FOIA Suit Seeking Trump’s Returns Fails

Over the past two plus years we have written four posts about Mr. Trump’s returns here, here, here and here. A good argument could be made that this is four posts too many; however, the recent decision of the DC Circuit in a FOIA case seeking those returns brought by the Electronic Privacy Information Center (EPIC) provides an opportunity to go beyond speculation about obtaining those returns and focus on how, in the interaction between FOIA and IRC 6103, the law does not permit third parties to use FOIA as a means of obtaining the returns or return information of others. In the course of ruling on this case the DC Circuit sets the IRS straight on the appropriate standard to apply to those making a FOIA request.

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Shortly after the 2016 election EPIC submitted a FOIA request to the IRS seeking the tax returns of Donald Trump for the years 2010 and forward. It also sought “any other indications of financial relations with the Russian government or Russian businesses.” Not surprisingly, the IRS declined to comply with the request. In declining the IRS provided two reasons: 1) the requested “documents, to the extent that any exists, consist of, or contain the tax returns or return information of a third party,” which “may not be disclosed unless specifically authorized by law” and 2) the IRS rules require consent of the third party when a request is made for their tax return. Because the IRS rules require the consent of the third party when a return is requested, the IRS did not even process the FOIA request.

EPIC submitted a second request trying a slightly different tack by citing to IRC 6103(k)(3). This provision allows the IRS to disclose return information to correct a misstatement of fact if correcting the misstatement is necessary to a tax administration purpose. This provision also requires that the IRS obtain the approval of the Joint Committee on Taxation before making a disclosure. The IRS responded to EPIC’s second request by notifying it that the second request also did not cite a basis for turning over to it the returns of President Trump. The IRS concluded this letter by notifying EPIC that it would not process any further requests from it on this topic.

EPIC brought suit seeking relief under both FOIA and the Administrative Procedure Act. The district court dismissed the suit and the DC Circuit affirmed the dismissal but in doing so provided some clarity regarding the reason for denying the request. The circuit court explained the interplay between FOIA and the IRC. It provided an explanation for how and when tax records stand outside the type of government record that can be obtained through a FOIA request. It noted, however, that the district court denied the request for failure to exhaust administrative remedies. That basis for dismissal was wrong but even though it was wrong other reasons for dismissing the case existed making the decision to deny the requested relief correct.

The court points out that this is not an ordinary exhaustion of remedies case where the litigant rushes to court without giving the agency the chance to consider the argument. Here, EPIC tried to get the IRS’ attention and got pushed away. The IRS argues that because EPIC’s request violated its published rules for considering a FOIA request by not obtaining President Trump’s permission to seek his tax returns EPIC did not exhaust the available administrative remedies. This is an interesting interpretation of the exhaustion doctrine which views the requester’s failure to do the impossible, obtain permission from a party who does not want to consent, as a failure to exhaust remedies.

According to the DC Circuit, the IRS “misunderstands its FOIA disclosure obligations. FOIA unambiguously places on an agency the burden of establishing that records are exempt.” To prevail, the IRS cannot rely on a perceived failure by the requester but must show that the information sought is subject to the IRC 6103(a) bar on disclosure. Although the Court agrees with the IRS that it can create published rules regarding the procedures to follow in making a request, the Court disagrees with the IRS that those rules can substantively shift the burden from the agency to the requester regarding the basis for denying the request. Here, “[n]one of the purposes of exhaustion supports barring judicial review of EPIC’s claims.” Still, the IRS has the ability to show that EPIC should not receive the requested documents by making a showing on the merits of the applicable statutes – which it does.

The scope of IRC 6103 in protecting taxpayer records is broad but is still limited in scope. The court notes that “[n]ot all IRS records constitute tax returns or return information.” It cites as an example of material not covered by those definitions the legal analysis contained in IRS Field Service Advice Memoranda. Here, the first part of EPIC’s request, the request for President Trump’s tax returns, clearly falls within the scope of tax returns and return information and “is plainly covered by section 6103(a)’s bar.”

With respect to the requested information concerning financial relations with Russia, the court finds that the request is framed in such a way that answering it reveals the fact that tax returns were filed, making any response one which would disclose tax returns or return information. Therefore, the court denies this request as well.

Moving on to EPIC’s revised request citing to 6103(k)(3), the court finds that this provision was not designed as a provision for parties to make a request to the IRS but rather for the IRS to make a decision to disclose information to avoid problems with tax administration. The court finds “Congress’s omission of any public right to ‘request’ disclosure under section 6103(k)(3) is intentional.” So, this provision affords the requestor no disclosure right. EPIC’s claim based on this provision fails.

Lastly, the court looks at the APA as a basis to disclose the returns. It finds that the APA claim should be dismissed because FOIA, not the APA, provides the basis for the remedy sought by the requestor. The fact that FOIA does not allow disclosure under this circumstance does not mean that the APA provides a separate remedy.

No doubt we have not heard the last of attempts to obtain President Trump’s returns. The harder people try to obtain the returns without success, the more respect I have for the IRS and the states in their administration of the disclosure laws. Maybe one day we will see the returns and learn great secrets. In the meantime we should appreciate that the disclosure laws which were tightened significantly in response to President Nixon’s attempts to misuse the IRS seem to be working well.

 

 

Like the First Amphibian Crawling Out of the Swamp onto Land, the Flora Rule Emerges from Title 26 to Possibly Infest Title 31

The case of Bedrosian v. United States, No. 17-3525, __ F.3d __, 2018 U.S. App. LEXIS 36146 (3rd Cir. Dec. 21, 2018) marks the possible jurisdictional cross-over of the Flora rule from the tax code into the broader reaches of the United States Code. This is not good news for individuals seeking to contest the application of the FBAR penalty – the penalty at issue in this case – or other liabilities with ties to taxes. For a discussion of the case and links to several of the documents filed in the case, look at the blog post by Jack Townsend. In addition to Jack’s excellent post which you should read for a fuller understanding of the issue here, I wish to acknowledge the assistance of Carl Smith and Christine Speidel in writing this post. While we regularly circulate the posts prior to publication, I reached out with a special request for help on this one due to my lack of knowledge about the technical workings of the FBAR provisions.

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The FBAR penalty arises from 31 U.S.C. 5314 and the following sections. The Third Circuit described the penalty as follows:

The Secretary has implemented this statute through various regulations, including 31 C.F.R. § 1010.350, which specifies that certain United States persons must annually file a Report with the IRS. Covered persons must file it by June 30 each year for foreign accounts exceeding $10,000 in the prior calendar year. 31 C.F.R. § 1010.306(c). The authority to enforce the FBAR requirement has been delegated to the Commissioner of Internal Revenue. Id. § 1010.810(g); see also Internal Revenue Manual § 4.26.1, Ex. 4.26.1-3 (U.S. Dep’t of Treasury Memorandum of Agreement and 4 Delegation of Authority for Enforcement of FBAR Requirements).

