Caleb Smith

About Caleb Smith

Caleb Smith is Associate Clinical Professor and the Director of the Ronald M. Mankoff Tax Clinic at the University of Minnesota Law School. Caleb has worked at Low-Income Taxpayer Clinics on both coasts and the Midwest, most recently completing a fellowship at Harvard Law School's Federal Tax Clinic. Prior to law school Caleb was the Tax Program Manager at Minnesota's largest Volunteer Income Tax Assistance organization, where he continues to remain engaged as an instructor and volunteer today.

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.

Consequences of the (Fake) Notice of Intent to Levy

At the recent Fall ABA meeting there was a panel discussing Collection Appeals (which Christine was a panelist on). A discussion arose about the purpose of the CP504 “Notice of Intent to Levy,” since it is not a “real” notice of intent to levy for IRC § 6330 purposes. It is, however, a “real” notice of intent to levy for IRC § 6331(d) purposes… but what is the distinction, and when does it matter?

I have historically looked at the CP504 as little more than an IRS scare tactic strongly encouraging voluntary payment. My view has since changed, thanks in part to the ABA meeting. In this post, I’ll talk about the importance of the CP504 and why the language on the notice does such a bad job of explaining what actual legal consequence it carries that it almost shouldn’t carry legal consequence at all.

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This is not the first time Procedurally Taxing or the tax community at large has weighed in on the problems of the CP504. Keith posted about how misleading the notice is back in 2016. The main issue Keith raised was that the CP504 misleads people into thinking that if you don’t respond to the CP504 Notice the IRS can levy on things that it cannot levy on (yet).

In other words, it misleads people.

The IRS heard Keith’s complaint, and admirably took some steps to remedy the issue by changing the language of the CP504 Notice a few years later. Keith posted about this small step forward with a copy of the new CP504 Notice back in 2018.

Flash forward to present day, and a newly formatted CP504 Notice…

I don’t exactly know what decisions were made, but we appear to be back in the bad old days Keith had originally lamented. My clients routinely receive CP504 Notices like the one here. The offending language is exactly what Keith had highlighted before:

Consequences If You Don’t Pay Immediately

We may levy your income and bank accounts, as well as seize your property or rights to property if you fail to comply. Property includes wages and other income, bank accounts, business assets, personal assets (including your car and home), Social Security benefits, Alaska Permanent Fund dividends, or state tax refunds. [Emphasis in original]

Now I am but a humble tax lawyer and professor, but in reading this I can imagine someone concluding that failing to pay the IRS immediately upon receiving the CP504 means that the IRS could levy their income and bank account. Those are the bolded terms, after all. However, because I also know that to be untrue (the IRS cannot levy on my bank account and wages if I don’t respond to the CP504), I have tended to read the notice as being little more than a scare tactic and carrying no real legal consequence. My misunderstanding about the CP504’s consequences are in no small part because the consequences the CP504 focuses on so boldly are incorrect.

Actual Legal Consequences

But the CP504 actually does carry important consequences, such that it is a letter you should actually pay close attention to. The consequences it carries are so simple, it is a shame that the letter doesn’t really highlight them:

First, the CP504 is the notice that allows the IRS to levy on certain property prior to offering a CDP hearing. For my clients that is almost exclusively their state tax refunds. The CP504 mentions this in very small print at the bottom of page 2. The full list of pre-CDP Notice levy property is at IRC § 6330(f). I always knew the IRS could levy on state tax refunds prior to giving a CDP hearing, but admittedly never really considered the CP504’s role in that process.

Second, and generally less importantly, the CP504 notice bumps up the “failure to pay” rate from 0.5% per month up to 1%. See IRC § 6651(d). This is generally less important for my clients because the maximum amount of penalty cannot exceed 25% in the aggregate, and a lot of very late tax years hit that mark quickly. Also, most of my clients are able to settle their tax debts with an Offer in Compromise, such that penalties are irrelevant.

With Legal Consequences Comes… Legal Consequences

So now, despite the CP504 Notices best efforts, we have a clearer idea of what the CP504 Notice actually does. But what happens if the CP504 Notice is defective? Because it serves an actual, legal purpose, defects may carry actual legal consequences.

As Keith noted in his prior post, the IRS used to combine the IRC § 6331(d) notice and IRC § 6330 CDP opportunity into a single letter. Now those two statutorily required notices are “spread” across two letters. This may be a self-inflicted wound by the IRS. For one, an extra letter adds real costs to the IRS: both the 6331(d) and 6330 notices are supposed to be sent certified. Arguably having two (required) letters instead of one essentially doubles the IRS’s chances of screwing up.

Possibly, the IRS could argue that the current IRC § 6330 letter (usually, the LT11) also meets and incorporates the IRC § 6331(d) requirements, such that it current practice is really a belt-and-suspenders approach. In other words, a bad CP504 letter would be “fixed” by the later LT11 letter. I don’t know that this argument has ever been raised. But even if it was, it would certainly not prevail for levies that precede the LT11 (for example, state tax refunds). Accordingly, the issuance of the CP504 Notice remains worth looking into.

For a CP504 Notice to meet the IRC § 6331(d) requirements it must be sent (by registered or certified mail) to the taxpayers last known address no less than 30 days before the levy. I somewhat doubt that any such letter that isn’t sent certified/registered would be considered invalid. (I couldn’t find any freely available cases, but U.S. v. MPM Financial Group, Inc. (2005 WL 1322801, at *4 (E.D. Ky. May 27, 2005) aff’d, 215 F. App’x 476 (6th Cir. 2007) makes that point. The real issues are timing and address concerns.

