Filing Form 1040 did not Extend Statute for Filing Form 945

Last year I wrote about the case of Quezada v. IRS. In the aspect of the case decided last summer, the bankruptcy court refused to grant summary judgment to the IRS regarding the statute of limitations for the taxpayer to file Form 945. The taxpayer argued that his Form 1040 provided the IRS with the information necessary and started the statute of limitations. The taxpayer needed the Form 1040 to serve as a surrogate Form 945 in order to discharge the liabilities it should have reported on Form 945. Now, the court has ruled on the issue and found for the IRS in Adv. Proc. No. 16-01101 (Bankr. W.D. Tex. 2018). The court provides a thoughtful analysis for its decision.

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Mr. Quezada operates a masonry company that builds projects for general contractors. He hires subcontractors to perform some of the work and provided to the subcontractors Forms 1099. The problem occurred because the Forms 1099 contained missing or incorrect TINs of the subcontractors. A missing or inaccurate TIN prevents the IRS from effectively using the Form 1099 to check on the reporting by the subcontractor. So, the IRS sent Mr. Quezada a notice in September 2006 that the 1099s had missing or inaccurate information and that if he did not correct the situation he had to start backup withholding. The IRS sent the same notice in 2007 and twice in 2009.

In 2008 the IRS began examining Mr. Quezada regarding his backup withholding liability for the subcontractors. This ultimately led to the recommendation of an assessment of $600,000 plus penalties of over $300,000. He eventually filed bankruptcy in which the IRS filed a claim for over $1.2 million. He brought an action to determine dischargeability arguing that the IRS waited too long to make its assessment. Mr. Quezada argued that his timely filed Forms 1040 and 1099 started the running of the statute of limitations on assessment while the IRS countered that he had an obligation to file Form 945 and his failure to file that form meant the statute never began running.

When a business pays an independent contractor, it must deduct backup withholding if the independent contractor fails to provide its TIN or if the IRS notifies the business that the TIN is incorrect. In addition to the backup withholding, the business must also file Form 945. Mr. Quezada argued that he had all of the TINs in a notebook but did not provide a record to the court and he had previously signed a sworn statement that he “did not obtain Social Security numbers (SSN) OR Taxpayer identification numbers (TIN) from all of [his] subcontractors.” The failure of proof in the trial coupled with the admission against interest caused the court to find that he had an obligation to file Forms 945.

Having found he had a duty to file the Forms 945, the court then looked at whether his failure to do so could somehow be excused. In Commissioner v. Lane-Wells, 321 U.S. 219 (1944) the Supreme Court analyzed whether a taxpayer who had filed a Form 1120 satisfied the requirement for filing a Form 1120H for holding companies. It found that Lane-Wells did not meet its statutory requirement for filing a return with respect to the holding company liability. The bankruptcy court found that Mr. Quezada, like Lane-Wells, had a separate liability requiring him to file two returns and preventing him from relying on the Form 1040 to satisfy his backup withholding liability.

The court also addressed his argument that he provided sufficient data to meet the Beard test. Beard v. Commissioner, 82 T.C. 766 (1984), aff’d 793 F.2d 139 (6th Cir. 1986) establishes the well-recognized test for what constitutes a return. Even though the bankruptcy court found that he had a responsibility to file the Form 945 return, if he could convince the court that his submissions on the Form 1040 essentially provided the information needed for the Form 945 he could meet the filing requirement. Beard has four tests: 1) sufficient data to calculate the tax liability; 2) document must purport to be a return; 3) honest and reasonable attempt to satisfy the tax law requirements; and 4) execution of the return under penalties of perjury.

The court found that he failed the second and fourth tests. He argued that missing TINs are “not relevant to his tax liability.” The court rejected this argument pointing out that the IRS needs to have the TINs in order for the Form 1099 to have meaning. The data provided did not meet the needs of the IRS and could not be considered sufficient. With respect to the third test the court explained that the IRS told him on several occasions of his failure and need to correct. His failure to correct over an extended period of time negates any argument that he acted in good faith and reasonably attempted to satisfy his tax law requirements.

This type of case provides a horrible result for a taxpayer such as Mr. Quezada if the subcontractors actually paid their taxes. Earlier this year we blogged about a case involving the misclassification of workers. We also posted a response from the National Taxpayer Advocate to our blog post. The situation faced by Mr. Quezada has similarities with the misclassification cases. The goal of backup withholding is ensuring that the third parties report their income to the IRS. If Mr. Quezada could show that his independent contractors actually reported their taxes, there should be some way to relieve him of at least a part of his liability. By failing to follow the rules, he causes the IRS to expend a fair amount of effort and for that he should be penalized. At the same time it seems he should have a path to reduce this crushing liability if he can prove that his independent contractors reported and paid the proper amount of tax. Maybe they did not pay and maybe, even if they did, he could not prove it but it seems a shame he does not have a chance to show that his failure did not result in loss to the IRS.

 

Recognizing Pat Mullarkey

This afternoon in the Great Hall of the Department of Justice people will gather to recognize and celebrate Pat Mullarkey who has served for almost four decades as the Chief of the Northern Trial Section of the Civil Section of the Tax Division.  He retires after working over 52 years at the Department of Justice.  I had the pleasure to work with Pat on several occasions.  He is a great lawyer and a great section chief who has mentored hundreds of trial lawyers over the course of his career.  You can find an interview of Pat about his career here on PT. More recently Pat was interviewed by Paul Merrion for MLex US Tax Watch (Lexis subscription required).

