Another Tax Case Headed for a Supreme Court Decision

After this morning’s post went up the Supreme Court granted cert in another tax case – In re Grand Jury, case number 21-1397, in the U.S. Supreme Court.

At issue is the IRS summons or subpoena power. In the case before the Court, the IRS seeks information from a law firm about its clients through a grand jury subpoena. The law firm seeks to shield privileged information from the IRS, but the firm also prepared the client’s tax returns and return preparation is not considered legal work protected by the attorney client privilege. What information can the IRS get when the information is mixed between privileged and non-privileged information in a manner making it difficult to parse the sometimes dual purpose documents created. A workable solution in this situation is difficult to reach and circuits have split.

Supreme Court Update for Taxes and the October 2022 Term

Thanks to Carl Smith, I write to point out the cases accepted for the Supreme Court term starting October 3, 2022, that might have some impact on tax procedure.  Three of the cases are related to the issues of jurisdiction and equitable tolling raised in Boechler during the last term and one relates to the calculation of the FBAR penalty.

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1)  Arellano v. McDonough – This case will be argued October 4.  The questions presented are:  (1) Whether the rebuttable presumption of equitable tolling from Irwin v. Department of Veterans Affairs applies to the one-year statutory deadline in 38 U.S.C. § 5110(b)(1) for seeking retroactive disability benefits, and, if so, whether the government has rebutted that presumption; and (2) whether, if 38 U.S.C. § 5110(b)(1) is amenable to equitable tolling, this case should be remanded so the agency can consider the particular facts and circumstances in the first instance.

2)  United States v. Bittner – This case will be argued on November 2.  Andy Weiner blogged this case for PT back in January.  This case presents the issue of the calculation of the penalty for failure to timely file the Foreign Bank & Financial Accounts information, commonly known as FBAR.  The IRS seeks to calculate the penalty based on each account not reported and taxpayers want to limit the penalty to the failure to file the form (which could contain multiple accounts).  The circuits are split.  The financial difference in the calculation of the penalty can be enormous with the per form approach limiting the penalty to $10,000 per year while the amount with the IRS approach is a multiple of the number of accounts times $10,000.  The Center for Taxpayer Rights has filed an amicus brief on behalf of the per form approach.  This brief was authored by Gwen Moore.  The American College of Tax Counsel has also filed an amicus brief arguing for the per form approach.  This brief was authored by the law firm of Kostelanetz & Fink.

3)  Wilkins v. United States – This is a private quiet title action, where the Circuits are split over whether the quiet title filing deadline in district court is jurisdictional. The issue of equitable tolling is not involved. I think this is an easy win for the petitioners.  The provisions granting district court’s jurisdiction are not the same as the filing deadline, and the filing deadline merely reads:

(g) Any civil action under this section, except for an action brought by a State, shall be barred unless it is commenced within twelve years of the date upon which it accrued. Such action shall be deemed to have accrued on the date the plaintiff or his predecessor in interest knew or should have known of the claim of the United States. 

The “shall be barred” language is similar to that in the FTCA deadlines, which were held not jurisdictional in Kwai Fun Wong (2015).  Oral argument has not yet been set.

4) MOAC Mall Holdings LLC v. Transform Holdco LLC — The cert. petition reads:

In Arbaugh v. Y & H Corp., this Court clarified that limitations on judicial relief should not be treated as jurisdictional absent a clear statement by Congress. At least six circuits have held that 11 U.S.C. 363(m) does not limit the appellate courts’ jurisdiction to review unstayed bankruptcy court sale orders, but rather limits only the remedies available in such an appeal. By its plain terms, Section 363(m) presupposes a “reversal or modification on appeal” of a sale order, and specifies only that such reversal or modification “does not affect the validity of [the] sale” to a good faith purchaser, leaving the courts free to fashion other remedies without that effect.

In the present case, the Second Circuit held, to the contrary, that Section 363(m) deprived the appellate courts of jurisdiction over an appeal from a lease assignment order deemed “integral” to an already completed sale order, notwithstanding that: the sale order was not contingent on the assignment; the sale price was fixed without regard to whether the lease could be assigned; and respondent had expressly waived (in successfully opposing a stay) any argument that Section 363(m) would bar appellate review. A month later, the Fifth Circuit re-confirmed that it also treats Section 363(m) as jurisdiction-stripping.

The question presented is:

Whether Bankruptcy Code Section 363(m) limits the appellate courts’ jurisdiction over any sale order or order deemed “integral” to a sale order, such that it is not subject to waiver, and even when a remedy could be fashioned that does not affect the validity of the sale.