Beginning with the last known address: this has primarily been an important topic on deficiency notices for some time (see posts here and here, among others). There is always a chance (perhaps a significant chance, given the IRS’s IT infrastructure) that the IRS will send a notice to the wrong last-known address. In such a case if the taxpayer doesn’t otherwise have actual knowledge of the notice, it should invalidate the CP504 Notice from serving its IRC § 6331(d) “notice” function.

What happens after a defective CP504 Notice has been mailed may be interesting. If the IRS levies on your state tax refund you will thereafter get a “Notice of Intent to Levy” under IRC § 6330. In my experience, a lot of time the IRS will send a CP504 Notice well in advance of actually taking any other collection actions, such that they may have had the wrong address in their file for the CP504 Notice, and then have corrected it by the time of the actual state tax levy.

If the state tax refund levy was improper because there was no valid IRC § 6331(d) notice preceding it, arguably you should be returned the state tax refund proceeds. That, at least, is the argument I’d make in the CDP hearing: the IRS plainly did not follow “the requirements of any applicable law or administrative procedure” in taking the refund. Accordingly, you should get it back: a very important potential remedy, given the limitations on refund jurisdiction in Tax Court. This matters enough to many of my clients (Minnesota income tax returns have some lucrative refundable credits) that a detailed review of the CP504 Notice validity is warranted.

My Plea: Make the Letter Useful

Again, the CP504 really only carries two legal consequences: (1) precursor to levy on very specific property (that might not matter at all to people in states without an income tax) and (2) increase the failure to pay penalty rate. If the goal of the notice is to inform people about the legal consequences of being issued a CP504 notice it does a tremendously bad job of it. Instead it reads like a scare tactic.

Perhaps this serves a useful function for the IRS in getting some people to voluntarily pay, but I think it comes at a reputational cost, and scares people into sub-optimal resolutions. A lot of my clients receive state tax refunds each year (particularly state property tax refunds) which they count on. A lot of my clients also are very clearly “can’t pay” candidates for an Offer in Compromise or Currently Not Collectible status.

The IRS’s mission isn’t simply to “get the most money” out of people. If it was, then the CP504 Notice would probably be justified. Rather, the IRS’s purported mission is to “Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities[.]” It is hard to see a misleading letter as “helping them to understand,” and I’d say the CP504 is an example of straying from that mission.

When Regulatory and Sub-Regulatory Guidance Collides… (Part Two)

My previous post covered the curious case of IRS Notice 2006-68 and it’s (seemingly) direct contradiction of Treasury Regulation § 301.7122-1(h). As I’ve covered before (here, here and here), IRS Notice 2006-68 takes an extremely taxpayer unfriendly (and I believe substantively wrong) interpretation of the “deemed acceptance” rule of IRC § 7122(f).

It turns out IRS Notice 2006-68 also takes a rather taxpayer unfriendly interpretation of whether taxpayers may be entitled to a return of payments they submit with an Offer in Compromise that is returned or rejected. The rule used to be “you get the money back, because it is a deposit.” Indeed, that is arguably still the rule under the Treasury Regulation… but not under the Notice that came later, when the underlying statute was changed in TIPRA. What controls?

I would say a very strong case exists for challenging Notice 2006-68, should someone find their way into court on it (which as a jurisdictional matter would be done most easily through Collection Due Process, as I’ve suggested here). Let’s look at why it is susceptible to challenge…

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Three Reasons Why Notice 2006-68 Is Unpersuasive Under Admin Law Principles

First Reason: An Agency Can Only Amend a Final Regulation Through Proper Procedures

As far as I can tell, it is an uncontroversial proposition that an agency can only amend a final rule through new rulemaking. See Columbia Falls Aluminum Co. v. E.P.A., 139 F.3d 914, 919 (D.C. Cir. 1998) and Sierra Club v. E.P.A., 755 F.3d 968, 977 (D.C. Cir. 2014).

In this instance, there is a final rule (specifically, the Treasury Regulation) that unambiguously says payments made with an Offer that is withdrawn or returned are refundable deposits. If the Treasury wants to change this rule they are free to do so… but only if they follow the proper procedures. This flows pretty clearly from the APA: specifically, 5 § 551(5) which includes “amending or repealing” a rule as an act of “rule-making” and 5 § 553 which requires notice and comment for the rulemaking at issue here.

As it stands, it appears that the final rule (Treas Reg. § 301.7122-1(h)) was amended through Notice 2006-68 -how else to explain the direct contradiction in treatment of payments sent with Offers? But Notice 2006-68 did not go through notice and comment… if anything, it acted as the notice for comments and never did anything after that.

This is a problem for Notice 2006-68. But perhaps not an insurmountable one. Maybe, the argument goes, Notice 2006-68 isn’t amending the Treasury Regulation because it is addressing an entirely different issue -the TIPRA payments are qualitatively different than the “sums submitted with an Offer in Compromise” referred to in the regulation…

Second Reason: The IRS Is Bound to Its Regulations

Hopefully I didn’t set up a straw-man argument, but the idea that Notice 2006-68 can ignore the regulation because the TIPRA language came after the regulation is a tough one for me to swallow. Yes, the Treasury Regulations predate the specific TIPRA language. But does that change the fact that the Treasury Regulations unambiguously addresses “sums submitted with an offer in compromise,” which is exactly what TIPRA payments are?

I don’t think the IRS can just ignore its regulation on that point. Note that the TIPRA statute is ambiguous, and could reasonably allow for TIPRA payments to be treated as deposits. This isn’t an instance of a later statute directly changing the law underpinning an earlier regulation. There is an argument that under the “Accardi Doctrine” (so named for the Supreme Court case) the IRS has to follow the regulation.

Judge Holmes has discussed the Accardi Doctrine in an interesting order I blogged on before, and frankly I think the time is nigh for it to step into the limelight in (non-criminal) tax controversy.

