About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Latest Round in PTIN Litigation With District Court Finding For Government In Steele v US

Longtime readers may recall a series of blog posts discussing the class action litigation challenging the IRS’s statutory authority to charge a fee for PTIN issuance and renewal. After an initial plaintiff victory in district court, the DC Circuit Court of Appeals held that the IRS was within its authority to charge the PTIN fees but remanded the case to determine whether the amount charged was excessive. For more on the DC Circuit opinion, as well as prior rounds in the skirmish, see In Major Victory for IRS DC Circuit Upholds IRS Annual Filing Program.

Late last month in the latest round in Steele v US the district court issued an order on discovery issues. The order includes some strong language about both parties, but the order reflects a decisive government win though the case awaits a resolution on the merits.

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The latest issue concerns the plaintiffs’ motion to compel discovery about the creation and implementation of the original PTIN program. The government alleged that some of the requested information was protected by the deliberative process privilege. In addition, the court considered the sufficiency of government’s responses to interrogatories.

As to deliberative process, as the opinion describes, that privilege protects from discovery “advisory opinions, recommendations and deliberations comprising part of a process by which governmental decisions and policies are formulated.” To benefit from it, the party asserting the privilege must demonstrate that the information is predecisional and deliberative.

The opinion nicely summarizes DC Circuit law on the substance and means for the government to assert deliberative process. It requires proof that the requested document was part of assisting an agency decisionmaker in making the decision, rather than supporting a decision that was already made.

In addition, case law provides the following three elements to benefit from the privilege:

  • A formal claim of privilege by the head of the department possessing control over the requested information,
  • An assertion of the privilege based on actual personal consideration by that official, and
  • Details regarding the information for which the privilege is claimed, along with an explanation why it properly falls within the scope of the privilege.

The major issue that the plaintiffs raised with respect to the government’s assertion of deliberative process was that the government failed to assert the privilege with sufficient detail, instead relying on “boilerplate descriptions” of the withheld documents. The remedy that the plaintiffs sought was discovery of every document withheld solely under the deliberative process privilege.

In strong language, the court disagreed. Calling the proposed remedy “incredible” the court criticized the motion for failing to evaluate the documents and asserted privilege on their own terms:

Plaintiffs’ compact motion shuns individual analysis of the documents in question, instead taking a blanket approach where one bad privilege log entry spoils the bunch.

The order also held that it was  “insincere of plaintiffs to argue that the government has failed to meet its burden in asserting the privilege for every privilege log entry” given that the given the declaration by the IRS’s Deputy Associate Chief Counsel that provided “details why twenty-six of the log entries were withheld.”

The order also included snippets of the government’s privilege log, which in its view also provided sufficient description beyond boilerplate. Some of the included details identified the contractor working with the IRS in setting up the PTIN program, the date, the topic, and who in the government was the intended recipient.  While some of the government’s language was repetitive, the order found that the government met its burden in establishing the elements for the privilege.

While there may have been a question as to whether the government was entitled to rely on deliberative process with specific documents the plaintiffs’ failure to drill down individually was fatal:

Because plaintiffs did not produce “a set of objections that identifies each log entry” that they challenge and because this Court cannot agree that each log entry is insufficient—especially given Goldman’s accompanying declaration—plaintiffs are essentially asking this Court to engage in an entry-by-entry analysis of the privilege log to evaluate whether the government has fulfilled its burden.

The second category of information in this discovery dispute related to interrogatories about the amount of time that IRS employees spent on PTIN-related tasks.  The government argued that the requests were irrelevant and in any event asked for information that the government did not in fact have. As to relevance, information about time spent could be helpful in establishing that the original fees in the PTIN program were excessive, and the court found that the low relevance bar was easily met. 

Unfortunately for the plaintiffs, however, the government prevailed on this challenge. As the order described, the plaintiffs were not really looking for an order forcing a response, but were in fact looking for an order requiring a “different response.”

The government has already provided plaintiffs with numerous declarations from various employees regarding staffing and PTIN work, including some time allocation breakdowns.  However, not all employees kept contemporaneous time records. The government contends that if the information sought by plaintiffs is not included in those materials already provided, it does not exist. 

The court chided the government, stating it “should have stated the nonexistence of this information more clearly in their actual interrogatory answers, instead of in their response to plaintiffs’ letter alleging deficiencies.” Despite that deficiency, the court declined to compel any additional responses, and agreed that “forcing employees and former employees to produce a detailed record of time spent on PTIN tasks over the last ten years based on memory alone is absurd.”

Conclusion

With this round over for now, the case slowly marches towards a resolution, though perhaps other more targeted discovery challenges await. In the meantime, a couple of years ago IRS reworked the PTIN user fees (see IRS Announces New PTIN User Fee in Proposed Regulations), with the fee now at $35.95 for initial applications and renewals. 

No Reasonable Cause For Failing To Include $238,000 From Information Return Sent To Old Address

Back in 2013, I wrote about Andersen v Comm’r, a summary opinion where a taxpayer failed to include $28,000 of W-2 income but was not subject to a 20% civil penalty for substantially understating income. In Andersen, the Tax Court held that there was reasonable cause for the omission and the taxpayer acted in good faith.

These types of cases are notoriously fact intensive. Whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis. Courts, based on the regulations, examine the pertinent facts and circumstances, including the taxpayer’s knowledge, education, and experience, as well as the taxpayer’s reliance on professional advice.

In Andersen, the taxpayers were sympathetic, with a long history of tax compliance, a consistent recordkeeping practice, and a longtime competent tax preparer. The preparer testified about why he reasonably believed that his clients had retired and would not have had wage income. In finding that the taxpayers had established reasonable cause and good faith, the Tax Court acknowledged that it was an “exceptionally close case” but held that no penalties applied.