Oral argument has not yet been set.

A Procedural Goldmine

Every once in a while a case comes along with a host of procedural issues.  Of course when the case has been open in the Tax Court for more than a decade, it has better chances for this to happen.  In the consolidated cases of Dollarhide Enterprises, Inc. v. Commissioner, Dk. Nos. 23113-12, 23139-12 & 21366-14, Judge Holmes brings us this procedural feast in an order.  Here is his description:

But we write at greater length because of the unusual circumstances that have caused the oldest of these cases to enter its second decade of litigation without there ever having been a trial. Along the way, these cases have brought to light potentially important circuit splits on a couple questions of great significance to those who follow tax procedure: (1) under what conditions can parties to a Tax Court proceeding make a binding settlement of the issues in the case without agreeing on the computations needed to enter a final determination and (2) what it means to file a return.

We have written before on the issue of when parties in a Tax Court case have entered into a binding settlement (here – discussing the 9th Circuit decision in Dollarhide, here, here and here) and on the issue of what is a properly filed return – here.  Dollarhide provides an opportunity to visit both issues again.

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As Judge Holmes explains in the opinion, the first two dockets were scheduled for trial in 2014 – a normal time frame for the first scheduled trial.  Due to the filing of the third petition, the cases were continued with required status reports.  In 2016 the parties reported that they had reached a settlement.

Their settlement did not take the form of an agreed decision for each of the three cases, but instead a “stipulation of settled issues.” This is an exceptionally common way for parties to wind down litigation in the Court. Because tax returns and notices of deficiency can include so many disputed items, settlements often consist of lists of issues in which the parties make mutual concessions or compromises. A taxpayer’s final bill — the amount he has to write a check for — is usually harder to figure out. The calculation often includes a computation of interest, arithmetic adjustments to other items (e.g. limits on deductibility computed by reference to a percentage of adjusted gross income), and a summing of penalties and additions to tax computed as a percentage of the resulting deficiency, reduced by any allowable credits.

The problem in this case arose because the agreement between the IRS and the Dollarhides had a different meaning for each party.  The Court’s description of the agreement states:

the Commissioner and the Dollarhides agreed to accept the “income, deductions, exemptions, and credits” on returns that the Dollarhides submitted in 2011 during the course of their audit for their 2006 and 2007 tax years. The Commission[er] also conceded that Dollarhide Enterprises had no tax deficiency at all.

To the IRS this agreement meant the Dollarhides would receive the credits they reported on their late filed 2006 return as the IRS computed the liability.  The IRS, however, did not view this settlement as a concession on the timeliness of the claim for the credits. To the Dollarhides this language meant they would actually receive the refunds their returns generated.  While it’s not necessary in a stipulation of settled issues to discuss statute of limitations issues, the failure to do so here created a huge chasm in the understanding of the agreement.  Once it became clear to the Dollarhides that the agreement they thought they reached with the IRS did not include the IRS actually paying them a refund, they balked on following through.  As is normal anytime there is a stipulation of settled issues and one party tries to back out, the other party usually moves forward to ask the Court to enforce the agreement.  The Court notes:

The Commissioner finally moved in December 2017 for entry of decision. This is, again, an extremely common motion in our Court that parties use to set up for decision disputes about the computation of a final deficiency once they’ve agreed on settlement of all the individual issues.

The Court ruled for the IRS on its Rule 162 motion.  The Dollarhides were unhappy with this result and said they would never have agreed if they had understood that it meant they did not receive their refunds.  Judge Holmes quoted from the Court’s earlier opinion:

In ruling on Rule 162 motions, we look to Federal Rule of Civil Procedure 60. See, e.g., Etter v. Commissioner, 61 TCM 1772, 1773 (1991). FRCP Rule 60(b) is the rule that’s applicable here, and the Dollarhides point us to FRCP 60(b)(3) which requires a showing of “fraud (whether previously called intrinsic or extrinsic), misrepresentation, or misconduct by an opposing party.” The fraud or other misconduct that the Dollarhides argue the Commissioner engaged in is not telling them about the legal requirement that they had only three years from the due date of their 2006 tax return to file a claim for refund of any overpayment.

The Court notes that the Dollarhides could have done the research to figure out that their late filing would result in the loss of the refund based on withholding credits; however, that’s when the second procedural issue in the case enters the scene.  Judge Holmes again quoted from the earlier opinion:

The Dollarhides do also complain that the only reason that they didn’t file their 2006 tax return within three years of its due date is that the revenue agent examining that year insisted that they submit it to her.