The crux of Accardi is that agencies have to follow their own “rules” when individual rights would be affected if they deviated from them. The rules the agency must follow sometimes include sub-regulatory guidance, but always include “legislative” regulations. Which, as a matter of fact, Treas. Reg. § 301.7122-1(h) would be. Sounds to me like the IRS has to follow the Treasury Regulation, at least so long as it can be said to “affect individual rights” by failing to return the TIPRA payments on non-processed Offers.

I’ve also read some Accardi adjacent (non-tax cases) that quote the Supreme Court case of Morton v. Ruiz, 415 U.S. 199 (1974) for the proposition that where “the rights of individuals are affected, it is incumbent upon agencies to follow their own procedures.” That case is particularly interesting in the context of Notice 2006-68, since it involved an agency (the Bureau of Indian Affairs) trying to restrict payments to certain individuals through sub-regulatory guidance (an internal manual) rather than publishing in the Federal Register (which was supposed to be their practice). The Supreme Court was not impressed with this attempted end-run around the APA…

Third Reason: No Deference Under Auer/Seminole Rock

At the end of the day, practitioners just want to know how much the Court is going to persuaded or “bound” by the agency interpretation. (At least in litigation… but litigation isn’t easy to come by in tax collection issues. I will cover more on that and why Notice 2006-68 is so toxic as a non-litigated issue in a following post.)

Should a challenge to Notice 2006-68 ever actually make it to a judge, the court should find that it’s interpretations of the statute are not entitled to much, if any, real deference. The general rule is that sub-regulatory guidance gets Skidmore deference. (A point made in the Feigh case I argued and blogged on.) I often call this “worthless” deference, because it frequently isn’t much more than the deference that IRS Counsel gets for making a good point on a brief -the court isn’t really “deferring” to that good point, it is just being persuaded by its own force of reasoning.

To the extent that the IRS would want to “shoehorn” Notice 2006-68 into some level of deference “above” Skidmore, its only real option is Auer deference: the level of deference agencies can sometimes be given on their interpretation of their own regulations. But even if the IRS changed course and decided to actually argue for Auer deference (it has a policy of not doing so) that wouldn’t work in this instance.

The Supreme Court does not defer to an agency interpretation of a regulation when the regulation itself is not ambiguous. The reason why makes good sense, so I’ll go ahead and quote the Supreme Court on it: “To defer to the agency’s position would be to permit the agency, under the guise of interpreting a regulation, to create de facto a new regulation.” Christensen v. Harris County, 529 U.S. 576, 588 (2000). In other words, it would give the agency an end-run around their need to go through notice and comment to amend a final regulation.

The regulation on point is blessedly unambiguous. There is no way the IRS could argue that Notice 2006-68 is merely an interpretation of it. So no Auer deference. And probably no deference at all.

…And Yet It Persisted.

I’ve laid out a lot of reasons why Notice 2006-68 is susceptible to serious challenges, both for its interpretation of IRC § 7122(f) and its denial of TIPRA payments as deposits. I think it is largely indefensible on its interpretation of the statutory language, and clearly problematic as sub-regulatory guidance masquerading as a legislative rule.

Yet the fact remains that Notice 2006-68 is celebrating its 16th birthday, essentially unscathed, after affecting likely tens-of-thousands of taxpayers. Why might that be? Are my arguments just nonsense?

Perhaps. Nonetheless, in an eventual follow-up post I’ll go into why I really think Notice 2006-68 has survived without challenge, why it is a problem we need to fix, and why it is a good example of the checks we need on agency rulemaking in the tax world.

When Regulatory and Sub-Regulatory Guidance Collides… (Part One)

Being tasked with “administering” the Internal Revenue Code is no easy job. Congress sometimes makes it even more difficult by having the IRS distribute direct payments (like the Economic Impact Payments (EIPs)) or by changing the law when filing season has already started (for example, by excluding unemployment benefits from income). Notice and comment rule-making takes time, and sometimes the IRS relies on the “quick guidance” that can be delivered through online FAQs or other sub-regulatory means.

While understandable as an interim action (really, just letting people know what the IRS “thinks” about the statute, but without force of law) it is problematic when “rights and obligations” flow from the guidance -believe it or not, sometimes the guidance is not well rooted in the statute (see posts on the incarcerated individuals and the EIP here, here and here).

It is similarly problematic when the quick guidance subtly morphs from temporary to permanent after years of inaction on finalizing regulations. And it is even more problematic (dare I say, inexcusable) when that quick guidance directly contradicts prior (still valid) notice and comment regulation. To hear more about one such instance that many PT readers have likely encountered without even realizing it, you’ll need to…

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Dream with me, if you will, of an individual that currently makes $35,000 but can’t afford to pay their back taxes. They used to work as an Uber driver where they were hammered with SE taxes. They’ve since become an employee, but they have virtually no disposable income. They submit an Offer in Compromise proposing to pay a $1,000 “lump-sum” to settle the back taxes. Per the Offer instructions, the individual includes $200 as a 20% payment on the Offer, as well as a $205 application fee.

Time passes. Months later, this individual gets a letter returning the Offer as “non-processible” because they have not made required quarterly tax payments. Oh, and on top of that, the $405 they sent in is not coming back.

Now this individual is in your office, regaling you with this tale of woe. You want to help them at least get back the 20% payment. You look at the Treasury Regulation (301.7122-1(h)) on point. Your eyes light up:

Sums submitted with an offer to compromise a liability […] are considered deposits and will not be applied to the liability until the offer is accepted[.] If an offer […]is determined to be nonprocessable […] any amount tendered with the offer, including all installments paid on the offer, will be refunded without interest.

You recall from your law school years that Treasury Regulations are basically the highest authority of agency rulemaking. Good as gold! Your client is getting the 20% payment back, right?

