Creating Tax Policy and Tax Procedure on the Fly

The current situation allows us to observe the creation of new tax procedures based on new polices in real time.  Listservs and web sites are alive with discussion of what to do as the IRS tries to figure out procedures in a matter of days after passage of legislation creating new and immediately applicable tax provisions in the middle of tax filing season with most of its employees sitting on the sidelines.  We all have empathy for the people at the IRS trying to push out procedures to address the new provisions while at the same time feeling frustration based on the lack of guidance. 

A recent exchange on the ABA Tax Section listserv for Pro Bono and Tax Clinics caught my eye as a good example of the types of issues practitioners seek to work out in order to guide clients.  Some of our recent posts written by Nina Olson, Carl Smith, Barbara Heggie and Bob Rubin also address these same types of concerns.  We welcome guest posts that raise procedural issues that need answers.  We hope that perhaps the blog can serve as another outlet for passing questions that need answering to those at the IRS trying hard to provide those answers. 

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It’s interesting, but not surprising, that many answers to the questions of procedure that require an immediate answer are driven not so much by policy as by computer capability.  Since the IRS has what some people might describe as a third world class computer system, some of the procedures that will apply will result from the quality, or lack thereof, of the computer system used by the IRS.  The computer capabilities at the IRS not only drive some of these decisions but are also hampering the IRS from having its employees work during this time when many are continuing to work from home.  Because many of the IRS employees do not have laptops they can use from home, they have been sent home not to work to help through this difficult time but just to sit.

Francine Lipman, William S. Boyd Professor of Law at University of Nevada, Las Vegas, William S. Boyd School of Law, writes first raising a few of the many unanswered questions concerning who will receive the rebates that the IRS will start sending out any day.

[w]e need guidance from US Treasury.

1) Will the IRS age adjust qualifying children to 2020? Or does a QC that is 16 in 2018 qualify for a $500 EIP if no 2019 tax return filed? And not qualify if a 2019 tax return is filed?

2) If one taxpayer claims a QC on her 2018 tax return and another claims the same QC on their 2019 tax return. What is the tie-breaker? 2019 > 2018? I do not believe they both get the $500 QC amount. What if someone else claims the QC in 2020?

3) If a taxpayer claims a 16 year old QC for 2018 and no 2019 tax return on record, will the 18 year old (former QC) nondependent get the full $1,200 when she files her 2020 income tax return or does she only receive $700 ($1,200 – $500)?

It seems to me that one long-standing rule of thumb that I believe will be applied to these EIPs is that the maximum amount of EIP per SSN will be $1,200. Thus, I believe these fact patterns will be interpreted to respect that long-standing guideline.

Responding to Francine, Bob Probasco, Director, Tax Dispute Resolution Clinic at Texas A&M University School of Law, responds.

Thanks, Francine.  There are those open questions and probably several others.

I suspect that the decisions – most of which have already been made or won’t be in time for advance refunds – will be driven by factors other than what makes sense from a tax law perspective.  They will be driven in part by:

● What has to be programmed now versus a year from now for processing 2020 tax returns

● Ease of programming in an antiquated system (Nina’s post on Procedurally Taxing, procedurallytaxing.com/…, Is particularly scary)

● What can be programmed and tested and have a relatively low likelihood of significant glitches when they flip the switch

That is, we need to think about these issues not just from a legal perspective and from looking at the desired results but also from a programming perspective, what can be accomplished.  That may turn out to be a bigger factor than equity and legal interpretation.

The IRS certainly was starting their programming efforts before the final legislation was enacted but I’m not sure how much of a jump they had.  And they’re aiming at sending out the first batch of payments (by direct deposit) in a week to 10 days.  That very likely means that the small teams of IT people and IRS attorneys and whoever else had to make very quick decisions without the normal level of vetting we expect for guidance.  They had no choice if they were going to meet the deadline.  They didn’t have time to think through and identify all the issues – heck, the experienced tax practitioners here are still identifying nuances and will be for quite some time – and some issues they identified may have been too difficult to program easily.

We can speculate, for example, whether the programming is structured to crunch all the information for all taxpayers, do cross-checks between different returns, before making the final decisions which returns get how much money.  That’s complex, but doable.  It might lead to inequitable results, of course. 

As a trivial example, right now when two divorced parents each claim the same qualifying child for the same tax year, the IRS may not identify the discrepancy and follow up until a year or so later.  At that point, there may be a correspondence exam and a long process – including Tax Court – before a final determination of which parent is entitled to claim the qualifying child.  Lots of due process.  We have a case like that now.  But in the context of the advance refunds, they need to make a determination before sending payments out this month.  There are only two choices that appear even feasible as a matter of programming.  A, apply the AGI tie-breaker rule automatically.  B, allow both parents the $500.  Alas, choice A (1) increases the complexity of the programming and (2) raises additional due process questions.  How does the losing parent challenge that?  That might be difficult to impossible other than through the audit process applied to the 2020 tax returns.  But that delays receipt of the money for someone who may really need it and may not even come up in 2020 if the qualifying child has “aged out.”  It also invites gaming the system, particularly since a parent who improperly claimed the qualifying child but got the $500 this month apparently would not have to give it back on the 2020 tax return.  (Is there an exception to the “no claw back” rule for improperly claiming a qualifying child, or was that primarily intended for changes in AGI?)

And I’m not at all sure what happens in that trivial example if the 2018 return was joint, parent A files a 2019 single return before the first batch of direct deposit advance refunds, and parent B files a 2019 single return after parent A receives the advance refund.  Is “first past the post” (in the horse racing, not electoral, sense) an equitable way to decide who gets the $500??

These kinds of issues abound.  The programming team won’t have identified all the issues, and won’t have identified all the nuances and potential problems arising from different solutions.  There’s no way they can/could in a very limited time.

