An IRC 6751 Decision Regarding the Initial Penalty Determination

In Palmolive Building Investors, LLC v. Commissioner, 152 T.C. No. 4 (2019) the Tax Court addressed one of the issues presented by the language of IRC 6751 regarding the initial determination of a penalty. Unlike the Walquist case involving IRC 6751 discussed here, the petitioner in the Palmolive case had excellent counsel and pursued the case without the distractions present in Walquist. Still, the taxpayer lost in is effort to knock out the penalty for IRS’s failing to follow the statute.

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The petitioner in Palmolive filed a partnership return claiming a huge charitable contribution for a façade easement. In an earlier decision the Tax Court sustained the IRS determination disallowing the deduction. At issue in this opinion is the correctness of the related penalty determination. The IRS not only disallowed the claimed contribution deduction, but the revenue agent (RA) examining the case asserted two penalties in the alternative – a 40% penalty for gross valuation misstatement and a 20% negligence penalty. The RA obtained the approval of the immediate supervisor on a Form 5701 attached to the Notice of Proposed Adjustments.

Petitioner requested an Appeals conference. The Appeals Officer (AO) proposed issuing an FPAA asserting four alternative penalties: the two proposed by the RA plus penalties for substantial understatement and substantial valuation misstatement. The AO’s immediate supervisor signed Form 5402-c on the approval line and an FPAA was eventually issued determining the imposition of all four penalties in the alternative.

An issue that the court does not decide concerns whether the 40% gross valuation misstatement also includes the 20% penalty. The IRS position was that approval of the 40% penalty necessarily included the lesser penalty if the valuation ultimately supported the lower penalty amount. Taxpayer contested this assertion. The court found that since the notice issued by Appeals included both and since the court found the additional penalties added by Appeals met the requirements of IRC 6751, deciding the issue of whether the 40% penalty necessarily included the lower penalty was unnecessary here.

The Tax Court begins its analysis by noting the statutory language.

Section 6751(b)(1) provides: No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination * * * .

At issue here is whether there can be more than one initial determination. The court noted that Congress sought to keep the IRS from using penalties as a bargaining chip in passing IRC 6751. The court finds:

on the undisputed facts, we hold that the “initial determinations” are those by Agent Wozek on or before July 2008 and by Appeals Officer Holliday in June 2014.

Petitioner argued that the RA did not propose and his supervisor did not approve all of the penalties. Therefore, because the RA’s determination was the initial determination, the subsequent determination by the AO does not meet the requirement of the statute. The court dismisses this argument stating:

Section 6751(b)(1) includes no requirement that all potential penalties be initially determined by the same individual nor at the same time.

Petitioner also argued that the IRS failed to follow its Internal Revenue Manual provisions which require that the case history reflect the decision to impose the penalty. The court replied that the IRM

does not have the force of law, is not binding on the IRS, and confers no rights on taxpayers.’” Thompson v. Commissioner, 140 T.C. 173, 190 n.16 (2013) (quoting McGaughy v. Commissioner, T.C. Memo. 2010-183, slip op. at 20).

The court found that the supervisory approval need not occur on a specific form and that the form used need not reference the employee recommending the imposition of a penalty.

This decision gives the IRS much more flexibility in meeting the requirement of IRC 6751 than the taxpayer’s arguments would have permitted. The IRS still must show supervisory approval at each level at which a new penalty is imposed, but the decision provides it with much latitude in how to accomplish the approval. The term “initial” in the statute does not limit the IRS to getting it right at the first step or else forgoing a penalty. The decision lines up with the purpose of the statute. Since the statute provides a difficult procedural roadmap for the court to follow, perhaps having the decision line up with the purpose is the primary goal to seek when writing an opinion on this topic.

Automatically Generated Penalties Do not Require Managerial Approval

This is the first of several posts on precedential cases decided by the Tax Court earlier this year regarding the IRC 6751 provision requiring preapproval by a manager before the assertion of certain penalties. The case of Walquist v. Commissioner, 152 T.C. No. 3 (February 25, 2019) represents the type of case that one might wish had been litigated by a petitioner other than a pro se petitioner that did not engage in the process; however, the outcome would almost certainly have been the same with a more robust litigation participant. In the Walquist case the Tax Court addresses the imposition of a penalty in a setting in which the IRS argues that automation removes the need for prior managerial approval. The court agreed.

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The IRS sent the Walquists a statutory notice of deficiency for 2014 determining a liability over $13,000 and a related accuracy penalty. Although petitioners earned almost $100,000 in 2014, on their return they claimed a deduction for almost the same amount based upon a “Remand for Lawful Money Reduction,” a tax protestor type claim. The IRS disallowed this claimed deduction resulting in the deficiency determined. The IRS handled the case through its Automated Exam Correspondence Unit designed to minimize the amount of human involvement in the audit.