And yet you’ve grown so cynical over the years you doubt yourself: if the answer is so obvious, why is your client even here? You look over the IRS Form 656 that your client submitted. Under Section 7, Offer Terms, it reads:

(h) The IRS will keep any payments that I make related to this offer. I agree that any funds submitted with this offer will be treated as a payment. I also agree that any funds submitted with periodic payments made after the submission of this offer and prior to the acceptance, rejection, or return of this offer will be treated as payments.

You wonder why the IRS Form would include terms that seem to go against their own regulations. So you continue digging…

It turns out the regulations you were so thrilled with are a bit dated. The 20% payment requirement at issue was added as part of TIPRA in 2006 and the Offer regulations are from 2002.

Fortunately, in lieu of updated regulations there is an IRS Notice on point.

Unfortunately, that IRS Notice is IRS Notice 2006-68.

Yes, that same IRS Notice 2006-68 that I lambasted in no less than three separate posts. It is here again to haunt you. In relevant part, the Notice reads:

The Service will treat the required 20-percent payment as a payment of tax, rather than a refundable deposit under section 7809(b) or Treas. Reg. § 301.7122-1(h).

There you have it. The Treasury Regulation clearly says money sent with an Offer is a deposit. The Notice clearly says, “not so, if it is part of the 20% payment.”

We are now at the title of this post: When regulations and sub-regulatory guidance collide, which one controls?

A Look to the Statute Before We Look to Admin Law

If the statute is clear about how to treat the payments than it shouldn’t really matter what the regulatory or sub-regulatory guidance says. The problem is when the statutory language is unclear, and there is at least some room for interpretation delegated to the agency.

And that is what we have here. To me, this is a “clearly unclear” statute.

We know that a 20% payment is (generally) required to accompany an Offer. Per IRC § 7122(c)(1)(A)(i) “In General- The submission of any lump-sum offer-in-compromise shall be accompanied by the payment of 20 percent of the amount of such offer.”

But our question is whether you can get that payment back, not whether you must submit a payment in the first place. Is the payment a deposit towards the Offer, or a payment towards the underlying tax? TIPRA doesn’t quite address this, though it does provide some more guidance. Per IRC § 7122(c)(2)(A):

Use of payment- The application of any payment made under this subsection to the assessed tax or other amounts imposed under this title with respect to such tax may be specified by the taxpayer.

There is a comfortable amount of wiggle room in this otherwise dry language.

The taxpayer gets to specify the “application” of the 20% payment towards “assessed tax or other amounts imposed under this title.” If it just read “assessed tax” that would be much clearer and reasonably read as limited to designating among the assessed taxes comprising the Offer. But the very broad phrase “other amounts imposed under this title” seems to leave the door open. Is the “TIPRA” payment an amount imposed under this title? 

Note also that the statute does not say that all payments “must” be applied towards “assessed tax or other amounts imposed under this title.” It merely says that when such payments are applied, the taxpayer gets to choose how they are applied. This says literally nothing about if a returned, non-processed offer must have the payment applied to assessed taxes. That is an IRS (not Treasury) interpretation only.

You won’t find much illumination in the legislative history, though I would suggest that if anything it cuts against the IRS Notice 2006-68 interpretation. The Conference Report distinguishes the “user fee” from the “partial payment” by saying that the user fee “must be applied” to the tax liability. But it is silent as to whether the “partial payment” must be. In other words, it creates more ambiguity on the issue rather than resolves it.

Fundamentally, the question remains about the required 20% payment. Is it always a payment towards tax (non-refundable), or might it sometimes be a payment towards the Offer (potentially refundable)?

At present, all we have are the thoughts of IRS Counsel as memorialized in Notice 2006-68. Without further going into depth on the merits of its interpretation, it is time to turn to the admin law question: what about the fact that Notice 2006-68 seems to be contradicted by an actual, still enforceable, Treasury Regulation?

Let’s look to the admin law authorities… in our next post.

Another Offer Denied, Another Reason for Submitting in Collection Due Process

I keep something of a running tally of cases where my clients would have been unjustly treated if not for the protections of Collection Due Process (CDP) hearings. As a practitioner, I think it helps me in advising and counseling my clients on a course of action: what are the pros and cons of proposing a “collection alternative” prior to doing so in a CDP hearing?

The main “con” is pretty straightforward: if the IRS does something crazy, you’re stuck arguing with the IRS (and not a court) about it. The recent case Richard Dillon et al. v. United States et al. illustrates that point nicely, both in terms of how impossible it is to get judicial review on Offers in Compromise outside of CDP, and how stuck you can be with a completely unreasoned IRS determination.

read more…

The Dillons apparently wanted to submit an Offer but couldn’t get their feet in the door -it was returned as non-processible. Rather than give up on it, they went to federal district court on an Administrative Procedure Act (APA) argument. The Dillon opinion resolves on a jurisdictional issue: whether there is a waiver of sovereign immunity. This, in turn, involves the intersection of the Anti-Injunction Act and the APA. While the APA generally waives sovereign immunity when there is an allegation of agency error and the requested relief is not for money damages, the waiver does not apply “if any other statute that grants consent to suit expressly or impliedly forbids the relief which is sought.” The Dillon court, like other federal courts before, concluded in part that the Anti-injunction Act and the tax exception to the Declaratory Judgment Act directly applied and thus under the APA “forbids the relief” that the Dillons sought.

Because of this jurisdictional issue the underlying substance of the complaint concerning the Offer is not given much attention. However, from the opinion we can glean the following:

The Dillons are married, live in St. Paul and owe about $150,000 in back taxes from 2011 – 2017. They are also “approaching retirement” and have about $180,000 in their retirement account. Every other aspect of their finances goes largely unsaid and apparently did not much matter.