The civil penalties for a FBAR violation are in 31 U.S.C. § 5321(a)(5). The maximum penalty for a non-willful violation is $10,000. Id. § 5321(a)(5)(B)(i). By contrast, the maximum penalty for a willful violation is the greater of $100,000 or 50% of the balance in the unreported foreign account at the time of the violation. Id. § 5321(a)(5)(C)(i).

The amount of the penalty imposed on individuals who the IRS determines willfully violated the provision makes the FBAR penalty potentially similar to the IRC 6707 penalty at issue in United States v. Larson, __ F.3d __ (2nd Cir. 2018) which we discussed here and here. The IRS assessed a willful FBAR violation penalty against Mr. Bedrosian of $975,789. While that is only a small fraction of the amount assessed against Mr. Larson and “only” 50% of the amount in the foreign bank account for the year he failed to report the account, this amount still presents a high bar for entry into court to litigate the correctness of the application of the penalty.

To understand how Mr. Bedrosian came to be in front of the Third Circuit, a short review of FBAR assessment and collection procedures may be helpful. When the IRS determines that someone has failed to properly report a foreign bank account, it does not send a notice of deficiency for this Title 31 violation. It makes a summary assessment. The “person” (not “taxpayer”) is given the opportunity to go to appeals before FBAR assessment. See IRM 4.26.17.4.6 (01-01-2007) Closing the FBAR Case Unagreed. See also IRM 4.26.17.4.7 (01-01-2007) Closing the FBAR Case Appealed, and IRM 8.11.6 FBAR Penalties (appeals procedures). There are also special procedures for FBAR examinations.

Not surprisingly, the IRM reflects in several ways the government’s position that FBAR penalties are not tax penalties subject to Title 26 requirements and norms. For example, Form 2848 can only be used to appoint a representative for an FBAR exam if there is a related income tax examination. If there is not, a representative must provide a general POA valid under state law. See IRM 4.26.8.2.

The collection process for FBAR cases does not follow the normal IRS practice for collection either. For a detailed discussion of collection of an FBAR penalty you might review the slide program to which Jack Townsend mentions. The program was presented at the May, 2018 ABA Tax Section meeting.

The FBAR regulation says that IRS has been delegated collection authority as well as assessment authority. 31 CFR 1010.810(g). However, the IRM on collection explains that while “authority to collect” has been delegated,

[IRS] Collection is not delegated any enforcement authority with respect to FBAR penalties. … The Bureau of Fiscal Service (BFS), formerly Financial Management Service (FMS), which is a bureau of the Department of the Treasury, is responsible for collecting all non-tax debts. This includes FBAR penalties.

IRM 5.21.6, Foreign Financial Account Reporting. There is nothing in the IRM about BFS collection procedures or requirements.

One might wonder if FBAR penalties can be compromised. The IRS position is that FBAR assessments cannot be compromised through the Offer in Compromise program “because the assessment is based on Title 31 violations and IRC § 7122 allows the IRS to compromise only Title 26 liabilities.” IRM 5.8.1.9.6 (05-05-2017). The Third Circuit, however, rejects this simple and clear distinction.

Mr. Bedrosian decided to pay 1% of the assessed liability, or $9,757, and bring a suit for recovery of that amount in district court under the Little Tucker Act.  The Tucker Act (28 U.S.C. sec. 1491(a)(1)) allows the Court of Federal Claims to hear suits against the United States founded upon a contract, the constitution, or a statute, without limitation as to amount.  The Little Tucker Act (28 U.S.C. sec. 1346(a)(2)) allows similar suits in district court, but only where the amount involved does not exceed $10,000.  Flora held that a tax refund suit under 28 U.S.C. sec. 1346(a)(1) (i.e., not the Little Tucker Act) can only be brought in the district court or the Court of Federal Claims after full payment of the tax in dispute.  Section 1346(a)(1) applies to suits brought for refund “under the internal -revenue laws”.  Neither party brought up the Flora rule as a jurisdictional hurdle here.  The Department of Justice counterclaimed for the balance of the liability rather than moving to dismiss the case for lack of jurisdiction, as it did in Larson, because it believed that the district court had jurisdiction to hear the case under the Little Tucker Act.  The district court did not raise Flora as a possible jurisdictional bar to the litigation.  The Flora issue emerged, sua sponte, from the Third Circuit at oral argument.  The court asked the parties to submit letter memoranda on the district court jurisdictional issue after the oral argument occurred. Jack Townsend’s post linked in the first paragraph above provides the links to the memoranda submitted to the Third Circuit on this issue.

Here is what the Third Circuit says in a footnote about the Flora issue:

The parties’ argument that Bedrosian’s claim is not within the tax refund statute is premised on the notion that the phrase “internal-revenue laws” in 28 U.S.C. § 1346(a)(1) refers only to laws codified in Title 26 of the U.S. Code. But that argument does not follow the statutory history of the tax refund statute, which suggests that “internal-revenue laws” are defined by their function and not their placement in the U.S. Code. See Wyodak Res. Dev. Corp. v. United States, 637 F.3d 1127, 1134 (10th Cir. 2011). The argument also ignores the Tax Court’s rejection of the proposition that “internal revenue laws are limited to laws codified in [T]itle 26.” See Whistleblower 21276–13W v. Comm’r, 147 T.C. 121, 130 & n.13 (2016) (noting that “the IRS itself acknowledges that tax laws may be found outside title 26”). We also observe, by analogy, that claims brought by taxpayers to recover penalties assessed under 26 U.S.C. § 6038(b) for failing to report holdings of foreign companies—a statute nearly identical to the FBAR statute, except addressing foreign business holdings rather than foreign bank accounts—are brought under the tax refund statute, 28 U.S.C. § 1346(a)(1). See Dewees v. United States, 2017 WL 8185850, at *1 (Fed. Cir. Nov. 3, 2017). Also, allowing a taxpayer to seek recovery of a FBAR penalty under the Little Tucker Act permits that person to seek a ruling on that penalty in federal district court without first paying the entire penalty, as Bedrosian did here by paying just under the $10,000 Little Tucker Act threshold. This violates a first principle of tax litigation in federal district court—“pay first and litigate later.” Flora v. United States, 362 U.S. 145, 164 (1960). We are inclined to believe the initial claim of Bedrosian was within the scope of 28 U.S.C. § 1346(a)(1) and thus did not supply the District Court with jurisdiction at all because he did not pay the full penalty before filing suit, as would be required to establish jurisdiction under subsection (a)(1). See Flora, 362 U.S. at 176–77. But given the procedural posture of this case, we leave a definitive holding on this issue for another day.