Contrast Andersen with last week’s LaRochelle v. Commissioner, another summary opinion involving a failure to include income reported on an information return.

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The facts in LaRochelle were not nearly as sympathetic as Andersen. The amount at issue was $238,000 from an IRA distribution in 2017. In 2016, the taxpayers had moved from DC to Florida but still owned a DC residence. They set up US Postal Service mail forwarding. They recalled receiving the $238,000 IRA distribution but not the 1099-R, which had been sent to their DC address.

The husband was sophisticated; he was “professionally engaged in more than ten business partnerships”, including one where he was in charge of day to day operations, including recordkeeping.  The taxpayers used a tax return preparer ( I assume a lawyer, though not clear from the opinion), who also represented the taxpayers in Tax Court (uh oh, see below).

The opinion itself is fairly straightforward. After discussing why the substantial understatement penalty is “determined by an IRS computer program without human review” and “automatically calculated through electronic means” it held that under Tax Court precedent it is exempt from the Section 6751 written supervisory approval requirement (for a different view on that, see Caleb’s discussion in Walquist Harms The Poor: Revisiting Supervisory Approval For Accuracy Penalties.)

The summary opinion also concludes that the taxpayers had not established that they were entitled to a reasonable cause good/faith defense. Failure to receive an information return is not enough to insulate a taxpayer from a penalty, especially when, as here, the taxpayer admits to recalling having received the money, especially a lot of money.

The taxpayers also argued that their use of a preparer justified excusing the penalty. The use of a preparer alone is not enough to establish that the taxpayers’ reliance amounted to good faith/reasonable cause:

Mr. LaRochelle did not explain what was meant by petitioners’ relying upon Mr. Lander to handle their tax return

Moreover, as the opinion notes, a failure to provide necessary information is fatal to a good faith/reasonable cause defense predicated on reliance on a competent tax return professional.

Concluding Thoughts

Tax Court Rule 24(g)(2)(A) generally provides that “[c]ounsel may not represent a party at trial if the counsel is likely to be a necessary witness within the meaning of the ABA Model Rules of Professional Conduct.” The opinion notes that Judge Leyden apprised the parties of the rule, and that the taxpayers stated that their preparer was not likely to be a necessary witness.  While it would not have mattered in this case had the preparer testified, it is almost always a bad idea, and a conflict of interest, to have the taxpayers’ return preparer represent the taxpayer at trial.

For taxpayers with numerous information returns, it would be prudent to set up an online account with IRS. On extension, the preparer and taxpayer can easily access all of the information returns, even those that a taxpayer may not have physically received.

Of course, all of this nonsense could be avoided if the IRS provided taxpayers with a government sourced online filing platform that could access information that the IRS has received from third parties. That day may be coming, as I discussed this past May in Momentum Possibly Building for IRS To Provide Online Filing Options For Taxpayers, but for now we have a back end process where a taxpayer who omits an item has to go through a post filing automated underreporter program and possible disputes as to whether there is enough justification to avoid a penalty. Sad.

Hat tip on this case to Ed Zollars, whose post in Current Federal Tax Developments alerted me to this case. Ed’s work is terrific, and I recommend readers subscribe. As Ed notes, many taxpayers mistakenly believe that the hiring of a preparer means that taxpayers can avoid responsibility.

Ed notes the responsibility that preparers have to correct clients about that misperception:

But tax professionals need to be aware of this belief on the part of their clients that merely hiring the professional and dropping off the documents they decided were relevant means the return they get back will contain no errors. It is important to remind clients that it is their responsibility to provide all relevant information for their return and to make use of tools the professional may provide…

Circuit Court Holds That LLC Distinct From Its Agent For Purposes of Criminal Referral Exception To Summons Power

In Equity Investment Associates v US the 4th Circuit considered the limits of the IRS summons power when there is a criminal investigation that relates to but does not directly involve a business entity. The case involved an LLC that donated a conservation easement. The IRS was examining the LLC while there were simultaneous criminal investigations of the LLC’s accountants/tax return preparers and other alleged co-conspirators.

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Under Section 7602(d), the IRS is barred from issuing a summons “with respect to any person if a Justice Department [criminal] referral is in effect with respect to such person.”

Under the BBA partnership audit procedures, Jack Fisher was Equity’s partnership representative. Equity was 80% owned by Southeast Property. In turn, Southeast Property was controlled by its managing member, Inland Capital Management, which Fisher managed.

The IRS issued a summons to Equity’s bank. IRS gave notice of the summons to Equity, which sought to quash that summons, arguing that a Justice Department criminal referral was already in effect for Equity or one of its agents (Fisher). In opposing the motion to quash and requesting that the court order enforcement of the summons, the DOJ submitted a declaration from an IRS Supervisory Special Agent who attested that there was no criminal referral for Equity. 

Equity’s tax return preparers had previously pleaded guilty to conspiring to defraud the United States for selling, along with co-conspirators, “investments” in fraudulent syndicated conservation-easement tax shelters. The government was also conducting a criminal investigation of Fisher, who was subsequently indicted for crimes related to the fraudulent syndicated easement scheme.

Does The Criminal Investigation and Prior Referral of Equity’s Agent Serve to Bar A Summons on Equity?

Equity’s argument was premised on using the definition of person in Section 7343, which states that for purposes of chapter 75 of the IRC, a person “includes an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.” Chapter 75 deals with crimes, offenses and forfeitures (Section 7201 through 7345).

Unfortunately for Equity, the prohibition on IRS summons power when a criminal referral is in place is in Section 7602, and that Code section is within Chapter 78, which deals with civil examinations and encompasses Section 7601 through Section 7655. There is no specific definition of person either in Section 7602 or Chapter 78.