The plot thickens.  Now petitioners have linked their understanding of the settlement to another procedural issue recently exposed in the 9th Circuit’s decision in Seaview Trading discussed here.  In Seaview Trading the 9th Circuit held that giving a tax return to an IRS agent who requested the return constituted the filing of the return.  The Dollarhides claim they also gave their return for the year at issue to someone at the IRS within three years of the due date of the return.  If giving the return to a person at the IRS happened within that time period and if that act constituted the filing of their return, then they had a reason for expecting a refund based on the terms of the stipulation of settled issues.

The Court also pointed out that the 9th Circuit failed to address a number of issues present in the appeal leaving the Tax Court to wonder what the appeals court intended with respect to issues not addressed.  With this background of an incomplete stipulation of settled issues, an unclear filing of the return and unanswered questions from the appeal, the Tax Court proceeds to discuss and decide the case.

Partial Stipulation

The Tax Court notes that it has dealt with partial stipulations previously and held that they create a binding agreement.

The first problem that these cases present then is whether our Court can continue to maintain its longstanding custom of enforcing partial settlements, disposing of any remaining disputes about computations with Rule 155 submissions, and then entering final decisions.

Is a stipulation of settled issues in the absence of a stipulation of decision enforceable?

We ourselves have held for many years that it is. Our leading case on the subject is from 1988, Stamm International Corp. v. Commissioner, 90 T.C. 315. In that case, as in the Dollarhides’ cases, the parties settled on an issue-by-issue basis. When they couldn’t agree on the final, bottom-line amount, the Commissioner tried to get out of the settlement on the ground that he thought the bottom-line amount should be much higher and when agreeing to the offer, neither he, nor the IRS’s lawyer had contemplated a Code section that the taxpayer established, would result in a much lower settlement. Stamm Int’l, 90 T.C. at 319.

Judge Holmes points out that Stamm is not the only case where the parties reached a partial settlement that had a different tax result than anticipated yet the Tax Court found the settlement binding.  The Fourth Circuit endorsed this practice in Korangyi v. Comm’r, 893 F.2d 69, 72 (4th Cir. 1990).

The first crack in this consensus came only in 2015. In a per curiam opinion from the Seventh Circuit, that court held that it was error for us to grant the Commissioner’s motion for entry of decision when the parties had settled all the individual issues but disagreed about the bottom-line number: “The Stipulation of Settled Issues . . . says nothing about the key issue in the case: the deficiency amounts for the tax years in question. Indeed, the Stipulation of Settled Issues does not even specify a method for determining the deficiency amounts.” Shah v. Comm’r, 790 F.3d 767, 770 (7th Cir. 2015).   

So, now there is a circuit split with the 7th and 9th Circuit declining to uphold stipulations of settled issues that do not lay out the final consequences of the settlement while the Tax Court and the 4th Circuit would enforce settlements on the issues without a discussion of the bottom line impact.

Return Filing

Judge Holmes notes that the issue of return filing was well settled before the recent 9th Circuit decision in Seaview Trading.

A return was “filed” only if it was delivered to the specific individuals identified by the Code or regulations. Allnutt v. Comm’r, 523 F.3d 406, 412-13 (4th Cir. 2008); see e.g. Coffey v. Comm’r, 987 F.3d 808, 812 (8th Cir. 2021) (quoting Comm’r v. Estate of Sanders, 834 F.3d 1269, 1274 (11th Cir. 2016)) (holding that for a return to be filled, it must be delivered to the individual specified in the Code or Regulations); Heard v. Comm’r, 269 F.2d 911, 913 (3d Cir. 1959) (holding that filing only occurs when the paper is received by the proper official). Thus, a taxpayer who sent his return to the wrong IRS service center would not have “filed” his return until it showed up at the right service center. Winnett v. Comm’r, 96 T.C. 802, 808 (1991).

He calls this an area ripe for much additional litigation.  He does not mention that the IRS was so unhappy with the decision in Seaview Trading that it has requested en banc review in the 9th Circuit which request is still pending.

Meaning of 9th Circuit Decision

Judge Holmes notes that the 9th Circuit did not address all of the issues in the case.  Specifically, it did not mention the 2007 individual case.  Because the Tax Court’s decision in that case occurred years ago, Judge Holmes questions whether he can vacate the earlier decision even though both parties urge that result.  He decides that

There is no statute, regulation, or useful precedent that either the parties or we can find. It is, however, the general rule that “an inferior court has no power or authority to deviate from the mandate issued by an appellate court.” Briggs v. Pa. R. Co., 334 U.S. 304, 306 (1948). We will therefore assume that we do have the power to vacate a prior decision and enter a new one in accord with the parties’ agreement in this situation. To do so doesn’t deviate from the mandate in these cases. And it will, one hopes, bring these cases to an end. Or at least allow the entry of decisions that neither party will have standing to appeal.