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I reached out to one of his assistants, Henry Riordan, who provided me with the following details about about Pat’s career:

In 1966, Mr. Mullarkey joined the Tax Division as a civil trial attorney.  In recognition of his exceptional talent, he was promoted to an Assistant Chief for the Civil Trial Section’s Western Region in 1977, and then to a Special Litigation Counsel position in early 1979.  Mr. Mullarkey became the Chief of the Civil Trial Section’s Northern Region in July of 1979 and has served continuously in that capacity since his appointment, except for two periods, one for six months and the other for two years, when he served as the Tax Division’s Acting Deputy Assistant Attorney General for Civil Litigation.

Mr. Mullarkey is a 1962 graduate of Marquette University with a B.S. in Accounting.  He received his J.D. from the Georgetown University Law Center in 1965, and an LL.M. in Taxation from that same institution in 1967.  After law school, Mr. Mullarkey was a judicial law clerk for a federal district court judge in the District of Columbia.

Mr. Mullarkey is a legend in the Department, as well as the federal tax bar.  He has been the recipient of a number of governmental awards including the President’s Meritorious Executive Award (twice), the Attorney General’s John Marshal Award for Outstanding Legal Achievement and, most recently, the Attorney General’s Mary C. Lawton Lifetime Service Award. Mr. Mullarkey has been a member of the J. Edgar Murdock Inns of Court of the Tax Court for thirty years.  He has served as an instructor at the Department’s National Advocacy Center and bankruptcy schools sponsored by the Office of Chief Counsel, Internal Revenue Service.  He has been a panelist at tax law conferences sponsored by the Federal Bar Association, sessions presented by the Tax Section of the American Bar Association and programs presented by other groups.  In February 2018, he received the Kenneth H. Liles Award from the Taxation Section of the Federal Bar Association.

Mr. Mullarkey has counseled many attorneys and is well known for his intellect and common sense.  He has supervised and mentored generations of attorneys, who have uniformly recognized their tutelage as the best experience in their careers.  Mr. Mullarkey’s enthusiasm for tax litigation has been infectious and his expertise and institutional knowledge will be greatly missed.

Section Chiefs in the Civil Trial Section play a critical role in developing tax litigation.  Because they serve as the lawyers for the IRS in district and bankruptcy courts, they interact regularly with the attorneys in Chief Counsel’s office where I worked.  Pat worked closely with the Chief Counsel attorneys served by the Northern Trial Section which primarily handles cases in the Northeast and he also worked closely with the Procedure and Administration Division of the National Office of Chief Counsel, IRS.  I reached out to Drita Tunuzi, currently the Deputy Chief Counsel (Operations) who previously served as the head of Procedure and Administration and who started her career in an office in the Northeast.  She had this to say about Pat:

Pat Mullarkey has seen many generations of DOJ and Chief Counsel lawyers over his years and they are all better for having worked for and with him.  He has provided outstanding service and wise counsel to the IRS over his career.  We wish him well in his retirement. 

I also received these comments made by John DiCicco, a colleague of Pat’s at DOJ and a former Acting Assistant Attorney General of the Tax Division:

I am not going to spend time telling you what a great lawyer Pat is.  That is indisputable.  Suffice it to say I learned more from Pat than any other lawyer I worked with. 

Instead, I want to talk about what a fine man Pat is.                 

I relied on Pat from the time I started working in the Division in 1974.  He always patiently answered my questions no matter how stupid they were.  He did the same for all the other lawyers who sought him out.  And seek him out they did.  No matter how busy he was, he would give his time to help the rest of us.               

Inclusive- I remember when I first started with the Division and Pat was a Senior Trial Attorney.  Every morning he would walk by and ask lawyers, especially the new lawyers if they wanted to go next door for breakfast or for coffee.  It made all of us feel we were part of a team working together toward a common goal.  Pat really fostered a sense of camaraderie.  

As an aside, unfortunately, the only place around that served breakfast was something called the “Kitchateria”.  How the Board of Health allowed that place to stay open was always a source of wonderment.   But we went with Pat. Not only to learn about our cases, but to learn about each other.  He made us feel we were working with top people, and maybe more importantly, that the work we did was important.  (Too, we always marveled at how Pat could hold down the “Kitchateria” food.) 

Pat was unceasingly fair and loyal.  He cared about all of his staff, not just his lawyers. And he cared about them not just professionally but personally. He always stood up for and supported his troops.  I remember once he even quit drinking a brand of beer because I had a case (no pun intended) with the Brewery and was always complaining about that piece of litigation. (Of course that I would complain about something was something of a rarity.) 

Pat was one of the four Division employees that I worked with who I always thought were irreplaceable—Pat, Steve Csontos, Bob Markham and Tommy Thompson.  The rest of us were fungible, but not Pat. 

Pat helped me immeasurably when I was the acting AAG. He agreed to serve as my deputy.  I knew that being a deputy was not his first choice (or second choice for that matter), and that he really loved being a section chief. He had little interest in the deputy position, else he would have had it years before.  Nonetheless, he willingly agreed to help, and as always, his help was superb. 

