the same lien—first, as a deduction from the amount that Debtor could exempt, and then, again, when the Debtor is required to satisfy the value of the lien to the IRS. The Bankruptcy Court reasoned that the Debtor would not have to unfairly pay twice on the same lien because the IRS Tax Lien “never attached to the Debtor’s homestead exemption.” “[T]he value of the Debtor’s exemption was always subordinate to the Tax Lien” and “[w]hen the Tax Lien is avoided, the Trustee steps into that avoided position.” Therefore, the court explained, “[i]f it so happens that the IRS’s now unsecured claim is also nondischargeable, it is no different than any other nondischargeable claim which will need to be paid by the Debtor.”  

Essentially, the IRS argued that the debtor’s homestead exemption withdrew the exempt property from the bankruptcy estate which would mean it is unavailable for the unsecured creditors of the estate.  The Ninth Circuit finds that:

When a debtor properly exempts a property interest under § 522, the exemption withdraws that property interest from the estate and, thus, from the reach of the trustee for distribution to creditors….

In reaching our holding, we conclude that the Bankruptcy Court erred by overlooking the key question of first impression before us: whether a trustee may use § 724(a) to avoid a lien secured by a debtor’s exempt

property. The Bankruptcy Court did not analyze this question. Instead, the Bankruptcy Court appears to have assumed that the Trustee could use § 724(a) to avoid a lien on the Debtor’s exempt property.

The majority was especially concerned that its result kept the debtor from having to pay the debt twice.  The majority took pains to distinguish the decision in Hutchinson v. IRS (In re Hutchinson), 15 F.4th 1229 (9th Cir. 2021).  I wrote about the bankruptcy and district court opinions in that case here and here.  It’s difficult to find a light of daylight between the two opinions except that the government did not raise the issue in Hutchinson but merely conceded that the result the trustee sought could attach.

I agree with the majority in Tillman.  While it may look like the avoidance provision seeks to preserve property for other creditors, in this instance applying the law as was done in the lower court opinions puts debtors in the bad position of paying twice since the exempt property will now be used to pay unsecured creditors who would otherwise not have the opportunity to get paid from this property while the debt owed to the IRS is not extinguished and can be collected after the bankruptcy.  The existence of the tax lien should not create a benefit for the unsecured creditors.

The dissent looks to the powers of the trustee to avoid liens and to the position of the IRS when it has a lien claim.  It finds the majority’s concern with the consequence of avoidance of the lien to be a troubling result does not matter because what matters is the language of the bankruptcy code.  The defense finds that the plain text supports the position of the lower courts.

Contrary to the IRS and majority’s view, the trustee’s authority to avoid a federal tax penalty lien isn’t nullified because it encumbers exempt property. The majority incorporates § 726’s reference to the distribution of the “property of the estate” to bar a trustee’s avoidance authority. The IRS instead relies on § 551’s limitation of preservation of liens “only with respect to property of the estate.”

This issue will not go away easily and may soon result in a successful Supreme Court petition.

Ken Weil, who knows a lot more about tax issues in bankruptcy than me and who occasionally writes guest posts for PT, sent me this case.  When I sent him my draft, he offered these comments which provide a slightly different, and probably better, perspective on the case:

The IRS objected to the trustee’s use of BC 724(a), presumably because it determined that collection of the nondischargeable tax penalty would be more difficult without the NFTL attached to the property. The tax year at issue was 2015.  The taxpayer filed for bankruptcy in January 2019.  Tax penalties in Chapter 7 are dischargeable after three years from the due date of the return, including extensions, for the failure to file penalty, or three years from the payment due date for the failure to pay penalty.  BC 523(a)(7); and see United States v. Wilson, No. 15-1448, Docket entry No. 10 (N.D. Cal. 2016) (opinion withdrawn as parties settled) (tax year at issue 2008; petition filed July 2012; 2008 return filed on extension; parties agreed that failure-to-pay penalty was discharged; held, failure-to-file penalty not discharged).  One has to wonder why the bankruptcy filing was not delayed until after April 15, 2019, at the least. 

The IRS argued that exempt property is not property of the bankruptcy estate.  Schwab v. Reilly, 560 U.S. 770, 775-776 (2010).  For avoidance to be available to the trustee, BC 724(a) and 551 require that the property in question be property of the bankruptcy estate. 

More precisely, an exempt interest in property is not property of the bankruptcy estate.  Schwab v. Reilly, 560 U.S. 770, 794-795 (estate retained interest in property beyond the exempt amount) (2010).  In other words, while the value of the homestead left the bankruptcy estate, the rest of the house remained in the bankruptcy estate.  In that situation, what is the property of the estate?  Does the trustee have the authority to use BC 724(a) if the part of the real property against which the trustee can avoid the IRS lien is out-of-the-bankruptcy estate yet the property itself remains property of the bankruptcy estate?  Without diving into the Schwab v. Reilly issue, the Circuit Court found that the applicable property interest was not property of the estate, and BC 724(a) was not available to the trustee.  The dissent felt that the house was property of the estate, and, under the literal terms of the statute, the IRS lien could be avoided.

As a policy matter, the IRS argued, and the lower courts agreed, that allowing the trustee to avoid the lien as to the homestead would cause a double payment by the taxpayer.  This is a true statement, but also this argument is a red herring.  If the secured tax obligation is nondischargeable, there is always the potential for a double payment, regardless of whether the property at issue is exempt property.  The first payment is made from property that otherwise would have paid the tax debt, and that money is spread among all creditors.  The second payment potentially comes postpetition from the debtor to the taxing authority because the debtor’s tax obligation was not discharged.

Here, the trustee could have potentially avoided the issue at-hand by timely filing an objection to the homestead exemption.  Then, the argument as to whether the homestead interest had left the bankruptcy estate would not have been available.  Instead, the argument would be whether the trustee can object to the exemption because the trustee has rights in the property under BC 724(a).

Ken also offered the following fact pattern as a way to think about the problem:

Suppose, Taxpayer

>Files for bankruptcy;

>Taxpayer has a nice car;

>Taxpayer makes a claim of exemption in an interest in that car, which exemption claim does not cover the entire value of the car, and the trustee does not object; and

>The IRS only has a FTL and not a NFTL.

The claim of exemption would scrub the FTL from that interest in the car but the FTL would remain attached to the rest of the car, which is property of the bankruptcy estate and subject to the trustee’s control.

Don’t know that there is anything to come of this because the trustee can avoid the FTL.  But, I suppose the trustee could decide the car was not worth administering and abandon it.  Then, the debtor gets the car back, and it is partially lien-free and partially subject to the FTL.