In the absence of a specific definition, the general Code definitional provisions in Section 7701 apply:

Section 7701(a)(1) states that “[w]hen used in [Title 26], where not otherwise distinctly expressed or manifestly incompatible with the intent thereof . . . [t]he term ‘person’ shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation.” § 7701(a)(1). That definition does not consider members, officers, or employees of a business entity to be a part of the same “person” as the business entity itself. By omitting officers, members, and employees from the personhood of business entities in § 7701(a)(1) but including those same people in the definition it adopted for § 7343, Congress made an express decision that “person” for purposes of § 7602 only means the business entity itself.

Equity also argued that even if Section 7701 applied, its definition is non-exclusive in the list of entities that count as a person. As such it asked the court to find that the “statute’s specific reference to only the business entities themselves is thus not exclusive because agents of a business entity are “otherwise within the meaning” of the term “person.”

The court disagreed, finding that person is “not naturally read to suggest both a business entity and its officers, members, and employees.”

And for the final nail in the coffin, the opinion considered how the general summons power in Section 7602(a) refers to entities and their agents in a manner reflecting their distinct status:

Indeed, § 7602‘s text shows that the statute considers business entities as distinct persons from their agents. Under § 7602(a)(2) “the Secretary is authorized . . . [t]o summon the person liable for tax or required to perform the act, or any officer or employee of such person.” If “person” already included the officers and employees of a business entity, there would have been no reason for Congress to have provided for “any officer or employee of such person” in § 7602(a)(2), and Equity’s preferred definition as applied to § 7602(a)(2) would create surplusage.

Was There a Referral For Equity?

The opinion also considered the district court’s denial of an evidentiary hearing concerning whether there was a Justice Department referral addressing Equity as an entity. As the opinion notes, a referral is not a generalized suspicion of criminal activity. It occurs only when (1) the IRS recommends a person to the Attorney General for prosecution or (2) the Justice Department requests a taxpayer’s information from the IRS.

Absent Equity introducing evidence that reflected an actual referral to the Justice Department with respect to Equity, the court declined to remand for an evidentiary hearing. The opinion sweeps in the Clarke standard for when in a summons challenge a district court should allow a hearing:

Equity’s other evidence only suggests that the government believed that Equity had committed a crime. However, suspicion and even criminal investigation does not prevent the IRS from issuing a summons. The IRS can continue to avail itself of the summons power until it crosses the “bright line” of making a Justice Department referral. See Morgan, 761 F.2d at 1012. It is evidence of “specific facts or circumstances” suggesting a Justice Department referral, not generalized suspicion, that Equity must rely on to meet its burden. See Clarke, 573 U.S. at 249.

Conclusion

Our blogging colleague Jack Townsend also discusses the opinion here. As Jack notes, this case reflects fairly straightforward holdings. As usual, Jack makes interesting observations, and for readers with a deeper interest I recommend a read.

Equity Investment Associates is generally consistent with other caselaw reflecting that an entity is distinct from the owners for summons purposes, an issue that may arise when an individual may have or wish to assert a privilege even though a summons is directed to a business entity. It is also yet another case reflecting the IRS focus on conservation easement and inflated charitable deductions. The opinion also discusses in a straightforward way how the use of an an entity treated as a partnership for tax purposes makes the easement donation scheme available to others by passing the corresponding deduction through to its members, thus spreading the claimed tax benefit to investors.  

APA Provides No Basis To Compel IRS To Provide Access To Appeals

Add Rocky Branch Timberlands v US to the list of interesting cases invoking the APA to challenge IRS actions.  As the case shows, the APA can be a taxpayer’s friend, but it is does not provide the means to get a court to second guess what the court believes are decisions that are solely committed to the agency’s discretion.

The case involves yet another audit of taxpayers claiming conservation easement deductions. The taxpayers, subject to the not quite dead TEFRA partnership audit procedures, initially refused to extend the SOL on assessment. With the three-year period coming close, the IRS issued a Notice of Final Partnership Administrative Adjustment (FPAA). The taxpayers changed their mind about the extension, and sent a signed 872-P extension form to the audit team and sought review before Appeals. IRS declined to sign the 872-P and refused to revoke its FPAA. The taxpayers sued, asking the court to order the IRS (1) to rescind the FPAA and (2) to sign the Form 872-P that would extend the time to assess, all with the hope of getting before Appeals and not having to take the case to Tax Court.

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The government filed a motion to dismiss for lack of jurisdiction.

The court quickly found in favor of the government. As to the taxpayer’s request to rescind the FPAA, the court noted that the Anti Inunction Act prevented the court from ordering an injunction that would restrain assessment.  The Supreme Court has carved an exception to the AIA when there is no adequate remedy and the plaintiff shows that the government could not prevail. Here, the opinion notes that the FPAA did in fact trigger a separate remedy: the chance to challenge the denial in Tax Court, one in which the taxpayer through the tax matters partner had in fact done.

As to the demand that IRS sign the extension/Form 872-P, the court looked to the APA, noting that while it waives sovereign immunity there is no basis for a court to gain jurisdiction if the decision is committed solely to the agency’s discretion. In addition, there is no jurisdiction if the agency decision is not final. Both of these exceptions have a fair bit of nuance described in Saltzman and Book, IRS Practice & Procedure in our soon to be revised but still really good discussion of the APA.

But there was not much nuance presented here. As to not being final agency action:

The IRS’s decision not to sign the Form 872-P, and thereby decline to extend the statutory period, was not a final agency action within the meaning of [5 U.S.C] § 704.  Rather, it was an intermediary and procedural step leading up to the issuance of the FPAA and did not alter Plaintiffs’ rights or obligations.  The IRS’s decision not to sign the Form 872-P did not alter the limitations period.