Having raised Flora as a possible jurisdictional defect to the suit, the Third Circuit decides that because the IRS filed a counterclaim the district court (and it) clearly have jurisdiction to hear the case. It decides not to make a definitive ruling on the application of Flora to FBAR cases. Maybe no other court will take the bait and after a few faltering footsteps on land the idea of applying Flora to provisions outside of Title 26 will head back to the swamp not to emerge again. Still, Bedrosian raises the specter of the extension of Flora yet again to matters never intended by the Supreme Court or anyone else when that Court ruled 5-4 on the shaky legal basis presented 60 years ago. Let’s hope that Bedrosian does not signal a new expansion of a doctrine that needs to be contracted and not expanded.

Bedrosian also presents a case involving the appropriate standard for review and the appropriate standard for willfulness in an FBAR case. The appeals court decides that the appropriate standard of review of the factual finding from the bench trial (that Mr. Bedrosian’s conduct was not willful) is to review the determination for clear error. However, the court must still correct any errors in the district court’s legal analysis. It decides that the appropriate standard for willfulness in an FBAR case mirrors willfulness in other contexts:

In assessing the inquiry performed by the District Court, we first consider its holding that the proper standard for willfulness is “the one used in other civil contexts—that is, a defendant has willfully violated [31 U.S.C. § 5314] when he either knowingly or recklessly fails to file [a] FBAR.” (Op. at 7.) We agree. Though “willfulness” may have many meanings, general consensus among courts is that, in the civil context, the term “often denotes that which is intentional, or knowing, or voluntary, as distinguished from accidental, and that it is employed to characterize conduct marked by careless disregard whether or not one has the right so to act.” Wehr v. Burroughs Corp., 619 F.2d 276, 281 (3d Cir. 1980) (quoting United States v. Illinois Central R.R., 303 U.S. 239, 242–43 (1938)) (internal quotation marks omitted). In particular, where “willfulness” is an element of civil liability, “we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well.” Fuges v. Sw. Fin. Servs., Ltd., 707 F.3d 241, 248 (3d Cir. 2012) (quoting Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 57 (2007)). We thus join our District Court colleague in holding that the usual civil standard of willfulness applies for civil penalties under the FBAR statute.

This is an important case for those practicing in the FBAR area. The Flora issue raises the possibility of expansion in a way that could make it much more difficult for individuals challenging an FBAR assessment. The discussion of willfulness provides some clarity that litigants may find useful.

 

Don’t Forget Guralnik and Parkinson during Tax Court’s Indefinite Closure

The government shutdown and last Friday’s closure of the Tax Court, as discussed here, provides an opportunity for taxpayers who would otherwise have missed the jurisdictional deadline for filing a Tax Court petition. Since the last government shutdown of any length the Tax Court’s precedent on jurisdiction has changed. A reminder of the Tax Court precedent regarding the impact of the closure of the Tax Court clerk’s office on the timeliness of filing a petition (and other documents?) is worth a visit. Carl Smith assisted me in the preparation of this post.

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Long time readers of this blog know that we paid a fair amount of attention to the Guralnik case a few years ago perhaps because the tax clinic at Harvard filed an amicus brief in that case. See our posts here, here and here. While the tax clinic argued that the Tax Court had the power to open its doors based on equitable tolling, the court rejected the clinic’s argument in favor of a non-equitable remedy that has both broader implications as discussed below and narrower ones for other petitioners.

Mr. Guralnik’s attorney sent a petition to the Tax Court in a Collection Due Process (CDP) case via Fed Ex on the 28th day after the issuance of the CDP Notice. Unfortunately, the Fed Ex delivery service selected (the best one offered) was not on the IRS list of approved delivery services because the IRS had not updated its list in the 11 years prior to Friday, February 13, 2015 when the petition was given to Fed Ex. Because the chosen delivery service was not on the IRS list, the IRS argued and the Tax Court agreed that the mailbox rule of IRC 7502 did not apply.

Petitioner needed the mailbox rule to apply, or an expanded reading of the “weekend and holiday” rule of IRC 7503, because the petition did not arrive in the Tax Court until Wednesday, February 18. Before you conclude that Fed Ex fell down on the job of delivering the petition, it is important to understand what happened in the intervening days during which the Tax Court was closed – Saturday, Sunday, Monday (President’s Day) and Tuesday (Snow closure). The petition arrived at the Court on the first day it opened after petitioner’s attorney delivered the petition to Fed Ex.

Prior law

Among the reasons that the IRS argued that the Tax Court lacked jurisdiction in Guralnik was that there were prior orders of the Tax Court in similar cases of the Clerk’s office being closed, and one of those cases involved a government shutdown.  Government shutdowns formed the basis for dismissals in the pre-Guralnik era. One of the cases forming the body of pre-Guralnik jurisdictional law in the Tax Court, McCoy v. Commissioner, Dk. No. 25941-13S, involved the dismissal of a case in which the taxpayer tried and failed to file the petition prior to the reopening of the Tax Court following the government shutdown.  In McCoy, hand delivery was made at the Tax Court the first date the Clerk’s Office was open after a 2013 government shutdown. The order in McCoy reads differently than the order that the Court posted for this shutdown. The difference might be attributable to the Guralnik case.

Current law

In a fully reviewed, precedential opinion, the Tax Court concluded that because it had no rule regarding days when its clerk’s office was closed it could borrow from the Federal Rules of Civil Procedure and treat filings received on the next day after closure as timely. The IRS argued vigorously against this result; however, as we posted here, the IRS appears to have accepted the result when the issue of the closure of the clerk’s office came up in a subsequent case, Parkinson v. Commissioner, Dk. No. 296-15. In Parkinson the Tax Court asked the parties to address the issue of the Court’s jurisdiction of a case in which the petition was filed after the last date to file unless one considered the Court’s extra holiday closure on January 2, 2015. After both parties filed responses indicating that the Guralnik opinion would apply to the court closure situation, the Tax Court seems to have accepted their arguments without further elaboration in its order.

Given the precedent set by Guralnik and the non-precedential acceptance of that precedent for the situation of the Court closing down to allow its employees off on the Friday after New Year’s Day, it appears almost certain that starting on December 30, 2018, the time for filing a petition in the Tax Court is extended until the government shutdown ends and the Tax Court clerk’s office reopens. Perhaps no taxpayers will benefit from this additional time within which to file their Tax Court petitions but knowing the rule could assist someone who might otherwise have missed the deadline.