In sum, I owe a debt of deep gratitude for all Pat did for me.  But more importantly, the American people owe him a huge debt of gratitude.  It is outstanding, selfless and unstinting civil servants like Pat, who make our Government function.        

Pat, thank you for all that you have done, and all the best in your new “career”.  I hope it lasts as long as last one. 

For over half a century Pat has impacted tax procedure because of the large role he has played in shaping the litigation strategies at the Tax Division.  The next chief of his section has very large shoes to fill. 

 

 

 

NTA Highlights Errors in IRS Calculation of Collection Statute of Limitations

We blogged previously on the problem of properly computing the collection statute of limitations here, here, here, here and here. Calculating the statute of limitations on collection has become quite difficult. The National Taxpayer Advocate (NTA) has just blogged on the subject making it clear not only that relying on the IRS calculation of the collection statute of limitations (CSED) might be unwise but highlighting again the difficulties in this area.

The NTA identifies five situations in which a computer glitch at the IRS causes the IRS to improperly calculate the CSED. Not surprisingly, the problems center on cases in which the taxpayer has entered an installment agreement (IA). When IAs start, end, restart, etc. can create problems in determining which can translate into problems in calculating the impact of an installment agreement on the collection statute of limitations.

The NTA identifies five situations with problems:

  • Multiple pending IAs with only one corresponding rejected IA determination;
  • One pending IA and one approved IA where 52 or more weeks have passed;
  • Multiple pending IAs with one approved IA, where 26 or more weeks have passed;
  • On pending IA with one rejected IA, at least 52 weeks later; and
  • One pending IA, with no other action on the IA request for at least 52 weeks.

The IRS agreed to review the cases in situation 3) above. The NTA cites to an unpublished report in which the IRS finds that 83% of the CSEDs on its system incorrectly identified the last date to collect. Then the NTA says that she believes the number of wrong CSEDs in the group is higher than stated in the unpublished report. By this point you should have a high level of discomfort with what the IRS may tell you about the CSED.

The NTA seeks to have the IRS audit all five of the identified areas of problem and to notify all impacted taxpayers. These taxpayers may have had money collection from them after the expiration of the statute of limitations. Most of the remainder of the post explains the remedies available to those who have wrongly overpaid their taxes. While understanding the remedies available certainly carries importance, my main take away from the post concerns the extremely high error rate in the group of identified cases and how that reinforces my general concern about the ability of the IRS to correctly calculate the CSED.

Another Clawback of Money Paid to the IRS

Last year, I wrote about a Ponzi scheme case, Zazzali v. United States in which the 9th Circuit allowed a bankruptcy trustee to recover money paid to the IRS by the perpetrator of the scheme prior to the filing of the bankruptcy petition. The payments could not be recovered for the estate using the preference provisions because of the timing and the nature of the payments; however, the court allowed the trustee to pull the money away from the IRS and into the bankruptcy estate using a combination of state remedy and waiver of sovereign immunity.

The 9th Circuit decision represented a split with the 7th Circuit, which had held in In re Equipment Acquisition Resources, Inc., 742 F.3d 743 (7th Cir. 2014) that a clawback under similar circumstances was not permitted under the applicable provision of the bankruptcy code. The last entry shown for the Supreme Court docket in Zazzali is Justice Kennedy granting the motion to extend the time to file a petition for a writ of cert. The motion was granted on April 9, and extended the deadline until May 18. The IRS regularly obtains extensions of time when considering whether to appeal. Here, it appears it decided not to appeal. Many reasons could exist for the decision not to appeal. In the meantime, the IRS lost another case with this issue, McClarty v. Hatchett, Case No. 17-451163-MBM (E.D. Mich. 2018) and has filed an appeal to the 6th Circuit in that case. So, the decision not to seek cert in Zazzali does not represent a concession of the issue by the IRS.

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At issue in these cases is the interpretation of B.C. 544(b)(1) and 548 and the interplay of one or both of these sections with B.C. 109 and the waiver of sovereign immunity. Where the Zazzali case involved a Ponzi scheme, the Hatchett case involves the use of funds belonging to the debtor, Laurestine Hatchett, to pay the federal tax liabilities of her husband. In 2014 the debtor’s children were appointed co-conservators of for her because of her disability which prevented her from managing her affairs. Mrs. Hatchett’s husband and her daughter were appointed her co-guardians. In 2015 real property was sold for over $300,000 which debtor owned 50/50 with her son. She received net proceeds of $122,827. The son turned the proceeds over to the father who deposited them into an account in the name of his law firm. A major portion of the proceeds were then used to pay federal taxes owed by Mr. Hatchett (the father) or his law firm.