They also will likely be pre-disposed to simple decision trees rather than complex, nuanced ones.  The latter is risky.  Several years ago, in my pre-law school career, I managed a small team (IT folks and accountants from the user group) on a systems development project.  That system was much more straight-forward than anything we’re talking about here and the volumes of data we were working with were several orders of magnitude less than what the IRS will be dealing with.  We spent over nine months on the project.  (Maybe more, this was at least 30 years ago and my memory is a little bit fuzzy.)  At the end, after extensive testing, we flipped the switch to go live – and it didn’t work.  The people at the IRS are a lot smarter than I am but the task they’re facing is also light years more difficult.  So I expect them to err on the side of simplicity rather than complexity/nuance.

A totally uneducated guess (and your guess is better than mine) for those examples you raised:

1. Seems the most likely to be addressed in the programming (not sure in which direction) if the age information is easily accessible from the Form 1040.  (I should know whether it is but I’m drawing a blank at the moment.)

2. Assuming they do a complete crunch of all the tax returns and cross-check before deciding the advance refund amounts – which itself is a herculean task – they can resolve that.  But it becomes a legal issue in addition to a programming issue, and either way they decide it will be subject to second-guessing.  What would be the logical basis for deciding one way or another?  I’m not sure there is one – it would have to be a fairly arbitrary choice.  They might even duck the question and give the credit to both; it will be – relatively speaking – a small subset of qualifying children, and overpaying might insulate them from a lot of criticism based on sympathetic taxpayers.  Then they will have more time to decide what to do when the 2020 tax return rolls around.

3. Depends on the resolution of #1?  I suspect that if this is an issue, they will take their time to decide what to do when the 2020 tax return rolls around.  This isn’t a decision that needs to be made this month.

And, one final thought.  We may not get “guidance” in the normal sense.  They’re making the decisions about the advance refunds – indeed, they already have.  We don’t need to know in order to apply for an advance refund in the normal sense of “apply.”  And I’m not sure they envision a mechanism for taxpayers to challenge the amount of their advance refunds.  In which case, we don’t need guidance in the normal sense for the challenge process.  All they do in the short term may be to tell us “if you can’t figure out how we arrived at the amount of the advance refund you received, here is our decision tree; but you can’t challenge it now.  We’ll provide more guidance in the next several months and by then it may have changed.”

Francine responded to Bob with the following brief message:

I agree 100% about [the] lack of forthcoming traditional “guidance.” Perfect is the enemy of the good here and the theory of second or even third, fourth best certainly applies now with a global pandemic and a corresponding economic free fall.

Thanks Bob and Francine for giving all of us issues to think about as we navigate how to guide clients in the absence of guidance from the IRS and thanks to everyone engaging in these types of discussions that may eventually impact decisions.  Thanks to the IRS employees working hard to implement legislation passed in the middle of the filing season and in the midst of extremely trying circumstances.  Do the best you can under a situation never faced before.

Offsets in a Time of Coronavirus

As discussed in yesterday’s post, Congress has created an override of the normal offset provisions for the CARES rebate.  It does not matter how much a taxpayer owes the IRS for prior years, if a taxpayer qualifies for the CARES rebate, the $1,200 rebate will pass through the normal offset provisions without stopping to satisfy the outstanding federal tax liability.  This is a sign of how much the government wants to put these checks into the hands of taxpayers and signals a difference in approach from the 2008 rebate checks where a large number were siphoned off to pay prior debts.

Also discussed yesterday was the decision of the Department of Education to pull back from claiming an offset of federal taxes this year. 

While it is nice that the IRS seems to acknowledge a small loosening of the normal offset bypass rules by requiring less documentation to request an offset bypass, it could go further.  It could follow the lead of the Department of Education and simply pull back from making offset for a period of time to allow taxpayers to get their refunds this year because of the extraordinary circumstances.  The IRS has this discretion as discussed above because the statute says may.  Why not exercise this discretion in the same manner as another department of the federal government?  Why should the Department of Education be making a policy decision about waiver of offset during this period different from the policy decision made by the IRS?

The issue of pulling back from making IRS offsets for a period of time took on greater urgency yesterday with the closing of the last IRS campus still running.  As long as Ogden was open it was possible for TAS to reach out to IRS employees who could perform the OBR.  Now that all of the service centers are closed there is no one home to make the OBR.  Anyone with a critical need for their refund, will not have OBR as an option because of the absence of IRS employees who could perform the OBR.

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On Friday April 3 the ABA Tax Section sent a letter to the IRS with a list of recommendations regarding how the IRS could respond to the COVID-19 impact on the tax system and on taxpayers.  One recommendation concerned offset and it provides:

… the Service has discretion to not offset a tax refund to cover a previous federal tax debt.20 In tandem with the stimulus checks provided by the CARES Act, offset bypass could provide powerful, targeted relief to those most in need. We recommend the Service provide relief from refund offset due to federal tax debt for all taxpayers with gross income less than 250 percent of the federal poverty line. In addition, we recommend the Service bypass refund offsets for returns claiming the earned income credit or additional child tax credit. Currently, the Taxpayer Advocate Service (“TAS”) assists with offset bypass refund (“OBR”) claims for individual taxpayers facing exigent circumstances. However, the tollfree number for TAS has been taken offline, and TAS local offices are busy meeting the demand of many struggling taxpayers and the challenges involved in remote work. TAS employees would be overwhelmed if they were required to individually request OBR for each eligible low-income taxpayer. A blanket policy of suspending refund offsets would enable TAS to focus on the many other taxpayer issues. Further, most low-income taxpayers are not aware of the OBR process and without Low Income Taxpayer Clinics (“LITCs”) and Volunteer Income Tax Assistance (“VITA”) sites to inform them, they likely will not know to request this assistance from TAS.