The Automated Exam process generated a 30-day letter to petitioners. Because the amount of the liability determined through the process exceeded $5,000, the program automatically placed on the notice an accuracy related penalty of 20% of the liability. Petitioners did not respond to the 30-day letter, resulting in the issuance of the SNOD. Petitioners timely filed a petition with the Tax Court in which they continued to assert tax protestor type arguments. The tax protestor activity did not stop and the court gives a detailed accounting of the time wasting efforts of petitioners before it ultimately imposes the IRC 6673 penalty because of their post-petition actions. I will not describe this aspect of the case as it is relatively boring.

The ultimate finding of the court with respect to the requirement for managerial approval is that:

Because the penalty was determined mathematically by a computer software program without the involvement of a human IRS examiner, we conclude that the penalty was ‘automatically calculated through electronic means,’ sec. 6751(b)(2)(B), as the plain text of the statutory exception requires.

The court goes on to say that this conclusion is consistent with the description of the imposition of a penalty in this situation as described in the Internal Revenue Manual and the context in which the statutory exception appears in IRC 6751. Computer generated penalties do not raise the concerns that caused Congress to enact IRC 6751 because no one is imposing them in order to influence to taxpayer to accept the liability or otherwise to coerce an outcome. The court stated that if the penalty imposed under these circumstances fails to meet the statutory exception it is difficult to imagine a penalty that would meet the exception.

The court noted that its conclusion in this precedential opinion was consistent with unpublished orders that it had issued in recent years. Another reason for paying attention to those orders.

The result here makes perfect sense. The IRS did not impose this penalty as a bargaining chip. The court provides a detailed analysis for its decision. Perhaps the only thing surprising about the opinion is that a precedential opinion on this issue did not previously exist. Although petitioners did nothing to advance their argument that the exception should not apply, their failure did not create the result in this case.

The decision here was the first of several precedential IRC 6751 opinions issues in the first few months of the year as the court continues to answer the questions raised by this unusual statute. We will cover all of the opinions in the coming days.

Capacity to File a Tax Court Petition

At issue in Timbron Holdings Corporation and Timbron International Corporation v. Commissioner, T.C. Memo 2019-31, is whether a corporation can file a Tax Court petition when its corporate charter has lapsed. The Tax Court holds that it cannot and that reviving the charter after the filing of the petition does not save the Tax Court case. The non-precedential opinion reminds us of the importance of corporate formalities when seeking to litigate regarding corporate tax liabilities.

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On March 2, 2009, and August 1, 2013, respectively, the California Franchise Tax Board suspended Timbron International’s and Timbron Holdings’ powers, rights, and privileges for failure to pay State taxes. Petitioners’ powers, rights, and privileges remained suspended as of July 6, 2017. The suspension of corporate powers provides another example of the types of state benefits that taxpayers can lose by not paying state taxes. I had not previously seen this exercise of power by a state but I do not represent corporations. The suspension must happen routinely in California with potentially far sweeping results including those at issue here. This means that corporations that fall behind in paying their state taxes will have difficulty in many contexts. It also could have significant consequences for the responsible persons of the corporations. This post will not discuss the broader issues.

The court notes that as of July 6, 2017, the powers remained suspended. The suspension of the corporate powers, of course, does not stop the IRS from auditing the corporation and from issuing a notice of deficiency. The IRS did issue the notice on July 14, 2016. The corporations responded by filing Tax Court petitions on October 11, 2016 which respondent answered the following month. In the answer the IRS did not raise the jurisdictional issue but such issues can be raised at any time. Several months later the IRS must have noticed the suspended powers and the fact the suspension existed at the time of the filing of the petitions and it filed motions to dismiss for lack of jurisdiction due to the lapse of corporate existence at the time of the filing of the petitions. In response the corporations did not argue with the fact of the suspension but argued that at the time of the filing of the petition “that they had obtained certificates of reviver and were considered ‘active’ as of September 27, 2017 (approximately 11 months after the end of the applicable period).”

The court set up the issue with the following statement:

Whether we have jurisdiction to decide a matter is an issue that a party, or this or an appellate court sua sponte, may raise at any time. David Dung Le, M.D., Inc. v. Commissioner, 114 T.C. 268, 269 (2000), aff’d, 22 F. App’x 837 (9th Cir. 2001). Jurisdiction must be shown affirmatively, and petitioners bear the burden of proving all facts necessary to establish jurisdiction in this Court. Id. at 270. Petitioners must establish that: (1) respondent issued them valid notices of deficiency and (2) they, or someone authorized to act on their behalf, filed timely petitions with the Court. See Rule 13(a), (c); Monge v. Commissioner, 93 T.C. 22, 27 (1989); see also secs. 6212 and 6213.

The court noted that corporate petitioners must have capacity to file a petition in order to for the court to have jurisdiction. (For a good discussion of the Timbron case commenting on Tax Court Rule 60(a), see Bryan Camp’s blog post here.) It then looks to California law to determine what it means to have the corporate powers suspended. The IRS relied on the case of David Dung Le, M.D., Inc. v. Commissioner, 114 T.C. 268, 269 (2000), aff’d, 22 F.App. 837 (9th Cir. 2001). In that case the Tax Court interpreted California law in a very similar situation and determined that “[i]n reaching our holding we cited Cal. Rev. & Tax. Code secs. 23301 and 23302 (West 1992 & Supp. 1999), noting that the Supreme Court of California has construed those sections to mean that a corporation may not prosecute or defend an action during the period in which it is suspended.”