On April 6, 2017, an involuntary chapter 7 petition was filed against debtor. While persons going into bankruptcy file almost all bankruptcy cases voluntarily, under the right circumstances creditors can “take” a person into bankruptcy involuntarily and that happened here. I did not go to the bankruptcy case to try to determine why; however, the involuntary bankruptcy was accepted by the bankruptcy court shortly after it was filed and a trustee was appointed to administer the bankruptcy estate. The trustee has a duty, and a financial interest because of the ways fees are paid, to find and bring back into the estate all money possible. The trustee looked at the transaction described above and determined that it fit the provisions of fraudulent transfer. The IRS in these situations has not participated in the fraudulent transfer other than to accept and apply funds as directed by the person making the payment. Based on the facts here, Mr. Hatchett’s transfer of his disabled wife’s funds to pay his personal or business tax liability certainly appears to be an improper conversion of her funds.

The IRS defended the action by arguing that sovereign immunity protected it from this action. Essentially, the IRS made the same arguments it previously made in Zazzali and Equipment Acquisition Resources.

The bankruptcy court started with an explanation of the applicable fraudulent transfer law and the two provisions in the bankruptcy code at issue here:

Fraudulent transfers can be avoided under two different sections of the Bankruptcy Code:

11 U.S.C. § 548, which creates a body of federal fraudulent transfer law, and 11 U.S.C. § 544(b), which gives the trustee power to avoid a fraudulent transfer by the debtor if the transfer would be voidable by one of the debtor’s creditors under state law. Specifically, § 544(b)(1) permits a trustee to step into the shoes of an actual creditor who has a fraudulent transfer remedy under other “applicable law” (i.e. a state fraudulent transfer statute) and exercise that creditor’s remedies on behalf of the bankruptcy estate. 11 U.S.C.§ 544(b)(1) provides, in relevant part, that a “trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim. . .

The key difference between an action under § 548 and an action under § 544(b)(1) is the reach-back period. Section 548, captures only transfers made in the two years preceding the filing of the bankruptcy. Section § 544(b)(1) looks to the specific state statute’s reach-back period, which is generally longer than two years. Thus, a bankruptcy trustee seeking to recover transfers made more than two years prior to the filing of the bankruptcy must file an action under 544(b)(1).

The court then discussed the interplay of sovereign immunity with the fraudulent transfer provisions since the IRS argument in the case was that sovereign immunity prevented the relief requested. BC 106 sets out the waiver of sovereign immunity and that section lists all of the bankruptcy code sections that waive immunity. Included in that list are 544 and 548. The court notes that the plain language of the statute includes the statutes at issue within the waiver of sovereign immunity citing favorably to the Ninth Circuit’s decision in Zazaali. The IRS argues that while 544 waives sovereign immunity it does not waive it for suits that could not be brought outside of bankruptcy. Since no waiver exists outside of bankruptcy for a creditor to sue the IRS under a state based fraudulent transfer statute, Congress could not have intended to allow such a suit by the trustee in a bankruptcy case.

The bankruptcy court rejected the IRS interpretation and followed the reasoning In Zazzali stating:

The Ninth Circuit’s broad reading of section 106 was bolstered by the fact that section 106(a)(1) was enacted after section 544(b)(1). As a consequence, when Congress passed 106(a)(1), it was, presumably, well aware of the fact that section 544(b) allowed a trustee to bring claims derived from applicable state law, a power that had been included in the Bankruptcy Code at the time the Code was enacted in 1978, and had existed under the Bankruptcy Act of 1898.

The court also cited the reason for the fraudulent conveyance statute in support of its decision:

It is undisputed that Debtor does not have a tax liability to the IRS. In its fraudulent transfer action under § 544(b)(1), the Trustee is simply seeking to recover money that Debtor should have used to pay her own creditors. In abrogating governmental immunity for suits brought under § 544, Congress’s clear intention was that the fraudulently transferred property must be recovered for the benefit of Debtor’s creditors, regardless of the status of the recipient of the fraudulent transfer.

The court then addressed additional defenses raised by the IRS. The IRS based the first of these defenses on BC 106(a)(5) which provides:

Nothing in this section shall create any substantive claim for relief or cause of action not otherwise existing under this title, the Federal Rules of Bankruptcy Procedure, or nonbankruptcy law.

In rejecting this argument the court finds that the substantive claim is permitted under otherwise existing law, specifically BC 544(b)(1).

It then moves to the IRS argument that the federal law in title 26 preempts the state law fraudulent conveyance action. The IRS arguments is that “state law is preempted where state law attempts to regulate conduct in a field that ‘Congress intended the Federal Government to occupy exclusively.'” In rejecting this argument the bankruptcy court finds that the argument of the IRS does not apply since the suit here has nothing to do with the payment or collection of taxes from Laurestine Hatchett. The fraudulent conveyance suit seeks to bring money into the bankruptcy estate wrongfully taken from her. The court focuses on her and not on the payment of taxes by her husband.

Finally, the court rejects the IRS argument that IRC 7422 prohibits the repayment of this money. IRC 7422 provides:

No suit prior to filing claim for refund.–No suit or proceeding shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Secretary, according to the provisions of law in that regard, and the regulations of the Secretary established in pursuance thereof. The bankruptcy court says that 7422 has no applicability to this situation.

The IRS will continue its arguments on this issue into the circuit court. If it loses again, I expect it will either seek to take this case to the Supreme Court or it will give up on this argument. In the meantime trustees will look for payments to the IRS by debtors in bankruptcy that satisfy the tax debt of someone other than the debtor.