Yesterday’s post also discusses how IRC 6402 and the Treasury Offset Program (TOP) work.  Even if the IRS exercises its discretion in the statute to pull back from taking 2019 refunds to past due taxes, some taxpayers will still lose their refunds to other debts that participate in TOP.  For broader relief Congress would need to step in and provide some direction as part of the next relief package.

Offset is a powerful collection tool.  A 2016 Treasury Inspector General for Tax Administration report states that the IRS collected about $7 billion per year through offset.  By substantially turning off the computers which normally capture federal payments headed out to taxpayers with outstanding federal tax and other federal obligations, Congress has made a strong statement about the need to get money into the hands of individuals devastated by the economic impact of COVID-19.  Should it do more?

If Congress wants to be consistent with its actions in CARES, it could suspend TOP for this tax season (with the exception of past due child support payments).  Similarly, if the administration wants to be consistent with the action of at least one of its departments, assuming the statutes governing the departments have the permissive language similar to IRC 6402(a), the administration could grant relief from offset across the board for this tax season.  If there is no Congressional action to broadly suspend TOP, the administration could take the lead and follow the example set by the Department of Education by suspending offset to all federal agencies.  The IRS could independently exercise its discretion as recommended by the ABA and suspend offset.  There are many possibilities here but action should come quickly.

Following Through on Promises

The case of In re Somerset Regional Water Resources, LLC, et al, No. 19-1874 (3d Cir. 2020) triggered in me a culturally insensitive response.  Growing up in Richmond, Virginia in the 1950s I was exposed to all sorts of sayings and cultural norms that do not fit well into 2020.  For the most part I think have little difficulty moving past the things I learned that were flat out wrong or were very culturally insensitive.  For example, in my Virginia history textbooks in the 4th and 7th grade when I was learning about the wonderful specialness of Virginia within the context of American and world history, I got to read about the happy slaves that came over from Africa.  Virginia is a great and special place but the history books it purchased for public school consumption in the 1950s and 1960s did not make it special in a good way. 

Virginia was a segregated society in my childhood and youth.  African American children were prevented by law from attending school with me until I reached the 10th grade.  I can remember many aspects of society that segregation impacted such as water fountains labeled “For Whites.”  Outside of my office now is a picture with a sign such as this, reminding me daily of past practices and laws that have thankfully moved into our history books and out of our lives.  I do not mean to suggest we have entered a post-racial society, but it is a society quite different than the one of my childhood and on this issue one that has greatly improved.

This case immediately brought to my mind a childhood phrase that I had not thought about in several decades.  The phrase is “Indian giver.”  Hopefully, most of my readers have not heard it and are puzzled by it.  It was used by children, and perhaps adults,in the 1950s in Richmond to refer to someone who promised to give something but who reneged on the promise.  Given the history of treaties between European settlers and native Americans, it would seem that the phrase should have been “White Man giver,” but it was not.  Thankfully, this offensive phrase seems lost to history but my childhood memories were rekindled in reading the case.  Rather than simply repress the memory of the phrase, I thought I would try to talk about it in a culturally sensitive way.  I apologize to anyone offended by the fact that I had this memory and chose to talk about it.

On to the case itself.

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A chapter 11 bankruptcy was filed by the LLC listed above in the case caption, its sole owner, Larry Mostoller, and his wife, Connie Mostoller.  The debtors’ largest lender agreed to lend another $1 million needed to keep the business afloat if Mr. Mostoller pledged a forthcoming personal tax refund as collateral for the loan.  In the negotiations all parties expected the refund to be about $1 million.  The refund would be generated by large business losses allowing the debtor to take them back to prior profitable years, 2013, 2014 and 2015, thereby obtaining a refund through the net operating losses.

The debtor got the loan and got the refund but then argued to the court, in an effort to avoid giving the creditor the refund, that the pledge of the refund related only to 2015 and not to the two other years. The debtor admitted that the interpretation of the agreement he urged the court to accept would render the collateral worthless but he, apparently was not bothered by that.  Not surprisingly, the creditor was bothered by this attempt to reform the agreement and keep it from receiving repayment of the loan.

The debtor lost the reformation argument in the bankruptcy court and the district court before continuing to pursue it before the Third Circuit.  If nothing else, his argument was good for the legal economy.

The cash infusion failed to save the company and the loan went into default.  Shortly after default Mr. Mostoller refused to file a refund claim for 2015 but did file claims for 2013 and 2014 which were the years really generating the refund from the carryback of the losses.  The Third Circuit’s opinion states that he testified that he “agree[d] that [the] Trust [aka the lender] gets half of the tax refund, minus the federal taxes due,” with the other half going to his wife.  At some point the trust agree to that proposal; however, when the refund came, he sought the whole amount.  In support of this position, the debtor made three arguments: (1) the bankruptcy court lacked subject-matter jurisdiction to decide the dispute; (2) the agreement unambiguously limited the refund to 2015; and (3) the refund was owned by Mr. and Mrs. Mostoller as tenants by the entirety preventing the trust from reaching it since the agreement was only between Mr. Mostoller and the trust.

Constitutional Argument re Scope of Bankruptcy Court Jurisdiction

Each of the courts looking at these arguments had little trouble knocking them down.  The constitutional issue of the bankruptcy court’s scope created quite a stir in the early 1980s after the passage of the 1978 Bankruptcy Code.  The issue went to the Supreme Court in the case of Northern Pipeline Construction Company v. Marathon Pipe Line Company, 458 U.S. 50 (1982).  The Supreme Court did limit the scope of bankruptcy courts in that case and laid the foundation for future disputes concerning that scope. Central to the outcome of that case was whether a dispute falls within the bankruptcy court’s statutory jurisdiction over core proceedings and whether the dispute could only have arisen in bankruptcy.  Here, the court found that the dispute fell within the bankruptcy court’s statutory jurisdiction found in 28 U.S.C.157(b)(2) because 157(b)(2)(D) confers jurisdiction over “orders in respect to obtaining credit.”  The court also found that without the loan order by the bankruptcy court the debtor could not have obtained the emergency financing it needed and could not have continued to survive.