After making this decision he enters a series of orders and a decision.  Maybe this is the end of the case or maybe the Dollarhides will continue to provide a basis for those interested in tax procedure to learn.

Graev’s Long Shadow: Section 6751(b) and Supervisory Approval of Penalties

Today we welcome guest blogger Professor Monica Gianni. Professor Gianni serves as an Associate Professor in the Department of Accounting of the David Nazarian College of Business and Economics at California State University, Northridge. She is the successor author to Volume 6, Tax Practice and Procedure, of the Bittker & Lokken treatise on Federal Taxation of Income, Estate and Gifts and Of Counsel at Davis Wright Tremaine LLP. She wrote to me and asked if I could mention her article forthcoming in The Tax Lawyer – a publication of the ABA Tax Section.  I suggested that she might do a better job of describing her article than me and persuaded her to write a description herself.  She writes on the penalty litigation that has consumed the Court – and this blog – for the past few years.  Keith

As a reader of this blog, you have undoubtedly read numerous posts on Section 6751(b). Section 6751(b) requires supervisory approval in writing prior to assessment of certain penalties. Enacted in 1998 as part of the IRS Restructuring and Reform Act, the statute’s purpose was to prevent IRS agents from using penalties as bargaining chips. The section remained essentially dormant for over 20 years, with both the IRS and taxpayers accepting the position that approval needed to be obtained only prior to assessment. The trilogy of Graev cases and the decision of the Second Circuit Court of Appeals in Chai v. Commissioner changed the Section 6751(b) landscape completely, opening a Pandora’s box of taxpayers using Section 6751(b) to avoid penalties on the technicality of no-written-supervisory approval. Hundreds of court cases have followed, resulting in cases inconsistently interpreting Section 6751(b) and well-counseled taxpayers avoiding tax penalties.

I’ve written an article on this subject, which is due to be published in the next volume of The Tax Lawyer—Supervisory Approval of Penalties: The Opening of a Graev Pandora’s Box. The article tries to bring some order into the case law that has resulted from a badly drafted statute. (You can download the article here). After examining the current state of case law, the article concludes by recommending that the statute be repealed. Internal IRS procedures can address issues with the conduct of IRS employees while not opening the door to taxpayers using a technicality to avoid penalties and IRS employees potentially imposing penalties overbroadly in their attempts to comply with Section 6751(b). While others argue that repeal is not the answer, there seems to be agreement that something needs to be done. As Keith Fogg has pointed out, if the statute isn’t repealed, “maybe we will still be litigating Graev cases into the next decade helping to provide a never-ending source of blog posts.” 

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The bulk of the litigation on this section has addressed when supervisory approval must be given to comply with Section 6751(b). The Tax Court has taken an expansive interpretation of the statute in favor of taxpayers, generally requiring that supervisory approval be obtained prior to the first formal communication to the taxpayer advising that a penalty will be imposed. The Circuit Courts of Appeals have started to disagree with the Tax Court. The Ninth Circuit, in Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, held that approval is required at the earlier of the assessment of the penalty or before the supervisor “loses discretion whether to approve the penalty assessment.” More recently, the Eleventh Circuit in Kroner v. Commissioner and Carter v. Commissioner reversed the Tax Court, holding that approval is required only before the assessment of penalties.

Rather than examine those decisions one more time, this post looks at procedural requirements of supervisory approval that have resulted from numerous Tax Court decisions in actions brought by taxpayers for penalty relief based on inadequate supervisory approval. First, what is required of a supervisor to fulfill the penalty-approval requirement? The simple answer is nothing but the approval itself. No cross-examination of the supervisor by the taxpayer is required, no reasonable-cause defense by the taxpayer has to be presented first, and there is no requirement that the “thought process” of the supervisor be analyzed or that her review of the penalty have been “meaningful.” The supervisor does not have to consider the merits of the penalty determination, does not have to have real estate expertise for a valuation penalty, and can even approve a valuation penalty before receiving the appraisal report. As summarized in Belair Woods, LLC v. Commissioner, the penalty approval form itself does not have to “demonstrate the depth or comprehensiveness of the supervisor’s review.”