 

A Counterclaim as an Informal Claim for Refund or as the Starting Date for Calculating the Refund Amount

Last year I wrote about a case in which the 9th Circuit accepted a request for injured spouse relief as an informal claim for refund in a situation in which the taxpayer should have filed a claim for refund. In Appelbaum v. United States, No. 5:12-cv-00186 (W.D.N.C. August 6, 2018) the court found that a counterclaim filed in a lawsuit operated as the time for starting the refund claim even if the counterclaim did not operate as a refund claim itself. Allowing the counterclaim to start the look-back period for measuring payments allows the taxpayer to obtain a larger refund. Treating a document as a type of informal claim for one purpose when it clearly does not work for another purpose bifurcates the refund claim in a manner that I do not recall seeing previously.

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Mr. Appelbaum held a position with Warde Electric Contracting, Inc. that caused the IRS to assess a trust fund recovery penalty (TFRP) against him in 2003 for over $2 million. Once it made the assessment the IRS began taking collection action against him. From the description in the opinion, it seems that Mr. Appelbaum did not affirmatively send payment to the IRS but it offset his refunds and levied on his social security payments.

Almost 10 years after making the assessment, the IRS brought suit against Mr. Appelbaum seeking a judgment of almost $4 million due to the accrual of interest and penalties since the initial assessment. The IRS usually brings such a suit when the statute of limitations is about to run out but it believes that it can collect more by extending the time for collection. I have written before about the unlimited period of time the IRS can obtain to make collection when it has a judgment. Usually, the decision to bring a suit to reduce the liability to judgment is a low cost and low risk maneuver; however, the decision backfires in Mr. Appelbaum’s case.

Representing himself, Mr. Appelbaum argued that the IRS failed to follow the notice requirements of 6672 which, at the time of the assessment against him, were still relatively new. After a bench trial, the court found that the IRS did indeed fail to give Mr. Appelbaum proper notice of the assessment. This meant that the IRS had to abate the assessment against him and because the statute of limitations on assessment of the TFRP had long since passed, it also meant that the IRS could not “fix” its mistake. So, Mr. Appelbaum was completely relieved of the liability. He was, however, not satisfied with simply being relieved of the liability but wanted his money back.

He counterclaimed in the case seeking the money the IRS had taken from his Social Security payments and “any and all payments received by the IRS that have been applied over the years against the Assessments from April 10, 2003 to the present.” The court said that it construed this counterclaim as a claim for refund under 28 U.S.C. 1346(a)(1). The court dismissed the claim for lack of subject matter jurisdiction because Mr. Appelbaum did not first file an administrative claim for refund as required by IRC 7422(a).

Mr. Appelbaum filed correct administrative claims in March of 2016. In August of 2016 the IRS granted him a refund of $19,556.00 of the $43,095.00 it had taken from him over the years. It determined this refund amount by looking to the payments it had recovered within two years prior to the filing of the claim. Mr. Appelbaum administratively appealed the determination arguing that the IRS should grant him refunds from a date two years prior to the time he filed the counterclaim for refund on May 1, 2013. In March of 2017 the IRS increased the refund amount it allowed Mr. Appelbaum to $31,162.00. At issue before the court is whether to compel the IRS to refund the remaining amount of levied Social Security and refund payments not yet returned to Mr. Appelbaum. The court states that the IRS can retain the monies received more than two years before the filing of the claim and notes that equitable tolling does not apply to refund claims citing to United States v. Brockamp, 519 U.S. 347, 354 (1997).

Then the court examined the facts to determine the correct date from which to apply the two year rule. It determined that the answer and counterclaim filed in the suit the IRS brought to reduce the liability to judgment “adequately put the IRS on notice that Defendant believed he was subjected to an erroneous tax exaction and that he desired a refund.” So, the court allowed him to obtain a refund from two years prior to the date of his counterclaim.

The decision to treat the counterclaim as an informal claim for refund after dismissing the counterclaim on jurisdictional grounds presents an interesting extension of the informal claim doctrine. The court did not cite any authority that a jurisdictionally flawed pleading could serve as an informal claim. I agree with the court that the pleading did put the IRS on notice that the taxpayer thought he should receive a refund. Certainly, in that respect it fits the norm for an informal claim but since it was a failed pleading, it also stands outside the norm for most informal claims.

For those seeking to assess the informal claim doctrine, the decision provides another example of something that can serve as an informal claim in one context even if it is a failed claim in another. The court seems to allow the use of the claim as the starting date for the refund only as a result of the “regular” claim for refund filed later. Is the filing of the regular claim for refund a predicate to using a pleading as an informal claim? Is this really an informal claim or an addendum to a formal claim allowing it to move the time period for calculating the refund to an earlier date? The case may raise more questions than it answers. Meanwhile, Mr. Appelbaum goes home very happy that the IRS decided to try to reduce his liability to judgment and the IRS realizes that it did not properly make a risk/reward calculation in this case.

 

Making an Offer in Compromise Does not Stop Seizure and Sale of Home

In United States v. Brabant-Scribner, No. 17-2825 (8th Cir. Aug. 17, 2018) the Eighth Circuit affirmed the decision of the district court allowing the sale of taxpayer’s home and affirmatively determining that an offer in compromise request filed by the taxpayer has no impact on the ability of the court to grant the request by the IRS to sell the home or on the IRS’ ability to sell the home once the court granted its approval. In reaching this conclusion the Eighth Circuit analyzes the exemptions to levy in IRC 6334 and the relief those provisions do and do not provide.