Interpretation of Agreement

With respect to the interpretation of the agreement, the Circuit Court, following the lead of the lower courts and following Pennsylvania contract law, found the relevant provision of the contract ambiguous.  It also found that given the facts surrounding the negotiations the interpretation of the lender best resolved the ambiguity in the agreement.  The court spends several pages parsing through the language of the agreement and the negotiations surrounding the agreement in order to reach this result.  This case really turns on this issue and the court was correct in addressing it fully.  Because of the fact-specific nature of the inquiry, I do not feel as though this aspect of the decision advanced the law very far but it did clearly explain why the arguments made by the debtor did not work.

Tenancy by the Entireties

Finally, the court addressed the tenancy by the entireties argument.  For states like Pennsylvania that give full weight to the common law interpretation of tenancy by the entireties, creditors of one party must be careful.  The IRS fought battles regarding the impact of tenancy by the entireties ownership for decades before the Supreme Court resolved most of the issues in United States v. Craft, 535 U.S. 274 (2002).  See prior discussions of Craft here and here. Here, the Third Circuit, a court well-versed in tenancy by the entireties law, looks at the tax refunds at issue in the context of the state property rights laws and federal tax law. It finds that “federal tax law provides that spouses’ ownership of a refund depends on how they owned the income that generated that refund understate property law.”  We have talked about a slightly different but similar issue of splitting refunds here and here

The Court gave no indication that it follows the blog but it walked through the issue of the ownership of joint refunds in appropriate fashion.  It first cited Ragan v. Commissioner, 135 F.3d 329, 333 (5th Cir. 1998) where that court explained that a joint return does not create “new property interests for the husband or wife in each other’s income tax overpayment.”  The 5th Circuit held that because the income on the return at issue belonged to the husband alone, the wife had no interest in the refund.  The Court then cited several other Circuit Court decisions before holding that “we now join our sister circuits in adopting this rule.”  After announcing that it adopted the prevailing law of the circuits around the country with respect to federal law treatment of federal tax refunds, the Third Circuit then looked at the facts of the Mostollers’ case with respect to Pennsylvania law.

In Pennsylvania, tenancy by the entirety requires the parties be married (no problem here) plus the “four unities of time, title, possession and interest.”  It explained that satisfying these unities requires that the spouses must “(1) have their interests vest at the same time, (2) obtain their title by the same instrument, (3) have an undivided interest in the whole, and (4) own interests of the same type, duration and amount.”  None of the unities existed here and they never merged their separate interests into a tenancy by the entireties interest.  So, the debtor must turn over half of the refund to the lender.

Conclusion

Maybe the Third Circuit could have issued a per curiam affirmance and did not need to spend 20 pages recounting the facts and laying out the resolution of the law. The tenancy by the entireties argument seems to have been an issue of first impression in the Third Circuit, perhaps driving the decision to write out in detail why Mr. Mostoller could not go back on his agreement.  The case provides some insights on the constitutional limits of bankruptcy courts to decide cases and the appropriate method for determining ambiguous agreements. Mostly, it provides an equitable result in a situation in which someone tried to act inequitably, and get the court’s blessing, in a court of equity.

Proving a Federal Tax Lien Has Expired

In the 1980s the IRS adopted self-releasing notices of federal tax lien (FTL).  The self- releasing lien saves the IRS time and effort of going to all of the courthouses where it files liens and recording a release.  One of the problems taxpayers have with the self-releasing lien comes from the lack of a specific piece of paper, the release, demonstrably showing the end of the lien.  Other problems can result from the self-releasing lien such as the failure of the IRS to refile all of the lien notices it has on file allowing one or more of several lien notices to self-release while refiling others.  This post will not address that problem though it does pose one of the difficulties with the self-releasing system.

The IRS filed a notice of federal tax lien (NFTL) against Todd Gordon in Clearfield County, Pennsylvania in 2005.  In the recent case of Gordon v. United States, No. 3:19-cv-00187 (W.D. Pa. 2020) the court examines the situation of the self-releasing lien and resolves some confusion in the state court regarding the NFTL.

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Not to belabor the background of FTLs but to quickly cover the basics for anyone not familiar with such liens, the FTL arises with the occurrence of three things: (1) assessment of the federal tax liability; (2) proper issuance of notice and demand pursuant to IRC 6303 (mailing the taxpayer a demand letter); and (3) neglect or refusal to pay the tax.  Take note that the existence of the FTL has nothing to do with recordation of the lien.

Because only the IRS and the taxpayer know about the FTL, Congress designed protections for competing creditors to allow the smooth flow of commerce.  The 1966 Federal Tax Lien Act established the system for the filing of the NFTL and the resolution of competition between the FTL and other creditors or persons with interest, such as purchasers, in property encumbered by a FTL.  IRC 6323 requires the IRS to record the FTL by way of a NFTL in order to perfect the FTL against certain parties.  The Gordon case concerns a filed NFTL and its self-releasing feature.

Although the court does not specifically talk about Mr. Gordon’s federal tax issues, I assume that he owed some amount of federal taxes which went unpaid after assessment.  The IRS then decides whether it wants to perfect its tax lien by filing an NFTL.  That decision embodies some policy concerns regarding the amount of the liability and the likelihood of the NFTL providing a benefit to the IRS in collecting the taxes.  I discuss these issues in a paper here.