As to discretion, the court similarly dismissed the taxpayer’s argument:

The IRS’s decision not to extend the statutory period was also discretionary.  Plaintiffs identify no requirement that the IRS agree to an extension, and the Court is aware of none.  To the contrary, the law provides the statutory period may be extended only upon agreement by the taxpayer and the IRS.  See 26 U.S.C. § 6501(c)(4); Feldman v. Comm’r, 20 F.3d 1128, 1132 (11th Cir. 1994).  This provision clearly provides the IRS discretion—co-equal to a taxpayer’s discretion—as to whether it will extend the statutory period.  It is strange that Plaintiffs would deny the IRS the same discretion is previously exercised in the very same review. 

A somewhat more interesting issue involved the taxpayer’s argument that the court should give some teeth to IRC 7803(e)(4), which as part of the Taxpayer First Act provides that review by Appeals (renamed Independent Office of Appeals) “shall be generally available to all taxpayers.”

As the taxpayer had sought access to Appeals prior to the issuance of the FPAA, the opinion noted that the request was moot in light of its decision to find that the AIA precluded the IRS from rescinding the FPAA. For good measure, the opinion stated that the APA would not help, as the discretion to decline to provide access to Appeals was solely vested in IRS. In finding that this was committed to the agency’s sole discretion, the court accepted the government’s analogy settlement power generally, as it is settled law that an agency’s decision to settle (or not) is solely a matter for agencies to determine.  

The opinion also concluded that the point in time that the taxpayers sought relief in the form of Appeals consideration, prior to the issuance of the FPAA, was merely an interim step in the agency process, and thus not final agency action.

Conclusion

The taxpayers have challenged the IRS’s denial of their deduction in Tax Court, so it is not as if they are without recourse to independent review on the merits. And the taxpayers’ initial refusal to sign the extension contributed to their problems. Add to the mix that there is not a lot of sympathy around those claiming easement deductions.

Yet, access to Appeals is a fundamental part of tax administration and embedded in the Taxpayer Bill of Rights. The language in this opinion, as well as other cases we have blogged about (including the Facebook case I discussed here)have held that access to Appeals is something that IRS can allow, or not allow, for essentially any reason. The TFA provides protections for taxpayers denied access to Appeals following the issuance of a stat notice.  Prior to that time, IRS controls the process, and the APA will likely not help.

IRC Levy Exemption for Disability Payments Ends Once Funds Hit Bank Account

The IRS’s levy powers are broad but not unlimited. One of the categories of payments that is protected from levy is disability payments relating to military service. The IRS has consistently argued that if a veteran receives disability payments and those funds comprise some or all of the money in a bank account, an IRS levy can reach those funds, unless the taxpayer can establish some other exemption.

Last year in Death and Taxes Keith discussed how “generally, the IRS takes the position that money in a bank account is fair game for its levy no matter what source, protected from levy or not, generated the funds in the bank account.” In his post Keith discussed that despite that general rule IRS decided to take an administrative pass on levying funds in a bank account if the funds in the account include money received by the taxpayers as COVID-19 Funeral Assistance funds provided by FEMA. A while back I discussed a 10th Circuit case that hinted at perhaps a disagreement with the IRS view that it could in fact levy on a veteran’s disability payments once they hit the account.

Earlier this month the Fifth Circuit in US v Charpia had occasion to revisit the issue of tracing, in a slightly different procedural path than typical cases we discuss.

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Charpia had pled guilty to defrauding the Government.  Part of the sentencing included restitution of over $900,000. The district court issued an order of garnishment and Charpia appealed the garnishment order, claiming statutory exemptions for certain funds in her bank account.  Charpia’s bank account had about $65,000 due to a lump sum disability payment that related to her military service.

This all implicated Section 6334(a)(10) because the Mandatory Victims Restitution Act cross-references the IRC exemption for service related disability payments.

As I discussed a while back in Tenth Circuit Raises Possible Defense to IRS Levying Bank Account with Veteran’s Disability Payments Section 6334(a)(10) prevents levy on “any amount payable to an individual” relating to military disability payments. (Note that the same language exempts unemployment compensation and workers compensation). The Fifth Circuit noted that there is not a lot of caselaw on the meaning of “amount payable” but in finding for the government it distinguished other exemptions that extend more broadly to amounts “payable to or received by” an individual, such as the 6334(a)(9) exemption for wages. Moreover the Charpia opinion noted that the few cases that interpreted the (a)(10) exemption looked to a plain Black’s Law meaning of the term payable, which is an amount “[c]apable of being paid” or “suitable to be paid” rather than funds that had been paid and were sitting in an account.

Conclusion 

It was not a complete loss for Charpia, however. As an alternate argument, she leaned on the Consumer Credit Protection Act (CCPA), which provides a 25% cap on “aggregate disposable earnings of an individual for any workweek which is subjected to garnishment.”

The court held that the only reason why Charpia did not receive her disability payments periodically was because the government initially denied her request and she received a lump sum payment to make up for payments that “otherwise would have been paid periodically. ” As such, the court held that the partial exemption under the CCPA applied, and the government was only entitled to seize 25% of the funds in her account. 