Following on the logic of filing documents late when the clerk’s office is closed, it would also seem that brief and other responses due to the Tax Court during the period of the clerk’s office closure can also be filed when the court reopens. For veteran procrastinators this may seem like an opportunity to sit back and wait; however, government shutdowns can end as quickly as they begin. A late night agreement among the parties could restart the government unexpectedly. While we do not recommend delaying a filing because of the shutdown, perhaps an opportunity exists for those who prefer not to file before the absolute last minute. Another reason for not waiting is discussed below; however, if you have a client appear in a situation that would otherwise be too late to file the petition, perhaps Guralnik will provide some magic for your client.

Tax Court action prior to shutdown

In addition to posting the notice on its website that we discussed in a prior post, the court issued nearly 300 orders on Thursday and Friday before it shutdown to the parties involved in the cases set for trial in the first two weeks of trial session in January. The orders generally contain the following language:

The parties are notified that the cases set for trial and/or hearing during the trial session scheduled to begin in New York, New York, on January 14, 2019, shall proceed as scheduled. To avoid potential complications caused by the partial government shutdown, it is

ORDERED that a paper copy of any document submitted to the Court for filing, either electronically or in paper, between the date of this Order and the date of the above-referenced trial session, shall be made available at the trial session by the party who submitted the document.

For a case containing the sample language see the order in Gross v. Commissioner (Docket No. 2010-18S). The fact that the Tax Court had to issue nearly 300 orders is just another example of the colossal waste of resources when the government shuts down. This one is probably small in comparison to others but provides a very tangible example.

Caveat

One caveat should be noted before relying on a government closure to make a petition filing’s timely: The Tax Court’s Guralnik ruling was never appealed, and no court of appeals has yet considered whether the Tax Court may import rules from the Federal Rules of Civil Procedure to extend Tax Court filing deadlines that have been in the past held jurisdictional. But, there are currently before the Ninth Circuit two companion cases of petitions sent in around the same time as Guralnik, also by FedEx First Overnight, that arrived a day late. In these cases, Organic Cannabis Foundation LLC v. Commissioner, Ninth Cir. Docket No. 17-72874, and Northern California Small Business Assistants, Inc. v. Commissioner, Ninth Circuit Docket No. 17-72877, it is not clear why the petitions were filed late, but it appears that the Federal Express driver could not access the open Tax Court Clerk’s Office on the last day – either because of construction work, police activity, or some other reason – so the driver returned the following day (one day too late if section 7502 can’t be used). In unpublished orders issued on July 25, 2017 (here and here), the Tax Court declined to extend Guranik to cover situations where the Clerk’s Office was in fact open.

In the Ninth Circuit, the taxpayers not only seek to extend Guralnik, but also argue (as the tax clinic at Harvard did in Guralnik) that the deficiency petition filing deadline is not jurisdictional and is subject to equitable tolling. The DOJ relies on the holding in Guralnik, but argues that Guralnik cannot be stretched to cover the situation where the Clerk’s office is actually open. Since the parties cannot confer jurisdiction in a case merely by not making certain arguments, it would not be impossible for the Ninth Circuit to eventually rule both in these cases that the filing deadline is jurisdictional and that the Tax Court cannot import into its own rules any rule from the Federal Rules of Civil Procedure that extends the filing deadline when the Clerk’s Office is formally closed. That is, nothing stops the Ninth Circuit from rejecting the latter holding in Guralnik. Thus, until there are some court of appeals rulings on this fact pattern, it may be wise not to try to rely on the closure of the government as a reason for not mailing a Tax Court petition on time or attempting hand delivery to the court on the first date it reopens. The cases before the Ninth Circuit are fully briefed, but a date for oral argument therein has not yet been set. Among the briefs there are amicus briefs from the Harvard tax clinic arguing that the filing deadline is not jurisdictional and is subject to equitable tolling.

 

Tax Court Operations During Federal Government Shutdown

The message below is posted on the Tax Court’s web site. The Tax Court was able to operate on a normal schedule after other parts of the government impacted by the government shutdown because it has a reserve of funds from the fees it collects. Even though the court itself shut down yesterday, it will continue to hold trial calendars for the first two weeks of scheduled calendars in January.   The IRS attorneys who represent the government in the cases on those calendars will undoubtedly be deemed essential for the period of the calendar and for some time before the calendar.   Still, it may be a little tricky for those with cases on these calendars.

The United States Tax Court is shut down starting Friday, December 28, 2018, at 11:59 p.m. and will remain closed until further notice.

The trial sessions scheduled for the weeks of January 7 and 14, 2019, will proceed as scheduled.

  January 7, 2019

  • Birmingham, Alabama – Judge Joseph Robert Goeke
  • Los Angeles, California -Judge Albert G. Lauber
  • San Antonio, Texas – Judge Mary Ann Cohen

January 14, 2019

  • Los Angeles, California – Chief Special Trial Judge Lewis R. Carluzzo
  • New York, New York – Special Trial Judge Daniel A. Guy, Jr.
  • Phoenix, Arizona – Judge Ronald L. Buch
eFiling and eAccess will be available. Taxpayers may comply with statutory deadlines for filing petitions or notices of appeal by timely mailing a petition or notice of appeal to the Court. Timeliness of mailing of the petition or notice of appeal is determined by the United States Postal Service’s postmark or the delivery certificate of a designated private delivery service.

Please monitor this website for information regarding the Court’s operating status.

 

Trends and Tactics in Collection Due Process Litigation During 2018

Despite reaching the age of 20 this past July, CDP continues to create new issues for practitioners to learn and advocate. Twenty years ago I headed the project to write the regulation for the new CDP statute. Writing the regulation proved challenging because CDP was such a departure from federal tax collection practice to that point.   As we have learned over the past 20 years, we failed to anticipate many CDP issues as we wrote the regulations and new issues continue to present themselves.

Over the course of 2018, we have written a number of CDP posts. I have collected the posts here. The issues are broken down into categories for ease of organization. Along with panelist Tom Thomas (who presided over the publication of the CDP regulations 20 years ago), Steve Milgrom, an attorney who is the Litigation and Volunteer coordinator for San Diego Legal Aid, and Scott Hovey, an attorney with the Washington, D.C. field office of Chief Counsel (IRS)(and an intern in the Richmond District Counsel’s office 20 years ago when I headed that office), I participated in a panel on the CDP developments in 2018 at a recent ABA Tax Section conference for low income taxpayers.