I am not a financial advisor, but that vignette conjures up a married couple that will likely struggle during retirement. Were they to liquidate their retirement accounts to pay their back debts they would have virtually nothing left after taxes. On these facts alone, liquidating their retirement accounts would very likely cause economic hardship in the Dillons most vulnerable years (i.e. during retirement). That’s how I see it, and that is also apparently how the Dillons’ attorney framed the Offer to the IRS.

Fortunately, the Treasury Regulations provide for exactly these sorts of Offers -ones where the taxpayer could theoretically full-pay, but a parade of horribles would ensue if they did. They are called “Effective Tax Administration” Offers and some examples are provided at Treas. Reg. § 301.7122-1(c)(3).

Unfortunately, the IRS is often loathe to accept Effective Tax Administration Offers. From both anecdotal evidence and this rather dated article the evidence suggests that getting an Effective Tax Administration Offer accepted is a massively uphill battle.

At its worst, the Dillon case shows just how bad the IRS may be at evaluating these Offers. Apparently, the Offer was “returned” (that is, not processed) without Appeal rights because the IRS determined that it was submitted “solely to hinder or delay” collection. See IRC § 7122(g) and Treas. Reg. § 301.7122-1(f)(5)(ii).

That’s pretty bold, and given the scant information I have, pretty ridiculous. For one, the debts aren’t likely to expire imminently. For two, the stated rationale (“we can collect more than you’re offering”) obviates the entire purpose of ETA Offers, which will always involve an Offer less than “Reasonable Collection Potential” -that’s their whole raison d’etre. Virtually every ETA Offer would be denied (indeed, go unprocessed) if submitting one for less than RCP was seen as intended to hinder or delay collection.

However, I’ve also been informed by those in the know that the IRS tends not to make “solely to hinder or delay” determinations lightly. Sometimes this appears to happen when the taxpayers account was assigned to a Revenue Officer (RO) and the taxpayers file an Offer to essentially take the matter out of the RO’s hands. If the RO has seen some bad taxpayer behavior (transferring property to nominees, etc.) they will reach out to the Offer unit and advise them to make a “solely to hinder or delay” determination.

So perhaps there are good reasons why the Offer unit didn’t let this ETA Offer through the door. I’d sure like to see some more facts…

Alas, no more facts are to be found. Indeed, the Dillons want more than just additional reasoning behind the IRS conclusion: they demand that the Offer be processed via a “writ or order” of the court. That remedy is why they went to court, and ultimately why they are unsuccessful on jurisdictional grounds. Note that if they were in the Tax Court on a CDP determination, however, not only would jurisdiction be clear cut, but the reasoning behind the “solely to hinder or delay” determination would be front and center. And to me, that would provide an important check on what may (or may not) be an irrational decision by the IRS that you’re otherwise stuck with.

Lessons Learned: Advising Clients on Offers

In the past, I mostly considered how “complex” my client’s Offer was in my advice about whether it was worthwhile to wait for a CDP hearing. If it was even remotely complex there was a good reason to wait for CDP.

Dillon emphasizes how low of a bar “complex” is in the Offer context. In my experience, virtually any Offer where the client wasn’t going to pay the full present value of their retirement account (say, because they were entering retirement) or the full equity in their home (say, because they had horrible credit and couldn’t borrow against it) has been enough of a reason to counsel waiting for CDP. I have seen too many times where the IRS review is just to look at the far-right column of the Form 433-A OIC and compare it to the total liability, ignoring any reasons why that is inappropriate that we’ve put forth in a narrative, and leave it at that: “Oh, you’re 64 and have $40,000 in retirement? Then it should be no problem at all to full pay a $30,000 liability.” I assure you this is barely a caricature of how the analysis tends to play out.

But Dillon (and to an extent, the Brown saga) raise other reasons to wait on CDP even if it isn’t a “complex” Offer. Two reasons immediately come to mind.

First, and obviously, in the absence of CDP you are stuck with bad or unjustifiable preliminary decisions made by the IRS as to whether your Offer is “processible.” Without CDP you can’t even get your foot in the door to dispute it, no matter how slam-dunk the underlying Offer may be.

Dillon underscores that problem. I’ve had cases where obvious Offer candidates are “returned without appeal rights” for failing to make quarterly payments where no such payments were required or failing to file a return when they did, in fact, file but the IRS rejected the return for ID verification issues. One was saved by the grace of CDP. The other will have a student assigned to it this semester.

Second, CDP keeps the IRS honest. And frankly, I’ve seen time-and-again that such value cannot be understated. Many of my clients just want to be heard: none of them are doing particularly well financially as virtually all of my clients being under 250% of the federal poverty line, per IRC § 7526. Yes, the IRS has a fair amount of latitude in when to accept an Offer, but if it is going to be rejected my client and I want to know the reasons why. Absent CDP I find that we are never given anything beyond a boilerplate “we’ve considered your circumstances and determined they do not justify accepting your Offer.” When pressed on this (which I really only can do with any value in CDP reviewing the administrative file) I often find that the IRS never really appeared to “consider the circumstances” at all.

A Parting Thought: The Value of Judicial Review on Collection Actions

As an academic who cares about tax administration, I’m not a huge fan of incentivizing people to “wait” on addressing their tax problems. It’s inefficient and costly.

(Note that the Tax Court may have inadvertently (and in my opinion incorrectly) further incentivized waiting until CDP in the context of arguing the underlying merits of the liability under IRC § 6330(c)(2)(B). As covered here, here, and here, if you are proactive in arguing against the underlying tax you may miss out on the chance to get court review later. I definitely don’t trust IRS Appeals enough on deficiency issues with low-income taxpayers (the common “prove the kid lived with you” scenario) to foreclose judicial review.)