While this was a partial victory for Charpia, it has limited use for traditional tax cases. The CCPA would not apply to a matter where the IRS were seeking to levy on the account, rather than the government seeking to collect under the Mandatory Victims Restitution Act,  because IRC 6334(c) provides that notwithstanding any other law, the only exemptions on the IRS’s levy power are found in IRC 6334(a)

Update on CIC Services And More On The Legislative vs Interpretive Rule Difference

This is an update on the CIC Services litigation. Following the March 2022 decision where a federal district court granted CIC’s motion for summary judgment and vacated the IRS Notice, the government filed a motion for reconsideration. It did not challenge the underlying merits determination that the IRS violated the APA by issuing the Notice without notice and comment. Nor did it challenge the court’s order to set aside the Notice. Instead, it challenged the court’s decision to order the IRS to return documents and information furnished to the IRS by nonparties pursuant to the Notice.

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The court granted the motion and last week issued a revised order that retracted its mandate that the IRS return the nonparty documents. It did so because CIC’s lawsuit was not brought on behalf of nonparties and was not a class action lawsuit:

Despite possessing a procedural device to assert claims and request injunctive relief on behalf of similarly-situated nonparties, CIC did not do so. As a result, while nonparty taxpayers and material advisors necessarily benefit from CIC successfully demonstrating that the Notice must be set aside and are no longer be required to produce documents and information pursuant to the Notice, CIC does not have any basis to seek affirmative injunctive relief requiring the IRS to return documents to nonparty taxpayers and material advisors.

Despite finding that the court originally overstepped its authority when it ordered the IRS to return what it had received pursuant to the invalidated notice, the court still could not resist taking shots at the IRS for what it perceived as the IRS’s unjust enrichment from issuing a notice that was procedurally invalid:

To be sure, this determination operates as a windfall to the IRS in that it allows the IRS to retain documents and information it was not entitled to collect from nonparty taxpayers and material advisors. If this were simply a matter of determining an equitable result, the IRS would have to return all documents and information produced pursuant to the Notice, especially considering the Sixth Circuit’s observations [ed: citing the circuit in the CIC case] that the IRS has a history of APA noncompliance.

A Different Take On Whether The IRS Was Required to Use Notice And Comment Procedures

One final point addressing whether a reg or IRB guidance requires notice and comment under the APA. I commend readers to a contrarian discussion from Jack Cummings, who, in a letter to Tax Notes [$], and in related work that he and Jack Townsend have separately undertaken (see, e.g., Townsend, The Report of the Death of the Interpretive Regulation Is an Exaggeration for a deep dive into the issue), argue that courts and many current academic takes are off the mark.  In Cummings’ letter to Tax Notes, he disagrees with the Sixth Circuit in Mann (and other courts) that held that a reg or IRB guidance is deemed legislative and thus requires notice and comment under the APA because not complying with the rule might lead to a penalty or higher taxes. This, to Cummings, proves too much:

But to begin, instead, with the fact that the person owed tax or penalty as a result of the rule, could make every tax rule legislative. Each tax rule has some negative effect on taxpayers.

Under the APA, agency rulemaking is not required to be issued using the notice and comment procedures if the rule is interpretative (or sometimes referred to as interpretive). For decades, IRS, Treasury, and practitioners have thought that most guidance Treasury or IRS issues pursuant to its general rulemaking authority under Section 7805(a) was not required to be issued using notice and comment procedures under 5 USC § 553(b). That historical view was the consensus at the time of the passage of the APA in the mid-20th century.

What constitutes an interpretative rule? Cummings argues that the inquiry should focus more on the statute that triggered the IRS guidance as compared to the possibility of penalties if one chooses not to comply. In Mann and CIC Services, that takes us to Section 6707A and its trigger for reporting on transactions that have a potential for tax avoidance or evasion.

From Cummings’ letter:

It’s reasonable to interpret section 6707A to mean that Congress understood the section’s standard as too vague for taxpayers to enforce on their own. So Congress gave the IRS discretion to select among more or less abusive transactions the ones that should be reported. That’s a grant of legislative rulemaking authority.

In contrast, if the statutory language were capable of interpretation off a starting point that was not hopelessly vague, Cummings would have held that the rule was interpretative (and not required to be issued with notice and comment).

More from Cummings:

If the statute says, in effect, “We’re unsure what the rule should be, so you write it,” then the rule is legislative. If the statute says, for example, that a taxpayer can deduct ordinary and necessary business expenses, and then the agency wrote a regulation stating its views on those words, those views would normally be considered to be interpretive.

So, while Cummings’ approach would not have led to a different conclusion in CIC Services (or Mann), it leads to finding the rule legislative on a different rationale. It would matter a lot in other cases when courts and the agency have to determine whether IRS is required to use notice and comment, and the rule has a statutory starting point capable of agency interpretation.

With colleagues Rochelle Hodes and Greg Armstrong, we are in the process of revising the considerable APA content in an extensive rewrite of Chapters 1 and 3 of Saltzman and Book, IRS Practice and Procedure (the first part of the rewrite on subregulatory guidance will be released this summer). This issue, among many others, will generate heavy discussion, as the relevance of administrative law principles in tax cases continues to become one of the key issues in tax procedure and tax administration.

Court Awards Damages When IRS Tried To Collect Following Discharge: Pandemic No Excuse

McAuliffe v United States involves IRS mistakenly sending collection letters following a bankruptcy discharge. Following bankruptcy, IRS opens itself up to damages claims if an IRS employee willfully violates the effect of a discharge or an automatic stay.

McAuliffe concludes that the pandemic does not excuse the IRS from failing to update its records; nor does the automatic nature of the collection process, which arguably severed the actions from any one misbehaving IRS employee. While the opinion finds the IRS actions willful, it notes that unlike with other misbehaving private creditors who fail to respect a discharge, the court has little discretion over the amount of damages it can award.