Perhaps the most remarkable feature of the presentation was that when we ran over our time, we were the last panel of the day, and the moderator went to stop the discussion the audience insisted that Steve finish telling his story of the Dang case. This is a case which he handled/continues to handle in which the IRS refused to levy on his client’s IRA in order to help the client by allowing the client to satisfy the tax liability without incurring the 10% excise tax under IRC 72(t). Steve’s persistent and effective advocacy for his client in that case resulted in the client paying tax due without having to pay a penalty for making the payment. Read more about the case in the link below if you missed it when we first wrote about that case.

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Jurisdiction (The Request) – CDP cases have two separate 30 day periods that taxpayers must successfully navigate in order to obtain an administrative and then a judicial review of their case. The first 30 day period starts with the issuance of a CDP Notice. The IRS must issue a CDP notice prior to taking most levy action. The IRS also must issue a CDP notice when it files a notice of federal tax lien. Because it does not know exactly when the local court will file the notice of federal tax lien, the IRS builds five days into the period after it sends the notice of federal tax lien to the local courthouse for filing. When it issues the CDP notice the taxpayer has 30 days (or 35 days for a lien notice) to send a request to the IRS seeking an administrative hearing with Appeals. The IRS has not made it easy to send in the requests and will deny a CDP hearing to taxpayers who do not carefully follow its procedures. The issue with which the Tax Court is now grappling is whether the failure to strictly follow the IRS procedures is a basis for denying a CDP hearing or whether substantial compliance might suffice. (For those with a subscription to Tax Notes, I published an article entitled “The Jurisdictional Ramifications of Where You Send a CDP Request,” there on November 12, 2018 that covers this issue in greater detail than our blog posts.)

Untimely CDP request – https://procedurallytaxing.com/eleventh-circuit-says-untimely-made-cdp-arguments-may-deserve-attention-from-the-bench-and-bar/

 

https://procedurallytaxing.com/cdp-requests-timely-filed-in-wrong-irs-office-tax-court-judges-disagree-on-jurisdictional-consequences/

 

Jurisdiction (The Petition) – If the taxpayer successfully requests a CDP hearing and Appeals decides to sustain the lien or levy, it will issue a determination letter giving the taxpayer 30 days within which to petition the Tax Court. If the taxpayer misses the 30 day deadline for a good reason, can the Tax Court accept the case based on equitable tolling or is the 30 day period to file the petition jurisdictional such that the Tax Court must deny the taxpayer entry into the court no matter how compelling the reason for late filing might be?

Is time to file CDP petition in Tax Court jurisdictional – http://procedurallytaxing.com/ninth-circuit-holds-period-to-file-tax-court-collection-due-process-petition-jurisdictional-under-current-supreme-court-case-law-usually-treating-filing-deadlines-as-nonjurisdictional/

 

https://procedurallytaxing.com/fourth-circuit-declines-to-rule-on-whether-cdp-filing-period-is-jurisdictional-but-holds-against-taxpayer-since-it-says-facts-do-not-justify-equitable-tolling/

 

Starting the 30 day period – The taxpayer has 30 days to file the request or petition the Tax Court in a CDP case but when does that 30 day period begin? IRS letters do not always get mailed on the date on the letter. Many IRS employees flex and generate letters from their home which they do not print and mail until they come to work in the office on a later date. The date on the letter may be the date it was generated and not the date it was mailed. In the Weiss case the Revenue Officer dated the CDP Notice and took it to the taxpayer’s house; however, he did not personally deliver the notice as he had intended because the taxpayer had a large dog. The Revenue Officer mailed the letter two days later but the letter still contained the original date on which he had intended to effect personal service. The Tax Court decided that the date of mailing and not the date stamped or written on the letter that controlled.

When does period begin for arguing CDP – https://procedurallytaxing.com/when-does-the-period-begin-for-filing-a-cdp-request/

 

Impact of CDP Request or Petition on the Statute of Limitations on Collection – Taxpayers who receive a CDP Notice must decide whether to request a hearing in part based on the impact the request will have on the statute of limitations on collection. Sometimes taxpayers do not seem cognizant of the impact their actions will have downstream. Every action in a CDP case should be taken with an eye on the statute of limitations clock. In addition to the cases discussed in the blog post see also Gilliam v. Commissioner, 121 AFTR 2d 2018-2211 (4th Cir. 2018)(unpublished opinion holding that taxpayer’s incorrect request for the IRS to review a levy could be perfected after the 30 day period and result in a CDP hearing rather than an equivalent hearing.)

Statute of Limitations and CDP – https://procedurallytaxing.com/some-developments-on-cdp-statutes-of-limitation-us-v-hendrick-and-weiss-v-commissioner/

 

Should Taxpayer Sign the Waiver Form Ending CDP – If the taxpayer reaches an agreement with Appeals, the Settlement Officer will ask the taxpayer to sign a waiver form terminating their CDP rights. While signing the form seems logical in some ways, what happens if the IRS does not follow the bargain you think you have struck? Would it be best to have the determination letter issued and go to Tax Court in order to get a more formal recordation of the agreement?

Waiving CDP rights – https://procedurallytaxing.com/when-to-waive-cdp-rights/

 

Standard of Review – When the Tax Court reviews the CDP case it generally reviews the issue de novo if the taxpayer contests the underlying liability and reviews for an abuse of discretion if the taxpayer seeks a collection alternative. If the taxpayer contests the application of a payment made by the taxpayer to the IRS, what is the standard of review for that contest?

Standard of review – https://procedurallytaxing.com/tax-court-clarifies-standard-of-review-in-cdp-payment-disputes/

 

Summary Judgment – When a taxpayer files a CDP petition in Tax Court seeking review of an issue decided on an abuse of discretion standard, Chief Counsel IRS frequently seeks to resolve the case by filing a motion for summary judgment. In seeking the motion for summary judgment, the government must follow certain steps and prove certain items. The Tax Court has criticized Chief Counsel attorneys regularly for seeking summary judgment without following the correct steps. How can you identify when you might have a defense to summary judgment based on the failure of the motion to include all necessary items?

Filing a correct summary judgment motion – https://procedurallytaxing.com/designated-orders-one-two-punch-for-respondent-in-cdp-disputes-before-judge-gustafson/

 

TBOR and CDP – CDP is a natural place to argue the application of the Taxpayer Bill of Rights. It could apply to the balancing test. The IRS could be required to verify that its actions complied with TBOR. In the recent case of Dang v. Commissioner, taxpayer argued that requiring him to liquidate his IRA in order to pay the tax liability violated the TBOR provision that a taxpayer should pay no more than the correct amount of tax. The taxpayer argued that the IRS should levy on the retirement account in order to save the cost of the 10% excise tax under IRS 72(t).  The Appeals officer who first heard the CDP case issued a determination letter saying that Appeals did not have the authority to grant the requested relief.  When the case reached Tax Court the Chief Counsel attorney almost immediately requested a remand to Appeals to allow Appeals to make a determination based on the requested relief.  The taxpayer opposed the requested remand as a waste of time but the Court granted the request and back in Appeals the relief requested by the taxpayer was granted.