The next question is—how is approval shown? The approval, by the express language of the statute, must be in writing. That being said, an actual signature is not required, and approval can be shown by an electronic signature or even by e-mail. If the approval form, however, shows no date of approval or the date is illegible, the taxpayer will prevail under Section 6751(b). The reason for the penalty on the approval form must be the same as contained in the Notice of Deficiency, and the specific penalty must be listed and not just a general statement that penalties are approved.

A further question is—who is the supervisor that must approve the penalty? Section 6751(b) requires that the taxpayer’s “immediate supervisor” approve the penalty, and this connection must be shown on the approval form. “Immediate supervisor” is not defined in the statute, and there are no regulations under this section. When faced with the issue, the Tax Court in Sand Investment Co. v. Commissioner determined that such supervisor “is most logically viewed as the person who supervises the agent’s substantive work on an examination, even if the examiner’s direct supervisor is someone else.” The IRS considers an acting supervisor to be the agent’s immediate supervisor if he has an approved Designation to Act or a Notification of Personnel Action on file.

If a taxpayer wants to challenge a penalty in court based on lack of IRS supervisory approval, are there any limitations? A taxpayer cannot raise the Section 6751(b) issue for the first time on appeal when the issue could have been raised in the Tax Court. Nor can the issue be raised for the first time at the district court level if it was not raised in administrative proceedings. For a TEFRA partnership action, Section 6751(b) must be raised at the partnership level and is not a partner-level defense. And, if a taxpayer enters into a closing agreement agreeing to the assessment of penalties rather than going to court, he waives any subsequent Section 6751(b) challenge.

The above describes just some of the procedural rules that have developed from numerous court cases post-Graev. Although there is more certainty now than there was prior to these cases, different results for taxpayers can occur depending on which circuit has venue over any ensuing appeal. Whether the statute has succeeded in preventing penalties from being used as bargaining chips seems to have become an irrelevant consideration, as taxpayers have used the statute to escape often well-deserved penalties.

Boechler Works

In Boechler v. Commissioner, 142 S. Ct. 1493 (2022) the Supreme Court held that the time period for filing a petition in Tax Court in a Collection Due Process (CDP) case is not jurisdictional.  The Supreme Court also held that the statute is subject to equitable tolling; however, we have predicted in many blog posts that based on historical patterns the most likely application of  the decision would occur when the IRS did not affirmatively raise late filing as a defense.  An order entered yesterday in Ahmad v. Commissioner, Dk. No. 37926-21L appears to be the first order holding that the IRS waived the right to raise late filing as a defense and allowing the case to move forward for a merits determination.

In Ahmad the IRS issued a CDP determination letter on November 23, 2021, sustaining the decision to file a notice of federal tax lien (NFTL).  He filed a petition challenging the filing of the NFTL because he is unemployed and on public assistance.  The IRS filed a motion for summary judgment which the Tax Court grants; however, in doing so it notes that he filed his petition on December 30, 2021.  This date is more than 30 days after the notice and appears to create a late filed petition. 

In footnote 7 of the order the Court notes that the IRS waived any potential objection based on the timeliness of the petition.  In the motion for summary judgment the IRS apparently expressly conceded that he filed the petition on time.  The Court states:

Therefore, the timeliness requirement in section 6330(d)(1) poses no bar to the Court’s jurisdiction in this case.

Earlier in footnote 7 the Court explained the impact of Boechler on the jurisdiction of the Court with regard to timely filing and made clear that the IRS must affirmatively raise timeliness in order to have the Court rule on this issue.

Prior to the Boechler decision the Tax Court did not merely rely on the IRS to raise the timeliness of the filing of a petition but it affirmatively analyzed the filing to determine timeliness.  Based on the research of the Tax Court’s show cause orders in these situations, Carl Smith determined that the Tax Court raised the timeliness issue in over 200 cases each year where the IRS never objected to the taxpayer’s case as late filed.  We predicted that far more taxpayers would benefit from the lack of Tax Court policing timeliness than would benefit from equitable tolling.  The Ahmad case doesn’t predict the number of times this will happen but it makes clear that absent an affirmative objection by the IRS the case will move forward to whatever disposition it deserves on the merits.

Here, the Court grants the summary judgment motion so the failure of the IRS to raise timeliness in the filing of the petition serves as a mere pyrrhic victory.  Nonetheless, the Ahmad case lets us know that a new era has begun.  I blogged earlier about this change in the whistleblower cases because of the DC Circuit’s decision in Myers v. Commissioner, 928 F.3d 1025.  Now it happens in CDP cases.  Depending on the outcome of Hallmark and other cases challenging the timeliness issue in deficiency cases, it could happen in deficiency cases where 95% of the cases exist.