I hope that the (much needed) increase in IRS funding (see Les’s post) will ameliorate some of the issues I’ve seen through better training and support. But even if it improves the quality of review on collection issues (a big “if” since it isn’t clear how much of that money would be going to exam, etc.) I believe the need for judicial review of collection actions remains. If you ever have a position contrary to the IRM, you have virtually no chance of success without judicial review.

And sometimes the IRS rules, frankly, are nonsensical or needlessly hurt low-income taxpayers. Vinatieri is the classic example, and Keith has noted other times where it seems that those in positions of power seem to just “make-up” rules. A judiciary check against that power, even if modest, I think, is in order. Most of my low-income clients are collection cases, and collection (the actual taking of their modest property) is a serious concern that can carry serious consequences if you get “the wrong person” at the IRS reviewing the case.

As a parting example, I once submitted an Offer for a homeless client. It was preliminarily rejected by the IRS on their determination that the taxpayer had disposable income because… yep, they weren’t paying for housing. Because the IRM (basically) says “take actual housing expenses,” and since stable housing was just a dream of theirs, they shouldn’t be allowed $1,000 in anticipated monthly housing costs while trying to leave a domestic violence shelter.

I kid you not.

I am convinced this particular case was resolved favorably only because I was able to say to Appeals, as they informed me they were upholding the determination: “do you really want this to play before a Tax Court judge?” I have heard from other colleagues (especially in California) that they’ve run into the homelessness housing expense issue before, with both failure and success. I don’t think the IRS, as an entity, endorses the position that homeless people shouldn’t be allowed the means to pay for housing. But that’s what the frontline workers (and the “Independent Office of Appeals”) end up doing based on their reading of the IRM. Part of me wished my case went to trial so that it could have gained some notoriety, and either led to the IRS changing the IRM on its own or a Tax Court decision that forced its hand.

But for now, I’ll settle for the fact that at least my particular client was given a positive outcome that would not have occurred in the absence of CDP. I’m sure there are other such examples from practitioners nationwide.

Contract Law and Rejecting Offers in Compromise

I apparently cannot stop writing about Offers and “deemed acceptance” under IRC § 7122(f). This is because I think it represents fertile ground for practitioners to help their clients, a way to hold the IRS accountable for getting things done in some semblance of a timely manner, and fix (or invalidate) an indefensible IRS Notice.

Yes, I am apparently the type of person that gets worked up over tax administration.  

My prior post got at the procedural issues with Notice 2006-68, as well as some of the substantive issues in its interpretation of the statute. On the substantive question, everything hinges on what it means to “reject” an Offer in Compromise. We looked at the legislative history of the statute and found that Notice 2006-68 doesn’t quite have a slam-dunk case for following Congress’s (albeit unstated) intent. In this post, I’ll go dive into the substance a bit more: what does it (or should it) mean to “reject” an offer for purposes of IRC § 7122(f)?

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To sum up, the statute provides that an Offer that is not rejected within 24 months of submission is “deemed accepted.” The IRS (through Notice 2006-68 and the relevant IRM) interprets this to mean that so long as a preliminary determination is made (to reject, return, or withdraw the Offer) within 24 months, it no longer matters how long it takes to reach a final resolution. I think that’s an unreasonable interpretation.

I also think that when you’re challenging a rule or interpretation as being “unreasonable,” it is important to have a ready answer for what a more reasonable replacement would be. I have no idea what the comments to Notice 2006-68 were. But had I been in practice at the time, here is what I would have submitted…

Protecting Both Taxpayer and IRS Interests: A Better Way Forward

I can understand where the IRS is coming from with Notice 2006-68. The IRS understandably doesn’t want a slew of Offers aging into acceptance just because people go to Appeals or insist on Collection Due Process (CDP) rights. Those things take time (though query whether two years should be enough in any case), and it might end up in bad Offers on $50 million dollar liabilities being erased on a foot-fault. This would be especially unfortunate in those instances where the IRS is truly carrying on negotiations with the taxpayer over those two years, but circumstances continually change.

But there are better ways to protect the IRS from being penalized on different layers of review -ways which would better ensure timely resolution of cases and are more defensible readings of the statute. Professor Camp recently wrote about the Brown case, and provides, I think, a clearer rationale for the outcome in Brown than what the Tax Court (or Notice 2006-68) provides. In a nutshell, Prof. Camp characterizes the role of IRS Appeals in CDP as “reviewing a rejection.” In that understanding the rejection does, in fact, happen with the original Offer unit, and Appeals (much like any other “Independent” adjudicatory function), just reviews that decision.

I wish I could go along with this. But as a practitioner, I cannot.

First, I cannot accept as true the proposition that IRS Appeals doesn’t “work” an Offer, and that it only reviews the rejection. As is particularly relevant to IRC § 7122(f), by the time the Offer actually gets to Appeals (usually many, many months later), circumstances have often changed. If too much time has passed, the IRS will ask for brand new bank statements, etc. Importantly, if the taxpayer raises new issues that have arisen since the original rejection Appeals will generally consider them on its own. See IRM 8.23.3.3.1.1 (08-18-2017). That, to me, seems like Appeals making their own determination by working the Offer on their own. The original rejection rationale may become, essentially, irrelevant.

Lastly, I cannot agree with the characterization as Appeals merely reviewing a rejection because that is not accurate as a matter of contract law. Note, very importantly, that IRS Appeals still has the power to accept the Offer. I will explain more about why that matters, but query whether Appeals is really reviewing a “rejection,” or only a “recommendation to reject.” Note the IRM heading on point: 8.22.7.10.4.5 (08-26-2020) “Collection Recommends Rejection” [emphasis added].