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Taxpayer owes the IRS over $500,000. The opinion does not discuss the actions by the taxpayer to pay or resolve her liability prior to the action by the IRS to sell her house. I imagine that the IRS considered her a “won’t pay” taxpayer. Before seeking to sell her home, the IRS had seized and sold her boat and levied on her bank accounts.

The 1998 Restructuring and Reform Act added IRC 6334(e)(1)(A) to require that prior to seizing a taxpayer’s principal residence the IRS must obtain the approval of a federal district court judge or magistrate in writing. Before the passage of this provision, the IRS could seize a taxpayer’s home with the same amount of prior approval needed to seize any other asset owned by the taxpayer. No approval was necessary to seize any asset of the taxpayer. Prior to 1998 collection due process did not exist. Prior to 1998 the 10 deadly sins did not exist one of which calls for the dismissal of an IRS employee who makes an inappropriate seizure. So, the landscape regarding seizures, and especially personal residence seizures, changed dramatically after 1998; however, the amount of litigation regarding seizure of personal residences is low and the Brabant-Scribner case offers a window on one aspect of this process.

As the IRS initiated the process of seizing her personal residence by obtaining the appropriate court approval, the taxpayer filed an offer in compromise. She filed an effective tax administration offer of $1.00, but the amount and sincerity of her offer do not really matter to the legal outcome of this case. The timing and the amount of the offer may have influenced the thinking of the judges and made them more inclined to dismiss her argument but her possibly bad faith effort to stop the approval and execution of the sale should not have affected the outcome here.

To convince the court to allow the sale of a personal residence, the IRS must show compliance with all legal and procedural requirements, show the debt remains unpaid and show that “no reasonable alternative” for collection of the debt exists. Taxpayer argued that her offer was a reasonable alternative; however, the court spends three paragraphs explaining that an offer does not matter in this situation. The relevant language in the applicable regulation is “reasonable alternative for collection of the taxpayer’s debt.” The court explains that the word “for” holds the key to the outcome.

“For” refers to an alternative to the sale of the personal residence such as an installment agreement or the offer of funds from another source to satisfy the debt. An offer in compromise is not an alternative for collection but an alternative “to” collection.

Having determined that the words of the regulation point toward a resolution other than an offer as providing the necessary alternative, the court looks at the remainder of the regulation for further support of its conclusion. It points to the provision in Treasury Regulation 301.6334-1(d)(2) which provides that the taxpayer has a right to object after the IRS makes its initial showing and “will be granted a hearing to rebut the Government’s prima facie case if the taxpayer … rais[es] a genuine issue of material fact demonstrating … other assets from which the liability can be satisfied.” This regulation, like the one providing an alternative “for” collection, looks not to relief from payment of the liability but a source for making payment. It does not provide the offer in compromise as a basis for relief. Based on this the court concludes that “nothing requires the district court to ensure that the IRS has fully considered a taxpayer’s compromise offer before approving a levy on a taxpayer’s home.”

Since the IRS properly made its case for seizing and selling the home and the taxpayer did not rebut that case, the Eighth Circuit affirms the decision of the district court to approve the sale. The decision provides clear guidance for district courts faced with the request by the IRS to seize and sell a personal residence. Personal residence seizures by the IRS remain rare at this point. Taxpayers faced with such a seizure, almost always taxpayers the IRS characterizes as “won’t pay” taxpayers, will find it difficult to stop the seizure and sale based on this decision. I do not think this decision will motivate the IRS to increase the number of personal residence seizures but it will make it a little easier to accomplish when it decides to go this route.

 

Interest Rate for Tax Exempt Corporations

In Charleston Area Medical Center Inc., et al v. United States, No. 1:17-cv-01528 (Ct. Cl. 2018) the Court of Federal Claims held that the interest rate applicable to corporations applies to tax exempt corporations just as it does for “regular” corporations. The court decided the case on the pleadings because the issue presented in the case was purely a legal issue with no factual dispute. Steve wrote about this issue a couple of years ago. There have been several cases decided since then making it worth a second trip for readers though for taxpayers the courts still play the same tune.

The case also raises interesting procedural issues because the taxpayer sought to bring the suit as a class action. Class action litigation does not occur often in federal taxes.

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Taxpayer is a tax exempt organization in West Virginia. The taxpayer is a medical and research center. It had medical residents working for it and paid employment taxes for these residents before the IRS made an administrative determination that medical residents qualified for the student exemption. As a result it sought and received a refund for the overpayment of tax. The IRS refunded the money with interest; however, the interest paid by the IRS was computed on the basis for the corporate rate specified in IRC 6621(a)(1)(A)-(B) which provides “[t]he overpayment rate established under this section shall be the sum of … the Federal short-term rate… plus…3 percentage points (2 percentage points in the case of a corporation).”

The taxpayer argued that the corporate rate should not apply to it because Congress did not intend that rate to apply to tax exempt entities. In addition to arguing that the corporate rate did not apply to it, the taxpayer filed a class action complaint seeking to represent other similarly situated organizations that also received refunds pursuant to the IRS concession regarding the student exception.