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In McAuliffe the husband and wife were co-debtors in a Chapter 13 case they filed in 2016. The IRS asserted a claim for $13,624.58 relating to tax years 2010 and 2011, of which $7,230.78 was secured. Prior to the bankruptcy, the taxpayers had entered into an installment agreement, but as per the Chapter 13 case, they terminated the agreement and paid the debts through their repayment plan. The taxpayers/debtors received a discharge on September 24, 2019. As an unsecured creditor, the IRS received a 22% distribution on the $6,393.80 unsecured portion of the claim.

Things went awry after the discharge. On February 5 and March 4, 2020, the IRS sent the McAuliffes two demand letters seeking to collect the liabilities from the discharged 2010 and 2011 tax years. On March 20, 2020, Mr. McAuliffe, a bankruptcy attorney, sent the IRS a letter addressed to the IRS’s Cincinnati Service Center advising the IRS of the discharge. On August 15, 2020, the McAuliffes received another IRS collection letter, leading to their filing a motion to reopen the bankruptcy case.

The IRS did eventually acknowledge McAuliffe’s March 2020 letter, with a September 29, 2020 letter stating it would need sixty days to review the liability. Despite the letter stating that IRS needed to review the account, on September 28, 2020, IRS actually abated the assessment.

In addition to the liabilities that were covered by the discharge, the McAuliffes also owed on their 2018 tax year. The taxpayers asserted that the IRS’s mistaken belief that the McAuliffes still owed for the discharged years led to a delay in setting up an installment agreement for the 2018 liability, which led the IRS to issue a soft notice of intent to levy, threatening to seize state tax refunds.

What led to the delay in updating its account to reflect the discharge and the six-month delay in responding to McAuliffe’s March 2020 letter? IRS blamed the combination of COVID and McAuliffe sending the correspondence to the Cincinnati Service Center rather than a bankruptcy specialist.

All of this factual background leads to the main issues in the case: whether the IRS is liable for damages and if so, how much?

Is IRS Liable for Damages?

In light of the IRS actions, the debtors reopened the bankruptcy case, and sought damages under Section 7433(e) for the IRS’s mistakes. That case was stayed pending a possible administrative resolution. The IRS and the McAuliffes failed to resolve the matter within six months, teeing the matter up for the bankruptcy court.

To find a violation of 7433(e) a debtor must show by clear and convincing evidence that the IRS “had knowledge [actual or constructive] of the discharge and willfully violated it by continuing with the activity complained of.”  IRS raised a number of arguments in support of its position that the actions were not willful.

First, IRS argued that the court needed to find that a specific employee willfully violated the discharge order, rather than the entity as a whole.  Moreover, IRS, in arguing that there was no willful violation, cited to cases where courts concluded that clerical errors alone were insufficient to justify finding damages:

The IRS’s attempts to characterize the actions here as “inadvertent” in light of these cases is unpersuasive. While the IRS here failed for nearly twelve months to enter the discharge in its systems, the debtors on their own behalf called and mailed multiple notices to correct the issue. The IRS instead disregarded these warnings and continued direct attempts to collect the discharged debts.

The opinion also rejected the IRS’s attempt to deflect blame by pointing to the taxpayer’s failure to contact an IRS bankruptcy specialist rather than the IRS office that issued the collection letters:

It contravenes common sense to require a debtor who receives a notice from Cincinnati to direct a response to a Richmond office involved in the bankruptcy claim filed four years prior rather than responding directly to the office from which he received the communications.

The IRS then argued that its automatic collection notices should not be viewed as collection action, a contention the court rejected:

The IRS contends that these letters were non-threatening and should not be seen as an attempt to collect. This court disagrees. The letters state a monthly payment due immediately and threaten default if no payment is made. Further, none of the letters included a disclaimer that they are not an attempt to collect. This surely gives the appearance of an attempt to collect, whether sent to a layperson or a well-experienced bankruptcy attorney and his spouse. The court agrees with the Plaintiff that these letters serve no purpose other than to collect discharged personal liabilities.

IRS also argued that the automatic nature of the notices removed them from any one IRS employee, and thus should insulate the agency from sanctions designed to punish the agency for its employee’s misconduct:

The IRS is a federal agency within the executive branch and serves an extremely important mission. If employees and automated systems in the Cincinnati office are disconnected from the interactions of other offices, the resulting shortcomings should not be attributed to the affected Plaintiff, but to the agency responsible.

As to COVID, the court was sympathetic, but noted that there was plenty of time following the discharge and before the pandemic hit for IRS to get the taxpayers’ account fixed:

While COVID-19 is having a significant impact on all levels of the federal government, it does not excuse repeated attempts to collect on a Plaintiff doing everything possible to correct any miscommunications. At the time when the serious impacts of the COVID-19 pandemic reached the United States in March 2020, the Plaintiff was nearly six months post-discharge and the IRS still had not properly applied the discharge order to the couple’s federal tax accounts. Further, the IRS had already mailed the first two automated notices.

While perhaps one mistaken notice might not have led to a finding of liability, the repeated notices that lasted almost a year after discharge, combined with multiple taxpayer attempts to halt the collection action, led the court to conclude that the IRS’s actions were willful.

What Damages?

McAuliffe sought court costs and legal fees and damages relating to the unlawful collection attempts. The court noted that Section 7433 is the exclusive remedy for IRS failure to respect a discharge order, unlike that for other creditors, where the bankruptcy code provides more discretion. Under 7433(e), courts generally look to actual pecuniary damages, plus costs and possibly legal fees, but the awarding of fees under Section 7433 is controlled by Section 7430. (Note that Saltzman and Book, IRS Practice & Procedure, courtesy of Keith, has an extensive discussion of damages relating to wrongful collection).

As to legal fees, Mr. McAuliffe represented his wife in the proceeding, and did not charge her for the representation. He had previously been a party to the reopened bankruptcy case, but as the opinion notes, he dismissed himself as a party on the eve of the evidentiary hearing. He likely did so due to McPherson v US, unfavorable Fourth Circuit precedent under Section 7430, which bars recovery of legal fees for pro se litigants.