There is another interesting TBOR case brewing in Tennessee, Freels v. Commissioner, Dk. No. 26674-17L.  Petitioner, like the petitioner in the Dang case discussed in the link below, faced a motion to remand filed by the IRS when the IRS attorney realized that the position taken by Appeals and Collection would not result in an affirmation by the Tax Court of the position taken in the determination letter.  Unlike the Dang case in which Judge Armen granted the requested remand, Judge Guy denied the remand in Freels in an order dated December 19, 2018.  Mr. Freels’ counsel, Mary Gillum who directs the low income taxpayer clinic at Legal Services of Middle Tennessee and the Cumberlands, made arguments similar to the arguments made by Steve Milgrom in Dang.  She argued that the IRS had failed to provide Mr. Freels with due process and violated his rights.  While the underlying nature of the violation of TBOR in the Freels case differs from the violation alleged in Dang, the nature of the argument is similar.  The Tax Court’s willingness to deny the remand and push forward for a resolution of the case (in taxpayer’s favor) may signal a new willingness to short circuit the dance back through Appeals to reach the right result and a victory for TBOR.

Arguing TBOR in CDP cases – https://procedurallytaxing.com/follow-up-on-tbor-and-cdp/

 

Seeking a Refund in a CDP case – The Tax Court position is that taxpayers cannot obtain a refund in a CDP case. Although the court issued a precedential opinion on this issue over a decade ago, it revisited the issue in some detail this year perhaps in anticipation of a challenge of the issue in the circuits.

Refund Jurisdiction in CDP cases – https://procedurallytaxing.com/does-the-tax-court-sometimes-have-refund-jurisdiction-in-cdp-cases/

 

Third parties and CDP – The IRS files nominee and alter ego liens and occasionally collects administratively from a third party. The IRS takes the position that third parties have no CDP rights. Third parties continue to push for some type of due process protection.

CDP rights of non-taxpayers – https://procedurallytaxing.com/are-alleged-alter-egos-successors-in-interest-and-or-transferees-entitled-to-their-own-cdp-rights/

 

When is CDP case in Tax Court over – Because of the unlimited ability to have a CDP case bounce back and forth between the Tax Court and Appeals, an issue exists concerning the end of the case. At some point the Tax Court case concludes. When that time arises, anything further the Tax Court has to say does not matter.

Ability of Tax Court to comment on CDP case after dismissal – https://procedurallytaxing.com/after-the-tax-court-finds-it-lacks-cdp-jurisdiction-seventh-circuit-says-it-should-keep-quiet-about-other-collection-issues/

 

Can the Settlement Officer in a CDP case take actions that would trigger an action for wrongful collection – Occasionally, the Appeals employee handling a CDP case will do something that the IRS believes violates their rights. If the action occurs during the CDP phase of the case, is that a collection phase such that the wrongful action gives the taxpayer a right to bring an action for wrongful collection or is the CDP process something different from collection action?

Misconduct in CDP case does not permit wrongful collection case – https://procedurallytaxing.com/sixth-circuit-holds-potential-misconduct-in-cdp-hearing-does-not-give-rise-to-wrongful-collection-action/ 

 

What is an administrative proceeding – A taxpayer can bring a CDP case to challenge the merits of a liability if the taxpayer did not have a prior opportunity to do so. The issue of prior opportunity implicates the ability to raise the innocent spouse issue as well. If the taxpayer can show that it did not have a prior administrative hearing in the innocent spouse context the taxpayer should have the ability to raise innocent spouse as a defense in a CDP hearing.

Administrative hearing – https://procedurallytaxing.com/what-is-a-prior-administrative-hearing/

 

Consideration of non-CDP Years – Can the IRS or the Tax Court consider years not included in the CDP notice in fashioning a remedy? Administratively, CDP would not prevent the IRS from providing relief if it chose to do so but the Tax Court is limited to the years in the notice. Morgan v. Commissioner, T.C. Memo 2018-98

 

 

 

Update on Obtaining Transcripts from the IRS

If you have been following the news from the IRS about the ability to obtain transcripts from it, you know that at the start of 2019 the IRS plans to make it harder to obtain transcripts. The Tax Section at the ABA has been working the issue to try to get the IRS to slow down the process to make sure that it has everything in place. The IRS has been moving relatively quickly in an effort to plug security concerns. Last December it cut off e-Services to everyone who was signed up and made them sign up again with enhanced security questions before allowing access. In August of 2018 in made an announcement about its intention to create a new improved system – improved from a security perspective and not from the perspective of ease in obtaining transcripts. In September 2018 it made a follow up announcement.

In the message reproduced below from ABA Tax Section Chief Counsel, Meg Newman, she provides an update of the ongoing efforts of the community to resolve issues of security versus access. This is an important message for anyone who regularly tries to obtain transcript information from the IRS.

Dear PBTC Community,

As many of you know, in August the IRS announced changes to transcripts including redacting Wage & Income (W&I) transcripts and an end to faxing any transcripts to representatives. The people at the IRS who have been working on this issue have real security concerns about the faxing process, but have also been sincere in listening to our concerns and have worked hard to address them. The Tax Section has been included in a working group to discuss potential ways for representatives to access unredacted W&I transcripts and other transcripts prior to CAF processing of POAs. On December 13, we submitted comments to the IRS summarizing our recommendations (www.americanbar.org/content/dam/aba/administrative/…).

Yesterday the IRS held a conference call and then released the attached fact sheet summarizing their decisions for how to address the concerns we have raised. The IRS was eager to get news out on this issue, and as a result some of the language in the fact sheet may be confusing. I clarified this morning with the IRS what they intended to convey. Here is a summary of the key points and some remaining issues.