As mentioned above, the taxpayer did not win the race to the court on this issue. By the time the Court of Federal Claims wrote its opinion here the government had already prevailed in the Second (Maimonides Med. Ctr. V. United States, 809 F.3d 85, 87 (2nd Cir. 2015) (this is the case Steve discussed in the earlier post)), Sixth (United States v. Detroit Med. Ctr., 833 F.3d 671(6th Cir. 2016)) and Seventh Circuits (Med. Coll. Of Wis. Affiliated Hosps., Inc. v. United States, 854 F.3d 930, 933 (7th Cir. 2017)) as well as the District Court in Kansas No. 16-1054 (D. Kan. 2017) appeal docketed, No. 18-3016 (10th Cir. Feb. 2, 2018)).

The Federal Circuit, following the reasoning of the other courts, found that the word corporation ordinarily refers to both for-profit and nonprofit entities. It noted that the dictionary definition of corporation does not depend on whether the entity is for profit or not for profit. IRC 7701 provides a broad definition of corporation. The Federal Circuit found that a textual analysis supports the view that Congress knew how to limit the type of corporation since it created a special rate specifically for large C corporations in IRC 6621(c)(3)(A). Finally, the court noted that throughout the Code the word corporation applies to for profit and not for profit corporations.

The court noted that the taxpayer’s argument relied on regulations superseded in 1996. It said that the language of the Code provided a clear basis for its decision but that even if it had not the long ago superseded regulations would not lead to the conclusion sought by the taxpayers. Additionally, taxpayers argued that the IRS position in their case (and the many identical cases preceding it) was inconsistent with Notice 2018-37 which announced that S corporations will receive unfavorable tax treatment notwithstanding the fact that the new statute excepts all corporations from such treatment. The court says that it takes no position regarding the proposed regulations but finds this argument has no bearing on the outcome of the case.

I do not know how many other tax exempt corporations will try the arguments made here. It appears that the issue is dead. It’s time for the tax exempt organizations to move to the lobbying phase of their efforts to obtain additional interest. Continuing to make this argument looks like a sure loser. Because the court dismissed the case, it did not get to the issue of certifying a class action against the IRS to recover a refund of interest for similarly situation tax exempt organizations.

 

 

 

Bankruptcy Court Limits Prior Supreme Court Decision on Equitable Tolling

Regular readers of the blog know that the tax clinic at Harvard has been pushing to break down jurisdictional barriers and have equitable tolling applied to allow taxpayers to get into court in situations in which the government has caused, or partially caused, them to miss the filing deadline. The IRS vigorously opposes our requests just as it vigorously opposed the equitable tolling request in the cases leading to the Supreme Court’s decision in Brockamp v. United States, 519 U.S. 347 (1997).

Sometimes the IRS wants to use equitable tolling. In 2002, it won a major victory in the Supreme Court in the case of Young v. United States, 535 U.S. 43 in which the court found that the time period for an income tax liability to have priority status could be tolled by a prior bankruptcy case. The decision significantly expanded the possible life of priority status for claims of the IRS. Priority status not only assists the IRS in recovering from the bankruptcy estate but makes the tax non-dischargeable because of the interplay of the priority and discharge provisions. In Clothier v. IRS, No. 18-00104 (Bankr. W.D. Tenn. 2018) the bankruptcy court held that Young no longer applies because of changes to the law in 2005.

I feel confident that the IRS will appeal this decision; however, the decision has nationwide implications and will no doubt cause enterprising bankruptcy lawyers, who previously did not think that the changes to the bankruptcy law in 2005 changed the outcome in the Young case, to litigate this issue around the country. When coupled with Internal Revenue Service v. Murphy, a case of first impression from the First Circuit issued on June 7, 2018, this might keep the IRS and the U.S. Attorneys representing the IRS busy at the end of a high number of bankruptcy cases obtaining rulings from the bankruptcy court regarding discharge. Our post on Murphy can be found here.

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Bankruptcy code section 507(a)(8)(A) has three subparts describing the income taxes that achieve priority status in a bankruptcy case. Subpart (i) describes income taxes for which the tax return is due within three years, including extensions, of the bankruptcy petition. This subpart would make a debtor’s taxes for the years 2017, 2016 and 2015 entitled to priority status if the debtor filed bankruptcy today because the returns for those years were due on April 15, 2018; April 15, 2017 and April 15, 2016, and each due date is within three years of today’s date. If the debtor obtained an extension to file the 2014 tax return, the due date for that return would have been October 15, 2015 and that due date is also with three years of today’s date. If the debtor did not obtain an extension to file the 2014 return, the due date of April 15, 2015 is more than three years from today’s date and any liability for that year would not meet the priority test imposed by subpart (i).

Because the ability to assess income taxes, and therefore to collect income taxes, involve the deficiency procedure which allows the taxpayer to delay the timing of the assessment by failing to file a return or declining to accept a proposed increase, Congress added two additional subparts to BC 507(a)(8)(A) to cover the eventuality that an assessment would not occur at or near the original due date for filing the return. The thinking behind the provisions for priority status for taxes was that the IRS should have a reasonable time to collect before a tax loses its priority status. It picked three years as the generally reasonable time but knew that the three year rule could be frustrated by certain taxpayer actions which is why it created subparts (ii) and (iii).