Instead, Mr. McAuliffe argued that he should be compensated because after his dismissal his representation of his wife resulted in lost business opportunities due to the time spent representing his wife. He also sought to distinguish the precedent that barred recovery from pro se litigants because following his dismissal he was technically no longer a pro se litigant.

The court found the lost opportunity argument too speculative, and in so doing noted that unlike cases more liberally awarding of fees purely under the bankruptcy code, its hands were tied:

The court realizes the annoyance and outright inconvenience that the Plaintiff and her husband may have suffered as a result of the IRS’s disregard for the discharge order (whether intentional or inadvertent), but any discretion which it would otherwise be afforded by the Bankruptcy Code is severely limited by relevant Tax Code provisions herein referenced.

As to his attempt to distinguish the adverse legal fee precedent, the court did not bite:

Put simply, McPherson is binding precedent in this circuit. While McAuliffe argues that the opinion applies only where an attorney seeks compensation for pro se representation, this conflation is misplaced. This court does not read the statute to apply solely to pro se representation, but applies it more broadly to the situation where the challenger seeks recovery of legal fees and no out of pocket legal expenses are incurred. Assuming for purposes of this analysis that the IRS’s position was not substantially justified, the Plaintiff nevertheless did not pay any out-of-pocket costs which would allow recovery of legal fees under 26 U.S.C. § 7430 and the precedent established in this circuit by McPherson.

As to other damages, McAuliffe argued that they felt pressure from the IRS’s issuance of notice of intent to levy relating to another year’s tax liability, leading them to accept the first offer on the sale of their house for an amount $15,000 less than its market value. The sale of the house occurred in 2021, a year after the IRS abated the assessment and unwound its mistaken failure to reflect the discharge. While it is likely that the IRS errors on the discharged debt may have led to a delay in a later year installment agreement, “the home sale a full year after the abatement is too distant in time and nature to attribute any possible damages to the discharge violation.”

The court did award the McAuliffe’s damages relating to interest and delinquency penalties on their 2018 liability. Despite 2018 not being before the court, the opinion notes that the mistake to respect the discharge of 2010 and 2011 liabilities led the IRS to be “uncooperative with the couple and unwilling to enter into any such agreement until approximately nineteen months after the original request was made. For eight months beyond the initial request (and more than a year past the discharge order) this uncooperativeness was attributable, in part or in whole, to the mistaken belief that the debtors still owed debts from 2010 and 2011.”

IRS argued that he 2018 debt was outside the court’s jurisdiction and subject to the Anti-Injunction Act.  The court disagreed, noting that it was not restraining the assessment or collection of the 2018 liability but finding that “any interest and missed payment penalties accrued from the initial March 2020 notice letter until the IRS’ eventual acceptance of the couple’s settlement offer are actual pecuniary damages that resulted from the IRS’s violation of the discharge order.”  The delay, according to the court, resulted in about an additional $500 in interest and delinquency penalties, which the court awarded to McAuliffe.

Conclusion

The McAuliffe opinion is interesting on a number of levels. The opinion discounts the government’s excuses for its mistakes. The court expects the multiple IRS offices involved with the case to communicate with each other. The court squarely rejects the IRS attempt to lean on the automated nature of the collection process to avoid liability, and it holds the IRS responsible for its delay when the taxpayers tried in good faith to inform the IRS that its actions were mistaken. While COVID complicates the question of fault, there were enough IRS mistakes prior to the pandemic to justify a finding of liability.

At the end of the day, McAuliffe walked away with not much in damages, and I suspect that case was brought mostly for the denied recovery of legal fees. While maybe it will not make the McAuliffes content, the opinion reflects judicial disapproval of the IRS and a shared frustration that the IRS should have done better.

Taxpayer Attending Rodeo Misses Receiving Collection Letter And Denied Chance to Challenge Liability in CDP Case

Hammock v Commissioner is a relatively straightforward Tax Court CDP bench opinion involving the assessment of responsible person penalties under Section 6672. The case makes its way to Tax Court because the taxpayer attempted to challenge the sizable underlying liability. Appeals, and then Tax Court, refused to allow the challenge because she neglected to file a timely administrative appeal following notice of a proposed assessment. This brief blog post considers Appeals refusal to exercise its inherent discretion to consider the underlying liability.

In Hammock, the facts are somewhat sympathetic. The bench opinion discusses how the taxpayers’ parents had founded and run a successful auto parts business that had over 35 employees. The taxpayer witnessed her parents’ death in an automobile accident, which resulted in her unexpectedly assuming her mother’s formal role as treasurer and finding someone to replace her father’s job in running the business.

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To run the day to day auto parts business Hammock turned to a family friend who had been involved before the parents’ death and became more so after their passing. Hammock also hired a formal CFO to assume some of the responsibilities that her parents previously performed. Hammock herself seems to have been largely absent, though she drew a salary and signed the occasional check.

It seems that the family friend used the business as a personal piggy bank, and what was once a very successful enterprise ran up hundreds of thousands of dollars in delinquent employment taxes, leading to its eventual bankruptcy.

With the employment tax delinquency came an IRS investigation into trust fund liabilities. After some communication from IRS, Hammock hired a tax attorney; he was the same attorney who was representing the CFO, who IRS was also investigating as a potentially responsible person.

Here is where things get dicey for Hammock. Unfortunately, the POA that counsel submitted did not specify the year or tax at issue. The IRS had the same POA problem with the CFO’s POA. IRS returned them both. Hammock and the CFO’s attorney submitted a new one that specified the tax and periods. Unfortunately the POA counsel resubmitted for Hammock did not have her signature; in contrast, the POA for the CFO was properly signed.