  1. As of January 7, 2019, representatives who have a need for unredacted (the IRS calls it “unmasked”) Wage & Income Transcripts can call PPS and request unredacted transcripts be sent to their secure mailboxes through eservices (the “Secure Object Repository” or the “SOR”).
    • The standard for what qualifies as a need for an unmasked transcript includes return preparation.
    • The fact sheet outlines the steps for requesting an unredacted transcript be sent to your SOR and includes the option to fax a POA to the PPS representative if one is not already on file through the CAF Unit.
    • Taxpayers can currently (and also in the future) request that an unredacted transcript be mailed to their last known address with the IRS as well.
  2. Faxing of transcripts will continue until February 4, 2019 (originally scheduled to cease on January 2, 2019, they extended it about 30 days).
  3. At some point prior to February 4, the IRS will complete the process to enable PPS representatives to send all individual transcripts to a representative’s SOR when the POA has not yet cleared the CAF Unit (through the same process we currently use to request PPS fax transcripts to us). This process for new clients, and TDS or mail for clients with a POA on file will be the only methods for representatives to obtain transcripts going forward. Taxpayers can also request transcripts be mailed to their last known address.
  4. The IRS is referring to transcripts other than W&I as “masked” or “redacted” as well. I clarified with them that only that the taxpayer’s social security number will be redacted down to the last four numbers. They assured me nothing else about an account transcript would look different in the “masked” form.
  5. We are hoping to work with the Wage & Investment Division to establish some system to get student attorneys CAF numbers more quickly so they can create eservices accounts early in the semester to access transcripts. This is a work in progress and we will send updates if we make progress.
  6. Business transcripts that are currently available through eservices will also be available through the same method as individual transcripts prior to a POA processing (this is not what the press release said, but I confirmed it is the case and they will be updating their material). The IRS is still working out a plan to replace faxing for a number of “internal transcripts and prints” relevant to the representation of large business entities. This is likely not relevant to this group, but something the Section has addressed in the working group.

The crucial and immediate message here is that anyone who does not currently have an eServices account, should start the process of obtaining an eServices account now. Some people find they can successfully open an account in one session, while others will need to have an activation code mailed to them which takes 7-10 business days. For practitioners who have student attorneys working with you, this is even more important as you will need to make the students delegated users so they can create eServices accounts.

The Tax Section is still part of the working group on this issue, so please feel free to contact me offline (megan.newman@americanbar.org) if you have feedback or questions not covered here.

Thanks,
Meg
——————————
Meg Newman
Chief Counsel
American Bar Association Section of Taxation
(202) 662-8645
megan.newman@americanbar.org

via ABA Tax Connect, Dec. 20, 2018

Effect of a Revoked Discharge on the Suspension of the Collection Statute of Limitations

On June 22, 2016, I wrote a post about the case of Bush v. United States in which the Tax Division of the Department of Justice argued that B.C. 523(a)(7) did not limit the exception to discharge with respect to the fraud penalty to a fraud penalty arising within three years of the date of the bankruptcy petition. In the Bush case the court ruled against the government and followed the precedent of three circuit court decisions from the early 1990s. After those three decisions the IRS had decided to abandon the argument that B.C. 523(a)(7) limited the exception to discharge to fraud penalty assessments arising within three years of the petition. I speculated in that post that maybe the government had changed its position though it was possible that the case merely reflected the arguments of an Assistant United States Attorney, similar to the situation in a recent post, who made a logical argument unaware of the history of the issue and the position of the government.

In the recently decided case of United States v. Joel No. 3:13-cv-01102 (W.D. Ky. Oct. 18, 2018) the taxpayer made the argument that the government lost in Bush and in the earlier cases. The government goes back to arguing that the circuit court cases were correctly decided, which suggests either that the Bush case was argued by a “rogue” government attorney or that the government has returned to the position it adopted following the three circuit losses in the early 1990s. The court ruled against the taxpayer and spent a little time parsing the confusing language of the statute. The Joel case concerns a post-bankruptcy effort by the IRS to reduce its assessment to judgment and to foreclose its lien on property held by an alleged nominee/alter ego. Most of the opinion focuses on the discharge of the underlying taxes and the effect of the prior bankruptcy case on the statute of limitations on collection.

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Depending on the impact of the prior bankruptcy, the statute could have expired prior to the filing of suit by the government. The court goes through a lengthy analysis in determining that the prior bankruptcy suspended the statute of limitations for a sufficient period of time to make the filing of the suit timely. Anyone interested in the interplay of the filing of a bankruptcy petition on the statute suspension for collection may find the case instructive. What makes this case somewhat unique and causes the taxpayer to argue about the fraud penalty is that the bankruptcy court granted Mr. Joel a discharge in his bankruptcy case and later revoked the discharge when his fraud came to light.

The fraud penalty was a minor point in the case, though because of the dollar amounts at issue the taxpayer may not have thought of it as minor. The tax years at issue are 1991, 1992 and 1993. Mr. Joel filed his first bankruptcy on November 8, 2001. He filed a chapter 7 petition and the court granted a discharge on February 7, 2002. The timing of the discharge reflects a normal time period of about three months for a debtor to obtain a discharge in a chapter 7 case with no objections. At the time of the discharge, the IRS would have written off the fraud penalty assessments as discharged pursuant to B.C. 523(a)(7) and made no further effort to collect those assessments because the discharge injunction of B.C. 524 bars creditors from collection against discharged debts.

After the grant of the discharge, the trustee became aware that Mr. Joel might not be a routine bankruptcy case. On January 29, 2003, the trustee brought an adversary proceeding in Mr. Joel’s bankruptcy case seeking to revoke the discharge because the debtor failed to list assets in the bankruptcy schedules and failed to surrender estate assets to the trustee. Additionally, on January 4, 2005, the IRS indicted Mr. Joel for IRC 7201 evasion of payment of his 1991-1993 taxes. In 2007, Mr. Joel pled guilty to evasion of payment and subsequent to that plea, the bankruptcy court ruled that he committed perjury in the filing of the bankruptcy schedules and revoked his discharge. This is where the position of the parties with respect to the discharge arguments gets somewhat reversed.

The IRS argues that the statute of limitations on collection should be suspended from the time of the bankruptcy filing until the time of the discharge revocation. Prior to the discharge, the IRS was prohibited from collecting the fraud assessment because of the automatic stay of B.C. 362(a). After the discharge, the IRS was prohibited from collecting because B.C. 523(a)(7) caused it to abate the assessment. It wasn’t until after the bankruptcy court revoked the discharge on June 20, 2007, that the IRS could reverse the abatement of any discharged taxes and penalties and begin to try to collect the liabilities again.

The debtor, in a quasi role reversal, argues that the fraud penalties were not discharged because of the language of 523(a)(7). Because the statute did not require the discharge of the taxes, the IRS had the ability to collect the taxes after the initial discharge lifted the automatic stay. So, the statute of limitations suspension lifted at the time of the initial discharge in 2002 and not the revocation in 2007. Because it lifted five years earlier, it had run by the time the IRS brought the suit.

The court looked carefully at the language of 523(a)(7) which provides:

A discharge under 727… of this title does not discharge an individual debtor from any debt-

(7) to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty –

(A) relating to a tax of a kind not specified in paragraph (1) of this subsection; or

(B) imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition….