Subpart (ii) provides priority for taxes assessed within 240 days of the bankruptcy petition. I will come back to talk about the exceptions to subpart (ii) which form the basis for this decision but first want to explain how it works. A typical case in which subpart (ii) would apply involves a liability assessed after a Tax Court case or an extended examination. If the IRS audited the debtor’s 2013 return, it might be April 1, 2018 before the Tax Court rendered a decision regarding additional taxes for that year and the IRS made an assessment based on the decision. If the taxpayer filed bankruptcy today, the income tax liability for 2013 would not receive priority status based on subpart (i) because more than three years have passed since the due date of the return; however, today’s date is less than 240 days after the making of the additional assessment for 2013 causing subpart (ii) to bring this liability into priority status. Note that if the debtor had an outstanding liability stemming from the filing of his return because he did not include sufficient remittance, the liability related to the return would not have priority status because it would fail the tests of both (i) and (ii). It would be a general unsecured claim while the liability for the same tax period assessed as a result of the Tax Court decision would have priority status.

Subpart (iii) applies to those taxes which the IRS can still assess. Building on the prior example, assume that the debtor filed a Tax Court petition for 2013 but the Tax Court has not yet rendered a decision. The IRS cannot yet assess the taxes in the notice of deficiency. It has a priority claim for those taxes based on subpart (iii). It would not have priority status based on subpart (i) since more than three years has passed since the due date of the return nor would it have priority status based on subpart (ii) since there has been no assessment within 240 days of the filing of the bankruptcy petition. While subpart (iii) would appear to grant priority status for unfiled or fraudulent returns since the assessment period would remain open in those instances, an exception prevents the IRS from gaining priority status if the reason the statute of limitations on assessment remains open is due to an unfiled or fraudulent return. The discharge provisions will allow the IRS to continue collecting from the debtor after bankruptcy on this type of debt but the priority provisions prevent the IRS from gaining an advantage over other creditors from the property of the estate when the debtor’s bad actions with respect to taxes created the problem.

Circling back to subpart (ii) and the issue in Clothier it is necessary to look at the exceptions that exist in that subpart. Prior to 2005, it contained an exception in the case of a pending offer in compromise which extended the 240 day period if an offer was pending during that time period for the period the offer was pending plus 30 days. In the 2005 bankruptcy legislation, Congress added a second exception which provides “any time during which a stay of proceedings against collections was in effect in a prior case under this title during that 240 day period, plus 90 days…”

The bankruptcy court here finds that the passage of this subsection, passed after the decision in Young, shows Congressional intent to overrule Young and to limit the application of the tolling of the priority period to the circumstance prescribed in the new subsection in subpart (ii). If correct, this means that the tolling permitted by Young would not apply to extend the time in subpart (i) which is the time period on which the IRS was relying in Clothier.

Here, the debtors filed the bankruptcy case at issue in the opinion on September 4, 2013. The tax years at issue in the discharge proceeding are 2008 and 2009 for which the debtors had extensions to file until October 15 of year of the respective years. Debtors filed a prior bankruptcy petition on January 19, 2012 which was dismissed on June 5, 2013.

The bankruptcy court quickly and correctly found that the 2009 liability was entitled to priority status under BC 507(a)(8)(A)(i) because the filing of the current bankruptcy fell within three years of the extended due date for the 2009 return, viz., the return was due on October 15, 2010 which was less than three years prior to September 4, 2013. (The bankruptcy filing was ill timed if motivated by eliminating this tax debt absent consideration of the effect of Young.)

A very different result, however, applies with respect to 2008. The due date for the 2008 return, as extended, clearly falls outside of the three year period in BC 507(a)(8)(A)(i). Here, the IRS filed a priority claim relying on Young which tolled the time period due to the prior bankruptcy filing. The prior bankruptcy existed long enough to cause the new bankruptcy to fall within the three year period. Because of the apparent codification of the Young decision in BC 507(a)(8)(A)(ii), the bankruptcy court finds that Young no longer helps the IRS when it relies on subpart (i). Since the IRS does not receive the additional tolling, the 2008 tax debt does not achieve priority status and since it was not classified as a priority debt it was discharged in the bankruptcy case.

I have not looked at the brief filed by the IRS in this case to discover what arguments it makes that equitable tolling should continue in the face of the statue change. The statute change was driven by the bankruptcy commission created in the 1994 bankruptcy legislation. That commission created a tax advisory panel which recommended several changes to the bankruptcy code to make it better align with the tax code. The recommendations of the tax advisory panel and the bankruptcy commission were wrapped up a few years before the decision in the Young case but, after the IRS victory in Young no one went back to the proposed legislation to remove the change to subpart (ii). Now we will find out if the bankruptcy court’s seemingly logical interpretation of the statutory change effectively overrules Young and limits the IRS to the new statutory provision.

The reason for tolling the time period still exists when the IRS relies on subpart (i) to achieve priority status. The tax clinic at Harvard has some experience with arguing equitable tolling. We will be thinking about filing an amicus brief on behalf of the IRS. Given our track record on this issue, it would be the kiss of death.