In Mr. Gordon’s case, the IRS decided to file the NFTL and appears to have recorded it in the county where he lived.  That location follows the requirement in IRC 6323 that the IRS record the NFTL in the county where the taxpayer resides in order to perfect the FTL with respect to all of the taxpayer’s personal property.  It also usually results in perfecting the FTL with respect to the taxpayer’s home since the home is located where the taxpayer lives.  The NFTL perfects the FTL with respect to any real property the taxpayer owns in the county where the IRS records it.  If the taxpayer owns real property in jurisdictions outside the county of residence, the IRS must file a NFTL in each of those counties in order to perfect the FTL with respect to the real property in those other locations.

The statute of limitations on collection limits both FTL and the NFTL.  The statute of limitations on collection lasts for ten years unless something suspends it, e.g., an offer in compromise, a Collection Due Process request, living outside the US continuously for more than six months and several other actions.  Here, the IRS filed the NFTL on September 6, 2005.  Because it normally takes several months after the assessment before the IRS files the NFTL, the statute of limitations on assessment would run from the date of the earlier assessment and not from the date of the recording of the NFTL.  Although it filed the NFTL against Mr. Gordon, the IRS did not bring suit against him nor did anything else suspend the statute of limitations on assessment.  The ten years from assessment ran at some point before September 6, 2015.  The NFTL self-released.  Release is a term of art here defined in IRC 6325(a) and it means, inter alia, that the lien is unenforceable.

Probably because the self-releasing feature of the lien does not provide a sufficiently affirmative statement of the death of the NFTL, Mr. Gordon brought an action in 2019 in the state court in the county where the IRS filed the NFTL to strike the lien.  The IRS, as it almost always does when sued in state court, removed the case to the federal district court.  The IRS does not like to engage in litigation in state courts.  After removal, the IRS moved to dismiss the case for lack of subject matter jurisdiction and failure to state a claim.  After all, the NFTL itself provided for exactly the relief Mr. Gordon sought in suing the IRS.  The IRS, no doubt, felt that defending the suit wasted its time and defeated the purpose of the time saving self-releasing feature of the NFTL.

The court states that “Gordon’s petition seeks to strike the NFTL, but all parties agree that the NFTL is no longer active, and therefore there is no active controversy over which this Court has jurisdiction.”  Mr. Gordon, however, argues that because of a judgment entered by the state court on its docket an active controversy exists.  The court disagrees with Mr. Gordon and states “this case is moot because there are no longer live issues before this Court and it is unable to effectively render relief.  The USA has also granted Gordon the relief he seeks to the extent that it can.”

The only dispute remaining is not a dispute with the IRS but with the state court which filed a judgment in error.  So, the court remands the case to the state court but with the IRS out of the picture.  I hope that Mr. Gordon can get the state court to remove the judgment.  The issue of seeking a clearer statement of release arises occasionally and taxpayers seek from the IRS some affirmative statement that the lien no longer exists rather than trying to rely on the negative implication of the self-releasing lien.  The IRS has a procedure for taxpayers to use in order to obtain a statement of the release that they could show to prospective creditors in order to clear up any uncertainty.  The provisions exists in IRM 5.12.3. I do not know if these provisions would assist Mr. Gordon in resolving his problem with the lien, but there may be others who want something more than a self-released lien to prove that the NFTL no longer actively reflects a liability owed to the IRS.

Affluent Lifestyle plus Ignoring Tax Debts Equals No Discharge

I have discussed the exception to discharge under BC 523(a)(1)(c) previously here, here and here.  These cases usually merit some discussion because they contain the kinds of facts that allow us to get a little riled up and actually root for the IRS.  The case of United States v. Harold, No. 16-05041 (Bankr. E.D. Mich. 2020) proves no exception to the general rule of these types of cases.  The IRS does not pursue this exception to discharge often but when it does the facts usually make for a mildly interesting blog post.

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Dr. Harold, the debtor here, is a medical doctor with an OB/GYN practice.  The court says that she has a successful, busy practice and works long hours.  At issue in this case are unpaid federal tax liabilities for 2004 through 2012 and 2014 which she could discharge in her chapter 7 case unless the exception for attempting to evade payment applied.  The court spends a paragraph talking about her husband, a former CPA who lost his license as a result of a conviction for a false statement on a bank loan application, bank fraud, tax evasion and filing a false return.  These actions took place prior to their marriage in 1993 and he now owns a consulting firm, Fidelity Refund Services.  Dr. Harold did not have experience in financial matters, and her husband handled all of her tax matters.

Their returns were routinely filed on extension or late.  She owed liabilities ranging from $5,000 to $42,000 for the years at issue despite averaging about half a million dollars in gross revenue from her practice during those years.  There appears to be some dispute as to the amount owed but it is at least $250,000.  During the years at issue the IRS sent at least 84 collection notices, very few of which Dr. Harold saw, because she worked long hours and her husband usually picked up the mail and handled the tax matters.  She did, however, know there were outstanding tax liabilities for many years.

The court then described the spending of money during the years at issue.  Spending drives these cases.  Many people owe the IRS but those who have enough money to spend on items that support an affluent lifestyle while not paying the taxes receive the scrutiny of the IRS in discharge cases.  The court first described the purchase of a new home in 2005 along the Detroit River waterfront.  This purchase created financial problems, because they could not sell their prior home and carried two mortgages until finally losing the original home to foreclosure in 2009.  They sent their children to private grade schools and high schools paying a total of $64,247 in tuition for their daughter and $ 89,474 for their son.  Then they sent their children to private colleges paying $118,390 for their daughter to attend Boston University and $53,088 for their son to attend Loyola University.

During these years the family took multiple family vacations to Mexico, Alaska, Puerto Rico, Orlando, Washington, D.C., Paris, Las Vegas, Hawaii, and Dubai in addition to numerous trips to go and visit colleges.  They drove expensive cars: a Jaguar, a Mercury Mountaineer, two Cadillacs, to Lincolns, a Lexus and a Harley Davidson motorcycle.  The debtors also actively sought to place their home beyond the reach of the IRS through a sale and leaseback scheme described by the court.