Courtney v US Illustrates Limits of Taxpayer Challenges to Allegedly Improper IRS Collection

The recent unpublished Fifth Circuit opinion in Courtney v US nicely illustrates the challenges that taxpayers face when they allege that the IRS has taken improperly used its administrative collection powers.

Courtney pled guilty to income tax evasion from over a million dollars of improper employer reimbursements for personal expenses that he disguised to look like service payments to a company that he controlled.  After a district court restitution order, a 2012 notice of deficiency, and an assessment, the IRS began to try to collect on the unpaid taxes.

Those efforts included a levy on Courtney’s personal individual retirement account, a notice of a federal tax lien, an attempt to seize assets from an irrevocable trust which benefits his wife and children, and levies against two limited liability companies affiliated with Courtney.

In the fall of 2021, Courtney sued the IRS, seeking damages under Section 7433 for allegedly improper collection and an injunction barring further collection actions against him, the limited liability companies and the irrevocable trust.

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The district court tossed the suit for two main reasons. First, Courtney had failed to exhaust his administrative remedies before seeking damages under Section 7433. Second, it held that the Anti Injunction Act barred his demand that the IRS cease collection.  In affirming the district court, the Fifth Circuit expanded on why Courtney could not use the courts at this stage to examine the IRS’s conduct.

Section 7433 requires that taxpayers file a claim with the IRS before going to court. In responding to the government’s argument that he neglected to meet that requirement, Courtney argued that bringing an administrative claim would be futile. Some cases have held that futility can lead a court to overlook the statutory requirement to file a clam with the IRS before going to court.

In rejecting that argument, the Fifth Circuit noted that the futility doctrine is extremely narrow. Even assuming that the “IRS has been unresponsive, difficult to work with, and disingenuous of previous arrangements agreed upon by the parties” it was insufficient. Futility requires  a court to conclude that the filing of a claim would be a useless formality, and Courtney did not meet that standard.

As to the Anti-Injunction Act preventing his demand that the IRS cease collection, Courtney argued that his claims fit under the Enochs v. Williams Packing exception “which applies only if “(1) it is clear that under no circumstances could the Government ultimately prevail…[and] (2) equity jurisdiction otherwise exists.”

Both prongs are difficult to meet; the first requiring a court to prove with certainty that the plaintiff would prevail on the merits and the second requiring a showing of irreparable harm.

The Fifth Circuit declined to find that the Enochs v. Williams Packing exception applied, concluding that it was not a certainty that it would decide on the merits that the government’s collection efforts were improper. Courtney claimed that the government failed to refute his allegations that the levies against the trust and LLCs were improper. In rejecting Courtney’s claim, the court noted that while the government must prove some factual connection between the LLCs, the trust and Courtney, the taxpayer bears the ultimate burden of persuasion. Here, the government had done enough to link Courtney with the entities and Courtney himself had possession of facts necessary for a court to determine whether any collection efforts were lawful.

If Courtney had plausibly alleged that the government had obstructed his ability to prove that the government’s collection actions were improper, perhaps the court would have addressed prong two of the Enochs v. Williams Packing test.  That prong is not easily satisfied anyway, with courts often reflexively stating that refund procedures are adequate, regardless of the taxpayer’s ability to pay.

Given Courtney’s long history with the IRS, it was unsurprising that he went to court. As the opinion reflects, outside CDP, it is not easy to get a court to consider the IRS’s collection, and taxpayers must follow the preliminary path of bringing allegations of improper conduct to the agency itself.

Tracing Social Security Payments          

Social security funds provide a safety net for recipients and generally receive protected status from creditors.  The case of In re Weber, 130 AFTR2d 2022-5161 (Bankr. M.D. Fla. 2022) examines what happens to social security payments when the taxpayer uses them to pay federal income taxes and then receives a refund partially based on the social security payments.  The bankruptcy court allowed Mr. Weber to shield the portion of his tax refund which represented the return of his social security payments citing to 42 USC 407.  The decision speaks to the power of the exemption of social security funds from private creditors.

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Mr. Weber filed a chapter 7 bankruptcy petition in February of 2022.  At issue is his 2021 income tax refund which the trustee seeks to claim as an asset for the benefit of the general unsecured creditors of the bankruptcy estate.  Mr. Weber argues that a substantial portion of the refund resulted from his decision to have money withheld from his monthly social security payments to pay federal taxes.  He overestimated what his federal tax obligation for 2021 would be for reasons not explained in the opinion.  Mr. Weber’s position is that just because he had a portion of his social security payment used to pay an anticipated federal tax liability did not change the character of the funds to such a degree that they lost the protection afforded to social security payments.