Petitioners argued that even though the state suspended its powers it still retained some rights and that those residual rights gave it capacity to file the Tax Court petition. They pointed to cases in California courts brought by suspended corporations which were allowed to proceed after the lifting of the suspension. The Tax Court rejected this argument pointing to its long history on this issue and discussing the fact that a post-petition restoration of rights did not revive a petition filed at the time corporate powers were suspended, for a court with limited jurisdiction. In this way it differentiated itself from the courts of general jurisdiction in California to which petitioners had cited.

Petitioners also argued that the 90-day period for filing a petition after the issuance of a notice of deficiency was not a jurisdictional time period. Since that period for filing a petition is not jurisdictional, petitions argued that the period could remain open until the restoration of corporate powers. The court dismissed this argument in a footnote citing to the Guralnik case in which the Tax Court, in a 16-0 reviewed opinion, rejected similar arguments concerning its jurisdiction raised by the tax clinic at Harvard. This is an issue we have discussed repeatedly in the blog though not in the context of lapsed corporate powers and not with an 11-month time frame to equitably toll.

The outcome here comes as no surprise. A host of cases have reached similar results including the almost identical case of David Dung Le. States regularly suspend corporations for failure to pay the annual registration fees. As states find more ways to suspend corporate powers, corporations must pay careful attention to their status at the time of filing the Tax Court petition. Chief Counsel, IRS will pay attention to this issue since it presents an easy way to dispose of a case. Then a corporation already in financial trouble will only have the opportunity to contest the IRS determination if it can come up with full payment of the liability in order to meet the Flora rule.

Fallout from the Shutdown – The Odyssey of a Tax Court Petition

I think we all expected that the length of the shutdown would create some interesting procedural issues. At the recent ABA Tax Section meeting Rich Goldman from Procedure & Administration in Chief Counsel’s office reported on an interesting case that arose because of the shutdown. In the end the taxpayers will get their day in court but their visit to the Tax Court got off to a rocky start.

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The case is Hackash v. Commissioner, Dk. No. 2406-19S. Mr. and Mrs. Hackash received a statutory notice of deficiency (SNOD) on October 22, 2018. They sent a petition to the Tax Court on January 16, 2019 via FedEx using one of the FedEx services designated by the IRS. At the time they sent their petition to the Tax Court, it was closed. FedEx attempted delivery several times (January 17, 18 and 22); I guess the delivery person was not reading the news about the shutdown. Each time the delivery person showed up there was no answer at the Tax Court.

The story told by Rich at the ABA diverges a bit from the Court’s order determining that it had jurisdiction. The order says that after the last failed attempt FedEx attempted to return the petition to petitioners. Rich said that FedEx took the petition to a location in Mississippi. Meanwhile, the Court resumed operations on January 28, 2019 at the end of the shutdown. According to Rich, someone in Mississippi noticed that they had a package destined for the Tax Court and shipped the package back up to D.C. where it was delivered to the Court on February 1, 2019. In shipping the package from Mississippi to D.C., FedEx used one of its lowest delivery services which has not made it onto the IRS list of approved services.

When the package arrived at the Court on February 1, more than 90 days had run since the sending of the SNOD. Because the package arrived at the Court via an unapproved delivery service and because it arrived well after the 90th day, the Court issued an order to show cause why the case should not be dismissed as untimely.

Petitioners were able to show the Court that they did timely mail the petition and show the various attempts by FedEx to deliver the package during the shutdown. Rich noted that they had kept their receipt from the original mailing. Based on the timely mailing of the petition in the first instance and the mailing by an authorized third party, the Court determined that it did have jurisdiction, stating:

I.R.C. section 7502(f) governs the treatment of private delivery services under section 7502. It provides that the sending of a petition by a designated private delivery service may be treated as timely mailed. In Notice 2016-30, 2016- 18 I.R.B. 676,2 the Commissioner includes FedEx Standard Overnight among designated private delivery services. See I.R.C. sec. 7502(f)(2); sec. 301.7502-1(c)(3), Proced. & Admin. Regs. As respondent further notes, Notice 2016-30 further provides that, under section 7502(f)(1), the date recorded by FedEx to its electronic data base or the date marked by FedEx on the cover of the item is treated as the postmark for purposes of section 7502. Accordingly, the Court concludes and agrees with the parties that the petition in this case was timely mailed/timely filed with the Court.

So, the taxpayers have a happy ending and we get a story from one of the problems created by the shutdown. I am sure this is not the only problem. Here, the taxpayers were diligent in responding to the Court’s order, they had used an authorized delivery service to initiate the mailing to the Court, and they had kept proof of mailing. I hope that they have an outcome on the merits equal to their outcome on the jurisdictional issue. I also wonder how many private delivery servers stood at the Tax Court’s doors during the shutdown waiting for someone to answer.