When IRS concluded its responsible person audit, it sent Form 1153 informing both Hammock and the CFO of its intent to assess a trust fund recovery penalty. That letter gives potential responsible persons 60 days to protest the proposed assessment. IRS sent the CFO’s proposed assessment to both him personally and to the attorney. Because the IRS never received Hammock’s perfected POA, it properly did not send her proposed assessment letter to her counsel, though did send it to her residence.

Hammock claimed to not have received the 1153 because she was out of town at a rodeo. All of this led to Hammock not filing a protest within 60 days. In contrast, the attorney did file a timely protest with respect to the CFO’s proposed assessment.

During a phone call counsel had with the RO concerning the CFO’s proposed assessment, the RO told the attorney that it had not received a perfected POA from Hammock and that it had in fact sent a 1153 to her. That led to the attorney’s submission of a belated perfected POA and a protest submitted after the 60 days had passed. Appeals declined to consider Hammock’s objections to the what became an assessment of over $579,000 in trust fund penalties.

The trust fund penalty assessment with respect to Hammock led to the IRS mailing her and her now properly authorized attorney a notice of federal tax lien and notice of intent to levy, triggering the CDP case.

Hammock’s attorney timely filed a request for a CDP hearing that only sought to consider the underlying trust fund liability and did not raise a request for a collection alternative.

For CDP purposes, unless there is actual receipt of the notice concerning the proposed assessment, the mailing of the notice to the last known address will not prevent a challenge to the underlying liability. If a person did not actually receive the notice allowing for an administrative appeal of the proposed assessment, they can challenge the amount or existence of the liability. (For more on when taxpayers can challenge the underlying liability, see Keith’s recent post discussing the issue, one we have covered quite often on PT).

Yet, as the opinion discusses, case law properly establishes that the absence of receiving a properly mailed notice does not automatically allow the right to challenge the amount or existence of a liability. To determine whether there is actual receipt when the IRS establishes that it has properly mailed the document, the cases consider whether there is enough evidence to overcome a presumption of receipt.

For these purposes, it is usually not enough to rely just on taxpayer testimony. Here, the opinion notes that Hammock claimed to be out of town attending a rodeo when the Form 1153 was delivered. She also testified that she had no recall of ever seeing it.  That testimony was contradicted by her counsel actually attaching the 1153 to the late-filed protest and an admission to Appeals at a supplemental hearing that she had in fact received the 1153.

The opinion helpfully contrasts Lepore v Comm’r, where a taxpayer was able to establish nonreceipt even when the IRS properly mailed a document to a taxpayer’s residence. In Lepore, there was testimony from a family member who did not live at the residence but said he received the document and did not give it to the taxpayer. Lepore had other positive facts, including a history of responding to IRS correspondence and proof of receiving a high volume of mail.

So Hammock was essentially out of luck in her efforts to automatically having the underlying liability as part of the CDP hearing. 

The opinion then focuses on the issue of ensuring that Appeals verified that the Commissioner met all requirements of applicable law and administrative procedure for collecting the trust fund recovery penalties. It quickly determines that there was no issue there, emphasizing that IRS had no obligation to inform counsel about Hammock’s 1153, especially given Section 6103 and the absence of a perfected POA.

Abuse of Discretion to Not Exercise Discretion?

So this case breaks no new ground yet I feel it worthy of a post for an ancillary issue. The regulations clarify that even if a taxpayer does not have a statutory right to challenge liability in a CDP hearing, Appeals has inherent discretion to consider liability.

The opinion notes that Hammock had requested that Appeals consider the liability as part of its discretionary CDP power.  In counsel’s pretrial memorandum, counsel asked the following:

“[D]id the appeals officer abuse her discretion by failing to consider all the evidence and refusing to hear Hammock’s challenge to the underlying liability” or whether “the IRS properly assess[ed] Hammock given it failed to conduct investigation or make factual findings to support the underlying liability determination.”

The opinion rejects this as the “taxpayer’s attempt to go to the merits of the underlying liability and not the question of whether all administrative steps were taken.” Fair enough but why did Appeals fail to consider liability as part of its administrative discretionary power?

The regulations clarify that Appeals could consider liability, even if the taxpayer had a prior opportunity and was unable to overcome the presumption of receipt. § 301.6330-1(e)(3), AE-11

In relevant part that reg states that

“[i]n the Appeals officer’s sole discretion, however, the Appeals officer may consider the existence or amount of the underlying  tax liability, or such other precluded issues, at the same time as the CDP hearing. Any determination, however, made by the Appeals officer with respect to such a precluded issue shall not be treated as part of the Notice of Determination issued by the Appeals officer and will not be subject to any judicial review.

When a taxpayer, like Hammond, requests that Appeals consider liability as part of a CDP request shouldn’t Appeals explain why it chose not to do so? Would any reason Appeals gives ever amount to an abuse of its discretion? Can the regulatory directive that “any determination” about this discretionary power not be subject to judicial review overcome the presumption in administrative law that agency actions are subject to judicial review?

Now there may be perfectly valid reasons why Appeals failed to exercise its discretion to consider liability in this case. And it may be that it is generally inappropriate for the Tax Court to order Appeals to consider the liability. But it seems to me that Appeals should explain its reasons for declining to exercise its discretion, and the Tax Court should play a role in ensuring that Appeals exercise its discretion in a way that fairly considers a good faith request to challenge a liability. To be sure, Hammock could have her day in district court, but the opportunity to raise and possibly resolve liability questions administratively is of some moment, and the Tax Court can play a more proactive role in that process.