You might ask why Mr. Weber had any taxes withheld from his social security payments.  The opinion indicates that he had a part time job as an employee.  The income from that job in 2021 was only $378.00 per month.  Based on that level of income, he would not have triggered any of his social security payments to become taxable, and he could have used wage withholding from the job to cover any taxes from his employment.  The facts suggest that his decision to withhold from his social security in 2022 was unnecessary.  We are not given information about prior years when his wages could have been higher and could have come from work as an independent contractor rather than an employee.  Higher income could have triggered tax on a portion of his social security payments making the withholding of a portion of the payment logical.  If he worked as an independent contractor, he might have found it simpler to have some of this social security payments withheld than to make quarterly estimated tax payments.  We just don’t have enough information to evaluate his thought process in having the withholding.  We do know that he overwithheld from his social security payments and that a significant portion of his 2021 refund resulted specifically from that withholding.

The trustee argued that once Mr. Weber’s social security payment went to the IRS as withholding for payment of taxes it lost its character as a protected social security payment and transformed into simply a tax payment the refund of which the trustee could reach for the benefit of the estate.  The trustee’s position is supported by the decision of the bankruptcy court in In re Crutch, 565 B.R. 36 [119 AFTR 2d 2017-1428] (Bankr. E.D.N.Y. 2017).

The bankruptcy court in Mr. Weber’s case stated:

Under 42 U.S.C. § 407, social security benefits are not subject to execution, levy, attachment, garnishment, or other legal process, and no other provision of law may limit or modify the exemption from execution except by express reference to the statute.

It acknowledged the Crutch decision but cited to another bankruptcy court decision, In re Spolarich, 2009 WL 10267351 (Bankr. N.D. Ind. Sept. 30, 2009), which it found more persuasive.  The court in Spolarich found the protection for Social Security payments exceptionally expansive and only subject to modification by express statute.  It determined that when a social security recipient uses a portion of that payment for tax withholding, the individual’s consent to the use of those funds extends only to the payment of tax liabilities and not to the payment of other claims stating:

[B]y the clear language of 26 U.S.C. §§ 3402(p)(1), the election to withhold [funds from social security payments] benefits only the Internal Revenue Service, and does not constitute a general waiver of the protections of § 407(a) with respect to Social Security benefits vis-à-vis other entities.

The bankruptcy court in Mr. Weber’s case agreed with the analysis in Spolarich and allowed him to exempt that portion of his 2021 tax refund traceable to the withholding of his social security payments.

We have discussed tracing of payments exempt from IRS levy in several posts.  This post written by Les discusses the issue and links to earlier post which also discussed the character of a protected payment once moved to an unprotected source. The issue of tracing arises in many contexts.  While the language of the social security statute may be particularly strong, the analysis here may be useful in other settings.  The policy issue of when a protected payment loses its special status is one worth considering.  If the Weber court got it right should the language of 42 USC 407 serve as a model for other statutes in which taxpayers receive payments protected from levies?  Can Weber assist taxpayers trying to fend off a levy to their bank account find assistance from the approach here?

TIGTA Report on Government Contractor Tax Delinquency

In 2014 Congress passed the Consolidated and Further Continuing Appropriations Act prohibiting federal agencies from using appropriated funds to award a contract or grant to a corporation owing any amount of delinquent federal taxes unless it considered suspension or disbarment.  A regulation, which goes by the catchy name Federal Acquisition Regulation (FAR), provides definitions and further guidance regarding this requirement.  We care because this is an easy way for the IRS to collect money. 

This provision follows a host of state and federal provisions linking the receipt of government employment or benefits or services with fulfilling tax obligations.  Over the past quarter century many states have passed legislation tying the receipt or continuation of licenses to the payment of taxes.  Many of my clinic clients came because the state of Massachusetts revoked their driver’s license due to failure to pay their state taxes.  While the revocation of driver’s licenses has the most far reaching impact, states take professional licenses as well.

The federal government does not issue many licenses but it has the ability to exert similar type of pressure for tax delinquency.  In 1998, it passed Section 1203 of the Restructuring and Reform Act (RRA 98).  This off code provision requires IRS employees to timely file their taxes or be fired.  The timely filing provision of Section 1203 is one of the so called 10 deadly sins that cause removal from employment but is by far the most impactful.  I will provide some data on this below.  Section 1203 is not the only federal provision creating an impact for tax delinquency.  Revocation or denial of a passport, passed in 2015 is another example and one which Les wrote about recently.  There has also been a movement to check federal employees outside of the IRS for tax delinquency though not as vigorously as might occur given the benefit of federal employment.