Tenth Circuit Agrees with Graev II – IRS Attorney Can Impose Penalties

The case of Roth v. Commissioner raises again the issue of whether the IRS can raise a penalty once the case arrives in Tax Court. In certain cases the IRS attorney assigned to a case once the taxpayer files a Tax Court petition sees a penalty issue that the examination division did not. In the Roth case, the IRS attorney raised an additional penalty in answering the petition. Because the answer will always receive a review from the docket attorney’s supervisor, the raising of the penalty in the answer does receive supervisory approval in the Office of Chief Counsel. At issue is whether IRC 6751 permits the raising of the penalty at that stage of the case.

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The Roths donated land to a conservation easement and valued the contribution at almost $1 million. The Tenth Circuit characterized their case as follows:

The Roths’ case is one of the so-called “gravel-pit cases” in which Colorado taxpayers claimed large deductions based on the appraisal and donation of conservation easements prohibiting the mining of gravel on what had historically been farmland. The IRS later determined these easements to be effectively worthless (or worth drastically less than the taxpayers claimed) because the subject farmland was more valuable as farmland than it would be if mined for gravel. Esgar Corp. v.Comm’r, 744 F.3d 648, 658 (10th Cir. 2014).

The revenue agent who audited the case disallowed the easement deduction almost in its entirety and imposed the 40% gross overvaluation penalty after obtaining the appropriate managerial approval. The Roths went to Appeals where the appeals officer made what the IRS characterized as a clerical error by reducing the penalty from 40% to 20%. The manager in the Appeals Office approved the report of the appeals officer and the notice of deficiency contained the 20% penalty. The Roths then filed a Tax Court petition. In answering the petition, the IRS attorney, and her supervisor, responded by asserting the 40% penalty. While appeals officers almost never raise new issues in a case, Chief Counsel attorneys regularly raise new issues that they spot when working a case. The ability and the willingness of Chief Counsel attorneys to raise new issues should cause taxpayers to think about potential issues in their cases before filing a Tax Court petition in knee jerk fashion. As happened here, filing the petition can result in more taxes than the IRS asserted in the notice of deficiency.

The Tax Court sustained the penalty, noting that the IRS had obtained the appropriate approvals at every step and that the IRS can change the penalty at the Tax Court stage if it acts appropriately in obtaining the penalty approval.

On appeal, the Roths acknowledged that the IRS obtained supervisory approval at every step but argued that the notice of deficiency contains the initial determination of the penalty locking the IRS into the amount of penalty in the notice. While the Tax Court and the Second Circuit had approved the initial raising of a penalty by a Chief Counsel attorney at the Tax Court stage, the issue was one of first impression in the Tenth Circuit and only the second time this issue has reached a circuit court. The Roths also framed the issue in a slightly different way than prior cases. The Tenth Circuit described the issue before it as follows:

In short, the Roths raise a narrow question of statutory construction: whether the statutory notice of deficiency constitutes the IRS’s § 6751(b) initial determination. To answer this question, after stating the standard for our review, we consider the meaning of § 6751(b) generally before applying that meaning to the facts before us.

The Tenth Circuit noted that the Roths raised a legal question which required it to give a de novo review. So, like other courts before it the Tenth Circuit began to try to interpret the puzzling language of IRC 6751 in order to determine if the word “initial” in the statute had the meaning offered in the taxpayer’s arguments. Because of prior cases seeking to make this same determination, the Tenth Circuit did not operate without the guidance of the prior judges who had struggled to fit the language of the statute into the norms of tax procedure. It stated:

Given these accepted definitions, § 6751(b)’s phrase “the initial determination of such assessment” poses an obstacle to plain-language interpretation. The Code does not require, or even contemplate, that “assessments” will be “determined.” See Chai, 851 F.3d at 218–19 (“[O]ne can determine a deficiency, and whether to make an assessment, but one cannot ‘determine’ an ‘assessment.’” (quoting Graev v. Commissioner (Graev II), 147 T.C. 16, No. 30638-08, 2016 WL 6996650 (2016) at *31 (Gustafson, J., dissenting) (internal citations omitted))). Indeed, the IRS has seemingly little discretion to make any determination with respect to the assessment of a liability.

The Tenth Circuit agreed with the Second Circuit that the language of IRC 6751 is ambiguous. So, it began to look at legislative history in order to find an answer to the meaning of the language. It found that the purpose of IRC 6751 was to prevent “rogue” IRS agents from proposing penalties in order to get taxpayers to agree to their adjustments. Having determined why Congress enacted the provision, the Tenth Circuit then set off to determine how it should apply the language of the statute given the facts in the Roths’ case.

According to the Tenth Circuit, nothing in the statute requires that the IRS include its initial determination in the notice of deficiency. It finds that the determination of the revenue agent could be viewed as the initial determination but also that the determination of the IRS attorney could be viewed as the initial determination as well. The court noted that the statutory scheme for the Tax Court clearly contemplates that the IRS can add additional liabilities and that adopting the position of the Roths would undermine that statutory context in which this question arose.