The court then worked through the existing Sixth Circuit law regarding BC 523(a)(1)(c) and the evidence needed to show an attempt to evade or defeat payment of the tax liability.  The court found that the evidence “overwhelmingly demonstrates that the Debtor engaged in conduct to evade or defeat the payment of her tax liabilities for the years 2004-2012 and 2014.”  The court recounted all of her pre-bankruptcy expenditures but seemed even more convinced by the post-filing efforts to insulate the family home from the federal tax lien.

Her actions convinced the court that she willfully intended not to pay her taxes.  It pointed out that all of her expenditures resulted from “voluntary, conscious and intentional choices.”  It did not matter that she delegated the handling of tax matters to her husband.  She knew his past tax issues and she knew the choices she was making regarding the non-payment of taxes.  The court applied her knowledge and action to the standards established by the Sixth Circuit in the case of Stamper v. United States (In re Gardner), 360 F.3d 551 (6th Cir. 2004).  The Gardner case established the mental state requirement of proof that the debtor had a duty to pay, knew of the duty and voluntarily or intentionally violated the duty. 

Dr. Harold argued that she did not voluntarily or intentionally violate the duty to pay her taxes because she had a strong religious need to send her children to Catholic schools and she relied on her husband to manage the family financial affairs.  The court quickly rejected these arguments.

The use of 523(a)(1)(c) to deny a debtor a discharge for willful non-payment of taxes began in a Sixth Circuit case almost 15 years after the adoption of the “new” bankruptcy code in 1978.  The case of Toti v. United States, 24 F.3d 806 (6th Cir. 1994) was the first circuit level court to approve of the use of the discharge exception in this way.  Since that time courts have struggled at times to decide both the standard for holding the taxpayer liable for the taxes and the amount of lavishness necessary to cause the bankruptcy court to say enough.  Here, the IRS clearly established that Dr. Harold went too far.  The case provides another lesson on the perils of maintaining a high lifestyle while putting off payment of taxes.  I seem to write about it every couple of years simply as a reminder that high personal expenditures while failing to pay taxes serves as a recipe for losing the ability to discharge old taxes in a bankruptcy case.

Jurisdiction of Wrongful Levy Claims

The case of i3Assembly, LLC v. United States, No. 3:18-cv-00599 (N.D.N.Y 2020) presents a sad outcome for a company taking over a government contract from a delinquent taxpayers and raises issues of jurisdiction discussed here on many occasions.  Because of a snafu, the IRS took money that should have been paid to i3Assembly and used it to satisfy the outstanding tax liability of the company that had the government contract before i3Assembly took it over. 

Although the company raises issues of equitable tolling in litigating the case, it is not clear that either the company or the Department of Justice Tax Division attorney have been closely following the many threads of discussion on jurisdiction present in this blog.  That’s unfortunate for the company, which may have had some arguments that it did not yet present, and disappointing from the government’s perspective if it neglected to cite to on point case law in other circuits adverse to the position it took in this case.

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 In 2015 i3Assembly acquired certain assets from VMR Electronics and it assumed certain liabilities; however, it expressly did not assume VMR’s outstanding liability to the IRS.  i3Assembly had a different EIN, used its own labor to fulfill the contracts and then sent invoices for the work it performed.  Instead of paying i3Assembly, the government sent the money to the IRS in response to a levy.  This levy was a Federal Payment Levy Program levy served on July 18, 2016.  The IRS sent a post-levy CDP notice to VMR, which probably was surprised and delighted to find out its obligation was being paid by i3Assembly.

After the first levy, a second levy occurred on July 22, 2016 and a third on November 16, 2016.  All of the notices were going to VMR.  i3Assembly was probably trying to figure out what was happening and attributed some of the delay in payment to dealing with the Defense Department and the government in general but it was trying to find out what was happening to its invoices.  The VP of i3Assembly had several telephone conversations with IRS officials regarding the wrongful levy of its funds starting in October 2016 and going through July 18, 2017, but i3Assembly never received a notice of levy.

On October 31, 2017, i3Assembly submitted an administrative wrongful levy claim to the IRS.  The IRS disallowed the wrongful levy claim for the first and second seizure stating that the claims were not filed within nine months of the levy.  It subsequently disallowed the claim for the third levy stating that i3Assembly failed to establish that the payment did not belong to VMR or that i3Assembly had an interest in the payment superior to the IRS.

On May 21, 2018 i3Assembly filed suit.  The IRS moved to dismiss and alternatively moved for summary judgment.  The court discussed the Federal Payment Levy (FPL) and the fact that it acts as a continuous levy.  The IRS argued that i3Assembly had to raise its concerns with nine months of the time the IRS put out the FPL, even though it had no idea the FPL existed or that it would take money intended for i3Assembly. 

i3Assembly admitted that it did not file its claim for wrongful levy within nine months of the first and second levies under the FPL but argued that equitable tolling should suspend the time frame for filing the wrongful levy claim.  It argues that its claim was timely for the third levy based on the date the funds were actually seized and i3Assembly put on notice of the seizure.  According to i3Assembly that occurred on July 22, 2017.  The IRS argued that the date of the notice is irrelevant because it had no duty to notify i3Assembly, and the time limit starts to run on the date the person possessing the property received the notice of levy back in July 2016.

i3Assembly pointed out the IRS argument creates an absurd result, because the period for filing a claim could pass before any property was seized or the party whose property was taken would have any idea of the taking.  The IRS responded that the statute and case law do not require notice to the person claiming their property was wrongfully taken and that the Second Circuit in Williams v. United States, 947 F.2d 37, 39 (2d Cir. 1991) had already determined that notice to the third party was unnecessary when calculating the time period.  The levy at issue in Williams, however, was not a continuous levy like the FPL.  When the FPL was served, there was no property to which it attached.  So, i3Assembly would not under any circumstances have received notice at that time.