On September 12, 2022, the Treasury Inspector for Tax Administration (TIGTA) published a report regarding payments to federal contractors and federal grantees with delinquent tax situations.  It makes sense to require contractors and grantees to pay their taxes just as it makes sense for employees to pay their taxes.  These entities are receiving a direct benefit from the federal government and in exchange should at least keep current on their tax obligations.  The report talks about the problem and the structure for the solution.

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TIGTA found that:

Between October 2018 and December 2019, Federal agencies awarded 2.1 million Federal contracts and grants to more than 83,000 awardees. We identified 3,978 entities that received $32.9 billion in Federal awards while owing $891 million in delinquent Federal taxes. This included 3,040 contractors that received $10.2 billion in Federal contracts while owing $621.8 million in delinquent Federal taxes and 938 grantees that received $22.7 billion in Federal grants while owing $269.2 million in delinquent Federal taxes.

The results can be seen in the following chart:

The TIGTA report indicates that employment taxes constitute most of the unpaid taxes reflected in the chart.  This did not surprise me. This has long been a major collection problem for the IRS.  The TIGTA report cited to a Government Accountability Office report from 15 years ago discussing the problem.  TIGTA produced a chart breaking down the amount of delinquency and the type of entity (corporation or grantee) owing the taxes.  It’s hard for me to get too excited about the entities falling in the lowest category and maybe even the next one or two categories but the high dollar categories contain some large amounts of unpaid tax.

These entities have been self-reporting that they have no tax problems.  The disclosure laws prevent the IRS from affirmatively going to other government agencies and discussing tax delinquencies.  One might hope that the exception to the disclosure law provided by the ability of the IRS to file a notice of federal tax lien might put many of these liabilities into the public sphere but you could see from the TIGTA report I recently wrote about on NFTLs that the IRS does not always file NFTLs on large dollar delinquencies.

Congress appropriated $30 million to the IRS to create an “application through which entities could request from the IRS a certification that the entity did or did not owe seriously delinquent taxes.”  Federal agencies could then require that potential contractors or grantees go to the IRS and obtain and include the certification as part of their application process for the contract or the grant.  TIGTA recommended in the report that the IRS priorities the development of this application and the IRS agreed.  Seems like a simple solution and a way to collect taxes without having to assign scarce Revenue Officer resources chase entities for payment.  Of course, nothing is simple and there will necessarily be situations in which entities will be fighting over the delinquent taxes or glitches in information will occur but the basics of the system should provide a simple collection mechanism.  Read the TIGTA report if you want more details.  This is the type of TIGTA report where I feel like the public is getting its money’s worth.

I mentioned earlier that I would circle back to Section 1203.  This is an off code provision and not a section of the IRC.  Les and I, through Procedurally Taxing, have partnered with the Pittsburgh Tax Review to create a volume on tax procedure which will be published in 2023.  The volume will focus on RRA 98 which will be celebrating its 25th anniversary in that year.  I have written an article for that edition on Section 1203 and wanted to give a little preview of the statistics.  I am troubled by the aspect of Section 1203 that served as symbolic legislation to punish IRS employees and talk about that in the paper.  The legislation, however, was far from symbolic in its impact on IRS employees.  TIGTA puts out stats on Section 1203 in its semiannual reports, though the information is fairly cryptic.  The statistics show that since enactment, an overwhelming majority of removals and mitigations under Section 1203 have been for late returns (8) or willful understatement (9). Since 2001 (the first year TIGTA published data in a semiannual report), IRS employees have also been removed for civil rights/constructive violations (3), concealed work error (4), assault or battery (5), I.R.C./IRM/Reg violation-retaliation (6) and threat of audit for personal gain (10).

As the table below shows, the removals and mitigations for violations other than late returns (8) or willful understatement (9) are rare. Please note in the table, the years 2001 and 2022 have only one semiannual reports worth of data, and in 2010, 2011, and 2012 the data for deadly sin number 8 and 9 were combined by TIGTA.

Using delinquency to deny employment, or licenses or contracts makes sense as an easy and appropriate way for government entities to ensure that everyone pays their fair share of taxes and particularly those directly benefiting from the government.  The use of these mechanisms which deny basic privileges must be accompanied by a robust system that ensures protection of taxpayer rights.  If the government uses an alleged delinquency or failure to file to collect, it must have a system that immediately and appropriately responds to concerns raised by the impacted party.  I applaud the use of these mechanisms to collect but worry that our broken tax system lacks the ability to fulfill its part of necessary bargain when they are used.