As its final reason for rejecting the argument of the Roths, the Tenth Circuit mentions that to accept their argument would upset Tax Court jurisprudence and it does not want to lightly do that. It cites to the Supreme Court case of Dobson v. Commissioner, 320 U.S. 489, 502 (1943). In the Dobson case the Supreme Court briefly flirted with the notion that Tax Court decisions should be given special deference because of the expertise of the Tax Court. Justice Jackson, a former Chief Counsel, IRS, argued for such a result but I had thought the case had very little viability at this point.

The decision here follows the decisions in the Second Circuit and the Tax Court. It adds little to the jurisprudence other than adding another circuit to those interpreting IRC 6751 to allow Chief Counsel attorneys to add penalties. Since the statute makes little internal sense, the court’s decision to pursue legislative history in trying to find an answer makes sense and fits with the approach of earlier courts that have wrestled with the provision. Still, it’s possible that other taxpayers will continue to attack this position in hopes that a court will back another interpretation of a confusing statute.

TBOR Provides no Relief in Tax Court Deficiency Proceeding

In Moya v. Commissioner, 152 T.C. No. 11 (2019) the Tax Court rejected petitioner’s argument that she could obtain relief in a deficiency case based on her assertion that the IRS had violated her TBOR rights. The precedential opinion cites to Facebook v. IRS (blogged by Les here) and picks up where the Facebook opinion left off in finding that TBOR creates no rights that did not already exist. Because Ms. Moya relied exclusively on TBOR in seeking relief and made no assignment of error regarding the substance of the adjustment in the notice of deficiency, she loses the case entirely with the exception of some concessions by the IRS.

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Ms. Moya is a college professor. She was teaching in Las Vegas at the time the examination began. During the examination she moved to Santa Cruz, California and requested that the IRS reassign her case to an examiner in her new location. She wrote to the examiner in Las Vegas to make this request. She received no response. She called with the same result. She wrote again and received correspondence from the IRS office in Denver indicating that her case would be moved to a location near her; however, the office in Las Vegas subsequently issued a notice of deficiency without ever meeting with her. She considered this a violation of her rights to have her questions answered and the right to meet with an IRS representative at a time and place convenient to her.

The notice of deficiency reduced Schedule C expenses that Ms. Moya had claimed for each of the three years under examination. In her Tax Court petition she chose not to challenge the disallowance of the expenses or the related penalties, but simply relied on the alleged violation of TBOR as the basis upon which the court could grant relief. This decision made the court’s job easier since it merely had to focus on the TBOR arguments. The decision also serves as a reminder that petitioners in Tax Court need to put at issue in the petition (or amended petition) everything they may wish to argue in the case.

By not assigning any error to the adjustments to her returns, Ms. Moya conceded those adjustments according to the Tax Court Rules 34(b)(4) and 41(b)(1) as well as a significant amount of case precedent.

In response to Ms. Moya’s TBOR argument, the IRS essentially argued that she could not make the TBOR argument in Tax Court because the proceeding is de novo. It cited to the case of Greenberg’s Express v. Commissioner, 62 T.C. 324 (1974) in support of its position. For anyone not familiar with Greenberg’s Express, it holds that the Tax Court will not look behind the notice of deficiency. It usually comes up in cases in which the taxpayer wishes to complain about the revenue agent or the audit process and is basically a statement by the court that it will not listen to those types of arguments in a deficiency case. The taxpayer must “get over” their concerns about the way the audit was conducted and instead address the merits of the audit determination. IRS attorneys regularly cite to Greenberg’s Express, because taxpayer complaints about the audit process arise frequently in Tax Court cases. Each Tax Court judge has a canned speech for taxpayers about this issue. The point of the IRS argument regarding Greenberg’s Express was that Ms. Moya essentially made a typical argument addressed by that case, just dressed up in different clothing.

Ms. Moya countered that her argument did not simply complain about the audit, but that TBOR elevated her concerns about the audit to something actionable in the Tax Court case. She sought to find rights created by TBOR that did not previously exist.

The Tax Court finds that “the history of the IRS TBOR makes clear that it accords taxpayers no rights they did not already possess.”  The court traces the statements of the Commissioner, the NTA and the legislative history.  The court cites favorably to the Facebook decision.  It concludes that:

We think there is ample evidence in the history recited to conclude that, in adopting a TBOR in 2014, the Commissioner had no more in mind that consolidating and articulating in 10 easily understood expressions rights enjoyed by taxpayers and found in the Internal Revenue Code and in other IRS guidance.  Certainly, the Commissioner had no power to legislate any new rights.

The court focuses on the Commissioner’s administrative adoption and not on the Congressional enactment of TBOR in 2015. An argument exists that making it law added something to TBOR. The court does not address any possible additional authority that occurs as a result of the passage of the law but nothing in the statute explicitly gives rights to the taxpayer not contained in the administrative provisions of TBOR. 

After the court rejects Ms. Moya’s TBOR arguments, it engages in an analysis that the court occasionally does when someone alleges bad or wrongful actions by the IRS during the examination process to determine if the IRS actions here violated norms to such an extent that the court would take action despite Greenberg’s Express. The court determines that the alleged violations here did not reach the level that would allow Ms. Moya to go behind the notice of deficiency. To go behind the notice and overcome the precedent in Greenberg’s Express would have required a very high level of IRS misconduct during the audit. Such cases are extremely rare.