The court states that:

On this record, the Court cannot determine what, if any, notice was provided to Plaintiff regarding the continuing levy under FPLP before the statute of limitations [on filing the wrongful levy claim] had run.  Absent any evidence regarding what information was provided to Plaintiff, and further briefing from the Defendant regarding due process, the Court at this time denies the motion to dismiss Count One with prejudice to renewal.

The court then discussed equitable tolling.  It found that i3Assembly had not alleged facts that would support equitable tolling for the first and second levies. With respect to the third levy, the court seems to find it possible that i3Assembly did have facts in the record that could support equitable tolling, but then it shifted to the need for i3Assembly to show that the statute at issue is one to which equitable tolling could apply.  In other words, the court needs to know if the time period for filing a wrongful levy claim is a jurisdictional time period.  In looking at this issue, it cites to cases from the 1990s and ignores all of the law on this issue that has occurred in the past 15 years.

I have not looked at the briefs but even if i3Assembly attorneys did not find the relevant case law, I would have expected the DOJ attorney to cite to the more recent case law.  In particular the 9th Circuit has ruled in Volpicelli v. United States, 777 F.3d 1042 (9th Cir. Jan. 30, 2015) that the time period in the wrongful levy statute is not a jurisdictional time frame.  I would have expected this decision to receive some mention as I would have expected the more recent and relevant law on jurisdiction to receive some mention.  Perhaps, i3Assembly’s attorneys will find the newer case law and find the Volpicelli opinion and file an appeal.  Carl has written a post on the last Second Circuit case, Mottahedeh v. United States, to seek equitable tolling in the context of wrongful levy. In that case, the court declined to grant equitable tolling but did so without citing to the recent Supreme Court case law as well.

Limitation of 24 Month Offer in Compromise

IRC 7122(f) provides that if a taxpayer submits an offer in compromise and the IRS does nothing on the offer for two years the offer is deemed accepted.  Congress added it in 2006 in response to concerns that the IRS action on offers moved too slowly.  Here is the exact language of the statute:

Any offer-in-compromise submitted under this section shall be deemed to be accepted by the Secretary if such offer is not rejected by the Secretary before the date which is 24 months after the date of the submission of such offer. For purposes of the preceding sentence, 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.

I previously wrote about aging offers in compromise into acceptance here and here.

The case of RAJMP Inc. v. United States, No. 3:19-cv-00876 (S.C. Cal. 2020) raises the issue of a taxpayer’s remedy in a situation in which the offer has aged into acceptance.  I found the limitations on the taxpayer’s remedy a bit surprising.

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The facts make me wonder if the corporate officers only recently read our blog posts about the impact of aging an offer into acceptance and call into question whether the offer did age into acceptance.  For purposes of this discussion I will presume that the offer did age into acceptance.  The taxpayer submitted it on July 14, 2006.  The IRS accepted it for processing on July 25, 2006.  The taxpayer alleges that the IRS has never issued a notice of rejection of the OIC (nor I presume a notice of acceptance.)  The OIC offered $400,000.  If accepted, the OIC would relieve the taxpayer of about $8 million in liability.  The opinion says that the taxpayer paid the IRS $400,000 but does not say when the taxpayer made the payment.  It does say that the IRS applied the payment to the taxpayer’s account rather than to the OIC, whatever that means.

Assuming that the offer aged into acceptance, which the IRS contests in the litigation, what does a taxpayer do to get the IRS to recognize the statutory offer acceptance and enforce the terms of the OIC contract?  RAJMP brought this suit in district court alleging (1) a continuing breach of contract; (2) a non-monetary claim under 5 U.S.C. 702; (3) violations of the Administrative Procedure Act (APA) and (4) “the Court’s anomalous independent equity jurisdiction, the Court’s supervisory power over federal officers and employees and the equity jurisdiction conferred by the Judiciary Act of 1789.”  In its prayer for relief it asks the court to enforce the contract, abate all balances of the outstanding assessments for the periods covered by the offer, issue any other orders deemed appropriate and award costs and legal fees. 

The IRS moved to dismiss the suit arguing that that the court lacked jurisdiction and the complaint failed to state a claim.  It argued that the Anti-Injunction Act (AIA) and the Declaratory Judgment Act (DJA) barred the relief requested.  The court quickly finds that the taxpayer’s request that the IRS abate the tax the OIC forgave “simply violates the AIA and DJA….”  Here, the Court finds that the remedy is requesting a ruling that the IRS may not collect any further taxes and that RAJMP is excused of its tax liability.  Accordingly, this is a case regarding collection or assessment of taxes.”

The court finds that IRC 7122(f) does not contain a waiver of the AIA or DJA.  One exception to the AIA exists if a taxpayer establishes that the IRS could not prevail and if equity jurisdiction otherwise exists.  The IRS argued that the taxpayer failed to prove either prong of this exception and the court agreed.  First, the court points to the affidavit of an IRS employee that the IRS properly rejected the offer.  The court cites to the affidavit as a basis for deciding that an IRS victory on the merits exists.  In addition to arguing for the possibility of a victory on the merits, the IRS argues latches and the court finds this a possibility.

In addition to failing the first prong of the exception to the AIA, the court goes onto the second prong and decides the case in a manner that would stop all taxpayers seeking a ruling on an offer through affirmative litigation in a district court.  It holds that the taxpayer has an adequate remedy in law and, consequently, does not meet the equitable remedy test. The court finds that the taxpayer could have pursued a monetary damage claim under the Tucker Act for breach of contract, could have paid the full $8 million balance and brought a refund claim, or could have waited for the IRS to sue to collect and raised the statutorily accepted offer as a defense.