It is perhaps simplistic (though also perhaps accurate) to read IRC § 7122(f) as an analysis of just two dates: (1) when the offer was submitted and (2) when the offer was finally resolved. There is room in the statutory text, I believe, for accommodating some of the IRS’s concerns. But that room is found in contract law, and not in Appeals mission as an independent arm of the IRS.

Contract Law and Offer Analysis

The words “offer,” “rejection,” and “acceptance” are familiar to anyone that has taken a first year contract lectures or bar review. While an Offer in Compromise is a product of statute, it is “properly analyzed as a contract between parties” and “is governed by general principles of contract law.” Dutton v. CIR, 122 T.C. 133, 138 (2004).

Let’s apply some contract law principles to the transactions that I am most concerned about.

We know that when an Offer is “returned” as non-processible it is considered “rejected” for IRC § 7122(f) purposes. That is settled in the Tax Court (and 9th Circuit) via the Brown v. CIR saga. The question I’ve posed is whether that continues to hold if the determination to “return” the Offer is not upheld by Appeals. In other words, is a “preliminary” determination to return an Offer a rejection?

The Restatement of Contracts would give some fodder to the argument that such a preliminary determination is not, in fact, a rejection. The Second Restatement of Contracts § 38 covers rejections, and provides:

(2) A manifestation of intention not to accept an offer is a rejection unless the offeree manifests an intention to take it under further advisement.

The comment explains:

The rule of this Section is designed to give effect to the intentions of the parties, and a manifestation of intention on the part of either that the offeree’s power of acceptance is to continue is effective. Thus if the offeree states that he rejects the offer for the present but will reconsider it at a future time, there is no basis for a change of position by the offeror in reliance on a rejection, and under Subsection (2) there is no rejection. [emphasis added.]

What does a preliminary determination letter say? In my experience, when you are in CDP it says something to the effect of “we are recommending rejection/return of your Offer, but Appeals has the final say.” To me, that really seems to meet the “not a rejection” description in the Restatement. What is Appeals providing if not a “reconsideration” of the Offer?

Treating a preliminary determination as a final rejection is probably not tenable under contract law. Indeed, a precedential Ninth Circuit case would appear to agree with my analysis. Consider the case of U.S. v. McGee, 993 F.2d 184 (9th Cir. 1993).

In McGee, the taxpayer was working with an IRS Revenue Officer on a potential Offer. After much negotiation, the Revenue Officer decided that the proposed Offer was not acceptable. The RO sent a letter indicating as much and providing that McGee “had 15 days to appeal the ruling.” McGee never did appeal. A little less than a month later, the IRS sent a final rejection letter.

The question before the Court was when was the Offer rejected: the initial letter giving 15 days to appeal, or the final letter?

Here’s where things get interesting. The 9th Circuit found that the Offer was “rejected” only with the final letter, and not with the preliminary rejection granting appeal rights. The earlier letter was not a final rejection, the Court found, but “merely notice of a proposed rejection.” McGee at 186.

And here’s where things get even more interesting.

Recall that Brown was in the 9th Circuit. Recall also that I criticized both the Tax Court and Court of Appeals for inappropriately looking at when Offer is considered “pending” for purposes of IRC § 7122(f) (which only looks at when an Offer is “submitted”).

In McGee (which predates IRC § 7122(f) by over a decade), the issue of when the taxpayers Offer was “pending” was very important, because while an Offer is pending the statute on collection tolls. This case was purely about the statute of limitations. The taxpayer wanted to argue that the Offer was not pending because it was rejected through the IRS’s preliminary determination to recommend rejection: this would have ended the statute of limitations a little earlier.

Apparently, this issue of Offers holding the collection statute open indefinitely through the failure of the IRS to conclusively reject them had come up enough that other circuits addressed it. The general sense was that the taxpayer was protected from an indefinitely open collection statute through their ability to withdraw the Offer (thus ending the tolling of the clock). See McGee at 186.

Lastly, consider whether under contract law principles the IRS Offer Unit even has the power to reject an Offer in a CDP case. When the case is in CDP, the final determination must be made with Appeals. The Offer unit can only “recommend” acceptance or rejection. A recommendation by someone that has not been delegated authority (i.e. agency) to make a final determination does not seem like a rejection to me. The Tax Court case of Hinerfield v. CIR, 139 TC 277 (2012) makes this point nicely.

In Hinerfield, the IRS came within a month of hitting the two-year deemed accepted date on the taxpayer’s Offer. Wary of triggering that statute, a rejection was sent at the last second. What was the hold up? Apparently, the Settlement Officer wanted to accept the Offer, but IRS Area Counsel (which reviews Offers covering liabilities over $50,000 per IRC § 7122(b)) recommended against accepting. Who gets the final say?

Appeals does. Only not in the form of the Settlement Officer. It needs to be the Appeals Team Manager. The IRM, policy delegations, and multiple blog posts from Keith illustrate the importance of that point.

Changing the facts, if the SO in Hinerfield had told the taxpayer that they accepted the Offer, the IRS would not be bound. It would be an ineffective acceptance. I would say the same of a rejection conveyed to the taxpayer where the person rejecting does not have the authority to do so… say, in a preliminary determination by the Offer Unit.

But if that’s the case, how can we get to a place where the IRS is protected against offers aging into acceptance just because of Appeals review? Again, a look to contract law…

The Proposal: Counteroffers as Restarting the Clock

Let me lay my cards on the table. As I have snarkily alluded to throughout my posts, I think 24 months should be more than enough time for the IRS to reach a final determination even if the Offer goes through Appeals. I also think that there is good reason to believe that Congress, in enacting IRC § 7122(f), was looking at the issue more from a taxpayer’s perspective than an IRS processing perspective: what taxpayers want is a final conclusion, not an initial determination followed by indefinite inaction. Yet IRS Notice 2006-68 says “initial determination with indefinite inaction thereafter is completely fine.”