The result here does not surprise me.  Taxpayers cannot point to anything in TBOR that gives them additional rights. Without something tangible, this case does seem like an attempt to go behind the notice of deficiency, simply using different dressing to make the argument. However, the decision here does not apply to non-deficiency cases. Although the outcome in a Collection Due Process or Innocent Spouse case might ultimately mirror the outcome here, those statutes have roots in equity where the pre-court process might create a better atmosphere for a TBOR argument. Several cases currently exist in the Tax Court in which taxpayers have made TBOR arguments in non-deficiency cases. We may not have to wait long to find out if TBOR has any legs in these types of cases.

Variance Doctrine Trumps IRS Failure to Obtain Administrative Approval of Penalty

Another variation on the Graev issue just popped up.  This one is in the refund context where the decision turned on who had the most important duty.  Did the duty of the IRS to obtain managerial approval before imposing a penalty override the duty of the taxpayer to raise the issue in the claim for refund?  The district court finds that the duty to exhaust administrative remedies by giving the IRS a chance to address the issues on which the taxpayer’s claim for refund is based must be satisfied and the taxpayer cannot rely on the duty of the IRS to properly approve a penalty to absolve the taxpayer’s duty to let the IRS know why the refund is sought.  The case is Ginsburg v. United States, 123 A.F.T.R.2d 2019-553 (M.D. Fla. 3/11/2019).

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Mr. Ginsburg engaged in a tax shelter promotion known as short option strategy.  He realized an economic loss of $113,950, and claimed a net loss of $10,069,506 for tax purposes.  He did not disclose the transaction on his tax return but simply reported the loss on a partnership return and netted a tax savings of over $3 million.  When the IRS audited his 2001 return, it disallowed the claimed loss and hit him with a 40% gross valuation misstatement penalty on the underpayment of tax attributable to partnership items. Of course this occurred long before Frank Agostino taught us all, including the IRS, about the importance of IRC 6751 which was enacted not long before the year at issue.  It seems that the IRS did not obtain the necessary written supervisory approval before imposing the penalty.

Mr. Ginsburg paid the taxes, penalties and interest in full as required by the Flora rule and then filed a claim for refund.  On his claim Ginsburg requested a refund of the gross valuation misstatement penalty, the interest paid on the penalty, and a portion of the underpayment interest he paid. He asserted that he reasonably and in good faith relied on accounting advice, legal advice, a tax opinion, his return preparer and a financial advisor.  This situation is classic in tax shelter situations because professionals do provide advice to the taxpayer about these types of transactions and taxpayers always want to use the professional advice to insulate themselves from the penalties that result when abusive tax shelters get picked up by the IRS.  In his refund claim, however, Mr. Ginsburg did not mention that he wanted a refund because the IRS did not fulfill its obligations under IRC 6751 as interpreted by Graev and other cases.

The IRS disallowed his claim for refund and he filed suit.  By the time his suit rolled around Mr. Ginsburg, or his representative, had read about the Graev case and realized that they might have a winner based on this case.  Hundreds of thousands of dollars are at stake so he wanted to make this argument even though he did not alert the IRS to it when he filed his claim for refund.  In his summary judgment motion, Mr. Ginsburg argued that the IRS had a duty to comply with IRC 6751 whether or not he raised the issue in his refund claim and, therefore, the court should allow his claim despite the variance between the claim and the basis for his argument in court.  The IRS, of course, disagreed and argued that the Court lacked jurisdiction because of the failure to exhaust administrative remedies.

The district court denied his claim pointing out he cited to no authority in support of his position that the duty to properly approve the penalty overrode the variance doctrine.  Citing Logan v. United States, 121 A.F.T.R.2d 2018-2193 (M.D. Fla. 6/21/2018), the court stated that it lacked subject matter jurisdiction to hear the case in the absence of a claim clearly identifying the issue the taxpayer now sought to use to overturn the decision.

Mr. Ginsburg also argued that the variance did not apply because he did not know that the IRS had failed to comply with IRC 6751. In making this argument he relied on El Paso CGP Co. v. United States, 748 F.3d 225; 113 A.F.T.R.2d 2014-1420 (5th Cir. 2014); however, the court here pointed out that the IRS took action subsequent to the filing of the claim in El Paso which the taxpayer there could not have known about.  Here, the taxpayer knew of the relevant facts, or could have known of them, but did not realize the importance of the supervisory approval until after making the claim.  The IRS did nothing to keep the taxpayer from knowing and nothing after the submission of the claim.  So, the court determined that the El Paso case did not provide any assistance to Mr. Ginsburg.

Mr. Ginsburg also argued that he should not be penalized because he relied on the advice of professionals.  The IRS responded with respect to each of the advisors he listed.  For several of the advisors, the IRS argued, and the court agreed, that he could not rely on their advice because the advisor promoted the scheme or was an agent of the promoter.  For one advisor he mentioned, the court found that he did not allege that the advisor knew the full facts and for one the court found that he did not list the advisor in his claim for refund triggering the variance doctrine with respect to that advisor.  The IRS also argued that he could not obtain relief from the penalty because as a businessman he knew that the deal was too good to be true.  In response to this argument the court stated:

The improbable tax advantages offered by the transaction should have alerted Plaintiff that the transaction was too good to be true, especially in light of his business experience. See Gustashaw, 696 F.3d at 1141–42 (finding transaction too good to be true where sophisticated taxpayer claimed a loss of $9,938,324 in exchange a $800,000 fee) ….