I do not find the frequently cited remedy of full payment followed by a refund suit to provide much comfort to the taxpayer.  Like a host of taxpayers receiving this wonderful advice, RAJMP probably does not have $8 million lying around waiting to be tied up in the refund claim/litigation process for several years.  I also do not find the advice of waiting for the IRS to sue very comforting.  This means the IRS can pursue its full range of administrative collection tools against RAJMP with impunity.  Collection suits are rare.  The taxpayer’s hope here would lie in the opportunity to raise the issue in Collection Due Process litigation (CDP) if the CDP opportunities have not already passed.

This leaves RAJMP with the best option of bringing a Tucker Act suit.  Maybe Congress intended taxpayers whose offers aged into acceptance bring Tucker Act suits.  The absence of a judicial remedy to resolve the aged into acceptance offer leaves the taxpayer searching for remedies when the period runs.  This seems like an odd remedy but maybe it presents the most logical choice.

The court rejects the APA as a source of remedy for the same reason it finds the taxpayer has failed to meet the second prong of the AIA test.  The court finds the APA does not provide a remedy if the relief is “expressly or impliedly forbidden by another statute.”  Here the AIA is that statute.

The court rejects the waiver of sovereign immunity and also finds that collection of tax does not provide a basis for a takings claim.  It also finds that because it lacks jurisdiction over the case, it cannot grant the taxpayer a preliminary injunction.

The IRS disputes the underlying argument that it failed to act on the OIC in two years.  In some fashion the taxpayer must fight out that factual issue when it finds the right judicial vehicle.  The RAJMP case, however, points out that a taxpayer will have difficulty litigating the statutory acceptance of an offer.  Presumably, the IRS would concede any case in which it determines that it did, in fact, fail to act within 24 months.  Where it refuses to do so, taxpayers must look for the right path to judicial relief.  This court suggest that path lies through the Tucker Act.

Suit Against H&R Block for Free File Violations

There has been much discussion of the failure of free file to deliver a free tax filing platform for low and moderate income taxpayers as initially promised.  You can find some great articles on the topic here, here and here.

This post does not address whether the IRS and its free file partners have done a good job with the free file program.  Rather, this post examines the attempt by the state of California to sue two of the free file participants under the unfair, fraudulent, and deceptive business practices act in that state.  The Los Angeles city attorney’s office is currently suing (on behalf of California) both H&R Block (complaint here) and Intuit (maker of TurboTax) (complaint here) over their implementation of the free file program.

The existence of suits like those brought by California may have a greater impact on the free file program than the oversight by the IRS which, as described in the articles cited above, seems less than robust.  If so, the lawsuit demonstrates a private litigation mechanism for changing some tax practice outside of the Internal Revenue Code, Congress and the ordinary administrative procedures.  Perhaps the state will succeed and perhaps it will lose, but the existence of lawyers primarily versed in consumer law bringing actions to change tax administration shows another path, in certain cases, to success in changing the system.

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California alleges several things about the free file program and these companies’ actions, which mirror the findings in some of the articles described above.  It alleges that Block & Intuit took affirmative actions to keep the public from appropriate awareness of the program in violation of the terms and spirit of the Free File Agreement.  It alleges that the free online program itself is inferior to another program with an almost identical name and that the companies made that program difficult to find.  It also alleges Block & Intuit made misrepresentations and employed deceptive marketing schemes.

I’ll focus here on the Block litigation, which has been more procedurally complicated than the Intuit suit (which is ongoing in California Superior Court). California brought the suit against Block in state court, but Block removed the case to federal district court on the basis that the state law claim implicates significant federal issues.  In this opinion the state seeks to return the case to state court and the federal district court agrees.

The court states that it must resolve all ambiguity in favor of remand to state court and that the party seeking removal to federal court bears the burden of establishing federal jurisdiction.  For this case to move forward in federal court the party seeking to have it heard in federal court must show, among other things, that a federal question is a necessary element of the state claim.

California argues that its complaint does not necessarily raise a substantial federal issue and resolution in state court remains possible without disrupting the balance of federal and state responsibilities.  Block argues that the relief sought necessarily depends on the interpretation of the Free File Agreement between Block, and other participants, with the IRS, a federal agency.  The court says that mere presence of a federal issue in a state suit does not automatically grant federal question jurisdiction but becomes one of federal jurisdiction when the federal issue raised is “basic, necessary, pivotal, direct or essential to the claim.”

Block sees the federal issue as central since the agreement the state seeks to enforce is an agreement between Block and the IRS.  The court discusses an earlier 9th Circuit case, Lippit v. Raymond James Fin. Servs., 340 F.3d 1033, 1040 (2003) raising an issue of deceptive practices in the selling of securities regulated by the SEC.  In that case the 9th Circuit determined that the plaintiff merely had to show the defendant acted unfairly or fraudulently which did not raise federal issues.

The court finds the suit by California similar to the Lippit case.  The proof of deceptive practices does not require an interpretation of federal law and the state court can properly decide the issue.

In the alternative, Block argued that even if the deceptive practices claim does not involve federal law, the other two claims in the case do.  The court determines that as long as the case could be decided under a state law claim remand to the state is appropriate.  The court looks at the unfairness part of the argument of California and determines that California could prevail on that claim irrespective of whether Block violated its federal agreement.  Similarly, it determined that the fraudulent or deceptive practices claim could be decided without resort to the Free File Agreement.

So, a state court may have a say in what happens to the Free File program and attorney generals have a way to police the program, even if the IRS has fallen down on its job of doing so.  In this somewhat rare area where state consumer law overlaps with IRS oversight, the consumer law provisions may provide a work-around to lax federal action and a path for taxpayers to actually receive the free file programs the program seemed to promise in its inception.