That isn’t fine, and it isn’t justifiable.

To me, the question is “when should the IRS reasonably get more than 24 months to evaluate an Offer?” The main reason I can think of is when the delay isn’t the fault of the IRS.

One such scenario would be when the IRS is waiting on the court to make a determination on a year involved in the Offer. In that scenario, the IRS is protected by the language of IRC § 7122(f) and doesn’t need to promulgate any regulations: “any period during which any tax liability which is the subject of such offer-in-compromise is in dispute in any judicial proceeding shall not be taken into account in determining the expiration of the 24-month period.”

Another scenario would be when the IRS has been engaged with the Offer, but the circumstances surrounding the Offer keep changing. For example, the taxpayer now owes for a new tax year or is now making more (or less) money. In those cases, what you are likely to be dealing with at the end of the day is a new Offer. Or, using contract law terminology, a “counter-offer.” Why does that matter?

Again, to the Restatement of Contracts, this time § 39 Counter-Offers:

(1) A counter-offer is an offer made by an offeree to his offeror relating to the same matter as the original offer and proposing a substituted bargain differing from that proposed by the original offer.

(2) An offeree’s power of acceptance is terminated by his making of a counter-offer, unless the offeror has manifested a contrary intention or unless the counter-offer manifests a contrary intention of the offeree.

The comments provide:

Counter-offer as rejection. It is often said that a counter-offer is a rejection, and it does have the same effect in terminating the offeree’s power of acceptance. But in other respects a counter-offer differs from a rejection. A counter-offer must be capable of being accepted; it carries negotiations on rather than breaking them off.

In my experience, the IRS makes counter-offers frequently, which usually culminate in sending the taxpayer amended Form 656 (i.e. contract) with the proposed terms. One could reasonably interpret such an IRS counter-offer as a “rejection” of the original Offer, which would thus stop the clock on IRC § 7122(f). But it would also be a submission of a new Offer, meaning that a new clock would start… thus precluding the IRS from delaying indefinitely all over again.

This, to me, appears to protect all the parties involved. Where the IRS is running up against the 24-month clock because the taxpayer’s circumstances are changing, it could easily require the taxpayer to submit an amended Form 656 to the offer examiner (or Appeals Officer) working the original case. While the IRC § 7122(f) clock would restart, I’m not sure taxpayers would be upset since they would continue to have someone at the IRS actually assigned to their Offer… and since up to this point virtually no one has succeeded on an IRC § 7122(f) claim anyway.

Conclusion: Bad Case Law, Bad Guidance, Bad Outcomes

If you can believe it, I have still more thoughts on IRC § 7122(f) that I may someday write about… but for now, this journey is at an end. When I originally read the Brown case, I saw it as the Tax Court reaching the right outcome for the wrong reasons.

After all the research I’ve put into these posts my thinking has changed. Now, I think both the outcome and the reasoning are wrong.

The taxpayer made, in my opinion, bad arguments.

First, he didn’t properly challenge Notice 2006-68. Indeed, according to the Tax Court opinion he appears to have conceded its authority, but instead argued that it is “inapplicable to CDP OICs.” Brown at 9. I don’t know why you’d concede challenging an IRS Notice (that appears to have some serious flaws) and instead draw focus to the implausible argument that the Notice doesn’t cover CDP offers. This was a tactical mistake.

Second, he tied the idea of an Offer “rejection” too closely to a Notice of Determination. Again, this seems like a flawed fixation on CDP. As the Tax Court characterizes the argument, the taxpayer considers the issuance of the Notice of Determination to be the “critical event” in IRC § 7122(f) analysis. That’s not a winning approach. The IRS can certainly reject an Offer (even in CDP) prior to issuing a Notice of Determination -it just has to be a conclusive, final rejection and not something “preliminary.” In other words, it has to be an effective rejection under contract law principles.

But from these flawed arguments the Tax Court also erred.

First, the Tax Court (and 9th Circuit) seem to think that clock on deemed acceptance doesn’t start running until an Offer is officially “pending.” That’s nonsense. Even IRS Notice 2006-68 doesn’t peg its IRC § 7122(f) analysis to a pending date. The statute specifically uses the word “submitted” rather than pending. Pending status is irrelevant to IRC § 7122(f) analysis. I hope over the course of my posts you’ll agree with me on that now.

Second, the Tax Court (with an assist from the 9th Circuit) uncritically treats a preliminary determination to return as being a rejection. Certainly, an actually returned Offer would be a rejected Offer. But if the Offer is never actually returned (or rejected), but only suggested that it will be… well, the Restatement of Contracts and the 9th Circuit (in McGee) have correctly found that is not definite enough to be a rejection.

To me, the problem with Brown isn’t that the taxpayer lost: I withhold judgment on a +$50 million tax liability being erased, and the Tax Court had to rule on the arguments that were put before it. Rather, the tragedy is that Brown will make IRC § 7122(f) claims more difficult moving forwards for the taxpayers that deserve its protection -namely, the low-income taxpayers that do, in fact, have their Offers shelved for months and then years.

Brown arguably stands for the proposition that a preliminary determination (to return or reject) an Offer is all that the IRS needs to do within 24 months. Thereafter it can take an indefinite amount of time to conclude the matter. I’ve looked at legislative history and GAO Report leading to IRC § 7122(f)… I struggle to believe that’s the outcome Congress had in mind. But because Brown is a precedential decision, others in the tax community will now have more of an uphill battle than they otherwise would have in getting to the right outcome. Nonetheless, I hope these posts have inspired you to join me in this fight.