I find the decision consistent with the variance doctrine.  The taxpayer here did not give the IRS a chance to fix the mistake administratively and brought a new theory to court.  The decision shows that it is easier to raise the Graev issue in Tax Court where the variance doctrine does not apply.  I suspect there may be others out there in the same situation as Mr. Ginsburg who have a large penalty imposed against them for tax shelter activity that occurred well before the IRS appreciated its responsibility under IRC 6751.  This case reminds those individuals to make sure that their claim for refund includes a Graev argument.  It’s hard to fault Mr. Ginsburg for failing to put this argument into his refund claim but it’s also hard to say the Court got this wrong.  I doubt this will be the last case on variance and Graev.

Seeking Attorney’s Fees for Violation of Automatic Stay

What does a court do when the statute requires exhaustion of administrative remedies before a grant of attorney’s fees and the administrative agency (here the IRS) guides people to perform an impossible act in order to seek to exhaust administrative remedies?  That was the issue facing the bankruptcy court in Langston v. Internal Revenue Service, Case No. 17-10236-B-13 (Bankr. E.D. Cal. 2019).  In the end, the court denied the request for attorney’s fees because of precedent in the 9th Circuit but the courts are split on the issue and the IRS is about a decade behind in updating its guidance to the public on how to make an administrative request to fix a problem it creates by violating the automatic stay. Outdated language referencing the non-existent “Chief, Local Insolvency Unit” role remains in the current version of the CFR.

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Mr. Langston is a retired federal employee who also owed federal taxes.  I don’t think he is the only retired federal employee with this issue, but the government especially wants individuals to whom it is paying a pension to pay their taxes.  So, it has a program for taking from their pension payments to satisfy the outstanding tax debt.  The program is a perfectly legitimate method for the IRS to collect past due taxes except when used while the automatic stay comes into effect.  That’s what caused the problem here.

Mr. Langston and his wife filed a Chapter 13 bankruptcy case in January 2017.  The bankruptcy court notified the IRS within two weeks of the filing and the IRS filed a proof of claim one week thereafter.  So, it is indisputable that the IRS knew about the automatic stay.  Normal procedures would have had it input a code into its computer system almost immediately after learning of the case.  Here, it is not the IRS specifically that took the action violating the stay.  The agency taking from his pension and sending the money to the IRS was the Office of Personnel Management (OPM).  It could well be that the debt offset indicator arrived at the OPM before the bankruptcy case and there was a delay in that office in taking action.  It is also possible that there was a delay at the IRS getting information about the stay to OPM or a delay at OPM in putting the stay into its system.  The bankruptcy court does not go into the details of how the problem occurred and it really does not matter in the resolution of the case, but it should matter to the IRS and OPM so that a system exists to immediately notify OPM of the stay and for OPM to immediately put the stay into its system. 

For undescribed reasons, OPM sent to Mr. Langston a letter he received in early April saying that it would withhold a part of his pension to satisfy the outstanding federal tax debt. OPM withheld almost $400 a month for four months starting in April 2017.  The Langstons’ bankruptcy lawyer filed an adversary proceeding in May 2017 after informally trying to convince the IRS to stop taking the money.  Their representative did not seek to formally stop the taking of the pension funds prior to bringing the suit.  The IRS eventually gave back all of the money taken by OPM.  In responding to the complaint which undoubtedly included a request for monetary damages, the IRS would have pointed out that the Langstons did not first try to resolve the problem administratively.  Apparently, in doing so the IRS informed the Langstons that they were supposed to send a request to the “Chief, Local Insolvency Unit” of their district.

A few reorganizations ago, there existed in every IRS district (also a thing of the past) an insolvency unit that handled bankruptcy cases and a few other related proceedings.  Most of the IRS bankruptcy function was centralized some time ago, and local offices no longer had someone with the title “Chief, Local Insolvency Unit.”  Of course, if you weren’t following the staffing flows of the IRS, you would have no easy way of knowing this and that was the problem the Langstons faced in trying to make their administrative request for relief.  Here’s what the court said about it:

Then, Langstons’ counsel tried without success to find the right “Chief, Local Insolvency Unit” to receive an administrative claim. Many web searches and even formal discovery was met with no identified “Chief, Local Insolvency Unit.” Exasperated, Langstons’ counsel sent the administrative claim addressed to “Chief, Local Insolvency Unit” to every IRS office located within this district. The IRS admitted in discovery that to their knowledge no employee retains the title of “Chief Local Insolvency Unit” after the IRS reorganized in 2010. The IRS instead referred debtors’ counsel to a listing of “Collection Advisory Groups.” The IRS did respond after receiving debtor’s administrative claim noting they were referring it to the “Local Insolvency Unit.” But the IRS did not name a “Chief” of that unit. And so, it goes.