The debtor first argued that (A) and (B) were conjunctive conditions and not disjunctive, such that a penalty must meet both conditions. The fraud penalty cannot meet the first condition because it relates to taxes on which the taxpayer has committed fraud, which are excepted from discharge under B.C. 523(a)(1)(C). It would make logical sense that the fraud penalty should be excepted from discharge. In many instances the IRS does not impose the fraud penalty until long after three years from the due date of the return because the IRS must amass evidence prior to imposing this penalty. The fraud penalty also represents the type of penalty that policy would dictate that the debtor should continue to owe. The legislative history of the statute implies that Congress intended the fraud penalty to continue.

The debtor’s problem here is the same one faced by the government when it litigated the meaning of this provision almost three decades ago. Subsections (A) and (B) are joined by the word “or.” The word “or” places (A) and (B) in a disjunctive and not conjunctive posture. Therefore, if either the condition of (A) or the condition of (B) applies, the provision discharges the fraud penalty. Subsection (B) refers to transactions occurring before three years before the petition date. The fraud penalty relates back to the due date of the return. Those due dates here occurred in the early 1990s, long before the filing of the bankruptcy petition.

Since the condition of (B) is met, the fraud penalty is discharged. The IRS correctly abated the fraud penalty when the bankruptcy court entered the discharge and the IRS receives the benefit of the period between the initial discharge and the revocation in calculating the statute suspension.

While this is not a huge issue, Congress should consider fixing B.C. 523(a)(7) to except from discharge the fraud penalty. Allowing the discharge of this penalty is not good policy. In most instances, I suspect the IRS will struggle to collect the fraud penalty because the individual who committed the fraud will have run through most or all of their assets before the IRS collection personnel arrive on the scene; however, cases exist in which the individual who committed fraud still has assets and the bankruptcy discharge should not protect those assets from collection.

 

The Federal Tax Lien and the Homestead Exemption

The case of In re Selander, No. 16-43505 (Bankr. W.D. Wash. Oct. 19, 2018) pits the bankruptcy trustee against the IRS. The trustee attempts to use a provision in Chapter 7 to take from property secured by the federal tax lien in order to pay his fees and other administrative costs. The IRS argues that when its lien attaches to property claimed by the debtor as a homestead, the provision allowing the trustee to use an asset secured by the federal tax lien does not apply. The case allows for an explanation of B.C. 724(b), in which Congress allows the use of money that would otherwise come to the government because of its secured position to pay unsecured priority creditors, and the interplay between the federal tax lien and the homestead exemption. The bankruptcy court here gets the law right and does a good job of explaining it.

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Mr. Selander filed a Chapter 7 petition on August 22, 2016. The Umpqua Bank filed a claim for over $5 million and the IRS filed one for over $700,000. The bank had liens against the debtor that predated the IRS’s federal tax lien. The debtor owned a ½ interest as a tenant in common of a home in the Seattle area. Other assets may have existed, but the house occupied the attention of the court.

The trustee of the bankruptcy estate found a buyer for the house for a gross sales price of $825,000. After paying off the mortgage, closing costs and the other owner, about $200,000 came to the bankruptcy estate. Washington is one of the states that allows debtors to choose between the federal bankruptcy exemptions in B.C. 522, or its own state-level exemptions, including a pretty generous homestead exemption of $125,000. The debtor elected to receive that amount as his homestead exemption.

The homestead exemption seeks to allow debtors something to get going after bankruptcy as part of their fresh start. While some states provide generous homestead exemptions and other states provide very little, the exemption in all states comes to the debtor subject to the federal tax lien. So, debtors owing federal taxes do not get the benefit of the homestead exemption that the state might intend since the state homestead law lacks the ability to pass property to the debtor in a way that overrides federal law. The operation of the federal tax lien vis-à-vis the homestead exemption has frustrated many debtors and provides one of many reasons to pay down federal tax debt prior to bankruptcy rather than to pay ordinary creditors.

The trustee ordinarily cannot use the homestead amount to pay his fees or to pay the claims of creditors of the estate. B.C. 522 carves the homestead amount out of the estate and gives it to the debtor as property exempt from the estate.

B.C. 724(b) allows the trustee to take an amount that would ordinarily go to the IRS because of the federal tax lien and use that amount to pay unsecured creditors of the bankruptcy estate entitled to priority status. The trustee is one of the creditors entitled to priority status. In the B.C. 724 analysis of Mr. Selander’s bankruptcy estate, nothing would go to the IRS because of the higher priority lien of Umpqua. That higher priority lien and the value of the assets in the estate prevents the IRS from having a secured claim against the estate. Without a secured claim held by the IRS, the trustee could not use B.C. 724(b) to carve out money to pay priority claimants.

Even though the IRS could not take from the estate, it stood to receive the homestead amount. The trustee argued that the payment of the homestead amount should allow the B.C. 724(b) carve out to occur even though the basis for the payment occurred from money not a part of the bankruptcy estate.

The court rejects the trustee’s argument, citing to relevant case law and finding:

There is no conflict between § 724(b) and § 522(k) because those two sections speak to different kinds of property. Section 724(b) involves property of the estate where the IRS holds a valid lien. In this scenario, Congress has made the decision that the bankruptcy trustee may subordinate the secured tax claim to pay administrative expenses. What § 724(b) does not address is the property a debtor removes from the estate by exemption, but still subject to a continuing lien of the IRS. This property is not covered by the plain language of § 724(b), which provides that it only applies to property ‘in which the estate has an interest….’ Exemptions remove property, or a certain value of that property, from the estate. Alsberg v. Robertson (In re Alsberg), 68 F.3d 312, 315 (9th Cir. 1995). Debtor’s Homestead Exemption removed the value of $125,000 from the estate but such exemption was powerless to eliminate the interest of the IRS in those funds claimed with the exemption.

The court noted that in the absence of the federal tax lien, the trustee’s attempt here would be a naked effort to take exempt funds to pay his fees, and that B.C. 522(k) prohibits that action. The bankruptcy court found that by claiming the homestead exemption, the debtor removed the property from both the estate and the application of B.C. 724(b).   It further found that the IRS need not bring a separate action to seize the money in the debtor’s bank account, but that the trustee should remit the $125,000 to the IRS. This victory by the IRS may benefit the debtor if the taxes were excepted from discharge. If the taxes would have been discharged by the bankruptcy, the debtor loses as well as the trustee since the debtor’s homestead exemption turns out to provide him with no benefit. Prior to filing bankruptcy, debtors should check the impact of a federal tax lien if they hope that bankruptcy will allow them to take certain assets with them. Mr. Selander’s case leaves him with a bankruptcy discharge but no major asset to take with him as he leaves bankruptcy.