The Langstons could not show they had actual damages from the taking of $400 of his pension for four months.  Of course, they did incur attorney’s fees as their attorney tried to get the IRS to stop taking their money.  So, they sought attorney’s fees even though they were not entitled to damages.  The IRS fought the payment of attorney’s fees stating:

… [the] court does not yet have subject matter jurisdiction to decide the attorney’s fees issue because the debtors filed this adversary proceeding before filing an administrative claim with the IRS. They reason that their waiver of sovereign immunity under § 106(a)(1) for attorney’s fees claims stemming from automatic stay violations is conditioned upon a debtor’s compliance with 26 U.S.C. §§ 7430 and 7433 and the applicable regulations before filing suit. Counsel for the United States noted in oral argument that the Plaintiffs have now complied with the exhaustion requirement because they filed the administrative claim, albeit at the wrong time and that more than six months have passed with no action by the IRS. 26 C.F.R 301-7433-2(d)(ii).

The debtors must have wondered, “Wait a minute, how could we file an administrative claim prior to filing suit when your instructions told us to file the claim with someone who does not exist?”  Seems like a reasonable question to ask.

The IRS responded with two arguments.  First, it argued

“all that is required to satisfy the plain language of the regulation is that a writing be sent to ‘Chief, Local Insolvency Unit’,” the actual existence of an individual with that title being immaterial for compliance. 

[Keep that in mind because this is not the only place where the title in the regulations or other IRS guidance does not match the actual lineup at the IRS. Of course, the IRS did not say where the taxpayers should mail this letter and that could become an issue in a future case.]

Second, the IRS argued that the debtors’ reliance on Hunsaker v. United States, 902 F.3d 963, 968 (9th Cir. 2018) was misplaced.  Les blogged the district court opinion in Hunsaker here and the bankruptcy court opinion here.  We did not blog the 9th Circuit’s opinion in Hunsaker, in which it reversed the district court and determined that the bankruptcy code did waive sovereign immunity to obtain damages for emotional distress.  The IRS argued that the Langstons’ reliance on the 9th Circuit opinion was misplaced because Hunsaker did not address the situation where the only issue involved attorney’s fees.  It determined that there was a waiver for emotional damages, but here that issue does not exist.

The bankruptcy court looked at the litigation on this issue around the country and found that courts are split over the sovereign immunity argument.  Focusing on 9th Circuit jurisprudence, it found a 1992 opinion, Conforte v. United States, 979 F.2d 1375, 1377 (9th Cir. 1992) (almost all cases involving Conforte are worth reading if you enjoy cases with lurid details) holding that debtors must exhaust administrative remedies in order to receive attorney’s fees.  So, on the legal aspect of the IRS argument, the court finds that the IRS is correct in the precedent controlling it.

Then the court addressed the factual issue of whether the debtors did try to exhaust administrative remedies despite the barriers imposed by the IRS.  It stated:

In none of the cases previously discussed have the courts examined this issue raised by Plaintiffs — that complying with the statute is impossible. The courts either found that the taxpayer made no attempt (see Swensen v. United States (In re Swensen), 438 B.R. 195, 198 (Bankr. N.D. Iowa 2010); In re Rae v. United States, 436 B.R. 266, 275 (Bankr. D. Conn. 2010); Kight v. Dep’t of Treasury/IRS (In re Kight), 460 B.R. 555, 566 (Bankr. M.D. Fla. 2011)), or found that the taxpayer’s attempt was deficient for a number of reasons (see Klauer v. United States (In re Klauer), 23 Fla. L. Weekly Fed. D 153, at *11-14 (M.D. Fla. 2007); Don Johnson Motors, Inc. v. United States, 532 F. Supp. 2d 844, 883 (S.D. Tex. 2007); McIver v. United States, 650 F. Supp. 2d 587, 593 (N.D. Tex. 2009); Barcelos v. United States (In re Barcelos), 576 B.R. 854, 857-58 (Bankr. E.D. Cal. 2017); Galvez v. IRS, 448 F. App’x 880, 886 (11th Cir. 2011); Kuhl v. United States, 467 F.3d 145, 148 (2d Cir. 2006); In re Lowthorp, 332 B.R. 656, 659-61 (Bankr. M.D. Fla. 2005)), but no court addressed whether compliance was possible because the tax-payer was required to send the documents to a person that did not exist, nor was that argument ever raised.

Because the debtors’ original and amended complaint did not allege that they exhausted their administrative remedies, the court ultimately concludes that it cannot award attorney’s fees.  But it does not stop there.  Before dismissing the case without prejudice, it finds that

Plaintiff actually did send such a notice but after the lawsuit was filed. The IRS now admits Plaintiffs have complied and could proceed with another action for attorney’s fees.

I do not know if that means we should stay tuned for the second suit for attorney’s fees or that the Langstons can get fees if the IRS does not adequately resolve the matter.  In any event, it’s clear that the law here is not clear.  It’s also clear that the IRS paints itself into a corner when it asks people to do the impossible.